Beware hidden costs as banks eye ‘Grexit’ – FT.com

A parallel currency for Greece? | Gavyn Davies

Europe’s slump deepens as Kabuki summit falls short – Telegraph

Resilient China: How strong is China’s economy? | The Economist

Artur Mas, el rescate de Cataluña y los nervios del mercado sobre España – elEconomista.es

Spanish Lender Seeks State Aid – Ratings Cut on 5 Banks – NYTimes.com

4th straight record low for mortgage rates – Lansner on Real Estate : The Orange County Register

9,200 OC homes worth half their mortgage – Lansner on Real Estate : The Orange County Register

Review & Outlook: A Mess the 45th President Will Inherit – Taxpayers now stand behind derivatives clearinghouses – WSJ.com

Analysis: China’s new privatization plan faces push-back risk | Reuters

BBC News – Weak rupee hitting Indian economy

Greek euro exit flowchart: what happens next | Business | guardian.co.uk

When Romney Messes Up and Tells the Truth About Austerity | | New Economic PerspectivesNew Economic Perspectives

JPMorgan Gave Risk Oversight to Museum Head Who Sat on AIG Board – Bloomberg

HSBC Preliminary May China PMI Falls, Signals Further Slowdown – WSJ.com

China targets infrastructure to lift economy, report says | Reuters

Slow and steady Mexico draws equity bets over Brazil | Reuters

BBC News – Six reasons why India’s rupee is in freefall

BBC News – Bankia shares suspended amid bailout request reports

Nationalised Spanish lender Bankia ‘to ask government for more than €15bn’ – Telegraph

Moody’s downgrades three big Nordic banks | Reuters

Former Lloyds head of fraud and security Jessica Harper charged over £2.5m fraud – Telegraph

• Links: 2009-01-26 26 Jan 2009
• Links: 2010-09-27 27 Sep 2010
• [Premium] Links 2012-05-12 2 May 2012

I’ll let you in on a secret: Greece was never going to hit its austerity targets anyway. Moreover, who says an anti-austerity Greek government could be elected and then go out and reject austerity? If you listen carefully, no one is saying they reject fiscal consolidation in Greece outright. No one. They may be saying they want some stimulus on the side or they want the timetable to be backloaded. But that’s a different story. Even so, Greece could default and stay in the euro zone. Eurozone default is not synonymous with breakup. I know people like Nigel Farage and Geert Wilders are talking about breaking the euro up. But, they’re on the fringe. Show me a mainstream politician talking this way. Most of Europe is still very committed to the euro. Even the most anti-austerity Greek politicians are telling you this. Why do you think Grexit is imminent then? We’re not there… yet. I’m betting on extend and pretend. And remember I’m a eurosceptic. I’m just reading the tea leaves.

As always, my concern is bank runs. That’s how a depression turns into a Great Depression.

• It is almost game over for the euro zone 1 Nov 2011
• Sean Egan says Spain could be the next domino in the euro zone crisis 8 Nov 2011
• Issing: Greek 50% haircut, euro zone exit; euro bond fans ‘gravediggers of stable euro’ 28 Sep 2011

I’ll let you in on a secret: before this crisis, when I thought about the budget deficit I was like everyone else in that I paid no attention to how the government budget interacted with the private and trade sector balances. This is a big error. If you do that, you treat the government budget deficit in isolation, when the reality is that the government is an integral part of an open economy with households and businesses that trade domestically and abroad. When the government balance changes, the balances for those businesses and households change too. If you are talking about deficits then, you need to know how changes in the government balance affect the rest of the economy.

Here’s the thing: when we exchange goods and services with each other, from an accounting perspective, it’s a wash; if you buy my goods, you get money and I get goods of equivalent value. If you pay for those goods with an I.O.U., with a debt, your liability, your deficit in the year we made the transaction, is exactly equal to the asset on my balance sheet and my surplus for the year. I mean this is basic accounting, folks. There’s no hocus pocus. Any person’s, any household’s, any business’s, any group’s, any government’s debt is someone else’s asset. Any person’s, any household’s, any business’s, any group’s, any government’s deficit is someone else’s surplus. Again, it’s basic accounting.

Think of it like exchange traded options and the profit and losses on the exchange. People buy and sell oil futures or soybean futures. At the end of the option period, they either have a loss or a profit and that period’s deficit or surplus is exactly offset by the deficit or surplus of the counterparties. When you sum up these deficits and surpluses they net to zero. Again, no hocus pocus. That’s how accounting works.

The same is true for national accounts. At the end of any accounting period, then, the sum of the sectoral financial balances must net to zero. The government balance – the private balance – capital account balance = 0. The government balance = the private balance + the capital account balance. See my post Economics 101 on government budget deficits for the full write-up. I credit British economist Wynne Godley for making this identity relevant to macro economics.

What does all this mean then? Put simply, the financial sector balances framework means that when the government sector runs a deficit, the non-government sector runs a surplus of equivalent size. So, to move any sector balance in an open economy, you need to move the other two balances exactly opposite in equivalent measure. To reduce the government deficit in any period, the private balance and the capital balance must increase by the exact same amount in that period.

Thinking about government deficits this way opens a whole new understanding of what cutting deficits means for the economy. What it should mean to you is that deficits are the effect and not the cause. Budget deficits are the result of the ex-post accounting identity between the sectoral balances and should not be a primary goal of public policy. Let me give you an example.

Why are deficits so high? What I have been saying is that private debt is the problem. Debt has been a substitute for income due to stagnant wages. Now that the credit bubble’s asset price inflation has turned to deflation, people, businesses and banks have found themselves saddled with debts that are not adequately underpinned by asset collateral. Businesses have done some serious heavy lifting here and debt in the corporate sector is not a problem. But households are still over-indebted. As long as household financial assets provide insufficient collateral for the debts that depend on them, the household sector will continue to maintain a reduced level of consumption and investment as a percentage of income to deal with that debt. Businesses see this and reduce their investment too. And we get stuck in a lower-investment, higher savings world that leads to deficits.

So, in that context, attempts at austerity make things considerably worse. If the government cuts back, the private debt overhang will still be there and the private sector will simply have less money to deal with it. The household sector will still attempt to keep its net saving, its surplus, high and so government cuts will be felt primarily in the form of reduced household consumption and increased private sector defaults. In the context of a still weak banking system, that could create the kind of downward spiral we witnessed during the Great Depression as banks failed. It creates the kind of paradox of thrift that makes deficit reduction harder which we are witnessing in the euro zone as many of us including James Montier predicted.

In my view, austerity is a failed paradigm. Clearly, government shouldn’t have wasteful programs to begin with. So there should be no need to cut them to cut a deficit. Moreover, the deficit is the result of an ex-post accounting identity between private savings, and capital account and government balances. It makes zero sense to target the effect (deficits) instead of the cause (excess credit growth and malinvestment). In plain English that means the policy prescriptions are the economic input and the deficit is the output. Focus on the policy and policy goals, not deficits.

The way I look at this crisis puts me into Ray Dalio’s camp. The right narrative for what has happened is that the depression has been the result of significant malinvestment that was built up during the so-called ‘Great Moderation’ as a result of loose monetary policy at the Fed and other central banks in a world awash in fiat money. The real policy question should be how to eliminate the malinvestment and reallocate capital investment to useful productive enterprises without creating a deflationary spiral. When credit is written down, GDP drops and people are thrown out of work. That can be mitigated. It is bank runs that create deflationary spirals. So the answer is to write down assets and recapitalise the banking system quickly rather than dragging it out. The goal should be to allow increased savings and debt and debt interest reduction to combine with increased income to accelerate the deleveraging process without causing runs.

I named my blog “Credit Writedowns” because I anticipated an historic wave of credit writedowns in the global banking system which would lead to a wave of deleveraging, systemic risk, and bank failures — in short, a massive financial and economic bust to rival the Great Depression. My hope had been to draw attention to the systemic risk associated with the deleveraging process necessary to purge these excesses. But since I began writing here four years ago, it has become clear to me that the goal of most policy makers is to avoid the pain of deleveraging by any means necessary. Their goal has been to extend and pretend, dragging it out, resisting credit writedowns and resisting recapitalising the banking system.

But debts that can’t be repaid, won’t be. Rather than resist this process, policy makers should embrace it and mitigate the downside.

• Private savings in a post-bubble world 4 Mar 2012
• Koo Calls For Stimulus as Private Sector Deleverages 19 May 2010
• The worrying European rebalancing of 2010 17 Aug 2011

(click image to enlarge)

Source: The Wall Street Journal

• Chart of the Day: Euro zone GDP by country 11 May 2012
• Finland wants two-tier euro zone with more power for AAA countries 17 Nov 2011
• Markets anticipate a euro zone solution within days 29 Nov 2011

• [Premium] Daily commentary: On JPMorgan’s gigantic mistake 14 May 2012
• The Fragile State of China’s FX Reserves 12 Apr 2011
• [Premium] Daily Commentary: On The Global Growth Slowdown 22 Mar 2012

By Adam J. Crawford, Junior Analyst

In less than a week’s time, the Facebook IPO has gone from the most-hyped technology event since Google went public into "blame-storming" mode. Details concerning the stock’s sudden drop, the market’s inability to process orders, and the (mis)behavior of insiders are starting to emerge. And it doesn’t look good.

The Scandal

When any stock drops as much out of the gate as Facebook has – down as much as 25% peak to trough in the days since the public premier of the stock – people start asking big questions… even more so when that stock carries a $50-billion-plus market cap, meaning the loss triggered billions in paper losses. Add on the fact that the Nasdaq market computers crumbled under the activity, and the scrutiny is intense.

What’s been uncovered so far is painting a picture of poorly managed expectations and questionable ethics. The key event behind the drop appears to be a massive shift in expectations from institutional investors at the last minute.

Evidently, a Facebook executive – at this stage we can only guess who – alerted analysts that previously issued revenue estimates were a bit optimistic. Shortly thereafter, the analysts took the unusual step of slashing revenue estimates during Facebook’s IPO roadshow. The information was then relayed to a select few potential institutional buyers. The financial community calls this "selective disclosure." I call it BS.

To make matters worse, Morgan Stanley (the lead underwriter and one of a select group of banks privy to the lower estimates) actually raised the offering price and issued more shares publicly, despite cutting the revenue estimate behind closed doors. Initially, Facebook shares surged due in large part to robust retail demand. However, once gravity took hold, Morgan Stanley chose to step in and provide some temporary support at the original offering price of $38 a share. The bank stepped into the market and bought millions of shares back from the public. It was able to do so without risking much capital thanks to the massive "greenshoe" allotment it took at the IPO – a gift of nonexistent shares the bank can sell risk free to the public if they have the demand. Stock goes up, and Morgan Stanley can force Facebook to cough up more shares, diluting investors and pocketing the profit. Stock goes down, and Morgan Stanley can buy them back below the IPO price, wiping out the excess volume and pocketing the price difference. Not bad deal, eh? Thankfully, most banks do exercise some level of ethical caution with those overallotment shares and use the process to instead stabilize the market, as happened with the over 60 million shares Morgan Stanley bought back from investors.

Consequently, Facebook shares stabilized and ended the trading day flat.

Facebook’s humdrum opening-day performance was a minor disappointment for speculative investors hoping to flip shares for a quick profit. The minor disappointment soon morphed into a major disappointment for all shareholders, once rumors spread about the behind-the-scene shenanigans mentioned above. One look at the stock chart will show you the unpleasant Monday-morning surprise shareholders arose to the next trading day.

(Click on image to enlarge)

Facebook shares have since settled near $32 a share but remain exceedingly temperamental. A skilled trader could probably make a few bucks off this volatility (but a day trader I am not, so I can’t help you there). As far as Facebook’s long-term potential goes, I can offer a quick analysis.

The Future Outlook

Despite our decrying of the trading practices of Wall-Street banks, when dealing with a company of this size and whose relationships with the banks run this deep, one of the best sources of data on the company will remain the consensus opinion of their research arms. Below are their earnings-per-share growth estimates for the next three years:

As you can see, earnings growth is projected to slow to 21% by 2014. That’s exactly the growth rate Google – a company with nearly 10 times the annual revenue of Facebook – is estimating for 2012. And for that kind of projected growth, the market places a value of 18.5 earnings on Google’s stock. Let’s be generous and award Facebook a 25 multiple for 21% growth. A little back-of-the-envelope math suggests that would place its value at about $20/share ($.80 EPS x 25) three years from now!

Coming at this from another direction, let’s assume that cash flow and net income will be the same in the years ahead. Let’s further assume the same growth rates shown above for 2012-2014 and add these rates for subsequent years:

When we apply a 10% discount rate to these data, we come up with a discounted cash flow valuation of $27.

With either approach, Facebook appears to be overvalued based on the ultimate arbiter of value, profitability. But the picture may be even worse than we’ve painted. Every assumption depends on tremendous – yes, slowing, but still on the "billions of dollars per year" scale – growth; and there are red flags popping up all over the place in that regard. Here are a few:

• General Motors, questioning their effectiveness, recently withdrew its display ads on Facebook. (Speaking of General Motors, Facebook’s market cap is bigger than GM’s andFord’s combined!)
• Revenue from advertising on mobile devices is likely to disappoint; the screens are simply too small and commerce activities less common and for lower value, to be as effective at advertising.
• In his IPO letter, founder Mark Zuckerberg wrote: "We don’t build services to make money; we make money to build services". In other words, maximizing revenue is not his priority. He is reluctant to extend ads beyond a certain point because he believes they become intrusive and compromise the experience. Noble as this may be, it will hamper the growth needed to justify the stock’s lofty valuation. Of course, Zuckerberg is a billionaire still at $27, $20, even $5 for the stock…

The Winners and Losers

With the company’s stock dropping, retail investors getting the hose, and profit opportunities coming, did any of the stakeholders win in the IPO process?

The primary loser in Facebook’s market debut appears to be the retail investors, because they were sold shares at an inflated price, based on inflated estimates that the investment banks making them knew to be wrong. However, it’s possible that Facebook will turn out to be a profitable investment still; and if it is, my hat’s off to you for taking the leap – we were busy focusing on opportunities with the odds more in our favor.

A close second in the loser category is Nasdaq. The exchange lacked the technology to properly handle the massive order flow, an ironic twist for the de facto "technology exchange," and the original electronic trading platform that once decried the failures of the NYSE to meet customer demand. As a result, many orders were either delayed or altogether failed to process. Obviously, the botched job could cost the exchange future business.

The primary winner is Mr. Zuckerberg for numerous reasons… 19.1 billion or so little green ones.

His cohorts also did fairly well, too. Here are just a few examples:

Facebook employees made out well on the deal, too… at least the ones there early enough to get sizable grants. We’ll know pretty soon just how many millionaires the event created, we’re sure – but it’s safe to assume quite a few. Let’s just hope for their sakes that the reality of earnings potential doesn’t hit too hard before their lockout periods expire.

In addition, some savvy traders apparently got in near the offering price and jumped ship in the $40s – probably a high-frequency trading firm or two.

The underwriters (e.g., Morgan Stanley) go into the "yet to be determined" category. Sure, they made a mint on the deal, but they also have drawn the attention of the busybodies in Washington, D.C. And any time Washington busts out the red tape, we all lose.

We also like to believe that Casey Extraordinary Technology investors were also winners in the process. They had straightforward advice to avoid what has proven to be a disaster of an IPO for both buyers and short sellers alike. But being successful at choosing what not to invest in is generally a much simpler task than finding the opportunities that do legitimately contain a solid chance of producing outsize returns.

We believe, though, that we have proven ourselves there as well, which is why we publish a full track record of all of our picks in each and every issue. In fact, we have a handful of promising biotechnology companies in particular which we think are excellent buys right now.

So I encourage you to take CET for a spin for 90 days. If you don’t think you’ll make your money back and then some after seeing what we have in store, then just hit reply and tell us so – we’ll refund every dime you paid. But – surer than betting on the Facebook face-plant, I’m willing to bet that you will stick around once you see what we can do for your portfolio.

No related posts.

With the depressionary circumstances in the European periphery dragging the euro zone into recession, policy makers are now discussing jointly guaranteed bonds, so-called euro bonds. Germany and Austria, however, have voiced strong opposition to this idea. Clearly, the issuance of joint euro bonds would help to solve Europe’s debt crisis by reducing the risk of default for countries whose sovereign bonds are under pressure. The question is whether it is politically realistic to expect euro bonds anytime in the near future.

[...]

Getting to euro bonds then requires some tricky political maneuvering. I have predicted that Germany will counter the push for a growth pact in the euro zone with its own push for a fiscal pact with teeth, a sort of souped-up Stability and Growth Pact that would permit penalties and E.U. oversight for failure to hit fiscal targets, potentially including euro zone expulsion. This is something that the present arrangement does not have.

[...]

Once a pathway to this kind of fiscal union is in place, countries like Germany and Austria will give euro bonds a go, but not before.

Read the full post on "The Path to Euro Bonds" at the Times website. The bottom line is Eurobonds won’t happen anytime soon.

Me, I am more concerned about the global growth slowdown in emerging markets than the crisis in Europe. This is a big, big story but no one is talking about it because Europe is sucking up all of the air. It’s not only Europe here. The reality is we are seeing a global economic backdrop with nearly every major developed and developing country slowing – all with less policy space across the board. That is not bullish.

P.S. – I failed to mention that this post is not an advocacy post but a forecast. My view doesn’t coincide with the German view but I think this is how things will play out.

• Otmar Issing: Germans Should Just Say No to Eurobonds 5 Dec 2010
• Eurobonds are a potential facet of European sovereign debt monetisation 30 Nov 2010
• Munchau Says Eurobonds Would End Sovereign Debt Crisis 6 Dec 2010

Commercial banks and savings institutions insured by the Federal Deposit Insurance Corporation (FDIC) reported an aggregate profit of $35.3 billion in the first quarter of 2012, a $6.6 billion improvement from the $28.8 billion in net income the industry reported in the first quarter of 2011. This is the 11th consecutive quarter that earnings have registered a year-over-year increase. However, loan balances declined by $56.3 billion (0.8 percent) after three consecutive quarterly increases.

FDIC Acting Chairman Martin J. Gruenberg said, "The condition of the industry continues to gradually improve. Insured institutions have made steady progress in shedding bad loans, bolstering net worth, and increasing profitability." He also noted, "The overall decline in loan balances is disappointing after we saw three quarters of growth last year. But we should be cautious in drawing conclusions from just one quarter."

More than two-thirds of all institutions (67.5 percent) reported improvements in their quarterly net income from a year ago. Also, the share of institutions reporting net losses for the quarter fell to 10.3 percent from 15.7 percent a year earlier. The average return on assets (ROA), a basic yardstick of profitability, rose to 1.02 percent from 0.86 percent a year ago.

Lower provisions for loan losses and higher noninterest income were responsible for most of the year-over-year improvement in earnings. First-quarter loss provisions totaled $14.3 billion, almost one-third less than the $20.9 billion that insured institutions set aside for losses in the first quarter of 2011. Net operating revenue (net interest income plus total noninterest income) totaled $169.6 billion, an increase of $5 billion (3.1 percent) from a year earlier, as gains from loan sales rose by $2.3 billion. Realized gains on investment securities and other assets were $2 billion higher than in the first quarter of 2011.

Asset quality indicators continued to improve as insured banks and thrifts charged off $21.8 billion in uncollectible loans during the quarter, down $11.7 billion (34.8 percent) from a year earlier. The amount of noncurrent loans and leases (those 90 days or more past due or in nonaccrual status) fell for an eighth consecutive quarter, but the percentage of loans and leases that were noncurrent remained high by historical standards.

Financial results for the first quarter of 2012 are contained in the FDIC’s latest Quarterly Banking Profile, which was released today. Among the findings:

Total loan balances fell. Credit card loans had a seasonal decrease of $38.2 billion, closed-end 1-4 family residential real estate loans fell by $19.2 billion, and home equity lines of credit dropped by $13.1 billion. Balances in constructon and development loans declined by $11.7 billion. However, loans to commercial and industrial borrowers increased by $27.3 billion, and auto loans were up by $4.5 billion.

The flow of money into insured deposit accounts slowed. Deposits in domestic offices increased by $67.8 billion (0.8 percent) during the quarter, after rising by more than $200 billion in each of the previous three quarters. Balances in large noninterest-bearing transaction accounts, which have temporary unlimited deposit insurance coverage, fell by $77.3 billion. In contrast, in the previous three quarters the balances in these accounts increased by more than $532 billion. Most of the current quarter’s decline occurred at a few of the largest banks that previously received a major share of the inflows. Balances in interest-bearing deposits at domestic offices rose by $100.1 billion.

The number of "problem" institutions fell for the fourth quarter in a row. The number of "problem" institutions declined from 813 to 772. This is the smallest number of "problem" banks since year-end 2009. Total assets of "problem" institutions declined from $319 billion to $292 billion. Sixteen insured institutions failed during the first quarter. This is the smallest number of failures in a quarter since the fourth quarter of 2008, when there were 12.

The Deposit Insurance Fund (DIF) balance continued to increase. The DIF balance — the net worth of the fund — rose to $15.3 billion at March 31 from $11.8 billion at the end of 2011. Assessment revenue and fewer bank failures continued to drive growth in the fund balance. The contingent loss reserve, which covers the costs of expected failures, fell from $6.5 billion to $5.3 billion during the quarter. Estimated insured deposits grew 0.7 percent in the first quarter.

"In summary, indicators of financial strength and asset quality continued to improve in the first quarter, but the process of recovery is clearly still ongoing," Acting Chairman Gruenberg said. He added, "The improved financial condition of the industry has not yet translated into sustained loan growth. We will continue to watch this indicator closely."

The complete Quarterly Banking Profile is available at http://www2.fdic.gov/qbp on the FDIC Web site.

• FDIC-Insured Institutions Earned $35.3 Billion in The Third Quarter of 2011 22 Nov 2011
• US Financial Institutions Make Accounting Gain of $29 Billion 24 May 2011
• Consumer credit down a massive 33% in Spain 1 Jul 2009

• Intervention Risks Rise In Latin America 7 Feb 2012
• Colombia Hikes Rates, Latin America Yields Very Attractive 28 Feb 2011
• Brazil has more monetary policy space in the event of global crisis 19 Aug 2011

· Euro area mfg PMI 45.0 in May vs 46.0 in April

· Euro area non-mfg PMI46.5 vs 47.9

· German mfg PMI 45 vs 46.3

· German non-mfg PMI 52.5 vs 52.6

· French mfg PMI 44.4 vs 46.9

· French non-mfg 45.2 vs 45.2

· German May IFO 106.9 vs 109.9

· UK Q1 GDP -0.3% vs -0.1% initial estimate

Here’s a chart via Bloomberg that gives the overall picture. The data are poor in all regions including Germany and France.

Markit, which collects the data, says that the latest PMIs are consistent with GDP in Europe contracting 0.5% this quarter.

• Asian Manufacturing PMIs suggest slowing economic growth 1 Sep 2011
• Here’s why US manufacturing data have pointed to weakness since March 1 Aug 2011
• Aznar: Spain will show fiscal discipline but we may need the ECB to avoid a “disaster” 21 Nov 2011