in unemployment is just the final part of an otherwise bleak economic
picture. Manufacturing is hurting too. Last Wednesday, the December
ISM Manufacturing Index plunged to 47.7, its lowest level in five
years. The news put the stock market into a 200-plus nosedive
and sent gold soaring over $800 per ounce. Since then, the news
has gotten progressively worse. The market fell another 200-plus
points on the Labor Depts report on Friday, followed by
238 point jolt on Tuesday on rumors of (potential) bankruptcy
at mortgage lending giant, Countrywide Financial, and a 2.6% plunge
in pending housing sales from the National Association of Realtors.
By the time ATT announced its fears of reduced consumer
spending the market was already barrel rolling towards earth
in a sheet of flames.
Jones is now 10% off its yearly high, the official sign of a correction.
More important, equities blew through their support levels indicating
a basic change in the markets trajectory. Its a primary
bear market now and any rebound will be temporary. Theres
still a lot of fat to be trimmed before overvalued stocks return
to the mean. No wonder Bush is nervous.
rate cuts and geopolitical jitters have sent gold skyrocketing.
Since August 2007, gold has gone from $650 per ounce to $887,
a whopping $237 in just 5 months. If that is not an indictment
of the Federal Reserve and their loosey-goosey monetary
policy; then what is? According to the Wall Street Journal
gold and oil have run almost in perfect tandem. The price
of gold has risen 239% since 2001, while the price of oil has
risen 267%. That means if the dollar had remained as good
as gold since 2001, oil today would be selling at about
$30 a barrel, not $99. (WSJ, 1/4/08)
right; the price of gas today is attributable to war, tax cuts
and the relentless expansion of credit by the Federal Reserve
NOT OIL SHORTAGES!
energy prices are increasing the cost of food production, which
creates a self-reinforcing inflationary cycle. Additional rate
cuts will only weaken the dollar further and put an even greater
burden on maxed-out consumers.
left on his Victory Tour of the Middle East, Bush
will be a stimulus package however meager and therell
also be more rate cuts by the Fed. That means that gold and oil
will continue to soar and the dollar will continue to get hammered.
Bernankes options are limited, as are Bushs. The system
is grinding to a halt and the Fed chief will have to use the tools
at his disposal to try to stimulate economic activity. It wont
be easy. Presently, he faces a number of challenges. Home prices
are falling, retail spending is off, commercial real estate is
in a sharp downturn, and many of the major investment banks are
capital impaired from their poor investments in mortgage-backed
bonds. If the Feds low interest smelling salts
dont revive the comatose American consumer and get
the cash registers at Target and Billy McHales ringing again
the world will face a global slowdown. Thats why the Fed
Funds rate will probably get hacked by 50 basis points by months
end and Comrade Bushs economic team will concoct a fiscal
bailout plan worthy of Fidel Castro.
We There Yet?
number of market analysts believe were already in recession.
David Rosenberg of Merrill Lynch put it like this: According
to our analysis, this [recession] isnt even a forecast any
more but is a present day reality.
argues that a weakening employment picture and declining retail
sales signal the economy has tipped into its first month of recession.
Mr. Rosenberg points to a whole batch of negative data to support
his analysis, including the four key barometers used by the National
Bureau of Economic Research (NEBR) employment, real personal
income, industrial production, and real sales activity in retail
and manufacturing. (UK Telegraph)
one chooses to call it a recession or not is irrelevant. When
the two behemoth asset-classes real estate and securities
begin to cave in, theres bound to be some ugly fallout.
Housing stayed strong during the dot.com bust. Not this time.
No way. The whole system is keeling over and it could take the
bond market along with it. As the two gigantic equity bubbles
lose gas, consumer spending will stall, business activity will
slow, more workers will get laid off, and prices will tumble.
Equities and commodities will be hit hard (even gold) and housing
prices will dive to new lows as the pool of potential buyers grows
smaller and smaller.
will be further aggravated by the lack of personal savings and
the huge debt-load which will push increasing numbers of homeowners,
credit card customers, even student loan recipients into default.
By 2009, bankruptcy will be the fastest growing fad in American
are now predicting that home prices will dip 30% by the end of
2008. That means that nearly 20 million homeowners will be upside-down,
that is, they will owe more on their mortgage than the current
value of the house. (Imagine owing $400,000 on a home that is
currently worth $325,000!) 40% of all homeowners in the US will
be upside-down by the end of next year. This is a grave systemic
problem that will have widespread implications. Experts already
know that when mortgage holders have negative equity
they are much more inclined to put their keys in the mailbox and
skip town. Hence, the name for this increasingly common practice
jingle mail. Secretary of the Treasury Henry
Paulson is desperately trying to put together a national rate
freeze to avoid, what could be, the most devastating surge
of foreclosures the world has ever seen. Paulsons rate freeze
does not offer New Hope as promised but, rather, a
lifetime of servitude paying off an asset of ever-decreasing value.
Underwater homeowners are better off taking the hit to their credit
and letting the bank repo the house. Let the bank worry about
it. They created this mess.
bubble is deflating faster than anyone had anticipated. Overall
sales have slipped more than 40% from their peak in 2005 whereas,
prices have gone down a mere 6.5%. Prices, which are a lagging
indicator, have a lot further to drop before they touch bottom.
Robert Schiller, Professor of Economics at Yale University and
author of Irrational Exuberance, predicted that
there was a very real possibility that the US would be plunged
into a Japan-style slump, with house prices declining for years.
Shiller, co-founder of the respected S&P Case/Shiller house-price
index, said: American real estate values have already lost
around $1 trillion [£503 billion]. That could easily increase
threefold over the next few years. This is a much bigger issue
than sub-prime. We are talking trillions of dollars worth
of losses. (Times Online, UK)
on the right track, but his estimates are way too conservative.
After all, in 2002, the median price of a single-family home in
Los Angeles was $270,000. But, by 2006, the cost of that same
house had doubled, to $540,000 pushed by unbridled
speculation fueled by unparalleled access to mortgage capital.
(LA Times) The problem was cheap credit that was readily
available to anyone who could fog a mirror. All that has changed.
The banks have tightened up their lending standards, and jumbo
loans (loans over $417,000) are nearly impossible to get. So,
why doesnt Schiller believe that prices will return to 2002
levels? They will. And theyll go even lower; much lower.
In fact, real estate is quickly becoming the leper at the birthday
party; everyone is staying away. That means that prices will fall
and more rapidly than anyone imagined. The word is out
on housing and its not good. The blood is in the water.
Get out before the pool of mortgage applicants dries up entirely.
The US banking
industry has never faced greater challenges than it does today.
Many of Americas largest and most prestigious investment
banks are seriously under-capitalized and buried beneath hundreds
of billions of dollars in complex, structured investments that
are being downgraded on a weekly basis. On top of that, many of
the banks main sources of revenue have vanished as investor interest
in sophisticated mortgage-backed bonds and derivatives has disappeared
altogether. For example, the sales of collateralized debt obligations
(CDOs) plunged 85% to $15.69 billion in the fourth quarter.
Also, The value of Alt-A mortgages . . . issued in the third
quarter fell 64% to $39.3 billion from the second quarters
record high of $109.5 billion . . . S&P said the dramatic
drop is the result of unprecedented credit and liquidity
disruptions for both borrowers and lenders (Dow Jones)
These are steep declines and represent a serious loss of revenue
from the banks bottom line.
the banks are simply in survival mode trying to conceal
the magnitude of their losses from their shareholders while attempting
to attract capital from overseas investors to shore up their sagging
collateral. (via Sovereign Wealth Funds)
are now struggling to fulfill their function as the main conduit
for providing credit to consumers and businesses. They have curtailed
their lending as their capital base has steadily eroded through
persistent downgrading. The Federal Reserve has tried to resolve
this issue by opening a Temporary Auction Facility (TAF), which
allows the banks to secretly borrow billions from the Fed without
the embarrassment of disclosing the transaction to the public.
The banks are also free to use Mortgage-backed securities (MBS)
and commercial paper (CP) as collateral for securing the Fed repos.
Its a sweetheart deal and more than 100 financial institutions
have already taken advantage of the Feds largesse.
a bad sign. It indicates that the banks are seriously overextended,
capital impaired and need a handout from the Central
Bank to keep from defaulting. It means that the vaults are stuffed
with worthless mortgage-backed slop that they are deliberately
hiding from their shareholders and depositors. If there were adequate
regulation then the banks would never have been allowed to dabble
in such risky debt instruments as subprime loans and toxic CDOs.
The whole catastrophe could have been avoided. Instead, hundreds
of billions of dollars will be wiped out, a number of banks will
fail, and public confidence in their institutions will be shattered.
the Federal Reserve announced that it will increase the
size of two scheduled auctions of emergency loans by 50 percent
to $30 billion as part of a global attempt by central bankers
to restore faith in the money markets. (AP) In other words,
the Fed will provide an even bigger begging bowl to prop up the
banks to maintain the appearance of solvency. It is an utter sham.
and scale of the approaching recession is impossible to forecast.
The real estate and stock markets will undoubtedly see trillions
of dollars in losses, but what about the estimated $300 trillion
dollars of derivatives, credit default swaps and other abstruse
counterparty options? Will the global economy freeze up when that
ocean of cyber-capital suddenly evaporates? Will that virtual
wealth simply vanish into the ether when the underlying assets
(CDOs, MBSs, ABCP) are downgraded to pennies on the dollar, or
when the number of home foreclosures catapults into the millions,
or when the dollar slips to a fraction of its current value? No
one really knows.
Fed President Dennis Lockhart summarized what we can expect in
a speech he gave last week titled The Economy in 2008.
upcoming recession will look like has been the topic
of a fierce debate on the Internet. Everyone seems to agree that
this is not a typical economic downturn resulting from overproduction,
under-consumption or malinvestment. Rather, it is the crashing
of humongous equity bubbles that were generated by the Feds
abusive expansion of credit and the unprecedented proliferation
of opaque structured-debt instruments. Many believe that the unwinding
of these bubbles will trigger a round of hyperinflation which
is already evident in soaring food, energy and health care costs.
These prices are bound to increase substantially as the Fed continues
to cut rates and further undermine the dollar.
real issue (it seems to me) is the unfathomable loss of market
capitalization, the growing insolvency of maxed-out consumers,
and the inability of the banks to freely extend credit to responsible
loan applicants. These three things are likely to drag down all
asset-classes, slow business activity to a crawl, and compel consumers
to hoard rather than spend. The dollar will strengthen in a deflationary
environment (if that is any consolation?).
Kasriel, Sr. V.P. and Director of Economic Research at The Northern
Trust Company answers some typical questions about deflation in
a recent interview with economic guru Mike Shedlock (Mish):
Mish: Would you say that consumer debt in the US as opposed to
the lack of consumer debt in Japan increases the deflationary
pressures on the US economy?
banks dont lend and consumers dont borrow; the economy
crashes. End of story. The whole system is predicated on the prudent
use of credit. That system is now in terminal distress. Everyone
to the bunkers.
Yes, absolutely. The latest figures that I have show that banks
exposure to the mortgage market is at 62% of their total earnings
assets, an all time high. If a prolonged housing bust ensues,
banks could be in big trouble.
What if Bernanke cuts interest rates to 1 percent?
In a sustained housing bust that causes banks to take a big
hit to their capital it simply will not matter. This is essentially
what happened recently in Japan and also in the US during the
Can you elaborate?
Most people are not aware of actions the Fed took during the
great depression. Bernanke claims that the Fed did not act strong
enough during the Great Depression. This is simply not true.
The Fed slashed interest rates and injected huge sums of base
money but it did no good. More recently, Japan did the same
thing. It also did no good. If default rates get high enough,
banks will simply be unwilling to lend which will severely limit
money and credit creation.
How does inflation start and end?
Inflation starts with expansion of money and credit. Inflation
ends when the central bank is no longer able or willing to extend
credit and/or when consumers and businesses are no longer willing
to borrow because further expansion and /or speculation no longer
makes any economic sense.
So when does it all end?
That is extremely difficult to project. If the current housing
recession were to turn into a housing depression, leading to
massive mortgage defaults, it could end. Alternatively, if there
were a run on the dollar in the foreign exchange market, price
inflation could spike up and the Fed would have no choice but
to raise interest rates aggressively. Given the record leverage
in the U.S. economy, the rise in interest rates would prompt
large scale bankruptcies. These are the two checkmate
scenarios that come to mind. (read
the whole interview here)
the whole inflation-deflation debate is academic.
The real issue is the length and severity of the impending recession.
Thats what we really want to know. And how many people will