Destitute family. Five children, aged two to seventeen years, American River camp, Sacramento, California
Ilargi: Went to see the movie adaptation of Cormac McCarthy's The Road last night. I know, I should have been working, but since we were going with a good friend and I’m off to Europe for a while this weekend, I went anyway.
The movie, starring Viggo Mortensen, Charlize Theron, Robert Duvall and Kodi Smit-McPhee, remains very close to the book. Which is an absolute gem. And books that good make one's mind work overtime in producing its own visuals, so I didn't know if seeing the film would be a good idea. Still don't, really. The movie is great, and I recommend it to everyone. It outdoes the book in the sense that it grabs you by the throat even more and leaves you with nowhere else to turn.
The collapse McCarthy envisions is not the one we address here at The Automatic Earth. A credit collapse, and whatever it is that comes after, is not the same as the fall-out of large-scale nuclear disaster. The main common thread here may well be that of the worries parents have for the future of their children. Once you're no longer there to protect them, what is going to happen? That is a general theme, a worry as old as the world, made more poignant by crises of virtually any kind. The Road provides an extreme version of the theme, but the reality of our economy is, for those willing to listen, extremely threatening as well. The chances that your children will be better off than you are fast approaching the freezing point, you just don't know how much worse off they'll be, and therein, in the uncertainty, lies the main threat.
After the movie, the good friend said that, in his view, things -referring to the credit collapse- are developing very slowly. I replied that they are not, that it's just his viewpoint that makes him see it that way. If and when you follow a development as closely as we do, that is, you read extensively about it on a daily basis, you risk having your view distorted. When I said that part of him wishes for things to unfold faster, he predictably denied that, and even took it as being accused of having "collapse cheerleading" views. Apparently there are places on the web where that exists. But that’s not what I meant. When you want to watch a flower grow, camping out 24/7 next to it can easily make the process seem real slow.
I have things like this John Williams graph in mind when I think of how fast or slow things are unfolding.
US unemployment, no matter how you measure it, U3, U6 or SGS, has gone up about 100% in the last 20 months, and 60% in the past year alone. And if you call that slow, than what is fast? You'd have to get to a speed that would be hindered simply by practical reasons. To lose jobs any faster than this you'd need something like government ordered mass closings, or a bank holiday or something. In other words, you’d have to do the exact opposite of what the US government does, which is to keep anything open that is broke. And that, more than anything, should make you sit and think. These unemployment numbers are here despite everything the government tries.
People like my friend and I do have the tendency to want to see it go faster, in order to have our fears, our ideas confirmed. We know it’s inevitable, so let's have it already, that sort of thing. That's not the same as cheerleading though. We're simply so focused on the topic that our perception of time gets warped. There's nothing slow about the development of US unemployment.
There's also nothing slow about the collapse of available credit in the US, another area of miscomprehension. Even if that's apparently hard to understand, borrowing money from a bank is not the same as borrowing money from yourself. Which is what you do when you sign up for a great looking 3.5% down mortgage covered by the FHA, a government agency. Or, if you want to make it a notch or two worse, if you’re not the one getting the loan, it's your neighbor who borrows your money to buy a home (s)he in all likelihood (just look at the stats) will default on a mere few years down the line, leaving you with any losses (s)he can't pay.
So if Jane Doe who flips burgers or Joe Blow who's a Wal-Mart greeter, are purchasing homes putting their $8000 tax credit towards a 3.5% downpayment, that's not credit, not in the way we have always defined credit. That's a government trying with all the means it can think of to perpetuate the lie that home prices are stabilizing or even going up again. Credit, the way we should define it, consists of one market party lending out money to another because it is confident the money will be returned, along with a profit in the form of interest.
Under the present circumstances, no commercial lender will touch these home-buyers with a ten-foot pole, simply because they are not confident the loan will be repaid. Moreover, the securitization craze that characterized the start of this millenium is over. Mortgage backed securities are as popular as holes in the head. And even though home prices have fallen some 30%, there is no sign of a return of confidence in the market. Which means there are two options going forward towards a market equilibrium. You can either let prices come down to a level that both lenders and borrowers are comfortable with (traditional credit), or you can set up a gigantic system of government intervention (not traditional credit). The choice Washington has made is glaringly obvious. The taxpayer underwrites 95% of all new mortgages, while the Federal Reserve has bought up even more in mortgage-backed securities.
That choice is not hard to explain. It keeps up appearances. It keeps banks alive. It keeps people in their homes and out of bankruptcy. And most importantly, it keeps them believing in magic for a while longer. Come to think of it, that's what makes The Road different: there's no reason or space for pretending. The flipside is that the lift Washington's choice provides to home prices is completely artificial, and temporary: when the support is withdrawn, prices must and will tumble, since they have been kept high by that support only. And when that tumble comes, your debts will have grown by a trillion here and a trillion there. So far, the artificial boost has cost roughly $1 trillion per month.
Credit, defined the way we used to define it, is gone. We throw TARP funds and FHA loans at the problem, and make people think they are the same sort of credit they have always known, that nothing has changed, just a minor bump in the road. But that same sort of credit will not return for a very long time, if ever. Both lenders and borrowers are profoundly broke, and they can neither lend nor borrow the way they used to. The system now runs on your money. Which you don't have.
My friend perceives things as unfolding slowly, until he takes a better look. Many think that there is something greatly reassuring in losing 'only' 500.000 jobs per month, in a rising gold price, in a sheikh who claims Dubai is strong and persistent, and most of all in a rising stock market. But the stock market is not the real economy. And neither is it representative of that economy, in fact it's probably less so now than at any point in the recent past. And it can turn in a second and on a dime.
But it still works. People claim there's plenty credit still to be had, that the markets can keep on going up, that things seem to remain pretty much normal. Still, if the only "credit" you can get is the one that goes from your left pocket to your right one, and if unemployment numbers are 60% higher than they were a year ago, with no sign of abating, things are by no means pretty much normal, and it makes no difference if they look to be from where you happen to be sitting. 17.5% unemployment is an astounding number, says Howard Davidowitz. Amen.
I sent my friend, who's an associate university professor, an email last night after I got home:
You can be impatient without being a [doom] cheerleader. It's just a different sort of impatience. I have it too, it's inevitable when you spend an abnormal amount of hours reading on it.
That's why it's important to ask yourself when you think it's all going slow: really?
My friend sent a reply today:
Things are not going slowly. It is a matter of perspective. My circumstances are simply better than many at present. That will change soon, with, for example, forced furloughs of public servants in Ontario, of which I am one.
Thanks for the wake-up.
He then finished with a quote from the book version of The Road, in what in the film is a conversation between Viggo Mortensen and Robert Duvall:
From among the many memorable scenes of The Road, the comments on "prepping" hit home with me:
They bivouacked in the woods much nearer to the road than he would have liked. He had to drag the cart while the boy steered from behind and they built a fire for the old man to warm himself though he didnt much like that either. They ate and the old man sat wrapped in his solitary quilt and gripped his spoon like a child. They had only two cups and he drank his coffee from the bowl he'd eaten from, his thumbs hooked over the rim. Sitting like a starved and threadbare buddha, staring into the coals.
You can't go with us, you know, the man said.
How long have you been on the road?
I was always on the road.
You can't stay in one place. How do you live?
I just keep going. I knew this was coming.
You knew it was coming?
Yeah. This or something like it. I always believed in it.
Did you try to get ready for it?
No. What would you do?
I don't know.
People were always getting ready for tomorrow. I didn't believe in that. Tomorrow wasn't getting ready for them. It didn't even know they were there.
I guess not.
Even if you knew what to do you wouldn't know what to do. You wouldn't know if you wanted to do it or not. Suppose you were the last one left? Suppose you did that to yourself?
Do you wish you would die?
No. But I might wish I had died. When you're alive you've always got that ahead of you.
Or you might wish you'd never been born.
Well. Beggars cant be choosers.
You think that would be asking too much.
What's done is done. Anyway, it's foolish to ask for luxuries in times like these.
I guess so.
Nobody wants to be here and nobody wants to leave.
What Recovery? U.S. Consumers Getting "Dramatically Worse," Howard Davidowitz Says
According to the National Retail Federation, retail sales over the Thanksgiving holiday weekend were $41.2 billion, up slightly from a year ago, while about 195 million consumers shopped, up from 172 million last year. Meanwhile, Coremetrics says the average online shopper spent 35% more on Black Friday vs. a year ago, while robust sales were predicted for Cyber Monday. Against that backdrop, you might expect Howard Davidowitz of Davidowitz & Associates to backtrack from some of the bearishness he's professed on Tech Ticker (and elsewhere) in the past year. But you'd be wrong.
"The consumer is in worse shape since I was here last" in August, Davidowitz says, citing the following:
- Unemployment has exploded: "We've lost a ton of jobs since I was here last," Davidowitz says, noting the "real" unemployment rate is 17.5%. "That's an astounding number."
- Housing continues to sink: "The consumers' biggest asset is down trillions" in value while "foreclosures are exploding" and a huge percentage have negative equity -- 23% according to CoreLogic.
- Record numbers of consumer bankruptcies: The American consumer has "never been further behind...never defaulted more" on mortgages, student loans, auto loans, and credit card bills, he says.
- Poverty on the Rise: One in eight Americans and one in four children are receiving food stamps, as The NYT reported this weekend.
"A lot of people were out on Black Friday -- you're always going to spend some money because it's Christmas," he says. "[But] the consumer continues to get dramatically worse."
Davidowitz predicts "the noise will be taken out" about "strong" Black Friday sales in the coming weeks and a sobering reality will settle in: "People will look a stores closing and a rash of bankruptcies after Christmas. People will start to look at this and say ‘wow, this is terrible,'" he says.
Somali sea gangs lure investors at pirate lair
In Somalia's main pirate lair of Haradheere, the sea gangs have set up a cooperative to fund their hijackings offshore, a sort of stock exchange meets criminal syndicate.
Heavily armed pirates from the lawless Horn of Africa nation have terrorized shipping lanes in the Indian Ocean and strategic Gulf of Aden, which links Europe to Asia through the Red Sea.
The gangs have made tens of millions of dollars from ransoms and a deployment by foreign navies in the area has only appeared to drive the attackers to hunt further from shore. It is a lucrative business that has drawn financiers from the Somali diaspora and other nations -- and now the gangs in Haradheere have set up an exchange to manage their investments. One wealthy former pirate named Mohammed took Reuters around the small facility and said it had proved to be an important way for the pirates to win support from the local community for their operations, despite the dangers involved.
"Four months ago, during the monsoon rains, we decided to set up this stock exchange. We started with 15 'maritime companies' and now we are hosting 72. Ten of them have so far been successful at hijacking," Mohammed said. "The shares are open to all and everybody can take part, whether personally at sea or on land by providing cash, weapons or useful materials ... we've made piracy a community activity."
Haradheere, 400 km (250 miles) northeast of Mogadishu, used to be a small fishing village. Now it is a bustling town where luxury 4x4 cars owned by the pirates and those who bankroll them create honking traffic jams along its pot-holed, dusty streets. Somalia's Western-backed government of President Sheikh Sharif Ahmed is pinned down battling hard-line Islamist rebels, and controls little more than a few streets of the capital. The administration has no influence in Haradheere -- where a senior local official said piracy paid for almost everything.
"Piracy-related business has become the main profitable economic activity in our area and as locals we depend on their output," said Mohamed Adam, the town's deputy security officer. "The district gets a percentage of every ransom from ships that have been released, and that goes on public infrastructure, including our hospital and our public schools."
In a drought-ravaged country that provides almost no employment opportunities for fit young men, many are been drawn to the allure of the riches they see being earned at sea. Abdirahman Ali was a secondary school student in Mogadishu until three months ago when his family fled the fighting there. Given the choice of moving with his parents to Lego, their ancestral home in Middle Shabelle where strict Islamist rebels have banned most entertainment including watching sport, or joining the pirates, he opted to head for Haradheere. Now he guards a Thai fishing boat held just offshore.
"First I decided to leave the country and migrate, but then I remembered my late colleagues who died at sea while trying to migrate to Italy," he told Reuters. "So I chose this option, instead of dying in the desert or from mortars in Mogadishu." Haradheere's "stock exchange" is open 24 hours a day and serves as a bustling focal point for the town. As well as investors, sobbing wives and mothers often turn up there seeking news of male relatives missing in action. Every week, Mohammed said, gang members and equipment were lost to the sea. But he said the pirates were not deterred.
"Ransoms have even increased in recent months from between $2-3 million to $4 million because of the increased number of shareholders and the risks," he said. "Let the anti-piracy navies continue their search for us. We have no worries because our motto for the job is 'do or die'." Piracy investor Sahra Ibrahim, a 22-year-old divorcee, was lined up with others waiting for her cut of a ransom pay-out after one of the gangs freed a Spanish tuna fishing vessel. "I am waiting for my share after I contributed a rocket-propelled grenade for the operation," she said, adding that she got the weapon from her ex-husband in alimony. "I am really happy and lucky. I have made $75,000 in only 38 days since I joined the 'company'."
Howard Davidowitz Sees Our Future And It Is Japan
Many economists draw comparisons between the United States now and Japan in 1990. For those who aren't familiar with Japan's recent economic history, this is not a good thing. Japan's stock market peaked in 1989 at about 40,000. It now trades around a quarter of that level, or 10,000. GDP, meanwhile, has barely grown at all. Economists used to refer to Japan's malaise as "a lost decade." Now they're saying "lost decades."
Our guest Howard Davidowitz sees a similarly horrific future in store for the U.S. He calls America's current path, rich in deficit spending and weak in currency a "road to nowhere."
He also doesn't buy the arguments of those who reassure us that Japan's problems are "cultural" and "demographic"--and, therefore, that it's different here. Japan's problems are the same as our problems (artificially low interest rates and a bailout culture), Davidowitz says. The only difference is that we're about 20 years earlier into the collapse. If we are Japan, what is the outlook for the stock market (and your retirement savings)? Not good. If the DOW behaves the way Japan's NIKKEI has, the DOW will trade at about 4,000 in 2025.
Morgan Stanley fears UK sovereign debt crisis in 2010
Britain risks becoming the first country in the G10 bloc of major economies to risk capital flight and a full-blown debt crisis over coming months, according to a client note by Morgan Stanley. The US investment bank said there is a danger Britain’s toxic mix of problems will come to a head as soon as next year, triggered by fears that Westminster may prove unable to restore fiscal credibility. “Growing fears over a hung parliament would likely weigh on both the currency and gilt yields as it would represent something of a leap into the unknown, and would increase the probability that some of the rating agencies remove the UK's AAA status,” said the report, written by the bank’s European investment team of Ronan Carr, Teun Draaisma, and Graham Secker.
“In an extreme situation a fiscal crisis could lead to some domestic capital flight, severe pound weakness and a sell-off in UK government bonds. The Bank of England may feel forced to hike rates to shore up confidence in monetary policy and stabilize the currency, threatening the fragile economic recovery,” they said. Morgan Stanley said that such a chain of events could drive up yields on 10-year UK gilts by 150 basis points. This would raise borrowing costs to well over 5pc - the sort of level now confronting Greece, and far higher than costs for Italy, Mexico, or Brazil.
High-grade debt from companies such as BP, GSK, or Tesco might command a lower risk premium than UK sovereign debt, once an unthinkable state of affairs. A spike in bond yields would greatly complicate the task of funding Britain’s budget deficit, expected to be the worst of the OECD group next year at 13.3pc of GDP. Investors have been fretting privately for some time that the Bank might have to raise rates before it is ready -- risking a double-dip recession, and an incipient compound-debt spiral – but this the first time a major global investment house has issued such a stark warning.
No G10 country has seen its ability to provide emergency stimulus seriously constrained by outside forces since the credit crisis began. It is unclear how markets would respond if they began to question the efficacy of state power. Morgan Stanley said sterling may fall a further 10pc in trade-weighted terms. This would complete the steepest slide in the pound since the industrial revolution, exceeding the 30pc drop from peak to trough after Britain was driven off the Gold Standard in cataclysmic circumstances in 1931. UK equities would perform reasonably well. Some 65pc of earnings from FTSE companies come from overseas, so they would enjoy a currency windfall gain.
While the report – “Tougher Times in 2010” – is not linked to the Dubai debacle, it is a reminder that countries merely bought time during the crisis by resorting to fiscal stimulus and shunting private losses onto public books. The rescues – though necessary – have not resolved the underlying debt problem. They have storied up a second set of difficulties by degrading sovereign debt across much of the world. Morgan Stanley said Britain’s travails are one of three “surprises” to expect in 2010. The other two are a dollar rebound, and strong performance by pharmaceutical stocks.
David Buik, from BGC Partners, said Britain is in particularly bad shape because the tax-take is highly leveraged to the global economic cycle: financial services provided 27pc of revenue in the boom, but has since collapsed. The UK failed to put aside money in the fat years to offset this time-honoured fiscal cycle. It ran a budget deficit of 3pc of GPD at the peak of the boom when prudent countries such as Finland and even Spain were running a surplus of over 2pc.
“We need to raise VAT to 20pc and make seriously dramatic cuts in services that go beyond anything that Alistair Darling or David Cameron are talking about. Nobody seems to have the courage to face up to this,” said Mr Buik. The report coincided with news that Britain is now officially the only G20 country still to be in recession. Canada reported that its economy grew by 0.1pc in the third quarter. Britain, by contrast, shrank by 0.3pc, the latest estimates show.
Morgan Stanley: First Comes The Banking Crisis, Then Comes The Sovereign Debt Crisis
What happens after governments go trillions into debt to rescue their banking systems? The governments themselves collapse. It's what Niall Ferguson has been warning about. It's the lesson that Roubini sees in Dubai.
And now Morgan Stanley, in a new report about the upcoming slog, reminds us of some history.
Banks De-Leveraging At Rapid Fire Pace
Analyst Dennis Gartman points out that banks are beginning to de-leverage post-crisis at a pace never seen before:
The Gartman Letter: One week ago this morning we wrote about the growth in bank assets, drawing upon a chart sent to us by our friend, Eric Pomboy of Syzygy Research Group. We noted that bank assets have been falling rather sharply over the course of the past several months as the nation’s banks collectively and individually deleverage at a pace we’ve not seen before in our lifetime, nor are we likely ever to see again.
From their highs approximately $12.6 trillion in late ’08, bank assets have fallen to $11.75 trillion in recent weeks, and as banks have de-leveraged they’ve essentially swapped-out loans for US Treasury security holdings. We said then that simply by “casting” forward a trendline that we thought rather evident we could guess-timate that the unwinding or deleveraging of America’s banks would stop sometime in mid’11 when total bank assets were down to $10.0-10.5 trillion.
We like to keep things simple. Advanced math and computers scare us, and in the case of Long Term Capital Management, or Bear Stearns, or Lehman or the IMF, they’ve proven utterly and rather completely worthless… or worse!
‘Deep down, even the fiercest equity bulls must be doubting themselves’
The latest missive from the dynamic SocGen strategy duo, Albert Edwards and Dylan Grice, landed in the FT Alphaville inbox on Tuesday, and it’s a stunner.
Some of the top lines from the presentation — titled: “The investment opportunity of a generation or the start of another lost decade?” — include (emphasis theirs):
We have just had the worst decade’s performance for equity investors on record. Relative to government bonds, equities have been an even bigger disaster. Surely after such a terrible decade for equity investors things can only get better?
On a ten year view, equities may indeed prove to be a good investment. On a 1-2 year view, however, we still see much pain to come. After what we have been though so far, where the bulls’ optimism has been crushed in 2001/2 and in 2007/8 surely there must be a heavy weight of self-doubt yoked onto the shoulders of the bulls - but apparently not!
The lesson from Japan is that while de-leveraging plays itself out, the global economy will remain extremely vulnerable. The Great Moderation is dead. It was built on a super-cycle of private sector debt. We know from Japan, we now return to what was before, i.e. highly volatile and unpredictable cycles. Recession will quickly follow recovery.
US equity valuations did not reach revulsion levels in March this year. After some 15 years of gross overvaluation do we really believe that this valuation bear market that has been in place since 2000 will finish with equities looking cheap for only three months? Long term-valuation measures suggest equities will fall substantially below March lows.
Government bonds are now an extremely poor investment. On a 10-year view, the insolvency of government finances will surely end in substantially higher inflation. Yet on a 1-2 year view, we believe the key threat remains deflation. Markets will react aggressively to this as the cycle stalls in 2010. Expect sub-2% bond yields to accompany new lows on the equity market next year. Thinking the unthinkable has paid off over the last decade and should continue to do so.
And here’s our favourite graphic from the piece:
That is scary.
Tri-Party Repo Could See 1st Round Of Reforms By Year-End
Progress is being made in reaching agreement on a first round of reforms for the crucial tri-party repo market and details could be revealed as early as the end of this year, according to people familiar with ongoing discussions. The reforms, which focus on margin requirements and intraday credit, are a first step in making security repurchase transactions more secure and preventing this $4.3 trillion over-the-counter market, where firms raise cash against collateral, from becoming a source of instability for the broader financial system.
They also come at a time when the repo market will be in the spotlight as the Fed plans for the day when it will start to pull the massive amounts of cash it has extended to markets from the system. The Fed is planning to use reverse repo operations--selling dealers securities such as Treasurys for cash with the agreement to buy them back later at a higher price--as one tool to achieve that goal. The drive to reform the repo market--whose smooth functioning is key to the health of the financial system--has recently gained traction, in part due to the expiry of the Fed's primary dealer credit facility in February 2010.
The facility serves as the current borrowing backstop for the big banks that deal directly with the central bank. Without it, the banks will have to rely more on repo for funding, which adds to the need to strengthen its functioning. According to one person involved with the talks, the New York Fed-sponsored Tri-Party Repurchase Agreement Infrastucture Task Force could issue a progress report on repo reform discussions and seek feedback from the broader market as early as December.
The reforms will focus on the tri-party repo market, which makes up the biggest chunk of the repo market. In this market, a clearing bank stands between the borrower and the lender, holding collateral and facilitating the trades. The two dominant clearing banks in the U.S. are J.P. Morgan Chase & Co. and the Bank of New York. In a first step, reform will focus on steps that market participants can address without outside input: standardizing margin requirements and tackling the issue of the intraday extension of credit in the market. Longer-term reforms to reduce systemic risk in tri-party repo are still being debated.
Standardized, or minimum margin requirements, would add security for the two clearing banks. Higher margins could be required for certain types of securities, such as commercial paper, or high-yield debt, or for riskier banks. Intraday credit has also been a top concern. Currently, for operational efficiency, the two clearing banks extend intraday credit on term repos, or repos longer than overnight, meaning they return cash to the lender and securities to the borrower each day even though the contract continues to run. That leaves the clearing bank on the line should either counterparty falter.
One possible solution is to bring the U.S. term repo market more in line with overseas markets, by not allowing term repos using less liquid securities, such as corporate debt, to unwind every day. Other transactions, such as those using the more liquid Treasury securities, would still unwind every day. The need for repo reforms has been apparent to policymakers for years, but was paid greater heed after severe disruptions in the market during the recent financial crisis. Borrowers, lenders, clearers, industry groups and the Fed came together in September to form the repo task force and have been meeting every few weeks since then. Members have been working on crafting an initial set of reforms that would help to protect the tri-party repo market from future financial market disruptions.
Job Cuts Loom as Stimulus Fades
Highway-construction companies around the country, having completed the mostly small projects paid for by the federal economic-stimulus package, are starting to see their business run aground, an ominous sign for the nation's weak employment picture.
Tim Word, vice president of Dean Word Co., a heavy-construction company in New Braunfels, Texas, said his income is now coming mostly from projects that are winding up. He said that in normal times he has about $100 million of signed contracts in hand. But that number has fallen to $30 million, and the pipeline is empty. In the past two years, his work force has shrunk nearly 40% to 260 from 420. "Having something to bid on is the lifeblood of the industry, and it's running out," said Mr. Word. He isn't sure what will happen next year without new projects. "There's no pavement fairy that's going to help."
Since the recession began in 2007, employment in the construction industry has fallen by 1.6 million, the Labor Department says. Though the housing sector accounts for many of those job losses, road builders have also suffered, and executives in the industry expect layoffs to rise next year. More broadly, the Congressional Budget Office late Monday said it estimates that the federal stimulus package sustained between 600,000 and 1.6 million jobs in the third quarter, and raised gross domestic product by 1.2 to 3.2 percentage points higher than it would have been without the program.
The construction industry's unemployment rate, including related extraction businesses, such as gravel processing, climbed to 19.1% in October, up from 10.7% a year earlier. The transportation and material-moving sectors saw unemployment rise to 11.6% from 7.9% over the same period. State officials and local contractors trace the industry's woes to the recession and the collapse of the residential and commercial real-estate markets. In addition, they cite the federal government's delayed plans to enact a transportation bill. In one version, the law would have provided $450 billion for highways and infrastructure projects over the next six years.
Congress is no longer actively considering the bill, which has been bumped aside by competing priorities such as the Obama administration's health-care overhaul and by growing support for reducing the federal budget deficit. Some lawmakers fear that continued stimulus spending could harm the economy down the road by saddling the nation with higher debt-servicing bills. But high unemployment could revive the transportation-spending bill's prospects. Earlier this year the Obama administration was opposed to pushing a big highway bill, deterred in part by the prospect of raising gasoline taxes to pay for it. Faced with a 10.2% jobless rate, however, officials here are rethinking their stance. Thursday, the White House will hold a "jobs summit" to discuss ideas, which are likely to include shifting some spending to transportation projects.
Without an infusion of federal funding, state transportation departments say they can't develop long-term roadway projects, which are critical to the industry. About half of states' funding for such projects comes from the federal highway trust fund, which is funded by the gasoline tax. Christian Zimmermann, chief executive of Pike Industries Inc., a 1,200-employee company in Belmont, N.H., that paves roads and operates gravel pits and asphalt plants, recalls waiting out 2003 and 2004 while Congress deliberated on the last highway bill. "It was miserable," he said. The industry's saving grace then was a booming private sector. This time around, the private sector isn't picking up the slack. "Two years ago, our phones would have been ringing off the hook with the good weather," Mr. Zimmermann said. "This year the phones ain't ringing."
Without long-term government projects, Mr. Zimmermann said he may have to lay off as many as 150 people next year. "The stimulus was a shot in the arm, but that's all it was," he said. Industry executives say that the $27 billion out of the $787 billion stimulus package that went to highway construction went mostly to relatively small "shovel ready" projects, those that didn't require much lead time. The $27 billion—77% of which had been committed as of Nov. 13, according to the Associated General Contractors of America—has saved some jobs.
"But if I'm a big company, I need major freeway rehabilitation work and bigger projects," said Steve Simmons, deputy executive director of the Texas Department of Transportation. Texas's wish list is taking "a back seat because we have no funding for it," Mr. Simmons said. In the near term, House Democratic leaders are considering paying for some transportation projects that weren't funded by the stimulus package. The size of the spending package hasn't been decided, nor has the question of how it would be funded. Congress is also weighing a broader set of initiatives to spark job growth. Jim Berard, spokesman for Rep. James Oberstar (D., Minn.), chairman of the House Transportation and Infrastructure Committee, said the White House is "warming" to the idea of considering a bigger highway bill sooner than it had initially planned.
A recent survey by the Associated General Contractors of America found that more than 76% of contractors expect state transportation departments to put less work up for bid in 2010 than this year. And 44% said they are likely to lay off employees next year. John McCaskie, chief engineer at Swank Associated Cos., said his New Kensington, Pa., bridge-and-highway rehabilitation company faces more competition for the few projects out there. He said contracts worth less than $2 million are attracting a dozen competitors these days, compared with around four previously. "You end up bankrupting your company to be the low bidder."
If contractors cut back, their equipment suppliers will be hurt as well, said Ken Taylor, president of Ohio CAT, Broadview Heights, Ohio, which sells equipment made by Caterpillar Inc. Contractors have usually placed orders for the spring construction season by now, he said. That hasn't happened, and he may need to eliminate $50 million of his $175 million inventory. Mr. Taylor has pared his staff to about 750, down from 1,000 in June 2008. "I feel like I'm at a spot where we've done a lot of things, and we should be able to manage through. But if it gets worse I may be looking at closing a couple locations."
Worse Than Enron?
by Nomi Prins
Enron was the financial scandal that kicked off the decade: a giant energy trading company that appeared to be doing brilliantly—until we finally noticed that it wasn’t. It’s largely been forgotten given the wreckage that followed, and that’s too bad: we may be repeating those mistakes, on a far larger scale. Specifically, as the largest Wall Street banks return to profitability—in some cases, breaking records—they say everything is rosy. They’re lining up to pay back their TARP money and asking Washington to back off. But why are they doing so well? Remember that Enron got away with their illegalities so long because their financials were so complicated that not even the analysts paid to monitor the Houston-based trading giant could cogently explain how they were making so much money.
After two weeks sifting through over one thousand pages of SEC filings for the largest banks, I have the same concerns. While Washington ponders what to do, or not do, about reforming Wall Street, the nation’s biggest banks, plumped up on government capital and risk-infused trading profits, have been moving stuff around their balance sheets like a multi-billion dollar musical chairs game. I was trying to answer the simple question that you'd think regulators should want to know: how much of each bank’s revenue is derived from trading (taking risk) vs. other businesses? And how can you compare it across the industry—so you can contain all that systemic risk? Only, there's no uniformity across books. And, given the complexity of these mega-merged firms, those questions aren’t easy to answer.
Goldman Sachs and Morgan Stanley, for example, altered their year-end reporting dates, orphaning the month of December, thus making comparison to past quarterly statements more difficult. In the cases of Bank of America, Citigroup and Wells Fargo, the preferred tactic is re-classification and opaqueness. These moves make it virtually impossible to get an accurate, or consistent picture of banks ‘real money’ (from commercial or customer services) vs. their ‘play money’ (used for trading purposes, and most risky to the overall financial system, particularly since much of the required trading capital was federally subsidized). Trading profitability, albeit inconsistent and volatile, is the quickest way back to the illusion of financial health, as these banks continue to take hits from their consumer-oriented businesses. But, appearance doesn’t equal stability, or necessarily, reality. Here’s how BofA, Citi and Wells Fargo play the game:
Bank of America : The firm reclassified its filing categories upon acquiring Merrill Lynch, but it doesn't break down the trading vs. investment banking revenues of Merrill. This either means the firm doesn’t truly know what's going on inside its new problem child, or doesn’t want to tell. (No wonder no one’s jumping for the upcoming CEO vacancy.) That said, despite the obvious information clouding, new acquisitions generally don’t have their activities broken out, which makes it a lot harder for regulators, shareholders, or we, taxpaying subsidizers, to know whether the merger was a success or not.
According to Scott Silvestri, Bank of America’s spokesman, “On our second quarter's earnings release, there was a note explaining why we changed reporting structure. But, with every quarter that passes, it's harder to unscramble the egg. It's been a merged entity since January 1, 2009.” He added that “we have an earnings supplement. Every quarter, we put out a standalone Merrill 10-Q that shows its profitability.” True, but what’s the point of issuing a separate Merrill report, without delineating Merrill’s contribution in its main books so that you can clearly see how specific parts of Merrill’s business impact similar ones in the merged entity? Furthermore, we can’t even figure this out ourselves—the Merrill results in the 10-Q don’t map directly to those of BofA’s books. This all just creates more complexities for a bank that still floats on $63.1 billion in various government subsidies.
When it wants to, it appears that BofA can merge and then break out Merrill’s numbers. Under the "Global Wealth & Investment Management ” classification, we discover that Merrill contributed three-quarters of the $12 billion BofA took in over the first nine months of 2009. According to Silvestri, “The numbers of the old Merrill are there because the brand name was kept, vestiges of the old Merrill Lynch exist.” Talk about semantics. Why not also break out the area where revenues tripled and trading account profits jumped significantly (from a $6 billion loss in 2008 to an almost $14 billion gain in 2009)? Something is clearly going on there: the best measure of trading risk, VaR (“value at risk” or a firm’s daily trading variation) doubled between 2008 and 2009. If I was the CEO, I’d want to see this critical comparison on my merged company filing.
Elsewhere, the sum of Bank of America’s quarterly figures doesn’t quite add up to the nine months totals. (A few hundred million of discrepancies between friends.) Another item "all other" is off by nearly a quarter of a billion dollars. And so on. The firm also declared, that it “may periodically reclassify business segment results based on modifications to its management reporting methodologies and changes in organizational alignment." In other words, whenever it feels like it. Comforting, isn’t it?
Citigroup : Another balance-sheet renovation, this time because of a sale (Smith Barney, which it offloaded to Morgan Stanley) rather than a purchase, and another trading miracle. Citigroup’s main trading arm, housed in what it calls the Institutional Clients Group (ICG), made $31.5 billion in net revenue for 2009, compared with a $7.8 billion loss in 2008. Its average daily value at risk jumped too, though “only” by 15 percent or so.
That’s a huge and extremely fast trading rebound for the main recipient of government subsidies (at $373.7 billion). But, there is no overall breakdown present in the summaries of Citigroup’s latest filings. And the sum of the trading totals doesn’t equal the parts, because the firm also noted that certain numbers deemed an “integral part of profitability” weren’t included in those computations, without giving any apparent reason. (After adding the missing number, it still didn’t add up.) Again, it’s “just” a couple billion of discrepancies, but with books this massive at banks this big and risky, accuracy matters. Plus, such nuances make it extremely difficult to understand its books for regulators or the public.
Citigroup’s Danielle Romero-Apsilos said that they periodically change reporting. "ICG existed, but after Smith Barney, we decided to divide it—we call one part securities and banking, one part global transaction services, etc.” That describes the chain of events, but doesn’t get closer to determining trading related revenue. Romero-Apsilos said, “We don’t break up the financials specifically for those businesses. Over the years, we may have broken out different things."
Wells Fargo : Yet more innovative accounting maneuvers. For example, the innocuous sounding category, “wholesale banking” which provides traditional lending, finance and asset management services, was expanded (following the Wachovia acquisition that completed on December 31, 2008) to include more speculative activities like fixed-income and equity trading. But, those activities aren’t broken down in the firm’s SEC filing, making it difficult to determine which portion comes from trading vs. commercial or investment banking. Wells Fargo spokesperson, Mary Eshet (who still has a Wachovia email address) confirmed there is no separate Wachovia 10-Q (like there is for Merrill Lynch), but that it wasn't the case that "Wells Fargo broke out trading related revenue previously either."
In fact, Wells just provides totals for their four main business segments, each of which increased sharply, Community banking rose from $33 billion in 2008 to an annualized $59 billion in 2009. Wholesale banking shot up from $8.2 billion in 2008 to $20 billion in annualized 2009. And, wealth, brokerage and retirement quadrupled from $2.7 billion in 2008 to $11.6 annualized for 2009. (The fourth segment is called ‘other.’) Yet, all these rosy numbers come with no specific breakdowns for their various trading business areas.
Separately, Wells states in its filing that its management accounting process is “dynamic” and, not “necessarily comparable with similar information for other financial services companies.” This statement should give lawmakers pause: if banks are so complex as to constantly fluctuate their own reporting, deciphering figures just before a crisis won’t exactly be a walk in the park. With taxpayers now on the hook, we need an objective, consistent evaluation of bank balance sheets complete with probing questions about trading and speculative revenues, allowing for comparisons across the banking industry. This lack of transparency leaves room to misrepresent risk and trading revenue.
The long-term solution is bringing back Glass-Steagall. Being big doesn’t just risk bringing down a financial system—it means you can also more easily hide things. Remember the lesson from the Enron saga: when things look too good to be true, they usually are.
Deflating the bubble
by Charles Goodhart
Between the failure of Lehman Brothers in September 2008 and March 2009 asset prices in financial markets, world trade, confidence and real output dropped faster than in 1929. Since then there has been an, almost miraculous, recovery in financial markets and confidence, and a stabilisation and incipient recovery in trade and output. The turning point coincided with the aggressive adoption of quantitative easing (QE), especially in the US and UK. The most common explanation of this recovery in financial markets is that it has been due to the abundant provision of liquidity; and liquidity is exactly what QE generates.
Yet QE has not worked as many had first expected. A now defunct theory of the supply of money had the central bank controlling this by operating to adjust the reserve base of the banking system. Banks were expected to maintain a reasonably stable ratio of reserves to assets/deposits so, if the authorities should raise their reserve base, primarily their deposits with the central bank, then total?assets/deposits should rise by the same level. Since total assets/deposits are normally a large multiple, say 25 times or more, of the reserve base, this relationship appeared to enable the central bank to adjust total bank?assets/deposits by a multiple of their open market operations to affect the reserve base, the “money multiplier” as the theory was known.
From June 2008 to June 2009, reserves held by commercial banks with their central bank doubled in the eurozone, and increased by an even greater percentage in the UK and US, yet bank deposits and total bank assets barely changed, so the multiplier collapsed to zero. Banks, in aggregate, just absorbed the additional reserves by allowing their ratio of reserves to deposits to balloon, without any attempt to use their greater liquidity/reserves to expand their balance sheet. Why?
This may appear to have been a purely passive response to cash injection, but nevertheless commercial bank treasurers will have consciously decided that accumulating vast cash reserves was preferable to using them in any other way. This may be partly insurance against uncertain future needs to roll-over wholesale funding. At a time of tightening bank capital requirements, and rising prospective defaults, the limitations on lending to private sector borrowers, except on most favourable terms, are obvious.
But why not buy safe public sector debt? Lower yields on short-dated government bonds, pushed down by QE, as well as interest rate risk, enhanced by rising debt ratios, may make public sector debt appear less attractive compared to the safe remuneration on deposits at the central bank. This is a condition for a typical liquidity trap; hence my proposal for applying a negative return, a charge, on such deposits. Perhaps a lesson that should be learned is that the relativities between the interest rate on bank deposits with, and borrowing from, central banks gives each central bank another degree of instrumental freedom, on top of their control over the official short-term rate.
Despite the total collapse of the money multiplier, QE has, I believe, been a major factor in the recovery of financial markets and confidence. The scale of asset purchases has been so large that it has led to a huge injection of liquidity, and to portfolio rebalancing, on a large scale amongst non-bank financial intermediaries and financial market participants more widely. Bond yields have come down quite sharply, more so in riskier corporate debt than in government debt, as risk premia also get reduced. Equities rise, and exchange rates fall in countries pursuing QE more aggressively (USA and UK) relative to those doing less (eurozone and Japan). The rise in asset prices and fall in yields, has allowed large corporates, including banks, to refinance themselves in capital markets; with fixed and inventory investment still low, such fund raising allowed repayment of bank loans. It is ironic that QE may have facilitated a reduction in bank lending and deleveraging.
So if QE has been such a success, and the prospective recovery still looks anaemic, why not continue it? Partly because the money multiplier has been defunct, QE has operated primarily via a restoration of prices, confidence and capital gains in financial markets rather than impinging directly on the access to credit and expenditure decisions of small and medium enterprises and households, where the real problems remain. If the authorities go on blowing up financial markets too much, at some point yet another bubble will develop. The last time the financial bubble burst, the taxpayers got soaked. There will not be a next time for this support mechanism, since the taxpayer neither can, nor will, repeat it. Central banks need to check their proclivity for generating a further bubble to overcome the effects of the previous bust. Certainly, we can never get the timing exactly right, but now does seem the moment to declare victory for QE and withdraw.
Howard Davidowitz's Winners of the Retail Apocalypse
Retail analyst Howard Davidowitz debuted on our show in February and declared the American consumer is toast, and that the U.S. standard of living is permanently changed. One of Tech Ticker's most popular guests ever, Davidowitz lit up our message boards.
With unemployment at 10.2% -- a 26-year high -- and Americans saving more and spending less, Howard, chairman of Davidowitz & Associates, remains bearish on the consumer. But not all retailers are created equal. In a fierce game of survival of the fittest, the most cost-effective, creative and nimble retailers are actually gaining market share in a weakened economy. Among the "gold standard" retail winners:
- Kohl's: A low cost-to-run leader that's able to offer quality merchandise at lower prices.
- Dollar Tree: With $1 goods, the chain is so profitable new stores operate in the black right out of the gate.
- Bed Bath & Beyond: With competitor Linens N Things out of business, the retailer of home merchandise is gaining strength.
- Wal-Mart: You know the story here. But now the behemoth is putting traditional food retailers out of business, too.
- Amazon.com: Shares of the online retailer hit an all-time high Monday as consumers turn to online shopping for bargain hunting and price-comparison shopping. Plus with no costs associated with running physicals stores, Amazon can compete with giant Wal-Mart.
And the retail losers? Sales trends so far aren't looking good for the luxury sector such as jewelry stores. While Tiffany's recently topped analysts' profit forecasts for the third quarter, some-store sales fell 6%. (Quarterly profits were helped by overseas sales and cost cutting.) Longer term, Tiffany's needs to reassess its revenue model, Davidowitz says.
FDIC too broke to Takeover Banks? No Bank Failure Friday on Black Friday. Can 5,300 Employees Deal with $5.3 Trillion in Deposits?
The Federal Deposit Insurance Corporation (FDIC) was hammered this week when a third quarter report demonstrated that the FDIC was running in the red to the sum of $8.2 billion. This is troubling since the FDIC protects deposits in member banks up to $250,000 and funds covered by the deposit insurance fund (DIF) are over $5.3 trillion, this amount is over one-third of our nationwide GDP. The FDIC as of Q1 of 2009 has 5,381 employees. Is that enough to deal with the enormous banking crisis?
The FDIC is proud of saying that since 1934 no depositor has ever lost a single cent of insured funds due to any bank failure. Yet what isn’t stated is the trillions needed to prop up the failing banking system. Of course, as time has gone on and the banking system has gotten more fragile the amount of insured deposits has ramped up:
- 1934 – $2,500
- 1935 – $5,000
- 1950 – $10,000
- 1966 – $15,000
- 1969 – $20,000
- 1974 – $40,000
- 1980 – $100,000
- 2008 – $250,000
Did you notice how no banks were taken over this week? This definitely bucks the overall trend for the year:
The FDIC has dealt with 124 bank failures in 2009. Yet this week the third quarter report shows the fund in the red, so no banks are taken over? Can it be that the FDIC is so deep in the red, that it is in poor shape to take over any additional banks? On November 20th only one bank was taken over. Maybe this was in anticipation of the quarterly report. Since the third quarter ended, the FDIC has taken over 29 additional banks so the fund is likely to be further in the red than the $8.2 billion announced.
What is troubling, as the fund goes negative, more deposits are now under the DIF purview:
From the second to third quarter, DIF-insured deposits increased by $491 billion yet the DIF balance swung down by $18.6 billion. Where will the fund be at by the end of the fourth quarter? It isn’t because banks are doing better. The number of troubled institutions has also increased to 552:
The troubled bank list is made up of banks that are still functioning. Banks like IndyMac and Washington Mutual that ended up costing the FDIC billions didn’t even appear on the list. Troubled banks under the FDIC watch now have over $300 billion in assets at risk. So what options does the FDIC have?
If you recall, the FDIC also has a lifeline of $500 billion with the U.S. Treasury:
“(FDIC) Chairman Bair distinguished the DIF’s reserves from the FDIC’s cash resources, which included $22 billion of cash and U.S. Treasury securities held as of June 30, as well as the ability to borrow up to $500 billion from the Treasury. “A decline in the fund balance does not diminish our ability to protect insured depositors,” Chairman Bair concluded.”
The FDIC instead of tapping into the U.S. Treasury has decided to assess early premium payments on banks. But how long this can go on is hard to say. Politically the nation is getting exhausted with bailouts going to a banking system that is failing and is clearly only taking taxpayer money to protect its balance sheet. In fact, since the major bailouts most lending has decreased in overall size:
This is where you see the real shift. You’ll notice that with residential loans, banks are now pushing government backed paper while tapering off their own balance sheet. If this is the case, why doesn’t the public just go to the U.S. government for mortgages with the benefit of the Fed’s zero bound interest rate? Also, you’ll notice that credit card lending has also fallen by 4.5 percent in the last year even though banks have received trillions in bailout funds. Where has the money gone? Take a look at the jump in loss reserves. A jump of 40 percent. Real estate owned has jumped by 65 percent. To be more clear, banks fooled the public by utilizing their spokespeople in D.C. that the money given to banks was necessary to maintain lending. But in reality, the trillions in bailouts were merely a requirement to patch up the balance sheet of banks.
I wouldn’t mistake the last couple of quiet weeks in terms of bank failures as good news. It just seems odd that a broke FDIC would be taking over a broke bank. Banks are in deep trouble. We just saw that Dubai, the hyper center of commercial real estate development has requested a pause on their debt payment. They like many homeowners are unable to make their payment. This merely serves as a reminder that problems still sit in the banking system. The FDIC will undoubtedly be using that $500 billion lifeline just like the FHA will be needing a bailout in 2010. How many bailouts will our fragile economy take while the money is funneled to the entrenched banking interests?
AIG May Face An $11 Billion Shortfall In Insurance Reserves
The disaster at AIG keeps getting worse. Today a Sanford C. Bernstein analyst released a note on his discovery that the insurer has an undisclosed $11 billion shortfall in reserves to pay property-casualty claims. Todd Bault said that AIG may have cut back on its use of reinsurance and become too "aggressive" in pricing workers' compensation and professional liability policies. As a result, AIG would likely have take a huge reserve charge before it could sell its Chartis property-casualty business.
“AIG shareholders and the federal government face considerably more uncertainty than they may have anticipated,” Bault wrote. For months there have been rumors that Chartis was selling insurance an unsustainably low levels. Chartis officially dismisses these as whining from competitors. But if Bault is right, it looks like there may be some merit to this complaint. Bault cut the price target on AIG from $20 to $12. Look out below!
Fed reduces AIG's debt by $25 billion
AIG announced Tuesday that it completed a deal wiping out $25 billion of its debt to taxpayers by selling stakes in two subsidiaries to the Federal Reserve Bank of New York.
The troubled insurer gave the New York Fed preferred shares of two of its international life insurance companies, including $16 billion of American International Assurance Co. and $9 billion of American Life Insurance Co. The deal was originally announced in March.
The deal brings the New York-based insurer's debt to the New York Fed down to $17 billion. AIG also still owes the U.S. Treasury $44.8 billion from a separate Troubled Asset Relief Program (TARP) loan, so the insurer still owes taxpayers just under $62 billion. AIG Chief Executive Bob Benmosche said, in a press release, that the debt reduction "sends a clear message to taxpayers: AIG continues to make good on its commitment to pay the American people back." AIG's stock rose more than 4% on the news in morning trading.
"The agreements further the goals of enabling AIG to fully repay the assistance that it has received from U.S. taxpayers and advancing the company's global restructuring process," the New York Fed said in a statement when the deal was first announced in March. The Federal Bank of New York initially provided $85 billion worth of support to AIG in September 2008, when the company was on the brink of collapse. AIG's government rescue plan has since been restructured three times, and its total bailout is now worth up to $182 billion.
But much of that bailout has come in the form of government asset purchases that AIG does not need to repay. In addition to the $25 billion announced on Tuesday, the government in March bought up nearly $40 billion of insurance agreements and mortgage-backed securities held by AIG and its business partners. To pay back the remaining $62 billion it owes the government, AIG will continue to sell off its assets. Despite recording two straight profitable quarters, AIG has said it will not generate enough earnings to repay taxpayers with profits alone. AIG said Tuesday's transaction will force the company to take a hefty $5.7 billion restructuring charge in the current quarter, which will likely wipe out any profits AIG would have registered in the last three months of 2009.
Despite the government support, the company still faces a steep uphill battle to return to health. Shares of the insurer tumbled 15% Monday, after Bernstein Research analyst Todd Bault told investors that he cut the 12-month price target to $12 a share from $20 because the insurer's "loss reserves are significantly deficient again, much sooner than we would have forecast two years ago." On Nov. 25, AIG announced that it had resolved its legal dispute with former chairman Maurice "Hank" Greenberg.
How the United States Inflated the World
After the United States discarded the gold standard, the dollar remained the worlds reserve currency. Trade around the world was still conducted in dollars even though it had depreciated against most currencies. This created havoc. Exporters to the United States received the depreciated dollars for their goods. OPEC (the Organization of Petroleum Exporting Countries), an exporter of oil to the United States, received less value for each gallon of oil exported. (The dollar fell about 50 percent against other currencies during the 1970s. This varied, depending on the foreign currency, and requires many qualifications). Since OPEC could buy fewer goods for each gallon of oil sold, it wanted more dollars for the exchange.
Another example, the trade loop between the United States and Germany, presented a similar problem for Volkswagen. When an American bought a Volkswagen, the dollars wound their way to Volkswagens headquarters in Germany. (This is a hypothetical case, with no knowledge of how Volkswagen operated.) The automobile manufacturer did not want dollars. It shipped them to the German central bank (the Bundesbank). In return, Volkswagen received deutschmarks at the appropriate exchange rate.
Americans were spending much more abroad than at home. Since dollars in circulation in Europe were rising in relation to deutschmarks spent on goods from the United States, cars from abroad cost more: Americans were paying for goods with less valuable dollars. The German government did not want its exporters to suffer. The Bundesbanks dollar-deutschmark transaction with Volkswagen increased the German money supply. This slowed the rise of the deutschmarks value against the dollar, but also increased German domestic inflation. In fact, the excess dollars led to inflation around the world. This flood of dollars led to price inflation in the 1970s. More recently, the flood of dollars has led to asset inflation, including the worldwide housing bubble.
The Federal Reserves Inflation Calculation
Arthur Burns [Chairman of the Federal Reserve 1970-1978 ed.] followed the most expeditious route to tame inflation: changing how the measure was calculated. Stephen Roach was a young economist at the Federal Reserve. After oil prices quadrupled, Arthur Burns instructed his staff to calculate a CPI stripped of energy costs. Burnss rationale was the blazing Yom Kippur War, over which the Fed had no control. Why the Federal Reserves influence should matter in how the rate of consumer price inflation is calculated could be better understood by reading memoirs of the Nixon administration than by studying Arthur Burnss seminal textbook, Measuring Business Cycles.
Roach recalls: Alas, it didnt turn out to be quite that simple. Burns thought the disappearance of anchovies off the Peruvian coast caused food costs to rise. They too were removed from the price index. Next went used cars, childrens toys, jewelry, and housingabout half the costs that consumers absorbed in their daily struggle with rising prices. Today, three decades after the anchovy shortage, without much ado from the economics guild, the media announces the monthly ex-food, ex-energy CPI, produced by the Bureau of Labor Statistics. This gently rising CPIa charade has compounded at a much lower rate than the true costs paid by Americans. This is one reason the collapse in living standards among the lower half remains a mystery to those who trust government press releases and the media that report them.
The science of economics as applied to national statistics was (and is) more a confiscation of the truth than a midwife to it. Incumbent and future politicians, including future Fed chairman Greenspan, introduced and nurtured such hullabaloo as hedonics and the birth-death rate in the highly publicized but little understood calculations of economic growth rates and unemployment numbers. The figures were a disgrace, and so were the parties responsible for their introduction and dissemination. Greenspans turn at the Council of Economic Advisers was to be a screen test for a future role in the charade, a dress rehearsal for his political, acting and dissembling talents, the inestimable qualities needed by a Fed chairman in an economy that was rocketing off its moorings.
In any case, numbers cannot capture inflation, which generally works hand in hand with deterioration.
The Collapse of Finance
by Bill Bonner
“Dubai sends markets into turmoil,” begins The Financial Times. Dubai is a financial center, built on sand. Probably a good thing US markets were closed for Thanksgiving when this news came out. In Europe, the Dubai affair caused the biggest drop in 7 months. European banks have lent $40 billion to Dubai. Jim Chanos, a famous short seller, thinks Dubai is merely the camel’s nose in the tent, so to speak. “China is Dubai times 1,000…if not a million.”
“People are panicking: this whole process counters everything that the rulers have been saying and the way it has been communicated before the holidays is confusing,” said one hedge fund manager. The ‘rulers’ are the fellows who run “Dubai World,” and incidentally Dubai itself. Whether they are fools, knaves or sly geniuses was what everyone wanted to know. Dubai officials announced that they had raised $5 billion on Tuesday. Two hours later they said they weren’t paying interest on it or on any of the rest of the $80 billion in borrowings. What’s going on? Are they really broke? Or are they playing for some kind of advantage?
“Dubai gambles with its financial reputation,” says one headline at the FT. Then, on the facing page, the editors think they know how the gamble will turn out: “A breath-taking blunder in Dubai…Dubai is looking more like Argentina than Singapore – but a lot less predictable,” says the FT editorial. No on is sure what is going on. Most people take from this story what we knew all along: lending to shady characters in sunny places is not an easy way to make money. Especially when the shady characters own the country. Trouble is, shady characters run near all the world’s countries. If an investor cannot trust the ruling family of Dubai, how can he trust the commies who run China? Or the hacks who run the United States of America?
To err is human. For a central banker, it is practically a professional requirement. Count on a major ‘error’ to trigger a sell-off in the world’s bond market. But Dubai’s mistake did not infect all other sovereign debt. German bond yields went down, not up. Investors sought safety from Dubai debt in Deutschland debt. But what is the real meaning of what is going on in Dubai? It’s the story of the collapse of the financial industry. Dubai has no oil…no natural resources…and no real industry. The rulers tried to turn it into a financial center. Entirely financed by debt. And now finance itself is falling apart.
“The camel put his nose in the tent,” says colleague Simone Wapler. “He saw that there was nothing there.”
What will he think when he gets a closer look at Britain’s finances? Britain, too, relies heavily on the financial industry. And Britain, too, is heavily dependent on debt. Its public finances are among the worst in the world. Japan’s public debt, to add another example, is already 200% of GDP. It’s expected to reach 300% in a few years. And yet, Japan – like the US and Britain – just keeps borrowing. How long can this go on? When will Britain, the US, and Japan announce their own moratoria on debt service payments? This bubbly bounce must not have much time left. And it is surrounded by 10,000 pins.
On Friday, US markets reacted to the Dubai news. The Dow lost 154 points. Gold lost $14. Oil slipped to $76. Our crash flag is still flying. But that was not a crash. Just a bad day. And today’s news tells us that other Gulf States are rallying around Dubai, ready to extend a helping hand and lend a buck or two. Oil is rallying on the news. Does that mean this bubbly trend is stronger than we thought? Is this a bubble made of Kevlar? Will it resist other pins? We wouldn’t count on it. When China pops, we’ll see US stocks down a lot more than 154 points. In fact, we expect to see the Dow in 5,000-ish territory when this bounce is over. And when that happens, emerging markets will probably be hit even harder.
Dubai was a “wake up call,” for investors in emerging markets, says The New York Times today. But the pin that pricks recovery hopes won’t necessarily be imported. There are plenty of sharp objects in the homeland too. There is, for example, the growing realization that the recovery is a fraud. “Half a recovery,” says a New York Times columnist, may be all we get. Today, the press will concentrate on analyzing Black Friday sales results. Already, The Wall Street Journal has rendered its verdict: more shoppers; fewer sales.
If the initial reports are correct, the traffic wasn’t bad on Friday. But retail outlets were only able to snag sales by offering discounts. It’s a deflationary world, after all. Shoppers want lower prices to make up for the fact that they have less money to spend. And they’ll get lower prices too. Because this is a de-leveraging cycle. The world has too much debt, too many factories and too many workers…at least for the real, available purchasing power. Prices will go down naturally until excesses are absorbed…dismantled…or converted to other uses.
But wait…there are also unnatural forces at work. Governments are bailing out bungled companies. They’re supplying zombie industries with fresh blood from the taxpayers. They’re standing in the way of the de-leveraging progress. They’re creating “money” out of thin air. It’s this last point that is most explosive. As long as government is just stalling the correction, it doesn’t cause too much distortion or volatility. But when it fiddles with the money…oh la la; that’s where it gets interesting.
Traditionally, people buy gold when they think the monetary authorities are up to something. Throughout the world, investors are getting edgy…they’re wondering how it is possible to add so much cash and credit to the economy without sending prices to the moon. We’ll tell you how it’s possible: there’s a depression. In a depression, the flow of cash and credit coagulates. Even if you increase the cash in bank vaults, it doesn’t circulate into the real economy. Banks don’t lend. People don’t borrow. Consumers don’t consume. It just sits there…waiting for the end of the depression…like a teenager waiting for Friday…
Thirty financial groups on systemic risk list
Thirty global financial institutions make up a list that regulators are earmarking for cross-border supervision exercises, the Financial Times has learnt. The list includes six insurance companies – Axa, Aegon, Allianz, Aviva, Zurich and Swiss Re – which sit alongside 24 banks from the UK, continental Europe, North America and Japan. The list has been drawn up by regulators under the auspices of the Financial Stability Board, in an effort to pre-empt systemic risks from spreading around the world in any future financial crisis.
Insurers are considered systemically important for a variety of reasons: they might, for example, have a large lending arm, such as Aviva, or a complex financial engineering business, akin to that of Swiss Re. AIG of the US, the failed insurance group, was proven to be a vast systemic risk last year, in large part because of its diversification from insurance into complex financial engineering. Raj Singh, chief risk officer of Swiss Re, said: “The real interconnectivity for the insurance industry is more muffled in that there needs to be a dual trigger for there to be any big systemic effects.”
The list, which is not public, contains many of the multinational bank names that would be widely expected.
The exercise follows the establishment of the FSB in the summer and is principally designed to address the issue of systemically important cross-border financial institutions through the setting up of supervisory colleges. These colleges will comprise regulators from the main countries in which a bank or insurer operates and will have the job of better co-ordinating the supervision of cross-border financial groups. As a spin-off from that process, the groups on the list will also be asked to start drawing up so-called living wills – documents outlining how each bank could be wound up in the event of a crisis.
Regulators are keen to see living wills prepared for all systemically important financial groups, but the concept has split the banking world, with the more complex groups arguing that such documents will be almost impossible to draft without knowing the cause of any future crisis. Paul Tucker, deputy governor of the Bank of England, and head of the FSB working group on cross-border crisis management, said recently that the wills – also known as “recovery and resolution” plans – would have to be drawn up over the next six to nine months. National regulators, led by the UK, are known to have begun pilot-testing the living wills exercise with some of the listed banks in the past few weeks.
Supervision spotlight: Banks
Bank of America Merrill Lynch
Royal Bank of Canada
Royal Bank of Scotland
Willem Buiter Will Join Citigroup as Chief Economist
Citigroup Inc. hired Willem Buiter, a former Bank of England official who has criticized the Federal Reserve for being too close to Wall Street, as its chief economist. Buiter, 60, will join the bank in January and fill the position left vacant by Lewis Alexander’s move to the U.S. Treasury eight months ago, New York-based Citigroup said in a statement today. The appointment by the bank, which is 34 percent owned by the U.S. government, puts an academic known for his outspokenness in its most senior economics position.
In 2008, Buiter told the Fed’s annual symposium in Jackson Hole, Wyoming, that it pays an “unhealthy and dangerous” amount of attention to the concerns of the biggest U.S. financial institutions. “As one of the world’s most distinguished macroeconomists, Willem’s deep knowledge of global markets and economies, and emerging markets economies in particular, will be invaluable to our clients,” Hamid Biglari, Vice Chairman of CitiCorp, said in the statement. Buiter, currently a professor of political economy at the London School of Economics, has been unafraid to speak his mind about former or potential future employers.
“In August 2007, several CEOs of major cross-border banks admitted they didn’t know what a CDO was,” Buiter said at the European Banking Congress on Nov. 20 in a discussion on the role of collateralized debt obligations in the financial crisis. “Most members of the Bank of England’s Monetary Policy Committee didn’t either.”
Buiter called Citigroup “a conglomeration of worst- practice from the across the financial spectrum,” in an April posting on his blog, posted on the Web site of the Financial Times. In June, he wrote in the blog that the appointment of former Citigroup Chairman Winfried “Win” Bischoff to help oversee a report on the future of U.K. international financial services was “the most ridiculous appointment since Caligula appointed his favorite horse a consul.”
Buiter was one of the founding members of the U.K. central bank’s rate-setting panel when he joined in June 1997. In March 1999, he voted for a 0.4-point interest-rate cut, the only attempt in the MPC’s history for a move that wasn’t in a quarter-point multiple. In 2008, Buiter turned his fire on his hosts when the Fed invited him to its annual retreat in the Teton Mountains. “The Fed listens to Wall Street and believes what it hears,” Buiter told an audience of central bank officials from the Fed and around the world. “This distortion into a partial and often highly distorted perception of reality is unhealthy and dangerous.” Fed Governor Frederic Mishkin said at the same event that Buiter’s paper fired “a lot of unguided missiles,” and former Vice Chairman Alan Blinder “respectfully disagreed” with his analysis of the central bank’s crisis management.
Buiter has been a consultant to Goldman Sachs Group Inc. since 2005, according to today’s statement. He has a bachelor’s degree from Cambridge University and a doctorate from Yale University. Questioned on Bloomberg Television today about government- controlled Dubai World’s request for a standstill agreement with creditors, Buiter said that they shouldn’t expect a full state- backed rescue. “This is a business that’s fallen on hard times and its creditors and bondholders simply have to take their lumps and not expect a sovereign bailout,” he said. Buiter was chief economist for the European Bank for Reconstruction and Development from 2000 to 2005. He has been an adviser to the International Monetary Fund, the World Bank and the Inter-American Development Bank, according to the statement.
Alexander, who had worked at Citigroup since 1999, left in March to become a counselor on domestic finance issues to Treasury Secretary Timothy Geithner. He was paid $2.4 million by Citigroup in 2008 and the first months of 2009, according to his financial-disclosure form filed with the Treasury. In December 2007, he predicted the U.S. would probably avoid a recession. Buiter is married to Anne Sibert, an economics academic who was appointed as a member of Central Bank of Iceland’s five- member Monetary Policy Committee earlier this year, according to a Web log posting on his site.
British households repay record amount of debt in October
British consumers repaid the highest amount of unsecured credit on record in October, reducing their debt at twice the rate economists had expected. Net consumer credit fell for the fourth straight month in October, dropping by £579m in October after a £299m decline the month before, Bank of England data showed on Monday. That was the biggest fall since records began in April 1993 and compared with analysts' expectations of a £200m fall. After a decade of easy credit and rising personal debt levels, Britons are paying the price of their borrowing binge as they suffer the longest recession in over 50 years.
Net mortgage lending, however, continued to rise, increasing by £922m. That was roughly in line with expectations and follows a similar £898m increase in September but is a tiny fraction of the volumes in the boom years up to mid-2007. Mortgage approvals also rose in line with expectations to 57,345 in October after a 56,205 rise the previous month. That was the highest since March 2008, but is well below average levels of around 85,000 a month during the years of rapid house price rises. "Approvals continued to inch higher, suggesting there is some improvement in underlying activity, but levels remain very depressed," said David Page, economist at Investec.
Broad money supply, M4, rose by 1.6pc in October, the biggest monthly increase since January. But the Bank of England's preferred measure, M4 excluding intermediate other financial corporations, dropped by 0.7pc on the month and by 5.3pc on three-monthly annualised rate. That will cast further doubt on the effectiveness of the central bank's £200bn quantitative easing policy, which many had expected to raise money holdings outside the financial sector and thereby stimulate economic growth. "The underlying position looks weak," said Ross Walker, economist at Royal Bank of Scotland. "There's not much evidence that QE is boosting those real economy money and credit aggregates. If it is working, it's through financial sector channels rather than through households and non-financial companies." BoE policymakers have argued that the policy of buying assets - mostly gilts - with newly created money is working well in that it has raised the price of those assets and brought down borrowing costs for large companies.
Merkel Faces Rebellion Over Planned Tax Cuts
Chancellor Angela Merkel's center-right coalition is already beset by internal disputes and controversy after just four weeks in office. Now she faces a rebellion by conservative state governors, who say the new government's plans for tax cuts worth 8.5 billion euros are irresponsible. Chancellor Angela Merkel's center-right coalition of conservative Christian Democrats and the pro-business Free Democratic Party (FDP) became embroiled in a potentially damaging dispute over tax cuts over the weekend as several conservative state governors voiced opposition to measures to cut taxes by €8.5 billion ($12.8 billion) on Jan. 1.
The governors of five states controlled by Merkel's Christian Democratic Union (CDU) threatened to vote against tax cuts in the Bundesrat upper house of parliament in December because they believe the resulting shortfalls in revenues will put an excessive burden on their state finances. Merkel has warned the governors that she will not compensate them for the tax cuts. The Free Democrats in particular are adamant that the tax cuts must go ahead to stimulate economic growth. The CDU governor of Schleswig-Holstein, Peter Harry Carstensen, has threatened to resign over the dispute, German newspapers reported at the weekend. Without his state's support in the Bundesrat, Merkel's tax relief plans will not pass.
CDU governors in Thuringia, Saarland, Saxony-Anhalt, Baden-Wuerttemberg and Saxony also voiced opposition to the plan, saying it was irresponsible to cut taxes at a time of deficits. "We can't cope with the tax cuts," Thuringia's CDU governor Christine Lieberknecht told the television station ZDF. "We can't vote for it. It wouldn't be responsible for our state and the budget." Andreas Pinkwart of the FDP, the deputy governor of Germany's most populous state, North Rhine-Westphalia, said the tax cuts were urgently needed to help small and medium-sized businesses. "Anyone who delays or criticizes them is threatening jobs," Pinkwart told Rheinische Post newspaper. "The delicate flower of recovery must now be strengthened. This requires brave and determined action."
Volker Kauder, the head of the CDU's parliamentary group, urged the states to back the tax cuts. "We've got to be sensible. We've got to give this coalition a successful start," Kauder told ZDF television on Sunday. The rebellion by state governors comes at a bad time for Merkel. Just one month into her second term, she had to reshuffle her cabinet on Friday when Labor Minister Franz Josef Jung resigned over charges that he covered up details of an air strike that killed Afghan civilians when he was defense minister. Merkel agreed the tax cuts with her FDP partners in coalition negotiations after the Sept. 27 election even though government debt has soared as a result of the economic crisis. Several politicians have warned that failure to implement the tax cuts would damage the government.
Pyongyang Revalues Won, Spurs Chaos
North Korea revalued its currency for the first time in 50 years and strictly limited how much old money could be traded for new, moves that appear designed to confiscate much of the cash people earned in market activities the country's authoritarian government doesn't like. The action triggered chaos, according to news outlets in South Korea that specialize in obtaining information from the North, as people rushed to banks and offices of the ruling Workers Party to get information, make exchanges or trade existing North Korean won for euros and U.S. dollars.
The revaluation was announced Monday over a cable-broadcast system that can't be monitored outside the country. North Korea issued new notes with an exchange value of 100 to 1 -- an old 1,000 won bill, for example, becoming a new 10-won note -- and said people could make exchanges from Tuesday to Saturday. The revaluation was confirmed Tuesday by China's state-run news agency, Xinhua, which has an office in North Korean's capital, Pyongyang. Xinhua quoted one store clerk as saying that state-run stores in the city are closed this week so employees can reprice goods.
It is the latest and most sweeping step by the North Korean regime to rein in an unofficial economy that has grown in recent years and is perceived to threaten the grip of dictator Kim Jong Il, the government and the Workers Party. For more than a year, reports from aid groups and media outlets that specialize in North Korea have described crackdowns on markets that operate unofficially but became the center of economic activity when the state-run distribution system broke down after a famine a decade ago. According to the reports, authorities have forced women, who more often than men are found selling goods in markets, into work at state-run factories and farms. In June, they closed the country's largest unofficial market, Pyongsong, where about 30,000 small businesses were believed to be selling food and goods in a suburb of Pyongyang.
The move will have little economic impact outside the country since the North Korea won isn't used for trade and isn't recognized for exchange by any country, even China, its chief trading partner and political benefactor. Merchants in the Chinese city of Dandong, the most active border crossing with North Korea, said Tuesday that North Korean trading partners had told them about the revaluation but that they didn't know the details. Trade on the China-North Korean border is mainly conducted in U.S. dollars and euros, so the Chinese traders said they weren't expecting much impact on their business.
Inside North Korea, the economic impact of the revaluation is difficult to gauge since there has been no official data about the size of the North Korean economy or its banking system since the 1960s. Until now, the won has traded officially at 135 per U.S. dollar. But defectors say that in North Korean border cities, where foreign currency is most necessary, the won has generally traded at about 2,000 to 3,000 per U.S. dollar. A typical North Korean earned about 5,000 won a day, aid workers and defectors say.
Initial reports indicated the government would allow only 100,000 old won to be exchanged for new. That would potentially wipe out the holdings of people who have earned and saved in won from market activities for years. Those who have saved in foreign currencies -- which, though not illegal, is difficult for ordinary North Koreans -- would appear unaffected. According to an account by NKNet, a Seoul-based Web service focused on North Korea, people in Pyongyang on Monday night pressed party officials to allow more money to be exchanged. In response, according to the report, the officials lifted the exchangeable amount to 150,000 won in cash and 300,000 won in savings accounts. North Korea last issued new currency in 1992 but hasn't revalued currency since 1959.
Martin Armstrong – WE WON!
Can you believe it? In the face of overwhelming pressure from YOU, the Department of Prisons backed down and agreed to keep Martin where he is! My understanding is that they just want to make the calling STOP!
Thank you to everyone who did, you may have just saved him from a terrible fate. I hope everyone realizes how RARE this event is. The Prison system is used to working in SECRET and they do stuff like this all the time according to my sources. Well, we shined a spot light on them and as soon as we did, they were forced to back down. This is a great example of the power that people possess and they don’t even know they possess it. It is, quite unfortunately, going to be very important that we use this power in the future again, and I’m sure that the next fight won’t be as easily won. That’s because the abuse in our prison system is a SYMPTOM of a much larger problem, that problem is rooted in our economy, in our money system, and in our failure to follow the rule of law.
Now then, we are still using the attorney to file a protective order for Martin, as we want to hold them to their word. The prisons are notorious for providing RETRIBUTION against prisoners who make waves – we must ensure that does not happen!
Also, there are other battles still to be fought! On the bigger issue of Martin being there to begin with, there is a law that prohibits courts from not honoring time served when they are sentenced. The judge in Martin’s case did not give credit for his time served while he was held in contempt of court as he made up his own exclusion to the rule… that exclusion does not exist in the law and the law says that the judge SHALL honor all forms of time served (shall is a mandatory word, I have a copy of the law coming). Then there’s the battle for punishment that is CRUEL and UNUSUAL. How come, three years after being beaten nearly to death, does he not have his teeth fixed?
And so, we may need your help again to get them to do what’s right. In the meantime, we can deservedly celebrate a clear VICTORY in keeping him safe for now! THANK YOU!