The age of financial repression and the shattered American Dream

One year one, QE2, the wealth effect experience, induced by Ben Bernanke has been nothing but a failure.

With interest rates at zero since 2008, income from US Treasuries and Certificate of Desposits have been nothing but short of miserable for pensioners.
And not only did the 401K, took a recent beating, but the house, previously used as an ATM, in the build up to the financial crisis, is no longer an instrument for pensioners to extract additional income and even help out the younger generation facing up with an increasing burden of student loans.

As per CalculatedRish recent post, here is "The New Retirement Plan: No Retirement"

http://www.transamericacenter.org/resources/TCRS12thAnnual%20WorkerNewRetirementFINAL05162011.pdf

What we learn from the survey mentioned is fairly dramatic:

39% of workers plan to work past age 70 or do not plan to retire.
54% of workers expect to plan to continue working when they retire.
40% now expect to work longer and retire at an older age since the recession.

"Fewer than one third (30%) have currently saved more than 100,000 USD in all household retirement accounts.
Most workers regarless of age or household income, agree that they could work until the age of 65 and still not have enough money saved to meet their retirement needs."

But it gets worse
"31% anticipate that they will need to provide financial support to family members."

As I indicated in "The end of the American Dream, the call for trade barriers and the rise in populism...", "There are 70 million Americans born between 1945-1960. One-third have zero retirement savings. The oldest are 64. The only money they have is equity in a house, so they must sell. This will add yet another flood of houses to the market, driving prices down even more."

In relation to the survey mentioned above they conclude with the following recommendation to the policymakers:
"From a public policy perspective, with so many workers planning to work past age 65, policymakers should consider tax incentives for employers to hire older workers along with job training / retraining programs for older workers -- to help keep them in the workforce."

But the issue is not only in the retirement space, there is a steady build up in the student loans space and given the house is no longer there to provide equity withdrawal to support younger generations, it is a growing concern, because rising education costs is also affecting consumption levels to some extent.

I also wrote the following in September 2010
"Even young graduates have become disillusioned, will they be able to therefore repay their student loans?"
"Student loan amount has exceeded the total credit card debts for the first time in the American history.":
"The total outstanding student loan is worth 850 billion USD and the most worrying factor is that some students do not even know on how much they owe and to whom..."

Now student loans are close to 931 billions USD, eclipsing 798 billions in credit card debt. Some experts estimate we could hit one trillion this year alone. Total student debt was 72 billions USD 15 years ago according to Mark Kantrowitz, who provides financial assistance for college students via financial aid website www.finaid.org.


Defaults on student loans nationwide have doubled in the past five years and are on the increase:

Only credit cards have a higher rate of delinquency at 12.2%, but  as indicated  in the below graph from St Louis Fed, overall, delinquencies are falling.
The unemployment rate for workers between 20 and 24 years old is 14.6% compared to 9.1% for the national average. According to Moody's the defaults on securitized private student loans rose to 5.4% in the second quarter. The annualized default rate widened from 5% in the first quarter and 4.5% a year ago, most coming from loans securitized in 2010, containing more delinquencies. The default rate peaked at 7.6% in the third quarter of 2009.

The deleveraging of US Households is still the most important story relating to the ongoing balance sheet recession:


The end of the American Dream of Home Ownership has been dented and its slowely but surely reversing back to the mean:


A concern is the rising trend in consumer loans at all commercial banks for our struggling US Household:


There is a stronger demand for consumer loans:

The good news it seems so far is that delinquencies on all loans and leases, to consumers, all commercial banks, is trending down, but again, there is what we see and what we don't see and if we end up moving back into recession, which looks like almost certain now, the picture could change rapidly:

Stay tuned!

 

The US downgrade was not a downgrade of America's economy but a dowgrade of its leadership.

This week post, will not deal with data and financial action of the last couple of days, as it is available to all to see, enabling one to draw its own conclusions on the state of the US economy in particular and Developed countries economies in general.
This week post is an intentional attack on the clear lack of leadership and political failures responsible for the current society and economic woes in the United States.

From the anonymity of a personal blog, to the wilderness of internet liberty (which reach and powers have extended, beyond our wildest dreams, allowing communities to discuss and gather, lies to be refuted, and, even government to be toppled),it appears more and more that common sense has left most of mainstream media as well as Washington. “The Truth is Out There” was the motto of the X-Files, and indeed it is, within a growing population of internet bloggers, less contrived by political intervention, and thanks to a healthy competition in both quality and content.

Make no mistake; the downgrade of the United States was not a downgrade of its economic might, but more and simply a downgrade of its leadership.
While the Tea Party has risen to prominence in US politics, it has only been able to do so, because it has been in a position to fill a political vacuum and feeding itself on economic woes. It closely follows the steps of the Greenback Party which was born because of the Great Depression of 1873.
I have touched on the subject at length in my post "I promise to pay the bearer on demand..." - Panics and Populism.

The great irony today is, that, whereas the Greenback party opposed the shift from paper money back to a bullion coin-based monetary system, the Tea Party members are supporting the reverse.

But this leadership vacuum did not start with this current administration. The gradual erosion of the American leadership started a long time ago. Did it started under the failed leadership of President Richard Nixon? The point here is not to argue about the exact date of the start of the decay and play the blame game, but its consequences on the US economy and what must be done to address it.

Many years ago the American people had been warned by one of its greatest leaders, in the tradition of the founding fathers of the United States of America such as Thomas Paine or Thomas Jefferson, namely President Dwight D Eisenhower in one of his greatest speech, his farewell address, on the 17th of January 1961. It is a must read: http://www.americanrhetoric.com/speeches/dwightdeisenhowerfarewell.html
“Another factor in maintaining balance involves the element of time. As we peer into society's future, we -- you and I, and our government -- must avoid the impulse to live only for today, plundering for our own ease and convenience the precious resources of tomorrow. We cannot mortgage the material assets of our grandchildren without risking the loss also of their political and spiritual heritage. We want democracy to survive for all generations to come, not to become the insolvent phantom of tomorrow.”

50 years on, American people did not listen and they had to face the embarrassment of US downgrade, much more representative of its lack of political guidance and wisdom than of its economic woes. As a currency issuer, it is a fallacy to believe the US can default, as it is a fallacy to believe that the FED is responsible solely for the dire economic situation of the American people.

American people have been failed not by the quality and ingenuity of its great business companies and business leaders (Apple, Google, IBM, the list is too long!) and people, but by its failed politicians and failed politics. The latest comments by Dallas Fed President could not be more evident to where the culprits are, for the current economic situation, namely Washington:
“I believe what is restraining our economy is not monetary policy but fiscal misfeasance in Washington. Pointing fingers at the Fed only diminishes credibility. The ugly truth is that the problem lies not with monetary policy but in the need to construct a modern, appropriate set of fiscal and regulatory levers and pulleys to better incentivize the private sector to channel money into productive use in expanding our economy and enriching our people.”

A great country needs great leadership, and the debt ceiling summer comedy debate between Republicans and Democrats made more damage to the image of American leadership in the world and its economy than to the safety of its Treasury Bonds. And I expect, like David Rosenberg, to the see the US 10 year bond yielding well below 2% in the near future but that is another story.

But there is hope. It is payback time, with the recent rebellion launched by great business leaders demanding accountability and leadership. From Warren Buffet to the CEO of Starbucks Howard Schultz, one can only hope that the tide is turning. Here is what Howard Schultz had to say: "Our national elected officials from both parties have failed to lead," he wrote. "They have chosen to put partisan and ideological purity over the wellbeing of the people. They have undermined the full faith and credit of the United States. They have stirred up fears about our economic prospects without doing anything to truly address those fears."

An Open Letter to Starbucks CEO Howard Schultz From American Small Business League President Lloyd Chapman

American small business have always been at the heart of any strong economic recovery America has had.
Here is what they have to say in relation to American leadership throught the voice of their speaker president:

"Congress needs to go back to work, focus on job creation and solve the crisis of uncertainty. That said, the most effective economic stimulus President Barack Obama and Congress could implement would be to direct more existing federal infrastructure spending to small businesses, our nation’s chief job creators. This is an issue my organization, the American Small Business League, advocates for on a daily basis.

The latest U.S. Census Bureau data indicates that small businesses create 90 percent of all net new jobs, employ more than half the private sector workforce, are responsible for more than half of GDP and more than 90 percent of U.S. exports. It is clear that economic recovery needs to be based on small businesses.

I think members of Congress realized this in 1953 when they passed the Small Business Act. Today that law requires that 23 percent of all federal contract dollars be awarded to small businesses. Yet since 2003, a series of federal investigations have found most of that money has gone to Fortune 500 companies and other large firms.

In Report 5-15, the Small Business Administration Office of Inspector General referred to the issue as, “One of the most important challenges facing the Small Business Administration and the entire Federal government today.

During President Obama’s campaign he stated, “It is time to end the diversion of federal small business contracts to corporate giants.”

The Small Business Act defines a small business as generally less than 500 employees and independently owned, which, by definition, excludes publicly traded companies. Therefore, President Obama could stimulate the economy with an executive order stating, “The federal government will no longer report federal contracts awarded to publicly traded companies as small business contracts.” Our research indicates this would redirect up to $200 billion annually in federal infrastructure spending to small businesses."

It is not too late to restore the greatness of America and cure its economic woes, and, if it has to go through a campaign donation boycott so be it.

Macro and Markets update - It's the liquidity stupid...and why it matters again...

Forget the sell-off in the equity space, it was expected. It seems you can't teach an old equity dog new credit tricks. It was the case in 2008 and again it looks like it is the case in 2011.
Earlier this year I explained the fundamental differences between equity markets and credit markets in the post: "A tale of two markets - Credit versus Equities". We have a different DNA.

As I posted back in January 2011, in 2007, there was a big disconnect between credit markets and the equities markets. Volatility was falling, I argued, while credit spreads were simply exploding, with sometimes gigantic intraday moves, early indicators of trouble brewing? Lessons learned in 2011? I don't think so.
I also indicated in this previous post the following:
"The recent significant increase in credit spreads for many financials have been driven by the markets concerned about the ability of the weaker players to access credit at reasonable rates."

We had an interesting disconnect in January 2011 if you look back at the previous post, as indicated by the graph where you had Eurostoxx 50 (SX5E), Itraxx Financial Senior 5 year CDS index, German Bund (10 year Governement bond, GDBR10), and at the bottom Eurostoxx 6 month Implied volatility.
Here is the graph from January 2011:

At the time, European High Yield debt was tighter than Bank Sub Debt. It is not the case today.

Here is today's update from the graph published in January 2011:

We can clearly see the acceleration in the flight to quality with the drop in the German 10 year government bond yield.
Since March, the Itraxx Financial 5 year CDS has been creeping higher, and finally the Eurostoxx gave up.

But back to the subject, liquidity and to be blunt, I do not like what I am currently seeing, it is going to be a long post.

The Unknown
As we know,
There are known knowns.
There are things we know we know.
We also know
There are known unknowns.
That is to say
We know there are some things
We do not know.
But there are also unknown unknowns,
The ones we don't know
We don't know.
—Donald Rumsfeld, Feb. 12, 2002, Department of Defense news briefing

In a CreditSights report published on the 17th, I had the opportunity to peak through their report on European Banks and liquidity issues.
What I've learnt:
Banks have been still reluctant to disclose their liquidity and short-term funding positions, in effect, European banks have failed to learn the lessons from 2008.
Although they have higher liquid assets and lower short-term funding reliance than in 2008, the lack of disclosure and market runours about their funding the market is gaining traction, hence the very high volatility in European Banks stock prices and widening CDS spreads.
But, ECB and other Central banks are still providing liquidity support, which alleviates somewhat funding concerns.

Truth is liquidity assessment were not included in the latest EBA (European Banking Association) stress tests we had in July.
Without hard data and hard facts, how do you refute rumours and reduce interbanking lending pressures? You can't.

One would have thought that after the 2008 debacle, lessons would have been learnt, and that greater transparency is a must.

CreditSights is describing what you can find or not...from the most recent financial information, i.e. banks'1H11/2Q11 earnings reports:
The bad:

"A maturity breakdown of funding liabilities in European banks' interim reports is rare. This makes impossible to calculate expected cash outflows."

The good:

"An increasing number of banks disclose their stock of prime liquid assets (including cash, government securities and other securities eligible with central banks).

Creditsights to add:

"We believe liquid assets are typically much higher than they were in 2008 in relation to banks' balance sheets, while short-term funding is typically smaller as banks have focused on lengthening their maturity profile. However, it is difficult to find comparative data."

Another issue is the lack of disclosure of the liquidity coverage ratio:
From CreditSights:

"Hardly any banks are yet disclosing their "liquidity coverage ratio" (LCR). Under Basel III and CRD4, banks will have to comply with a new liquidity coverage requirements from 2015, after an observation and review period beginning in 2011. The aim is to ensure that banks have sufficient high quality liquid assets to withstand an "acute stress scenario" lasting for 30 days. The requirement would be a minimum LCR of 100%. In other words, the stock of high quality liquid assets should be sufficient to cover 30 days of cash outflows in stressed conditions."

and Creditsights to add on the subject:

"In current market conditions, this ratio would be a useful indicator, but it is impossible to calculate it accurately for European banks, which are reluctant to disclose it before the regulators have finalised the definitions."

The circularity issue weighting on liquidity:
In highly-indebted Eurozone countries, the issue of circularity comes from the high correlation with their sovereign creditworthiness, meaning they are experiencing very high level of stress on their current funding.

Conclusion for the banks in the peripheral countries:
The ECB is currently the ONLY SOURCE of wholesale funding for these smaller banks and have therefore prevented aggressive deleveraging to happen and liquidations.

According again to CreditSights in their report, Italy's net reliance on the ECB remained low in relation to its large banking system's total liabilities (2% at the end-July). But, gross liquidity provided to Italian banks in the ECB's main and long-term refinancing operations virtually doubled from 41 billion euros at end of June to 80 billions euros at end of July 2011. It never even reached 50 billion euros since the end of 2008.

There is a rising risk of a credit crunch in Southern Europe.

A widening gap between Euribor and OIS is indeed a sign of stress in the interbank market. The full allotment provided by the ECB is mitigating so far liquidity concerns.

According to another report, this time by Morgan Stanley (European Banks - The Stress in bank funding and policy options - 15th of August 2011), European banks are starting from a better position than in 2008 given their latest funding survey which suggests that "Europe's leading banks are on average issued around 90% of their term funding needs for 2011 with significant liquidity pools, better solvency and resolute ECB commitment to support the system".

What we learn from this additional Morgan Stanley report:

"ECB support for bank funding is deep; it is also growing notably in Italy. We have regularly shown the periphery is already dependent on the ECB: 20% of Greek banking assets, 15% of Irish, 8% of Portuguese; 4% of Cypriot are funded at ECB window."

Why liquidity matters again? Because bank funding is a key source for bank earnings, ability to lend, therefore a drag on the economic recovery if it doesn't happen smoothly.
While the US boast a Temporary Liquidity Guarantee Programme (TLPG), a similar mecanism is not currently available in Europe so far.

With the markets currently shut down with the ongoing volatility and turmoils, long term funding is beginning therefore to be a concern and the consequences very easy to understand, but unfortunately maybe not so easy to understand for our European politicians.
Lack of funding means that bank will have no choice but to shrink their loan books. If it happens, you will have another credit crunch in weaker European economies, meaning a huge drag on their economic recovery and therefore major challenges for our already struggling politicians.

As a reminder, 50% of banks earnings for average commercial banks come from the loan book: no funding, no loan; no loan, no growth; and; no growth means no earnings.

So what does that all lead to, very simple, an American solution, to European woes, namely a European TARP programme in conjunction with a European TLPG programme.

Given the strong correlation between sovereigns and their banks, as recently shown in the CDS markets for both Sovereign spreads and Financial Subordinated CDS for some European banks in the peripherals, it is a serious matter to consider, and no offense to our equity friends complaining about a nasty sell-off (believe me equity friends, you ain't seen nothing yet, like in 2008), if the funding issues we mentioned here are not been addressed, it could get worse, much worse.
I posted this several times, but, remember, a bank is a leverage play on the economy, it is the second derivative of a sovereign. In fact, according to Morgan Stanley, the correlation has been 0.8 with peripherals and European banks in the last 6 months (so what were our equity friends thinking?).

And if our equity friends don't believe this, then maybe these few Itraxx 5 year CDS charts will tell them more about what is going on out there and it ain't pretty in the credit space:
Itraxx Crossover 5 year index (High Yield):

Hey! That W sign on the chart, technically is that a buy sign? I'm afraid not equity friends.

Bank Risk rising? Bank Risk soars above credit crisis peak - Bloomberg - Chart of the Day - Itraxx Financial Index of CDS linked to 25 banks and insurers:

Fact: "The cost of insuring senior bonds of European banks against default is higher than when Lehman Brothers Holdings Inc. collapsed, as funding dries up and concern mount lenders won't get bailed out again" - Bloomberg

What we have is a 37% increase from July 28 to 237 bps as of today.
It was 149 bps when Lehman went down in September and peaked at 211 in March 2009.

So yes, I don't like what I am seeing and here are some more food for thoughts:
Point 1:
Yesterday according to Bloomberg, Lars Frisell chief economist at Sweden's financial regulator told Swedish banks should step up preparations for a freeze in interbank debt markets as Europe's debt crisis is intensifying.
“It won’t take much for the interbank market to collapse,” Frisell said yesterday in an interview in Stockholm.
He added:“It’s not that serious at the moment but it feels like it could very easily become that way and that everything will freeze.”
And guess what I saw today on the 10 year Swedish Goverment bond yield? A massive 22 bps tightening move, which incidentally is the biggest tightening move of the day in the European bond market and I don't like these kind of moves:

10 year Swedish bonds breaking the 2% level yield down.
The three-month Stockholm interbank lending rate reached 2.59% yesterday, the highest since December 2008. The rate rose to more than 5 percent in 2008 as the market froze following the Lehman collapse.

Point 2:
From Bloomberg article today - By Chitra Somayaji - Aug. 18 (Bloomberg)
"U.S. regulators are stepping up scrutiny of local operations for Europe’s largest banks on concern that the region’s sovereign debt crisis may lead to
funding problems, the Wall Street Journal reported today. The Federal Reserve Bank of New York has been holding talks with the lenders and sought information about their access to funds to maintain operations in the U.S., the Journal said,citing people it didn’t identify. The regulator has also been asking some lenders to overhaul their structure, it said. Policy makers, who aim to avert a repeat of the 2008 global financial crisis, are concerned that Europe’s debt problems may curtail the banks’ ability to fund loans and meet their obligations in the U.S., or lead them to siphon funds from the U.S., the newspaper said."

Point 3: Philly Fed - you know the score by now

More fun?
Let's compare Michigan Confidence/Philly Fed and NFP (Nonfarm Payrolls):

Point 4:
Again on Bloomberg, Austria is joining Finland in asking Greece for collateral in exchange of new emergency loans:

“It always was our position in the council that if there is a collateral setup, Austria will participate,” Harald Waiglein, a spokesman for Austria’s Finance Ministry.

"The Netherlands, Slovakia and Slovenia have also expressed interest in getting collateral should the Finns manage to strike a deal, Waiglein said."

"The agreement requires Greece to deposit cash in a state account that Finland will invest in AAA rated bonds. The interest generated will raise the amount, which has yet to be disclosed, to cover Finland’s bailout contribution. The bilateral arrangement needs approval from other euro members,Finland’s Finance Ministry said."

Another risk of European political bickering in the coming weeks. Stay tuned.

And finally, and because it has been a long day and some people, once again, are aging in dog years this week, including me, I give you one last chart, supportive of the deflation story, Swiss 30 years bond versus Japanese 30 years bond:

To be continued!