Decline of the Empire

The State of The Union

Tonight President Obama will deliver his first State of The Union address to Congress. Sure he accomplished nothing—make that less than nothing, things got worse—in his first year in office. And as we wait with baited breath for the reassuring words of the President, what else could possibly go wrong...?

Ben Bernanke Week

Fed Chairman Ben Bernanke's reappointment is up for a vote this week in the Senate. Those interested in his unbelievable obtuseness on the Housing Bubble should read Barry Ritholtz's Observations On Bernanke. To this day, Bernanke denies that Greenspan's low interest rates after the 2001 recession had anything to do with inflating the bubble.

Allow me to quote from John Kenneth Galbraith's The Great Crash 1929, pages 26-27.

The regulation of economic activity is without doubt the most inelegant and unrewarding of public endeavors...

The great exception to this dreary story is the regulatory activity of the central bank—with us, the Federal Reserve System. Here is regulation of a seemly and becoming sort. No one apologizes for it; men of impeccable conservatism would rise to espouse such regulation were they call upon to do so, which they almost never are. This regulation is not the work of thousands of clerks... Rather it emerges in the measured and orderly discussion of men of quiet and dignified mien, each at his accustomed place around a handsome table in a richly paneled and richly draperied room. These men do not issue orders; at most they suggest. Chiefly, they move interest rates, buy or sell securities, and, in doing so, nudge the economy here and restrain it there. Because the meanings of their actions are not understood by the great majority of the people, they can reasonably be assumed to have superior wisdom. Their actions will on occasion be criticized. More often they will be scrutinized for hidden meaning.

Such is the mystique of central banking. Such was the awe-inspiring role in 1929 of the Federal Reserve Board in Washington, the policy-making body which guided and directed the twelve Federal Reserve banks. However, there was a jarring difficulty. The Federal Reserve Board in those times was body of startling incompetence.

And this is also the story of 2006 when Bernanke became Fed Chairman, and before that during the Greenspan Era when Bernanke was merely a cheerleader for the now discredited Bubble Master. Did Bernanke suggest there was trouble in 2006? No. Did Bernanke nudge the economy here, restrain it there? No.

Galbraith goes on to explain that when the economy is booming as it was during the Housing Bubble, government officials (or central bankers) will never use their regulatory powers or powers of persuasion to end the madness. For if they were to intervene to prevent economic catastrophe, to prevent the bubble from blowing up, they would need to blow it up. This is a delicate matter requiring deft maneuvering. Think of a balloon. Does it make any difference in the effect if you prick it with a pin, as opposed to dropping an anvil on it? Still, it could have been done or at the very least, warnings could have been issued. This would have required great courage.

Money was being made. People were being fleeced. All was right with the world, especially the banking world. As the Cajuns say, Laissez les Bon Temps Roulez! But had action been taken, everyone would know exactly who was to blame for ending the Good Times. They would know exactly who the party poopers were. Here's Galbraith again—

The very effectiveness of such a measure was the problem. Of all the weapons in the Federal Reserve arsenal, words were the most unpredictable in their consequences. Their effect might be sudden and terrible. Moreover, these consequences could have been attributed with the greatest of precision to the person or persons who uttered the words. Retribution would follow. To the more cautious of the Federal Reserve officials in the early part of 1929 silence seemed literally golden.

As Galbraith said in another context, Ben Bernanke was not a man "to expedite his own demise." So the Housing Bubble was allowed to run its course right up to the inevitable crash while Bernanke said plain vanilla things like this—

I think over a period of time, the housing prices are likely to stabilize. I don’t expect them to keep rising at this rate indefinitely; I don’t think anybody really does. But, again, I do think that the bulk of the increases are associated with strong economic fundamentals. (9 Aug 2005)

And later this—

Home prices, which have climbed at double-digit rates in recent years, still appear to be rising for the nation as a whole, though significantly less rapidly than before. These developments in the housing market are not particularly surprising, as the sustained run-up in housing prices, together with some increase in mortgage rates, has reduced affordability and thus the demand for new homes.” (9 July 2006).

Etc. So, should we let the Chairman continue in his job? Of course not.

The Federal Reserve Board in those times was body of startling incompetence. And I would add, startling timidity (at least right up to the day the financial system melted down). Bernanke still defends his indefensible stance. Ben says bubbles can't be identified. What he knows and doesn't know follows directly from an overpowering impulse to cover his ass. But History will not treat him well. And where are short-term interest rates? They're at 0.25%. Here we go again!

It is what it is. And what it is is what it was in 1929.

Obama's Mad As Hell, and He's Not Gonna Take It Anymore

Exactly one day after Republican Scott Brown's victory in Massachusetts, where he won Ted Kennedy's vacant Senate seat, President Obama got religion on the Too-Big-To-Fail banks.

I know this is now "old news" in this fast-paced world of ours, but come on now! No cynical thing I could say seems to capture what needs to be said here, so Paddy Chayefski will have to do it for me. So, without further ado...

The Reverse Square Root

Calculated Risk has another update about economists anticipating a sharp upturn in 2009:Q4 GDP. He quotes a Bloomberg survey.

Gross domestic product expanded at a 4.6 percent pace from October through December ... according to the median estimate of 74 economists surveyed by Bloomberg News. ... “Inventories are going to be responsible for at least half of the growth, if not more,” said Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc. in New York.

MarketWatch found a set of even more optimistic economists, but this time the focus was on an unsustainable inventories boost. See my post The Inventories Blip.

Economists surveyed by MarketWatch are forecasting a 5.5% annualized increase ... "Although we anticipate a large rise in GDP, underlying growth is expected to be rather tepid, held down by declines in structures, government spending, and motor vehicle sales," wrote Peter D'Antonio, an economist for Citigroup Global Markets...

Most of the boost in the economy in the fourth quarter came not from sales of goods and services but from the adjustment in the inventories of unsold goods.

If you look at the flood of indicators coming in every week, you might notice a characteristic pattern in a large number of them.

Figure 1 — The characteristic shape of many economic indicators. Look at Housing Starts or First Amercian Core House Prices, for example, from Calculated Risk. The part outlined in red highlights the reverse (horizontally flipped) square root shape of the recovery.

Figure 2 — A reverse (horizontally flipped) square root symbol.

Now obviously you will be able to find a lot of graphs that don't look like Figure 1. Most notably, unemployment continues to rise and rise. This is the "jobless" recovery, or put another way, employment is a "lagging" indicator. Unfortunately, it will "lag the recovery" for many years to come. Eventually you will hear about a "New Normal" characterized by high jobless rates.

The 2009 4th quarter GDP number, which will no doubt be revised downward in future BEA updates, forms part of the short-lived comeback (a "V") in the reverse square root of Figures 1 & 2 before things flatten out (or deteriorate).

The American economy is unsound. Read 7 Things About The Economy Everyone Should Be Worried About. The "V"-shaped recovery won't last long. For the much longer term, see Japan.

Remedy du Jour

Yves over at Naked Capitalism likes to put up pictures of warm, fuzzy animals to counteract all the bad news she's reporting. She calls this the antidote du jour.

Music is one of those things that makes life worth living, hard times or not. So, here's my inaugural remedy du jour. To hell with them, right folks? First up is Linda Ronstadt doing Heart Like A Wheel in 1976.

In this one, the unworthy Bryant Gumbel interviews Pat Metheny before he and his buddies play the beautiful song Letter From Home. It's worth it to hear Metheny talk about music (in 1989).

Is It All Over For Ben Bernanke?

Fed chairman Ben Bernanke's term is over at the end of the month. Predictably enough, President Obama elected to re-up the chairman, but unless the Senate votes to keep him, he's outtahere. Mish covers all the particulars of where the Senate stands in Dump Bernanke — How You Can Help!

So, should Bernanke get another term? That depends on who would replace him. If it's Paul Volcker, I would be happy with that. See my 2009 — A Year We Will Live To Regret.

But what if it's Larry Summers? Yes, Larry Summers' name has been bandied about as a possible replacement should Bernanke not be re-confirmed. This makes sense in so far as Larry is Satan's Earthly Representative for Economic Affairs. But I am getting ahead of myself.

Here's the New York Times on the debate over Bernanke's reappointment—

By the end of the day, the White House had extracted a statement of support for Mr. Bernanke from the Senate majority leader, Harry Reid of Nevada, who had been noncommittal. Mr. Reid’s statement, issued after the markets closed, was intended to signal that Democrats, backed by some Republicans, could come up with the 60 votes necessary to break a deadlock and reconfirm Mr. Bernanke.

But even then Mr. Reid’s statement was remarkably unenthusiastic. After meeting with Mr. Bernanke on Thursday, Mr. Reid warned: “The American people expect our economic leaders to keep Wall Street honest and level the playing field for middle-class families.”

And in his statement Friday, Mr. Reid said he had decided to support Mr. Bernanke with trepidation and only after he received a commitment that the Fed chairman would take additional steps to increase the flow of credit to middle-class Americans.

Reid will vote to confirm Benanke if he increases the flow of credit to Middle Class Americans? A blogger's work is made so much easier by limitless stupidity!

Figure 1 — Total consumer credit outstanding in the United States since 1943. After rising sharply since the early 1980's, outstanding credit is contracting for the first time since record keeping began.

It goes without saying that the Middle Class is threatened by too much debt. Americans are shedding debt and increasing savings as circumstances permit. Many are defaulting on debt (e.g. walking away from bad mortgages), not least because they don't have a job, or their work hours have been cut. They are trying to save themselves.

Banks are not lending because—

• falling asset values (in housing, commercial real estate) are causing huge losses on their balance sheets
• consumers are defaulting (on mortgages, credit cards), which is another hit on the balance sheets
• consumers are unwilling to take on more debt
• credit-worthy borrowers are harder & harder to find
• small businesses aren't demanding more credit because future consumption doesn't warrant expansion

Etc. I wonder if Harry is aware that several regional banks fail each week. It must be because they're not lending. The Too-Big-To-Fail banks would have failed, but they were bailed out, and their future losses are guaranteed with your tax money and China's investments.

And here's the perspicacious Harry Reid basing his vote on whether Ben Bernanke will increase the flow of credit to the Middle Class! Will wonders never cease?

Still, I wonder if ordinary citizens had access to the Fed's discount window, where dollars can be borrowed at 0.25%, what they might be able to do with all that free money. Just imagine it, you calling up the Fed and telling them you want $10,000,000 transferred immediately to your bank account (and here's the number...). You could buy treasuries with the money, paying somewhere around 2-3% (depending on what you buy). This would easily cover your interest costs on the ten million. J.P Morgan Chase does it. Why not you? Is this what Harry Reid wants? I'm all for it!

Empire Declares The End of Democracy

They frankly own the place
    —Sen. Richard Durbin, D-Ill., in 2009 admitting the taboo about banks’ influence in Congress

In a "landmark" 5 to 4 ruling, the Supreme Court declared an end to limits on corporate donations to political campaigns. (And, oh yeah, labor unions too). Thus ends any curb on the ability of special interests to buy politicians.

A chance remained, albeit small, that laws on the books curtailing bribes would continue to be enforced, or even strengthened, to preserve what little representative government we had left. That's all over now.

The conservative majority of the Supreme Court just made a mockery of its claim to judicial restraint, overturning decades of law and legal precedent with a decision that will inevitably corrupt our democracy.

More than a century ago, President Teddy Roosevelt saw what today’s court is blind to — that unleashing corporations to drench our political campaigns in special interest money will drown out the voice of regular citizens.

Roosevelt banned corporate political spending by signing the Tillman Act in 1907. Four decades later, Congress extended the same ban to unions. Supreme courts have affirmed these limits as legitimate several times since.

But Thursday, in a 5-4 decision, this supposedly conservative court swept all that away. So now, instead of soliciting their employees or members for voluntary donations to political action committees, unions and corporations can tap their general funds for political causes, allowing them to spend much more.

In a day when special interests already hold our democracy by the throat, the court has helped them tighten their grip.

This comes as a blow to those of you who still believe in Human Progress. Way back in 1907, T.R. banned corporate political spending. We're far more "enlightened" now.

The root of the now unsolvable problem is that way back when—I'm too lazy to look it up—corporations were accorded the rights of individuals, which obviously included those freedoms included in the Bill of Rights. That is why you will find the Supreme Court's ruling hailed as a "victory" for the Free Speech guaranteed under the 1st Amendment.

Clearly, a corporation is not an individual. But construed another way, a corporation is an individual—the person who runs the place. This person can spend the considerable resources of the corporation to buy politicians, and now his unfettered ability to do so, which considerably dwarfs your own unless you are Soros, Gates or Buffet, has been "legislated" by the judiciary. These expenditures, of course, are easily justified as the cost of doing business.

There was a time when such news would have been shocking, provoking anger, protests, much gnashing of teeth, wailing, beating of breasts, and so forth. But as we roll forward in 2010, after decades of corporate Pavlovian training, the American people are beaten down, trampled underfoot, cowed, subservient, submissive, compliant, thoroughly brainwashed, and thus incapable of responding with the appropriate outrage to the complete annihilation of what many of them still fondly think of as a "Democracy."

Empires and democracies do not go together. As a friend asked, why go through the charade of having a Congress? After all, even casual observers can see that they fuck up everything they do, on those rare occasions when they do something. In part, that's because they are already bought & paid for. For several years now, they have been spending America into bankruptcy, an event which is not as far down the road as you might think (maybe 10-12 years away if current debt growth is maintained). So why don't we just get rid of them?

So abolishing the Congress sounds good to me. Then we wouldn't have all this pretense in America that we live in a Democracy in which people step up each election year to cast their meaningless ballots. Unfortunately, the Powers That Be are well aware that such fakery keeps the people submissive, for what is more powerful than maintaining the illusion that power resides in our hands when it does not?

The Roman poet Juvenal asked who will guard the guardians themselves? Quis custodiet ipsos custodes? The answer, then as now, is nobody will.

On Moral Obligations, Part II

Tech Ticker's Aaron Task and Henry Blodgett interviewed The Atlantic economics editor Megan McArdle on walking away from your mortgage.

Our guest Megan McArdle ... thinks [walking away] is wrong. First, Megan says, walking away from your mortgage voluntarily is often financially stupid: There are plenty of fees and costs associated with defaulting, and your credit rating will be destroyed for years.

Second, Megan says, it is morally wrong to walk away, because your mortgage represented "a promise to pay." If everyone entered into a mortgage with a secret plan to walk away if the house value falls, Congress would write new laws allowing mortgage-lenders to go after borrowers' other assets (which already exist in some states). This would make borrowing money harder and more expensive for everyone.

As Meghan clarifies as the interview goes along, she is not talking about the huge majority of underwater people who can not afford to keep their house. No, she is talking about that tiny minority of people who think of their house purely as investment (not a place to live, raise your kids, etc.). She's not heartless! Meghan is simply outraged that these (very few) speculators would further injure the banks. 

After making this important clarification, Meghan talks about the terrible dangers of a bad credit rating. Anytime you hear this argument, be aware that the only threat here is not to you; the bad credit rating prevents you from borrowing money in the future to buy stuff you can not afford. Thus the real threat is to the American Way, in which the economy grows through debt-based consumption.

Meghan then goes on to defend the banks, who apparently can do not wrong. I assume she's hoping to go far in this world through her exquisite knowledge of who is powerful and who is not.

Watch the video.

On Moral Obligations

The Theater of the Absurd continues. The latest brouhaha is over morality. One view says that underwater homeowners have a moral obligation to keep paying their mortgages. The other view says they have the right to turn in the keys and walk away.

Empires and morality are like oil and water—they don't mix. Here I take morality and ethics to be the same thing. It has surely been decades since ethics, which is exemplified best in some version of the Golden Rule, has played a role  in decision-making in America.

• Do not do to others what you do not want them to do to you

During the housing bubble, Real Estate screwed new homeowners by creating complex contracts with built-in time bombs. They were reassured that all was well, for house prices would never go down. Based on the same faulty but lucrative (and short-lived) assumption, the Too-Big-To-Fail Banks created risky, complex, bundled securities or derivatives backed by these fraudulent mortgage contracts, and sold them to gullible (but greedy) investors, which were often pension funds, or other big banks, many of which were in Europe. Earnings were fabulous! — while the bubble lasted. Ratings Agencies (like Moody's) blessed this fraud at every step.

Government regulators engaged in Navel Gazing. Economic growth was going like gangbusters! Why rein in a good thing? Ben Bernanke still won't admit the Fed's low interest rates played any role in enabling the bubble. Thus the Fed, along with all the other potential regulators, exercised none of its regulatory powers.

This was clearly a Ponzi Scheme, for home prices would continue to rise only if there were new buyers to push up prices. Eventually, the scheme ran out of new buyers, due in no small part to the exorbitant prices being asked, and the value of the homes (assets in econ-speak) crashed.

Some of the home buyers—a small percentage—were speculators, some were hoping to increase their wealth in so far as wages had not increased much in the previous decade, and some just wanted to own a house.

In this entire chain of events, did anyone care about the effects of their actions on counterparties? Did they consider, in line with the Golden Rule, whether they themselves would want to be the screwee (and not the screwer)?

Yes, some home buyers were screwed pure & simple. There are always people at the bottom of a fraudulent chain. In a Ponzi Scheme, these are usually the last ones in. Also remember that greed makes us blind. People asked how Bernie Madoff (and many others like him) could screw them like he did. But they never questioned the steady (and hefty) returns on their "investment." Gullibility allows Ponzi Schemes to work. There's a sucker born every minute said P.T. Barnum, a man who knew what he was talking about.

No one in Real Estate or the Banks or the Ratings Agencies or in the Government acted in an ethical way, not as long as there was money to be made. There were conflicts of interest everywhere. And damn the consequences, which we are living with now. Worst yet, nothing has changed.

One would need to write a book, in multiple volumes, to detail the utter lack of ethics that has governed the Empire since World War II. America is like a giant game of Survivor. Your only choice now, if you intend to keep playing, is to try not to get kicked off the island. To prevent that, you'll almost certainly have to screw some people.

Almost everybody has little choice but to keep on playing this cutthroat game—if they want food & shelter, that is. That's why it's called Survivor. So, should you walk away from your underwater mortgage? The answer is obvious.

The Inventories Blip

When a normal "business-cycle" recession is ending, a boost in inventory spending by businesses often signals that things are returning to normal. From Calculated Risk's Q4 GDP: Beware the Blip—

San Francisco Fed President described the impact of inventory changes back in September: The Outlook for Recovery in the U.S. Economy

I expect the biggest source of expansion in the second half of this year to come from a diminished pace of inventory liquidation by manufacturers, wholesalers, and retailers. Such a pattern is typical of business cycles. Inventory investment often is the catalyst for economic recoveries. True, the boost is usually fairly short-lived, but it can be quite important in getting things going. ...

But what if this doesn't "get things going"?

Good question. Of course, the reason for asking it is our reasonable expectation that things are going nowhere. Also see Paul Krugman's Blip. Giant Squid forecasters believe the fantasy GDP number may be quite large—

In a research note released last night, Goldman Sachs raised their estimate of Q4 GDP from 4.0% to 5.8%. They cautioned that the "headline will be an eye-popper", but that this growth is mostly due to inventory changes: "More than two-thirds of our estimated increase comes from a sudden stabilization in inventories". They also noted "anything between 4½% and 7% is possible given the volatility of the inventory data".

The rest of the note cautions on 2010, and Goldman still sees sluggish growth of just under 2.0% with the unemployment rate peaking in early 2011.

An inventory spending boost is a "blip" because it is a one-time event during the early stages of recovery. Remember, inventory spending can rise without any concomitant rise in personal consumption expenditures (PCE), which make up 71% of GDP in the United States.

The 4th quarter GDP advance estimate is due January 29th.

Some of you may recall that the advance estimate for 2009:Q3 was 3.5%. This number was met with great fanfare, in so far as Declining Empires must maintain the appearance that all is well. Many fewer of you will recall that this number was revised down to 2.2%, which would be considered very sluggish growth coming out of the biggest downturn since the Great Depression. That is, if anyone remembers that this was the "final" number after all the downward revisions—always down, never up?

Now, we're about to go through this same ludicrous process, doomed to repeat the same mistakes over and over. You sports fans will enjoy the stock market bounce when the 2009:Q4 number hits the airwaves.

Is this the best we can do? I'm afraid it is.