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S&P Gives US a Thumbs UP

Wednesday, June 12th, 2013

The S&P has upped the US.  It has raised the outlook for US debt from “negative” to “stable” which some take as an indication that we are unlikely to see a ratings slide like the one in 2011 that took us from AAA to AA+ anytime soon. The agency cited a lower federal deficit, the willingness of the Fed to stimulate the economy some more, and a slightly improved political climate as reasons. S&P also estimates, citing Congressional Budget Office data, that federal debt held by the public will stabilize at 84 percent of GDP in the near future. Congressional Budget Office projected the U.S. deficit will shrink to $642 billion this year, from over $1 trillion the past four years. Much of this, of course can be attribute to the tax increases, along with the sequestration cuts that kicked in March 1.

One of the ironies of the credit downgrade is that it also abraded a little of Standard & Poor’s brand. According to Treasury officials, the firm made an error in estimating discretionary spending levels at $2 trillion higher than what the Congressional Budget Office estimated. After being alerted, S&P lowered its calculations by $2 trillion but pressed ahead with the downgrade which irked many in the Treasury department.

The question is, does it mean anything? Many maintain that S&P’s downgrade two years ago had no consequences for U.S. interest rates, the stock market or the value of the dollar. Taking a look at the real estate industry, we see the foreign investment in the US actually increased with the first half of 2013 posting $7.97 billion, a 25% jump over 2012– evidence that global capital still believes in the US as a safe haven for their money. According to the OECD, the US economy will grow 1.9% this year and 2.8% in 2014.

The 4th Quarter Rush to Sell

Friday, January 4th, 2013

With the Bush era tax cuts on capital gains poised to expire at the end of the year, the investment sales market went on a tear in the 4th quarter. According to CoStar, total deals were up 46% from the same time a year ago based on transaction data through Dec. 31, according to Brian Kerschner, real estate economist for Property and Portfolio Research (PPR), CoStar’s analytics and forecasting company.

Not surprisingly, it was small-cap deals — assets most likely to be sold by owners hoping to mitigate the tax consequences of a sale – that really spiked, increasing in volume by 77% in the fourth quarter. Large-cap deals typically have less exposure to capital gains because they tend to involve REITs and pension funds which are tax advantaged investors.

The maximum rate for long-term capital gains had been 15% for individuals earning up to $85,650 a year or families earning up to $142,700. If we had gone over the cliff, the rate would have jumped to 20%.

Deals that closed in the waning days of 2012 included the following:

  • Amazon.com had the blockbuster of the year:  It paid $1.16 billion for its Seattle headquarters, encompassing 11 buildings totaling 1.8 million square feet.
  • Cupertino, CA-based Mission West Properties, Inc. sold all of its real estate assets for about $1.3 billion in two separate transactions
  • Dexus Property Group sold the majority of its U.S. industrial portfolio for $561 million as part of its strategy to exit the U.S. market by April, reallocating proceeds from offshore property sales to core Australian properties, CEO Darren Steinberg said. The sale of 26 of Dexus’  27 American properties was achieved at a significant premium to their book value.

Incidentally, the same logic applied to the residential market. New York, for example, saw an extraordinary 2,598 home sales in the last three months of 2012 — the highest for a Manhattan fourth quarter in at least 25 years.

Under the terms of the fiscal-cliff deal reached Tuesday, capital-gains taxes increased only for annual incomes over $400,000 for individuals and $450,000 for households. They will pay a new capital gains tax rate of 23.8%.

QE3 A Boon to CMBS

Tuesday, November 13th, 2012

If history repeats itself, QE3 will be good for commercial mortgage-backed securities (CMBS). The Fed’s third round of quantitative easing – which is purchasing $40 billion of residential mortgage-backed securities (RMBS) each month from Fannie Mae and Freddie Mac – will free up money for the commercial real estate market and lure investors away from other vehicles in their hunt for maximum yield.  QE3 is expected to last at least until 2015.

“The primary difference between 2012 and 2010 is that commercial property prices in healthy markets are stronger than they were just two years ago.  At its peak, CMBS constituted 40 percent of all commercial real estate loans,” said John O’Callahan of CoStar.  O’Callahan notes that “Investment returns of 40 percent or more for riskier assets during QE1 were largely a result of a bounce-back from the lows caused by investor panic in late 2008 through early 2009.  The overall impact of QE becomes clearer upon examining QE2.  Prices of equities and high-yield bonds, including CMBS, gained a respectable 12 to 15 percent.”

Low interest rates mean that returns will narrow to as little as 150 basis points, forcing investors to look elsewhere for respectable yields.  Currently, B-piece CMBS investors are achieving 20 percent and higher yields.  By contrast, the Dow Jones Industrial Average’s yield has remained below three percent each of the last 20 years.

CMBS has “been a boon for us,” said Kenneth Cohen, head of CMBS at UBS Securities.  “You’ve seen a fairly good size increase in loan pipelines.  Our pipeline has increased probably 50 percent over the last six weeks.”  Borrowers also are cashing in on the favorable loan terms.  According to Fitch Ratings, loans in 2012 are averaging 95.7 percent of a stressed property’s estimated value; that’s up from 91.6 percent in 2011.

Despite the good news, industry experts don’t expect the resurgent CMBS market to resolve all financing woes.  For example, the encouraging loan terms are of minimal help to commercial real estate owners who are under water, nor will new issuance be adequate to refinance the $54 billion in CMBS loans coming due this year.  Additionally, some ratings firms warn that the credit quality of CMBS loans could increase risk for some investors.  In response, Moody’s Investor Services’ now requires that senior bonds have expensive credit protection.

Cyber Threats to Our Economy

Monday, August 13th, 2012

All of Wall Street is abuzz about stock brokerage Knight Capital which was brought to the edge of bankruptcy by a software glitch. Seventeen-year old Knight is one of the most trusted trading intermediaries for many of America’s largest mutual-fund companies and retail brokers. It could have all ended when, on August 1st, a software glitch caused a barrage of unintended trades, affecting the opening prices of more than 100 securities, with a particularly large impact on half a dozen shares. Knight was left with a hole in its accounts of $440 million and promptly saw most of its customers flee. Kudos to Knight’s management which did superb damage control, righting technical problems, retaining skittish employees, pacifying regulators and luring back customers while securing a financing package compelling enough to restore confidence — a capital injection of $400 million in equity from a consortium of financial firms, including Jefferies Group, an investment bank; Blackstone, the private-equity giant; GETCO, a Chicago-based competitor; and two brokers, Stifel Financial and TD Ameritrade – in return for 70% of the equity of the firm. Employees with long-term equity incentives saw their stakes wiped out but the company was saved. Knight’s near miss is a reminder of the seriousness of computer malfunctions. We saw glitches on Facebook’s first day of trading on the NASDAQ stock exchange (caused by and upgrade to the Nasdaq OMX platform) and a shaky debut for BATS Global Market on its own electronic exchange.  utside of Wall Street, a software bug caused Southwest Airlines to charge online customers several times over for the same flight.

Computer shutdowns are catastrophic because there are few insurance products to protect businesses from glitch-related losses.  “If they’d had a fire in a server room, then that would have been covered,” says Robert Hartwig, president of the Insurance Information Institute, but such catastrophic losses from a software malfunction go beyond most comprehensive cyber insurance plans, which generally cover first party business interruption losses and costs association with hacking attacks. Part of the reason is that the rising number of costly data breaches is prompting insurance underwriters to re-examine cyber insurance plan coverage and policy rates. An industry study conducted by NetDiligence found insurance payments for data breaches climbed to an average of $3.7 million between 2006-2011, up more than 50 percent from $2.4 million for claims filed between 2000 and 2005.

“These incidents are certainly a wakeup call for software quality at these organizations,” says Eric Baize, senior director of the product security office at RSA, a division of EMC. “Updates now happen frequently on a weekly basis. It needs to be done increasingly in a time-pressured manner,” and developers often don’t get enough time

Back to the Drawing Board for Greece

Monday, July 9th, 2012

International lenders and Greece will renegotiate the program on which the second financial bailout for Athens is based because the original has become outdated, according to a senior Eurozone official.  Greece received a €130-billion bailout in February from the European Union and the International Monetary Fund (IMF).  General elections in May and June delayed the bailout’s implementation.  The United States, the IMF’s largest member, supports discussions to review the Greek bailout program, but German Chancellor Angela Merkel countered that any relaxing of Greece’s reform promises is unacceptable.

“Anybody who would say that we need not, and cannot renegotiate the MoU (memo of understanding) is delusional, because he, or she, would be under the understanding that the whole program, the whole process, has remained completely on track ever since the weeks before the Greek first election,” the official said.  “Because the economic situation has changed, the situation of tax receipts has changed, the rhythm of implementation of the milestones has changed, the rhythm of privatization has changed — if we were not to change the MoU –it does not work.  We would be signing off on an illusion.  So we have to sit down with our Greek colleagues and say: this is where we should be in July, and this is where we are in July, and there is a delta.  Let’s find out what the delta is and then how to deal with the delta — that is a new MoU,” according to the official.

According to the official, representatives of the IMF, the European Central Bank and the European Commission will visit Greece as soon as a new government is in place to review the program’s implementation and prepare for negotiations.  “It is no secret, quite logical in fact, that due to the time passed without a functioning government in place that can take the required decisions, because of this, there have been significant delays,” the official said.  “The conclusion is that they have to engage in discussions on the memorandum of understanding and bring it back onto an even keel.”

Meanwhile at the G-20 summit in Mexico,  leaders of the world’s most powerful economies say they have produced a coordinated global plan for job creation, which it calls the top priority in fighting the effects of the European economic crisis.  The draft says “We are united in our resolve to promote growth and jobs.”

An editorial in the Australian Financial Review warns Europe not to misrepresent the issue. “The optimism that followed Greece’s election has proved to be short-lived as investors acknowledge the poll result doesn’t really change all that much in terms of Europe’s ongoing debt crisis.  Less than a day after Greece pulled back from installing anti-austerity parties in office, European bond markets were once again in meltdown on concerns that Spain, Italy, Portugal and Ireland may need more financial aid to prevent default.  The European Union’s financial ‘firewall’ is clearly not up to the task, with the yield on Spanish 10-year bonds soaring to a Euro-era high of 7.29 percent.  In Athens, talks are under way to form a pro-EU coalition government between the center-right New Democracy party and the socialist Pasok party, reducing the likelihood of a near-term Greek exit from the Eurozone.  Yet rather than insist that Athens stick to the tough conditions it agreed to as part of the EU’s €240 billion ($300 billion) rescue packages, there are signs that European leaders may again be preparing to fudge the issue.  German Chancellor Angela Merkel insists that Athens must stick to its austerity commitments and that there is no room for compromise.  But other European politicians are starting to talk about giving Greece more time to fix its problems.  This appears to confirm the Greeks will never live up to their austerity conditions and that the exercise was all about kicking the can further down the road.”

Devaluation would be the optimal way for Greece to jump start its economy.  Because that option is not on the table this time, achieving competitiveness is going to be much harder.  One of the bailout’s stipulations requires the government to cut pensions, slash the number of public servants and control costs – in other words, the “austerity” option.  Others prefer a program to stimulate growth and boost revenue, although one that would likely involve increased spending.  This is the “growth” option.  Angela Merkel favors austerity while French President Francois Hollande prefers the “growth” option.  In this debate, the Germans are in control because they are the ones that are going to cough up the money.  They have the ability to help because, contrary to most of Europe, they practice austerity and thrift.  If German taxpayers are going to have to pay higher taxes to save nations like Greece, they think their European brothers and sisters should share some of the pain.

According to a Washington Post editorial, Germany and other creditworthy E.U. governments were right to tell Greeks before the election that they could not choose both the Euro and an end to austerity and reforms, as several populist parties were promising.  Yet now that voters favored parties that supported the last bailout package, it’s time for Angela Merkel and other austerity hawks to make their own bow to reality. For Greece to stabilize, some easing of the terms of EU loans will be needed, at a minimum; an extension of deadlines for meeting government spending and deficit targets may also be necessary.  Unless it can deliver such a relaxation, there is not much chance the new administration in Athens will be able to push through the huge reforms still needed to make the economy competitive, including privatizations, deregulation and public sector layoffs.

“In the end, a Greek slide into insolvency and an exit from the euro may still be unavoidable. That’s all the more reason why EU leaders must at last agree on decisive measures to shore up the rest of the currency zone, beginning with Spain and Italy.  Measures under discussion for a summit meeting next week, including euro-area bank regulation, are positive but not sufficient.  In the end, banks and governments must be provided with sufficient liquidity to restore confidence — something that will probably require the issuance of bonds backed by all Euro-area countries, or greatly increased lending by the European Central Bank.  As German officials invariably point out, bailout measures will be wasted unless they are accompanied by significant structural reforms by debtor nations.  But without monetary liquidity, and the chance for renewed growth, the Euro cannot be rescued.”

Is the Eurozone Sustainable?

Thursday, June 14th, 2012

Mario Draghi, president of the European Central Bank (ECB), has asked policymakers to focus their crisis support on solvent Eurozone banks.  “The ECB will continue lending to solvent banks and will keep the liquidity lines active and alive with solvent banks,” Draghi said.

World stock markets have lost roughly $4 trillion as European turmoil proliferated after inconclusive Greek elections and the danger of Spain’s finances being overwhelmed by its banking crisis.  The ECB has taken the lead in fighting the turmoil by infusing the banking system with more than one trillion Euros ($1.24 trillion), cutting its benchmark rate to a record low and purchasing government bonds.  When asked whether the ECB can tame financial turmoil and help cap widening bond spreads, Draghi said that “it’s not our duty, it’s not in our mandate” to “fill the vacuum left by the lack of action by national governments on the fiscal front,” on “the structural front, and on the governance front.”

Draghi favors using the permanent bailout fund, the European Stability Mechanism (ESM), to inject capital into banks.  “People are actually working on finding ways that the ESM could be used to recapitalize banks,” he said.  “ The issue is not so much the use of ESM money to recapitalize banks but whether this could be done directly without having to go to governments.”

Despite the ECB’s efforts, Draghi admits that the setup of the 17-country euro currency union may be unsustainable.  According to Draghi, the financial crisis proved the inadequacy of the financial and economic framework set up for the Eurozone.  “That configuration that we had with us by and large for ten years which was considered sustainable,  I should add, in a perhaps myopic way, has been shown to be unsustainable unless further steps are taken,” he said.

Draghi said the next step “is for our leaders to clarify what is the vision…what is the euro going to look like a certain number of years from now.  The sooner this has been specified, the better it is.”  In 1989, European Commission President Jacques Delors issued a breakthrough report that charted the initial path to the creation and launch of the Euro 10 years later and detailed goals. “The same thing should be done now,” Draghi said.  He compared Europe’s efforts to those of someone crossing a river in thick fog while struggling against a strong current.  “He or she continues fighting but does not see the other side because it is foggy.  What we are asking is, to dispel this fog,” he said.

“Can the ECB fill the vacuum of lack of action by national governments on fiscal growth? The answer is no,” Draghi told the European Parliament.

Ongoing discussions about closer Eurozone economic union have been revived by growing apprehension that Spain may need an international bailout.  June elections in Greece could see major wins by anti-bailout parties, possibly leading to the country’s departure from the Euro.  Asked about the potential for a bank run, Draghi said: “We will avoid bank runs from solvent banks.  Depositors’ money will be protected if we build this European guaranteed deposit fund.  This will assure that depositors will be protected.”

Germany is loath to risk more of its taxpayers’ money to prop up Eurozone partners and has rejected any joint deposit guarantee.  “The financial crisis has heightened risk aversion in a dramatic way,” Draghi said.  “I urge all governments to keep this in mind, because it is better to err by too much in the very beginning rather than by too little,” he said, referring to the failure of regulators to correctly assess the needs of failed Franco-Belgian bank Dexia and Spain’s Bankia.

Bank of Italy governor Ignazio Visco said political inertia and bad economic decisions had put “the entire European edifice” at risk and only a clear path to political union could save the Euro.  “There are now growing doubts among international investors about governments’ cohesion in guiding the reform of European governance and even their ability to ensure the survival of the single currency,” Visco said.

EU Economic and Monetary Affairs Commissioner Olli Rehn said Europe needs tighter budget discipline and more integrated rescue funds to forestall the Euro’s breakup.  “We need a genuine stability culture and a much upgraded common capacity to contain common contagion,” he said.  “This is the case, at least if we want to avoid a disintegration of the euro zone and instead make the euro succeed.”

Basel III Compliance Requires 29 Biggest Banks to Raise $556 Billion

Wednesday, June 6th, 2012

The world’s largest banks need to raise as much as $566 billion of common equity to meet Basel III rules on capital to be implemented by 2019, cutting shareholder returns, according to analysts at Fitch Ratings.  The 29 global banks that regulators believe are too big to fail need new capital that equals nearly 23 percent of the lenders’ current $2.5 trillion of aggregate common equity, according to the report.  The median lender could meet the requirements with three years of retained earnings, according to Fitch.

Basel III is the latest version of a global regulatory standard on bank adequacy, stress testing and market liquidity risk, requires banks to hold 4.5 percent of common equity, an increase from the two percent under Basel II.  The higher standard is an attempt to prevent a repeat of the 2008 financial crisis.

International banking regulators meeting under the sponsorship of the Bank for International Settlements in Basel are seeking to implement rules to prevent taxpayers being forced to rescue failing banks.  In addition to boosting capital requirements, they are instituting rules on leverage ratios and funding to ensure lenders can withstand future crises.  “There’s a shortfall and we wanted to see what covering that implies,” according to Martin Hansen, a Fitch analyst.  The Basel III rules “create incentives to reduce expenses further and to increase pricing pressure on borrowers and customers where feasible,” he said.  The banks global systemically important financial institutions must hold a special capital surcharge of between one and 2.5 percent of assets weighted by risk.

The banks are likely to reduce their holdings of more volatile, lower-rated assets, potentially increasing borrowing costs for weaker companies and reducing the availability of credit.  The borrowers’ securities would become harder to trade, forcing companies borrow from less regulated lenders such as private equity firms and hedge funds, according to a Fitch report, called “Basel III: Return and Deleveraging Pressures.”  “If banks decide to originate risk and then pass it on to outsiders then it adds to the stability of the banking system,” Hansen said.  “Risk hasn’t been reduced, though — it’s been moved from one part of the system to another.”  The median return on equity of the 29 lenders was 7.3 percent last year and averaged 11 percent between 2005 and 2011.  That is expected to decline to 8.5 to nine percent as the banks make up the capital shortfall, according to Hansen.

Since it is impossible for regulators to perfectly align capital requirements with risk exposure, some banks might seek to increase return on equity through riskier activities that maximize yield on a given unit of Basel III capital, including new forms of regulatory arbitrage,’ Hansen said.

James Moss, another Fitch analyst, said the banks, which have a collective $47 trillion in assets, will have to look at the full spectrum of ways to meet the new capital requirements.  “This is a very dynamic time for banking so the strategic side of bank planning is going to get a lot of attention over the coming years,” he said.  “Basel III creates a trade-off for financial institutions between declining return on equity, which might reduce their ability to attract capital, versus stronger capitalization and lower risk premiums, which benefits investors.”

Our overall objective remains to strengthen the resilience of the banking sector in the European Union while ensuring that banks continue to finance economic activity and growth,” said Michel Barnier, EU Internal Markets Commissioner.  “The final compromise must contribute to financial stability, the necessary basis for growth and employment.”

Beware: Double Dip Ahead?

Thursday, May 31st, 2012

The 17-nation Eurozone is at risk of falling into a “severe recession,” the Organization for Economic Cooperation and Development (OECD) warned, as it called on governments and the European Central Bank to act quickly to keep the slowdown from becoming a drag on the global economy.  OECD Chief Economist Pier Carlo Padoan warned the euro-zone economy has the potential to shrink as much as two percent in 2012, a figure that the think tank had described as its worst-case scenario last November.  The OECD -which comprises the world’s most developed economies — said its average forecast was that the Euro-zone economy will shrink 0.1 percent in 2012 and grow a mere 0.9 percent next year.  “Today we see the situation in the Euro area close to the possible downside scenario” in the OECD’s November report, “which if materializing could lead to a severe recession in the Euro area and with spillovers in the rest of the world,” Padoan said.

The report believes that Europe will lag behind other countries, especially the United States, where the economy is expected to grow 2.4 percent this year and 2.6 percent in 2013.  “There is now a diverging trend between the euro area and the U.S., where the U.S. is picking up more strongly while the euro area is lagging behind,” Padoan said.  Europe is split between a wealthier north that is growing and the southern nations that are falling into recession, according to OECD statistics.

The global economic outlook is still cloudy,” said Angel Gurria, OECD Secretary General. “At first sight the prospects for the global economy are somewhat brighter than six months ago.  At closer inspection, the global economic recovery is weak, considerable downside risks remain and sizable imbalances remain to be addressed.”

Germany, Europe’s largest economy, will grow two percent next year after expanding 1.2 percent in 2012.  France, the Eurozone’s second-biggest economy, will grow 1.2 percent next year after expanding 0.6 percent this year, the OECD said.  By contrast, Italy’s economy is expected to shrink 1.7 percent this year and 0.4 percent in 2013.  Spain will remain mired in recession, with contraction of 1.6 percent this year and 0.8 percent in 2013.  Padoan has asked Eurozone leaders to enter into a “growth compact” to promote expansion while cutting deficits.  French President Francois Hollande has made achieving this type of pact the focus of his European diplomacy.

The OECD is chiefly concerned that problems with European sovereign debt are a significant threat to growth around the world. “The crisis in the Eurozone remains the single biggest downside risk facing the global outlook,” Padoan said.  “This is a global crisis which is largely a debt crisis.  It is a result of excessive debt accumulation in both the private and public sectors.  One can not safely say we’re out of the crisis until debt comes down to more manageable levels.”

To protect its economic recovery, the OECD urged the American government to move very gradually to tighten its budget.  A wave of U.S. spending cuts and tax hikes – known as the “fiscal cliff” — are set to take effect in January unless politicians agree to delay at least some of them.  Bush-era tax cuts and benefits for the long-term jobless are both expected to expire.  Another $1.2 trillion in spending cuts on federal programs would take effect as a result of Congress’ failure last year to find a comprehensive deal to cut the budget deficit.  The OECD said these actions would be the wrong fiscal policy given the still-fragile condition of world’s largest economy.  “The programmed expiration of tax cuts and emergency unemployment benefits, together with automatic federal spending cuts, would result in a sharp fiscal retrenchment in 2013 that might derail the recovery,” according to the OECD.

Wall Street economists say that fiscal policy could tighten by about $600 billion in 2013, or about four percent of GDP, if lawmakers cannot agree on what programs to cut.  Goldman Sachs estimates the “fiscal cliff” could trim approximately four percent from GDP in the first half of 2013.  The majority of economists, however, expect lawmakers to act before that particular hammer has an opportunity to fall.

Eurodammerung?

Wednesday, May 23rd, 2012

Despite Germany’s strong manufacturing output in March, it was not enough to compensate for a slump across the rest of the Eurozone with declining production, a signal that an expected recession may not be as mild as policymakers hope.  Industrial production in the 17 Eurozone countries declined 0.3 percent in March when compared with February, according to the European Union’s (EU) statistics office Eurostat.  Economists had expected a 0.4 percent increase.

The figures stood in stark contrast with German data showing output in the Eurozone’s largest economy rose 1.3 percent in March, according to Eurostat, 2.8 percent when energy and construction are taken into account.  “With the debt crisis, rising unemployment and inflation, household demand is weak and globally economic conditions are sluggish, so that is making people very reluctant to spend and invest,” said Joost Beaumont, a senior economist at ABN Amro.

According to Eurostat, output declined 1.8 percent in Spain; in France — the Eurozone’s second largest economy after Germany — output fell 0.9 percent in March.  Many economists expect Eurostat to announce that the Eurozone went into its second recession in just three years at the end of March, with households suffering the effects of austerity programs designed to slash debt and deficits.

“Industrial production is a timely reminder that first-quarter GDP will likely show a contraction,” said Martin van Vliet, an economist at ING.  “With the fiscal squeeze unlikely to ease soon and the debt crisis flaring up again, any upturn in industrial activity later this year will likely be modest.”  European officials believe that the slump will be mild, with recovery in the 2nd half of this year.  The strong economic data seen in January has unexpectedly faded point to a deeper downturn, with the drag coming from a debt-laden south, particularly Greece, Spain and Italy.

Economists polled by Reuters estimated the Eurozone economy contracted 0.2 percent in the 1st quarter, after shrinking 0.3 percent in the 4th quarter of 2011.  “We suspect that a further slowdown in the service sector meant that the wider economy contracted by around 0.2 percent last quarter,” said Ben May, an economist at Capital Economics.  “What’s more, April’s disappointing survey data for both the industrial and service sectors suggest that the recession may continue beyond the first quarter.”

“It is evident that Eurozone manufacturers are currently finding life very difficult amid challenging conditions,” said Howard Archer at IHS Global Insight. “Domestic demand is being handicapped by tighter fiscal policy in many Eurozone countries, still squeezed consumer purchasing power, and rising unemployment.”  Eurozone governments have introduced broad austerity measures in order to cut debt, and these have undermined economic growth.

European watchers also expect to see Greece exit the Eurozone.  Writing for Forbes, Tim Worstall says that “As Paul Krugman points out, the odds on Greece leaving the Eurozone are shortening by the day.  In and of itself this shouldn’t be all that much of a problem for anyone. Greece is only two percent of Eurozone GDP and it will be a blessed relief for the Greeks themselves.  However, the thing about the unraveling of such political plans as the Euro is that once they do start to unravel they tend not to stop.”

The European Commission hopes Greece will remain part of the Eurozone but Athens must respect its obligations, the European Unions executive Commission said.  “We don’t want Greece to leave the Euro, quite the contrary – we are doing our utmost to support Greece,” European Commission spokeswoman Pia Ahrenkilde Hansen said.  Greece is likely to face new elections next month after three failed attempts to form a government that would support the terms of an EU/IMF bailout.  Opinion polls show most Greeks want to stay in the Eurozone, but oppose the harsh austerity imposed by the emergency lending program.  “We wish Greece will remain in the euro and we hope Greece will remain in the euro … but it must respect its commitments,” according to Ahrenkilde.  “The Commission position remains completely unchanged: we want Greece to be able to stay in the Euro.  This is the best thing for Greece, for the Greek people and for Europe as a whole,” she said.

European Central Bank (ECB) policymakers Luc Coene and Patrick Honohan voiced the possibility that Greece might leave the currency bloc and reached the conclusion that it will not be fatal for the Eurozone.  According to Luxembourg’s Finance Minister Luc Frieden “If Greece needs help from outside, the conditions have to be met.  All political parties in Greece know that.”  There are powerful incentives for keeping Greece stable, one of which is that the ECB and Eurozone governments are major holders of Greek government debt.  A hard default could mean heavy losses for them; if the ECB needed recapitalizing as a result, that debt would fall on its members’ governments, with Germany first in line.  “If Greece moves towards exiting the Euro…the EU would then need to enlarge its bailout funds and prepare other emergency measures,” said Charles Grant, director of the Centre for European Reform think-tank.

Meanwhile, Britain’s Deputy Prime Minister Nick Clegg warned euro skeptics to avoid gloating over the state of the Eurozone as Greece tries to assemble a workable government.  According to Clegg, “We as a country depend massively on the prosperity of the Eurozone for our own prosperity, which is why I can never understand people who engage in schadenfreude – handwringing satisfaction that things are going wrong in the euro.  We have an overwhelming interest – whatever your views are on Brussels and the EU – in seeing a healthy Eurozone.  That’s why I very much hope, buffeted by these latest scares and crises in Greece and elsewhere, that the Eurozone moves as fast as possible to a sustainable solution because if the Eurozone is not growing and the Eurozone is not prosperous it will be much more difficult for the United Kingdom economy to gather momentum.”

JP Morgan Chase’s $2 Billion Loss Under Investigation

Monday, May 21st, 2012

As the Department of Justice and the FBI open their investigation into how JP Morgan Chase lost $2 billion, the government is investigating to determine if any criminal wrongdoing occurred.  The inquiry is in the preliminary stages.  Additionally, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC), which regulates derivatives trading, are also looking into JPMorgan’s trading activities.  JPMorgan CEO Jamie Dimon said that the bank made “egregious” mistakes and that the losses tied to synthetic credit securities were “self-inflicted.”

The probe is perceived as necessary, given the ongoing debate about bank regulation and reform, and one expert said it raised the level of concern around what happened.  “The FBI looks for evidence of crimes and goes after people who it alleges are criminals.  They want to send people to jail.  The SEC pursues all sorts of wrongdoing, imposes fines and is half as scary as the FBI,” said Erik Gordon, a professor in the law and business schools at the University of Michigan.

According to Treasury Secretary Timothy Geithner, the trading loss “helps make the case” for tougher rules on financial institutions, as regulators implement the Dodd-Frank law aimed at reining in Wall Street.  Geithner said the Federal Reserve, the SEC and the Obama administration are “going to take a very careful look” at the JPMorgan incident as they implement new regulations like the “Volcker Rule,” which bans banks from making bets with customers’ money.  “The Fed and the SEC and the other regulators — and we’ll be part of this process — are going to take a very careful look at this incident and make sure that we review the implications of what that means for the design of these remaining rules,” Geithner said.  Under review will be “not just the Volker Rule, which is important in this context, but the broader set of safeguards and reforms,” Geithner said, noting that regulators will also scrutinize capital requirements, limits on leverage and derivatives markets reforms.  “I’m very confident that we’re going to be able to make sure those come out as tough and effective as they need to be,” Geithner said.  “And I think this episode helps make the case, frankly.”

Geithner said that Dodd-Frank wasn’t intended “to prevent the unpreventable in terms of mistakes in judgment, but to make sure when those mistakes happen — and they’re inevitable — that they’re modest enough in size, and the system as a whole can handle them.”  The loss “points out how important it is that these reforms are strong enough and effective enough,” he said.

With the passage of Dodd-Frank, banks are required to hold more capital, reduce their leverage and assure better cushions across the financial system to accommodate losses.  Geithner’s comments are similar to those made by other White House officials, who have avoided blasting the bank for its bad judgment, and instead used the event to bolster the case for the financial overhaul.

“We are aware of the matter and are looking into it,” a Justice Department official said “This is a preliminary look at what if anything might have taken place.”  The inquiry by the FBI’s financial crimes squad is in a “preliminary infancy stage,” the official said, and federal law enforcement agents are pursuing the matter “because of the company and the dollar amounts involved here.”

JPMorgan’s and the financial system’s ability to survive a loss that large showed that reforms put in place after the 2008 financial crisis have succeeded.  Nevertheless, the loss by the nation’s largest bank highlights the need for tough implementation of the Volcker Rule on proprietary trading and other rules that regulators are still finalizing.  “The whole point was, even if you’re smart, you can make mistakes, and since these banks are insured backed up by taxpayers, we don’t want you taking risks where eventually we might end up having to bail you out again, because we’ve done that, been there, didn’t like it,” according to President Obama.

Mark A. Calabria, Director of Financial Regulation Studies for the Cato Institute, takes a contrarian view.  Writing in the Huffington Post, Calabria says that “Unsurprisingly, President Obama and others have used the recent $2 billion loss by JPMorgan Chase as a call for more regulation. Obviously, our existing regulations have worked so well that more can only be better!  What the president and his allies miss is that recent events at JPMorgan illustrate how the system should — and does — work.  The losses at JPMorgan were borne not by the American taxpayer, but by JPMorgan.  The losses also appear to have been offset by gains so that in the last quarter JPMorgan still turned a profit.  This is the way the system should work.  Those who take the risk, take the loss (or gain).  It is a far better alignment of incentives than allowing Washington to gamble trillions, leaving someone else holding the bag.  The losses at JPMorgan have also resulted in the quick dismissal of the responsible employees.  Show me the list of regulators who lost their jobs, despite the massive regulatory failures that occurred before and during the crisis.

According to Calabria, “President Obama has warned that ‘you could have a bank that isn’t as strong, isn’t as profitable making those same bets and we might have had to step in.’  Had to step in?  What the recent JPMorgan losses actually prove is that a major investment bank can take billions of losses, and the financial system continues to function even without an injection of taxpayer dollars.  It is no accident that many of those now advocating more regulation are the same people who advocated the bailouts.  Banks need to be allowed to take losses.  The president also sets up a ridiculous standard of error-free financial markets.  All human institutions, including banks and even the White House, are characterized by error and mistake.  Zero mistakes is an unattainable goal in any system in which human beings are involved.  What we need is not a system free of errors, but one that is robust enough to withstand them.  And the truth is that the more small errors we have, the fewer big errors we will have.  I am far more concerned over long periods of calm and profit than I am with periods of loss.  The recent JPMorgan losses remind market participants that risk is omnipresent.  It encourages due diligence on the part of investors and other market participants, something that was sorely lacking before the crisis.”