FedUpUSA

Archive for August, 2010

The Federal Reserve’s decision to expand its quantitative easing by purchasing more Treasuries is a dangerous one, says Keith McCullough, CEO of research firm Hedgeye.

“That could lead the country to the brink of collapse,” he wrote in a Fortune magazine column.

McCullough agrees with economists Carmen Reinhart and Ken Rogoff, who recently wrote that government debt in excess of 90 percent of GDP pulls down economic growth.

“It’s a point from which it’s almost impossible to return,” McCullough wrote.

Government debt will reach 62 percent of GDP by Sept. 30, the Congressional Budget Office predicts.

“On July 2nd, we cut both our third quarter 2010 and full year 2011 GDP estimates for the U.S. to 1.7 percent,” McCullough says.

“Now, even our estimate for 2011 is still too high. There will be a downward bias to our U.S. growth estimates as long as debt-financed-deficit-spending continues to be the solution politicians and central bankers turn to as a fix to our financial crisis.”

Others have been critical of the Fed’s latest easing move too, comparing it to the Bank of Japan’s futile fight against deflation in 2001-06.

“I don’t think anyone in the market is fooled” by the distinction between Fed policy now and BOJ policy then, Stephen Stanley, a former Fed researcher who is now chief economist at Pierpont Securities, told Bloomberg.

“That is a problem, both substantively and also from a perception standpoint.”

Money News

A little over a week ago, U.S. Treasury Secretary Timothy Geithner penned an article for the New York Times entitled “Welcome To The Recovery” in which he touted the great strides that the U.S. economy was making.  But with unemployment still dangerously high and with foreclosures and personal bankruptcies continuing to set all-time records, should we really be talking about a “recovery”?  The truth is that the numbers don’t lie, and statistic after statistic shows that the economic fundamentals continue to get progressively worse.  The U.S. government can continue to try to pump up with economy with more debt, but the reality is that there is not going to be a legitimate “recovery” until consumer spending rebounds.  Consumer spending makes up the vast majority of U.S. GDP.  But without good jobs, consumers are not going to be able to spend money.  Unfortunately, our jobs base continues to be erode as millions upon millions of middle class jobs are shipped over to China, India and dozens of third world nations by the global predator corporations that now dominate the world economy.

The U.S. government cannot create real wealth out of thin air.  It can borrow even more money and flood the economy with even more paper currency, but the short-term “buzz” that creates does absolutely nothing to solve our long-term economic problems.

It is the private sector that actually creates wealth.  But unfortunately, over the last several decades we have allowed that wealth to become highly concentrated.  Now the giant global predator corporations have decided that American workers aren’t really that desirable after all.  They are slowly taking away their factories and their offices and they are moving them to where people are willing to work for one-tenth the pay. 

So where does that leave middle class American “consumers”?

Well, it leaves us in a world of hurt.

The following are 15 key economic statistics that just keep getting worse and which reveal the horrific economic plight in which we now find ourselves…. 

1 – The number of Americans who are receiving food stamps rose to a new all-time record of 40.8 million in May.  The number of Americans receiving food stamps has set a new all-time record for 18 months in a row.  But there is every indication that things are going to get even worse.  The U.S. Department of Agriculture projects that the number of Americans on food stamps will increase to 43 million in 2011. 

2 – The U.S. economy lost 131,000 more jobs during the month of July.  But the truth is that the U.S. economy has been bleeding jobs for a long time.  According to one analysis, the United States has lost 10.5 million jobs since 2007.  Meanwhile, immigrants (both legal and illegal) continue to pour into this nation in unprecedented numbers.

3 – Americans who are out of work are finding it incredibly difficult to get back into the workforce.  In the United States today, the average time needed to find a job has risen to an all-time record of 35.2 weeks.

4 – The U.S. government keeps trying to pump up the economy with debt, and in the process things are getting wildly out of control.  According to a U.S. Treasury Department report to Congress, the U.S. national debt will top $13.6 trillion this year and climb to an estimated $19.6 trillion by 2015.

5 – The interest on all of this debt is becoming increasingly oppressive.  As of July 1st, the U.S. government had spent $355 billion so far in 2010 on interest payments to the holders of the national debt.  The total for 2010 should be somewhere in the neighborhood of $700 billion.  According to Erskine Bowles, one of the heads of Barack Obama’s national debt commission, the U.S. government will be spending $2 trillion just on interest on the national debt by 2020.  Keep in mind that the entire U.S. government budget is less than $4 trillion for the entire year of 2010.

6 – If the U.S. government was forced to use GAAP accounting principles (like all publicly-traded corporations must), the annual U.S. government budget deficit would be somewhere in the neighborhood of $4 trillion to $5 trillion.

7 – Social Security will pay out more in benefits in 2010 than it receives in payroll taxes.  This was not supposed to happen until at least 2015.  In the years ahead, these new “Social Security deficits” are projected to be absolutely catastrophic. 

8 – There are simply far too many retirees and not nearly enough workers to support them.  Back in 1950 each retiree’s Social Security benefit was paid for by 16 workers.  Today, each retiree’s Social Security benefit is paid for by approximately 3.3 workers.  By 2025 it is projected that there will be approximately two workers for each retiree.

9 – Wealth continues to become highly concentrated at the top.  Since 1973, the average CEO’s salary has increased from 26 times the median income to over 300 times the median income.

10 – According to a poll taken in 2009, 61 percent of Americans ”always or usually” live paycheck to paycheck.  That was up significantly from 49 percent in 2008 and 43 percent in 2007.

11 – The Mortgage Bankers Association recently announced that more than 10% of all U.S. homeowners with a mortgage had missed at least one mortgage payment during the January to March time period.  That was a new all-time record and represented an increase from 9.1 percent a year ago.

12 – A recent survey of last year’s college graduates found that 80 percent moved right back home with their parents after graduation.  That was up substantially from 63 percent in 2006.

13 – During the first quarter of 2010, the total number of loans that are at least three months past due in the United States increased for the 16th consecutive quarter.

14 – The total number of U.S. bank failures passed the 100 mark in July of this year.  In 2009, the total number of U.S. bank failures did not pass the century barrier until October.

15 – The U.S. dollar continues to rapidly decline in value.  An item that cost $20.00 in 1970 would cost you $112.35 today.  An item that cost $20.00 in 1913 would cost you $440.33 today.

Any rational observer (and clearly U.S. Treasury Secretary Timothy Geithner does not qualify) can see that the foundations of the U.S. economy are coming apart.  The rapidly accumulating mountain of debt that has fueled our “prosperity” is impossible to repay and is going to progressively choke the life out of our economic system.  The good jobs that we have allowed to be shipped out of our country are never coming back.  Every single day, more wealth flows out of this country than flows into it.

Anyone who claims that things are getting “better” is either ignorant, completely deluded or is purposely lying. 

The U.S. economy is not getting “better”.

The U.S. economy is dying.

You should adjust your plans accordingly.

The Economic Collapse

The economic profession and bankers on Wall Street have taken a hit to their credibility with missing the biggest recession since the Great Depression.  It is understandable for the average person on the street to miss something as nuanced as a tiny recession but for a group of professionals whose mission statement involves understanding the economy and then to miss the biggest economic headwinds in a century is just inexcusable. This is no tiny recession.  We have witnessed the unfortunate destruction of trillions of dollars and untold damage to the American working and middle class.  Yet we are told from these same professionals that we are in a recovery.  There is plenty of room to remain skeptical about this group.

If we look at the wealth destruction of U.S. households it becomes obvious why there is little feeling of recovery going around:

Source:  Fed Flow of Funds report

To clarify the chart, we are looking at the peak value of all household assets without liabilities in 2007.  At this point, all assets were valued at $65.86 trillion.  Today, the market value is closer to $54.56 trillion.  So if Americans feel poorer they should because we are $11.3 trillion away from the peak reached three years ago. This is an incredible amount of wealth destruction.  This is why working and middle class families have been pushed off the financial ledge and are facing some of the toughest times in generations.

The too big to fail banks have benefitted from this economic calamity by solidifying their financial prowess by co-opting the government and providing generous handouts to their lot.  An incredible amount of money flowed into the banking sector and it breaks down as follows:

Source:  It Takes a Pillage

The Federal Reserve has put the most money in play here yet this is one of the least understood institutions in America.  If they handed out the largest amount of money, then why do we so rarely hear about them in the mainstream media?  It is a good question but speaks more to the fact that banks have bought out plenty of players in key industries to carry their message.  The working and middle class were largely taken for a ride.  Of course, some money was thrown down to the public but it looks like this in comparison:

Source:  It Takes a Pillage

And then you wonder how it is feasible for some banks to charge Americans 79.99 percent interest rates on credit cards.  It almost begs for laws to outlaw usury.  Yet the current government apparatus seems to be ineffectual at controlling the Wall Street machine.  The recovery seems to be trickling down to a few hands but the vast majority of Americans are starting to wonder what is going on with this un-recovery.  It is a chapter from 1984 where many are asking each other if things are truly better since the mainstream media and government say it is so.  Clearly it is not and $11 trillion in destroyed wealth is going to put us into a very serious recession.  Sure the bailout amount nearly equals the amount of household wealth destroyed but somehow this money is filtering its way back to the top 1 percent of the country.

I’ve talked about the large number of bank failures that will total at least 1,000 when all is said and done.  Back in early 2009 we saw the emerging trend of a consolidation of power in the banking sector:

Source: FDIC

Today there are 7,932 institutions as of the first quarter in 2010.  These institutions hold over $13 trillion in total assets.  A large portion of this is shaky commercial and industrial real estate loans.

The number of institutions officially in trouble keeps growing:

Source:  FDIC

You have to wonder what people are looking at when they think we are in a recovery.  Is it the 40 million Americans now receiving food stamps?  Is it the nearly 15 million Americans with no work?  The only group that seems to be recovering is the banking sector but that isn’t news.  Welcome to the un-recovery.

My Budget360

Let’s talk about the economy – and the lack of jobs.

In the week ending July 31, the advance figure for seasonally adjusted initial claims was 479,000, an increase of 19,000 from the previous week’s revised figure of 460,000. The 4-week moving average was 458,500, an increase of 5,250 from the previous week’s revised average of 453,250.

Uh huh.  Note that the previous week was revised (again), but even so, the claims number is creeping ever-closer to the 500,000 level that marks “depressed”, and further and further away from the 300,000 level that marks “reasonably decent conditions.”

Why?

I’ll tell you why.

We have refused to address of the structural problems in the economy.  We have instead allowed our elected idiots to paper over those problems, and they have done so.

So Wall Street had a nice rally off the 666 lows to just over 1200.  A rally that is dissipating and sell-offs are now coming with increasing frequency and violence.

Just as they did in the early part of, and the summer of, 2008.

Everyone wants The Fed to come save the day.  It can’t.

Policy rates are at zero.

“Quantitative easing” doesn’t solve anything, as all you’re doing is debasing the currency, which in turn makes everything more expensive (or depresses wages – same outcome) and that in turn means that purchasing power decreases, which means that forward economic activity decreases as well.

It is exactly identical to giving a speed freak more meth.  Each dose produces not improvement, but pain avoidance.  But the cost of each dose is that the addict’s teeth become more rotted and their eyes more sunken.  The systemic damage accumulates with each bout of abuse.

While the addict seems to feel somewhat better for a short while with each dose he takes, he is in fact being systemically poisoned.  Eventually, bereft of teeth and with his body deprived of the ability to process nutrition, the addict will die irrespective of how much more drug he or she consumes.

The only solution for an addict caught in this spiral is to stop and take the pain of detoxification.  The pain is considerable – even excruciating.   Indeed, it feels even worse when the drug is stopped than it did in the depths of hell to which addiction had taken the sufferer.

Yet it is the only path out.

Such it is with the economy.

Barack Obama and Congress simply do not get it.  They think they, along with The Fed, can “prime the pump” with “stimulus”, just as the meth-head thinks he can “stimulate” recovery with “just one more hit.”

He’s wrong, as is Congress, Barack and The Fed.

The excess capacity in the economy cannot be sustained.  It simply doesn’t matter whether policymakers like this or not.  An economy that can only run at its former rate when mainlining speedballs cannot continue to operate in this fashion without killing the host.  Detoxification and a slowing of the economic metabolism to sustainable levels is the only way you survive.

Along the path to perdition we allowed a tapeworm to take up residence in the bowels of our economy: “financial innovation”.  It was not that long ago – indeed, within my lifetime and experience – during which bankers earned $50,000 a year and bank stocks returned 7% dividends – and no capital appreciation at all.  Banks made loans and held them to maturity, consuming the ~2% spread they needed to survive and paying out the entirety of the rest of it to shareholders in the form of dividends.  They were stodgy, old-school businesses that performed a vital intermediation function – and consumed ~5% of the economy in doing so.

Now financial innovation has gone from 5% of the economy to 20%.  But as the tapeworm grows larger, it consumes more and more of the fuel that the body takes in.  Soon the tapeworm not only consumes enough of the fuel to cause you to starve even though you’re eating like a horse, it in addition gets so large that it blocks the intestines – and can produce life-threatening stoppages and infections.

There is no way to reason with such a tapeworm.  It, like all organisms, will seek to survive, grow and reproduce – and it doesn’t care if you like it or not.  Your only choices are to kill it – or, if you don’t – die.

We as a nation must eradicate the tapeworm.  We must relegate the financial system to its former status as an intermediator – the old stodgy bank – and dismantle the complex and intertwined institutions that are sucking the economy dry.  We have refused for two decades to do this, believing in the Alan Greedscam and Turbo Tax Timmy mantra that a strong and diverse financial system is inherently necessary to a strong economy.

These statements are lies.  That they’re lies is trivially proved: financial innovation in all of its forms is inherently parasitic – that is, it produces nothing in the economy.  In it’s role of distributing risk it inherently must siphon off some portion of actual production to itself.

That means that the productive portions of the economy must produce more to feed the beast within.  But the beast inexorably grows – it reached 25% of the “earnings” in the S&P during the bubble years.

But that 25% wasn’t the bank’s earning power – it belonged to other actors in the economy and was stolen from them as a form of “tax”, just as the tapeworm steals your nutrition.

This in turn goaded CEOs to take on more and more leverage so they could “make their numbers” with that inherent 25% siphoned off.  And that, in turn, resulted in the market and economy as a whole levering to unsustainable levels.

Our error in 2007 and 2008, as I have repeatedly said, is that we refused to force these firms to face the music for their actions.  Actions that, in many cases, were outright fraudulent – and where they weren’t, they were unsound and unsustainable.

New York City has grown addicted to the tax and business revenue from these firms, but that doesn’t mean the rest of the nation can sustain New York City, any more than the rest of the nation can sustain California’s insistence on giving sanctuary to the 4% of our population that are illegal immigrants – who give birth to 8% of our babies, and who pay 0% of their hospital bills.

This is the result:

We’ve blown 14% of GDP in new debt to maintain the tapeworm, attempting to mainline speedballs into the arm of the economy.  It’s not working.  The reason is that the tapeworm is consuming nutrition faster than the economy can take it in, and as a consequence we are now in economic death spiral, exactly as I noted in 2007.

One way or another that parasite will be removed.  We either do it ourselves and suffer the pain required to heal or the market will do it for us with horrific and destructive results.

Those are the only two options folks.

The Fed cannot fix this.  Nor can Congress so long as the debate is focused on taxes.  We are running structural deficits of fourteen percent of GDP – nearly half of the federal budget is being borrowed.  This is akin to someone who is bringing home $2,500 a week but spending $3,800 – there is no reasonable way to increase one’s earnings by that amount – they must instead stop spending or they will go bankrupt. 

I know that the government at all levels has made promises to people.  We don’t have the money.  It doesn’t matter if we want to keep the promises or not when we are physically unable to do so, and the tapeworm is continuing to eat more and more of the nutrition that flows past it.

The last speedball served to the Stock and Credit markets is about out of juice and we are headed for a future with a ticker on the market that looks like the masthead on The Ticker if we don’t cut this crap out – NOW.

Time’s up folks.

The Market-Ticker

The zero interest rate policy (ZIRP) will kill the banks. Falling interest rates help banks by increasing the value of their bond and loan portfolios. This is the well understood inverse relationship between discount rate and present value of a future sum. But you see keeping interest rates at zero does virtually nothing for the banks as rates cannot fall further. There is a short window where ZIRP is a positive but an “extended period” (in Fedspeak) is just slow death for the banks.

During that short period, the banks are still collecting on portfolios constructed when rates were higher but as those higher-yielding assets mature, there is nothing comparable to replace them. We hear constantly how banks can just borrow at zero and invest in Treasuries – pocketing the difference. That would be fine if yields on Treasury debt were not low and falling along with everything else. The other problem is that this simplistic formula assumes that banks’ operating expenses are negligible. Both unstated assumptions fail any sort of reality check.

Back in the real world, T-bills yield virtually nothing. The 2-year note is now at 50 basis points as of today. The 5-year is at 1.43% and the 10-year at 2.68%. Assuming zero borrowing cost (which is overly generous), net interest is equal to gross interest. Large banks generally require a net interest spread of more than 2% to cover their expenses, so they will lose money even buying 5-year Treasuries. If they invest their entire portfolio in 10-year notes, they’ll make about a 50 basis point spread on assets pre-tax. But the 10 years is a lot of risk in terms of time for rates to change and also a long time to tie up the money. And banks care BARELY eke out a profit by taking this extreme level of maturity risk. There is a reason why you never see loan portfolios with 10 year average maturities.

For those advocates who think banks can rebuild their balance sheets by buying Treasuries, you might ultimately be correct but there are so many things that can go wrong with that scenario. First consider the size of the hole in bank balance sheets. Recent activity at the FDIC suggests that many troubled banks are overstating the value of their assets by 30% or more – that is the average size of the hit when the FDIC takes them over. At a rebuild rate of 50 basis points annually (with a lot of risk) it would take a literal lifetime to repair the balance sheets via this strategy. It was much easier in the early 1990s when rates for the 10-year started at 9% and never went below 5.5%. There was plenty of room to generate capital gains on bank bond portfolios wit falling rates and still leave a reasonable current yield at the end. Anybody using that era as a template for bank recovery is going to be sorely disappointed. Does anybody still wonder why Japan is trapped despite 20 years of ZIRP?

All of this assumes that ZIRP is sustainable over decades and that the financial system is sufficiently stable to endure the pressure over the long term. Neither one is proven and the ability to fund the debt implied by ZIRP is particularly shaky. If it works, it will take 60 years As one one of our favorite bloggers Karl Denninger says “the math is never wrong.”

JengaFinance