Thursday evening I noticed something very interesting going on within the "financial media". All of a sudden the evening before Friday's big jobs report many of the media outlets started to run stories about how great the jobs report on Friday was going to be, and how it was clearly going to show our economy had turned the corner. Several financial analysts (and I use the term analysts lightly) suddenly downgraded their predictions for job losses to around 250k from much higher numbers and CNBC even took the effort of running a 1/2 hour special on how great the numbers were going to be.
Pumping up impending economic numbers in the financial media is not uncommon but this went FAR beyond anything I'd ever seen before. It was pretty clear there was some type of coordinated leak. The media outlets would have not stuck their necks out to the degree they did the evening before the numbers came out if they weren't sure of the outcome. It's not uncommon for gov. administrations to influence the media this way, by leaking reports to create positive press but this tactic seems is being taken to an extreme level lately.
Sure enough Friday morning the jobs report came and we only had 247k job losses a huge improvement from previous months, <sarcasm>clearly a sign the recession is nearing it's end</sarcasm>. Simply the that fact you saw unemployment rates decline at the same time you had 200k job losses should be a tip off that unemployment statistics are not all that they are cracked up to be. In fact when you look inside the internals of the report you see a lot of interesting number fudging to make the headline number look much better than it should have been. The report on the whole was certainly not what I would label as proof that our economy is on the mend.
One thing that pops out was the insanely huge number (422k) of people that "exited the workforce" in July. Due to the method unemployment statistics are calculated, they don't count. One reason for this is many of the layoffs, particularly at large unionized companies happen through "early retirement" programs and thus don't effect the unemployment stats in the same way. The other is as people use up their unemployment benefits without finding a job they drop off the reporting. From the standpoint of economic health, it's still less people working, earning less money to spend and paying less taxes. In fact if the US has a shrinking workforce at the same time our population is still expanding that is really bad news economically.
There were also some other one time items that added a positive influenced the jobs report more positively such as a large number of the jobs created were census workers, who will only be on the job for a couple months. The birth-death model a model that's supposed to account for creation of jobs via new companies that otherwise don't show up in the statistics also showed by far and away the largest job creation during a July in history. Never mind this is a completely ficticious number that just comes out of a computer model, not from any actual data. These numbers get revised at the end of the year based off real tax withholding data. So far tax withholding data from the first six months of the year suggests we had 500k-1m more job losses than the computer models say.
There seems to be a huge and coordinated initiative to spin and scew any economic data being presented right now, to increase public confidence. It's really starting to bother me, I don't like being lied to or manipulated. True, this happens all the time, but to the degree it's occuring right now makes me think there maybe a lot more fear in the gov. about our economic situation than they are letting on.
I'm a couple weeks behind this one, as all the media focus lately has been on the health care bill. I've had several interesting discussions around cap and trade lately that inspired me to put my thoughts down into a blog post.
Disclaimer
I consider myself a fairly environmentally conscious person, I do believe based on data and observations human activity is creating a huge and very negative impact on the global climate. I'm extremely worried about the this planet over the next several decades. To me the health of this planet overrides any economic impacts of decisions, but at the same time I believe doing what is right for the planet can be done in ways that is also very economically beneficial in the long run. I'm not writing this post to debate these points...
Cap and Trade is a Wolf in Sheeps Clothing
The idea behind the bill sounds fine based on the highest level talking points, incentivize investment in alternative energy and at the same time disincentivize the polluters. Once you look under the hood though, the best phrase I can use to describe it, is "financial scam".
What got me looking at, and thinking about the impacts of the cap and trade bill was when I noticed the biggest supporters throwing the most lobbyists and money behind it was not the alternative energy industry but the Wall Street investment banks. Why?
It comes down to the whole "trade" part of the bill where carbon credits received can be traded/sold to carbon producers. It's been estimated that this could create the largest derivatives market, larger than the CDS's (credit default swaps). These credits would trade on an exchange (partially owned by Goldman Sachs) and would be a multi-billion dollar windfall for the investment banks.
Since the number of carbon credits available is fixed, and is reduced each year this creates a made in heaven market for large traders and speculators (hedge funds, investment banks). The carbon bubble will become the new credit bubble, as speculators suck productive money from the system.
Destructive Impacts on the Alternative Energy Industry
I've got a lot of friends involved in the alternative energy industry who believe this bill is a windfall for the industry and will spark the next big revolution in alternative industry. Be careful what you wish for, the long term impact on the industry may in fact be very destructive.
It's analogous to what happened with the housing market and credit bubble in 02-06 with all these new fangled mortgage products, CDO's, CDS'. Everybody touted these products as being great for the housing industry as they made housing more "affordable" and accessible to the masses. We now realize the truly destructive nature of these products, which incidentally were created by the same Wall Street banks behind the cap and trade bill.
Particularly as the price of carbon credits in driven up by speculators, it will become extremely profitable for companies producing them. The catch is the total number of credits is limited and there really isn't a direct tie between a technology being beneficial long-term, and producing carbon credits. You will see hundreds of companies pop up, simply built to capture huge profits from carbon credits, with technologies that otherwise would not make any sense.
In much the same way as imprudent lenders pitching alternative mortgage products forced prudent lenders out of the mortgage business, viable alternative energy technologies will be squeezed. Investment will be redirected from the productive to the speculative, with very negative consequences. Of course this bill is practically designed to create a "carbon bubble", who's popping in a few years, will sow yet another round of economic destruction laying waste to a whole industry while the pig men walk away with their sacks of money.
"It will be interesting to see how those TARP funds play out and what the aftermath will be. My guess will be massive inflation.... think about it this way."
"One thing is for certain. If inflation rears its ugly head, interest rates will increase to combat that."
"Still have you noticed how no one is talking about the inflation rate? We know that in order to spend the "trillions" that more money will have to be printed."
This also seems to be the common thread in the media and much of the financial world, everybody is expecting or thinks we are currently experiencing a huge, hidden inflation. I'm going to lay out the case, why I not only don't any evidence of it, I expect the opposite, a very deflationary outcome, over the next several years.
Truth be told the central banks around the world, including our FED, are desparately trying to return to an inflationary environment. There is nothing they fear more than deflation, but their efforts to reignite the inflationary engine can only be described as an epic failure.
We already had the massive inflation through credit expansion
For about a 5 year period between 2002-2007 and maybe a little bit before the US went through a massively inflationary period, not represented by the standard government inflation or money supply numbers. It was caused by what many sometimes refer to as the "shadow banking" system (because it doesn't show up in the numbers) that drove massive credit expansion.
Not that it was exactly very hidden. It drove speculative bubbles all around us, both residential and commercial real estate, commodities, corporate debt fueling leveraged buy outs and equities. If you believed the CPI numbers published you saw inflation rates of around 2-3% during this period. Several economists have calculated the real inflation rate was actually somewhere between 10-15% annually during this period. This lead to both real interest rates that were very negative, and also a very negative real wage growth.
The last year and a half we've seen the exact opposite, a massive credit contraction, driving deflation across almost all asset classes. Just as the government numbers as an artifact of what they measure severelly understated the inflationary period they are massively understating the amount of deflation that is ocurring. Look around at real estate, stocks, bonds, commodities. Do you see rising or falling prices over the last two years?
Credit destruction is MANY times larger than credit creation
The most common inflationary argument is the FED and other central banks are printing trllions, upon trillions of dollars that are being pumping into the system. While there has been a couple trillion in money put into the system, the actual amount used to monitize debt through quantitative easying is only around a trillion or less. Now counter balance a trillion vs. over $50 trillion in global wealth destruction in 2008 alone. What's the bigger number? To put in bluntly the FED and other central banks are merely pissing into the wind with their efforts.
The money isn't moving
Now here is the real crux of the problem for central banks why money supply creation and stimulus are not having their intended inflationary effect. While the technical definition of inflation is size of the money supply, all the inflationary effects people worry about are instead driven by the velocity of money. A small amount of money moving very fast through an economy creates more inflationary effects than a large amount of money sitting on a balance sheet plugging holes.
In fact the velocity of money has completely collapsed as it's being used to pay down and service debts or cover losses. The last time the velocity of money was this slow, was heading into the Great Depression. Below is a chart of MZM the broadest measure of monetary velocity.
The hyperinflationary setup
For those people worried about imminent hyper-inflation, it might be worth looking historically at characteristics of hyper-inflationary collapses. There have been dozens of well documented ones throughout history, some of the ones that come of most peoples minds first are the Weimer Republic in 1920's Germany and recently in Zimbabwe.
Hyperinflation almost always occurs following a severe deflationary collapse. While I've made my case we are experiencing deflation right now, we are no where near what would be considered a collapse, yet. It also ocurrs in a countries that base purchasing power on a stable foreign currency. In other words if you have the world reserve currency like the US dollar, it is near impossible to get hyperinflation. It's much more likely you see hyperinflation in foreign countries that attempt to peg their currencies to the US dollar, which would result in a relative strengthening of the dollar.
I could see us, creating a setup for hyperinflation if the dollar looses reserve currency status, and we experience a deflationary collapse, but it would take us several years to get there.
Interest rates rising without inflation
Ok, so I've gone on record saying I expect rising interest rates and possibly a crash in the US Treasury market within the next year. If rates are rising doesn't that imply inflation? Well not exactly...
Inflationary expectations are only one component of what sets interest rates, the other major one is risk of default. The higher the risk of default the higher rates must go. It's this rising risk of default that I expect to significantly push up rates not inflation. In fact the rising rates may have a highly deflationary impact as it will further choke off credit, stalling economic recovery.
We are now officially half way through the year so it's time for me to do an update to my2009 market and economic predictions, also known as, Matt is being a buzz-kill again. The quick scorecard is, four have already occured, four I'm still predicting will happen, one I still think will occur but probably not this year and one is DOA.
The media has become fairly delirious from smoking few too many of those "green shoots" as of late along with 90% of economists calling for the recession to end shortly. It should be noted that a similar number of economists were confident we'd avoid a recession in the first place. They are latching onto month to month fluctuations in data claiming the economic recovery is upon us, while almost all trending and forward looking data is continuing to paint a fairly pessimistic outlook.
Another main factor in my continued pessimistic outlook is the attempt by those in charge to play confidence games instead of solving problems. If we believe things are getting better, they will, right? Confidence without the foundation to support it, is not a very good economic base to build from.
1. The "Credit Crisis" morphs into much wider economic crisis
Ok, I think this one is playing out as we've moved from people claiming we're just having financial system and housing issues to seeing dramatic drops in employment and even more dramatic drops in tax revenues (corporate, income, sales). While the official government reported unemployment rate is now up to 9.6% the broader unemployment measure like U6 has now skyrocketed to 16.4% the highest since the 70's.
The data shows job losses are actually accelerating, not decelerating. With the unbelievably dramatic drops across the board in tax revenues, we are just beginning very extensive layoffs from the nations largest employer, the local, state and federal governments. We also have not seen the layoffs happening in the automotive industry show up in the official numbers yet.
2. The recession gets an upgrade
While I didn't expect an official pronouncement this year my prediction is that we'd meet the criteria for a depression not just a recession, which is defined by more than a 10% total loss in GDP. I still think this is going to happen, and in fact I think the forward looking data makes this almost a lock to happen. Though, this quarters GDP coming in flat or even just slightly positive wouldn't surprise me.
For some great visuals on how bad the economic trends really are check out this post on Nate's Economic Blog.
3. Pension funds, the biggest non-story of 2008 becomes THE STORY of 2009
Ok, I'll give myself about 1/3 of a point for this one. The story is huge, it's just getting almost no play in the main stream media. Many of the largest pension funds in the country are in deep trouble shifting into riskier and riskier investment strategies to make up shortfalls. For example CALPERS the largest pension fund in the country shifting large portions of their assets to real estate right at the top of the bubble and then stocks right at the top. They are in a massive hole, and have stated they are relying on being able to borrow from the state of California to fill the massive hole. Yes, the state who tomorrow will start issuing IOU's in lieu of checks to pay bills.
Not to be outdone by California, PBGC (Pension Benefit Guaranty Corporation) which insures pension funds including those at GM and Chrysler followed suit. Why are the pension funds pursuing such a risky strategy that would once have been looked upon as insanity?
He said the previous strategy of relying mostly on bonds would never garner enough money to eliminate the agency's deficit. "The prior policy virtually guaranteed that some day a multibillion-dollar bailout would be required from Congress," Boston Globe article on PBGC
As they say, when in a hole, keep digging, or something like that...
4. House prices continue to fall, but in most regions not as fast
Not much to add here, the Case-Schiller data showed a 19% year over year price drop first quarter, with declines in all 20 major markets they track. Anecdotal the declines in many markets appear to be slowing but historically in housing downturns the steepest declines occur in the first 2 years, where the average overall length of price declines in 5-7 years. There's also still a huge backlog of foreclosures sitting on bank balance sheets which have been held back from the market. This will keep inventories in most markets elevated for some time and keep the downward pressure on prices.
Update: Just saw the updated Case Schiller data released today, basically shows what I expected. Still declining across the board but at a much slower pace.
5. The stock market is far from seeing a long term bottom
My prediction was that we'd see the November lows of 738 on the S&P500 broken this year, and we saw that happen in the first quarter of this year ominously putting in a low at 666 on the S&P 500. Despite a several month, 35% straight up rally since then I don't believe we've seen the lows for this bear market, and see a high probability of the S&P500 going under 500 later this year. Simply put we are still in a deleveraging phase and we've seen a massive drop in corporate profits making the stock market extremely overvalued at it's current level by almost all metrics. These profits by and large were driven by the credit bubble, particularly in financials and unless we are able to blow another massive bubble they are not returning, like some are placing bets on.
6. Where does the bailout money come from when it's time to pay up?
We'll have to see, they just started issuing the debt a couple weeks ago, and we're now issuing as much treasury debt per week as we were per year less than a decade ago. This is at the same time the major foreign buyers are slowly inching their way to the door, buying shorter and shorter duration debt, as the FED tries to hold back the flames through quantitative easing.
7. A crash in the US Treasury market?
This was the prediction I said I was the most hazy on last year, and now I think it's inevitable due to the insane government spending we've seen coupled with the gigantic collapse in tax revenue. The FED has been pulling every trick in the book trying to surpress rates and support the treasury market through quantative easing. History shows these types of efforts are simply fingers in the proverbial dike that inevitably bursts. If the treasury market does crash you'll see double digit interest rates on mortgages within a few months.
On a related note, the consensus of late seems to be for rising interest rates but due to (hyper)inflation. I simply don't see the case, all of the data points to massive deflation. Oh, the FED's monetizing debt and printing. The problem is the deflationary pressures and wealth destruction is dozens of times larger. Also, the FED pumping money is only inflationary if the money moves, as inflation really is the velocity of money not the size of the money supply. A small amount of money moving very fast through an economy is more inflationary than a large amount of money that sits on a banks balance sheet plugging holes. The fact it's being used to plug holes that are not magically going away, is exactly why I don't see it suddenly becoming inflationary.
8. GM files for bankruptcy despite the automaker bailout
My prediction was that both GM and Chrysler would file for Chapter 11 bankruptcy this year despite their bailout at the end of 2008 with the goverment providing massive DIP (debtor in possession financing). Check...
9. Regional bank failures and consolidation accelerate
We're up about 50 regional bank failures this year compared to 25 all of last year. Technically I guess this counts as acceleration but it's still well below the hundreds I was expecting. It has nothing to do the increased stability in the banking system and more to do with the FDIC and OTS not doing their job to protect depositors and tax payers.
A good example of this is Bank United a large regional bank in Florida that collapsed about two months ago, at an estimated cost of about $10 Billion. This bank was on my list of dead men walking back in April of 2007, due to the how badly their loan portfolio had already depreciated. Two years ago it was clear from their balance sheet without pulling accounting tricks they were insolvent. Every Friday for nearly two years I was shocked when I didn't see an announcement his bank had been seized due to how far gone it was. Had it been seized two years ago it's likely there would have been very little, if any cost to the FDIC and US taxpayers, instead it cost us $10 billion.
Then two weeks ago the head of the OTS resigned after it turned out he had ordered the Bank United to falsify financial statements to cover up their insolvency. Yes, the top banking regulator was ordering banks to fudge their financials so they would appear solvent and would not be seized. Bank United is not an isolated case, not by a long shot. In fact, 2 other high ups at the OTS resigned or were fired in the last year for pulling similar stunts with other banks. There is a organized effort to avoid failures at all costs by covering up the problems and hoping they go away. This just makes the ultimate failure many times worse.
The government banking "stress tests" meant to prove to the public and investors how sound are banking system was a similar sham. We're already well past the loan default rates used in their most stressful scenarios, banks were asked to provide the valuations for complex securities like CDO's, and provided values many times above current market prices. Commercial real estate, who's impact on bank balance sheets is likely to be worse than residential mortgages, showed almost no losses in the stress test numbers.
Suffice to say, I expect the next "unexpected" banking crisis to rear it's head this fall at the latest and this time I'm not sure if there's the will political will to throw a few hundred billion more at it.
10. A revolt against corruption
Grrrrrrrr... Where's that change Mr. Obama... Must stop writing here or I'll launch into a rant and this post will be 20 pages before I know it...
Yesterday was a big day for me, after 8 months of planning and product development work finally launched my new startup, Timu. Timu gave me a chance to apply many of the lessons learned with designing and building ActiveRain to another market, amateur sports.
It's a social networking platform specifically built to solve the communications problems encountered by athletes, sports teams and their fans. Online social networking is a natural way to solve many of these problems. Yet, existing social networks provide disjointed solutions that do not handle sports specific features, such as player rosters, game results and statistics. At the same time existing sports web site offerings provide little interactivity and user engagement.
Individual athletes can setup an profile on Timu in minutes. Profiles can be customized with information about the sports they participate in, teams they play on, and their competitive highlights. Photos, videos can be uploaded, and various “widgets” can be added or modified. These profiles serve as one center of communication within Timu.
Coaches, players, or parents can create a team center for your team on Timu. Team centers provide many features like team news, schedules, player rosters, photos, game results, statistics, statistics and a wide range of commmunication tools. All of the people associated with the team can be invited to become members of the team center, which can then function as a hub for team communications.
Currently Timu supports about 30 different sports ranging from baseball and soccer to unicycling. Each of these sports has it’s own section or hub on Timu including photos, videos, game results and discussions. Timu members can participate in the conversation at these hubs about their sport. As Timu grows we will be providing the ability to view these hubs by region, subsection of a sport, or even by sporting venue.
The administration's new banking rescue plan was officially released this morning after the details of it had been leaked over the weekend. It sure didn't take long but pretty much every economist and financial blogger not connected with Wall Street has already ripped it to shreds calling it everything from a massive tax payer fraud, another big bank hand out and a massive government sponsored confidence game. Economist and former Nobel prize winner Paul Krugman spent no less than 3 posts since Saturday blasting it. While Mike Shedlock (Mish) went so far as to proclaim Treasury Secretary, Tim Geithner the architect of this plan (and of many of the bank bailouts and AIG bailout fame/shame), "the most dangerous man in America"
Actually it was pretty easy to rip apart quickly as it's basically a repackaged version of former treasury secretary Hank Paulson's proposed plan which was also blasted to smithereens. Of course it's unfair to blast a plan without providing your own for saving the banking system, so here goes...
Unlike the administration, FED and Treasury department I do NOT believe solving the banking crisis will solve the our economic or housing problems, but we still need to solve it or it will contribute to things getting much worse. Surprisingly we already have a good solution to the banking crisis, one that was born out of previous banking crisis', and that has been battle tested and has worked great for over 70 years in dealing with thousands of banks. It's called FDIC receivership, and it was notably used recently for dealing with several large institutions including Washington Mutual and IndyMac.
Banks are legally mandated to carry a certain amount of cash reserves relative to their loans and other assets and liabilities to ensure they can safely pay depositors that want to withdraw funds. If they fall below this threshold the FDIC and OTS is required to come in and seize the institution taking it into receivership to protect both depositors and tax payers. This is one of the things you submit to when operating a bank in the US and to be able to have your deposits FDIC insured.
In FDIC receivership, the bank is essentially cleaned up to be return to private operation as quickly as possible. Incompetent management is given the boot, the books are combed over looking for fraud, liabilities are zero'd out with stock holders and then bond holders taking the first loss while depositors are protected. The now clean in unencumbered bank is then sold off to another bank either in whole or in pieces whatever, is more workable. It's different from the concept of nationalization as the whole goal is to return the bank to private operation in short order. In fact receivership often only lasts days and appears near instantaneous to the public.
Now the crisis in our banking system, is that a huge number of banks including several or the very largest in the US would prove to be below reserve requirements if they were to use proper accounting, write down their bad loans and assets. Falling below these reserves would mean the FDIC would legally required to take these banks into receivership to protect depositors and tax payers. The Treasury rescue plans all revolve around trying to keep the banks above reserve requirements by pumping cash into them and making accounting/regulatory changes so they don't have to properly account for losses. Why?
While, FDIC receivership is a very effective and well tested for dealing with these sorts of banking crisis', it also has a high political cost. The incompetent bank executives that have been lining the politicians pockets for years would almost certainly find themselves out of a job, and many on Wall Street would eat substantial losses on stock and bond holdings in these banks. There is also the fact that people don't want to admit some of the banks that have been mainstays of the US banking system for decades may in fact be failures. I guess it just comes down to the fact there isn't the political will in Washington to actually solve the crisis.
The details of the Treasuries much anticipated toxic asset plan to "cleanse" the banking system and restore financial stability are now public. My reaction posted on Twitter as I was reading it.
@timu_matt: Reading the Treasuries new toxic asset plan. Everytime I think they can't get more hell bent on destroying this country they surprise me again.
Yeah, that pretty much sums it up. In a nutshell the plan revolves around the Treasury and FDIC loaning private investors money to buy the toxic assets from the banks. These loans would be made at almost no money down, when you combine the Treasury and FDIC incentives these (non-recourse) loans would account for up to 97% of the purchase price. The treasury is essentially trying to create a whole bunch of private "hedge funds" operating on insane amounts of leverage (33x), overpaying for toxic assets.
Wait, isn't excess leverage one of the main causes of this mess? At 33x leverage, 3% drop in the value of the assets blows up the investor, but hey the US taxpayer the one taking taking the loss on 97% of it, so who cares. This scheme basically opens the door for wide scale gambling in the financial system at the taxpayers expense. Now, you want to know the truly sick part?
The biggest gamblers in this system will be the big banks themselves. They will practically be fighting each other to grossly overpay for each others (and their own) toxic assets. Hey, they make money either way no matter how much they overpay, it's the tax payer on the hook. Seriously, we might as well pass some new legislation so that any federal taxes we pay go directly into the coffers of the big banks just to formalize the whole arrangement, because that is what we've been doing informally for months now.
So this afternoon the Congressional Budget Office or CBO released their updated budget projections for the US government and the numbers are both a shocker and a head scratcher. They are now projecting the US gov to run budget deficits, of $1.8 Trillion this year and $1.4 Trillion next year. That is the US government is projected to spend nearly 75% more money than they took in via taxes this year, and another similar percentage next year. To put this in perspective our budget deficit the last four years was about the same as what we'll now have in a single year.
Now here's the head scratcher, the projections assume a total GDP loss of 1.5% this year and growth of 4.1% next year, basically calling for an amazing economic recovery later this year. To call this projection insanely optimistic would be an understatement, and means their overall deficit projections are almost certainly way too low.
The US government is going to have to borrow an estimate $1.8 Trillion via the US Treasury market this year, plus roll over existing debt. We're going to be issuing somewhere close to 4X the amount of debt this year as last year. The primary source of this funding for more than a decade has been foreigners, primarily Asian and Middle eastern countries. These countries have recycled their massive surpluses from selling the US oil and cheap lead painted, plastic crap to the US into treasuries, effectively funding our government.
Guess what's happened to those surpluses as the global economy has cooled and the US consumer has slowed their buying? Yes, they are rapidly vanishing. In fact the available data from Jan, shows purchase of long term treasuries by foreigners slowed very significantly. To fund our budget they must buy several times the US treasuries than they have money to buy, the math simply does not work.
The Treasury, CBO and Congress are living in a complete fantasy land right now. This massive spending is not just imprudent, but it simply can't be funded no matter how many times we click our red slippers together.
Going off the reservation on another financial rant/post today...
The other day I saw this great post explaining Fractional Reserve Banking in really simple terms. It really lays the foundation for why our Federal Reserve and Treasury's policies not just now but over the last decade have helped lead us to where we are now and have actually been a main contributor to our worsening financial crisis.
Without going into the details of how it works (follow the link if you want a clear explanation), fractional reserve banking is the type of banking system that the US and pretty much every other country have operated under for hundreds of years. There is nothing inherently bad about it, it's actually been very beneficial to society. Without it banks could not lend money at rates at even close to the rates they do and still make money. Many of the advances in society we've had, for example the industrial revolution may not have occurred without fractional reserve lending. Certainly the concept of home loans, car loans and credit cards would not exist today.
Now like almost all good things, fractional reserve banking has some trade-offs. The main one being that a cycle of boom and busts is mathematically inevitable within it. As money is recycled through the banks, society becomes increasingly in debt and each additional cycle of lending generates less economic production, as more money is eaten up by interest costs.
You eventually reach a point in which the system becomes mathematically impossible and a "reset" is necessary. The people who took on too much debt for unproductive uses like consumption (buying that new SUV, boat, 6 TV's) go bankrupt along with the banks who made the imprudent loans. The total indebtedness of society is again reduced to a manageable level by defaulting debt. These resets are an inevitable artifact of a fractional reserve banking system, and occur fairly regularly through things like recessions. They need not be cataclysmic, society changing events and typically occur well before the mathematical brick wall is reached.
For more than a decade the US at all levels government, corporate and individuals have increasingly taken on greater and greater indebtedness, while at the same time the economic productivity from this debt has decreased. Particularly over the last 6 years, the amount of debt we've taken on has been impressive but what was it used for? Buying a house, and a new car is a great thing it really doesn't generate long term economic production in the same way building a factory does. At the same time our manufacturing base has moved off-shore, most of our economic "growth" was not real nor sustainable.
Our fractional reserve banking system reached that point were a "reset" was needed to stabilize things and get back to productive ways. Instead the geniuses at the Federal Reserve (yes I'm talking about you Greenspan) came up with the idea that could prevent an inevitable and needed business cycle through manipulating monetary policy, effectively lowering reserve requirements in banks and deregulation. Instead of letting the system flush itself out and going through what probably would have been a fairly bad recession in 2002, they lowered rates and took actions that allowed increasing amounts of debt. Deregulation occurred that allowed for banks to increase leverage and this debt trickled down to the consumer level via cheap lending. Massive debt was added to society for things such as home loans and leveraged buy-outs in the corporate world, neither which generate lasting economic benefit.
Over the last two years this legacy has been carried to the extreme by Bernanke, Paulson and co. as they continued to do the exact opposite of what must happen to stabilize our financial system. Remember the two things needed to “reset” a fractional reserve banking system and get it operating smoothly again is a reduction in total indebtedness through the default of bad loans, and the failure of those banks that made those loans. So guess what they’ve done and continue to do. Artificially hold down rates, increase total debt in the system via injecting massive liquidity, prevent the bad debt from defaulting and prop up banks that made bad loans.
It makes you want to bang your head against a wall, at least it makes me want to.
Why do people continue to act like these guys are saviors steering our country through this crisis when their actions do the exact opposite, and are in fact some of the main perpetrators of this crisis?
Since the beginning of the financial crisis I’d get asked what my solution to the problem would be and my response would basically be “let them fail” and stop trying to artificially prop things up. People would look at me like I was insane, that’s not a solution, it would create a disaster, lots of companies would fail, the government just needs to do more. No, that is how you fix it and every attempt the government takes to intervene and prevent the needed reset, itself only creates a new, bigger problem. The years of continuous government intervention and artificial attempts to circumvent corrective market forces is a primary reason this crisis has gotten so bad and continues to get worse.
Which brings us back to todays FED announcement that they are planning to purchase US treasuries to hold down long-term rates, but that’s for another post...
We've all seen several prominent asset bubbles and their collapses in the last decade. The collapse of the stock market in 2000 and again in the last year, the ongoing "housing bubble" bursting, a less talked about but no less spectacular recent collapse in the commodities and corporate debt markets. A bubble is usually used to refer to a boom that gets so far away from fundamentals and often purely driven by psychology or artificial attempts to keeps the good times rolling. Boom and busts are a natural economic cycle, where the principal "The bigger they are, the harder they fall" rules the day.
While, bubbles in across so many assets have burst during the past year, one mountainess asset bubble continues to bulge over the horizon, the US treasuries market, the mechanism which with the US government funds itself. This market exhibits almost all the typical classic signs of an asset bubble, a disconnect from fundamentals and artificial influence like todays announcement of the FED buying long term US treasuries to attempt to prop it up.
Lets say the following person came to you and asked for what amounts to an unsecured loan.
They currently have debt in excess of 4x their annual income.
They have spent more money than they've made nearly every year for the last decade.
They project to spend 72% more than they'll make in the during year with similar losses stretching off into the horizon.
Their estimated future liabilities are several times their hard assets.
Does this profile look like a person that over the long term is going to be able to make due on that loan? Would you give them a long term loan? Yet, the world keeps loaning this person (The US Government) massive amounts of money at what is currently a 2.5% interest rate for a 10 year term. Need anymore proof the US treasury market is not running off fundamentals?
It's a very similar situation to GM, for which ironically there is this saying, "as GM goes so goes the country". For several years anyone that looked at GM's balance sheet knew that failure was inevitable. The only reason they kept operating is that for years people kept loaning them money at insanely low interest rates. But then in the last year something changed, due to credit market troubles people began questioning whether GM really could fail, the cheap loans dried up and GM was forced back into financial reality.
So why do people loan the US gov. money at 2.5%? Well it all comes down to safety and the idea that if anyone can make good on their loans, well just because the can. The fundamentals don't support it, they say failure to pay back these loans in inevitable, it's just a question of when.
But, but the US gov. has a printing press
Oh, we're forgetting one thing, these loans are payable in US currency and the US gov. has this handy machine called a printing press, so they can just print up more money to pay their debt. Now here's the problem, the US gov prints money, US currency become worse less, inflation goes up and you have to get more interest on your loan or you are loosing money. So, isn't this just another fundamental disconnect suggesting a growing asset bubble?
When does it pop?
It's notoriously hard to determine the peak of an asset bubble. Many correctly saw the real estate bubble and predicted it's immanent collapse, several years before it did. But there are a few common signs, that asset bubbles are nearing their end.
One of them is a peak in "irrational exuberance", that is people believing the bubble will continue for the foreseeable future. In 2000, the stock market crashed at the same time surveys were showing the highest percentage of people were bullish on the stock market. What is now seen as the peak of the real estate bubble coincides with surveys showing a similar insane bullishness of real estate. Same with the recent commodities bubble. Sentiment in the US treasury market seems to be reaching that same irrational peak with nearly everyone expecting long term treasury rates to stay depressed for the foreseeable future.
Also near peaks you begin to see increasing amounts of artificial manipulation to keep the party going. Manipulation of earnings statements in 2000, increasingly inventive lending schemes in 05-06. This is how I view todays announcement by the FED that they will begin buying long-term US treasuries in order to hold down interest rates. It's an artificial attempt to keep the US treasury bubble inflated, and I take it as a sign this last asset bubble may in fact be nearing it's peak.
So what would the bubble bursting mean?
Well to put it in four words, "Much higher interest rates" and a true funding crisis for the US Government. Just like with GM, the US government would be rudely jolted out of a financial stupor. The forced contraction of government spending almost overnight would be rather shocking to put it lightly.
Disclaimer: ActiveRain Corp. does not necessarily endorse the real estate agents, loan officers and brokers listed on this site. These real estate profiles, blogs and blog entries are provided here as a courtesy to our visitors to help them make an informed decision when buying or selling a house. ActiveRain Corp. takes no responsibility for the content in these profiles, that are written by the members of this community.
Posted by 
;)
;)
