Tuesday, August 31, 2010

I am Really Worried!

The US economy is in the dumpster and is not showing signs of real recovery. Meaning, JOBS, AND NOT GOVERNMENT JOBS. Make no mistake here. The government(any government) can only create temporary jobs as Roosevelt did back in the depression and Obama did with the census. Business is the only group who can create long term sustainable employment. And Business is not investing in growth or employment until they think there is a more reasonable or even favorable climate toward business and taxes in Washington. Chicken and Egg? We shall see. Meanwhile there is a worthwhile Wall Street Journal column in today's paper that I share with you here:

By ANDY KESSLER

We should have eaten those toxic assets instead of sweeping them under the carpet.

The Troubled Asset Relief Program (TARP) was a foolish bait and switch. To prevent the 2008 financial crisis from worsening, TARP was originally designed to buy toxic mortgage derivatives weighing down banks and Wall Street, but no one could decide what price to pay for them. Too high and TARP would look like a government handout. But if the Treasury paid what they were worth, which was not much, financial firms would have to take huge write-offs, forcing many of them into insolvency and even nationalization.

So Treasury Secretary Hank Paulson switched plans, investing TARP funds directly into banks for a piece of equity. The idea was that banks would "earn out" their toxic portfolio—i.e., slowly write them off against the profits gained by the Federal Reserve's zero interest rate policy. It was a bold bet that the Treasury and Fed could engineer an economic recovery without allowing the bottoming action of a sharp but swift repricing of the U.S. housing stock. It turns out they only bought time, not a recovery, and now we are paying for that mistake.

Despite all efforts, the deleveraging continues. The $862 billion Congressional stimulus didn't stimulate the economy because it went into unproductive projects. The Fed's $1.4 trillion quantitative easing/dollar printing sent 30-year mortgage rates to record lows, but not enough people are buying homes because home prices haven't fallen enough to clear the inventory. And with 9.5% unemployment and 18.4% underemployed, there are more sellers than buyers.

Home sales dropped 27% from a year ago July to a 3.83 million annual rate, which was blamed on the May expiration of the $8,000 home buyer's tax credit. Dig deeper and it's even scarier. Existing home inventory (the number of homes for sale) now stands at four million units—that's a 12.5-month supply versus the average 6.2-month supply since 1999. As late as 2005, home inventory was just 2.5 million. Using that as a baseline or normal number, there are now around 1.5 million "extra" homes on the market that are not selling and either empty or soon to be foreclosed.

And those toxic mortgage assets? As far as I can tell, most are still there, valued at "mark to wish" since the Financial Accounting Standards Board's relaxation of "mark to market" accounting rules. Who knows what they're really worth? The stock market is guessing not much, sending finance stocks like Bank of America, Wells Fargo and even J.P. Morgan down close to 52-week lows. The Dow is once again flirting with 10,000. Money that had been flowing into stocks is now flowing into bond funds.

Wall Street smells a rat. Why? Because without a housing turnaround, jobs in construction, decoration, mortgage banking, auto sales and finance will stay in the doldrums. Delinquency rates, which are a leading indicator of foreclosures, are on the rise. According to the latest Mortgage Bankers Association survey, in the second quarter, prime adjustable-rate mortgage (ARM) delinquency rates rose to 9.3%, with prime fixed-rate mortgages seeing delinquencies up 4.75%. On the subprime side, ARM delinquencies hit 30.9% with fixed at 22.5%.

This is not good for banks that still own toxic assets of any type of mortgage, subprime or not. If home prices fall further, and I can't see too many scenarios where they won't, these toxic assets are all set to drop in value. At some point, buyers of bank debt will get nervous. Think of these mortgage derivatives as soon to be nonperforming loans, the same ones that were a 20-year anchor dragging down Japan.

If this toxic sludge were sitting on a shelf at the Treasury or Fed, it really wouldn't matter. They can both hold them indefinitely without any real consequences. But instead, even a small uptick in foreclosures could take down the banking system—again. The trajectory is scary, but we don't have to get there.

There are three fixes:

• QE toxic. The Fed's quantitative easing has been focused on buying Treasurys as well as packages of high-quality mortgage assets. It's time to go back to the original TARP and start buying toxic assets directly from banks, no matter the price. If they become insolvent, set up the Treasury to inject capital a la TARP2 and allow the Federal Deposit Insurance Corporation (FDIC) to implement a quick-turnaround, prepackaged bank resolution and receivership. Clean those balance sheets up for good, else we relapse into financial crises again and again.

• Import buyers. Someone has to step up and buy those 1.5 million extra homes in inventory. I would wager there is a backlog of high-paying jobs for educated foreigners well beyond what H1-B visas allow to trickle in. In the name of financial stability, create a million visas for qualified immigrants, say, those with a masters or Ph.D., and watch home prices start to rise.

• Wait. Business deleveraging is an overhang for the economy, but it's really the consumer that is overdrawn. Digging through household liabilities numbers, I calculate that since 2006 consumers overshot by approximately $4 trillion in debt. Even at normal economic growth rates, that calls for at least seven years of consumer deleveraging. We're now three years into it. Bad policy (tax increases and regulatory burdens) will only extend it. You can't hurry up this deleveraging.

There are so many price distortions that markets, let alone business leaders, are confused as to what is real. So they sit on their hands. The only way out is to let prices go to where they need to go to clear the overhang. This is especially true of housing and the housing assets clogging up bank balance sheets. Next time banks are under fire (and I hope we are not heading toward a next time), buy them out, fire management and restart the franchise with a clean bill of health. We are starting to see what the alternative is.

Mr. Kessler, a former hedge fund manager, is the author most recently of "Grumby" (Vigilante, 2010).

Thursday, August 5, 2010

One Score Card on the The Fiscal Crisis

I hope you find this WSJ article informative. The newspaper is usually not friendly to government intervention which makes this assessment compelling. It is written by David Wessel of the WSJ.

"Although few realized it at the time, the devastating financial crisis began when money markets seized up in August 2007, prompting the first responders at the Federal Reserve and European Central Bank to act. With the modicum of hindsight that three years offer, what do we know now that we didn't know then?

A few lessons are widely accepted: Unfettered, poorly supervised finance can be dangerous to economic growth. Bankers and financial engineers do what rules encourage and permit, even if it means trouble later. Regulation was less than optimal, if not negligent. And borrowing heavily in good times in the hope they'll last forever is as imprudent as it sounds for homeowners and big bank CEOs.

A few other conclusions, though, are in dispute or are underappreciated. Here are three:

Government, which did fail to head off the crisis, saved us from an even worse outcome.

Hostility to the Bush-Paulson-Geithner-Bernanke (and largely Obama-blessed) bank bailouts, Obama fiscal stimulus and Fed meddling in markets is proof the public doubts this. (Full disclosure: My book, "In Fed We Trust," credits the Fed with a major role in averting another Depression.) Experts debate whether the Treasury and Fed were too soft on the banks and the bankers when they rescued them, about how much the Obama stimulus accomplished, and whether it was the right size and shape.

Those important arguments obscure the really big question: If the government hadn't done what it did, would unemployment be higher and the recession have been deeper and longer?

No one can answer a what-if question with certainty, and those skeptical of the potency of government spending won't be persuaded by economic models that assume government spending is potent.

But we know now that the economy was imploding in late 2008. We know now with detail how paralyzed financial markets were, and how rotten were the foundations of some big banks. We know now that even after all the Fed has done, we still risk devastating deflation.

So the short answer has to be: Yes, it would have been far worse had the government failed to act.

The biggest single bill to taxpayers will come not from a bank bailout, but from mortgage giants Fannie Mae and Freddie Mac.

Most people believe big Wall Street banks got bailed out and continue to profit from low interest rates. That's true, but many banks have paid back taxpayers with interest. Fannie and Freddie, though, burdened by huge mortgage portfolios, have taken $145 billion so far. In a new analysis, Alan Blinder of Princeton University and Mark Zandi of Moody's Analytics put the ultimate price for saving them at $305 billion.

That compares with $71 billion in estimated costs to the Federal Deposit Insurance Corp. for closing failing banks, $38 billion for American International Group, $29 billion for General Motors and its finance arm, GMAC, and somewhere between zero and a profit for banks in which taxpayers invested directly, according to the Blinder-Zandi calculations.

The government didn't nationalize the banks. Someday, it will sell its stake in GM. But it nationalized the mortgage market and hasn't found a way out. So taxpayers keep pumping money into Fannie and Freddie at a rate of greater than $1 billion a week.

The overall cost to Americans as taxpayers looks less than feared initially; the human and economic toll greater.

In narrow budget terms, the rescue of the financial system won't cost as much an initially estimated. The Congressional Budget Office has cut its estimate of the ultimate cost of the Troubled Asset Relief Program (which doesn't include Fannie or Freddie) to $109 billion from $350 billion and probably will reduce it further later this month. Bank losses are simply less than initially thought. In October 2009, the International Monetary Fund estimated U.S. banks would take write-downs of $1.085 trillion. By April 2010, it had reduced that by almost 20% to $885 billion. Officials at the Fed whisper that they may not lose a nickel on all their extraordinary lending.

But only the profoundly pessimistic in August 2007 imagined how deep and prolonged the recession would be, how much federal tax revenues would fall and thus how much the government would borrow, and how many would be out of work for so long. "The most pressing danger we now face is unacceptably weak growth and persistent unemployment rather than outright economic collapse," Peter Orszag said in his last speech as White House budget director.

So the good news is that we're not in a Great Depression. The bad news is that an army bigger than the entire population of Los Angeles has been out of work for a year—4.3 million people—and that just counts those still looking for work.

No wonder there's so much skepticism about the efficacy of fiscal stimulus, and such strong resistance to even think about doing more".

Hope you got something from that analysis. For the people out of work, homes and hope this is not a recession, it is a Great Depression. Job creation we all know is key and we also know that government can not create long term employment. Only the private sector can do that. There are trillions of corporate dollars sitting on the side lines waiting to understand how the administration will act towards business.

Tax cuts expiring, health care costs sure to rise, it is no wonder that business and thinking citizens are nervous and sitting on the side lines.

I wonder what you think? Please comment and have a great day.