[Book authors Mian and Sufi] argue that, rather than failing banks, the key culprits in the financial crisis were overly indebted households. Resurrecting arguments that go back at least to Irving Fisher and that were emphasised by Richard Koo in considering Japan’s stagnation, Mian and Sufi highlight how harsh leverage and debt can be ”“ for example, when the price of a house purchased with a 10 per cent downpayment goes down by 10 per cent, all of the owner’s equity is lost. They demonstrate powerfully that spending fell much more in parts of the country where house prices fell fastest and where the most mortgage debt was attached to homes. So their story of the crisis blames excessive mortgage lending, which first inflated bubbles in the housing market and then left households with unmanageable debt burdens. These burdens in turn led to spending reductions and created an adverse economic and financial spiral that ultimately led financial institutions to the brink.

This interpretation resolves the anomalies that Mian and Sufi highlight. Households do not spend while they are still overly indebted, which precipitates slow growth even after banking is restored to health. Spending slowdowns are caused by household over-indebtedness, so of course they precede problems in the banking system. And, when consumers do not spend, businesses have less need to borrow to finance investment, inventories or receivables.

Their analysis, presented with far more depth and subtlety than I have been able to reflect here, is a major contribution that furthers our understanding of the crisis. It certainly affects what I will examine in trying to predict and forestall future crises. And it should influence policies aimed at crisis prevention by demonstrating the insufficiency of keeping financial institutions healthy and by making a case for macroprudential measures directed at preventing runaway growth in household debt.

Read it all (my emphasis).

All eyes were fixed Wednesday on Spain, as the country’s borrowing costs showed no signs of slowing their climb amid nervousness about the health of the banking sector and the possibility of the crisis spreading to other euro countries.

Europe’s economic stagnation and continuing financial turmoil in the euro zone have weighed on confidence, the European Commission said Wednesday. The commission’s indicator of business sentiment in the 17-nation euro zone fell in May to 90.6 from April’s revised 92.9. The decline, it said, “was driven by falling confidence in all business sectors, especially in industry and retail trade.”

Jonathan Loynes, an economist in London with Capital Economics, noted that the sentiment data showed “acute weakness across the peripheral economies,” but that the Dutch, French and Germans were also less optimistic. He described it as “overall, an unambiguously weak picture which only looks likely to get worse as the debt crisis continues,” and predicted that euro zone gross domestic product would decline by 1 percent this year, with 2013 “likely to be much worse.”

Read it all. Also, if you want a single picture to keep an eye on, it is the Spanish German 10 year spread which you may see there (yes, that is correct, it is at all all time high).

Here’s a breakdown of the numbers. The report, citing White House budget office figures, estimated $46 billion of costs under the Troubled Asset Relief Program to support struggling homeowners. It showed $2 billion of overall gains on the Treasury’s investments in various bailed-out companies, such as American International Group Inc. (AIG), some of which are held outside of TARP. Other Treasury programs to buy mortgage-backed securities and to guarantee money-market funds would produce $26 billion of gains, the report said.

Add up those categories, and the projected net cost so far is $18 billion. On top of that, there’s the current net cost of the government-sponsored housing financiers Fannie Mae and Freddie Mac, which the Treasury pegged at $151 billion. So how did Treasury project a potential gain overall?

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The crisis of the euro zone has finally hit the potholed road of real politics, with the Greeks now openly questioning whether their commitment to Europe and its single currency still matters more to them than control over their own future and economic well-being.

During the two-year financial crisis, the wealthier countries of northern Europe, led by Germany, have insisted that their heavily indebted brethren in the south radically cut spending in return for emergency loans. They have stuck to that prescription even though austerity has undermined growth and increased unemployment in Greece, Spain, Portugal and now Italy, betting that people in those countries will swallow the harsh medicine because their only alternative is to default and possibly leave the euro zone altogether.

The turmoil in the government of Prime Minister George A. Papandreou means that Greece is about to call that bet. Many Greek politicians appear to be calculating, at this late stage, that they have more to lose by sticking to Germany’s terms than by risking a messy default, and even going it alone with their old currency, the drachma, outside the euro zone.

Read it all.

After a weekend of tense meetings among world finance officials here, euro-zone leaders were weighing options to maximize the size of their bailout fund by borrowing against it. The move could provide trillions of dollars of firepower to rescue governments and banks””-but only if all 17 euro-zone legislatures approve a two-month-old agreement to broaden the bailout fund.

Highly public opposition from Germany, the largest and most powerful euro-zone economy, could block the plan.

Policy makers are “focused on their own internal restraints, so that we don’t have the outcome that we need,” Antonio Borges, head of the International Monetary Fund’s Europe department, said Sunday. While key players were understandably acting in self-interest, he said, it was generating “disastrous” collective results.

Read it all.

The reserve powers would be well advised to pull out all the stops to save Europe and its banking system. Together they hold $10 trillion in foreign bonds. If they agreed to rotate just 4pc of these holdings ($400bn) into Spanish, Italian, and Belgian debt over the next two years, they could offer a soothing balm. None has yet risen to the challenge. It is `sauve qui peut’, with no evidence of G20 leadership in sight.

Once again, the US has had to take charge. The multi-trillion package now taking shape for Euroland was largely concocted in Washington, in cahoots with the European Commission, and is being imposed on Germany by the full force of American diplomacy.

It is an ugly and twisted set of proposals, devised to accomodate Berlin’s refusal to accept fiscal union, Eurobonds, and an EU treasury. But at least it is big.

Read it all.

It is apparent not only that US banks have lost confidence in their European counterparts and have started shutting them out of inter-bank funding markets, but also that US officials are busy making matters worse by seeking to shift blame for America’s dire domestic performance on to influences from this side of the Atlantic. “Seventy-five per cent of the dark things happening in the world economy are because of the eurozone,” one of Geithner’s team said at Marseille….

Markets are convinced of several things: that Greece is politically incapable of meeting the austerity demands imposed by the EU and the IMF, and is now locked into a spiral in which its debt position can only become worse as its economy deteriorates; that a default on Greek sovereign debt is therefore inevitable sooner rather than later, and will impose losses on European banks, including the likes of Société Générale and Crédit Agricole of France, which may in turn need to be bailed out by their governments; and that the eviction of a bankrupt and incorrigibly irresponsible eurozone member is not only a technical possibility but an economic necessity if the single currency is to survive at all.

Read it all.

Should America embark on such fiscal contraction at a time when economic growth has already slipped to stall speed, and debt deleveraging continues with a vengeance, I would like to flee to Mars for safety.

Yes, there is such a concept as an “expansionary fiscal contraction”, as in Ireland (1980s), Denmark (1990s), arguably Canada (1990s), and the UK after both 1932 and 1993, but in every successful case this was accompanied by monetary loosening. That card has already been played this time.

Should America instead opt to evade these fiscal cuts by actually defaulting on debts accumulated by self-indulgent baby boomers, I would also like to flee Mars because such an outcome might be even worse.

Read it all.

In February, President Obama submitted his budget. The CBO reported that it would steeply boost the national debt.

In April, the president released a revised deficit-reduction plan so short on detail that the CBO deemed it too vague to evaluate.

Also in April, the Senate unanimously rejected the president’s February budget. Since then, the Democratic leadership in the Senate and the White House have put forward no clear budget approach….

Read it all.

From 2001-07, he argues, the dollar underwent a long, steady decline against the euro, tacitly encouraged by U.S. monetary authorities. In response to the dollar’s decline, investors diverted capital into inflation hedges, notably real estate, leading to the subprime bubble. By mid-2007, the real-estate bubble had burst. In response, the Fed reduced short-term interest rates rapidly, which lowered the dollar further. The subprime crisis was severe, but with looser money, the economy appeared to stabilize in the second quarter of 2008.

Then, in summer 2008, the Fed committed what Mr. Mundell calls one of the worst mistakes in its history: In the middle of the subprime crunch””exacerbated by mark-to-market accounting rules that forced financial companies to cover short-term losses””the central bank paused in lowering the federal funds rate. In response, the dollar soared 30% against the euro in a matter of weeks. Dollar scarcity broke the economy’s back, causing a serious economic contraction and crippling financial crisis.

In March 2009, the Fed woke up and enacted QE1, lowering the dollar against the euro, and signs of recovery soon appeared. But in November 2009, QE1 ended and the dollar soared against the euro once again, pushing the U.S. economy back toward recession.

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A group of the largest US banks and fund managers stepped up the pressure on Congress and the Obama administration to reach a deal to increase the country’s debt limit, saying that even a short default could be devastating for the financial markets and economy.

The warning over the debt limit is the strongest yet to come from Wall Street, highlighting growing nervousness among investors about the US political system’s ability to forge a consensus on fiscal policy.

The most pressing budgetary issue confronting Congress and the Obama administration is the need to raise the US debt ceiling, which stands at $14,300 billion.

Read it all.

I wonder if Mr. Obama is at all embarrassed by the 2012 budget. Like his previous two budgets, this one breaks all those “Morning in America” campaign promises of a “new” Washington.

The 2012 budget also is a repudiation of the findings of his very own bipartisan deficit commission.

The Bowles-Simpson commission had plenty of sensible recommendations, like cutting funds for the Corporation of Public Broadcasting, eliminating the Office of Safe and Drug-Free Schools and raising the qualifying age for Social Security.

But you’ll find precious little of this in the 2012 budget. At the White House, political sense apparently matters a lot more than common sense.

Read it all.

US Treasury Secretary Timothy Geithner has told Davos delegates rapid, drastic spending cuts are “not the responsible way” to cut national budget deficits.

He also said the US was more confident now there was a sustainable expansion, but said it was not a boom.

Mr Geithner said “education, innovation, and investment” were the way forward for the US economy.

Read it all.

The longer people stay out of work, the more trouble they have finding new work.

That is a fact of life that much of Europe, with its underclass of permanently idle workers, knows all too well. But it is a lesson that the United States seems to be just learning.

This country has some of the highest levels of long-term unemployment ”” out of work longer than six months ”” it has ever recorded. Meanwhile, job growth has been, and looks to remain, disappointingly slow, indicating that those out of work for a while are likely to remain so for the foreseeable future. Even if the government report on Friday shows the expected improvement in hiring by business, it will not be enough to make a real dent in those totals.

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Anyone wondering what President Obama will face when he arrives in South Korea on Wednesday for a global financial summit meeting need look no further than an announcement by China’s leading state-endorsed rating agency, which downgraded the United States’ credit rating on Tuesday ”” and provocatively questioned American leadership of the global economy.

The agency cited the Federal Reserve’s decision to pump more money into the United States economy and warned of Washington’s “deteriorating debt repayment capability” and “the serious defects in the United States economic development and management model,” which it predicted would lead to “fundamentally lowering the national solvency.”

In the rest of the world, the United States is still the gold standard of credit risks, and the Chinese downgrade is not expected to have much real impact. But the sharply worded attack from the country that is buying billions of dollars in American debt each month was just the latest rhetorical assault on the United States, as officials from China to Germany to Brazil suggest that Washington’s addiction to debt has greatly diminished its credibility.

Read it all.

China kept up a drumbeat of criticism of U.S. easy money policies on Tuesday, warning two days before a G20 world economic summit that Washington could destabilize the global economy and inflate asset bubbles.

Nearly a week after the Federal Reserve announced it was going pump as much as $600 billion into the economy, world leaders continue to bash the plan, saying it will flood global markets with cash without doing much for the U.S. recovery.

President Barack Obama acknowledged in Jakarta that the Group of 20 rich and developing nations “still have a lot of work to do” to ensure balanced global growth.

Read it all.

U.S. Treasury Secretary Timothy F. Geithner refrained from pushing for current-account targets while China softened its stance on the Federal Reserve’s quantitative easing days before a summit of the Group of 20.

The Fed’s move to buy $600 billion of Treasuries could contribute “tremendously” to global growth, Vice Finance Minister Wang Jun said after Asia-Pacific Economic Cooperation forum finance chiefs met in Kyoto, Japan, Nov. 6. At the same gathering, Geithner said current-account deficits or surpluses aren’t “something that is amenable to limits or targets.”

Policy makers from Asia to South America have warned that the Fed’s decision to pump liquidity into the U.S. will depress the dollar and spark flows of capital to emerging markets that threaten asset-price bubbles. China’s Vice Foreign Minister Cui Tiankai said Nov. 5 the U.S. step may hurt global confidence, while rejecting state-planning style targets for trade deficits.

Read it all.

The uncertainty over the legal status of foreclosed homes in the nation could further depress home prices and delay the recovery of the housing market, the Obama administration said on Wednesday.

The warning came at the first Congressional hearing since the magnitude of the problem gained wide attention. Distressed properties make up one quarter of all home sales.

Revelations about paperwork shortcuts and so-called robo-signed affidavits, as well as the likelihood of protracted legal battles by homeowners and inquiries by state and federal officials, will hinder foreclosure proceedings and discourage prospective buyers, a Treasury Department official said.

“Together, these two factors may exert downward pressure on overall housing prices both in the short and long run,” said the official, Phyllis R. Caldwell, chief of the homeownership preservation office at the Treasury.

Read it all.

Pundits are restless, an election looms ”“ so this week, President Barack Obama is proposing yet another round of special favors, aimed at improving the economy. Prominent columnist Paul Krugman wants the plans to be “bold” and to involve huge amounts of money. Here’s a contrasting view: government should stop declaring recovery plans, bold or otherwise.

Maybe the constant announcing of new plans ”“ especially plans backed by borrowing or tax cuts ”“ is, itself, an impediment to economic growth.

Read it all.

The Obama administration and the Federal Reserve want to fix the United States economy by spending more money. But while that approach might work for Europe, it is risky for the US. The nation would be better off embracing traditional American values like self-reliance and small government.

There’s no question about it: The 20th century was America’s era. The United States rose rapidly from virtually nothing to become the most politically powerful and economically strongest country in the world. But the financial crisis and subsequent recession have now raised doubts about its future. Are we currently witnessing the beginning of the end of the American era?

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It increasingly seems as if the policy makers attending like physicians to the American economy are peering into their medical kits and coming up empty, their arsenal of pharmaceuticals largely exhausted and the few that remain deemed too experimental or laden with risky side effects. The patient ”” who started in critical care ”” was showing signs of improvement in the convalescent ward earlier this year, but has since deteriorated. The doctors cannot agree on a diagnosis, let alone administer an antidote with confidence.

This is where the Great Recession has taken the world’s largest economy, to a Great Ambiguity over what lies ahead, and what can be done now. Economists debate the benefits of previous policy prescriptions, but in the political realm a rare consensus has emerged: The future is now so colored in red ink that running up the debt seems politically risky in the months before the Congressional elections, even in the name of creating jobs and generating economic growth. The result is that Democrats and Republicans have foresworn virtually any course that involves spending serious money.

The growing impression of a weakening economy combined with a dearth of policy options has reinvigorated concerns that the United States risks sinking into the sort of economic stagnation that captured Japan during its so-called Lost Decade in the 1990s.

Read it all.

“The economy is going to limp along for the next few months,” said Gus Faucher, an economist at Moody’s Analytics. There’s even a one in three chance it could slip back into recession, he said.

Many temporary factors that boosted the economy earlier this year are fading. Companies built up their inventories after cutting them sharply in the recession to match slower sales. The increase provided a boost to manufacturers, but now many companies’ stockpiles are in line with sales and don’t need to grow as much. In addition, the impact of the government’s $862 billion fiscal stimulus program is lessening. That leaves the private sector to pick up the slack. But businesses are cutting back on their spending on machines, computers and software, according to a government report earlier this week. And the housing sector is slumping again after a popular home buyer’s tax credit expired in April.

Read it all.

We don’t have alternative universe laboratories to run control bailout experiments, but we can imagine the alternative outcomes if different actions were taken.

So let’s do just that. Imagine a nation in the midst of an economic crisis, circa September-December 2008. Only this time, there are key differences: 1) A President who understood Capitalism requires insolvent firms to suffer failure (as opposed to a lame duck running out the clock); 2) A Treasury Secretary who was not a former Goldman Sachs CEO, with a misguided sympathy for Wall Street firms at risk of failure (as opposed to overseeing the greatest wealth transfer in human history); 3) A Federal Reserve Chairman who understood the limits of the Federal Reserve (versus a massive expansion of its power and balance sheet).

In my counter factual, the bailouts did not occur. Instead of the Japanese model, the US government went the Swedish route of banking crises: They stepped in with temporary nationalizations, prepackaged bankruptcies, and financial reorganizations; banks write down all of their bad debt, they sell off the paper. Int he end, the goal is to spin out clean, well financed, toxic-asset-free banks into the public markets.

Read it all.

From the FT’s Alphaville blog:

So the US Treasury’s centrepiece mortgage modification programme ”” Hamp ”” is something of a failure. That much we knew already.

But Laurie Goodman over at Amherst Securities brings up another point.

The programme actually has a lower success rate than other modification programmes ”” even those that involve a similar amount of payment reduction.

Read it all.

Read it all. Yves Smith (of the Naked Capitalism blog) speaks for me when she quips: “The worst is he might actually believe his PR”–KSH.

…there is skepticism over the president’s commitment to reducing the huge and dangerous budget deficits which America now faces. A strong step toward deficit reduction next year ”” like undertaking the difficult task of trying to fix Social Security ”” would earn deeper credibility with business and with all Americans.

Another problem is that the administration’s rhetoric ”” which too often employs inflammatory words like “reckless” ”” has the effect of tarring all of business with the same brush. The White House might better distinguish between Wall Street, Big Oil and health insurers, which have all incurred public wrath, and the majority of businesses, which haven’t.

The tension between President Obama and the business community is hurting both sides and may hamper economic recovery. Closing that divide requires the business community to mute its criticism, and the administration to make personnel and policy adjustments. Neither should be hard.

Read it all.

A new Time poll reveals just how hard the task is: Two-thirds of respondents say they oppose a second government stimulus package. And 53% say the country would have been better off without the first one.

The result is a White House pulled in three directions at once as it tries to repair the economy ”” and ensure that Obama and the Democrats can survive a rising tide of public anger. First, the Obama team is improvising ways to pass piecemeal spending items through a Congress where stimulus has become a toxic word. At the same time, the White House is signaling its concern about that budget deficit that has Tea Partyers raging ”” both through token gestures, like a White House contest that lets the public vote on cost-cutting ideas submitted by federal employees (the winner gets to meet Obama and see his or her idea go in the President’s next budget), and through Obama’s support for the work of a bipartisan deficit commission. And finally, the White House is trying to explain to angry liberals that it’s doing everything possible to keep the economy moving and fight Republican resistance to new spending.

It’s a delicate balancing act, on a par with Obama’s effort to pass health care reform without appearing to get too involved in the details. And just as it did in the health care battle, the future of Obama’s presidency ”” as well as the fate of the American economy ”” may hang on the outcome.

Read it all.

Federal Reserve Chairman Ben S. Bernanke and then-New York Fed President Timothy Geithner told senators on April 3, 2008, that the tens of billions of dollars in “assets” the government agreed to purchase in the rescue of Bear Stearns Cos. were “investment-grade.” They didn’t share everything the Fed knew about the money.

The so-called assets included collateralized debt obligations and mortgage-backed bonds with names like HG-Coll Ltd. 2007-1A that were so distressed, more than $40 million already had been reduced to less than investment-grade by the time the central bankers testified. The government also became the owner of $16 billion of credit-default swaps, and taxpayers wound up guaranteeing high-yield, high-risk junk bonds.

By using its balance sheet to protect an investment bank against failure, the Fed took on the most credit risk in its 96- year history and increased the chance that Americans would be on the hook for billions of dollars as the central bank began insuring Wall Street firms against collapse. The Fed’s secrecy spurred legislation that will require government audits of the Fed bailouts and force the central bank to reveal recipients of emergency credit.

“Either the Fed did not understand the distressed state of some of the assets that it was purchasing from banks and is only now discovering their true value, or it understood that it was buying weak assets and attempted to obscure that fact,” Senator Sherrod Brown, an Ohio Democrat and member of the Senate Banking Committee, said in an e-mail when informed about the credit quality of holdings in the Maiden Lane LLC portfolio. The committee held the April 3 hearing.

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To believe Christopher Dodd, the Connecticut Democrat who is chairman of the Senate Banking Committee, the end of government bailouts is near. In truth, the financial-overhaul legislation now before Congress would do little to arrest the bailouts already in progress.

When the U.S. government rescued American International Group Inc. in 2008, it reasoned that a disorderly failure of the financial-services giant would lead to an economic catastrophe. What the Treasury and Federal Reserve said they needed was a way to wind down systemically important institutions without sending them into bankruptcy courts, to keep the companies from triggering defaults on their obligations that would cascade throughout the broader financial system.

Congressional leaders say their final bill will deliver the resolution authority regulators have been seeking. “It will end bailouts, ensuring that failing firms can be shut down without relying on taxpayer bailouts or threatening the stability of our economy,” Dodd said June 10 at the House-Senate conference committee where the differences between the two chambers’ bills are being negotiated.

It wouldn’t end AIG’s rescue, though. The reason AIG hasn’t failed is that the Fed and the Treasury continue to stand behind it. There’s no sign this will change anytime soon. Nor would the legislation force the government to do otherwise.

Read the whole thing.

The United States suggested Europe’s debt crisis would have minimal impact on global growth, but China took a more pessimistic view, warning it would impact demand for its exports and other regions would suffer too….

“The euro zone problems haven’t been cleaned up yet,” said Nagayuki Yamagishi, a strategist at Mitsubishi UFJ Morgan Stanley Securities in Tokyo. “And even though the global economy is definitely showing more signs of recovery than it did 6 months ago, worry continues that the euro zone’s woes will put a brake on this growth.”

Read it all.