Monday, May 31, 2010

The U.S. Economic Collapse Top 20 Countdown

"20 - Gallup's measure of underemployment hit 20.0% on March 15th. That was up from 19.7% two weeks earlier and 19.5% at the start of the year.
19 - According to RealtyTrac, foreclosure filings were reported on 367,056 properties in the month of March. This was an increase of almost 19 percent from February, and it was the highest monthly total since RealtyTrac began issuing its report back in January 2005.
18 - According to the Bureau of Labor Statistics, in March the national rate of unemployment in the United States was 9.7%, but for Americans younger than 25 it was well above 18 percent.
17 - The FDIC's list of problem banks recently hit a 17-year high.
16 - During the first quarter of 2010, the total number of loans that are at least three months past due in the United States increased for the 16th consecutive quarter.
15 - The Spanish government has just approved a 15 billion euro austerity plan.
14 - The U.S. Congress recently approved an increase in the debt cap of the U.S. government to over 14 trillion dollars.
13 - The FDIC is backing 8,000 banks that have a total of $13 trillion in assets with a deposit insurance fund that is basically flat broke. In fact, the FDIC's deposit insurance fund now has negative 20.7 billion dollars in it, which actually represents a slight improvement from the end of 2009.
12 - The U.S. national debt soared from the $12 trillion mark to the $13 trillion mark in a frighteningly short period of time.
11- It is being reported that a massive network of big banks and financial institutions have been involved in blatant bid-rigging fraud that cost taxpayers across the U.S. billions of dollars. The U.S. Justice Department is charging that financial advisers to municipalities colluded with Bank of America, Citigroup, JPMorgan Chase, Lehman Brothers, Wachovia and 11 other banks in a conspiracy to rig bids on municipal financial instruments.
10 - The Mortgage Bankers Association recently announced that more than 10 percent of all U.S. homeowners with a mortgage had missed at least one payment during the January-March time period. That was a record high and up from 9.1 percent a year ago.
9 - The official U.S. unemployment number is 9.9%, although the truth is that many economists consider the true unemployment rate to be much, much higher than that.
8 - The French government says that its deficit will increase to 8 percent of GDP in 2010, but by implementing substantial budget cuts they hope that they can get it to within the European Union's 3 percent limit by the year 2013.
7 - The biggest banks in the U.S. cut their collective small business lending balance by another $1 billion in November. That drop was the seventh monthly decline in a row.
6 - The six biggest banks in the United States now possess assets equivalent to 60 percent of America's gross national product.
5 - That is the number of U.S. banks that federal regulators closed on Friday. That brings that total number of banks that have been shut down this year in the United States to a total of 78.
4 - According to a study published by Texas A&M University Press, the four biggest industries in the Gulf of Mexico region are oil, tourism, fishing and shipping. Together, those four industries account for approximately $234 billion in economic activity each year. Now those four industries have been absolutely decimated by the Gulf of Mexico oil spill and will probably not fully recover for years, if not decades.
3 - Decent three bedroom homes in the city of Detroit can be bought for $10,000, but no one wants to buy them.
2 - A massive "second wave" of adjustable rate mortgages is scheduled to reset over the next two to three years. If this second wave is anything like the first wave, the U.S. housing market is about to be absolutely crushed.
1 - The bottom 40 percent of all income earners in the United States now collectively own less than 1 percent of the nation’s wealth. But of course many on Wall Street and in the government would argue that there is nothing wrong with an economy where nearly half the people are dividing up 1 percent of the benefits."

at http://theeconomiccollapseblog.com/archives/the-u-s-economic-collapse-top-20-countdown

France Worries About AAA Rating, Grece Urged to Abandon Euro

"France admitted on Sunday that keeping its top-notch credit rating would be "a stretch" without some tough budget decisions, following German hints that Berlin may resort to raising taxes to help bring down its deficit...

THE Greek government has been advised by British economists to leave the euro and default on its €300 billion (£255 billion) debt to save its economy.
The Centre for Economics and Business Research (CEBR), a London-based consultancy, has warned Greek ministers they will be unable to escape their debt trap without devaluing their own currency to boost exports. The only way this can happen is if Greece returns to its own currency.
Greece’s departure from the euro would prove disastrous for German and French banks, to which it owes billions of euros.

Doug McWilliams, chief executive of the CEBR called the move “virtually inevitable” and said other members may follow. “The only question is the timing,” he said. “The other issue is the extent of contagion. Spain would probably be forced to follow suit, and probably Portugal and Italy, though the Italian debt position is less serious..."

at http://globaleconomicanalysis.blogspot.com/2010/05/france-worries-about-aaa-rating-uk.html

Marc Faber on the Coming Economic Catastrophe Triggered by the Next AIG to Fall

at http://www.marketoracle.co.uk/Article19917.html

Sunday, May 30, 2010

Sovereign Defaults, Social Unrest and Higher Gold Prices

"The magnitude of current private and government debt, coupled with massive unfunded contingent liabilities for promises of future services to their citizens, will prove to be impossible for many nations to fund. Massive inflation in the money supply will become the preferred vehicle to deflect the default monster and will result in vastly devalued currencies and price inflation as a prelude to default. Such action will be a desperate attempt to buy time to stave off the inevitable and will result in social unrest caused by persons whose comfortable lifestyle and elevated standard of living is about to disintegrate before their very eyes."

at http://www.marketoracle.co.uk/Article19904.html

Household, corporate and government indebtness, deleveraging and different paths of recovery

"...In this New Normal environment it is instructive to observe that the operative word is “new” and that the use of historical models and econometric forecasting based on the experience of the past several decades may not only be useless, but counterproductive. When leveraging and deregulating not only slow down, but move into reverse gear encompassing deleveraging and reregulating, then it pays to look at historical examples where those conditions have prevailed. Two excellent studies provide assistance in that regard – the first, a study of eight centuries of financial crisis by Carmen Reinhart and Kenneth Rogoff titled This Time is Different, and the second, a study by the McKinsey Global Institute speaking to “Debt and deleveraging: The global credit bubble and its economic consequences.”

The Reinhart/Rogoff book speaks primarily to public debt that balloons in response to financial crises. It is a voluminous, somewhat academic production but it has numerous critical conclusions gleaned from an analysis of centuries of creditor/sovereign debt cycles. It states:

The true legacy of banking crises is greater public indebtedness, far beyond the direct headline costs of bailout packages. On average a country’s outstanding debt nearly doubles within three years following the crisis.

The aftermath of banking crises is associated with an average increase of seven percentage points in the unemployment rate, which remains elevated for five years.
Once a country’s public debt exceeds 90% of GDP, its economic growth rate slows by 1%..."
at http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2010/February+2010+Gross+Ring+of+Fire.htm

Saturday, May 29, 2010

End of the 'Exorbitant Privilage'? More than $5 trillion current account deficit and more than $50 trillion net debt by 2030 and the international reserve status of dollar

"...To a large extent, the US external deficit has an internal counterpart: the budget deficit. Higher budget deficits generally increase domestic demand for foreign goods and foreign capital and thus promote larger current account deficits. But the two deficits are not "twin" in any mechanistic sense, and they have moved in opposite directions at times, including at present. The latest projections by the Obama administration and the Congressional Budget Office (CBO) suggest that both in the short run, as a result of the crisis, and over the next decade or so, as baby boomers age, the US budget deficit will exceed all previous records by considerable margins. The Peterson Institute for International Economics projects that the international economic position of the United States is likely to deteriorate enormously as a result, with the current account deficit rising from a previous record of six percent of GDP to over 15 percent (more than $5 trillion annually) by 2030 and net debt climbing from $3.5 trillion today to $50 trillion (the equivalent of 140 percent of GDP and more than 700 percent of exports) by 2030. The United States would then be transferring a full seven percent ($2.5 trillion) of its entire economic output to foreigners every year in order to service its external debt.

This untenable scenario highlights a grave triple threat for the United States. If the rest of the world again finances the United States' large external deficits, the conditions that brought on the current crisis will be replicated and the risk of calamity renewed. At the same time, increasing US demands on foreign investors would probably become unsustainable and produce a severe drop in the value of the dollar well before 2030, possibly bringing on a hard landing. And even if the United States were lucky enough to avoid future crises, the steadily rising transfer of US income to the rest of the world to service foreign debt would seriously erode Americans' standards of living..."

at http://iie.com/publications/papers/paper.cfm?ResearchID=1312

Friday, May 28, 2010

Still a ton of deleveraging to do

"...A recent report from Deutsche Bank's Bill Prophet, entitled "Alternative Universe," foretells a story of approaching disaster and even goes so far as to say "the health of the US commercial banking system will inevitably get worse before it gets better. And this has undeniable consequences for the rates market, if not Fed policy."

The reason? Bank balance sheets have hardly shrunk at all. This applies to both commercial and residential real estate.
Says Prophet on RMBS:

Nevertheless, we find it inconceivable that these assets are being marked anywhere close to their recoverable value, and the reality is that commercial bank exposure to them is as large now as it was 12 months ago. And in fact when we look at the entire $2tr portfolio of residential real estate assets on bank balance sheets (which would of course include the home-equity loans shown above), we reach a similar conclusion. Namely, as of the end of Q3-’09, the value of  “home mortgage” assets has declined by just 1.6% from the end of ‘08 (see Chart 7). Similar to CRE, these assets could be worth hundreds of billions of dollars less than where they are currently being marked..."

at http://www.businessinsider.com/how-the-us-banking-system-will-inevitably-get-worse-before-it-gets-better-2010-1#total-holdings-at-commercial-banks-are-barely-off-their-bubble-levels-1

Wednesday, May 26, 2010

Financial crisis, bail-outs, fiscal stimulus, exploding public debt, collapse in tax revenues, fiscal tsunami and sovereign defaults

"...As government debt levels explode in the aftermath of the financial crisis, there is  growing uncertainty about how quickly to exit from today’s extraordinary fiscal stimulus. Our research on the long history of financial crises suggests that choices are not easy, no matter how much one wants to believe the present illusion of normalcy in markets. Unless this time is different – which so far has not been the case – yesterday’s financial crisis could easily morph into tomorrow’s government debt crisis.

In previous cycles, international banking crises have often led to a wave of sovereign defaults a few years later. The dynamic is hardly surprising, since public debt soars after a financial crisis, rising by an average of over 80 per cent within three years. Public debt burdens soar owing to bail-outs, fiscal stimulus and the collapse in tax revenues. Not every banking crisis ends in default, but whenever there is a huge international wave of crises as we have just seen, some governments choose this route.

We do not anticipate outright defaults in the largest crisis-hit countries, certainly nothing like the dramatic de facto defaults of the 1930s when the US and Britain abandoned the gold standard. Monetary institutions are more stable (assuming the US Congress leaves them that way). Fundamentally, the size of the shock is less. But debt burdens are racing to thresholds of (roughly) 90 per cent of gross domestic product and above. That level has historically been associated with notably lower growth.

While the exact mechanism is not certain, we presume that at some point, interest rate premia react to unchecked deficits, forcing governments to tighten fiscal policy. Higher taxes have an especially deleterious effect on growth. We suspect that growth also slows as governments turn to financial repression to place debts at sub-market interest rates..."

at http://globaleconomicanalysis.blogspot.com/2010/01/massive-layoffs-coming-in-nyc-nevada.html

Tuesday, May 25, 2010

It's the debt, stupid: $4.5 trillion sovereign debt issuance projected in 2010

"...National governments will issue an estimated $4.5 trillion in debt this year, almost triple the average for mature economies over the preceding five years. The U.S. has allowed the total federal debt (including debt held by government agencies, like the Social Security fund) to balloon by 50% since 2006 to $12.3 trillion. The pain of repayment is not yet being felt, because interest rates are so low--close to 0% on short-term Treasury bills. Someday those rates are going to rise. Then the taxpayer will have the devil to pay.

Whether or not you believe the spending spree was morally justified, you have to be concerned about the prospect of a dismal, debt-burdened fiscal future. More debt weighs heavily on GDP, says Carmen Reinhart, a University of Maryland economist. The coauthor, with Harvard professor Kenneth Rogoff, of This Time It's Different: Eight Centuries of Financial Folly (Princeton, 2009), Reinhart has found that a 90% ratio of government debt to GDP is a tipping point in economic growth. Beyond that, developed economies have growth rates two percentage points lower, on average, than economies that have not yet crossed the line. (The danger point is lower in emerging markets.) "It's not a linear process," she says. "You increase it over and beyond a high threshold, and boom!" The U.S. government-debt-to-GDP ratio is 84%...

If the GDP doesn't expand at "normal" rates of 3% to 5% coming out of this recession, wrestling down the debt will be very tough, indeed--perhaps impossible without drastic cuts in spending and higher tax rates on many fronts. The Congressional Budget Office currently projects the fiscal deficit will decline from 10% of GDP next year to around 4.4% from 2013 to 2015. But that assumes economic expansion of at least 4%, not the 2% predicted in the study by Reinhart and Rogoff. You see the vicious cycle here: Debt depresses growth, and then low growth makes paying down the debt an impossible task.

U.S. corporate income tax receipts were down 55% in the year ended Sept. 30, 2009 to $138 billion. It may be a long while before these tax collections get back to where they were. As corporate profits recover, factory utilization will be up and inflation will be close behind. At that point the 0% yield on Treasury bills will be history. Rolling over the national debt will become a lot more expensive. Higher rates on Treasuries will work their way through the debt market, driving up the cost of money for homeowners, businesses and already struggling state and local governments.

"The economy over the last six months has been on a sugar high," says Benn Steil, senior fellow at the Council on Foreign Relations and author of Money, Markets and Sovereignty (Yale, 2009), a survey of the relationship between money and the state. If Congress and the Obama Administration don't trim deficits, he says, "we will get to the point where credit is much more expensive in the U.S. than it ever has been in the past."

Most states are already having trouble paying their bills and, of course, don't have printing presses with which to finance their debts. They are turning to Washington for help and may succeed in putting some of their liabilities on the federal balance sheet. With growing off-balance-sheet obligations, notably unfunded pension liabilities (see graphic in "Debt Weight Scorecore"), the states will be competing for years with the federal government for scarce taxpayer dollars.

"U.S. states are like emerging markets," says Reinhart. "They spend a lot during the boom years and then are forced to retrench during the down years." Cutting expenses sounds good theoretically, but look at California: Students (and faculty) are up in arms over proposed tuition increases and cutbacks at the state's once prestigious university system; state employees are mounting a fierce legal battle against furloughs and other wage concessions..."

at http://www.forbes.com/forbes/2010/0208/debt-recession-worldwide-finances-global-debt-bomb.html?boxes=financechannelmostemailed

Sunday, May 23, 2010

$4.47 Trillion Ticking Bomb

"...Decades from now the summer of 2008 will likely be remembered to mark the turning point where legislative blundering took an otherwise serious financial crisis and molested it into an epic financial collapse.

By fully assuming the liabilities of Fannie Mae and Freddie Mac, the two colossal and corrupt (and conduit of corruptness funneling junk Countrywide Financial loans onto the implied balance sheet of the federal government) government sponsored enterprises, the federal government has thrust taxpayers into an abyss of insolvency with one mighty shove.

Given the sheer size of these government sponsored companies, with loan guarantee obligations recently estimated by Federal Reserve Bank of St. Louis President William Poole of totaling $4.47 Trillion (That’s TRILLION with a capital T… for perspective ALL U.S. government debt held by the public totals roughly $4.87 Trillion) this legislative reversal making certain the “implied” government guarantee is reckless to say the least..."

at http://paper-money.blogspot.com/2010/01/ticking-prime-bomb-fannie-mae-monthly.html

Saturday, May 22, 2010

International Trade, International Security and Dual-Use Technologies

"...China’s rise as a high-tech military power is central to US security concerns, while a European debate on the implications of a rising China beyond the economic sphere is conspicuous by its absence. Concerns about Intellectual Property Rights (IPR) have prevailed in debates on high technology transfers to the PRC, with less attention being paid to the ‘dual use’ nature of many of these technologies that can be utilised in both civilian and military applications. Unlike the United States, the European Union has no overview on the amount and generation of sensitive technology exported to the PRC. European policy on dual-use technologies is fragmentary at best, while conflicting export regimes and shrinking investments in research and education throughout the European Union are putting the EU’s technological lead at risk. This pressure further increases the need to find outside revenues to fund innovation and the next generation of technology – which could come from the expanding Chinese market. Given the central role of dual-use technologies in today’s information-based warfare, the EU’s traditionally high level of technology exports to China has become a sensitive topic across the Atlantic in recent years, as was highlighted by the clash over the potential lifting of the EU arms embargo in 2004/2005. In sum, dual-use technology transfers touch on aspects of competitiveness and innovative capacity, market access and security concerns.

A proactive policy needs to be based on a common understanding of China’s potential as a military superpower and of its likely impact on the European Union, the EU’s policies and its relationship with the United States."

at http://ipezone.blogspot.com/2010/02/eu-china-and-dual-use-technology.html

Friday, May 21, 2010

Alternative international reserve currency: Bancor

"...The U.S. dollar survives as reserve currency because there is no apparent substitute. The euro has its own problems. Moreover, the euro is the currency of a non-existent political entity. National sovereignty continues despite the existence of a common currency on the continent (but not in Great Britain). If the dollar is abandoned, then the result is likely to be bilateral settlements in countries’ own currencies, as Brazil and China now are doing. Alternatively, John Maynard Keynes’ bancor scheme could be implemented, as it does not require a reserve currency country. Keynes’ plan is designed to maintain a country’s trade balance. Only a reserve currency country can get its trade and budget deficits so out of balance as the U.S. has done. The prospect of U.S. default and/or inflation and decline in the dollar’s exchange value is a threat to the reserve system.


The threats to the U.S. economy are extreme. Yet, neither the Obama administration, the Republican opposition, economists, Wall Street, nor the media show any awareness. Instead, the public is provided with spin about recovery and with higher spending on pointless wars that are hastening America’s economic and financial ruin..."

at http://www.marketoracle.co.uk/Article17004.html

Thursday, May 20, 2010

After a wave of international banking crises, a wave of sovereign defaults and restructurings often follows within a few years: The Greece case

"...As demonstrated in my recent book with Carmen Reinhart This Time is Different: Eight Centuries of Financial Folly , Greece has been in default roughly one out of every two years since it first gained independence in the nineteenth century. Loss of credibility, if it comes, can bite hard and fast. Indeed, the historical evidence slams you over the head with the fact that, whereas government debt can drift upward inexorably for years, the end usually comes quite suddenly.

And it can happen to any country, although advanced countries can usually tighten fiscal policy with sufficient speed and credibility that the pain comes mainly in slower growth. Unfortunately, for emerging markets, adjustment is often impossible without help from the outside. That is the precipice on which Greece stands today...

...One of the more striking regularities that Reinhart and I found is that after a wave of international banking crises, a wave of sovereign defaults and restructurings often follows within a few years.

This correlation is hardly surprising, given the massive build-up in public debts that countries typically experience after a banking crisis. We have certainly seen that this time, with crisis countries’ debt already having risen by more than 75% since 2007..."

at http://www.project-syndicate.org/commentary/rogoff65/English

Wednesday, May 19, 2010

Total net liabilities (including off-balance sheets such as social security, pension and health liabilities) of the U.S. and the E.U. add up to "$135 trillion"

"...The outlook goes from murky to unbelievably grim, if one includes off-balance sheet items such as social security, pension and health liabilities, which have been promised to us over the years by well meaning but financially inept governments.

As Societe Generale's Dylan Grice puts it:

"I don't see how our governments can pay these liabilities. EU and US net liabilities add up to around $135 trillion alone. That is four times the capitalization of Datastream's World equity index of about $36 trillion, and forty times the cost of the 2008 financial crisis."

I also note that Greece, not included in the chart, stands at 875% debt-to-GDP when including off-balance sheet items!..."

Tuesday, May 18, 2010

Deleveraging has a long way to go in the U.S. Worse than government borrowing replaces private borrowing, public debt increases and growth slows: Reinhart and Rogoff revisited

"...In John's opinion – and I do not disagree – we are still only in the second or third innings of the de-leveraging process (chart 1). Years of excessive debt accumulation cannot be reversed in 18 months, and it will take at least another 5-6 years to play out, possibly longer.

The other part of John's argument – and again it is hard to disagree – is that it remains an open question how much de-leveraging has in fact taken place. As you can see from chart 2, US sovereign debt has risen as fast as private debt has declined (and the picture is similar in many other countries), providing support for the argument that all we have achieved so far is to move liabilities from private to public balance sheets, effectively burdening tomorrow's taxpayer..."

Monday, May 17, 2010

What is the real U.S. budget deficit when the GSEs are not kept off the balance sheet?

"...the GSEs enjoy not only the constant "bid of first refusal" courtesy of the Fed's MBS QE program, but an explicit Treasury guarantee that has no ceiling as of last Christmas eve...

...Fannie and Freddie belong on the balance sheet if we're in an era of transparency. The White House is already forecasting $1.3 trillion budget deficit for 2011, which is about $3 of spending for every $2 of government receipts. Fannie and Freddie are wards of the State. Orszag already promised that that's where they should be. And he's not putting it there. Shades of Enron..."

Sunday, May 16, 2010

Contagion can emerge quickly and often in unpredictable ways: The key lesson from the ERM crisis of 1992 and the Asian crisis of 1997

"The key lesson from the ERM crisis of 1992 and the Asian crisis of 1997 is that contagion can emerge quickly and often in unpredictable ways. Unwinding of leveraged positions by distressed market participants, herding behaviour among investors, and loss of liquidity that gives way to general flight to quality can all lead to heightened correlations between markets and, in extremely circumstances, set off a self-filling crisis on a regional/global scale. There have been clear signs over the past week that the distress in the Greek government bond market is increasingly being felt in other euro area countries such as Spain and Portugal.

The most likely explanation of this development is the “demonstration effect” – the Greek crisis is likely to have caused investors to re-evaluate the fundamentals of these countries. Spain and Greece may not have strong financial or economic links, but their fundamentals have a lot in common.

The possibility of contagion of the Greek crisis may not end with Spain. There is a presumption among investors that in the worst case scenario (and we are not there yet) the EU will give Greece financial assistance. If this is an isolated event, the effect on the overall public finances of the EU is unlikely to be substantial. However, a bailout of Greece may make aid to other countries in similar situations more likely (moral hazard). A series of open-ended bailouts would not only undermine the fiscal positions of core euro area countries such as Germany and France but, more dangerously, would weaken their political commitment to the continuation of the euro area project.

This is probably why Greece is exerting what may seem to be a disproportionate influence on the markets of other euro area countries...

If it was a mistake three months ago to view the Greek crisis as a localized event, it would be a mistake now to see it as a euro-area-specific event. Indeed, global sovereign risk premia, which declined steadily in the first half of 2009, have been all moving higher at varying speeds since last September..."

Saturday, May 15, 2010

The financial crisis is coming to a new, potentially more deadly phase

"Are we about to enter a third, and this time fatal, leg of the financial crisis? The problems of euroland which have so unsettled markets this week – and in particular those of Portugal, Ireland, Greece and Spain (the "pigs", as they have become known in financial circles) – are worrying enough in themselves.

But they are also a proxy for much wider concern about how national governments extract themselves from the fiscal and monetary mire they have created in fighting the downturn. It's proving messy, though, and they are running the risk of provoking an even worse crisis in the process.

Think of the three phases of the economic implosion like this. The first was a fairly conventional, if extreme, banking crisis where a cyclical overexpansion of credit and lending suddenly, and violently, corrects itself in a great outpouring of risk aversion.

In the second phase, governments and central banks attempt to counter the economic consequences of this crunch with unprecedented levels of fiscal and monetary support. Temporarily, at least, it seemed to work.

Until now, investors have been happy to finance the resulting deficits, in part because government bonds have seemed the only safe place to put your funds, but also because central banks have, in effect, been creating money to compensate for the paucity of private-sector credit. The mechanism varies from region to region, but much of this new money has found its way into deficit financing.

We are now entering the third, inevitable phase of the crisis where markets question the ability of even sovereign nations to repay their debts. Unnerved by this loss of fiscal and monetary credibility, governments and central banks are being forced, much sooner than they would have wished, to start withdrawing their support..."

Friday, May 14, 2010

Deficits, public debt and the ring of fire

“These red zone countries are ones with the potential for public debt to exceed 90% of GDP within a few years’ time, which would slow GDP by 1% or more. The yellow and green areas are considered to be the most conservative and potentially most solvent, with the potential for higher growth…

A different study by the McKinsey Group analyzes current leverage in the total economy (household, corporate and government debt) and looks to history, finding 32 examples of sustained deleveraging in the aftermath of a financial crisis. It concludes:

1) Typically deleveraging begins two years after the beginning of the crisis (2008 in this case) and lasts for six to seven years.


2) In about 50% of the cases the deleveraging results in a prolonged period of belt-tightening exerting a significant drag on GDP growth. In the remainder, deleveraging results in a base case of outright corporate and sovereign defaults or accelerating inflation, all of which are anathema to an investor.

Debt situation as it stands:”

Sunday, May 9, 2010

Risking Great Depression II

"...the Europeans are not being careful – and it’s not just about Greece any more. Worries about government debt and associated public sector liabilities (e.g., because banking systems are in deep trouble) have spread through the eurozone to Spain and Portugal. Ireland and Italy are next up for hostile reconsideration by the markets, and the UK may not be far behind.

What are the stronger European countries, specifically Germany and France, doing to contain the self-fulfilling fear that weaker eurozone countries may not be able to pay their debt – this panic that pushes up interest rates and makes it harder for beleaguered governments to actually pay?

The Europeans with deep-pockets are doing nothing – except insist that all countries under pressure cut their budgets quickly and in ways that are probably politically infeasible. This kind of precipitate fiscal austerity contributed directly to the onset of the Great Depression in the 1930s...

the stronger EU countries are not willing to help – in part because they want to be tough, but also because they do not have effective mechanisms for providing assistance-with-strings. Unconditional bailouts are simple – just send a check. Structuring a rescue package that will garner support among the German electorate – whose current and future taxes will be on the line – is considerably more complicated.
The financial markets know all this and last week sharpened their swords. As we move into this week, expect more selling pressure across a wide range of European assets.

As this pressure mounts, we’ll see cracks appear also in the private sector. Significant banks and large hedge funds have been selling insurance against default by European sovereigns. As countries lose creditworthiness – and, under sufficient pressure, very few government credit ratings will hold up – these financial institutions will need to come up with cash to post increasing amounts of collateral against their derivative obligations (yes, the same credit default swaps that triggered the collapse last time).

Remember that none of the opaqueness of the credit default swap market has been addressed since the crisis of September 2008. And generalized counter-party risk – the fear that your insurer will fail and this will bring down all connected banks – raises its ugly head again..."

Saturday, May 8, 2010

Debt Intolerance: When public debt/GDP ratio surpasses 90 percent, median GDP growth rates fall by one percent, average growth rate falls considerably more

"...the relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one percent, and average growth falls considerably more...

Private debt, in contrast to public debt, tends to shrink sharply for an extended period after a financial crisis. Just as a rapid expansion in private credit fuels the boom phase of the cycle, so does serious deleveraging exacerbate the post-crisis downturn...

Periods of sharp deleveraging tend to associated with much lower growth and higher unemployment. The magnitude of the current deleveraging episode in the United States has no counterpart in the post-war period. In varying degrees, the private sector (households and firms) in many other countries (notably both advanced and emerging Europe) are also unwinding the

debt built up during the boom years. Thus, private deleveraging may be another legacy of the financial crisis that may dampen growth in the medium term...

The sharp run-up in public sector debt will likely prove one of the most enduring legacies of the 2007-2009 financial crises in the United States and elsewhere. We examine the experience of forty four countries spanning up to two centuries of data on central government debt, inflation and growth. Our main finding is that across both advanced countries and

23 emerging markets, high debt/GDP levels (90 percent and above) are associated with notably lower growth outcomes...

Why are there thresholds in debt, and why 90 percent? This is an important question that merits further research, but we would speculate that the phenomenon is closely linked to logic underlying our earlier analysis of “debt intolerance” in Reinhart, Rogoff, and Savastao(2003)..."

Thursday, May 6, 2010

The Commercial Real Estate implosion is going to take down hundreds of banks in the next few years

"What has been lost in the housing talk recovery is the grim statistics that commercial real estate has fallen 37 percent in value in the last year. This wouldn’t be such a big problem aside from the tiny detail that some $3 trillion in commercial real estate loans are still outstanding. The commercial real estate debacle is already happening with defaults reaching 16 year highs. This is already occurring before many of the commercial real estate loans reach their refinance dates. In some instances banks are simply ignoring non-payment and giving borrowers a few more months or even years. Why? Because they can still claim the note is current and claim the asset at inflated values...

In reality, the CRE implosion is going to take down hundreds of banks in the next few years. Residential lending became a key part of the too big to fail banking model and smaller regional banks simply were unable to keep up. So instead they funded local CRE projects that are now ticking financial bombs on the balance sheet of hundreds of banks..."

Sunday, May 2, 2010

Contagion can emerge quickly and often in unpredictable ways: The key lesson from the ERM crisis of 1992 and the Asian crisis of 1997

"The key lesson from the ERM crisis of 1992 and the Asian crisis of 1997 is that contagion can emerge quickly and often in unpredictable ways. Unwinding of leveraged positions by distressed market participants, herding behaviour among investors, and loss of liquidity that gives way to general flight to quality can all lead to heightened correlations between markets and, in extremely circumstances, set off a self-filling crisis on a regional/global scale. There have been clear signs over the past week that the distress in the Greek government bond market is increasingly being felt in other euro area countries such as Spain and Portugal. The most likely explanation of this development is the “demonstration effect” – the Greek crisis is likely to have caused investors to re-evaluate the fundamentals of these countries. Spain and Greece may not have strong financial or economic links, but their fundamentals have a lot in common.

The possibility of contagion of the Greek crisis may not end with Spain. There is a presumption among investors that in the worst case scenario (and we are not there yet) the EU will give Greece financial assistance. If this is an isolated event, the effect on the overall public finances of the EU is unlikely to be substantial. However, a bailout of Greece may make aid to other countries in similar situations more likely (moral hazard). A series of open-ended bailouts would not only undermine the fiscal positions of core euro area countries such as Germany and France but, more dangerously, would weaken their political commitment to the continuation of the euro area project.

This is probably why Greece is exerting what may seem to be a disproportionate influence on the markets of other euro area countries...

If it was a mistake three months ago to view the Greek crisis as a localized event, it would be a mistake now to see it as a euro-area-specific event. Indeed, global sovereign risk premia, which declined steadily in the first half of 2009, have been all moving higher at varying speeds since last September..."