The complexity of the summit’s potential fixes for the euro zone’s sovereign debt and banking seizure has been debated in the finest of details across news agencies, newspapers and the web on a minute-by-minute basis for the past several weeks.

And for some commentators the outcome is now binary. A solution that ticks all the boxes would deliver a surge of relief to markets, banking and global economic confidence at large. Failure would spell disaster, the end of the euro in its current form, double-dip world recession or even depression.

Complicating the picture, as ever, is the fact so many views are tinged with some political tilt or bias on the issue.

Those intent on saving the euro at all costs via deeper European integration now talk in apocalyptic terms, in part to prod governments and electorates into taking what they see as the only sensible option of deeper cross-border links.

The euro-skeptic lobby is equally vociferous in deriding a structure they always felt was doomed to fail, reinforcing their long-held political arguments on economic sovereignty and wariness of supranational integration.

For many money managers, the more prosaic reality is probably somewhere in between and something that just “works.” And despite some of the most sophisticated financial analysis money can buy, many are just bamboozled by the politics.

CONFUSED, FROZEN, LOOKING FOR ANSWERS

“Our investors are confused,” Laurence Fink, chief executive of the world’s largest money manager Blackrock, said late Wednesday. “We have many clients worldwide who are confused, frozen, looking for answers.”

If European governments acted with a sensible long-term view, Fink added, investors “would rush right back into the marketplace.”

But it’s the variety of ideas surrounding a “sensible long-term view” that throws us back into acres of grey area.

All of which might explain why there has been little or no net move in the world’s benchmark financial prices and indices for almost two months — plenty of ebb and flow and volatility, but no real direction since August.

What is more, the fog surrounding the euro fine print means more and more money managers are hoping the recent stabilization of global growth can by itself hold markets together even in the face of European “muddle through.”

Data out over recent weeks has shown a jump of more than one percent in US retail sales and a 15 percent jump in U.S. housing starts in September, third-quarter Chinese national output growth still in excess of 9 percent, record UK exports in August and a steady Q3 corporate earnings season so far.

On Thursday, a key gauge of U.S. business sentiment from Philadelphia’s Federal Reserve jumped to a 6-month high.

For equity strategists at Deutsche Bank, European crisis management may well manage to lower risk around the world and to cut global cost of capital. But they figure that the longer-term price for Europe will be lower growth too and this will be a slow burner for all economies.

“Beyond the outcome of this weekend, we think that the European crisis is approaching an end. While the focus is on estimating the costs, the market believes that a European recession and dilution to banks’ shareholders is a small price to pay compared to the alternative.”

Yet, not all agree. Investors still fear some non-specific disaster trigger in European government debt funding to be the biggest leftfield shock to their portfolios ahead.

In their latest monthly poll of 286 funds with more than $700 billion of assets under management, Bank of America Merrill Lynch showed on Wednesday that over 60 percent still saw the biggest “tail risk” to be in European sovereign debt — although that figure was closer to 70 percent last month.

In many ways, the job of the summit is to cut that fear.

ON THE TABLE

So, a deal of some sort now seems almost certain. The history of the EU suggests it will have some plan and that is the running assumption in financial markets. This at least takes the cliff-hangar aspect away from Monday markets.

The details then hinge on three key areas. First is on ways to leverage the zone’s 440 billion euro rescue fund to give it the firepower to buy sovereign debts on primary or secondary markets and be available to recapitalize weak banks hit by writedowns on any restructured government bonds.

The second is a credibly deep restructuring and write-off of Greek debts to ensure future sustainability. The third area involves bolstering euro institutions to insulate the rest of the bloc’s borrowers going forward, possibly even the prospect of joint bonds or a single finance ministry in the future.

As is typical, markets are seeking to simplify the instant “buy/sell” decision by focusing on headline numbers.

Most reckon the capacity of the European Financial Stability Fund needs expanding to between 1 and 2 trillion euros, involving a possible bank recapitalization of at least 100 billion euros as well as significant bond buying and an agreed private sector haircut on Greek debts of around 50 percent.

Beyond that — there is a blizzard of nuances on practicalities and efficacy as well as legal and constitutional

minefields and loopholes.

Focusing on market behavior before and after previous “do or die” weekends over the past two years, Barclays analysts Paul Robinson and Yuki Sakasai showed global equities and risk assets closely correlated with the euro and tended to weaken into the event. But they also cautioned against assuming easy correlations lasting for long.

“The crisis has been so complicated and the “small print” so important that the initial response of assets is not a very reliable guide to the response over the following period,” they told clients, adding that global risk may decline on a deal but European growth may subsequently weaken.

And if summit outcome disappoints, many may simply turn their eyes to the next major summit — the Group of 20 summit in Cannes 10 on November 3-4.

(by Mike Dolan; editing by Ron Askew)

(Muchfinance) – Uncertainty is rampant in financial markets and businesses, and for the first time economists can measure how big a bite it takes out of growth.

The models show that not only political uncertainty hurts output. So too can Federal Reserve policy.

When Fed interest rates are near zero and most designed to support growth, uncertainty can get further heightened making it even more damaging than in normal circumstances with higher drops in output. The knowledge that the Fed cannot cut rates further feeds uncertainty, and it also can worsen inflation.

The projections by a handful of leading economists show that the market upheaval unleashed by August’s U.S. debt debacle has not yet worked its way through the U.S. economy.

It will rob an estimated 1.75 percentage points from output with the full impact hitting in the first quarter of 2012, heightening the risks of recession next year.

The findings are laid out in two new papers from economists at Boston College and in a working paper issued by the Philadelphia Federal Reserve Bank that build upon recent work at Stanford University.

The studies come just as slow growth is dogging policymakers and the Fed is under attack for its ultra-loose monetary stance.

They are likely to fuel arguments about what the proper role of the Federal Reserve should be and could provide fodder to U.S. lawmakers who argue the central bank should focus solely on fighting inflation.

The studies also underscore the risks from both sides of the Atlantic as policymakers in Europe and the United States grapple with resolving deep sovereign debt problems.

At a minimum, the models estimate that elevated levels of uncertainty rob 0.3-0.5 percentage points from output.

CANCELED PLANS

Business people and economists know well how investment and spending get put on hold when uncertainty rises.

Take Rose Corona, owner of Corona Ranch, a farm and feed store in Temecula, Calif.

Over the past two years, she has canceled plans to build a $70,000 hay barn, postponed replacing a $20,000 generator to pump well water and is waiting before she fences her grapefruit groves. She also laid off nine of her 35 employees.

Her annual revenues have fallen below $5 million since the 2008-2009 recession and her costs have soared. Now she is concerned by talk in Washington about regulating dust stirred up by plowing and about higher taxes for the rich. This double whammy of weak demand and uncertainty over business conditions is restraining her investment plans.

“If I have to pay more taxes, is it going to allow me to hire more people? You don’t pull up the weak by pulling down the strong. We all need to help but there is only so much blood I can give,” Corona said.

Now economists have a way to model the impact.

Stanford University economist Nicholas Bloom used the Chicago Board Options Exchange VIX Index of stock market volatility as a proxy for uncertainty. When it spikes above 40, output growth falls by about 2 percentage points in the next six months and takes about nine months to recover, he found.

Building on his work, Boston College economists Susanto Basu and Brent Bundick built a model that shows that when uncertainty about future demand as measured by the VIX rises by one standard deviation, it reduces growth by 0.3 percentage points over the following year.

When Fed rates are very low, the uncertainty impact is amplified by 50 percent, they found.

After the collapse of Lehman Brothers, for instance, a shock that caused massive financial upheaval worldwide and led the Fed to slash interest rates toward zero, their model found uncertainty contributed 2.5 percentage points to the steep decline in Gross Domestic Product over a one year period.

“High uncertainty creates low demand by inducing households and firms to cut back on spending in order to build up nest eggs for possible bad times in the future, and low demand in turn reduces growth and employment,” Basu said.

BUDGET SHOCKS

A model developed by economists at the University of Pennsylvania, Duke University, and the Phillie Fed came to similar conclusions, although it focused explicitly on fiscal uncertainty.

The researchers looked at four factors — uncertainty over the path of government spending, labor tax, capital tax and consumption tax — and found that when all four are elevated by two standard deviation points, output is depressed by 0.5 percentage points.

The impact of this fiscal volatility shock is equivalent to the Fed raising interest rates by 25 basis points, but it lasts about twice as long with the steepest decline in output seen three quarters after the shock, the researchers said.

They also found like Basu that when monetary policy is extremely loose, it magnifies the impact of fiscal uncertainty.

Additionally, businesses tend to raise prices in anticipation of higher marginal costs and to secure their profits against declining sales, causing inflation even as output is falling.

The researchers conclude that in response to fiscal uncertainty, the Fed would do better to concentrate more on inflation than on job growth.”

“We find, interestingly, that a stronger focus of monetary policy on inflation, rather than on employment, alleviates the negative outcomes of fiscal volatility shocks on economic activity,” they said.

Some U.S. lawmakers are proposing limiting the Fed’s mandate to inflation-fighting only.

Basu said he was surprised that his model showed a negative growth impact when Fed rates are near zero, and it suggests that a combination of fiscal and monetary policy is needed to jump start the economy.

“It gives a lot of support to those who say that zero-bound interest rates are a major constraint on Fed policy, and we need to use fiscal policy to further support growth,” he said.

(To read the papers:

Federal Reserve Bank of Philadelphia working paper series, “Fiscal Volatility Shocks and Economic Activity” by Jesus Fernandez-Villaverde, University of Pennsylvania; Juan Rubio-Ramirez, Duke University; Pablo Guerron-Quintana and Keith Kuester, Philadelphia Fed, double-click: here

Boston College paper: “Uncertainty Shocks in a Model of Effective Demand” by Susanto Basu and Brent Bundick: here )

The Internal Revenue Service mishandled claims for the education tax expense credit that was a key part of President Barack Obama’s 2009 economic stimulus bill, said the Treasury Inspector General for Tax Administration (TIGTA).

“The IRS does not have effective processes to identify taxpayers who claim erroneous education credits,” said Russell George, head of the government’s IRS watchdog unit.

“If not addressed, this could result in up to $12.8 billion in potentially erroneous refunds over four years,” he added.

The IRS said that it “strongly disputes the findings” of the TIGTA report, which it called “flawed and superficial.”

Still, the IRS acknowledged it can do more to determine a tax credit recipient’s eligibility.

The agency said it will revise reporting forms to ask for more information and that it is looking at ways to use Department of Education data to verify claims.

The IRS watchdog said most of the erroneous beneficiaries had no documents to prove they were in college; others may not have been in the classroom long enough to qualify or were graduate students; while still others lacked valid Social Security numbers.

“The IRS doesn’t know who a student is” and there is little third-party verification for a lot of college enrollment claims, said Elaine Maag, senior research associate at the Tax Policy Center, a think tank.

CREDIT WIDENED

The 2009 Obama administration stimulus built on the existing education tax credit. The expanded credit was later extended to include 2011 and 2012 tax returns.

The law increased the education tax credit’s maximum amount to $2,500 from $1,800 a year. Up to 40 percent of the tax credit was refundable for low-income households with minimal tax exposure, meaning qualifying taxpayers could get up to $1,000 in cash.

The bulk of the TIGTA findings can be attributed to a mismatch between individual tax returns and forms submitted by colleges, the IRS said.

The incomplete data “does not in and of itself mean the taxpayer is ineligible for the credit,” IRS said.

It is “unfair” for TIGTA to say the tax credits were erroneously offered when the data do not correlate, IRS said.

The TIGTA findings may be attributable to a calendar variance, Maag said.

Conceivably, a student could pay tuition and claim the tax credit in December for an upcoming semester starting in January, while the college may not report that student as enrolled until the semester begins.

Therefore, the individual’s form and the college’s form fall in different tax years. “It’s very difficult to align data from the two sources,” Maag said.

(Reporting by Kevin Drawbaugh and Patrick Temple-West; Editing by Andrew Hay)

The state is trying to determine whether the bank and Countrywide Financial had sold the securities to investors under false pretenses, the paper reported, citing a person familiar with the matter.

Bank of America bought Countrywide in 2008, leaving itself with billions in losses from soured loans and lawsuits.

The subpoenas come as state attorneys general and federal officials are negotiating a broad mortgage settlement with Bank of America and other major lenders. California reportedly walked away from those talks two weeks ago, although it is possible the state could still sign onto an agreement.

Bank of America declined to comment to Reuters.

The company’s shares were down 2.8 percent at $6.22 in morning trading.

(Reporting by Rick Rothacker in Charlotte, North Carolina, editing by Gerald E. McCormick and Lisa Von Ahn)

The bill paves the way for the governor to declare a state of fiscal emergency that leads to a recovery plan for Harrisburg, which filed for bankruptcy last week.

Harrisburg, a city of about 50,000, is struggling to pay for essential services as well as about $300 million in debt that funded an incinerator project that failed to generate expected cash.

The Harrisburg City Council voted 4-3 on October 11 to file for a Chapter 9 municipal bankruptcy as a way of resolving a massive debt crisis brought on by the funding of an incinerator that hasn’t generated enough cash.

The action immediately generated conflict between the City Council and the mayor, Linda Thompson, the state legislature, and the governor, who dispute the legality of the Council’s action in filing for bankruptcy.

A U.S. bankruptcy judge set a November 23 hearing date on the legality of the bankruptcy.

Mark Schwartz, a lawyer hired by the City Council to handle the Chapter 9 bankruptcy case, called the governor’s signing of the takeover act “absolutely perverse.”

“It’s too little, too late,” he said in a telephone interview on Thursday, dismissing the new law as “clearly unconstitutional.”

Schwartz added that the legislation really didn’t do anything since the governor “must now get approval from the bankruptcy court” to take over the city.

Governor Corbett signed the bill in a private ceremony, according to the governor’s spokeswoman, Kelli Roberts.

“The bill signed into law today will help to enforce Act 47 when municipalities fail to adopt a fiscal recovery plan, making it clear that if there is a failure to act, the state will intervene,” Corbett said in a statement.

Under the law, the governor can declare a fiscal emergency after it is determined the city is insolvent or near insolvency, unable to provide vital services and has not adopted a fiscal recovery plan.

“I remain a strong proponent for municipal governments tackling their own problems and coming together to develop a fiscal recovery plan when necessary,” Corbett said. “But when that fails to happen, the state has to take action to ensure public safety.”

When a fiscal emergency is declared, the State Department of Community and Economic Development Secretary is granted powers to develop an Emergency Action Plan to coordinate essential services. These services include pension and debt payments.

The governor can then petition the state court for the city to be placed into receivership. The receiver will have 30 days to develop a fiscal recovery plan that is submitted to the court. Once approved, the receiver can implement the plan to take control of the municipality’s finances relating to the plan.

Throughout the process, if the city adopts and implements an acceptable fiscal recovery plan, a takeover is averted.

Mayor Thompson said the city will comply with the law. Thompson opposed the bankruptcy filing.

The mayor said in a statement that she will use the current financial recovery plan as the starting point for any discussions, saying implementation of some version of the plan is preferable to entering into receivership or bankruptcy.

“If we don’t attempt to solve our own problems, the alternatives will be far worse,” Thompson said.

A legislative panel estimated the cost of placing Harrisburg into receivership would be between $2.15 million and $2.55 million in the first year. The costs would be about $1 million for the state and between $1.15 million to $1.55 million for Harrisburg.

“This is all process and no money,” Schwartz said. “There’s not 10 cents for Harrisburg.”

The troubled incinerator is owned by the Harrisburg Authority, a separate municipal entity, but the city and the surrounding Dauphin County guarantee much of that debt.

Twenty years ago, there was a similar conflict between Bridgeport, Connecticut, and its state government when the city chose to file for bankruptcy to deal with sinking revenue and escalating demand for services fueled by a recession.

Connecticut objected to the move and a judge subsequently ruled Bridgeport was not insolvent and therefore did not meet technical requirements for filing under Chapter 9.

(Reporting by Chip Barnett in New York; Additional reporting by Karen Pierog in Chicago; Editing by James Dalgleish)

Mortgage applications rose last week: MBA

(Muchfinance) - Applications for U.S. home mortgages rose last week for the first time in a month as interest rates tumbled even further, an industry group said on Wednesday.

The Mortgage Bankers Association said its seasonally adjusted index of mortgage application activity, which includes both refinancing and home purchase demand, rose 6.3 percent in the week ended September 9 compared to the week before.

The MBA's seasonally adjusted index of refinancing applications gained 6.0 percent, while the gauge of loan requests for home purchases climbed 7.0 percent.

The refinance share of mortgage activity rose to 77.3 percent of total applications from 77.1 percent.

At the same time, it might be prudent for investors to avoid low-yielding U.S. debt and some European debt as Europe battles its worsening debt crisis, the head of the world’s largest asset management firm said on Wednesday.

Fink said tough steps are necessary in Europe but he is confident moves will be made to prevent the common currency union from collapsing.

“We are going to find a solution in Europe, and Germany will have to play a major role,” he said in New York at the Delivering Alpha conference sponsored by CNBC and Institutional Investor.

However, there will be uncertainty for some time, and it might make more sense to invest in stocks instead of bonds, he said. “You could still be buying European equities,” Fink said. “The companies have been beaten down and they will be fine.”

At a Barclays Capital conference on Tuesday, Fink recommended some beaten-down European blue chip stocks like conglomerate Siemens AG, insurance giant Allianz and food maker Nestle.

At the Delivering Alpha conference, he said the U.S. housing sector is still weighing on economic growth, but he forecast the sector would recover in a few years.

“The housing picture is improving but it will still take two or three years to fix,” he said.

In the precious metals area, Fink said gold stocks could still be profitable, particularly as they have not yet fully reflected the rally in the metal’s price.

(Reporting by Svea Herbst-Bayliss; edited by Aaron Pressman and John Wallace)

Fed cutting rate on reserves weighed

(Muchfinance) - Investors and traders are rethinking whether the U.S. Federal Reserve might reduce the interest it pays banks on their excess reserves as another tool to stimulate lending and to avert another recession.

While Fed Chairman Ben Bernanke and other Fed officials have mentioned such a move as a policy option, investors and traders had placed a low probability that the U.S. central bank would use it because it risks cutting bank profitability and causing turmoil in money markets.

That prevalent view was challenged after Goldman Sachs economists issued a report late Tuesday saying they see "a greater than 50 percent chance" that the Fed would trim the interest rate it pays on excess bank reserves, which is currently at 0.25 percent.

Banks were holding $1.7 trillion in excess reserves with the Fed at the end of August, according to Fed data.

Goldman economists predict the Federal Open Market Committee could reduce that rate to 0.10 percent.

"It's on the table. They keep mentioning it as a possibility," said James O'Sullivan, chief economist at MF Global in New York.

U.S. short-term interest rates futures rose on Wednesday as traders reconsidered the chances that the Fed might reduce the interest rate on excess reserves.

The three-month rate on overnight indexed swaps, which gauges expectations on the Fed's policy rate, fell to 0.0550 percent, just a hair above the recent low of 0.0525 percent in early August.

With the Fed's next policy meeting a week away, there are growing expectations that the U.S. central bank will announce a program to buy long-dated Treasuries in an attempt to lower mortgage rates and other long-term borrowing costs.

The need to revive "Operation Twist," which was first undertaken in 1961, has been questioned by some investors.

Another perceived risky move from the Fed, to manipulate the short end of the U.S. yield curve, might not be worth the gamble since it would hurt the fragile banking sector, some analysts said.

"Why would the Fed double down now when they have been cautious up till now," said Steve Ricchiuto, chief economist at Mizuho Securities USA in New York

Lowering the interest rate on banks' excess reserves with the Fed would further erode banks' bottom line if the Fed also engages in "Operation Twist," which would lower the interest margins banks earn on their loans and securities.

"It's a double whammy for banks, and banks are at the heart of the problem," Ricchiuto said.

Goldman economists raised other shortcomings of the Fed cutting the interest rate on reserves. They said banks could levy fees on customers to make up for reduced interest income.

Such a move, they say, would also make it harder for the $2.6 trillion U.S. money market mutual fund industry to recoup their operating costs as its earnings have suffered in the current near-zero rate climate orchestrated by the Fed.

Distress on money funds could disrupt money markets, which exacerbated the global credit crunch in late 2008.

Still, Goldman economists see a better-than-even shot that the Fed's rate-setting committee would make such a move.

Cutting the interest rate on excess reserve is "clearly an imperfect option with very limited impact on interest rates, but with a lack of other tools and an unwillingness to expand the balance sheet (at least for now), we believe a majority of the committee could support it," they wrote in the note.

Flat retail sales keep U.S. on recession watch

(Muchfinace) - Growth in U.S. retail sales stalled in August after a spending battle in Congress crushed consumer sentiment, leaving the economy perched uncomfortably close to recession.

The weak data puts more pressure on the Federal Reserve to try to boost growth, while a report showing flat wholesale prices in August could support arguments within the central bank to take action.

"The slowdown in the economy is real," said Steven Ricchiuto, chief economist at Mizuho Securities in New York. "It's a broad-based slowdown, and that's pivotal."

Retail sales were unchanged last month from July, the Commerce Department said on Wednesday. The government also lowered previous estimates for growth during June and July.

The data was the latest hard evidence the United States is flirting with recession. Other reports have shown there was no employment growth in August, while claims for jobless benefits rose in early September.

Consumer confidence plunged last month after a battle over the deficit slammed stock prices and pushed the nation to the brink of default. The country's debt was then downgraded.

"The consumer reacted to the debt ceiling (fight), the downgrade and the equity market swoon by basically hunkering down and not spending," said Tom Porcelli, senior U.S. economist at RBC Capital Markets in New York.

Citing the weak data, Nomura cut its forecast for third-quarter U.S. economic growth to 2.4 percent from 2.6 percent.

However, major U.S. stock indexes shook off the data and closed higher after European leaders showed new urgency in efforts to contain the euro zone debt crisis.

U.S. economic growth slowed sharply during the first half of the year. That has left the economy vulnerable to shocks like an escalation of Europe's woes, and U.S. Treasury Secretary Timothy Geithner urged the continent on Wednesday to move more aggressively to solve its troubles.

RECESSION FEARS

Consumer spending accounts for about two-thirds of U.S. economic activity, and the retail sales figures showed spending during the first two months of the third quarter was weaker than many forecasters expected.

An increase in sales of electronics, gasoline and food was balanced by drops in purchases of cars, furniture and clothes. Spending at restaurants and bars also dipped.

A gauge that hews most closely to the measure the government uses in calculating GDP rose just 0.1 percent.

A Reuters poll released on Wednesday found economists see a nearly one-in-three chance the United States could re-enter recession. Many economists expect the Fed will unveil new measures to boost growth next Tuesday following a two-day meeting.

U.S. households still feel the pain from the country's 2007-2009 recession. A report on Tuesday showed the U.S. poverty rate -- already the highest in the developed world -- rose last year to 15.1 percent, its highest level since 1993.

Companies are also feeling the pinch. Best Buy Co cut its profit outlook for the year on Tuesday, citing economic uncertainty.

Policymakers are struggling to counter the weakness.

President Barack Obama is lobbying Congress to approve his recently unveiled job stimulus program but opposition Republicans have harshly criticized parts of the plan.

Fed Chairman Ben Bernanke has hinted at further monetary stimulus, although three policymakers within the central bank last month dissented over a pledge to keep interest rates low into 2013.

A separate report on Wednesday from the Labor Department showed prices received by U.S. producers were unchanged in August, held down by a drop in energy costs. That could help keep inflation from being an immediate roadblock to further monetary stimulus.

Another report from the Commerce Department showed U.S. business inventories rose slightly less than expected in July, suggesting firms remained cautious about future demand.

"The economy will be sluggish for long time to come," Toys R Us CEO Jerry Storch told reporters in New York.

(Additional reporting by Mark Felsenthal in Washington and Richard Leong, Emily Flitter and Dhanya Skariachan in New York; Editing by Andrea Ricci, Neil Stempleman and Dan Grebler)