Thisbe, 'quite the Babylonian'
Ilargi: I’m starting to wonder how many people there are left who actually believe all the talk about the economic recovery we're supposed to have entered. You know, the one proclaimed by governments, central bankers, institutions such as the IMF and the entire flock of parrots and parakeets that call themselves media and are all set 24/7 to repeat their every word, chirping, tweeting and twittering as they go along. And I'm afraid there still are far too many such believers left. They have a great shot at losing a lot of money in the next few months.
I also wonder how many people have gotten real nervous by now. Who've asked themselves what I asked a while back: what are the odds that the stock markets will keep on rising? And on what grounds would they do so? Surely many must have realized by now that perhaps that talk about a recovery is just that, talk. The strength of their belief may depend, to a large degree, on the job market. After all, it should be obvious that "jobless recovery" is a term used exclusively by people who do have jobs, and often cushy ones.
I like this little graph, because it provides a very nice picture of the effect of the hundreds of billions in taxpayer money spent by the American government on the job market. From about May through September the country has bought itself a slight decrease in the rate of job losses. Still, the unemployment rate has gone up despite all the cash and credit so generously supplied by you, the taxpayer. And it by no means tells the entire story; indeed, it may well relate only the rosiest parts available.
Now other, less positive, parts are slowly being revealed that could change and even shatter the image we have of the job market. Here's a few choice bullet points from the reports that came out this week:
- Job losses for September, according to the Bureau of Labor Statistics' U3 calculations, were 263.000.
- This brings the U3 unemployment rate to 9.8%.
- While the U6 rate reached 17%.
- The household survey by the same BLS indicates that employment fell by 785,000.
- An alternate view at the household survey suggest 995,000 fewer people were working in September than in August, while the labor force contracted by 1,262,000 people and the number of people "not in the labor force" rose by 1,516,000.
- More than a half a million people dropped out of the labor force
- 551,000 initial jobless claims were filed.
I don't know about you, but I assure you that I have a hard time seeing the forest through the trees here. It's simply too much of a strange coincidence that the number most trumpeted in the media is always the lowest (U3) one. As soon as you peel away just the first few underlying layers, it becomes clear that this number merely scratches the surface. Most of the 10 million or so people who get counted in U6, but not in U3, are very much unemployed or at least underemployed. The bottom line is that even though the 263,000 number is unrealistically low, likely by a lot, it is the one that government and media stubbornly keep providing, as if the American people, who after all pay the salaries of the BLS employees, are too stupid to have a right to hear the real data.
The latest report does lift the veil a little bit: The Labor Department yesterday admitted it may have underestimated unemployment numbers by as much as 17%, partly because of its faulty birth/death model, which is a useless tool in times like these. The BLS data missed 824,000 lost jobs for the year through last March, with most of the additional job loss occurring in the first quarter of 2009. The potential revision would mean that the economy lost 5.6 million jobs for the period instead of the 4.8 million suggested until now.
[..] the tax records showed the Labor Department’s payrolls figures overestimated payrolls by about 150,000 [..] That implies the estimates missed the mark by about 675,000 in the first quarter of this year [or 225,000 per month] , which currently shows a 2.1 million drop in payrolls.[..]
Calculated Risk added these new numbers to his usual graph which compares job loss percentages in recessions.
Catherine Rampell at Economix provides a similar graph, but using the share of employment:
Awfully bad as it is, the unemployment situation, of course, is but one aspect of an economy that will now grow weaker at a rapid clip.
- US personal bankruptcy filings will exceed 1.4 Million by the end of the year, more than the 1.3 million they reached right before the bankruptcy laws were altered with aim of bringing bankruptcy numbers down.
- Bank card delinquencies hit a record high last month.
- Meredith Whitney says:
- Anyone counting on a meaningful economic recovery will be greatly disappointed. How do I know? I follow credit, and credit is contracting. Access to credit is being denied at an accelerating pace. Large, well-capitalized companies have no problem finding credit. Small businesses, on the other hand, have never had a harder time getting a loan.
- Small business loans are hard to find, and credit-card lines (a critical funding source to small businesses) have been cut by 25% since last year.
- [..] more than 32% of U.S. homes are worth less than their mortgages.
- Small businesses primarily fund themselves through credit cards and loans from local lenders. In the past two years, credit-card lines have been cut by over $1.25 trillion. During the same time, 10% of all credit-card accounts have been cancelled.
- Anyone counting on a meaningful economic recovery will be greatly disappointed. How do I know? I follow credit, and credit is contracting. Access to credit is being denied at an accelerating pace. Large, well-capitalized companies have no problem finding credit. Small businesses, on the other hand, have never had a harder time getting a loan.
But the worst part of it all is that deflation is here, and it’s here to stay for a while. In the past few days, we could see heavy hitters like David Rosenberg, Joseph Stiglitz, Janet Tavakoli address deflation in the same way that we at The Automatic Earth have even for longer than the 20 months that this site exists. Ironically, at about the exact same moment when we figured perhaps we were the only ones left (with Mike Shedlock, Bob Prechter and a few Minyans) to warn of the perils of deflation, it is slowly turning into a mainstream concern. As Tavakoli tells Max Keiser (who still can't believe it), the debts are simply too overwhelming. Not that anyone has seriously attempted to address them.
- "We are certainly in a deflationary state," said David Rosenberg, chief economist and strategist with Gluskin Sheff and Associates in Toronto. "Of that, there's no doubt."
- "I think people still have no clue as to just how weak the economy is," Mr. Rosenberg said. Remove the "impressive medication" administered by governments, and most economies are at a virtual standstill. The U.S. economy faces a decade of stagnation, he said.
- [..]"deflation will last until we see the next secular trend of expanding household balance sheets, and that is some time away" Mr. Rosenberg said.
The Federal Reserve decides to stick with another label for the exact same phenomenon.
- "Disinflationary winds are blowing with gale-force effect," [Chicago Fed president] Evans said in a Sept. 9 speech in New York.
- The Fed needs to "keep inflation expectations from slipping to undesirably low levels in order to prevent unwanted disinflation," Vice Chairman Donald Kohn said Sept. 10 in Washington during a speech at the Brookings Institution.
In other words, the government's unemployment data have proven to be unreliable. That in itself is not new, but what is, is the Labor Department's own admission that its stats are flawed. It still hasn't fully opened up by any means, but the cracks are now visible to the naked eye.
The potential for a continued rally in the stock markets is becoming more questionable by the day. If those markets start caving in, as we think they simply must, the hollowness of the recovery proclaimed by governments and media will also lie exposed to naked eye. Whether or not the government and the Federal Reserve have been busy painting lipstick on the markets pig though the past 6 months is no longer even relevant; they will be powerless to do so going forward.
We have the likes of Paul Krugman, Robert Reich and, in the UK, Samuel Brittan, shrieking loudly for more, much more, stimulus. They see the problem coming, that's true, but they fail to see that the US and UK governments opted sometime in 2007-2008 to pour money into their financial systems, and that money cannot be spent a second time.
Many of us remember how a trillion here and a trillion there were doled out withe message that the taxpayer was likely to make a healthy profit on this "investment". Haven't heard that one for a bit. The reality is that between what Washington has thrown into AIG, the Wall Street banks and the Fannie and Freddie and Ginnie family, as bankrupt as it is incestuous, there are only losses.
If and when financials stocks get hammered, banks and insurers -among others- will be forced to execute additional gigantic writedowns and losses. With a 3.6 million official housing inventory, to which we can add a 7 million shadow one, America will have a 25 month supply of unsold homes. If Fannie and Freddie weren't dead yet, that would do it. The losses are yours.
The Krugman clan now wants you to finance a second stimulus. And it will come (albeit under an alternative moniker), but it can bring only more misery for the people. The government will get a little more transparent in a desperate fight for credibility, but it was lost a long time ago. And it's not a specific government, it's the entire system that's morally broke. The entire economic, financial and political sytems, all of it and all of them, broke, broker and broken.
I asked above how many people are left that still believe all the talk about that heavily promoted recovery. And though I know they are there, scores of them, that at the same time is something that I'm starting to find hard to believe. Look at the numbers, and never forget that many of them are not even anywhere near as bad as the real ones.
Yes, consider this your storm warning. Batten down the hatches, don’t let your kids wander off, and please, take off those silly rose-colored glasses. From now on in, just the naked eye.
Job losses accelerate to 263,000 in September
The nation's job losses accelerated in September, driving the unemployment rate to a 26-year high of 9.8% and casting a cloud over the incipient recovery, economic data showed Friday. Nonfarm payrolls fell by a greater-than-expected 263,000 in September, the Labor Department reported. It marked the 21st consecutive month of job losses. Since the recession began in December 2007, 7.2 million jobs have been lost and the unemployment rate has doubled. While disappointing, the September numbers were not catastrophic, some economists said.
"We are more inclined to view September as a temporary setback than as a signal that the decelerating trend in job losses has stalled out," wrote Stephen Stanley, chief economist for RBS Securities. "It is far too early to be pulling the alarm on this nascent recovery." But another economist sounded the warning. The "weak employment report lessens hope for a sustainable recovery," wrote Harm Bandholz of UniCredit Research. "Once the impact of the inventory cycle and the fiscal stimulus has run its course, gross domestic product growth will slow down substantially again."
The employment figures also carried a political dimension, as Republicans said the continued job losses proved the stimulus had failed, while Democrats said they proved that government support is essential. Job losses "would have been far worse" without the stimulus, Vice President Joe Biden said. "We are headed for what appears to be, at best, a jobless recovery," said Rep. John Boehner, the Ohio Republican who leads the GOP in the House. "That is not what the American people were promised."
Details of the report were almost universally dismal, with the number of unemployed people rising by 214,000 to 15.1 million. And of those, 5.4 million have been out of work longer than six months, accounting for a record 35.6% of the jobless. More than a half a million people dropped out of the labor force, and the employment participation rate fell to 65.2%, the lowest in 23 years. The average duration of unemployment rose to 26.2 weeks, a record high.
An alternative gauge of unemployment [U6] , which includes discouraged workers and those with part-time employment, rose from 16.8% to 17% -- the highest in the 15-year history of the data. Total hours worked in the economy fell by 0.5%. The average workweek dropped back to an all-time low of 33 hours. In addition, average hourly earnings rose just 1 cent, or 0.1%, to $18.67. Average hourly earnings are up 2.5% in the past year. Economists surveyed by MarketWatch had been looking for a smaller payroll loss of 167,000. They also had expected the unemployment rate to rise to 9.8%.
In August, payrolls fell by a revised 201,000, and the unemployment rate was 9.7%. Payroll losses in July and August were revised lower by a total of 13,000. The government announced that it would likely lower total employment by about 824,000, or 0.6%, in its annual benchmark revision in January. Such a revision, based on tax records, is about three times the normal revision of 0.2%, marking a failure for the much-maligned birth-death model. The large error came during the early part of 2009, when large numbers of businesses were failing that could not be captured by the usual statistical procedures, the Bureau of Labor Statistics said.
If the benchmark is close to the preliminary estimate, the cumulative job loss in the recession would rise to about 8 million. In its survey of 400,000 business establishments, the government found that private-sector employment fell by 210,000 to stand at 130.9 million jobs in September. Government employment fell by 53,000, most were in local government. Employment in the goods-producing sector fell by 116,000 last month, including 64,000 in construction and 51,000 in manufacturing. Service-producing jobs also fell, down by 147,000 including 39,000 in retail. The only major sector showing a greater number of jobs was health care and education, which added just 3,000.
Of 271 industries, about 32% were hiring in September, down from 35% in August, the data showed. In its survey of 60,000 households, the government found that employment fell by 785,000. The unemployment rate for adult men rose to 10.3% and the rate for adult women rose to 7.8%. The unemployment rate for teenagers rose to a record 25.9%. The jobless rate for the whites rose to 9% and the rate for African-Americans increased to 15.4%, while the rate for Hispanics fell to 12.7%. The participation rate for adult men fell to a record-low 74.7%, while the participation rate for teenagers dropped to a record-low 36.9%.
U.S. unemployment claims spike
The number of people applying for initial jobless claims in the United States rose by 17,000 last week, to 551,000, U.S. data revealed Thursday. The spike was the first increase in four weeks, the U.S. Department of Labour said. The Wall Street consensus expectation was for initial claims to come in at 531,000. That would have been a slight increase on the 530,000 initial claims the Labour Department reported for the week ended Sept. 19. But on Thursday, the department upwardly revised its data for the previous week, saying initial claims actually came in at 534,000 during the period.
The number of new applicants for state unemployment benefits may have risen, but the total number of people receiving those benefits fell by 70,000 people to 6.09 million. That was better than the 6.1 million economists had been expecting. It's not clear to what extent the decrease in jobless claims was due to the unemployed finding new jobs, and how can be attributed to still-jobless Americans simply running out of benefits. Most states offer 26 weeks of benefits, but earlier this year, Congress approved federally funded extensions of up to 53 weeks in some cases.
As recently as last month, Democratic Congressman Jim McDermott brought forward a bill that would offer an additional 13 weeks of benefits for more than 300,000 jobless people who live in states with unemployment rates of at least 8.5 per cent. Most of those people were set to run out of benefits by the end of September.
September Unemployment: Actual loss 995,000
Headlines: 263,000 "jobs lost" and unemployment rate up to 9.8%.
That's not good - there goes the "second derivative" argument.
Weekly earnings are also down by $1.54, which is bad news too.
But the Household Data is VASTLY worse than reported. Here are the month-over-month changes, and they're in the realm of frightening. (all numbers in thousands)
Civilian Labor Force: 154,879 to 153,617 this month.
Employed: 140,074 down to 139,079 this month.
That's a loss of 995,000 jobs, not 263,000, and the labor force contracted by 1,262,000 people.
The participation rate was absolutely decimated, down 0.6% this last month alone. The people "not in the labor force" rose by a staggering 1,516,000 in the last month.
The government doesn't count people as "unemployed" who have given up and exited the labor force, but as I have repeatedly noted whether the government counts them or not the corner store owner sure as hell does!
The fact of the matter is that nearly 1 million fewer people were working in September as compared to August; there has been absolutely no improvement in that trend whatsoever.
U.S. Job Losses May Be Even Larger as Labor’s Model Breaks Down
The U.S. economic slump earlier this year was so severe it short-circuited the government’s model for calculating payrolls, raising the risk that today’s jobs report may be too optimistic. About 824,000 more jobs may be subtracted from the payroll count for the 12 months through last March when the figures are officially revised early next year, a Labor Department report showed today. The revision would be the biggest since the government started adjusting the numbers in 1991.
The bulk of the miss occurred in the calculations for the first quarter of this year, the Labor Department said. The economy shrank at a 6.4 percent annual pace in the first three months of 2009, the worst performance since 1982. The figures raise the possibility that the government’s calculations continue to miss the mark. "We are probably still underestimating job losses," said John Silvia, chief economist at Wells Fargo Securities LLC in Charlotte, North Carolina. "There could be another 30,000 to 40,000" that the data isn’t picking up.
That would mean the loss of jobs for September could turn out to be as high as 300,000, rather than the 263,000 reported today by the Labor Department. Today’s report also showed the jobless rate climbed to 9.8 percent last month, a 26-year high. The potential revision for the year through last March would mean that the economy lost 5.6 million jobs for the period instead of the 4.8 million now on the books. The payroll estimates are based on a government survey of about 160,000 businesses and government agencies covering around 400,000 worksites. Once a year, the Labor Department revises its payroll figures after combing through tax records from the unemployment insurance program that covers practically all businesses. Those records are only available after a lag, explaining why it takes more than a year to make the tabulations.
The department uses a formula, known as the birth/death model, to determine the influence on payrolls from the formation and demise of businesses. Because the government doesn’t know if a company fails to respond because it has gone out of business or is just late, it estimates the number of companies that may have folded. By the same token, it plugs in an estimate for the formation of new businesses to account for their hiring. From April 2008 through December, the tax records showed the Labor Department’s payrolls figures overestimated payrolls by about 150,000, said Chris Manning, the national benchmark branch chief at the Bureau of Labor Statistics. That implies the estimates missed the mark by about 675,000 in the first quarter of this year, which currently shows a 2.1 million drop in payrolls.
"In this period of steep job losses, the birth/death model didn’t work as well as it usually does," Manning said in an interview. "To the extent that there was an overstatement in the birth/death model, that is likely to still be there." The model added about 184,000 jobs to the payroll total last quarter compared with a 135,000 increase in the same period in 2008, before the financial crisis deepened with the collapse of Lehman Brothers Inc.
"This birth/death model is still assuming that we are getting new jobs from new-business creations," David Rosenberg, chief economist at Gluskin Sheff & Associates Inc. in Toronto, said in an interview. "These additions are coming somewhere from ‘Alice in Wonderland,’" he said, referring to the novel by Lewis Carroll detailing the adventures of a girl that fell down a rabbit hole into a fantasy world. "Even though the current data is bad, the numbers are actually even worse," Rosenberg said.
Early Job Cuts Worse Than First Thought, as More Companies Go Belly Up
The loss of 263,000 jobs last month brings the total drop in U.S. employment to 7.6 million since the recession began — and revisions suggest the losses could turn out to be even steeper. Total U.S. nonfarm employment as of March was probably lower by 824,000 than previously thought, or about six-tenths of a percent, the Bureau of Labor Statistics said Friday, reflecting the unusual severity of job losses during the first quarter.
“Most of the additional job loss… appears to be due to in part to an increase in the number of business closings,” said BLS Commissioner Keith Hall in a statement.
The findings come from preliminary benchmark revisions released Friday along with the monthly employment report, which will be finalized and published on Feb. 5 of next year. The annual revisions, based on unemployment insurance tax reports, give a more accurate view of the labor market than the government’s monthly surveys. The benchmark revisions are typically small, raising or lowering employment levels by around two-tenths of a percent. But not this time.
The BLS’s birth/death model underestimated just how many businesses were folding — particularly during the January through March quarter — as the recession worsened. Economists had been bracing for a downward revision, but not necessarily one of this magnitude, which means the U.S. has likely shed more than 8 million jobs since December 2007. For example, in a note Thursday, Goldman Sachs economist Ed McKelvey said he expected the revision to be “on the order of -150,000 to -200,000.”
“It’s a huge number, much more than usual,” said Nigel Gault, chief U.S. economist at IHS Global Insight. The government’s models “tend to assume dying firms get replaced, but that didn’t happen.” Mr. Gault said the revisions suggest the economy was doing even worse in the first quarter than previously assumed, and cast doubts on the recovery. One temporary silver lining: it could be good news for corporate profits in the just-finished third-quarter, since firms saw increased sales while continuing to cut back on wages and salaries, he said. “But then, where’s the future demand coming from?”
“Today tells us employment’s going down, hours worked are down, incomes are falling — so how can we sustain robust growth in consumer spending in that environment? The consumer doesn’t have to lead the expansion,” he said, “but the consumer has got to be part of it.”
F.D.I.C. Closes Three More Banks
Regulators have shut down Warren Bank in Warren, Mich., and two small banks in Colorado and Minnesota, raising the number of failed banks this year to 98. The Federal Deposit Insurance Corporation took over Warren Bank, with about $538 million in assets and $501 million in deposits as of July 31. The Huntington National Bank, based in Columbus, Ohio, agreed to assume the deposits and about $83 million of the assets of the failed bank. The F.D.I.C. will retain the remaining assets for later disposition. Warren Bank’s six branches will reopen Saturday as offices of Huntington National Bank. The failure of Warren Bank is expected to cost the deposit insurance fund about $275 million.
Regulators also shut the Jennings State Bank, in Spring Grove, Minn. Central Bank of Stillwater, Minn., agreed to assume the bank’s $52.4 million in deposits and essentially all the bank’s assets, which totaled $56.3 million on July 31. The F.D.I.C. estimates the closing of Jennings State Bank will cost the deposit insurance fund about $11.7 million. Regulators also shut the Southern Colorado National Bank in Pueblo, Colo. Legacy Bank of Wiley, Colo., agreed to assume the deposits and essentially all of its assets. The two branches of Southern Colorado National Bank will reopen Saturday as Legacy Bank offices.
U.S. bank card delinquencies hit record high
Delinquencies in U.S. bank cards rose in the second quarter to 5 percent of all accounts, while delinquencies in direct auto loans showed improvement, dropping to 2.46 percent, the American Bankers Association said on Thursday. Job losses, shorter work weeks and drops in incomes drove up consumer delinquencies during the quarter, with record highs reported in home equity loans, home equity lines of credit, and bank cards, the ABA said.
"The picture won't change until the labor market improves and the economy picks up steam. This is going to take time," said James Chessen, chief economist for the ABA. The unemployment rate rose to 9.7 percent in August, the highest figure since 1983, and is expected to remain high into next year even as the economy recovers. The industry group said its composite ratio of delinquencies, which tracks eight closed-end installment loan categories, hit a record high at 3.35 percent of all accounts, compared to 3.23 percent of all accounts in the previous quarter. It defines a delinquency as a late payment that is 30 days or more overdue.
But it noted a few bright spots in which delinquency rates improved: direct auto loans, indirect auto loans, and mobile home loan delinquencies. Direct auto loans fell to 2.46 percent of accounts from 3.01 percent, while indirect auto loans fell to 3.26 percent from 3.42 percent. "The good news is that consumers are clearly being more cautious by saving more, spending less and making great efforts to repair their balance sheets," Chessen said.
The Credit Crunch Continues
by Meredith Whitney
Anyone counting on a meaningful economic recovery will be greatly disappointed. How do I know? I follow credit, and credit is contracting. Access to credit is being denied at an accelerating pace. Large, well-capitalized companies have no problem finding credit. Small businesses, on the other hand, have never had a harder time getting a loan.
Since the onset of the credit crisis over two years ago, available credit to small businesses and consumers has contracted by trillions of dollars, and that phenomenon is reflected in dismal consumer spending trends. Equally worrisome are the trends in small-business credit, which has contracted at one of the fastest paces of any lending category. Small business loans are hard to find, and credit-card lines (a critical funding source to small businesses) have been cut by 25% since last year.
Unfortunately for small businesses, credit-line cuts are only about half way through. Home equity loans, also historically a key funding source for start-up small businesses, are not a source of liquidity anymore because more than 32% of U.S. homes are worth less than their mortgages. Why do small businesses matter so much? In the U.S., small businesses employ 50% of the country's workforce and contribute 38% of GDP. Without access to credit, small businesses can't grow, can't hire, and too often end up going out of business. What's more, small businesses are often the primary source of this country's innovation. Apple, Dell, McDonald's, Starbucks were all started as small businesses.
What's especially disturbing is how taxpayer dollars have supported "too big to fail" businesses yet left small businesses unassisted and at a significant disadvantage. Small businesses do not have the same access to government guarantees on their debt. After all, most of these small businesses don't issue public debt. As is true in most recessions, banks' commercial lending portfolios shrink as creditworthy customers pay down their debts and the less-worthy borrowers are simply denied loans. Banks, in other words, want to lend only to those that don't want to borrow. Challenging as that may be, in the last cycle small businesses at least had access to their credit cards.
Small businesses primarily fund themselves through credit cards and loans from local lenders. In the past two years, credit-card lines have been cut by over $1.25 trillion. During the same time, 10% of all credit-card accounts have been cancelled. According to the most recent Federal Reserve data, small business lending is down 3%, or $113 billion, from fourth-quarter 2008 peak levels—the first contraction since 1993. Credit cards are the most common source of liquidity to small businesses, used by 82% as a vital portion of their overall funding. Thus, it is of merit when 79% of small businesses surveyed tell the Small Business Association that credit-card lending standards have tightened drastically and their access to credit lines has decreased materially.
Incentives should be provided to smaller banks to step up small-business loans on a greater scale. Smaller banks could not only bridge gaps created by the shut down in the securitization market but also gaps being created by a massive contraction in credit-card lines. Arguably credit would perform better with these types of loans as they would reintroduce and reinforce the most important rule in banking: "Know Your Customer." I believe that we are only in the early stages of the second half of this credit cycle. I expect another $1.5 trillion of credit-card lines to be removed from the system by the end of 2010. This includes not only the large lenders reducing exposure but also the shuttering of several major subprime credit-card lenders.
Beginning in the fourth quarter of 2007, lenders began reducing available credit by zip code. During the past four quarters, lenders have cut "inactive" accounts (whether or not the customer viewed the account as a liquidity vehicle). The next phase will likely be credit-line cuts as lenders race to pre-emptively protect themselves from regulatory changes associated with the Credit Card Accountability, Responsibility and Disclosure Act, passed in May of this year, and the 2008 Unfair and Deceptive Acts and Practices Act.
Regulators should be mindful that regulatory change during the midst of a credit crisis often ends with unintended consequences. Those same consumers that regulators are trying to help are actually being hurt by a vast reduction in available credit. Main Street represents the foundation of this country. Reviving it should take priority over any regulatory reform or systemic overhaul.
US Personal Bankruptcy Filings to Exceed 1.4 Million by the End of the Year
Consumer bankruptcies topped one million for the first nine months of this year, the highest point since the system was overhauled in 2005. The number of personal bankruptcy filings for the nine months rose to 1,046,449 as of Sept. 30, the American Bankruptcy Institute, an organization made up of attorneys, accountants and other bankruptcy professionals, said Friday, using data from the National Bankruptcy Research Center. There were 773,810 personal bankruptcy filings for the same time period in 2008.
September's filings reached 124,790, 41% higher than the same month last year. The 2005 revamp was intended to make it harder for Americans to shed their debts by filing for bankruptcy. In that year, before the law took effect, there were 1.35 million bankruptcy filings in the first nine months.
But a tough economic climate has sent filings soaring again and ABI expects personal bankruptcies to exceed 1.4 million by the end of the year. "Bankruptcy filings continue to climb as consumers look to shelter themselves from the effects of rising unemployment rates and housing debt," the institute's Executive Director Samuel J. Gerdano said.
The Amazing Cash-For-Clunkers Cliff Dive
This is what an economic strategy of pulling it forward looks like. In August, car buyers were going nuts with a $4,500 incentive to trade clunkers in for brand new cars. Many warned, of course, that these sales would simply end up decreasing future sales, getting us nowhere. Well, September's here, and... yeah. A monthly sales rate of over 14 million units annualized quickly fell to just above 9 million.
September A Clunker For Automakers
Economic bubbles always pop, as stock and real estate investors painfully found out last year. So there's little surprise that one of the micro bubbles the government created to mitigate the damage popped, too. And quickly. After a swift boost in sales over the summer on the back of the government's "Cash for Clunkers" program, auto dealers returned to the reality of empty showrooms after Labor Day.
Sales tumbled across most of the industry in September, with year-over-year numbers coming in worse than expected for some carmakers. Both General Motors and Chrysler were off more than 40% from September 2008. The damage was much less severe at Ford Motor, which saw a 5.1% drop, thanks to a decent month for its 2010 Taurus and an uptick in sales of its F-Series pickup trucks. Incentives came down a bit from last September, but still averaged more than $3,000 per vehicle at the much-diminished Big Three, according to Edmunds.com.
Major foreign automakers lost ground as well: Sales dropped 13% at Toyota and 7% at Nissan. All together, industry sales were off 23% from last September and 41% from August, according to the tracking firm AutoData. "It was a little worse than what we expected," says Jesse Toprak, vice president at TrueCar.com, a consumer site that offers pricing advice for new cars. His forecasts suggest that when all the numbers shake out, GM, Chrysler and Ford could wind up with their lowest combined domestic market share ever for September--less than 45% of the North American market. GM is also set to shut down its Saturn unit after a deal to sell the brand to Penske Automotive Group fell through.
The bleak month served as a reminder that juicing up sales by handing out cash does more long-term harm than good. Consumer spending shot up 1.3% in August, the biggest one-month jump in eight years, as the government pumped billions into programs like Cash for Clunkers and homebuyer tax credits. Incomes, though, rose only 0.2% during the month, as unemployment hovered close to 10%. So after spending most of 2009 socking more savings away, Americans reversed course in August, back to the pre-recession blueprint of spending more than they made.
That's easy to do when the deal seems too good to pass up--the same mentality that got so many consumers in trouble in the first place. But the likely long-term result is even slower spending going forward, as great deals courtesy of the government reduced pent up demand. "They're good political tools, and make it look like the government is doing something," says Wachovia Securities economist Mark Vitner of the taxpayer-financed incentive programs. "It buys some time, but there's no real lasting benefit to the economy."
Whether it's homes, cars, boats or anything else, don't expect real consumer spending--that is, people spending their own money, not the taxpayers'--to grow until early next year, according to Vitner. And figure spending growth to trail income growth for another three or four years, as Americans rebuild their household finances. Consumers put that chore aside in August, setting them another month behind. "People just lost so much wealth," Vitner says, while pointing out that consumers are unlikely to step up and buy cars until job numbers improve. Claims for unemployment insurance rose by 17,000 to 551,000 last week, more than expected. Economists generally consider 400,000 claims to be the dividing line between a growing and shrinking job market.
Toprak of TrueCar.com says that some dealer feedback indicated that the Cash for Clunkers program pulled in a lot of fence-sitting customers who were almost ready to buy as it was, as opposed to inducing those intent on postponing any car purchases for a while. If that's true, then the program's effect on future demand won't be too severe. Of course, demand looks weak anyway, given the job market blahs and the fact that October and November are generally dealers' worst months of the year. "We've got a ways to go; folks realize we're not bouncing back as quickly as we hoped," says Vitner.
Japan vehicle sales up 3.5% in September
Sales of vehicles (excluding minivehicles up to 660cc) in Japan rose 3.5% to 321,737 in September from a year earlier, the Japan Automobile Dealers Association (JADA) said in a statement today. It was the second straight month of growth which has been driven by government incentives to encourage sales of smaller and more fuel-efficient cars. Under the government programme which began in June, consumers can apply for a 250,000 yen (US$2,800) subsidy if they scrap a car more than 13 years old to buy a new one, and 100,000 yen for a new car purchased without scrapping an old one. The subsidies are available retroactively for purchases from April 10. The program is due to expire at the end of March.
The government expects the incentives to lead to the sale of an additional 690,000 vehicles this fiscal year. Electric, hybrid, natural-gas, and some diesel vehicles also qualify for an exemption from the country's weight and purchase taxes. "The auto industry continues to see the positive effect of government incentives," said a JADA official. However, analysts caution that the state of Japan's economy remains very fragile and that without incentives, sales would be depressed.
Japan August vehicle output falls 26%
Japanese production of cars, trucks and buses in August fell 25.9% year on year to 571,787 units for the 11th straight month of decline though the rate of decline slowed for the sixth consecutive month, the Japan Automobile Manufacturers Association (JAMA) said. Car production fell 24.6% to 493,661 units, truck output 32.9% to 71,698 units and bus production 31.9% to 6,428 units. Exports last month plunged 44.6% to 275,186 units for the 11th straight month of decline, Kyodo News noted.
Toyota 'a step away from "capitulation to irrelevance or death"'
Akio Toyoda, president of Toyota, the world’s biggest automaker, might as well have thrown himself on the ground in a tearful kowtow. From grief over a fatal crash linked to Toyota floor mats to regrets over the company’s forecast for a second consecutive annual loss, the executive spewed a litany of apologies to astonished reporters gathered for a briefing Friday at the Japan National Press Club.
Toyota was shamefully unprepared for the global economic crisis and now is a step away from "capitulation to irrelevance or death," said Mr. Toyoda, the grandson of the carmaker’s founder. The company, he added, is "grasping for salvation." Quoting from a popular business book by the management guru Jim Collins, he declared the automaker had gotten too arrogant on "the hubris born of success" and the "undisciplined pursuit of more."
Mr. Toyoda’s public display of grief follows a tradition of remorse in Japan, where profuse public apologies — often accompanied by repeated bowing — are the norm for scandal-tainted politicians and executives at unprofitable companies. Yet given how few words of contrition have been spoken in the past year by chief executives whose companies have made huge losses, asked for government aid or simply gone bankrupt, Mr. Toyoda’s comments were striking.
Toyota expects a record loss of ¥450 billion, or $5 billion, for the year that will end in March, as car sales stay sluggish. But it is still considerably better off than its American rivals. In 2008, the Japanese automaker overtook General Motors to become the world’s biggest producer of cars. Though the company has come under fire at home for laying off scores of temporary workers in Japan, it has so far protected its 69,000 full-time employees. But that is not good enough, Mr. Toyoda moaned. The company has been betraying its roots as a quality automaker, he said.
A recent fatal car accident in the United States, possibly linked to oversize floor mats in one of Toyota’s Lexus luxury models, was "extremely regrettable," he said, and had undermined the company’s reputation for safety. That August crash killed a highway patrol officer and three family members outside San Diego, possibly when the accelerator got jammed by the rubber floor mat. As a result, Toyota could face a recall of 3.8 million cars, its biggest ever in the United States.
"Four precious lives have been lost. I offer my deepest condolences," Mr. Toyoda said. "Customers bought our cars because they thought they were the safest. But now we have given them cause for grave concern," he said. "I can’t begin to express my remorse." And Mr. Toyoda did not stop there. It was "agonizing" to decide to cease production at a California plant this year, after General Motors, its partner in the venture, decided to pull out. "I know it’s a big blow to the local economy," he lamented.
The Japanese people were also owed an apology, he said, because Toyota was no longer coming out with cars that excited them. Auto sales have fallen in recent years, partly because of a growing disinterest in cars among younger Japanese. "They say that young people are moving away from cars," he said. "But surely it is us — the automakers — who have abandoned our passion for cars."
The appointment of Mr. Toyoda, who took the helm of the automaker in June, is seen as an attempt by Toyota to return to its roots, after a period of what some have called recklessly fast expansion overseas, and into bigger vehicles like SUVs. He repeatedly talks of his grandfather, the company founder, Kiichiro Toyoda, who "would himself go to the scene to fix Toyota cars that broke down," and the need for Toyota to stay small enough to care about individual customers. Even Japan’s tax collectors were targets of Mr. Toyoda’s litany.
"I want Toyota to return to profit, so we can start paying taxes and go back to contributing to society," he said. And in a peculiar show of deference, even the reporters gathered were issued an apology. "I’m sorry I am standing on a podium, standing above you," Mr. Toyoda told the seated audience. "But my seniors always taught me that I must stand when addressing those who are above me."
Some Japanese apologies should be taken with a grain of salt, however. "Sometimes, this apology business is a way to avoid taking real action or responsibility," said Robert Dujarric, director of the Institute of Contemporary Japanese Studies at Temple University’s Japan campus. "When you hear these long apologies," Mr. Dujarric said, "It makes you want to say: ‘Don’t be sorry, just do something about it."’
Europe's jobless youth 'tragedy' rattles EU ministers
European finance ministers have delayed the withdrawal of emergency stimulus until 2011 at the earliest, fearing continued strains in the credit system and an alarming rise youth unemployment. The decision agreed today at a mini-summit on EU exit strategies in Gothenburg comes despite warnings from the International Monetary Fund that several countries face an "unsustainable debt trajectory". "The time has not yet come to withdraw fiscal stimulus," said Jean-Claude Juncker, chair of the `Eurogroup’ of EMU finance ministers. "The economic situation remains very fragile."
EU officials have been unnerved by a further rises in euro area unemployment to 9.6pc in August, reaching 18.9pc in Spain. The pattern of past cycles is that it Continental Europe is much slower than the US or the UK to regain jobs as the economy recovers because of rigid labour markets. It is likely to be even more painful this time because the crisis has inflicted permanent damage to the EU’s industrial foundations. Joaquin Almunia, the EU’s economics commissioner, said Europe’s potential growth rate had been "cut in half" to just 1pc by the events of the last two years, chiefly due to destructive effects of bursting debt bubbles. This poses a grave challenge for Europe as the fuse burns ever closer on its demographic time-bomb.
Barclays Capital said that almost 60pc of the 3.9m jobs lost in the eurozone since April last year have been in Spain alone, but Germany is likely to start catching up soon because it has seen a dramatic spike in short-term workers -- typically a symptom of "labour hoarding" that comes before a purge. Youth unemployment has reached 39pc in Spain, 31pc in Lithuania, 28pc in Latvia, 26pc in Ireland and Slovakia, 25pc in Italy and Hungary, 24pc in France.
"There's tragedy unfolding here," said Julian Callow, Barclay’s Europe economist. "This is going to haunt the political outlook for years to come. Europe has been in denial about this because youth are not a powerful lobby like the unions, so they can be ignored. This will erode Europe’s human capital and threaten a lost generation of workers," he said. "The only solution to hold Europe together is a substantial devaluation of the euro. Manufacturing industry in Spain and Italy has been hollowed out over the last decade in a competitive shift from West to East. This is very serious but the EU seems to be too fragmented politically to do anything about it." he said.
Anders Borg, Sweden’s pony-tailed finance minister and host of the EU mini-summit, said Europe will have to bite the bullet sooner or later on spending cuts or face the likelihood that public debt will balloon to over 100pc of GDP across the region. "Obviously, we have to discuss exit strategies," he said. The EU has to move with great care. Eurozone credit has been contracting for several months. There is mounting evidence that small companies without access to the bond markets are finding it impossible to roll over loans or extend credit lines.
An EU stress test unveiled yesterday said European banks (including British) "appear sufficiently capitalized to head off a severe macro-economic deterioration" but may face further losses of €400bn by the end of next year. The International Monetary Fund said in its Financial Stability Report that European banks have written down just 40pc of their likely losses so far, compared to 60pc for US banks. "Substantial write-downs lied ahead," it said. The IMF said the delay in Europe was due "lags in the credit cycle", accounting rules, and the higher dependence of European banks on old-fashioned lending that crystalizes losses more slowly. They will face rising defaults in Eastern Europe for year to come.
"Considerable uncertainty remains regarding the value of distressed assets and asset quality in general, which continues to raise questions about banks’ capital bases and their capacity to lend," it said Europe’s have raised $437 billion in Tier 1 capital, mostly as preferred shares and subordinated debt. They will need another $380bn to ensure a 10pc capital ratio. The IMF said some of this will need to be "tangible capital" to absorb losses and revive lending. BN Paribas and Unicredit are raising over €4bn each. Total losses worldwide are likely to be $2.8 trillion. The banks have confessed to $1.3 trillion of worthless debt so far. They have another $1.5 trillion to go.
Deflation taking root in global economies
Fuelled by overcapacity, shrinking credit, reduced corporate spending and falling consumer demand, deflation is on the rise
The spectre of a crippling bout of deflation is hanging over the global economy. Fuelled by continuing overcapacity, shrinking credit, reduced corporate spending and falling consumer demand, deflation is on the rise in its old stomping ground of Japan and taking root in the battered U.S. and European economies. Consumer prices fell at their fastest clip ever last month in Japan, which has been fighting a losing war against deflation for much of the past two decades. Germany, Europe's biggest economy, has now suffered through four consecutive months of sliding prices, and the rest of the region that uses the euro is not faring much better.
That deflation should be such a threat may run counter to market fears that inflation will quickly follow the massive, and costly, global effort to fight the financial crisis. But many observers see deflation as the greater threat. That's because it's harder to stamp out once it becomes embedded in an economy, as happened during the Great Depression. The result would inevitably be years of dismal economic performance, staggering unemployment, and deeply pessimistic consumers and businesses that cease spending and focus on surviving, economy watchers warn.
Famed bond investor Bill Gross is loading up on longer-term government bonds to capitalize on his view that the U.S. is facing just such a grim development. "We are certainly in a deflationary state," said David Rosenberg, chief economist and strategist with Gluskin Sheff and Associates in Toronto. "Of that, there's no doubt," Mr. Rosenberg said.
Inflationistas fear that massive government injections of cheap money into the economy are about to send asset values and prices skyrocketing. On Tuesday, Richard Fisher, president of the Federal Reserve Bank of Dallas and a prominent inflation hawk, said the U.S. central bank could raise interest rates quickly if the economy stabilizes. But he pointedly added that there may be deflationary risks in the near term and rising unemployment.
"While the commentariat is focused on inflation, the real issue for now is deflation, driven by virtually 10-per-cent unemployment in the U.S., Germany, France, Italy, China, India et al," said Ken Courtis, an investment banker based in Hong Kong and an expert on Japan and other Asian economies. In Japan, a succession of governments have tried every trick in the playbook to inflate the economy. Nothing seems to have had a lasting effect.
"While Japan counts unemployment somewhat differently, it is running at close to 6 per cent, and if you consider that the labour market is contracting at about 1.1 per cent [annually], you can get a sense of the intensity of the downdraft," Mr. Courtis said. Japan is exporting far fewer of the products that once made its economy so successful. For example, auto exports are about half the level of the previous five years, sidelining plants, workers, and parts and materials suppliers.
Americans and others could face a similar fate as the "Japanese disease" spreads, although the Federal Reserve and other central banks have moved faster and much more aggressively than the Japanese in efforts to counter deflationary dangers. "I think people still have no clue as to just how weak the economy is," Mr. Rosenberg said. Remove the "impressive medication" administered by governments, and most economies are at a virtual standstill. The U.S. economy faces a decade of stagnation, he said. "That's a perfectly plausible scenario."
Not every economy watcher buys the deflation scenario, however. "It may be a boring story, but neither deflation nor inflation is a particular risk," said Avery Shenfeld, chief economist at CIBC World Markets. Indeed, during this recession Canada has so far been spared some of the conditions that pave the way for deflation, such as falling wages. But if the virus hits in the United States, it could easily spread north. And the fragile U.S. economy is extremely vulnerable just now. U.S. lending has been contracting at record levels, excess manufacturing capacity is widespread, consumers have curtailed spending, real wages are falling and unemployment is still rising.
Including the underemployed, the U.S. jobless rate is actually 17 per cent, nearly double the official rate of 9.5 per cent, Mr. Rosenberg said. To prevent a deflationary outcome, policy makers have to stop worrying about how they'll rein in future deficits and start persuading the public that they'll do whatever it takes to keep the pumps primed and cash savings nearly worthless, said Arthur Heinmaa, managing partner with Toron Capital Markets in Toronto.
The lessons from Japan show that officials have to be "credibly reckless," Mr. Heinmaa said, paraphrasing one of Federal Reserve Board chairman Ben Bernanke's lines. If and when it does hit, "deflation will last until we see the next secular trend of expanding household balance sheets, and that is some time away," Mr. Rosenberg said.
Stiglitz Deflation Threat Pushes Bernanke to Keep Rates at Zero Next Year
The U.S. faces the possibility of deflation for the first time since the Eisenhower administration, a threat that may prompt the Federal Reserve to keep interest rates near zero through next year. Executives at Kroger Co., the largest U.S. supermarket chain, blamed deflation for a 7 percent drop in earnings in the second quarter, while falling prices for food, gasoline, and electronics left August sales unchanged at Costco Wholesale Corp. A sustained price drop might set off a chain reaction in which lower profits force employers to pare wages and payrolls. That would erode consumer demand, exacerbating wage cuts and firings.
Such a spiral led to Japan’s "lost decade" of slow economic growth in the 1990s. A more vicious version in the U.S. helped create the Great Depression six decades earlier. Bond investors are forecasting retreating consumer prices, as shown by the yield they demand to hold a one-year bond versus a similar inflation-protected bond. "Deflation is definitely a threat right now," Nobel laureate Joseph Stiglitz, 66, a professor at Columbia University in New York, said in a Sept. 22 interview. "The combination of the deflation threat and the sluggish recovery should keep the Fed on hold for quite a while."
Consumer prices are experiencing deflation, with the consumer price index sliding for six straight months from year- earlier levels, the longest stretch of declines since a 12-month drop from September 1954 to August 1955, according to the Labor Department. So far, the core consumer-price index, which excludes food and energy, is facing disinflation, a slowing in the pace of increase. The core index rose 1.4 percent in August from a year earlier, down from 2.5 percent in September 2008.
Regional Federal Reserve Bank Presidents Janet Yellen, of San Francisco, James Bullard, of St. Louis, Richard Fisher, of Dallas, and Charles Evans, of Chicago, have expressed concern in past weeks about the possibility of declining prices. "Disinflationary winds are blowing with gale-force effect," Evans, 51, said in a Sept. 9 speech in New York. While the economy contracted 2.7 percent during the 1953 recession, it shrank 3.8 percent in the current recession, the most since the 1930s. Economists at New York-based JPMorgan Chase & Co. and Goldman Sachs Group Inc., the second- and fifth- biggest U.S. banks by assets, say there’s so much deflationary excess labor and plant capacity in the economy that the Fed won’t raise interest rates until at least 2011.
"The potential for a deflationary downdraft continues for several years" if economic growth doesn’t accelerate, Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co. in Newport Beach, California, said in a Sept. 29 interview with Bloomberg Radio. At their most recent meeting on Sept. 23, Fed policy makers agreed to leave the benchmark interest rate in a range of zero to 0.25 percent, where it’s been since December 2008. Only 69.6 percent of the country’s factories, utilities and mines were in use during August, close to the record low of 68.3 percent reached in June.
Former Fed Chairman Alan Greenspan said the economic rebound won’t prevent a further slowing of the pace of price increases. "We are still, by any measure, in a disinflationary environment," Greenspan, 83, said in a Sept. 30 Bloomberg Television interview in Washington. At the same time, recent reports on manufacturing, housing, and consumer spending suggest that any investor concerns about the danger of deflation are overblown, said Dean Maki, chief U.S. economist at Barclays Capital Inc. in New York. The median projection of economists surveyed by Bloomberg News is for first quarter growth of just 2.4 percent, compared with a decline of 6.4 percent in the first quarter of 2009. Maki sees a 5 percent expansion in the first quarter of 2010. That would translate into higher prices.
"Inflation is driven more by the level of demand and pace of growth than by the size of the output gap," said Stephen Stanley, chief economist at RBS Securities Inc. in Stamford, Connecticut. "As the economy returns to solid growth in 2010, we are quite confident that, in sharp contrast to the consensus Fed view, core inflation will be creeping higher." Fed officials are already planning for that, and publicly discussing an exit strategy once the economy does pick up. At that point, the Fed may have to move with "greater force" than some anticipate to keep inflation from accelerating too rapidly, Fed Governor Kevin Warsh, 39, said in a Sept. 25 speech in Chicago.
That day is far off for bond investors. Inflation fears, raised by the more than $1 trillion the Fed has pumped into the economy by lowering rates and buying Treasuries and mortgage- backed securities, are fading. "There’s been a significant flattening on the long end of the curve," reflecting concern about deflation, said Pacific Investment’s Gross, 65, who is buying longer-maturity Treasuries in response. The yield on the 10-year note, which was 3.95 percent on June 10, was 3.18 percent at the close of New York trading yesterday. The difference in yield between nominal and inflation-protected Treasury securities maturing in one year is negative 0.4 percent, suggesting investors expect deflation during the next 12 months. Over five years, that inflation premium is now 1.21 percent, down from 1.86 percent on June 10.
The Fed needs to "keep inflation expectations from slipping to undesirably low levels in order to prevent unwanted disinflation," Vice Chairman Donald Kohn, 66, said Sept. 10 in Washington during a speech at the Brookings Institution. Falling consumer prices are partly a reflection of a 52 percent decline in oil prices to about $70 a barrel yesterday from $145.45 a barrel on July 3, 2008. The slowing in core prices is more of a concern, said Michael Feroli, an economist at JPMorgan. The core rate fell following three prior recessions in which unemployment rose above 7 percent. That "suggests that core inflation could well be below zero within two years," Feroli said in an interview.
Core CPI fell 5.3 percent following the recession of 1973- 1975, 10.7 percent following the recession of 1981-1982 and 3 percent following the recession of 1990-1991. Unemployment was 9.7 percent in August, and it will likely climb to 10 percent in the fourth quarter, according to the Bloomberg survey of economists. The jobless rate was estimated to average 8.8 percent in 2011. With unemployment elevated, companies may not need to raise pay to attract workers, even when the economy picks up. "My personal belief is that the more significant threat to price stability over the next several years stems from the disinflationary forces unleashed by the enormous slack in the economy," Yellen, 63, said Sept. 14 in San Francisco.
Wages for U.S. workers fell for eight months in a row, dropping 5.6 percent from October 2008 to June 2009, according to Commerce Department figures. In contrast, wages continued to grow in the 1954-1955 deflation period. Stagnating wages and fading job prospects are sapping demand. Consumer spending may increase in the fourth quarter by just 1 percent and in 2010 by an average of only 1.6 percent, according to the median estimate in the Bloomberg survey of economists. Consumption rose by an average 5.7 percent a quarter in the five years before the recession began in December 2007. "A weak labor market in a competitive environment puts downward pressure on wages," said Stiglitz, who won the Nobel prize for economics in 2001. "So, the possibility of another actual decline in wages cannot be ruled out."
The deflation danger is compounded by household debt, said Paul Ashworth, senior U.S. economist at the consulting firm Capital Economics in Toronto. U.S. homeowners owed $13.9 trillion in the third quarter of 2008, compared with an average of $8.5 trillion in the 57 years the Fed has kept records. "As incomes start to fall, that debt gets bigger in real terms: You have a smaller income to pay off that debt," Ashworth said. "Deflation combined with high indebtedness can be very problematic."
Inflation happens when too much money chases too few goods. Gary Shilling, president of the investment research firm A. Gary Shilling & Co. of Springfield, New Jersey, said that even as the Fed continues to pump money into the economy, the money supply, as measured by the central bank’s M2 index, has dropped one percent since mid-June. "Look what is happening to money supply, it is actually contracting now when supposedly the economy is picking up," Shilling said in an interview on Bloomberg Television Sept. 21. The economy is facing deflation "because you’ve got basically an excess-supply world," he said.
Profits have evaporated as companies lose pricing power. The 419 non-financial firms in the S&P 500 reported earnings down 28 percent in the quarter ending June 30. Analysts surveyed by Bloomberg anticipate a 30 percent decline for the third quarter, which ended this week. "Businesses trying to sell products and services feel they are pushing on a string and are adjusting their behavior accordingly," Fisher, 60, the Dallas Fed president, said in a Sept. 3 speech at the University of California in Santa Barbara. "They are cutting prices." Rodney McMullen, president of Cincinnati-based Kroger, blamed price reductions for second-quarter earnings that fell 10.5 percent short of analysts’ estimates. "We certainly sold more units. But lower retail prices and profit per unit pressured" results, McMullen told analysts in a Sept. 15 conference call. "We began to see deflation."
The average amount spent per transaction in August at Issaquah, Washington-based Costco was about 7 percent below last year, Bob Nelson, vice president for financial planning, said on a Sept. 3 conference call with investors. At Wal-Mart Stores Inc., the world’s largest retailer, "headwinds" from deflation were in part responsible for a 1.4 percent drop in second-quarter revenue to $100.9 billion, chief financial officer Thomas Schoewe told analysts Aug. 13.
Does money contraction signal serious trouble?
Many readers think I have been talking balderdash about the money supply. Specifically, that contraction of credit and M3 money in both the US and Europe signals double-dip trouble ahead.
I have dabbled in this subject from time to time. The money and credit data gave a crystal clear warning in July 2008 (as I wrote in a blog at the time). It is worth looking at the charts in that blog. They could not have been uglier.
I have returned to this theme over the last month — with slightly less conviction than a year ago, I must admit — mostly relying on the thoughts of Tim Congdon from International Monetary Research, the team at Lombard Street Research, and David Rosenberg at Gluskin Sheff.
M3 money — the best leading indicator, a year or so in advance — has been shrinking at a 5pc annual rate since June in the US. It has been slightly negative since March in the eurozone.
The Fed says M2 contracted at a 7.3pc annual rate in August, and 3.1pc rate in July. It has shrunk since May.
M1 contracted at a 3.7pc rate.
The monetarists do not agree among themselves about the meaning of this, however. Germany’s top theorist, Prof Roland Vaubel from Mannheim University, tells me this is all tosh because narrow M1 is growing fast, at least in Europe.
Simon Ward from New Star Management, one of the UK’s small club of monetarists, has been in touch to tell me that I am barking up the wrong tree. The picture is much more benign than it looks.
His argument is that velocity of circulation is picking up fast. This can be inferred because money is pouring into mutual funds and there is growth in narrow M1 as people shift funds out of savings accounts into cash and cash-like accounts. Such shifts are a leading indicator that M3 velocity is rising, even if growth is not yet visible in the data.
This mimics the US in the early 1990s, not Japan at the onset of the Lost Decade, let alone the Great Depression. A steep yield curve (as banks and funds play the carry trade by borrowing at near zero short-rates to buy longer-dated bonds at higher interest) is artificially depressing the broad money indicator — for now.
Simon argues that credit stagnation is in any case caused by lack of demand for money, not by the refusal of banks to lend (Ergo, no credit crunch), and that bank lending data in the US does not include the Fed’s purchase of mortgage bonds.
Here’s his latest note on this.
Hmhh. He may be right, (I dispute that M1 is growing in the US) but I suspect that the rush by banks to meet tougher capital adequacy ratios is acting as a form of vicious monetary tightening (Tim Congdon says the G20 drive for higher ratios in the middle of a downturn is the equivalent of the liquidationist stupidity of the early 1930s. Our leaders risk pushing the world economy over a cliff).
I also suspect that something totally different is going on with M1, and won’t be so pretty. People are putting savings in narrow money accounts because you get zilch interest whatever you do — not because they are about to go on a spending spree. This may distort M1 in the other direction entirely. In any case, M1 shrank over August in the US.
What is clear is that zero rates are playing havoc with the indicators, so nobody really know what is going on — and that includes the central banks. You have to trust your instincts here. We are in the field of psychology and anthropology. Econometric models are useless once events take a dramatic turn. They are dangerous, allowing ideologues to push their theories beyond the point of common sense.
Ben Bernanke, of course, stopped paying any attention to M3 broad money a long time ago. He was largely responsible for abolishing the data at the Fed (though it is easily reconstructed). This was another of his grave errors. Had he been watching M3, he would have known that the bubble was getting out of hand in 2005 to 2006, and equally that the banking system was going to start collapsing in 2007, and to disintegrate in 2008. It was all there, as clear as daylight.
It took some cheek for Bernanke to say at Jackson Hole this August that nobody could have seen the banking crisis coming. They did it fact see it, and shrieked from the rooftops. He had cloth over his ears.
In as much as he pays any attention to money, it is only to narrow M1. I fear that this is going to take him –and the world — smack into another crisis. You need to look at everything.
Here are a few charts from the St Louis Fed to chew over:
Max Keiser interviews Janet Tavakoli
US Banks With 20% Unpaid Loans at 18-Year High as Doubts Over Recovery Deepen
The number of U.S. lenders that can’t collect on at least 20 percent of their loans hit an 18-year high, signaling that more bank failures and losses could slow an economic recovery. Units of Frontier Financial Corp.,Towne Bancorp Inc. and Steel Partners Holdings LP are among 26 firms with more than one-fifth of their loans 90 days overdue or not accruing interest as of June 30 -- a level of distress almost five times the national average -- according to Federal Deposit Insurance Corp. data compiled for Bloomberg News by SNL Financial, a bank research firm. Three reported almost half of their loans weren’t being paid.
While regulators may not force firms on the list to close, requiring them to raise capital and curb loans may impede recovery in Florida, Illinois and seven other states. The banks are among the most vulnerable of a larger group of lenders whose failures the FDIC said could cost $100 billion by 2013. "There are some zombie banks out there," said Bert Ely, chief executive officer at Ely & Co., a bank consulting firm in Alexandria, Virginia. "Neither the banking industry nor the economy benefits from keeping weak banks in business."
Ninety-five banks have failed this year at the fastest pace in almost two decades, depleting the FDIC’s insurance fund. The agency proposed on Sept. 29 that financial firms prepay three years of premiums, which would add $45 billion of reserves. The fund sank to $10.4 billion as of June 30, the lowest since 1993. It will run at a deficit starting this quarter, the agency said. The cost of this year’s failures to the FDIC equals 25 percent of the banks’ assets, according to agency data. Applying the same ratio to the $14.1 billion of assets held by the 26 lenders on SNL’s list means the FDIC could face additional losses of $3.5 billion.
Non-current loans averaged 4.35 percent of the total at U.S. banks as of June 30, the most in 26 years of FDIC data. Regulators typically take notice at 5 percent, according to Walter Mix, a former commissioner of the California Department of Financial Institutions. Corus Bankshares Inc.’s bank unit in Chicago was shut Sept. 11 after 71 percent of its loans soured. The last time so many banks had 20 percent of their loans more than 90 days overdue was in 1991, near the end of the savings-and-loan crisis, when there were 60, according to an SNL analysis of FDIC data. That year the number of bank failures was less than half those at the peak of the crisis in 1988; this year closings are almost four times what they were in 2008.
For banks with 20 percent of loans overdue, "either they’ve got a massive amount of capital, or the FDIC just hasn’t gotten around to them," said Jeff Davis, an analyst with FTN Equity Capital Markets in Nashville. Lack of staff and money are slowing shutdowns, he said. At least 17 of the 26 banks have been hit with civil penalties or enforcement orders that demand improved management and more capital, according to data compiled by Bloomberg. Failure to comply can lead to seizure. The number of distressed banks is larger, with the FDIC counting 416 companies on its confidential list of "problem" lenders at mid-year.
The data were compiled by Charlottesville, Virginia-based SNL from FDIC records. Institutions that had loans less than 50 percent of assets were excluded, as were those closed since the end of June. The calculation didn’t include restructured loans modified after borrowers couldn’t keep up with the original terms, which have default rates of 40 percent to 60 percent within two months, according to SNL senior analyst Sebastian Hindman. Had such loans been included, the list would have swelled to 49 lenders holding $48.4 billion in assets.
Firms range in size from Frontier Bank in Everett, Washington, with $3.98 billion in assets, to Gordon Bank in Gordon, Georgia, with $35 million in assets. Six of the banks are in Florida and five in Illinois. "While these aren’t your giant banks, they are the guys your local strip mall and commercial real estate investors get their funds from," said Joseph Mason, a Louisiana State University banking professor and visiting scholar at the FDIC. The bank with the highest level of non-current loans, 49 percent, is Community Bank of Lemont in Lemont, Illinois, a town of about 13,000 people 30 miles southwest of Chicago. Bad loans at the bank, about a third of them in construction and development, increased fivefold from a year earlier, according to FDIC data.
In February, the FDIC ordered Lemont, a unit of Oak Park, Illinois-based FBOP Corp., to stop "operating with management whose policies and practices are detrimental to the bank and jeopardize the safety of its deposits." Calls to the bank seeking comment weren’t returned. Another Illinois lender, Benchmark Bank, also had an increase in non-current loans, to 25 percent as of June 30 from about 1 percent a year earlier. "Everything was so positive for so long in this area, it came as a surprise when it stopped," said John Medernach, Benchmark’s CEO, who added that a building boom and bust in his region may have wrecked more than just his balance sheet.
"I stop and think of all the rich farmland that has been developed into subdivisions during the boom years," Medernach said. "It makes you wonder what we’ve been doing." Frontier Bank, owned by Frontier Financial, reported a sixfold rise in overdue loans to $764.6 million in the quarter ended June 30 from a year earlier, or 22 percent, according to FDIC data. More than 43 percent of the bank’s delinquent loans were in construction and development, FDIC data show. The bank has 51 branches in northwestern Oregon and western Washington.
In July, Frontier Financial agreed to be acquired by SP Acquisition Holdings Inc., controlled by CEO Warren Lichtenstein, who heads the New York-based investment firm Steel Partners LLC, according to a presentation on the bank’s Web site. The deal would give Frontier access to about $456 million and create "an over-capitalized bank" that may consider acquisitions, the presentation said. The stock-swap transaction is scheduled to be completed in the fourth quarter.
Frontier "was a well-run organization for the majority of its history," said Jeffrey Rulis, a banking analyst at D.A. Davidson & Co. in Lake Oswego, Oregon. The offer by SP Acquisition is "probably not what current shareholders envisioned a couple of years ago." The company’s stock has dropped 92 percent in the last 12 months, and the bank posted an $84 million loss in the first half. Patrick Fahey, Frontier’s CEO, said the transaction will resolve the bank’s credit issues. He declined to elaborate while a shareholder vote is pending.
Lichtenstein’s Steel Partners Holdings LP controls WebBank, a Salt Lake City lender with $35.5 million in assets and 31 percent of its loans overdue, according to SNL. More than 90 percent of construction and development loans weren’t current as of June 30, according to the FDIC. John McNamara, WebBank’s chairman and a managing director at Steel, declined to comment. Determining which banks to close is "more of an art than a science," said William Ruberry, spokesman at the Office of Thrift Supervision, which regulates four of the 26 lenders. "Examiners and the supervisory people have a lot of information that’s not public, and they know the circumstances of an institution and everything that goes into it."
FDIC spokesman Greg Hernandez said in an e-mail that the agency doesn’t comment on individual institutions. Capital levels, profitability and financial strength of the owners are considered in addition to soured loans when deciding a bank’s fate, Hernandez said. "There may be personal guarantees, there may be other collateral that will more than make up for the impairment on the 20 percent," said Tom Giallanza, assistant superintendent for the State of Arizona Department of Financial Institutions, in a Sept. 15 interview. One bank on the list, Mesa, Arizona-based Towne Bank of Arizona, is in Giallanza’s state, with 28 percent of its loans non-current. Towne Bancorp CEO Patrick Patrick declined to comment.
H&R Block Bank, with 29 percent of its loans overdue, is dwarfed by the Kansas City, Missouri-based tax preparer that owns it. The bank’s deposits totaled $720.1 million as of June 30; assets at the parent company, H&R Block Inc., included more than $1 billion in cash and cash equivalents on July 31. The lender’s balance sheet is strong enough to be considered "well- capitalized" by regulators, according to FDIC reports. The bank is a legacy of H&R Block’s subprime home lending that ended with more than $1 billion of losses for the parent company. The unit was kept open because it’s an inexpensive way to fund the company’s financial products, President Russell Smyth said a year ago. Spokeswoman Elizabeth McKinley didn’t respond to requests for comment.
Regulators may be pacing themselves on closings because the FDIC fund "is only so big," there isn’t enough staff to close all the struggling banks at once and customers aren’t staging mass withdrawals that would force action, said Kevin Fitzsimmons, a managing director at Sandler O’Neill & Partners LP, a New York brokerage firm specializing in banks. While a high level of non-performing assets doesn’t mean a bank can’t survive, "in some cases it creates a hole that’s too deep to climb out of," Fitzsimmons said.
EU Says European Banks Might Lose $585 Billion But Could Withstand Deeper Recession
A stress test of the European Union’s biggest banks showed they could withstand an even deeper recession, though with almost 400 billion euros ($581 billion) in losses, according to a report to EU finance chiefs. Under current EU economic forecasts for 2009 and 2010, the largest banks in the region would maintain an average Tier 1 capital ratio "well above" 9 percent, the officials said yesterday in a statement after meeting in Gothenburg, Sweden. A "more adverse" scenario would boost losses and cut the average ratio to about 8 percent.
The five-month study was ordered by ministers after a similar one in the U.S. European Central Bank President Jean- Claude Trichet emphasized that the potential losses for the region’s 22 largest banks represents an "adverse" scenario and not a base-line case. "All systemic institutions showed that they were very resilient," Spanish Economy Minister Elena Salgado told reporters today. "That’s a good result." No bank among the 22 included in the test would see its Tier 1 capital ratio fall below 6 percent as a result of the adverse scenario, according to the statement. The minimum Tier 1 capital requirement for banks under the Basel accords is 4 percent.
"This resilience of the banking system reflects the recent increase in earnings forecasts and, to a large extent, the important support currently provided by the public sector to the banking institutions," the officials said, referring to capital injections and asset guarantees. European financial institutions have posted $498 billion in losses since the onset of the credit crunch in mid-2007, less than half the $1.08 trillion in losses reported in the U.S., according to Bloomberg data. U.S. regulators found earlier this year that 10 financial companies led by Bank of America Corp. needed to raise a total of $74.6 billion of capital, in results made public on May 8. Releasing the findings helped calm investors, U.S. Comptroller of the Currency John Dugan, who oversees national banks, said at the time. The EU didn’t publish the names of the banks it studied.
Trichet and other officials said the methodology used in the report, prepared by the Committee of European Banking Supervisors, differed from that used by U.S. authorities and the International Monetary Fund. The divergence in part reflects different accounting standards, they said. The Washington-based IMF this week cut its projection for global writedowns on loans and investments by 15 percent to $3.4 trillion, citing improvements in credit markets and initial signs of economic growth. The tally was based on a new methodology after criticism of an April estimate of about $4 trillion. Losses on bad assets are projected to increase from July 2009 through next year by $470 billion in the euro area, according to the report.
Bank capital reserves will still have to improve to strengthen the financial system, according to Bundesbank President Axel Weber. "In the future, not only the quality but also the level of banks’ capital has to increase in order to make them more resilient," Weber said in Gothenburg. The finance chiefs intend to make stress testing routine and possibly annual. "We would like such tests to be published regularly," French Finance Minister Christine Lagarde told journalists.
The Brussels-based Bruegel research group urged the ministers to set a deadline for member states to withdraw credit guarantees for banks to spur them to raise new capital and write off bad loans. "Bank recapitalization and restructuring should be completed in all EU countries as a matter of urgency," the institute said in a report on post-crisis exit strategies. To encourage this, governments should "agree on a timetable and firm deadlines for termination of government guarantees."
Ministers also discussed EU proposals to centralize financial regulation through the establishment of European banking, systemic and risk monitoring agencies. Swedish Finance Minister Anders Borg said yesterday that finance chiefs hoped to reach a political agreement on supervision by the end of the year. Ministers also said after talks yesterday that the pace of economic recovery means they probably won’t withdraw emergency stimulus measures before 2011. U.K. Chancellor of the Exchequer Alistair Darling told reporters today it was "absolutely vital" to continue supporting the economy.
"The policy of maintaining support for our economies as we come through recession is absolutely vital," Darling said. "Whilst there is more confidence now than there was six months ago, it is by no means the case that the job is done." The Group of 20, which includes the EU’s Britain, France, Germany and Italy, committed last week to conducting "robust, transparent stress tests as needed" and called on banks to retain a greater portion of current profits to bolster capital.
Firms Have $4.52 Billion to Purchase Toxic Assets
Investors have agreed so far to plow more than $1.13 billion into a long-awaited Treasury Department program to buy the toxic assets at the heart of the financial crisis. The Treasury announced that two of the nine investment firms tapped earlier this year to participate in the Public-Private Investment Program have raised at least $500 million -- a precursor to obtaining government financing. The firms, Invesco Ltd. and TCW Group Inc., will get two forms of government financing: a dollar-for-dollar capital match and debt financing, giving them a total of $4.52 billion in purchasing power.
The size of the program, known as PPIP, is expected to reach $40 billion, including both private and public financing. The Treasury has committed to match, dollar for dollar, as much as $10 billion in capital raised by the firms, with an additional $20 billion in debt financing. The $1.13 billion raised by these fund managers so far is a small drop in the $1.64 trillion market for mortgage-backed securities that are backed by nongovernment agency guaranteed mortgage loans. The commercial-mortgage-backed securities market is likewise large compared with the current PPIP program, at about $700 billion.
The seven remaining firms are expected to qualify for the program and the Treasury plans to announce how much they have raised over the next few days and weeks. The Treasury is staggering the announcements because it has taken some funds longer to get formal investor sign-offs. "I am pleased with the progress we have made in launching PPIP," Treasury Secretary Timothy Geithner said in a statement. "This program allows Treasury to partner with leading investment management firms to increase the flow of private capital into the market for [toxic assets] and give taxpayers a chance to share in the profits."
The Treasury isn't disclosing the names of those investing in the funds but people familiar with the matter said the investors include private and public pension funds, sovereign-wealth funds and individual investors.
Together, the firms will help banks sell distressed real-estate related investments, including commercial and residential mortgage-backed securities that have been at the heart of the financial crisis.
Banks Have Us Flying Blind on Depth of Losses
There was a stunning omission from the government’s latest list of "problem" banks, which ran to 416 lenders, a 15-year high, as of June 30. One outfit not on the list was Georgian Bank, the second-largest Atlanta-based bank, which supposedly had plenty of capital. It failed last week.
Georgian’s clean-up will be unusually costly. The book value of Georgian’s assets was $2 billion as of July 24, about the same as the bank’s deposit liabilities, according to a Federal Deposit Insurance Corp. press release. The FDIC estimates the collapse will cost its insurance fund $892 million, or 45 percent of the bank’s assets. That percentage was almost double the average for this year’s 95 U.S. bank failures, and it was the highest among the 10 largest ones.
How many other seemingly healthy multibillion-dollar community banks are out there waiting to implode? That’s impossible to know, which is what’s so unsettling about Georgian’s sudden downfall. Just when the conventional wisdom suggests the banking crisis might be under control, along comes a reality check that tells us we’re still flying blind. The cost of Georgian’s failure confirms that the bank’s asset values were too optimistic. It also helps explain why the FDIC, led by Chairman Sheila Bair, is resorting to extraordinary measures to replenish its battered insurance fund.
Georgian, which had five branches catering to local businesses and wealthy individuals, was chartered in 2001. By 2003, the closely held bank had raised $50 million from an investor group led by a longtime local banker, Gordon Teel, who remained chief executive officer until last July. It grew at a breathtaking pace, fueled by the real-estate bubble. From 2004 to 2007, total assets almost tripled to $2 billion from $737 million. Annual net income rose seven-fold to $18.3 million. The bank touted its philanthropy, including a $1 million pledge to a local children’s hospital, and boasted of a growing art collection showcasing Georgia painters.
As recently as its March 31 report to regulators, Georgian said it met the FDIC’s requirements to be deemed "well capitalized." By June 30, that had dropped to "adequately capitalized," after a $45 million second-quarter net loss. Georgian also reported a 12-fold jump in nonperforming loans to $306.4 million from $24.7 million three months earlier, mostly construction loans. Georgian’s numbers made it seem as if the surge arose from nowhere. On its March 31 report, the bank said just $79.1 million of its loans were 30 days or more past due. That included the loans it had classified as nonperforming.
Georgian’s new CEO, John Poelker, downplayed any concerns. "Whether there is enough capital for the bank to be a survivor isn’t an issue," he told Bloomberg News for an Aug. 5 article. What wasn’t made public until Sept. 25, the day it closed, was that Georgian Bank had agreed to a cease-and-desist order with the FDIC on Aug. 31 after flunking an agency examination. The 19-page order described various "unsafe or unsound banking practices and violations of law and/or regulations," including failing to record loan losses in a timely manner. Georgian neither admitted nor denied the allegations.
The FDIC updates the public about the number of banks on its problem list once a quarter. An FDIC spokesman, David Barr, said Georgian was added to the FDIC’s internal list in July. He said the agency adds banks to the list based on exam ratings, not the data in their financial reports. As for the 416 banks on the list as of June 30, up from 305 a quarter earlier, the FDIC said their combined assets were $299.8 billion. (The FDIC didn’t name the banks, per its usual practice.) If Georgian’s experience is any guide, the real-world value of those assets probably is much less.
That might help explain why the FDIC keeps increasing its estimates for the losses it’s anticipating from future bank failures. In May, the agency said it was expecting $70 billion of losses through 2013. This week, it bumped that to $100 billion. The agency also said its insurance fund would finish the third quarter with a deficit, meaning liabilities exceed assets. The FDIC, backed by the full faith and credit of the U.S. government, will get whatever money it needs to protect depositors. For now, it plans to raise $45 billion by collecting advance payments from the banking industry. Those payments will cover the next three years of premiums that the banks owe.
In effect, the FDIC is taking out a massive, no-interest loan to cover its bills. Borrowing from the future won’t improve its insurance fund’s capital, however, only its liquidity. The big question is what the FDIC will do next time, should its loss estimates keep rising -- and there’s no reason to believe they won’t. By statute, the insurance fund is supposed to be funded solely by the banking industry. The FDIC could keep borrowing from the banks, directly or through more advances.
The agency could tap its $500 billion credit line with the U.S. Treasury. It still would have to pay back the money with fees from the industry, assuming the banks can’t persuade their minions in Congress to change the law. As it stands, the only way to boost the fund’s capital immediately is by charging the banks a lot more money for their insurance premiums. Given the odds that other surprises like Georgian Bank are lurking, the FDIC will have to bite this bullet eventually.
Drop Moody’s Into the Volcano
by Michael Hirsch
Why Wall Street's big ratings agencies should go the way of Arthur Andersen after Enron.
Remember Arthur Andersen? The giant accounting firm ceased operation in 2002 after authorities learned that its auditors had shredded documents related to Enron's fraudulent schemes and were probably complicit in those practices. Even though the firm's felony conviction was later vacated by the Supreme Court, Arthur Andersen's name was so tarnished, and it faced so many outstanding lawsuits, that no one wanted to do business with it any longer. End of story. That's life in the capitalist system, folks.
One of the most distressing things about the current financial scandal is that there has been no similar reckoning against the firms that were supposed to be watching the system for the investment public. Why haven't the rating agencies that were complicit in the subprime-mortgage securities scandal suffered the fate of Arthur Andersen? Despite some moves in Congress to change their behavior, U.S. authorities are still treating the agencies with extreme gentleness.
Moody's and Standard & Poor's, the two giants of the industry, are still around despite causing the loss of hundreds of billions of dollars by badly rating subprime-mortgage-backed securities. Not only that, they are basically doing business the same way, taking fat fees from the investment banks whose securities they rate.
In testimony before the House Committee on Oversight and Government Reform on Wednesday, a former Moody's managing director, Eric Kolchinsky, alleged that the firm was criminally deceiving investors by purportedly inflating ratings on securities even into the current year, long after the subprime scam had been exposed and the market crash had occurred. Richard Cantor, the firm's chief risk officer, dismissed the allegation as "without merit" at the hearing, but allowed that Moody's did "not give a high grade" to its own performance.
It's important to understand why Moody's and company live on, and why they haven't been forced to endure the rough justice administered to Arthur Andersen. The government is simply too afraid to let that happen. Like many of the big banks, the ratings agencies have been deemed too big or important to the system to fail. Indeed, their prominence in the financial landscape is an ironic result of the government's efforts to fix the system after the Wall Street mania of the '20s led to the Great Depression.
"Back in 1936, the bank regulators told banks if you are going to buy bonds, and have them in your portfolios, those bonds cannot be speculative. They must be investment grade. Who is the arbiter of what is speculative and investment grade? These handful of rating agencies," says Lawrence White, a financial expert at New York University. "In essence, the bank regulators were outsourcing this safety decision. The rating agencies' judgments secured the force of law."
Today the main ratings agencies continue to be anointed by the government as "Nationally Recognized Statistical Rating Organizations," in other words as arbiters of what banks, pension funds, and others restricted to "safe" investing can legally buy. Until recently they have even been given First Amendment protections afforded to journalists to protect them against liability for erroneous assessments. It was no accident that among those scheduled to to testify today was Floyd Abrams, the great First Amendment lawyer famed for his defense of The New York Times and other newspapers. His client this time was Standard & Poor's.
But here's the rub. The assessments of accountants like Arthur Andersen can be tested. If an accountant doesn't follow GAAP, or Generally Accepted Accounting Principles, his negligence can be checked, and he can be cast out of the profession—or prosecuted. By contrast, ratings agencies, despite carrying the government's imprimatur, each have their own unique methods of rating. There is no standardized approach as there is in the accounting industry. "They are masters of their own methodologies. You have to prove their own methodologies are wrong," says Kolchinsky. So there is very little accountability or transparency. Under the current system, the agencies almost can't be caught out, even while they enjoy the government's protection. And absolute power, as we know, corrupts absolutely.
The sad thing is that in the days before the subprime securities scandal, Moody's was considered the class act of the ratings agencies, just as Arthur Andersen was once a globally respected firm. Its ratings systems, like Andersen's accounting practices, worked very well in the pre-derivatives days of ordinary corporate or municipal bonds. Back then, the agencies' ratings assessments were publicly available and could be checked. But as the era of "structured finance"—private derivatives or securitized-asset deals between companies—took off, the ratings systems started getting more slippery.
As debt began to get packaged and repackaged in ever-more complex bundles of securities, it was impossible to double-check the ratings within those bundles. The fact that every ratings company had its own methodology only made things more complicated. There was no longer any public accountability—the embarrassment of getting a rating badly wrong—to weigh against the temptation of fees from big deals from the issuers. At first subtly, then profoundly, that began to corrupt the culture of once-respectable rating agencies like Moody's. They had become vassals of the Wall Street firms they were rating, and neither the Fed nor the SEC was closely watching the change.
In order to create more competition, the SEC has expanded the population of "nationally recognized" ratings agencies doing "structured finance," but Moody's and S&P are still by far the most dominant. And if the whistleblower, Kolchinsky, is to be believed, they'll never improve because they are fatally conflicted, forever tempted to tailor ratings for the investment-bank clients who pay them to make their securities look good. "The management of the [Moody's] Derivatives group has become desperate to generate revenue," Kolchinsky wrote. "The business lines remain too powerful." Kolchinsky himself hopes that Moody's can be reformed rather than forced out of existence.
But another former Moody's executive, Sylvain Raynes, while endorsing Kolchinsky's critique, says there's no other way but to make Moody's pay the ultimate price. "We need a virgin to throw into the volcano," he says. "It's not possible to reform Moody's. It's like saying 'I'm a reformed Nazi.' " A third ex-Moody's man, economist Jerome Fons, agrees that it will be almost impossible for Moody's and the other firms to drop the issuer-pay model that causes such conflicts of interest and to return to the old method by which investors themselves pay for ratings. "They've had the highest margins of any company on the S&P 500, over 50 percent profit margins," he says.
There are some cracks in the dam of support the big ratings agencies have been getting. In early September, New York District Court Judge Shira Scheindlin ruled that Moody's and Standard & Poor's can't get a blanket protection under the First Amendment if they are not issuing ratings to the broader public. "Where a rating agency had disseminated their ratings to a select group of investors" it is "not afforded the same protection," she wrote. Now investors like Warren Buffett have begun to pull the stakes in from the agencies. One bill currently being considered in Congress seeks to make the raters legally liable for bad decisions—though it will have a high hurdle getting past the First Amendment issue.
NYU's White, who was also a witness Wednesday, says it's time to move past the special relationship with the ratings agencies. He believes that the only solution is to change the system fundamentally, so that big investment managers and banks do their own assessments of the securities they buy, with the help of independent ratings firms acting on a consulting basis, rather than depending lazily on what Moody's rates triple or double A. That will also put more burden on regulators to get involved in assessing the portfolios of their charges.
"The burden would be on the bank to justify to the regulator the safety of the bank's bonds," he says. But to make that happen, dramatic action might be needed—and the first order of business is to clear the behemoths of the ratings world out of the way. Says Raynes: "Moody's should be the Arthur Andersen of the subprime crisis."
Leaving Affordable Mortgage May Become Winning Gambit
Scott Conroy pays the mortgage every month on his one-bedroom condominium in San Diego, even though it’s worth 33 percent less than what he owes and it may take more than a decade to break even. Homeowners like Conroy who can afford their monthly payments are weighing whether to sell and pay the difference, stick it out until housing prices recover, or walk away. In the U.S., 26 percent of borrowers owe more than their home is worth, said Karen Weaver, global head of securitization research for New York-based Deutsche Bank Securities. In parts of California, Florida and Nevada, it’s as high as 75 percent.
So-called strategic defaults, in which homeowners stop paying their mortgages while remaining current on other debts, rose 128 percent to 588,000 last year, according to Experian PLC, a Dublin-based credit-checking company, and Oliver Wyman, a New York-based consulting firm. Two-thirds of those who walked away defaulted on their primary residences. "You’re looking at an extremely long horizon in order to see a return of home values to where they were at their peak," said Stan Humphries, chief economist for Zillow.com, the Seattle-based real estate data service. "It could be 15 to 20 years in some markets."
Strategic defaulters represent about 4 percent of all homeowners underwater. That trickle could become a flood as the likelihood recedes that home prices will soon return to their peak values, said Rick Sharga, senior vice president of Irvine, California-based RealtyTrac Inc., an online seller of real estate data. In San Diego, where Conroy lives, home values are down about 40 percent since March 2006 when he bought his place, according to the S&P/Case-Shiller Index of 20 U.S. metropolitan areas. Prices have rebounded for three consecutive months, returning to the October 2002 level, before the start of the housing boom. Nationwide, home values are what they were in September 2003, according to the Case-Shiller index as of July.
"You have to ask yourself: Are you just renting the home from the bank?" said Michael Joe, a foreclosure expert at the Legal Aid Center of Southern Nevada. "Would it be cheaper to walk away and rent across the street?" Conroy, 32, and his wife purchased their home for $385,000 in March 2006, a month before marrying. The property was reassessed this summer for $250,000. The couple is trying to save, he said, knowing they may have to move to a bigger place within 18 months to start a family. "We’ve given up on this dream of having equity in our home," Conroy said. "We don’t expect to walk away with cash in hand, we expect to pay."
More homeowners may opt to take a hit to their credit score rather than come up with cash to cover the loss, especially in California and the nine other U.S. states where the legal repercussions of foreclosures are less than other parts of the country, said Sharga. Ten states are so-called non-recourse, prohibiting deficiency judgments after most home foreclosures: Alaska, Arizona, California, Hawaii, Minnesota, Montana, North Dakota, Oklahoma, Oregon and Washington, according to the National Consumer Law Center, based in Boston. The bank can repossess your home in those states, not other assets, to settle the debt.
In California, a second-mortgage holder may try to pursue a delinquent borrower to repay through litigation, said Rick Brooks, a financial adviser with the San Diego-based wealth advisory firm Blankinship & Foster. Banks generally prefer not to sue because it can easily cost $60,000 or more, said Debra Guzov, co-founder of the law firm Guzov Ofsink LLC, based in New York. Banks may be more willing to accept foreclosure alternatives, such as a short sale or deed-in-lieu of foreclosure, in states where a lender can’t sue for personal assets, said Brad Geisen, chief executive officer of Foreclosure.com, based in Boca Raton, Florida.
In a short sale, the borrower finds a buyer for the home at an acceptable price and the bank agrees to forgive the difference, said Greg McBride, senior financial analyst with North Palm Beach, Florida-based Bankrate.com. In a deed-in-lieu of foreclosure, the bank sells the home after a similar debt negotiation. A 2007 law exempts from tax up to $2 million of debt forgiven in a foreclosure or similar proceeding for a primary residence, according to Internal Revenue Service spokesman Eric Smith. The tax break extends to 2012.
The lender’s willingness to negotiate varies and depends on the loan balance, condition of the property, location, and resale opportunities, said Alberta Hultman, chief executive officer of USFN, an association of U.S. mortgage banking attorneys based in Tustin, California. Short sales or deeds-in-lieu of foreclosures are considered the same as a foreclosure on your credit score, said Craig Watts, spokesman for Minneapolis-based FICO Corp., owner of the credit-scoring formula most widely used by U.S. lenders. A foreclosure remains on a credit report for seven years. Credit scores can begin to rebound in as little as 2 years if bills are paid on time, according to FICO.
"You really want to think through the inability to borrow and higher rates that you’ll pay," Christopher Van Slyke, a partner at Trovena LLC, a wealth management firm based in La Jolla, California, said of walking away. "If you don’t have the gun to your head then stay right where you are," said Cheryl Morhauser, a financial adviser based in Nevada City, California, whose clients’ average net worth is $1.5 million to $3 million.
Jennifer Albaugh, 34, plans to keep her Las Vegas home, where prices have dropped 49 percent since she bought it in December 2004, according to the S&P/Case-Shiller index. Albaugh, who owns a fabric store, might have sold her 3,000-square-foot house for as much as $550,000 four years ago, she said. Today she owes more than $300,000 on her mortgage and says her house isn’t worth even close to that. She and her husband are still looking to buy a bigger home for their two kids, especially while rates are low and might turn their current home into a vacation rental, she said. "Walking out of your house to get a better deal down the street is just not the right thing to do," she said. "It hurts everybody."
Morality and social stigmas play an important role in whether someone who can afford the payments will walk away, said Paola Sapienza, professor of finance at Northwestern University’s business school, in a July study on strategic defaults. Eighty-one percent of 1,646 homeowners interviewed think it is morally wrong, the study found. "If you know someone who’s done it you’re way more likely to do it," Sapienza said. "That’s the scariest part, is that there might be some contagion part of this."
Albaugh and Conroy, the San Diego homeowner, said they’re frustrated by the lack of help for homeowners like them who keep paying. "It seems like the banks are more willing to work with people who aren’t making their payments rather than people who are," Conroy said.
Slump Removes Hard Hats' Ladder to Prosperity
In recent years, men without college degrees, who found it difficult to get the factory jobs that sustained their counterparts in decades past, have turned to construction work to climb into the American middle class.
Now they are falling from it. Neal King, 41 years old, is one of them. He entered the Army after high school, held one hourly job after another and eventually moved his family to this booming Gulf Coast city from Alabama in 2006 upon hearing there was work in construction. Steady work on highways and condominium projects for about $10 an hour, plus frequent overtime, catapulted the family into a four-bedroom rental, a point of pride for Mr. King. "I never imagined I'd live in a home with a swimming pool," he said. Mr. King is currently out of work and that dream home.
By the peak of the housing boom in 2006, construction surpassed manufacturing as the biggest employer of men with at most twelve years of schooling. About 19.5% worked in construction, compared with 19.2% in manufacturing, according to an analysis of Census Bureau data by the Economic Policy Institute, a left-leaning think tank. Before the deep recession of the 1980s, 12% worked in construction and 36% in manufacturing. Hourly wages for those with less than a high school degree grew faster than wages of those with college and advanced degrees this decade, according to EPI.
Men with no more than a high school education working in construction earned an average of $17.34 an hour in 2006, a 20% premium to their peers in, for example, the service sector, according to Lawrence Katz, a Harvard University economist. "The housing boom helped less-educated men in particular," he said. But that work evaporated with the housing bust, and then the commercial real estate collapse. And while the recession may be ending, construction is unlikely to return to pre-boom levels for many years, despite the jobs generated by the government's stimulus efforts. That's left this group of workers who lack post-high school education with few job prospects in a labor market that increasingly favors brains over brawn. "The one sector that was their escape this decade -- construction -- has collapsed," said Mr. Katz.
Construction, which currently employs about 5% of all workers outside agriculture, has accounted for about 18% of the nation's job loss in the past year. Construction has given back the 1.1 million jobs it added during the boom, plus half a million more. The industry, which employed 7.7 million Americans at its peak, has seen total employment fall 20% since January 2007, according to the Labor Department. Naples gives a sense of the fallout. Once a sleepy resort town, it was transformed in less than two decades by a flood of well-off retirees and vacationers, and by developers eager for a piece of their wealth. Growth reached a frenzy mid-decade amid an influx of migrants from other parts of the U.S. and Latin America. The city's work force grew by one-third from 2003 to 2006. One of four jobs added was in construction, which by mid-2006 employed about 18% of Naples's workers.
The ensuing bust wiped out Naples's construction job growth -- and then some. As of August, the Naples metropolitan area had roughly 11,600 workers in construction, according to Florida's labor department, a 50% drop from the peak. The metro area's unemployment rate stands at 12.6%, as of August, compared with 8.5% a year earlier. Construction's decline, here and elsewhere, has fallen hardest on the least-educated men and particularly Hispanics, who represent 14% of the overall labor force but held one in four construction jobs nationwide before the bust, according to the Pew Hispanic Center.
The bust has left families like the Kings devastated. Mr. King hasn't found construction work in over two years. A couple stints -- working on a hotel loading dock and then as a night stocker with Walmart Stores Inc. -- proved short-lived, as Mr. King saw his hours cut and his take-home pay dwindle to less than what he could receive on unemployment. While Mr. King continues looking for construction work, the family has traded their home for a smaller one on a busy corner.
Mr. King spends his days driving around the city at dawn scanning for new construction sites that might need an extra hand, working the occasional odd job and searching job postings online at the local unemployment office. There are some management-level openings but they require better qualifications. "If I had more school or a degree, maybe I could get a position like that," he said. Despite their troubles, the Kings consider themselves relatively lucky. By renting rather than buying, they have avoided a mortgage they can no longer afford. And after Rita King, 43, lost her teaching job at a school for at-risk kids, she landed a position as a receptionist with a psychiatrist.
Many others waylaid by the industry's collapse have less to fall back on. Duane Gregory, a wiry 46-year-old, once stopped by St. Matthew's House -- Naples's only homeless shelter -- to pick up day laborers to assist him on his roofing jobs. Now that the work has dried up, he said he is homeless, too. He has managed to stay busy working odd jobs, including some remodeling work and other small tasks. But he said he has had to give up his marina-front apartment.
"My kids don't know I'm here," he said, sitting inside St. Matthew's House after a day spent near Fort Myers installing ceiling tiles in an elementary school. But Mr. Gregory, who has an associate's degree in architectural drafting, is determined to stay in Naples. "I made Naples my home," he said in an August interview. "It's like my ship, and I'm the captain going down with it."
Earlier this month, Mr. Gregory was jailed for trespassing. He couldn't be reached for comment. His assigned public defender, Rachel Doernberg, said she hasn't yet spoken with Mr. Gregory, whose arraignment is scheduled for Friday, but he hasn't posted his $2,500 bail. One hurdle in the way of re-employing these workers: Many are Hispanic immigrants, often lacking the education, language skills, or, like construction worker Cesar Morales, the desire for re-employment in office jobs or service-sector work.
"When I finished high school, I didn't have money for college," said Mr. Morales, 19, who was born in Mexico City and moved to the U.S. a decade ago with his father and brothers. So instead, he began working in construction full-time, installing sheetrock for $90 a day. "I was making pretty good money," said Mr. Morales. "I used it to buy a laptop, shoes, clothes, I sent money back to my family that's still in Mexico." But Mr. Morales lost his sheetrock job in January. After a few months of unemployment, he has been able to find work through a local branch of staffing firm Labor Finders International laying pipes for $8 an hour. "It's not as good as it was, but I'm a lucky guy to have a job," he said. It is a relief to be working in construction, he says. "To get an office job, you have to go to school, and you need money to go to school," he said. "I don't even like office jobs. I like construction better."
Strong dollar "very important": Geithner
Treasury Secretary Timothy Geithner said on Thursday that a strong dollar was very important to the United States and the rest of the world needs to be convinced Americans will be more thrifty in future. "A strong dollar is very important to this country, I mean that, and it's very important that people recognize it," he told a news forum at the Newseum in downtown Washington.
Speaking just before departing for Istanbul, Turkey, for a Group of Seven finance ministers' meeting, Geithner said the dollar's "exceptional" role in the global financial system invests the United States with extra responsibility. Questions have been raised about whether the world will be willing to keep financing huge American debts forever or whether they might seek an alternate reserve currency. Geithner made clear, in response to questions, that he was aware of the debate and of the importance of persuading others that the United States was willing to take measures to preserve the currency's value.
"It does bring special responsibilities and burdens on the United States and it's very important that we make not just Americans but make the world understand that we are going to go back to living within our means," he said. Geithner added, "And we are going to make sure that our independent Federal Reserve keeps inflation low and stable over time...and we are going to run fiscal policy in this country consistent with that basic objective of going back to living within our means."
The U.S. is headed for a record deficit of around $1.8 trillion this year and, according to the Congressional Budget office, an estimated $1.4 trillion deficit in fiscal 2010. Geithner said there were signs of global economic recovery, which would produce more revenues, but he stressed they were only tentative signs at this point. He said the financial crisis the world continues to work through stemmed partly from the fact that central banks kept interest rates too low for too long and created conditions for an asset bubble that eventually burst.
"There was a long period where monetary policy around the world was very, very loose and accommodative," Geithner said, adding that allowed risk-taking to become excessive. "You had a huge boom in wealth outside the United States and that money was looking for a home and it created huge demand progressively for what proved to be very risk types of financial assets," Geithner said, adding that government "failed the test" of preventing the buildup in risk.
The Fall Guy
The political class has finally got its man, which is to say that Bank of America CEO Ken Lewis has announced he will retire at the end of the year. Don't you feel better already? Someone had to be sacrificed as expiation for the financial panic and bailout, and the politicians are determined to convince voters that the bankers did it all. So heave-ho, Mr. Lewis had to go. His alleged offense—investigated by the SEC, a House oversight committee and New York Attorney General Andrew Cuomo—is that his bank failed to adequately disclose to shareholders potential losses and employee bonuses at Merrill Lynch prior to their December vote to approve the BofA takeover of Merrill.
Thus the same government that told Mr. Lewis to keep his mouth shut and close the Merrill transaction now says he should have been more candid with shareholders. The same government that also threatened his job if Mr. Lewis didn't accept Merrill's mounting losses along with new federal money—while refusing to provide an agreement in writing because it didn't want to inform taxpayers—now questions the disclosures he made to investors. Too bad the same investigative resources will never be used to find out how financial "systemic risk" was supposed to be reduced by forcing Mr. Lewis to merge the country's largest deposit-taking bank with a failing Wall Street trading firm.
On the weekend that Lehman Brothers failed in September 2008, could Mr. Lewis have bought a teetering Merrill Lynch for less than he agreed to pay? Probably. Could he have killed the deal or negotiated a better price before the January closing if Treasury Secretary Hank Paulson hadn't pressured him not to make an issue of Merrill's rising trading losses? Perhaps. But his real, and ultimately fatal, mistake was to believe the feds when they urged him to buy Merrill—and, before that, Countrywide Financial—in the name of saving the financial system. He forgot the oldest lesson about the second oldest profession: Never trust a politician.
Pain in Spain May Linger as Banks Prop Up Property Prices to Avoid Losses
Maria Jose Lozano, a civil servant from Madrid, left a recent property fair empty-handed after discovering that home prices were still out of reach in a market where sales have dropped 50 percent from their 2006 peak. "We came here expecting to find a bargain, or at the very least some reduced-price homes, but we’ve seen nothing," said Lozano, 49, after browsing through the offerings, including properties that lenders such as Banco Santander SA and Caja Madrid acquired in exchange for canceling developers’ debts.
Banks bought about 110,000 homes to keep losses off their books as Spain’s property bubble burst, according to real estate researcher RR de Acuna & Asociados in Madrid. Now they’re using strategies reminiscent of the boom times -- 100 percent mortgages, low interest rates and free cars -- to sell homes, potentially slowing a drop in prices that’s needed to spur recovery from Spain’s worst recession in 60 years. "Maybe you can create some accounting value with all these tricks, but in the end it doesn’t make the situation any better and in the long term makes it worse," said Luis Garicano, a professor of economics and strategy at the London School of Economics, in a phone interview.
Spanish lenders acquired at least 20 billion euros ($29 billion) of real estate in the past 18 months, according to data compiled by analysts at Zurich-based Credit Suisse Group AG. There are as many as 1.6 million empty homes in Spain, an overhang that may take seven years to clear with annual demand running at about 218,500 units, Acuna & Asociados estimates. Instead of cutting prices, banks are offering more generous financing terms for their own properties than those being sold by third parties, said Fernando Rodriguez de Acuna, president of Acuna & Asociados. "The banks are reducing financing costs to get rid of their housing stock, but this solution has its limits," he said in an interview. "The only way banks will be able to sell homes they haven’t sold in the mid-term will be to do so at a loss."
Santander, Spain’s biggest lender, has acquired more than 4 billion euros of real estate and is selling homes through Altamira Santander Real Estate, its property arm. Altamira offers clients variable-rate mortgages at the one- year euro interbank offered rate plus 0.4 percent, according to its Web site. That’s 1.64 percent at current rates. Santander offers a variable rate mortgage at Euribor plus 1 percent, according to data published by El Pais newspaper. The bank also offers 100 percent financing, mortgage insurance and aid to buyers of holiday homes, according to the Web site. Altamira said in August that it had sold at least 1,100 of the 2,550 newly built properties it had on sale.
A spokeswoman for Madrid-based Santander declined to comment on whether the bank’s policies were slowing a recovery. The spokeswoman, who asked not to be identified because of company policy, said Santander’s booth at the property fair was informational, and it didn’t try to sell homes at the event because it believes prices have adjusted to the market. Banco Popular Espanol SA, Spain’s third-biggest commercial bank, bought 2.3 billion euros of property and is selling homes through its Aliseda Gestion Inmobiliaria unit. La Caixa, Spain’s biggest savings bank, throws in a free car for anyone under 35 who buys an apartment through its property company.
Banco Popular has no intention of selling homes for less than the bank thinks they’re worth because low interest rates mean the cost of holding them is comparatively cheap, Chief Financial Officer Jacobo Gonzalez-Robatto said in July. "We don’t have any timetable," he said at the bank’s earnings press conference.
The tactics employed by banks mean house prices are adjusting more slowly in Spain than other countries, said the LSE’s Garicano. Spanish home prices have declined 8.3 percent from their peak in the fourth quarter of 2007, according to the National Statistics Institute. That compares with a 25 percent drop in Ireland, a report by Irish Life & Permanent Plc shows. The decline is 12 percent in the U.K., according to Hometrack Ltd.
By other measures, Spain has been harder hit by the global recession than other European countries. Eurostat data show that Spain has the highest unemployment rate in Europe at 18.5 percent, and the Organization for Economic Cooperation and Development forecasts the economy will continue to shrink next year as other European nations start to recover. The Spanish economy may contract 0.9 percent next year, making it the worst performer in the 30-nation OECD after Hungary and Ireland, the Paris-based group forecast in June.
Carlos Solchaga, Spain’s finance minister from 1985 to 1993, said banks have succeeded in putting a break on price declines and preventing the fire sale seen in other countries. "The banks are doing what they have to do," said Solchaga, who now heads Solchaga Recio & Asociados, a Madrid- based consulting firm. "The reality is that they are contributing to the process of price reductions." Caixa Catalunya, a Barcelona-based savings bank, slashed prices on some homes as it sold 600 of the 3,700 properties it had on offer. About half of the homes sold for 30 percent less than the offer price and a quarter brought discounts of 10 percent to 20 percent, said Pol Clota, the bank’s commercial director for real estate. The rest were sold for full price. "If we have this real estate, we have to do something with it and the competition is very fierce," Clota said in an interview at the property fair.
Developers say they now have to compete with banks, as well as each other, to shift stocks of unsold property. "Sometimes that competition is unfair in that they can offer better financing," said Ignacio Iglesias, a spokesman for Nozar SA, a closely held developer that filed for protection from creditors in September. Spanish banks acquired homes from developers to cushion the impact of a property crash that increased loan-loss provisions by 70 percent to 9.7 billion euros in the first half, according to central bank data. Bad loans as a proportion of lending rose to a 13-year high of 4.73 percent in July and may exceed 8 percent over the next year, Credit Suisse estimated last month.
The problem is that banks may have taken real estate onto their books using valuations that don’t describe their true value, said the LSE’s Garicano. In a market where transactions have collapsed and some appraisals are based on sellers’ asking prices, valuations may bear little relation to what buyers are prepared to pay, he said. While the Bank of Spain requires lenders to set aside a provision equal to 10 percent of a property’s balance sheet value, they may be forced to report additional losses if asset values drop below the amount of the original debt.
"Some banks won’t let prices fall because they don’t want to recognize their losses," said Pedro de Churruca, general director for Spain of property broker Jones Lang LaSalle in Madrid. "Significant losses would emerge if they did that." Back at the property fair, Lozano and her husband, Fernando Cano, watched as lines of would-be buyers formed alongside the stands run by Caja Madrid and Pryconsa, a developer that now has to compete with banks to sell its properties. About 40,000 people attended the three-day fair, according to IFEMA, the organizer of the event. Three more are planned during the next year. "Prices haven’t dropped and buyers won’t return to the market until they do," Cano said.
A cool look at the current deficit hysteria
by Samuel Brittan
The British political classes are going through one of their occasional bouts of masochism, with party leaders vying with each other on the theme of who can cut public spending faster and more effectively. Spice is added by talk of leaks and secret plans; and ideology by arguing about the balance between tax increases and spending curbs. My own bottom line is that all this is in response to a largely imaginary budget crisis. If we have a normal economic recovery the red ink will diminish remarkably quickly. If we don’t, it won’t and won’t need to.
All the secrecy and conspiracy-mongering is quite unnecessary and would soon disappear if ministers read the documents to which they attach their names and if opposition leaders, instead of searching in rubbish bins, did the same thing. I hope readers will forgive me if I follow the official practice of talking in terms of percentages of gross domestic product. Even the most inveterate number-crunchers must have become dizzy with all the figures in billions and trillions of pounds and dollars launched on the world since the credit crunch.
The key document is the 260-page Treasury publication with the sensational title Budget 2009 (popularly known as "the Red Book"). The key table – surprise, surprise – is Table 1.1. You will see here the famous or infamous pledge to halve the Budget deficit in four years. Public sector net borrowing is projected to reach a peak of 12.4 per cent of GDP in the current financial year, declining gradually to 5.5 per cent by 2013-14. This is based on the assumption that GDP itself recovers by a modest 1 per cent next year but returns to an above-trend rise of 3? per cent by 2011. The Red Book even shows the tax take (defined as net taxes and national insurance contributions) rising over the period by 2.3 percentage points of GDP, of which 1 percentage point is accounted for by an increase in the income tax take. This is before the slash and burn offensive hinted at by one opposition party or the "progressive austerity" by another.
The Treasury is understandably coy about giving more details about how the fiscal tightening is to be achieved. The Institute of Fiscal Studies estimates that, allowing for expenditure not under immediate government control, departmental spending would have to be cut by an average of 2.9 per cent a year in real terms to achieve official objectives; and in practice the axe would fall particularly severely on Labour’s beloved public investment.
Suppose we turn our attention from annual deficits to public sector debt. The Red Book shows it rising from about 30 per cent of GDP at the beginning of this decade to 65 per cent in the current financial year. The pace of increase begins to slow down in the coming decade; but debt is put at 76 per cent and still rising slowly in 2013-14. The Treasury is of course well aware of the hazardous nature of these projections and how they depend on all sorts of guesses about interest payments, social security spending and many more unknowables. But it believes that is erring on the side of caution in what it presents to ministers. The debt projections look horrifying internationally only if we look at rates of increase. The ratios themselves, as projected by the International Monetary Fund, show Britain well below the US and only slightly above France and Germany. UK official estimates will change slightly in the pre-Budget report, due out in a couple of months, but are unlikely to be radically different from those in the last Budget.
Debt ratios of this size are historically far from unprecedented. In the early Victorian period the ratio was nearly 200 per cent and almost reached that level again in the early 1920s. In 1956 it was just under 150 per cent. Harold Macmillan, who was chancellor at the time, quoted the historian Lord Macaulay: "At every stage in the growth of that debt it has been seriously asserted by wise men that bankruptcy and ruin were at hand; yet still the debt kept on growing, and still bankruptcy and ruin were as remote as ever." In fact the debt was gradually reduced from the peaks mentioned above without any heroic gestures.
The danger of premature tightening was illustrated in the US in 1936-37, when the ending of a war veterans’ bonus and the introduction of social security taxes helped push the US back into recession when recovery from the Great Depression was far from complete. The big error of the current discussion is to confuse the budget balances of individuals and companies with the government budget balance, which needs to be in deficit so long as attempted savings exceed perceived investment opportunities. Gordon Brown more or less understands this, and I wish he would use his talents to explain such fundamentals instead of stirring up an outdated class war.
The Truth About Jobs That No One Wants To Tell You
by Robert Reich
Unemployment will almost certainly in double-digits next year -- and may remain there for some time. And for every person who shows up as unemployed in the Bureau of Labor Statistics' household survey, you can bet there's another either too discouraged to look for work or working part time who'd rather have a full-time job or else taking home less pay than before (I'm in the last category, now that the University of California has instituted pay cuts). And there's yet another person who's more fearful that he or she will be next to lose a job.
In other words, ten percent unemployment really means twenty percent underemployment or anxious employment. All of which translates directly into late payments on mortgages, credit cards, auto and student loans, and loss of health insurance. It also means sleeplessness for tens of millions of Americans. And, of course, fewer purchases (more on this in a moment). Unemployment of this magnitude and duration also translates into ugly politics, because fear and anxiety are fertile grounds for demagogues weilding the politics of resentment against immigrants, blacks, the poor, government leaders, business leaders, Jews, and other easy targets. It's already started. Next year is a mid-term election. Be prepared for worse.
So why is unemployment and underemployment so high, and why is it likely to remain high for some time? Because, as noted, people who are worried about their jobs or have no jobs, and who are also trying to get out from under a pile of debt, are not going do a lot of shopping. And businesses that don’t have customers aren’t going do a lot of new investing. And foreign nations also suffering high unemployment aren’t going to buy a lot of our goods and services. And without customers, companies won't hire. They'll cut payrolls instead.
Which brings us to the obvious question: Who’s going to buy the stuff we make or the services we provide, and therefore bring jobs back? There’s only one buyer left: The government. Let me say this as clearly and forcefully as I can: The federal government should be spending even more than it already is on roads and bridges and schools and parks and everything else we need. It should make up for cutbacks at the state level, and then some. This is the only way to put Americans back to work. We did it during the Depression. It was called the WPA.
Yes, I know. Our government is already deep in debt. But let me tell you something: When one out of six Americans is unemployed or underemployed, this is no time to worry about the debt. When I was a small boy my father told me that I and my kids and my grand-kids would be paying down the debt created by Franklin D. Roosevelt during the Depression and World War II. I didn’t even know what a debt was, but it kept me up at night.
My father was right about a lot of things, but he was wrong about this. America paid down FDR’s debt in the 1950s, when Americans went back to work, when the economy was growing again, and when our incomes grew, too. We paid taxes, and in a few years that FDR debt had shrunk to almost nothing. You see? The most important thing right now is getting the jobs back, and getting the economy growing again.
People who now obsess about government debt have it backwards. The problem isn’t the debt. The problem is just the opposite. It’s that at a time like this, when consumers and businesses and exports can’t do it, government has to spend more to get Americans back to work and recharge the economy. Then – after people are working and the economy is growing – we can pay down that debt. But if government doesn’t spend more right now and get Americans back to work, we could be out of work for years. And the debt will be with us even longer. And politics could get much uglier.
Mission Not Accomplished
by Paul Krugman
Stocks are up. Ben Bernanke says that the recession is over. And I sense a growing willingness among movers and shakers to declare "Mission Accomplished" when it comes to fighting the slump. It’s time, I keep hearing, to shift our focus from economic stimulus to the budget deficit. No, it isn’t. And the complacency now setting in over the state of the economy is both foolish and dangerous.
Yes, the Federal Reserve and the Obama administration have pulled us "back from the brink" — the title of a new paper by Christina Romer, who leads the Council of Economic Advisers. She argues convincingly that expansionary policy saved us from a possible replay of the Great Depression. But while not having another depression is a good thing, all indications are that unless the government does much more than is currently planned to help the economy recover, the job market — a market in which there are currently six times as many people seeking work as there are jobs on offer — will remain terrible for years to come.
Indeed, the administration’s own economic projection — a projection that takes into account the extra jobs the administration says its policies will create — is that the unemployment rate, which was below 5 percent just two years ago, will average 9.8 percent in 2010, 8.6 percent in 2011, and 7.7 percent in 2012. This should not be considered an acceptable outlook. For one thing, it implies an enormous amount of suffering over the next few years. Moreover, unemployment that remains that high, that long, will cast long shadows over America’s future.
Anyone who thinks that we’re doing enough to create jobs should read a new report from John Irons of the Economic Policy Institute, which describes the "scarring" that’s likely to result from sustained high unemployment. Among other things, Mr. Irons points out that sustained unemployment on the scale now being predicted would lead to a huge rise in child poverty — and that there’s overwhelming evidence that children who grow up in poverty are alarmingly likely to lead blighted lives.
These human costs should be our main concern, but the dollars and cents implications are also dire. Projections by the Congressional Budget Office, for example, imply that over the period from 2010 to 2013 — that is, not counting the losses we’ve already suffered — the "output gap," the difference between the amount the economy could have produced and the amount it actually produces, will be more than $2 trillion. That’s trillions of dollars of productive potential going to waste.
Wait. It gets worse. A new report from the International Monetary Fund shows that the kind of recession we’ve had, a recession caused by a financial crisis, often leads to long-term damage to a country’s growth prospects. "The path of output tends to be depressed substantially and persistently following banking crises." The same report, however, suggests that this isn’t inevitable: "We find that a stronger short-term fiscal policy response" — by which they mean a temporary increase in government spending — "is significantly associated with smaller medium-term output losses."
So we should be doing much more than we are to promote economic recovery, not just because it would reduce our current pain, but also because it would improve our long-run prospects. But can we afford to do more — to provide more aid to beleaguered state governments and the unemployed, to spend more on infrastructure, to provide tax credits to employers who create jobs? Yes, we can. The conventional wisdom is that trying to help the economy now produces short-term gain at the expense of long-term pain.
But as I’ve just pointed out, from the point of view of the nation as a whole that’s not at all how it works. The slump is doing long-term damage to our economy and society, and mitigating that slump will lead to a better future. What is true is that spending more on recovery and reconstruction would worsen the government’s own fiscal position. But even there, conventional wisdom greatly overstates the case. The true fiscal costs of supporting the economy are surprisingly small. You see, spending money now means a stronger economy, both in the short run and in the long run. And a stronger economy means more revenues, which offset a large fraction of the upfront cost.
Back-of-the-envelope calculations suggest that the offset falls short of 100 percent, so that fiscal stimulus isn’t a complete free lunch. But it costs far less than you’d think from listening to what passes for informed discussion. Look, I know more stimulus is a hard sell politically. But it’s urgently needed. The question shouldn’t be whether we can afford to do more to promote recovery. It should be whether we can afford not to. And the answer is no.
Krugman and the pied pipers of debt
Investors are celebrating an incipient “recovery,” but the interventions that were responsible for it are sowing the seeds of a more violent contraction down the road. The problem, quite simply, is debt. We’ve accumulated record amounts, yet many economists tell us we need more.
Leading the charge is Paul Krugman. He exhorts us to borrow our way back to prosperity, but he doesn’t acknowledge that his brand of Keynesian economics ignores the consequences of debt. If you look at a chart of America’s total debt burden, he’s leading us over a cliff.
The problem begins with the flawed way Krugman and other economists measure well-being. Primarily, they look at measures of activity, like GDP. These tell us how much people spend, but say nothing about where we get the money.
Every so often, we overextend ourselves, buying too much useless stuff with too much borrowed money. So we cut back, dumping the third family car and swapping the McMansion for a townhome.
But this is problematic for Krugman and other economists. Less spending means falling GDP. It means “recession.”
They ride to the rescue with two blunt instruments — monetary and fiscal policy — that encourage more borrowing and thus more spending. More spending equals “growth” so economists congratulate themselves for engineering “recovery.”
But if recessions never happen, bad businesses and unpayable debts are never washed away. They grow like cancer inside the system.
Since the mid-1980s, we’ve intervened whenever the economy hiccuped, so sectors that should have shrunk sharply — like housing and finance — never did. Feasting on easy credit, these sectors have exploded as a percentage of the economy.
Now, since individuals and corporations refuse to borrow more, the only way to grow spending is for the government to borrow.
According to George Cooper, author of The Origin of Financial Crises, “what is missing from today’s debate is recognition that previous growth rates were artificially supported by an unsustainable credit binge, itself the result of the misapplication of Keynesian policy.”
Cooper counts himself a Keynesian but says Keynesian policy has become “dangerously distorted.” “We should be using Keynesian stimulus only to arrest the rate of credit contraction not to reverse it. The harsh truth is that our economies desperately need a recession.”
That’s because they desperately need to de-lever. As you can see in the first chart, debt relative to GDP is at record highs.
If we want sustainable growth, spending that drives it must come from savings, not more borrowing. To get there, we must first pay old debts. And that means recession.
Krugman is clearly aware of the consequences of excessive borrowing.
“I’m terrified about what will happen to interest rates once financial markets wake up to the implications of skyrocketing budget deficits,” he wrote in 2003, citing a $1.8 trillion 10-year deficit projection from the Congressional Budget Office.
Fast forward six years, total debt has jumped 70 percent relative to GDP and optimistic projections put the 10-year deficit at $9 trillion.
This time, however, Krugman dismisses deficit “hysteria,” arguing that we can grow our way out of debt. “We did it during the Clinton administration,” he told me when he visited Reuters last week.
But we didn’t. While Clinton balanced the federal budget, Americans plowed through their savings. We kept growing because, in the aggregate, we were still accumulating debt.
Krugman has also argued that we can handle larger deficits because we have in the past. After all, public debt peaked at 118 percent in 1945 compared with 65 percent today.
Two problems. First, the argument ignores tens of trillions of unfunded obligations for Medicare and Social Security, debt Krugman loudly lamented in his 2003 column.
It also ignores the higher private debt burden facing us today. According to economist Steve Keen, “Private sector debt accumulated in the 1920s was wiped out by the Depression, so in 1945 the private sector’s debt burden was only 45 percent of GDP. In that situation it was easy to wind down public debt from levels reached to finance WWII.”
Today, private debt is a suffocating 300 percent of GDP, making more public debt that much harder to pay down.
We know how this movie ends. Look at California — or Argentina.
We chortle from afar — “how did their budget get so out of whack?” — yet our own profligacy puts us squarely on that path. Like them, we’ve shown no political will to deal with debt. And so it will deal with us.
But we can print our own currency, you say. If all else fails, the United States can inflate its way out of debt.
Nonsense. If we try, our foreign lenders will cut us off.
As Krugman warned in 2003: “My prediction is that politicians will eventually be tempted to resolve the (fiscal) crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt. And as that temptation becomes obvious, interest rates will soar.”
Yet today Krugman is leading the march, arguing that we can borrow indefinitely as long as deflation remains a threat.
Tell that to the Chinese.
What happens when they stop buying our bonds? To Cooper’s point, we’ll need government intervention to cushion the blow of de-leveraging. But there’s a difference between cushioning the blow and reinflating the bubble, which is what we’re doing, wasting trillions propping up housing and banking.
The risk is that we’ll have nothing left when we really need it, when the Great Leveraging becomes the Great De-Leveraging.
New Data Raise Fears of a Post-Stimulus Hangover
The fragile economic recovery has relied heavily on government stimulus spending, but new data show that as the money runs out, a sustained rebound may be elusive. The dramatic decline in sales reported Thursday by the Big Three automakers suggested the extent to which the stimulus act has propped up the economy. The government's wildly popular "Cash for Clunkers" program drove consumer spending to its highest level in eight years in August. But after it ended, so did the growth in auto sales. General Motors' sales plunged 36 percent in September compared with August. Ford plummeted 37 percent. Chrysler dove 33 percent.
Cash for Clunkers "was a one-time boost of sales followed by a crater," said Ben Herzon, an economist at Macroeconomic Advisers. The firm forecast that the program was likely to have no effect as a stimulant for national economic output. Other economic data released Thursday showed that the deep wounds of the recession have yet to heal. Weekly jobless claims rose more than expected, a sign that businesses are still concerned about the future. The monthly unemployment rate, scheduled for release Friday, is expected to rise, albeit at a slower rate. Consumer loan delinquencies remain at record highs, and manufacturing growth has slowed. "It is a warning not to take the near-term strength of the economic recovery for granted," said Paul Dales, U.S. economist for Capital Economics.
The major stock market indexes tumbled Thursday as investors seemed to lose confidence in the nascent recovery. The Dow Jones industrial average, which in recent days seemed poised to break 10,000 for the first time in about a year, dropped 2 percent to 9,509. The broader Standard & Poor's 500-stock index fell 2.6 percent. The tech-heavy Nasdaq declined 3.1 percent. The most robust of the economic data also benefited from stimulus money. A surprising 6.4 percent jump in pending home sales in August to the highest level since March 2007 was boosted by consumers rushing to take advantage of the federal $8,000 tax credit for first-time home buyers, which will expire next month.
The index increased in every region of the country. In the South, including the Washington region, pending sales rose 0.8 percent. The index measures the period after a buyer has signed a contract but has not yet closed on the deal. It is viewed as a forward-looking indicator of home sales. Consumer spending -- which accounts for more than two-thirds of the gross domestic product -- also rose more than expected in August, up 1.3 percent from the previous month. But much of that rise was driven by the government clunkers program that ended in August and gave consumers a credit of up to $4,500 for trading in their old cars for new, more fuel-efficient ones. It remains unclear whether those sales were merely borrowed from other months or will represent a net increase.
Economists took some comfort in August's 1 percent increase in the sales of nondurable goods, including clothing, food and fuel, following a 0.3 percent dip in July. Still, August is the peak of the back-to-school shopping season, and many states held sales-tax holidays to encourage consumers to spend -- another temporary government stimulus. "A continued but gradual recovery in consumer spending seems the most likely course," said Nigel Gault, chief U.S. economist for IHS Global Insight. Overshadowing those gains were reports that showed manufacturing growth slowed in September and more people filed for unemployment benefits last week.
The Institute for Supply Management's index of business activity fell to 52.6 in September, the second consecutive month the reading has been above 50, the benchmark for growth, but August's reading was a more encouraging 52.9. Thirteen of the 18 industries surveyed in the index reported growth, led by the wood- and paper-product sectors and apparel. In addition, 30 percent of businesses said they expected their industry to benefit from the government's stimulus package.
But economists' bigger concern is that many Americans are out of work, and their ranks continue to increase. That puts them in poor position to pay off the mounds of debt accumulated during the boom times.
Weekly jobless claims rose to 551,000 last week, up 17,000 from the previous week and more than forecast. Though the weekly figures tend to be volatile, the increase is a sign that companies are still cutting back on labor and remain cautious about the prospects for recovery.
Economists are hoping a clearer picture will emerge Friday when the monthly unemployment rate is slated for release. It is expected to rise slightly, and many economists believe it will eventually top 10 percent, dampening the prospect of a consumer recovery. Throughout the recession, shoppers have cut back their spending to build their savings and pay down debt, bringing the personal savings rate to its highest level in about a decade. But many consumers are still burdened with heavy loans taken out during more prosperous times.
Delinquency rates hit record highs during the second quarter for home equity loans and lines of credit as well as bank cards, according to the American Bankers Association. Home equity loan delinquencies -- defined as accounts that are 30 days or more overdue -- rose from 3.52 percent in the first quarter to 4.01 percent of accounts in the second quarter, the ABA reported Thursday. Bank card delinquencies rose from 4.75 percent in the first quarter to 5.01 percent of accounts in the second quarter.
The ABA also reported increases in delinquencies on personal loans. "Falling behind on debt payments is an unfortunate side effect of high unemployment and a frozen job market," said ABA chief economist James Chessen. "The picture won't change until the labor market improves and the economy picks up steam. This is going to take time."
Cities Too Poor To Bury Dead
In morgues across the country the corpses of dead poor are stacking up as the the government runs out of money to bury them. State and county budgets for interring indigent and unclaimed bodies have been drying up faster than usual in the current economy, as more families are unable to come up with the money to lay their loved ones to rest. CNN's Assignment Detroit project released a report Thursday detailing how 67 people lie in wait at the Wayne County morgue. Unemployment, at a staggering 28% in Detroit, prevents many from affording to provide their family members a final resting place, and Detroit's $21,000 annual budget to bury unclaimed bodies ran out three months ago. More bodies are being left to the control of the state, who are having a harder time picking up the slack.
Detroit may be over-exposed as a cite of poverty porn, but stacks of stagnant bodies rotting in city buildings offer a bleak picture of the city's ability to provide for its most vulnerable citizens. Carl Schmidt, Wayne County's chief medical examiner, noted the despair of the condition. "There are many people with sad lives," he said, "But it is even sadder when even after you are dead, there is no one to pick you up." But it's not just Detroit. In Jefferson County, Alabama, the state has only recently resumed burying the indigent and unclaimed, reports al.com. The county has been unable to afford to pay its employees who handle burials and grave maintenance since August, but some hospitals have started footing the bill until the county can afford to continue their services.
The state of Illinois faced similar fears as its Department of Human Services announced in June that it would be unable to continue paying for burial or funeral services. Budget cuts, reported the State Journal-Register, had shredded the $15 million the state annually puts aside to bury the approximate 10,000 corpses it takes care of. In August, the state rescinded, and approved $12.6 million for those purposes, which affords $1,655 per indigent burial, according to a report by the Southern, much to the delight of cemeteries and funeral homes. Funeral homes still absorb some costs to bury the unclaimed, but the load is much lighter. "It was going to become a big financial burden," said Tony Cox, coroner of Gallatin County.
The state's backup plan -- relying on funeral homes and cemeteries -- was ultimately an appeal to charity; they are not legally bound to provide interment services, said Harvey Lapin, general counsel for the Illinois Cemetery and Funeral Home Association. The state barely avoided that option. "One way we look back at a culture is how they dispose of their dead," said Schmidt. "We see people here that society was not taking care of before they died -- and society is having difficulty taking care of them after they are dead."