Morning Report

Vital Statistics:

Last Change Percent
S&P Futures 1258.3 3.3 0.26%
Eurostoxx Index 2362.8 -6.560 -0.28%
Oil (WTI) 101.1 0.110 0.11%
US Dollar Index (DXY) 78.546 -0.059 -0.08%
10 Year Govt Bond Yield 2.08% 0.03%

Euro markets are down slightly in reaction to the downgrade warning from S&P late yesterday. They note the tightening credit conditions across Europe as well as the growing risk premiums on sovereign debt. The political situation is mentioned as well. S&P is assigning a 40% chance of a fall in output for the Eurozone as a whole in 2012. FWIW, the Euro markets are treating this as a non-event, with little movement in sovereigns and equities.

Banking regulators are finally addressing the fact that “risk-free” assets like sovereign debt are not risk-free after all. The Basel Committee on Banking Supervision is considering letting banks use equities and corporate debt, in addition to cash and sovereigns to satisfy capital standards.
Money quote from the article citing a lawyer at Allen & Overy: “In a world where Nestle is seen as less risky than Portugal, it makes complete sense, but it is politically and economically very difficult. The state requires someone to Hoover up its own debt. Discouraging banks from investing in some countries’ bonds could have a damaging effect on sovereign borrowing.” I would be shocked if Basel let banks use equities and corporates as Tier I capital, but stranger things have happened.

The real estate metrics have been improving lately, and we have another data point with the latest earnings announcement from Toll Brothers. Toll is at the high end of the housing market, and is concentrated in NYC, Boston, and Washington DC. Think McMansions and lofts. Toll is reporting lower cancellations than last year (7.9% vs 8.8%), a 15% increase in $ backlog, and a 12% increase in unit backlog. They mention the urban New York City market as a bright spot, with new buildings in Hoboken, Manhattan, and Brooklyn. I would caution reading too much into NYC real estate as it is a US dollar play as well, and foreign investors view US real estate as dirt cheap. In 2011, Toll used excess cash to buy back stock stock and debt (3 million shares and $55 million of debt). In 2012, they intend to use cash on expanding the business. Toll is giving limited guidance, but anticipates an uptick in business – they are guiding to deliver between 2,400 and 3,200 homes in 2012, vs. deliveries of 2611 in 2011 and 2,642 in 2012. I wouldn’t read too much into this announcement re pricing, (I still think real estate is going down), but it does bode well for construction, which typically leads the economy out of recession and has been MIA in this recovery.

42 Responses

  1. If Basel permits banks to treat corporate bonds like sovereign debt will the Fed follow suit or ignore it?

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  2. I don't know if anyone here follows Stiglitz or not but he's got a pretty decent piece up re Europe and comparisons to the US that I found interesting.The quest for a clear, simple answer recalls the discussions that have followed financial crises around the world. After each crisis, an explanation emerges, which the next crisis shows to be wrong, or at least inadequate. The 1980’s Latin American crisis was caused by excessive borrowing; but that could not explain Mexico’s 1994 crisis, so it was attributed to under-saving.Then came East Asia, which had high savings rates, so the new explanation was “governance.” But this, too, made little sense, given that the Scandinavian countries – which have the most transparent governance in the world – had suffered a crisis a few years earlier.There is, interestingly, a common thread running through all of these cases, as well as the 2008 crisis: financial sectors behaved badly and failed to assess creditworthiness and manage risk as they were supposed to do.These problems will occur with or without the euro. But the euro has made it more difficult for governments to respond. And the problem is not just that the euro took away two key tools for adjustment – the interest rate and the exchange rate – and put nothing in their place, or that the European Central Bank’s mandate is to focus on inflation, whereas today’s challenges are unemployment, growth, and financial stability. Without a common fiscal authority, the single market opened the way to tax competition – a race to the bottom to attract investment and boost output that could be freely sold throughout the EU.Moreover, free labor mobility means that individuals can choose whether to pay their parents’ debts: young Irish can simply escape repaying the foolish bank-bailout obligations assumed by their government by leaving the country. Of course, migration is supposed to be good, as it reallocates labor to where its return is highest. But this kind of migration actually undermines productivity.

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  3. @ Mark. I can't really see that – the regulators in the US still consider US debt as risk free. This trial balloon is simply recognizing the reality that markets are not considering Euro sovereigns risk free anymore. Given Jamie Dimon's "anti-American" rant about Basel III (basically saying Basel favored Euro banks at the expense of American banks) a few months ago, I would be interested in what he is thinking now.

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  4. "The quest for a clear, simple answer recalls the discussions that have followed financial crises around the world. After each crisis, an explanation emerges, which the next crisis shows to be wrong, or at least inadequate."I have 2 words for Stiglitz: Asset Bubbles.You want your common theme, there ya go.Liberal economists like Stiglitz and Krugman are central bank doves, and thus refuse to recognize the unintended consequences of their dovishness – asset bubbles. They prefer to blame bubbles on banksters instead of Central banks. Charles Kindleberger's classic "Manias, Panics, and Crashes" delves deep into historical bubbles. Too-loose monetary policy is a critical factor in virtually every modern bubble. In fact, Stiglitz bemoans the ECB focus on inflation, even with policy as loose as it already is. I believe they are ideologically blinded to role the central bank has in creating asset bubbles. Which is a shame, because the consequences of getting it wrong on monetary policy are asymmetric. If the bank is too tight, we get a recession which is easily cured by easing. If the bank is too loose, we get asset bubbles which cause intractable recessions when they burst.

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  5. "…the consequences of getting it wrong on monetary policy are asymmetric. If the bank is too tight, we get a recession which is easily cured by easing. If the bank is too loose, we get asset bubbles which cause intractable recessions when they burst."I like the contrast as you present it, Prof. Friedman.

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  6. Thanks Mark.Did you see the WSJ piece today on how difficult it has been for the Feds to get criminal prosecutions in financial crimes?http://online.wsj.com/article/SB10001424052970204083204577080792356961440.html?mod=WSJ_Markets_BelowLiveUpdates&_nocache=1323185610510&user=welcome&mg=id-wsj

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  7. Sound like the porridge needs to be just right.

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  8. "Charles Kindleberger's classic "Manias, Panics, and Crashes" delves deep into historical bubbles." Also worth reading:This Time Is Different: Eight Centuries of Financial Folly"Sound like the porridge needs to be just right."Or government efforts to heat or cool the porridge cause more problems than they solve, especially if they are predicated on a conceit that they have more control over the economy than they actually do.

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  9. Followed your link, Brent – thanx. It does confirm similar stories I have read elsewhere.jnc, monetary policy in this country is largely the domain of the Federal Reserve, not the government. Unless you consider the Fed a fourth or fifth branch!

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  10. "jnc, monetary policy in this country is largely the domain of the Federal Reserve, not the government."I consider the Federal Reserve to be part of the government. It's certainly not a private entity. It's simply shielded from certain types of political pressure by design. More practically, Federal Reserve and Treasury policy have been coordinated in lockstep since the crisis started in 2008.

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  11. Mark:Followed your link, Brent – thanx.I guess you are ignoring me now?

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  12. While I don't often agree with him, Stiglitz is the thinking man's Krugman.

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  13. "monetary policy in this country is largely the domain of the Federal Reserve, not the government. Unless you consider the Fed a fourth or fifth branch!"Actually, I believe the dual mandate came from Congress in the late 70s, and is a big part of the problem. It directs the Fed to control inflation and prevent unemployment. The net effect of this mandate pushes the Fed to keep interest rates as low as they dare, as long as inflation (as defined by the CPI) is behaving. Which is a recipe for asset bubbles.

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  14. Brent:You ain't seen nothing yet. 2012 will be remembered as the Year of the Great Race, as central banks all over the world compete to see who can ease the fastest. Look for a cut from the ECB next. I think it might even come this week. I can't remember when they meet next.

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  15. John….Dec 8. Thursday.

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  16. jnc, Brent, and Scott – comments read and points well taken. Obviously one of the "similar" articles was Scott's edition, which I failed to attribute.John, I take it continued easing is an attempt to use inflation of currency supply to offset deflation of sovereign debt as an asset. It will not make Euro businesses suddenly decide to expand, right? In fact, there is plenty of liquidity now, isn't there, by traditional measures?

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  17. All told, a pretty accurate assessment I think. I edited the piece a little to make it fit. The original is here:http://finance.yahoo.com/blogs/breakout/fed-ruining-entire-class-investors-says-jim-rogers-153315477.html"No matter what you've heard to the contrary, "there is QE3, the Fed is pumping money into the system," says legendary investor Jim Rogers, disregarding most every Federal Reserve statement over the last six months. Rogers has been a critic of the Fed's quantitative easing programs and artificially low interest rates, pointing to the latter as something akin to QE3 in drag."They're lying to us," he says of the Fed. "One reason the markets are holding up so well is that they are printing money as fast as they can."In a pyrrhic victory for America, Rogers believes things will eventually get so bad that Americans will finally vote for real change and economic progress. Alas, the measures he feels are needed to cure our economy are so harsh that those same officials will also get tossed out when voters realize just how harsh the road back to prosperity is.Regardless of the necessary suffering, spending cuts are needed in order to save the most fiscally responsible citizens, those whose savings are funding this disaster."What the Federal Reserve is doing now is ruining an entire class of investors," says Rogers. By forcing rates down and keeping the economy on a flatline, he believes the Fed could cause another lost generation of investments. Suffice it to say, vaporizing those who faithfully accumulated savings over the years is no way to restore confidence in our financial markets.That being the case, and having established what the depths of suffering the world is facing now, the obvious question is where Rogers is putting his money to avoid or even profit from the pain."I'm long commodities and currencies; I'm short emerging market stocks, U.S. technology stocks, and I'm short European stocks," Rogers tells me after pronouncing himself a terrible market timer. His logic behind the portfolio is that he wins if the economy turns up due to commodity scarcity. And if the economy remains weak, Rogers' short positions will more than offset his long positions.As for gold, an investment he's been holding for years, Rogers has a mixed view."Gold has been up 11 years in a row," he says, adding it's "very unusual for any asset in world history and I'd expect the correction to continue." That said, he's not selling any of his gold and would look to buy weakness, depending on the global situation.He's long select commodities and currencies, short Europe, tech and emerging markets."

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  18. scott:Thanks, 25 basis points then I would guess.

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  19. john:25 bps seems to be the consensus.Mark:I was only kidding. Forgot to put the 😉 thing after my comment.

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  20. Mark:That's a bit too narrow for me. There's a lot of competing interests in the world. For instance China is backing off it's tightening because their data over the last 6 months has turned and they now fear a slowing economy more than they do the inflation they were fighting previously. The biggest fear of nearly all governments in the world today seems to be that things don't all go up forever. The idea of a business cycle is competely dead. One illlustration of that in this country is that stocks trade at an 86% correlation to the indices now, a historical record. There are no longer any safe havens anywhere.

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  21. And as we know, if it is a "consensus", it must be so!

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  22. scott:Are you speaking ex-cathedra, or is your opinion different?

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  23. john:I'm not all that tuned into the Euro market, but I think it'll be 25 bps. Everyone is expecting it, and I don't think they want to surprise anyone with either too much or too little.

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  24. For Jon Corzine, what a long strange trip it's been, to coin a phrase. From this in August:"Jon Corzine’s Treasury Secretary Appeal" http://www.cnbc.com/id/44018956/Jon_Corzine_s_Treasury_Secretary_AppealTo this four months later:"Will Jon Corzine Plead the Fifth?" http://www.cnbc.com/id/45567036

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  25. "Brent:You ain't seen nothing yet. 2012 will be remembered as the Year of the Great Race, as central banks all over the world compete to see who can ease the fastest. Look for a cut from the ECB next. I think it might even come this week. I can't remember when they meet next."I think the John Carney article you linked to a while back made a fair case that there was counteracting deflationary pressure in Europe due to sovereign debt being reassessed for risk and that it actually was removing money from the money supply. That's obviously not the case in the United States.Europe's Real Problem? DeflationAlso, this is interesting:The Deutsche Mark is Coming Back

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  26. jnc:Yes, the concerted action by the central banks removed that problem, at least temporarily.

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  27. Guys, look at Ezra this morning. He has been interviewing Merkel Admin folks in Germany and oppo party wonks, too. They all tell him the same stuff Roland, the Daimler security specialist, told us a week ago Monday night at dinner. The Euro will be saved. Germany is not in a panic, or even a big hurry.Ezra adds how this all makes sense to Germany."To them, the run on Italy and Greece and Portugal and Spain is a feature, not a bug. It's leverage, and they want to use it.Look how much it has already gotten them. Greece, Portugal, Italy and Ireland are working their way through stringent deficit-reduction plans. The widely disliked governments of Greece and Italy, which proved unequal to the task of fiscal reform, have been toppled. There is a good chance that the Eurozone might become what Germany has always wanted it to be: a fiscal union, in which the members meet their deficit targets and reform their labor markets. And none of this would have happened without the markets making their run at the European periphery.So to understand the German position, look at it from their perspective: Why in the world would Germany let up the pressure now? When they're so close to amending the very treaty underlying the Eurozone? When France has joined with them on a set of reforms? When the market is doing what the Germans never could?"Again, the whole German perspective, as I heard it a week ago Monday night, and as Ezra writes here, is much more upbeat than our view. But Ezra points out that Germany may play the timing game too fine. I don't think they will.

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  28. Looks like they are following Rahm Emmanuel's advice:"Never let a serious crisis go to waste. What I mean by that is it's an opportunity to do things you couldn't do before."

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  29. Interesting to note:Tracy Postert, Occupy Wall Street Protester, Takes Job On Wall Street "An Occupy Wall Street protester has ditched her tent in Zuccotti Park in favor of a position at one of Wall Street's financial institutions.It all started when Wayne Kaufman, chief market analyst for John Thomas, saw Tracy Postert's placard that read: "PhD Biomedical Scientist Seeking Full Time Employment", according to the New York Post.Grabbing a copy of her CV, Kaufman decided she might be a good fit for a junior analyst position."I thought, 'Maybe this is a person who could help us understand these early-stage biotech companies that financial people just don't always understand,'" Kaufman told ABC News.By then, Postert had already spent 15 days at the Occupy encampment where she touted anti-capitalist messages with signs that read: "Reagan Sucks" and "I'll vote after the revolution," according to the Telegraph."I had been unemployed for so long, I thought why not?" Postert told the New York Post.Now she's worked at the financial firm for three weeks and is in the midst of studying for her financial analyst exams."

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  30. 'n every gimmick hungry yob digging gold from rock 'n roll,Grabs the mike to tell us he'll die before he's sold,But I believe in this and it's been tested by research,He, who fucks nuns, will later join the church.Death or Glory, the Clash

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  31. Mark:Misleading headline of the day:"Geithner Doesn't See Fed Funding IMF Euro Response" Then in the story what he actually said was: "The reports I've read in the press about what the Fed can do are not accurate," he told a news conference with German Finance Minister Wolfgang Schaeuble, who said Europe can expect further support from the United States and the International Monetary Fund." You'll note that saying reports are innacurate is essentially saying nothing. It could even be read to say that the Fed has MORE power than described.Geithner as head of the NY Fed, had a seat at the table for every meeting where the Fed brokered what we NOW know were 16 trillion in deals during the financial crisis. To think that he has suddenly gone on the wagon and taken the pledge is possible, but not the way to bet.

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  32. John, understood. I know what Geithner wants.Sheila Bair for SecTreas was an idea whose time came in 2008 and has not yet gone.

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  33. Here's a wildly inappropriate but well written blog which has some interesting things to say about Germany:http://www.marxist.com/secret-behind-germanys-economic-recovery.htm

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  34. While not an expert, I don't find the idea that Germany may be riding a peak before a trough surprising. We we so often thing we, or some other country, have it licked and winter will never come for us (or them, depending) always mystifies me. Economic cycles have a long history of turning robust economies into recession economies.

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  35. From the FT:"Eleventh-hour negotiations have begun to create a much bigger financial “bazooka” to present at this week’s European Union summit that could include running two separate rescue funds and winning increased support for the International Monetary Fund."You mean of course that Geithner's supposed declaration didn't last two hours? LOL

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  36. @Kevin,Just wait until China's real estate bubble implodes. Think you'll get a mea culpa out of Flathead? Me neither.

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  37. It would be too facile to say that overtight credit = recession and too loose credit –> bubble –> intractable recession. The tech crash was a bubble, but the resulting recession wasn't overly deep.Perhaps worse recession? Certainly the periods of growth following 1982 and 1991 were more vigorous than those in the aughts. Of course, replacing one bubble with an even bigger bubble has the sound of a Ponzi scheme. As it's financial bubbles, perhaps it should be a Fonzi scheme.Aaaaayyyyy.

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  38. "t would be too facile to say that overtight credit = recession and too loose credit –> bubble –> intractable recession. The tech crash was a bubble, but the resulting recession wasn't overly deep."If it weren't for the real estate bubble, I believe the recession following the tech bubble would have been much worse.Sit on it 😉

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  39. Just noticed this: We we so often thing weNot sure what I was doing there. We so often think we . . .

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  40. Argument in the alternative is tough to do. Just ask Sec. Geithner. ;-)Now, pardon me while I go jump a shark.BB

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  41. Heard Carl Icahn defending Ben Bernanke on CNBC today. It just made me feel all dirty and confused, like my first Playboy.

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