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Tuesday, January 11, 2011

Transcript 419A: Non-Events of 2010, Part I

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This is the Annual Demand Side account of news widely reported in the economics media that didn't really happen. Our list today is familiar from last year:

Housing prices have bottomed out
Problems with the banks have been resolved and banks have stabilized
Its corrolary, the bailout of banks has ended,
Demand is returning
The unemployment rate has topped out, employment is rebounding
The Federal Reserve is doing whatever it takes and preventing further damage to the economy
A robust recovery is underway

So let's begin with the oft-reported item that the EUROPEANS HAVE A HANDLE ON THEIR SO-CALLED SOVEREIGN DEBT CRISIS

The headlines of the day refute this claim. The Greek bailout turned into the Irish bailout. Seldom noted is the complete divergence of the two economies. The Greeks brought it on themselves, it is argued, and the Irish, well ... mmm. In fact, the two economies are not similar. The Greeks were widely castigated for profligacy. The Irish were the poster-child of corporate welfare, having offered the lowest corporate tax rates in Europe and boomed on a housing bubble.

The similarity, of course, is the banks. In the case of the Greeks. The rational restructuring of their debt was put off limits to avoid the chaos of triggering credit default swaps, which would have shuffled the financial paper in unknown ways and rewarded the speculative attacks. The Greek double-play, for example, involved bidding up the spread on Greek bonds and insuring oneself with credit default swaps. The Irish situation was much more obviously a failure of the banks. The Irish government had in the first days of the banking crisis explicitly guaranteed the debts of the banks. When the value of the loans held came up craps, the Irish people were on the hook. ARE on the hook.

The banks and their continued weakness promise to put every man, woman and child in the Eurozone in hock for decades to come.

But in light of the Greek double play and contemporary speculative attacks moving to Portugal and Belgium, we offer a preview from next week's forecast edition with audio from the Economist's Zani Minton-Beddoes


Yes, I know we ragged on the Economist last week. Maybe they do have one or two good staffers.

What next?

How about with one of the most widely reported items, one that had a significant effect on the 2010 mid-term elections.


Construction spending is down

The American Recovery and Redevelopment Act -- also known as the Obama stimulus plan -- was widely reported to have been a waste of money, doing nothing for the economy and costing north of seven hundred billion dollars. In fact, the stimulus was poorly designed, being one-third useless give-aways to business, one-third low impact tax cuts and one-third high impact public spending, much of it on construction of infrastructure, and some of it in pass-throughs to state and local government.

As we've argued at demand side since the beginning, rebuilding the American economy by rebuilding America and addressing climate change is the best model for stimulus. At a minimum it was necessary to bail out state and local government as tax revenues fell and budgets were slashed. Instead, you have the ridiculous contrast of billions in cash balances on corporate balance sheets and slashing of needed public goods and services. Those goods and services come with jobs. The cash balances and the speculation still rampant on Wall Street do not.

The efficacy of ARRA was attested to in a mid-year report from Alan Blinder and Mark Zandi, which demonstrated the higher growth and lower unemployment rate directly related to the Act. We are now on the cusp of its expiration. There is nothing left of the tax cuts and candy for business, and the aid to states and localities is about to fall off a cliff. As for construction spending: Public construction had grown into the vacuum created by collapsing residential construction. No investment by business has arrived from its tax cuts and low interest rates. Now the rational construction of infrastructure and public goods are being scaled back.

According to US Census, construction spending increased in November 2010 by 0.4% month-over-month (MoM) – and is still down approximately 6% year-over-year. In 2005 the government accounted for 20% of construction spending – in 2010 it was 40%. The public sector cutbacks will at least be $12 billion per month. Currently private sector non-residential construction is running at 2005 levels. The collapse in construction spending is all in private sector residential construction.

We are about to see whether the ARRA really had no effect. The tax cut package passed in the lame duck session will not provide stimulus of any magnitude. It is, as we've argued, a repeat of the 2008 experience. With states and localities now feeling the full brunt of the financial meltdown and the Great Recession, and no counterweight from the federal government, we expect stagnation and decline.



Consumption expenditures have been pointed to as evidence that demand is returning. These expenditures are being inflated by rising commodity -- including oil -- prices. Median incomes are shrinking, and remember, effective demand is composed of increases in incomes and the change in debt. Consumer credit is still contracting. We'll get to that in a moment. Just a bit of evidence first.

Manufacturing New Orders Remain Flat in November 2010, according to Global Economic Intersections analysis of private surveys. Also from Econ Intersect, a caution on Christmas sales. People, they say, are inundated with many different variants of December 2010 retail sales numbers depending on the sample. For example, on-line sales have been reported up from 12% to 18% – but on-line sales are not yet a significant part of Christmas retail sales. A Bank of Tokyo Mitsubishi sample of major retailers' same store sales demonstrated that December’s year-over-year increase was similar to any other month in 2010 – and that is very disappointing for the bulls who believed consumers would spend with reckless abandon during this holiday season.

The Consumer Metric Institute (CMI) Contraction Watch started flashing warning signs of a leveling off in consumer spending in late December.

As for consumer credit,

on January 7, Steven Hansen at Econ Intersect, noted that the Federal Reserve released the November 2010 G.19 compilation of consumer credit outstanding showing that revolving credit decreased at an annual rate of 6-1/4 percent, and nonrevolving credit increased at an annual rate of 4-1/4 percent. The majority of revolving credit is from credit cards, while nonrevolving credit includes automobile loans and all other loans not included in revolving credit, such as loans for mobile homes, education, boats, trailers, or vacations. Whither the increase? The Federal government continues to build its portfolio in nonrevolving credit adding over $30 billion in the last month alone. The Federal government has no revolving credit holdings.

This year the Federal government has increased its credit portfolio by $129 billion. Although not broken out, it is assumed this growth is due to student loans. This month's annualized increase is 13.8% – and without the government’s purchases, non-revolving credit would have declined.

Ignoring the government’s involvement in non-revolving credit, consumer credit contracted $197 billion this year- and contracted $68 billion including their portfolio.

As Steve Keen has pointed out, demand growth throughout the 1990s and 2000s was driven by an increase in debt. When debt contracts, or even flat-lines, effective demand is significantly reduced. As I remember, Keen pointed to 23 percent of private demand in the run-up to the collapse was fueled directly by increases in debt. This is 23 percent above the best-case for current debt-driven demand.

And Now, another event widely reported that is not matched by phenomena in the real world,


If by fully operational, we mean they are providing credit to the real economy, we can dismiss the reported events as emanating from Area 51. Banks are not lending, they are speculating on one hand and taking their various back-door bailouts on the other. Internal incentives are still skewed toward short-termism and risk.

But even there we are talking about only the mega-banks. Smaller and regional banks continue to be closed methodically by the FDIC, as quickly as the examiners can get to the next town.

As to the bailouts, at Demand Side we have talked about banks borrowing at zero from the Fed and carrying their cash a few keystrokes down to the Treasury where they lend at two or three or four percent and pocket the spread. But others have written about bailouts in other areas. In May, 2010, John R. Talbott wrote at Salon.com about the transfer of $1.2 trillion in assets from banks onto the Fed balance sheet, about $1 trillion of this in mortgage backed securities. The actual value of these securities is unknown because there is no accounting surveillance.

On January 3, 2011, Econ Intersect reported that Bank of America has reached a settlement with Fannie Mae and Freddie Mac to pay them $2.8 billion compensation for the bank having sold the GSEs bad mortgages. The actual eventual losses on these bad mortgages are unknown and may be many times the $2.8 billion settlement amount. This action may well be the start of a process that will be a backdoor bailout, transferring many billions (or even hundreds of billions) of bank losses to the federal government.

The most recent rate of bank charge offs, which hit $45 billion in the past quarter, and have now reached a total of $116 billion, is at 3.4%, which is same as the peak in the Great Depression, 3.4% in 1934.

The total exposure of the Fed is unknown. Without transparent accounting, there is no way to know if any of these MBS assets are as toxic as the synthetic CDOs that went into the Abacus 2007-AC1 securities offering by Goldman Sachs (GS) that quickly lost all value and are the subject of the civil case SEC vs. Goldman Sachs. William K. Black has testified that, as a class, the so-called “liar loan” sub prime mortgage issuance has resulted in losses between 50% and 85%.

How much of the MBS related securities acquired by the Fed have resulted in (as yet unrecognized) losses of more than 50%? How many toxic assets were acquired at nominal value when they contained large current and future unrealized losses? How many other assets were acquired above true value? You will remember that Demand Side did not need accounting reports to identify these purchases by the Fed as purchases of garbage.

In May, Talbott described the motivation of the Fed to engage in such deception -– namely, to avoid the collapse of banks into bankruptcy. Talbott went on to describe how Fannie and Freddie can be used in the future as a mechanism for the Fed (with government complicity) to transfer the bad assets to the taxpayers. Since the GOEs (government owned enterprises) are off balance sheet to the federal debt, the deception can be hidden from less discerning observers.

Bank of America is still far from out of the woods. The $2.8 billion settlement covers only mortgages produced by Countrywide up to 2008 for Freddie Mac and is less specific for Fannie Mae. Other government claims may still be made. And others besides the government may also make claims. One estimate is that MBS insurers may have claims in the $10 – $20 billion range. And of course we have the potential for claims from other banks, pension funds and others. The putback process is just beginning.

At the core of the banks' problem is, of course, the debt bubble around housing. A returning headline from last year's list:


Although in 2009, there were more than a few reports that the house price recovery was underway. No such reports in 2010. But did house prices bottom. No.

Deceleration in growth rates and outright declines in the Case-Shiller Index for November confirmed that a second dip in residential home prices is underway. The 10-City Composite was up only 0.2% and the 20-City Composite fell 0.8% from their levels in October 2009. Home prices decreased in all 20 MSAs. In October, only the 10-City Composite and four MSAs – Los Angeles, San Diego, San Francisco and Washington DC – showed year-over-year gains. While the composite housing prices are still above their spring 2009 lows, six markets – Atlanta, Charlotte, Miami, Portland (OR), Seattle and Tampa – hit their lowest levels since home prices started to fall in 2006 and 2007.

Calculated Risk relays an LA Times description of new declining cities. Some neighborhoods are never going to come back. Potential candidates in a Rockefelleer Institute of Government study include several inland California metropolitan areas that grew rapidly during the boom -- Stockton, Modesto, Fresno, Riverside and San Bernardino. Las Vegas and Miami also made the list.

A city in decline is one that has suffered a sustained population drop, leaving behind empty houses, apartment buildings, offices and storefronts. Cleveland and Detroit, for instance, suffered from the erosion of manufacturing and the loss of residents. Instead of eroding a particular industry, however, study cites the housing bust's leaving behind a glut of homes and foreclosures. Calculated Risk points out that there IS a particular industry in those cities that has disappeared -- construction!

We'll abbreviate our list for the moment, and be back on Friday

1 comment:

  1. The housing market still has further to fall and without rising median wages then the prospects are for them to slump for years.