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Friday, January 10, 2014

Transcript: New Year's Report: Economic Events Widely Reported that Never Really Happened

The folks that are in the top 20% of the income distributions, in the population, they account for 60% of the spending. The top 5% account for 35% of the spending. You know, that's just not healthy, you know, longer run. I do think our most significant long-term problem is the distribution of income and wealth.

That was Mark Zandi -- Conservative with open eyes. Adviser to John McCain's presidential bid. That combined with yesterday's Wall Street Journal revealing that one in three U.S. households was below the poverty line some time in 2013. Tells you all you need to know.
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Today on the podcast, our annual New Year's review of events -- economic events -- widely reported that never really happened. How is that? Largely because economists and economic commentators tend to see what they expect. So they report things before they actually happen or assume what is happening is what they expect. There is no more common phrase when you listen to Bloomberg or CNN than "We are beginning to see signs of ..." dot dot dot. As in, "We are beginning to see signs of corporate investment or capital spending." "We are beginning to see signs of a turnaround in small businesses." There used to be a code word, "green shoots," but that has shriveled in usage under the heat of actual events. The entirety of the recovery, Demand Side would say, is composed of those beginnings that never really came to fruition, and the recovery is brightest in the eyes of those who expect it, or those whose eyes are fixed firmly on the stock market.

It might be countered that Demand Side is seeing what he expects: Bouncing along the bottom with downside risks. An economy on life support. But at least you have not heard the phrase, "We are beginning to see signs of..." Either we are blind to the good news because -- as other economists -- we are wedded to our prior views. Or, possibly, we are right.

There is a long list,

Of course, it begins with "The economy is gaining strength, is humming along, is well into recovery." We spend most of our time telling you how bad things are and the list is too long to dwell on that here today. Let's move to number two.

The financial sector has stabilized, banks are safe, lending is back to normal, we can move on.

Not. 2013 was a year of conflict in financial regulation. Armies of banking lobbyists vs. the public interest, fought on the grounds of the U.S. Congress and the various regulatory authorities. It was bad news in 2012 when the London Whale's massive speculation in credit default swaps was characterized as hedging. It not only burnt up billions of JP Morgan Chase money, but turned the tide of opinion against Jamie Dimon, formerly the golden boy. Now not so much.

The fines and penalties levied against JP Morgan are evidence of a corrupt system, one that was corrupt when he was the golden boy, and one that is still corrupt. Just yesterday, or Wednesday, actually, JPM added another 2.6 billion to that tally for its role in the Bernie Madoff Ponzi scandal. This was the largest ever amount for violating the Secrecy Act, which requires banks to file reports on potentially suspicious activity. JPM set the all-time record for all US corporations for any penalty settled for 13 billion for its sales of mortgage backed securities before the financial crisis.

The number of nine figure settlements is too long for today. In ten figures in 2013, Morgan Chase has ponied up $1.8 billion for improper foreclosures, the robo-signing debacle, where it added $3.7 billion in aid for some of the homeowners it screwed. Later in the year it paid out $4.5 billion to 21 institutional investors for dodgy MBS it sold them before the crisis. Other big fines have come in for rigging the Japanese yen vs. LIBOR, defrauding credit card customers, and manipulating California and Midwest electricity markets. That's just one bank. One we bailed out in 2008 and 2009 and continue to feed with cheap Fed money and too big to fail insurance.

The Financial Services Oversight Council last year identified emerging threats from fire sales and run vulnerabilities in money market funds and broker-dealers operations in the tri-party repo market. The LIBOR rigging scandal has still not installed a rate that is regulated. Self-reporting of rates is still the mode of the day. Not sure if anybody got jailed in that, but if so, it wasn't in the U.S. The other frauds have gone without punishment. The fines are a cost of doing business. One can only imagine what they got away with.

Certainly there is no stability in Wall Street employment. Head count continued to fall over 2013. Sadly, average annual compensation per employee at Goldman Sachs dropped by $100,000 by the end of 2013, down to only $314,000. It is likely the ex-Enron traders on the commodity desks are still in the 1%, which is above $360,000. Investment and trading operations continue to be downsized. The casino just isn't paying out like it used to, or rather the number of tables has shrunk. The industry used to be the target of the best and the brightest. Now more than 20% of Wall Street employees want out, according to an industry survey. Many of them will get their wish.

But business is good, right?

Number three on our list was business is getting back to normal. It is finally okay.

I guess it depends on what you mean by okay. If you mean the balance sheet looks good at the bottom and the stock price is doing well, maybe so. If you mean the components of companies such as their employees and suppliers have come back, not so much. The huge corporate layoffs are still laid off. Balance sheets look good because debt is cheap -- for the big guys -- and they are not investing.

Okay also depends on what you mean by business. The corporate side of the economy is okay in the above sense. But small business -- those who actually operate in a free market -- the darlings of the market fundamentalists and the Neoclassicals -- have not recovered. They are getting squeezed by slack demand from their consumers, but also by ever more difficult terms from the megacorporations to whom they are suppliers or from whom they buy their inputs.

The NFIB -National Federation of Independent Business -- optimistm indext last reported for November did actually rise, but it remains at deep recession levels. Sales, hiring, taxes and government led the complaints from the business owners surveyed.

Side note. We don't make this point often enough,There are two private sectors. The corporate sector and the market sector. Whenever somebody asks you if you have a theory of the firm, say, "Which one? The megafirm which controls its supply chain, manipulates its consumers and has captured its regulators and legislators, Or the market firm, which hires, buys and sells, and borrows without control?"

The standard economic theory obscures this difference to the point that even small businessmen don't understand it. They think of themselves as little brothers -- except perhaps the smaller and regional banks who don't get the too big to fail insurance and the consequent lower borrowing costs that the big banks get.

John Kenneth Galbraith wrote forty years ago: "Few features of the neoclassical economics arouse more admiration for its effect than the way it rationalizes and conceals the disadvantages of the weak. One theory of the firm applies for all.... The small firm that is subordinate to the market is greatly cherished by the neoclassical pedagogy. Economists abuse that which they love."

In 1988 the AEA, when it still had credibility, that is the American Economic Association, ran two sessions back to back on the economics of Galbraith. Afterward he was asked what he himself thought was his major contribution, he replied:
The things that have concerned me most is the bimodal character of the modern economy and the unwisdom of having an economic instruction that assumes that General Motors, General Electric, and Mitsubishi are of the same order of structure, motivation and institutional character as are agriculture, handicrafts, artisan activities and services. I believe that the modern economy needs to be seen in terms of the very different character of the great corporations from the small competitive enterprise, which does conform in a general way to classical and neoclassical market theory. Additionally ... I do not believe that the modern economy functions, either in its microeconomic or its macroeconomic behavior, in a socially acceptable fashion. I accordingly believe that there is a large role for state intervention which cannot be decided by general theory, but involves a pragmatic consideration of the social consequences in the particular case.
The NFIB's , independent business, must now work longer, harder and cheaper to stay afloat. A hidden wage reduction. Their homes are not much good for collateral. Life is not good.

Moving on.

Number four: The fracking revolution is an economic Godsend. Widely reported ....

The farmers and ranchers of the northern plains are not convinced it is a godsend. The occupants of small towns in Pennsylvania are not convinced. Everybody is convinced on Wall Street, though. You know our opinion on the environmental collapse being engendered by fossil fuels. The real economic recovery is in green jobs and new energy, rebuilding transportation, retrofitting buildings, dealing with education and infrastructure. Having somebody in from Texas for six months of construction who bids up rents and then leaves is not economic development. The cheap energy which is supposed to help domestic manufacturing will generate, even by optimistic estimates, paltry numbers of jobs. Burning more fossil fuel, cracking and pressurizing the geology, is going to allow more robots and more profits, but the cost will be paid in environmental sustainability and community health.

Number five: The housing market is in recovery, set to take off. Everyone has heard this.

Case Shiller prices are back to 2004 levels anyway. That reported December 31. Up 13 plus percent year-over-year. Many months of positive numbers. Of course if the housing market goes down 40 percent and comes back 20 percent, we're still 25% below the top, since the denominator has changed. But that's picky.

Prices are one thing. Quantity is another. In spite of all the growth in the economy over the past fifty years, home sales for the first eleven months of 2013 were higher than only five other years in that fifty-year period -- the first four years of the Great Recession and a single year in the depths of the Reagan-Volcker recession of 1982. Quite the recovery.

What sales action there has been was juiced by demand from foreign money in gateway cities, and by hedge funds buying up distressed properties and foreclosures to turn them into rentals. That is a healthy housing market? Take those influences, for3eign money looking for US real estate and vulture funds and ... well ... Another false dawn.

Meanwhile interest rates have risen a little and volume has gone down. With the end of QE and the end of shovelling of money into MBS, we may see more interest rate rises. QE, the experiment that didn't work and leaves a huge obstacle in the way.

Headwinds for Housing? Some. Real median household income is now back below 2004 by about ten years, at $51,000. Property taxes are going up. Affordability is going down. Banks are beginning to show signs of easing lending standards. That phrase should have warned you that they did not to any meaningful degree do that in 2013. Single family housing starts are up, maybe you heard. But the bottom line is that sales are still at depression levels.

Meanwhile, as reported at EconIntersect, home equity lines of credit -- HELOC's -- are about to reset. These were the get-the-cash-out-of-your-equity loans that banks pushed on homeowners during the bubble years.

Quoting from Keith Jurrow:

To see the danger of a HELOC reset to the borrower, you need to understand what a HELOC is. A HELOC is similar to a business line of credit and has some similarities to a consumer credit card as well. Using the residence as security, a homeowner is usually given a line of credit with a prescribed limit upon which the borrower can draw at any time. During the zaniest bubble years, some banks actually offered HELOCs where the available credit increased automatically as the equity in the house rose along with the home’s value. For bubble-era HELOCs, the homeowner received a draw period of anywhere from five to ten years when funds could be drawn. During this draw period, the borrower was usually required to make interest payments only. The rate was adjusted monthly and was pegged to the prime rate. Here is the problem. At the end of the 10-year draw period, the loan becomes fully amortizing. The repayment period was typically between ten and twenty years at the end of which the HELOC had to be fully repaid. HELOCs were irresistible because the interest-only monthly payment was not very much – often only a few hundred dollars. Why worry about the fact that in ten years it would become fully amortizing? Borrowers focused on the soaring value of their home.

The earliest bubble era HELOCs are beginning to face the end of the 10-year draw period. Take a good look at this chart showing originations of both HELOCs and closed-end second mortgages from the New York Federal Reserve Bank. HELOC originations are in red. You can see that they began to soar in 2003. Those HELOCs have started to reset this year. An increasing number of resets will occur next year with the 10-year anniversary of the 2004 vintage HELOCs. Still more will reset in 2015 and nearly as many in 2016. Now take another look at the earlier chart showing quarterly HELOC originations. The annual origination figures look like this: That is a total of 10.8 million HELOC originations during the peak bubble years. This does not even include those originated during 2004. Nearly 40% of these bubble era HELOCs were opened in California where the average amount was roughly $130,000. For those HELOCs originated between 2004 – 2007 which are still in existence and have an accompanying first mortgage, it is no exaggeration to say that 98% or more of those properties are now underwater. Now here is the truly frightening part. When the 10-year draw period ends, the HELOC converts to a fully amortizing loan. The payoff period varied from a minimum of ten years to a maximum of twenty. Most had fifteen year payoff periods. How much might the monthly payment increase? Let’s take a typical California HELOC from 2004 with a balance of $150,000. Using today’s average HELOC rate of 5.5%, the interest-only payment would be about $687 per month. When the loan becomes fully amortizing with a payoff period of fifteen years beginning some time in 2014, the monthly payment would soar to roughly $1,225 per month. Quite a jump! If the loan balance was higher, the leap in monthly payment would be even greater. How many HELOC borrowers will be willing and able to pay this amortizing amount?

This graph shows us the delinquency rate of HELOCs based on the year of their origination. Clearly, the delinquency rates are highest for the two years 2006 and 2007. The graph is important because it tells us that the delinquency rate for HELOCs originated during the bubble era is much higher than the overall 5% rate reported by some of the “too-big-to-fail” banks for their entire HELOC portfolio.


When the 2004 HELOCs begin to reset in January, the payment shock for the borrowers will be huge. I am confident that many of them will see their monthly payment double and even triple.

Housing recovery? Not so much

Number 6: Inflation is low but stable.

Housing affects inflation. All those rents going up are right in the inflation numbers. Never mind the great deflation in actual house prices. It's owners equivalent rent that matters. Other real assets are deflating. The proof is that in spite of low interest rates and lots of cash, nobody is building more. A great deal of the inflation is in health care, which is lower to be sure, and in housing. The inflation is specifically not in incomes, as they continue to plummet for the median household.

With low inflation or outright deflation, we have lost the best way out of the mess. The way we used in 1980 and 1973 and even 1991. Inflate down the real cost of the debt. With O'Hoover austerity and entrenched financial interests holding on to their debtors by the throat, we are in for a long,s low slog until the next crisis.

Why would we want inflation? Costs going up doesn't seem like much of a boon for the economy. We want inflation as it is properly defined. A general rise in prices and incomes. Because the debt is fixed, so if everything else rises and debt stays the same, it is lower in relative terms. This exposes the foolishness of the current thinking, because inflation today IS strictly about costs of goods and services going up. It is plainly not incomes which are rising. So it is really not inflation, it is just price rises. We would say, with incomes and asset prices going down, we have deflation.

Number 7: Widely reported, Economic conditions in Europe have stabilized.

Well, we don't have crisis watch in the news every day. Does that mean things are good? No. It simply means the financial markets are no longer in panic. The ECB has taken on the bad debts of many banks, it has promised to lend freely to Spain and Italy should they come under attack, and it has generally talked tough. Stagnation and depression continues. The social costs continue to mount. Greece and Spain, Portugal and Ireland, it is either exit or radicalize. The poor are getting poorer. This is not a happy time, and it is not a stable time. Political disruption has to come out of poverty and unemployment. Debts that cannot be repaid will not be repaid. The Troika's remedy for Greece has proven poison. They started with debt at 120% of GDP. With the madness of austerity, it has shrunk to 180% of GDP. You have to be standing upside down to see that as progress. Unfortunately, the monetary authorities at the ECB, IMF and EU are indeed inverted. We can only hope that the transition to anti-bank, write-down-the-debt, socially coherent policies is democratic and peaceful. The exact situation was faced in the 1930's by Hitler. His economic miracle was repudiating the debt and employing people directly.

Number 8: Unemployment ... widely reported ... is getting back down to normal levels. Employment is growing strongly.

Oddly nobody seems to be taking a victory lap. Of course, 7 percent is not good, but it is better. Right?

No. Adjusted unemployment is still high. We repeat our chart here, showing unemployment adjusted for participation. We're at 11 percent in 2007 terms. Employment growing at 200,000, 250,000, a month is a good number. Not so much. 500,000 is a good number. At the present rate of growth of employment, it will be 2019 before we see pre-crisis employment levels that match the labor force. And today, even in absolute numbers, we are employing fewer people than six years ago.

Say it with me, bouncing along the bottom. Sloped downward as most of those new jobs pay less than those that are lost. Many are part-time. This is stagnation.

Check out the link to Steven Rattner at the New York Times, or google Rattner New York Times title "America in 2013, as told in charts."

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