Pushing String

How will Americans cope with a world where borrowing, even after the credit crunch de-crunches, has a whole new set of rules? Household debt sits at around $13.8 trillion! The people have actually borrowed more than their government, and as I have said in a recent blog, U.S. households have borrowed 139% of their disposable income.

Big investment banks, allowed under that infamous April 28, 2004 SEC ruling I have written so much about to borrow well above the 12 to 1 debt to equity ratios imposed on the smaller financial institutions (Lehman Bros. and Bear Stearns died at somewhere between 32-22 to 1), now have to de-leverage (reduce their debt). This is especially true for companies like Morgan Stanley and Goldman Sachs that have voluntarily elected to become commercial banks, where the debt-to-equity ratios remain at that 12 to 1 level. Guess where they are getting some of the money they need to pay off that debt (and create enough balance sheet solidity to handle any crises that may fall in the coming months)? Yeah, that hoarding thing again.

Besides the fact that the “home equity” is just a house, and in spite of the fact that losing a job (or the prospect of losing a job or getting less overtime, etc.) puts a damper on spending, exactly how are Americans going to cope with a world that has moved one giant step towards “pay-as-you-go” versus “go-now-and-pay-later”? Credit card limits and restrictions, discussed in earlier blogs, make borrowing for consumer goods much more difficult. Car purchases have all but ceased. Restaurants are experiencing severe drops in customers, and travel is something that seems to be relegated to necessity, business or a “virtual” trip on a computer or on television.

Empty stores and restaurants don't make Christmas look bright. We spent $460.2 billion last year in the 2007 holiday season, but don't expect anything but down this year. If you are looking for bargains – except for Japanese electronics (sorry, even with the Japanese stock market down, the yen is even stronger than the dollar) – boy is this going to be a great shopping season! And escapist movies – forget the serious stuff – are doing gangbusters at the box office.

Bit by bit, we will rebuild this economy. For all those who missed the Great Depression (almost all of us), the Great Recession (2008-????) will be the life lesson that generations of Americans will carry with them into the future. This is not a short-term fix which changes because we have a new President and a reconfigured Congress.

The key for the next administration is to recognize that government spending falls into three general categories: 1. Stuff we can't stop or limit, like paying our national debt or keeping us safe from criminals and our enemies, 2. stuff that really brings us no or very limited value (like the Iraq War, ethanol subsidies and pure pork), and 3. investments in our future growth (such as infrastructure development and repair, energy research, education and health care). The second category is where a President and the Congress have to cut the most, and the third category, despite rising deficits (don't worry about that!), is actually how we invest and fund our recovery and our future. Simple plan on a vicious political battleground. We will be back… but it will take years… Sometimes, it just feels like we're pushing string.

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

Bottom’s Up!

Banks won't really lend until they think we've hit “bottom.” They're hoarding cash to cover their bottoms. What is “bottom” and why does it matter? Are we looking at the Dow? Interest rates? Jobs? What? Well, let’s start with a basic proposition: banks don't often lend (or lend much) against assets that are depreciating in value, where money is scarce or where the borrower is unlikely to be able to pay the debt on time and on schedule.

Grassroots lenders don't have the money right now anyway (liquidity – money is still stuck way up in the system, per my earlier blogs), most people are watching their net worth fall (stocks and real estate), incomes are falling (so unless you have a big cushion, well – banks like cushions a lot), people are losing their jobs (unemployment), businesses are losing customer/clients or dropping sales and factory orders are down (gross domestic product – GDP), unsold inventory is up, houses are falling in value, etc. Even stuff we assume will hold value – like gold and oil – is dropping because there are fewer buyers and the buyers that exist cannot afford to pay what they did before (because they aren't doing as well). Negative growth and high unemployment are hallmarks of a recession.

The dollar is holding against most other currencies because, for example, folks are even more worried about the emerging markets – and the Euro has less stability than you might think because the Euro-based economies of European countries like Iceland, Hungary, Ukraine and Belarus have been hit much worse than the U.S. – they're looking for bailouts from the International Monetary Fund.

We are, politely, “de-leveraging,” a word that means getting rid of excess debt. We can get there by filing for bankruptcy (the Lehman Bros. debacle), renegotiating existing loans (by force – if the government will act, or by choice – if you know what you are doing), paying off debt (sometimes by selling assets – what some tycoons had to do to pay off their “margin calls” – loans they took to fatten up on juicy stocks that eventually gave them indigestion), getting “bailed out” by someone, merging with a solvent player and most certainly by not borrowing (often because we can't anyway). Credit card debt is a hidden issue waiting in the wings, by the way.

So bottom is kind of “everything.” House prices have to stabilize, unemployment has to level off, the stock market has to stop falling through the floor (and get back to the “couple of points” up or down every day), and people need to borrow based on real values at market interest rates but there has to be money in the lending system. We're not at bottom now; experts see that as possibly as much as several months away. I sure hope not, and there is so much that the government can do (see prior blogs) to right the ship.

So in simple English, the financial institutions who might lend you some money probably won't start until the bottom is reached (or when they are sure what it will be), because you can only go up from there. Right now, a whole lot of folks are trying to figure out what the bottom is and when we will arrive there. Hope it’s soon!

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

Magic Formula + High Rollers = Hedge Funds

They preached to the rich that they had the answers – philosophically-driven investment vehicles for the rich. Some crawled and leaped into emerging markets (high-growth but unstable developing countries), a few financed movies while others created and plied the infamous derivative trade – many packaging subprime mortgages, rating them in tranches and either holding them or selling them as high-yield instruments to institutions like Bear Stearns, AIG and Lehman Bros. A lot of billionaires were born and made in those deals.

Today, even the federal bailout has excluded investing in these funds, as hedge funds are pulling their investments out of emerging markets as fast as they can, tanking the local currencies against a rising dollar and yen. Investors are pulling their money, when they can, out of hedge funds themselves (literally dumping their investments in the already volatile marketplace), and that is a big shoe rapidly slipping off the foot ready to drop. The New York Times today: “Hedge funds lost an estimated $180 billion during the last three months and some are near collapse. Investors are demanding their money back, and Wall Street is bracing for a shake-out in the $1.7 trillion industry.”

Since many of these funds still carry the subprime mortgage derivative bundles, any attempt by banks to lower interest rates or reassess principal necessarily makes the subprime mortgages that remain in those funds worth even less. So what are the funds holding such toxic derivatives doing about this potential further dilution in their retained subprime derivative packages? What every other red-blooded American company would do under the circumstances. Sue the banks to stop them from fixing bad mortgages with realistic interest rates!!!

Today’s New York Times also reports that: “At least two funds, Greenwich Financial Services and Braddock Financial, have told banks that they may take legal action if loans are renegotiated in a way that hurts the funds’ financial interests.” Ooh baby! Calling all lemmings! There are some hedge fund guys out here beginning a new suicidal march to the sea! Okay hedgey guys , bring it on, and then let’s RICO (Racketeer Influenced and Corrupt Organizations Act) them into some free room and board and regulate them out of existence!

I’m Peter Dekom, and I’m feelin’ it!

America: Addicted to Debt

It’s un-American not to be in debt over your eyeballs! We, as individual consumers, borrow more than we earn! For four years in a row, an event that has not occurred since the Great Depression. That alone is an alarming fact. People believed that real estate could only rise. Everyone seemed to borrow more than was prudent, even beyond the sub-prime market. As the January 23, 2008 New York Times noted: “Everyone from first-time home buyers to Wall Street chief executives made bets they did not fully understand, and then spent money as if those bets couldn't go bad. For the past 16 years, American consumers have increased their overall spending every single quarter, which is almost twice as long as any previous streak.”

We all follow the lead of our government that borrowed 100% of the cost of the Iraq War. The United States currently owes $9.5+ trillion of “national debt” (the aggregation of unpaid deficit-borrowings), which in turn generates a massive $350-$400 billion dollars in annual interest payments, mostly to other countries that have politely funded our deficits. Put another way, the national debt currently grows by $1 million a minute or $1.4 billion a day!

We Americans have another form of debt; we call it a “trade deficit” – it runs about $60-$70 billion a month – what happens when you import much more than you export. The November 30, 2006 Business Week predicted that “[f]or the first time in recent memory, the cost of imported goods and services will exceed federal revenues. In other words, Americans will soon pay more to foreigners than they do to their national government.” That happened this year. Even with the slowdown from the recession/depression (whatever you want to call this total meltdown). With massive amounts of our national debt in foreign hands, with global competition accelerating at the expense of U.S. workers and with oil reserves predominantly in antagonistic foreign hands, the future of our economy is decreasingly within our own control. We live based upon the “kindness” of strangers.

So enter Wall Street. Not only did they encourage all the above consumer borrowing, they repacked the debt and sold “derivatives” (including aggregations of risky mortgage loans), making fees creating, buying and selling these “derivatives,” but they fell so much in love with debt, that investment bankers (who make the big bucks when companies are bought and sold – mergers and acquisitions) decided that you really didn't need a whole lot of equity to buy huge companies either – you could use stock and, gotta love ‘em, debt. Lots of it, not a whole lot different from people buying houses without much of a down-payment.

They even figured out how to make even more money by creating layers of debt – the top guys (senior debt) got paid 100% with interest before the next level (mezzanine debt) gets paid off with its higher rate of interest (being in second position is always riskier than being on top). The shareholders (the equity) sit at the bottom, hoping their management made the right decision.

The investment bankers figured out how to get still higher fees by structuring and supplying the high interest mezzanine debt. And giant hedge funds were created, some within these very investment banks, to raise all that capital needed to fuel the mortgage demand, the mezzanine debt demand and all of the other “needs.” A little equity, not a whole lot of government interference (the government even made interest rates so cheap, why not borrow?!), the debt just got higher and higher.

As long as the marketplace was going up, who cared about the debt load? You got a new house or a nice new company or a nice new investment. The housing market woke up in 2007; the financial markets awoke slightly after Bear Stearns went down, but went back to sleep only to awaken to one of the greatest market crashes in American history in the last few days. Lehman Bros. was gone. AIG, an insurance company alive only by government intervention. There was blood in the streets and no short term “fixin’s” gonna right a ship that has run so far aground.

Bottom-line: The laissez-faire lending markets do not work. The derivative markets are a disaster. Without government oversight, required limits on how much real equity you need to borrow and how you will pay it back, we will watch the markets react over time, minus a whole lot of companies and homeowners, until the next debacle. What kind of America will we be then? Competitive? Vibrant? Hopeful? Or a worse version of what the unregulated economy gave us this week?

I'm Peter Dekom and I approve this message.