Posts Tagged: QE2

Foreign Policy / Justice System / Political / The Federal Reserve — 0 Comments
13
Feb 11

Restoring Federal Reserve Accountability

In We Cannot Separate Politics and Economics. And Those Who Speak Out Against Bad Policy are Helping the Economy…And Our Individual Investments; Washington’s blog makes an important point about the poor state of economic analysis.  Modern economists naively analyze the economy without regard to the interplay of politics:

Some people criticize the injection of politics into economic discussions.

But economic historians tell us that economists used to understand and accept that economics is wholly interrelated with politics, and that politics affects our economy. They note that modern economists have artificially tried to somehow separate the two, like Descartes tried to separate the mind from the body.

Indeed, the father of modern economics – Adam Smith – talked a lot about politics in relation to economics. Washington’s Blog

Recognizing the inter-connectedness of politics and economics, the discipline was originally referred to as “political economy.”  In fact Georgetown University has a political economy major.

The blog goes on to criticize the multi-trillion dollar expenditures on the Iraq and Afghanistan wars and the consequent deleterious effect on the economy.  Moreover, for the last ten years we have undermined any semblance of a free market by living under a state of economic emergency.   We have massively lost trust in government.  With the financial crisis and lack of prosecutions the public has also lost trust in our financial institutions, the SEC and the Justice Department.  But what is missing from this excellent analysis is the role of the Federal Reserve.

The Federal Reserve: Earnest Technocrats or Politicians in Disguise?

The Federal Reserve has a limited statutory mandate: maintain full employment and price stability.  Under Ben Bernanke the Federal Reserve has gone far afield from that mandate:

We now have a fourth branch, the imperial Federal Reserve.  Without our permission, this rogue branch is dictating economic policy for the United States.  Mission creep is taking the Fed from its dual mandates of employment and stable prices to its own self-proclaimed mandate: economic stimulation (in direct contravention of the views of the newly elected Congress and the American public) and dollar devaluation.   In QE2 it also has taken on the role of guardian of stock market prices. See Who Elected Ben Bernanke?

Bernanke has crossed into the realm of political decision making:

  • Ultra low short-term interest rates have fattened bank profits at the expense of retirees, pension funds and insurance companies.
  • QE2 money printing has set off a speculative binge in commodities hurting consumers.
  • QE2 has hurt the value of the dollar, favoring US exporters over foreign importers.
  • Higher import prices have hurt consumers since we have de-industrialized America.  Consequently, we are dependent on cheap foreign-made goods.
  • QE2 has exported inflation to foreign countries. Revolutions in the governments of our allies, Egypt and Tunisia, are not a coincidence.  Higher food prices in impoverished economies are a breeding ground for unrest. See A Perfect Storm in Egypt
  • QE2 has set off currency wars and raised global tensions with China, the EU countries, Brazil, and emerging economies.
  • QE2 permits the Federal Reserve to purchase a major portion of newly issued Treasury debt.  This permits continuance of unprecedented federal budget deficits.  Thus, Congress avoids making the necessary tough budget cutting decisions.
  • QE2 has also perversely raised the all important 10-year Treasury note yield by 1.25%, thus increasing mortgage rates and retarding any housing recovery.

Holding the Federal Reserve Accountable

The Federal Reserve cherishes its vaunted independence.  This independence was predicated on adhering to a technocratic, apolitical agenda of controlling money supply to provide a background for economic growth.  The Federal Reserve is now overtly operating in a political role: it determines winners and losers in the economy (banks favored over savers), the value of the dollar (exporters favored over importers and consumers), and financial speculators (the wealthy over the middle class and Wall Street over Main Street).  It is also interfering in foreign policy, exporting inflation in key commodities to foreign countries (many of which are our allies) and triggering a potential currency war and protectionism.  Finally, Dr. Bernanke recently lectured Congress about deficits: a topic far afield from the role of the Federal Reserve. See Bernanke Makes Sure Fed Reminds Congress Deficits Bigger Than QE2

Let me repeat: Ben Bernanke was not elected and he is not a benign technocrat.  Politics and economics are intertwined.   He was wrong about the housing crisis, the financial crisis and QE1.  Our politicians must rein him in and restore economic policy control to elected officials.

Some would argue that encroaching on Federal Reserve independence would undermine the institution hurting economic policy.  The military is under the control of civilian political leadership and there is no uproar over “military independence.”  If the military can be under political control then the Fed can be too.  The real issue is accountability and the Federal Reserve has little, if any accountability.  Conversely, it will also make our profligate elected officials equally accountable for economic policy.

It will not be easy or elegant, but it will begin to restore trust in our government and economy.

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American Society / Banking / Business / Financial / Political / Regulation / The Federal Reserve — 0 Comments
1
Feb 11

Many Answers, No Solutions

Why do we never get an answer, When we’re knocking at the door…With a thousand million questions, About hate and death and war…’Cause when we stop and look around us, There is nothing that we need…In a world of persecution, that is burning in its greed.

Question, Justin Hayward (The Moody Blues)

The Financial Crisis Inquiry Commission (FCIC) issued its 576 page report analyzing the 2008 financial crisis.   Some of the findings:

  • The crisis was both foreseeable and avoidable.
  • Widespread failures in financial regulation and supervision proved devastating to the stability of financial markets.
  • Dramatic failures in corporate governance and risk management practices in systemically important companies such as AIG, Citicorp, Merrill Lynch and Fannie Mae were a key cause of the crisis.
  • A combination of excessive borrowing, risky investment and lack of transparency put the financial system on a collision course with the crisis.  Both households and companies borrow too much and save too little.  Risks were hidden from the public.
  • Government regulators (Treasury, the Federal Reserve, etc.) were ill-prepared to deal with the crisis and their responses were late and inconsistent.
  • There was a systemic breakdown in ethics and accountability.  Households lied to get mortgages and financial institutions knowingly underwrote bad loans.
  • Collapsing mortgage lending standards and the mortgage securitization pipeline lit and spread the flame of contagion and crisis.
  • Unregulated derivatives were a major contributing force to system instability.
  • The credit rating agencies charged with properly evaluating securities were a major contributor to financial destruction.

Even the public and political leaders were to blame for not reigning in excesses.

Republican members dissented from the report, and instead focused on the government encouraging home ownership and the roles of Fannie Mae and Freddie Mac and the majority’s over-focusing on lax regulation and greed.  See Financial Crisis Inquiry Commission’s 10 Major Findings

Some Observations

-          When everyone is to blame, no one is to blame.   The FCIC report focuses on ten areas, including the roles of the public and our political leaders.  Blame is so diffuse there is essentially no blame.  The uninformed average citizen will simply breathe a sigh of relief and hope that this does not happen again.

-          The FCIC report states that there was mortgage fraud, SEC violations and ethical lapses.  Where are the prosecutions?

-          The FCIC report misses an obvious culprit.  Easy money in the form of excessively low interest rates was the Federal Reserve response to the bursting of the internet stock market bubble in 2000.  Interest rates were kept too low for too long and stoked the housing boom. Easy money is misdirected into speculation and economically dubious projects.

-          The FCIC report reacts in horror to the Lehman bankruptcy.  The report implies that bankruptcies of large financial institutions are not acceptable.  Preventative regulation is not enough.  Instead of more regulation, wouldn’t fear of bankruptcy encourage more financial prudence?

Where Are We Today?

The public and our leaders should be asking whether or not we are in a better position today to avoid a new financial crisis.  We have punished savers, pension funds, insurance companies and retirees with zero percent interest rates.  We have run over $4 trillion in deficits and supplied $23 trillion in financial guarantees. We have stubbornly high unemployment and meager economic growth. Through outright money printing (QE2), we have triggered new bubbles in commodity and equity markets.  Both markets appear overpriced.  To show their true financial picture, banks are cheering another delay of the Financial Accounting Standards Board attempt to reinstate mark to market accounting.  We operate in a perpetual state of economic emergency.

Interestingly, we rushed to pass the Dodd-Frank financial reform bill even before the completion of the FCIC report.  We prescribed medicine before a diagnosis.

We applaud ourselves for avoiding financial Armageddon, and we are making many of the same pre-2008 mistakes.

Some Modest Proposals

We could do better.  Some obvious and necessary changes we could implement immediately:

§  End zero interest rate policies and quantitative easing (money printing).  Saving and investment will return and business will expand again.

§  End guarantees to our “too big to fail” financial institutions (and others as well).  Financial prudence will return without excessive new regulation.

§  Permit the imprudent to go bankrupt.

§  For two reasons, aggressively prosecute the guilty: 1.) our democracy is based on the principle that no person or institution should be above the law, and 2.) prosecution will chasten and deter the reckless.

§  Remove Bernanke and Geithner.  The Federal Reserve under Bernanke could not foresee the crisis. It failed to regulate the mortgage lending practices of the banks.  As head of the Federal Reserve Bank of New York, Geithner failed to control the reckless practices of Citicorp and other banks under his jurisdiction.

§ Impose claw back provisions on bank bonuses.  In exchange for providing deposit insurance, TARP, below market interest rates for bank, the public has a right to demand that bank bonuses be “at risk.” This means that in good years bankers get to keep their bonuses, but in bad or abusive years those bonuses can be reclaimed by shareholders, creditors or the government.

According to Einstein, insanity is “doing the same thing over and over again and expecting different results.”  We continue to repeat past behaviors.  With QE2 we introduced nuttier behavior to prop up our too big to fail banks. The FCIC report raised a million questions and too few solutions.  Thus, we are truly facing a world that is “burning in its greed.”

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American Society / Economics / Financial / investing / Political / The Federal Reserve — 0 Comments
15
Dec 10

Market Discipline and Sustainable Growth

Many of the Federal Reserve maneuverings are well documented and analyzed: asset purchases of junk value mortgage backed securities, QE1 and QE2. Many of these strategies exceed the Fed statutory mandate of ensuring stable prices and full employment raising  political and even constitutional problems.

Less discussed are two economic consequences:  destruction of market discipline and weakening sustainable growth.  Administration economic policies have prompted unlimited and bogus guarantees to various enterprises.  Moreover, these policies have intruded in the marketplace, backstopping and buttressing private companies that ought not to be supported.

Destruction of Real Risk Taking

In A Desperate Fed – QE2.0 is a Hail Mary Toward the Wrong End Zone, Atlantic Capital Management (ACM) brilliantly dissects QE2. (Note-the report should be read in its entirety at Zero Hedge).  ACM posits that the Fed’s objective is to create negative real interest rates, thus making safe investments expensive.  Worse, the Fed hopes to promote spending over saving, and risk taking over liquidity in order to “stimulate” the real economy.  ACM characterizes this policy as “forced distortions of normal economic functioning.”

The ACM report breaks down and details the harm:

  • Growth in household spending will be more difficult through increases in energy and food prices more than offsetting the effect of lower mortgage payments through lowered interest rates.
  • QE2 may aid US exports, but at the same time will lower the value of the US dollar.  But who will buy our goods?  Imported Chinese goods will be more expensive, without American goods or services being sold to the Chinese middle class.  Moreover, our largest import, energy, will become more expensive.    Exporting to Europe seems a long shot with the EU’s current budgetary problems.  And the threat of a currency war remains, as all nations simultaneously seek to devalue their currencies.
  • Without much final demand, most of our “recovery” has focused on inventory building, with little corresponding pull from consumers purchasing goods.
  • The government controlled auto industry and financial arm, Ally Bank, has again fostered auto industry inventory buildup with lack of the “pull” of final sales.  The suspicion is that building inventory is related to the highly publicized and promoted GM IPO to justify government intervention.
  • Zero interest rate policies have discouraged new bank loans.  Instead, banks make profits from borrowing short term at a virtual zero cost and purchasing longer dated Treasury securities.  Similarly, smaller banks are reducing their loan portfolios and not making perceived risky loans to businesses and consumers.

In sum, the economy is devoid of the real risk taking that produces a sustainable recovery and a thriving business environment.

Destruction of Market Discipline

ACM’s prescription for the ailing economy: market discipline.  What is needed to dispel the economic uncertainty which discourages productive investment and real risk taking:

…is for businesses and investors alike to know without any sliver of a doubt that government and businesses and consumers are being forced to regulate themselves.   With the threat of illiquidity and bankruptcy never far away, economic actors will behave as if their survival depends on maintaining sound and sustainable habits. And that brutal market discipline is what makes investors less uncertain about investing, makes banks less uncertain about lending to households, makes businesses less uncertain about future growth.  Discipline leads directly to long-term sustainability and high quality wealth. See A Desperate Fed – QE 2.0 is a Hail Mary Toward the Wrong End Zone

The Fed and the government have opted for QE2, government guarantees, zero interest rate lending to favored banks, and nationalization of businesses over market discipline.  They have removed market enforcement “in favor of political hocus pocus, ‘nobody loses’ nonsense.”  Market discipline would be even a greater economic tonic than increased government regulation.

Sustainability

Separately, economist John Hussman attacks the Fed also on the grounds of undermining a sustainable recovery:

From my perspective, an “economic recovery” that requires a tripling in the Fed’s balance sheet, continues to average 450,000 new unemployment claims weekly, and relies on fiscal stimulus to counter utterly stagnant personal income, is ipso facto (by the fact itself) not a “standard” economic recovery. We have swept an enormous volume of bad debt under rugs, behind dams, and in back of curtains (not to mention in off-balance sheet vehicles such as Maiden Lane that were created by the Federal Reserve). But it is all effectively still there, festering. Meanwhile, our policy makers are trying to reignite financial bubbles in order to create an illusory “wealth effect” to propagate spending patterns that were inappropriate in the first place.  See The Cliff

Hussman believes that the stock market is richly valued with possible peak earnings.  Against a backdrop of higher inflation and diminishing ability of the government to intervene in markets, current corporate earnings are not sustainable.

A Seriously Unbalanced Economy

ACM and Hussman paint a portrait of a seriously unbalanced economy.  Government interventions and policy gimmickry only worsen our economic problems.  This could end one of two ways: our policy makers like Dr. Bernanke come to their senses, or external forces impose market discipline.

Perhaps the recent dramatic decline in the 10-year Treasury note is just such a market warning sign.  Until then smart investors should be very cautious when investing in the financial markets.

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American Society / Banking / Financial / Political / The Federal Reserve — 0 Comments
1
Dec 10

Perception is Reality

One of my more difficult tasks in corporate life was explaining to my employee-attorneys that perception was reality.  What did I mean?  An attorney could be the smartest and most hardworking, but if he was rude, late, sloppy or arrogant, all that intelligence and hard work were useless.  The reality for clients was that he was an ineffective attorney.

Attorneys love to argue, and employees generally react defensively to criticism.  So, conveying the “perception is reality” message was always a challenge.   Many a time I heard detailed factual rebuttal citing brilliant legal arguments, an excellent memo or brief, or a creative idea.  In each case the attorney missed the point.  All of those counterexamples might have been true, but irrelevant.  Once perceived as ineffective or a poor performer, that became reality.

Missing New Realities

It is clear now that government has favored Wall Street and the large money center banks over taxpayers, savers, and the unemployed.  QE2 has now captured the public’s attention and criticism.  In fact, a video critical of QE2 and the Fed has had close to three million viewers.

The video suggests that the Fed is printing money, causing inflation, and buying Treasury securities at premium prices from Goldman Sachs.  Further, it blames the Fed for the internet boom and bust and the housing crash.

Richard Alford, a former Fed economist, parses the video. See “Quantitative Easing Explained” and its Critics. He has inconsistencies in his argument, and he suggests that the Fed avoid defensive and legalistic responses to its mistakes.  His advice to the Fed is to simply get its message out.  Like my employee-attorneys,  Mr. Alford misses the point, and his reasoning is fatally flawed.   The video resonates because its message is true and the Fed cannot muster much of a response without sounding defensive. So much for Mr. Alford’s suggested public relations campaign.  For my purpose here, however, a quote from Mr. Alford works.  A part of his article accurately captures the public’s mood, describing the reality of growing political anger:

…The video is a general protest against the role the Fed has played in transferring wealth from savers and taxpayers to Goldman Sachs and other Wall Street firms. The Fed is seen as picking winners and losers: Wall Street is seen as the winner and savers and the taxpayers are seen as the losers…

The American people care deeply about fairness, but the Fed is perceived to care more about the health of Wall Street than fairness.  Instead of addressing the underlying issue of fairness and the efficiency of the bailouts, the Fed defenders focus on a narrow legal prohibition. “Quantitative Easing Explained” and its Critics.

The Reality of Numbers

In a democracy, economic interventions spill over into the political realm.  The political backlash is on display in the latest Rasmussen survey of likely voters (thanks to Zero Hedge) See Many Say Government Operating Outside the Constitution:

  • 44% believe that the government is operating outside the limits of the US Constitution.
  • 65% are either somewhat or very angry at the policies of the federal government. 65% prefer a smaller government.
  • 70% believe that government and big business collude against the interests of investors and consumers.
  • Only 20% feel that the government has the consent of the governed (previous survey).

Back to Reality

The public gets it.  We understand that the government has rewarded the folks who have wrecked the economy and punished the average citizen.  Again we are back to “perception is reality.”  While academically elegant, theoretical explanations of Fed policy may play well at Princeton lectures, the American public does not want to hear how Dr. Bernanke studied the Great Depression and intends to save us from another one.

Our reality is high unemployment, diminishing savings, declining house prices, diminishing net worth and arbitrary and unfair governmental actions.  Failure to assert political leadership and reign in the Fed has gone on way too long.   Clearly, reality has deteriorated enough that almost half of our average citizens question whether the government is operating outside the Constitution, that is, illegally.

If the underlying message of the elite is that  “we need to destroy the Constitution to save it”  we are heading down a very dangerous path.

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Banking / Business / Economics / Financial / International Finance / The Federal Reserve — 0 Comments
17
Nov 10

Unintended Consequences of QE2

In several previous posts we have discussed why QE2 is wrong-headed and potentially disastrous.  Let’s look at some of the unintended consequences since its announcement on November 3.

Bond Market

The stated goal of QE2 was to lower interest rates to stimulate spending.  The methodology was the purchase of intermediate term (5-15 years) Treasury securities.  Looking at last month’s performance of the Treasury market we see the following: five-year (current yield – 1.46%; one month ago 1.13%); ten-year (current yield -2.83%; one month ago – 2.51%); 30-year (4.23%; one month ago – 3.95%).  Source – Yahoo Finance, November 17th. Similarly, QE2 has triggered a crash in the municipal bond market. Yields have risen one-half percent since November 5th.  See Tax- Exempt Muni Bonds Tumble; Munis Continue Collapsing.   Increases in interest rates only favor banks over the real economy.  See Bond Market to Bernanke: F@&k You

The G-20 Meeting

QE2 has set off a currency war.  Our trading partners recognize that the Federal Reserve is flooding the world with US dollars.  To avoid importing inflation, these countries are contemplating erecting protectionist measures such as controls on imported capital.  Writing for the Asia Times, David Goldman captures the international turmoil:

…Never before has the world displayed the sort of public contempt for American policy that Germany, China and others expressed last week. Wolfgang Schaueble’s Spiegel interview last week describing quantitative easing as “clueless,” followed by Federal Chancellor Angela Merkel’s open attack on it during the G20 meetings, is entirely new, as is the Chinese and other Asian threat to simply keep dollars out.

The rest of the world is right and the Fed is wrong. QE2 is turning into Titanic I. The Fed has been exporting inflation through excess money creation; holders of dollars buy foreign currency, which forces foreign central banks to intervene on foreign exchange markets by selling their own currency. The foreign central banks create new local currency in order to buy the unwanted dollars and stabilize their exchange rates, which adds to inflationary pressures in their countries. They use the dollars they have bought to buy Treasuries.  See Exchange Controls and Deflation

Since countries such as Japan and China are major purchasers of US Treasury securities, alienating these purchasers will have the unintended consequence of further driving up US interest rates.  Mr. Goldman advises investors to avoid financial markets and stick to cash during this turbulent period.  In a disingenuous defense of QE2 William Dudley, President of the New York Federal Reserve Bank, claimed that: “I don’t think we knew that the dollar would necessarily weaken.”  Before implementing a controversial policy as QE2, shouldn’t Professor Bernanke and his cohorts have considered a falling dollar and rising commodity prices?

Cost Push Inflation

Living through the 1970’s, cost push inflation, where input prices compressed profit margins, was a major cause of the steep bear market in stocks.  Carefully massaged  current government inflation statistics need to be taken with a grain of salt.   In the real world companies as diverse as Kraft, Dean Food, Kimberly Clark and Campbell Soup have cited cost pressures, and reported poor quarterly results.  Kimberly Clark’s announcement cited its “highest-ever cost inflation…” And So it Begins… (Cost-Push Margin Compression)

The already beleaguered consumer is experiencing real world inflation at the checkout counter:

There might not have been a second round of quantitative easing, if Federal Reserve Chairman Ben Bernanke shopped at Walmart.

A new pricing survey of products sold at the world’s largest retailer showed a 0.6 percent price increase in just the last two months, according to MKM Partners. At that rate, prices would be close to four percent higher a year from now, double the Fed’s mandate. See Walmart: Inflation is Up

Stocks are now priced for perfection, the market’s way of telling us that investors have not considered rising inflation.  Declining profit margins will result in price earnings multiple shrinkage and a falling stock market.  See The Cliff

Misallocation of Capital

Since the US does not have exchange controls, the Federal Reserve cannot control where its newly created dollars are invested.  We have identified commodity speculation as one area for these funds.  See 1984 in 2010.  Further, money is being invested in emerging markets instead of the US economy.

Despite the belief that the Federal Reserve can create unlimited amounts of dollars, any society has limited capital resources.  These can either be invested wisely in new productive enterprises or squandered through speculation.  QE2 encourages the latter.  By artificially attempting to suppress interest rates the following occurs:

You get asset and credit bubbles – every time. The reason is simple: You have paid someone to perform an uneconomic activity.  That is, an activity which would not be performed by free actors in a free market system because it would inevitably lead to loss becomes profitable due to intentional interference in the market.

Maintenance of such a thing over time requires that “someone” be given incentives to perform non-economic activities.  This in turn fuels asset bubbles and that, in turn, leads to cycles of booms and busts. See Dishonesty All Around – Monetary and Security

Constant intervention in the economy will only lead to an inevitable bust.

Real Solutions

We are headed down a dangerous path: not only dangerous to our financial portfolios, but dangerous to our security.  Currency wars and protectionism lead to real wars.  The history of the 1930s is a dramatic example.

The ways out of this quagmire are painful.  They involve writing down debt, losses to bondholders, a failure of several “too big to fail banks” and a shock to the equity markets.  The pain will be great, but swift.   Remaining on our current course will be worse.

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11
Nov 10

1984 in 2010

In George Orwell’s 1984, protagonist Winston Smith works in the Ministry of Truth.  In Airstrip One in the mythical Oceana, the Ministry serves as a perpetual propaganda machine exercising public mind control.  Winston eventually rebels against “Big Brother.”  Ultimately, he is captured, tortured and “re-educated.”

Today’s media subject us to a constant barrage of spin, messaging, falsehood and half-truth.  We have traveled from the “No Spin Zone” to the “24/7 Spin Zone.”   Dangerously, it is our own government controlling and propagating news and messages:

1.      Spin:  QE2 is designed to meet the two Federal Reserve goals of high employment and low inflation.   [Bernanke op-ed Washington Post]  Truth:  Revealed later in the op-ed piece is that QE2 supports stock prices.  Moreover, the real likely beneficiaries of QE2 are our failing large banks.

2.      Spin: QE2 will not result in the Federal Reserve monetizing our national debt.  [Bernanke June 3, 2009 testimony before Congress]:   Truth:  “For the next eight months, the nation’s central bank will be monetizing the federal debt.”  Richard Fisher, President of the Dallas Federal Reserve Bank   Speech November 8, 2010

3.       Spin:  “Structural unemployment is not increasing.”  Federal Reserve Bank of San Francisco Report Is Structural Employment on the Rise?    Truth:  In The New Reality: Permanent Job Loss , we explored the new labor force dynamics.  Noted economist David Rosenberg estimates that we have a permanent job loss of 6.2m workers.  With slow revenue growth, outsourcing, skills mismatches and tight credit conditions unemployment will remain high.

4.      Spin:  “Jobs Expand by 151,000.”   Bureau of Labor Statistics Report Truth:  This statistic is patently misleading. Labor force participation is dropping (58%): more workers are no longer participating in the labor force (36%) and therefore are not counted.  Moreover, the BLS uses the birth-death model which fictitiously creates jobs based on demographics.

5.      Spin:  Inflation is low (below 2%),  therefore Social Security cost of living adjustment does not apply.  Truth:  The Federal Reserve uses a 2.2% inflation deflator when calculating Gross Domestic Product.  Since the beginning of the summer the following commodities jumped in price: corn (71%); oil (24%); oats (106%); wheat (67%); soy (44%); copper (47%); gold (21%) and silver (48%).  Commodity price increases have passed through to higher retail prices in every sector. Source:  Karl Denninger

6.      Spin: After performing stress tests on 19 banks, secretary Geithner declared the banking system fundamentally sound.  Truth:  Even after TARP, TALF, government guarantees and other programs have exceeded last year’s number of bank failures.  And this with two months of the year to go.  See Tracking Bank Failures: 2010 Exceed 2009 Bank Failures. More takeunders like that of Wilmington Trust are certainly possible, and that bank discounted its stock by 40%.  See A Canary in the Mine

7.      Spin:  The Administration has assured us that the brewing mortgage foreclosure crisis is merely a paperwork problem.   Truth:  Foreclosuregate raises a number of significant problems related to mortgage securitization.  Problems range from poor underwriting standards to outright fraud in court filings.   See This Magic Moment, Postscript to Foreclosuregate

8.      Spin:  The Treasury Secretary assures our trading partners and us that the US wants a strong dollar.   Truth:  QE2 has weakened the dollar and enraged our trading partners.  Since summer 2010,  the dollar has declined 16%.

9.      Spin:  the economy is recovering.   Truth:  Interest rates been held at zero percent for an extended period of time.  If the economy is recovering, why do we even need QE2?

10.  Spin:  Initial unemployment claims for the week of November 6, 2010, dropped by 24k .  Truth:  Unfortunately, that series has been revised downward from the previous week 36 times out of 42 weeks in 2010.  Similarly, continuing claims for unemployment insurance have been revised downward 42 out of 44 weeks.  Finally, without BLS adjustments the initial claim report would have shown a loss of 38k jobs.  Jobless Claims at 435K on Expectation of 450k, To Be Revised Worse Next Week

Becoming Winston Smith

The US Ministry of Truth has been on a concerted campaign to ignore or distort economic statistics to convince the American public that the recession has ended and a recovery is well under way.

The newest object of government attention is the stock market, with the goal of boosting prices to induce a recovery.  Charles Hugh Smith estimates that the Fed’s QE2 efforts since June have resulted in a net loss to the US economy of $4.6T.  That loss includes the 19% gain in the stock market.  See Fed’s QE2 Misadventure Costs U.S. Households $4.6 Trillion

We have been so conditioned to hear lies and spin that we can no longer discern the truth.  We have all become like 1984’s Winston Smith, the wayward and tragic civil servant. So far, no politician has the guts to stand up and say we have real structural problems in the economy. It will take more than hope and spin to solve our problems.  There needs to be some period of economic contraction, debt write off, fiscal and monetary austerity and probably another stock market crash before a real recovery can happen.  Who will have the courage to tell us an unpopular, unspun truth?

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27
Oct 10

The US Economy: An Impaired Asset? Part I

Rather than a political entity, for a moment view the United States as a massive corporation with divisions.  Think of housing stock, commercial real estate, manufacturing capacity, technology, mass transportation, infrastructure, airports, power, pipelines, and telecommunication, and one can easily imagine the nation as a conglomerate of assets: US INC.

However, assets depreciate and not may be worth the value assigned by the owner.  Accounting principles recognize that assets must constantly be evaluated.  Enter the concept of the impaired asset:

…long-lived assets and certain identifiable intangibles to be held and used by an entity (must) be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for recoverability, the entity should estimate the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment loss is recognized. Otherwise, an impairment loss is not recognized. Measurement of an impairment loss for long-lived assets and identifiable intangibles that an entity expects to hold and use should be based on the fair value of the asset. Summary of Statement – FAS 121

The accounting profession recognizes that an asset becomes obsolete when its income can no longer support it. Thus it becomes an impaired asset and must be written down to fair market value.

Telephone Companies and Impaired Assets

An example from the mid-1990s is the technological and business transition that faced US local telephone companies. As the industry sought to meet the demand for high speed data services and internet transport, regional phone carriers (the predecessors of Verizon,  AT&T and others) needed to switch from the slower, reliable copper cable network to fiber optic technology.  Similarly, switching went from analog to digital to “soft switches” to handle higher volumes of traffic.  Recognizing that income from voice services could no longer support the sunken costs of the investment in copper cables and analog switches, the companies were required to recognize an impairment charge and write down the value of their assets. See The Future of the Regional Bells

Focusing on the Present State of the American Economy

The current state of the US economy bears a striking resemblance to the telecom industry scenario of that era.   We have a boatload of impaired, non productive assets call residential and commercial real estate.   Encouraged by the government’s desire to create an “ownership society” and artificially low interest rates, Americans overspent on housing.  Housing prices were driven artificially high to the point where incomes could no longer support buyers’ investments in their homes.  Collaterally, commercial real estate mirrored the housing boom with wildly expanding retail and office space.  Again, our national income could no longer support this expansion.

Technology conspired to impair even more assets and reduce our national income.  Faster telecommunications, larger and faster ships, cheaper foreign labor, and transferability of skilled labor made it feasible for offshore production and services.  Again left behind were empty factories, shopping malls, office buildings and warehouses.   The Midwest was particularly hard hit with factory closings and high unemployment.  Returning to our corporate metaphor, US INC  purchased too many assets at historically high prices with insufficient corporate income and profits to support them.

Hiding the Problem

Since FASB has suspended mark to market accounting in 2009, the banks have been the main culprit and beneficiary in failing to mark down these impaired assets.  The Federal Reserve continued the deception when they purchased from the banks over $1.25 T of impaired mortgage backed securities.  So now the taxpayer is another potential holder of impaired assets.

The Federal Reserve is on a maniacal quest to start QE2 (quantitative easing) to purchase even more impaired mortgage backed securities.  If the mid-1990s telephone companies were the object of the Federal Reserve’s affection, perhaps they would have been buying the impaired copper telephone networks and paying top dollar.

Part II will discuss further impairments and solutions.

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American Society / deflation / Economics / Financial / investing / Political / The Federal Reserve — 0 Comments
18
Oct 10

Ben Bernanke is a Dinosaur

Ben Bernanke and I are almost the same age.  In this age of public confessions, I have one.  Ben Bernanke and I are dinosaurs.  Ben and I went to school during the 60s and 70s.  During that period inflation was the major economic problem.   In 1973, the Arab oil embargo kicked inflation into high gear, and wages soared.  It was not until Paul Volcker pushed interest rates to nose bleed levels did the Great Inflation subside.  Mr. Bernanke seeks to solve 2010 problems with remedies that may have worked in 1973.  Since he is fighting the last war, I do not think he will be successful.

The New Reality

That was then.  We need to look at now:

  • Consumers are Deleveraging -  That means people are paying their debts, leaving less for discretionary purchases. Deleveraging is emblematic of a solvency problem, not liquidity.  Adding liquidity through QE2 (quantitative easing) does not remedy the solvency issue.
  • Demographic Trends – As the large number of Baby Boomers near retirement the trend shifts from spending to savings.  In a zero interest rate environment savings become vital.
  • Global Overcapacity – Overcapacity exists in key industries such as electronics, autos and steel.
  • Depressed Housing Prices – Housing prices remain depressed, removing a major asset which consumers borrowed against to enable personal spending.
  • High Unemployment – With so many people looking for work, employers feel little wage pressure (except for awarding large Wall Street bonuses).
  • Price Deflation – We see free or cheaper goods and services.  Can’t afford a movie ticket?  Choose from free movies on broadcast television or the internet.  Don’t want to spend money on a personal seat license, tickets and parking for an NFL football game? Stay home and watch it on television.  Want to see your favorite Broadway show? Wait for the tickets to be half price at TKTS.
  • The Internet as a Deflationary Force – From the time I began blogging and said the internet was a deflationary force,  its impact has only intensified.   Amazon and other online sellers are only exacerbating the decline in commercial real estate values.
  • Endless Amounts of Commercial and Industrial Space – The confluence of the depression in the FIRE (finance, insurance, real estate) economy; manufacturing and service jobs being moved offshore and the rise of online retailing has depressed the commercial and industrial real estate market.  A short trip around my relatively prosperous hometown reveals vacancies in everything from retail, apartment, warehousing, office, medical and manufacturing space.  New for sale and for lease signs seem to sprout up each week.

Rosenberg and Deflation

One thesis espoused in this blog is that we have inflation in everything we need (gasoline, basic foodstuffs) and deflation in everything we do not need (plasma televisions, vacation homes).  David Rosenberg debunks the fear mongering of inflationists.  See Rosenberg Still Sees Deflation Despite Consistent Speculative “Limit Up” Opens in Pretty Much Everything

Despite a speculative equity market binge, a weakening U.S. dollar, an economy that seemingly avoided a double-dip recession last quarter, and a renewed boom in commodity prices, what continues to prove elusive in this questionable recovery is pricing power in the broad retail sector.

How apropos it was for Ben Bernanke to utter the word “deflation”, not once, but twice, in his Boston speech this morning. Because fifteen minutes later, the September consumer price index data were released and showed a goose-egg — that is 0% — on the key core CPI measure (which excludes food & energy), for the second month in a row. In the past, this has happened but 7% of the time, so it is a rare enough…event to at least mention.

The headline rate of inflation, despite everything that has been thrown at it in terms of unprecedented monetary, fiscal and bailout stimulus, sits at 1.1% today. The core rate, proven to be the key driver for bond yields, which is why it is a focal point, is now running at a mere 0.8% year-over-year rate, the lowest since March 1961 when Ben Bernanke was in grade school.

While QE1 may have worked in terms of bringing mortgage and corporate spreads out of orbit and preventing an all-out contraction in the money supply, it has not managed to stop the economy from sputtering, the unemployment rate from remaining near 10%, and underlying inflation from grinding lower. Consider for a moment that when the Fed first hinted at QE1 in December 2008, the jobless rate was 7.4% and the core inflation rate was 1.8%. See Rosenberg Still Sees Deflation Despite Consistent Speculative “Limit Up” Opens in Pretty Much Everything

Rosenberg supports the thesis that inflation in discretionary purchases has declined or remain unchanged.

While commodity prices have been firming of late with the downdraft in the dollar, what is key is that we are seeing discernible deflationary trends evolve in many segments of the service sector. Movies, personal care services, hotels, delivery services, and education all deflated last month — education deflated at its fastest pace ever…

Moreover, despite what the price of cotton is doing, clothing prices are still in decline, and other “goods” such as furniture, appliances, audio-video equipment, motor vehicles and home improvement all posted price declines last month as well.  See Rosenberg Still Sees Deflation Despite Consistent Speculative “Limit Up” Opens in Pretty Much Everything

The Last Voyage of QE2

Ben Bernanke is determined to institute a second round of quantitative easing (QE2) through direct purchases of Treasury securities.  The goal is to induce inflation, but the evidence clearly does not support that outcome.   Good luck, Dr. Bernanke.

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