The acceleration in the deterioration of Sovereign Credit - The impact of youth unemployment and the jobless recovery.

"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."
Dwight D. Eisenhower.
Farewell Adress - 17th of January 1961


Interesting Regression Analysis - as displayed by M&G Investments:

The issue is clear, youth unemployment is very high in peripheral countries in Europe. The danger being, the higher the rate of unemployment, the higher the risk for social unrest linked to the deterioration of Sovereign Credit, the slower the economic growth:

European map displaying Youth Unemployment Rates for 2009:

As the below graphs, shows, there is clearly a divide in Europe and the speed of the economic growth is impaired for many countries, such as Italy and France due to the very high level of unemployment for youths. Italy and France are in the danger zone clearly. They are already above the European average rate for youths unemployment rate. It does not bode well for the economic growth of the countries above the average. Structural reforms are urgently needed. Spain cannot delay any longer structural reforms of its very inefficient labor market.

The performance of labor markets generally reflects the performance of the economy as a whole.

Germany is powering ahead, with its very low youth unemployment level:

It is very important to look at the impact of youth unemployment in the light of recent events in Tunisia and now Egypt. There is a direct correlation to these events. It does not bode well for other countries facing similar youth unemployment levels, in the table below you can see the levels of the youth unemployment rates in 2001:

Youth unemployment clearly plays for a large part in the social unrest we have recently witnessed in Tunisia and now Egypt.

http://news.blogs.cnn.com/2011/01/28/young-educated-and-underemployed-the-face-of-the-arab-worlds-protesters/

"Muslim-majority countries in North Africa and the Middle East have the highest percentage of young people in the world, with 60 percent of the regions' people under 30, according to study by the Pew Forum on Religion and Public Life."

The arabic countries have a growing youth population:

CDS spreads for North African and Middle-East are widening due to the contagion from Tunisia (October 2010 until End of January 2011):

North African Middle-East CDS OCT10-JAN11 - Egypt, Lebanon, Tunisia, Morocco:

Sovereign Wideners for the 28th of January 2011 - CMA's Sovereign CDS data:

Egypt's cumulated probability of defaults now stands at 24%, above Spain which stands currently at 21% according to CMA.

Are young arabs satisfied with efforts to increase the number of quality jobs? (Gallup survey April 2009)

The jobless recovery:
During the recent crisis, youth unemployment has surged dramatically. The jobless recovery is a serious obstacle to the reduction of youth unemployment and rapid economic growth:

http://www.euractiv.com/en/socialeurope/eu-faces-jobless-recovery-admits-andor-news-501633


"EU Employment Commissioner László Andor has admitted that the EU is experiencing a "jobless recovery", amid warnings from the International Labour Organisation (ILO) that the situation might not improve this year."

"More than 23 million workers are currently registered as unemployed across the whole of the EU. This means that the number of job seekers has increased by 46% (some 7.3 million people) since March 2008.

Europe's young people are facing an especially difficult situation. Across the EU as a whole, the youth unemployment rate, for those under 25 years of age who are not in full-time education, is now at a record level of 21%."

"Young people in Spain face an especially difficult challenge in trying to find work, as more than 43% of young people under the age of 25 (not counting those in full-time education) are registered as unemployed."

"It is key that reforms are undertaken to reduce the rigidity that characterises many European labour markets. Flexibility is crucial in times of recovery in order to promote job creation," BusinessEurope declared.

For those of you who would like to go through the latest report on the Global Employment Trends for 2011, the International Labor Organization (ILO) report is available at the following address:

http://www.ilo.org/global/publications/ilo-bookstore/order-online/books/WCMS_150440/lang--en/index.htm


The jobless recovery is typical of a balance sheet recession.

In the US, unemployment among people under 25 with bachelor’s degrees reached 9.6% in December, up from 8.6% in November and 5.9% just two years earlier. A stagnant labor market means the USA cannot create enough jobs for the thousands of young people set to graduate in 2011.

Are we going to witness a major conflict between generations? We were warned by Dwight D. Eisenhower in his prescient Farewell Address delivered 50 years ago on the 17th of January 1961, a must read...

"Crises there will continue to be. In meeting them, whether foreign or domestic, great or small, there is a recurring temptation to feel that some spectacular and costly action could become the miraculous solution to all current difficulties."
What would Dwight D. Eisenhower have thought about Bernanke's QE2, about TARP, about Alan Greenspan?

In his great farewell speech Dwight D. Eisenhower also added:
"But each proposal must be weighed in the light of a broader consideration: the need to maintain balance in and among national programs, balance between the private and the public economy, balance between the cost and hoped for advantages, balance between the clearly necessary and the comfortably desirable, balance between our essential requirements as a nation and the duties imposed by the nation upon the individual, balance between actions of the moment and the national welfare of the future. Good judgment seeks balance and progress. Lack of it eventually finds imbalance and frustration. The record of many decades stands as proof that our people and their Government have, in the main, understood these truths and have responded to them well, in the face of threat and stress."

Dwight D. Eisenhower's wisdom was clearly not taken onboard. He would have been deeply shocked by the Financial Crisis Inquiry Report
and its conclusions but that's another matter...

Resolution Trust Corporation II - the unavoidable Sequel

How to fix the US Commercial Real Estate Mess:

The US need a Resolution Trust Corporation similar to the one put in place during the Saving and Loans Crisis. The RTC was established in 1989 until mid 1995 and closed or otherwise resolved 747 thrifts with total assets of 394 billion USD.

http://en.wikipedia.org/wiki/Resolution_Trust_Corporation

"The Resolution Trust Corporation pioneered the use of so-called “equity partnerships” to help liquidate real estate and financial assets which it inherited from insolvent thrift institutions. While a number of different structures were used, all of the equity partnerships involved a private sector partner acquiring a partial interest in a pool of assets, controlling the management and sale of the assets in the pool, and making distributions to the RTC reflective of the RTC’s retained interest."

Between 1986 and 1991, the number of new homes constructed per year dropped from 1.8 million to 1 million, which was at the time the lowest rate since World War II.

Where are we now? In a worse situation than anytime between 1986 and 1991.



The hole is much deeper. We have beaten the record since the Saving and Loans crisis. Desperate times need decisive action and setting up a new RTC would definitely be the right move in the right direction.

We have a lot to learn from the Saving and Loans crisis:

http://en.wikipedia.org/wiki/Savings_and_Loan_Crisis#Imprudent_real_estate_lending

"Between 1980 and 1994 more than 1,600 banks insured by the Federal Deposit Insurance Corporation (FDIC) were closed or received FDIC financial assistance."

How many banks failure have we had so far this year? 129 banks went under and the year is not over yet.

In 2009, 140 banks failed.

Because the situation is worse than during the Savings and Loan Crisis, where 1600 closed down or received help, you can expect more bank failures in this ongoing crisis.

http://bankpred.blogspot.com/

"If you look at the most recent FDIC statistics on problem banks, you would see that there were 829 problem banks at the end of the last quarter."



Don't believe the situation is improving in the CMBS space:



This is what the banks are in fact doing with their damaged Commercial Real Estate Exposure:



B notes are comparable to Sub debt where the coupon payment is deferred (similar to Upper Tier 2 financial paper).

But it isn't only happening in the Commercial Real Estate space. Many large banks have recently suspended foreclosures, kicking the can down the road:

http://online.wsj.com/article/SB10001424052748704657304575539963605720860.html

"As of August, there were more than 4.4 million home loans that were either in the foreclosure process or 90 days past due, according to mortgage research firm LPS Analytics. Since 2006, about 6.4 million homes have been lost through the foreclosure process."

According to the article, it is due to documentation issues...I don't believe it is the real reason.

"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."

Given that 1 out of 4 US Household is already in negative equity, you can do the math.

The Mortgage mess:



In addition to the rising delinquencies in Mortgages, the Unsecured Home Equity Loans exposures of large US banks have not been resolved (the HELOC time bomb).



http://www.housingwatch.com/2010/04/13/the-heloc-bust-next-problem-for-big-banks/

"In an interview with Bloomberg, CreditSights' senior bank analyst Baylor Lancaster said: "While a lot of people are looking for dramatic improvement in the short term, one area that still has to be worked through in a material way is home equity." The writedowns from HELOCs are not likely to show up in earnings reports until later this year, Lancaster said."

"Together with Citigroup the banks hold about 42 percent of the $1.1 trillion in second-home liens. Unlike first mortgages, they are typically not bundled and sold off to investors but kept on the banks' books. The biggest home-equity lender in the U.S. is Bank of America, holding some $138 billion in such loans. Wells Fargo has about $123.8 billion of home-equity loans."

In addition to these unresolved issues:

"Fannie and Freddie are "actively exercising their right to put back to the original lenders a considerable amount of the troubled mortgages in their portfolios," write analysts Tom Abruzzo and Christopher Wolfe. The agencies have a right to require lenders to buyback delinquent mortgages, if it is determined the mortgage loan did not meet GSE investor underwriting or eligibility standards."

http://www.housingwire.com/2010/08/19/fitch-big-four-banks-face-180bn-in-buybacks-from-fannie-and-freddie?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed:+housingwire/uOVI+(HousingWire)

"Under a moderate loss scenario, in which the banks buyback 35% of delinquent loans and recover 55% of the money, Fitch expects losses around $27bn."

http://www.benzinga.com/10/09/485561/%E2%80%9Cthe-giant-elephant-in-the-room%E2%80%9D

"“Home equity is the giant elephant in the room and everybody knows it,” said Anthony Sanders, a finance professor and director of the Center for Real Estate Entrepreneurship at George Mason University."

"“If 25% of mortgages are underwater, [the second liens on those homes] should be classified as nonperforming loans, which would require a 50% reserve,” said Rebel Cole, a finance and real estate professor at DePaul University in Chicago and a former Federal Reserve Board economist."

"The four institutions now hold at least $423 billion of home equity loans, including $151 billion of loans to borrowers who are either underwater or close to it, according to data provided to the House Financial Services Committee in April."

You need to watch very closely the delinquency rate for second liens loans.

"Banks are required by regulators to charge off loans after 180 days of nonperformance, according to the Fed and the Office of the Comptroller of the Currency, which supervises large banks that service 65% of all mortgages.

A bank does not have to classify a home equity loan if the value of the property has dropped, said Bryan Hubbard, an OCC spokesman.

But Cole and others argue that banks ought to reassess the underlying credit quality of loans and account for problem credits if the collateral has changed. “Regulators have the power to force the banks to reserve against these loans, but choose not to do so,” he said."

"Gerald Hanweck Sr., a finance professor at George Mason and a former visiting scholar at the Federal Deposit Insurance Corp., agreed that banks are loath to take losses on performing loans even if the value of the home has dropped 30% or more and a default is likely."

"“The banks have been accounting for [home equity loans] at par and the reason is that supervisors won't force the writedowns,” Hanweck said. “If the loan is performing, that's their fallback, but the underlying value of the property is still less and is insufficient to support the valuation.”

But forcing writedowns would have negative consequences for capital positions, which banks have spent the last few years rebuilding and will have to further buttress in coming years under the new Basel III standards."

Allowing banks to repay TARP money early was not a smart move:

"Lenders Balk at Buying Back $11 Billion in Bad Loans from Fannie Mae and Freddie Mac"

http://www.realestatechannel.com/us-markets/residential-real-estate-1/real-estate-news-fannie-mae-freddie-mac-edward-j-demarco-federal-housing-finance-agency-bad-home-loans-loan-default-rates-home-foreclosures-fhfa-3266.php

"Banks that sold bad mortgages to Fannie Mae and Freddie Mac promised to buy the loans back, according to their regulator. But many of the nation's largest institutions aren't living up to their end of that commitment, reports DSNews.com."

http://www.thestreet.com/story/10865656/1/mortgage-buybacks-hit-profit-not-capital.html

"Miller's assumptions for a "base case" scenario show that Bank of America stands to lose $9.1 billion, or 34 cents per share, on both Fannie-Freddie and private-label buyback demands. JPMorgan Chase stands to lose $8.7 billion, or 27 cents per share; Citigroup stands to lose $3 billion, or 5 cents per share; Wells Fargo $2 billion, with no per-share loss estimate provided; SunTrust $1.05 billion, or 31 cents per share; Morgan Stanley $948 million, or 44 cents per share; and other lenders less than $500 million."

Setting up a new RTC would alleviate the burden face by banks. Until all the toxic assests have been dealt with, the crippled financial sector will not function properly. The banks are hoarding cash due to these issues and cannot participate in a sustained recovery through lending and enabling investment. It will take a very long time to clean up all the mess. By not appropriately dealing with these toxic assets issues today via a new RTC means it will take a much longer period for the economy to heal. We will see more bank failures in the process.

Hemingway: Kicking a can down the road illustrated...

The 750 billion Euros Poker hand: All in !

The G20 and the ECB finally caved in to the Markets and the Nuclear option plan, Quantitative Easing. Central bank have been instructed to buy Government bonds (Greek debt as well...) on the secondary market.

Again, we are pointing towards the same road, deflation then inflation.

As I said it before, the game is to debase the currency and generate inflation down the line, the EU follows the path of the US and the UK, as Japan did previously, and failed.

This is why Gold has not retraced significantly.

Gold is now a one way market, the only way is up, as Yazz sung back in 1988:

"We been broken down
the lowest turn
and been on the bottom line
sure ain't no fun
but if we should be evicted from our homes
we'll just move somewere else
and still carry on
Hold on, Hold on, Hold on

Chorus
The only way is up, baby
For you and me, baby
The only way is up
For you and me"



The G20 governments are basically postponing the day of reckoning and delaying the bond vigilantes. The structural issues have not been adressed yet. Also who is going ultimately to pay for this?

For the time being the bond vigilantes have been kept at bay, but should financial and fiscal discipline not materialise in the near future, you can expect them to be back with a vengeance.

The massive rally we have seen from CDS indices moving dramatically tighter to bank shares massive double digits equity moves, it really points to short covering, particularly in respect to the EUR/USD.

The big challenge is still very real. Following the financial crisis, banks have been busy repairing their balance sheets, credit has not flown dramatically back into the economy and banks have been net buyers of treasuries, borrowing at zero and locking a nice spread in the process.
Now countries are facing a similar music. Most European countries need to repair their public finances. For some, like the UK it will be easier as the UK control its currency.

In relation to the latest bail out:

David Goldman in his excellent blog Inner Workings sum it up nicely:

http://blog.atimes.net/?p=1463

"The banking system really was about to come down. The reason is that sovereign debt is a bigger problem than subprime mortgages ever were. We know from available data that two-thirds of the US deficit, according to available numbers, has been financed by domestic as well as foreign banks during the last quarter of 2009 and the first quarter of 2010. This is clear from the Treasury’s data on international capital flows, which shows $50 to $60 billion a month worth of purchases of US Treasury securities from abroad, almost all of it from London or the Caribbean, that is, offshore banking centers. US banks meanwhile are adding Treasuries to their portfolios as fast as they shed commercial and industrial loans. Detailed data is not available on international banks’ holdings of Greek, Spanish, Portuguese or Italian bonds, but we know from anecdotal evidence that the weak sisters of southern Europe have been financed by bank treasuries just as the United States has.

It’s all been done by smoke and mirrors. The governments bailed out the banks in September 2008, and again in various increments through the Spring of 2009. The great Keynesian stimulus that was supposed to guarantee recovery left most industrial countries with government deficits in excess of 10% of GDP. How does the US finance a deficit equal to 12% of GDP with a savings rate of 2.5%? By bank leverage. The banks, once bailed out by the governments, in turn bail the governments out. And when the weaker governments threaten to go belly up, the banking system freezes up."

This is why a decisive action had to be taken, the system was freezing up again, the signs were very clear in the credit markets, looking at the TED spread as well as the OIS-Libor rate. The interbank market was drifting towards a Lehman style freeze.

Since the near collapse of the financial system, the patient who already had one cardiac arrest had to be resuscitated. Following TARP, this is the second defibrillator attempt.