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Here we go again:

Forget for a moment the IMF, and instead direct your gaze upon the MMF: Money Market Funds. These are a type of mutual fund that is, according to the SEC, required by law to invest in low-risk securities. They pay dividends that are supposed to reflect short-term interest rates. They are not (repeat NOT) federally insured.

Except they were.

Recall that during the credit crisis, these supposedly uninsured, supposedly low risk vehicles for squeezing a few pennies more out of cash fell below their One Dollar ($1) benchmark. When that happened, the Fed and Congress rescued them with a bailout as well.

Why on earth taxpayers were on the hook for an investment 3rd parties made is beyond my comprehension. Investors in equities were not made whole for their losses, that is the chance they took. Investors in bonds were not made whole, unless they were clever enough to lend to banks. Despite the foolishness and bad investment judgment of creditors to Bank of America, Citigroup, Bear Stearns, etc. were made whole.

The idea of systemic risk sure comes in handy from time to time.

And guess what? It appears that we are once again, looking at systemic risk of the banks and money market funds, who once again, made some very ill-advised lending. Only this time, instead of giving money to home buyers who could not possibly ever pay it back, they lent money to Countries, who could not ever pay it back.

Here is Randall Forsyth in this morning’s Barron’s

“RETURN-FREE RISK.” That’s just one of the turns of phrase that Jim Grant has tossed off over the years as editor of the invaluable Grant’s Interest Observer and as Barron’s most illustrious alum.

The term could well apply to major money-market funds, which provide yields barely visible to the naked eye but could suffer collateral damage from any potential fallout from a possible default by Greece. Grant was way out ahead of the crowd by pointing out in his latest issue, dated June 17, that the five largest money funds, Fidelity Cash Reserves (FDRXX), Vanguard Reserve Prime (VMRXX), Fidelity Institutional Money Market Market Portfolio (FNSXX), Fidelity Institutional Prime Money Market Portfolio (FIPXX) and BlackRock Liquidity TempFund (TMPXX) held an average of 41% of their assets in European banks’ short-term debt. Fitch Ratings added in a report last week that the top 10 money funds, with assets of $755 billion, had about half their assets in European bank liabilities.

It’s doubtful that any money-fund holder has forgotten the aftermath of the Lehman Brothers bankruptcy in 2008, which caused The Reserve Fund, a pioneer in the field, to “break the buck” — have its net-asset value fall below $1 a share — owing to its holding of Lehman commercial paper. Since the crisis, the Securities and Exchange Commission has mandated money funds hold at least 10% of their assets in paper that can be converted into cash in one day and 30% in paper due in 60 days or less (or redeemable within seven days).

European Central Bank President Jean-Claude Trichet last week declared the financial risk situation was “code red.” That was his characterization of an assessment by Europe’s new risk monitor, the European Systemic Risk Board, that the highly interconnected financial system inside and outside the European Union means debt woes of several countries could spread rapidly if conditions worsen, the Associated Press reported.

Given that, money funds with European exposure and yielding about 0.01% would seem the very embodiment of return-free risk. But it seems the generals have prepared well for the last war, so 2008-style runs aren’t likely.

It appears that once again, bankers have shown themselves to be incapable of assessing risk properly. And why should they? Every time they screw up, most of them get rescued, while a tiny percentage are allowed to ignominiously whither and die.

The lesson these banks have learn is not to be more prudent with their risk taking, but rather, to make sure they are not amongst the smallish group of financiers who are unconnected in DC. The credit crisis taught them that Risk Management is for Suckers, and the real money s in pol;itical lobbying and owning a Congressman or two.

Moral Hazard anyone?

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Source:
Show Ralph the Money
RANDALL W. FORSYTH
Barron’s, JUNE 25, 2011 
http://online.barrons.com/article/SB50001424053111904548404576397770227805578.html

Is the Chinese Economy Sputtering for the Same Reasons as the American Economy?

It was tempting to believe that China was different.

With its command and control economy with some of the trappings of free market capitalism, trillions in reserves, and abundant natural resources, many thought that China would “decouple” from the Western world’s problems and sail into a prosperous future.

However, despite its long history, exotic names and seemingly strong position, China cannot avoid the rules of economics which have applied to all countries throughout history.

Corruption and Phony Bookkeeping

Corruption and the failure to follow the rule of law is one of the main factors which has dragged down the American economy.

The fact that – according to the Chinese central bank – Chinese officials stole $120 billion and fled the country does not auger well for China.

Scandals among various Chinese companies are not helping, either.

And then there are the made up statistics. As Warren Hatch of Catalpa Capital Advisors notes:

As Li Keqiang, the vice premier and heir-apparent to Wen Jiabao, laconically remarked to the US ambassador a few years ago, most of the statistics in China are “for reference only.”

And Charles Hugh Smith argues:

Despite their many differences, the economies of China and the U.S. share a number of key traits: both are corrupt, rigged, crony-Capitalist, rely on phony statistics and propaganda and operate with two sets of rules: one for the Elites, and another for the masses.

Despite their many differences, the economies of China and the U.S. share a number of key traits: both are corrupt, rigged, crony-Capitalist, rely on phony statistics and propaganda and operate with two sets of rules: one for the Elites, and another for the masses.

Can We Trust You?

The credit crisis hit in 2008 largely because American banks lost trust in one another. Specifically, top economists say that each bank had so much bad debt on its books (in the form of mortgage backed securities and derivatives which worth the paper they were written on) which made them essentially insolvent that they assumed that all of the other banks must be in a similar situation … so they stopped lending to each other.

This drove the price which banks charged each other for loans (libor) skyrocket, and the whole credit market froze up.

The same thing is now happening in China. As ZeroHedge reports, Chinese interbank lending is freezing up and “shibor” – the prize which Chinese banks charge each other for loans – is skyrocketing.

Bloomberg notes:

China’s money-market rate climbed to the highest level in more than three years as a worsening cash crunch prompted the central bank to suspend a bill sale.

The seven-day repurchase rate, which measures interbank funding availability, has more than doubled since June 14, when the People’s Bank of China ordered lenders to set aside more money as reserves for a sixth time this year. The central bank suspended a sale of bills tomorrow, according to a statement on its website today.

“Banks have to hoard cash to meet the regulator’s capital or loan-to-deposit requirements by the end of every quarter,” said Liu Junyu, a bond analyst at China Merchants Bank Co., the nation’s sixth-largest lender. “So we won’t see the shortage easing.”

(Admittedly, there may have been temporary factors leading to the rise in shibor, which might be smoothed out in the future. But the point is that China is not immune from credit squeezes.)

Less Bang for the Buck

Each dollar of debt incurred by the American government creates less and less benefit. For example, Jim Welsh points out:

Since 1966, each dollar of additional debt has given the economy less of a boost. In 1966, $1 dollar of debt boosted GDP by $.93. But by 2007, $1 dollar of debt lifted GDP by less than $.20.

Karl Denninger notes:

What is this chart? Why, the history of our idiocy. It’s quite simple; this is the multiple that each dollar of debt (anywhere in the economy) has returned in GDP looked at on a quarter-on-quarter basis, net of the debt increase itself. That is, if the multiple is “1″ then for each dollar of debt added to the economy there was one dollar of output in the form of GDP added as well during the same period of time. If it’s “0″ then the debt itself produced no additional output, but did fund itself. If it’s negative, well, into the black hole you go. Since this is a quarterly number it’s quite noisy but there’s no mistaking what it tells you.

If you pay attention you’ll note that since 1980 this has never been positive – not even for one quarter – and it was only rarely positive before that time!

Similarly, Martin Wolf of notes

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Dwight Perkins of Harvard argued at the China Development Forum that the “incremental capital output ratio” – the amount of capital needed for an extra unit of GDP – rose from 3.7 to one in the 1990s to 4.25 to one in the 2000s. This also suggests that returns have been falling at the margin.

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The thesis advanced by Prof Pettis is that a forced investment strategy will normally end with such a bump. The question is when. In China, it might be earlier in the growth process than in Japan because investment is so high. Much of the investment now undertaken would be unprofitable without the artificial support provided, he argues. One indicator, he suggests, is rapid growth of credit. George Magnus of UBS also noted in the FT of May 3 2011 that the credit-intensity of Chinese growth has increased sharply. This, too, is reminiscent of Japan as late as the 1980s, when the attempt to sustain growth in investment-led domestic demand led to a ruinous credit expansion.

As growth slows, the demand for investment is sure to shrink. At growth of 7 per cent, the needed rate of investment could fall by up to 15 per cent of GDP. But the attempt to shift income to households could force a yet bigger decline. From being an growth engine, investment could become a source of stagnation.

And if you think that bailouts as an attempt at stimulus are solely a Western game, think again.

China is bailing out local governments, giving cash for clunkers, and trying just about every possible type of bailout.

Consumer Spending Declines

Consumer frugality is obviously slowing the American economy. But the Chinese consumers are picking up the slack, right?

Actually, Bloomberg reports that consumer spending is down:

At the Haiyang Zhuangshi Co. hardware store in Beijing, sales of paint and aluminum window frames are slowing, one sign of a diminished role for consumer spending in China that’s foiling government objectives.

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Hu’s loss underlines the dilemma for Premier Wen Jiabao: his campaign to control inflation is undermining attempts to make consumers a bigger driver of the world’s second-largest economy. Failure to lessen dependence on exports and investment spending leaves the nation more vulnerable to swings in external demand and subject to asset booms and busts.

Government data this week showed retail sales growth slowed to 16.9 percent in May, less than the average of the past five years and a figure that’s inflated by soaring prices for food. By contrast, spending on fixed assets such as factories and property climbed 26 percent, excluding rural households, in the first five months, the fastest pace in almost a year.

Analysts at Capital Economics, a London-based research group, estimate that private consumption may have fallen to 34 percent of gross domestic product last year, the lowest level since China began opening its economy to market mechanisms more than three decades ago. Just 10 years ago, the share was 46 percent, Capital Economics calculates.

“Just at a time when the government in China and a lot of people elsewhere are hoping to see Chinese consumers step up to the plate, actually they’ve been staying away from shops,” said Mark Williams, an economist in London with Capital Economics and a former adviser on China to the U.K. Treasury. “The trend over the past couple of years has been relentlessly downward.”

All Bubbles Eventually Burst

I noted in July 2009:

One of the top experts on China’s economy – Michael Pettis – has a[n] essay arguing that China is blowing a giant credit bubble to avoid the global downturn.

Pettis documents reports and statistics from modern China, of course. But he ends with a must-read comparison to ancient Rome:

Let me post here a portion of Chapter 15 from Will Durant’s History of Roman Civilization and of Christianity from their beginnings to AD 325

The famous “panic” of A.D. 33 illustrates the development and complex interdependence of banks and commerce in the Empire. Augustus had coined and spent money lavishly, on the theory that its increased circulation, low interest rates, and rising prices would stimulate business. They did; but as the process could not go on forever, a reaction set in as early as 10 B.C., when this flush minting ceased. Tiberius rebounded to the opposite theory that the most economical economy is the best. He severely limited the governmental expenditures, sharply restricted new issues of currency, and hoarded 2,700,000,000 sesterces in the Treasury.

Read the rest of this entry »

Some really early morning linkage before the weekend begins:

• The Hindsight Fallacy – The real reason it’s so hard to predict bubbles. (Slate)
• Table of Chinese Reverse Mergers on U.S. Exchanges (Bloomberg)
• Pessimism about National Economy Rises, Personal Financial Views Hold Steady (Pew Research)
• Oil Traders: Tapping Reserve Was ‘Genius’ Move by Obama (CNBC)
• Ron Paul worries Fort Knox gold is gone (CNNMoney)
• The Prince Who Blew Through Billions (Vanity Fair)
• Peter Taylor on Al-Qaeda (The Browser)
• Me, Inc. (Boston Review)
• Honda wins big in J.D. Power’s individual segment study (Left Lane)
• The Beer Archaeologist (Smithsonian.com)

What are you reading?

Succinct summation of week’s events:

Positives:

1) Greek PM wins vote of confidence to continue on with hopefully enough backing to pass the newly austere budget next week (I call the victory a lack of a negative rather than a positive)
2) May Durable Goods bounce from April weakness as hopefully Japan supply issues begin to recede
3) AAA said gasoline prices fell another .06 on the week to $3.60, the lowest since March 30th
4) German IFO business confidence unexpectedly rises to 3 month high
5) China done raising rates after Wen’s comments in FT?

Negatives:

1) Greek uncertainty infecting Italy and Spain as Moody’s states it has more watchful eye over many Italian banks
2) Euro zone mfr’g and services index falls to weakest since Oct ’09
3) German ZEW 6 month economic confidence falls to lowest since Jan ’09
4) China’s HSBC flash mfr’g PMI falls to 50.1 from 51.6, a hair above the breakeven level and the slowest since July ’10
5) Initial Jobless Claims disappoints again, now above 400k for 11th straight week
6) Existing Home Sales inventory to sales ratio rises to 9.3 months, the most since Nov. In the aggregate, tax credit induced buyers last yr now have homes below what they paid.

The Minneapolis Fed has a cool tool that lets you compare a variety of different attributes over past recessions and recoveries:
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Recessions

click for interactive graphics

Recovery

Source: Federal Reserve Bank of Minneapolis: The recession and recovery in perspective

Lets catch up with what Matt Trivisonno is seeing over at his Withholding-Tax data crunching site, The Daily Jobs Update:

Federal withholding-tax collections over the last four workweeks came in only slightly above the corresponding period from 2010. Total collections were $126.25 billion versus $125.59 billion – only $659 million more.

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That’s the raw data. But of course, we had a big tax cut back in January. So, taking that into consideration, there is little doubt that we still have a very healthy year-over-year growth rate. And that fits with the fact that we have 1.7 million more private-sector jobs now than we did a year ago.

However, this data does corroborate the last “Employment Situation” report that showed only 83,000 private-sector jobs added to the economy in May, and doesn’t support an upside surprise in the June NFP.

Looking at a longer time-period, we see the second-derivative flattening out, and declining a bit.

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Again, adjusting upward a bit for the tax-cut, this measure is not yet in dire straits. The flattening out is normal as we can see in the last cycle on the third chart:

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The growth-rate went sideways for all of 2006 and 2007 before finally rolling over in 2008.

The second quarter is coming in light as seen on the final chart:

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But again, adjusting the last two bars on the chart upward a bit for the tax-cut shows a respectable performance.

So, while we have solid evidence for a slow-down in hiring, the withholding data is not yet indicating a wave of mass layoffs like we saw in the spring of 2008.

Source:
Daily Jobs Update
by Matt Trivisonno

Since 5:30am, yields have been steadily rising in Spain and just over the past 40 minutes have spiked again. The 2 yr note yield is up to the highest since late May and just 2 bps from the most since Nov. The Spanish 10 yr yield is up another 5 bps to the highest since May 2000. Spanish stocks are also selling off by 1.4%. STD and BBVA are the two big Spanish banks to watch. I’ve seen no specific news to account for the weakness.

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Adding to my previous note, Italian yields are also spiking with the 2 yr yield up 12 bps to the highest since Dec ’08 and the 10 yr up 5 bps to 1 bps shy of the most since Nov ’08. Italian banks are also down sharply with Unicredit down 5.5% and Intesa down 4.9%. Both banks were down yesterday too after Moody’s put on credit watch 13 Italian banks. Thus, today’s pressure in both Italy and Spain seem to be a carry over from yesterday in that worries are building again in whether the EU can contain the debt crisis around Greece, Ireland and Portugal.