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    Daily Digest – Jan 31

    by Davos

    Saturday, January 31, 2009, 1:46 AM

  • Davos 2009, Are We Headed for a Great Depression? (Video)
  • Seriously alarmed (Hat Tip DamTheMatrix)
  • Bank Closures # 4, 5, & 6
  • GDP (Chart)
  • Worst January on Record for Stocks
  • Option ARMs See Rising Defaults 
  • Mayor’s Plan Calls For 23,000 Fewer City Jobs
  • Layoffs for January 2009 at America’s 500 largest public companies 162,962
  • Layoff Daily 
  • Chinese Premier Blames Recession on U.S. Actions (Video, Davos Keynote)
  • Russians to U.S.: Give us the Fed (Hat Tip PineCarr)
  • growing difficulty for britain 
  • US set for ‘big bang’ financial clean-up 
  • Glenn Beck, Inconvenient Debt (Hat Tip Trad) (Video)
  • H.R.1
  • H.R.1 Tables
  • Getting with the Program 


Davos 2009, Are We Headed for a Great Depression? (Video)

Seriously alarmed (Hat Tip DamTheMatrix)

The slide in sterling has turned "disorderly".

We can argue over whether or not the first phase of devaluation acted as a shock-absorber for a badly mismanaged economy, providing a cushion against debt deflation and the housing crash. But the latest dive has a very malign feel.

For the first time since this crisis began eighteen months ago, I am seriously worried that British government is losing control.

The currency has fallen five cents today to $1.39 against the dollar. It is now perched precariously on a two-decade support line — the levels tested in 2001 and 1992. If it breaks that line, traders may send it crashing down towards dollar parity.

The danger is blindingly obvious. The $4.4 trillion of foreign liabilities accumulated by UK banks are twice the size of the British economy. UK foreign reserves are virtually nothing at $60.6bn. (on this, more later in a piece I’m writing today)

If the Government is forced to nationalise RBS and perhaps Barclays with their vast exposure in dollars, euros, and yen, it risks being submerged. It is one thing for a sovereign state to let its national debt jump in a crisis — or a war — perhaps even to 100pc of GDP. It is another to take on foreign debts on such a scale with no reserves. Yes, the banks have foreign assets as well to match the debts. But how much are these assets really worth?

This is the moment when the "rubber hits the road" — to borrow from American argot — the moment when the reckless debt experiment of our economic and political leaders comes back to haunt.

We cannot even do what Iceland did to save its skin. Reykjavik refused to honour the foreign debts of its buccaneering banks. It let them default, parking the losses in Resolution Committees. Small islands can do that. Iceland has fish instead, and lots of metals.

Britain cannot follow suit. The debts are too big. If London takes such disastrous action it will set off global panic and lead to an asset death spiral, drawing the entire world into deep depression.

What have our leaders wrought? The reckless conduct of City, the fiscal incontinence of Gordon Brown (3pc deficit at the top of the cycle), and the pitiful regulation of the UK housing boom have all combined to bring the country to the brink of disaster.

England has not defaulted since the Middle Ages. There is a real risk it may do so now.

And no — just so there is no misuderstanding — it would not have been any better if Britain had joined the euro ten years ago. The bubble would have been just as bad, or worse, as Ireland and Spain can attest. We have our disaster. They have their disaster. When the dust has settled in five years we can make a proper judgement on the sterling-EMU issue. Not now.

The Baby Boomers have had their moment in power. The most spoilt generation in history has handled affairs with its characteristic hedonism. The results are coming in.

The blithering idiots.


Bank Closures # 4, 5, & 6

GDP (Chart)

Worst January on Record for Stocks 

Stocks wrapped up their worst January on record with a final plunge on Friday. 

The Dow Jones Industrial Average finished January down 8.84% on the month. Perviously, the worst January for the Dow had been that of 1916, when it fell 8.64%. Friday, the Dow dropped 148.15 points to 8000.86 after briefly dipping below the 8000 mark. The Dow has fallen five straight months and in 12 of the last 15.

The S&P 500-stock index lost 2.28% Friday to end at 825.88, for cumulative losses in January of 8.57%. Until Friday, its worst January from 1929 onward occurred in 1970, when it lost 7.65%.

Both stock-market indexes are off by more than 40% from their 2007 highs.

Stocks popped at the open Friday, but spent most of the day in the red. Traders cited fears that plans wouldn’t go forward for a so-called bad bank to soak up toxic assets from financial institutions, and bleak economic news, in particular Friday’s report of a 3.8% contraction in fourth quarter GDP. It was better than the 5.5% fall that economists had expected, but suggested the recession, now in its second year, is cutting deep.

A slew of layoff announcements, skepticism of the Obama stimulus plan, and a series of bleak earnings reports all crunched U.S. stock markets over the course of the week. Those developments left investors who exited stocks last year with little desire to put their money to work in the markets, limiting any stock rallies.

"I don’t think anyone is willing to put money to work until we get clarity out of the new government," said Matthew Cheslock, managing director at Cohen Capital Group LLC.

Investors have grown wary of efforts to right the ship. The Obama stimulus plan has received a lukewarm reception among market participants and buzz about the possible creation of a "bad bank" to soak up toxic assets has waxed and waned, perplexing investors. After a three-day jump to start the week, the bottom dropped out for stocks on Thursday and Friday.

"There’s been too much back-and-forth, it’s a wishy-washy market," said Debra Brede, president of D.K. Brede Investment Management Company. "One day you think [the government] is going to do something serious to help the banks, and the next day it’s not such a great idea. Markets hate uncertainty, and it’s not clear it’s a good plan. We need to get these banks cleaned up and move forward." 

Option ARMs See Rising Defaults  

As of December, 28% of option ARMs were delinquent or in foreclosure, according to LPS Applied Analytics, a data firm that analyzes mortgage performance. That compares with 23% in September. An additional 7% involve properties that have already been taken back by the lenders. By comparison, 6% of prime loans have problems. Problems with subprime are still the worst. Just over half of subprime loans were delinquent, in foreclosure, or related to bank-owned properties as of December. 

Nearly 61% of option ARMs originated in 2007 will eventually default, according to a recent analysis by Goldman Sachs, which assumed a further 10% decline in home prices. That compares with a 63% default rate for subprime loans originated in 2007. Goldman estimates more than half of all option ARMs outstanding will default.  

Mayor’s Plan Calls For 23,000 Fewer City Jobs 

Mayor Michael Bloomberg proposed a $43.4 billion budget Friday for the fiscal year starting on July 1 that includes heavy cuts in city jobs, cuts in services and increases in costs for everyday New Yorkers. 

"When you talk about reducing city expenditures, you are really talking about reducing headcount," Bloomberg said. "You can only get so much blood out of a stone."

The mayor’s plan calls for a reduction of almost 23,000 jobs through layoffs and attrition. About 15,000 employees would be laid off, including 14,000 Education Department employees, and 7,700 jobs would be lost through attrition.

Bloomberg’s Budget Proposal

The plan calls for a repeal on the sales tax exemption on clothing, raising the sales tax by 1/4 of a percent, raising parking meter rates and issuing more fines to unsanitary restaurants.

Bloomberg said Wall Street firms are expected to lose a total of $47.2 billion for 2008, and even more in 2009. The figures are devastating for New York City.

The mayor said Wall Street’s losses will affect the city for years.

The city is also now projected to lose nearly 300,000 jobs through 2010. Some 46,000 will come from the financial sector.

The gap for fiscal 2010 is at $4 billion and growing

Who’s Saying What?

Naturally, the reaction poured in Friday after Bloomberg spoke.

Rep. Anthony Weiner said, "I believe that it’s generally a bad idea to raise taxes on the middle class especially when times are so hard for New Yorkers. The work from the recovery bill we’ve just passed in Washington should send billions to New York, including for education. I’d hope the city budget will avoid cuts if these federal funds can be used."

Speaker Christine Quinn said, "Losing 14,000 teachers would deal a devastating blow to our schools and schoolchildren, which have shown remarkable growth and improvement in recent years. We cannot — and will not — allow this to happen. Our state and federal governments must step up to the plate and help us fully cover our education costs."

Teamsters President Gregory Floyd said, "We will be working to make sure that the mayor doesn’t balance the budget on the backs of working men and women. Like our predecessors, we will be coming to the table to examine the city’s budget woes, and we will see where we can be helpful."

Public Advocate Betsy Gotbaum said, "While I recognize the need to erase our budget deficit, I’m concerned that some job cuts — particularly those at (Adult Child Services) — will compromise the safety and welfare of our children. Nearly 1,000 ACS jobs are slated to be eliminated, and this stands out as a major cause for concern."   

Layoffs for January 2009 at America’s 500 largest public companies 162,962

Layoff Daily

Chinese Premier Blames Recession on U.S. Actions (Video, Davos Keynote)

Russians to U.S.: Give us the Fed (Hat Tip PineCarr) 

DAVOS, Switzerland (Fortune) — The Russians are upset that the U.S. dollar is the world’s principal reserve currency, and this week in Davos they have been putting forward suggestions for how to fix the issue. First came Prime Minister Vladimir Putin, who called in a speech on Wednesday for efforts to "facilitate the emergence of several reserve currencies." 

On Thursday it was the turn of German Gref, a former Economics Minister who is now CEO of Russia’s largest bank, state-owned Sberbank. His proposal during a panel discussion went even further than Putin’s: In the absence of any serious competitors to the dollar, he advocated international control of U.S. monetary policy.

The biggest risk facing the world, he said, is that the U.S. dollar plays a global role but is managed narrowly "in the vested interests of only one country." In other words, he’s pushing for the U.S. Federal Reserve to be governed more like an international institution than "merely" as the U.S. central bank.

Pressed by Fortune to explain what he means, Gref acknowledged that he hasn’t yet worked out the mechanisms for how Russia and other countries would have a formal say in U.S. monetary policy.

But he insisted that the dollar’s status as both the U.S. currency and as a global one is "one of the three to four main reasons for this crisis." Moreover, if the situation isn’t changed, "we will stay in the same international crisis."

I talked to several Russians and Russian watchers who are attending the World Economic Forum, and they say that while the Kremlin has long grumbled the dominance of the dollar, this is the first time they’ve heard Russian officials putting forward specific solutions – including having a say in U.S. monetary policy.

The Russians are chafing about the greenback because it has been extremely volatile over the past few years – and because their oil and gas is sold in dollars. And of course, the dollar is a potent worldwide symbol of American economic and political power, which they aren’t all that crazy about either.

The Russian central bank has tried to mitigate the issue by devaluing the ruble against a basket of currencies that comprises the dollar and the euro, rather than just the dollar. When the financial crisis exploded last fall, the ruble came under heavy selling pressure.

For several weeks, the central bank tried to prop it up, but after blowing through about $150 billion to no avail, it has since allowed the Russian currency to devalue gradually. 

Growing difficulty for Britain 

The U.K. is in trouble. Today it was reported that the British economy contracted a much worst-than-expected 1.5% during the fourth quarter (not annualized!), the steepest economic decline since the dark days of 1980. Manufacturing activity sank a dismal 4.6%, while services contracted by 1%. Some forecasts now have the British economy this year suffering the most severe economic contraction since 1946. There’s now a strong case for using "depression" when describing this deepening financial and economic malaise. 

The pound today traded at the lowest level against the dollar since 1985. This currency has depreciated 30% against the dollar over the past 12 months. Against the yen, the pound has collapsed 42% during the past a year. There is little room left for conventional monetary policy. At 1.50%, the Bank of England’s (BofE) base lending rate is today at the lowest level since 1694.

Curiously, the British pound has declined 6.5% against the dollar so far this month, while the dollar index has gained about 6%. I say "curiously," as I would argue that in key aspects of financial and economic structuring, the U.K. provides a microcosm of our own systemic vulnerabilities. In a recent Bloomberg interview, Jim Rogers stated "The pound sterling is going to be under pressure. The U.K hasn’t got much to sell the world anymore." His comments to the Financial Times were even harsher: "I don’t think there is a sound U.K. bank now, at least, if there is one I don’t know about it… The City of London is finished, the financial centre of the world is moving east. All the money is in Asia. Why would it go back to the west? You don’t need London."

Following our direction, the U.K. over the past decade gutted their already shrunken manufacturing base as it shifted headlong into "services" and finance. While this finance and asset inflation-driven Bubble economy seemed to work miraculously during the boom, the post-Bubble reality is a severely impaired financial system and an economic structure incapable of sufficient real wealth creation.

I feel for British policymakers. Just five short quarters ago, overheated nominal GDP was expanding at about a 6% pace. And with inflation surging to the 5% level, the Bank of England pushed its base lending rate to 5.75% (summer of ’07). I’ll give the BofE Credit for trying to tighten financial conditions. It was, however, in vain, as Acute Global Monetary Disorder overwhelmed domestic policymaking. BofE tightening only widened interest-rate differentials, especially compared to near zero borrowing rates in Japan. Finance inundated the City of London in a finale of unwieldy speculative excess, setting the stage for a reversal of flows, de-leveraging and today’s collapse.

Yesterday, U.S. insurance company Aflac dropped 37% on concerns for its exposure to European "hybrid" securities – in particular preferred-type instruments issued by the large U.K. banks. According to research by Morgan Stanley (Nigel Dally), "When it comes to capital adequacy and investment portfolio strength, Aflac has historically been viewed as the gold standard across the industry." Accordingly, the Street responded violently to the report highlighting the company’s potentially significant exposure to securities that have suffered huge losses in market value (Aflac rallied sharply today). According to the Morgan Stanley report, some of the hybrid securities issued by U.K. lenders Royal Bank of Scotland (RBS), HBOS, and Barclays are now trading at between 15 and 45 cents on the dollar.

Not long ago during the boom’s heyday, these types of securities were viewed as low risk instruments. They were, after all, issued by major – and at the time well-capitalized -banking institutions. In the worst-case scenario, these institutions (and their hybrid securities) were viewed as too big to fail. In reality, these banks were issuing a most dangerous class of securities – higher yielding ("money-like") instruments appealing to even the more conservative investors. Today, the entire U.K. banking system is enveloped in a vicious downward spiral. Tens of billions of securities that only a short time ago were perceived as safe are being heavily discounted for the possibility the issuing institution will be "nationalized."

On Wednesday, troubled Royal Bank of Scotland promised to lend $8.7bn in exchange for various lines of government support. The market took the news as a huge leap toward nationalization and governmental control over the U.K. banking sector. Even RBS’s CEO was quoted as saying, "We’ll be one the first guinea pigs." The markets now view that U.K. policymakers will have few available options other than borrowing hundreds of billions to recapitalize their banks and support the securities markets.

Ten-year government "gilt" yields spiked 29 basis points higher this week to 3.68%, with a 2-wk gain of 55 bps. On Tuesday, Britain reported a $20.5bn (14.9bn pounds) fiscal deficit for the month of December. Spending was up 6%, while tax receipts were down 5.5%. The European Commission is now forecasting the U.K. deficit to surpass 8% of GDP this year. After trading at about 20 bps this past June, the cost of U.K. Credit default swap protection has spiked to 147 bps (traded as high as 165bps Wednesday).

The U.K. gilt market seemed to lead global bond rates higher this week. As the scope of global financial sector capital shortfalls and forthcoming economic stimulus become clearer, bond market nervousness grows. U.S. 10-year yields ended the week 31 bps higher at 2.59%, about 110 bps below comparable gilts. There should be little doubt that our new Administration will move quickly and decisively to try to bolster the financial sector and stabilize the real economy.

I fully expect our Post-Bubble Financial and Economic Predicament to parallel that of Britain. At some point, our problems will likely be of much greater scope due to, among other things, our system’s larger size. So far, the U.K. has suffered a more acute crisis due to its inability to stabilize its troubled financial sector. For one, it is suffering through a more destabilizing outflow of speculative finance (unwind of carry trades). Also, the U.K. financial structure has traditionally been less government-influenced – leaving it today more vulnerable to a crisis of confidence. Outside of government debt instruments, confidence has faltered for large cross-sections of U.K.’s financial claims ("moneyness" has been lost).

Our system has to this point proved relatively more stable due primarily, I believe, to the instrumental role played by government and quasi-government institutions such as the FHA, Fannie, Freddie and the Federal Home Loan Banks. The market’s perception of "moneyness" is retained for multi-Trillions of U.S. claims – a dynamic that bolsters the view that the U.S. dollar retains its "reserve currency" and safe-haven status. And as long as this confidence holds, faith in the government’s capacity for system "reflation" endures. But it all has the look of a fragile confidence game, and I fully expect the invaluable attribute of "moneyness" to be tested at some point.

There is absolutely no doubt that a massive inflation of U.S. financial claims is in the offing. One would suspect it is only a matter of when market perceptions of "moneyness" adjust. This week’s jump in gilt yields could portend a troubling new phase in the U.K. financial crisis. It could also be a harbinger of a more general crisis of confidence for global currencies and debt markets. The long-bond suffered its worst week since 1987 (according to Bloomberg). Gold was up $43 today and $56 for the week. 

US set for ‘big bang’ financial clean-up 

The Obama administration is gearing up for a "big bang" announcement next week that will combine a bank clean-up with measures to reduce home foreclosures and probably steps to kick-start credit markets. 

The plan will involve an overhaul of the troubled asset relief programme – the $700bn bail-out fund – including strict curbs on compensation at banks receiving public aid. The Tarp overhaul is intended to restore public confidence in what is a deeply unpopular programme and ensure that taxpayer money is not used to fund excessive pay, bonuses and dividends to shareholders.

"There will definitely be a cap of some sort on bonuses," said a Wall Street executive who has taken part in talks with the authorities. "The political climate is such that there is a need to punish Wall Street."

The announcement will follow Friday’s news that the US economy contracted at an annualised rate of 3.8 per cent in last year’s final quarter – less than analysts were expecting, but still the worst quarter since 1982. The fall was cushioned by ballooning inventories, which suggest the economy could shrink faster than expected in the first quarter.

The "big bang" approach reflects the belief of Tim Geithner, Treasury secretary, and Lawrence Summers, National Economic Council director, that the Bush administration was wrong to dribble out policy initiatives. Mr Geithner intends to present a "comprehensive" plan that policymakers hope will command market confidence.

Details of the financial overhaul are being finalised and have yet to be approved by President Barack Obama, but it may include both the purchase of toxic assets by a "bad bank" and insurance-style guarantees for problem assets remaining on bank balance sheets.

Anti-foreclosure efforts are likely to focus on subsidising programmes that reduce unsustainable monthly mortgage payments, though there may also be support for schemes that subsidise the partial writedown of loans that exceed the value of the home. Treasury may also unveil new efforts to revitalise dysfunctional securitisation markets. 

Glenn Beck, Inconvenient Debt (Hat Tip Trad) (Video)


H.R.1 Tables

Getting with the Program 

Two years ago, Financial Armageddon raised eyebrows and caused lots of sniggers with an in-your-face title and a table of contents that included the following section: 


5. Economic Malaise
6. Systemic Crisis
7. Depression
8. Hyperinflation

Since then, of course, we’ve gone through the first two phases, and all signs indicate that the third is currently unfolding.

For the most part, the mainstream analytical crowd has been unwilling to allow for or even acknowledge these outcomes until the facts made it virtually impossible to do so.

Now, however, some of the establishment types are beginning to get with the program a little faster than they did before.

In "Hyperinflation Is a Possibility, Say Morgan Stanley," the Financial Times’ FT Alphaville blog details one recent example.

That’s not in Zimbabwe by the way.

Morgan Stanley’s Jocahcim Fels and Spyros Andreopoulos look at the possibility of hyperinflation hitting the western shores of the UK, Europe and the US in their latest note. Their conclusion is a little scary (our emphasis).

One stark lesson from the ongoing financial and economic crisis is that so-called black swans – large-impact, hard-to-predict and seemingly rare events – can occur more frequently than generally believed.With policymakers around the world throwing massive conventional and unconventional monetary and fiscal stimuli at their economies, we think that it is worth exploring the black swan event of very high inflation or even hyperinflation.

While such an outcome is clearly not our main case, the risk of hyperinflation cannot be dismissed very easily any longer, in our view. We discuss the historical evidence, the conditions that can lead to very high or hyperinflation, and whether and how it might happen again.

So hypinflation is a black-swan event that, given all the other black-swan events of late, should not be dismissed.

As they remind, the classification of hyperinflation is: an episode where the inflation rate exceeds 50 per cent per month. In history this has occurred in the 1920s in Austria, Germany, Hungary, Poland and Russia. Germany in 1923, for example, experienced a 3.25m per cent inflation rate in a single month (see picture left). Since the 1950s hyperinflations have been experienced in Argentina, Bolivia, Brazil, Peru, Ukraine and Zimbabwe – so confined largely to developing and transitioning economies.

The root cause of hyperinflation is: ‘excessive money supply growth, usually caused by governments instructing their central banks to help finance expenditures through rapid money creation.’

Back to whether it could happen to Europe or the US? Morgan Stanley says possibly yes, under certain conditions.

Firstly, the rapid expansion of the monetary base by the Fed, ECB and BoE would have to continue and feed into a more rapid and sustained expansion of money in the hands of the general public.



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