Author: Daniel Indiviglio

Continental airlines announced today that it will lay off 600 more reservation agents this year. That’s in addition to the 500 it laid off last year. Since January I have been documenting the fact that, at least anecdotally speaking, we’re still seeing big companies laying people off. That’s exactly the opposite of what we hoped we’d see in 2010 — new hiring. Is this latest news more reason to worry?

The Wall Street Journal reports, after firing these 600 employees Continental will still have 2,000 reservation agents. For those who like percentages, the company is trimming back roughly 23% of its reservations staff. So it’s a pretty deep cut.

The companies says it’s doing this because so many people are taking advantage of online booking, instead of buying tickets over the phone. It’s logical that there’s truth in that. Of course, last year they eliminated 500 jobs, or 16%. So the question is: did the company vastly underestimate how many fewer people were booking over the phone last year when they made those cuts or has their phone-based reservations really dropped by a whopping 23% year-over-year (and 35% in two!)?

I think both those situations are pretty unlikely. In reality, the company may have felt the need for additional cost cutting in this tough economic environment and thought that a little extra hold time (~23%?) for those buying tickets by phone might be worth the cost savings of not employing those 600 people.

Under normal economic times, that probably wouldn’t bother me so much. After all, these job losses appear to be more structural than cyclical. Yet, shouldn’t all such cost cutting have already taken place over the past two years if we are to expect an employment recovery in 2010? That’s clearly not what we’re seeing here. In fact, Continental is cutting even more reservation agents in 2010 than it did in 2009.

And that’s discouraging. At the very least, I would have hoped that the extremely high levels that unemployment reached towards the end of 2009 would have encompassed such cost savings already. But, instead, a growing number of large companies are indicating that the layoffs will continue into 2010. That implies that the correction may not yet be complete.

Bloomberg reports that business economists have provided a little more hope that corporate investment could help bring an economic recovery. The National Association for Business Economics survey of 48 economists found an expected increase in business spending of 7.2% in 2010. That’s a significant increase from the 4.2% gain expected from the survey back in November. This continues to provide a little hope that, even if consumers don’t ramp up their spending, businesses may pick up the slack.

Back in October, I began suggesting that the U.S. would probably have to look to corporate spending to lead recovery. There have been kernels of evidence contributing to that hypothesis ever since. Today’s news marks another significant datapoint. 7.2% is a large increase, and much larger than what’s expected from consumers, who I recently noted aren’t spending much more now than they did in 2009.

But it is enough? I guess that depends on what you mean by “enough.” Even if consumer spending is flat in 2010, businesses increasing their investment in this manner would certainly ensure that we don’t find ourselves in a double-dip recession. But I’m not convinced it will result in a quick recovery in unemployment. It’s important to remember that consumer spending amounts to 70% of the U.S. economy. So, even if you assume that the other 30% is all business spending (and it isn’t quite that simple), that would translate to GDP growth of 2.2% for the entire economy, if consumer spending, government spending and net exporst all stay flat. And if consumers, for some reason, ended up spending just 3.1% less, then it would erase that entire 7.2% spending growth on the part of business.

So the narrative remains the same: we really need a recovery in consumer sentiment for the broader economy to achieve significantly better economic growth prospects. Still, this rebound in business spending is notable. It should ensure that we remain on a good path, and that employment improves steadily, though slowly. And during that time, as unemployment declines, consumers should start feeling more comfortable opening up their wallets again too.

The Economist had an interesting article recently co-written by Credit Suisse’s investment banking head Paul Calello and former chief risk officer Wilson Ervin. They suggest that, rather than bail out banks in the future, they could be “bailed-in.” What does that mean? Essentially that regulators could take hold of troubled banks and require them to rework their capital structure to avoid failure. It would sort of work like a pre-packaged bankruptcy. The idea makes sense, but I wonder: isn’t this exactly what a new resolution authority would do?

We all remember how Lehman tried to avoid bankruptcy, but failed. The authors give a lengthy explanation of how a so-called bail-in would have worked in that case:

How would it have worked? Regulators would be given the legal authority to dictate the terms of a recapitalisation, subject to an agreed framework. The details will vary from case to case, but for Lehman, officials could have proceeded as follows. First, the concerns over valuation could have been addressed by writing assets down by $25 billion, roughly wiping out existing shareholders. Second, to recapitalise the bank, preferred-stock and subordinated-debt investors would have converted their approximately $25 billion of existing holdings in return for 50% of the equity in the new Lehman. Holders of Lehman’s $120 billion of senior unsecured debt would have converted 15% of their positions, and received the other 50% of the new equity.

The remaining 85% of senior unsecured debt would have been unaffected, as would the bank’s secured creditors and its customers and counterparties. The bank’s previous shareholders would have received warrants that would have value only if the new company rebounded. Existing management would have been replaced after a brief transition period.

The equity of this reinforced Lehman would have been $43 billion, roughly double the size of its old capital base. To shore up liquidity and confidence further, a consortium of big banks would have been asked to provide a voluntary, multi-billion-dollar funding facility for Lehman, ranking ahead of existing senior debt. The capital and liquidity ratios of the new Lehman would have been rock-solid. A bail-in like this would have allowed Lehman to open for business on Monday.

So essentially, you wipe out current shareholders and convert a portion of debt to equity. Then hope banks provide (a lot of) liquidity. A few comments.

First, the authors don’t see why bankruptcy code can’t do this today. Here’s their answer: it can, but not quickly. That’s what bankruptcy proceedings are for, and they can last years. Clearly, that’s not an option if you want to avoid a disastrous financial crisis. The authors want to streamline the process; well, I do too. And that’s the whole concept behind a non-bank resolution authority. It would require “failure plans” from large institutions that would anticipate how to handle bankruptcy. Indeed, a firm’s failure plan could look exactly like this. With the new regulator, this would be possible. But for now, it isn’t. Once in place, it may wind-down some institutions if their problems are too great to keep them afloat, but in other instances it could rely on plans like this for reorganization.

My biggest concern with this idea is liquidity. I’m a little less confident than the authors that banks would get in line to provide billions of dollars in cash to their troubled brethren. After all, we’re talking about a market where a credit crunch is probably underway. And liquidity is a significant problem for a bank that runs into trouble. I remember talking to people who worked at Lehman in 2008 about how, internally, people were worried about the firm making payroll in its final weeks.

But overall, I agree that a quick, orderly, bankruptcy plan makes sense. But so does everyone else who supports the idea of a non-bank resolution authority. Indeed, that’s exactly what we’re calling for. Other reforms should still be put in place, however, like leverage limits and higher capital requirements to promote bank safety in a more general sense.

(Thanks to our esteemed Deputy Managing Editor, James Gibney, for bringing this article to my attention!)

Over at Simon Johnson’s Baseline Scenario blog, Harvard Business School professor David Moss writes a compelling post on the need for financial reform to include leverage requirements, which would require banks to have more capital to back up their borrowing. Anyone who thinks excess leverage wasn’t a major cause of the financial crisis needs to study it a little harder. If banks hadn’t borrowed so heavily, they would have been better able to absorb the losses associated with the mortgage market, and there may never have been a credit crisis. My favorite part of Moss’s piece was his final paragraph, where he reminds readers that limiting leverage is not a new or un-American concept:

For those who worry that limiting leverage is somehow inconsistent with American tradition, it is worth remembering that the nation’s founders strictly limited bank leverage in their own time, frequently at less than 4-to-1. Although bank runs remained a problem in early America because of the absence of deposit insurance, the dangers of high leverage were already well appreciated. Let’s not lose sight of that wisdom now.

Indeed, there’s nothing un-American about being prudent. And 30-to-1 leverage (what some big banks weighed in at in late 2007, according to Moss) is anything but prudent. That means if a bank’s assets incur more than a 3.23% loss, then they will become insolvent. Yes, it may have fairly diverse assets, but if the economy gets screwed up enough, such a loss rate is possible — as we learned in 2008.

So what is the right level? That’s not an easy question to answer, but I don’t really see much harm in erring on the side of caution. Banks will still be able to make plenty of money — they just won’t be able to borrow excessively to do so. The House’s financial regulatory proposal would limit leverage to 15-to-1. The Senate’s original version, 10-to-1. What we’ll finally get, however, remains unclear.

Of course, excess leverage isn’t just a problem for banks: it’s also a problem for businesses and consumers. The U.S. was overleveraged in virtually every facet of economics. Too much borrowing and not enough assets is also part of the reason we have so many foreclosures: wacky mortgage products encouraged Americans to have little, no or even negative equity in their homes. If a bank had required a 10% down payment for all homes, then at least that would ensure that the borrower couldn’t be more than 9-to-1 leveraged on that loan in isolation.

If we learn anything from the financial crisis, it should be that borrowing can be a dangerous behavior. And that lesson should be most heeded by anyone extending credit. Lenders and counterparties should all take note. Even in the absence of stricter leverage requirements for banks, counterparties should begin worrying about how much leverage the institutions they do business with have. After all, if their borrowing is excessive, there’s a chance they won’t be able to live up to all their obligations. And creditors to both businesses and consumers should ensure that an economic shock won’t result in defaults as well. More prudent lending and borrowing won’t restrain the innovative American spirit: it will ensure its survival.

Remember way back last spring when Congress changed the rules that credit card companies must follow? Most of those changes take effect today. If you haven’t already received a disclosure about these changes from your credit card company (I did Saturday), then you probably will. But I thought it might be helpful to go through a few highlights.

As I mentioned on Saturday, these highlights are included with the information contained in the Federal Reserve’s new credit card education web site. Since there are so many changes, I’ll only summarize the most significant ones. So if you want additional detail check out that site.

Interest Rates And Fees

A huge portion of the changes affect interest rates and fees.

45 Days Notice

Credit card companies must give you 45 days notice if they change your interest rates, most fees or terms. At that time they will give you an opportunity to opt out, if you don’t like those changes. That means the account will be closed, and you must pay off your balance over time. The company is allowed to change your minimum payment at that time, but repayment should follow the same terms for interest rates and fees.

Bear in mind that not all interest rate changes require notice — only term-altering changes. For example, if you’ve already agreed to any rate changes (like a variable rate or an expiring introductory rate), then no additional notice is required.

No “Arbitrary” Rate Increases In First Year

So long as you pay your card responsibly, the credit card company may only change your interest rate during your first year if you have already consented to it doing so. Again this would include agreements to a variable rate, or an expiring introductory offer. However, if you are 60-days delinquent, then it can still raise your rate.

Treatment Of Balances

There are some pretty nice changes for consumers about how interest rates and payments will be applied to balances. First, if the company increases your interest rate, then it will apply only to new purchases. Now, as you use the card more, minimum payments will still pay off the balances with the lower rate first (as before). But if you pay more than the minimum, then those payments must be applied to the balance with the highest interest rate. This should help consumers to more easily pay off their cards.

Over-Limit Fees

In the past, credit card companies loved it if you went over your credit card limit — they would often allow you to do so, but not before forcing you to pay a lofty fee for that “flexibility” each time. Now, you’ll have to opt-in to incurring that fee. Of course, that means that if you haven’t opted-in, then your purchase will be denied if it exceeds your limit. But it can also save you from paying that fee, if you would prefer not to. And if you do opt-in, then they can only charge you that fee once per cycle, not each time you go over the limit like they used to.

Non-Penalty Fee Caps

The legislation also puts a non-penalty fee cap on new credit cards at 25% of the credit limit. That means, if you have a $1,000 credit limit, then you can’t incur more than $250 in fees for the first year. But if fees are related to penalties for things like delinquency or default, then there are no limits.

Payment

Some changes also focus on how consumers pay off their cards:

Statement Changes

Credit card companies will be required to include additional information on statements about payoff. In particular, they will have to tell consumers how long it will take to pay off the balance if only making the minimum payment. Companies must also tell them how high a payment they would need if they wanted to pay off the balance in just three years.

Payment Dates

The credit card company must make your due date at least 21 days after when it mailed (or when you received) your statement. Your due date will also be the same date each month (ex: the 10th). If that date falls on a weekend or holiday, then the payment is due on the soonest business day thereafter. The new rules dictate that cut-off time for payments cannot be earlier than 5pm.

Other Miscellaneous Changes

No Two-Cycle Billing

Companies are now prohibited from charging customers interest on their balance more than once per billing cycle.

Protection For Young Consumers

If you’re under 21, you now must prove that you can afford your credit card, or you will require a cosigner when opening a new account. Presumably that means you will need to have income or savings. And if you are under 21 and have a cosigner, then he or she must agree in writing to any credit limit increase.

With all these changes, it’s important to remember that they really only protect responsible consumers. If you fail to pay your bill on time, then the credit card company can still generally penalize you as much as it likes. In order for the companies to continue making healthy profits, all consumers have probably already seen their interest rates and/or fees increase over the past year. So that’s all the more reason to make sure you use your card prudently — these protections do not come without cost.

The Federal Reserve went live with a new web site yesterday meant to help educate consumers about credit card terms and disclosures. It’s actually pretty nice and should be helpful to anyone who lacks a robust understanding of credit cards. Check it out here. I’m impressed with the site’s good functionality and broad information.

The site has a several central functions:

– Explains how to understand credit card offers
– Helps consumers read credit card statements
– Provides a card payoff calculator
– Explains the new credit card rules that take effect next week
– Provides a Public Service Announcement video (complete with soft jazz)

It also has tips for improving your credit score and using your credit card wisely. Additionally, the site includes a terminology glossary and a summary of credit protection laws.

Many of the features are interactive, with additional information appearing on graphics as you scroll over. The website is quite good.

It’s nice to see the Fed take its duty of educating consumers seriously. I hope this new site gets significant exposure. One of the best ways to improve the credit industry is simple education. And the Internet can be a powerful tool towards that end. If all borrowers had better understood some of the mortgage products they were signing onto during the housing bubble, for example, the market’s collapse wouldn’t have been as severe.

Yesterday, I wrote about how a compromise forming in the Senate for financial reform may include providing the Treasury with more systemic risk regulatory power than the Federal Reserve. The proposal would place the Treasury Secretary at the head of the table and the Fed Chairman at his right hand. Some are criticizing this compromise, because they think it’s crazy to give the Treasury regulatory authority. They have some good arguments, but it’s too early to know if the compromise is all bad just yet.

A few prominent bloggers are unhappy about this proposal. Calculated Risk quips:

I can just imagine a council in 2004 and 2005 led by ex-Treasury Secretary John Snow with Alan Greenspan as Vice Chair.

And Felix Salmon raises some strong criticisms. He worries that this could result in systemic risk regulation becoming too politically driven, since the Treasury is a part of the executive branch. Consequently it sways as the political winds change in Washington. That’s not the mindset you want for a regulator.

He also worries about Congress’ influence:

I suppose it makes sense that a member of Congress would want to have anybody and everybody maximally accountable to Congress. But that doesn’t make it a good idea. Regulators are like judges: they work best with a minimum of political interference. We saw that with the regulation of Fannie Mae and Freddie Mac: it got hijacked by Congress to the degree that the nominal regulator was to all intents and purposes powerless to do anything but that which Congress demanded. And the consequences were disastrous.

These are all fair objections. But I think we really need to wait a little longer to see how the final proposal reads before jumping to any conclusions.

As I’ve said before, I would have preferred to see something like in Dodd’s original plan, where an entirely new agency was created specifically to monitor systemic risk. That way, you wouldn’t have to worry about its independence or bias resulting from other duties. For that reason, I do not advocate providing the Fed with this power.

If the plan calls for a sort of sub-agency in the Treasury to take on this task with real safeguards in place to ensure independence, then it might not be so bad. The role of the Treasury Secretary could turn out to amount to little more than the designation as chairman on a council of virtual equals. He may sit at a round table, rather than at the head of a rectangular one. Unless his vote has more weight or he has some sort of regulatory veto power, his title might not mean that much.

But if it turns out that the Treasury Secretary has a very hands-on role and large degree of autonomy to control systemic risk regulation, then that’s bad. Salmon and others are right to worry about the Treasury’s independence if that’s the case.

I’m hoping for the former conception, but worry we’ll get the latter. Maybe it’s the cynic in me, but I don’t find it altogether shocking that Congress and the Obama administration would prefer to keep this power to themselves, rather than cede it to a new, more independent body as Dodd’s original proposal called for.

The Mortgage Bankers Association released its fourth-quarter data today. As you might expect, the percentage of loans in foreclosure increased — to 4.58%, from 4.47% in the third quarter. That’s the bad news. The good news is that delinquencies declined to a seasonally adjusted percentage of 9.47% from 9.64% in Q3. Should we treat this data as a generally positive for housing’s recovery? The MBA thinks so.

Foreclosures are a lagging indicator of housing market health, while delinquencies are a leading indicator. That’s why the MBA thinks the decline in delinquencies should carry more weight than the increase in foreclosures. Jay Brinkmann, MBA’s chief economist says:

“The continued and sizable drop in the 30-day delinquency rate is a concrete sign that the end may be in sight. We normally see a large spike in short-term mortgage delinquencies at the end of the year due to heating bills, Christmas expenditures and other seasonal factors. Not only did we not see that spike but the 30-day delinquencies actually fell by 16 basis points from 3.79 percent to 3.63 percent. Only three times before in the history of the MBA survey has the non-seasonally adjusted 30-day delinquency rate dropped between the third and fourth quarter and never by this magnitude. If the normal seasonal patterns hold for the first quarter, we should see an even steeper drop in the end of March data.

Let’s hope he’s right. But it can really only be interpreted as a good sign that delinquencies are declining. The big question is whether this trend will continue into future quarters.

As far as the states still suffering, Florida and Nevada continue to feel the most pain. Brinkmann also says:

“Florida continues to be the worst state in terms of delinquencies with 26 percent of Florida mortgages one payment or more past due as of December 31st. 20.4 percent of Florida mortgages are 90 days or more past due or already in the process of foreclosure. Nevada is the second worst state with 24.7 percent of its mortgages one payment or more past due and 19 percent 90 days or more past due or in foreclosure.

It’s kind of incredible to try to imagine that one-out-of-four homeowners with mortgages in an entire state could be having trouble making their payments. But that’s the reality Florida and Nevada both face. And what’s even worse is that one-in-five have defaulted, which usually means those borrowers face losing their homes, unless they manage to modify their mortgages.

The conclusion I draw from this news is pretty straightforward. Things were still pretty awful last quarter in housing, but there’s reason to be cautiously optimistic about the future.

President Obama will announce a new initiative today in Las Vegas to assist struggling homeowners in five of the states hit hardest by the collapse of the real estate market. He’ll do so by providing up to $1.5 billion in funding for programs that those states think up independently, so long as the Treasury approves. The intention is that these states can develop good ideas to address the regional challenges in preventing foreclosure. The initiative has some pros and cons, but overall it’s a pretty interesting idea.

First, a little more detail. That $1.5 billion will come from the bank bailout (TARP) slush fund. So Obama doesn’t need anyone’s permission to use it. Of course, this also means that it will add to the deficit. And there’s the first con.

Second, the funds will only be available to five states: Nevada, California, Arizona, Michigan and Florida. They’re the usual suspects when we talk about how bad the housing market is. Real estate’s collapse was widespread, but it was far more severe in these five states. Their home prices declined by more than 20% from their peak. As a result, it probably makes sense to focus on these few, though the other 45 probably wouldn’t have minded a piece of the $1.5 billion pie.

But, really, targeting who gets this assistance makes a lot of sense. Yesterday, I mentioned that one of the problems with the home buyers credit is that many homeowners who would have bought a home anyway still get the government money. That causes needless government spending. By targeting the worst-hit states, the unintended beneficiary problem will be less severe, though it’s impossible to eliminate entirely.

I also like the idea that state governments will essentially have to “earn” this month by coming up with innovative ways to prevent foreclosures. As I’ve said in the past, the Treasury’s Home Affordable Modification Program isn’t reaching as many struggling homeowners as anticipated. The administration must see this new initiative as a way to reach even more.

So what will these states come up with? Principal reductions? Payment deferrals for the unemployed? Home to rental conversions? Presumably anything goes — so long as the Obama administration approves. That’s also a pretty smart move politically, because it could allow for some of these states to institute more controversial measures. If such programs aren’t instituted nationwide, then they should have only a minor place in national headlines.

Overall, this new initiative is a fascinating strategy. It’s a pretty savvy move on the part of the Obama administration, as it targets the worst hit states, gives them flexibility and likely minimizes political fallout that would result from a new nationwide program. I’ll be curious to see what the states come up with.

Bloomberg reports that start-up mortgage insurer Essent Group is optimistic about its business prospects. Goldman Sachs and JP Morgan are too — they’re part of a group of investors that put $500 million equity in the new firm. Given the market landscape, I think that’s probably a very smart investment.

Essent’s CEO, Mark Casale says:

“We feel like the market is starting to turn around,” Casale said. “Our timing is actually very good,” he said. “Guidelines are tighter, underwriting has been much better over the last couple of years. We believe it is going to be a very good market.”

Quite right. The mortgage market has collapsed. Even if it isn’t on a vast, upward trend, its losses for new originations at this point will probably be limited for the foreseeable future. And since underwriting standards generally require lower loan-to-value ratios, higher down payments and better overall credit, losses should be minimal. Meanwhile, insurers can probably get away with charging higher premiums than in the past, using recent mortgage market experience as an example of the kind of potential losses that they’re guarding against.

(High Revenue) – (Low Cost Base) = No-Brainer

To make matters even better for Essent, think about its competition — or lack thereof. Arguably no industry has taken as bad a beating over the past few years as mortgage insurers. The industry has suffered incredible losses, rating agency downgrades and near collapse. Their balance sheets are still reeling. Their reputational risk is probably irreparable. That means two things: the amount of guarantee volume the established insurers can afford is probably limited, and fresh healthy entrants will be very attractive to mortgage investors.

The big question is whether Essent would do any better in a future housing market crash. After all, its CEO comes from Radian — one of those insurers that suffered billions in losses. The reality is that this “new” company will probably be made up of a lot of the old employees from those mortgage insurers that failed to make accurate risk calculations. The hope must be that they’ve learned a thing or two over the past few years. Of course, even if they haven’t we won’t find out until another epic housing market collapse, which is probably at least several decades off.

The Bureau of Labor Statistics announced this morning that an important measure of inflation, the Consumer Price Index, rose by 0.2% in January on a seasonally adjusted basis. That matches the rise for the prior four months. It was also lower than the 0.3% rate that economists expected. So-called “core” inflation, which excludes food and energy, actually declined by 0.1%. This data and the numbers behind it show that inflation is still under control.

First, here’s monthly change in CPI for the past year provided by BLS:

If you look at the components of inflation, it becomes clear that January’s rise is due mostly to food and energy. For the month, food prices rose by 0.2% and energy prices rose by 2.8%. If you take those factors out of the equation, then “core” CPI actually declined by 0.1%. That’s very low. In fact, it’s the first negative reading for this statistic since the early 1980s. Here’s a graph since 2000:

Without food and energy, you actually find a very smooth line for the 12-month percent change in CPI:

As you can see, the red line is virtually flat. Most movement in the price level is being driven by food and energy, but mostly energy. Within energy, gasoline prices rose 4.4% in January — the biggest increase since August. Gasoline prices have also risen 51% in the past 12 months.

The other than food and energy, the only other item categories with price levels that rose in January were medical-related goods and services and used autos. All others declined.

Today’s inflation news should serve as a reminder that inflation isn’t what we should be worrying about at this time. Even with the economic improvement we’re experiencing, inflation is clearly under control. In fact, the measure without food and energy is deflationary. Monetary supply tightening will have to happen eventually, but this data makes clear that doing so in the near-term would be premature. The risk of a double-dip recession continues to far outweigh that of wild inflation.

In a late-afternoon announcement, the Federal Reserve said Thursday that it was raising the discount rate from 0.50% to 0.75%. That’s the rate at which it charges banks for emergency borrowing. It also raised the minimum bid for Term Auction Facility (TAF) auctions. It is, however, leaving the ever-important federal funds rate at its exceptionally low level of between 0% and 0.25% for an “extended period.” These actions mark new steps in the Fed’s exit strategy: now that the crisis is over, it’s time to wean banks off borrowing from its balance sheet. I’ve got a few observations.

First: well, that was quick. It was only last week Bernanke wrote that the Fed would be raising the discount rate “before long” in a prepared speech. He was supposed to say this before the House Financial Service Committee, but the snow preempted the meeting. Now it’s pretty easy to understand why he decided to release the speech anyway: he didn’t want to catch anyone off guard. The meeting hasn’t been rescheduled.

The discount rate increase should have little immediate impact, since not many banks are borrowing from the discount window. Even those who need emergency funding have instead generally chosen to participate in the TAF since its creation. But that’s ending in March, and the Fed statement also increased the minimum bid in TAF auctions from 0.25% to 0.5%. That means that banks are being discouraged from borrowing emergency funds from the Fed, whether through the TAF or the discount window.

So while the move isn’t terribly significant in the short-term, it does show just how serious the Fed is about reducing banks’ dependence on its lending. This won’t actually soak up any monetary supply already out there, but it will discourage banks from borrowing more.

Gallup has some sobering news about consumer spending: it might not be improving as much as we thought. In fact, it seems spending was virtually flat in January 2010 compared to January 2009. Since consumer spending makes up 70% of the economy in the U.S., if that doesn’t rebound, it will be hard for anything else to either. Let’s look at the data.

Here’s what Gallup shows for self-reported spending broken into two income segments:

For upper-income Americans, that’s an increase of less than 3%. For middle- and lower-income income Americans, that’s a decrease of 7%. As you can see, in both graphs 2009 also looked an awful lot worse than 2008. Gallup says that this could be a “new normal.”

I’m not sure about that. But this does show that spending isn’t really improving very much — if at all. It also reinforces the idea that the recovery probably won’t be particularly steep.

Today, a letter signed by a number of prominent economists was sent to Congress suggesting a tax credit for companies that hire additional workers. The proposal isn’t a completely awful idea. It could encourage some firms to hire more quickly than they otherwise would have. My colleague Derek Thompson has written about the idea before, listing pros and cons. I have several additional concerns. No matter what scenario you can imagine, the credit may be pointless at best or harmful at worst.

Before getting into scenarios, under what condition will a firm hire due to a tax credit? The size of the credit would have to be equal to (or greater than) the total cost (salary, benefits, overhead, etc.) a firm incurs on those employees that are hired for the time that would have elapsed until they the firm would have brought them on without the credit. Let’s consider three scenarios: if the credit is too large, too small or just right.

Too Small: A Waste Of Money

If the credit is made too small, then it won’t encourage any companies to ramp up hiring. Instead, the only companies who will end up collecting it are those that would have hired anyway. Those companies would be rewarded for what they were already planning on doing.

This is a major criticism of other government tax credits like the first-time home buyers credit. There’s no way to separate those who were motivated by the credit to act and those who would have done so anyway. This would result in purely wasteful government spending. Unfortunately, given the challenge of passing any new spending measures in Congress these days, the credit ending up too small to actually create any new labor demand is a real danger.

Too Large: A Double-Dip?

If the credit is larger than it should be, then this could create a labor demand mismatch: companies who actually shouldn’t be hiring based on their future demand may do so just to get the credit. Unfortunately, such a credit probably can’t be targeted at specific industries and firms — so it can’t just be given to those that should be or would soon be hiring. Not all firms and industries will rebound in the same way.

If firms are encouraged to hire more than real demand will warrant their doing so, that will cause inventories to rise again: consumers and businesses won’t buy as much as they’re producing. This could result in big inventory surpluses. Firms will only allow those inventories to grow so much before they begin laying people off again, so to liquidate their excess supply. Firms laying workers off again once the recovery appears to be well underway could spook the markets and damage the strengthening consumer sentiment. If these firms had instead wait to hire until actual market demand for goods and services dictates, then you’d have a smooth recovery with less risk of a double-dip.

Just Right: What’s The Point?

But let’s say that Washington somehow gets the credit just right (see definition above). In that case, the government and individuals should be indifferent to the tax credit and extending unemployment. In both scenarios, those individuals would have had approximately the same income, and the government would have faced approximately the same expenditures. The only difference is that the companies would have created excess inventory during the time period when they wouldn’t have otherwise begun hiring, which I already explained is probably undesirable.

For these and additional reasons others have mentioned, I’m pretty skeptical that a hiring tax credit would be a great idea. It’s based on the theory that companies aren’t hiring when they should be. I’m not sure how that could be a real problem: unless firms are turning away business, they’ll have to hire before long if they see demand increasing. As a result, it would be better to allow employment to follow its natural growth path or rely on other stimulus measures, rather than risk the negative consequences explained above.

A New York Supreme Court judge has ruled that Wall Street banks’ lawsuit against bond insurer MBIA won’t be dismissed. The banks are angry because they believe MBIA used illegal tactics to shield some of its assets from making good on its insurance contracts on securities that went bad. Even though regulators approved of how MBIA split itself into two entities, banks think they should still be entitled to damages. While this is tricky as a matter of law, I agree in principle.

Let me provide a little background. MBIA insures different kinds of bonds. For example, it can insure a municipal bond so that investors incur fewer losses if the bond goes bad. It happened to insure a large number of mortgage-backed securities and other structured products, many of which suffered big losses when the housing market collapsed. As a result, the company began having trouble living up to all of its guarantees: it hadn’t anticipated such a calamity and didn’t have the necessary capital to absorb the associated losses.

As a result, it split the company into two parts: one for its municipal bond business and another for everything else, including the toxic bond guarantees. Bloomberg News explains:

MBIA created the National Public Finance Guarantee Corporation, which assumed $5.4 billion of the MBIA Insurance Corporation’s assets and its public finance obligations. MBIA’s structured finance guarantees, including those related to mortgage securities, remained the obligation of the MBIA Insurance Corporation.

The banks and investors holding insured toxic bonds were not amused. They believed that they should have a claim on those $5 billion in assets that MBIA split off to create a focused municipal bond insurance arm. That’s why they sued.

This is a difficult case, because, inexplicably, the move was approved by a regulator, the New York State insurance superintendent. If a regulator says it’s okay, how could MBIA be breaking any laws?

As a matter of law, I’m really not sure what should happen in this case, because the problem I see here is that a regulator should never have approved of this tactic. It was unfair to those who believed that the guarantees on the bonds they purchased would be backed up by all of MBIA’s assets. After all, if they’d known that some $5 billion in assets would be shielded from their claims, then they probably would have viewed the insurance less favorably.

A company should not be able to just split itself up so to shield its assets from its losses. In an economy where firms are becoming more and more diversified, you can begin to imagine this setting a precedent where divisions that do extremely poorly could just be split off from well-performing parts of a firm. Then, other companies owed money by those troubled divisions would just be out of luck. That would create incredible moral hazard for management to allow separate divisions to take as much risk as they like, without needing to worry much about consequences.

Yesterday, I wrote about some new data in the Treasury’s monthly report (.pdf) on its Home Affordable Modification Program report. There is another really interesting chart in the report I think worth mentioning: the progress report for banks and servicers making modifications. It shows that some banks are having great success modifying mortgages, while others struggle.

The chart I’m talking about lists the most major banks and servicers taking part in the program. It then provides a bunch of different data points including estimated eligible delinquent mortgages, trial modification progress and permanent modification progress. Rather than just paste the chart in this post, I thought it might be more useful to sort the banks and servicers based on several different measures of how well they’re doing.

Trial and Permanent Modifications vs. Total Eligible

First, let’s look at a sorted version of a column that the chart itself actually provides: the total trial and permanent modifications as a share of eligible delinquent mortgages. This is a sort of all-in progress measure, since some of those trials won’t achieve permanent status and the percentage considers the entire pool of potential troubled homeowners that could qualify for modifications. Here’s how it breaks down:

The clear leaders are Citi and GMAC. They’ve made progress modifying a full 50% of estimated eligible mortgages. That’s quite impressive. A few other big banks aren’t far behind, with JP Morgan and Wells Fargo also above the average (“Total”) performance. Less impressive is Bank of America, with only a 22% score. Purely pitiful is Wachovia with just 3% of its eligible mortgages modified.

Permanent Modifications vs. Trials Extended

Next, let’s look at a different measure: the percentage of modifications have been made permanent out of those total trial modifications extended. This shows the challenge banks and servicers are having bringing mortgages from trial to permanent status:

Here, some of the smaller servicers are leading the way. Wells Fargo is the only big bank that even manages to tie the average score of 9%. Meanwhile, some of the other big ones like JP Morgan, Bank of America and Wachovia are struggling, with scores of 5% or less.

I included an extra column here, because I think there’s a story to be told. Smaller servicers are generally doing much better than the larger ones. This could be used to support the thesis that the big banks are having logistical difficulty with processing all of these modifications. Whether they don’t have enough staff or just have poor systems for keeping their documents organized, something is going wrong.

Permanent Modifications vs. Total Eligible

Finally, let’s consider how many modifications have been made permanent as a total portion of those eligible. This shows progress servicers have made bringing modifications permanent versus what was possible in totality:

Interestingly, GMAC leads the way here. Citi and Wells Fargo are also above average, though their scores are still only single-digit percentages. The scores of some others, like Bank of America and Wachovia are really quite ugly. They’ve barely made any progress in permanently modifying their pool of bad mortgages.

Just How Many Mortgages Are Eligible?

This report’s servicer progress chart provides one other puzzling data point. In the second chart above, you can see that the total estimated number of eligible loans is about 3.4 million. Yet, yesterday, I noted a new chart that the Treasury provided in the report this month claims the total number of estimated mortgages eligible for the program is only about 1.7 million. These numbers can’t both be correct, and they’re very far off. If the servicer chart is accurate, then the program on a whole isn’t doing nearly as well as that new chart would imply. But if the new chart is right, then the servicers are doing much better than their chart would indicate.

Lawmakers might be on the brink of finally deciding how a new systemic risk regulator should be structured. The New York Times reports that a new compromise would create a council of regulators, led by the Treasury Secretary. It would also reduce the amount of new power given to the Federal Reserve and provide more to the new council and Treasury. This is a good development: it demonstrates a move towards a better solution for systemic risk regulation and shows continued progress in the financial reform effort in the Senate.

First, is this compromise more like the Senate’s proposal or the legislation the House passed in December? Recall, the Senate sought to create a new agency to handle systemic risk, while the House wanted to give most of the regulatory power to the Fed. Unfortunately, this report provides few details. In addition to explaining that there would be a council of regulators headed by the Treasury Secretary, it says:

Assigning the Treasury Department the job of spotting incipient trouble and addressing it quickly has support among senators from both parties, though several important provisions, including whether the council would have the ability to bypass existing banking regulators and impose its own rules on huge financial firms, remain to be worked out.

The effect would be to diminish the authority of the Federal Reserve, whose regulation of banks has been criticized for failing to head off the problems.

From this, it sounds like a true compromise. In the House version, the Treasury Secretary led a council of regulators who looked at big picture issues. That appears to remain intact. The original Senate version would have had its new systemic risk agency chief as leader of the council. But if the Times’ source is right about the diminished role of the Fed, then that’s a win for the Senate’s vision. It sought to have a separate regulator take on this duty. While it appears that no entirely new agency would be created by the compromise, more power would lie within the Treasury and council, not the Fed.

This makes a lot of sense. Here’s why:

“Let the other traditional regulators focus on direct banking regulation and have the Fed focus more exclusively on monetary policy,” said one committee member, Senator David Vitter, Republican of Louisiana. “It’s not like they have a small or unimportant portfolio.”

The idea is that the central bank should stick to central banking. When it comes to systemic risk, it would still have an important seat at the table, as the Fed chief would be vice chairman of the council. So it would still share any data that it has compiled on mounting systemic risk. But the actual regulatory authority would be elsewhere, as it should be. That eliminates any conflict of interest that could exist between prudent regulation and central banking. It would also allow the Fed to focus on its already challenging purpose.

One sort of obvious takeaway from this news is that the Senate’s effort is hardly stalled. The Times reports that Senate Banking Committee Chairman Christopher Dodd (D-CT) and at least a few prominent Republicans, including Richard Shelby (R-AL) and Bob Corker (R-TN), also think it makes sense for the Fed to have less power in systemic risk regulation.

The Treasury, and consequently the White House, is also on board. That, however, should be unsurprising, since the executive branch is the big winner in the compromise, as it would gain most of the power the Fed loses. Yet, according to this report, even Fed Chairman Ben Bernanke is okay with this new proposal. The article is unclear on how the House will react. While that’s important, the House based most of its bill on the Treasury’s original proposal. So if it’s taking orders from the White House, then it should also comply with these changes.

I’ll continue to closely monitor how this compromise evolves. We still don’t know many of the details, so I’m not entirely convinced that the final bill will look like what this report indicates. The Fed may still end up with more power, particularly if the House balks. But overall, this news is very encouraging.

The Treasury released its monthly progress report (.pdf) on its Home Affordable Mortgage Program, meant to prevent foreclosures through mortgage modification. It shows continued progress in the modification effort. The permanent modifications are finally beginning to materialize. They nearly doubled in January, now at 117,302 from 66,465 in December. The report also offers some interesting new data.

First, let’s look at my favorite chart, which I’d argue is the most important. I wrote about this one last month, when I noted that it dropped a line I liked — number of requests for financial information sent to borrowers. I had used that to calculate the program’s success rate, since that could be thought of as the total pool of who might want a modification.

They didn’t bring that statistic back, but the chart continues to evolve. Here’s what it looked like for December:

And here’s what it looks like in this month’s report, for January:

The changes begin about four lines up from the bottom in January’s version. They dropped pending permanent modifications (though you can still get this on page 7). They then added a bunch of lines. The first is “Trial Modifications Cancelled” — the ones that failed to go permanent. They’ve also split up permanent modifications into total started, total cancelled, and total active.

This break down will eventually be very interesting, because it will help to define the re-default rate. It’s pretty broad data, however, so it’s hard to get a meaningful understanding of how high that re-default rate really is now, because we don’t know the vintages of those failed modifications. If we did, we could identify if underwriting standards are getting better or worse. But we should still keep an eye on this and the trial modification cancellation statistics.

The Treasury also included another interesting chart:

Remember that statistic I referred to above that got taken out last month — number of requests for financial information sent to borrowers? In November, it was over 3 million. But this new chart indicates that only 1.7 million homeowners were ever eligible for the program. This shows lots of Americans were requesting information, but weren’t ultimately eligible.

It also serves to make the Treasury’s statistics look a little better. As the earlier chart I referred to above shows, 1.3 million trial plans have been offered. That means approximately 75% of eligible borrowers have received trial offers. Clearly, the Treasury wants people to conclude that banks are doing a pretty good job pushing modifications out to those who qualify.

Of course, this raises a separate objection: why are only 1.7 million out of the 5.6 million troubled homeowners eligible? And if only 1.7 million Americans have been eligible up to now, then it’s hard to imagine how the Treasury will reach its goal of offering “reduced monthly payments for up to 3 to 4 million at-risk homeowners” through the program. If that’s really its objective, then the way the program works should be re-examined.

Today, the Federal Reserve released the minutes of January’s Federal Open Market Committee meeting. When analyzing the statement a few weeks ago, I noted my surprise at Kansas City Fed Governor Thomas Hoenig’s decision to vote against the monetary policy action. While I generally find myself on the same page as Hoenig, I didn’t agree with his vote. But today’s minutes provide some additional detail, so let’s look at why he actually dissented.

The Fed minutes say:

Mr. Hoenig dissented because he believed it was no longer advisable to indicate that economic and financial conditions were likely to “warrant exceptionally low levels of the federal funds rate for an extended period.” In recent months, economic and financial conditions improved steadily, and Mr. Hoenig was concerned that, under these improving conditions, maintaining short-term interest rates near zero for an extended period of time would lay the groundwork for future financial imbalances and risk an increase in inflation expectations. Accordingly, Mr. Hoenig believed that it would be more appropriate for the Committee to express an expectation that the federal funds rate would be low for some time–rather than exceptionally low for an extended period. Such a change in communication would provide the Committee flexibility to begin raising rates modestly. He further believed that moving to a modestly higher federal funds rate soon would lower the risks of longer-run imbalances and an increase in long-run inflation expectations, while continuing to provide needed support to the economic recovery.

Hoenig’s concern is understandable. As I’ve mentioned before, whether we like it or not (I don’t), the market overanalyzes the Fed’s every word. While nobody really knows what “an extended period” means, it probably doesn’t mean a month or two. Hoenig must prefer “some time” because it’s a tad more vague, which means it gives the Fed a little more wiggle room to raise rates sooner if necessary. He must anticipate that could happen if the recovery suddenly becomes more rapid.

I don’t entirely disagree with Hoenig — insofar as it would be nice for the Fed to feel less pressured to keep rates very low, in the unlikely event that a broad, robust recovery is suddenly sprung upon us. Yet, as I just mentioned, the market looks at the Fed statement probably too closely. So it would definitely notice if the language changed from “an extended period” to “some time.” And there’s a danger that it could freak out.

Presumably, that’s what the other committee members worried about. While most economists believe that we’re in a recovery, they also see that recovery as slow, particularly for employment. As a result, the economy is still fragile. The last thing the Fed should do is something that might spook the market. That could send banks and investors reeling and help cause a double-dip recession.

But don’t get me wrong: the Fed can’t avoid raising rates forever, so it can’t say that they should be kept low for “an extended period” forever either. Should it change that language during the March meeting? What about April or June? It depends on the recovery. If employment shows tangible improvement, consumer sentiment and spending continue on an upward trend, the housing market clearly stabilizes and the financial markets are successfully weaned off government and Federal Reserve assistance, then perhaps. So until we can be sure that the recovery won’t regress, I’ll have to side with the majority of Fed governors on this one.

Walgreen Co. will acquire New York City-based drugstore chain Duane Reade for $1.1 billion in cash. As anyone who has spent much time in the city knows, Duane Reade is, by far, its most dominant drugstore chain. But its ambition never extended much past the confines of the five boroughs. The move makes sense for Walgreen, but will likely transform many New York City storefronts in time.

This marks a nostalgic day for New Yorkers who have come to love (and sometimes hate) one of the most plentiful stores in the city. Having lived in Manhattan for six years, like most residents, Duane Reade played a pretty prominent role in my life. It is really the only drugstore in most areas. Once in a while you come across a Rite Aid, CVS or Walgreens, but Duane Reade is king. You generally can’t walk more than a few blocks without encountering one.

As far as a business decision, it seems pretty obvious why Walgreen would want to complete this acquisition. It suddenly has the New York City drugstore market cornered. And that’s a pretty huge population. It had 70 stores in the city. Now it will have 327. While the specific terms of the deal would have to be examined to know if it was a bargain for Walgreen, there’s no doubt that it makes strategic sense given the potential synergies the horizontal acquisition should provide.

So does this mean the end of Duane Reade? Not yet, according to the press release:

Duane Reade will continue to operate under its brand name after the transaction closes. With Walgreens currently operating 70 stores in the New York City metropolitan area, decisions will be made over time as to the best, most effective way to harmonize the Walgreens and Duane Reade brands. Walgreens expects to retain Duane Reade’s store, pharmacy and distribution center employees and many members of Duane Reade’s senior management team following the acquisition. Over time, consolidation of core functions at the corporate offices will occur.

In other words, for the time being, you’ll still see Duane Reade stores. But I would be shocked if this didn’t change over time. In particular, the generic products would almost certainly be produced with Walgreen’s name, because there’s no point for the same firm to produce the same product with two names for different stores. The store names will likely change in time too, because Walgreen will want that brand recognition for all of its locations. Some Duane Reade management will almost certainly be eliminated, as with virtually all acquisitions.

So collect those Duane Reade products while you can New Yorkers, because one day soon they may be collector’s items.