Halloween

Why Ponzi finance has always failed. TPC, referencing Richard Koo.


A few from Paul Krugman:
More on Friedman/Japan. & The moral equivalent of stagflation. & Accounting identities. & Sex and drugs and markets' role.

October 29

Misguided love affair with China; China's massive monetary expansion and crack-up boom. Mish.

The problem with QE2. Comstock Partners.

POMO still matters. Jim Bianco.


I wouldn't normally be this liberal in extensively excerpting from another author's post, but the IRA's weekly letter is only freely available for one week, after which time it goes behind a subscription firewall, and I thought this post worthwhile enough to have recorded:
Triple Down: Fannie, Freddie, and the Triumph of the Corporate State. Chris Whalen, IRA.

Despite examples of the success of restructuring with F and even General Motors, the invidious cowards who inhabit Washington are unwilling to restructure the largest banks and GSEs. The reluctance comes partly from what truths restructuring will reveal. As a result, these same large zombie banks and the U.S. economy will continue to shrink under the weight of bad debt, public and private. Remember that the Dodd-Frank legislation was not so much about financial reform as protecting the housing GSEs. Because President Barack Obama and the leaders of both political parties are unwilling to address the housing crisis and the wasting effects on the largest banks, there will be no growth and no net job creation in the U.S. for the next several years. And because the Obama White House is content to ignore the crisis facing millions of American homeowners, who are deep underwater and will eventually default on their loans, the efforts by the Fed to reflate the U.S. economy and particularly consumer spending will be futile. As Alan Meltzer noted to Tom Keene on Bloomberg Radio earlier this year: "This is not a monetary problem."
Indeed, the public embrace by the Federal Open Market Committee of further quantitative easing or "QE", instead of calling for the immediate restructuring of the largest zombie banks, actually threatens to push the U.S. into a deeper and far more dangerous economic path. According to the Q2 2010 Bank Stress Index survey conducted by IRA and our review of the Q3 2010 earnings results, the financial condition of smaller lenders is actually improving. While the FDIC now has over 800 banks on its troubled list, the righteous banks for which we currently have "positive" outlooks in The IRA Advisory Service are showing better earnings and less credit stress.
Part of the reason for the improvement is that the FDIC and state regulators have taken a very hard line with smaller banks, pushing many into resolutions and distressed asset sales. But for the healthy lenders that survive and investors that buy failed banks, there will be a lot of money left on the table -- profits that will come back into earnings via recoveries and other windfalls and help to boost the private economy. Resolution and liquidation is how a free market economy regenerates. The trouble is, the approach taken with the large banks and the GSEs is precisely the opposite of that applied to smaller lenders. The policy of the Fed and Treasury with respect to the large banks is state socialism writ large, without even the pretense of a greater public good.
Forget Treasury Secretary Tim Geithner lying about the relatively small losses at American International Group (AIG); the fraud and obfuscation now underway in Washinton to protect the TBTF banks and GSEs totals into the trillions of dollars and rises to the level of treason. And the sad part is that all of the temporizing and excuses by the Fed and the White House will be for naught. The zombie banks and GSEs alike will muddle along until the operational cost of servicing bad loans engulfs them. Then they will be bailed out -- again -- or restructured....
So why did our BSI measure show rising stress in Q2 2010? Over the past several years, the large zombie banks actually looked better on our BSI survey than the average, this due to overt subsidies, QE and low interest rates. But now the larger lenders are sinking under the weight of rising servicing costs, falling asset returns and other problems linked to mortgage securitizations. So while the Fed continues to try to revive the largest banks via massive monetary ease, the FOMC is at the same time preparing to do further damage to solvent lenders, insurers and other investors via QE2.
The IRA has spoken to a number of executives in banks and life insurance companies about the impact of QE and Fed zero interest rate policy on their income statements and balance sheets. The universal message: If rates do not return to "normal" levels by year-end, the pain in terms of reduced earnings on assets and the resultant negative cash flow will start to become so apparent that the financial markets will actually notice. In particular, we have been told that by year end several of the largest publicly traded banks and life insurers could show significant declines in net interest earnings due to QE -- declines driven by falling net interest income that may provoke ratings downgrades. And when this next systemic crisis comes -- whether in December or later in 2011 --- the full blame will belong to the members of the Bernanke Fed and the Obama Administration.....
Walter Bagehot believed that central banks should lend aggressively in times of financial insolvency, the rate of the loans should be very high -- not zero as is the current FOMC policy. John Hussman wrote: "Bagehot's name has surfaced in a few editorials in recent weeks, but they have invariably focused on the "lend freely" portion of his advice, while overlooking Bagehot's admonition to impose costs, capital requirements, and other safeguards where public funds are concerned. In short, liquidity should be available to Fannie Mae and Freddie Mac, but the interest rates charged should be very high."
Of course the problem of adopting Bagehot's rule regarding high real credit costs is that you immediately expose all of the insolvent financial institutions -- including the US Treasury. This the Obama Administration, Treasury Secretary Geithner and the functionaries on the FOMC will not do. But the examples of Ford, GM and the smaller banks in the U.S., most of which have restructured without bankruptcy, suggest that the path to economic renewal requires reorganization and losses to creditors.
In the case of the large banks and GSEs, this means a great deal of pain for investors and taxpayers alike when, no, if, these institutions are finally restructured. But that is the good news and thereby lies the path to national recovery. What we need from the Fed is some leadership on the issue of making the White House take responsibility for restructuring the economy.

The Bank of Canada's revised forecasts

The Bank of Canada's Monetary Policy Report (MPR) released last week laid out its latest views on the economy, which substantiated why it left rates unchanged at 1%.

For starters, after trekking along from 2000-2007, the economy suffered a severe drop-off in 2008/09 which hasn't even come close to being re-couped.

Through June 2010, real GDP remains 4.9% below trend growth, which is up from the 6.6% gap as of June 2009.

And though the economy has turned up since troughing in May 2009, the continuation of that rebound isn't turning out to be as robust as the Bank had hoped and thought.

After growing at an annualized rate of 4.9% during the fourth quarter of 2009, the economy expanded 5.8% in the first quarter of this year, which trailed the Bank's forecast of 6.1%; and then growth decelerated in the second quarter to just 2%, lagging the Bank's forecast of 3%.

The Bank has now revised its growth forecasts down for each of the next five quarters, though it increased its forecasts for the five quarters after that. (This, by the way, is par for the course for the Bank ---- every time it revises its forecasts for growth in the near-term, it must, by the necessity of its mandate, revise its forecasts for later-term growth commensurately in the opposite direction. More on this later.)

Just for point of comparison, I think its worth noting how this forecasted growth, if it materializes as now expected, would compare to trend growth.



Though it does show how underwhelming this recovery has been and is projected to be, obviously trend growth from last decade doesn't hold much relevance as far as the Bank is concerned.

What the Bank is concerned with is how actual economic activity compares to what the Bank views as potential output. And growth of potential output these days is much lower than trend growth of the economy was for the last 5-10 years, because of a slowdown in the growth of the economy's rate of labour utilization, and, more particularly, of labour force productivity.




Canada entered the recession with the economy in a situation of excess demand (actual GDP above potential), but is now experiencing excess supply (actual GDP below potential).

As of July, the Bank believed that the output gap would be eliminated (actual GDP would converge on potential) by the end of 2011. Despite lowering its estimates for the growth of potential output (1.6% in 2010, 1.8% in 2011 and 2.0% in 2012), the Bank now forecasts that the output gap won't be eliminated until the end of 2012.

Here's why this is telling.

The Bank's job is to try to get CPI on target by the end of its forecast horizon, which in this case is to the end of 2012. It therefore needs to eliminate the output gap during that time period.

It previously had thought that it would have CPI on target by early 2012, by virtue of having eliminated the output gap by the end of 2011.

As of July, the Bank was forecasting that growth in 2012 would be 2% because (a) it believed that the output gap would be eliminated by then, (b) it wanted to keep CPI on target, and (c) it believes that the growth rate of potential output would be about 2% in 2012.

Therefore, to keep inflation on track, it would need to keep actual economic activity consistent with the economy's potential growth. Presumably, in order to do that, it would have needed to return to neutral monetary policy in 2011.

But by downgrading its views on economic growth for the last two quarters plus the next four quarters, the Bank is faced with the situation of having to engineer more growth nearer to the end of its forecast horizon in order to meet its objective.

In other words, because monetary policy works with a lag of at least 12 months, its economic growth forecasts for the next four quarters must be based in part on where it has its overnight rate set right now. So, despite remaining extraordinarily accomodative, the Bank doesn't think economic growth will be either (a) as strong as it had previously thought, or (b) strong enough to close the output gap.

Though year-over-year growth of 3.8% in 2010 followed by 2.7% in 2011, which were its forecasts as of the July MPR, would have done the job, growth of 3.0% this year (compared to 1.6% potential growth) followed by 2.4% next year (compared to 1.8% potential growth), which are its current forecasts, won't.

Therefore, the Bank will be required to enhance growth opportunities in 2012 in order to achieve the growth rate of 2.8% (compared to 2.0% potential growth) required to close the output gap.




Given that the Bank forecasts the output gap will not be closed until a year later than earlier projected, it seems safe to assume that the Bank will not return to neutral monetary policy until a year later than it earlier would have assumed.

As such, if its base case scenario had been that once it started hiking its overnight interest rate in July it would do so in sequential meetings until rates had been normalized, it seems that, based on currently available information, a resumption of that projected path of interest rates will likely wait a year.

Personally, given my expectations for deterioration in the U.S. economy (due to continued household deleveraging, continued reluctance on the part of banks to increase lending, fiscal spending headwinds rather than tailwinds, the end of the inventory bounce, spending cutbacks at the state and local levels, reluctance on the part of the business sector to make capital expenditure investments given its overcapacity, and no imminent rebound in the housing market or in the labour market), plus concerns about the unsustainability of household spending in Canada, as well as the prospect of global forces of competitive currency devaluation impairing Canadian trade balances, I am reluctant to believe that the Bank will be successful at closing the output gap over its forecast horizon.

In any case, on a breakeven basis, the current 2-year yield of 1.43% would be consistent with a time-path of overnight rates that involved the Bank staying on hold at 1% until October 2011, at which time rates would be hiked in four consecutive meetings to get to 2%.

October 27

Bernanke leaps into a liquidity trap. John Hussman.

At present, however, the governors of the Fed are creating massive distortions in the financial markets with little hope of improving real economic growth or employment. There is no question that the Fed has the ability to affect the supply of base money, and can affect the level of long-term interest rates given a sufficient volume of intervention. The real issue is that neither of these factors are currently imposing a binding constraint on economic growth, so there is no benefit in relaxing them further. The Fed is pushing on a string....
Quantitative easing promises to have little effect except to provoke commodity hoarding, a decline in bond yields to levels that reflect nothing but risk premiums for maturity risk, and an expansion in stock valuations to levels that have rarely been sustained for long... The Fed is not helping the economy - it is encouraging a bubble in risky assets, and an increasingly unstable one at that. The Fed has now placed itself in the position where small changes in its announced policy could have disastrous effects on a whole range of financial markets. This is not sound economic thinking but misguided tinkering

Night of the living Fed. Jeremy Grantham, GMO Quarterly Letter.

The urban legend of the bond bubble. Scott Minerd, Guggenheim Investment Mgmt.

Canada has options for FX tensions if needed -- Carney. Reuters.

"There are heightened tensions in currency markets. Together, we -- the Bank of Canada, the government of Canada -- maintain considerable options to control the situation if that is necessary," Carney said. "What is important is that we have to observe persistent strength in the Canadian dollar, which has the potential to seriously influence Canadian economic growth ... we have options in those circumstances," he said.

Also

Carney said there was a limited role for the central bank in targeting housing prices, suggesting better tools would come from the government, such as tougher rules for mortgage insurance terms introduced earlier this year.

other fare:
Barack Obama: The oligarchs' president. Charles Ferguson, Salon.

Rates

Why should rates rise?

- because they seem really low, don't they?


Why should rates stay low?

- bonds remain in a secular bull market

- there's no evidence of any catalysts that would prompt higher rates (the theory that there will be a flight away from bonds due to fears about the Fed running its printing press remains in the same category as the theory early in the year that huge budget deficits would cause rates to sky-rocket)

- though nominal rates are low relative to historic norms, real rates are very much consistent with historic averages (and, if anything, long Treasuries look cheap)

- the swamp of new Treasury issuance was early this year, and the market digested that, and now there will be less prospective new issuance of longer-dated Treasuries;

- plus there's a new buyer, the Fed, which, if it intends to expand its balance sheet by $1 trillion, could digest virtually all new supply

- as long as the Chinese and OPEC need to recycle the dollars they get from their bilateral trade surpluses with the U.S., there will be foreign buyers of bonds

- easy monetary policy is here to stay as long as unemployment remains high and inflation remains low

- unemployment will remain high and inflation will remain low as long as economic growth remains below potential growth (and even for a not insignificant period of time after growth exceeds potential, as it will take a long time for the output gap to close)

- other asset markets are much riskier than bond markets, so, despite all the talk of a bond bubble, bonds as an asset class, with a guaranteed rate of return if held to maturity, will remain in demand, particularly with LDI, etc.

- the fixed income portion of household balance sheets remains low, and aging boomers will continue to need income-producing assets and more stable portfolios

- the banks have been big buyers of bonds, and as long as they're reluctant to increase their lending to households, they'll continue to be motivated to make money off the yield curve




what have I missed (for either argument)?

October 25

Ben Davies: On trading and the markets. via Jesse.

Noam Scheiber on Richard Koo's balance sheet recessions. Rortybomb.

The housing double dip is here. Pragmatic Capitalism.
never mind today's existing home sales release, which, at 4.53 million, was both up from last month and beat expectations of 4.3, because (a) it, plus the previous 2 months, represent the worst 3 months on record (albeit back to only 1999); (b) this September data precedes foreclosuregate, and given that 1-in-3 existing home sales was a distressed sale, this portion of the market can be expected to be less busy if rights to title are questionable; and (c) with inventory still at double-digit levels (10.7 months), pressure on prices will persist (Case-Shiller and Core Logi data both suffer a lag, as each of their reports due this week will represent 3mth weighted averages of June, July and August)



other fare:

about the rally in D.C. on Saturday:
Can Jon Stewart restore our sanity? Olivia Scheck, 3QD.

Of course this tendency isn’t new or unique to American politics. My own view, best articulated by the psychologist Jonathan Haidt, is that humans are actually wired to behave this way during instances of disagreement, acting more like lawyers, committed to defending their own moral and political intuitions, than like scientists in search of truths about the world. We see this tendency – to search for evidence that proves our point rather than that which might undermine it – in our own discussions with friends and colleagues, but nowhere is it more overt than in partisan politics.

E-mail auto-response. Martin Marks, The New Yorker.

The origin of complex life: it was all about energy. Discover.

The poetry of science: Richard Dawkins and Neil DeGrasse Tyson. 3QD.

October 20

Wells Fargo: Loan Repurchase Reserve Liability Of $1.3 Billion On $144 Billion In Loan Originations. zero hedge.

Here's That Devastating Report On Bank Of America That Everyone Is Talking About. Branch Hill Capital via Business Insider.

Emerging markets at risk from a gigantic bubble. Peter Tasker, FT.


other fare:
What is dark matter? Michio Kaku, BigThink.

October 19

That piece sent out by David Kotok, The Foreclosure Mess, was stolen from Gonzalo Lira:
The Second Leg Down of America's Death Spiral.
includes the colorful language that Kotok stripped out, including the start:

I swear to God Almighty: Mortgage Backed Securities are America’s Herpes—the gift that keeps on oozing.

one can see why Kotok edited the original, given comments like this:

People still haven’t figured out what this all means—but I’ll tell you: If enough mortgage-paying homeowners realize that they may be able to get out of their mortgage loan and keep their house, scott-free? Shit, that’s basically a license to halt payments right the fuck now. That’s basically a license to tell the banks to fuck off.

What are the banks gonna do—try to foreclose and then evict you? Show me the paper, motherfucker, will be all you need to say.

but why Kotok would not only not publish it without proper attribution, but why he'd originally plagiarize it, and then try to cover his tracks, that's another story; not cool!

for a cooler head on the whole mortgage situation, read:
A little bit of sanity, please. Paul Jackson, HousingWire.

QE2 won't save our sinking ship. Randall Wray.

Deleveraging, deceleration and the double dip. Steve Keen.

the stabilization in employment has occurred because the rate of deleveraging has slowed... But the rate of change of debt is still negative: it’s just risen from a low of -6% to -2%. For the deceleration effect to continue... the level of debt relative to GDP would need to rise. This is highly unlikely... So the deceleration in deleveraging should give way again at some point, and then the NBER may be forced to begin dating the next recession—which is still a continuation of the current Depression.

FDIC folds to banks, again. Bruce Krasting.

The NY Fed explains how the government spends first and issues bonds later. Pragmatic Capitalism.

October 18

this basically reflects what I opined in my last post, but much more amusingly:
Through the looking glass again. Ultimi Barbarorum.

if anyone tells you they have a clear view on what is going to happen to the econo-world from here, walk away briskly. As Ed Hyman of ISI puts it, with the now imminent onset of QE2 we are in “scary times”, a world of “unintended consequences”. The only intellectually honest position to take at this point, it seems, is to admit we haven’t a clue.

he goes on to discuss many of the factors in play
The Recklessness of Quantitative Easing. John Hussman.
Hussman says that QE didn't save us from the crisis --- lying about asset prices did --- but, unfortunately, the benefits about this "suspension of truthful disclosure" don't solve the underlying solvency problems

Presently, the U.S. financial sector is essentially opacity masquerading as solvency. As Meredith Whitney has observed, the "recovery" of the U.S. financial sector has been a two stage process - massive writeups of troubled assets on balance sheets, followed by large reductions in loan loss reserves on income statements. This activity has not only driven the improvement in operating earnings reported by banks, but has been one of the primary contributors to the recovery in the aggregate earnings of the S&P 500 Index. It is not a process that should be extrapolated.

Why foreclosure fraud is so dangerous to property rights. Barry Ritholtz.

The foreclosure mess. David Kotok.

Bank restructurings likely as foreclosures overwhelm big banks. video of Chris Whalen at AEI.

more video of Whalen on panel at AEI here, with Roubini and others; Whalen starts at 1:07 (fast forward to one-hour, seven-minute mark)

October 16

Why China's growth rate may halve. Bijal Shah.

China - the mother of all grey swans; Japan - past the point of no return. Vitaliy Katsenelson.

WTF!

How the hell does one make sense of the world now?

How does one predict where the markets will next head?

To figure that out, not only do you have to figure out the trajectory of the economy --- strengthening, though soft? or softening, though positive? or softening into contraction? --- and to do that you need to (a) figure out the underlying trend of private domestic demand, (b) determine the impact of inventory adjustments, (c) evaluate the incremental impact of changes in fiscal spending, (d) ascertain the contribution of net exports given differing behaviour of regional growth (e.g. is a strong China good for U.S. net exports? slowing Europe?)

But then you have to throw in the wildcards of:

the election and the prospective outlook for the extension of the Bush tax cuts

QE2 --- what impact it will have on the economy (+ve? none? -ve?), and what first-order impacts it will have on the markets (baked in the cake? lagged?), plus the second-order feedback loop effects between the markets and the economy and vice versa

the mortgage foreclosure mess

beggar-thy-neighbour geopolitical/economic policies, including currency wars and potential for trade wars

The current period seems all too familiar: a period of the market's stubborn refusal to acknowledge the writing on the wall. That the economy is weak, there is no question. If that were not the case, then QE2 would not even be in the discussion. But it seems many view this as a win-win environment: either the economy turns and all is well with the world so asset prices (except bonds) go up; or QE2 is necessary and asset prices (including bonds) go up! Hallelujah!
Such people never learn.

In 2000, in the face of crumbling fundamentals, the market stubbornly ignored valuations, treating valuation analysis as a quaint historic notion of no current relevance. Then the market fell over 50%.

In 2007, in the face of a monstrous debt bubble and housing market crash, the market decided to keep dancing rather than face the music; and then, once it did realize that subprime really might not be contained, it somehow imagined that the Fed could somehow solve all the world's problems with lower rates (the distinction between illiquidity and insolvency never having really been appreciated). Then the market fell over 50%.

Today, the problems seem worse, and the potential for solutions more remote.

Take just the mortgage situation alone:

Banks are still insolvent: their balance sheets and their earnings statements have been goosed by accounting gimmickry, including mark-to-model and off-balance-sheet legerdemain, as well as reducing loan-loss provisions even as non-performing loans continue to escalate, i.e. all the same sort of zombie-bank stuff used in Japan.

Okay, well, I'm quite willing to acknowledge the obvious: the U.S. government has been bailing out the banks for the last 3 years, injecting capital without taking charge, not only letting the banks continue with their standard operating procedures, but changing FASB rules to boot --- and they're NOT about to abandon that strategy now!

So perhaps the fact that the banks are insolvent is irrelevant --- there will be no second shoe to drop in the credit crisis, the next wave of mortgage resets and the CRE situation notwithstanding.

And surely the Feds would not let foreclosure-gate put at risk their grand master plan! How could they possibly do that? What would be the point of QE2 if Obama et al had any thoughts of actually going after the banks for foreclosure fraudulence? The former would have no chance of success if the latter were happening, so, clearly, the latter won't happen.

But but but

But foreclosures in the U.S. are not a federal matter, they're governed by state law. Hmmm.

And...

But BoA, JPM and Citi are each down 5-9% this week. Meanwhile, 5yr CDS on BoA have shot out to 193 from 152. Could this be the tip of the iceberg?

In 2007, when the ABX started falling, most of the Street remained in the "contained" camp --- losses would be minor; there was no need to over-react --- but it didn't take too many months for the ABX to drop 60% and for the S&P 500 Financials index to drop from a 2007 high of 510 to a 2009 trough of 78. Ay, carumba!

Have the problems from that period actually been fixed? Are the underlying cashflows to support all that debt that still remains actually there? Have either employment or housing prices rebounded to give support to mortgage-based valuations? Or, perhaps is there just a lot of smoke and mirrors? And not only that but now actual malfeasance. (If you don't know who owns the loans or who has the right to foreclose, can a raft of lawsuits investor losses and bank writedowns be all that far behind?)

Count me as a skeptic.

But even if the skeptic in me is right, what about QE2? Perhaps the banks could be as messed up as possible, but if the Fed still gives them free use of the printing press (even a badly-managed bank can make money by borrowing at 0% and investing at 3 or 4%), especially if the Fed telegraphs that it will buy whatever the banks have already bought, and will do so at higher prices. How easy is that!

So even if QE2 can't do much for Main Street, surely it can do something for Wall Street. What could possibly go wrong?

Lots, that's what. How about a full-fledged currency war-morphed-trade war?

Too many known unknowns, never mind unknown unknowns.

All I know is, whenever people think about the market being in a win-win situation, they've got their head stuck u-no-where.

Stock prices and bond yields certainly could go up from here. I just don't think that's the way the odds are tilted. Not will all those wildcards.

All in all, I think the market's interpretation (the stock market's, that is; the bond market is always right! well, maybe not always --- like early 2010, when Treasury issuance, inflation and bond vigilantes prevailed --- but at least the bond market is always right before the stock market!) of current events is no more correct today than it was in either 2000 or 2007. Just another flight of fantasy.

October 15

mortgage industry expert Laurie Goodman and colleagues at Amherst Securities put together a report: The Housing Crisis -- Sizing the Problem, Proposing Solutions.


other fare:
Future Chaos: There Is No "Plan B". Chris Martenson re: peak oil.

Changing Education Paradigms. RSA Animate.

October 13

from A long road ahead in regaining lost jobs in the NYT:


Fed Chief Gets Set to Apply Lessons of Japan's History. John Hilsenrath, WSJ.

flashback to 1999:
Japanese Monetary Policy: A Case of Self-Induced Paralysis? Ben Bernanke.

Why is the Fed doing this? James Hamilton.

Why printing money makes sense. Dean Baker, Guardian.

The Japan syndrome. Ethan Devine, Foreign Policy.

China's teetering on the verge of its own lost decade, and a meltdown in Beijing would make Japan's economic malaise look like child's play.

other fare:

Global power: On top of the world. Why the West’s present dominance is both recent and temporary. The Economist.

What Mr Morris shows is that over a period of 10,000 years one civilisation after another hit a “hard ceiling” of social development before falling apart, unable to control the forces its success had unleashed....
There is, on the other hand, a real possibility that we fail to negotiate even the next 50 years without triggering environmental catastrophe, global pandemics or nuclear war. In which case, both West and East will simultaneously crash into the hard ceiling of our own era.

Global aging. Phillip Longman, Foreign Policy.

The Real Perils of Human Population Growth. David and Maria Pimentel.

October 12

Still vulnerable. Lacy Hunt and Van Hoisington.
the whole commentary is very much well worth a read, but this excerpt is notable:

The Fed's adoption of QE2 may lead to severe unintended consequences. There are two possibilities: 1) QE2 does manage to temporarily improve GDP via continued overleveraging of the economy with non-repayable loans, 2) QE2 goes into the history’s dustbin of failed projects, along with QE1, cash for clunkers, tax credits for first time home buyers, and other numerous failed attempts to boost the economy with rebate checks.

For QE2 to work, a renewed borrowing and lending cycle must take place, resulting in a further leveraging of the already highly overleveraged U.S. economy. Such additional leverage would not be beneficial since increasing indebtedness from these levels ultimately leads to economic deterioration, systemic risk, and in the normative case, deflation, as documented by Rinehart and Rogoff in their book, This Time Is Different. Therefore, at best QE2 can be nothing more than a short-term panacea exacerbating the serious structural problems already facing the United States.

OECD updated its Composite Leading Indicators for October.
the OECD characterizes Germany, Japan and Russia as in expansion, a possible peak in the U.S., downturns in China, Canada, India, the U.K., France and Italy, and a slowdown in Brazil

October 11

No margin of safety, no room for error. John Hussman.

stat of the day:
according to Industry Canada, in 2008, 77.7% of Canada's exports were to the U.S.; in 2nd place was the U.K., at 2.7%; just 2.2% of our exports were to China

October 8

Janet Tavakoli: On the "biggest fraud in the history of the capital markets". interview with Ezra Klein of Washington Post, via zerohedge.

When we had the financial crisis, the first thing the banks did was run to Congress and ask for accounting relief. They asked to be able to avoid pricing this stuff at the price where people would buy them. So no one can tell you the size of the hole in these balance sheets. We’ve thrown a lot of money at it. TARP was just the tip of the iceberg. We’ve given them guarantees on debts, low-cost funding from the Fed. But a lot of these mortgages just cannot be saved. Had we acknowledged this problem in 2005, we could’ve cleaned it up for a few hundred billion dollars. But we didn’t. Banks were lying and committing fraud, and our regulators were covering them and so a bad problem has become a hellacious one....
This can be done with a resolution trust corporation, the way we cleaned up the S&Ls. The system got back on its feet faster because we grappled with the problems. The shareholders would be wiped out and the debt holders would have to take a discount on their debt and they’d get a debt-for-equity swap. Instead we poured TARP money into a pit and meanwhile the banks are paying huge bonuses to some people who should be made accountable for fraud. The financial crisis was a product of our irrational reaction, which protected crony capitalism rather than capitalism. In capitalism, the shareholders who took the risk would be wiped out and the debt holders would take a discount but banking would go on.

The true nature of our balance sheet recession. Bob Bronson, via dshort.
includes link to Richard Koo's presentation

Pictures of deflation. Chris Whalen presentation to AEI.

The largest U.S. banks remain insolvent and must continue to shrink. Failure by the Obama administrationto restructure the largest banks during 2007 to 2009 only means that this process is going to occur over the next 3 to 5 years --- whether we like it or not. The issue is recognizing existing losses --- not if a loss occurred.

Japan Launches Global Quantitative Easing. John Makin, AEI.
the article is alright, but actually not that informative; but it is noteworthy if only for this quote:

"The experimental-drug phase of monetary policy has begun."

October 7

QOTD:

There is lots of instability caused in part by the flood of liquidity from the Fed and the ECB. The irony is that the Fed is creating all this liquidity with the hope that it will revive the U.S. economy. It is doing nothing for the U.S. economy and causing chaos for the rest of the world --- Joseph Stiglitz

Adam Posen discusses the dangers of insufficient stimulus. Peterson Institute for International Economics.

Our situation (in the U.K., the U.S., and arguably in most of the major Western economies) is one where policy makers face a long uphill battle, in which monetary ease has an ongoing role to play, even if it may not deliver recovery on its own. Insufficient monetary action risks turning sustained low growth and near deflation into a self-fulfilling prophecy. This happened in Japan in the 1990s, and in U.S. and Europe in the 1930s. I don’t think things will be “that bad” in the sense of an outright depression, but we face a real risk of long-term stagnation with some distracting upward blips and slowly eroding capacity....
The short-term blips in the economy are no way to judge whether we are coming out of this state of the world. We saw similar starts and stops in the Great Depression and in Japan

The market believes in QE2. Paul Krugman notes the pickup in inflation expectations. (also perhaps evidenced by the steepening in the 10s-30s curve)

Asha Bangalore expects pick-up in bank credit, the lack of which so far has been "the major culprit behind the lackluster recovery."

excellent review of why CRE is a major problem:
Consumer deleveraging = commercial real estate collapse. Jim Quinn, via naked capitalism.

DC waking up to escalating foreclosure train wreck: Grayson calls for FSOC to examine foreclosure fraud as systemic risk. naked capitalism.

In a new period of instability, Obama becomes Hoover. Chris Whalen, Reuters.

the avalanche of mortgage defaults now hitting Bank of America, Wells Fargo and other large lenders could force these banks to seek new government bailouts in 2011, an outcome that will expose the Obama Administration’s incompetence for all to see.

tomorrow's non-farms payroll report will also provide an initial estimate on revisions to historical data through March:
Job losses in 2009 likely bigger than thought. Reuters.
by the by, initial jobless claims were once again a bit better than expected, but, for the 23rd time in the last 24 weeks, there were upward revisions to past data


The U.S. Is In A "Race To The Fiscal Bottom. David Stockman, Business Insider.

The two parties are in a race to the fiscal bottom to see which one can bury our children and grandchildren deeper in debt....
We are not in a conventional business cycle recovery, so stimulus is futile and just adds needlessly to the $9 trillion of Treasury paper already floating dangerously around world financial markets. Instead, after 40 years of profligate accumulation of public and private debt, and reckless money-printing by the Fed, we had an economic crash landing, which left us with an enduring structural breakdown, not just a cyclical downturn. In effect, we undertook a national leveraged buyout, raising total credit market debt to $52 trillion which represented a 3.6X leverage ratio against national income or GDP....
The only solution is a long period of debt deflation, downsizing and economic rehabilitation, including a sustained downshift in consumption and corresponding rise in national savings. And a key element of the latter is a drastic reduction in government dis-savings through spending cuts and tax increases — and these measures need to start right now. Keynesian policymakers who say wait for the midterms to address the deficit are like battleship admirals: They are fighting the last war with the same failed strategy that gave rise to our current predicament......
After the abomination of the Bush/Paulson bailout of the big banks, the state has no boundaries whatsoever. So fiscal policy is now just a fiscal food fight....
Obama’s presidency is a profound disappointment. So far, he’s proven that when Republican’s start elective wars, Democrats can’t end them; when Republicans empty the Treasury, Democrats can’t replenish it; when Republicans put a middle-class destroying money printer at the head of the Fed, Democrats reappoint him; and when the Republicans unleash an orgy of dangerous speculation on Wall Street, Democrats pass a contentless, 2,300 page, enabling act which will do nothing to protect Main Street from another financial meltdown, even as it keeps K Street fully employed.

October 6

Foreclosure fraud reveals structural and legal crisis. Barry Ritholtz.

gold biggest beneficiary of continuing competitive global currency devaluation:

Global central bank action may follow BoJ moves on rates. Bloomberg.
RBA surprised by holding rates steady, and Japan is back to ZIRP and more QE;
BoE and ECB tomorrow

Why it doesn't feel like a recovery. Washington Post.
neat graphics showing economic growth vs potential growth and implications for output gap

Credit for the Recovery. Daniel Gross, NYT.
includes this quote of the day:

the decline in personal debt is driven less by Americans giving up on credit cards than on credit card issuers giving up on Americans

Will America come to envy Japan's lost decade? Ezra Klein, Washington Post.

Hatzius Says Fed Easing Measures Will Probably `Fall Short'. Bloomberg.

Mexico issues 100-year bond. Reuters.

Canadian Housing Observer 2010. CMHC.

October 4

IMF admits that the West is stuck in near depression. Ambrose Evans-Pritchard, Telegraph.

UK tiptoeing towards Japan, warn consultants. Telegraph.

Is China getting religion on restructuring its economy? Yves Smith.

5 positive and 5 negative investment themes from Gary Shilling. Pragmatic Capitalism.

Flawed Paperwork Aggravates a Foreclosure Crisis. Gretchen Morgenson, NYT.
and the negative consequences of this mortgage mess will be exacerbated if it leads to more strategic defaults

4ClosureFraud posts Lender Processing Services mortgage document fabrication price sheet. Yves Smith.

Economic measures continue to slow. John Hussman.

Based on the data that we've observed in recent months, my view remains that a fresh downturn in the economy remains a not only a possibility but a likelihood. Little of the economic improvement we've observed since 2009 appears intrinsic, but instead appears driven by enormous government interventions that are now trailing off. Still, while I believe that there is a second shoe that has not dropped, I recognize that the full force of government policy is to obscure, stimulate, intervene and borrow in every effort to kick that can down the road. I believe that the unaddressed and unresolved problems relating to debt service, employment conditions and housing are too large for this to be successful

other fare:
amusing maps of Europe: mapping sterotypes

October 1

Riksbank's Svensson Warns Against Rate Rises Amid Housing Boom. Bloomberg.

Bank of England’s Posen: Central Banks Should Do More — A Lot More. WSJ Real-Time Economics.

We will only know we will have done enough with QE or other monetary stimulus when we have clear indications that our policies are moving the desired variables — market interest rates, wages, output, employment, and inflation expectations — sufficiently and in the right directions on a sustained basis. I do not think that is not enough for a central bank to say, ‘Look, we expanded our balance sheet more than any time in history,’ or ‘we did things we never did before,’ and argue that therefore we must have done a lot, if not too much (not that the Bank of England has done so). In my opinion, that is backwards logic. It would be like saying ‘that fire must be out, because we’ve already pumped more water than for any previous fire we’ve fought,’ or ‘we must have gotten to our destination, because I’ve been driving for hours and we’ve already used a full tank of gas.’

This is a worse fire than any of us have ever seen in our lifetimes, and we are farther from home than we have ever been, and so we cannot judge our progress by how much effort or resources we have already put in,” he continued. “We can only gauge the success of our efforts by our results, and until we achieve those results, there is no danger from our heavy use of the available instruments. This is not a normal situation with finely balanced risks on both sides or with monetary policy able to finely calibrate to an outcome.

The money quandary. Rebecca Wilder.

Market is out on a limb. Comstock Partners.

The October Absolute Return Letter. Neils Jensen.