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, it 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.
Over the last several months I left a couple of semi cryptic posts Timu, the startup company that I left ActiveRain back in the fall to found. Obviously from the logo I posted people were able to correctly guess what industry it was in, sports. This inspired some guessing around ActiveRain about how exactly Timu was related to sports and what if anything Timu stood for.
After several months of development work, we finally opened Timu up this week in a private beta test. Unlike how so many web 2.0 companies slap a beta sticker on a product (cough, Google) and launch it like that this is an actual beta test with a small group of users to work out the kinks before a real launch in the not so distant future.
So what is Timu?
While Timu isn't yet open to the public, we are finally letting the cat out of the bag about what Timu is. Timu is a communication and social networking platform for sports teams. Whether it's little league, high school or adult rec. leagues Timu allows teams to take advantage of social networking concepts to help teams to schedule, coordinate, organize and share.
I've played on and still play on several sports teams, and team communication away from the game has always been a problem. How do you know when practices are, who's going to make it to games, is the game rained out? These are some of the core problems that Timu will help to solve.
We're initially launching the platform for baseball and softball teams but will be adding in all the other major sports over the next year.
And what does it stand for?
I've seen plenty of guess about with Timu actually stands for, a couple of my favorites have been "Tetherball in my utopia", and "Teams in Motion United". Sorry to ruin the guessing, but Timu isn't an acronym for anything, but it does have a relevant meaning. Timu means "Team" in Swahili, plus it was a short, easy to remember and acquirable domain name :)
Looking for some beta testers
While Timu is not yet open to the public, we are still looking for a few additional beta test teams. If you play on, organize or coach a baseball/softball team and would like to participate and help shape the direction of a really cool application, let us know.
So I haven't written a blog post in what pretty much seems forever, after my massive barrage this fall on the bank bailouts and economic issues. Many people are surprised I haven't chimed in on the massive "stimulus" bill that every-bodies been talking about. Part of the reason is I've been way getting things ready to launch with Timu and haven't followed all the details as closely as I have in the past but also because I just got burned out, frustrated and cynical with everything, particularly anything that involves Congress.
But, ok here's a few quick thoughts...
First of all and this one is gonna strike a nerve with a lot of ActiveRainer's, housing is not the core problem. Housing is a symptom of the core problem. True, it's a massive symptom that is causing pain for most Americans but because it's not the core problem, so we won't solve our economic issues by trying to fix housing alone. It won't lead us out of the mess like some claim, never has, never will. The core problem was/is massive amounts of cheap credit that caused people, corporations and even the government to take on a unsustainable debt load while at the same time not creating much of anything productive. Look at the LBO (leveraged buy out) boom that occurred at the exact same time as a prime example. Due to cheap credit corporate raiders bought out and literally destroyed thousands of productive companies for a short term gain. Enron should have been a warning, but it became a model.
Our amazing recovery after the .COM crash was a mirage, masked by financial wizardry, that attempted to create money out of nothing, and distorted the true state of the economy. Simply put we were looking for a quick fix but didn't create sustainable growth (thank you Greenspan and the financial industry).
Ok, now back to the stimulus, the problem is we are attempting to do the exact same thing, and I think it was Einstein that said the definition of insanity is "doing the same thing over and over again and expecting different results" The stimulus no matter what it is used for is no free lunch. It's simply the government taking on more debt which will come out of our pockets at a later date either via taxes or the government finally needing to start of the printing presses to not just inflate but hyper-inflate. Unless that stimulus is being used efficiently to create long term growth (which it's not) then it's a net negative for us, plus it masks the true problems a little bit longer allowing them to grow. I've read economics paper layout how similar attempts during the 1930's actually lengthened the great depression rather than saved the US, yet for some reason most economists seem to be gung hoe about it this time around.
But, but everybody is screaming about how the government HAS TO DO SOMETHING NOW. The problem is unless you do the right thing we'll actually make the problem worse, and we've been stuck in this loop now for years. We have to get out of this near term thinking where we are just reacting to short term problems and kicking the can a little farther down the road.
If the government is going to use stimulus it has to be done very efficiently to make sure that you are creating more long term value with each dollar spent than is being spent. Think of it like taking out a loan to build a business or an investment. Unless you can use that money to make more money it's just a bad idea because YOU will have to pay it back. The stimulus roughly works out to $7,500 per tax payer before interest (and yes it's debt, there is interest), so ask yourself, is your $7,500 being invested wisely or are you just buying $7,500 of stock in the next Enron?
As promised I put together my list of market and economic predictions for the New Year. I somewhat unfortunately managed to go 10 for 10 in last years predictions (Recap). Admittedly my crystal ball is a bit hazier this year, and the law of averages should give people hope. Sorry, if my predictions this year aren't any more optimistic, but I'm not going to pull a David Lereah and will just call them like I see them.
1. The "Credit Crisis" morphs into much wider economic crisis
During 2008 we saw what was first labeled as the sub-prime crisis morph into a mortgage crisis then a credit crisis as problems spread to every type of debt security. This year we are going to see the issues spread much deeper into the wider economy. Job losses, particularly during the last quarter of 2008 were horrific using the reported government numbers, but downright terrifying when you factor out their number fudging. In much the same way as government inflation numbers showed almost low inflation over the past several years when it was fairly high, there's several artifacts of the BLS's job reports that make them look much better than they really are. Things such as the Birth/Death model and the fact that 637,000 left the job force last month because they couldn't find work (so they obviously don't count). Using broader measures without these fudge factors, unemployment is the worst since 1983, running closer to 12% at the same time job losses are accelerating.
2. The recession gets an upgrade
Ok, I'm getting a little ahead of myself here, after all it was just officially declared we were in a recession about a month ago (backdated to last Dec) but almost everybody crunching the number on their own could have pretty much declared a recession over a year ago. While we almost certainly won't get an official declaration this year, I think it will become apparent to independent number crunchers we will be closing in on depression territory by years end. A depression is defined as a GDP loss of over 10% Almost across the board economic numbers are coming in as some of the worst on record and in many cases the plunges are worse than they were in the 1930 time frame.
3. Pension funds, the biggest non-story of 2008 becomes THE STORY of 2009
This maybe one of the biggest stories of this last year and not next to no major press. Simply put many of the largest public pension funds were trying to be hedge funds and were decimated. These pension funds everybody expects to be invested in nice safe things found themselves already underfunded and decided to pile money into riskier and riskier things, CDO's, risky MBS's, huge positions in financial stocks, even the historically volatile commodity market.
Take for example CalPERS, California's massive pension fund, they lost 103% on their residential morgage investments. Yes, you read that right 103%, because like a hedge fund, leveraged up and used borrowed money. CalPERS lost 25% of all assets just since July 1st ($70 Billion), and while I can't find the number to reference, I saw it calculated they lost 47% of assets in the last year. Of course learning their lessons from Bear Sterns and Lehman Brothers, they continue to claim, nothing to see here, we're well capitalized.
Unfortunately, CalPERS is far from alone, this same type of risk taking was par for the course among many of the large pension fund and so far the losses have been kept surprisingly quiet. Baring the most amazing economic recovery in history, many are toast and the damage is trillions.
4. House prices continue to fall, but in most regions not as fast
I'm basing this mainly on historical price trends in when regional real estate markets have collapsed. The price declines typically last 5-7 years before bottoming out, but the steepest of the price declines typically occur within the first 2 years before leveling off somewhat.
5. The stock market is far from seeing a long term bottom
Back in Oct. when we hit an intermediate bottom on the equity markets, about 738 on the S&P500, I started telling people I thought there was a good chance we were about to start a multi-month rally, mainly due to the massively negative sentiment I was seeing. As a side note it's interesting that in almost all markets, sentiment is the most negative near bottoms and most positive right at tops. So far we've managed to rally for a month and a half and it may continue for some time, but we are far from the overall bottom.
For example during the great depression we saw more than half a dozen multi-month stock market rallies taking the market up over 40% in short periods of time, yet despite this the total loss from peak to trough was nearly 93%. Based on many types of analysis that people have done and some of my own looking at technical patterns, historical trends and economic impacts and valuations, I think a very likely bottom could be in the 300-500 range on the S&P500 within the next couple years. That would equate to a 68-81% loss off of the peak or 45-68% loss of where we currently are after all the nastyness in the fall.
People subscribing the buy and hold philosophy maybe in for a shock. The whole stock market comes back and gains 8% of year over time that people like to spout is actually predicating on picking some very "convenient" date ranges. There's been some rather lengthy (15-20 year) periods in the last century where annual stock market returns were closer to 2% and well below that of bonds.
6. Where does the bailout money come from when it's time to pay up?
When you add up all the bailout money that's been committed to in the last several months it adds up to over $8 Trillion. Yes, $8 Trillion, to put that in perspective the total tax revenues of the US government last year was $2.7 trillion. While that much money has been committed to, that is not the same as actually spent or handed over, similar to social security. Most of it is in the form of backing various debt securities, which are likely to go bad in the future. It's basically a giant credit default swap written by the government, and we've all seen what happens to those. So, what happens when it comes time to pay up? Who knows? Truthfully I don't think they have a plan, I think they're just trying to kick the can down the road a little bit longer hoping for a miracle, and a new person to be in their position. This maybe related to the next prediction.
7. A crash in the US Treasury market?
This is probably the prediction I am feeling the haziest about, particularly since I thought we were on the verge of a crash in the treasury market late last year and instead it rallied. But the US treasury market is beginning to look like just another giant asset bubble, and asset bubbles have a tendency to continue longer than anyone expects before collapsing. Right now prices of long term US treasuries are the highest, thus yields the lowest they've been in, well as long I can find historical data. This is mainly due to a flight to safety from all other asset classes, particularly other types of debt, mortgages, corporate corporate bonds, etc.
Now the problem, is this is depressing long term US treasury yields to a range of 2.5% at the same time the US is taking on a unsustainable debt load plus massive future bailout commitments (see #6). So, either the market for US treasuries is pricing in a very, very lengthy period of deflation/depression or the market is just setting up for a spectacular crash very similar to the situation in 1931 that sends interest rates soaring. Neither is good but given the US debt load now, a treasury crash this would bankrupt the US, giving the US two choices of either hyper-inflation or flat out defaulting on debt, both which have some terrifying consequences. Interestingly enough, guess what's the best performing asset in hyper-inflation, yes real estate.
8. GM files for bankruptcy despite the automaker bailout
They just got billions in low cost government loans, but that isn't going to tide them over for very long. Given how fast they are burning cash, (you couldn't burn it faster with a forklift and a blast furnace) along with a continued economic decline they'll need continuous giant cash infusions. There's a good chance the next cash infusion this spring comes in the form of DIP (debtor in possession) financing for a pre-packaged bankruptcy. Really, a bankruptcy is the best thing that could happen to GM as it's the only legal way it's going to be able to restructure in a way that allows for long term survival. Chrysler is in the same boat, but Ford is in substantially better financial shape and will probably avoid bankruptcy. If the government really wanted to help Detroit it would be better off using part of that money to supply seed funding to several new car companies but unbordened by past liabilities and being smaller and more agile could be more innovative.
9. Regional bank failures and consolidation accelerate
I was somewhat shocked to only see 25 bank failures on the FDIC's Failed Bank List at the end of the year. Though you could realistically add several others like Wachovia that when through FDIC forced/assisted mergers. To me not proof that the banking system is in better shape than I thought, but rather that the FDIC and OTS are even more incompetent than I thought. There are dozens, probably more like hundreds of regional banks that appear better capitalized than they really are, due to um, creative accounting. As far as the biggest of the banks go, keep an eye on Wells Fargo, who've continued to profess they are clean, just don't look to far into their books.
Allowing them to continue to operate while realistically very under-capitalized is putting more and more depositor and tax payer money at risk. These bank failures and mergers mean that the banking system will continue to consolidate into a few super banks, clearly including the likes of Citigroup, Bank of America, JP Morgan/Chase, etc. The problem is these are some of the worst offenders out there, they simply get to survive because they happened to be the biggest thus are getting the direct government assistance. Is this really good for America? I think you know the answer to that one.
10. A revolt against corruption
The last 10 years ago has probably been some of the most corrupt years this country has seen at all levels both government and corporate. Much of this corruption still has yet to get the exposure it rightfully deserves. What was once frowned upon became the status quo.
Maybe this is more of a hope than a prediction, but 2009 may mark a turning point in this cycle. Maybe it'll be a new incoming president (for the record I think both parties are equally as corrupt) or maybe the spreading economic problems will finally cause people not to be able to afford their cable bill, thus interrupt their stream of American Idol and Dancing With The Stars. I don't know but hopefully people not only wake up but start to display the outrage needed to actually change things.
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