Wednesday 23 March 2011

"the more it changes, the more it's the same thing" - Review of the ongoing economic issues

"plus ça change, plus c'est la même chose"—"

Jean-Baptiste Alphonse Karr (November 24, 1808 – September 29, 1890)
French critic, journalist, and novelist.

Ireland 10 year bonds are trading now north of 10% for the first time since December 1992.
As I previously posted, we are in a time machine and just made a quick trip to the past:

European Government Bonds - Back to the Future?
"From 1991 until 2010 Ireland's Government Bond Yield for 10 Year Notes averaged 5.72 percent reaching an historical high of 10.47 percent in December of 1992 and a record low of 3.06 percent in September of 2005."

The yield on Ireland’s two-year securities rose 57 basis points to 10.44 percent. The 10-year yield exceeded 10 percent for the first time since the euro was introduced in 1999.

The problems is that the Irish financial sector troubles are just too big now for the Irish Government to cope with.

According to a recent article in Bloomberg by Joe Brennan published on March 18, "Ireland Said to Weigh Allowing Banks to Set Up Asset Warehouse"
Ireland is finally giving in setting up an Irish "Resolution Trust Corporation".
Joe Brennan commented:

"Irish authorities are considering allowing the country’s debt-laden lenders to set up a company to warehouse more than 60 billion euros ($84.8 billion) of loans that would be wound down or sold over time, according to three people familiar with the matter."

The reality behind this move is that the deposit outflows experienced by Irish banks since last year is making them increasingly dependant on funding from the ECB.
From the same article:
"Irish central bank Governor Patrick Honohan said the ECB wanted to accelerate deleveraging, Ireland has “put in the condition of no fire-sale losses because the state cannot afford it,” he said."

On the 31st of March we will get the results from the capital and liquidity stress tests on Irish Banks.

Joe Brennan added:
"So-called viable lenders, including Bank of Ireland Plc, Allied Irish Banks Plc (ALBK), Irish Life & Permanent Plc and EBS Building Society, need to cut their loan-to-deposit ratios to 122.5 percent, “which is acceptable to Europe,” Finance Minister Michael Noonan said March 14. The average loan-to-deposit ratio is currently about 170 percent."

From TBTF (Too Big To Fail) to TBTB (Too Big To Bail)...

Joe Brennan also indicated in Bloomberg news the following sobering fact:
"Irish Credit Bureau Chief Executive Officer Seamus O’Tighearnaigh said that 9.5 percent of loans registered with the company are at least one month in arrears, up from 0.75 percent in 2006, the Sunday Times reported."

The example of Ireland clearly showed the issue, where Ireland's public finances were put in disarray due to the massive bail out need of its financial sector (please see previous posts on that subject: The European Vortex, The Irish Black Hole, Ireland in the need of a lucky Shamrock).

5 years CDS on Portugal stands at 536 bps and Ireland 5 years CDS increased by eight basis points to a seven-week high of 625 bps, according to CMA.

Portugal's government as well is collapsing, given parliament is not willing to bite the bullet and to accept the latest austerity measures proposed by the government. Another EU member bites the dust as I type this latest post. You can expect another bumpy ride in the Eurozone.

The housing hangover issues are still the biggest problems plaguing not only the Irish economy but the US economy as well.

U.S. New-Home Sales fell to the lowest level on record:

Yes indeed, the more it changes, the more it stays the same...

Bank of America CEO Brian T. Moynihan said:
"The problem of delinquent mortgages and falling home values is the most stubborn, entrenched and damaging economic problem our country faces today."
Bank of America's CEO is correct. I touched on the subject of the impact of real estate on the US economy in my post "Extend and Pretend" - Banks bloated balance sheets and the Impact of Real Estate crisis.

January home prices in the U.S. fell 0.3 percent from December, according to the Federal Housing Finance Agency. Prices nationwide fell 3.9 percent in the 12 months ended in January.

So big is the issue that Bank of America had to segregate almost half of its mortgages Into ‘Bad Bank’ according to Bloomberg report from Dawn Kopecki published on the 8th of March:

"The legacy portfolio will hold 6.7 million loans with outstanding principal balance of about $1 trillion."

"Of the 13.9 million loans Bank of America services, about 3.5 million are held by the company on its balance sheet. The rest are owned by other investors."

"Bank of America services 14 million mortgages, or one out of every five in the U.S., and its loan-servicing portfolio exceeds $2.1 trillion in size. Of its mortgages, 10 million came from its 2008 acquisition of troubled California lender Countrywide Financial Corp. More than 80% of its delinquent loans were acquired through Countrywide."

Bank of America is also actively selling its exposure to commercial real estate:
BofA Is a ‘Very Active’ Seller of Commercial Real Estate to Limit Losses
The US Treasury is as well reducing its portfolio of Mortgage Backed Securities, looking at selling 142 billion USD worth of MBS guaranteed by Fannie Mae and Freddie Mac at the tune of 10 billion per month.

As I wrote in "Resolution Trust Corporation II - the unavoidable Sequel", 1 out of 4 US Household is already in negative equity, "Desperate times need decisive action and setting up a new RTC would definitely be the right move in the right direction".

For more on the difficult situation for the US economy and the impact of households in negative equity please look at the following post:

The end of the American Dream, the call for trade barriers and the rise in populism...

So far 25 banks failed in the US in 2011. 157 banks failed in 2010 according to FDIC. Increasing loan losses on commercial real estate are expected to result in hundreds of bank failures in the coming years.
The Unofficial Problem Bank list on the 19th of March stands at 982 institutions with assets of 430.4 billion USD, up from 964 institutions with assets of 420.7 billion USD as per the excellent CalculatedRisk blog.

For Robert Burney, a banking and finance professor at Coastal Carolina University:
"It's a race between deteriorating portfolios and recovering economies,"
Read more:

The US need more job creation but negative equity weights heavily on job mobility:
Non Farm Payrolls from 1992 onwards.

At the same time inflation in the UK keeps creeping up, no surprise there. It was expected previously on numerous posts on this blog.

UK inflation from January 1989 until March 2011:

Mervyn King at the Bank of England doesn't seem to be able to keep the ink dry, yet another letter to the Chancellor.

The Bank of England purchased around 165 billion GBP of assets by September 2009 and around 175 GBP billion of assets by end of October 2010.

Any coincidence with the rise in inflation in the UK is of course purely fortuitous given QE started in March 2009...

As a reminder of the risk of QE:
"Quantitative easing may cause higher inflation than desired if it is improperly used, and too much money is created. It can fail if banks are still reluctant to lend money to small business and households in order to spur demands. Quantitative easing can effectively ease the process of deleveraging as it lowers yields. But in the context of a global economy, lower interest rates may contribute to asset bubbles in other economies."

Consumer confidence in the UK is still at the lower end:
January 1992 - March 2011

Are we seeing asset bubbles in other economies? China? Brasil? Etc.
Most certainly. QE is exporting inflation first in emerging markets then back to developped countries:

Both the UK economy and the US economy are in "The Hurt Locker".

As a reminder from previous post The Endgame - Fin de partie:

Inflation, Not Deflation, Mr. Bernanke
By Andy Xie 08.16.2010 18:12
"The globalization reality is that developed economies like Europe, Japan, and the U.S. will suffer slow growth and high unemployment. Stimulus is the wrong medicine for solving problems. Believing this will lead to excessive stimulus, which causes inflation and bubbles in emerging economies first and inflation in developed economies later. The wrong policy prescription pushes the global economy through unnecessary gyrations, stagflation and possibly another major financial crisis in the emerging economies. It's high time for Mr. Bernanke to wake up from his stimulus obsession."

Can we expect QE3?

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