Wednesday, September 9, 2009

Links and Some Smarmy Editorial Comments

It's been a long day. Sorry if today's comments make me seem a little extra bitter:

Let the Fed keep throwing money at it: In this analysis by one of the many Tyler Durdens from Zero Hedge, the author explains why consumer spending is not going to come back strong no matter how much liquidity the Fed pumps into the system. Between job losses that lead to foreclosures and increased Baby Boomer saving as opposed to spending, consumption as a percentage of GDP is likely to drop well below the 70% mark. So where has all the Fed liquidity gone you ask? Into speculative stocks of course…

Mortgage activity is primarily FHA or Freddie or Fannie guaranteed suggesting a very limited secondary market - in fact 47% of the housing market transactions are at the low end of the market. About half of the new foreclosures are prime rate loans with a new foreclosure action taken for every 6 to 10 jobs lost adding up to approximately 1.2 million related to job loss. Next year a large wave option ARM loans many of which include negative amortization will reset causing even more foreclosures even at current unemployment rates. In short, we have several years supply of houses.

The Baby Boomer generation account for 47% of our national spending prior to this recession but just 7% of the national saving. This group comprised 78% of the spending growth in the economy from 1995 to 2005. This has changed dramatically as a result of the large declines in wealth and likely will not come back. Since the sheer numbers of this group far outstrips any other demographic group, its permanent reduction in spending is part of the reason we think consumer spending will make up a smaller percentage of our GDP even after the economy recovers.

So where has all the money gone? The chart below shows the rise in the stock market causing the valuation to be somewhat extended in our view - some liquidity found a home here. Large rises in just the last month in small cap stocks, plus 17%; most shorted stocks, plus 17%; stocks with the lowest analyst rating out performing those with the highest rating by 380 basis points, all suggest some speculation.

Guess what? The wealth gap is increasing: So you think the US is a developed economy, huh? I remember when one of the hallmarks of a developed economy was the existence of a middle class and when huge income gaps were associated with third world countries and emerging markets. So when you take a look at the extreme gap between CEO pay and that of American workers it makes you wonder what kind of country we live in and what is going to eventually happen to the middle class:

In a brief article on the topic by Yahoo!'s Heesun Wee, the average ratio between salaries for CEOs and the American worker in 2007 was 344 to one. This figure dipped slightly last year, 2008, to 319 to one. But according to the Institute, this figure is set to rise, which, according to IPS's director John Cavanagh is "really worrisome."

"If nothing is done -- if the federal government does nothing this fall in terms of CEO pay, the ratio will likely go up this year and there will be huge stock option gains by the CEOs of some of the worst-run companies," Cavanagh proclaims.

The topic of CEO pay in Washington may not currently be on the front burner, as the markets have rallied and political focus has shifted toward healthcare reform.

Cavanagh supports the pay chasm as a critical issue, the gap is "still very, very high" higher than most other countries "decent and in sync with democracy." (His words, not mine). He proclaims that if you go back a generation in America, on average, the CEO to worker pay gap was about 30 to one.

Another huge surprise: the government may be underestimating future deficits: Here is an excerpt from an analysis done by a group called US Budget Watch that makes some startling predictions about the future fiscal deficits of the US if Obama and Congress continue on the current path to oblivion. The message? Watch out if you think Treasuries are the safest bet right now:

US Budget Watch has constructed its own “current policy” baseline by assuming select policies do not conform to current law (see for details). Over the next decade, keeping certain policies in place would result in roughly $3 trillion less in revenues than is scheduled under law and close to $2.5 trillion more in spending, including interest. Complying with current policies without offsetting the costs would result in drastically larger deficits between 2010 and 2019 and would cause the ten-year deficit total to grow from an already dangerously high $7.1 trillion to $12.6 trillion. Debt held by the public would rise to over 90 percent of GDP by 2019, as opposed to 68 percent without those changes.

The mounting debt under such a scenario would likely crowd out private investment to a significant degree, resulting in stunted economic growth. At the same time, it would ensure that government interest payments would consume a large and rising share of the budget, leaving little room for anything else. And, at some point, our rising debt would make continued borrowing prohibitive, as our lenders and investors cease their large-scale purchasing of U.S. Treasury bonds. If it came to this, the result would likely be a serious fiscal and economic crisis, followed by steep and perhaps crippling tax increases and spending cuts.

Blame the shorts! Hat tip to Lincoln Minor for sending out the link to this interview with Jim Chanos. For any of you who think that short sellers are these nefarious ruffians who want to see the collapse of the economy, read this exchange between Chanos and interviewer Rob Johnson (not the former Bills QB). You see, no matter how much money these guys can make, if they live in the US and want their children to grow up in a thriving country it makes sense to put profit motive aside when there is the potential for systemic collapse. Chanos warned the regulators about the dangers in the global financial system and they dismissed him. Maybe one day people will see short sellers in the same light as market participants who only bet that stocks will grow to the sky. I am not holding my breath though and neither should you:

Rob Johnson: Let me, before we talk about the response of the officials, underscore what you just said. You would be viewed by a policymaker as someone who’s earning their livelihood from your portfolio, and policymakers are skeptical of listing to market participants because they think the investor is trying to cajole them in a direction that enhances their returns.

But in this case you’re disclosing that you’re short these institutions, and you’re talking to them, warning them, in a way that could mitigate a crisis and diminish the returns that you would otherwise obtain.

So in essence, you are talking about public policy here very distinctly from what would benefit you, which would be – in your portfolio – which would be this calamity.

Jim Chanos: I do have four children and I sometimes put other things beyond any financial return, and the size of this problem was so large that, you know, if I wasn’t going to sound the alarm bells certainly I figured someone else would, and I was being asked by the U.S. government to come and give a presentation and give my thoughts freely and I took that seriously.

So where’s this reform we have been waiting for? In this op-ed piece in the NY Times, former Fed Vice Chairman Alan Blinder outlines why financial industry reform hasn’t been enacted yet. I am paraphrasing and summarizing but it basically comes down to the fact that the incentives for Congress and the administration are not aligned with the best interests of people on Main Street. If that is a surprise to you I apologize for being the bearer of bad news:

After all we’ve been through, and with so much anger still directed at financial miscreants, the political indifference toward financial reform is somewhere between maddening and tragic. Why is the pulse of reform so faint? I see five main reasons:


Can you spare a dime to help ex-Fannie Mae execs pay their legal bills? No? Well too bad. Apparently taxpayers are funding the legal costs of two former Fannie employees who admitted no wrong wrongdoing (of course) but did agree to pay a trivial fine of $31.4 MILLION. This is just another example of the clusterfuck that comes about when the government is forced to takeover or become shareholders in (formerly) private businesses:

Almost two years later, in 2006, Fannie’s regulator concluded an investigation of the accounting with a scathing report. “The conduct of Mr. Raines, chief financial officer J. Timothy Howard, and other members of the inner circle of senior executives at Fannie Mae was inconsistent with the values of responsibility, accountability, and integrity,” it said.

That year, the government sued Mr. Raines, Mr. Howard and Leanne Spencer, Fannie’s former controller, seeking $100 million in fines and $115 million in restitution from bonuses the government contended were not earned. Without admitting wrongdoing, Mr. Raines, Mr. Howard and Ms. Spencer paid $31.4 million in 2008 to settle the litigation.

When these top executives left Fannie, the company was obligated to cover the legal costs associated with shareholder suits brought against them in the wake of the accounting scandal.

Now those costs are ours. Between Sept. 6, 2008, and July 21, we taxpayers spent $2.43 million to defend Mr. Raines, $1.35 million for Mr. Howard, and $2.52 million to defend Ms. Spencer.

(Picture of Alan Blinder courtesy of