The Market Ticker

God the pumping is getting disgusting.

I want to put forward something objective and impossible to argue with:  MATH.

Let's go back to this chart:

$2.5 trillion in consumer credit outstanding.

Now let's focus on the underlying fundamental reality of consumer-generated GDP and economic activity in general, and the impact of what I call the rate spread on that activity.

Back in 2007 before the mess got out of hand you could get a 5% 1 year CD.  That's the savings rate, or what you were paid to save money.

In addition prime credit on revolving accounts was typically handed out (like candy) at 9.9% or less.  I had credit cards with offered rates under 10% and so did a lot of other people.  "Higher risk" but still "standard" rates were in the mid-teens (13-14%), with only penalty rates exceeding 20%.  Nearly everyone could avoid a penalty rate by refinancing their house and paying off their credit card with the HELOC if required.

Ok.

Now we have this "crisis" but due to the lack of will in Congress, regulators and The Fed they fail to force the bad assets out into the open where they are marked to the market and the people who have those bad assets go under.  Doing so would result in a lot of bank bankruptcies.  This is thought of as "bad", but in fact it is only bad for the banks that have lied - the good banks (and there are some) and credit unions would win huge from such an event, as they'd not only get your deposits but also your loan business.

Nonetheless most if not all of the "big banks" are the ones who have Congress in their pocket and they're on the bad list.

So in response to this fees and interest rates have gone to the moon.  I run no balance on my plastic and have a near-perfect FICO (being "dinged" only because I don't carry balances), charging and paying off every month, generating a very nice "discount" income for any card issuer that gives me credit.  Nonetheless I have seen interest rates repriced "for market reasons" up to 13, 14 and in one case to 17.9%.

In addition the interest rate available on a 1 year CD has gone down from 5% to 1%.

What this does to the "spread" and thus private consumer activity is tremendous.  Revolving credit is instantly repriced on the outstanding balance at the new interest rate, as are the CDs when they roll over, typically after a year.

For the "typical Grandmother" who was making 5% on her CD and paying 9.9% on her plastic, the spread was 4.9%.  That is, 4.9% was the "real cost of credit" to her annualized. 

Reasonable.

Now the credit card is 18.9% and her CD earns 1%.  The spread is now 17.9%, or nearly 18%, an increase of 12.8%.

For the "subprime" borrower its awful as well.  He has no savings, so the CD rate means nothing.  But his credit card went from 20% to 36% due to missing one payment.  He's seen a spread increase of sixteen percent.

Why does this matter?

It matters tremendously!

Remember, from the above there is $2.5 trillion outstanding in consumer credit.  An increase of just ten percent in the spread cost for money means that $250 billion dollars each and every year does not get spent on consumption (and employment of those who make what was consumed), it instead goes to the banks to paper over their fraudulently-marked paper!

How big of a deal is this? 

Our economy (at present) is around $13 trillion dollars (was closer to $14, but heh, 'tis a recession, right?) 

This is thus a real and permanent 1.92% decrease in private-activity GDP each and every year and it will NEVER GO AWAY so long as "The Bezzle" mandates that the spread be used to cover up the fraudulent accounting at the banks and other financial institutions!

Nor does it stop with consumers.  Corporations are also paying outrageous spreads over comparable Treasuries to borrow money compared to just a couple of years ago, and that interest once again is going to the banks and other institutions that buy their paper and use the excess spread to paper over THEIR losses on mismarked paper.

As such the $250 billion number is almost certainly greatly understating the true amount of the damage.

Folks, if you think that this sort of game-playing is somehow "beneficial" to the economy or it is "no big deal" this ought to disabuse you of that notion RIGHT NOW.

There is no possible way to generate a durable trend-growth economic recovery ever in the future until this game-playing stops.  This is the fundamental reason that Japan never turned the corner and had a durable recovery and it is why we won't either.

It simply can't happen.  The mathematics make it impossible, as that excess spread comes off GDP each and every year until the bad paper is either removed from the system or amortized and the excess spread disappears.  Since most of this paper (especially that related to houses!) has amortization schedules measured in decades and an underwater homeowner cannot refinance, this drain on our economy is going to remain for years, not months.

There is only one way to stop it: FORCE all of the bad paper into the open immediately, close all the defunct institutions that this uncovers, and remove the excess liquidity so that the rate spread contracts back to a reasonable level.  This means that I will once again be able to get a 5% CD and I will once again see "good credit risks" offered revolving credit at under 10%.

While this would trash a bunch of banks (and it should) it would free upwards of $250 billion dollars a year in consumer spending!

Our regulators and government officials are both protecting crooked dealing and destroying our economic recovery prospects.

Wake up America.

From his speech at Jackson Hole:

 A year after the onset of the current crisis in August 2007, financial markets remained stressed, the economy was slowing, and inflation--driven by a global commodity boom--had risen significantly. What we could not fully appreciate when we last gathered here was that the economic and policy environment was about to become vastly more difficult. In the weeks that followed, several systemically critical financial institutions would either fail or come close to failure, activity in some key financial markets would virtually cease, and the global economy would enter a deep recession. My remarks this morning will focus on the extraordinary financial and economic events of the past year, as well as on the policy responses both in the United States and abroad.

And ignore your role in creating it.  Don't worry, I'll take care of that for you.

History is full of examples in which the policy responses to financial crises have been slow and inadequate, often resulting ultimately in greater economic damage and increased fiscal costs. In this episode, by contrast, policymakers in the United States and around the globe responded with speed and force to arrest a rapidly deteriorating and dangerous situation. Looking forward, we must urgently address structural weaknesses in the financial system, in particular in the regulatory framework, to ensure that the enormous costs of the past two years will not be borne again.

You've done nothing of the kind going forward just as you haven't looking backward.  I have no confidence whatsoever that this will change, but perhaps others do.  That's for them to decide.

Notwithstanding these significant concerns, however, there was little to suggest that market participants saw the financial situation as about to take a sharp turn for the worse. For example, although indicators of default risk such as interest rate spreads and quotes on credit default swaps remained well above historical norms, most such measures had declined from earlier peaks, in some cases by substantial amounts. And in early September, when the target for the federal funds rate was 2 percent, investors appeared to see little chance that the federal funds rate would be below 1-3/4 percent six months later. That is, as of this time last year, market participants evidently believed it improbable that significant additional monetary policy stimulus would be needed in the United States.

That's because you were willfully ignoring the facts that were staring you in the face - not surprising, given that you were one of the chief architects of the policies that led to the mess.

Nevertheless, shortly after our last convocation, the financial crisis intensified dramatically. Despite the steps that had been taken to support Fannie Mae and Freddie Mac, their condition continued to worsen. In early September, the companies' regulator placed both into conservatorship, and the Treasury used its recently enacted authority to provide the firms with massive financial support.

Both Fannie and Freddie were running with 80:1 leverage ratios, and prime mortgage default rates were projected to head north of 2%.  What could possibly go wrong, given that math?  (Psst: A 2% loss with 80:1 leverage puts you some 30% underwater - a catastrophic situation that cannot possibly be survived.  This forecast was known more than a year in advance of Fannie and Freddie's collapse, and both I and others, using nothing more than published balance sheets and quarterly reports, called both of these firms "zeros" long in advance of their collapse on that basis.)

Shortly thereafter, several additional large U.S. financial firms also came under heavy pressure from creditors, counterparties, and customers. The Federal Reserve has consistently maintained the view that the disorderly failure of one or more systemically important institutions in the context of a broader financial crisis could have extremely adverse consequences for both the financial system and the economy. We have therefore spared no effort, within our legal authorities and in appropriate cooperation with other agencies, to avert such a failure.

You have actually entirely ignored the limits of your legal authority, including most specifically your taking of equity in securities that do not have the formal full faith and credit of the US Federal Government.

Nobody in Congress seems to care, but I do.  The fact that there is no "or else" in the Federal Reserve Act (as amended) is likely the cause, as the worst punishment that can be meted out to you would be impeachment (and even that's open to question) or refusal to reappoint you.

In contrast, in the case of the insurance company American International Group (AIG), the Federal Reserve judged that the company's financial and business assets were adequate to secure an $85 billion line of credit, enough to avert its imminent failure. Because AIG was counterparty to many of the world's largest financial firms, a significant borrower in the commercial paper market and other public debt markets, and a provider of insurance products to tens of millions of customers, its abrupt collapse likely would have intensified the crisis substantially further, at a time when the U.S. authorities had not yet obtained the necessary fiscal resources to deal with a massive systemic event.

An event you fostered.  Let us not forget that you had supervisory authority over JP Morgan, Bank America, Citibank and others, yet you allowed these institutions to enter into credit default swaps and other instruments with AIG, even though you knew or should have known that AIG had no ability to perform on those obligations.  That is, you intentionally abdicated your responsibility during the boom years to supervise these institutions, and now you wish to claim that this was an "unanticipated" problem. 

That is a lie.

The two largest remaining free-standing investment banks, Morgan Stanley and Goldman Sachs, were stabilized when the Federal Reserve approved, on an emergency basis, their applications to become bank holding companies.

That too is a lie.  These firms survived only because you negotiated a back-door transfer of taxpayer money, free of all obligation, through AIG to these companies.  Their application to become bank holding companies also came with exemption requests for BHC leverage limits, which you granted, thus leaving the liability for their continued gambling (and boy have they!) on the taxpayer's back as well.

The failure of Lehman Brothers demonstrated that liquidity provision by the Federal Reserve would not be sufficient to stop the crisis; substantial fiscal resources were necessary. On October 3, on the recommendation of the Administration and with the strong support of the Federal Reserve, the Congress approved the creation of the Troubled Asset Relief Program, or TARP, with a maximum authorization of $700 billion to support the stabilization of the U.S. financial system.

You and Hank Paulson lied about your intentions for that $700 billion dollar appropriation.  That this was a knowing lie, in that the intended disbursement changed before it was finally voted up in Congress, is fact, not supposition - it was disclosed by Neal Kashkari during questioning under oath by Congress that The Fed and Treasury had shelved the "bad asset" purchases several days prior to the final vote, but you never informed Congress of your altered intent.

In short, you and Treasury acquired access to that $700 billion under false pretense.  In an honest world we would call that theft by conversion, or simple fraud.  But we live in a world where regulatory capture and fraud are part and parcel of everyday life in Washington DC.

Overall, the policy actions implemented in recent months have helped stabilize a number of key financial markets, both in the United States and abroad. Short-term funding markets are functioning more normally, corporate bond issuance has been strong, and activity in some previously moribund securitization markets has picked up. Stock prices have partially recovered, and U.S. mortgage rates have declined markedly since last fall. Critically, fears of financial collapse have receded substantially. After contracting sharply over the past year, economic activity appears to be leveling out, both in the United States and abroad, and the prospects for a return to growth in the near term appear good.

Bah.

The Federal Government expanded spending by 15% annualized from the first to second quarters of this year.  This resulted in a nominal improvement in GDP from worse than the first quarter to a printed number that was much better, but that nominal print does not change private economic activity; it hides it.

Far more important than this sort of accounting game and its psychological impact is the cost of maintaining the charade.  In the second quarter the cost of this scheme was some $400 billion dollars, plus another $250ish in direct costs to support the more than $20 trillion in guarantees and backstops committed. 

While 1% per quarter in cash costs against those guarantees sounds quite reasonable and low, it is nonetheless a massive expenditure of public funds that must continue indefinitely until those guarantees are withdrawn.  An indefinite extension of these guarantees is not possible as this would result in an addition to federal spending of one trillion annually for the indefinite future - an amount that vastly exceeds any other single federal program and is clearly unsustainable.

But at the root of these support and guarantee programs lie the root of the crisis - your actions, and that of other regulators.  Let's examine one of your other statements in this regard:

 To be sure, the provision of liquidity alone can by no means solve the problems of credit risk and credit losses; but it can reduce liquidity premiums, help restore the confidence of investors, and thus promote stability. It is noteworthy that the use of Fed liquidity facilities has declined sharply since the beginning of the year--a clear market signal that liquidity pressures are easing and market conditions are normalizing.

Nonsense.  Withdraw any material part of the $12 trillion+ in formal guarantees and the more than $20 trillion in formal and informal, and I'll believe you.  The Fed has withdrawn none of it and it has urged Treasury to withdraw none of it.  As just one example Citibank alone has more than $300 billion of formal guarantees provided by the Federal Government against so-called "assets" that are almost certainly not worth what they are marked at.

Indeed, we know this is the case essentially across the board when it comes to our banking system, as in essentially every case where a bank has failed assets have been shown to be "mismaked" by anywhere from 10-50%.  The recent acquisition of Colonial is a prime example - their "asset book" was in fact overvalued in the bank's own view by some 37%, with BB&T re-marking the assets to the market at that level.  That you, the rest of The Fed and other regulators have allowed this situation to not only arise but continue to allow it to persist is an outrage - this is out-and-out fraud, it is pervasive, and we are treated to multiple examples of it on virtually every Friday.

In an honest nation every regulator associated with this insanity would have been drummed out of office and indicted for public corruption, bank executives would be in the dock on fraud charges and we would have performed a comprehensive examination of every bank's books to detect the level of intentional falsehood on every bank in the nation by now. 

We haven't and I bet we won't until it all comes tumbling down - an outcome that is ultimately assured, simply because "that which can't go on forever, won't."

We've utterly failed to perform the necessary clearing of the credit system of bad assets.  Instead you, along with Treasury and Congress, have chosen to paper over those bad assets and hide them.  This has prevented you, the FDIC and Treasury from being forced to close these institutions, but it leaves them zombies, stuffed chock full of toxic garbage that they cannot sell (lest they be instantly recognized as insolvent) and are forced to expend precious cashflow maintaining the illusion of "par" value.  This was aided and abetted by Congressional pressure applied to FASB - a change made by them quite literally at gunpoint in what was arguably the most outrageous display of institutionalized fraud I have seen in my 46 years on this planet.

While there are many who argue that "the ends justify the means" this is a false argument and a further lie.  We have accomplished exactly nothing of long-term positive impact, as without honest marks on these assets institutions cannot freely trade them - that is, there is no liquidity in these assets on the balance sheet and the credit intermediation system remains clogged and non-functional.

Unfortunately all modern monetary systems are credit-based.  The importance of this should be understood by you, since you're a monetarist and classic Keynesian, yet you seem to miss the essential point, at least in public.  In reality I suspect you're changing your underwear every time you testify before Congress or speak where anyone other than those "in on" the clever scam might question you, lest reality be discovered: The Fed has utterly failed to improve the real velocity of credit circulation and without it they've accomplished nothing.  In fact the deflationary forces are winning and will continue to do so until and unless the bad assets are flushed from the system and thus rendered impotent. 

Hell-bent and determined to protect those "special bankers" who are you're friends and cronies, not to mention accomplices in creating this mess in the first place, The Bernanke Fed has refused to demand full accountability to market prices on these assets.  This is no surprise - but it is also no surprise that with a constrained credit system consumer credit card rates are up dramatically, in many cases to 30% or more and banks are charging upwards of $10 billion a quarter in fees - most of them junk fees such as manufactured NSF charges and similar abuses in a mad dash to cover the cash-flow shortages that are impacting on these so-called "assets" that have gone septic and are poisoning the firm. 

There will be no durable economic recovery until this problem is addressed, and that can only happen when those bad assets are marked to the market, their deficiency is recognized and they are able to trade freely at a true market price - a combination of recovery value (if any!) against defaults and ongoing cash flow.  That's the definition of a market price, yet you, along with the banks, have continually done your damndest to avoid this discovery, starting with the "Super-SIV" proposal in the fall of 2007 and continuing to the present day.

Although we have avoided the worst, difficult challenges still lie ahead. We must work together to build on the gains already made to secure a sustained economic recovery, as well as to build a new financial regulatory framework that will reflect the lessons of this crisis and prevent a recurrence of the events of the past two years. I hope and expect that, when we meet here a year from now, we will be able to claim substantial progress toward both those objectives.

We could start by locking up everyone involved in creating this mess Ben - including you.

Buffett, iStockanalyst, PIMCO and of course myself....

“No government, or central bank, is bigger than the bond and currency markets. Foreign bondholders aren’t going to sit idly by while any government … even the government of the U.S. … openly decides to trash its currency by printing it with reckless abandon. And they aren’t going to sit by while the government manipulates prices higher.

Yep.

Look, I'm no fan of Buffett and PIMCO, as anyone who's read my column for more than a week knows.  Both have been the subject of many a barb, with both profiting mightily from what amounts to unbridled Government Largess and the intentional overlooking of fraudulent activity in the financial markets.

Profiting from Fannie being backstopped, for example, is obscene.  Its not illegal, but it is obscene.  So is profiting from banks that are allowed to jack interest rates to 30% to cover their own sin of writing loans without a prayer in Hell of the borrower being able to pay.

But this belies the point here, which is that as I have outlined in today's treatises we as a nation are at a crossroads.

We can defend the dollar which will cause interest rates to rise significantly, choking off false growth and forcing the defaults being hidden to the surface, or we can continue an economic policy that fosters fraud and deceit.  If we do the latter we will continue to see revulsion for all forms of dollar-denominated debt and like a creeping case of gangrene it will travel from the corporate and agency space, eventually infesting US Treasuries as well.

The only remaining question is whether the monetary and fiscal authorities will amputate the gangrenous hand or whether they will allow sepsis to set in and kill the entire nation - including its currency and potentially the government.

Before you dismiss me as some off-the-wall Internet kook, you might want to consider that in addition to those of us who have been pounding the table for the last couple of years on these points, we now have both PIMCO and Warren Buffett adding their voices to our chorus.

These individuals may not be someone who you like, but they are people who appear to have come to the same conclusion - even if they got there via a different, more-circuitous route.

From Marketwatch:

Resales have gained for four consecutive straight months, the longest streak of increases since 2004. "Momentum is building," said Lawrence Yun, NAR's chief economist.

In other news July remains the last full month before school starts and spring and summer are always the strongest months for home sales.

The NAR is shameless.  After David Lereah wrote not one but two books pumping real estate right into the top and managed to suck in millions of Americans (then crush them) you'd think that the NAR would learn.

You'd be wrong.

There has never been a year where seasonality doesn't matter to home sales, as any family with children will tell you - moving during the school year sucks and is avoided whenever possible.

Let's see if Yun is forced to do the "Yum Yum" on those words when September - December's numbers print.  I wouldn't bet against that, given the delinquency numbers released yesterday.

The CBO's annual Social Security Update is out, and its pretty ugly:

This is pretty ugly; we were not supposed to have a negative income-to-outlay view on Social Security for another decade or so.

Well, the recession fixed that.  Tax receipts are in the toilet but outlays sure aren't. 

This is a major problem - everyone wants to point to the "zero hour" for Social Security when the "trust fund" goes negative, as is shown in this graph:

This, unfortunately, is terribly misleading.  The Social Security "Trust Fund" contains nothing other than IOUs.  That is, it does not contain money, it contains "special" Treasury Bonds that form part of the "public debt."

How much? According to Treasury, about $4.3 trillion dollars worth.

But here's the issue - those aren't bonds or bills that the Social Security system can sell as it sees fit.  They're what are called "intragovernmental holdings", with the key focus there being the last part of the first word: mental, which is what you have to be to do something like this.

Here's the issue: Since these are not marketable securities the Social Security system cannot sell them to raise cash.  It must instead "redeem" them with Treasury, forcing Treasury to cough up actual cash.  This in turn requires Treasury to sell more bills or bonds to the public, since Treasury is operating with a deficit running (at present) more than $1.5 trillion dollars annually.

So the correct view of when Social Security (and Medicare!) is in trouble is not in 2037 or whatever, it is now, because the cash flow requirements are going to force the government to sell even more bonds to the public in order to pay supposedly-guaranteed "benefits."

What happens when you sell bonds into a saturated market?  Yields go up.  Maybe a lot - which of course makes your interest payments go up.  This can quickly turn into a self-reinforcing cycle that does critical damage to the federal budget.  This can get rather interesting - fast.

That's bad.  Now let's add the other two issues to the mix for the "worse."

We'll start with China:

Aug. 21 (Bloomberg) -- China plans to tighten capital requirements for banks, threatening to curb the record lending that’s fueled a 60 percent rally in the nation’s stock market, three people familiar with the matter said.

The China Banking Regulatory Commission sent draft rule changes to banks on Aug. 19 requiring them to deduct all existing holdings of subordinated and hybrid debt sold by other lenders from supplementary capital, said the people, who have seen the document. Banks have until Aug. 25 to give feedback, said the people, declining to be named as the matter is private.

Let's be clear: The Chinese index has doubled over the last couple of months because the Chinese banking system has been handing out money like candy, much of it going directly into the stock market as speculators take out loans to buy stocks.  This is a major problem because China's market does not have the sort of formal margin controls and requirements that the US (and most other nation's) market has; there is no ability to short, for example.  As a consequence if the market were to dive (it has "corrected" some 20% off its recent high) it could bankrupt not only lots of individual investors but also the bank that made the loan, since the speculator will be wiped out and almost certainly has nothing else to collect from!

This lending soundness problem has been compounded by the Chinese banks selling securities to each other and then counting them against their second-level "Tier 2" capital.  In effect there has been no public sale and no actual cash changing hands for this debt; the banks have been practicing a circle-jerk of "liquidity", somewhat similar to what has happened in the US with Bernanke buying back Treasury issues less than a week later.  This of course is extraordinarily dangerous in that it creates an interconnected web of firms that can blow each other up if they fail, similar to what happened with Bear Stearns and Lehman.

It's amusing how the Chinese will chastise us for having inadequate controls over rampant speculation and derivatives, yet when it comes to their own banking system they let the party go on until a parabolic blow-off appears to be well underway before saying "heh wait a second - there's no real money in this game; everyone is passing bonds off to one another and pretending they're raising actual capital!"

Needless to say if this blows up it will have dramatic (and really ugly) consequences for the Chinese economy, and will filter over here.  Bet on it.

Finally, we have the Eurozone putting up a surprise this morning:

Aug. 21 (Bloomberg) -- The euro rose and European stocks gained after services in Germany and manufacturing in France unexpectedly expanded, reinforcing speculation that the global recession is easing. U.S. index futures advanced.

Well, yes.  But the futures advanced because of this:

The pattern of the last couple of months remains intact - Dollar dives, stocks go higher as "hot money" comes out to play.  The problem with this sort of move is that it is exactly backwards; a weak dollar isn't the siren call of good things, quite to the contrary.

If that nice pink line breaks there's little left to hold - there is a chop zone around 76 (where an island was left before) and then a final support level down around 71-72. 

Below that?  Nothing.  The dollar has never been there.

Worse, there's an argument to be made that the spike high at the end of 08 and into 09's market lows was a failed breakout - meaning that we're headed (at minimum) down to the 72 area.  A break under 72 could take the Dollar to 40, which would force oil prices upward dramatically, taking out the old highs with ease, instantly destroying any hope of economic recovery.

Tough choices here, although I would characterize it more as "damned if you do (tighten up liquidity) and defend the dollar, but doubled-damned straight to Hell if you don't."

We live in interesting times.....