Petit Julien welcomes you back to the Populist Pub.
Nearly 18 months into this recession, skepticism is growing about what "recovery" might look like. We hear talk of "green shoots" in an economy that is being remade into another bubble economy, this time based on "government finance". Is it really "stimulating" to the real economy to inject massive amounts of liquidity into the financial system? This unprecedented intervention includes Federal Reserve Credit, Treasury borrowings, agency debt, mortgage-backed securities issued by GSEs, as well as increased involvement of the FDIC. The latest estimates of the size of this bubble is around $14 Trillion which, amazingly, dwarfs the mortgage finance bubble it replaces. The question many analysts ask is whether the FED will be able to withdraw liquidity from the system in the proper amounts and at the right time in order to avert the inevitable inflation when it begins. Ironically, the FED will then find itself in the familiar position of being trapped by the risk of bursting another historic bubble!
Few economists or financial experts agree with the course of action the government has been taking. Criticism has recently become more frequent, more numerous and much more pointed. The appearance of cronyism, conflict of interest and outright corruption in all branches of the government, on Wall Street and in the MSM are evident on a weekly, if not daily basis. Yet, the policies remain in effect; real oversight and reform are nowhere in sight. There is little transparency with respect to actions already taken and we are told no plan B is in place because none is needed.
I think the May 8th editorial from The Automatic Earth sums up the situation fairly well.
In the beginning, there was the Glass-Steagall repeal, rejection of securities regulations, ultra-low interest rates, the president talking up homeownership. Then there was light, and with it came $14 trillion in taxpayer funded alphabet soup support (equity, loans, guarantees). First through the Treasury, and when that became tough, through the back door steps of the Federal Reserve and FDIC. Along the way, Fannie Mae and Freddie Mac were used to buy up mortgages and AIG to gobble up derivatives’ risk. All three are now part of the taxpayer alphabet soup. The $23 billion loss Fannie announced today is on you, America. And there is nothing in sight that says the annual loss for 2009 will be below $100 billion. For Fannie alone. But don't get all excited just yet, the combined Fannie and Freddie mortgage portfolio's contain some $6 trillion in goodies, and they're by law required to add $40 billion more each month, almost half a trillion per year, to keep the bankers' profits flowing. And all of it is yours. Even though both are still publicly traded and Obama didn't include them in his budget, claiming they're private companies and "their securities are not backed by the full faith and credit of the Federal Government"(that would be your faith, and your credit). That way he can try and fund the losses, with your money, outside of Congress, I guess. After all, only $400 billion of your cash has been promised to the F&F black hole cabal that keeps home sales going, and prices elevated, in the US. And, yeah, I know what you're saying, I’m not so sure I want to know the whole picture on their securities portfolio either. That could be real ugly. Regulator, anyone? Obama wants the Federal reserve to be the one and only overseer on the financial industry. The whole set-up has had only one thing in mind since the get-go: don't let the banks lose any money, if only because if they shed any more of it, some goat herder in a dress will pick them up for chump change on a drizzly Monday afternoon just to have something to do. Plenty's been said about the stress tests, and it all boils down to two points. First, there's no mention of valuing bad assets, and why should there be with accounting standards out the window and PPiP waiting in the wings? And second, under the tests, the required Tier 1 common stock amounts to 4% of the risk-weighted assets. Which means that all the biggest US banks, including those that hold most of your deposits, are allowed a 25 to 1 leverage ratio. Which sounds more like a hedge fund or a casino to me. Only 5 years ago, investment banks needed 8% in Tier 1. And then, of course, the golden calf was born. Now that the poor beast has been slaughtered, the only prudent way to go forward, prudent as in looking out for the man in the street, would be to a 10 to 1 ratio, if that, at least until the system has been cleared of its problems. But that won't happen. Because it would show all US banks to be insolvent. I've said it before: there's no need to game the plan. The plan is the game. The heads of government were once the heads of the banks, and the other way around. The banks have virtually unlimited losses, and the government has virtually unlimited access to capital, that of its citizens. You have to admit, it works like a charm. But not for you.
Most of us here at EP commiserate daily about the unsound policy making and the adverse effects the policies have had on the real economy. We track and discuss on a regular basis the weaknesses in the economic fundamentals which underly any meaningful, sustainable recovery. We question where we are heading if/when the policies fail, or maybe even if they succeed! Either way it seems, there is a growing consensus that the ultimate outcome will be painful and will persist for a long time. That largely explains why we hesitate to ponder the details of what lies ahead.
So, it was with sober curiosity that I read The Worst Case Scenario (Someone Has To Say It) from Seeking Alpha. As the author (an investment consultant I expect) freely admits, this is not your boilerplate doom-saying. Current policies, being what they are, will lead to bad consequences and the author shows no reluctance to define the level of consequence nor the time frame in which it will occur. Whether you agree with the timing and/or the conclusions stated in the ten scenarios is less important than the reference points they provide for further discussion, debate and perhaps even action. For instance:
Prediction two. With public pension systems and tens of millions of 401k holders virtually wiped out—and with the Baby Boomers retiring en masse—there will be tremendous pressure on the government to get into the stock market in order to bid up prices.
Therefore, sometime in 2010, the Federal Reserve will create and loan out hundreds of billions of fresh dollars to the usual well-connected suspects, instructing them to buy up stocks on the public’s behalf. This scheme will have a fancy but meaningless name—something like the “Taxpayer Assurance Equities Facility”. It will have no effect other than to serve as buyer of last resort for capitulating smart-money types who want to get out of stocks entirely.
Personally, I prefer "Facility Assurance for Taxpayer Equities" or "FATE". "TAEF" just lacks that je ne sais quoi.
Prediction four. “Quantitative easing” will fail to restart previous patterns of lending and consumption. As the government sends out additional “rebate” checks and takes ever-more drastic measures to force banks to lend, hyperinflation could take hold. However, comprehensive debt relief via a devaluation of the dollar is even more likely. This would entail the government issuing one “new” dollar for some greater number of “old” dollars—thus reducing both debts and savings simultaneously. This would make for a clean slate a la Fight Club.
As there are many more debtors than savers in the U.S., the vast majority would support devaluation. The Chinese and other foreign holders of our bonds would be screaming mad, but unable to do anything. Every country that has not found a way out of dollar-denominated reserve assets by 2012 will see its reserves eliminated.
All ten are thought provoking and would make an interesting survey, I think. Ultimately, though, it is the final scenario that is the most controversial and, therefore, the one that matters the most.
Prediction ten. As an economy is never independent of the society within which it functions, the next few paragraphs will focus on social and political factors. These factors will have as much of an impact on market and consumer confidence as any developments in the financial sector.
Whether rightly or not, President Obama, having come to power at the dawn of this crisis, will be blamed for it by over 50 percent of the population. He will be a one-term president. In response to his perceived socialization of America, there will be a swarm of secessionist and extremist activity, much of it violent. Militias and armed sects will be more prominent than in the early 1990s. Stand-off dramas, violent score-settlings, and going-out-with-a-bang attacks by laid-off workers and bankrupted investors—already a national plague—will become an everyday occurrence.
For both economic and social reasons, millions of immigrants and guest workers will return to their home countries, taking their assets and skills with them. The flow of skilled immigrants will slow to a trickle. Birth rates will plummet as families struggle with uncertainty and reduced (or no) income.
Property crime will explode as citizens bitter over their own shattered dreams attempt to comfort themselves by taking what is not theirs. Mutinies and desertions will proliferate in an increasingly demoralized, over-stretched military, especially when states can no longer provide the educational and other benefits promised to their National Guard troops.
There will be widespread tax collection issues, and a huge backlash against Federal and state bureaucrats who demand three-percent annual pay raises while private sector wages remain frozen or worse. In short, the “Tea Parties” of tomorrow will likely not be so restrained.
Finally, between now and 2012, we are likely to see another earth-shaking national embarrassment on the scale of the 9/11 attacks or Hurricane Katrina and its aftermath. This will demonstrate conclusively to all Americans that their government, even under a savior-figure like Obama, cannot, in fact, save them.
By 2012, there will be a general feeling that the nation is in immediate danger of blowing up or coming apart at the seams. This fear will be justified, given that the U.S. has always been held together by the promise of a continuously rising material standard of living—the famous “pursuit of happiness”—rather than any ethnic or religious ties. If that goes, so could everything else. We were lucky in the 1930s—we may not be so lucky again.
Recognizing potential pitfalls is a prerequisite for avoiding them. Will the government find the wisdom to do the right thing for the majority of its citizens, or will the special money interests continue to rule the day?