from the Front Lines of the Financial Crisis
NOV 04 2008
In its latest economic outlook, Merrill Lynch economists
"worry about inflation, or more precisely," a
lack of it. From crashing global equity markets, falling
commodity prices, rising unemployment, stagnant wages, over-indebted
households, declining production, the continuing housing
crisis, and more. All pointing to several future quarters
of negative growth. Showing that Fed chairman Bernanke will
face "his greatest fear: deflation." An analysis
of the coincident to lagging indicators signals "deep
In his October
24, commentary, Merrill's North American economist David
Rosenberg sees "economic data deteriorating in a very
serious way (and says) we are witnessing unprecedented stuff
* the two-year
housing recession "is still far from over" with
new lows in a number of key readings;
* it's "morphed into a capex recession, industrial
production" had its worst decline in 34 years;
* consumer confidence showed record declines;
* retail sales keep falling; evidence is that auto and
chain store sales will show four straight down months;
it's happened only four other times since 1947, so "we're
living through a 1-in-200 event;"
* based on CPI data, prices are falling; at a rapid pace
also seen only four other times since 1947;
* GDP will decline at 2% annual rate in Q 4; 4% in Q 1
2009 and 3.3% in Q 2.
"This recession is unlike any seen in the last five
decades." Typically caused by inflation, inventory
cycles or aggressive Fed tightening. "This is a balance
sheet recession deeply rooted in asset liquidation and debt
repayment, and would seem to have more in common with pre-WW
Going back to
1855, "a typical recession lasts 18 months." It's
no assurance this one won't be longer. Rosenberg thinks
it started in January and believes will end "within
a month of the National Bureau of Economic Research (NBER)
making the call." It defines recession as "a significant
decline in economic activity spread across the economy,
lasting more than a few months, normally visible in real
GDP, real income, employment, industrial production, and
wholesale-retail sales." Some say that occurs when
economic growth is negative for two or more consecutive
The signs are
evident and growing, yet NBER is usually late making its
call. It may hold off until housing shows signs of stabilizing.
For some analysts, it's the core economic problem, and as
long as it keeps eroding no end of recession is in sight.
The latest data aren't encouraging:
10 and 20-city composite indexes set new record declines
of 17.7% and 16.6% respectively; year-over-year dropping
for 20 consecutive months; Case-Shiller predicts a peak
to trough 28.6% drop in its 10-city composite index; it
also sees up to 50% declines in some areas;
* nominal house prices down 20% from their 2006 peak;
according to the Center for Economic Policy Research (CEPR),
this implies a 27% real decline; a loss of $5 trillion
in housing wealth, and 60% of the bubble deflated so more
is yet to come; at least another 10 - 15% to return to
trend levels; another question is "whether markets
will overshoot on the downside;" a very distinct
* on October 29, CEPR reported record high ownership vacancies
according to Census Bureau data at 2.8%; for rental units
at 9.9%, slightly below the peak first quarter 10.1% level;
CEPR predicts a fully deflated housing bubble by mid-2009
but added a caveat; "With the employment picture
turning bleaker and the plunge in the stock market,"
housing is certain to be even more negative in coming
months; "the tens of millions of workers....fearful
about their future job prospects will be very reluctant
to buy a new home;" compounded by trillions of lost
personal wealth (from home and stock market losses) will
make households "much more cautious in all their
* the Office of Federal Housing Enterprise Oversight (OFHEO)
index fell .6% in its latest July reading and is down
5.3% on a year-over-year basis; its sharpest decline ever;
* Fitch expects home prices to fall another 10% in the
next 18 months and will decline by an average 25% in real
terms over the next five years; beginning from the second
quarter 2008; they're now back to early 2004 levels and
* the PMI Group predicts home price declines will double
to a national average of 20% by next year with lower values
in areas experiencing the sharpest increases;
* economist Paul Krugman cites his "preferred metric;"
the ratio of housing prices to rental rates; it shows
the former got way overvalued; will retrace and result
in about a 25% home valuation decline;
* Goldman Sachs forecasts a 15% home price decline with
no recession and 30% with one; and
* The Economist sees "no end in sight....to America's
housing bust as prices continue to fall fast."
On October 28,
economist Nouriel Roubini was even more alarming on housing
citing "The recessionary macro effect of the worst
US housing bust ever." He reported the view of a "senior
professional in one of the (world's) largest financial institutions"
who emailed him "privately and confidentially."
As early as a year ago, he predicted "the worst housing
recession in US history" and described "a bust
process" in four phases:
mortgage defaults, home prices start falling, sale volumes
fall, housing starts and permits decline;" it's been
happening and we're beginning phase two;
bankruptcies, housing starts and permits crash, substantial
layoffs in construction and real estate-related fields
(mortgage brokers, mortgage lenders, etc.);"
price declines in major metro areas, large rise in defaults
of prime but low-equity mortgages;"
government intervention to help households going bankrupt;"
a political phenomenon so its timing and nature can't
be reliably forecast.
He cites clear
phase two evidence already:
smaller builder and subcontractor bankruptcies;
* Levitt Corp. home-building unit getting loan default
* national home builder Tousa with $1 billion in senior
notes and subordinated debt hired law firm Akin Gump Strauss
Hauer Feld as a precaution in case of bankruptcy; and
* Neumann Homes and Enterprise Construction file for bankruptcy.
with his emailer "with one caveat." He believes
we're past the beginning of phase two; most of its aspects
have occurred, and we're heading into phase three or close
to it; he cites sharply falling home prices; rising defaults
in prime and near prime mortgages; also some prime and near
prime lenders in trouble; we're also getting close to phase
four as "over a dozen proposals to rescue 2 million
plus households on the way to default and foreclosure are
now being debated in Washington." Debate is one thing.
Meaningful action another and likely a ways off at best.
Possibly once a new president is in office for something
substantial if it comes at all.
Rubini's emailer followed up with another. That consensus
now "admits" what it denied last year. The reality
of a severe housing downturn. In price action and foreclosures.
The worst since the 1930s. But they're still behind the
curve by acknowledging "only minor macro effects."
He called it extraordinary that a decline this severe is
being taken dismissively. "Perhaps the most astonishing
aspect of this event is the refusal to recognize the possible
dimensions, the impact of what is coming." It's "delusional"
to believe that the "biggest housing recession in US
history will not have severe macro effect. Most of the consensus
(according to Bloomberg earlier)" was for 1.8% fourth
quarter growth. It then predicted a Q 4 slow growth bottom
with "economic growth recover(ing) in soft landing
On what basis,
he asks? "Mostly wishful thinking (because of) the
economic and financial shocks leading to falling demand
(and a worsening housing bust); anemic capex spending; slowdown
in commercial real estate demand; sharp private consumption
slowdown and weak supply (from weakening ISM - Institute
of Supply Management;" falling employment; a glut of
new and existing homes; weak auto sales; consumer durables;
"a capacity overhang;" and excess inventory);
these factors will persist well into the new year.
The latest Q
3 GDP report hints at what's coming. A minus .3% with personal
consumption (PCE) dropping 3.1%. The first decline since
1991 and largest drop since falling 8.6% in 1980. Residential
construction also fell at a 19.1% annual rate. Its 11th
straight quarter drop. It now represents 3.3% of GDP. Its
lowest level since 1982. Non-residential investment fell
1% and will likely fall further in Q 4. A quarter likely
to be much weaker than Q 3 as most private activity is slowing.
Only government spending remains strong.
On October 31,
still another disturbing report. Bloomberg reported that
the "US Chicago Purchasers Index (the Institute for
Supply Management-Chicago, ISM) Falls by Most on Record."
To 37.8 down from 56.7 in September, and its lowest reading
since the 2001 recession. A clear indication of a deepening
downturn. Readings below 50 signal contraction.
Another Shoe to Drop: Credit Cards
Even The New
York Times published a rare ahead-of-the-curve October 28
admission. In an Eric Dash article headlined: "Consumers
Feel the Next Crisis: Credit Cards." As they're squeezed
by an "eroding economy." An "already beleaguered
banking industry" is threatened as lenders are sharply
curtailing credit card offers and "sky-high credit
lines." Even creditworthy consumers are affected because
of growing amounts of bad loan losses. An estimated $21
billion in the first half of 2008.
increasing, analysts forecast at least another $55 billion
in the next 18 months. Around 5.5% of outstanding debt now
and may "surpass the 7.9% level reached after the technology
bubble burst in 2001." As a result, lenders like American
Express, Bank of America, MasterCard and Visa are "tightening
standards (and) culling their portfolios of the riskiest
customers." Credit lines are being reduced as well,
and lenders are avoiding over-indebted consumers. Treading
carefully in housing ravaged areas and with customers employed
by troubled industries.
already strapped households. With lower credit scores. Higher
rates for those rated creditworthy. Less willingness to
allow high balances. Less availability of loans with many
needing them shut out. "The depth of the financial
crisis has shocked a credit-hooked nation into rethinking
its habits. Many families once content to buy now and pay
later are eager to trim their reliance on credit cards....At
the same time," lenders are retrenching with one CEO
saying "If you're not fearful, you're crazy."
It's seen in
mail solicitations slowing to a trickle. "Credit card
issuers have realized their market is shrinking and that
there is no room for extra credit cards, so they have to
scale back," according to Mintel analyst Lisa Hronek.
"People are completely maxed out with mortgages, home
equity lines and credit card debt."
hard on both ends. Rising losses and shrinking profits for
issuers. Less credit availability for consumers already
strapped and cutting back of necessity. At a time the only
bull market is in bailouts. Amidst towering debt levels.
Soaring defaults. Wobbly global economies. Some cratering.
America teetering. Confidence shattered, and everyone wondering
First the Banks.
Next "the Coming Insurance Meltdown"
analyst Mike Larson of Weiss Research. AIG was just the
beginning. Falsely called an "anomaly (and that) the
rest of the insurance industry is doing just fine."
Larson and Weiss disagree and identified "46 insurers
with $500 million or more in assets that are at an elevated
risk of failure." It's seen in their share prices.
Down 80 - 90% for some because the largest US and Bermuda-based
insurers have lost $98 billion year-to-date, and they have
more in unrealized losses.
A Possible Gotterdammerung?
On October 28,
from the Financial Times forum in a Peterson Institute for
International Economics Anders Aslund article titled: "It
can be worse than the Great Depression." A possibility,
not a prediction. Because of "the worst global asset
bubble and financial panic" since that time. Because
lessons learned then haven't prevented new mistakes, and
unlike in the 1920s, "CNBC and Bloomberg can spread
worldwide panic instantly." Old blunders may not be
repeated, but "new policies (may be) even worse."
Anders laid out
a "then" and "now" comparison:
* Then: exchange
rates over-zealously defended; Now: floating exchange
rates could cause a trade panic;
* Then: the money supply shrank dramatically; Now: monetary
expansion and budget deficits are dangerously excessive;
currency collapses may result; the fundamentals don't
justify the current dollar surge;
* Then: nations didn't go bankrupt; some may today; some
major ones; Italy, for example, had over 100% of GDP in
public debt before the crisis; it risks major state bankruptcies;
America was unmentioned, but the rapidly mounting public
debt and money supply growth alone pose immense risks,
including default and future hyperinflation;
* Then: subprime loans existed at modest levels, but that
era didn't have "non-transparent collateralized debt
obligations;" Now: derivatives "created the
mother of all bubbles; the deeper the financial system,
the harder we may fall;"
* Then: the Great Depression "largely emanated from
two countries, the US and Germany; Now: "never before
has the world seen such a monstrous and truly global bubble;"
* Then: financial institutions engaged in minimal overleveraging;
Now: it's mirror opposite; "never have big financial
institutions been as overleveraged as Fannie Mae and Freddie
Mac or the former US investment banks, not to mention
the hedge funds;"
* Then: protectionism froze global trade; Now: frozen
finances in countries like Iceland, Ukraine and possibly
others have temporarily left them outside the world financial
* Then: the dollar and gold "were unchallenged sources
of value;" Now: the dollar is neither stable nor
the uncontested world currency;
* Then: policymakers made mistakes but "stood for
principles;" Now: "George Bush is assembling
(Group 20 leaders) for a photo opportunity in Washington
on November 15;" failure to come up with meaningful
corrective policies "could unleash untold (global)
financial panic;" and
* Then: the 1920s lacked television and the internet for
fast information dissemination; Now: information and decisions
move instantly; often with no transparency; the combination
is potentially harmful.
Europe Anticipation Bulletin (GEAB), LEAP/E2020's Disturbing
In its October
15 28th edition. About a "global systemic crisis."
An alert because its researchers believe that before summer
2009 "the US government will be insolvent (and will)
default and be prevented to pay its creditors (holders of
US Treasury Bonds, of Fannie May and Freddy Mac shares,
etc.)." It envisions "the setting up of a new
Dollar to remedy the problem of default and of induced massive
drain from the US." It gives five reasons for its prediction:
* the current
US dollar surge is temporary; the result of world stock
* the Euro has become "a credible 'safe haven;' "
an alternative to the dollar;
* the out-of-control US public debt;
* the collapsing US economy; and
* future "strong inflation or hyper-inflation;"
"the whole planet has become aware that a global systemic
crisis is unfolding, characterised by the collapse of the
US financial system and its contagion to the rest of the
world." As a result, "a growing number of global
players are beginning to act on their own." In their
own self-interest. Because US policies are ineffective.
The crisis is very serious and "far more important,
in terms of impact and outcome, than" in 1929. With
the US economy weaker now than then. Because of unmanageable
public debt. Reckless consumer borrowing and spending. Enormous
current account and budget deficits. A hollowed out industrial
base, and a highly inflated dollar.
With that in
mind, it's up to "vigilant" citizens and "clear-sighted"
leaders to assure that America won't "drive the planet
into a disaster." It will take divergent policies.
What's "good for the rest of the world will not be
good for the US." America defaulting will be partly
from "this decoupling of decision-making...."
A new dollar will be "imposed." And "one
morning (in) summer 2009....after a long week-end or bank
holiday," Americans will discover that their "US
T-Bonds and Dollars are only worth 10 per cent of their
A Jesse's Cafe
Americain commentary suggests something similar. That in
2009, "the US will be forced to selectively default
and devalue its debt." Because of its extraordinary
financial needs. A $2 trillion annual deficit. It will take
a terrible toll on Treasuries. Forcing a significant drop
by 2011. We're approaching "the apogee of the Treasury
bubble, with the credit bubble" already broken.
Once market deleveraging
subsides, "the dollar and Treasuries will drop, perhaps
with momentum, as the rest of the world realizes that the
US has no choice but to default." Unless foreign sources
(for a while at least) keep buying American debt despite
the risk. Offer debt forgiveness. The dollar is devalued
short of default. Taxes raised substantially, and debt instruments
pay higher interest rates. Even then, these measures may
fall short and prove ineffective.
America way exceeded
its debt service ability from real cash flows. A turnaround
will require a "severe devaluation and selective default."
For GEAB down to 10 cents on the dollar. Following on its
March 2008 prediction that by yearend "a formidable
debacle will affect pension funds (worldwide) endangering
the entire system of capital-based pensions." Their
revenues collapsing "at the very moment when they should
be making their first large series of payments to pensioners."
A disturbing picture in the current climate that may reveal
other unexpected hazards in the coming months.
On October 28,
Bloomberg reported on the Treasury's "unprecedented"
2009 financing needs. To fund a growing budget deficit and
raise hundreds of extra billions to contain the current
financial crisis. To assure guarantees the government committed
for. Almost $6 trillion alone for Fannie and Freddie debt
and mortgage securities. With continued growing demands
as other obligations arise. Plus over $1 trillion annually
for national defense with all expenditure categories included.
An impossible burden Bloomberg didn't mention. A deepening
dilemma as the financial crisis grinds toward more unsettling
What Euro Pacific
Capital's Peter Schiff writes about in his 2007 book "Crash
Proof: How to Profit from the Coming Economic Collapse."
What he adds to in commentaries on his web site: europac.net.
His latest on October 31 titled "The Tales Get Taller."
Debunking mainstream explanations for recent dollar strength.
A currency he's very bearish on. Because of our extreme
profligacy. Decades of borrowing trillions we can't repay.
How we blew it on consumption and by letting our industrial
are now too big to contain. A possible bankruptcy is ahead.
"The main lesson our creditors will learn from this
crisis is not to lend American consumers any more money.
Once the lending stops, our 'cart before the horse' borrow
to spend economy will crumble. While the rest of the world
absorbs their losses and moves on, we will be digging our
way out of the rubble for years to come. Earthquakes are
caused by the fundamental shifts of tectonic plates beneath
the Earth's surface. A similar move is underway in the global
days are over, he believes. We've gone from a nation of
savers, investors and producers to one of borrowers, consumers
and gamblers. Official government statistics lie. They conceal
hidden truths. America's house of cards is crumbling. It
won't be pretty when it collapses. His advice is get out
of the dollar. Get your money out of the country while you
can, and gold is one of his recommendations.
Gold is on Paul
Amery's mind as well in his Prudent Bear.com October 31
commentary titled "The Credit Crisis Endgame."
He sees it likely becoming "a bloody standoff between
investors and governments (on a) market for government bonds"
He reviewed the
unfolding credit crunch stages:
* its beginning
with liquidity drying up in "esoteric, structured-finance
securities, linked to riskier types of mortgages;"
* it then spread "to more mainstream mortgage bonds,
structured finance in general, and other types of debt;"
* by early summer 2008, it hit many non-financial companies
having trouble refinancing loans;
* by late summer, it affected sovereign states; mostly
ones with high current account deficits like Iceland,
Hungary and Ukraine;
* it points globally to a spreading ailment affecting
major economies and their bond markets.
The US for example.
While nominal Treasury bond yields declined (10 year T-bonds
at 4% October 31), their credit risk component has been
increasing since last year. Credit specialists CMA DataVision
shows the 10 year credit default swap (CDS) spread rose
steadily. From 1.6 basis points in July 2007; to 16 basis
points in March 2008; to 30 basis points in September; and
to over 40 basis points on October 27. In other words, insuring
against a US government bond default rose 25-fold in the
past 15 months. The same is true for Britain and Germany.
find this astonishing. How could America or other major
states default on their debt? It would be "the equivalent
of a (financial market) nuclear explosion" smashing
global economies with it.
dollar is the world's reserve currency. The Fed can create
unlimited amounts of them, so any default would likely be
through inflation and devaluation, some argue.
Maybe not, according
to University of Maryland's Carmen Reinhart and Harvard's
Kenneth Rogoff in their April 2008 paper: "The Forgotten
History of Domestic Debt." They explained that throughout
history debt defaults have been more common than realized.
They're the rule, not the exception, in times of severe
for example. Budget and national debt levels have exploded.
Bailout amounts will increase them and cause enormous strains.
Morgan Stanley forecasts a sharply rising 2009 fiscal deficit.
Besides the escalating national debt, to more than double
the previous 1983 record. As a percent of GDP, it's expected
to be around 70% in 2009. The tip of the iceberg, some say,
compared to the private debt to GDP ratio. At an unprecedented
300%, according to University of Western Sydney economist
He saw the storm
coming before most others. He's also very skeptical about
the rescue plan and compares it to King Canute's effort
against the tide. Given the enormity of the problem, he
sees the possibility of the debt pyramid crashing from a
violent and uncontrollable chain of defaults, taking the
government bond market down with it.
Strains in the
US Treasury market are already evident in spite of their
historically low yields. Recent auctions have had poor bid-to-cover
ratios and long "tails" indicate weak demand.
Secondary market delivery failures are also at record levels.
Another sign of poor liquidity. If the worst of all possible
worlds happens - a US debt default - the consequences will
be "cataclysmic for the financial economy." The
entire system will be bankrupt.
Where to hide
if it happens? Amery suggests a few safe havens. The "ultimate"
one being in precious metals. Think gold. Understand also
that the $725/ounce October 31 spot price reflects market
manipulation (over the short term) to drive it down from
its March 2008 high above $1000. As one analyst puts it:
I'll "give you three good reasons why gold is (underperforming).
First: manipulation. Second: rampant manipulation. Third:
incessant, nonstop, unabated, fiendish manipulation."
He also believes
the process is only temporary and won't stop the metal's
eventual rise. Given the current crisis and its likely duration,
it won't surprise experts to see its price above $1000 again
before it ends.
A Final Comment
In spite of trillions
of asset losses. American and global households hardest
hit. Wobbly world economies getting weaker. The virtual
certainty of a deep and protracted recession, and the likelihood
of no robust recovery when it ends.
Despite all this
and Wall Street's worst year in decades, it's celebrating
like it always does. With big bonuses. In the many billions
of dollars. According to Bloomberg, Merrill Lynch plans
$6.7 billion. Goldman Sachs about $6.85 billion and Morgan
Stanley about $6.44 billion.
that Goldman, Morgan Stanley, Merrill, Lehman Bros. and
Bear Stearns paid their employees "a cumulative $145
billion in bonuses from 2003 through 2007," or more
than the Philippines' GDP. In 2007, the firms paid out a
record $39 billion. In a year when three of them posted
their worst quarterly losses ever and their shareholders
lost over $80 billion. Two of them no longer exist. Another
went into forced liquidation. Their combined 2008 losses
should way exceed last year when they're reported.
Yet there's plenty
of money for bonuses. Courtesy of ESSA/TARP. For executive
pay and dividends as well. At a time all these companies
are insolvent. Their survival dependent on federal handouts.
US taxpayers are on the hook for them as their consumption
declines. According to the Commerce Department at the fastest
rate in 28 years. Because they don't get big bonuses. Are
maxed out on credit and haven't the money to spend.
But the Fed and
US Treasury do and plan to dispense more of it. To other
takers lining up. Sovereign nations. Insurance companies.
GM and Chrysler perhaps for their reported merger. Dependent
on government cash to complete it. Any other company as
well deemed worth saving. Big campaign contributors with
friends in high places. What beleaguered homeowners don't
to help them appear meager at best. For a fraction of the
millions in trouble with inadequate suggested funding amounts.
A suggested $40 billion for 20 million or more homeowners
facing foreclosure. With more at issue as well, according
to The New York Times. Giving qualified borrowers a few
grace years. Perhaps three. For lower mortgage payments
that won't reduce their principal balance. It would only
provide temporary relief and delay today's problem for a
later time. When households may be no better off than now,
yet face higher ARM reset obligations.
but not proposed, is a 1930s type Home Owners' Loan Corporation
(HOLC) plan that refinanced homes at affordable rates and
prevented foreclosures. One on a grand scale as part of
an enlightened New Deal agenda.
In lieu of "trickle
down" to fraudsters, "trickle up" for beleaguered
households. An idea so far with no traction for a new administration
to consider. The one now in charge has no "imminent"
plan, according to White House spokesperson, Dana Perino.
On October 30, she added only that "If we find one
that we think strikes the right notes....then we would move
forward and announce it." Ones so far advanced are
for Wall Street. Main street apparently can wait.