A guide for the perplexed to the economic mess

The problem with the economy is clear, but it’s been obfuscated out of most people’s minds. So, to put it simply: Financial institutions loaned out a huge amount of money against assets that are now worth far less and whose value is still falling. Somehow, someway, the difference between these two numbers has to reconciled. Simply put, money loaned (X) – current value of assets (Y) = amount of debt to be accounted for (Z). Solve the equation and you know exactly how solvent our economy is.

This week we have found out that Y equals even less of X than previously thought – and the previously thought numbers were already pretty bad. That is because banks screwed up the paperwork so badly they are having major problems proving they do indeed have a legal right to the homes they gave mortgages on. Short form: The banks effectively gave that money away. So the debit side of their ledgers just got a whole lot redder and Z just got a whole lot larger.

Now Z was bad before this latest fiasco was discovered. How bad? Bad enough the banks and the government have gone out of their way to make to figure out what Z is worth. My theory is they believe – perhaps reasonably – disclosing Z will cause the world’s economy to go into freefall. Unfortunately Z is not going away. So because these groups cannot change the value of X and the value of Y keeps getting smaller, they have resorted to fiddling with the – and the =.

First, the government tried to purchase mortgage debt(X) from the banks. The problem with this is that selling X would mean declaring its value, i.e. providing a real number for Y. This would mean admitting what everyone knows – that a number of banks have debts well in excess of their assets.

Because this didn’t work, the government tried to alter the equation’s minus sign by giving banks enough funds to be able to withstand solving for Y. Under this plan we get X + $100s of billion – Y = Z. Given how hesitant banks were to take toxic asset relief payments (or whatever they’re calling it now) it is reasonable to conclude that Y = way more than hundreds of billions.

But wait, you say! Many of these financial institutions have already repaid the bailout money! Yes, that is true. However keep in mind, they repaid it with money borrowed from the government. This is robbing Peter to pay Paul as imagined by M.C. Escher. Those staircases are never going to meet up but it allows both the banks and the government to say that they do while hoping that no one reads the fine print.

So being unable to either 1) increase X enough to do any good or 2) stop the actual value of Y from declining, the government tried letting financial institutions play lets pretend with the book value of Y. Recent changes in accounting rules let institutions can the value of a property at what they think it would go for in an “orderly” sale, as opposed to a forced or distressed one. Or, to quote the head of the central bank of Wonderland: “When I use a word,” Humpty Dumpty said, in rather a scornful tone, “it means just what I choose it to mean—neither more nor less.”

What all those measures did was to allow the economy to continue to operate because we all pretended the problem would somehow go away. This is an attempt to put off the day of reconciliation until some time in the far distant future when someone will have figured out a solution that won’t hurt. However, this is impossible. The solution will hurt, and it will hurt a lot.

All talk of growing our way out of the recession is absurd. It is based on the belief that we can continue to increase the size of the economy as was done earlier in this decade. Let’s make one thing clear: The last decade’s worth of growth was funded by loans against assets that were never worth those loans in the first place. Trying to go back to that means continuing to believe in the fiction that it was ever sustainable in the first place.

The healthy economy of our future won’t resemble this in anyway. We will have to accept far more modest growth and lower our expectations about always having the newest stuff. We may have to pay our farm workers enough that those jobs, and others like them, because financially appealing to American citizens. That will mean paying a lot more for food and other things.The US has to become home to manufacturing again. This will mean enacting things – like tariffs – that a lot of powerful corporations don’t want. NAFTA and other free trade agreements are going to have to change drastically.

Of course, we don’t have to do these things. Regardless of what we do, though, the economic equation will be resolved and that debt will somehow be accounted for.

But hey, the Dow’s over 11K so no worries, right?

Advertisement

The end of the end of the Great Recession

It is hard to believe that a man is telling the truth when you know that you would lie if you were in his place. – Mencken

Remember all that robust economic activity we heard so much about last month? The stuff about the economy expanding at 3.5% for the third quarter of this year and “officially” marking an end to the Great Recession? Ooops.

It was only 2.8% according to revised Commerce Department numbers. (And every reporter who is even semi-competent knew this reduction was coming. This number will be revised at least once more.)

That 0.7% difference is big. It means the basis of all this activity was mostly a result of the Federal gov’t running up its credit card and not by the creation of goods and services as a result of non-government created demand. Most of the spending was the result of government subsidies of the housing and auto industries via the Cash For Clunkers program and the $8,000 tax “credit” for 1st time homebuyers. It had been hoped that these would spur ancillary spending and thereby help the economy. This was not the case. People spent only on the things they could get a deal on.

And even that spending was problematic as the FHA seems intent on recreating the subprime insanity that got us into this mess.

Robert Toll, CEO of Toll Brothers, said today at a New York home builders conference that FHA lending could create another huge crisis in the mortgage industry, referring to it as “yesterday’s subprime.” He also went as far as calling it a “definite train wreck,” noting that a “flag will go up in the next couple of months” for bail out money.

It is worth pointing out that Mr. Toll’s money comes from the FHA so he  has a vested interest in NOT saying this.

Nor were individuals the only ones to reign rein in their spending:. Via AP: “Companies cut back spending on commercial construction — a weak spot in the economy — at 15.1% annualized pace. That was deeper than the 9% annualized cut back first estimated.” On the plus side: Corporate profits climbed by the most in five years.

Oh, wait, you mean you aren’t a corporation?

OOOOOPS, again.

Maybe that’s not good news.

The AP story tries so hard to offer both sides of the story that it contradicts itself in places:

For the current quarter, some economists think economic growth will slow to around a 2.5 percent pace, though others say it could reach 3 percent if holiday sales turn out better than expected. [I would like some drug testing done on those “others”.]

Most say they think the economy will weaken again next year, with growth at a pace of around 1 percent as the impact of the $787 billion stimulus package fades and consumers keep tightening their belts under the strain of high unemployment and hard-to-get credit.*

So for some reason consumers are going to shell out in this quarter but then stop. I may have missed it but I don’t think there has been a subsidy for Christmas presents. Unlike some other economists, I think most people know January follows December and behavior that won’t make sense then doesn’t make sense now.

By the way, the professional wishful thinking classes will be out in force for Black Friday so make sure not to believe a single damn thing they say. Reporting false bright numbers about the coming weekend is an annual and longstanding tradition. See: Journalists still too lazy to report truth about Black Friday

Journalists deeply irritated at working over the long weekend writes stories that begin: “Great Black Friday sales numbers mean a big shopping season. Insert somebody’s numbers to support this and then a quote or two from an analyst.” Publish, forget, and hope no one notices that they are ALWAYS — even in good economic times — WRONG.

I don’t know which irritates me more, that we are being lied to so badly or that we are so eager to go along with it.

PS: The FDIC Deposit Insurance fund is now in “Negative Territory” (ie, broke) as the number of bank failures continues to increase.

*The article has a great example of how journalists say what they believe to be true without getting caught at it: “What’s not clear is whether the recovery can continue after government supports are gone. If consumers clam up, the economy could tip back into recession.”

New reg lets banks ignore actual value of “underperforming” loans

It is only fitting that on Halloween the Federal government is increasing the number of zombies among us.

Federal bank regulators issued guidelines allowing banks to keep loans on their books as "performing" even if the value of the underlying properties have fallen below the loan amount.

The rationale?

While CRE (commercial real estate) borrowers may experience deterioration in their financial condition, many continue to be creditworthy customers who have the willingness and capacity to repay their debts. In such cases, financial institutions and borrowers may find it mutually beneficial to work constructively together.

Nothing inspires confience in me like the phrase “financial institutions and borrowers may find it mutually beneficial.” Especially since banks are not required to only apply this rule to “creditworthy customers who have the willingness and capacity to repay their debts.”

I really can’t top what Doug McIntyre wrote at DailyFinance.com:

The FDIC appears simply to be taking losses that would be incurred in the normal course of business and pushing the true accounting for them into the future. It is to the political benefit of Washington to make it appear that the banking sector is getting better. It also probably helps the FDIC, which is essentially insolvent, from having to come up with billions of dollars to insure deposits at failing banks.

Some can argue that this regulation just does for commercial real estate what had already been done for home mortgages. In April, the Financial Accounting Standards Board approved a new set of rules allowing financial firms to fiddle with how big their real-estate losses are. (New accounting rules let bankers set the value of their own toxic assets)

When I use a word," Humpty Dumpty said in rather a scornful tone, "it means just what I choose it to mean – neither more nor less.”

HOORAY? Sub-prime mortgages “back to pre-crisis levels”

The Fed says sub-prime mortgages again make up more than 20% of the nation’s outstanding mortgages.

After plummeting in early 2008, the share of borrowers with FICO credit scores lower than 660 has returned to just higher than 20 percent, the same share as when subprime securitization peaked in 2006.

Once upon a time this number was a bad thing because all those loans were held by private institutions many of which basically collapsed when it turned out people couldn’t pay them off.

Today it is a good thing because Government-backed agencies Fannie Mae, Freddie Mac and Ginnie Mae "are providing unprecedented support to the housing market — owning or guaranteeing almost 95% of the new residential mortgage lending." So all is jake now that you, me and every other US citizen are guaranteeing these turkeys.

The reason for this rebound is not that due to any increase in the financial stability of people with lousy credit scores. No, it’s because the Federal Housing Authority seems determined to recreate the housing bubble “by providing vital insurance that enables borrowers to qualify for loans with as little as 3.5% down.”

The FHA is, of course, a picture of fiscal health. The agency recently admitted that “a soon-to-be-released audit will show that its reserve fund has fallen below the level required by law, meaning it will not be enough to cover 2% of all outstanding FHA mortgages.”

One solution proposed to get the agency’s reserves back up to what the law requires:  Raise the minimum down payment on FHA loans to 5%.

But – reports the LA Times — “new FHA Commissioner David H. Stevens said such a move could threaten the nascent housing recovery. A person looking to buy a $300,000 house, for instance, would have to raise an additional $4,500 for the down payment.”

If you can’t afford another $4.5K for the down payment, you probably can’t afford $300K either.

Says who?

The FHA itself. That’s because – just like in the last housing bubble – the lenders don’t really have a clue as to how much the borrowers can repay. We know this because the FHA has admitted it really hasn’t done much to screen the lenders for things like basic competence.

According to a report by the FHA inspector general: “The agency approved nearly 3,300 lender applications in fiscal 2008, more than triple the year before. But the number of workers evaluating applications remained the same. In a review of 22 approved applications, the audit found that only one contained all the necessary documents.”

History repeats itself first as tragedy then as farce, someone once said. Unfortunately the farce doesn’t leave you any better off than the tragedy.

By the time this is all done the economy will look like it’s been hit by a typhoon of monkeys.

BON TON ROULEZ!!!

If the Wall Street Journal Is So Smart, How Come They Agree With Me?

Me:

Second, housing starts are at a nine month high! Great, just when a huge amount of housing stock is about to be dumped on the market, aka, more foreclosures.

Them:

Recovery Obstacle: So Many Houses

They have to get better reporters over there.

The stock market is an idiot

Yesterday the NYSE broke 9,000 and huzzahs and hosannas rang through the land. Redemption was at hand and all was right with the world. This was a sure sign the economy was recovering.

"What I like about the rally that we’ve seen so far is the breadth of it. It’s not really confined to a single sector. It’s broadly spread. That gives me confidence," said John Coyne, president of Philadelphia-based Brinker Capital, with $8 billion under management. "It’s been a wonderful run-up here. It’s certainly helping to restore investor confidence, given the trauma that people went through."

This all came about because of better earnings by Goldman Sachs, Ford and and the great good news that sales of previously owned homes rose 3.6 percent in June, the third consecutive monthly improvement! Never mind that Goldman’s money is based on accounting tricks and a fixed game or that the sale of homes is up because the price of homes is falling faster than Alan Greenspan’s reputation. It’s all good.

(Also never mind that UPS reported disappointing second-quarter earnings and doesn’t expect business to pick up over the next few months. Now that, ladies and gentlemen, is a reliable economic indicator.)

PAY ATTENTION:

THE STOCK MARKET AT 9,000
IS NO SMARTER THAN IT WAS AT 13,000.

There is a continuing and unfounded belief that stock markets somehow reflect reality. They don’t. They reflect the psychology of investors – whether individual or institutional. It is not a picture of what is but of what investors think will be. The Dow at 13,000 reflected nothing but the fact that too many people believed US housing prices could only move in one direction. Conversely, The Dow at 6,450 reflected people’s belief that our banking system was dead in the water.

I believe the current market numbers reflect mass denial. Denial that the US is populated by zombie banks, denial that unemployment is in double digits, denial that these profits have come because of slashed expenses – which is hardly sustainable. The rise in the Dow and other markets is more a reflection of wishful thinking and short-term profit-grabbing than it is anything else.

It could be that the above paragraph is wrong. Maybe recovery is upon us and the billions of dollars lost by banks and people in the meltdown do not need to be accounted for. Even if I am wrong about my assumptions and outlook I am right about this: The markets are no better at augury than the Romans were who relied on the flight of birds or examining the livers of sheep. If they were then we would never have crashes.

Top 10 Marketing Blunders of 2008

Yeah, there’s a lot more than 10 here. What can I say? It was a very good year for very bad things.

(PS: If you liked this would you mind going here and voting for it on Digg?)

GRAND PRIZE FOR SUSTAINED ORGANIZATIONAL EFFORT

(tie)

The John McCain Presidential Campaign

• “Our economy, I think, is still — the fundamentals of our economy are strong.”
• Has no idea how many houses he (or his wife) owns.
• Picks Sara Palin, the Broad to Nowhere who couldn’t find Russia or Africa on a map.
• Campaign adviser and former HP CEO Carly Fiorina says Palin couldn’t run a major corporation.
• Campaign adviser and former senator Phil Gramm says Americans are whiners about economic problems.
• “Shutting down” his campaign to fix the bailout.
• “Lipstick on a pig”
• Egregious attack on Dungeons & Dragons that clearly cost him the election. (OK, maybe not so much the last one).

GM

• June: with gas heading to $4-a-gallon, company announces it is trying to sell the Hummer brand. As of today, sale is still pending.
• August: with gas at $4-a-gallon, company announces it will take the bold move of investing “$500 million to build a new fuel-efficient, small car the automaker says will show it can make money in head-to-head competition with its Japanese rivals as it fights to return to profitability.”
• October: Asks Treasury Dept. for $10 billion to pay for proposed merger with Chrysler
• Early November: car company that already isn’t selling cars argues it can’t file for bankruptcy because “people won’t buy cars from a bankrupt car company.”
• Late November: leads troika of Detroit CEOs to DC to ask for taxpayer money to balance the books. Each flies in on wings of attitude and three separate corporate jets.
• December: runs weasel-word mea culpa in Automotive News: “While we’re still the U.S. sales leader, we acknowledge we have disappointed you. At times we violated your trust by letting our quality fall below industry standards and our designs become lackluster. We have proliferated our brands and dealer network to the point where we lost adequate focus on our core U.S. market. We also biased our product mix toward pick-up trucks and SUVs. And, we made commitments to compensation plans that have proven to be unsustainable in today’s globally competitive industry.“

Runners Up

1. Ford features “Space Oddity” — a song about astronaut suicide — in new car campaign.
2. Framingham State College  uses the word blah 137 times in a 312-word fundraising letter.
3. Disney (multiple entries): Bans kids from DisneyWorld restaurant; Changes “It’s A Small World” to “A Salute to All Nations, But Mostly America”; and Sells “High School Musical” panties for tween girls with the phrase “Dive In” on them.
4. Woolworths (UK) launches Lolita brand of beds for young girl
5. JetBlue lives up to Southwest’s parody ad by charging for pillows.
6. Russia uses smiling kids in tourism ad for war zone
7. Residents of Lesbos sue those other lesbians over brand name
8. Motrin gets headache from viral moms video
9. Butcher’s ads feature “Meat Products, Fresh Service” on naked woman
10. Hershey asks if you’ve found Mr. Goodbar

Special Jury Awards

Co-Branding That Shouldn’t Have Been

• Windows Vista toilet paper
• The Muppets appear on DVD for Law & Order: SVU
  
• Barbie® Rice Krispies® Treats
• P&G starts hip-hop record label (Bounce® and Beyonce? Jay Z and Oral B®? 50 Cent and Febreze®? Snoop Dogg and Eukanuba®? Ghostface Killah and Ghost®? Lil Wayne & Pampers®?)

The Alpha & Omega of Over-reaching

• God’s chosen racing team loses at the Indy 500
• “Pope’s Cologne Provides Solace to Grieving Widow”
• “Can Batman Teach Spiritual Truth?”
• Email service lets you taunt friends after The Rapture
• McDonalds compares Ray Kroc to Martin Luther King Jr.

Product Failure

• LifeLock ID protection service fails to protect CEO’s identity
• Anti-shark device found to attract sharks

The Penguins Of Irony “Oh NO You Din’t” Awards

• Publisher says bankruptcy puts magazine chain in “a position poised for wonderful growth
• WaMu continues to send credit card offers after going out of business

Previous years’ lists

• Top 10 from 2007
• Dozen Dumbest Press Releases from 2006
• 10 Dumbest Business Quotes from 2006

Why houses are losing their value to society as well as investors

Prof. Biggest Big Brother CollateralDamage has written (and the Washington Post has published) a fine article about how the value of houses has declined in ways beyond the price tag.

But the experience of owning a home, that cherished ideal of Americans for two centuries, no longer engendered the regularity, good conduct and economy the Victorians had thought it would. Outright greed took hold. Ordinary homebuyers proudly spoke of “flipping” houses: buying a home — maybe not even living in it — and soon thereafter selling it for the quick profit. Others borrowed against their homes — to finance still other purchases. As Presidents Bill Clinton and George W. Bush urged higher homeownership rates, real estate operators pushed subprime loans, no-document loans and hidden adjustable rates on the gullible and the avaricious. Virtually anybody could and had to own a home.

He stays away from snarky opinion and actually includes facts and stuff like that. I hope this sort of thing doesn’t gain popularity among the public.

Did mortgage crisis cause crash of flying saucer?

A Chattanooga, TN, house shaped like a flying saucer recently sold for $135,000, far less than expected. The 38-year-old, structure is perched on six “landing gear” legs, has multiple levels, three bedrooms, two bathrooms and an entrance staircase that lowers and retracts with the push of a button. The new owner — who didn’t want to speak with the press — faces some uniquenterior decorating challenges as the curve of the exterior creates a sloping ceiling and short side walls. On the plus side the building has a striking curved bar and a custom designed bathtub.

A neighbor, Ron Parimore, told the Chattanooga Times Free Press that former owners in the 1970s got in an argument and the wife pulled up the stairway, drove her husband’s truck underneath it so he couldn’t get the stairs down and left him stuck inside.

Jury duty shakes my faith in humanity

As even a casual observer can tell I am not all that impressed by humanity en masse. Singularly, we shows signs of brilliance. Collectively I’m not sure how we ever made out of the swamps, let alone down from the trees. So you can imagine my feelings of dread as I and 13 others chosen pretty much at random from the Boston-area gene pool sat down to come up with a verdict after 10 days of a trial on the scintilating topic of the rights to run a golf course. Simply put, the high-bidder for a contract to run a city course charged favoritism after he didn’t get said contract. The city of course denied this. Although very ably represented the city had the drawback of having to put on the stand several people who are among the veracity challenged, or so I thought. Turns out I wasn’t the only one who thought this and within an hour we had reached a verdict. I was deeply impressed at the insight of my fellow jurors who were about as much of a demographic cross-section as you could want. By the end of the entire process I would have to say it was cynical preconceptions 0, actual experience 1.

Fortunately, before this could sink in and change my outlook of the world I came across the following about the George Bush Desert Classic:

Half of US still believes Iraq had WMD

According to a Harris Poll taken last month, a full 50% of U.S. respondents said they believe Iraq did have the forbidden arms when U.S. troops invaded in March 2003. What makes this even better: That’s up 14% since last year. The interesting question that this raises for me is, oddly enough, not given this level of credibility how is it the nation is not awash in deeds to the Golden Gate Bridge (housing bubble? what housing bubble?). No, what I want to know is how it is that the president’s approval ratings are so low if half of us think that the invasion of Iraq actually made sense? Furthermore, what has happened in the last year to give this idea more — not less — plausibility? Y’know the White House keeps complaining that the press is only reporting the bad news out of Iraq. Well, if this is the result they ought to be cheering each time another bombing is reported.

Or, in the words of one of my beloved Texas aphorisims: “You keep giving them books and giving them books and they keep chewing on the covers.”

While this might lead some to despair, I choose to follow the advice of Mencken: “Life may not be exactly pleasant, but it is at least not dull. Heave yourself into Hell today, and you may miss, tomorrow or next day, another Scopes trial, or another War to End War, or perchance a rich and buxom widow with all her first husband’s clothes. There are always more Hardings hatching. I advocate hanging on as long as possible.”

Troubling sign: Threat of housing bubble being used in marketing

What song do you whistle as you go by the graveyard?

Luxury Mountain Home Demand Continues To Grow Despite Warnings of Housing Bubble Burst

KNOXVILLE, Tenn., May 23 /PRNewswire/ — Despite warnings of a burst in the housing bubble, real estate continues to grow in value, particularly among mountain properties. In East Tennessee, where the Smoky Mountains reign, the demand for luxury homes increased by 137 percent from 2000-2005. In the Rockies, buyers paid more for real estate in the first nine months of 2004 than they did in all of 2003.