The Market Ticker

You have to love Krugman being credited with the late-day rally:

“I would not be surprised if the official end of the U.S. recession ends up being, in retrospect, dated sometime this summer,” he said in a lecture today at the London School of Economics. “Things seem to be getting worse more slowly. There’s some reason to think that we’re stabilizing.”

U.S. stocks erased an earlier decline after Krugman made his comments. The Standard & Poor’s 500 Stock Index was little changed at 939.14 at 4:07 p.m. in New York after slumping as much as 1.5 percent earlier, and the Dow Jones Industrial Average gained 1.36 points to 8,764.49.

Now that sounds good, right?

Ehhhhh.... watch how these buttclowns cover either possibility:

Krugman, a Princeton University economist, has warned recently that the U.S. government hasn’t done enough to help the country’s economy recover. Last month, at a conference in Abu Dhabi, he said the fiscal stimulus is “only enough to mitigate the slump, not induce recovery.”

....

Even with a recovery, “almost surely unemployment will keep rising for a long time and there’s a lot of reason to think that the world economy is going to stay depressed for an extended period,” Krugman said.

This is how you manage to claim you are never wrong.  You simply say both things, and that way, no matter what happens you're covered.

Let's go back and review for a minute or two.

Last week I cited this "victim" of the credit crisis:

Far from being one of those who used easy-money loans to speculate on homes proliferating across the desert soil of greater Phoenix, she has lived in the same modest, stucco-sided condo in suburban Mesa for a dozen years. She bought the two-bedroom home in 1997 for $77,500.

....

Like tens of millions of other American homeowners, she added to her mortgage balance as the value of her condo swelled, at one point exceeding $200,000. She refinanced to pay off some credit cards and settle into a 30-year, fixed-rate loan. Later, she took out a home equity line of credit to buy a new Hyundai. She refinanced again in 2007, borrowing $20,000, mostly for a new roof.

Now let's dissect this.

This woman's pay is listed as "more than $1,000 every other week" in take-home pay.

From that we can work backward; there are 26 pay periods, so that's more than $26,000 in "take home" pay.  If we back out FICA and other tax withholdings, we likely wind up somewhere around $40,000 gross.

This income buying a $77,500 condo is quite conservative.

But note what happened: Over the space of 10 years, that $77,500 mortgage turned into $144,000, or about 70,000 in extra debt.  Over ten years, that's $7,000 of additional spending beyond income per year.

Note that she was taking home $26,000 after taxes, but spending almost one third again as much through taking on more and more debt.

This, ladies and gentlemen, is why we are in this damn mess!

Now you say "well, so what?"

I'll tell you what: There are millions of Americans just like her.  And that's a problem - not because people like her might go broke (they will) but because that excess, pulled-forward demand in the economy cannot be re-created. 

IT IS NOT POSSIBLE.

Now spending 30% more than you make is an extreme case.  Or is it?

Its not as extreme as you'd think.  Some people lived within their means, certainly.  Quite a few people did.

But let's assume that one in ten households lived at an excess spending level somewhere around hers.

That means that about 4-5% of aggregate demand has simply disappeared and cannot return - all other things being equal.

But of course all other things are not equal.  When this woman no longer can buy a new car, the people who build the car have no work - and they get laid off.  This further contracts the economy.

In reality, each dollar of excess spending that doesn't happen is, economists tell us, backed by $2-4 worth of economic activity. 

This means that somewhere between 10-20% of consumer demand is simply gone and cannot return.  Since the consumer is 70% of GDP, this in turn translates into a contraction in GDP of somewhere from 7-14%.

And that's just people who spent beyond their incomes.  Millions more spent at their income, but did so using debt.  That's a further contraction in GDP of some unknown amount.

The fact is this:

Essentially the entire "recovery" from 2003 to 2007 was nothing more than pulled-forward demand via "fog-a-mirror" credit that is now exploding and will continue to explode.  That demand is permanently gone but less than 1/3rd of the balance sheet damage that has to be taken before the economy and market can clear has been recognized and absorbed.

THE OTHER 2/3RDS IS YET TO COME, AND COME IT WILL WHETHER WE LIKE IT OR NOT!

I have argued that we are facing at least a 20% contraction in GDP before we reach equilibrium.  This, of course, horrifies economists and politicians, as they ramped up government spending at the same time, and firing government workers or not paying millionaire-size pensions to firefighters is politically difficult - at best.

Yet just as outsize spending creates more GDP increase than you'd think, so debt overhang creates more drain than you'd think. 

The math works both ways.

Krugman has no chance of being correct.  We haven't come anywhere near clearing the bad debt out of the economy, but we have to and further, we must reset downward economic output to match actual consumer demand.

Until we do any attempt to "deal with the recession" is an exercise in can-kicking, and the bond market is getting tired of the idea that government will spend double what it takes in via taxes - fast.

Obama might be able to fool you just as did George Bush, but neither can or will fool the bond market. 

The Chinese, Saudis and others with actual money that we are attempting to borrow to kick that can once again have figured out our scam and they are headed for the exits.

Bernanke's "Quantitative Easing" is almost identical in intended effect to a program The Fed ran during and after WWII to try to keep people's war bonds from depreciating (due to increases in interest rates.) 

It didn't work and The Fed abandoned the program in 1951.

The bottom line is that until austerity comes to the fore, bad debt is flushed and the economy is ratcheted down to a sustainable level of output there can be no durable recovery. 

Housing MUST CONTRACT IN PRICE to a sustainable, affordable level.  It has not finished doing so and until it does reach that equilibrium with interest rates in the 7-8% range we are not at the bottom.

As a direct consequence of the math, which is never wrong, I sent the following to Krugman by email this afternoon:

You were quoted on Bloomie this afternoon claiming it (the recession) would be over by September.

I'm the guy who writes http://market-ticker.org.

I'll bet you're wrong - not a snowball's chance in hell The Recession is over on or before September.  We'll go with the NBER's official claim (even though I'd argue its flawed.)

The loser puts on a clown suit and either shows up at CNBC to wear it and admit they're wrong, or, if CNBC won't have the loser, does it on Youtube.

Game? 
 
--
Karl Denninger

I'm willing to bet that I will get no reply to that challenge, because, of course, Krugman will claim he didn't actually make that prediction.  He hedged his bet so that when (not if) what's left of the housing market implodes under higher interest rates he can claim that he "never said it would be over."

Yeah, right Paul.

And by the way - if you bought the market this afternoon into that ramp job?

Good luck.

You're going to need it.

Disclosure: Lightly short the broad market and will be shorter than a field mouse soon.

As I have often said, "I don't do specific investment advice."

There are several reasons for this, among them being:

1. I'm not a registered investment advisor.  That is, it is actually illegal for me to run someone else's money (other than as a trustee, such as for my daughter.)
2. It is flatly impossible for me to calibrate someone's risk appetite and capacity, both physical and mental, to absorb possible loss, over The Internet or, for that matter, without an extensive inventory of someone's income, assets and liabilities.  (By the way, most so-called "financial planners" don't do nearly enough in this regard to FULLY understand their clients.)

But at turning points in the market - such as prior to 2008 - it was easy to see what was coming - even if timing was somewhat uncertain.

This is one of those times, and it compels me to publish a list of "10 things you must do now" - that is, if you have your eye on the ball.

The last week's wild gyrations in the bond market have made clear that Bernanke and his "pals" are quickly losing control of the bond curve.  Friday's selloff in 2s was particularly ominous as that money did not go into equities or precious metals - it simply "went".  The 2year is commonly thought of as the "demarcation line" between the short and long end, so when I saw 2s get sold down the antenna went up in a major way.

It is one thing for people to flee the long end of the bond curve; that's bad.  Its another for people to flee Treasury bonds in general - that's an unmitigated disaster.  The auctions last week showed that there is an incredible appetite from foreigners for very short term government debt - 4 week to 52 week bills - where the indirect bidder activity was at or close to double historical norms.  This, in the face of the incredible amount of issuance that is occurring, tells me that they're selling something to replace it with these short-term instruments.  Friday told us what the "something" was.

Folks, we have taken the wrong road.  At the fork in mid 2007 and indeed into 2008 when the fork was still accessible I wrote extensively on the path we had to take if we wanted to avoid at best a Japan-style flatline of the economy for years, and at worst something beyond the 1930s in terms of awful. 

We have done nothing to rid ourselves of toxic debt.  The implosion of the PPIP, the latest incantation of the "Super-SIV" (remember that?) makes clear: government will not force recognition of losses and thus the clearing of the market, as doing so would destroy too many who have bribed, er, made "campaign contributions", to the political sphere.

Worse, government not only took on these debts themselves (via The Fed and Treasury with their "support" programs) but continues to issue more and more debt to fund what is a categorically-insane federal budget - one that is, this fiscal year, going to run a deficit of some forty percent.  To put this in perspective when George W. Bush was President many (myself included) were screaming about 10% fiscal deficits.  Barack Obama proposes to run a deficit four times greater in percentage terms.  Where are all the media and other pundits who were yelling about Bush's "deficits for war"?  Silent, that's where, because this time the person doing it is a Democrat.

But math doesn't care about politics.  Math IS.

As a consequence we will instead face the music that this debt overhang will impose on us, whether we like it or not.  We have now transferred some $12 trillion in either liabilities or "promises" to The Federal Government, representing a tripling of the "public float" of outstanding debt and a doubling of the nominal amount. 

This approaches the GDP of the nation in "additions" and exceeds it in total - a demonstrably unsound liability and at or beyond the "warning levels" that Moody's, S&P and Fitch have said would trigger possible "AAA" downgrades.  That is coming, whether it happens now or later.

The demographics also cannot be argued with.  The boomers have had their retirement decimated.  Even with the market levitating at a P/E (on GAAP earnings) of some 120 times (!), they've still lost more than 30%.  Computing P/Es on "operating earnings" is a sham and a fraud, declaring that investment and credit losses don't really matter, yet if you go over to the WSJ "data page" or Yahoo's, that's what you'll find.  (Why do they do this?  That's easy - if you saw a P/E of 120, what would you do as an investor?)

As the boomers are forced to pull their retirement funds they will come out of stocks and ultimately yank the underpinning out from under all asset classes.  It is inevitable.

You have undoubtably seen the "quotes" up above on the banner of this page.  Those are not abstract musings.  They are mathematical computations of where the indices and those names should be trading without the excess liquidity provided by pulled-forward debt demand.  Will the indices and names get there?  Probably not, because not all debt-driven demand will disappear.  But it is a sobering reminder, in your and my (along with everyone else's) face of exactly how much fraud we have countenanced in our financial system.

Pulled-forward demand cannot be pulled forward a second time.  You can keep layering it up but each layer leaves behind interest expense and a principal overhang, both of which must ultimately be either paid off or defaulted. 

Now add to this the foolish (arguably insane) pandering to the UAW in favor of bondholders with both Chrysler and GM.  The government (wisely?) decided to make "secured" bondholders in GM whole - something they didn't do with Chrysler.  Who were they?  Largely the very same banks who got TARP payments.  Gee, what a surprise.  The "ordinary bondholder" - that is, the retiree or parent trying to finance their kid's college education got hosed, while the UAW, who was also unsecured, got more than twice the recovery they should have.  Worse, none of their "legacy costs" - pensions, medical and hourly pay - were brought in line with competitors.  GM and Chrysler will go bankrupt again, this time after draining more than $50 billion out of the Treasury! 

Honda and Toyota executives have to be chuckling at the stupidity of our government, and salivating at the opportunity to take GM and Chrysler apart - for a second time.

The risk of a "sudden stop" event where the bond market tells the government to "piss off" has never been higher.  A ratcheting up of the yield curve, when the average maturation of government debt is now just under 4 years, could easily double interest expense in the budget.  This would put the government in a nasty box: either curtail spending by twice that much (that is, roughly $800 billion) immediately or the addition to the deficit could force another ratchet higher in yield.  This is a "death spiral" that can happen with amazing speed.  If it does, everything you think the government should provide will disappear and asset prices - all of them - will collapse along with the economy.

How likely is this outcome?  About 60%.  Not certain - yet - but too high.  A couple of years ago I would have pegged this sort of nightmare scenario in the 20% range.  Back in September and October, 30-40%.  In March, 50%, but driven by pension fund explosions in the large-cap space.  Now that seems to be temporarily off the table due to the rally in the stock market (gee, think Bernanke saw that risk too?) but the problem wasn't resolved - they just shifted the risk once more, this time to the Treasury curve.  If the government is once again forced to pull liquidity to defend the Treasury complex (and I believe they will) we will ratchet the risk higher, as the stock market will again decline precipitously but we will have cleared nothing, leaving the risks as cumulative.

How many times can we "kick the can"?  An infinite number of times?  Absolutely not.  Each kick fills the can with more and more sand, until you stub your toe.

Do you want to be investing in stocks right now?  Why?  On the back of a 40% rally?  If you missed it, you did.   What are the odds of another 40% increase?  Back to 2007 highs?  With unemployment knocking on 10%? - the "more severe" stress test scenario - and almost certain to not stop there? 

Now consider the risk of a 40% decline - that is, back to the March lows or worse.  Unthinkable?  Think again; it happened before, didn't it?  Care to bet against the macro economic environment?

Don't say you weren't warned.

So without further adieu, here's my list of 10 things you need to be doing now:

Stop listening to those who claim that "The Market is telling you the recession is ending/over."  Baloney.  What was the market telling you in October of 2007 when the SPX hit 1576?  That everything was great and "subprime was contained", right?  Any more questions on that piece of nonsense?

Get out of debt - NOW.  Revolving debt in particular is murderous.  If your credit line hasn't been cut back or your interest rate jacked, you're one of the few.  It will happen.  Going bankrupt due to increasing debt service requirements (with or without job loss) sucks. 

Stop spending more than you make - in fact, do the opposite - start saving.  NOW.  You need to be saving 10% of your gross income.  Not net or "excess" - gross.  These funds serve two purposes: an emergency fund (which you're likely to need) and if you have one already it will also serve as a fund to buy up assets that will be puked up when things get really bad.  You don't get wealthy by selling to some other sucker - you get wealthy by buying when nobody has any money to buy - that is, by driving the hardest bargain you can imagine!

I've said it before but it bears repeating: have the ability to make it even if you lose your job.  Most people say three months of reserves are necessary.  I've said six months to two years, and I'll reiterate it.  And reserves means cash, not credit.  Parked in a credit union is ok - but be prepared to make that actual cash in a big honking hurry if you need to.  How do you know if you need to?  If and when the first Treasury auction fails, the market crashes below the 666 March low and/or a big bank fails, you need to.

Pull ALL of your business from ANY bank that has received federal assistance.  The community banks and credit unions have been screwed by the crony government interests in two ways - first, by regulators allowing bankrupt banks to pay overly-large CD rates when they're insolvent (that's fraud on its face) and second by proposing to tax them through FDIC assessments to pay for the sins of the imprudent.  Withdraw your consent and assistance - move your funds to a credit union or local community bank, but before doing so ask to see their financials and look specifically for over-leverage in commercial real estate and other development "assets".  HIT THE BAD GUYS IN THE WALLET - THE ONLY PLACE THEY UNDERSTAND!

If you have assets in the stock market, and have thus enjoyed the rally off SPX 666, either sell or hedge that exposure RIGHT  NOW.  The upside risk is what - 10%?  What's the downside risk?  50% or more.  You can hedge effectively with PUTs which have gotten much cheaper as the VIX has fallen, or simply sell out and go to cash.  In my opinion you're insane to play for another 10% gain when you may suffer a 50% loss, but that's my view.  Just don't say you weren't warned if you do nothing and the collapse occurs!

Figure out what you're going to do if we suffer a "sudden stop" and be prepared to execute that plan.  Consider what a collapse in trucking, for example, does to the food supply into major cities.  This is a low-probability risk right now (perhaps 10-20%) but if it happens major cities will become free-fire zones within hours.  A gun won't do you a damn bit of good when there's a potential rifle barrel sticking out of every window and the person behind it is interested in the bag of groceries you're carrying.  You are not Rambo (and by the way, have you noticed that Rambo always goes after bad guys in some small, flat hellhole?  Ever wonder why?  With a sniper rifle poking out of every second window even John Rambo doesn't stand a chance.)  Those who live on the coasts have hurricane plans.  Everyone needs a "sudden stop" plan, and it must not rely on access to credit of any sort, because if "it" happens that access will disappear instantly.  For people in rural America, this might not be that big of a deal.  For those who live in big cities it is - and its something you probably haven't thought through to the degree you need to.

Don't count on metals.  I know, I know, we're going to hyperinflate and gold is going to the moon.  I have one question: Can you eat it, drink it, run your car on it, sleep under it, or screw it?  No?  That's a problem.  A "sudden stop" is not a hyperinflationary event - it has good odds of being quite the opposite.  God help you if you put your eggs in that basket and are wrong.

Acquire lawful means of self-defense.  Your odds of being victimized are roughly 1 in 100 annually under normal conditions.  What happens when its 1 in 5?  Think it won't be?  Ok, if doesn't really get bad then you spent money on something you don't need, but you still have it and can sell it (even if you take somewhat of a loss.)  If you wait, and then decide you need it, what are the odds of being able to find a firearm?  And by the way, weapons you don't know how to use in a competent and cool fashion if you need to are worthless or worse.  This means range time and/or professional instruction, and both take time, effort and money.  Again, this is called "hedging" - your life and property, this time (instead of your investment portfolio)

Figure out who your friends are - and aren't.  This isn't about who you like.  Its about who you can trust with your back - no questions asked.  If things get bad the second-to-the-last thing you want to be is alone - right before being around anyone who is less than 100% trustworthy.  Think about this point long and hard - this doesn't mean dumping acquaintences now, but it does mean knowing who you group with if you need to - and who you avoid.

Jesus, when does the idiocy stop?

Kagan defended the use of funds from the Troubled Asset Relief Program and argued that Indiana's appeal lacks legal merit. In addition, she said the losses to the Indiana funds "cannot outweigh" the potential broader problems a collapse of Chrysler would present.

"As an economic matter ... blocking the transaction would undoubtedly have grave consequences," Kagan wrote.

This is the Administration's response to the appeal to the United States Supreme Court (which has not decided whether to grant cert or not) on blocking the Chrysler 363 asset-strip to Fiat.

Here's the problem - the rule of law is not about "the economy will be better if we do this."

Under that rubric you have no right to life, property, or pursuit of happiness.  After all, it would undoubtedly be better for the economy as a whole if the government re-instituted slavery for anyone who was jobless - go build that road or bridge under penalty of being shot!

That is the essence of the government argument - we know this is blatantly unlawful, but the economy will suffer if we don't do it, so we'll break the law, and we demand that the USSC put its stamp of approval on our actions.

The issue is not about whether Chrysler should go bankrupt or not.  Clearly, they should.

It is about whether bankruptcy priority, which is a matter of black-letter law, can be overturned not by the operation of the law in a courtroom by a judge but rather by Treasury, who came in and strong-armed a "resolution" that favored one unsecured creditor class over another which, according to the law, has actual priority.

The infirmity of such an argument isn't just that it is a demand for a rubber stamp of a blatantly-unlawful act - it is that the claim of economic harm is in fact reversed.

If you destroy the priority rights of creditors in a bankruptcy you have effectively defined all bond investors as having no priority whatsoever in a liquidation.

This will lead to the demanded coupon for corporate debt rising dramatically, which in turn will create even more economic damage.

The balance of harms isn't even examined in the government's brief, for the simple reason that strong-arming one corporate merger under the bankruptcy code can't possibly outweigh the impact on corporate debt issue of every firm in America.

Rather than deal with that infirmity the government simply ignores it as though it does not exist.

But whether the USSC decides to hear the case or not, the market cannot be strong-armed into buying corporate debt.  In the court of the capital markets government is powerless to demand that corporate debt issues be taken down by private investors.

The Obama administration is making a grave mistake, and should the USSC refuse cert (which I expect) the repercussions of this action will be firmly "owned" by President Obama and his administration.

Buckle up.

Now the Chinese are getting desperate - their BS is becoming transparent to anyone with a brain:

NEW YORK (Reuters) - A top Chinese banker on Sunday called on the U.S. government and the World Bank to sell yuan-denominated bonds in Hong Kong and Shanghai to encourage the development of debt markets in those centers and to promote the yuan as a major international currency.

Baloney.

The intent of such a sale would be to make The United States subservient to China and its currency.

This, by the way, is how both Weimar Germany and Argentina were forced into hyperinflation. 

See, if your currency declines when you have issued debt in a foreign currency then the principal value of that loan has just gone up.  This in turn causes your credit rating to decline (your debt-to-income goes up) which in turn forces your currency lower, which makes the principal value go up again, which.....

Got it?  Good.  This is called a "death spiral" and is how you destroy a nation's economy, right before you come in and destroy its government - either politically or, in the extreme case, with guns, soldiers and, nowdays, nuclear weapons.

Gee, you don't think that a nation that is a "currency manipulator" might force such a spiral to initiate once they have suckered us into selling RMB-denominated debt, do you?

Such a step as selling RMB-denominated debt would be suicidal for The United States, and as such my answer - and that of our government - to China is and must be best and most-simply expressed in the following image:

Yes, I said 1.2 million, not the 600,000 reported:

WASHINGTON (Reuters) - President Barack Obama said on Monday he expected to create or save 600,000 jobs over the next 100 days by expediting 10 major projects funded by a huge stimulus package that Congress passed in February.

Uh huh.  This is what The White House says thus far:

The White House said the $787 billion Recovery and Reinvestment Act has helped save or create over 150,000 in the first 100 days since it was signed.

And what about the other 600,000?  That was from Bush's "stimulus" package, remember?

"We know they're going to be helpful," Paulson said on CNN television. "These checks should be a big part of adding 500,000 to 600,000 additional jobs this year."

That was March 31st, 2008.

How'd it work out?

600,000 must be a nice round number.  I wonder if they left the other two "6s" off - you know, "666,000"? 

After all, the words of these politicians appear to be about as trustworthy as what comes out of the mouth of this fine fellow:

Disclosure: Long Beelzebub; you know he's lying.