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    Daily Digest – June 2

    by Davos

    Tuesday, June 2, 2009, 3:05 PM

  • “Is Larry Summers Taking Kickbacks From the Banks He’s Bailing Out?”
  • Swine Flu May Be Human Error; WHO Investigates Claim
  • 7 States Now With Historical High Unemployment Rate. Michigan 22.8 Percent Unemployment Rate (U-6) with Official Government Data.
  • Map (Unemployment)
  • Quiet (Video)
  • Bond Vigilantes Confront Obama as Housing Falters
  • FDIC Banking Report: 305 Troubled Institutions up from 90 in 2008. $13.5 trillion Assets held with 2.1 Million Employees at 8,200 Institutions.
  • The Fall of the Mall (Chart)
  • The Shadow Banking System and Hyman Minsky’s Economic Journey
  • Zoellick Warns Stimulus ‘Sugar High’ Won’t Stem Unemployment
  • Fed Clueless Perplexed About Spike in Bond Interest Rates


“Is Larry Summers Taking Kickbacks From the Banks He’s Bailing Out?”

The Ames piece is provocative, but it’s certain no explicit payoff was made. But the flip side is it is highly likely the banks invested to curry favor with Summers. Even if the only payoff was privileged access to him, that alone would be troubling,

From Ames:

Is Larry Summers taking kickbacks from the banks he’s bailing out?

Last month, a little-known company where Summers served on the board of directors received a $42 million investment from a group of investors, including three banks that Summers, Obama’s effective “economy czar,” has been doling out billions in bailout money to: Goldman Sachs, Citigroup, and Morgan Stanley. The banks invested into the small startup company, Revolution Money, right at the time when Summers was administering the “stress test” to these same banks.

A month after they invested in Summers’ former company, all three banks came out of the stress test much better than anyone expected — thanks to the fact that the banks themselves were allowed to help decide how bad their problems were (Citigroup “negotiated” down its financial hole from $35 billion to $5.5 billion.)

The fact that the banks invested in the company just a few months after Summers resigned suggests the appearance of corruption, because it suggests to other firms that if you hire Larry Summers onto your board, large banks will want to invest as a favor to a politically-connected director…

According to filings obtained for this story, Summers first joined the board of directors of Revolution Money back in 2006 (when it was called “GratisCard…Revolution Money/GratisCard was a startup headed by former AOL chief Steve Case. Revolution Money billed itself as the Next Big Thing in online payment,…

In September 2007, Revolution Money announced that it had raised $50 million from a group of investors including Citigroup, Morgan Stanley and Deutsche Bank. Some found the investment strange even then, because normally big banks don’t get involved in seeding small startups — that’s the domain of venture capitalists, not mega-banks. Especially not in September, 2007, when these same megabanks were Chernobyling their way into full-fledged balance-sheet meltdown.

What seems clear is that at least part of Revolution Money’s success in raising funds is due to their star-studded board of directors — which included not only Larry Summers, but also the notorious Frank Raines, the former Fannie Mae chief whom Time Magazine named to its “25 People To Blame For The Financial Crisis” list. Raines is still a board member.


Swine Flu May Be Human Error; WHO Investigates Claim

Adrian Gibbs, 75, who collaborated on research that led to the development of Roche Holding AG’s Tamiflu drug, said in an interview that he intends to publish a report suggesting the new strain may have accidentally evolved in eggs scientists use to grow viruses and drugmakers use to make vaccines. Gibbs said he came to his conclusion as part of an effort to trace the virus’s origins by analyzing its genetic blueprint.

“One of the simplest explanations is that it’s a laboratory escape,” Gibbs said in an interview with Bloomberg Television today. “But there are lots of others."

7 States Now With Historical High Unemployment Rate. Michigan 22.8 Percent Unemployment Rate (U-6) with Official Government Data.

There have been many comparisons to the past with our current recession. For the most part, people are trying to find something familiar so they can have a better sense of where we are heading. The only problem is that there isn’t much in our own history to guide us forward. This is a unique and deep recession unlike anything we have seen since World War II. When I put together a post highlighting that 24,700,000 Americans are unemployed or underemployed some people questioned the actual number. The only issue is that this number is from official government data which if we look at the stress tests, tend to be conservative.

Even with government data, 7 states have now broken statewide historical unemployment averages. Those states are:

  • Oregon: 12.1%
  • South Carolina: 11.4%
  • California: 11.2%
  • North Carolina: 10.8%
  • Rhode Island: 10.5%
  • Florida: 9.7%
  • Georgia: 9.2%

Map (Unemployment)

Quiet (Video)


Bond Vigilantes Confront Obama as Housing Falters

For the first time since another Democrat occupied the White House, investors from Beijing to Zurich are challenging a president’s attempts to revive the economy with record deficit spending. Fifteen years after forcing Bill Clinton to abandon his own stimulus plans, the so-called bond vigilantes are punishing Barack Obama for quadrupling the budget shortfall to $1.85 trillion. By driving up yields on U.S. debt, they are also threatening to derail Federal Reserve Chairman Ben S. Bernanke’s efforts to cut borrowing costs for businesses and consumers.

The 1.4-percentage-point rise in 10-year Treasury yields this year pushed interest rates on 30-year fixed mortgages to above 5 percent for the first time since before Bernanke announced on March 18 that the central bank would start printing money to buy financial assets. Treasuries have lost 5.1 percent in their worst annual start since Merrill Lynch & Co. began its Treasury Master Index in 1977.

“The bond-market vigilantes are up in arms over the outlook for the federal deficit,” said Edward Yardeni, who coined the term in 1984 to describe investors who protest monetary or fiscal policies they consider inflationary by selling bonds. He now heads Yardeni Research Inc. in Great Neck, New York. “Ten trillion dollars over the next 10 years is just an indication that Washington is really out of control and that there is no fiscal discipline whatsoever.”

Investor Dread

What bond investors dread is accelerating inflation after the government and Fed agreed to lend, spend or commit $12.8 trillion to thaw frozen credit markets and snap the longest U.S. economic slump since the 1930s. The central bank also pledged to buy as much as $300 billion of Treasuries and $1.25 trillion of bonds backed by home loans.

For the moment, at least, inflation isn’t a cause for concern. During the past 12 months, consumer prices fell 0.7 percent, the biggest decline since 1955. Excluding food and energy, prices climbed 1.9 percent from April 2008, according to the Labor Department.

Bill Gross, the co-chief investment officer of Newport Beach, California-based Pacific Investment Management Co. and manager of the world’s largest bond fund, said all the cash flooding into the economy means inflation may accelerate to 3 percent to 4 percent in three years. The Fed’s preferred range is 1.7 percent to 2 percent.

“There’s becoming an embedded inflationary premium in the bond market that wasn’t there six months ago,” Gross said yesterday in an interview at a conference in Chicago.


FDIC Banking Report: 305 Troubled Institutions up from 90 in 2008. $13.5 trillion Assets held with 2.1 Million Employees at 8,200 Institutions. (Please use link to view many, many charts)

What is drawing down the funds? It is the amount of banks going under and being taken over by the FDIC. The number is growing. Last year, the FDIC had 90 banks on its troubled list. Today, there are now 305. Keep in mind that last year gigantic failure IndyMac Bank which ate up nearly $10 billion of the fund wasn’t even on the troubled bank list. So take the 305 bank list for what it is worth from the FDIC. It is also the case that the FDIC will play a crucial role in the private-public investment program being dolled out by the U.S. Treasury. Recent reports estimate that the program will start in July and should be a taxpayer rip off to the ultimate extreme.

The PPIP will game the system and foot taxpayers with the bill of the most toxic assets in the world. Private investors will only need to come up with 5 percent while the U.S. Treasury will kick down 5 percent and the rest will largely be financed by non-recourse loans by the FDIC. It is incredible that we are going to give this institution which is already dealing with tremendous amounts of bank failures the duty of handling some of the most toxic mortgages known to the world.

That is why that in the last year the actual amount of assets at these 8,200+ institutions actually decreased for the first time in 2 decades:

The Fall of the Mall (Chart)

The Shadow Banking System and Hyman Minsky’s Economic Journey (12 pages, an important read IMHO)

The Financial Instability Hypothesis: Minsky took Keynes to the next level, and his huge contribution to macroeconomics comes under the label of the “Financial Instability Hypothesis.” Minsky openly declared that his Hypothesis was “an interpretation of the substance of Keynes’s General Theory.” Minsky’s key addendum to Keynes’ work was really quite simple: providing a framework for distinguishing between stabilizing and destabilizing capitalist debt structures. Minsky summarized the Hypothesis1 beautifully in his own hand in 1992:

“Three distinct income-debt relations for economic units, which are labeled as hedge, speculative, and Ponzi finance, can be identified.

Hedge financing units are those which can fulfill all of their contractual payment obligations by their cash flows: the greater the weight of equity financing in the liability structure, the greater the likelihood that the unit is a hedge financing unit. Speculative finance units are units that can meet their payment commitments on ‘income account’ on their liabilities, even as they cannot repay the principal out of income cash flows. Such units need to ‘roll over’ their liabilities (e.g., issue new debt to meet commitments on maturing debt).…

For Ponzi units, the cash flows from operations are not sufficient to fulfill either the repayment of principal or the interest due on outstanding debts by their cash flows from operations. Such units can sell assets or borrow. Borrowing to pay interest or selling assets to pay interest (and even dividends) on common stock lowers the equity of a unit, even as it increases liabilities and the prior commitment of future incomes.…

It can be shown that if hedge financing dominates, then the economy may well be an equilibrium-seeking and -containing system. In contrast, the greater the weight of speculative and Ponzi finance, the greater the likelihood that the economy is a deviation-amplifying system. The first theorem of the financial instability hypothesis is that the economy has financing regimes under which it is stable, and financing regimes in which it is unstable. The second theorem of the financial instability hypothesis is that over periods of prolonged prosperity, the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system.

In particular, over a protracted period of good times, capitalist economies tend to move from a financial structure dominated by hedge finance units to a structure in which there is large weight to units engaged in speculative and Ponzi finance. Furthermore, if an economy with a sizeable body of speculative financial units is in an inflationary state, and the authorities attempt to exorcise inflation by monetary constraint, then speculative units will become Ponzi units and the net worth of previously Ponzi units will quickly evaporate. Consequently, units with cash flow shortfalls will be forced to try to make position by selling out position. This is likely to lead to a collapse of asset values.”

 Zoellick Warns Stimulus ‘Sugar High’ Won’t Stem Unemployment

May 30 (Bloomberg) — World Bank President Robert Zoellick warned policy makers that fiscal-stimulus plans are insufficient to turn around the “real economy” and rising joblessness threatens to set off political unrest across the globe.

“While the stimulus has given an impulse, it’s like a sugar high unless you eventually get the credit system working,” Zoellick said in an interview yesterday with Bloomberg Television’s “Political Capital with Al Hunt.” “When unemployment increases, that’s probably the most political combustible issue.”

Zoellick’s caution is a contrast with private economists, who are raising their outlooks for growth from India to China as stimulus measures take effect. The biggest developed and emerging nations have committed spending increases and tax cuts totaling 2 percent of their combined economies, a level the International Monetary Fund recommended to end the recession.

The World Bank is monitoring private companies’ abilities to roll over “a lot” of debt in the developing world, Zoellick said. At the same time, he played down risks to the global recovery posed by rising U.S. Treasury yields, saying that “in terms of absolute levels, rates are still pretty low for most players.”

Fed Clueless Perplexed About Spike in Bond Interest Rates

Lordie, if this Reuters article is to be taken at face value, the Fed is even more detached from reality than I feared. The Fed does not understand why the Treasury bond market had a mini-panic last week. Is it that investors believe the “green shoots” story and are seeking riskier assets? Or is it that they are worried about burgeoning Treasury auctions and a possible fall in the dollar?

Note there is another theory, that it was Fannie and Freddie moves to manage their duration risk that caused the mess. However, it did appear that the selloff in the dollar and longer Treasuries was triggered by Standard & Poors’ announcement that it was putting the UK on negative watch, meaning it is at risk of losing its AAA rating.

While both factors, a shift to riskier assets and worries about a tsunami-like incoming tide of Treasuries, bizarrely, are in play, from what I can tell, the second, the fear of the growing Treasury calendar, is the big driver. Look, the Chinese have done everything but put up a billboard in Time Square to let the US know that it is not happy about US fiscal deficits (really, it ought to be, they need the economy to be something other than prostrate) and has moved aggressively to the short end of the yield curve.

So we have two possibilities. Either the Fed is as completely clueless as this story suggests it is, or it is coming to realize that it cannot, like the Wizard of Oz, manage all the variables it is trying to control and tune things as it would like. Doug Noland offers a similar line of thought (hat tip Andrew U):

The notion that there is a system price level easily manipulated by our monetary authorities to produce a desired response is an urban myth. During the 2000-2004 reflation, I would often note that “liquidity loves inflation.” The salient point was that the Fed could indeed create/inflate system liquidity. It was, however, quite another story when it came to directing stimulus to a particular liquidity-challenged sector. Almost inherently it would flow instead to where liquidity – and resulting inflationary biases – were already prevalent.

The Fed’s reaction strikes me, behaviorally, as a re-run of 2007. The Fed saw the credit contraction as only the subprime mess, therefore something familiar, sat on its hands, then overreacted. As things appear to be working out not to its liking, it its reflex again is to hold pat. I’d expect the Fed to overreact as before if it comes to believe it has a real problem on its hands.

The fact set this time of course is wildly different. The Fed is trying to achieve aims that are not internally consistent, namely, prop up asset prices by directing credit to preferred sectors, and create positive inflation expectations.

Keeping yields (or more accurately spreads, the Fed claims it is only trying to control spreads) while also trying to raise inflation expectations, albeit modestly, is a conflict. Higher inflation expectations mean higher yields, particularly on long dated assets like mortgages. And enough observers think privately that the Fed secretly wants to create much more significant inflation, say 5-6%, to alleviate the real debt burden on households. Those sorts of worries among bond investors are cause enough for some to abandon the long end of the curve.

And the “will the Fed amp up its quantitative easing” is yet another concern. Even though the Fed could in theory control rates at the long end of the curve via its unlimited firepower, Mr. Market could well play a game of chicken. If the Fed decided to hold a particular long rate, it could well wind up owning that market. The Fed is no doubt well aware of this risk, which may be the big reason it is holding off, and hoping this problem somehow resolves itself.


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