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Ageno School of Business dean Terry Connelly on business, the economy, and more. . .

January 24, 2012 • 6:17 pm 0

For Once, a Consequential Fed Meeting

Wednesday’s conclusion of the first Fed meeting of 2012 may herald a new working majority at the Board more closely aligned with Chairrman Ben Bernanke’s view of the economy and the role of the Fed in supporting employement as well as restraining inflation. What would be the consequences?

First, the identification  of an inflation rate of 2% , give or take a few basis points, as the specific target of Fed policy. Secondly, related to that objective, a new transparency with respect to the individual expectation of the Reserve  Board members as to the likely course of interest rates over the next several quarters and indeed as far out as 2014. This will not be revealed by name but by a sort of collective range of projections, dropping off the highs and the lows to try to contain market speculation as to who on the Board  specifically is the high or the low. Thirdly, related to these projections, would be a change in the language of the Fed’s starement heretofore guaranteeing low interest rates through mid-2013 — words will be added to in effect EXTEND the period of low rates into 2014. And finally, there may even be an initiation of a form of QE3 — the Fed’ s version of stimulus — this time focused squarely on the housing market by way of extending the Fed’s purchases of bonds from Treasuries to mortgage-backed securities.

All four of these actions may not be reflected in the official post-meeting statement ,and some may come out shortly after the meeting. But any one of these four actions would lead the financial markets to anticipate the other three in due course. The main concern, if and when the entire policy package comes together, is whether the markets will somehow misinterpret the Fed’s “new transparency” in ways which the Fed does not intend and would soon have to correct, especially in the face of continued market nervousness about the Euro debt crisis. (The US markets simply have yet to understand that all negotiations continue on to the next Euro “Summit” —  because no side can politically or financially afford to leave an impression that they gave in too soon – this is all that is really going on with the Greek debt issue.)

Filed under: Blogroll, Bond Market, European central bank, Federal Reserve, Stock Market, US Economy, US Politics , , , , , ,

January 14, 2012 • 3:49 am 0

It’s Still A Greek Haircut — Short Back and Sides

Here’s what’s going on with the European Debt Crisis, and particularly the Greek bond “haircut” negotiations; the fact that the barbershop closed over the long three-day weekend is of much more moment than the Standard & Poor’s downgrade of most Eurozone sovereign credits, which was widely anticipated by the financial markets (we should have guessed they would do it on Friday the 13th).

Here’s the deal:

Greece owes more money to its bondholders than it can ever afford to pay off, so the Eurozone “leaders” came to an agreement with the representatives of the major bank holders of Greek bonds back in December that the holders  would take a 50% haircut on the face value of their holdings in an exchange of those securities for new Greek bonds of considerably longer duration; but they deferred setting the  exact terms of exchange, including importantly the interest rate they would be paid on the new longer term debt  That rate — if set too low – would of course constitute an even deeper ‘haircut’ on the total value of their  holdings.

Most of the banking institutions holding  Greek sovereign debt can ill afford write-down on their balance sheet beyond 50%, which would put them in potential need for financial bailouts from their governments (the same governments S & P just downgraded, in part because of this very risk. But of course these governments would also have to pony- up more money to Greece if the interest rate is set so high on the new bonds that Greece can’t afford to pay the it off when due! It is this “balance of terror” that negotiators in December  felt would  lead to a rational, face-saving (as well as other-parts -of -the-anatomy-saving) deal on the interest rate that all parties could live with, by now.

Most of these bank holders bought the debt early on, but only some have the protection of hedges with credit default swaps, which would  theoretically (depending on the solvency of the counter-party) pay 100% of face value if Greece forced a haircut by legislation and thereby actually “defaulted”. The existing bonds are governed by Greek  law, which Greece could at least try to change to force harsher terms on the holders. Thus  the banks are  being “asked”   to choose between getting 50% or less of face value by “voluntary’ agreement, or, in a some but not all cases, take their chances on getting 100% through their CDS “insurance” under circumstances where the whole financial system might nonetheless collapse (a la Lehman) around them — and their insurers — because a forced conversion would likely foreshadow  a disorderly Greek default, which is exactly what most everyone has been trying to avoid! look like a voluntary haircut deal to me.

But now come some  hedge funds (the only lower form on the financial system’s Tree of Life apparently lower than Bain & Company in a Newt Gingrich taxonomy) that bought up Greek sovereign debt a the current market rate of t20-25% of face value, looking to cash in on the 50% haircut deal that they thought  would be a 100% windfall for themselves. And they have the Gaul (some of them may be French) to be so upset by the low interest rate Greece proposes to pay on their new bonds (with a push from the IMF,  Greece’s lender of last resort, which loves its own pocket book more than the hedge funds’ for sure) that they are threatening to walk away from any “voluntary” deal — I guess because just a 75% profit in a couple months isn’t enough). Greece being aware of this has threatened to change Greek law on the hedgies to force them to go along with a haircut deal struck with a majority of holders (the banks stuck, as described above,  between a rock and a hard place), knowing that this amounts to a default that could bring down the whole Euro house —  including Greece, as their Finance Minister well knows. The hedge funds seem tempted to bet that, rather than see that event happen, even the new Iron Lady of Europe, Frau Merkel, will come up with the  dough to let Greece pay a high enough  interest rate on the new bonds to keep the hedgies in hedge heaven.

Do we see any public spirited citizens in the room? This is not the first time the hedge funds or the Greeks  have played chicken with the world economy. My guess is that sometime in the next week Merkel will politely but firmly tell them  to stop the games or go to hell (namely, back to the drachma). This posture  worked in December with a slightly different cast of characters, and it worked with Berlusconi. But we may have a return to the wilder market days of last fall for a few moments this coming week or two before the dust settles. The effects of S&P’s downgrades can wait on this, because the too-easy ‘solution’ of letting Greece default is too much like the pre-Lehman “moral hazard’ talk that caused us all the trouble in the first place.Because if Greece is the new Lehman, then Italy, or Spain, or even France, is the next AIG, Merrill Lynch, or Bank of America, with or without further downgrades. But definitely without the lender of last resort that the Fed and the US Congress were able to be…unless the Iron Lady takes off the leash she holds on the ECB — dream on hedgies!

 

Filed under: Blogroll, Bond Market, European central bank, European economy, Federal Reserve, Global Economy, Stock Market, US Economy , , , ,

January 6, 2012 • 10:53 pm 0

Questions for the Markets

1. Euro and Euro sovereing debt prices go down, the Us market goes down (even with strongly improved US employment, manufacturing and consumer spending). Are hedge funds that are short the US stock market and anxious to get back long at lower levels effectively shorting Italian and Spanish sovereign debt with derivatives in order to drive down the US markets?  (Yes.)

2. Did the stock market get traded down by the big funds on this friday get traded down despite the good employment numbers because those numbers tend to help Obama, whom the  hedgies hate? (yes again.)

3. Are the Euro currency and bond vigilantes driving down sovereign  bond prices this week to force “Markozy”to give in to market pressures at their meeting next week and turn loose the ECB to directly support bond prices? (Not a chance.)

4. Will the ECB lower interest rates next week? (My guess yes, but the market thinks no because of the falling Euro. But  note that Germany must really, secretly like the falling Euro, at least for a while — helps their exports outside Europe.)

5. Is Standard and Poor’s holding off downgrading France because it has become afraid they will be blamed for killing Sarkozy’s re-election and ushering in a Socialist government in France in this April’s election?

6. Will the US Fed announce QE III in the mortgage bond markets sometime shortly after its January meeting? (Y

7. How many governors (and current opponents) has Romney promised  to be on “really  short list” he VP nomination to? (at least six.)

 

 

 

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December 27, 2011 • 6:14 pm 0

Europe vs US — Will QE on the QT by the ECB Save the Year?

In the US for most of 2011, the words of Pogo the Possum have prevailed in our political economy:  ”We have met the enemy and it is us.”  This reality was most evident in the gridlock in Congress over budgets, debt and taxes that endured for almost all of this past year, culminating in the recent momentary stalemate  over the extension of the payroll tax cut into 2012. We get the Congress we deserve. And despite the frequent media commentary that cites a national desire for compromise and deal-making between the parties, the politicians with their ears closest to the ground hear a firm insistence on intransigent from their most loyal supporters (and campaign funders). Fortunately,  our situation can be changed for the better by a shift  in public sentiment that in turn changes political will — and this in fact happened on Christmas night at Speaker Boehner’s House. For once, the polls showed the pols that voters were backing-off their love affair with “lines in the sand”, and we got a deal.

Europe, on the other hand, remains tangled in its own underwear: in particular, the German strict construction of the European Union treaties to the effect that the European Central Bank can never act as a “lender of last resort” to its sovereign states, even to prevent a financial panic and  the collapse of the Euro currency. (German authorities seem to be most fond of enforcing the rules they themselves are the first to break: originally, by violating the Euro limits on national debt; and now, by their own political interference in ECB decisions, which they separately argue should be “independent” from such influence  –at least from other governments.) In effect, if the German position is not merely a negotiating posture to force recalcitrant Mediterraneans to get their budget acts in good German order — as many market participants seem to hope — the Euro currency is essentially a suicide pact!

All this could come to a head as soon as the first quarter of 2012 when Italy and Spain are forced to refund billions of maturing debt. At prevailing pricing trends, they cannot afford to do so without bankrupting their budgets. They need a financial  backstop to effectively put a lid on their sovereign debts’ interest rates by massive and timely market intervention — exactly what the Germans say the ECB cannot do.

Among Europe’s financial eminences, only the semi-disgraced Dominique Strauss-Kahn  seems to understand just how serious the situation is, but he is effectively without political force.

As we approach year-end, however, the ECB has attempted an elegant  hook-slide around  Germanic obstinacy by extending to three years its virtually unlimited lending facility to EU banking institutions at a rock-bottom short term rate that normally applies only to very short term borrowings. This yield curve tinkering –let’s call it QE on the QT  by the ECB — enables these banks to hold on to their existing holdings of Eurozone sovereign debt purportedly to maturity, thus deferring further write-downs impairing their capital or  the dumping of such bonds on a highly nervous market. It also invites the banks to buy into the refunding rollovers due. $500 billion of this offer was taken up by Europe’s banks, and another opportunity will be in place by February to continue  shoring-up the banking sector, which in turn helps the sovereign sector (which would have to bail out failing  banks to prevent Lehman-lke economic collapses int their economies).

The main fly in the ointment as we end 2011 remains the rating agencies’ posture toward Euro sovereign credits. These agencies collectively failed to downgrade the  US mortgage debt instruments that brought on our own financial meltdown in 2007 and the Great Recession that followed. They now seek to display their new-found backbone by following up Standard and Poor’s questionable downgrade of  US  credit on political grounds with threats of downgrading Europe’s safest credits, including France and Germany.

Ironically, a quick-trigger downgrade in Europe in early 2012 could have the same effect as the slow trigger in the US of 20005-07 — a massive collapse of global confidence this time in Europe’s financial structure, and a potential global depression along with it. If we are lucky, the agencies will notice the subtlety of “Super Mario” Draghi at the ECB — he may be the first Italian politician to outwit the Germans. As the US begins to sense its own economic recovery (look for a great jobs number on at the end of January’s first week), we can only hope this is the case.

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November 24, 2011 • 10:50 pm 0

Thanksgiving Ode to Disney

Bashful = Huntsman

Doc = Paul

Dopey = Perry

Grumpy = Gingrich

Happy = Romney

Sleepy = Santorum

Sneezy = Cain

Snow White = Bachman

 

 

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November 24, 2011 • 10:44 pm 0

The Dean Emeritus Thanksgiving Haiku

Euro debt hurts all

Bankrupt countries can’t pay off –

Snow came  soon this Fall.

 

Berlusconi’s gone

Just after Pappandreou –

Snow obscures the dawn.

 

France is on the ropes

Triple A in jeopardy –

Snow will dash their hopes.

 

Germans fear their past

They hold the cards too tightly –

Snow will come too fast.

 

Sarkozy laments

Merkel plays “Mother May I?” –

Snow will drive events.

 

No plans make real sense

ECB, ESFS

Snow won’t pay the rents.

 

Super-Congress fails

Gang of 12 could not agree –

Snow will sting like nails.

 

Taxpayers complain

Republicans redebate –

Snow is worse than rain.

 

GOP stands firm

No  benefits or taxes –

Snow could  make them squirm.

 

No one left to trust

Obama’s lost his mojo –

Snow does  leave a rust.

 

Jamie Dimon squawks

But the Street is Occupied –

Snow won’t stop the Walks.

 

Markets trade on fear

Pessimism reigns supreme –

Snow will melt next year!

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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November 1, 2011 • 5:43 am 0

A November to Remember

This month will be a corker.

Let’s just look at the first few days. Overnight the Greek government says it will put the recent bailout deal with the rest of Europe to a vote of its people. The EU has a long history of failed referendums on deals sprouted in Brussels, but this one could be the mother of all cliffhangers to start 2012 off with a bang. It could be a clever move by the government to wring an endorsement from a populace that hates the bailout terms of austerity, but badly wants to stay in Club Euro, which it cannot to with a “no” bvote. But it could also be too clever by half and doom Greece — and the rest of us — to the effects of a Lehmanesque disorderly default.  There will a vote of confidence in the greek Parliament on this plan this week before the US market close on Friday (the same day as out monthly unemployment report).

But wait: there’s more. Just tonight, China reported weaker than expected export on purchasing managers reports, along with a bit of tepid growth in a manufacturing survery. Will this send a shudder of “hard-landing” fear into the global markets — or will traders sense that now the Chinese leadership will finally turn course and start stimulus again in some form — and even perhaps send signals to the G-20 meeting this thursday that they may well find it in their hearts to help out the European Financial Stability Fund  if only to protect their endangered export market.

But there’s more. Ill all this global sturm and drang bring the Fed a step closer to QE 3 in its post-meeting statement and Chair’s press conference on wednesday. (Australia cut its interest rates tonight as well: but they’ve got room to cut — the US Fed can only play bond-market games at this point. Best guess; a double nod to a slightly improving domestic business sector but an enhanced statement of willingness to do the necessary should the European situation continue (despite the agreements of the European governments of last week)  to pose a threat to global financial stability.

But wait, there’s still more. The European Central Bank holds it first meeting under its new italian Chair this Thursday — right after the US Fed and right before the Greek Parliament confidence vote. Will They give a hint of interest rates cuts in the near future to stave off Euro-recession in the wake of austerity; will they continue to buy Italian bonds in the secondary markets to facilitate effective “transmission” of their monetary policy (but really to stave off a run on the whole Italian sovereign debt by the Euro-bond vigilantes)?

What a week we have in store, and this just gets us to November 4: and we haven’t even mentioned the SuperCommittee and the risk of s second downgrade of US debt if it can’t come up with something by November 23, just  three weeks away. We have scary “headline risk” up to our eyeballs  –  or maybe it’s just Halloween!

 

 

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October 24, 2011 • 5:55 am 0

US to Help Pay for Euro Bailout

Here’s the deal on Europe:

Ger,any won’t put up any more moneythan already committed to the Stability Fund.

But the Fund is insufficient to save the day.

France wanted to make the Fund a bank so it could borrow unlimited amounts from the European central bank t extend its clout.

but Germany (and the ECB leadership) vetoes that.

The European banks will have to take bigger haricuts on their greek debt holdings to bring those debts down to an at least arguably manageable level for Greece going forward the next decade or more (new papaer to be issued to replace the old, post-haricuts).

But taking steep haircuts (50% + instead of the previously negotiated 21% (which was being arbitraged by hedge funds with trading actually at the 50% haircut level) means that banks must be recapitalized.

Germany says that the banks themselves must first raise capital, and then their own countries should pony up to help them re-cap.

But if France does that, it could lose its triple A credit rating, which in turn would jeopardize the integrity of the Stabilization Fund itself.

Soto bring more money to the table to fix both sovereign debt problems and the bank re-cap needs, Europe will need to do two things — (1) set up a “special purpose vehicle” ) shades of Enron?) to ttreact Brazilian and Chinese investments that could be used to prop up the Stabilization Fund indirectly (a sort of synthetic Euro-zone bond issuance) and (2) swallow its pride and bring in the IMF’s deep pockets (which of course are funded in no small measure by the US taxpayer).

Do you think this might be an issue in the next Republican debate?

Of course, China and the US are big exporters to Europe, and their stacok markets have suffered because of europe’suncertainties lately, so they have a strong interest in seeing things right . And in the US at least, we learned from Lehman that “real” hazard trumps “moral” hazard.

Germany has vetos sing the

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September 21, 2011 • 1:11 am 0

Extraordinary Political Intervention

It’s bad enough the Republican Party has sought, fairly successfully, to politicize the Supreme Court. But at least in that effort they have had compnay from the Democratic side as well over the decades. But their attempt this very evening to blatantly inject Presidential politics into the deliberations of the Open Market Committee of the statutorily independent Federal Reserve Board is one of the most egregious examples of overreaching we have seen in a long while, and it deserves immediate condemnation.

In attempting to intimidate Charirman Bernanke and his colleagues in the same vein as Governor Perry of Texas, the risisng Presidential candidate, did a couple weeks ago with his “treason” charge against the Fed Chairman, the Republican Congressional leadership has laid bare for all to see that indeed their driving and sole purpose is to keep the economy in the tank and assure President Obama’s defeat. In attempting to put a straight jacket on the indepedent Fed in the form of a “quiet period”‘ of Fed inaction in terms of the  economy in the year leading up to a Presidential election undermines the integrity of the national bank and the standing of the US in the financial world.

One can obviously hold differing economic theories than the Fed or its Chair and freely criticise the decisions of the Open Market Committee as a routine part of the US political  process. But to posit that the Fed owes a “duty of impotence” because its actions might influence the economy in a way that could turn to the President’s benefit (as Perry argued) takes the political process into a room where it does not belong.

Hopefully the living former Fed Chair, Mr. Greenspan, and other former Fed Board members, who are free to speak out in response, will condemn this act of political subterfuge and sabotage immediately and with vigor. And assuredly, Chariman Bernanke and his colleagues should go ahead and do whatever they are going to do on September 21 and thereafter without fear or favor in terms of  either political side.

Imagine what the Republican reactions would have been if President Obama had sent a letter to Chairman Bernanke tonight asking the Committee to take “extraordinary action” to revive economic growth: this move by the Republican leadership in Congress is clearly a low  point of both arrogance and hypocrisy.

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September 20, 2011 • 9:42 pm 0

Better Fed Than Dead

Terry Connelly is dean emeritus of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.

 

Traders ares speculating that the fed is bound to disappoint the markets on wednesday as there is really nothing much they can do tohelp the economy grwo any more, and nothing much that they can agree on in any event. I think they are wrong, on both counts.

 

As to the second matter first — Ben Bernanke’s background is not in the corporate world, where a Board of Directors, like the Fed’s Open Market Committee at least in structure and mission, is expected to be unanimous or nothing at all. Instead, the Chairman’s background is steeped in academic strcuture. Like any dean of a strong minded faculty (including myself, although I have lived in the other world of business, too), he knows that no faculty is likely to be unanimous about anything, and it does not bother him particularly even he has two or three public dissenters to Fed policy. And he gets great marks from his colleagues for courtesy and openness. Most faculties prefer to debate more than decide, anyway, because down deep they have mutual respect for their diverse opinions, no matter have pointed their disagreements. Ben will do a deal with majority support and not hold out for the “perfection’ of unanimity. You don’t have a specially-extended  two-day meeting and then do nothing; unless you want to contribute to market carnage.

 

And what ‘s to be done? Lengthening the maturity of the Fed’s balance sheet (the so-called “twist’) was sexier  when it was really just a teenage dance move, but it would help hold down longer-term interest rates that are the base for mortgages and consumer loans. Lowering the interest rate it pays banks to keep their excess reserves on deposit with the Fed will also help at the margin to push them to lend, finally. (This step should be staged to prevent a huge washover of deposits into money market funds and risking their valuation.) Both these moves would be welcomed by the financial markets, especially in terms of reducing the current obsession with every choreographed move in the Greek default process, as the “troika” of EU. ECB and IMF negotiators string bailout approval VERY PREDICTABLY BUT ALSO INEVITABLY  to the last minute so as to hold in check the negative public  opinion in Germany about spending more money on the Greeks. (They cannot afford to be scene as anything other than the strictest of lenders, so they drag things out to create that impression while the markets forget that it was just last week that Merkel and Sarkozy said the deal would get done! Traders can be downright stupid at times.)

And, by the way, don’t let this loose talk that we’d all be better off just to let Greece default right now (rather than waiting until 2013 when the lead countries of the European Community get their banks in shape to sustain losses in a managed default) get the better of your memory. That’s what folks said about “letting Lehman fail” before the great mistake (predicted in this blog) that triggered the Great Recession. Moral: don’t listen to the drumbeat on CNBC, ever!

 

 

 

 

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About Terry Connelly

Find out more about Terry Connelly and Golden Gate University's Ageno School of Business

 

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