Woe is Me!

The President is telling us that the economy is not “as bad as we think” – I will ignore the 30% increase in February foreclosure notices, the record 5.3 million adults that the Labor Department says are unemployed (8.1% direct unemployment, 15% unemployment under the government’s “alternative measurement” – the highest in a quarter century), the 6.2% 4^th quarter contraction in the gross domestic product (the worst since the end of the Great Depression), the worse drop in family net worth from October to December since 1951 ($5.1 trillion), the continuing free fall of home values … and look at the good news: Bernie Madoff is in jail, and the market’s in a seeming rally. Even GM stock is up on news that they aren’t drawing on their next government bailout loan installment.

After all, the “market” is that leading economic indicator that trades based on future expectations (unlike housing starts, employment, etc. which are trailing indicators). Think they can keep it going? Remember, traders do seem to be focused on one huge issue that my blog has hammered on often: the toxic assets on the balance sheets of so many big banks.

Madlen Read, writing for the March 12^th Associated Press, reported: “The rally got an extra dose of adrenaline [on the 12^th] after an accounting board told Congress it may recommend an easing in financial reporting rules of tough-to-sell assets — a change that banks say would help their bottom lines. Upheaval in the banking industry has been dogging the market since 2007, and hope that banks might finally get relief in how they value their bad assets spurred a flurry of buying on Wall Street… ‘We might find that the banks are not as bad, or not bad at all, if these assets are marked differently," said Doreen Mogavero, president of the New York floor brokerage Mogavero, Lee & Co.’” Love labels, don’t you?

So does that news (and the President’s cheery statement) make you happy or unhappy? A March 12^th piece put together by AP’s Kevin Freking (great name, huh?!) reported on a new poll on Americans' well-being during this mess, conducted by Gallup in partnership with Healthways and America 's Health Insurance Plans. I call it the happy face poll. It seems that the unhappiest states in the land are West Virginia (sheer misery) followed in order by Kentucky, Mississippi, Ohio and Arkansas, but the happiest states, in order, are Utah (really happy), Hawaii, Wyoming, Colorado and Minnesota.

I started to think that skiing must have had something to do with it (okay, Hawaii would have to be water skiing, but hey?) or that folks who voted for that other guy were still brooding (doesn’t explain Ohio ), but I think it has to do more with fun, open space and jobs. And then I got to thinking how Mother Nature must be looking at this economic malaise; if She is, maybe She is saying, “Silly, people, if you consume and waste less because you have less, my natural beauty is only enhanced by keeping my natural resources intact, my air and seas are a bit less polluted because you aren’t sucking oil out of me and spewing garbage all the time; keep up the good work.”

We’ve had two consecutive months with a Friday the 13^th! But all we’re gonna be happy and most certainly not triskaidekaphobic, right?! No worries!

I’m Peter Dekom, and someone seems to have hit the “reset” button.

Waitin’ fer the Boss to Die

OK, we know that property, sales and income tax revenues are dropping faster than a stone tossed off the leaning Tower of Pisa; cutbacks in towns and states are expected except for the glimmer of a maybe from Mr. Obama’s bailout package. We know that individual private retirement plans – like the wonderful 401(k)s – are tumbling off the cliff like that car at the end of the movie Thelma and Louise, if you remember that far back. We see our lifestyle deteriorating, taste the smell of hot dogs-in-lieu-of-a-NY-steak and see the value of the dirt beneath our homes descend deeper that a cry of Hades far below… but what are we missing?

Long term inflation as the dollar tanks (maybe with a few dozen other major currencies) in the distant future, a permanent downward reset in our standard of living and our life expectations? We’re getting’ universal health care, one way or the other, so there’s something out there for the those who have to carry their own health insurance policies, but what about our sons, daughters and grandchildren? What have we left them?

I was thinking, as my self-funded pension plan registered lower than a thermometer jammed into a snow bank on a frigid day, that I probably would never retire, that they would have to pry my decomposing body from my office chair before I would relinquish my legal career… and then I thought about what that meant, multiplied across the vast desert of the self-employed, those whose pension plans sank even lower than mine and those in a dwindling universe of un-unionized, unprotected by civil service laws and otherwise hardworking (assuming they still have a job) body of Americans… and their children.

If coots remain at their desks longer, and whole job sectors disappear from view (like who’s going to hire a derivatives trader anyway?!), doesn’t it strike you that, even after this economy starts growing again, promotions will be harder to get, entry level jobs will need to push harder from below, all through the hierarchy of workers above, to dislodge that aging lump of desperation at the top of the structure unwilling to leave, because there ain’t no pension to fall back on!

The young have an even stronger reason to create technology that makes constant retraining a survival skill, one that will pry the wrinkle-cream set from their tenured roosts. Can you teach elderly hounds new tricks? Are there going to be real structures that address this need, and are the “walker ain’t a Texas Ranger” set willing to embrace this reality?

So let me get this straight… we’ve allowed our educational standards to plummet making it hard to get the education to compete with the rest of the world, allowed education costs to push post-secondary education beyond the affordability of oh-so-many, we have incurred and will continue to incur massive governmental deficits that generations to come will have to pay off through higher taxes and reduced standards of living, and we have tanked the very retirement system that allows limping decrepits to move on (and out) and open up job opportunities for the coming generations.

We really can’t have this intergenerational job war going on; we do need to figure out how to use training to move our willing and able population through the work force of the future and prepare our workers for the inevitable phasing out at the legitimate end of a career. Are we just assuming that the future will create new technologies that the next generation will simply take over? But does that make the old world of prunes obsolete so that while they can’t retire, they are now unable to earn money except by slinging hash at the local diner? But maybe the terror of where we are is just too damned powerful to let us think about the “next”… we have to deal with a horrific “now” first. But someday…

I’m Peter Dekom, and I actually am this message… and so are all of you, one way or another!

$1.4 Trillion Loss vs 67% Approval Rating

After seven weeks of the Obama Presidency, the numbers seem to say it all. The Dow has fallen 21% since the Inauguration, 44% since its peak in 2007. An inept administration or a horrific avalanche from the last administration that could not be stopped with a mere $787 billion bailout package? And what exactly is Wall Street saying with this continued and seemingly unstoppable decline?

Wall Street clearly does not see the path. An understaffed Treasury Secretary Tim Geithner, his key lieutenants not even in place, is struggling with how to get the financial ship right again, without tapping into an additional “ask” from a reluctant Congress and a mass of angry taxpayers. The March 10, WashingtonPost.com: “[S]ome prospective candidates for Treasury posts have been held up because the White House is carefully examining every candidate to avoid the kind of embarrassing tax problems that dogged Geithner and other nominees, sources familiar with the matter said. During Geithner's vetting process, the administration found that he had not paid some of the taxes he owed for his work at the International Monetary Fund, and that revelation sparked some opposition to his candidacy on Capitol Hill…

“The sources added that the agency is also facing difficulties recruiting financial experts because of rules that require senior Treasury officials to divest of their investments. With the markets plummeting, some candidates have been reluctant to sell their holdings and come to the department.” And that’s for senior appointments; they haven’t even gotten around to the day-to-day operational junior appointments.

One huge issue stands in Wall Street’s way, and whether you call it blackmail or a chokehold, in the way of our hitting bottom and beginning a tortuously slow rise from the ashes, it just sits there like a rotting corpse that no one will remove: the mass of bad investments (adoringly labeled “toxic” assets) dragging down the balance sheets of our biggest (and some of our smallest) banks – $2 trillion worth, by many estimates. Mostly in tanked bundles of subprime mortgage derivatives.

Our housing industry needs those assets disposed of, our business sector (America’s employers) need those assets removed to free up banks to use their balance sheets to access lending capital, the unemployed or soon-to-be-unemployed need money flowing for the sake of jobs, and even companies seeking to restructure in bankruptcy rather than liquidate (the Circuit City example) need debt to come back. As you have seen in recent blogs, the engine of America needs a direct and immediate federal intervention – whether you nationalize a few banks, create a central “bad bank” to take those assets (but valuation is tricky) or allow the banks to create their own split bad bank/good bank scenario – we need it now. The markets won’t settle for less. Don’t believe me? Look at the market after Citigroup (which has terrified analysts as home of the “toxic soup”) announced a first quarter profit. Explosion! Not subtle! Hmmm?!

But what’s with the 67% Obama approval rating? Hey, give the guy a break; he just got there, he’s trying to find a solution and we all know this one is going to take some time. With American business wanting a clear path to the removal of those toxic assets from the heart of the economy – banks and other financial institutions – and Congress and the taxpayers not wanting to write more checks (the Federal Reserve is buying more of the federal deficit as we are selling less of it overseas) – the resulting battle would normally provide an academic a thrill a minute… if it didn’t touch each and every one of us so painfully.

I’m Peter Dekom, and I approve this message.

Treasury’s Tight Wire Act

Americans hate huge financial institutions (“they caused all this”), and there is strong resonance in the Republican cry to let the big boys with battered bogus balance sheets fail. The American government is heavily invested in many of these institutions, because they believe that if one of these bigger monstrosities goes under, they will drag the entire economy down into a real “down-and-dirty” depression. Remember September 15, 2008, when Treasury let Lehman Bros. fail? Think of everything that happened since based on that fallen domino.

Insurance giant AIG, which got money even before the Lehman fall, is behind massive numbers of policies in the entire insurance industry – many insured policy holders think that because they signed with one insurance company, that company is the only structure they need to worry about. Finding out that their risk is now and has been covered by AIG would create a gut-wrenching, soul-sapping realization that a vast number of Americans would lose their life and casualty insurance, even if they have paid the premiums already. Huge corporations and small business alike – including a host of very unpopular financial institutions (foreign and domestic) – are insured by AIG which is very, very BIG.

So it is with the biggest financial institutions – like Citigroup, Bank of America, Wells Fargo, JP Morgan Chase, and the list goes on and on and on. The impact on everything from employment, real estate and the stock market – bad enough as we know it is – would be nothing short of catastrophic with these failures. It would be akin to pushing an evil fat man off the cliff with a chain securely fastened to your own legs.

Letting the chips fall where they may be great in the longest term for those who are under 45, unless you realize that higher education would no longer be affordable middle class goals, but for people north of the age dividing line, the future would be a bleak “reset” in which even solid jobs based on experience and education would vaporize permanently by the millions, what little is left of home values would plummet to new depths and personal pensions would drop through the floor. But we wouldn’t be “wasting” taxpayer money, the pundits say – most voters seem to agree – and the deficits would not increase further. I say we’d have deflation of unprecedented size since the Great Depression.

So the conundrum is how to effect the necessary restructuring of a financial sector we all hate without going off the same cliff we want to push the big banks off of? Can you imagine asking Congress for another trillion+ plus dollars any time soon? The March 9^th NY Times: “To avoid asking Congress for more money, [Treasury Secretary, Tim] Geithner has been trying to stretch government money by working with private investors, the Federal Reserve and government-controlled companies like Fannie Mae and Freddie Mac, the mortgage giants. But that has introduced other tough policy issues, many of which remain unresolved.

“ ‘Their huge problem is that the American public is not willing to accept large losses for large financial institutions,’ said Vincent Reinhart, a former Fed official and senior fellow at the American Enterprise Institute, a conservative research and lobbying organization. ‘Everything they are doing is about having the smallest possible footprint on the federal budget. They don’t want to engage the Congress and they don’t want to engage the American people in that discussion.’ ”

On the other hand, if we don’t bite the bullet, act decisively and deal with almost $2 trillion of toxic assets on the books of those big financial bad boys, we’ll be joining them in a short, magnificent moment as we drop off the cliff with them. We don’t like going to the dentist either and those with cancer most certainly do not enjoy chemotherapy!

I’m Peter Dekom, and I approve this message.

Dancing Around the Issues

Can you hear it? The clock ticking? It’s the depression clock that recently seemed to “spring forward” as the economy was clearly “falling back.” As the bank examiners were looking at the internal financial information of the 20 biggest banks, I wondered if they were required to wear any special protective clothing to assess those truly toxic assets. We kind of know what they are going to find, and it won’t be pretty.

As long as those toxic assets – like overvalued foreclosed properties, subprime mortgage derivatives carried at prices which will never sustain, really obviously bad classified loans (“suspect” loans like those where the interest may be current, but there really is no way for the borrower to pay back all or a significant part of the note), credit default swaps that will generate a loss when a likely default occurs, etc. – are on the books of those behemoths, they are impaired financial institutions and cannot function to unfreeze the credit markets. As smaller banks get the next federal “look-see, stress test,” I suspect we will find more “bad”… but small local banks have more of a foreclosure issue than a bad investment strategy.

I have argued that we already have a nationalized banking industry – FDIC charges its 8,305 member banks to guarantee depositors up to $250K, the Federal Reserve controls the flow of money and effectively price of loans, the Comptroller of the Currency (along with the other federal institutions listed above) controls the ratio and quality of assets required for a bank to lend money, and the Department of the Treasury has spread massive direct federal investment (the TARP bailout) into the banks themselves. Taking over full ownership, true “nationalization” as most people see it, has not occurred yet, but when a bank goes under, the FDIC pays off its depositors to the extent required and shoves the operations into a surviving bank, we get very, very close.

The fact is that the impairment of toxic assets described above literally prevents the subject banks from having the right ratios to release loan funds in sufficient amounts to make a difference. So whether we effect true nationalization – let the government take over ownership of the biggest banks whose collapse would literally drop the stock market way below current horrific levels if we let them fail (look what the September 15, 2008 collapse of Lehman Bros. did to our economy – the real beginning of the market crash that still falls to this economy) – or some euphemistic alternative “bad” bank/good bank” scenario – where toxic assets are either insured by the government or placed into a Resolution Trust Corp. (where we placed failed thrifts in the 1990s) owned by the government or simply split our existing banks into bad and good operations (letting the latter fail or get government assistance), or allows backs to create and then separate “bad banks” internally – the government is going to have to effect “one of the above” soon.

Some argue that government ownership of the biggest banks – the pure nationalization scenario – gives those banks an advantage over those financial institutions that remain private, and of course. that the government cannot nationalize the entire sector (nor does it need to). Writing in the March 8^th NY Times, Alan S. Blinder is a professor of economics and public affairs at Princeton and former vice chairman of the Federal Reserve notes: “SO, on closer inspection, the best-sounding arguments for nationalization are really arguments for bullet-biting. Worse yet, even talk about nationalization can be harmful if it puts bank stocks under further selling pressure. After all, who wants to own a stock whose value is heading toward zero? Which is why Mr. Bernanke [Federal Reserve Chairman] and Mr. Geithner [Treasury Secretary] have taken pains to beat down rumors that nationalization is coming…

“Let’s first at least explore what is called the ‘good bank, bad bank’ approach. [T]basic idea is to break each sick institution into two. The ‘good bank’ gets the good assets, presumably all the deposits and a share of the bank’s remaining capital. As a healthy institution, it can presumably raise fresh capital and go on its merry way as a private company.

The ‘bad bank’ inherits the bad assets and the rest of the capital — which, after appropriate markdowns of the assets, will not be enough. So, again, someone must fill the hole. And, realistically, given the mess we’re in, much of that new capital would likely come from the taxpayers.”

In my own words, “government, pick one of the above” and soon – the longer we wait, the more it will cost taxpayers – and then let’s get on to the issue of how to get loan money to borrowers who may no longer be qualified for loans under current standards but must receive loans unless you really want to see a full-on depression.

I’m Peter Dekom, and I approve this message.

Retrain or Restrain

In recent blog, I identified one group of economists who believe that what this “recession headed for a depression” actually is… well… it’s just a permanent adjustment – they call it a “reset” – to real and justifiable values. They tell us that cheap borrowed money gave unqualified and imprudent buyers the opportunity to bid up the price of stocks, homes, businesses – not because they were actually rising in value, but because an unregulated market was artificially creating unsustainable demand for assets that really were not, in absolute value, growing. We artificially increased demand with cheap money, while the supply of worthy assets remained at much lower level. Let the market fall, they say, and let the chips fall where they may.

This reset some has truth and some fiction. Some assets actually did grow – many new technology companies, real estate in nice neighborhood near central areas of jobs and businesses in urban areas with real population growth, low margin mass retailers, new forms of entertainment like video games, to name a few – but even these prices were inflated by excess demand.

But the truth tells you that homes, far from urban centers with long commute times created to serve unqualified buyers, financial companies that built their values on buying overvalued assets with cheap money or those that in fact helped generate the cheap money and the unqualified borrowers, and manufacturers (and their retailers) that allowed costs and benefits to their workers to reflect hyper-inflated values are the most vulnerable structures for a permanent “reset.” These are the core “impaired values” that have literally dragged down the economy… not just for themselves, but for all of us.

The March 7^th New York Times tells us that “Across the nation, 19 million houses and apartments — nearly one out of every seven — are vacant, the highest percentage since the 1960s. But only about six million of those homes are for sale or for rent. That means millions more could still flood onto the market, depressing prices further.” They note that most of the currently reported real estate sales are really banks buying homes out of foreclosure.

So if there is a reset taking place, the above arenas are likely to see that downward adjustment as their lot in life for the foreseeable future, we need to address that reality. The government is trying to find that tipping point where they can eliminate as many of these business models constructed on unsustainable growth assumptions from the rest of the economy – a necessary and healthy separation but for one huge variable – jobs. What do you do with the millions of people whose training and livelihoods are in fact based on these real dinosaurs of inflated businesses that really cannot return to anywhere near their prior “values”?

With a seeming monthly job loss adding half a percent point every month, the government’s February unemployment number, 8.1%, show that 651,000 jobs were lost. If you apply what I feel is a better government number to quantify unemployment – the “alternative measurement” which adds those who want jobs but don’t know where to look and those who can pick up part-time or occasional work but want full time work – the unemployment number rises to over 15%. The old recession model just assumed that when times get better, normal employment will resume. But will it?

The March 7^th NY Times provides this perspective: “ ‘These jobs aren’t coming back,’ said John E. Silvia, chief economist at Wachovia in Charlotte, N.C. ‘A lot of production either isn’t going to happen at all, or it’s going to happen somewhere other than the United States. There are going to be fewer stores, fewer factories, fewer financial services operations. Firms are making strategic decisions that they don’t want to be in their businesses.’… Since the recession began, the economy has eliminated a net total of roughly 4.4 million jobs, with more than half of those positions — some 2.6 million — disappearing in the last four months alone.” And it’s true that extreme financial crisis does weed out those sectors whose time was running out anyway. It always has.

Yet the prospect of millions of jobless Americans with unwanted skills is a nightmare for any politician, and you can only go so far in trying to keep people employed where their business has already met the grim reaper of obsolescence. The American lifestyle most certainly will be downsized for most of us for probably the rest of our lives. Growth will return, but at a more realistic pace (I think we learned our lesson) and from a lower starting point. Green growth, efficient energy use and the elimination of wasteful practices can moderate that contraction, but we are going to be living with less for a long time.

I addressed the financial sector in earlier blogs… proposing solutions, so I suspect that I have to add some clear solutions to this blog as well. The only answer to stem this jobless trend (which includes the quality of the work as well as the sheer number of the employed) is a theme I have been harping on for years: education. We need smaller classrooms, better equipment in the classroom, more “state-of-the-art” training for teachers to prepare them to teach relevant subjects, more hours in the classroom starting at earlier years, and reinforcement in parents of the necessity of an education. We need more post-high school training – not just college but trade schools – and think of the research departments of our best universities as job-creating machines. We also need a massive new commitment to adult education – it needs to be cheap or free, but we have to prepare millions of displaced Americans with relevant training in fields with real potential.

Finally, we need to avoid a litany of bad habits: expelling or suspending disruptive children from classroom (there have to be better alternatives – maybe boot camp – to tossing an unskilled gang member out into the streets with nothing to do but get in trouble), cutting education budgets at the first sign of trouble, funding the rich in the hope (yet unrealized in 30 years of testing) that they will “trickle down” money and jobs to the less fortunate or even the middle class, and reaching to import restrictions and protectionism (which will generate retaliation instantly) instead of deal with the real “job skill” issue. And if we can get “secure” immigrants either with lots of investment capital or serious and relevant education, since they have created 25% of the sustainable jobs in this country in recent years, give them green cards!

I’m Peter Dekom, and I approve this message.

Blank Banks Blink

On March 1^st, FDIC head, Sheila Blair, wrote a letter to the senior managers of the 8,305 insured banks and savings & loans, telling them that there would be an increase in FDIC assessments to prevent the Federal Deposit Insurance Corporation (the government corporation that protects depositors from bank failures up to $250,000) from becoming insolvent. In her words: "Without substantial amounts of additional assessment revenue in the near future, current projections indicate that the fund balance will approach zero or even become negative."

This additional assessment ($27 billion this year alone) will reduce an already strained credit market by literally reducing the amount of money that banks are legally permitted to lend – as if they were actually really lending. But with the FDIC projecting $65 billion in insured losses from expected bank failures by 2013, the remaining $18.9 billion (as of the end of 2008, down from $52.4 billion at the end of 2007) is clearly inadequate. From January of 2008 to present, we’ve seen 41 banks fail… and this is only the beginning. Bank examiners applying the legendary “stress test” are very likely to accelerate the failure rate as they uncover hidden “surprises.”

In fact, “surprises” are proving quite a challenge to the new administration, in power less than two months and discovering that their projection of fourth quarter GDP contraction - 3.8% - was really nearly double that at a nasty 6.2% (the highest since the end of the Great Depression)… and we don’t even have the new unemployment and contraction numbers for the first quarter of 2009.

As the government issues new treasury bonds to pay for the rising deficit, as international buyers are willing to purchase fewer and fewer of our bonds (they have their own problems and cash shortfalls), we are watching the Federal Reserve increasing their purchase of these governmental debt instruments. Ask yourself where the Fed gets the money to make these “market-sustaining” bond purchases? They just buy them… increasing “the M1 – money supply” … in laymen’s terms, they “print” (in a virtual way) money. If the rest of the world weren’t so horribly positioned, particularly Europe, we’d already be seeing the beginnings of an inflationary spiral.

Some people call what has occurred a reset, in which assets are dropping from over-inflated values driven by easy credit to their real values (a permanent adjustment, a new bottom that will be the total basis for future growth), and this government interference is merely an unsustainable attempt to hold those inflated values to the previously unacceptable levels through all of this market support. Here’s how it looks in the banking sector: Bank of America stock is hovering a near-insolvency levels at a couple of dollars a share – even Citigroup slipped under a buck (it once traded at $55/share), and if the NYSE hadn’t recently changed its rules, would have already been de-listed from the exchange. Lots of other big banks are not too far behind.

So many financial institutions are still carrying assets like subprime derivatives on their books at values that are unsustainable in light of the facts. Like this one from J.W. Elphinstone at the Associated Press on March 5^th: “A stunning 48 percent of the nation's homeowners who have a subprime, adjustable-rate mortgage are behind on their payments or in foreclosure, and the rate for homeowners with all mortgage types hit a new record… But that's not the worst of it…. A record 5.4 million American homeowners with a mortgage of any kind, or nearly 12 percent, were at least one month late or in foreclosure at the end of last year, the Mortgage Bankers Association reported. That's up from 10 percent at the end of the third quarter, and up from 8 percent at the end of 2007.”

Some other soothsayers think that the government is so mired in the banking system – that it is already the real party-in-interest (hence we really already live in a world where banking has effectively already been nationalized) – and that the government might as well hit the “reset button,” before we reach a “Great Depression level collapse” where they believe this economy is truly headed based on numbers like those above, and forgive all home mortgage and consumer credit card debt, which will do more to “restart” our economy than a litany of continuing and escalating government bailouts.

What’s my opinion? Folks are complaining that I point out all of the issues, but I am short on solutions. OK… Let me start with a simple set of what I perceive to be essential steps that the government can and must take to restore credit and solidify the financial sector.

1. Keep those bank examiners working on the stress test, and apply the most vigorous analysis, avoiding the banks’ emphasis on “tier 1” plus “tier 2” assets. Take a good hard look at “assets” (like derivatives) that are carried at one value by bank A and at a vastly reduced value by bank B. Let the banks that are going to fail meet their maker as soon as possible. Shore up the remaining banks, and stop worrying about whether you are “nationalizing” any of them. The government has effectively owned or controlled banks for quite a while now, particularly since the meltdown. This is a huge financial commitment, probably over $1 trillion, but if this does not take place, the “bad of the now” will look pleasant well before this time next year.

2. For a period of at least 6 months, maybe even a full year, guarantee interbank lending among and between FDIC lenders. This encourages loan syndication, necessary to provide cash flow to larger American businesses (we call them “employers”).

3. Don’t throw the baby out with the bath water, but begin a new set of banking regulations making credit ratings real, allow banks to create securitized loan packages under strict new standards (and require that originating banks keep at least 15-20% of these loans so they always have “skin in the game”), but give business and the public confidence that you are really regulating!

4. Understand that with rising unemployment, sinking real estate values, falling sales and consumer activity and a seriously-impaired stock market, there are virtually no qualified borrowers or solid assets left under relatively conservative lending practices that are sufficient for banks to consider loans (under normal credit analysis parameters) even when they have money. So the government needs directly to fund (or at a minimum guarantee) loans based on temporary set of reduced standards that effectively would allow credit with reasonable risks taking into consideration that everybody is “impaired” in this environment. In short, the government has to focus as much on borrowers as it has on lenders.

I’m Peter Dekom, and there are answers!

The China Syndrome – Chimerica?

For anyone who watched the opening and closing Olympic ceremonies this summer – “PM” (pre-meltdown) – it sure looked like China was making a huge statement, both to its own people and the rest of the world: we’re here, we’re ready, and we’re officially an active global power. Before the meltdown, Chinese consumers only accounted for 1/3 of China’s sales; the rest was generated from exports. Funny, I bet they didn’t count on the virtual collapse of the global economy, the disappearance of demand from consumers everywhere, the drain on global employment and a deflationary trend that that threatens to prolong this managed depression into a relatively long-term reality.

China had been one of the major buyers of U.S. national debt as our deficits ballooned. But with their own $586 billion stimulus package, their ability to “buy bonds” seems significantly diminished, placing our borrowing base in serious jeopardy. China is hurting; their accelerating unemployment numbers suggest that riots and social unrest lie just beyond the horizon. Demand for Chinese manufactures has fallen with the global meltdown.

The March 4^th Associated Press reported: “Beijing's stimulus is aimed at reducing reliance on exports, which plunged by 17.5 percent in January, by pumping money into the economy through higher spending on public works to boost domestic consumption. [But t]he government points to rising bank lending and power consumption as signs its slump might already be bottoming out.” While Chinese still have huge foreign currency reserves and her people have significantly better savings rates than we do, it is hardly a foregone conclusion that the PRC will still be able to continue to help underwrite our deficits.

As Secretary of State, Hillary Clinton, met her counterpart from the Peoples Republic of China (Foreign Minister Yang Jiechi) on her recent Asia trip, she was less than subtle in hoping that China continues supporting the U.S. national debt: “She thanked Mr. Yang for China’s ‘continuing confidence’ in the United States, as the largest foreign buyer of Treasury securities. He offered a noncommittal statement that China would decide where to invest its foreign-exchange reserves on the basis of safety, value and liquidity.” Feb 22^nd NY Times.

The February 6^th New York Times: “Beijing authorities disclosed [February 2^nd] that based on an agriculture ministry survey of villages just before the Chinese New Year holiday [at the end of January], about 20 million of the nation’s 130 million migrant workers are unemployed… Electric utility use was down nearly 8 percent in December from a year ago in Guangdong and across China. Electricity is an excellent barometer of the Chinese economy because most usage is industrial, said Jing Ulrich, the chairwoman of China equities at JPMorgan Chase.” The February 23^rd NY Times noted that the area in the southern and coastal regions of China are particularly hard hit – the heart of the export market.

But don’t count the Chinese down and out. With a centralized government, China can change directions faster than most. China can address problems with amazing focus, eventually transitioning their “we make things that others design” economy into one that originates and elevates in quality. For some of us, the mantra of our youth was a notion that if the tag said “made in Japan,” it merchandise was probably cheap and shoddy. How times change. China seems irretrievably on that path. Their annual production of patents is clearly out-accelerating our own.

The signs of China’s coming of age, notwithstanding the economy, are everywhere. China is still living up to its de facto announcement; they are an active global citizen. They provide back-channel diplomacy to douse fires – much like the détente the effected in North Korea. They even set their warships off Somalia to participate in a multinational force aimed at stabilizing the shipping lanes from the massive piracy that has plagued the area. Small signs of profound import.

But in the long term, China’s consumption patterns, her environmental pollution as she struggles to regain its former glory, perhaps usurping the United States as the world’s largest economy sooner rather than later, her competition for global resources – minerals, timber, oil and food – eventually bidding up prices for these commodities, and her astronomical increase in automobiles (perhaps temporarily put on hold pending a better economy) and other energy-sucking consumer goods, may threaten us in a different way… but there may well be a huge silver lining in this effort, notwithstanding some harsh side-effects.

Every major financial catastrophe has been able to point to a massive and clear force for economic recovery. The Great Depression ended with the spending associated with World War II. The .com explosion reignited us after the real estate collapse of the early 1990s, and a false real estate economy pulled us out of the .com collapse. Unfortunately, Obama’s alternative energy research stimulus to the contrary, there does not seem to be a harbinger of what massive force is going to be our savior this time.

Unless, of course, you believe Jim Cramer, a well-known market analyst (CNBC) who blogged on the February 4^th theStreet.com, that maybe it will be China’s growth itself that is the force that will lead the world back to economic stability: “China doesn't do anything small. It will build big, it will feed big, it will use energy big, it will buy big, and we should do everything we can not to stand in the way of China even though it is clear that a Democratic U.S. president and his Treasury secretary aren't going to be out there being all warm and fuzzy with the Chinese. . . Do not scorn this move. In a universe where every day I see companies' prospects get worse, not better, China is the only good game in town, and on Earth, for that matter.”

As Douglas McIntyre points out in his March 3^rd blog, China’s economy is even a measure of our own recovery: “China’s GDP has to stop falling and hold at a level of 6% growth. If it drops well below that, it means that demand for inexpensive manufactured goods in the US, UK, and EU has dried up completely. If China economic expansion holds, even at levels that are low compared to the last decade, there is a sign that economic activity in the West still has a pulse.” 2008 showed a 6.8% growth, and while the Chinese government believes that it can push growth to 8%, most analysts suggest that even 6% is optimistic, but it is still growth! We’re contracting!

So Chinese-American interdependence may be the force that saves the economic world – if that relationship remains intact. “Chimerica” is a word coined by Harvard Professor, Niall Ferguson, who made this recent comment (the February 23^rd www.theglobeandmail.com) about whether or not China will truly cooperate with the United States in dealing with this economic maelstrom: “They have nowhere else to go. They have no other strategy that they can adopt in time to cushion the blow. Their exports are contracting at a terrifying speed. They want at all costs to avoid any kind of big shift in policy. They want to keep, as far as possible, the U.S. importing Chinese goods. They want to keep currencies stable. They are still buying dollars … At least officially, Chimerica is intact. But I stress ‘officially' because there's considerable public disquiet.” If Chimera stops functioning, all bets are off.

Hillary Clinton, touring an energy-efficient power plant in Beijing on her Asia trip, stressed the need for a joint U.S./PRC effort in discovering and building technologies to reduce greenhouse emissions. This may be a part of the solution, if the Chinese buy in, but most of that new growth will come from within China herself – if her leaders so decide. In a world where hope is in short supply and the answers defy the most educated experts and government leaders, it is well worth noting that solutions may well come from unexpected places.

I’m Peter Dekom, and I approve this message.

It Ain’t Recess; I’m Depressed

Okay, things are nasty, and we know life is hard and getting harder. If you live in Latvia, Iceland or Ukraine, you’d have a hard time calling what is going down in your country a “recession,” but then, exactly what is a depression? The Great Depression of the 1930s had all the “really bad” hallmarks – years of contracting economics (from 1929 to 1933, there was a 33% GDP contraction, and from 1937 to 1938, the drop was 18.2%), massive unemployment (25%, but who knows exactly if you can compare their definition of “unemployment” with our current metrics), and a wiped out stock market.

We have an easier time defining a recession. About.com calls the garden variety definition one in which “a decline [occurs] in the Gross Domestic Product (GDP) for two or more consecutive quarters.” But as they point out, this single parameter description is not enough for true economists: “The Business Cycle Dating Committee at the National Bureau of Economic Research (NBER) provides a better way to find out if there is a recession is taking place. This committee determines the amount of business activity in the economy by looking at things like employment, industrial production, real income and wholesale-retail sales. They define a recession as the time when business activity has reached its peak and starts to fall until the time when business activity bottoms out. When the business activity starts to rise again it is called an expansionary period. By this definition, the average recession lasts about a year.”

Great, under anybody’s definition we know we’ve passed the recession test, but if December of 2007 was the start of this one, we are about to break a record for the duration of post Great Depression downturns by more than a furlong. Does that longer period of damaged economics qualify as a true depression? Since depressions happen so rarely, there are no really clear standards by which to make an absolute determination, but there are a few factors that appear to be particularly relevant.

The first is most certainly duration. And if this downturn stays around for years, that alone may be enough, since the longest “recession” post-Depression was 17 months… but the economists also want a GDP fall of at least 10% - with a new report telling us that the economy had a 6.2% drop in the fourth quarter of 2008, it seems pretty clear that the 10% number is just around the corner (guestimates would suggest that the last quarter of 2008 and the first quarter of 2009 could easily combine to exceed this level fall). The worst post-Depression GDP drop was only 4.9% - in the early to mid-1970s.

Experts need to see a market collapse as well, but with the Dow falling to well below half of a high experienced in 2007 and showing no signs of life anytime soon, we seem to meet that requirement in style.

Finally, there is unemployment. Economists add the requirement of a reasonably sustained period of significant joblessness – over 10%. We’re likely to hit pretty close to 8% in a couple of days, but even at the January numbers, 7.6%, the official “unemployment rate,” the government has its “alternative measurement” based on adding the official unemployment rate to a statically-generated sampling of (i) those who are only able to get part-time or occasional work (but want full time) and (ii) those who want jobs but have given up looking. That alternative measurement tends to be about 1.86 times greater than the naked unemployment rate. At 7.6% official unemployment, we are at least over 14.1% in the alternative measurement, and if you happen to live in a state that already meets the 10% requirement (like California), the alternative measurement is around 18.6%!

By my estimates, we are in a clear transition from recession to depression, a standard that will become even more clearly established if this downturn stays at or below current levels well into 2010 or if the GDP collapses into a free fall in the next quarter or two. But remember, “depression” is just a word… and not all depressions are considered equal. It’s like the difference between a mild cold (mild recession), a bad cold (recession), the flu (a longer, feverish illness which is a depression) and pneumonia (a Depression).

We’re sick, and our very hospitals may not even be there to take care of us! The March 3^rd LA Times: “The economic decline is continuing to ravage the nation's hospitals, with half of them operating in the red and many planning service and staffing cuts.” Okay, I don’t feel any better either, but at least we all can agree that whatever this monster is, well, it’s absolutely horrific.

I’m Peter Dekom, and I approve this message.

New Pain in the Ukraine

As our Dow dipped below 7,000, the first time since 1997, because of the seeming free fall of our insurance sector (notably AIG, which is getting an additional $30 billion from the government), that dark cloud paled in comparison to a failing economy on the other side of the world. Ukraine, a former part of the USSR, was supposed to be the model “democracy built from the ashes of Soviet authoritarianism.” Russia’s Putin has battled with Ukraine’s leadership, as the latter has pushed more towards the rest of Europe than towards Moscow. Relations between Kiev (the capital of the Ukraine) and Moscow have been downright cold – made colder still when the Russians cut off the supply of natural gas (used to heat homes in a very cold winter) in January over a price dispute, which spread to other European nations as the conflict broadened to include Ukraine’s entitlements to transport that gas across her territory.

But even as she has pressed to be more “European,” Ukraine’s currency (the hryvnia) has been falling, her banks failing, and since this is a fairly large country (46 million people) with a boatload of loans and investments from the rest of Europe, the impact of an economically failed state would have an exceptionally bigger impact on the rest of the continent than the collapse of vastly smaller nations like Latvia and Iceland. Hard times have produced power failures, water stoppages and shortages of basic commodities as both municipalities and people are losing their buying power.

Many key economists feel that if Ukraine fails, she will take the rest of Eastern Europe with her. Investor confidence in the area is teetering far beyond the negativity we see here in the U.S., and it will not take much to push this entire region over the edge. Putin’s political machine is watching, ready to pounce on a “wayward” child that may need to be brought back into the Russian fold, by force (military or economic) if necessary. Putin has uttered more than once that Ukraine is an example of what happens to former Soviet countries that have turned to the Western approach versus the more pragmatic Russian model. An opposition candidate, former prime minister, Viktor F. Yanukovich, favors just such a move back towards Mother Russia.

With unemployment soaring and the economy in shambles, even the once feuding President (Viktor A. Yushchenko) and prime minister (Yulia V. Tymoshenko) are trying to get along, as the International Monetary Fund, which was about to inject a $16.4 billion emergency loan to the Ukraine, is forcing a new level of austerity on this already-damaged nation. Needless to say, the existing government is rapidly falling out of favor with its constituency. Change is in the air.

Riots and protests have punctuated the chaos, as banks have exacerbated the pain by limiting daily withdrawals from bank accounts to a mere $35 a day. The March 1^st NY Times described one such protest in the capital city: “On the city’s outskirts, more than 200 tractor-trailer rigs were parked [February 26^th], their drivers threatening to block roads if the government did not help them with their debts, which they said were caused in part by the drop in the value of Ukraine’s currency… The truckers dispersed Friday, only after the government said it would try to address their demands, but they said they would be back soon if they were ignored.”

The Times continued with why collapse could spell disaster for an already deeply-divided Europe: “‘Ukraine is a linchpin for stability in Europe,’ said Olexiy Haran, a professor of comparative politics at Kiev Mohyla University. ‘It is a key player between the expanding European Union and Russia. To use an alarmist scenario, you could imagine a situation in Ukraine that Russia tried to exploit in order to dominate Ukraine. That would make for a very explosive situation on the border of the European Union.’”

We may soon feel the ripples even here in the United States.

I’m Peter Dekom, and I approve this message.

Hollywood Bombs

I found the juxtaposition of articles about how Iran now has enough fissionable material to fabricate an atomic weapon – assuming that they have not done so already – with an LA Times piece about Iran’s quest to secure an apology from Hollywood for the way that industry has depicted Iran in its films… well ironically amusing. After all, Hollywood probably has produced more “bombs” than all the nuclear weapons on earth.

A small U.S. delegation that included Academy of Motion Picture Arts and Sciences, President Sid Ganis, and film stars Annette Bening and Alfre Woodard, met this weekend in Tehran to engage in work-shops and discussion groups. A senior Iranian cultural official demanded an apology from the Academy for the "insults and libel" propounded by Hollywood by the American film community. I am reminded of the call (a “fatwa” issued by the late Ayatollah Khomeini) in the late 1980s for loyal Muslims to kill-on-sight Salman Rushdie, the author of the anti-Islamic tome, The Satanic Verses. I note the uproar over the Danish “political cartoon” depiction of Islam in highly critical terms, igniting protests and even killings.

Mahmoud Ahmadinejad’s response to President Obama’s invitation for dialog – a claim that he would engage in dialog only if the U.S. treated Iran as an equal superpower (which of course carries with it the acceptance of Iran as a legitimate contender in the nuclear arms race) – is evidence of the cultural disconnect between the West and the Middle East. It’s about “respect.”

As the U.N. presses member states to pass a new provision that would mandate each member pass new laws making disrespecting, including criticizing, religion criminal – particularly Islam – we can clearly see that “speech” in Muslim eyes is vastly much less important than “respect.” A law of that kind would clearly violate our First Amendment guarantees of free speech, even though the U.S. also has a dark side of book-banning even by governmental school districts if not major religious groups.

Considering that until the Ottomans began serious decline in the 1700s, being labeled the “sick man of Europe” in the 1800s, with the small exception of the 119-year Crusades, the Islamic world wreaked havoc with the West for most of its history. Muslims were the power, even preserving our great books in their libraries as Western ancestors burned books during the Dark Ages (and at other times in European history). Since the Ottoman’s fall at the end of World War I, the lot of most of the Islamic world has continued to be one of decline and humiliation. Until oil financed and empowered a new source of pride and militancy.

In U.S. prisons, and among the street gangs of our own nation, showing disrespect is grounds for immediate retaliation, which often calls for death as the only real response. Yet the right to “disrespect” in embedded in the sanctity of our First Amendment – a right that most certainly has not found a voice in gang conflicts between Pagans and the Hells Angeles, Crips and Bloods or Norteños and the Sureños – is something that most Americans feel very strongly about. While the notion of free speech is deeply woven into the fabric of Western cultural and political thought, we see laws all over the world abridging free speech, from criticisms of the royal family in very moderate Thailand, general censorship in China to the harsh and often-viewed-as-repressive fundamentalist regimes of the Middle East.

To understand Middle Eastern politics, the problems and the possible solutions to regional conflict, is to understand that one of the driving forces of Middle Eastern politicians as well as religious leaders (often one and the same): to rise above the vast stretches of humiliation imposed on the Middle East and its people by the West and to force the West to acknowledge the superiority and pride of what many in the West consider to be a “backward” and “unenlightened” region. Middle Eastern politicians can always find popular resonance to the extent they drive home the “respect” issue to their constituents.

In the end, this conflict of fundamental values – free speech versus controlled and mandated respect, the barrier to so many of the “lasting solutions” for Middle East peace – becomes the battleground on which the fate of the world may well be decided.

I’m Peter Dekom, and I approve this message.

The New “Nationalized” League

Despite all protests to the contrary, and avoiding actually using the “n” word – nationalization – the government “nationalized” Citigroup last week. The February 28^th dailyFinance.com: “The truth is, Citi's deal with the Treasury Department comes largely at the expense of the company's current common shareholders, who will be left owning just 26 percent of its stock. Other investors in its preferred shares, like Saudi Prince Alwaleed bin Talal and an investment fund run by the government of Singapore, will own as much as 38 percent.” Since preferred shareholders don’t vote, and the U.S. government looks like it will own 36% of the company’s common – voting stock. Who’s kidding whom?

Citi’s CEO, Vikram Pandit tells the world that management will “run Citi for the shareholders.” That means that the bank is not yet an unleashed public policy vehicle, won’t be spewing credit into a world that desperately needs it, and will be applying the same rigorous asset and borrower analysis that federal bank examiners are currently requiring. We don’t want a repeat of the subprime crisis in yet another segment of our economy, they say. Citi’s stock dropped to as low as $1.42, 43% off Friday’s close, and the bank has signaled that they may issue a further $50 billion plus in new stock (now that’s a stock I want in my portfolio… er… not).

Exactly how much has Citi received from the government so far? dailyFinance.com: “In total, Citi has received $45 billion in capital injections from the government. It has also issued $20.6 billion in short-term bonds under a guarantee program run by the FDIC, according to SNL Financial.” So they can’t just start lending their hearts out; they still have to make sure they are not lending against declining assets, questionable receivables from customers who may or may not have the ability to pay or folks with declining incomes or even threats of possible job loss. In short, in a managed depression, where virtually everyone in this economy has those negative attributes, they really cannot lend to almost anyone who really should be getting credit!

The eventual solution, once the feds have ascertained which banks are good, which deserve federal money and which need to die? In the pure credit markets, not looking at housing at all (a whole ’nuther solution I’ve blogged about before), the government needs to (i) guarantee bank-to-bank lending (the ability to spread risk and credit syndicated credit lines which supports jobs and businesses) for at least six months, since banks don’t even trust each other, (ii) a segregated, government issued or guaranteed loan fund (the bank can get a piece of the loan as upside) where this direct release of funds through government efforts can be issued to that risk pool identified above (not the new subprimes, but the people and businesses who need the lending capacity to restart the economy, even if they are not perfect risks) and (iii) sanction credit-backed derivatives under new ratings standards where the issuing banks much retain at least 15% of the loan bundles on their books (they have to have skin in the game) in order to restart the cycle of replenishing credit, but this time under solid economic terms.

As the government continues its “nationalization under another name” policy, sooner or later, it is going to have to inject that “lending cash” directly into the marketplace, because banks and investors are still loathe to (if not prohibited from) lending in a falling market against assets of unclear value to borrowers who may lose income. And without this jump-start, we are stuck in neutral with little hope of getting this engine moving again.

I’m Peter Dekom, and I approve this message.