Commentaries

from Rolfe Winkler:

Lunchtime Links 2-2

Homeownership rate falls to 2000 level (CR) At 67.2% it's still way overstated. Home "ownership" is a misnomer in cases when the owner has withdrawn mortgage equity or when the price of the home has fallen below the principal value of the mortgage. A better measure of homeownership, I think, is just to look at total owner's equity as a % of household real estate. The most recent Fed Flow of Funds report (page 104, line 50) puts the figure at just 37.6%...

U.S. could extend bank fee beyond 10 years, Geithner says (Di Leo/Crittenden, WSJ) The proposed tax on non-deposit liabilities should be permanent, and should target ALL liabilities, including repos. Deposits are guaranteed via FDIC. While that insurance is dramatically underpriced (witness the cash-strapped state of the DIF) at least banks pay something for it. Non-deposit liabilities are also effectively guaranteed, for the biggest banks anyway, via the promise that none which is too big will be allowed to fail. To counter moral hazard, this implicit guarantee must be taxed in order to offset any benefit derived from lower funding costs.

Must-Read: What's a college degree really worth? (Pilon, WSJ) A lot less than you think, as argued here before. This piece is well-written with lots of good data!

AIG derivatives staff said to forgo $20 million in retention bonuses (Katz/Son, Bloomberg) They're still well-paid, but this is better than nothing I suppose.

Deficits as a national security issue -- Sanger NYT & Seib WSJ -- Good to see prominent columnists picking up the thread. A refresher on the Suez Crisis of 1956 offers helpful background.

Rising FHA default rate foreshadows foreclosure crush (ElBoghdady/Keating, WaPo) Key line: "the FHA projects that it will pay out claims to lenders on one out of every four loans made in 2007 -- the worst rate in at least three decades. The claim rate should be nearly the same on the vastly larger volume of loans made in 2008."

Goldman spokesman's most withering rebuttals (Daily Intel) Methinks he doth protest too much...

from Rolfe Winkler:

Obama’s blowout budget

Now that the worst of the financial crisis is behind us, one would think the budget deficit might start to come down. Actually, no. Obama's proposed budget sets a new deficit record -- $1.6 trillion this year compared to $1.4 trillion last year.

The President thinks he can help the economy with more deficit spending. But debt is the reason we have a jobs problem in the first place. We've accumulated more debt than our incomes can support (see chart at bottom) so the economy is trying to pay it down, leading to less spending and higher unemployment. Adding to the debt pile only makes the employment picture uglier in the long-run.

In his blog entry introducing the budget, Office of Management and Budget Chief Peter Orszag tries to argue that the administration is working to close the deficit. Meanwhile the spin from the White House is that this budget marks the beginning of a "new era of responsibility." Of course that's not at all what we're getting. Orszag even trots out the line that we can grow our way out of debt:

Economic recovery – on its own – would take our deficits from 10 percent of GDP to 5 percent of GDP.

But GDP -- a measure of spending -- can't grow unless we're spending more. Seems to me the only way for aggregate spending to grow faster than government spending is for the private sector to spend more. But households are tapped out. They're saving more to repair already busted balance sheets.

We've published the following chart here at Reuters, which illustrates a key talking point for deficit doves:

from Rolfe Winkler:

Afternoon Links 1-20

Must Read -- Short sale fraud + follow-up (Olick, CNBC) Great sleuthing from Diana Olick. Sounds like outright fraud being committed by big banks. One follow up question: In many cases, the second-lien holder is also the first lien holder. How is that impacting short-sales?

Buffett opposes bank fee (CNBC) See 2/3rds down the page. Obfuscation worthy of a banker. This should come as no surprise as Buffett is Wells' top shareholder. He previously opposed the bank stress tests because it diluted his shareholdings. Nevermind that the stress test forced the bank to raise desperately needed capital. It's a shame, really. As his career winds down, he's sacrificed his reputation as a financial straight-shooter to protect his wealth.

In other Buffett news: He's opposed to Kraft's bid for Cadbury (he's a big Kraft shareholder) and he split his shares, something he never wanted to do. So not a great day for the Oracle.

FT as shameless Fed booster (NakedCapitalism) Yves takes down the FT piece that said the Fed has made a killing on its AIG holdings.

CRE prices up 1.0% in November, not expected to continue (CR) Moody's released its data for CRE prices for November today. They showed a month over month uptick for the first time in a while. That said, this is not a super reliable index due to the few number of data points available. And Moody's says to expect prices to head back down.

Scott Brown successfully capitalized on bank bailout blues (Bottari, CMD) Walker Todd sent a missive over this morning noting, too, that while the healthcare bill's unpopularity certainly played a role in Brown's surprise win, anger over Obama's kowtowing to banks may have pushed him over the edge. Unfortunately, Republicans are equally captured by the bank/homeowner lobby.

Foreclosure efforts failing b/c don't reduce principal (Nasiripour, HuffPo) Helpful confirmation of a fact that is well-known.

from Rolfe Winkler:

BlogArt: Dubai’s Tower of Babel

(ht Reddit)

Plus it was built with slave laborers...

Update: Here's a view from a helicopter...

from Rolfe Winkler:

Could England be headed for a “sudden stop?”

From Landon Thomas at NYT: In Britain, visions of Japan's decade of stagnation

Britain may finally be emerging from recession, but many analysts warn that it is a false dawn. In fact, they argue, the economy here is so ravaged by growing debts and ruined banks that it could well be following in the steps of Japan’s lost decade of the 1990s.

I still don't understand why we refer to Japan's "lost decade," singular. The country is now moving into its third consecutive lost decade.The Nikkei is still at 1984 levels.

But back to the UK: the NYT piece quotes the latest research from Variant Perception (no link). I got it in my inbox earlier this week and it's a fascinating (though not pleasant) read. Notably, they talk about the outside possibility of a "sudden stop" event. As mentioned in this space before, a "sudden stop" is what happens to emerging economies when they lose access to capital markets. Confidence is lost in the government's ability to pay back debt and everyone races to get out of the system. See Argentina.

The problem is acute for indebted emerging markets because they don't borrow in a currency they can print. So, the argument goes, you can't have a sudden stop in Britain, or the US, because we print the currency in which our debt is payable.

I'll let the VP guys take it from here:

The UK’s fiscal situation is in its most precarious state for 30 years. The Bank of England has responded by cutting rates to historic lows. This has merely bought time. Debt in the household sector remains at its highs, and enormous relief has been provided to many overleveraged mortgage holders who hold tracker deals [i.e. teaser-rate mortgages]. They have been able to ride out the recession so far without defaulting. As their trackers expire and they reset to higher rates they will face acute problems.

Usually a government can quickly return to fiscal vitality after a cyclical upturn. The UK will find this difficult. Structural problems such as a heavy reliance on the business and finance sectors and a consumer that will eventually have to deleverage will provide strong headwinds to any sharp turnaround in revenues.

To pay for the shortfall in income, the UK government has stepped up bond issuance to generational highs. This is not sustainable and taxes will eventually have to rise. However, there is a belief that raising taxes will increase revenue. We believe the opposite is true, and the state will have to borrow more than is projected, for longer than is hoped.

The Bank of England has embarked upon a quantitative easing program to support the gilt market. The sheer size of the initiative raises the question of whether it will be able to reverse it in a stable and orderly manner. Any trip-ups in its unwind would raise yields considerably.

The structural problems in the domestic economy, and difficulties in other economies across the globe, will impede the prospects for sustainable growth in the UK. Debt will continue to grow, and the creditworthiness of the country will continue to weaken. Investors will be more and more reluctant to meet the borrowing needs of the UK.

If the situation continues to deteriorate there is a non-negligible possibility the UK could face a ‘sudden stop’ in capital inflows. A debt crisis would precipitate a currency crisis. This would not be especially unusual for the UK: during the postwar period, there has been one on average every 15 years. These have happened like clockwork.

The possibility of this course of events unfolding is small, but not negligible. If a new government is formed next year, perhaps they will be able to enact the policies that will reduce the deficit and restore confidence in the financers of the UK deficit. We believe, though, that to say the UK will not have a debt crisis is complacent and pays no heed to the past.

from Rolfe Winkler:

Krugman on the invisible bond vigilantes

Paul Krugman is complaining of deficit hysteria over on his blog again. Where are the bond vigilantes? he wonders. Since we're still able to sell debt so cheaply, why is anyone worried about more deficit spending?

As always, there are numerous holes in his argument that he chooses to ignore.

1. The chart he uses is the most charitable view of America's public debt burden. It's simply public debt outstanding. This ignores money the government owes itself to fund future benefits. More importantly, it ignores unfunded liabilities. Paul puts debt to GDP at 60%. In reality, public debt is closer to 500%. And that's using 2005 figures.

2. Krugman ignores private debt (household, business, financial) which still stands at a suffocating 300% of GDP according to the latest flow of funds report. If households are drowning in private debt, they can't exactly afford tax increases to pay off more public debt. This is a key argument against those who say that we can borrow more because we have in the past, specifically during the '40s when we were fighting WW2. Yes, public debt was much higher then. But private debt had been virtually wiped out by the Depression. So the total public + private debt burden was far lower than it is today.

(Click chart to enlarge in new window)

Again, the chart above excludes unfunded liabilities. Including them would put the total debt burden closer to 800% of GDP. Truly an astonishing figure.

Commercial paper market still smaller than 2003

Earlier today the Fed’s commercial paper data caught my eye – the nearly $70 billion surge in short-term borrowing in the latest week was hard to miss. At $1.3 trillion, the CP market is still a shadow of its former self. It peaked at $2.2 trillion in the summer of 2007 right before the bottom fell out of credit markets.

But that’s a good thing. Much of the growth during the boom came in the asset-backed part of the market, which subprime mania infected during the boom. When money market managers woke up to the fact that they may have exposure to subprime, they bailed, helping to spark a run on short-term markets that only buckets of liquidity from the central banks stopped.

It will be worrying if the surge in CP continues indefinitely, though, since we all know how dangerous it can be when companies become too addicted to cheap short-term borrowing. But for the moment, it doesn’t seem excessive. Even with the $234 billion expansion since the end of July, the market is still smaller than where it stood in 2003 at $1.35 trillion.

from Rolfe Winkler:

Big Mac Index meets National Debt Clock

A cool press release from The Economist just hit my inbox. They've launched a global public debt clock:

In the spirit of The Economist's famous Big Mac Index, the Global Public Debt Clock is not perfectly accurate, but rather is intended to provide a graphic perspective on an important economic issue.

• Global public debt is currently at nearly $35 trillion and is predicted to rise to $45 trillion by 2011
• US public debt is currently at $6.7 trillion and is predicted to rise to over $10 trillion by 2011
• Chinese public debt per capita is currently $649.52. In the US, per capita debt is $21,863.70 and will rise to $32,307 per person by 2011

Another reason to take the number with a grain of salt: It only includes "publicly-held" debt. So for instance, for the U.S., the figure is $6.7 trillion. But if you include the debt the government owes itself (i.e. money borrowed from entitlement "trust funds" to finance other spending), then the figure is $11.8 trillion. And if you count the unfunded promises of Social Security and Medicare, the figure is over $60 trillion. Again, that's just the U.S.

But it would be difficult to make comparisons across countries this way, which is why publicly-held debt is the right measure for the Economist to use. Just keep in mind that it understates the total....

Be sure to play around with the map at the bottom. It's pretty nifty.

Deleveraging in action, Bank of England edition

Ever since branches started forming outside Northern Rock branches two years ago, British consumers have been told they have way too much debt. They finally appear to be paying attention. Bank of England data released today shows net lending to individuals fell by £600m between June and July. Nothing surprising there, you might say. Surely it’s only normal that people are paying back their debts. Except that this is the first drop since the Bank started recording monthly data back in 1993. Or, as the Bank’s statisticians put it:

Total net lending to individuals fell by £0.6 billion in July, showing a net repayment for the first time in the series.

For most of the past two years, the net lending figures have been falling. But they had not turned negative, until now. The question is whether this is a one-month blip or the beginning of a trend. Certainly, the drop in mortgage lending is at odds with other recent figures. Also in July, according to the British Bankers Association, the number of mortgage applications that have been approved rose to their highest level for a year and a half. The question is whether those new borrowers will compensate for the people who have decided it is high time they paid off some debt. Watch this space.

Take the L out of LBO

In a perfect world, we would simply ban leveraged buyouts. The vast majority of these debt-laden corporate takeovers are no less predatory and value-destroying to a company than a loan shark who charges usurious rates of interest.

Realistically, a prohibition on private equity deals will never happen, given the big dollars involved in these transactions and the sizeable campaign contributions that private equity chieftains shower on politicians from both parties.

So here’s another way to prevent private equity firms from again saddling their corporate prey with too much debt: Prohibit banks from committing financing to any LBO where the private equity buyers are not willing to pony up at least 50 percent of the purchase price.

A 50 percent equity threshold would stop banks from giving in to their worst impulses, which are to do whatever they can to win favor with the private equity firms, in the hopes of rich fees and the promise of lucrative stock and bond underwriting deals down the road.

And it will force banks going forward to make more loans to companies looking to expand their operations and create jobs — not destroy jobs, as is often the end result of an LBO.

Requiring a private equity firm to put up a dollar for every dollar in a financing that a deal needs to get done is not as extreme as it may sound.

In fact, at the end of the two most recent LBO booms, it was not uncommon for the small number of deals that did get consummated to involve equity commitments in excess of 40 percent, according to data compiled by Standard & Poor’s Leveraged Commentary & Data.