naked capitalism

Yves here. Even though I agree with a good bit of Hudson’s post, I take exception to part of his argument, both in general and with Krugman. Hudson fails to distinguish between private sector debt (particularly consumer debt, whose overall level is negatively correlated with economic growth) and debt issued by a government that also issues its own currency. As we have stressed, unless a country runs a trade surplus (and if some countries run surpluses, other countries must run deficits), when the private sector delevers, the government sector needs to run deficits to accommodate the private sector deleveraging (otherwise GDP and wages contract, which is the austerian result Hudson wants to avoid). And that includes debt writeoffs. Although Krugman argues for deficit spending largely from a Keynesian perspective, he sometimes invokes the sectoral balances approach we described above.

Richard Koo, who coined the expression “balance sheet recession” stresses how financial-crisis-hangover high private sector debt loads are crippling. Consumers and businesses prioritize paying down debt over investing.

By Michael Hudson, a research professor of Economics at University of Missouri, Kansas City and a research associate at the Levy Economics Institute of Bard College. His new book summarizing his economic theories, “The Bubble and Beyond,” will be available in a few weeks on Amazon.

Paul Krugman is widely appreciated for his New York Times columns criticizing Republican demands for fiscal austerity. He rightly argues that cutting back public spending will worsen the economic depression into which we are sinking. And despite his partisan Democratic Party politicking, he said from the outset in 2009 that President Obama’s modest counter-cyclical spending program was not sufficiently bold to spur recovery.

These are the themes of his new book, End This Depression Now. In old-fashioned Keynesian style he believes that the solution to insufficient market demand is for the government to run larger budget deficits. It should start by giving revenue-sharing grants of $300 billion annually to states and localities whose budgets are being squeezed by the decline in property taxes and the general economic slowdown.

To focus the argument against “Austerian” advocates of fiscal balance, Mr. Krugman hopes that economists will stop distracting attention by talking about what he deems not necessary. It seems not necessary to write down debts. All that is needed is to reduce interest rates on existing debts, enabling them to be carried. He does not advocate shifting taxes off labor onto property. The implication is that California can afford its Proposition #13 that has fiscally strangled the state by freezing taxes on commercial property and homes at long-ago levels. It is not necessary to change the economy’s tax shift off real estate and finance, except to restore a bit more progressive taxation.

The effect of Mr. Krugman’s suggestions is for the government to subsidize the existing financial and tax structures, not write down debts or make the tax system more efficient. So I am afraid that his book might as well have been subtitled “How the Economy can Borrow its Way Out of Debt.” That is what budget deficits do: they add to the debt overhead.

Mr. Krugman has gotten censorial regarding the debt issue over the last month or so. In last Friday’s New York Times column he wrote: “Every time some self-important politician or pundit starts going on about how deficits are a burden on the next generation, remember that the biggest problem facing young Americans today isn’t the future burden of debt.” Failure to see today’s economic problem as one of debt deflation means a failure to recognize the need for debt writedowns, restructuring the banking and financial system, and shift taxes off labor back onto property, economic rent and asset-price (“capital”) gains. The effect is to defend the status quo – and to me, that makes Mr. Krugman a conservative. I see little in his logic that would oppose Rubinomics, which has remained the Democratic Party’s program under the Obama administration.

Many of Mr. Krugman’s readers find him the leading hope of opposing even worse Republican politics. But what can be worse than the Rubinomics that Larry Summers, Tim Geithner, Rahm Emanuel and other Wall Street holdovers from the Democratic Leadership Committee have embraced?

Perhaps I can prod Mr. Krugman into taking a stronger position on this issue. But what worries me is that he has moved sharply to the “Rubinomics” wing of his party. He insists that debt doesn’t matter. Bank fraud, junk mortgages and casino capitalism are not the problem, or at least not so serious that more deficit spending cannot cure it.

Criticizing Republicans for emphasizing structural unemployment, he writes: “authoritative-sounding figures insist that our problems are ‘structural,’ that they can’t be fixed quickly. … What does it mean to say that we have a structural unemployment problem? The usual version involves the claim that American workers are stuck in the wrong industries or with the wrong skills.”

Using neoclassical sleight-of-hand to bait and switch, he narrows the meaning of “structural reform” to refer to Chicago School economists who blame today’s unemployment as being “structural,” in the sense of workers trained for the wrong jobs. This diverts the reader’s attention away from the pressing problems that are really structural.

The word “structural” refers to the systemic imbalances that neoclassical economists dismiss as “institutional”: the debt overhead, the legal system – especially bankruptcy and foreclosure laws, regulations against financial fraud, and wealth distribution in general. In 1979, for example, I juxtaposed economic structuralism to Chicago School monetarism in my monograph on Canada in the New Monetary Order. I have elaborated that discussion my textbook on Trade, Development and Foreign Debt (new ed. 2010). The tradition is grounded in the Progressive Era’s reform program. That is what classical political economy was all about – and what the neoclassical reaction sought to exclude from the economic curriculum. From the neoclassical writers through Rubinomics deregulators, the debt problem simply disappears.

So this is getting serious. I realize that it is more difficult to criticize someone for an error of omission than for an error of commission. But the distinction was erased a month ago when Mr. Krugman got lost in the black hole of banking, finance and international trade theory that has engulfed so many neoclassical and old-style Keynesian economists. But last month Mr. Krugman insisted that banks do not create credit, except by borrowing reserves that (in his view) merely shifts lending savings from wealthy people to those with a higher propensity to consume. Criticizing Steve Keen, who has just published a second edition of his excellent Debunking Economics to explain the dynamics of endogenous money creation, he wrote:

Keen then goes on to assert that lending is, by definition (at least as I understand it), an addition to aggregate demand. I guess I don’t get that at all. If I decide to cut back on my spending and stash the funds in a bank, which lends them out to someone else, this doesn’t have to represent a net increase in demand. Yes, in some (many) cases lending is associated with higher demand, because resources are being transferred to people with a higher propensity to spend; but Keen seems to be saying something else, and I’m not sure what. I think it has something to do with the notion that creating money = creating demand, but again that isn’t right in any model I understand.

Keen says that it’s because once you include banks, lending increases the money supply. OK, but why does that matter? He seems to assume that aggregate demand can’t increase unless the money supply rises, but that’s only true if the velocity of money is fixed…

But “velocity” is just a dummy variable to “balance” any given equation – a tautology, not an analytic tool. As a neoclassical economist, Mr. Krugman is unwilling to acknowledge that banks not only create credit; in doing so, they create debt. That is the essence of balance sheet accounting.

Mr. Krugman then doubled down on his assertion that bank debt creation doesn’t matter. People decide how much income they want to save or how much to borrow to buy goods that its stagnant wage levels no longer are enabling them to afford. Everything is a matter of choice, not a necessity (“price-inelastic” is the neoclassical euphemism):

First of all, any individual bank does, in fact, have to lend out the money it receives in deposits. Bank loan officers can’t just issue checks out of thin air; like employees of any financial intermediary, they must buy assets with funds they have on hand.

So how much currency does the public choose to hold, as opposed to stashing funds in bank deposits? Well, that’s an economic decision, which responds to things like income, prices, interest rates, etc.. In other words, we’re firmly back in the domain of ordinary economics, in which decisions get made at the margin and all that. Banks are important, but they don’t take us into an alternative economic universe.

As I read various stuff on banking — comments here, but also various writings here and there — I often see the view that banks can create credit out of thin air. There are vehement denials of the proposition that banks’ lending is limited by their deposits, or that the monetary base plays any important role; banks, we’re told, hold hardly any reserves (which is true), so the Fed’s creation or destruction of reserves has no effect.

“Your money or your life” is what banks mean when they say, in effect, “Take out a mortgage or go without a home,” or “Take out a student loan or go without an education and try to get a job at McDonald’s.”

This blind spot with regard to debt derails Mr. Krugman’s trade theory as well. If Greece leaves the Eurozone and devalues its currency (the drachma), for example, debts denominated in euros or other hard currency will rise proportionally. So Greece cannot leave without repudiating its debts in today’s litigious global economy. Yet Mr. Krugman believes in the old neoclassical nonsense that all that is needed is “devaluation” to lower the cost of domestic labor. Costs can “be brought in line by adjusting exchange rates.” the problem is simply exchange rates. That will reduce labor’s cost and other domestic costs to the point where governments can export enough not only to cover their imports, but to pay their foreign-currency debts (which will soar in depreciated local-currency terms).

If this were the case, Germany could have paid its reparations debt by de
preciating the mark in 1921. But it did – a billion-fold, and even this did not suffice to pay. Neoclassical trade theorists just don’t get this.

Blindness to the debt issue results in especial nonsense when applied to analysis of why the U.S. economy has lost its export competitiveness. How on earth can American industry be expected to compete when employees must pay about 40 percent of their wages on debt-leveraged housing, about 10 percent more on student loans, credit cards and other bank debt, 15 percent on FICA, and about 10 to 15 percent more in income and sales taxes? Between 75 and 80 percent of the wage payment is absorbed by the Finance, Insurance and Real Estate (FIRE) sector even before employees can start buying goods and services! No wonder the economy is shrinking, sales are falling off, and new investment and hiring have followed suit.

How will the government running a larger deficit cope with today’s dimension of the debt problem – except to enable states and localities to spend marginally more revenue and avoid further layoffs, while the military industrial complex steps up its “Pentagon capitalism”?

This is the problem not only the United States but also in Europe. Germany balks at bailing out Greece until it will streamline its bloated government and inefficient bureaucracy, stop tax evasion by the wealthy, clean up corruption and, in a word, be more Germanic. The U.S. “Austerian” budget cutters whom Mr. Krugman criticizes likewise can point to wasteful government spending, failing to distinguish positive infrastructure investment from “roads to nowhere” promoted by Congressional earmarks to the tax loopholes inserted by politicians whose campaigns are sponsored by special financial interests, real estate and monopolies.

But I fear that Mr. Krugman is being drawn into the gravitational pull of Rubinomics, a dark Democratic Party hole from which the light of clarity dealing with the debt issue and bad financial and legal structures simply cannot escape. The only variables he admits are structure-free: The federal government can spend more, and interest rates can be lowered (especially on mortgages) so that the higher debt overhead can be afforded more easily. No need to write it down. That extreme a structural solution lies outside the scope of his neoclassical economics.

The problem is that bank debt creation plays no analytic role in Mr. Krugman’s proposals to rescue the economy. It is as if the economy operates without wealth or debt, simply on the basis of spending power flowing into the economy from the government, and being spent on consumer goods, investment goods and taxes – not on debt service, pension fund set-asides or asset price inflation. If the government will spend enough – run up a large enough deficit to pump money into the spending stream, Keynesian-style – the economy can revive by enough to earn its way out of debt.”

That is the problem with neoclassical economics. It brainwashes students to treat all activity as current spending and consumption. Debt is left out of account.
Without recognizing its role, on cannot see that what is preventing American industry from exporting more is the heavy debt overhead diverting income to pay Finance, Insurance and Real Estate (FIRE) expenditures. How can U.S. labor compete with foreign labor when employees and their employers are obliged to pay such high mortgage debt for its housing, such high student debt for its education, such high medical insurance and Social Security (FICA withholding), such high credit-card debt – all this even before spending on goods and services?

In fact, how can wage earners even afford to buy what they produce? The problem interfering with the circular flow between producers and consumers (“Say’s Law”) is not “saving” as such. It is debt payment. And without writing down debts, the U.S. economy will shrink just as will those of Greece, Spain, Portugal, Italy, Ireland, Iceland and other countries subjected to the Washington Consensus of neoliberal austerity.

An article by law professor Linda Coco, “Debtor’s Prison in the Neoliberal State: ‘Debtfare’ and the Cultural Logics of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005,” (hat tip Michael Hudson) is a an informative, if disheartening, overview of the significance of the bankruptcy law reforms implemented in 2005.

Debtor’s Prison in the Neoliberal State

One might cynically observe that after 25 years of making it easier for consumers to borrow and encouraging them to load up, banks realized that they might have too much of a good thing and realized they needed to improve their ability to extract payments from the credit junkies they had created. But the passage of the 2005 law had been a prize the financial services industry had chased for over a decade. Credit card company MBNA (later bought by Bank of America) was one of the most aggressive backers of the bill. MBNA had penciled out that the new law would increase its profits $85 million a year, by extracting an extra $100 a month on average from consumers in bankruptcy.

As Coco points out, bankruptcy expert Elizabeth Warren said the new law would destroy the consumer bankruptcy system. It greatly restricted access to Chapter 7 bankruptcies (which apply all consumer funds, ex retirement accounts, to existing debts and wipes out the balance) and also made certain types of debt non-dischargeable, most important, student loans (note the change applied to private student loans). It also created hurdles to filing bankruptcy by making the process more costly: higher court charges and attorney fees, as well as requiring useless but borrower-paid credit counseling. As Jialan Wang noted in VoxEU, these changes increased the cost of filing for bankruptcy by 60%. She and her co-authors of a NBER paper found that this had the intended effect of inhibiting families from filing for bankruptcy, and getting an extra chunk of cash (they looked at tax rebates) led to an uptick in bankruptcy filings. She noted:

Liquidity-constrained households are likely to have the most to gain from bankruptcy, yet they are the ones screened out by high fees. Moreover, the increased costs do little to mitigate strategic behaviour such as OJ Simpson’s notorious purchase of an expensive home in Florida to exploit that state’s generous bankruptcy provisions.

This is only one piece of a bigger picture, and Coco sees the overall impact as a major shift between creditor and borrower rights, the creation of “debtfare”:

Under the guise of preventing abuse, BAPCPA imposes a litany of confusing procedures and requirements on consumer debtors and their counsel; therefore it contravenes the purpose of the 1978 Code which sought to provide debtors with a clean slate and a fresh start. BAPCPA destroys a “safety valve [for society] to deal with financial consequences of misfortunes,” and it undermines “one of the few areas of consumer law that works reasonably well to meet consumer needs.” BAPCPA successfully frustrates the operation of the 1978 Code, because it manifests fundamental changes in the class and power structures of the U.S. economy….

Free-market policy and the practice of deregulation facilitated enormous debt loads which resulting in a socio-economic experience of “debtfare”52 for the average American.53 Debtfare is interlocking payment obligations that last for years, such as mortgage payments, credit card payments, car loan payments, and other monthly debt obligations. Debtfare is a socially constructed trap. Political scientists Genevieve LeBaron and Adrienne Roberts explain debtfare as structures “that lock people’s current and future life choices and possibilities into unequal and unfree capitalist relations and limit their social and physical mobility within these relations.”54 BAPCPA supports the structures of debtfare by limiting the possibility of a discharge of debts and by regulating the manner, form and amount of debt repaid. By forcing repayment to lenders both inside and outside the bankruptcy system, BAPCPA mandates a lifestyle of austerity for middle class debtors. Thus, the insidious effect of BAPCPA is the creation of a large group of Americans servicing burdensome debts without any relief.

Consider how this works in practice. In the word before 2005, lenders had more incentive to restructure the debts of overextended individuals. Now the power has shifted decisively in their favor. While the original consumer bankruptcy law assumed the borrower was a good faith actor who had fallen on hard times, the 2005 revisions presume the stressed borrower is operating in bad faith, legitimating more punitive standards. It’s more costly for the borrowers in the most duress to file for bankruptcy. And the ones with higher incomes go into a 60 month straightjacket if they can work out a repayment plan. Those are based on budgetary norms from another planet. I recall learning in the mid 2000s (I had several tech friend who either had filed for bankruptcy or considered it) that the food expenditures allowed for a single person in Manhattan was $200 a month. The result is that many borrowers continue to struggle to pay make payments outside of bankruptcy and some file for bankruptcy (and not all make it through the more draconian repayment requirements).

Coco describes the overall impact:

BAPCPA’s impact on the middle class is effectuated in many areas. First, the Act seeks to re-moralize consumer debt relations and reignite and re-enforce notions of social stigma denying debtors access to a fresh start. Second, the Act creates increased fiscal and procedural barriers to entry for the consumer in financial distress. Third, once in the bankruptcy system, trap doors and pitfalls work to ambush the unwary or the unrepresented resulting in needy debtors falling out of the bankruptcy system and losing the protection of the automatic stay. Fourth, after the debtor survives the initial filing requirements, scrutiny of the debtor’s income and expenses to determine the disposable income and the kind of relief, if any, available to the debtor. Finally, BAPCPA reduces the “fresh start” benefits of bankruptcy by requiring repayment plans and reaffirmation agreements, making more debts non-dischageble, limiting dischargeability of debts, and limiting dollar amounts of exempt property. In effect, BAPCPA’s mandated austerity reduces the overall benefits gained from the bankruptcy process.

Borrowers can also simply stop paying lenders and wait out the statute of limitations in their state. But as we’ve observed in other posts, debt collectors are becoming far more aggressive, including finding ways to get non-payers jailed (not for the debt per se, but for failing to show up for a hearing, with the debt collectors often found not to have given proper notice).

Most members of what remains of the middle class view debt slavery as someone else’s problem, the result of greed or at best bad planning. But Elizabeth Warren’s research found that most bankruptcies were the result of job losses, medical emergencies, and divorce. It’s easy to be moralistic and not recognize that our hold on financial security is largely illusory. But the campaign to stigmatize borrowers in trouble has been effective, and it will take a concerted effort to rally citizens against the march of debt peonage.

At the Atlantic Economy Summit in Washington last month, Sheila Bair fielded a question about the just-released results of the latest bank stress tests. The former FDIC chief took pains to point out that they were an improvement over earlier iterations by virtue of keying off a truly dire economic scenario, but then ticked off a number of ways in which they fell short. One was in that they focused solely on credit risk, when historically, adverse interest rate moves have proven very effective in decimating the banking sector. Witness phase one of the savings and loan crisis, in which hasty deregulation and gimmickry in the early 1980s set up the crisis later in the decade, or the derivatives wipeout of 1994, in which an unexpected 25 basis point Fed funds increase created bigger losses than the 1987 crash, or the losses on US bond portfolios in 1997 and 1998, which among other things nearly wiped out Lehman.

The perils of interest rate risk have largely receded from memory since the US has been in a long-term disinflationary trend since 1983. But with rates at zero, we have nowhere to go but up from here.

Chris Whalen, in his latest newsletter, argues that this risk is even nastier than it might appear. One way of mitigating interest rate risk is by holding shorter-dated instruments. The reason is that the more back-weighted your payments are, the more exposure you have to changes in interest rates.

Investors measure this sensitivity via duration. There are somewhat different ways to measure it. One is the weighted average of payments. That gives you a result than under most circumstances is very close to the price sensitivity of a bond to interest rate changes. At “normal” interest rates, a current coupon bond of just under 10 years will have a 10% sensitivity to interest rate changes.

But, as Whalen points out, this all goes haywire when interest rates are super low. So much of the value is in the repayment of principal and so little in the intervening interest payments that it pushes duration out and increases interest rate risk disproportionately. That effect may be further compounded by the fact that banks are desperate for yield and with the yield curve flatish, they are likely to be extending the maturity of their assets.’And of course, anyone holding mortgages will see them extend, since refis will halt and home sales will probably be depressed, since higher interest rates mean more expensive mortgages, which all other things being equal, means lower home prices.

Whalen sets forth his concerns:

For a number of years now, US banks have been loading up on low yielding paper that is a function of the Fed’s efforts to reflate the US economy. Since many Americans are not able to refinance their home mortgage, the Fed’s efforts are not particularly effective, but we are not supposed to talk about housing. Banks and corporations have been able to refinance their debts, lowering interest expenses but also increasing the volatility – that is, the duration — of bonds and related swaps and options.

The trouble with low interest rates is that as coupons fall, the duration on a given bond lengthens exponentially. Whereas the duration on a Fannie Mae 5 or 6 can be measured and managed using traditional interest rate risk management tools, in a low or zero rate environments the effective duration on low or no coupon securities becomes so long and so difficult to manage that hedging becomes problematic.

Keep in mind that most banks today are seeking to maximize net interest margins on an interest rate book where the effective yield is falling. There is little incentive to lend cash or securities to other banks given that rates are zero, so banks simply place their excess cash into government and agency debt that has little cash flow yield and essentially infinite duration risk – risk that cannot be hedged.

“Of course, the banks also own a lot of duration…1.35 trillion of GSE MBS, notes one of the members of our mortgage finance discussion thread. “The Chinese had to sell to someone.” But such levity aside, the fact is that most banks are not even trying to hedge their interest rate books because cash flows on earning assets are so paltry. Thus as and when interest rates do rise, many larger banks that fund themselves in the markets will come under immediate pressure.

Now banks may be able to cover some of this up for a while. They may be able to put these low-yielding assets in a hold to maturity book (as they did in when similarly caught in the 1990s) which will spare them taking mark to market losses. But they’ll still lose money on an ongoing basis if they have assets that yield 3% that they are now funding at 5%.

A reader added another cheery thought via e-mail:

There is also a coming problem for HELOC borrowers – these loans will reset from interest only payments to principal and interest payments in the not too distant future. The HELOC interest only period was typically around 10 years, so that would put the reset dates in 2-3 years for a big chunk of bank portfolio HELOCs. Wells Fargo, in particular, also did a huge amount of convertible HELOCs – in a rising environment, borrowers could convert to fixed rate HELOCs, at the current market rate. This would have the effect of making the par valued variable rate loans convert to below par fixed rate loans for Wells, if rates rise significantly. If it happens at the same time that many of the same loans are also experiencing payment shock due to a conversion to P&I payments, that could get really ugly for Wells with big step ups in both duration and credit risk. Something to look forward to!

Indeed. Of course, if we’ve zombified our economy as well as Japan has, this day of reckoning may be very long in the making. And given the consequences to banks of leaving ZIRP, perennial zombification may be a feature rather than a bug.

By Delusional Economics, who is horrified at the state of economic commentary in Australia and is determined to cleanse the daily flow of vested interests propaganda to produce a balanced counterpoint. Cross posted from MacroBusiness.

Back in November last year I posted on my confusion over the jubilation shown by the citizens of Spain as they elected Mariano Rajoy as their new political leader. Mr Rajoy’s strategy during the election campaign was to say very little about what he was actually intending to do to address his country’s financial problems, preferring to simply let the incumbent party fall on its own sword so that he could take the reins. It became obvious soon after the election that, despite his party’s best efforts to dodge questions, the intention was simply to continue with even more austerity.

Since that post I have continually warned that although Spain is obviously a different country to Greece in regards to how its problems have manifested, it still faces significant macroeconomic challenges that were not being correctly reflected in the bond market.

…. Spain which I consider to be the major unrecognised problem. The country has seen its yields tumble since December on the back of the ECB’s 3-year LTRO but there hasn’t been anything in the economic metrics of the country to support such action. Spain has 23% unemployment and still rising, the banking system is under-capitalised and still has unknown exposure to the country’s housing market collapse. On top of that the rising unemployment rates is pushing up bad loans in the banking system to 7.4%, a 17-year high, and is still rising.

As I mentioned this week, since I made those comments bad loans have risen further , house prices have continued to fall and the government’s debt position has worsened.

So it should come as little surprise to MacroBusiness readers that overnight the bank of Spain announced that the country has now fallen back into recession:

Spain’s economy is suffering its second recession since 2009, the Bank of Spain said, obstructing the government’s efforts to reorder public finances as it prepares the budget for this year.

“The most recent information for the start of 2012 confirms the prolongation of the contraction in output in the first quarter of this year,” the Madrid-based central bank said in its monthly bulletin today.

Spain’s gross domestic product declined 0.3 percent in the fourth quarter of last year, less than two years after emerging from the last recession. Prime Minister Mariano Rajoy will present his 2012 budget on March 30, amid growing pressure from investors and European peers to rein in the deficit, which was 8.5 percent of GDP last year.

And so, once again, we see failings of economic logic creeping back into Europe. The reason that Spain’s economy is suffering is because the government sector is attempting to de-leverage in the face of the same behaviour from the private sector after the collapse of the Spanish housing market. You can obviously point to all sort of things that happened in the past and claim they never should have been allowed to occur. Where were the bank regulators? the macro-prudential oversight ? the fiscal policy in order to push against the housing bubble?. All good questions, but none of them change the fact that the Spanish economy is demonstrating its current behaviour because of the government sectors attempt to lower its deficit.

As I have explained previously in terms of national income, a country with a long running current account deficit has been borrowing goods and services from the rest of the world. In order to support this one, or both, of the non-external sectors of the economy will have expanding debt positions and due to this the economy tends to restructure around consumption over investment and production. Because the external sector is a net drain on capital from the country, the government and/or private sector must continually expand their debt in order to maintain economic growth.

In many cases this debt accumulation leads to asset bubbles, because the expanding debt drives asset prices which attracts speculation and in doing so accelerates the external borrowing. This in turn drives up national income, which in turn drives higher prices and further speculation. In the EuroZone, if either sector’s debt is accumulating faster than its income then at some point in the future a limit will be reached and the rate of debt accumulation will fall. This leads to falling asset prices and national income, which ultimately leads to a crisis as accumulated debts start to sour.

This is what we have seen in Spain. The private sector accumulated large debts on the back foreign capital inflows leading to a housing bubble. This bubble has since collapsed leaving the private sector in a position of significant wealth loss and indebtedness, the banking system holding significant and growing levels of bad debts and the economy structured around the delivery of a failed industry.

Prices for Spanish homes fell 3.4 percent in the first quarter from the previous three months as the euro area’s fourth-largest economy shrank and reduced mortgage lending crimped demand, according to Idealista.com.

Sellers cut asking prices for existing homes by an average of 2.9 percent in Barcelona, 1.9 percent in Madrid and 2.2 percent in Valencia, Idealista, Spain’s largest property website, said in an e-mailed statement today.

“Prices have continued to fall due to difficulty in obtaining mortgage financing,” said Fernando Encinar, co- founder of Idealista. “Legislation passed by the government in February to push banks to provision for real estate will result in similar declines over the remaining quarters of the year.”

Prime Minister Mariano Rajoy is battling to turn around a slump in the real-estate industry. His government forecasts an economic contraction of 1.7 percent this year that will push Spain’s unemployment rate, the European Union’s highest, to 24.3 percent. The government passed a decree in February forcing Spanish banks to make deeper provisions for losses linked to real estate in an effort to push down prices and boost sales.

The growing unemployment is leading to a slowing of industrial production, which means that even though the country is importing less it also appears to be exporting less. Combine this with the interest payments on borrowings from the rest of the world and at this point Spain continues to run a current account deficit which, in the most basic terms, means Spain is still paying others more than it is being paid back. That is, the external sector is still in deficit.

So with the external sector in this state and the private sector unable and/or unwilling to take on additional debt as it attempt to mend its balance sheet after an ‘asset shock’, the only sector left to provide for the short fall in national income is the government sector. If it fails to do so then the economy will continue to shrink until a new balance is found between the sectors at some lower national income, and therefore GDP.

It may appear logical to you that this must occur, and I don’t totally disagree, but that doesn’t change the fact that under these circumstances there is simply no way that the private sector will be able to continue to make payments on the debts it has accumulated during the period of significantly higher income. This is a major unaddressed issue.

This is why we continue to see a rise in bad and doubtful debts in the Spanish banking system which, under direction from the Government, banks continue to merge.

Spain’s biggest bank in terms of assets has been created after CaixaBank bought Banca Civica for 977m euros ($1.3bn, £817m). The government has amended laws to encourage mergers between banks, many of which collapsed following the bursting of the property bubble.

Banca Civica itself was formed by combining four troubled “cajas”, or regional savings banks. The merged bank will have 14 million customers.

CaixaBank will have 342bn euros in combined assets, deposits of 179bn euros and loans totalling 231bn euros, the bank said. The CaixaBank deal will be completed by the third quarter and will generate cost savings and other benefits of 540m euros by 2014.

The problem is that, apart from economies of scale, merging banks doesn’t actually help that much because impaired assets don’t suddenly disappear. The other issue is that Spanish banks have been large users of the ECB’s 3 year LTRO facility which means they have continued to load up their balance sheets with their own countries sovereign debt in order to participate in the carry trade.

It is quite possible, as I explained above, that the LTRO was masking the true value of those sovereign bonds and that Spanish banks have made a terrible decision by making those purchases. Here are the current 10 year yields for Spanish government bonds, courtesy of Bloomberg:

If yields continue to rise, and I see no reason to discount this possibility, then Spanish banks are eventually going to have to front-up more capital to cover those ECB loans. Where exactly is this going to come from?

And so I am starting to get a bit of deja vu.

The eurozone’s public debt crisis is not over despite calmer financial markets this year, the OECD said on Tuesday, with a warning that the bloc’s banks remain weak, debt levels are still rising and fiscal targets are far from assured.

As the eurozone heads into its second slump in just three years, the Organization for Economic Co-operation and Development (OECD) said the 17-nation area needed ambitious economic reforms and there could be no room for complacency.

“Market confidence in euro area sovereign debt is fragile,” the Paris-based economic think tank said in a report on the state of the eurozone’s health. “The outlook for growth is unusually uncertain and depends critically on the resolution of the sovereign debt crisis,” it said.

….

OECD chief Angel Gurria has called for “the mother of all firewalls” – some 1 trillion euros – but finance ministers look more likely to agree to a level nearer 700 billion euros.

I’m sure we’ve been here before.

I bet JP Morgan wishes it never hired Linda Almonte.

American Banker has released the first in what will be a series of stories on debt collection abuses by the New York bank. It confirms critics’ worst accusations against the financial services and belies Jamie Dimon’s tiresome assertions that JP Morgan is better than its peers. Dimon may still be right if you think excelling in abusing and extorting customers is commendable.

The American Banker story discusses the operations of a unit that handled delinquent credit card borrowers. Handling these accounts involved using three different computer systems that communicated reasonably well on current borrowers but not with delinquent or defaulted ones. As a result, the operation had involved a high level of manual checks to make sure the amounts borrowers owed were accurate before they were sent off to collection (which in high population states, was an in-house operation, but for most, involved the use of outside law firms.

In 2008, JP Morgan installed new management in the San Antonio operation that oversaw ligitigation, including the verification of borrower information. Edmond Helaire came in as the lead, and the story makes clear that his newly hired deputy Jason Lazinbat went on a campaign to improve results, procedures be damned. Linda Almonte, who was a process specialist who had worked at WaMu, joined in 2009 and was fired, as she charged in a wrongful termination lawsuit, for refusing to send files to collection that has obvious problems in them. Almonte filed a whistleblower complaint with the SEC in 2010 (see an Abigail Field story for more detail). Her charges:

1. Chase Bank sold to third party debt buyers hundreds of millions of dollars worth of credit card accounts. . .when in fact Chase Bank executives knew that many of those accounts had incorrect and overstated balances.

3. Chase Bank executives routinely destroyed information and communications from consumers rather than incorporate that information into the consumer’s credit card file, including bankruptcy notices, powers of attorney, notice of cancellation of auto-pay, proof of payments and letters from debt settlement companies.

4. Chase Bank executives mass-executed thousands of affidavits in support of Chase Banks collection efforts and those Chase Bank executives did not have personal knowledge of the facts set forth in the affidavits.

Now I’d not expect the SEC to know what to do with this (as in these are not securities law issues) and I don’t know whether she tried complaining to the FTC or the OCC then. However, the American Banker story quotes current and recent employees who confirm that he bad practices that Almonte called out are still very much alive. Specifically:

“We did not verify a single one” of the affidavits attesting to the amounts Chase was seeking to collect, says Howard Hardin, who oversaw a team handling tens of thousands of Chase debt files in San Antonio. “We were told [by superiors] ‘We’re in a hurry. Go ahead and sign them.’”…

The records the law firms used to sue people sometimes differed from Chase’s own files at an alarming rate, according to a routine Chase presentation prepared by Almonte and later submitted to the Securities and Exchange Commission. Some law firms’ records disagreed with Chase’s in almost 20% of cases sampled, a rate far above what is regarded as an acceptable level of errors.

“That’s horrendous,” says a former Chase attorney who was informed of the numbers by American Banker…

Borrower correspondence sent to the San Antonio facility, such as bankruptcy notifications, address changes, and hardship requests were being dropped on an unmanned desk, according to a 2009 printout from Chase’s troubleshooting log….

“I understand there were documents trashed, yes,” she says. [Carol] McGinn retired from the San Antonio facility in June of 2010 after she says she became uneasy with how it was being managed.

And of course, there are robosigners too:

One of Chase’s most prolific affidavit signers was Ruben Alcaraz… By law, collection affidavits require the signer to be familiar with the bank’s pertinent records…

Numerous former employees say that Alcaraz and his colleagues rarely if ever reviewed such files. They routinely signed stacks of affidavits on flights and in meetings, which in some cases were attended by Helaire, Lazinbat and Chase compliance staffers. Nobody objected, Almonte and others say.

Alcaraz also describes himself in the court documents as an “officer of the bank” and an “Assistant Treasurer.” High-level Chase management had instructed the staff to stop signing documents using such titles around the middle of the last decade, four Chase sources say. But Lazinbat ordered them to do it anyway.

One has to assume that Almonte signed a confidentiality agreement as part of the settlement of her suit against JP Morgan. Yet it appears she had decided to step forward again despite the risk of having an army of lawyers come after her:

“This is not an accident anymore,” Almonte now says. “The same people who created this problem at Chase are still in charge. They aren’t going to fix it unless they’re forced to.”

Let’s hope she succeeds. She’s right, of course. The fact that JP Morgan kept Lazinbat in place said it had no intention of shaping up. And one has to assume that the occasional warnings from on high that he should be doing some things differently were seen as pro forma. Put it another way: if the see-no-evil-if-it’s-done-by-bank OCC is taking this case “very seriously,” it’s likely to be every bit as bad as the American Banker account suggests.

One of the common complaints from banks that the concerns raised by borrowers over robosigning are mere “paperwork” problems, that everyone who is foreclosed on deserved it, and no one was really hurt. That is patently false, as there have been an embarrassing number of instances where someone with no mortgage was foreclosed on, as well all too many cases of servicer-driven foreclosures. And that’s before we get to damage to property records.

Attorney Timothy Fong called our attention to a below the radar form of chicanery that is predictable when you have nonjudicial foreclosure with no significant oversight and agents who lack incentives to do a good job. To some translate of the account below, MFRS = Motion for Relief of Stay. Even though a bankruptcy is supposed to hold all creditors at bay until the court sorts out what to do (which in a Chapter 13 is to develop a payment plan), servicers typically harass the borrower by filing Motions for Relief of Stay, which is a fancy of saying, “I want the house now.” If the borrower has hired a competent BK attorney, he can beat it back (although this still wastes the borrower’s by definition scarce funds). But a lot of people hire friends or family that are not BK savvy, and the banks hope to trip them up (either by not responding to the filing, or by signing a document in which the servicer agrees not to file future Motions for Relief of Stay, but which includes some innocuous looking but hugely detrimental provisions).

You need to read the part I boldfaced to see how widespread this sort of bankruptcy hijacking has become. And notice further how this works: the fraudsters pretend a person in bankruptcy owns a property that isn’t his. Not only does the financially stressed borrower have to incur costs to clear this up, but he also is at risk of being construed to be a participant in the scheme. From a recent post in Los Angeles Bankruptcy Law Monitor.

Local attorney Gerald McNally, Jr. of McNally and Associates, P.C. explains the mechanics of a bankruptcy hijacking:

The mechanics of the hijacking and why we as Debtors’ Counsel are burdened with this plague:

1. a random deed is downloaded from the county recorder’s database (through access to a title company or a service like Dataquick).

2. The original information on the deed is photoshopped out, and the fraudulent information is photosshopped in—leaving the original county recorder’s filing imprint, and the notary stamp.

3. This is then presented to the foreclosure trustee as evidence to stop the sale.

4. Where the fault lies is that neither the Lender, nor the Title Officer of the title company guaranteeing the trustee’s sale does what he/she/it ought to do.

5. What the Bank/T.O. OUGHT to do is take the instrument number of the deed and look it up. This is very easy to do with either the Ticor or the other major database. Then it would be easy to determine if the document was genuine. And if the document was not genuine, reject the deed and complete the foreclosure.

6. Instead, the Bank/T.O. just ASSUMES the correctness of the false deed and then contacts Debtor’s Counsel; now this pile of “doo doo” becomes the Debtor’s Counsel’s problem, and must almost be handled unpaid.

7. Compounding the crime, Counsel for the Lender, often files its MFRS with the false deed, a patent violation of Rule 9011. Even after being advised by Debtor’s Counsel with evidence that the false deed is in fact patently false.

8. So the bankruptcy system is burdened by (1) the laziness and/or cowardice of the lender and/or title company, not to mention their counsel who file these baseless MFRS documents.

9. In fact, counsel for one lender admitted that 30% of the deeds used as a basis for these MFRSs were fraudulent.

So get this: the procedures are so bad that totally bogus documents can be created and slipped into the bankruptcy of an innocent victim to stop foreclosure sales. Even worse, the servicer, who OUGHT to know better, treats this person in BK who suddenly materialized out of nowhere from his perspective as a real owner and hits him with a motion for relief of stay so they can take a house from him that he never owned. And the foreclosure mill lawyers don’t question this because more motions of relief of stay means more fees.

If this example wasn’t such a serious indictment of our system, it would serve as a black comedy in bureaucratic incompetence.

By Philip Pilkington, a writer and journalist based in Dublin, Ireland

While I was writing on the unsustainability of the haircut deals yesterday, the peripheral bond markets in Europe rallied. My argument was that when other countries started getting uppity and demanding haircuts, European government bond investors would slowly but surely come to realise that they were the ones on the end of the hook and that politicians didn’t give a damn about them. This would eventually result in their piling out of the bond markets, sending yields into the stratosphere. The ECB would then be forced to step in and buy up bonds in the secondary market – or perhaps do something even more responsible, who knows?

And indeed, as the Greek deal began to solidify, Ireland quickly joined the queue:

Ireland would see any European Central Bank contribution to the restructuring of Greek debt as a precedent that would boost Dublin’s efforts to ease the burden of its own sovereign debt, the country’s finance minister said on Wednesday.

In the meantime, however, the markets for peripheral company and bank debt rallied – and rallied rather hard at that. The FT reports:

For all the uncertainty over Greece, Europe’s bond markets have been rallying strongly. Now the ‘risk on’ sentiment has spilled over into markets for company and bank debt, with investors snapping up a wave of bond issues from Italy, Ireland and Spain.

Of course, this isn’t the European government bond markets; this is just company and bank debt. And we can’t expect investors get nervous until they start seeing governments in countries like Portugal rattle the cage and demand a haircut. But still, some explanation is surely needed.

Is it that these investors are stupid? Well, we should never assume stupidity when easy moneymaking might be involved. And that, of course, is precisely what’s happening here. Per the FT:

Bankers say that the European Central Bank’s €489bn injection of much-needed liquidity through a three-year loan programme into Europe’s financial system not only provided unlimited and cheap funds to the region’s banks but helped to lure cash-rich investors back into the public bond markets, and those of so-called peripheral eurozone nations in particular.

Sorry, what? Let’s hear that again:

Torsten Elling, co-head of the European rates syndicate team at Barclays Capital, says that the ECB’s so-called longer-term refinancing operation has convinced investors to look at higher-yielding assets again. “The door is open for covered and senior unsecured bond issues in the periphery. There’s definitely demand from investors and that’s been driven by the LTRO.”

Aha! Of course! It’s the ECB bailout that is facilitating this bond market rally. Investors grab the LTRO funds and bang them into high-risk assets, while at the same time investors are told that they’re going to get burned in the Greek bond market.

Naked they came from their mothers’ womb, and naked they shall depart. The Troika gave and the Troika has taken away; may the name of the Troika be praised!

Yesterday I claimed that the Eurocrats had not thought their strategy through; I said that they had not considered how bond markets would react when more haircuts became inevitable and began to be demanded by other countries. Was I wrong? Is there indeed a master plan? Is the LTRO the mechanism by which this master plan is launched?

No. I don’t think so. The LTRO bailout fund will not stem the tide in this regard. The key problem is that this is not a liquidity crisis, but a solvency crisis. And it is not a solvency crisis in the typical sense, but a solvency crisis of a group of sovereign states that don’t use their own currencies.

The LTRO cannot make up for the fact that countries such as Ireland and Portugal do not issue their own currency and are being starved for funds by their de facto central bank, the ECB. This is for the simple fact that, as a BCA Research reports said recently (via WSJ blog):

The ECB’s LTROs can solve the banks’ refinancing needs for the next few years if they choose to take advantage. [But] the LTROs’ effect on peripheral sovereign debt is only indirect and is subject to the banks’ fickle appetite for risk.

The LTRO then, has a few functions. The most obvious is to keep the banking system operating while the Eurocrats continue to spit fire on the economies of the periphery and, in doing so, greatly increase the risk on these very banks’ holdings of sovereign debt. Tied to this, the Eurocrats can walk daily into the same room as the bankers and the financiers and not get shouted at for ruining their portfolios. Oh, it’s a wonderful life!

Yet people would be misled if they thought that this was, at heart, a nefarious banker-driven scheme. No, the bankers are being kept wriggling on the hook like everyone else. They’re just being fed rather well.

At heart this is, as it always has been, a political problem. And it must be said that, disgusting and ruthless though it all is, those that are pulling the strings are doing a rather good job at balancing all those political forces – like the bankers and the financiers – that might have the power to actually hold them accountable for their destructive and reckless actions.

But the situation remains a house of cards. And once other peripheral countries, squeezed hard in the vise of austerity, begin to demand the haircuts that are all but inevitable, those same bankers and financiers will look back to Greek default and remember just how important their interests really are relative to the naked political desires of those in power.

This Real News Network segment was recorded before the deal was announced today, but the observations are still germane.

Amar Bhide, a former McKinsey colleague, one-time proprietary trader, and now professor at the Fletcher School, takes a position in the New York Times today that goes well beyond Volcker Rule restrictions. He argues that all financial deposits need to be guaranteed, and as a result, what is done with those deposits needs to be restricted severely.

I could not have said this better myself:

Relying on the Fed and other central banks to counter panics is dangerous brinkmanship. A lender of last resort ought not to be a first line of defense. Rather, we need to take away the reason for any depositor to fear losing money through an explicit, comprehensive government guarantee. The government stands behind all paper currency regardless of whose wallet, till or safe it sits in. Why not also make all short-term deposits, which function much like currency, the explicit liability of the government?

Guaranteeing all bank accounts would pave the way for reinstating interest-rate caps, ending the competition for fickle yield-chasers that helps set off credit booms and busts…

Banks must therefore be restricted to those activities, like making traditional loans and simple hedging operations, that a regulator of average education and intelligence can monitor. If the average examiner can’t understand it, it shouldn’t be allowed. Giant banks that are mega-receptacles for hot deposits would have to cease opaque activities that regulators cannot realistically examine and that top executives cannot control. Tighter regulation would drastically reduce the assets in money-market mutual funds and even put many out of business. Other, more mysterious denizens of the shadow banking world, from tender option bonds to asset-backed commercial paper, would also shrivel.

These radical, 1930s-style measures may seem a pipe dream. But we now have the worst of all worlds: panics, followed by emergency interventions by central banks, and vague but implicit guarantees to lure back deposits.

Go read the op ed in full. And circulate it widely. We are past the point of half measure when it comes to banking.

By Michael Olenick, founder and CEO of Legalprise, and creator of FindtheFraud, a crowd sourced foreclosure document review system (still in alpha)

The National Association of Realtors (NAR) has announced that their estimates for home sales have been materially incorrect since 2007, and that they plan to restate the number of homes sales downward. Apparently the NAR derives their homes sales information from the Multiple Listing Services, the proprietary “want-ads” real-estate agents use to list houses for sale.

Their error stems from several causes, but one of the biggest is overestimating the number of people who sell their homes without a real-estate agent. During the height of the housing boom many people skipped real estate agents, and their 6% commissions, opting to sell houses on their own.

I can see how some people would have decided to skip an agent back then. When I moved from CA to FL in 2005, I went on a weekend vacation with the family, left the house with a real estate agent for an open-house, and came back to nine bids, all well above asking price. I was amazed, but also wasn’t sure what the real estate agent did since my former house obviously sold itself.

NAR took the number of people who came to this same realization, and projected many people were selling homes without real estate agents. They ignored one small factor — the national housing collapse — and the apparently difficult to infer fact that when houses became harder to sell more people hired real estate agents. They also used old Census data to project population trends and they didn’t factor in changes based on consolidation in the MLS market. In other words, they massively blew it.

NAR data is the sole benchmark for existing home sales in the monthly scorecard released by the Dept. of Housing and Urban Development (HUD), under supervision of the White House. As of Nov., 2011, the NAR statistics are the exclusive measure used to measure existing home sales, a vital component used by government agencies, banks, economists, and others to gauge the health of the housing market. Additionally, the data has been cited by the Dept. of the Treasury and various branches of the Federal Reserve.

My own data, derived from sales and mortgage information filed at the courthouse, showed that the NAR figures were wrong. So did data from CoreLogic, a title insurance spin-off based in CA that works on real estate data, who also takes their data from court records. Court records are the best source of real estate data, because any definitive move in real property requires a filing at the courthouse.

I asked colleagues at other companies in my industry and every one of them — from my tiny FL-based one to giant behemoths — uses courthouse data. We all knew that the NAR data was incorrect. Banks must have known, Fannie Mae and Freddie Mac, with their large portfolios of real-estate, surely must have noticed that their properties weren’t selling. It seems impossible that the small army of economists employed by the Federal Reserve could have overlooked the error. Some of us complained but nobody listened because the NAR data was presumed to be definitive. If ours was different, then ours must be incorrect, even if all of ours showed the same trend.

I’m regularly asked to analyze, comment on, or write about trends in housing and foreclosure data. But this week’s non-surprise from the NAR brings up a deeper issue; the methods used to compile that data. Besides home purchases, which isn’t really something I focus on, I’ve found some reports about foreclosure filing estimates to be wildly off.

Last week I wrote that Bank of America had transitioned from filing Countrywide foreclosures as “BAC Home Loans” to “Bank of America.” My analysis about their reason for doing so was the crux of the article. But it’s also noteworthy that there were a number of materially incorrect articles published about an enormous “surge” of filings by BOA when, in fact, there was an increase but most of the “surge” came from changing the name under which they file.

That is, people saw “Bank of America” filings spike, but didn’t notice “BAC Home Loans” filings declined. I spoke to a couple reporters that wrote those stories. They verified the corresponding decrease with county officials, but nobody ran a correction.

It’s not only backwards-looking data collection that’s questionable. My systems wade through a morass of garbage generated by poorly written bank and law firm computer systems chock-full of obvious errors.

One of my colleagues is Prof. Linda Allen, Chair in Banking & Finance at Baruch College of business, at CUNY. Prof. Allen is a long-time academic who understands finance, and especially real estate finance. Her long list of publications speak for themselves; she’s a genuine expert in the field. She predicted the real estate bust in academic papers long before it came along, and I’m fortunate to have her using my data for some of her research.
I ask Prof. Allen when I’m stumped about finance questions. Most of her answers are along the lines of “Michael, you know that language is a swap to hedge against daily LIBOR fluctuations” (um .. yep .. I knew that). But she was more straightforward when asked why the data collection systems at banks suck.

“Someone high on the food chain in one of the biggest banks admitted to me that they were not being paid to do the back office stuff,” Prof. Allen wrote. “You have to understand the disdain on the street for the operational end of the business. I wrote an article entitled ‘Revenge of the Back Office Nerd,’ that states that this inattention to the back office brought down the entire system.”

I know that banks hire great software engineers, but I also know that they’re more likely to end up creating quant-trading systems than writing operational software. But you’d think that with amounts of money swooshing around the system one of them would stop downstairs to take a peek, if for no other reason than to ensure that the data their systems use for trading is accurate.

One of President Obama’s planks surrounded data transparency; making sure that regular people had access to the information that affects their lives. Part of the meltdown in the derivative markets was a lack of transparency, which exists to this day. We still don’t have a full list of the loans Fannie Mae owns, despite that Freddie Mac has been publishing this data, albeit in a difficult to aggregate manner, for years.

Finance is difficult, and hitting an iceberg is bad. But hitting one because somebody thought a lowly looking should wear blinders, because they weren’t worth of enjoying the view, is worse. The NAR fiasco is our big and already injured ship scraping needlessly and perilously close to disaster. There’s a possibility that when their revisions are released we’ll know that, in hindsight, we should have made different decisions than we did.

Even if we manage to escape disaster we should take this mess as a warning. Let’s demand open, honest, full disclosure about data, data collections, and collection methodologies from any organization generating information used to build public policy.

The Eurocrats finally seem to have realized time is running out. The abrupt market downdraft of last week appears to have focused their minds on the need for a much larger scale rescue mechanism of some form, with numbers like trillions attached, and that will move the Eurozone further towards fiscal integration, another badly needed outcome.

Your truly, along with a lot of the English language press, seems to have misread the resignation of Jurgen Stark from the ECB as a Bundesbankian repudiation of sorts. Instead, it’s a sign that Germany realizes its interests lie in preserving the Eurozone. Per Marshall Auerback:

Most of the ‘blame the Mediterranean profligates rhetoric we’ve been hearing has been diversionary, to draw local attention away from the fact that Germany’s hardcore Bundesbankers are losing this battle. .

The pan-Europeanists are the ones who will support a coordinated response to financial issues, not coincidentally because this will be the only way to retain existing benefit levels once some sovereigns and the banks exposed to them go soft.

Stark’s replacement, Asmussen, is an SPD guy and even though he makes all of the same hawkish noises, he’s not as hard-line as Stark.

Remarks from Angela Merkel over the weekend confirm that the Germans understand full well that they can’t afford a Greek exit:

Merkel rejected Greece leaving the euro area, saying that “we can’t force it, but I don’t believe in that in any case” because it would send a signal to financial markets that attacks on euro-area sovereigns can succeed.

“Maybe Greece leaves, the next country leaves and then the next country after that,” she said. “They would speculate against all the countries.” A small group of euro countries would be left at the end, deprived of the euro’s advantage as the currency appreciates, she said.

Thus Germany is going to pass its version of the TARP on Thursday, which is legislative approval of increased powers of the EFSF, which looks like a sovereign bailout device but is really a “save the French and German banks” vehicle.

The problem is now that the European elite finally realizes it needs to Do Something Big, Fast, political timelines look way out of synch with market demands. As Wolfgang Munchau notes:

The debate has focused entirely on what cannot be done rather than what can – no eurozone bond, no monetisation, no bail-out, no break-up, no this, no that. As the world is discussing the next crisis resolution steps, the European authorities are still struggling with the implementation of the ratification of the rather minor changes to the EFSF agreed by the European Council on July 21, or the perverse debate about Finland’s request for collateral. European policy has been constantly lagging behind.

This will continue. On Thursday, the Bundestag will vote on the EFSF. In October, it will vote on the next loan tranche for Greece. In the new year, it will vote on the European stability mechanism, the successor to the EFSF. By then it may have to vote on a third Greek programme, as the second, not yet ratified, programme is already way out of date. There may be second programmes for Portugal and Ireland as well. Each, of course, will require a separate vote in the Bundestag.

Berlin, however, is not the only source of uncertainty. Parliamentary majorities are melting in Helsinki, The Hague, Bratislava – and Athens. Do we really believe the Greek government can implement one austerity plan after another with a majority of five seats?

So even if Europe’s leaders were to come together tomorrow and agree on all the necessary steps to end the crisis, they would not have solved it until they could demonstrate that they enjoyed full political support. That is unlikely to be the case for a while yet.

And this presupposes they can agree on what to do. The supposed experts, the banksters, are in disarray as to remedies. From Bloomberg:

Wall Street leaders, urging coordinated action from world governments to solve the European sovereign-debt crisis, struggled themselves during four days of meetings in Washington to agree on what’s needed to end it.

The chiefs of firms including JPMorgan Chase & Co. (JPM), Goldman Sachs Group Inc. (GS), Deutsche Bank AG (DBK) and Societe Generale (GLE) SA met for three hours at the National Archives on Sept. 23. They differed on which government and private solutions may restore confidence in European debt and banks, and on some elements of regulation

In one sense, this result isn’t surprising. In fact, it’s bizarre to have US CEOs, who aren’t all that expert in a lot of the issues, try to come up with a solution (normally, you have staffers work to define issues and possible solutions, and have the CEO meetings ideally be ceremonial, or if necessary, to try to make headway on contested issue.

Their anxiety and desire to, um, help, is no doubt due to the number of shoes that might drop in the near future. From the New York Times:

“The next three weeks are absolutely critical, and they can still stabilize the markets, but I wouldn’t tell my clients to put money to work until we see it,” said Rebecca Patterson, chief market strategist at J.P. Morgan Asset Management. “As we stand right now, European policy makers have gotten well behind the curve. It’s not about the periphery anymore; it’s about the core, too.”

A fresh indicator of market confidence in European borrowers will come as Italy sells billions of euros in bonds this week, culminating on Thursday. Weak demand at an auction on Sept. 13 brough global worries about the safety of Italian debt, which stands at a whopping $2.3 trillion, making Italy one of the world’s largest borrowers.

What is more, Italy’s debt load equals 120 percent of the country’s gross domestic product. In Europe, only Greece is in worse shape, with debt totaling roughly 150 percent of G.D.P.

In addition, the Greek Parliament must vote this week on a recently proposed property tax increase that is seen as a test of whether the country will stick to past promises to tighten its belt.

Greece is also trying to show its austerity program is enough to qualify for an aid payment due in October.

And if that isn’t nervous making enough, past agreements may come unglued. Again from the Times:

Under a deal worked out in July, European banks agreed to take a 21 percent loss on their holdings of Greek debt as part of a restructuring that would give Greece more time to pay back what it owes, but now it appears political leaders in Germany and elsewhere want the banks to take a bigger hit.

Wolfgang Schäuble, Germany’s finance minister, suggested as much in a tough speech delivered to international bankers at the Institute for International Finance over the weekend. He argued that because of their bad lending decisions, bankers shared the blame for Greece’s predicament and should also share in the cost.

“Without a substantial contribution from financial institutions,” he said, “the legitimacy of our westernized capitalized systems will suffer.”

But Josef Ackermann, chief executive of Deutsche Bank and the chairman of the Institute for International Finance, quickly rejected any effort to renegotiate what had been agreed to in July. “It is not feasible to reopen the agreement,” he said.

No wonder the big banks are freaked out. These rescues, after all, are really to save their hides.

And if that isn’t discouraging enough, Paul Krugman reminds us that even if the Eurozone officialdom manages to cobble together a big enough rescue vehicle and get it passed, this is still just a bigger, better, kick the can down the road strategy that in the end will fail. These maneuvers fail to address the underlying problem of German’s high level of exports within the Eurozone, and reliance on austerity rather than growth strategies (and writedowns) to help reduce debt level in periphery countries:

Think of it this way: private demand in the debtor countries has plunged with the end of the debt-financed boom. Meanwhile, public-sector spending is also being sharply reduced by austerity programs. So where are jobs and growth supposed to come from? The answer has to be exports, mainly to other European countries.

But exports can’t boom if creditor countries are also implementing austerity policies, quite possibly pushing Europe as a whole back into recession.

Also, the debtor nations need to cut prices and costs relative to creditor countries like Germany, which wouldn’t be too hard if Germany had 3 or 4 percent inflation, allowing the debtors to gain ground simply by having low or zero inflation. But the European Central Bank has a deflationary bias — it made a terrible mistake by raising interest rates in 2008 just as the financial crisis was gathering strength, and showed that it has learned nothing by repeating that mistake this year.

As a result, the market now expects very low inflation in Germany — around 1 percent over the next five years — which implies significant deflation in the debtor nations. This will both deepen their slumps and increase the real burden of their debts, more or less ensuring that all rescue efforts will fail.

And I see no sign at all that European policy elites are ready to rethink their hard-money-and-austerity dogma.

This is all looking hopelessly ugly. I keep trying to remind myself this would make for great theater if we all didn’t have a stake in the outcome. But that line of thinking does not provide as much solace as it should.

As much as the dot com era conditioned US individual investors to focus on stock market movements, credit markets are where the real action lies. Deterioration in the bond markets almost without exception precedes stock market declines (although debt instruments can also send out false positives). In the stone ages of my youth, the rule of thumb was a four-month lag. In 2007, that guide was not at all bad. The bond market turn began in June 2007 (yours truly took note of it then, see here for the critical development, but was not convinced it was the Big One until corroborating data came in in July). The stock market obligingly peaked in October 2007.

Now given the extraordinary degree of government interventions, turns are not as obvious, market upheavals have repeatedly been beaten back, and relationships between stock and bond market price movements are likely to be less reliable than in the past. But one thing that is a clear danger signal is liquidity leaving the banking system. It’s like the preternatural calm when the water leaves the beach, revealing much more shore than usual, before the tsunami rolls in.

A very good overview at the end of last week by the International Financing Review highlighted one clear danger sign: many mid tier banks in Europe are unable to get funding in interbank markets and are increasingly dependent on the ECB. The whole piece is very much worth reading. Key extracts:

Bankers who once ran the now-defunct repo facilities for medium-sized European banks say the credit lines were withdrawn after risk managers became concerned about their own exposure to the unfolding sovereign debt crisis, leaving some clients now solely reliant on central banks for cash….

The closure of traditional credit lines is a clear sign that concern about European sovereign debt has infected the region’s banks. Many in the region are big holders of the debt of their respective governments. According to the EBA stress tests published in July, the 90 banks it surveyed held a total of €326bn in Italian government debt, €287bn of Spanish public debt, and €215bn of French debt.

“Everyone has been cutting their exposure,” said the head of another European investment bank. “It started with Greece, then Spain and now Italy. People don’t want to do business with these banks. Many of them have good underlying businesses, but they are stuffed.”…

For many, the European Central Bank is now the last remaining source of liquidity. Under its open market operations – brought in during the depths of the crisis to pump liquidity into the region’s banks – its member central banks provide unlimited repo financing against certain eligible assets.

Demand for that money has been picking up of late, as banks feel the squeeze of dry private credit lines. Earlier this week, the Italian central bank said lenders asked for €80.5bn of liquidity during July, almost double what it had provided only a month earlier, in a sign of banks’ deteriorating finances.

Total use of the ECB’s main refinancing and long-term refinancing facilities – both part of the open market operations – are now close to €500bn, up from about €400bn in the spring.

FT Alphaville also took up the theme of Eurobank financing stress, citing Morgan Stanley analyst Huw van Steenis, who points out that the 5 year CDS of Eurobanks are trading wider than they did in 2008 and provided this cheery chart:

And the journalist from (Graham) Greeneland, John Dizard, also points that the system is close to going into a critical state:

Not that there’s a European banking crisis just yet. We can see how close we are coming, though. As US money market funds cut back on their European exposures, even the best European banks have to fill the gap by borrowing euros short term from the ECB, and swapping those into dollars. Last week the cost of that process for large banks reached between 80 and 85 basis points. Measuring that against the 100 basis point penalty rate for the Federal Reserve dollar swap facility with the ECB, the system was about 15 or 20 one hundredths of 1 per cent away from a crisis.

Dizard also points out that the Eurozone isn’t prepared to enter into broad scale bank recapitalization programs; they’ll have to take place on a country by country basis. Yet he argues that the concerns are still overdone, for the Fed would ride to the rescue with swap facilities in a crisis, so US money market funds can keep their funding of Eurobanks (via repos) in place.

Yet it does not appear that money market funds are all that sanguine. They’ve been pulling back from European banks for a while; the dry up of funding to medium-sized banks described in the IFR article is in part due to their newfound caution. And one can’t forget how public hostility can impede action. The reason the authorities didn’t bail out Lehman was that it was politically unacceptable to do so. And I’m not saying a rescue was the right answer, but relying solely on a private sector solution and not considering a resolution or a good bank/bad bank structure was remarkably short-sighted. Here again, a failure to appreciate the downside may again lead to sluggish responses and tactical rigidity that could prove deadly in a crunch.

One of the reasons the economy continues to be mired in high unemployment is the lack of hiring by small businesses, which have been the engine of job growth in the US for the last decade. In the last expansion, the largest companies shed jobs, and that trend has gotten only worse as a result of the crisis. Not only are giants like Cisco cutting headcounts, but the heretofore-insulated-from-bad-things-by-your-tax-dollars big banks are following suit. And not surprisingly, recent surveys of new businesses show they remain cautious about hiring.

Needless to say, if companies can’t afford to hang on to the staff they have, that certainly isn’t a plus for the economy. The use of pawn shops by small enterprises to make ends meet is likely to be one step before the end of the rope.

Many small businesses make use of credit to finance inventory or to cover short term funding needs. Credit cards are a major source of financing to small companies who are not big enough or long enough established to qualify for business loans.

Small businesses took it on the chin early in the downturn as credit card companies slashed credit lines on credit cards in an indiscriminate manner (many cut everyone in zip codes that showed large housing price declines; Advanta, which was focuses solely on small business, failed; American Express dropped its two credit line products aimed at business owners). As the recession continues, a sign of continued distress is the use of pawn shops, the traditional banks to the least bank-worthy, to help these enterprises make payroll.

I wonder if a culprit is delays in getting paid. I’m seeing that happen in my space. The big ad agencies are dickering over invoices from publishers to a previously unheard-of degree and will hold up an entire payment, which consists of many items (different ad placements from different advertisers) over a single item they’ve decided to question. In addition, some have also formally gone to 90 day payment. I am told this is not driven by the advertisers but is an effort by the agencies to improve their own cash flow.

From CNN Money (hat tip reader Valissa):

Squeezed by tight credit and tempted by record high gold prices, small business owners are finding an alternative to the bank: the pawn shop.

More than half of the customers at online pawn shop, Pawngo, are small business owners, said Todd Hills, CEO of the Denver-based company.

“These guys can’t wait. They have businesses. They have employees they need to pay,” said Hills, who launched Pawngo in June. “This is a great way to solve a short-term need.”..

With pawning, there are no applications, credit checks or dings to the credit report if the customer defaults on the loan. “You can still bring your stack of papers into the bank, it doesn’t guarantee you will get a loan,” said Hills.

While individual consumers may walk into a pawn shop with a couple hundred dollars worth of jewelry looking for cash to fill up the gas tank or the refrigerator, small business owners tend to come in with more expensive items, said Ray Shaffman, a salesman at Gables Pawn and Jewelry in Miami.

Gables Pawn and Jewelry has seen customers come in with watches made by Rolex, Cartier and Patek Philippe. It pays between $5,000 and $10,000 each for them, said Shaffman.

“To make payroll is the number one reason” small business owners come to the shop, said Shaffman. “They don’t have enough flow, enough cash, to pay their employees. And they got to pay their employees. Otherwise, they have much more complicated problems.”

I wish I knew the terms of these loans. I would assume the interest rates are extortionate and the loans are overcollateralized by a large margin. This is a high touch form of lending, so the charges, both explicit and hidden, have to cover the transaction costs.

In general, going to the pawn shop is a desperate measure, and seeing it depicted by CNN as not unusual among small business owners is another sign of the severity of our economic woes.

Not only is Obama assuring that he will go down as one of the worst Presidents in history, but for those who have any doubts, he is also making it clear that his only allegiance is to the capitalist classes and their knowledge worker arms and legs.

You don’t need to go further than the first page of today’s New York Times for proof. The Grey Lady has realized rather late in the game that automatic stabliizers and emergency programs have been propping up the economy, and the fact that they are soon to disappear will be more than a bit of a downer. Apparently it is now OK for Pravda to make that shocking revelation from Moody’s (the source of the key data in the article) because the budget debate is so far advanced that the executioner has already started the downward swing of his axe; the only question is whether he will get a clean kill of the average citizen’s economic wellbeing or whether it will be a protracted, messy death. From the New York Times:

An extraordinary amount of personal income is coming directly from the government.

Close to $2 of every $10 that went into Americans’ wallets last year were payments like jobless benefits, food stamps, Social Security and disability, according to an analysis by Moody’s Analytics. In states hit hard by the downturn, like Arizona, Florida, Michigan and Ohio, residents derived even more of their income from the government.

By the end of this year, however, many of those dollars are going to disappear, with the expiration of extended benefits intended to help people cope with the lingering effects of the recession. Moody’s Analytics estimates $37 billion will be drained from the nation’s pocketbooks this year.

The article also points out that people who are on the verge of being broke typically need to spend the money they get from the government as quickly as they receive it, which leads to a high multiplier effect, estimated at 2:1. Duh!

Other self inflicted wounds are just as bad, however:

In terms of economic impact, that is slightly less than the spending cuts Congress enacted to keep the government financed through September, averting a shutdown.

The other front page article, appallingly, shows Obama, rather than the Republicans, pushing for $4 trillion in deficit cuts:

Mr. Obama, meeting with leaders from both parties at the White House, bluntly challenged Republicans a day after Speaker John A. Boehner pulled back from a far-reaching agreement aimed at saving as much as $4 trillion over 10 years, officials briefed on the negotiations said. The meeting ended after an hour and 15 minutes with little progress, but the two sides agreed to resume talking Monday, and every day after that, until a deal is done.

White House officials said Mr. Obama was still determined to pursue the boldest package possible — one that would require new tax revenue as well as cuts in Medicare and other entitlement programs — but he faces steadfast opposition from Republicans and growing qualms among Democrats.

And per Politico, suddenly the Republicans are looking comparatively sane:

House Minority Whip Steny Hoyer is likening the current battle over whether to raise the debt ceiling to the 2008 bailout of Wall Street.

Though he conceded that it may be a “bad analogy,” the No. 2 House Democrat said the passage of the Troubled Asset Relief Program under President George W. Bush was an instance where Congress came together to act amid an economic crisis.

“It was a Republican president, a Republican secretary of the Treasury, and a Republican-appointed head of the Federal Reserve asked a Democratically led Congress to act because the administration said we had a crisis and the alternative of not acting would be catastrophic,” Hoyer said Wednesday to reporters.

“My suggestion to my Republican friends is that they do the same,” he added…

Congress needs to act with that same urgency now, he said, to raise the $14.29 trillion debt ceiling.

“If Congress has the will to do so, we could pass a debt limit extension within 24 hours,” he said. “We need to come to an agreement … Republicans need to put everything on the table.”

Even knowing how dedicated to bad ends Obama is, I still feel like I’ve walked into a parallel universe. He’s now determined to make these horrific entitlement cuts a sign of his manhood. This is “Change” for sure, to a more brutal, grasping, dog eat dog society, all administered by self serving elites. They will in the end reap the whirlwind they are creating, but not before it mows a path of destruction through our social order.

Oregon judges have delivered a series of setbacks to servicers and securitization trusts. A recent decision, Hooker v. Northwest Trustee Services, ruled that assignments of the beneficial interest (as in, transfers of the note) needed to be recorded. That makes any foreclosure in the name of the mortgage registry MERS a non-starter, since MERS was never and could never be the holder of the beneficial interest. This will have little impact going forward, since MERS has instructed servicers to stop foreclosing in its name, but there are plenty of foreclosures in the pipeline that were initiated in the name of MERS.

The latest move is that Judge Grand reversed a foreclosure sale due to the failure of the parties representing the lender to satisfy the requirements of Oregon’s recording statute. To put it mildly, foreclosure actions are seldom reversed. The decision is terse but it has wideranging ramifications. The Oregonian provided a good write-up of the case. Key extracts:

A Columbia County judge has blocked U.S. Bank from evicting a Vernonia woman whose home it purchased in foreclosure, concluding in a case with far-reaching implications that her lenders had not properly recorded mortgage documents.

Last week’s action appears to be the first in which an Oregon judge has halted an eviction and declared a foreclosure sale void after the fact. The ruling, if it stands, raises questions about the validity of other recent foreclosures in the state and could create serious problems for lenders and title companies, as well as for buyers of such properties…

A U.S. Bank spokeswoman said the bank would cease further eviction action and assess its “appropriate next steps.”

Nearly all foreclosures in the state occur without a judge’s involvement under so-called nonjudicial proceedings. But this ruling, legal observers say, could potentially divert more foreclosure actions into courtrooms, a more time-consuming and costly proposition that could exacerbate the state’s housing slump.

“This will certainly be problematic for lenders,” said David Ambrose, a Portland real-estate attorney.

It also casts doubt on the validity of already completed foreclosure sales in which lenders resold mortgages without recording the sales in county recorder offices. Many of those questionable transactions, including Flynn’s, involve the Mortgage Electronic Recording System….

The path will remain muddled for the mortgage industry until a definitive case reaches the Oregon Supreme Court or lenders decide to take a different strategy and negotiate settlements with distressed homeowners, real estate attorneys say.

The article has the background of the case and makes clear that this is a qualified win for the borrower, since it is unclear who has title to her condo. She bought it 20 years ago (and therefore has equity in the property) but fell behind on payments after she quit her job and her new business proceeds plus other sources of income weren’t enough for her to stay current.