As regular readers of “Legally Speaking” know, the courthouse is not always a solemn place where matters of great import are considered by Solomonic judges and argued by zealous advocates.It is also a place with its own “Twilight Zone” moments, as the following examples illustrate.
Criminal defense attorney Bill Whitaker recently had one of those “Wanna get away?” moments you see in Southwest Airlines commercials.During closing argument in federal court in Akron, Ohio, Whitaker seemed to forget his role on behalf of defendant Jimmy Dimora, who stood accused of corruption and criminal conspiracy charges in a case involving huge amounts of alleged kickbacks paid to Ohio government officials.Whitaker confidently told the jury he expected a verdict of “guilty” on each and every one of the counts.The defense lawyer realized his mistake after he returned to the counsel’s table where his client was sitting, at which point he promptly turned to the jury and said, “I mean, not guilty.”Too bad trials aren’t conducted using playground rules, and you can’t just blurt out “Do over!”
There are lots of people who waste time at work on the Internet.Some, I’ve heard, actually will go so far as to watch porn sites.But one place where this exercise in bad judgment gets even worse is if your job is that of a court clerk, and that particular day at work involves a rape trial.54 year-old London court clerk Debasish Majumder has worked for years at his court, but in December 2011 he became, by his own admission, “bored.”Unfortunately for Majumder, this boredom overcame him during a rape trial, and he was caught surfing porn sites during witness testimony, only to be caught by the judge (who later reported the clerk to authorities).Police found “child pornography and other extreme images” on Majumder’s home computer.The clerk will now have to stave off boredom in a jail cell, after being charged and pleading guilty to misconduct in public office and possession of indecent images.
In February, a Texas special education officer resigned after being caught on camera sleeping during a due process proceeding brought by the parents of a special needs student against the KellerIndependentSchool District.During the 3-day long hearing, special education judge Larry Craddock allegedly slept for extended periods of time.Attorneys and the child’s parents say that they “dropped water bottles,” tried coughing and shuffling books in futile attempts to wake up the sleeping hearing officer, who resigned after being told they also caught him on video with cell phone cameras.While Craddock blames the episode on “medication,” it turns out this judge is no stranger to catching a few winks on the job.In a 2006 grievance filed against Craddock in a Houston-area family, he was accused of falling asleep 15 times during their due process hearing.
If you’re going to commit a crime, but have a habit of doodling, you may want to reconsider.In Oregon, an appellate court recently upheld the conviction of a man whose cartoon drawing depicting a holdup scene was used as evidence against him. Ariel Jasso was on trial in 2009 for the robbery of a marijuana dealer with several others.Although Jasso denied taking part in the robbery, responding police found (on a school paper in Jasso’s backpack) a carton showing a gunman demanding “jewlery” from a frightened-looking woman.Reasoning that the doodle pointed to greater involvement in the crime than Jasso would admit, the trial court admitted it as evidence and the appellate court agreed that the judge was right to do so.Jasso’s defense attorney tried to dismiss it as just “a doodle in a notebook,” but later admitted it “was a pretty damning piece of evidence.”
A courthouse deputy at the FrederickCounty (Maryland) Courthouse spotted an unusual object next to one of the courthouse columns on March 7, 2012: a coconut.He alerted other authorities to the suspicious food item, and the sheriff’s office, police department, fire and rescue personnel, and the Maryland State Fire Marshal’s Bomb Squad all responded, and the courthouse was evacuated.The coconut was later determined to be “safe.”Another triumph of taxpayer dollars at work!
A New York woman, Lindsay Blankmeyer, has filed a federal lawsuit against her former college, Stonehill College of Boston, Massachusetts, alleging that the administrators at the Catholic school didn’t do enough to keep her roommate from having too much sex.Blankmeyer claims that her roommate was constantly having sex with her boyfriend or engaging in “sexually inappropriate video chatting” with him while Blankmeyer was in the room.She alleges that though she tried to persuade school officials to either move the randy roommate or find Blankmeyer a different room, StonehillCollege administrators took no action.Blankmeyer maintains that the situation caused her to fall “into a dark and suicidal depression” resulting in a leave of absence from school as well as “extensive psychiatric and medical treatment.”A StonehillCollege spokesperson denies the allegations.
Finally, we have police charges only Franz Kafka could love.A man in Winnipeg in Manitoba, Canada was pulled over by police on March 2, 2012, and issued a $199.80 ticket for violating an ordinance against talking on a cellphone while driving.There’s just one problem: neither the man nor his wife were carrying—or even own—a cell phone!He begged the police to search the car, reportedly telling them he couldn’t have been talking on an imaginary cellphone.But that didn’t stop the police from issuing the ticket anyway.The driver even tried reporting the incident to the local police department, but was just laughed at, leaving him with only one choice: fight the ticket in court.
Most Americans know about the brave group of Texans who met 176 years ago on March 2 at Washington-on-the-Brazos to demand their God-given freedoms from a despot named Santa Anna, who was almost as unpopular in Mexico as in Texas.
The average length of the blink of an eye lasts no more than 300 to 400 milliseconds.The typical individual blinks around 10 times in a minute’s span, depending on external stimuli.Yet as fleeting an act as it may be, the blink of an eye may decide the fate of 33 year-old accused murderer Ricardo Woods.
Woods has been charged with fatally shooting 35 year-old David Chandler on October 28, 2010.Chandler was sitting in the passenger seat of a car at an intersection in Cincinnati, when he was shot in the head and neck.Despite two surgeries, Chandler was paralyzed; he lived for two more weeks before dying on November 12, 2010.Because of his injuries, he could only communicate by blinking.But that didn’t stop police from interviewing him the same day he was shot.
Police brought a priest, the Rev. Phillip Sehr, into Chandler’s hospital room to administer last rites.They also videotaped their in-hospital questioning of Chandler, asking him to blink three times for “yes,” and twice for “no” in response to each question.According to prosecutors, Chandler knew Ricardo Woods from having been involved in drug deals with him.Hooked up to a ventilator, Chandler allegedly was shown just one photo—a photo of Woods—and purportedly identified “O” (Woods’ street name) with a series of blinks.According to prosecutors, the videotaped session showing Chandler’s blinking identification should be admissible as evidence because, even though only one photo was shown to the victim instead of a whole lineup, Chandler was well-acquainted with Woods and the identification came soon after the shooting.In addition, having been administered the last rites, Chandler believed that his death was imminent; in that event, under the rules of evidence, the dead man’s “testimony” could be used during trial as what is known as a “dying declaration.”
But Woods’ criminal defense attorney, Kory Jackson, disputes the blinking “testimony” and maintains it shouldn’t be allowed as evidence.According to Jackson, the blinks are inconsistent, and there are flaws in the interpretation of these blinks.He says “In lots of responses, he isn’t answering correctly.He either doesn’t blink or blinks too many times.”In addition, Jackson believes that Chandler’s condition at the time and the medications that were used to treat him could have impacted the man’s ability to comprehend and respond to the officers’ questions.
However, Hamilton County Common Pleas Judge Beth Myers rejected Jackson’s arguments.After reviewing the video of the questioning, Judge Myers ruled that Chandler’s “pronounced, exaggerated” eye movements were reliable evidence.She found that “the identification is reliable and there is not a substantial likelihood of misidentification.”With that decision, Woods’ trial was set to go forward in mid-November 2011, but just as the trial was about to start, it was delayed for unknown reasons. The trial has not yet occurred.
When the trial does proceed, will it be fair for a jury to be swayed by the video of the deceased identifying his killer by blinking?Murderers have been convicted on the basis of “ear witness testimony” and even a victim’s bloody scrawl of his killer’s name.While this blinking “testimony” may give new meaning to the term “eyewitness,” perhaps there is something to defense lawyer Jackson’s protests.After all, the reflexes of blinking are controlled by multiple muscles in the upper and lower eyelid (muscles that are not only important to blinking, but to other functions as well, like squinting or winking).Could Chandler’s injuries and the medications he was on have affected his blinking, despite Judge Myers’ belief that the eye movements were “pronounced” enough to constitute a reliable identification?Jackson points out that the interpretations of the blinks were inconsistent, with Judge Myers disagreeing with how the detectives interpreted at least 2 of the blinks.
Jurors will eventually get to watch the videotaped interview, and they will decide for themselves what meaning to attribute to a dying man’s blinking eyes.And when they decide, Ricardo Woods may go from innocent to guilty—in the blink of an eye.
February 21 – CNBC (John Carney): “The Washington Post ran a long and well-wrought article on Modern Monetary Theory over the weekend. The piece, by Dylan Matthews, starts with Jamie Galbraith’s experience trying to explain to a large audience of economists in the Clinton White House that the budget surpluses the federal government was running was immensely destructive. Or, rather, it starts with those economists laughing at Galbraith’s attempt to explain this. It was obvious to me way back before I had ever heard of MMT that governments should probably never run a budget surplus—or should do so only in dire emergencies. When the government runs a surplus, that means it is taking more money out of the economy than it is spending back into the economy. It is making us poorer.”
In my initial CBB back in 1999, I trumpeted the need for a Contemporary Theory of Money and Credit. Some thirteen years later, I lament that the void remains as large as ever. Mr. Matthews’ Washington Post article highlighted “Modern Monetary Theory,” an alternative economic framework with Keynesian roots that is receiving heightened attention in our age of unrelenting government stimulus. I will not be jumping on board.
From Mr. Matthews’ article: “‘Modern Monetary Theory’ was coined by Bill Mitchell, an Australian economist and prominent proponent, but its roots are much older. The term is a reference to John Maynard Keynes, the founder of modern macroeconomics. In ‘A Treatise on Money,’ Keynes asserted that ‘all modern States’ have had the ability to decide what is money and what is not for at least 4,000 years. This claim, that money is a ‘creature of the state,’ is central to the theory. In a ‘fiat money’ system like the one in place in the United States, all money is ultimately created by the government, which prints it and puts it into circulation. Consequently, the thinking goes, the government can never run out of money. It can always make more.”
And from Wikipedia: “Chartalism is a descriptive economic theory that details the procedures and consequences of using government-issued tokens as the unit of money, i.e. fiat money… The modern theoretical body of work on chartalism is known as Modern Monetary Theory (MMT). MMT aims to describe and analyze modern economies in which the national currency is fiat money, established and created exclusively by the government. In MMT, money enters circulation through government spending; Taxation is employed to establish the fiat money as currency, giving it value by creating demand for it in the form of a private tax obligation… Because the government can issue its own currency at will, MMT maintains that the level of taxation relative to government spending (the government’s deficit spending or budget surplus) is in reality a policy tool that regulates inflation and unemployment, and not a means of funding the government’s activities per se.”
My “contemporary theory…” takes an altogether different approach. “Money” is not foremost a creature “ultimately created by the government,” but is instead primarily an issue of market perceptions. “Money” is as money does (“economic functionality”). The reality is that we today operate in an age of globalized electronic Credit – a comprehensive virtual web of computerized general ledger debit and Credit entries linking creditors and debtors round the globe. This “system” of electronic IOUs comprises myriad types of financial obligations of diverse structure, maturity, Creditworthiness and currency units of accounts. Importantly, if the marketplace perceives that a Credit instrument will act as a highly liquid and stable store of nominal value, this Credit enjoys “moneyness.” It is the nature and nuances of contemporary marketable debt – especially with respect to the prominence of governmental and central bank support - that should be the analytical focal point. A static view of government-based “fiat money” is anachronistic.
Economists argued in the late-nineties that government budget deficits were a “fiscal economic drag.” They later claimed that the 2001 recession proved their point. Many of these same economists today support ongoing massive deficit spending. They fret over the thought of “austerity.” I take issue with this line analysis, especially from a monetary theory perspective.
First of all, it’s generally inaccurate to claim that government surpluses “take money out of the economy” and “make us poorer.” To this day, the economic community fails to appreciate key monetary dynamics from the nineties – issues that remain just as relevant today. The federal government ran a small surplus in 1998, a surplus of about $100bn in 1999 and one approaching $200bn in 2000. There was talk of paying down the entire federal debt. Economists and policymakers alike were oblivious to momentously destabilizing developments in “money” and Credit. We’ve made little analytical headway since.
Nineties’ surpluses were primarily driven by a massive inflation of government receipts. In the five year period 1995-2000, federal revenue surged 46% to $2.057 TN. Over this period, federal spending rose 16% to $1.872 TN – hardly a fiscal drag and harbinger of recession. Why were receipts exploding? Well, because system Credit was surging. In the four years ended in 1999, total U.S. marketable debt jumped 37% ($6.9TN) to $25.389 TN. The annual growth in system marketable debt increased from 1995’s $1.196 TN to 1999’s $2.070 TN. In four years, Non-Financial debt expanded 27% ($3.6TN) to $17.291 TN, although the real fireworks were courtesy of an evolving financial sector.
In the four years ended 1999, total Financial Sector borrowings jumped 74% ($3.1TN) to $7.349 TN. What was driving this historic growth? Primarily the GSEs. In just four years, GSE Credit obligations (agency debt and GSE MBS) jumped 64% ($1.5TN) to $3.888 TN. And with rampant GSE Credit growth ensuring market liquidity abundance, outstanding Financial Sector corporate bonds jumped 56% in four years, while the Asset-backed Securities (ABS) marketplace doubled. CPI may have been relatively tame, but Credit and speculative excess were fueling historic asset market inflation. And asset market capital gains – bonds, tech stocks, houses, etc. – were helping fill government coffers (and boosting expenditures!) from Sacramento to WashingtonD.C.
I’m not sure how a modern monetary theory can be relevant without delving deeply into the profound role the evolution of GSE and Wall Street finance had on U.S. and global finance; on the fiscal position of the U.S. and advanced economies; on our asset markets, economic structure and on financial fragility more generally. To focus on federal spending, surpluses and deficits at the expense of recognizing the momentous distortions wrought by Washington finance (Treasury, GSE and Federal Reserve – OK, throw in the IMF and World Bank) is a failure of analytical diligence.
The 2008 crisis and subsequent economic and financial fragilities were a direct consequence of a historic Bubble in mortgage finance. Washington’s fingerprints were all over the mispricing of finance that fueled near-catastrophic asset market distortions and economic maladjustment. It was an abject failure in policymaking. Those that have called for even greater government involvement in our economy and markets are content to disregard past mistakes. For those of us paying attention, there’s no doubt that we want Washington extricated from monkeying with market pricing mechanisms.
The lack of respect for “money” and moneyness is a primary issue I have with most monetary analysis. They don’t get it. From the perspective of my analytical framework, money is both powerful and precious. Historically, sound money has been as rare as government-induced monetary inflation has been commonplace. The biggest risk coming out of the 2008 crisis was that runaway Washington fiscal and monetary stimulus would destroy Creditworthiness at the heart of our monetary system. We're well on our way. Throughout history, mistakes in monetary management have tended to beget only bigger mistakes.
Somehow, many “monetary” economists seem to believe that money is like Doritos chips: don’t fret, quite easy for us to make a lot more. After witnessing the consequences of a collapse in confidence in Wall Street Credit and, more recently, the Credit obligations of Greece and Portugal, there is no excuse for such complacency. Yet conventional wisdom holds that Washington will always enjoy the capacity to “print” its way out of trouble. Default risk is a myth, it is believed. It is similar thinking that ensured the spectacular mortgage Credit boom and bust. It is one thing to issue fiat currency; it is quite another to sustain market confidence when Credit is expanding uncontrollably.
The GSE/mortgage monetary inflation was not as conspicuous. Today, we are witnessing in broad daylight the dangerous side of “money.” The Treasury is issuing Trillions of debt - in an environment of virtually insatiable demand. Over the years, I’ve noted how a boom fueled by risky junk bonds wouldn’t be that dangerous from a systemic point of view. Limited demand for junk would create self-imposed market constraints. A Bubble in “money,” on the other hand, would tend to last longer, go to greater excess and, as such, have much greater deleterious impacts on financial and economic structures. And severe structural impairment can require multi-decade workouts and restructuring periods (think Great Depression and Japan). Money, even in its modern form, remains precious and, potentially, extremely dangerous – and this is the bedrock of my Contemporary Theory of Money and Credit.
Fine, economists can sit around and debate deficit spending and the role of fiscal stimulus in recessions and recoveries. Meantime, there is scant discussion of the extraordinary monetary backdrop and untested experimental nature of monetary management. Governments have assumed unprecedented roles in the marketplace, much to the advantage of a multi-Trillion global leveraged speculating community. Government market backstops have been instrumental in the mushrooming of global derivative positions to the hundreds of Trillions. A financial insurance marketplace of unfathomable scope has been operating on the flimsy premise of liquid and continuous securities markets. Meanwhile, most economists, “monetary” and otherwise, argue that tame inflation ensures that there is little risk associated with ongoing massive government stimulus and market intervention.
Most today fail to appreciate the potential catastrophic consequences of a crisis of confidence in “money” – a crisis of confidence in the moneyness of government debt and associated obligations. I sense little appreciation for the momentous role played by “money” as the core foundation of overall global Credit – or for Credit as the fuel for global economic activity. We saw again in 2011 how abruptly things can begin to unravel when the marketplace perceives that policymakers don’t have the situation under control. We’ve witnessed, as well, how quickly aggressive concerted global policy responses can transform de-risking/de-leveraging back to re-risking/re-leveraging. In a span of a few weeks, problematically illiquid markets morphed right back into liquidity abundance and speculative excess.
From a monetary and market perspective, we’ve returned to the precarious stage. Risk embracement and leveraging create market liquidity abundance. Strong markets then emboldened the perception that policymakers have everything under control, which stokes even more speculation and stronger risk market inflation. And global risk asset prices - from stocks, to junk bonds to sovereign debt to emerging market debt and equities – enjoy inflated prices based on the view that policymakers can ensure a low-risk macro backdrop. Market players impute moneyness upon Trillions of debt instruments of suspect quality – Credit that will be vulnerable in the next bout of risk aversion and attendant de-leveraging.
I just don’t believe that policymakers have the situation under control. Sure, they can incite a reversal of short positions and risk hedges. They so far retain the capacity to foment “risk on” and speculative excess. Yet, in reality, this is more destabilizing than it is a source of system stability. The amount of mercurial speculative finance has become so enormous as to be unmanageable. When this massive pool embraces risk things can quickly get out of hand (how about $150 crude?). But when this pool inevitably turns risk averse, illiquidity and market disruption once again become immediate problems. And it all hinges on the perception of the efficacy of policymaking and the moneyness of sovereign debt – and, in the end, the sustainability of the massive issuance of non-productive government Credit. The analysis of Bubbles and Bubble dynamics is integral to a Contemporary Theory of Money and Credit.
This afternoon, former Bundesbank Vice President and ECB Executive Board member Juergen Stark warned that public finances in advanced economies were in “dire straits” and that fiscal deficits were “unsustainable.” He was also critical of the ECB bond purchase program, warning that “intervention in the sovereign bond markets postponed adjustment requirements.” I’m with Mr. Stark on this – and I’m with the German economic viewpoint more generally. Indeed, my analytical framework draws heavily from the “Austrian”/German perspective of the overriding importance of stable money and Credit. The Germans well appreciate the danger of monetary inflation, flawed policymaking doctrine, economic maladjustment and Bubbles. And most American economists believe the Germans remain hopelessly fixated on the Weimar hyperinflation experience. I fear our economic community remains hopelessly fixated on flawed economics.
For the Week:
The S&P500 added 0.3% (up 8.6% y-t-d), and the Dow increased 0.3% (up 6.3%). The broader market was resilient. The S&P 400 Mid-Caps added 0.1% (up 12.1%), while the small cap Russell 2000 dipped 0.2% (up 11.6%). The Morgan Stanley Cyclicals gave up 0.4% (up 15.7%), and the Transports dropped 1.9% (up 2.4%). The Morgan Stanley Consumer index declined 1.2% (up 2.9%), while the Utilities added 0.1% (down 3.2%). The Banks were down 2.0% (up 13.5%), while the Broker/Dealers were up 1.8% (up 20.1%). The Nasdaq100 added 0.8% (up 14.3%), and the Morgan Stanley High Tech index gained 0.8% (up 17.6%). The Semiconductors fell 1.9% (up 16.3%). The InteractiveWeek Internet index slipped 0.4% (up 11.7%). The Biotechs declined 0.6% (up 23.6%). Although bullion was little changed, the HUI gold index jumped 4.1% (up 8.7%).
One-month Treasury bill rates ended the week at 7 bps and three-month bills closed at 9 bps. Two-year government yields were little changed at 0.29%. Five-year T-note yields ended the week up a basis point to 0.85%. Ten-year yields declined 3 bps to 1.97%. Long bond yields ended down 5 bps to 3.06%. Benchmark Fannie MBS yields dipped 3 bps to 2.84%. The spread between 10-year Treasury yields and benchmark MBS yields was little changed at 87 bps. The implied yield on December 2012 eurodollar futures rose 4 bps to 0.61%. The two-year dollar swap spread increased 2.5 to 31 bps. The 10-year dollar swap spread increased 2.5 to 10.5 bps. Corporate bond spreads narrowed. An index of investment grade bond risk declined 3 to 96 bps. An index of junk bond risk fell 24 bps to 547 bps.
Debt issuance picked up. Investment grade issuers included American Honda $1.75bn, John Deere $1.5bn, Citigroup $1.25bn, Reliance Holdings $1.5bn, Cargill $1.0bn, Viacom $750 million, Alexandria Real Estate $550 million, Marriott International $400 million, Ryder System $350 million, and CSX $300 million.
Junk bond funds saw inflows decline to $837 million (from Lipper). Junk issuers included United Rentals $2.8bn, Ball Corp $750 million, Goodyear Tire $700 million, Range Resources $600 million, and Viasat $275 million.
I saw no convertible issuance this week.
International dollar bond issuers included BHP Billiton $5.25bn, Arcelormittal $3.0bn, DBS Bank $1.0bn, Banco Bradesco $1.0bn, Buenos Aires $415 million, and Methanex $250 million.
Ten-year Portuguese yields jumped 60 bps to 12.41.% (down 36bps y-t-d). Italian 10-yr yields ended the week down 9 bps to 5.47% (down 156bps). Spain's 10-year yields fell 20 bps to 5.03% (up one basis point). German bund yields declined 4 bps to 1.88% (up 6bps), and French yields declined 5 bps to 2.95% (down 19bps). The French to German 10-year bond spread narrowed one basis point to 107bps. Greek two-year yields ended the week up 1,050 bps to 199% (up 7,347bps). Greek 10-year yields slipped 3 bps to 32.07% (up 75bps). U.K. 10-year gilt yields fell 12 bps to 2.07% (up 9bps). Irish yields declined 3 bps to 6.82% (down 144bps).
The German DAX equities index added 0.2% (up 16.4% y-t-d). Japanese 10-year "JGB" yields rose 3 bps to 0.97% (down a basis point). Japan's Nikkei jumped 2.8% (up 14.1%). Emerging markets were mixed. For the week, Brazil's Bovespa equities index slipped 0.4% (up 16.2%), while Mexico's Bolsa added 0.1% (up 2.3%). South Korea's Kospi index slipped 0.2% (up 10.6%). India’s Sensex equities index fell 2.0% (up 16%). China’s Shanghai Exchange jumped 3.5% (up 10.9%). Brazil’s benchmark dollar bond yields fell 4 bps to 3.19%, while Mexico's dollar bond yields were little changed at 3.54%.
Freddie Mac 30-year fixed mortgage rates were up 7 bps to 3.95% (down 100bps y-o-y). Fifteen-year fixed rates increased 3 bps to 3.19% (down 103bps). One-year ARMs were down 9 bps to 2.73% (down 67bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up 10 bps to 4.72% (down 83bps).
Federal Reserve Credit declined $0.7bn to $2.917 TN. Fed Credit was up $412bn from a year ago, or 16.4%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 2/22) jumped $14.4bn to $3.462 TN (3-wk gain of $52bn). "Custody holdings" were up $73.3bn year-over-year, or 2.2%.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $943bn y-o-y, or 10.1% to $10.253 TN. Over two years, reserves were $2.437 TN higher, for 31% growth.
M2 (narrow) "money" supply surged $27.8bn to a record $9.80 TN. "Narrow money" has expanded 12.6% annualized year-to-date and was up 10.1% from a year ago. For the week, Currency increased $4.1bn. Demand and Checkable Deposits slipped $0.4bn, while Savings Deposits surged $29.5bn. Small Denominated Deposits declined $2.8bn. Retail Money Funds dipped $2.3bn.
Total Money Fund assets rose $6.0bn to $2.665 TN. Money Fund assets were down $30bn y-t-d and $85bn over the past year, or 3.1%.
Total Commercial Paper outstanding dropped $24.5bn to $937.6bn. CP was down $109bn from one year ago, or down 10.4%.
Global Credit Watch:
February 23 – Bloomberg (Sandrine Rastello): “The International Monetary Fund will seek to keep its exposure to Greece under a new bailout package at 30 billion euros ($39.8bn), including money still owed from a previous loan, an IMF official said. IMF Managing Director Christine Lagarde has indicated that the fund’s credit to Greece after the second loan will remain at the maximum available under a 30 billion-euro loan agreed in 2010, said the official, who spoke… on condition of anonymity. About 10 billion euros of the first loan hasn’t been disbursed, the official said.”
February 21 – New York Times (Peter Eavis): “Greece's debt restructuring is dragging credit-default swaps back into the spotlight. The last time this financial instrument was on the global stage was in 2008, when the American International Group’s credit-default swaps brought the insurer, as well as the wider financial system, to the brink of collapse. A.I.G. had unique weaknesses, and regulators have started to overhaul the credit-default swap market since 2008. European policy makers have nonetheless looked warily at credit-default swaps, at least until recently, while they structured the Greek rescue over the last six months. They aimed for a voluntary debt exchange that would not initiate the default swaps, fearing that payments on the swaps might set off destabilizing chain reactions through Europe's financial system. But now, with Europe's $172 billion aid package for Greece, it appears that the nation is going to take a step that substantially increases the likelihood that its swaps take effect.”
February 21 – Bloomberg (Marcus Bensasson): “Greece’s economy will contract 4.3% this year and stall next year before returning to growth in 2014 under assumptions used to calculate the country’s debt sustainability before of an agreement on a second bailout. The nation’s debt will peak at 168% of gross domestic product in 2013 and decline to 129% in 2020, according to a base scenario… from the troika…”
February 20 – Bloomberg (Angeline Benoit): “Spain’s debt load is set to double from where it was when Europe’s sovereign debt crisis began, eroding the economic advantages that distinguished it from the region’s periphery and helped shield it from Greek contagion… Spain went into the crisis with public debt of 40% of its gross domestic product, compared with an average ratio of 70% in the euro region. The European Union forecasts its debt will have almost doubled by next year, as Moody’s… says Spain is losing one of its ‘key relative credit strengths.’”
February 23 – Bloomberg (Angeline Benoit): “Spanish residential mortgages decreased for a 20th month in December as the euro area’s fourth-largest economy contracted and banks reined in lending amid a surge in bad loans. The number of home loans fell 37.2% from a year earlier after a 35.8% drop in November... The total amount lent on all mortgages fell 37.4%...”
Global Bubble Watch:
February 20 – Bloomberg (Keiko Ujikane): “Standard and Poor’s affirmed Japan’s sovereign-debt rating at AA-while maintaining a negative outlook and warning that a downgrade is likely if medium-term growth prospects weaken. The ranking is ‘supported by the country’s ample net external asset position, relatively strong financial system, and diversified economy,’ S&P said… It cited the yen’s role as a ‘key international reserve currency.’”
February 20 – Bloomberg (Svenja O’Donnell): “Asking prices for London homes rose to close to a record in February, helping push national values up the most in almost a decade, Rightmove Plc said. Average asking prices in the U.K. capital rose 2.5% from January to 449,252 pounds ($710,300), less than 1,000 pounds below the record reached in October…”
The dollar index declined 1.2% this week (down 2.2% y-t-d). On the upside, the Swiss franc increased 2.7%, the Swedish krona 2.6%, the Norwegian krone 2.5%, the euro 2.3%, the South African rand 1.9%, the New Zealand dollar 0.4%, the British pound 0.3%, the Singapore dollar 0.3%, and the Brazilian real 0.2%. On the downside, the Japanese yen declined 2.0%, the Mexican peso 1.1%, the Canadian dollar 0.3%, the Australian dollar 0.1% and the Taiwanese dollar 0.1%.
February 20 – Bloomberg (Chanyaporn Chanjaroen and Nicholas Larkin): “Malca-Amit Global Ltd., a Hong Kong- based company that stores and transports precious metals and diamonds, plans to open a vault in Beijing and is doubling space in Singapore as rising demand spurs gold’s 12th year of gains.”
The CRB index jumped 2.7% this week (up 6.8% y-t-d). The Goldman Sachs Commodities Index surged 3.9% (up 10.9%). Spot Gold was little changed at $1,722 (up 10.2%). Silver surged 6.0% to $35.42 (up 27%). April Crude jumped $6.17 to $109.77 (up 11%). March Gasoline rose 4.5% (up 19%), while March Natural Gas dropped 5.0% (down 15%). March Copper gained 4.1% (up 13%). March Wheat slipped 0.5% (down 2%), and March Corn declined 0.2% (down 1%).
February 20 – Bloomberg: “China’s January home prices recorded their worst performance in at least a year, with none of the 70 cities monitored by the government posting gains as Premier Wen Jiabao reiterated his determination to maintain property curbs. Prices in 47 of the cities fell, while home values in the remaining 23 were unchanged from December…”
February 20 – Bloomberg: “Lamborghini SpA, maker of the $1 million Aventador LP 700-4, said industry sales of ultra-luxury sports cars may slow as signs that China’s economy is weakening puts off some buyers. ‘If you look at the economy right now, there may be some uncertainty to make people wait a little,’ Christian Mastro, Lamborghini’s Asia Pacific general manager, said… ‘The number of people able to spend this kind of money is limited, it’s not unlimited.’”
February 20 – Bloomberg (Sophie Leung): “Hong Kong’s inflation accelerated to 6.1%, the fastest pace in six months, in January… The increase in the consumer price index from a year earlier compared with 5.7% in December…”
February 20 – Bloomberg (Andy Sharp): “Japan posted a record trade deficit in January as the yen’s strength and weaker global demand eroded manufacturers’ profits and slowed the nation’s recovery from last year’s earthquake and tsunami. The gap widened to 1.48 trillion yen ($19bn) and shipments dropped 9.3% from a year earlier as energy imports surged…”
February 24 – Bloomberg (Shigeru Sato, Takako Taniguchi and Mariko Ishikawa): “Japan’s lenders are missing out on a global rally in bank bonds as the central bank warns that their near record holdings of government debt put them at risk of writedowns… A 1 percentage-point increase in benchmark yields would cause a loss of 3.5 trillion yen ($44bn) on Japanese government bonds, or JGBs, held by the nation’s major banks, BOJ Governor Masaaki Shirakawa said…”
Asia Bubble Watch:
February 23 – Bloomberg (Katrina Nicholas): “The region’s biggest lenders say property deals and refinancing will buoy Asia-Pacific syndicated loans in 2012 after the slowest start in eight years… Syndicated lending dropped to $12.8 billion this year, down 71% from the same period last year, making it the worst start since 2004… Companies outside of Japan have as much as $47.9 billion of bank debt to refinance this year and an additional $210 billion before 2016, data on 1,531 loans tracked by Bloomberg show.”
Latin America Watch:
February 23 – Bloomberg (Matthew Bristow): “Brazil’s current account deficit in January was the widest on record after the real appreciated the most of any major currency this year. The deficit in the current account… rose to $7.1 billion from $6 billion in December…”
Unbalanced Global Economy Watch:
February 22 – Bloomberg (Fergal O’Brien): “European services and manufacturing output unexpectedly shrank in February as the euro-area economy struggled to rebound from a contraction in the fourth quarter. A euro-area composite index based on a survey of purchasing managers in both industries dropped to 49.7 from 50.4 in January…”
February 22 – Bloomberg (Johan Carlstrom): “Swedish unemployment rose more than estimated last month as growth slows in the largest Nordic economy… The… unemployment rate… rose to 8% from 7.1% in December…”
February 20 – Bloomberg (Kati Pohjanpalo): “Finnish inflation accelerated in January from the lowest level in a year as taxes on alcohol and fuels increased. Consumer price inflation… accelerated to an annual 3.2% last month, compared with 2.9% in December…”
February 23 – Bloomberg (Alison Vekshin): “After a man with a laptop walked into Best PC Value computer repair in Stockton, California, owner Richard La Frentz telephoned the police. Hours before, the same man had been recorded by a security camera hopping a locked gate behind the store and stealing the computer. The police didn’t come. They told La Frentz to call his insurance company, he said. ‘It is the Wild West out here,’ said La Frentz… who keeps two handguns at his store in Stockton’s Miracle Mile shopping district. ‘When I call the police department, I don’t get help. The city can’t help me because of the condition that it’s in.’ Stockton, an agricultural center of about 292,000, is fighting to avert bankruptcy by shrinking its payroll, including a quarter of the roughly 425-member police force.”
February 24 – Bloomberg (Alison Vekshin and Michael B. Marois): “Stockton, California, may take the first steps toward becoming the most populous U.S. city to file for bankruptcy next week, according to a revised City Council agenda… Local officials will consider whether to begin a type of mediation that allows creditors to participate, the first move toward a Chapter 9 bankruptcy filing under a new state law…”
Wall Street’s 2010 results were disappointing and the howls of banker anguish over shrunken bonuses have reverberated through the better Manhattan restaurants, bars and clubs. The rise in financial services’ share of the economy, seemingly so inexorable, has at least paused. Is this merely a blip, or is it the beginning of a reversal, in which financial services returns to its historically modest position in our economic life, and other forms of wealth creation take its place?
The increasing share of financial services in GDP has been inexorable since World War II. Taking the “finance and insurance” sector of the national accounts as a benchmark, its share of GDP rose from 2.4% of GDP in 1947 (the first year available) to a local peak of 4.3% of GDP in 1972. Then it was flat for a few years, surged during the 1980s to 6.0% of GDP in 1987 and surged again in the 1990s to a peak of 8.2% in 2001. That later peak was not surpassed during the housing finance boom of the mid-2000s, surprisingly, but was finally topped in 2010, in which the sector represented 8.5% of GDP. Thus the surge in financial services activity is consistent and long-term, nearly quadrupling as a share of GDP over the last 63 years.
At first sight, that makes it appear as though financial services’ growth is an inexorable feature of a modern economy. However if you go back further, recognizing that GDP figures before 1947 are not very accurate (the concept was only invented in 1934) you will see a further surge in financial services, from a low of about 1.5% of GDP in 1880 to a peak around 6% of GDP in 1929 – followed by a catastrophic drop during the Depression and World War II.
The 1930s decline in financial services income is not surprising. Stock brokerage and investment management, which had been becoming major businesses by 1929, were decimated by the downturn. The Glass-Steagall Act, separating commercial from investment banking, may have been useful safety legislation, but it resulted in the de-capitalization of brokerage and underwriting businesses, leading to a dearth in public debt and stock issues in the late 1930s such as had not been seen since before the Civil War. Home mortgage lending, conducted in the 1920s without government guarantees, but on unsound principles of 10-year maturities and inadequate amortization, was equally decimated by the decline in house prices. Deposit banking was badly damaged by the disappearance of one third of U.S. banks in 1932-33.
Only insurance remained a stable and reliable financial services product, and seems likely to have maintained its share of GDP, more or less. However the decline in other financial services was not just a product of poor markets (thought it was to an extent a cause of them) but represented a reorientation of the U.S. economy away from finance – egged on by populist politicians who found it easier to blame the Great Depression on finance rather than on their own errors.
It has to be said therefore that Barack Obama has so far failed where FDR succeeded, in that finance has not yet declined as a share of U.S. GDP. That may however be about to change. (Incidentally, the massive Wall Street contributions to Obama’s 2008 campaign surely represent in its purest form the adage, supposedly coined by Lenin, that capitalists will sell you the rope with which to hang them!)
Once the current period of artificially low interest rates ends, its stimulus to asset prices and leverage will also end. At that point, many of the products and services that have pushed up finance’s salience will become unprofitable.
One such product that has already declined from its peak is securitization. In its initial incarnation, securitization seemed a useful way to remove excess home mortgage assets from bank balance sheets and transfer them to investors who would welcome this new low-risk asset class. The business was greatly facilitated by the availability of quasi- government guarantees from Fannie Mae and Freddie Mac. However after the subprime debacle it became clear that securitization could be used by unscrupulous operators to originate mortgage loans that should never have been made.
Today, much of the demand for securitized products comes from mortgage REITs, leveraged up the eyeballs and gambling on the spread between short-term and long-term rates. Once that spread disappears, there will be a gigantic glut of this paper on the market as the mortgage REIT losses wipe out their capital bases. The home mortgage market will be disrupted, and will operate only at considerably higher interest rates in relation to Treasuries. Finance’s intermediation profits will be correspondingly diminished, or wiped out altogether. Fannie Mae and Freddie Mac will report losses so large that they may prompt even a spineless Congress to put those useless behemoths out of business.
The derivatives sector is largely responsible for the financial services growth of the last three decades. One of the changes that have boosted derivatives’ salience has been the practice by industrial companies to treat their finance departments as profit centers, thereby encouraging speculative game playing by finance staff claiming to “hedge” exposures. As innumerable investors can attest, the principal effect of such hedging is to make financial statements completely impenetrable, so that hedged oil companies, for example declare huge profits when prices fall, the reverse of their economic reality. A little shareholder pressure and reformed corporate governance should eliminate much of this activity.
While it seems likely that interest rate swaps, currency swaps and their associated options will remain a modest part of the financier’s toolkit, the same cannot be said of their eldritch cousin credit default swaps. The principles of the Life Assurance Act of 1774, which forbade taking out policies on unrelated lives and then arranging accidents, must be applied to this market, so that counterparties cannot take large naked short positions on credit. The legal and payment uncertainties surrounding these instruments in any case make them almost pure gambling contracts. There will doubtless be another financial crash shortly, in which CDS are heavily implicated; it is to be hoped that regulators don’t neglect this area after the next crash as they did after the last one.
Fast trading, whereby institutions position their machines at the stock exchange in order to get earlier information of trading flows, on the basis of which they trade, is pure rent-seeking and a form of insider trading. The various Tobin tax proposals being mooted, while they may do other damage, should at least cut off this illicit source of financial services revenue.
Hedge funds and private equity funds have been major beneficiaries of loose money, attracting institutional capital by promising superior investment returns unlinked to the conventional equity market. It should already be clear, and is becoming increasingly so to the dumbest state pension fund and even to the Harvard endowment, that both these claims are untrue. In the long run, the returns of hedge funds and private equity funds are not superior, especially net of their excessive fees. Second, those returns are highly correlated to the stock market, since they depend crucially on the readily available and excessively cheap money on which all bubbles are built.
Finally, in Europe especially, financial services companies have sought to be universal dumpsters for government debt. While the pre-2008 belief that government debt was risk-free was nonsense, in general financial services entities (unlike some unleveraged global manufacturing companies) are not better credit risks than the governments under which they operate. Hence it makes no sense for them to hold government debt, other than as part of their underwriting function. They have been encouraged to do so by the spuriously steep yield curves of recent years, which have encouraged them to invest in long-term paper, while funding it in the short-term market. Like the unfortunate First Pennsylvania Bank in 1980, some of them will pay the ultimate price for this folly, while others will merely suffer large losses and be forced to sell off operations and fire staff in order to survive.
However, the principal factor cutting back financial services’ share of the economy is the tsunami of regulation that has been and is being imposed on the industry as a result of the 2008 crash. This also happened in the 1930s: the SEC and the Glass-Steagall Act deflated financial services inordinately, doing great economic damage thereby. It is now clear that the damage from Dodd-Frank’s 848 pages arises not from the Act itself, which was fairly anodyne and missed many of the better legitimate targets among the industry’s bad practices, but the regulations it encouraged, which contain a large multiple of the complexities of the Act itself. Much of the financial services industry will be engaged in battling those regulators every inch of the way, while other parts of its business will be severely hampered by the rules they produce.
There are thus three factors cutting back financial services’ share of the economy. First, there is a natural reaction against the excesses of recent decades, in which some of their more egregious business practices will no longer work and will be abandoned. Second, an end to the current excessively loose monetary policy will result in a dampening of speculation and a reduction (much of it the hard way, through bankruptcy) in systemic leverage. Finally, the surge of regulation through Dodd-Frank and the equivalent EU regulations will itself dampen activity in the sector, forbidding some practices and making others uneconomic. Just as deregulation from the 1970s encouraged the growth of the financial services sector so new regulations, imposed ineptly, will cut it back as they did in the 1930s.
The financial services sector may not fall back to the 2.4% of GDP it represented in 1947, but it could easily fall back to the 4% or so of GDP it represented in the 1970s, about half the current size in terms of the overall economy. The moral is thus clear: don’t put too much money in bank stocks, and above all, don’t waste the lives of your intelligent offspring by encouraging them to enter this currently overblown sector, prone to parasitism in bull markets.
(Originally appeared in The Bear's Lair.)
Martin Hutchinson is the author of "Great Conservatives" (Academica Press, 2005)—details can be found on the Web site —and co-author with Professor Kevin Dowd of “Alchemists of Loss” (Wiley – 2010). Both now available on Amazon.com, “Great Conservatives” only in a Kindle edition, “Alchemists of Loss” in both Kindle and print editions.