naked capitalism

Taliban attack Nato base in Afghanistan BBC

Analysis: Why Silicon Valley should fear ACTA ITNews

Cheerio! Rolfe Winkler. Congrats! He is going to the Wall Street Journal.

New Legislative Effort to get Bankruptcy Exemption….For Guns. MIke Konczal

Rob Parenteau gets sectoral balances right Steve Waldman

The High Budgetary Cost of Incarceration John Schmitt, Kris Warner, and Sarika Gupta, CEPR (hat tip reader Gordon). Bottom line: if you need to cut state and local budgets, the vogue for locking people up would be a very useful fad to reverse.

Secretary of Energy Steven Chu Confirms that Some of BP’s Oil Well Casing Has Been Demolished George Washington

NASA to Do More Flights to Measure Change in BP Oil-Spill Size Business Week (hat tip reader Doc Holiday)

Bank Fee Is Eliminated in Financial Bill New York Times

The Procrustean Democracy of AmericaSpeaks: Part One Lambert Strether. This is a disgrace, I had wanted to post on it tonight, will hopefully address it later today.

Time to shut down the US Federal Reserve Ambrose Evans-Pritchard, Telegraph

Crisis is back with a vengeance as ECB’s sterilisation auction flops Eurointelligence

Consumer Confidence Crushed EconomiPic Data

What Is Goldman Sachs Thinking? Simon Johnson

Financial Reform Legislation Does Not Eliminate Too Big To Fail Mark Thoma. We knew that, but glad word is getting out.

This global game of ‘pass the parcel’ cannot end well Martin Wolf, Financial Times. Today’s must read

Antidote du jour:

The New York Times has unearthed a damning tidbit about the bailout of AIG:

When the government began rescuing it from collapse in the fall of 2008 with what has become a $182 billion lifeline, A.I.G. was required to forfeit its right to sue several banks — including Goldman, Société Générale, Deutsche Bank and Merrill Lynch — over any irregularities with most of the mortgage securities it insured in the precrisis years.

Yves here. How one reacts to this depends in no small measure as to how one views the salvage operation. For all intents and purposes, the rescue of AIG was merely a way to save the banks; the credit default swaps had been too big a source of faux capital (for US firms, via risk-dumping, and for Eurobanks, as part of a regulatory arbitrage) to let the insurer go. So any effort by the officialdom to aid the banks, most notably by paying out 100% on credit default swap exposures (which had already been written down by counterparties to less than par) was simply an effort to funnel more cash to the banks. Since we’ve had massive backdoor bailout mechanisms in addition to the overt ones, this orientation should come as no surprise.

But then we get to the funny business. Why a broad waiver? Why shouldn’t AIG (and by extension, taxpayers) not recover in the event of fraud? And we turn again to the ambiguous standing of AIG. By all rights, it ought to be owned by the government. The reason it isn’t is that we don’t do nationalization in America, and full ownership would require AIG’s debts to be consolidated with government debt. So another way to read this requirement is that the Fed and Treasury were opposed to having fraud at the banks exposed, period.

That is a very troubling stance for bank regulators to take. And experts agreed:

“Even if it turns out that it would be a hard suit to win, just the gesture of requiring A.I.G. to scrap its ability to sue is outrageous,” said David Skeel, a law professor at the University of Pennsylvania. “The defense may be that the banking system was in trouble, and we couldn’t afford to destabilize it anymore, but that just strikes me as really going overboard.”

“This really suggests they had myopia and they were looking at it entirely through the perspective of the banks,” Mr. Skeel said.

Yves here. Also note that the banks mentioned by the Times account for a significant proportion of the Maiden Lane III exposures (the $62.9 billion CDO portfolio; note this does not include all CDO guarantees assumed by the Federal Reserve; seven Goldman Abacus trades stayed with AIG and were salvaged via credit extensions to AIG). An analysis by Tom Adams and Andrew Dittmer showed the significance of Merrill, Goldman, and SocGen (percentages based on par amount):

1. Merrill as both packager and counterparty 7.7%
2. Goldman as both packager and counterparty 7.4%
3. Merrill as packager, Goldman as counterparty 9.6%
4. Goldman as packager, SocGen as counterparty 15.9%

We thought these interrelationships were potentially significant; they account for 40.6% of the Maiden Lane III exposures. Then add in:

5. Anyone else with a pulse as packager, SocGen as counterparty 11.0%
6. Anyone else with a pulse as packager, Goldman as counterparty 5.5%

That bring you to 56.5% of the total.

Goldman, either as packager or as swap counterparty, was involved in 38.4% of the Maiden Lane transactions, plus had additional AIG exposure through seven Abacus trades (we only have tranche exposure on three of these transactions):

Abacus 2004-1
Abacus 2004-2
Abacus 2005-2
Abacus 2005-3
Abacus 2005-CB1
Abacus 2006-NS1
Abacus 2007-18

Yves here. The time is long overdue that Lloyd Blankfein’s early and extensive involvement in the AIG rescue be investigated in detail. The legal waiver no doubt was particularly beneficial to Goldman, and given that it is now being sued by the SEC, it is fair to ask if he put the idea of the waiver forward. It is highly unlikely to have occurred to the Fed and Treasury officials unprompted, particularly given the fevered pace at which the AIG rescue was cobbled together.

Moreover, in noting the officialdom’s deference to Wall Street, Blankfein features prominently:

In that regard, the newly released Congressional documents show New York Fed officials deferring to bank executives at a time when the government was pumping hundreds of billions of taxpayer dollars into the financial system to rescue bankers from their own mistakes. While Wall Street deal-making is famously hard-nosed with participants fighting for every penny, during the A.I.G. bailout regulators negotiated with the banks in an almost conciliatory fashion.

On Nov. 6, 2008, for instance, after a New York Fed official spoke with Lloyd C. Blankfein, Goldman’s chief executive, about the Fed’s A.I.G. plans, the official noted in an e-mail message to Mr. Blankfein that he appreciated the Wall Street titan’s patience. “Thanks for understanding,” the regulator said.

Yves here. This obsequiousness is noteworthy because the Times also stresses that the Fed’s own advisors (Morgan Stanley, Black Rock, and Ernst & Young) were advocating a tough stand with the banks, including haircuts on their guarantees with AIG. But Treasury appears to have carried the day:

For its part, the Treasury appeared to be opposed to any options that did not involve making the banks whole on their A.I.G. contracts. At Treasury, a former Goldman executive, Dan H. Jester, was the agency’s point man on the A.I.G. bailout. Mr. Jester had worked at Goldman with Henry M. Paulson Jr., the Treasury secretary during the A.I.G. bailout.

Yves here. And in an astonishing lapse, Jester still owned Goldman stock. By any standard, he should not have been involved at all in the process, much less in a crucial role. But because he was a contractor, and not a government employee, this arrangement was kosher. Not surprisingly, Jester opposed measures that would require Goldman and other banks to take any pain.

The Times reminds readers it pays to be a bankster:

All of this was quite different from the tack the government took in the Chrysler bailout. In that matter, the government told banks they could take losses on their loans or simply own a bankrupt company; the banks took the losses.

Yves here. The Audit the Fed investigation will shed even more light on the AIG rescue, but the seamy dealing of Treasury means that investigations need to extend into its role as well. But it will take a public hue and cry for that to come to pass.

We’ve warned for some time that the eurozone’s sure-to-fail muddle-through approach to its structural challenges was rattling investor confidence. Worse, its insistence on wearing an austerity hairshirt was not only committing Europe to deflation, but had high odds of sucking the global economy down along with it. Given how fragile the recovery is in advanced economies, and the magnitude of the debt overhang in many nations, a downturn could easily morph into a deflationary downspiral, potentially a full blown depression.

Let’s recap of some of the troubling sightings. First is that Spanish banks in particular, along with other Eurobanks, have been on the ECB drip feed for some time. Recall that the Spanish banking authorities pushed for the release of stress information on their banks precisely because they hoped that it would reassure the market and improve access to private funding. However, in a rather remarkable bureaucratic dedication to deadlines over common sense, the ECB is terminating a €442 billion one year liquidity facility on July 1 (FT Alphaville has been covering this intensively). An unknown but believed-to-be-large portion of the facility was used to fund carry trades within the EU, particularly that of Spanish and Greece sovereign debt (until spread widening late last year started burning fingers). To the extent it has been used to finance bank operations, the theory has been that banks would avail themselves of shorter-term ECB facilities, particularly its three month program.

Wellie, so that should not prove bothersome, right? Theory does not seem to have translated very well into practice. Europe opened badly on Tuesday, and the flight to safety continued in the US, with yields on ten-year Treasuries falling below 3%. There is also evidence of liquidity-hoarding, with an ECB sterilization operation going badly.The lousy US consumer confidence figures are the public face of considerable nervousness about the business outlook. For instance, despite the brave talk of recovery, corporate bond issues have fallen as companies increase cash levels rather than expand operations.

The ECB has retreated a tad in the face of the vote of no confidence from the markets, and will offer unlimited three month loans today, in advance of the termination of its one-year facility. More detail from the Financial Times:

Fears that the European Central Bank was scaling back emergency support to eurozone banks too soon sparked sharp falls in financial markets on Tuesday, with the euro tumbling to an eight-and-a-half year low against the Japanese yen….

“We will make sure that there are no problems and everything goes OK,” Christian Noyer, France’s central bank governor, told Europe 1 radio. But he warned that “there are some banks that are in a less good situation that might eventually suffer”.

Elena Salgado, Spanish finance minister, appealed to the central bank to take into account the liquidity needs of the Spanish banking system. She said on Spanish radio: “The ECB says it doesn’t like governments telling it what to do. I simply say I hope that on this occasion, as in others, the ECB will be aware of the needs of the Spanish financial system.”

Yves here. These visible signs of stress between national bank regulators and the ECB is not confidence-inducing, to say the least.

Ambrose Evans Pritchard pointed to other troubling indicators:

Triple tremors from the banking crisis in Spain, crumbling confidence in the US, and a setback in China’s leading economic indicator all combined with a vengeance on Tuesday. “The market in risky assets has capitulated ­today amid fears that the ­global recovery is petering out,” said Gavan Nolan, head of credit at Markit…

China’s Shanghai composite index of equities fell 4pc on Tuesday and is now 55pc below its peak in late 2008. The authorities have been tightening this year to slow inflation and curb property speculation as home prices in Shanghai and Beijing reach 13 times incomes, but it is unclear whether they can engineer a soft-landing in an economy where state-owned banks have built up huge hidden debts…

“Foreign capital flight is under way. This can only make matters worse given the climate of insecurity and the country’s lack of credibility,” said Borja Duran from Wealth Solutions in Madrid.

Spreads on Greek debt have jumped 350 basis points since the EU announced its plan in early May. Portuguese and Spanish yields have both jumped sharply despite direct action by the European Central Bank to force down yields. Private buyers are clearly dumping their holdings onto the ECB as fast they can.

Mr [Hans] Redeker [curency chief at BNP Paribas] said Japanese life insurers and institutional investors are slashing their ­estimated $700bn holdings of European debt. The funds are being recycled into yen, which reached ¥107 against the euro yesterday, the strongest in nine years.

Reader Swedish Lex early on had pointed to the importance of contagion spreading to Italy, and that is under way, per Evans-Pritchard:

The latest twist is a rise in credit default swaps on Italian debt, which jumped 16 basis points to 203 yesterday. An auction of Italian bonds this week went badly, with low bid-to-cover ratios….

Italy has been largely immune to Europe’s bond crisis until now, thanks to high savings…

Italy’s public debt is the third largest in the world after the US and Japan. Everybody knows that if the crisis ever reaches Rome, the game is up for monetary union.

This Sydney Morning Herald story (hat tip reader Gordon) highlights a Bank of England report that not only points out the magnitude of the financing needs of major banks over the next few years, a daunting $5 trillion, but also indicates that US and European bank refinancings are falling short of their rollover calendar. This suggests that we may witness a combination of balance sheet shrinkage and more covert and overt funding support.

From the Sydney Morning Herald:

Banks around the world must refinance more than $US5 trillion ($5.8 trillion) of debt in the coming three years, a massive rollover that poses threats to financial stability and growth.

The need to replace these funds, which are medium and long term, will place pressure on bank profit spreads and in turn may either prompt deleveraging, where banks sell assets that they can no longer economically finance, or simply lead to a bout of credit rationing, where borrowers must pay more to borrow, thus crimping investment and economic growth…

US banks have issued $US230 billion of debt in the first five months of the year, about 60 per cent of the rate they need to achieve over the three year period. Euro zone banks have issued $US133 billion, or about 70 per cent of their needed run rate.

One easy to see consequence is that, all things being equal, the cost for banks to issue debt should rise, as should competition among banks for consumer deposits. It is possible that a global desire to save more helps to blunt this effect, but even so the macroeconomic effect and the effect on asset prices will both be strongly downward.

The Bank of England June 2010 Financial Stability Report gives a more detailed breakdown:

This is what deleveraging looks like…and note that these challenges remain after banks have already made progress in improving their capital buffers. This chart shows the fall in UK banks’ overall leverage (click to enlarge):

So it looks to be semi-official. The “stress test” label, in Europe as in the US, signifies an exercise that is designed to produce attractive report cards, as opposed to provide a valid measure of the sturdiness of a bank’s balance sheet in difficult conditions.

So what is the biggest concern investors and counterparties have about European banks? Sovereign risk exposure. So what do the ECB stress tests apparently exclude? Sovereign risk exposure.

From Bloomberg:

Deutsche Bank AG, Commerzbank AG and Bayerische Landesbank passed a stress test that evaluated how about 25 European lenders would weather an economic downturn, said three people familiar with the results.

The three German lenders’ tier 1 capital ratio, a key measure of financial strength, exceeded a threshold of 6 percent under the economic scenario, said the people, who declined to discuss the performance of banks outside Germany. The tests didn’t include sovereign debt, two people said.

As world watches soccer’s Cup, Nike critic sees red Los Angeles Times

Team’s Work Uses a Virus to Convert Methane to Ethylene New York Times (hat tip reader Crocodile Chuck)

Newsflash : Airline food is inedible Gumbat Stew

A Republican Party that Really, Really Doesn’t Want Any Black or Hispanic People Voting for It Ever Again… Brad DeLong

More on Boycotting BP from the LAT Columbia Journalism Review

South Carolina: Outlier or National Precursor?Patrick Caddell and Kendra Stewart, RealClearPolitics. Is the “No Incumbent Left Standing” movement getting traction?

Guess What: Financial Reform Might Seriously Be DEAD Cluserstock

Ten untruths about central clearing Deus Ex Macchiato

The three biggest lies about the economy MarketWatch (hat tip reader John L)

In Ireland, a Picture of the High Cost of Austerity New York Times

Shock therapy is best cure for banks Financial Times. Note this is an editorial.

Britain ‘might not cope with another bank emergency‘ Independent

Force banks to bolster capital, says BIS, as G20 is criticised for delay on reforms Guardian

Official warns of asset risk for Fed Financial Times. This confirms the Ambrose Evans-Pritchard report that the Fed is divided on further QE if (ahem, when) the economy stalls. But then we have this: RBS tells clients to prepare for ‘monster’ money-printing by the Federal Reserve Ambrose Evans Pritchard, Telegraph (hat tip reader nohongosean)

Volcker Rule May Give Goldman, Citigroup Until 2022 to Comply Bloomberg. This “accommodation” makes clear what a farce the rule is.

Greece’s best option is an orderly default Nouriel Roubini, Financial Times

Slugfest! This unfortunate paper Economics is Hard. Don’t Let Bloggers Tell You Otherwise by Kartik Athreya of the Richmond Fed elicited a firestorm of reactions. I am tempted to weigh in belatedly, but here are some of the better responses thus far:

Don’t Let Fed Economists Tell You Otherwise… Mark Thoma

Bloggers can’t do economics. Discuss. FT Alphaville

Do I Have Anything Interesting to Say? Matt Yglesias

Economists behaving foolishly Ryan Avent

Economics Is Hard? Karl Denninger (hat tip reader Scott)

Fed Economist: Bloggers are Stupid Bruce Krasting

Antidote du jour:

By Richard Smith, a London-based capital markets IT consultant

In my last post, “Tracking the Rabbit through the Anaconda” , I mocked Geithner a bit and promised you all a spot of moaning about what’s missing from the financial reform bill.

Well, the anaconda has now had the time it needed to produce its offering. As an outsider considering the 20 hour orgy of bill consolidation and last-minute horsetrading that rounded off the whole process, I must say I find the US legislative process combines frivolity, pomp and ineptitude in a way that – reminds me of dear old England. Perhaps you are all very proud.

Shadow banking reform is the subject this post, since it is terribly important, much more compact than the rest of the reform, and the outcome is very very depressing. That leaves consumer finance, derivatives, and consumer finance for later. And let us see what FASB deliver in accounting changes, if anything.

This is how it all looked to me four weeks ago:

“The shadow banking stuff now looks appropriately targeted, by and large. They have sort of got it. Doubtless there will be nits to pick, down in the detail…

…To be honest, at this level of description the proposals don’t look quite as horrific as they might have done (after TARP et al, one’s expectations were modest indeed). So should one hold out for more, or quite a lot more? Is perhaps this – all holes and no cheese – still the right take on what will emerge?”

With respect to shadow banking, it seems, alas, that I was still far too optimistic; the short answer to the last question above is a resounding YES, and here is why.

Thoughtful NC regular RueTheDay has returned to blogging, and saved me some re-exposition with this crisp recap on the shadow banking system and its role in the Great Financial Crisis. To add: US shadow banking assets at the peak were $8-10Trn. That depends on what you include; the NYFRB’s relatively inclusive figure for market-based credit puts the figure at $16Trn (see Fig 1 here ), comfortably larger than the traditional deposit-based banking sector’s $10Trn.

Whatever the bonus-enhancing attractions of near-infinite ROC, you really wouldn’t want a run on that little set-up, and naturally, in September ’08, we got one. Trouble was, there wasn’t much equity in those shadow banks, and no liquidity buffers at all. Shadow banking “equity” – the capital that is there to absorb losses and promote investor confidence in the bad times – is something of a nebulous concept. Instead of ordinary equity you have various kinds of guarantee, for instance:

for SIVs: ‘liquidity puts’ (vide CitiGroup SIVs)

for money market funds: informal guarantees that the buck will not be broken, extended by the fund’s parent, but not credible in a crisis (vide Reserve Fund Sept ’08 and the ensuing shadow banking seize up)

for repo: haircuts for repo collateral, that increase dramatically in a crisis, and thus, precipitate runs

for in house hedge funds: you sometimes have an honour system, whereby the parent informally undertakes to indemnify hedge fund investors against losses (following through on that promise killed Bear Stearns)

for financial insurers: you might have a huge well-capitalized parent (though AIG and the monolines turned out to be not quite well capitalized enough)

Roughly speaking, it would be safe to say that the amount of equity in shadow banks turned out to be negligible.

Now suppose you decided: “Well, shadow banking is just a form of banking. Let’s just ignore the liquidity issue for the moment, and ignore the variety of business models of the various kinds of shadow bank, and require the shadow banks to put up a not very demanding 5% capital cushion and regulate to that, somehow.” Assume, for simplicity, that we want to keep all that lovely shadow banking activity going and that shadow banks’ assets are identical in size to their liabilities; that 5% capital cushion would then be 5% of $8-16Trn. That’s between $400Bn and $800Bn of capital to raise.

Or, perhaps more likely, our shadow banks take 50% losses on 15% of their loans that they never never want to do again (the CDO bonanza, etc), and then need 5% equity on the rest. That way our shadow banks would need $925-$1,850 billion in equity. Which is impressive, but fair enough: the traditional banking system has about $1.3Trn of equity, and we know the shadow banking system is the same size, or somewhat bigger, and more prone to runs. Why, pray, should it not at least be capitalized to the same level, either by new capital, or by shrinkage?

So – do you want a big capital raise, or a massive credit contraction (that would in turn impact OTC derivatives activity), or another crash? Not an enticing choice, and perhaps unsurprisingly Geithner’s 6th May marketing statement doesn’t have anything to say about capital and liquidity in shadow banks. So I suppose “another crash” is the preferred option, by default.

Though actually, when you do delve into the bill, you find, with one exception (the Collins amendment, which is a departure from Treasury’s script) that there isn’t much nitpickable detail at all. It just doesn’t have much to say about shadow banking. In May the US Treasury Secretary identified four shadow-banking related reforms. Here they are, with summaries of their form. Since there is no more detail now than there was in the May puff piece, I quote from it again; what detail there is ain’t encouraging.

Comprehensive Constraints on Risk Taking

“Chairman Ben S. Bernanke will have a seat on a newly created Financial Stability Oversight Council. That board will deputize the Fed to set tougher standards for disclosure, capital and liquidity. The rules will apply to banks as well as non-bank financial companies, such as insurers, that pose risks to the financial system.”

Repo Markets

“These reforms [FSOC, above]will give the Federal Reserve the authority to build a more stable funding system, take action to address the unstable aspects of the short-term repo markets, and ensure that these markets are used much more conservatively in the future. ” Well I hope this infrastructure paper isn’t the sneak preview – the paper itself acknowledges, in a strangled kind of way (p 4, para 2), that infrastructure isn’t the key issue.

Higher Standards for Money Market Mutual Funds

“The President’s Working Group on Financial Markets is preparing a report setting forth options to reduce the susceptibility of money funds to runs.”

Ratings Agencies:

Bloomberg have an update , needed because Geithner’s proposals have (did you guess?) been watered down: “The overhaul legislation requires the SEC to conduct a two-year study on whether to create a board to decide who rates asset-backed securities. That curbed a Senate proposal to establish the board with SEC oversight. After the study, the board would be established only if regulators can’t come up with a better alternative.

Congress also softened a proposed liability provision, making it harder for investors to sue ratings agencies than it would have been under language approved by the House in December.”

Or perhaps you would prefer the short version:

Comprehensive Constraints on Risk Taking:

TBC, by a committee called the Financial Stability Oversight Council.

Repo Markets:

TBC, by FSOC.

Higher Standards for Money Market Mutual Funds:

Options for standards are TBC, by a committee called The President’s Working Group on Financial Markets. The actual standards will then be selected – by yet another committee perhaps, or maybe the same one.

(I can’t find anything in the sneak preview that addresses csissoko’s more fundamental gripes here and here )

Ratings Agencies:

TBC. First a two year study by an SEC committee on whether a) to create a committee to approve ratings agencies (perhaps they should pick a resonant name for it first), or b) do something else. After that, do whatever the SEC decides to do, assuming they reach a conclusion; otherwise, create a committee to approve ratings agencies…

It seems to have been drafted by the Monty Python crew when you put it like that, but I don’t think it’s a terribly unfair caricature. Not to downplay the importance of other reforms, but a page or to create the committees to save the world, some Fed initiatives that were already in hand before the legislative process started, and then 1,495 pages of other stuff? It seems out of balance.

Still, there is the Collins amendment. It is pretty sensible: bank holding companies will have to be capitalized to the same level as their subsidiaries. You’d think that will force more capital behind some shadow banking activities at least: repo for instance? With due deference to the creativity of accountants, perhaps it will put pressure on some kinds of OBS vehicle too? Here’s hoping…

Collins does have a smart move on capital quality, specifically TruPS, which no longer count as capital. Though not just yet – if you are a big bank, you have 5 years to replace TruPS with proper capital; if you are a small bank, up to 20 years. TruPS were a feature of the crisis, especially once repackaged into (you guessed it) CDOs . The whole idea that holdings in other banks’ debt should count as bank capital is batshit insane, and not even in hindsight; cross holdings have been known to be major contagion vectors since the investment trust fiasco of 1929 (see JK Galbraith “The Great Crash”; UK readers may also remember the Split Capital Investment Trust disaster of 2002, our very pale British imitation of the Wall Street Crash). And in something between 5 and 20 years, that TruPS coupling will be gone, perhaps after another crash. The pace of reform is not dizzying.

The Treasury Secretary’s angle on the very reasonable Collins amendment makes me unsure whether these avowals about shadow banking reform were totally sincere:

The lesson of this crisis, and of the parallel financial system, is that we cannot make the economy safe by taking functions central to the business of banking, functions necessary to help raise capital for businesses and help businesses hedge risk, and move them outside banks, and outside the reach of strong regulation.

But compare Geithner’s ringing words with Geithner joining hands with the banks versus the Collins amendment. The attempt to unpick the Collins amendment looks suspiciously like the familiar “divide and conquer” approach to banking regulation, but led, it seems, by the US Treasury. The steps would be: try to dilute the US regs now, then, in due course, dilute the Basel III provisions on leverage (presumably Geithner is actually the US official said to be opposing the Basel III tightening of capital rules), then, exploit the international dimension to excuse porous regulations. And then you are back to business as usual.

Still, Collins’ amendment has survived; that is a little victory for Collins, or more accurately, I suspect, Sheila Bair and FDIC – see more here (though you should take the stuff about Eurobank leverage with a grain of salt).

So where does that leave us with our shadow banking reforms? Well, we have a modest tweak to bank capital requirements, of unknown efficacy (Collins) and a bunch of new committees, mostly in the Fed. The mountain has laboured, and brought forth a mouse.

Or you might prefer to pursue the anaconda/rabbit imagery to a physiologically realistic conclusion.

A reader with considerable experience in real estate who has asked to remain anonymous pointed to an article in Housing Wire describing some possible unintended consequences of the Administration’s push for more short sales:

This past week, I received an email from one of my dearest friends that has really stuck with me. It illuminates perhaps one of the single largest shifts in borrower psychology likely to come from a push to short sales:

My neighbors are being foreclosed on….

The house and land (1.3 acres) was valued at $1.8m a few years ago. Now, they are behind on payments and the bank wants to force a short sale for only $700k. She told me that she tried to modify the mortgage twice already, and has been turned down. She is willing and able to make payments on the $700k amount, but the bank is refusing and would rather sell to someone else.

he message paints an interesting picture of a potentially hidden angle to the recent short sale push by the Administration, banks, and Realtors: a renewed call for broad principal forgiveness.

It’s not too hard to see this sort of thinking quickly becoming the norm among many distressed homeowners, as a push for short sales grows ever stronger and many ask themselves why someone else is getting the better deal. More than 11 million borrowers currently owe more on their mortgage than it is worth, according to CoreLogic—and this group of borrowers would love nothing more than to replace their current underwater mortgage with whatever the accepted “short sale price” is deemed to be.

I don’t know that such a response on the part of borrowers could be deemed irrational, either. Many will ask themselves why they have a mortgage at a higher amount, especially if the bank is willing to sell the house to another buyer for less money. Why does someone else get the lower purchase price? Isn’t easier for the bank to just give me that loan instead? I already live here.

The NC correspondent carries it one step further, and points to second lien holders as the likely impediment:

The real solution to the mortgage market problem is principal write downs of underwater mortgage loans. It’s behind discussions of cramdown legislation. It is what TARP money should have been used for because it would have had the dual impact of helping both borrowers and banks.

Second liens – and the JPM, Citi, Wells illusionary accounting – are a big obstacle to cramdowns, which is really total BS. These were high risk loans when made and should be treated as such now. Of course, the truth is, no one has any idea how to model how many 2nd lien borrowers will default over time. There is no reliable historical data and the current accounting conventions completely obscure the real value of second lien risk.

The Housing Wire piece makes an outstanding point about the ridiculousness of short sales and the absence of cramdown legislation. I wouldn’t be surprised if this is an area of future litigation. The only way the banks, their regulators and congressional lapdogs can deal with the issue is by ignoring it.

I doubt that the administration had this outcome in mind when they advocated more aggressive short sales (but it is a remote possibility). If they were unaware of the implications of a push to short sales for individual homeowners, you have to marvel at their blindness or cluelessness.

Finally, how does the Fannie push against “strategic defaulters” fit in? Perhaps, if they can justify that they have segregated “bad” defaulters from “good” ones, they can rationalize principal write downs rather than forcing the sale to other parties?

The political types are terrified of pissing off the “good” borrowers who have been paying their mortgages all along. As a result, the Administration may be trying to gradually get to the cramdown treatment, while avoiding looking like they exhausted all other possibilities first. Interestingly, they didn’t seem so concerned about a slow, measured approach when it came to bailing out the banks.

In the scheme of things, the overall economy would be much better off if the bulk of underwater mortgages were crammed down to levels borrowers can afford, so that more borrowers were kept in their homes, less housing turnover was needed, fewer foreclosure related expenses were incurred (and wasted on lawyers), and the shadow inventory was drastically reduced. For fairness, the crammed down portion of the mortgage can be subordinated so that any subsequent appreciation in value can be captured, in whole or in part, by the lender. The existing second liens would be toast, currently, but would have a further subordinated right if housing really appreciated a lot in the future.

I can’t see any public policy reason why our entire economy should hinge on rewarding second lien lenders, who knew they were undertaking speculative loans in the first place, at the expense of home owners, housing, etc.

Yves here. Sadly, I think we know the real reason for the continued pursuit of this “spare the second lienholders any pain” program. And it has nothing to do with sound public policy. It has everything to do with the fact that the biggest second lien holders, Citi, Bank of America, JP Morgan, and Wells, have simply massive holdings among them and are too big to fail. Admitting the magnitude of the second lien losses would also be hugely embarrassing to Treasury, since it would reveal what a farce its stress tests were, and that the big bank remain woefully undercapitalized.

While the headline focuses on her outlook for housing, Whitney is bearish across the board, seeing little reason to cheer on the employment and bank earnings fronts. She sees a 10% fall in housing prices in the next six months (!), which will hit bank earnings (Whitney has argued since at least early 2009 that banks have been goosing earning by underreserving for losses) and the economy generally (a further decline in home equity plus lack of mobility of consumers wanting to sell their houses but facing a declining market has implications for consumer spending generally). She point out that consumer credit is tightening, which puts a crimp on small businesses (both via lower revenues and via restricted access to funds), the biggest engine of hiring, and on top of that, municipalities and states are cutting spending and shedding jobs.

From Fortune (hat tip Glenn Stehle):

Click here to view the segment.

A similar grim take from Barry Ritholtz via John Mauldin:

Today, residential real estate confronts numerous headwinds: Credit, once given to anyone who could fog a mirror, is now tight. Today, demand is far below what it was during most of the past decade. Home prices are still unwinding from artificially high levels, and remain over-priced. Inventory is elevated. A huge supply of shadow inventory is out there: Speculators and flippers who overpaid but have held onto their properties await modestly higher prices to sell. Bank owned real estate (REOs) continues to increase. That’s before we get to the fact that unemployment remains high, and is unlikely to improve anytime soon. Oh, and wages have been flat for a decade.

This are not encouraging factors about housing.

This is known, or at least should be by those who have looked at the data. I cannot explain why some economists still have not figured this out.

In my analysis, price stands out as being the prime mover of the next leg down. High unemployment, and a decade of flat wages aren’t helping to create any new housing demand. And the millions in homes they cannot afford will eventually add more pressure to inventory and prices. Indeed, we are still working

But the bottom line is Home prices remain too high: There can be no doubt that home prices have moved way down from the 2005-06 peaks. How did I reach the conclusion that, even after a 33% decrease in prices, home prices are high?

By using traditional metrics: Whether we are looking at US housing stock as a percentage of GDP or Median income versus home prices or even ownership versus renting costs, prices remain elevated. Indeed, we see prices remain above historic means.

Consider price relative to income. From 1977 to 2010, the median US home price was 4.1 times median household income….Home prices are still above that mean. Oh, and that mean is artificially elevated due to the 2002-07 boom. It’s the same with home prices relative to rentals, or housing value as percentage of GDP….

Further, we should not assume that prices merely mean revert back to historic levels. What usually happens when markets get wildly overvalued – and a ~3 standard deviation price move sure qualifies — is they get resolved not by reverting to the mean, but by careening far beyond it.

In other words, brace yourself for further downside. Extend and pretend is finally about to run into ugly reality.

Dear readers, your blogger feels like death warmed over. Please bear with me if posts are light the next few days.

Dolphins prefer high-energy fish BBC

Neutrino experiments sow seeds of possible revolution Science News

Heedlessly Hijacking Content David Carr, New York Times

California welfare recipients withdrew $1.8 million at casino ATMs over eight months Los Angeles Times (hat tip reader John D)

U.S. officials say Karzai aides are derailing corruption cases involving elite Washington Post. Quelle surprise!

The Market Crash as Double-Entendre Dating Ad Paul Kedrosky

From CNBC Business Journalist to Critic of Bankers on MSNBC New York Times

Fresh moves to unlock loan pool Financial Times

Banks Move Quickly to Blunt U.K. Levy Wall Street Journal

The €442bn question — a guideline FT Alphaville. Alphaville has been nervous for some time re an upcoming termination of an important ECB liquidity facility.

Another summit that disappoints Eurointelligence

Dire warning over impending slide of British manufacturing Independent

Osborne’s first Budget? It’s wrong, wrong, wrong! Independent (hat tip reader John D)

Is monetary policy too expansionary or not expansionary enough? Martin Wolf

The Third Depression Paul Krugman

Austerity: A Prisoner’s Dilemma? Peter Dorman

Gag orders in the Gulf continue Lambert Strether

BP’s Dumb Investors George Monbiot. From last week but still germane.

States Weigh Big Claims Against BP Wall Street Journal

BP oil spill: Barack Obama and David Cameron agree BP must not collapse Telegraph This is appalling. So BP is TBTF? If its liabilities are bigger than its assets, it should be restructured, full stop.

The Mother of All Cross-Border Bankruptcies? Jason Kilborn. Corrects some urban legends on how a BP BK would proceed.

Antidote du jour:

By Rob Parenteau, CFA, sole proprietor of MacroStrategy Edge, editor of The Richebacher Letter, and a research associate of The Levy Economics Institute

Richard Alford has correctly identified the need to address global imbalances – rather than simply slouch our way back to some milder version of status quo before the pre- Lehman meltdown arrangement, as we presently appear to be doing – if we are to have any hope of finding a sustainable global growth path. On this much we can surely agree. As to the method of addressing global imbalances, however, and perhaps even the true nature of these imbalances, we find ourselves deeply at odds with some of his diagnosis and most of his prescriptions.

Richard specifically takes issue with those of us who have been warning about the pursuit of large, prolonged fiscal retrenchment paths in the eurozone. He believes this is a bit of a diversionary tactic on our part, akin to a stance John Connolly once took, of restating our problem as their problem to deal with, not ours. The solution to the US problem is plain and simple in Richard’s mind: stop fighting austerity policies abroad, and start advocating their implementation at home.

Now it is true, as a matter of double entry book keeping, that if the US as a nation is going to reduce the gap between its spending and its income (which would reduce the currently widening trade deficit by definition), then nations that are major trading partners of the US must be prepared to reduce their net saving. Just as it takes two to tango, there are two sides to every exchange or transaction. One nation cannot increase its financial balance or net saving with the rest of the world unless the rest of the world is prepared to reduce its net saving. So from a rational perspective, rebalancing global growth does, as a matter of fact, require both sides to move in the right direction. This is not a theory – it is simply an accounting reality. One side can initiate the move, but both must be prepared to move.

Frequently, we are told by neoliberals, who dominate the economics profession and policy making circles, that there is something called the “twin deficits” that must be recognized and addressed in the US. The twin deficit story goes like this: an increase in the fiscal deficit will tend to lead to an increase in the current account (or trade) deficit. Therefore, if reducing the US current account deficit is a desirable if not a necessary policy objective, then it is surely necessary to reduce the fiscal deficit. We have been hearing this story for nearly three decades from the neolibs.

The problem with the twin deficit story is the facts do not seem to bear the theory out. Below you may observe a chart for the US the shows the current account balance as a share of GDP, and the combined government fiscal balance as a share of GDP. You will notice the twins seem unrelated – not even separated at birth.

Specifically, look at the entire decade of the ‘90s, when the twins moved in opposite directions. The fiscal balance increased, while the trade balance fell. This is supposedly impossible under the neoliberal twin deficits story. Then observe the shaded bars, which encompass recessions of the past 45 years. Lo and behold, in nearly each of the recessions of the past nearly half century, the fiscal balance has fallen while the trade balance has risen. The facts indicate the twin deficit story is at best an incomplete or unreliable story (click to enlarge).

Why might this be the case? The neoliberals are not playing with a full deck – or at least they are keeping some cards up their sleeves. In prior articles, policy briefs, and public presentations, we have traced out the fact that while for the economy as a whole, total saving out of income flows must equal total investment in tangible assets (houses, plant and equipment, etc.), this is not true for any one sector of the economy. Breaking the economy down into three sectors – government, foreign, and domestic private sectors – we can derive the following identity which must hold true at the end of any accounting period (we can provide the simple algebra to derive this upon request – it appears in other publications of ours, as well as in much of the research Wynne Godley performed while at the Levy Institute):

Domestic private sector financial balance + government financial balance – current account balance = 0

Or

DPSFB + GFB – CUB = 0

This means in order for the current account (CUB) and the fiscal balance (GFB) to be twins, as the neoliberals often assert, such that a fall in the fiscal balance (say an increase in the fiscal deficit) leads to a commensurate fall in the current account balance (say an increase in the trade deficit), then there must be little or not change in the domestic private sector financial balance (DPSFB). This, it turns out, is empirically false. The DPSFB is rarely stable, especially in the past two decades of serial asset bubbles, when both the household and nonfinancial business sectors have gone deeper than ever into deficit spending territory under the influence of asset prices kiting ever higher.

So what is the true twin of the trade deficit? We can split the DPSFB, as we hinted just above, into the household and nonfinancial business sectors.

DPSFB = HFB + NBFB

When we do so, we notice a new set of twins arises from the historical data. The true twin of the CUB is the HB, or household financial balance. And of course, this makes perfectly good sense since most of the trade deficit is in the area of tradable consumption goods (click to enlarge).

So if we decide the US CUB needs to turn around, we best find a way to increase the HFB, or the net saving positions (saving minus investment) of the household sector. How can this be achieved? Expanding and rearranging the accounting identity above, we find:

HFB = CUB – GFB – NBFB

If we want to get the two true twin financial balances increasing in value (thereby reducing the current account or trade deficit) then we have two choices available. Either reduce the government financial balance (increase fiscal deficits) or reduce the NBFB (get businesses to run down their free cash flow positions by reinvesting more of their profits in tangible capital equipment). If we rule out the former on neoliberal concerns about fiscal sustainability, we are left with but one choice to improve the position of the true twins, and that is a higher reinvestment rate in the domestic business sector.

And this, dear reader, brings us to the heart of the matter. Remember the global savings glut you keep hearing about from Greenspan, Bernanke, Rajan, and other prominent neoliberals? Turns out it is a corporate savings glut. There is a glut of profits, and these profits are not being reinvested in tangible plant and equipment. Companies, ostensibly under the guise of maximizing shareholder value, would much rather pay their inside looters in management handsome bonuses, or pay out special dividends to their shareholders, or play casino games with all sorts of financial engineering thrown into obfuscate the nature of their financial speculation, than fulfill the traditional roles of capitalist, which is to use profits as both a signal to invest in expanding the productive capital stock, as well as a source of financing the widening and upgrading of productive plant and equipment.

What we have here, in other words, is a failure of capitalists to act as capitalists. Into the breach, fiscal policy must step unless we wish to court the types of debt deflation dynamics we were flirting with between September 2008 and March 2009. So rather than marching to Austeria, we need to kill two birds with one stone, and set fiscal policy more explicitly to the task of incentivizing the reinvestment of profits in tangible capital equipment. A program to do so would include the following measures:

1) a prohibitive tax on retained earnings that are not reinvested with a 24 month period after they have been booked;

2) a financial asset turnover tax that raises the cost to businesses of playing casino games in various financial asset markets, rather than reinvesting profits in the productive capital stock;

3) a reinvigorated public or public/private investment program that helps speed up the shift to, and lower the costs of production of new energy technologies.

Regarding the last proposal, we must be willing to recognize the history of US economic development includes a number of very large and very bold public and public/private investment initiatives that provided numerous business opportunities and the basis for breakthrough technologies to emerge. The canal, railroad, highway, and other initiatives were hardly the doorway to the communist gulag they are made out to be. Indeed, if anything, Asia has mastered the use of this approach to push one of the most rapid adoptions of capitalism ever.

We know we need to reconfigure our energy infrastructure – we knew it over thirty years ago. It is time to act, and the third proposal could include such measures as solarizing all government buildings in the southern states in order to drive unit costs of solar cell production down, which in turn would increase the competitiveness of US producers of solar cells in global markets. There are undoubtedly more proposals we could bring to bear on the business sector to break the global corporate saving glut and force capitalists to act as, well, capitalists, but for the moment, this is a good enough place to start.

To conclude, Richard summarized his recent Naked Capitalism piece as follows: “The structural problems are reflected in mutually determined unsustainable current account and fiscal deficits, as well as depressed saving rates.”

Notice how his statement fingers the wrong twins – the fiscal and current account deficits are asserted to be mutually determined. Neoliberals tell this fib all the time. Empirically, we have shown you this is false, at least for much of the last four decades of US history, Theoretically, we have shown you this is also a suspect assertion: if you bother examine the macrofinancial balance equation in its full form, you find the neolib fib requires an implicit assumption that the DPSB show little or no change over time, which again is empirically false.

Notice the emphasis on depressed savings rates needing to be reversed and revived, when, as we argued above, the real source of US and global imbalances is a corporate savings glut. Firms are earning generous profits, but they are not reinvesting them in tangible productive assets. This visibly short circuits long run growth prospects, and is the foundation of the structural problem Richard alludes to, but we doubt he would recognize it as such.

That neoliberals with credentials, credibility, tenure, and positions of policy influence can continuously assert these glaring misconceptions is either malpractice, malfeasance, or both. It is not our place to speculate on their motives, though we have our own hunches (here is a heavy hint: just follow the money). Call it innocent fraud if you must, but neoliberals would have us marching to Austeria on the basis of their hollow, unsubstantiated slogans. It is high time for the neolibs to finally drop their fibs and step out of the way. Sorry Lady Thatcher, but there is an alternative to Austeria.

*Earlier in the month we coined the terms Austeria and Austerian Economics. We introduced these concepts in our June 10th BNN TV interview, and in our June 11 Richebacher Letter Weekly Alert to describe the policy stance we saw the G-20 embracing for Austeria, formerly know as the eurozone. (And yes, bloggers elsewhere who have been erroneously attributing these terms to Mark Thoma’s subsequent June 17th use of it at Economist’s View – please consider doing a little fact checking now and again).

We noted a bit more than a week ago that we expect the European banks stress tests to backfire. The US version was a successful con game because the officialdom provided adequate disclosure about the process and stayed firmly on message, the banks were allowed to “manufacture” as analyst Meredith Whitney put it, impressive earnings, putting a tail wind behind their stock prices, and there was a mechanism for the US to inject capital if banks who were directed to raise equity levels were not able to do so.

We pointed out these conditions were not likely to be operative in the case of the Eurobanks, with the most obvious likely gaps a unified strategy among European leaders (this has been notably absent so far; why should the banks be any different?), doubts about whether there is enough “stress” in the stress tests (due either to insufficient transparency or overly generous macroeconomic assumptions), and most important, lack of a credible equity injection mechanism. In Germany, perceived to be the strong man of the EU, the size of its banking sector is so large relative to its GDP as to raise doubts about its ability to backstop its banks. Moreover, the German population is dead set against further bailouts.

Today, the Financial Times reports that the stress tests will be conducted on 100 banks, with details that were not encouraging:

The number of European banks subjected to stress tests is likely to rise, with sources suggesting that as many as 100 institutions will be involved in a broader exercise to shore up market confidence.

European Union leaders have already agreed to publish stress test results for 26 banks next month – mainly big, cross-border institutions – to address concerns about the eurozone’s exposure to sovereign debt.

But one German government official said those tests, which are being conducted by the Committee of European Banking Supervisors (CEBS), would be expanded to cover “significant market share” in each market – about half of all bank balance sheets in each country.

While the total number of financial institutions to have stress tests published remained open, the German official also said the country’s eight Landesbanks had agreed to publication.

The weakened Landesbanks had resisted publication until now, arguing that testing their ability to withstand sovereign defaults would send the wrong signal to bond investors.

The German government had supported this line but has come round to viewing publication as a potentially important confidence-building exercise.

Yves here. How pray tell do you “build confidence” by exposing the dirty laundry of sick banks? Pretty much everyone knows the Landesbanken are in bad shape.

We had also warned that coming up with credible stress levels would be problematic. Given the wide differences in economic performance among the eurozone member nations, it would make sense for each country to set its own metrics. But then you would need to have them trade notes and recalibrate, possibly renegotiate (since one country adopting tougher relative standards could make the rest look bad).

Instead, the eurozone appears to be adopting a “one size fits all” standard, which is not credible:

CEBS has said the parameters were being set at a pan-European level, despite suggestions from several banks that have been tested that the stress scenarios were nationally specific.

In a limited exercise last year, CEBS said its stress scenario involved a 2.7 per cent fall in GDP this year and 12 per cent unemployment.

Yves here. Ahem, unemployment in Spain is already at 20%. So we are seriously going to set the stress test level at 12%? No wonder the Spanish banking minister was so keen to publish results (I assume the test on Spanish banks was less nonsensical, but I could be wrong here).

The story indicates that analysts are already skeptical:

But one top banker said that even if the list were expanded it would not serve the purpose of sufficiently reassuring the markets. “You need total transparency,” he said. “You need to publish the results of the entire banking system – otherwise, suspicions will remain.”

Wolfgang Munchau, in a Financial Times comment (hat tip readers Don B and Swedish Lex) raises more general concerns about ongoing efforts to shore up the eurozone. The first part of his piece describes a staggering gulf in perceptions: eurozone officials who genuinely believe their salvage operation is going well, versus investors who see continuing disarray, last minute expedients, a failure to address significant, fundamental issues, and therefore see a breakup as inevitable.

Munchau turns to the the stress tests as what he expects to pan out as another example of poor planning and undue optimism by eurozone polcymakers:

I only hope that they know what they did when they recently announced the publication of the stress tests for 25 banks. Once these are published, the markets will immediately demand to see the tests for all banks. Once that happens, in turn, governments will need to produce a convincing recapitalisation strategy. I fear, however, that they are once again committing themselves to going down a road without a map.

Without an endgame, this exercise will end in disaster. At some point the markets will realise that large parts of the German and French banking systems are insolvent, and that they are going to stay insolvent. You might think that Europe’s policy elites cannot be so stupid as to commit themselves to stress tests without a resolution strategy up their sleeves. But I am afraid they probably are. Europe’s political leaders and their economic advisers are, for the most part, financially illiterate.

Is there a way out? Yes there is, but the chance of a resolution to the crisis is starting to fade. The first step would have to be a serious attempt to resolve bank balance sheets. This is as much a German and French banking crisis as it is a Greek and Spanish debt crisis. You need to resolve both problems simultaneously. Resolution would require a large fiscal transfer, not from Germany to Greece, but from the German public sector to the German bank sector – in the form of new capital. The same would apply to France.

Beyond this restructuring, the eurozone will need to commit itself to a full-blown fiscal union and proper political institutions that give binding macroeconomic instructions to member states for budgetary policy, financial policy and structural policies. The public and private sector imbalances are so immense that they are not self-correcting. And you have to be very naive to think that peer pressure is going to resolve anything.

There is no point in beating about the bush and issuing polite calls for the creation of independent fiscal councils or other paraphernalia. This is not the time for a debate on second-order reforms. I am aware that, at a time of rising nationalism and regionalism throughout the EU, there is no consensus for such sweeping reforms. But that is the choice the EU’s citizens and their political leaders will have to make – a choice between reverting to dysfunctional and, as it transpires, insolvent nation states, or jumping to a political and economic union.

Yves again. Munchau is clearly not optimistic that EU leaders recognize the magnitude of the challenges to achieving a better union. Not only has wearing rose colored glasses blinded them to the difficulties before them, but it has also led them to fail to prepare their citizens adequately. That almost assures a popular backlash even if the officialdom were to get religion late in the game.

The Financial Times highlights a concern we had raised early on about the effort by BP to drill a relief well to stop the flow of oil into the Gulf. While many analysts have acted as if the BP forecast, that the well would be completed by August, there is no reason to assume the initial effort will succeed, particularly at this depth, which is unprecedented for this effort. We pointed out the last effort to drill a relief for a large leak in the Gulf, at Ixtoc in 1979, took ten month to yield results. The commentary i the story suggests that a delay would not be as severe.

From the Financial Times:

Almost 6,060m below the surface of the Gulf of Mexico and 4,500m below the seabed, BP’s engineers are zeroing in on a narrow target: the 25cm-wide steel casing of its old Macondo well, which has been leaking oil since late April…

While those in the industry believe the relief wells will eventually stop the oil, they note the scale of the challenge. In addition to the depth, the original drilling process suffered several setbacks because of the difficult geology and pressures.

“Drilling a well thousands of feet into rock to hit a target no more than six inches [15cm] wide isn’t exactly a sure thing,” says Guy LeBas, strategist at Janney Capital Markets. “There remains a risk that the leak could continue past August.”

BP, under pressure from Washington, is drilling two relief wells to multiply the chances of success…

The intersection is targeted for a section of the pipe that is less than 10 inches in diameter.

“It may take a couple of tries,” says Jonathan Parry, of consultants IHS CERA and who previously worked as a deepwater engineering advisor for Chevron. “It may take more than one relief well,” Mr Parry says.

Experience suggests that it can take several attempts – and more time than BP has so far admitted…

“It is extremely difficult,” says a geologist. Oil engineers warn that the extra attempts do not require a full, new relief well, however. If BP fails to intersect the well at its first attempt, the engineers will backtrack and use their directional drilling systems, which allow them to move their drill like a snake. Each attempt will take days or weeks, rather than the three months needed to drill a new well, they say

On other fronts, another concern raised early on, that the dispersant used by BP, Corexit, was dangerous and could cause additional harm, appears to be valid. Crops near the Gulf Coast are showing damage consistent with Corexit toxicity. From SFGate (hat tip reader Doc Holiday):

BP’s favorite dispersant Corexit 9500 is being sprayed at the oil gusher on the ocean floor. Corexit is also being air sprayed across hundreds of miles of oil slicks all across the gulf…

Corexit 9500 is a solvent originally developed by Exxon and now manufactured by the Nalco of Naperville, Illinois (who by the way just hired some expensive lobbyists). Corexit is is four times more toxic than oil (oil is toxic at 11 ppm (parts per million), Corexit 9500 at only 2.61ppm).

In a report written by Anita George-Ares and James R. Clark for Exxon Biomedical Sciences, Inc. titled “Acute Aquatic Toxicity of Three Corexit Products: An Overview” Corexit 9500 was found to be one of the most toxic dispersal agents ever developed…

The UK’s Marine Management Organization has banned Corexit so if there was a spill in the UK’s North Sea, BP is banned from using Corexit. In fact Corexit products currently being used in the Gulf were removed from a list of approved treatments for oil spills in the U.K. more than a decade ago. The Environmental Advisory Service for Oil and Chemical Spills at IVL, Swedish Environmental Institute, has, upon request of the Swedish Environmental Protection Agency evaluated Corexit extensively and recommended it not be used in Swedish waters.

The Swedish study concludes: “The studies suggest that a mixture of oil and dispersant give rise to a more toxic effect on aquatic organisms than oil and dispersants do alone… The research on toxicity of oils mixed with dispersants has, however, shown high toxicity values even when the dispersant per se was not very toxic.” A report for the Alaska Department of Environmental Conservation Division of Spill Prevention and Response concluded that Corexit actually inhibits bacterial degradation of crude oil. It may look good on the surface but it will take longer for natural bacteria to eat up the crude oil.

Studies on Corexit and its effects on plants are consistent with the damage sustained in the lower Mississippi area. Check out the table on page 877 of the study. While no one precisely knows, all the signs point to BP’s use of aerosolized Corexit brought inland by the ocean winds or rain.

Yves here. Note the author points out that the link between Corexit and crop damage at this point is “conjecture”. Update 2:30 AM: Reader Kalpa believes the more likely culprit for the plant damage is sulfur trioxide vapors released from the Lucite Chemical plant in Millington, Tennessee, which was shut down by the EPA until the problem was resolved. Back to the original post.

However, other commentators are concerned that evaporating oil and dispersants may be harming clean-up crews and Gulf residents. From the Orlando Independent Examiner (hat tip reader Doc Holiday):

Toxins that are released into the air from evaporating oil and dispersants may pose a greater health risk to clean-up workers and Gulf residents than oily water when the thickest parts of the oil slick wash ashore…

Scientists and researchers, however, are keenly aware of potential health risks to people not only from exposure to oil in the water, but also to fumes in the air. The Institute for Southern Studies (ISS) reported as early as May 10 that, “the latest evaluation of air monitoring data shows a serious threat to human health from airborne chemicals emitted by the ongoing deep water gusher.”…

A report published by the Louisiana Environmental Action Network (LEAN) analyzed data released by the EPA taken from a testing site in Venice, LA between April 26 and May 26 (see chart). The results show unsafe levels of both Hydrogen Sulfide and VOCs in the air.

For instance, on May 3 hydrogen sulfide had been detected at concentrations more than 100 times greater than the level known to cause physical reactions in people. The fluctuations in readings are attributed to many factors such as wind speed and direction, heat index and other atmospheric conditions that vary on a daily basis.

A more recent report published by the Natural Resources Defense Council (NRDC) analyzes offshore air quality data released by BP. The findings replicate conclusions in earlier reports that the level of toxins in the air is unsafe for humans. “Nearly 70% (275 out of 399) of offshore air samples had detectable levels of hydrocarbons and nearly 1 in 5 (73 out of 399) had levels greater than 10 parts per million (ppm), which is an EPA cutoff level for further investigation. 6 samples exceed 100 ppm which in a previous monitoring summary was labeled as the action limit.”

Moreover, there are now reports of BP oil on the US East Coast (hat tip reader emca from Alexander Higgins):

I confirmed that water and oil mixture then does indeed extend to the Florida Keys as shown on the ROFFS map which directly contradicts the statement NOAA has made stating that the Florida Keys and South Florida will be unaffected by the spill.

ROFFS also told me that in addition to the confirmed Jacksonville oil concentration that there are unconfirmed reports of oil in Fort Pierce, Florida which is south of the Jacksonville as well as unconfirmed reports of oil as far north as the Washington D.C and Maryland area.

The post includes a recording and transcript of the call. Higgins also has a cheery report that the mixture of oil and Corexit is damaging boat hulls.

Emca also pointed out that BP is not cooperating with effort to fingerprint the oil, which would enable researchers to be certain that oil sighted is indeed from the Gulf leak.

Needless to say, this is all pretty disheartening.

.

The bond markets are quicker-trigger to register concern about deteriorating fundamentals than the stock market, with risky credits the canaries in the coal mine.

Bloomberg reports that spreads have widened in both leveraged loans and emerging market debt, but also notes some analysts see this rise as a blip rather than a trend. From Bloomberg:

The percentage of corporate bonds considered in distress is at the highest in six months, a sign that debt investors expect the economy to slow and defaults to rise.

The number of speculative-grade companies worldwide with yields at least 10 percentage points more than government bonds climbed to 399 this month, or 16.7 percent of the total, the highest share since December, according to Bank of America Merrill Lynch index data…

The 2010 default rate in the U.S. may jump as high as 6 percent by year-end from 1.3 percent currently, according to analysts at Goldman Sachs Group Inc…

While Goldman Sachs forecasts defaults will climb this year, JPMorgan Chase & Co. analysts led by high-yield credit strategist Peter Acciavatti wrote June 25 that the rate will be 2 percent in 2010. The divergent views reflect uncertainty in credit markets as investors weigh the effects of Europe’s sovereign debt crisis and concern that the U.S. economy may tip back into recession…

Elsewhere in credit markets, the extra yield investors demand to own corporate bonds rather than government debt is poised to widen the most this quarter since 1998, prices of leveraged loans are set to fall, emerging market debt spreads are headed for their first quarterly increase since the final three months of 2008 and asset-backed debt sales are slowing.

Why kangaroos evolved small arms and long legs BBC

WARNING: 3D Video Hazardous to Your Health Audioholics

The 36 Hours That Shook Washington Frank Rich, New York Times

Toronto in lockdown as G20 protesters clash with police Raw Story

Prime property most at risk of slump, says Savills Telegraph

Spain’s Debt Maturity Wave Hits Next Month And It’s Already Obvious They Don’t Have Enough Cash Clusterstock

Brent Coon: tough-talking lawyer going after BP on his Harley Guardian

BP and Counterparty Risk Streetwise Professor

Extreme Measures: Arming the Zealotocracy, Serving the Elite Chris Floyd

Antidote du jour from reader Matthew K:

I’m from Vancouver, BC, and have been a reader for a couple years. We took my in-laws on a Rockies Road Trip last week, and were lucky enough to come within a few feet of a mother black bear and her two cubs. (They sauntered past our parked vehicle.)