Thursday, November 10, 2011

Economic Events of the Week

Thursday – Jobless Claims
Friday – Veteran’s Day - stock market open, bond market and banks closed

e21 Reaction & Commentary
e21 Commentary: Backing Away from Confronting Social Security’s Realities (Charles Blahous)

Washington Update
Debt Panel Misses First Deadline (National Journal)
Supreme Court Health Care Reform Path Could be Set Thursday (Politico)

Market Talk
This is the Way the Euro Ends (Paul Krugman’s Blog)
Ugly Day for Stocks (Goldman Sachs)
Italy Sparks Market Bloodbath: Financial Stocks Collapse (Zero Hedge)
Finito (Free Exchange)
Italy: Illiquid-But-Solvent (The Street Light)

Editorials & Opinions
The Republican Retreat on Housing Reform: Part II (Christopher Papagianis in National Review)
The Answer is: Spend Less. Period. (Grover Norquist in Politico)

e21 Reaction & Commentary

e21 Commentary: Backing Away from Confronting Social Security’s Realities (Charles Blahous)

On Sunday, October 29, the Washington Post published a front-page article by Lori Montgomery about Social Security. The piece explained that the current excess of Social Security expenditures over incoming tax revenues was straining the federal budget and that the recent recession had caused this situation to arise earlier than previously anticipated. The article itself was unexceptional but the reaction to it was not. A number of commentators on the left, including Paul Krugman, Jared Bernstein and Dean Baker, criticized the Post’s portrayal of Social Security finances. The following Sunday, the Post’s Ombudsman posted a follow-up piece that defended the article in some respects. Unfortunately, while attempting to accommodate the viewpoints expressed by critics, the Ombudsman committed some factual errors that undercut the original article’s informational value.

Washington Update

Debt Panel Misses First Deadline (National Journal)

With a third of November gone, the super committee has missed a soft deadline to deliver a deficit-cutting package to the Congressional Budget Office, and that means time is nearly up for lawmakers to propose anything the numbers-crunchers haven’t seen before. All through the fall, super-committee staff and the CBO have said the package needed to be in CBO’s hands for scoring by the end of October or the beginning of November. While committee members have traded pieces of proposals with CBO staff, the special committee of 12 has not submitted a comprehensive proposal. And it’s not looking good. By law, the final package must be a scored piece of legislation by Nov. 21, giving committee members 48 hours to review it before they vote. That leaves 11 days for the group to reach an agreement, put it into legislative language, and get it scored. But there is no sign that the committee is close.

Supreme Court Health Care Reform Path Could be Set Thursday (Politico)

The nine Supreme Court justices could decide as soon as Thursday whether — and how — to wade into the politically charged legal waters of health reform. The Obama administration has asked the court to jump in, so it appears more than likely the justices will agree to decide whether the health law’s requirement that nearly all Americans obtain insurance is constitutional. The justices will have to decide which of four pending cases challenging the individual mandate the court should hear and whether to take up other aspects of the law as well. The justices are scheduled to meet for a private conference Thursday, and they could make a decision on how to go forward. The court typically would release its decision on Monday, but it could come as soon as Thursday afternoon. The justices could also delay a decision to a later conference. Assuming they agree to hear the case, oral arguments likely would take place in the spring, and a ruling would come in June — just in time for the presidential nominating conventions.

Market Talk

This is the Way the Euro Ends (Paul Krugman’s Blog)

With Italian 10-years now well above 7 percent, we’re now in territory where all the vicious circles get into gear — and European leaders seem like deer caught in the headlights. Every even halfway plausible route to euro salvation now depends on a radical change in policy by the European Central Bank. I believe that the ECB rate hike earlier this year will go down in history as a classic example of policy idiocy. We would probably still be in this mess even if the ECB hadn’t raised rates, but the sheer stupidity of obsessing over inflation when the euro was obviously at risk boggles the mind. I still find it hard to believe that the euro will fail; but it seems equally hard to believe that Europe will do what’s needed to avoid that failure. Irresistible force, meet immovable object — and watch the explosion.

Ugly Day for Stocks (Goldman Sachs)

Ugly day for stocks. As it was an ugly day everywhere. Europe getting worse at an accelerating rate, and it’s not clear if there are any quick fixes available this time. Technicals might start getting worse too. SPX drops 47 to close 1229 (-3.67%). The DOW drops 389 to close 11781 (-3.20%). The NASDAQ drops 106 to close 2622 (-3.88%). The VIX adds 8.68 to close 36.16. EURUSD sheds 2% today – that’s as serious as downdrafts in the pair get. Post 2008, there have only been two days that have seen bigger losses.  In credit, the market opened significantly wider in spread and continued throughout the day.

Italy Sparks Market Bloodbath: Financial Stocks Collapse (Zero Hedge)

So much for the US decoupling. Following 5 days of persistent refusals to deal with reality, the real world finally came back with a bang, and while the overall market tumbled the most in two months, it is really financial stocks that took the brunt of today's beating. As the chart below shows, the XLF has literally collapsed with most major banks on the ropes, and the broker dealer index down 6.45% the most since August 10. The reason? Italy of course, and the fear that once the country is forced to write down its debt, the bank failures will proceed in waves: first Italian banks, then French, and then everyone else, especially those that have already been in the market's crosshairs for their exposure. And if today was ugly, tomorrow promises to be an absolute bloodbath with Italy deciding to proceed with the issuance of €5 billion in 1 year bills into what may well be a bidless market.

Finito (Free Exchange)

Silvio Berlusconi’s promise to resign has done nothing to calm European bond markets. Italian bond yields are soaring today; both the two-year and the ten-year are above 7%. There are rumours that the ECB is in the market and buying heavily. If so, it's not having the desired effect. The ECB can't hope to keep yields reasonable through brute force. It will need to make an expectations-changing announcement. Will it? Italy's yields aren't the only ones rising. Markets are ditching Irish, Spanish, Belgian, and French debt too. I can't believe that Europe would allow so damaging an outcome as a financial collapse and break-up to occur. And I still don't understand why, if this is all as obvious as it seems to me, equities aren't down 20% now, rather than 2% or 3%. But the window within which something could be done to prevent it is closing, and fast. I hope to be proven astoundingly wrong in my assessment, but I'm struggling to see alternative outcomes.

Italy: Illiquid-But-Solvent (The Street Light)

The rate on Italy's ten-year bonds are currently at about 7.25%, creating a fairly sharp inversion over the 2-to-10 year portion of the yield curve. In other words, while investors are demanding a risk premium on all maturities of Italian bonds, they are now demanding a higher risk premium on shorter maturity bonds than on longer maturity bonds. This implies that market participants believe that Italy's potential difficulties in repaying its bonds are concentrated in the next couple of years, and that if Italy can get through that stretch then the risk of default diminishes. This is not to say that there couldn't also be some concerns about Italy's long-term solvency; but those concerns are clearly being overshadowed by worries that Italy may not make it through its current liquidity crisis. Which means that no matter what steps are taken to change Italy's long-term budget picture, if Italy isn't provided with the liquidity it needs to get through the next couple of years, then long-run solutions are really rather irrelevant.

Editorials & Opinions

The Republican Retreat on Housing Reform: Part II (Christopher Papagianis in National Review)

Last week, I highlighted an ongoing debate in the House that could mark a Republican retreat from the party’s pledge to pare back government control of the housing market. There is a new wrinkle that has the potential to change the outcome of this debate. Any day now, the Federal Housing Administration is expected to release its (latest) quarterly report to Congress on the status and health of its mortgage-insurance fund. In its last quarterly report FHA shows that it has $2.8 billion in its capital-reserve account. This is the capital that is supposed to protect taxpayers against the default risk on the total amount of FHA insurance that’s still in-force, which now stands at ~$1 trillion. What are the implications of all of this? Well, that it’s possible that FHA will require a congressional bailout. And the new numbers could signal that this dreaded “bailout” day may be closer than most people think.

The Answer is: Spend Less. Period. (Grover Norquist in Politico)

The federal government is spending too much money. Our nation has made more than $63 trillion in unfunded promises, to be paid for by future generations. It poses an existential threat to America’s dynamic, pro-growth economy. The solution to this problem is to reduce federal spending. This is a fairly straight-forward point – but one that is lost in our nation’s capital, where tough choices are avoided on a daily basis. A mechanism for dealing with our nation’s fiscal problems was set-up this summer: the supercommittee. Some are now suggesting that instead of addressing the real problems our nation faces — by reducing government spending — the supercommittee should recommend tax increases to meet its deficit reduction targets. Tax increases are what politicians always do when they are not willing to govern—that is, to cut and reform government spending. The problem, of course, is that tax hikes crowd out and displace spending reform.

e21: Economic Policies for the 21st Century is a nonprofit, nonpartisan organization dedicated to economic research and innovative public policies for the 21st century. Drawing on the expertise of practitioners, policymakers, and academics, we aim to advance free enterprise, fiscal discipline, economic growth, and the rule of law.

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