Monday, March 10, 2008

Signs of the Economic Apocalypse, 3-10-07


Gold closed at 974.20 dollars an ounce Friday, down 0.1% from $975.00 for the week. The dollar closed at 0.6512 euros Friday, down 1.1% from 0.6584 at the close of the previous Friday. That put the euro at 1.5356 dollars compared to 1.5189 the Friday before. Gold in euros would be 634.41 euros an ounce, down 1.2% from 641.91 at the close of the previous week. Oil closed at 105.47 dollars a barrel, up 3.7% from $101.73 for the week. Oil in euros would be 68.68 euros a barrel, up 2.5% from 66.98 euros at the close of the Friday before. The gold/oil ratio closed at 9.24 down 3.7% from 9.58 for the week. In U.S. stocks, the Dow closed at 11,893.69 Friday, down 3.1% from 12,266.39 at the close of the previous week. The NASDAQ closed at 2,212.49 Friday, down 2.7% from 2,271.48 at the end of the week before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 3.54%, up three basis points from 3.51 for the week.

The big news last week was the fall in stock prices following the announcement of sharp drop in jobs in February in the United States.

US: 63,000 jobs lost as economy continues downslide

Patrick Martin

8 March 2008

Total US employment fell by 63,000 jobs in February, the second consecutive monthly decline and worst showing in five years, according to a Labor Department report released Monday. The figure demonstrates that the recession in the US economy is worsening and that the corporate onslaught against the jobs and living standards of working people will intensify.

The stock market plunged 147 points, following Thursday’s drop of 215 points, in a decline that has taken the Dow-Jones Industrial Average to well below the 12,000 mark. The New York Stock Exchange closed at 11,893.69, its lowest point in nearly two years, and more than 2,100 points down from the peak last October 11. The total losses on all stocks traded are approaching three trillion dollars in less than five months.

The wave of selling was fueled by the jobs report, although Wall Street frequently celebrates such indicators of job market distress because rising unemployment dampens wage demands and business costs and makes it possible for the Fed to cut interest rates without sparking inflation.

In the current context, however, such concerns are dwarfed by the fear that rising unemployment will trigger a further wave of defaults on mortgages, credit cards and other consumer debt, exacerbating the credit crisis that has unfolded over the past eight months since the crisis in the sub-prime mortgage market erupted. Moreover, inflation is raging, symbolized by the soaring price of oil, over $106 a barrel in trading Friday, and the price of gold, now approaching $1,000 an ounce.

To be blunt, what Wall Street fears now is not a recession—it is already widely accepted that the US economy slipped into recession last fall—but the collapse of major financial institutions and market dislocations which could set the stage for a full-scale worldwide depression, of a kind not seen since the 1930s.

In an effort to stave off the wave of selling triggered by the jobs report, the Federal Reserve announced Friday that it would make $100 billion in new credit available to major banks this month, on top of $160 billion in short-term loans it has extended in occasional auctions since December. The Fed also announced that it will increase the size of the short-term lending in auctions set for March 10 and March 24 from $30 billion to $50 billion apiece.

Fed Chairman Ben Bernanke has already indicated that the central bank will likely cut interest rates again at the next meeting of its Open Market Committee, now set for March 18. The Fed has cut rates by 1.25 percent in the last two months (2.25 percent since October) in an increasingly desperate effort to stimulate the financial markets.

The job report was particularly jolting to financial markets because most economists had predicted a small rise in payrolls, with forecasts estimating the increase at 25,000 jobs. Some 52,000 net jobs were eliminated in manufacturing, as well as 39,000 net jobs in construction, on top of a loss of 25,000 jobs in January.

Despite these numbers, the official jobless rate actually declined slightly, from 4.9 percent to 4.8 percent, because 450,000 unemployed stopped looking for work in February and accordingly were excluded from the count, which is based on the number of people actively seeking jobs.

The Labor Department report also found that January’s net job losses were worse than initially reported, 22,000 compared to 17,000, meaning that 85,000 net jobs have been eliminated since the first of the year. The agency also cut in half its estimate of net job creation in December, from 82,000 to 41,000.

The US economy must generate an increase of 150,000 new jobs each month just to keep pace with population growth, so the figures reported mean that over the past three months job creation fell short of the number of workers seeking employment by nearly half a million jobs.

The top economic adviser to President Bush, Edward Lazear, chairman of the White House Council of Economic Advisers, told the press Friday that the US economy might actually shrink in the first quarter, the first time that any top official has admitted that the US growth rate would fall below zero. “We don’t really know whether it will be negative or not,” he told reporters. “We have definitely downgraded our forecast for this quarter.”

The official government definition of a recession is two consecutive quarters of zero or negative growth, a figure increasingly likely for the first half of 2008. J.P. Morgan’s chief economist, Bruce Kasman, told the Associated Press, “It is appropriate to characterize the US economy as having entered a recession in the first quarter.”

The jobs report was only one of a series of economic reports and market events that have shaken financial markets in the last few days. Particularly significant was the default by two major companies caught in the aftershocks of the mortgage crisis.

Thornburg Mortgage, the second-largest independent mortgage lender in the US, after Countrywide, revealed Wednesday that it was in default on $610 million in loans after failing to meet a margin call from one lender, J. P. Morgan.
The company, based in Santa Fe, New Mexico, said it would restate its 2007 financial results and take a charge of $428 million to reflect losses on adjustable-rate mortgages.

CEO Larry Goldstone issued a bitter statement Friday warning that the company might be unable to continue as a going concern, and declaring, “The panic that has gripped the mortgage financing market is irrational and has no basis in investment reality.”

Thornburg specializes in luxury homes and has relatively few sub-prime mortgages. Its margin calls began after the Swiss bank UBS announced a write-down February 14 on the value of $26.6 billion in “Alt-A” mortgages—higher-priced and higher value than sub-prime. Since then, Thornburg’s share price has been driven down from $11.54 to $1.22 Thursday.

On Thursday, Carlyle Capital, a subsidiary of the giant hedge fund Carlyle Group based in the British Channel Islands, said it had failed to meet margin calls from banks on $21.7 billion in mortgage-backed securities.
The company was heavily engaged in purchasing mortgage-backed bonds issued by Fannie Mae and Freddie Mac, the two huge government-sponsored institutions that underwrite much of the US home mortgage market. Carlyle Group is expected to provide credit to prevent a default of Carlyle Capital, but the crisis casts a shadow over the most important financial institutions in the US mortgage industry.

A report Thursday by the Federal Reserve showed that household net wealth fell for the first time in five years, dropping $532.9 billion, or 3.6 percent, in the fourth quarter of 2007. The collapse of real estate values accounted for a third of the decline, while the decline in financial assets accounted for nearly half.

The Fed report also found that for the first time since such records began in 1945, American homeowners owed more on their homes than they owned. Average net home equity dropped below 50 percent—a figure that is even more remarkable since one third of US homeowners have either paid off their mortgages or bought without a mortgage, and therefore have 100 percent equity.

Other figures reported include:

* An increase in the proportion of mortgages in foreclosure to 2.04 percent, an all-time high and nearly double the level of 1.19 percent a year ago. The proportion of loans either past due or in foreclosure hit 7.9 percent in the fourth quarter, up from 6.1 percent a year earlier, and the highest since figures were first collected in 1979.

* A published estimate that mortgage losses would cost the banks $400 billion, about 40 percent of the $1 trillion in combined capital of all banks insured by the FDIC. Bank lending would be cut by $900 billion as a result.

* The Federal Reserve “beige book” report on business conditions in the United States, released Wednesday, found weak or no growth in 8 of 12 regions.

* Factory orders for January plunged 2.5 percent, according to the Commerce Department, while orders for durable goods fell more than 50 percent.

* Credit-card borrowing soared 7 percent in January, up from an increase of 2.8 percent in December, as consumers had to resort to charge cards to finance their expenses. Consumer debt overall rose 3.3 percent, nearly double the growth rate of 1.8 percent in December.

The reaction in official Washington to the dismal developments was a combination of imbecilic rhetoric and inadequate action. President Bush made a hastily organized appearance before television cameras to understate the obvious, admitting “It’s clear our economy has slowed,” and adding, “Losing a job is painful and I know Americans are concerned about our economy. So am I.”

Declaring, “our economy will prosper,” Bush touted the economic stimulus package approved by Congress last month at the instigation of the White House, although the size of the package, $168 billion, is less than one third of the decline in net worth of the fourth quarter, and entirely dwarfed by the trillions wiped out in the real estate collapse.

Bush urged taxpayers to buy consumer goods with their $600 or $1,200 rebates when they get them, which will not be until May or June, although surveys already predict that the vast majority will use the money to pay urgent bills.

So here we are now where many of us have been predicting we would be. No one should be surprised. The only surprise is that it has taken this long. All one needed was common sense to see what was coming. Timing, however, is a different matter. Investors and speculators always want to know the timetable. Therefore there is a lot of room for manipulation when it comes to the timing. The following predictions, which don’t come with timetables, make a lot of sense:

How This Economy Is Going To Play Out

Ian Welsh

March 8, 2008

Back in November, I wrote a brief article describing how I expected the financial meltdown underway to continue, and how I expected it to impact the real economy. Below I'm reprinting the 10 predictions I made and I've put in italics those which have already occurred.

1) Housing prices and sales will continue to decline. Expect 3 years before the bottom, as a very optimistic best case scenario.

2) Commerical real-estate will suffer a steep decline as well.

3) Consumer demand will drop. Unemployment will rise.

4) The US will go into a recession at best, a depression at worst. Expect first stagflation (high inflation and high unemployment), both because of the increased price of imports and deliberate pump priming by the Fed, then deflation, as asset prices collapse so hard they take everything else with them. The other likely scenario is stagflation followed by hyperinflation. Formal inflation numbers put out will become not just a joke amongst market-watchers, but amongst the actual population. Same thing with unemployment numbers.

5) The Asian economies are not going to "decouple", they are going to have their own financial crises and recessions. Yes, this includes China.

6) China's stock market will collapse some time next year. China will go into a recession. There will be huge amounts of violence and the Chinese government will redirect anger towards the US and Japan.

7) Multiple banks will probably go insolvent. They are simply holding too much crap paper. There will be an extreme tightening of consumer debt of all kinds, including consumer loans, credit cards and mortgages (this is already beginning, but you ain't seen nothing yet). Even people with good credit will start having difficulty getting loans.

8) Protectionism is going to get stronger.
Even if Clinton, a free trader, is put in power, by the time the 2010 Congressional elections are over no "free trade" bill will be able to pass Congress and in fact actual tariffs are likely to be put in place.

9) I wouldn't be surprised, at some point, to see capital controls put in place to stop money-flight from the US.

10) When the full extent of how bad things are hits Joe Public, expect a move for reregulation of Wall Street and to reinstitute something similiar to Glass-Steagall.

Bonus Predictions:

11) The government will have to bail out Fannie Mae and Freddie Mac because they are insolvent. Minimum 500 billion dollars. Possibly much more.

12) Large waves of government layoffs at the municipal and state levels as the inability to raise money cheaply and the reduced property taxes cascade through the system.
(Yes, this is already starting to happen, so it's kind of a safe prediction. But it's going to get magnitudes worse. Many many municipalities are going to go bankrupt, and many states will be unable to maintain any but the barest of services.)

13) The price of oil will actually drop as there is an actual demand reduction for oil. Don't expect this to necessarily be reflected in pump prices, which are constrained by refinery capacity.

14) The federal government will become the largest holder of mortgages, and in effect, owner of houses, in the country. By far. The Fed, which has been accepting sub-prime paper already, is going to wind up stuck with a lot of it, because some of the banks using it as "collateral" are not going to survive absent huge government bailouts.

15) A serious collapse of the US stock market, probably by September at the latest. Maybe within a couple months.

The important thing to know about all of these predictions is that they aren't new. They aren't even, really, from November. Myself, Stirling, the late Oldman and others were writing about how current policies lead to stagflation, for example, as far back as 2004. Stirling and I were talking about the Housing Bubble as far back as 2002 when it became clear that Greenspan had dropped rates so far he was bound to create one.

This is not to say that we were particularly bright (and lord knows I got the timing wrong), rather it is to say that for the last 6 odd years, nothing has changed. The basic pattern of the Bush years was set in stone after 9/11, the policies of the Presidency, the Fed and Congress haven't changed. So the events unfolding now are just the logical consequences of decisions made years ago such as:

  • to invade Iraq;
  • to make tax cuts for the rich in order to bail them out from the dotcom crash;
  • to drop interest rates through the floor;
  • to allow a telecom oligopoly to form;
  • to condone Chinese mercantilist policies which subsidized Chinese exports with a low Yuan;
  • to tolerate the Yen carry trade, and
  • to refuse to regulate the creation of money in the form of securitization and exotic derivatives.

In 2002 and 2004 the American people voted to continue these policies, including the war in Iraq. In 2006 they voted to end at least some of these policies, but Congress and the President decided to kick the ball down the field, pass some pork bills and wait till 2009 to do anything about any of it. Their bet was they could hold the meltdown off till after the election. They were wrong.

So, what had to be, now is. The performance with the stimulus bill, which was about the worst bill one could create if the actual purpose was to, oh, stimulate the economy, plus the various other futzing around by Congress indicates that no serious changes will be made before 2009. Occasionally something smart may be done, some good idea may go through on the margins, but overall we're in a gray zone where the train trundles on towards that light in the tunnel, and nothing is going to turn it around until a new Congress and new President are sworn in.
And when they do get in, what are they going to do? The truth is that even they don't really know. There are no easy answers because the US (and the world, in a sense) has dug itself into a hole that is bigger than the pile of dirt on the side. More damage will be done than there is free money hanging around to fix. The miracle of leverage in reverse is going to remind everyone why "over-leverage" is something old style brokers considered the greatest mistake anyone could make.

The old, oil based, suburban sprawl economy based on forever rising house prices, on easy credit, on subdivision after subdivision--on running up credit cards and on leverage piled on leverage piled on arbitrage, is in the middle of cracking up, spectacularly. While there will be a short term reduction in the price of oil, in the long term oil is still going up and the America of the sprawl economy; the economic geography of America, looks entirely different at $4/gallon gasoline than it does at $2/gallon gasoline. Huge swathes of exurbia and suburbia become simply economically unviable. Zombie Burbs.

Since I've been contributing here at FDL, a big part of what I've been writing has been an attempt to give readers a basic toolset with which to understand the intersection of politics and economics (and, at the macro level, they always intersect). Over the next few months I'm going to start writing less about what has happened than about what can happen. Not just about how we can "fix" things, but what sort of future the status quo path leads to, what other types of futures are available to us and what the tradeoffs are for various futures (and there are always tradeoffs. Never agree to a plan without knowing who's paying, and what, because if you don't, it's probably you.)

The past is not the future, and the trendline is never inevitable. Hope may not be a plan, but there is always at least a chance to make a change, and make that change for the better. As the American economy collapses around us so too will a lot of the American power and policy apparatus which has made the status quo, a status quo which has served so few so well, and so many badly, so hard for anyone to change. And in the shadow of the collapse there will be a time when we are freer to make choices about what sort of society we want to live in than we have been for a long time.

But only if we're ready for it. Only if we have thought about what sort of world we want. If we don't know, others will know for us, decide for us…

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