Iceland Growing It's Real Estate Bubble Just 3 Years After Their Complete Economic and Financial Collapse

Who could have guessed that people's more so short sighted and their memory so close to a goldfish's?

(Bloomberg) May 30, 2012 — Iceland’s crisis-management policies are creating the island’s next property bubble less than four years after its banking meltdown threw the economy into its worst recession. 

Prices for new homes touched a record last quarter, having surged 40.1 percent since the final three months of 2010, according to estimates by the National Registry of Iceland in Reykjavik. Average house prices have risen 11.3 percent since the market bottomed at the end of 2009, according to central bank data at the end of the first quarter. 

[...] “Last year, investors finally realized that the capital controls aren’t going anywhere any time soon,” Jonsson said. “That has led to a change in investors perspective, and they’re now moving in greater numbers into longer assets and snapping up properties.”

Another unintended consequence of stupid government actions.

An average apartment cost about 28 million kronur in May, the National Registry of Iceland estimates. That compares with 12.4 million kronur in 2001. The average Icelandic household earned about 4.4 million kronur in 2011, according to Statistics Iceland.
“The exorbitant prices in the housing market, so early after the collapse of the Icelandic economy, are quite shocking,” said Finnur Eiriksson, a computer scientist living in Reykjavik. “I’ve decided to stay in the rental market for some time to come. For anyone that has been shopping around, the drop in property prices after 2008 hasn’t been significant enough.”

Well, looks like Finnur is sport on!

EON and RWE Pay Consummers To Take Their Production Off The Grid

Here's a very good Bloomberg report about the state of the renewable energy in Europe. This is a very good report from several reasons that I will try to list here:

1. It shows how much effort there is behind something everyone takes for granted: the electricity that turns your lights on and makes your appliances work.
2. It also shows that the price of some commodities, such as electricity can go below zero. It is also true for natural gas. Having worked in commodities trading in a firm that also traded electricity, I can tell you that these occurrences were quite rare.
3. It's good to push for green energy, but the way governments do it, is as with every other government action, destroying value instead of creating it.
4. Yet another example of completely stupid regulation: The law in Germany is that renewables have priority, so utilities have the choice of turning plants down for a few hours or paying a negative price to someone in Germany or abroad
5. And, from one side they force you to take a loss (see 4.) and from the other hand, they take public money and hand it too you to keep your plants running: the International Energy Agency said in August. U.K. energy regulator Ofgem is considering paying generators to keep plants open as back-up suppliers, compensating them for down time.
6. The (un?)intended consequence is that coal, gas, and nuclear power plants will slowly be shut down and or disappear, making electricity production far less reliable, and most probably making the prices not only unstable, but also move higher.

Sept. 30 (Bloomberg) — The 15 mile-per-hour winds that buffeted northern Germany on July 24 caused the nation’s 21,600 windmills to generate so much power that utilities such as EON AG and RWE AG had to pay consumers to take it off the grid.

Rather than an anomaly, the event marked the 31st hour this year when power companies lost money on their electricity in the intraday market because of a torrent of supply from wind and solar parks.

The phenomenon was unheard of five years ago. With Europe’s wind and solar farms set to triple by 2020, utilities investing in new coal and gas-fired power stations no longer face stable returns.

As more renewables come on line, a gas plant owned by RWE or EON that may cost $1 billion to build will be stopped more often from running at full capacity. It may only pay for itself on days like Jan. 31, when clouds and still weather pushed an hour of power on the same-day market above 162 ($220) euros a megawatt-hour after dusk, in peak demand time.

“You’re looking at a future where on a sunny day in Germany, you’ll have negative prices,” Bloomberg New Energy Finance chief solar analyst Jenny Chase said about power rates in wholesale trading. “And a lot of the other markets are heading the same way.”

Europe’s biggest power markets give preference to renewable energy including forcing some utilities to use their fossil-fuel plants less. That cuts into profit, complicating investment decisions as the companies try to meet emission targets and replace older plants and networks that Citigroup Inc. estimates will cost them more than 900 billion euros by 2020.

Profit Margins Northern Europe’s renewable-energy goals call for about 200 gigawatts of solar and wind capacity by 2020, or almost a third of the current installed base, compared with about 70 gigawatts today, according to the Finnish energy consultant Poyry. Even by 2014, gross profit from burning coal in Germany may skid by as much as 41 percent, according to Barclays Plc.

The gross margin at a coal power plant after deducting fuel and emission permit costs, the so-called clean dark spread, may “collapse” to as low at 3.50 euros a megawatt-hour, Barclays analysts including Peter Bisztyga said in a Sept. 1 report. The spread was at 6.15 euros today, Bloomberg data show. Narrower margins mean it will take longer for companies to pay off building new gas- and coal-fired facilities. Those plants are needed.

They can run around the clock, preventing blackouts when the sun sets or the wind dies as European power demand grows 5 percent through 2015 compared with 2010, according to Paris-based bank Societe Generale SA’s forecast.

“The more intermittent technology like renewables, the more baseload generation will be squeezed out,” Volker Beckers, chief executive officer of RWE’s U.K. Npower unit, said in an interview at Bloomberg’s London bureau. Npower’s plants are largely coal- and gas-fired, or baseload, meaning they can run around the clock. Electricite de France SA is spending 6 billion euros on its new 1,650-megawatt nuclear reactor at Flamanville in Normandy. Dong Energy A/S, Denmark’s biggest utility, inaugurated its first power station in the U.K. in February, an 824-megawatt combined-cycle gas turbine plant for 600 million pounds.

[...] “Too much wind can depress power prices, but then there are times when very little wind is blowing,” Poyry Director Phil Hare said in a telephone interview. Based on weather patterns over the past 10 years, there’s a 72-hour period each year when a wind farm would produce less than 5 percent of its potential output, Hare said. “Some other plant has to be there, but the company has to make the return on its investment in just those 72 hours over 10 years.”

[...] Solar plants in Germany generated as little as 23.8 megawatts at 7 a.m. Berlin time yesterday compared with 11,570 megawatts at 1:30 p.m., according to a European Energy Exchange AG’s website, tracking power capacity. A steady supply of 1,000 megawatts is enough for about 2 million homes in Germany. Power prices on the Epex Spot SE exchange in Paris that handles German and French supply vary hour-by-hour depending on how available capacity is. At times they can become negative when renewable energy peaks and there’s a surplus of power. Take Renewable Output At such times, generators or the grid operator pay consumers to take their electricity if they aren’t able to reduce output or hedge it.

Grid operators in Germany, Europe’s biggest power market, are also required to take renewable output if it is available, just as in Spain and France. The highest-ever hourly price in the combined German-French intraday market was 162.06 euros a megawatt-hour for delivery between 6 p.m. and 7 p.m. in Germany on Jan. 31, while the lowest was minus 55.11 euros for 2 p.m. to 3 p.m. on Feb. 6, data from the exchange showed.

The negative German prices on July 24 occurred on a day when winds averaged 15 mph in the northern state of Mecklenburg- Western Pomerania, home to many wind farms, Bloomberg weather data show. Germany’s same-day electricity price was below zero for nine hours on that windy day on July 24, with negative prices for a total of 31 hours so far in 2011, according to Epex data. France had 9 negative hours this year.

The joint French-German intraday market started last year and has so far helped to “buffer the volatility of prices,” Epex company spokesman Wolfram Vogel said by e-mail on Sept. 16. “The law in Germany is that renewables have priority, so utilities have the choice of turning plants down for a few hours or paying a negative price to someone in Germany or abroad,” EON spokesman Georg Oppermann said in a telephone interview. The company’s traders can protect EON against losses by watching weather patterns, he added. “The huge amount of renewable capacity due to be added to the grid will depress not just spreads but also the outright power price,” UniCredit analyst Scott Phillips said.

“This is clearly a negative predominantly for all thermal power plants, particularly coal.” Britain plans to install more than 8,000 offshore wind turbines by 2020 to get 15 percent of electricity from renewable sources. Germany installed 7.4 gigawatts of solar photovoltaic capacity last year, the most of any nation, driving total capacity to 17,200 megawatts. Spain aims to get 20.8 percent of its total energy from marine energy, geothermal and offshore wind projects, as well as hydropower, by 2020.

German wind power capacity peaked at close to 12,000 megawatts on July 24, according to Meteogroup data, the last day of negative prices. Four days later, the most that the country’s wind parks generated was 315 megawatts. Photovoltaic and solar-thermal plants may meet most of the world’s demand for electricity by 2060 -- and half of all energy needs -- with wind, hydropower and biomass plants supplying much of the remaining generation, the International Energy Agency said in August. U.K. energy regulator Ofgem is considering paying generators to keep plants open as back-up suppliers, compensating them for down time.

The so-called capacity payments, which also are being studied in Germany, are likely to favor gas over coal, as gas plants can be turned on and off faster, according to Phillips.

Subsidized power rates called feed-in tariffs, a proposed carbon floor price in Britain and other measures favoring renewable projects will lead to a shift in the “merit order” of plants across Europe, he said. Power from renewable projects will be the first to be used, followed by gas-fired power plants, which release less carbon-dioxide than coal stations. “Margins are going to get worse over the next few years but as the value of the plant for backup starts getting interest, it becomes an issue of what they’re worth, not what they cost,” Hare said.

Releasing 70,000 Psychiatric Patients Shows How Deep Japan's Debt Problems Are

If I remember correctly, they did the same in San Francisco in the Reagan years?

Anyway, when you reach such extreme decision, it really means that you are back to the wall and have hard time finding space to breath.

Yet again, the case for the unintended consequences of the government's action are highlighted (see below).

In any case, this is sad and lives are at stake. But there's no way out of this and nature's law will prevail.

Sept. 14 (Bloomberg) -- [...] the government [...] wants to empty 70,000 beds to reduce the highest rate of psychiatric hospitalization among developed nations, lowering its 1.8 trillion yen ($23.5 billion) annual mental-health payments. Facing the world’s largest public debt and the fastest aging society, Prime Minister Yoshihiko Noda is trying to curtail growth in the country’s 34.8 trillion yen-a-year health bill. 

“The only thing the government has in mind is cutting medical costs,” said Yugo Miyata, who runs Yokohama Camellia Hospital on the outskirts of Tokyo. “If hospitals force out 70,000 patients immediately, we must be ready for several thousand of them to be homeless on the street.” 

The effort to reverse a five-decade policy of isolating psychiatric cases is unrealistic because most patients have no living relatives or have been hospitalized too long to cope outside, and because of the stigma in Japan of having a mentally ill relative [...] 

Care of the mentally ill accounts for 5.2 percent of the nation’s 34.8 trillion yen medical bill.

While the U.S. and western Europe began closing asylums and integrating patients into the community in the 1960s, in Japan the stigma of mental illness has ensured that the nation’s 1,076 psychiatric hospitals maintain a 90 percent occupancy rate. Japan has 13.5 times more psychiatric beds per 100,000 people than the U.S. and 4.5 times more than the U.K., according to OECD data. [...]

The mentally ill have been largely separated from society in Japan since the 1950s, when the government prohibited people from locking up sick relatives at home.  [...] 

“Many patients don’t need medical care,” said Okazaki at Tokyo Metropolitan Matsuzawa Hospital. “But they have no home to return to as their parents have died and their siblings don’t feel they have a duty to support them.” 

Treating Japan’s more than 300,000 psychiatric in-patients costs about 400,000 yen per patient per month on average, according to a 2009 health ministry survey. Between 70 percent and 100 percent of that cost is covered by the government, depending on the patient’s age and relatives’ ability to pay. For seniors, the state pays as much as 90 percent of the bill.
[...] 

With large subsidies, psychiatric hospitals, 90 percent of which are owned by doctors, have little incentive to release patients, according to the OECD report. Government payouts for seniors had “the unintended effect of turning hospitals into de facto nursing homes,” the report said. “Keeping patients in beds is an easy way to gain revenue.” 

Psychiatric patients in Japan are hospitalized for 307 days on average, compared with just over a week in the U.S. and about 11 weeks in the U.K., according to government figures. [...]

Deflation Illustrated: NYFed Q3 Report on Household Debt and Credit Shows Continued Decline in Consumer Debt

Consumer credit deflation is still the name of the game, and the long term shift from being borrowers to savers in most areas of the globe after 20 years of credit binge is the reason why deflation cannot be fought by central bankers. Here's a quote from the New York Fed Q3 Report on Household Debt and Credit:

The Federal Reserve Bank of New York today released its Quarterly Report on Household Debt and Credit for the third quarter of 2010, which shows that consumer debt continues its downward trend of the previous seven quarters, though the pace of decline has slowed recently. Since its peak in the third quarter of 2008, nearly $1 trillion has been shaved from outstanding consumer debts.

Additionally, this quarter’s supplemental report addresses for the first time the question of how this decline has been achieved and notes a sharp reversal in household cash flow from debt, indicating a decrease in available funds for consumption. According to newly available data through year end 2009, the payoff of debt by consumers reduced their cash flow by about $150 billion, whereas between 2000 and 2007, borrowing had contributed more than $300 billion annually to consumers’ cash flow.

This is not only the result of the shift in people's behaviours, but also an unintended consequence of low interest rates and of the misuse and abuse of option-ARMs and other non-fixed mortgages: when your saving account pays 0% in interest, but that your mortgage costs you 4% or your credit card costs you 18%, you end up just repaying your debt.

This unintended consequence, and unseen by such bright people as Ben Bernanke and his friends at the Fed is going to be one of the main reasons why he's bound to fail. People want to save, badly need to save, and they are actually not even impacted by the low interest rates, as reimbursing a 4% interest mortgage is like saving at 4% on a savings account.

Those people who are really losing in the current environment are those who use the income from fixed income securities and saving accounts to earn their living: mostly older people. But in any case, people with no debt to reimburse are the exception and not the majority, so the general shift and trend is in motion, and I don't see how it could be stopped.

Excluding the effects of defaults and charge-offs, available data show that non-mortgage debt fell for the first time since at least 2000. Also, net mortgage debt paydowns, which began in 2008, reached nearly $140 billion by year end 2009. These unique findings suggest that consumers have been actively reducing their debts, and not just by defaulting.

“Consumer debt is declining but only part of the reduction is attributable to defaults and charge-offs,” said Donghoon Lee, senior economist in the Research and Statistics Group at the New York Fed. “Americans are borrowing less and paying off more debt than in the recent past. This change, which we continue to study carefully, can be a result of both tightening credit standards and voluntary changes in saving behavior.”

Also noteworthy in the third quarter:

• Household delinquent debt continues to decline and currently account for about $1.3 trillion or 11 percent of consumer debt, representing an 8.2 percent decline from a year earlier; 

• The proportion of current mortgage balances that transitioned into delinquency rose slightly from 2.6 percent to 2.7 percent, after about a year of decline. 

• Given the similar pattern observed in the third quarter of 2009, one might suggest this is a seasonal effect, though the New York Fed continues to closely monitor such developments. 

• About 457,000 individuals received home foreclosure notices on their credit reports between July 1 and September 30, 2010, a 5.5 percent decrease from the second quarter and a 6.4 percent drop from a year earlier. 

• The number of new bankruptcies noted on credit reports fell 16 percent from the previous quarter (from 621,000 to 522,000), but is 1 percent higher from a year earlier.

How EU incompetent ministers get it all upside down

The NYT reported a few days ago:

A deal was struck Monday to establish a 440 billion-euro safety net for debt-laden countries in the euro zone, a move that officials hope will calm the markets that have helped prompt a slide in the value of the euro.

They got it completely upside down. What happens is the following:

1. The countries like Greece have borrowed and spend way too much compared to their means, so they are not able to service the debt and even less to reimburse the principal.
2. Normally, when debt burden rises, the risk of default rises, so the interest rate goes up, reflecting the higher risk taken by the creditors.
3. When this goes too far, and a default or bankruptcy is about to happen, interest rates skyrocket. The amount of credit available collapses. Which is highly deflationary.
4. In deflation, the value of currencies rises. It means the Euro should go up against other currencies
5. If an actual default on the debt occurs, credit is destroyed, which is even more deflationary.
6. In deflation, the value of currencies rises. It means the Euro should go up against other currencies
7. But, everybody knows that the politicians and the central banks are fools, incompetents and incapable of letting the markets clear the system, and let the borrower default and clear the debt from the balance sheets and in the process, let the lenders either take their losses (or fill for bankruptcy). So in that case, the markets know that politicians and central banks will start to print like crazy in order to prevent the default.
8. Printing is pure inflation, and it means that the Euro should fall against other currencies.
9. So the conclusion is that these ignorant bureaucrats think that their printing 440 billion euros “will calm the markets that have helped prompt a slide in the value of the euro” while in fact, it is precisely the prospect of having this massive printing of worthless paper that created the drop.

The unintended consequences of the government foreclosure delaying strategy aimed at supporting house prices

It's always interesting to find the unintended consequences of every government policy and see how they achieve the exact opposite result of their original goal. He're a is a quote from a post that CalculatedRisk published on the 5th of June:



BofA executive Jack Schakett made some interesting comments earlier today:

"There is a huge incentive for customers to walk away because getting free rent and waiting out foreclosure can be very appealing to customers."

Schakett noted that the foreclosure process is currently taking 13 to 14 months ...

For many the timeframe is apparently much longer. On Monday David Streitfeld wrote in the NY Times: Owners Stop Paying Mortgages, and Stop Fretting

The average borrower in foreclosure has been delinquent for 438 days before actually being evicted, up from 251 days in January 2008, according to LPS Applied Analytics.
...
More than 650,000 households had not paid in 18 months, LPS calculated earlier this year. With 19 percent of those homes, the lender had not even begun to take action to repossess the property ...

These long foreclosure time lines can have a significant adverse impact on housing.

Housing economist Tom Lawler alerted me to a 2008 research paper by Freddie Mac economists Amy Crews Cutts and William A. Merrill: Interventions in Mortgage Default: Policies and Practices to Prevent Home Loss and Lower Costs. They studied the foreclosure time lines and costs in several states and found that 270 days is sufficient time to allow the borrower to cure, and any more time actually incentivizes the borrower to strategically default:

There are many challenges that policy makers, investors, servicers and borrowers face in minimizing the incidence of home loss through foreclosure. Among them is the tension between too little time in the foreclosure process, such that some borrowers are unable to recover from relatively mild setbacks before they lose the home but investors minimize pre-foreclosure time related costs, and too much time in the foreclosure process, such that the borrower is incented to let the home go to foreclosure sale during which no mortgage payments are made (in essence, free rent for a significant time) and investor costs rise rapidly.
...
A sweet spot for the optimal time in foreclosure likely exists around a statutory timeline of 120 days (the current national median, and equivalent to 270 days after adding in 150 days for pre-referral loss mitigation activities by servicers through workouts) in which the borrower’s incentives are aligned with both a high probability of curing out of the foreclosure and keeping the pre-foreclosure costs to the investor contained.

One of unintended consequences of the government foreclosure delaying strategy (probably aimed at limiting supply and supporting house prices), is that strategic defaults have gained fairly widespread acceptance. And that means the eventual cost to the taxpayer will be higher than if the lenders had either modified the loans, or foreclosed, or approved a short sale, within about 270 days.

FHA bailout on the way

After Fannie Mae, Freddie Mac and to some extent Ginnie Mae, it is now the FHA's turn to get a government bailout. Please consider:

Oct. 8 (Bloomberg) -- The Federal Housing Administration, which insures mortgages with low down payments, may require a U.S. bailout because it has $54 billion more in losses than it can withstand, a former Fannie Mae executive said.

“It appears destined for a taxpayer bailout in the next 24 to 36 months,” consultant Edward Pinto said in testimony prepared for a House committee hearing in Washington today. Pinto was the chief credit officer from 1987 to 1989 for Fannie Mae, the mortgage-finance company that is now government-run.

The FHA program’s volumes have quadrupled since 2006 as private lenders and insurers pulled back amid the U.S. housing slump, Pinto said. The jump has left the agency backing risky loans and exposed to fraud in a “market where prices have yet to stabilize,” he said.
[My comment: when could wonder why private lenders and insurers have pulled back. Probably because mortgage rates at artificially low level do not reflect the current risk they would be willing to take to lend?]

Representative Maxine Waters, a California Democrat, said at the hearing it is a “myth” the FHA is the “next subprime.” West Virginia Republican Shelley Moore Capito touted the agency’s role in serving first-time buyers as it backs a third of loans for home purchases. She also said more consideration should be given to anti-fraud efforts and whether some consumers should pay more.
[My comment: Yes, right. Let's see what happens in the next few months...]

Falling prices will push the FHA’s single-family fund’s reserves below a 2 percent cushion above projected losses required by Congress, Stevens said last month. The shortfall will be cured in two to three years, he said today.

The idea the FHA needs a rescue is “just plain wrong,” Stevens said in an Oct. 6 letter to the Wall Street Journal. That’s in part because the FHA’s accounting method means its reserves are enough to cover more than 30 years of projected losses, assuming no revenue from new business.
[My comment: this is such a ridiculous statement that it removes all credibility from Stevens...]

Note that FHA is yet another example of unintended consequences and government interventions hazards.

Allowing people borrow a lot more than what they could in a normal market simply creates a financing bubble and is the source of rising home prices, that doesn't serve any buyer but only helps sellers. Thus defeating the very purpose of the FHA. This is exactly what happened with Fannie, Freddy, Ginnie and the housing bubble, in case anybody forgot that, now that the recession is over and the S&P back at in the thousands points.

Of course, when you only require to put in a 3% downpayment maximum (down to 0% if you include the $8,000 tax credit for home priced at less than about $260k-280k), you simply create a moral hazard since there's a huge incentive for borrowers to walk away as soon as they mortgage becomes 'underwater'.

From Wikipedia:

The Federal Housing Administration (FHA) is a United States government agency created as part of the National Housing Act of 1934. The goals of this organization are: to improve housing standards and conditions; to provide an adequate home financing system through insurance of mortgage loans; and to stabilize the mortgage market.
[...]
Following the Subprime mortgage crisis, FHA, along with Fannie Mae and Freddie Mac, became the source of much of the United States mortgage financing. The share of FHA mortgages went from 2 percent to over one-third of mortgages in the country. Without the subprime market, many of the riskiest borrowers ended up borrowing from the Federal Housing Administration, and the FHA could suffer substantial losses. Joshua Zumbrun and Maurna Desmond of Forbes have written that eventual government losses from the FHA could reach $100 billion
[...]
A borrowers downpayment may come from a number of sources. The 3.5% requirement can be satisfied with the borrower using their own cash or receiving a gift from a family member, their employer, labor union, non-profit or government entity.
[...]

Bank of America Urged to Pay U.S. for Merrill Accord

Following up on yesterday's post:

July 15 (Bloomberg) -- Bank of America Corp. benefited from implied federal backing on about $118 billion of Merrill Lynch & Co. assets and owes the government compensation, the chairman of a House of Representatives committee studying the purchase of Merrill said.

“If you or anyone at Bank of America made a commitment, verbal or otherwise, to enter into this deal with the United States government, I urge you to honor that commitment,” Edolphus Towns, a New York Democrat, said in a letter yesterday to Chief Executive Officer Kenneth Lewis that was obtained by Bloomberg News. “It is the right thing to do.”

Regulators say Bank of America owes at least part of a $4 billion fee it agreed to pay in January because the company benefited from U.S. backing on Merrill assets such as mortgage- backed bonds, Bloomberg News reported on July 13, citing people familiar with the matter. The Charlotte, North Carolina-based bank says it owes the Treasury nothing because the plan was never put into effect, according to the people, who declined to be identified because the negotiations are confidential.
[...]
Bank of America disclosed the guarantees Jan. 16, along with its first quarterly loss in 17 years. Its news release headlined the guarantee and called the program an “agreement.”
[...]
The plan called for the Federal Reserve, the Treasury, and Federal Deposit Insurance Corp. to participate in a loss-sharing agreement for loans, mortgage-backed securities and financial instruments that could last 10 years, according to company and Treasury documents. Most of the holdings came from Merrill Lynch, acquired Jan. 1.

The bank would pay a $4 billion fee in preferred stock and warrants, plus an annual fee of 20 basis points for undrawn amounts of the $118 billion, or $236 million, according to Treasury’s summary of terms, with more fees if the bank used the program. A basis point is 0.01 percentage point.
[...]

Repeating myself:

In any case, this shows one more time that government intervention leads to unintended consequences.

These consequences are going to be major because, irrelevant of whether BofA is right or wrong:

• BofA will not be able to get any backing when the markets collapse.
• The public image of BofA is going to get hurt.
• BofA has put itself in a position where the government can now do anything they want. They are owned...

Bank of America is trying to avoid paying billions of dollars in fees to U.S. taxpayers

Isn't that rich? It is obvious that BofA indeed benefited from the US Gov backing. Legally, contracts do not need to be signed to be binding. It's just the proof that is more difficult to make when there's no written/signed agreement. But in the case of a public agreement like this one, I don't think it's going to be difficult to make a case against BofA...

In any case, this shows one more time that government intervention leads to unintended consequences.

These consequences are going to be major because, irrelevant of whether BofA is right or wrong:

• BofA will not be able to get any backing when the markets collapse.
• The public image of BofA is going to get hurt.
• BofA has put itself in a position where the government can now do anything they want. They are owned...

July 13 (Bloomberg) -- Bank of America Corp. is trying to avoid paying billions of dollars in fees to U.S. taxpayers for guarantees against losses at Merrill Lynch & Co., saying the rescue agreement was never signed and the funding never used.

Regulators contend Bank of America owes at least part of a $4 billion fee it agreed to pay in January -- even without a completed legal document -- because the company benefited from implied U.S. backing on about $118 billion of Merrill Lynch assets, such as mortgage-backed bonds, people familiar with the matter said. The Charlotte, North Carolina-based bank says it owes the Treasury nothing, according to the people, who declined to be identified because the negotiations are confidential.

Bank of America [...] “got a moral commitment for insurance without tendering a check, so it appears they got something for nothing,” said Representative Brad Sherman, a California Democrat on the House Financial Services Committee. “If the government takes the risk, the government needs to be paid.”

Both sides are under pressure from lawmakers who questioned whether taxpayers are being adequately rewarded for propping up lenders, and why Bank of America’s January acquisition of New York-based Merrill Lynch required a publicly funded bailout. The U.S. provided the bank $20 billion in capital plus the asset guarantees to keep Chief Executive Officer Kenneth Lewis from abandoning the takeover of money-losing Merrill, once the world’s biggest brokerage.
[...]
Both sides agree the accord was never signed and the funding went untapped, the people said. Bank spokesman Scott Silvestri and Treasury’s Andrew Williams declined to comment.
[...]
Bank of America disclosed the guarantees Jan. 16 along with its first quarterly loss in 17 years. The bank’s news release headlined the guarantee and called the program an “agreement.”
[...]
Bank of America would absorb the first $10 billion of losses, with U.S. agencies covering 90 percent of subsequent deficits, said the bank’s Jan. 16 statement. The bank “would pay a premium of 3.4 percent of those assets,” the lender said. Similar commercial accords impose fees of as much as 6 percent, said Christopher Whalen, managing director of Institutional Risk Analytics, a Torrance, California, research firm.

The bank would pay a $4 billion fee in the form of preferred stock and warrants, plus an annual fee of 20 basis points for undrawn amounts of the $118 billion, or $236 million, according to Treasury’s summary of terms, with more fees if the bank tapped the program. A basis point is one-hundredth of a percent. Bank of America could end the guarantee any time if the U.S. consented, with an “appropriate fee” to be negotiated, the document said.

The term sheet said it was “accepted and agreed by and among the following as of Jan. 15, 2009” and listed the bank, Treasury, Fed and Federal Deposit Insurance Corp. Each specific instrument in the pool of covered assets “must be identified on signing of the guarantee agreement,” the sheet said.
[...]
“It’s the fault of the government for never getting it signed,” said Townsend, who said his firm has purchased shares of the bank. “But part of the inherent unfairness in dealing with government is that they can manipulate all kinds of things to make your life hellish.”
[...]
“Treasury has to appear tough,” said Kevin Jacques, a former economist for the agency, referring to the Merrill Lynch guarantees. “Otherwise this will be politicized and people will say that the bank and Treasury were in this together and they just ripped off the American taxpayer,” said Jacques, now a finance professor at Baldwin Wallace College in Berea, Ohio. “There is a political cost here if they just let Bank of America walk.”

The Monkey Experience

This blog is also about [...] the world that has been pulled over your eyes to blind you from the truth. And sometimes, we are blinding yourself by following conventions and processes without turning on your brain and questioning it.

This is not new, but I felt like sharing it.

So next time remember this simple experience and make sure you know the reason why are doing what you are doing:

Begin with a cage containing five monkeys. Inside the cage, hang a banana on a string and place a set of stairs under it. Before long, a monkey will go to the stairs and start to climb towards the banana. As soon as he touches the stairs, spray all of the other monkeys with cold water. After a while, another monkey makes an attempt with the same result, and all the other monkeys are sprayed with cold water. Pretty soon the monkeys will try to prevent it.

Now, put away the cold water. Remove one monkey from the cage and replace it with a new one. The new monkey sees the banana and wants to climb the stairs. To his surprise and horror, all of the other monkeys attack him. After another attempt and attack, he knows that if he tries to climb the stairs, he will be assaulted.

Next, remove another of the original five monkeys and replace it with a new one. The newcomer goes to the stairs and is attacked. The previous newcomer takes part in the punishment with enthusiasm! Likewise, replace a third original monkey with a new one, then a fourth, then the fifth.

Every time the newest monkey takes to the stairs, he is attacked. Most of the monkeys that are beating him have no idea why they were not permitted to climb the stairs or why they are participating in the beating of the newest monkey. After replacing all the original monkeys, none of the remaining monkeys have ever been sprayed with cold water. Nevertheless, no monkey ever again approaches the stairs to try for the banana. Why not? Because as far as they know that's the way it's always been done around here.

Of market interventions and unintended consequences - 20081207

The government interfering with the free markets always ends with the opposite result of what was the government was originally trying to achieve. This is the law of unintended consequences.

So I have been watching this interview of Bill Ackman with Charlie Rose. I really like Bill Ackman and really respect him a lot. He is very bright and it is always worth listening to him when he makes public statements. You can wath the interview on YouTube. He says a lot of interesting things in this interview (and also a few things I strongly disagree with), but what really stroke me was this unintended consequence of the ban on short selling that the government's regulation body, the SEC, imposed on the market participants overnight a few weeks ago. I am not a hedge-fund manager so I hadn't seen this unintended consequence of banning short selling:

The rules of the game were changed midstream. I think if the government had said: "Look, we’re going to phase out short selling over a period of time", it wouldn’t have been disastrous for the industry. But if you have investors who commit to their partners to stay balanced, they don’t want to be more than a certain amount long versus the amount that they’re short. You lose the ability to insure yourself. Short selling is really a form of protecting yourself from the market going down. By taking away that very important tool, managers got imbalanced. They were actually forced to sell their long positions. [emphasis added]

Central Banks Market Tinkering & The Unintendended Consequence - pt 2

Another unintended and costly consequence of the Fed tinkering the rates and changing the rules overnight and panicking has been spotted by Mish:

Why Banks Aren't Lending

• Banks are insolvent.
• Banks do not trust each other.
• There can be no trust with suspended mark to market accounting. No one believes what assets on balance sheets are really worth and there is no way to find out.
• By suspending mark to market accounting the SEC heightened mistrust.
• As part of the TARP passed by Congress, the Fed is paying interest on reserves.
  

Bernanke wanted ability to pay interest on reserves to put in a floor on interest rates. I am quite certain he believed he could hold rates at 2 with this provision. It did not work that way did it? The Fed Fund rates is now at 1.50 and interest rates futures suggest it is headed to 1.00 by March.

But an easily seen (yet still unseen by the Fed) ramification of paying interest on reserves is the fact that banks can collect interest by leaving money on deposit at the Fed rather than lending it out [emphasis mine].

Why should banks risk lending money to consumers or bank when instead they can deposit money at the Fed and collect interest? Thus, paying interest on reserves not only failed to put in a floor on rates, it also gave banks one huge reason not to lend.

This cancerous activity is now starting to get extremely counterproductive.

Central Banks Market Tinkering & The Unintendended Consequences

Bloomberg reported that the major central banks decided to lower rates all together by 0.5% in order to help the credit markets:

Oct. 8 (Bloomberg) -- The Federal Reserve, European Central Bank and four other central banks lowered interest rates in an unprecedented coordinated effort to ease the economic effects of the worst financial crisis since the Great Depression.

The Fed, ECB, Bank of England, Bank of Canada and Sweden's Riksbank each cut their benchmark rates by half a percentage point.

Is this going to help the markets recover? No.
Is this a good thing for the economy? No.
Is this a good news for your savings and your currency? No.

Why isn't it going to help the markets?

Well, to understand this, you need to read again the quote above. Who is missing there? We have the US, EuroZone, Sweden and Canada. One major bank is missing, and it is Japan. Japan's rate is already at 0.5%, so they won't decrease it to 0.0% (hopefully!!). But what happened with a "surprise" rate cut (which I had forcasted this week-end) is that it created a massive short-squeeze on the Yen, with the hundred of billions of USD and EUR invested by borrowers of JPY. This led the Yen to rise 10% against the USD in a couple of minutes only! The USD crashed from about 106-107 Yen to 99!

The unintended consequence of market tinkering is that the yen-carry-trade will have to unfold and lead to a massive delveraging that is going to cost a lot to many players and investors and further sunk the markets.

Why isn't it a good thing for the economy?

Because the economy is already chocking due to too much credit and the unability of the market players and consumers to pay back. This is not going to help people borrow more. This is not going to help the banks neither, since the effective Fed Funds rates was already 0.0% as I mentioned yesterday.

People who couldn't pay back their mortgages won't be able to do so thanks to a 0.5% decrease rate.

Why isn't it a good thing for your currency?

Inflation will be unleashed (if it wasn't already). Gold is up 40$ an ounce.



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