Banks in the European Union will have to restrict their investment in risky operations under new rules proposed by Brussels as part of a response to the current financial crisis.

"We are acting ambitiously to prevent lightning striking twice," said Jose Manuel Barroso, the president of the European Commission, the EU's main regulator introducing the new legislation on Monday (13 July).

New rules in the financial sector are supposed to prevent crisis "lightning striking twice"

The blueprint aims to revise the bloc's existing rules on capital requirements for banks in two key areas - securitisation and remuneration, viewed by experts as the key factors contributing to the crisis in the financial sector.

Both are linked with risk taking in the financial sector: securitisation involves pooling and repackaging of cash-flow-producing financial assets into "securities" then sold to investors that could worsen or lose their credit if the transaction is improperly structured.

EUOBSERVER / BRUSSELS - Non-EU members Norway, Iceland and Liechtenstein are set to renew a five-year funding scheme of over €1 billion for energy, social and democracy projects in the bloc's poorest member states.

"We have made good progress and we hope to finalize the negotiations before the summer break," Rune Bjastad, spokesman for the Norwegian mission to the EU told this website.

Over the last five years, Norway contributed over €1 billion in regional aid to the EU's new member states

Norway is the leading negotiator with the European Commission, with Oslo funding 97 percent of the current €1.3 billion allocated to EU's 12 most recent members, as well as Greece, Portugal and Spain.

In parallel to the renewal of the funding scheme, which ended in April, Oslo is also negotiating bigger export quotas for its fish products onto the EU market.

Singapore's economy has leapt out of recession, expanding in the second quarter at its fastest rate in nearly 6 years, thanks to a surge in biomedical production and construction.

Gross domestic product for the April-June period rose at an annualized and seasonally adjusted rate of 20.4 percent, versus a median forecast in a Reuters poll of 16.4 percent and the first rise after four consecutive quarters of contraction, preliminary government data showed on Tuesday.

From a year earlier, GDP fell 3.7 percent as manufacturing and service industries continued to contract, the data showed. That compared with expectations for a fall of 5 percent.

Analysts remained cautious over the data and questioned its sustainability given volatility in Singapore's drugs output and a weak global outlook, but said other export-dependent Asian
economies were also likely to see improved second quarters.

The core of the problem, the unavoidable truth, is that our economic system is laden with debt, about triple the amount relative to gross domestic product that we had in the 1980s. This does not sit well with globalisation. Our view is that government policies worldwide are causing more instability rather than curing the trouble in the system.

...

The only solution is to transform debt into equity across all sectors, in an organised and systematic way. Instead of sending hate mail to near-insolvent homeowners, banks should reach out to borrowers and offer lower interest payments in exchange for equity. Instead of debt becoming "binary" - in default or not - it could take smoothly-varying prices and banks would not need to wait for foreclosures to take action. Banks would turn from "hopers", hiding risks from themselves, into agents more engaged in economic activity. Hidden risks become visible; hopers become doers.

It is sad to see that those who failed to spot the problem (or helped to cause it) are now in charge of the remedy. Just as the impending crisis was obvious to those of us who specialise in complexity and extreme deviations, the solution is plain to see. We need an aggressive, systematic debt-for-equity conversion. We cannot afford to wait a day.

The whole paper is worth reading

"Dieu se rit des hommes qui se plaignent des conséquences alors qu'ils en chérissent les causes" Jacques-Bénigne Bossuet

The Department of Justice has opened an investigation into the credit derivatives market, with letters sent to over a dozen dealers asking for several years' worth of detailed information about trading and pricing.

The move comes as the regulatory spotlight continues to shine on the credit default swaps (CDS) market, a sector of the privately-traded derivatives universe that grew dramatically in the last decade and generated huge profits for Wall Street.

...

The letters, sent to banks with an equity stake in Markit Group, which provides pricing data on the CDS market and has developed many of the most closely-watched derivatives pricing benchmarks in it such as the mortgage sector's ABX, CDX and ITraxx Europe indices, were sent recently.

According to people who have seen the letter, it does not specify why the DoJ is seeking the information and whether it is a fact-gathering mission or linked to specific concerns of misconduct or market dominance. It was sent by the anti-trust division of the DoJ. The DoJ declined to comment.

In mid-March, the administration proposed that toxic assets could and would be safely removed from banks balance sheets.  We were skeptical, and the the PPIP now seems to have slipped into irrelevance (loans; securities).  But the administration still put an impressive effort into persuading independent analysts, and broader public opinion, that they should do something clearly beneficial for banks.  This was "all hands on deck," and it definitely had an impact on the debate, at least for a while.

Now, the administration's major remaining initiative is its version of a Financial Product Safety Commission - something that would be clearly beneficial for the public.  And the skepticism - and outright opposition - comes from the banking sector.

The Securities and Exchange Commission has created a new group of examiners to oversee credit rating agencies, which came under sharp criticism for their role during the financial crisis.

The SEC has already adopted a number of measures to increase transparency at credit rating agencies, which are paid by the issuers they rate. But greater oversight is needed with officials expected to conduct both routine and special examinations of their activities, Ms Schapiro is set to tell a Congressional oversight hearing on Tuesday.

The plan is part of a wide range of structural changes being made at the SEC, which has faced withering criticism in the past year for its oversight of financial firms and ratings agencies as well as for failing to detect the Bernard Madoff fraud in spite of credible allegations brought to it for at least a decade.

A businessman walks into a government minister's office and says he needs help. What should the minister do? Invite him in for a cup of coffee and ask how the government can be of help? Or throw him out, on the principle that government should not be handing out favors to business?

This question constitutes a Rorschach test for policymakers and economists.

Reprising much of the diary and comments on Chris Cook's No One Saw it Coming?
Parenteau adds some useful observations, starting with the common characteristics of those who did see it coming.

The dissenters, Bezemer found, shared an emphasis on a stock/flow coherent macroeconomics. That is, starting from what should be an uncontroversial, accounting based view that at the level of the economy as a whole, total income must equal total expenditures, and total assets must equal total liabilities, those who saw this coming were able to identify unsustainable sectoral cash flow and balance sheet developments. In advance, a stock/flow coherent macroeconomics revealed the reasons why the Great Moderation was bound, by construction, to eventually give way to the Great Disruption.

As Bezemer put it,

"Surveying these assessments and forecasts, there appears to be a set of interrelated elements central and common to the contrarians' thinking. This comprises a concern with financial assets as distinct from real sector assets, with the credit flows that finance both forms of wealth, with the debt growth accompanying growth in financial wealth, and with the accounting relation between the financial and real economy."

Having performed one such analysis for the Levy Economics Institute in 2006 (http://www.levy.org/vdoc.aspx?docid=866) and studied financial instability reports issued by the Levy Institute, the BIS, the IMF, and others prior to the recent financial crisis, we believe Bezemer has it largely correct. If policy makers are indeed serious about the "never again" pledge regarding a financial crises the size of the recent one, they will need to set aside the prevailing macroeconomic paradigm - one which has largely made itself irrelevant by approaching macro as little more than aggregated microeconomics. Instead, they will need to become familiar with a stock/flow coherent macroeconomics that highlights the way financial conditions can shape economic outcomes. This is an economics examined and utilized by J.M. Keynes, Irving Fisher, Hy Minsky, Wynne Godley, Kurt Richebacher, and others - it is an economics especially relevant to the world we actually inhabit.

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If macroprudential supervision or any such related effort at reducing the odds of systemic economic crises unfolding from financial instability is to be successful, the core analytics will need to be built around a stock/flow coherent approach macroeconomics. The ground work in this area has been already been done by the likes of Claudio Borio, Wynne Godley, Levy Institute research associates, and others working in financial stability projects within various national and international institutions. Without paying attention to unsustainable sectoral cash flows and the resulting balance sheet leverage building up over time, financial vulnerabilities that can trip up the entire economy - indeed, as we have seen, the entire global economy - will remain largely invisible to investors, entrepreneurs, and policy makers. Perhaps that serves the interests of asset bubble perpetrators, but after recent events, it is high time to question whether those interests should remain paramount.

Voit released quarterly reports today for CRE in Las Vegas, San Diego and Orange County.  The reports show the vacancy rates are up and lease rates falling. It also shows new construction has slowed sharply. Here are a couple of graphs for Orange County and San Diego. We are seeing a similar pattern nationwide, although new construction in these areas probably slowed earlier than most of the country.

This graph shows the annual Orange County office vacancy rate and new construction since 1988.

In 2007 the rapid increase in the vacancy rate was due to a huge increase in new space combined with negative absorption as a number of Orange County financial companies (like New Century) went under. New construction has almost stopped, but the net absorption rate is still negative, so the vacancy rate is still rising.

The second graph is for San Diego. The dynamics are similar, but construction halted later than in Orange County.

Although Voit didn't provide a similar graph for Las Vegas, the situation is clearly worse:

   At the close of the second quarter, approximately 10.9 million square feet of vacant office product remained on the market, producing an average vacancy rate of 22.1 percent. When excluding owner-user buildings, the vacancy rate jumps to 24.2 percent for speculative space. Vacancy rates are up from the 19.6 percent posted three months prior, while the comparison to the 16.9 percent vacancy rate from the second quarter of 2008 is even more dramatic.

Great pair of charts from the NY Fed on the various policy responses to the financial crises

Financial Turmoil Timeline

International Responses to the Crisis Timeline

>

Hat Tip: VoxEU via Mike Panzner

Average length of unemployment highest since 1948. - WSJ.com

The recent unemployment numbers have undermined confidence that we might be nearing the bottom of the recession. What we can see on the surface is disconcerting enough, but the inside numbers are just as bad.

The Bureau of Labor Statistics preliminary estimate for job losses for June is 467,000, which means 7.2 million people have lost their jobs since the start of the recession. The cumulative job losses over the last six months have been greater than for any other half year period since World War II, including the military demobilization after the war. The job losses are also now equal to the net job gains over the previous nine years, making this the only recession since the Great Depression to wipe out all job growth from the previous expansion.

Here are 10 reasons we are in even more trouble than the 9.5% unemployment rate indicates:

The NY Times Room for Debate is discussing how we should interpret Goldman Sach's compensation pool, which will be an $11.36 billion set aside for the first half of 2009. Here's the unedited version of my entry (you may like the shorter, edited version better):

And it's not just that the financial sector needs to get smaller so that resources can be used productively elsewhere, the financial sector also needs to change its ways so that risk accumulations do not threaten the financial system and the broader economy. As Robert Reich notes today, Goldman's chief financial officer tells Bloomberg News that "Our model really never changed, we've said very consistently that our business model remained the same." Thus, a second signal from Goldman's unexpectedly large earnings is that firms such as Goldman Sachs are returning to the same high-risk strategies backed by too big to fail government guarantees that got us into trouble in the first place, and that aspect of Goldman's success is worrisome. It's a signal that the excesses that led to the high incomes of financial executives have not ended.

...

Other entries from William K. Black, Yves Smith, Charles Geisst, David Merkel, and Jeffrey Miron.

Following the publication of the first proposed EU law on hedge funds, driven by the French and Germans, many London based fund managers have called for the directive to be altered otherwise they would abandon Europe. The debate has increased as Sweden embarks upon its EU presidency

The Swedish Finance Minister suggested that the Swedish Presidency of the EU would not pursue "overzealous initiatives against hedge funds and private equity firms" and is hopeful of finding compromise between the UK on one side and the French and Germans on the other.

European Commission: Hedge funds are high-risk private investment partnerships that make huge wagers on market movements and are suitable only for professional and institutional investors.

Under the proposed law, managers of hedge funds and similar `alternative investment funds' that handle at least €500 million (€100 million for those using borrowed money) would have to register with regulators.

They would also have to disclose information about their business, for example the extent to which they use borrowed money or financial instruments to boost potential returns.

DOW JONES NEWSWIRES
WASHINGTON (Dow Jones)--Securities regulators on Tuesday issued a joint alert warning investors against buying or retaining over-the-counter shares of the now-bankrupt General Motors Corp. The alert, sent out by the Securities and Exchange Commission and the Financial Industry Regulatory Authority [FINRA], said there is "widespread misunderstanding by investors" that the stock in the bankrupt GM company is related to the "new" General Motors Co. that emerged from bankruptcy last week as a new entity that will belong in part to the U.S. and Canadian governments. "Motors Liquidation Company and the 'new' GM are separate and distinct," the alert said.

Not to be confused either with, according to the NYT, the closely held "Vehicle Acquisition Company but soon to be renamed the General Motors Company"? Persons such as the UAW who accepted OLD GM warrants in consideration of OLD GM fiduciary obligations may liken VAC to a GSE-controlled special purpose entity or pupa from which their ownership interest in the NEW!GM will materialize.

"The new GM currently has no publicly traded securities, and none of Motors Liquidation Company's publicly owned stocks or bonds are or will become securities of the new GM." The alert added that "Motors Liquidation Company is currently winding its way through bankruptcy court - and there is a real possibility that stock holders will receive nothing from these proceedings." Finra, the self-regulatory group for the brokerage industry, halted over-the-counter trading in old GM stock under the GMGMQ ticker symbol last Friday. A new ticker symbol - MTLQQ - will be issued for the old stock to avoid having it confused with the new GM, which does not have any publicly traded securities....

The alert added that investors are often confused by the fact that a company's securities may continue to trade after bankruptcy even though the common stock of that company is likely to be cancelled.

## Zombie Chronicles

Diversity is the key to economic and political evolution.

Video of Spitzer on Bloomberg TV today discussing Goldman-Sachs and the Matt Taibbi article in Rolling Stone this week as well as the reality of the bail-out and how a fictional "paper economy" has replaced the manufacturing base.  

It is nice, by the way, to have Eichenbaum et al showing that the paradox of thrift is real even in a model with lots of maximizing bells and whistles. Has someone told Gene Fama and John Cochrane?

Washington is bluffing that it will not bail out California, and every other state suffering from collapsed revenues and massive job losses. If cuts in police and schools don't force DC off from its current position, then the math will. Because in many states the aggregate revenue losses and looming cuts to state payrolls will largely render the intended effects of federal stimulus as moot. Frankly, unless Washington prints money and bails out every state that needs capital, including California, federal power will decline amidst this severe economic recession, and the process of a soft American devolution will begin. If you think this idea is outrageous, then you've still not come to terms with a core reality of our current situation: the structure of this financial crisis is wholly different than any in our post-war era. This isn't a recession. This is collapse.

Creditflux reported last week that the lawyers of bankrupt Lehman Brothers recently filed in English courts a request to overturn the concept of bankruptcy-remoteness for special purpose vehicles (SPVs). If granted, this request could spell the end of securitization as a once-upon-a-time multi-trillion credit product, regardless of how many PPIP or TALF revisions the administration throws into the CRE fire.

...

   A ruling against the investors would be hugely negative for the credit markets as the concept of bankruptcy-remoteness will most likely not be valid for any transactions where the swap counterparty has a U.S. connection. The immediate outcome will be potential ratings downgrades of funded synthetic transactions, as rating agencies factor in the lower ratings of swap counterparties (provided they have a U.S. connection). In some instances, this could lead to forced unwinds by ratings-sensitive investors, resulting in significant upward pressure on spreads. In the medium to longer-term, this outcome could present a huge hurdle in restarting the securitization market especially as most traditional investors, who are also ratings-sensitive, are unable to participate in the market.

Pay at Goldman Sachs this year is set to beat the boom levels enjoyed before the financial crisis, when top executives raked in tens of millions of dollars in year-end bonuses.

The prospect of bumper pay and bonuses at Goldman, which on Tuesday reported surging second-quarter profits and is a bellwether for Wall Street banks, is likely to reignite a fierce debate in the US over bankers' pay.