Green Shoots or Scorched Earth?

Bulletins From Clunkerville

By Mike Whitney

August 14, 2009 "Information Clearing House" -- Is the economy really recovering or is it all just hype?

Here's what we know. The Fed doesn't drop rates to zero unless its facing a 5 alarm fire and needs to pull out all the stops. The idea is to flood the markets with liquidity in order to avoid a complete financial meltdown. It's a last-ditch maneuver and the Fed does not take it lightly.

The Fed initiated its zero interest rate policy, ZIRP, eight months ago  (December 16 2008) and hasn't raised rates since. In the meantime, Fed chair Ben Bernanke has pumped huge amounts of money into the financial system using thoroughly-untested and unconventional means. No one knows whether Bernanke can roll up his multi-trillion dollar lending facilities or not (and avoid Zimbabwe-like hyperinflation) because no one has ever created similar programs. It's all "make-it-up-as-you-go" policymaking. What we do know, however, is that the Fed intends to keep rates at rock-bottom for the foreseeable future, which means that the lights are all still blinking red.

Here's an excerpt from the Federal Open Market Committee (FOMC) on Wednesday:

"The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve is in the process of buying $300 billion of Treasury securities. To promote a smooth transition in markets as these purchases of Treasury securities are completed, the Committee has decided to gradually slow the pace of these transactions and anticipates that the full amount will be purchased by the end of October. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted."

Translation: The economy is still getting battered and the Fed will keep rates at zero until the storm passes.  Bernanke will continue to purchase boatloads of Fannie and Freddie mortgage-backed securities (MBS) to avoid an even-more precipitous decline in housing prices. The Fed will also purchase $300 billion in US Treasuries (monetization) in an effort to prime the pump and keep long-term interest rates artificially low. (Note: The Fed is only suspending its monetization program--Treasury buy-backs--because the dollar dropped to a dangerous support level, below which lies the abyss. Thus, Bernanke's announcement is not a sign of confidence in the fictional "recovery", but fear of a "disorderly unwind" of the dollar.)

On balance, the Fed's statement is an expression of desperation, not optimism. Bernanke would like nothing more than to prove to his critics wrong by raising rates and shutting down a couple lending facilities. But he has no choice. The situation is dire. Just imagine where housing prices would be today if Bernanke hadn't bought  $1 trillion of mortgage-backed securities? Housing would be crashing even harder than it is already.

The Fed is in a pitch-battle with deflation, and it's losing ground fast. If that wasn't true, then Bernanke would simply raise rates .50 basis points and soak up some of the excess liquidity he's been spraying everywhere. But he can't, because if he did, the equities markets would plummet 500 points in an afternoon and the financial system would be tossed back on the rocks. Bernanke's liquidity is the only thing keeping the economy vanishing into a deflationary black hole.

The economy is still on life-support and the "green shoots" storyline is pure fiction. The financial system will be on a drip-feed from the Fed for years to come. Maybe forever.  Things aren't better; they're worse. Look at the facts.

There were 1.9 million foreclosures in 2009 in the first six months, and there will be another 1.5 before the end of the year. Is that better?

According to Bloomberg:

"A glut of unsold homes is also pushing down prices. The 3.8 million homes for sale in June would take 9.4 months to sell at the current pace of transactions, according to the National Association of Realtors. The inventory turnover rate averaged 4.5 months in the six years from 2000 to 2005.....More than 18.7 million homes, including foreclosures, residences for sale and vacation homes, stood vacant in the U.S. during the second quarter....Total home sales fell 23.7 percent in June versus a year earlier." (Bloomberg)

Bloated supply, falling prices, record foreclosures, flagging demand--and according to Deutsche Bank--48 percent of all mortgages will be underwater by 2011. It's all bad.

Here's another clip from Bloomberg today 8-12-09:

"Home price declines in the U.S. accelerated in the second quarter, dropping by a record 15.6 percent from a year earlier, as foreclosures weighed on values.

The median price of an existing single-family home dropped to $174,100, the most in records dating to 1979, the National Association of Realtors said today.

‘I don’t think we’re at a bottom yet in home prices,’ said Scott Anderson, a senior economist at Wells Fargo & Co. in Minneapolis. ‘There’s also a pretty big shadow supply of houses. People are kind of waiting for the bottom but there’s a pent up supply out there.”...Home prices are tumbling even as mortgage rates remain near all-time lows. The average U.S. rate for a 30-year fixed home loan was to 5.22 percent last week, down from 5.25 percent the prior week.’" (Bloomberg)

The decline in housing prices is accelerating, not slowing down. The historic collapse in real estate is ongoing and it is wiping out trillions in homeowner equity making it increasingly difficult for consumers to borrow on the diminishing value of their collateral. This is why foreclosures, defaults and personal bankruptcies are soaring. According to the American Bankruptcy Institute: consumer bankruptcy filings reached 126,434 in July, a 34.3 per cent increase year over year, and a 8.7 per cent increase sequentially (116,365 in June). July's number is the highest monthly total since the October 2005 bankruptcy reform aka the Bankruptcy Abuse Prevention and Consumer Protection Act.)

This is why households and consumers can no longer spend as much as they had before the crisis. Credit lines are being pared back; personal savings are rising, and GDP (excluding fiscal stimulus) is shrinking.

Every one of the 3.5 million foreclosures represents hundreds of thousands of dollars the banks will never recoup. That's why the rate of bank failures will be much greater than current estimates. The banks are facing a triple-whammy; soaring foreclosures, tumbling asset prices, and a meltdown in commercial real estate. The combo has created a gigantic capital hole which is forcing the banks to slow lend even to applicants with flawless credit. The Fed has built up excess bank reserves by $800 billion, but it hasn't made a bit of difference. They banks are still not able to lend.

The uptick in housing last month reflects seasonal changes and a shifting of pain from the low end of the market to higher priced homes; nothing more. Homes that are priced over $1 million are now sitting on the market for 20 months; a lifetime in real estate parlance. High-end neighborhoods have turned into leper colonies. Zero interest; zero traffic. Expect a crash this year.

Now take a look at this from CNBC's Diana Olick:

"The number of homes listed officially on the market, while still at historically high levels, might be only the tip of the iceberg," said Stan Humphries, chief economist at real estate website Zillow.com in Seattle, Washington.

“According to Zillow's latest Homeowner Confidence Survey, 12 per cent of homeowners said they would be ‘very likely’ to put their home on the market in the next 12 months if they saw signs of a real estate market turnaround, 8 percent said ‘likely,’ while 12 percent said ‘somewhat likely.’
Survey results could translate into around 20 million homeowners trying to sell their homes, a startling number given that the Census bureau indicates there are 93 million U.S. houses, condos and co-ops, Humphries said.

“According to the National Association of Realtors, the market is currently on track to sell 4.89 million homes annually.

"’At this pace, it would take about four years to run through this amount of backlogged inventory,’ he said.

"’Shadow inventory has the potential to give us another leg down on home prices during the second half of the year,’ said Steven Wood, chief economist at Insight Economics in Danville, California. (Diana Olick, "Shadow inventory lurks over US housing recovery" CNBC)

The banks are using all types of accounting tricks to hide the real losses or the true value of downgraded assets. The only difference between a common crook and a commercial banker is a well-paid accountant.

The banking system is broken and it’s only going to get worse as the hammer comes down on the commercial real estate market. The Fed and Treasury are already working out the details for another stealth bailout that they'll initiate without Congress's approval. It's all very hush-hush. The plan will involve more mega-leveraging of government liabilities. Bernanke has appointed himself the de facto Czar of Hedge Fund Nation, Clunkerville USA. An article in this week's Financial Times further illustrates how the Fed has transformed the economy into a riverboat casino:

"The Federal Reserve Bank of New York is aggressively hiring traders as its seeks to manage its burgeoning securities holdings, making the central bank one of Wall Street's most active recruiters of financial talent.

“The Fed, which says that most of its new recruits come from private sector financial firms, is hiring employees as many banks, rating agencies, hedge funds and private equity groups shed staff. New York city officials recently estimated that the sector's woes would lead to a loss of up to 140,000 jobs.

“The Fed's need for more traders is a direct consequence of the central bank's efforts to keep credit flowing through the US economy. The Fed has been buying fixed-income securities at such a rate that its assets have more than doubled to $2,000bn in the past year, leading the central bank to conclude that it needs more people to monitor the markets and to manage its credit risks." (Financial Times, "NY Fed in hiring spree as assets soar", Aline van Duyn)

Can you believe it? The Fed is drafting a gaggle of professional speculators just to keep all its balls in the air. What a joke. This isn't a recovery; it's a sit-com. Here's Warren Buffett summing it up on CNBC:

"I get figures on 70-odd businesses, a lot of them daily. Everything that I see about the economy is that we've had no bounce. The financial system was really where the crisis was last September and October, and that's been surmounted and that's enormously important. But in terms of the economy coming back, it takes a while.... I said the economy would be in a shambles this year and probably well beyond. I'm afraid that's true."

"The economy is in a shambles". That's from the horse's mouth. Inventories are down 11 per cent year-over-year, durable goods are down 10.4 per cent y-o-y, industrial capacity is at record lows, manufacturing is still contracting, housing is in the tank, shipping and rail freight are scraping the bottom, retail is in a long-term funk, and--according to Krugman--the slight dip in unemployment was a statistical anomaly. Here's Bob Herbert's great summary of the unemployment data:

"Some 247,000 jobs were lost in July, a number that under ordinary circumstances would send a shudder through the country. It was the smallest monthly loss of jobs since last summer. And for that reason, it was seen as a hopeful sign. The official monthly unemployment rate ticked down from 9.5 percent to 9.4 percent....The country has lost a crippling 6.7 million jobs since the Great Recession began in December 2007...

“The percentage of young American men who are actually working is the lowest it has been in the 61 years of record-keeping, according to the Center for Labor Market Studies at Northeastern University in Boston. Only 65 of every 100 men aged 20 through 24 years old were working on any given day in the first six months of this year. In the age group 25 through 34 years old, traditionally a prime age range for getting married and starting a family, just 81 of 100 men were employed.... The numbers are beyond scary; they’re catastrophic.

“This should be the biggest story in the United States. When joblessness reaches these kinds of extremes, it doesn’t just damage individual families; it corrodes entire communities, fosters a sense of hopelessness and leads to disorder....

“A truer picture of the employment crisis emerges when you combine the number of people who are officially counted as jobless with those who are working part time because they can’t find full-time work and those in the so-called labor market reserve — people who are not actively looking for work (because they have become discouraged, for example) but would take a job if one became available....The tally from those three categories is a mind-boggling 30 million Americans — 19 percent of the overall work force.

“This is, by far, the nation’s biggest problem and should be its No. 1 priority." ("A Scary Reality" Bob Herbert, New York Times)

Sorry, Bob, the media has no time for unemployment news. It tends to undermine the positive vibes from green shoots stories.

The stock market rally has made it harder for people to see the truth. But the facts haven't changed. Deflation is setting in across all sectors and the economy has reset at a lower rate of economic activity. Housing prices are falling, consumer spending is slowing, layoffs are rising, and demand is getting weaker. That means growth will be sub-par for the foreseeable future. Here's an excerpt from a speech given by San Francisco Fed Janet Yellen drawing the same conclusion:

"I don’t like taking the wind out of the sails of our economic expansion, but a few cautionary points should be considered... a massive shift in consumer behavior is under way.. American households entered this recession stretched to the limit with mortgage and other debt. The personal saving rate fell from around 8 per cent of disposable income two decades ago to almost zero. Households financed their lifestyles by drawing on increasing stock market and housing wealth, and taking on higher levels of debt. But falling house and stock prices have destroyed trillions of dollars in wealth, cutting off those ready sources of cash. What’s more, the stark realities of this recession have scared many households straight, convincing them that they need to save larger fractions of their incomes.... a rediscovery of thrift means fewer sales at the mall, and fewer jobs on assembly lines and store counters....

“This very weak economy is, if anything, putting downward pressure on wages and prices. We have already seen a noticeable slowdown in wage growth and reports of wage cuts have become increasingly prevalent—a sign of the sacrifices that some workers are making to keep their employers afloat and preserve their jobs. Businesses are also cutting prices and profit margins to boost sales..... With unemployment already substantial and likely to rise further, the downward pressure on wages and prices should continue and could intensify....

“If the economy fails to recover soon, it is conceivable that this very low inflation could turn into outright deflation. Worse still, if deflation were to intensify, we could find ourselves in a devastating spiral in which prices fall at an ever-faster pace and economic activity sinks more and more."

"Falling prices." "Deflation." "Devastating spiral." That's not the kind of honesty that one expects from a Fed chief. Yellen must have stopped drinking the lemonade.

And don't forget the banking system is still broken. Not a dime from the $700 billion TARP bailout was used to purchase toxic assets. The banks are still drowning in red ink. Bernanke has known since last September when Lehman Bros. defaulted, that the bad assets would have to be removed before the economy could recover. An underwater banking system is a constant drain on public resources and a drag on growth. Bernanke knows this, but rather than remove the assets by nationalizing the banks or restructuring their debt (as he should have done) he expanded the Fed's balance sheet by $1.2 trillion which provided the liquidity that financial institutions pumped into the stock market. "Bernanke's Rally" has generated the capital the banks needed to keep them from writing-down their debts or filing for Chapter 11, but the problems still persist right below the surface. Just this week, Elizabeth Warren's Congressional Oversight Panel released a damning report which stressed the need to address the issue of toxic assets. According to the COP's report:

"Financial stability remains at risk if the underlying problem of toxic assets remains unresolved.... If the economy worsens, especially if unemployment remains elevated or if the commercial real estate market collapses, then defaults will rise and the troubled assets will continue to deteriorate in value. Banks will incur further losses on their troubled assets. The financial system will remain vulnerable to the crisis conditions that TARP was meant to fix....

“Changing accounting standards helped the banks temporarily by allowing them greater leeway in describing their assets, but it did not change the underlying problem. In order to advance a full recovery in the economy, there must be greater transparency, accountability, and clarity, from both the government and banks, about the scope of the troubled asset problem.

“The problem of troubled assets is especially serious for the balance sheets of small banks. Small banks‘ troubled assets are generally whole loans, but Treasury‘s main program for removing troubled assets from banks‘ balance sheets, the PPIP will at present address only troubled mortgage securities and not whole loans.

“Given the ongoing uncertainty, vigilance is essential. If conditions exceed those in the worst case scenario of the recent stress tests, then stress-testing of the nation‘s largest banks should be repeated to evaluate what would happen if troubled assets suffered additional losses."

To sum up: There will be no real recovery until the toxic assets problem is resolved. Unfortunately, the Treasury and Fed have shown that they intend to sweep this issue under the rug for as long as possible.

Toxic assets, falling home prices, widespread malaise in the credit markets are just part of the problem. The deeper issue is the dismal condition of the US consumer who has seen his home equity dissipate, his retirement funds sawed in half,his access to credit curtailed, and his job put at risk. Ordinary working class Americans now face what David Rosenberg calls, "the era of consumer frugality---new paradigm of savings, asset liquidation and debt repayment ." Life styles will have to be toned-down and living standards lowered to meet the new deflationary reality. More and more people will be forced to jettison their credit cards and live within their means. It's not the end of the world, but it does foreshadow a protracted period of negative growth, social unrest and persistent high unemployment. Stock market euphoria can last a long time, but the laws of gravity still apply. Things will shake out eventually---and when they do--stocks will return to earth, debts will be written down, and a new era of thriftiness will ensue. Until then, it looks like we'll just keep faking it.