Quote of the Day: Fed’s allocation of credit is an Inappropriate Use of Central Bank’s Asset Portfolio

A balance sheet has two sides, though, and it is the asset side that can be problematic. When the Fed buys Treasury securities, any interest-rate effects will flow evenly to all private borrowers, since all credit markets are ultimately linked to the risk-free yields on Treasurys. But when the central bank buys private assets, it can tilt the playing field toward some borrowers at the expense of others, affecting the allocation of credit.

If the Fed’s MBS holdings are of any direct consequence, they favor home-mortgage borrowers by putting downward pressure on mortgage rates. This increases the interest rates faced by other borrowers, compared with holding an equivalent amount of Treasurys. It is as if the Fed has provided off-budget funding for home-mortgage borrowers, financed by selling U.S. Treasury debt to the public.

Such interference in the allocation of credit is an inappropriate use of the central bank’s asset portfolio. It is not necessary for conducting monetary policy, and it involves distributional choices that should be made through the democratic process and carried out by fiscal authorities, not at the discretion of an independent central bank.

Some will say that central bank credit-market interventions reflect an age-old role as “lender of last resort.” But this expression historically referred to policies aimed at increasing the supply of paper notes when the demand for notes surged during episodes of financial turmoil. Today, fluctuations in the demand for central bank money can easily be accommodated through open-market purchases of Treasury securities. Expansive lending powers raise credit-allocation concerns similar to those raised by the purchase of private assets.

Moreover, Federal Reserve actions in the recent crisis bore little resemblance to the historical concept of a lender of last resort. While these actions were intended to preserve the stability of the financial system, they may have actually promoted greater fragility. Ambiguous boundaries around Fed credit-market intervention create expectations of intervention in future crises, dampening incentives for the private sector to monitor risk-taking and seek out stable funding arrangements.

This is from Federal Reserve Bank of Richmond President Jeffrey M. Lacker and his Director of Research John A Weinberg at the Wall Street Journal

The point is that the de facto easing policies embraced by central banks as the FED has been to invisibly redistribute resources in favor of certain parties which leads not only to the accumulation of imbalances but also to ethical controversies such as moral hazard, inequality et.al.

And along the same redistributive basis, Germany’s Bundesbank chief Jens Weidmann last week warned against the ECB’s proposed QE via Asset Backed Securities

From Reuters: (bold mine)

ABS are created by banks pooling mortgages and corporate, auto or credit card loans and selling them to insurers, pension funds or now the ECB.

Then the credit risks taken by private banks would be transferred to the central bank and therefore taxpayers without them getting anything in return," said Weidmann, who is also an ECB policymaker.

"But that goes against the basic principle of liability that is fundamental to a market economy: Those who derive benefit from something should bear the loss if there are negative developments," he was quoted as saying.

Bottom line: There are natural limits to the central bank’s embrace of Keynesian zero bound quasi boom policies. Those limits are becoming increasingly apparent even to central bankers.

Chinese Mini-Bank Runs: Show ‘em the Money and Deposit Insurance

The other day I posted here of a mini-run of a small Chinese rural bank in progress. 

What course of action has been taken in order quell the run? 

Well, Show ’Em the money!!! Literally.

From the Guardian: (bold mine)

Rural banks in China's eastern city of Yancheng stacked piles of money in plain view behind teller windows to calm depositors queueing at bank branches for a third consecutive day, following rumours they had run out of cash.

According to residents of Sheyang county, panic began on Monday with a rumour that a branch of one local bank turned down a customer's request for a 200,000 yuan (£19,500) withdrawal. Banks declined to comment and Reuters was unable to verify the rumour.

The affected institutions are tiny compared with the scale of China's financial sector, and the rush for cash appears to be an isolated incident so far. Rumours found especially fertile ground there after a failure of three less-regulated rural credit co-operatives last January. Yet the news caught nationwide attention, reflecting growing public anxiety as regulators signal greater tolerance for credit defaults.

Well did show 'em the money work? Unfortunately not. (bold mine). From the same article...

Despite repeated appeals from local officials for calm, by Tuesday the run had extended to another local bank, the Rural Commercial Bank of Huanghai, residents said.

Earlier on Wednesday police and security guards stood by as dozens formed a long queue outside while an electronic sign urged depositors not to be worried by rumours.

The governor of Sheyang county, Tian Weiyou, posted a two-minute video statement on the county government's website on Wednesday, urging depositors not to panic. In it he said: "Please be assured that the People's Bank of China and the rural commercial bank system will ensure the interests of all depositors will be protected. The county's rural commercial banks will ensure that there will be enough funds for depositors to withdraw at any given time."

As one would note, "tiny" and "isolated" in the above report seem to have been negated by "extended to another local bank"

What this instead shows is the periphery-to-the-core dynamic in motion or the contagion from the fringe moving into the center.

The article goes on to advocate deposit insurance as a solution to the banking system's debt problem. 

But deposit insurance will signify a short term solution that comes not only at the cost of taxpayer money but also increases systemic risks from moral hazard—tendency to take on more risks because the costs of the risks will be borne by another party—in the long run.

As International University of Geneva Professor Frank Hollenbeck explained at the Mises Institute (as applied to the US) [bold mine]

Deposit insurance is one of the two factors which allows banks to take such risky gambles. Created in 1933, it is a perfect example of government policy that ultimately will be determined to have done more harm than good. It was supposed to reduce risks, but has done just the opposite. When governments provide flood insurance the private sector would never consider, people then build homes in areas prone to suffer from severe flooding.

Prior to deposit insurance, people were careful about where they deposited their money to pay rent or food bills. If a bank ran into trouble by undertaking poor lending practices, people would quickly try to pull their money out of the bank. Bank runs were a good thing because runs served to force banks to be extremely careful about their lending practices. The threat of a bank run maintained sound incentives.

Deposit insurance is a perfect example of Frederick Bastiat’s parable of the broken window: what is seen, and what is not seen. For about 70 years, bank runs have been eliminated; giving depositors what some would say is the illusion of protection. That is what is seen. What is not seen is, without insurance, banks would have been taking much less risks with deposits, and governments would have been less able to finance spending through bank purchases of their bonds.

In other words, deposit insurance is a privatize profits-socialize losses transfer mechanism that works in favor of the banking system charged to taxpayers.

And this also means that a lot today’s global financial and economic imbalances, aside from inflationism, stems from many other price distorting regulations such as deposit insurance. 

Two wrongs don’t make a right. 

China's problems has been about massive accumulation of unproductive debt fueled by fractional reserve banking, thus markets should clear such imbalances.

Meanwhile, the periphery to the core “run” on Chinese institutions continues…
 
Updated to add: With the shrinking availability of domestically sourced liquidity as the financial spigot have been closing, Chinese developers have reportedly tapped on a new way of financing: cross border Commercial Mortgage Backed Securities (CMBS).

Parallel Universe: Booming German and French Stocks as Economies Stagnate

In a the world where central bankers have become demigods, the disconnection between the financial markets and the real economy have increasingly become evident.

From the Bloomberg:

The German economy expanded less than forecast in the first quarter and France’s slipped into recession, increasing pressure on the European Central Bank to do more to stimulate growth.

German gross domestic product rose 0.1 percent from the fourth quarter, when it fell a downwardly revised 0.7 percent, the Federal Statistics Office in Wiesbaden said today. Economists forecast a 0.3 percent gain, according to the median of 41 estimates in a Bloomberg News survey. The French economy contracted 0.2 percent in the three months through March after shrinking the same amount in the final quarter of last year.

The above data revealed in the charts below. [Charts courtesy of tradingeconomics.com and stockcharts.com]

 

The German equity market bellwether, the DAX, has been on an uptrend (upper pane) since October 2011 even when statistical economic growth peaked during the first semester of 2010 and continues to worsen (lower pane). Thus, the two year divergence can hardly be interpreted as anomaly.

Year to date, the DAX, as of yesterday’s close, has been up 9.55% even as statistical economic growth is at the borderline with the negative.

The French phenomenon seems even more elaborate.

The French equity market as measured by its bellwether, the CAC, has been on an uptrend along with the German DAX where both began to reverse near simultaneously higher during the last quarter of 2011.

Ironically, the French economy has been zigzagging mostly in the recessionary territory (lower window) even as the stock market continues to boom through 2012 (upper window).

Once again, the French economy has been reported above as enduring a statistical recession, but the CAC has been up 10.38% year to date as of yesterday's close.

The above has been exhibiting the unintended consequences of central bank policies.

The micro or the real economy continues to suffer from real economic obstacles (high taxes, more mandates, relative price distortions, regulations and etc….) which deters investments, but adds to the incentives generated by easy money policies in diverting capital towards yield chasing activities in the financial markets, where the latter have also been buttressed by central bank guarantees.

Such parallel universe is a sign of an unsustainable bubble in progress. 

For now we see a boom. Eventually we would either see a grand bursting of these bubbles that would likely lead to cascading wave of debt defaults or a currency crisis.

Implied Government Guarantees on BRIC Banking system

Even in the BRICS, there has been an implied guarantee by their respective governments on their banking system, as indicated on their credit ratings.

From Reuters:

The ability of Brazil, Russia, India and China to support their leading banks is tightly correlated to the credit rating on the banks, according to ratings agency Moody’s. The agency compares the ratings of four of the biggest BRIC banks which it says are likely to enjoy sovereign support if they run into trouble…

In a self-perpetuating cycle, ratings will be higher because governments are prepared to provide high levels of support to the banks, reflecting the lenders’ systemic importance and in some cases government ownership.

Bailouts on the politically privileged banking system have become a global standard. And this encourages the moral hazard behavior where banks take unnecessary risks because they know they will be supported once "they run into trouble". This adds to the yield chasing phenomenon that increases systemic fragility.

Moreover this implies that the public's savings, even in emerging markets, will continue to be under duress from indirect and direct confiscations in favor of the banking system.

More Signs of Global Pandemic of Bubbles

You just got to love today’s entropic financial conditions that has been edified from the “this time is different” mindset.

From Central Bank News: (bold mine)

Households worldwide have boosted their borrowing since the 1970s and in some countries, such as the United States and Australia, the total amount now exceeds that of companies, the Bank for International Settlements (BIS) said, introducing a new public database for total credit in 40 countries…

In addition to the growth of household borrowing, the data shows how credit has substantially outgrown economic growth in nearly all countries.

In the 1950s, total credit was around 50 percent of Gross Domestic Product in many advanced economies and then grew over the next 20-30 years and started to top 100 percent in the 1960s and 1970s. By the late 1980s, credit boomed in some countries, such as the United States and the United Kingdom.

Other countries, like Germany and Canada, saw modest credit growth while Ireland is the extreme case: In 1995 it had a credit-to-GDP ratio of around 100 percent. Fifteen years later, the ratio peaked at 317 percent and hasn’t dropped much since.

The explosion of credit with accompanying boom-bust episodes is hardly limited to advanced economies. In Thailand, for example, private sector borrowing rose from 12 percent of GDP in 1958 to 75 percent 30 years later, BIS said.

“A rapid expansion in credit then followed that ended in the 1997 Asian crisis. Thailand’s credit-to-GDP ratio nearly halved over the subsequent 13 years, but started to increase again from 2010 onwards,” BIS said.

In general, emerging economies have tracked advanced economies in increasing the level of household credit. In the 1990s, when data are first collected for emerging economies, household borrowing made up 10-20 percent of total credit. Now, it has risen to 30-60 percent, corresponding to the current levels of many advanced economies.

Yet despite easy money environment which has entailed a monstrous increase in debt, governments have failed to institute necessary reforms

Again from another article from Central Bank News: (bold mine)

Global debt by households, governments and non-financial enterprises has mushroomed by some $30 trillion since 2007, but governments in advanced economies are not taking advantage of the flood of cheap money to carry out necessary structural reforms that will pay off over time, warned the BIS…

“Combining households, non-financial enterprises and government since 2007, global debt has risen a combined $30 trillion dollars, or roughly 40 percent of global GDP, “ Cecchetti told journalists in connection with the publication of BIS’ March quarterly review.
“One reason to be sceptical about the efficacy of further monetary or fiscal easing is that debt levels are very high and continue to rise,” he said, adding: “It is telling that as asset prices are rallying and firms are issuing more debt, investment in the major advanced economies is not picking up."

Regardless of economic or political persuasion, it is clear that economic growth is driven by investment and this is financed through borrowing, either by governments or the private sector.

But households are overburdened, firms are hoarding cash, and governments have reached their borrowing limits. No one wants to borrow more, nor should they, Cechetti said.

With monetary and fiscal policies reaching their limits, Cecchetti appealed to policy makers to get busy with structural reform, such as addressing the time bomb in the pension and healthcare systems and reducing barriers to the reallocation of capital or workers across sectors.

Why change when the good times have been rollin'? 

Central bank policies only provide the incentives of moral hazard to political authorities, thus the reluctance to reform. This shouldn't be hard to understand.

All these "kicking the can down the road" policies have been designed to maintain the status quo of the cartel of the political triumvirate institutions of the welfare-warfare state (notice the "time bomb"), banking system and central banking.

Oh surging local currency bond markets in Asia heightens the risks of a bubble, says the ADB… (bold mine)

Emerging East Asia’s local currency bond markets continued to expand in 2012, signaling ongoing investor interest in the region’s fast-growing economies but also raising the risk of asset price bubbles, said the Asian Development Bank’s (ADB) latest Asia Bond Monitor…

By the end of 2012, emerging East Asia had $6.5 trillion in outstanding local currency bonds versus $5.7 trillion at the end of 2011. That marked a quarterly increase of 3.0% and an annual increase of 12.1% in local currency terms. The corporate markets, though smaller than the government bond markets, drove the increase, growing 6.2% on quarter and 18.6% on year to $2.3 trillion.

Emerging East Asia is defined as the People’s Republic of China (PRC); Hong Kong, China; Indonesia; the Republic of Korea; Malaysia; the Philippines; Singapore; Thailand; and Viet Nam.

Investors have been putting their money to work in emerging East Asia since the early 1990s, but the flows have picked up pace in recent years because of low interest rates and slow or negative economic growth in developed economies while emerging East Asia has enjoyed high growth rates and appreciating currencies.

Investment is increasingly coming from overseas, with foreign ownership in most emerging East Asia local currency bond markets increasing in the second half of 2012. In Indonesia, for example, overseas investors held 33% of outstanding government bonds at the end 2012, while foreign holdings of Malaysian government bonds had reached 28.5% of the total at the end of September 2012.

The fastest-growing bond market in emerging East Asia in 2012 was Viet Nam, 42.7% bigger than at end 2011, largely due to the rapid expansion in the country’s government bond market. The Philippine and Malaysian markets grew 20.5% and 19.9% respectively, while India’s market expanded by a strong 24.3% to $1.0 trillion. Japan still has the largest market in Asia at $11.7 trillion, followed by the PRC at $3.8 trillion.

Governments in emerging East Asia are increasingly opting to sell longer-dated bonds – another sign of strong market confidence in the economies of the region – which is making them more resilient to possible volatile capital flows. This is particularly the case in Indonesia and the Philippines. Maturities tend to be shorter in the corporate bond markets of the region.

Contra ADB, confidence is transient and can snap anytime. Yet the Asian-ASEAN bubble has been staring right on our faces.

 

Yet if something can’t go on forever, it will stop (Ben Stein’s law).

Don’t worry. Be happy.

ECB’s Mario Draghi Unleashes “Unlimited Bond Buying” Bazooka, Fed’s Ben Bernanke Next?

So finally, the ECB via president Mario Draghi unleashed what seems as the penultimate “shock and awe” rescue mechanism for the EU: the supposed “unlimited but sterilized” buying of bonds.

From Bloomberg, (bold added)

European Central Bank President Mario Draghi said policy makers agreed to an unlimited bond- purchase program to regain control of interest rates in the euro area and fight speculation of a currency breakup.

The program “will enable us to address severe distortions in government bond markets which originate from, in particular, unfounded fears on the part of investors of the reversibility of the euro,” Draghi said at a press conference in Frankfurt after the ECB held its benchmark rate at a record low of 0.75 percent. “Under appropriate conditions, we will have a fully effective backstop to avoid destructive scenarios with potentially severe challenges for price stability in the euro area.”

Draghi has staked his credibility on the bond plan, which is the most ambitious yet in the central bank’s fight to wrest back control of rates in a fragmented economy and save the euro after nearly three years of turmoil. Now it’s up to governments in Spain and Italy to trigger ECB bond purchases by requesting aid from Europe’s rescue fund and signing up to conditions

“Governments must stand ready to activate the EFSF/ESM in the bond market when exceptional financial-market circumstances and risks to financial stability exist -- with strict and effective conditionality,” Draghi said. The ECB reserves the right to terminate bond purchases if governments don’t fulfil their part of the bargain, he added…

The ECB’s program, called Outright Monetary Transactions, will target government bonds with maturities of one to three years, including longer-dated debt that has a residual maturity of that length, Draghi said. Purchases will be fully sterilized, meaning that the overall impact on the money supply will be neutral, and the ECB will not have seniority, he said.

Note that ECB bond purchases have not truly been “unlimited” as they supposedly conditional to the requested “aid” by crisis stricken nations from the ESM and will be “fully” sterilized. Aside from conditionality on reforms.

As usual political terminologies matter.

The idea of full sterilization means that money will be drained from the other sectors and will allegedly be neutral. This could be the reason behind the underperformance and the tepid gains of gold and other commodities as oil and copper despite the ECB's opening of the inflation spigot.

Moreover, perhaps too, the ECB assumes that need for bond buying may be checked or will have the desired effect of providing carrot and stick approach for governments to take appropriate corrective fiscal measures.

Unfortunately this won’t likely be the case.

Not only is the bond buying going to be an incentive for delaying the necessary reforms for the PIGS (out of moral hazard dilemma), but the ECB’s sterilization activities will likely be also restricted.

University of Chicago Professor John Cochrane at the Bloomberg explains…...

If past were to rhyme, in November of last year, the ECB has missed sterilizing her purchases.

So if the ECBs action to sterilize are encumbered, then this means either that the ECBs buying will have short run effects, or that designated conditions represents smoke and mirrors which may pave way for the massive unsterilized actions or monetary inflation.

Nonetheless, I think the ECB’s unlimited option has been coordinated with the US Federal Reserve.

Just a few days back, four Federal Reserve presidents discussed of the same open-ended buying option.

From another Bloomberg article,

Federal Reserve Chairman Ben S. Bernanke says the U.S. economy is “far from satisfactory.” His colleagues are moving to embrace policies that will stay in place until he’s satisfied.

Four Fed presidents have come out in favor of an open-ended strategy for bond buying, with three calling for the program to begin now. Rather than specify a fixed amount of bonds to purchase by a certain date, such a strategy would leave the Fed able to announce a pace of purchases that it could adjust as the economy gets closer to Bernanke’s goals.

“You would be able to react to the incoming data in an incremental way and not be in a situation where you have to either drop the bomb or do nothing,” St. Louis Fed President James Bullard said in an interview last week during the Fed’s annual monetary policy symposium in Jackson Hole, Wyoming.

Bernanke used the forum to defend unorthodox policies such as bond purchases and made the case for further action to reduce an unemployment rate that he called a “grave concern.” Stocks and Treasuries jumped after the speech as investors increased bets the Fed will opt for further easing as soon as its next meeting Sept. 12-13.

I am inclined to the view that the FED will move to compliment the ECB for political reasons. I think that Bernanke’s tenure depends on President Obama’s re-election and thus would work to ensure of policies that will be “stock market friendly”

And as I previously said, the combined actions by central banks will eventually lead to deepening stagflation manifested through high consumer prices and the real risks of a food crisis that amplifies risks of social instability, as well as, overseas bubbles.

Central bank fixes has only short term narcotic effects, that risks long term unintended consequences.

As the great Professor Ludwig von Mises presciently warned,

But the boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a “crack-up boom” and in a collapse of the money and credit system. Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis. The depression follows in both instances.

For now, the risk ON “orgy of speculation” environment may have been activated based on a partial fulfilment of market’s addiction for central bank steroids.

But given the vagueness of conditionalities from the ECB program and of the response by other central bankers to real economic events, the sustainability of such risk ON conditions remains unclear.

We are approaching the Mises moment.

Bad News Is Good News: Global Markets Rise on MORE Stimulus Expectations

Bad New is Good News.

Global markets continue to ascend on EXPECTATIONS of MORE bailouts. [yes markets have been enchanted by the Bernanke Put- pattern of providing ample liquidity to protect the asset markets]

From the Bloomberg,

U.S. stocks advanced, sending the Standard & Poor’s 500 Index to the highest level in more than a month, as investors speculated the Federal Reserve will announce more measures to stimulate the world’s largest economy…

Signs of slowing growth amid Europe’s turmoil could mean the Fed, which began a two-day meeting today, could extend its so-called Operation Twist, according to JPMorgan Chase & Co. (JPM) and Jefferies & Co. The program involves selling short-term debt and buying longer-term bonds. A more aggressive response could be warranted if the Fed see high costs in a slowdown of growth.

Fed’s Options

The central bank may expand its balance sheet, extend Operation Twist and/or lengthen its short-term interest rate guidance beyond late 2014, Goldman Sachs Group Inc. chief economist Jan Hatzius wrote today.

“A decision not to ease is tantamount to a tightening,” he wrote in an e-mailed report to clients today. “At this point we’d be quite surprised if we saw no easing.”

Expectations for further policy action gave stocks their first back-to-back weekly gain since April on June 15. The S&P 500 earlier this month was on the brink of a so-called correction, or a 10 percent drop from a recent peak, on concern about a global slowdown and a worsening of Europe’s crisis.

Markets have constantly been fed with the forging of new deals and from vows of a backstop from policymakers to mitigate or curb the crisis.

The US Federal Reserve’s FOMC concludes their periodical meeting today and will be announcing their actions.

As pointed out above, the markets have already been pricing in, or have been frontrunning, a supposed new easing program from the FED.

Earlier, emerging markets including the Philippines through the IMF, has also promised contributions to assist in the rescue of Europe’s political and banking class. This serves as an example of the ‘poor’ (Filipino and EM Taxpayers) rescuing the rich.

Now the it’s the G-20’s turn to make the next round of pledges.

From another Bloomberg report,

Euro-area leaders at the Group of 20 summit pledged to “take all necessary policy measures” to defend the currency union and boost protection of the region’s struggling banks, according to the final statement issued at a meeting in Mexico.

With contagion from the debt crisis rippling through the world economy, participants at the G-20 summit in the beach resort of Los Cabos backed measures to spur growth and cut budgets in Europe while saying the U.S. will “calibrate” the pace of its spending cuts to avoid a “sharp fiscal contraction” in 2013.

At the end of the two-day summit, the leaders of advanced and emerging economies said Europe is taking steps toward closer economic union “that lead to sustainable borrowing costs.” The G-20 also backed Europe’s plans to move toward a more integrated banking industry.

Talks among G-20 leaders at Los Cabos were dominated by the crisis in 17-nation euro region and its threat to the world economy. Bond yields in Spain, the region’s fourth-biggest economy, rose to a euro-era record yesterday, above the 7 percent level that led to bailouts in Greece, Ireland and Portugal.

The group welcomed the plan to rescue Spain’s banks and the European Union’s efforts to build up its crisis defenses, including the European Stability Mechanism, the region’s permanent bailout fund scheduled to start up in July.

Pledges upon pledges upon pledges.

Again market dynamic becomes a question of the FULFILLMENT or NON-FULFILLMENT of such expectations. Eventually markets will DEMAND not merely promises or assurances but ACTION.

Oh by the way, technician Carl Swenlin, at the stockcharts.com Blog says that the markets deserve a cautious stance, than blindly fixating on the bullish reverse head and shoulders pattern

My problem is that, being a person who likes things to be nice and neat, I wanted the right shoulder to be more even with the left shoulder. But no. What we have is a formation that is very lopsided, but I think it is close enough to be considered a completed reverse head and shoulders pattern. The neckline has been penetrated, so the minimum upside target is about 1430.

Unfortunately, the bullish breakout on the price chart is contradicted by the Climactic Volume Indicator (CVI) chart, which spiked to a level that usually signals a short-term top.

Conclusion: It is possible that Saturday's upcoming elections in Greece may have triggered some short-covering ahead of the weekend, resulting in a rally that may prove to have no legs. The breakout is far from decisive, and the CVI indicates a possible exhaustion climax, so I remain skeptical of the rally.

A REVERSAL of markets expectations, which may be prompted for by the diminishing returns from guarantees and or from dissatisfaction from political actions, can be swift, dramatically violent and nasty.

Be very careful out there.

EU Debt Crisis: Why Eurobonds Won’t Work

A new bailout mechanism has been proposed for the Eurozone.

From the Associated Press,

Germany has again made clear its opposition to French proposals for jointly-issued bonds from the 17-nation eurozone as a way to create economic growth and ease the region's financial crisis.

At Saturday's G-8 summit, German Chancellor Angela Merkel — under urging from U.S. President Barack Obama and French President Francois Hollande — signed up to a statement that called for mixing painful cutbacks with growth-promoting measures to deal with a crisis that threatens the global economy.

The leaders warned that budget deficits have to come down. But they also acknowledged that an approach that's based mostly on austerity and longer-term reforms can't help countries out of recessions this year or next.

How exactly to encourage growth has become a controversial topic among European leaders, who will meet Wednesday in Brussels to try to find common ground.

France's Hollande has pushed for issuing debt backed by financially strong countries like Germany to finance growth in weaker countries like Greece or Portugal as one solution to the problem. Germany, however, has long and firmly resisted the idea of introducing eurobonds, arguing they would lessen pressure for heavily indebted countries to get their finances in order. They would also likely raise borrowing costs for countries in better shape, such as Germany.

Eurobonds would be "a prescription at the wrong time with the wrong side-effects," Steffen Kampeter, a deputy finance minister, told Deutschlandfunk radio.

"We have always said that as a first step we need solidity in European finances, and that is the fiscal compact," a budget-discipline pact that Merkel championed and Hollande has criticized, he said.

Germany's tough stance against the idea of eurobonds came as France's new finance minister met his German counterpart for the first time on Monday.

The talk about “growth-promoting measures” is patently silly. Such political rhetoric represents newspeak, meant to delude the public from reality.

This crisis exists because the EU governments has commandeered significant share of their resources to political activities (welfare state, bailouts, transfers, bureaucracy and etc.) which represents consumption.

Since governments thrive on taxes, whom are like parasites living off from a host, government activities have NOT been established for production, which means they DO NOT promote growth.

It is COMMERCE that gives the productive economic growth.

Yet these governments are hesitant to make the required reforms to make resources available for productive commercial activities through entrepreneurship, and to make their economies competitive (e.g. labor reforms).

The reality is that each and every government expenditure comes at the expense of private commercial activities. Consumption comes at the expense of production. So there is no general economic growth. There will be growth only for crony industries and companies and on the budgets of these political masters.

The proposed Eurobond is another example of the prevailing bailout mentality. This represents another redistribution of resources from Germans and other productive EU nations to the spendthrift crisis plagued PIGS. So bad behavior will be rewarded, which is likely to encourage more bad behavior.

And that’s why there has been vocal resistance on the overtures for a bailout through a common bond by Germany, whom will bear most of the burden.

Analyst Michael Sedacca at the Minyanville nicely explains the why the mechanism won’t work…

One of the biggest reasons why a eurobond will never work is Germany. It is by far the largest guarantor for anything jointly issued in the eurozone. For the European Financial Stability Facility (or EFSF), they currently guarantee 29.06% (on a GDP weighted basis), which is by far the biggest majority. If, for example, Spain were to “step out” because they needed to take money from the facility, their share jumps to 34%.

Next, the on-the-run 10-year note from the EFSF (rated AA+) carries a coupon of 3.5% and implied yield-to-maturity (or YTM) of 2.86%. For the German 10-year note, it is 1.75% and implied YTM of 1.44% -- essentially, double what they have to pay for their own debt by being tied to the rest of the eurozone. However, they aren't directly affected by these payments because Germany and the other eurozone countries are paying with capital to backstop the new issues and make the interest payments. So there's no direct change of money flow at the German Treasury; there is just a faster depletion of whatever capital is at the EFSF.

In theory, if a eurobond were to go through, Germany would be on the hook for a hefty chunk of this base interest rate change. It gets even worse if you shorten the maturity; the current two-year German bond has a coupon of 0.25% (YTM of 0.05%) and the EFSF note is at 1%. Assuming these bonds would be weighted by GDP, on interest payments alone, Germany would be paying four times what they have to pay for their own debt.

And as I pointed out before, political redistributions through centralization of the EU will intensify political frictions

Mr Sedacca adds,

The biggest change, however, is the ceding of sovereignty. If all of the countries agree to tie themselves to the mast of the euro, the fighting and mudslinging will get even worse than it already is. As it is, when signing up for the bailout of Greece, Finland required additional collateral in order to cover their potential losses. They knew they could potentially be lending into a hole.

Of course all talk about Eurobond may actually be a cover for what is truly intended: massive money printing by the ECB

Mr. Sedacca seem to share my outlook

All of that being said, I think we will see the European Central Bank lending directly to the European Stability Mechanism to buy bad assets directly off banks' balance sheets before we see a eurobond. That will likely be met with a positive reception from the market.

At the end of the day all these kicking of the proverbial can down the road means the worsening of the crisis which is likely to set stage for massive inflation and of the ballooning prospects of the disintegration of the European Union.

Who is to blame for JP Morgan’s $2 billion loss?

It’s all about bad decisions, argues Mike Brownfield of the conservative Heritage Foundation

Heritage’s David C. John explains that while JP Morgan’s loss represents a clear failure of management, it’s not a systemic problem that requires or would be fixed by additional regulation. For starters, JP Morgan is a $2.3 trillion bank with a net worth of $189 billion, meaning that this loss reduced the bank’s capital ratio from 8.4 percent to 8.2 percent. In other words, the bank can absorb the loss, and it’s nowhere close to needing any form of federal intervention.

Some more perspective could be gleaned by examining the $3.2 billion loss the U.S. Post Office experienced in the most recent quarter, or the billions lost on risky green energy bets made by President Obama and Energy Secretary Steven Chu. Only those losses weren’t incurred by private investors, but by you the taxpayer.

What’s more, John explains, the regulations that are now being called for — particularly the so-called Volcker Rule — would not have prevented the losses since it would not have affected this transaction. Finally, John writes, the system worked as is. “JPMorgan Chase losses were not discovered by regulators; they were discovered by the bank itself conducting its own management reviews.”

What America is witnessing is the left using the news of JP Morgan’s bad judgment as an excuse for more government regulation. But as even Carney acknowledged, regulations “can’t prevent bad decisions from being made on Wall Street.”

It’s true that regulations “can’t prevent bad decisions”. But I’d go deeper. Regulations, on the other hand, can induce bad decisions.

Moral Hazard is when undue risks are taken because the costs are not borne by the party taking the risk. So when regulations and political actions (such as bailouts) rewards excessive risk taking, by having taxpayers shoulder the burden of the mistakes of the privileged parties like JP Morgan and other Too Big To Fail banks, then we should expect more of these.

At the Think Market Blog, Cato’s Jerry O’ Driscoll expounds further,

Reports indicate that senior management and the board of directors were aware of the trades and exercising oversight. The fact the losses were incurred anyway confirms what many of us have been arguing. Major financial institutions are at once very large and very complex. They are too large and too complex to manage. That is in part what beset Citigroup in the 2000s and now Morgan, which has been recognized as a well-managed institution.

If ordinary market forces were at work, these institutions would shrink to a size and level of complexity that is manageable. Ordinary market forces are not at work, however. As discussed on this site before, public policy rewards size (and the complexity that accompanies it). Major financial institutions know from experience they will be bailed out when they incur losses that threaten their surivival. Morgan’s losses do not appear to fall into that category, but they illustrate how bad incentives lead to bad outcomes.

Large financial institutions will continue taking on excessive risks so long as they know they can off-load the losses on taxpayers if needed. That is the policy summarized as “too big to fail.” Banks may be too big and complex to close immediately, but no institution is too big to fail. Failure means the stockholders and possibly the bondholders are wiped out. Until that discipline is reintroduced (having once existed), there will be more big financial bets going bad at these banks.

CBS News: US Taxpayers Taking a Hit on Green-Renewable Energy Firms

Political supported green renewable energy companies have been sinking US taxpayer funds.


(hat tip: Mark Perry)

From CBS

It's been four months since the FBI raided bankrupt Solyndra. It received a half-billion in tax dollars and became a political lightning rod, with Republicans claiming it was a politically motivated investment.

CBS News counted 12 clean energy companies that are having trouble after collectively being approved for more than $6.5 billion in federal assistance. Five have filed for bankruptcy: The junk bond-rated Beacon, Evergreen Solar, SpectraWatt, AES' subsidiary Eastern Energy and Solyndra.

Others are also struggling with potential problems. Nevada Geothermal -- a home state project personally endorsed by Senate Majority Leader Harry Reid -- warns of multiple potential defaults in new SEC filings reviewed by CBS News. It was already having trouble paying the bills when it received $98.5 million in Energy Department loan guarantees.

SunPower landed a deal linked to a $1.2 billion loan guarantee last fall, after a French oil company took it over. On its last financial statement, SunPower owed more than it was worth. On its last financial statement, SunPower owed more than it was worth. SunPower's role is to design, build and initially operate and maintain the California Valley Solar Ranch Project that's the subject of the loan guarantee.

First Solar was the biggest S&P 500 loser in 2011 and its CEO was cut loose - even as taxpayers were forced to back a whopping $3 billion in company loans.

Nobody from the Energy Department would agree to an interview. Last November at a hearing on Solyndra, Energy Secretary Steven Chu strongly defended the government's attempts to bolster America's clean energy prospects. "In the coming decades, the clean energy sector is expected to grow by hundreds of billions of dollars," Chu said. "We are in a fierce global race to capture this market."

Economist Morici says even somebody as smart as Secretary Chu -- an award-winning scientist -- shouldn't be playing "venture capitalist" with tax dollars. "Tasking a Nobel Prize mathematician to make investments for the U.S. government is like asking the manager of the New York Yankees to be general in charge of America's troops in Afghanistan," Morici said. "It's that absurd."

My comment:

This represents the political economy of anthropomorphic climate change. Argue about the validity of global warming then divert taxpayers money on money losing projects that benefits only politically allied cronies and their political wards.

This is further proof that even with subsidized money, green or renewable energy can hardly take off simply because consumers don't see them as reliable alternatives (in spite of the global warming bugaboo).

This also proves that government picking out of 'winners' is no guarantee of success.

Even more, the issue of moral hazard applies as cronies are hardly motivated to see the success of these companies since they know government will absorb the losses on their behalf and even perhaps knew or anticipated that these companies would eventually fail, hence, became milking cows.

And corruption will signify another aspect here, since public-private partnerships naturally leads to the prioritization of the whims of the political masters rather than of consumers.

Also one can pretend to know about the future (as the energy secretary) when we really don't.

End of the day what is unsustainable won't last. What is a fraud or unnatural will be exposed for what they are. That's how events have been playing out as shown above.

Green Jobs: The Anatomy of Government Failure

From the Washington Post, (bold emphasis mine)

A $38.6 billion loan guarantee program that the Obama administration promised would create or save 65,000 jobs has created just a few thousand jobs two years after it began, government records show.

The program — designed to jump-start the nation’s clean technology industry by giving energy companies access to low-cost, government-backed loans — has directly created 3,545 new, permanent jobs after giving out almost half the allocated amount, according to Energy Department tallies.

President Obama has made “green jobs” a showcase of his recovery plan, vowing to foster new jobs, new technologies and more competitive American industries. But the loan guarantee program came under scrutiny Wednesday from Republicans and Democrats at a House oversight committee hearing about the collapse of Solyndra, a solar-panel maker whose closure could leave taxpayers on the hook for as much as $527 million.

The GOP lawmakers accused the administration of rushing approval of a guarantee of the firm’s project and failing to adequately vet it. “My goodness. We should be reviewing every one of these loan guarantee” projects, said Rep. Marsha Blackburn (R-Tenn.).

Obama’s efforts to create green jobs are lagging behind expectations at a time of persistently high unemployment. Many economists say that because alternative-­energy projects are so expensive and slow to ramp up, they are not the most efficient way to stimulate the economy.

“There are good reasons to create green jobs, but they have more to do with green than with jobs,” Princeton University economics professor and former Federal Reserve vice chairman Alan Blinder has said.

The loan guarantee program can also be unwieldy. It works like this: Companies negotiate with the Energy Department for a government loan guarantee, which means taxpayers will pay off bank loans if the project fails. Then the Office of Management and Budget must sign off on the guarantees, often changing terms…

Solyndra’s closure prompted concerns about whether the administration made good bets in the rest of its portfolio of clean-tech projects it had helped subsidize with taxpayer-guaranteed loans. The primary investors in Solyndra were funds tied to a major Obama fundraising bundler, Tulsa oilman George Kaiser.

My take:

Again the article proves that there hardly has been any qualm for political authorities to spend on other people’s money because they won’t be held accountable for decision failures.

The political process of picking winners does not guarantee success.

Wrong decisions by political stewards ultimately mean higher taxes which decreases the competitiveness of the economy. Oh don’t blame globalization for the effects of stupid domestic policies.

Importantly, this has been lucid evidence of how central planning fails and how politics can’t subvert the will of the markets.

With taxpayer guarantees, the political beneficiaries of loans (stimulus) from the government are not only protégés of the administration (crony capitalism) but notably have not been subject to the discipline of market forces, and thus, can or will recklessly handle finances even to the risk of finagling them. Call it corruption and moral hazard.

Quote of the Day: Nassim Taleb on Bankers Ethics

Celebrated author of the Black Swan theory fame Nassim Nicholas Taleb and Mark Spitznagel questions the propriety of nearly $5 trillion paid to bankers, who continues to operate on the model of privatizing profits and socializing losses.

They write, (bold emphasis mine)

One may wonder: If investment managers and their clients don’t receive high returns on bank stocks, as they would if they were profiting from bankers’ externalization of risk onto taxpayers, why do they hold them at all? The answer is the so-called “beta”: banks represent a large share of the S&P 500, and managers need to be invested in them.

We don’t believe that regulation is a panacea for this state of affairs. The largest, most sophisticated banks have become expert at remaining one step ahead of regulators – constantly creating complex financial products and derivatives that skirt the letter of the rules. In these circumstances, more complicated regulations merely mean more billable hours for lawyers, more income for regulators switching sides, and more profits for derivatives traders.

Investment managers have a moral and professional responsibility to play their role in bringing some discipline into the banking system.

So ad hoc conventionalism or peer pressures have been one of the key influences for the financial industry to shore up bank equities, which apparently has resulted to the unethical banking practices brought about by the sense of entitlement and moral hazard from continued government support.

Obviously this has been part of the comprehensive framework to buttress the decadent welfare state-central banking-banking system architecture.

Read the rest of their excellent piece here

Quote of the Day: Agency Problem in the Mutual Fund Industry

From Investment guru David F. Swensen of Yale University

The companies that manage for-profit mutual funds face a fundamental conflict between producing profits for their owners and generating superior returns for their investors. In general, these companies spend lavishly on marketing campaigns, gather copious amounts of assets — and invest poorly. For decades, investors suffered below-market returns even as mutual fund management company owners enjoyed market-beating results. Profits trumped the duty to serve investors…

This churning of investor portfolios hurts investor returns. First, brokers and advisers use the pointless buying and selling to increase and to justify their all-too-rich compensation. Second, the mutual fund industry uses the star-rating system to encourage performance-chasing (selling funds that performed poorly and buying funds that performed well). In other words, investors sell low and buy high.

Read the rest here

This has been a dynamic which I have repeatedly been talking about, see here and here

I agree with Mr. Swensen that EDUCATION has to be in the forefront in the campaign to protect investors against such conflict of interests

But I strongly disagree with the suggestion that the SEC has to play a greater role in regulation and enforcement.

One of the reasons why investors have become vulnerable has been due to the complacency derived from the expectations that the nanny state will do the appropriate due diligence and provide protection in behalf of the investors.

Such smugness reduces individual responsibilities and increases the risk taking appetite. Yet for all the regulations and bureaucracy added over the years, why has Bernard Madoff been able to pull one off over Wall Street and the SEC?

Romanticizing the role of arbitrary regulations and bureaucrats won’t help.

Two, unquestionably putting clients ahead is an ideal goal. But this is more an abstraction in terms of implementation. The ultimate question is always how? The devil is always on the details. Has more regulations led to greater market efficiency or vice versa?

Or to be specific in terms of the industry's literature how should these be designed, should they encourage short term trades or long term investments? How does the regulators determine which is which?

Three, it would be wishful thinking to believe that regulators know better than the participants with regards to the latter’s interest. Yet giving too much power to regulators would translate to even market distortions, more conflict of interests, corruption, regulatory arbitrages and benefiting some sectors at the expense of the rest. For example, the shadow banking industry, which has played a crucial role in the 2008 crash, has been a collective byproduct of myriad regulatory arbitrages.

Lastly, since regulators are people too, conflict of interest with the regulated is also likely to occur. This means that the risk of the agency problem dynamic will not vanish but take shape in a different form; the difference is that conflict of interest will shift from the marketplace to the political realm. This is known as regulatory capture.

The Phisix-ASEAN Alpha Play

It’s simply amazing how the Philippine Phisix-ASEAN bourses appear to have sidestepped the generalized negative actions of global markets.

As the chart above exhibits, ASEAN represented by the FTSE ASEAN 40 ETF (ASEA) has been traipsing on the upper side of price levels while major developed economy bellwethers, the US S&P 500 (SPX), Europe’s Stoxx 50 (STOX50) and Emerging Markets’s MSCI Emerging Free Index (MSEMF) have been foundering.

The apparent dissonance could be traced to mostly political events which has shifted from concerns over the debt crisis in Europe’s periphery to the “divisive” US debt ceiling vote.

It would be tempting to say that the ASEAN region has been “decoupling”, even as we are cognizant that globalization has been deepening the interdependencies of all kinds of markets, and not just limited to financial markets.

Today’s deepening financial globalization, enhanced and facilitated by digital technology has been fueling capital mobility worldwide. Thus, foreign ownership of global equities, particularly in Emerging Markets, has significantly been expanding.

Among ASEAN bourses, levels of foreign ownership has been significant, as evidenced by Thailand and Indonesia where foreigners own more than 20% share of equity, based on market capitalization[1].

This makes the region modestly sensitive to exogenous or geopolitical or financial markets shocks.

From the start of the year, the range of the percentage of foreign trade to total trade in the Philippine Stock Exchange has been at 35-45% or about the median at 40% (see above chart).

While this has changed the complexion of the current market conditions compared to 2003-2007 where foreign trades dominated, foreign trades still remains a pivotal force to be reckoned with.

So it is unclear whether ASEAN and the Phisix would function as an alternative haven, which if such trend continues or deepens, could lead to a ‘decoupling’ dynamic, or will eventually converge with the rest. The latter means that either global equity markets could recover soon—from the aftermath of the Greece (or PIIGS) bailout and the imminent ratification of the raising the US debt ceiling—or that if the declines become sustained or magnified, the ASEAN region eventually tumbles along with them. My bet is on the former.

Therefore, I would caution any interpretation of the current skewness of global equity market actions to imply ‘decoupling’. As I have been saying, the decoupling thesis can only be validated during a crisis.

In the meantime, we can read such divergent signals (between ASEAN and the World) as motions in response to diversified impact from geopolitical turbulence.

Under the current conditions, where political developments have been functioning as the key driver of the marketplace (which seems to continually confirm my thesis[2]), a politically induced marketplace, swimming in a pool of liquidity, may have differentiated returns based on risk-adjusted Alpha[3].

Also, current market actions also appear to tell us that political crisis may have less an influence or has a limited contagion effect than from a fully blown economic or financial crisis. This implies that the marketplace could have been habituated or conditioned to the instinctive and systematic policy responses by governments to reflate the system at any emergent signs of distress or simply to flood the world with money.

One may call this a variant of the Greenspan-Bernanke Put[4] or applied in genre, a central banker’s put, by implementing policies aimed at buttressing the financial markets mostly through the reduction of interest rates and or through asset purchases.

Thus, like the boy who cried wolf, every unfolding political dilemma has gradually been discounted or seen as an opportunity to buy or lever up. Typically such landscape which routinely discounts risks factors through a boost in market psychology particularly overconfidence, which should spillover to risk appetites, sows seeds to the Hyman Minsky[5] Ponzi dynamics.

And operating in a Alpha environment, national structural idiosyncrasies, such as political economic system, fiscal outlook, divergent effects from local policies and the dissimilar impact from global monetary policies on the region’s economies both of which contributes distinctly to local cycles, and etc…, could serve as interim forces at work.

In simple sense, Philippine and the ASEAN asset markets could be seen as interim beneficiaries from today’s jumbled geopolitical climate.

Again, this line of thought is predicated on expectations where any political resolution from the du jour predicaments of major developed economies, as the US today, would work in the direction of the intrinsic structure of 20^th century designed political institutions of reflating the system.

In other words, global political leaders will largely lean on inflationist policies based on artificially suppressed interest rates and the financing of bailouts by money printing applied to politically favored sectors or to governments.

And these policies which results in perennial boom busts cycles, would eventually be ventilated on global markets, including the Philippines and her ASEAN neighbors too.

So far these actions seem to be in the operating handbook or manual of policymakers from the US to Europe to Japan to China to the Philippines, only the scale varies.

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[1] Lanzeni, Maria Laura Emerging Markets: Contagion from trouble in the eurozone has not been widespread. Will it remain like this?, Deutsche Bank July 29, 2011

[2] See Stock Market Investing: Will Reading Political Tea Leaves Be A Better Gauge? , November 30, 2008

[3] Wikipedia.org Alpha (investment)

[4] Wikipedia.org Bernanke Put

[5] Wikipedia.org Understanding Minsky's financial instability hypothesis