Federal Reserve Chairman Ben Bernanke believes the current crisis has been one of the most difficult financial and economic episodes in modern history, and is the worst since the Great Depression. Picking the corn from the crap, Chairman Ben made the following observations (I have paraphrased on occasion):
- The Fed is seeing tentative signs that the sharp decline in economic activity may be slowing, for example, in data on home sales, homebuilding, and consumer spending, including sales of new motor vehicles. And no sooner than the words came out of the Chairman's mouth, the Department of Commerce released their advanced March 2009 Advance Monthly Sales for Retail Trade and Food Services. In fairness, I think the Chairman was referring to forward indicators. In any event as you can see below, it is hard to spot any sign that the economic decline is slowing. As retail sales reflect what the consumer is doing (and they were 70% of the pre-Great Recession economy), we are going to have to wait one more month until the perma-bulls can call an end to the recession.
- The net inflow of foreign saving to the United States went from 1.5% of GDP in 1995 to 6% of GDP in 2006. Bernanke says this would have been good but money was not put to good use. Credit became too easy making things like housing bubbles while lending practices degraded. The large flows of global saving into the United States drove down the returns available on many traditional long-term investments, such as Treasury bonds. So boys and girls, because traditional investments were not attractive anymore, the financial community created the alphabet soup of toxic crap (CDO, CDS, etc) to make everybody happy. This is the Fed's “enhanced” story of how we got into this mess.
- The Fed's lending to financial institutions has helped to ease conditions in Monetary Policy Response to Inflation is a Fools Journey a number of key financial markets, reduced important benchmark interest rates (such as the London interbank offered rate, or Libor, to which payments on some mortgages and other types of loans are tied), I guess that the actions of the Bank of England were not the proximate cause of the reduction of LIBOR – live and learn.
- The time will come when the economy has begun to strengthen, financial markets are healing, and the demand for goods and services, which is currently very weak, begins to increase again. At that point, the liquidity that the Fed has put into the system could begin to pose an inflationary threat unless the FOMC acts to remove some of that liquidity and raise the federal funds rate. The Fed is thinking carefully about these issues; indeed, they have occupied a significant portion of recent FOMC meetings. I can assure you that monetary policy makers are fully committed to acting as needed to withdraw on a timely basis the extraordinary support now being provided to the economy, and we are confident in our ability to do so.
It is this point on inflation that should be the most troubling. Consider that lowering the federal funds rate did not restart the economic engine, the Fed and the Treasury have been doing a lot of unorthodox procedures to stimulate. These will create a hidden momentum in the economy – and the only way to kill its effects is to strangle the economy. The Fed is being overly optimistic that it can safely kill inflation without killing the economy (if inflation happens – but this is a discussion for another day).
A fool is o ne who is deficient in judgment, sense, or understanding. One who acts unwisely on a given occasion.
Additional Economic Events from this Past Week
Nouriel Roubini and his RGE Monitor believes the banks will pass their stress tests but we should consider the following:
“In brief, banks are benefiting from close to zero borrowing costs and fewer competitors; they are benefiting from a massive transfer of wealth from savers to borrowers given a dozen different government bailout and subsidy programs for the financial system; they are not properly provisioning/reserving for massive future loan losses; they are not properly marking down current losses from loans in delinquency; they are using the recent mark-to-market accounting changes by FASB to inflate the value of many assets; they are using a number of accounting tricks to minimize reported losses and maximize reported earnings; the Treasury is using a stress scenario for the stress tests that is not a true stress scenario as actual data are already running worse than the worst case scenario.”
Other commentators also point to the fact that many of these banks were among the main recipients of AIG bailout funds in previous months, e.g. Goldman Sachs ($12.9 billion), Merrill Lynch ($6.8 billion), Bank of America ($5.2 billion), Citigroup ($2.3 billion) and Wachovia ($1.5 billion), according to New York Times data. The firms involved dismiss this factor as immaterial for Q1 earnings. Nevertheless, the GAO noted in a report at the end of March that Treasury should require that AIG seek additional concessions from employees and existing derivatives counterparties.
Meanwhile, in the real economy credit growth to the private sector has continued to slow at a fast pace in the U.S. as well as in Europe, while U.S. credit card charge-offs rose to an all-time high in February at 8.82%. Moody's predicts the charge-off rate index will peak at about 10.5 percent in the first half of 2010, assuming a coincident unemployment rate peak at 10 percent. In turn, Fitch warns that credit card delinquencies point to record defaults ahead. Keep also in mind that global high-yield defaults are expected to reach 15% by the end of 2009 and that the commercial real estate market has just turned.
The Producer Price Index for March 2009 showed a moderate decrease. My take is that the PPI is stabilizing, and that monthly variations should be expected until inventory levels return to normal. There is no indication of deflation in goods.
Several reports have been issued this week on industrial production – I have commented on them here . Overall the results are dismal as industrial production has fallen to 1998 levels. There is some expectation (hope?) in certain regions of the country that the rate of production destruction is reducing. I believe the bottom in industrial production is 4 to 6 months way. However, once the bottom is reached, the expensive task of re-optimizing production must be undertaken.
The daily Treasury yield curves for April 2009 are here .
The Philly Fed released their April business survey summarized as follows:
According to respondents to the April survey, activity in the region's manufacturing sector continued to decline this month, but some indexes suggest that the declines are diminishing. However, indicators for general activity, new orders, shipments, and employment all remained negative. Even more strongly indicative of continued weakness were the indexes for prices, which reached record lows. In contrast, most broad indicators for future business conditions improved this month, suggesting that the region's manufacturing executives expect a recovery in business activity over the next six months
This conclusion is in line with the general trend we are seeing across America. However, the optimism that things will be getting better is misplaced – things will just stop getting worse.
The Treasury is beginning to swap out some of its expensive 12.5% Treasury Bonds originally issued in 1984 and due in August 2014. There are $4.3 billion of these bonds outstanding, of which $3.4 billion are held by private investors. The Treasury estimates gross savings from the call to be about $2 billion. Oh well, the Government has no desire to let those that hold high value bonds ride the gravy train. What do you want to bet if the majority of these bonds were owned by banks they would not be recalled?
Housing starts fell -10.8 percent in March 2009 . On a year-over-year basis, overall housing starts were down -48.4 percent in March . On a year-over-year basis, building permits were down -45.0 percent in March. Regionally, The mortgage loan application volume decreased 11% (unadjusted for Easter / Passover) compared with the previous week and increased 45.6 percent compared with the same week one year earlier. The refinance share of mortgage activity was 77.8% of all loans. The average interest rate for 30-year fixed-rate mortgages decreased to 4.70 percent from 4.73 percent . Foreclosures have climbed to 804,000 in 1Q 2009 .
Real average weekly earnings were about unchanged from February to March after
seasonal adjustment. A 0.3 percent decrease in average weekly hours was offset by a 0.2 percent increase in average hourly earnings and a 0.1 percent decrease in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W).
The Fed has issued a paper exploring whether minorities were targeted for expensive credit in 2004-06, the peak period for subprime lending. The conclusion:
If any pricing differential exists, minority borrowers appear to pay slightly lower rates. We also find that borrowers in Zip Codes with a higher percentage of black or Hispanic residents or a higher unemployment rate actually pay slightly lower mortgage rates.
Mortgage rates are also lower in locations that experienced higher past rates of house price appreciation .…….. these results suggest the possibility that subprime lending did serve as a positive supply shock for credit in locations with higher unemployment rates and minority residents .
The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.2% in March 2009, before seasonal adjustment (0.1% seasonally adjusted). The index has decreased 0.4% over the last year, the first 12 month decline since August 1955. I am not a lover of the CPI, but this should confirm we are in a black swan event.
The decrease was due to a 3.0% decline in energy. An 11% increase in tobacco and smoking products accounted for over sixty percent of the March rise. When indexes do strange things, I would be really careful how I interpret what is going on. Although most of us believe we know, I would not bet on it.
The rate of job destruction had a slight decrease for the week ending April 11 with the four week moving average with 651,000 jobs being lost every 4 weeks. Some punters might be pointing to an 8% reduction in seasonally adjusted initial claims this week – however these are advance numbers and have been notoriously inaccurate and volatile. This is why I have been consistently using 4 week moving average numbers.
Filing for Bankruptcy: General Growth Properties (Owns 200 malls – second largest mall operator in the USA) (GGP), AbitibiBowater (ABH). Bank failures reported last week: New Frontier Bank (Greeley, CO), Cape Fear Bank (Wilmington, NC). Bank failures this week: Great Basin Bank of Nevada (Elko, NV) and American Sterling Bank (Sugar Creek, MO).
Economic Indicators Published this Past Week
The WLI from ECRI is continuing to show improvement in economic conditions six months from now. In their statement last Friday, they said With the upturn in Weekly Leading Index growth continuing for over five months, growth in U.S. economic activity will begin to improve in short order.
More and more indicators are clearly showing a bottoming of the economic slide. I am watching how elements of demand are playing out. I am glad I have not created some quantitative formula which I am married to – as there is so much liquidity in the market that the normal recessionary models are suspect. Additional unusual factors such as real estate value decline, high levels of debt, the global nature of this Great Recession are compounding the difficulties the traditional forecasting tools are facing.
In major recessions (depressions), the downward movements come in waves. There will be consolidation levels where people and business wait and see. Only in hindsight will we know if what we are currently seeing is the bottom, or a mere consolidation on our way to our new normal.
If you would like a summary of all government financial indicators, click here .