Posts Tagged: Federal Reserve

Banking / Economics / Financial / Political — 0 Comments
26
Aug 10

Artificial Sweeteners Turn Sour

Last week in Artificial Sweeteners we discussed how government intervention has distorted the economy, the stock market and the housing market.  The basic thesis:

Excessive economic stimulus and a misguided zero interest rate policy has created false bottoms in the housing and stock markets.   See Artificial Sweeteners

Dour economic statistics released this past week only confirm that thesis.  While extrapolating from one month’s statistics is dangerous, nevertheless the numerosity and interrelated nature of recent reports raises questions whether there ever was an economic recovery.

Scanning the Headlines

The past week we have been bombarded by negative economic reports from housing to employment to durable goods.  A quick look at the headlines:

The Super Sweetener

The Congressional Budget Office calculates that stimulus added 4.5% to GDP.  Further, these programs created up to 3.3m jobs.   One estimate is that without stimulus, GDP would have been negative 3.5%.   What happens next?

So now that the stimulus is tapering off, America has the following rather unpleasant things to look forward to: a 4.5% reduction in run rate GDP as the direct economic boost disappears, the gradual loss of 1.4 to 3.3 million jobs, and the eventual realization that non-recurring, one time items can not be projected into perpetuity, despite what Keynesian dogma may preach. See CBO Estimates that Stimulus Boosted Q2 GDP by 4.5%, Standalone Number is likely under around -3.5%

Shoveling Money to No Avail

Morton Zuckerman captures the folly of current economic policy:

Tons of money have been shoveled in to rescue reckless banks and fill the huge hole in the economy, but nothing is working the way it normally had in all our previous crises. See End of American Optimism

All we have created is a “new normal” of slow or little growth. Compared to sales growth of 4% in past recessions, sales are increasing at a little over 1%.

…there are at least 14.5 million Americans still searching for work: 1.4 million of them have been jobless for more than 99 weeks, 6.5 million have been jobless for over 27 weeks. This is a stunning reflection of the longer-term unemployment we are coping with.

The unemployment numbers are worse than reported. Last year the Labor Department admitted it over-counted the number of jobs by 1.4 million….

Since April, the Labor Department has counted 550,000 nonexistent jobs under this so-called birth/death series. Without these phantom jobs, the economy this year created virtually no jobs—certainly not the 600,000 the administration has been touting.

The Obama administration projects the unemployment rate will drop to 8.7% by the end of next year and 6.8% by 2013. That is totally unrealistic. See The End of American Optimism.

A policy of artificial sweeteners has misled the American public and merely put off the day of reckoning.  Trillions of stimulus dollars have masked underlying weakness in the American economy.  Instead of these sweeteners, banks should have been forced to write off bad debt, insolvent firms should have gone bankrupt, government interference in the economy should have dwindled,  and programs increasing employment costs should have stopped.

If the economy were permitted to self correct, we would be on our way to recovery rather than be suffering the sour aftertaste of artificial sweeteners.

GD Star Rating
loading...
  • Share/Bookmark
American Society / Business / Economics / Executive Compensatio / Financial / Justice System / Political / Regulation — 0 Comments
16
May 10

Surfing the Financial Crisis

I’ve been watching the financial crisis since it began in 2007.  Every so often it is good to step back and consider some of the anomalies. Thus, some disconnected thoughts:

-          The time between crises gets shorter.  It was seven years from the dot.com to the sub-prime crash.  It has taken us only one year from TARP and other alphabet soup US-based federal bailout programs to the European Commission trillion dollar bailout.  With the Euro plunging after the bailout, how long will it be to the next crisis?

-          If everything is really improving why have short-term US interest rates not risen? I am amazed that for over 2-years of regular Treasury auctions, 3 month bill rates have ranged between .1 – .2%.  Why does the Federal Reserve keep stating in its guidance that it intends to keep rates at zero for an extended period of time?

-          Why would anyone invest in the US equity markets?  The most active stocks each day are severely troubled, probably insolvent companies:  Citicorp, Fannie Mae, AIG, and Bank of America. More than sixty percent of every day’s volume is non-human, computerized, automated trading.  And what is worse, computers doing this trading are shaving cents off each transaction to the detriment of institutions and retail investors.   No one believes in long term investment value any more. Respected analysts believe the market is severely overvalued and should probably trade at the 850 S&P level.

-          How do Goldman Sachs and JP Morgan have perfect trading performance, that is, making money every day of the first quarter?  Karl Denninger has calculated the odds of achieving this feat at one in many trillions.  Have the SEC and other government regulators taken an extended holiday during the financial crisis? It sure seems that way.

-           The 1987 version of the SEC portrayed in the movie Wall Street was able to detect illegal activity in the fictional Blue Star Airlines and arrest the hapless Bud Fox.  Mary Schapiro and the current SEC staff can’t seem to find water with two hands if they fell out of a rowboat in the middle of the Atlantic.

-          Why do things keep getting more complicated and less clear? Yes, we live in a complex world.  But I have a deep suspicion that complexity is being used as a subterfuge to mask true intent.  Why do we need multi-thousand page financial and health reform legislation, customized credit default swap instruments and impenetrable corporate proxy statements? The answer: complexity is designed to disguise the essence of each issue.

-           Why is the Federal Reserve afraid of a full-fledged audit?   As taxpayers, we are the ultimate financiers for the various government bailout programs. What happened to sunshine as the best disinfectant in public matters?  This is an economic, not a national security matter. Or in the minds of the government, has everything become a national security matter, even the Fed’s purchase of the Red Roof Inn?

-          Why is Senator Chris Dodd, himself compromised with a Countrywide below market loan, allowed to lead financial reform?

-          With a Justice Department of 100,000 employees, why haven’t we indicted a major financial institution?

We live in dangerous times.  Perhaps some of our leaders should be thinking about some of these questions and issues.

GD Star Rating
loading...
  • Share/Bookmark
American Society / Economics / Financial / International Finance — 0 Comments
11
May 10

Extend, Pretend and Crash?

After Monday’s European Union’s (“EU”) trillion dollar bailout, Zero Hedge’s headline encapsulated what had transpired:  “Even Keynes Is Spinning in His Grave.” “Extend and pretend” is now official worldwide economic dogma, as embodied in this unprecedented bailout. Why extend and pretend?  Has anything really changed?

Pretending as Public Policy

We live in an age of irresponsibility.  We seem to be responding to all types of crises with sluggish denial and finger pointing.  From Katrina to the Financial Crisis to the Deepwater Horizon oil rig disaster, government massages the news, assigns culprits and acts only when pushed by market events or an outraged public.  Instead of thoughtful, real and comprehensive solutions the policy is “extend or pretend.”  More plainly, the goal is to conjure a stop gap solution and pray that time and luck will save the day.

A History of Extend and Pretend

At the end of the Bush Administration, the financial crisis lent itself to “extend and pretend” policymaking.  The fractious, polarized political culture made it ever easier to opt for this policy choice.  Obama, if anything a master politician, has adhered to these same choices.  Let’s look at how “extend and pretend” continues even now:

-          Mark to Market Accounting – Facing pressure from the banks and Congress, in April 2009, the SEC suspended the mark to market accounting rules for bank assets. Given mounting foreclosures in the housing market, it is highly likely that the banks are not properly valuing these assets.  Pundits believe that many major banks are insolvent.

-          The Federal Reserve – Through the TARP and other bail out programs, as of March 31, 2010, the Federal Reserve balance sheet has expanded to over $2 trillion, mainly in dubious mortgage backed securities.  Once again, analysts are questioning the worth of these securities and the Fed’s solvency.

-          Government Sponsored Enterprises (“GSEs”) –We are ignoring the hapless Fannie Mae and Freddie Mac agencies in the midst of our stock market and banking dramas.  Despite the vaunted financial reform efforts, we haven’t even considered crafting a solution to the GSE mess.  Instead of reform, on Christmas Eve 2009, the Administration extended unlimited financial assistance to these businesses.   Buried in our naïve enthusiasm for the ECB bailout is a painful reminder of taxpayer obligations.  Fannie Mae posted a quarterly loss of $11.5b and needs at least $8.4b from the government to continue.

-          General Motors – After proudly proclaiming in a national ad campaign that they had re-paid loans to the government, Senator Grassley found that the company merely tapped a US Treasury escrow account to repay its TARP loan.

Extend and Pretend Goes Global

Today’s EU trillion dollar bailout is more of the same. The three part program is to create a 750 billion Euro fiscal support program, buy bonds in dysfunctional markets (quantitative easing) and enter into swap lines with the Federal Reserve to obtain dollars.   This is “extend and pretend” taken to an entirely new level.  It is not even clear or sure whether the EU can obtain IMF approval to move forward. Problem countries will require austerity measures.  In sum, this is exponential “extend and pretend,” as troubled governments pretend to have a program to calm their markets and citizens.  And even if they enact these programs they do not deal with underlying structural issues in the EU, where too little income supports too much debt.

It All Comes Down to Honesty

The political elites in the US and Europe do not want to face the economic realities.  Honesty and candor with electorates are in short supply.  Instead of leaders we have a class of venal and calculating politicians. Happy to solve the problems of today with band aids, they invite greater calamities, where the patient may be lucky to make it out of intensive care and may yet succumb to massive infection.

GD Star Rating
loading...
  • Share/Bookmark
American Society / Banking / Economics / Executive Compensatio / Financial / Political / Uncategorized — 0 Comments
10
Mar 10

Are We a Socialist Country?

Europeans and Russians are socialists.  Americans are staunch capitalists.  Maybe all it took was a financial crisis to reveal the slide toward socialism in America.  During the Cold War, faced with a military threat from the Soviet Union, Americans would rather have died than become socialists:  better dead than red.  Unwittingly, we now invite socialism into our lives.  Ironically Wall Street firms and large industrial corporations, the purported bastions of capitalism, have paved the way to socialism.  A left-leaning Administration has been only too happy to oblige.

The Slippery Slope

The road to hell is paved with good intentions.  I do not think any of the pillars of our economy intended that the country become socialistic.   Each entity was merely maximizing its own position, seeking to enhance shareholder value.   When financial crisis hit, our formerly capitalistic businesses could not rush to Washington fast enough to seek support, bailouts and guarantees from the government.   The government was only too happy to oblige with the passage of TARP and then an alphabet soup of government support and guarantee programs.  In one short crisis period from summer 2008 to spring 2009, the government ignored 200 years of American economic and constitutional history to save a group of greedy and profligate bankers and industrial corporations.   The end result: we privatized profit and socialized losses.

A Factual Progression

Here are the events that have taken us on the path to socialism:

  • The Federal Reserve’s active role in the forced sale of Bear Stearns to JP Morgan
  • The Government seizure of Fannie Mae and Freddie Mac
  • TARP:  Government purchase of troubled assets from private financial institutions
  • Goldman Sachs and Morgan Stanley become banks by expedited process  to obtain government guarantees
  • Government seizure of AIG and complete payback to private institutions for credit derivative losses
  • Federal Reserve intervention in broker mergers, with guarantees against losses (Washington Mutual with JP Morgan, Wachovia with Wells Fargo)
  • Federal Reserve intervention with $1.3 trillion in loans to companies outside the financial sector (GE).
  • Government removal of management at GM and Chrysler
  • Restrictions on executive pay for banks receiving bailout funds
  • Government restrictions on foreclosures unless there has been a Home Affordable Modification Program review.
  • Administration desperation to pass comprehensive health insurance program.   See Timeline:Global  Economy in Crisis

How Did We Get Here?

We invited the devil in the door.  Banks claimed that they could not withstand loan and derivative losses.  Unemployed Americans wanted extensions in unemployment benefits and stimulus programs.  Nobody wanted to see the stock market crash and their portfolios and retirement plans decimated.  Big business wanted the profit opportunity in universal health care coverage.  Insurance companies did not want to hurt their policy holders.  Auto workers wanted to maintain their rich union contracts.  The litany goes on.

Once we were a brave, independent and self-reliant nation.  Now when adversity strikes our first inclination is to blame others and call Washington for a bailout or a handout.  I do believe in the concept of welfare.  Welfare was meant for the truly dire circumstance, the impoverished citizen. Welfare was not meant for auto workers to maintain above market wages and job guarantees, banks to get paid in full for risky derivative bets, GE or GM, homeowners who falsified their income disclosures to remain in McMansions or every insurance policy to be paid in full.

Capitalism is about freedom, risk and failure.  Without failure there can be no progress.  The slide toward socialism is an escape from freedom and ultimately an end to progress.

My European immigrant grandfather lived through the Depression, World War Two, and into the 1980’s.  He once told me he was most proud that he never went on relief (welfare).  We should return to the ways of our forbearers, regain our mettle and become too proud to ask for a handout or bailout.   Our freedom and that of our children depend on it.

GD Star Rating
loading...
  • Share/Bookmark
Financial — 0 Comments
8
Sep 09

What are the Unintended Consequences of Low Interest Rates?

The Federal Reserve has announced that it intends to pursue a low interest rate policy not only now, but for years to come.  The CNBC cheerleaders mindlessly applaud the Fed for pursuing such a policy.  Let’s play devil’s advocate and examine the heretical position that low interest rates are destroying the US economy.  Let’s look at two classes of investors and examine the unintended consequences of a low interest rate policy.

You retired from a large company sometime in 2005 at age 65 with a final salary of $125k with stay at home spouse.   Your lump sum pension, 401k and personal savings have allowed you to accumulate $2m in investable assets.   With interest rates at 6 percent you plan on $120k in income plus a maximum social security benefit of approximately $27k.  In other words, you can relax and look forward to a financially secure retirement with your assets generating $150 k per year of income.  But after the financial crash, we are in “Bernanke World” where interest rates on 3 month T-bills drop to .1 percent.  Our new retiree shops around and finds 12 month CD rates of .90 percent.  Suddenly, $150k annual income drops to approximately $50k of income including social security payments.  Our retired couple has gone from a life of 3-4 great vacations, visits to the grandchildren and dining out several times a week to barely being able to afford housing, food and supplemental medical insurance.

A couple of observations about the plight of our hypothetical couple: the standard response heard in the media is that our couple can just go back into the workforce.  What workforce would that be? Statistics demonstrate that one of the hardest hit groups in this recession is workers over 50.  What employer is clamoring for our now 69-year old couple to re-enter the workforce?  It seems there are just so many Wal-Mart greeter positions.  They are not particularly high paying positions, at least not enough to make up our hypothetical $100k income shortfall.  Further, my guess is that applicants significantly outpace available jobs.

Where is the political support for our couple?  Where is the vaunted AARP?   Where is the AARP’s famed lobbying machine to make the case that bankers (and quite undeserving ones at that) are being favored over thrifty, hardworking retirees? Where is the Congressional response to the plight of our couple?

Other investor constituencies negatively affected by low interest rates are defined benefit pension funds (the classic pension benefit) and insurance companies.  These groups have a basic goal of matching long term liabilities, e.g. pension payments, annuity payments and life insurance payouts with long term assets that will out earn these liabilities.  This is a pretty simple business model with the insurance company or pension fund keeping the excess earning in the form of a profit or a surplus. In the case of a pension fund this surplus or reduce future funding costs for the sponsor, i.e., a company, university or governmental entity.  Insurance companies and pension funds live in an actuarial world of an assumed return on assets.   Insurance companies were guaranteeing that annuities written in the past several decades would earn in excess of 4, 5 or 6 percent.  Pension funds projected that earning on assets would be between 7 to 9 percent.  These aggressive projections moved ever upwards as the 25-year long bull market gave a false sense of confidence to actuaries and financial executives.  Both the pension and insurance company projected earnings levels are now confronting the reality of a low interest rate world.

In a low interest rate world this patented formula is virtually destroyed.  Bridled by fiduciary concerns limiting risk taking, there is a large potential shortfall between projected and actual earnings.  The ramifications are enormous.  Insurance company earnings will be negatively impacted, corporate sponsors of defined benefit pension plans will be negatively impacted as companies by law will be required to make additional contributions affecting net income and cash flows and states and municipalities will be required to increase taxes to meet funding shortfalls.  The Federal Reserve is forcing fiduciaries to take even greater risk to try to catch up with past underperformance.  The autumn 2008 debacle in the financial markets does not auger well for increased risk taking at this point in the economic cycle.

I do not purport to know what the real rate of interest should be, but neither does the Federal Reserve.  I do know that artificially pegging an interest rate at an artificially low number has numerous unintended consequences, two of which are described above.  Driving investors to greater level of risk taking has never ended well.  Get the Federal Reserve out of the equation and let the free market decide the level of interest rates.

GD Star Rating
loading...
  • Share/Bookmark