Posts Tagged: zero interest rates

Banking / Financial / Political / The Federal Reserve — 0 Comments
30
Dec 11

The Road to Financial Nihilism

Nihilism is defined as “the total rejection of established laws and institutions.”  We are currently living through an age of financial nihilism.  Nihilism is also usually associated with radical elements that reject all authority.   I would submit that business elites and the political establishment are spawning political, legal and financial nihilism.

The Great Financial Crisis in the fall of 2008 led us on this path.  Perhaps it started with the best of intentions to save the financial system, but the unintended consequences of intended financial actions has negated any good from these efforts.  Let’s look at the particular elements of this sad condition:

  • Zero Interest Rates – When a market sets interest rates, important information is conveyed to market participants.   Interest rates in a free market environment measure risk of repayment, a fair rate of return and the potential for inflation.  When the Federal Reserve anchors interest rates at near zero for “an extended period of time,” investors can no longer make long-term rationale investment decisions. Thus, money is likely to be mal-invested in uneconomical projects or speculation increases in economically sensitive commodities such as oil, metals and grain.
  • Suspension of Mark to Market Accounting – At the start of the financial crisis, Congress leaned on the Financial Accounting Standards Board to suspend “mark to market” accounting (that is, the valuing of an asset in the most honest way, that is, taking into account its impairment or loss of value) .  In its most basic form, this is just plain dishonesty.   This dubious practice spread to banks in Europe as well.   Thus, there is no transparency in bank balance sheets; we (and even the banks themselves) simply can no longer believe the numbers on any institutional balance sheets. The result is that European banks are no longer willing to lend to one another.   Why?  These banks are now leveraged as much as 50-1, thus only a 2% drop in asset prices puts them at risk of failure.  We know that sovereign European bonds have dropped much more than 2%.   Thus, it is likely there is little or no real collateral to support a loan. See Art Cashin Exposes the Behind the Scenes Panic in Europe. With housing prices continuing in decline in the United States, I would suspect that many US banks too are hiding losses, and are in more dire straits than they or the Administration admits.
  • Stress Tests – To reassure the public, both the Federal Reserve and the European Banking Authority ran stress tests on large banks.  Dexia (Belgium’s largest company) passed the most recent round of these “stress tests,” and then failed within three months.   Irish banks failed four months after their 2010 round of these tests.  See How Did Europe’s Bank Stress Test Give Dexia a Clean Bill of Health?  Bank of America and Citigroup shares have plummeted in 2011.  The Federal Reserve performed similar stress tests on these and other major American banks.  How credible were our “stress tests?”
  • Eroding the Sanctity of Brokerage Accounts – The collapse of MF Global revealed that a brokerage firm could appropriate segregated customer accounts for its own uses.  It appears that MF Global circumvented US laws on account segregation by pledging customer accounts against a repo agreement in London.  Now, customers may never recover their monies.  See MF Global: The SERIOUS Issue Reaches Mainstream Media.  Karl Denninger points out that the standard brokerage agreement permits hypothecation and re-hypothecation, meaning that your brokerage account can be pledged to support a brokerage company or bank loan.  Since derivatives have preference over depositors, customer’s segregated accounts funds are at risk.
  • Eroding the Sanctity of Real Property – To speed securitization of mortgages, the banks created an alternative mortgage registration system which bypassed centuries-old rules of settled property law.  A recent report documents the disastrous consequences:

… “thanks to the Mortgage Electronic Registry System’s (MERS) failure to accurately complete and/or publically record property conveyances in the frenzy of banks securitizing home loans and ins subsequent foreclosure actions, neighbors of a foreclosed property (with a sequential conveyance) as well as a foreclosed property itself will have unclear boundaries and clouded/unmarketable titles making it difficult, if not impossible, for these homeowners to sell their properties and for subsequent purchasers to obtain title insurance on the property.”

The report goes on to point out that courts have criticized the MERS model as flawed and have ruled against MERS’ stance to foreclosure. MERS is described as being “wholly inaccurate and not allowing homeowners to fight foreclosures because it [MERS] shields the true owner of a mortgage in public records.” See Study Claims that MERS Destroyed the Chain of Title and Consequently, the Housing Market

And worse yet, in sorting through the avalanche of subsequent foreclosures, mortgage servicers have filed fraudulent affidavits and false documentation. See e.g., Nevada Files First Criminal Charges in Robo-Signing Case

  • Greek Credit Default Swaps – In good faith, buyers purchased credit default swaps on Greek bonds to hedge against a potential default.   The European authorities strong-armed banks and other investors to accept “voluntary” 50% haircuts on Greek bonds.  Because of this “voluntary” characterization the credit default swaps were not triggered.  With Spain, Ireland, Italy, Portugal and other countries suffering huge losses on their bonds, is it likely that investors will invest in these bonds when the hedge of a credit default swap can be negated through European financial authority fiat?   See Credit Default Swaps Useless as Hedge Against Default
  • Federal Reserve Intervention in Markets – So far, when stock markets have faltered, the Federal Reserve has come to the rescue through quantitative easing (QE1& 2) or Operation Twist.  Thus, investors cannot know the true value of any stock since the Federal Reserve will not allow it to fall to a market-determined price.   Similarly, with zero interest rates and purchase of mortgage- backed securities, the Federal Reserve will not allow house values to fall to market clearing prices.
  • Failure to Prosecute – Outside of a handful of insider trader prosecutions there has been no attempt to prosecute the malefactors of Wall Street. Excuses range from opining that the practices were legal, to the difficulty in building a case.  In the Savings and Loan crisis of the early 1990s the same difficulties existed, yet 1100 prosecutions were brought with 800 banks executives sent to jail.  See In Financial Crisis, No Prosecutions of Top Figures

Real World Consequences

We have eliminated price discovery from our markets.  We have neither permitted stocks to fall nor interest rates to rise.  Instead of prosecuting the banks that caused this problem, we shower them with interest free loans from the Federal Reserve so they can speculate or earn risk free profits by re-depositing funds with the Federal Reserve.  Thus, capital is being diverted from sound investments and used for speculative purposes or worse.

European financial authorities have destroyed the efficacy of hedging sovereign bonds in their handling of the Greek bond haircuts.  And thus another important market is being destroyed.

More ominously, Karl Denninger reports that in the wake of the MF Global failure, farmers are eschewing the hedging of crops through commodity futures and instead selling directly to food companies.  Thus, price stability will be diminished and consumers will ultimately pay higher prices.

The failure to “mark to market” and run honest stress tests has resulted in a freezing of interbank loans (a classic credit squeeze) and resulted in a silent run on banks, as UBS reports (bold face type in original text):

European banks are making great use of the ECB’s overnight deposit facility. Last night they parked $590 billion at the ECB breaking the record they had set the night before. They are clearly unwilling to lend to other European banks, highlighting the distrust and fear in the interbank marketplace.

The distrust on the streets is said to be growing also. Barroom gossip says that safe-deposit boxes are in a demand that borders on frenzy. They allow you to take your Euros and covert them into something of value (gold, Swiss Francs, etc.) and sock it away in a safe place.

 Others are said to be buying property in London and elsewhere lest you awake one day and discover that your Euros have reverted to drachmas or lira.

 Savvy bankers are said to be setting up personal and communal trusts domiciled in places like the Bahamas, the Caymans or the Isle of Jersey. Some banks are offering depository accounts denominated (and repayable) in alternate currencies like the dollar or the yen.

 We think a Lehman-like event would most likely be triggered by a run on a bank or a series of banks. The scramble for currency (value) protection among the public could turn into that bank run in the same way that a crowd can instantly turn into a mob. Watch the money flows out of Greece and Italy very carefully. The pot continues to bubble. See Art Cashin Exposes the Behind the Scenes Panic in Europe

If the Administration, The Federal Reserve and the European Authorities had set out to destroy capitalism, free markets and the current financial system, they could not have done a better job.   Free markets and a free people are intertwined.  The road to financial nihilism is ultimately a very dangerous path.

 

 

 

 

 

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American Society / Banking / Financial / Political / The Federal Reserve — 0 Comments
7
Jun 11

Unemployment and the Fall of Labor

U.S. Government and private statistics, reported last week, reinforced our dismal unemployment trend:

  • The unemployment rate rose to 9.1%.
  • Only 54,000 jobs were added in May with numbers revised downward for April as well.  This number especially alarms when compared to the projections of 150,000 to 175,000 new hires.
  • Employment in states, counties, and municipalities fell to their lowest levels since 2006, as governments were forced to reduce their workforces to meet budget targets.
  • New unemployment claims continue to average more than 400,000 per week.
  • 13.9 million individuals are unemployed. 8.5 million people work only part time.
  • 4 million individuals have given up looking for a job.
  • 6.2 million have been unemployed for more than six months. See Dismal Payroll Data

Economic experts, an oxymoronic term and group if ever there was one, offer a number of explanations: over regulation, the costs of complying with Obamacare, illegal immigration, free trade, an anti-business administration and other excuses.   Prophet without Profit has consistently argued that structural change has happened in the American work force.  This economy, recession and “recovery” is neither your father’s nor grandfather’s, and we are kidding ourselves to think we can treat it as such.  See, e.g., Why this May be Worse than the Great Depression and The New Reality: Permanent Job Loss.

The Fall of Labor

In Game Over, Mark Lapolla, managing director of Knight Capital Americas rationally explains our high unemployment:

  • We have created a worldwide economic system where we swap American intellectual property for cheap foreign labor from countries like China or Vietnam.
  • Enterprises based on intellectual property need less capital, commodities and most importantly, less labor.
  • The amount of human labor to produce an economic value has become “de minimis.”
  • Productivity for each newly added worker added has soared, approximately $80,000 per worker compared to a national average of $14,000.
  • Technology has supplanted labor in our enterprises.
  • Evidence of the problem is in high unemployment, duration of unemployment, and little or no wage growth.
  • The housing boom was a temporary salve to workers to permit extraction of wealth from homes.  That band aid policy is now over.
  • The few new highly skilled jobs that appear are being filled by over qualified employees.  They earn much less than they earned in their last jobs.  They do not contribute to a healthy level of economic consumption.

Implications

The implications are quite stark.   A society built on consumption must become a society of savers.  Unemployment will remain high for much longer than may be politically palatable.  Good jobs in the work force are going to require a high level of scientific, computer and mathematical skills.   Finance, retailing and other service jobs will be in a long decline.  Similarly, high unemployment will equal slow growth.  The housing market will continue to stagnate.

In the same vein Charles Hugh Smith recognizes these structural labor force problems.  America has focused too long on the quick fix of creating instant wealth through financial schemes or social media like Facebook and Twitter. We are now paying for our long term neglect of manufacturing job creation, and our failure to pursue a rationale industrial policy:

The U.S. has a distinct industrial policy: benign neglect, ignorance, favoritism towards real estate development and financialization, and a fanatic devotion to short-term profits and cost-cutting. Productive vs. Unproductive: Manufacturing vs. Financialization

To bring America back we are going to need to de-emphasize getting an MBA, and to focus on technical skills:

The U.S. culture denigrates skilled labor and glorifies the C.E.O. and innovator as god-like heroes. Other nations, notably Germany, maintain a value and education system which recognizes and nurtures technical skills. In the U.S., we fawn over social media companies that generate billions in new wealth for Wall Street and a handful of founders and venture capitalists, and drill into every student’s head the value not of tradecraft skills but of a four-year business degree. Productive vs. Unproductive: Manufacturing vs. Financialization

Smith concludes that in the winner take all, extraction economy, we get a small number of wealthy winners and the remaining 90% are relegated to living in a corporate-colonial economy ruled by financial oligarchs.

Our Next Steps

The first step is to recognize that our industrial and employment policies are deeply and structurally flawed.  We are applying outmoded policies to a vastly changed economic situation.  The second step is to stop wasteful and ultimately fruitless government efforts like boosting the stock market or housing market through quantitative easing or zero interest rates.   The third step is to reorient economic policy to encourage a return to manufacturing, to re-train the labor force in technical areas, and to create incentives to save and invest.  Otherwise, last week’s headlines will become even scarier.

 

 

 

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5
Apr 11

Rates Are Low, Morals Are Lower

Monday, the Wall Street Journal awakened to “discover” the plight of the elderly: Fed’s Low Interest Rates Crack Retirees’ Nest Eggs by Mark Whitehouse.  The Journal describes elderly Americans, who worked all their lives and saved what they thought were sufficient funds to live out their remaining years in comfort. With the Federal Reserve’s zero interest rate policy retirees are realizing miniscule returns on their savings. They must therefore resort to spending their principal and cutting back on all expenditures.  Some examples of this new reality:

Forrest Yeager, a 91-year-old resident of this seaside community, had been counting on his retirement savings to last until he died. The odds are moving against him. With short-term bank CDs paying less than 1%, the World War II veteran expects his remaining $45,000 stash to yield just a few hundred dollars this year. So, he’s digging deeper into his principal to supplement his $1,500 monthly income from Social Security and a small pension.

“It hurts,” says Mr. Yeager, who estimates his bank savings will be depleted in about six years at his current rate of withdrawal. “I don’t even want to think about it.”  See Fed’s Low Interest Rates Crack Retirees’ Nest Eggs.

Most recent (2009) Labor Department data  show that annual investment income over the last two years examined for 24.6 million households headed by a person 65 and over has fallen 37 % to a meager $2564.    In 2010, 33% of retirees dipped into savings to pay living expenses.

Hand Wringing

At this time, investing in short-term certificates of deposit, time deposits and money market funds would yield .24% annually, one-tenth the level of late 2007.  Inflation is now running at an annualized rate of 5.6%.   Richard Fisher, President of the Dallas Federal Reserve is quoted in the article:

“Americans who have done everything right, have worked hard, saved their money and stayed out of debt are the ones being punished by low interest rates,” says Richard Fisher, president of the Federal Reserve Bank of Dallas and a voting member of the Fed’s policy-making open market committee. “That state of affairs is not sustainable for a long period of time.”  See Fed’s Low Interest Rates Crack Retirees’ Nest Eggs

While recognizing the problem, Mr. Fisher’s comments strike me as surrealistic and disingenuous in the extreme.  Why is he hand wringing when he, more than most others, can effect change?  He is a voting member of the Federal Reserve!  In his position of influence, he can actually change the insane policies of the Fed.

Our Golden Years?

What are senior citizens doing to get by?  Mr. Whitehouse’s article lists a number of changes he is observing in financial behavior:

  • Investing in the stock market, even though much retirement saving has been devastated in the last two bear markets (2000, 2008)
  • Shopping at thrift shops and eating in subsidized community centers
  • Cutting or eliminating all other expenses such as movies or hobbies
  • Invading principal for living expenses

Re-entering the workforce is not an option for most retirees, as jobs are more scarce, or a senior age candidate may have more physical limitations on their employment options.

Unintended Consequences

The Journal recognizes that zero interest rate have been a windfall for the banks at the expense of the elderly.   All savers are hurt by the zero interest rate policy, but that is the obvious consequence.

Low rates don’t just hurt retirees. They also penalize people of any age hoping to build up funds for the future, and discourage rainy-day savings that could make U.S. consumers more resilient to job losses and other financial jolts. Americans’ net contributions to their financial assets, such as bank and 401(k) accounts, amounted to 4% of disposable income in 2010, according to the Fed. That’s the lowest level since it began maintaining records in 1946—except for 2009, when people actually pulled money out. See Fed’s Low Interest Rates Crack Retirees’ Nest Eggs

No wonder we have a sluggish economic recovery: we have no new savings to invest in the economy.  Further, if we want housing prices to recover, how does a young couple develop sufficient savings for a house down payment?

Return to Sanity

Zero interest rate policies punish the elderly in two ways: reducing personal income, and driving up basic need cost, such as food and energy.  Expecting the elderly to reenter a workforce that already has too many unemployed and underemployed individuals is absurd.  We are punishing that part of society who played by the rules: they worked hard, lived within their means, paid off their mortgages and saved for retirement.  Unfortunately, the Federal Reserve and the Obama Administration decided to reward the banks who made ridiculous loans, created fraudulent mortgage backed securities, overpaid their executives and nearly crashed the entire financial system.  Where is the morality of favoring the profligate over the thrifty?

Mr. Fisher and his colleagues could end the insanity tomorrow.  Stop the Federal Reserve’s interventions in the financial markets and let the market determine the true rate of interest.  Savers everywhere, elderly or not, will thank you.

 

 

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16
Mar 11

Economics and the Welfare State: Oil and Water?

Despite the constant cheerleading from the White House, the Federal Reserve and main stream media, we are still mired in the financial crisis of 2008.  While skeptics argue that the stock market recently has made a recovery high from its March 2009 low, major negative macro trends remain unresolved.  A look at these trends:

  • The Burgeoning Welfare State – Government at every level made too many expensive promises to too many citizens.  In the US we created and expanded entitlement programs: health care (worsened by the new Obamacare initiatives), food stamps, extended unemployment benefits, social security and prescription care coverage among others.
  • Unwillingness to Use Taxation to Pay for the Welfare State – Whether it is called Reaganomics or supply side economics, government policy has been to reduce taxes and to ignore the growth in entitlement and defense spending.   We have endured endless deficits for more than a decade, and are projected to endure more1 through 2020.  Political leaders are incapable of rejecting new entitlements or increasing taxes to pay for them.
  • A Love Affair with Debt – Government policy favored debt over equity.  Borrowing was encouraged at every level of the economy: states borrowed to excess to cover budget shortfalls, and artificially low interest rates lured home purchasers into huge mortgages. Homeowners then used home equity to extract cash through multiple re-financings and home equity loans. Corporations borrowed to buy back stock and to acquire other companies; the finance industry borrowed to speculate.
  • Global Wage Arbitrage – The US and other Western economies became high wage countries.  Manufacturing workers, state and federal employees, finance, insurance and real estate workers earned high wages disproportionate to their contributions to the economy. At the same time, improvements in high speed telecommunications and shipping permitted outsourcing of manufacturing and service jobs in low wage countries.  Frankly, western workers became massively overpaid.
  • An Over-Financialized Economy – Our best and brightest workers were wooed to Wall Street to develop non-productive products such as credit default swaps, interest rate derivatives and mortgage backed securities.  As a result careers in manufacturing, engineering, and science attracted less talent.  An inadequately regulated Wall Street continued to assume risk, threatening the entire global financial and economic system.  These risks have been hidden through extend and pretend accounting devices and reflating bank balance sheets with loans at zero interest rates.  Compared to outstanding liabilities and risk, banks remain woefully undercapitalized.
  • Imperial Over Reach – The end of the cold war left the US as the only superpower.  Instead of truly creating a lasting “peace dividend” and reducing our military, the US continues to maintain more than 750 military bases around the world.  Further, in the past decade we have been engaged in wars in Afghanistan and Iraq, fueling an ever increasing defense budget that we cannot reduce or afford.
  • Peak Resources – Whether we are truly living through “peak oil” the current soaring prices of basic commodities and energy demonstrate that we are facing peak everything.   With a falling dollar engineered by the wizards Bernanke and Geithner, Americans are forced to spend more of their incomes on basic foodstuffs and energy.  Not only are we in a wage competition for jobs, we are in a competition for the basics of life.  Inflation in basic foodstuffs was a trigger in the Tunisian and Egyptian revolutions and unrest throughout the Middle East and North Africa.

At A Cross Roads

No longer is this a Republican or Democratic issue, or a conservative or liberal issue.  These may no longer be just American issues.  Conventional politics has failed.   Western nations and Japan (after its current crisis) need to re-think welfare state promises.  Politics as usual cannot continue.

We need a new paradigm to adjust to our economic situation.  World crises, both natural and political, that we never could have predicted, will now impact our economic future.  These are subjects for future posts.

 

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American Society / Demographics / Economics / Housing / Technology / The Federal Reserve — 0 Comments
22
Feb 11

People Who Need People

To begin my one course in demography, the professor cheerily introduced the subject: “it is not that we are living longer, it is just that we are dying at a slower rate.”  Until recently, this was the last time that I thought about demographics. A blog post by David Goldman for the Asia Times explores the generational factors affecting our currently depressing housing trends. See Housing Prices and Demographics

Baby Boom Retirement and New Families

Demographers have been warning about a generational oversupply of homes.   Baby boomers are retiring, seeking to sell their current residences and move into smaller digs.  At the same time new family formation has plunged, weakening demand for the homes those retirees are leaving.

Sometimes it helps to look at the world with a kind of simplicity. Think of it this way: Credit markets derive from the cycle of human life.  Young people need to borrow capital to start families and businesses; old people need to earn income on the capital they have saved.  We invest our retirement savings in the formation of new households. All the armamentarium of modern capital markets boils down to investing in a new generation so that they will provide for us when we are old. See Housing Prices and Demographics

Two parent families with children are the driving force in housing demand.   While US population has jumped from 200 million to 300 million since 1970, two parent families have remained at 25 million. Housing units with three or more bedrooms were 36 million in 1973 and72 million in 2005.   Thus, the growth in home ownership for affluent two-parent families is lagging behind that for relatively poorer childless and single parent families.

Implications

In David Goldman’s world the cycle has gone wrong, with negative implications for our capital markets:

….something different is in play when investors are reasonably panicked. What if there really is something wrong with our future–if the next generation fails to appear in sufficient numbers? The answer is that we get poorer.

The declining demographics of the traditional American family raise a dismal possibility: Perhaps the world is poorer now because the present generation did not bother to rear a new generation. All else is bookkeeping and ultimately trivial. This unwelcome and unprecedented change underlies the present global economic crisis. We are grayer, and less fecund, and as a result we are poorer, and will get poorer still–no matter what economic policies we put in place.  See Housing and Demographics

Completing his thesis, unless we restore the traditional family to a central position in American life, we cannot expect the same level of wealth accumulation we experienced in the 1980’s and 1990’s.  Immigration and foreign investment cannot sufficiently compensate for the lack of family formation and capital.  The end result:

We are going to be poorer for a generation and perhaps longer. We will drive smaller cars and live in smaller homes, vacation in cabins by the lake rather than at Disney World, and send our children to public universities rather than private liberal-arts colleges. The baby boomers on average will work five or ten years longer before retiring on less income than they had planned, and young people will work for less money at duller jobs than they had hoped. See Housing and Demographics

The Job Corollary

I have the highest respect for David Goldman, but one area that he did not touch on is jobs or the lack thereof.   It is a bit like the chicken and egg problem.  Do secure jobs come first, so that workers start families, have children and ultimately buy houses?  Or are families formed, children born, houses purchased and jobs created and procured as an outgrowth of this cycle?  I think that a secure job environment must come first.

Jobs are critical to any analysis of societal wealth.   One could expand upon Mr. Goldman’s thesis and posit that we have too many people in the modern labor force. As we have discussed in this blog, technology and changing societal patterns have created a surplus of labor:

Right now the supply of people is too high.  How has this happened?  Medical technology has slowed infant mortality.  Better medical care and pharmaceuticals lengthen lives.  Women can control their own reproduction.  They can enter the workforce rather than tend to large families.

On the demand side, technology has dramatically changed the nature of work. A modern factory no longer has thousands of people producing cars or steel.  Gone are the Dickensian portraits of 19th century factory life. Computers, robotics and other labor saving devices allow smaller factories to produce cheaper and better products.  Brains have trumped brawn, but the result is a surplus of labor.  Combine improved productivity with a surplus of people and large scale unemployment ensues.  To offset declining incomes households piled on debt over the last 20 years. Income can no longer can support the ever expanding amount of debt in society.  See Are There Too Many People?

The trend to substitute capital for human labor has only been worsened by the Fed’s radical zero interest rate policies:

Low interest rates reduce the cost of capital, hence increase the propensity of employers to use capital-intensive technologies, substituting capital for labor wherever possible. Conversely high interest rates, by making capital more expensive, increase the propensity of employers to hire more labor and train its existing workforce to produce more output rather than investing in capital-intensive equipment….While the Greenspan/Bernanke monetary policies have increased recorded productivity growth, therefore, they have reduced job creation, in this recession creating a pool of long-term unemployed that will remain a miserable underclass until they pass on, decades in the future. See Paradise Regained

Where Are We Now?

We are in the worst of all possible economic paradigms.  We have high structural unemployment, meaning that it will not be easy to reduce the unemployment rate as many jobs do not need doing.   With the combined problems of a lack of jobs and poor level of family formation, housing will continue to suffer.  We built too many houses with too much debt.  We have not let house prices fall to clear this market of its surplus.   Zero interest rates and federal supports to the banks continue to impoverish the middle class and impede job formation and hiring.  Finally, food and energy inflation require an ever greater percentage of family income, and reduce needed savings for house down payments and upkeep.

People who need people also need lower prices and secure jobs.  And they need them fast.

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4
Jan 11

From Under-Reaction to Over-Reaction

DC Beltway insiders, abetted by their friends in academia, are expert at identifying and recommending political curatives for the ills of society. At the most sophisticated and effective level, punditry has a predictable genesis and trajectory.  First, from the chaos of all manner of the environment’s input, whether in universities or “think tanks” academics identify a societal problem that needs correction.  Many times, what follows is often widespread agreement that a problem exists and needs correction.  When that occurs, the process gains momentum, traction, attention and support from different constituencies.  Politicians whip up widespread public support.  Pundits produce inspirational articles and editorials in support of the corrective action.  Myriad examples emerge of the consequences of the unsolved problem.  Some examples may emerge of solutions to the problem, albeit solved on a finite, boutique, scale.  Soon we have groundswell support to “do something.”  We lobby, pass legislation, establish agencies and write regulations.  At the beginning all goes well, but soon problems arise. We experience administrative overreach, which is often worse than the original problem.  So what has begun as a good idea becomes misshapen beyond recognition and becomes its own societal problem. Some examples:

-          The problem: discrimination on the basis of race or sex.  The solution: Passage of the Civil Rights Act of 1964.  Starting with a simple corrective of ending discrimination we have built an administrative Rube Goldberg empire: the Equal Employment Opportunity Commission, the Office of Federal Contract Compliance, state anti-discrimination agencies. Soon class action and affirmative action programs were introduced as mandates.  Further, the Obama Administration now desires to expand the scope of anti-discrimination laws regarding the concept of equal pay for equal work to a new more troubling concept of “comparable worth.”  Employers are now beset with charges of discrimination and class actions. See ‘Comparable Worth’ Rears Ugly Head in Age of Obama

-          The problem: America lacks universal health care coverage.  The solution: The passage of Obamacare.  The law is byzantine beyond explication:

…the health system is complex, yes, but also ornate. The new law creates 68 grant programs, 47 bureaucratic entities, 29 demonstration or pilot programs, six regulatory systems, six compliance standards and two entitlements.

Getting that massive enterprise up and running will be next to impossible. So Democrats streamlined the process by granting Health and Human Services Secretary Kathleen Sebelius the authority to make judgments that can’t be challenged either administratively or through the courts.  See Obamacare Only Looks Worse on Further Review

The law has other consequences: 117 million current health care plan participants may need to change plans in 2013; 16 million new participants may be forced into Medicaid: Medicare benefits will be reduced to pay for the program; a 3.8% additional tax will be imposed on investment income; a 40% excise tax on “Cadillac” health plans and a $2100 increase for families buying private insurance plans.

-          The problem: Public employees need employment workplace protections. The solution: In 1962, President Kennedy extended collective bargaining rights to federal employees.  While federal employees could only bargain over working conditions, not salary and benefits, this precedent set the stage for widespread collective bargaining rights for public unions.  At the state and local level bargaining occurs over all issues.  Politicians have recognized the efficacy of acceding to union demands.

Thus, we have had an explosion in public sector salaries and benefits, especially lucrative pension plans.  As states and municipalities face huge budget deficits and massive pension plan underfunding, these entities are considering benefit cutbacks, bankruptcy and large tax increases.  The public, facing job insecurity or unemployment are revolting against increased taxes.  See Strained States Turning Laws to Curb Unions; Cash-Strapped States Seeks Laws to Curb Labor Union Power

-          The problem: The financial crisis threatens the solvency of US banks. The solution: The government ignores its own advice to the troubled Japanese financial system.  Instead of forcing the banks to write down bad assets, the government undertakes a costly and legally and economically dubious program of buying trouble assets.  It has  forced $700b dollars of funds on troubled banks, and continued to guarantee bankrupt Fannie Mae and Freddie Mac, and maintain a zero interest rate policy for over two years.   The economic consequences have been enormous:  unemployment near 10%; savers and retirees punished;  oil and other commodity prices exploded and the dollar substantially lower.

Taking it to the Limit it Too Many Times

We have lost the ability to identify a societal problem and implement a measured and thoughtful solution.  We have also lost the ability to forebear, take no action and let the problem work itself out.  We move from under-reacting to over-reacting.  Over-reacting imposes enormous costs on society.  Thus, we have backlashes against affirmative action, a move to repeal Obamacare, tax revolts against the privileged financial protections afforded to public employees, and simmering resentment toward Treasury and Federal Reserve policies which favor Wall Street over Main Street.

Perhaps in matters of important policy, more thoughtfulness, realism and humility, rather than brash hubris and impulsiveness, would restore confidence in both our government and our economy.

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30
Dec 10

Are We Getting the Government We Deserve?

There is an old labor relations saying: “companies get the unions that they deserve.”   In plainer words, poorly managed companies, constantly at war with their employees, tend to spawn highly aggressive, combative unions.   Put most succinctly, bad management yields bad labor relations.

In this context, let’s look at our series of rolling economic crises.  Our government’s response to each one has been to encourage or spawn “bubbles.”   (1.) Federal Reserve chairman Greenspan recognized the internet bubble.  Instead of squelching the identified “irrational exuberance,” he continued to encourage speculation.  (2.) Responding to the internet market crash, the Greenspan Fed spawned the housing bubble.  (3.) With housing now in shambles, the Bernanke Fed is openly trying to create a stock bubble. See Who Elected Ben Bernanke?

My hypothesis is that our political leaders do not have the courage to speak truth to the electorate.  Economies need recessions as a curative for financial and business excess. Without these necessary corrections, the seemingly easy way out of low interest rates, easy credit and promises of speculative riches becomes public policy.  If we are a populace seeking easy fixes to complex problems, we get a government that acts accordingly.

Spending is Easy, Savings is Hard

In Retirement Account Fantasy and Middle Class Erosion – 1 of 3 Americans Has Zero Dollars in a Retirement Account (“Retirement Account Fantasy”) the author exposes our dangerously low level of retirement savings.

1 out of 3 Americans has zero in any retirement account (not one slowly eroding dollar).  Half of Americans have $2,000 or less which puts them one month away from needing government assistance. See Retirement Account Fantasy

In a recent insurance company survey, 84% of young adults (18-29) and 60% of adults (30%) recognize that they need at least a million dollars to retire.   Actual retirement savings are nowhere near that:

The median retirement account for US households is $2,000.  This is why the vast majority of retirees depend on Social Security as their primary source of funds in old age even though Social Security was never designed to be a long term pension system.  The average retirement account is closer to $50,000 a year but this is heavily skewed by the top 1 percent that keep most of their funds in stock wealth.  See Retirement Account Fantasy

Thus, we have a failed retirement savings system which only exacerbates the shortfall in social security funding.  In turn, the government will be forced to borrow even more to fund future social security payments.

Ants and Grasshoppers

The author of Retirement Account Fantasy lays the blame for the retirement savings shortfall on our low income growth, income inequality and Wall Street pilfering.  While these observations are true they describe the patient’s symptoms, not causes.  The causes are a lack of savings and true investment rather than speculation.  Government has only worsened this problem through accommodative monetary and economic policies.  Zero interest rates are a disincentive to save and invest.

Prior to 2008, there was comparatively low unemployment and GDP growth.  Like the ant in the fable of the Ant and the Grasshopper, workers could have chosen to over save and under spend.  That would have required living in a home one could afford, and spending money that one actually had.  Instead, during this period we had our national savings rates turn negative.  Debt (especially housing debt) became a virtue and cash an anathema.

Instead of a policy of shared sacrifice and thrift, the government encouraged consumer spending, especially on expensive items such as McMansions and SUVs as a means to achieve economic salvation. See The Greediest Generation – Where has Shared Sacrifice Gone?

Reflecting more on the issue, I believe there is a deeper societal issue.  We live in an age of instant gratification.  If a web page loads too slowly, we need a better “app” or a better device.  If a marriage does not meet our expectations, we divorce our “life long” partner and look for a new one.  We suffer poorly even minor hardships.  Faced with a recession, we ask government to bail us out.

What happened to the ethic of earlier generations:  savings equals freedom: freedom to leave a job, start your own business, transfer to a new location, avoid government assistance, or simply to retire by choice while healthy and vigorous.

Right now government openly favors financial elites who are the merchants and promoters of debt.   But the way out of the financial crisis requires personal sacrifice and discipline.  Unfortunately, we seem to lack that will; thus, we get the government we deserve: easy fixes, easy money, short lived artificial booms and long-lived genuine crashes.

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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 / British Society / Financial / Pensions — 0 Comments
29
Sep 10

True Confessions: A War on Savers

We have lived through the war on drugs and the war on poverty.  We now have a British government official admitting that we now have a war on savers.  Deputy Governor of the Bank of England Charles Bean told pensioners to stop moaning about low interest rates:

Older households could afford to suffer because they had benefited from previous property price rises….They should “not expect” to live off interest, he added, admitting that low returns were part of a strategy.

Savers shouldn’t necessarily expect to be able to live just off their income in times when interest rates are low. It may make sense for them to eat into their capital a bit…. very often older households have actually benefited from the fact that they’ve seen capital gains on their houses.   See Savers Told to Stop Moaning and Start Spending

Post crisis, savers in Britain are now averaging interest on their savings of less than a quarter percent (.023) as compared to just under three percent (2.8).  The response of groups representing pensioners is swift and angry.

National Pensioners Convention spokesperson Dot Gibson said:

“For years we’ve been told to put money aside for our retirement only to find that interest rates have sunk and now we have to use our savings just to pay the bills.” See Savers Told to Stop Moaning and Start Spending

Save Our Savers spokesperson Jason Riddle added:

“The Bank was aware that there was a lack of saving before the financial crisis, but those who were prudently saving while others spent, are being heavily punished.”  See Savers Told to Stop Moaning and Start Spending

The article calculates that savers have lost 18 billion British pounds due to low interest rates.

Elites Gone Wild

The political and financial elites have spun the truth to persuade the public to accept post-crisis bank prosperity at the expense of the real economy. But the truth has a funny way of rearing its ugly head and reasserting the plight of Main Street at the mercenary hands of Wall Street greed.   Last week Charles Munger, Vice Chairman of Berkshire Hathaway and partner of Warren Buffet, spoke at the University of Michigan.  He attempted to justify the bank bailouts and corporate guarantees:

“You should thank God” for bank bailouts, Munger said in a discussion at the University of Michigan on Sept. 14, according to a video posted on the Internet. “Now, if you talk about bailouts for everybody else, there comes a place where if you just start bailing out all the individuals instead of telling them to adapt, the culture dies.”

“Hit the economy with enough misery and enough disruption, destroy the currency, and God knows what happens,” Munger said. “So I think when you have troubles like that you shouldn’t be bitching about a little bailout. You should have been thinking it should have been bigger.”  See Berkshire’s Munger Says Cash-Strapped Should ‘Suck it In’ and Not Get Bailout

Mr. Munger fears that bailouts would lead to another Adolph Hitler.

Mr. Munger’s contempt and disdain for the middle class and working poor came out later in the Michigan session:

To another who asked whether the government should have bailed out homeowners instead of Wall Street, Munger said: “You’ve got it exactly wrong.” “There’s danger in just shoveling out money to people who say, ‘My life is a little harder than it used to be,’” Munger said at the event, which was moderated by CNBC’s Becky Quick.  “At a certain place you’ve got to say to the people, ‘Suck it in and cope, buddy. Suck it in and cope.”  See Berkshire’s Munger Says Cash-Strapped Should ‘Suck it In’ and Not Get Bailout

I am OK, You are Not

Bean and Munger have demonstrated the arrogance of the elites.  Is it alright for Berkshire Hathaway, which is heavily invested in the financial markets through significant stakes in Wells Fargo, Goldman Sachs and GE, to be bailed out by the government?  Should we, the “little people,” 25 million of whom are unemployed or underemployed, just “suck it up?”

Mr. Bean’s recommendation for financial survival is to tap into the capital gains on one’s home.  How does a pensioner do that?  Borrowing with no income to support the loan?  Selling the home, paying tax and moving where?    Take out a financially sketchy disadvantageous reverse mortgage?   Alternatively, go out and get a job when there is massive UK unemployment?

Mr. Munger laments that the bailouts to the banks were not in even higher amounts.  Neal Barofsky, inspector general for TARP, estimated that bailouts and guarantees were in excess of $23 trillion.  See Credit Ghettos.  Mr. Munger, how much more should have been handed out to Wall Street?   Why does that type of behavior not destroy the currency and lead to Munger’s feared re-run of the Weimar Republic and Hitler?

Munger and Bean demonstrate how out of touch the financial elites in Britain and America are with the plight of the middle class.  It also demonstrates how pernicious zero interest rates are for the middle class, pensioners and savers in general.  We have discussed the immorality of zero interest rates extensively.  See War on Prudence,  Nothing from Nothing, Is the Administration Determined to Make the Elderly Poor?

Luckily, in the United States we have the ballot box to effect change.  Last time the elites in Europe said “let them eat cake” change took place on a scaffold with a guillotine.

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Economics / Financial / Political — 0 Comments
5
Aug 10

Zero Interest Rates Equals Zero Jobs

Following World War II, typical economic downturns and recoveries have been “V” shaped.  That is, a sharp downturn in Gross Domestic Product and rising unemployment followed a quick turnaround in both economic activity and employment numbers.   This time is different.  We are witnessing zero or negative job growth and an anemic recovery.

Today’s situation is a different animal: a balance sheet recession.  Both businesses and individuals took on too much debt. And that debt was unsupported by income.  We are now saving to pay down that debt (the most recent savings rate increased to 6.4%), or defaulting on obligations (in May home foreclosures rose 44% to a new record).

Paradoxically, second quarter earnings demonstrate that corporations are beating earnings estimates and reporting healthy profits.   Gluskin, Sheff reports that

…78% of the companies reporting have beaten estimates and earnings per share are up 42% year over year versus initial expectations of 27%.

Companies have focused on tight cost controls to achieve these results.  The most recent durable goods report provides a clue to how costs are being controlled.

Orders for non-military capital equipment excluding aircraft climbed 0.6 percent last month after jumping 4.6 percent in May, more than previously reported, figures from the Commerce Department showed in Washington. See Second Quarter Earnings: Companies Beat But Investors Shrug

Looking further, we see we are in a jobs depression. Karl Denninger slices through the obfuscatory government data and finds that from July 2009 to July 2010 unemployment is 17% worse. See Watch the Birdie (Jobless Claims). After trillions of dollars of stimulus and guarantees and a zero interest rate policy, all we have to show for the effort is zero, or negative, job growth.

My strong suspicion is that management is substituting capital for labor.

A Brief Anecdote

One of my friends is the cost cutting guru for his company.  Always on the lookout for new labor saving technology, he found a type of packaging machine that could replace five employees currently performing the function manually.  His view is that labor saving technologies are the only thing preventing the economy from crashing.  By laying off those five employees, the machine pays for itself in two years or less.

On the other hand, employees unionize, get sick, go on vacation, file worker’s compensation and discrimination claims, and go out on pregnancy and family medical leave.  As an employer, machines suffer none of these disabilities.  Substituting capital for labor is firmly rooted in all corporate cost cutting strategies.

Unintended Consequences

With Obama, Bernanke, Geithner and Summers setting economic policy, I always feel it is improvisation night.   This team seems to bounce from one economic policy to the next with little thought given to unintended consequences.

-          Zero Interest Rates – I have written about the pernicious effect of zero interest rates on savings, especially for senior citizens.  See e.g. Is the Administration Determined to Make the Elderly Poor? Nothing from Nothing.  However, the upside is that low interest rates encourage the creditworthy to borrow for capital investment.  For example, IBM was able to borrow at 1% for 3 years.  If you can purchase labor saving machines with low interest rate loans and tax depreciation savings, why not?

-          Expensive Social Programs – Ignoring high levels of unemployment and economic stagnation the Obama Administration pushed ahead to pass health care reform.  The law does not apply to businesses with less than 50 employees.  The perverse effect is obvious:

…potential tax penalties for employers with more than 50 workers could cause many smaller businesses to rethink any hiring or expansion plans.

“It could have a negative effect on hiring as businesses figure out just how much the new law and offering health benefits will actually cost them,” many … small business clients have kept their staffs below 50 workers to avoid the complicated compliance requirements of laws such as the Family and Medical Leave Act.

“The new tax penalties for businesses with more than 50 employees will certainly make many business owners think twice about expanding and hiring more people….”  See Small Businesses Ponder Impact of Health Care Reform

Add in the threatened expansion of unions through the Employee Free Choice Act and no wonder large and small businesses are reluctant to hire.

Machines Make Better Employees

At its core, the Democratic Administration has failed in its campaign promises to reduce unemployment and get the economy back on track.  Through its zero interest rate policy the Federal Reserve and the Administration have “manufactured” our current high unemployment rate.  Today’s jump in new unemployment claims, to a weekly rate of only emphasizes the point. See Weekly Initial Unemployment Claims Increase to 479,000

The net effect is that machines provide better value than employees.  The labor market has structurally changed and not for the better.  Zero interest rates coupled with zero forethought is harming the working population.

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