Article 43

 

Saturday, August 11, 2007

The Next Recession Part 7

A large, long-term increase in consumer indebtedness has raised concerns that the next U.S. recession could originate in the household sector. The housing boom of recent years has resulted in a surge in new consumer debt, most of it in the form of mortgages.
- SCENARIOS FOR THE NEXT US RECESSION - FDIC Report - March 23, 2006

housingbubble.jpg

The impending credit crisis cant be avoided, but it could be mitigated by taking radical steps to soften the blow. Emergency changes to the federal tax code could put more money in the hands of maxed-out consumers and keep the economy sputtering along while efforts are made to curtail the ruinous trade deficit. We should eliminate the Social Security tax for any couple making under $60, 000 per year and restore the 1953 tax-brackets for American’s highest earners so that the upper 1%-- who have benefited the most from the years of prosperity---will be required to pay 93% of all earnings above the first $1 million income. At the same time, corporate profits should be taxed at a flat 35%, while capital gains should be locked in at 35%. No loopholes. No exceptions.

Congress should initiate a program of incentives for reopening American factories and provide generous subsidies to rebuild US manufacturing. The emphasis should be on reestablishing a competitive market for US exports while developing the new technologies which will address the imminent problems of environmental degradation, global warming, peak oil, overpopulation, resource scarcity, disease and food production. Off-shoring of American jobs should be penalized by tariffs levied against the offending industries.

The oil and natural gas industries should be nationalized with the profits earmarked for vocational training, free college tuition, universal health care and improvements to then nations infrastructure.
- Mike Whitney

The Grim Reaper Pays A Visit To Wall Street

By Mike Whitney
Information Clearinghouse
August 10, 2007

Alan Greenspan’s low-interest, subprime, snake-oil Caravan took another spin down Wall Street today---ripping up pavement, knocking down power-poles and sending traders scampering for safety. When the dust finally settled, Maestro’s wrecking ball had lopped another 387 points off the Dow Jones leaving markets reeling and investors cringing in fear. No doubt about it; the mood on the “Street” has taken a 180 overnight. A long procession of bears---marching three-abreast with arms locked - can now be seen winding through downtown Manhattan. Their sense of triumph is palpable.

Meanwhile the last wounded bullstill writhing at curbside-- is being carted off to slaughter.

MORTGAGE BLUES

No one has summed up the disaster in the mortgage lending business better than Paul Muolo of Broker Universe:

“I’ll put it bluntly: if you operate a non-depository mortgage firm and don’t have a deep-pocketed parent or hedge fund as a sugar daddy you’re likely to be out of business by year-end, probably sooner. In the 20-plus years that I’ve been covering residential finance I haven’t seen a financial meltdown this swift since the S&L crisis of the mid-to-late 1980s. One subprime executive who closed his shop a few months ago told me, This is a liquidity crunch the likes I have never seen. Meanwhile, the mudslide is rolling downhill from Wall Street to mortgage bankers, to loan brokers, and then the consumer.

The mudslide from Wall Street. That says it all.

In a matter of days, the credit markets have frozen making it impossible to secure financing on anything from a leveraged buyout (LBO) of a major corporation a meager home loan. The cheap money and easy credit have vanished into the summer-ether leaving the investment banks holding $300 of billion toxic debt they have no way of off-loading.

It’s a real mess and there are no simple solutions. Lenders are standing on the sidelines waiting for the next shoe to drop or the next body to float to the surface. Deals are going undone; business is grinding to a halt.

What were the geniuses at the Federal Reserve thinking when they dropped rates to 1% and pumped out trillions of dollars that made their way into no documentliars loans to applicants with bad credit? Didn’t they know thered be a day of reckoning when the housing and credit bubbles would smash into each other taking down much of the US economy with them?

Was it an HONEST MISCALCULATION OR A SINISTER PLOT? Or, maybe, it was just stupidity?

Who knows; who cares. Whatever it was; the aftershocks are bound to be felt for a very long time. Decades maybe.

WARNINGS FROM CHINA

The Chinese have added to the subprime woes by THREATENING TO DUMP their reserves of US dollars and US Treasuries if congress passes protectionist legislation. According to MarketWatch:

A report in the U.K.’s Daily Telegraph that China, the second-largest foreign holder of U.S. government debt with $407 billion, is prepared to sell its holdings in the event of U.S.-imposed trade sanctions. Japan owns $615 billion of Treasuries.

That ought to stop congress in a hurry. China has $1.3 trillion of US paper they can toss into the jet-stream and crash the greenback whenever they choose. That’s why theyve stockpiled dollar-backed assets for the last decade---not because they like us. They don’t. They intend to use their massive FOREX reserves like a cattle-prod to keep us in line. Thats how bankers always do it. And China is now America’s banker. Thats why it pays to run the country the old fashioned way; by strengthening the manufacturing sector, increasing exports and building up national savings. Debt is just the fast-track to slavery.

China is now calling the shots. If they even get a whiff of US-imposed tariffs, they’ll bring the US economy to its knees. And theres nothing congress can do about it either. They’d be better off just pulling up a lawn-chair and watching as US jobs and wealth go chugging off to the Far East.

But China is probably the least of our worries. The looming credit crunch is a much bigger immediate concern. The Wall Street Journal provided a glimpse of sudden breakdown in lending in an article earlier this week: (Credit Chill Freezes Leveraged Deals WSJ Aug 3)

The big chill gripping global credit markets has caused 46 leveraged financing deals around the world to be pulled since June 22, representing more than $60 billion in funding that companies had planned for mergers and acquisitions.

The number of deals pulled last year: zero.

Another article put it like this:

The investment grade corporate bond market HAS GROUND TO A HALT, making it difficult for companies to access capital and hard for investors to find a place to put their money to work. ԅ.The problems in the primary market could, if they persist, throw a wrench in the workings of corporate America, making it tougher for companies to finance, among other things, investments, buyouts and equity buybacks.For July, corporate bond issuance was down 77% from June. (Corporate Bond Market has come to a Standstill, Wall Street Journal)

Still, President Dumbo assures us that, “There’s enough liquidity in the system to allow markets to correct and that the U.S. economy remains the envy of the world.”

Err, correction; Was the envy of the world.

The easy money is drying up, the big mergers are slowing down and the hand-wringing in the front office has just begun. Next question: How low can the stock market go?

At present valuations; stocks are vastly overpriced reflecting the inflationary pressures from our recycled $800 billion current account deficit and the loony expansion of the money supply at the Federal Reserve (now running at a whopping 13%). Presently, the stock market is hanging on by its fingernails. One little gust of wind - like a few more collapsing hedge funds - and the market will go somersaulting through deep-space.

The ISI Groups Andy Laperriere put it like this: “Its worse than the most pessimistic assumptions”. In these kinds of financial corrections, it pays to expect more surprises. (WSJ Aug 6, 2007)

Still, even though the subprime contagion has spread to all loan-categories, the glut of homes continues to increase, and the mortgage industry is flat-lining on the emergency room floor; there is room for optimism. Consider the comforting comments of Secretary of Treasury Henry Paulson:

“I don’t think it (the subprime mess) poses any threat to the overall economyԅ..In an economy as diverse and healthy as this, losses may occur in a number of institutions, but that overall this is contained and we have a healthy economy.”

Contained?!?  This is contained?

Newsweeks Daniel Gross had this reaction to Paulson’s remarks:

If the containment policy of the Cold War worked as well as this subprime-mess containment policy, we’d all be speaking Russian and living on collective farms.

Gross is right - weve only begun to see the spillover from the housing fiasco. There’s plenty more carnage in the pipeline. Paulson needs to stop blowing smoke and tell the truth.

A SELF-REINFORCING NEGATIVE CYCLE

Economy.com’s head honcho, Mark Zandi, gave the best overview of what lies ahead in the near term as credit becomes scarcer:

“There is a substantial risk that the mortgage market will devolve into a self-reinforcing NEGATIVE CYCLE. Mounting credit problems could beget more restrictive underwriting standards, which would weigh heavily on the fragile housing market as potential borrowers become unable to obtain credit, and existing borrowers facing large payment resets are unable to refinance. Foreclosures would mount, leading to weaker house prices, falling homeowners’ equity and even more substantial credit problems. The cycle repeats with more intensity and the mortgage market corrections unravel into a crash.”

“The Great Unwinding” appears to be taking place already and can be expected to accelerate as inflationary pressures increase and the price of oil---which has gained 20% in the last 3 months---continues its upward trek. There are other concerns, too, besides the slump in housing sales and falling stock market. The downstream effects of tight credit will hurt retail sales and employment. We can anticipate a decline in both areas in the next two quarters. Auto makers have already reported the weakest sales in 9 years. Theres also been a steady erosion of investor confidence and a plunge in consumer spending from 3.7% to 1.3%. Credit card debt continues to soar, but that’s only because the poor American consumer is strapped and has no where else to turn. He has no savings and his wages have stagnated. What choice does he have except to use the plastic?

Some market analysts believe that the credit storm will pass without inflicting too much damage. Dont bet on it. The big picture is pretty grim. Trading in mortgage-backed securities (MBSs) has slowed to a trickle while the appetite for corporate bonds has nearly disappeared. No one really knows how many trillions of dollars will be lost in funky mortgage-related CDOs. But one thing is certain; the blow-ups in the hedge fund industry will continue through the autumn and early winter. These are End Times for the fund managers; they’d better make their ablutions and kiss their kids goodbye.

Still, the sudden reversal in the credit markets is not without its lighter side. Jim Kunstler provided this witty summary of frantic traders trying to sort through the current mess while still enjoying the waning of summer:

One can only imagine the number of cell phone minutes racked up this weekend out in the Hamptons by players trying desperately to finagle their way out of the brutal fact that their firms and funds suddenly lay exposed to the cruel ravages of reality. A lot of catered crab tidbits and mini-quiches must have gone uneaten out along the dunes as weeping men in blazers realized that “marked to market” had come to mean the same thing as “holding a bundle of shit.”

Weeping men in blazers. Priceless. Later in the post, Kunstler offers this synopsis of the subprime, CDO, Ponzi-loan racket which is swirling through the financial markets like a tornado:

The whole racket this time was designed to dissociate the loan contracts as far as possible from their company of origin, and then to slice and dice the liabilities of ownership so finely that all the lawyers theoretically ever producible in the life of this universe, or several like it, may never succeed in patching together a coherent skein of ultimate responsibility. In the meantime, a remorseless chain of mere procedure in the form of default and foreclosure notices issued by computers will be sent through the mail, and sheriff’s deputies will fan out through the subdivisions with their rolls of yellow tape, tossing residents out on the street (if they haven’t already mailed in their keys to some company that fired all its employees and shuttered its offices back in June). (CLUSTERFUCK NATION by Jim Kunstler)

As the banks tighten up their lending standards; the number of business deals will drop accordingly and the economy will slow to a crawl. This process is already underway. A few “Up Days” in the stock market mean nothing. This is a Force-5 hurricane headed for a trailer park. Nothing will slow it down. The problems are too deeply rooted---the infection too far along. The huge, overleveraged bets will progressively unravel and the economy will go into freefall. It’s always painful when fundamentals re-emerge and economic gravity takes hold.

When credit markets freeze, consumers become wary of spending too much, and the economy stalls. This is how deflationary cycles begin. The DAILY RECKONING’S Bill Bonner puts it like this:

“The Fed is still talking about the risk of inflation...while the risk of deflation rises daily. Deflation happens when liquidity dries up. Suddenly, money disappears. Lenders dont lend. Spenders don’t spend. The velocity of money declines as everyone holds on to what hes got...fearful of losing it.”

When this happens even the feds can’t do much about it. They have their printing presses...but they have no good way of getting the money into the hands of people who will move it around. The usual way is through the credit markets. The Federal Reserve pushes down short-term interest rates, for example, enabling lenders to offer money at lower rates.

But when a deflationary mentality takes hold of people, the last thing they want to do is to borrow money. Theyre afraid that they might not be able to pay it back. Besides, in deflation, consumer prices fall.As prices fall, consumers become even more reluctant to spend. They begin to see that theyll get a better deal if they wait.Ŕ

Spenders don’t spend. Lenders dont lend. That says it all. People get scared and liquidity gets choked off at the source. This is the reinforcing negative cycle which ends in Depression. The only way it can be avoided is by central banks quickly taking action and priming the economic pump with cheap credit that stimulates economic activity. But the Fed doesnt want to lower rates because foreign investment will flee the country and put the greenback in a fatal swoon.

According to reports on the internet, the Bank of Canada has assured financial market participants and the public that it will provide liquidity to support the stability of the Canadian financial system and the continued functioning of financial markets. (see entire entry HERE. )

This sounds serious.

And a similar report on Bloomberg:

The European Central Bank, in an UNPRECEDENTED RESPONSE to a sudden demand for cash from banks roiled by the subprime mortgage collapse in the U.S., loaned 94.8 billion euros ($130 billion) to assuage a credit crunch.THE ECB SAID IT WOULD PROVIDE UNLIMITED CASH as the fastest increase in overnight Libor since June 2004 signaled banks are reducing the supply of money just as investors retreat because of losses from the U.S. real-estate slumpԅ. ( CB OFFERS UNLIMITED CASH AS BANKL LENDING COSTS SOAR - BLOOMBERG NEWS AUG 9 )

Hmmmmm. Has the light started blinking RED yet?

CREDIT CRUNCH: Out of the pan, into the fire

The impending credit crisis cant be avoided, but it could be mitigated by taking radical steps to soften the blow. Emergency changes to the federal tax code could put more money in the hands of maxed-out consumers and keep the economy sputtering along while efforts are made to curtail the ruinous trade deficit. We should eliminate the Social Security tax for any couple making under $60, 000 per year and restore the 1953 tax-brackets for AmericaԒs highest earners so that the upper 1%-- who have benefited the most from the years of prosperity---will be required to pay 93% of all earnings above the first $1 million income. At the same time, corporate profits should be taxed at a flat 35%, while capital gains should be locked in at 35%. No loopholes. No exceptions.

Congress should initiate a program of incentives for reopening American factories and provide generous subsidies to rebuild US manufacturing. The emphasis should be on reestablishing a competitive market for US exports while developing the new technologies which will address the imminent problems of environmental degradation, global warming, peak oil, overpopulation, resource scarcity, disease and food production. Off-shoring of American jobs should be penalized by tariffs levied against the offending industries.

The oil and natural gas industries should be nationalized with the profits earmarked for vocational training, free college tuition, universal health care and improvements to then nations infrastructure.

Unfortunately, these issues cannot be resolved within the framework of the current political model---the system has been thoroughly corrupted by private interest and corporate money. The feudal system of predatory capitalism is incompatible with democratic values, civil liberties, and basic human needs. Ending the two party Duopoly would be a good place to start---along with public funding of political campaigns. Then we can begin the serious work creating a world where environmental protection, human rights, and economic justice have a chance to flourish.

CREDIT MELTDOWN: Another Katrina?

Neither Bush nor his colleagues at the Federal Reserve will use the present crisis to bring about the sweeping changes that would strengthen the middle class, build confidence in the financial system, or eliminate inequities in the present distribution of wealth. Instead, they will choose the path of least resistance, that is, Bernanke will eventually lower interest rates and set-off a hyperinflationary cycle that will destroy the currency, strip workers and pensioners of their savings and retirements, and plunge the country into third-world poverty.

Inflation is the purest form of class warfare. That’s why we can say - with some degree of certainty - that it will be GEORGE BUSH’S first choice.

SOURCE

---

Very Scary Things

By Paul Krugman
NY Times
August 10, 2007

In September 1998, the collapse of Long Term Capital Management, a giant hedge fund, led to a meltdown in the financial markets similar, in some ways, to whats happening now. ... The Fed coordinated a rescue..., while Robert Rubin, the Treasury secretary..., and Alan Greenspan,… the Fed chairman, assured investors that everything would be all right. And the panic subsided…

What’s been happening in financial markets over the past few days is something that truly scares monetary economists: liquidity has dried up. That is, markets in ... financial instruments backed by home mortgages ... have shut down because there are no buyers.

This could turn out to be nothing more than a brief scare. At worst, however, it could cause a chain reaction of debt defaults.

The origins of the current crunch lie in the financial follies of the last few years… The housing bubble was only part of it; across the board, people began acting as if risk had disappeared.

Everyone knows now about the explosion in subprime loans ... and the eagerness with which investors bought securities backed by these loans. But investors also snapped up ... junk bonds, driving the spread between junk bond yields and U.S. Treasuries down to record lows.

Then reality hit… First, the housing bubble popped. Then subprime melted down. Then there was a surge in investor nervousness about junk bonds…

Investors were rattled recently when the subprime meltdown caused the collapse of two hedge funds operated by Bear Stearns… Since then, markets have been manic-depressive, with triple-digit gains or losses in the Dow ... the rule rather than the exception for the past two weeks.

But yesterdays announcement by BNP Paribas, a large French bank, that it was suspending ... three of its own funds was, if anything, the most ominous news yet. The suspension was necessary, the bank said, because of “the complete evaporation of liquidity in certain market segments” - that is, there are no buyers.

When liquidity dries up ... it can produce a chain reaction of defaults. Financial institution A cant sell its mortgage-backed securities, so it can’t raise enough cash to make the payment it owes to institution B, which then doesnt have the cash to pay institution C…

And here’s the truly scary thing about liquidity crises: its very hard for policy makers to do anything about them.

The Fed normally responds to economic problems by cutting interest rates… It can also lend money to banks that are short of cash: yesterday the European Central Bank ...  lent banks $130 billion, saying that it would provide unlimited cash if necessary, and the Fed pumped in $24 billion.

But when liquidity dries up, the normal tools of policy lose much of their effectiveness. Reducing the cost of money doesn’t do much ... if nobody is willing to make loans. Ensuring that banks have plenty of cash doesnt do much if the cash stays in the banks’ vaults.

There are other, more exotic things the Fed and, more important, the executive branch of the U.S. government could do to contain the crisis if the standard policies dont work. But for a variety of reasons, not least the current administration’s record of incompetence, wed really rather not go there.

Let’s hope, then, that this crisis blows over as quickly as that of 1998. But I wouldnt count on it.

SOURCE

The Next Recession
PART 1 - PART 2 - PART 3 - PART 4 - PART 5 - PART 6 - PART 7 - PART 8 - PART 9 - PART 10 - PART 11 - PART 12 - PART 13

Posted by Elvis on 08/11/07 •
Section Dying America • Section Next Recession, Next Depression
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