Happy stock highs belie bonds teetering on edge
By Robert Cole The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
Some nice round numbers have equity investors smiling. The Dow Jones industrial average crossed the 13,000 level for the first time since before the crisis and Britain’s FTSE 100 index is headed towards 6,000. Many in the market may be wondering if the run can be sustained. But the real danger may be lurking for bondholders.
The FTSE 100 index crossed 6,000 for the first time back in April 1998. It has risen through the mark and slipped back below it 41 times – not counting the occasions it flip-flopped during intra-day trading. In that context, investors might wonder if the event is even worth marking, let alone celebrating.
The warming U.S. economy, coupled with encouraging news on the European front, accounts for much of the renewed confidence. Investors are also attracted by what looks like discounted value. In the United States, the multiple on the more broadly based S&P 500 index, at 12.5 times forward earnings, is below the 25-year average of 15. The UK equivalent is 10.2 times. The first time the FTSE 100 hit 6,000 the forward price-to-earnings multiple was 18.9.
If recession hits and corporate earnings decline, hindsight will reveal the major indices to have been deceptively cheap. Any remaining potential upside, meanwhile, may do little more than compensate for the inherent risks in stocks. Debt markets, however, look more precarious.
Yields on 10-year bonds issued by the U.S. and British governments are still settled around 2 percent. That suggests debt instruments are as dear as they have been at any time in modern market history. They also offer little, if any, protection against inflation.
True, monetary policy on both sides of the Atlantic is about as lax as could be. What’s more, the Japanese precedent shows that bond yields and equities prices can stay persistently low together. But any feelings of vertigo by equity investors are probably misplaced. It is expensive sovereign bonds that are more likely headed for an overdue fall.
Citi, BofA prove too big to punish harshly
By Agnes T. Crane
The author is a Reuters Breakingviews columnist. The opinions expressed are her own.
Sticking it to Uncle Sam should attract harsh punishment. But the fines Citigroup and Bank of America will pay – $158 million and $1 billion respectively – to settle claims they defrauded the U.S. government look easily handled. Citi has even admitted fraud in its dealings over home loan insurance. A ban from participating in the government’s mortgage insurance programs would be a better deterrent. But unfortunately, Washington needs big banks too much.
BofA’s alleged misdeeds are still murky since its settlement was conveniently wrapped up in the broader $25 billion deal between federal and state enforcers and big mortgage servicing banks over so-called robo-signing transgressions. But the complaint against Citi offers a brutal account of the drive for profit squashing quality control. The Federal Housing Administration ended up insuring shoddy Citi mortgages that, in some cases, were in default within six months.
Federal insurance programs rely to a large extent on banks’ good faith in delivering mortgages that genuinely meet the required standards. Citi’s admission that it failed to do this came only after someone blew the whistle last year. It was a breach of the government’s trust and it has cost taxpayers money.
The penalties for ripping off the government usually go beyond dollars and cents. Yet Citi’s fine, in particular, is hardly crippling. And BofA has already set aside enough money to cover a good chunk of its settlement. A temporary ban on doing business with the FHA, on the other hand, would deliver more punch and show others in the industry that Washington won’t tolerate abuses of its largess.
Yet that’s unlikely to happen. The FHA, once a niche player focused on low-income housing, now backs about a third of new mortgages including super-sized ones for wealthy home buyers. The market for FHA-qualified mortgages runs $25 billion a month. While Citi has only a 2 percent share, BofA is the largest player with more than 26 percent, according to FTN Financial, using mortgage servicing as a proxy for origination activity. Booting offending banks out of the government’s program could make mortgages even harder to come by.
Renters need to flex muscle in U.S. housing debate
By Agnes T. Crane The author is a Reuters Breakingviews columnist. The opinions expressed are her own.
Though America’s mortgage system subsidizes homebuyers, its dysfunction has cost all taxpayers dearly. Few constituencies with much clout are pushing for change. But the nation’s 39 million rental households – often an afterthought in the housing debate – ought to be up in arms. They might find unlikely allies, too.
Renters may be the only big group in the United States that isn’t invested in the status quo. Homeowners, realtors, homebuilders and banks all benefit from the government’s hand in housing, exercised through Fannie Mae and Freddie Mac, which buy and guarantee mortgages, through other federal vehicles, and through tax rules that subsidize mortgage interest.
This makes home financing cheaper and, usually, more liquid, which in turn makes homes of any given price more affordable and potentially easier to sell on. Banks and investors, meanwhile, are wedded to the security a government guarantee brings to their respective loans and bond investments. And politicians, who have long extolled the virtues of homeownership, are loath to do anything that would make it more difficult for voters to achieve their idea of the American Dream. The trouble is, that’s what would happen if reforms are introduced that reduce or scrap the role of the government’s money and policy objectives in the market.
But rent-payers ought to like that idea. They miss out on the huge tax deductions mortgage interest payers get. And their savings bring in more return when the Federal Reserve hikes interest rates, in contrast to households with equity in homes that in theory go up in value when the Fed pushes lending rates lower and lower. Meanwhile, renters have been hurt by fallout from the housing bust. As taxpayers, they are set to suffer the costs of the government’s attempts to shore up housing – more than $150 billion and counting in losses at Fannie and Freddie alone. And as struggling homeowners hit the rental market, rents are going up too.
At the same time, the ranks of renters are filling up with younger Americans who have witnessed the nightmare of homeownership rather than the dream espoused by older generations. The 44-and-under crowd has been hard hit, with their homeownership rate falling by more than seven percentage points since 2005 to 62.3 percent, according to the U.S. Census Bureau. This matters since they will tell their tales for years to come, potentially undermining the belief that homeownership is part and parcel of American prosperity.
Meanwhile, borrowers who owe more than their home is worth are weakening a key supposed advantage of homeownership: that mortgage deeds bring good deeds to a neighborhood. That probably still applies when someone has a chunky equity stake in their home. But more than a quarter of homeowners now do not. This group is much less likely to fork over, say, $20,000 to fix a leaky roof if it’ll only help the bank’s bottom line rather than their own. Underwater homeowners look a lot like renters with giant mortgage millstones hanging around their necks.
It certainly is understandable that renters would be less organized than the Real Estate Industrial Complex made up of brokers, agents, owners, banks, etc… Unfortunately, their control of the legislative process and policy in this realm is as strong as it gets. Renters get a break every now and then when market forces convulse under horrible policy – but policy makers get right back to punishing renters.
Still a long slog ahead for U.S. jobs
By Daniel Indiviglio and Richard Beales
The authors are Reuters Breakingviews columnists. The opinions expressed are their own.
There’s still a long slog ahead for the unemployed in America. Jobs growth has started picking up. But even at a rate of 250,000 a month, a hair above January’s figure, full employment may not be reached until 2020. A new Breakingviews calculator shows how a faster or slower rate of job creation changes that picture.
The important headline variable is the jobs growth reported in the U.S. monthly employment report – the stronger, the better. But a few other factors also matter when looking ahead. One is population growth, and another is how quickly the labor participation rate increases toward a more typical level. That’s the percentage of the population defined as either working or looking for work.
Since the recent recession began, millions of workers have become discouraged and temporarily given up on finding a job. The labor participation rate has declined from 66.4 percent in 2007 to 63.7 percent in January. Suppose participation recovers to that 2007 level by January 2020. This trend coupled with population growth at the average rate seen between 2003 and January this year would call for almost 200,000 new jobs a month just to hold the unemployment rate – 8.3 percent as of January – steady.
Then there’s the question of what level of joblessness reflects, essentially, full employment, since there will always be people between jobs. The calculator allows this input, as well as the other key ones, to be changed, but starts out assuming that 5 percent unemployment is the target.
With these assumptions, full employment would only be reached again in America in early 2020. If the monthly job creation rate jumped to 300,000, that date would be brought forward nearly four years.
Gingrich makes Goldman 4-letter word – to no avail
By Daniel Indiviglio
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
The Florida Republican primary’s big winner tonight may be Wall Street’s most infamous bank. Front-runners Newt Gingrich and Mitt Romney are trying to connect one another to the financial crisis. Gingrich paints his rival as an agent of the giant vampire squid, while Romney criticizes his opponent for being paid handsomely for advising Freddie Mac to inflate the housing bubble. But in a state still in pain from the bust, Romney’s line is winning.
In Florida, the battle occurs through the airwaves. Romney, the former Massachusetts governor, has spent more than $15 million advertising in the state, four times as much as his competitor. One Romney ad, in particular, zeroed in on Gingrich’s role in the housing bubble.
It argued that the former House speaker was paid $1.6 million by Freddie “while Florida families lost everything in the housing crisis.” Such criticism strikes a painful chord in Florida. In Tampa and Miami, for instance, home prices are down about 50 percent from their peak, according to S&P/Case-Shiller’s indexes through November.
Though he doesn’t have the financial firepower of Romney, Gingrich is attacking from a different angle. He has been complaining loudly about his opponent’s connection to Wall Street, claiming that the crony capitalism he says is embraced by President Barack Obama would continue in a Romney presidency. Gingrich even asserted in a Fox News interview this week that Republicans would be letting Wall Street and Goldman Sachs buy the election if Romney wins.
Each criticism is a stretch. Gingrich’s advice hardly led Freddie to suddenly decide to lower loan standards and pour more gasoline onto the raging housing boom. Similarly, Romney is a client of Goldman’s and has received a hefty amount of campaign contributions from some at the bank, but that doesn’t mean he’s in bed with the squid.
U.S. private sector emerges from government shadow
By Martin Hutchinson
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
The U.S. private sector is emerging from government’s shadow. Headline annualized GDP growth of 2.8 percent in Friday’s fourth-quarter data looks more anemic when inventory growth is netted out. But overall in 2011, as government has retreated private enterprise has regained strength.
At first glance, the first estimate of fourth-quarter economic growth was disappointing. The headline number was below the consensus forecast, while nearly two percentage points of growth were represented by inventory accumulation, generally considered a negative factor since it isn’t usually sustainable. Personal consumption expenditures were subdued, growing at just 2 percent, as was non-residential fixed investment, at 1.7 percent.
But on closer inspection the figures were stronger than they looked. Relatively weak final sales and domestic consumption followed surges in those factors in the previous quarter, while the inventory build-up followed a previous quarter drawdown, thus probably holding few negative implications for the future.
Moreover, government has been shrinking and the private sector correspondingly strengthening. For 2011 as a whole U.S. GDP grew by only 1.7 percent. But gross private product, which excludes government expenditure, grew by 2.7 percent. In the fourth quarter, the private sector grew at a robust 4.5 percent annual rate, while government shrank at both the federal and state and local levels.
Inflation was also subdued during the quarter, presumably affected by the decline in resource prices in the autumn. For 2011, the price index for personal consumption expenditures, Federal Reserve Chairman Ben Bernanke’s favorite inflation metric, grew at 2.4 percent, a restrained level – if still 0.4 percentage point above the Fed’s newly stated target.
Uninvited guest, Mr 99 Percent, crashes Davos
By Rob Cox
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
The most difficult guest to avoid bumping into at the World Economic Forum this year has no badge. He was not invited to the annual gathering in Davos, but he haunts the panels, hallway conversations and politicians’ speeches. He is Mr. 99 Percent, the specter of the unemployed and disenfranchised.
Not everyone at the Swiss conference is a member of the privileged 1 percent, but the whole point of the endeavor is to bring together the powerful of the world (and Mick Jagger). And the Indian billionaires, Chinese entrepreneurs, Wall Street chieftains and leaders of organized labor agree on one thing. An increase in civil unrest would be bad for business. The only beneficiaries of last year’s confrontations in the streets of downtown Manhattan, north London or Santiago were the makers of tear gas and barricades.
But the power-brokers and plutocrats cannot agree on what should be done. The Forum’s agenda is a bit schizophrenic. A Wednesday panel, “The Seeds of Dystopia,” focused on how to keep the 225 million unemployed around the world from losing faith in capitalism and civic institutions. One idea was to pay more attention to limiting the ratio of executive compensation to average worker pay.
But at the same time, and just down the hall, a hedge fund manager, a consultant and a corporate chairman discussed “The Compensation Question.” Their answer, in a nutshell, was that it’s a matter for shareholders – leave us alone.
Some panels are defensive. “The Dark Side of Connectivity” focused on the security risks created by new technologies such as the social networks that let protesters – from Cairo’s Tahrir Square to Manhattan’s Zuccotti Park – organize in real time. But some people are hopeful. Former U.S. Treasury Secretary Larry Summers sees the cries against wealth disparity as a symptom of the economy’s woes. By that token, the protests will diminish as growth rebounds.
Window dressing. If you mean to disrupt Davos and what it stands for, you want to dig in and use your teeth.
Fed doubles risk of being whipsawed by market
By Martin Hutchinson
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
The U.S. Federal Reserve could be setting itself up for an uncomfortable surprise. It extended its commitment to keep interest rates near zero from about 18 months to three years on Wednesday. Job creation, the departure of Chairman Ben Bernanke or rising inflation could force a damaging reversal before then – or lead the Fed to drag its feet to avoid one.
In his press conference, Bernanke said that with the fed funds rate at zero the U.S. central bank had two means of affecting monetary policy, namely securities purchases and guidance. By pushing out the date when it expects rates to start going up from mid-2013 to late 2014, the Fed has potentially reduced yields on long-term paper.
Bernanke also outlined the Fed’s long-run goals and policy strategy, setting a soft inflation target of 2 percent, based on the annual change in the price index for personal consumption expenditures. He noted that a hard target would be incompatible with the Fed’s dual mandate, which includes promoting full employment as well as minimizing inflation.
The U.S. unemployment rate was 8.5 percent in December, down 0.6 percentage point since August. Should that pace of improvement continue, unemployment would reach the Fed’s estimated “normal” range of 5.2 percent to 6 percent by mid-2013 – well before Bernanke’s new zero-rate end date.
Meanwhile, the PCE price index was up 2.5 percent in November from the previous year. Given that’s already above the Fed’s soft target, it seems likely that inflation will rise sufficiently within the next three years to warrant an interest rate rise. Finally, Bernanke’s own term of office ends in January 2014. This year’s elections may determine whether he will get another term, and a different chairman could spearhead a very different policy.
Latest U.S. bank stock surge could prove fickle
By Antony Currie
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
The latest bull run in U.S. bank stocks may prove fickle. The big six, including Goldman Sachs and Bank of America, have added $100 billion of market value since mid-December, a 23 percent jump, despite meager fourth-quarter earnings. Receding fears over Europe have helped better align bank valuations with balance sheet and income realities. But no further rally is warranted with more ugly surprises likely.
The latest surge in bank shares largely reverses the sharp declines suffered after MF Global’s bankruptcy at the end of October. That brought the dangers of opaque and off-balance-sheet exposures to the fore once again, at least for a few weeks. Investors have since shrugged off those fears and turned their attention to earnings. But those don’t look pretty. All four of the top U.S. commercial banks by assets – BofA, Citi , JPMorgan and Wells Fargo – reported a decline in core earnings last year, even after allowing for any asset sales. And Goldman Sachs and Morgan Stanley are, along with BofA and Citi, floundering with returns on equity in the mid-single digits.
That’s not exactly the stuff of a market bounce. But consider where it has left valuations. Wells had the highest return on equity last year, at 12 percent, which may just be enough to cover its cost of capital. Assuming results don’t worsen, trading around 20 percent above book value doesn’t look off base.
The same goes for BofA. Even after its 40 percent share rally in recent weeks, it only trades at a third of book value, or assets minus liabilities, right in line for a bank beset by mortgage problems that will struggle to eke out much more than 5 percent equity returns for a while. Even Goldman and Morgan Stanley don’t seem overpriced at 80 and 60 percent of net asset value, respectively, considering their mid-single-digit equity returns. And they usually prosper first when business picks up.
The trouble is, shareholders have a penchant for overreacting to both good news and bad. With nothing too solid underpinning the latest stock advances, any more jitters about U.S. or European economies – a distinct possibility given the fragile conditions – could drive bank stocks right back down again.
Alluring subprime debt can still poison investors
By Agnes T. Crane
The author is a Reuters Breakingviews columnist. The opinions expressed are her own.
Subprime mortgage debt has got its mojo back. A growing number of investors reckon there’s life yet in the mortgage market’s toxic sludge from the crisis – and that now’s the time to buy. But buyers should tread carefully.
Yields are certainly enticing. Last year’s battering lopped up to a third off the value of subprime mortgage bonds, leaving some fetching 10 to 12 percent, according to Barclays estimates. U.S. junk bonds, by contrast, offer less than 8 percent. Moreover, while the U.S. housing market is hardly in a recovery, few think home prices will fall by more than a few percentage points from here.
Investment banks in particular look eager to scoop up the mortgage sludge. Credit Suisse has just bested Goldman Sachs and two other broker-dealers to a $7 billion slice of the subprime holdings the Federal Reserve took from American International Group in 2008 – though the central bank will not disclose the price until April. It’s not the first time this year the Swiss bank has been involved in the market: the bank’s senior managers are getting in on the act, too, voluntarily buying $450 million-worth of securities and putting them into a fund of mostly subprime bonds that the bank set up in 2008 to pay staff bonuses.
Less swift investors may be focusing on the chance of a good deal of supply coming onto the market. All in, some $1.2 trillion is walled up in U.S. banks, insurers, hedge funds and European firms, according to Barclays. Banks, especially, may be big sellers as Basel III capital rules are onerous for securitized debt. Europe’s lenders hold some $70 billion, with up to $20 billion potentially for sale, while U.S. banks are sitting on around $200 billion, according to Barclays’ tally.
But subprime mortgage bonds have long been an illiquid asset. The analysis required to price such complex securities makes trading them incredibly difficult. And any attempt to sell more than a small amount can quickly whack prices. That happened last year when the Fed used public auctions to get rid of some of its AIG waste and ended up offloading less than it hoped.
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Predictions 2012: Upside down and inside out
Edited By Robert Cole
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