Small banks, already penalized with a higher cost of funds than the large banks (link) have more recently been forced to contract due to ‘wholesale funding’ restrictions being imposed by the regulators.

Bank regulators distinguish between what they call ‘retail’ and ‘wholesale’ funding, and have set limits of small banks for ‘wholesale’ funding. This policy is meant to reduce the liquidity risk of a bank not being able to roll over its funding should depositors decide to take their dollars to another bank. The theory is that ‘retail’ deposits are ‘sticky’ and less likely to move to another bank, while ‘wholesale’ deposits are more likely to move. And the ‘better’ the ‘account relationship’ the more likely the funds are to stay with the bank. Oddly, when I inquired if the maturity of the deposit is a consideration the regulators responded ‘no.’ So that means a 10 year CD obtained through a broker is considered a wholesale deposit, which must be limited, while money market deposits from local depositors that can leave the next day are the core retail deposits required by the regulators for ‘stability.’

But apart from this obvious regulatory failure to recognize what’s more stable and what’s less stable for individual banks, there is also a highly problematic macro issue. In the banking system as a whole, loans create deposits, meaning that for each loan made by a bank (bank assets) there exists a bank deposit of the same amount originally created at the time of the loan as that bank’s liability. In short, for the banking system as a whole, loans equal deposits.

The problem is that money center banks attract more of these total deposits than the small banks in the normal course of business. That leaves the small banks short of deposits by an equal amount. This is easily resolved by the small banks needing funding borrowing the excess funds held by the large banks. And if the large banks decide to keep their excess funds at the Federal Reserve Bank the small banks can simply borrow from the Fed to cover their shortage. In any case the total funding of the banking system remains equal to the total loans outstanding, with the Fed acting as a ‘broker’ to facilitate system wide liquidity. However, when regulators restrict this ‘wholesale funding’ between banks, and also deem borrowings from the Fed ‘wholesale funding,’ they put powerful forces in place that force the small banks to either pay higher rates to attract deposits from the large banks, which is often impossible as large corporate customers can’t deal with small banks, or force the small banks to cut back on lending to reduce their dependence on wholesale funding.

The net result is a misguided regulatory policy that is both increasing the cost of funds to small banks and forcing small banks to cut back on lending.

The remedy is quite simple, have the Fed offer funding (fed funds) to all member banks at it’s target interest rate, which is the rate the Fed desires to in fact be the cost of funds for its banking system as a matter of public policy. In any case, bank borrowing and lending is rightly constrained by capital and other regulatory requirements, and not available funding, which is always attainable at a price. Using the liability side of banking for market discipline, as is currently the practice for small banks, is always evidence of a lack of understanding of banking fundamentals and counter to further public purpose.

Please distribute this to your favorite regulator, Congressman, and Fed official, thanks!

I got a nice mention in a CNBC article today:

Why Portugal Downgrade Didn’t Slam Stocks

By Antonia Oprita

July 13 (CNBC) — Investors do not see Portugal’s rating downgrade by Moody’s as an event that will shake the markets, but it confirms the fact that the outlook for some economies in the euro zone is still cloudy, economists and market analysts told CNBC Tuesday.

Moody’s slashed Portugal’s credit rating by two notches to A1, citing a deterioration of the country’s debt ratios and weak growth prospects.

Portugal’s debt-to-GDP and debt-to-revenue ratios have risen rapidly in the past two years, Anthony Thomas, vice president and senior analyst in Moody’s Sovereign Risk Group, said in a statement.

The euro fell after the announcement and the spread between Portuguese and German 10-year government bonds widened by 4 basis points to 290 points.

“The bond markets response hasn’t been dramatic,” Martin van Vliet, euro-zone economist at ING Bank, told CNBC.com.

The downgrade came a little before a Greek auction to sell 6-month T-bills, the first since a bailout package agreed by the European Union and the International Monetary Fund in May.

Greece sold 1.625 billion euros ($2.03 billion) of 6-month instruments at a yield of 4.65 percent, up from 4.55 percent in a similar auction on April 13, according to Reuters.

“The markets will probably reason that the risk of default in six months is small,” van Vliet said.

Growth Is Key

Economic growth in Europe’s peripheral countries will be crucial to bring back investor confidence but more and more analysts fear a slowdown in the second quarter everywhere in the world.

“The outlook for Portugal is not particularly optimistic,” David Tinsley, economist at National Bank of Australia, said. “It is in a very slow growth trajectory and therefore all its fiscal retrenchment has got to come from public spending cuts.”

Over the longer term, investors are still afraid of the risk of default and European Central Bank President Jean-Claude Trichet hinted that the need to intervene by buying bonds is not that strong any longer, according to van Vliet.

“My guess is that they will have to continue buying bonds,” he said. “It all depends on whether the economy will start growing in Greece.”

The risk of default by one of the southern European countries was the main fear in the markets earlier this year, when ratings downgrades sparked massive selloffs in stocks as well as bonds and investors were taking refuge in US Treasurys, gold and cash.

“The process of credit downgrades reinforcing confidence erosion, I think that’s a bit over,” van Vliet said.

Default Risk Is Gone

Investors will slowly realize that the risk of default by European nations on their debt is gone, and they will push up stock prices and the euro, according to economist Warren Mosler, founder and principal of broker/dealer AVM.

In June, Mosler told CNBC.com the euro was likely to rise to between $1.50 and $1.60 because of the austerity measures in Europe.

He reaffirmed his stance, saying that there had been a “mad rush for the exits” by Europeans, who bought dollars and gold, pushing the euro down, when the default risk was high.

But the ECB’s decision to buy Greek bonds showed the bank was ready to spend money to defend countries in the euro zone and “there is no limit to what the ECB can spend,” Mosler told CNBC.com.

The ECB has put itself in a top position by doing this, as it can impose terms and conditions on any country that sells it its bonds, he explained.

“What that did is it shifted power from fiscal policy to the ECB,” Mosler said. “I would say they will not buy these bonds unless they can impose their terms and conditions.”

“It allows them to cut out one member selectively, without the whole system collapsing,” he said.

Still looks to me like the UK budget deficit has been more than sufficient to support at least modest GDP growth.

UK Headlines:

U.K. Economy Grew Unrevised 0.3% in First Quarter

U.K. Consumers Predict Economy Will Worsen, GfK Survey Shows

U.K. Mortgage Approvals Rose 2% in May From April, CML Says

U.K. Profit Warnings to Climb as Deficit Cuts Kick In, E&Y Says

Osborne Says U.K. Budget Cuts Needed to Avoid ‘Downward Spiral’

U.K.’s Budd to Propose More Independent OBR, Telegraph Says

Blanchflower Says Economy May See Long Decade of Slow Growth

The loss seems to have been over the proposed sales tax increase, which would have been a strong negative for GDP, so this result is equity friendly:

“Public support for the DPJ rebounded when Kan took, but tumbled quickly after he floated a rise in the sales tax from 5 percent to help rein in debt.”

“Critics blame Kan’s eagerness to hike the rate for causing the DPJ’s major defeat in Sunday’s Upper House election.”

Japan Headlines:

DPJ Suffers Crushing Defeat; LDP Wins Most Seats

Corp Goods Prices Up 0.5% On Year In June

Japan’s used vehicle sales in Jan.-June fall to 2nd-lowest level

IMF Shinohara: Japan Must Be Cautious Discussing Taxes; No Sharp Yuan Rise

Edano: Won’t Rigidly Stick To Drafting Sales Tax Hike This Fiscal Year

LEAD: Tokyo stocks edge lower as post-election uncertainty weighs+

This latest announcement of the purchase of Irish bonds shows the ECB is continuing its policy of buying national govt bonds to facilitate solvency:

EU Headlines:
Europe’s bankers in talks over bail-out fund

Support for European spending cuts strong

European Bank’s Economist Is Optimistic on Sovereign Debt, but Critics Are Wary

EU Ministers Pressured to Give More Stress Test Data

ECB’s Bini Smaghi Favors Lower Deficit Limit for Stability Pact

ECB Buys 8 Billion Euros of Irish Bonds, Sunday Tribune Says

ECB Buys 8 Billion Euros of Irish Bonds, Sunday Tribune Says

July 11 (Bloomberg) — The European Central Bank bought about 8 billion euros ($10.1 billion) of Irish government bonds in the last seven weeks, the Sunday Tribune said, without saying where it got the information. The purchases account for as much as 10 percent of outstanding Irish bonds, the Dublin-based newspaper said.

I looked into the North Dakota State Bank and didn’t see any reason that would make much of a difference, so I check out their ‘export’ industries:

https://www.dmr.nd.gov/oilgas/stats/DailyProdPrice.pdf

https://www.dmr.nd.gov/oilgas/stats/gasprodsoldchart.pdf

https://www.dmr.nd.gov/oilgas/stats/DrillStats.pdf

all found here:

https://www.dmr.nd.gov/oilgas/

And all with under 500,000 people.

The ECB has ‘written the check’ by buying national govt bonds in the secondary market in sufficient size to allow the national govs to fund themselves, and equities are coming back as solvency fears abate.

There is still solvency risk, but now that risk is the risk of the ECB cutting off any nation in question.

And with exports firming the same forces are causing the currency to strengthen to the point where net exports remain relatively stable.

The ECB is also in full control of the banking system liquidity, as it too is dependent on ECB funding, and dictates terms and conditions there as well, where there need be no failures (even a bank with negative capital can be sustained by liquidity provision) unless the ECB decides to let a bank fail.

EU Headlines:

ECB’s Trichet Says European Economy Showing ‘Encouraging’ Signs

Trichet dismisses fears over eurozone

Trichet Says European Capacity to Decide Always Underestimated

Trichet Says Bond Market Developments ‘Going in Right Direction’

Trichet Calls for ‘Appropriate’ Action on Stress Tests

Banks Will Need More Cash After Stress Tests

EU ‘Stress’ Tests Shrouded in Secrecy

EU Commission’s Barroso Says Bank Stress Tests Are ‘Credible’

ECB’s Bini Smaghi Says Greece Must Maintain Consolidation Effort

Bini Smaghi Says Market Rate Increase Won’t Affect Bank Loans

Stark Says ECB’s Monetary Analysis Enforces Discipline

Annual German Inflation Slows in June to 0.9 Per Cent

German Upper House Approves Naked Short-Selling Ban

French Manufacturing Rose in May, Lifted by Exports, Car Output

Italian Production Climbs as Weak Euro, Recovery Lifts Exports

Spain to allow cajas to sell 50% of equity

Greece Approves Austerity Plan Amid Outcry

Makes perfect sense to me that payrolls would be a function of sales.

Fits with yesterday’s chart and the theme of modest positive growth until private sector credit expansion kicks in

Maersk lifts full-year profit guidance

July 7 (Reuters) — Danish group AP Moller-Maersk upgraded its earnings guidance for the full year, saying on Thursday its container shipping business had rebounded faster than expected. “The upgrade is due to a combination of [freight] rates and cost reductions,” chief executive Nils Smedegaard Andersen told Reuters. “The improvement of especially the container business has since then been greater than envisaged and the company now expects that the profit for 2010 will exceed the profit for 2008 [which was $3.5bn corresponding to DKr17.6bn at the time], provided that freight rates, oil prices and the USD exchange rate remain stable at current levels,” it said. Andersen added: “We know the development in the second quarter, and have a degree of certainty about how the third quarter is going, and there are prospects for good utilisation [of the fleet] in the peak season.”

Seems the fall off after the tax credit ended April 30th has yet to fully run its course:

US Mortgage Applications Soar on Refinance Demand

July 7th (Reuters) —Refinancing drove total U.S. mortgage applications to a nine-month high last week, while demand for loans to purchase homes sunk to a near 13-year low as buyers remained sidelined after the expiration of federal tax credits.

Mortgage rates stuck around record lows, the Mortgage Bankers Association said on Wednesday, giving homeowners another chance to cut monthly payments by refinancing.

Refinancing requests jumped 9.2 percent in the week ended July 2 to the highest level since May 2009, lifting total applications by 6.7 percent, seasonally adjusted, to the highest level since early October 2009.

Demand for mortgages to buy homes slipped 2 percent. It was the eighth weekly drop in the nine weeks since the federal tax credits for homebuyers expired on April 30.

“For the month of June, purchase applications declined almost 15 percent relative to the prior month and were down more than 30 percent compared to April, the last month in which buyers were eligible for the tax credit,” Michael Fratantoni, MBA’s vice president of research and economics, said in a statement.

The average 30-year mortgage rate was little changed in the week ended July 2, climbing 0.01 percentage point to 4.68 percent.

The borrowing rate lingered just above the record low of 4.61 percent set in March 2009, according to the MBA’s records that date back to 1990.

Fifteen-year mortgage rates rose to 4.11 percent last week from the record low 4.06 percent set the prior week.

Refinancings accounted for 78.7 percent of all applications last week, the highest share since April 2009, the industry group said.

Tepid employment growth and a surprisingly steep slump in pending home sales kept interest rates low.

Home purchases will stay weak over the next few months as the housing market adjusts to the end of government incentives, and prices should bottom around the third quarter, said Robert Andrews, senior research analyst at IBISWorld in Santa Monica, California.

Fallout from record defaults and foreclosures are also likely to sway many younger buyers from making such a big commitment in the near term, he said.

“People in my generation, people 20 to 30 years old, saw the downside risk associated with housing, so I think there’s going to be a bit weaker demand over the next few years,” said Andrews.

Refinancing, likewise, is unlikely to approach the levels seen last year when mortgage rates were near current levels.

Borrowers who could qualify for refinancing have in most cases already refinanced, most analysts agree.

Looks like the deficits got high enough in the US and Euro zone to reverse things, and I’d guess UK and Japan as well even though the charts don’t yet show the reversal because past deficits of this magnitude would have been more than sufficient and there recent data is showing signs of a turn.

This is all usually indicative of a multi year upturn, who magnitude depends on the extent private credit expansion kicks in.
In the past the ‘borrow to spend’ private credit expansions have been helped by a variety of ‘peculiar’ events, including the credit expansion due to sub prime and other housing frauds most recently, the dot com era’s borrowing to fund impossible business plans, the credit expansion driven by the S and L frauds in the 80′s, emerging market credit expansion before that, etc. etc.

This time might be different/less robust if credit expansion channels are kept honest and fiscal policy tightened.

With deficit spending running at about 7% of gdp modest growth should continue, with the ‘hand off’ coming when private sector credit expansion kicks in, which could be a while.

Karim writes:

What respondents are saying…

• “The general upswing in the economy, albeit minor, has had a positive effect.” (Arts, Entertainment & Recreation)
• “Pricing pressures continue to increase as we see the economy begin to improve. Orders are still lagging in our industry.” (Professional, Scientific & Technical Services)
• “Slow pace, but better than last year at this time.” (Accommodation & Food Services)
• “Funding issues and cash flow issues continue to affect public sector procurement. Almost all capital acquisitions have been suspended.” (Public Administration)
• “We have seen a slight improvement in business activity over the past month.” (Wholesale Trade)

Looks like my story is unfolding. OK Spanish auction as well. Assuming equity markets were down say 20% from the highs pricing in half the risk of default, they should adjust upward by most of that as default risk fades:

The European Central Bank bought €4bn ($5bn) in eurozone bonds last week, the same as in the previous two weeks, indicating it had fallen into a pattern of low-level intervention in sovereign debt markets, the FT reports.

Very well done by Mike Norman who’s on this email list.

This video makes it all the more obvious that Fox is on a propaganda mission, at best to support ratings, at worst to be subversive, rather than engaging with Mike on the facts.

You tube link:

Mike Norman on Fox

link:

Galbraith’s latest!

GE chief gives vent to frustration over China

June 29 (FT) — General Electric chief executive Jeff Immelt told Italian industrialists at a dinner on Wednesday that he was worried about the way Beijing was treating foreign companies. “I am not sure that in the end they want any of us to win or any of us to be successful,” said the man who runs the largest manufacturing company. “After 30 years of progressive market reforms, many foreign businesses in the country feel as though they have run up against an unexpected and impregnable blockade,” Joerg Wuttke, former head of the European Chamber of Commerce, complained in the Financial Times in April. The American Chamber of Commerce in Beijing has made similar statements, while a new survey of European companies released this week by the European Union Chamber of Commerce in China showed that almost half expect even more problems with regulators during the next two years.

GE has moved production out of China.

FDI (foreign direct investment) alters fx reserves and currency levels, as does domestic inflation.

Yes, I think we have a nice L shaped economy with modest GDP growth and modestly improving employment, so far mostly evidenced by the increased hours worked that you’ve been pointing out. Acceleration happens when/if some aspect of private sector credit growth takes off.

If euro solvency risks are indeed fading, it should be back to an ok market for stocks (which could have a large one time shift upwards to reflect the reduced euro risk), and low rates from the Fed until something changes.

Like Japan, the budget deficit may be large enough to keep it all from collapsing but not enough for the kind of growth that would trigger higher rates from the Fed.

Karim writes:

Data off recent peaks but still firmly in expansion territory:
Anecdotes mixed:

• “Component lead times are increasing sharply.” (Computer & Electronic Products)
• “Market had begun to change, but it is now declining again.” (Wood Products)
• “BP oil spill will impact business conditions over the next few months.” (Fabricated Metal Products)
• “The economy continues to be sluggish, with orders 8 percent to 10 percent below last year.” (Nonmetallic Mineral Products)
• “Retail sales are strong for both the domestic and international markets.” (Food, Beverage & Tobacco Products)

Q2 ended

ECB rolled it all over

Greece weathered the quarter end storm without going parabolic as in previous spikes, as ECB buying continues to provide the secondary market liquidity that enables dealers to buy the auctions.

Euro back up towards 1.24

This would be the time for equity markets to bottom and start discounting fading solvency risk

Might get a temporary pull back on tomorrow’s employment report but seems a weak economy is already fully discounted by US equities, probably also well beyond the actual weakness.