Substance and Talking Points

I try to set aside Sunday mornings for catching up on some newspaper reading and to watch political shows such as Meet the Press, keeping my eyes on the page/computer and my ears on the TV, drifting back and forth depending on what I'm reading or hearing. This week's Barrons', which I've read forever it seems (now online, having forsaken the print version), had a remarkably to the point article by Doug Kass, founder and President of Seabreeze Partners, and well-known "short-seller" which echoes some of what I've written about the subject of the growing abyss between the haves and the have not's and its impact on the misery of the middle class. Kass' term for this misery is "Screwflation" (combing inflation with the screwing of the middle class). Here are some of his bullet points although its best to read the entire article:

* While...corporate profits will soon attain a new peak, median real wages have made little recent progress....Moreover...an unprecedented four years of declining home prices have further weakened the confidence and purchasing power of the middle-class screwees.

* Unemployment has exacerbated screwflation's impact on all but the wealthiest Americans.

* Because there are few areas of the domestic economy that can replace the prerecession strength in real estate, a recovery in jobs will be more difficult than in previous cycles. Work related to real estate accounted for nearly 40% of U.S. job growth in 2001-06–almost all of it middle-class.

* Back in 1980, the richest 1% of Americans captured 9% of national income. Today, the richest 1% receive about a quarter of national income.

* [The] rise [ of commodity prices] falls more heavily on low- and middle-income families, who spend most of their money on the necessities of life. Add rising health care, education and other costs to commodity prices, and the result is a poor foundation for growth.

* Difficult fiscal decision...must be made this summer in Washington. The needs to accelerate job growth and to control the federal deficit seem irreconcilable.

* A shallow and fragile domestic economic recovery may be exposed to and be vulnerable to the need to cut spending–but drastic spending cuts will jeopardize the shallow recovery in jobs. Not moving on deficit reduction holds its own risks, of U.S. dollar weakness, soaring interest rates and higher unemployment....Partisanship already makes a real solution less likely.

Kass concludes with some excellent suggestions, but with Washington in gridlock, even on such major issues of raising the debt ceiling, and in the throes of pre-Presidential election rhetoric (see Meet the Press discussion below), one can't be terribly optimistic about implementing them:

* Policies that could help quickly include: extending the payroll-tax cut initiated by the Obama administration; reducing income taxes for the middle class; providing federal funds for infrastructure spending; creating incentives for businesses to make new capital investments; allowing tax-free repatriation of U.S. corporate earnings made abroad, if they are earmarked for the creation of American jobs; the launch of an energy plan that taps domestic resources; and the use of federal-housing financing to slow foreclosures and distressed sales.

While reading that article of substance, I was watching Meet the Press, particularly David Gregory's interview with Debbie Wasserman Schultz, the Democratic National Committee Chair and Reince Priebus, the Republican National Committee Chair. Talk about talking points galore. Here is the entire transcript.

Gregory immediately baits the debate with so called "facts:"

MR. GREGORY: All right. Well, let's talk more, let's talk more about the economy in some more detail. This is the president's standing in terms of handling the economy in the public's eye, and it's pretty negative right now. Sixty percent almost, 59 percent, disapprove of the president's handling of the economy . And there are facts that back that up that are difficult for this administration and for the Democrats: unemployment's up 25 percent since Inauguration Day for President Obama ; the debt's up 35 percent, over $14 trillion; a gallon of gas up over 100 percent, with gas $3.75, higher than that in certain parts of the country . Why should Americans trust Democratic governance right now on the economy , and particularly the president's?

The numbers might be correct but one has to wonder about the "cause" of the "effect." Naturally, both Schultz and Priebus jump on their talking points:

REP. SCHULTZ: ...when President Obama took office, the month before he was inaugurated, the economy was bleeding 750,000 jobs a month, David , and we were not headed in the right direction. Now, I know we -- and President Obama has said we have a long way to go . We'd like the pace of recovery to, to, to be picked up. But we have definitely begun to turn the economy around. You, you fast-forward two and a half years later now, and the economy has created 2.1 million private sector jobs, a million of those jobs just in the last six months. We've had 15 straight months of job growth .

Priebus has his talking points:

MR. PRIEBUS: David , the chairwoman's living in fantasyland. We know that the facts are the facts, and we can't get away from that. And Barack Obama is defenseless to the truth on what's going on in the American economy . We have lost as -- two and a half million jobs since Barack Obama 's been president. And of that two and half million jobs, almost 45 percent of those people have been out of work for six months. That number, that number rivals the Great Depression .

Back and forth, your talking points vs. mine. It is a sign of the silly season of an impending election, with the danger that the increasing polarity will result in a stalemate that leaves our economy on the edge of a cliff once again.

But, can they both be "right?" The Bureau of Labor Statistics' Employment, Hours, and Earnings from the Current Employment Statistics survey (National) 2001 -- 2011 confirm that, indeed, we've lost about 2.5 million jobs since Obama was inaugurated, and we've gained almost 1 million jobs in the last six months. But the BLS also shows about 4.4 million non-farm jobs lost in the 12 months before Obama took office. How's that for a talking point?

One can play with all these statistics any which way to "prove" a point of view. The fact of the matter is we had tremendous job growth in the three plus years before the collapse of the economy (and almost the collapse of our entire economic system) in 2008, but those jobs "created" were heavily real estate and construction related during a housing run-up which we now know was merely a chimera. These are jobs that would not have come into existence without the frothy, nothing-down, exotic mortgage real estate market and the complicity of the investment banks and Washington to get those deals done. We simply "borrowed" from the future. Now, those jobs our out of the system with no prospects of returning soon. It is going to be very difficult to have robust job creation if, as Doug Kass suggests, real estate represents 40% job growth without solving our foreclosure and distressed sales issues which is now on such an enormous scale.

And how fair is it to "mark" a President's starting point for job creation as the date of his inauguration? The economy is a leviathan which cannot be turned on a dime. And, by the time Obama was making some headway, he lost control of Congress. Now we have such a polarized government, it is a wonder that any jobs are being created.

And, really, what control does the President have on world oil prices? We could have an army of rigs in the Gulf of Mexico and it wouldn't make much difference in prices as it is a world market for oil. The US cannot effect prices much by creating marginally more supply. Now, controlling the speculative aspect of prices may be a different matter, but financial regulation is habitually resisted by Obama's adversaries.

Agreed, we should have a national energy policy, but for it to have any teeth it will mean some hardship. In Europe, gas is twice the price as it is here. People learn to drive smaller cars, take mass transit, etc. No one would agree to that here so a national energy policy is simply kicked down the road, by both parties.

Finally, the deficit. Does anyone really think that if McCain was elected it would be much different today? President George Bush's 2001 and 2003 tax cuts have been big contributors as well as funding for the wars in Afghanistan and Iraq. Granted, President Obama's 2009 stimulus bill is also in the mix. But that was enacted when the Federal Reserve no longer could cut interest rates (they were already effectively at zero) and there was general agreement that the economy was still in crisis and without a stimulus, it would slip off the cliff again. And one one argues the bill failed to create jobs as intended. No Republicans voted for the act and now that they control Congress, one has to wonder what they will vote for or block. We know the talking points, and Kass makes substantive suggestions, but can Congress even function any longer?

Peacocks Preening

The bird moved forward a little. Then it turned its head to the side and braced itself. It kept its bright, wild eye right on us. Its tail was raised, and it was like a big fan folding in and out. There was every color in the rainbow shining from that tail....The bird made this strange wailing sound once more. 'May-awe, may-awe!' it went. If it'd been something I was hearing late at night and for the first time, I'd have thought it was somebody dying, or else something wild and dangerous. --- Raymond Carver, Feathers

It has been that kind of "wild and dangerous" week in Washington, the showing of the feathers -- May-awe, may-awe! -- the Democrats crucifying the oil industry in Congressional Hearings, with the irony of Jay Rockefeller, a great-grandson of Standard Oil Company's John D. Rockefeller, grilling oil executives over tax breaks, even though the "mere" few billion yearly in such breaks wouldn't even move the needle on the national debt. And, of the $4 dollars being paid at the pump, those tax breaks are negligible. Not that I understand their need for those tax breaks: let the politicians battle that one out. But what I do understand is grandstanding when I see it. May-awe, may-awe!

What our Congressional leaders should be addressing is the need for a national energy policy, but we've been talking, talking, about that ever since the gas lines of the early 1970's. We have the technology but not the will to do what is necessary and every administration has kicked that can down the road.

It shows the dysfunctional nature of our government and we are paying for it, literally, in our national debt, at the pump, and at the supermarket, etc. Senator Rockefeller, when you made your political accusation to the oil executives, " I think you're out of touch, deeply profoundly out of touch," you should have been addressing Congress instead.

Speaking about being out of touch, we also had the preening of the Republicans, best represented by House Speaker John Boehner's remarks at the New York Economic club: "It's true that allowing America to default would be irresponsible...but it would be more irresponsible to raise the debt ceiling without simultaneously taking dramatic steps to reduce spending and reform the budget process." May-awe, may-awe! As Congress would like to raise the debt limit by $2 trillion, that means $2 trillion in cuts which sounds idyllic, just like ending oil tax incentives. But we are supposed to hit the debt ceiling within days or weeks. Can one imagine Congress being capable of engineering $2 trillion in cuts in such a short time? Impossible. So there it is, an implied ultimatum to the President: no tax increases and show me the $2 trillion or we don't care whether there is a default by the US on its debt. Catastrophic for our country, but that's the Rambo image our "leaders" like to project, no matter what the consequences to our economy and jobs. May-awe, may-awe!

Natty Bumppo Economics

The recently completed $38 billion battle of brinksmanship over next year's federal budget is going to look like child's play in comparison to the upcoming showdown over the need to increase the debt ceiling. So, so much more is at stake, including the dollar's status as a reserve currency. And yet, our congressional "leaders" have declared a recess until sometime in early May, only a couple of weeks before the Treasury hits the debt ceiling. No doubt the recent move in gold and dollar weakness reflect an increasing anxiety that the United States Government could actually default. S&P has put the US on credit watch. Without Congressional action we will simply greatly increase the cost of inevitably having to borrow anyhow when Armageddon comes knocking at our fiscal door, and who will want to lend to a deadbeat government? Why would our politicians even play such a game? Is it a form of political conspiracy to bring the government to its knees?

Agreed, carrying unsustainable debt is a sure death knell as well. But debt on the balance sheet comes not only from making poor judgments and being profligate, it also comes from failing to raise revenue. Both sides of the income statement --- expenses AND revenue ---need to be examined by our absentee representatives.

It is wishful thinking, particularly as the economy has been on life support through the Federal Reserve since the 2008 financial crisis, that we can grow enough to offset the tax cuts that have been implemented since the Clinton years. US taxpayers with the highest adjusted gross income have watched their federal tax rates fall from about 30 percent in 1995 to 17 percent by 2007. No argument that we need to simplify the tax code, but tax revenues need to be higher, simple as that. We need to revisit those Clinton rates again, a graduated tax rate without the loopholes. Close as many doors as possible to the underground economy. Eviscerate tax avoidance strategies.

We also need to shore up Social Security by increasing the wage limits for SS taxes -- or how about a similar "donut hole" we give to seniors for their drug needs, taxing wages for social security to a certain limit, then no tax until another higher limit is reached, and then resume taxing for social security revenue. On the expense side of the income statement, means testing will have to be instituted and the retirement age slowly moved back.

The ideas put forth for privatizing Medicare will slowly kill the program, so desperately needed by the middle class. Cost containment measures have to take first priority. A voucher program is smoke and mirrors. Can you imagine the average senior having to make such decisions with insurance companies pulling the strings?

And Medicare being entirely turned over to the States, many of which can hardly make their own budgets balance? Disaster for the poor.

These are huge issues and I don't mean to simplify any of them, but defaulting on our debt is NOT the first step in resolving any of these problems. It will be our last.

The amazing thing about this "movement"-- if it is fair to call it that -- is some of the people who would be hurt the most just say "bring it on, let the government fail." Perhaps this notion harkens back to the idealized Natty Bumppo from James Fenimore Cooper's Leatherstocking Tales. But this is not a mythical tale of American rugged individualism and "one shot, one kill." It is about cooperation and compromise. We need our representatives to do the hard, serious work they were hired to do without all the political posturing and partisanship, and without the brinksmanship of the twelfth hour.

She's Quick on the Trigger

With targets not much bigger than the president's deficit commission. I don't think I've ever actually READ anything by Sarah Palin, although I've seen her paraded before TV cameras, so it was with some interest that I noted "her" opinion column in the Wall Street Journal, Why I Support the Ryan Roadmap; Let's not settle for the big-government status quo, which is what the president's deficit commission offers.


I had expected a folksy take on the topic in keeping with her TV persona, perhaps sprinkled with homey references to Alaska wildlife, or more aptly the disappearing wildlife when Sarah Oakley has her high-powered rifle with telescopic sight at her side, but instead was greeted by a more or less professionally written piece of journalism, quite possibly with the help of the people at News Corp which owns the WSJ and also owns Fox which in turn employs Ms. Palin. She or her ghost writer is "disappointed" in the deficit commission's recommendations but commends the commission for exposing "the large and unsustainable deficits that the Obama administration has created through its reckless 'spend now, tax later' policies." I go speechless when reading such an accusation, feeling like Melville's Billy Budd confronting the evil Claggett. Sarah, do you really believe what "you" wrote? Not only are the deficits at least partially shared by your Party (not to mention the National Debt most of which could be pinned on the Bush era), but Congress now has the opportunity to roll back some of the tax forgiveness for the super wealthy, both in terms of incremental tax rates and the inheritance tax, and your Party is stonewalling that prospect. However, pardon my impertinence, "a man never trifles / with gals who carry rifles...Annie Get Your Gun.

The More Things Change....

Welcome to the twilight zone. When I read stories such as Microsoft possibly borrowing to increase its dividend and stock buybacks, I see it as just another sign of the American economic system gone wild. There was once a day when companies borrowed money to finance expansion for the production of goods. Now we borrow to pay shareholders or make titanic bonuses to executives. Or we finance our deficit by borrowing from China to keep the American consumer, AKA Hamster on a Wheel, buying at the local official distributor of goods made in China (and other emerging countries), Wal-Mart. But even with interest rates at all time lows, we cannot create borrowing demand in housing, or small business so unemployment remains intolerably high.

In the past I’ve written about many of the pieces of the economic conundrum we’ve created for ourselves, the problem of job creation, the local government crisis, the underfunded pension guarantees, entitlements, banking bailouts, the inflation/deflation tug of war, and in general our consumption oriented society. In fact, while everyone feels a little better as we have thrown so much $$ at the economy to keep it afloat, repair some damage to everyone’s 401Ks, the really major challenges lie ahead, and in one of the more divisive political environments as the midterm elections loom. The more things change, the more they stay the same…. Alphonse Karr
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Inflation or Deflation?

I remember watching Wall Street Week with the late Louis Rukeyser in the late 1970s and early 1980s during another alarming economic period, with talk of South American style inflation reaching the U.S. and the mindset that goes along with that fear, people buying gold, eschewing long term US Treasuries which were yielding around 15%. It seemed each and every week investors were waiting for reports on the “money supply” with any large increase reinforcing the then prevailing view. In retrospect, how much simpler and more benign economic matters seemed then.

Now money supply measurements are not even discussed. Instead, we wait with baited breath for the Fed’s latest interest rate decision, endeavoring to parse the Federal Open Market Committee’s statements, comparing them with prior statements for clues as to what the future holds.

Today seems to be the inverse of those days with US Treasuries yielding nearly nothing, and the fear of deflation driving investor psychology, leaving few alternatives to us average folk not of CNBC’s fast money crowd. By the Fed’s decision to reinvest its portfolio of maturing mortgages in U.S. Treasury debt, rather than shrinking its balance sheet, it has embarked on a method of monetizing debt. Normally this would ring the inflation bells but not in this economic environment where spending is a higher priority than reducing debt or saving. Deflation is a state of mind that once it takes hold becomes a self fulfilling prophecy, particularly in the wake of the economic turmoil and bailouts of the financial sector of the last few years, with high unemployment and state and local government fiscal problems, leaving the Fed with few remaining options. And, unlike inflation, we have little experience with it other than the 1930s and Japan’s ongoing battle with it since the early 1990’s.

As reflected by CD rates of nearly zero, it is an investment environment where one has two choices, take risk (which is being encouraged by the government’s actions) or put your savings under a mattress (which, in a deflationary environment produces a positive return without risk). Inflation or deflation? One has to wonder what the Fed knows that we don’t. It is a conundrum for the saver. Bring back the good old days of Wall Street Week!

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Long-Term Thinking

This entry is a redirect to the site of the John Hussman, an academic economist turned mutual fund manager, who takes a long-term perspective and invests accordingly. He has been a frequent critic of the overall bailout strategy arguing that until we clear out bad loans, requiring those who made them to take losses, we are doing nothing more than applying band-aids to wounds that need major suturing.

It is amazing to watch the markets since late 2007 as governments around the world have gone into hock, writing blank checks to the financial sector. This has reengaged investors, driving up markets, and leaving risk-adverse investors with the option of getting no return or being forced into riskier investments. It is as if governments are introducing the same problem as a solution. We all get a sense that there will be serious long-term consequences and perhaps recent developments in Europe are indicative. In the U.S. we have time bombs of Fannie, Freddie, deteriorating state and municipal government finances, Medicare and, now, the economic consequences of an ecological disaster in the Gulf, which will linger for generations. How much longer can difficult, lasting solutions be deferred?

Meanwhile, investors can always follow Dilbert’s Scott Adams’ investment “advice” bearing in mind that in humor there is much truth, although he does carry the disclaimer “not to make investment decisions based on the wisdom of cartoonists.”

Here are some key points Hussman makes in his latest piece:

* The fundamental problem is that we have not, as a global economy, accepted the word "restructuring" into our dialogue. Instead, we have allowed our policy makers to borrow and print extraordinarily large band-aids to temporarily cover an open wound that will not heal until we close the gap. That gap is the difference between the face value of debt securities and the actual cash flows available to service them. The way to close the gap is to restructure the debt. This will require those who made the bad loans to accept the associated losses. By failing to do that, we have failed to address the essential problem faced by the world, which is that we have created more debt than we are able to service.

* When our policy makers insist on defending reckless lenders with public resources, we have to recognize that this is not free money. When the government issues a paper liability for real value, that real value gets directed to the recipient at the expense of countless other activities. Even seemingly costless interventions can be redistributions of wealth. For example, the strategy of dropping short-term interest rates to nearly zero as a way of increasing the interest spread earned by banks has the direct effect of impoverishing savers, very often elderly people who rely on lower risk investments for capital preservation.

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Bill Gross Redux

As I’ve noted in some prior blog entries, Bill Gross, the world’s preeminent bond manager from PIMCO, also happens to be an excellent writer. I read his monthly comments as much for their style and wit, as I do for their content. His piece this month Don't Care, although primarily about the sovereign debt crisis, seques into the topic using the experience we’ve all had, the vapidity of cocktail conversation, the inherent disinterest of people in other people, coming to the conclusion that “the careful discrimination between sovereign credits is becoming more than casual cocktail conversation. A deficiency of global aggregate demand and the potential impotency of policymakers to close the gap are evolving into a life or death outcome for the weakest sovereigns, with consequences for credit and asset markets worldwide.”

But I am not going to discuss sovereign debt here (perhaps the most serious one ultimately being our own) but, instead, the experience he so eloquently and hilariously describes as the blather of the social gathering. He even incorporates a graph entitled the “Cocktail Party Empathy Chart,” the X-axis being “Seconds Into The Conversation” and the Y-axis being “How Much I Really Care About What You Are Saying.” As one might imagine, there is a diagonally dropping line from ten to zero in about ninety seconds.

Although Gross covers the five topics such conversations normally wander off to, I’ll use his general observation as my own seque into a very recent experience relating to my last entry , in which I said I was happy to see the preview performance of American Buffalo as it gave me an opportunity to form my own opinion of the production. Since then, three professionally written reviews have appeared, one in the Palm Beach Post which was positive but, I thought, could have been more enthusiastic and two unconditionally excellent reviews, one in The New Times, Broward/Palm Beach and the other from Skip Sheffield’s blog.

We were at a social gathering recently and someone asked whether anyone had seen this new production of American Buffalo so I began to glowingly describe the production and was interrupted by the comment that the Palm Beach Post didn’t seem to be overly enthusiastic. Exactly my point I began to say, and before I could expand upon that it was pretty clear to me this person was more interested in talking about something else relating to one of those five “unbearable minute-and-a-half” topics, not really wanting a thoughtful reply. On Bill Gross’ X/Y graph, I hardly lasted the 90 seconds!

But why should this be a surprise? We don’t even listen to each other on the bigger issues. Look at the recent hyped meeting on healthcare between the President and leaders of Congress, each party pushing its own agenda, preening for their constituents in the all-day televised meeting. Hey, it makes no difference whether we will bankrupt the nation, as long as I look good! Who cares what the other has to say?

But I digress. Thanks, Bill Gross, for reminding us that we need to listen to each other, although I guess he might agree it all seems pretty hopeless.

Well Worth Noting…

Two interesting articles, one an interview with Richard Koo, a former economist with the Federal Reserve Bank of New York and now chief economist of Nomura Research Institute, which appeared in this week’s Barron’s Magazine, A Japanese Rx for the West: Keep Spending and the weekly commentary of the economist and mutual fund manager John Hussman, Timothy Geithner Meets Vladimir Lenin

Koo’s views might seem to be counterintuitive – government needs to increase deficit spending on a three to five year plan while the private sector is repairing its balance sheet. Japan failed to recognize the dangers of “a balance sheet recession” and the USA could make the same mistake. I would agree, provided spending is focused on our infrastructure or alternative energy, or on myriad other public projects that resonate in our economy, creating jobs while fixing our roads and public transportation, encouraging energy independence, reducing greenhouse gases, and improving our educational system. Such investments are aimed at Main Street, not Wall Street. I would imagine Koo would be the first to note that bailouts of irresponsible investment bankers do not constitute the kind of government borrowing he means.

Koo contends that while the private sector repairs its balance sheet, writing down debt on devalued assets, it is imperative for the Federal government to borrow because even if interest rates are zero, the public sector cannot be induced to borrow: “The only way the government can turn this economy around is to do the opposite of the private sector -- borrow the money the private sector saved and spend it, which means fiscal stimulus. That's what saved Japan from entering a Great Depression.”

In effect we can’t make businesses borrow by giving capital to the banking system which only encourages more reckless economic behavior – it has to be spent elsewhere, and what better place than our infrastructure and energy independence?

John Hussman, meanwhile, writes about the very kind of borrowing we must eschew, especially as it is being done without our elected constituency’s input: the Treasury’s recent announcement that it would provide Fannie Mae and Freddie Mac UNLIMITED financial support for the next three years, reminding us that it was Vladimir Lenin who said: “The best way to destroy the capitalist system is to debauch the currency.”

As Hussman notes, “in a single, coordinated stroke, the Treasury and the Federal Reserve have encroached on spending powers that are enumerated for the Congress alone.” And perhaps worse, “…homeowners who have been diligently making their payments will keep their homes, and homeowners who took out mortgages they couldn't afford will keep their homes as well with no adverse consequence to the lenders – since the underlying loans are now owned largely by the Fed, and the Treasury has pledged its unlimited support. Why pay one's debts if it becomes optional, and the Treasury stands to absorb unlimited losses at public expense?”

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The Vanishing Work Ethic

Hat tip to my former colleague, Jim Wright, who put me on to Steven Malanga’s interesting and well-researched article in the City Journal, “Whatever Happened to the Work Ethic?” which strikes at the heart of our economic crisis. Things have changed in America where we used to work hard to make things and where borrowing and bailouts were eschewed.

As Malanga states: “What would Tocqueville or Weber think of America today? In place of thrift, they would find a nation of debtors, staggering beneath loans obtained under false pretenses. In place of a steady, patient accumulation of wealth, they would find bankers and financiers with such a short-term perspective that they never pause to consider the consequences or risks of selling securities they don’t understand. In place of a country where all a man asks of government is “not to be disturbed in his toil,” as Tocqueville put it, they would find a nation of rent-seekers demanding government subsidies to purchase homes, start new ventures, or bail out old ones. They would find what Tocqueville described as the “fatal circle” of materialism—the cycle of acquisition and gratification that drives people back to ever more frenetic acquisition and that ultimately undermines prosperous democracies.”

Malanga’s full analysis of the topic is well worth reading.

On the eve of President Obama’s inauguration I wrote “The winners in this economy were not only the capitalists, the real creators of jobs due to hard work and innovation, but the even bigger winners: the financial masters of the universe who learned to leverage financial instruments with the blessings of a government that nurtured the thievery of the public good through deregulation, ineptitude, and political amorality. This gave rise to a whole generation of pseudo capitalists, people who “cashed in” on the system, bankers and brokers and “financial engineers” who dreamt up lethal structures based on leverage and then selling those instruments to an unsuspecting public, a public that entrusted the government to be vigilant so the likes of a Bernie Madoff could not prosper for untold years. Until we revere the real innovators of capitalism, the entrepreneurs who actually create things, ideas, jobs, our financial system will continue to seize up. That is the challenge for the Obama administration – a new economic morality.”

I still await that new economic morality.

Meanwhile, since the National Debt passed $11 trillion in March, the markets have moved strongly on the upside, led by the financials, anticipating a recovery from the Great Recession. I see little difference in the general shape of our financial institutions other than the federal government (uh, we the taxpayers) standing ready to bail out any deemed to pose a systemic risk to the system. As of the end of August the National Debt now stands at $11.8 trillion, so over the next several weeks that will undoubtedly pass the $12 trillion mark. That’s $1 trillion in additional debt in only 6 months. I make this observation in advance as this blog will go silent for several weeks while are traveling overseas.
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Citigroup Raises Pay as Unemployment Rises

It is a tired old argument in the financial service sector, raising salaries “to retain the best talent.” Today the New York Times reports Citigroup Has a Plan to Fatten Salaries .

It goes on to note “industrywide, total compensation is expected to rise 20 to 30 percent this year, approximately to the levels of 2005, before the crisis, according to Johnson Associates, a compensation consulting firm.” It was during that time the instruments of financial destruction began to flourish, so why not roll back the clock to then?

Having run a business in both good times and bad times, we all benefited from the former and we all had to tighten our belts during the latter. Why should the financial services industry be except from the financial laws of gravity and why does the Board of Directors approve such policies while their shareholders suffer and their businesses take government funds? Bank of America and Morgan Stanley are also raising base salaries. Guess they too are concerned about “retaining the best talent.” All of this as unemployment rises -- where does this logic end? It almost seems like a back door form of price-fixing, as isn’t it inevitable that the expense of these coordinated salary increases find their way into the cost of financial products?

Juxtapose that to an article in the same edition of the Times: Despite Recession, High Demand for Skilled Labor. Some jobs such as registered nurses, geological engineers, and welders are going unfilled, even during the recession. These are jobs that actually produce something and are critical to our society. One might as well work in the financial services industry where compensation is immune to supply and demand.

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Bombshell

“We are out of money.”

This is the “news” we’ve feared, although expected, but not so soon: the admission that the US economic system (not necessarily the stock market which lives in its own fantasy land before it adjusts to reality) is insolvent. President Obama, responding to a question about the cost of health care in an interview on C-SPAN yesterday, said, “Well, we are out of money now.”

Just a couple of weeks ago I noted, “One gets the feeling that the Obama administration has little choice but to let this kind of bad news out slowly, hoping the market and the psyche of the country can absorb it without disrupting the tenuous nature of the recovery, particularly in the credit and stock markets. Until REAL unemployment recedes deficits will inevitably grow beyond forecasts.”

Obama’s admission seems to be a continuation of the letting-the-news-out-slowly “strategy” the consequences of which are staggering, not only for holders of US Treasuries, but just about every world currency because of the symbiotic relationships between the lending economies and the consuming economies. For sometime I’ve been concerned about this, particularly because of the mathematical confluence of rising healthcare costs and rising unemployment. “Are T-Bills “risk free,” especially as the US seems to be on a course to guarantee every debt and every major corporate shortfall, not to mention the twin time bombs of Social Security and Medicare/Medicaid as the baby boomers retire and unemployment rises? Now there is a Black Swan.” So, today’s headline “Fix is hard for Medicare, Social Security finances” does not come as a surprise, but it is disturbing that we have so long delayed the inevitability of facing up to this hydra headed conundrum. “If we cannot even acknowledge these economic truths, there can be no national plan to deal with the dire consequences.”

Maybe President Obama’s statement was more of a Freudian slip, but it is now out there, to be “pondered" by the markets, and, hopefully, to be finally faced up to by Congress.
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Slowly Letting Out the Bad News

Among all the talk of green shoots, the recession bottoming, and the hope that the spending will produce growth, a new headline from Reuters: "White House forecasts higher U.S. budget deficit.”

One gets the feeling that the Obama administration has little choice but to let this kind of bad news out slowly, hoping the market and the psyche of the country can absorb it without disrupting the tenuous nature of the recovery, particularly in the credit and stock markets. Until REAL unemployment recedes deficits will inevitably grow beyond forecasts. The recent unemployment figures include some “gains” because of recently hired government census workers and fails to count workers who have just given up or are working part-time, and does not yet include the 1.6 million college seniors graduating this year.

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Waiting for someone to explain it

The global financial crisis: life imitating art? It’s hard to see the connection, but as with any great work of music or literature, we could be smack in the development section, when themes or characters, introduced in an earlier time, are permanently changed and emerge as something very different. This period in the financial crisis is being played out with the dissonance of a Shostakovich, or the absurdity of postmodern literature. As Eugene Ionesco wrote in the program notes for his play The Chairs, “as the world is incomprehensible to me, I am waiting for someone to explain it.” Perhaps we all feel the same way about the global financial crisis. It would indeed be an absurdity to conclude that after these convulsions, it will be business as usual.

But the day-to-day machinations of the market, bailouts, and politics obfuscate the possible outcomes. Are the capitalistic underpinnings of the new world economy at an inflection point, to be changed for better or worse after this economic turmoil has passed? For some insight into a speculative, but well argued bigger picture I give a hat tip to my friend Bruce who put me onto the article After capitalism written by Geoff Mulgan and published in the UK Prospect Magazine.

Capitalism, in spite of several boom and bust cycles has survived, although the US economy has changed drastically, abandoning some of its manufacturing capabilities to cheaper overseas labor, focusing on intellectual capital, and becoming more of a service oriented consumer economy. It is now just a part of a highly interconnected world economy dominated by multinational corporations. With an insatiable appetite for goods and energy, however, we’ve become a nation of borrowers, living on leverage and the largess of countries willing (still) to buy our debt.

At the same time the nature of capitalism has changed. The financial institutions that once existed to solely support industry are now an industry onto itself, trading derivatives and exotic financial instruments and, with this fundamental change, perhaps we’ve arrived at another precipice of “creative destruction,” Joseph Schumpeter's term for the consequence of radical departures.

Mulgan argues that capitalism is sure to change but will not disappear. Instead, it will not dominate in our culture as it did in the “greed is good” era. Capitalism has been adaptable but in some ways has sown seeds of its own destruction. He cites the “collapse of the savings rate—to around zero by 2007 in the US when it needs to be closer to 30 per cent to cope with ageing…a stark symptom of a capitalism that has lost the ability to protect its own future.”

Then, in retrospect, the Great Depression can be seen as both “a disaster and an accelerator of reform. One implication of [Carlota] Perez’s work, and of Joseph Schumpeter’s before her, is that some of the old has to be swept away before the new can find its most successful forms. Propping up failing industries is in this light a risky policy. Perez suggests that we may be on the verge of another great period of institutional innovation and experiment that will lead to new compromises between the claims of capital and the claims of society and of nature.”

Mulgan postulates, “If another great accommodation is on its way, this one will be shaped by the triple pressures of ecology, globalisation and demographics.” This will lead to changes away from consumption to savings and will underscore capitalism’s need to come closer in balance with nature rather than its destruction. Capitalism, in effect will become the servant rather than the master. But “it remains to be seen what political visionary will seize upon ‘servant capitalism.’ (Obama should be ideally suited to offering a new vision, yet has surrounded himself with champions of the very system that now appears to be crumbling.)”

Where today’s seismic financial activity will settle is still a black hole of the unknowable, but for an interesting macro view on the future of capitalism, check out Mulgan’s piece.
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$11,033,157,578,669.70

Here’s a landmark worth noting: From The Debt to the Penny and Who Holds It, over the weekend (as of March 16) the National Debt quietly surpassed $11 trillion, rising almost $50 billion during that brief period. Here’s what we can do to help out.
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The View From Here

Although we are some 140 miles from Cape Canaveral, the view of yesterday’s shuttle launch into the twilight sky was spectacular. The shuttle program is one of our nation’s greatest accomplishments. To the left and below are some photographs of the launch, the view from here but beginning with CNN's.

There were other developments over the weekend impacting another sort of “view from here.” One story that grabbed some headlines, but then quietly went into the night was China’s prime minister’s concern about their holding some $1 trillion investment in American debt. Clearly there is some anxiety about the long-term safety of their investment, a remarkable public admission by such a large holder of US debt, one that is symbiotically attached to our hip -- something akin to yelling fire in a theatre while sitting far from the exits. But in Barack We Trust, President Obama saying that our debt is safe in spite of our record deficits, bailouts, and our national debt about to pass the $11 trillion mark. I mentioned this “Black Swan” before, that is confidence in the ability of the US to meet its financial obligations, without hyperinflating its currency.

The other story that will not go quietly into the night, because of the measure of outrage, is the $165 million in bonuses that are being handed out to the same executives that had a hand in creating the alchemy of credit default swaps. We’ve heard this song before, when Congressional Hearings revealed the extent that bonuses were handed out to the banks.

Then there is also outrage that foreign counterparties profited by receiving some money through AIG’s $170 billion bailout, but the main focus will continue to be the bonuses, although its size is but a pimple on the ass of the bailout vista.

The irony is the performance criterion of the bonuses is probably the very short-term thinking that encouraged leverage creation, AIG superimposing a hedge fund business on top of its, then, AAA rating. So why pay these bonuses? We’re told they are “retention bonuses” to keep the “best and the brightest” in the AIG stable -- as if there are not hundreds of unemployed qualified financial professionals who could immediately replace each of the AIG financial wizards. We are also told that these people will sue if they are not paid. Let them sue. Do they really want their names and reputations to go down in the annals of financial infamy?

But on to the happier news of the successful, although delayed, shuttle launch. Here are a series of photographs, only three minutes apart, from the launch as televised on CNN to the shuttle’s appearance only one minute later over our home, to the vapor tail just three minutes after the launch: beautiful and breathtaking.

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Music For Our Times

Maybe it is merely a coincidence that directly or indirectly through professional musicians I recently received emails with the text of Karl Paulnack’s welcome address that was given to entering freshmen at the Boston Conservatory. Although this was made last September it is just making the rounds via email.

The timing of this address, at least the timing of it becoming well known at this particular moment in our economic malaise, is noteworthy. For the past decade we have “mortgaged” the country’s future for fast, easy gains, and government, corporate America, and consumers alike have been complicit in this unprecedented moral breakdown, perhaps similar to the roaring 20's, resulting in the depressed 30's which only WW II could rescind. Today we are left with the consequences of failing financial institutions, declining residential and commercial property, and other gathering storms, bad consumer loans and ultimately failing municipalities as their taxing power is dependent on a strong labor market and real estate values, and finally inflation. And the global nature of the crisis just makes it more frightening. This collapse is building a crescendo of anxiety.

It is easy to think of the arts being irrelevant in such an atmosphere. This is the very idea that Paulnack’s address contradicts. In fact, music is not only relevant but also essential to our survival. This address by the director of the Boston Conservatory music division who is also an accomplished pianist should be required reading during these tumultuous times.

Paulnack reminds as that even in WWII’s concentration camps there was music. “Art is part of survival; art is part of the human spirit, an unquenchable expression of who we are. Art is one of the ways in which we say, ‘I am alive, and my life has meaning.’”

Or after 9/11 the author remembers, “people sang around fire houses, people sang ‘We Shall Overcome.’ Lots of people sang America the Beautiful. The first organized public event…was the Brahms Requiem, later that week, at Lincoln Center, with the New York Philharmonic. The first organized public expression of grief, our first communal response to that historic event, was a concert. That was the beginning of a sense that life might go on. The US Military secured the airspace, but recovery was led by the arts, and by music in particular, that very night.”

The essence of his message is “music is one of the ways we make sense of our lives, one of the ways in which we express feelings when we have no words, a way for us to understand things with our hearts when we cannot with our minds.” He therefore charges the incoming freshman: “I expect you not only to master music; I expect you to save the planet. If there is a future wave of wellness on this planet, of harmony, of peace, of an end to war, of mutual understanding, of equality, of fairness, I don’t expect it will come from a government, a military force or a corporation. I no longer even expect it to come from the religions of the world, which together seem to have brought us as much war as they have peace. If there is a future of peace for humankind, if there is to be an understanding of how these invisible, internal things should fit together, I expect it will come from the artists, because that’s what we do. As in the concentration camp and the evening of 9/11, the artists are the ones who might be able to help us with our internal, invisible lives.”

The full address can be read here.

Perhaps this is one of those times when music “is needed to make sense of our lives.” Music is among the oldest of human activity (certainly predating economics!) and as Daniel Levitin states in his innovative work This is Your Brain on Music, an argument “in favor of music’s primacy in human (and proto-human) evolution is that music evolved because it promoted cognitive development. Music may be the activity that prepared our pre-human ancestors for speech communication and for the very cognitive, representational flexibility necessary to become humans.”

One of my favorite melodies is from a similar era, the depression years, the plaintive, ironical song, Smile, written by Charlie Chaplin, for the 1936 film Modern Times, in which he starred. In the film, Chaplin’s Little Tramp struggles to survive the Great Depression and the indifference of the modern industrialized world. The song’s melody captures the sadness of the times while the lyrics remind us to “smile and maybe tomorrow, you'll see the sun come shining through.” This is my own brief piano rendition of Smile in Windows Media format.
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The 177K

“I looked at my 401K and it’s now a 201K ba-dum-bum-CHING!" So, the joke goes today, but, don’t look now, it’s a 177K based on the S&P 500 as shown below. If you were able to buy the inverse of the change in the National Debt during the same period, your 401K would be a 485K. Interestingly, invested in gold it would be about the same, 498K, and with the 30 year Treasury bond you’d have a 544K for the same period. So much for hindsight, but much to be said about asset allocation.

The water torture nature of the decline in equity values, without the capitulation everyone has been waiting for, as well the disappearance of Bear Stearns, Lehman Brothers, Merrill Lynch, and the implosion of AIG, Bank of America, Citi, GM and, now, even GE, speaks worlds about the gravity of the situation. AIG has become a bottomless pit into which we have dumped $170 billion in taxpayer’s money and now have 79.9% ownership of an asset that seems destined to become a black hole of unknown proportions. While President Obama’s sincerity in following through on promises for health care reform and other social issues is applauded – and highly trumpeted on the government’s new web site http://www.recovery.gov/ -- if our financial institutions entirely fail, everything else becomes meaningless.

Paul Volcker gave one of the clearest explanations as to how we got to this point in a speech he gave in Canada a couple of weeks ago, saying “this phenomenon can be traced back at least five or six years. We had, at that time, a major underlying imbalance in the world economy. The American proclivity to consume was in full force. Our consumption rate was about 5% higher, relative to our GNP or what our production normally is. Our spending – consumption, investment, government — was running about 5% or more above our production, even though we were more or less at full employment. You had the opposite in China and Asia, generally, where the Chinese were consuming maybe 40% of their GNP – we consumed 70% of our GNP.”
Full text: http://www.ritholtz.com/blog/2009/02/paul-volcker/

He argued, “in the future, we are going to need a financial system which is not going to be so prone to crisis and certainly will not be prone to the severity of a crisis of this sort.” In effect the Glass-Steagall Act that had been enacted during Depression 1.0 separating commercial and investment banks -- and had been repealed in 1999 thanks to Phil Gramm and other deregulation zealots– needs to be reinstated during this Depression 2.0. Where is Paul Volcker to lead the way back to the 401K?

October-07 401K
November-07 383K
December-07 380K
January-08 357K
February-08 344K
March-08 342K
April-08 359K
May-08 362K
June-08 331K
July-08 328K
August-08 332K
September-08 301K
October-08 251K
November-08 232K
December-08 234K
January-09 214K
February-09 190K
March-09 177K
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Brother, Can you Spare a Dime?

Only about $57 billion more to go until the Public Debt tops $11 trillion. Since I last wrote about this on January 12 http://lacunaemusing.blogspot.com/2009/01/bailout-math-and-implications.html it has soared by some $332 billion, so the $11 trillion mark is just around the corner. Something I failed to notice before: the government gratefully accepts “contributions” to reduce the debt (no kidding) so I include the appropriate information from the government’s web site:

How do you make a contribution to reduce the debt?

Make your check payable to the Bureau of the Public Debt, and in the memo section, notate that it is a Gift to reduce the Debt Held by the Public. Mail your check to:

Attn Dept G
Bureau Of the Public Debt
P. O. Box 2188
Parkersburg, WV 26106-2188
http://www.treasurydirect.gov/govt/resources/faq/faq_publicdebt.htm#DebtOwner
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Bailout Math and Implications

In an effort to try to understand the more than $8 trillion guarantee our government has made to bailout our financial mess, I tried to assemble a spreadsheet and before long I was drowning in acronyms and conflicting information that was beginning to remind me of an elaborate shell game a Bernie Madoff might have constructed. How can we manage to make transparency so confusing?

To the rescue, though, is a magnificent, clear summary published by Bianco Research which came to my attention through the From Behind the Headlines blog by Michael Kahn http://quicktakespro.blogspot.com/. While the details can be seen from what was published in SFO Magazine http://sfomag.com/images/charts/012009/GettingTech_fig1_0109.jpg here is a summary of Bianco's work (figures are in billions):

Measuring the Size of the Bailouts

THE FEDERAL RESERVE (Net Portfolio Commercial Paper Funding,
Term Auction Facility, Other Assets, Money Market Investor Funding Facility, MBS/FHLB Agency in Reverse Auctions, Term Securities Lending Facility, AIG Loan, Primary Credit Discount, Asset Backed Commercial Paper Liquidity, Primary Dealers and Others, Bear Stearns Assets, Securities Lending Overnight, Secondary Credit)
FEDERAL RESERVE TOTAL $5,065.0 Maximum / $1,839.5 Current

THE FDIC (FDIC Liquidity Guarantees, Loan Guarantee to GE)
FDIC TOTAL $1,539.0 Maximum / $139.0 Current

TREASURY DEPARTMENT (Fannie/Freddie Bailout, Spring 08 Stimulus Package, Treasury Exchange Stabilization Fund, Tax Break for Banks, Citibank Asset Backstop, Tem Asset-Backed Securities Loan Facility)
TREASURY DEPT TOTAL $1,803.0 Maximum / $597.0 Current

FHA (Hope for Homeowners) $300 Maximum / $300 Current

DEPT ENERGY (Auto Loans) $25 Maximum / $25 Current

GRAND TOTAL $8,707.0 Maximum / $2,875.5 Current

Here is a translation of how this looks in “real dollars:”
$8,707,000,000,000/$2,875,500,000,000

These staggering figures are before the Obama infrastructure / jobs programs get into full swing, so we can be talking about more than $9 trillion. To put this in perspective, according to the Congressional Budget Office GDP in 2009 will be $14.2 trillion, while outlays will be $3.5 trillion and total revenues $2.3, a deficit of some $1.2 trillion.

This assumes we can have confidence in government projections. Looking at the real world in a rear view mirror, this is how the budget deficits have been ramping up the National Debt since the Bush administration took office:

9/30/2000 $5,674,178,209,887
9/30/2001 $5,807,463,412,200
9/30/2002 $6,228,235,965,597
9/30/2003 $6,783,231,062,744
9/30/2004 $7,379,052,696,330
9/30/2005 $7,932,709,661,724
9/30/2006 $8,506,973,899,215
9/30/2007 $9,007,653,372,262
9/30/2008 $10,024,724,896,912
1/8/2009 $10,608,325,323,173

I include the latest figure (more than a $½ trillion increase in only 100 days) from the following handy calculator http://www.treasurydirect.gov/NP/BPDLogin?application=np as it shows a parabolic trend. The extent to which the bailouts work is going to enormously impact the budget projections, both on the revenue and outlay sides of the ledger. Tweaking the former down because of the severity of the recession and the latter upwards because of more bailouts puts us on an irreversible course. It was not long ago that the main discussion concerning the long-term budget centered on the ticking time bombs of Social Security, Medicare, and Medicaid. These threats have not disappeared, but they become even more formable as our precious resources have to be spent on surviving today to wage that war tomorrow.

The foregoing figures come from the Congressional Budget Office. Their published outlook http://www.cbo.gov/ftpdocs/99xx/doc9958/01-08-Outlook_Testimony.pdf is remarkably pointed:

The Budget Outlook for 2009
The federal fiscal situation in 2009 will be dramatically worse than it was in 2008. Under the assumption that current laws and policies remain in place (that is, not accounting for any new legislation), CBO estimates that the deficit this year will total $1.2 trillion, more than two and a half times the size of last year’s. As a percentage of GDP, the deficit this year will total 8.3 percent (as compared with 3.2 percent in 2008)––the largest since 1945.

The deterioration in the fiscal picture results from both increased outlays and decreased revenues. Relative to what they were last year, outlays will rise dramatically— by 19 percent according to CBO’s estimates. Much of that increase is a result of policy responses to the turmoil in the housing and financial markets—particularly spending for the TARP and the conservatorship of Fannie Mae and Freddie Mac. In addition, economic developments have reduced tax receipts (particularly from individual and corporate income taxes) and boosted spending on programs such as those providing unemployment compensation and nutrition assistance as well as those with cost-of-living adjustments.

Without changes in current laws and policies, CBO estimates, outlays will rise from $3.0 trillion in 2008 to $3.5 trillion in 2009 (see Table 5). Mandatory spending is projected to grow by almost $570 billion, or by 36 percent; nearly three-quarters of that growth results from the activities of the TARP and CBO’s treatment of Fannie Mae and Freddie Mac as federal entities. Discretionary spending is projected to grow by $52 billion, or by 4.6 percent. In contrast, net interest is anticipated to decline by 22 percent as a result of lower interest rates and lower inflation. In total, outlays will be equal to 24.9 percent of GDP, a level exceeded only during the later years of World War II.

Spending for certain other mandatory programs is expected to rise sharply this year. The faltering economy has increased outlays for unemployment compensation and the Supplemental Nutrition Assistance Program. Unemployment compensation is projected to nearly double— from $43 billion last year to $79 billion this year— as a result of increased unemployment and legislation to date extending such benefits. Outlays for the nutrition assistance program are expected to grow by 27 percent— from $39 billion to $50 billion—primarily because of increases in caseloads and benefits (resulting from higher food prices).

The three largest mandatory programs—Social Security, Medicare, and Medicaid—are all anticipated to record growth of at least 8 percent this year. Some of that growth stems from the relatively high rate of inflation recorded early in 2008, which boosted cost-of-living adjustments for retirees and the cost of health care. In addition, rising unemployment will add to Medicaid spending by increasing the number of beneficiaries.

Discretionary spending under current laws and policies is projected to grow by 4.6 percent in 2009. In CBO’s baseline, defense outlays rise by 5.0 percent and nondefense outlays by 4.1 percent. However, most programs are currently operating under a continuing resolution, which holds funding for 2009 at the level provided for 2008. Final appropriations and additional funding for operations in Iraq and Afghanistan may increase outlays for 2009 and beyond, and any stimulus package may raisediscretionary spending further.