The Apotheosis of Deal Making
For Ben Bernanke and the Fed these have been bare knuckle flying days. Never has the dominant central bank moved so radically into a new orbit as has the US Fed this year. Conversely, for the Media this launch into monetary outer space has been greeted with the kind of yawn that might have been reserved for a weather balloon.
Never mind the Bear Stearns rescue that was done so hastily that it appears no one bothered to insist that JP Morgan Chase return future windfalls estimated to be in the billions against guarantees the Fed made to get the deal done in a weekend. The Bear deal did close to end out a very perilous week and what looked like a potential domino game of other falling investment houses --Lehman Brothers was most named as the next-- was stemmed, at least for the time being. This respite, coupled with recent moves up in the markets and the dollar, has gained Bernanke street creds and has kept the flak to a minimum, and directed mainly by capitalist purists, long used to not being listened to. Politically, it also has served as leverage for those who would rescue the millions of underwater adjustable mortgage holders.
While it's true that the Fed's rescue of an important "investment house" crossed a bright historical line, it was also widely recognized that the banking world itself has changed so radically in the last decades as deal making has replaced the sweat and toil of agriculture and manufacturing, that the commercial banks and the investment houses overlap in the kind of credit issued and the kind of paper they accept either as "insurance" or "assets" to back their financing of deals. And it wasn't just Bear and Lehman Bros. etc. who were taking enormous losses, it was also the world's largest "commercial" banks; i.e, Citi, Deutsche, UBS, HSBC, etc. who were announcing multibillion write-downs as far as the eye could see.
The lesson to be drawn is that the Fed and the key European central banks (ECB, BOS, BOE,) have made it abundantly clear that no rash of bad deal making, no matter how egregious the imbalances created are, will be allowed to fail. The Bear deal made headlines, that couldn't be helped but a much more radical plan to create a superfund for bad debt that could go to $800 billion by year's end passed unnoted!
TAF, the Fed's Superfund for Toxic Waste
Last December 17, the Fed announced that it was about to offer US Banks (This was later expanded to include the Bank of Switzerland and the European Central Bank) a deal that they couldn't (and wouldn't) refuse. In exchange for the highly discredited --we prefer the word, toxic--mortgage backed securities on their books, the Fed would offer the banks at face value highly secure US Treasury notes. This deal was called TAF, or Term Auction Facility. In exchange, the Fed charges only 2% --slightly below market, that is, for paper that would probably mark to market at an average discount of 20%-- in interest.
In essence, to get around reserve rules and allow the banks to keep lending, the Fed is taking them off the hook for the bad paper they issued and bought and for the collateral they received from hedge funds that were gambling in the real estate bubble that was fueled by these mortgage backed securities. Remember, the mojo that fueled the rush to lend anybody standing (Chicago voting rolls had better actuaries) with the dough to get into their dream house, came directly from the red hot mortgage backed security and credit swap markets that looked great on the balance sheet of the hedge funds, generated huge annual bonuses for the poo-bahs, and eventually spread as far as the coffers of small towns on the banks of the Norwegian fjords.
So, once again, now that the party is over, the bonuses banked, the private jets furbished and the summer and winter palaces built, the Fed has rushed in to sweep up Wall Street's left over garbage. However, quite significantly, since this was a very big party, even the limits of the US Federal Reserve may be stretched by the time this plays out.
The Fed had been buying up Treasuries for over a hundred years and before this latest rescue operation now in full stride, it had managed to accumulate a war chest of over $800 billion. It's more than a little notable, that by early May, they had already drawn down that pool by more than $150 billion.
In May, Bernanke and crew decided to double down on their bet when they realized that this was not just a mortgage crisis but instead a major debt crisis that includes consumer and student loans as well as automobile credit. To meet the threat that Americans might start walking away from their gas guzzlers and piles of credit card debt, they agreed to expand the definition of eligible paper beyond residential and commercial mortgage backing to anything with a rating above AAA/Aaa asset backed securities. Remember, one of the sub plots of the whole greedy asset-backed security mess, was the way the bond rating agencies decided to jump into the party by trading good ratings for expanded business. In this pool, AAA/Aaa could mean practically anything, even used cars!
Bernanke's big bet is that the failure in the real estate markets will have begun to normalize by the end of the year. And for this to happen he has managed to buy time by putting his $800 billion stake on the table where everyone can see it. For the moment, this has had a calming effect on the stock market and even has slowed the decline of the dollar.
By the end of the year, this hiatus may look more like a pause between storms and if housing prices continue to fall, job losses accelerate and consumers pull way back , it's quite possible Bernanke will have blown the entire pool of Treasurys built up over a century in just a single year. Little wonder, then, that he has given his own encouragement to Congress to move in its rescue of the little guys struggling to hold onto their houses. Too many empty houses on the market could tip the balance.
But there are headwinds that could counter the stimulus that comes from artificially low interest rates, government supported mortgages and a giant green light for bankers to continue to lend. For one thing, a majority of the houses that need rescuing are located in exurban locations. Commuters from these locations where just about everyone has a long commute, often driving the de rigeur SUV or pick-up are getting doubly clobbered as they fill up their tanks and do the weekly supermarket run. Also, a number of the most vulnerable no-money-down mortgage holders were working in the then booming construction industry. In order for prices to even bottom out, new building will remain at a standstill for a long time to come. The combination of a slowdown and the kind of inflation that hurts consumers most, also spells trouble for the commercial building market as company's shrink their staffs. The Fed and Congress's best efforts may not be enough to convince people to keep paying for homes, much less cars, they can't and never could afford.
In CreditWorld, Leverage is King
Most Americans not only do not have savings but most have accumulated large amounts of plastic debt as they attempted to live better even while struggling to keep up wages and pay for health care, fuel and food prices that have only accelerated even as jobs get harder to find.
By lowering interest rates to artificial levels for the second time in five years --to make its TAF subsidy less conspicuous?-- the Fed is also telling savers that they are losers in this new economy. There is little wonder that people who sat on the sidelines while their neighbors were tapping their houses like ATM's now see themselves as the losers. In CreditWorld, it's obvious that Aesop's Tales get flipped upside down.
We have been in bubble mode back since the Keating Five. Since then we have had a succession of bubbles all fanned by Fed policies. We can offer some ideas on what the Fed will sacrifice next to keep the party going one more time.
The Dollar Has No Clothes
Where the buck stops and starts, erosion of the world's preeminent store and measure of value, the US dollar, can serve as a metaphor for the way we grok an expanding, inter-related sphere of critical but slow boiling crises like: energy, health care, population, food, water, climate change, human rights, personal freedom, trade imbalance, wealth division; etc.
FUD and Band-Aids
The dollar is, after all, merely the material meter with which we value all our goods and labors. And yet the precipitous shrinking of this measure, of anywhere between 50 and 150% over the last decade against basic materials has all but escaped mention in the agenda-driven, zeitgeist whirlpool we call the Media. Obviously, once again, it serves no one's agenda to call attention to this inconvenient happening just as it appears to serve no one's interest to understand the consequences of peak oil in an energy driven world economy.
We can offer some "politicized" explanations for the inconvenience, like the cost of a long war to folks who want to expand it to Iran, the war's impact on the price of oil, the insistence on borrowing from foreigners holding excess dollars-- to offset government deficit spending and soak up the overhang from the trade imbalance, the fostering of easy credit needed to jack up the consumer component of the economy to over 70% even as wages stagnate and manufacturing and services are outsourced, the fudging of the CPI to grossly hide inflation and the loosening of controls on how the financial sector can create money.
Here in Dymaxia, we have no magic ways to tap into pools of truth. We are as unarmed as you, dear reader, to insist on what gets talked about on the loud megaphones that, when blared, reach everyone. So, when we try to discern agendas; we mainly revert to the "who stands to gain" approach.
In TV-land we notice there are rarely analysts who insist that borrowing a trillion dollars to fight a war has a negative affect on the value of our currency. There are rarely analysts who make plain that the war in the Persian Gulf is about the control of the flow of petroleum even as it is so completely obvious it sometimes shows up as a slip of tongue by some soon to be sorry politician. There are rarely analysts who make clear that it has been Iran, that has been the greatest beneficiary of our sorry adventure in Mesopotamia. It even took forever for anyone to note that Bush's brain was running on empty even though nobody had ever heard him successfully string three words together.
Time Outs are Ugly
The blogosphere, with all its cacophony, is the repository of an enormous pool of gray matter and hands-on knowledge. One only need think about Wikipedia, warts and all, to grasp its potential to gather information in a cooperative endeavor. But for all its vitality it is a David in the face of a massive Goliath. The whole sorry run-up to the war and the fool me twice rant on the success of the Surge has shown just how a repetitive Media acting in unison can drown out wiser voices.
China, as well as many other more or less totalitarian regimes, has gone further in managing to suppress activity on the Net. Likewise, here in this country, the major internet service providers (led by AT&T and Verizon) have been waging a legislative battle to gain control of the Internet's pipes they manage and parse them into fast lanes (for paid media stuff) and slow lanes (for everybody else). Advocates for Net Neutrality understand that the speed in which a web page, or say, a YouTube clip, is delivered to a browser can ultimately have a major impact on users' preferences for competing info sources. Lest we forget, here's a brief list of YouTube moments that have, for better or worse, had significant weight on this election: Jeremiah Wright's "God Damn America" rant, Hillary's Bosnia misinformation episode, Allan's Macaca Moment (yes, he was an insider conservative pick), McCain's confusion over Sunnis and Shiites, etc.
Ultimately, a sure sign our experiment in democracy is failing is when citizens continue to vote against their best interests. There is, it seems, one tried and true way to make this happen, through cacophony and confusion that elevates wedge issues far above their significance and neutralizes inconvenient facts and truths. Imagine pointing out to people that the price of gasoline or their basic foodstuffs hasn't really gone up so much as the dollars we use to pay for them have gone down. Imagine how that would affect the mass psychology! Instead the story line goes: India and China are now getting richer and they are buying up all our excess petrol, rice and corn. Shouldn't we be wondering how this cosmetic explanation gained such mainstream currency?
Peak Oil?, When's the Last Time You Heard About Peak Oil?
The great issue of our moment, is the nonrenewable fuel crisis. It shapes the most fundamental aspects of our government policies in enormous ways that then need to be obscured by those who would allow us down this --for them very profitable-- path towards the most momentous crash this civilization has ever known. If you look at the War as an extension of our status-quo oil policy, and the cost of maintaining that war at its present inconclusive level and the cost of borrowing to sustain that and factor that in as a direct subsidy to petroleum, the price we really pay per barrel goes ballistic. Now, add in the cost of keeping the Persian Gulf open for shipping, the naval and air power, control and command structures for the region and all the unintended consequences that grow out of our preoccupation with keeping the spigots open, then factor in the burgeoning cost of global warming, not to mention road building and maintenance and you are talking about the greatest subsidy in our history for an ultimately declining industry that will, by the definition of its finiteness, only fail us if we insist on remaining addicted to its supply.
What is worse, as long as we insist upon basing our energy mix around imported oil, we are sending more dollars out of the country into the coffers of the very same countries we feel most threatened by! This, we submit, is collective insanity of the first order and it it doesn't convince you, dear reader, that something very fundamental in the way we process information in this country is entirely broken, then, we suppose, you are reading this for laughs.
Corn to Ethanol, a Metaphor for our Time
It might take chutzpah and confusion to get here but once in Washington, the real money is in the FUD and band-aid businesses: take the current economic crisis-- the product of serial bubbles and across the board excess borrowing from the government down to the lowliest citizen. As a remedy for these excesses, the President announces, without worrying how it might be paid for, that he is sending everybody in the country a check that he promises is sure to kick-start a new recovery to the "slowdown", Congress funds a way for communities to buy up foreclosed properties, the Fed has its back window open soaking up the financial waste products on the books of the major banks and brokerages and it's printing presses running over-time to serve up cheap (when you factor in inflation, interest rates are now negative) money for the next bubble, farmers are paid to turn corn into ethanol even if the process absorbs as much energy as it produces and food shortages pop up around the world, and the Presidential candidates promise programs or further tax cuts, with no way to pay for them. "Got a Problem?, we'll lower a tax!
You might think that this money for nothing, kicks for free approach to solving what is essentially a borrowing crisis, might have raised the curiosity of those who tell the national narrative. How, they might ask, have we found ourselves in the position of facing lower salaries for workers, rapidly rising food prices, gasoline prices that might have showed up in some SUV driver's nightmares a few years ago, and a dollar that is so anemic that travelers abroad have taken to complaining they can't afford un Grand Mac not to mention a coffee and croissant. Watched or not, pots will come to a boil, and now it seems we have come to one of those moments where the steady stream of bubbles in the weak dollar kettle can't be ignored. Of course, as they ignored the rise of CO2 in the atmosphere and its effects, or the decline in ordinary peoples' earning power over the years, the pundit class continues to prate, as if they were playing pin the donkey's tail on their own asses.
Connecting the Dots
First off, there's the unavoidable price at the pump that's brought one of the least enjoyable aspects of traveling in Europe to our own pump islands. You no longer have to imagine paying over 120 bucks to fill up your tank; it's enough it seems to make some people want to give up a job that requires a 150 mile daily commute in their Tundra, if they could only find another. No wonder then, that people are tucking the keys under the Hummer's driver side mat and walking away from that 5000 sq. ft. dream house now 20 or 30% under water, with heating and cooling bills to match.
For that matter, has anyone noticed that while the price of gas was going up, the value of the US dollar was somewhat symmetrically falling when measured against food staples, raw materials, precious metals or even other trading partner currencies like the Euro or Yen?
Of course, we are not on a gold standard, that is, there is no official link between the metal and the dollar but quite curiously we can see that even though the price of oil is actually quoted in dollars, the sellers of that black liquid are getting no more today, if measured in gold, then they did five years ago.
Once upon a time, there were, in more primitive days, political positions that would argue in favor of a weaker or stronger currency. Populists, remember William Jennings Bryant and his famous Cross of Gold speech, would argue for the government to soften its golf restraint to print more money to stimulate growth, Conservatives, with notions of protecting their net worth, argued against the notion. Later it was said that a cheap currency protected both industry and worker by cheapening exports and making imports more costly. Significantly, it was Richard Nixon who broke off the last link between a precious metal --in this case, silver-- and the dollar, thereby making the American printing press, the world printing press. Today, a weak dollar benefits the balance sheets of multinationals who can shift resources in and out of markets and magnify the "growth" of foreign profits by converting them, on paper, at least, into cheaper dollars. For instance, last month, it was Ford's turn to show a profit abroad that magically out-totaled its losses in the US.
For those of us who measure our spending ability in dollars, it is hard today to make the argument that a less valuable dollar has some beneficiary impact. The old saw that currency devaluation acts as a stimulus for export trade has a very hollow ring to a society that has outsourced most of its manufacturing capability to other parts of the world. A low dollar may be helping China and India to establish markets in the "strong" Euro and Yen zones but it has done little or nothing to offset the ever growing trade deficits being run up in this country.
Curiously, outside of Ron Paul's run, none of the present candidates talks about the impact of the dollar's value on all us and so while broadly "the economy" is perhaps the major issue, the role our currency plays appears to get short shrift. Paul, though somewhat coherent, probably has done little to broaden the discussion. By putting a lot of focus on the gold standard, which only rewards gold producing countries, and combining that with an unreal role for government, Paul turns off most progressives and fiscal conservatives who might otherwise be repelled by a weak dollar policy that punishes all of us with savings and earnings in dollars while rewarding multinational corporations that can hedge their holdings abroad and further gimmick earnings.
There are many reasons why the weak dollar has been shut out of the national political discourse by both parties; it's just plain inconvenient since: it makes our assets less valuable in a global economy, it makes it advantageous for players outside the dollar zone to purchase US assets, it tilts corporate power to companies that can do a large part of their business outside the dollar zone and most importantly, it boosts the prices of staples and raw materials where there is global demand. Like the recent rise in oil prices vis à vis the dollar, the same thing is happening with the price of rice, corn and wheat, the basic food staples the world depends upon. And like petroleum, the food story has a raft of causes. Being somewhat simple in nature and style, we here in Dymaxia, will make the argument that the price of food, like the price of copper, or platinum or uranium has followed closely the ascent of the price of oil (and, of course, the symmetric decline of the dollar).
It's the Dollar, Stupid
We are left to wonder why the two Democratic candidates have not seized on the weak dollar as an argument against McCain and his supply side bromides that will lead to further deficits as far as the eye can see. One supposes they are afraid of being ridiculed the way Paul was made to suffer. Ultimately, this may be a mistake because there is a visceral component to the issue. We in this country are being beggared in order to protect global hegemony for our great global corporate entities. In fact, this is actually and certainly, a potent enough issue, if past currency crises are examples, to be successfully used as an argument for pay as you go government!
Many of the most successful investors over the last six years have bet against the dollar. They looked at the supply-side (debt-fueled) script that Bush was intent on playing out, they looked at the historically unprecedented shift of manufacturing capability out of the US to Southeast Asia that insured an ever increasing trade deficit, they looked at the ensuing shift in demand for basic commodities including food and energy, they looked at the laissez-faire postures coming out of Greenspan's Fed, and finally, once underway, they concluded that the cost of the Iraq War, particularly as it was funded off the books, would further weigh on the dollar, the world's reserve currency.
We are far from our Zimbabwe moment --the rest of the world is paying a price for the weak dollar and will ultimately intervene to support it-- where it takes a wheelbarrow of currency to buy a loaf of bread but we are beginning to see some weird distortions: the price of basic foodstuffs has climbed throughout the world. This is partially due to weather changes, they say --the rice crop in Australia-- and partially due to increasing demand, particularly in Southeast Asia, and partially to the use of corn for ethanol production but also to the decline of the value of the dollar. The US is a major grain producer, a weak dollar would indicate that grain becomes cheaper when purchased outside the dollar zone. This is not the case, of course. Instead, like oil that is also denominated in dollars, food grain prices have climbed as currencies in the raw materials exporting parts of the world have not followed the US dollar down, countries like Canada, Australia and New Zealand.
Because so much of our food is packaged, manufactured product, the raw material component price has not had such a startling impact as say, the price of corn has had on Mexican families who rely on the grain as a key part of their diet. There have been demonstrations in a number of countries beyond Mexico including most recently violence in the streets of Haiti. It is possible then to foresee troubled times around the globe because of a devaluation in the US.
As we've also often noted, paradoxically, the oil rich Arab states, the Chinese and the Japanese have a vested interest in supporting the dollar regime, even as it appears to be falling apart. This is because they are major holders of the dollar in the coffers of their banking systems. They could precipitate a world financial crisis that would make the present leveraged banking crisis feel like a warm breeze in the eye of a hurricane. To be sure, they are all working overtime trying to figure out the least destabilizing ways to lower their dollar positions. We can look for the Chinese, say, to be out seeking stakes in entities that own and control raw material assets and distribution.
Another factor driving the value down is our artificially low interest rates. Money from abroad that might normally flow into the US for safe harbor bond purchases, will instead go to places where interest rates are higher. Today, the rates set by the governing central banks in Europe, Australia, New Zealand and Europe are about where the US was before the Fed rushed in with its record setting cuts. Low interest rates make it cheap for companies to borrow and thus stimulate business activity. What's dismissed is that low rates hurt savers and retirees who have managed to be thrifty and are now living off those savings, even as much as a cheap dollar does. Together, there is a double whammy of inflation and wealth erosion.
Miraculous Recovery
There are some out there who are already heralding that we are on the brink of recovery in the US, even as we are just entering into this Recession. After all, the stock market has performed well this month and the unemployment figures don't seem so bad. Our guess is that unemployment and job loss will be revised upward in the future as they are measured by means that tend to obscure the facts at the outset and end of cycles.
What that would mean is that the financial system has managed to absorb $100's of billions in bad paper, that construction workers who have lost their jobs have some how ended up on their feet, that ordinary Americans, no longer able to borrow against their houses, are bellying up to the bar and paying more for gas and food and still yet are able to keep the 70% of our economy that depends on their consumption on track for growth, that continuing job losses in manufacturing are being replaced elsewhere, that interest sensitive savers are able to absorb the hit of low returns, that high diesel costs are not driving up retail costs and that continuing job shrinkage --we need 150,000+ new jobs per month just to keep pace with population growth-- are all being overcome by some miraculous happenings off the radar somewhere.
Moral Hazard is a term of art, it has an old fashioned kind of zing to it, like a Jane Austin novel where the cardinal points are attraction, marriage, pound sterling per year, and caddish behavior (a seducer runs off with a foolish 15 year old with no intention to marry her, or even worse, commit marriage sans income).
Lately, of course, moral hazard has become in the popular press something associated with the ongoing financial crisis. Roughly defined, it invokes the requirement that investors, fully rewarded for their wins, must also pay the whole price for their haircuts. And so, it's not bad behavior, per se, that must be reckoned to the full but behavior that results in material loss, wanton or not. In this latest crash there has been no shortage of the usual caddish behaviors: salespeople were spiffed to get customers into financially disadvantageous loan agreements, borrowers faked their personal financial data, rating agencies put their AAA imprimaturs on toxic paper, bankers created an insatiable demand for loans they could package and pass on, "counterparties" cleaned up writing default swaps they could market, regulators looked the other way, brokerages shorted the securities they themselves issued to their own customers, hedge funds borrowed heavily to get their bets into the game, bankers made extreme loans to hedge funds, bankers created off the-book entities to issue suspect paper, etc.
And, of course, when this rash of bad behavior went from endemic to epidemic, the usual calls for government intervention went out, first by the general public when foreclosure signs began to sprout in their neighborhoods like mushrooms in a rainy Fall and then in the weightier pages of the WSJ and FT when it became clear that the great investment houses, themselves, had been left swallowing their own toxic waste and melting into the ground like a serial Three Mile Manhattan, London and Basil. As fast as the Fed and the ECB pumped "liquidity" into the markets, the faster the banking system seemed to fuse to a halt. Something more radical than winners and losers was occurring, hence the concerted move to a bail time-out for the whales left flapping on the beaches.
For the cynics here in Dymaxia, it came as no surprise that the bailouts would extend well beyond the former limits of the commercial banks all the way to the free-market precincts of the hedge fund industry. After all, by definition hedge funds are highly leveraged entities that do their borrowing from their willing commercial and investment banker brethren. We also remembered Ben Bernanke's famous "helicopter" speech in which he vowed to keep the government printing presses going day and night to supply whatever money might be needed to keep the system off (or on, we couldn't recall) its knees.
To ourselves, laying down the editorial pages of the Wall Street Journal, we mused, moral hazard is about as quaint a notion today as the characters in Austin's Sense and Sensibility might have appeared to Choderlos de Laclos, the author of Les Liaisons Dangereuses, had he lived long enough to contemplate them. In the end, it was the chronicler of another gilded age that seemed more appropriate, and so we deferred to the much maligned Marquis de Sade for our contemporary standards for hazardous morals.
As we noted in our last posting,
Pushing on a String of Discontent: Bernanke's Tale: Bernanke's Tale, the Wall Street executives who led their companies so deeply into this quagmire, would surely not admit, even under oath, that the good performance their companies produced as the pyramid scheme unfolded, and for which they were so richly rewarded by cash and stock option bonuses, had little or nothing to do with the hard landings their companies were experiencing today. "Who could have predicted," their chorus lamented, "that the unprecedented growth in home equity and home ownership, would have resulted in a bursting bubble?" And like all farces that recount the foibles of the Gods, economists, the regulators and the mainstream press, echoed in polyphonic tone from across the stage, "who would have predicted"?
And so, in keeping with the moment's theme of decadent farce and moral hazard, we asked rhetorically, will those entities that are now rushing in to save the remnants of Bear Stearns (it was too late for these guys who, it appears, were so swimming in toxic waste that a special $29 billion fund had to be set aside by the Fed to soak it up) and most recently Lehman Brothers (they've already availed of $4 billion in back-up spare change) be asked to take back some of the bonuses that were paid out to top executives during the recent up years?
The answer, of course, is that it will take another round of heat, at least, before anyone begins looking for a couple of high level guys for some communal bloodletting. After all, James Cayne, the Chairman and CEO at Bear Stearns, we hear from those same journalists who continue to insist on calling that company's forced by-out, a non-bailout, has paid dearly for the loss of equity he suffered. His shares, they remind us, went for $10 a piece when just a couple of years ago they were trading at $171. We are, by this light, supposed to suffer for the good chap who like a Long Island Nero, played bridge while his firm and his bonus shares sank into the clutches of the goodly fiends at JPMorgan Chase.
Quaint, we say, because today's gilded age has funneled so much wealth into the hands of this super class that counts its yearly earnings not in the hundreds of millions but in the thousands of millions of dollars even while the tax rates paid by this über group are less than those paid by the lowest wage earners. Last year, a tepid attempt by Congress to reckon hedge fund manager earnings as taxable earnings was quickly shunted to that special place on Capitol Hill where all high minded efforts go to be stored, like Walt Disney's body, for a better day.
Speaking of which, the distortions created by economic policies that hide the cost of war, rely on declared and hidden deficit spending, encourage plastic-based consumerism, personal credit extension, negative real-term interest rates to discourage saving, and money printing dollar devaluation are now emerging like the dead from the earth on Judgment Day: basic commodities, like food and energy costs ripple upward even as economic activity slows, the banks, unsure of the value of their own securities, refrain from lending and wages continue to fall for the vast middle even by normal definitions-- measured against wages in the Euro and Yen zone, the loss in buying power for the average American over the decade has accelerated in a way that is astounding.
The housing bubble, the ultimate, live today, pay tomorrow spree, where anybody could borrow as much as he wanted, was the antidote to the sinking of American economic hegemony. And yet there is also a Main Street equivalent to the moral hazard story that has appeared, like a throwback to some cloth coat Republican era, both in George Bush's and John McCain's rhetoric as they have been forced to grasp the systemic and political implications of a housing bubble meltdown: never mind the dastardly builders, loan brokers and debt packagers, what about all those obnoxious speculators you used to run into at every wedding, first communion and bar mitzvah party? All of them had just successfully flipped a whole bunch of condos somewhere or other, turned their log cabin into a country manor house and had all become safely installed in their suburban equivalent of Monticello. Are these the guys who need to be bailed out of all their flimsy loan deals?
As for those Members of Congress who are supposed to be working to get aid to all the poor folks who just happened to get sucked into the housing frenzy at the wrong moment or through devious paper sleight of hand (remember those spiffs that pulled brokers toward selling loans with trap doors built in) , we wish them the best or luck. They will need every ounce of backbone they can stiffen, or, not only will the lion's share go to the same scoundrels who partied on the way up (NYTimes on the Senate version,
Big Tax Breaks for Businesses in Housing Bill) but also to the shareholders of the two big once quasi governmental agencies that were designed during the New Deal to save housing during that desperate period, Fanny Mae and Freddy Mac. The proposal on the table would build in government backing to expand Fanny and Freddy's capacity to lend to soak up bad mortgages designed to spin out of control with a new crop of fixed-rate models to homeowners even if their present houses are already underwater.
Beyond the personal debacles, a falling housing market that might lose up to 40% of present value is predicted to cause the kind of Main Street financial chaos that would spread beyond containment. Of course, the new plan would require the Federal Government to provide guarantees for all these new underwater loans in case homeowners just plain decide to walk away from their homes in search of greener pastures. It needs to be noted that here, once again, the backstop is going to be the already battered dollar, and the recipient agencies, though hybrids of a sort (Fannie, for instance, uses its quasi status to avoid paying local property taxes for its headquarters in DC), these are private stock issuing entities just emerging from bookkeeping scandals that fortified private industry level salaries and bonuses for their executives.
You already know that the US finances a very expensive war by printing dollars off the books (which no doubt explains why billions of them have just disappeared into the Mesopotamian underground) runs a built in deficit that grows from year to year and buys ever more from abroad. The Federal Reserve is providing hundreds of billions to backstop a financial system that has taken shock one, the blowback from the sub-prime crisis but may soon face the prospect of seeing the loans and counterparty paper issued to "insure" the equally speculative business of highly leveraged buyouts come a cropper as well. This Recession is like the new year, hardly a baby still. Prolonged recessions can be trouble for a number of corporations under normal circumstances but for leveraged buyouts paying out enormous debt loads, a few bad quarters can be as toxic as the sub-primes were for leveraged financial giants like Bear and Lehman Bros.
We recall that up to a short while a ago, LBO's, or leveraged buy-outs, were all the rage on Wall Street. Last week, one of them, Linen and Things, with 17,000 employees around the country, announced they were shutting their doors. With gas prices expected to hit $4 a gallon this summer ( it's already there in some places, while the Diesel fuel that truckers rely on has already passed that line across the country), building activity down, and the price for food hitting the roof, it's hard to believe that Linen and Things will be the only stretched out retailer to bite the dust. As the Chinese currency, the RMB is inevitably pushed up to counter the worldwide inflation in raw materials, the price of retail goods in the US will have to move with it, despite what the round smiley face signs at the end of the aisle tell us.
Those who argue that this Recession still has a long way down to go, certainly have more than their share of arguments and data to back it up. Watch out!
In other words, while we were staging this most excellent pyramid game, no one complained about a hundred million here or there, not even our stockholders; so now why shouldn't we be paid a little extra for managing the hard times we are going through? In effect, "you really want to know where the bodies are buried, then get real!"
But for just a moment, never mind the titans at the top of the world, that mentality works on regional levels as well. Here in Washington, a local marvel at the crest of another bubble when the capitol region was fast becoming a tech Mecca, Friedman, Billings, Ramsey, or FBR as it's known, have been on a nearly consistent losing streak that has seen practically every investment they've undertaken this millennium, lose money. Just recently their board announced that they (the founders) were awarding their top executives (themselves) a massive bonus-- one supposes to keep themselves in place so they can do even more damage.
Here's what Steven Pearlstein, a columnist at the Washington Post had to say on that account in his Friday column:
"But for pure chutzpah, nothing tops the recent announcement that, following a year in which the company posted an operating loss of $740 million, Billings and three other top executives were awarded bonuses and stock grants worth $30 million, at the time equal to nearly 9 percent of FBR's market value."
The Ultimate Bear Trap
But, of course, last Friday was different. it marked a clear point of demarcation, as the government moved from mere propping and backstopping to the next big step in this menacing financial unraveling. Friday saw hundreds of billions pledged for the first phase of a pure and simple bail-out for one of Wall Streets bare knuckle gangs. The Fed was now taking mortgage backed securities no one else wanted as loan collateral, albeit for 28 day loans, not for a commercial bank, as comes under its mandate, but instead to ward off the collapse of a brokerage and trading business that specialized in mortgage-back finance.
As you no doubt remember there was an incident back last summer when a couple of hedge funds managed by Bear Stearns -- Wall Street's fifth largest investment and clearing businesses-- that had borrowed large sums of money to invest in (actually, soak up paper sitting on Bear's books) mortgage-backed securities, ran into a reef. See our piece, The Big Crack
It was the first major extrinsic sign that the great easy money home lending bubble was about to burst. Of course, anybody looking should have foreseen this outcome as the pyramid scheme finally ran out of suckers, in this case some of Bear Stearns own high worth customers.
Every so often there comes a point when a downdraft causes Wall Street and Main Street to collide: right then down on Main Street people's wages were standing still even while they were gobbling up high priced homes for themselves that had doubled or trebled in price over the course of a few short years. The easy lending had also fostered a pack of players looking to "buy" (no money down, no questions asked) and flip neighboring properties as they came on line. And if you wanted to know how, all you had to do is look at the ads in your local paper or even check your mail every day. There was no shortage of banks and brokers who were bending over backwards to lend you money against the accrued value in your own house as they urged you to buy a newer, bigger one.
But never mind the collateral, the money kept getting easier: first, you didn't need any money down, so you could borrow up to 100% or the purchase price, then you didn't need to pay back any of the principal, then not even at the going opening mortgage rate for the first couple of years and finally, you only had to pay off the teaser interest part of the loan. Finally, the word got out that you didn't really need to prove you had a job or reliable income to get a loan, you could just make up an income figure and move the family into your Mac-mansion as fast as you might get a pizza delivered there.
The Huge Sucking Sound from Wall Street
There was, it seemed, an uncannily huge demand to underwrite these mortgages no matter what shape or form they came in, and it came all the way from the heights of Wall Street. For, with the ink still wet on the loans, they'd be immediately taken off the hands of the issuing banks and, with a special kind of magic known only to these financial wizards, crammed into some three-letter financial gadget (ABS, SIV, CBO, CLS) that would pack them together with a mix of other peoples' loans, and send them off as fodder for this new, largely unregulated and soon-to-become massive, shadow banking system.
The Fed's easy money policies, laissez faire attitude and the tsunami of new dollars being created by trade-deficit recycling, had, it seems, been turned into a great demand for paper that paid even just a percent or two more than the safe stuff and so a profitable bundling business turned into profitable underwriting businesses and bundles were sliced, diced and rebundled in secondary and tertiary derivative markets and sold to anyone who wanted to lay down cash or step up to the window and borrow to leverage their bets. Investors around the world were rushing into the hedge funds that were pulling off these tricks, ready to pay the fund managers up to a third of the paper profits in fees for the privilege.
At the end, there was even a perverse echo of the previous bubble, the hedge fund doing an IPO; cherry on the cake: to leveraged buy-out companies like Blackstone and the Carlyle Group. Carlyle Capital, a spin-off of highly successful defense industry investor Carlyle Group (more below) took the scheme of borrowing heavily to buy mortgage-backed paper as a business model and brought it to the stock market. They issued an IPO on the Carlyle name, registration in the Isle of Guernsey, selling shares to the public through the Amsterdam Exchange! Other such highly leveraged companies went into the market selling bonds or creating further derivatives. Last summer, just before the first crack occurred, Bear Stearns, themselves, tried to palm off another load of their own toxic paper, to a subsidiary they were trying to hastily bring public. They didn't get it launched until it was too late, thereby saving a whole bunch of suckers their money until, one assumes, the next Ponzi moment.
Smart Guys, Smart Money
But now, this Ides of March we are just beginning to see the leading edge of the worst effects of this splurge in mindless highly leveraged bet making. What may be mind-boggling is that the so-called smartest guys, the ones who had to know what kind of toxic crap they were creating, buying, insuring, lending against and selling, so flooded the market that they got caught up eating their own dog food trying to make it still look palatable. Time-wise, it's hard not to parallel this with the exploits of Elliot (Ness) Spitzer who had boosted his career by slapping down Wall Street's greediest no-gooders. The same week that finished with gritty, uncooperative (they had balked at joining the other big investment firms in the LTCM bail-out in the 90's) Bear Stearns finding itself in the ignominious position of being on its knees before a rival bank, JPMorgan Chase, Spitzer would have to quit as New York's Governor because money and electronic tracking traps, he himself had souped up to use on others, would, in a federal investigation, ensnare the enforcer himself, pants down.
In contrast to the "irrational exuberance" that characterized the last crash-- this time the tectonic plate has moved much further than the precincts of stock touters and patsies. This time, the folly occurred far outside the grasp of the regulators-- and it is spreading to impact ordinary home and car owners, folks on fixed incomes, municipalities, bridge and tunnel authorities and the states, themselves, who all reside way beyond the precincts of the giant global banks and investment houses.
After all, when you normally hear about margin calls, it's the banks and brokerages requiring their clients to put in more capital to back up their bets. This time around, it's the banks themselves that are hearing the margin calls. They are being asked to "mark to market" all of this Byzantine three-letter asset-backed paper they have on their books as collateral. The only problems is, that having lost confidence in their own holdings, this time there is no market to mark to. Trading has slid to a near halt.
So guess who has opened up a window to accept the toxic waste? Why it's our very government sending in the cavalry, with bushels of ordinary people's tax dollars. That same no-good government, if you read the editorial page of the Wall Street Journal on most ordinary days, that is supposed to be standing aside and letting the private sector do it's magic. Never mind the deficits already on the government's books, never mind the money being thrown into the endless War, the Federal Reserve now stands at the ready to suck up the waste product of greed with yet more borrowed money. And so, in this nasty tale, so sinks the dollar ever further.
Since the fiasco of 1929, when borrowed money underlying the stock bubble brought the developed world economy to its knees,, there have been rules in place that limit a bettor's ability to borrow money to buy securities. In recent years, the onset of leveraged and highly leveraged hedge funds has driven something of a major loophole into these rules.
There were, obviously, no such rules, only practices, in place when it came to the mortgage business at a time that the Federal Reserve was pushing interest rates down, down, down to soften the landing of the Tech Bust.
Greenspan's Legacy, the New Shadow banking System
One of the great ironies of this present and particularly alarming crash --they seem to come back to back at greater frequency-- is how avoidable it might have been had not we come to a particularly dangerous fork in the ideological setting that led up to what now is clearly going to be more than a mere "two quarters and out, garden variety recession" that the majority of economists can somehow still project. Here in Dymaxia, we often excoriate the mainstream press for their birds on a telephone wire, reflexive reporting. Economists, seem to have invented the phenomenon. No single societal group seems to be more consistently wrong at every turn, even in their rear view mirrors.
At their historic crest, the mood in the dominant party back in 2000 was to eliminate regulation wherever possible and to generally roll back any public protection that might have been created since the mid-Depression Roosevelt years. Unfortunately for that movement, we were in the aftermath of the Enron debacle and it was all too crystal clear that, despite all the regulation in place, it was still possible to game the stock market big time. That wasn't the moment that Congress could be seen thinking of getting rid of the market police at the Securities and Exchange Commission, rather they begrudgingly toughened reporting standards with Sarbanes Oxley.
But the guy sitting inside the Fed, the man who'd gained palpable clout for how he'd managed the Tech Bust (by bringing interest rates down to near zero), was Alan Greenspan, an acolyte who had once literally sat at the feet of novel writer, Ayn Rand, an icon of a newly invigorated Conservative movement that was striving to restore, in Randian terms, the power of the individual over that of the collective.
Anything less than a purposely anesthetized Federal Reserve Governor, would have smelled a rat, when, in a moment of low inflation, housing prices started to take off wildly. For a boom to turn into a bubble you need a blind regulatory eye, the promise of ever rising prices to suck more and more people in and plenty of freshly printed, readily available money to lend them. The promise goes something like this: "Buy now, even if you have to borrow everything you can plus some, because this time next year you'll be able to sell, get everything back plus a profit and move on to the next killing."
Bubbles are something we will always have, as long as there's a natural dose of greed around. But as night follows day, there will be busts, too. Fear, will sooner or later rear its head. The smart money is supposed to get in early and out of the way when the bubble begins to crash.
Ironically, central banks, like the Fed, came into being to ensure that the inevitable crashes didn't pull perfectly innocent participants going about their day to day business in the banking system into some extraneous financial world wreckage. They are there to regulate, to make rules to thwart bubbles and backstop only to protect the innocent bystanders. For such, the Fed is mainly limited to using its hold on interest rates to slow or quicken the economy, to keep things on a smooth course.
Unlike its predecessor, the Tech pyramid, the impetus for the Housing Bubble, however, can be almost entirely laid at the doorstep of the Fed, itself. The Fed quite significantly has the power to require banks to manage their lending practices. Greenspan, it's clear, decided not to get in between the banks and their more risky business partners, including the completely unregulated hedge fund industry, even as it knew that the once hard walls separating banks and the brokerage business had been freshly pulled down. The theory, no doubt being that savvy adults, bankers included, ought to know what they are doing and take the up as well as the down consequences for their actions. Consequence, after all, is the cornerstone of laissez faire capitalism.
In Greenspan's zeal to unleash the unregulated hedge fund industry even as commercial banks were spreading into the investment world, he managed amnesia regarding one of the main tenants of the Austrian School that he professes adherence to, and that has to do with the printing of paper money with nothing "real" behind it. The modern Fed is in the business of printing money with nothing behind it, no inconvenient bars of gold no silver, no nothing. And now, in this Spring of discontent, it seems, it is also in the business of mitigating the consequences of bets gone horribly wrong.
Credit, Credit, Everywhere but not a Drop to Drink
This latest pyramid, we all know, started in the mortgage industry as homeowners were given the opportunity to trade in older more traditional mortgages for loans that had lower introductory interest rates. The kicker was that these older loans demanded a 20% down payment and over time further equity built up as the monthly payments included principal as well as interest. It's a cliché but also a truism that house's have traditionally served as a ordinary folks' largest and most important piggy bank, not, as in our present paradigm, it's ATM machine. The Fed could have cut the bubble off at its knees by taking a hard stance on the lending rules and the valuation of the derivatives that were being issued to fuel the worst excesses, the excesses that have actually brought the financial system to its knees. When questioned, Greenspan, from his pinnacle, repeatedly said he saw no intrinsic peril in the practices.
Yesterday, the government agency that measures such things, made public that for the first time since the end of World War II -- in the shadows of the Great Depression, that is-- Americans own less of their houses than do the banks and other lenders. It came in 51% to 49%. So much for the piggy bank and so much for the household! The conversion to a nation of debtors in just a short period was complete.
For those unhappy folks whose house now is worth less than they owe on it, there is another kind of choice: Do I hang around and struggle to pay off a mortgage, set to bump upward in many cases, or just walk away? For a lot of folks with nothing in and facing ever scarier job prospects, this is a no brainer. And so more houses go onto the market and prices in surrounding neighborhoods start to drop as well. This second wave is ushering in a new chapter where companies that have borrowed on the basis of ABS-type bundles of these prime mortgages are also being called in to put up more solid collateral. Clearly, the problem has begun to spread in a number of directions. And worse for all the innocent bystanders, the Fed, in it's policy of hastily lowering interest rates, the public be damned, merely spits against the wind, yet, all the while, sewing the seeds of the next big distortion, sure to take root from interest rates that in real terms --that is, after you take inflation into account-- are already negative.
Of course, while the banks were inundating home owners with loan offers, they were also chasing every living American to open up a new line of plastic credit debt. If you were maxed out, no worry, just consolidate --6 month teaser rate-- and come play with us, they beckoned. American families now owe an average of $28,000 in credit card debt, often with interest rate tags of over 20%, not to mention penalties if they miss a payment.
Then there's the added glow that a bubble or pyramid scheme brings to the players early in. But this last bubble driven expansion had a weird hue to it from the start, all its own. Americans, even as their jobs were being shipped abroad, were borrowing and spending at a rate never before seen in our history, and mainly for stuff no longer made by them. It's no exaggeration that we now don't even question that 70% of our economy is based, not on what we make but on what we consume, nor do we second guess the massive trade imbalance that has ensued. The American consumer, it is said, is the engine that fuels the entire world economy.
And for the world, that ought to be very bad news. While every day consumers were borrowing, and the shadow banks were leveraging in the billions, they were being matched in spades by their own Government as it refused to tax for its own spending needs and even set the trend by running a major war --$12 billion a month-- off the books. This government borrowing together with the trade deficit has in just one Administration pushed down by half the buying power of the dollar, especially in Europe and Japan but most significantly in the Middle East, where the oil is. Consumers are now pouring money down the Exxon and Shell funnel to Arabia even before they can even get to Wal*Mart and Target for their little contribution to the Chinese dream. Never mind, the Spender in Chief encourages them to go out and spend. Got problems, he says, just save my tax cuts, and I'll send you a check in the mail.
A feeble dollar makes us all poorer but it is yet another gimmick governments use to stimulate business. In the old model, a cheap dollar would have led to higher exports thus stimulating the domestic economy. But in a service economy where manufacturing has largely been sent abroad, there's nothing extra to sell. Goods, and particularly raw materials, from abroad get more expensive in dollar terms and before you know it you have a systemic inflationary force. It should be noted, that the Fed is betting that a slowing economy will take care of that inflation by pushing down demand. In other words, even as the Fed is pushing the pedal to the metal, it's betting that its mainly going to spin the wheels. That mud, it seems, is being thrown into the eyes of all those who predict this will be a two-quarters and out event.
Japan, a mega-industrial power you don't hear much about these days, has been in a state of low or no growth for over twenty years despite the fact that the Bank of Japan --their version of the Fed-- has kept interest rates a near real-term zero over most of that time. The government refuses to force the banks to clean the mountains of bad debt they accumulated in their own stock bubble way back in the 80's. Still, Japan runs an annual trade surplus with the US of over $80 billion, holds over a $trillion in reserves, and their people save at a healthy rate. Their population continues to age and they appear culturally unable to absorb foreigners to replace their work force. Could America's brand of borrow and bail out, create our own version of a limping giant?
Saving has totally disappeared as a concept in the US. With houses now tapped out, university costs soaring and the education gap between high earners and the stagnant middle class ever widening, the coming generation, routinely emerges from college and graduate school with tabs in the hundreds of thousands of dollars. Working folks have to dread a medical event that can throw them into even deeper debt.
What the housing bubble did was temporarily mask the hard truth of falling manufacturing jobs and the wages and benefits that came with these often unionized jobs. Easy lending combining low (initial) payments and very loose requirements had a major impact. Many people --depending where you live, of course-- saw the values of their homes rising by 10 or 20 percent per year as all the churning encouraged people to "trade up". The activity also brought in speculators who saw how easy it was to buy houses on margin and flip them as prices soared.
For the Administration, this was no-questions-asked territory. It was being hailed as the result of lowering taxes on the wealthiest players in the game even as they were wracking up the biggest pay-offs of their careers. By the no-tax theory, increased activity brings increased tax revenue and the whole thing pays for itself. So never mind, the growing domestic deficit and never mind the equally ballooning foreign trade deficit. In the end, it would all shake itself out. And if it didn't, well that would be the problem of the next Administration, and the debt that of the next generations.
Now that this is starting to spin out of control, everyone with their own skin in the game is running the other way. No one trusts what's on the other guys books so no one is loaning despite the Fed's best efforts. Present Fed Governor Bernanke is printing money as fast as he gets interest down. But that's like trying to stop the flow of water by putting your hands into a stream.
To attack the problem of mortgage backed securities as collateral, the Fed has announced that it will lend to banks and accept, in exchange the toxic collateral that no one else will take. For this it has made available the sum of $400 billion dollars, which, is half the amount the Fed holds for all market intervention it makes. But that was earlier in the week, before it was forced to intervene in saving Wall Street's 5th biggest firm, Bear Stearns. This Bear Stearns rescue marks the first federal bail-out of a major bank since, yes, since, the Great Depression! To close the deal that saw JPMorgan Chase take Bear Stearns for less than the building it owns and occupies is worth, never mind the $80 billion it claimed in assets just last November, the Fed agreed to scoop up $30 billion in further toxic waste. Clearly, the skin they, the Fed, have in the game is other people's money, in this case the taxpayer's.
But that's not all that happened in this week. In a clear echo of the Bear Stearns crack, a leveraged hedge fund started by the investment bank giant, Carlyle Group, was being called to put up more security against the $22 billion it too had borrowed to get into the mortgage security margin play game. And so a few million here and another 100 million there and before you know it, additional billions of dollars are coming off of balance sheets of the world's great financial institutions in write-downs. In the end, the Carlyle Group decided to let technically separated Carlyle Capital sink into bankruptcy rather than pay out a billion to save it's own good name. That decision shook all it's Wall Street lenders, including Bear Stearns where it may have been the straw that broke the camel's back.
Perfect Storm, Yet?
It's been estimated there are still more than $100 billion in write-downs to come in the area around mortgage paper alone. Last time out, we wrote about something as obscure as the CDO's and CLO's, called credit-default swaps, or CDS's. This is a gargantuan insider "insurance" market that is fairly unregulated. It is estimated to total the staggering sum of $45 trillion. If this market should start to unravel, it is impossible to predict where the outcome might lead. And sure enough, in the noise around the collapse of Bear Stearns, there is already talk of failing CDS's. No doubt this is where the Fed has placed itself as counterparty to shield JPMorgan from god knows what else.
As we've noted, the aftershocks coming from the sub-primes has spread into what are traditionally boringly safe markets like the ones for municipal bonds. The sub-prime fiasco has also called into question the reliability of a lynch pin of the system, the credit rating agencies, which, for greed of their own, were willing to bestow their highest AAA imprimatur onto mortgage-backed securities, including some with a tranche or percentage of sub-primes in the mix.
What's poisoning the municipal bond market, that cities, states and their agencies use to finance their projects, is the state of the so-called monoline insurers who cover the risk of municipal bonds by selling insurance on the basis of their own AAA credit ratings. These insurers have nearly gone belly up because they too jumped into the CDO and CLO security game, providing added cover to the toxic waste products. Now the municipalities issuing bonds to cover things like stadiums, bridges, sewer systems, etc. are having a hard time convincing investors that the insurance they hold to ensure their AAA rating will actually cover them. Investors who could rely on the ratings and the insurance, are now forced to try to figure out which water company is more solvent than say, the nearby sewer authority. As a result, mundane bond auctions have been failing for weeks on end.
There is more of the pernicious circular dynamic here since these very municipalities depend on property taxes and user fees to pay off their bonds. As their property bases shrink as people walk away from underwater mortgages, the very income the municipalities need to pay off their debt is called into question; hence investor apprehension.
On this very shaky weekend, the thought occurred to us: what if some other unexpected jolt --our proverbial black swan-- were to hit this truly unprecedented situation, a 9/11 type event or a pandemic episode like the Avian Flu, or a run on the dollar as foreign banks moved to Euros or Yen?
Moral Hazard
We are now at the point we predicted it would all come to: where the Fed is putting up public money to bail out the greediest layer of society, the guys whose bonuses are in the millions, who set up their shell companies in the Caribbean to get out of paying taxes on profits, who treat their salaries at the Bush capital-gains rate. The guys who, as Warren Buffett put it, pay less in taxes than their secretaries do.
For every $billion the Fed puts up to suck up the excess waste, will players have to pay a special tax on the bonuses they took home while the party was roaring? We wager not!
And will the Fed in it's zeal to bring interest rates down find some way to compensate regular folks for the little bit of interest they are losing on their savings? After all, seniors present and future are encouraged to save so they will have something to live on in retirement. Low interest rates, like pushing on a string, may stimulate some movement but it's just as likely to be as distorting as it is in Japan where housewives are said to borrow Yen at the low rates to invest in high interest places like Australia and New Zealand. The hedge funds call this activity the carry trade and it is ready to make a comeback at a fund near you, soon.
Few Americans are aware that the dollar has lost about 8% of its value in terms of the euro or yen in just the last couple of weeks. Most seem conditioned to think about these kinds of movements as little more significant than blips on a control-tower radar screen. Needless to say, that's not the way we see it in dymaxia. Here, with a little background is why our metaphorical instrument of choice would be the seismograph.
The US, through a post World War II treaty signed at Breton Woods and later revised by the Nixon Administration, was granted a special role in the world economy. It manages the only fiat (paper-backed) currency in the globe that is considered by the world's central bankers as a "reserve currency"; that is, giving it a status once limited to gold or silver. For most of the last 50 years the system has, with a few noticeable strains, worked out pretty well, especially for the US which gets to spend money that ends up sitting in Central Bank coffers rather than returned for redemption. In addition, and this has nothing to do directly with Bretton Woods, the US has gotten a further lift through the pricing mechanism for petroleum, which is quoted and traded in dollars.
For most of these decades of the world paper dollar economy a number of factors have weighed in the favor of the mechanism. The US has provided a degree of political stability rare in recent world history and its economy has up to this day --with some major mutations, the how of which we'll talk about-- remained a major driving force in world economic growth.
But in recent years there have been a number of cracks. Two factors that have changed the most radically on the US side are the trade balance of goods and services and official US internal attitudes towards domestic personal and government debt --at the time of Bretton Woods, the US was running the largest trade surplus in the world and neither political party would be taken seriously if it advocated breaking the link between spending and the taxpayers; from grade school on, Americans were urged to save as a patriotic duty. After all, it was the Savings Bond campaign that was used to finance World War II.
Today this all would sound pretty darn quaint... if it weren't so serious! In the last four years even as American families were urged to pile on more personal debt, the government has borrowed more than in all its prior history. According to the Treasury Department, America's first 42 Presidents (from George Washington to Bill Clinton) borrowed a combined total of $1.01 trillion from 1789 to 2000, Between 2000 and 2005, President George W. Bush has borrowed $1.05 trillion - and he's got a few more years left to go. As a result every child born in the country today comes into the world with a debt of nearly $400,000. For the rest of the world, we have witnessed the rapid economic growth in China and some parts of the Indian economy as Americans outsource more and more of their manufacturing and professional services. US trade debt with China alone has now reached over 250 billion a year and climbing. For the world, in total, the US is expected to buy nearly a $trillion this year more than it brings in by 2007.
Ironically US domestic deficit spending and its emphasis on subsidizing capital has been the driver of this growth. It has also kept the overall US economy moving along, at least in terms of corporate profits. US global corporations, acting as financial and infrastructure masters have been able to capitalize on their superior logistical role as intermediaries in this new system. For working Americans who have suffered flat wages since the 1980's and seen their competitively paid jobs exported in ever greater slices to the emerging centers of labor surplus, the picture has not been so good. What helped many put off the pain was first a tech bubble that lured them into the investor class and then, a just-in-time, Fed-induced housing bubble, into the refinancing class. Americans may not have earned more but they have been able to borrow more against plastic or, if they owned one, their homes, as historically low interest rates and easy lending practices fueled a housing boom that rose right out of the embers of the collapsing tech stock bubble. But even increased mortgage debt and interest only loans didn't quite match their appetites for more goods, bigger houses and bigger cars. During the same period per family, non-mortgage household debt (plastic) also rose to historical levels (presently $37k per family).
Grocking that even the Chinese, Japanese and Saudis, dedicated to desperately keeping the golden lamb around for one more fleecing, could no longer absorb all these over-leveraged dollars and that inflation was imminent, the Fed has recently moved into Plan C, or Bubble 3. After tightening interest rates steadily over the last year and a half, this week they made that move again for the 18th straight time. But, for the economists and the MSM flacks who blithely cheerlead the debt economy, insisting the house of cards is "solid", rising rates have collided with another critical reality, oil prices.
By some time in 2007, as we said, the US will probably buy a trillion dollars a year more than it sells to the rest of the world. In world economic history, the US and the rest of world for that matter, since we are all linked by the same printing press, are already far out into uncharted territory.
Geology, of course, is not just a metaphorical part of the economy. The latest fissure is reflected in the price of both yellow and black gold. Both of these commodities have moved from low price ranges to historically high prices in little over the last couple of years. Gold has always been in short supply. The developed world, on the other hand, has experienced an unprecedented rush in economic development thanks primarily to the open tap of cheap, plentiful energy, something it took the natural world eons to deposit.
Since prehistory, gold, though treated as a primitive relic by many modern economists, has proved time and time again to be a reliable, universal store of value. In times of fiat money, it tends to recede into the background as the influx of newly leveraged money fuels growth only to return to prominence when the inevitable bust occurs. In the last few centuries the importance of gold has been in direct ratio to the number of years a paper or fiat currency has remained in circulation. Historically, every government that has managed a fiat currency has succumbed to the temptation of printing more than the world can handle and after there is an initial surge in economic activity as more money rushes from pocketbook to pocketbook, prices start to climb out of control. Twentieth century central banking was founded on the principal that economies needed a referee able to step in when things swing too far out of balance. The major tool of central bankers has been their ability to tighten and loosen credit primarily through interest rates but sometimes through regulation and external currency manipulation. For Japan Inc., the exchange value of the yen is never underestimated. The hand of the Bank of Japan is never far from the currency trading floor.
Like the next big quake somewhere on the Pacific rim, no one knows exactly how much force has to build up before there's the violent shock. In the case of today's overhang, the friction that is keeping this enormous shelf from moving too fast is the counter effort being made by China, Japan the Saudis to relieve the pressure on the dollar. These countries are the major beneficiaries of America's insatiable appetite for things big and small, fast and slow. They are the global Atlases of the currency world but always with the caveat, only for as long as they are willing. In effect, they have become America's bankers of last resort. As the major dollar holders and purveyors, they stand to suffer enormous losses should things suddenly slide into a trough..
When Bush pronounced that the US was addicted to petroleum it was like a drug dealer blaming his clients for his job choice. What Bush didn't say is that the US public is addicted to spending borrowed money. The Fed it might be added has, through the housing bubble, been the money pusher of last resort but even it has no control over the flow of oil or dollars for that matter. Proven oil reserves, can like dollars, be printed on paper but sooner or later they have to matched by actual deposits.
The Fly in the Desert
Oil as we said, is also priced in dollars but unlike the Chinese, of late the oil producers have refused to completely go along with the game, possibly because of something only they know for sure. The amount of proven reserves of oil in Saudi Arabia, the world's largest source, is a state secret. In the last few years Shell, the second biggest oil company in the world has regularly reduced its estimates of how much oil it holds in "proven" reserve. An ever growing number of geologists believe that we have reached a point in history, that has been dubbed Peak Oil. Peak oil occurs when the amount we extract going forward is less than the amount of new oil we discover. For the US, for example, although it was long denied, this event occurred sometime around 1970
The Fed, of course, knows that these major tectonic problems can't wait for the politicians. Any number of them have proposed using coercion to urge the Chinese to raise the value of their yuan against the dollar, as if that alone would help. Unfortunately for them, the US no longer makes most of things it buys from the Chinese; the global corporations that run those businesses and technologies have moved manufacturing permanently abroad. No one could seriously think they will move their furniture making facilities, say, back to North Carolina. Any move at all, would likely be to someplace like Vietnam where labor costs are even cheaper than in China. A higher yuan, on the other hand, coupled with rising oil prices might just be the tremor that sends the whole edifice tumbling. In any case, as you'll see below, we are likely to find out fairly soon.
The US has, in fact, become addicted to bubbles. In the 1990's during the tech bubble stocks of a publicly traded Texas fish oil company that changed its name to dot com, doubled its capital value overnight and companies that never brought a product to market or ever would, were valued in the billions as more and more investors threw their money into the game. Win or lose, most Americans --already accustomed it seems to the odds in Las Vegas, agreed it was a load of fun. Even after that bubble burst and the blood was still being swabbed off the exchange floors, the public began hankering for the next one.
It's precisely at this moment that The Fed, saw its role change from banker of last resort, and master of soft landings, to owner of its own bubble blowing machine and thus, master of soft soars and soft bottoms.. By pushing down interest rates and, more importantly, minimum loan requirements, to historical lows, before long the public was busily refinancing their homes and speculating in condo's.. It was a no brainer. Not only could you lower your monthly payment by periodically refinancing in a rising market, but you could pull cash you had paid in back out. Once again, just like in the dot.com days, we had "money for nothin' and our kicks for free". For big investors money could be borrowed in the US and relent somewhere else where rates were higher. The hedge funds got fat and so did the loan writers.
For the Fed it became time to slow the housing bubble down before it too ended in disaster. With mortgage payments going up, gasoline prices hitting new highs, and the stock market rising, the public mood was turning sour. The virtuosi at the Fed, it seems, already had their next move in sight. They knew that the only thing keeping the dollar from dropping was the draw of higher interest rates in the US than in Japan or Europe. Short term investors could move money into the US for a couple of extra points at a fast enough pace to keep the dollar firm for a while. All the Fed had to do was begin to hint that it might stop raising interest rates for the dollar to begin to slide. The Fed was now on its way to creating Bubble # 3, we'll call it the "cheap dollar bubble", coming to a pleasure palace near you soon. What all central bankers like most, is gradual. So when the dollar moved almost all the way back to its historical low against the euro last week, the Fed added the word "yet" to its pronouncement on interest rates. Here's what the meaning of yet is: "we want a cheap dollar but we want it to play out over months, not days or weeks."
Check out the price of copper, or scrap metal, or oil, or gold or just about any other commodity. In the face of these upward inflationary pressures the Fed should be pushing rates up further. The only thing other than the combined wills of the Chinese, Japanese and Saudi national corporations that has kept the dollar up against these overwhelming deficit numbers has been, as we said, the lure of relatively high US interest rates. Whether its this month or next, the Fed is going to "pause' in its course to raise rates. When they pause, private money, the majority portion not controlled by the central bankers around the world, anticipating a falling dollar will have to look around for better deals.
After all, countries can lend money at a loss to meet larger national goals but private foreign money won't stand for, say, 10-20% depreciation on T-paper paying 5%. Smart money in the US will also start looking abroad for shelters against a falling dollar further pushing the dollar down. The Fed won't intervene because cheaper dollars will automatically lower in real terms US debt while triggering yet another bubble of financial and trade activities for bankers, hedge funds and investors. Once again global corporations with ties in London, New York and Tokyo will be able to straddle the gaps pulling value wherever it can be best leveraged. Foreign profits will look particularly good on balance sheets as they get calculated back into cheap dollars. Corporations like Cargil, ADM, Boeing, John Deere will benefit from the competitive edge they get from the cheap dollar. The US stock markets will anticipate these paper profits and not fall too quickly, thinks the Fed.
Look for a cheap dollar bubble in a market near you. Expect ever higher commodity prices and eventually a budge in the price of Chinese goods upwards. It won't be a good time to travel abroad and we may see hoards of foreign tourists ready to take advantage of the bargains over here. Energy is going to go up, maybe close to the breaking point. But even there, the Fed can't really mind. After all, the public would never stand for a raise in taxes to discourage petroleum consumption but they can always blame the Saudis and Chavez for $4 a gallon petrol, or if that fails, all the politicians.
John Mauldin, one of the more astute observers, may have been the first to dub this the "Muddle Through Decade". Mauldin accepts many of the negative points made by his Austrian-school oriented friends but somehow counterbalances their arguments with a fundamental appreciation for the enormous expansionist momentum (our words, not his) of an American-led world economy.
For many of those (highly bearish) Austrian-school fundamentalists, we have already been moving headlong into a precipitous imbalance for more than a decade. They see a perilous world economy buoyed by one more dangerous gimmick than the prior.
Their great villain is, of course, Fed Governor Greenspan, who through the manipulation of one market after another, has been the chief priest of this cult of irresponsibility. It was Greenspan, after all, who blew into the pipe of the great Tech Bubble of the late 90's thereby allowing stock valuations to reach unmaintainable levels. For the critics, a wiser steward would have held back after the crash and allowed those same corporate equity values to wind down to levels in line with profits thereby laying the groundwork for a soundly based re-expansion. Greenspan's second deadly sin, in their eyes, is the great asset/debt bubble that was unleashed by the Fed after the Tech Bubble burst as the central bank yanked down interest rates to negative levels in real terms in order to stimulate widespread debt while encouraging the Administration to pursue a course of reckless deficit spending.
As frustrated Cassandras, the sound-money bears have stood on the sidelines pointing to the flight of US manufacturing capacity and jobs, the increasingly massive trade and current account debt, the impending shortages of basic commodities like petroleum, the grievously poor quality of the growing number of loans being issued by US lenders, the suspicion that huge pools of funds are under the trigger-finger management of largely unregulated, potentially irresponsible hedge funds, and any number of other risk factors, not least of which, the eventual impact of a costly and extended, and ultimately unpopular war.
The bulls and Administration cheerleaders, not surprisingly have seen these last couple of years in a positive light even if the stock markets have somehow not quite got the message, something that never fails to baffle them. The bulls have focused on positive, slightly above average GDP growth over the period, strong corporate profits, positive job growth, low unemployment numbers, the positive effect of the bump up in housing values and associated business and job activity, and the great growth stimulus being provided to the world economy by the emergence of India and China as economic powers. They see only the demonstration of the real economy's resiliency in the face of rising petroleum prices, the negative impact of the War, the recovery from 911 and the Tech Bubble, etc.
Mauldin's muddle-through scenario gets played out over and over again in the financial pages of the world's press. On any given day we can see the announcement of fairly positive job numbers on one page and pictures of over 10,000 people waiting in line to get 400 minimum wage jobs at a newly opening Wal-Mart, as we did last week, in Oakland, just across the bay from Silicon Valley to the south and San Francisco city where house prices are so high that nearly 70% of the population rents.
The disconnect is so extreme that it can get surreal. It may also be reflected, quite ironically given the way it shakes out, in the Blue-state Red-state line-up of the present political equation. Real wages in the US have been stagnant since the 1980's (especially in the red state heartland) while CEO salaries have grown a thousand fold. Corporations and the wealthy (based mainly on the blue-state left and right coasts) also have benefited from greatly reduced tax rates. The War and rising oil prices have also fattened the portfolios and wallets of plugged-in segments of the population, located mainly along the coasts. At the same time, outside the public sector, the labor unions have never been weaker since the Second World War.
The bulls await the kick-in of a second wave that takes the relatively narrow stimulus of low taxes, deficit spending and the housing "boom" and turns it into a broad recovery that will last for years boosted further as oil prices finally recede along with the financial and psychological costs of the War. The bears await the impending collapse of the housing bubble --signaled, once again ironically, by their boogey-man Greenspan in a speech this week-- the swooshing sound of foreign capital as it pulls out of the US financial markets unleashing the full weight of the accumulated foreign and domestic debt of the last few years and the death by a thousand blows of a moribund economy they'd liken to Terry Schiavo.
The muddle-through argument relies, despite the raft of acknowledged problems, on a belief in the positive momentum of an ungainly but nonetheless growing world economy, the basic strength and ingenuity of the American workforce and the bet that in times of real stress, it's more likely that capital will flow into the relatively safe haven of US capital markets rather than in even more perilous opposite directions. The US, they argue, is the engine of the world economy, it's in everybody's interest to keep it on life support even if the Fed walks away. In a muddle-through world, there is more productive capacity than customers, prices for many items remain down --see GM's move to (permanently, our words extend its employee discount-- as do interest rates as capital seeks but cannot find high return investments thereby forcing governments to fight deflation by issuing even more cash.
For the time being, the muddle through equation seems to be holding: markets go sideways, up and down almost in random patterns, and foreigners continue to cover our excesses by recycling their dollars back into US securities. Just this week, the Wall Street Journal pointed out that even as US mortgage loans get issued to riskier and riskier borrowers (40% percent of all new mortgages are in this category), the market for REITs --the securities that back these loans and make it possible for the banks to issue them while shedding the risk-- remains strong, even growing in popularity with the Asian bankers who seem to hold the key to the low interest-rate economy we now live in.
The Fed will continue to push up rates until as Greenspan said in Jackson Hole somewhat forkedtonguedly: "If we maintain an adequate degree of flexibility, some of America's economic imbalances, most notably the large current-account deficit and the housing boom, can be rectified by adjustments in prices, interest rates, and exchange rates rather than through more wrenching changes in output, incomes and employment."
In other words, Greenspan, now zigging to cover his backside, will have higher prices, higher interest rates and a lower dollar while avoiding a bust that's sure to follow. That's what we call hyper-flexibility here in Dymaxia.
Here at Dymaxion Web HQ we recently had to take time out to handle a problem
with the floor in one of the bathrooms in our more than century old townhouse.
We could have waited, even as floor tiles began to pop loose revealing a water
damaged sub-floor layer. Happily, we could determine there was not yet apparent
serious damage to the structural joists. In other words, nothing was about to
fall in. Still, we decided it was past high-time to go after the problem despite
the inconvenience.
We don't pass this bit of domestic trivia along for local color but rather, to
make a point: It takes a long time to rip down a structure that has been
constructed on solid building principles. We say this, because it came to mind
as we listened to the Mago, Allan Greenspan, as he led Congress to the
well of wishful thinking. "Frothy" was the word he used to describe the housing
market, evoking images of a soothing summer milkshake at the local Dairy Queen.
Since the 1980's, when supply side policy first got traction, real wages for the
bottom half of society have remained level while those in the uppermost cohorts
have increased to plateaus last seen in the days of Louis the XVI. To compensate
for this gap in buying power, earners below the pinnacle, with Greenspan's
guiding hand, have greatly increased the amount of debt they've taken on. We
have, it seems, progressed from a supply side economy theoretically based on
increased production to a debt-side economy based on greater borrowing.
Contrary to the original theory, private investors who received the greatest
subsidies through a series of personal and corporate tax breaks and government,
treasury and fed policy have not reinvested in more production capacity,
certainly not in the US. Since 2001, when the present debt bubble began to form,
the US has lost 16% more of its manufacturing jobs. Investors during this period
have looked increasingly for profits in financial markets and the ever growing
pool of hedge funds.
On the make side of the equation, General Motors, once our leading employer,
has not turned a profit in its core business of manufacturing automobiles for
the past few years while its mortgage lending arm has prospered. In concert, in
a few short years, US big-three's market share has fallen, probably
irrecoverably, from 43% to 35%.
Every bubble, and economic history has plenty of them, like every good scam, is
based on some plausible argument: In the 90's we were experiencing a shift away
from the military spending that had drained the Treasury during the Cold War
while entering into a new age of worldwide communication and globalization ,
which would, as its proponents argued, radically change the economic equation.
No doubt, the Internet has caused a great deal of change but in hindsight, we
can also see that of all the thousands of companies with millions of employees
that were once valued in the trillions of dollars by naive investors looking at
a market with no upper limits, one can count on one's fingers the number
prospering less than ten years after. Over $5 trillion dollars in assets went up
in smoke when the stock bubble finally collapsed in 2001.
All that remains of those trillions, are great piles of tee-shirts yellowing in
many a dot-comer's closet. Pawing through them, it's impossible to make out what
these companies offered as their "value proposition" other than the magic
".com". The only thing we remember is that they did IPO's and within a number of
days their stock sold for over a hundred dollars a share. Here, for instance, in
our drawer, is a white blue and yellow one that says: "add content and shake".
With all eyes on Silicon Valley, the real story during those years and after was
the dramatic changes going on in Southeast Asia, particularly China and India.
Communication and computing power was being turned into jobs and capacity not in
the US but in Southeast Asia. But American attention had turned elsewhere. First
there was the predictable near total collapse of the market, then the attack on
the World Trade Towers, then the ill-fated invasion.
Even without counting the costs of the Wars in Iraq and Afghanistan --kept "off
the books"-- the government, to stimulate activity and reward wealthy backers,
went into debt mode borrowing heavily from countries only too eager to take
great chunks of US consumer market share in return.
With the government spending well beyond the amounts it collects in taxes and
fees another method had to be found to cover the gap between spending and
revenues. Enter countries like China, Japan, South Korea and Saudi Arabia that
are happy to run hundreds of billion dollar trade surpluses with the US. China,
alone, this year is expected to rack up a two hundred billion dollar trade
surplus. In figures out today, China's month over month surplus widened a
further 14% in April alone. Overall for April, the US bought $57 billion more
than it sold to foreigners, or about $2 billion dollars a day that has to be
borrowed from those same foreigners. Foreign debt has reached unprecedented
heights. The trade deficit this year will represent over 6% of GDP.
The result of all this official and consumer borrowing is a situation contorted
enough to inspire a carny side show operator. This dollar recycling has resulted
in keeping long-term interest rates at historically low rates even as the Fed
now raises short-term rates. At some point, if this continues, we may see a day
when short term rates actually exceed long term rates. That has happened before
and, BTW, has always preceded a recession.
But low long term rates and an excess of capital, has set off another bubble in
the US, this time in housing. The concurrence of historically low interest rates
with the migration overseas of industrial production and better paying
manufacturing and service jobs, investors and the financial services providers
have turned their attention to the housing market. With all stops removed
--check out no money down, interest only loans-- the housing bubble has probably
now reached the same point as the NASDAQ when it peaked in early 2001. Like any
Ponzi Scheme, the last guys in get left holding the bag. The rates are variable
and also timed to increase at a certain point, which means that when long term
rates finally start to move up with all the bottled up inflationary forces
pushing up consumer prices, many home buyers will be left stranded with houses
that they can't sell at the price they paid and much higher monthly requirements
than they can meet.
Curiously, the Bush Administration is pushing hard for a revaluation of the
Chinese Yuan --China has up to now kept its currency pegged to the dollar and
thus has ridden down with the dollar. Since the US is entirely reliant on the
good will of the Chinese to continue financing US deficits, the Administration
lacks any great levers but if it succeeds it may not like what happens. A higher
priced Yuan will mean higher prices in Wal-marts and Target and that will fuel
inflation in this country. This jump of prices across the board on consumer
goods may just be the trigger that kicks long term rates up thereby pricking the
housing bubble while causing a further erosion in US jobs --home building, being
one of the few bright spots.
The Chinese have said they are quite happy with the Yuan as it is but in the
background, again according to the WSJ, they have begun moves to create the
mechanisms that would allow controlled trading in their currency. It's expected
by many that some time this year they will begin experimenting with the currency
market. If the US economy continues its pattern of hobbling along without
picking up steam --and with an ever decreasing manufacturing base, it's hard to
imagine otherwise-- then the Yuan move just might be the straw that bust the
housing bubble.
This is a great time for American consumers, who have dropped their savings rate
to less than 1% of income while at the same time increasing plastic and mortgage
debt to unprecedented heights. Every once in a while, all you have to do is go
back to the well and borrow even more from willing lenders offering ever more
creative financing tools. After all, we're a rich country with a massive
economic base, why would it collapse now?
There's a lot of speculation around Washington as to what exactly it was that caused Alan Greenspan's epiphany. The whisper campaign has it that the rapture occurred over a cup of morning coffee when Alan's wife, who was leafing through the movie page, suddenly sprung on the 78 year old Alan, the tricky question of retirement. You can't, she said, go on forever; it's about time you started thinking about your legacy. After all, up until the collapse of the dotcom bubble Alan was frequently equated in omniscence at least to the status of a pre-Galillean pope. No doubt that's heady stuff even for someone who is perhaps the world's second most powerful man.
Alan --we call him that not out of personal familiarity-- is, of course, often in the habit of speaking in tongues when he is not in his more normal guise of the oracle of Constitution Avenue. Those around him have to bend forward and listen very carefully. Thus, when Alan, the great mover of markets, decides to be loud and clear, you had better be warned that something really, really big is up.
Alan testified twice before various House and Senate banking committees this week and what he had to say each day has upset a great number of apple carts. Over at the White House, Karl Rove thought he had a problem when Halliburton started running TV ads claiming it wasn't who they knew but who they are.
But first, a little contextually important Alan-history: in his younger days the oracle of Constitution Avenue was a disciple of the famous libertarian writer Ayn Rand. Rand is most famous for her novels depicting strong individuals (Gary Cooper played an architect in the movie made from one) who in lonely heroism battle the machinations of a bureaucratic and corrupt system. In recent years, if he is to be judged by his actions, Alan had done a complete 180 degree flip-flop. Most recently, in order to soften the pain of the dotcom bust, he has pursued the most vigorous central bank manipulation of the economy in history. In sum, laissez fare might have been something he found on the menu of a French restaurant for all he knew.
Most of us, over the years, have come to accept the idea that our central bankers are there to smooth the economy from the cyclical bumps and dips that typify economic activity. That's usually managed by raising and lowering interest rates at key points to discourage overly aggressive markets and to give a little heart therapy to moribund ones.
In the world of Alan Greenspan we are no longer supposed to suffer the consequences of what the master once typified as "irrational exuberance". So this time around the so-called recession after the great boom and bust of the 90's was so short lived --at least, officially-- that economists, who seem to travel in packs when it comes to announcing that a strong recovery is just around the corner, can't even agree when it began or when it ended, even according to the official government numbers. (Of course, we know those numbers do indeed lie and that will be the subject of one or more of these future columns)
And so on the eve of a massive meltdown, without any need for prompting and with Alan cheering it on, the administration decided to pump huge amounts of money into the economy by cutting taxes while boosting spending both domestically and, more tellingly, internationally, as the military was unleashed on Iraq to create an $80 billion a year wad of government contracts . But why would average Joe taxpayer worry about that? He was promised lower taxes as far as the eye can see.
In the meantime our Alan was doing his bit at the Fed. He cut interest rates to the lowest they had been in half a century and encouraged the banks to lend, lend, lend. The American megaconsumer, who never needs any encouragement, was also urged to get out and buy their way out of the downturn. Not only did auto manufacturers offer no down payment, 0 percent financing but mortgage bankers were allowed to drop even minimum requirements on balloon home mortgage loans whose rates will skyrocket as interest rates start to go up, as they inevitably must. Instead of cutting back and saving a little money, as is their normal instinct in a downturn, consumers went out, refinanced their houses increasing their debt, bought newer bigger, more energy guzzling cars and houses, paid off their plastic debt and went right out and maxed out their cards again.
And so, indeed, there wasn't much of a recession and for a while it looked like all this activity would bear its fruits. Companies, which did cut back mightily in hiring, started to make profits and the stock market, after 3 losing years, started to take off. And so....one might say, so far so good. The only trouble was (is), the normal things that happen as you get into the second or third year of a recovery just didn't seem to happen. First, the job market, which requires 150,000 new jobs per month just to match the newcomers in the economy, continued to be downright anemic, at best losing better paying jobs and creating more Wal-Mart greeters and burger flippers
Equally ominous, there was no "pent-up demand". That's an economist's buzz word that is used to describe what happens when people hunker down and put off replacing their old appliances for a year or two. And so our friend Alan, in this parable, finds himself suddenly pushing on a string. Yes, he has lowered interest rates as far as they can go without the banks paying customers to take their money, and yes, he has pushed up home prices so people could bump up their mortgages and yes, he pulled the rug out from under the dollar, and yes, the government sent tax rebates back to everybody on a very unprogressive scale but still, here we are in an election year and things are starting to slide backwards.
Alan, it seems, may be riding the little train that couldn't. So what does he do short of self flagellation; why he carries his brief all the way up onto that Golgotha called Capitol Hill and lets go a little truth. On Tuesday, he startled everyone who was listening --they do a lot of sleeping up there so it was probably a pretty tight number-- with a dire warning that the two government agencies, Fannie Mae and Freddie Mac, that back home mortgages may be in serious financial trouble. Some of you, who aren't sleeping, may remember that not too long ago there was a little flap with one of these Agencies, Fannie Mae, when they were found to have cooked their books to the tune of $5billion last year. They actually had hid some of their earnings. Now why, you might ask, would a publicly traded but semi-governmental agency want to hide earnings of that magnitude. You needn't wait for an answer, we'll give you our opinion: Because they want to have some cushion against all those lousy loans they've got out there, houses with flimsy mortgages that won't be able to be paid when rates go up as the housing bubble too, comes to its dire end and kaplunk.....
So Alan was covering his reputed ass for posterity, a posteriori, it seems when he suddenly warned that these agencies that were merely following his lead turn out to hold the mortgages to millions of houses that can't be paid off by maxed out unemployed ex-consumers.
But Alan wasn't finished there. The next day he went in front of another august Capitol Hill body and washed his hands of the deficit. Yep, you heard it first here. Alan does not take any responsibility for the growing deficits. As he told the Senators, tax cuts are great, they stimulate the economy, the only trouble is that they drive up the deficit. And, he went on to say, there's nothing to do but cut spending and cut it fast.... Because, the baby boomers are going to retire starting five years from now and they are going to want to collect their social security checks every month and get their promised medical care, something they have just been contributing to since they started working back in the Sixties.
Okay, says Alan, maybe they paid in but deep down inside they never thought they'd get it back. They should have put more money aside for a rainy day like me. It's the fault of modern medicine, people live too long. They were supposed to contribute to the account but die before they could collect.
Yes, our friends, the second most powerful man in the world is telling you to save your money. Of course, he hasn't told you how much and how fast he, or his successor, is going to depreciate the dollars you do save, when recession phase 2 sets in, has he?
rmb
Copyright 2004 Richard Mendel-Black All Rights Reserved
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There's a lot of speculation around Washington as to what exactly it was that caused Alan Greenspan's epiphany. The whisper campaign has it that the rapture occurred over a cup of morning coffee when Alan's wife, who was leafing through the movie page, suddenly sprung on the 78 year old Alan, the tricky question of retirement. You can't, she said, go on forever; it's about time you started thinking about your legacy. After all, up until the collapse of the dotcom bubble Alan was frequently equated in omniscence at least&nbs