In the US, soaring inequality and stagnant real incomes have long threatened this deal. Thus, Prof Rajan notes that “of every dollar of real income growth that was generated between 1976 and 2007, 58 cents went to the top 1 per cent of households”. This is surely stunning.

“The political response to rising inequality ... was to expand lending to households, especially low-income ones.” This led to the financial breakdown. As Prof Rajan notes: “[the financial sector’s] failings in the recent crisis include distorted incentives, hubris, envy, misplaced faith and herd behaviour. But the government helped make those risks look more attractive than they should have been and kept the market from exercising discipline.”

No comment needed

So much for rebalancing the UK economy. Seem to be lagging the rest of Europe.

The slow creep of deflation.

From The Prudent Bear (www.prudentbear.com) by Doug Noland dated June 18:

 

A Prominent Indicator Of Financial Conditions:

I would like to follow up on last week’s examination of the Fed’s “flow of funds” data with more focus on Financial Conditions.  Over the past seven quarters (back to Q2 2008), Federal borrowings have increased $3.274 TN, or 49%, to $9.972 TN.  Over the same period, GDP increased $104bn, or 0.7%, to $14.601 TN.  This massive fiscal expansion was instrumental in stabilizing the economy.  It certainly wasn’t the only factor.

In just 21 months, Federal Reserve assets expanded $1.387 TN, or 146%, to $2.339 TN.  Of course, the Fed also stoked ultra-loose financial conditions when it dropped short-term interest-rates to near zero.  From the high in January 2009, Money Market Fund Assets declined $1.1 TN, an unprecedented outflow of finance upon global risk markets.  Renewed Risk Embracement by the global leveraged speculating community played a pivotal role in loosening Financial Conditions, although there is little transparency when it comes to securities leveraging, “carry trades,” sophisticated derivatives and other global sources of finance for speculation.

From crisis lows to this past April’s highs, the S&P500 rallied more than 80%.  The broader market was even stronger, with the S&P400 Mid-caps and Russell 2000 small cap indices more than doubling.  The Morgan Stanley Retail Index almost tripled from lows, and the S&P Regional bank index surged 250%.  Commodities indices rallied almost 50%.  Synchronized fiscal and monetary stimulus propelled spectacular equity and debt market reflation across the globe.  Confidence, right along with faith in policymakers, skyrocketed.

I have posited that the policy response to the bursting of the Wall Street/mortgage finance Bubble unleashed the Global Government Finance Bubble.  It now appears that the Greek debt crisis will mark a key Bubble inflection point.  

From a market perceptions point of view, it’s a changed world.  Faith in government policymaking has been badly shaken.  Confidence that fiscal and monetary stimulus ensures ongoing global reflationary forces has waned.  Markets now appreciate that massive stimulus can’t assure market stability.  Indeed, further deterioration in government finances is now recognized as creating instability, uncertainty, and heightened systemic risk throughout the markets.  The world will now look at structural debt issues in a much less positive light.

From a flow of funds perspective, one can identify four key sources of finance that propelled the recent 18-month reflationary period.  First, recall that federal liabilities increased about $340bn in 2007.  This debt growth ballooned to $1.63 TN annualized during the first quarter and averaged about $1.60 TN annualized over the past six quarters.  Second, reflation was fueled by Federal Reserve monetization - especially the $1.2 TN increase in agency debt/MBS holdings over the past five quarters.  Third, zero rates encouraged a massive flow out of relative safety in search of higher returns.  Fourth, there was the critical - if not transparent - re-risking and leveraging for the hedge funds, sovereign wealth funds and other global speculators.

All four of these critical sources of reflationary finance now have issues.  Alan Greenspan’s op-ed piece in today’s Wall Street Journal – “U.S. Debt and the Greece Analogy” - highlights the newfound attention to our nation’s structural debt predicament.  Though I’ll somewhat reserve judgment until the next crisis or economic downturn, the political pendulum appears to have swung decisively against additional bailouts, stimulus measures or other programs that would worsen our dismal fiscal situation.  Staggering amounts of government spending stabilized the system, while it increasingly appears we will garner few additional “benefits” from double-digit percentage-to-GDP deficits.

Similarly, caution is the watchword when it comes to anticipating additional benefits from monetary policy.  Granted, the Fed is likely stuck in the vicinity of zero indefinitely.  I am nonetheless skeptical that this necessarily equates to ongoing ultra-loose financial conditions.  I would argue that the Trillion-plus purchases of MBS had a momentous impact on marketplace liquidity, especially when it came to unfreezing the private-label MBS marketplace.  I expect a divided Fed to approach any additional monetization of MBS cautiously.  

Slashing rates certainly has a powerful impact when it comes to inciting Risk Embracement and asset inflation.  I don’t, however, anticipate that zero rates will have a great expansionary influence in a period of renewed risk aversion and faltering markets.  Looking at this issue from the Household sector perspective, zero rates can have varying benefits as well as costs.  On the back of surging securities prices, Household net worth jumped $6.30 TN over the past year (ended 3/31).  Previous low rate environments saw households enjoy huge housing wealth effects, including the free-flowing extraction of (inflating) home equity.  Near zero returns on household savings may not be a big issue when assets markets are rapidly inflating and households are tapping cheap sources of borrowings.  But that’s not the likely backdrop going forward.  Instead, zero rates may prove an impediment to consumption after this cycle’s atypical (especially in regard to housing and private-sector Credit expansion) reflationary dynamics have run their course.

I’ll be surprised if the wall of liquidity fleeing low returns isn’t in the process of slowing toward a trickle – or perhaps even reversing.  Especially with the continued drag from weak housing and jobs markets, the household sector is not favorably positioned to take on additional market risk.

I would find it very surprising if the European debt crisis did not mark a key inflection point for the global leveraged speculating community.  Painful (and highly correlated) losses in debt, currency, equities and commodities markets would seem to ensure heightened risk aversion going forward.  Clearly, sovereign debt has a greater degree of risk than was perceived in the marketplace prior to the Greek eruption.  A more cautious approach to “carry trades” (i.e. borrowing in yen or dollars to purchase higher-yielding instruments in other currencies) and leverage more generally seems certain.  This equates to more challenging marketplace liquidity and tighter financial conditions.

Prior to Greece, market perceptions held that aggressive global fiscal and monetary stimulus ensured highly-liquid markets that would demonstrate strong inflationary biases.  Virtually across the board, global risk assets were robust.  Not surprisingly, seemingly endless financial flows into the speculative markets distorted risk perceptions.  Nowhere was this more apparent than in the markets for Credit default protection.

Prior to Greece, risk insurance was cheap – insurance protecting against sovereign debt, corporate and municipal bonds, Credit instruments generally, equities and overall systemic risk.  Importantly, the perception of inexpensive and highly liquid market insurance spurred risk-taking and self-reinforcing leveraged speculation.  The abrupt dislocation in Greek and, only somewhat later, European Credit default swap (CDS) protection put an immediate end to inexpensive market protection.  And the subsequent synchronized decline in global risk markets illuminated inherent liquidity issues throughout.  It is my view that the end of the misperception of readily-available insurance protection marks an inflection point for the Global Government Finance Bubble.

While most view Greece and European tumult as of only minor consequence to the U.S., I believe it marks an inflection point for U.S. financial conditions.  Risk premiums have risen and non-government debt issuance has slowed.  Moreover, the cost of financial insurance has increased markedly.  Changes in insurance market dynamics could have the most profound impact on risk-taking – hence financial conditions – in the coming weeks and months.  

June 18 – Financial Times (Brendan A. McGrail and Allison Bennett):  “Illinois sold $300 million of Build America Bonds at a yield premium over Treasuries about 40% higher than two months ago after lawmakers failed to close a $13 billion budget deficit for the year starting July 1.  The fifth most-populous U.S. state sold the taxable debt maturing in 2035 priced to yield 7.1%... or 297 bps over… Illinois offered Build Americas of similar maturity at spreads of 205 bps and 210 bps in two April issues… Risk aversion among investors amid Greece’s efforts to impose austerity measures contributed to swell the state’s borrowing costs, said Tom Boylen, a managing director… for BMO Capital Markets.  ‘A lot of this is a global thing,’ Boylen said. ‘There’s a bigger magnifying glass on credit.”

June 17 – Bloomberg (Allison Bennett):  “The cost of insuring bonds issued by Illinois against default rose to a record high as lawmakers sought to close a $13 billion budget deficit… The cost of a five-year credit-default swap to insure Illinois obligations rose 6 bps to 308.61 bps today, or $308,610 to insure $10 million of debt… The gain makes insuring bonds from the fifth-most populous state the most costly among municipal issuers and puts it 66 bps above Spain.”

State of Illinois (five-year) CDS traded at about 160 bps to begin the month of May (closed today at 312 bps).  The cost of insuring against a default by the state was 25 bps back in May 2008.  State of California CDS this week also jumped above 300 bps, this after beginning May below 200 (traded about 60 bps in the summer of ’08).  After starting May at 140 bps, State of New York CDS closed today at 249 bps (traded most of 2008 below 50 bps).  Since the Greece crisis, the cost of State of New Jersey default protection has jumped about 70% to 249 bps.

As a Prominent Indicator of Financial Conditions, I will be closely monitoring developments throughout municipal debt markets.  State and local finances are stretched and vulnerable.  The weak link?  This susceptibility has become more acute post-Greece, with the marketplace now reassessing the efficacy of policymaking and the sustainability of reflationary forces.  Akin to Greece, state and local officials lack the luxury of Washington’s electronic printing press and helicopter “money.”  And, again like Greek debt, things deteriorate rather rapidly when the market turns nervous and demands significantly higher yields.  Meanwhile, the market’s faith is waning with respect to the ability of recovery to cure structural state and local deficits, as well as in the federal government’s capacity to move forward with numerous additional bailouts.

 

Gap widening between the stimulus happy and the frugal. Should be an interesting G20.

Nationwide warns of closures as profits slump

By Adam Jones

Published: May 26 2010 09:43 | Last updated: May 26 2010 09:43

Nationwide, the UK’s biggest building society, indicated on Wednesday that it might close administrative offices and branches following a decline in demand for residential mortgages and savings products.

Classic case of debt revulsion.