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America slides deeper into depression as Wall Street revels

Agreed.

Sad part is it can all be reversed with a few simple spread sheet entries. A full payroll tax holiday and per capita revenue distributions to the states to restore demand, output, and employment

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More on the Bernanke testimony:

Shortly after the failure of Lehman Brothers, I was in Brazil at an international meeting, and I had a meeting there with bankers, and I asked them how the Brazilian economy was doing. And they said well, it had been doing fine, but within a week after Lehman Brothers collapsed, it was like a frigid wind descended on the economy in Brazil. And there was an enormous impact almost immediately on their economy, on their ability to raise funds and make loans.

In dollars, I’m sure.

And it’s astonishing how quickly that one failure spread throughout the world, and created a very severe recession, not just in the U.S., but around the world.

The Federal Reserve, by making a large loan under very tough terms to AIG,

But allowing those funds to be used to meet margin calls on CDS and probably other related market losses. That’s perhaps the most controversial part. Those payments to creditors perhaps could have been labeled ‘loans from the Fed’ subject to AIG ultimate solvency rather than payments from the Fed.

prevented the failure of that institution, and, therefore, tried to contain the impact of the Lehman Brothers failure on the rest of the global financial system. I’ll come back and talk more about AIG, and those things later, but that was just the first step of many that we took to try to stop the crisis.

Subsequently, again, very concerned with the possibility of a global financial meltdown, we worked with Treasury and the Congress to develop a bill that would provide funding that the Fed, the Treasury and other agencies could use to stabilize the financial system, to prevent collapse of the financial system.

This immediately became relevant, because in mid-October, the crisis heated up again to the point that we thought that we were again within days or hours of a collapse of many of the largest financial firms in the world. It was a dramatic weekend. It was Oct. 10 or 11, Columbus Day weekend, when the Finance Ministers and the central bankers of seven of the largest industrial economies had a meeting here in Washington, which, of course, I attended. Usually, those meetings are very scripted and very dry. In this case, there was palpable concern among the participants that the collapse of their financial system might be just days away, and there was a great deal of discussion about how we, collectively, as the policy makers leading those countries could stop the collapse.

In the days that followed, countries all over the world, particularly the advanced industrial countries, took strong measures to prevent the collapse of the financial systems. That included putting capital into banks;

Obviously they didn’t know it was nothing more than regulatory forbearance.

it included preventing the failure of large financial firms; it included guaranteeing the debts of financial firms so they could borrow and keep themselves afloat; it included making short-term loans to firms so that they would have the short-term credit they needed to pay off lenders who were withdrawing their funding. And, again, this was the U.S. doing this, but also many of the most important industrial countries around the world simultaneously, including the U.K., Germany, France, Switzerland and others.

Again, many of those creditors ‘bailed out’ by the Fed’s liquidity provisions could have had those funds labeled ‘loans from the Fed’ rather than simply receiving payments from the Fed.

The result of this collective global effort over that week was essentially to succeed in stabilizing the global banking system, in that subsequent to that week the fears of utter collapse were largely overcome.

Now, in the following months after that, there were still many, many great difficulties in the financial markets. And the Fed, and other central banks and Treasuries around the world, worked very hard to restore the normal functioning of those markets. For example, following the Lehman failure, there was a run where ordinary investors went as quick as they could to pull their money out of money market mutual funds, which are a common investment vehicle for many Americans. It was very analogous to 100 years ago when a bank was about to fail, and the depositors would go to the bank, they would run and pull their money out as quickly as possible, and then the bank would fail. The money market mutual funds were experiencing exactly the same phenomenon.

The Fed and the Treasury working together provided short-term loans to these funds. The Treasury provided some insurance to depositors, or to investors so they would know they wouldn’t lose their money. We stopped the run on the money market mutual funds, and that was an example of how we helped stabilize the situation.

Not sure why that was critical?

There were many other steps we had to take helping individual institutions, and providing programs for backstop lending to make sure that the key markets in the financial system were functioning again, because for months after Lehman Brothers, the amount of fear and uncertainty in the financial markets was so elevated that these markets were, essentially, not functioning properly, and it took really many months until we had reached the point that these markets had begun to approach a normal state.

Doesn’t mention the dollar swap lines to foreign CB’s???

But bank lending is still weak. The banks had a near-death experience, they are now lending in a difficult economic environment. We are strongly encouraging them to lend. We have taken a lot of steps to help them raise new capital, so they’ll have a basis on which to make new loans. And we are taking a number of steps to try to open up markets through which investors invest directly in various forms of credit, like auto loans and credit card loans. All of these steps are improving the financial situation, but particularly the banking sector, we’re still in the convalescent stage.

They only bought AAA traunches which didn’t address the credit issues. They were more worried about taking losses than restoring auto credit, but wanted to give the appearance they were doing something.

As I said, I was a professor. I never worked for Wall Street. I have no connections on Wall Street. In fact, when I first became chairman, I was criticized in some quarters for not being close enough, or knowing enough about Wall Street. So, why did I take these actions?

I didn’t take these actions, or the Federal Reserve didn’t take these actions because we were trying to help bankers, or trying to help Wall Street. What I understood, and what knowledgeable people all around the world understood, is that the financial system is essential to the functioning of any economy. And that if the financial system had collapsed to the extent to which we believed was very likely in September and October 2008, then no force on earth, no policy, could have prevented the collapse of the entire U.S. economy with long-lasting and extreme consequences for every American.

How about a proportionate fiscal response, like a payroll tax holiday and per capita revenue distributions to the States? Instead, he continues to preach ‘fiscal responsibility.’

It was because we were concerned about jobs and incomes and the economic well-being of every American that we intervened to prevent the collapse of the financial system.

Now, going forward, we have a lot to do to get the economy back to stability, get jobs created. You can talk as much as you like about the things we’re doing there, but we’re also going to have to take some very strong steps to make sure that the crisis doesn’t ever happen again.

There were, certainly, weaknesses in our financial regulatory system. There were weaknesses in the way that financial regulators supervised the banks and other financial institutions. And the financial institutions themselves made lots of mistakes in terms of their ability to measure the risks that they were taking, and to control them properly. And to make sure we don’t ever have a crisis like this again, we need to have extensive reform in the private sector, in the public sector, to eliminate these risks in the future.

You had said that the banks were convalescent still, Mr. Chairman. Can you talk to us a little bit more about what that means?

Well, the banks have been stabilized. They’ve raised a good deal of capital, so they’re in much better shape than they were. They are lending, but they are not lending enough to support a healthy recovery. One important reason for that, is that given their losses, given what they’ve been through, they’re being very conservative in the face of what is still a very weak economy; and, therefore, a sense that many borrowers are quite risky.

As bank supervisors, we have a difficult challenge. We have told the banks very clearly that we want them to make loans to credit-worthy borrowers, where there are borrowers who can repay the loans. It’s in the interest of the banks, it’s in the interest of the economy, and, of course, it’s in the interest of the borrowers for those loans to get made.

But the problem is, of course, that we got into trouble in the first place by banks making loans that couldn’t be repaid, so we don’t want banks to make bad loans. Therefore, we are trying to work with banks to make sure that they are, in fact, able to make as many good loans as possible, that they have enough capital, that they have enough short-term funding, and that the examiners and the regulators who work with the banks are not unduly restricting the loans that they make. We want to work with the banks to make sure that they balance the appropriate prudence and caution against the need to make good loans for the economy, and for their own profits.

Banks and the entire private sector is necessarily procyclical.

Only govt via fiscal policy can be countercyclical.

So, what this means is that economic policy, and financial oversight have to take into account all the international dimensions of that. So, for example, on the monetary policy side, we have worked carefully and closely with other central banks to talk about monetary policy in different parts of the world. In fact, during the heat of the crisis in October 2008, the Federal Reserve and five other major central banks cut interest rates together on the same day, as a sign of how committed we were to cooperating on monetary policy.

Doesn’t seem concerned that interest rate cuts may in fact be deflationary as he knows they remove interest income for the private sectors (Bernanke, Sacks, Reinhart, 2004 Fed paper- see ‘the fiscal channel’)

The system worked.

It did work. It was an important first step. I mean, even after we took those steps, the financial markets were in a great deal of stress, and credit at all levels was very much constrained. But it stabilized the situation, and from there, we were able to take a number of steps to - both we, and our partners in other countries - to get the key markets working again, to get the banks stabilized, and to begin the very difficult process of getting the financial system back on its feet.

Never realizing that all the alphabet soup measures to get liquidity going missed the point that all the Fed had to do was lend fed funds to member banks without limit, as the ECB effectively did by immediately accepting any and all bank collateral, to immediately restore bank liquidity.

So, while it’s difficult to know exactly what the outcome would have been, certainly, just judging on what happened after the failure of a single firm, the collapse of the global financial system would surely have led to a far deeper recession, higher unemployment, much greater fiscal cost to the taxpayer, and to rebuild the financial system, and to get the economy moving again. And almost certainly, [we would have had] many, many years of subnormal - substandard - performance by the U.S. economy, and by other industrial economies, as well. Again, we can’t know precisely, but I think if anything, the financial crisis last fall was as severe, and as dangerous as anything we’ve ever seen, including the 1930s.

The whole point of going off the gold standard in 1934 was to be able to provide liquidity without limit to the banking system, so the fact that he did that, however belatedly, is nothing to brag about. It also allowed for unlimited fiscal responses, which he still seems to not fathom.

There is an irony here that’s literary, that here’s this man who spends his life distinguishing himself studying economic history. And then one day you wake up and realize that you’re at the center of economic history in this really unusual chapter. How do you process that personally? I mean, how does that change how you go from being the academic expert to you are in the arena?

Well, I certainly didn’t anticipate when I came to Washington in 2002, I certainly didn’t anticipate these events, or how things would evolve. No question about it. And when I became chairman in 2006, I thought that - I hoped that my main objectives would be improving the management, communication and monitoring policy.

We were certainly attentive to the risks of financial crisis. Secretary Paulson and I talk frequently to people on Wall Street, and we secured the Federal Reserve. We set up a team of staff drawn from different disciplines to try to identify problems and weaknesses in the financial sector. So, we were certainly aware of the risks of financial crisis, but one as large and as dangerous as this one, I certainly did not anticipate. I wish I had, but I didn’t.

Then when the crisis came, you know, rather unexpectedly, a different part of my training and research became relevant, which was to work on financial crises generally, and also on the Great Depression. And I believe very much that that experience, and that knowledge, was very helpful to me in many dimensions of this effort, ranging from - I think the most important lesson, there are many lessons, but I think the most important lesson was that we were not going to have a healthy stable economy with a completely dysfunctional financial system. We had to take strong measures to prevent that from happening.

And in the 1930s, the Federal Reserve was quite passive, and allowed the banks to fail, and we know the result of that. So, we were determined that that wasn’t going to happen on my watch, on our watch, so we were prepared to take very strong actions to avoid that.

That was under the gold standard. Nothing could be done without losing the nation’s gold supply. It was only after the banks reopened in 1934 with a non convertible currency could there be credible deposit insurance unlimited Fed provision of liquidity. Clearly he doesn’t understand that or a) he’d be stating it b) I don’t want to say…

You’ve been quite forthcoming, I think, in your testimony about saying, there’s a lot of things you didn’t see, there’s some things that we didn’t do. If I gave you a kind of do-over to go back as long as you want to say you know what, if we’d seen this, if we’d looked at the sub-prime mortgage crisis. I mean, how could you have handled it, and the Fed handled it better to have a different outcome?

Well, we have, based on the experience of the crisis, we - the Treasury and others - have made proposals for how the financial regulatory system ought to be reformed and restructured. I’ll say a word about that. If we had been in that forum, I think we would have avoided the crisis. So, there were some important lessons.

One was that our regulatory system was too myopic. It was too focused on individual firms, or individual markets, and there was nobody paying attention to the broad overall financial system. So, the Federal Reserve was not entrusted with looking at the whole financial system. We were - we had very specific assignments. We were supposed to look at specific institutions. Those institutions did not include many of the firms that had severe problems, like Lehman Brothers or Bear Stearns or AIG. Those were outside of our purview, and since they were outside of our purview, we didn’t look at them.

They missed one critical factor- allowing bank loan officers to work on a commission basis. Nor, did the regulators look into actual loan files to check for fraudulent appraisals and income statements promoted by loan officers working on a commission basis. Regulation is necessarily a work in progress. Mistakes will be made, including mistakes of this scale. Critical to our well being is the knowledge of how to keep these errors in the financial sector from damaging the real economy. And that requires appropriate fiscal responses to sustain aggregate demand, preferably in an equitable manner.

But there were many situations where there was really nobody who was looking carefully at what was going on, and nobody who was looking at how the parts of the system fit together. So, a very important recommendation that we have made is that there be a more systemic approach - that is, have some arrangement whereby a regulator, or a group of regulators, has responsibility to look at the system as a whole, and try to identify emerging problems, or gaps in the regulatory apparatus, or weaknesses in individual institutions, as they relate to other institutions, that threaten the integrity of the system as a whole.

Better still, most of the issues came from allowing banking activities that in fact served no further public purpose. That includes any bank participation in secondary markets, loaning against financial assets, using LIBOR as an index, and many others.

We didn’t have that. Therefore, nobody paid enough attention to AIG, nobody paid enough to attention to credit and call swaps, nobody paid enough attention to some of the activities of investment banks. You go on, and on, and on. Again, if we had had a more comprehensive overview approach that would have been helpful.

A second key element is the problem too big to fail, and how to address that. So, I just want to be very, very clear that even though the Federal Reserve was involved in rescuing Bear Stearns and AIG, we did that extremely reluctantly, and with - it was a very distasteful thing for us to do. We did not do it - we were not set up to do it. We were - it was very difficult for us to do, but we did it because there was no appropriate mechanism, there was no set of laws that would allow the government to intervene in a situation like that in a way that would allow the firm to fail, but would not have all the negative consequences for the financial system and the economy.

So, we had a situation where there were firms who were literally too big to fail, or too complex to fail, or too interconnected to fail. When they came to the edge of collapsing, we had only two very, very bad choices: we either bailed them out, put taxpayer money at risk, put the Federal Reserve at risk in terms of our lending, or we could let them collapse and have all the hugely negative consequences for the financial system and for the economy.

So, what we did not have, and what we very much need going forward, is a third option, and that option should be a legal framework which allows the government - and I think that means, in practice, the Treasury and Federal Deposit Insurance Corporation - to intervene when a large complex systemically critical firm is about to fail, and to allow the firm to fail, impose losses on the lenders, the creditors of the firm, the shareholders, fire the management, protect the taxpayer, but be able to do that in a way that protects the system, so that the financial system is protected from the immediate impact of that collapse.

I submit we already have that for the large banks, and the others as well. He just didn’t grasp how to use it. The receivership they did set up did not have to pay off all the creditors, and if there were issues, it would have been a relatively simple matter to petition congress for an ‘emergency’ alteration of current law. They didn’t even try.

We did not have a system like that in place. I think if we had, we could have dealt with Lehman Brothers and AIG in a much more satisfactory way. We would have avoided many of the problems. And, most importantly, we would have not, in some sense, rewarded failure, which is what happened. In the future, it’s important that firms be allowed to fail if they, in fact, take excessive risks, and make bad gambles.

But that mechanism is not in place now.

The mechanism is not in place, and we have asked Congress to address it, and I believe that they will. But until they do, we are really still in a situation where we don’t have good options in dealing with potential collapse of a global financial firm.

It isn’t that hard to do.

Right now people are sort of looking to you, and to Congress, to kind of break the back of unemployment. And you’ve talked about how that is really our biggest challenge right now. Do you feel there is anything else that can be done, or has the Fed shot all its bullets, and has Congress shot all its bullets?

Well, the Federal Reserve has been very aggressive on the unemployment side. So, let me just first say that even though the recession may be technically over., in a sense that the economy is growing, it’s going to feel like a recession for some time, because unemployment remains very high, about 10%. And even people who have jobs, there are many people who are on short hours, that are in voluntary part-time, or maybe people who are not technically unemployed, only because they stopped looking. So, the labor market is in very weak condition, and we’re not going to see a healthy, vibrant economy again until the labor market - the job market - has recovered. So, that is really an extraordinarily important objective for policy going forward. And, certainly, our job won’t be done until the economy is growing again, and jobs are being created.

The Federal Reserve’s attempts to address employment issues, we’ve done several things. Certainly, one of the things is we’re using our monetary policy. In December 2008, while the crisis was still in an intense phase, we cut the short-term interest rate that is the measure of our monetary policy almost to zero. The first time that had ever been the case, the Fed had ever done that, in order to provide the maximum amount of support to the economy, and it remains close to zero today. So, that is a very powerful measure.

Again, he gives no weight to the possibility that the interest income he removed from ’savers’ is weighing on the economy, even though it’s in his own paper from 2004.

Having used that tool to its maximum extent, we have then turned to new and innovative tools, things that have never been done before in the Federal Reserve. I’ll give you two examples. One, we’ve purchased about $1 trillion worth of mortgages that are guaranteed by Fannie Mae and Freddie Mac, and the U.S. Treasury. And in doing those purchases, we have succeeded in reducing the national 30-year fixed-rate mortgage rate from about 6-1/2% to about 4.8%. By lowering mortgage rates that way, we have helped to stabilize the housing sector, to help stabilize the housing crisis, and allow people to refinance, to buy homes. And that, obviously, should get construction started again and house prices stabilizing, and people being able to meet their mortgages. That’s obviously going to be helpful.

The far more effective way would be to directly fund the agencies at the fixed rate the Fed wanted for mortgages and allow that funding to be prepaid without penalty if the mortgages prepaid. But that was never even a consideration.

We’ve also created a program that helps bring credit from Wall Street to support a wide variety of consumer and small-business loans. So, for example, our program allows Wall Street money to come in and support auto loans, credit card loans, student loans, small business loans, commercial real estate loans. By providing that conduit, we are supporting what the banks are doing to get credit flowing into those important sectors.

But only the AAA pieces, as previously discussed.

And I guess a third thing, an additional thing I would mention is that we serve not only as monetary policy makers, but also as bank supervisors. And there we’ve been sparing no effort, as I talked about earlier, to get the banks able and willing to lend again, to create - particularly the small businesses - to create the credit that’s needed to create new jobs and get employment back on track.

I would mention, in particular, our leadership of the stress tests. In the spring, the Federal Reserve led an effort to evaluate the balance sheets of 19 of the largest banking companies in the U.S., and our report on those balance sheets, along with the FDIC, the OCC, to other banking agencies, our reports on those balance sheets is public, greatly increased the confidence in the banking system, which meant that they were able to go out and raise new capital in the stock market, and many of them have paid back the capital to the government.

Still no clue it was only regulatory forbearance.

But by raising new capital, they increased their own capacity to lend. And, as conditions improve, they’ll be able to make new loans as well.

So, by keeping interest rates low, including both short-term rates and long-term rates, like mortgage rates, by supporting a flow of credit to small businesses, consumers and the like, that is our primary effort. Those are the tools that we have. We can always do more, if necessary, but those are the tools that we are applying trying to get job growth going again.

They have more tools but aren’t using them? Unless this is a bluff, what are they waiting for? This is an extraordinary statement.

And we have seen, obviously, the labor market is still very weak, but the last report we saw shows that we’re now coming closer to the point where we’ll stop seeing job losses and start seeing job gains.

We’ve talked about a lot of those extraordinary things you’ve done. But is that it? Like now do we have to - because there’s still really bad numbers, even your forecasts are like what, 10% [unemployment] this year, 9% going forward, I think like 8% in 2012. Do we just have to kind of now sit back and take it?

Well, the Federal Reserve will continue to see what other policy actions we can take. And we’ve really been very aggressive, thus far. And the additional steps aren’t as obvious or clear as the ones that we’ve already taken.

Right, they don’t have any actual ideas.

A lot of the scope now is on the fiscal side of the house. As you know, the government passed a major fiscal program earlier this year, and I think it was just today the President announced a number of individual - a package of programs to try to address unemployment. So, [there are] a lot of new initiatives probably coming from the fiscal side.

While he preaches fiscal responsibility. See below.

Did they ask you for your opinion of those before…

Well, our staffs confer frequently with the Treasury and other parts of the Economic Advisory Groups that advise the President. And we often give our views. Our views are solicited. But, of course, they are responsible for their policy choices.

Have you said before, or are you prepared to say now, that a second stimulus, a round of incentives, is a good idea, on the fiscal side?

So, my domain is monetary policy and financial stability. And we have done, of course, a lot of aggressive things to try to support the economy, try to support job creation. I generally leave the details of fiscal programs to the Administration and Congress. That’s really their area of authority and responsibility, and I don’t think it’s appropriate for me to second guess.

You have said that there’s a long-term deficit program that needs to be dealt with. You said health care costs ought to be cut back, so it’s not like you won’t talk at all about the fiscal situation. Regardless of the details, which I understand that you don’t want to tell them how to do it, do you think that the fiscal side ought to do something?

Well, let me say this, I think that it’s very important that whatever actions that Congress and Administration take on the fiscal side, that they begin soon, or even sooner, to develop a credible medium-term interest strategy for fiscal policy, one that will persuade the markets and the public that over the medium term, the next few years, we will - we, as government, we, as a country - will be able to bring our deficits down to a level that could be sustained over a period of time.

Yes, he’s clearly part of the problem, not part of the answer. He’s failed to realize the ramifications of lifting convertibility in 1934 (and 1971 internationally) and is one of the leading deficit terrorists.

If we can do that, which will increase the confidence of the markets in American fiscal policy, that would give us more scope to take action today, because, again, there would be confidence that we have a way out, a way back towards sustainability.

There is no sustainability issue and he should know that. But he doesn’t even fully understand monetary operations of the Fed itself.

In your testimony the other day, one Senator talked about here’s the money that the federal government takes in, here’s what we spend on entitlements. It’s basically the same. Everything else we have to borrow for. I mean, there are a lot of people saying that it’s not sustainable, as you have said. And they said one of the only solutions is some kind of tax, a sales tax, value-added tax, something other than an income tax. But would you be in favor of any of those alternatives?

So, the way I put this before Congress before is that the one law that I strongly advocate is the law of arithmetic. (Laughter.) That law of arithmetic says that if you are a low-tax person, then you have to - you are responsible for finding ways on saving on expenditure, so that you don’t have enormous imbalances between revenues and spending. And by the same law of arithmetic, if you were somebody who believes that government spending is important, and you are for bigger and more spending, and bigger programs, then it’s incumbent upon you to figure out where the revenues are going to come from to meet that spending. So, again, I think that’s, again, Congress’ main responsibility.

I have spoken about deficit, and I think deficits are important, because they address broad economic and financial stability. We need to talk about that. But in terms of the specifics about how to get to fiscal balance, that’s the elected officials’ responsibility.

He sees spending as revenue constrained where that concept is entirely inapplicable to non convertible currency and floating fx policy.

Do you think Congress is fiscally illiterate? Economically illiterate?

No, of course not. But what they have to deal with is not just a question of understanding. It’s a question of making very, very tough choices, and in a political environment, where people understandably are resistant to cuts in programs or benefits, or increases of taxes. So, there needs to be tough choices made, there needs to be leadership. And I don’t envy Congress those choices, because they’re very difficult ones to make.

Are you saying that time for fiscal and monetary stimulus is over? And, if so, what’s the downside of pushing even harder?

There are not easy solutions. It’s an enormous problem. I think the Federal Reserve - one direction that we can go is to continue to encourage the extension of credit, small businesses, in particular, create a lot of jobs, particularly during economic recoveries. And we have lots and lots of evidence and anecdotes suggesting that small businesses are particularly harmed by the tightness of the bank lending standards and unavailability of credit. So, everything we can do, and that the Administration and Congress can do, to support credit extension to all business, but primarily small business, would be a very powerful.

You don’t think it’s a liquidity problem?

Well, I mean, interest rates are very low, so I think it’s going to be a question, first of all, of getting credit flowing again. And the Federal Reserve has got a role to play there. And then, Congress and the Administration will consider possible programs and fiscal policies.

You’re definitely not okay with long-term profligacy, but are you okay with them doing something in the short-term?

I think if they do that, it’s critically important they clarify the longer-term plan for establishing sustainable fiscal [policy].

Again ducking the question. But it’s clear he is not a supporter of using fiscal adjustments to sustain aggregate demand.

Adair Turner, the chief British [financial services] regulator, said that we’ve learned that much of what the financial services sector did in the past 10 years has no economic or social value. Do you agree? Did the financial services sector just get too big, and should it be smaller?

Okay. Well, a strong financial system is very important. It allocates capital to new businesses and new industries. It allows for people to invest in a wide range of activities, so it’s critically important to have a good financial system. And the evidence for that is that when the financial system breaks down, the system just doesn’t function.

That is not evidence for that. Seems a breakdown of logic???

You see what the impact has had on the economy. With that being said, the financial system is unique to the extent, first, that it is so critical to the economy, and, secondly, to the very, very old tendency to succumb to booms and busts.

Again, this is too confused to not be an insight into his basic sense of logic.

And, therefore, we do need to have an effective comprehensive financial regulatory system that will essentially allow us to tame the beast so that it provides the benefits, the growth and development without creating these kinds of crisis.

And then this says it all regarding his understanding of monetary operations:

Okay. When the Federal Reserve buys mortgages, it pays for them by creating reserves the banks hold in Federal Reserve. So, as we purchase $1 trillion of mortgages, we’ve created roughly $1 trillion of reserves that banks hold at the Federal Reserve. The banks, at this point, are just willing to hold those reserves with the Fed, and not do anything with them.

Banks don’t ‘do anything’ with reserves.

Ultimately, if the economy normalized, and the Fed took no action, the banks would take those reserves, try to lend them out, and they would begin to circulate, and the money supply would start to grow.

Banks don’t ‘lend out’ reserves.

And then, ultimately, that would create an inflationary risk.

This is not how it works.

So, therefore, as the economy begins to recover, and as we move away from this very weak economic environment, the Federal Reserve is going to have to pull those reserves out of the system.

We have a number of means for doing that, which we have explained to the markets, and the public, and everyone is confident we can do that. And we will do that over time, in order to make sure that as we come out of this crisis, we don’t generate inflation at the end.

Reserve management has nothing to do with inflation with a non convertible currency and floating fx. This is ancient gold standard rhetoric.

So, the reserves can be pulled out through various mechanisms or can mobilize. And we don’t have to do that yet, but when the time comes, we have tools to do that.

And are there lurking dangers in those mortgages that you purchased that we don’t even know about now?

Well, the mortgages are guaranteed. The credit, even if they go bad, Fannie and Freddie with the backing of the U.S. Treasury will pay them off, so the Fed is not taking any credit risk by holding these mortgages.

It’s comforting for you, but not for the taxpayers. Right?

Well, on the other hand, what’s happening is that we earn the interest from those mortgages, and then we remit that interest back to the Treasury, so the money finds its way back to the taxpayer.

That’s exactly how the Fed’s portfolio removes interest income from the private sectors.

And, indeed, the Federal Reserve will be paying the Treasury a good bit more money the next few years than it has in the past, because of the interest we’re earning on these mortgages we acquired.

On that note, this week we did learn the TARP is going to pay back nearly all of what it was required to from the taxpayer. Looking back a year later, are surprised by that?

Well, we said at the beginning that the TARP money was an investment. It was going to acquire assets, and that most or all might come back to the taxpayer. Right now, if you look at all these repayments from banks, and the fact that the government is sitting on capital gains, as well as other investments, I think it’s a reasonable probability that the TARP money invested in financial institutions, that the great majority of it will come back to the taxpayer. So, in the end, we will have stabilized the financial system and avoided this global crisis at not a small amount of money, but relative to the alternative, a quite small amount of money.

Were there days where you woke up and you thought, what am I not thinking of that we could be doing?

We had a philosophy right here, which was what we called blue-sky thinking. And what blue-sky thinking was, was we have a problem, I want everybody to give me just three associations. What can you think of? How can we approach this, what can we do? And we’ll worry about getting rid of the silly answers later. So, there’s been a lot of creativity here, and I give credit to terrific staff . I think one of the lessons of the depression, and this is something that Franklin Roosevelt demonstrated, was that when orthodoxy fails, then you need to try new things. And he was very willing to try unorthodox approaches when the orthodox approach had shown that it was not adequate.

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Proposals for the Banking
System, Treasury, Fed, and FDIC (draft)

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ECB’s Stark Says Economy May Recover Sooner Than Forecast

Stark Says State Debt May Boost Long-Term Market Rates, BZ Says

*ECB’S STARK SEES `NO BIG PROBLEMS’ UNWINDING ASSET PURCHASES

*ECB’S STARK COMMENTS IN INTERVIEW WITH BOERSEN-ZEITUNG

*ECB’S STARK SAYS RISING GOVT DEBT MAY BOOST LONG-TERM MKT RATES

*STARK SAYS ECB CONSIDERS RISK OF DEFLATION `VERY SMALL’

*ECB’S STARK SAYS MUST NOT OVERESTIMATE SIZE OF OUTPUT GAP

Higher levels of unemployment will be needed for long term price stability

*ECB’S STARK SAYS POTENTIAL GROWTH RATE HAS PROBABLY DECLINED

Higher levels of unemployment will be needed for price stability

*ECB’S STARK SAYS OUTPUT GAP MAY BE SMALLER THAN SOME THINK

Higher levels of unemployment will be needed for price stability.

*ECB’S STARK SAYS MUST BE CAUTIOUS ABOUT INFLATION OUTLOOK

*STARK: STIMULUS, INVENTORIES WON’T CREATE SUSTAINABLE GROWTH

*ECB’S STARK SAYS ECONOMY MAY RESUME GROWTH SOONER THAN EXPECTED

*ECB’S STARK SEES SIGNS ECONOMY IS STABILIZING

*ECB’S STARK SAYS RATES ARE `APPROPRIATE’

Karim writes:

Stark is also engaging in classic Fed bashing; knowing full-well that the output gap is the key driver of the Fed’s inflation model while the ECB looks at a broader series of measures and places much more emphasis on monetary aggregates

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Dollar Is Dirt, Treasuries Are Toast, AAA Is Gone

by Mark Gilbert

May 21 (Bloomberg) —

The odds on the dollar, Treasury
bonds and the U.S. government’s AAA grade all heading for the
dumpster are shortening.

True, but for the wrong reason. There is no solvency issue, but markets are pricing it in anyway.

While currency forecasting is a mug’s game and bond yields
can’t quite decide whether to dive toward deflation or surge in
anticipation of inflation, every time I think about that credit
rating, I hear what Agent Smith in the “Matrix” movies called
“the sound of inevitability.”

Several policy missteps suggest that investors should stop
trusting — and lending to — the U.S. government. These include
the state’s pressure on Bank of America Corp. to buy Merrill
Lynch & Co.; the priority given to Chrysler LLC’s unions over
the automaker’s secured creditors; and the freedom that some
banks will regain to supersize executive bonuses by giving back
part of the government money bolstering their balance sheets.

When you buy treasury securities the government debits your transaction account and credits your securities account at the Fed.

When those securities mature the government debits your securities account and credits your transaction account. That is all there is too it.

There is no solvency issue at the operational level

Currency markets have been in a weird state of what looks
almost like equilibrium for the past couple of months. What’s
really going on is something akin to an evenly matched tug of
war that fails to move the ribbon tied around the center of the
rope, giving the impression of harmony while powerful forces do
silent battle until someone slips.

“All currencies are being debased dramatically by their
central banks at extraordinary speeds and so in relative terms
it appears there is no currency problem,” Lee Quaintance and
Paul Brodsky of QB Asset Management said in a research note
earlier this month. “In reality, however, paper money is highly
vulnerable to a public catalyst that serves to acknowledge it is
all merely vapor money.”

The ‘value’ is the purchasing power of real goods and services.
The largest and deepest thing for sale is labor.
Seems like currency still buys labor at pretty much the same price as the recent past,
And maybe even a bit more.

In fact, it may buy a bit more of just about everything vs a year ago. Particularly houses and land.

But yes, next year can always bring a different story.

Flesh Wounds

Why pick on the dollar, though? Well, not necessarily
because the U.S. economy is in worse shape than those of the
euro area, the U.K. or Japan. The biggest problem is that
external investors — particularly China — have more skin in
the dollar game than in euros, yen or pounds, which makes the
U.S. currency the most likely candidate to meet the cleaver in a
crisis of confidence about post-crunch government finances.

China owns about $744 billion of U.S. Treasury bonds in its
$2 trillion of foreign-exchange reserves.

Chinese exports, though, are dropping as the global economy
weakens, with overseas shipments declining 23 percent in
April from a year earlier, leaving a nation that has already
expressed concern about its U.S. investments with less to spend
in future.

China doesn’t ’spend’ it’s dollars on real goods and services which is why they
Have a trade surplus in the first place.

They sold things in exchange for ‘dollar balances’ which are financial assets and
then exchanged some of those balances for alternative USD financial assets as they
accumulated $744 billion of financial assets.

‘Heavy Hand of Government’

Those kinds of concerns are starting to surface in a
steepening of the U.S. yield curve, driven by an increase in 10-
and 30-year U.S. Treasury yields.

True, though there is no economic imperative for the treasury to issue a 30 year security in the first place.

In fact, the treasury issuing securities and the Fed later buying them is functionally identical to the treasury never issuing them in the first place.

(note that Charles Goodhart of the Bank of England has recently been proposing the UK do exactly that- cease issuing long securities rather than issuing them and having the BOE buy them.)

The 10-year note currently
yields 3.23 percent, about 235 basis points more than the two-
year security, which marks a near doubling of the spread since
the end of last year.

Yes, though from very low flight to quality yields at the height of the fear of oblivion.

“When the government parks its tanks on capitalism’s
lawns, that spells trouble for those who invest, add value and
create jobs,” says Tim Price, director of investments at PFP
Wealth Management in London. “Trillion-dollar bailouts do not
only leave massive public-sector deficits in their wake, they
also leave the presence of the heavy hand of government all over
industry and markets, so the outlook for government bonds is
less promising than the economic textbooks on deflation would
have us believe.”

A totally confused chain of logic, though government does often reduce shareholder value when it intervenes. But that’s a different point.

Earlier this month, the U.S. reported the first budget
deficit for April in 26 years, with spending exceeding revenue
by $20.9 billion, even though that’s the month when taxpayers
have to stump up to the Internal Revenue Service and the
government’s coffers should be overflowing. So far this fiscal
year, the U.S. shortfall is $802.3 billion, more than five times
the $153.5 billion gap in the year-earlier period.

Those are the ‘automatic stabilizers’ at work, which, fortunately, are out of the hands of
Congress. While they work the ugly way- falling employment and rising transfer payments- they do work to restore net financial assets to the private, non government sectors and thereby reverse the contraction.

Budget deficits = non govt ’savings’ of financial assets
To the penny
It’s even an accounting identity. Not theory. Ask anyone at the CBO.

Deathly Deficit

For the fiscal year ending Sept. 30, the Congressional
Budget Office forecasts a record deficit of $1.75 trillion,

That includes the purchase of financial assets which doesn’t add to aggregate demand.

Up until now the fed has always bought the financial assets when government wanted to do that and that hasn’t ‘counted’ as deficit spending for exactly that reason.

This time around the treasury bought financial assets and confused things, much like 1936 when social security first started and was accounted for off budget rather than consolidated as we quickly figured out was the right way to do it and it’s fortunately been done that way ever since.

almost four times the previous year’s $454.8 billion shortfall
and about 13 percent of gross domestic product. Bear in mind
that the target demanded of European nations wanting to join the
euro was a deficit no greater than 3 percent of GDP.

Yes, which is responsible for their poor economic performance as well.

David Walker, a former U.S. comptroller general,

And foremost US deficit terrorist

wrote in
the Financial Times on May 12 that the U.S.’s top credit rating
looks incompatible with “an accumulated negative net worth” of
more than $11 trillion and “additional off-balance-sheet
obligations” of $45 trillion. “One could even argue that our
government does not deserve a triple A credit rating based on
our current financial condition, structural fiscal imbalances
and political stalemate,” he wrote.

As if government payments are operationally constrained by revenues.

They are not, as chairman Bernanke made clear a few weeks ago
when he explained how he makes payments by changing numbers in bank accounts.

That is the only way there is for government to spend in its own currency, which
is nothing more than the process of making spread sheet entries on its own books.

Any constraints on the US ability to make payments in dollars is necessarily self imposed (and
can just as readily be removed by those wanting to spend the money.)

Said another way, government checks don’t bounce unless government decides to bounce its own checks.

If you want to claim govt won’t pay because it will vote not to pay, fine.

But not because ‘deficits can’t be financed’ or any other nonsense like that.

No Default

It is undeniable that the U.S. government’s ability to
finance its borrowing commitments has deteriorated as its
deficit has ballooned.

The ability to deficit spend is the ability to make entries on its own spreadsheets.
Nothing more.
The idea that that can ‘deteriorate’ indicates a fundamental lack of understanding of monetary operations.

Dropping the U.S. from the top rating
grade, though, wouldn’t mean the nation is about to default on
its debt obligations; there’s a subtle distinction between
ability to pay and propensity to fail to pay.

And a less subtle distinction between knowing how it works and not knowing how it works.

There’s also a
compelling argument that no government should be enjoying the
benefits of a top credit grade in the current financial climate.

There’s nothing to ‘enjoy’ or even care about.

Note Japan was heavily downgraded with a debt to GDP ratio triple the US,
With no ill effects as three month rates remained near 0 for the last
15 years and 10 year Japanese govt bonds fluctuated between .5 and 1.5%

Using the definitions outlined by Standard & Poor’s, a one-
step cut into the AA rated category would nudge the U.S.’s
creditworthiness into a “very strong” capacity to fulfill its
commitments, just weaker than the “extremely strong”
capabilities demanded of AAA rated borrowers.

S&P cannot change the actual creditworthiness of the US, or any other
issuer of its own currency. There can be no solvency issue no matter what they do.

That seems an
appropriately nuanced sanction — albeit one that the rating
companies might turn out to be too cowardly to impose.

(Mark Gilbert is a Bloomberg News columnist. The opinions
expressed are his own.)

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• Producer Price Index MoM (Released 8;30 EST)
• Producer Price Index YoY (Released 8:30 EST)
• PPI Ex Food & Energy MoM (Released 8:30 EST)
• PPI Ex Food & Energy YoY (Released 8:30 EST)
• Initial Jobless Claims (Released 8:30 EST)
• Continuing Claims (Released 8:30 EST)
• Jobless Claims ALLX (Released 8:30 EST)

Producer Price Index MoM (Mar)

Karim writes:

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Producer Price Index YoY (Mar)

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PPI Ex Food & Energy MoM (Mar)

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PPI Ex Food & Energy YoY (Mar)

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Initial Jobless Claims (May 1)

Karim writes:

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Continuing Claims (May 1)

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Jobless Claims ALLX (May 1)

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UN Panel says world should ditch dollar

by Jeremy Gaunt

Mar 18 (Reuters) — A United Nations panel of experts

Who don’t understand how monetary systems work….

will recommend next week that the world move away from using the dollar as a reserve currency and adopt a shared basket of currencies instead, one of its members said on Wednesday.

Avinash Persaud, chairman of consultants Intelligence Capital and a former currency chief at JPMorgan, said the proposal was to create something like the old Ecu, or European currency unit, that was a hard-traded, weighted basket.

“It is a good moment to move to a shared reserve currency,” he told the Reuters Funds Summit in Luxembourg.

He doesn’t either.

The United States, he said, was finding it hard to manage policy while remaining the reserve currency and the rest of world was also unhappy with the generally declining dollar.

Persaud said the recommendation would be one of a number delivered to the United Nations on March 25 by the U.N. Commission of Experts on International Financial Reform.

More of the blind leading the blind.

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It all still looks very, very weak. But so low that even small improvements will show high % gains.

• MBA Mortgage Applications (Released 7:00 EST)
• MBA Purchasing Applications (Released 7:00 EST)
• MBA Refinancing Applications (Released 7:00 EST)
• Challenger Job Cuts YoY (Released 7:30 EST)
• Challenger Job Cuts TABLE 1 (Released 7:30 EST)
• Challenger Job Cuts TABLE 2 (Released 7:30 EST)
• Challenger Job Cuts TABLE 3 (Released 7:30 EST)
• Challenger Job Cuts TABLE 4 (Released 7:30 EST)
• ADP Employment Change (Released 8:15 EST)
• ADP ALLX (Released 8:15 EST)
• RPX Composite 28dy Index (Released 9:00 EST)
• RPX Composite 28dy YoY (Released 9:00 EST)
• ISM Non Manufacturing Composite (Released 10:00 EST)

MBA Mortgage Applications (Feb 27)

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MBA Purchasing Applications (Feb 27)

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MBA Refinancing Applications (Feb 27)

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Challenger Job Cuts YoY (Feb)

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Challenger Job Cuts TABLE 1 (Feb)

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Challenger Job Cuts TABLE 2 (Feb)

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Challenger Job Cuts TABLE 3 (Feb)

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Challenger Job Cuts TABLE 4 (Feb)

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ADP Employment Change (Feb)

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ADP ALLX (Feb)

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RPX Composite 28dy Index (Dec)

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RPX Composite 28dy YoY (Dec)

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ISM Non Manufacturing Composite (Feb)

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The World Won’t Buy Unlimited US Debt

by Peter Schiff

Jan 23 (Wall Street Journal) — Barack Obama has spoken often of sacrifice. And as recently as a week ago, he said that to stave off the deepening recession Americans should be prepared to face “trillion dollar deficits for years to come.”
But apart from a stirring call for volunteerism in his inaugural address, the only specific sacrifices the president has outlined thus far include lower taxes, millions of federally funded jobs, expanded corporate bailouts, and direct stimulus checks to consumers. Could this be described as sacrificial?

No. Good point! Why should utilizing idle resources be sacrificial?

It’s only during times of scarcity does ’sacrifice’ come into play.

What he might have said was that the nations funding the majority of America’s public debt — most notably the Chinese, Japanese and the Saudis — need to be prepared to sacrifice.

They already have been and want to continue net exporting to the US.

That is true sacrifice, and they are begging to be allowed to continue doing it.

They have to fund America’s annual trillion-dollar deficits for the foreseeable future.

No, we have funded their savings.

These creditor nations, who already own trillions of dollars of U.S. government debt, are the only entities capable of underwriting the spending that Mr. Obama envisions and that U.S. citizens demand.

No, they push to get to the front of the line to accumulate USD financial assets as part of their desire to net export (sacrifice) to the US.

These nations, in other words, must never use the money to buy other assets or fund domestic spending initiatives for their own people.

Yes, it’s better for us if they don’t. But they can at any time. And lucky for us they don’t want to.

When the old Treasury bills mature, they can do nothing with the money except buy new ones. To do otherwise would implode the market for U.S. Treasurys (sending U.S. interest rates much higher)

Maybe.

and start a run on the dollar. (If foreign central banks become net sellers of Treasurys, the demand for dollars needed to buy them would plummet.)

Only if they sell USD for other currencies, or spend those USD here.

And if the dollar goes down, so what? While it’s not my first choice to enact policy that causes the dollar to go down for other reasons, it does not alter the real wealth of the US.

Real wealth= everything produced domestically plus everything imported minus everything exported.

Exports are always a cost, imports a benefit.

In sum, our creditors must give up all hope of accessing the principal, and may be compensated only by the paltry 2%-3% yield our bonds currently deliver.

And if they never spend the USD interest earned is of no real consequence either.

As absurd as this may appear on the surface, it seems inconceivable to President Obama, or any respected economist for that matter, that our creditors may decline to sign on.

You would think they would have realized net exports hurt them long ago. But as of today they are still clawing and biting to increase net exports.

And, worse yet, our fearless leaders are trying to reverse that and balance of trade account.

Their confidence is derived from the fact that the arrangement has gone on for some time, and that our creditors would be unwilling to face the economic turbulence that would result from an interruption of the status quo.

No, they do it to support their export industries that have disproportionate political clout, supported by international mainstream economics that praises exports and condemns imports.

But just because the game has lasted thus far does not mean that they will continue playing it indefinitely.

Agreed! But we should strive to continue it, not strive to end it.

Thanks to projected huge deficits, the U.S. government is severely raising the stakes. At the same time, the global economic contraction will make larger Treasury purchases by foreign central banks both economically and politically more difficult.

No, it makes it more urgent, as they have no instinct to increase their domestic demand, but instead focus on supporting their exports.

The root problem is not that America may have difficulty borrowing enough from abroad to maintain our GDP, but that our economy was too large in the first place. America’s GDP is composed of more than 70% consumer spending.

Pretty normal. The entire point of any economy is consumption. The rest is investment which represents a down payment on future consumption.

For many years, much of that spending has been a function of voracious consumer borrowing through home equity extractions (averaging more than $850 billion annually in 2005 and 2006, according to the Federal Reserve) and rapid expansion of credit card and other consumer debt. Now that credit is scarce, it is inevitable that GDP will fall.

Yes, but because government doesn’t understand its role in sustaining domestic demand.

Neither the left nor the right of the American political spectrum has shown any willingness to tolerate such a contraction. Recently, for example, Nobel Prize-winning economist Paul Krugman estimated that a 6.8% contraction in GDP will result in $2.1 trillion in “lost output,” which the government should redeem through fiscal stimulation. In his view, the $775 billion announced in Mr. Obama’s plan is two-thirds too small.

Agreed!

Although Mr. Krugman may not get all that he wishes, it is clear that Mr. Obama’s opening bid will likely move north considerably before any legislation is passed. It is also clear from the political chatter that the policies most favored will be those that encourage rapid consumer spending, not lasting or sustainable economic change. So when the effects of this stimulus dissipate, the same unbalanced economy will remain — only now with a far higher debt load.

There is no reason for fiscal balance to ‘dissipate’ but instead can be continually altered to support aggregate demand/output/employment.

Currently, U.S. citizens comprise less than 5% of world population, but account for more than 25% of global GDP. Given our debts and weakening economy, this disproportionate advantage should narrow. Yet the U.S. is asking much poorer foreign nations to maintain the status quo, and incredibly, they are complying. At least for now.

We aren’t asking them to export to us, they are demanding the right to export to us.

You can’t blame the Obama administration for choosing to go down this path. If these other nations are giving, it becomes very easy to take.

In fact, foolish not to.

However, given his supposedly post-ideological pragmatic gifts, one would hope that Mr. Obama can see that, just like all other bubbles in world history, the U.S. debt bubble will end badly. Taking on more debt to maintain spending is neither sacrificial nor beneficial.

He misses the point. There is no financial risk to government ‘debt’, only the risk of inflation.

Government continuously has the option to sustain domestic demand and no reason not to do so apart from deficit myths and a lack of understanding of our monetary system.

Mr. Schiff is president of Euro Pacific Capital and author of “The Little Book of Bull Moves in Bear Markets” (Wiley, 2008).

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• Euro Area Sector Analysis (Released n/a EST)
• US Sector Analysis (Released n/a EST)
• Japan Fiscal Balance as % of GDP (Released n/a EST)

Euro Area Sector Analysis (Dec 17)

 
Karim writes:
Euro-middle of historical range. But with government deficits nearing Maastricht limits (though those limits will be bent, it will be grudging), not much chance for large enough fiscal stimulus to make a difference to private demand.

Yes, deficits seem too small to support higher levels of output and employment.

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US Sector Analysis (Dec 17)

 
Karim writes:
U.S.-still far below peak of early 90s. Nearing levels of earlier this decade, but much private demand growth in recent years fueled by credit (unlikely to be repeated, certainly not to same extent).

Yes, we are still paying the price for allowing the budget to go into surplus. The deficit needs to be substantially higher to restore output and employment, to ‘make up’ for the surplus years that drained the financial equity needed to support the credit structure.

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Japan Fiscal Balance as % of GDP (Dec 17)

 
Karim writes:
Japan-well off recent peaks, in some part due to some fiscal tightening in recent years. Fiscal policy starting to be loosened, but private savings still have ways to go to get back to levels that were associated with the moderate period of domestic demand growth from 2003-2006.

Yes, and with their higher propensity to not spend income they require a higher deficit to sustain output and employment.

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Securitized Products Weekly Update: 12/22/08

Overview

Securitized products continued to have a positive tone last week assisted by momentum from FOMC announcements. The RMBS sector benefited the most in hopes that aggressive downward pressure on mortgage rates will increase prepay speeds (thus enhancing yields in a deeply discounted market). CMBS shorter pays and junior AAAs firmed on the week along with more seasoned super dupers.

CMBS/X

• CMBS cash continued to stabilize (from violent Nov swings) last week on lighter flows, with shorter pay A1-A3 supers and AM/AJ classes tightening the most and LCF’s (Last Cash Flow classes) firm but generally unchanged
• LCF’s trading around +950 (~$70 price; 12% yield) although the market is becoming more bifurcated between deals considered to be safer and those perceived to have real credit risk; the trading range between the most/least desirable ‘07 LCF’s is now in the 350bps range
• Non-super AAAs seeing renewed buying interest; AMs were up another 5-6 pts week-over-week now trading in hi 40s
• The market is taking increased note of relative value in shorter pay A1-A3 classes, as those classes tightened 50-75bps on the week
• CMBX.AAA.4 tightened 77 bps on the week on relatively light flows and profit taking
• The street reports spending increasing efforts to educate opportunity funds interested in CMBS; appx 25% have started buying and 75% still completing due diligence
• Fitch reports that CRE loan delinquencies (held in CRE CDOs) declined from Oct to Nov from 3.1% to 2.8% as a result of increasing loan extensions being granted
• Centro, distressed Australian retail REIT who levered up to buy U.S. shopping centers, averted bankruptcy by transferring 90% ownership control to lenders in exchange for loan extensions on maturing debt
• GGP, a major U.S. mall REIT, was able to extend maturing secured loans in exchange for lender concessions
• Both the Centro and GGP situations reflect lenders reluctance to foreclose/liquidate in this market and indicate that more extensions/modifications are likely for maturing CRE (commercial real estate) loans that cannot be refinanced
• Market chatter about the Federal Reserve possibly buying CMBS directly in secondary markets continues to get some press
• JPM liquidated a portfolio of CMBS securities on margin from Guggenheim, a levered CRE strategy fund and large TRS player
• CMBS market tone improving and feels like it will be better bid after the turn, although the fact that new loan origination remains in a deep freeze is of concern

RMBS

• RMBS continued to rally this week, Jumbo and Alt A super seniors were up 3-5 pts and Option ARMs were up 2 points
• ABX 06 AAAs were up 2-4 pts and 07 AAAs were up 4-5 post FOMC moves and the government’s stated objective of driving down mortgage rates
• Optimism in RMBS was sparked by hopes that lower mortgage rates will drive faster prepay speeds as the non-agency market presently prices to rock-bottom CPR assumptions
• Both ML and JPM announced buy recommendations on non-agency AAA MBS based upon assessments that increasing traction from aggressive federal actions will accelerate the bottoming of the housing market and mitigate the risk of an over-correction on the downside
• Affordability in a number of MSAs has now fully corrected to pre-bubble levels and lower mortgage rates will speed up the process across all markets
• Although affordability metrics have improved and will further benefit from lower mortgage rates, rising unemployment will be a major headwind
• Although mortgage modification efforts have yet to show results, the market senses a growing conviction on the part of the new administration to aggressively pursue mortgage modifications that will entail removing loans from securitized pools and encouraging principal reductions
• JPM expects bottoming of house pricing to now occur in mid-09, escalating this timeframe from a prior expectation of 1H10
• Citi is aggressively buying Option ARM super seniors and effectively setting market levels for this sector
• Housing starts dropped to the lowest level in 50 years
• JPM is advocating buying RMBS AAA Mezz trading in the $30s as it has the greatest convexity upside to increased mods/prepays
• ML/Citi issued buy recommendations on super senior Option ARMs and certain Alt A AAA structures
• Although most government actions have been initially directed towards improving conforming mortgage markets, non-agency RMBS is expected to become the beneficiary of 2009 actions expected to focus on foreclosure forbearance and more aggressive modification/principal writedowns

Credit Cards/Autos

• Better tone to ABS market at higher-end of credit stack although flows were generally light and domestic Auto ABS continues to struggle
• New Unfair or Deceptive Acts or Practices (”UDAP”) legislation passed will increase regulatory cost to card issuers but will have no significant adverse impact on profitability or trading levels
• Some additional TALF details were announced including a term extension from one to three years; since TALF will only apply to newly issued ABS, it is likely to create a bifurcated market between TALF eligible and non-eligible ABS; TALF rate and haircut terms have yet to be announced
• The BACCT (BofA) Credit Card Master Trust began trapping excess spread at the C class (BBB) level, prompting Card mezz classes to widen 50-75bps on the week
• JPM significantly enhanced the WAMU Credit Card Master Trust by swapping out $6B of weaker accounts for stronger accounts
• Although Nov results showed card charge-offs increased ~20bps to 6.7%, this was more than offset by margin improvement from declining Libor which boosted overall excess spread to 6.0%, up from 4.3% in Oct
• Many synthetic CDOs invest note issuance proceeds in AAA credit card ABS due to cards historic ratings stability and available liquidity; liquidations of synthetic CDOs continues to adversely impact AAA card technicals as more AAA classes are forced back into the market
• Auto ABS was buffeted by news highlighting rapid deterioration at GM and Chrysler and culminated with an announced bridge loan to get them over the turn
• Independents and foreign issuer shelves continue to outperform domestic Auto ABS
• Volkswagen was able to issue a new $1B ABS transaction last week; 1 year AAAs came at L+350

CDO/CLO

• Little trading activity last week. BWIC with a AAA CRE CDO bond was talked in single digits (although didn’t trade) reflecting the rating agencies unwillingness to downgrade AAA CRE CDO paper. Market consensus on the bond was that there was little likelihood for any return of principal
• Moody’s cautioned today that it will be reviewing their ratings on 109 CRE CDOs. AAAs may be downgraded 2-6 notches (4-8 notches on lower rated tranches). Moody’s expects to complete their review by Feb 09
• JPM has been a large buyer of super senior AAA CLO paper the last few weeks. Huge OWICs over the last few weeks in 450a for high quality managers, which is about 100bps tighter than where BWICs had been trading. Current count has JPM adding $1.1BN to their $14BN AAA CLO exposure
• A large wave of S&P downgrades on high yield loans last week threaten to trigger OC test failures in CLOs. Failure of OC tests results in cash flows being redirected from mezz class to senior note holders
• S&P announced that they are reviewing the assumptions used to model CLOs and placed many mezz classes on negative watch over the last few weeks. BBB/BB classes are expected to be most impacted

Securitized Products

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FACTBOX: What is quantitative easing?

Tue Dec 16, 2008 3:30pm EST

NEW YORK (Reuters) - The Federal Reserve on Tuesday cut its target for overnight interest rates to zero to 0.25 percent, bringing it closer to unconventional action to lift the economy out of a year-long recession.

“The message is they’re instituting quantitative easing on a fairly large scale,” said Doug Roberts, chief investment strategist at Channel Capital Research.com.

Under quantitative easing, central banks flood the banking system with masses of money to promote lending.

Central banks exchange non or low interest bearing assets- reserve balances- for longer term higher yielding securities.

Since lending is in no case ‘reserve constrained’, the ‘extra’ reserves do nothing for lending.

The purchase of the longer dated securities results in lower longer term rates than otherwise. The lower borrowing rates may or may not alter aggregate demand.

The lower rates for savers definitely lowers aggregate demand.

They usually do this when lowering official interest rates no longer is effective because they already are at or near zero.

True!

The central banks add cash by buying up large quantities of securities — government debt, mortgages, commercial loans, even stocks — from banks’ balance sheets,

Yes.

giving them plenty of new money to lend.

No, they already and always have infinite ‘money to lend’.

Available funds are not a constraint for the banking system.

The constraints are regulated asset quality and capital requirements that are expressed in the rates bank charge.

Not the total quantity of funds available.

It is a tool used by Japan earlier this decade to combat deflation and stimulate the economy.

Didn’t work then either. It was fiscal policy that kept them afloat, though not a large enough deficit to sustain output at full employment levels.

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Karim writes:

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(email exchange)

Thanks, this is yet another example of the WSJ publishing and thereby promoting authors with no understanding of monetary operations, which means the WSJ editors don’t have any either.

Feel free to send this along the the WSJ with your own introductory comments as well!

>   
>   This is a well written piece, by Mr. Wood of CLSA.
>   

I respectfully don’t agree.

>   
>   He has long maintained a bearish bias which comes through in the
>   article. The points he raises I believe are cogent and logical and ones I
>   have addressed as well over recent days and months.
>   

It doesn’t seem you understand monetary operations either.

>   
>   The end of the article discussing gold I found to be particularly of
>   interest.
>   

The Fed Is Out of Ammunition: A Discredited Dollar Is a Likely Outcome of the Current Crisis

By Christopher Wood

With an estimated $4 trillion in housing wealth and $9 trillion in stock-market wealth destroyed so far in the United States, there is little doubt that we are witnessing a classic debt-deflation bust at work, characterized by falling prices, frozen credit markets and plummeting asset values.

Yes, as well as fiscal automatic stabilizers working their way to the rescue as always.

Those who want to understand the mechanism might ponder Irving Fisher’s comment in 1933: When it comes to booms gone bust, “over-investment and over-speculation are often important; but they would have far less serious results were they not conducted with borrowed money.”

Irv was writing in the context of the gold standard of the time, and that did very well.

But it’s inapplicable with today’s non convertible currency and floating FX.

The growing risk of falling prices raises a challenge for one of the conventional wisdoms of the modern economics profession, and indeed modern central banking: the belief that it is impossible to have deflation in a fiat paper-money system.

You can easily have deflation if the deficit is allowed to get and remain too small.

Yet U.S. core CPI fell by 0.1% month-on-month in October, the first such decline since December 1982.

Pull back in commodity prices mainly, after a long run up, but yes, for now the moment the outlook is deflationary.

The origins of the modern conventional wisdom lies in the simplistic monetarist interpretation of the Great Depression popularized by Milton Friedman and taught to generations of economics students ever since. This argued that the Great Depression could have been avoided if the Federal Reserve had been more proactive about printing money.

On the gold standard this might have worked, though it would have meant the need to rapidly devalue the conversion rate which would have considered a government default. And this did happen.

Today it is inapplicable with non convertible currency and floating FX.

Yet the Japanese experience of the 1990s — persistent deflationary malaise unresponsive to near zero-percent interest rates — shows that it is not so easy to inflate one’s way out of a debt bust.

Doesn’t show that at all. Just shows the depth of their reluctance to use sufficient deficit spending to restore output and employment via increased domestic demand. They want to be export driven and have paid the price for a long time.

In the U.S., the Fed can only control the supply of money;

No, it only can control the term structure of risk free interest rates.

it cannot control the velocity of money or the rate at which it turns over.

True.

The dramatic collapse in securitization over the past 18 months reflects the continuing collapse in velocity as financial engineering goes into reverse.

By identity.

True, this will change one day. But for now, the issuance of nonagency mortgage-backed securities (MBS) in America has plunged by 98% year-on-year to a monthly average of $0.82 billion in the past four months, down from a peak of $136 billion in June 2006. There has been no new issuance in commercial MBS since July. This collapse in securitization is intensely deflationary.

Yes, though offset by increased government deficit spending, increased export revenues (for a while), and increased direct lending by banks to hold in portfolio (which is how it was all done in not so distant past cycles).

It is also true that under Chairman Ben Bernanke, the Federal Reserve balance sheet continues to expand at a frantic rate, as do commercial-bank total reserves in an effort to counter credit contraction.

In an effort to lower rates and thereby counter credit contraction.

Thus, the Federal Reserve banks’ total assets have increased by $1.28 trillion since early September to $2.19 trillion on Nov. 19. Likewise, the aggregate reserves of U.S. depository institutions have surged nearly 14-fold in the past two months to $653 billion in the week ended Nov. 19 from $47 billion at the beginning of September.

So??? Just entries on a government spread sheet with no further ramifications.

But the growth of excess reserves also reflects bank disinterest in lending the money.

So?

This suggests the banks only want to finance existing positions, such as where they have already made credit-line commitments.

Banking is necessarily pro cyclical- get over it!

Monetarist Bernanke and others blame Japan’s postbubble deflationary downturn on policy errors by the Bank of Japan.

Not me. It was the lack of sufficient deficit spending, as above.

But he and others are about to find out that monetary gymnastics are not as effective as they would like to think. So too will the Keynesians who view an aggressive fiscal policy as the best way to counter a deflationary slump. While public-works spending can blunt the downside and provide jobs, it remains the case that FDR’s New Deal did not end the Great Depression.

Mixing metaphors. The New Deal’s deficit spending was far too small to restore output and employment.

There are no easy policy answers to the current credit convulsion and intensifying financial panic — not as long as politicians and central bankers are determined not to let financial institutions fail, and so prevent the market from correcting the excesses.

Yes there is an easy answer- make a sufficiently large fiscal adjustment.

This is why this writer has a certain sympathy for Treasury Secretary Henry Paulson, even if nobody else seems to. The securitized nature of this credit cycle, combined with the nightmare levels of leverage embedded in the products dreamt up by the quantitative geeks, means this is a horribly difficult issue to solve.

Couldn’t be easier. Start with a payroll tax holiday where the treasury makes all FICA payments for employees and employers.

The spread around a few hundred billion in revenue sharing to the states for operations and infrastructure.

Crisis over.

Virtually everybody blames Mr. Paulson for the decision to let Lehman Brothers go. But this decision should be applauded for precipitating the deflationary unwind that was going to come sooner or later anyway.

The Japanese precedent also remains important because the efforts in the West to prevent the market from disciplining excesses will have, as in Japan, unintended, adverse, long-term consequences.

Doesn’t even mention output and employment.

In Japan, one legacy is the continuing existence of a large number of uncompetitive companies which have caused profit margins to fall for their more productive competitors.

Who cares?

Another consequence has been a long-term deflationary malaise, which has kept yen interest rates ridiculously low to the detriment of savers.

Interesting bit of logic!

Meanwhile, the most recent Fed survey of loan officers provides hard evidence of the intensifying credit crunch in America. A net 83.6% of domestic banks reported having tightened lending standards on commercial and industrial loans to large and midsize firms over the past three months, the highest since the data series began in 1990. A net 47% of banks also indicated that they had become less willing to make consumer installment loans over the past three months.

Banks are necessarily pro cyclical- get over it!

Consumers are also more reluctant to borrow. A net 48% of respondents indicated that they had experienced weaker demand for consumer loans of all types over the past quarter, up from 30% in the July survey. This hints at the Japanese outcome of “pushing on a string” — i.e., the banks can make credit available but cannot force people to borrow.

Good! Lower taxes for any given amount of government spending. Bring it on! Now!

The Fed Is Out of Ammunition

With a fed-funds rate at 0.5% or lower in coming months, it is fast becoming time for investors to read again Mr. Bernanke’s speeches in 2002 and 2003 on the subject of combating falling inflation. In these speeches, the Fed chairman outlined how policy could evolve once short-term interest rates get to near zero. A key focus in such an environment will be to bring down long-term interest rates, which help determine the rates of mortgages and other debt instruments. This would likely involve in practice the Fed buying longer-term Treasury bonds.

Yes. And not do a lot for output and employment until fiscal adjustment takes hold.

And do we really want to encourage an increase in private leverage? Been there done that, right?

It would seem fair to conclude that a Bernanke-led Fed will follow through on such policies in coming months if, as is likely, the U.S. economy continues to suffer and if inflationary pressures continue to collapse. Such actions will not solve the problem but will merely compound it, by adding debt to debt.

I think he’s got it right there.

In this respect the present crisis in the West will ultimately end up discrediting mechanical monetarism —

Hope so. It flies in the face of theory and reality.

and with it the fiat paper-money system in general — as the U.S. paper-dollar standard, in place since Richard Nixon broke the link with gold in 1971, finally disintegrates.

Why??? Deflation as above? Deflation is the increase in value of a currency. Disintegration is via inflation???

The catalyst will be foreign creditors fleeing the dollar for gold. That will in turn lead to global recognition of the need for a vastly more disciplined global financial system and one where gold, the “barbarous relic” scorned by most modern central bankers, may well play a part.

Fleeing the dollar for gold means inflation. He’s been preaching deflation for this whole piece. Can’t have it both ways.

Mr. Wood, equity strategist for CLSA Ltd. in Hong Kong, is the author of “The Bubble Economy: Japan’s Extraordinary Speculative Boom of the ’80s and the Dramatic Bust of the ’90s” (Solstice Publishing, 2005).

Aha! Hong Kong has a fixed FX policy, much like a gold standard. He’s applying fixed FX analysis to the us which has a floating FX policy.

The WSJ should have told him this and rejected this op-ed piece.

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Germany Retains `Stable’ Rating Outlook at Moody’s Amid Crisis

By Rainer Buergin

Nov. 24 (Bloomberg) — Germany retained a “stable” outlook at Moody’s Investors Service on its Aaa government bond ratings even as the financial crisis puts strains on public coffers, the rating company said today in an e-mailed report.

Moody’s, in a regular credit analysis, kept the “Aaa - stable” rating for Germany’s government bonds, the country ceiling and the bank deposit ceiling, both in foreign and local currency.

“Germany’s public debt payment capacity is strong and Moody’s anticipates no problems with regard to affordability or adverse debt dynamics, even with the impact of the economic slowdown likely to be felt on both sides of the government balance sheet,” said Moody’s analyst Alexander Kockerbeck.

Chancellor Angela Merkel’s government faces revenue shortfalls this year and will have to expand net borrowing in 2009 as the worst economic recession in at least 12 years takes its toll on the budget. Lawmakers last week authorized higher net federal borrowing in 2009 compared with 2008, the first increase since Merkel came to office three years ago.

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(email exchange)

>   
>   On Wed, Nov 12, 2008 at 11:37 PM, Morris wrote:
>   
>   The Muni stuff is more interesting… See the data…if the USA loses AAA.,
>   what does that make states with Budget Gaps of over 10pct of GDP and
>   NO capability for a funding mechanism to print money????
>   

Dependent on the US government/banks for credit, like the rest of us- (we may now need both a payroll tax holiday and a trillion or so of revenue sharing for the states).

And restoring growth and employment is no big deal, actually, if government sustains demand at reasonable levels, which it always, readily, can do.

We sent men to the moon 40 years ago, cram mind boggling technology into cell phones, do robotic surgery, and don’t understand how a simple spreadsheet called the monetary system works.

Remarkable!

US May Lose Its ‘AAA’ Rating

The United States may be on course to lose its ‘AAA’ rating due to the large amount of debt it has accumulated, according to Martin Hennecke, senior manager of private clients at Tyche.

Yes, that may happen, as ratings agencies have no clue how it all actually works.

“The U.S. might really have to look at a default on the bankruptcy reorganization of the present financial system” and the bankruptcy of the government is not out of the realm of possibility, Hennecke said.

With government spending not constrained by revenue, any such event would be an unnecessary political response.

“In the United States there is already a funding crisis,

Not for government.

And a close look at actual monetary operations shows government best thought of as spending first and then borrowing or collecting taxes. Any constraints are necessarily self imposed (debt ceilings, no overdraft at Fed provisions, paygo policy).

and they will have to sell a lot more bonds next year to fund the bailout packages that have already been signed off,” Hennecke told CNBC.

No, the Fed government sells bonds after they spend, not in order to spend.

In order to solve or stem the economic slowdown, Hennecke suggested the US would have to radically reduce spending across all sectors and recall all its troops from around the world.

No, to stem the slowdown the US has to increase its deficit- increase spending and/or cut taxes.

Fortunately, this is already underway via the ‘automatic stabilizers’ as tax revenue slows and transfer payments increase.

Unfortunately we still don’t have the good sense to do this proactively.

>   
>   On Thu, Nov 13, 2008 at 6:53 AM, Morris wrote:
>   
>   Your theories are quite interesting- why wouldn’t the G20 announce
>   this sort of massive WW stimulus package of say, 10 trillion dollars to
>   restart all local economies?
>   

They might.

Two points:

1. Deficits need to be ongoing to sustain the financial equity that supports credit structures. It’s not just a matter of ‘jump starting’ though that certainly doesn’t hurt.
We got into this mess by letting deficits get too low. We have yet to recover from the surplus years of the late 90’s that reduced private sector financial equity by maybe a trillion USD, back when that was a lot of money.

2. Any nation is better off by doing it unilaterally in sufficient quantity to restore output and employment. The last thing anyone needs is foreign consumers competing for scarce resources.

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Doesn’t look as bad as many would expect.

Maybe it’s being supported by lower fuel prices.

TABLE-US chain store sales fell 1.0 pct last week-ICSC

(Reuters) The International Council of Shopping Centers and Goldman Sachs on Tuesday released the following seasonally adjusted weekly data on U.S. chain store retail sales.
 

WEEK ENDING	INDEX 1977=100	YEAR/YEAR CHANGE	WEEKLY CHANGE
		(percent)	(percent)
Nov 8	477.2	0.4	-1.0
Nov 1	482.0	0.9	0.6
Oct 25	479.3	1.3	0.5
Oct 18	477.0	0.9	-1.6

 
The ICSC weekly U.S. retail chain store sales index is a joint publication between ICSC and Goldman Sachs Group Inc. It measures nominal same-store sales, excluding restaurant and vehicle demand, and represents about 75 retail chain stores.

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Here’s my take on the events of the last year:

Paulson/Bush/Bernanke pressed a ‘weak dollar’ policy to use exports to sustain GDP, rather than a fiscal package to support domestic demand.

This kept the US muddling through but took demand from the rest of world.

The rest of world had become ‘leveraged’ to their exports to the US.

As US imports fell and US exports accelerated, the rest of world economies slowed and support was removed for their credit structures.

No government moved to support domestic demand until the modest US fiscal package of a few months ago. It was too little too late.

None of the credit based economies have the institutional structure to sustain growth and employment with soft asset/collateral prices.

No private sector loans are ’safe’ when collateral values and income are falling.

The lesson of Japan is that with a general deflation of collateral values it took a federal deficit of at least 8% of GDP just to stay out of recession.

Not sure what it will take here.

The payroll tax holiday would be a good start and probably sufficient to reverse the shortfall of demand.

The US, UK, Japan, etc. will survive a slowdown due to their ‘automatic stabilizers’ that will rapidly increase deficits until they are sufficiently large to turn things around.

The eurozone doesn’t have the institutional structure that will allow this process to work as it does in the other nations with non-convertible currencies.

The eurozone can only hope the rest of world recovers quickly and supports eurozone exports.

Without a US fiscal package US domestic demand will remain weak until the deficit gets large enough via falling tax revenue and rising transfer payments.

Without foreign CB buying of USD, US imports will not increase enough to support rest of world demand.

All this means a decisive US fiscal response, such as the payroll tax holiday, will support:

• Both US and rest of world aggregate demand.
• Support the financial sectors from the bottom up.
• Increase US real terms of trade.

(Not to forget the need for an energy package to keep higher crude prices from hurting our real terms of trade and reducing our standard of living.)

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Saved by the Deficit?

by Robert B. Reich

BOTH presidential candidates have been criticized for failing — at Tuesday’s debate and previously — to name any promises or plans they’re going to have to scrap because of the bailout and the failing economy. That criticism is unwarranted. The assumption that we are about to have a rerun of 1993 — when Bill Clinton, newly installed as president, was forced to jettison much of his agenda because of a surging budget deficit — may well be mistaken.

No, it’s ridiculous! Cutting back is for times of excess aggregate demand - hardly the case today.

At first glance, January 2009 is starting to look a lot like January 1993. Then, the federal deficit was running at roughly $300 billion a year, or about 5 percent of gross domestic product, way too high for comfort.

Why?

By contrast, the deficit for the 2009 fiscal year is now projected to be $410 billion, or about 3.3 percent of gross domestic product. That’s not too worrying.

No number per se is worrying. It’s things like output, employment, and maybe inflation that are worrying.

But if the Treasury shovels out the full $700 billion of bailout money next year, the deficit could balloon to more than 6 percent of gross domestic product, the highest since 1983. And if the nation plunges into a deeper recession, with tax revenues dropping and domestic product shrinking, the deficit will be even larger as a proportion of the economy.

True, as a matter of accounting. But none of the above is symptomatic of excess aggregate demand.

Yet all is not what it seems. First, the $700 billion bailout is less like an additional government expense than a temporary loan or investment.

It’s an exchange of financial assets, much like the Fed does continuously, with no effect on demand.

The Treasury will take on Wall Street’s bad debts — mostly mortgage-backed securities for which there’s no market right now — and will raise the $700 billion by issuing additional government debt,

No, the government first pays for the mortgage securities and then offers Treasury securities (or now, interest-bearing reserves, which are functionally the same as Treasury securities) to support the overnight rate that the Fed’s target rate.

much of it to global lenders and foreign governments.

They exchange real goods and services for balances at the Fed because they want to. We then offer them alternative financial assets in the form of Treasury securities via an auction process that is bought at necessarily attractive levels.

As America’s housing stock regains value, as we all hope it will,

Yes, deep down we all hope for ‘inflation’…

bad debts become better debts, and the Treasury will be able to resell the securities for at least as much as it paid, if not for a profit.

And that would drain aggregate demand and be contradictionary, just like a tax.

And if there is a shortfall, the bailout bill allows the president to impose a fee on Wall Street to fill it.

Also draining aggregate demand.

Another difference is that in 1993, the nation was emerging from a recession.

Yes, because the deficit was allowed to get up to 5% of GDP.

Government deficit = Non-government accumulation of net financial assets, etc.

Although jobs were slow to return, factory orders were up and the economy was growing. This meant growing demand for private capital.

If so, loans create deposits: loanable funds went out with the gold standard.

Under these circumstances, the deficit Bill Clinton inherited threatened to overheat the economy.

I don’t recall any evidence of an overheating economy back then?

He had no choice but to trim it, a point that the Federal Reserve chairman, Alan Greenspan, was not reluctant to emphasize. Unless President Clinton cut the deficit and abandoned much of his agenda, interest rates would rise and the economic recovery would be anemic.

Interest rates would rise only if Greenspan, not market forces, raised them, which he may have threatened to do.

Next year, however, is likely to be quite different. All economic indicators are now pointing toward a deepening recession. Unemployment is already high, and the trend is not encouraging. Factory orders are down. Worried about their jobs and rising costs of fuel, food and health insurance, middle-class Americans are unable or unwilling to spend on much other than necessities.

Under these circumstances, deficit spending is not unwelcome. Indeed, as spender of last resort, the government will probably have to run deficits to keep the economy going anywhere near capacity, a lesson the nation learned when mobilization for World War II finally lifted us out of the Great Depression.

Agreed!!!

Finally, not all deficits are equal. As every family knows, going into debt in order to send a child to college is fundamentally different from going into debt to take an ocean cruise. Deficits that finance investments in the nation’s future are not the same as deficits that maintain the current standard of living.

Agreed!

Here again, there’s marked difference between 1993 and 2009. Then, some of our highways, bridges, levees and transit systems needed repair. Today, they are crumbling. In 1993, some of our children were in classrooms too crowded to learn in, and some districts were shutting preschool and after-school programs. Today, such inadequacies are endemic.

Yes, trillions of USD could be spent on infrastructure. But the key to ‘affordability’ at the macro level is unemployment and excess capital in general.

In 1993, some 35 million Americans had no health insurance and millions more were barely able to afford it. Today, 50 million are without insurance, and a large swath of the middle class is barely holding on.

Insurance is an entirely different issue than whether people are getting health care or not. He should make that point and then address the real issue (distribution of health care and other real goods and services) and not miss the financial for the real issues.

In 1993, climate change was a problem. Now, it’s an emergency.

Moreover, without adequate public investment, the vast majority of Americans will be condemned to a lower standard of living for themselves and their children. The top 1 percent now takes home about 20 percent of total national income. As recently as 1980, it took home 8 percent. Although the economy has grown considerably since 1980, the middle class’s share has shrunk. That’s a problem not just because it strikes so many as being unfair, but also because it’s starting to limit the capacity of most Americans to buy the goods and services we produce without going deep into debt.

That’s because incomes are too low, the largest taxes are the regressive payroll deductions, and the deficit is too small.

Time for a payroll tax holiday.

The last time the top 1 percent took home 20 percent of national income, not incidentally, was 1928.

Good statistic!

Perhaps it should not be surprising, then, that the Wall Street bailout has generated so much anger among middle-class Americans. Let’s not compound the problem by needlessly letting it prevent the government from spending what it must to lift the prospects of Main Street.

Agreed, but not by writing this type of thing.

Feel free to distribute.

Robert B. Reich, a secretary of labor under President Bill Clinton and a professor at the University of California, Berkeley, is the author of “Supercapitalism.”

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Things have come apart very quickly as government officials have demonstrated they are in this way over their heads.

Especially as it becomes clear the enormous efforts expended to get the TARP passed will do little if anything to address any of the current woes.

Government, including the Fed, has lost what little credibility it may have had.

While they have the ’silver bullet’ at hand with fiscal policy, they are reluctant to use it due to deficit myths left over from the gold standard that are no longer applicable.

Note earnings growth has moderated but not yet gone negative, ex financials.

Not reported is that core earnings for financials (ex writeoffs) are probably reasonably strong.

Q3 Earnings: Not So Pretty

by Juan Aruego

This earnings season is looking ugly and there hasn’t been much talk about which sectors are bringing the pain.

What’s different this quarter is that expectations for everyone are falling.

Until now, the weakness has been concentrated in banks. But this quarter, the consumer discretionary sector is getting crushed. Estimates have plunged from +15% on July 1st to -9% today.

Other depressing factoids:

• Four sectors are now expected to see earnings fall. Together they make up 27% of all earnings

• Only one sector, energy, is looking at growth above seven percent. Oh, for the days when double-digit growth was de rigueur.

• Can you believe that just three months ago, analysts thought Q3 financials’ earnings would be nearly unchanged from last year? How times have changed.

Amazingly, the ex-financials growth rate is still in the double digits, but it has fallen from 16.7% on July 1st to 11.3% now. As good as that sounds, excluding financials from the overall number is starting to feel a lot like paying attention to core CPI because it’s not as bad as overall CPI… especially since most of the upward drive is coming from the energy sector. Pull out the energy sector and the “growth” consensus plunges to -14.7%.

Here are all the numbers for you earnings wonks out there:

Q3 2008 Earnings Growth Estimates

Sector	Today	July 1st
Consumer Discretionary	-9%	15%
Consumer Staples	-1%	1%
Energy	53%	58%
Financials	-67%	-4%
Health Care	6%	8%
Industrials	3%	6%
Materials	5%	11%
Information Technology	7%	12%
Telecomm. Services	-5%	-4%
Utilities	3%	7%
S&P 500 Overall	-4.3%	12.6%
Without Energy Firms	-14.7%	4.7%
Without Financials	11.3%	16.7%

 
Special thanks to Thomson Reuters and its earnings gurus for the data to back up this story.

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