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    Daily Digest – Feb 12

    by Davos

    Wednesday, February 11, 2009, 10:26 PM

  • Economy How We Can Restore Confidence, By Charles T. Munger
  • Jim Rogers (Video, Bloomberg, Hat Tip JoeManC)
  • Congressman Capuano to Banks, "I don’t have one penny in a bank." (Video)
  • Chinese exports (-17.5%); imports (-43%)
  • European bank bail-out could push EU into crisis
  • Fed Looking Unlikely to Buy Treasurys
  • Chairman Ben S. Bernanke
  • Real Treasury Yields Moving Lower (Chart)
  • More…
  • Treasury Will Back up to $1 Trillion in Toxic Assets 
  • Coming Wave of Resets – Is there a Simple Answer?
  • Government Involvement Should Be Limited If Possible, Geithner Says 
  • Ireland to take control of banks, while plans for Fortis are rebuffed
  • California’s Pain Is Only Beginning (Hat Tip Jason A.)
  • Compensation Ratios (Table)
  • Wholesale Inventories Rising Dramatically  
  • Banking Committee: Videos of CEOs’ opening statements 
  • Meltdown 101: Highlights of economic stimulus plan
  • Jobs (Interactive)


How We Can Restore Confidence, By Charles T. Munger

Our situation is dire. Moderate booms and busts are inevitable in free-market capitalism. But a boom-bust cycle as gross as the one that caused our present misery is dangerous, and recurrences should be prevented. The country is understandably depressed — mired in issues involving fiscal stimulus, which is needed, and improvements in bank strength. A key question: Should we opt for even more pain now to gain a better future? For instance, should we create new controls to stamp out much sin and folly and thus dampen future booms? The answer is yes. 

Sensible reform cannot avoid causing significant pain, which is worth enduring to gain extra safety and more exemplary conduct. And only when there is strong public revulsion, such as exists today, can legislators minimize the influence of powerful special interests enough to bring about needed revisions in law. 

Jim Rogers (Video, Bloomberg, Hat Tip JoeManC)

Congressman Capuano to Banks, "I don’t have one penny in a bank." (Video) 


Coming Wave of Resets – Is there a Simple Answer? 

Brad Setser notes that, in spite of interference from Chinese holidays, further collapse is likely indicated by east asian exports to china. a devastating collapse in global trade, all in all — but Setser goes further: 

What worries me the most? The possibility that the sharp y/y fall in imports doesn’t just reflect a fall in imported components or a fall in commodity prices, but rather a major deceleration in China’s domestic economy.

In some sense, it is hard to imagine a worse combination. China’s export are falling, making China understandably reluctant to allow its currency to appreciate. But China’s trade surplus is also rising … certainly in nominal terms and quite possibly in real terms. That isn’t good for the world.

At a time when the world is short demand, China seems to be subtracting from global demand not adding to it. The best solution: an absolutely enormous domestic stimulus in China. 

European bank bail-out could push EU into crisis 

"Estimates of total expected asset write-downs suggest that the budgetary costs – actual and contingent – of asset relief could be very large both in absolute terms and relative to GDP in member states," the EC document, seen by The Daily Telegraph, cautioned. 

"It is essential that government support through asset relief should not be on a scale that raises concern about over-indebtedness or financing problems."

The secret 17-page paper was discussed by finance ministers, including the Chancellor Alistair Darling on Tuesday.

National leaders and EU officials share fears that a second bank bail-out in Europe will raise government borrowing at a time when investors – particularly those who lend money to European governments – have growing doubts over the ability of countries such as Spain, Greece, Portugal, Ireland, Italy and Britain to pay it back.

The Commission figure is significant because of the role EU officials will play in devising rules to evaluate "toxic" bank assets later this month. New moves to bail out banks will be discussed at an emergency EU summit at the end of February. The EU is deeply worried at widening spreads on bonds sold by different European countries.

In line with the risk, and the weak performance of some EU economies compared to others, investors are demanding increasingly higher interest to lend to countries such as Italy instead of Germany. Ministers and officials fear that the process could lead to vicious spiral that threatens to tear both the euro and the EU apart.

"Such considerations are particularly important in the current context of widening budget deficits, rising public debt levels and challenges in sovereign bond issuance," the EC paper warned. 

Fed Looking Unlikely to Buy Treasurys 

The Federal Reserve is looking increasingly unlikely to purchase long-term U.S. Treasury securities any time soon, as the central bank gears up to launch a different program aimed at jumpstarting the market for consumer loans. 

Federal Reserve Chairman Ben Bernanke raised the idea of purchasing Treasury bonds in November and the Fed has tipped its hand to the possibility of such purchases in its last two policy statements.

Such a move could help to bring down long-term interest rates, something that could indirectly help consumers and businesses since many loans are benchmarked to Treasury yields.

But Mr. Bernanke notably left the idea out of his testimony to the House Banking Committee Tuesday.

Fed officials could be preoccupied by a new program aimed at jumpstarting consumer loan markets, an effort being coordinated with the Treasury Department. That program represents an enormous commitment by the Fed. The Term Asset-backed Securities Loan Facility, which will help finance asset backed securities tied to consumer loans, could result in as much as $1 trillion in new Fed loans, a huge expansion in its balance sheet.

The central bank’s balance sheet has already swelled from less than $900 billion a few months ago to $1.8 trillion. Moreover, the loans the Fed will be making under the asset backed securities program are three year loans, long-term commitments that could be a challenge to unwind later.

Officials don’t want to take any options off the table. But given those potential long-term encumbrances, a dive into purchases of long-term Treasury bonds looks less likely in the near-term.

The big commitment to the asset backed securities program could lead to another change for the Fed and Treasury. Last year, the Treasury helped the Fed to finance the expansion of its balance sheet by issuing short-term bills and leaving the cash from those bills on deposit at the central bank for the Fed to use in lending programs.

Chairman Ben S. Bernanke 

Federal Reserve programs to strengthen credit markets and the economy
Before the Committee on Financial Services, U.S. House of Representatives, Washington, D.C.

February 10, 2009 

Chairman Frank, Ranking Member Bachus, and other members of the Committee, I appreciate this opportunity to provide a brief review of the Federal Reserve’s various credit programs, including those relying on our emergency authorities under Section 13(3) of the Federal Reserve Act. I will also discuss the Federal Reserve’s ongoing efforts to inform the Congress and the public about these activities.

Federal Reserve Programs to Strengthen Credit Markets and the Economy As you know, the past 18 months or so have been extraordinarily challenging for policymakers around the globe, not least for central banks. The Federal Reserve has responded forcefully to the financial and economic crisis since its emergence in the summer of 2007. Monetary policy has been especially proactive. The Federal Open Market Committee (FOMC) began to ease monetary policy in September 2007 and continued to ease in response to a weakening economic outlook. In December 2008, the Committee set a range of 0 to 25 basis points for the target federal funds rate.

Although the target for the federal funds rate is at its effective floor, the Federal Reserve has employed at least three types of additional tools to improve the functioning of credit markets, ease financial conditions, and support economic activity.

The first set of tools is closely tied to the central bank’s traditional role of providing short-term liquidity to sound financial institutions. Over the course of the crisis, the Fed has taken a number of extraordinary actions, including the creation of a number of new facilities for auctioning short-term credit, to ensure that financial institutions have adequate access to liquidity. In fulfilling its traditional lending function, the Federal Reserve enhances the stability of our financial system, increases the willingness of financial institutions to extend credit, and helps to ease conditions in interbank lending markets, reducing the overall cost of capital to banks. In addition, some interest rates, including the rates on some adjustable-rate mortgages, are tied contractually to key interbank rates, such as the London interbank offered rate (Libor). To the extent that the provision of ample liquidity to banks reduces Libor, other borrowers will also see their payments decline. 

Real Treasury Yields Moving Lower  

Even with the Treasury sell-off witnessed over the past few weeks, with expectations for inflation on the rise, real yields of Treasury bonds (as computed by taking the nominal Treasury rate and subtracting the implied inflation rate embedded in an inflation swap) have been declining at a rapid rate.(Note that I didn’t just graph TIPS real rates as TIPS are trading cheap due to technical / liquidity issues). What does this all mean? 

The Good: The U.S. Government is borrowing on the cheap (and needs to borrow a lot so cheap = good)

The Bad: Real rates are the lowest they have been since Lehman went under… signifying continued stress in markets if investors are willing to take 0.50% real returns over the next 5 AND 10 years 

Real Treasury Yields Moving Lower (Chart)

Treasury Will Back up to $1 Trillion in Toxic Assets  

Up to $1.0 trillion in insurance financing for the purchase of toxic assets was announced by the U.S. Treasury on Tuesday. For its part, the Federal Reserve announced the expansion of the Fed lending facility, the TALF – to include up to another $1.0 trillion in consumer debt, such as mortgage-backed securities. 

The U.S. Treasury’s program will enter into a private and public sector partnership where both sides will provide insurance financing on toxic debt.

The solution is hoped to jump-start trading in frozen markets and spur price discovery on the debt.

However, the final details of the toxic debt program remain unclear, according to Treasury Secretary Tim Geithner.

"We are exploring a range of different structures for this program, and we will seek input from market participants and the public as we design it," Geithner said. "We believe this program should ultimately provide up to $1 trillion in financing capacity, but we plan to start it on a scale of $500 billion, and expand it based on what works."

Geithner said the strategy is likely to take time to impact the markets.

Coming Wave of Resets – Is there a Simple Answer? 

Want some more bad news? Well sorry about that because London’s Financial Times says we ain’t seen nothing yet. 

According to an article written last week by Eric Uhlfelder, Credit Suisse maintains that about $1 trillion in Alt-A and option payment mortgages are scheduled to have rate resets in the next 30 months. These resets, the bank says, could cause as much future damage as the subprime crisis has already inflicted.

If these resets and the resulting increased monthly payments send defaults soaring, and given other factors such as job losses and falling home prices there is every indication they will, the bank projects that foreclosures over the next four years could reach nine million or 18 percent of all mortgages.

The newspaper estimates that there are approximately three million Alt-A loans outstanding with a value of $1 trillion. Fannie Mae, which owns or guarantees about 30 percent of them has called them loans with a higher risk of default than non-Alt-A loans.

At the time they were issued they weren’t viewed as particularly risky. They were primarily given to borrowers with reasonable credit scores who would have been prime prospects except for an inability to document sufficient income. No one seemed to much care whether this indicated a lack of documentation or a lack of income. As many of these loans carried introductory or teaser rates, the amount that borrowers owe each month (and in the case of option payment loans the amount they owe in total) has increased as home prices have fallen.

Whitney Tilson, a partner in T2 Partners an asset management firm, told The Times that he expects the reset in rates to accelerate default rates, further flood the housing market, and put even more downward pressure on housing prices preventing establishment of a price floor which is viewed as critical to ending the current economic crisis. And he projects an even more grim scenario than Credit Suisse – a 50 percent default in both option ARM and Alt-A loans.

As these defaults happen it will spill over into the securities market where a T. Rowe Price spokesperson estimates some $800 billion in securities are backed by Alt-A mortgages. As these securities fall in value, perhaps to pennies on the dollar, there will be a further tightening of credit markets.

Most of you reading this are mortgage professionals and all of this brings me to a question. I know full well that I am not the only one asking it, yet I have yet to hear a reasonable answer. Why don’t the powers that be, the wizards behind the screen, waive these resets? For that matter, why don’t they lower rates across the board at least temporarily so as to reduce payments for everyone. I know about securitization and all of the nameless and faceless investors that supposedly won’t allow this to happen. But wouldn’t they rather be collecting 4 percent on their investment rather than not collecting 9 percent?

It seems like such a simple thing to do. Or am I just simple for asking? 

Government Involvement Should Be Limited If Possible, Geithner Says  

U.S. government wishes to limit its involvement in the financial
marketplace wherever possible, according to U.S. Treasury Secretary
Timothy Geithner speaking before the Senate Budget Committee on the
Troubled Asset Relief Program on Wednesday. 

Aside from his
comments on limiting government involvement, the Treasury Secretary’s
opening remarks before the body remained virtually identical to those
delivered on Tuesday, when he promised to seek input from the Senate
regarding his proposed private-public Financial Stability Trust plan. 

comments echoed his televised speech on Tuesday, outlining plans to
increase transparency on how funds are spent; creating a "stress test"
for major financial institutions participating in the program; the
establishment of a so-called Private-Public Investment Fund that will
lift the burden of toxic assets by insuring them; initiatives to boost
consumer and business lending in cooperation with the Federal Reserve;
and finally, a housing program designed to stem foreclosures.

President Obama is committed to moving quickly to reform our entire
system of financial regulation so that we never again face a crisis of
this severity," he said. 

Ireland to take control of banks, while plans for Fortis are rebuffed 

Ireland moved toward greater government control of its financial system Wednesday by bailing out its two largest lenders, while shareholders in Fortis, once the biggest bank in Belgium, derailed state-led plans to sell the nationalized business to BNP Paribas of France. 

Together, the moves suggested that Europe – like the United States – was still struggling to find the right template for stabilizing its banks, one that could soothe jittery markets and an increasingly incensed public.

The Irish government, meeting Wednesday night, approved a capital injection of €3.5 billion, or $4.5 billion, each for Allied Irish Banks and Bank of Ireland, a Finance Ministry official said. Bloomberg News reported later Wednesday night that the ministry confirmed the move in an e-mail message.

That made Ireland the first European Union country to take de facto control of all of its most important banks. Last month, the government stepped in to nationalize the teetering Anglo Irish Bank, which was No.3.

In Brussels, the vote by Fortis shareholders left the bank’s Belgian operations in government hands while BNP Paribas decided whether to go to court or take its money – nearly €7 billion – and walk away. 

California’s Pain Is Only Beginning (Hat Tip Jason A.) 

BIG SUR, Calif. — As Sacramento squabbles over the state’s $42 billion deficit, Californians are getting a bitter taste of what’s to come after the steep budget cuts that are inevitable when legislators and Gov. Arnold Schwarzenegger finally hammer out a deal. 

Some world-famous parks like Pfeiffer Big Sur State Park may not open this year. After-school programs in low-income areas are being scuttled, putting high-risk teens on the street just as police forces are being cut. Schools are closing classrooms, and some highway projects have ground to a halt. The state may not be able to monitor some sex offenders as required under law.

A budget deal may restore some of the missing funds. But everyone knows that not all monies will flow again after a deal, and Californians increasingly fear they are seeing a hint of their future.

"Before it gets better, it’s going to get a lot worse," said Joseph Valentine, director of Contra Costa County’s Department of Employment and Human Services. The department, which administers social services such as food stamps, has cut 12%, or $25 million, of its budget. It has managers answering reception-desk phones, and Mr. Valentine expects another round of cuts.

The empty coffers have hit some California icons. Pfeiffer Big Sur may not reopen this summer because work on a new bridge to the campground was halted, part of a $6 million renovation project that state officials have ordered frozen along with hundreds of millions of dollars in other state infrastructure projects. Dan and Vickie Coughlin of Torrance, Calif., face not camping in the park with their daughters, ages 10 and 13, for the first time since they were born. When they were advised they couldn’t book reservations, "it just broke my heart, and my kids almost cried," said Ms. Coughlin.

Other states face budget cuts too, but California’s budget mess stands out for its size. Its deficit is projected at $42 billion by mid-2010. Since Gov. Schwarzenegger declared a fiscal emergency 14 weeks ago, he and lawmakers have been deadlocked over how to close the gap. Democrats want tax increases and moderate spending cuts; Republicans seek deep cuts and no tax increases; the governor wants a combination. 

Compensation Ratios (Table)

Wholesale Inventories Rising Dramatically  

In other words, even if final consumer demand picks up, wholesalers won’t necessarily be buying from producers as they already have the inventory piling up. 

Banking Committee: Videos of CEOs’ opening statements

Meltdown 101: Highlights of economic stimulus plan 

Q: What are some of the tax breaks in the bill?
It includes Obama’s signature "Making Work Pay" tax credit for 95
percent of workers, though negotiators agreed to trim the credit to
$400 a year instead of $500 – or $800 for married couples, cut from
Obama’s original proposal of $1,000. It would begin showing up in most
workers’ paychecks in June as an extra $13 a week in take-home pay,
falling to about $8 a week next January. 

Jobs (Interactive)

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