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Lending follows the markets.

As the economy improves banks and other lenders figure it out and jump in.

Also, today’s news on personal income is very bullish as well.

It shows fiscal policy ‘works’ as it did for q2 last year.

The concern is that the ’savings rate’ is high which takes away from spending.

Not necessarily.

The ’savings’ comes from federal deficit spending.

Net federal spending adds financial assets to someone’s account in the non government sector that can’t ‘go away.’

The federal spending can be spent many times over and savings will still go up by the same amount.

So to me it looks like the deficit spending is currently high enough to have sufficiently restored savings to levels that promote at least modest increases in consumption.

But not yet enough to bring unemployment down as the output gap continues to grow.

JPMorgan, Citigroup Expand in ‘Jumbo’ Home Mortgages

by Jody Shenn

June 26 (Bloomberg) —JPMorgan Chase & Co. and Citigroup Inc. are expanding in “jumbo” mortgages used to buy the most expensive homes, helping revive a market that shriveled amid a three-year jump in homeowner defaults.

JPMorgan resumed buying new jumbo loans made by other lenders this month, after halting purchases in March, spokesman Tom Kelly said. Borrowers must have checking accounts with the bank, he said. Citigroup is again offering the loans through independent mortgage brokers, spokesman Mark Rodgers said.

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Please send this on to Eugenio Aleman at Wells Fargo

Thinking The Unthinkable: The Treasury Black Swan, And The LIBOR-UST Inversion

Posted by Tyler Durden

>   The below piece is a good analysis of a hypothetical Treasury/Dollar black swan
>   event, courtesy of Eugenio Aleman from, surprisngly, Wells Fargo. Eugenio does
>   the classic Taleb thought experiment: what happens if the unthinkable become
>    not just thinkable, but reality. Agree or disagree, now that we have gotten to
>   a point where 6 sigma events are a daily ocurrence, it might be prudent to
>   consider all the alternatives.

In previous reports, I have touched upon the concerns I have regarding the overstretching of the federal government as well as of monetary policy while the Federal Reserve tries to maintain its independence and its ability, or willingness, to dry the U.S. economy of the current excess liquidity.

Excess reserves are functionally one day Treasury securities.
It’s a non issue.

Furthermore, we heard this week the Fed Chairman’s congressional testimony on the perils of excessive fiscal deficits and the effects these deficits are having on interest rates at a time when the Federal Reserve is intervening in the economy to try to keep interest rates low.

His thinking is still on the gold standard in too many ways.

Now, what I call “thinking the unthinkable” is what if, because of all these issues, individuals across the world start dumping U.S. dollar notes, i.e., U.S. dollar bills?

The dollar would go down for a while.
Prices of imports would go up.
Exports would go up for a while

All assuming the other nations would let their currencies appreciate and let their exporters lose their hard won US market shares, which is certainly possible, though far from a sure thing.

Why? Because one of the advantages the U.S. Federal Reserve has over almost all of the rest of the world’s central banks is that there seems to be an almost infinite demand for U.S. dollars in the world, which has made the Federal Reserve’s job a lot easier than that of other central banks, even those from developed countries.

In what way? They set rates, that’s all. It’s no harder or easier for the Fed than any other central bank.

if there is a massive run against the U.S. dollar across the world then the Federal Reserve will have to sell U.S. Treasuries to exchange for those U.S. dollars being returned to the country, which means that the U.S. Federal debt and interest payments on that debt will increase further.

Not true. First, they have a zero rate policy anyway so they can just sit as excess reserves should anyone deposit them in a bank account, and earn 0. Or they can hold the cash and earn 0.

This means that we will go from paying nothing on our “currency” loans to having to pay interest on those U.S. Treasuries that will be used to sterilize the massive influx of U.S. dollar bills into the U.S. economy, putting further pressure on interest rates.

No treasuries have to sold to sterilize anything.
A little knowledge about monetary operations would go a long way towards not letting this nonsense be published in respectable forums.

If we add the nervousness from Chinese officials regarding U.S. debt issues, then we understand the reason why we had Treasury secretary Timothy Geithner in China last week “calming” Chinese officials concerned with the massive U.S. fiscal deficits. I remember similar trips from the Bush administration’s Treasury officials pleading with Chinese officials for them to continue to buy GSEs (Freddie Mac and Freddie Mae) paper just before the financial markets imploded.

Yes, they have it wrong, and it’s making the administration negotiate from a perceived position of weakness while the Chinese and others take us for fools.

But the situation today is even more delicate because of the impressive amounts of U.S. Treasuries s we will have to issue during the next several years in order to pay for all the programs we have put together to minimize the fallout from this crisis.

Issuing Treasuries does not pay for anything. Spending pays for things, and spending is not operationally constrained by revenues.

The Treasuries issued support interest rates. They don’t ‘provide’ funds.

Furthermore, if China and other countries do not keep buying U.S. Treasuries, then interest rates are going to skyrocket.

There’s some hard scientific analysis. They go to the next highest bidder. The funds to pay for the securities come from government spending/Fed lending, so by definition the funds are always there and the term structure of rates is a matter of indifference levels predicated on future fed rate decisions.

This is one of the reasons why Bernanke was so adamant against fiscal deficits in his latest congressional appearance.

And because on a gold standard deficits can be deadly and cause default. He’s still largely in that paradigm that’s long gone.

Of course, the U.S. government knows that the Chinese are in a very difficult position: if they don’t buy U.S. Treasuries, then the Chinese currency is going to appreciate against the U.S. dollar and thus Chinese exports to the U.S., and consequently, Chinese economic growth will falter.

Yes, as I indicated above.

The U.S. and China are like Siamese twins joined at the chest and sharing one heart. This is something that will probably keep Chinese demand for Treasuries elevated during the next several years. However, this is not a guarantee, especially if the Chinese recovery is temporary and they have to keep on spending resources on more fiscal stimulus rather than on buying U.S. Treasuries.

Again, this shows no understanding of monetary operations and reserve accounting. The last two are not operationally or logically connected.

Thus, my perspective for the U.S. dollar is not very good. And now comes the caveat. Having said this, what is the next best thing? Hugo Chavez’s Venezuelan peso? Putin’s Russian rubble? The Iranian rial? The Chinese renminbi? Kirchner’s Argentine peso? Lula da Silva’s Brazilian real? That is, the U.S. dollar is still second to none!

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Power Point I did for a conference discussion.

Financial Architecture Fundamentals

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This article gives Baum a bad name.

‘Legacy of Debt’ Gives Fiscal Stimulus Bad Name: Caroline Baum

Commentary by Caroline Baum

June 5(Bloomberg) — By the time the U.S. government unveiled its Public Private Investment Partnership in March, the toxic loans and securities clogging bank balance sheets had become “legacy assets.”

What if deficit hawks took the same tack and marketed the $787 billion fiscal stimulus as “legacy debt?”

They would be making yet another error. This is no basis for an article unless one is intent on being part of the problem rather than part of the answer.

“The $787 billion the U.S. Treasury will be borrowing or confiscating from you via taxation will saddle future generations with a legacy of debt,” the press release might read. “Your children and grandchildren can look forward to higher taxes, a lower standard of living and minimal government support in their old age.”

Wonderful, another deficit terrorist spewing counterproductive rhetoric and irresponsible journalism.

First, there is no intergenerational transfer of debt in real terms. Whatever goods and services our children produce will be consumed by whoever happens to be alive at that time. And a nominal government deficit does not keep them from operating at less than full employment.

Second, government securities function as benefits for investors, not costs. One buys them voluntarily and, at the macro level, directly or indirectly, as an alternative to holding reserve balances at the Fed. This means they are purchased at prices where they are preferred to holding balances at the Fed. Nothing is ‘taken away’ by sales of treasury securities and total (non government)holdings of financial assets remain unchanged.

Third, taxes function to reduce aggregate demand. Taxes need be raised in the future when aggregate demand is deemed too high, and not the deficit per se. That is a scenario of low unemployment and high consumption relative to available resources. Not ‘a lower standard of living’ or ‘minimal government support in their old age.’

Maybe the public would balk. And maybe some member of Congress would be bold enough to sponsor a measure to call off the still-uncommitted expenditures.

And thereby contribute to even lower output and employment.

After all, the economy appears to be recovering without fiscal stimulus.

??? The relative improvement has come only after the (non TARP) deficit got over 6% of GDP
And it has barely slowed the collapse.

The 9.4% unemployment is clear evidence aggregate demand is grossly deficient.

The rate of decline in real gross domestic product has slowed from an average 6 percent in the fourth quarter of last year and first quarter of 2009. Real GDP is expected to fall 1.9 percent in the current quarter, according to the median forecast of 61 economists in a Bloomberg News survey from early May. Less negative is the first step toward positive.

Yes, due to the ‘automatic stabilizers’ increasing the deficit, as above.

And only when GDP grows faster than productivity does the output gap fall.

And that’s before any real money gets spent. So far $36.7 billion has been distributed via various government agencies, according to Recovery.gov, the Web site that tracks where your tax dollars are going. That’s 7.4 percent of the $499 billion of outlays ($288 billion of the $787 billion is “tax relief”) and 29 percent of the funds that have been committed to a purpose or a project.

Patient, Heal Thyself

Tax relief comes in the form of larger monthly paychecks for workers and tax credits — for investment in renewable sources of energy, for first-time home buyers — that are encouraging activity now even though the benefit is in the future.

Still, it’s a trickle, not a waterfall.

So if fiscal stimulus can’t take credit for the improvement in the economy, what can? The answer is a combination of monetary policy and self-healing (an economy’s natural tendency is to grow).

Wrong. It’s been all fiscal to this point. Yes, its healed itself, via the very ugly automatic fiscal stabilizers of falling revenue and rising transfer payments with rising unemployment. This could have been avoided with proactive fiscal measures last July.
The Federal Reserve has thrown the kitchen sink at the economy, using traditional and non-traditional means to provide liquidity and credit when the banking system wasn’t up to the task.

Lower rates have drained aggregate demand as savers lost a lot more income than borrowers gained. The Fed’s portfolio alone has removed over $50 billion of annual interest income from savers and investors.

Fed’s CPR

Even before the Fed lowered the overnight interbank lending rate to 0 to 0.25 percent in December,

Savers have seen rates fall by about 5%, reducing aggregate demand, while most borrowers have seen little, if any, drop in rates as bank net interest margins widened to over 4%. And this additional bank income has a marginal propensity to consume of near 0.

the central bank was already ministering to markets and institutions outside its normal discount window customers, otherwise known as depository institutions. It was supporting the commercial paper market; had committed to purchase mortgage-backed securities and agency debt; had agreed to finance investor purchases of asset-backed securities; and had leant support to specific institutions, taking on some of Bear Stearns’s toxic, I mean, legacy, assets in March 2008 and bailing out American International Group in September.

Yes, and all of this has served to lower the term structure of rates and reduce saver’s incomes.

That’s the beauty of monetary policy. It can be implemented instantaneously. The Fed’s challenge is to be as quick on the return trip.

And, as per Bernanke’s 2004 paper, said rate cuts reduce aggregate demand via the ‘fiscal channel’ which means it reduces interest paid by government which needs to be offset by easier fiscal policy to not be a drag on output and employment.

The problem with fiscal stimulus, aside from the fact that it’s a misnomer, is that it arrives too late.

And further delayed by articles like.

Also, a payroll tax cut is instant, as would be per capita revenue sharing checks to the states.

At least that was the standard criticism prior to the enactment of the $787 billion American Reinvestment and Recovery Act of 2009 in February. The government’s tax and spending policies require the approval of a majority of the 100 senators and 435 members of the House of Representatives. And as we know, these 535 individuals sometimes confuse the people’s business with their own: getting re-elected.

True, which includes dealing with public opinion that is further jaded by unintentionally subversive articles like this one.

Preferred Stimuli

This time around, a new president with solid majorities in both Houses of Congress was able to saddle future generations with trillions of dollars of debt less than a month after he took office. The Congressional Budget Office projects the debt- to-GDP ratio rising to 70 percent in 2011, the highest since the early 1950s, when the U.S. was winding down the war effort.

You are including purchases of financial assets which is highly misleading and shows a further lack of understanding of public accounting.

If you believe, as I do, that monetary policy is the more potent of the stimuli, that fiscal “stimulus” just transfers spending from tomorrow to today and from the private sector to the government, with no net long-term gain, then maybe it’s time to stand up for the next generation.

And stand against the accounting identities.

Government deficits add directly non government savings of financial assets. To the penny.

Changes in interest rates only shift incomes between savers and investors.

And all the econometric evidence shows ‘monetary policy’ does little or nothing while fiscal policy is directly traced to changes in GDP.

Besides, where is it written that the ill effects of years of over-consumption and under-saving have to be repaired in a year? Instant gratification means future deprivation.

Over consumption? Did we consume more than we produced? No, investment remained positive during the growth years, which were years of high investment as well. That is not over consumption.

Now, with the recession and consumer pull back, is when investment is falling and we can be said to be thereby over consuming.

Word Choice

Fed Chairman Ben Bernanke used part of his June 3 testimony to the House Budget Committee to warn of the consequences of unchecked spending, even in the face of recession and financial instability.
“Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth,” he said.

Yes, sadly, he’s in that camp as well. As is the entire administration if you believe their current rhetoric.

If it takes a marketing gimmick — labeling fiscal stimulus a “legacy of debt” — to convey the message to the public and Congress, so be it.

How about taking the effort to get it right and trying to undo the damage you’ve done…

(Caroline Baum, author of “Just What I Said,” is a Bloomberg News columnist. The opinions expressed are her own.)

Opinions are her own, as selectively published by Bloomberg News.

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Barney Frank’s letter to members of the House Financial Services Committee

To: Members, Financial Services Committee

From: Barney Frank, Chairman

Today the Treasury announced that 10 of the largest financial institutions participating in the Capital Purchase Program (CPP) will be allowed to repay the $68 billion investment made by American taxpayers.

That does not alter ‘taxpayer’ risk. They lose once private capital is gone in either case.

That is good news on three fronts. First, it means the program is working and has begun to help restore stability to our vital financial system.

The ‘improvement’ had nothing to do with TARP. It may have been helped by the FDIC not closing down these institutions when capital was deemed deficient, but the FDIC could have kept those institutions open under those same terms and conditions as imposed by TARP.

Second, it means that the government will have additional resources to address continuing needs without having to ask taxpayers for more money or increasing borrowing.

Functionally the FDIC can impose the same terms and conditions. The difference is that the FDIC is ‘funded’ by a tax on banks, rather than TARP being an obligation of ‘general revenues.’ However, the FDIC is guaranteed by the government and the FDIC tax on banks that is passed through to the general public might be more regressive than the average IRS tax.

Also, regarding ‘borrowing’ the TARP funds advanced to banks add the reserves that are used to buy the additional government securities.

And, third, it means that that the taxpayer protections and compensation restrictions that Congress insisted be included in the original legislation are having the intended effect - taxpayers are participating in the upside as these institutions recover and raise additional private capital in order to exit the government program.

Again, functionally the FDIC could have imposed the identical terms and conditions.

In sum, today’s announcement means that over one third – approximately $70 billion - of the $199 invested through the CPP has been, or will soon, be repaid. In addition CPP recipients have already paid an additional $4.5 in preferred stock dividends during the past seven months. That means that almost $75 billion has already been earned or repaid. Further those who repay have the right to repurchase the warrants held by Treasury at current market value – further increasing the return to taxpayers.

Yes, it has functioned as a tax on banks and the private sector in general, thereby reducing aggregate demand during a punishing recession that has resulted from government’s failure to sustain aggregate demand.

Congratulations- job well done!!!

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What seems to be happening is bank ‘funding needs’ are become funding needs of Germany itself.

While this adds to Germany’s funding pressures, this process can go on indefinitely unless/until germany cannot somehow fund itself.

Not long ago the finance ministers announced they had a contingency plan for that possibility but wouldn’t say what that plan was leaving open the possibility they were bluffing. The CDS markets could be the best leading indicators of real trouble. With the US ‘recovery’ hitting a ’soft patch’ of very low and very flat gdp and unemployment rising with productivity gains, an export dependent Eurozone looks like it will continue to struggle.

It just dawned on me that the Bush recovery got help from the fraudulent sub prime lending while it lasted, as the Clinton expansion got an assist from the pie in the sky valuations of the dot com boom, as the Reagan boom was assisted by the fraudulent S and L lending while that lasted. Without that kind of supplemental dose of aggregate demand, the automatic stabilizers alone while braking the decline probably do not produce all that robust of a recovery.

And if we follow the lead of Japan and tighten fiscal with every green shoot we wind up with the same results.

DJ WestLB Was Close To Being Shut Down Over Weekend

June 8 (Dow Jones) — German state-controlled bank WestLB AG was
close to being shut down over the weekend, people familiar with the
situation told Dow Jones Newswires Monday.
Bundesbank President Axel Weber and President of Germany’s BaFin
financial regulator Jochen Sanio threatened to close down the state bank
at crisis talks held over the weekend, the people familiar with the
talks said. It was only after this threat that savings banks agreed to
raise the guarantee framework for the debt-laden bank, the people said.

Late Sunday, WestLB owners said they raised their guarantee
framework for the bank by another EUR4 billion. The people familiar with
the situation said the savings bank agreed to extend the guarantee
umbrella after it was ensured that a solution wouldn’t hamper the spin
off of toxic assets into a so-called “bad”
German bank.

Regional banking associations WLSGV and RSGV together hold more than
50% of the shares, while the state of North Rhine-Westphalia has a 17.5%
stake and NRW.BANK holds 31.1%. NRW.BANK’s owners are the state of North
Rhine-Westphalia with 64.7% and WLSGV and RSGV with 17.6% each.

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As suspected at the time, some (not all) of the failed banks were undervalued by the FDIC to facilitate a quick transfer to other institutions to the detriment of the former shareholders.

Worse, the FDIC said some of the banks failed due to liquidity and not capital impairment.
This means they failed because FDIC deposit insurance and Fed lending failed to do their job of supporting the liability side of banking as per the business model of this long standing ‘public/private partnership’ called banking.

JPMorgan $29 Billion WaMu Windfall Turned Bad Loans Into Income

by Ari Levy and Elizabeth Hester

May 26 (Bloomberg) — JPMorgan Chase & Co. stands to reap a $29 billion windfall thanks to an accounting rule that lets the second-biggest U.S. bank transform bad loans it purchased from Washington Mutual Inc. into income.

Wells Fargo & Co., Bank of America Corp. and PNC Financial Services Group Inc. are also poised to benefit from taking over home lenders Wachovia Corp., Countrywide Financial Corp. and National City Corp., regulatory filings show. The deals provide a combined $56 billion in so-called accretable yield, the difference between the value of the loans on the banks’ balance sheets and the cash flow they’re expected to produce.

Faced with the highest U.S. unemployment in 25 years and a surging foreclosure rate, the lenders are seizing on a four- year-old rule aimed at standardizing how they book acquired loans that have deteriorated in credit quality. By applying the measure to mortgages and commercial loans that lost value during the worst financial crisis since the Great Depression, the banks will wring revenue from the wreckage, said Robert Willens, a former Lehman Brothers Holdings Inc. executive who runs a tax and accounting consulting firm in New York.

“It will benefit these guys dramatically,” Willens said. “There’s a great chance they’ll be able to record very substantial gains going forward.”

When JPMorgan bought WaMu out of receivership last September for $1.9 billion, the New York-based bank used purchase accounting, which allows it to record impaired loans at fair value, marking down $118.2 billion of assets by 25 percent. Now, as borrowers pay their debts, the bank says it may gain $29.1 billion over the life of the loans in pretax income before taxes and expenses.

Purchase Accounting

The purchase-accounting rule, known as Statement of Position 03-3, provides banks with an incentive to mark down loans they acquire as aggressively as possible, said Gerard Cassidy, an analyst at RBC Capital Markets in Portland, Maine.

“One of the beauties of purchase accounting is after you mark down your assets, you accrete them back in,” Cassidy said. “Those transactions should be favorable over the long run.”

JPMorgan bought WaMu’s deposits and loans after regulators seized the Seattle-based thrift in the biggest bank failure in U.S. history. JPMorgan took a $29.4 billion writedown on WaMu’s holdings, mostly for option adjustable-rate mortgages and home- equity loans.

“We marked the portfolio based on a number of factors, including housing-price judgment at the time,” said JPMorgan spokesman Thomas Kelly. “The accretion is driven by prevailing interest rates.”

Wachovia ARMS

JPMorgan said first-quarter gains from the WaMu loans resulted in $1.26 billion in interest income and left the bank with an accretable-yield balance that could result in additional income of $29.1 billion.

Wells Fargo arranged the $12.7 billion purchase of Wachovia in October, as the Charlotte, North Carolina-based bank was sinking from $122 billion in option ARMs. As of March 31, San Francisco-based Wells Fargo had marked down $93 billion of impaired Wachovia loans by 37 percent. The expected cash flow was $70.3 billion.

The Wachovia loans added $561 million to the bank’s first- quarter interest income, leaving Wells Fargo with a remaining accretable yield of almost $10 billion.

Government efforts to reduce mortgage rates and stabilize the housing market may make it easier for borrowers to repay loans and for banks to realize the accretable yield on their books. With mortgage rates below 5 percent, originations surged 71 percent in the first quarter from the fourth, a pace that may accelerate during 2009, said Guy Cecala, publisher of Inside Mortgage Finance in Bethesda, Maryland.

Recapturing Writedowns

Wells Fargo, the biggest U.S. mortgage originator, doubled home loans in the first quarter from the previous three months, in part through refinancing Wachovia loans.

“To the extent that the customers’ experience is better or we can modify the loans, and the loans become more current, that could help recapture some of the writedown,” Wells Fargo Chief Financial Officer Howard Atkins said in an April 22 interview.

Banks still face the risk that defaults may exceed expectations and lead to further writedowns on their purchased loans. Foreclosure filings in the U.S. rose to a record for the second straight month in April, climbing 32 percent from a year earlier to more than 342,000, data compiled by Irvine, California-based RealtyTrac Inc. show.

Accretable Yield

The companies bought by Wells Fargo, JPMorgan, PNC and Bank of America were among the biggest lenders in states with the highest foreclosure rates, including California, Florida and Ohio. Housing prices tumbled the most on record in the first quarter, leaving an increasing number of borrowers owing more in mortgage payments than their homes are worth, according to Zillow.com, an online property data company.

“We’ve still got a lot of downside to work through this year and probably through at least part of next,” said William Schwartz, a credit analyst at DBRS Inc. in New York. “If I were them, I wouldn’t be claiming any victory yet.”

The difference in accretable yield from bank to bank is due to the amount of impaired loans, the credit quality of the acquired assets and the state of the economy when the deals were completed. Rising and falling interest rates also affect accretable yield for portfolios with adjustable-rate loans.

PNC closed its $3.9 billion acquisition of National City on Dec. 31, after the Cleveland-based bank racked up more than $4 billion in losses tied to subprime loans. PNC, based in Pittsburgh, marked down $19.3 billion of impaired loans by 38 percent, or $7.4 billion, and said it expected to recoup half of the writedown. After gaining $213 million in interest income in the first quarter and making some adjustments, the company has an accretable-yield balance of $2.9 billion.

‘Being Prudent’

“We’re just being prudent,” PNC Chief Financial Officer Richard Johnson said in a May 19 interview.

Johnson said he expects the entire accretable yield to result in earnings. The company has taken into “consideration everything that can go wrong with the economy,” he said.

Bank of America, the biggest U.S. bank by assets, has potential purchase-accounting income of $14.1 billion, including $627 million of gains from Merrill Lynch & Co. and the rest from Countrywide. Bank of America bought subprime lender Countrywide in July, two months before the financial crisis forced Lehman Brothers into bankruptcy and WaMu into receivership.

As market losses deepened, Bank of America had to reduce the returns it expected the impaired loans to produce from an original estimate of $19.6 billion.

Countrywide Marks

“The Countrywide marks in hindsight weren’t nearly as aggressive,” said Jason Goldberg, an analyst at Barclays Capital in New York, who has “equal weight” investment ratings on Bank of America and PNC and “overweight” recommendations for Wells Fargo and JPMorgan.

Bank of America spokesman Jerry Dubrowski declined to comment.

The discounted assets purchased by JPMorgan and Wells Fargo make the stocks more attractive because they will spur an acceleration in profit growth, said Chris Armbruster, an analyst at Al Frank Asset Management Inc. in Laguna Beach, California.

“There’s definitely going to be some marks that were taken that were too extreme,” said Armbruster, whose firm oversees about $375 million. “It gives them a huge cushion or buffer to smooth out earnings.”

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Yes, he’s got that part very right!!!

>   On Mon, May 25, 2009 at 11:06 PM, Roger wrote:
>   
>   Federal Reserve Vice Chairman Donald Kohn:
>   
>   Interactions between Monetary and Fiscal Policy in the Current Situation
>   
>   [I]n the current weak economic environment, a fiscal expansion may be much more
>   effective in providing a sustained boost to economic activity.
>   Doesn’t say anything about when. Looks like it’s already too late to forestall a pileup.
>   

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Completely agreed about the possibility of a bank blow up.

And it’s also possible the government plan blows up the government.

The eurozone is the region vulnerable to ratings downgrades- both banks and national governments.

Not the UK and US governments where spending is not revenue constrained.

The ECB can ’save’ the eurozone but only by extending credit beyond that ‘permitted’ by the treaty which in some ways they have already done.

This warning comes from a financial regulator:

German debts set to blow ‘like a grenade’

by Ambrose Evans-Pritchard

May 25 (Telegraph) — German debts set to blow ‘like a grenade’
Germany’s financial regulator BaFin has warned that the toxic debts of the country’s banks will blow up “like a grenade” unless they take advantage of the government’s bad bank plans to prepare for the next phase of the crisis.

German Chancellor Angela Merkel’s bad bank plan has been heavily criticised Photo: EPA
Jochen Sanio, BaFin’s president, said the danger is a series of “brutal” downgrades of mortgage securities by the rating agencies, which would eat into the depleted capital reserves of the banks and cause broader stress across the credit system. “We must make the banks immune against the changes in ratings,” he said.

The markets will “kill” banks that try to go it alone without state protection, warning that banks have €200bn (£176bn) of bad debts on their books. “We are pretty sure that within a month or two our banks will feel the full force of the sharpest recession ever on their credit portfolios,” he said, speaking after the release of BaFin’s annual report last week.

The International Monetary Fund (IMF) has called for a stress test for Europe’s banks along the lines to the US Treasury’s health screen, saying the region “urgently needs to weatherproof its institutions”.

The IMF said European institutions have written down less than 20pc of projected losses of $900bn (£566bn) by 2010. Euro area banks will have to raise a further $375bn in fresh capital, compared with $275bn for US banks. The Tier one capital ratio is 7.3pc in Europe, and 10.4pc in the US.

The German bad bank plan has been heavily criticised as an attempt to brush the problems under the carpet until after the elections in September. It allows banks to spread losses over 20 years in an off-balance sheet vehicle – much like the “SIVs” that masked their extreme leverage in the first place – and risks repeating the Japanese error of letting “zombie” banks limp on rather than purging the system.

The recession has hit Europe much harder than expected. German GDP has contracted by 6.9pc over the last year, and the eurozone as a whole has shrunk 4.6pc, although there are signs that the economy may be through the worst.

Germany’s IFO business confidence index rose to 84.2 in May, the highest since December, and German exports have started to rise again after a catastrophic fall of 16pc. But Carsten Brzeski from ING said it is too early to celebrate.

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Looks to me like this is going to be a strong headwind for a while, that is offsetting some of the fiscal expansion. It should be a ‘good thing’ as it means tax cuts and/or increased government spending is in order, but that’s not in the cards.

The non government sectors are large net savers to the tune of the cumulative government budget deficit spending.

Savers are continuously getting recouponed lower as fixed rate CD’s, tsy secs, etc. mature. This reduces aggregate demand.

Borrowers are helped some but not as much as borrowing rates remaining high due to the price of risk.

Net interest margins for banks and other lenders remain high and are drains on aggregate demand as banks are not spending their operating profits on goods and services, but instead adding to reserves.

Personal Income Graph

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(email exchange)

The ’short cut’ would be to allow banks to mark to model aggressively and then write off the losses over 20 years so the losses don’t alter capital ratios.

And while it does drive down their ‘economic net worth’ and reveals ‘actual shareholder equity’ immediately, as long as they can fund themselves with insured deposits and central bank funding operations, they are not affected.

They may even be allowed to pay dividends based on reported (though arguably overstated) earnings.

And they can still raise new capital if the new investors can get in at levels that give sufficient returns on investment.

Also, as is the case in the various US plans, the price the assets are sold at is critical.

The government does not want to overpay and subsidize bank shareholders, and there is no advantage for a bank to sell too low.

This plan also adds to the ‘financial stress’ of the German national government and weakens its creditworthiness as their economy continues to deteriorate and deficit funding needs grow.

While more support from the ECB has been discussed, it is not a certainty.

>   
>   On Wed, May 13, 2009 at 7:07 AM, wrote:
>   
>   Original Message 5/13 7:02:27
>   The German government today approved a “bad bank” plan to take
>   toxic assets off the balance sheet of banks. The plan will likely be
>   passed by parliament within six weeks.
>   
>   The key idea of the plan is to give banks up to 20 years to cover their
>   losses from toxic structured assets without putting much taxpayer >   money at risk.
>   
>   
>   Judging by the initial draft, the key elements of the plan are:
>   
>   Banks can deposit toxic structured assets at 90% of the book
>   value in an in-house special purpose vehicle (”bad bank”).
>   
>   In return, the banks receive bonds that are guaranteed by the
>   government’s bank support agency (SoFFin) against a fee. The
>   banks thus swap bad assets against good assets.
>   
>   Independent auditors will determine the “true” value of the toxic
>   structured assets.
>   
>   The banks than have up to 20 years to build up reserves in equal
>   annual instalments to cover the difference between the face value
>   (minus the 10% haircut) and the “true” value. In the end, the banks
>   will also have to make up for any difference between the “supposed
>   ”true” value of the toxic assets and the amount that their “bad
>   banks” realise upon winding down the bad assets.
>   
>   
>   The problems of the Landesbanken, which go well beyond toxic structured
>   assets, will be dealt with by a separate procedure to be unveiled within a
>   few weeks.
>   
>   We haven’t seen all details of the law yet, and it may well be changed
>   in parliament.
>   
>   For banks, participation in the scheme is voluntary. The basic idea, namely
>   to ease bank balance sheets constraints up-front and to give them up to 20
>   years time to build up reserves against losses from toxic structured assets,
>   looks sound. As usual, the devil could be in the detail. So far, German banks
>   have accepted government support only late and reluctantly because they
>   consider the conditions attached as too harsh. If few banks participate, the
>   ”bad bank” plan may not much impact on lending behaviour of banks.

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(email exchange)

>   
>   On Tue, May 12, 2009 at 10:35 AM, wrote:
>   
>   We are talking trillions of dollars from our pocket…
>   

The Fed is lending to its member banks. That is the same as the banks taking in deposits insured by the FDIC. Banks specific loans are only seen by regulators as a matter of public purpose.

Do you want every loan by every bank revealed? If so, lobby congress, as the majority in congress doesn’t want that.

Your beef is with congress, not the Fed.

Also, loans to member banks are not ‘dollars from our pocket’ unless they aren’t repayable, and the regulators monitor banks for capital compliance and they’ve done an ok job so far in that regard. Relatively few FDIC losses given the magnitude of the slowdown.

>   
>   Where is accountability for keeping the dead alive?
>   

Funding banks is not keeping the dead alive. All banks are always publicly funded via FDIC insured deposits. So happens the Fed is offering funds cheaper and for longer term than the FDIC, so it’s getting the business.

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Looks to me at current prices every public company is a takeover target, including Berkshire itself.

Buffett Resumes US takeover Hunt as Prices, Competition Ease

by Betty Liu and Erik Holm

Mar 12 (Bloomberg) — BillionaireWarren Buffett, who took a four-country tour of Europe less than a year ago in search of takeover targets, now says buying opportunities are presenting themselves in the U.S.

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Citigroup Will Have to Sell More Assets: Whitney

Mar 10 (CNBC) — Whitney also said that the government is trying to sweeten deals for the private sector in order to get more cash infusions into U.S. banks. “The government cannot do it alone,” said Whitney. “They need the private sector to come back.”

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(email exchange)

>   
>   On Mon, Mar 9, 2009, Mauer wrote:
>   
>   And then there’s this, which nobody focused on last week, fixating instead on the employment
>   numbers.
>   

Yes, another indicator moving sideways rather than down.

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Maybe the ECB is quietly asking their banks to reduce their USD borrowings, causing them to bid up USD LIBOR?

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Let your Washington contacts know I’m available to help them formulate their questions!

SENATE COMMITTEE ON THE BUDGET HOLDS A HEARING ON ECONOMIC AND BUDGET CHALLENGES

MARCH 3, 2009

WITNESSES:
FEDERAL RESERVE SYSTEM BOARD OF GOVERNORS
CHAIRMAN BEN BERNANKE

GREGG: Thank you, Senator Wyden.

And thank you, Mr. Chairman, for attending this hearing today.

I think Senator Wyden, as acting chairman, has touched a core of one of the primary issues I’m interested in, which is the question of confidence. Whether or not the economy recovers depends in large part on the confidence of the American people in the value of their homes and in the fact that they’ll keep the job, confidence of those people
who buy our instruments that are debt is solid and sound, confidence that our currency is strong.

Wrong. It depends on having sufficient income to buy their own outputs and to net save as desired.

In the short run, one can accept the fact that debt is going to go up significantly because of the need to address this economy with the liquidity that only the government can put into it.

But in the long run, one has to ask how can this country sustain a debt to GDP ratio of 67 percent, deficits of over 3 percent, or as far as the eye can see, and expect to maintain the value of the dollar or the ability of people to come and buy our debt?

Like Japan? The yen seems strong enough to me with ratios twice that high.

There is a tsunami of debt headed at us — $66 trillion in unfunded liability. It will essentially overwhelm the capacity of our children to pay it and the ability of this nation to sustain it.

The usual mainstream nonsense.

BERNANKE: By December the Federal Open Market Committee had brought its target for the federal funds rate to an historically low range of zero to .25 percent, where it remains today.

(Which has removed maybe $200 billion annually in net interest income for the non government sectors)

Unfortunately,

Here we go. Deficits per se are bad.

the spending for financial stabilization, the increases in spending and reductions in taxes associated with the fiscal package, and the losses in revenues and increases in income- support payments associated with the weak economy will widen the federal budget deficit substantially this year. Taking into account these factors, the administration recently submitted a proposed budget that projects the federal deficit to increase to about $1.8 trillion this fiscal year and to remain around $1 trillion in 2010 and 2011.

As a consequence of this elevated level of borrowing, the ratio of federal debt held by the public to nominal GDP is likely to move up from about 40 percent before the onset of the financial crisis to more than 60 percent over the next several years, its highest level since the early 1950s, in the years following the massive debt buildup
during World War II.

Of course, all else equal, this is a development that all of us would have preferred to avoid.

He’s obviously in a fixed FX paradigm

We are better off moving aggressively today to solve our economic problems. The alternative could be a prolonged episode of economic stagnation that would not only contribute to further deterioration in the fiscal situation,

As if that’s the larger issue

but would also imply lower output, employment and incomes for an extended period.

Of secondary importance to the deficit issue.

With such large near-term deficits, it may seem too early to be contemplating the necessary return to fiscal sustainability. To the contrary, maintaining the confidence of the financial markets requires that we begin planning now for the restoration of fiscal balance.

Not true.

As the economy recovers and resources become more fully employed, we will need to withdraw the temporary components of the fiscal stimulus. Spending on financial stabilization also must wind down. If all goes well, the disposition of assets acquired by the Treasury in the process of stabilization will be a source of added revenue for the Treasury in the out years.

How about instead:

Whatever it takes to sustain output and employment is the right fiscal and policy.

Determining the pace of fiscal normalization will entail some difficult judgments. In particular, the Congress will need to weigh the costs of running large budget deficits for a time

What costs?

against the possibility of a premature removal of fiscal stimulus that could blunt the recovery.

That’s a real cost.

We at the Federal Reserve will face similar difficult judgment calls regarding monetary policy.

In particular, policy-makers must remain prepared to take the actions necessary in the near term to restore stability to the financial system and to put the economy on a sustainable path to recovery. But the near-term imperative of achieving economic recovery and the longer-run desire to achieve programmatic objectives should not be allowed to hinder timely consideration of the steps needed to address fiscal imbalances.

Why are they imbalances???

There are no gold reserves that can be depleted due to a convertible currency.

Without fiscal sustainability,

Fortunately, that isn’t an operational issue.

in the longer term we will have neither financial stability nor healthy economic growth.

Thank you for your attention. I’m happy to take your questions.

Senator Gregg?

GREGG: Thank you, Mr. Chairman.

And after that is all said and done, four years from now, when one certainly hopes, presumes and expects that we will be beyond these dire economic situations, we will be looking at a government which is taking up 22 percent of the gross national product,

(Probably the lowest in the world)

has a 67 percent ratio of publicly held debt to the GDP, and no end in sight and, in fact, it continues to work its way up, with deficits running at three to four percent, minimum, from 2013 to 2019, which is the end of the
window for this budget.

Reads like conditions for stability to me.

BERNANKE:GREGG: But your place is to protect the value of the dollar and protect the ability …

GREGG: … to sell the debt…

BERNANKE: … go on to say my concern here, as I expressed, was that there needs to be fiscal sustainability. If government spending is higher, it needs to be recognized that that will involve higher taxes in order to maintain a close reasonable balance between revenue and outlays.

So his target is a ‘close reasonable balance’.

That does have some implications for efficiency of the economy.

Does have some implications for efficiency? Is that all? Not that there is such a thing in the first place.

BERNANKE: Well, Senator, the CBO, for example, has done simulations which show that in 2030, under current laws, Medicare, Medicaid and Social Security would take up about, alone, would take up about 16 percent of GDP, which is pretty close to non-interest spending. It’s pretty close to the entire federal non-interest budget.

So it’s clear that in order to get control over the overall budget situation, we’re going to need to look at entitlements.

We don’t have the real resources to give the elderly a modest minimum standard of living and we don’t have the real resources to look after our health???

The current excess capacity alone is more than enough to do both.

If we don’t get a sustainable fiscal situation and deficits continue in large amounts for a long period, then it will become more difficult to sell our debt and interest rates will rise and it will be counterproductive.

Like Japan?

BERNANKE:Yes. So there’s been a lot of talk about banks and their ability to lend. In fact, for many types of credit, nonbank securitization markets are the main source of funding and those markets have largely closed down.

And so by restoring and re-stimulating activity in securitization markets, we hope to get credit flowing for a number of different critical areas.

We can’t ‘get credit going’ without securitization?

Of course we can!

The Fed could easily enable the banks, their legally designated agents, to do this with similar funding and guarantees.

Senator Cardin?

GRAHAM: Thank you, Mr. Chairman.

I’m trying to ask Senator Gregg’s question a little bit differently. Is there any outer limit on the federal government’s ability to borrow money?

BERNANKE: Certainly, there are outer limits.

Really??

GRAHAM: What are they and how close are we to them?

BERNANKE:Well, it’s — it’s hard — it’s hard to — to judge in any kind of explicit way, since we don’t — don’t know. I mean there are countries have clearly — for short periods of time has clearly had very high levels of debt.

Like Japan? For almost 20 years?

The United States had more than 100 percent debt to GDP ratio during World War II. The Japanese during their financial crisis raised the debt to GDP ratio above 100 percent.

Above 150% for considerable periods of time.

But clearly, that’s not a healthy situation.

Clearly?

It’s one in which interest payments can become a very important part of the — of the government’s outlays.

The Fed sets those interest rates. And Congress taxes interest income.

Nor operationally is the ability to make payments revenue constrained.

We had been — over years had been bringing our debt to GDP ratio down to about 40 percent. Now we’re going to see a jump to 60 or 65 percent.

We need to be I think looking for a — what’s called a primary deficit — that is, the deficit excluding interest payments, a somewhere close to balance. That would be sufficient to stabilize our debt to GDP ratio. I think that would be a good objective.

Interesting, more gold standard rhetoric.

How about an objective like optimal output and employment?

It’s very hard to know how much higher — how much higher the debt to GDP ratio could be before the international financial markets begin to — to balk. And so I think the prudent thing to do is to try and maintain stability of the debt to GDP ratio.

Like Japan, where 10 year JGB’s are under 1.5%, outstanding securities are over 150% of GDP, deficits range to over 8% of GDP, and they’ve been downgraded below Botswana???

Government rates go to where the CB sets them, end of story.

GRAHAM: Has there always been a buffer zone to — between reality and this magical place? And is there a buffer zone today?

BERNANKE: Well, as — as I think the recent experience is showing, confidence and expectations are critical.

Yes, he truly believes this.

And I think the markets will be quite able to absorb, for example, the large amount of issuance we’re seeing in the next couple of years, if there is a reasonable expectation and confidence in the same markets that the United States is serious about getting its budget position under control in the longer-term.

He truly believes that’s the case.

GRAHAM: There are some projections that exist that in 2050 the debt to GDP will be 300 percent. What kind of effect will that have, if that became a reality?

BERNANKE: Well, I don’t think that’s going to happen. It can’t happen, because things would break down before then.

GRAHAM: Something has to change first.

BERNANKE: Something…

GREGG: Happen, but not to change.

BERNANKE:That’s right.

GREGG: For it not to happen, right? Something has to change.

BERNANKE: Something would change, whether it was either change in policy or change in the willingness of the — of the lenders to finance the debt.

What generally changes is inflation keeps the nominal debt to GDP ratio down, but that’s another story that he knows well. And the reason he doesn’t want to go there is because that story says the risks are inflation and not solvency or the ability to sell securities.

GRAHAM: I’ve only got 15 seconds. My question, basically, is will we ever know in this country whether or not we’re repeating the Japanese mistake? Do you have any test out there to let us in Congress know that we’re throwing good money after bad, when it comes to certain institutions?

BERNANKE: The Japanese mistake was not acting quickly enough or aggressively enough, and I think that’s not our problem.

Yes, on fiscal policy.

SANDERS: Thank you, Mr. Chairman.

ALEXANDER: But — but they are (inaudible) to — to specify — the first risk is that you don’t get your money back. You think you will. The second risk would be that you’d — the more paper — the more money you print, the more likely we have inflation down the road…

(CROSSTALK)

BERNANKE: Senator, that’s aptly correct. So you’re absolutely right that in order for us to begin to raise interest rates and begin to stabilize the economy.

Now that they can pay interest on reserves they don’t have to ’shrink the balance sheet’ to raise rates. Bernanke should know that.

At that time when the economy begins to grow again, we’re going to have to shrink the balance sheet and we are very comfortable — we’re watching that very, very carefully. It’s very important. We spend about half of our time at FOMC meetings, looking at the balance sheet and trying to make that evaluation.

Interesting use of FOMC time!

Worrying about something of no consequence whatsoever.

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NYC defaulted when I first started in the early 70’s.

Charlie Sanford, my department head at Banker’s Trust, was the one who pulled the plug.

He was at a meeting for a revenue anticipation bond and said in his distinctive voice something like, “Revenue, what revenue? We’re out.”

>   
>   On Tue, Mar 3, 2009 at 10:35 AM, Russell wrote:
>   
>   Gambling man?
>   

50% Chance NYC Will Default on Its Debt in 5 Years

by Joe Weisenthal

Mar 3 (Business Insider)

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This is relentless and tends to cushion downturns:

Personal Income and Outlays

Mar 2 (BEA) — Personal current transfer receipts increased $66.6 billion in January, compared with an increase of $29.9 billion in December. The January change in current transfer receipts reflected 5.8-percent cost-of-living adjustments to social security benefits and to several other federal transfer payment programs; together, these changes added $41.1 billion to the January increase.

Government wage and salary disbursements increased $12.9 billion in January, compared with an increase of $1.4 billion in December. Pay raises for civilian and military personnel added $9.7 billion to government payrolls in January.

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Central bank liquidity swaps (13) $374,590- $5,097

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