Where do you get your news? CNN? MSNBC? CNBC? FoxNews? The major networks?
There's a problem if you answered "yes" to any of the above. Of course, we all know what the problem is. MSNBC might as well be called "The Obama Channel," and Fox could be called "The McCain Channel." CNN and the networks fall closer to the MSNBC side of the aisle. The point is, they're all biased.
Watch them all, like I do, and you wind up with the distortions, half-truths and outright lies of both sides, but still no facts. It's entertaining, but not very informative.
Let's talk specifically about the fail-out, as I now like to call it.
If you watched those outlets listed above, you thought it was bound to pass. Paulson, Pelosi, Dodd, Frank, and their ilk made sure they got all the face time with the press, and the media basically ignored the opponents, who were seen as being on the fringe.
Early on, nobody was talking about the ten-to-one constituent opposition to the bailout. They just buried it. (I found out from a Wall Street dealer e-mail that went out to client firms.)
If you wanted to know what was really being said, you could tune in to C-SPAN at ten o'clock at night, when a brave few stalwart lawmakers were fighting the good fight in a near-empty chamber.
But most of us won't watch C-SPAN. We don't want the full context, live, we want the sound bites, spun. So we tune into CNBC or Fox or MSNBC and they tell us what they want us to believe.
I'm going to single out CNBC now, because they report market news, and because I have the most experience with them.
For one thing, I watch them throughout the day, because, like most brokerage firms, my firm has a live CNBC satellite feed to our trading desk.
For another, I know how they get their "experts" and "panelists."
When you see that trader from UBS talking about stocks, or that analyst from Citigroup talking about futures, you might be wondering, "How does a guy like that get picked from among the thousands of traders and analysts out there? Wow - he must be really smart."
I'll tell you how he gets picked: advertising dollars.
UBS and Citi are big advertisers on CNBC. But I'll get back to that later. First, I need to provide proof for my bold claim.
I have personally been invited to appear on several CNBC shows, including Larry Kudlow's. (As an aside, did you know that Larry used to be Bear Stearns' chief economist back in the late '80s and early '90s? Then he started missing meetings with important Bear clients. Turned out he had a nasty little coke habit. Just thought you'd want to "bear" that in mind.)
When I got the first call inviting me on, I was flattered. I could barely contain my enthusiasm when I said, "Sure!"
"Great," I was told. "The minimum package is $15,000, and for that you get ..." Now, this was $15,000 back in about 1999 or so, when I got my first invite. I can only imagine what the price tag is now - I don't know, because I no longer take their calls. I know the drill.
Okay, so why wouldn't I spend the money for that opportunity for my business? And why does UBS?
Simple. My clients generally don't watch CNBC, and my firm doesn't profit from the market conditions that a UBS profits from.
Generally speaking, investment firms make money when people are investing. Remember the dot-com bubble? The day-trading how-to's? Everybody and his brother tuned into CNBC. But during a bear market, we watch other stuff - something that'll cheer us up.
And banks make money when people and companies are borrowing. During a recession, that's not happening.
That's why bank and Wall Street economists are always over-optimistic. And that's why CNBC commentators like the marginally attractive but sadly vapid Erin Burnett look for the silver lining in every cloud.
Oh, a big name can get on CNBC for free. Alan Greenspan, Warren Buffett, Jim Rogers, Mark Cuban - those people are courted constantly by CNBC. But to pick an analyst or a trader to provide today's infomercial - er, insights - they contact investment firms, offer their package, and get a list of names, corresponding to the market or area of the economy in which those individuals have expertise. And they offer them air-time based on the ante.
So now you know how it works. Free speech meets free enterprise. As Russian comic Yakov Smirnoff says, "America - what a country!"
Wednesday, October 22, 2008
The Scarlet Letter
I wrote my Representative and Senators before the votes on the bailout. My Senators both voted against it, but my Representative voted for it.
He sent me an e-mail reply today, explaining why he voted for it with the standard "sure the people don't like it, but we're smarter than the people and had to save them from themselves" gambit.
He should wear that letter like a badge of shame.
He even cited the fact that Warren Buffett was for it, which was purely self-serving on Buffett's part, just like his recent attempt to jawbone the stock market higher after he bought into GE and Goldman. He quoted Buffett as saying he'd rather be "approximately right" than "precisely wrong," saying that to do nothing would have been "precisely wrong."
And, incredibly, he tried to explain derivatives to me - me, a guy who cut his teeth evaluating risk-controlled arbitrage strategies by thrifts, traded futures, and valued and managed mortgage and interest rate derivatives including captions, swaptions, and residuals.
So, in case anyone's interested, here's my response to him:
"Dear Congressman Moore,
I appreciate your response. However, I fear that in this instance, both you and Mr. Buffett - who, as a professional investor, stands to profit mightily from the stance he's taking, regarding the bailout and his euphoric urging of Americans to buy stocks - are both precisely wrong. (Regarding the stock market, I believe today provided ample evidence of that.)
I am an economist who has been accurately forecasting the current economic crisis for at least 18 months now, and foresaw the perils of excess government intervention in the markets as early as 2001, after the Greenspan-inflated dot-com bubble burst. I have also actively traded and managed many of the complex derivatives you attempt to explain. As such, I am all too aware of the causes for this crisis, which has roots as far back as the New Deal. In fact, most of the causes are legislative in nature - DIDMCA, the Tax Reform Act of 1986, etc. I do not accept your partisan view of the causal factors - your Democratic colleagues, notably Messrs. Frank, Dodd and Schumer, are at least equally complicit in the current state of the US economy. Rep. Frank, in particular, stated in 2004: "I'm willing to roll the dice when it comes to subsidized housing." Given that he - and you - are standing at the craps table with taxpayer money, that attitude is dereliction of duty bordering on the criminal.
Now is not a time for partisan finger-pointing, it is a time for realistic solutions, which you and your colleagues have failed yet again to provide. Rest assured that you will never have my vote as long as I live, because I and my fellow taxpayers will be paying for your reckless, uninformed and irresponsible decision-making for at least that long.
Sincerely,
Brian Hague"
He sent me an e-mail reply today, explaining why he voted for it with the standard "sure the people don't like it, but we're smarter than the people and had to save them from themselves" gambit.
He should wear that letter like a badge of shame.
He even cited the fact that Warren Buffett was for it, which was purely self-serving on Buffett's part, just like his recent attempt to jawbone the stock market higher after he bought into GE and Goldman. He quoted Buffett as saying he'd rather be "approximately right" than "precisely wrong," saying that to do nothing would have been "precisely wrong."
And, incredibly, he tried to explain derivatives to me - me, a guy who cut his teeth evaluating risk-controlled arbitrage strategies by thrifts, traded futures, and valued and managed mortgage and interest rate derivatives including captions, swaptions, and residuals.
So, in case anyone's interested, here's my response to him:
"Dear Congressman Moore,
I appreciate your response. However, I fear that in this instance, both you and Mr. Buffett - who, as a professional investor, stands to profit mightily from the stance he's taking, regarding the bailout and his euphoric urging of Americans to buy stocks - are both precisely wrong. (Regarding the stock market, I believe today provided ample evidence of that.)
I am an economist who has been accurately forecasting the current economic crisis for at least 18 months now, and foresaw the perils of excess government intervention in the markets as early as 2001, after the Greenspan-inflated dot-com bubble burst. I have also actively traded and managed many of the complex derivatives you attempt to explain. As such, I am all too aware of the causes for this crisis, which has roots as far back as the New Deal. In fact, most of the causes are legislative in nature - DIDMCA, the Tax Reform Act of 1986, etc. I do not accept your partisan view of the causal factors - your Democratic colleagues, notably Messrs. Frank, Dodd and Schumer, are at least equally complicit in the current state of the US economy. Rep. Frank, in particular, stated in 2004: "I'm willing to roll the dice when it comes to subsidized housing." Given that he - and you - are standing at the craps table with taxpayer money, that attitude is dereliction of duty bordering on the criminal.
Now is not a time for partisan finger-pointing, it is a time for realistic solutions, which you and your colleagues have failed yet again to provide. Rest assured that you will never have my vote as long as I live, because I and my fellow taxpayers will be paying for your reckless, uninformed and irresponsible decision-making for at least that long.
Sincerely,
Brian Hague"
Thursday, October 16, 2008
Dumb and Dumber
And dumbest.
Dumb: Sen. McCain's economic plan, which is two-pronged.
Prong one: Let people who are 59 or older withdraw from their retirement accounts at a tax rate of 10%, instead of their current tax rate.
Okay, the dis-savings attribute of this is less severe than his rival's plan, and I get the age component: help out those people who are near retirement age, and let them bail in the face of a bear market.
But for one thing, they can "bail" without withdrawing: just rebalance the portfolio. Buy inverse index funds, or bond funds, or bank CDs, or just put it in a money market fund, for crying out loud.
And for another, why tax them at all? Just reduce the withdrawal age to 59, at least temporarily. Lots of people retire in their 50s now anyway. And if you're trying help someone get money out before the market tanks further, why add a 10% hickey on the hit they've already taken?
Prong two: cut the capital gains tax. Hey, I'm all for that, and I understand the increased-investment-stimulates-the-economy logic. But, ah, Senator - not too many portfolios are sporting capital gains these days. Great idea, bad timing, little immediate benefit. I thought your plan was to fix the economy, now?
Dumber: Sen. Obama's plan, also two-pronged.
Prong one: already covered it, yesterday. Worse than McCain's idea.
Prong two: provide a $3,000 tax credit for every job a business creates.
Let's see, average hourly earnings in this country are about $18 (for now). Multiply that by the typical full-time schedule of about 2,000 hours a year, and you're paying $36k. Plus bennies and overhead at about 15% on top of that, plus hiring costs. So all-in, first year, this new position costs you upwards of $45k.
And you want to entice me to add this expense to my business by offering a tax credit worth about 7% of the cost.
Senator, if I need more employees, I'll hire them. If the revenue I can generate with another warm body justifies the expense, you can be assured I'll create a job.
But your generous offer is one of those trades that's hard to make up on volume.
Dumbest? The stock market.
No, I'm not just bitter because I'm short, and had a red-letter day yesterday, and looked set for another one tomorrow, only to give up half of yesterday's gains.
Here was the data slate that hit the market today:
Inflation: the headline reading was down, and the core reading was flat. Neutral signal, basically.
Jobless claims: initial claims were down more than expected, on workers temporarily sidelined by Gustav going back to work. But continuing claims were up unexpectedly, to a new cyclical high. And that's worse because that means once a worker loses his job, he has trouble finding a replacement job. So he's chronically unemployed. Bad news.
Net foreign purchases of US securities: who really cares, for the most part? Not a market-mover.
Industrial Production: the biggest drop since 1974. Ouch. A real recession signal in the year-over-year number. Bad news.
Capacity utilization: down two and a half points, twice as big a drop as forecast, and the first reading below the traditional recession threshold of 78% since the last recession. Bad news.
Philly Fed index: huge drop. It fell three times as much as forecast. Another bad sign for manufacturing.
That was the morning's slate. Also, Citi and Merrill reported yet another quarter of losses, on even more bad bond write-downs.
The market wanted to rally. It tried early on, focusing solely on the inflation number, ignoring that even though the core reading was flat, it's still a half-point above the Fed's comfort zone, and the fact that core producer prices were up for the month, higher core consumer prices are coming, so this is temporary relief at best.
Besides, who gives two hoots about inflation right now? Not Ben Bernanke, I can promise you.
So in the first hour of trading, the Dow was up more than 100 points.
Then reality set in.
The stark reality that, even if the inflation number was spun as a positive, the overwhelming bad news that the manufacturing sector - supported all year by exports, and the last bastion of hope for the US economy - is falling completely out of bed (you heard it here first, by the way), caused a free-fall. by mid-morning, the Dow was down almost 400 points, to 8,200.
Then, it rallied back. We even got another piece of bad news, ugly-bad, at 1:00 EDT, when the National Association of Home Builders reported their builder sentiment index had fallen to a new record low.
Yes, housing's still in the toilet. And getting worse all the time. And what's even worse is the strong correlation (which I've mentioned before) between the NAHB index and the S&P 500 lagged 18 months. So if this new low represents the bottom, that means the bottom for stocks is about another 18 months out.
All these guys looking at every big down day keep talking about whether we're nearing a bottom. This isn't going to happen quick. It's going to look more like the Bataan Death March, with Paulson and Bernanke poking us with their bayonets at every step.
Still, the Dow came storming back to neutral on the day. And it bounced around there from late morning until within about an hour of the close, staying within a range of about 100 points either side of yesterday's close.
And that was telling. Why, you ask?
Because yesterday's close was uncomfortably close to Friday's, which was the low for this bear market to date. And this market wants desperately to avoid setting another low this quickly. Desperately. And a drop of about 125 points would have gotten it there.
So, it took off in the last hour of trading, posting a euphoric, 400-point gain in the face of a slew of bad economic data.
And in the face of all reason and logic.
But I'm not worried. Monday's gain - aided by the closing of the bond market and the banks - was similarly euphoric. And in two days, it pretty much evaporated.
This one won't take any longer, I'll bet. Oh, we may get a Friday rally, since the market loves to end the week positive.
But we may also get a new low. Reality may set in with today's data. Add in the fact that the next shoe to drop - hedge funds - was a hot topic of discussion today, as was the fact that November's ARM resets are going to produce huge jumps in payments due to the spike in LIBOR over the past month, and you have a perfect recipe for panic.
But only if you're logical. The stock market is not.
Tomorrow will also bring the monthly housing starts and building permits numbers. They're already at 17-year lows. You think they'll be up? And the first look at consumer confidence for October. Where do you think that'll come in: higher, or lower?
Today's late rally was attributed to four different causes that I saw. First, the inflation data wasn't as bad as expected - a "hey, at least it didn't go up" reaction. I already debunked that one.
Second, Citi's loss wasn't as bad as expected. Okay. But it was still a loss. And Merrill's was worse than expected.
Third, Yahoo rallied when a Microsoft exec made an off-the-cuff comment that a deal could still happen. Well, Yahoo's CEO didn't say he welcomed it. So it's not likely.
Finally, as stocks sold off, oil dipped below $70 a barrel. Okay, that one could be legit.
But it's around $72 right now.
So, take three false-hope signals, add in a fourth signal that has since reversed direction, and stack it up against five really bad signs. Add in further bank write-downs. Toss in the imminent collapse of half the world's hedge funds, triggering massive sales of securities, driving prices down further. Sprinkle on the specter of a fresh tsunami of foreclosures after ARM payments go up 10-13% in November.
Then throw in what happens in Asian and European markets overnight. I don't think they'll be as irrationally exuberant as ours, to steal a phrase from Mr. Bubble.
Top it all off with the special sauce of a couple more pieces of bad economic news tomorrow.
And the smart money is on a big sell-off.
Oh, it'll be a volatile day, too. Get this: since the beginning of September, 27 of the 33 trading days have seen triple-digit moves in the Dow. The average change (on an absolute value basis)?
295 points. Take out those six double-digit days, and it's well over 300.
So if you're worried about your 401(k), or your job, take heart. It could be worse.
You could be a stock trader.
(Sorry if you are.)
Dumb: Sen. McCain's economic plan, which is two-pronged.
Prong one: Let people who are 59 or older withdraw from their retirement accounts at a tax rate of 10%, instead of their current tax rate.
Okay, the dis-savings attribute of this is less severe than his rival's plan, and I get the age component: help out those people who are near retirement age, and let them bail in the face of a bear market.
But for one thing, they can "bail" without withdrawing: just rebalance the portfolio. Buy inverse index funds, or bond funds, or bank CDs, or just put it in a money market fund, for crying out loud.
And for another, why tax them at all? Just reduce the withdrawal age to 59, at least temporarily. Lots of people retire in their 50s now anyway. And if you're trying help someone get money out before the market tanks further, why add a 10% hickey on the hit they've already taken?
Prong two: cut the capital gains tax. Hey, I'm all for that, and I understand the increased-investment-stimulates-the-economy logic. But, ah, Senator - not too many portfolios are sporting capital gains these days. Great idea, bad timing, little immediate benefit. I thought your plan was to fix the economy, now?
Dumber: Sen. Obama's plan, also two-pronged.
Prong one: already covered it, yesterday. Worse than McCain's idea.
Prong two: provide a $3,000 tax credit for every job a business creates.
Let's see, average hourly earnings in this country are about $18 (for now). Multiply that by the typical full-time schedule of about 2,000 hours a year, and you're paying $36k. Plus bennies and overhead at about 15% on top of that, plus hiring costs. So all-in, first year, this new position costs you upwards of $45k.
And you want to entice me to add this expense to my business by offering a tax credit worth about 7% of the cost.
Senator, if I need more employees, I'll hire them. If the revenue I can generate with another warm body justifies the expense, you can be assured I'll create a job.
But your generous offer is one of those trades that's hard to make up on volume.
Dumbest? The stock market.
No, I'm not just bitter because I'm short, and had a red-letter day yesterday, and looked set for another one tomorrow, only to give up half of yesterday's gains.
Here was the data slate that hit the market today:
Inflation: the headline reading was down, and the core reading was flat. Neutral signal, basically.
Jobless claims: initial claims were down more than expected, on workers temporarily sidelined by Gustav going back to work. But continuing claims were up unexpectedly, to a new cyclical high. And that's worse because that means once a worker loses his job, he has trouble finding a replacement job. So he's chronically unemployed. Bad news.
Net foreign purchases of US securities: who really cares, for the most part? Not a market-mover.
Industrial Production: the biggest drop since 1974. Ouch. A real recession signal in the year-over-year number. Bad news.
Capacity utilization: down two and a half points, twice as big a drop as forecast, and the first reading below the traditional recession threshold of 78% since the last recession. Bad news.
Philly Fed index: huge drop. It fell three times as much as forecast. Another bad sign for manufacturing.
That was the morning's slate. Also, Citi and Merrill reported yet another quarter of losses, on even more bad bond write-downs.
The market wanted to rally. It tried early on, focusing solely on the inflation number, ignoring that even though the core reading was flat, it's still a half-point above the Fed's comfort zone, and the fact that core producer prices were up for the month, higher core consumer prices are coming, so this is temporary relief at best.
Besides, who gives two hoots about inflation right now? Not Ben Bernanke, I can promise you.
So in the first hour of trading, the Dow was up more than 100 points.
Then reality set in.
The stark reality that, even if the inflation number was spun as a positive, the overwhelming bad news that the manufacturing sector - supported all year by exports, and the last bastion of hope for the US economy - is falling completely out of bed (you heard it here first, by the way), caused a free-fall. by mid-morning, the Dow was down almost 400 points, to 8,200.
Then, it rallied back. We even got another piece of bad news, ugly-bad, at 1:00 EDT, when the National Association of Home Builders reported their builder sentiment index had fallen to a new record low.
Yes, housing's still in the toilet. And getting worse all the time. And what's even worse is the strong correlation (which I've mentioned before) between the NAHB index and the S&P 500 lagged 18 months. So if this new low represents the bottom, that means the bottom for stocks is about another 18 months out.
All these guys looking at every big down day keep talking about whether we're nearing a bottom. This isn't going to happen quick. It's going to look more like the Bataan Death March, with Paulson and Bernanke poking us with their bayonets at every step.
Still, the Dow came storming back to neutral on the day. And it bounced around there from late morning until within about an hour of the close, staying within a range of about 100 points either side of yesterday's close.
And that was telling. Why, you ask?
Because yesterday's close was uncomfortably close to Friday's, which was the low for this bear market to date. And this market wants desperately to avoid setting another low this quickly. Desperately. And a drop of about 125 points would have gotten it there.
So, it took off in the last hour of trading, posting a euphoric, 400-point gain in the face of a slew of bad economic data.
And in the face of all reason and logic.
But I'm not worried. Monday's gain - aided by the closing of the bond market and the banks - was similarly euphoric. And in two days, it pretty much evaporated.
This one won't take any longer, I'll bet. Oh, we may get a Friday rally, since the market loves to end the week positive.
But we may also get a new low. Reality may set in with today's data. Add in the fact that the next shoe to drop - hedge funds - was a hot topic of discussion today, as was the fact that November's ARM resets are going to produce huge jumps in payments due to the spike in LIBOR over the past month, and you have a perfect recipe for panic.
But only if you're logical. The stock market is not.
Tomorrow will also bring the monthly housing starts and building permits numbers. They're already at 17-year lows. You think they'll be up? And the first look at consumer confidence for October. Where do you think that'll come in: higher, or lower?
Today's late rally was attributed to four different causes that I saw. First, the inflation data wasn't as bad as expected - a "hey, at least it didn't go up" reaction. I already debunked that one.
Second, Citi's loss wasn't as bad as expected. Okay. But it was still a loss. And Merrill's was worse than expected.
Third, Yahoo rallied when a Microsoft exec made an off-the-cuff comment that a deal could still happen. Well, Yahoo's CEO didn't say he welcomed it. So it's not likely.
Finally, as stocks sold off, oil dipped below $70 a barrel. Okay, that one could be legit.
But it's around $72 right now.
So, take three false-hope signals, add in a fourth signal that has since reversed direction, and stack it up against five really bad signs. Add in further bank write-downs. Toss in the imminent collapse of half the world's hedge funds, triggering massive sales of securities, driving prices down further. Sprinkle on the specter of a fresh tsunami of foreclosures after ARM payments go up 10-13% in November.
Then throw in what happens in Asian and European markets overnight. I don't think they'll be as irrationally exuberant as ours, to steal a phrase from Mr. Bubble.
Top it all off with the special sauce of a couple more pieces of bad economic news tomorrow.
And the smart money is on a big sell-off.
Oh, it'll be a volatile day, too. Get this: since the beginning of September, 27 of the 33 trading days have seen triple-digit moves in the Dow. The average change (on an absolute value basis)?
295 points. Take out those six double-digit days, and it's well over 300.
So if you're worried about your 401(k), or your job, take heart. It could be worse.
You could be a stock trader.
(Sorry if you are.)
Tuesday, October 14, 2008
The Natural Course of Things
Once again, credit my lovely wife for her wisdom.
During last spring's heavy flooding in Iowa and Missouri, we were watching news coverage of residents of river towns frantically putting up sandbags. My wife made the following observation (I'm paraphrasing):
"It's fine, and understandable, that they're doing that. But the river has pretty much gone where it's wanted to go for centuries, and there's really nothing man can do to stop that."
Somebody please tell Hank Paulson and Ben Bernanke. Quick. Before we all drown in a river of debt.
They started out by pretty much ignoring the rising waters.
On July 19 of last year - two days after the Bear Stearns hedge fund collapse - Bernanke told the Senate Banking Committee that losses from the subprime fiasco might total as much as $100 billion.
Today's estimates? According to the IMF, $1.4 trillion. (To be fair, not all of that is directly from subprime. But whether the flooding comes entirely from rainfall directly on the river itself, or whether some of it comes from various tributaries that are also affected by the rain, the guy watching the water level should see the flood coming.)
It's also interesting that less than a month after Bernanke made that bold estimate, his Fed began cutting interest rates, "acknowledging for the first time that an extraordinary policy shift is needed to contain the subprime-mortgage collapse," according to Bloomberg.
So after ignoring the rising waters, Bernanke and Paulson began casually tossing a sandbag here, another there, thinking the raging waters would be "contained." Now, they're throwing everything they've got at it. Come to think of it, since the US is broke and the Fed is insolvent, they're throwing stuff they don't have at it. In the form of money. Mountains of money.
Our money.
But this thing is looking less like a flooded river, and more like one great big honkin' mother of a tsunami.
And by throwing money at it, they're not really throwing sandbags. They're throwing great big buckets of ... water.
See, the river will seek its natural course, and its natural level. As I laid out yesterday, so will markets, whether they be for stocks, real estate, jobs, dollars ... whatever.
And men trying to stop that from happening is as futile as men trying to alter the course of the Mississippi.
Especially when the men are incompetent.
************
Let's get back to that IMF estimate of total losses, because it lies at the heart of part one of the two-part reason Paulson's ever-shifting TARP plan will fail.
Total US bank losses to date have been about $385 billion (for the world, it's $637 billion, or just less than half the IMF forecast). US financials have raised just $338 billion in capital to offset the losses. Now, that doesn't sound too bad - they've raised 88% of what they've lost, so they're only down $50 billion or so.
But they've raised $177 billion of that capital - more than half the total raised - in the third and fourth quarters of this year. And that includes the first round of TARP money - everybody else, from China to Korea to Singapore to Abu Dhabi - is done giving money to Wall Street. And not all of them have yet reported third quarter losses. And none of them have yet reported fourth quarter losses.
It's going to get ugly when they do.
Ultimately, even with the TARP money, the banks will just be back to break-even on their losses to date, if that. So the TARP money will have been wasted. Why?
Because the whole notion behind the shift from buying crappy bonds to injecting capital in the banks has been that the latter will encourage banks to lend. Banking is a leverage game: a dollar of capital can be deployed into a multiple of that dollar in loans. And that primes the economic pump, sending cash from Wall Street to Main Street (oh God, I can't believe I just said that).
Paulson even handed out instructions with his TARP checks, telling the banks to go out and lend, much like his boss told us all after 9/11 to go out and shop. (Remember those ads? "Do your business, all over the country." I used to laugh every time I saw them, since "do your business" is what we tell our dogs when we want them to poop.) Paulson's exact words:
"The needs of our economy require that our financial institutions not take this new capital and hoard it, but to deploy it."
While GMAC isn't a bank and didn't get any TARP money, it is a consumer lender. How is it "deploying" its capital?
It sent a letter to all GM dealers yesterday telling them it would not lend money to any would-be car buyer with a FICO score below 700.
The prime cut-off is 680.
This will really help GM sell cars and avoid bankruptcy.
Other banks aren't going to start lending either. They don't want to go back to the days of making loans to people who can't repay them. And the only way they will is if the government nationalizes them, and does it themselves, using our tax dollars.
Gulp!
(There's a third reason Paulson's plan won't work: Paulson's running it.)
************
Here's a sinister little plot for you. Remember why Fannie and Freddie went belly-up? The two largest mortgage insurers in the world, who between them guaranteed more than $5 trillion in loans at their zenith, were originally chartered to buy only "conforming" loans - those that met stringent underwriting standards, and thus were the highest-quality mortgages in the market. But at one point their combined exposure to subprime loans amounted to 48% of their balance sheets.
So what are they up to now that Uncle is at the helm? From the Credit Union Journal:
"The Treasury Department, which took over Fannie Mae and Freddie Mac last month, is directing the two secondary mortgage giants to start buying $40 billion a month of distressed mortgage securities in order to recreate the failing market. Officials plan to pump new liquidity into the secondary market by having Fannie and Freddie buy up subprime, Alt-A and non-performing prime mortgages."
On whose authority? This is an end-around to the TARP. It allows Treasury to ultimately spend the entire $700 billion of TARP money injecting capital into banks, while spending an unlimited amount of money buying crap assets through Fannie and Freddie.
Which is exactly what caused Fannie and Freddie to fail in the first place.
So they're going to make Fannie and Freddie fail again. Only now, we're the shareholders who will take the hit. Write your Congresspersons. This has got to stop, now!
************
Still in a quandary about who to vote for in just a few weeks? This won't make it any easier.
I reported before on McCain's plan to spend $300 billion of the TARP money buying up bad mortgages.
Bold prediction: if John McCain is elected, we will see the largest one-month spike in mortgage delinquencies on record, covering every home whose market value is below its mortgage balance, and/or whose mortgage interest rate is above 5.25%.
As for Obama, he produced his own brilliant idea yesterday. Remember a week ago, when he and every other politician was crying, "We can't let the value of people's retirement accounts keep going down!"?
Well, he wants to let people withdraw up to $10,000 from their tax-deferred retirement accounts, penalty-free. Won't that make the value of the accounts go down, even if the market doesn't?
Both of these guys have clearly taken leave of their senses. Probably just dizzy from running around in circles, screaming, "The sky is falling!"
Besides encouraging dis-saving, this hare-brained scheme has another shortcoming:
The people that would do this wouldn't spend the money to stimulate the economy anyway. They'd probably stash it in their new wall safe. A local news station reported that a local company that sells in-home wall safes has seen sales skyrocket over the past several months. That's confidence in the banking system.
************
Here's another sign of what's to come: remember the money market mutual fund that "broke the buck" last month, spurring panic in the money markets and leading the feds to basically turn money funds into bank deposits by insuring them (even though the FDIC is about broke)? Well, it had promised to distribute $20 billion to its investors by yesterday.
It can't. Why? It doesn't know what its holdings are. Not what they're worth. But how many shares each investor owns.
Gulp!
************
For the people who still blame mark-to-market accounting for the current mess, besides the rational explanations of what it is, how it works and why it's important that I've already provided, here are a couple of more simple rubrics to help you get it.
There was no mark-to-market accounting in 1929. Or in 1987. And the stock market still crashed.
On a similar note, remember how speculators were blamed for the sharp spike in oil prices? How it couldn't possibly be supply and demand fundamentals driving the price?
Suddenly, oil is dropping like a rock. Where are those voices now? Why aren't they blaming speculators for shorting oil? Why are they suddenly accepting the specter of reduced demand from a global recession as a fundamental price driver?
Back to mark-to-market: there have been, in the past, bank bailouts that worked. They were expensive, averaging about 13% of the respective countries' GDP. But some of them worked.
To put that GDP number in perspective, US GDP is around $14 trillion. So the price tag to bail out our banking system would be about $2 trillion. But that doesn't factor in the impact on US inflation, interest rates and tax rates of adding that to an already-trillion dollar deficit. Which is why, in my humble opinion, bailing out US banks won't succeed.
But another reason is that in the case of every successful banking system bailout, the countries have forced immediate write-downs of bad assets to poo levels (poo is just slightly above zero, in case you didn't know).
We want to do just the opposite, and eliminate price transparency altogether. Crazy.
************
Random thought, from a good friend and fellow cynic: why do we call it "nationalizing the banks" when Britain does it, and "injecting capital into the banking system" when we do it?
************
My t-shirt idea of the week: with Iceland now essentially bankrupt, we can cheer ourselves up with t-shirts that proclaim, "At least we're not Iceland."
On the front. The back would read, "Yet."
************
I'll leave you with this additional gem from my wife. Citing the book of Proverbs (Isaiah needs a rest), she referred to the verse that says, "For everything, there is a season ..."
That's akin to seeking the natural course of things. In the markets, there's a time to prosper, and a time to lose your shirt.
But what Washington is trying to do is make it summer all the time. As the leaves start to turn colors and fall, lawmakers are up the trees with Elmer's glue and green spray paint.
Good luck with that.
During last spring's heavy flooding in Iowa and Missouri, we were watching news coverage of residents of river towns frantically putting up sandbags. My wife made the following observation (I'm paraphrasing):
"It's fine, and understandable, that they're doing that. But the river has pretty much gone where it's wanted to go for centuries, and there's really nothing man can do to stop that."
Somebody please tell Hank Paulson and Ben Bernanke. Quick. Before we all drown in a river of debt.
They started out by pretty much ignoring the rising waters.
On July 19 of last year - two days after the Bear Stearns hedge fund collapse - Bernanke told the Senate Banking Committee that losses from the subprime fiasco might total as much as $100 billion.
Today's estimates? According to the IMF, $1.4 trillion. (To be fair, not all of that is directly from subprime. But whether the flooding comes entirely from rainfall directly on the river itself, or whether some of it comes from various tributaries that are also affected by the rain, the guy watching the water level should see the flood coming.)
It's also interesting that less than a month after Bernanke made that bold estimate, his Fed began cutting interest rates, "acknowledging for the first time that an extraordinary policy shift is needed to contain the subprime-mortgage collapse," according to Bloomberg.
So after ignoring the rising waters, Bernanke and Paulson began casually tossing a sandbag here, another there, thinking the raging waters would be "contained." Now, they're throwing everything they've got at it. Come to think of it, since the US is broke and the Fed is insolvent, they're throwing stuff they don't have at it. In the form of money. Mountains of money.
Our money.
But this thing is looking less like a flooded river, and more like one great big honkin' mother of a tsunami.
And by throwing money at it, they're not really throwing sandbags. They're throwing great big buckets of ... water.
See, the river will seek its natural course, and its natural level. As I laid out yesterday, so will markets, whether they be for stocks, real estate, jobs, dollars ... whatever.
And men trying to stop that from happening is as futile as men trying to alter the course of the Mississippi.
Especially when the men are incompetent.
************
Let's get back to that IMF estimate of total losses, because it lies at the heart of part one of the two-part reason Paulson's ever-shifting TARP plan will fail.
Total US bank losses to date have been about $385 billion (for the world, it's $637 billion, or just less than half the IMF forecast). US financials have raised just $338 billion in capital to offset the losses. Now, that doesn't sound too bad - they've raised 88% of what they've lost, so they're only down $50 billion or so.
But they've raised $177 billion of that capital - more than half the total raised - in the third and fourth quarters of this year. And that includes the first round of TARP money - everybody else, from China to Korea to Singapore to Abu Dhabi - is done giving money to Wall Street. And not all of them have yet reported third quarter losses. And none of them have yet reported fourth quarter losses.
It's going to get ugly when they do.
Ultimately, even with the TARP money, the banks will just be back to break-even on their losses to date, if that. So the TARP money will have been wasted. Why?
Because the whole notion behind the shift from buying crappy bonds to injecting capital in the banks has been that the latter will encourage banks to lend. Banking is a leverage game: a dollar of capital can be deployed into a multiple of that dollar in loans. And that primes the economic pump, sending cash from Wall Street to Main Street (oh God, I can't believe I just said that).
Paulson even handed out instructions with his TARP checks, telling the banks to go out and lend, much like his boss told us all after 9/11 to go out and shop. (Remember those ads? "Do your business, all over the country." I used to laugh every time I saw them, since "do your business" is what we tell our dogs when we want them to poop.) Paulson's exact words:
"The needs of our economy require that our financial institutions not take this new capital and hoard it, but to deploy it."
While GMAC isn't a bank and didn't get any TARP money, it is a consumer lender. How is it "deploying" its capital?
It sent a letter to all GM dealers yesterday telling them it would not lend money to any would-be car buyer with a FICO score below 700.
The prime cut-off is 680.
This will really help GM sell cars and avoid bankruptcy.
Other banks aren't going to start lending either. They don't want to go back to the days of making loans to people who can't repay them. And the only way they will is if the government nationalizes them, and does it themselves, using our tax dollars.
Gulp!
(There's a third reason Paulson's plan won't work: Paulson's running it.)
************
Here's a sinister little plot for you. Remember why Fannie and Freddie went belly-up? The two largest mortgage insurers in the world, who between them guaranteed more than $5 trillion in loans at their zenith, were originally chartered to buy only "conforming" loans - those that met stringent underwriting standards, and thus were the highest-quality mortgages in the market. But at one point their combined exposure to subprime loans amounted to 48% of their balance sheets.
So what are they up to now that Uncle is at the helm? From the Credit Union Journal:
"The Treasury Department, which took over Fannie Mae and Freddie Mac last month, is directing the two secondary mortgage giants to start buying $40 billion a month of distressed mortgage securities in order to recreate the failing market. Officials plan to pump new liquidity into the secondary market by having Fannie and Freddie buy up subprime, Alt-A and non-performing prime mortgages."
On whose authority? This is an end-around to the TARP. It allows Treasury to ultimately spend the entire $700 billion of TARP money injecting capital into banks, while spending an unlimited amount of money buying crap assets through Fannie and Freddie.
Which is exactly what caused Fannie and Freddie to fail in the first place.
So they're going to make Fannie and Freddie fail again. Only now, we're the shareholders who will take the hit. Write your Congresspersons. This has got to stop, now!
************
Still in a quandary about who to vote for in just a few weeks? This won't make it any easier.
I reported before on McCain's plan to spend $300 billion of the TARP money buying up bad mortgages.
Bold prediction: if John McCain is elected, we will see the largest one-month spike in mortgage delinquencies on record, covering every home whose market value is below its mortgage balance, and/or whose mortgage interest rate is above 5.25%.
As for Obama, he produced his own brilliant idea yesterday. Remember a week ago, when he and every other politician was crying, "We can't let the value of people's retirement accounts keep going down!"?
Well, he wants to let people withdraw up to $10,000 from their tax-deferred retirement accounts, penalty-free. Won't that make the value of the accounts go down, even if the market doesn't?
Both of these guys have clearly taken leave of their senses. Probably just dizzy from running around in circles, screaming, "The sky is falling!"
Besides encouraging dis-saving, this hare-brained scheme has another shortcoming:
The people that would do this wouldn't spend the money to stimulate the economy anyway. They'd probably stash it in their new wall safe. A local news station reported that a local company that sells in-home wall safes has seen sales skyrocket over the past several months. That's confidence in the banking system.
************
Here's another sign of what's to come: remember the money market mutual fund that "broke the buck" last month, spurring panic in the money markets and leading the feds to basically turn money funds into bank deposits by insuring them (even though the FDIC is about broke)? Well, it had promised to distribute $20 billion to its investors by yesterday.
It can't. Why? It doesn't know what its holdings are. Not what they're worth. But how many shares each investor owns.
Gulp!
************
For the people who still blame mark-to-market accounting for the current mess, besides the rational explanations of what it is, how it works and why it's important that I've already provided, here are a couple of more simple rubrics to help you get it.
There was no mark-to-market accounting in 1929. Or in 1987. And the stock market still crashed.
On a similar note, remember how speculators were blamed for the sharp spike in oil prices? How it couldn't possibly be supply and demand fundamentals driving the price?
Suddenly, oil is dropping like a rock. Where are those voices now? Why aren't they blaming speculators for shorting oil? Why are they suddenly accepting the specter of reduced demand from a global recession as a fundamental price driver?
Back to mark-to-market: there have been, in the past, bank bailouts that worked. They were expensive, averaging about 13% of the respective countries' GDP. But some of them worked.
To put that GDP number in perspective, US GDP is around $14 trillion. So the price tag to bail out our banking system would be about $2 trillion. But that doesn't factor in the impact on US inflation, interest rates and tax rates of adding that to an already-trillion dollar deficit. Which is why, in my humble opinion, bailing out US banks won't succeed.
But another reason is that in the case of every successful banking system bailout, the countries have forced immediate write-downs of bad assets to poo levels (poo is just slightly above zero, in case you didn't know).
We want to do just the opposite, and eliminate price transparency altogether. Crazy.
************
Random thought, from a good friend and fellow cynic: why do we call it "nationalizing the banks" when Britain does it, and "injecting capital into the banking system" when we do it?
************
My t-shirt idea of the week: with Iceland now essentially bankrupt, we can cheer ourselves up with t-shirts that proclaim, "At least we're not Iceland."
On the front. The back would read, "Yet."
************
I'll leave you with this additional gem from my wife. Citing the book of Proverbs (Isaiah needs a rest), she referred to the verse that says, "For everything, there is a season ..."
That's akin to seeking the natural course of things. In the markets, there's a time to prosper, and a time to lose your shirt.
But what Washington is trying to do is make it summer all the time. As the leaves start to turn colors and fall, lawmakers are up the trees with Elmer's glue and green spray paint.
Good luck with that.
Monday, October 13, 2008
Truth, and Consequences
As I write this, the Dow is up more than 400 points because G7 leaders met ever so briefly to pledge they'd capitalize their respective countries' banks, and because Henry Paulson announced that's what he'll do with the TARP money.
A. We got a similar rally when Congress first began talking about "doing something." Remember what happened since then?
B. Paulson started hinting last week that he'd deploy the TARP money by directly infusing capital into banks. What's new?
C. All this demonstrates is that the guy in charge of righting the ship can't make a sound decision. And this instills confidence in the markets? I guess it also demonstrates that when stock traders want a rally, they'll produce one.
But make no mistake: this is a dead-cat bounce.
True, last week's massive sell-off was, in part, fear-induced. But the fears were well-founded. They were the fear of a recession that is inevitable no matter how many fingers Hank is able to put in the dike, and the fear of what a trillion dollar deficit will do to the US dollar, tax rates and interest rates.
President Bush has been trying to jawbone the fears away, much as FDR did in his inauguration speech in 1933, when he famously said, "We have nothing to fear but fear itself."
I agree. But I have to point out that his words didn't change much. The US economy and the stock market ultimately recovered in 1946.
Okay, let's turn our attention to consequences. I want to hit on several things that the Chicken Littles have been crying for in begging the government to "do something." I'll couch each in terms of paraphrased quotes that represent things we've all been hearing, unless we've kept our TVs and radios off for the last month (in which case, kudos to you).
"We can't let home prices keep falling."
First, I'm sympathetic to the notion of a family losing their home to foreclosure. What a terrible experience that would be. I wouldn't want it to happen to me.
That's why, when I bought a house, I saved a reasonable down payment first, researched the market, got a fixed-rate loan with payments I could afford, and made sure I didn't spend so much money on other stuff that I couldn't make the mortgage payment first and foremost.
That's why, if my home price did decline below my mortgage balance, I'd recognize that it's still my home, and not an investment, and that if I continue paying the mortgage down, the home price will eventually recover, and I'll once again own more than I owe. Because I know that, just as home prices can't go up forever, they can't go down forever either.
And that's why, if I did lose my job, I'd sell everything else I had, work two or three jobs if I had to, to be able to continue making my mortgage payment on time.
I recognize that not everyone is in my situation. And I also believe that the expansion of homeownership is a worthwhile goal, both economically and socially. But here's a simple fact: about 65% of Americans can actually afford to be homeowners. The only way we can expand homeownership above that number is by some kind of financial artifice.
That's exactly what happened in the subprime fiasco: a perfect storm of regulatory pressure, credit scoring, financial "innovation," Wall Street risk-parsing, and dubious marketing.
And, in the end, we did no favors shoe-horning a renter into a home he or she could not afford, letting them live in it for a few years, then taking it away from them.
(It kind of reminds me of how the S&L regulators enticed healthy thrifts to take over sick ones by letting them book "goodwill" as capital, then, after a few years, they took away the "goodwill," declared them insolvent, and shut them down, too.)
Here's how markets work: they go up, and they go down. Why? Because the sometimes go up at a pace above their long-term sustainable rate of growth. In housing, that should be roughly akin to the rate of inflation, discounting extreme supply and demand factors in certain markets like Manhattan. And that rate is about 3-4%.
Well, home prices went up by double digits for several years due to the subprime frenzy and the speculative excess it spawned. Everywhere. Not just in places like Manhattan, but in places where there's plenty of buildable land.
That is a classic example of a bubble. And every bubble demands a correction.
Here's a little exercise for you. Look at the S&P/Case-Shiller Home Price Index for each of the 20 metro markets it covers. Go back to before the housing bubble began, and plot the trendline at the long-term sustainable growth rate for that particular market, whatever it happens to be. Trace it all the way out to the end of 2008.
And you'll find that home prices still have not fallen to where they should be.
"Stop home prices from falling further?" Go ahead and try. Home prices have to fall further, to reach market equilibrium. How is Washington going to stop that from happening? Fix home prices? Say, "You have to buy a house this year, and you have to pay no less than X?"
The day they start doing that, color me gone.
It is both a truth and a consequence that home prices are going to fall further.
"People are losing money in their 401(k)s - we have to do something about that."
I find this almost comical. It was Washington, influenced by businesses, that led the grand exodus from defined benefit to defined contribution retirement plans to begin with. In doing so, they placed the risk directly on the shoulders of the employees.
We took that risk. We make money in the good times, and, unless we successfully rebalance, we lose money in the bad times.
On paper.
Look, if you were planning to retire next year, and now can't, I truly sympathize. I'm sorry you continued to expose yourself to too much risk for your age and life situation, and that you now face the consequences.
But I've had at least two retirees call me to ask if they should move their money. When I asked them what they were invested in, they said they were in a balanced lifestyle fund targeted to their age, invested mostly in bonds, and that it was returning around 4.75% year-to-date.
I told them if they were making money in this environment, they were fine.
But what about the guy who's 30, and fully allocated to equities?
Well, by the time he retires, he'll likely earn the long-term, sustainable historical average that stocks have returned, of about 11%. If he's diversified somewhat into bonds, maybe 8%.
That's more than twice the inflation rate. That should allow any diligent saver to retire comfortably. Only greed could make us expect higher returns than that.
Oh, but we do, because we are indeed greedy. We see those bubbly 25% returns for a couple of years, and it gets good to us. We think it'll go on forever.
See, this is the same story as housing. Only here, the long-term sustainable growth rate is, as I said, about 11%. So let's try the same exercise we tried above.
Go back to before the dot-com bubble, which was inflated by easy money beginning in late 1998, when Greenspan bailed out the Long-Term Capital Management hedge fund (important lesson: bailouts inflate bubbles, and bubbles burst, creating severe corrections). Plot the long-term sustainable growth rate of stock prices - pick any index - from about 1982, when the long-term bull market began, through year-end 2008.
You'll find that when the dot-com bubble began, stocks appreciated at a rate well above what could be sustained. Then it corrected from 2000 to 2002 - hard. But it didn't get all the way down to where it needed to be. Why?
Government intervention. A bailout, again in the form of too-easy money, again courtesy of Alan Greenspan, and again igniting a fresh bubble. This time, in housing.
You'll also find that, even with last week's carnage, the stock market still has not corrected to where its long-term sustainable growth rate would peg it. That level is around 7-8,000 on the Dow, or about 700 on the S&P, or about 1,400 on the NASDAQ.
So we're fairly close. The bad news is, the way corrections work, the market may fall below that mark, then rebound to it.
In the case of stock prices, it is theoretically easier for the government to intervene in a way that props them up, than it is for house prices.
They can simply keep pumping federal money into the economy until growth resumes, and stock prices go up on the prospects for that growth.
But for one thing, that only creates a new bubble. And three massive bubbles in a row, within a relatively short time frame, would totally destroy the US economy, and take the rest of the world with it.
And for another, the theory doesn't work when you're facing a trillion dollar deficit, and when your national debt is approaching 100% of GDP.
You then become a net-debtor nation, and in order to finance all that spending, you have to a) raise taxes by a massive amount, which further depresses spending and investment and causes further economic decline, as happened when Hoover raised taxes in 1932, and b) pay much higher interest rates on government debt you issue, in order to entice foreign investors, who hold the bulk of it, to buy more.
Folks, that is already happening. The ten-year Treasury yield has been rising since the last rate cut. Why? The ten-year note, since it matures in ten years, anticipates future events. A ten-year note trades like a strip of ten one-year bills. And if investors think that bill yields will go higher over the next ten years, they demand higher rates on the ten-year note.
What happens when those rates go up? Well, for one thing, 30-year fixed-rate mortgages are priced off the ten-year. So mortgage rates will go up, even if the Fed cuts the funds target to zero. That won't help solve the housing-led crisis we're in.
Another consequence is that the government has to print even more money, because it's now paying even more in interest - money it doesn't have, because it's still deficit spending. So the deficit gets wider, and that drives rates higher, in a never-ending inflationary spiral.
And they might as well buy every man, woman and child in the country a wheelbarrow in which to take their worthless US dollars to the grocery store.
So here's another truth, and another consequence: when you've enjoyed well-above-trend returns on your 401(k) for several years, you have to expect well-below-trend returns - and probably losses - for a while to get you back on trend. You should plan on the trend, take the good times with a grain of salt, and not worry through the bad times. And, as you near retirement, get out of the risky stuff to an increasing degree.
"We have to keep people from losing their homes."
This is closely related to the home price issue, and I've addressed it before, so I won't belabor it. But here's one important point.
Let's say we're going to pursue the McCain solution of refinancing all the "bad" mortgages into 30-year, fixed rate mortgages at 5.25%. Besides the near-impossible task of finding who now owns all those mortgages, piecing the tranches back together into whole loans, and buying them up - and besides the fact that most of those mortgagors won't be able to make the payments even at 5.25% now - here's the fundamental flaw:
Who will hold the mortgages? Banks won't. They're currently getting more than 5.25% on the mortgages they make. And they're through with making loans to people with impaired credit, who probably won't pay them back.
Investors won't either, for the same reasons. Their risk appetite has waned considerably. And they're back to pricing risk appropriately. So they won't pay par for a 5.25% mortgage-backed bond with a ton of credit risk.
That leaves Uncle Sam - you and me. And that's just what's being proposed. They say we'll ultimately make money on this.
So we're going to accept a 5.25% return on mortgages in a 6%-plus market, with rates sure to rise even further. And suffer eventual default rates that are about what they currently are on the subprime ARMs we're replacing.
Tell me again how we make money on that trade?
Fact is, we don't. We lose on the subsidized yield, we lose even more in a rising rate environment, and we suffer principal losses when they default - which, by the way leads to another glut of foreclosed homes on the market, which creates another overall housing slump.
And the ultimate direct cost to the taxpayer alone will be much, much more than $300 billion.
So, once more, it is both a truth and a consequence that more people are going to lose their homes.
"If we don't do something, people are going to lose their jobs."
Guess what? They already are. And that happens in every recession. Is the government proposing to guarantee that everyone has a job? (Perhaps - the trial balloon of resurrecting the WPA has already been floated .)
Furthermore, about 800,000 people have already lost their jobs since January. If the government spends a ton of money ensuring, somehow, that no one will lose their job going forward, how do they explain the timing of their actions to the guy or gal that got canned in January?
Truth and consequence: more people are going to lose their jobs.
"If we don't act now, more banks will fail."
How many new banks and bank branches have cropped up on every street corner over the past ten years? Can't we live with a few less banks?
Look, bank growth exploded during the housing bubble, because everybody wanted to get into the hyper-profitable lend-and-sell loan game. So it is only a natural consequence that the number of banks will contract when the demand for credit drops sharply.
During the S&L crisis, 747 institutions failed. Thus far in this debacle, 15 have gone down.
The truth is, we have a long, long way to go before we get back to equilibrium.
"We have to un-freeze the credit markets so people will start borrowing again."
Why are so many people whose ARM rates, and thus their mortgage payments, risen, defaulting on the loans?
Because they can't afford the higher mortgage payments when they already have two six-year car loans on brand-new luxury cars they bought with no money down, and several maxed-out credit cards, which combined eat up all of their take-home pay.
As with the banks, we need less credit right now. It is a natural and healthy cleansing of a system that got bloated with greed and excess, which was unnatural and unhealthy. So let's purge it.
More borrowing is not the answer. It's like a glutton who becomes obscenely obese, to the point that he becomes diabetic and has a heart attack.
So the doctors put him in the hospital and work to regulate his blood sugar and do a triple bypass. But they say, "Why, he's become so accustomed to his three milkshakes a day and his quart of ice cream at bedtime - we can't deprive him of that!" So they continue to gorge him. What eventually happens?
Again, I am totally sympathetic to the notion of people losing their jobs, their homes, and a portion of their retirement savings. A big part of the problem, though, is that we focus on those things, and place our faith in dollar-denominated things.
We have survived recessions before. Some of us have lived in poverty. Some of us have survived even worse: the Holocaust, ethnic cleansing in Eastern Europe or Africa, etc.
The key word is "survive." Many who have made it through bad experiences unscathed have been able to do so by placing our faith in the only One that can ultimately sustain us.
But in a nation that increasingly attempts to separate itself from the Creator it acknowledged at its birth, we're becoming increasingly reliant on government - man - to fix things.
And they can't.
The more they try, the worse it gets. So please, Washington, get the message: go home. Visit your constituents. Listen to them, not to your pals on Wall Street. Pay attention when they tell you, "Enough, already!" Then go on a nice junket or whatever you do on your lengthy recesses.
Because the more you spend, the worse it ultimately gets.
The fundamental message is, "We do not have faith in you."
A. We got a similar rally when Congress first began talking about "doing something." Remember what happened since then?
B. Paulson started hinting last week that he'd deploy the TARP money by directly infusing capital into banks. What's new?
C. All this demonstrates is that the guy in charge of righting the ship can't make a sound decision. And this instills confidence in the markets? I guess it also demonstrates that when stock traders want a rally, they'll produce one.
But make no mistake: this is a dead-cat bounce.
True, last week's massive sell-off was, in part, fear-induced. But the fears were well-founded. They were the fear of a recession that is inevitable no matter how many fingers Hank is able to put in the dike, and the fear of what a trillion dollar deficit will do to the US dollar, tax rates and interest rates.
President Bush has been trying to jawbone the fears away, much as FDR did in his inauguration speech in 1933, when he famously said, "We have nothing to fear but fear itself."
I agree. But I have to point out that his words didn't change much. The US economy and the stock market ultimately recovered in 1946.
Okay, let's turn our attention to consequences. I want to hit on several things that the Chicken Littles have been crying for in begging the government to "do something." I'll couch each in terms of paraphrased quotes that represent things we've all been hearing, unless we've kept our TVs and radios off for the last month (in which case, kudos to you).
"We can't let home prices keep falling."
First, I'm sympathetic to the notion of a family losing their home to foreclosure. What a terrible experience that would be. I wouldn't want it to happen to me.
That's why, when I bought a house, I saved a reasonable down payment first, researched the market, got a fixed-rate loan with payments I could afford, and made sure I didn't spend so much money on other stuff that I couldn't make the mortgage payment first and foremost.
That's why, if my home price did decline below my mortgage balance, I'd recognize that it's still my home, and not an investment, and that if I continue paying the mortgage down, the home price will eventually recover, and I'll once again own more than I owe. Because I know that, just as home prices can't go up forever, they can't go down forever either.
And that's why, if I did lose my job, I'd sell everything else I had, work two or three jobs if I had to, to be able to continue making my mortgage payment on time.
I recognize that not everyone is in my situation. And I also believe that the expansion of homeownership is a worthwhile goal, both economically and socially. But here's a simple fact: about 65% of Americans can actually afford to be homeowners. The only way we can expand homeownership above that number is by some kind of financial artifice.
That's exactly what happened in the subprime fiasco: a perfect storm of regulatory pressure, credit scoring, financial "innovation," Wall Street risk-parsing, and dubious marketing.
And, in the end, we did no favors shoe-horning a renter into a home he or she could not afford, letting them live in it for a few years, then taking it away from them.
(It kind of reminds me of how the S&L regulators enticed healthy thrifts to take over sick ones by letting them book "goodwill" as capital, then, after a few years, they took away the "goodwill," declared them insolvent, and shut them down, too.)
Here's how markets work: they go up, and they go down. Why? Because the sometimes go up at a pace above their long-term sustainable rate of growth. In housing, that should be roughly akin to the rate of inflation, discounting extreme supply and demand factors in certain markets like Manhattan. And that rate is about 3-4%.
Well, home prices went up by double digits for several years due to the subprime frenzy and the speculative excess it spawned. Everywhere. Not just in places like Manhattan, but in places where there's plenty of buildable land.
That is a classic example of a bubble. And every bubble demands a correction.
Here's a little exercise for you. Look at the S&P/Case-Shiller Home Price Index for each of the 20 metro markets it covers. Go back to before the housing bubble began, and plot the trendline at the long-term sustainable growth rate for that particular market, whatever it happens to be. Trace it all the way out to the end of 2008.
And you'll find that home prices still have not fallen to where they should be.
"Stop home prices from falling further?" Go ahead and try. Home prices have to fall further, to reach market equilibrium. How is Washington going to stop that from happening? Fix home prices? Say, "You have to buy a house this year, and you have to pay no less than X?"
The day they start doing that, color me gone.
It is both a truth and a consequence that home prices are going to fall further.
"People are losing money in their 401(k)s - we have to do something about that."
I find this almost comical. It was Washington, influenced by businesses, that led the grand exodus from defined benefit to defined contribution retirement plans to begin with. In doing so, they placed the risk directly on the shoulders of the employees.
We took that risk. We make money in the good times, and, unless we successfully rebalance, we lose money in the bad times.
On paper.
Look, if you were planning to retire next year, and now can't, I truly sympathize. I'm sorry you continued to expose yourself to too much risk for your age and life situation, and that you now face the consequences.
But I've had at least two retirees call me to ask if they should move their money. When I asked them what they were invested in, they said they were in a balanced lifestyle fund targeted to their age, invested mostly in bonds, and that it was returning around 4.75% year-to-date.
I told them if they were making money in this environment, they were fine.
But what about the guy who's 30, and fully allocated to equities?
Well, by the time he retires, he'll likely earn the long-term, sustainable historical average that stocks have returned, of about 11%. If he's diversified somewhat into bonds, maybe 8%.
That's more than twice the inflation rate. That should allow any diligent saver to retire comfortably. Only greed could make us expect higher returns than that.
Oh, but we do, because we are indeed greedy. We see those bubbly 25% returns for a couple of years, and it gets good to us. We think it'll go on forever.
See, this is the same story as housing. Only here, the long-term sustainable growth rate is, as I said, about 11%. So let's try the same exercise we tried above.
Go back to before the dot-com bubble, which was inflated by easy money beginning in late 1998, when Greenspan bailed out the Long-Term Capital Management hedge fund (important lesson: bailouts inflate bubbles, and bubbles burst, creating severe corrections). Plot the long-term sustainable growth rate of stock prices - pick any index - from about 1982, when the long-term bull market began, through year-end 2008.
You'll find that when the dot-com bubble began, stocks appreciated at a rate well above what could be sustained. Then it corrected from 2000 to 2002 - hard. But it didn't get all the way down to where it needed to be. Why?
Government intervention. A bailout, again in the form of too-easy money, again courtesy of Alan Greenspan, and again igniting a fresh bubble. This time, in housing.
You'll also find that, even with last week's carnage, the stock market still has not corrected to where its long-term sustainable growth rate would peg it. That level is around 7-8,000 on the Dow, or about 700 on the S&P, or about 1,400 on the NASDAQ.
So we're fairly close. The bad news is, the way corrections work, the market may fall below that mark, then rebound to it.
In the case of stock prices, it is theoretically easier for the government to intervene in a way that props them up, than it is for house prices.
They can simply keep pumping federal money into the economy until growth resumes, and stock prices go up on the prospects for that growth.
But for one thing, that only creates a new bubble. And three massive bubbles in a row, within a relatively short time frame, would totally destroy the US economy, and take the rest of the world with it.
And for another, the theory doesn't work when you're facing a trillion dollar deficit, and when your national debt is approaching 100% of GDP.
You then become a net-debtor nation, and in order to finance all that spending, you have to a) raise taxes by a massive amount, which further depresses spending and investment and causes further economic decline, as happened when Hoover raised taxes in 1932, and b) pay much higher interest rates on government debt you issue, in order to entice foreign investors, who hold the bulk of it, to buy more.
Folks, that is already happening. The ten-year Treasury yield has been rising since the last rate cut. Why? The ten-year note, since it matures in ten years, anticipates future events. A ten-year note trades like a strip of ten one-year bills. And if investors think that bill yields will go higher over the next ten years, they demand higher rates on the ten-year note.
What happens when those rates go up? Well, for one thing, 30-year fixed-rate mortgages are priced off the ten-year. So mortgage rates will go up, even if the Fed cuts the funds target to zero. That won't help solve the housing-led crisis we're in.
Another consequence is that the government has to print even more money, because it's now paying even more in interest - money it doesn't have, because it's still deficit spending. So the deficit gets wider, and that drives rates higher, in a never-ending inflationary spiral.
And they might as well buy every man, woman and child in the country a wheelbarrow in which to take their worthless US dollars to the grocery store.
So here's another truth, and another consequence: when you've enjoyed well-above-trend returns on your 401(k) for several years, you have to expect well-below-trend returns - and probably losses - for a while to get you back on trend. You should plan on the trend, take the good times with a grain of salt, and not worry through the bad times. And, as you near retirement, get out of the risky stuff to an increasing degree.
"We have to keep people from losing their homes."
This is closely related to the home price issue, and I've addressed it before, so I won't belabor it. But here's one important point.
Let's say we're going to pursue the McCain solution of refinancing all the "bad" mortgages into 30-year, fixed rate mortgages at 5.25%. Besides the near-impossible task of finding who now owns all those mortgages, piecing the tranches back together into whole loans, and buying them up - and besides the fact that most of those mortgagors won't be able to make the payments even at 5.25% now - here's the fundamental flaw:
Who will hold the mortgages? Banks won't. They're currently getting more than 5.25% on the mortgages they make. And they're through with making loans to people with impaired credit, who probably won't pay them back.
Investors won't either, for the same reasons. Their risk appetite has waned considerably. And they're back to pricing risk appropriately. So they won't pay par for a 5.25% mortgage-backed bond with a ton of credit risk.
That leaves Uncle Sam - you and me. And that's just what's being proposed. They say we'll ultimately make money on this.
So we're going to accept a 5.25% return on mortgages in a 6%-plus market, with rates sure to rise even further. And suffer eventual default rates that are about what they currently are on the subprime ARMs we're replacing.
Tell me again how we make money on that trade?
Fact is, we don't. We lose on the subsidized yield, we lose even more in a rising rate environment, and we suffer principal losses when they default - which, by the way leads to another glut of foreclosed homes on the market, which creates another overall housing slump.
And the ultimate direct cost to the taxpayer alone will be much, much more than $300 billion.
So, once more, it is both a truth and a consequence that more people are going to lose their homes.
"If we don't do something, people are going to lose their jobs."
Guess what? They already are. And that happens in every recession. Is the government proposing to guarantee that everyone has a job? (Perhaps - the trial balloon of resurrecting the WPA has already been floated .)
Furthermore, about 800,000 people have already lost their jobs since January. If the government spends a ton of money ensuring, somehow, that no one will lose their job going forward, how do they explain the timing of their actions to the guy or gal that got canned in January?
Truth and consequence: more people are going to lose their jobs.
"If we don't act now, more banks will fail."
How many new banks and bank branches have cropped up on every street corner over the past ten years? Can't we live with a few less banks?
Look, bank growth exploded during the housing bubble, because everybody wanted to get into the hyper-profitable lend-and-sell loan game. So it is only a natural consequence that the number of banks will contract when the demand for credit drops sharply.
During the S&L crisis, 747 institutions failed. Thus far in this debacle, 15 have gone down.
The truth is, we have a long, long way to go before we get back to equilibrium.
"We have to un-freeze the credit markets so people will start borrowing again."
Why are so many people whose ARM rates, and thus their mortgage payments, risen, defaulting on the loans?
Because they can't afford the higher mortgage payments when they already have two six-year car loans on brand-new luxury cars they bought with no money down, and several maxed-out credit cards, which combined eat up all of their take-home pay.
As with the banks, we need less credit right now. It is a natural and healthy cleansing of a system that got bloated with greed and excess, which was unnatural and unhealthy. So let's purge it.
More borrowing is not the answer. It's like a glutton who becomes obscenely obese, to the point that he becomes diabetic and has a heart attack.
So the doctors put him in the hospital and work to regulate his blood sugar and do a triple bypass. But they say, "Why, he's become so accustomed to his three milkshakes a day and his quart of ice cream at bedtime - we can't deprive him of that!" So they continue to gorge him. What eventually happens?
Again, I am totally sympathetic to the notion of people losing their jobs, their homes, and a portion of their retirement savings. A big part of the problem, though, is that we focus on those things, and place our faith in dollar-denominated things.
We have survived recessions before. Some of us have lived in poverty. Some of us have survived even worse: the Holocaust, ethnic cleansing in Eastern Europe or Africa, etc.
The key word is "survive." Many who have made it through bad experiences unscathed have been able to do so by placing our faith in the only One that can ultimately sustain us.
But in a nation that increasingly attempts to separate itself from the Creator it acknowledged at its birth, we're becoming increasingly reliant on government - man - to fix things.
And they can't.
The more they try, the worse it gets. So please, Washington, get the message: go home. Visit your constituents. Listen to them, not to your pals on Wall Street. Pay attention when they tell you, "Enough, already!" Then go on a nice junket or whatever you do on your lengthy recesses.
Because the more you spend, the worse it ultimately gets.
The fundamental message is, "We do not have faith in you."
Sunday, October 12, 2008
Of Prophets
In a recent post I quoted the prophet Isaiah, who apparently foretold the housing bust. Okay, not really, but he did wisely warn against the perils of greed, and the consequences of excess.
Here's one more gem from Isaiah, this time chapter 15, verse 9:
"Dimon's waters are full of blood, but I will bring still more upon Dimon ..."
For the uninitiated, the CEO of JPMorgan Chase, which acquired what was left of Bear Stearns in a federally-assisted shotgun wedding in March, and which is rumored to have forced the sale of Merrill Lynch to B of A by calling in Merrill's lines of credit, is a man named ...
Jamie Dimon.
Back when Dimon was CEO of Bank One, he was reported to have once said about the banks' competitors, "I hate them! I want them to bleed!" Hmmm.
Now, I'm no Isaiah, but I thought I'd retrace some of my prognostications over the past year and a half. Not to pat myself on the back, but to establish some street cred - or should I say Street cred, as in Wall Street - before talking a bit about what's coming. And that needs to be talked about, because no one in the media is talking about it, nor is anyone in Washington, or on Wall Street, or on Main Street (by the way, if I hear a politician utter the "Wall Street - Main Street" sound bite one more time, I swear I will vomit).
April, 2007. In an article titled, "The US Economy in 2007: Headed South for the Winter?", which appeared in our company's newsletter, MarketCast (you can read it at www.cnbsnet.com; click on "MarketCast," then "Search all MarketCast articles," then use the pull-down menu to pick the month and year), I predicted a recession in late 2007 or early 2008.
The tools I used to make this call were the behavioral patterns of three economic indicators that have proven to be generally reliable predictors of recessions: the Chicago Purchasing Managers' Index, the Leading Economic Indicators index on a year-over-year basis, and the spread between the two- and ten-year Treasury note yields. All three signs pointed to a recession six to 12 months hence.
Now, we have not yet met the traditional definition of a recession, defined by the National Bureau of Economic Research (NBER) as two or more consecutive quarters of negative GDP growth. But the last recession, in 2001, didn't even meet that definition, even though the NBER recognized it as a recession.
And many economists - including yours truly - believe the NBER definition is useless, as it means a recession can only be identified in hindsight. It's like driving a car on a mountain road, with tight curves and steep drop-offs, navigating with nothing but your rear-view mirror.
And many economists are now saying we've been in a functional recession since the first quarter.
May, 2007. I followed up with another MarketCast article whose title was taken from a famous quote by then-President George H.W. Bush: "As Housing Goes, So Goes the Economy?" In that piece, I used the historical relationship between the National Association of Home Builders (NAHB) sentiment index and the S&P 500 (as a proxy for the health of the economy) to predict a recession, and a downturn in the stock market.
A steep one.
The correlation between the NAHB index and the S&P, lagged about 18 months (the idea being that housing downturns lead economic contractions by about that length of time) is quite high - over 83% at the time I wrote the article. Also at that time, the NAHB index appeared to have begun to turn up. So on that basis, I predicted we'd see the S&P start dropping, and fall for about 18 months, which would have put the bottom at about November of this year. I called for a "sharp correction," but stopped short of pegging the S&P's ultimate low at the point suggested by the trend.
That low was 600. The S&P closed at 899 Friday, and traded below 840.
But, the NAHB index did not continue rising. It fell further, and sharply. At the time of the article's publication, the latest reading was around 40, after it had hit a bottom of 30 a few months earlier. It ultimately fell as low as 16, just a couple months ago. Then it ticked up to 18 last month.
It's due out next week, and is forecast to have fallen back down to 17. In other words, we may not have seen the bottom yet. Even if we have, though, the bottom in the S&P is likely about 16 months from now. I don't want to think about the level.
December, 2007. I wrote a follow-up piece titled, "Recession Indicators Revisited." In it, I noted that there had been significant fluctuation in the Chicago Purchasing Managers' Index, thus the signal was not entirely clear. But I noted that the only support for the factory sector in 2007 had been foreign demand for US exports, which were cheap due to the dollar's weakness versus most foreign currencies, as economies abroad were, at the time, relatively healthy.
I maintained my LEI year-over-year prediction, and I noted that the duration of the most recent yield curve inversion might lengthen the time between the two-year/ten-year spread reaching a positive 50 basis points (half a percent) and the onset of recession. And I noted the reversal of fortunes for the NAHB index.
I also added this warning:
"[T]he domestic economy has been sustained to some degree this time by a more global economy. That latter point has resulted in strong foreign demand from robust economies abroad that have sustained output in the U.S., owing in large part to the ever-weakening dollar. But some of those economies are at fragile points themselves, and several have their own mounting housing crises. We've seen the spread of the U.S. housing contagion overseas; it'll be that much worse when other countries' housing slumps hit full bloom. And the worst isn't yet over for our own housing market."
Finally, I addressed the Dow Theory, which holds that holds that a bearish trend in the Transportation Index, accompanied by the testing of a recent low in the Industrials, indicates the beginning of a full-fledged bear market in the Industrial Average. I noted that those conditions had been met in November, signaling a bear market may be underway.
Of course, we now know the market peaked in October, and now easily meets the definition of a bear market.
I've also given numerous presentations over the last year where I predicted housing would not recover before 2010; that credit market conditions would become dire; that the more the government intervened, the worse things would get; and that we could face a prolonged and painful downturn - by "prolonged and painful" I mean something akin to Japan's "Lost Decade," or, with sufficient government monkeying, a depression. Some of this doom and gloom you've read here.
A quick recap of some other, recent warnings:
1. A week before Labor Day, I predicted Fannie and Freddie would fail by the holiday. Missed that one by six days.
2. On Friday, September 12, I predicted that Lehman would go belly-up or be rescued the following Monday. Nailed that one. I also predicted that WaMu was toast. The toast was done two weeks later.
3. In our firm's quarterly economic outlook contest, my predictions for the third quarter were the most dire that I or anyone else in the company had ever made.
They were also the most accurate since we've been doing the forecast.
4. I should also point out that I bailed out of stocks in my daughter's 529 plan last October, and in the rest of our accounts in March. We even went short the market in my wife's IRA, which is up a healthy 60% since then - and that's not annualized.
Now, I'd like to turn my attention to a brief (for me) overview of what's to come - and these things are not yet fully priced into stocks.
Manufacturing
As I noted, the factory sector, normally a casualty of an economic downturn, remained resilient through 2007 and the first half of 2008 due to the weak dollar and strong foreign demand. But my prediction that foreign economies would soon weaken has come true, in spades. Heck, the entire nation of Iceland may go bankrupt, and take much of the British banking system with it.
The result of the rapid weakening of foreign demand has been a most unwelcome inventory bulge in US factories and businesses. That's evident in the Wholesale and Business Inventories series, both of which were still rising at last check. But these data series lag, so "last check" in this case is August.
More recent evidence is available from the regional Fed banks' survey-based manufacturing indices, plus the Chicago Purchasing Managers' Index noted above, and the national Institute for Supply Management Index. These measures are coincident, meaning the data is released during the month for which it reports. We'll see the first of these numbers for October next week, for example. And the forecasts are gloomy.
But - more important - beginning in September we started to see the inventory components of those measures come down. Way down. How do factories reduce inventory overhangs, when nobody's buying anymore?
1. Slash prices, which hurts profits.
2. Slash production, which idles workers.
Both measures result in layoffs.
So here's the factory sector outlook: a sharp contraction in the fourth quarter, and weakness throughout 2009, and at least until both domestic and global economies gain strength. Which could be quite a while.
Retail
Retailers are bracing for a dismal holiday season. Consumer credit actually contracted - meaning people paid off more than they borrowed - for the first time in more than a decade in August, posting the sharpest drop ever.
Why is that significant? Three reasons. First, August is back-to-school shopping month, the penultimate month in the retailer's season. Second, August saw a spike in auto sales due to deep end-of-model-year discounting. Absent the auto lending that took place in August, how much more would credit have contracted? And third, August pre-dated the current "credit freeze" everyone's screeching about.
Look for retailers' fourth-quarter numbers to be down. Way down. And look for major retrenchment in the sector after year-end.
Employment
One of my predictions throughout the first quarter of 2007 was that we'd see jobless claims begin to trend higher in the second quarter. I was wrong. I missed it by a quarter. Claims began trending upward in July, with the pace accelerating in November, then going vertical of late. The US economy has suffered net job losses every month this year, and the total loss is around 800,000 jobs.
That's about half what we'll lose next year.
Part of the reason for that is the continued decline in the financial sector and construction. Part of it is that companies that have been able to hang on by just letting attrition run its course and freezing new hires, will have to start cutting. That hasn't been widespread yet. It will be in 2009. And part of it is that the previously resilient factory and retail sectors will, as noted above, slow sharply.
Housing
The correction is not done yet. The bottom hasn't arrived. Inventories are still too high. And now the negative wealth effect from stocks' decline is sidelining more would-be buyers, which will prolong the downturn.
And, starting in 2010, we're going to see the beginnings of a non-bubble-related, systematic housing correction, one that has to do with the aging of the Baby Boomers and their reduced demand for housing, with fewer Gen X, Y, Z, Millennials, and whoever else is coming up the ranks to fill those vacated homes.
Stocks panicked last week, primarily over the "credit freeze," and lawmakers' impotence in staving off a recession, which market participants should know is impossible. So in essence, we've begun, finally, to price a recession into stocks.
But we have yet to price in the earnings numbers we're going to see from the factory sector for the fourth quarter, and the outlooks they'll print for 2009. We have yet to see the retailers' holiday numbers, or their 2009 guidance. We have yet to see the labor trends. And we have yet to see the bottom in housing, or the end of bank failures.
None of that is priced into the market. So when those things come to realization, the market will go down further.
Tomorrow, we'll take a look at the consequences of excess and leverage, and why government should stop the madness and just leave the markets alone.
Here's one more gem from Isaiah, this time chapter 15, verse 9:
"Dimon's waters are full of blood, but I will bring still more upon Dimon ..."
For the uninitiated, the CEO of JPMorgan Chase, which acquired what was left of Bear Stearns in a federally-assisted shotgun wedding in March, and which is rumored to have forced the sale of Merrill Lynch to B of A by calling in Merrill's lines of credit, is a man named ...
Jamie Dimon.
Back when Dimon was CEO of Bank One, he was reported to have once said about the banks' competitors, "I hate them! I want them to bleed!" Hmmm.
Now, I'm no Isaiah, but I thought I'd retrace some of my prognostications over the past year and a half. Not to pat myself on the back, but to establish some street cred - or should I say Street cred, as in Wall Street - before talking a bit about what's coming. And that needs to be talked about, because no one in the media is talking about it, nor is anyone in Washington, or on Wall Street, or on Main Street (by the way, if I hear a politician utter the "Wall Street - Main Street" sound bite one more time, I swear I will vomit).
April, 2007. In an article titled, "The US Economy in 2007: Headed South for the Winter?", which appeared in our company's newsletter, MarketCast (you can read it at www.cnbsnet.com; click on "MarketCast," then "Search all MarketCast articles," then use the pull-down menu to pick the month and year), I predicted a recession in late 2007 or early 2008.
The tools I used to make this call were the behavioral patterns of three economic indicators that have proven to be generally reliable predictors of recessions: the Chicago Purchasing Managers' Index, the Leading Economic Indicators index on a year-over-year basis, and the spread between the two- and ten-year Treasury note yields. All three signs pointed to a recession six to 12 months hence.
Now, we have not yet met the traditional definition of a recession, defined by the National Bureau of Economic Research (NBER) as two or more consecutive quarters of negative GDP growth. But the last recession, in 2001, didn't even meet that definition, even though the NBER recognized it as a recession.
And many economists - including yours truly - believe the NBER definition is useless, as it means a recession can only be identified in hindsight. It's like driving a car on a mountain road, with tight curves and steep drop-offs, navigating with nothing but your rear-view mirror.
And many economists are now saying we've been in a functional recession since the first quarter.
May, 2007. I followed up with another MarketCast article whose title was taken from a famous quote by then-President George H.W. Bush: "As Housing Goes, So Goes the Economy?" In that piece, I used the historical relationship between the National Association of Home Builders (NAHB) sentiment index and the S&P 500 (as a proxy for the health of the economy) to predict a recession, and a downturn in the stock market.
A steep one.
The correlation between the NAHB index and the S&P, lagged about 18 months (the idea being that housing downturns lead economic contractions by about that length of time) is quite high - over 83% at the time I wrote the article. Also at that time, the NAHB index appeared to have begun to turn up. So on that basis, I predicted we'd see the S&P start dropping, and fall for about 18 months, which would have put the bottom at about November of this year. I called for a "sharp correction," but stopped short of pegging the S&P's ultimate low at the point suggested by the trend.
That low was 600. The S&P closed at 899 Friday, and traded below 840.
But, the NAHB index did not continue rising. It fell further, and sharply. At the time of the article's publication, the latest reading was around 40, after it had hit a bottom of 30 a few months earlier. It ultimately fell as low as 16, just a couple months ago. Then it ticked up to 18 last month.
It's due out next week, and is forecast to have fallen back down to 17. In other words, we may not have seen the bottom yet. Even if we have, though, the bottom in the S&P is likely about 16 months from now. I don't want to think about the level.
December, 2007. I wrote a follow-up piece titled, "Recession Indicators Revisited." In it, I noted that there had been significant fluctuation in the Chicago Purchasing Managers' Index, thus the signal was not entirely clear. But I noted that the only support for the factory sector in 2007 had been foreign demand for US exports, which were cheap due to the dollar's weakness versus most foreign currencies, as economies abroad were, at the time, relatively healthy.
I maintained my LEI year-over-year prediction, and I noted that the duration of the most recent yield curve inversion might lengthen the time between the two-year/ten-year spread reaching a positive 50 basis points (half a percent) and the onset of recession. And I noted the reversal of fortunes for the NAHB index.
I also added this warning:
"[T]he domestic economy has been sustained to some degree this time by a more global economy. That latter point has resulted in strong foreign demand from robust economies abroad that have sustained output in the U.S., owing in large part to the ever-weakening dollar. But some of those economies are at fragile points themselves, and several have their own mounting housing crises. We've seen the spread of the U.S. housing contagion overseas; it'll be that much worse when other countries' housing slumps hit full bloom. And the worst isn't yet over for our own housing market."
Finally, I addressed the Dow Theory, which holds that holds that a bearish trend in the Transportation Index, accompanied by the testing of a recent low in the Industrials, indicates the beginning of a full-fledged bear market in the Industrial Average. I noted that those conditions had been met in November, signaling a bear market may be underway.
Of course, we now know the market peaked in October, and now easily meets the definition of a bear market.
I've also given numerous presentations over the last year where I predicted housing would not recover before 2010; that credit market conditions would become dire; that the more the government intervened, the worse things would get; and that we could face a prolonged and painful downturn - by "prolonged and painful" I mean something akin to Japan's "Lost Decade," or, with sufficient government monkeying, a depression. Some of this doom and gloom you've read here.
A quick recap of some other, recent warnings:
1. A week before Labor Day, I predicted Fannie and Freddie would fail by the holiday. Missed that one by six days.
2. On Friday, September 12, I predicted that Lehman would go belly-up or be rescued the following Monday. Nailed that one. I also predicted that WaMu was toast. The toast was done two weeks later.
3. In our firm's quarterly economic outlook contest, my predictions for the third quarter were the most dire that I or anyone else in the company had ever made.
They were also the most accurate since we've been doing the forecast.
4. I should also point out that I bailed out of stocks in my daughter's 529 plan last October, and in the rest of our accounts in March. We even went short the market in my wife's IRA, which is up a healthy 60% since then - and that's not annualized.
Now, I'd like to turn my attention to a brief (for me) overview of what's to come - and these things are not yet fully priced into stocks.
Manufacturing
As I noted, the factory sector, normally a casualty of an economic downturn, remained resilient through 2007 and the first half of 2008 due to the weak dollar and strong foreign demand. But my prediction that foreign economies would soon weaken has come true, in spades. Heck, the entire nation of Iceland may go bankrupt, and take much of the British banking system with it.
The result of the rapid weakening of foreign demand has been a most unwelcome inventory bulge in US factories and businesses. That's evident in the Wholesale and Business Inventories series, both of which were still rising at last check. But these data series lag, so "last check" in this case is August.
More recent evidence is available from the regional Fed banks' survey-based manufacturing indices, plus the Chicago Purchasing Managers' Index noted above, and the national Institute for Supply Management Index. These measures are coincident, meaning the data is released during the month for which it reports. We'll see the first of these numbers for October next week, for example. And the forecasts are gloomy.
But - more important - beginning in September we started to see the inventory components of those measures come down. Way down. How do factories reduce inventory overhangs, when nobody's buying anymore?
1. Slash prices, which hurts profits.
2. Slash production, which idles workers.
Both measures result in layoffs.
So here's the factory sector outlook: a sharp contraction in the fourth quarter, and weakness throughout 2009, and at least until both domestic and global economies gain strength. Which could be quite a while.
Retail
Retailers are bracing for a dismal holiday season. Consumer credit actually contracted - meaning people paid off more than they borrowed - for the first time in more than a decade in August, posting the sharpest drop ever.
Why is that significant? Three reasons. First, August is back-to-school shopping month, the penultimate month in the retailer's season. Second, August saw a spike in auto sales due to deep end-of-model-year discounting. Absent the auto lending that took place in August, how much more would credit have contracted? And third, August pre-dated the current "credit freeze" everyone's screeching about.
Look for retailers' fourth-quarter numbers to be down. Way down. And look for major retrenchment in the sector after year-end.
Employment
One of my predictions throughout the first quarter of 2007 was that we'd see jobless claims begin to trend higher in the second quarter. I was wrong. I missed it by a quarter. Claims began trending upward in July, with the pace accelerating in November, then going vertical of late. The US economy has suffered net job losses every month this year, and the total loss is around 800,000 jobs.
That's about half what we'll lose next year.
Part of the reason for that is the continued decline in the financial sector and construction. Part of it is that companies that have been able to hang on by just letting attrition run its course and freezing new hires, will have to start cutting. That hasn't been widespread yet. It will be in 2009. And part of it is that the previously resilient factory and retail sectors will, as noted above, slow sharply.
Housing
The correction is not done yet. The bottom hasn't arrived. Inventories are still too high. And now the negative wealth effect from stocks' decline is sidelining more would-be buyers, which will prolong the downturn.
And, starting in 2010, we're going to see the beginnings of a non-bubble-related, systematic housing correction, one that has to do with the aging of the Baby Boomers and their reduced demand for housing, with fewer Gen X, Y, Z, Millennials, and whoever else is coming up the ranks to fill those vacated homes.
Stocks panicked last week, primarily over the "credit freeze," and lawmakers' impotence in staving off a recession, which market participants should know is impossible. So in essence, we've begun, finally, to price a recession into stocks.
But we have yet to price in the earnings numbers we're going to see from the factory sector for the fourth quarter, and the outlooks they'll print for 2009. We have yet to see the retailers' holiday numbers, or their 2009 guidance. We have yet to see the labor trends. And we have yet to see the bottom in housing, or the end of bank failures.
None of that is priced into the market. So when those things come to realization, the market will go down further.
Tomorrow, we'll take a look at the consequences of excess and leverage, and why government should stop the madness and just leave the markets alone.
Thursday, October 9, 2008
What You Permit, You Promote
Since hearing a parenting expert utter that phrase on the radio, my wife has had the saying prominently posted on our refrigerator.
And, as she noted today, it applies as equally to managing or regulating a business as it does to raising a child.
Yesterday I commented on the fact that AIG, having received a bailout in the form of an $85 billion loan from the Fed, celebrated by holding a $440,000 boondoggle at a posh resort, including $23,000 worth of spa treatments. (Okay, not really; they already had the event planned, but they still lacked the judgment to cancel it. Or at least cut back on the perks.)
Late yesterday, after the market closed, I watched in disbelief as Bubblevision announced the Fed's reaction to learning of its new beneficiary's spendthrift ways:
They loaned AIG an additional $37 billion.
Let's put this in parenting terms. Your kid gets a job mowing lawns - very enterprising. But he doesn't maintain his lawnmower, and he squanders his money on video games and thus can't buy gas, let alone pay to fix the machine.
So you give him money to fix it, and the first thing he does is go out and buy more video games. When he brings them home, you give him more money to fix the mower and buy gas.
What you permit, you promote.
So what news did we get this morning?
Junior was headed to the video game store again.
Yes, AIG's execs announced they had another boondoggle planned next week at the posh Ritz-Carlton resort at Half Moon Bay in California. (At least they're doing their part to stimulate the beleaguered California economy. Maybe Arnold won't need that $7 billion loan from Paulson after all.)
The highlight of the Bloomberg story about the planned second junket was this gem:
"AIG considered buying advertisements to explain its position, only to be told by its public-relations consultant, George Sard, that it would be 'a really bad idea.'"
No kidding.
Sard went on: "To spend the taxpayer's money on an expensive ad campaign to apologize for how you used taxpayer money leaves you open to further attacks."
Forget the boondoggles or the proposed ad campaign. That the guys in charge at AIG have to hire a PR consultant - using taxpayer money - to explain this to them is wretched excess enough. They should be summarily canned, not for the boondoggles, but for not being smart enough to run a business.
Later this morning, the upcoming conference was canceled "after a re-evaluation of the costs under the new circumstances." AIG's CEO told Hank Paulson yesterday that management would "rethink expenses," according to Bloomberg. But apparently it took the backlash from this morning's annouced second boondoggle to make them think hard enough to make a good decision. Sheesh.
This is also an object lesson in government intervention, and why it is always, always wrong.
Part of AIG's problem all along - as with the other institutions that find themselves on the brink of failure these days - is that they spent too lavishly. To cover the spending, they took on too much risk. They made money off a bubble. Times were good. So they spent even more.
Then the bubble burst.
But they didn't stop spending. Had we not bailed them out, they'd have either failed, in which case the lavish over-spending would have stopped, or they'd have been forced to slash spending to survive. Either way, the bad behavior ends.
However, when we bailed them out, they continued their errant ways, then we gave them more money, so they saw no reason to change their behavior. Until they got spanked for it.
What you permit, you promote.
That's why you have to let poorly-run businesses, who've taken excessive risks and ignored prudent expense management, to fail. Just as you'd let your kid fail if he was being irresponsible. (Okay, in some instances you'd bail your kid out. But you love your kid. You don't "love" a company.)
On a related note, sometimes intervening isn't the right thing to do because it doesn't address the root problem. Let's use another parenting analogy. Your kid develops a thyroid problem and begins to gain weight. You think it's because he must be eating too much, so you starve him, and he gets really, really sick.
That's somewhat similar to the short-selling ban that the SEC extended three days past the passage of the bailout bill. Their "thinking" was that it was short-sellers that were driving down the stock prices of the financials, threatening their failure.
The ban expired at midnight last night, so the short sellers were back in the market today.
In the three trading days that the ban was in effect, the Dow shed about 1,500 points. So with the short sellers out of the market, stocks tanked.
Today, the Dow is down again, but by the least amount since the bailout was passed, at least as of mid-afternoon.
Gee, with the short sellers back in the market, you'd think it would be down a million points.
Short sellers did not cause bank stocks to tank. Crappy balance sheets full of still-overvalued crappy securities caused bank stocks to tank.
************
A couple of random thoughts for the day. Britain's bank bailout will entail the UK government buying equity stakes in banks, effectively infusing them with much-needed capital to make loans. Instead of just buying their crappy bonds at prices above market value and sticking taxpayers with the losses when they sell them.
Sound like a better plan than ours? Hank Paulson thinks so, too. He announced this morning that that is exactly what he's going to do with at least part of the bailout money.
This guy is running around like a chicken with its head cut off, without the foggiest notion what to do about this mess or how much it'll cost. Then, when somebody else does it right, he sees the light, and copies them.
He should be fired. Now. Let Britain's Exchequer run the US Treasury Department too. He's apparently a pretty smart guy.
So a friend of mine who's a private wealth manager, hearing the news that the US taxpayer will now be buying into the banking sector, e-mailed me and said that he's been trying to keep his clients out of bank stocks all year, and now his efforts have proven futile.
The other thought for the day is a grim one. I've said before that we're in uncharted waters. Never in my life have I seen or heard things like the comment a while back from S&P that if the government keeps taking on debt, it might have to review the credit ratings on US Treasuries.
Speaking of that, I also saw last night that the Treasury is going to revive some of the maturities that were retired back when we were running a surplus. I think the specific headline on the news ticker was something like "Treasury to bring back certain security structures to address borrowing needs."
What does that obtuse statement mean?
It means they don't think there's enough demand for the current line-up of three-, six-, and twelve-month bills, two-, five-, and ten-year notes, and 30-year bonds to entice enough buyers for all the debt the US is going to have to take on to fund all these bailouts. So they're throwing the kitchen sink at the market, hoping they'll bring some more buyers out of the woodwork.
Oh, they will. But at much higher interest rates. Risk is being priced appropriately these days, for the first time in a very long time. And the US as a nation is becoming an increasingly risky investment. Looking more like subprime every day, in fact. Could somebody with a 90% debt-to-income ratio get a loan today? Of course they couldn't. So how does the US government expect to?
Final thought along these "I never thought I'd hear this" lines. An article from Reuters today led with this ominous line (emphasis added):
"The United States moved closer to taking equity stakes in banks on Thursday ahead of a G7 meeting of economic powers trying to stave off world financial ruin."
And, as she noted today, it applies as equally to managing or regulating a business as it does to raising a child.
Yesterday I commented on the fact that AIG, having received a bailout in the form of an $85 billion loan from the Fed, celebrated by holding a $440,000 boondoggle at a posh resort, including $23,000 worth of spa treatments. (Okay, not really; they already had the event planned, but they still lacked the judgment to cancel it. Or at least cut back on the perks.)
Late yesterday, after the market closed, I watched in disbelief as Bubblevision announced the Fed's reaction to learning of its new beneficiary's spendthrift ways:
They loaned AIG an additional $37 billion.
Let's put this in parenting terms. Your kid gets a job mowing lawns - very enterprising. But he doesn't maintain his lawnmower, and he squanders his money on video games and thus can't buy gas, let alone pay to fix the machine.
So you give him money to fix it, and the first thing he does is go out and buy more video games. When he brings them home, you give him more money to fix the mower and buy gas.
What you permit, you promote.
So what news did we get this morning?
Junior was headed to the video game store again.
Yes, AIG's execs announced they had another boondoggle planned next week at the posh Ritz-Carlton resort at Half Moon Bay in California. (At least they're doing their part to stimulate the beleaguered California economy. Maybe Arnold won't need that $7 billion loan from Paulson after all.)
The highlight of the Bloomberg story about the planned second junket was this gem:
"AIG considered buying advertisements to explain its position, only to be told by its public-relations consultant, George Sard, that it would be 'a really bad idea.'"
No kidding.
Sard went on: "To spend the taxpayer's money on an expensive ad campaign to apologize for how you used taxpayer money leaves you open to further attacks."
Forget the boondoggles or the proposed ad campaign. That the guys in charge at AIG have to hire a PR consultant - using taxpayer money - to explain this to them is wretched excess enough. They should be summarily canned, not for the boondoggles, but for not being smart enough to run a business.
Later this morning, the upcoming conference was canceled "after a re-evaluation of the costs under the new circumstances." AIG's CEO told Hank Paulson yesterday that management would "rethink expenses," according to Bloomberg. But apparently it took the backlash from this morning's annouced second boondoggle to make them think hard enough to make a good decision. Sheesh.
This is also an object lesson in government intervention, and why it is always, always wrong.
Part of AIG's problem all along - as with the other institutions that find themselves on the brink of failure these days - is that they spent too lavishly. To cover the spending, they took on too much risk. They made money off a bubble. Times were good. So they spent even more.
Then the bubble burst.
But they didn't stop spending. Had we not bailed them out, they'd have either failed, in which case the lavish over-spending would have stopped, or they'd have been forced to slash spending to survive. Either way, the bad behavior ends.
However, when we bailed them out, they continued their errant ways, then we gave them more money, so they saw no reason to change their behavior. Until they got spanked for it.
What you permit, you promote.
That's why you have to let poorly-run businesses, who've taken excessive risks and ignored prudent expense management, to fail. Just as you'd let your kid fail if he was being irresponsible. (Okay, in some instances you'd bail your kid out. But you love your kid. You don't "love" a company.)
On a related note, sometimes intervening isn't the right thing to do because it doesn't address the root problem. Let's use another parenting analogy. Your kid develops a thyroid problem and begins to gain weight. You think it's because he must be eating too much, so you starve him, and he gets really, really sick.
That's somewhat similar to the short-selling ban that the SEC extended three days past the passage of the bailout bill. Their "thinking" was that it was short-sellers that were driving down the stock prices of the financials, threatening their failure.
The ban expired at midnight last night, so the short sellers were back in the market today.
In the three trading days that the ban was in effect, the Dow shed about 1,500 points. So with the short sellers out of the market, stocks tanked.
Today, the Dow is down again, but by the least amount since the bailout was passed, at least as of mid-afternoon.
Gee, with the short sellers back in the market, you'd think it would be down a million points.
Short sellers did not cause bank stocks to tank. Crappy balance sheets full of still-overvalued crappy securities caused bank stocks to tank.
************
A couple of random thoughts for the day. Britain's bank bailout will entail the UK government buying equity stakes in banks, effectively infusing them with much-needed capital to make loans. Instead of just buying their crappy bonds at prices above market value and sticking taxpayers with the losses when they sell them.
Sound like a better plan than ours? Hank Paulson thinks so, too. He announced this morning that that is exactly what he's going to do with at least part of the bailout money.
This guy is running around like a chicken with its head cut off, without the foggiest notion what to do about this mess or how much it'll cost. Then, when somebody else does it right, he sees the light, and copies them.
He should be fired. Now. Let Britain's Exchequer run the US Treasury Department too. He's apparently a pretty smart guy.
So a friend of mine who's a private wealth manager, hearing the news that the US taxpayer will now be buying into the banking sector, e-mailed me and said that he's been trying to keep his clients out of bank stocks all year, and now his efforts have proven futile.
The other thought for the day is a grim one. I've said before that we're in uncharted waters. Never in my life have I seen or heard things like the comment a while back from S&P that if the government keeps taking on debt, it might have to review the credit ratings on US Treasuries.
Speaking of that, I also saw last night that the Treasury is going to revive some of the maturities that were retired back when we were running a surplus. I think the specific headline on the news ticker was something like "Treasury to bring back certain security structures to address borrowing needs."
What does that obtuse statement mean?
It means they don't think there's enough demand for the current line-up of three-, six-, and twelve-month bills, two-, five-, and ten-year notes, and 30-year bonds to entice enough buyers for all the debt the US is going to have to take on to fund all these bailouts. So they're throwing the kitchen sink at the market, hoping they'll bring some more buyers out of the woodwork.
Oh, they will. But at much higher interest rates. Risk is being priced appropriately these days, for the first time in a very long time. And the US as a nation is becoming an increasingly risky investment. Looking more like subprime every day, in fact. Could somebody with a 90% debt-to-income ratio get a loan today? Of course they couldn't. So how does the US government expect to?
Final thought along these "I never thought I'd hear this" lines. An article from Reuters today led with this ominous line (emphasis added):
"The United States moved closer to taking equity stakes in banks on Thursday ahead of a G7 meeting of economic powers trying to stave off world financial ruin."
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