Tag Archives: Financial Times

Helicopter Ben Now In Holding Pattern, Neutral In Tone

The Fed, with Ben Bernanke’s speech:

The annual meeting at Jackson Hole always provides a valuable opportunity to reflect on the economic and financial developments of the preceding year, and recently we have had a great deal on which to reflect. A year ago, in my remarks to this conference, I reviewed the response of the global policy community to the financial crisis.1 On the whole, when the eruption of the Panic of 2008 threatened the very foundations of the global economy, the world rose to the challenge, with a remarkable degree of international cooperation, despite very difficult conditions and compressed time frames. And when last we gathered here, there were strong indications that the sharp contraction of the global economy of late 2008 and early 2009 had ended. Most economies were growing again, and international trade was once again expanding.

Notwithstanding some important steps forward, however, as we return once again to Jackson Hole I think we would all agree that, for much of the world, the task of economic recovery and repair remains far from complete. In many countries, including the United States and most other advanced industrial nations, growth during the past year has been too slow and joblessness remains too high. Financial conditions are generally much improved, but bank credit remains tight; moreover, much of the work of implementing financial reform lies ahead of us. Managing fiscal deficits and debt is a daunting challenge for many countries, and imbalances in global trade and current accounts remain a persistent problem.

This list of concerns makes clear that a return to strong and stable economic growth will require appropriate and effective responses from economic policymakers across a wide spectrum, as well as from leaders in the private sector. Central bankers alone cannot solve the world’s economic problems. That said, monetary policy continues to play a prominent role in promoting the economic recovery and will be the focus of my remarks today. I will begin with an update on the economic outlook in the United States and then review the measures that the Federal Open Market Committee (FOMC) has taken to support the economic recovery and maintain price stability. I will conclude by discussing and evaluating some policy options that the FOMC has at its disposal, should further action become necessary.

The Economic Outlook
As I noted at the outset, when we last gathered here, the deep economic contraction had ended, and we were seeing broad stabilization in global economic activity and the beginnings of a recovery. Concerted government efforts to restore confidence in the financial system, including the aggressive provision of liquidity by central banks, were essential in achieving that outcome. Monetary policies in many countries had been eased aggressively. Fiscal policy–including stimulus packages, expansions of the social safety net, and the countercyclical spending and tax policies known collectively as automatic stabilizers–also helped to arrest the global decline. Once demand began to stabilize, firms gained sufficient confidence to increase production and slow the rapid liquidation of inventories that they had begun during the contraction. Expansionary fiscal policies and a powerful inventory cycle, helped by a recovery in international trade and improved financial conditions, fueled a significant pickup in growth.

At best, though, fiscal impetus and the inventory cycle can drive recovery only temporarily. For a sustained expansion to take hold, growth in private final demand–notably, consumer spending and business fixed investment–must ultimately take the lead. On the whole, in the United States, that critical handoff appears to be under way.

However, although private final demand, output, and employment have indeed been growing for more than a year, the pace of that growth recently appears somewhat less vigorous than we expected. Notably, since stabilizing in mid-2009, real household spending in the United States has grown in the range of 1 to 2 percent at annual rates, a relatively modest pace. Households’ caution is understandable. Importantly, the painfully slow recovery in the labor market has restrained growth in labor income, raised uncertainty about job security and prospects, and damped confidence. Also, although consumer credit shows some signs of thawing, responses to our Senior Loan Officer Opinion Survey on Bank Lending Practices suggest that lending standards to households generally remain tight.2

The prospects for household spending depend to a significant extent on how the jobs situation evolves. But the pace of spending will also depend on the progress that households make in repairing their financial positions. Among the most notable results to emerge from the recent revision of the U.S. national income data is that, in recent quarters, household saving has been higher than we thought–averaging near 6 percent of disposable income rather than 4 percent, as the earlier data showed.3 On the one hand, this finding suggests that households, collectively, are even more cautious about the economic outlook and their own prospects than we previously believed. But on the other hand, the upward revision to the saving rate also implies greater progress in the repair of household balance sheets. Stronger balance sheets should in turn allow households to increase their spending more rapidly as credit conditions ease and the overall economy improves.

Household finances and attitudes also bear heavily on the housing market, which has generally remained depressed. In particular, home sales dropped sharply following the recent expiration of the homebuyers’ tax credit. Going forward, improved affordability–the result of lower house prices and record-low mortgage rates–should boost the demand for housing. However, the overhang of foreclosed-upon and vacant housing and the difficulties of many households in obtaining mortgage financing are likely to continue to weigh on the pace of residential investment for some time yet.

In the business sector, real investment in equipment and software rose at an annual rate of more than 20 percent over the first half of the year. Some of these gains no doubt reflected spending that had been deferred during the crisis, including investments to replace or update existing equipment. Consequently, investment in equipment and software will almost certainly increase more slowly over the remainder of this year, though it should continue to advance at a solid pace. In contrast, outside of a few areas such as drilling and mining, business investment in structures has continued to contract, although the rate of contraction appears to be slowing.

Although most firms faced problems obtaining credit during the depths of the crisis, over the past year or so a divide has opened between large firms that are able to tap public securities markets and small firms that largely depend on banks. Generally speaking, large firms in good financial condition can obtain credit easily and on favorable terms; moreover, many large firms are holding exceptionally large amounts of cash on their balance sheets. For these firms, willingness to expand–and, in particular, to add permanent employees–depends primarily on expected increases in demand for their products, not on financing costs. Bank-dependent smaller firms, by contrast, have faced significantly greater problems obtaining credit, according to surveys and anecdotes. The Federal Reserve, together with other regulators, has been engaged in significant efforts to improve the credit environment for small businesses. For example, through the provision of specific guidance and extensive examiner training, we are working to help banks strike a good balance between appropriate prudence and reasonable willingness to make loans to creditworthy borrowers. We have also engaged in extensive outreach efforts to banks and small businesses. There is some hopeful news on this front: For the most part, bank lending terms and conditions appear to be stabilizing and are even beginning to ease in some cases, and banks reportedly have become more proactive in seeking out creditworthy borrowers.

Incoming data on the labor market have remained disappointing. Private-sector employment has grown only sluggishly, the small decline in the unemployment rate is attributable more to reduced labor force participation than to job creation, and initial claims for unemployment insurance remain high. Firms are reluctant to add permanent employees, citing slow growth of sales and elevated economic and regulatory uncertainty. In lieu of adding permanent workers, some firms have increased labor input by increasing workweeks, offering full-time work to part-time workers, and making extensive use of temporary workers.

Pete Davis:

After a detailed review of recent subpar U.S. economic performance, he discussed the pros and cons of more quantitative easing.   Rarely have other Fed chairs offered such insight into their thinking, but, based upon his extensive study of the Depression, Mr. Bernanke strongly believes that Fed transparency is essential to reviving markets.   So the Federal Open Market Committee stands ready to provide more quantitative easing at its September 21 meeting, if not before, if the economy continues to falter.   We are fortunate to have Mr. Bernanke’s leadership in this crisis.

Gavyn Davies at Financial Times:

The much awaited speech by Ben Bernanke at Jackson Hole was largely a holding operation. He did not deviate much, if at all, from the tone of the statement issued after the August meeting of the FOMC, which is understandable given that his policy committee contains several members who do not want the Fed chairman to offer any strong hints about further policy easing at this stage. More evidence of a weakening US economy, and much more discussion within the committee, will be needed before this can happen.

Mr Bernanke’s description of the current and future prospects for the economy was a little more up-beat than the current consensus of opinion among market economists, and more optimistic than my own assessment. Picking over the details of what he said, he suggested that GDP growth would be moderate in the remainder of 2010, and would rise next year, with unemployment and capacity utilisation falling slightly in 2011. This implies that he expects GDP growth in 2011 to be somewhere around 2.5 per cent, just fractionally above the long term trend; and that in turn might imply a growth rate of around 1.5 to 2 per cent in the second half of 2010. This would be roughly the same as the GDP growth rate in Q2, which has just been revised downwards to 1.6 per cent.

Importantly, there was no hint that the Fed expects a double dip in the economy, and there was an explicit statement to the effect that the risks of falling into deflation are very low. However, the chairman said that the inflation rate was already a little below the rate which the Fed considers optimal, and he gave a fairly clear commitment that the FOMC would “certainly use its tools as needed to maintain price stability – avoiding excessive inflation or further disinflation.” The last two words might be read as slightly dovish, since he clearly wants to avoid any further drop in core inflation from its current 1 per cent rate, and therefore will not wait until there is a serious threat of outright deflation (falling prices) before taking further action.

Clive Crook:

I would have been astonished if he had outright promised more QE or other steps: this was not the occasion. Even so, the neutral tone was a bit more neutral — a bit less friendly to renewed action — than I had expected. He said that the current risk of falling into deflation is not “significant”, partly because the public trusts him and the Fed to get it right. That seems just a little complacent. Of course, he says he is attentive and ready to change his mind, but still…

Justin Fox at Ezra Klein’s place:

The Fed chairman’s basic message was the same thing he’s been saying for more than a year: There are downside risks, but we have the tools to combat them. And we know that at some point we’ll have vacuum up most of this money we’ve printed. But that point is still far (recedingly far) in the distance.

One passage of the speech that did get my attention was this, as Bernanke explained the Federal Open Market Committee’s recent decision to reinvest the proceeds of maturing mortgage securities (they’re maturing faster than expected because so many people have been refinancing their mortgages to take advantage of ultra-low rates):

We decided to reinvest in Treasury securities rather than agency securities because the Federal Reserve already owns a very large share of available agency securities, suggesting that reinvestment in Treasury securities might be more effective in reducing longer-term interest rates and improving financial conditions with less chance of adverse effects on market functioning.

In other words, we already own everybody’s mortgages, so no point in buying more. Our nation’s mortgage-finance industry is for the time being a wholly owned subsidiary of the Federal Reserve System. Now that’s what I call really existing socialism.

Paul Krugman:

Bernanke more or less admitted that the economic situation has developed not necessarily to America’s advantage, nothing like the growth he was predicting six months ago. But he argued that 2011 will be better, because … well, it was hard to see exactly why. He offered no major drivers of growth, just a general argument that businesses will invest more despite huge excess capacity, and consumers spend more despite still-huge debts and home prices that are likely to resume their decline.

Oh, and sure enough, he declared that inflation expectations are well-anchored, although the market says otherwise.

So: I guess this speech marked a small step toward QE2 and all that. But mainly the message was that just around the corner, there’s a rainbow in the sky.

So I’m going to have another cup of coffee, but skip the pie (in the sky).

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Mighty, Mighty Voodoo

Martin Wolf at Financial Times:

To understand modern Republican thinking on fiscal policy, we need to go back to perhaps the most politically brilliant (albeit economically unconvincing) idea in the history of fiscal policy: “supply-side economics”. Supply-side economics liberated conservatives from any need to insist on fiscal rectitude and balanced budgets. Supply-side economics said that one could cut taxes and balance budgets, because incentive effects would generate new activity and so higher revenue.

The political genius of this idea is evident. Supply-side economics transformed Republicans from a minority party into a majority party. It allowed them to promise lower taxes, lower deficits and, in effect, unchanged spending. Why should people not like this combination? Who does not like a free lunch?

How did supply-side economics bring these benefits? First, it allowed conservatives to ignore deficits. They could argue that, whatever the impact of the tax cuts in the short run, they would bring the budget back into balance, in the longer run. Second, the theory gave an economic justification – the argument from incentives – for lowering taxes on politically important supporters. Finally, if deficits did not, in fact, disappear, conservatives could fall back on the “starve the beast” theory: deficits would create a fiscal crisis that would force the government to cut spending and even destroy the hated welfare state.

In this way, the Republicans were transformed from a balanced-budget party to a tax-cutting party. This innovative stance proved highly politically effective, consistently putting the Democrats at a political disadvantage. It also made the Republicans de facto Keynesians in a de facto Keynesian nation. Whatever the rhetoric, I have long considered the US the advanced world’s most Keynesian nation – the one in which government (including the Federal Reserve) is most expected to generate healthy demand at all times, largely because jobs are, in the US, the only safety net for those of working age.

True, the theory that cuts would pay for themselves has proved altogether wrong. That this might well be the case was evident: cutting tax rates from, say, 30 per cent to zero would unambiguously reduce revenue to zero. This is not to argue there were no incentive effects. But they were not large enough to offset the fiscal impact of the cuts (see, on this, Wikipedia and a nice chart from Paul Krugman).

Indeed, Greg Mankiw, no less, chairman of the Council of Economic Advisers under George W. Bush, has responded to the view that broad-based tax cuts would pay for themselves, as follows: “I did not find such a claim credible, based on the available evidence. I never have, and I still don’t.” Indeed, he has referred to those who believe this as “charlatans and cranks”. Those are his words, not mine, though I agree. They apply, in force, to contemporary Republicans, alas,

Kevin Drum:

You should read the whole post. It’s mostly a recap of the past 30 years of Republican economic nihilism, but it’s a very clear, crisp recap. Wolf’s conclusion is sobering:

This is extraordinarily dangerous. The danger does not arise from the fiscal deficits of today, but the attitudes to fiscal policy, over the long run, of one of the two main parties. Those radical conservatives (a small minority, I hope) who want to destroy the credit of the US federal government may succeed. If so, that would be the end of the US era of global dominance. The destruction of fiscal credibility could be the outcome of the policies of the party that considers itself the most patriotic.

Our best hope, I think, is that Republicans nominate a Palin/Ryan ticket in 2012 and then go down to such an epic defeat that they finally get some sense knocked into them. On the other hand, the last time that happened we got Richard Nixon out of the deal. So maybe we’re just doomed no matter what.

Brad DeLong:

Like Paul Krugman, Martin Wolf is (almost) always right. And as in the case of Paul Krugman, given that Martin Wolf is (almost) always right I really really really wish he would be a little more optimistic. Perhaps if he drank more expensive wines at dinner?

Here Martin makes the case that America’s future depends on the rapid destruction of the Republican Party and its replacement by an alternative opposition party to the Democrats

Paul Krugman:

Wolf’s argument and main points are similar to those I made in a recent column; that’s not a criticism, because we need more people saying this.

Martin ends on a deeply pessimistic note. I wish I could disagree.

Doug J.:

I’m not sure that I agree that supply-side economics was the dominant factor in transforming Republicans from a minority party into a majority party; I don’t think the Republicans have been a majority party for many of the past 30 years and, to the extent that they have been, regional realignment based on opposition to civil rights has been the most important factor, IMHO.

That said, the supply side myth is, truly, economic crack cocaine that has the potential to bring about something as cataclysmic as a US government default—something many conservatives say they would welcome. The only thing that is likely to stop it is a demographic trend that may marginalize the Republican party.

Henry Farrell:

Martin Wolf in the FT today

Whatever the rhetoric, I have long considered the US the advanced world’s most Keynesian nation – the one in which government (including the Federal Reserve) is most expected to generate healthy demand at all times, largely because jobs are, in the US, the only safety net for those of working age.

I’m not sure I agree (or more precisely: your level of agreement with this statement will depend on exactly how you want to define Keynesianism) – but it’s worth pointing out that this is at the least quite consonant with Tyler Cowen’s arguments about Germany. On the one hand, this intellectual convergence could be taken as suggesting that Tyler’s case suggests that German-style social democracy works better than US style Keynesianism (an argument which I think Tyler agrees with, at least with respect to Germans). On the other, it could be taken as suggesting that despite Wolf’s frequent minatory statements about the external consequences of the German model, he believes that it works better in relative terms than US-style Keynesianism in providing internal economic security and political stability. Certainly, he is quite skeptical about the prospects of the US economic system given Republicans’ role as a blocking minority and perhaps majority in the near future (his most provocative suggestion is that Republicans are a perverted species of Keynesians).

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An Oily Smorgasbord Of BP-Related Blog Posts

Michael Whitney at Firedoglake:

Early on the Fourth of July, the US government announced it was taking over the main website of the BP oil disaster response, deepwaterhorizonresponse.com. From early on in the disaster, that site has served as a joint venture of BP and various government agencies to post press releases, media advisories, photos, video, and other PR materials about the oil, including a mailing list for media and other interested parties.

Now, the Department of Homeland Security wants to make a “one-stop shop” for the disaster response under a .gov URL. That means shutting down the current site, and taking another look at who has access to post on the site, with government deciding control of the content and message.

So why did DHS allow BP to walk off with the mailing list of everyone who signed up for information about the disaster?

I’ve received emails from the site every day since it went live 10 days after the disaster. Every email has come from some variation of “Joint Information,”  or “Deepwater Horizon Response.” Yet today, less than 24 hours after DHS announced it planned to take over the response website, I get my very first email from “BP America Press Relations,” titled “BP update on Gulf of Mexico spill.” The email from BP was sent to the same address with which I signed up on the original response website.

It seems quite clear that either BP made a copy of the mailing database before it loses access to the site, or the government will continue to give them access to the database. It’s also clear that no matter what, this is in clear violation of the privacy policy of the website, of the US Coast Guard, and of the government itself.

Juliet Eilperin at WaPo:

In recent weeks, the Obama administration has sought to distance itself from BP in handling the Gulf of Mexico oil spill — with one notable exception: When it comes to assessing how badly the spill has harmed the gulf, the two sides are working hand in hand.

Their shared goal? To calculate the incalculable: how much it will cost to restore the gulf to its pre-spill state.

But this close collaboration between federal and state authorities and BP — which is routine procedure under a legal process known as the Natural Resource Damage Assessment (NRDA) — has begun to spark concerns among lawmakers and some environmentalists.

“I want this to be independent, for the credibility of the information,” said Sen. Ben Cardin (D-Md.), who as chair of the Environment and Public Works Subcommittee on Water and Wildlife will hold hearings this month on the issue.

The collaborative approach, established under the 1990 Oil Pollution Act, marks a sharp departure from the 1989 Exxon Valdez spill, where the federal government kept the oil company at arm’s length. Exxon hired its own boats and experts, who followed state and federal officials at a distance, replicating the tests they believed were being done so they could provide a rival analysis

Ed Crooks and Lina Saigol at Financial Times:

Although BP generates a huge amount of cash with oil prices at their present levels, the market is still concerned about its financial strength in the face of rising liabilities.

So it is only natural that BP is looking at a range of options for improving its liquidity.

Its problem is that very few sources of finance are open to it at the moment. Since the failure of its attempt to use a “top kill” – pumping drilling fluid down the well so it can be cemented over – at the end of May, the markets have become alarmed about BP’s financial position.

The shares have hit 14-year lows, its bonds have also fallen sharply, and the price of its credit default swaps – the cost of insuring the company’s debt against default – have soared. Its debt has been downgraded by all the major rating agencies, pushing up the cost of its borrowing.

The UK oil producer is not in a position to make a significant difference to its financial position until its second-quarter results on July 27 at the earliest, when it will give some idea of the total bill it is facing. More crucial to investor confidence is the success of BP’s latest plan to stop the leak – a relief well, which is scheduled for completion in August.

In the near-term, the company is not facing a liquidity crisis. The agreement it reached with the White House in mid-June, which gave it three-and-a-half years to pay into a $20bn (£13.2bn) fund to compensate victims of the spill, has bought BP precious time.

By suspending the dividend for the rest of the year and cutting capital spending, it is freeing about $10bn of cash, and plans another $10bn of disposals during the next 12 months.

However, a rapid escalation of liabilities, or a squeeze on cash flows caused by a fall in the oil price, could still force it to raise new funds.

Jeff Neumann at Gawker:

According to a report in today’s Washington Post, in the current fiscal year, BP has fuel contracts with the US military worth at least $980 million. And the Environmental Protection Agency, before the oil spill, had looked into barring BP from all federal contracts due to its 2006 Alaskan oil spill and the deadly 2005 explosion at one of its refineries in Texas. If successful, the EPA would have cut BP off from signing contracts with the Defense Energy Support Center (DESC), which handles military fuel purchases. From The Washington Post:

Jeanne Pascal, a former EPA lawyer who until recently oversaw the review of BP’s possible debarment, has said she initially supported taking such action but held off after an official at the Defense Department warned her that the Pentagon depended heavily on BP fuel for its operations in the Middle East. “My contact at DESC, another attorney, told me that BP was supplying approximately 80 percent of the fuel being used to move U.S. forces” in the region, Pascal said. She added that “BP was very fortunate in that there is an exception when the U.S. is involved in a military action or a war.”

A Defense Department spokeswoman, Wendy L. Snyder, disputed Pacal’s claims, saying the DESC “informed the EPA that there are adequate procedures and processes to protect the U.S. military missions should EPA determine that BP should be debarred.” The Post talked to BP spokesman Robert Wine, who said he knew of at least one “big contract” agreed to between BP and the Pentagon after the Gulf oil spill, and:

He did not challenge Pascal’s claim that BP’s health, safety and environmental unit had been moved lower on the corporate structure before the gulf spill, reporting to the head of a business unit instead of directly to the top executive. But, Wine said, “what difference does that make?”

“Safety comes through the organization through every root,” he said, and remains “paramount in every part of the business.”

Yeah, why should safety and people’s lives be put in the hands of the person who actually runs the company, when you can pawn that stuff off to some desk jockey? But at least we know the government is living up to all of the big talk, right? We’ll see. On June 2, Attorney General Eric Holder said, “If we find evidence of illegal behavior [by BP], we will be forceful in our response.”

Glenn Greenwald:

Last week, I interviewed Mother Jones‘ Mac McClelland, who has been covering the BP oil spill in the Gulf since the first day it happened.  She detailed how local police and federal officials work with BP to harass, impede, interrogate and even detain journalists who are covering the impact of the spill and the clean-up efforts.  She documented one incident which was particularly chilling of an activist who — after being told by a local police officer to stop filming a BP facility because “BP didn’t want him filming” — was then pulled over after he left by that officer so he could be interrogated by a BP security official.  McClelland also described how BP has virtually bought entire Police Departments which now do its bidding:  “One parish has 57 extra shifts per week that they are devoting entirely to, basically, BP security detail, and BP is paying the sheriff’s office.”

Today, an article that is a joint collaboration between PBS’ Frontline and ProPublica reported that a BP refinery in Texas “spewed tens of thousands of pounds of toxic chemicals into the skies” two weeks before the company’s rig in the Gulf collapsed.   Accompanying that article was this sidebar report:

A photographer taking pictures for these articles, was detained Friday while shooting pictures in Texas City, Texas.

The photographer, Lance Rosenfield, said that shortly after arriving in town, he was confronted by a BP security officer, local police and a man who identified himself as an agent of the Department of Homeland Security. He was released after the police reviewed the pictures he had taken on Friday and recorded his date of birth, Social Security number and other personal information.

The police officer then turned that information over to the BP security guard under what he said was standard procedure, according to Rosenfield.

No charges were filed.

Rosenfield, an experienced freelance photographer, said he was detained shortly after shooting a photograph of a Texas City sign on a public roadway. Rosenfield said he was followed by a BP employee in a truck after taking the picture and blocked by two police cars when he pulled into a gas station.

According to Rosenfield, the officers said they had a right to look at photos taken near secured areas of the refinery, even if they were shot from public property. Rosenfield said he was told he would be “taken in” if he declined to comply.

ProPublica’s Paul Steiger said that the reporting team told law enforcement agents that they were working on a deadline for this story about that facility, and that even if DHS agents believed they had a legitimate reason to scrutinize the actions and photographs of this photographer, there was no reason that “should have included sharing them with a representative of a private company.”

These are true police state tactics, and it’s now clear that it is part of a pattern.  It’s been documented for months now that BP and government officials have been acting in unison to block media coverage of the area

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Now I’m Free… Free Falling…

Christopher Wood at Wall Street Journal:

World financial markets reacted bearishly to Germany’s surprise announcement last week banning “naked” short-selling of euro-zone government debt, derivatives and some financial stocks. Short selling is considered naked when it involves the sale of an asset that isn’t owned by the seller and isn’t borrowed to cover the position while it’s held. The news disturbed investors because of the unilateral nature of Germany’s action. It’s also seen as a potential prelude to other antimarket actions from Germany, or for that matter the U.S. and other Western nations, where the political backlash against free markets continues.

Also causing anxiety is the ominous rise in recent weeks in the three-month London interbank offered rate (Libor), the rate the most creditworthy banks charge each other for loans. This could result in yet another European credit crisis with banks becoming increasingly unwilling to lend to each other because of the interconnected holdings of “junk” European government debt. Bank for International Settlements (BIS) data shows that European bank exposure to sovereign debt in Portugal, Italy, Ireland, Greece and Spain totalled $2.8 trillion at the end of last year, accounting for 89% of international banks’ total exposure to those countries.

Moving beyond Europe, a further negative for investors to contend with has been China’s current tightening cycle; most particularly a machine-gun burst of antispeculation measures in the past two months aimed at its booming residential property market. China’s leadership, worried by growing social concerns about unaffordable apartment prices, will want to see official confirmation that both residential property transactions and residential property prices are falling, as indeed is now the case. Transaction volumes are down more than 50% from the levels reached in the first half of April. Prices will soon follow.

[…]

Meanwhile, in America bank lending continues to decline as does the velocity of money in circulation. If this persists, markets will face worryingly low GDP growth in the U.S. going into 2011. It’s this prospect that’s begun to be discounted in the recent stock-market correction, which has already seen the S&P 500 give up all its gains for the year. This will sooner or later pave the way for another round of fiscal easing in Washington when both the Obama administration and Congress give up on their current hopes of a normal U.S. recovery.

That political mood swing will again raise the protectionist risk in Washington, with the lightning rod being the Chinese exchange rate. Beijing has been signaling that it will resume incremental appreciation of the renminbi by the middle of this year. But with the renminbi having appreciated by 24% against the euro since late November, China’s leaders may be having second thoughts. A trade row between China and the U.S. on top of the growing concerns about a “double dip” in the West is the last thing markets will want to contend with. But they may have to.

Gwen Robinson at Financial Times:

A big swing up – and back down – for Chinese stocks at the start of the week spoke more eloquently than any analyst could about the market’s extreme sensitivity to any hint of price-curbing measures in China’s overheating property market.

And it’s also shed some light on the role of the country’s restricted A-shares.

After suffering big sell-offs ahead of the recent slide in western markets last week, Chinese stocks surged 3.5 per cent on Monday, their biggest gain since November, largely on reports that the government may defer a planned property tax for several years.

But on Tuesday, the Shanghai market closed down 1.9 per cent on a fresh media report that the government was preparing to step up measures to curb property prices.

As Bloomberg reports, the Economic Observer, a local newspaper, said Shanghai would start a property tax trial next month. In fact, the paper had run a report last month about the trial tax, also in its online English-language edition.

Tuesday’s reconfirmation nevertheless prompted some bearish predictions from analysts of a double-dip for the economy, barely a week after another round of property-induced fears hit stocks.

Calculated Risk:

S&P/Case-Shiller released the monthly Home Price Indices for March (actually a 3 month average), and the Q1 2010 National Index.

The monthly data includes prices for 20 individual cities, and two composite indices (10 cities and 20 cities).

From S&P: The First Quarter of 2010 Indicates Some Weakening in Home Prices

Data through March 2009, released today by Standard & Poor’s for its S&P/Case-Shiller Home Price Indices … show that the U.S. National Home Price Index fell 3.2% in the first quarter of 2010, but remains above its year-earlier level. In March, 13 of the 20 MSAs covered by S&P/Case-Shiller Home Price Indices and both monthly composites were down although the two composites and 10 MSAs showed year-over-year gains.

Housing prices rebounded from crisis lows, but recently have seen renewed weakness as tax incentives are ending and foreclosures are climbing.

Naked Capitalism:

Oh, if you don’t love the smell of naplam in the morning, you will not be happy with the market actions.

Per my delayed Bloomberg, Euro flirting with recent lows, at 1.2281. Gold off at $1187 an ounce. (which fits if you believe in deflation, even though gold does well in deflation, the inflationistas may have pushed it too far too fast and be exiting the trade). The Nikkei had a bad day and is off 3.1%. Stoxx 50 is off 3.03%, the FTSE is down 2.54%,

In case you also missed it, the US and China have temporarily buried the hatchet, escalating North Korean tension leading the US to act a tad more submissive and the Euro slide making this not exactly the best time to escalate a fight.

Meanwhile, Geithner is trying to talk up the market: “Geithner Says Europeans ‘Acting Forcefully’ to Mend Finances.” But absent internal rebalancing, fiscal austerity puts Europe on a deflationary path, and its only refuge is to really tank the euro to provide some lift via higher exports. And that will come at the expense of its trading partners, and is eventually likely to produce protectionist measures.

Felix Salmon:

Alphaville has most of the datapoints you need this morning. There’s the European bourses, which started off low and basically haven’t moved all day; the FTSE 100 is now pretty definitively below 5,000 for the first time since September. There’s the flight-to-Germany trade: 10-year Bunds are now below 2.86%. There’s Libor, which is looking ugly and getting worse. There’s the euro, of course, which is now at 1.22. And, in case you want policymaker panic rather than market panic, there’s the proposed German short-selling ban.

All of which makes the downward lurch in US stock prices seem pretty reasonable, in context. Stocks are naturally volatile things, and when you decisively break a barrier like Dow 10,000, there’s no predicting what will happen next. But you might want to have another look at the spreadsheet that Frank Tantillo and I put together comparing the Dow at the bottom of the flash crash to the Dow now: not only is the average at pretty much exactly the same place, but nearly all of the component stocks are within a point or two of their flash-crash lows. (IBM, 3M, and P&G are the outperformers; Caterpillar and Microsoft are the underperformers.)

The S&P 500 is down 2.8% today: another day like this, and it’ll break back down into triple digits. Just remember, though, that it was not all that long ago the S&P was trading below 700. As ever, if you’re invested in stocks, make sure you have a strong stomach. And expect a lot more volatility going forwards.

Ryan Avent at Free Exchange at The Economist:

To what does all of this amount? Clearly, the outlook for the global economy has worsened in the last month, but by how much? Markets provide some evidence. In America, stocks are still up a good 50% from the lows hit early in 2009. Commodity prices, too, are well above the levels they plumbed during the darkest days of the recession. If the outlook isn’t as good as it was in April, it is still considerably better than it was last spring. But this grows less encouraging as markets continue to fall.

One interesting question is the extent to which the current downturn is rooted in structural factors rather than demand shortfalls. It’s easy to identify both. There are persistent trade imbalances which need to be resolved, labour market transitions which need to take place, and balance sheet holes—across sovereigns, firms, and households—that need to be filled. At the same time, developed economies continue to operate well below potential, and the deflationary signs in Europe and America point to too-timid central bank policy.

In the early stages of the recession, the addressing of structural factors was put on hold. Countries ran large cyclical deficits to offset the impact of falling demand, China paused its appreciation of the renminbi against the dollar, and so on. As European debt fears have grown, however, the ability of some countries to delay structural adjustments has vanished. Similarly, some economists have argued that it is now time for China to unleash its domestic demand, in order to provide a much-needed boost to the world economy.

So is the right approach now to embrace structural reforms and hope for the best? Obviously, when the capacity to delay adjustments has been met, there is little choice but to adjust. At the same time, these will be wrenching shifts, in some cases, and it would be preferable to make them over a period of decades rather than years. America would do well to solve its fiscal troubles through tweaks over the course of the next decade, as opposed to rapid, Greek-style crash austerity. But it’s just as important to ensure that these shifts take place in an environment of sufficient demand. Structural reform in a deflationary world will often mean battles over a shrinking pie, and those can quickly become bitter. This must be avoided.

It is going to become steadily more difficult for countries to put off needed structural adjustments to their economies. It is critical that central banks facilitate and accommodate these shifts. They’re going to trigger an increased demand for cash and security. If the Fed and the ECB continue on their disinflationary path, then the global economy may be in real trouble. A world in which demand collapses just as structural shifts can no longer be avoided is one we’d all prefer to avoid.

Dodd:

If you were hoping the economy was due for a turnaround soon, prepare to batten down the hatches instead. The money supply is shrinking at a rate not seen since the Great Depression — and the White House seems intent on repeating history:

The M3 figures – which include broad range of bank accounts and are tracked by British and European monetarists for warning signals about the direction of the US economy a year or so in advance – began shrinking last summer. The pace has since quickened….

It’s frightening,” said Professor Tim Congdon from International Monetary Research. “The plunge in M3 has no precedent since the Great Depression. The dominant reason for this is that regulators across the world are pressing banks to raise capital asset ratios and to shrink their risk assets. This is why the US is not recovering properly,” he said.

The US authorities have an entirely different explanation for the failure of stimulus measures to gain full traction. They are opting instead for yet further doses of Keynesian spending, despite warnings from the IMF that the gross public debt of the US will reach 97pc of GDP next year and 110pc by 2015.

Having spent almost $1 trillion to no effect, Larry Summers has apparently convinced President Obama that another $200 billion will “keep growth on track.”

UPDATE: Ben Herzon

Paul Krugman

Annie Lowrey at Washington Independent

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J.P. Morgan Is Dead And So Are A Bunch Of Presidents

Amir Efrati, Susan Pulliam, Serena Ng and Aaron Lucchetti at the Wall Street Journal:

U.S. prosecutors are investigating whether Morgan Stanley misled investors about mortgage-derivatives deals it helped design and sometimes bet against, people familiar with the matter said, in a step that intensifies Washington’s scrutiny of Wall Street in the wake of the financial crisis.

Morgan Stanley arranged and marketed to investors pools of bond-related investments called collateralized-debt obligations, or CDOs, and its trading desk at times placed bets that their value would fall, traders said. Investigators are examining, among other things, whether Morgan Stanley made proper representations about its roles.

Among the deals that have been scrutinized are two named after U.S. Presidents James Buchanan and Andrew Jackson, a person familiar with the matter said. Morgan Stanley helped design the deals and bet against them but didn’t market them to clients. Traders called them the “Dead Presidents” deals.

The probe is at a preliminary stage. Bringing criminal cases involving complex Wall Street deals is a huge challenge for prosecutors. The government must prove beyond a reasonable doubt that a firm or its employees knowingly misled investors, a high bar. The government launches many criminal investigations that end without any charges being filed.

Tracy Alloway at Financial Times:

If those deals sound familiar to you it’s because, well, they should.

In addition to being named after the US’s only bachelor and duelling presidents, respectively, they also made a cameo appearance — along with Goldman Sachs’ Abacus deal — in a December New York Times article. From “Banks Bundled Bad Debt, Bet Against It and Won” :

Banks also set up ever more complex deals that favored those betting against C.D.O.’s. Morgan Stanley established a series of C.D.O.’s named after United States presidents (Buchanan and Jackson) with an unusual feature: short-sellers could lock in very cheap bets against mortgages, even beyond the life of the mortgage bonds. It was akin to allowing someone paying a low insurance premium for coverage on one automobile to pay the same on another one even if premiums over all had increased because of high accident rates.

Felix Salmon:

I’d love to know more about this feature. I’m not looking for a quick one-sentence summary which can be dropped into a newspaper article, but a detailed explanation of exactly what it was and how it worked. Does anybody have offering documents from Citi or UBS for these deals which might include such a thing?

I think this shows the limitations of print-based journalism, and the long way we have yet to go before newspapers fully embrace the web. Both the WSJ and the NYT give the impression that they have seen and understood the structures in question, and that they’re simply summarizing them in order to make their stories easier to read for a broad audience. That’s fine — but once you’ve done that, do please give the full details online to finance geeks who want to understand the deals on a finer-grained level.

There were lots of synthetic CDOs structured and sold at the end of the subprime boom, but the ones being singled out by regulators and prosecutors seem to be the unusual ones — first the Goldman deal which was created at the behest of John Paulson, and now the Morgan Stanley deal with this mysterious embedded structure. It would be a great service if the news media, rather than just trying to report the news, also published primary documents and full details of what they’re writing about, so the rest of us can come to our own conclusions.

Naked Capitalism:

To give an idea how difficult it is to investigate bad practices in the CDO market, we had been told about the dead President deals (and a similar program by Citigroup) but were not able to find the offering documents through our normal research avenues. It is likely going to take continued investigation by prosecutors and lawsuits from private parties to unearth a good bit of what happened in this market.

Update 1:00 AM: From one of our CDO sources via an old e-mail:

And if anyone wants to do the digging, MS and C had their own mini-ABACUS programs as well. The MS deals were all named after US presidents and the C deals were all named “Franklin” I believe.

Another source just wrote us:

I did see a couple of deals with the long short feature described in the articles. Of course, these were marketed as a way for investors to get the benefit of a more bearish bet on the housing market.

The theory was that the CDO manager would use CDS to go short some portion of the MBS market as a hedge on the bullish bet. Usually the short bucket was limited to about 10% of the deal. This is consistent with the way senior bonds were marketed to investors (and insurers) in 2007 – by taking the top class, the investors were supposed to be making a conservative investment, remote from any mortgage credit risk, as opposed to investing at a more risk sensitive BBB level.

Wouldn’t it be ironic if this feature was put in so the equity could get a further leveraged short bet while the senior investors ended up with the long side.

It was not uncommon for prop desks to hire a different investment bank to be the lead on their deals. I came across that a couple of times with Morgan Stanley, in fact. It was pretty confusing, since the people at Morgan who were supposedly on the prop desk were the same people who you’d talk to on deals where they were acting as the lead banker for a deal. Even though they hired a third party lead bank for their prop deals, the individuals at the prop desk would still act like they were the bankers on the deals.

Finally, I am pretty confident that there is a direct connection between the mortgage deals that Morgan Stanley was trying to originate and sell and the bonds that went into these CDOs. The opportunity for manipulating the pricing on the mortgage deals would have been significant. By manipulating the price of the sub bonds on the mortgage deals, they could have influenced the pricing on the senior bonds of the mortgage deals that were going to real cash investors – especially the GSEs.

In this scenario, the investment bank brings a mortgage deal with loans they bought or originated. Their own CDO buys the sub bonds at artificially low prices. They place the sub bonds of the CDO into another CDO for which the investment bank is the warehouse provider, so they set the price on the CDO sub bonds at an artificially low level. The super senior of the CDO goes off to a bond insurer, and so the price is never disclosed or really tested in the market either.

In such an opaque market, there is a lot of bad stuff that could have gone on.

He also reminded me that another member our team, Andrew Dittmer, had found a Gretchen Morgenson mention of the Morgan Stanley transactions in her December 24 article, but like the Wall Street Journal story, lacking specific deal names and amounts:

Morgan Stanley established a series of C.D.O.’s named after United States presidents (Buchanan and Jackson) with an unusual feature: short-sellers could lock in very cheap bets against mortgages, even beyond the life of the mortgage bonds. It was akin to allowing someone paying a low insurance premium for coverage on one automobile to pay the same on another one even if premiums over all had increased because of high accident rates.

Given that the Wall Street Journal story indicated that Morgan Stanley received a subpoena about these transactions in December 2009, one has to wonder whether Morgenson was a recipient of a leak from a Department of Justice or SEC contact, and whether those parties might have been using the media to influence the decision-making within their own agency, as in to increase the public profile of these deals to create more support for going ahead.

Charlie Gasparino at Fox News:

As of today, neither Citi, Deutsche Bank nor Morgan Stanley have received so-called Wells Notices issued to either firm. A Wells Notice indicates that the commission’s enforcement staff is recommending to the full commission that the firms should be charged with civil securities fraud.

That said, people with knowledge of the matter say the probes are ongoing.

The SEC’s increased interest would also signal that the Justice Department’s probe of the sale of CDOs is actually wider than the two firms in the news as preliminary targets of federal prosecutors, Goldman Sachs and Morgan Stanley. The SEC regularly refers to the Justice Department cases which it considers significant.

The wider interest by the government increases the chances that Wall Street and federal officials may ultimately reach a “global settlement” with the securities industry as it finds a pattern of allegedly improper conduct in the sale of these so-called structured products. In such a settlement, each firm will pay a fine based on the level of alleged misconduct.

The SEC declined to comment on possible investigations into Morgan Stanley, Citi and Deutsche Bank. The banks also declined to comment.

The last high-profile global settlement was crafted by former New York Attorney General Eliot Spitzer and the SEC over Wall Street’s use of fraudulent stock research to entice small investors into buying Internet stocks, many of which went bust or declined significantly in value during the 2000-2001 collapse of the technology market.

In addition to all the big firms settling the matter with the SEC and Spitzer, two prominent stock analysts, Henry Blodget, formerly of Merrill Lynch, and Jack Grubman, formerly of Citigroup, were also charged and banned from the securities industry. Sources say Grubman is a telecommunications industry consultant, while Blodget has re-emerged as a journalist.

Tiernan Ray at Barron’s:

Shares of Morgan Stanley (MS) are off $1.36, or 5%, at $27.02 following the front page story in The Wall Street Journal by Amir Efrati, Susan Pulliam, Serena Ng, and Aaron Lucchetti that the firm is being investigated by federal prosecutors regarding its mortgage-backed derivatives contracts, citing anonymous sources.

Morgan Stanley says that it didn’t misrepresent its position in the collateralized debt obligations, known as the “dead presidents,” even though it bet against some of them, according to the authors.

In an online update of the story, MS CEO James Gorman at a press conference in Tokyo stated tjat the firm has not been contacted by the justice department and has no knowledge of an investigation, the authors write.

Colin Barr at Street Sweep:

The investment bank’s stock sank early Wednesday on reports that it was facing a probe of its dealings in subprime-related debt. The Securities and Exchange Commission sued Goldman Sachs (GS) last month over its handling of a similar deal, known as a collateralized debt obligation, and investors have since been on the lookout for the next bank to face a federal investigation of bubble-era shenanigans.

The thought that Morgan Stanley (MS) might be the next to face the music seemed likely, given a jump this morning in the cost of insuring against a default on the firm’s debt. The annual price of buying protection on Morgan bonds rose 8% in morning trading to $206,000 per $10 million of five-year debt, according to CMA.

But the firm’s assertion that it hasn’t been contacted by the Justice Department seems to have won the day. By the end of the day, Morgan Stanley shares were down just 2% and its credit default swap spreads were actually a bit narrower than they were at the end of the day Tuesday, indicating that there is less of a perceived risk for Chairman John Mack (right) and company.

With the stock trading near book value and everyone expecting additional scrutiny of questionable trades, it will take more than a mere report of a probe to move the needle. “We think downside potential is relatively limited from current levels,” Citi analyst Keith Horowitz wrote Wednesday morning. He rates Morgan Stanley hold.

That makes sense, for the moment. But given the backlash against the banks and the extent of bubble-era envelope-pushing on Wall Street, “hold onto your seats” might be the more apt rating for the big banks.

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Greece Is Melting, Euro Is Falling, Germany Is Angering…

Nicholas Kulish and Matthew Saltmarsh at NYT:

European leaders scrambled Wednesday to quell the market instability growing out of Greece’s debt crisis, with German officials seeking legislative approval for a major contribution to an international aid package that looks as if it could reach 120 billion euros ($160 billion) over the next three years.

One day after cutting Greece’s status to junk and downgrading Portugal, a major ratings agency also cut Spain’s debt rating by a notch and the euro reached a one-year low, underscoring how difficult it will be for Europe to contain problems that started in Greece.

“Every day which is lost is a day where the situation is getting worse and worse, not only in Greece but in the whole European Union,” said Dominique Strauss-Kahn, managing director of the International Monetary Fund. “It’s the confidence in the zone which is at stake and that’s why we need to act swiftly and strongly.” After meeting here with Mr. Strauss-Kahn, Chancellor Angela Merkel of Germany seemed to find a new sense of urgency in dealing with the crisis. “It’s completely clear that the negotiations by the Greek government with the European Commission and the I.M.F. must now be accelerated,” she said. “Germany will do its part to safeguard the euro as a whole.”

Germany’s finance minister, Wolfgang Schäuble, said the government could present draft legislation on a bailout plan as early as Monday and get such legislation through the lower house of Parliament by next Friday if negotiations with Greece over the terms of the deal were concluded, as hoped, by the end of this week.

Tyler Cowen:

The assessment seems to be this:

What a growing number of investors suggest is really needed is a “shock and awe” figure, enough to convince the markets that peripheral European economies will not be left to fail.

For better or worse, I do not expect such a figure is forthcoming.  I also do not see how such a figure would do more than postpone the basic problem, which is that several European economies have been pretending to be much wealthier than they really are and to make financial plans on that basis.

Felix Salmon:

The markets have learned their lesson: now that Greece and Portugal have been downgraded, the rush to the exits is palpable: the flight to quality is on, and bond yields in the European periphery are going stratospheric.

Greece’s bonds can still be used as collateral at the ECB: Moody’s hasn’t (yet) downgraded them. But S&P’s sovereign-ceiling principles mean that all of Greece’s banks now have a junk rating, and it’s surely now only a matter of time until Moody’s and Fitch follow S&P’s lead and Greek debt becomes a speculative credit instrument rather a government bond which is safe in anybody’s eyes.

The trick about going short an imploding asset class, of course, is that it only works if you’re in the minority. If everybody is doing it, you just get overshooting asset markets and chaos — which is what we’re seeing now. As far as the financial markets are concerned, if any bailout comes now, it’ll be too late: no country can sustain Greece’s combination of funding costs and debt-to-GDP ratio, no matter how much German money it burns through. Plug 13% yields into my Greek debt calculator, and the results aren’t pretty, even if they don’t have any effect at all on all the other optimistic assumptions.

More Salmon:

Nouriel Roubini, it can be safely said, gives good panel — especially when the subject is the eurozone and the possible disintegration thereof. He’s been bearish on the PIGS in general and on Italy in particular for many years now, but I don’t think it comes as much surprise to him or to anybody else that Greece is the first country really in the firing line.

[…]

Nouriel’s base case, then, is Argentina 2001: after all, Greece has a much higher debt-to-GDP ratio, much higher deficit-to-GDP ratio, and much higher current-account deficit than Argentina had back then. And if that’s the base case, there’s no way that Greek debt should be trading anywhere near its current levels.

Of course, this being Nouriel, it goes downhill from there: if Greece is worse than Argentina, he says, then Spain is worse than Greece. Its housing bubble and bust has left the banking sector much weaker than Greece’s; its unemployment situation, especially with the under-30 crowd, is much worse than Greece’s; and the cost of any Spain bailout would be so much more enormous than the cost of a Greek bailout as to be almost unthinkable. The only thing that Spain has going for it is that it isn’t quite at the edge of the abyss yet; if it gets its political act together and implements tough fiscal and structural reforms now, it can save itself. But clearly no one saw that happening, given Spain’s political history over the past 20 years.

There’s no good news here. The least bad course of action for Greece, in Nouriel’s eyes, is some kind of coercive yet orderly debt restructuring, which keeps the face value of the debt unchanged but which reduces coupons and pushes out maturities. And an exit from the euro. Alternatively, the ECB steps in and cuts interest rates so low that the euro gets pushed down towards parity with the dollar, which would accomplish something similar without nearly as much pain.

One member of the audience, though, had a really good question: what happens to the European system of sovereign guarantees of interbank lending? When those sovereign guarantees aren’t worth much any more, Euribor is likely to spike, since suddenly there’s a lot more credit risk involved in interbank lending. And there are hundreds of trillions of euros of debt contracts linked to Euribor, which could suddenly get very expensive and take control of short-term interest rates out of the hands of the ECB.

And in any case it’s worth remembering that even though Greece’s debts are small in relation to Spain’s, they’re still large in relation to, say, those of Lehman Brothers. And given that there is no formal mechanism for leaving the euro (or for defaulting on sovereign euro-denominated debt, for that matter), there will almost certainly be a range of unexpected and chaotic events somewhere down the line. That’s why I feel that although Greek bond yields are certainly going to be volatile for a while, we’re going to see higher highs and higher lows — there’s pretty much nothing, at this point, which could reassure the markets and turn Greece back into an interest-rate play rather than a credit play.

Even a massive IMF bailout, which is probably the best-case scenario for Greece right now, wouldn’t suffice to bring yields back down to their pre-crisis levels. As Nouriel pointed out, the IMF, as a preferred creditor, would make sure it was repaid, in the event of default, long before bondholders. And as a result, even if the probability of default dropped, the recovery value on Greek bonds in the event of default would drop as well. And so yields wouldn’t come down as much as you might think.

Tony Barber at Financial Times:

Nothing captures Germany’s anger and frustration with Greece better than the story – if you can call it that – in Tuesday’s Bild, the mass-circulation German tabloid.  “Goodbye, euro. Bild gives the drachma back to the bankrupt Greeks.”  Beneath the headline is a picture of a well-dressed, bespectacled young man, presumably German, handing a wad of drachmas – a defunct currency – to a rather frightened-looking, middle-aged Greek lady.  The message is brutally clear: we Germans don’t want to share the same money as you lot.  Drop out of the eurozone and leave us alone.

Does Bild speak for the entire German nation and, specifically, for German policymakers?  Clearly not.  But here and there in government circles the sentiments are shared. Consider the remarks of Jürgen Koppelin, a budget expert in the liberal Free Democratic party, which is part of Germany’s coalition government.  It cannot be ruled out, he said on Tuesday, that “Greece would have to leave the eurozone for a time… The Greek currency could be depreciated.  That could even help them with exports.”

The irresponsibility of these comments is mind-boggling.  Exporting more products would no doubt help Greece’s economy in the medium and long term.  But what we are seeing is an emergency in which Greece has effectively been shut out of the bond markets.  The yield on two-year Greek government bonds hit 16.22 per cent on Tuesday, and the 10-year bond yield hit 9.77 per cent.  This tells you that the markets have no faith that Greece can meet its refinancing needs without massive external assistance.  Even the roughly €45bn promised by Greece’s 15 eurozone partners and the International Monetary Fund will not be enough.

The choice is simple.  Either Greece gets a much bigger loan package, or it restructures its debt, dealing a shock – but not a fatal shock – to the European banking system.  But as the Bild story and Koppelin’s remarks make clear, the political conditions for extra financial help from Germany just do not exist.

Naked Capitalism:

The real risk here is to Eurobanks. They ran with even higher leverage ratios than US banks, they are believed to have recognized less of the losses thus far on their books than their US peers. Even worse, readers report that the major dealers (and the Eurobanks were part of this cohort) are carrying toxic assets at prices that are vastly above likely long-term value. Eurobank exposure to Greece is over $190 billion, and total periphery country exposure is roughly $900 billion.

In the subprime crisis, many pundits and the Fed itself thought the losses would be contained, unaware that for every $1 in BBB subprime bonds, another $10 in CDS had been written, and that many of these exposures sat with highly levered firms, namely insurers and dealers, who were not able to take much in the way of losses. The gross level of exposures looks much worse here and the banks most at risk have not done much (save take government handouts) to rebuild their balance sheets.

So the whole idea that the financial crisis was over is being called into doubt. Recall that the Great Depression nadir was the sovereign debt default phase. And the EU’s erratic responses (obvious hesitancy followed by finesses rather than decisive responses) is going to prove even more detrimental as the Club Med crisis grinds on.

The VIX posted its biggest one-day increase since 2008 but its level of 22 is positively tepid compared to crisis norms. Portugal, whose total debt to GDP is higher than Greece’s, is under pressure as bond spreads continue to widen. Hungary’s premier-in-waiting stated that the country, which was bailed out last year, will not be able to meet IMF fiscal targets and should widen its deficit even more to stoke growth. Traders went into risk-aversion mode, with emerging market and junk bonds also suffering. And as we mentioned, quite a few people in London expect a significant devaluation of the pound after their elections.

A further source of trouble is political. If the euro continues on its expected slide and the pound is devalued, the dollar’s strength will put a major dent in the US ambitions to increase exports. Moreover, the rise in the greenback relative to other currencies will no doubt make China much more reluctant to revalue the renminbi against the dollar.

Japanese markets are down over 2% at this hour, with the rest of Asia faring better.

Matthew Yglesias:

At any rate, the question now is what kind of way forward exists. It appears that either Europe’s monetary union needs to be undone or else a fiscal union needs to be forged. But neither is possible! And as I’ve been trying to emphasize, the Eurozone is a more important trade partner for the United States than the much-more-discussed China. A meltdown over there seems sure to have consequences here and not good ones.

Arnold Kling:

I know that the Senate and the mainstream media would be shocked to hear me say this, but what is going in Greece and elsewhere could turn out to be more significant than the Goldman ABACUS deal.

UPDATE: Megan McArdle

Rod Dreher

UPDATE #2: Paul Krugman

James Joyner

More McArdle

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Whoever Paid For That Microphone, He Paid For It In Pounds

Will Heaven at The Telegraph liveblogs:

9.42pm (WH) Onto health, but still the pace is bothering me. The American Presidential debates are an opportunity for US politicians to look, well, presidential. But do any of ours look electable? It’s scatter-gun with notes.

9.40pm (WH) Cameron sounding positively Churchillian defending Trident.

9.39pm (RC) A dose of relative calm when talk turns to the military: mood more sober and serious. Brown comes off well, as can talk with gravitas about the tough decisions he’s had to make as PM.

9.37pm Neil Midgley tweets: “Another ITV fail – blocking line of sight from leaders to audience with cameras.” Meanwhile, Iain Dale says: “Brown’s lipstick is running. Or becoming more and more orange.”

9.34pm Damian Thompson writes:

We’ve got to remove this dark cloud on this economy by acting now, says Cameron. He makes it sound like a minor operation: an appendectomy rather than a quadruple bypass. Brown goes on to imply that if you act now the patient will die. Clegg: tax the banks, “but let’s not get obsessed about mythical savings on waste” or pretend that it’s all down to timing. Probably sounds grown-up to younger people in the audience; to anyone with experience of election tactics, it’s textbook Liberal Democrat opportunism. The idea that control-freak Lib Dems would be prepared to tackle even the silliest quangos is absurd. This is a party that can’t see a dog turd on the pavement without wanting to set up a committee to discuss “options” for cleaning it up.

9.33pm Janet Daley asks:

Why is DC allowing GB to say that Tories would be “taking £6 billion out of the economy”? Raising taxes takes money out of the economy, cutting them puts money back into the real economy.

9.31pm (WH) Alastair Campbell tweets: “The longer it goes on the more shallow Cameron looks and the more substantial Gordon looks. Clegg doing well as I knew he would.” A reluctant admission?

9.29pm (RC) “The only way we’ve kept our economy moving is because the Government stepped in to ensure there were sufficient levels of growth,” says Gordon. Um… didn’t it contract quite significantly?

9.28pm Ed West notes:  Cameron used the phrase “jobs tax” about half a dozen times in 120 seconds.

9.27pm James Delingpole asks:

Clegg now TOTALLY overdoing the engagement with the questioner thing. “Where are you Robert?” he asks. Robert, sitting at the back, looks deeply embarrassed. It’s like when Jeffrey Archer overdoes the repeating-your-name-to-show-you-he-remembers-it-and-cares trick. You’d really rather he didn’t. It’s so not English.

9.26pm (RC) Cameron talks about ‘removing’ the deficit, glossing over the fact that this will involve a profound restructuring of our economy and public sector. Brown repeats standard line about big choices and securing the recovery – referring to the Tories’ NI policy as “taking money out of the economy”, which is a bizarre interpretation by any standards. Clegg doing well – mastered his brief, and can refer to Lib Dems’ shiny policies without the others having time to knock them down.

9.24pm Krishnan Guru-Murthy tweets: “Suspect Cameron will regret having the centre position – it isn’t helping him. Clegg acting as though he was in middle anyway.”

9.22pm Bryony Gordon sends us her thoughts:

Please stop banging on about all the real people you have met. Clegg, stop waving your hands about – you look like you want to throttle Stewart. Oh, and was the set stolen from a kilroy silk show from the early 90s?

9.21pm Damian Thompson notes:

This might seem like a trivial point, but it isn’t. Dave’s makeup has been severely botched. I’ve seen less slap on the faces of a Gilbert and Sullivan troupe in Reading. Not only that, but someone has attempted to darken his eyebrows; someone in a hurry, by the looks of it. The Leader of the Opposition is (I think) putting in a confident performance, but he is orange. And some idiot on his staff has said: that looks fine.

9.19pm Harry Mount writes:

The debate is only really coming alive in the press room here in Manchester when one of them gets angry. A groan goes up the moment they try to squeeze in a much-rehearsed soundbite (”You can’t airbrush your policies, David, the way you airbrush your posters”) or furiously use the questioner’s first name (”Yes, Jacqueline,” says Nick; “Yes, Helen,” says Dave).

9.17pm (RC) Further to last post, think problem is lack of applause. People in press room are referring to particular answers getting nods from the crowd – especially Cameron and Clegg talking about personal experiences with education – but there’s no audible cue that tells you how well things went down.

9.15pm (RC) After a long debate about how to clean up politics – which Nick Clegg managed to focus on a pledge of his own party’s – the abiding impression is that the format is leading each leader to cancel the others out somewhat. The result – which seems to be confirmed by commentary so far – is that people aren’t having their minds changed, but their existing instincts confirmed. Interventions by moderator also make the leaders seem like naughty schoolboys, which doesn’t help them appear statesmanlike.

Andrew Sullivan’s live-blog:

4.08 pm Just an anthropological point: Cameron just tried to sum up what they all agree on. It was a classic Alpha Male move. I give him a Beta-plus. Brown so far is combative and smiling his grisly smile constantly. Clegg comes across as a bit of a whiner – which is always the trap for the third party. But he’s very effective and telegenic. No question that Clegg and Cameron seem of a different and younger generation. But you can see why nervous voters might find the older bloke a little more reassuring in a pinch.

But if Cameron is trying to prove he is of prime ministerial caliber, he’s succeeding. The policy differences are, so far, numbingly small.

4.06 pm Brown’s raising the question of hereditary peers in the House of Lords is classic class-baiting Cameron.

4.02 pm. Cameron wants to streamline government – and cut the number of MPs – to reduce the fiddling of parliamentary expense accounts? Shurely shome mishtake. Meanwhile, Brown keeps sucking up to the Lib Dems. A hint of the possibility of a Lib-Lab pact? Cameron fights back with a quite effective parry on the tardiness of Labour’s interest in constitutional reform. If they wanted to get rid of hereditary peers, they could have done so in the last 13 years.

4.00 pm. Brown says he was “shocked and sickened” by the expenses scandal among members of parliament. He wants recalls of dodgy MPs. He wants an elected House of Lords.

3.58 pm. Brown is getting very aggressive. He keeps interrupting Cameron. Now there’s a jibe about air-brushing. It doesn’t seem that fitting for a prime minister. It seems a little insidery. But without imbibing the current atmosphere in Britain lately, it’s hard for me to judge how this strategy will go down with the viewers.

3.55 pm. Brown tries to get a rehearsed joke about Tory posters. But he’s the first to start bickering and talking about the meta-issues. Another Brown rehearsed line: “This is not Question Time, David. This is Answer Time.” Good line. Badly delivered. But Cameron ducks the question on funding of the police.

3.54 pm. Brown offers legal injunctions against the police if a case lags. He’s implying that Tory budget cuts could reduce the number of cops on the street. Clegg just keeps repeating that nothing seems to change as the two parties alternate in power.

3.50 pm On crime, more police on the streets seems a common refrain. Cameron wants to get drug addicts off the streets and into rehab. Rehab as an anti-crime measure is unimaginable in an American context. And from the right?

3.48 pm. Cameron touts welfare reform as a cure for immigration excesses. Now he’s talking about tougher sentences for burglars and murderers. Not exactly hugging hoodies, is it?

3.44 pm They’re all vying to get immigration “under control”. Brown rather awkwardly says it already is under control. But he suffers the plight of incumbency. If they’ve been in office for the past 13 years, it’s a little late to get tough. Clegg keeps banging on about regional caps for immigrants – not a national one.

3.39 pm Cameron’s hair is much more presidential. And his first immigration answer – a clear vow to reduce immigration levels – seems clearer than Brown’s obviously scripted description of his meeting with chefs. Yes, chefs.

Iain Martin’s live blog at WSJ

Joshua Keating at Foreign Policy:

The format: FAST! If anything, I think U.S. networks could learn from ITV’s presentation of the debate, which kept statements short, questions direct and substantive, and a moderator who was willing to cut off the candidates when they started to ramble or repeat themselves.

That being said, all three candidates seemed to be rushing to get as much information as possible, and I suspect that many voters probably had a hard time following the discussion at times. At times, they seemed to be struggling to present their entire platform when a few bullet points would have sufficed.

Gordon Brown: Not surprisingly, the dour prime minister seemed the most ill-at-ease with the debate concept, often getting bogged down in unnecessary detail and becoming tetchy in response to criticism. It’s hard to say after watching the debate what Brown’s pitch is, other than it’s way too dangerous to elect David Cameron. In particular, challenging the premise of a question by a soldier complaining about inadequate equipment for troops in Afghanistan seemed like a mistake. Brown was strongest on the economic questions where he seemed to effectively paint Cameron’s proposals as vague.

David Cameron: Not surprisingly, the younger more dynamic Cameron seemed much more comfortable with the format and his “hope over fear” closing statement was strong (though the constant invocations of “hope” and “change” bordered on hopejacking). Cameron dominated the early questions on immigration and law-and-order issues, though he seemed to get seriously outwonked by both Brown and Clegg on pocketbook issues. He didn’t do a whole lot to dispel his image as a smooth-talking policy lightweight.

Nick Clegg: Meh. The third-party candidate scored a few hits, but had a hard time distinguishing his political positions from Brown’s or his anti-establishment bona fides from Cameron. The anti-nuclear rhetoric he broke out on the defense question seemed both unrealistic and a bit of a non sequitur. It is telling how many times both Cameron and Brown began their answers with “I agree with Nick,” though.

Overall winner: Cameron, though given how much the format favored the conservative, it wasn’t exactly a knockout punch.

Janet Daily at The Telegraph:

No great surprises then. Gordon Brown was the most negative of the three, using much of his allotted time to attack David Cameron. He was also boorish, interrupting Cameron and even talking over the chairman. He made a gratuitously nasty reference to Cameron having “airbrushed” his own poster, and a quite irrelevant jibe about Lord Ashcroft. He claimed repeatedly that problems such as immigration and crime were already under control, but then said that his party was planning to deal with them. He was, as usual, repetitive and obsessive in his insistence on “spending” as his trump card.

David Cameron did very well without adding anything especially startling or novel to the debate. What came across was clarity, authenticity and an appropriately authoritative manner for a potential prime minister. I thought he missed a precious opportunity to slap down Brown’s absurd assertion that the Tories would be “taking six billion pounds out of the economy” by not implementing most of the Labour National Insurance rise when, in fact, it is raising tax that takes money out of the real economy. But Cameron did make the most of the disastrous effect that the NIC rise would have on the NHS and education budgets.

Nick Clegg was assiduously courted by the Prime Minister: I lost count of how many times Brown said, “I agree with Nick”. Clegg began with platitudes but livened up later as he got into his predictable condemnations of the “two old parties”. (Could somebody please tell him that the Liberals are a much older party than Labour?) It will take a pretty sophisticated viewer to appreciate that the LibDems have an absurdly unfair advantage in being able to offer an utterly unrealistic programme. Clegg could attack both the real alternatives without worrying about the credibility of his own policies. So it is scarcely surprising that he “won” most of the instant polls. My guess is that this will make scarcely any difference to the outcome of the election except to confirm that Brown is a dead man walking.

Gideon Rachman at Financial Times:

Was this the night when the Conservative Party saw the chance of an overall majority slip away, ensuring that Britain is heading for a hung parliament? My impressions of the first ever leaders’ debate seems to be the same as that of the great British public. Nick Clegg won.

Snap polls after the debate showed the Lib Dem leader as the clear victor. More significantly, the first poll of post-debate voting intentions that I’ve seen – just broadcast on Sky News – showed a big jump in those saying that they intend to vote for the Lib Dems. They went up from 19% in the polls to 26%, just behind Labour. Of course, there are still three weeks and two debates to go. But, if that trend holds, we’re definitely going to end up with a hung parliament – with the Lib Dems holding the balance of power.

So what went right for Clegg? As I wrote on my blog a few days ago, I’ve long been slightly puzzled about why the charm and quickness that I’ve seen from Clegg in private has never really translated into his public image as leader. Tonight that changed. I think the format favoured Clegg. Or rather Question Time in parliament which, up until now, has been the only opportunity he has had to go head-to-head with the other leaders, does the Lib Dem leader no favours. He is just no good at the shouted put-downs that are the essence of Question Time and is also shoved off to one side of the chamber, away from the two main leaders, which marginalises him. Tonight he debated Cameron and Brown on equal terms – and in a format that favoured warmth and under-stated humour, rather than raw aggression and one-liners. It worked much better for him.

Clegg’s main tactic was obvious but effective. He portrayed the two other leaders as representatives of an exhausted system, and went some way to capturing the crucial banner as the “change” candidate. He was also effective in giving the impression that he alone was being honest about the fiscal dilemmas that Britain is going to face. His attack on David Cameron for suggesting that fiscal problems can be solved by cutting “waste” was skilful. Of course, there were also contradictions in Clegg’s presentation. On the one hand, he argued that “cutting waste” is largely an irrelevance  – and then he reeled off a list of wasteful projects that needed to be cut. But apparently it didn’t matter.

Fraser Nelson at The Spectator:

None of them dropped any clangers – nor did anyone have killer one-liners. I’m struggling to recall a single line from the debate. Cameron scored when he thanked the soldier and the nurse for their service: he relied on anecdotes, whereas Brown emptied his statistics on the poor viewer. I can’t deny that Clegg’s answers were stronger than I expected, and those who had never heard of him may well have been impressed. From the offset, it was said that Clegg had most to gain from these debates. So it was to prove.

Clegg gorged on the plague-on-both-your-houses lines, pitching desperately for the anti-politics vote. “All I would appeal for is a bit of honesty in this debate” and “The more they argue, the more they sound like each other.” Etc.

Only a few exchanges jumped out at me. The first was the military.  Brown starts, as he always does when talking about the military, with a garbled sentence  “Let me say, first of all, my pride and my admiration for the Armed Forces.” Brown can never speak in grammatically correct sentences when talking about the military (sending “best wishes” to the deceased, etc) because he does not understand the military. “Every Urgent Operational Requirement that our Armed Forces have asked us for has been met,” drones Brown. Then says how terrorist plots start “in that region” (that’s his way of saying “Pakistan”).  Cameron’s response, when it came, was far more subdued. He should have said it was a scandal that soldiers died in Belfast-era Range Rovers etc – there are enough examples to go through. Instead, he mentioned a policy area. Cameron was evidently told not to go after Brown in this way, not to be too Flashman (to use Alan Johnson’s analogy). A shame, in my view. I could have seen far more raw anger from Cameron, because he does feel it.

Cameron was at his most convincing when speaking directly to the nurse. “Can I thank you for your incredible service to the NHS. What it did for my family and my son, I will never forget. The dedication, the love. Thank you for all that you have done.” This left statistics-spouting Brown in the shade.  And on the economy, he beat Brown by dismissing his (ridiculous) claim that £6bn of cuts posed some mortal danger to the economy. All he’s doing is proposing is to cut 1 percent of government spending: what family has not had to cut their budget by at least as much? The answer, he said, is to cut the waste and cut the tax.

I was once given a George W. Bush doll which, if you pressed a button on his lapel, would recite one of his soundbites. At times, this is what this debate felt like. At every given topic, the leaders recited their given answers. People have heard Brown’s repertoire, they’ve heard Cameron’s. But not Clegg’s. He enjoyed the novelty factor. I hope he enjoys it: tonight may very well be the high point of his political career.

Alex Massie:

On immigration and crime all three men tried to out-populist one another. Who knew that foreign students were such a threat to this green and pleasant land? Who knew that foreign chefs could possibly be such a danger? When Nick Clegg recounted an anecdote about how a poor chap had been burgled while at his father’s funeral one half-expected him to add that, “And by the way, the father was murdered by a cleaver-wielding Vietnamese chef…”

True, David Cameron was right to stress the importance of rehabilitation and, later, of welfare reform. But these were small nuggets of decency and common-sense in a swamp of hysteria and lie-telling populism that was enough to make one think that my three-year old niece’s analysis was depressingly accurate.

Things did, mercifully, get a little better thereafter and there was more give and take and general spikiness than seemed likely given the absurdly stringent nature of the “rules”. It was both more interesting and even more exasperating than one expected.

Nick Clegg clearly won and not just on the basis of the Expectations Game either. He was personable, effective and pretty good at putting across his entirely reasonable “Plague on Both Your Houses” stance.

On the plus side for David Cameron his opening statement was the sharpest, clearest and best, noting and appreciating the public’s mood. His closing statement was fine too but for long periods of the contest Cameron seemed oddly passive and, at times, strangely shut out of the contest. My impression was that he was the most nervous of the participants but, of course, I may be mistaken.

More culpably, time and time again Cameron declined to call Brown out. Perhaps he didn’t want to seem angry or aggressive but it was absurd for him to fail to challenge Brown’s repeated assertions that raising taxes by £6bn fewer pounds somehow constitutes “taking money out of the economy”. If it’s not paid in tax then does this money simply evaporate? Cameron never made this argument. Ronald Reagan and Margaret Thatcher would have. Instead Dave became bogged down in tedious details about waste and 1% of government revenue. A real missed opportunity.

And that’s rather how I feel the whole night was for Cameron. He could have slain Brown tonight but he did not. The result of that failure was to let Brown escape.

Martin Bright at The Spectator:

Shall we stop being cynical for a moment and congratulate Brown, Cameron and Clegg for being the first political leaders in Britain to take part in a televised election debate? Indeed, we should particularly congratulate Gordon Brown for agreeing to this. He had by far the most to lose.

There is absolutely no doubt that Nick Clegg won this. He faltered from time to time, but was the only one confident enough to take thoughtful (if sometimes stagey) pauses.

I thought Gordon Brown also did surprisingly well. He kept his cool and showed that he is an accomplished debater. His jokes were over-prepared and characteristically dreadful, but he warmed up through the 90 minutes and challenged Cameron very effectively on several occasions, especially over police spending.

Cameron was disappointing, but people forget that he was not entirely convincing against David Davis in the Tory leadership debates.

Gordon Brown should be worried precisely because he did relatively well in the debate. For some reason this doesn’t appear to have made any impact on the way people thought about him.

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