4/1/2015: Greek Crisis 4.0: Politics 1 : Reality 0

With hundreds of billions stuffed into various alphabet soup funds and programmes, the EU now thinks that Greece has been isolated, walled-in, that contagion from the volatile South to the sleepy North is no more (http://www.reuters.com/article/2015/01/03/us-eurozone-greece-germany-idUSKBN0KC0HZ20150103). Backing these beliefs, the EU and core European states have gone on the offensive defensive when it comes to Greek latest iteration of the political mess.

Yet, for all the 'measures' developed - from European Banking Union, to 'Genuine' Monetary Union, to EFSF, EFSM, ESM and ECB's OMT, LTROs, TLTROs, ABS, etc etc - the EU still lacks any clarity on what can be done to either facilitate or force exit of a member state from the EMU.

The state of the art analysis of the dilemma still remains December 2009 ECB Working Paper on the subject, available here: http://www.ecb.europa.eu/pub/pdf/scplps/ecblwp10.pdf which is, frankly put, a fine mess. Key conclusion, however, is that "a Member State’s exit from EMU, without a parallel withdrawal from the EU, would be legally inconceivable; and that, while perhaps feasible through indirect means, a Member State’s expulsion from the EU or EMU, would be legally next to impossible."

So much for all the reforms, then - lack of clarity on member states' ability to exit the euro, whilst lots of clarity on measures compelling and incentivising a member state to submit to the euro area demand (e.g. bail-ins, access to Central Bank funding etc) - all the evidence indicates that the entire objective of 2009-2014 reforms of the common currency space has been singular: an attempt to simply lock-in member states' into the euro system even further. Disregarding any monetary or fiscal or financial or economic or social realities on the ground.

Which brings us back to the starting point: at 175% debt/GDP ratio, Greece cannot remain within the euro area (for domestic and international financial, economic and social reasons). Yet, it cannot exit the euro area (for domestic and international political reasons). Politics 1 : Reality 0, again.

4/1/2015: Homeownership, House Prices and Entrepreneurship

Two papers on related topics, the link between enterprise formation and homeownership/mortgages. In the past, I wrote quite a bit about various studies covering these, especially within the context of negative equity impact of reducing entrepreneurship and funding for start ups.

In the first paper, Bracke, Philippe and Hilber, Christian A. L. and Silva, Olmo, "study the link between homeownership, mortgage debt, and entrepreneurship using a model of occupational choice and housing tenure where homeowners commit to mortgage payments."

The paper, titled "Homeownership and Entrepreneurship: The Role of Mortgage Debt and Commitment" (CESifo Working Paper Series No. 5048: http://ssrn.com/abstract=2519463) finds that, from theoretical model perspective, "as long as mortgage rates exceed the rate of interest on liquid wealth [short-term bonds, deposits etc - and this usually is the case in all markets]:

1. mortgage debt, by amplifying risk aversion, diminishes the likelihood that homeowners start a business; 
2. the negative relation between mortgage debt and entrepreneurship is more pronounced when income volatility is higher; and
3. the relation between housing wealth and entrepreneurship is ambiguously signed because of competing portfolio and hedging considerations. 

Empirical analysis by the authors "confirm these predictions. A one standard deviation increase in leverage makes a homeowner 10-12 percent less likely to become an entrepreneur."

So back to negative equity. Negative equity is significantly increasing leverage taken on by the borrower. For example: original mortgage with LTV of 75% set against property price decline of 10% generates leverage increase of 8.3 percentage points. In Irish case, same mortgage (in Dublin case) brought back to current valuations of the property from the peak prices pre-crisis implies a leverage increase of, roughly, 50 percentage points, which is, roughly an increase of 12 standard deviations.


The second study is by Jensen, Thais Laerkholm and Leth‐Petersen, Søren and Nanda, Ramana, titled "Housing Collateral, Credit Constraints and Entrepreneurship - Evidence from a Mortgage Reform" (CEPR Discussion Paper No. DP10260: http://ssrn.com/abstract=2529930). The paper looks at "how a mortgage reform that exogenously increased access to credit had an impact on entrepreneurship, using individual-level micro data from Denmark."

The authors find that "a $30,000 increase in credit availability led to a 12 basis point increase in entrepreneurship, equivalent to a 4% increase in the number of entrepreneurs. New entrants were more likely to start businesses in sectors where they had no prior experience, and were more likely to fail than those who did not benefit from the reform."

What does this mean? "Our results provide evidence that credit constraints do affect entrepreneurship, but that the overall magnitudes are small. Moreover, the marginal individuals selecting into entrepreneurship when constraints are relaxed may well be starting businesses that are of lower quality than the average existing businesses, leading to an increase in churning entry that does not translate into a sustained increase in the overall level of entrepreneurship."

So the study basically shows that mortgage credit constraints in Denmark are not highly important in determining the rate of successful entrepreneurship. But the study covers only intensive margin constraints - in other words it covers credit availability increases over and above normal operating credit markets. This does not help our understanding of what happens in the markets where credit constraints are severe. 

3/1/2015: Greek Crisis 4.0: Timeline

Neat timeline of the Greek Crisis 4.0 forward, via @zerohedge

Click on the chart to enlarge

The above shows key points of uncertainty and pressure, with all of these hanging in the balance based on January 25th national elections.

Prepare for loads of politically-induced volatility.

Meanwhile, Greek manufacturing PMI remain in contraction territory:

3/1/2015: Can LTV Cap Policies Stabilise Housing Markets?

The Central Bank of Ireland late last year unveiled a set of proposals aimed at cooling Irish property markets, including the controversial caps on LTV ratios on new mortgages. And this generated loads of controversy, shrill cries about the cooling effect of caps on property development and even speculations that the caps will put a boot into rapidly rising (Dublin) property prices. In response, our heroic property agents unleashed a torrent of arguments about supply, demand, sparrows and larks - all propelling the property prices to new levels, 'despite' the CBI measures announced (see for example here:  http://www.independent.ie/business/personal-finance/property-mortgages/property-prices-set-to-rise-despite-lending-cap-plan-30879087.html for a sample of property marketers exhortations on matters econometric).

But never, mind the above. Truth is, the measures announced by the CBI are genuinely, for good economic reasons, have low probability of actually having a serious impact on property prices. At least all real (as opposed to property agents' economists') evidence provides for such a conclusion.

A recent paper by Kuttner, Kenneth N. and Shim, Ilhyock, titled "Can Non-Interest Rate Policies Stabilise Housing Markets? Evidence from a Panel of 57 Economies" (BIS Working Paper No. 433: http://ssrn.com/abstract=2397680) used data from 57 countries over the period spanning more than three decades, to investigatee "the effectiveness of nine non-interest rate policy tools, including macro-prudential measures, in stabilising house prices and housing credit."

The authors found that "in conventional panel regressions, housing credit growth is significantly affected by changes in the maximum debt-service-to-income (DSTI) ratio, the maximum loan-to-value ratio, limits on exposure to the housing sector and housing-related taxes. But only the DSTI ratio limit has a significant effect on housing credit growth when we use mean group and panel event study methods. Among the policies considered, a change in housing-related taxes is the only policy tool with a discernible impact on house price appreciation."

On DSTI finding, the authors estimate that setting a maximum DSTI ratio as the policy tool allows for a typical policy-related tightening, "slowing housing credit growth by roughly 4 to 7 percentage points over the following four quarters." In addition, on tax effectiveness, the authors found that while "an increase in housing-related taxes can slow the growth of house prices", this result is "sensitive to the choice of econometric method" used in model estimation.

Finally, on CBI-favoured LTV limits: "Of the two policies targeted at the demand side of the market, the evidence indicates that reductions in the maximum LTV ratio do less to slow credit growth than lowering the maximum DSTI ratio does. This may be because during housing booms, rising prices increase the amount that can be borrowed, partially or wholly offsetting any tightening of the LTV ratio."

In other words, once prices are rising, LTV caps are not terribly effective in controlling house price inflation.

3/1/2015: Trade Protectionism Since the Global Financial Crisis

A year ago, ECB paper by Georgiadis, Georgios and Gräb, Johannes, titled "Growth, Real Exchange Rates and Trade Protectionism Since the Financial Crisis" (ECB Working Paper No. 1618. http://ssrn.com/abstract=2358483) looked at whether the current evidence does indeed support the thesis that "…the historically well-documented relationship between growth, real exchange rates and trade protectionism has broken down."

Looking at the evidence from 2009, the authors found that "the specter of protectionism has not been banished: Countries continue to pursue more trade-restrictive policies when they experience recessions and/or when their competitiveness deteriorates through an appreciation of the real exchange rate; and this finding holds for a wide array of contemporary trade policies, including “murky” measures. We also find differences in the recourse to trade protectionism across countries: trade policies of G20 advanced economies respond more strongly to changes in domestic growth and real exchange rates than those of G20 emerging market economies. Moreover, G20 economies’ trade policies vis-à-vis other G20 economies are less responsive to changes in real exchange rates than those pursued vis-à-vis non-G20 economies. Our results suggest that — especially in light of the sluggish recovery — the global economy continues to be exposed to the risk of a creeping return of trade protectionism."

One thing to add: the above does not deal with trade-restrictive policies relating directly to financial repression, such as outright regulatory protectionism of incumbent domestic banks and asset managers, or direct and indirect subsidies pumped into the incumbent banking system.

2/1/2015: Irish Banking System: Still Reliant on Non-Deposits Funding

A handy chart from Deutsche Bank Research on sources of funding - focusing on deposits - for euro area banks.

Irish banks are an outlier in the chart, with domestic household and Non-Financial Companies deposits forming second lowest percentage of banks' funding in the entire euro area. As of Q3 2014, Irish banking system remains less deposits-focused and more funded by a combination of other sources, such as the Central Banks, Government deposits and foreign/non-resident deposits.

And the dynamics, post-crisis, are not impressive either: since the onset of the Global Financial Crisis, there has been lots of talk about increasing reliance on deposits for funding banking activities. Ireland's extremely weak banking sector should have been leading this trend. Alas, it does not:

2/1/2015: Credit and Growth after Financial Crises

Generally, we think of private sector deleveraging as being associated with lower investment by households and enterprises, lower consumption and lower output growth, leading to reduced rates of economic growth. However, one recent study (amongst a number of others) disputes this link.

Takats, Elod and Upper, Christian, "Credit and Growth after Financial Crises" (BIS Working Paper No. 416: http://ssrn.com/abstract=2375674) finds that "declining bank credit to the private sector will not necessarily constrain the economic recovery after output has bottomed out following a financial crisis. To obtain this result, we examine data from 39 financial crises, which -- as the current one -- were preceded by credit booms. In these crises the change in bank credit, either in real terms or relative to GDP, consistently did not correlate with growth during the first two years of the recovery. In the third and fourth year, the correlation becomes statistically significant but remains small in economic terms. The lack of association between deleveraging and the speed of recovery does not seem to arise due to limited data. In fact, our data shows that increasing competitiveness, via exchange rate depreciations, is statistically and economically significantly associated with faster recoveries. Our results contradict the current consensus that private sector deleveraging is necessarily harmful for growth."

Which, of course, begs a question: how sound is banking sector 'return to normalcy at any cost' strategy for recovery? The question is non-trivial. Much of the ECB and EU-supported policies in the euro area periphery stressed the need for normalising credit operations in the economy. This thinking underpinned both the bailouts of the banks and the bailouts of their funders (bondholders and other lenders). It also underwrote the idea that although austerity triggered by banks bailouts was painful, restoration of credit flows is imperative to generating the recovery.

2/1/2015: Monetary Policy and Property Bubbles

Returning again to the issue of lender/funder liability in triggering asset price bubbles (see more on this here: http://trueeconomics.blogspot.ie/2015/01/112015-share-liability-debtor-and-lender.html), CEPR Discussion Paper "Betting the House" (see
http://www.cepr.org/active/publications/discussion_papers/dp.php?dpno=10305) by Òscar Jordà, Moritz Schularick, Alan M. Taylor asks a question if there is "a link between loose monetary conditions, credit growth, house price booms, and financial instability?"

The authors look into "the role of interest rates and credit in driving house price booms and busts with data spanning 140 years of modern economic history in the advanced economies. We exploit the implications of the macroeconomic policy trilemma to identify exogenous variation in monetary conditions: countries with fixed exchange regimes often see fluctuations in short-term interest rates unrelated to home economic conditions."

Do note: Ireland and the rest of euro periphery are the prime examples of this specific case.

The authors find that "…loose monetary conditions lead to booms in real estate lending and house prices bubbles; these, in turn, materially heighten the risk of financial crises. Both effects have become stronger in the postwar era."

So let's give the ECB a call… 

2/1/2015: Negative Deposit Rates: Swiss Method

The best explanation of the Swiss negative deposit rates intervention I've read so far is here: http://perspectives.pictet.com/2014/12/19/switzerland-the-snb-introduces-negative-interest-rates/ via Pictet Perspectives.

1/1/2015: Russian Reserves Down USD10.4bn in the Week of December 26th

CBR published data on Russia's foreign exchange reserves for last week (through December 26th), showing another drop in reserves to the tune of USD10.4 billion. So far, since the onset of the accelerated Ruble crisis, Russian FX reserves are down 26.1 billion. December total (excluding December 29-31) decline in reserves is now USD32 billion, which makes it the  worst month for FX losses since the January 2009 when Russia lost USD39.4 billion in reserves. December 2014 so far ranks as the third largest decline month for the entire period for which data is available (since January 1998).

Couple of charts to illustrate:

As of the end of last week, Russian External (Forex) Reserves stood at USD388.5 billion, down from USD420.5 billion in the last week of November. Since the beginning of the sanctions period (from the week of the Crimean Referendum) through the end of last week, Russian reserves are down substantial USD 98.1 billion, while from January 2014 through end of December 2014, the reserves are down approximately USD107 billion. At this rate, and accounting for varying degree of liquidity underlying the total reserves cited here, but omitting the reserves held by larger state-owned enterprises, by my estimates, Russia currently has roughly 18-20 months worth of liquid reserves available for cover of debt redemptions and unrelated forex demand.

1/1/2015: Tech Bubble 2.0 & the Irrelevant VCs

Very interesting take on the growing irrelevance of the VC sector in terms of tech funding and tech valuations bubble: http://www.institutionalinvestor.com/Article.aspx?ArticleId=3412986#.VJzH58AjJA

Some quotes:

"…standard VC line on a standard question in technology today…" is that "it's been a very good year for VC, but 2014 fundraising is still nowhere near levels of 1999 and 2000". Hence, no tech bubble, despite the fact that "Soaring valuations for private companies, some of them in sectors previously thought bubble-prone - even media start-ups are being valued at over USD1 billion these days - have made the bubble question one of this year's most asked". In fact, "2014 has been the year of the monster funding round, led by taxi service Uber, which raised USD1.2 billion in June; Cloudera, a big data start-up, and Flipkart, an e-commerce site, also closed rounds greater than USD1 billion." Note: Uber is now being forced, literally, out of major markets by legislators, regulators and bad PR.

The reason why VC industry is below 1999-2000 bubble funding allocations is, however, not the absence of the bubble, but the decline of the VCs relevance to the sector, where increasingly funding comes from hedge funds, large mutual funds and other non-VC investors.

The above makes it also harder for us to put actual data behind the argument as to whether or not we are witnessing a bubble formation in tech funding, because many non-VC funding sources are not transparent. Two players who tried to put the number on 2014 funding inflow into tech sector find "overall equity funding levels for this year, including investments from traditional VC, dedicated seed funds, angel investors, corporate venture arms and private equity, in the region of USD100 billion. Once mutual and hedge fund stakes are added, it seems fair to conclude that investments in private companies will end the year at or above the levels seen during the dot-com boom."

Ouch! There is a good indication of a bubble maturing, not just forming.

And double-ouch! The old VCs are simply not as relevant anymore.

And triple-ouch! When the dot-com bubble burst in 2001-2002, much of the impact was absorbed by the VCs, which have weaker exposure to the markets at large. This time around, the impact is going to be more broadly based, with adverse spillovers to the markets, pensions funds and bigger investment funds.

1/1/2015: US Mint Gold Coins Sales: 2014

End of 2014 and Q4 2014, so time to update my relatively infrequent coverage of data for US Mint sales of gold coins. Here's the data for the sales of American Eagles and Buffalo coins.

Starting with quarterly data:

• Sales of US Mint gold coins in Q4 2014 reached 183,500 oz up on 141,000 oz in Q3 2014 and the highest reading since Q1 2014. However, y/y Q4 2014 sales were down 4.2% having posted a rise of 24.2% y/y in Q3 2014. There is quite a bit of volatility in Q4 sales. For example, Q4 2013 sales were down 29.5% y/y and Q4 2012 sales were up 74% y/y.
• Sales of US Mint gold coins also fell in terms of average coin weight. In Q4 2014, average coin sold carried 0.57 oz of gold per coin, down from 0.61 oz in Q3 and down from 0.71 oz/coin average in Q4 2013. Still, Q4 2014 reading was second highest in oz/coin sales terms in 2014.

Chart below illustrates.

Monthly trends were less favourable in December. Volume of gold sold via coinage sales by the US Mint fell well below the period average and the series have now been trending below historical averages (both across 2006-2014 range and 2012-2014 averages) since May 2013.

The same dynamics: falling oz/coin average, and falling number of coins sold can be traced in full year sales figures, as illustrated in the chart below.

As above clearly shows, the decline in total number of coins sold has been relatively moderate, compared to historical trend, with sales of 1,322,000 coins in 2014 running very close to 2006-2013 average of 1,361,625 coins. But sales in oz terms have been poor: in 2014 total sales of US Mint gold coins run at 702,000 oz against the 2006-2013 average of 983,250 oz. Thus 2014 was the third worst year on record (since 2006) in terms of sales of coinage gold, but ono the fifth worst year on record in terms of sales of coins by numbers. The average coin weight at 0.53 oz per coin in 2014 was the poorest on record.

Year on year full-year dynamics were poor as well: total coinage gold sold by oz fell 36% y/y in 2014 and there was a decline of 22% in the number of coins sold. Meanwhile price of gold declined (based on month-end USD denominated prices) by 9.94% y/y.

Most of the poor performance in US Mint sales took place in H1 2014, when coinage gold sales in oz terms fell from 790,500 oz in H1 2013 to 377,500 oz in H1 2014.

In the end, 2014 was a poor year for US Mint sales. Even stripping out the sales of the American Buffalo and looking at the American Eagle sales alone - thus allowing the data to cover 1986-2014 period - the trend remains to the downside for both oz sold and coin numbers, with oz sold under-performing the downward trend.

That said, sales of American Eagles remain above the averages for both coin numbers and gold volumes once we strip out 1998-1999 anomalies.

All in, the explanation for 2014 performance is continued decline in demand for gold coins from shorter-term investors seeking safe haven. In general, this is expected and is likely to continue: gold coins are normally the domain of collectors and longer-term long-only investors. We are witnessing a moderation in demand trends toward 1987-1997 and 2000-2008 averages.