A Grim Outlook for the Eurozone?

Ambrose Evans-Pritchard, who has been consistently alarmed about Europe (and often charged in comments of going overboard in general, and on this topic in particular) sounds a particularly loud alarm on Europe, based on the view that the ECB has not eased enough.

I have limited insight here. I have been told that German banks are clamping down hard even on very sound Mittelstand borrowers, and the Mittelstand companies are the German growth engine. I was also just in Europe in June, well before the peak of tourist season, in cities along the Rhine and Danube. I saw far fewer signs of visible distress than in New York, meaning no homeless (that may not be a valid indicator, between social services and policy possibly shooing them away) and no shuttered retail stores (while vacancies are pretty high throughout Manhattan). And the streets and stores all looked pretty busy, although I have no benchmark for what normal activity would be.

The one thing we may discount in our assessment of the responses of most European countries to the crisis is that they have far greater automatic stabilizers than we do, Germany, for instance, has generous unemployment programs. So with their high level of automatic stimulus, fewer discretionary measures are needed.

That does not speak to the adequacy of the overall effort, particularly on the monetary front, which Evans-Pritchard addresses.

From the Telegraph:

Without a radical change of strategy, the ECB risks pushing the weakest states into a debt-compound spiral that can only end in bond crises and/or the disintegration of Europe's monetary union – whichever comes first.

The International Monetary Fund says the eurozone will contract by 4.8pc this year, worse than the UK (-4.2pc) or the US (-2.6pc). The deepest damage will occur next year as Europe remains mired in slump, even as the rest of the world recovers. It is the length of recession that matters most for jobs, social stability, and public finances. I am not easily shocked any longer but I did sit up when Spain's budget chief Luis Espadas said the economic collapse could "easily" push Spanish public debt to 90pc of GDP by 2011. This is up from 36pc in 2007.

Nobody knows where the tipping point lies on public debt, though anything above 100pc of GDP in a currency union is courting fate. Some are already there. The European Commission says Italian debt will jump to 116pc in 2010. Greece is vaulting back to 109pc, Belgium to 101pc, France to 86pc.

Even German finances are falling apart.....Berlin says the deficit is heading for 6pc next year, taking debt to 82pc. This is happening all over the world, of course. But the ECB is compounding the effect, whether for reasons of politics, Bundesbank fetishism, or misjudgment. By refusing to join the US, Japan, Canada, Britain, and Switzerland in quantitative easing (QE) the ECB has allowed a contraction of private credit this summer. The M3 "broad" money supply has shrunk since February.

Ignore M3 at your peril. It flashed awarning signal in the US months before the collapse of Lehman Brothers last September; it is flashing the similar warning signals in Europe now.

Professor Tim Congdon from International Monetary Research said the eurozone money figures are "horrifying" and portend a serious crunch ahead. "My verdict is that the senior people in the ECB [and the Fed] have little organised understanding of the debt-deflationary processes initiated in late 2008," he said.

Ireland's M3 contracted at a 30pc annual rate last month, a death sentence for a hyper-indebted economy...

In Germany, the Mittlestand lobby (BVMW) says half its members are facing a liquidity squeeze, while the strutting finance minister, Peer Steinbrück, has assumed a ghostly pallor. "We must take seriously the threat of a credit crunch in the second half of this year," he said.

Mr Steinbrück has called for a suspension of the Basel II accounting rules in order to rescue banks, and even suggested that the German government undertake direct lending to boost credit. The regulator BaFin has already told us that bad debts are set to "blow like a grenade" this year. A leaked BaFin memo said "problematic" assets have reached €816bn (£700bn), led by Hypo Real with €268bn.

ECB experts think eurozone banks will have to write down a further €203bn by the end of next year. Yet ECB policy-makers seem unwilling to face the implications. Yes, they have injected €442bn in a one-year tender, but the money is not reaching the economy. Simon Ward from Henderson New Star said the ECB is repeating errors made in Japan when it first trifled with QE, relying on banks to pass on credit rather going for massive bond purchases.

Inevitably, Europe's politicians are taking matters into their own hands. They will not sit idly by as millions lose their jobs. If the ECB deflates, budgets must bear the strain, and that is exactly what Europe cannot afford with a birthrate of 1.53 per woman and the onset of demographic decline. The commission says the number of workers per pensioner over 65 will halve from four to two by 2040. Age-related costs will explode by 15pc of GDP in Greece, 9pc in Ireland, Spain and Holland. The populations of Germany and Italy will soon be shrinking.

Viewed strategically, Europe's mix of monetary deflation and rampant deficit spending by the states is nothing short of lunatic.
Needless to say, Britain faces it own colossal mess, but of a different kind. It is the Prime Minister who is taking the country over a cliff, not the Bank of the England. Voters will soon have the joy of sacking him. How do Europe's voters sack the ECB?

Guest Post: There Will Be No Recovery

Submitted by Jesse of Le Café Américain

"The banks must be restrained, and the financial system reformed, and balance
restored to the economy, before there can be any sustained recovery."

Often a closing comment from our blog, essentially this is what Robert Reich is saying in his recent essay on the economy.

The median wage must generally increase for consumption to resume, and for this to happen the heavy taxes of the financial sector and the oligarchs on the real economy must be lowered significantly in proportion to its size.

There is reason for pessimism that this can happen voluntarily. I have come to the conclusion that there is a pathological drive in some small portion of the population to acquire and control and devour rather than consume, even to their own destruction.

The law sets limits on the speed on highways to protect the many from the reckless and willful behaviour of the few. That we ought not to set limits on the banking system is a remarkable bit of speciousness.

There are obvious questions of how to limit, and how to detect and prevent and prosecute violations, but few can argue that not regulating traffic is the best solution to the difficulty of the task. The comparison of highway regulation to economic commerce and financial transactions is more valid than obtuse. And there are many Wall Street bankers guilty of at least manslaughter in this most recent episode of reckless defiance of the common good for the sake of personal profits.

The comparison of this latest epidemic of bad economic behaviour is strikingly reminiscent of the Gilded Age at the end of the 19th century and the Roaring 20's. As you may recall both periods were followed by economic dislocation and a world in flames.

Why we allow this sort of bestial behaviour to ravage the many, in the mistaken support of 'free markets,' where nothing these people touch can remain free and effective and efficient for long, is truly an accomplishment of propaganda and those blinded by ideology.

Robert Reich
When Will The Recovery Begin? Never.
Thursday, July 09, 2009

The so-called "green shoots" of recovery are turning brown in the scorching summer sun. In fact, the whole debate about when and how a recovery will begin is wrongly framed. On one side are the V-shapers who look back at prior recessions and conclude that the faster an economy drops, the faster it gets back on track. And because this economy fell off a cliff late last fall, they expect it to roar to life early next year. Hence the V shape.

Unfortunately, V-shapers are looking back at the wrong recessions. Focus on those that started with the bursting of a giant speculative bubble and you see slow recoveries. The reason is asset values at bottom are so low that investor confidence returns only gradually.

That's where the more sober U-shapers come in. They predict a more gradual recovery, as investors slowly tiptoe back into the market.

Personally, I don't buy into either camp. In a recession this deep, recovery doesn't depend on investors. It depends on consumers who, after all, are 70 percent of the U.S. economy. And this time consumers got really whacked. Until consumers start spending again, you can forget any recovery, V or U shaped.

Problem is, consumers won't start spending until they have money in their pockets and feel reasonably secure. But they don't have the money, and it's hard to see where it will come from. They can't borrow. Their homes are worth a fraction of what they were before, so say goodbye to home equity loans and refinancings. One out of ten home owners is under water -- owing more on their homes than their homes are worth. Unemployment continues to rise, and number of hours at work continues to drop. Those who can are saving. Those who can't are hunkering down, as they must.

Eventually consumers will replace cars and appliances and other stuff that wears out, but a recovery can't be built on replacements. Don't expect businesses to invest much more without lots of consumers hankering after lots of new stuff. And don't rely on exports. The global economy is contracting.

My prediction, then? Not a V, not a U. But an X. This economy can't get back on track because the track we were on for years -- featuring flat or declining median wages, mounting consumer debt, and widening insecurity, not to mention increasing carbon in the atmosphere -- simply cannot be sustained.

The X marks a brand new track -- a new economy. What will it look like? Nobody knows. All we know is the current economy can't "recover" because it can't go back to where it was before the crash. So instead of asking when the recovery will start, we should be asking when and how the new economy will begin. More on this to come.

Links 7/12/09

Elephant carwash raises zoo cash BBC

Searchers shovel Northwest dirt seeking giant worm Associated Press (hat tip reader John D)

Geithner: Too soon to decide on more stimulus Reuters. Obama is too chicken to go to Congress, so we'll leave this operation to Helicopter Ben.

To Control Bubbles, the Fed Must First Control Itself David Merkel

When Will The Recovery Begin? Never. Robert Reich

Ed Lazear on the Stimulus Package Menzie Chinn, Econbrowser,IEven a takedown is probably attention more than Lazear warrants.

Ben Stein Has Not Heard of Global Warming Dean Baker. Same issue as Lazear...

"Trumped by Darwin?" Mark Thoma

Guest Post: China Panic Tyler Durden (hat tip reader yves d)

Toxic Equity Trading Order Flow on Wall Street Sal L. Arnuk and Joseph Saluzzi (hat tip reader Barbara)

Have a Problem With Paying Attention to the Details, Ms Fiorina? TobyWollin, Firedoglake (hat tip reader John D)

Freddie Buys in its Sub Debt – Heinous! Bruce Krasting

Antidote du jour:

Guest Post: Review of Barry Ritholtz's "Bailout Nation"

Submitted by Richard Smith, a somewhat jaded capital markets IT professional, aviator and amateur mathematician who lives in London. He has been watching the capital markets from the sidelines for over twenty years. He frets over his ducklings, and should probably get out more.

The indefatigable Barry Ritholtz is a fund manager and TV talking head: one of the few CNBC regulars who made sense during the 06/07/08/09 financial crisis. As if that wasn’t enough day jobs, he also is also the author of the blog “The Big Picture”, one of the top finance/economics blogs. Perhaps he wasn’t quite in the vanguard of prophets of doom, but he caught on pretty fast and blogged about it from ’06 onwards.

The blog’s hallmarks are a pungent style (sometimes ribald), irascible disdain for unevidenced assertions of all kinds (especially, partisan ones and trolling), a hapless love for enormous graphical charts, and a knack for apposite quotation and concise summary. Ritholtz is, if you like, a serial producer of soundbites that have content. With some training in law and mathematics, he has good background for making sense of the crisis in the markets. Oh, he talks about his fund on the blog from time to time, but that’s only to be expected, and you really couldn’t call it hard selling.

Evidently that’s still not enough hats for him, since in ’08, with the financial crisis just getting into its stride, he embarks on a high level economic history of the US from 1791 to the present, covering the early incarnations of the Federal Reserve, the Depression, the manufacturer and railway bailouts of the 70s and 80s. Its (sadly) rare perspective is that it is all written from a moderate Republican viewpoint (be suspicious of the Federal Reserve, see bankruptcy as a natural and desirable aspect of capitalism, concede that well-functioning free markets do need some kind of regulation, admit that there were some good things about the institutions established as part of the New Deal). It is a plausible and detailed story to a non expert like me. Dealing with the slow demise of the automakers, he gives a perhaps excessively concise summary of American car design and manufacturing quality post war (“…shit…”).

Then in August ’08 he realises that he is fundmanaging, talking-heading and blogging his way through a crisis that will give him a once-in-a-lifetime seam of subject matter, so he switches to a more-or-less real time chronicle of events, and manages to conclude at just the right time, in March ’09, with the first phase of the crisis at an end.

So how does finance blogging’s master of the soundbite shape up on a bigger canvas? Not too badly, in the circumstances. The change of focus leaves the first few chapters of economic history dangling somewhat. Is the moral hazard idea strong enough to link the bailout of Lockheed with the bailout of AIG? Well, it could do with more elaboration than it gets here. Still, the structural sacrifice is well judged: he is pretty much first to market with a colourful narrative of ’08, some shots at identifying a set of causes and culprits, a takedown of some common red herrings, and a somewhat hazy initial verdict on the outcome of the massive state interventions that will keep American financial markets ‘free’. Ritholtz is blessedly unencumbered by the quintessential American Protestant hypocrisy that what you call a thing matters more than what it is. With so much self-serving obfuscation around, this really matters.

The narrative is pretty good. Somewhere the piece on the Fannie and Freddie collapse got lost or remodelled but the rest of the highlights are there – the fantastic outbreak of greed, fraud and delusion in the housing market and in the financial markets; the monolines, Countrywide, Bear, Lehman, AIG, Citi, BoA/Merrill, the rating agencies, the TARP and its predecessors and successors. The global perspective is largely ignored, but it’s a minor omission; perhaps, though, rolling in more instances of bank folly from overseas would have provided ready counters for some of the more parochially American ideas about the root causes of the crisis.

Looking for deep analysis of causes (psychological, moral, political, economic) in a book constructed on the fly like this is a fool’s errand. Nor does Ritholtz have much to say about the details of key crisis mechanisms: the shadow banking system, the modern versions of banks runs via prime brokerages; he skips the technicalities of the various financial innovations that contributed to the crisis (off balance sheet vehicles, CDOs, CDS); nor does modern financial theory put in an appearance. Instead he sticks to an ordinary, except very very enormous, story of folly and greed. He gives us a list of people and institutions that are to blame. Of course a screw-up on this heroic scale takes many hands to bring it off, so the environment is target-rich; Ritholtz’s list is so long that his bounteous ire is expended on many targets and the impact is diffused. There just isn’t enough indignation to go round – a fact which, in the wider world, and aided and abetted by many who are quite content with the status quo ante, is already taking any momentum there might have been out of moves towards large scale reform of the financial system.

Consistent with Ritholtz’s line in the early chapters, Alan Greenspan is his chief villain, for his 20-year history of large scale market interventions via interest rate manipulation (all the while insisting that state intervention in markets was deplorable), his aggrandizement of the Fed’s role, his increasingly evidently witless insistence that enlightened self-interest makes regulation unnecessary. Next up is the Fed itself, then the arch-deregulator Phil Gramm; then it’s the ratings agencies, and the SEC. The list goes on and on and on though, so you will have to buy the book to get the picture. One point Ritholtz highlights, that I haven’t seen beaten to death anywhere else, is the remarkable fecklessness of institutional bond and equity holders, these days far more preoccupied with hitting their benchmarks than with corporate governance. Maybe overt and closet indexing really has had the dire effect on management scrutiny by shareholders that was predicted for it twenty years ago. Bank equity is treated as option money by holders, who shrug. Bank bondholders buy CDS, and shrug. Bank capital is treated as option money by bank employees, who shrug. Management have their cumulative bonuses and severance terms – you can guess what their shoulders are doing. This set-up didn’t end well in 09 and won’t next time, either.

Two comments on the deregulation piece of Barry’s rant.

First, the demise of Glass-Steagall. Ritholtz sees this as kicking off Citi’s foray into universal banking; in fact it is more of a belated recognition of the status quo. American banks have been trying to end-run Glass-Steagall for a long long time. London’s Big Bang was an early straw in the wind: in 1986 Bank of America, Chase and Citi were buying up not very good UK securities trading firms at silly prices, because they could establish roughly Anglophone subsidiaries in an overlapping time zone doing something completely forbidden in the US. There is regulatory arbitrage, by God. Incidentally, London is still trading off its ability to be 5% sleazier than the States: witness the location of AIGFP and ofthe world HQ of the hedge fund industry. Anyhow, with a precedent established, courtesy of Big Bang, Citi could buy SSB confident that its legal path would be smoothed. As it was – and be damned, inter alia, to the proper functioning of FDIC, whose charter becomes unworkable when you have universal international banks trading in securities. Now we have ‘too big to fail banks’ – Barry for once has little to say about the self-serving contradictoriness of this construct, wherein a bank can attain a sort of critical mass and is henceforth exempted from any kind of market discipline, and can always depend on a bailout. This is not free-market capitalism: it is a one way bet that must end up lethal for nationalfinances at some point. It is therefore alarming to see any restructuring of these not-so-dormant financial supervolcanoes (proliferating after the BoA/Merrill and JPM/Bear/Wamu mergers) moved so quickly and firmly off the reform agenda.

Secondly, elsewhere in the book, Ritholtz highlights a little mentioned clause in the Securities Litigation Reform Act of 1995 that effectively eliminates liability for fraud from the accountants who audit companies. Presumably that wouldn’t have made it into the books if there wasn’t a pre-existing concern among the well connected and legally liable. But it is a green light for much worse: within two years Jim Wadia is at the controls in Andersen, and they are willing to sign off any old books and dream up any old accounting wheezes. Within 6 years you have WorldCom and Enron. 10 years later you have the full blown financial-economic nirvana of off balance sheet entities of banks, whereby the bank derives the economic benefits of risky loans without (apparently) actually owning the risks. In the meantime company accounts mean little, the audit means nothing, and the auditors are actually conniving at frauds (see Satyam). The spectacular repudiation of commercial good practice, integrity, honesty and responsibility embodied in this legsislation means that it definitely belongs in Ritholtz’ list. As if the dominance of the Big Four accounting firms wasn’t bad enough in itself, this legislation’s implications for the level of integrity we can look for in corporate conduct in future years are discouraging. AA won the race to the bottom; how far behind were the others? I can’t help wondering whether Phil Gramm has something to do with this piece of law. Its relevance to the situation at Enron, where Gramm was deeply connected, is striking.

Ritholtz and red herrings: one of the eye-catching features of this crisis has been the underperformance of the traditional print and TV media: miles behind the game by and large, and mostly a source for a proliferation of self-serving red herring explanations served up by gormless media hacks. One-year Naked Capitalism vets will remember that in the run-in to the Lehman bankruptcy, Yves, whose idea of an exotic portfolio seems to involve adding a few Ginnie Maesto the predominant T-Notes and T-Bills, was suddenly portrayed as a ruthless short seller propagating negative rumours about Lehman for profit. Lehman, meantime, was supposedly in great shape and terribly hard done by. Well, none of that was exactly right, it turned out, quite quickly. In a good chapter, Barry deals briskly with some of these useless memes: Mortgage Interest Deduction, Naked Shorting, Fannie and Freddie, and (a particular hot button issue for Barry), the CRA, now incomprehensibly resuscitated by the usually more astute John Carney.

Ritholtz had his own run-in with red herrings, and won: his pretty uncontroversial attack on the practices of the rating agencies appears to have led his first publisher, McGraw-Hill, a subsidiary of ratings agency Standard and Poors, to start making difficulties with publication. No Chinese walls there, eh? McGraw Hill underestimated their author, and made the fatal error of suggesting to Ritholtz that the reason for cold feet was that the claims in the book were poorly documented, leaving them with nowhere to hide when, as readers of his blog might have expected, he came up with 30 closely written pages of references. They are still in the book and are a nice set of primary sources, at least if the web links last for a bit – Barry, take local copies! Anyhow, Wiley stepped up and that particular exercise in truth suppression failed. What an indictment of American publication practices that episode is. But what an advantage to be able to blog about it...

Ritholtz includes a table of the bailout monies committed to the rescue – it is particularly salutary to be reminded of theabsurdly easy terms of the recapitalization of Citi. What a rip-off – one more giant subsidy conducted, with brazenimpudence, in the name of free markets.

Some vague talk of ‘unintended consequences’ is as much as he’s prepared to vouchsafe about the expected outcome of these and other fantastic and largely involuntary acts of largesse from the American taxpayer. He’s no macroeconomist (is that a drawback?). Lastly there are suggestions, variously non-surprising or wacky, from his blog readers about what to do about the mess. Despite the rapid drafting, the index is actually useful – nice touch – some behind the scenes work there.

So – does Ritholtz give us a convincing synthesis of the root causes, and a clear view of what may happen next? Not really; but that’s asking a bit much in the timescales available to him. Any really first rate trainwreck just needs a run of uncorrected errors, that needn’t have anything to do with each other. We can certainly see a run of mistakes in the historical record of the last 25 years. Greed and illusion, unleashed by deregulatory dogma and regulatory somnolence? It will be interesting to see what diagnosis and prognosis Yves comes up with.

In the mean time, you can refresh your memory of events, source your references, have a go at rebutting fatuous partisan claims, and enjoy scathing commentary, choice phrases, and juicy quotes, with ‘Bailout Nation’.

"The Fed Under Fire"

The summary of this video (hat tip reader Barbara):

The Federal Reserve is one of the most powerful and secretive institutions in Washington, long considered beyond the reach of lawmakers. But now, as details emerge of how the Fed secretly doled out more than a trillion dollars during the financial crisis, a rare bipartisan movement in Congress demands that the Fed be held accountable.

It also features William Greider, author of Secrets of the Temple. Enjoy!