Let's score the 2009 edition first:
I count 14 "hits" (including half-points) out of 25, for a score of 56%. That's not so good, especially compared to last year.
Ok, so where did I go wrong?
That's pretty simple: I dramatically underestimated the willingness and ability of "the criminal class" (that would be those in DC and on Wall Street) to lie, cheat, steal, paper over insolvency and get away with it - at least for a while.
Will this ultimately lead to an actual recovery? No. It mathematically can't. A short-term bounce in various metrics, yes, just like an insolvent person can spend on his credit cards until they get cut off and look like they're improving.
The S&P 500 currently stands at roughly 1120. Most "market callers" are expecting another 20% increase next year, which would put it at 1350, just 15% off the all-time high of 1576 and fairly close to where it finished 2007 - that is, as if 2008 and 2009 never happened. Lunacy, says I, unless leverage can return to where it was in 2007.
Let's remember what happened in 2005 and 2006 that made those things possible. Investment and commercial banks were stuffing various sorts of securitized paper with garbage loans they knew could not be paid, then selling them off to "investors" (who would later be shown to be bagholders.) This allowed for an unprecedented expansion in consumer and financial system credit - and that, in turn, allowed the buying of "stuff", whether it was companies playing LBO or you buying a house to flip with an OptionARM.
That was the legacy of the "expansion" in 2005 through 2007, and it is not coming back.
In short this time it really is different, and the proof is right here:
This is the first time since records began at The Fed that credit outstanding has decreased. I have taken the liberty of breaking down the periods into 10 year chunks, which makes it easier to see:
Pay attention to this last graph, as it is the important one in terms of the 2003-2007 "recovery" - note that we went from ~32 trillion in outstanding debt to $53 trillion at the peak, an expansion of 66%.
That's how we "recovered" from the tech bust, and to believe that we will "recover" from this one you must either find a way to expand debt by a similar amount - that is, to nearly $90 trillion all-in - or figure out how you will get $35 trillion in spending in the US economy above and beyond what we're doing now over the next three to four years. In short, we cheated, and to believe we can do it again you must explain how we can cheat once more - and to that degree.
And by the way, for those keeping score - since our monetary system is debt-based declining credit outstanding is the definition of deflation in the monetary sense!
This is exactly what Bernanke said he could avoid. He was wrong and there is no further room for argument on that point.
Further, I do not believe for a second that the Bernanke's "pulling back" from the monetary playing field has a thing to do with the "stability" of the markets, especially housing. Specifically, there is no evidence to be found that housing has stabilized or is improving - quite to the contrary. Treasury's "modification" programs have been a joke, with banks either not following through with their supposed responsibilities and borrowers unable to provide documentation of income and assets (because they didn't have the documentation required at the time of the original loan, and still don't!) In short all these "programs" are simply an attempt to paper over the Ponzi in residential housing - with little actual success, but lots of smoke, mirrors and lies.
Madoff got away with the same game for years - produce some false statements and keep soliciting for that new business. All is well until the cash flow forces disclosure of the fact that you're broke - then the ugly truth, that there is no money as it's all gone - comes out.
Such is happening now. Servicers have been passing through the interest payments on MBS but principal isn't there to be repaid. The journal entries are being ignored - for now - because none of this trash is actually trading. It's all being held at or near "par" (100 cents on the dollar) when in fact many of these securities will be lucky to recover anything at all. Even the "credit supported" tranches are in trouble - nobody ever believed, especially in the "prime" space, that defaults could reach beyond 2 or 3% and recoveries be under 80 or so. But they are. Worse, the HELOCs and "silent seconds" are in fact worth zero where the house is worth less than the first note due to priority of claims - yet most of those are being carried at or near full value.
A big part of the reason for this deterioration is due to "misclassification" of loans. That is, loans were claimed to be "prime" when they were not - they were either "ALT-A" or worse, Subprime in fact, but stuffed into MBS as "prime paper" and then resold onward. Fannie and Freddie have been recently fingered as a major part of this, but unlike the author of the recent WSJ Opinion piece I believe this scam went much further than the two GSEs - and there has yet to be any honest examination (say much less prosecution) for this conduct.
There's a rather complex "prisoner's dilemma" going on at the present time, with none of the banks wanting to liquidate either securities or inventory lest they trigger an avalanche. Yet each is eying the door, fully-aware that the first one through will be the only one who gets through should anyone bolt. One of the more-interesting identities for the man yelling "FIRE!" could be a lawsuit - or state prosecution - over the myriad misrepresentation in this space during the bubble years.
Last year (2009) there was almost no net debt issuance between corporates and Treasuries, adjusted for Quantitative Easing. Indeed, it was only about $200 billion. That this sort of extreme measure was required to prevent a bond market implosion is rather telling. But what's worse is what's on the calendar for 2010 - nearly $2 trillion of net issue, duration-adjusted. A huge part of this is Treasury debt, and there the news is even worse, as there's a serious duration problem in this regard - nearly half (about 40%) has a maturity of one year or less. This means that Treasury must roll over that debt - about $3 trillion worth - "or else."
Ask the asset-backed commercial paper market and auction-rate securities folks what happened to them when their short-duration paper couldn't be rolled on commercially-reasonable terms. Then extrapolate that to what happens to Treasury if (or possibly when) they're unable to roll $3 trillion plus issue another $2 trillion on top of it to fund the deficit. Do you really think that $5 trillion and change of Treasury paper is going to be "all ok" sans "monetization" - or will "they" foment an intentionally-engineered stock market crash to scare people into Treasury debt? I wish Timmy the best of luck with this - he's going to need it.
Remember, the belief that foreigners will not be there to rescue us this time around is not speculation - it in fact is born out by the latest TIC data, which showed that China had bought a net zero in Treasury issue in October. Nor did anyone else step to the plate. In short foreign nations are chock full of their own issues and are either issuing debt themselves or need their capital internally.
The equity market loves "liquidity" no matter how it comes, whether the truth is embedded in reports or not. Nasdaq 1999 anyone? Those firms were not making money and never would but that didn't stop their stocks from doubling, tripling, and in some cases skyrocketing to 10x their IPO prices.
The key point is that most of them eventually collapsed and were worth zero, but if you were quick (or lucky) you made a lot of money. Of course the other side of that ditty is that if you weren't you lost everything.
There are many who claim that valuations are not "extended" or "bubble-like" and point to the disasters of Q3 and Q4 of 2008 as "drags" on the P/E ratio, claiming that one should ignore negative earnings. This is kinda of like going to the casino and only counting the winning wagers when determining how well you've done. It may look impressive when you brag to your friends but it won't change the fact that you go home broke, and ignoring negative earnings is part and parcel of the same sort of disease.
The fact of the matter is that if you look to corporate and personal income taxes they have all but collapsed. These are of course regressive and governments have been handing out various tax breaks to corporations so this may not be a fair indication of business and consumer activity.
However, sales taxes are, if anything, going up in percentage charged - not down - and yet they are also deep in the red in terms of collections by the states. Since some "necessities" (specifically food in many states) are not taxed this is particular troublesome since this trend points directly toward a collapse in discretionary spending - exactly what we need to power the economy forward. Then there's China, which reported on the 27th that toy shipments to the US were down 15% year/over/year from 2008 - but we're told that Christmas sales were down "only" 1%. Riiiiight.
So much for "economic recovery."
Productivity has been on a tear - and no wonder. Watching everyone around you get laid off has a way of providing a hell of an incentive to work harder, lest you follow your friends to the unemployment line.
These trends - letting employees go and demanding that your remaining workers do more for the same pay, does provide a lift to profits. For a while. But it also destroys the base of consumers you need to buy those products over time, and thus the lift that you enjoy from such downsizing and squeezes is short-lived. The hangover from that speedball should be hitting in Q1 or Q2 of the coming year, and I expect it to be quite the doozy.
China, on the other hand, has outdone us. Burdened with far too much capacity they are, of course, building even more! That would be great except that there's no chance they can absorb the output internally. Not that they care in the short term, as their definition of "GDP" is different than ours - they count a product when it is produced, not sold. Gee, why are there all these products lined up unused, from cars to washing machines to - gasp - literal empty CITIES of townhouses and apartments? How far does that bubble inflate before it blows up? Hell if I know - the Chinese are not exactly models of transparency so the degree of game-playing they can get away with before someone yells "FIRE!" and runs for the door is more difficult to discern than it is over here.
In the last few days the Chinese Premier has said that he won't "bow to pressure" to allow the yuan to appreciate. This of course is code for a weak currency which China desperately wants for its export trade. Then again, so does Japan, and so does anyone else who exports. Competitive devaluation sounds quaint, but you're seeing it, and it is likely to continue as an attempt to play "beggar thy neighbor" in the coming year - and beyond. Playing with explosives these nations are (including our country!)
In the credit arena few lessons seem to have been learned. CDOs, CDO^2s and other similar loose-pin grenades aren't back - yet - but an awful lot of questionable deals are, including, believe it or not, a couple of PIK/Toggle issues. Those, for the uninformed, are bonds that allow payment not in money but in more debt! This sort of "debt pyramiding" is the epitome of stupidity when done by a person and a fairly reliable sign of impending default. In the corporate world we call it "reaching for yield." Uh huh.
Many market commentators believe that last year and through March 09 was a "financial panic" similar to 1987, from which the market recovered quickly. Really? Go look up the page a bit at the credit chart for the 1980s. Do you see any contraction in 1987 and 1988 - anywhere? Nope. None. In fact, credit growth continued unabated even though the stock market crashed. The same occurred in the 2000-2003 time frame (again, look above) during the Tech Implosion. That's the differentiating factor: This was not a market panic, it was and is a credit lock-up caused by outstanding debt exceeding servicing capacity for several years, where the premise became not paying debt through current income but rather a Ponzi-style pyramid that permitted refinancing and the appearance of solvency only so long as asset prices rose!
This is an event that last occurred in America in the 1920s and it occurred this time for the same reason it did the last time: lax or utterly absent regulation allowed people to foist off trash on people while claiming that it was "money good", just as happened with Florida Swampland in the 1920s. The entire premise of the so-called "financial innovation" then, as now, was fraud.
The simple fact of the matter is that greed often comes with stupidity and nearly always is shortly followed by disaster. "Rescued" by governments the "princes of finance" learned nothing, were forced to disgorge nothing, and still walk free among us instead of being either jailed or worse, strung up from a lamp post.
Whether the people of the various nations will put up with another trip down the bailout, Quantitative Easing or "stimulus" road is another matter entirely. Tim Geithner and others have gone too far in their grandstanding, cheerleading and claims of "Armageddon Avoided" - or if you prefer, "Mission Accomplished." Such claims make for great sound bites but have a habit of slamming the door on future intervention, especially if the need for it appears shortly after the claimed "success." Remember well that 2010 contains a midterm election in November, and as things stand our new President has seen his approval rating drop faster than a condemned man does through the floor when the handle is pulled.
Then there's the "HAMP", or "mortgage modification" programs generically (there have been several.) It was claimed that HAMP in particular would prevent 4 million foreclosures by the end of 2009. It has actually resulted in about a half-million trial modifications, but fewer than 100,000 permanent changes. This should not surprise - the reason people got in trouble in the first place as that they bought more house than they could reasonably afford on any rational mortgage plan, using schemes such as 1.5 or 2% negative amortization "OptionARMs." These were not actual mortgages in intent - they were predicated on ever-rising home "values" so that they could be rolled over in a couple of years and amounted to a perpetual below-market rent payment to a bank, collateralized via the speculative bet that prices would continue to rise. When home prices stopped going up there was literally no way around the inevitable - foreclosure.
Government refuses to recognize this as all the trash paper is literally everywhere around the globe! What's worse is that the very same banks that were making these bets along with homeowners then extended HELOC and other second-priority lines behind the first, extending the trash brigade even further.
Never mind Geithner's insanity, as displayed here:
GEITHNER: We were very careful from the beginning—but the qualifications get lost—to say that we are going to focus the bulk of the financial force on bringing interest rates and mortgage rates down to cushion the fall in housing prices and help stabilize home values, which will feed into people's basic sense of financial stability.
The reason we got a bubble in the first place was due to excessively-low rates - that is, a cost of borrowing money that did not reflect the fundamental economic realities of repayment and duration risk.
Insanity defined: Doing the same thing over and over but expecting a different result.
There is much hot air blown about how businesses and consumers have "de-levered." Hogwash. Again, back to the top graph - we've taken a whole $21 billion off the net credit exposure. Oh sure, if you remove FedGov from the picture (and you arguably should) it's more like $850 billion - but let's be real here - we're talking about a fifty-three trillion dollar debt.
Even a trillion is less than a 2% reduction in net leverage!
That's "de-leveraging"? Like hell.
There is much, much more to go. To get back to the leverage levels seen in 2000 - which themselves were overheated - we'd have to drop back some twenty five percent, or roughly $13 trillion dollars.
We're less than 10% of the way there, and we were overheated in 2000.
What's a more reasonable leverage level? How about the "more reasonable" time period between 1951 and say, 1983? 175% of GDP? That would require we cut the outstanding debt by close to half!
Will we see policies that accomplish that? Not voluntarily!
On a more-macro (beyond one year) level, let's look at this last-decade debt chart again:
In the beginning of 2000 the total systemic debt outstanding was approximately $25 trillion. It is now about $53 trillion, or more than double where it was in 2000. Let's look at where we were in various metrics at that time:
This little game of Ponzi (faking "GDP" by taking on more and more debt), by the way, is not new. I present for your edification the following table:
This is the aggregate GDP (that is, all GDP produced) during each decade from 1960 onward, the "DTi" (or debt increment) during that decade - that is, the additional debt outstanding in all sectors during that decade, and the percentage of "GDP" that in fact was NOT from production, but rather was "created" due to raw borrowing.
What we are facing down today is a fifty year Ponzi scheme. Drill that into your head folks - for fifty years we have created false output gains, with the last 40 of those years having between 15-20% of each year's supposed "GDP" not created by the work of people, but by BORROWING MORE MONEY which will have to be repaid with interest.
This is why we hit the wall in 2007.
To run an increase in GDP of about 5%, as so many "pundits" are claiming we will going forward, we would have to increase the total debt in the system to roughly $90 trillion dollars from the present $53 trillion over the next ten years.
That debt would, of course, need to be serviced. And nobody in their right mind can possibly believe that government could take on another $37 trillion - when the current oustanding public debt is just seven trillion (that is, government would have to increase its debt by 500%!)
If you take nothing else away from this Year in Review Ticker, it should be that singular chart above and a decent understanding of what it means:
To come back into equilibrium, assuming we do not decrease debt in the system at all, we would have to shrink GDP by about 20%. But shrinking GDP means that money available to pay down debt would also decrease which would generate even more defaults.
This is how deflationary depressions happen - years, even decades of playing Ponzi by layering debt upon debt. Bernanke and Geithner, along with President Obama, are well-aware of these facts which is why they are all pounding the table demanding that banks "loan more."
The problem with such a prescription is that the wise person won't borrow, for he knows what's coming. The unwise has no collateral to pledge, and thus can't borrow.
If the government forces (either by persuasion or legislation) lending to those who can't pay they only extend the Ponzi and in doing so make the inevitable collapse WORSE.
We have made no progress economically in terms of the common weal of the average American but have added debt in dramatic amounts to paper over the deficiency. That's the bottom line on the 2000s, and despite all the crooning that "the economy is on the mend" one has to look at the reality of the common man on the street to see what's coming around the bend for our economy and ask the following question:
How do we get positive economic growth when by every metric available the disposable personal income available to Americans has gone down, personal wealth has in fact decreased when one subtracts out debt (and you must; nobody in their right mind argues that if you go to the bank and take a cash advance for $20,000 on your credit card that you are "more wealthy" as a consequence of having done so!) and while employment at first blush looks "equal" to 2000 in fact there are 25 million more unemployed due to population growth - people who create drag on the economy due to entitlement spending rather than contributing to productive output?
So with all this said, here's what I believe we're looking at for 2010... ready or not, here it comes!
Note: Subject to minor edits/revisions and perhaps an addition or two until the end of January 1st, as usual.
Edit: 1960s DTi had a misplaced divisor - corrected and paragraph referencing "nutty Ponzi" in that decade removed.
Where We Are, Where We're Heading (2013) - The annual 2013 Ticker
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