May 6, 2024

Logical Minds Reject “Solution” Of More Debt

January 31, 2009 by Leave a Comment

Logical minds are questioning the wisdom of US stimulus (deficit) spending.   We have already seen the end results of excessive borrowing and spending by the State of California – see California Defaults.

Global Worries Over U.S. Stimulus Spending

DAVOS, Switzerland — Even as Congress looks for ways to expand President Obama’s $819 billion stimulus package, the rest of the world is wondering how Washington will pay for it all.

“The U.S. needs to show some proof they have a plan to get out of the fiscal problem,” said Ernesto Zedillo, the former Mexican president who helped steer his country through a financial crisis in 1994. “We, as developing countries, need to know we won’t be crowded out of the capital markets, which is already happening.”

While the focus in Washington has been on putting together a stimulus package that will attract broader political support when it comes up for a vote in the Senate, here in Davos the talk has been about the coming avalanche of Treasury debt needed to pay for the plan on top of the bailout measures approved last fall, like the $700 billion Troubled Asset Relief Program, or TARP.

American officials maintain they are aware of the challenge. A top White House adviser, Valerie Jarrett, promised in Davos on Thursday that once the stimulus plan achieved its intended affect, the United States would “restore fiscal responsibility and return to a sustainable economic path.”

“Even before Obama walked through the White House door, there were plans for $1 trillion of new debt,” said Niall Ferguson, a Harvard historian who has studied borrowing and its impact on national power. He now estimates that some $2.2 trillion in new government debt will be issued this year, assuming the stimulus plan is approved.

“You either crowd out other borrowers or you print money,” Mr. Ferguson added. “There is no way you can have $2.2 trillion in borrowing without influencing interest rates or inflation in the long-term.”

“This is a crisis of excessive debt, which reached 355 percent of American gross domestic product,” he said. “It cannot be solved with more debt.”

While Mr. Ferguson is a skeptic of the Keynesian thinking behind President Obama’s plan — rather than borrowing and spending to stimulate the economy, he favors corporate tax cuts — even supporters of the plan like Mr. Zedillo and Stephen Roach of Morgan Stanley have called on the White House to quickly address how it will pay for the spending in the long-term.

The stimulus is widely expected to pass, but once it does, Mr. Roach said the focus would shift to “who foots the bill and what is the exit strategy. We don’t have the answer to either question.”

Mr. Zedillo, who remembers how Mexico was forced to tighten its belt when it received billions from Washington to keep its economy from collapsing in 1994, was even more blunt.

“People are not stupid,” Mr. Zedillo said. “They see the huge deficit, the huge spending, and wonder what comes next.”

US Should Take Its Own Advice

We could not come close to achieving fiscal responsibility when we did not have a financial crisis.  It is absurd to think that “at some future date” we will do so.  There is no easy solution to our financial nightmare.  The attempt to postpone and paper over the debt crisis with additional borrowed or printed money merely guarantees a bigger problem down the road.

Mr. Zedillo, former Mexican President, notes that his country was told by America  to “tighten its belt when facing financial collapse”.   Is the United States exempt from the same logic?  Why are we not taking the same advice we force upon others?

Filed Under: Bailout, Dollars, Economy Tagged With: ,

Notable Links

January 29, 2009 by Leave a Comment

An $800 Billion Mistake

As a conservative economist, I might be expected to oppose a stimulus plan. In fact, on this page in October, I declared my support for a stimulus. But the fiscal package now before Congress needs to be thoroughly revised. In its current form, it does too little to raise national spending and employment. It would be better for the Senate to delay legislation for a month, or even two, if that’s what it takes to produce a much better bill. We cannot afford an $800 billion mistake.

Start with the tax side. The plan is to give a tax cut of $500 a year for two years to each employed person. That’s not a good way to increase consumer spending. Experience shows that the money from such temporary, lump-sum tax cuts is largely saved or used to pay down debt. Only about 15 percent of last year’s tax rebates led to additional spending.

The proposed business tax cuts are also likely to do little to increase business investment and employment.

The problem with the current stimulus plan is not that it is too big but that it delivers too little extra employment and income for such a large fiscal deficit. It is worth taking the time to get it right.

The same politicians who are telling us that the stimulus package must be enacted ASAP are the same ones who did not see the financial crisis coming and then tried to deny it.  We are being told that we face disaster if we do not act quickly.

The world will not end if this spending bill is not passed this week.  We heard the same “we must act now” warnings last year with the $750 billion TARP disaster.  The politics of fear is wearing thin.   The so called stimulus act should be debated and time given to the American public to decide if this massive expenditure of money will accomplish anything other than running up more debt.

My advice to Congress and the President

How about this?  Come clean with the American public about the problems we face as a nation.  Admit that we have indebted ourselves to such an extent that our economic future is now at risk.  Stop trying to sell the idea that spending and borrower will fix the problem.   The problem caused by too much debt cannot be cured by more borrowing.  How about admitting that we are overextended financially and need to face sacrifices instead of passing the problem on to our children?  If the politicians can’t put these thoughts into words, they can simply hold up a picture of the chart below.

Courtesy:  http://mwhodges.home.att.net/

The Real Long-Run Value of Gold

To match its inflation-adjusted peak of $850 an ounce – as recorded by the London PM Gold Fix of 21st Jan. 1980 – the price of gold should now stand nearer $2,615.

“Ask the investor who rushed out to Buy Gold precisely 29 years ago, at $845 an ounce, about gold as an inflation hedge,” as Jon Nadler – senior analyst at Kitco Inc. of Montreal, the Canadian dealers and smelters – said on the 29th anniversary of gold’s infamous peak last week.

“They could sell it for about $845 today…[but] they would need to sell it for something near $2,200 just to break even, when adjusted for inflation.”

Because for gold to reach $2,200 an ounce in today’s money (if not $2,615…) would mean something truly remarkable in terms of its real long-run value.

  • Inflation-adjusted, that peak gold price of 21 Jan. 1980 saw the metal worth more than 5 times its purchasing power of 1913;
  • In March 2008, just as Bear Stearns collapsed and gold touched a new all-time peak of $1,032 in the spot market, the metal stood at its best level – in terms of US consumer purchasing power – since December 1982;
  • Touching $2,200 an ounce (without sharply higher inflation undermining that peak), gold would be worth almost 6 times as much as it was before the Federal Reserve was established in real terms of domestic US purchasing power.

Is gold a smart investment in terms of preserving purchasing power?  Depends on when you purchased it as the article explains.  Virtually every asset class except gold has seen a major drop in value over the past two years – something to think about.

TURNING JAPANESE – THE AUDACITY OF REALITY

Every day seems worse than the previous day. Five hundred thousand people are getting laid off every month. Our banking system is on life support. Retailers are going bankrupt in record numbers. The stock market keeps descending. Home prices continue to plummet. Home foreclosures keep mounting. Consumer confidence is at record lows. You would like to close your eyes and make it go away. Not only is the news not going away, it is going to get worse and last longer than most people can comprehend.

These “experts” fail to see the big picture and have no sense of history. It took 28 years to get to this point and it will take at least a decade to repair the damage. If the politicians running this country try to take the easy way out (very likely), add another decade to the recovery timeframe. Some indisputable facts will put our current predicament in perspective:

Another great article by James Quinn who assesses America’s economic future.  A very sobering and detailed analysis well worth reading.

Filed Under: Bailout, Economy, Gold Tagged With: , ,

Early Results On “Stimulus Package” – Greed, Corruption & Stupidity

January 25, 2009 by Leave a Comment

The US Senate and House of Representatives is busily putting together a stimulus package that should cost $825 billion.  The massive spending package, all conducted with borrowed money, will be spread over a wide variety of programs designed to “stimulate the nation back to prosperity”.   All of the debate on the stimulus package seems to center on how the money should be spent.  No one is debating whether we can afford this massive spending.  There has been no intelligent discussion or analysis of whether the stimulus will work, despite the historical evidence that it won’t (See Stimulus Plan Condemns Us To Further Wealth Destruction.

Most Americans seem optimistic that the stimulus plan will work and that the money will be wisely spent.

Let’s look at some early returns for an idea of how $850 billion will be spent.

Politicians Asked Feds to Prop Up Ailing Bank

Two Illinois congressmen urged the Treasury in October to avoid taking any regulatory action against a struggling bank in their state, illustrating the aggressive efforts some politicians are taking to help hometown lenders during the bank crisis.

“This is a disturbing parallel to precisely some of those things that made the savings-and-loan debacle into a political scandal as well as a financial scandal,” said William Black, an associate professor at the University of Missouri-Kansas City, who was a bank regulator in the S&L crisis.

Regulators didn’t think National Bank of Commerce qualified for a cash injection because its financial condition was so perilous. On Oct. 22, Ronald G. Schneck, an official of the bank’s federal regulator, the Office of the Comptroller of the Currency, told the bank it should “act as if capital replenishment funds will not be received,” according to the letter by Reps. Davis and Gutierrez.

Instead, on Nov. 6, OCC officials told the bank it wouldn’t be getting any TARP money. They said the Treasury had decided “to not grant assistance to restore to the Bank to an adequately capitalized status,” according to a document reviewed by The Wall Street Journal.

An OCC spokesman said: “While we don’t comment on TARP applications, it should be noted that the amount needed to recapitalize the bank was far in excess of what was allowable under TARP’s capital purchase program.”

The US Treasury did the right thing when they refused to invest more money in this failing bank.  What thought process lead these 2 congressmen to believe that they would be spending money wisely by investing taxpayer money in a Zombie bank?

Political Interference Seen in Bank Bailout Decisions

Troubled OneUnited Bank in Boston didn’t look much like a candidate for aid from the Treasury Department’s bank bailout fund last fall.

The Treasury had said it would give money only to healthy banks, to jump-start lending. But OneUnited had seen most of its capital evaporate. Moreover, it was under attack from its regulators for allegations of poor lending practices and executive-pay abuses, including owning a Porsche for its executives’ use.

Nonetheless, in December OneUnited got a $12 million injection from the Treasury’s Troubled Asset Relief Program, or TARP. One apparent factor: the intercession of Rep. Barney Frank, the powerful head of the House Financial Services Committee.

Treasury Secretary nominee Timothy Geithner, testifying Wednesday at his Senate confirmation hearing, acknowledged “there are serious concerns about transparency and accountability…confusion about the goals of the program, and a deep skepticism about whether we are using the taxpayers’ money wisely.”

“It’s totally arbitrary,” says South Carolina Gov. Mark Sanford. “If you’ve got the right lobbyist and the right representative connected to Washington or the right ties to Washington, you get the golden tap on the shoulder,” says Gov. Sanford, a Republican.

Several Ohio banks received funds after Ohio’s congressional delegation complained bitterly about the treatment of Cleveland-based National City Corp., which regulators forced into a merger rather than provide with cash. And in Alabama, the state’s top banking official says a windfall there — five banks are slated to receive funds — is testament to the influence of two powerful Alabama lawmakers who sit on key congressional committees.

Rep. Frank, besides heading the Financial Services Committee, has longstanding ties to OneUnited, and recalls having had a deposit account at a predecessor bank in the 1960s.

Later that month, Rep. Frank was intimately involved in crafting the legislation that created the $700 billion financial-system rescue plan. Mr. Frank says that in order to protect OneUnited bank, he inserted into the bill a provision to give special consideration to banks that had less than $1 billion of assets, had been well-capitalized as of June 30, served low- and moderate-income areas, and had taken a capital hit in the federal seizure of Fannie Mae and Freddie Mac.

On Oct. 27, the FDIC and Massachusetts bank regulatory officials, alleging poor lending practices and executive-compensation abuses by OneUnited, slapped it with a strong enforcement action, a cease-and-desist order. Among other things, the officials told the bank to get rid of a 2008 Porsche for executives.

Mr. Frank said he didn’t try to interfere with the regulatory process. “We have never told the regulators that they should ease up on them or not order them to do this or that,” he said.

He cites the bank’s status as the state’s only financial institution owned by African-Americans.

The free market should have been allowed to work in this case and this poorly run bank with its overpaid executives should have been closed.  Instead, based on Mr Frank’s parochial interests and ties to this corrupt institution, OneUnited receives $12 million from the taxpayer.  It would be interesting to know how much in political contributions Mr Franks received from OneUnited.

Even at a time of an unprecedented national crisis, our politicians cannot take the high road and look at the situation from a standpoint of the National interest.  The US itself will be just as bankrupt as OneUnited if we attempt to bailout every failed business entity in the country.  If the nation survives this crisis, it will be in spite of the actions taken in Washington.

In an incredibly ironic statement on the stimulus plan, Democratic Senator Inouye of Hawaii stated that “We must respond to this crisis with all the weapons at our disposal.  If we fail to act, the situation will almost certainly worsen, and the American people will continue to pay a heavy price.”  With clueless fools like Senator Inouye voting to spend trillions of taxpayer dollars to help us, we will be lucky to survive as a nation.  The Senator clearly does not see that the government and the Fed caused the financial meltdown.  He clearly does not see that the government is only going to make the situation far worse by trying to reflate the asset bubble.  Most of all he clearly does not see that he is putting the nation on the road to financial destruction by burying us in more debt.

My take on the stimulus plan is that the money will be largely wasted by keeping alive Zombie business entities that are poorly run by overpaid executives.  Money to the losers will only serve to hurt the successful.  The successful should not have to subsidize those who fail; this type of wealth shifting will  make us all equally poor.  Much of the stimulus money spent will be based on political connections, self interest and self dealing.   The economic situation will worsen as borrowed money is spent foolishly.  The only sure result of the stimulus package will be to put the sovereign credit of the United States at further risk.

Filed Under: Bailout, Corruption, Stimulus Plan Tagged With: ,

‘Atlas Shrugged’ – Banned in Washington

January 21, 2009 by 3 Comments

Equality Through Poverty

Ayn Rand’s 1957 classic novel, Atlas Shrugged, depicts how governments ultimately destroy the most productive sectors of a society, leaving everyone equally poor.

‘Atlas Shrugged’ : From Fiction to Fact in 52 Years

Stephen Moore – Wall Street Journal – No One Explains It Better – (Highlights)

Some years ago when I worked at the libertarian Cato Institute, we used to label any new hire who had not yet read “Atlas Shrugged” a “virgin.” Being conversant in Ayn Rand’s classic novel about the economic carnage caused by big government run amok was practically a job requirement. If only “Atlas” were required reading for every member of Congress and political appointee in the Obama administration. I’m confident that we’d get out of the current financial mess a lot faster.

[Atlas Shrugged] Getty Images

The art for a 1999 postage stamp.

Ultimately, “Atlas Shrugged” is a celebration of the entrepreneur, the risk taker and the cultivator of wealth through human intellect. Critics dismissed the novel as simple-minded, and even some of Rand’s political admirers complained that she lacked compassion. Yet one pertinent warning resounds throughout the book: When profits and wealth and creativity are denigrated in society, they start to disappear — leaving everyone the poorer.

Many of us who know Rand’s work have noticed that with each passing week, and with each successive bailout plan and economic-stimulus scheme out of Washington, our current politicians are committing the very acts of economic lunacy that “Atlas Shrugged” parodied in 1957, when this 1,000-page novel was first published and became an instant hit.

Rand, who had come to America from Soviet Russia with striking insights into totalitarianism and the destructiveness of socialism, was already a celebrity. The left, naturally, hated her. But as recently as 1991, a survey by the Library of Congress and the Book of the Month Club found that readers rated “Atlas” as the second-most influential book in their lives, behind only the Bible.

For the uninitiated, the moral of the story is simply this: Politicians invariably respond to crises — that in most cases they themselves created — by spawning new government programs, laws and regulations. These, in turn, generate more havoc and poverty, which inspires the politicians to create more programs . . . and the downward spiral repeats itself until the productive sectors of the economy collapse under the collective weight of taxes and other burdens imposed in the name of fairness, equality and do-goodism.

The current economic strategy is right out of “Atlas Shrugged”: The more incompetent you are in business, the more handouts the politicians will bestow on you. That’s the justification for the $2 trillion of subsidies doled out already to keep afloat distressed insurance companies, banks, Wall Street investment houses, and auto companies — while standing next in line for their share of the booty are real-estate developers, the steel industry, chemical companies, airlines, ethanol producers, construction firms and even catfish farmers. With each successive bailout to “calm the markets,” another trillion of national wealth is subsequently lost. Yet, as “Atlas” grimly foretold, we now treat the incompetent who wreck their companies as victims, while those resourceful business owners who manage to make a profit are portrayed as recipients of illegitimate “windfalls.”

The full article is well worth reading, not to mention the book itself.    Unfortunately, this book is more likely to be banned than read in Washington.

Filed Under: Bailout, Economy, Stimulus Plan Tagged With: ,

The Stimulus Plan Condemns Us To Further Wealth Destruction

January 21, 2009 by 1 Comment

Will Spending Borrowed Money Create Wealth?

There seems to be near universal agreement at all decision making levels of government that we can borrow and spend ourselves into prosperity.  Let’s consider some worthwhile contrary opinions.

Leave the New Deal in the History Books

When Barack Obama takes office on Tuesday, his first order of business will be a stimulus package estimated to be close to $1 trillion.   Sages nod that replicating aspects of FDR’s New Deal will help pull the country out of a recession. But the experience under FDR largely provides a cautionary tale.

Mr. Obama’s policy plans are driven by the conventional economic wisdom that the New Deal economic programs ended the Great Depression. Not so. In fact, thanks to New Deal policies and programs, the U.S. economy faltered for years longer than it might otherwise have done.

President Roosevelt came to office much as Barack Obama will, shouldering an economic crisis that began under his predecessor. In 1933, Roosevelt’s first year, unemployment hit nearly 25%, as people lost jobs and homes in towns across the country. Believing that government played a key role in restarting growth, FDR, within his first 100 days as president, created an alphabet soup of new agencies that mandated actions or controlled public spending and impacted private capital flow within the U.S. economy.

At first, it seemed to be working.  Then things turned for worse again: By the fall of 1937, the U.S. entered a secondary depression and unemployment began to rise, reaching 19% in 1938.

By 1939 Roosevelt’s own Treasury secretary, Henry Morgenthau, had realized that the New Deal economic policies had failed. “We have tried spending money,” Morgenthau wrote in his diary. “We are spending more than we have ever spent before and it does not work. . . . After eight years of this Administration we have just as much unemployment as when we started. . . . And an enormous debt to boot!”

Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson have been correctly focused on shoring up financial institutions to prevent a collapse of the financial system, and stave off a severe decline in the general price level. If that were to occur, the unspoken fear has been that the U.S. and global economy could go into a deflationary death spiral that would cause the collapse of the international financial system.

As a short-term matter, the moves of the Fed and other central banks have been correct, but in the long term a return to growth will depend on dynamic job creation by American business — not the U.S. government.

As a result, the New Deal forced the allocation of money away from the private sector. As economist Henry Hazlitt wrote back in 1946, New Deal programs prevented the creation of the types of jobs which have the multiplier effect of successful businesses. Creating “work” prevented innovation and new jobs that would create other jobs.

Governments cannot create wealth by taxing and borrowing to fund make work jobs.  The expenditure of massive amounts of money on politically inspired spending will simply deprive the private sector of needed capital.  Central economic planning has never worked nor will it work now.  The fact that there appears to be near unanimity in Washington that we need to borrow and spend our way to “prosperity” is enough to cause grave concerns since at a minimum it implies that there will be little constructive debate on the merits of the consensus view.

The Obsession With Government Spending

Despite adverse experience, the Keynesian stimulus idea has a viselike hold on policymakers

The U.S. is enacting a “stimulus” program of gargantuan peacetime proportions to rejuvenate our recessed economy. We are not alone in this. Japan, China, Europe and numerous other nations are doing the same–not yet as big as our program but based on the idea that governments can rekindle growth.

It’s all mostly wasted effort.

Despite its sheer size, the impact of the new President’s fiscal program, after the initial euphoria, will be painfully limited. Instead of a jolt like from downing a six-pack of Red Bull, we’ll get the economic equivalent of a tepid cup of decaffeinated tea. In fact, the waste and misuse of much of the money–inevitable in any quick, massive government-managed or -directed program–will negate much of the good in parts of this infrastructure-spending package.

The blunt truth is that government spending is a poor substitute for private business and consumer investing and spending. Were it otherwise, the Soviet Union would have won the Cold War, and Japan, which had numerous Obamaesque stimulus packages in the 1990s, would have boomed instead of remaining dead in the water in what was a 12-year recession.

Why this belief in government spending? After surveying the wreckage of the Great Depression, British economist John Maynard Keynes posited that markets left to themselves were inherently unstable and that government intervention could prevent debilitating economic slumps.

So why did such an approach fail so miserably in the 1930s?

What about Japan’s spending binge in the 1990s that still left its economy stagnant?

What about western Europe, which has had a massive government presence during the last 30 years but has created only a small fraction of the private-sector jobs that the U.S. has?

Despite adverse experience, the Keynesian stimulus idea has a viselike hold on policymakers, pundits and academics.

Events can also roil economies, as we experienced after 9/11. But most often, bad government policies bring on the most damaging downturns. The Great Depression was ignited by trade wars, high taxes and bad monetary policies. The great inflation of the 1970s was caused by the Federal Reserve’s excessive money printing. The current crisis was brought on by the weak dollar, the reckless extravagances of Fannie Mae and Freddie Mac and regulatory errors, such as mark-to-market accounting.

The fact that policy makers best solution is nothing more than a continuation of past failed policies reinforces the intellectually bankrupt theory of a borrow and spend solution.   Hurry up and do something, anything, would best describe the stimulus plan.

Final Steps To Insolvency?

Can Obama Make Government Solvent?

Mr. Obama has been handed an opportunity. He will put the welfare state on a path to solvency or he won’t, and we’re likely to find out soon. His stimulus spending plans will blow up in his face unless the bond markets (which will be called upon to finance them) are convinced the dollar will remain sound and spending under control.

Sadly, to those from whom much is expected, sometimes not enough is given. FDR can have been a great leader who sought the best for his country, and the ’30s still have been a succession of political disasters. Both things can be true. Presidents ride the tiger. Without apparent cognitive dissonance, Mr. Obama already has taken to denouncing Washington’s “anything goes” culture while simultaneously outlining plans to borrow perhaps $1 trillion to distribute to anybody and anything that happens to fit the wish list of some Democratic Party constituency group (and a few GOP ones too).

He certainly will meet with a gratifying success in the spending portion of his plan. The revelation will be whether he can deliver anything else.

Government solvency now has to be considered by serious minds as we see numerous countries headed down that path. The rush to spend  massive amounts of borrowed money is a sign of fiscal insanity.   Large government programs are always instituted in haste after a crisis has occurred.   Invariably, the government solution only makes the original problem worse.  Let us hope that at a minimum, any major government initiatives are properly debated before enactment and sharply curtailed.

Filed Under: Bailout, Economy, Stimulus Plan Tagged With: , ,

Insolvent Banking System Eludes Government Containment

January 20, 2009 by 2 Comments

Denial Of Reality Becoming Impossible

The game of pretending that the world banking system and national governments are solvent becomes more difficult by the hour.

The true magnitude of the write downs that the banking industry needs to take to reflect the reality of asset impairment was highlighted by the Royal Bank of Scotland.   Pretending that the losses do not exist is no longer worth the effort since no one is fooled anymore.  There can be no recovery in bank lending unless impaired assets are written down and sufficient amounts of new capital are raised.  This is the point at which things get interesting since the capital markets are not open to the banks; the lender of only resort to the banking industry are the world’s central governments.  The really scary question now is whether the central governments have the financial capacity to recapitalize the banking industry (along with everyone else) without resorting to printing money on a grand scale.

Far from being contained, as some have proclaimed, the banking crisis continues to expand.  The debate is no longer focused on whether the banking industry is solvent.  The real question is whether central governments can contain the economic meltdown.

Consider the size of losses reported by Royal Bank of Scotland and the excuses and comments by RBS Chief Executive Stephen Hester.

RBS Expects Huge 2008 Losses

LONDON — Royal Bank of Scotland Group PLC said Monday that tough market conditions in the fourth quarter and mounting impairment charges could push it to a 2008 full-year loss of as much as £28 billion ($41.29 billion), the U.K.’s biggest ever corporate loss.

The government currently owns just under 58% of RBS after last year underwriting a £15 billion rights issue that saw little take-up by existing shareholders.

The move means RBS will now have to pay back less to the government, but it has also to agree to boost lending to consumers and businesses. The Monday update comes ahead of the announcement of its 2008 results on Feb. 26.

RBS Group Chief Executive Stephen Hester said: “The dislocation of credit markets and the global economic downturn continue to hit RBS hard, as with many other banks.

“We are making progress in recognizing excess risk and dealing with it. Significant uncertainties and risks inevitably remain.

“In this context, the support we are receiving from the government benefits all our stakeholders and enables us to provide more customer support in return.”

“With enhanced core capital, removal of the preference share dividend and the prospect of further asset and liquidity measures, RBS is able to continue its strategic restructuring purposefully,” he added.

What Chief Executive Hester is really saying is that he managed RBS poorly and took ridiculous lending risks; no one will buy our shares or debt securities and we need a government bailout to prevent closing the bank.  Nonetheless, we now recognize “excess risk” and are ready to start lending again once we receive government funding.

Hester should be fired for incompetence –  he dissipated investor money and bank capital and now wants to try his hand with government supplied funding.

The question of how the British Government will raise the funds to bail out RBS is answered by The Telegraph.

Bank of England Edges Closer to Printing Money

Under the scheme’s terms, the Bank will be able to buy assets including corporate bonds and commercial paper, a move which Mervyn King, the Bank’s Governor, called “an important additional tool to improve financing conditions in the economy”.

The asset purchase facility does not in itself amount to quantitative easing or “printing money”, because the scheme initially will be financed by Treasury Bills and does not involve an increase in the money supply.

However, the Treasury has given the Bank’s Monetary Policy Committee the option to go down that road by extending the scheme at a later date and paying for assets with what amounts to newly created money and not Treasury bills.  Quantitative easing is a more unconventional tool available to the Bank beyond interest rates as it attempts to halt the pace of economic decline in the UK.

“This does not mean that quantitative easing will definitely happen, but does allow the MPC to move fairly quickly if they want to,” he said.

Ross Walker, economist at Royal Bank of Scotland, said: “This framework could readily evolve into full-blown quantitative easing – we would expect it to do so given the proximity of Bank Rate [to zero] and deteriorating economic conditions, perhaps as soon as March/April.”

I agree with Ross Walker – full blown money printing will occur as demands on the British treasury continue to explode in size.   The British Government, approaching the limits of their borrowing capacity, will come to the rescue of RBS and others by printing money.  At this point, no one is even trying to pretend that RBS is solvent or that the British government can bailout every failing enterprise.  The end result will be a catastrophic destruction of confidence world wide.  When governments’ last resort is to print money, one can sense that the end of the old order is near.

Half of Europe Trapped in Depression

Events are moving fast in Europe. The worst riots since the fall of Communism have swept the Baltics and the south Balkans. An incipient crisis is taking shape in the Club Med bond markets. S&P has cut Greek debt to near junk. Spanish, Portuguese, and Irish bonds are on negative watch.

Dublin has nationalised Anglo Irish Bank with its half-built folly on North Wall Quay and €73bn (£65bn) of liabilities, moving a step nearer the line where markets probe the solvency of the Irish state.

A great ring of EU states stretching from Eastern Europe down across Mare Nostrum to the Celtic fringe are either in a 1930s depression already or soon will be. Greece’s social fabric is unravelling before the pain begins, which bodes ill.

This week, Riga’s cobbled streets became a war zone. Protesters armed with blocks of ice smashed up Latvia’s finance ministry. Hundreds tried to force their way into the legislature, enraged by austerity cuts.

“Trust in the state’s authority and officials has fallen catastrophically,” said President Valdis Zatlers,
who called for the dissolution of parliament.

Spain lost a million jobs in 2008. Madrid is bracing for 16pc unemployment by year’s end.

Private economists fear 25pc before it is over. Spain’s wage inflation has priced the workforce out of Europe’s markets. EMU logic is wage deflation for year after year. With Spain’s high debt levels, this is impossible.

Italy’s treasury awaits each bond auction with dread, wondering if can offload €200bn of debt this year. Spreads reached a fresh post-EMU high of 149 last week. The debt compound noose is tightening around Rome’s throat. Italian journalists have begun to talk of Europe’s “Tequila Crisis” – a new twist.

Greece no longer dares sell long bonds to fund its debt. It sold €2.5bn last week at short rates, mostly 3-months and 6-months. This is a dangerous game. It stores up “roll-over risk” for later in the year. Hedge funds are circling.

Printing money, a self destructive tactic is the last option left to the governments mentioned above.  Expect major social unrest in these countries as their governments collapse the national wealth through the printing press.

Depression Ahead, Prepare for Stock Rout

LONDON (Reuters) – Societe Generale said on Thursday that the United States’ economy looks likely to enter a depression and China’s could implode.

In a highly bearish note, veteran cross asset strategist Albert Edwards said investors should now cut equity exposure after a turn-of-the-year rally and prepare for a rout.

He predicted that the S&P 500 index of U.S. stocks could be set for a fall of around 40 percent from recent levels.

“While economic data in developed economies increasingly reflects depression rather than a deep recession, the real surprise in 2009 may lie elsewhere,” Edwards wrote.

“It is becoming clear that the Chinese economy is imploding and this raises the possibility of regime change. To prevent this, the authorities would likely devalue the yuan. A subsequent trade war could see a re-run of the Great Depression.”

Edwards has long been one of the most bearish analysts in London, first with Dresdner Kleinwort and then with SocGen.

The world Central Governments are resorting to the nuclear option – printing money – in a last attempt to hold the financial system intact.   Had they allowed selected major bankrupt institutions to fail, severe financial pain would have been inflicted on many.   The strategy of attempting to save all bankrupt industries with printed money will result in worthless currencies worldwide,  thereby guaranteeing financial ruin for all.

Filed Under: Bailout, Banking Industry, Confidence Tagged With: , , ,

We Are All Keynesians Now

January 9, 2009 by Leave a Comment

Do Deficits Matter?

In the short term, it may not matter what anyone thinks.  There is a near universal political consensus that spending is the only solution that will save the economy.  This consensus is backed by a long list of economic experts; the same people who in the recent past had been predicting clear skies and strong economic growth.

Will borrowing and government spending bring back happy days and prosperity?   We will not know the ending to our grand Keynesian experiment for a number of years.   What we may discovery sooner is the borrowing limits of the US Government.

In the long run, deficits do matter.

For those inclined to consider this matter further, the following links are good reads.

FOMC saw specter of depression, deflation

Minutes show members grappling with fresh approach to monetary policy

WASHINGTON (MarketWatch) – Members of the Federal Open Market Committee at their mid-December meeting saw increasing risks of depression and deflation as they grappled with employing new tools to stabilize an economy that was rapidly weakening, according to truncated minutes of the meeting released on Tuesday.
“The overwhelming message gleaned from the minutes of the meeting is one of fear — fear of a deep recession, and fear of a debilitating deflationary spiral that would capsize a debt-laden economy,” wrote Joshua Shapiro, chief economist for MFR Inc.
Some participants at the meeting saw “the distinct possibility of a prolonged contraction, although that was not judged to be the most likely outcome,” the minutes said. Inflationary pressures were likely to dissipate, and “some members saw significant risks that inflation could decline and persist for a time at uncomfortably low levels.” Read the Fed release.

The Deficit Spending Blowout

But there’s more. None of that includes the new fiscal “stimulus” that President-elect Obama has promised to introduce upon taking office in two weeks. The details aren’t known, but Mr. Obama and Democrats have been talking about at least $800 billion, and probably $1 trillion, in new spending or various tax credits and reductions over two years. Toss that in and add more expected bailout cash, and if the economy stays slow the deficit could reach $1.8 trillion, or a gargantuan 12.5% of GDP. That 2006 Democratic vow to pass “pay as you go” budgets seems like a lifetime ago, which in political terms it was.

Obama on Stimulus: Details To Come

So, who then determines what’s an infrastructure project? The infamous “Bridge to Nowhere” was “infrastructure.” Plans were drawn up for it. Workers would have been employed to build it. What’s the difference between pork, a boondoggle and useful infrastructure?

U.S. projects the biggest deficit since World War II.  Can the country borrow its way back to prosperity?

Reasons abound for the ballooning deficit, including a 6.6% decline in tax revenues compared to 2008; more than $180 billion in transaction costs associated with the Troubled Asset Relief Program (TARP), the Treasury Department’s bailout fund for the U.S. economy; the $240 billion price tag of the government’s takeover of mortgage buyers Fannie Mae (nyse: FNM – news – people ) and Freddie Mac (nyse: FRE – news – people ); and increased spending on unemployment compensation.

Stimulus may spur jobs – abroad

NEW YORK (CNNMoney.com) — President-elect Barack Obama this week proposed a massive economic stimulus program with a lofty goal amid a deep recession: create 3 million jobs.

How many of those jobs will end up in China, South Korea or other countries?

Crisis and plan to fix it unprecedented

“I know the scale of this plan is unprecedented, but so is the severity of our situation,” he said. “As the economy recovers, the deficit [will] start to come down. We cannot have a solid recovery if our people and our businesses don’t have confidence that we’re getting our fiscal house in order.”

German auction fails and Britain debt hits danger level

There are fears that the next crisis in the global financial system could prove to be a rebellion by the bond vigilantes, already worried by talk of a bond bubble. This would push up rates used to fixed mortgages and corporate bond deals. Central banks can offset this for a while by purchasing bonds directly — “printing money” — but not indefinitely.

The US alone is expected to issue $2 trillion (£1.3 trillion) of debt this year, and the Europeans are not far behind. Italy alone must tap the markets for €200bn as it rolls over its huge stock of public debt and meets the cost or recession. Fitch Ratings said Ireland, Greece, the Netherlands, and France face a heavy calendar of auctions as maturities fall due.

Filed Under: Bailout, Interest Rates Tagged With: , , , , ,

Congress Proposes Cram-Downs As New Mortgage Solution

January 7, 2009 by 2 Comments

The plight of homeowners delinquent on their mortgages has been the focus of much debate lately.  There have generally been two major lines of thinking:

-The best course is to let free market principles apply.  If homeowners cannot afford the mortgage payment, the old fashioned remedy of foreclose should take place, turning an overburdened homeowner into a renter.

-Those more inclined to assess the loss of a home in terms of human suffering rather than as an economic equation have sought to provide relief to struggling homeowners by modifying the terms of the original mortgage.

As the number of mortgages in default grew, the situation attracted the attention of politicians.  Their viewpoint seemed to focus on helping the homeowner stay in the home, regardless of cost.

The governments’ efforts to encourage the banking industry to cure the foreclosure problem through voluntary participation in loan modifications was a failure.   For a variety of reasons the loan mods were not working.   Data from the Comptroller of the Currency shows that over 50% of modified loans re-defaulted within 6 months.  With many loan mods, payments went up for the borrowers and principal was hardly ever reduced.  The loan mods actually left many borrowers in a worse position than when they started.  In addition, most of them had negative equity before and after the loan mod.  The negative equity position locked them into the house, unable to sell or refinance.

Today, from Washington, a new solution – giving bankruptcy courts the power to alter the terms of the original mortgage.

Lawmakers Set New Mortgage Bankruptcy Bill

WASHINGTON (Reuters) – Legislation designed to stem foreclosures by allowing bankruptcy judges to erase some mortgage debt will be introduced by Congressional Democrats on Tuesday, and hopes are high that it will pass after a similar plan failed last year.

“Economic conditions have only worsened since we last debated this plan,” said Rep. Brad Miller, a member of the House Financial Services Committee who plans to introduce a bankruptcy reform bill on Tuesday. “Until we stop the slide in foreclosures and falling home prices, the economy will get worse still.”

The legislation would change allow bankruptcy judges to modify home loans in the same way that they currently may modify other unsettled obligations, such as credit card debt.

The lending industry has said that allowing bankruptcy judges to modify mortgage obligations would change how they weigh risk. Currently a lender knows that it has recourse to foreclosure if a borrower fails to meet mortgage payments, but the lender does not have to factor in the possibility that the payments it receives could be decreased by a judge.

What will be the impact of allowing bankruptcy judges to discharge (cram-down) mortgage debts?  Some of the issues and questions to be considered include the following.

1.  Interest rates are correlated to risk – that’s the way things work in a free market.   If a mortgage loan is made with the risk of principal impairment by bankruptcy, this risk has to be priced into the loan rate.  Reducing mortgage principal by legislative fiat may bring unintended adverse consequences.

According to The Mortgage Bankers Association “It is our position that if this proposal were to become law, mortgage rates would increase by at least one and a half points. In addition, lenders will be forced to require higher down payments and charge higher costs at closing. All these increased costs would be necessary to account for the new risks that lenders will face when judges decide to change how much borrowers owe on their mortgages.”

2.  Since total mortgage delinquencies are less than 10% and not all of these cases will wind up in bankruptcy,  cram downs might help less than 5% of mortgaged homeowners.   If the MBA is correct and mortgage rates rise significantly due to cram downs, expect a significant backlash from the other 95% of mortgaged homeowners who will wind up paying for the losses through higher interest rates.

3.  According to The Housing Wire, 50% of Americans oppose bailing out troubled homeowners. “These findings indicate that there are significant political barriers to proposals now being drafted in Congress”

The bankruptcy discharge of a mortgage balance will be viewed by many as the ultimate bailout.  The final compromised bill may result in contorted regulations that ultimately benefit few homeowners.

4.  The free market has a solution for “troubled homeowners” which is known as foreclosure.  Does the free market solution lose all merit merely because the number of foreclosures increased dramatically due to imprudent borrowing and lending?

5.  According to Rep. Brad Miller, “Until we stop the slide in foreclosures and falling home prices, the economy will get worse still.”   Rep. Miller is confusing a symptom of the disease as the cause.  Falling home prices did not cause our economy to weaken.    The housing asset bubble that burst was due to reckless lending, fueled by a government providing easy credit and obsessed with making everyone a homeowner. Political interference in economic matters usually delays a solution by impeding the free market forces that will ultimately prevail anyways.

6.  If the mortgage cram down bill is passed, it will drive many homeowners to bankruptcy, lured by the promise of wiping out mortgage debt.   The loan modification program allowed the banks to pretend that the amount they were owed would still be repaid over time.  When the loan gets reduced in bankruptcy, this illusion will be gone.  More write offs by the banks could lead to a self defeating cycle of tighter credit, stricter mortgage underwriting, weaker housing prices and further bailouts.

7.  How many homeowners that are incapable of handling the burden of home ownership will be allowed to remain in their homes, only to face foreclosure again at a later date?

8.  Continued massive government support of the mortgage market will be necessary since investor demand for mortgage securities is likely to remain low due to collapsing housing prices and the risk of mortgage debt being discharged by bankruptcy. How does an investor properly price a mortgage security where the asset value underlying the security is declining and also face the risk that the principal investment may be impaired by court decree?

9.  The Fed is now expected to absorb virtually all of the new mortgage backed securities this year.   With the Fed extending its purchases into virtually every asset class, a question comes to mind.  As the Fed assumes the losses of all failing economic entities in the country, at what point does the US Government begin to share the credit quality of those being bailed out?

Filed Under: Bailout, Banking Industry, Housing, Interest Rates, Mortgages Tagged With: , ,

Fed’s Asset Purchases Continue To Expand

January 7, 2009 by 1 Comment

The $8 Trillion Dollar Bailout

NEW YORK (CNNMoney.com) — Sitting down? It’s time to tally up the federal government’s bailout tab.

There was $29 billion for Bear Stearns, $345 billion for Citigroup. The Federal Reserve put up $600 billion to guarantee money market deposits and has aggressively driven down interest rates to essentially zero.

The list goes on and on. All told, Congress, the Treasury Department, the Federal Reserve and other agencies have taken dozens of steps to prop up the economy.

Total price tag so far: $7.2 trillion in investment and loans. That puts a lot of taxpayer money at risk. Now comes President-elect Barack Obama’s economic stimulus plan, some details of which were made public on Monday. The tally is getting awfully close to $8 trillion.

The amount of $8 trillion is incomprehensible to most people, including myself.   But there is an interesting way to contemplate the amount of $8 trillion dollars.  The total amount of home mortgage debt outstanding in 2008 amounted to only $10.6 trillion (see Mortgage Holiday).  If the government had simply used the $8 trillion to directly payoff consumers’ mortgage debt, all of us could have seen an 80% reduction in our mortgage payments!  Go figure.

Stop the Bankruptcy Cram Down

As Congress debates legislation to empower the Treasury to purchase troubled mortgage-related assets, some are trying to weigh the bill down with ancillary, unnecessary provisions. The one which concerns us the most is a provision that would allow bankruptcy judges to unilaterally change the terms of many mortgage loans, including the loan balance, as part of Chapter 13 bankruptcy proceedings. By granting judges this power, this bill would throw into question the value of the collateral that backs every mortgage made in this country — the home.

The fact remains that the lending community remains united against this idea. It is our position that if this proposal were to become law, mortgage rates would increase by at least one and a half points. In addition, lenders will be forced to require higher down payments and charge higher costs at closing. All these increased costs would be necessary to account for the new risks that lenders will face when judges decide to change how much borrowers owe on their mortgages.

Interest rates are correlated to risk – that’s the way things work in a free market.   If a mortgage loan is made with the risk of principal mark downs in bankruptcy, this risk has to be priced into the loan rate.

During the bailout vote, Democratic Senator Dick Durbin of Illinois argued for the right to give bankruptcy judges the ability to change the terms of a mortgage.  With the change of power in Washington, the odds of mortgage cram down legislation passing is very high.

Since total mortgage delinquencies are less than 10% and not all of these cases will wind up in bankruptcy,  cram downs might help less than 5% of mortgaged homeowners.   If the MBA is correct and mortgage rates rise significantly due to cram downs, expect a significant backlash from the other 95% of mortgaged homeowners who will wind up paying for the losses through higher interest rates.

Mortgage/Treasury Spreads Reflect Risk

Bloomberg) — Federal Reserve officials are focused on driving down the spreads between U.S. Treasury yields and consumer and corporate loans, after cutting the main interest rate to almost zero failed to revive lending.

Credit costs for households and businesses haven’t followed yields on government debt lower. Fifteen-year fixed-rate mortgages were at 5.06 percent last week, 2.59 percentage points above 10-year Treasury yields; the spread averaged 0.88 point in 2003, when the Fed slashed rates to 1 percent.

Chairman Ben S. Bernanke sees the thawing of frozen credit markets as critical to a recovery, and is determined to try to prevent a second wave of credit distress as the U.S. weathers bad economic news over the next two quarters. The Fed is now looking at ways to revive lending by using its balance sheet to hold loans and bonds that investors don’t want.

“Investors in general don’t want to take on the risk,” said Richard Schlanger, who helps manage $15 billion in fixed income securities at Pioneer Investments in Boston. “It is going to reach the point where the Fed will intervene again.”

If spreads between treasuries and mortgages followed the historical norm, mortgage rates on both the 15 and 30 year mortgage would be at least 1.5% points lower.   The question that is not addressed, of course, is how much higher would mortgage rates be without government price support?  Since private buyers see a poor risk/reward ratio in owning mortgages, does the government establish a permanent presence as mortgage lender of last resort?

In addition to providing price support to mortgages, we now have a Federal Reserve pledging to bring down consumer and corporate lending rates as well.   The announcement that the Fed would be buying mortgage backed securities brought down mortgage rates.  Can the Fed do the same in other debt markets by purchasing securities that free market investors view as too risky to own?

With the Fed extending its purchases into virtually every asset class, a question comes to mind.  As the Fed assumes the losses of all the failing economic entities in the country, at what point does the US Government begin to share the credit quality of those they are bailing out?

Filed Under: Bailout, Federal Reserve, Interest Rates Tagged With: , ,