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?

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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.”

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.

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.