Wednesday, July 29, 2009

Fareed Zakaria Interviews Roubini, Zuckerman, and Ferguson

I found this interview from CNN really interesting. It is fascinating to listen to some real heavy hitters talk about the economy and what the future holds for us. The scariest comment in the interviews occurred about half-way thorugh when Dr. Ferguson commented that world wide houselhold assets have fallen to 1989 levels, but the associated debt has hardley declined. So we lost 20 years of wealth, but kept all the debt. How can that be counted as a good thing?


Monday, July 27, 2009

Bernanke Takes His Show on the Road - It is About Time!

Anyone that has ever played competitive sports in front of a crowd, realizes that the game looks a lot different on the field than it does from the stands. The players also get tired of "Monday morning quarterbacks" who try to tell them what they did wrong when the complainers were in fact not on the field and had "no skin in the game". That is my view of Ben Bernanke. Everyone wants to criticize the job he is doing, but 99+% of the people criticizing could not do his job, do not appreciate the pressure he is under, and would more than likely have gone into cardiac arrest sometime last fall. I am glad to see that he is going on the road and taking his show to the people. Ben Bernanke, probably the most important person the US, should spend a little more time amongst the people. Just maybe the people will understand what Ben does and Ben will get to know them. After all that is where he is from. Text in bold is my emphasis. From Reuters that is also Yahoo News:

Federal Reserve Chairman Ben Bernanke traveled to the U.S. heartland to defend the central bank's actions and reaffirm his assessment of an improving, but still vulnerable, U.S. economy.

Taping a special that will air on television network PBS over three days this week on its program The NewsHour, Bernanke said a financial crisis that rivaled that of the 1930s needed decisive actions.

"I was not going to be the Federal Reserve Chairman who presided over the second Great Depression," Bernanke said.

"When you're in a situation like this, a perfect storm, sometimes you have to do things that are a little unorthodox, out of the box."

About 190 citizens from the Kansas City area, assembled by a nonpartisan civic group, were on hand for the taping at the Kansas City Fed, moderated by veteran news anchor Jim Lehrer.

Some two dozen peppered the chairman with questions ranging from the Fed's role in consumer protection actions, to efforts to stem foreclosures, to the outlook for the dollar.

Bernanke sought to demystify the role of the Federal Reserve, and especially debunk ideas that the Fed has almost unfettered power as an unelected fourth branch of government.

"I'm answerable to the American people," Bernanke said.

Bernanke said the Fed is doing all it can to turn the U.S. economy around, and that he was confident the nation would be back on a strong growth track within a few years.

"The Federal Reserve has been putting the pedal to the metal," he said, adding that "recessions happen," even though the current one is especially long and painful.

Bernanke's core message was similar to that he delivered last week in congressional testimony: that the recession should end soon, but that considerable risks remain -- especially relating to the labor market.

It takes GDP growth of about 2.5 percent to keep the jobless rate constant, Bernanke noted. But the Fed expects growth of only about 1 percent in the last six months of the year.

"So that's not enough to bring down the unemployment rate," he said.

Latest government data show the U.S. unemployment rate at 9.5 percent, the highest since 1983, and many forecasters expect the rate to keep climbing even after the recession technically comes to a end.

With unemployment high and factories producing well below capacity, inflation should not be a problem -- giving the Fed some breathing room on interest rates, Bernanke said.

"But once the economy starts to grow, and begins to move ahead, it will be very important for the Fed to start to unwind, to raise interest rates."

Asked about his opinion on the dollar, a topic many Fed officials veer away from, Bernanke said the U.S. central bank, in general, supports a strong dollar policy.

"The best way to have a strong dollar is to have a strong economy," he added.

Mostly cool under fire, Bernanke bristled with emotion when asked about a measure before Congress to open the Fed's monetary policy decision-making to scrutiny by a congressional watchdog, the Government Accountability Office.

"I don't think the American people want Congress running monetary policy. That's exactly what (the bill) would do," he said.

Markets would likely assess that inflation would rise if Congress or the administration started to meddle with interest rate decisions, he added.

A group of about two dozen protesters picketed outside the Kansas City Fed building on Sunday night to call for more disclosure by the central bank.

As he did in testimony on Capital Hill last week, Bernanke suggested Congress get its own act together -- and form a plan to get massive budget deficits under control.

"It is very, very important for the Congress and the administration to develop a plan, to say, 'Here is how we're going to get back to fiscal sanity.'"

Retirees Elbert and Gloria Willingham of Overland Park, Kansas, who were among the studio audience, gave Bernanke two thumbs up.

"I'm very impressed with Bernanke. I strongly hope that Obama sees fit to reappoint him -- it would be bad for the economy if he didn't," Elbert Willingham said.

"He's down to earth and believable. He's got the ideas, but also the practical understanding," his wife added. "He cares about the small businessman.

Bernanke's term as chairman ends in January and while his reappointment is seen as likely, it is not a given.

Sunday's event was the latest in a series of moves by Bernanke to communicate outside of the Fed's usual channels.

Bernanke recently spoke at the National Press Club in Washington, and last week outlined the Fed's likely "exit strategy" from its unconventional policy programs in an op-ed piece in the Wall Street Journal.

Friday, July 24, 2009

The Good News is the Economy is Probably Hitting Bottom - The Bad News is the Economy is in Quite a Hole

I thought the editorial today in the WSJ was a balanced and fair discussion of the economy. It is probably hitting bottom in many sectors, but there is still plenty of nasty macroeconomic numbers out there (namely, unemployment related). I especially like the way the author explains that even if there is no growth (that is there is no improvement), at least we are not declining any longer. However, let's not all get excited about the recovery. As the author points out we are in quite a hole and it is going to take some time to climb out of the hole. Text in bold is my emphasis.

How’s the economy, you ask? I have the proverbial good news and bad news, but in this case, they’re exactly the same: The U.S. economy appears to be hitting bottom.

First, the good news. Right now, it looks like second-quarter GDP growth will come in only slightly negative, and third-quarter growth will finally turn positive. Compared to the catastrophic decline we recently experienced—with GDP dropping at roughly a 6% annual rate in the fourth quarter of last year and the first quarter of this year—that would be a gigantic improvement.

Furthermore, there is a reasonable chance—not a certainty, mind you, but a reasonable chance—that the second half of 2009 will surprise us on the upside. (Can anyone remember what an upside surprise feels like?) Three-percent growth is eminently doable. Four percent is even possible. Surprised? How, with all our economic travails, could we possibly mount such a boom? The answer is that this seemingly high growth scenario isn’t a boom at all. Rather, it follows directly from the arithmetic of hitting bottom.

Bear with me for two paragraphs while I do some numbers. In recent quarters, several critical components of GDP have declined at truly astounding annual rates—like minus 30% and minus 40%. You know the culprits: housing, automobiles and business investment. (Also inventories, about which more later.) Eventually, those huge negative numbers must turn into (at least) zeroes. Notice that the move to zero doesn’t constitute a boom, not even a dead cat bounce, but merely the cessation of catastrophic decline. In fact, hitting zero growth and staying there would be a disaster scenario. We’ll almost certainly do better.

But watch what happens when—and remember, it’s when not if—the arithmetic of bottoming out takes hold. Housing, which is down to 2.6% of GDP, will serve as an example. In the first quarter, spending on new homes declined at a stunning 39% annual rate. If that minus 39% number turned into a zero in a single quarter, that change alone would add a full percentage point to that quarter’s GDP growth (because 2.6% of 39% is about 1%). If the move to zero were to happen over two quarters, it would add about a half point to each. Many people think housing may in fact bottom out in the third or fourth quarter. Autos may already have passed their low point. And business investment will follow suit.

Now back to inventories. Recent quarters have seen an almost unprecedented liquidation of inventory stocks, which means that American businesses were producing even less than the paltry amounts they were selling. That, too, must come to an end. As inventory change turns from a large negative number into just zero, GDP will get another a big boost.

Now the key point: None of these events are probabilities; they are all certainties. The only issue is timing, about which we can only guess. But if several of these GDP components happen to bottom out at roughly the same time, we could be in for a big quarter or two.

Feeling a little better? There’s more.

Remember the fiscal stimulus that everyone seems to be complaining about? One of the critics’ complaints is that little of the stimulus money has been spent to date. OK. But that means that most of the spending is in our future.

And remember all those interest-rate cuts the Federal Reserve engineered in 2008, in a futile effort to stem the slide? The Fed’s efforts were futile largely because widening risk and liquidity spreads negated any impacts on the interest rates real people and real businesses pay to borrow. Now those spreads are narrowing, which allows the Fed’s rate cuts to start showing through to consumer loan rates, business loan rates, corporate bond rates, and the like. In short, monetary stimulus is in the pipeline—a pipeline that was formerly blocked.

So why, then, is everyone feeling so blue? That brings me to the bad news: The U.S. economy is hitting bottom.

If things feel terrible to you, you’re not hallucinating. Economic conditions are dreadful at the bottom of a deep recession. Jobs are scarce. Layoffs abound. Businesses scramble for penurious customers. Companies go bankrupt. Banks suffer loan losses. Tax receipts plunge, ballooning government budget deficits. All this and more is happening right now, in what looks to be this country’s worst recession since 1938. At such a deep bottom, few people have reason to smile. (Bankruptcy lawyers maybe?)

What’s more, GDP is not terribly meaningful to most people. Jobs are—but they will take longer, maybe much longer, to revive. The last two recessions, while shallow, illustrated painfully that job growth may not resume for months after GDP bottoms out. And the unemployment rate won’t fall until job growth rises “above trend” (say, 130,000 net new jobs per month). That’s a long way from where we are today. So, even though the economy may be making a GDP bottom about now, the unemployment rate will probably keep rising for months—which is bad news for most Americans.

One last, obvious, but unhappy, point: The bottom of a deep recession leaves the nation in a deep hole. Our economy now has massive unemployment and vast swaths of unused industrial capacity. It will take years of strong growth to return to full employment.

After the last big recession bottomed out at the end of 1982, the U.S. economy rebounded sharply, with a remarkable six-quarter spurt in which annual GDP growth averaged 7.7%. That spurt induced President Ronald Reagan, running for reelection in 1984, to declare “It’s morning again in America.” Nobody thinks we can repeat that today, hampered as we are by a damaged financial system, decimated household wealth, rising foreclosures, and traumatized consumers who have suddenly learned the virtues of thrift.

So, yes, the good news is also the bad news. The economy is hitting bottom, but it’s a long, uphill climb to get out.

Thursday, July 16, 2009

B of A Under a Memorandum of Understanding

I include this article, not because I am trying to take a swipe at B of A, but because it speaks to the overall fragility I keep hearing about in banking from various contacts in the industry. Fragile does not mean B of A or the banking industry is broken, but it does mean that we and the banks could be in for a few sleepness nights before all this over. From Yahoo News:

Bank of America Corp is operating under a secret U.S. regulatory sanction that requires it to overhaul its board and address perceived problems with risk and liquidity management, The Wall Street Journal reported, citing people familiar with the situation.

Rarely disclosed publicly, the so-called memorandum of understanding (MOU) gives banks a chance to work out their problems without the glare of outside attention, the paper said.

Financial institutions that fail to address deficiencies can be slapped with harsher penalties that include a publicly announced cease-and-desist order, the newspaper said.

According to the paper, the order was imposed in early May, shortly after shareholders of the bank stripped Chief Executive Kenneth Lewis of his duties as chairman.

The MOU is the most serious procedural action taken against Bank Of America by federal regulators since the financial crisis erupted, the newspaper said.

The report said the MOU surprised some Bank Of America executives who had not expected federal regulators to issue such a formal rebuke. It said the bank responded swiftly with six directors resigning since May 26.

Bank of America faces a series of deadlines, some at the end of July and others in August, the paper said.

Foreclosures are Up in the 2nd Quarter

In spite of all the efforts of various governmental agencies foreclosures continue to increase in the US. A combination of a weak housing market and increasing unemployment are moving more and more families into a foreclosure position. It is now about 1 in 84 households. The 2nd quarter 2009 is the highest on record in terms of the number of foreclosures. Someone please explain to me again about green shoots. From Market Watch:

U.S. properties in the process of foreclosure in the second quarter rose to a record quarterly level of nearly 890,000, RealtyTrac reported on Thursday.

The total is up 11% from the first quarter and 20% from the year-earlier period, the Irvine, Calif., online marketplace and research firm reported.

In June, properties in foreclosure totaled 336,000, exceeding 300,000 for a fourth month and driving the second-quarter total to the highest level since RealtyTrac began its survey in the first quarter of 2005.

As of June 30, nearly 1.53 million U.S. properties were subject to a default notice, auction-sale notice, or bank repossession, RealtyTrac reported.

Nearly 1.2% of all U.S. housing units -- 1 in 84 -- were subject to a foreclosure filing in the first half, RealtyTrac reported.

Despite an industrywide moratorium on foreclosures earlier this year plus legislative action and more efforts by lenders to modify the terms of mortgages, "foreclosure activity continues to increase to record levels," RealtyTrac Chief Executive James J. Saccacio said in a statement.

Wednesday, July 15, 2009

A View About the Last 9 Months

Below are some comments about what has occurred in the last 9 months. I like these comments because the author cuts to the point about the mixed results of the last 9 months. Furthermore, he explains that our Uncle Sam cannot continue to prop up the market and eventually the market will have to sustain itself, or not. But, ultimately, it is on its own. Text in bold is my emphasis. From the WSJ:

I remember once buying the stock of a small company and I couldn't believe my luck. Every time my fund bought more shares the stock would go up. So we bought even more and the stock kept climbing. When we finally built our full position and stopped buying the stock started dropping, ending up at a price below where we started buying it. We were the market.

Just about every policy move to right the U.S. economy after the subprime sinking of the banking system has been a bust. We saved Bear Stearns. We let Lehman Brothers go. We forced Merrill Lynch, Wachovia and Washington Mutual into the hands of others. We took control of Fannie and Freddie and AIG and even own a few car companies, pumping them with high-test transfusions. None of this really helped.

.We have a zero interest-rate policy. We guaranteed bank debt. We set up the Troubled Asset Relief Program (TARP) to buy toxic mortgage assets off bank balance sheets. But when banks refused to sell at fire sale prices, we just gave them the money instead. Dumb move. So we set up the Public-Private Investment Program to get private investors to buy these same toxic assets with government leverage, and still there are few sellers. Meanwhile, the $1 trillion federal deficit is crowding out private investment and the porky $787 billion stimulus hasn't translated into growth.

At the end of the day, only one thing has worked -- flooding the market with dollars. By buying U.S. Treasuries and mortgages to increase the monetary base by $1 trillion, Fed Chairman Ben Bernanke didn't put money directly into the stock market but he didn't have to. With nowhere else to go, except maybe commodities, inflows into the stock market have been on a tear. Stock and bond funds saw net inflows of close to $150 billion since January. The dollars he cranked out didn't go into the hard economy, but instead into tradable assets. In other words, Ben Bernanke has been the market.

The good news is that Mr. Bernanke got the major banks, except for Citigroup, recapitalized and with public money. June retail sales rose 0.6%. Housing starts jumped 17% month to month in May and will likely be flat for June. Second quarter GDP may be slightly up. And he was successful in spreading a "green shoots" psychology throughout the media. But the real question is, now what? Government interventions are only meant to light a fire under the real economy and unleash what John Maynard Keynes called our "animal spirits." But government dollars can't sustain growth.

Like it or not, the stock market is bigger than the Federal Reserve and the U.S. Treasury. The stock market anticipates only future profits and prosperity, not government-funded starter fluid. You can only fool it for so long. Unless there are real corporate profits from sustainable economic growth, the stock market is not going to play along. It's the ultimate Enforcer.

In mid-May, Mr. Bernanke's outlook seemed to change. Maybe he didn't approve of the sharp housing rebound -- like we need more houses! Maybe he saw inflation in commodity prices -- oil popping to $72 from $35. Or, more likely, he finally realized that he was the market and took his foot off the money accelerator, as evidenced in the contracting monetary base (see nearby chart). Sure enough, things rolled over -- the market dropped 7.5% from its peak, oil prices dropped almost 17%, and even gold has lost some of its luster. But in July, the Fed started buying again and the market rallied.

Can the U.S. economy stand on its own two feet without Mr. Bernanke's magic dollar dust? Eventually, but apparently not yet. Unemployment stubbornly hit 9.5% in June, according to the Bureau of Labor Statistics. Housing prices are still dropping, albeit at a slower pace, and foreclosures are still rampant.

But I think what really bothers the market is that the structural problems that got us into trouble in the first place still exist. We took the easy way out and, with the help of Treasury Secretary Tim Geithner's loose "stress tests," swept banking problems under the carpet. We waved off mark-to-market accounting and juiced bank stock prices to help them recapitalize, but all those toxic mortgage assets on bank balance sheets are still there as anchors on lending. All the pump priming and stock market flows didn't get rid of them.

Hats off to Mr. Bernanke for getting the worst behind us. He'll be pressured politically to keep pumping out dollars, but he should resist the urge. The stock market will ignore his dollars if it doesn't believe they'll turn into real profits. Green jobs and government health-care clerks do not make a productive, sustainable economy. That can only come from innovative companies with access to growth capital. The stock market won't turn bullish until it sees that type of economy.

Again, when it's clear that you are the market you have to stop buying and begin tackling the hard stuff. By not restructuring banks, by not getting bad loans off bank balance sheets, by not standing up to the massive increases in government debt crowding out private capital, the Fed and Treasury are holding back real economic growth.

The Handwriting is on the Wall

The handwriting is on the wall. When the President wants to increase appropriations to community colleges, he is not doing this because he has extra money to spend. He is basically saying that our national workforce has to re-trained. The old economy is gone and it is not coming back. In fact I would add one more thing to re-training. Pick a profession that has a future. Forget about learning how to fix computers, these are becoming appliances. The growth in the future is going to be in the medical and phyical care of the baby boomers and the medical profession is usually understaffed.

In addition if you can afford it move out of areas that were hard hit by the economic downturn to areas that are more economically viable. You can find these on the internet. For example, choose places where the state or local unemployment rate is below the national average of 9.5%. Go visit the place and see how hard it is to get a job and see what kind of workers the area needs.

Text in bold is my emphasis. From the WSJ:

Obama announced a $12 billion community-college initiative designed to boost graduation rates, improve facilities and develop new technology.

The president framed the initiative as an opportunity to change the face of Rust Belt states like Michigan that have traditionally relied heavily on unskilled labor, particularly in the manufacturing sector.

"Some of the jobs that have been lost in the auto industry and elsewhere won't be coming back," President Obama said in a speech at Macomb Community College in Warren, Mich., "They are casualties of a changing economy." . . . .

. . . . While small compared to the $100 billion in stimulus money the Obama administration has to spend on education, it would mark a substantive increase in direct federal spending on community colleges. A recent report by the Brookings Institution, a liberal think tank, estimated the federal government provides community colleges with about $2 billion a year in direct support, about a tenth of what it spends on public-four year schools.

Mr. Obama has called education key to the nation working its way out of the recession and competing more effectively internationally. Saying he wants to bolster high-school and college-graduation rates for all Americans, he has used the availability of additional federal funds to try to persuade budget-strapped states, public schools and colleges to undertake new initiatives.

The president said the program is inspired in part by a Michigan program that offers displaced auto workers tuition assistance at community colleges to seek retraining for alternative careers, such as in the health-care industry, which until recently has been expanding in the state.

Administration officials said they plan to fund the new initiative with savings that result from proposed changes in the federal student loan program. They have proposed eliminating private lenders from the program and making the federal government the sole lender. The Congressional Budget Office has estimated such a change would save $87 billion over the next decade, although it still faces opposition from private lenders.

Enrollment at two-year schools has been booming for more than a decade, due partly to increased demand for more college-educated workers and sharply higher costs of a four-year college degree. Still, community colleges in many states have seen their funding cut as state budgets have floundered. This has forced many to cut some course offerings and classes even as they are enrolling more students. Concerns have grown that these institutions will not be able to meet the growing need.

Of the nation's 18.7 million graduate and undergraduate college students, about 6.7 million, or 36%, attend two-year schools. With an average age of 29, they tend to be older than students at four-year schools and work longer hours at jobs outside the classroom. Many need remedial classes; fewer than a third earn their associates degrees in three years or less.

In a conference call Monday, Martha Kanter, undersecretary of education, said the nation's two-year colleges and their students have experienced "significant economic hardship" during the current recession. "And we're very concerned about providing access and opportunity during this terrible fiscal climate," she added.

Of the funding, $9 billion will be used to award grants through an "access and completion" fund. These grants are designed to spur community colleges and states to launch programs designed to raise graduation rates and produce graduates who are ready for the workplace or for a transfer to a four-year school. Administration officials say such measures could include forming partnerships with major employers or bolstering counseling and remedial-education programs.

Another $2.5 billion will help pay for renovations to community-college facilities. Administration officials said many are outdated, short on class space and ill-equipped to handle modern technology. The funds are to be used as seed money to help raise private funding or to pay the interest on construction bonds and loans.

About $500 million will be used to develop online curriculum for community-college students.

Monday, July 13, 2009

Preview of Roubini's (RGE Monitor) Quarterly Forecast - Things Remain Weak

Below is a summary of Nouriel Roubini's quarterly forecast of the US economy, which remains fairly weak. My only comment is that Dr. Roubini has put the forecast in its best possible light. I hope he is right. Text in bold is my emphasis. From the RGE Monitor:

The United States is in the 20th month of a recession that has been by far the longest and most severe of the post-war period. While comparisons with the Great Depression are frequent and appropriate (especially if we look at the pace of contraction in industrial production), the aggressiveness of policy measures has significantly reduced the probability of a near-depression. Economic activity fell off a cliff in Q4 2008 and Q1 2009, with two consecutive quarters of sharp contraction – by 6.3% and 5.5% respectively – in line with our previous forecasts. The general consensus is that this recession will end sometime in the second half of 2009. While RGE Monitor expects more quarters of negative real GDP growth in 2009, we also expect the pace of contraction of economic activity to slow significantly. We forecast negative real GDP growth in Q2 2009 and Q3 2009, and for real GDP to remain flat in Q4. After the sharp contraction in economic activity in 2009, growth will reenter positive territory only in 2010, and then at a very sluggish rate, well below potential.

Even if economic activity stops contracting by the end of 2009, that might not mark the official end of this recession. Recessions are not measured exclusively by GDP contractions. Unemployment, industrial production, real manufacturing, wholesale retail trade sales and real personal income (less transfer) are all considered when it is time for the National Bureau of Economic Research (NBER) to put dates around recession periods. As reported by the NBER, this recession started in December 2007, and all the above indicators peaked between November 2007 and June 2008. U.S. real GDP will stop contracting at the end of 2009, but it is likely that many of the above indicators will not bottom out (or peak, in the case of unemployment) before mid-2010.

Improvements in real economic activity are present and visible in the reduction of the pace of job losses, in the improvement in indicators of manufacturing activity, in the stabilization of housing starts and in the improvement of financial conditions. However, RGE Monitor does not yet see signs of a strong and sustainable recovery.

Lingering Concerns


Labor market conditions are still quite dire, more than 3.4 million jobs have been lost in 2009 and about 6.5 million have been lost since the beginning of the recession. Compare this with the 2.5 million jobs lost in the recession of 2001; 1.5 million lost in the recession of the early 1990s; 3 million in the one of the early 1980s; 2.2 million in the one of the 1970s. The pace of job losses has fallen from the 600K plus per month registered between December and March 2009 to about 350K in May and 467K in June; the average monthly job losses in this recession is now at about 360K. While the recent slowing of losses is a positive development, we have to put this in perspective: in previous post-war recessions, average monthly job losses have ranged between 150 thousand and 260 thousand. Moreover, average weekly hours in private nonfarm payrolls are at the lowest since 1964, as employers have cut employees’ hours. Job openings and turnover openings continue to fall and are at the lowest levels since 2000, indicating continued weakness in the economy.

The U.S. consumer is still the engine of U.S. growth, and contributes to over 70% of aggregate demand. While saving rates are headed for the high single digits and high oil prices together with long-term rates keep putting a dent in personal consumption, the over-leveraged consumer is finding some support in the tax breaks of the fiscal stimulus package. Yet the over-indebted U.S. consumer – whose deleveraging process yet has to start – will likely continue to put the brakes on consumption, while the savings rate continues to creep up. While this will encourage a rebalancing in the U.S. and global economy, in the medium-term it isn’t likely to support strong U.S. and global growth.

Housing starts appear to have stabilized and will likely move sideways for quite some time. However, housing demand is not yet improving at a pace that can guarantee that the lingering inventory overhang will dissipate. This implies that home prices will continue to fall. RGE Monitor expects home prices to continue to fall through mid-2010.

U.S. industrial production has been contracting for 17 months in a row – with a short break in October 2008. Industrial production usually finds a bottom shortly after the ISM manufacturing index does. While the index probably found its bottom back in December 2008--at depression levels of 32.9--industrial production remains in a mode of contraction that started in January 2008.

Financial conditions are showing some improvement. Banks are borrowing at zero interest rates and higher net interest margin can definitely help rebuild capital. Regulatory forbearance, changes in FASB (Financial Accounting Standards Board) rules and under-provisioning might enable banks to post better than expected results for a few quarters. However, relaxation of mark-to-market rules reduces the banks’ incentives to participate in the Public-Private Investment Program (PPIP) and therefore reduces the likelihood that the program will succeed in clearing toxic assets from banks’ balance sheets. The muddle-through approach might be successful in a scenario in which the U.S. and global economy recover soon and go back to potential growth during 2010, but according to RGE’s forecasts, this is highly unlikely. While we might have positive surprises coming from the banking system in the next couple of quarters, the situation could turn around again after that, jarring confidence in financial markets in a way that would spill into the real economy. Increases in the unemployment rate, well beyond the rates envisioned by the adverse scenario of the recent bank stress tests, imply that recapitalization needs are larger than what the too-lenient stress test prescribed. The U.S financial system – in spite of the massive policy backstop – thus remains severely damaged, and the credit crunch remains unlikely to ease very fast.

A sharp rise in public debt burden – the U.S. Congressional Budget Office estimates that the public-debt-to-GDP ratio will rise from 40% to 80% (in the next decade), or about $9 trillion – will also put a dent on growth. If long-term rates were to increase to 5%, the resulting increase in the interest rate bill alone would be about $450 billion, or 3% of GDP. The implication is that the fiscal primary surplus will have to be permanently increased by 3% of GDP, which could constitute further pressure on the disposable income of the U.S. consumer.

Not only does the U.S. economy face downward risks to growth in the medium-term, but potential growth might fall as well. The U.S. population is aging. With employment still falling – and another jobless recovery on the horizon – the rate of human capital accumulation will fall. Moreover, workers who remain unemployed for a long period of time lose skills, while young workers that enter the workforce, but don’t find a job, don’t acquire on-the-job skills. Reduced investments in worker training and education, coupled with lower capital expenditure, are a recipe for lower productivity ahead.

Deflationary pressures are still present in the U.S. economy. Demand is falling relative to supply and excess capacity is still promoting slack in the goods markets. Moreover, the rising slack in labor markets, which is pushing down wages and labor costs, implies that deflationary pressures are going to be dominant this year and next year. This implies that the Fed will keep monetary policy loose for a while longer. However, discussion of an exit strategy has to start now as investors’ concerns about the Fed’s ballooning balance sheet and expectations of inflation both mount.

There are also signs that a double-dip recession could materialize toward the second half of next year, or in 2011. If oil prices rise too much, too fast, too soon, that’s going to have a negative effect in terms of trade and real disposable income in oil-importing countries. Also, concerns about unsustainable budget deficits are high and are pushing long-term interest rates higher. If these budget deficits are going to continue to be monetized, eventually, toward the end of next year, there is a risk of a sharp increase in expected inflation that could push interest rates even higher. Together with higher oil prices, driven up in part by this wall of liquidity rather than fundamentals alone, this could be a double whammy that would push the economy into a double-dip or W-shaped recession by late 2010 or 2011.

In conclusion, the outlook for the U.S. economy remains very weak. The recent rally in global equities, commodities and credit may soon fizzle out as worse-than-expected earnings and financial news take their toll on this rally, which has gotten ahead of improvements in actual macroeconomic data.

Sunday, July 12, 2009

This Weekend's Contemplation - There is No Recovery, There is Only a New Economy

The following from Robert Reich, former Secretary of Labor under Clinton, is a new way to view the current hopes of a recovery - there is no recovery because the economy is morphing into a different type of economy. At this point no one knows what the new economy will look like. Many will find this view unsettling, but it is probably correct. We are not going back to the way it was, but I am not sure where we will end up. In my mind our time would be better spent designing the economy we want going forward and forgetting about the way it was. From CommonDreams.org:

The so-called "green shoots" of recovery are turning brown in the scorching summer sun. In fact, the whole debate about when and how a recovery will begin is wrongly framed. On one side are the V-shapers who look back at prior recessions and conclude that the faster an economy drops, the faster it gets back on track. And because this economy fell off a cliff late last fall, they expect it to roar to life early next year. Hence the V shape.

Unfortunately, V-shapers are looking back at the wrong recessions. Focus on those that started with the bursting of a giant speculative bubble and you see slow recoveries. The reason is asset values at bottom are so low that investor confidence returns only gradually.

That's where the more sober U-shapers come in. They predict a more gradual recovery, as investors slowly tiptoe back into the market.

Personally, I don't buy into either camp. In a recession this deep, recovery doesn't depend on investors. It depends on consumers who, after all, are 70 percent of the U.S. economy. And this time consumers got really whacked. Until consumers start spending again, you can forget any recovery, V or U shaped.

Problem is, consumers won't start spending until they have money in their pockets and feel reasonably secure. But they don't have the money, and it's hard to see where it will come from. They can't borrow. Their homes are worth a fraction of what they were before, so say goodbye to home equity loans and refinancings. One out of ten home owners is under water -- owing more on their homes than their homes are worth. Unemployment continues to rise, and number of hours at work continues to drop. Those who can are saving. Those who can't are hunkering down, as they must.

Eventually consumers will replace cars and appliances and other stuff that wears out, but a recovery can't be built on replacements. Don't expect businesses to invest much more without lots of consumers hankering after lots of new stuff. And don't rely on exports. The global economy is contracting.

My prediction, then? Not a V, not a U. But an X. This economy can't get back on track because the track we were on for years -- featuring flat or declining median wages, mounting consumer debt, and widening insecurity, not to mention increasing carbon in the atmosphere -- simply cannot be sustained.

The X marks a brand new track -- a new economy. What will it look like? Nobody knows. All we know is the current economy can't "recover" because it can't go back to where it was before the crash. So instead of asking when the recovery will start, we should be asking when and how the new economy will begin. More on this to come.

What is Quantitative Easing and Why is Everyone Talking About It?

Quantitative easing is a monetary policy central banks (like the Fed) use to manage the money supply and stimulate the economy when interest rates are close to zero. It is a much more direct form of monetary policy as opposed to the more indirect form used during periods of more "normal" interest rates.

Here is a link to pamphlet published by Bank of England explaining Quantitative Easing. The pamphlet is well written and very understandable.

If you want a more detailed discussion try Wikipedia. This is also an excellent discussion and it covers both the concept, process, and risks. One of the current problems in the US is that the banks are just sitting on the money to cushion the blow of additional losses.

Saturday, July 11, 2009

Maybe, Just Maybe, the Consumer Understands That This Is a Long Slow Recovery

I have often told anyone that would listen that it will take to the end of this year for the US consumer to figure out that this is going to be a long, hard slog back to anything that looks like a "normal" economy (whatever that is). According to the survey results below it looks like the consumer just may be catching on. The consumer is finally figuring out that the stock market results are not matching the macroeconomic data, jobs are not returning anytime soon, and almost everyone is at risk of loosing their job. I don't know what the common greetings are in your part of the country, but I hear, "do you still have a job?" quite often. Also any response that is affirmative is considered good. Text in bold is my emphasis. From YahooNews.com:

U.S. consumers' moods soured in early July on persistent worries about jobs, a survey showed on Friday, offering little hope their spending will help the sputtering economic recovery.

Another report showed domestic demand for foreign goods slumped in May, reflecting persistently weak consumer spending, which helped shrink the monthly trade deficit to the smallest since 1999.

Consumer sentiment wilted in early July to the weakest since March, when confidence in the financial sector and economy was at a low, the Reuters/University of Michigan Surveys of Consumers showed.

Consumers' growing anxiety about a protracted economic downturn, job security and loss of wealth were key factors depressing sentiment, the survey said. Americans were also uneasy about the recent slip in stock prices, some analysts said.

"It underlines the ongoing gloom facing the U.S. consumer and further delays prospects for a near-term recovery. That will weigh heavily on risk sentiment," said Brian Dolan, senior currency strategist with Forex.com in Bedminster, New Jersey.

"Consumers concluded that the economic downturn would last longer and their personal finances would not recover as quickly as they had previously expected," the Reuters/University of Michigan Surveys of Consumers said in a statement. . . . .

. . . . Recent income gains were reported by the fewest consumers in the more than 50-year history of the survey, the statement said.

The survey's expectations component "has been seen as reasonably influenced by equity price moves. Having had a good quarter, equities are down so far in July, so we thought that would be a little bit of a subtraction," said John Ryding, chief economist with RDQ Economics in New York. . . . .

. . . . "Consumers reported a larger negative shift in their longer term outlook for the economy. The majority of consumers thought that widespread unemployment would persist over the next five years," the survey said. . . . . .

. . . . The U.S. trade gap narrowed unexpectedly to $26 billion in May, the smallest since November 1999, as exports rose and domestic demand for foreign goods slumped, the government said.

May's import level was the lowest since July 2004 and May marked the 10th straight month in which imports declined, underscoring the weakness in the U.S. economy.

The Commerce Department said exports increased 1.6 percent in May while imports fell 0.6 percent. Economists said the drop in imports signaled continued weakness in the recession-mired U.S. economy.

"The trade deficit report is another indicator that things are not improving as expected," said William Larkin, portfolio manager with Cabot Money Management in Boston. "There is growing pessimism about how quickly the U.S. will recover, which I think will be slower than people expect." . . . .

Friday, July 10, 2009

A More Enlightened Perspective on the Labor Markets

In most recessions the unemployment numbers can be a lagging indicator. But in the current recession the unemployment numbers are critical because without workers or work people cannot buy which drives the economy and the consumers cannot rebuild their balance sheets, which drives consumption in the future. The following is from my favorite author Ambrose Evans-Pritchard at the UK Telegraph. It speaks to the problems of unemployment both in the US and Europe and what it means for society as a whole. The most important quote in the article is, "The reason why this does not "feel" like the 1930s is that we tend to compress the chronology of the Depression. It takes time for people to deplete their savings and sink into destitution." Text in bold is my emphasis:

One dog has yet to bark in this long winding crisis. Beyond riots in Athens and a Baltic bust-up, we have not seen evidence of bitter political protest as the slump eats away at the legitimacy of governing elites in North America, Europe, and Japan. It may just be a matter of time.

One of my odd experiences covering the US in the early 1990s was visiting militia groups that sprang up in Texas, Idaho, and Ohio in the aftermath of recession. These were mostly blue-collar workers, – early victims of global "labour arbitrage" – angry enough with Washington to spend weekends in fatigues with M16 rifles. Most backed protest candidate Ross Perot, who won 19pc of the presidential vote in 1992 with talk of shutting trade with Mexico.

The inchoate protest dissipated once recovery fed through to jobs, although one fringe group blew up the Oklahoma City Federal Building in 1995. Unfortunately, there will be no such jobs this time. Capacity use has fallen to record-low levels (68pc in the US, 71 in the eurozone). A deep purge of labour is yet to come.

The shocker last week was not just that the US lost 467,000 jobs in May, but also that time worked fell 6.9pc from a year earlier, dropping to 33 hours a week. "At no time in the 1990 or 2001 recessions did we ever come close to seeing such a detonating jobs figure," said David Rosenberg from Glukin Sheff. "We have lost a record nine million full-time jobs this cycle."

Earnings have fallen at a 1.6pc annual rate over the last three months. Wage deflation is setting in – like Japan. Interestingly, The International Labour Organisation is worried enough to push for a global pact, fearing countries may set off a ruinous spiral by chipping away at wages try to gain beggar-thy-neighbour advantage.

Some of the US pay cuts are disguised. Over 238,000 state workers in California have been working two days less a month without pay since February. Variants of this are happening in 22 states.

The Centre for Labour Market Studies (CLMS) in Boston says US unemployment is now 18.2pc, counting the old-fashioned way. The reason why this does not "feel" like the 1930s is that we tend to compress the chronology of the Depression. It takes time for people to deplete their savings and sink into destitution. Perhaps our greater cushion of wealth today will prevent another Grapes of Wrath, but 20m US homeowners are already in negative equity (zillow.com data). Evictions are running at a terrifying pace.

Some 342,000 homes were foreclosed in April, pushing a small army of children into a network of charity shelters. This compares to 273,000 homes lost in the entire year of 1932. Sheriffs in Michigan and Illinois are quietly refusing to toss families on to the streets, like the non-compliance of Catholic police in the Slump.

Europe is a year or so behind, but catching up fast. Unemployment has reached 18.7pc in Spain (37pc for youths), and 16.3pc in Latvia. Germany has delayed the cliff-edge effect by paying companies to keep furloughed workers through "Kurzarbeit". Germany's "Wise Men" fear that the jobless rate will jump from 3.7m to 5.1m by next year. The OECD expects unemployment to reach 57m in the rich countries by the end of next year.

This is the deadly lag effect. What is so disturbing is that governments have not even begun the spending squeeze that must come to stop their countries spiralling into a debt compound trap.

French president Nicolas Sarkozy, with a good nose for popular moods, says: "We must overhaul everything. We cannot have a system of rentiers and social dumping under globalisation. Either we have justice or we will have violence. It is a chimera to think that this crisis is just a footnote and that we can carry on as before."

The message has not reached Wall Street or the City. If bankers know what is good for them, they will take a teacher's salary for a few years until the storm passes. If they proceed with the bonuses now on the table, even as taxpayers pay for the errors of their caste, they must expect a ferocious backlash.

We are fortunate that the US has a new president enjoying a great reservoir of sympathy, and a clean-broom Congress. Other nations must limp on with carcass governments: Germany's paralysed Left-Right coalition, the burned-out relics of Japan's LDP, and Labour's death march in Britain. Some are taking precautions: Silvio Berlusconi is trying to emasculate Italy's parliament (with little protest) while the Kremlin has activated "anti-crisis" units to nip protest in the bud.

We are moving into Phase II of the Great Unwinding. It may be time to put away our texts of Keynes, Friedman, and Fisher, so useful for Phase 1, and start studying what happened to society when global unemployment went haywire in 1932.

California Issues IOUs

California issued IOUs on Wednesday worth just over $26B. The amount is small compared to some of the bank bail-outs or AIG. They also mature in October. The best part of the article below is the history lesson from 1932 in Chicago, just in case you were wondering if our Uncle Sam would eventually guarantee the IOUs. Text in bold is my emphasis. From Market Watch:

More than $300 million in IOUs issued by California will likely be a nice little earner for banks like J.P. Morgan Chase & Co., Wells Fargo & Co. and Bank of America Corp., but the fiscal woes of the Golden State also present a new risk for an already troubled sector.

California, the largest economy in the United States and one of the biggest in the world in its own right, has issued 91,000 IOUs worth $354 million as of late Wednesday as it struggles with a budget deficit of more than $26 billion.

The fiscal crisis deepened Friday when California delayed a $4 billion payment to its Education Department, and the president of the state's university system proposed furloughing tens of thousands of employees.

The IOUs, officially known as registered warrants, are being used by California to pay tax refunds, bills from vendors, financial aid for students and social-service programs run by local governments.

'Banks accepting IOUs from the state of California should get a reasonably strong new earnings asset as we believe the threat of default is very low.'

Banks including J.P. Morgan , Bank of America , Wells Fargo and Citigroup Inc. agreed to accept the IOUs from customers. That helps recipients of the IOUs get cash.

The banks, however, have said that they won't accept the IOUs after Friday, leaving holders of the IOUs with little way to get cash in future. The Securities and Exchange Commission said late Thursday that the warrants are securities, which means they can only be traded by qualified investment professionals and not on Internet sites like eBay and Craigslist.


According to banking analysts at Keefe, Bruyette & Woods, the sector shouldn't be so cautious about accepting the IOUs.

The warrants mature on Oct. 1, when California has said it will pay the cash it owes, plus 3.75% in tax-free interest. That works out to a tax-equivalent yield of 6.5%. Assuming banks can borrow money at roughly 1.5% on average, the sector is making an annualized spread of 5% until the IOUs come due in October, KBW analysts Julianna Balicka and Fred Cannon, wrote to investors on Friday.

"Banks accepting IOUs from the state of California should get a reasonably strong new earnings asset as we believe the threat of default is very low," they said.

While the state faces a $26.3 billion budget deficit, that's peanuts compared with some of the financial holes that the banking sector found itself in last year. That makes a federal government bailout of California more likely, if it comes to that, according to Balicka and Cannon.

The state's $26.3 billion hole is about the same as the $25 billion that the U.S. government pumped into Wells Fargo last year to help that bank survive the financial crisis, the analysts noted.

The Golden State's deficit is about 13% of the $203 billion the government spent bailing out many lenders through its Troubled Asset Relief Program, excluding money some banks have since repaid, the analysts added.

"If the federal government was willing to put $25 billion into Wells Fargo bank to prevent failure, we have to believe that it would put $26.3 billion into the state of California," Balicka and Cannon wrote.

However, California's IOUs are part of a broader fiscal problem that could weigh on banks active in the state over the longer term, the analysts warned.

"Whatever solution does occur will likely entail significant spending cuts and we believe that the budget impasse will be negative for the general economy and for municipalities, impacting the operating markets of local community banks," they wrote. "This will be yet another pressure point contributing to weakness in loan portfolios already suffering from high unemployment and eroding real-estate values."

J.P. Morgan, Wells Fargo, Bank of America and U.S. Bancorp are among the largest national banks active in California, KBW noted.

A Little History

In 1932, Chicago issued similar IOUs, called tax anticipation warrants. Its financial condition continued to get worse, setting off the biggest bank panic of the Great Depression.

Smaller banks with notable exposure to state and municipal securities include Westamerica Bancorp and CVB Financial Corp. , KBW said.

The most damage to California banks may come from loans extended to consumers and businesses that depend on revenue from state projects that could be cut, the analysts said.

However, they said banks' exposure to California's woes is small and the problem won't be a "game changer" for the sector.

"We view this as another data point that underscores our cautious approach to California banks generally," they wrote.

Joseph Mason, an expert on financial crises at Louisiana State University, is more concerned about the potential impact of California's IOUs on banks.

In 1932, in the middle of the Great Depression, Chicago issued similar IOUs, called tax anticipation warrants, Mason explained in a research note earlier this week.

These IOUs were issued to city employees, students and creditors, and by the spring of 1932 the warrants began to circulate as an alternative to cash from Milwaukee to Michigan.

Chicago's financial condition continued to get worse, raising questions about the value of the IOUs. That put pressure on local and regional banks that had accumulated the warrants, Mason said.

By June, Chicago city officials and bankers went to Washington, D.C. for help, but their request for $80 million in aid was rebuffed by Congress.

When the delegation got back and announced Congress' decision on the train platform, the biggest bank panic of the Great Depression ensued, according to Mason and Charles Calomiris, an expert in financial institutions at Columbia Business School.

Lines formed at every bank in Chicago. The president of First Chicago Bank, as Mason described it, shouted from a pillar in the lobby of his institution that the Federal Reserve was sending plenty of cash.

"By June 23, Chicago bank depositors had witnessed, in a matter of two weeks, the collapse of some of the largest businesses in their city," Calomiris and Mason wrote in a 1997 article in the American Economic Review.

The current financial crisis already has produced a modern-day bank run. This time investors in securitizations panicked, rather than bank depositors who are now insured by the FDIC, Mason said.

Both runs were triggered by a lack of information about the quality of assets and who held those assets, he explained.

"Allowing banks -- chief among them Bank of America and Wells Fargo -- to accept new forms of questionably valued assets is therefore probably not prudent at the present time," Mason wrote this week.

"Regulators should be thinking of how to track these IOU concentrations and place limits on undue accumulations," he added. "Alternatively, the Federal Reserve should be thinking about how similar state IOUs fit into their asset repurchase programs in preparation for the next possible stage of the crisis."

Wednesday, July 1, 2009

Is Cheap the New "Cool"?

This is an interesting question that will not be answered for the next few years. It will take that long to figure out if there has been a permanent change in consumer behviour. But it is a question that is worth asking. The real issue is whether consumer behavior has changed sighificantly over the long term. Have people figured out that a house is a place to live and not an investment? Or have people figured out that eventually there is a natual limit to living beyond your means? Text in bold is my emphasis. From YahooNews.com:

When Jeff Yeager's book "The Ultimate Cheapskate" came out 18 months ago, he felt like a voice crying in the wilderness telling people to ditch their cell phones, hoard their pennies and pay off the mortgage.

Now the Internet abounds with self-proclaimed penny-pinchers offering tips on living frugally as the recession bites into America's shop-'til-you-drop lifestyle.

The rise of thrift may be bad news for a U.S. economy where in 2006 consumer spending accounted for 70 percent of gross domestic product.

"Cheap is the new cool," said Yeager, who also has a blog called "The Ultimate Cheapskate" offering advice on enjoying life more by spending less. An Internet search for "cheapskate" finds a string of similar blogs.

"When the book came out, it and I were viewed as quaint little novelties, but now it's being taken much more seriously," Yeager said.

When he advised people to focus on paying off their mortgage as soon as possible and stay in their first home forever, Yeager said his publisher warned him to tone down his "radical" ideas.
Now the subprime mortgage crisis has shown the fallacy of acting as if house prices always go up and people are saving like rarely before. Official data last week showed that U.S. savings jumped to a record annual rate of $768.8 billion, the highest level since records began in 1959, and the saving rate climbed to a 15-year high of 6.9 percent of income.

Yeager said it was discouraging that hopes of an economic recovery are pinned on consumer spending rather than manufacturing and production.

"Some of the lessons we should be taking away from this -- like we can't live on borrowed money, we can't live beyond our means -- part of the solution being put forward for getting out of this mess goes back to that," Yeager said.

It is a paradox that Lauren Weber, a journalist and author of the forthcoming book "In Cheap We Trust," a history of thrift in America, said is part of the national character.

Thrift, hard work and simple living were deeply embedded in America's early values, embraced by the Puritans and founding father Benjamin Franklin whose aphorism "a penny saved is a penny earned" is often invoked today.

"We're very confused," Weber said. "We're told that saving money is good for the soul, it's virtuous to save money. On the other hand, we're told it's basically unpatriotic, it's like burning the flag, to cut up your credit cards."

Credit card debt soared 25 percent in the past decade as consumers were flooded with offers of easy money, pushing spending up at rates that far exceeded wage growth.

In the last decade, American households piled on $8 trillion in debt, an increase of 137 percent, taking total consumer debt to around $14 trillion by late 2008, including home mortgages, credit and store cards and auto loans.

With the collapse of home prices and stock investments, consumers are changing their ways, at least for now.

Every industry from insurance to car makers has changed its marketing strategy to emphasize value, according to Fran Kelly, president of Boston-based advertising agency Arnold Worldwide.
But "cheap" is still a dirty word for many.

Arnold client McDonald's has boosted sales because of its inexpensive Dollar Menu and by adding fancy coffee drinks for much less than chains such as Starbucks.

"With McDonald's we're talking about a better coffee at a great price, but we never say cheap," Kelly said.

Price cuts are one way to boost sales, but businesses don't like to do that. Many are finding other ways to attract customers without actually cutting their prices.

"It's hip to get a deal," said Ginger Boyle, co-owner of Beverly Hills beauty salon Planet Salon. She has managed to boost sales by 14 percent through monthly promotions, but she said it's getting tougher as people want more for their money.

Two years ago, a new customer might get a free lipstick, she said. "That won't even work anymore. Now you bring a friend in and I'll give you 50 percent off on your next haircut."
While most retailers are suffering, thrift stores like Housing Works, a group that serves AIDS patients in New York, are more popular than ever.

Housing Works president Richard Vorisek, who has worked in the fashion industry for 20 years at big brands such as Polo Ralph Lauren, said sales so far in the financial year to July were up 10 percent, despite a fall in donated goods.

Housing Works, which specializes in second-hand designer merchandise, has nine stores in New York, including two that opened in the fashionable districts of Soho and Tribeca in the last four months, and it plans to open another in the fall.

"We're in expansion mode," Vorisek said.

The trillion-dollar question is whether the recession will mean a fundamental shift in consumer behavior. Weber, who spent several years researching her book on thrift, doubts it.

"Like most Americans I assumed that we were once a thrifty nation and we've become profligate," she said. "It's not true at all. We've cycled through this virtue of thrift over and over again in our history."

Retailers hope she's right. But Yeager, who also writes for environmental web site www.thedailygreen.com, said Americans might be a lot happier if they spent less time and money trying to accumulate possessions.

"We shouldn't be asking 'How do I get this stuff for less?' We should be asking 'Do we really need it?'" he said.

Yeager recalled a woman who came to a book signing event and berated him for his insensitivity about the recession, saying that if the economy did not improve she would have to cancel the family's cable television subscription.

"Half the world's population lives on less than $2 a day, and we're in a funk because we're going to have to give up cable service," Yeager said.