Bob Carlson

December 18, 2014

The Next Rumble in Europe

Filed under: Economy,Financial crisis — Bob @ 1:20 pm

The depression in much of Europe raises two concerns. One is that poor economic growth there will reduce growth in other countries. The other is more longlasting and dangerous. Economic conditions are so poor in Europe that they are likely to lead to political and cultural upheavals if they endure for long. We’ve seen the fringe parties gain strength in the polls and even some recent elections. With so many youth unemployed with no hope of finding jobs, they are susceptible to appeals from the fringe parties. Here’s a news article discussing some recent demonstrations by extremists in Germany. Without economic improvement in Europe, these events are likely to increase.

Lutz Bachmann, the head of Pegida, a nascent anti-foreigner campaign group, led the crowds, either waving or draped in German flags, in barking chants of “Wir sind das Volk”, or “We are the people”, the slogan adopted by protesters in the historic “Monday demonstrations” against the East German government in the runup to the fall of the Berlin Wall.

Associating themselves with the freedom demonstrations has given Pegida protests an air of moral respectability even though there are hundreds of rightwing extremists in their midst, as well as established groups of hooligans who are known to the police, according to Germany’s federal office for the protection of the constitution.

“The instigators are unmistakably rightwing extremists,” a federal spokesman said.

Geopolitics and the Markets

Filed under: Economy,Financial crisis — Bob @ 9:20 am

The markets are affected at least as much by international affairs these days as by economics. There are a couple of pressing situations. One is Russia, especially regarding Ukraine.

Russia is beset right now by a combination of falling commodity prices and economic sanctions imposed by western countries. This analysis from Stratfor.com indicates that Russia is prepared to endure these problems. They won’t change Russian behavior or lead to the demise of Vladimir Putin. It’s a view most of us haven’t heard or considered and is worth reading.

Russians’ strength is that they can endure things that would break other nations. It was also pointed out that they tend to support the government regardless of competence when Russia feels threatened. Therefore, the Russians argued, no one should expect that sanctions, no matter how harsh, would cause Moscow to capitulate. Instead the Russians would respond with their own sanctions, which were not specified but which I assume would mean seizing the assets of Western companies in Russia and curtailing agricultural imports from Europe. There was no talk of cutting off natural gas supplies to Europe.

If this is so, then the Americans and Europeans are deluding themselves on the effects of sanctions. In general, I personally have little confidence in the use of sanctions. That being said, the Russians gave me another prism to look through. Sanctions reflect European and American thresholds of pain. They are designed to cause pain that the West could not withstand. Applied to others, the effects may vary.

December 15, 2014

The Scoop on the Dodd-Frank Revision

Filed under: Economy,Financial crisis — Bob @ 1:09 pm

The omnibus spending bill pushed through Congress at the last minute contained a change in the Dodd-Frank financial regulation law. Opponents of the change called it a gift to Wall Street and big banks, and people on both the left and the right were united in opposition. But does it really matter? Here’s a post that downplays the significance of the change. The post also includes a roundup of other interesting financial news during the week.

I have my biases, but I have a hard time believing equity derivatives will bring down a bank. Uncleared CDS, I’ll grant you, has a rough track record, though the market is slowly moving away from it in general. But the big derivatives risks, by notional, were going to be allowed to remain in the depository banks anyway. “Oh but no one could be blown up on interest rate swaps,” you say, as the Fed discusses the timing of rate increases.

December 11, 2014

Warning Signs in Europe

Filed under: Economy,Financial crisis — Bob @ 1:17 pm

The European economy is deteriorating, and that’s a risk to global economic growth. More importantly, the European economy is so bad that the political and social structure in many parts of the continent is at risk. Stratfor.com has a clear-eyed assessment of the situation, touching on events and conditions in four key countries. There’s a lot more to know about what’s going on in Europe. Fringe parties and extremists that were popular jokes a few years ago now have realistic chances of doing well in elections and becoming either the dominant parties or key players in coalitions. But the linked article is a good place to start.

When the European Central Bank promised to intervene in financial markets almost two years ago, the European Union lost the sense of urgency it had in the early stages of the crisis. The European Union, and particularly Germany, chose caution instead of action. Should Greece generate financial turmoil in Europe again, the Europeans will have to go back to the negotiating table and discuss all the issues that have so far been avoided.

November 25, 2014

A Dark View of Europe

Filed under: Economy,Financial crisis — Bob @ 9:20 am

For some time, the biggest risk to the U.S. and global economies has been from Europe. Policymakers managed to halt the downward spiral in 2011 and 2012, but they haven’t generated anything close to the growth needed to restore employment to decent levels. Recent data indicate the continent is at risk of losing what growth it has and slide back into negative growth.

People became more optimistic recently after European Central Bank President Mario Draghi indicated the ECB would begin a QE-like program in coming months. But significant actions haven’t been taken, and there are those who doubt they will be, at least as long as Germany is part of the ECB. Here’s a very pessimistic report on the situation that’s probably very accurate. The political situation in Europe is very difficult. The most likely scenario is that Germany leaves the ECB or the weaker economies (Greece, Italy, and others) leave and establish their own monetary policies. And here’s a report of fresh German opposition to Draghi’s plans.

Although the Bundesbank has been careful not to close the door to QE, it is very hard to imagine the circumstances under which it would ever give its consent—and what makes the Bundesbank such a formidable opponent for Mr. Draghi isn’t the formal power that it possesses, which is limited, but the extent to which it shapes and reflects German public opinion.

By the same token, German officials have made it abundantly clear to me that if Mr. Draghi ever tries to buy government bonds, the ECB should be under no illusions that it will face multiple legal challenges from Germany and that the finance ministry will come under intense pressure to mount a challenge itself. If Mr. Draghi didn’t know it before, he must now realize that the political firestorm that would surround any decision to launch QE would be so destabilizing and do such damage to the ECB’s credibility that it would undermine whatever good he hoped to achieve.

November 21, 2014

Long-Term Effects of Severe Downturns

Filed under: Economy,Financial crisis — Bob @ 1:13 pm

There was a lot of debate in 2009 after some economists published research concluding that economic growth always is slower after a financial crisis and that it takes a long time for the economy to return to its old high. Some people disputed the data and conclusions. Now, the Federal Reserve has published new research concluding that indeed growth is much slower after a severe recession and that the economy isn’t capable of higher growth for some time. But the surprise conclusion is that perhaps the Fed shouldn’t keep interest rates low for a long time. It’s possible that inflation could spike up despite all the unused capacity if the Fed stimulates for a long time after the recovery begins.

Fed officials have held their short-term interest rate near zero for nearly six years, in part because they believe the difference between the economy’s output and its potential—the so-called output gap—is large, and should therefore hold down inflation pressures. But if the economy’s potential rate of growth is lower than they thought, that would mean the output gap is smaller than estimated and inflation price increases could start picking up sooner than expected. That would argue for raising interest rates sooner than currently envisioned.

November 11, 2014

Behind the Scenes of the Mortgage Scandals

Filed under: Economy,Financial crisis — Bob @ 1:20 pm

The government’s been busy touting the multi-billion dollar settlements it obtained against major banks for fraudulently selling mortgage securities before the real estate crash. Rolling Stone tells a different story. It interviews an attorney for Chase bank who says the fraud was deliberate and rife, and that the government colluded with the banks to keep the facts under wraps and avoid criminal prosecutions.

Back in 2006, as a deal manager at the gigantic bank, Fleischmann first witnessed, then tried to stop, what she describes as ”massive criminal securities fraud” in the bank’s mortgage operations.

Thanks to a confidentiality agreement, she’s kept her mouth shut since then. ”My closest family and friends don’t know what I’ve been living with,” she says. ”Even my brother will only find out for the first time when he sees this interview.”

Six years after the crisis that cratered the global economy, it’s not exactly news that the country’s biggest banks stole on a grand scale. That’s why the more important part of Fleischmann’s story is in the pains Chase and the Justice Department took to silence her.

She was blocked at every turn: by asleep-on-the-job regulators like the Securities and Exchange Commission, by a court system that allowed Chase to use its billions to bury her evidence, and, finally, by officials like outgoing Attorney General Eric Holder, the chief architect of the crazily elaborate government policy of surrender, secrecy and cover-up. ”Every time I had a chance to talk, something always got in the way,” Fleischmann says.

November 7, 2014

Europe on the Edge

Filed under: Economy,Financial crisis — Bob @ 6:20 pm

The European Central Bank concluded its recent meeting by keeping interest rates unchanged. But it didn’t announce a big policy to boost monetary policy, despite signs of falling inflation and growth. But ECB President Mario Draghi said the staff is preparing a policy to implement when needed. That promise continues to drag the euro down against the dollar but it isn’t inspiring confidence yet that it will help the European economy. Read a roundup here.

To keep the euro zone from slipping into deflation, the ECB has started pumping more money into the banking system through purchases of private debt and offers of long-term loans, aiming to boost its balance sheet by up to 1 trillion euros.

There is growing doubt whether these measures will be enough, but the ECB is expected to wait until it gets a clearer view of the impact of its asset purchases and four-year loans to banks before moving further.

Sources close to the ECB have told Reuters that its plan to buy private-sector assets may fall short and pressure is likely to build for bolder action early next year, firstly moving into the corporate bond market.

November 4, 2014

Financial Crises and Growth

Filed under: Economy,Financial crisis — Bob @ 1:20 pm

During the depths of the financial crisis, debate was ignited by the publication of This Time is Different, a book that argued, among other things, that after a financial crisis it takes a long time for economic growth to return to normal. Though questions arose about some of the data later, most analysts accept the data, arguments, and conclusions. Now, a couple of economists weigh in on the other side. This article provides a good summary of both sides of the debate.

Their finding: Declines in economic output, as measured by gross domestic product and industrial production, following crises were on average moderate and often short-lived. There was a lot of variation in outcomes, so there was nothing cut and dried about how economies respond to crises.

The Romers further point out that, in some cases, financial crises are set off by weakness in the economy. That makes it difficult to determine what counts as crisis-related declines in output and what doesn’t. “Thus, our estimates are, if anything, likely to be an overestimate of the impact of financial distress,” they write.

Mr. Rogoff says that he and Ms. Reinhart have “some fundamental areas of disagreement” with the Romers’ work “that I’m sure will be sorted out over time by further discussion, further revisions, further research and further papers.”

October 17, 2014

Dangers of Large Mutual Funds

Filed under: Economy,Financial crisis,Investing — Bob @ 5:20 pm

Some of you might remember back to the stock market crash of October 1987, when major indices fell about 25% in one day. There was a lot of finger pointing at the time about the cause, but I remember a number of people saying that a major mutual fund company decided to unload a lot of stocks quickly. That crash of 1987 happened and reversed quickly, partly because stock markets are so big and liquid. But what about other markets, such as high-yield and distressed bonds.

New attention is being drawn to the fact that a few large mutual fund companies control major positions in some asset classes and even in the bonds of some companies. There are several potential concerns. One is that all this mutual fund buying gives a false picture of how liquid and efficient the market is. Another concern is that if these funds suffer large redemptions they’ll have to sell the bonds quickly and at whatever price they can. It could be like the fall of 2008 again. Read the linked article for more.

The chief risk officer of Goldman Sachs, Craig W. Broderick, warned at the I.M.F. meetings last week that the asset management firms that now hold the bulk of these bonds had not yet been tested in terms of how they would react to a market shock.

“Now there is plenty of liquidity,” Mr. Broderick said. “But when things are different, the alternative providers will not be there.”

The term of art for this scenario is a liquidity mismatch, with some going so far as to call it a systemic liquidity mismatch. If, for example, there is a sustained emerging-market crisis and a fund wants to liquidate these bonds to meet redemption demands, the manager will be required to provide cash immediately even though it may take several days to sell the securities in question.

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