America's Economic Collapse
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|Jim Quinn||December 1st 2008|
Cutting Edge Economic Crisis Analyst
The United States government has been in non-stop bailout mode for the last three months. How has it done? How has the nation’s economy been impacted if at all? Here’s a report card.
Troubled Asset Relief Program
The Troubled Asset Relief Program or TARP has distributed $179 billion to the largest financial institutions in the United States. The first $125 billion was forced on the nine largest financial institutions by Henry Paulson on October 28. Since that forced feeding, 21 other financial institutions have applied for and received an additional $54 billion from the $700 billion trough. Now every shaky company in America is trying to figure out how to get a piece of the action. American Express and GMAC are converting to “banks” so they can get bailed out by taxpayers for loaning money to people who couldn’t repay them.
By any reasonable assessment, the Troubled Asset Relief Program has been a miserable failure and a complete waste of taxpayer money. The basis used to ram the bill through Congress was the purchase of the toxic assets off of bank’s books. Not one dollar has been used for this purpose. The main purpose for passing the $700 billion bailout was to restore confidence in the markets.
On October 3 when the TARP was signed into law, the S&P 500 was at 1,114. Today, it is 887. The 20 percent decline in the markets in six weeks doesn’t show much confidence in Paulson’s acts. Paulson changing course every few days has shown the world that he is “winging it.” He has floundered from buying toxic assets to jamming capital down the throats of banks to his current plan to support consumer debt. Did Paulson lie to Congress about buying toxic assets?
Paulson has handed out a grand total of $310 billion of the initial $350 billion tranche. He would have to go back to Congress for the 2nd $350 billion tranche. Congress was supposed to create a five-member congressional oversight panel, but hasn’t. The White House was supposed to nominate, and the Senate was supposed to confirm a special inspector general to audit and investigate where the funds are going. After six weeks, President Bush hasn’t proffered a nomination.
Poorly run automakers (GM, Ford, Chrysler), poorly run cities (Atlanta, Philadelphia, Detroit, and Phoenix), and poorly run states (California) are begging for a piece of the pie. The banks that received the first $179 billion have not made any loans with the special money. Indeed, some are using the money to buy other banks. It appears their goal is to become “too big to fail.” Others, like Citigroup, are using the money to buy back bad assets from off the balance sheet SIVs they created. SIVs are the “structured investment vehicle” instruments that Citibank invented in 1988 to become part of its so-called “shadow banking” system. The solvency of the SIV world is now in question.
Hence, TARP has failed.
Federal Reserve Actions
As of May 15, 2008 the Federal Reserve Bank of the United States had $881 billion of assets, $840 billion of liabilities, leaving $41 billion of capital. Federal Reserve Chairman Ben Bernanke has been quite busy since then. He has created the Term Auction Facility, the Term Securities Lending Facility, the Primary Dealer Credit Facility, the Commercial Paper Funding Facility, and a Money Market Investor Funding Facility— all in the last eight months. The Fed also started paying interest to banks on reserves.
Banks are finding it easier and safer to borrow from the Federal Reserve, earn interest on their TARP capital, and not make any loans. All of the facilities and programs are a crutch that allows banks to do no business. Why would a rational banker make loans to businesses and consumers as we are entering the deepest recession since the 1930’s? The Government is actually encouraging reckless lending as the solution to previous reckless lending.
In the space of two months, Ben Bernanke has doubled the balance sheet of the Federal Reserve. When Paulson and Bernanke were marketing the rescue plan in front of Congress in September they stressed transparency, oversight and openness. The lack of transparency and oversight were the reason that our financial system came to a grinding halt. Without transparency, no bank trusts any other bank. The black box aspects of derivatives have eliminated trust in the system.
Ben Bernanke is withholding the names of all financial institutions that have borrowed from the Fed and will not reveal the collateral that they have put up for those loans. The Fed has lent $2.2 trillion to banks in the last few months. The Fed has refused to reveal any information regarding these loans. Bloomberg News has sued the Fed under the Freedom of Information Act to force them to reveal where $2.2 trillion of taxpayer money has gone. The Bloomberg lawsuit argues that the collateral lists ``are central to understanding and assessing the government's response to the most cataclysmic financial crisis in America since the Great Depression.'' Investment Manager Ted Forstmann’s opinion was, “It’s your money; it’s not the Fed’s money. Of course there should be transparency.”
Ben Bernanke, in front of House Financial Services Committee two weeks ago, had this to say: ``Some have asked us to reveal the names of the banks that are borrowing, how much they are borrowing, what collateral they are posting. We think that's counterproductive. First, the success of this depends on banks being willing to come and borrow when they need short-term cash. There is a concern that if the name is put in the newspaper that such-and-such bank came to the Fed to borrow overnight for a perfectly good reason, that others might begin to worry is this bank creditworthy and that might create a stigma, a problem, and might cause banks to be unwilling to borrow, and that would be counterproductive.''
Bottom line: the goal of unfreezing the system has been a failure.
Negative Wealth Effect
As government bureaucrats and politicians are trying to figure out how to resolve the financial crisis, people in America are suffering dramatic declines in their net worth. Since 1945, there has been consistent growth in American household net worth, with only a slight drop during the “Dot Com” Crash. The net worth of U.S. households peaked at $58.7 trillion in 2007. We are now in the midst of the greatest decline in the history of the United States. America’s household balance sheet tells an interesting story. Americans experienced a dual boom in stocks and real estate between 2002 and 2007. Real estate assets grew by 51 percent and financial assets by 55 percent over this time period. These increases gave rise to a positive wealth effect. When people perceive themselves to be richer due to the increase in the value of their home and actual increases in investments, they are more likely to spend. This perception, along with a strong employment market led Americans to make some dreadful decisions.
Even though real estate rose by 51 percent, mortgage debt rose by 75 percent. What Americans are learning is that real estate can decline, but the debt stays forever. Much of that extra mortgage debt was used to buy TVs, cars, kitchens, bathrooms, and vacations. None of these items have the potential to appreciate. Based on the decline in housing and the stock market, household net worth has likely declined by over $10 trillion since the beginning of the year and is now back to 2003 levels. By the time this recession is over, we will likely eliminate all of the net worth created during the entire Bush administration. It was all an illusion, created by humungous amounts of debt, fraud, manipulation and deceit.
American consumers are under intense stress. Now that there is no equity to borrow against their houses, Americans have done the next best thing. They whipped out one of their 30 credit cards. The credit card write-offs will be the next tsunami that hits our banking system and will be subsidized by taxpayer funds.
According to bestselling author and financial guru John Mauldin, credit card debt has exploded in the last few months. Mauldin states: “Commercial Bank 'exposure' via the total amount of credit card 'loans' outstanding has risen more in the last ten weeks, than it did in the previous ten months combined !
Moreover, the growth in the last ten-weeks, $32.3 billion, or about $600 million per 'shopping day' since the beginning of August ... represents nominal growth of + 9.3 percent ... or ... + 48.3 percent annualized over the last ten weeks."
According to American Express, delinquencies on credit payments rose to 4.1 percent of all credit outstanding in the Q3, up from 2.5 percent in Q3 of 2007, with Bank of America's rate rising even more steeply, to 5.9 percent in the quarter. What’s more, the 'pool' of loans deemed 'uncollectable' rose to a high 6.7 percent in the Q3, soaring from 3.6 percent last September. What consumer spending there is has been fueled in part by credit card. The second largest "merchant-vendor" for credit card use is now McDonalds. This suggests that many consumers are in serious distress when they need to get their $4 Big Mac and fries with a credit card.”
The unemployment rate is currently 6.5 percent, according to “U-3” government figures. The so-called U-3 rate is Washington’s “official” unemployment rate, tabulating rate and duration. But a broader “U-6” measure reflects a figure of 11.8 percent, which includes discouraged and marginally attached workers. If you are still discouraged after one year, the government ignores you in their calculations. If these workers are included, the real unemployment rate is 16 percent. The U.S. has lost 1.2 million jobs in ten months. The U-3 rate is forecasted by many economists to reach 9 percent by late 2009. That would be another 3.6 million job losses. These are the kind of numbers that could lead to social unrest. The social services system and food banks will be pushed to the breaking point.
The S&P 500 has declined by 40 percent in 2008. It has provided an average annual return of -2 percent over the last 10 years. It has provided an average annual return of 5.8 percent over the last 15 years. These aren’t the returns that the Wall Street PR machine has been promising. They have convinced people that stocks always go up over the long run. It depends on your definition of “long run.” Pension funds, endowment funds, and financial advisors use annual returns of 8 percent to 10 percent in their models and assumptions. This shortfall in return will have devastating impacts on states, counties, and companies with traditional pension plans, along with 401k investors.
So far, 2008 is shaping up to be the worst year for the stock market in history. When someone had $10 million and now has $5 million, it is a shame. When a 64-year-old guy who has worked hard his whole life, followed the rules, contributed to his 401k every week, listened to the stocks for the long run mantra, and accumulated $500,000 in his 401k, losses $250,000, it is a tragedy. People who thought they could retire will now have to work for many more years. Millions are losing their jobs, while their home value declines and their mutual fund holdings have been cut in half. This is the negative wealth effect in full bloom. People are scared to death and will not spend anywhere near the level they have spent over the last 20 years. Forced frugality has arrived.
Auto Maker Bailout
Americans have heard that if the Big 3 U.S. automakers were to fail, 1 in 10 workers in America would lose their jobs. According to the Bureau of Labor Statistics, there were 145 million employed workers in October 2008. According to their own information, the U.S. carmakers employ the following number of workers worldwide:
General Motors 266,000
Ford Motor 87,700
Total Workers 485,830
Approximately 377,000 of these jobs are in the U.S. This is 1 in 385 jobs in the country. The Center for Automotive Research, based in Ann Arbor, and funded by the Big 3, issued a report, just before their CEOs went before Congress, that 2.95 million direct and indirect jobs would be lost if the Big 3 ceased operation. Even this very broad interpretation of lost jobs comes to only 1 in 49 jobs. The 1 in 10 jobs appears to be an exaggeration to gain support for the bailout. In recent days, the CEO’s of GM, Ford and Chrysler flew to Washington DC on private corporate jets to beg for $25 billion from U.S. taxpayers.
The General Motors corporate jet costs $36 million. Rick Wagoner’s roundtrip cost $20,000. A coach roundtrip fare would have cost $600. This hubris of corporate executives who have made the strategic decisions that have ruined their industry is not surprising. Robert Nardelli, collected $123 million in compensation and a $210 million severance package in his six year reign at Home Depot. He flew to Washington on a corporate jet after firing 28,000 Chrysler employees in the last two years. Rick Wagoner has raked in $25 million in the last 5 years, while leading his company to a $72.6 billion loss since 2005. Alan Mulally, who became CEO of Ford in late 2006, received $28 million of compensation for four months of work in 2006. Ford has lost $24 billion since 2006.
General Motors will burn through its remaining cash is less than sixty days. Ford has a little longer. Chapter 11 Bankruptcy will allow these companies to close unprofitable plants, close dealerships, rid itself of awful management, and renegotiate UAW contracts. They will come out of bankruptcy with leaner cost structure that will allow them to compete with Honda, Nissan, and Toyota on an equal footing. If Congress bails them out with taxpayer funds, they will continue to pay workers $70 per hour versus the $42 per hour paid by the Japanese automakers. We are heading down a path towards corporatism, where government merges with corporate interests. This corporate fascism is clearly taking hold as no one knows where the Treasury and Federal Reserve will set a line they will not cross.
The incoming Obama administration is now floating the idea of a $500 billion to $700 billion stimulus package. The story which is being sold to the American public is that we must do this to save the country. The country is going through a necessary de-leveraging that will take years to complete. There is no stimulus package that will stop this de-leveraging process. There is no easy way out. Obama will convince the American public that once we save the country with the stimulus program, he’ll then address the long-term problems. He’ll convince the Republicans to support the stimulus package by delaying the tax increases on the rich. Democrats have never seen a spending plan they wouldn’t support. Republicans have never seen a tax that they didn’t want to cut. This is the kind of cooperation that will quickly lead to a $13 trillion national debt.
Tax cuts for the middle class sounds great, except that a tax cut today is just a tax increase on our grandchildren. Former Comptroller of the U.S. David Walker describes the use of debt in our country in these words: “Individuals go into debt, and when they pass away, the debts go with them. But government debts stay, and they have to be assumed by our children and grandchildren. That’s not only fiscally irresponsible; it’s morally reprehensible.”
Government has been the problem, not the solution. If the American public believes that another stimulus package will solve our problems, they are badly mistaken. There will be no easy answer to a problem that built up over a 25-year period. Americans will need to spend less, save more, and finally live within their means. The next 25 years will not be as fun and carefree as the past 25 years. Government must address the $53 trillion of unfunded liabilities, develop a cohesive realistic energy policy, enact a simple tax policy, create a plan to repair our crumbling infrastructure, and encourage ideas that work for improving our educational system.
Cutting Edge Financial Crisis Analyst James Quinn is a senior director of strategic planning for a major university. This article reflects his personal views, and does not necessarily represent the views of his employers and is neither sponsored nor endorsed by them.