Greece; a country on the edge of a nervous breakdown

Greece is  only days away from national humiliation. The Greek government will admit what we all already know-that it can no longer service its debt. It will ask its creditors to restructure and write down government liabilities to more manageable levels.

Understandably, the Greek people have become deeply pessimistic about the future. This is reflected in the latest consumer sentiment surveys. Sentiment has fallen off a cliff, and Greeks are on the edge of a collective nervous breakdown.

Nevertheless, it is wrong to think that Greece is an outlier. It is not a special case. It is not unique. The Greek government made the same mistakes that other European countries made.

Yikes

From the Telegraph.....

The total exposure of foreign banks to the struggling quartet of Greece, Ireland, Portugal and Spain tops $2.5 trillion (£1.6 trillion) once all forms or risk are included, according to the latest data from the Bank for International Settlements.

Italy needs money now

Am I being too cynical....?

Italy has asked for financial aid from the European Union to cope with what it said could become a mass influx of refugees from the uprising in Libya. The interior Minister Roberto Maroni said, somewhat hysterically Italy “cannot be left” to handle the impending exodus alone.

For good or ill, the Libyans seem ready to stay at home. Cecilia Malmstrom, the E.U. commissioner for home affairs, said "For the moment, we have not seen any people coming to Europe from Libya. There has been a considerable decrease of people coming from Tunisia."

It is always good to prepare for every contingency, especially if it involves a large handout from Brussels

Goodbye Axel Weber and Kevin Warsh - we will miss you

Yesterday, Paul Krugman took another step on his journey from esteemed academic to banal journalist. In the New York Times, he produced a short and nasty piece on the departure of two highly respected central bankers, Axel Weber of the Bundesbank and Kevin Warsh, of the Federal Reserve.

Here is what Krugman had to say:

Eurozone inflation creeps upwards

In December, the Eurozone inflation rate crept above the 2 percent target. Higher food and energy prices were the primary reason for the above target out-turn. However, if these items are extracted from the Eurozone CPI, then inflation was broadly flat at around 1 percent

Ten things you should know about US foreclosures

Ten horrible facts about the terrible condition of the US housing market and the phenomenal rate of home foreclosures.

Financial sector profitability, how things have changed.

"From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent.

In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent. Pay rose just as dramatically.

From 1948 to 1982, average compensation in the financial sector ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007."

Simon Johnson, "The Quiet Coup", The Atlantic (May 2009).

UK bond yields - where are they going?

Since early October, the yield on 10 year UK government bonds has crept up 73 basis points. That is equivalent to three typical hikes of the Bank of England's bank rate.

Should we worry? Have financial markets finally realized that the government may have difficulties in repaying the huge amounts of debt it has issued since the financial crisis began?

There are at three reasons for taking a calm and measured approach to rising bond yields:

• Yields were higher earlier this year - In February, the yield hit 4.23; currently the yield stands at 3.69.  Back then the investors were worrying about an election, and the possibility of a renewed Brown mandate.  As the election approached, investors calmed down as New Labour's poll numbers declined.   
• The government has announced a fiscal consolidation plan - The coalition has what appears to be a credible plan to reduce the deficit.  It is also prepared to enact difficult measures, such as hiking university fees, increasing the coalition's credibility in terms of dealing with our huge fiscal difficulties.
• Rates need to rise anyway - If the UK economy is to return to anything looking like normality, then interest rates will have to rise, including bond yields.  Therefore, the recent increase reflects better growth prospects and a move towards stability. As such, we should welcome this modest upward shift in yields.

Overall, these are plausible arguments.  Nevertheless, the monetary policy committee seem to be behind the curve.  Their unwillingness to raise rates has increased perceptions that the inflation rate in the UK may start to pick up.  Recent inflation data underlines this threat. The Bank of England's survey on inflation expectations, released earlier this week, confirms that people are expecting higher inflation in the future.

If inflation were to pick up further, then yields would begin to pick up extremely rapidly.  Financing new government debt will become more expensive. If yields increase dramatically, then the government's fiscal reduction strategy may be in jeopardy.  There would also be negative effects on private consumption and investment.

An early hike in the bank rate would go a long way to reducing these concerns.  It would send a signal that the MPC will tackle any inflationary pressures.  It would also signal that the UK economy has started to take the first tentative steps towards the exit in terms of the financial crisis.

Unfortunately, the MPC have one eye on the large rollover problems that UK banks have to face next year and 2012.  You see, it is always about the banks.  The UK economy would benefit from a rate hike, but that banks would be squeezed. 

In any choice between the interests of financiers and and the rest of us, the financiers always seem to win.

Socially useless, privately useful.

Earlier this week, Lord Turner described much of our banking sector's activities as "socially useless". Well, if much of banking provides no value to society, why do bankers bother? The reason is simple, industry insiders are using these "socially useless" activities to rip off shareholders and savers.

Whatever bankers might say, running a bank is a straightforward business. A bank makes loans, and receives interest. It also provides non-lending services, such as money transfers, exchange rate sales, for which it receives fees. So long as a bank lends to firms and individuals who can pay back the loans, then the cash just rolls in.

Once the cash floods into the bank, it needs to be distributed. Some of it needs to go on running costs. Of course, the government needs their cut; a modest amount of tax needs to be paid. The rest goes to either the staff, the shareholders, or to depositors.

For the jokers who run banks, the question is simple; how do we get to keep as much of the residual profits without passing it on as interest payments to depositors or alienating the shareholders?

The answer is to generate a huge quantity of useless financial transactions which can be passed off as risk management techniques. These transactions, which are typically described as derivatives, generates huge bonuses for the staff and neatly redistributes income away from shareholders and depositors.

So, Lord Turner is right when he says that much of banking is socially useless. However, for bank staff, it is privately very useful. It keeps the profits of banking in the pockets of bankers at the expense of the rest of us.

This time it is different

Between 1964 and 2007, the UK fiscal deficit averaged 2.7 percent of GDP. Some years it was higher, others it was lower.

However, no government ever attempted to push the deficit into double digits.

Until now......

So, there is nothing to worry abou then....

Central bankers continue to be complacent about the risks of inflation...

From the FT...

The world’s central bankers were in no hurry to start raising interest rates as they headed home on Sunday from the US Federal Reserve’s annual retreat in Jackson Hole, Wyoming.

In private and in public, most officials indicated they believed that rates could be maintained at ultra-low levels for a considerable time without generating excess inflation, in spite of better economic data and a return of “animal spirits” in financial markets.

Some used the platform of the conference to push back against calls for early implementation of “exit strategies” that would reverse the current extraordinary degree of monetary stimulus.

“There is no reason to re-assess our monetary policy stance,” Erkki Liikanen, Finland’s central bank governor, told Bloomberg news agency. Ewald Nowotny, Austria’s central bank chief, said he did not favour adding a surcharge to the European Central Bank’s next offer of one-year loans to banks – a view shared by some other European officials in Jackson Hole.

At last some sanity...

The government needs to reverse this foolish VAT cut as soon as possible

From the Guardian....

The Treasury dashed hopes of an extension to the government's VAT holiday tonight after the latest figures for public borrowing revealed a collapse in tax revenues and prompted City forecasts of a £200bn deficit for the whole financial year.

With the City taken aback by the rapid deterioration in the state's finances, aides to the chancellor, Alistair Darling, stressed that the Treasury could not afford the £12bn cost of the VAT cut for a second year and the tax would return to 17.5% from January 1.

It is only a matter of time

When the UK finally slips into a government borrowing crisis, what is the likelihood that we will be told that it was totally unforeseeable? "We never realized that government bond yields could increase to 10 percent overnight".

July's public finance numbers were truly awful. In a normal July, the government runs a surplus. The reason for this seasonality is straightforward. The corporate sector often pays its taxes on a three monthly basis, and July is a big tax month.

However, this July the government ran up a deficit of ₤5 billion. So far this year, the deficit is running at ₤43 billion. This number will soon start to rocket. Typically the government receives most of its revenues in the between January to April as the tax year ends. The last six months of the year, the government always runs a deficit.

The writing is now on the wall for government finances. The UK deficit is unsustainably large. The clock is ticking. Something big is going to happen within the next 12-18 months.

We are now looking at three scenarios. Under the first scenario, the government stops spending, raises taxes and reduces the deficit through an emergency budget. Under the current government this is extremely unlikely, but I still hold out hope that Cameron and Osbourne will do the patriotic thing when they are elected next summer.

In scenario two, the private sector call time on the deficit and refuse to lend more money. Interest rates on government debt will rise and the government will get the message and revert to option one. Be warned. This could happen quickly and may be linked to a sterling crisis.

In scenario three, the Bank of England continues to buy government debt with newly printed cash. The private sector gently exits from the UK bond market as King and the MPC monetize the deficit. This is basically the Zimbabwean economic model. It is likely to have the same devastating effects on growth and living standards here in the UK if the Bank of England and the government persist with quantitative easing.

However, there are precious few signs that the monkeys running monetary and fiscal policy are thinking beyond a nine month horizon. The UK economy is now drifting into some very dangerous territory, and when we do nosedive into a crisis, be ready for the "I didn't see it coming" excuses.

Such complacency

Bernanke consistently got it wrong before the US housing bubble burst. Now, he is pumping up the money supply to revive the economy. Since his judgement has been so poor in the past, does anyone have any confidence that he is getting it right now?

UK house price to earnings ratio converging to long run average

According to the Halifax, the long run price to earnings ratio is almost exactly four. Currently, the ratio is 4.33, falling from an all time high of almost six.

The Halifax ratio was calculated using ₤36,576, which is apparently the national average wage for a man in full time employment. (I will let the obvious sexist implications of using that measure pass). The average house price is estimated to be ₤159,623.

What do you think? Is the crash over, and the boom about to begin? Should we believe the Halifax numbers?

Loan shark who charged 2,437 per cent

Obviously, Mr. Kiely didn't hear about the Bank of England's zero interest rate policy. From the Telegraph....

John Kiely, a loan shark, was branded a "ruthless individual" by a judge in Manchester as he was jailed. Kiely, 36, was sentenced to five years at Manchester Minshull Street Crown Court for offences including blackmail and illegal money lending.

Judge Adrian Smith told multi-millionaire Kiely: "It's clear to me you are a ruthless individual who has displayed a high degree of criminal sophistication." Kiely charged up to 2,437 per cent interest on loans and used an army of enforcers to collect debts owed by poor families on Manchester housing estates, the jury that convicted him last month heard.

One of his victims, Donna Ockerby, 45, claimed she was left fearing for her life and was forced to move to a secret location to escape him. Kiely was convicted of two counts of blackmail for his actions towards her.

Mrs Ockerby, an auxiliary nurse, borrowed £300 from "Johnny Boy Kiely" to pay for her wedding dress in January 2007 because she was "absolutely desperate", the jury heard. He dispensed the money from a roll of £20 notes from his black Range Rover, complete with the personalised number plate "B0Y".

Mrs Ockerby said she faced aggressive demands for money when she struggled to repay her debt because her working hours were cut. On one occasion Kiely turned up unannounced at her semi-detached house and grabbed hold of her. Another time he turned up and banged on her door early in the morning, the court heard. Mrs Ockerby told the jury she feared for her life when a concrete block was thrown at her window just hours after a debt collector called.

I really should be more grateful to banks

Yesterday, I received the following comment:

Alice handily ignores the increased quality of life brought to everyone in the UK over the past decade through the substantial contribution to the country's GDP by the financial services industry.

Net-net, this effect dwarfs the amount the Government will have spent re-capitalising the banks... it wouldn't surprise me if the UK taxpayer actually turned a profit when Northern Rock and RBS are sold off.

But don't let facts stand in the way of your vitriol Alice

I have been feeling pangs of guilt all day. Have I really been so ungrateful for all the wonderful things that the financial sector has done for me during the last 10 or so years? Will I be the lucky beneficiary of the bail-out as NRK and RBS are sold off for a profit? Oh, I do hope so.

But what of the relationship between the financial sector and GDP growth? Have I, buried deep in a pile of vitriol, missed the "substantial contribution" to the country's GDP generated by the financial system?

The financial sector can generate real increases in GDP in three ways. First, it offers an efficient payments system. However, banks have been doing this effectively for at least a century. Very little additional GDP was generated in the last 10 years because banks clear cheques and handle inter-bank transfers quickly.

Second, banks help finance investment, which increases the productive capacity of the economy and generates higher living standard. However, the sad truth is that these days most bank lending goes on financing consumption and housing related speculation. Investment levels in the UK have barely changed over the last ten years.

Which brings us onto the third channel through which banks can affect GDP - they can finance consumption. However, this kind of lending simply transfers disposable income from the future into today. If I take a loan to buy a plasma TV. Consumption goes up today, and this is reflected in GDP. However, I have to pay the loan back and this means lower consumption and GDP in the future.

This is why the UK economy enjoyed such strong growth over the last decade. We were spending money we expected to get in the future. Banks allowed us to do this, and we built up a massive pile of household debt. In fact, this debt stock is so high that banks can no longer rely on us to pay it back. This led to many of our banks sliding into insolvency, leading the government to commit 90 percent of GDP to clean up the mess.

For this, anonymous wants me to feel grateful. Sorry, I can't do it. Instead, I am angry about the excesses of the past that have led to this sorry state of affairs. I am fearful for the future because of the cost that the bank bailout will impose on my standard of living.

You can call that vitriol if you want, but that is how I feel.

The taxpayer put money in, and the bankers take it out

I think I am going to become a communist.

While taxpayers were pumping in uncountable billions into the US financial system, bankers took out multi-million dollar bonuses. How on earth could that be justified? If it wasn't for taxpayers, these banks would have been forced into bankruptcy.

At least in the US there is sufficient transparency to ensure that taxpayers know they have been ripped off. How many UK bankers in loss making banks received multi-million pound bonuses, generously financed by UK taxpayers?

From the Financial Times.

Citigroup and Merrill Lynch, which together lost $55bn in 2008, paid bonuses of more than $1m to a total of 1,400 employees, according to a New York state report on Thursday on bonus payments by banks propped up with taxpayer funds.

The study, compiled by Andrew Cuomo, New York attorney-general, showed that JPMorgan Chase and Goldman Sachs, which both finished in the black last year, paid the most million-dollar bonuses - 1,626 and 953, respectively.

However, the totals at a profitable bank like Goldman were nearly matched by two of the year’s biggest losers on Wall Street. Citi, which suffered a $27.7bn loss, paid million-dollar bonuses to 738 employees. Merrill, which lost $27.6bn, paid 696 bonuses of $1m or more.

Lets roll those loaded dice

There is something deeply disturbing about this chart. It shows that mortgage approvals have picked up over the last four months. While lending activity hasn't yet reached the levels seen during the bubble, there is no doubt that banks are returning to the housing market.

This chart is disturbing because mortgage lending is the only credit market that has seen a pick up in activity. Credit to the corporate sector is contracting. Firms are, on a net basis, actually paying loans back. Things aren't much better for consumers. Interest rate spreads on credit cards have actually increased, and consumer credit growth is close to zero.

So why are banks ready to return to the housing market and at the same time abandon other credit activities? Well, I have my answer. This is a classic case of moral hazard.

Regardless of what the government said in public, the recent bailout had only one objective in mind - put a floor under house prices. The liquidity support and the guarantees were all aimed at stabilizing the housing market. In effect, the government offered to insure banks and their property speculating clientele. The message from Brown and Darling is clear - "we will support house prices no matter how much it will cost".

Banks have picked up on this commitment. Bankers understand all too clearly that the government didn't offer any real support to corporate or consumer lending. Only property matters. Therefore, it is rational for banks to return to mortgage lending while at the same time, cut back on other credit activities.

With this huge de facto insurance contract in their back pocket, banks are cranking up another housing bubble, and it is happening with the financial support of the taxpayer. Moreover, as recent RICS data suggests, there is army of potential house buyers out there ready to dive in and speculate again on property prices.

It is the rational response. After all, we have a government that is ready to guarantee that no one will lose if they speculate on housing. If there are any losses, the government will ensure that the hapless taxpayer will pick up the bill.

US real estate lending growing at 6.4 percent

There are many occasions when I wonder just how serious was this credit crunch. Here is a good example - US real estate lending by banks.

This chart tracks the annual change in real estate lending. Currently, it is running at about 6.4 percent. Moreover, at no time did it ever actually decline. As such, it was always possible for US borrowers with good credit ratings to get new mortgages.