Saturday, December 6, 2014

Weekly Commentary, October 25, 2012: The Perils of Bubbles and Speculative Finance

Let’s return this week to the broader global Macro Credit Thesis. First of all, we live in a highly over-indebted world that becomes only more so each year. Moreover, the global system is today in an exceptionally high-risk phase of rapid non-productive debt growth in concert with historic financial and economic imbalances. Global policymakers are desperate to reflate debt and economic structures, in what I believe is both ill-advised and inevitably destined for failure. And there is the issue of history’s greatest financial mania…

The Greek debt crisis was the first crack in the global government debt Bubble. For the past two years, I’ve drawn various parallels between Greece and the subprime eruption here in the U.S. In both cases, the marginal borrower in respective Bubbles lost access to cheap market-based finance. The sovereign debt crisis in Europe set in motion dynamics that would see the crisis methodically gravitate from the “periphery” to the “core,” while U.S. mortgage finance saw the surge in subprime defaults migrate to a broader base of “prime” borrowers. And, of course, along the way there were aggressive policy responses. I have argued that, at the end of the day, the policy responses in ’07 and ‘08 contributed to the seriousness of the late-2008 financial and economic dislocation.

Taking a step back, I guess we shouldn’t be too surprised by the prolonged nature of the unfolding European/global crisis. After living though the severity of a chaotic 2008, global policymakers have been determined to react more quickly and forcefully. Especially in Europe, this has bought time and ensured that respective boom and bust dynamics drag on.

Three years ago, Greece could borrow for two years at about 2.0%. The marketplace recognized that Greece had buried itself in debt, although players were as well confident that Europe would never allow a Greek default. By May of 2010, Greek two-year yields surpassed 18% and the nation was hopelessly insolvent. Two and one-half years later, Greece (population – 11 million) has burned through two bailouts – and more than $200bn – and is today trapped in depression and desperate for additional bailout support. It seems inevitable that Greece will exit the euro. Yet, and especially after the European crisis began spiraling out of control this summer, the marketplace is confident that European officials remain determined to postpone all days of reckoning.

When the subprime crisis erupted in the spring of 2007, it marked an end to an era. The ultra-easy mortgage Credit that had fueled a buying, building, spending and price Bubble throughout housing and the broader U.S. economy was coming to a conclusion – although, somehow, very few appreciated this at the time. Still, the hedge funds and others did recognize that they had to reduce exposures to high-risk “private-label” mortgage-backed securities (MBS). And after the flow of finance into the riskiest mortgage-related securities and derivatives reversed, some speculators even moved to take short positions.

The resulting dramatic tightening of financial conditions at the “periphery” (i.e. subprime) then began to wear away at confidence in somewhat less risky mortgages (i.e. “Alt-A”). And as the marginal homebuyer lost access to mortgage Credit, inflated home prices reversed and headed lower. Declining home prices then began to weigh on confidence in mortgage finance more generally, which led to a further tightening of mortgage Credit. This added pressure on leveraged holders of mortgage instruments, while further pressuring real estate values and market confidence. And as the nation’s housing markets began to buckle, the marketplace increasingly feared the financial and economic consequence of a major downturn. In the fourth quarter of 2008, a crisis of confidence finally erupted at the “core” due to unmanageable problem debt and related system leverage. Faith that policymakers could keep things under control was shattered. Europe has been on a similar track.

Importantly, stimulus measures by the Federal Reserve failed to stem the debt crisis – failed to stop the crisis of confidence from gravitating from the “periphery” to the “core.” The Bubble was creating an ever increasing amount of suspect Credit, problem loans and related excess that would surface come the inevitable bursting. Indeed, I would argue that by prolonging the mortgage finance Bubble (in terms of lending, leveraged speculation and economic maladjustment) Federal Reserve policymaking ensured a more problematic scenario. The system would have been more resilient had the markets begun discounting the significantly changed post-Bubble backdrop in the initial months of 2007 (better yet, much earlier). Instead, increasingly speculative markets became fixated on predictable policy responses. Stock and global risk market prices fatefully diverged from fundamental (post-Bubble) prospects. The S&P500 traded to a record 1,575 in October of 2007 – heading right into the worst crisis in decades.

I am convinced – actually, at this point, it seems rather obvious - that global policymakers have made a very problematic situation worse. The global system would be less vulnerable today had speculative markets not again fixated on aggressive policy measures. I argued at the time that the ECB’s Long-Term Refinancing Operations (LTRO) only exacerbated European fragilities. In particular, the $1.3 TN of central bank liquidity ensured that Spanish, Italian and other European banks increased their exposure to suspect sovereign debt. It was a policy roll of the dice. The LTROs did incite big rallies in European debt and equities, along with global risk markets more generally. Not unpredictably, within months Europe was succumbing to an even deeper crisis. Global markets and economies were hanging in the balance.

In desperation, ECB president Draghi fashioned his “big bazooka:” Outright Monetary Transactions (OMT) – the promise of open-ended support for Spain and other troubled issuers. Importantly, Mr. Draghi made an extraordinary warning to those that had positioned bearishly against Europe. And while the jury is very much out on whether Draghi has much of a bazooka, this somewhat misses the point. The Draghi Plan incited a major short-covering rally in Spain, Italy and periphery bonds, in European equities, and global risk markets more generally. Indeed, the Draghi Plan forced the sophisticated speculators to cover their European shorts and even go leveraged long. Instead of a roll of the dice, it was betting the ranch.

The consensus view has Europe now moving beyond the worst of its crisis. Debt auctions have been going smoothly. Spain and Italy in particular have issued huge amounts of debt, now having satisfied much of their 2012 borrowing requirements. At least on the surface, the situation appears to have significantly stabilized over the past few months. Unfortunately, I believe this optimism has highly fragile underpinnings.

Many believed that the worst of the mortgage crisis had passed by April 2008. The Fed had orchestrated JP Morgan’s takeover of failing Bear Stearns. Clearly, most believed at the time, the Fed was sufficiently on the case and would not allow a further crisis escalation. The reality, however, was that altered financial and economic backdrops were quickly moving beyond the Fed’s control.

These days, the European economic backdrop seems to deteriorate by the week. Importantly, the Draghi Plan and bullish market reactions have not translated to the real economy. Indeed, the bursting Bubble “periphery to core” dynamic has actually gained momentum. I posited earlier in the year that there were broad ramifications for the crisis having afflicted “core” country Spain. The Spanish economy is significant, and its economic depression is now increasingly reverberating throughout the region. Importantly, fellow “core” economies in Italy, France and Germany are today showing ill-effects.

The Italian economy is weak and the German juggernaut is weakening. Yet I am most closely watching happenings in France. France’s October manufacturing PMI index was reported at a weak 43.5, confirming that September’s 3.3 point decline was no fluke. ECB monthly lending data released earlier in the week offered no encouragement. Lending to French corporations showed another marked decline, from 1.5% annualized to only 0.6% for the month. Lending was still at a 3% annualized rate back in April. Lending to households declined to 2.7% annualized in September (down from 4.2% back in May).

I have expected heightened attention directed at France’s deteriorating economic fundamentals, along with closer scrutiny of French financial institutions. Thursday, Standard & Poor’s downgraded many of France’s major banks, including its largest lender (financial conglomerate), BNP Paribas. From Bloomberg: “France’s 13-year-high unemployment rate, government debt approaching 90% of gross domestic product and trade deficits ‘are being aggravated in our view by the on-going euro-zone crisis, a more protracted recession across Europe, and lower domestic-growth prospects,’ S&P said. French banks also face ‘potentially limited, but still noteworthy, impact from an ongoing correction in the housing market,’ it said.”

The bloated French banks are heavily exposed to myriad risks (regional sovereigns, corporate, mortgage, capital markets, emerging markets, etc). I’ll also be rather surprised if, before all is said and done, the housing correction has only a “limited impact.” Indeed, the aggressive European policy responses over recent years have inflated home prices in France, Germany and throughout the northern nations perceived by the marketplace as safe havens from the crisis at the periphery. It’s a similar dynamic to when Fed policy responses to “periphery” mortgage problems actually lowered yields and extended the life of the “core” agency MBS Bubble. In Europe, safe haven inflows have worked to extend “core” country booms. But with these “core” economies now succumbing, there will be only deeper concern for the soundness of Europe’s major financial institutions.

The Draghi Plan is risky business. The speculator community was enticed back into European debt and equities markets, and in the process the euro. But how stable is this finance? Are the speculators true believers or policy opportunists? Investors in Spanish and Italian debt were willing to buy, knowing that these high-yielding markets were backstopped by the Draghi ECB. These markets became a magnet for trading-oriented fund managers looking for immediate performance. And as markets rallied, the perception took hold that the worst of the crisis had passed. Global speculators and investors jumped on the bandwagon, believing that more normalized financial conditions would spur a self-reinforcing economic recovery. In a world of intense investment performance pressure, performance-chasing and trend-following trading strategies ensured large technically driven flows into the region.

It’s going to be an interesting couple months. There’s an election approaching that could have major market ramifications. Perhaps “fiscal cliff” worries can be pushed out to 2013. But this hedge fund, performance-chasing and trend-following market dynamic really has me intrigued. This week again seemed to provide evidence that at least some traders have one eye fixed on the exits. Spain 10-year yields were up 22 bps and Italian 10-year yields rose 13 bps. Portuguese yields surged 47 bps. Spain Credit default swap prices surged 31 bps. The French to German 10-year bond spread widened 10 bps. European stocks were hit, with the German DAX and French CAC 40 both down 2.0%. It is also worth noting the weakness in commodities prices. This week saw notable declines in industrial-related commodities, including tin, nickel, lead, zinc, copper, palladium, and platinum – not to mention the slide in energy prices.

There are literally thousands of hedge funds these days fighting for survival. They cannot afford to miss a rally. But they also can’t tolerate significant losses. Everything is on a short leash. There are also thousands of mutual fund managers and other investors that will buy on strength or sell on weakness. It has become a highly speculative and unsettled backdrop. Meanwhile, markets have traded north as fundamentals have headed south.

It all becomes even more interesting when one ponders the credibility of Draghi’s OMT. How big, really, is that bazooka of his? How much firepower does the ECB actually have when the Bundesbank is opposed to the whole thing? Is it even legal? And how big does it have to be if the markets start to fret about France? Would the OMT lose credibility if the marketplace begins to fear a significant economic downturn and bank problems in France and Germany? Or does the market stick with the view that the more dire the situation the more Draghi and European politicians can be counted on to “do whatever it takes.” They can hold it together through year-end, can’t they?

Well, it’s shaping up to be quite a confidence game. But it’s those weak-handed hedge funds. Do they hold tight - or do some decide it might be best to be first in line before the crowd rushes for the exits?

For the Week:

The S&P500 declined 1.5% (up 12.3% y-t-d), and the Dow fell 1.8% (up 7.3%). The Morgan Stanley Cyclicals lost 1.1% (up 12.4%), and the Transports slipped 0.6% (up 0.7%). The Morgan Stanley Consumer index fell 1.4% (up 9.5%), and the Utilities dropped 1.7% (up 0.3%). The Banks were hit for 2.4% (up 25.1%), while the Broker/Dealers added 0.3% (up 1.2%). The S&P 400 Mid-Caps declined 1.3% (up 10.9%), and the small cap Russell 2000 fell 0.9% (up 9.8%). The Nasdaq100 slipped 0.5% (up 17.0%), and the Morgan Stanley High Tech index fell 1.6% (up 9.5%). The Semiconductors gained 0.7% (up 0.8%). The InteractiveWeek Internet index declined 0.9% (up 8.2%). The Biotechs sank 5.3% (up 30.9%). With bullion down $10, the HUI gold index declined 0.9% (down 1.5%).

One and three-month Treasury bill rates ended the week at 11 bps. Two-year government yields were little changed at 0.30%. Five-year T-note yields ended the week up a basis point to 0.76%. Ten-year yields declined 2 bps to 1.75%. Long bond yields declined 3 bps to 2.91%. Benchmark Fannie MBS yields rose one basis point to 2.24%. The spread between benchmark MBS and 10-year Treasury yields widened 3 bps to 49 bps. The implied yield on December 2013 eurodollar futures dipped one basis point to 0.415%. The two-year dollar swap spread was unchanged at 10 bps, while the 10-year swap spread increased one to 4 bps. Corporate bond spreads widened. An index of investment grade bond risk rose 4 to 98 bps. An index of junk bond risk jumped 34 to a seven-week high 517 bps.

Debt issuance remained strong. Investment grade issuers this week included Reynolds America $2.55bn, Marathon Oil $2.0bn, Catholic Health Initiative $1.5bn, Citigroup $1.5bn, CR Bard $500 million, Block Financial $500 million, Cargill $450 million, Equity One $300 million, New York Life $300 million, and Zions Bancorp $200 million.

Junk bond funds saw inflows of $142 million (from Lipper). Junk issuers included Clear Channel $2.0bn, Post Holdings $775 million, Foresight Energy $600 million, Lamar Media $535 million, WMG $500 million, Targa Resources $400 million, United Rental $400 million, BOE $335 million, Nexstar Broadcasting $250 million, and Shearers $235 million.

I saw no convertible debt issued.

International dollar bond issuers included Chile $1.5bn, Sweden $1.0bn, Royal Bank of Canada $1.0bn, Virgin Media $900 million, Telesat Canada $900 million, Odebrecht Finance $850 million, Sydney Airport $825 million, SK Telecom $700 million, Tupras-Kurkiye Petrol $700 million, Brunswick Rail $600 million, Bolivia $500 million, Industrial Senior Trust $500 million, Turkiye Vakiflar $500 million, Finansbank $350 million, and Investcorp $250 million.

Spain's 10-year yields jumped 22 bps to 5.55% (up 51bps y-t-d). Italian 10-yr yields rose 13 bps to 4.89% (down 214bps). German bund yields slipped 6 bps to1.54% (down 29bps), while French yields rose 4 bps to 2.24% (down 89bps). The French to German 10-year bond spread widened a notable 10 bps to 71 bps. Ten-year Portuguese yields surged 47 bps to 7.85% (down 492bps). The new Greek 10-year note yield jumped 66 bps to 16.81%. U.K. 10-year gilt yields were down 19 bps to 1.68% (down 29bps). Irish yields rose 4 bps to 4.61% (down 365bps).

The German DAX equities index fell 2.0% (up 22.6% y-t-d). Spain's IBEX 35 equities index declined 1.7% for the week (down 9.2%). Italy's FTSE MIB dropped 1.8% (up 3.3%). Japanese 10-year "JGB" yields declined 2 bps to 0.76% (down 23bps). Japan's Nikkei dipped 0.8% (up 5.7%). Emerging markets were under pressure. Brazil's Bovespa equities index was hit for 2.8% (up 0.9%), while Mexico's Bolsa declined 1.3% (up 12.8%). South Korea's Kospi index dropped 2.7% (up 3.6%). India’s Sensex equities index slipped 0.3% (up 20.5%). China’s Shanghai Exchange sank 2.9% (down 6.1%).

Freddie Mac 30-year fixed mortgage rates rose 4 bps to 3.41% (down 69bps y-o-y). Fifteen-year fixed rates jumped 6 bps to 2.72% (down 66bps). One-year ARMs slipped a basis point to 2.59% (down 31bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 2 bps to 4.01% (down 84bps).

Federal Reserve Credit rose $9.1bn to $2.829 TN, with a three-week gain of $43.5bn. Fed Credit was down $4bn from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 10/24) increased $5.9bn to a record $3.609 TN. "Custody holdings" were up $189bn y-t-d and $212bn year-over-year, or 6.2%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $524bn y-o-y, or 5.1% to $10.751 TN. Over two years, reserves were $1.797 TN higher, for 20% growth.

M2 (narrow) "money" supply jumped $28.9bn to $10.211 TN. "Narrow money" has expanded 7.4% annualized year-to-date and was up 6.9% from a year ago. For the week, Currency increased $1.9bn. Demand and Checkable Deposits rose $27.4bn, and Savings Deposits increased $7.3bn. Small Denominated Deposits declined $2.5bn. Retail Money Funds fell $5.1bn.

Money market fund assets were little changed at $2.569 TN. Money Fund assets were down $126bn y-t-d, with a one-year decline of $65bn, or 2.5%.

Total Commercial Paper outstanding dropped $19bn to $924 billion CP was down $35bn y-t-d and declined about $37bn from a year ago.

Currency Watch:

October 22 – Bloomberg (Neal Armstrong and Allison Bennett): “The $4 trillion-a-day foreign-exchange market is losing confidence in central banks’ abilities to boost a struggling world economy. Rather than sparking bets on growth, the JPMorgan Chase & Co. G7 Volatility Index, which doubled in 2008 before policy makers employed extraordinary measures to address faltering global expansion, has dropped to a five-year low. While small foreign-exchange swings historically favor the strategy of borrowing in low-yielding currencies to buy those with higher returns, a UBS AG index that tracks profits from the so-called carry trade has fallen to the lowest level since 2011.”

The U.S. dollar index increased 0.6% to 80.07 (down 0.1% y-t-d). For the week on the upside, the New Zealand dollar increased 0.9%, the British pound 0.6%, the South Korean won 0.6%, the Australian dollar 0.4%, the South African rand 0.2%, and the Singapore dollar 0.1%. For the week on the downside, the Norwegian krone declined 2.0%, the Swedish krona 1.8%, the Mexican peso 0.8%, the Danish krone 0.7%, the euro 0.7%, the Swiss franc 0.7%, the Japanese yen 0.4%, the Canadian dollar 0.3%, and the Taiwanese dollar 0.1%.

Commodities Watch:

The CRB index dropped 3.0% this week (down 2.8% y-t-d). The Goldman Sachs Commodities Index fell 2.6% (down 0.9%). Spot Gold was down 0.6% to $1,711 (up 9.4%). Silver slipped 0.2% to $32.04 (up 15%). December Crude sank$4.16 to $86.28 (down 13%). November Gasoline was little changed (up 2%), while November Natural Gas dropped 6.0% (up 14%). December Copper declined 2.4% (up 3%). December Wheat fell 1.0% (up 32%), and December Corn dropped 3.1% (up 14%).

Global Credit Watch:

October 25 – Bloomberg (Julie Cruz and Dorothee Tschampa): “The European debt crisis is moving north into the region’s corporate engine room. Companies from Schneider Electric SA to Daimler AG reduced forecasts for the year, while Sweden’s Sandvik AB said it will cut production… ‘The current economic situation is marked by a growing insecurity and volatility,’ Daimler Chief Financial Officer Bodo Uebber said on a conference call… Daimler ‘can’t hold onto targets that are then not realistic. We have to accept that it is so.’ Almost half of the companies in the Stoxx Europe 600 Index that have reported earnings this quarter missed estimates for net income as consumers and governments rein in spending. The effects of the debt crisis that started in Greece in 2009 have spread to Germany, the region’s largest economy… ‘The problems of southern Europe are spreading to the core of the continent,’ said Markus Steinbeis, who helps manage about 1 billion euros ($1.3bn) at Huber, Reuss & Kollegen Vermoegensverwaltung GmbH in Munich. ‘The earnings figures are showing slowing growth trend in the core. We will see slow growth ahead of us in Europe as a whole.’”

October 26 – Telegraph (Philip Aldrick): “Greece is facing the prospect of more austerity to cover the €30bn cost of being given two more years to meet the conditions of its international bail-out. Dutch finance minister Jan Kees de Jager said that ‘Greece must bear the costs of any delay’, as think tank Open Europe warned that a two-year extension would cost at least €28.5bn to ensure the struggling eurozone nation can refinance its debts and pay its bills. His comments came as Ireland appeared to clash with its eurozone partners despite being hailed as a bail-out ‘success story’.”

October 22 – Bloomberg (Simone Meier): “The euro region’s combined debt burden surged last year to the highest since the start of the single currency as governments struggled to fill budget gaps and contain the fiscal crisis. The debt of the 17 nations using the euro climbed to 87.3% of gross domestic product in 2011 from 85.4% the previous year… That’s the highest since the euro was introduced in 1999. Greece topped the list with debt at 170.6% of GDP, followed by Italy and Portugal at 120.7% and 108.1%... The EU’s debt-to-GDP limit is 60%.”

October 25 – Bloomberg (Jana Randow): “Lending to households and companies in the euro area contracted at the fastest pace in almost three years in September amid a deepening economic slump. Loans to the private sector fell 0.8% from a year earlier after dropping an annual 0.6% in August… That’s the fifth decline in a row and the steepest since October 2009… The 17-nation euro economy may have fallen into recession in the third quarter after shrinking 0.2% in the previous three-month period. While the ECB’s pledge to buy unlimited bonds of debt-strapped countries has shored up investor confidence, business sentiment in Germany, Europe’s largest economy, unexpectedly declined in October to the lowest in more than 2 1/2 years.”

October 25 – Bloomberg (Alex Webb and Keith Naughton): “Ford Motor Co. will shut three European plants, its first factory closings in the region in a decade, and cut 5,700 jobs to stem losses that the carmaker predicts will total more than $3 billion over two years. The shutdown of two U.K. factories and a plant in Belgium will remove production capacity for 355,000 vehicles, or 18% of the carmaker’s total in the region… The carmaker is forecasting losses wider than $1.5 billion each this year and next in Europe… The closings, more extensive than those planned or carried out by PSA Peugeot Citroen, General Motors Co.’s Opel unit and Fiat SpA, are in response to a car-market drop that may be the worst in 19 years.”

October 24 – CNBC (Catherine Boyle): “There is growing concern among policymakers and analysts that the true extent of European banks’ debt problems is being masked. Sir Mervyn King, Governor of the Bank of England, became the most high-profile policymaker to date to warn of the dangers of banks putting off foreclosures… His stern warning to U.K. banks that they need to drop the ‘pretense’ that some of their bad debts will be repaid was coupled with the statement that they have ‘insufficient capital’ to deal with losses which have remained undeclared. Essentially, what seems to have happened is that banks across the euro zone have put off foreclosures on weak businesses – a process known as forbearance. This has been enabled by low interest rates across the region and rescue packages which have injected unprecedented amounts of liquidity into the banking system and helped keep struggling economies afloat. The scale of forbearance is hinted at in relatively low rates of company insolvencies.”

October 25 – Bloomberg (Fabio Benedetti-Valentini): “France’s aid to PSA Peugeot Citroen SA’s troubled finance arm brings the state’s backing for the nation’s banks to more than 60 billion euros ($78bn). The government yesterday said it will guarantee 7 billion euros in new bonds by Banque PSA Finance, the consumer-finance unit of Europe’s second-largest carmaker. The aid comes on top of support for Dexia SA, the French-Belgian municipal lender, and for home-loans company Credit Immobilier de France. ‘These bank rescues on the quiet should be getting more critical market attention,’ said Bill Blain, a strategist at Mint Partners… ‘We don’t know what’s next, but it certainly demonstrates that some of the specialized financial institutions remain very, very weak.’”

October 23 – Bloomberg (Stephanie Bodoni): “The euro area’s 500 billion-euro ($652bn) bailout fund faces another test as the European Union’s highest court weighs claims that the firewall violates EU law and should be banned in its current form. A complaint by Thomas Pringle, an independent member of the Irish parliament, has reached the EU Court of Justice, which has the power to topple the European Stability Mechanism, or ESM. Pringle, the European Commission and European Parliament as well as EU nations including Ireland, Germany and France attended a hearing at the court today. A ruling is possible as soon as the end of the year under a fast-track procedure. ‘Developed in haste, the ESM treaty is at odds with and undermines the EU legal order,’ John Rogers, a lawyer for Pringle, told the EU court… ‘In trying to defend the compatibility of the ESM with the EU treaties, the intervening member states and institutions have had to engage in mischaracterization and distortion in the confusion of form and substance and in legal and conceptual contradictions.’”

October 23 – Bloomberg (Angeline Benoit and Ben Sills): “Spanish Prime Minister Mariano Rajoy said there is a case for easing budget-deficit targets set by the European Union as the recession undermines tax revenue. ‘I think what a lot of other people think,’ Rajoy told the Spanish senate… ‘Things could be done more calmly, taking into account especially that we are in a recession, but in any case I can’t give up on Spain’s commitments.’ Rajoy’s comments undercut Budget Minister Cristobal Montoro’s insistence that Spain can stick to the path of budget consolidation demanded by the EU…”

October 25 – Bloomberg (Sharon Smyth): “Spain’s efforts to sell as much as 90 billion euros ($117bn) of toxic property assets it uses to create a bad bank from lenders that take state aid will be constrained by the size and inability to provide credit to potential buyers, adding to the risk of taxpayer losses. ‘When managing tens of thousands of assets scattered across the whole of Spain, big is not beautiful, it’s sheer chaos,’ said Mikel Echavarren, chairman of Irea, a Madrid-based financial adviser. A large, ‘clumsy’ bad bank will be at a ‘tremendous’ disadvantage and will generate losses that Spaniards will have to pay for.”

October 25 – Bloomberg (Angeline Benoit): “Andalusia, the region that is the third-biggest contributor to Spain’s economy, called on the government to find new ‘formulas’ to fund the 17 semi- autonomous states after Madrid was shut out of debt markets. ‘If financial markets’ attitude doesn’t change, regions will demand from the government a new fund or measures to help their treasuries,’ said Andalusia government spokesman Miguel Angel Vazquez Bermudez…”

October 25 – Bloomberg (Esteban Duarte, Emma Ross-Thomas and Ben Sills): “European authorities are pushing Bankia group to impose losses on junior debtholders as Spain purges a banking system clogged with about 180 billion euros ($234bn) of bad real estate assets, people familiar with the talks said. The European Central Bank and European Commission want investors including preference shareholders to swap their securities for new shares to reduce the cost to the taxpayer…”

Germany Watch:

October 23 – Bloomberg (Jeff Black and Brian Parkin): “Mario Draghi is taking his sales pitch into the lion’s den. By appearing before a joint session of three committees of the German parliament in Berlin tomorrow, the European Central Bank president is seeking popular support in Europe’s largest economy for his plan to purchase government bonds to stem the debt crisis. While Draghi says his so-called Open Market Transactions are required for price stability, some German policy makers say they are an affront to the monetary orthodoxy upon which the ECB was founded. ‘Draghi is on a mission to smooth concern that OMT won’t send inflation skyrocketing or lumber German taxpayers with liabilities they can’t pay,’ said Frank Schaeffler, finance spokesman for the Free Democrats… ‘Many lawmakers -- even if they don’t admit it -- have grown suspicious of the ECB and its head, once dubbed the most German of non-German central bankers.’”

October 25 – Bloomberg (Rainer Buergin): “Chancellor Angela Merkel would fail to secure the backing of her coalition for as much as 20 billion euros ($26bn) in extra aid for Greece, said Otto Fricke, her junior coalition partner’s budget spokesman. Fricke… cited an agreement between the Greek government and its international creditors as saying that Greece will get a loan of 16-20 billion euros to supplement its second rescue package… Germany’s parliament would need to approve the loan. Fricke, a Free Democratic Party lawmaker, told reporters… that he sees ‘no majority for such a thing.’”

October 25 – Bloomberg (Jeff Black and Finbarr Flynn): “Bundesbank board member Andreas Dombret said bad debts held by banks before the arrival of a new supervisory mechanism shouldn’t be assumed by Europe’s joint bailout fund. ‘Legacy assets are those risks which evolved under the responsibility of national supervisors,’ Dombret said… ‘It follows that these assets have to be dealt with by the respective member states. Anything else would amount to a fiscal transfer.’ Irish optimism that the country would be able to receive funds from the European Stability Mechanism to help reduce the burden of its 64 billion-euro ($83bn) bank rescue was dented last month when the finance ministers of Germany, the Netherlands and Finland said so-called legacy assets would be excluded from the bailout facility. While German Chancellor Angela Merkel conceded Oct. 21 that Ireland is a “special case,” the Bundesbank remains against permitting such a move. Dombret said allowing countries to repair their banking sectors using ESM funds would rapidly overburden the facility.”

Global Bubble Watch:

October 25 – Bloomberg (Sandrine Rastello and Doug Alexander): “Resistance to new regulations and implementation delays have left the global financial system no safer than it was at the eve of the 2008 crisis, International Monetary Fund Managing Director Christine Lagarde said. ‘The world’s financial system is still not functioning well,’ Lagarde said… ‘While fundamental changes do take time, the basic structures that we found problematic before the crisis are still with us.’”

October 25 – Bloomberg (Johan Carlstrom): “Sweden needs immediate measures to tame the nation’s growing private debt burden and take pressure off the central bank’s interest rate policy, Governor Stefan Ingves said. The Riksbank was forced to take household debt risks into account when it agreed yesterday to keep its main lending rate unchanged at 1.25%, Ingves said…”

China Bubble Watch:

October 26 – Bloomberg: “Illicit financial outflows from China totaled $3.79 trillion from 2000 through 2011 as people sought to evade taxes and hide gains through offshore accounts, according to a report by the group Global Financial Integrity. Money was moved through methods that included false invoicing of outbound and inbound shipments, the Washington-based advocacy group that includes former New York County District Attorney Robert Morgenthau on its advisory board said in a report… Of the $2.83 trillion that flowed illicitly out of China from 2005 through 2011, $595.8 billion became cash deposits or financial assets in tax havens such as the British Virgin Islands… It was released as the family assets of China’s leaders have come under increased scrutiny amid a widening income gap in the world’s second-biggest economy. ‘I’ve studied the proceeds of crime, corruption, and tax evasion for decades, and the magnitude of illicit money flowing out of China is astonishing,’ GFI Director Raymond Baker said… ‘There’s no other developing or emerging economy that even comes close to suffering as much in illicit financial outflows.’”

October 24 – Dow Jones: “China’s economic slowdown is expected to reveal significant damage to the balance sheets of Chinese banks resulting from a massive lending spree that dates back to the 2008 global financial crisis, ratings agency Standard & Poor's said… Credit risks such as falling net interest margins and a rise in bad loans are likely to beset Chinese banks, which have faced a margins squeeze since China's interest rate regime was loosened in June, S&P said… ‘While cheap loans associated with the lending spree have helped the banks contain their credit losses in the past few years, the damage to their balance sheets is about to surface,’ the report said. The rating company said the trigger for banks' credit woes is the slowdown in Chinese economy… Chinese banks are set to see a rise in non-performing loans in coming quarters, hit by increasing credit costs and slowing economic growth, Liao Qiang, director of financial institutions ratings at S&P, told reporters…”

October 22 – Bloomberg: “Chinese factories are losing pricing power in the worst wholesale-cost deflation since 2009, signaling corporate earnings may deteriorate further and putting a damper on global inflation pressures. Steelmaker China Oriental Group Co. says falling prices are wiping out profits, while Yunnan Copper Industry Co. cited the declines for a third-quarter loss. The producer price index fell 3.6% in September from a year earlier…”

Japan Watch:

October 26 – Bloomberg (Ma Jie, Anna Mukai and Yuki Hagiwara): “Toyota Motor Corp. led Japanese carmakers in reporting production cuts in China after anti-Japan protests flared in the world’s largest automobile market. Asia’s largest carmaker said today it reduced September production in China 42% from a year earlier…”

European Economy Watch:

October 24 – Bloomberg (Stefan Riecher and Simone Meier): “Euro-area services and manufacturing output contracted more than economists forecast in October and German business confidence dropped to the lowest in more than 2 1/2 years as Europe’s recession deepened. A composite index based on a survey of euro-area purchasing managers in services and manufacturing fell to 45.8, the lowest in more than three years, from 46.1 in September… In Germany, the Ifo institute’s business climate index unexpectedly dropped to 100.0 from 101.4 in September.”

October 26 – Bloomberg (Angeline Benoit): “Spanish unemployment climbed to a fresh record in the third quarter as a deepening recession left one in four workers jobless… Unemployment, the second highest in the European Union after Greece, rose to 25.02% from 24.6% in the previous quarter…”

October 23 – Bloomberg (Angeline Benoit): “Spain’s economy contracted for a fifth quarter, adding pressure on Premier Mariano Rajoy to seek more European aid even as the euro area’s fourth-largest economy met a bill sales target. Gross domestic product fell 0.4% in the three months through September from the previous quarter, matching the contraction of the second quarter…”

October 26 – Bloomberg (Bradley Keoun and Elena Logutenkova): “UBS AG, Switzerland’s largest bank, will cut as many as 10,000 jobs companywide as the trading business shrinks, a person with knowledge of the plan said.”

Latin America Watch:

October 22 – Bloomberg (David Biller): “Brazil’s government is cracking down on luxury boat owners who allegedly evaded taxes and customs duties, as rising incomes in the world’s second-largest emerging market drive demand for high-priced leisure goods. The federal government’s tax authority yesterday instructed a team of 30 employees, supported by boats and helicopters, to inspect foreign-made yachts and other ‘suspect’ vessels, some of which may be used to launder money, the agency said… Brazil’s warm climate, long coastline and growing economy have enticed both shipbuilders and boating enthusiasts to its shores in recent years. Production of fiberglass recreational boats grew to 4.7 million in 2010 from 3.5 million in 2006… The value of motorboat, sailboat and jet ski imports ballooned to $133 million from $13 million in the same period, the group said.”

U.S. Bubble Economy Watch:

October 25 – Bloomberg (Chris Burritt): “Ford Motor Co. and Dow Chemical Co. joined a growing number of companies firing thousands of workers as sluggish U.S. growth and Europe’s deepening recession lead to a persisting slump in sales. North American companies have announced plans to eliminate 62,600 positions at home and abroad since Sept. 1, the biggest two-month drop since the start of 2010… Firings total 158,100 so far this year, more than the 129,000 job cuts in the same period in 2011.”

Central Bank Watch:

October 26 – Bloomberg (Jeff Black): “European Central Bank Executive Board member Joerg Asmussen said tapping Europe’s bailout fund won’t automatically trigger the ECB’s bond-buying program. A government’s application to the rescue fund for aid is ‘a necessary, but not a sufficient condition for us to become active,’ Asmussen said… ‘The ECB council independently decides in each case to what extent and for how long an intervention on monetary policy grounds is necessary.’”

October 26 – Bond Buyer: “Richmond Federal Reserve Bank President Jeffrey Lacker warned… that the Fed is taking undue inflation risks -- both with its asset purchases and with the quasi-commitment to sustained low interest rates it is making through its communications strategy. Lacker… doubted the third round of ‘quantitative easing’ would do much good and said the concentration on buying mortgage-backed securities is an unwarranted ‘allocation of credit’ by the central bank. He also expressed strong dismay with the FOMC’s declaration that it will hold rates down at very low levels even after the economy starts growing more rapidly.”

California Watch:

October 26 – Bloomberg (Alison Vekshin): “Los Gatos, California, where Apple Inc. co-founder Steve Wozniak can be seen riding the sidewalks on his Segway, isn’t often mentioned in the same breath as Fresno, an agricultural hub seeking to stave off insolvency. Yet both are on a list of more than two dozen California cities, including some of the most affluent, with securities facing possible credit downgrades by Moody’s… Rating companies and investors are scrutinizing the willingness of California localities to budget for bond payments after three of the state’s municipalities filed for bankruptcy since June.”