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May was the month when rally got some strength and it separated perma-bears from more flexible opportunistic speculators who decided to ride the wave ("Damn the torpedoes, full speed ahead! "). Actually Edward Harrison was the only one among blog posts collected below here who raised this question and warned about recently bias (thinking inertia). See his More thoughts on the fake recovery
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Rogers and Faber were skeptics and missed the stock rally completely despite being pretty shrewd speculators. They underestimated the Wall Street ability to engineer a rally fueled by fresh Fed money. In a way they proved to be very bad advisers for 401K plankton. Roubini was out of touch with "new stock market reality" too, but that's not surprising.
2009 proved that stock market can be quite detached from larger economy. And that fundamentals in not the only thing that can driving stocks higher: the big banks and hedge funds which were playing the momentum trades can get them higher too. Substantially higher as we see in retrospect (retail investor was absents from the scene during 2009 rally). Andy Kessler is right, it’s another sucker’s rally, but the truth is that with Fed injections of steroids "a sucker rally" can last more then a year.
Also the firms can improve their profit margins by drastic cost cuttings and that process can continue for a at least a couple of years until nothing can be cut... As Leo Kolivakis noted in comment to More thoughts on the fake recovery
"What people need to understand, however, is that the stock market will gyrate in between, with huge bear market rallies."
Here is a typical skeptical comment of the day:
"the truth of the matter was that our entire economy was a bubble. That we had excess economic capacity not supported by our fundamental needs or abilities."
So true. In fact, we have an Agrarian Economy. Consumers are the soil, big finance and government are the farmers. The soil has been so over-farmed at this point that, rather than let it lie fallow to recover, we are pouring on the XXX power fertilizer in order to squeeze out one more harvest. This is despite the label on the XXX fertilizer bag warning that its use may lead to the need for a complete topsoil transplant.
May 26, 2009 | FT.com
I believe the risk posed by this debt is systemic and could do more damage to the economy than the recent financial crisis. To understand the size of the risk, take a look at the numbers that Standard and Poor’s considers. The deficit in 2019 is expected by the CBO to be $1,200bn (€859bn, £754bn). Income tax revenues are expected to be about $2,000bn that year, so a permanent 60 per cent across-the-board tax increase would be required to balance the budget. Clearly this will not and should not happen. So how else can debt service payments be brought down as a share of GDP?
Inflation will do it. But how much? To bring the debt-to-GDP ratio down to the same level as at the end of 2008 would take a doubling of prices. That 100 per cent increase would make nominal GDP twice as high and thus cut the debt-to-GDP ratio in half, back to 41 from 82 per cent. A 100 per cent increase in the price level means about 10 per cent inflation for 10 years. But it would not be that smooth – probably more like the great inflation of the late 1960s and 1970s with boom followed by bust and recession every three or four years, and a successively higher inflation rate after each recession.
The fact that the Federal Reserve is now buying longer-term Treasuries in an effort to keep Treasury yields low adds credibility to this scary story, because it suggests that the debt will be monetised. That the Fed may have a difficult task reducing its own ballooning balance sheet to prevent inflation increases the risks considerably. And 100 per cent inflation would, of course, mean a 100 per cent depreciation of the dollar. Americans would have to pay $2.80 for a euro; the Japanese could buy a dollar for Y50; and gold would be $2,000 per ounce. This is not a forecast, because policy can change; rather it is an indication of how much systemic risk the government is now creating.
Why might Washington sleep through this wake-up call? You can already hear the excuses.
“We have an unprecedented financial crisis and we must run unprecedented deficits.” While there is debate about whether a large deficit today provides economic stimulus, there is no economic theory or evidence that shows that deficits in five or 10 years will help to get us out of this recession. Such thinking is irresponsible. If you believe deficits are good in bad times, then the responsible policy is to try to balance the budget in good times. The CBO projects that the economy will be back to delivering on its potential growth by 2014. A responsible budget would lay out proposals for balancing the budget by then rather than aim for trillion-dollar deficits.
“But we will cut the deficit in half.” CBO analysts project that the deficit will be the same in 2019 as the administration estimates for 2010, a zero per cent cut.
“We inherited this mess.” The debt was 41 per cent of GDP at the end of 1988, President Ronald Reagan’s last year in office, the same as at the end of 2008, President George W. Bush’s last year in office. If one thinks policies from Reagan to Bush were mistakes does it make any sense to double down on those mistakes, as with the 80 per cent debt-to-GDP level projected when Mr Obama leaves office?
The writer, a professor of economics at Stanford and a senior fellow at the Hoover Institution, is the author of ‘Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis’
Economist's View
Selected comments
wjd123 says...
"Manufacturing is analogous. In America and elsewhere around the world, it's a success. Since 1995, even as manufacturing employment has dropped around the world, global industrial output has risen more than 30%."--Robert Reich
Every time I hear economist droning on about the real culprit in the lost manufacturing jobs being technology and calling people names like technophobes, neo-Luddites, anti-globalists or whatever other name Dr. Reich can come up with, I start to think that here is another economist that just doesn't get it.
People in manufacturing don't like losing their job to technology but that isn't their gripe. They accept technology. No, their real gripe and the gripe of most Americans is about proceedural fairness.
Don't take my word that economist don't get the distinction; take the word of another economists, Dani Rodrik of Harvard.
From "Trade and procedural fairness""... I think, why the archetypal man on the street reacts differently to trade-induced changes in distribution than to technology-induced changes (i.e., to technological progress). Both increase the size of the economic pie, while often causing large income transfers. But a redistribution that takes place because home firms are undercut by competitors who employ deplorable labor practices, use production methods that are harmful to the environment, or enjoy government support is procedurally different than one that takes place because an innovator has come up with a better product through hard work or ingenuity. Trade and technological progress can have very different implications for procedural fairness. This is a point that most people instinctively grasp, but economists often miss. (Notice that even in the case of technology, we have significant restrictions on what is allowable—c.f. human-subject review requirements—and wide-ranging debates about the acceptability of things like stem-cell research.)"--Dani Rodrik
Denis Drew:
The distribution of those benefits will by necessity remain unequal until American labor wakes up and feels the "hidden hand" picking its pocket.
In any modern discipline what some eighteenth century philosopher (Smith?) parablized as the "hidden hand" would be recognized as an inter-related collection of equilibrium points -- which manages like a living thing to produce complete but hardly fair distribution.
To use another metaphor: the game is not all about Xs and Os (as the Chicago Boyz magically imagine); it is about two players facing off down in the market dirt.
But, American labor -- unique in all the world -- has no idea it has to play hard against a bargaining opponent -- just work hard and play by the rules. Get that straightened out in their heads and we can pass laws to change the distribution of benefits the labor market overnight: sector-wide labor agreements as practiced all over the first, second and third worlds and doubling the minimum wage over three years (at 2 1/2% direct inflation spread out -- everybody else will get their inflation raises and we will hardly notice except for the disappearance of drug selling street gangs).
If we predicted to Americans of 1968 that by 2006, 25% of the workforce would be earning less than the minimum wage......of 1968 (!)......while CBO would report top one percentile households would average $1.2 million of a year they would have given a million to one odds against it.
http://www.cbpp.org/cms/index.cfm?fa=view&id=2789 http://www.cbpp.org/cms/index.cfm?fa=viewid=2789
Doc at the Radar Station says...
Reading Reich's comments kinda got my bullshit meter blinking a little bit. I think I'm going to have to re-read Kurt Vonnegut's "Player Piano" next week:
http://en.wikipedia.org/wiki/Player_Piano
The conventional wisdom with "progress" and "labor-saving" tends to think that we are creating leisure for ourselves. Well, that's not what has happened. What's happened is more like "The Matrix". Wealth has simply flowed upward from the productivity enhancements and workers can be as miserable as ever.
mrrunangun says...
Union power within the USA will not work as long as sufficient labor arbitrage is available to importers. It matters not whether the import is a component or a finished product. America has been aiding the development of our industrial competitors as a matter of geopolitical policy since 1945. This is no longer wise policy. The mercantilist economies of east Asia have had employment of their populations in manufacturing as a primary goal of policy. Western European industrial competitors are adopting more nationalistic policy measures while preaching free trade to the US.
Union power in service industries outside of government are liable to displacement by alternative means of producing their service. As hotel nights have become more expensive, short-term condo rentals have replaced more hotel stays.
Unless we are willing to engage in serious protectionism, unionization to improve wage distribution will not work. More good quality permanent jobs in the US economy are going to be necessary for the country to successfully recover from the current troubles. I do not see where those jobs are going to come from. My chief beef with the stimulus is that it fails to address that need in favor of funding programs that were good solutions to the problems of a different era. IMHO we are in greater need of manufacturing jobs than of healthcare jobs. That is because I believe that equity in employment is more important than equity in health services.
Posted by: mrrunangun | Link to comment | May 30, 2009 at 07:52 PM
run75441 says...
save_the_rustbelt says...Gee Mr. Reich:
You left academia and toured a real honest to goodness factory? How noble of you to grovel and potentially get your hands dirty. What were they making?
Your views do not portray reality of what a modern factory is today, at least to the 11 or so million people still working within manufacturing. No assembly lines and 2 people actually instructing macines what to do? Or did you mean two people watching the process control charts, establishing the ranges, checking to it and I get paid to see those factories rather handsomely. Robert, the machines are already programmed according to the product they are making in each cell or focus line.
You are not the first to allude to ever increasing efficiencies since the sixties. Ingersoll Engineers did as well as Drucker and they both worked with industry to straighten out those spaghetti farms of manufacturing throughput. Labor was the fallout from that straightening and improvement Robert; but, that fallout from manufacturing improvements is not as bad as what we have experienced since China entered the WTO.
Brenda Rosser wrote a small piece on Economospeak writes a nice piece: "0% of Chinese Exports to the US are from Forein Owned Corporations" ttp://econospeak.blogspot.com/2009/05/60-of-chinese-exports-to-us-are-from.html It is a nice piece and she begins to expore the world of manufacturing. With in her footnotes is another piece from the EPI: "S - China Trade 1989-2003" http://epi.3cdn.net/c523ff01bec5bc1c25_7nm6i278j.pdf
Just a couple of exerpts from it as I am sure anyone can take a few minutes and read the 20 pages of it as it is rather simple for some of us Manufacturing people to understand as old fashion as we may be perceived by the lofty academics.
"Some economists reject the general notion that growing trade deficits can cause a net loss of job
opportunities. Their most common argument is that employment levels are determined by macroeconomic policies such as monetary and fiscal policies and, most relevant to trade, exchange rates, and that, in the long run, the economy is usually at full employment. In fact, when the economy is operating at full employment, as in the late 1990s, growing trade deficits affect the distribution of jobs rather than the overall number of jobs in the economy. Growing trade deficits resulted in less employment in manufacturing and more jobs in non-traded goods such as services, retail trade, and construction (Bivens 2004).In the long run, monetary and fiscal policies are usually adjusted to maintain full employment. If jobs intraded-goods industries pay better than the alternatives for workers affected by trade deficits, then the most important effects of growing trade deficits will be on the distribution of wages and incomes.
Numerous studies have borne this out, demonstrating the significant negative effects that trade has had on the distribution of income over the last few decades
of variable but generally growing trade deficits(TDRC report, chapter 3). In addition to offering higher wages for workers with comparable education and skills, manufacturing jobs also tend to offer better benefits.On the other hand, the economy has operated well below potential output since 2001 because total employment growth has failed to keep up with growth in the working-age population (Price 2004). In this environment, the persistence of large and growing trade deficits has had a depressing effect on the overall level of employment, as well as its distribution across major sectors of the economy. The growth in the global U.S. trade deficit reduced manufacturing jobs by 1.78 million between 1998 and 2003 alone (Bivens 2004). In 2003 the manufacturing sector represented only 11.2% of the 129.93 million total U.S.jobs. But for the loss of these jobs in manufacturing, and in the economy as a whole, the manufacturing share of U.S. employment would have been 1.4 percentage points (12.3%) higher in 2003 than it actually was."
and here:
"The effects of China’s movement up the product ladder are immediately apparent in Table 3b, which examines the employment effects of trade between 1997 and 2003. For example, between 2001 and 2003, loss of job opportunities in apparel (-24,000), textiles (-23,000), leather products (-14,000) and rubber and plastics (-15,000) fell off sharply compared to the 1989-97 period. (Note that the manufacturing trade deficit with China increased by about $45 billion in each of these periods, although the first is eight years long while the second lasted only two years.) Job displacement increased sharply in furniture (-39,000) and nonelectrical machinery (-50,000), including nearly a tripling in computers (-30,000). The largest amount of employment displacement in this period occurred in electronic machinery (-91,000 jobs), which included audio/video equipment (-28,000), communications equipment (-11,000, a near tripling), and semiconductors (-25,000)."
Mr. Reich with this analogy you are no better than GM's Waggoner or Dephi's Miller. You look at the bottom line and make an intuitive macro guess as to what is wrong without looking at the micro of the situation. Learn the problem sir by leaving your desk.
Posted by: run75441 | Link to comment | May 30, 2009 at 08:39 PM
"I recently toured a U.S. factory containing two employees and 400 computerized robots. The two live people sat in front of computer screens and instructed the robots. In a few years this factory won't have a single employee on site, except for an occasional visiting technician who repairs and upgrades the robots. ..."
Very extreme example.
And the role of productivity is exaggerated. Foreign factories do not have a productivity advantage, those factories have a very low wage advantage.
And many of the new "green" jobs can be done overseas as well. Windmills can be built in China, just watch.
Doc at the Radar Station says...
One of Marx's theories that still seems relevant today. I think this is true with respect to "service" as well as "production" occupations.
http://en.wikipedia.org/wiki/Marx's_theory_of_alienation
Marx attributes four types of alienation in labour under capitalism. These include
- the alienation of the worker from his or her ‘species essence’ as a human being rather than a machine;
- between workers, since capitalism reduces labour to a commodity to be traded on the market, rather than a social relationship;
- of the worker from the product, since this is appropriated by the capitalist class, and so escapes the worker's control;
- and from the act of production itself, such that work comes to be a meaningless activity, offering little or no intrinsic satisfactions.
leo:
Reich's argument seems like bait and switch to me. It's something we've been hearing since at least the beginning of the 1990s, if not earlier: 'manufacturing is oh-so-19th-Century, we need to move on to more modern activities'.
Then out of the other side of their mouths we hear, 'it may be out-of-date, but we moved it all to [name your favorite 'emerging' country].'
So, either it's out of date and has no value or it's still has value and we want to move it off-shore -- but it can't be both.
Ultimately we need our washing machines and flat-panel displays. To claim it doesn't matter where they come from is an arrogance of Clintonian proportions -- that we can no longer afford.
cm says...
robertdfeinman: "activities that "primitive" groups engaged in"
The more I have been exposed to all the BS in business, the more I can sympathize with this view. But have economies focused on those activities (and otherwise presumably based mostly on subsistence farming?) that you mentioned ever functioned outside a tribal or feudal society?
And without having direct proof, I suspect that most societies, including "primitive" ones, have been stratified into an elite and those compelled to support the elite, and that the majority or at least a substantial part of the respective populations hasn't lived very happily.
One could even go as far as saying that today's individualism and (quasi) anonymity of most economic and social transactions are defining feature of modernity, setting it apart from tribal and feudal societies. Its mirror image is disengagement and the deterioration of community. In earlier days communal cohesion (and conformity!) was largely defined and enforced by religion (parishes), in combination a lack of individual and mass transit so that most people would be stuck in their place. In not too few cases this would even be formalized as restrictions on individual movement and settlement.
I'm not sure we want to go back there. What (reasonable) balance between individual freedoms and effective community would work I cannot imagine. Which is not to say I'm opposed to the concept. I truly cannot imagine how to get "from here to there" - that's always the big problem with social theories.
Bruce Wilder says...
str: "Foreign factories do not have a productivity advantage, those factories have a very low wage advantage."
I think that's a bad analysis.
The direct labor requirement is so small, it scarcely matters what the wage rate is. If assembly hours in a $10,000 auto are less than 10, the difference between $30/hr labor and $10/hr labor is less than 2% of the cost of the car.
There are any number of other costs, which could easily offset, or even completely swamp, the wage rate. Production delays of a few days, the cost of transporting the finished product, quality anomalies, etc.
The "subsidy" provided by the Chinese willingness to depress the value of their own currency was as much, or more, a subsidy to capital returns on manufacturing investments. Wage rates, per se, were not a critical part of that -- they did not need to be.
The U.S. should consider whether we can afford corporate executives, who make $10 million plus per year, while driving their firms and their industries into the ground. But, that's a different kind of excessive wage problem.
In the end, the problem of wages is partly a matter of distribution and partly a matter of productivity.
Productivity cannot be ignored; it is fundamental.
But, the problem of what makes investment in highly productive manufacturing capability profitable enough to justify does not begin, or end, in wage rates. To a large extent, it begins and ends with the gatekeepers, with distribution.
It is not "skill" that matters, crucially; it is gatekeeping.
The choke points in the American economy have moved to gatekeeping. A buyer at Wal-Mart has more market power, more influence on a manufacturer's ability to invest or prosper than any union.
FT Alphaville
Posted by Gwen Robinson on May 28 08:28.
Green shoots, yellow weeds, gloom and doom, or rosy future? The pundits are out in full force to prognosticate on prospects for a US economic recovery. Some of their arguments make for great reading, but few are convincing.In a post called “The worst is over for the economy”, Henry Blodget at Clusterstock is excited about a new - and uber-bullish - report by Paul Kasriel and Asha Bangalore of Northern Trust. “They were early in calling the recession, and they have now been early in calling the recovery”, he notes, adding:
Paul and Asha’s latest reports argue that the worst is over and that we’ll see a weak recovery by the end of the year. The stimulus is kicking in and the housing, manufacturing, employment, and consumer-spending trends are beginning to improve (which in some cases means “decline less”). Bank lending is loosening, finally, and spreads are returning to normal. But the plunge in household net worth relative to debt will likely keep a lid on spending and growth for at least the next year.
In contrast to such optimism or, at the other extreme, the dark views of pundits such as Marc “Dr Doom” Faber , Martin Feldstein, Harvard economics professor, former chairman of President Ronald Reagan’s Council of Economic Advisors and president of the US National Bureau for Economic Research, has produced an excellent prognosis of US economic prospects (hat tip to James Kwak of Baseline Scenario).
The Bruce Blog, an aptly-named blog run by Bruce B. Brugmann, editor and publisher of the San Francisco Bay Guardian, has posted the piece, written originally for Project Syndicate.
In Feldstein’s view, the evidence of a real economic recovery so far is unconvincing. Obama’s stimulus package will provide something of a boost and fuel a short spurt of growth. But as effects of the stimulus wear off, growth will fade again, he warns.
The next few months will see some real improvements that will reduce the rate of overall economic decline, or even produce a temporary rise in the GDP growth rate, owing to the Obama administration’s fiscal stimulus measures…The stimulus package will add about $60 billion to overall GDP during April, May, and June, or roughly 1.5% of quarterly output. But when the GDP figures for the second quarter are reported later this summer, the government’s statisticians will annualize the 1.5% increase and add 6% in calculating the annual growth rate. If economic activity apart from the stimulus package is continuing to decline at nearly the 6% annual rate that was recorded in the last two quarters, the temporary boost from the stimulus package will suffice to make the overall GDP change close to zero or even positive.
But, he cautions:
…the key thing to bear in mind is that the stimulus effect is a one-time rise in the level of activity, not an ongoing change in the rate of growth. While the one-time increase will appear in official statistics as a temporary rise in the growth rate, there is nothing to make that higher growth rate continue in the following quarters. So, by the end of the year, we will see a slightly improved level of GDP, but the rate of GDP growth is likely to return to negative territory.
The bottom line, according to Feldstein, is that while the Obama administration’s economic policies are moving roughly in the right direction, they are not substantial enough to make a longer term difference.
Feldstein concludes:
The positive effect of the stimulus package is simply not large enough to offset the negative impact of dramatically lower household wealth, declines in residential construction, a dysfunctional banking system that does not increase credit creation, and the downward spiral of house prices. The Obama administration has developed policies to counter these negative effects, but, in my judgment, they are not adequate to turn the economy around and produce a sustained recovery.Having said that, these policies are still works in progress. If they are strengthened in the months ahead — to increase demand, fix the banking system, and stop the fall in house prices — we can hope to see a sustained recovery start in 2010. If not, we will just have to keep waiting and hoping.In the end, it’s probably anybody’s guess - though some guesses are better-informed than others. That’s why we might leave you here with a recent article in The Onion, which ran a cheeky piece earlier this month headlined: “Nation ready to be lied to about the economy again”. Read on:After nearly four months of frank, honest, and open dialogue about the failing economy, a weary U.S. populace announced this week that it is once again ready to be lied to about the current state of the financial system.Tired of hearing the grim truth about their economic future, Americans demanded that the bald-faced lies resume immediately, particularly whenever politicians feel the need to divulge another terrifying problem with Wall Street, the housing market, or any one of a hundred other ticking time bombs everyone was better off not knowing about.
In addition, citizens are requesting that the phrase, “It will only get worse before it gets better,” be permanently replaced with, “Things are going great. Enjoy yourselves.”
And so on…
Selected Comments
- dhome May 28 23:53
Great to see Alphaville referencing the one authoritative US financial commentary site – The Onion. As its July 14, 2008 piece entitled: “Recession-Plagued Nation Demands New Bubble To Invest In”; showed; The Onion business section has been consistently ahead of the curve. A recession was not declared (NBER) until December 2008. And finally the FED made it easier for the average US citizen to invest in Treasury Bonds.
- -- Report
User3696767 May 28 09:52
I agree with Mr. Feldstein. Will be a VL shaped "recovery".
May 29, 2009 | NYT
What about this article in which Mr. Krugman is quoted as saying that he "... also opposed regional monetary policies that continue to peg local currencies to the dollar, citing the expected decline in the value of the dollar by the end of the year..."?
Unless Mr. Krugman was misquoted, he seems to be predicting the imminent collapse of the dollar at a conference in Abu Dhabi, while promising its continuing strength to Times readers.— Michael Wolfe, Henderson, Texas
It’s important to realize that there’s no hint of inflationary pressures in the economy right now. Consumer prices are lower now than they were a year ago, and wage increases have stalled in the face of high unemployment.
Deflation, not inflation, is the clear and present danger.
So if prices aren’t rising, why the inflation worries? Some claim that the Federal Reserve is printing lots of money, which must be inflationary, while others claim that budget deficits will eventually force the U.S. government to inflate away its debt.
The first story is just wrong. The second could be right, but isn’t.
... ... ...
It is as if, after the worst economic contraction since the Great Depression, once banks get the "all clear" from who knows where that the system has righted itself and it's back to business as usual, all those excess reserves will just vanish. Now, it’s true that the Fed has taken unprecedented actions lately. More specifically, it has been buying lots of debt both from the government and from the private sector, and paying for these purchases by crediting banks with extra reserves. And in ordinary times, this would be highly inflationary: banks, flush with reserves, would increase loans, which would drive up demand, which would push up prices.
But these aren’t ordinary times. Banks aren’t lending out their extra reserves. They’re just sitting on them — in effect, they’re sending the money right back to the Fed. So the Fed isn’t really printing money after all.
Still, don’t such actions have to be inflationary sooner or later?
Selected commentsIt must be nice, Dr. Krugman, to live someplace where the prices are dropping. Here in Florida, our food prices are increasing, as are our electic bills. Our legislature has increased taxes, and insurance companies are raising are increasing Medicare Part D monthly premiums and copays. Pharmaceutical companies are raising the price of medications, and we just received notification that our rents will increase in October. All this is happening as we read that the government is preparing to eliminate COLA increases for Social Security recipients for the next three years.
I don't know if you would call this inflation. I call it impossible to live. Every time costs increase, we take the difference out of our food budgets or our medication expenses. I don't know how many meals a day you eat, sir, but I'm at two and on my way down to one.
I wish that economists would stop playing with figures and start realizing the impact of increasing prices of everyday items on people.— Marion, Largo, FL
Your model works in a national economic framework, not a globalized economic framework. China, which suddenly has a lot of dire situations creeping up on it, has decided it's not interested in purchasing our debt any more -- and due to falling trade surpluses has less excess capital with which to do so any way. Nobody else is going to buy our debt at basement-low interest rates. Therefore, the interest rates on treasury bonds will have to increase in order to entice other investors, which will in turn raise interest rates on all of the other loans begged to the 10-year note.
Our entire response to the recession has been based on the mistaken assumption that property and investments values had been driven artificially low by the crisis, instead of driven artifically high by the housing bubble. We are using debt to prop up property values and keep interest rates artificially low. This is not sustainable in the long-term. An economic recovery is going to involving suffering through the plummeted property and investment values and higher interest rates until both correct to their realistic values.— Adam L., Albany, NY
Yet the money lent to the financial institutions is dwarfed by the money spent on the Iraq-Afghanistan-(and now)Pakistan military ventures. Is not the squandering of this money, which could be used to improve our domestic infrastructure and quality life instead of to blow up people, inflationary?— pdxtran, Minneapolis
Whenever I hear the terms "inflation" and "productivity" being used, particularly by a businessperson, I know exactly what they mean: the only "inflation" the powers that be are concerned with is inflation of worker's salaries, and all "productivity" means is that we work harder for less money.
Cup O' Joe
http://cupojoe.blogspot.com— Joe V., Chicago, IL
When the Europeans, Russians, Indians and Chinese decide that they're through with the dollar as the reserve currency, then Americans will have to actually pay for imports in hard currency and that will result in the evaporation of the dollar's buying power.
Inflation will gallop, but that will be due to external not internal economic factors.— Marc Salomon, San Francisco
Regarding inflation fears -- I think the concern is that the dollar will at some point significantly devalue if we are purchasing our own debt, as the Fed is currently doing with Treasuries -- a true "monetizing of the debt." If this comes to pass, then interest rates will eventually need to rise in order to attract sufficient foreign investment. But, since the rising of interest rates places substantial pressures on the servicing of our domestic debt, the Federal government cannot afford to let them rise far enough to quell inflation. So perhaps it's more meaningful to talk about the inflation threat in terms of the devaluation of the dollar?
— lv, palo alto
Conventional wisdom may say, that "Consumer prices are lower now than they were a year ago." But I suspect that Prof. Krugman doesn't do the grocery shopping in his family, doesn't rent his home, and doesn't have to pay out of his own pocket for health insurance.
— EdA, Silver Spring, MD
Prof Krugman does not comment on the impact of the growing economies of China, India and others on the cost of commodities. It seems possible that once the world economy starts growing again, we could easily revert to the period in 2008 when gas touched $4+ and there was a worldwide shortage of rice etc.
It is not clear that earth has enough oil or other resources to support even a fraction of the populations of China, India and other large developing countries at a standard of living that the US and Europe are accustomed to. As competition for resources increases, it appears prices will rise leading to inflation.
Perhaps it means that debt does not matter as much now, and the US should spend money more aggressively on energy independence, infrastructure and such. The dollar will be worth less going forward, and that should provide debt relief.
— rabinnyt, San Francisco Bay Area
Dr. Krugman's argument is worth considering: it's not just the "printing" of money, but also how it circulates that is importance in determining the inflationary potential of monetary policy.
However, his argument is also 1. ahistorical and 2. apolitical, and that's a weakness.
1. He notes the overwhelming-debt experience of the US after WWII. However, that was then. The US emerged from the war in a unique position: it was stronger than any other nation had ever been in history, giving it the clout to impose stable conditions for capitalism on the non-communist world; the physical destruction of capital in Germany and Japan during the war literally paved the way for the start of a period of growth based on investment in the "real" economy; and the experience of the Depression and war had crushed any labor reistance to the expansion plans of the capitalists after the war. Those were the ingredients of the very real (as opposed to asset-generated) post-war boom.
Those conditions do not exist today. With the luxury of hindsight, we can actually see that the post-war boom petered out in the 1970s and that since then the Western economies and Japan have been staving off economic stagnation through state spending and the inflation of various asset bubbles.
What's new in this crisis is that it has struck at the heart of the global power that generated and maintained the political and social conditions for the post-war boom around the globe. It is silly to compare the experiences of Japan, Canada or any other country in recent decades to the predicament of the US today. The huge difference is that those crises were local or regional and not global-systemic.
2. Dr. Krugman may be right that the quantitative easing in itself may not be inflationary in these circumstances, but that is only reassuring if we take a rather narrow, fetishistic view of what money is. Money is not a thing, it is a social relationship. The weight of a currency - it's buying power - is inherently social. The credibility of the US economy has been shattered over the past seven months or so. That can only have an effect on the dollar, which, as it says on the bills, is based on "trust".
A final point: I'm not convinced that we have to have either inflation or deflation exclusively. For example, we have falling car prices and rising interest rates on mortgage loans right now.— John MacCormak, Athens, Georgia
No inflation and prices are falling? I'm not so sure about that. What I'm seeing around here is the same price on the package as a year ago, but less in the package. And believe it or not, the size of the box is still the same, but there is less in that box. Toilet paper rolls are smaller, paper towels are smaller, there is far less cereal in a cereal box, the aluminum foil roll is smaller, fewer socks in a package, it's across the board. The consumer is just being fooled into thinking prices are the same but you're getting less for your money these days.
— lulugirl765, Wisconsin
Dear Dr. Krugman,
Indeed if Japan is the precursor then The Longer end of the US Curve must be a Buy. Notwithstanding, the recent coordinated rhetoric about 'green shoots', hopes of a V are an absolute outlier and an L much more likely. In fact, one could argue that short term rates might even properly be at a negative rate at this time. Under normal circumstances this should be a supremely bullish environment for Long Term rates.
However, as you say, there is a political and macro dynamic at play here as well. Long Term rates have never been under the purview of Bernanke et al in the way short term rates are. Their influence diminishes the further along the curve you travel. Therefore, in many regards its a little like that poem you [and I like] The Second Coming
Turning and turning in the widening gyre
The falcon cannot hear the falconer;
Things fall apart; the centre cannot hold;
The lack of purchase happened when 10 year Yields blew through 3.05% which had been a line in the sand until the moment Bernanke realised he could no longer defend it.
QE was always a sleight of Hand in the sense we were selling Bucketloads of Bonds and were saying out of the corner of our mouths that we would buy one Bucketload back. This is called a bluff and it has been called.
We are asking for a material extension of the overdraft facility at exactly the time the Free Markets [Those outside the control of Bernanke and Geithner], think of China or even use Temasek as a proxy, they are seeking to taper their exposure. The first hint and signifier was the Copper market, deep in the minutiae of the Commodity complex. The recent run up in the Commodity complex, the endemic weakness of the Dollar are the siren calls.
We are swimming against a rising tide. And I think this tide has risen in part because the US transferred a very poor balance sheet from the Private sector to the full faith and guarantee of the US Government. The impairment is showing in the spike in long term yields.
These FASB type tinkering at the edges did not build confidence, it drained it further.
I see very little that can staunch this rout.
Aly-Khan Satchu
www.rich.co.ke
Twitter alykhansatchu— Aly-Khan Satchu, Nairobi Kenya
Looking at it from the standpoint of Working America, there could be inflation and deflation at the same time, two different trends in parallel. The gap between the wealthy and everyone else is only widening. As workers are laid off and lose their homes, wealthy investors are buying them up at lowered prices as investments. One high tech employment agency has predicted on the blogs that 50% of the workforce will have contract employment rather than full time employment. Contract (i.e. temporary) workers will not have the stability to take on a mortgage. So there will be a class of the super rich and those with permanent jobs competing for real estate and a class of temporary workers who cannot become homeowners. Deflation can exist for the underclass while the extremely wealthy compete to purchase large estates and luxuries at inflated prices. Women can already experience this in the fashion industry, because a skirt costs $140 in a high end store, but less than $15 at a discount chain store. Similarly, the prices of the most expensive furniture will stay the same, but the temporary contract workers often have to relocate, so their furniture is passed from one worker to another at low prices via craigslist or the Goodwill Store. It is as if there are two completely different subcultures operating at the same time.
— LAS, Redmond, WA
I think mr. Krugman is really out of touch with ordinary people that spend most of their income on basic necessities. He comes from an elite class with plenty money to spare. When food prices and gasoline price go up, it does not show up on his radar because those money only take a tiny portion out of his income of hundreds of thousands. Another things is that the inflation numbers reported by the US government can't be trusted because they are filtered and managed so that it can fool the Americans to think that there is very little or no inflation.— Winson, HK
Paul - the inflation fears (at least for me) stem from my mistrust of the Fed's political ability to unwind this current balance sheet/interest rate structure in time to avoid inflation taking hold. If this were a video game, or an academic case study, Bernanke may be able to read the data correctly and soak up the excess reserves in time...but he's got a lot of heat on him to save the world and keep money cheap at all costs. Is it possible that we almost need a 'double dip' recession where the Fed causes a tight money "normal" slowdown on the heals of this one to safely soft launch the economy with a stable currency?
Please don't mock my intelligence or others who fear the unprecedented Fed risk that's on the table right now. No one can bail out the dollar except the printer.— Jason, Buffalo, NY
According to you "the Fed is just buying debt from the government and private sector". But buying these items from themselves or others must have a cost which also will need to be payed back in some manner. The more stuff the Fed buys while hugely in debt can only mean at the very least higher interest rates! Perhaps inflation is the wrong word. How about the real danger of a devalued dollar or more specifically significant reduction in our buying power.O how about the factual discussions from other huge countries that the Dollar is starting to look risky. Which will further de-value our Dollar. IT might by definition be inflation but it will sure feel like that. Further more I find a flaw in your reasoning that we should not worry about going into 100 % debt of GDP as we have done so in the past. Things are different now.
Back in world war II we had the biggest industrial or production based economies in the world. What do we produce now? Other than articles like this, that attempt smoke and mirrors. No this government binge will not bring property. We need to stop borrowing and starting producing. Otherwise it makes perfect sense to be concerned Nick Laudani
— NickLaudani, Boston,Ma.
Jon (profile) wrote on Thu, 5/28/2009 - 6:21 am
BH, the first option was my plan a few years ago. It worked great and helped increase my salary when I did find a job.
As for the unemployment numbers, I'm puzzled why economists and the media are saying this is a sign that the recession/depression is bottoming out. The weekly numbers are within about 4% of the highest numbers lately, which does not signify any significant change. The graph shows plenty of >=4% fluctuations where the trend reversed afterward. Also, with GM on the verge of bankruptcy, it is very foolish for all these economists and the media to say that the numbers are bottoming out. Are these folks on antidepressants or is the Obama administration telling them to talk happy talk?
Clinton got sucked into the black hole of the prevailing economic
ideology of the time.
Summers, Rubin, Greenspan, Gramm all of them.
Prodded of course by the titans at the time namely Sandy Weill.
As a Democrat and a big Clinton fan over the years, I cannot deny that Clinton made huge blunders signing the repeal of Glass Steagall and legisltation the following year, both penned by Phil Gramm by the way, that deregulated the derivatives market. At the time very few people raised eyebrows about either of these pieces of legislation. In fact I believe the derivatives legislation, Commodities Futures Modernization Act, was the last piece of legislation Clinton signed as President and was hidden in some larger legislation, and signed at at time that no one was really paying any attention to it.
Clinton overall was a pragmatist and he presided over a very prosperous economic period. Nevertheless he bought into the conservative, free market, deregulation is good, mantra of the time, which was shared by almost all Republicans, Alan Greenspan and a large portion of Democrats, including Summers, Rubin and Geithner.
Rather than blame Clinton for going along with the program, I personally blame the philosophy itself. I consider it to be part of the Reaganomics mindset which basically ruled the country from 1980 until the Great Recession of 2008. It is Reaganomics much more than Clinton the man who should be what history puts most of the blame on for the massive mess we see today. For the mess didn’t begin with the signing of these foolish pieces of legislation. The debt, derivatives, and deregulation (3Ds as I call it) all began with Ronald Reagan and ended with the hyperinflationary depression that we are only beginning to experience today. http://www.jonasclark.com/wordpress/wp-content/uploads/2008/12/usdebt_serendipitythumb.jpg
May 28th, 2009 | The Big Picture
Clinton got sucked into the black hole of the prevailing economic ideology of the time.
Summers, Rubin, Greenspan, Gramm all of them.Prodded of course by the titans at the time namely Sandy Weill.
Permabear:
Calvin Jones and the 13th Apostle:As a Democrat and a big Clinton fan over the years, I cannot deny that Clinton made huge blunders signing the repeal of Glass Steagall and legisltation the following year, both penned by Phil Gramm by the way, that deregulated the derivatives market. At the time very few people raised eyebrows about either of these pieces of legislation. In fact I believe the derivatives legislation, Commodities Futures Modernization Act, was the last piece of legislation Clinton signed as President and was hidden in some larger legislation, and signed at at time that no one was really paying any attention to it.
Clinton overall was a pragmatist and he presided over a very prosperous economic period. Nevertheless he bought into the conservative, free market, deregulation is good, mantra of the time, which was shared by almost all Republicans, Alan Greenspan and a large portion of Democrats, including Summers, Rubin and Geithner.
Rather than blame Clinton for going along with the program, I personally blame the philosophy itself. I consider it to be part of the Reaganomics mindset which basically ruled the country from 1980 until the Great Recession of 2008. It is Reaganomics much more than Clinton the man who should be what history puts most of the blame on for the massive mess we see today. For the mess didn’t begin with the signing of these foolish pieces of legislation. The debt, derivatives, and deregulation (3Ds as I call it) all began with Ronald Reagan and ended with the hyperinflationary depression that we are only beginning to experience today. http://www.jonasclark.com/wordpress/wp-content/uploads/2008/12/usdebt_serendipitythumb.jpg
Steve Barry:Permabear:
- Well as some say, Clinton was the most successful Republican President since Eisenhower.
Permabear is 100% correct…debt started rising in 1980…clearly a new paradigm was in effect. It was already out of control by 1987, when Reagan made the colossal, unimaginably disastrous blunder of installing the maestro. Total credit proceeded to go on a drunken orgy, continuing to this day to heights we cannot recover from in our lifetimes. The pain of it unwinding has yet to be felt. What we have had so far is just credit growth slowing. The deflationary debt crash should start soon, with plant closings and massive defaults.It was the maestro…so blind that he could not recognize the greatest credit bubble the world may ever know…that could have maybe stopped it from happening.
I hate to get into “Godwin’s Law” territory, but I think when the history of this period is written by those who are looking back rather than by those of us who lived through it, it will be seen in much the same way as the rise of the Nazis in Germany, or the Salem Witch Trials, or the John Law’s Mississippi Company scheme in France, or any number of other highly destabilizing events, in which ultimately no one person can be blamed.
As was the case in every single one of those situations, blame will be apportioned to many parties acting on behalf of many different interests, but the overall conclusion will be that at a critical point in history, everybody went crazy all at once. Virtually all major interests simultaneously decided that it was OK to deny and throw away rules and traditions that had worked so well, despite the fact that any logical analysis showed this change to be irrational if not completely insane.
In this case, we have met the enemy and he is us, along with all those who have claimed to represent us at any point in the past 20-25 years.
Sudden Debt
Long-term interest rates are jumping, with yields on 10-year treasuries now up to 3.73%. Apart from the significant impact on the real economy (e.g. higher mortgage rates ), this development is also placing into doubt the validity of a long-standing leading indicator, i.e. the yield spread between 10-year and 2-year treasury bonds (see chart below, click to enlarge).
Economists and market analysts commonly use this spread as a predictor of future economic activity and, thus, the direction of corporate profits; and from there, the prospects for the stock market. Indeed, it is one of the components of the official Leading Economic Index calculated by the Conference Board.
Right now the spread stands at 273 basis points (2.73%), the widest ever. Many analysts, therefore, are predicting the economy will turn around in short order and start growing smartly once more (the V- Gang). Ditto for corporate profits and, predictably enough, for share prices. which have been discounting exactly such a possibility for the last three months. To judge from the shop-talk in the various dealing rooms I contact on a regular basis, the 10-2 spread is the single most fashionable indicator right now.
I think this to be a grave mistake. I believe that, unlike other instances, the spread is widening because of two developments unprecedented in the history of the US (though common enough in other, less developed countries, in the past).
Clearly, therefore, the widening of the spread is not due to fundamental economic strength. Instead, it is indicative of the rising risk premium that investors are demanding for lending the US government money for longer period of time.
- On the short end, the Fed is engaged in massive monetary operations (quantitative easing) and is keeping short rates near zero.
- On the long end, the Treasury is bailing out financial and other corporations by promising to inject trillions of dollars it does not have and has to borrow. This massive supply of new Treasury bonds - present and upcoming - is putting upward pressure on long rates and placing the country's AAA credit rating in serious jeopardy.
May 15, 2009 | Online Journal
What do you suppose it is like to be elected president of the United States only to find that your power is restricted to the service of powerful interest groups?
A president who does a good job for the ruling interest groups is paid off with remunerative corporate directorships, outrageous speaking fees, and a lucrative book contract. If he is young when he assumes office, like Bill Clinton and Obama, it means a long life of luxurious leisure. Fighting the special interests doesn’t pay and doesn’t succeed.
On April 30, the primacy of special over public interests was demonstrated yet again. The Democrats’ bill to prevent 1.7 million mortgage foreclosures and, thus, preserve $300 billion in home equity by permitting homeowners to renegotiate their mortgages, was defeated in the Senate, despite the 58-vote majority of the Democrats. The banksters were able to defeat the bill 51 to 45.
These are the same financial gangsters whose unbridled greed and utter irresponsibility have wiped out half of Americans’ retirement savings, sent the economy into a deep hole, and threatened the US dollar’s reserve currency role. It is difficult to imagine an interest group with a more damaged reputation. Yet, a majority of “the people’s representatives” voted as the discredited banksters instructed.
Hundreds of billions of public dollars have gone to bail out the banksters, but when some Democrats tried to get the Senate to do a mite for homeowners, the US Senate stuck with the banks. The Senate’s motto is: “Hundreds of billions for the banksters, not a dime for homeowners.”
If Obama was naive about well-intentioned change before the vote, he no longer has this political handicap.
Democratic Majority Whip Dick Durbin acknowledged the voters’ defeat by the discredited banksters. The banks, Durbin said, “frankly own the place.”
It is not difficult to understand why. Among those who defeated the homeowners bill are senators Jon Tester (Mont), Max Baucus (Mont), Blanche Lincoln (Ark), Ben Nelson (Neb), Many Landrieu (La), Tim Johnson (SD), and Arlan Specter (Pa). According to reports, the banksters have poured a half million dollars into Tester’s campaign funds. Baucus has received $3.5 million; Lincoln $1.3 million; Nelson $1.4 million; Landrieu $2 million; Johnson $2.5 million; Specter $4.5 million.
The same Congress that can’t find a dime for homeowners or health care appropriates hundreds of billions of dollars for the military/security complex. The week after the Senate foreclosed on American homeowners, the Obama “change” administration asked Congress for an additional $61 billion dollars for the neoconservatives’ war in Iraq and $65 billion more for the neoconservatives’ war in Afghanistan. Congress greeted this request with a rousing “Yes we can!”
The additional $126 billion comes on top of the $533.7 billion “defense” budget for this year. The $660 billion -- probably a low-ball number -- is 10 times the military spending of China, the second most powerful country in the world.
How is it possible that “the world’s only superpower” is threatened by the likes of Iraq and Afghanistan? How can the US be a superpower if it is threatened by countries that have no military capability other than a guerilla capability to resist invaders?
These “wars” are a hoax designed to enrich the US armaments industry and to infuse the “security forces” with police powers over American citizenry.
Not a dime to prevent millions of Americans from losing their homes, but hundreds of billions of dollars to murder Muslim women and children and to create millions of refugees, many of whom will either sign up with insurgents or end up as the next wave of immigrants into America.
This is the way the American government works. And it thinks it is a “city on the hill, a light unto the world.”
Americans elected Obama because he said he would end the gratuitous criminal wars of the Bush brownshirts, wars that have destroyed America’s reputation and financial solvency and serve no public interest. But once in office, Obama found that he was ruled by the military/security complex. War is not being ended, merely transferred from the unpopular war in Iraq to the more popular war in Afghanistan. Meanwhile, Obama, in violation of Pakistan’s sovereignty, continues to attack “targets” in Pakistan. In place of a war in Iraq, the military/security complex now has two wars going in much more difficult circumstances.
Viewing the promotion gravy train that results from decades of warfare, the US officer corps has responded to the “challenge to American security” from the Taliban. “We have to kill them over there before they come over here.” No member of the US government or its numerous well-paid agents has ever explained how the Taliban, which is focused on Afghanistan, could ever get to America. Yet this hyped fear is sufficient for the public to support the continuing enrichment of the military/security complex, while American homes are foreclosed by the banksters who have destroyed the retirement prospects of the US population.
According to Pentagon budget documents, by next year the cost of the war against Afghanistan will exceed the cost of the war against Iraq. According to a Nobel prize-winning economist and a budget expert at Harvard University, the war against Iraq has cost the American taxpayers $3 trillion, that is, $3,000 billion in out-of-pocket and already incurred future costs, such as caring for veterans.
If the Pentagon is correct, then by next year the US government will have squandered $6 trillion dollars on two wars, the only purpose of which is to enrich the munitions manufacturers and the “security” bureaucracy.
The human and social costs are dramatic as well and not only for the Iraqi, Afghan, and Pakistani populations ravaged by American bombs. Dahr Jamail reports that US Army psychiatrists have concluded that by their third deployment, 30 percent of American troops are mental wrecks. Among the costs that reverberate across generations of Americans are elevated rates of suicide, unemployment, divorce, child and spousal abuse, drug and alcohol addiction, homelessness and incarceration.
In the Afghan “desert of death,” the Obama administration is constructing a giant military base. Why? What does the internal politics of Afghanistan have to do with the US?
What is this enormous waste of resources that America does not have accomplishing besides enriching the American munitions industry?
China and to some extent India are the rising powers in the world. Russia, the largest country on earth, is armed with a nuclear arsenal as terrifying as the American one. The US dollar’s role as reserve currency, the most important source of American power, is undermined by the budget deficits that result from the munitions corporations’ wars and the bankster bailouts.
Why is the US making itself impotent fighting wars that have nothing whatsoever to do with its security, wars that are, in fact, threatening its security?
The answer is that the military/security lobby, the financial gangsters, and AIPAC rule. The American people be damned.
Paul Craig Roberts [email him] was Assistant Secretary of the Treasury during President Reagan’s first term. He was Associate Editor of the Wall Street Journal. He has held numerous academic appointments, including the William E. Simon Chair, Center for Strategic and International Studies, Georgetown University, and Senior Research Fellow, Hoover Institution, Stanford University. He was awarded the Legion of Honor by French President Francois Mitterrand. He is the author of Supply-Side Revolution : An Insider’s Account of Policymaking in Washington; Alienation and the Soviet Economy and Meltdown: Inside the Soviet Economy, and is the co-author with Lawrence M. Stratton of The Tyranny of Good Intentions : How Prosecutors and Bureaucrats Are Trampling the Constitution in the Name of Justice. Click here for Peter Brimelow’s Forbes Magazine interview with Roberts about the recent epidemic of prosecutorial misconduct.
- Phoevos said...
- My understanding is that Marc Faber sees the following most likely scenario:
1. An overdue market correction, but a mild one (meaning higher low from SPX 740).
2. Alternatively, no meaningful correction, rather a sideways movement.
3. After either 1 or 2 above, we rally into sometime in July for an SPX target of 1100 or so.
4. After that we engage in a more meaningful and severe correction.
FYI, Robert Prechter (an Elliottician with strong deflationary bias) who also advised his clients to cover shorts a week or two prior to March 6th, he has issued a recent opinion (week ago) that we will will see a very sharp correction (based on his Elliott signals).
Therefore, both Faber (an inflationist) and Prechter (defletionist) basically agree on the final outcome. Of the two, Faber is much closer to the existing market bullish bias on the premise that fiscal stimulus will force investors into equities because of lack of investment alternatives.- internet said...
- IMHO the baby boomers as a cohort will be the most deflation-inducing cohort in modern history....you've got a whole generation that:
1. has seen housing prices collapse;
2. over-"invested" in second homes, boats, etc.
3. hold 401ks not appreciating at the magic 8% as per the actuaries/investment advisers (assuming that annual contributions matched the acturarial levels needed to sustain retirement income);
4. see real wages stagnating; and
5. probably will be realizing soon that as a generation they will have to work well past 55/60/65.
then you have the children of baby boomers dealing with the wage deflation caused by constant manufacturing/clerical/higher-end white collar outsourcing to China, India, Eastern Europe, etc.
imho.- Stevie b. said...
- (sri - poss. dupe)
Leo "The excess liquidity is likely to create a new asset bubble (commodities, oil, alternative energy?) and another meltdown."
Possibly, and if so nearly right, but maybe you missed out 1 word -bigger-, as in "...another, bigger meltdown".
And how long do you think the markets will allow this particular bubble to blow for anyway? Like a stale bit of gum, it wont last long and it will produce a runt of a bubble, because the markets are not just going to lie back and think of America, they'll pop it in its infancy - just look at the bond market already, and marry that to a failing $ and buoyant gold, cos that's what could be next on the agenda.- Justin S. said...
- NakedCapitalism frequently posts articles about the potential for dollar devaluation or a currency collapse. Consider Yves post from May 5th- Andy Xie: "If China loses faith the dollar will collapse".
I am a little bit confused why discussions about dollar devaluation or currency collapse are considered worthwhile concerns at NakedCapitalism, and yet prognostications about hyperinflation are considered jawboning that which is unworthy of consideration. I recognize they are not the same thing exact thing- and yet, is gold not a textbook hedge against either eventuality (hyperinflation or currency collapse)?
I'd be curious to read Edward's, Leo's, or Yves specific opinions about the relative worthiness (or not) of gold in the current climate. I'm not a gold bug, though I do own some. Frankly, it's been the best-performing asset in my own portfolio for several years, and for the time being I remain bullish on it, thanks in part to continued posts at NC and elsewhere about currency risks in this environment. Does anyone here entertain the possibility of massive further dollar devaluation (~15%) in the next 5 years? Or- forgive me- currency collapse?- Gregory said...
- I always listen to Marc Faber with interest, and found him on the mark more than once. I'm having a hard time swallowing this one though, but only because with such massive unrelenting deflation underway it seems remote. Of course, I look at the FED's balance toxic balance sheet and how it appears they won't be able to deflate well even if they wanted to and I think, who knows. The way this weeks bonds are going, it's looking more like they are losing control of the long rates, and that spells massive asset price loss and deflation to me over a longer time frame. But who knows.
On another note, I must say I'm not enjoying the NK comments anymore. For example, between Leo's strutting and LIL's cheerleading of it, this string was positively painful to read. By singling them out I don't mean just them, it's several people in several threads whose comments are of such content that I find that I'm reading the comments here at NK less and less. Yves, I think you did the right thing with disabling anonymous comments, but it's not stopped the histrionic character type from making the comments a joyless read--and I'm the guy who revels in troubling news and debate. The comments are starting to read like the histrionics you see over at MSM herd sites.- Maybe some of you people have lost a lot of money and are just feeling nastier in general. And it's certainly not just this blog (but wow what a change from a couple years ago here). It wouldn't be so bad if some of the frail egos wasn't so big and inflated. I welcome the deflation not only in the economy, but in human interaction.
May 21, 2009 | Sudden Debt
Consumption makes up 70% of the US economy. Given that American households are in no great hurry to resume borrowing and that banks are, likewise, in no condition to resume lending to incremental borrowers, growth will be dependent on the other, non-consumption 30%. How fast can government spending and corporate investment grow, to outstrip the weakness of the household sector? Not that fast...
Surely, we can't bet on them growing so fast as to generate a sustainable V-recovery. After a period of inventory-to-sales adjustments that will last a few months (happening already, I believe), we will enter The Great Reset period. And this will go on for years, even decades.
The conclusion is that corporate profits in the financial and consumer sectors are going to be weak for a long time to come. Markets, too, are going to eventually figure this out...
So I’m actually reading Hyman Minsky’s magnum opus, here in Seoul. (Yay Amazon Kindle; boo its habit of crashing every hour or so, and having to be reset. Are other people having that problem?) And I have to say that the Platonic ideal of Minsky is a lot better than the reality.
There’s a deep insight in there; both the concept of financial fragility and his insight, way ahead of anyone else, that as the memory of the Depression faded the system was in fact becoming more fragile. But that insight takes up part of Chapter 9. The rest is a long slog through turgid writing, Kaleckian income distribution theory (which I don’t think has anything to do with the fundamental point), and more.
To be fair, it took me several decades before I learned to appreciate Keynes in the original. Maybe a reread will make me see the depths of Minsky’s insight across the board. Or maybe not.
I guess the point is that you can be a bad writer and a great economist. (and vise-versa - as Krugman demonstrated himself -- NNB)
And I really am gravitating toward a Keynes-Fisher-Minsky view of macro, although of the three I’d much rather read Keynes.
Selected comments:
And I really am gravitating toward a Keynes-Fisher-Minsky view of macro From there you must incorporate a broader view of balance sheets and cash flows, something I have found lacking in most analysis these days. When consumers over-leverage they face cash flow issues and that hurts aggregate demand. I don’t care that the debt is internal, it represents a distribution of income issue from consumers to investors. Even if these groups are largely the same, in our current structure it shifts current income into tax sheltered savings that most people do not want to touch due to penalties and that have already lost much of their value. Koo is on to something. Although in the case of Japan it seems businesses leveraged up much more than in the US, the US consumer is fighting for cash flow to service debt and, wherever possible, de-leverage and replenish savings. This is bad news for aggregate demand. — Mark PalermoNow if we could just get you to come around to Randall Wray’s view of the money creation process, you would be really making some progress!!! I agree about his writing ability. He is a horrible writer on many levels. However, I did find many different chapters to be full of insights. I think this book is second only to the GT in terms of insights per page. — Mike S
You might have more luck with Minsky’s intellectual bio of Keynes (titled John Maynard Keynes), especially since it embeds Keynes’s own discussion into the text. The Key Minsky Point, IMOH, is that Keynes should have based his investment theory on the price of capital assets, rather than the interest rate. The price of capital assets represents the discounted value of expected returns, but, Minsky claims, the discount factor incorporates entreneurial uncertainty as well as the interest rate. A liquidity trap results when the (implicit) price of capital assets drops below the price of investment goods (new capital assets) because of extreme uncertainty. This can occur even before the interest rate has hit bottom. In a sense, Minsky’s has the IS curve go vertical in a trap, rather than the LM curve horizontal. I think you are under-valuing Kaleckian distribution theory, since the collapse of I causes the collapse of profits that were intended to meet cash committments (to use Minsky-speak), forcing asset sales and contributing to the downward spiral of a crash. Just saying. — betsy
Even the mere challenge put forward by Minsky to the traditional view is brilliant in itself: financial fragility is perfectly plausible, and for those who claim stability there’s a lot to demonstrate. Well, not now, because now we know it can’t be demonstrated. So Minsky was right - in the 1980s. Of course the role of derivatives is highly ambiguous with respect to the financial fragility thesis. But the challenge remains in exactly the same form: those who claim that stability is even possible have a lot to demonstrate - and again, not now, because now we know there’s no stability. So this single - admittedly not so well-written book - has a lot of weight: it’s the book that should have been discussed for 25 years but wasn’t. — Thomas W.
This is a theme I have been hammering on for some time: As more people lose their jobs, we will see increasing foreclosures, adding further stress to banks’ already ugly balance sheets.
As the New York Times notes, the number of prime mortgages that were “delinquent at least 90 days, were in foreclosure or had deteriorated to the point that the lender took possession of the home” jumped enormously as job losses accelerated. Over the period when BLS was reporting 500k plus job losses a month, from November’08 to February ‘09, the numbers of distressed properties “increased more than 473,000, exceeding 1.5 million.” Total loan value = more than $224 billion. (Sources: The Times, First American CoreLogic).
Thus, even if the recession ended tomorrow, the US will still have another 500k - one million foreclosures. And if the recession continues for another 6 months to a year, well, you do the math. (Hint: About 2 - 3 X as many)
"America's reigning political-economic ideology has demonstrably failed."
May 8, 2009 | Seeking Alpha (reprinted at Jgus blog)
Disclaimer from Jgus blog
"Just to clarify - I did not write the article, nor do I necessarily agree with all of the predictions made. At least not to the degree/level that some of them go. I do, however, feel like it's well worth one's time to consider these possibilities and at least have some sort of plan in place in case events like these do come to pass."
Since the economy began sliding downhill in late 2007, mainstream economic and market experts have consistently erred on the sunny side.
As late as June 2008, mainstream consensus held that the U.S. was heading for a "soft landing" and would avoid recession. Several months later, the slump was acknowledged to have started in January 2008, but we were supposed to see renewed growth by mid-2009, with unemployment peaking in the eight-to-nine percent range. A quick "shovel-ready" stimulus bag was supposed to set us back on the road to prosperity.
In January, recovery projections were pushed forward to late 2009. Today, the consensus is for a mid-2010 recovery, with unemployment peaking at just over 10 percent. Clearly, the mainstream has struggled to catch up to reality for well over one year. What are the chances that they finally have it right this time?
Moreover, the mainstream continues to see what is going on as a plain-vanilla recession that will be quelled with some on-the-fly monetary and fiscal tinkering. Washington, we are told, will pull us out of this slump - as soon as the masses can be enticed back to the shopping malls. Then things will return to how they were before. But what if the experts and politicians are wrong not only on their ever-changing recovery timeline, but also on the nature - nay, the very existence - of a recovery?
America's reigning political-economic ideology has demonstrably failed.
Given that its government is obviously fumbling along without a clue, its foreign and domestic credit is tapped out, and its 300 million people are discovering that their hopes for continuous material improvement will never be met, could the U.S. be headed the way of the USSR?
Instead of a recovery as the mainstream envisions it, what if America permanently bankrupts, impoverishes, and marginalizes itself? What if its cherished institutions fail across the board? For example, what happens when the police realize that their under-funded pension plans cannot support a decent retirement? Will they stay honest, or will they opt to survive by any means necessary? These are questions that the mainstream does not even begin to contemplate.
In the interests of providing you with an alternate vision - something outside the mainstream - below are ten predictions for America through the year 2012. This is not boilerplate doom-saying. Rather, I am laying out in highly specific terms what will happen over the next three-odd years. Others have thrown around the term "Depression", but I am going to tell you precisely what it means for you, your investments, and your community.
When these predictions come true, I expect to be rewarded with a seven-figure consulting gig, a book contract, or a high-level position in whatever administration succeeds the doomed Obama team - that is, if anyone succeeds it at all.
Prediction one [Partially materialized in 2009 (S&P dropped to 680 or so), no stock market holidays --NNB]
The twenty-five-year equities bubble pops in 2009. U.S. and foreign equities markets will stop treading water and realign with economic reality. Stock prices will cease to reflect the "greater fool" mentality and will return to being a function of dividend yields, which have long been miserable. The S&P 500 will sink below 500. In a bid to stem the panic, the government will enforce periodic "stock market holidays", and will vastly expand the scope of its short-selling prohibitions - eventually banning short-selling altogether.
Prediction two
With public pension systems and tens of millions of 401k holders virtually wiped out - and with the Baby Boomers retiring en masse - there will be tremendous pressure on the government to get into the stock market in order to bid up prices.
Therefore, sometime in 2010, the Federal Reserve will create and loan out hundreds of billions of fresh dollars to the usual well-connected suspects, instructing them to buy up stocks on the public's behalf. This scheme will have a fancy but meaningless name - something like the "Taxpayer Assurance Equities Facility". It will have no effect other than to serve as buyer of last resort for capitulating smart-money types who want to get out of stocks entirely.
Prediction three
Millions of new retirees - including white-collar people with high expectations for a Golden Retirement - will be left virtually penniless. Thousands will starve or freeze to death in their own homes. Hundreds of thousands will find themselves evicted and homeless, or will have to move in with their less-than-enthusiastic children. Already strained by the rising tide of the working-age unemployed, state and local welfare services will be overwhelmed, and by 2012 will have largely collapsed and ceased to function in many parts of the country.
Prediction four
"Quantitative easing" will fail to restart previous patterns of lending and consumption. As the government sends out additional "rebate" checks and takes ever-more drastic measures to force banks to lend, hyperinflation could take hold. However, comprehensive debt relief via a devaluation of the dollar is even more likely. This would entail the government issuing one "new" dollar for some greater number of "old" dollars - thus reducing both debts and savings simultaneously. This would make for a clean slate a la Fight Club.
As there are many more debtors than savers in the U.S., the vast majority would support devaluation. The Chinese and other foreign holders of our bonds would be screaming mad, but unable to do anything. Every country that has not found a way out of dollar-denominated reserve assets by 2012 will see its reserves eliminated.
Prediction five
The government will stop pretending that it can finance continuous multi-trillion-dollar deficits on the private market. By late 2010, the sole buyers of new U.S. Treasury and agency bonds will be the Federal Reserve and a few derelict financial institutions under government control. This may or may not lead to hyperinflation. (See prediction four).
Prediction six
As the need for financial industry paper-pushers declines and people have less money to spend on lawyers and Starbucks (SBUX), unemployment will rise until the private sector has eliminated all of its excess capacity and superfluous or socially needless jobs. The government's narrow unemployment figure (U3) will rise into the high teens by late 2010. The government's broader unemployment figure (U6) will cease to be reported when it reaches 25 percent - it will simply be too embarrassing. Ultimately, one in three work-eligible Americans will be unemployed, underemployed, or never-employed (e.g. college grads permanently unable to find suitable work).
Prediction seven
With their pension dreams squashed, and their salaries frozen or cut, police and other local government workers will turn to wholesale corruption in order to survive. America's ideal of honest, courteous, and impartial cops, teachers, and small-time local functionaries will have come to an end.
Prediction eight
Commercial overcapacity will strike with a vengeance. By 2012, thousands of enclosed malls, strip malls, unfinished residential developments, motels, truck stops, distribution centers, middle-of-nowhere resorts and casinos, and small-city airports across America will turn into dilapidated, unwanted, and dangerous ghost towns. With no economic incentive for their maintenance or repair, they will crumble into overgrown, plywood-and-sheet-rock ruins.
Prediction nine
By the end of 2010, tens of millions of households will have fallen behind on their mortgages or stopped paying altogether. Many banks will be unable to process the massive volume of foreclosure paperwork, much less actually seize and resell the homes.
Devaluation (as mentioned in prediction four) could ease the situation for those mortgage holders still afloat, but it would also eliminate any incentive for most banks to stay in the mortgage business. In any case, the housing market in many parts of the country will lock up completely - nothing bought or sold.
With virtually no loans being made, even the government will finally acknowledge that most banks are fundamentally insolvent. A general bank run will only be averted through a roughly one trillion-dollar recapitalization of the FDIC, courtesy of new money from the Federal Reserve.
Prediction ten
As an economy is never independent of the society within which it functions, the next few paragraphs will focus on social and political factors. These factors will have as much of an impact on market and consumer confidence as any developments in the financial sector.
Whether rightly or not, President Obama, having come to power at the dawn of this crisis, will be blamed for it by over 50 percent of the population. He will be a one-term president. In response to his perceived socialization of America, there will be a swarm of secessionist and extremist activity, much of it violent. Militias and armed sects will be more prominent than in the early 1990s. Stand-off dramas, violent score-settlings, and going-out-with-a-bang attacks by laid-off workers and bankrupted investors - already a national plague - will become an everyday occurrence.
For both economic and social reasons, millions of immigrants and guest workers will return to their home countries, taking their assets and skills with them. The flow of skilled immigrants will slow to a trickle. Birth rates will plummet as families struggle with uncertainty and reduced (or no) income.
Property crime will explode as citizens bitter over their own shattered dreams attempt to comfort themselves by taking what is not theirs. Mutinies and desertions will proliferate in an increasingly demoralized, over-stretched military, especially when states can no longer provide the educational and other benefits promised to their National Guard troops.
There will be widespread tax collection issues, and a huge backlash against Federal and state bureaucrats who demand three-percent annual pay raises while private sector wages remain frozen or worse. In short, the "Tea Parties" of tomorrow will likely not be so restrained.
Finally, between now and 2012, we are likely to see another earth-shaking national embarrassment on the scale of the 9/11 attacks or Hurricane Katrina and its aftermath. This will demonstrate conclusively to all Americans that their government, even under a savior-figure like Obama, cannot, in fact, save them.
By 2012, there will be a general feeling that the nation is in immediate danger of blowing up or coming apart at the seams. This fear will be justified, given that the U.S. has always been held together by the promise of a continuously rising material standard of living - the famous "pursuit of happiness" - rather than any ethnic or religious ties. If that goes, so could everything else. We were lucky in the 1930s - we may not be so lucky again.
Disclosure: no positions relevant to this column.
Big Jake lives and works in the Washington, DC area. He has five years of experience in the Federal bureaucracy, Congress, and the lobbying sector. He is also a U.S. Army veteran. Notwithstanding his long-time involvement with government, Big Jake has no personal interest in any political party or ideology.
Dalio: Let's call it a "D-process," which is different than a recession, and the only reason that people really don't understand this process is because it happens rarely. Everybody should, at this point, try to understand the depression process by reading about the Great Depression or the Latin American debt crisis or the Japanese experience so that it becomes part of their frame of reference. Most people didn't live through any of those experiences, and what they have gotten used to is the recession dynamic, and so they are quick to presume the recession dynamic. It is very clear to me that we are in a D-process.
Why are you hesitant to emphasize either the words depression or deflation? Why call it a D-process?
Both of those words have connotations associated with them that can confuse the fact that it is a process that people should try to understand.
You can describe a recession as an economic retraction which occurs when the Federal Reserve tightens monetary policy normally to fight inflation. The cycle continues until the economy weakens enough to bring down the inflation rate, at which time the Federal Reserve eases monetary policy and produces an expansion. We can make it more complicated, but that is a basic simple description of what recessions are and what we have experienced through the post-World War II period. What you also need is a comparable understanding of what a D-process is and why it is different.
You have made the point that only by understanding the process can you combat the problem. Are you confident that we are doing what's essential to combat deflation and a depression?
The D-process is a disease of sorts that is going to run its course.
When I first started seeing the D-process and describing it, it was before it actually started to play out this way. But now you can ask yourself, OK, when was the last time bank stocks went down so much? When was the last time the balance sheet of the Federal Reserve, or any central bank, exploded like it has? When was the last time interest rates went to zero, essentially, making monetary policy as we know it ineffective? When was the last time we had deflation?
The answers to those questions all point to times other than the U.S. post-World War II experience. This was the dynamic that occurred in Japan in the '90s, that occurred in Latin America in the '80s, and that occurred in the Great Depression in the '30s.
Basically what happens is that after a period of time, economies go through a long-term debt cycle -- a dynamic that is self-reinforcing, in which people finance their spending by borrowing and debts rise relative to incomes and, more accurately, debt-service payments rise relative to incomes. At cycle peaks, assets are bought on leverage at high-enough prices that the cash flows they produce aren't adequate to service the debt. The incomes aren't adequate to service the debt. Then begins the reversal process, and that becomes self-reinforcing, too. In the simplest sense, the country reaches the point when it needs a debt restructuring. General Motors is a metaphor for the United States.
As goes GM, so goes the nation?
The process of bankruptcy or restructuring is necessary to its viability. One way or another, General Motors has to be restructured so that it is a self-sustaining, economically viable entity that people want to lend to again.
This has happened in Latin America regularly. Emerging countries default, and then restructure. It is an essential process to get them economically healthy.
We will go through a giant debt-restructuring, because we either have to bring debt-service payments down so they are low relative to incomes -- the cash flows that are being produced to service them -- or we are going to have to raise incomes by printing a lot of money.
It isn't complicated. It is the same as all bankruptcies, but when it happens pervasively to a country, and the country has a lot of foreign debt denominated in its own currency, it is preferable to print money and devalue.
Isn't the process of restructuring under way in households and at corporations?
They are cutting costs to service the debt. But they haven't yet done much restructuring. Last year, 2008, was the year of price declines; 2009 and 2010 will be the years of bankruptcies and restructurings. Loans will be written down and assets will be sold. It will be a very difficult time. It is going to surprise a lot of people because many people figure it is bad but still expect, as in all past post-World War II periods, we will come out of it OK. A lot of difficult questions will be asked of policy makers. The government decision-making mechanism is going to be tested, because different people will have different points of view about what should be done.
What are you suggesting?
An example is the Federal Reserve, which has always been an autonomous institution with the freedom to act as it sees fit. Rep. Barney Frank [a Massachusetts Democrat and chairman of the House Financial Services Committee] is talking about examining the authority of the Federal Reserve, and that raises the specter of the government and Congress trying to run the Federal Reserve. Everybody will be second-guessing everybody else.
So where do things stand in the process of restructuring?
What the Federal Reserve has done and what the Treasury has done, by and large, is to take an existing debt and say they will own it or lend against it. But they haven't said they are going to write down the debt and cut debt payments each month. There has been little in the way of debt relief yet. Very, very few actual mortgages have been restructured. Very little corporate debt has been restructured.
The Federal Reserve, in particular, has done a number of successful things. The Federal Reserve went out and bought or lent against a lot of the debt. That has had the effect of reducing the risk of that debt defaulting, so that is good in a sense. And because the risk of default has gone down, it has forced the interest rate on the debt to go down, and that is good, too.
However, the reason it hasn't actually produced increased credit activity is because the debtors are still too indebted and not able to properly service the debt. Only when those debts are actually written down will we get to the point where we will have credit growth. There is a mortgage debt piece that will need to be restructured. There is a giant financial-sector piece -- banks and investment banks and whatever is left of the financial sector -- that will need to be restructured. There is a corporate piece that will need to be restructured, and then there is a commercial-real-estate piece that will need to be restructured.
Is a restructuring of the banks a starting point?
If you think that restructuring the banks is going to get lending going again and you don't restructure the other pieces -- the mortgage piece, the corporate piece, the real-estate piece -- you are wrong, because they need financially sound entities to lend to, and that won't happen until there are restructurings.
On the issue of the banks, ultimately we need banks because to produce credit we have to have banks. A lot of the banks aren't going to have money, and yet we can't just let them go to nothing; we have got to do something.
But the future of banking is going to be very, very different. The regulators have to decide how banks will operate. That means they will have to nationalize some in some form, but they are going to also have to decide who they protect: the bondholders or the depositors?
Nationalization is the most likely outcome?
There will be substantial nationalization of banks. It is going on now and it will continue. But the same question will be asked even after nationalization: What will happen to the pile of bad stuff?
Let's say we are going to end up with the good-bank/bad-bank concept. The government is going to put a lot of money in -- say $100 billion -- and going to get all the garbage at a leverage of, let's say, 10 to 1. They will have a trillion dollars, but a trillion dollars' worth of garbage. They still aren't marking it down. Does this give you comfort?
Then we have the remaining banks, many of which will be broke. The government will have to recapitalize them. The government will try to seek private money to go in with them, but I don't think they are going to come up with a lot of private money, not nearly the amount needed.
To the extent we are going to have nationalized banks, we will still have the question of how those banks behave. Does Congress say what they should do? Does Congress demand they lend to bad borrowers? There is a reason they aren't lending. So whose money is it, and who is protecting that money?
The biggest issue is that if you look at the borrowers, you don't want to lend to them. The basic problem is that the borrowers had too much debt when their incomes were higher and their asset values were higher. Now net worths have gone down.
In 2007, Dean Baker proposed an idea he called "own to rent", in which homeowners facing foreclosure would be given the option of staying in their home indefinitely, provided they paid market rent. The notion was that stressed families would be spared the cost and disruption of moving if they were indeed viable renters (a big deal for kids in school). It would also save the bank the cost of foreclosure and the expense of maintaining a home and readying it for sale.
Selected Comments
Critics argued it was a terrible idea, that banks would come out worse, and that the former owners would make lousy tenant (it appears not to have occurred to them that the now-tenants probably have improvements they made, giving them more attachment to the house than a typical rental).
Well, this obviously stupid idea is taking place full bore in Phoenix, as entrepreneurs find owners facing foreclosure and offer to buy the home if they remain as tenants.
- Tom Lindmark said...
- Yves, I think that you might have read too much into the article.
The investors are buying houses from those facing foreclosure or who in fact have been foreclosed upon and offering to rent back the property to them if they are interested. They are not predicating their purchase on the occupant continuing as a renter. I can assure you that they are not walking from these houses if the occupant chooses not to remain.
As for the Phoenix model, it is not quite as benevolent as you might think. I can't speak to the assertion in the article that the owners are counseling the current tenants in order to groom them for a purchase of the property down the road. I can speak to some fairly questionable activities that are going on in this sphere. It has been a common practice (scam) in this town and elsewhere to entice tenants into lease/purchase agreements that require a substantial upfront payment. A portion of the lease payments are supposedly dedicated to the down payment. Normally, the upfront payment is to be applied as a deduction of the purchase price.
Here's the con. In order for the lease payments to be applied to the down payment they must exceed the fair market rent for the property. In other words if you pay $1200 for a house that would normally rent for $1000 then $200 per month will apply to your down payment. The catch? You have to document up front that the lease is above market. This is almost never done and of course most borrowers don't know about this little catch. Bottom line, you submit your loan to an underwriter and he or she says no way, the rent was not above market.- It doesn't end there. The upfront payment that's supposed to be used to reduce the purchase price is all well and good. The problem is that loans are approved on the basis of the lower of cost or appraisal. So assume your lease/purchaser has decided to go ahead and buy the house. He has cleaned up his credit, has a new job and the right ratios and after the appraisal it's agreed between both parties that the property is worth $100,000. He gave you $5,000 upfront with the agreement it would be applied to the purchase price. So the purchase price is now $95,000. All well and good but remember the loan underwriter is now going to look at the transaction and say the relevant transaction amount is now $95,000 and I need to see a down payment of x% on that amount.
Notice that the upfront payment is never structured to be a down payment. The only way to do that is for the investor to cough up the money at the time of exercise of the agreement and they aren't structured in that manner.
The sad truth is that most of these deals never work out. For the tenant/buyer that is. They work out for the seller/lessor because they're structured never to close.
Wow, I didn’t mean to go on like this. I hope it makes sense. The bottom line is that sometimes these deals are legit but most of the time they don’t and serve mostly to line the pockets of the lessor. Too often it amounts to nothing more than a scheme to sell an over priced house to an unqualified borrower...
- Mark from Michigan said...
- Homes under $100k in Phoenix sell faster than you can believe - my bro is trying to buy one right now, anything that wasn't stripped by the former "owners" is snapped up in a few days.
As to this notion that the former "owners" might have improved the property, based on my experiences in actually looking at these homes, it's hogwash. 10 yr old homes have 10 yr old fixtures and appliances. 30 yr old homes look 40 yrs old inside.
During the bubble, you didn't have to improve your home to sell it, now, the banks refuse to make even minor repairs.
Once in a while you encounter a half-done flip, but those aren't usually eligible for financing because of missing fixtures.
As to these out-of-town specuvestors, I suspect they'll get their butts handed to them. Meth/grow/drop houses are all over town, even the locals get fooled - In fact, I believe our own "pink underpants" sheriff had a drop house next door. An out-of-towner doesn't stand a chance...
The thing that really concerns me, is that the foreclosures are cleaned up by outside crews without the bank ever looking at them. You never know if a given house was a "cooker", because all of the the evidence is taken away by low-wage, untrained cleaning crews.
Since meth houses are highly toxic, I suspect a wave of articles on people buying bank-owned homes and finding out later that the places are killing them.
From Peter Goodman and Jack Healy at the NY Times: Job Losses Push Safer Mortgages to Foreclosure (ht shaun)In the latest phase of the nation’s real estate disaster, the locus of trouble has shifted from subprime loans ... to the far more numerous prime loans issued to those with decent financial histories.
...
From November to February, the number of prime mortgages that were delinquent at least 90 days, were in foreclosure or had deteriorated to the point that the lender took possession of the home increased more than 473,000, exceeding 1.5 million, according to a New York Times analysis of data provided by First American CoreLogic, a real estate research group. Those loans totaled more than $224 billion.
- crazyv wrote on Sun, 5/24/2009 - 7:12 pm
Here is the basic problem if there is no rapid expansion of jobs as most economist expect then those losing a job today are likely to default on their mortgages once their unemployment benefits stop. 66% of people losing a job will end up with a mortgage default in the future. Just the job losses from the last six months will give us about 2 million defaulting mortgages. So that give us us another leg down in the economy as real estate prices continue to take it on the chin.
I just don't see how in a highly leveraged economy one get a flat economy - the worst is over but the recovery will take time.. It is either going to fly or crash. Its like saying that an airplane can level out after its engines have stopped.
May 23, 2009 | Asia Times
...
Be it the tightening of credit spreads or the rising prices for high-yield bonds or therising prices of commercial mortgage-backed securities, the sole buyers inevitably tend to be the very financial institutions whose holdings of these securities in 2007 jeopardized the entire financial system.
It is not the hedge fund villains who have ridden back from their dirty past to ramp up their purchases of distressed securities, bonds and equities; rather these hedge funds are still going bust at regular intervals. There are many examples of silly behavior in global markets as I write this:
1. US and European stocks are pretty much where they started the year, give or take a few points, despite macroeconomic data getting steadily worse;
2. Significant jumps in the stock prices of various emerging market countries, including those in Asia, in the last few weeks;
3. Credit spreads of the world's most leveraged companies have tightened dramatically since the beginning of the year, despite rising corporate defaults;
4. Some of the most beaten-up parts of the securitization market including residential and commercial mortgage-backed securities (RMBS / CMBS) have shown some improvement in recent weeks even as property sales / price data gets progressively worse;
5. Banks have raised new capital (including for example Bank of America's $13.2 billion common equity issued this week) from the sale of common equity to the public.
My basic premise is that it is in understanding the dynamics of point No 5 above that the rest of the market moves make any sense. In other words, I contend here that financial institutions globally are misrepresenting economic data for their own short-term selfish ends.
Could anything have been done to prevent this? The decision by the Federal Reserve to drop interest rates so quickly in the first few months of 2008 likely contributed to some of the commodity price speculation. In the spring of 2008 I had further recommended some temporary sales of oil out of the Strategic Petroleum Reserve as another measure that might have proven beneficial. There is also a tradeoff between our goals of environmental protection and reducing U.S. energy use, and certainly there are policy options we could have explored for reducing our demand for low-sulfur oil in particular. I would recommend that the U.S. have an emergency plan in place for various regulatory adjustments that could be made on very short notice to help reduce petroleum demand in response to any future crisis in global oil supplies. For example, in my opinion the decision to accelerate the shift to winter fuel requirements was helpful in containing the economic damage from Hurricane Katrina in the fall of 2005.
But although there are some concrete steps that might have helped, it would be a mistake to focus exclusively on short-term gimmicks. The fundamental problem that I have highlighted above-- booming world petroleum demand in the face of stagnant world oil production-- is very much a long-run challenge. The reality is that no policy could have prevented a substantial increase in the price of oil between 2005 and the first part of 2008. The main lesson that I hope we draw from this experience is that this long-run challenge is something with very real and present short-run consequences.
Will the recent uptick in oil prices undermine prospects for recovery from the recession? Retail gasoline prices have risen about 50 cents a gallon from their low in December. That takes away about $70 billion from consumers’ annual spending power, which is hardly helpful for the broader challenge of restoring household balance sheets to a level where spending could be expected to pick back up. But let me emphasize that although I believe that the initial spike in oil prices was an important element of the process that produced our current difficulties, we are currently at a point at which the multipliers and spillovers associated with the recession dynamic itself have become far more important factors than the price of oil. The problems faced by U.S. automakers at the moment-- and those problems are very, very daunting-- are not caused by the price of gasoline. What is needed to restore U.S. vehicle sales now is not lower gas prices but instead more income, jobs, and confidence on the part of consumers.
Notwithstanding, the recent rise in oil prices again underscores the present reality of the long-run challenges. Even if we see significant short-run gains in global oil production capabilities, if demand from China and elsewhere returns to its previous rate of growth, it will not be too long before the same calculus that produced the oil price spike of 2007-08 will be back to haunt us again.
5/23/2009 | CalculatedRisk
From The Times: Professor Robert Shiller warns Britain may suffer a double recession
One of the world's most influential economists warns today that Britain faces the prospect of two recessions in quick succession.Shiller is talking about the British economy, but the U.S. economy has many of the same problems.
Robert Shiller, Professor of Economics at Yale University, said that the recent stock market bounce should be treated with caution.
...
The apparent upturn could soon go into reverse, he told The Times, marking a repeat of economic patterns in the 1930s and the 1980s. Such a double-dip slowdown has been nicknamed by economists a “W-shaped” recession, where recovery is so fragile, the country could be plunged into another slowdown as soon as it emerged from the last.
...
Last week Alistair Darling, the Chancellor, brushed aside doubts that his Budget forecasts had been overoptimistic and predicted that the recession would be over by Christmas. Many economists in the City believe that Britain will stagnate until the end of 2010 and that unemployment will continue to rise well after that.
... he warned that “there is a real possiblity of another recession. We may well see more bad news. It is a real failure of the imagination to think otherwise.”
He said that there were a number of issues that threatened any long-term recovery for the British economy - rising unemployment, mortgage defaults, and another wave of new company failures that “could surprise us yet”.
Professor Shiller also said that the banks were still harbouring large portfolios of troubled assets.
...
He added: “In 1931 in the US, President Hoover unveiled his recovery plan - there was a huge stock market rally — the market improved but it didn't hold because bad news kept coming in. Increased confidence can be a self-fulfilling prophecy but it doesn't always hold.”
Professor Shiller said, however, that he believed another likely scenario to be one where Britain would face a continuous decline with house prices falling for a number of years, drawing comparisons with the decade of misery in Japan in the 1990s.
ResistanceIsFeudal (profile) wrote on Sat, 5/23/2009 - 9:45 am
Danny (profile) wrote on Sat, 5/23/2009 - 10:23 am
EvilHenryPaulson (profile) wrote on Sat, 5/23/2009 - 11:37 amjust occurred to me, it wasn't only children playing the games
MTV's My Super Sweet 16, Bridezilla, Renovate my house, ...
The unnatural conditions of profligate credit extension created an entire culture and corresponding set of values. you can believe anything until the money runs out - and the money becomes self-validating.We don't live in a bubble economy merely, but a bubble culture.
It's going to take a lot of time to undo the damage, if it is even possible to recover. we'll see, I guess.
Danny (profile) wrote on Sat, 5/23/2009 - 10:43 amResistanceisFeudal-
In the last thread you seemed to agree in principle that Keynesian stimulus does nothing to fix an economy. I agree with you that it can "buy time," however. But I don't see our leaders doing ANYTHING to fix the underlying problems. Where's new leveraging regulation? Where's government intervention in the mortgage markets - requiring 20% down on everything always? (I'm not a sadist or that unrealistic - Obama should make it a tiered system - 5% down in '09, 10% down in '10, and then 20% down by '11 in perpetuity).
Blankfiend (profile) wrote (in reply to...) on Sat, 5/23/2009 - 5:08 pmIn all seriousness, an L-shaped recovery is precisely what we should hope for. Last September when this crisis kicked into high gear, an economics reporter (forget his name) from the WaPo said on Charlie Rose that the truth of the matter was that our entire economy was a bubble. That we had excess economic capacity not supported by our fundamental needs or abilities. So that every single asset class and component of our economy would need to deflate to a sustainable level. Not deflate and then re-inflate. But deflate permanently.
That is an L-shaped recession. And that is the only healthy, sustainable outcome.
YLSP (profile) wrote on Sat, 5/23/2009 - 10:04 am"the truth of the matter was that our entire economy was a bubble. That we had excess economic capacity not supported by our fundamental needs or abilities."
So true. In fact, we have an Agrarian Economy. Consumers are the soil, big finance and government are the farmers. The soil has been so over-farmed at this point that, rather than let it lie fallow to recover, we are pouring on the XXX power fertilizer in order to squeeze out one more harvest. This is despite the label on the XXX fertilizer bag warning that its use may lead to the need for a complete topsoil transplant.
A member of the TickerForum has been keeping track of the Fed buyback. Link here
Fed has spent $123B. At this rate their $300B will be done on August 11.
For some reason I think they will announce more money for buy-back and less for buying MBS'?
ResistanceIsFeudal (profile) wrote on Sat, 5/23/2009 - 10:05 am
Vonbek777 (profile) wrote on Sat, 5/23/2009 - 11:58 amChristmas this year should be interesting...I don't know how retail sales will go...I mean I know they will be down drastically but I am trying to figure out whether Mrs. and Mr. America will buck the trend with a good ole fashion yule tide cheer...a finally gasp before the lights go out, or if bunker mentality will have Mrs. America knitting sweaters and socks for gift-giving. I really can't tell yet.
I can't imagine the birth rate won't go up. A lot more evenings staying at home, colder houses to lower heating bills, need for low-cost distraction from a punishing reality (besides teevee, which many can't live without any more), and fewer malls to shop in. Gotta do something with all that extra time.
Not sure I share your analysis. What evidence is there that the few exporters we have are thriving with a devalued �....certainly not Jaguar/Land Rover, or any other major exporter that I can see. Sadly we have decimated our export industries during the years our currency has been hugely over valued given the illusion of success provided by our smoke and mirrors Financial Services Industry...an Industry given far too "encouragement" by this and previous governments.
And these days we no longer have North Sea oil in abundance, so now we are a net importer, and dollar denominated oil prices and our devaluation mean we have had little benefit from the drop in oil prices. Given the time it will take for our export capacity to re-grow and benefit from devaluation, our short term propensity to import will continue and we will import inflation on the back of the devaluation...to say nothing of the inflationary impact of QE. It seems to me that the outlook is further inflation, and further devaluation, along with higher taxation (depressing demand) to reduce debt. Happy Days
Peter Kinnaird
on May 22, 2009at 10:18 AM
Report this commentMay 24 | cnn.com
In an interview that airs today on C-SPAN, when asked by host Steve Scully
Q: "At what point do we run out of money?"
A: "Well, we are out of money now. We are operating in deep deficits, not caused by any decisions we've made on health care so far. This is a consequence of the crisis that we've seen and in fact our failure to make some good decisions on health care over the last several decades."
FT.com
The president’s excuse was was that he sought to turn the page on “a dark and painful chapter”. It was a “time for reflection, not for retribution”, he said.
He is quite wrong. Reflection complements the law. It is not a substitute for it. Those who can be charged with these offences should be tried and, if found guilty, punished according to the law. If among the guilty parties are CIA agents and former vice-president Dick Cheney, then so be it. If you cannot do the time, you should not do the crime. This is not vengeance, it is justice - and it is the law. Justice must be done and must be seen to be done before healing and reconciliation can start.
... ... ...
I was in the US shortly before 9/11 and shortly afterwards. The transformation in the public psyche was astonishing. Not just in New York and Washington DC, but everywhere I went, people were traumatised and visibly and audibly afraid. Both reason and principles went out of the window. It is true that this was the first serious ‘external’ attack on the US mainland since the War of 1812. There has been extremely bloody conflict since then, but all of it internal, including the Civil War and the routine fire-arms-related private violence which claims currently around 15,000 lives each year (not counting a somewhat larger number of fire-arms-related suicides).
September 11, 2001 is more than seven and a half years in the past, but the US polity and public appear no less traumatised by it today than they were in the immediate aftermath of the outrages. A very primal mood of insecurity and fear continues to afflict most of the nation and its politicians.
Fear is a poor guide to policy. It caused the US to launch an unnecessary second war against Iraq and it led its leaders to compromise the most important principles on which the country was founded.
Moon of Alabama
By now everyone knows that Edward Liddy just stepped down as Chairman and CEO of AIG. I believe this is highly relevant to this blog as the event validates many of the criticisms I have leveled at the majority of MoA posters. Liddy left because he could no longer tolerate the self-aggrandizing politics that was hindering his honest attempt at paying off tax-payers in as careful and deliberate a fashion as possible.
In trying to navigate between the Scylla and Charybdis of a) unrelenting criticism, and b) unrealistic expectations, he threw in the towel and answered the prayers of some and, as the saying goes: “Hell is answered prayers”:
Who is going to replace him? Obviously someone with knowledge and experience (= a hated ‘insider’?), maybe a turn-around specialist (= “vulture capitalist”?). Or somebody with sufficient ‘stature’ to face of a hypocritically angry Congress and Senate baying for blood when they should be sacrificing their own?
Liddy did the right thing. The American public didn’t deserve the services of somebody who took on the most difficult and high profile job in the U.S.A. for a nominal salary of $1 per year.
I often use analogies to make a point, so let me offer you another one:
There’s been an earthquake in Iran. The whole system is corrupt and buildings are built sub-standard, with the construction mafia pocketing the difference. 50,000 have already died and another 200,000 sit among or beneath the rubble. There is a desperate need for excavators, bulldozers and other machinery and equipment in the immediate vicinity, but these are all owned by the same contractors that caused the mess to begin with, and their employees are equally inept or corrupt. Now, what does the Government do? Forbid the use of those companies/contractors and call in new people and equipment from far away, knowing full well that every second’s delay could cause an additional death? Seize the equipment by decree and risk a protracted battle, I mean a really nasty one, between the government and the construction mafia that would divert attention from the job of saving lives?
What would I do if a solution were within my power? I would enlist the aid of everyone in the vicinity, whether corrupt or otherwise, to get the remaining people out from under the rubble and to hospital, and then, and only then, would I hold inquiries and dole out punishments. The U.S. economy has suffered precisely such an earthquake. Actions born of anger alone will not save it.
FT: Hostile atmosphere too much for Liddy - (alternative link)
Posted by b at 04:28 AM | Comments (26)
May 22, 2009 | NYTimes.com
On Thursday, the influential bond fund manager Bill Gross of Pimco said in an interview on Bloomberg Television that the United States might eventually lose its triple-A credit score.
The dollar’s sharp slide has renewed concern that investors worldwide were beginning to favor other currencies, foreign economies and commodities like oil and metals.
... ... ...Only recently, the economy was veering into a spiral of lower prices and lower wages that economists feared would deepen the downturn. As prices dropped precipitously at the end of last year, consumers could stretch their dollars farther. But policy makers worried that a deflationary cycle would make consumers less likely to spend money if they constantly believed prices would be cheaper in the future.
Now, some are starting to warn about an economic beast called stagflation — the combination of higher prices and a struggling economy.
“The economy may be at greater risk of inflation than the conventional wisdom indicates,” Charles I. Plosser, president of the Federal Reserve Bank of Philadelphia, warned in a speech Thursday. He said prices could climb 2.5 percent in 2011, a higher forecast than the Fed’s expectations of 1 to 1.9 percent inflation.
Although the United States government officially supports a strong dollar, policy makers have let its value slide in past years because a weaker dollar makes American exports cheaper and more attractive. But a weaker dollar also makes imports — like crude oil from the Middle East — more expensive, raising the costs of energy and transportation.
“Everyone says a little inflation can’t hurt us,” said Martin D. Weiss, chairman of Weiss Research. “What they don’t seem to understand is, that’s inflation in a growing economy. Inflation on top of rising unemployment is another thing entirely. It’s much more painful, and it could be the straw that breaks the camel’s back.”
Some experts say fears of inflation and the loss of the dollar’s strength are overblown.
With the global economy in its worst downturn since World War II, and European banks facing up to $1 trillion in new losses from Eastern European investments, the euro may begin to weaken on its own against the dollar, they say. The United States remains the world’s default reserve currency, these experts add, and Treasury debt is still considered the world’s safest investment.
The Federal Reserve’s own forecasts call for inflation to hover in a “low range,” rising only about 0.6 to 0.9 percent this year. Consumer prices dropped sharply over the last six months as demand plummeted, and prices were flat last month after falling slightly in March.
According to the Labor Department, consumer prices in April were down 0.7 percent from a year earlier, their biggest decline in decades. Airline tickets cost less, gasoline is cheaper than last year, and retailers are still offering deep discounts to beckon consumers.
But while lower demand and a sluggish economy normally act to constrain inflation, some experts said the pressure on prices in the months ahead might be driven by economic activity elsewhere in the world, not just inside its biggest economy.
“There is growth in the emerging markets,” said Mr. Darst of Morgan Stanley. “There’s an international demand as well as a U.S. demand. The inflationary pressures are going to be coming from outside the walls of Troy.”
Calculated Risk
Selected comments
“The federal government’s total liabilities,” Walker explained, “translates into a de facto mortgage of about $455,000 for every American household and there’s no house to back that mortgage.
In other words, our government has made a whole lot of promises that, in the long run, it cannot possibly keep without huge tax increases.”
Now with Obama giving trillions away it’s probably more like $650,000 for every American household which equates to math on $200K liabilities per person at avg family size of 3.25.
As The Triumph of the Banking Oligarchs continues at huge taxpayer expense perhaps most Americans should look forward to being a much BIGGER version of Argentina or Mexico in the near future !
Unless Obama steps up to the plate to break the financial oligarchy that is blocking essential reform 98% of Americans had better get a new dream and fast --
Turbo wrote on Fri, 5/22/2009 - 1:37 pm
I wonder if Greenspan had a similar epiphany when he was sitting in the hot tub with Barbara Walters?
sm_landlord wrote:
dr munch;
"Ain't a depends undergarment out there that's big enough to contain the shit coming out of him."
He a politician who happens to be an economist. And you expected what exactly?
mmckinl wrote on Fri, 5/22/2009 - 1:41 pm
Greenspan was the useful idiot ... used to implement Trickle Down Reaganomics ...
Schaeffer (profile) wrote on Fri, 5/22/2009 - 1:49 pm
via ZeroHedge
Ron Paul on May 19
http://www.youtube.com/watch?v=2IU3iE8nC2Mlove or hate the guy, it's quite a speech - I can only imagine if it were delivered by a true orator what impact it might have on the sheeple
among the great lines:
"slavery sold as liberty"
"The philosophy that destroys us is not even defined"
"We have broken from reality on a psychotic mission"
mmckinl wrote on Fri, 5/22/2009 - 1:52 pm
Angry Saver (profile) wrote on Fri, 5/22/2009 - 1:54 pmkm4 wrote on Fri, 5/22/2009 - 1:48 pm ...
Another great post ...
~ US unemployment about to surpass that of the EU
~ In 2007, 51% of college students graduated with a job. In 2009, it's 19.7%
~~~~
It's all falling apart ... of course college grads without jobs are not in the unemployment stats ...
Bernanke is also clearly incapable of seeing the big picture. He's just another academic that gets lost in the weeds/details.
Example. Real growth in the U.S. has been remarkably steady, except for the GD. So why does he feel the need to predicit the future? Steady as she goes seems more apt. Further, real growth has slowly but steadily declined with the increase in the relative size of finance in our eCONomy. And real incomes for the majority have suffered mightily as well. Yet, rather than recognizing the extractive nature of the overgrown finance monster, Bernanke is intent on preserving it. He is a seriously twisted dude.
awyerliz wrote on Fri, 5/22/2009 - 1:56 pm
He has to think this way. He is in a certain time and place and not capable of transcending
his circumstances. If he were, he'd be out.mmckinl wrote on Fri, 5/22/2009 - 1:58 pm
mmckinl wrote on Fri, 5/22/2009 - 2:01 pm"It's the President's responsibility to nominate the chair"
~~~~
The President picks from a list ...
Drawn up by the banksters ...
lawyerliz
"He has to think this way. He is in a certain time and place and not capable of transcending
his circumstances. If he were, he'd be out."~~~~
"It is difficult to get a man to understand something when his job depends on not understanding it."
~ Upton Sinclair
Yalt wrote on Fri, 5/22/2009 - 2:06 pm
It's easy enough to say he's a dolt, but do you think it's an accident that the policies selected on the basis of this particular neoclassical perspective invariably seem to benefit the sector of the economy that controls the Fed and Treasury? Bernanke, Paulson, Geithner, Summers were all put in these positions to do exactly what they've done. It's an open question in each individual case whether they are willing participants in the scam or naive and doltish innocents whose known ideologies have been found useful, but when the most powerful sector of a society is plundering the public purse it's not merely the result of a series of mistakes.
mmckinl wrote on Fri, 5/22/2009 - 2:09 pm
Yalt Fri, 5/22/2009 - 2:06 pm
Yep ...
And as long as the banksters reap the profit and prerogative
of the creation of currency and credit they will always have the money and power
to plunder the public's purse ...
Turbo wrote on Fri, 5/22/2009 - 2:10 pm
I'd say 90% of bond traders are contemplating when the optimal time to convert one's entire net worth into gold, a homestead a guns is. The official statistics are probably going to show deflation for the rest of the year, so you don't want to be jumping the gun, but the only point for debate seems to be timing.
Angry Saver wrote on Fri, 5/22/2009 - 2:11 pm
Expect Bernanke to announce a ceiling on long term Treasury rates soon enough
Good luck with that. This isn't the 1940s when we we a trade surplus country. If Bernanke explicitly caps rates, foreigners just might stop lending us $2 billion/day.
We have serious problems, but diluting real capital (spreading the problem out) is not the solution. And neither is kicking the problem down the road.
I see nothing wrong with an austerity plan. I don't see how we can go wrong with conservation and prudence either.
Yalt,
Am I being fair? Absolutely not. After all, I couldn't conversely offer a solution and he has managed to keep markets open, which is in my opinion a major accomplishment.
I don't think Bernanke is stupid. His work is fine. But he does behave stupidly and his work is narrow minded. His perspective is that credit rates and spreads are the genesis of the entire economy. From housing demand, to manufacturing activity, to service sector employment. He doesn't step outside the central banker shoes to look at the system, he doesn't consider a larger context that form decisions à la Minsky.
He's smart enough, and he should know better. At the very least, if he behaved smartly, he would have resigned to let someone else take the fall so that he may be of use when the real work begins. I think this may be the case of an old dog, still smart, incapable of learning new tricks and he feels truly overwhelmed.
Serious about him instituting a ceiling on long term treasury rates though. It's his only hypothetical tool which he hasn't used. He will do it, and it does make sense in a number of respects -- even if you believe in a big crash ultimately.
"Where the recency bias caused people in 2006 to extrapolate ever increasing asset prices and a world of low interest rates and muted business cycles, today it has caused many to think we are headed straight for the Great Depression II and that financial Armageddon is upon us."
A recent post I published on both Credit Writedowns and Naked Capitalism, “Both initial claims and continuing claims now pointing to recovery,” has left the impression that I am a wild-eyed bull – for which I have been duly smacked about the head. This is far from the case. A recent post by Nouriel Roubini to which Marshall Auerback alerted me is very much in line with my viewpoint. I would like to share snippets of that post with you along with some quotes from my own past posts and updated commentary to clarify how I see the economy progressing. But, I also want to reiterate the point of NOT viewing the economy only through the lens of recent events, and of taking a measured, objective view of data.
... ... ...
Look, the fact of the matter is we are in depression. This is no ordinary recession. That means the negative effects of deleveraging and its drag on growth will continue for the foreseeable future until the excesses are largely unwound – recovery or not. This is the principle reason, I do not see the recession ending this Spring despite the jobless claims signal. While I wrote the jobless claims post to highlight this fact, I cannot dismiss the data out of hand. The signal is there and it has been reliable for the 40 years of data collected on jobless claims as Robert Gordon has indicated.
In my view, econobloggers and their readers are suffering from the same recency bias that created the housing bubble – viewing future events through the distorted lens of recent events only, without adequate consideration of the natural boom-bust nature of the global economy. I said as much in my post, “Through a glass darkly: the economy and confirmation bias in the econoblogosphere.” Where the recency bias caused people in 2006 to extrapolate ever increasing asset prices and a world of low interest rates and muted business cycles, today it has caused many to think we are headed straight for the Great Depression II and that financial Armageddon is upon us.
However, the picture is not as stark as this. While we may be in a mild depression, policymakers around the world have gone to great lengths to prevent a Great Depression II. In my view, the Federal Reserve has effectively demonstrated it is willing to risk hyperinflation in order to beat back the deflationary forces. And with most major economies engaging in extreme fiscal stimulus and monetary stimulus, one can only conclude that the worst is over and we will see a cyclical recovery. Moreover, the gifts to the financial sector have been large and will continue (see posts here and here) and have diminished the crisis of confidence we suffered post-Lehman. You may not like the means used to achieve this, but the effects are clear.
This is what I call The Fake Recovery. Underneath the surface, all of the problems are still there to a lesser extent: the massive debt burdens, the weak financial sector, the poor savings in the U.S.. We are likely to see the lingering effects of deleveraging to fix these problems take a percentage point away from growth for some time to come. This means the recovery in 2010 is going to be weak. Could we see jobless claims average 450,000 in recovery? Certainly. And 450,000 jobless claims was a figure that meant recession in 2001, so that is no recovery to write home about. And, while it seems increasingly likely we will get a recovery by year’s end or Q1, a double dip recession like we saw in 1980-82 is still a very distinct outcome.
The reason that recovery will come and it won’t feel like one is simply because the terms ‘recession’ and ‘recovery’ are misunderstood. Most people would define a recession loosely as ‘a period when the economy is not doing well.’ A recovery is axiomatically then ‘a period when the economy is doing better.’ But, that is a misnomer. I don’t think many people get the fact that GDP as reported is a first derivative statistic or that recession is a first derivative term (i.e. it measures the change in output, income, sales and employment). Now, I tried to make this point in “Economic recovery and the perverse math of GDP reporting,” the point being a fall from 100 in year 0 to 90 in year 1 and jump back to 92 in year 2 would be considered a deep recession followed by a weak recovery. Anyone living through such an experience would not be experiencing ‘recovery.’ And as far as the U.S. goes, the middle class has been losing ground for some 35 years. The deleveraging process is going to further this sense of loss.
So, I have an idea which Marshall Auerback inspired. Let’s get rid of the term recovery altogether. Let’s call what we see coming an end of the recession or an end to the worst of it. My worry is that any recovery will be used to prevent true reform to our financial system, to roll back recent trends in regulatory oversight and anti-trust, or to provide sufficient relief to two-income families.
Unfortunately, for most of us, it will not feel anything like a recovery. Yet, it may be used to continue business as usual.
Selected Comments
Terry Maynard:
Ed–Thank you for this clarification and expansion of your earlier remarks on your website which, frankly, were more narrowly focused (on unemployment & its meaning) and more upbeat than your expectations stated here.
I think this piece points out the need to avoid appearing to make major judgments on the basis of a single (or 2 or 3) lines of data. Certainly, this deep recession is more complex than the employment situation. Both the "green shoots" crowd and the Armageddonists usually find their single data series to support their views–and usually they are both wrong.
I am generally in the Roubini-Harrison camp in terms of our economic outlook. NTL, I see the possibility of a temporary economic upturn in Q4 as holiday shopping & the stimulus actually produce some positive results. After that, it's back to decline through mid-2010 when the broader impact of the stimulus finally catches up with the ebbing decline in economic activity. Maybe that's a "W", maybe not. In any case, the right hand side of that W is going to be very weak and prolonged.
Thanks for your post & keep it up.ineup32:
As someone with a limited economic perspective I appreciate your attempt to educate regarding the meaning of the word “recovery” as professional economist view the term. Hopefully your are recovering from the verbal beating administrated by the blogging community as your viewpoint is always appreciated.
Edward Harrison:
lineup, Yves says ‘I must be popular’ if you all are beating me up. So thanks for keeping me honest. Frances, I was referring toopen market operations.
Bernanke says he can sell assets (treasurys?) once recovery is manifest to get those deposits back. But, there are multiple problems with this. First, when does he plan to do it? If he goes to early, he’ll smother a recovery and we get a double dip. If he waits too long, you get inflation. I think he’ll rather wait than act pre-emptively given the structural problems. This means inflation. And judging from the yields on the ten year, I am not alone.
But, also remember, the Fed now has tons of so-called toxic assets on its balance sheet. How are they going to sell these? If they sell treasurys and are left only with the other assets, their balance sheet would look even worse. I see this a a real problem.avd:
You cannot have recovery until after sound business takes over phony business. What Fed is doing is proping up the pillars of phony economy. This might work short term but longer term it only works for a more profound failure. Expect a few months of less-bad and even good news to end with a brutal crash.
Leo Kolivakis:
Hi Edward,
As you know, I have written extensively on the D-process and W-recovery. What people need to understand is that there are nearly 10 million out of work. Even if these people eventually find jobs, they will likely settle for less income, and in some cases, substantially less.
I am hopeful on certain sectors of the economy – health care, infrastructure and alternative energy – but I doubt they will be able to absorb the job losses from the auto sector and FIRE (finance/real estate/ insurance) sector.
What people need to understand, however, is that the stock market will gyrate in between, with huge bear market rallies.
Here is a part from a recent comment of mine:
While I respect David Rosenberg, I strongly doubt Asia will lead us out of this global downturn and I don’t buy the bullish Canada story.
The way I read the markets is that risk appetite has increased as hedge funds put risk trades back on: long stocks, long corporate bonds, long commodities, long commodity stock indexes, long commodity currencies, long emerging markets.
It’s not fundamentals driving stocks higher; it’s the big hedge funds that are playing the momentum trades. Andy Kessler is right, it’s another sucker’s rally:
The stock market still has big hurdles to clear. You can have a jobless recovery, but you can’t have a profitless recovery. Consider: Earnings are subpar, Treasury’s last auction was a bust because of weak demand, the dollar is suspect, the stimulus is pork, the latest budget projects a $1.84 trillion deficit, the administration is berating investment firms and hedge funds saying “I don’t stand with them,” California is dead broke, health care may be nationalized, cap and trade will bump electric bills by 30% . . . Shall I go on?
Until these issues are resolved, I don’t see the stock market going much higher. I’m not disagreeing with the Fed’s policies — but I won’t buy into a rising stock market based on them. I’m bullish when I see productivity driving wealth.
For now, the market appears dependent on a hand cranking out dollars to help fund banks. I’d rather see rising expectations for corporate profits.
My only warning to portfolio managers who share this view is that this sucker’s rally still has legs so be careful thinking that it’s bound to break down anytime soon. In fact, it might go a lot higher from here.
Longer term, I agree with Paul Krugman, rising unemployment, which is expected continue after the recession ends, could lock the U.S. into a “depressed economy” for as long as five years:
Krugman said he would not be surprised if the U.S. recession, which began in December 2007, ended in August or September this year. Deteriorating labour markets, however, are likely to continue into 2011, meaning “the period of a depressed economy” could last until 2013 or 2014.
Krugman, who teaches at Princeton University, won the Nobel Memorial Prize in Economic Sciences last year for his analysis of how economies of scale can affect international trade patterns. He also writes columns for the New York Times newspaper.
The U.S. economy, the world’s largest, contracted a worse-than-expected 6.1 per cent annualized drop in the first quarter. Americans increased purchases of cars, furniture and appliances but businesses cut back spending and exports had their biggest drop in 40 years. The U.S. unemployment rate hit 8.9 per cent in April and many economists expect it to reach 10 per cent by year’s end.
Krugman said while economic indicators from around the world are improving, they suggest the pace of economic decline has only slowed.
“I share the optimism that the worst of this may be over,” he said, also noting a stabilization in financial markets.
“What’s really hard, however, is to say when does this go beyond stabilization to an actual recovery.”DownSouth:
@Edward Harrison
I sense that the malaise is much more deeply rooted than what you believe. What can we call it? A postmodernist funk? But I think what you are seeing is your entire Enlightenment and, speaking more specifically of economics, neoclassical, worldviews coming under increased scrutiny.
Turning back the clock to four centuries ago, many Americans undoubtedly now find themselves in a mood not unlike that which pervaded early 17th-century Spain. “There are many things here that seem to exist and have their being, and yet they are nothing more than a name and an appearance,” the Spanish satirist Quevedo wrote. Or as J.H. Elliot wrote in Imperial Spain: 1469-1716:
It was in this atmosphere of desengaño, of national disillusionment, that Cervantes wrote his Don Quixote, of which the first part appeared in 1605, and the second in 1614. Here, among many other parables, was the parable of a nation which had set out on its crusade only to learn that it was tilting at windmills. In the end was the desengaño, for ultimately the reality would always break in on the illusion. The events of the 1590s had suddenly brought home to more thoughtful Castilians the harsh truth about their native land–its poverty in the midst of riches, its power that had shown itself impotent.~
So who are some examples of modern-day arbitristas, as the 17th-century Spanish skeptics came to be known? First and foremost I would put President Carter, who on July 15, 1979 pretty well doomed his political career with his “Crisis of Confidence” speech in which he spoke of a less materialistic, more self-reliant democracy.
Then there was Robert L. Heilbroner, who in 1988 published Behind the Veil of Economics in which he wrote:
[C]ontemporary mainstream economists are largely uninterested in questions of historic projection, regarding capitalism as a system whose formal properties can be “modelled,” whether along general equilibrium or more dynamic lines, without any need to attribute to these models the properties that would enable them to be perceived as historic regimes and without pronouncements as to the likely structural or political destinations toward which they incline. At a time when the need for institutional adaptation seems pressing, such a historic indifference to the fate of capitalism on the part of those who are professionally charged with its self-clarification does not augur well for the future.~
You can add to these those criticisms that fall more into a Malthusian vein, such as John Gray who in Al Qaeda and What it Means to be Modern has a chapter on “Geopolitics and the limits of growth.” Then there’s Herman Daly who wrote a scathing critique of neoclassical economis in “A Steady-State Economy.”
But perhaps the critic of the neoclassical economic paradigm who has garnered the most attention has been Nassim Nicholas Taleb, who in The Black Swan, after relating his pleasant boyhood days in the “stable paradise” of Lebanon, wrote:
The Lebanese “paradise” suddenly evaporated, after a few bullets and mortar shells. A few months after my jail episode, after close to thirteen centuries of remarkable ethnic coexistence, a Black Swan, coming out of nowhere, transformed the place from heaven to hell…
I had been told in highschool that the planets are in something called equlilibrium, so we did not have to worry about the stars hitting us unexpectedly. To me, that eerily resembled the stories we were also told about the “unique historical stability” of Lebanon. The very idea of assumed equlibrium bothered me. I looked at the constellations in the sky and did not know what to believe.frances snoot :
Mr. Harrison:
Where do you think the two trillion dollars went that the Fed lost in open market operations? If the official story is ‘we don’t know’, then the collateral for the loans must be toxic at best, or nonexistent.
No wonder capital is fleeing America.
Seems like the only thing keeping the structure of the banking system standing is the bankers shaking hands.
No mention in Mr. Kolivakis reply about a bond market dislocation. It is happening; isn’t it?
Edwardo:
At this stage, because of the status of the marginal productive capacity of debt, which as of 2003 was zero, QE, and all the other reflation endeavors will do quite the opposite of what they are intended to do, namely, spark economic activity.
Allow me to put forward a different metaphor than green shoots, yellow weeds, etc. We are in the eye of the Hurricane. The second half of this year, and into 2010 are going to be worse than ‘08.
Buckle up!Edward Harrison:
Leo,
Interesting comments. You could be right that this rally has legs. By the way, the 2002-2007 rally was a bear market rally that lasted 5 years. Just because stocks are rallying doesn’t mean they won’t collapse lower. Generally, I find it hard to believe a bull market is at hand given the P/E ratio never reached secular bear market lows. Add in the structural problems you and Krugman are referencing and you can see why renewed weakness brings us lower just like this last recession has done.
By the way, Leo, don’t you think pension issues will come to the fore if the market goes lower? I was surprised they had not become a major issue this year.
By the way, I intend to right a post that we could see a massive upside surprise in GDP due to less bad inventory de-stocking and a less bad capital investment number by Q4. It really is amazing that we are not seeing more savings here given the debt levels, but the Obama team is encouraging a return to the previous growth dynamic. Not encouraging for a sustainable recovery.gne1963:
It is interesting to note that in April, 21 states had *FALLING* unemployment. Another 11 had NO RISE in unemployment. Kinda looks like a peak has formed.
Red Pill:
“especially in the face of quantitative easing. Don’t underestimate the power of printing money.”
I am deeply troubled by this idea that the Fed “printing money” does not have downside risks comparable or worse than letting the “D process”
work out. People buy our debt with the expectation that we will be SOMEWHAT sane regarding our currency. We already have a farce of a mortgage market. Even with the Fed supporting housing prices sales go down with reductions in employment and salaries. And they will continue to go down even with “smaller increases” in unemployment.
Am I the only one who thinks this whole discussion is insane!
Why don’t we just print money all the time!
Tell me how Fed actions turn into inflation in salaries.
Tell me how Fed actions turn into inflation in salaries.
Tell me how Fed actions turn into inflation in salaries.
Until that happens it will be a D process as people will not be able to service outsized debts. I agree with an earlier comment that the debt/GDP ratio is the most important graph. Any discussion of recovery that does not address this problem is fluff in my opinion. Extending more credit does not help a D process. The only thing I see the Fed doing that even has a remote chance of increasing salaries and employment is massively buying treasuries and then government hiring people and overpaying them relative to the weak labor market. But, then I guess if you don’t work for the gov your screwed. Proceed to torches and pitchforks.
I see the end game of the current course as falling wages and employment with possible milder US deflation (in US RE, US stock, discretionary purchases made in the US) due to Fed “printing” but there will be a dollar collapse and inflation in everything imported.
The Fed is playing a very dangerous game and debasing our currency or proceeding to the final death spiral of issuing treasuries to pay interest on treasuries is not a better outcome in my opinion than a full on depression.
We need to have grown up discussions in the US because I think the dollar is getting tired. We were very irresponsible. I do not think there is some magic solution to get out of paying the consequences.kingcalvin:
To even discuss inflation in this environment is to show your lack of any sort of grasp of reality. Read Mish’s post on Deflation and his 16 points. We are 16 for 16. Deflation has set in. Falling asset prices, falling wages, falling employment and a banking system that is contracting wildly. Credit is not increasing in any way shape or form. I am a veteran of the credit industry for the last 20 years, and even now underwriting standards are getting tougher… this is real-time, folks. The “money” the feds are providing to backstop our system is still being hoarded, as the banks are preparing for bigger and bigger losses down the road. For ANY economist to ignore the second wave of foreclosures combined with rising credit card defaults and CMBS defaults and say there is any reason to believe that we are laying a foundation for a bottom, or to mention inflation at all is unbelievable. Unbelievable. Where is your HEAD!?! This credit crisis is far from over. Far from over. I’m a realist… Deflation is here and if the Fed thought for a milli-second that inflation would be a problem ANY time in the next 5 year, they wouldn’t have done ANY of the things they’ve done recently. Quantitative easing??? COME ON…. look at the 10 Yr-Tbill yield… steady climb since they’ve announced it. The FED knows deflation is here to stay…. they are throwing everything they possibley can at it and it continues. Wake up… my goodness the current economic conventional “wisdom” is so yesterday.
Hugh:
There is quite a diversity of views here. I think this reflects a US and world economy in considerable flux.
What we have is team Obama throwing a lot of money at the problem without addressing any of the fundamental issues: homeowners, high unemployment, insolvent financial institutions of all kinds, indebtedness, weak regulation, and over-securitization to name a few. So all of this money being made available to the financial sector is having peripheral effects without solving anything.
I think this is why we see a few scattered positive signs and so much pessimism.Leo Kolivakis :
Edward wrote:
"By the way, Leo, don't you think pension issues will come to the fore if the market goes lower? I was surprised they had not become a major issue this year."
>>>I am surprised you are not aware that the pension time bomb has exploded everywhere. Just go back and read some of my archived daily comments on Pension Pulse.
When it comes to pension deficits, two things to keep in mind: 1) lower stock markets means lower asset prices and 2) lower interest rates means lower discount rate of future liabilities, which means higher liabilities for the future.
As I wrote a while back, if the deficits from the Iraq war was Bush's legacy, the pension deficits will be Obama's legacy.
President Obama and his economic team are trying to reflate the securitization, stock market, hedge fund and private equity bubbles by reigniting inflation. It's their only hope of dealing with this mess.
The trillion dollar question: Will it work or will this lead to an even more disastrous outcome?
Cheers,
Leo42:
Well, I don’t know much about de/inflation or bonds and stuff, but I do know that I’ve been out of work since February and have applied for about a gazillion jobs, but getting nothing. Yeah I could probably flip burgers or load freight but that’d pay me less than what I get from state UI, so there’s no incentive for me to take any job. I know I’ll probably never make nearly what I made at the last job ever again, and I’ve been prepared for that for a few years (no debt, nice savings account), but still, when I see and hear these bloviating asses claiming that everything’s going to be OK, green shoots, oh look at the price of GS (after getting $10bil in tax money funneled to them via AIG), blah blah blah, it’s comically obvious that this is a sucker’s rally.
Basically, if you have a job now, you are extremely lucky, and you’d better realize that ASAP because there are NO jobs out there other than low-wage scut work.Keopele1991:
The problem with most predictions is that they are based on a narrow perspective or a view of one aspect of the economy! Most experts don’t have an understanding of more than one area relating to the economy. I see the “experts” make statements that only take into account their area of expertise and are unaware of factors outside there realm of expertise. This is a very narrow veiw and is the # one problem I see with most opinions.
I have done objective research in many diiferen’t area’s that affect our economy and have come to some conclusions that are pretty dire.Keopele1991:
Sorry for all my typos in my last post!
I want to be more clear and specific than my last post. First I want to identify what area’s I have researched.
1. History of U.S. Monetary and fiscal policy.
2. Human psychology on the macro scale as it relates to the economy and history of civilization.(this one is key and most important)
3.Global developement and use of non-renewable resources.
4.Global distribution and control of natural resources.
5.Production and use of non-renewable resources.
6.Economic dependence on non-renewable resources.
7.Understanding the switch to sustainable resources and the infrastructure requirements to do so!
8.Global population growth and distribution of resources as it realates to growth.
9.I worked in banking and finance for 10+ years and saw the insanity of the people in control of this system and it’s obvious problems. (Classic Sociopathy created a very unstable system)
10.Global warming and understanding the non-linear physics of nature on a broad scale based on statistical info from our past.
When you take into consideration all these factors I have spent thousands of hours researching over the last two years, you soon realize we are screwed no matter what we do.There will be pain and suffering. We are just at the begining of this unprecidented cycle in human history. I think if people spent the time doing the research I have done they would be terrified! I have come to terms with the reality I see and just have come to the understanding that it is inevitable.
The only thing I am not sure of is how fast our demise will be! 2 years or 20 years.
I worry for our children, but not myself.
May 22, 2009 | FT Alphaville
While the rate of economic contraction is now lower than the free-fall and near-depression experienced by many economies in the fourth quarter of 2008 and the first of 2009, he says, the recent optimism that “green shoots” of recovery will lead the recession to bottom out by the middle of this year–and that recovery to potential growth will rapidly occur in 2010 — appears “grossly misplaced”, for three noteworthy reasons:
First, the current deep and protracted U-shaped recession recession in the U.S. and other advanced economies will continue through all of 2009, rather than reach a trough in the middle of this year as expected by the optimists.
Second, rather than a rapid V-shaped recovery, growth will remain sluggish and sub-par for at least two years into all of 2010 and 2011. A couple of quarters of more rapid growth cannot be ruled out as we get out of this recession toward the end of the year or early next year as firms rebuild inventories and the effects of the monetary and fiscal stimulus reach a delayed peak. But structural weaknesses of the U.S. and the global economy will cause both a below-trend growth and even the risk of a reduction of potential growth itself.
Third, we cannot rule out a double-dip W-shaped recession, with the wings of a tentative recovery of growth in 2010 at risk of being clipped toward the end of that year or in 2011. This will result from a perfect storm of rising oil prices, rising taxes and rising nominal and real interest rates on the public debt of many advanced economies, as concerns rise about medium-term fiscal sustainability and the risk that monetization of fiscal deficits will lead to inflationary pressures after two years of deflationary pressures.It almost makes another popular, though less ubiquitous, doomster, CLSA strategist Christopher Wood, look optimistic. But that’s only in contrast to the “perfect storm” and “double-dip W” predictions of Roubini.
In Friday’s issue of his client newsletter Greed & Fear, Wood notes that the fundamental situation in the West remains “profoundly deflationary”:
The latest evidence of this was provided by the April US CPI data in America. Headline CPI declined by 0.7% YoY which was the sharpest
annualised decline since June 1955 . And remember the US inflation data, or rather deflation data, does not include house prices. It is also the case that the rental index or shelter component of the CPI index, which accounts for 33% of the CPI basket, is still rising by 1.6% YoY.Meanwhile, all the anecdotal evidence suggests that velocity is likely to decline further as deleveraging takes its course and as the financial services sector faces a regulatory backlash as a natural consequence of the belated recognition by the Davos crowd of all the excesses tolerated during the credit bubble. In this sense, the regulators will in practice end up compounding, not combating, the deflationary trend.
And all that is why, Wood says, he still does not buy the inflation story:
For if velocity of money in circulation is not rising it is hard to see where “inflation” will come from. From this point of view, he considers the recent back up in US Treasury bond yields, though a natural consequence of the equity relief rally, as presenting a long-term buying opportunity
President Obama might be modeling his presidency after Franklin D. Roosevelt's. In hard times, most Democrats think fondly of the New Deal—certainly Obama's media fans are making the connection—but thus far, he is shaping up less like the 32nd president and more like the 18th, Ulysses S. Grant
Little that we have seen in his first 100 days suggests that the 44th president sees the danger of over-reliance on high finance. Yet in the Grant administration it was wheeling, dealing, and outright corruption that plagued the nation and besmirched the incumbent. And now that trillions are sloshing up and down K Street, the same muckraked fate looms for the Obama administration.After being inaugurated in 1933, Roosevelt proclaimed, "The money changers have fled from their high seats in the temple of our civilization." This wasn't just aspirational rhetoric; it was directional policy. So he closed the banks, temporarily, and drafted legislation that led to major changes in the regulation of not only banks but also of stock brokerages and utilities. Indeed, all of corporate America was transformed. In his inaugural address, Obama attacked "greed and irresponsibility," adding that sometimes "the market can spin out of control." But few will remember those words, because it's unlikely that anyone will remember Obama as a financial reformer.
If anything, the financiers are more solidly in charge now than they were during George W. Bush's presidency, when the New York Times declared that "Government Sachs" was a reality. Today, such figures as Timothy Geithner, Lawrence Summers, and Steven Rattner are accelerating the Bush era's finance-favorable policies, piling bailout on top of bailout. Even nonfinancial policies are being drafted to serve Wall Street; the "cap-and-trade" greenhouse gas proposal, for example, would do more to boost the bottom line of neo-Enronesque pollution mongers than to reduce carbon dioxide.
How did this happen? As economist Simon Johnson observed recently, "A whole generation of policymakers has been mesmerized by Wall Street." And now Obama seems similarly ensorcelled. Johnson, a former chief economist for the International Monetary Fund, writes in the Atlantic that America is descending into the financial vortex that Russia, Argentina, and Thailand plummeted into back in the '90s. How so? The same insiders and self-dealers who created the crisis "are now using their influence to prevent precisely the sorts of reforms that are needed." And yet, he adds, "The government seems helpless, or unwilling, to act against them." That "quiet coup," Johnson warns, could turn America into a "banana republic."
Meanwhile, out beyond the Bailout Cities of Washington and New York, times are hard and getting harder. Unemployment is rising. Off the top of one's head, it's possible to think of three ways to put people back to work. The first, of course, is the orderly functioning of the free market. But when that fails, government jobs are a proven expedient. A third possibility, simply giving money to banks in the hopes that they will lend money and create employment—after the bankers pay themselves their bonuses, of course—is the worst option. After all, in this globalized, funds-are-fungible world, why shouldn't the banks use their bailout money to create jobs in China, India, or Dubai? In fact, that's exactly what they have done, according to a congressional study by Ohio Democratic Rep. Dennis Kucinich.
By contrast, FDR took on unemployment directly. By January 1934, Uncle Sam had hired 4.25 million Americans, some 8 percent of the U.S. workforce. That's the history Obama should study. But since he seems unaware of a non-trickle-down approach to recovery, Obama, like Grant before him, is easy prey for the finance-minded sharpies infesting his administration. Nobody's accusing him of any personal foibles, but few accused Grant of personal wrongdoing, either. His problem was that his economic vision seemed limited to railroad men and land speculators; similarly, Obama's inbox is filled with briefing papers from the once-and-future Wall Streeters who dominate his economic team.
May 21, 2009 | Thomson Reuters Business News - MSN Money
CHICAGO (Reuters) - Data on Thursday underscored that the U.S. economic recovery, when it arrives, will be a long slog, with a key factory index showing only marginally less weakness and unemployment tipped to hit double-digit levels.
Financial markets were also slammed by suggestions of the unthinkable -- that the United States could lose its coveted triple-A credit rating.
The developments came a day after the Federal Reserve, in minutes released from its April policy meeting, said that a full U.S. recovery could take five or six years.
May 21, 2009 | FT Alphaville
Bear market rally or start of a bull market? It is the question everyone wants answered right now. But George M://www.federalreserve.gov/newsevents/press/monetary/20090429a.htm"> sees the unemployment rate rising to between 9.2% and 9.6%.The great unwind.
The biggest hurdle of all, as David Roche highlighted in this column yesterday, is that the great debt restructuring, especially of mortgages, has barely begun. The collapse in asset values has left household and aggregate economy debt ratios (in relation to GDP, net worth, income and cash flows) at record highs as of March 2009. These ratios will all decline markedly over the next 2-3 years as debt restructuring occurs.
The markets will face two strong balance sheet headwinds. The increases in household savings and unemployment will be outside our ‘normal’ experience, accentuating the household sector’s balance sheet repairs. And banks’ assets will continue to shrink as they too deleverage.
Of banks
We should continue to see financial institutions lining up to sell assets and issue equity into a rising equity market, and looking to dispose of non-core businesses. In the US, the rush to issue equity to pay off Tarp funding and meet stress test capital requirements has raised about $40bn in the last two weeks, though this is just 13 per cent of what would be needed. These observations underscore the essential truth about a deleveraging crisis, namely that it is a multi-year work in progress. Banks have been at it for less than a year, and households have barely begun.
Emerging markets
The good news is that the recovery in China and some other emerging nations, which experienced a steep but quite familiar downturn, looks genuine. And it is surely of consequence that oil and some other commodity prices, especially softs, have risen in spite of the aggregate demand weakness in richer nations. However, even in emerging markets, growth optimism has to be tempered to the extent that they rely on exports to western consumers, whose spending and borrowing will remain subdued.
In conclusion.
We can assess probabilities about the avoidance of more drastic protectionism, the return of global imbalances, the exit strategies from quantitative easing and asset purchases, and a fiscal credibility crisis. But probabilities are as far as we can go, for we have no reliable templates, and that alone argues for sustainably higher risk premiums.
Related link:
George Magnus, green shoot weed-whacker - FT Alphaville
May 20, 2009 | FT Alphaville
The “green shoots of economic revival” meme started when Ben Bernanke used the phrase in an interview with CBS back in March.* Since then, it’s been picked up and deployed with abandon.But the latest minutes of the Federal Open Market Committe, released at 14H ET on Wednesday, suggest the Fed’s outlook is far less optimistic than Bernanke let on - and contrast strikingly with upbeat testimony from Timothy Geithner delivered earlier in the day.
Here are some of the headlines that flashed across the wires when the statement was released:
- DJ Fed May Need To Buy More Treasurys, MBS
- FED FORECASTS DEEPER RECESSION IN 2009, SLOWER REBOUND IN 2010
- FED: SOME OFFICIALS SAW POTENTIAL NEED TO BUY MORE ASSETS
- FED OFFICIALS JUDGED SYSTEM `VULNERABLE TO FURTHER SHOCKS’
And here are some extracts from the minutes (emphasis FT Alphaville’s):Almost all participants viewed the near-term outlook for economic activity as having weakened relative to the projections they made at the time of the January FOMC meeting, but they continued to expect a recovery in sales and production to begin during the second half of 2009.
With the strong adverse forces that have been acting on the economy likely to abate only slowly, participants generally expected a gradual recovery: All anticipated that unemployment, though declining in coming years, would remain well above its longer-run sustainable rate at the end of 2011; most indicated they expected the economy to take five or six years to converge to a longer-run path characterized by a sustainable rate of output growth and by rates of unemployment and inflation consistent with the Federal Reserve’s dual objectives, but several said full convergence would take longer.
Participants projected very low inflation this year; most expected inflation to edge up over the next few years toward the rate they consider consistent with the dual objectives. Most participants–though fewer than in January–viewed the risks to the growth outlook as skewed to the downside. Most participants saw the risks to the inflation outlook as balanced; fewer than in January viewed those risks as tilted to the downside. With few exceptions, participants judged that their projections for economic activity and inflation remained subject to a degree of uncertainty exceeding historical norms.
Participants’ projections for 2009 real GDP growth had a central tendency of negative 2.0 percent to negative 1.3 percent, somewhat below the central tendency of negative 1.3 percent to negative 0.5 percent for their January projections.
Participants noted that the data received between the January and April FOMC meetings pointed to a larger decline in output and employment during the first quarter than they had anticipated at the time of the January meeting. However, participants also saw recent indications that the economic downturn was slowing in the second quarter, and they continued to expect that sales and production would begin to recover–albeit gradually–during the second half of the year, reflecting the effects of monetary and fiscal stimulus and of measures to support credit markets and stabilize the financial system along with market forces.
Their projections for the average unemployment rate during the fourth quarter of 2009 had a central tendency of 9.2 to 9.6 percent, noticeably higher than the actual unemployment rate of 8.5 percent in March–the latest reading available at the time of the April FOMC meeting. All participants revised up their forecasts of the unemployment rate at the end of this year relative to their January projections, reflecting the sharper-than-expected rise in actual unemployment that occurred during the first quarter as well as the downward revisions in their forecasts of output growth in 2009.
Most participants anticipated that growth next year would not substantially exceed its longer-run sustainable rate and hence that the unemployment rate would decline only modestly in 2010; some also pointed to the friction of a reallocation of resources away from shrinking economic sectors as likely to restrain progress in reducing unemployment.
(*It must be noted that Albert Edwards appeared to see green shoots in February. But he was only pretending)
Economy WatchTreasury: $98.7 Billion Left In Bailout Funds
2:41 PM ET: This morning the Treasury Department released its tally so far of how much has been spent so far of the $700 billion government bailout, or TARP program, which stands for Troubled Asset Relief Program (Although, of course, none of the original TARP money went to buy TA. That's why Treasury had to roll out the P-PIP, or Public-Private Investment Program.)
Bottom line: There's $98.7 billion remaining in bailout funds that have not been spent yet. That doesn't count $25 billion Treasury expects in repayments.
Here's the scorecard on which entities have received TARP money and how much of it they've received:
Programs under Bush administration:
-- AIG: $40 billion
-- Citi/Bank of America: $52.5 billion
-- Autos: $24.9 billion
-- Capital purchase program: $218 billion
-- TALF 1.0: $20 billion
Subtotal $355.4 billionPrograms under Obama administration:
-- Housing: $50 billion
-- AIG (second investment): $30 billion
-- Auto suppliers: $5 billion
-- Additional autos: $10.9 billion
-- TALF asset expansion (new issuance): $35 billion
-- Unlocking SBA lending markets: $15 billion
-- TALF for legacy securities: $25 billion
-- Other P-PIP programs for legacy assets: $75 billion
Subtotal: $245.9 billionTotal committed (without potential repayments) $601.3 billion
Total remaining (without potential repayments) $98.7 billion
Conservative estimate of potential repayments $25 billion
Total committed (including potential repayments) $576.3 billion
Total remaining (including potential repayments) $123.7 billion
May 20, 2009 | CNBC.com
The stock market may hit new lows this year or the next as the current rally has been largely caused by the money printed by central banks and fundamental problems remain unsolved, legendary investor Jim Rogers told CNBC Wednesday.
His views echo those of renowned bear Marc Faber, who told CNBC last week that the rises in share prices did not mean the world was embarking on a path of sustainable economic growth.
"I'm not buying shares if that's what you mean. Not at all," Rogers told "Squawk Box Asia."
"The bottom will probably come later this year, next year, who knows when," he added.
Governments have not solved the essential problems that caused the crisis but instead they "flooded the world with money," according to Rogers. Trying to solve the problem of too much consumption and too much debt with more consumption "defies belief" and will not work, he said.
"I mean … you give me 5 or 6 trillion dollars, I'll show you a very good time, there's no question about that," Rogers said.
A long-term advocate of commodities, he reiterated that this will be the first sector to rise when the world gets out of the crisis, as investment in new mines, the oil sector and agriculture has been curtailed during the crisis and this will create a shortage.
"Fundamentals for General Motors are not getting better. Fundamentals for Citibank are not getting better. I can think of very few industries in the world where the fundamentals are getting better. But the fundamentals of commodities are getting better, full stop," he said.
"I think I'm going to make more in agriculture, I think I'm going to make more in some other real assets for awhile, I think I'll make more in silver. But I do own gold," Rogers added. (Click here to read why Rogers thinks currencies are the next crisis).
The price of oil is also likely to remain high despite the fact that the recession is taking its toll on demand, he said.
"You know supplies worldwide are declining at the rate of anywhere from 4 to 6 percent a year, yes, demand is down at the moment but in longer term, unless somebody discovers a lot of oil very quickly, the surprise is going to be how high the price of oil stays, and how high it eventually goes," Rogers added.
Mish's Global Economic Trend Analysis
Inquiring minds are investigating the Federal Reserve Bank of San Francisco report on Household Deleveraging and Future Consumption Growth.
In the long-run, however, consumption cannot grow faster than income because there is an upper limit to how much debt households can service, based on their incomes. For many U.S. households, current debt levels appear too high, as evidenced by the sharp rise in delinquencies and foreclosures in recent years. To achieve a sustainable level of debt relative to income, households may need to undergo a prolonged period of deleveraging, whereby debt is reduced and saving is increased.
Children whose parents are being destroyed by debt now, will keep those memories for a long time.
Think the US stock market is going to come roaring back if consumer deleveraging plays out as it must? Think again.
Expect another "Lost Decade" when it comes to housing and the stock market. It's the deflationary payback for the greatest credit binge in world history.
queenbee says:@Gael,
There are plenty of posters who will give you advice. Mish represents Sitka and they have two funds, but the buy ins are 50k and 125k if I am not mistaken. A simple question as you ask depends on much more information. Taxhaven and I like gold and silver miners, Black Swan has talked about a muni-fund call ATOIX and others buy gold and silver bullion and coins.Some play the ETF's, so pick your poison or just buy the highest yield CD in an FDIC insured bank under the limit the government guarantees. If you can find safety in this market you are smarter that most of us. The miners I have invested in are SLW AUY IAG and HL. FCX is another one but it is pricey are 50/share.
threadkilla says:"What would you recommend for someone at retirement age caught in such a trap"?
have you seen the movie solent green?
there is only ONE industry that matters in the USA.........wallstreet....they WILL be made whole, you will starve and our leadership will use race, religion, unions...whatever it takes to keep your eye of the looting.
Entropy says:
“While I agree with Mish's analysis there is one factor not there.
401k's, is this not how many people save... via workplace incentives to invest in 401k's?
This has to have an effect on Wall St (after all they used that money to gamble and pilfer) but many people still use them.
I am not arguing Mish, but I would be interested in your opinion. I know I personally am out of the 401K since 2007 (Thanks Mish!) and I have no plans on returning yet. But this is a major investment vehicle for many folks.
Gildas says:
“@Gael "What would you recommend...?'
I am of retirement age, but I am not retiring, nor do I have any intention of retiring until the lights go out or I simply can't work any longer, God forbid: that's recommendation number one.
Number two is to make the paradigm change, forget previous notions of "retirement," move someplace affordable and pleasant (most likely has to be outside US), radically downscale consumption and grow your own food.
I greatly sympathize with those whose savings have been wiped out by a combination of financier plunder and their own complacency, those who failed to sell out while the selling was good, but what's done is done and they must regroup and do whatever they must to keep afloat, including teaming up with others, etc. I have recently started a web site, still largely under construction, which will deal with these issues in detail and at length: www.fromthecatacombs.info
I had hoped to be able to supplement writing income with trading, but I suspect it will be less and less easy and money transfer more difficult, so I have to conclude that "invest accordingly" means invest where I can keep an eye on my tangible investments, things like a machine shop, a small-scale cannery... things that can be sold or traded locally.
Being "broke" and "poor" is a relative concept: I live a very comfortable, fuflfilling and enjoyable life on under eight hundred dollars a month: yes, that's eight-zero-zero. I save money, because I don't need or want to spend more than that.
The years ahead seem almost certain to be lean years, perhaps decades, and speculation and investment destined to be problematic for the non-financier. Best to consider cashing out of the whole system and "going native" in a rural setting. Start by studying the Amish.
Sekar says:
“What would you recommend for someone at retirement age caught in such a trap?
I would recommend high yield bonds and a few dividend returning stocks. Deleveraging overall is going to be ugly for equities markets but if one has the time, skill and patience, you can make money trading.
I also like tax-free municipal bonds. I think everyone's standard of living will either stay flat, at best, or decline slowly over the remainder of their lives.
James Cole says:
“Some thoughts on the stock market rally from Jesse's Cafe Americain, "If something looks like bait and smells like bait, it probably has a hook in it".
"The notion of trading in markets against market makers and insiders trading for their own trading profits heavily equipped with zero cost government funds and advantageous inside information would be almost laughable if it was not such a tragic abuse of productive capitalism and free markets"
"Wall-Street has a few IPOs it wishes to bring out this week to test the waters for a larger IPO from AIG of one of it's units. And of course the banks continue to sell secondary offerings".
All told, the above makes a good case for some to work hard to pump the market up at the right time. No one can argue that this rally has not had some legs that are hard to account for. A bear market rally, yes, easy to explain. The depth of this rally? Maybe that needs a bit of pump priming?
Morally bancrupt elite is a problem
As we told Tim Rayment of The Times of London in his article, “Joseph Cassano: the man with the trillion-dollar price on his head,” in our view AIG never had the possibility of generating sufficient income to cover its CDS contracts, thus honoring these gaming debts of AIG at face value as Tim Geithner, Ben Bernanke, et al., have done using public funds is ridiculous, even criminal. As we’ve said before, AIG should be in bankruptcy so that all creditors may be treated fairly - but “fairly” means a steep discount to par value without the subsidy from the Fed.
- Charles said...
- "The "bad incentives" turn of phrase, while narrowly correct, does not put blame where blame was due. The industry's leadership designed the compensation schemes; they were not visited upon them by a mysterious outside force."
Yves,
The compensation schemes are a product of cranky economic theories, both from the left (Keynesianism) and from the right (Supply Side Economics), that are all justifications of what is essentially a Ponzi scheme at a governmental and national level. Legitimizing Ponzi scheme at the highest level is putting the rot into the head of the proverbial fish.
It was then inevitable that the deception business for bankers (including a lot of self deception...), and the chicanery business for lawyers became the career of choice for the best and brightest of Generation X and Y, especially in English-speaking countries.I cannot resist quoting Keynes at the end of his GT :
- "I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Not, indeed, immediately, but after a certain interval; for in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age, so that the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest. But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil."
- Hydroponics Book said...
- I have what I feel is a better suggestion for how this all transpired.... We are in the late stages (upper leverage curve) of a fractional reserve banking model, and there are very few good options are left.
For the bankers... I seriously question the thought that Henry Paulson was incompetent/ignorant when he lobbied congress in 2004 to loosen leverage limits, and I dont think all of the other players were any more incompetent for increasing their leverage ratios. In Paulson's case, I think he saw additional leverage as the best bet to keeping the industry/economy moving forward.
On the regulator side, I do not believe they were any more ignorant/incompetent either. They no doubt breathed a sign of relief when they thought that the unregulated securitization market would be the answer to how to safely allow additional leverage into the system. I also suspect that they watched in horror when they realized the entire securitization model was crashing down at such a light speed pace.
The scary part to me is not how we got here, but that no one yet has come up with where we go from here. It is rather obvious that the federal government cannot keep leveraging higher indefinitely, the sums are too large to inflate your way out of it, and there does not appear to be any way that consumers and/or businesses can make up the difference. If we can get china's 1.1 Billion people to leverage that might help, but this scenario seems highly unlikely as well, but until this question is answered, it does not take a Nobel laureate economist to predict where the global economy is headed.
- Hugh said...
- There are all of these paradoxes out there. I have one called the paradox of greed. You see it is in the interest of any individual bank to game the system as much as possible and maximize their short term profits off of volume and fees. However when all banks do this, none are looking out for the long term health of the underlying economy which must support all this gamesmanship and the system collapses. This used to be called the killing the goose that laid the golden egg but now we talk about these things in terms of information asymmetries and paradoxes. Still however you describe it the goose is just as dead.
- DownSouth said...
- @Charles,
Great quote from Keynes.
Here's one from another source:
[I]t is impossible to justify the degree of inequality which complex societies inevitably create by the increased centralization of power which develops with more elaborate civilizations. The literature of all ages is filled with rational and moral justifications of these inequalities, but most of them are specious. If superior abilities and services to society deserve rewards it may be regarded as axiomatic that the rewards are always higher than the services warrant. No impartial society determines the rewards. The men of power who control society grant these perquisites to themselves. Whenever special ability is not associated with power, as in the case of the modern professional man, his excess of income over the average is ridiculously low in comparison with that of the economic overlords, who are the real centers of power in an industrial society. Most rational and social justifications of unequal privilege are clearly afterthoughts. The facts are created by the disproportion of power which exists in a given social system. The justifications are usually dictated by the desire of the men of power to hide the nakedness of their greed, and by the inclination of society itself to veil the brutal facts of human life from itself. This is a rather pathetic but understandable inclination; since the facts of man's collective life easily rob the average individual of confidence in the human enterprise. The inevitable hypocrisy, which is associated with all of the collective activities of the human race, springs chiefly from this source: that individuals have a moral code which makes the actions of collective man an outrage to their conscience. They therefore invent romantic and moral interpretations of the real facts, preferring to obscure rather than reveal the true character of their collective behavior. Sometimes they are as anxious to offer moral justifications for the brutalities from which they suffer as for those which they commit. The fact that the hypocrisy of man's group behavior...expresses itself not only in terms of self-justification but in terms of moral justification of human behavior in general, symbolises one of the tragedies of the human spirit: its inability to conform its collective life to its individual ideals. As individuals, men believe that they ought to love and serve each other and estabilish justice between each other. As racial, economic and national groups they take for themselves, whatever their power can command.~
--Reinhold Niebuhr, Moral Man & Immoral Society
msnbc.com
I have a question that I'm sure a lot of people wonder about. What is a "back-to-normal" economy? Is it to go back to fiscal irresponsibility and reckless spending?
Jason P., Kandahar, AfghanistanA lot people are wondering what the “new” normal will look like once the worst of the financial crisis and recession have passed. Even the most optimistic scenarios see only very gradual improvement in economic growth, with unemployment remaining high for the next several years. The only honest answer is that no one really knows.
... ... ...Finally, the impact on consumers, investors, savers, workers and homeowners can’t be understated. For the past 30 years, we have lived with the mistaken belief that we can buy stocks and houses without any real risk of losing money over the long run. Lesson learned.
It’s also becoming clear that we can either expect less services and benefits from our government or pay more in taxes. Borrowing the difference isn’t a sustainable plan.
Econbrowser
The Federal Reserve reported Friday that its index of industrial production fell another 0.5% in April, after having fallen 1.7% in March.
Selected commentsAnonymous
Bob_in_MAJDH wrote:
any decrease means we're producing less than we did the previous month, and recovery requires growth, not a slower rate of decline.
Professor,
Thank you for your straight forward honesty. Good post!
jgThere were a couple things that led me to believe the April number would be worse than it than it was. Retail sales have been falling faster than consumer goods production the last two months. For Feb & Mar, retail sales less gasoline fell about 1.4% and consumer goods production fell just .3%. But maybe the difference can be explained by a greater fall in imports?
The other odd thing is that the rate of decline rail traffic YoY has been increasing over the last 5-6 weeks. Year to date, the decline is 18%, about inline with the drop in trade, but 50% greater than the fall in industrial production.
For the 4-week moving average is down 22% YoY, for the last week it was 25%, and these declines are broad-based. So it seems odd that the decline in industrial production is decelerating.
Rail stats:
http://railfax.transmatch.com/Something else I meant to add. The explanation to the dichotomy between the trend in rail traffic and production could lie in inventories. The conventional wisdom is that this quarter will be the one where producers get their inventories in line with sales.
But the inventory/sales figure didn't change between Feb and Mar:
http://www.census.gov/mtis/www/mtis_current.htmlAnd perhaps it's actually worsening again?
Though the explanation may lie elsewhere.
Posted by: Bob_in_MA at May 17, 2009 10:24 AM
Good points on the discrepancy between falls IP and rail traffic, Bob.
This mess has only just begun, and will not appreciably ameliorate until household debt gets chopped by at least one-third; that is what marked the bottom of the last depression.
Posted by: jg at May 18, 2009 08:06 AM
naked capitalism
Fit for a MinskyStepping back for a moment, it’s worth pondering how negatively amortizing loans inflated the last stages of the housing bubble. For this we turn to the late economist Hyman Minksy and his financial instability hypothesis. In a nutshell, Minsky theorized that stability destabilizes because it encourages imprudent risk-taking. Stability becomes instability in three stages, with three corresponding types of debt—so-called hedge units, speculative units and Ponzi units. The debt products perpetuating the housing bubble fit this mold perfectly.
- A “hedged” debt unit is one where the borrower’s income is sufficient to pay interest and principal in full each month. He should be able to pay off his mortgage on schedule, regardless of price fluctuations.
- A “speculative” debt unit is one where the borrower’s income is sufficient to pay interest but not principal. The borrower is speculating that the value of the collateral will not decline, and that sale proceeds will be sufficient to pay off the principal. If prices climb, the borrower ‘s bet pays off.
- A “Ponzi” debt unit is one where the borrower’s income is insufficient to pay down either interest or principal. The borrower is speculating that the house price will go up, and that sale proceeds will be sufficient to pay off principal and unpaid interest.
Over the last 10 years, mortgage finance progressed from hedge units (fixed rate, 20 percent down mortgages) to speculative units (interest-only, 10 percent down), to Ponzi units (negative amortization, zero down). Towards the end of the bubble, prices got “too high” because marginal buyers had no hope of paying off their mortgage without further price appreciation. Eventually there are no greater fools looking to buy and the Ponzi scheme implodes. Option ARM lenders bankrolled this, the last stage of the housing bubble, by pumping Ponzi-finance into the market.
Barrons.com
JIM KEEGAN DOESN'T HAVE MUCH USE FOR WHAT He calls the "green-shoots-and-glimmer camp" that sees optimistic signs of economic stabilization when more than a half-million people lose their jobs. Instead the RidgeWorth Intermediate Bond Fund co-manager, who headed for safety way ahead of the pack in 2007 and 2008, is waiting out what he sees as a long-term readjustment by the U.S. consumer.
To buy into the consensus view that stabilization will quickly lead to recovery, "you have to believe that this is a normal business cycle," Keegan says.
He doesn't. "This is not a normal inventory adjustment cycle," says Keegan, who leads a team of portfolio managers including Perry Troisi, Adrien Webb, Michael Rieger and Seth Antiles. Keegan is also chief investment officer of Seix Investment Advisors, which sub-advises RidgeWorth funds.
The $1.1 billion RidgeWorth Intermediate Bond Fund has returned almost 9% employing a defensive strategy in the year through May 13 -- Keegan's first year managing RidgeWorth funds after coming over from American Century Investments. That puts it in the top 1% of its peer group, according to Morningstar, which rates it five stars overall. Over the past three years, the fund has returned 7.61% annually on average. Institutional shares (ticker: SAMIX) comprise the vast majority of the fund. It has two other classes: A shares (IBASX) for the retail market and R shares (IBLSX) for the retirement market.
Keegan actually saw the financial crisis approaching as far back as early 2007. He told the Wall Street Journal in April of that year he was worried about the collateralized debt obligation "phenomenon." He predicted, back then, a vicious cycle of ratings downgrades, forced sales and valuation issues. "Who knows where that will end?" he asked.
That question remains unanswered, he says today.
Still, reflecting his cautious outlook emphasizing the safest corporate debt, Keegan's fund has lagged a bit so far in 2009. April, Keegan explains, was "a month of high beta," meaning big rewards for taking risk. Junk bonds, for instance, posted record monthly gains.
"I would not characterize our portfolio as high beta," Keegan says. "We think the high-yield market has really run like the equity market: too far, too fast."
The core of Keegan's strategy is retrenchment by U.S. consumers as they go from their debt-enabled buying binge of the last decade to balance-sheet repair. He figures the process won't stop until the consumption portion of gross domestic product shrinks from more than 70% now back to its long-term average around 65%.
That process may already be occurring. According to the Federal Reserve, consumers slashed borrowing in March by the largest dollar amount since the government started keeping track in the 1940s.
A few percentage-points worth of spending relative to GDP doesn't seem like a lot, unless you are talking about a $14 trillion economy. "I've always been of the theory that if you get the consumer right, you're going to get U.S. GDP right and you'll get the trend in global GDP right," Keegan says.
He favors the debt of staples like regulated utilities, health care, pharmaceuticals and other defensive sectors. Though he is overweight investment-grade corporates -- almost 40% of his portfolio -- they don't show up among his top individual holdings (see chart), a reflection of just how diversified his fund is.
In February, RidgeWorth added Roche Holdings, the Swiss pharmaceutical giant. Keegan likes its strength in oncology and low patent-expiration ratio. "From a bondholder's perspective, the cash flow tends to be very stable, and you have very predictable servicing of debt," Keegan says. He bought the new debt at a spread of 345 basis points (or 3.45 percentage points) over 10-year Treasury yields.
In addition to Wal-Mart Stores , he also holds bonds of U.K.-based Tesco , the world's third-largest retailer after Wal-Mart and France's Carrefour.
What is certain is that the near-term economy will be driven in spurts and starts as mass psychology shifts from one extreme to another. The next catalyst in my view will be the interplay of the impact of stimulus spending coupled with the failure of the green shoots materializing into anything worthwhile. And while this will make the life of daytraders interesting, the traditional buy and hold approach to asset accumulation must be delayed indefinitely, until the critical equilibrium discussed above is achieved. Until that happens, anyone who claims the economy is headed in the right direction (either much higher or much lower), is merely spreading their own agenda or has an opinion that is fundamentally not rooted in actual facts.
Selected comments
- Don said...
- "as the ability to raise cash has fallen, actual cash holdings must rise. And, unfortunately for the Obama administration, this is not a temporary hoarding, this is a permanent rebalancing in the trillions of dollars order of magnitude. As money demands skyrockets, the velocity of money plummets."
This sounds to me like your saying that a Flight to Safety does just that. Money ends up in safe investments. However, this is real money. So some people have money.
"For now, the immediate focus should be on whether confidence can return: in collateral, in lending, in risk taking, in entrepreneurship. In the meantime, any talk of inflation is premature. The deflationary shock has to wear off first, and in many asset classes it has not even accelerated yet."
Shouldn't we attempt to attack the Fear and Aversion to Risk and the Flight to Safety with disincentives to save and incentives to invest? I'm not sure how we would know that they work until we try them.
As for QE, if short term interests rates are low, and longer term rates begin to go up, then you have a disincentive to save and a longer term signal of confidence. That seems good to me. It won't work on its own, but with rising stocks, a short term sales tax decrease, tax incentives for investment, and some govt spending, you can at least have a plan to attack the problem. It doesn't strike me as a priori false or doomed to fail.
As for the casino, I never get that analogy, since there's a winner: namely, the casino. The money doesn't disappear.
Don the libertarian Democrat
[May 11, 2009] The lecture comes in two videos, Part 1 and Part 2. Enjoy!
- GawainsGhost said...
- I've been saying the same thing for years.
I resigned from teaching in 02, when my father was sick and dying of cancer, to help my mother run her real estate company. We deal mainly with repossessed homes, and from what I've seen fraud is endemic and systemic.
I'm talking about mortgage fraud, appraisal fraud, brokerage fraud, accounting fraud, you name it. I'm talking about a monstrosity of a manufactured home that sold for $280,000 in 06, was foreclosed on six months later, then resold for $45,000 in 07. I'm talking about builders using phantom buyers, appraisers routinely overvaluing properties by at least $35,000, mortgage brokers falsifying documents, buyers taking out liar's loans, not only on the house but the appliances and furniture as well, then gutting the home, stealing everything and disappearing. I've seen it all.
Question: If one of the constitutional duties of government is to protect the citizens from fraud, then why is fraud so rampant? Answer: Because the government is not doing its job.
I am sickened and sad at heart.
5/16/2009 | CalculatedRisk
From CNBC: Economic Recovery Still Months Away: Roubini, Rogoff"People talk about a bottom of the recession in June, but I see it more like six to nine months from now," Roubini said. "The green shoots everyone talks about are more like yellow weeds to me."
...
"I see slow growth for the next couple of years," Roubini said, "even if there is a recovery. Large budget deficits will push out growth."
...
"I think there will be a bounce in the second half of the year from the massive stimulus package," [Kenneth Rogoff, professor at Harvard University's Department of Economics] said. "But I think the longer run trend is very slow, so we're vulnerable to dipping down again sometime in the next couple of years, like Japan."
Selected comments
Richard Kline said...- attempter said...
- Markopolos is guilty of the sin of having been correct from the beginning and vocal about things. Therefore he or anyone like him can never be considered for positions of authority as long as the same system remains in place.
(It's the same case where people say they'd love to have seen someone like Roubini or Born in top economic positions in this administration. It was probably systematically foreclosed.)
It's like Krugman says about war opponents - to have credibility within the system you have to have made conformist mistakes to begin with, and only later have changed your mind.
So what's valued is not true intelligence but belated learning ability within conformism.
It is even more telling that Bo Prez has brought NONE of this talent into positions of authority, which instead he busily packed with yesterday's shills.
Zero Hedge
Mr Patterson said the US Treasury is out of its depth and seems to be trying to put off drastic action by pretending that the banking system is still viable.
“It’s a sham. The banks are insolvent. The US government is trying to sedate the public because they are down to the last $100bn (£66bn) of the $700bn TARP funds. They think they’re doing this for the greater good of society,” he said, speaking at the Qatar Global Investment Forum.
Mr Patterson said it would be better for the US to bite the bullet as Britain has done, accepting that crippled lenders must be nationalised. “At least the British are not hiding the bail-out,” he said.
MatlinPatterson said private equity and hedge funds were deluding themselves in hoping to go back to business as usual after the trauma of the last 18 months.
“This is not a normal recession and there will be no V-shaped recovery. The crisis has destroyed leveraged companies. We’re going to see a catastrophic increase in the number of LBO’s (leveraged buyouts) going into default because they’re knee-deep in debt and no solution exists since they can’t refinance,” he said.
“Alfa hedge funds have been making their money by gambling with excessive leverage, so the knife that cuts off leverage is going to cut off their heads as well,” he said.
Like many bears, Mr Patterson expects the great crunch to end in deliberate inflation, deemed a lesser evil than outright depression.
“The US government has thrown 29pc of GDP at this crisis compared to 8pc in the early 1930s. The Fed’s balance sheet has risen from $900bn to $2.7 trillion to bail out the system. America has to do it because the only way out is to debase the currency, but that is going to lead to some very high inflation three years down the road,” he said.
Matlin Patterson, however, has missed the Spring rebound, the most powerful rise in equities in over 70 years. “We shorted the equity rally because we thought it was lunatic. We’ve kept adding positions seven times, and we’re still holding,” he said. Ouch!
Mish's Global Economic Trend Analysis
Last month Credit Card Defaults Hit 20 Year High and it should be no surprise that this month is worse. Next month will be worse and so too will the month after that. As long as we are shedding 500,000 jobs a month how can one expect anything else?
Remember that credit cards are unsecured loans. Card chargeoffs are a direct hit to the bottom line. That bottom line is looking bleak regardless of what nonsense Geithner and Bernanke are spewing about banks being well capitalized.
Selected commentsMarvin says:
Great post at Naked Capitalism on a populist interpretation of Boom/Bust
(see Mish's home page)Big point: average worker earnings (real) peaked in 1972. Its been downhill ever since.
Why: we are a kleptocracy, just like the ones that Jared Diamond writes about.
shazaSome interesting musing from Hoye today:
1. For participants, post-bubble bear markets have been sudden and severe. The 1929
example ran for three years and the post 1873 example lasted for five years.The latter has been the best guide for our recent mania and its bust
2. As we all know, in 1929 the Dow made its high in September and the recession started in August.
3. In 1873 the bear started in September, and the recession in October.
This time around, the stock market high was in October 2007 and this recession started in
December of 2007.Close enough to fit the post-bubble model, with implications that financial history is now in the early stages of another Great Depression.
4. The probability of a depression has been discussed in the media.
It seems that both sides have yet to provide adequate research, with the establishment's response limited to a classic non sequitur..... "This is nothing like the Great Depression, where we had 25% unemployment".
5. Sound research would compare unemployment numbers from the first year after the crash.
In 1930 the number was around 8%, and in noting that there could be some difference in methodology today's number is an 8 percenter.
ME: I would not rely on the 25% unemployment to be the benchmark of a depression!
6. Will it get to 25 percent?
This remains to be seen, but unemployment in the private sector will be the worst since the last great depression.
"'The Worst Is Yet to Come': If You're Not Petrified, You're Not Paying Attention," doesn't sober these delusiabulls up quickly, I'm afraid nothing will.
This outlook is based on the following main points:
- With the unemployment rate rising into double digits - and that's not counting the millions of "underemployed" Americans - consumers are hitting the breaks, which is having a huge impact, given consumer spending accounts for about 70% of economic activity.
- Rising unemployment and the $8 trillion negative wealth effect of housing mean more Americans will default on not just mortgages but student loans and auto loans and credit card debt.
- More consumer loan defaults will hit banks, which are also threatened by what Davidowitz calls a "depression" in commercial real estate, noting the recent bankruptcy of General Growth Properties and distressed sales by Developers Diversified and other REITs.
As for all the hullabaloo about the stress tests, he says they were a sham and part of a "con game to get private money to finance these institutions because [Treasury] can't get more money from Congress. It's the ‘greater fool' theory."
CNBC.com
The U.S. economy isn't likely to recover for months, and even then will remain weak for a long time, two well-known economists told CNBC.
Nouriel Roubini, co-founder and chairman at RGE Monitor, also known as Dr. Doom, and Kenneth Rogoff, professor at Harvard University's Department of Economics, both said the economy still faces serious challenges.
"People talk about a bottom of the recession in June, but I see it more like six to nine months from now," Roubini said. "The green shoots everyone talks about are more like yellow weeds to me."
"I think there will be a bounce in the second half of the year from the massive stimulus package," Rogoff said. "But I think the longer run trend is very slow, so we're vulnerable to dipping down again sometime in the next couple of years, like Japan."
Roubini said that the financial crisis was more than a crisis of confidence. "It was a crisis of excessive leverage of housing and the corporate sector," said Roubini. "We're not reducing the leverage, we're pushing the losses from the private sector on the government and increasing public debt. That's going to be a drag for growth."
"Housing's going to take five years to recover, and we have a long way to go," Rogoff said. "The broader risks from the downturn are to the dollar and interest rates," Rogoff added. "There's more and more debt and if interest rates go up, we're going to feel it. It's hard to see how we'll have booming growth for the next five years." "I see slow growth for the next couple of years," Roubini said, "even if there is a recovery. Large budget deficits will push out growth."
2009-05-15 | CalculatedRisk
From CNBC: Credit Card Defaults Reach Record Highs in April
U.S. credit card defaults rose in April to record highs, with Citigroup and Wells Fargo posting double digit loss rates ...
April March Citigroup 10.21% 9.66% Wells Fargo 10.03% 9.68% JPMorgan Chase 8.07% 7.13% Discover Financial Services 8.26% 7.39% And the beat goes on ...
Selected comments
blognround (profile) wrote on Fri, 5/15/2009 - 8:55 pmso the banks raise rates, increase transaction fees, lower credit lines, in times of the lowest historical interest rates in history, maximizing their spreads and ensuring that they expose many more customers to defaults..... their behavior is insane and inane...
no rational person could pursue these policies and attempt to simultaneously justify their business model, and then lobby and complain about their situation. Congress if they can stop from being purchased long enough, by the banking lobby, and if they really cared about consumer welfare, should reintroduce usury laws http://en.wikipedia.org/wiki/Usury and lock in their spread, it will reduce the credit card defaults and put pressure on Banks to act in the public interest. so we get Jabber from DC but little substantial action.
Usury statutes in the United States
Each U.S. state has its own statute which dictates how much interest can be charged before it is considered usurious or unlawful.
If a lender charges above the lawful interest rate, a court will not allow the lender to sue to recover the debt because the interest rate was illegal anyway. In some states (such as New York) such loans are voided ab-initio[21]
However, there are separate rules applied to most banks. The U.S. Supreme Court held unanimously in the 1978 Marquette Nat. Bank of Minneapolis v. First of Omaha Service Corp. case that the National Banking Act of 1863 allowed nationally-chartered banks to charge the legal rate of interest in their state regardless of the borrower's state of residence.[22] In 1980, due to inflation, Congress passed the Depository Institutions Deregulation and Monetary Control Act exempting federally chartered savings banks, installment plan sellers and chartered loan companies from state usury limits. This effectively overrode all state and local usury laws.[23][24] The 1968 Truth in Lending Act does not regulate rates, except in the cases of some mortgages, but it does require uniform or standardized disclosure of costs and charges.[25]
May 15, 2009
As with my most recent post here on Naked Capitalism about Larry Summers, I want to write a thought piece here, as much for discussion’s sake as for its analysis. Now, the core of what you are about to read is something I put together and posted on Credit Writedowns in March of ‘08. At the time, I was struggling with the dichotomy between the perceived increase in wealth in the United States and the obviously poor macro statistics on debt, leverage and earnings for the middle class. This piece was the product of that struggle.
I should warn you that it is at odds with some of what you will see me write here since I am basically a libertarian and the piece is very populist. When I wrote the piece, I can’t say I was 100% behind this interpretation of events. Nevertheless, as time has passed during this financial crisis, many events have validated this view in my eyes (the dichotomy between the bank/insurance company bailouts and the auto bailouts being a prime example). Therefore, I would be curious to read your responses.
As to the data that reinforces this view, you can find more at the following posts:
- Chart of the day: real hourly earnings (Jun 2008)
- Charts of the day: US macro disequilibria (Oct 2008)
I intend to follow this post with one titled “De-regulation as crony capitalism” or something to that effect, because the theme underneath this post is that Special Interests which favor elites are always present in any society, at any time regardless of the form of government. This was true in Egypt, Rome and Greece. It was true in the Soviet Union and it is certainly true in the United States. Therefore, it is axiomatic that de-regulation favors elites through crony capitalism, which is basically what we have seen over the past few decades. This is not the invisible hand of Adam Smith on display and makes the case for some minimal level of regulatory oversight.
One last comment: this post also is in line with my view that the United States has been in relative decline for some time, probably since World War II. The U.S. reached its apex as an economic and military power when large parts of Europe and Asia lay in ashes in 1945. In the intervening time, the U.S. has not recognized its relative decline. This has led to imperial over-stretch and a redistribution from the middle class to elites (This view is in line with Kennedy’s “The Rise and Fall of the Great Powers’ and deserves another separate post as well).
Below is the post. Feel free to comment whether you agree or disagree. Enjoy.
In an earlier post, I said that populism was the problem, not the solution. I reject populist methods of tariffs and protectionism because they are self-defeating economic poison. However, in this brief post, I do want to give voice to a populist interpretation of the last 35 years of U.S. economic history. This is a story of unequal re-distribution of wealth from the less fortunate to the more fortunate. This is a story of the United States in which the rich get richer at the expense of everybody else. At the conclusion, ask yourself: is this true and, if so, what should we do about it?
The Theory of Kleptocracy
First, let's use a theory from Guns, Germs, and Steel by Jared Diamond as the center-piece for this little theory. In Chapter 14, entitled "From Egalitarianism to Kleptocracy," Diamond postulates that more stratified societies are by definition less egalitarian, but more efficient and are, thus, able to eradicate or conquer more egalitarian, less stratified societies. Thus, all 'advanced' societies with high levels of GDP are complex and hierarchical.
The problem is: these more stratified, more complex societies are in essence Kleptocracies, where those in power re-distribute societal wealth to themselves. Those at the bottom of the society's pyramid accept this unequal, non-egalitarian state of affairs because they too benefit from their society's relative advancement. It's a case of a rising tide lifting all boats.
Diamond says the Kleptocrats maintain power using 4 different methods:
"1. Disarm the populace, and arm the elite."
"2. Make the masses happy by redistributing much of the tribute received, in popular ways."
"3. Use the monopoly of force to promote happiness, by maintaining public order and curbing violence. This is potentially a big and underappreciated advantage of centralized societies over noncentralized ones."
"4. The remaining way for kleptocrats to gain public support is to construct an ideology or religion justifying kleptocracy."Kleptocracy in America?
The obvious corollary of this theory is that most successful modern societies are, in fact, kleptocracies. The key is to use the four methods to gain popular support in order to re-distribute as much wealth to the ruling class as the populace will support. If the ruling class takes too much, it will be overthrown and replaced by a new ruling class (which in turn will re-distribute wealth to itself using the same four methods).
While this angle seems cynical, it is a a line of argument that has great internal consistency.
So, is the United States a kleptocracy? Of course it is! Is that bad? Well, it obviously depends on who you are in society. But, it also depends on whether the kleptocracy is efficient and fair over the long term. Let me explain this last statement a bit more.
Efficiency and Fairness
Because any heavily stratified society is by its very nature non-egalitarian, there always exists the potential for disenchantment amongst the masses. The U.S. is no exception. In order to prevent this disenchantment from leading to revolt, the ruling class must appear to strive for efficiency and fairness.
- According to dictionary.com, efficiency means "accomplishment of or ability to accomplish a job with a minimum expenditure of time and effort." So, for the US, it means the ability to increase productivity at a rate which makes the U.S. wealthier on a per capita basis now and in the future. And remember, it is the perception of efficiency, not actual efficiency which is important.
- To be fair is to be "free from bias, dishonesty, or injustice." For the United States, this means maintaining the perception that most every person has the opportunity to succeed while few, if any, have unobstructed paths to guaranteed success.
Is the U.S. efficient and fair?
That's the $64,000 question, isn't it. My populist take: no, the United States is neither efficient nor fair.
The United States has been living beyond its means for some time. Since the 1960s, we have run up a massive federal debt and current account deficit, while debt levels have doubled on a percentage of GDP basis. Our present levels of consumption are simply not justified by our current levels of productivity, if we want to maintain our present standard of living in the future.
Were we not the world's major military superpower with the world's reserve currency and the world's largest economy, we would have succumbed to our profligacy years ago. Paul Kennedy has a great book on "The Rise and Fall of the Great Powers." By contrast, many developing countries have gone bankrupt in the last 30 years from Argentina to Zimbabwe. Yet, we are in worse shape than were they, if one looks at the signposts which represent our macroeconomic health: debt-to-GDP levels, current account deficit as a percent of GDP, Government budget deficit, savings rate, etc.
The fact is our day of reckoning is upon us. We will soon realize that our massive debt and an outsized credit bubble have not only saddled us with debt, but it has also misallocated capital so that we are less productive than we believed. We have built miles and miles of telecom dark fibre when we could have invested in schools. We have built massive numbers of new homes, when we could have repaired our bridges and roads. The last 35 years have been an illusion of extreme productivity and wealth because we have artificially pulled forward demand by misallocating resources in order to consume today, what could have been consumed tomorrow. In essence, we are consuming today, while unwittingly making it more difficult to consume tomorrow because we believe we are wealthier than we truly are.
And as for fairness, Real Weekly Earnings peaked over 35 years ago in September 1972! Using the CPI to adjust wages to today's dollars, the average worker made $738.48 per week in September 1972. In January 2008, that figure was $598.18.
(Note: these figures are expressed in Jan 2008 dollars. I use the CPI Index to calculate real dollars, which is based on 1982-1984 dollars. But, I then multiply this figure by 2.1108, which represents the BLS's index factor for Jan 2008).
So, we are getting poorer. And we have been for over 35 years. Only during the end of the Clinton Administration was there an appreciable upswing in real weekly wages over this time period. Don't believe me? See the raw data yourself, here and run the numbers.
In the meantime, CEOs are earning hundreds of millions of dollars, even when they are forced to leave because of poor management which cost their firms billions. In 2005, the average CEO earned 262 times what an average worker gets. In 1965, that figure was 24 times (see story).
Conclusions
There it is: the U.S. ruling class is not living up to its role in either efficiency or fairness. We are getting poorer.
That is why people are so angry. That is why the poll numbers for the President and Congress are so low [remember, I wrote this in March 2008]. And that is why so many people are suffering from the housing bubble.
The question you should ask yourself is this: Why has it taken the citizens of the U.S. so long to figure all this out? Answer: Even though the gulf between rich and poor was widening and the rich were getting richer, we thought we too were getting richer as well. We thought that we too were profiting from all of this "productivity." In the 1980s, we came out of a steep double dip recession and stagflation and we won the cold war. This inflated our sense of well-being. In the 1990s, there was the tech bubble to inflate our assets. In this decade, there was the housing bubble. So, we thought we were getting rich too. We didn't mind that the ruling class was benefiting disproportionately as long as we too appeared to be benefiting.
But, what was really happening is we were loading up on debt. We were not benefiting at all
And now that there are no more cold wars we can win quickly, no more tech stocks, no more double digit house price increases, and no more asset bubbles to hide the naked truth -- now we realize that we were getting poorer all the time -- just as it felt to us. The ruling class have used the four methods to maintain popular support that I enumerated before in order to give the appearance of equity and efficiency. All the while, the rich were milking the system for all they could.
I advise anyone who finds this populist line of argument compelling to read Jared Diamond's Pulitzer Prize-winning book. Chapter 14 is especially rich. Once you realize that we the American people have been duped for the last generation, you will be angry. And this is why we need a major change in Washington. The politics and policies of the past just will not do.
Selected comments
- Ned Bushong said...
- You'll never get a voluntary change from Americans, they are too lazy. But an involuntary change is coming, society as we have known it, is finished. Our political leaders have given away every bit of our foundation. All we can do is return to 'existence' then start rebuilding a new society.
http://www.bushongbusiness.com/opinion.html- May 15, 2009 10:42 AM
- lrm21 said...
- We live in a constitutional republic, or perhaps we did at one time. And everyman has vote and a stake in the game.
And so we are to blame for our problems for continuing to put the same thieves in charge of the gold, and then express outrage not because they steal from Paul and Mary thats ok, its only when they steal from you and me that its a problem.
People think that their responsibility ends at the voters booth but I think Thoreau said it best on how the average man, I prefer SHEEP, is a cop out via voting
====
"All voting is a sort of gaming, like checkers or backgammon, with a slight moral tinge to it, a playing with right and wrong, with moral questions; and betting naturally accompanies it. The character of the voters is not staked. I cast my vote, perchance, as I think right; but I am not vitally concerned that that right should prevail. I am willing to leave it to the majority. Its obligation, therefore, never exceeds that of expediency. Even voting for the right is doing nothing for it. It is only expressing to men feebly your desire that it should prevail. A wise man will not leave the right to the mercy of chance, nor wish it to prevail through the power of the majority. There is but little virtue in the action of masses of men. "You lament the Kleptocrats, but who keeps giving them the keys to the vault?
- May 15, 2009 10:49 AM
- Doc Holiday said...
- Re: "we won the cold war"
It looks like America is having a Berlin Wall moment these days and I'm not sure if the walls are going up or coming down, but there is a dynamic social shift underway that will destroy our country.
Saith John Bogel (September 2007): " "My estimate is that the financial sector takes $560 billion a year out of society," Bogle explains to Bill Moyers. "Banks, money managers, insurance companies, certainly annuity providers. They're all subtracting value from the economy."
From:
- Doc Holiday :
- In this book, Bogle abhors what he sees as rampant cheating among his peers - not only mutual fund managers but brokers, bankers, lawyers and accountants. It's not just a few bad apples, he says: "I believe that the barrel itself - the very structure that holds all those apples - is bad."
Many people are still reluctant to concede that abuse was so widespread, since what they fear most is an assault by government in the form of tougher regulations. Unsurprisingly, loud complaints are now being lodged by influential lobbyists in Washington about the Sarbanes-Oxley Act of 2002, the only serious measure passed in the wake of the scandals to control business excess. And the tough-minded chairman of the Securites and Exchange Commission, William Donaldson, recently stepped down in the face of opposition from the White House and business interests.
Genuine shareholder democracy, he argues, would require chief executives to worry about the long-term health of the company, not the short-term fluctuations of stock prices. They would be far less tempted to manipulate earnings. In particular, if shareholders had appropriate voting power, the abuses associated with executive stock options could be reduced. Because shareholders do not have adequate voting rights, Bogle says, reform continues to be stymied.
From:
- Paul Boisvert said...
- Great post, Edward! As a socialist, I agree with almost all of it -- you libertarians are deadly accurate about economic phenomena once you realize/admit that "free-market" capitalist economic interactions have substantial involuntary and/or coercive aspects, broadly speaking -- i.e, that organized market power exercised by and for elites actually exists.
- Thanks for admitting it--see if you can get your fellow libertarians to see the light! My only comment is that you need to parse "efficiency" by asking 'what "jobs" do we WANT to accomplish (efficiently)? And over what time frame should we measure the real costs of accomplishing those jobs, including fixing global environmental destruction down the road?' Once we think through those questions honestly, the case for capitalism pretty much evaporates. Also, Jared Diamond's book Collapse is another must-read, though he offeres no solutions at the end but to hope that big business "decides" to save the planet--a pipe dream if ever I heard one...
Again, very perceptive post!- May 15, 2009 11:23 AM
- Size said...
- I'm curious if your weekly wage figures are comprehensive.
Over the period of time that you mention, money wages declined but perks such as health insurance have gone up. Since health insurance is compensation, it's misleading to leave it out.
Also, typically, wage figures don't include bonuses and tips. However, both of those things have become a larger portion of total compensation over the time period you cover.
I believe that once you factor in all compensation, you will find that average compensation has, in fact, risen.
- May 15, 2009 11:40 AM
- attempter said...
- This piece is an excellent summary of the delusions of the last 35 years.
The only thing I'd add is that increasingly the kleptocrats no longer even try to create the perception of the rising tide lifting all the boats.
Sure, they still mouth the same trickle-down lies, but clearly no one including the liars themselves believe it any more.
Now it's just brazen rent-seeking and theft. Lobbying, bribery, anti-public lawsuits, capture, trying to destroy all social spending once and for all, trying to obstruct any solution to any problem once and for all.
By coincidence, this was the subject of my own blog post a few days ago, if anyone would like to read it at:
http://attempter.wordpress.com/- May 15, 2009 11:43 AM
- X said...
- Although they love to invoke Smith, today's "free-marketeers" envision almost exactly the opposite of Smith's free market. Absence of rent-seeking and monopoly charges were what Smith meant by "free market," while today the sort of freedom they have in mind is freedom for the powerful to crush those they oppose. That is a perverse sort of freedom that should cause libertarians to run screaming for the exits.
@Size: So do you think that workers are better off now than in the '70s? If average compensation truly is higher now, it could only be because of the very tip-top pulling up the average. Run of the mill blue collar work does not compensate workers at anywhere near the level of the '70s. I want to say it is closer to half than to even. Health benefits for most blue-collar jobs provde no value whatsoever. They consume an unreasonable portion of income in premiums yet do not even "insure" since the deductibles and copays still lead to financial ruin in the case of a serious health event. Workers are better off without it since they pay the premiums now, but still end up bankrupt when they need the "insurance."
- May 15, 2009 12:20 PM
- William A. Sigler said...
- Superb post -- I'd quibble on going back 35 years with income, since that was largely before the rise of two-income families. As in the gilded age with immigrants, individual incomes have gone down partly to accomodate all those extra workers, but families have felt their boats were rising until quite recently.
The question of the age seems to be why Americans are so passive in the face of what appears to be complete and open corruption of the system. Theories abound, from flouride to the Republocrat shell game, but I think people are much more aware, at least at an instinctual level, of what's going on than most thinkers give them credit for, they've just checked out in the face of their powerlessness.
This may occur is in part because taking on debt has the psychological effect of lowering one's sense of worthiness -- thus one becomes more afraid of losing what one has, exhibits all kinds of irrational, instinctive behaviors to hold on to what one has, and in general, forgives the system because one can't forgive oneself.
- May 15, 2009 12:48 PM
- Richard Smith said...
- Size - you seem to be mistaken about the inclusion of bonuses and benefits in earnings stats.
The BLS stats do include benefits in kind and bonuses. See here: http://tinyurl.com/p753rd. Not hard to track down and I can't understand why you didn't bother to check.
Earnings don't include tips, for obvious reasons. I assume you will agree that the 20% decline in real earnings is unlikely to be made up by tips.
The fact that you don't know whether the BLS stats include tips, benefits and bonuses can't possibly be used to support your claim that wages have gone up, can it? You would need to supply some actual evidence to support that claim.
- May 15, 2009 12:50 PM
- gpp said...
- I agree with this assessment.
The loss of efficiency is a natural process in the evolution of a civilization (Quigley).It comes from the evolution of instruments (serving external purposes) to institutions (mainly serving their own purposes).
This process takes place on many levels:
education (minize student contact hours, maximize grants, physical infrastructure, fund raising)
corporate leadership (stuff your own pockets)
political leadership (get reelected)
health care (maximize revenue for yourself not the health of the patient)
the military (promote your own wellfare, fight only the likes of the Taliban and Somali pirates)
religious leadership (squeeze the believers so you have the means to sin and ask for forgiveness)
...As the standard of living declines for most and anger rises the idea is born that progress can only be made by destroying others.
War is coming.
- May 15, 2009 12:53 PM
- Problem Is said...
- This is a very good analysis. On the question of what kind of method the kleptocracy uses in the US:
"4. The remaining way for kleptocrats to gain public support is to construct an ideology or religion justifying kleptocracy."
Read Alex Carey's "Taking the Risk Out of Democracy" to fully appreciate the use of "sacred and satanic symbolism" in US propaganda through out the US history really, but Carey focuses on US corporate propaganda of the 20th century.
The religion is "free markets equal democracy," non capitalism equals Satanism. This is religious propaganda to keep crony capitalism in power. US corporations and financial elites never met a fixed market they did not love... Propaganda and indoctrination has been the tool that drove the last 40 years. The fixed market propaganda has been overwhelming. You cannot discount the first tenant of fascism… corporate owned governance. You see clearly right now with the vast amounts of public tax money bailing out Wall Street and corporations beyond any sanity.
Look at the mass manipulation of GDP, CPI and U3 unemployment as propaganda to further the entrenchment of the political class. This is propaganda in action. The American public truly believed in 2006 unemployment was 4%, prices rose at 2.3% and GDP was growing. The American public, a product of an educational system designed so they are just smart enough to show to work on time and follow directions but can't do enough math to read a statistical chart let alone analyze one.
The second key reading would be Joseph Tainter's "The Collapse of Complex Societies." The Laws of Diminishing Returns are real and they apply to more than just the marginal benefit of the next acre of corn you plant. Complexity and hierarchy of a society reach their own diminishing returns.
We see this today. Poor billions more into the US military and the marginal benefit is practically null at this point. Poor billions into education and the marginal benefit to society and GDP is greatly reduced from its peak in the 1950s. Poor trillions into the financial sector and well you could have produced more marginal benefit by burning the trillions for heat.
I applaud Edward for taking a serious analytical approach or "big picture" look at the foundations of where we are today. He is correct to use real wage comparisons and the fact that this is not now nor probably has been a functioning democracy in decades. I also applaud Edward for breaking the cult of "free markets equal democracy" for calling the US capitalist system what it is, fixed market oligarchy.
How else can the same idiots fail upwards? Do you really think George Bush is smart enough to go to Yale? Smart enough to take out a $500k loan, invest it in a Rangers stadium deal and make $14 million? In what universe is Bush smart enough for that? Only in a fixed market kleptocracy.
Thank you Edward!
- May 15, 2009 1:36 PM
- asphaltjesus said...
- Irm21, I share the same opinion as you in this matter. But, there are powerful social forces that restrain legitimate political discourse between individuals in the U.S.
As easy as it may be to call others sheep, I think the name-calling doesn't add to the discussion.
The article was an elegant summary of things no one in the U.S. wants to discuss. (class, for one is a huge no-no. Income distribution is another.) Any broad discussion on the matter will quickly be hushed and the primary actors marginalized as 'socialists.'
Most Americans still want to pretend in the America taught in History and Political Science textbooks. And for reasons I don't understand, they are quite indifferent they are being robbed.
- May 15, 2009 1:42 PM
- asphaltjesus said...
- Problem is said Look at the mass manipulation of GDP, CPI and U3 unemployment as propaganda
- Let's go crazy and take the raw data from BLS and start calculating our own statistics. It's far from impossible, there's lots of standard modeling out there and it's easy to publish everything including the methodology.
I would argue that even if a scientifically decent set of stats are generated, they will be quickly marginalized simply because they may be more accurate.
It would be a fun exercise, but needs a team of volunteers with discipline to do well.
- May 15, 2009 1:53 PM
- DownSouth said...
- @Edward Harrison said: “Diamond postulates that more stratified societies are by definition less egalitarian, but more efficient and are, thus, able to eradicate or conquer more egalitarian, less stratified societies.”
I vehemently disagree. Egalitarianism as used here is a red herring. Just because a society is more eglalitarian does not mean it is less efficient. In fact, in many cases just the opposite is the case.
It seems to be an almost universal human trait to admire and want to reward (and serve) exceptional merit and achievement. Not too many people have a problem with that. As Rousseau pointed out, where the rub comes is when wealth and rank no longer correspond to merit. Societies that fail to maintain an equitable balance between wealth and rank on the one hand and demonstrable merit and achievement on the other open themselves up to civil disorder. This makes them vulnerable to conquest or dissolution. (As an aside, libertarianism is correct in its recognition that merit deserves reward. Its failure is that its mechanism for proportioning reward to achievement is flawed.).
Walter Bagehot further elaborated on this theme in Physics and Politics:
He (Bagehot) begins indeed by showing that "Natural Selection" in the early stages of the march of civilization--the better organized, more cooperative groups conquer the less unified. But then more and more other qualities, initiatives, and ideas--liberty, free discussion, written law, habits of calm reflection, of tolerance and generosity--conduce to survival, because they make for an ever higher degree of cohesion. These virtues are the strength of the national state, whose power a less developed people cannot successfully withstand.~
--Jacques Barzun, From Dawn to Decadence~Jonathan Haidt recently delivered a completely modern take on the same theme:
For a long time there was a consensus that emerged beginning in the 1960s that human cooperation can be explained so parsimoniously just by these two beautiful simple processes: kin selection...and reciprocal altruism... And that’s all we need is just these two. This consensus had a kind of, almost a quasi-religous aspect to it in that people who challenged it, people who tried to produce or talk about other processes were often treated as though they were committing a kind of sacrilege. There was almost an emotional response, a rejection of people who tried to bring in other processes...
But in, just in recent years, in the last 10 or so years...things have changed. The consensus has unraveled and there’s an increasing appreciation that natural selection really does work at multiple levels at the same time and then the question is what are the factors that make inter-group vs. inter-individual competiton more or less important. The basic dynanic that’s been recognized since Darwin is that group efforts, cooperative efforts are always threatened by free riders, by people who reap the benefits of cooperation without making any contribution. This problem was thought to be fatal in the 60s but what has now been realized... is that culture is a solution to the free rider problem. Cultures are extremely good at solving free rider problems. Cultures come up with all kinds of mechanisms. We have abilities to gossip, we have institutions and practices that help us gossip efficiently, text messaging and the internet nowadays. But the gossip has been around for quite a long time, all sorts of religous practices, legal practices, all sorts of institutions help us ferret out free riders and make free riding costly.
And once free rider problems are solved, and this is true for any species or at any level, once free rider problems are solved and you create a new one-for-all, all-for-one dynamic, you then get a major transition in evolutionary history. Big changes happen because of the enormous gains from cooperation.~
http://thesciencenetwork.org/programs/beyond-belief-candles-in-the-dark/jonathan-haidt-1So how does this dynamic play out in history? Here’s one example:
By contrast with the West, the eastern (Roman) empire was relatively untroubled by civil wars and internal unrest during the period of the invasions, and this greater domestic stability was undoubtedly a very important factor in its survival. If the eastern empire had faced internal distractions in the years immediately following the Gothic victory at Hadrianopolis in 378, similar to those that the West faced in the period following the 406-7 barbarian crossing of the Rhine, it might well have gone under. There is no very obvious reason for this greater stability in the East, beyond good luck and good management. In particular, through the dangerous and difficult years after Hadrianopolis, the eastern empire had the good fortune to be ruled by a competent and well-tried military figure, Theodosius (emperor 379-95), who was specifically chosen and appointed from outside the ranks of the imperial family to deal with the crisis. By contrast, the ruler of the West during the years of crisis that followed the Gothic entry into Italy in 401 and the great crossing of the Rhine in 406 was the young Honorius, who came to the throne only through the chance of blood and succession, and who never earned any esteem as a military or a politica leader. Whereas the figure of Theodosius encouraged a healthy respect for the imperial person, that of Honorius, dominated as he was by his military commanders, probably encouraged civil war... Honorius was [frequently portrayed] in elaborate armour, [holding] an orb surmounted by a Victory, and a standard with the words “In the name of Christ, may you always be victorious.” Reality was less glorious—Honorius himself never took the field; and his armies triumphed over very few enemies other than usurpers... As one contemporary source wryly noted: “This emperor, while he never had any success against external enemies, had great good fortune in destroying usurpers.”~
--Bryan Ward-Perkins, The Fall of Rome and the End of Civilization~And who was the Western Roman empire fighting against? What kind of political system did it have?
Because the first medieval rulers had been barbarians, most of what followed derived from their customs. Chieftans like Ermanaric, Alaric, Attila, and Clovis rose as successful battlefield leaders whose fighting skills promised still more triumphs to come. Each had been chosen by his wariors... Lesser tribesmen were grateful to him for the spoils of victory, though his claim on their allegiance also had supernatural roots...
But the chieftans had been chose for merit, and early kings wore crowns only ad vitam aut culpam—for life or until removed for fault.~
--William Manchester, A World Lit Only by Fire~But once a society matures, it seems the rank and file become quite (some would say overly) tolerant of the failings and shortcomings of the elite:
[A]s soon as workers have something more to lose than their chains, as soon as they have the slightest stake in the status quo, (it need not be property, it need be only a fairly secure job or the minimum security of a semi-adequate unemployment dole), they will suffer the slings and arrows of outrageous fortune, rather than fly to evils that they know not of.~
--Reinhold Niebuhr, Moral Man & Immoral Society- For the rich and powerful could maintain their prestige only by giving the general public what it wanted. It wanted properity, economic expansion. It had always been ready to forgive all manner of deficiencies in the Henry Fords who actually produced the goods, whether or not they made millions in the process.~
--Frederick Lewis Allen, Since Yesterday- May 15, 2009 2:13 PM
- Leo Kolivakis said...
- Edward,
Excellent post, I loved reading Guns, Germs and Steel. You wrote: "There it is: the U.S. ruling class is not living up to its role in either efficiency or fairness. We are getting poorer."
I happen to think the U.S. ruling class never really lived up to their role except to create a indebted and subservient class that is struggling to get by. For some strange reason, in the U.S., people still believe that if you work hard enough, you too can make it. For the majority of people, this is simply a pipe dream.
I laugh when I see these ads running on U.S. televison networks about how terrible Canadian healthcare is and how much better it is in the U.S.. The ads are pure nonsense, but if you brainwash people to believe it, they will oppose universal healthcare.
Our Canadian system is far from perfect, but when I see the stark statistics of uninsured in the U.S., I can't help but conclude the corporatization of healthcare has been an abysmal failure.
My brother is a psychiatrist and he explains it very simply. He thinks the asymmetry in information between healthcare providers and patients if so huge that you need to control it or else abuse will be rampant. As he says, "When you mix profits with healthcare, most people lose out."
There is another secular trend worth noting here. Manufacturing jobs are disappearing in developed nations and along with them, so is the middle class.
The rich are getting richer and the masses are amassing more debt to get by. Elizabeth Warren said it in the documentary Maxed Out: "They will never pay off those debts."
Worse still, there is a full front assault on pension plans. The Canadian government just announced they will not help GM's pension plan here in Canada.
Around the world, companies are freezing pensions or scrapping them altogether. next up, i expect serious cuts in public pension benefits and an increase in contribution rates.
The power elite have to accept the limits of unconstrained capitalism. If they don't recitfy some of these injustices, we are going to have another major social dislocation.
So far, the masses have not revolted, but the way things are going, I think this might happen over the next decade and maybe sooner.
cheers,
Leo
- May 15, 2009 2:30 PM
Hugh said...
- I am surprised in a discussion like this Naomi Klein Shock Doctrine is not mentioned. It is not all about happiness. Scaring people and then using their fear and confusion to drive policy is at least as important.
Individual wages went flat with Carter but household income continued to grow as more families had two wage earners, as pointed out above. Carter has oil shocks and recession to deal with. So wages not going up during his Presidency was understandable. It is really with Reagan that the stagnation in real wages becomes institutionalized even in conditions of economic expansion.
It is really with Reagan that you have the creation of the paper economy. You have recycling of oil revenues, tax cuts for the wealthy, high deficits, explosion of the national debt as well as the destruction of unions, stagnation of wages, and increases in Social Security taxes. All these things conspired to move us from a worker based economy to an investor led one, from the real economy to a paper dominated one.
The discrepancy between the two could only be sustained through massive debt. We were producing less and buying more. I used to think that Clinton represented a reaction to these trends but really he was a conitnuation benefiting from Greenspan's easy money policies. It was still the same game. LTCM, the dot com bubble, Enron, all should have been wake up calls. Instead the last brakes to the system were removed and the pace of speculation in paper markets became even more feverish.
And then it collapsed. It burst as all bubbles do. We are left with the remnants of a financial system which has long ceased to serve any useful economic purpose and which can consume trillions without blinking an eye or achieving anything at all. We also have what's left of our real economy, distorted and looted as it has been by the demands and expectations of a paper economy totally divorced from reality. And we have debt, lots and lots of debt.
So yes, we are and will be poorer. Indeed for many in this country, recession hit them 5 or more years ago. They have known for a long time they were poorer. The difference is without the masking curtain of the paper economy and its bubbles, the rest of us are coming to this realization as well.
Eleanor said...
- Yep - welcome to what we affectionately call "regulatory capture" in my neck of the woods. It's been growing for 35 years or more, and I'm very glad to see it at least called by its true, vampire name.
My question is how the process can be reversed without the empire collapsing entirely. We all recognize that new productive capacity and some serious innovation in the REAL economy is needed if we are to avoid waves of barbarians coming over the hill for the next decade (well, it may be a little late). What I don't hear are good suggestions for where that investment should be made, and what skills are really needed to support it. If we need to leapfrog, where do we start that process?
For the past 20 years, I have known that I was not keeping up with my parents. I have watched as the standard of living for myself and people like me, and the kind of open economy that permitted my grandfather to build a business that made him wealthy, were gone. The American dream died quietly quite a long time ago -- the insane run up in housing prices just made it more visible.
May 14, 2009 | OptionARMageddon
In an interview with Charlie Rose on Tuesday, Tim Geithner admitted the bubble was caused by Greenspan's easy money policy. Unfortunately, Charlie didn't ask the obvious follow-up: "why will this time be different? Why will Bernanke's easy money policy lead to different results?" Here was the crucial exchange:Rose: "Looking back, what are the mistakes and what should you have done more of? Where were your instincts right, but you didn't go far enough?"What makes Geithner's admission so frustrating is that the government is engaged in the same disastrous policy today, to fight the same bogeyman: deflation.
... ... ...
Geithner: "...I would say there were three types of broad errors of policy and policy both here and around the world. One was that monetary policy around the world was too loose too long. And that created this just huge boom in asset prices, money chasing risk. People trying to get a higher return. That was just overwhelmingly powerful."
Rose: "It was too easy."
Geithner: "It was too easy, yes....
As Geithner makes plain, a huge side effect was that investors seeking meaningful returns inflated the bubble taking flyers on overpriced, risky securities. Toxic structured products are the obvious example. Credit rating agencies get lots of blame as enablers, rating trash "AAA." But fixed-income investors wanted an excuse to invest in riskier stuff that carried slightly higher yields; hell, artificially low interest rates meant many needed an excuse.*
Truly low risk securities like Treasurys and money market instruments were yielding so little, they were of no use to portfolio managers trying to match assets with liabilities.
But what happens when low-risk fixed-income securities yield 0% or close to that? Asset managers are more or less forced to seek higher interest rates through riskier investments.
So what are the results of our latest experiment with rock-bottom rates? Investors are piling back into risky investments across the board. Taking just one example, FT noted this week that high-yield debt is skyrocketing. The "experts" cited in the article claim this is proof that we've come through the worst of the recession. In their brains, markets operate efficiently, so running bulls must reflect improving fundamentals.
First of all, efficient market theory doesn't apply to asset markets the way it applies to goods markets. But even if it did, how can folks pretend that any market with fixed prices is operating efficiently? With their stranglehold on interest rates via open market ops, central banks everywhere are engaged in a massive price fixing scheme that distorts investor incentives across all asset markets.
Geithner admits such a policy was a disaster before, that the "overwhelmingly powerful" force of low rates inflated the bubble. So how can he/Bernanke justify the same approach this time 'round? No doubt they'd argue they've no other choice: a ponzi system "relying on credit" needs credit to flow or else it will collapse. It doesn't occur to these guys that the system itself is flawed, that we need a gut renovation, not just another layer of paint.
No doubt de-leveraging would be quite violent if the Fed left rates higher. But de-leveraging is the only solution to the crisis. God forbid Bernanke's easy money policy actually "works;" God forbid he "rescues" the economy by reflating the credit bubble. De-leveraging is coming, whether we want it to or not. Better to rip the band-aid off quickly...Selected comments
- DownSouth said...
- I don't see that there has been any deleveraging whatsoever.
► Household debt is no longer growing, but has not fallen either, being essentially flat.
► Ditto business debt.
► Federal Government debt is exploding.
► The net is that total non-financial sector debt is not growing as fast as it was six quarters ago, but it is still growing at a healthy clip.
► Ditto financial sector debt--still growing, just not as fast.
... ... ..
Even more troubling is the fact that, even though the financial sector is able to borrow money at almost 0% interest, easing its borrowing costs, there are signs the reduced interest rates are not trickling down to households and businesses. In fact, the interest rates and fees households and businesses pay may actually be going up. This is in an environment where falling profits and falling wages mean less money available to service debt.
Congress and the Obama administration are throwing a lifeline to the financial services sector, who are using it to blow yet another bubble in securities, while leaving households and businesses to bite the big one.
Sounds like a recipe for social unrest, if not revolution, to me.
- X said...
- I think the response to why this time is different would be that this time they won't leave rates too low for too long. This time they will raise rates at the right moment instead of leaving them too low.
Not that I buy that, but I think that would be their obvious response. The nightmare remains that their fix "works" and we never do get around to deep reforms. The housing bubble barely lasted us five years and threw us into this crisis on a terrible footing. Another quick bubble and bust would give us a worse crisis and on a worse footing to deal with it.
Right about now we need a dose of both Roosevelts (trust-busting and redistribution of wealth/power) but in the absence of direct action to pressure the government we will likely have neither.- Doc Holiday said...
- In addition to the fine input and output today here @ NC, I have also enjoyed reading stuff from Henry C K Liu (related to this matter at hand):
MONETARISM ENTERS BANKRUPTCY, Part 3
Credulity caught in stress test
Systemic risk and credit rating
Thus there were two dimensions to the cause of the current credit crisis. The first was that unit risk was not eliminated, merely transferred to a larger pool to make it invisible statistically. The second, and more ominous, was that regulatory risks were defined by credit ratings, and the two fed on each other inversely. As credit rating rose, risk exposure fell to create an under-pricing of risk. But as risk exposure rose, credit rating fell to exacerbate a further rise of risk exposure in a chain reaction that detonated a debt explosion of atomic dimension.
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Also see:
Parting Glass
- rootless cosmopolitan said...
- The whole argument about how the Fed's low interest rates were responsible for the crisis is founded, of course, on the assumption, that there is a strong causal link from the Fed's interest rates to market interest rates, inflation and GDP growth. But is there? Why, for instance, do you think the Fed funds target rate significantly determines the interest rates to be paid for a mountain of credit of more than 50 trillion US-dollars? Such a causal link would have to be proven first. I don't think is has so far.
rc- DownSouth said...
- X,
I believe there are a couple of things that are different this time that might give Bernanke a little more control over the monetary situation than what Greenspan had (assuming they both use the same toolkit--control of interest rates and the monetary base--and rule out the use of regulation).
It seems some years back the banking system bifurcated into 1)the traditional banking system and 2)the shadow banking system:
Robert Marks, an enterprising New York economist, devoted a page in Barron's to an intiguing and disconcerting thesis: that by 2004, the unprecedented magnitude of credit and debt in the United States had made irrelevant the traditional focus of the Federal Reserve Board on the nation's money supply. Total nonfiancial credit-market debt in the $23 trillio range, he argued, had effectively supplanted the $3 trillion money supply as the best guide to the actual economy.~
--Kevin Phillips, American Theocracy~
My question then is this: If the Fed elects to eschew regulation, as Greenspan did, does that not then limit its control to the traditional banking system, and to only two tools--control of interest rates and control of monetary base?
Greenspan did start curtailing the growth in the rate of the monetary base beginning in the fall of 2002. He began raising interest rates in about the middle of 2004.
http://research.stlouisfed.org/publications/mt/20081101/mtpub.pdf
However, the money supply kept on growing. Was that not so because of what was going on in the shadow banking system?
If we take a look at these charts from Brad Setser's post, we see that capital flows from foreign sources to purchase U.S. corporate bonds began to increase precipitously starting towards the end of 2004.
http://blogs.cfr.org/setser/2009/01/21/should-the-us-worry-about-the-drop-in-foreign-demand-for-us-long-term-assets/
Were those capital flows not all occurring within the shadow banking system? It seems the only way to have slowed down or put a stop to those movements would have been through regulation, which, because of Greenspan's libertarian/neoliberal theology, was unthinkable.
But things may be different now. It is my understanding (see May 12, 2009 Guest Post: Is Inflation Inevitable? submitted by Leo Kolivakis) that the shadow banking system is in tatters. Foreigners are no longer buying U.S. corporate bonds. If that is so, and remains so, then would Bernanke not have comparatively more control over the monetary situation using the traditional tools of interest rates and monetary supply?- Don said...
- "But fixed-income investors wanted an excuse to invest in riskier stuff that carried slightly higher yields; hell, artificially low interest rates meant many needed an excuse.*"
"Asset managers are more or less forced to seek higher interest rates through riskier investments."
I agree with you about the search for higher yields, but there is no such thing as "more or less forced". Actual human beings made decisions and gave advice that was either negligent or criminal, in many cases. Wanting to achieve higher returns with less risk is silly. Lower interest rates cannot "cause" any sentient being to do anything. An incentive is just that. It is not a command or irresistible urge. This is a mechanistic explanation of human behavior.
"to fight the same bogeyman: deflation"
Not only is it not a bogeyman, it is far worse than inflation. A Debt-deflationary Spiral has no natural stopping point. From my view, that's what Fisher's paper showed, and the current crisis validates Fisher's theory.
Nevertheless, I liked your post, because you made plain the assumptions you are working under, which allow me to understand your argument and why you believe it. Many differences come from different assumptions.
Don the libertarian Democrat
May 13, 2009 | Forbes.com"Credit card lines are being cut at an accelerating pace," Whitney said on Tuesday, "and this clearly does not bode well for consumer confidence or prospective consumer spending."
From its peak, she estimates that over $1 trillion in lines have already been cut from the market. One predominant reason she remains so cautious on the U.S. consumers and prospective consumer spending over the next year and a half is the overwhelming trend she sees in available consumer liquidity.
... ... ...
Whitney's argument resonated with a similar warning made by Gus Sauter, chief investment officer at mutual fund mega-house Vanguard, who said high individual debt will stifle the kind of explosive growth the U.S. saw after past severe recessions in the 1950s and the 1980s. (See "Gus Sauter's Slow Recovery.") Americans, he said, will learn to live, at least for awhile, with lower growth and earnings rates and slightly higher unemployment.
5/13/2009 CalculatedRisk
From Bloomberg: William Seidman, Who Led Cleanup of S&L Crisis, Dies
In his memoir [published in 1993], Seidman offered a set of lessons learned. They included, “Instruct regulators to look for the newest fad in the industry and examine it with great care. The next mistake will be a new way to make a loan that will not be repaid.”Those two sentences should be emblazoned above every desk of every financial regulator.
My condolences to Mr. Seidman's family and friends.
By Moe Tkacik - May 8, 2009, 4:00PMRemember the rumors that AIG Financial Products had "thrown in the towel," handing over massive portfolios of derivatives to the trading desks of major investment banks to unwind in a process that gave the beleaguered banking sector a profitable first quarter?
We first heard them back in March from the blog Zero Hedge. Then, sure enough, the banks began reporting first quarter earnings that for the most part beat expectations -- all thanks to record and near-record revenues for their trading operations.
Then the fixed income chief at the hedge fund BlackRock essentially confirmed the story to Bloomberg Radio in a wry interview we partially transcribed.
And now we've heard from an anonymous executive at AIG who is "familiar" with AIG FP...
Our source says it "is becoming assumed throughout the industry that AIG FP finding new ways to roll over" -- which is to say, using bailout money to offer counterparties on its trades generous terms in closing out its contracts with the massive issuer of credit default swaps and other exotic derivatives options. While he did not want to name names or go into detail about any specific transactions, he said we should watch for signs of AIG FP employees being rewarded for their generosity with jobs working for their old counterparties under eyebrow-raising terms -- "like if you have a noncompete," the source explained, "and you go to a competing firm doing something far below you for an extreme salary."
An exodus of employees at AIG Financial Products has already threatened to cost taxpayers hundreds of billions more dollars. And to think some executives might be hastening their departure from the zombie insurer by squandering billions of taxpayer dollars is...while perhaps unsurprising, still a little nuts.
"The staggering thing," our source says, "is the size of these deals.
In his entertaining book “Richistan,” Robert Frank of The Wall Street Journal declares that the rich aren’t just different from you and me, they live in a different, parallel country. But that country is divided into levels, and only the inhabitants of upper Richistan live like aristocrats; the inhabitants of middle Richistan lead ample but not gilded lives; and lower Richistanis live in McMansions, drive around in S.U.V.’s, and are likely to think of themselves as “affluent” rather than rich.
Even these arguably not-rich, however, live in a different financial universe from that inhabited by ordinary members of the middle class: they have lots of disposable income after paying for the essentials, and they don’t lose sleep over expenses, like insurance co-pays and tuition bills, that can seem daunting to many working American families.
FT.com Willem Buiter's Maverecon
The story may be apocryphal but, si non e vero, e ben trovato. A World Bank official addresses the head of state of some emerging market country on the finer points of the World Bank’s new drive for improved governance at all levels of government and on the harm done by corruption. The Emerging grandee listens for a while and then reflects: “you call it corruption, we call it family values”.
... ... ...
When a surprising number among our elected representatives have their snouts in the trough in a way that is clearly unethical and illegitimate and, in some cases, outright criminal, the act of exposing this betrayal of the public trust deserves a public commendation, not the threat of legal action.
May 13, 2009 | Yahoo! Finance
Back in early March when the market was in freefall, many of the hardcore bears like Doug Kass, Barry Ritholtz and Richard Suttmeier flipped to a bullish view. Not so for Gary Shilling, president of A. Gary Shilling & Co., who stuck with his bearish stance here on March 12.
Fast forward to today: despite a 30%-plus rally off the March lows, Shilling is still sticking with a target of 600 for the S&P 500 in 2009. Shilling concedes the rally has been powerful and that he's getting some "flack" from clients about possibly having missed a major turning point.
"It could be the bottom...but in my view there's enough in the way of problems out there that it probably is a bear market rally," Shilling says, citing the following main reasons why he thinks the economy will remain sluggish and the market will suffer another comeuppance this year:
- Slowing consumer spending: Today's weaker-than-expected April retail sales report is another reminder of how strapped Americans are in saving vs. spending mode.
- Financial deleveraging: There was a lot of "financial fluff" in derivatives, Shilling says, but they did help accelerate the so-called velocity of money. The end of the securitization boom means less easy access to credit and less financial activity from consumers and corporations alike.
- End of the commodity boom: Along with stocks, commodity prices have been rising steadily from the March lows (prior to today, that is). But the end of the speculative fever in commodities is going to mean a lot less spending from emerging markets, he says, most notably in the Persian Gulf.
- Rise of the Bureaucrats: From higher taxes to the auto industry to today's stories about the Obama administration seeking to control compensation in the banking industry, the government's role in the economy is only increasing. That can't be good for growth, Shilling says, especially as this is a worldwide phenomena.
Calculated Risk
However, even with the sharp decline in inventories, the inventory to sales ratio was flat in March at 1.44.
There has been a race between declining sales and declining inventory. And even if sales start to stabilize, inventory levels are still too high, and further inventory reductions are coming.
Comrade Coinz (homepage, profile) wrote on Wed, 5/13/2009 - 8:24 am
The sad thing about the "green shoots" meme is that it might have drawn some battered investors back into equities, hoping to recoup some losses.The result is they will be summarily sheared like the sheep they are. Brrrrrr...Brrrrrrrzzzrrrrttt...Next!
ghostfaceinvestah (profile) wrote on Wed, 5/13/2009 - 8:45 am
"Spending all our money on bandaids. Chrysler, AIG, IG of FED."
Johnny Lee, don't forget the biggest of them all, Fannie/Freddie/FHA. We are now in a position in this country where 95% of housing finance is provided by the government, and a large portion of that debt is being monetized by the Fed.
But yet, almost NO ONE mentions this (notwithstanding CR, of course). Just yesterday, Freddie asked for another $6.1B of their bailout fund, and no one blinked an eye. It probably wasn't even discussed on CNBC, let alone ABC, CBS, etc.
And when people talk about the Fed printing money, they talk about them buying Treasuries. That support is tiny compared to the MBS they are buying (300B of treasuries, 1.25T of MBS, another 200B of agency debt - WAKE UP!!!!!).
This is why I think we are in far worse shape than any other country during this downturn - we have a totally broken housing finance system. Other countries have guarantees, etc., but nothing even close to the scale we have in this country.
And no one in Congress has lifted a finger to fix it.
We are doomed, make no mistake about it.
pavel.chichikov (homepage, profile) wrote on Wed, 5/13/2009 - 8:51 am
'"End the middle-class entitlements" - Larry Kudlow
Ignore the Wall St. welfare? With all that has taken place over the last year this guy has balls."
You can see those outside a pawnbroker's shop. In some of those establishments you can pawn an old guitar or a watch. In others, you can pawn your compassion and morals.
alybaba (profile) wrote on Wed, 5/13/2009 - 9:00 am
Apologies if already posted
Real Rate Shock Hits CEOs as Borrowing Costs Impede Recoveryhttp://www.bloomberg.com/apps/news?pid=20601109&sid=am.gkYZFlB0A&refer=home
Annualized consumer prices fell by 0.4 percent in March, the first decline in 54 years, and Treasury yields jumped to a five-month high. That pushed real investment-grade corporate borrowing costs to 8.34 percent, the highest level since 1985, according to data compiled by Bloomberg and Merrill Lynch & Co.
Blackhalo (homepage, profile) wrote on Wed, 5/13/2009 - 9:01 am
"What the heck is Kudlow talking about now? I have studiously avoided exposure to his vacuous pronouncements for years, now.
What is he defining as "middle-class entitlement," and what good does he postulate coming from "ending" said efforts?"One hopes that he refers to the mortgage deduction, not knowing how that is a gift to GE.
Basel Too (profile) wrote on Wed, 5/13/2009 - 9:09 amWhat is he defining as "middle-class entitlement,"
Mortgage interest deduction?
Comrade Coinz (homepage, profile) wrote on Wed, 5/13/2009 - 9:13 am
Employer sponsored insurance?
@chicago dude,
I was having my car serviced a month ago and stopped in for a chat with the finance manager. He said he has never seen the car biz this bad, this was at a Japanese dealer not asGoogle hard hit as most. He said they have started selling cars at a loss to move inventory, though he said they end up with a $100-$200 after factory incentives are paid. Most of the sales people can't afford their health insurance, and most of the management has taken a 25% salary cut. He said if things don't change within the next few months, half of all auto dealers will close by the end of the year.
Anecdotal shoots.
Comrade Elmer Fudd (profile) wrote on Wed, 5/13/2009 - 9:17 am
"middle class entitlement"
able to afford house
able to afford car
able to afford health care
able to send children to college
able to maintain employment
able to retire
able to do above without collecting a mountain of debtthe Kudlow's have done a pretty good job ruining the "middle class"
bearly (profile) wrote on Wed, 5/13/2009 - 9:21 am[Raising interest rates to reflect the actual risk is also reasonable]
Don't forget (useless) CDS lowered credit costs in the past. Now that the market realizes legacy CDS was nothing but a fraud, new CDS is beginning to reflect risk. More pressure on yields. And the USG is crowding out private capital demands.
Yields are heading higher, across the board. Higher yields are not friendly to equities...
Bronte CapitalMoreover there are law suits (whose basic premise I agree with) that JP Morgan whilst doing due diligence on Washington Mutual was also badmouthing them in the press and encouraging the regulator to take them over. [It is easier to sue JPM than the Federal Government.]
That said – we have a fairly comprehensive proof that JP Morgan did lie to regulators. The only issue is did they lie to regulators when encouraging them to confiscate Washington Mutual or did they lie when they were conducting the stress test? If they lied to Sheila Bair to get them to confiscate WaMu and she believed them then she must resign. But the alternatives I see are worse.
Selected Comments
- Anonymous said...
- Sunlight Is a Powerful Disinfectant
The Washington Mutual “sham” or “confiscation” theory isn’t just for columnist and angry shareholders anymore. Quinn (Co-counsel with Weil for WMI) filed a motion of discovery on May 1st that would be in the envy of most movie script writers.
In its lengthy motion, Quinn is asking Judge Walrath for full disclosure of all documents between FDIC, JPM with respect to WaMu. Quinn has laid out a series of suspicious events that are at a minimum accusing JPM of shorting for the purpose of devaluing, withholding deposits, planting moles in the WaMu organization, pre-arranged bidding for WaMu and downright collusion between the FDIC (Bair) and JPMc and breach of confidentiality agreements.
Quinn has requested some 54+ production request for documents which leads many WMI shareholders to believe that Quinn has the ‘smoking gun’ but wants to see if JPMc will produce the gun under orders from Judge Walrath, of course – Quinn will win either way as JPMc nor the FDIC will allow themselves to be the subject of court deposition or JPMc/FDIC will attempt to parlay its position in court and fail in its attempt to pull the wool over Judge Walraths and the public’s eye.
To quote a WMI shareholder “Sunlight is a powerful disinfectant…” and Quinn’s motion is going to test that axiom. And let’s not forget that an entire crew of dedicated and motivated WMI shareholders have found suspicious connections with respect to FDIC and JPM, to include JPM being given 3 weeks notice that a Bid for WaMu assets would take place, refused bids the night of the FDIC’s receivership by other banks by FDIC’s premise that the bids were non-conforming, OTS guidelines stated that WaMu was well capitalized - all finalizing in the minds of many WMI shareholders that the receivership of WaMu was planned and executed by parties with unclean hands.
Quinn’s motion will be ruled on by Judge Walrath on May 20th, 2009.
Link to motion: http://www.kccllc.net/documents/0812229/0812229090501000000000002.pdf
5/12/2009 | CalculatedRisk >
And from PIMCO's El-Erian:It was clear to us that, despite the very high hurdle that we always apply to such a statement, the world has changed in a manner that is unlikely to be reversed over the next few years. Put another way, markets are recovering from a shock that goes way, way beyond a cyclical flesh wound.And Bloomberg quotes Paul Krugman:
...
For the next 3–5 years, we expect a world of muted growth ...“It looks to me now as if the markets are now pricing in a rapid recovery, that they’re pricing in a V-shaped recession, which I consider extremely unlikely,” Krugman said at a forum in Shanghai today. “The market seems to be looking as if this is going to be an average recession, but it’s not.”I thought a depression was unlikely, and I think an immaculate recovery is also unlikely. Something in the middle - that will feel like a recession to many - is more likely.
As I noted last week (see A Return to Trend Growth in 2010? and The Impact of Changes in the Saving Rate on PCE ), the usual engines of recovery - personal consumption expenditures (PCE) and residential investment (RI) - will both remain under pressure (even if they show some sluggish growth).
My forecast is for unemployment to stay elevated for some time, and that suggests minimal wage growth. And I also think household will increase their saving rate to repair their household balance sheet (and because of an aging population). This suggests PCE growth will probably be below trend.
And for RI, there is far too much inventory for any significant rebound in new home construction. So where will the growth come from?
Posted by Tracy Alloway on May 12 13:00. 32 comments.Meredith Whitney appeared on CNBC Monday afternoon with some insightful comments on the recent rally in banks.
Via Clusterstock:
They were overdone all the way into this rally. What happened was the government — I call this the great government momentum trade — the government enabled the banks to have better than expected, More…
Meredith Whitney appeared on CNBC Monday afternoon with some insightful comments on the recent rally in banks.Via Clusterstock:
They were overdone all the way into this rally. What happened was the government — I call this the great government momentum trade — the government enabled the banks to have better than expected, better than even the banks could organically deliver, first-quarter earnings. That looks like it could continue into the second-quarter and the third-quarter. The banks rallied from well below tangible book multiples to almost two times tangible book multiples. It was something, even though I said it was going to happen, I couldn’t believe it with my own eyes because the underlying core earnings power of these banks is negligible.
Again "Government Sucks" folks were caught shoplifting
Goldman Sachs has agreed to a $60m settlement to resolve claims by a Massachusetts regulator that it participated in unfair and deceptive lending practices involving subprime mortgages, it was announced on Monday.
can have a jobless recovery, but you can’t have a profitless recovery.
- inthewoods Says:
May 12th, 2009 at 7:35 amSounds to me like Kessler is suffering from the classic “do you want to be right or do you want to make money” issue.
- Bruce in Tn Says:
May 12th, 2009 at 7:21 amhttp://money.cnn.com/2009/05/11/news/economy/stimulus_jobs/index.htm?postversion=2009051118
750,000 stimulus jobs by August - White House
“The report assumes that it takes about $92,000 of government spending to create one “job year,” or one job for one year.”
Heh, heh, heh…….Ho, ho, ho……let’s see…750,000×92,000=69,000,000,000…!
HEH, HEH, HEH…
dead hobo Says:
May 12th, 2009 at 7:33 amYou can’t have a recovery without consumer spending. And consumers won’t spent if they face personal uncertainty regarding their jobs and budget. You definitely won’t see big spending on discretionary items unless Uncle Stupid discovers speculators in the oil pits. Only an idiot would believe oil prices are going up because oil prices are going up. But that’s the logic behind oil speculations. Again.
Current demand has nothing to do with rising prices. Fantasy future demand is a part of the sales pitch. This pitch brings in the rubes and is also probably reserved for some pesky investigators Uncle Stupid might have hired out of college.
ben22 Says:
May 12th, 2009 at 8:14 amOne look at the DOW Transports, and there doesn’t look like much of a recovery going on. The S&P may not be very predictive but the transports often tell a pretty good story about what’s going on.
One question: What exactly has been done to take “armageddon off the table”?
Mortgage resets aren’t going to stop until 2012, credit deflation appears in full swing and if CRE does in fact blow up, and the S&P burns from here, and lets say sets a new low, say thats 40-50% down from here. What exactly are we going to call that? How did we take it off the table, the stress test? Joking right?
Zero yields. Ok, so its an easy environment to make some money if you are bank. Well I’m not so sure that’s really worked, after all, all the banks had to pull some accounting tricks to have a profit during the last reporting period, orphan months, asset revaluation, market speculation etc.
And the printing press, well if someone can point out to me the massive benefit this has had I would appreciate it.
I’m not so sure I understand, about two months ago we were setting new lows, we haven’t even re-traced much of this entire move down and all the sudden AAII bulls is getting closer to my target of where it was October 2007, and on top of that, I keep see that armageddon is off the table.
Now Bruce puts up a link that I was looking for as well. To call a top to this rally I’d like to see Obama say that we no longer need wasteful government spending because they have done enough, they have won. The announcement that we get 750k jobs by August due to the stimulus, which to my knowledge wasn’t all to be spent until 2012, well that’s a start to what I was looking for.
Andy T Says:
May 12th, 2009 at 8:15 amWeak Dollar Giving Heroin Shot to all Asset Classes
In the last few weeks we’ve pointed out that the risk to the upside in the stocks and commodities was a weakening of the Dollar. We encouraged top pickers in the indices to pair it up with a DX short of some kind because of how awful the Dollar looked. And, so it goes. The Dollar has been predictably weak. The rally in commodities and stocks has had everything to do with the debasement of the currency. Alas, there truly is no free lunch.
The DX has now reached some of the minimum downside objectives and is now generating intraday bullish RSI divergence. We’re not suggesting covering DX shorts, but once a market meets minimum objectives, we start to open our eyes for bottoming action.
There’s another possibility worth considering….the weak Dollar has been the ‘heroin rush’ required to force asset prices off the floor….at what point does a precipitously falling greenback affect stocks negatively? i.e. end of 2007/early 2008? An ‘orderly devaluation’ is clearly what Big Ben wants. However, markets have a way of disappointing.
Over the next year, our forecast is for a bullish DX. This move is correcting the initial wave of debt deflation. Once this bull market correction ( B Wave) has run its course, we’ll be set up for a strong C wave higher. 80 - 78 would be a terrific zone to hold for DX bulls.
- ben22 Says:
May 12th, 2009 at 8:34 amAT,
I agree, dollar seems to be moving pretty much opposite the DOW so a bottom in the dollar probably indicates a top for the DOW. I think I see the trend channel you are describing around 80, which looks like the bottom of the channel.
- dblwyo Says:
May 12th, 2009 at 8:36 amThe meme is that we’re in for a V-shaped recovery which we can already see in the green shoots. Green shoots aren’t a crop and they may turn into yellow weeds. Aside from that minor detail how big a crop - this is going to be (the Fed, OECD, IFM, World Bank, Summers, Roubini, me) a long, slow, painful, drawn out and jobless recovery where earnings are going to be poor for a long time. In fact we’re dealing with two hidden bubbles. The Tech bust which drove stock prices over l.t. economic growth and the Housing ATM Finance bubble. For the first time in post-WW2 history corporate profits surged above l.t. trend because companies weren’t hiring nor investing in capex. What of all that damage is being repaired ? Right now the market is fully priced and then some for a V along with a normal quick recovery. Given that’s the common “wisdom” how long will it take for denial to be replaced by reality and what’re the markets going to do in the meantime ? And what about earnings and PEs. Making a lot of assertions here so if you want the charts and words to back it up:
http://llinlithgow.com/bizzX/2009/05/from_economy_to_markets_more_b.htmlStuart Says:
May 12th, 2009 at 8:37 am“productivity driving wealth”
Now there’s a concept.
“750,000 stimulus jobs by August - White House”
Not a frickin’ chance unless they’re including smoke and mirrors stats and more gov’t census workers. Obfuscation and delay tactics are more blatant and obvious as ever. One of these days even headline writers will clue in.
ben22 Says:
May 12th, 2009 at 8:38 amDeflation/Inflation
Watching CNBC in the morning is always a fun event. One thing I’ve noticed in the last 1/2 hour is that the word deflation isn’t even being mention, instead there is just a constant argument about when the inflation actually gets here, is it 1 year, 3 years, 5 years, etc.
Most of these peeps have decided there is NO other conclusion beside eventual inflation.
This could make deflation even worse as people are slow to switch sides.
Oh also, this guy Barbera answered my question above about why armageddon is off the table, it’s b/c the financial index has doubled off the lows. I should have known!
shakazulu Says:
May 12th, 2009 at 8:39 amYes, Andy T. is correct in my opinion. It is possible to have a recovery and a monster rally in the stock market, even with 97% unemployment. We could also finance the pay of our representatives soley with from cigarette and beer taxes . However, if this comes to pass and you are not prepared to deal on the black market then be ready to starve or die. The slow burn that took down Zimbabwe has been almost a 30 year ride. Geithner should be retired by then.
dvdpenn Says:
May 12th, 2009 at 9:13 amNot sure what “nationalized health care” is doing in a list alongside California going broke. But I suppose that’s the view from certain towers …
Marcus Aurelius Says:
May 12th, 2009 at 9:14 amBruce:
Our biggest corporations have already moved overseas — it’s called “Globalism.”
China (they’re communists, you know), Singapore, or Taiwan? Anyone who wants to move their corporate HQs there can go, as far as I’m concerned. Just make sure the corporate officers move with their companies, and remove US corporate status and protections when they do. Wanna be a Chinese corporation? Good luck
Monopolies are not capitalism. Monopolies are dictatorships. We have laws to protect capitalism/innovation/entrepreneurialism from monopolies. If laws were broken, and a party is damaged as a result, the recourse is to take them to court. There is nothing wrong with that.
Crony capitalism (not really capitalism, at all), lack of law enforcement, and bloated/entrenched companies with teams of corporate lawyers is a large part of what got us where we are today.
I hope anyone who gamed the system gets sued into oblivion.
May 12th, 2009 at 9:26 amAndy T and Ben22:
Check the dollar index. While it is declining, it’s much stronger now than it was a year ago.
A strong dollar will kill us, BTW.
snapshot Says:
May 12th, 2009 at 9:27 amhttp://www.scribd.com/doc/15245616/egan
Barry - Thought you might like this…
Sean Egan - Solving the Credit Crisis
“..until they address the issue of rating shopping, they won’t accomplish anything.”
Calvin Jones and the 13th Apostle Says:
May 12th, 2009 at 9:30 amI’m bullish when I see productivity driving wealth.
That will be a long wait, my friend. Has this guy been on the sidelines for years? Because the average schmoe hasn’t seen real wealth from productivity gains in 30 years.
hopeImwrong Says:
May 12th, 2009 at 9:31 am“The Obama administration warned corporate America on Monday that the government will more aggressively investigate big firms that hurt smaller competitors”
What a joke. Does this mean, just like he is doing with the banks?
I should have voted for McCain.
ZackAttack Says:
May 12th, 2009 at 9:43 amI don’t understand their concept of Armageddon, so I can’t evaluate whether that’s off the table or not. What would “Armageddon” entail?
May 12th, 2009 at 9:48 amArmageddon, literally:
http://en.wikipedia.org/wiki/Armageddon
In an economic sense, it means the end of our monetary/financial system, I think.
edhopper Says:
May 12th, 2009 at 9:51 amI think we now have not so much a classic Bear or Sucker’s rally, but rather another Fed induced Stock Bubble. Like most bubbles it will last longer, go higher and crash harder than one would expect looking at the economic fundamentals.
Mike in Nola Says:
May 12th, 2009 at 9:52 amInteresting numbers behind the headline Trade Gap number; both exports and imports fell at the same time, showing the continuing decline in world trade. Hurting our manufacturing and gonna kill China in the near term.
Andy T Says:
May 12th, 2009 at 9:55 amZackAttack, Not sure what author’s view is, but some economists would argue that Armageddon looks something like this:
With the shadow banking and securitization imploded, credit becomes severely constrained. That doesn’t matter, though, because individuals and firms have no need for credit anymore. Seeing that asset prices continue to fall and with little good new business prospects, nobody wishes to borrow anything. Consumer spending falls 20-30% as Americans discover frugality and the “simpler life.” Vast swaths of strips malls, tanning salons, nail salons, gymns, Chachki-style restaurant chains all go under. U-6 unemployment goes to 25%. Suburban areas turn into ghettos and a ‘cheap housing’ alternative for large extended families. A majority of municipalities default on obligations under the burden of promised safety nets with a declining tax base.
April 7, 2009 | The Baseline Scenario
U.S. Outlook
Like the global economy, the U.S. economy only looks worse than it did two months ago, with unemployment up to 8.5% and no real indicators of an incipient recovery. (See Calculated Risk’s March summary for all the dismal details.) The causes of economic weakness are largely unchanged and widely known:
- De-leveraging by consumers (paying down debt, voluntarily or involuntarily), leading to reduced consumption and increased saving
- De-leveraging by companies, leading to reduced investment
- Reduced supply as well as demand for credit, constraining even those who want to borrow and spend
- Continuing falls in real estate prices
This combination of reduced spending and reduced credit has sharply depressed aggregate demand, creating a classic vicious cycle where reduced demand leads to reduced economic activity which leads to reduced spending power via increased unemployment and reduced corporate profits. In addition, concerns about financial system solvency are constraining the ability of financial institutions to supply the credit needed by the economy. There will likely be a rolling wave of defaults and debt restructurings in the US and around the world over the next couple of years; this is hard to avoid and constitutes a major reason why the recovery will be slow compared with previous recessions.
The Obama administration’s responses to date can be grouped into three broad areas: the financial sector, the real economy, and monetary policy. In each case, the administration has made great efforts that either are yet to pay off or will not pay off.
Financial Sector
The core problem is that large segments of the financial sector are insolvent, or that many market participants believe that large segments of the financial sector are insolvent. In either case, the problems are situated on the asset side of financial institutions’ balance sheets. Although banks have taken hundreds of billions of dollars of writedowns on toxic assets, the fear is that they will need to write down hundreds of billions or over a trillion dollars more as those assets continue to deteriorate in value.
In the early phases of the crisis, concerns focused on structured securities (CDOs, CDOs-squared, etc.) that experienced disproportionate losses as default percentages on underlying assets increased. However, as the crisis has spread from the financial sector into the real economy, increasing default rates are taking their toll even on plain-vanilla assets, such as whole mortgages. (Along the way, the financial sector has moved from a liquidity crisis to a solvency crisis.) Because banks’ assets are sensitive to macroeconomic conditions, it is difficult if not impossible to put a bound on their expected losses as long as there is uncertainty about how long and deep the current recession will be.
The core problem today is that there is a gap between the current book value of assets and the real value of those assets, at least as perceived by many market participants. That gap is large enough to threaten the capital cushions of at least some banks. Many people have suggested solutions to this problem, ranging from outright government takeover (followed by balance sheet cleanup and privatization) to cheap government credit insurance.
However, the Obama administration’s proposals so far have been relatively modest, perhaps due to unavoidable political constraints. The overall strategy has been to:
- Insist that the banks are fundamentally healthy, and that the market prices of their assets are artificially depressed due to a lack of liquidity in the market
- Continue providing just-enough capital on an as-needed basis to keep banks afloat, while avoiding any more aggressive measures, as was done in Citigroup’s third bailout
Note that this strategy is not internally illogical: if you believe that asset prices will recover by themselves (or by providing sufficient liquidity), then it makes sense to continue propping up weak banks with injections of capital. However, our main concern is that it underestimates the magnitude of the problem and could lead to years of partial measures, none of which creates a healthy banking system.
The main components of the administration’s bank rescue plan include:
- Stress tests, conducted by regulators, to determine whether major banks can withstand a severe recession, followed by recapitalization (if necessary) in the form of convertible preferred shares
- The Public-Private Investment Program (PPIP) to stimulate purchases of toxic assets, thereby removing them from bank balance sheets
The stress tests have two main problems. First, they are no longer credible, because the worst-case scenarios announced for the stress tests are no worse than many economic forecasters expect in their baseline scenarios. Second, the administration has as much as said that the major banks will all pass the stress tests, making it appear that the results are foreordained. It is possible that the stress tests will be used to force banks to sell assets as part of the PPIP, which would be a good but unexpected consequence.
We also do not expect the PPIP to meet its stated objective of starting a market for toxic assets (both whole loans and mortgage-backed securities) and thereby moving them off of bank balance sheets. In essence, the PPIP attempts to achieve this goal by subsidizing private sector buyers (via non-recourse loans or loan guarantees) to increase their bid prices for toxic assets. Besides the subsidy from the public to the private sector that this involves, we are skeptical that the plan as outlined will raise buyers’ bid prices high enough to induce banks to sell their assets. From the banks’ perspective, selling assets at prices below their current book values will force them to take writedowns, hurting profitability and reducing their capital cushion.
As long as the government’s strategy is to prevent banks from failing at all costs, banks have an incentive to sit the PPIP out (or even participate as buyers) and wait for a more generous plan. Again, the key question is how the loss currently built into banks’ toxic assets will be distributed between bank sharedholders, bank creditors, and taxpayers. By leaving banks in their current form and relying on market-type incentives to encourage them to clean themselves up, the administration has given the banks an effective veto over financial sector policy. There is a chance that the PPIP will have its desired effect, but otherwise several months will pass and we will be right where we started.
Ultimately, the stalemate in the financial sector is the product of political constraints. On the one hand, the administration has consistently foresworn dictating a solution to the financial sector, either out of deep-rooted antipathy to nationalization, or out of fear of being accused of nationalization. On the other hand, bailout fatigue among the public and in Congress, aggravated by the clumsy handling of the AIG bonus scandal, has made it impossible for the administration to propose a solution that is too generous to banks, or that requires new money from Congress. As a result, the administration is forced to work with a small amount of remaining TARP money, leverage from the Fed and the FDIC, and the private sector.
The Real Economy
With each month, the outlook for the real economy gets worse. It is particularly disturbing that economic forecasts are being revised downward every month as well. However, the administration has at least partially delivered on two major policy measures necessary to help restart the real economy.
The fiscal stimulus package signed in February should help, but it is simply too small given the size of the problem. After deducting the fix to the Alternative Minimum Tax (alternative for stimulus purposes), the package was only about $700 billion, of which a large part was in tax cuts of questionable impact. This will partially compensate for falling private sector demand and improve the economy from where it would have been otherwise, but it cannot be expected to turn around the economy on its own. In an ideal world, the administration would be planning a second stimulus package as a contingency measure for later this year. However, given that the bill passed with zero Republican votes in the House and only three votes in the Senate (those votes bought with major concessions), it seems unlikely that the administration will be able to get Congress to commit another half-trillion dollars anytime soon.
The housing plan announced in early March is also a positive step, albeit one that should have been implemented months before, by the previous administration. The housing plan relies heavily on cash incentives to loan servicers and second-lien holders who are willing to modify mortgages. However, only time will tell whether those incentives are sufficient to actually change servicers’ behavior on a large scale. Again, this is far better than nothing, but whether it is enough to counteract the ongoing free-fall in housing prices remains to be seen.
In addition, the Obama administration took a harder line on GM and Chrysler, rejecting their restructuring plans and giving them new, tight deadlines to work out deals with their workers and creditors (GM) or with Fiat (Chrysler). In order to pressure bondholders to make concessions, the administration is trying to signal that it is willing to let the auto companies go into bankruptcy. But from a political perspective, they seem to be in a no-win situation. A Democratic administration that lets GM go bankrupt could face a revolt from one of its core constituencies; but bailing out the auto industry will only increase bailout fatigue from an increasingly resentful Non-Bailed-Out Majority that no longer identifies with autoworkers.
Monetary Policy
With the economy still stalled and the executive branch struggling with political constraints, the Federal Reserve has seemed increasingly willing to step into the breach. As an independent agency within the government, armed with emergency powers under Section 13(3) of the Federal Reserve Act, the Fed is the one actor that can, to some extent, simply take matters into its own hands. And although everything the Fed does is wrapped in gradualist language to cushion its impact on the markets, the Fed does seem to have embarked on a new, more aggressive phase of monetary policy.
Until late in 2008, the Fed’s primary role was to provide liquidity, in the form of short-term lending to financial institutions. Since then, however, it has expanded its role in at least two directions. The Term Asset-Backed Securities Loan Facility (TALF) puts the Fed in the position of deciding where to allocate credit across the economy. And the recent decision to start buying long-term Treasury securities means that the Fed is using new approaches to create money. While there is a debate over whether this constitutes “quantitative easing” or just “credit easing,” this represents a major expansion of the Fed’s role, which we discussed in our recent Washington Post Outlook article. These actions may help create moderate inflation and prevent the onset of sustained deflation; there is also a danger that inflation will be substantially higher than expected.
Regulation
Since virtually no one is happy with the current situation, there has unsurprisingly been discussion of how the financial sector should be changed in the future. Treasury Secretary Geithner outlined his proposals in Congressional testimony, with an emphasis on the need for centralized monitoring of systemic risk, and for the power to take over any financial institution that could bring down the system as a whole.
One of the root causes of the crisis, and of the difficulty in resolving it, has been the political power and ideological influence of the financial sector, which we discuss at length in our Atlantic article. Our preferred solution is to have smaller banks. Early indications, however, are that the Geithner plan will go a different direction – allowing large banks, but giving regulators new powers over them. The resolution authority currently being sought by the Administration – and which we support – may have unintended consequences, some of which could ultimately prove positive if handled in the right way.
On a worrying note, the Financial Accounting Standards Board recently caved in to banking industry pressure (transmitted by the House Financial Services Committee) and relaxed the rules implementing fair value accounting. In some circumstances, financial institutions will find it easier to ignore market transactions and use internal models in order to value assets on their balance sheets. We think that fair value (”mark-to-market”) accounting has played a small role, if any, in the crisis. However, the full impact of this rule change will not be known until we see how it is applied by batteries of lawyers on Wall Street and in Washington; for one thing, it could change banks’ incentives to participate in the PPIP. And the fact that the financial industry, at this moment in history, still has the power to get its way in Washington is disturbing.
U.S. Summary
On balance, we believe that the Obama administration, and Fed Chairman Bernanke, are making every effort to combat the financial and economic crisis. However, some aspects of the response, most notably the fiscal stimulus, have been underpowered. And a combination of ideological and political constraints has hampered the administration’s efforts to rescue the banking system. For these reasons, we still do not see the mechanism that will cause the economy to turn around.
In this context, we interpret the recent stock market rally as indicating that the economic decline is slowing; it does not necessarily denote that rapid recovery is just around the corner. We would also emphasize that credit markets are pricing in a substantial risk of default for some leading brand names, both in financial services and manufacturing – as the system stabilizes and bailouts become harder to justify, the probability of default for large companies may continue to rise.
Selected comments
- All very social and fine pointed. Nicely written.
I have no idea what France’s economy looks like on an average day.
Here in the US, I’ll venture my own uninformed perspective.
I worked in electronics, computers, technology, most of my life. It was a very good and satisfying way to earn a living and it produced good stuff that others could use.
Throughout my career, there was always a way to be smart and get a little more, do a little more, keep working, do good.
In the 80’s I noticed a trend where the company started focusing on quarterly results to keep the stock market happy. This, I think, is frequently not good for long term goals.
Competition increased, I left.
But many other companies seemed too be focused on the stock market or extremely short term gains.
Quickly most of the US innovation was squashed, production ceased, the good companies merged into mega tyrannies.
I have thought for a long time that I was watching a shell game in motion. No new money, just slide it around.
- First, thank you for taking on the task of explaining the economic crisis to people like me – people who are not economists and find themselves stunned at the magnitude of the problem.
However, some questions were inspired by the following paragraph:
“The core problem is that large segments of the financial sector are insolvent, or that many market participants believe that large segments of the financial sector are insolvent. In either case, the problems are situated on the asset side of financial institutions’ balance sheets. Although banks have taken hundreds of billions of dollars of writedowns on toxic assets, the fear is that they will need to write down hundreds of billions or over a trillion dollars more as those assets continue to deteriorate in value.”
1) I keep reading about banks who claim to be healthy, claim to have accepted TARP funds only because Paulson made them do it. (Northern Trust is one example – several of the CEOs who recently appeared in front of Congress also made this claim.) All that makes me wonder if there is a foundation of truly healthy banks that exist today within this economy. Did Paulson’s solution – flood the industry with money/indiscriminately throw billions at banks without regard for whether or not they needed it – did this approach actually add fuel to the fire? Would a more focused approach to addressing just the diseased banks been more effective?
2) Perhaps you’ve answered this in detail elsewhere, but whenever I look at the appalling amount of toxic debt on the books of these institutions, I am incredulous. More than a trillion dollars in toxic assets! How did such highly paid executives let their businesses get to this point? Are you as astonished as I am by the reckless business decisions that got these businesses into such a hole?
3) Is greed so ingrained in the business ethos that the only way to avoid this catastrophic scenario in the future is to act if businessmen are incapable of managing their businesses in a responsible manner? I.E. forgo the siren call of Reagan the De-Regulator and slap a host of rules surrounding the operations of American businesses? I realize some regulation is essential – but these people seem to have left their MBAs in a closet somewhere in favor of a more Darwinian approach to killing what they ate. Or maybe Darwin was the principle philosopher studied at the Ivy League programs. Though there appear to be few fit to survive these days.
Again thank you for your analysis. I am new to your blog and will poke around for more info. anne
April 7, 2009 at 10:41 am
- Anne,
I’m only going to respond to #3.
I can tell by your writing that you may be smarter than me, certainly more informed academically.
You mention — businessmen incapable of managing their businesses in a responsible manner. From the context, I have to think you are referring, actually, to bankers or Wall Street types. The ones who actually made a number of bad choices leading directly to our current economic catastrophy.
In my mind their trade, these certain ones, though a form of business, has evolved more into a form of speculation or pure gambling with the huge assets provided by others, rather than what most people would think about hearing the term businessman.
These particular “businessmen” found themselves in this in this god-like position of power where they had huge amounts of chips (money) provided by the house. The house stake grew largely due to “lack of regulation”.
These “businessmen” would place bets with the house money. Only safe ones. But the odds are so good. Look at the numbers — this vs. that. The “businessmen” made money — the house happy — game riskier — everyone happier — **Game over**.
Now, in my mind, real businessmen play a part in our current situation for a different reason related to Wall Street.
I first noticed it back around the middle 80’s. Companies I worked for, rather than thinking about what was best for the company in the long term, started to focus on stock price. Was this driven by leaders vested interest? Could be.
Now everything the company does is driven by how the numbers look on a quarterly basis. Is this any way to run a company? Yes for the stock market, no for the long term goals.
Number, numbers. Short term, move it, sell it, off-shore, merge, reduce, consolidate. Wallmart.
In my opinion we have killed the golden goose and the last of its blood fertilized this last bubble. My question is, do we have enough of a real economy left to sustain a recovery without artificial financial smoke and mirrors?
Gordon Brown, the British Prime Minister, is in big trouble. It turns out that a medium-sized industrialized democracy like the UK can be run in pretty much the same way as a traditional emerging market – fiscal irresponsibility (cyclically-adjusted general government deficit now forecast at 12.2 percent of GDP for 2010) gives you a boom for a while, but the eventual day of reckoning is economically painful and politically disastrous. If you also need to deal with an oversized bubble finance sector, that makes the adjustment even more painful.... ... ..
Blanchard is clear that the IMF sees the need to “fix the financial system”. He also assumes this will happen slowly, and indicates this slowness is not helpful for the recovery. The implication is that the US will resort to even more fiscal stimulus if the recovery proves sluggish – look at his slide on p.7, dealing with fiscal sustainability (this is discussed at about minute 11 in the webcast). This presentation of country averages is an IMF way of talking about difficult country-specific situations without being indelicate – and the point here is to push you to think about the nonconvergent (red…) debt path with contingent liabilities (i.e., what the government is committing to the banking system without acknowledging the fact); the yellow path for debt, with slow economic growth, also does not look good.
Blanchard doesn’t show the US debt forecast – presumably that would be indelicate. But at the 13:13 mark, he warns that the US may be heading in the same fiscal direction as Ireland (!), “the [US budget] numbers are not great but we hope that something will be done.”
The content and timing of that ”something” is left vague – add your suggestions below.
Selected comments
- Bankrupt banks should absolutely not be recapitalized, they should be placed into receivership. This is flatly insane – “recapitalizing” these bankrupt institutions is going to very soon cause a hyperinflationary blowout of the US Dollar.
It’s astounding that anyone would suggest that we can save the paper – the trillions upon trillions in worthless derivatives the banks hold. What you’re suggesting here is tantamount to saving the afterbirth and killing the baby. MONEY IS JUST THE MEDIUM OF EXCHANGE. MONEY ITSELF HAS NO VALUE. Cursed are those who worship at the Altar of Mammon.
You’re approaching this from an entirely erroneous perspective. Why are the banks insolvent? Because people can’t pay their bills. Why can’t people pay their bills? Because they have too much debt and not enough income. Why is that? Because for 3 decades, the neoliberal/fascist money-worshipers have let the PRODUCTIVE PHYSICAL ECONOMY rot away in order to invest in worthless paper financial assets and create the largest debt bubble in history.
The problem is that you assume that economy is a monetary phenomenon. It is not, an economy is a physical entity, and it is governed by physical laws.
- “Because for 3 decades, the neoliberal/fascist money-worshipers have let the PRODUCTIVE PHYSICAL ECONOMY rot away in order to invest in worthless paper financial assets and create the largest debt bubble in history.”
Hear, Hear!
I own a factory, producing stuff out of steel for the last 25 years, working hard on production and marketing, creating products and selling them at a competitive price.
At the same time I’ve seen the stock market go beserk three times: in the 80’s, the internet bubble and now the financial bubble. I’ve seen these pinstripe suited financial honchos driving their Porsches and Ferrari’s becoming the contemporary idols (American Psycho! http://www.filmwad.com/fw_images/2009/02/03/christian-bale-pulls-an-american-psycho.jpg) where a poche business card and utter greed is more important than a good product and good people management.
This devils network has to be exterminated from the roots up.
Banks should be forced to go back to where they belong: serving the community and industry. But as I’ve said before, only a REVOLUTION could make this work, not these soft half working measurements.
“Change, Yes we Can!” But, can we??
By Most Measures, Stocks No Longer Look Cheap:
While the rebound was a relief for battered stock investors, it complicated matters for those still trying to decide whether to get in or add new holdings. Higher prices have made stocks less of a screaming buy by several valuation measures.
For example, based on the last 12 months of operating earnings, the S&P 500 was changing hands late last week at a price-to-earnings ratio of 14.7, according to Morgan Stanley. That is still below the average trailing P/E of 17 for the last 25 years but up sharply from 10.5 in February.
Looking ahead to expected earnings for the next year, the story is less compelling for buying stocks. The S&P 500 was at a forward P/E of 14.5 late last week compared with a 25-year average of 15, according to the Morgan Stanley data. But many investors are reluctant to put too much weight on the forward P/E ratio during a period of significant uncertainty about the earnings outlook.
- Barry Ritholtz Says:
Analysts Turning Bearish on S&P 500 After 14% Rally (Bloomberg)
http://www.bloomberg.com/apps/news?pid=20601087&sid=algJ_1hrRxrE&- Ned Bushong Says:
May 11th, 2009 at 10:43 amOne of my indicators is so overbought that you have to go back to the dot.bomb days to see a similar reading. http://www.bushongbusiness.com/opinion.html
- Onlooker from Troy Says:
May 11th, 2009 at 11:43 amMy biggest mistake here was to think that we (human kind) wouldn’t be susceptible to the same kind of market psychology that existed during ‘29-’32 when there were such huge rallies in the midst of such dismal economic conditions. I thought it must have been due to a lack of good, reliable, timely information. People were much more isolated than we are now and vulnerable to rumor and other misinformation.
Well, apparently not. We’re just really good at denial and self delusion. We have tons of information at our fingertips now clearly outlining just how bad things are and will be for the foreseeable future. Yet our arrogance and sense of exceptionalism leads us to believe it that the data could not possibly be telling us the truth. Somehow we’ll pull another rabbit out of the hat. And it’s not just Americans. The same holds true to some extent all around the world.
Of course that thinking also helps to justify our continued course of action in stealing wealth from future generations. We’ve pulled a decade or more of demand into the present over the last couple of decades through debt driven consumption, and now we want to pull more to ease our pain. Does that not break down at some point? I know we tell ourselves that a future generation will find some font of great productivity and catch up. That’s just immoral rationalization for our own bad behavior.
- Bruce N Tennessee Says:
May 11th, 2009 at 11:57 amHere’s your summer stimulus:
http://www.cnbc.com/id/30682967
GM CEO: Bankrupty Likely, Firm May Leave Detroit
I guess my only comment on this is: Sure seems like we poured a lot of money down this rat hole…..
- FromLori Says:
May 11th, 2009 at 12:29 pmhttp://market-ticker.org/archives/1030-The-Economic-Tsunami-Is-Curling-Over.html
- Bruce N Tennessee Says:
May 11th, 2009 at 12:30 pmhttp://finance.yahoo.com/tech-ticker/article/244597/Merrill’s-Rosenberg-Goodbye-Thank-You-Yes-It’s-Just-a-Sucker’s-Rally?tickers=xlf,dia,spy,%5Eixic?sec=topStories&pos=9&asset=&ccode=
Merrill’s Rosenberg: Goodbye, Thank You, Yes It’s Just a Sucker’s Rally
some of the same things that we talked about last week…
May 10 2009 | FT.com
Wells Fargo, deemed to need $13.7bn of capital by the US government’s stress test last week, claims to have the earning power to fill its capital deficit by November and apply to repay “as soon as practical” $25bn of government funds.
“We think we already have a lot of capital and, with our earnings, we are accumulating regulatory capital at a very high rate,” said Howard Atkins, chief financial officer.
“Left to our own devices, we are hopeful we would be allowed to start paying back [the troubled asset relief programme] soon.”
The San Francisco-based lender’s assertions underscore the divergence of opinion over future earnings power between regulators and bank executives involved in the stress test.
In its forecast that the 19 banks would require $74.6bn in additional equity to withstand future shocks, the government took a relatively dim view.
Time Magazine assesses Geithner and the stress tests in a reasonably honest article entitled "Stress Tested: Has Geithner's Bank Confidence Game Worked?"...
A "confidence game" is, of course, just the formal name for a con job.
Still, even if the numbers are based more on positive thinking than cold hard facts, it's tough not to be impressed by what Geithner and company have accomplished. In addition to the boost in public confidence, they've apparently figured out how to get the banks to support Geithner's other iffy program, the one designed to rid banks of toxic assets.[GW's Comment: This is the program where the banks are buying each others' toxic assets so they can dump the tab on the American taxpayer]
All of which goes to show that whatever his faults, Tim Geithner knows how to game America's confidence in the banking system. But does that mean the stress tests themselves are one big confidence game? Perhaps. The playwright David Mamet said such scams get their name not from the confidence the victim places in the con man, but the trust the con man pretends to place in the victim to elicit trust in return. By that standard, Geithner may be the most effective con man around, for better and for worse.
May 09, 2009 | Calculated Risk
A large portion of Alt-A (like Option ARMs) is held on bank balance sheets. So the building Alt-A crisis will be written down as the losses are estimable. Tanta mentioned this last year in: Subprime and Alt-A: The End of One Crisis and the Beginning of AnotherIf the "subprime crisis" was about "exotic securities," the "Alt-A crisis" is going to be about bank balance sheets.And this brings up a second key point:
The Fed estimated both future losses and future earnings. As Dr. Roubini noted, there will be a race between losses and earnings - and if the Fed overestimated earnings or underestimated losses, the banks will need additional capital. If Hatzius is correct, the banks will win (or draw) the race - if Roubini is correct, the banks will lose.
But whether the banks win or lose the race, the rapidly rising defaults for Alt-A (and HELOCs and Jumbo Prime) loans will impact house prices in neighborhoods where the loans are concentrated (mostly mid-to-high end areas).
Odds are that you’ve been over-invested in equities. At the end of 2007, almost one in four workers between the ages of 56 and 65 held more than 90 percent of their 401(k) in stock, according to the Employee Benefit Research Institute in Washington. More than two in five held more than 70 percent in stock. They will be well into Social Security before recovering their losses.
Maybe these 401(k) holders managed their risk by owning a bond portfolio on the side, but I doubt it. More likely, they’re investing aggressively, in hope of making up for the fact that they started serious saving late. They gambled and lost. The market is no respecter of your personal need to make money in a hurry.
Continued Contributions
On the other end of the investment spectrum, younger and lower-paid employees with 401(k)s are doing better than you might think. Accounts worth less than $10,000 grew an average of 40 percent in 2008, because workers continued making contributions. The new money they put into their plans more than covered the market loss.
If the recession is indeed near its end, stocks will continue trending up. But “the past may not be prologue,” says market analyst Steve Leuthold of the Leuthold Group in Minneapolis. Future returns may lag behind the market’s historical returns, he says, because of the mature state of the U.S. economy.
In general, growth in corporate earnings and gross domestic product are the primary factors driving a nation’s long-term stock market performance. Leuthold sees annual GDP rising in the 2 or 3 percent range, compared with 5 or 6 percent during America’s days of emerging growth and global leadership.
Mature or Developing
Western Europe is also mature and, arguably, so is Japan. That leaves the developing countries in Asia, Latin America and Eastern Europe. You might have sworn off them, after they got clobbered last year. But they remain the parts of the world with the highest potential for growth. A Plan B investor will own them in moderation, balanced with safer investments such as quality bonds, including inflation-protected Treasuries.
If you lost your job or saw your income chopped, Plan B is the only way to go. For those still standing, the message is the same. There’s a lot of struggle left in the economy and the global financial system. When we muddle out of this recession, the Fed will have to fight inflation, with unknowable results. The times call for more savings, less debt and a ready-for-anything investment mix.
May 7 (Bloomberg) -- A group of U.S. senators agreed to a plan that would give consumers as much as $4,500 toward the purchase of a new, fuel-efficient car or truck, Senator Debbie Stabenow said.The Senate proposal closely tracks a deal struck in the House earlier this week, said Stabenow, a Michigan Democrat. Congress needs to move quickly on the plan to respond to a drop in auto sales that has affected all automakers producing cars in the U.S., she said.
From the NY Times: Shift to Saving May Be Downturn’s Lasting Impact
The economic downturn is forcing a return to a culture of thrift that many economists say could last well beyond the inevitable recovery.
This is not because Americans have suddenly become more financially virtuous or have learned the error of their free-spending ways. Instead, these experts say, Americans may have no choice but to continue pinching pennies.
This shift back to thrift may seem to be a healthy change for a consumer class known for spending more than it earns, but there is a downside: American businesses have become so dependent on consumer spending that any pullback sends ripples through the economy.ShadowInventory (profile) wrote on Sat, 5/9/2009 - 1:49 pm
Saving because they are not making their mortgage payments? Because their credit lines are being reduced/cancelled? Because they got the fear of god put into them as U6 climbs up to 16% and they are surrounded by layoffs? Maybe there is some hope for rational behavior from the great masses yet....
Bob Dobbs (homepage, profile) wrote on Sat, 5/9/2009 - 1:54 pm
In uncertain times it's in peoples' best interest to save. And to be fair, people as a whole should have detected the uncertainty years ago. But they were drugged by easy credit and the housing bubble.
But if I hear about the "paradox of thrift" one more time, I'm going to bust somebody's nose, even Krugman;s. Average Joe didn't get us into this mess, although he went along. Average Joe shouldn't have to lead the way out. The people who profited the most from financial innovation should lead the way out. What -- no volunteers?
And if that means growing the economy some way other than mere consumer spending and consumer product production -- so be it. In fact, better be it. I expect we'll get there in about 3 years. There -- or the end of our society as we know it.
MrM (profile) wrote on Sat, 5/9/2009 - 1:58 pm
Copied from the previous thread that just went deadImproving markets helped U.S. banks
Other observers might argue that the banks helped the markets to stage this rally despite the absence of substantial improvements in economic fundamentals precisely to help themselves through the stress tests.
See for example numerous posts at ZeroHedge on GS principal trading volumes (here is a good example and another one).
Also, recall claims in early March by Citi and BofA of how nicely things had turned around for them.
It's political poison now, but after the next wave of this crisis, when it will be too late to fix the banks the right way, the shock doctrine will be the only option left.
Southern in SF (profile) wrote on Sat, 5/9/2009 - 1:59 pm
I wonder about this as well. With the release of the stress tests we are being told everything is peachy, get back out there and spend.
But things aren't peachy and we know it. What will happen when the banks come back for more money? And we know they will. Why did the government choose to lie to us? With these tests they could have come out and said these banks are toast, these are ok. Have the FDIC handle the loses through government backstop vs. shoveling more money into these banks.
Are we really that fucked? Could they not tell us the truth because we couldn't handle the truth? Or are we as a country really controlled by the banks?
Economist's ViewDissent:
Are We Turning Japanese?, by James Surowiecki: Over the past few days, the idea that the Obama Administration’s failure to nationalize the banks may very well doom the U.S. economy to the kind of Lost Decade that Japan endured has become ubiquitous. (Here are Paul Krugman, Joseph Stiglitz, Mark Thoma, and Atrios on the danger of turning Japanese.) In the wake of the stress-test results, it’s become obvious to everyone that the Administration is counting on banks to earn their way out of trouble—recapitalizing themselves over the next couple of years via profits. But the skeptics suggest that this is a recipe for disaster, because this didn’t work in Japan, where banks that had been propped up by the government were never able to earn their way back to health, eventually requiring the government to step in and take more decisive action. ...
As I’ve said before, there’s something peculiar about the repeated insistence that Japan’s experience demonstrates that the Obama approach can’t work. Japanese banks may not have been able to earn their way out of trouble in the nineteen-nineties, but American banks did, in both the early nineteen-eighties and the early nineteen-nineties. ...
The assumption behindorate borrowers to keep making their interest payments, and to put off bankruptcy. That made the banks’ balance sheets look better, and also kept companies afloat. The economists Ricardo Caballero, Takeo Hoshi, and Anil Kashyap, in fact, found that thirty per cent of publicly-traded firms were “on life support from banks in the early 2000s.”
Evergreening had two effects. First, because the borrowers had little chance of ever actually paying off their debts (because their underlying businesses were so weak), it kept Japan’s economy from making the adjustments necessary to start growing again. ... Second, it limited Japanese banks’ profitability, because it effectively meant that, instead of making good new loans, they were constantly throwing good money after bad. As a result, they were never able to earn their way back to health. ...
In thinking about the relevance of the Japanese experience to our own, what’s important to note is that Japanese banks did not engage in evergreening solely because it temporarily improved their balance sheets. Rather, they did so because social norms and explicit government pressure encouraged them to do so. ... In fact, Peek and Rosengren point out that government-controlled banks were more likely, not less, to keep extending credit to weak firms.
While U.S. banks have come under political attack at various times for being too tough on borrowers, there’s been no concerted attempt to force them to evergreen. And, in contrast to Japanese banks, U.S. banks have proved more than willing in the past to be tough on old borrowers even while extending new loans. The result has been that at times like now—when net profit margins on loans are high—they have been able to become tremendously profitable, and to, in fact, earn their way out of trouble, as the Obama Administration is counting on. Unless you think that this is going to change—that U.S. banks are going to start evergreening their loans, and continuing to pile up new bad debts—then it seems unlikely that we’re really heading down the road that Japan took.
My point has never been that the current strategy to fix the banking system cannot work. I've argued that it might work, and it's cheaper and more politically expedient than nationalization. But we don't know for sure that it will work, and it's not the fastest or most certain way to end the problems in the financial sector. But we didn't choose to nationalize, and now that we are now on the banks can "earn their way out of trouble" path, the politics and budgetary cost of changing course are prohibitive. That's what makes us likely to "muddle along" should the present course of action fail to produce the desired results. We didn't choose the optimal solution to begin with, and we are unlikely to move there any time soon even if the present policies fail, as I think they might. Instead, we'll keep hearing we're almost there and just a little more time and a few more dollars ought to do it and continue to prop up the system. That's why I hope the policies do work, and work well, because if they don't, there are no practical alternative choices to "the muddle-through strategy."
Blog Directory (washingtonpost.com)
This morning's news that U.S. unemployment has hit 13.7 million, pushing the rate to 8.9 percent, tells only half the story of this recession.
The total number of Americans who are not working full-time but ought to be is actually about 22 million, or 15.8 percent, according to the Bureau of Labor Statistics.
Who are those other 8.3 million Americans? Call them the unofficially unemployed.
Despite quite a few warnings, the stock market rally continues to grind upwards. Although past is not always prologue, this upswing has not featured a new leadership group, as enduring bull markets normally do, nor has it reached the crushing valuation lows (PEs of 5-8 versus roughly 11 in early March), Moreover, despite the mythology to the contrary, bottoms of major bear markets coincide with rather than precede the upturn. And according to Carmen Reinhart and Kenneth Rogoff, stock market declines in countries suffering major financial crises take 3 1/2 years to bottom.
Ambrose Evans-Pritchard gives some other reasons to be cautious, particularly for possible late entrants. Note that he sees the risk of deflation and is not certain that the heavy duty pump priming by major central banks will prove sufficient.
From the Telegraph:Bear market rallies can be explosive. Japan had four violent spikes during its Lost Decade (33pc, 55pc, 44pc, and 79pc). Wall Street had seven during the Great Depression, lasting 40 days on average. The spring of 1931 was a corker. James Montier at Société Générale said that even hard-bitten bears are starting to throw in the towel...That is a tell-tale sign.
"Prolonged suckers' rallies tend to be especially vicious as they force everyone back into the market before cruelly dashing them on the rocks of despair yet again," he said. Genuine bottoms tend to be "quiet affairs", carved slowly in a fog of investor gloom. Another sign of fakery – apart from the implausible 'V' shape – is the "dash for trash" in this rally. The mostly heavily shorted stocks are up 70pc: the least shorted are up 21pc. Stocks with bad fundamentals in SocGen's model (Anheuser-Busch, Cairn Energy, Ericsson) are up 60pc: the best are up 30pc.
Teun Draaisma, Morgan Stanley's stock guru, expects another shake-out. "We think the bear market rally will end sooner rather than later. None of our signposts of the next bull market has flashed green yet. We're not convinced the banking system has been fully fixed," he said
Mr Draaisma said US housing busts typically last nearly about 42 months. We are just 26 months into this one. The overhang of unsold properties on the US market is still near a record 11 months. He expects the new bull market to kick off later this year – perhaps in October – anticipating real recovery in 2010.
Keep an eye on the upward creep in yields on the 10-year US Treasury,....This alone threatens to short-circuit the rally. The yield reached 3.3pc last week, up over 1pc since January and above the level in March when the US Federal Reserve first launched its buying blitz to pull rates down. Bond vigilantes are taunting the Bank of England in much the same way, driving the 10-year gilt yield to 3.73pc.
The happy view is that this tightening of the bond markets is proof of recovery fever, but there is a dark side. Governments need to raise $6 trillion (£4 trillion) this year to fund bail-outs and deficits, led by this abject isle with needs of 13.8pc of GDP (EU figures). China fired a warning shot last week, saying the West risks setting off "inflation for the whole world" by printing money. It hinted at a bond crisis.
Yes, the glass is half full. China's PMI optimism gauge has jumped back above the recession line. The global PMI has been rising for seven months. But this usually happens after a crash as companies rebuild battered inventories for a quarter or two.
Note that container volumes in Shanghai fell 17pc in January, 22pc in February, and 9pc in March. Rail freight volumes in the US were down 32pc in April on a year earlier.
The Economic Cycle Research Institute (ECRI) says the US recession will be over by summer, insisting that its leading indicators have never been wrong – except once, in the Great Depression. Quite.
SocGen's other bear, Albert Edwards, says the new element in this slump is that GDP is contracting in "nominal" terms, not just real terms. Money incomes are flat. It is a crucial difference.
"This is like drinking hemlock. The US is gradually slipping further towards outright deflation, just as Japan did," he said. As companies retrench en masse they risk tipping the whole economy into Irving Fisher's "debt deflation trap".
If we are spared – still a big if – we can thank a handful of central bank governors and policy-makers who tore up the rule book, defied tabloid opinion, and took revolutionary action in the nick of time....
We can now test the Friedman-Bernanke hypothesis that the Fed could have halted the Depression by letting rip with bond purchases. Japan was not a proper test. It eked out a recovery of sorts earlier this decade by embracing QE, but only in the context of a global boom and a yen crash.
There is at least one more boil to lance before we put this debt debacle behind us. The IMF says eurozone banks have so far written down a fifth of likely losses ($750bn) compared to half for US banks. They must raise $375bn in fresh capital. Good luck.
Germany's BaFin regulator goes further, warning of $1.1 trillion of toxic assets on German bank books. Landesbanken are a calamity. If the IMF and BaFin are right, Europe has not yet had its crisis. When it does, we will see a second stress pulse through Eastern Europe and Club Med.
The echoes of 1931 are ominous. That year began with green shoots, until Austria's Credit-Anstalt buckled in the summer and took Central Europe with it. Continentals who still thought it was an American crisis learned otherwise. Plus ça change.
naked capitalismWhen I read Yves’ compelling post "Details on Banks' Victory Over Treasury in Stress Tests Emerge" based on a Financial Times story this morning, it confirmed my view. Now, the essence of Yves' post was a revelation that the Obama Administration has worked out deals with the large U.S. banks in which they will not be required to raise the amounts of capital needed under the recently released stress tests if the can earn their way into a better capital position.
This makes plain a key assumption under which I have long felt the U.S. government under both Bush and Obama has been operating. The fact that American banks could earn their way out of recession is a claim I have made several times (emphasis added).
- Eric L. Prentis said...
- Larry Summers’ Assumptions: #1 & #5, are contradictory and mutually exclusive, leading to Larry’s assumed oxymoronic statement; The weak US economy is in a “self-equilibrating-death-spiral,” it just needs more time. This is why Summers and Geithner present Janus-faced positions, they don’t know what to believe except to save their benefactors, i.e., the banks. Summers and Geithner are on-the-take Wall Street shills which should preclude these paid-off toadies from being in government. President Obama, are you listening, you and the economy are running out of time.
- Doc Holiday said...
- Edward,
I may just have to switch over to your blog more often, as I like your take on this matter, which is a matter of valuation and accountability. Does time provide the means for banks to hide from accountability, from fraud, collusion and all their favorite activities?
As some may recall: Private wealth among families in the United States is continuing to decline after dropping by a staggering $15 trillion between June 2007 and December 2008...
There will come a time when banks, appraisers and homeowners all find a new dance to go through on the floor of some ballroom, and the music will change and commerce will move forward, just as time and progress have always done -- but in this situation, there is no way in hell that these crooked banks can re-engineer $15+ Trillion anytime soon!
- pepster said...
- I'm very, very happy about the outcome of the stress test - because I think Summers, Geithner, et al. might have just sealed their fate and actually sped up the day that we get a more definitive resolution to the banking crisis, such as nationalization.
As we all know by now, the outcome of the stress test is that the banks are all "fine." They just need to raise a bit more capital, that's all, and then earn their way out. But with CRE just starting to implode, mortgage defaults moving up to hit prime/jumbo/Alt A loans, unemployment continuing to increase, credit card bills not getting paid back, wage reductions for many still lucky enough to have jobs, uncertainty about how effective the PPIP will be given how TPG lost their entire stake on WaMu, and so on and so forth, I see a good possibility that in the not too distant future banks will need more capital injection from the government, but crucially, I don't think Congress will give it to them anymore, not with simmering anger over Paulson's TARP, the flap over bonuses, and then the results of the stress test. I think the general reaction here will be something like "the stress test showed the banks were supposed to be okay, so why in the hell are banks asking for more money AGAIN!?!?!?!"
Yes, I know the bankers fund a lot of politicians, but I'm betting these guys will be smart enough to realize lobbyist money doesn't mean a damn thing if constituents vote you out of office. So I think the results of this stress test actually accelerate the ultimate endgame, which I think will be nationalization. Who knows if this will actually happen or not, but this is how I see it.
But look at how they describe the challenge and the solution.• Unsustainable deficits in the federal budget threaten the health and vigor of the American economy.Read through the entire document, there is not a hint that those deficits were also driven by out of control defense spending or tax cuts for the wealthy, as with every single Peterson backed call for fiscal responsibility the solution allways starts and stops with 'entitlements'. And for those who say 'Wait neither Brookings or AEI is a Peterson production', not that this document is hosted at Concord which was founded and to all accounts still ultimately controlled by Peterson.
• The first step toward establishing budget responsibility is to reform the budget decision process so that the major drivers of escalating deficits—Social Security, Medicare, and Medicaid—are no longer on autopilot.
Some more links: AEI A First Step Toward Fiscal Responsibility Which step would be? Why a Bi-Partisan Commission! This one evenly split between Republicans and Democrats, meaning of course that Blue Dogs control the outcome. Or you could just explore the links at The Bipartisan Commission: a bipartisan way to solve our nation's financial challenges and what are those challenges?The following are some useful websites which provide additional information concerning the fiscal problems that the federal government faces concerning entitlement spending on Medicare and Social Security as well as possible solutions, including the establishment of a bipartisan commission to find solutions for these problems.And among those 'useful websites'? Hmm, the Concord Coalition and the Peter G. Peterson Foundation.
They say even paranoids have real enemies, and if Social Security was personified it would be twitching madly ever time it looked over its shoulder and saw a representative of PGP. Which in this case includes Conrad, Gregg, Cooper and Wolf.Bruce Webb
I think of opponents of Social Security as being made up of equal groups of liars, thieves and sociopaths.
ilsm says:in the federal budget threaten the health and vigor of the American economy."
What will be different? Why are deficits unsustainable with "entitlements" on autopilot.
[Aside entitlements is ideologic speak for FICA/Disability, Medicare and Medicaid. While discretionary include corporate welfare and the war machine.]
Answer to what is different now is that deficits were only sustainable when the excess FICA were rolling in.
Deficits are only sustainable when you never expect to pay back the excess SS receipts.
Tax cuts only shifted wealth to the upper crust.
Nothing else was planned.
Now a comment on strategy: tactics without strategy are noise before defeat.
What is the strategy to make it so that threats to the future health of the US economy are mitigated?
Control of discretionary spending is at least a part of the answer.
All we will hear from this side is tactics, no idea what victory will mean for any one other than the wealthy.
Who will try to win on their terms.Nancy Ortiz says:
“Stealing. Most of us know what stealing is. Most of us also know what taxes are. Most of us have family members and/or friends who receive SS benefits.
Suppose your mother gets $1000 a month from SS as a widow. She lives alone, yadda yadda, sends you Christmas presents, etc. Now think of your mother with no income. Whose gonna give her the $1000 she is not getting from SS, assuming you decide not to let her live on the street? Right.
So, the idea that current retirees are ripping off current workers fails of one important reality test. Every family in the US receives a current subsidy through SS benefits paid to its family members. Then, receive SS benefits themselves later on.
The FICA taxes held in Treasury bills reduce the amount of general revenues needed to finance govt operations, thus constituting a dollar for dollar reduction on the amount of gen rev IRS has to collect. Net result--lower income tax rate than would otherwise be possible.
I think people who argue against Social Security should just fold their arms over their chests and say, "I don't care what you say, I don't like it, and I don't want anyone to have it." More sensible really, since nothing they say otherwise is correct and represents more of a superstition than a tenable argument. Have a nice day, eh
May 8, 2009 | Telegraph
"The current market turmoil is without precedent in the postwar period. With a significant risk of recession in the US, compounded by sharply rising inflation in many countries, fears are building that the global economy might be at some kind of tipping point," it said.
"These fears are not groundless. The magnitude of the problems yet to be faced could be much greater than many now perceive," it said. "It is not impossible that the unwinding of the credit bubble could, after a temporary period of higher inflation, culminate in a deflation that might be hard to manage, all the more so given the high debt levels."
Given the constraints under which the BIS must operate, this amounts to a warning that monetary overkill by the Fed, the Bank of England, and above all the European Central Bank could prove dangerous at this juncture.
European banks have suffered worse losses on US property than American banks. Their net dollar liabilities are $900bn, mostly short-term loans that have to be rolled over, a costly business with spreads still near panic levels. Mortgage and consumer credit has "demonstrably worsened".
The BIS cautions the ECB to handle its lending data with great care. "The statistics may understate the contraction in the supply of credit," it said.
The death of securitisation has forced banks to bring portfolios back on to their balance sheets, while firms in need are drawing down pre-arranged credit lines. This is a far cry from a lending recovery.
Warning signs are flashing across Eastern Europe (ex-Russia) where short-term foreign debt is 120pc of reserves, mostly in euros and Swiss francs. Current account deficits are 14.6pc of GDP.
"They could find it difficult to secure foreign funding if global financing conditions were to tighten more severely," it said. Swedish, Austrian and Italian banks have drawn on wholesale markets to lend heavily to subsidiaries across the region. This could "dry up".
China is not immune, although the BIS has dropped last year's comment that growth is "unstable, unbalanced, unco-ordinated and unsustainable".
The US accounts for 20pc of China's exports, but that does not capture the inter-links across Asia that ultimately depend on US shopping malls. "There is a risk that China's imports overall could slow down sharply should the US economy weaken further," it said.
Global banks - with loans of $37 trillion in 2007, or 70pc of world GDP - are still in the eye of the storm.
"Inter-bank money markets have failed to recover. Of greatest concern at the moment is that still tighter credit conditions will be imposed on non-financial borrowers.
"In a number of countries, commercial property prices are beginning to soften, traditionally bad news for lenders. These real-financial interactions are potentially both complex and dangerous," it said.
Do not count on a fiscal rescue. "Explicit and implicit debts of governments are already so high as to raise doubts about whether all non-contractual commitments will be fully honoured."
Dr White says the US sub-prime crisis was the "trigger", not the cause of the disaster. This is not to exonerate the debt-brokers. "It cannot be denied that the originate-to-distribute model (CDOs, CLOs, etc) has had calamitous side-effects. Loans of increasingly poor quality have been made and then sold to the gullible and the greedy," he said.
Nor does it exonerate the watchdogs. "How could such a huge shadow banking system emerge without provoking clear statements of official concern?"
But there have always been excesses in booms. What has made this so bad is that governments set the price of money too low, enticing the banks into self-destruction.
"The fundamental cause of today's emerging problems was excessive and imprudent credit growth over a long period. Policy interest rates in the advanced industrial countries have been unusually low," he said.
The Fed and fellow central banks instinctively cut rates lower with each cycle to avoid facing the pain. The effect has been to put off the day of reckoning.
They could get away with this as long as cheap goods from Asia kept a cap on inflation. It seduced them into letting asset booms get out of hand. This is where the central banks made their colossal blunder.
"Policymakers interpreted the quiescence in inflation to mean that there was no good reason to raise rates when growth accelerated, and no impediment to lowering them when growth faltered," said the report.
After almost two decades of this experiment - more or less the Greenspan years - the game is over. Debt has reached extreme levels, and now inflation has come back to life.
The easy trade-off has metamorphosed into a vicious trade-off. This was utterly predictable, and was indeed forecast by the BIS, which plaintively suggested in this report that central banks might like to think of an "exit strategy" next time they try such ploys.
In effect, this is an indictment of rigid inflation targets (such as Britain's), which prevent central banks from launching a pre-emptive strike against asset bubbles. In the 1990s, they should have torn up the rule-book and let inflation turn negative in light of the Asia effect.
The BIS suggests that a mix of "systemic indicators" should be used. The crucial objective is to slow credit growth and make sure that the punchbowl is taken away before the drunks run riot. "We need policy measures to lean against credit-drive excess," it said.
If there are going to be more bail-outs on both sides of the Atlantic - as there will be - the "socialised risks" should be taken on by political systems, and not dumped on the books of central banks.
"Should governments feel it necessary to take direct actions to alleviate debt burdens, it is crucial that they understand one thing beforehand. If asset prices are unrealistically high, they must fall. If savings rates are unrealistically low, they must rise. If debts cannot be serviced, they must be written off.
"To deny this through the use of gimmicks and palliatives will only make things worse in the end," he said.
Let us all cheer Dr White off the stage.
07 May 2009 | Telegraph
China has given its clearest warning to date that emergency monetary stimulus by Western governments risks setting off worldwide inflation and undermining global bond markets.
"A policy mistake made by some major central bank may bring inflation risks to the whole world," said the People's Central Bank in its quarterly report.
"As more and more economies are adopting unconventional monetary policies, such as quantitative easing (QE), major currencies' devaluation risks may rise," it said. The bank fears a "big consolidation" in the bond markets, clearly anxious that interest yields will surge as western states try to exit their QE experiment.
Simon Derrick, currency chief at the Bank of New York Mellon, said the report is the latest sign that China is losing patience with the US and aims to diversify part its $1.95 trillion (£1.3 trillion) foreign reserves away from US Treasuries and other dollar securities.
"There is a significant shift taking place in China. They are concerned about the stability of the global financial system so they are not going to sell US bonds they already have. But they are still accumulating $40bn of fresh reserves each month, and they are going to be much more careful where they invest it," he said.
Hans Redeker, head of currencies at BNP Paribas, said China is switching into hard assets. "They want to buy production rights to raw materials and gain access to resources such as oil, water, and metals. They know they can't keep buying bonds," he said
Premier Wen Jiabao left no doubt at the Communist Party summit in March that China is irked by Washington's response to the credit crunch, suspecting that the US is engaging in a stealth default on its debt by driving down the dollar. "We have lent a massive amount of capital to the United States, and of course we are concerned about the security of our assets. To speak truthfully, I do indeed have some worries," he said.
Days later, the central bank chief wrote a paper suggesting a world currency based on Special Drawing Rights issued by the International Monetary Fund.
Some economists say China is suffering from "cognitive dissonance" by anguishing so much over its reserves, accumulated as a result of its own policy of holding down the yuan to promote exports. Quantitative easing by the US Federal Reserve and fellow central banks may have saved China as well, since the country's growth strategy is built on selling goods to the West.
GreenLightAdvisor Views
Back in late June, we [GreenLightAdvisor.com] interviewed Stephen Briese, a seasoned commodities trader, who, based on CoT (Commitments of Traders) reports, published regularly by the CFTC, posited that there was an estimated 200-days of paper oil held by investors/speculators, among them some of the large endowments and pension funds, as well as sovereign wealth funds re-investing their oil profits back into none other than the paper stuff. Briese is the author of The Commitments of Traders Bible.
Is Wall Street to blame for 2008’s oil bubble? Steve Kroft, from CBS’ 60 Minutes investigates:
Click play to watch the CBS 60 Minutes story aired on January 8, 2009. This is a must see story.Dan Gilligan of the Petroleum Marketers Association says it is naked futures investors via indexes that are more interested in investing in paper oil for profit.
As the president of the Petroleum Marketers Association, [Dan Gilligan] represents more than 8,000 retail and wholesale suppliers, everyone from home heating oil companies to gas station owners.
When 60 Minutes talked to him last summer, his members were getting blamed for gouging the public, even though their costs had also gone through the roof. He told Kroft the problem was in the commodities markets, which had been invaded by a new breed of investor.
“Approximately 60 to 70 percent of the oil contracts in the futures markets are now held by speculative entities. Not by companies that need oil, not by the airlines, not by the oil companies. But by investors that are looking to make money from their speculative positions,” Gilligan explained.
Gilligan said these investors don’t actually take delivery of the oil. “All they do is buy the paper, and hope that they can sell it for more than they paid for it. Before they have to take delivery.”
“They’re trying to make money on the market for oil?” Kroft asked.
“Absolutely,” Gilligan replied. “On the volatility that exists in the market. They make it going up and down.”
Hedge fund manager, Michael Masters says that for every barrel of oil actually consumed in the US, there were 27 barrels traded every day, and interest in commodities indexes grew from $13-billion to $300-billion in 5 years.
About the same time, hedge fund manager Michael Masters reached the same conclusion. Masters’ expertise is in tracking the flow of investments into and out of financial markets and he noticed huge amounts of money leaving stocks for commodities and oil futures, most of it going into index funds, betting the price of oil was going to go up.
Asked who was buying this “paper oil,” Masters told Kroft, “The California pension fund. Harvard Endowment. Lots of large institutional investors. And, by the way, other investors, hedge funds, Wall Street trading desks were following right behind them, putting money - sovereign wealth funds were putting money in the futures markets as well. So you had all these investors putting money in the futures markets. And that was driving the price up.”
In a five year period, Masters said the amount of money institutional investors, hedge funds, and the big Wall Street banks had placed in the commodities markets went from $13 billion to $300 billion. Last year, 27 barrels of crude were being traded every day on the New York Mercantile Exchange for every one barrel of oil that was actually being consumed in the United States.
There were no disruptions to supply, and India and China did not suddenly increase their consumption overnight. In fact, supply was rising and demand falling.
Michael Greenberger, a former director of trading for the U.S. Commodity Futures Trading Commission, the federal agency that oversees oil futures, says there were no supply disruptions that could have justified such a big increase.
“Did China and India suddenly have gigantic needs for new oil products in a single day? No. Everybody agrees supply-demand could not drive the price up $25, which was a record increase in the price of oil. The price of oil went from somewhere in the 60s to $147 in less than a year. And we were being told, on that run-up, ‘It’s supply-demand, supply-demand, supply-demand,’” Greenberger said.
A recent report out of MIT, analyzing world oil production and consumption, also concluded that the basic fundamentals of supply and demand could not have been responsible for last year’s run-up in oil prices. And Michael Masters says the U.S. Department of Energy’s own statistics show that if the markets had been working properly, the price of oil should have been going down, not up.
“From quarter four of ‘07 until the second quarter of ‘08 the EIA, the Energy Information Administration, said that supply went up, worldwide supply went up. And worldwide demand went down. So you have supply going up and demand going down, which generally means the price is going down,” Masters told Kroft.
Investment banks fuelled the energy market.
Masters believes the investor demand for commodities, and oil futures in particular, was created on Wall Street by hedge funds and the big Wall Street investment banks like Morgan Stanley, Goldman Sachs, Barclays, and J.P. Morgan, who made billions investing hundreds of billions of dollars of their clients’ money.
“The investment banks facilitated it,” Masters said. “You know, they found folks to write papers espousing the benefits of investing in commodities. And then they promoted commodities as a, quote/unquote, ‘asset class.’ Like, you could invest in commodities just like you could in stocks or bonds or anything else, like they were suitable for long-term investment.”
Its an important informative piece of journalism. Make sure you watch it, in case you missed it.
August 21, 2008 | Washington Post
Regulators had long classified a private Swiss energy conglomerate called Vitol as a trader that primarily helped industrial firms that needed oil to run their businesses.
But when the Commodity Futures Trading Commission examined Vitol's books last month, it found that the firm was in fact more of a speculator, holding oil contracts as a profit-making investment rather than a means of lining up the actual delivery of fuel. Even more surprising to the commodities markets was the massive size of Vitol's portfolio -- at one point in July, the firm held 11 percent of all the oil contracts on the regulated New York Mercantile Exchange.
The discovery revealed how an individual financial player had gained enormous sway over the oil market without the knowledge of regulators. Other CFTC data showed that a significant amount of trading activity was concentrated in the hands of just a few speculators.
The CFTC, which learned about the nature of Vitol's activities only after making an unusual request for data from the firm, now reports that financial firms speculating for their clients or for themselves account for about 81 percent of the oil contracts on NYMEX, a far bigger share than had previously been stated by the agency. That figure may rise in coming weeks as the CFTC checks the status of other big traders.
Some lawmakers have blamed these firms for the volatility of oil prices, including the tremendous run-up that peaked earlier in the summer.
"It is now evident that speculators in the energy futures markets play a much larger role than previously thought, and it is now even harder to accept the agency's laughable assertion that excessive speculation has not contributed to rising energy prices," said Rep. John D. Dingell (D-Mich.). He added that it was "difficult to comprehend how the CFTC would allow a trader" to acquire such a large oil inventory "and not scrutinize this position any sooner."
The CFTC, which refrains from naming specific traders in its reports, did not publicly identify Vitol.
The agency's report showed only the size of the holdings of an unnamed trader. Vitol's identity as that trader was confirmed by two industry sources with direct knowledge of the matter.
CFTC documents show Vitol was one of the most active traders of oil on NYMEX as prices reached record levels. By June 6, for instance, Vitol had acquired a huge holding in oil contracts, betting prices would rise. The contracts were equal to 57.7 million barrels of oil -- about three times the amount the United States consumes daily. That day, the price of oil spiked $11 to settle at $138.54. Oil prices eventually peaked at $147.27 a barrel on July 11 before falling back to settle at $114.98 yesterday.
The documents do not say how much Vitol put down to acquire this position, but under NYMEX rules, the down payment could have been as little as $1 billion, with the company borrowing the rest.
The biggest players on the commodity exchanges often operate as "swap dealers" who primarily invest on behalf of hedge funds, wealthy individuals and pension funds, allowing these investors to enjoy returns without having to buy an actual contract for oil or other goods. Some dealers also manage commodity trading for commercial firms.
To build up the vast holdings this practice entails, some swap dealers have maneuvered behind the scenes, exploiting their political influence and gaps in oversight to gain exemptions from regulatory limits and permission to set up new, unregulated markets. Many big traders are active not only on NYMEX but also on private and overseas markets beyond the CFTC's purview. These openings have given the firms nearly unfettered access to the trading of vital goods, including oil, cotton and corn.
Using swap dealers as middlemen, investment funds have poured into the commodity markets, raising their holdings to $260 billion this year from $13 billion in 2003. During that same period, the price of crude oil rose unabated every year.
CFTC data show that at the end of July, just four swap dealers held one-third of all NYMEX oil contracts that bet prices would increase. Dealers make trades that forecast prices will either rise or fall. Energy analysts say these data are evidence of the concentration of power in the markets.
CFTC leaders have argued that speculators are not influencing commodities' prices. If any new information arises during the agency's examination of swap dealer activity, officials said they would report it to Congress.
"To date, the CFTC has found that supply and demand fundamentals offer the best explanation for the systematic rise in oil prices," CFTC spokesman R. David Gary said, reading a statement that had been crafted by agency officials. "Regardless of their classification . . . the CFTC's market surveillance group scrutinizes daily the positions of all large traders, both commercial and non-commercial, to guard against market manipulation."
Victoria Dix, a spokeswoman for Vitol, declined to answer questions. The firm, through Dix, released a statement that stated only that it had not been contacted by the CFTC about the reclassification of its business and that its trading status remained unchanged. CFTC officials said they do not typically contact firms that are reclassified.
On its Web site, the firm says it has $100 billion a year in revenue and describes its thriving global energy-trading business.
For most of the past century, regulators put limits on financial actors to prevent them from dominating commodity exchanges, which were much smaller than the bond or stock markets. Only commercial operations, such as farms, airlines, manufacturers and the middlemen that handle their trading activities, were allowed to buy nearly unlimited quantities. The goal was to allow these businesses to minimize the effect of price swings.
The first major change to this regulatory framework occurred in 1991, when Goldman Sachs, through a subsidiary called J. Aron, argued that it should be granted the same exemption given to commercial traders because its business of buying commodities on behalf of investors was similar to the middlemen who broker commodity transactions for commercial firms.
The CFTC granted this request. More exemptions soon followed, including one to the Houston-based energy trader Enron.
"When the CFTC granted the 1991 hedging exemption to J. Aron (a division of Goldman Sachs), it signaled a major shift that has since allowed investors to accumulate enormous positions for purely speculative purposes," said Rep. Bart Stupak (D-Mich.) Now, he added, "legitimate businesses that hedge and take physical delivery of oil are being trampled by the speculators who are in the market purely to make profit."
A second turning point came when Congress passed the Commodity Futures Modernizati on Act of 2000. The law formally allowed investo r s to trade energy commodities on private electronic platforms outside the purview of regulators. Critics have called this piece of legislation the "Enron loophole," saying Enron played a role in crafting it.
In the months after the act was passed, private electronic trading platforms sprang up across the country, challenging the dominance of NYMEX.
"Investment banks had been frustrated with the established exchange because they really were never able to get control of it," said Michael Greenberger, a law professor at the University of Maryland and a former staff member at the CFTC.
The most successful of the private platforms was InterContinental Exchange, or ICE, founded by Goldman Sachs, Morgan Stanley and a few other big brokerages in 2000. ICE soon opened a trading platform in London, allowing its founders to trade vast quantities of U.S. oil overseas without being subject to regulation.
The exemptions for swap dealers and the development of overseas markets allowed big brokerages to open the door for more hedge funds, pensions and big investors to move into commodities.
In the coming years, commodity investments by funds could grow to $1 trillion, veteran hedge fund manager Michael Masters said in testimony before the Senate earlier this year. In an interview, he said this trend could raise commodity prices for everyone in the coming years and "have catastrophic economic effects on millions of already stressed U.S. consumers."
Meanwhile, commodities have been good business for big Wall Street brokerages. Its commodity trades helped keep Goldman Sachs profitable during the credit crisis, said Richard Bove, a banking analyst at Ladenburg Thalmann.
"Business is lousy right now," Bowie said of Goldman Sachs. "Commodities and currencies are clearly the strongest business they have right now."
In the coming months, swap dealers expect to have yet another venue for oil speculation. The CFTC has stated it would not stand in the way of trading in U.S. oil contracts overseas in Dubai. Goldman Sachs and Vitol are among the major investors in this new exchange.
May 08, 2009 | Yahoo! Finance
Results of the stress test brought a collective sigh of relief from Washington D.C. to Wall Street Friday, and stocks were rallying again on a growing sense the financial crisis has past.
Don't you believe it, says William Black, an Associate Professor of Economics and Law at the University of Missouri - Kansas City.
"It's in the interest of the financial community to send this propaganda out," Black says. "It's remarkable not that they do it but that it still works."
In other words, this isn't the first time we've been told "the crisis is over" and that "banks are well capitalized" - and probably won't be the last.
The professor and former financial regulator foresees another wave of foreclosures and future bank losses of more than $2.5 trillion vs. the government's $599 billion estimate.
Simply put, the stress tests weren't strong enough to be considered "wimpy," Black says. Furthermore, Fannie Mae, Freddie Mac, AIG and IndyMac were deemed to have "passed" much more stringent government stress tests before their respective failures, he notes, recalling the grim history:
- Fannie and Freddie: In July 2008, Treasury Secretary Paulson testified that Fannie and Freddie were "adequately capitalized" under the test. In August 2008: "even in [Freddie's] most severe stress tests, [show] losses ... less than $5 billion." Actual losses: 20 to 40 times greater.
- AIG: "It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of those [CDS] transactions." AIG claimed in 2008 "Using a severe stress test ... losses could go as high as $900 million." Actual losses: 200 times greater.
- IndyMac: Sold over $200 billion of "liar's loans." Actual losses: 160 times greater than its tests.
- Rating Agencies: Their stress tests gave AAA ratings to toxic waste. Actual losses: more than an order of magnitude greater.
"The examinations and stress tests are shams -- always precise, always farblondget," Black claims.
So while others are celebrating the end of the crisis, ask yourself this: If the government sees up to $599 billion in additional bank losses, why are they requiring banks "only" raise $75 billion? That suggests the government thinks the banking sector is overcapitalized by $525 billion.
"Once people learn they're being lied to, they react very badly," Black says. "And of course this is not the first lie."
Maybe you really can fool some of the people all of the time.
Mish's Global Economic Trend AnalysisThe official results of the stress test are in ;-).
Selected comments
Mark says:
“The business cycle is alive and well! If you look at consumer credit growth and GDP you see that all the GDP growth since 2001 has been credit fueled.
No credit = 8 year recession. Check it out at the April 2009 Global Monitor here:
http://www.slideshare.net/bizcyclemonitor/2009-april-global-monitor
Robert says:
More at: http://www.business-cycle-monitor.com/Debt is dumb. Who in their right mind would go in the hole when jobs are being shed? The debt contraction is good news. The FIRE economy is over no matter how much DC and Wall Street keep trying to re-inflate it. Small business will be what leads us out of the depression but it will take a few years.
NYCityBoy says:“On CNBC this morning they concluded that if there are only 500,000 - 600,000 job losses this month that the market should really soar. I just can't fathom this madness. It just all seems wrong. Good luck longs. Good luck shorts. I'm staying out. Our savings account, and our quality of life, are the only two investments I care about any more.
NYCityBoy says:
“If you go to the NY Times website there is a blurb about the NY Fed chair resigning. You better know what you're looking for. They made sure the headline is tiny. It is much smaller than the headline trumpeting that the banks only need $75 billion. When I try to click on the link it won't even open. You won't see me ever paying for the NY Times. It reminds me of NPR. I listen to classical music on NPR at work. I will never give them a nickel. Turn it on sometimes. Between their ads for the National Association of Realtors and their Wall Street updates by Bloomberg (which always sound like they're written by CNBC) it is pretty disgusting. Today I am leaving NPR off. I don't think I can stomach those Wall Street updates. I will stare out the window, looking at this sunny day, while playing a Neil Young CD.
Leo Chen says:
“from the NYT's comes this article on Iraq.
Like The Great Recession, George Bush's Great Military Invasion and Occupation of Iraq has had devastating consequences on the lives of our American Combat Soldiers and Marines as well as on our Treasury, [Minus 3 TRILLION Dollars worth, according to a Washington Post analysis] -- disregarding the disaster that we have visited upon the men, women, and children of Iraq.
http://www.nytimes.com/2009/05/08/world/middleeast/08security.html?_r=1&hpsg says:
“http://business.theage.com.au/business/world-business/toyota-posts-91b-loss-forecasts-more-20090508-axsg.html
Toyota posts $9.1b loss, forecasts more
Um, WOW would have thought toyota could have done betterJames Cole says:
“Leo Chen, This will get me massive negative karma, but denial is the American way. When the history books are written, the Iraq invasion will be the point where imperial overreach started the permanent economic decline in the US. We borrowed a trillion to invade and occupy Iraq, so far we have not paid one thin dime out of our pockets for the war. When the bills come due, people will remember Iraq as the beginning of the end.
Economist
This week's Buttonwood column in The Economist looks at the global stock market rally that is now entering its third month, raising the possibility that some investors will begin looking at their neckties for signs of trouble.
Happy days are here againThis has really been something to behold. As this is written, U.S. markets are now up almost 40 percent from their March lows with some emerging markets up over 50 percent.
Investors' optimism has returned very quickly. Too quickly
MOST students suffer from pre-exam nerves. But the financial markets were remarkably sanguine ahead of the results of the stress tests of American banks (published after The Economist went to press). By the close of trading on May 4th, the S&P 500 index had regained all the losses it suffered earlier in the year.
Financial stocks have in fact been rallying ever since March, when Citigroup hinted that its trading performance in the first quarter had been better than expected. That optimism was borne out in other banks, albeit with the help of some one-off factors that may have overstated the underlying recovery in their finances. Big losses on commercial property and consumer debt are still to come. Nevertheless, the system has come a long way since the meltdown of last autumn.
What could go wrong?The trouble with this picture is that it all seems too neat. Bear markets are normally pitted with some vigorous rallies, as investors in Japan have discovered over the past 20 years. Often these rallies result from the technical position of investors, and this may be another example. After their battering in 2008, many hedge funds entered the year either betting against the market (going short) or holding large cash positions. As the market has rallied, those funds have had to chase it higher, thereby giving the rebound stronger impetus.
The economic data may have improved, but only from some terrible lows. It would have been amazing, given the amount of stimulus thrown at the economy in the form of lower oil prices and interest rates, quantitative easing and fiscal deficits, if there had not been some kind of rebound.
...
Companies are still defaulting on their debts at a steady rate; 40 issuers did so in April and Moody’s expects the default rate to reach 14.3% by next March. Even the results season has been mixed. Andrew Lapthorne at Société Générale points out that 62% of American companies have missed expectations for sales. That implies the profit improvement is coming from higher margins, something that it is hard to believe can persist given the economic backdrop.
The danger is that sentiment has flickered higher rather as a dissected frog’s leg will twitch when an electric current is applied. The world is still drowning in debt, unemployment is still rising, wages are stagnant and the threat of higher taxes hangs over consumers. This was not a conventional downturn; it is unlikely to herald a conventional recovery.
Pat G. Says:
May 7th, 2009 at 11:50 pmPoliticians and corporate America (especially the bankers) are sleeping together. We have the best government money can buy. Kids form average American families are dieing everyday in the Mid East in order to protect politicians and bankers who in turn, fraudulently pick pocket their parents 401K’s. There is only one thing that will stop this and I’m afraid it’s coming.
constantnormal Says:
May 7th, 2009 at 10:29 pmMannwich — chill, man — you’re gonna blow an artery. Pull out a copy of Bonfire of the Vanities and turn off the computer. Immerse in some fantasy where the Masters of the Universe get their just desserts.
2009.02.25 | YouTube
Transcript:
We have to come to the realization that there is a sea change in what’s happening. This is an end of an era and that we can’t re-inflate the bubble, just as we devised a new system of Bretton Woods in ‘44 which was doomed to fail. It failed in ‘71 and then we came up with the dollar reserve standard which was a paper standard; it was doomed to fail and we have to recognize that it has failed. And if we think we can re-inflate the bubble by artificially creating credit out of thin air and calling it capital; believe me, we don’t have a prayer of solving these problems. We have a total misunderstanding of what credit is vs. capital. Capital can’t come from the thin air creation by the Federal Reserve System; capital has to come from savings. We have to work hard, produce, live within our means and what is left over is called capital. This whole idea that we can re-capitalize markets by merely turning on the printing presses and increasing credit is a total fallacy; so the sooner we wake up to realize that a new system has to be devised, the better.
Right now I think the Central Bankers of the world realize exactly what I’m talking about and they’re planning, but they’re planning another system that goes one step further to internationalize regulations, internationalize the printing press. Give up on the dollar standard, but we have to be very much aware that that system will be no more viable. We have to have a system which encourages people to work and to save. What do we do now? We’re telling consumers to spend and continue the old process; it won’t work.
The Baseline Scenario
The great corporations which we have grown to speak of rather loosely as trusts are the creatures of the State, and the State not only has the right to control them, but it is duty bound to control them wherever the need of such control is shown.
Theodore Roosevelt, “Address at Providence,” 1902 (emphasis added)
By “creatures of the State,” Roosevelt meant not that corporations were created by the state, but that their existence and power existed because of and in concert with the state. A few years ago, someone reading this quotation would have probably thought first of Halliburton; today, it evokes the large banks that are too big to fail.
That quotation was pointed out to us by Zephyr Teachout, a law professor at Duke, who has been proposing new antitrust laws aimed at reducing the political power of large firms.
U.S. antitrust law was rooted in late-nineteenth-century hostility toward large corporations, but in practice became focused less on size than on specific anti-competitive practices. The Sherman Act of 1890 was aimed at collusion among companies to constrain freedom of trade, while the Clayton Act of 1914 went further in specifying anti-competitive practices, such as bundling or mergers that create excessive concentration in an industry. Over the past few decades, in part under the increasing influence of free-market economic theory, antitrust enforcement by the Department of Justice has become more tolerant of size and concentration in themselves, and has focused instead on whether mergers will benefit or harm consumers. On the one hand, increased concentration increases the ability of large firms to raise prices, hurting consumers; on the other hand, or so the argument goes, larger firms gain economies of scale that enable them to reduce costs and therefore reduce prices to consumers. (If you believe that, take a look at the price of text messaging on your mobile phone bill.)
So it seems likely that existing antitrust laws, as currently enforced, would be unlikely to do the trick of breaking up large banks. Even though the four largest banks hold about 60% of assets in the U.S. banking system, that’s not nearly concentrated enough to attract the attention of the DOJ. And while there may very well be illegal collusion among large banks, there is no smoking gun that I’m aware of, and you certainly wouldn’t need collusion to explain the events of the last decade, or the uniformly high prices charged for services such as equity underwriting. (One of the major implications of game theory, which was standard fare in first-year graduate micro by the 1990s, if not earlier, is that what looks like collusive behavior could also result from individual rational action.)
Teachout’s response is clear: write new laws. In particular, she argues, existing antitrust law does not address the problem of political influence.
There are many reasons a “too big to exist” conception of antitrust law makes good sense for a democracy. Perhaps most importantly, large companies have proven to have disproportionate power over the political process. Concentrated financial power often leads to concentrated political power; if you have a lot of cash, one of the most efficient uses of it to maximize profits is to petition the government to change the rules in your favor. Economies of scale might work all too well when it comes to influencing government.
This argument would barely have gotten a hearing in the 1990s and earlier this decade, when companies were scrambling over each other trying to merge, and the business media were constantly congratulating the “winners” in the battle to become big (even though, in most mergers, any actual gains go to the shareholders of the acquired company, since the acquirer invariably overpays). Now that we have official endorsement from a Republican administration that even the third-largest investment bank (Merrill) was too big to fail (and widespread regrets over letting the fourth-largest investment bank fail), and we have increasing recognition of the linkages between Wall Street and the federal government, the need for new laws may receive serious consideration. In addition, there is evidence (I’ll try to post on this another time) that, at least when it comes to banks, there is a size beyond which any economies of scale are outweighed by coordination problems, most tellingly in risk management. (And, there is the simple fact that large banks tend to charge higher fees, charge higher interest rates on loans, and pay lower interest rates on deposits than small banks.)
There is another, minority view, which is that a new approach to enforcing existing laws could be used against large banks. The general principle is that laws are defined by their interpretation. For an example, look no further than TARP, which gave Treasury the power to purchase “assets” of troubled banks, meaning things on the asset side of their balance sheet - and was prompty interpreted to mean that Treasury could buy preferred stock in those banks, which is only an “asset” from the perspective of the buyer, not the seller. Of course, to get your interpretation to stick, you may have to convince a court, in the antitrust case probably the Supreme Court. But it would not be the first time the Court has changed an interpretation that was once considered settled. For example, when the Court found an individual right to bear arms in the Second Amendment in District of Columbia v. Heller, 128 S.Ct. 2783 (2008), it was reversing a precedent that had not even bothered revisiting since 1939.
What would the argument be? Well, for one thing, having banks that are too big to fail, and then having to bail them out to the tune of hundreds of billions of taxpayer dollars, is clearly bad for “consumer welfare” in general. However, consumers under this argument are only being affected indirectly, so that argument may not stick. But perhaps someone can come up with a better legal theory here.
By James Kwak
ReutersIn recent weeks, a number of investors and economists have declared the recession all but over based on a handful of seemingly positive signs, including a flurry of better-than-expected earnings from U.S. companies.
They may be getting ahead of themselves.
Aggressive cost-cutting through layoffs and capital expenditure reductions has, it's true, helped many companies report profits that surpassed analysts' estimates.
But beneath what can be perceived as "green shoots" of recovery, experts say, lie the germinating seeds of what could be a much deeper, more prolonged recession.
"I think the clear and present danger is the negative feedback loop for the economy," said Greg Peters, head of global-fixed income and economic research at Morgan Stanley in New York.
"If people are getting laid off and if capital expenditures are being pulled back, then that has a cascading effect that is much more long-lasting on the economy."
Analysts and investors argue that while job, capex and R&D cuts may shore up individual profits temporarily, they are bad news in the aggregate. They swell the ranks of the unemployed, reduce the wages of those who keep their jobs, and hurt an already struggling economy by further crimping consumer and corporate spending.
And that will only ricochet back on the companies themselves, reducing demand for their products and services and putting additional pressure on their sales and margins.
"As corporations cut payrolls and deleverage they are acting perfectly rationally," said Robert Reich, the former U.S. Labor Secretary under President Bill Clinton who now teaches at the University of California, Berkeley.
"But if that's what every corporation does, we're going to end up with far more job losses and in a deeper economic hole. Who's going to be left to buy all the goods and services these companies produce?"
THE BEAT GOES ON ... JOB LOSSES TOO
The list of U.S. companies able to report better-than-expected results for the most recent quarter because aggressive cost cuts offset falling sales is a long one.
It includes appliance maker Whirlpool Corp, advertising powerhouse Omnicom Group Inc, specialty glass maker Corning Inc, wireless telephone service provider Sprint Nextel Corp, drug maker Pfizer Inc tool maker Black & Decker Corp, and Kraft Foods Inc.
Based on the number of earnings that beat forecasts, one would never guess the United States is in the midst of the worst economic downturn since the Great Depression. According to Thomson Reuters Director's Report of the 365 S&P 500 companies that have reported earnings so far this quarter, 65 percent delivered better-than-expected results.
"In the aggregate, companies are reporting earnings that are 10.4 percent above the estimates, which is above the 1.6 percent long-term average" based on figures since 1994, John Butters, director of U.S. earnings at Thomson Reuters, wrote in his "This Week in Earnings" report last Friday.
But the cuts behind those beats add up, too. U.S. data due out this week is expected to show that employers cut another 620,000 jobs in April, according to a Reuters poll of economists, lifting the unemployment rate to 8.9 percent. That is up from 8.5 percent in March -- double what it was just two years ago and the highest level since 1983.
Over time, those cuts -- and the distress they cause -- become part of a self-reinforcing cycle, hurting consumer spending, which is responsible for the lion's share of U.S. economic activity -- and further pinching corporate results, experts said.
WHO WILL BUY WHEN NO ONE'S BUYING?
In fact, it is already happening. Although this past quarter was marked by a number of earnings surprises, it was also noteworthy for the number of companies that cut their forecasts, citing a deteriorating sales environment.
"We are still seeing forward earnings estimates being adjusted down," said Keith Wirtz, president and chief investment officer of Fifth Third Asset Management, which manages $22 billion.
To be sure, some pretty powerful voices are sounding a more upbeat note about the economy.
U.S. Federal Reserve Chairman Ben Bernanke said on Tuesday that the recession should end this year, as long as there is no relapse of the credit squeeze that has strangled the economy. And the Business Council, a private group of top U.S. CEOs, said its members see light at the end of the tunnel and are expecting a rebound, at least in the United States and China, next year.
Still, perhaps too many executives are talking like Harold "Terry" McGraw, the CEO of publisher McGraw-Hill Cos Inc, who stressed last week that "cost containment will be a priority for us all year."
As a result, Wirtz said he expects companies to remain "lean and mean ... slow to add expense early into the recovery phase."
And in a system where one man's expense is another man's paycheck, that kind of discipline is bad for the economy.
This conundrum, identified early in the 20th century by economist John Maynard Keynes as "the paradox of thrift" or the "paradox of savings" is, of course, one of the major headwinds facing the economy as it struggles to pull out of the downturn.
Simply put, consumers are now saving when the economy really needs them to spend and businesses are now relentlessly firing and cutting costs when the economy really needs them to be hiring.
The result, according to Keynes: declining incomes across the board.
Which is why Reich believes President Barack Obama's stimulus plan, which injects $787 billion into the economy over two years through tax cuts and spending, does not go far enough and may need to be expanded.
"In this environment, the government has to step in as the spender of last resort," he said.
Finally, secured debt holders' argument that they're getting the shaft relies on their belief that the true value of the bank debt is worth more than what the government was offering. But in this cycle, investors have frequently overestimated the amount of recovery they could get by taking possession of distressed assets. Think about the banks that foreclosed on a borrower and figured they'd be able to recoup 70 percent of the mortgage's value by selling the home—only to find that when they dumped the house onto a market already glutted with thousands of other foreclosed properties at a time when financing wasn't available, the best offer amounted to only 30 percent of the mortgage's value. That's also what is happening in the world of corporate debt. Ed Altman, the sage of high-yield debt at New York University, estimates that so far in 2009, the recovery rate has been 25 percent (25 cents on the dollar), compared with 42 cents on the dollar in 2008 (about the historical average) and 56 cents in 2007. It turns out that the Detroit executives weren't the only ones counting on a taxpayer-funded bailout.
bfriesen - Wednesday May 06, 2009 09:26AM EDT
At least Obama is trying to save the economy rather than just start wars we don't need, fight them badly, funnel money into his pet corporations and sit in his hands. You'd rather have John McCain and the same failed "leadership" that got us here? It's only been a few months....to save an entire nation!!??? Give these people a chance. After all, you gave Bush 8 years to mess everything up.warm_paw - Wednesday May 06, 2009 09:28AM EDT
Obama's gotta fix the excesses of the last two decades. Wall Street has been crooked as hell. Ebbers, Madoff - bond rating agencies, SEC failure, CDS markets. Who allowed a CDS to be created? Or to be allowed to write a default swap on any kind of contract by any kind of person? Obama wasn't on the radar while all the kids on Wall Street were mixing up this garbage. If the public expects Wall Street to be trusted to clean itself up you better give your head a shake. Bush should have intervened and taken the reins - he was too busy clearing brush in Texas. Not sure if he'd have understood the problem anyway. I'm behind Obama - my fear is all of the idiot's who want to return to stealing money who want to say he is a dictator. Medicine don't always taste good, but it heals you.Kwak - Wednesday May 06, 2009 09:36AM EDT
Hedge Fund Managers are just the scum of the earth. Look what they did last year to the oil and gas industry, for by their greed they have caused a lot of the problems the US economy has endured the past year. They think it is a shame Washington is lending a hand to help out the auto industry now. I guess it was ok though for Washington to bail out Wall Street and the banking industry who really put our economy in the mess it is in by not verifying individuals income or loaning mony to anyone who had a pulse. "F" them all!!![email protected] - Wednesday May 06, 2009 09:41AM EDT
Give me a break. As was reported this morning the holdouts on Chrysler hold less than 5% of the debt. And this guy who is basically a vulture investor is screaming blue murder. Yesterday in a marathon session the courts, not president Obama, threw out both their suits including one that wanted to keep the bondholder's name secret. They claimed they had been receiving death threats.....their evidence.... rants on the Washington Post blog. File Asness's self interested letter along with the Cramer and Santelli rants.WalterSteveFreeman - Wednesday May 06, 2009 09:49AM EDT
"Level of anger"??? "some abuses"??? It'll be pitchforks, torches, tar and feathers if these cats don't get a clue. Asness needs to remember that the line "let them eat cake..." didn't go over too well.momhaley - Wednesday May 06, 2009 09:56AM EDT
How much the hedge funds are to blame in the current crisis, driving companies experiencing weakness down to the ground, I don't know. What I have decided is they have had too much power in their ability to make or break stocks by virtue of their volume. For that reason, I am no longer contributing to the market after many years of doing so. As in all things, too much power of the hedge funds to me is a bad thing. The market survived before their rise. My financial future should not be at their mercy, of which they have none so far as I can tell. What is going on is a natural rebalancing of the country's economy. All things in this world wax and wane.freemarketer6 - Wednesday May 06, 2009 09:57AM EDT
Tough bannanas hedge fund crook. Maybe your scummy associates should have not issued 60 trillion dollars in worthless derivatives. I've lost a ton of money because of you frauds. I sincerely hope someone takes you out.Yahoo! Finance User - Wednesday May 06, 2009 09:58AM EDT
Boo Hoo Hoo. Cry me a river, Cliffy AssNest! It's greedy scumbag hedge fund managers like you that caused some of this mess with your unethical "get clients the most return they can" while trashing the entire market in the process! If you don't like your options, go invest somewhere else!Yahoo! Finance User - Wednesday May 06, 2009 10:03AM EDT
Obama must be doing something right, or this hedge fund managers would not be whining.Rajeev S - Wednesday May 06, 2009 10:04AM EDT
I didn't hear any of these hedge fund managers complaining when the government was giving Chrysler billions of dollars to help them avoid bankruptcy. Then it was perfectly all right for the government to get involved.... If the Hedge Funds clients are going to lose money then they should blame the Hedge Fund Managers for investing it in a company that was losing market share and losing revenue...kapil_m - Wednesday May 06, 2009 10:04AM EDT
the problem is the system is rigged against working folks-- i.e. pensions and health care benefits are in the category of unsecured creditors. so basically if joe hardworker works for 20 years and builds up his pension and his company goes bankrupty he's gotta wait in the line at the PGBC (gov't insured pension) for 1/3 of what he was promised. The problem isn't that bond holders are getting 100 cents on the dollar, it's that regular people who count pension and retired health care benefits as part of their compensation--they go to work everyday thinking this is part of their comp-- are being robbed. A more just system would have companies subscribe to proper annuties to gurantee pensions-- it's should be a real expense everyyear-- not the BS underfunded pension liabilty lines you see on balance sheets.Barbara C - Wednesday May 06, 2009 10:06AM EDT
Cerberus Capital, the hedge fund partially owned by former Treasury Secretary John Snow, bought Chrysler in 2005 and paid way too much for it. When asked to provide additional money to help Chrysler last year, Cerberus (which is the Greek and Roman multi-headed mythological creature who guards the gates of Hades for a living) ran screaming from the room. Chrysler took TARP money instead. It retains its stake in Chrysler Financial and GMAC (which received also TARP funds) but it wanted the taxpayer to bail them out of their poorly timed investment in Chrysler Motors. So Hank the Shank Paulson made sure his buddy John Snow got taxpayer money and now we have to listen to hedge fund managers whine about how they're being treated. And, just as a side note, Obama got more money from the financial industry than any other presidential candidate. Go to the Federal Elections Commission Web Site and see for yourselves. Obama is owned by Wall Street and the Unions.jasonswmwatcher - Wednesday May 06, 2009 10:07AM EDT
Not a surprise to learn that Asness (a-hol) is a graduate of GS.Yahoo! Finance User - Wednesday May 06, 2009 10:07AM EDT
I'll be more interested in complaints by the hedge fund industry when we see more transparency. After all, isn't that a most basic element of what is required to having a working free market? Oh wait, I forgot, don't look behind the curtain!J - Wednesday May 06, 2009 10:13AM EDT
The major liabilities owed to unions are based on health care and, contracts (remember how sacred contracts are!) that the relevant parties agreed to. It's so funny that the same people who hate the unions so much also tend to be against a viable national health care plan and demand that contracts promising huge bonuses be respected. Many of the large, industrial companies in trouble now would never be in such a state of crisis if the United States provided health care, in some sensible form or another, to all of its citizens. But corporations have generally fought against such a plan, so this is where it leaves them. And as for the hedge funds, if you invested millions and billions in bonds of companies as crappy, excuse me, risky as Chrysler, you weren't really a very good investment manager, were you? Going for high returns is great, and charging huge fees for achieving great returns is fine too. But high returns usually come with an associated amount of risk, so don't cry me a river when it turns out your investments stink. If the investment manager didn't factor in the liabilities to the unions, the lousy products, etc., that's his fault! I will agree that picking favorites is a potential danger of the political process. Gee, I don't recall Mr. Asness screaming about anyone picking favorites as the Bush Administration opened the floodgates of favors to big business for the last eight years. Give me a break! Take away the lobbying powers and campaign donations of the hedge fund industry, big finance, big pharma, big oil, etc., and then you'll have some credibility when you criticize unions for doing the same thing. The influence of both corporations and unions distort the political process to the detriment of the nation. Calling one out but not the other is simply ignorant, dishonest, or both.Mike - Wednesday May 06, 2009 10:13AM EDT
Aren't these the same Elite who voted for Obama? Ahhh, the first fight during the honeymoon.CharlesM - Wednesday May 06, 2009 10:14AM EDT
While it is said that hedge funds have smart people--not true. 95% of what they do is illegal. They (hedge funds) buy large positions, short or long, and then start the desired rumor. This is illegal but hedge funds get away with it. Hedge funds use insider trading all the time which is illegal (talk to management of companies and acquire information the the small traders don't have)--should be jailed for this. Hedge funds don't want regulators to know their positions because they could be prosecuted for their behavior. If I used all the illegal things that hedge funds do in my trading, I would be far more successful.J - Wednesday May 06, 2009 10:15AM EDT
Typically I would feel sympathy for the hedge fund guys. However, one of these hedgefund "gurus" recently ripped me off. George Schulze of Schultze Asset management (the owner of SAMCO hedge funds) put Tweeter Electronics into bankruptcy and confiscated about 3 million dollars worth of customers deposits and used it to pay his largest creditor Wells Fargo. Then he declared bk the next day locking everyone out from getting their deposits back. The courts also made sure that no one would get equivalent merchandise either. These hedge fund guys will not hesitate to rip you off in an instant, but when they get ripped off, its another story. Karma people, karma. I am not an Obama fan, but I still feel no pity for hedge fund millionaires.chemic76 - Wednesday May 06, 2009 10:15AM EDT
The rich get richer off the backs of the working men and women, but that wasn't enough ; they had to get richer and avoid taxes by taking jobs overseas and exploiting uneducated women and children, so no, NOT screw the unions, screw YOU, you wall mart buyin , scab , non-union, un american.....etc..etc..etc...Funk n' Groovin' - Wednesday May 06, 2009 10:17AM EDT
PROOF - That these hedge fund guys live in their own fantasy world up in the clouds. If it wasn't for TARP, the other programs, and all the guarantees the the taxpayer put up, virtually all of these hedge funds would now be bankrupt! This whiner is lucky to be in business at all. Lets use the RICO acts to go after these guys for running manifestly corrupt and fraudulent operations. Then we'll see what they have to say.Yahoo! Finance User - Wednesday May 06, 2009 10:20AM EDT
Hedge funds are market manipulators and basically corrupt they created alot of the financial problems we are experiencing now, I can't wait for the list of funds that wouldn't play ball with the gov't and chrysler to be revealed so people involved can boycott and pull any investments they may have in these funds out!koswell - Wednesday May 06, 2009 10:23AM EDT
Hedge funds were one part of the big worldwide casino built on debt and leverage for the world's wealthy to play in. The collapse of this debt-ridden scam has cost many working Americans about half of their 401k's, plus half of the value of their other stock holdings, plus a third of the value of many of their homes, plus 10 trillion or so (I gave up counting it) in taxpayer bailout money. All for a big sandbox for self described big wigs to play in. Public anger? Negative populist sentiment? Why wouldn't there be? And lots of it.Lou V - Wednesday May 06, 2009 10:24AM EDT
Unions are not the problem. It's the greed for more and more money from the big wheels. You can't blame union employees for wanting more money when it's those people who make the products and they get nothing for it. It's the union's who has helped those workers get what they deserve along with raises to go along with the cost of living that most of the rest of us do not get unless your some CEO, CFO or politician. My guess is those who do not like union are jealous because they have no one to stand up for their rights as employees and to help them get more.gcnycdude - Wednesday May 06, 2009 10:32AM EDT
Oh please cry me a river! Mr. Cliff Asness has a last name befitting his silly tirade. The elephant in the room that he fails to acknowledge that many large institutions and smaller ones in no way maintained their fiduciary duty to their customers by investing assets in instruments clearly outside of the guidelines of the clients stated and written investment goals. Why? Well that’s because they use it to cover losses in other investment areas of the Hedge fund company. Often these practices go unnoticed and get balanced out over the course of time but guess what this time it didn’t work out so great. Hedge funds have played a major role in our financial system implosion by at a minimum engaging in risky behavior and in more cases than they wish to acknowledge clearly unethical or illegal behavior. I often agree that the government usually makes of mess of things and they do have some culpability in this mess (reducing financial restrictions, Fannie Mae, etc.) but lets be clear almost no one I know in finance believes that if AIG wasn’t bailed out that we would now be facing a worldwide depression and I believe it took us 16 years to get out of the last one. I believe without the swift intervention (swift by government standards) Mr Asness and many of his colleagues in both hedge funds and banks would be jobless! Does anyone believe this action was unnecessary or another government mistake? Unfortunately Capitalism in this country was broken and the US Government is not the one who broke it. Wall Street had an opportunity to police itself for many years and its efforts have been found wanting. Lastly, what are the Hedge Funds crying about they were left with a simple set of options. 1. Agree to take 30% on dollar offered by the government. 2. or Take their chances in bankruptcy court where they have believe they will get a better deal. Either way Chrysler is headed toward insolvency and ironically because the government is guaranteeing car warrantees they will get a better deal than if Chrysler was allowed to simply fail without any government assistance. So really what is he really crying about? Either way Chrysler is headed toward insolvency and let's face it many Hedge funds have played a major role in our financial system implosion by at a minimum engaging in risky behavior and in more cases than they wish to acknowledge clearly unethical or illegal behavior.SarahTX2 - Wednesday May 06, 2009 10:33AM EDT
Confirms what I've thought all along. This recession is a recession of the rich, those with big investments and more houses than they can live in. Many of those who've lost jobs were getting paid way too much money anyway. Even those with just their simple 401k's, did they not wonder back when the 401k business started in the 80's that it's ultimately just gambling, since the vast majority of workers with 401k's had no investment experience and no time to learn it. The 401k's were a scam from the get-go.ralph h - Wednesday May 06, 2009 10:33AM EDT
First off, hedge funds are already tax payer subsidized. Asness pays capital gains rates 15% on his income. Second, the only reason they didn't ask for a bailout is because no one would give them one because hedge funds have received bailouts before: LONG TERM CAPITAL MANAGEMENT. I am sorry, as far as I am concerned, the fat little pig Asness can go die in a corner. I wonder if he blocked client withdrawals too? Many hedge funds have or had blocked withdrawals of funds (because they were doing so poorly), which is essentially a bailout using their customer's funds--nice.michael.perry68 - Wednesday May 06, 2009 10:35AM EDT
If you wanna know the REAL deal of "Abuse of power," try taking a look back into the G.W Bush Years. Maybe then you'll REALLY know what "Abuse of power" is.anydaynow_us - Wednesday May 06, 2009 10:36AM EDT
The Hedge Fund Industry has gotten away with a lot of things for a long time. The Hedge Fund Industry Caused the Housing fall out AND single handedly caused Gasoline prices to sky rocket last year. The PBS program Front Line documented all of the above in several very interesting and revealing shows! It's about time the Hedge Fund Industry be held accountable!Yahoo! Finance User - Wednesday May 06, 2009 10:36AM EDT
The most amazing of this all is that the rightwing rednecks STILL DON'T GET IT! Bring your own rope, morons.
TO UNDERSTAND HOW economies work and how we can manage them and prosper, we must pay attention to the thought patterns that animate people’s ideas and feelings, their animal spirits. We will never really understand important economic events unless we confront the fact that their causes are largely mental in nature.
It is unfortunate that most economists and business writers apparently do not seem to appreciate this and thus often fall back on the most tortured and artificial interpretations of economic events. They assume that variations in individual feelings, impressions, and passions do not matter in the aggregate and that economic events are driven by inscrutable technical factors or erratic government action. In fact, as we shall discover in this book, the origins of these events are quite familiar and are found in our own everyday thinking. We started work on this book in the spring of 2003. In the intervening years the world economy has moved in directions that can be understood only in terms of animal spirits. It has taken a rollercoaster ride. First there was the ascent. And then, about a year ago, the fall began. But oddly, unlike a trip at a normal amusement park, it was not until the economy began to fall that the passengers realized that they had embarked on a wild ride. And, abetted by this obliviousness, the management of this amusement park paid no heed to setting limits on how high the passengers should go. Nor did it provide for safety equipment to limit the speed, or the extent, of the subsequent fall.
What had people been thinking? Why did they not notice until real events—the collapse of banks, the loss of jobs, mortgage foreclosures— were already upon us? There is a simple answer. The public, the government, and most economists had been reassured by an economic theory that said that we were safe. It was all OK. Nothing dangerous could happen. But that theory was deficient. It had ignored the importance of ideas in the conduct of the economy. It had ignored the role of animal spirits. And it had also ignored the fact that people could be unaware of having boarded a rollercoaster.
What Have People Been Thinking?
Traditional economics teaches the benefits of free markets. This belief has taken hold not just in the bastions of capitalism, such as the United States and Great Britain, but throughout the world, even in countries with more established socialist traditions, such as China, India, and Russia. According to traditional economics, free market capitalism will be essentially perfect and stable. There is little, if any, need for government interference. On the contrary, the only risk of major depression today, or in the future, comes from government intervention.
This line of reasoning goes back to Adam Smith. The basis for the idea that the economy is essentially stable lies in a thought experiment which asks: What do free, perfect markets imply? The answer: If people rationally pursue their own economic interests in such markets, they will exhaust all mutually beneficial opportunities to produce goods and exchange with one another. Such exhaustion of opportunities for mutually beneficial trade results in full employment. Workers who are reasonable in their wage demands—those who will accept a wage that is less than what they add to production—will be employed. Why? If such a worker were unemployed, a mutually beneficial trade could be arranged. An employer could hire this worker at the wage she requires and still have some spare extra output for a larger profit. Of course some workers will be unemployed. But they will be unable to find work only because they are engaged in a temporary search for a job or because they insist on pay that is unreasonably high—greater than what they add to production. Such unemployment is voluntary.
There is a sense in which this theory about the economy’s stability is remarkably successful. For example, it explains why most people who seek work are employed most of the time—even in the troughs of severe depressions. It may not explain, for example, why 25% of the U.S. labor force was unemployed in 1933 at the height of the Great Depression, but it does explain why, even then, 75% of the workers who sought jobs were employed. They were engaging in the mutually beneficial production and trade predicted by Adam Smith.
So, even at its worst, this theory deserves high marks—at least by the criterion of a schoolboy we once overheard at a restaurant. He was complaining about the C he had received on a spelling test—despite the fact that 70% of his answers were correct. Furthermore the theory does so well even in its worst prediction in two hundred years. Most of the time—as now, when the U.S. unemployment rate is still 6.7% (although rising)—it predicts remarkably accurately.
Consider yet again the Great Depression. Few people ask why employment was as high as 75% in 1933. Instead the common question is why 25% of the labor force was unemployed. To our mind macroeconomics concerns departures from full employment. Failure to be at such full employment must then result from a departure from the classical model of Adam Smith.
We do believe, like most of our colleagues, that Adam Smith was basically right regarding why so many people are employed. We are also willing to believe, with some qualifications, that he was essentially correct about the economic advantages of capitalism. But we think that his theory fails to describe why there is so much variation in the economy. It does not explain why the economy takes rollercoaster rides. And the takeaway message from Adam Smith—that there is little, or no, need for government intervention—is also unwarranted.1
Animal Spirits
The thought experiment of Adam Smith correctly takes into account the fact that people rationally pursue their economic interests. Of course they do. But this thought experiment fails to take into account the extent to which people are also guided by noneconomic motivations. And it fails to take into account the extent to which they are irrational or misguided. It ignores the animal spirits.
In contrast, John Maynard Keynes sought to explain departures from full employment, and he emphasized the importance of animal spirits. He stressed their fundamental role in businessmen’s calculations. “Our basis of knowledge for estimating the yield ten years hence of a railway, a copper mine, a textile factory, the goodwill of a patent medicine, an Atlantic liner, a building in the City of London amounts to little and sometimes to nothing,” he wrote. If people are so uncertain, how are decisions made? They “can only be taken as a result of animal spirits.” They are the result of “a spontaneous urge to action.” They are not, as rational economic theory would dictate, “the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.”2
In the original use of the term, in its ancient and medieval Latin form spiritus animalis, the word animal means “of the mind” or “animating.” It refers to a basic mental energy and life force.3 But in modern economics animal spirits has acquired a somewhat different meaning; it is now an economic term, referring to a restless and inconsistent element in the economy. It refers to our peculiar relationship with ambiguity or uncertainty. Sometimes we are paralyzed by it. Yet at other times it refreshes and energizes us, overcoming our fears and indecisions.
Just as families sometimes cohere and at other times argue, are sometimes happy and at other times depressed, are sometimes successful and at other times in disarray, so too do whole economies go through good and bad times. The social fabric changes. Our level of trust in one another varies. And our willingness to undertake effort and engage in self-sacrifice is by no means constant.
The idea that economic crises, like the current financial and housing crisis, are mainly caused by changing thought patterns goes against standard economic thinking. But the current crisis bears witness to the role of such changes in thinking. It was caused precisely by our changing confidence, temptations, envy, resentment, and illusions—and especially by changing stories about the nature of the economy. These intangibles were the reason why people paid small fortunes for houses in cornfields; why others financed those purchases; why the Dow Jones average peaked above 14,000 and a little more than a year later fell below 7,500; why the U.S. unemployment rate has risen by 2.5 percentage points in the past twenty-four months, with the end of this rise not yet in sight; why Bear Stearns, one of the world’s leading investment banks, was only (and barely) saved by a Federal Reserve bailout, and why later in the year Lehman Brothers collapsed outright; why a large fraction of the world’s banks are underfunded; and why, as we write, some of them are still tottering on the brink, even after a bailout, and may yet be the next to go. And we know not what is yet to come.
Macroeconomics with and without Animal Spirits
Of course there is a rich body of macroeconomics that explains why there are fluctuations in the economy. Indeed that is what the macroeconomics textbooks are all about. We will give just two examples. In the post–World War II period, economists felt that they could explain deviations from full employment by a single type of animal spirit: that workers dislike money wage cuts, and that employers are therefore reluctant to make them.4 This tradition then morphed into a slightly more sophisticated explanation for why wages are slow to change. It explains fluctuations in employment arising from shifts in demand as due to the fact that wages and prices are not all set simultaneously. This concept in macroeconomics is known as “staggered contracts.”5 The macro textbooks are full of many other departures from the simple thought experiment of Adam Smith, in which there is always a meeting of minds and contracts are negotiated between rational people motivated purely by economic interests.6
And that leads us to the philosophical difference between this book and standard economics texts. This book is derived from a different view of how economics should be described. The economics of the textbooks seeks to minimize as much as possible departures from pure economic motivation and from rationality. There is a good reason for doing so—and each of us has spent a good portion of his life writing in this tradition. The economics of Adam Smith is well understood. Explanations in terms of small deviations from Smith’s ideal system are thus clear, because they are posed within a framework that is already very well understood. But that does not mean that these small deviations from Smith’s system describe how the economy really works.
Our book marks a break with this tradition. In our view economic theory should be derived not from the minimal deviations from the system of Adam Smith but rather from the deviations that actually do occur and that can be observed. Insofar as animal spirits exist in the everyday economy, a description of how the economy really works must consider those animal spirits. That is the aim of this book.
In producing such a description, we think that we can explain how the economy works. This is a subject of permanent interest. But, writing as we are in the winter of 2008–9, this book also describes how we got into the current mess—and what we need to do to get out of it.
How the Economy Really Works and the Role of Animal Spirits
Part One of this book will describe five different aspects of animal spirits and how they affect economic decisions—confidence, fairness, corruption and antisocial behavior, money illusion, and stories:
- The cornerstone of our theory is confidence and the feedback mechanisms between it and the economy that amplify disturbances.
- The setting of wages and prices depends largely on concerns about fairness.
- We acknowledge the temptation toward corrupt and antisocial behavior and their role in the economy.
- Money illusion is another cornerstone of our theory. The public is confused by inflation or deflation and does not reason through its effects.
- Finally, our sense of reality, of who we are and what we are doing, is intertwined with the story of our lives and of the lives of others. The aggregate of such stories is a national or international story, which itself plays an important role in the economy.
Part Two of this book describes how these five animal spirits affect economic decisions, demonstrating how they play a crucial role in answering eight questions:
- Why do economies fall into depression?
- Why do central bankers have power over the economy, insofar as they do?
- Why are there people who can’t find a job?
- Why is there a tradeoff between inflation and unemployment in the long run?
- Why is saving for the future so arbitrary?
- Why are financial prices and corporate investments so volatile?
- Why do real estate markets go through cycles?
- Why does poverty persist for generations among disadvantaged minorities?
We see that animal spirits provide an easy answer to each of these questions. We also see that, correspondingly, none of these questions can be answered if people are viewed as having only economic motivations which they pursue rationally—that is, if the economy is seen as operating according to the invisible hand of Adam Smith.
Each of these eight questions is fundamental. They would occur to anyone with a natural curiosity regarding the economy. In providing natural, satisfactory answers to all of them, our theory of animal spirits describes how the economy works.
In answering these questions, in telling how the economy really works, we accomplish what existing economic theory has not. We provide a theory that explains fully and naturally how the U.S. economy, and indeed the world economy, has fallen into the current crisis. And— of perhaps even greater interest—such a theory then allows us to understand what needs to be done to extricate ourselves from the crisis. (We present our analysis and recommendations in the postscript to Chapter 7, the chapter dealing with the powers of the Federal Reserve.)
Newsweek.com
Smart decisions don't grow in a vacuum. The most successful presidents recognize the fact and encourage debate—and even rivalry—between their advisers. They do their best to consider the options fully. All the same, it's harder than many people might imagine for our national leaders to keep the field of opinions from turning into a monoculture.
It's the curse of the modern presidency. Our chief executives need to make an active, aggressive effort to reach beyond their immediate circle of advisers, to demand fresh thinking and avoid the sycophancy that comes with the Oval Offiorge W. Bush lived in a bubble, partly of his own making, that walled off creative dissent or even, in some cases, common sense.
Mindful of his predecessor, Barack Obama seems to be trying harder to make sure he hears all sides. On the night of April 27, for instance, the president invited to the White House some of his administration's sharpest critics on the economy, including New York Times columnist Paul Krugman and Columbia University economist Joseph Stiglitz. Over a roast-beef dinner, Obama listened and questioned while Krugman and Stiglitz, both Nobel Prize winners, pushed for more aggressive government intervention in the banking system.
That sort of outreach is admirable—but it would be a mistake to make too much of it. A couple of hours of conversation is no substitute for methodical inquiry and debate. At present, Obama's economic advice is closely controlled by his chief economic adviser, Larry Summers, who acts as a kind of gatekeeper, determining what Obama sees and hears—and what he does not. Paul Volcker, the wise old hand who ran the Federal Reserve in the 1980s and whipped inflation, chairs an advisory panel that does not appear to do much advising. "Our ruling intelligentsia in economics runs the spectrum from A to A-minus," says a member of the Congressional Oversight Panel on the banking bailout, who requested anonymity when speaking about the administration. "These guys all talk to each other, and they all say the same thing."The most successful presidents encourage debate and even rivalry between their advisers. FDR played his aides against each other. This produced some chaotic results in dealing with the Depression but worked reasonably well during World War II. Some presidents only pretend to encourage dissent. During Vietnam, LBJ used State Department adviser George Ball as his in-house dove—more to placate critics than to listen to his advice.
... all paper flows to him through an elaborate staffing process. He, like all presidents, is the captive of a system that has been designed for efficiency but is inevitably isolating. It will take more than a few dinner parties to avoid the fate of presidents who lost touch with reality.
Smart decisions don't grow in a vacuum. The most successful presidents recognize the fact and encourage debate—and even rivalry—between their advisers. They do their best to consider the options fully. All the same, it's harder than many people might imagine for our national leaders to keep the field of opinions from turning into a monoculture.It's the curse of the modern presidency. Our chief executives need to make an active, aggressive effort to reach beyond their immediate circle of advisers, to demand fresh thinking and avoid the sycophancy that comes with the Oval Office. Otherwise, they'll only hear what they want to hear—or what their aides tell them. To judge from "War of Necessity, War of Choice," Richard N. Haass's new book on presidential decision-making with regard to Iraq, George W. Bush lived in a bubble, partly of his own making, that walled off creative dissent or even, in some cases, common sense.
Mindful of his predecessor, Barack Obama seems to be trying harder to make sure he hears all sides. On the night of April 27, for instance, the president invited to the White House some of his administration's sharpest critics on the economy, including New York Times columnist Paul Krugman and Columbia University economist Joseph Stiglitz. Over a roast-beef dinner, Obama listened and questioned while Krugman and Stiglitz, both Nobel Prize winners, pushed for more aggressive government intervention in the banking system.
Viktor said: May. 05, 4:17 PMI'm not really sure what the big deal is about this. We are in extraordinary circumstances and sometimes you do what it takes to get the job done. I have no sympathy for a bunch of hedge fund crybabies who did not make the money they were expecting on the Chrysler deal. So what?
The Obama administration played hardball? He is from Chicago and became President out of nowhere, so hardball is to be expected. Incidentally, politicians in this country (and everywhere else) lie with alarming regularity because the population is too infantile to accept the truth. After all lying is the secret elixir of "free" elections.
And by the way, anyone under a misnomer that we are living in a free society, have a free market, or have a free press needs to get a clue in all seriousness. This is an imperial state with the veneer of freedom superimposed on it to keep the natives from upsetting the apple cart.
Spend five minutes thinking how much freedom we all really have. Not much in my opinion.
Dominatrix Nut Kicker said: Yeah strap a pair on and I will kick the shit out them. You know you love it.
The union is a creditor just like Perella PussyWhine-berg. Of course they get equity. The retirees are creditors too. They actually did something useful. They are owed. Put them at the front of the line.clawback said:
May. 05, 4:27 PMIt's funny, one of my favorite political cartoons of the last 8 years modified a Nazi propaganda poster and it said "It's not fascism when WE do it!"
Perfect. Hilarious. And it's going to be applicable for at least another four years. What a massive gang of dipshits we are to exchange Red-State Fascism for Blue-State Fascism in a matter of weeks. We're #1, I suppose.
Selected comments
Asoka said: "That is the story of CFN blog... always a disaster waiting out on the time horizon (like Y2K) and the disaster never happens."
Yes, it never fails to amaze me how people here will latch on to the latest negative news and turn it into their biggest gut fear, blowing it way out of proportion. People don't seem to be able to process that the media thrives on this sort of shit, and put it in context. That being said, I don't buy into your rosy future scenario.
As I survey the landscape economically, both on a local and national basis, I continually find myself asking the same question over and over again, “if we are going to have a recovery, where will the jobs come from?” Locally, the building industry has lost over 75% of their employees in the last two years. Micron, (world headquarters here) looks a lot like the rest of techno-America and our industrial base. They employed over 10,000 a couple of years ago and after eliminating another 2,000 jobs over the next few months will be down to 5,000 by the end of the year. Of course, we have already had a couple of car dealerships shut their doors and I have no doubt most of the others have had layoffs during the recent decline. I have been surprised how well retail has held up. I expected to see a lot more for rent signs around in retail areas, and while they are there, it has not happened in the numbers I expected.....yet. The idea that we will all start selling each other real estate and lattes again (and what else is their, in the near term) strikes me as fantasy much as it does JHK. We have real, serious, and chronic economic problems.
I predict a blip up as optimism and false hopes for a quick recovery from a typical recession wash through the country. Then we will see another decline in housing and retail sales. Oil?....I don't see that being a big problem in the next 2-4 years. Higher prices yes.....shortages, not likely. People just haven't got it through their heads yet, we are seeing a major economic event here and not a typical recession.
I'm not quite sure what Obama's strategy is. Does he actually believe we can return to the false economy we have had for the last several years? Or is he hoping that a quick upturn will give him the popularity and momentum to make the real fundamental changes which have to come? I fear if things turn for the worse, we will have a set up for a real wacko right wing junta, in the form of a fraudulent election.
Posted by: dale | May 04, 2009 at 11:25 AM
My fear, and it's one buttressed by both Bernanke's testimony today and by what we are hearing about the stress tests, is that the political environment has put us on the path the Japanese followed in the 1990s: doing just enough to keep troubled banks alive but never decisively solving the problem. The result in the Japanese case was a sustained period of economic problems and slow growth, and we may be headed in the same direction.
May 4, 2009 | Consider the Evidence
Matt Miller’s new book, The Tyranny of Dead Ideas, is very good. I agree with a great deal of what he has to say. On what Miller thinks is our most important problem, though, the book falls a little short.
Here’s a brief summary of what Miller suggests are six influential but misleading ideas, why they’re wrong, and what we should do:
1. Taxes hurt the economy, and they’re always too high
It’s time, says Miller, to stop pretending that federal tax revenues can remain at their current level, much less be reduced. Rising costs of Medicare (and eventually Social Security) alone will require increases. And real solutions to the myriad other problems we face necessitate further increase. Even (honest) conservatives acknowledge this, though few are willing to do so publicly. “Once this rendezvous with reality trickles down from conservative intellectuals to pols, and liberals find the courage to say the obvious, we’ll start the debate we need: not about whether taxes should go up, but given that taxes are going up, what’s the best way to fund the government we want, consistent with strong economic growth and other vital goals such as saving the planet?” (p. 183).
Miller’s answer is a value-added tax (VAT) and a carbon tax. On the former, “liberals will find that they can offset the regressive tilt of a VAT in several ways: first, by using it to fund progressive programs (like universal health coverage); second, by using a fraction of the proceeds to boost subsidies to the working poor; or third, by exempting certain basic necessities from the tax” (p. 186). I agree.
2. Your company should take care of you
Structuring our health insurance system around employers was reasonable once upon a time, but these days it’s asinine. It results in bloated health care expenditures, inadequate coverage, and an excessive cost burden on firms. This role needs to be shifted to government. Yes.
... ... ...
6. Money follows merit
Traditionally, Americans haven’t gotten too worked up about high levels of income inequality because they’ve believed that the big paychecks go to those who contribute the most. But when CEOs of companies whose stock price has fallen through the floor walk away with $25 million severance packages and financial players run the economy into the ground yet rake in mammoth bonuses, things clearly have gone awry. Miller says frustration is likely to be especially pronounced among highly-educated professionals who, for reasons that seemingly have nothing to do with merit or societal contribution, bring home a mere $150,000 a year instead of $15 million.
Inequality is a major problem, in Miller’s view. Indeed, he says it is “the preeminent economic issue of the twenty-first century” (pp. 146, 148).
Here’s what he believes these “lower uppers,” and more broadly we as a society, will and should do:
Now that their second-tier status is awakening them to the fragility of ‘merit’ as the source of their self-esteem and as the basis for where they ‘deserve’ to stand in society, Lower Uppers will start seeing luck’s hand elsewhere. They’ll see it not only in their own story or in the fate of the ultrarich above them, but in the destiny of millions of their countrymen, now buffeted and struggling with rapid economic change. They’ll be open to fresh appeals about what these powerful forces outside people’s control should mean for society’s basic arrangements. As a result they’ll become stronger voices for equal opportunity, and for some set of minimal protections appropriate for a wealthy nation like the United States. Like their Progressive Era predecessors … they’ll also see justice (and take satisfaction) in asking the ultrarich to kick a little more into the pot to make this happen. (pp. 195-96)
Compared to Miller’s other proposals, this is pretty vague. One of the things I like most about Miller’s earlier book, The Two-Percent Solution, is that he picked a small set of problems and offered specific proposals for what to do. To some extent that is true of The Tyranny of Dead Ideas as well. Miller gives us concrete numbers for what the federal government’s contribution to school expenditures should be and for what share of GDP tax revenues will need to rise to, and he tells us what specific programs will help to cushion the impact of globalization. But here, on this “preeminent issue,” detail is absent.
This omission is even more problematic because though Miller advocates higher taxes on those with top incomes, in a prior chapter he offers a caution: “Some suggest … we eliminate the cap on the amount of earnings subjected to the 12.4 percent payroll tax, so that it would apply to a person’s entire income. While at first blush this step might seem fair, if it were done in addition to proposals to return marginal income tax rates to the 39.6 percent that prevailed under President Clinton, it would effectively boost marginal rates beyond 50 percent — and this would be before high tax states and localities add what could be another 7 to 10 percent. You don’t need to be a Reagan Republican to think that marginal income tax rates at these levels would have negative economic effects” (p. 185).
It isn’t easy to figure out exactly what the tax rate should be on high-income households, or what programs would be most useful in boosting the living standards of those in the lower half of the income distribution. I wish Miller, whose policy thinking tends to be both interesting and level-headed, had made more of an attempt. It’s a small scar on what’s otherwise a very helpful book.
May 4, 2009 | Big Picture
When team Obama hit Washington on January 20 2009, the crisis was in full throat. Markets were plummeting, credit was frozen, and panic was widespread. I give the benefit of the doubt to a new administration to simply withstand the initial waves of fear, stop the freefall, and achieve some stabilization.
Sure, the usual crowd (including my buddy Larry Kudlow) blamed the inherited mess on Obama, as did the speak-first-think-later pundits like James Cramer. I noted at the time the blame was misplaced. I doubt any credit for the rally will be forthcoming; consistency is not the strength of partisans or carnival barkers.
Most DC watchers were disappointed when the Obama team continued the Bush policies of massive monetary giveaways to insolvent firms, run by incompetent management. And the appointment of Larry Summers and Tim Geithner, two people involved in either contributing to the credit crisis or helping to make it worse was not encouraging. The Bush Paulson Bailout policy of shoveling unconscionable amounts of money at these firms were continued by the new Obama economic team.
During W’s reign of error, I was a consistent basher of his ruinous decision-making; I have since been named one of the 14 most most strident critics of Obama’s economic policies. This isn’t partisanship, its legitimate policy criticism.
There is some hope for a break from the past: Rumors that Rahm Emmanuel and David Axelrod wanted to allow an FDIC recievership / liquidation / nationalization and were overruled by Summers and Geithner were enormously disappointing to many economic observers. Some people think that you are supposed to follow the rule of law and allow the FDIC to do its job. Last I checked, the size of the insolvent bank was irrelevant to whether the bankruptcy and liquidation laws were applicable.
Despite all of those disappointments, the Chrysler bankruptcy is encouraging. Why? Consider the circumstances. Here we are 100+ days later, and some stabilization has occurred. The economic data is still “not good,” but it has become “less bad.” The market has rallied from 6,500 to 8,000, and the sentiment levels have dramatically improved.
This is an environment that should encourage the emergency footing of the economic team to stand down. One would also imagine that David Axelrod and Rahm “never let a good crisis go to waste” Emmanuel will want to push forward on some of the Obama agenda, rather than merely continue the Bush policies.
... ... ...
Or, they can continue the Bush policies — a surefire way to “own” the mess they inherited.
- aitrader Says:
May 4th, 2009 at 9:47 amNice chat. I’m with ya on the “bear market bounce”. Looking for a downturn this Summer equal or greater to the recent 30% upswing.
You also called it on “throwing good money after bad” and put in a valid question mark on what the auto bankruptcies may do to the financial sector.
I think you soft-pedaled the implications of a continued worsening of economic data, whether or not it accelerates or decelerates on the way down. If 1.5 trillion dollars (which aren't paid for yet btw) can’t do it - and we’re talking the US alone here - then what will? I think we’re in a much stickier wicket than many/most want to admit.
But hey, I’m a majority of one
- Blissex Says:
May 4th, 2009 at 9:02 am«Are banks really so different than automakers? So far, the answer has been yes.»
Automakers are unionized, banks aren’t. That makes all the difference. Sure, by letting the automakers fail there is a short term cost to some security and business owners, but destroying the last mass unions in industry is a big long term win for financial and industrial businessmen.
For the past 30 years the policy of government, business and finance has been to destroy or offshore as many jobs as possible in unionized industries, and to subsidize and favour non-union, mostly service, industries. It is a matter of power even more than money.
- aitrader Says:
May 4th, 2009 at 10:44 amChrysler is a dress rehearsal. A little chimp. An organ grinder’s monkey. The gorilla in the room is GM. Perhaps Obama and team are using it as a walkthrough to gear up and ready the US economy for the main event.
And on that note, just how the f*** can Ford still claim they are “doin’ fine” with an utter collapse of their two nearest domestic competitors and an unheard of drop in auto sales across the board. Am I the only one that holds his nose whenever Ford CEO Mulally shows up and claims they’ve got plenty of cash? Something here smells here. Stinky like sewage and doctored accounting.
- DeDude Says:
May 4th, 2009 at 12:56 pmIf the political wing of the administration has anything to say, they will take down at least one or two of the big banks. Unless they do that there will be hell to pay at the midterm elections. After they have declared most of the big ones solid, there is no reason to think that taking down a few of them would have severe systemic consequences.
- DL Says:
May 4th, 2009 at 1:10 pmDeDude @ 12:56
I’ll take the other side of that trade. Obama won’t “take down” Citi or BAC or any of the other big ones.
- Mannwich Says:
May 4th, 2009 at 1:17 pmDL: Agreed. The geo-political implications of taking down either are too large at this point. For better or for worse (I still think worse), O has tied his wagon to these bank bailouts. He’s not going to take them down now
- bshaheen Says:
May 5th, 2009 at 7:54 amWere in the “con” game period now, as in confidence, where the Gov. has pretty done all it can, and more, and now we hear more and more happy talk about “green shoots” and all of the data and earnings are all “better than expected” with the accompanying ohhs and ahhs on GNBC (Greed NBC). So now its all propaganda that’s supposed to palliate fear and give the impression that things will only get better. Its easy to beat expectations when expectations are so low that if they were any lower, you’d be talking about a dead body. Things can only fall so far off a cliff.
- Grindstone Financial Says:
May 5th, 2009 at 8:23 amOne thing that’s different about this recession and the market’s reaction to this recession is that we now live in a 24 hr news cycle full of blogs, tweets and cable news. During 74 or 82 you had to wait for the morning paper to get a good read on the markets and how stocks had behaved during the previous day. There was time to digest information, but not anymore. Also, the number of market participants was probably a small fraction of what it is today.
The market’s become a momentum traders dream and “buy and hold” might have to be filed away next to your Victrola record player.
Finally, for all of the posters that think there is excessive bearishness on TBP, troll around some other websites. It’s 1999 for some of the mouthbreathing, CNBC chasing crowd.
- Myr Says:
May 5th, 2009 at 8:49 amI disagree with your framing of the question
I’m wondering if this is March 1930 (where we had a 6 month, 50% bear market rally followed by calamity) or Jun 1991 in Japan ( followed by 17 years of sideways and downwards moves).
The nation is drowning in debt (unlike 1974 or 1982) that can’t be serviced. This will take a long time to play out.
- Marcus Aurelius Says:
May 5th, 2009 at 9:12 amIt’s neither — the scenarios don’t jive, neither will the outcome. Virtually everyone sees the non-correlation in the traditional relationship between economic fundamentals and the behavior of the markets.
So, what’s keeping the markets up? Non-traditional measures. That’s what.
The Fed is using open market operations to allow primary dealers to purchase stocks (or some other equally nefarious fiscal fuckery). We’re witnessing the pump phase of the biggest pump and dump in history.
Equilibrium will win, in the end. There’s still no such thing as a free lunch.
- Run on 401Ks coming?
401(k)s Hit by Withdrawal Freezes. Investors Cry Foul as Some Funds Close Exits; Perils of Distressed Markets
By ELEANOR LAISE
Some investors in 401(k) retirement funds who are moving to grab their money are finding they can’t.
Even with recent gains in stocks such as Monday’s, the months of market turmoil have delivered a blow to some 401(k) participants: freezing their investments in certain plans. In some cases, individual investors can’t withdraw money from certain retirement-plan options. In other cases, employers are having trouble getting rid of risky investments in 401(k) plans.
When Ed Dursky was laid off from his job at a manufacturing company in March, he couldn’t withdraw $40,000 from his 401(k) retirement account invested in the Principal U.S. Property Separate Account.
That fund, which invests directly in office buildings and other properties, had stopped allowing most investors to make withdrawals last fall as many of its holdings became hard to sell.
Now Mr. Dursky, of Ottumwa, Iowa, is looking for work and losing patience. All he wants, he said, is his money.
“I hate to be whiny, but it is my money,” Mr. Dursky said.
The withdrawal restrictions are limiting investment options for plan participants and employers at a key time in the markets. The timing is inconvenient for the number of workers like Mr. Dursky who are laid off and find their savings inaccessible.
Though 401(k) plans revolutionized the retirement-savings landscape by putting investment decisions in the hands of individuals, the restrictions show that plan participants aren’t always in the driver’s seat.
Individual investors mightn’t even be aware of some behind-the-scenes maneuvers causing liquidity problems in their retirement plans. Many funds offered in 401(k) plans lend their portfolio holdings to other investors, receiving in exchange collateral that they invest in normally safe, liquid holdings.
The aim is often to generate a small but relatively reliable return that can help offset fund expenses. But in recent months, many of the collateral investments have gone haywire, prompting money managers to restrict retirement plans’ withdrawals from the lending funds.
Some stable-value funds also are blocking the exits. These funds, available only in tax-deferred savings plans such as 401(k)s, typically invest in bonds and use bank or insurance-company contracts to help smooth returns. But in cases of employer bankruptcy and other events that can cause withdrawals, these funds can lock up investor money for months at a time.
Investors in the Principal U.S. Property Separate Account said they understood the risk of losses, but didn’t think their money could be locked up for months or years. Most participants in the 15,000 plans holding the fund haven’t been able to make any withdrawals or transfers since late September.
“To sell property at inappropriately low prices in order to generate cash for a few would hurt the majority of investors and violate our fiduciary obligations,” said Terri Hale, spokeswoman for Principal Financial Group Inc., the parent of the fund’s manager. The fund, which had $4.3 billion in net assets at the end of April, still is making distributions for death, disability, hardship and retirement at normal retirement age.
As of April 28, redemption requests that had yet to be honored totaled nearly $1.1 billion, or roughly 26% of the fund’s net assets. Principal doesn’t anticipate that it will make any distributions to investors who have requested redemptions until late 2009 or beyond, Ms. Hale said. Meanwhile, the fund continues to fall, declining 25% in the 12 months ending April 30.
Some investors have lost hope of recovering their money. Judith Sterner, a 69-year-old part-time nurse, had more than $12,000 in the fund when she tried to transfer that balance to a money market last fall. But her transfer was denied, and her stake has since declined to less than $10,000.
“This $12,000 represents a year of my retirement money that I don’t have,” said Ms. Sterner, of Morton Grove, Ill.
Principal still allows new investors into the fund. It categorizes the U.S. Property account as a fixed-income investment, alongside much stodgier funds holding high-quality bonds. New investors are warned of potential withdrawal delays, Ms. Hale said. As for the fixed-income categorization, she said, “a substantial portion of the account return is based on income streams from rents, and its returns have been comparable to fixed-income funds.”
While the problems selling real-estate investments are relatively straightforward, withdrawal restrictions related to securities lending stem from far more obscure practices.
Funds often lend out portfolio holdings, through a lending agent, to other investors. These borrowers give the lender collateral, often amounting to about 102% of the value of the securities borrowed. Some of the collateral pools in which funds invest this collateral held Lehman Brothers Holdings Inc. debt and other investments that plummeted in value or became hard to trade in the credit crunch.
Though agents who coordinate funds’ lending programs share in profits from securities lending, the risk of such collateral-pool losses falls entirely on the funds that have lent the securities and, ultimately, retirement plans and other investors holding those funds.
The problems have limited retirement plans’ ability to get out of securities-lending programs, though participants’ withdrawals generally haven’t been affected.
Retirement plans offered to employees of energy company BP PLC last fall tried to withdraw entirely from four Northern Trust Corp. index funds engaged in securities lending. Certain holdings in Northern’s collateral pools had defaulted, been marked down, or become so illiquid that they could only be sold at low values, according to a BP complaint filed in a lawsuit against Northern Trust.
The BP plans halted new participant investments in the funds and asked to withdraw their cash so it could be reinvested in funds that don’t lend out securities.
But under restrictions imposed by Northern Trust in September, investors wishing to withdraw entirely from securities-lending activities would have to take their share of both liquid assets and illiquid collateral-pool holdings, according to a Northern Trust court filing. BP rejected that option, and the companies still are trying to resolve the matter in court.
Northern Trust’s collateral pools are “conservatively managed” and focus on liquidity over yield, the company said.
State Street Corp. in March notified investors of new withdrawal restrictions in its securities-lending funds. Until at least the end of the year, plans can make monthly withdrawals of only 2% to 4% of their account balance, the notice said.
Plans wishing to withdraw entirely from lending funds will have to take a slice of beaten-down collateral-pool holdings.
“Given the current state of the fixed-income market, we felt it was prudent to put some well-defined withdrawal parameters in place,” said State Street spokeswoman Arlene Roberts.
Write to Eleanor Laise at [email protected]
John Mauldin's weekly E-Letter, Sell in May and Go Away, is a good read. My favorite portion of the E-Letter is the section "A Dangerous End Game". Let's take a look.
The Fed and the Obama administration are playing a dangerous game. The Fed is going to print trillions of dollars to forestall deflation and try to re-ignite the economy. But for a variety of reasons we will go into next week, a real, sustainable recovery may be a few years away. What happens when the market start balking at high and unsustainable national deficits? What happens when inflation (finally) does return? Can the Fed remain independent and take back the money it is printing in the face of what will likely be a tepid recovery? And if they don't, what happens to the dollar?
Next year, we will be entering what will certainly be the most dangerous era in my lifetime for the US economy. It is not clear what will happen. There are a lot of paths that can be taken, though some are more likely than others. For those who are convinced that high inflation and a falling dollar are absolutely, unequivocally in the future I have just one word: Japan.
Yes, there are differences, but there are a lot of similarities. While I think the most likely outcome is a long Muddle Through recovery, the likelihood of a lost decade of deflation a la Japan is a very real potential outcome. And the possibility of stagflation and a seriously impaired dollar is also quite real.
Investors, businessmen, and entrepreneurs need to be as nimble as possible. A free market will figure out what paths to take, and I am still optimistic about the long term. But we have some very dangerous times in front of us, and we need to be realistic.
Clusterfuck Nation
People of good intentions and progressive predilection are scratching their heads wondering just how President Barack Obama managed to turn himself into George W. Bush Lite with sugar-on-top just twelve weeks after that fateful walk down the US Capitol's east stairway to the waiting helicopter. I'm hardly the first observer to note that Mr. Obama's actions in the face of an epochal finance fiasco and economic collapse are a mere extension of the pre-January-20 policies, carried out by much the same cast of characters.
The assumption up until now was something about the reassuring value of continuity -- if we could just prop up an ailing set of banks for a little while, the US public could resume a revolving credit way-of-life within an economy dedicated to building more suburban houses and selling all the needed accessories from supersized "family" cars to cappuccino machines. This would keep everyone employed at the jobs they were qualified for -- finish carpenters, realtors, pool installers, mortgage brokers, advertising account executives, Williams-Sonoma product demonstrators, showroom sales agents, doctors of liposuction, and so on.
This was a dumb strategy for such a supposedly bright group of people surrounding Mr. Obama. That old economy was dead on arrival January 20th. Even the kindest physicians don't put corpses on life support. This particular corpse has been placed in the world's cushiest intensive care unit, with transfusions running about a trillion dollars a month -- not to mention hefty bonuses for the attending nurses. Instead, a fast and furious wake might have been held, with the corpse of the old economy laid out on a granite countertop for all to toast and bid farewell. President Obama might have led this exercise with some aplomb -- even while directing his new justice department warriors to round up a host of suspects in the old economy's suspicious death.
What it comes down to, apparently, is a leadership elite across all sectors -- politics, business, academia, media -- that is incapable of processing the truth, and then conveying it to the broad American public. Alas, this also appears to be a common theme in history, with a commonly tragic outcome, which is that elites get ruthlessly dumped and replaced by new elites, often composed of zealots, maniacs, nincompoops, and others generally ill-disposed to the able management of complex affairs. It's called the "circulation of elites," and in times of crisis it tends to take on a kind of downward spiraling flavor, with each gang of discredited leaders tossed out for a progressively worse one until a kind of exhaustion is reached -- whereupon the archetypal man-on-a-white-horse arrives on the scene.
Mr. Obama looked to be the man-on-a-white-horse -- on the exhaustion of Reagan-Bush Jesus-Republicanism -- but he's coming off more like Philippe Égalité (Louis Philippe Joseph d'Orléans, duc d'Orléans) in 1793, with perhaps Newt Gingrich waiting offstage to become Robespierre in 2012 -- and some obscure US Army captain now toiling in Kirkuk slated to become the American Napoleon of 2015. As you've surely heard a thousand times now, history doesn't repeat itself but it rhymes. The enormities of Wall Street today are a little like those of the French Ancien Régime at Versailles. If America encounters the sort of disruptions of food and energy supplies that are brewing on the horizon, and unemployment keeps arcing up its current trajectory, civil uproars could easily follow. Readers think I joke about the Hamptons going up in flames. But the antics of the bankers, hedge funders, the CEOs, the Madoffs, and even the P. Diddy's of our time, are liable to attract murderous attention as the public mood moves from sour to wrathful.
So, what people of good intention and progressive predilection want to know is how come Mr. Obama doesn't just lay out the truth, undertake the hard job of cutting the nation's losses, and get on with setting this society on a new course. The truth is that we're comprehensively bankrupt, and no amount of shuffling certificates around will avail to alter that. The bad debt has to be "worked out" -- i.e. written off, subjected to liquidation of remaining assets and collateral, reorganized under the bankruptcy statutes, and put behind us. We have to work very hard to reconfigure the physical arrangement of life in the USA, moving away from the losses of our suburbs, reactivating our towns, downscaling our biggest cities, re-scaling our farms and food production, switching out our Happy Motoring system for public transit and walkable neighborhoods, rebuilding local networks of commerce, and figuring out a way to make a few things of value again.
What's happened instead is what I most feared: that our politicians would mount a massive campaign to sustain the unsustainable. That's what all the TARP and TARF and PPIT and bailouts are about. It will all amount to an exercise in futility and could easily end up wrecking the USA in every sense of the term. If Mr. Obama doesn't get with a better program, then we are going to face a Long Emergency as grueling as the French Revolution. One very plain and straightforward example at hand is the announcement last week of a plan to build a high speed rail network. To be blunt about it, this is perfectly fucking stupid. It will require a whole new track network, because high speed trains can't run on the old rights of way with their less forgiving curve ratios and grades. We would be so much better off simply fixing up and reactivating the normal-speed track system that is sitting out there rusting in the rain -- and save our more grandiose visions for a later time.
I don't like to be misunderstood. With the airlines in a business death spiral, and mass motoring doomed, we need a national passenger rail system desperately. But we already have one that used to be the envy of the world before we abandoned it. And we don't have either the time or the resources to build a new parallel network.
But grandiosity is just another way that we lie to ourselves about where we're at and what is really possible. Surely Mr. Obama knows that hope fades where the light of truth doesn't shine. He is a charming fellow. I don't especially want to see Newt Gingrich chop his head off.
Clusterfuck Nation
Euphoria managed to out-run swine flu last week as the epidemic-du-jour, with "consumer" confidence jumping and the big bank stocks nudging up. The H1N1 virus fizzled for now, at least in terms of kill ratio, though we're warned it might boomerang in the fall with a vengeance. No one was surprised to see Chrysler roll over like a possum on a county highway, but the memory of their muscle cars will linger on like a California surfing song. Here in the northeast, where Sundays are not spent at the Nascar oval, the spring foliage reached the tenderly explosive stage and it was hard to feel bad about anything.
For now, the "bottom" is in -- that is, the bottom of this society's ability to process reality. It may continue for a month of so, even after the "stress test" for banks is finally let out of the massage parlor with a "happy ending." But events are underway that are beyond the command of personalities. We're done "doing business" in all the ways that we've been used to, but we just can't get with the new program. Let's count the ways:
1. The revolving credit economy is over. It's over because we can't increase energy inputs to the system, which is one way of saying "peak oil." Of course hardly anybody believes this right now because the price of oil crashed nine months ago, along with global manufacturing and trade. But nothing has changed on the peak oil scene -- except perhaps that ever more new oil projects have been cancelled for lack of financing, which will boomerang on us (even if swine flu doesn't) in the form of much lower future oil production. In any case, the credit fiesta is over, and the "consumer" economy with it, because industrial growth as we have known it is over. It's over globally, too, though all regions of the world will not experience its demise the same way at the same rate.
The Asian nations may swap things around a while longer but China is basically screwed. They have less oil left than we have (which is saying, not much at all) and they won't corner the rest of the global oil market without starting World War Three. Meanwhile, they're running out of water and food. Good luck becoming the next global hegemon. Oh, and Japan imports 90 percent of its energy; India over 80 percent. Fuggeddabowdit.
Credit will not vanish everywhere overnight -- even in the USA -- because it is not distributed equally everywhere. But it will vanish in layers, and here in the USA a very broad layer of the lower and middle classes are now losing their access to it in one way or another -- personally, in small business -- and they will never get it back. Anyone who intends to thrive in the years just ahead had better plan on doing it on the basis of accounts receivable -- and what they receive might not even necessarily come in the form of US dollars. It may come in the form of gold or silver or in the promise of reciprocal services rendered.
This has enormous implications for two of the items in which our credit-dispensing operations are most deeply vested: houses and cars. Unfortunately, these are exactly the things that economic life has been based on for decades in our nation, which leads to the next categories:
2.) The suburban living arrangement is over, along with all its accessories and furnishings. Taken as "all of a piece," the suburban expansion was one sixty-year-long orgasm of hypertrophy. We did it because we could. We won a world war and threw a party. We had lots of cheap land and cheap oil. It made lots of people lots of money and all its usufructs have become embedded in our national identity to the dangerous degree that the loss of them will provoke a kind of national psychotic breakdown. In fact, it already has. The completely unrealistic expectation that we can resume this way of life is proof of it.
The immediate problem is that we can't build anymore of it. The next problem will be the failure of the stuff that already exists. The first stage of that is now palpable in the mortgage foreclosure fiasco and, just beginning now, the tanking of malls, strip centers, office parks and other commercial property investments. The latter will accelerate and become visible very quickly as retail tenants bug out and weeds start growing where the Chryslers and Pontiacs once parked. The next stage, which involves large demographic shifts in how we inhabit the landscape, has not quite gotten underway.
3.) The Happy Motoring fiesta is over. You'd think that with Chrysler crawling into the bankruptcy court, and GM just weeks away from the same terminal ceremony, the news media would begin to suspect that the foundation of everyday life in this country was cracking. Instead, all we hear is blather about "market share" shifting to Toyota. News flash: not only will we make fewer automobiles in the USA, but Americans will buy far fewer cars made anywhere. We'll keep the current fleet moving a while longer, but when it's too beat to repair, we won't be changing it out for a new fleet -- despite all the fantasies about hybrids, plug-and-drive electrics, and so on. The masses will be too broke to buy these things. What's more, they will be very resentful of the shrinking economic "elite" who can afford them. And, anyway, our roads and highways are destined to fall apart very quickly because there is no way we can sustain the necessary rate of normal maintenance. Meanwhile, we remain completely un-serious about public transit -- even about fixing the vestiges that still exist. The airline industry, of course, will be toast inside of five years.
4.) Our food production system is approaching crisis. There's no way we can continue the petro-agriculture system of farming and the Cheez Doodle and Pepsi Cola diet that it services. The public is absolutely zombified in the face of this problem -- perhaps a result of the diet itself. President Obama and Ag Secretary Vilsack have not given a hint that they understand the gravity of the situation. It is probably one of those unfortunate events of history that can only impress a society in the form of a crisis. It also happens to be one of the few problems we face that public policy could affect sharply and broadly -- if we underwrote the reactivation of smaller, local farm operations instead of shoveling money to giant "agribusiness" (or Citibank, or Goldman Sachs, or AIG...). I maintain that this may be the year that the crisis gets our attention, because capital is suddenly harder to get than fossil-fuel-based fertilizer.
All these epochal discontinuities present themselves, for the moment, as a season of muted "hope" and general apathy. The days are suddenly mild. We've resumed old and happy habits of grilling meat outdoors and motoring to those remaining places that were not blanketed with franchised food huts and discount malls. We have a new, charming president with an appealing family. Newly-minted dollars are flowing to the "shovel-ready." The new bad news is less bad than the old bad news (or seems to be). And the year just past has been such a bummer that our hard-wired human nature tells us that good things must be just around the corner.
Personally, I think a lot of good things await us, but not the ones we're expecting -- not a return to buying slurpees on credit cards. It will be very salutary to leave behind the junk empire we've accumulated and move into an epoch of quality and purpose. For the moment, though, our hopes reside elsewhere.
Lakshman Achuthan is a regular misinformed guesser... Poor schmuck ;-)
After flipping through several channels, I landed on CNN, where a host of "Your $$$$$" announced that a guest would be joining them after the break who was not only one of the first to call the current downturn, but who was now claiming that "the end of the recession was in sight."... I learned that the "expert" making this prediction was Lakshman Achuthan, managing director of the Economic Cycle Research Institute (ECRI). Apparently, his research group had recently made the following announcement (via Reuters):
"The economy is on the cusp of a growth rate cycle upturn -- a cyclical acceleration in economic growth ..In other words, U.S. economic growth ... which is still plunging deeper into negative territory, will start becoming less negative in short order."
... ... ...
Hmm, interesting. OK, I thought, let's do a quick Google search to try and verify the firm's alleged forecasting prowess in regard to the current recession-cum-depression. Below are two of the reports I found [Italics mine]:
"Gauge of U.S. Economy Falls in Latest Week - ECRI" (Reuters, Dec. 29, 2006):
The Economic Cycle Research Institute, an independent forecasting group, said its Weekly Leading Index slipped to 138.5 in the week ending Dec. 22 from 139.7 in the prior week, due to higher interest rates and more jobless claims.
However, annualized growth in the week ended Dec. 22 rose to 3.8 percent from 3.4 percent in the prior period, a reading not reached since last February.
"Given the steady improvement in the WLI, recession is no longer a serious concern," said Lakshman Achuthan, managing director at ECRI.
"Achuthan of ECRI Sees U.S. Slowdown But No Recession: Audio" (Bloomberg, Nov. 16, 2007)
Lakshman Achuthan, managing director of Economic Cycle Research Institute, talks with Bloomberg's Tom Keene in New York about Americans' concerns about the likelihood of a recession, the outlook for the U.S. economy and the impact of the dollar on inflation.
5/03/2009 CalculatedRisk
Paul Krugman writes in the NY Times: Falling Wage Syndrome
Wages are falling all across America.
...
[A]ccording to the Bureau of Labor Statistics, the average cost of employing workers in the private sector rose only two-tenths of a percent in the first quarter of this year — the lowest increase on record. Since the job market is still getting worse, it wouldn’t be at all surprising if overall wages started falling later this year.
Kansas City Fed president Thomas Hoenig has a plan for allowing large and systemically important banks to fail. If we prevent financial institutions from becoming so large and systemically important in the first place, the plans below wouldn't be needed. But if we going to allow such institutions to exist - not my first choice but for now we have what we have - then this is a reasonable approach to take. One difference I have, though, is that I think that stronger form of guarantee for depositors, a key component of the Swedish plan, is needed. That changes the equity calculations when you look solely at the flow of money to depositors, and the politics of that aren't great, but the improved overall outcome can more than compensate for the cost of the government guarantees:
Troubled banks must be allowed a way to fail, by Thomas Hoenig, Commentary, Financial Times: When the financial crisis began ... in 2007, US policymakers reacted quickly out of fear that ... events would lead to a global economic collapse. In my view, the policy response ... has been ad hoc, resulting in inequitable outcomes among firms, creditors, and investors. Despite taking a number of actions..., uncertainty continues and markets remain stressed.
I believe there is an alternative method for addressing this crisis...: the implementation of a systematic plan to resolve large, problem financial institutions. ... Boiled down..., the plan would require those firms seeking government assistance to make the taxpayer senior to all shareholders, with the government determining the circumstances for managers and directors. ...
Non-viable institutions would be allowed to fail and be placed into a negotiated conservatorship or a bridge institution, with the bad assets liquidated while the remainder of the firm is ... re-privatised as soon as is feasible. ...
This plan has ... management and shareholders bear the costs for their actions before taxpayer funds are committed. This process also is equitable across all firms; is similar to what is currently done with smaller banks; and provides a definitive process that should reduce market uncertainty. ...
In contrast..., the current policy raises a host of issues:
- Certain companies have not been allowed to fail and, as a result, the moral hazard problem has substantially worsened. ...
- So-called “too big to fail” firms have been given a competitive advantage and, rather than being held accountable..., they have actually been subsidised in becoming more economically and politically powerful.
- The US government has poured billions of dollars into these firms without a defined resolution process... The longer resolution is postponed, the greater the losses and the larger the debt burden.
- [T]he Federal Reserve is making loans directly to specific sectors of the economy, causing the Fed to allocate credit and take on a fiscal as well as a monetary policy role. This ... may compromise ... independence ... and make it more difficult to contain inflation in the years to come.
- We have entrenched these even larger, systemically important, “too big to fail” institutions into the economic system, assuring that past mistakes will be repeated.
Certainly, the approach I suggest for resolving these large firms also is not without substantial cost, but it looks to both the short and long run. ... While I agree that central banks must sometimes take actions affecting the short run, they must keep the long run in focus or risk failing their mission.
MAY 1, 2009 | Clusterstock
Now that stocks have rallied nearly 30% off their low, pundits agree: It's a new bull market. So be very afraid.
Market punditry is a lagging indicator, not a leading one. Pundits are excellent at describing what has happened, not what is going to happen.
But doesn't the 30% rally off the bottom obviously mean that the bears are fools, that it's finally safe to get back in the water? No. It doesn't obviously mean anything.
Take a look at the charts below, from Doug Short. (Check out the interactive version here >)
First, the "mega-bear quartet"--an overlay chart of the bears that began with the DOW in 1929, the NIKKEI in 1989, the NASDAQ in 2000, and the S&P in 2007. The last one, the current bear, is the blue line. The horizontal axis is time from the peak, measured in years.
If you're feeling confident that the 30% rally means that happy days are here again, take a look at the humongous rallies in the NIKKEI (red) and NASDAQ (green) that happened at this point in the process. Then look at what happened afterward:
FT Alphaville
So, here’s Citi’s unsurprising conclusion.
2009 is shaping up to look more like a twilight zone. Earnings are falling faster than share prices, the market is re-rating, cyclicals are re-rating aggressively and earnings momentum strategies are struggling — all signs of twilight zones. Are we saying that the next bull market has started? No but we are saying that markets have stabilised and are unlikely to fall beyond the March 2009 lows.
Earnings declines have further to go from here. So with flattening prices and falling earnings, we think this is the start of a protracted twilight zone.
It is sensible to gradually increase exposure to risk through the year. But, near term we would be less willing to chase the current risk rally.
John Quiggin explains why Austrian business cycle theory "hasn’t developed in any positive way" since the 1920's, and has since become "ossified dogma":
Austrian Business Cycle Theory, by John Quiggin: I’ve long promised a post on Austrian Business Cycle Theory, and here it iquiggin.com/index.php/archives/2009/05/03/austrian-business-cycle-theory/">...continue reading...]
May 3, 2009 | NYTimes.comQ: Do you think this recession is a big-enough event to make us as a country willing to make some of the sorts of hard choices that we need to make on health care, on taxes in the long term — which will not cover the cost of government — on energy? Traditionally those choices get made in times of depression or war, and I’m not sure whether this rises to that level.
A: THE PRESIDENT: Well, part of it will depend on leadership. So I’ve got to make some good arguments out there. And that’s what I’ve been trying to do since I came in, is to say now is the time for us to make some tough, big decisions.
The critics have said, you’re doing too much, you can’t do all this at once, Congress can’t digest everything. I just reject that. There’s nothing inherent in our political process that should prevent us from making these difficult decisions now, as opposed to 10 years from now or 20 years from now.
It is true that as tough an economic time as it is right now, we haven’t had 42 months of 20, 30 percent unemployment. And so the degree of desperation and the shock to the system may not be as great. And that means that there’s going to be more resistance to any of these steps: reforming the financial system or reforming our health care system or doing something about energy. On each of these things — you know, things aren’t so bad in the eyes of a lot of Americans that they say, We’re willing to completely try something new.
But part of my job I think is to bridge that gap between the status quo and what we know we have to do for our future.
Q: Are you worried that the economic cycle will make that much harder? I mean, Roosevelt took office four years after the stock market crashed. You took office four months after Lehman Brothers collapsed. At some point people may start saying, Hey, why aren’t things getting better?
THE PRESIDENT: It’s something that we think about. I knew even before the election that this was going to be a very difficult journey and that the economy had gone through a sufficient shock and that it wasn’t going to recover right away.
In some ways it’s liberating, though, in the sense that whether I’m a one-termer or a two-termer, the problems are big enough and fundamental enough that I can’t sort of game it out. It’s not one of these things where I can say, Oh, you know what, if I time it just right, then the market is going to be going up and unemployment will be going down right before re-election. These are much bigger, much more systemic problems. And so in some ways you just kind of set aside the politics.
What I’m very confident about is that given the difficult options before us, we are making good, thoughtful decisions. I have enormous confidence that we are weighing all our options and we are making the best choices. That doesn’t mean that every choice is going to be right, is going to work exactly the way we want it to. But I wake up in the morning and go to bed at night feeling that the direction we are trying to move the economy toward is the right one and that the decisions we make are sound.
Since May 2008, more than 120 new retirees have joined the “$100,000 Club” – each month - every month. That’s been going on for the last 12 months – more than 1,500 have joined that well-paid retirement group ; this rate of increase will accelerate as droves of retired public safety workers who are now in the $90,000 to $100,000 range receive annual cost of living increases.tenbeers
“Again, wherever you find the financial industry, you uncover a lot of snakes. Seems like the focus needs to remain on them as well, while distractions are spun to keep the eye off the ball in these pension stories. Tell me again, why do these previously owned car salesman get paid so much again?:
Some ideas to counter the bush era anything-goes deregulatory and look the other way environment from:
http://www.nakedcapitalism.com/2009/05/guest-post-systemic-fraud-at-public.html
I have already written about the Mother of all stealth scams. Nothing like a huge financial crisis to bring out all the cockroaches. This hardly surprises me and remember my dire warning: Madoff was the tip of the iceberg. There will be many more fraudsters that will get nabbed in the next few years.
Just how systemic is fraud in the financial industry and at public pension funds? We don't know, but when you mix greedy placement agents with public pension fund managers who control billions, the potential for kickbacks is huge.
What can pension funds do to stop abuse before it happens? First, they should segregate duties so the person(s) making the investment has to pass through several checks, including an internal auditor, before the decision is cleared. Importantly, there should also be clear segregation of duties between those making the investment decisions and the finance professionals valuing them.
Second, pension funds need to beef their whistleblower policies so people are encouraged to report abuse. This is one of the most effective ways to stop fraud. Maybe there should be a direct link between public pension fund employees and the state's Attorney General's office or the provincial or federal Auditor General's office.
Third, have your fraud procedures verified by a certified fraud examiner (read more on CFEs by clicking here). This should include someone who scrutinizes travel/meal/entertainment expenses to make sure there is no abuse going on when some hedge fund or private equity manager is trying to woo a pension fund manager to invest with them....
It truly is the Wild West out there, but I am glad to see the Attorney General of New York is pursuing the pension probe and trying to clean up public pension funds.
May 2, 2009 | Mish's Global Economic Trend Analysis
backwards
evolution says: Yesterday, 2:02:50 PM From Automatic Earth:
"It’s funny that many Americans will call the French 'cheese-eating surrender monkeys' and, yet, the French would never quietly slip away into the night to live in a carpark or a tent city while bankers get billions in taxpayer financed bonuses. So why do Americans go so quietly?
The country today is different. America has an enormous middle class that is heavily invested in the financial system and is hardly about to organize for its overthrow.
This mentality, of course, allowed for the greatest transfer of wealth in America since the pilgrims first took this country from the original inhabitants. George Bush and Hank Paulson, with the help of their friendly media barons (the same ones that are now pumping faux populism), warned the country that if they didn’t hand over $700 billion for Hank’s three-page wealth transfer plan, the markets would crash. Well, the ransom got paid, and the markets crashed regardless, but at least the financial oligarchy got their bonuses.
People who have lost half the value of their 401(k) plans, in other words, want to regain it by having the economy rebound, not by seizing the assets of Exxon Mobil Corp. People who have lost a home want to rebuild their credit and buy another one, not liberate the property of the wealthy."Declaration of Dependence.
davepowers says:
great analysis, Mish. thanks for updating
so basically fixed income folks trying to make a buck via interest on their assets have taken a pounding due to lower rates designed, in part, to subsidize those who took on ARM mortgages. once again, the prudent (or attempted prudent) are punished to rescue the less prudent.black swan says:
Helena says“Roger J,
I'm not sure what you find compelling about that minyanville article. It says:"Even I know what that means: The money coming into the market isn't picking stocks on fundamentals, etc. It just wants to be in stocks.
You can make your own conclusions on that one."Sorry, but I just don't find that very profound. I conclude that the movement and force is coming from the big quant funds, and the pressure bursts seem to come all at once. Goldman Sachs is by far the most powerful force moving the US stockmarket.
The Zero Hedge blog site has got the goods on this, and it gives you the stats on an updated basis. The market is all about swing trading. All one has to do to make money is to know which way GS is swinging it. If the news in the real world is really bad, GS punishes the shorters (those who play the market as if it reflects the real world), and takes the market up by forcing them to cover. You can't mess with leverage and momentum, all you can do is try to catch the wave and stay on your board until just before it crashes. When it comes to the crooked card dealers who run the stock market casino, don't bet against the House of Goldman or the House of Morgan.>How could educated professionals NOT know what they signed? I just can't feature what
>people were thinking. Was it a bet that house price would continue the bubble and they would
> have 100Ks worth of equity without paying anything but interest for the short term?The banks and mortgage brokers really pushed these products in some parts of the country. Plus, it's so stressful to buy a house on top of working and taking care of the kids. You just want to get it over with and move in the house. When we bought, they pushed the nonsense ARMs so hard and so relentlessly we almost caved in (even though we'd said "no" many, many times), even though we knew they didn't make sense. Some friends (one traded currencies, the other had a JD/MBA from a top school) did cave in, even though they wanted a fixed. You get tired of fighting the bank or mortgage broker and just do what they want in order to close the deal and move on with your life. You figure you can refi later.
I think it can be really difficult to hold up against all the pressure of the RE broker, the bank, and all the other professionals relentlessly pushing you to take an ARM instead of a fixed unless you are very confident and sure that the ARMs don't make financial sense. Many people aren't sure and do whatever the pros advise them to do.
on retailing, manufacturing and services industries could last "quite a long time," Berkshire Hathaway Chairman Warren Buffett said Saturday.
"I think our retail businesses will not do well for some time" as U.S. consumers save more, Buffett told investors at the company's annual shareholders meeting. "I would not look for any quick rebound in retail, manufacturing and services businesses."Selected Comments (317 Comments)
Arbitrage_Macht_Frei (profile) wrote on Sat, 5/2/2009 - 11:25 am
The great unwashed public only starts saving again, just as the dollar is about to get deep-sixed...
Timing was never their forte.
ShadowInventory (profile) wrote on Sat, 5/2/2009 - 11:30 amAMF - agree that the great masses are financially ignorant...
If we are truly heading into massive inflation, then the place to be is commodities and also money market fund interest rates will be rising along with interest rates in general.. bond prices will fall...
Some stocks will rise - probably Exxon etc... but the market overall will probably be flat to down... I dont play currencies so I dont know how that will shake out - We dont have the Swiss Franc any more as the stalwart and I doubt if the Euro will hold up in inflation...
I would rather have some gold and also there is an etf symbol GSG which represents commodities based on their consumption in the global economy ...
I will be reducing my GNMA bond fund allocation and increasing my commodity allocation if the Fed shows signs that they are not going to hold rates down by buying an infinite supply of tbonds...
MrM (profile) wrote on Sat, 5/2/2009 - 11:40 amAre Buffett's comments enough to pierce the bubble on Monday
(a) Buffett himself acknowledges making a number of really bad calls recently like ConocoPhillips or Wells Fargo
(b) With most institutional investors remaining on sidelines and much of the NYSE volume coming from Goldman Sachs, it is hard to believe that Buffett's comments will move the manipulated marked one way or the other (not that the market would not move for other reasons)
Arbitrage_Macht_Frei (profile) wrote on Sat, 5/2/2009 - 11:43 amI remember the late 70's-early 80's and the mantra was all interest rates all the time, it ruled our lives.
Interest rates don't mean squat this go round, you get almost the same rate of return from your mattress, as you would having your money in the "safest" place, UST's.
UST's are akin to a lifeboat that can only carry so many passengers, and the more people on board, the more risk of capsizing...
1-800-JESUS (profile) wrote on Sat, 5/2/2009 - 11:44 amI've seen similar "low end selling lot hotcakes" postings over on Seattle Bubble. I think this points to two things which are occurring.
First, there are a lot of moron first time buyers who held off for a few months, but are now rushing to buy anything (agents are claiming multiple bids are common now). Second, there is incredible compression coming to the market which will insure these folks are underwater by next year, probably by quite a bit. Those $600k-$2m homes which are not selling at all, and those markets now have years of inventory, will eventually have to fall in price to find buyers.
As they do, the lower end will have to fall even further to compensate. When that will happen is anyones guess, but with the FHA the only game in town eventually these people will want to fall into their loan brackets.
dcr100 (profile) wrote on Sat, 5/2/2009 - 11:45 amBuffett -- "I would not look for any quick rebound in retail, manufacturing and services businesses."
Ummmm, what else is there? Fishing?
ShadowInventory (profile) wrote on Sat, 5/2/2009 - 11:48 amI've been getting 4.5% - 5% in GNMA bonds for years... and if this is the GD2 then that's the place to be.... mmf rates have been below 1% for some time now... GNMA bonds are as good as tbonds for risk... But if rates get out of hand then I'll flip into mmf's again and ride the wave.... With an asset allocation strategy you always wind up buying low and selling high, just not always at the pivot points - but hitting a pivot point is all luck anyway... Asset allocation will not save you from cliff diving however.... But I hope we will not have another big cliff dive in my lifetime...
ShadowInventory (profile) wrote on Sat, 5/2/2009 - 11:51 amA rebound in housing without a rebound in industry? All those buyers have govt jobs? I dont think so... median housing price cant get too much over 3x median income or there is going to be a 'correction'
ShadowInventory (profile) wrote on Sat, 5/2/2009 - 12:03 pmCash is great, right before the devaluation...
ShadowInventory (profile) wrote on Sat, 5/2/2009 - 12:13 pmI tried that 1-800-JESUS number and got a call center in Bangalore...
ShadowInventory (profile) wrote on Sat, 5/2/2009 - 12:20 pmOne nice thing about holding physical gold is that it can be passed along without the govt knowing about it thereby avoiding inheritance taxes... Also gold coins are incredibly beautiful - put a stack on the table and watch your guests get gold fever... But they earn no interest, and a significant amount is really heavy too - then you need a vault etc... So the gold etf is a good choice instead if you just want to play a trading move... but that is really just gambling unless you are prepared for a long holding period and working from long term charts...
energyecon (homepage, profile) wrote on Sat, 5/2/2009 - 1:30 pm
Not zombie banks, vampire banks - keeping them alive is going to suck the life out of the real economy - not an original observation, but one that bears repeating...
May 1, 2009
Today is May Day, and while International Workers’ Day (Labour Day in the UK), means little in the USA, its a big holiday in Europe. Banks and markets are closed on the continent, (England celebrates on Monday).
Speaking with Mike Panzner this morning (his clients are mostly Europeans) made me think about this: Which region is the true Socialist state?
-Europe has cradle to grave health care plans, generous unemployment benefits, and free or subsidized college costs.
-The US gives away public assets (oil, gas, mineral rights) for pennies on the dollar, has huge subsidies and tax breaks, and bails out reckless speculators.
It turns out that both regions are welfare states — only in Europe, the natural population (i.e., people) is the recipient, while in the US, the corporate population is the beneficiary.
Food for thought . . .
Selected Comments
Oleg Says:
May 1st, 2009 at 10:42 amFood for thought: every American consulate in [Eastern] Europe has a long list of people waiting to relocate to the US; not many of the American “natural population” dreams of emigrating to Europe, damn idiots.
Mannwich Says:
May 1st, 2009 at 10:53 am@Oleg: Really? Do you have actual data to back up your claims? I’ve heard from many Americans who love living in Europe and would never come back.
wally Says:
May 1st, 2009 at 11:29 amThe biggest consequence - and least understood - of the Bernanke - Paulson - Geithner - Summers approach to the “crisis” is redistribution of income from future taxpayers, corporations and savers to speculators, wealthy individuals and the financial industry.
Politically, it is also the most dangerous aspect.km4 Says:
May 1st, 2009 at 11:29 amSo far team Obama has done nothing to readily address or materially change so The Triumph of the Banking Oligarchs continues at huge taxpayer expense.
Froglips Says:
May 1st, 2009 at 11:27 amSpeaking of Europe more particularly of my fellows frog citizens,
Unlike the popular US belief, America is still quite popular here. I ain’t going into details but I notice American propaganda is wide spread. Let’s not forget that Europe has been a battle ground for America fighting the communists and the ties run deep. Am I saying socialist parties are controlled by America, yes, and so is Sarkozy.
To be honest, in this environment France is benefiting from having had strong unions who protected manufacturing. On another stand, I just came back from a walk in town where May Day socialist were walking home from their 1st of May labor day parade, these people were affluent, very well dressed representative of the easy life government employees have.
Although unemployment has been rising at about the same rate than in the US, people here have not yet been disturbed by our current great financial implosion. The social benefits are outstanding, top notch medical care is always sought and basically free.
Trouble is still on the program, the cost of socialism is at every level of the economy and it does depend on a fairly well performing economy. France, being a country of officially 65 millions with a 27.6 active population and about half who are employed by some form or another of public entity or from public grants that leaves about 14 millions producing for 65 million. Lay-off have so far been in the producing sector at the rate of 80K per month.
This pyramid is hardly sustainable and with an ever flowing flux of illegal Muslim migrants who gets on the state dole as soon as they step foot, if the coffers run dry or, if the population realizes that their assets held in banks are insolvent things could get out of hands really quick and nasty. French banks heavily invested in wall street and are far from being in good shape.
Having a good medical coverage is natural as well as well constructed retirement benefits. Socialism for the arts and theaters is as useful and perversive as giving it to the wall street bankers.
All in all, French people have a far better life and lifestyle (no GM food crap) have a much longer lifespan. Five weeks of paid vacation and 12 national holidays… a 35 hours work week (an aberration) and a nice country. You won’t get filthy rich, even if you can but, you will live a comfortable life much more so than in the US. With such, I should be off for tropical Africa, if I can take it, for a few years.
African countries are in debt but, not that much in debt, when she has huge mineral resources. I am going…
Bailout watchdog Elizabeth Warren warns that the government stress tests of the nation's largest banks, which are set to be made public next week, will do nothing to improve the health of the banks without sufficient transparency.
"If we don't see the details of the stress test, if we don't see the complete details of the stress test, there's a real possibility no one buys any of the outcomes," said Warren, who chairs the Congressional Oversight Panel, monitoring the Troubled Asset Relief Program. "And [if no one buys the results] then we are where we are today. We are in the same place that we are without the information from the stress tests."
In an interview with the Huffington Post, the Harvard Law School Professor laid down four markers for a stable and sufficient recovery, offered support for the prosecution of individuals proven to have committed crimes that contributed to the economic downturn, and criticized bank executives for their rising compensation levels. She also insisted that if Goldman Sachs wanted to pay back the bailout funds it received to get out from under government restrictions, it should have to return all funds, including guarantees and money it receives as a counterparty to AIG.
But it was her broader comments on the Treasury Department's efforts to resuscitate the banks (delivered from the 5,000-foot high vantage point, as she insists) that stuck out as disconcerting. "The answer is still not clear," Warren said, when asked whether the government had secured enough changes in the business and corporate structure at these financial institutions in exchange for the money offered through its bailout program.
"This is the question I asked at the hearing last Tuesday," she said. "This is why I dragged myself out of bed [while suffering from what one staffer called 'nasty cold']. Because this is the question I care a lot about... And I'm not clear on the answer that the secretary gave."
Part of the problem, Warren said, was that there was not enough transparency with the stress tests and their results, which will be made public on Monday. "So far," she said, "we just don't have enough detail." In some respects, she acknowledged, public perception was as important as reality. If no one has confidence that the test was rigorous, it won't work. At the same time, while it would be difficult to have faith in a process that deemed struggling banks like Bank of America and Citigroup solvent, the public had to understand that it was not beyond the realm of reason.
"Like everything, the devil's in the details. It is entirely possible the banks have excess capital as a result of the capital infusion program," she said, in reference to the two aforementioned institutions.
Transparency, however, is just one component of the recovery process. Accountability, clarity and assertiveness were the other three measures that Warren said would determine whether the U.S. economic recovery would mirror Sweden's quick rebound or Japan's lost decade.
To more closely resemble the former, Warren argued that investigations may have to be launched into whether criminal activity contributed to the financial system ending up in its current state."The public needs confidence that if there was wrongdoing, it would be prosecuted," she said. "Now that's not the same as saying, there are people who should be prosecuted. That requires knowing that there was an underlying crime... However, I do think that people must have confidence that if there was wrongdoing, it would be prosecuted. We can't survive without that."
As for post-bailout malfeasance, already the Special Inspector General has pinpointed 20 cases of potentially illegal misuse of TARP funds. It is a purview separate from Warren's. But the broader point remains true: The process by which the banks are to be revived is a delicate one, demanding openness to ensure the public's trust even if the information unearthed ain't pretty.
Along those lines, Warren argued that the government had to carefully handle Goldman Sachs' proposal to repay the $10 billion it was given in TARP money -- viewed largely as an attempt to free itself from government intrusion.
"I think the message is powerfully important," said Warren. "If a company doesn't want taxpayer dollars and it's willing to repay in full on ALL outstanding obligations -- and let's be clear, on all outstanding obligations, it means all the guarantees, no government involvement -- then... the case for not accepting repayment of taxpayer dollars is very difficult to make."
Likewise, Warren warned that the rise of compensation at some of the nation's largest financial institutions -- to levels similar to or greater than before the current crisis began -- threatened to tear the already fraying thread of public confidence in the financial sector.
"I think there's a fundamental disconnect between bankers who think its business as usual and the public that believes that when banks use hundreds of billions of taxpayer dollars things should change," she said. "A lot of the people wanted to dismiss the consumer anger over AIG and say 'Oh it's just about a tiny little slice, it doesn't matter.'... And I think its much bigger than compensation, I think its much more powerful. I think many, many people have not yet grasped this, many of the experts, the so-called experts, have not grasped the significance [of this]."
The goal, in the end, was to build a new framework around which the banks would not only be revived but the economy itself would find more stable footing. In this respect, the financial system is just the top of the pyramid, critical in helping other facets of the economy but just one of several metrics in determining the government's success.
"As I see it," said Warren, "unemployment continues to climb, foreclosures are on the rise, uh, consumer spending contracts and uh, credit costs are going up. And that is not a stable situation."
naked capitalism
The investigation is another effort to stamp out graft and the practice of "pay to play," which involves giving gifts or campaign donations to win public contracts. So far the probe has looked into the web of relationships and business contracts involving money managers, politicians and pension officials spanning the country from New York City and the state capital, Albany, to Texas, New Mexico and California.
On Thursday, the U.S. Securities and Exchange Commission, which is working with Cuomo, charged that Dallas-based Aldus Equity Partners won New York pension business because of "its willingness to illegally line the pockets of others."
The state pension fund had aimed to hire more women and minority-owned investment firms and had begun talks with one. But Aldus was chosen, Cuomo said, when the minority-owned firm "allegedly refused to pay kickbacks to Morris and another associate."
Aldus, a private equity firm, says it manages over $5 billion, and the probe already has cost Aldus clients in New Mexico and New York. Cuomo said Aldus also is active in Louisiana, Oklahoma, Texas, California, and New York City.
Just this week, the bankers and their lobbyists -- who you might have reasonably stantive bankruptcy reform in the Senate, helped pull the plug on a government-brokered deal with Chrysler, and tried feverishly to throw up a roadblock in the way of credit card reform in the House.
You heard me right. America's bankers -- those wonderful folks who brought us the economic meltdown -- are still being treated as Beltway royalty by those in Congress.
According to Sen. Dick Durbin, the banks "are still the most powerful lobby on Capitol Hill. And they frankly own the place."
When it comes to reforming our financial system, we are truly through the looking glass. I mean, since when did it become "to the vanquished go the spoils"? How do the same banks that have repeatedly come to Washington over the last eight months with their hats in their hands, asking for billions to rescue them from their catastrophic mistakes, somehow still "own the place"?
But the banks continue to be rewarded for their many failures.
Let's start with bankruptcy reform. The banks scored a lopsided victory on Thursday when the Senate rejected an amendment that would have allowed homeowners facing foreclosure to renegotiate their mortgages under the guidance of a bankruptcy judge. The measure would have helped 1.7 million homeowners keep their houses, and preserved an additional $300 billion in home equity.
Given the tidal wave of foreclosures that have so destabilized our economy, this seems like a no-brainer piece of legislation. There were over 800,000 foreclosures in the first three months of 2009 -- more than 341,000 in March alone.
But the banking lobbyists went after it with guns a-blazing - even after Durbin and the measure's other backers seriously diluted the bill. These concessions did nothing to sway the Mortgage Bankers Association (whose members' subprime schemes have helped bring us to the point of collapse), the Financial Services Roundtable, and the American Bankers Association, among other hired guns (check out this video of the Mortgage Bankers Association's annual meeting, held the night before the cramdown vote, and note the overpowering scent of self-congratulations).
And their aim was true -- and deadly. Heading into the vote, those pushing for reform hoped to gather the 60 supporters needed to bring the cramdown amendment to a final vote. Instead, Durbin struggled to find 45 Senators willing to side with consumers. The final tally: Bankers 51, Consumers 45.
Twelve Democrats sided with the banks -- Max Baucus, Michael Bennet, Robert Byrd, Tom Carper, Byron Dorgan, Tim Johnson, Mary Landrieu, Blanche Lincoln, Ben Nelson, Mark Pryor, Arlen Specter, and Jon Tester -- as did every Republican who voted.
As HuffPost's Ryan Grim reported, some of the key Democrats who voted against the measure have been on the receiving end of major banking industry campaign contributions:
The banking and real estate industry have funneled roughly $2 million into Landrieu's campaign coffers over her 12-year career, according to data from the Center for Responsive Politics. The financial sector is Nelson's biggest backer; he's taken $1.4 million from banks and real estate interests... Tester has fielded roughly half a million in his two years in office. Lincoln has taken $1.3 million from banking and real estate interests.In the run-up to the vote, Durbin called it a "test": "Who is going to win this debate?" he asked. "The mortgage bankers and the American Bankers Association or the consumers across America?"
We just got our answer.
The shocking swagger of those in the financial sector was also evident in the negotiations that resulted in Thursday's announcement that Chrysler would file for Chapter 11 bankruptcy.
For much of the back-and-forth between Chrysler, its lenders, and the Treasury Department, those lenders (comprised of banks, including Goldman Sachs, Citigroup and JP Morgan -- all recipients of bailout money -- and private equity firms) were playing hardball. They repeatedly rejected attempts by Treasury to get them to lower the amount of Chrysler's debt.
The car company owes its creditors $6.9 billion. Treasury proposed that the banks and private equity firms accept 15 percent of what they are owed. The creditors scoffed at that and suggested they'd settle for getting 65 percent of what they are owed (around $4.5 billion), plus a 40 percent stake in Chrysler and a seat on the company's board.
Picture this for a moment. On one side you have the Treasury, which has helped funnel tens of billions of dollars to these banks, making what it considers an equitable proposal. On the other side, you have the bankers, the recipients of that government largess, showing their gratitude by scoffing at Treasury's proposal and demanding a much, much better deal. Clearly, Goldman has gotten way too used to sweetheart deals like the 100-cents-on-the-dollar payout it received as part of the AIG bailout.
Treasury eventually upped the proposal to $1.5 billion (22 percent of what the creditors were owed) and a 5 percent equity stake in the carmaker. Again the bankers scoffed, before finally, at the 11th hour, agreeing to accept $2 billion (around 29 percent) and a small equity stake.
A Treasury official took a victory lap, calling the deal "an exceptional accomplishment in line with the President's firm commitment that all stakeholders sacrifice to make this deal succeed."
Then the 12th hour arrived and the hedge fund managers, who hold around 30 percent of the Chrysler debt, decided they didn't want to sacrifice that much after all and refused to sign off on the deal -- even after the offer was sweetened with an additional $250 million. At least the hedge funds had not improved their balance sheets with billions in taxpayer dollars and government loan guarantees before scuttling the deal.
As for credit card reform, the House's resounding 357-70 passage of Carolyn Maloney's Credit Card Holders' Bill of Rights would seem like a rare defeat for the banking lobbyists who furiously opposed it. But a number of elements of the legislation demonstrate that even when the bankers lose, they still win. For instance, despite the desperate urgency of the situation, all but one of the consumer-friendly provisions of the bill won't take effect for a year. And the bill doesn't contain any cap on credit card interest rates -- an amendment to cap rates at 18 percent never got any traction. And, of course, the bankers will get another crack at derailing credit card reform when the Senate takes up its version of the bill, sponsored by Chris Dodd, later this month.
So no matter how badly the banking industry fails and how much its failures cost us, it continues to be Washington's 800 lb gorilla -- and the greatest risk to Barack Obama's presidency.
At his press conference, Obama bemoaned the fact that he "can't just press a button and suddenly have the bankers do exactly what I want."
It's too bad the same can't be said for the bankers, who keep pressing Congress's buttons, and getting pretty much what they want.
P.S. The Huffington Post Investigative Fund is looking for freelance journalists to help delve into the financial crisis/bank bailout. We are accepting investigative story pitches -- and also looking for writers able to take on assignments in this area. Send your resumes and story ideas here.
US households have been a key driver of the multi-decade US credit cycle. Again, circumstances of the moment are completely different than was seen at the last secular low of substance. As a very quick and powerful note, we need to remember that in early 1982, US households held very little in the way of equities. Today you can see the number stands at 17 % of household net worth, but we have to remember this is down from 25% a few years ago as a result of market value contraction since that time. Moreover, this number does not include IRA’s, 401(k)’s, etc. The baby boom generation has been the generation of equity ownership, starting with very little exposure to now significant exposure (inclusive of the qualified plan money). This will not repeat itself again and was a key demand driver of the last three decades.
Interest rates and inflation? Fed interest rate flexibility has been used in its entirety. In 1982, vast flexibility was in the hands of the Fed in terms of being able to shape economic and financial market outcomes vis-à-vis monetary policy. No more and never again anytime soon. For all intents and purposes, headline inflation has been completely rung out of the system…for now. All of the potential for lowering interest rates and riding a powerful wave of disinflation wildly supportive to real economies and financial markets (including valuations) is behind us, not in front of us.
Finally, we’ve used the Bob Shiller historical S&P P/E data as valuation markers for equities in this little compare and contrast exercise. S&P yields have been climbing as of late, but from very low points in prior years. Moreover, clearly getting in the way here has been meaningful dividend cuts or outright elimination over the last year. This is not about to stop any time soon. Point being, we’re on our way, but at nowhere near equity character secular lows of historical note. Simple enough. Likewise, although P/E multiples are now very low relative to recent period experience, this assumes earnings trough now, which is not necessarily a given. You can also see that Shiller P/E numbers even after the already in place contraction are twice what was seen at the secular lows of 1982, not that these secular low P/E's are a prerequisite for bull markets, but they sure do help in terms of framing potential risk/reward outcomes.... ... ...
Personally we do not believe the infrastructure components are currently in place to support a new secular bull market, despite the S&P and equity index friends essentially going nowhere point-to-point over the last decade. But that certainly does not mean there are no investment opportunities. Quite the opposite. What these numbers tell us is that a reconciliatory period for the US will probably extend for years, meaning volatility will be a fact of life. Secondly, we simply need to think and act differently ahead relative to correct behavior in the secular equity and economic bull of the 1982 period to date. The context of the global is the reference point from which we need to work. Circumstances today are different than the prior equity and economic secular lows. Not bad at all, but different. This is the very thinking which will shape our actions ahead.
FT.com Willem Buiter's MavereconCDS in Kazakhstan
A fascinating contribution by Gillian Tett in today’s Financial Times on the role of CDS in the default of the largest Kazakh bank, BTA, raises a number of wider issues. Last week, BTA went into partial default when Morgan Stanley and another bank demanded repayment of loans they had made to BTA and BTA was unable to comply. Tett also discovered that, just after calling in its loan to BTA, Morgan Stanley asked the International Swaps and Derivatives Association (ISDA) to start formal proceedings to settle credit default swaps contracts written on BTA. I don’t know the aggregate value of the credit default swap contracts written on BTA that Morgan Stanley owned, whether it was smaller or larger than the value of the loans to BTA called by Morgan Stanley, or who the writer(s) of these CDS contracts was or were. But it raises concerns.
The reason it raises concerns can be made clear with the following hypothetical example. Assume some large western bank, let’s call it St. Manley Organ Bank, has made a loan of size A to BTA or has bought its debt in amount A. As a creditor to BTA, St. Manley Organ would normally want to avoid a default by BTA, because St. Manley Organ is bound not to get paid in full in the event of a default by BTA. Continue reading "Derivatives and attempted state capture in Kazakhstan"
- 1. "If St. Manley Organ had bought CDS contracts for a larger amount of BTA debt than it owns, that is, if A < L, then St. Manley Organ has a net short position in BTA debt, provided the writer (seller or issuer) of the CDS is creditworthy." Is there any chance that the idiot who sold insurance to a larger value than the debt is creditworthy?
Posted by: Pait | May 1 07:32pm | Report this comment
2. In conventional insurance markets there are mechanisms to prevent individuals from insuring more than their potential loss (eg putting an excessive value on house contents). If a loss occurs, insurers will limit the payout to fixing the actual damage, or replacing the ruined carpet. There are also mechanisms for sharing information to make sure you do not insure (and claim on) the same risk with two insurance companies.
Since CDS are bets, not insurance contracts, these mechanisms are absent - you can over-insure and (via the auction mechanism) obtain compensation for losses you have not incurred. The seller of CDS protection does not behave like an insurance company - it is more like a bookmaker, in that it accepts a small bet which has a low probability of winning. Like bookmakers, CDS sellers do not care how much others are willing to bet against them, and they have no way to find out. In any case you could always achieve a net short position by purchasing CDS on the same risk from two different counterparties.
Acquiring this sort of short position would not matter if St. Manley Organ has no mechanism for affecting the outcome (this is why bookmakers do not care about the size of your bet, provided that you cannot fix the horse-race). But if St. Manley Organ can precipitate default (for example, by refusing to permit rescheduling even if this is clearly in the interest of an unprotected creditor) then there is a real moral hazrd issue.
All of this is also relevant to the bankruptcy of Chrysler, and the impending fate of GM. It would be very interesting to know what the net CDS positions of the bondholders who rejected restructuring were. But I do not know of any way to find out.Posted by: William Peterson | May 1 08:31pm | Report this comment
Angry Bear
rdan
May 1st, International Workers' Day, commemorates the historic struggle of working people throughout the world, and is recognized in many countries (66?) but not the United States, Canada, and South Africa. This despite the fact that the holiday began in the 1880s in the United States, with the fight for an eight-hour work day.
The WHO has designated swine flu an "imminent" pandemic, and raised its alert to a level 5 out of a possible 6. The World Bank guesstimates the cost of a severe pandemic at 4.8% of world GDP (yikes!). Yet the US had a very nice day for equity investors yesterday, and the Japanese stockmarket is up handsomely as of this hour. What gives?
The usually dour Ambrose-Evans-Pritchard argues yes, in reporting that is less apocalyptic than his normal style, argues that investors are underestimating the possible repercussions:
Over the last couple of days I have been deluged by notes from City analysts and economists suggesting that H1N1 avian-swine flu poses no great threat to the global economy because the authorities showed during the 2003 SARS epidemic in Asia that outbreaks can be contained.
This is a misreading of the threat we face.SARS is a coronavirus. It is extremely hard to catch. Just 8,000 people were infected worldwide during the entire epidemic (10pc died).
Today's H1N1 outbreak is an influenza virus, which is far more contagious.
Dr. Keiji Fukuda, the WHO's assistant director-general, said it is already too late to stop the spread of the disease. “At this time, containment is not a feasible option.It is entirely possible that we may see a very mild pandemic. I think we have to be mindful and respectful of the fact that influenza moves in ways we cannot predict.
The worst pandemic of the 20th century occurred in 1918, and it also started out as a relatively mild pandemic that wasn’t very much noticed in most places. Then in time it became a very severe pandemic, one of the most severe infectious disease episodes ever recorded.
Perhaps because so few market players studied science, or have a current link to science, they seem not to realize that the world’s virologists and flu experts are in a state of nail-biting, ashen-faced, fear.Rob Carnell, chief economist at ING, is one of the exceptions. “We believe fear of infection will lead to drastically altered behaviour. It may be that swine flu does not tip the human fear scale sufficiently, but if it did, with the economy already in tatters, the results could be catastrophic,” he said in a note today.
We may be lucky. The virus may indeed prove mild - like the Hong Kong flu in 1968 - or burn out altogether as it mutates.
The early cases in the US and Canada give hope. So does the apparent fall-off in the fatality rates in Mexico.
But as Dr Fukuda said, nobody can pre-judge the virulence of this pandemic. Least of all the markets.
Mexico City illustrates what can happen. People are avoiding discretionary outings. As the BBC reports:What was once one of the noisiest, dirtiest, busiest places in the world, has become strangely sterile - a quiet city, where many people wear masks outdoors, and most don't go out.
In Mexico City alone, the mayor, Marcelo Ebrard, has put the figure at $88m (£59m) a day
But how much will swine flu hit the wider Mexican economy?Tourism, which represents 8% of Mexico's gross domestic product (GDP), is the sector which will inevitably be hardest hit.
In the current environment, most people see little incentive to visit Mexico, and plenty of reason to leave.
The Mexican government has lobbied hard behind the scenes to prevent its borders being closed, or any formal quarantine being imposed.
But other governments and airlines are beginning to apply their own restrictions.
Cuba and Argentina have already stopped direct flights to Mexico. France is seeking a formal European ban on flights.The real cost of swine flu depends on how long this crisis lasts.
UBS bank in Mexico City estimates the crisis could take out 0.2% of annual GDP if it subsides in the next two weeks, or 0.8% of GDP if it goes on for two months.
- The Cost Of A "Non-Trivial" Flu Epidemic(Zero Hedge, 4/29/09)
From the Daily Telegraph:
The World Bank estimated in 2008 that a flu pandemic could cost $3 trillion (£2 trillion) and result in a nearly 5% drop in world gross domestic product. The World Bank has estimated that more than 70m people could die worldwide in a severe pandemic.Australian independent think-tank Lowy Institute for International Policy estimated in 2006 that in the worst-case scenario, a flu pandemic could wipe $4.4 trillion off global economic output.
Two reports in the United States in 2005 estimated that a flu pandemic could cause a serious recession of the US economy, with immediate costs of $500bn-$675bn.ARS in 2003 disrupted travel, trade and the workplace and cost the Asia Pacific region $40bn. It lasted for six months, killing 775 of the 8,000 people it infected in 25 countries.
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May 29th, 2009 at 11:00 pm
Through some quick Jethro like ciphering: about $2.7B flowed into SPY in the last 10 minutes today. The volume was about 3x the recent normal. Now if you’re big money and wanted in, why would you wait until the close and run up the price on yourself? Unless you wanted to run up the price.
The portion of my brain that wants to believe in conspiracies (the paranoidamus) thinks the PPT plan was to snug up the SPY and QQQQ at the May 8 highs. Then Monday morning, throw a few more $billion at the open to blow through that resistance point, send the shorts scrambling, and we’re off to 1000.