Whales and humans linked by ‘helpful grandmothers’ BBC

Extinction of Woolly Mammoth, Saber-Toothed Cat May Have Been Caused by Human Predators Science Daily (hat tip reader John M)

Tibetan Adaptation to High Altitude Occurred in Less Than 3,000 Years Science Times (hat tip reader John M). I think I’ve seen similar findings for Peruvians in the Andes.

When the scientific evidence is unwelcome, people try to reason it away Guardian. Some of you no doubt are familiar with the studies mentioned, but a nice recap nevertheless.

Is Julia Gillard the new Bob Hawke? Larvatus Prodeo

The Glittering Prizes: War Crime Continues to Pay Chris Floyd

Jobs and Democrats, Tobin Harshav, New York Times. The article blurb on the first page: “Not even liberal bloggers believe the White House spin on the economy.” Um, I must confess I avoid, as much as I can, “liberal bloggers” who buy the Team Obama party line. John Mauldin, along with others, shredded the ugly aspects of today’s report, 362,000 jobs added in the birth/death adjustment (with the BLS insisting jobs are being added in respectable numbers in hospitality and construction) and the drop in unemployment a function of the departure of discouraged workers from the labor pool

Almost Surreal in its Delusions Michael Panzner

ECRI Weekly Leading Index Growth Lowest In 13 Months Ed Harrison

Biggs Cuts Stock Investments by Half as Risk of Recession Grows Bloomberg. This is funny, I recall Biggs being very bullish when the S&P was higher, see Barton Biggs Says U.S. Stocks Oversold, Sees ‘Big Pop`: Video (May 27, S&P at 1068) and Biggs Sees Buying Opportunity on Overblown Europe Fears: Video (May 20, S&P at 1071)

Protestants Can’t Trade Paul Kedrosky. Hah! Explains a lot.

Obama’s public touch grates with business Financial Times

Hedge-Fund Lending Draws Scrutiny Wall Street Journal

Market Microstructure and Capital Formation Rajiv Sethi

BP: the inside story Financial Times. This is intriguing, and there is no way of telling how much is BP spin versus a reasonably realistic account. The intriguing bit is the story contends that BP really did not know how bad the leak was early on and it really did believe the top kill would work. Those are awfully convenient, from a liability standpoint, but they could actually be true, and if so, this says that BP was a company massively unaware of the limits of its capabilities.

Antidote du jour:

Andy Grove, who lead Intel to dominance of an extremely competitive, risky industry, has a very important opinion piece at Bloomberg (several readers pointed to it, including John M, dr, Crocodile Chuck). He makes a series of points that are the polar opposite of the de facto US industrial policy, of the naive view that the US can have a viable society based on “knowledge workers”, rentiers, and service industries that depend on their earnings. Sadly, my Washington contacts tell me that the belief that the US cannot compete in anything other than financial services is deeply entrenched there, no doubt fed by media stories that draw misleading inferences from appealing-seeming case studies (see this New York Times story and Richard Kline’s able shredding in comments yesterday here and here for an example)

One thing American businessmen have utterly lost sight of is the importance of providing employment. The focus on “maximizing shareholder value” when shareholders are on the very bottom of the liability side of the balance sheet, not merely legitimates but extols screwing other stakeholders to the extent management can pull it off (and management, suborned via stock-related compensation, has gotten very good at doing just that). By contrast, in Japan, entrepreneurs like Konosuke Matsushita are revered not because they got rich, but because they created good jobs for many people.

Only some of Grove’s stature could poke such a stick in the eye of visibly floundering conventional wisdom that nevertheless remains firmly entrenched because it serves those at the top of the food chain very well (it doesn’t hurt that his piece is exceptionally well argued). My only quibble is that he unintentionally supports the fiction that we don’t have industrial policy in America. Following the money demonstrates the reverse; tax breaks, subsidies, tariffs, and what issues are front and center tell you who the favored children are, including financial services, Big Pharma, the sugar industry, and real estate. And this isn’t as radical an idea as he intimates. Australia, which ranks above the US in the Heritage Foundation’s dubious Economic Freedom Index (the Heritage Foundation clearly never had an encounter with the ATO, which makes the IRS look like pussycats), has very clear priority industries. For instance, its Commonwealth Scientific and Industrial Research Organisation (CSIRO) is one of the world’s biggest science organization and is focused around priority industries for Australia, with its main divisions being information sciences, energy sciences, agribusiness, manufacturing and minerals, and environment (the latter is involved both in new tech and minimizing adverse consequences of current industrial activities).

Please do read this thoughtful article in full and discuss in comments (if you have trouble with the Bloomberg link, as I did, please try here).

The stress tests conducted on 19 large American banks by the US Treasury in 2009 were an amazingly effective exercise in salesmanship and sleight of hand. Banking industry experts, including Bill Black, Chris Whalen, and Josh Rosner, dismissed the process as mere theatrics: too little staffing and not enough “stress” in the economic forecasts and loss assumptions (particularly on second mortgage). My pet peeve was that the banks ran the tests on their trading books using their own risk models, the very ones that had performed so well in preparing them for them in the runup to the crisis.

But the Treasury’s Tinkerbell strategy worked. If they could create enough confidence, if they could get enough people to applaud, the banks would live – at least for a while. The spectacle of daily coverage in the business press of the tests, including the howls-on-cue from the banksters, outraged by supposedly-unreasonable demands the Administration, created the impression that Something Was Being Done. And the Treasury did get one critical bit right: it had a credible process for making sure the banks would be able to plug any capital shortfall it identified, and that was by having able to have the government pony up the money to fill any shortfall they identified that the banks couldn’t fill on their own.

Imitation is the most sincere form of flattery. The ECB and European bank regulators are copying the US playbook for the stress tests, with results for 100 banks expected to be released around July 23. But the European authorities seem to have failed to understand why the US effort worked. The first was that Team Obama is particularly good at PR, and it used those skills to full advantage. Despite considerable evidence otherwise, it got the press to convey the message that the tests were tough, and the banks really were sound. Second, Geithner & Co. had a kitty they could draw on.

By contrast, the Europeans have been simply dreadful at the optics of their various rescue operations, with disarray and disagreements covered extensively by the media. Admittedly, this exercise is being conducted by bank regulators, so it is likely to be more cohesive, but “more cohesive”, with a process involving agencies in different countries, may not be cohesive enough. And “show me the money” is a major problem. The reason for this exercise is concern over possible sovereign debt losses. Who is going to back up the banks at risk? Um, sovereign states, admittedly ones not considered at risk of default (France and Germany), but whose ability to bail out their own banks is limited for practical and political reasons.

A story in today’s Financial Times provides confirmation of the skeptics’ concerns:

After another fast-moving news week, as it emerged that about 100 European institutions will be included in the tests – four times the size of the original group – some bankers are confident that the expanded programme will reveal that much of the banking sector is healthier than investors think…

But big questions remain about how rigorous the expanded tests will be, particularly with respect to the sector’s exposure to Greek, Spanish and other eurozone sovereign debt

Institutions will be asked to disclose their total sovereign debt holdings, and the tests will now include a loss rate or so-called haircut of about 3 per cent on all eurozone sovereign debt investments, according to several sources.

Let’s see how this all stands up. Eurobank exposure to Club Med sovereign debt is roughly $900 billion (note this excludes debt to eastern Europe, another possible source of tsuris). A 3% loss on that is $27 billion.

Ahem, let’s take a more skeptical view. Eurobank holdings of Greece’s government debt is $190 billion. Williem Buiter, now chief economist at Citigroup and a bit of an expert on sovereign default, estimated the haircut on a Greek restructuring at 20% to 25%. But S&P later downgraded Greece, and remarked:

At the same time, we assigned a recovery rating of ‘4′ to Greece’s debt issues, indicating our expectation of “average” (30%-50%) recovery for debtholders in the event of a debt restructuring or payment default. The ‘AAA’ transfer and convertibility assessment is unchanged.

Yves here. Do the math. Even if you assume the low end of Buiter’s now-charitable estimate, banks will take losses on Greece alone of $38 billion, 41% greater than the level provided for in the stress tests. If S&P is nearer to the mark, the losses will be $95 to $133 billion.

And the more Greece takes new loans before its debt is restructured (a restructuring or default looks inevitable; no country in the modern era has ever had this high a percentage of debt to GDP in a currency it does not control paid its creditors in full), the worse off the banks that hold debt now will be. The new loans will be senior to the current debt, which means the writedowns on the now-outstanding sovereign debt is likely to be high.

Analysts are discussing which banks will need to raise capital:

Friday’s edition of the Financial Times reported the expectation among bankers that the likes of Spain’s Banco Popular, and Monte dei Paschi and Banca Popolare di Milano in Italy were likely candidates for capital raisings.

All three said they had no capital-raising plans. Banco Popular said it was one of the best capitalised banks in Europe, with a core tier one capital ratio of 8.8 per cent.

BPM said its core tier one ratio was 7.9 per cent. Like tier one, core tier one ratio is a measure of capital strength.

At the same time, there were suggestions in Spain that policymakers were considering going further than counterparts elsewhere in Europe, increasing the required ratio for passing the tests in an effort to boost the confidence value of the exercise.

The FT took note of investor doubts:

News of the tests’ increased rigour has not fully eased concerns about transparency.

“The stress test idea is a shambles,” said one senior analyst in London.

“The whole thing is a complete joke.”

He said that the market’s expectations of securing meaningful disclosures through the tests were so low that any useful information would be a welcome surprise. “Ironically you might just get a boost if there are any decent disclosures at all,” he said.

Maybe the Europeans will pull a rabbit out of the hat, but the odds do not appear to favor them. John Gapper, in a comment on the stress tests, is doubtful:

Even some of those who in principle support the idea of banks being honest with investors are worried about the forthcoming European bank “stress tests” – successors to tests on US banks last year. “I have a horrible feeling that this will turn out to be an exercise in damaging confidence,” says one bank analyst….

The worst case is that southern European banks, loaded with bonds denominated in euros, will turn to governments for relief and trigger another sovereign debt crisis. Spain, which is trying to solve a crisis among its cajas – regional savings banks – is a potential victim….

he tests were certainly a turning point in confidence in Mr Geithner himself, who had suffered a rough few months in the job. Whether it turned the tide for banks is less clear; the US stimulus and other measures to restore consumer and business confidence were large factors.

In addition, European banks’ problems are more intractable and complex, and probably less amenable to a quick fix. For one thing, there was little question last year that the US could afford to rescue banks if it had to, whereas European governments are now heavily in debt.

Furthermore, European banks have inherent funding problems that their US and Asian counterparts lack – they are far more reliant on wholesale markets. US and Asian banks cover their loans with retail deposits, while Barclays Capital estimates the ratio of loans to deposits at European banks to be 120 per cent.

This leaves these banks vulnerable to a liquidity crisis…

Europeans do things in one way and Americans in another; Europe believes in discretion while the US likes openness even at the risk of embarrassment. We will soon find out if European banks can be salvaged by American methods and we had better hope so.

Precisely.

‘Sea monster’ whale fossil unearthed BBC

Canadian, Please YouTube (hat tip Marshall Auerback)

On Average, Charter Schools Are About Average Matt Yglesias

Factory Jobs Return, but Employers Find Skills Shortage New York Times. Notice the somewhat bizarre stand of employers. I can seem them upset at not finding workers with sufficient math skills; that’s an educational issue. But they are also caviling about not finding workers who can “can operate sophisticated computerized machinery, follow complex blueprints.” Is this REALLY a workforce issue, or an unwillingness of employers to provide on the job training, which used to be the norm? Having said that, a separate issue is the abysmal failure of our educational system, particularly in its indifference to vocational training.

‘One in ten’ UK graduates unemployed BBC

The Little, but Real, Effects of Unemployment Mike Konczal

Strategies for “Success” in Afghanistan Ann Jones, TomDispatch

BP’s Gulf Intercept Well Ahead of Schedule With 600 Feet to Go Bloomberg. Encouraging, but they need to hit an itty bitty target for the well to work.

France Calls Google a Monopoly New York Times

Fed Made Taxpayers Junk-Bond Buyers Without Congress Knowing Bloomberg

Late Change Sparks Outcry Over Finance-Overhaul Bill Wall Street Journal. So tell me why, exactly, corporate users should get away with not putting up reasonable margin on derivatives contracts. And the Journal fails to add that most large corporations treat Treasury as a profit center. In other words, these companies do more than just hedge.

ECB avoids disruption as banks repay funds Financial Times

As the EU squares up to bankers and their bonuses, where does that leave the City? Telegraph (hat tip reader Swedish Lex)

Davidowitz: Credit Crisis “A Gigantic Ponzi Scheme, Lies And Fraud” Ed Harrison

Cash calls expected as Europe’s banks face tests Financial Times

Early warning indicators and the global crisis: New evidence Jeffrey Frankel and George Saravelos Vox EU

Habitat For Humanity Among Top U.S. Homebuilders Huffington Post

Myths of Austerity Paul Krugman

Middle class families face a triple whammy Edmund Conway, Financial Times (hat tip reader Swedish Lex)

Antidote du jour:

By Marshall Auerback, a portfolio strategist and fund manager

Wolfgang Munchnau is right. Only a closer union can save the euro. In the longer term, it will be necessary to put in place a permanent fiscal arrangement through which the central euro zone authorities distribute funds to be used by member nations. Ideally this should be in the hands of the equivalent to a national treasury responsible to an elected body of representatives—in this case, the European Parliament.

But politically, this is a non-starter, particularly in today’s environment. Germany in particular would only accede to a “United States of Europe” run on German lines, in effect making the euro zone a “United States of Germany” or, at the very least, a European Union with strongly German characteristics.

Enter the European Central Bank: With little fanfare, the ECB has been responding to the EMU’s solvency mess by conducting large-scale bond purchases in the secondary market (which, unlike direct purchases of government debt, is not contrary to the Treaty of Maastricht rules) for the debt of the EMU nations. As Bill Mitchell has noted, it is remarkable how little press coverage this has generated, but despite saying there would be neither be bailouts, nor unsterilized bond purchases, the ECB is now buying huge amounts of PIIGS debt to ensure the funding crisis in the EMU is contained. Given that this substantially reduces the insolvency risk, this is probably a wise policy, although it does little to address the underlying design flaws in the system which we have discussed before.

But there are fundamentally anti-democratic overtones in the action. Perhaps financial coup d’etat is too strong a characterisation, but there is no question that ECB is now by far and away the most powerful institution without peer in the EMU. As Mitchell argues, “they stand between the system collapsing or muddling through. And they can force austerity onto citizens throughout the member nations but never face the judgement of the voters.”

Which is why we think that questions about the success of the ECB’s alleged sterilisation policy is besides the point: the ECB is finally responding to the euro zone’s potential solvency mess by conducting large-scale bond purchases in the secondary market (which, unlike direct purchases of government debt, is not contrary to the Treaty of Maastricht rules) for the debt of the EMU nations.

The Eurocrats, who have always found democracy to be antithetical to “sound economics” and “good policy”, now have the opportunity of using this crisis to ram through their vision of Europe, which is fundamentally anti-labour and pro capital.

In economic terms, this action is the same as Warren Mosler’s proposed revenue sharing proposal, although it is not done on a per capita basis, and is potentially rife with moral hazard, since it can theoretically mean that the biggest spenders – who will issue the most government bonds, which can then be bought by the ECB in the secondary market – are rewarded However, the ECB can eliminate this moral hazard problem simply by indicating to miscreant countries that it will refuse to buy their debt in the secondary markets if it does not continue to adhere to “responsible” fiscal policy. By embracing this quasi-fiscal role, the ECB in effect becomes the “United States of Europe”. The ‘distributions’ the ECB will make will be via buying enough national government debt in the secondary markets to keep the national governments solvent and able to fund their deficits, at least in the short term markets.

The reality, then, is that the ECB has become the political arbiter for fiscal decisions made by each of the euro zone national governments. If the ECB determines that any member nation is not complying to their liking, they will start threatening to stop buying their debt, thereby isolating them from the ECB credit umbrella, while allowing the remaining nations to remain solvent. And soon the bureaucrats who run the ECB will realise that the non-sterlisation of the bonds doesn’t create inflationary pressures and they will keep doing it, as they will find it to be a very powerful tool to keep national government spending plans which they don’t like in check. ECB spending on anything is not (operationally) revenue constrained as the member nations are, so this policy is nominally sustainable, even if fundamentally undemocratic.

The austerity measures which will be enforced (and thereby secure the tacit backing of Germany) will result in lower growth, and maybe even negative growth, but the solvency issue is gone as long as this policy is followed. With the ECB in effect backstopping the bonds of the national governments, it facilitates the latter’s ability to secure funding again in the market place via renewed bond issuance.

With currency stability developing and inflation ultimately a function of fiscal balance, the fundamental forces in place that drove the euro substantially higher against the US the dollar earlier this year might reassert themselves as private portfolio preferences shift back toward the euro, especially as the mechanism to remove the default risk that drove the portfolio shifts that weakened the euro is now in place. Dollar aversion could well be heightened by renewed fears of a double-dip recession in the US.

If we were to hazard a guess, we would suggest that euro denominated risk assets would outperform US assets for the balance of this year. Another possible investment outcome in the short term is a potential fall in the price of gold (the positive price action until recently has hitherto acted as something akin to “euro vaporisation insurance risk”) As the perceived euro insolvency/evaporation risk diminishes, gold holders who bought on this basis could well shift their money back into euros.

Power, then, has shifted inexorably to the ECB, presumably under substantial influence of the national government finance ministers (ECOFIN), as the ECB directly or indirectly moves to fund the entire banking system and national government. deficits. This is an institutional structure that is fully sustainable financially, with the economic outcome a function the size of the national government. deficits they allow. There has been increasing evidence in the last few weeks or so that suggest that the public deficits across the EU are propping up demand just enough to stop a depression scenario. Growth in Europe though extremely weak is positive, exports are picking up (for now), and there is some evidence that the falling euro will continue to help the external sector.

But the actions of the ECB are neither politically desirable, nor sustainable over the longer term. The conflict will remain the money interests in Europe who put currency strength as a priority, versus the exporters who favor currency weakness. The consensus will be that unions and wages in general must be controlled, which will create ongoing social turmoil. That’s not a great environment, especially in the “new normal” of subpar returns on financial assets.
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The Financial Crisis Inquiry Commission grilled Goldman chief operating officer Jonathan Cohn and CFO David Viniar this week, with today’s session focusing on AIG, and in particular, whether Goldman’s collateral calls were abusive and damaged the insurer.

Readers know that I have perilous little sympathy for Goldman. However, it is important that investigations focus on matters likely to hit pay dirt. And despite the sabre rattling at the New York Times and various websites on the matter of Goldman’s collateral marks, we think the ire is misguided, and this is one of the few cases where Goldman’s defense is sound. By contrast, the Commission missed other smoking guns.

To recap: Goldman, like other major dealers, had bought credit default swaps from AIG to hedge against some CDO exposures. The case against Goldman, in simple terms, is:

1. Goldman was overly aggressive in marking down the CDOs it had insured with AIG. Remember, the bigger the losses reported on the CDOs, the more cash AIG would have to pony up to Goldman

2. Goldman’s actions contributed to AIG’s demise.

Tom Adams, a former monoline executive, and I have performed considerable, in-depth examination of the AIG CDS on CDOs that were bought out by the Fed at par (the CDOs wound up in a vehicle called Maiden Lane III). We debunked this thesis, presented in a New York Times article, in February:

There is a wee problem with this account. Goldman’s marks were proven correct. With the benefit of hindsight, most players, particularly AIG, were in denial….

In late 2007 and early 2008, the monolines were facing similar issues to AIG….The rating agencies not long afterwards started downgrading AAA asset backed securities CDOs, verifying the “aggressive” position [monoline short Bill] Ackman and Goldman were taking.

The story also repeats the AIG/Fed flattering claim that these CDOs have “rebounded.” We’ve discussed long form in other posts that given the continued, serious deterioration in the underlying mortgages, this notion is simply not credible. The decay in credit quality across the portfolio is severe, and there has been no “rebound” in prices of severely distressed CDOs….

The jig was up for AIG by January of 2008 and the debate was only one of timing, not of what the actual outcome would be. Coincidentally, Ambac, FGIC and XLCA were downgraded in January 2008 directly as a result of high expected losses in their CDO portfolios. Any case against Goldman for aggressive marks against AIG by the SEC or other parties would have take the market environment into consideration. Across the board, CDOs were causing losses and downgrades for the people who insured them. It therefore makes plenty of sense that Goldman would be requesting more collateral for their exposure with AIG.

Yves here. So why were the other AIG counterparties more generous in their marks than Goldman? They held considerable CDO inventory. If they were the packager and had marked down their AIG positions, they’d have to provide similar prices to any customer who had bought a long position in the same CDO from them. And more important, they might be required by auditors or regulators to reduce the prices of similar CDOs, which would result in losses.

While this line of inquiry looks illadvised, others have been neglected. Why has no one questioned any of the banks of the absurdity of relying on guarantees from the monolines and AIG? Insurance on subprime was rife with what traders call “wrong way risk”: if you needed to collect on your insurance policy, the very events that would lead you to put in a claim would be likely to damage the guarantor. (Goldman would assert it did recognize the risk and had bought CDS on AIG, but that is also flawed: as we saw, an AIG default was a probable systemic event. Those contracts suffered from wrong way risk too). Put more bluntly, the idea that you could hedge subprime risk, particularly on the scale Goldman could likely have inferred was taking place, was almost certain to result in non-performance on the insurance. Did this occur to Goldman’s vaunted risk management operation? It might be revealing to follow that thread.

The Independent highlighted another missed opportunity:

As well as diffusing the spat with the FCIC, Mr Cohn provided new numbers that he said proved the bank did not “bet against its clients” in the market for mortgage derivatives as the credit crisis unfolded, as has been alleged…..

He said Goldman had reviewed all the mortgage securities and derivatives it had created since December 2006, following fraud charges levelled by US regulators earlier this year. It underwrote $47bn (£31bn) of residential mortgage-backed securities and $14.5bn of collateralised debt obligations, and took short positions on the products – which would rise in value if the products fell – of less than 1 per cent of their value.

“During the two years of the financial crisis. Goldman Sachs lost $1.2bn in its residential mortgage-related business,” Mr Cohn told the panel. “We did not ‘bet against our clients’, and the numbers underscore this fact.”

Yves here. This smacks of being the sort of artwork that is technically accurate in its detail, but misleading in the picture it presents.

The role of a financial firm is to facilitate commerce, by helping companies raise money, by allowing investors and savers to deploy funds. But they have lost sight of their role, and many of their activites at best have no social utility and at worst are extractive and destructive. For instance, short sellers have a useful role to correct the pricing of instruments that were created for legitimate uses. But no one until recently would have considered creating positions anew to serve the interests of short sellers was a good idea. It is pouring talent and capital into purely speculative activities. Bear Stearns, far from a vestal virgin, refused to work with subprime short John Paulson to create synthetic CDOs that would enable him to bet against subprime bonds cheaply.

Now let’s look at Cohn’s remarks. They aren’t just a little misleading, they are a lot misleading.

1. Cohn isolates Goldman’s shorting in 2007 and 2008. But Goldman’s Abacus program, which was designed for the firm to establish short positions, started in 2004. Goldman had insured 5 2004 and 2005 Abacus trades with AIG, along with 22 2004 and 2005 CDOs structured by Merrill, 9 2004 and 2005 CDOs structured by other banks, and 2 of its own 2005 cash CDOs. So the roughly $15 billion that Goldman made from AIG is expressly excluded from Cohn’s presentation.

2. The comparison is further misleading by comparing its activity over a period of time (underwriting over a two year period) versus its short position that was presumably measured at a single point in time

3. What does “short positions on the products” mean, exactly? Technically, if you take down the short sided of a synthetic CDO, you have short positions in tranches of subprime bonds and other assets. If you only kept the short side on particular RMBS in that CDO, not all, you are arguably not short the CDO, but short some bonds. Similarly, Goldman may also have used the ABX or the TABX indices to establish short positions, so it could be taking a view against the market without being short the specific transactions it was pedalling.

4. Pray tell, how was this “less than 1%” arrived at? The dollar amount of the short position was CERTAIN to be small because Goldman used credit default swaps. The cost of establishing a short position was only 100-140 basis points until spreads started blowing out at the end of 2006 (and they tightened again in March 2007). The proper comparison would be the notional amount insured versus the cash position.

The FCIC also bears other signs of being badly unprepared, witness this exchange reported in the Huffington Post (hat tip reader Francois T):

The panel created to investigate the roots of the financial crisis escalated the government’s assault on Goldman Sachs on Thursday, criticizing the Wall Street firm for failing to turn over basic documents and accusing it nearly lying under oath.

For a second consecutive day, the bipartisan Financial Crisis Inquiry Commission reiterated its request for additional data from Goldman, namely figures regarding the firm’s derivatives activities. And for a second consecutive day, Goldman’s top executives demurred.

“We generally do not have a derivatives business,” David Viniar, Goldman’s chief financial officer, told the panel Thursday under oath.

Goldman Sachs holds more than $49 trillion in notional derivatives contracts, making it the third-largest derivatives dealer among U.S. banks, according to first quarter figures from national bank regulator the Office of the Comptroller of the Currency. The commission has found that Goldman is a party to more than 1 million different derivatives contracts, Commissioner Brooksley Born disclosed Thursday.

“We don’t separate out derivatives and cash businesses,” Viniar clarified under questioning. The derivatives units are “integrated” into the firm’s cash businesses, making it difficult for the firm to isolate its derivatives data, he said.

In January, the panel asked Goldman chairman and chief executive Lloyd C. Blankfein for a breakdown of the firm’s revenues and profits from its derivatives activities. He said the firm would comply. The commission reiterated that request Wednesday and Thursday.

Viniar said the firm doesn’t “keep” records outlining its revenues from its derivatives dealing.

“I am very skeptical that you can’t measure these revenues and profits,” Born told Viniar. “I urge you to provide us with this information. It’s been about six months we’ve been asking for it… and it makes one wonder also why Goldman has the incentive or impetus not to reveal this information.

“You’re suggesting you don’t give it to your regulators. You don’t put it in your financial reports… so you don’t give it to the market… [or to your counterparties],” Born continued. “And you’re refusing to give it to us. I hope very much that we will see this very shortly.”

Viniar took exception to that last comment.

“Commissioner, again, we’re not refusing anything,” Goldman’s chief financial officer said. “We don’t have a separate derivatives business.”

Viniar then said that Goldman isn’t alone in not breaking out its derivatives-specific revenues and profits.

Born quickly shot back.

“They don’t,” Born, the nation’s former top derivatives regulator, conceded. “But some other firms have provided us with that data when we’ve asked for it, and Goldman Sachs hasn’t.”

Phil Angelides, the panel’s chairman, could barely contain his incredulousness.

“Are you telling me you have no system at your company that tracks revenues or assets of contracts, and liabilities and payments under contracts?” Angelides asked. “You have no management reports, no financial reports that track these contracts?”

“I’ve never seen one,” Viniar responded. Pressed further, Viniar added that the firm doesn’t track these things because it’s “not meaningful.”

Viniar again was asked to provide the data.

Yves here. I have to tell you, this is a ridiculous line of questioning. What the hell is the FCIC trying to get at? There is NO SUCH THING as a “derivatives business”. This in fact illustrates how financial services lobbyists have managed to muddy policy debates, to the advantage of the industry, by lumping a lot of disparate activities under the derivatives banner.

Goldman no doubt has commodities futures businesses, FX and currency swaps, and corporate and asset backed credit default swaps activities. I’m sure it also engages in stock and bond index and futures trading in a number of markets. I’m a big believer in knowing what questions you are trying to answer when drilling into data, and I see no utility in having an aggregate figure across these activities.

And some firms do manage the cash and derivatives businesses of related businesses on an integrated basis. In particular, it appears from the voluminous Goldman documents released by the Senate that Goldman ran its cash and synthetic CDO packaging business from the same business unit. This would not be unusual.

Now the flip side is Goldman clearly does have transaction level information and could no doubt provide analyses to address specific FCIC questions . But it isn’t clear at all what the FCIC wants. This reminds me of the sort of exercise I’d fight tooth and nail as an associate at McKinsey, because it was a complete waste of client time and money, that of simply taking whatever data the client had and cutting it various ways to see if anything emerged. It would provide a lot of charts for a progress review, and if it produced any insight, it was completely random and could have been arrived at much more cheaply with a more deliberate approach.

So as much as Goldman is a deserving target, the FCIC appears to be quite overmastered by them, in part due to insufficient preparation (a function of insufficient budget, staffing, and unrealistic deadlines) and lack of well honed interviewing skills on behalf of its commissioners.

When a CEO has a major foot in mouth episode, it’s usually the result of uncontrolled candor. And today’s outburst by GE CEO Jeffrey Immelt appears to be true to form.

According to the Financial Times, the GE cheiftan said some less that politic things about China and Obama at a private gathering which his operatives tried to characterize as being taken out of context. Yeah, right. His commentary so typifies what you’d expect from the top executive of a large multinational (and major financial firm to boot) that it’s hard to see his remarks as anything other than a reflection of his views. They happen to be ugly because they represent American corporate arrogance writ large.

From the Financial Times:

Jeffrey Immelt, General Electric’s chief executive, has launched a rare broadside against the Chinese government, which he accused of being increasingly hostile to foreign multinationals…

“I really worry about China,” Mr Immelt told an audience of top Italian executives in Rome, accusing the Chinese government of becoming increasingly protectionist. “I am not sure that in the end they want any of us to win, or any of us to be successful.”

Yves here. This is almost comical. A US corporate executive thought the Chinese officialdom was supportive of their business goals? China is out for China, period, and that is a stance that that the US would be well advised to emulate, rather than being brainwashed (or bribed) into thinking that the interests of large multinational are aligned with national goals.

I may sound like a complete Luddite, but I have LONG questioned the wisdom of foreign firms locating factories in China and exposing themselves to the risk of piracy, counterfeiting, and other forms of technology transfer. This is an authoritarian country where organs are harvested from prisoners who are still alive. Given how brutal they are to their own citizens in the name of preserving state authority and perceived national interests, the only reason for them to play nice with foreign companies is if they think the arrangement benefits them, not because they give a rat’s ass about their health. It would not be impossible for them to seize assets (with trumped up charges) but Chinese businessmen are sufficiently skilled at stacking the deck to suit their interests that such crude measures are unlikely ever to prove necessary.

Consider this commentary in the Asia Times, in a review of Poorly Made in China: An Insider’s Account of the Tactics Behind China’s Production:

Chinese manufacturers cut corners wherever they can, from product quality to factory equipment and maintenance. They unilaterally change product and packaging specifications to trim costs. They raise prices after the deal is signed, leaving the importer to absorb the added cost. They reproduce their customers’ products for sale at higher margins in other markets. With support from government, bankers, and networks of fellow manufacturers, they conduct manufacturing and customer relations as a game, treating the other party as a patsy not a partner, playing for the short term of making an extra penny at the risk of product quality but also taking a long-term, multidimensional outlook that outflanks the hapless customer….

For Chinese manufacturers, a deal with an importer can be desirable even if it doesn’t appear profitable. Reasons range from domestic counterfeiting opportunities to status to customer contacts (for disintermediation – cutting out the importer to deal direct with retailers) – to cash flow or capital (secured by an enlarged plant) for other investments. While most small importers are playing checkers, focusing on profit on each contract, Chinese manufacturers are playing chess – and playing to win – Midler says.

Yves here. Now this extract describes the situation facing firms contracting in China, not major manufacturers like GE setting up operations in the country. But step back a second and look at the ruthlessness of the tactics, the routine cheating and the willingness to sacrifice short term profits for the long game. Immelt and his ilk, no doubt seduced by too many meeting and dinners with government officials who told him what he wanted to hear, was unwilling to to consider that a big globe spanning company could be played like a rube, used when he was valuable and squeezed when he had served his purpose. After all, isn’t that how almost all Big Co’s behave? But they act so wounded when the table are turned on them.

Immelt’s diatribe on Obama verges on childish:

Mr Immelt also had harsh words for Barack Obama, US president, lamenting what he called a “terrible” national mood and expressing concern that over-regulation in response to the global financial crisis would damp a “tepid” US economic recovery. Business did not like the US president, and the president did not like business, he said, making a point of praising Angela Merkel, Germany’s chancellor, for her defence of German industry.

Yves here. This tactic by big business, to howl over trivial, cosmetic reregulation as if it were rape, illustrates how they believe they should be in the driver’s seat and government and the public at large should fall into line. Look at his distorted logic: the recovery is going to be “tepid” (actually, we should be so lucky as to have it be as warm as “tepid”) and the national outlook is sour because we are still working through the aftereffects of a massive credit bubble, with GE profiting handsomely from helping to create this disaster. But no, let’s airbrush out the real cause, the utter recklessness of financial services firms around the world, and shift blame to Obama.

And who cares if Big Business likes Obama? I dimly recall that the major corporate interests of their day hated Teddy Roosevelt and FDR, both now considered to have been fine leaders, and were quite fond of Calvin Coolidge and Herbert Hoover, both of whom rate among the ten worst presidents. So being popular with businesses may well be a negative performance indicator.

It would be nice to see Immelt’s pique as a sign that major companies are finally being called to heel by governments, but the indignities GE has suffered are too minor to warrant such a hopeful conclusion. His reaction is reminiscent of a spoiled toddler who has had a few toys removed from his well stocked playpen.

,

This is a wonderful short video by RSAnimate based on a talk by radical, as in Marxist, sociologist David Walker.

For those who recoil, Marx was the first to take note of the propensity of capitalism towards instability. By contrast, neoclassical economics, which has dominated policymaking in advanced economies, posits that economies have a propensity to equilibrium, and that equilibrium is…full employment! Marxists also look at long term trends in corporate profitability, and because Marxists use that as an important framework, it seems to be verboten as a line of inquiry in other schools of economics. Weird.

I found this talk to be engaging. Hope you like it. Hat tip reader Don B, via the New York Observer:

Or you can watch Harvey’s full lecture:

Apologies for thin posts, I have an article deadline…

Distressed Ravens Show That Consolation Is For The Birds, Too GrrlScientist

Harbour seals ‘pupping earlier’ BBC

Aborigine ‘cooked’ to death in prison van Telegraph (hat tip reader Pat D)

Wrong Time for Congo Debt Forgiveness Kerry Kennedy, Huffington Post

CNN: Almost All Exxon Valdez Cleanup Crew Dead YouTube (hat tip reader Cocomaan). Scary, but I have not seen independent verification.

No Fishing Zone in the Gulf Expands WCTV (hat tip Doc Holiday)

Biologists find ‘dead zones’ around BP oil spill in Gulf Telegraph

Avertible catastrophe Financial Post. Read this and get angry. Reader Vlad adds:

Some of my contacts in the Gulf states are now saying that the rage has now mainly switched from BP to Fed government – Katrina in slo-mo. It doesn’t mean they forgave BP – just that they are more pissed off with White House, which I’d say is takes some effort on the govt’s side.

Wall Street sees little gain in levy win Financial Times

U.S. Regulatory Bill’s Support May Weaken as Senate Delays Vote Bloomberg

Still Not Looking Up Michael Panzner

Bankers Who Broke Big Dig With Swaps Gone Awry Get Paid for Fix Bloomberg (hat tip reader bob)

The BIS is part of the problem billy blog

The Asian century calls for a rethink on growth Kevin Brown, Financial Times

Antidote du jour:

In an interesting bit of reporting disparity, news of planned EU legislation on bank pay is a top story on the front page of the Financial Times, yet is buried in the Wall Street Journal and didn’t make the cut at the New York Times. Admittedly, that is no doubt in part due to that any EU pay restrictions will affect London based bankers. But it is the US FT edition that is presenting this story prominently, and with good reason. To have rules like that imposed over such a large number of important markets to US firms is going to pose quite a conundrum. No one with an operating brain cell (or who is any good) will take a posting in regions that subscribe to the EU pay model if he can have more liberal pay elsewhere. That in turn means the US firms might need to adopt similar measures.

The high concept of the legislation is that it will substantially defer the payment of bonuses. As the Financial Times explains:

Under legislation expected to pass the European parliament next week, between 40 and 60 per cent of bonuses would have to be deferred for three to five years and half the upfront bonus would have to be paid in shares or in other securities linked to the bank’s performance.

As a result, the cash portion would be limited to between 20 per cent and 30 per cent, far tighter the limits currently used by most members of the 27-nation bloc…

National regulators will have some discretion in applying the rules to their own countries but the overall percentages appear to be fixed. Regulators would be able to impose financial or non-financial penalties on groups with risky remuneration policies.

The legislation would also force banks to link bonuses more closely to salaries – with the aim of reducing the importance of such payments in the financial sector.

Any banks bailed out by taxpayers must rebuild their capital first and repay those funds before focusing on employee pay.

On Wednesday, lawmakers and EU officials welcomed the agreement and said it should help to reduce the “bonus culture” in the banking sector.

“This EU-wide law will . . . end incentives for excessive risk-taking,” said Arlene McCarthy, the MEP steering the legislation through the European parliament.

The Wall Street Journal provided additional detail:

The new rules would also ensure high pension payments are generated as contingent capital, with their final value linked to the strength of the bank. The measures aim to avoid the kind of bloated severance packages for disgraced departing executives that have caused an outcry in Europe.

Banks would also be required to hold a minimum amount of capital to ensure they are covering risk from their trading book and complex securitized investments, such as mortgage-backed securities, to avoid a repeat of risk-related losses like those seen during the financial meltdown. The capital requirements would take effect in 2012.

One has to assume that a big goal is to make sure most of the cash a performed earned is still at the firm in case his results are later found to be, ahem, exaggerated.

Needless to say, the industry sabre-rattling started almost immediately. Back to the Financial Times:

Senior bankers contacted were reluctant to comment but said they believed the instruments would be difficult to design and warned that tough pay rules could drive business to Asia and the US, which have shunned strict limits on bonuses.

Angela Knight, of the British Bankers’ Association, said politicians should realise most banks have already changed their pay practices and keep in mind that “this is an international and mobile business”,

Yves here. The EU has gotten similar threats on other financial services initiatives and has not been deterred. As we noted:

In March, the EU announced plans to restrict the operations of private equity funds. This is far from surprising, since US and UK firms have exhibited a nasty propensity to lever up firms, pull out a lot in the way of special dividends, and too often overdo the cash extraction and leave a bankrupt hulk in their wake. The irony is that while that is peculiarly seen as a legitimate way to do business here, most EU member states are not at all happy with it. The EU has been working on a proposal to restrict investors in the EU from putting funds in private equity and hedge fund firms outside the EU, and also limit the ability of foreign investors to buy European companies.

The amusing aspect of this initiative, as we noted in an earlier post, is the private equity industry immediately started threatening that the proposal would “seriously disturb” many of the world’s biggest PE funds. So? That would seem to be a feature, not a bug.

Yves here. The contretemps got even more entertaining:

The EU seems unintimidated by various threats the hedge fund and private equity fund industry have tried to make to forestall efforts to restrict the activities of those firms….

The idea that any government dare tell the moneybags what to do is a bit of a stunner to the industry, which has gotten used to having its way in the US and UK. But despite the loud noises from the industry, there has been no change in the stance of the Europeans.

Indeed, it gets even better. An EU parliamentarian who is the rapporteur on the proposed reforms, in effect said that what was at stake was 3000 hedge fund jobs…

From the Guardian (hat tip reader Swedish Lex):

Jean-Paul Gauzès, the European parliament rapporteur on a proposed directive on alternative investment, said: “If the directive wipes out two or three thousand speculators, I am not going to be sad.”

US based readers might assume that non-EU firms could slip the leash, but that may be easier threatened than done. The EU is requiring private equity firms and hedge funds to be licensed locally and adhere to local regulation Securities firms already require local licenses, so anyone operating within the country would presumably be captured in this net. It isn’t clear how the EU would deal with bankers flown in for particular deals, or whether firms will try clever dodges (locating trading desks, say, in Moscow). But the EU operates under a principles-based regime, which also gives it considerable latitude to attack practices designed to circumvent rules.

This will most decidedly continue to be amusing.

We and other cynics were very skeptical of the pre-G20 announcement by China that it was moving to a more market-oriented currency regime at some unspecified point in the future (particularly since China had said pretty much the same thing in 2005, and actually had committed to some baby steps then).

Now that it is clear that any action will be modest and very much delayed (or worse, has high odds of being a devaluation against the dollar if the euro falls further), the US is resuming the war of words against China, and it is Obama who is now applying pressure. Before, the criticism was almost entirely at the Geithner level or below, so this relatively mild statement so close to the G20 is more significant that it appears. From Bloomberg:

President Barack Obama said the U.S. will keep up pressure on China over its currency valuation to ensure fair trade.

“If China has a currency that’s undervalued, that makes our exports more expensive, it makes their imports cheaper,” Obama said in response to an audience question at an event in Racine, Wisconsin. “So we have been putting pressure on them to say, let’s make sure that we’re not favoring one side or another.”

Obama discussed currency policy with Chinese President Hu Jintao while both were at the Group of 20 summit in Toronto last week. Some lawmakers in Congress are pressing for stronger action, including letting U.S. companies seek tariffs on Chinese imports.

Yves here. The real determinant will be economic performance. If the growth falters and unemployment rises, which we deem likely, then the pressure on the president and Congress to Do Something will also rise. And the next window for certifying China as a currency manipulator is mid-October, temptingly close to mid-term elections.

China is almost certain to resist even token appreciation, both on general principle and given that its growth is easing off. While investment is now a bigger contributor than exports (and the two together are an unprecedented level of GDP), manufacturing growth is starting to ease off. And note China engaged in extraordinary stimulus measures in 2009, pumping $1.4 trillion of liquidity into its banks system (and unlike here, applying pressure for banks to lend). The impact of the falling euro (both on competitiveness of Chinese products, and on demand as austerity measures push the eurozone into deflation) will put a crimp into the export sector just as China is throttling back on loan growth. Again from Bloomberg:

China’s manufacturing expanded at a slower pace for a second month in June, adding to signs that growth in the world’s third-largest economy is moderating.

The Purchasing Managers’ Index fell to 52.1 from 53.9 in May, the Federation of Logistics and Purchasing said in an e- mailed statement today. That was less than the median 53.2 estimate in a Bloomberg News survey of 12 economists…

Qu [Hongbin, a Hong Kong-based economist at HSBC Holdings Plc,] said “resilient” private consumption and government spending on public housing will help to sustain growth.

That outlook hasn’t been shared by investors, who sent the Shanghai Composite Index to a 14-month low yesterday. The MSCI Asia Pacific Index dropped 1.1 percent as of 10:40 a.m. in Tokyo. The world is relying on China to help sustain a recovery that Group of 20 leaders this week described as “uneven and fragile.”

Taliban attack Nato base in Afghanistan BBC

Analysis: Why Silicon Valley should fear ACTA ITNews

Cheerio! Rolfe Winkler. Congrats! He is going to the Wall Street Journal.

New Legislative Effort to get Bankruptcy Exemption….For Guns. MIke Konczal

Rob Parenteau gets sectoral balances right Steve Waldman

The High Budgetary Cost of Incarceration John Schmitt, Kris Warner, and Sarika Gupta, CEPR (hat tip reader Gordon). Bottom line: if you need to cut state and local budgets, the vogue for locking people up would be a very useful fad to reverse.

Secretary of Energy Steven Chu Confirms that Some of BP’s Oil Well Casing Has Been Demolished George Washington

NASA to Do More Flights to Measure Change in BP Oil-Spill Size Business Week (hat tip reader Doc Holiday)

Bank Fee Is Eliminated in Financial Bill New York Times

The Procrustean Democracy of AmericaSpeaks: Part One Lambert Strether. This is a disgrace, I had wanted to post on it tonight, will hopefully address it later today.

Time to shut down the US Federal Reserve Ambrose Evans-Pritchard, Telegraph

Crisis is back with a vengeance as ECB’s sterilisation auction flops Eurointelligence

Consumer Confidence Crushed EconomiPic Data

What Is Goldman Sachs Thinking? Simon Johnson

Financial Reform Legislation Does Not Eliminate Too Big To Fail Mark Thoma. We knew that, but glad word is getting out.

This global game of ‘pass the parcel’ cannot end well Martin Wolf, Financial Times. Today’s must read

Antidote du jour:

The New York Times has unearthed a damning tidbit about the bailout of AIG:

When the government began rescuing it from collapse in the fall of 2008 with what has become a $182 billion lifeline, A.I.G. was required to forfeit its right to sue several banks — including Goldman, Société Générale, Deutsche Bank and Merrill Lynch — over any irregularities with most of the mortgage securities it insured in the precrisis years.

Yves here. How one reacts to this depends in no small measure as to how one views the salvage operation. For all intents and purposes, the rescue of AIG was merely a way to save the banks; the credit default swaps had been too big a source of faux capital (for US firms, via risk-dumping, and for Eurobanks, as part of a regulatory arbitrage) to let the insurer go. So any effort by the officialdom to aid the banks, most notably by paying out 100% on credit default swap exposures (which had already been written down by counterparties to less than par) was simply an effort to funnel more cash to the banks. Since we’ve had massive backdoor bailout mechanisms in addition to the overt ones, this orientation should come as no surprise.

But then we get to the funny business. Why a broad waiver? Why shouldn’t AIG (and by extension, taxpayers) not recover in the event of fraud? And we turn again to the ambiguous standing of AIG. By all rights, it ought to be owned by the government. The reason it isn’t is that we don’t do nationalization in America, and full ownership would require AIG’s debts to be consolidated with government debt. So another way to read this requirement is that the Fed and Treasury were opposed to having fraud at the banks exposed, period.

That is a very troubling stance for bank regulators to take. And experts agreed:

“Even if it turns out that it would be a hard suit to win, just the gesture of requiring A.I.G. to scrap its ability to sue is outrageous,” said David Skeel, a law professor at the University of Pennsylvania. “The defense may be that the banking system was in trouble, and we couldn’t afford to destabilize it anymore, but that just strikes me as really going overboard.”

“This really suggests they had myopia and they were looking at it entirely through the perspective of the banks,” Mr. Skeel said.

Yves here. Also note that the banks mentioned by the Times account for a significant proportion of the Maiden Lane III exposures (the $62.9 billion CDO portfolio; note this does not include all CDO guarantees assumed by the Federal Reserve; seven Goldman Abacus trades stayed with AIG and were salvaged via credit extensions to AIG). An analysis by Tom Adams and Andrew Dittmer showed the significance of Merrill, Goldman, and SocGen (percentages based on par amount):

1. Merrill as both packager and counterparty 7.7%
2. Goldman as both packager and counterparty 7.4%
3. Merrill as packager, Goldman as counterparty 9.6%
4. Goldman as packager, SocGen as counterparty 15.9%

We thought these interrelationships were potentially significant; they account for 40.6% of the Maiden Lane III exposures. Then add in:

5. Anyone else with a pulse as packager, SocGen as counterparty 11.0%
6. Anyone else with a pulse as packager, Goldman as counterparty 5.5%

That bring you to 56.5% of the total.

Goldman, either as packager or as swap counterparty, was involved in 38.4% of the Maiden Lane transactions, plus had additional AIG exposure through seven Abacus trades (we only have tranche exposure on three of these transactions):

Abacus 2004-1
Abacus 2004-2
Abacus 2005-2
Abacus 2005-3
Abacus 2005-CB1
Abacus 2006-NS1
Abacus 2007-18

Yves here. The time is long overdue that Lloyd Blankfein’s early and extensive involvement in the AIG rescue be investigated in detail. The legal waiver no doubt was particularly beneficial to Goldman, and given that it is now being sued by the SEC, it is fair to ask if he put the idea of the waiver forward. It is highly unlikely to have occurred to the Fed and Treasury officials unprompted, particularly given the fevered pace at which the AIG rescue was cobbled together.

Moreover, in noting the officialdom’s deference to Wall Street, Blankfein features prominently:

In that regard, the newly released Congressional documents show New York Fed officials deferring to bank executives at a time when the government was pumping hundreds of billions of taxpayer dollars into the financial system to rescue bankers from their own mistakes. While Wall Street deal-making is famously hard-nosed with participants fighting for every penny, during the A.I.G. bailout regulators negotiated with the banks in an almost conciliatory fashion.

On Nov. 6, 2008, for instance, after a New York Fed official spoke with Lloyd C. Blankfein, Goldman’s chief executive, about the Fed’s A.I.G. plans, the official noted in an e-mail message to Mr. Blankfein that he appreciated the Wall Street titan’s patience. “Thanks for understanding,” the regulator said.

Yves here. This obsequiousness is noteworthy because the Times also stresses that the Fed’s own advisors (Morgan Stanley, Black Rock, and Ernst & Young) were advocating a tough stand with the banks, including haircuts on their guarantees with AIG. But Treasury appears to have carried the day:

For its part, the Treasury appeared to be opposed to any options that did not involve making the banks whole on their A.I.G. contracts. At Treasury, a former Goldman executive, Dan H. Jester, was the agency’s point man on the A.I.G. bailout. Mr. Jester had worked at Goldman with Henry M. Paulson Jr., the Treasury secretary during the A.I.G. bailout.

Yves here. And in an astonishing lapse, Jester still owned Goldman stock. By any standard, he should not have been involved at all in the process, much less in a crucial role. But because he was a contractor, and not a government employee, this arrangement was kosher. Not surprisingly, Jester opposed measures that would require Goldman and other banks to take any pain.

The Times reminds readers it pays to be a bankster:

All of this was quite different from the tack the government took in the Chrysler bailout. In that matter, the government told banks they could take losses on their loans or simply own a bankrupt company; the banks took the losses.

Yves here. The Audit the Fed investigation will shed even more light on the AIG rescue, but the seamy dealing of Treasury means that investigations need to extend into its role as well. But it will take a public hue and cry for that to come to pass.

We’ve warned for some time that the eurozone’s sure-to-fail muddle-through approach to its structural challenges was rattling investor confidence. Worse, its insistence on wearing an austerity hairshirt was not only committing Europe to deflation, but had high odds of sucking the global economy down along with it. Given how fragile the recovery is in advanced economies, and the magnitude of the debt overhang in many nations, a downturn could easily morph into a deflationary downspiral, potentially a full blown depression.

Let’s recap of some of the troubling sightings. First is that Spanish banks in particular, along with other Eurobanks, have been on the ECB drip feed for some time. Recall that the Spanish banking authorities pushed for the release of stress information on their banks precisely because they hoped that it would reassure the market and improve access to private funding. However, in a rather remarkable bureaucratic dedication to deadlines over common sense, the ECB is terminating a €442 billion one year liquidity facility on July 1 (FT Alphaville has been covering this intensively). An unknown but believed-to-be-large portion of the facility was used to fund carry trades within the EU, particularly that of Spanish and Greece sovereign debt (until spread widening late last year started burning fingers). To the extent it has been used to finance bank operations, the theory has been that banks would avail themselves of shorter-term ECB facilities, particularly its three month program.

Wellie, so that should not prove bothersome, right? Theory does not seem to have translated very well into practice. Europe opened badly on Tuesday, and the flight to safety continued in the US, with yields on ten-year Treasuries falling below 3%. There is also evidence of liquidity-hoarding, with an ECB sterilization operation going badly.The lousy US consumer confidence figures are the public face of considerable nervousness about the business outlook. For instance, despite the brave talk of recovery, corporate bond issues have fallen as companies increase cash levels rather than expand operations.

The ECB has retreated a tad in the face of the vote of no confidence from the markets, and will offer unlimited three month loans today, in advance of the termination of its one-year facility. More detail from the Financial Times:

Fears that the European Central Bank was scaling back emergency support to eurozone banks too soon sparked sharp falls in financial markets on Tuesday, with the euro tumbling to an eight-and-a-half year low against the Japanese yen….

“We will make sure that there are no problems and everything goes OK,” Christian Noyer, France’s central bank governor, told Europe 1 radio. But he warned that “there are some banks that are in a less good situation that might eventually suffer”.

Elena Salgado, Spanish finance minister, appealed to the central bank to take into account the liquidity needs of the Spanish banking system. She said on Spanish radio: “The ECB says it doesn’t like governments telling it what to do. I simply say I hope that on this occasion, as in others, the ECB will be aware of the needs of the Spanish financial system.”

Yves here. These visible signs of stress between national bank regulators and the ECB is not confidence-inducing, to say the least.

Ambrose Evans Pritchard pointed to other troubling indicators:

Triple tremors from the banking crisis in Spain, crumbling confidence in the US, and a setback in China’s leading economic indicator all combined with a vengeance on Tuesday. “The market in risky assets has capitulated ­today amid fears that the ­global recovery is petering out,” said Gavan Nolan, head of credit at Markit…

China’s Shanghai composite index of equities fell 4pc on Tuesday and is now 55pc below its peak in late 2008. The authorities have been tightening this year to slow inflation and curb property speculation as home prices in Shanghai and Beijing reach 13 times incomes, but it is unclear whether they can engineer a soft-landing in an economy where state-owned banks have built up huge hidden debts…

“Foreign capital flight is under way. This can only make matters worse given the climate of insecurity and the country’s lack of credibility,” said Borja Duran from Wealth Solutions in Madrid.

Spreads on Greek debt have jumped 350 basis points since the EU announced its plan in early May. Portuguese and Spanish yields have both jumped sharply despite direct action by the European Central Bank to force down yields. Private buyers are clearly dumping their holdings onto the ECB as fast they can.

Mr [Hans] Redeker [curency chief at BNP Paribas] said Japanese life insurers and institutional investors are slashing their ­estimated $700bn holdings of European debt. The funds are being recycled into yen, which reached ¥107 against the euro yesterday, the strongest in nine years.

Reader Swedish Lex early on had pointed to the importance of contagion spreading to Italy, and that is under way, per Evans-Pritchard:

The latest twist is a rise in credit default swaps on Italian debt, which jumped 16 basis points to 203 yesterday. An auction of Italian bonds this week went badly, with low bid-to-cover ratios….

Italy has been largely immune to Europe’s bond crisis until now, thanks to high savings…

Italy’s public debt is the third largest in the world after the US and Japan. Everybody knows that if the crisis ever reaches Rome, the game is up for monetary union.

This Sydney Morning Herald story (hat tip reader Gordon) highlights a Bank of England report that not only points out the magnitude of the financing needs of major banks over the next few years, a daunting $5 trillion, but also indicates that US and European bank refinancings are falling short of their rollover calendar. This suggests that we may witness a combination of balance sheet shrinkage and more covert and overt funding support.

From the Sydney Morning Herald:

Banks around the world must refinance more than $US5 trillion ($5.8 trillion) of debt in the coming three years, a massive rollover that poses threats to financial stability and growth.

The need to replace these funds, which are medium and long term, will place pressure on bank profit spreads and in turn may either prompt deleveraging, where banks sell assets that they can no longer economically finance, or simply lead to a bout of credit rationing, where borrowers must pay more to borrow, thus crimping investment and economic growth…

US banks have issued $US230 billion of debt in the first five months of the year, about 60 per cent of the rate they need to achieve over the three year period. Euro zone banks have issued $US133 billion, or about 70 per cent of their needed run rate.

One easy to see consequence is that, all things being equal, the cost for banks to issue debt should rise, as should competition among banks for consumer deposits. It is possible that a global desire to save more helps to blunt this effect, but even so the macroeconomic effect and the effect on asset prices will both be strongly downward.

The Bank of England June 2010 Financial Stability Report gives a more detailed breakdown:

This is what deleveraging looks like…and note that these challenges remain after banks have already made progress in improving their capital buffers. This chart shows the fall in UK banks’ overall leverage (click to enlarge):

So it looks to be semi-official. The “stress test” label, in Europe as in the US, signifies an exercise that is designed to produce attractive report cards, as opposed to provide a valid measure of the sturdiness of a bank’s balance sheet in difficult conditions.

So what is the biggest concern investors and counterparties have about European banks? Sovereign risk exposure. So what do the ECB stress tests apparently exclude? Sovereign risk exposure.

From Bloomberg:

Deutsche Bank AG, Commerzbank AG and Bayerische Landesbank passed a stress test that evaluated how about 25 European lenders would weather an economic downturn, said three people familiar with the results.

The three German lenders’ tier 1 capital ratio, a key measure of financial strength, exceeded a threshold of 6 percent under the economic scenario, said the people, who declined to discuss the performance of banks outside Germany. The tests didn’t include sovereign debt, two people said.

As world watches soccer’s Cup, Nike critic sees red Los Angeles Times

Team’s Work Uses a Virus to Convert Methane to Ethylene New York Times (hat tip reader Crocodile Chuck)

Newsflash : Airline food is inedible Gumbat Stew

A Republican Party that Really, Really Doesn’t Want Any Black or Hispanic People Voting for It Ever Again… Brad DeLong

More on Boycotting BP from the LAT Columbia Journalism Review

South Carolina: Outlier or National Precursor?Patrick Caddell and Kendra Stewart, RealClearPolitics. Is the “No Incumbent Left Standing” movement getting traction?

Guess What: Financial Reform Might Seriously Be DEAD Cluserstock

Ten untruths about central clearing Deus Ex Macchiato

The three biggest lies about the economy MarketWatch (hat tip reader John L)

In Ireland, a Picture of the High Cost of Austerity New York Times

Shock therapy is best cure for banks Financial Times. Note this is an editorial.

Britain ‘might not cope with another bank emergency‘ Independent

Force banks to bolster capital, says BIS, as G20 is criticised for delay on reforms Guardian

Official warns of asset risk for Fed Financial Times. This confirms the Ambrose Evans-Pritchard report that the Fed is divided on further QE if (ahem, when) the economy stalls. But then we have this: RBS tells clients to prepare for ‘monster’ money-printing by the Federal Reserve Ambrose Evans Pritchard, Telegraph (hat tip reader nohongosean)

Volcker Rule May Give Goldman, Citigroup Until 2022 to Comply Bloomberg. This “accommodation” makes clear what a farce the rule is.

Greece’s best option is an orderly default Nouriel Roubini, Financial Times

Slugfest! This unfortunate paper Economics is Hard. Don’t Let Bloggers Tell You Otherwise by Kartik Athreya of the Richmond Fed elicited a firestorm of reactions. I am tempted to weigh in belatedly, but here are some of the better responses thus far:

Don’t Let Fed Economists Tell You Otherwise… Mark Thoma

Bloggers can’t do economics. Discuss. FT Alphaville

Do I Have Anything Interesting to Say? Matt Yglesias

Economists behaving foolishly Ryan Avent

Economics Is Hard? Karl Denninger (hat tip reader Scott)

Fed Economist: Bloggers are Stupid Bruce Krasting

Antidote du jour:

By Richard Smith, a London-based capital markets IT consultant

In my last post, “Tracking the Rabbit through the Anaconda” , I mocked Geithner a bit and promised you all a spot of moaning about what’s missing from the financial reform bill.

Well, the anaconda has now had the time it needed to produce its offering. As an outsider considering the 20 hour orgy of bill consolidation and last-minute horsetrading that rounded off the whole process, I must say I find the US legislative process combines frivolity, pomp and ineptitude in a way that – reminds me of dear old England. Perhaps you are all very proud.

Shadow banking reform is the subject this post, since it is terribly important, much more compact than the rest of the reform, and the outcome is very very depressing. That leaves consumer finance, derivatives, and consumer finance for later. And let us see what FASB deliver in accounting changes, if anything.

This is how it all looked to me four weeks ago:

“The shadow banking stuff now looks appropriately targeted, by and large. They have sort of got it. Doubtless there will be nits to pick, down in the detail…

…To be honest, at this level of description the proposals don’t look quite as horrific as they might have done (after TARP et al, one’s expectations were modest indeed). So should one hold out for more, or quite a lot more? Is perhaps this – all holes and no cheese – still the right take on what will emerge?”

With respect to shadow banking, it seems, alas, that I was still far too optimistic; the short answer to the last question above is a resounding YES, and here is why.

Thoughtful NC regular RueTheDay has returned to blogging, and saved me some re-exposition with this crisp recap on the shadow banking system and its role in the Great Financial Crisis. To add: US shadow banking assets at the peak were $8-10Trn. That depends on what you include; the NYFRB’s relatively inclusive figure for market-based credit puts the figure at $16Trn (see Fig 1 here ), comfortably larger than the traditional deposit-based banking sector’s $10Trn.

Whatever the bonus-enhancing attractions of near-infinite ROC, you really wouldn’t want a run on that little set-up, and naturally, in September ‘08, we got one. Trouble was, there wasn’t much equity in those shadow banks, and no liquidity buffers at all. Shadow banking “equity” – the capital that is there to absorb losses and promote investor confidence in the bad times – is something of a nebulous concept. Instead of ordinary equity you have various kinds of guarantee, for instance:

for SIVs: ‘liquidity puts’ (vide CitiGroup SIVs)

for money market funds: informal guarantees that the buck will not be broken, extended by the fund’s parent, but not credible in a crisis (vide Reserve Fund Sept ‘08 and the ensuing shadow banking seize up)

for repo: haircuts for repo collateral, that increase dramatically in a crisis, and thus, precipitate runs

for in house hedge funds: you sometimes have an honour system, whereby the parent informally undertakes to indemnify hedge fund investors against losses (following through on that promise killed Bear Stearns)

for financial insurers: you might have a huge well-capitalized parent (though AIG and the monolines turned out to be not quite well capitalized enough)

Roughly speaking, it would be safe to say that the amount of equity in shadow banks turned out to be negligible.

Now suppose you decided: “Well, shadow banking is just a form of banking. Let’s just ignore the liquidity issue for the moment, and ignore the variety of business models of the various kinds of shadow bank, and require the shadow banks to put up a not very demanding 5% capital cushion and regulate to that, somehow.” Assume, for simplicity, that we want to keep all that lovely shadow banking activity going and that shadow banks’ assets are identical in size to their liabilities; that 5% capital cushion would then be 5% of $8-16Trn. That’s between $400Bn and $800Bn of capital to raise.

Or, perhaps more likely, our shadow banks take 50% losses on 15% of their loans that they never never want to do again (the CDO bonanza, etc), and then need 5% equity on the rest. That way our shadow banks would need $925-$1,850 billion in equity. Which is impressive, but fair enough: the traditional banking system has about $1.3Trn of equity, and we know the shadow banking system is the same size, or somewhat bigger, and more prone to runs. Why, pray, should it not at least be capitalized to the same level, either by new capital, or by shrinkage?

So – do you want a big capital raise, or a massive credit contraction (that would in turn impact OTC derivatives activity), or another crash? Not an enticing choice, and perhaps unsurprisingly Geithner’s 6th May marketing statement doesn’t have anything to say about capital and liquidity in shadow banks. So I suppose “another crash” is the preferred option, by default.

Though actually, when you do delve into the bill, you find, with one exception (the Collins amendment, which is a departure from Treasury’s script) that there isn’t much nitpickable detail at all. It just doesn’t have much to say about shadow banking. In May the US Treasury Secretary identified four shadow-banking related reforms. Here they are, with summaries of their form. Since there is no more detail now than there was in the May puff piece, I quote from it again; what detail there is ain’t encouraging.

Comprehensive Constraints on Risk Taking

“Chairman Ben S. Bernanke will have a seat on a newly created Financial Stability Oversight Council. That board will deputize the Fed to set tougher standards for disclosure, capital and liquidity. The rules will apply to banks as well as non-bank financial companies, such as insurers, that pose risks to the financial system.”

Repo Markets

“These reforms [FSOC, above]will give the Federal Reserve the authority to build a more stable funding system, take action to address the unstable aspects of the short-term repo markets, and ensure that these markets are used much more conservatively in the future. ” Well I hope this infrastructure paper isn’t the sneak preview – the paper itself acknowledges, in a strangled kind of way (p 4, para 2), that infrastructure isn’t the key issue.

Higher Standards for Money Market Mutual Funds

“The President’s Working Group on Financial Markets is preparing a report setting forth options to reduce the susceptibility of money funds to runs.”

Ratings Agencies:

Bloomberg have an update , needed because Geithner’s proposals have (did you guess?) been watered down: “The overhaul legislation requires the SEC to conduct a two-year study on whether to create a board to decide who rates asset-backed securities. That curbed a Senate proposal to establish the board with SEC oversight. After the study, the board would be established only if regulators can’t come up with a better alternative.

Congress also softened a proposed liability provision, making it harder for investors to sue ratings agencies than it would have been under language approved by the House in December.”

Or perhaps you would prefer the short version:

Comprehensive Constraints on Risk Taking:

TBC, by a committee called the Financial Stability Oversight Council.

Repo Markets:

TBC, by FSOC.

Higher Standards for Money Market Mutual Funds:

Options for standards are TBC, by a committee called The President’s Working Group on Financial Markets. The actual standards will then be selected – by yet another committee perhaps, or maybe the same one.

(I can’t find anything in the sneak preview that addresses csissoko’s more fundamental gripes here and here )

Ratings Agencies:

TBC. First a two year study by an SEC committee on whether a) to create a committee to approve ratings agencies (perhaps they should pick a resonant name for it first), or b) do something else. After that, do whatever the SEC decides to do, assuming they reach a conclusion; otherwise, create a committee to approve ratings agencies…

It seems to have been drafted by the Monty Python crew when you put it like that, but I don’t think it’s a terribly unfair caricature. Not to downplay the importance of other reforms, but a page or to create the committees to save the world, some Fed initiatives that were already in hand before the legislative process started, and then 1,495 pages of other stuff? It seems out of balance.

Still, there is the Collins amendment. It is pretty sensible: bank holding companies will have to be capitalized to the same level as their subsidiaries. You’d think that will force more capital behind some shadow banking activities at least: repo for instance? With due deference to the creativity of accountants, perhaps it will put pressure on some kinds of OBS vehicle too? Here’s hoping…

Collins does have a smart move on capital quality, specifically TruPS, which no longer count as capital. Though not just yet – if you are a big bank, you have 5 years to replace TruPS with proper capital; if you are a small bank, up to 20 years. TruPS were a feature of the crisis, especially once repackaged into (you guessed it) CDOs . The whole idea that holdings in other banks’ debt should count as bank capital is batshit insane, and not even in hindsight; cross holdings have been known to be major contagion vectors since the investment trust fiasco of 1929 (see JK Galbraith “The Great Crash”; UK readers may also remember the Split Capital Investment Trust disaster of 2002, our very pale British imitation of the Wall Street Crash). And in something between 5 and 20 years, that TruPS coupling will be gone, perhaps after another crash. The pace of reform is not dizzying.

The Treasury Secretary’s angle on the very reasonable Collins amendment makes me unsure whether these avowals about shadow banking reform were totally sincere:

The lesson of this crisis, and of the parallel financial system, is that we cannot make the economy safe by taking functions central to the business of banking, functions necessary to help raise capital for businesses and help businesses hedge risk, and move them outside banks, and outside the reach of strong regulation.

But compare Geithner’s ringing words with Geithner joining hands with the banks versus the Collins amendment. The attempt to unpick the Collins amendment looks suspiciously like the familiar “divide and conquer” approach to banking regulation, but led, it seems, by the US Treasury. The steps would be: try to dilute the US regs now, then, in due course, dilute the Basel III provisions on leverage (presumably Geithner is actually the US official said to be opposing the Basel III tightening of capital rules), then, exploit the international dimension to excuse porous regulations. And then you are back to business as usual.

Still, Collins’ amendment has survived; that is a little victory for Collins, or more accurately, I suspect, Sheila Bair and FDIC – see more here (though you should take the stuff about Eurobank leverage with a grain of salt).

So where does that leave us with our shadow banking reforms? Well, we have a modest tweak to bank capital requirements, of unknown efficacy (Collins) and a bunch of new committees, mostly in the Fed. The mountain has laboured, and brought forth a mouse.

Or you might prefer to pursue the anaconda/rabbit imagery to a physiologically realistic conclusion.

A reader with considerable experience in real estate who has asked to remain anonymous pointed to an article in Housing Wire describing some possible unintended consequences of the Administration’s push for more short sales:

This past week, I received an email from one of my dearest friends that has really stuck with me. It illuminates perhaps one of the single largest shifts in borrower psychology likely to come from a push to short sales:

My neighbors are being foreclosed on….

The house and land (1.3 acres) was valued at $1.8m a few years ago. Now, they are behind on payments and the bank wants to force a short sale for only $700k. She told me that she tried to modify the mortgage twice already, and has been turned down. She is willing and able to make payments on the $700k amount, but the bank is refusing and would rather sell to someone else.

he message paints an interesting picture of a potentially hidden angle to the recent short sale push by the Administration, banks, and Realtors: a renewed call for broad principal forgiveness.

It’s not too hard to see this sort of thinking quickly becoming the norm among many distressed homeowners, as a push for short sales grows ever stronger and many ask themselves why someone else is getting the better deal. More than 11 million borrowers currently owe more on their mortgage than it is worth, according to CoreLogic—and this group of borrowers would love nothing more than to replace their current underwater mortgage with whatever the accepted “short sale price” is deemed to be.

I don’t know that such a response on the part of borrowers could be deemed irrational, either. Many will ask themselves why they have a mortgage at a higher amount, especially if the bank is willing to sell the house to another buyer for less money. Why does someone else get the lower purchase price? Isn’t easier for the bank to just give me that loan instead? I already live here.

The NC correspondent carries it one step further, and points to second lien holders as the likely impediment:

The real solution to the mortgage market problem is principal write downs of underwater mortgage loans. It’s behind discussions of cramdown legislation. It is what TARP money should have been used for because it would have had the dual impact of helping both borrowers and banks.

Second liens – and the JPM, Citi, Wells illusionary accounting – are a big obstacle to cramdowns, which is really total BS. These were high risk loans when made and should be treated as such now. Of course, the truth is, no one has any idea how to model how many 2nd lien borrowers will default over time. There is no reliable historical data and the current accounting conventions completely obscure the real value of second lien risk.

The Housing Wire piece makes an outstanding point about the ridiculousness of short sales and the absence of cramdown legislation. I wouldn’t be surprised if this is an area of future litigation. The only way the banks, their regulators and congressional lapdogs can deal with the issue is by ignoring it.

I doubt that the administration had this outcome in mind when they advocated more aggressive short sales (but it is a remote possibility). If they were unaware of the implications of a push to short sales for individual homeowners, you have to marvel at their blindness or cluelessness.

Finally, how does the Fannie push against “strategic defaulters” fit in? Perhaps, if they can justify that they have segregated “bad” defaulters from “good” ones, they can rationalize principal write downs rather than forcing the sale to other parties?

The political types are terrified of pissing off the “good” borrowers who have been paying their mortgages all along. As a result, the Administration may be trying to gradually get to the cramdown treatment, while avoiding looking like they exhausted all other possibilities first. Interestingly, they didn’t seem so concerned about a slow, measured approach when it came to bailing out the banks.

In the scheme of things, the overall economy would be much better off if the bulk of underwater mortgages were crammed down to levels borrowers can afford, so that more borrowers were kept in their homes, less housing turnover was needed, fewer foreclosure related expenses were incurred (and wasted on lawyers), and the shadow inventory was drastically reduced. For fairness, the crammed down portion of the mortgage can be subordinated so that any subsequent appreciation in value can be captured, in whole or in part, by the lender. The existing second liens would be toast, currently, but would have a further subordinated right if housing really appreciated a lot in the future.

I can’t see any public policy reason why our entire economy should hinge on rewarding second lien lenders, who knew they were undertaking speculative loans in the first place, at the expense of home owners, housing, etc.

Yves here. Sadly, I think we know the real reason for the continued pursuit of this “spare the second lienholders any pain” program. And it has nothing to do with sound public policy. It has everything to do with the fact that the biggest second lien holders, Citi, Bank of America, JP Morgan, and Wells, have simply massive holdings among them and are too big to fail. Admitting the magnitude of the second lien losses would also be hugely embarrassing to Treasury, since it would reveal what a farce its stress tests were, and that the big bank remain woefully undercapitalized.

While the headline focuses on her outlook for housing, Whitney is bearish across the board, seeing little reason to cheer on the employment and bank earnings fronts. She sees a 10% fall in housing prices in the next six months (!), which will hit bank earnings (Whitney has argued since at least early 2009 that banks have been goosing earning by underreserving for losses) and the economy generally (a further decline in home equity plus lack of mobility of consumers wanting to sell their houses but facing a declining market has implications for consumer spending generally). She point out that consumer credit is tightening, which puts a crimp on small businesses (both via lower revenues and via restricted access to funds), the biggest engine of hiring, and on top of that, municipalities and states are cutting spending and shedding jobs.

From Fortune (hat tip Glenn Stehle):

Click here to view the segment.

A similar grim take from Barry Ritholtz via John Mauldin:

Today, residential real estate confronts numerous headwinds: Credit, once given to anyone who could fog a mirror, is now tight. Today, demand is far below what it was during most of the past decade. Home prices are still unwinding from artificially high levels, and remain over-priced. Inventory is elevated. A huge supply of shadow inventory is out there: Speculators and flippers who overpaid but have held onto their properties await modestly higher prices to sell. Bank owned real estate (REOs) continues to increase. That’s before we get to the fact that unemployment remains high, and is unlikely to improve anytime soon. Oh, and wages have been flat for a decade.

This are not encouraging factors about housing.

This is known, or at least should be by those who have looked at the data. I cannot explain why some economists still have not figured this out.

In my analysis, price stands out as being the prime mover of the next leg down. High unemployment, and a decade of flat wages aren’t helping to create any new housing demand. And the millions in homes they cannot afford will eventually add more pressure to inventory and prices. Indeed, we are still working

But the bottom line is Home prices remain too high: There can be no doubt that home prices have moved way down from the 2005-06 peaks. How did I reach the conclusion that, even after a 33% decrease in prices, home prices are high?

By using traditional metrics: Whether we are looking at US housing stock as a percentage of GDP or Median income versus home prices or even ownership versus renting costs, prices remain elevated. Indeed, we see prices remain above historic means.

Consider price relative to income. From 1977 to 2010, the median US home price was 4.1 times median household income….Home prices are still above that mean. Oh, and that mean is artificially elevated due to the 2002-07 boom. It’s the same with home prices relative to rentals, or housing value as percentage of GDP….

Further, we should not assume that prices merely mean revert back to historic levels. What usually happens when markets get wildly overvalued – and a ~3 standard deviation price move sure qualifies — is they get resolved not by reverting to the mean, but by careening far beyond it.

In other words, brace yourself for further downside. Extend and pretend is finally about to run into ugly reality.