Thirteen Aspects of Our Current Economic Situation

1) Tuesday night I started out with the concept of a “housing mismatch.” Wednesday, with a hat tip to Calculated Risk, I can make my case better. The low end of the market is humming, as new buyers come in. Makes sense. Who gets the capital together for a downpayment? New homebuyers for homes on the lower end. But homeowners that want to upgrade are stuck, because the buying power of the equity of their current home has deflated. Thus few upgrading buyers, and they are typically a large part of the housing scene. Good article — helps point out why this cycle in residential real estate may have prices drop below equilibrium levels. We are close to equilibrium now, but nowhere near reversing.

2) How should bank solvency be regulated? If sticking with the existing model, the bank examiners must be more rigorous, and they should consider some stressful scenarios, such as we are experiencing now, or worse. Perhaps a market-based solution would help, such as that which former Fed Governor Poole has proposed.

His objective is the too big to fail institutions, but he says that all banks would have to issue subordinated debt. This would be difficult to implement for small banks. Small issue sizes in the debt market are tough to place, and rolling over 1% each year makes the sizes smaller still. The sub debt would have to be at the operating bank subsidiaries, which are smaller than the holding companies.

I like the idea, though. Maybe a market would develop for small bank sub debt… maybe even funds specializing in it. The yields could be significant, and even protected to some degree, given the need to roll it over to stay operating.

That said, loss incidence might be infrequent, but loss severity and correlation would be high. That’s true of losses on unsecured financial debt generally, but it would be worse with sub debt.

This idea is not new, but it is worth a try. The financial analysis of banks by regulators who have little economic incentive to be right, and hampered by politics has not worked well. It would be replaced by profit-seeking analysts who do have an incentive in the health of the bank in question.

3) Given the fall in global trade, export-driven nations are getting hit hard. Maybe that can help explain why Treasuries are selling off on the long end — aside from excess supply due to the humongous deficit, there is less need to recycle excess dollars by buying Treasuries.

4) Okay, I was wrong about the Indiana Pension System winning in the short run regarding secured Chrysler debt. Given the time pressures, the suit was rejected. Maybe they will win on appeal, but how that works out after the deal is done is messy.

5) GM bondholders have rejected a settlement, and so the company will likely go through chapter 11. I do not get the large amount of financing that the US government is putting up. What? Do they want to repeat the losses they will experience through AIG?

6) With the shrinkage in market capitalizations, the number of sell side analysts declines. No surprise here. The number of sell side analysts is proportional to the money that can be made by investment banks off of underwriting and trading. As market capitalizations fall, so do revenues for investment banks.

7) Tuesday, I said that if California defaulted, we would face a constitutional crisis. I still think that is true. I ran across Felix’s thoughts on the matter today, though they are one month dated. The upshot to me is that there are no ways of enforcing payment if a state won’t pay on their municipal debts. This is a hole in the system, and one that could pinch many in the US, not just Californians.

8 ) Federal Reserve Transparency act of 2009? Bring it on. Yea, Ron Paul, one of the few economically literate memebers of Congress. The Fed gets away with a lot because they aren’t purely private or public. They use their dual status to hide — when it is more useful to be a government institution, they are that. Vice versa, when being private allows the avoidance of FOIAs.

9) This is one long article. How sunk are we regarding peak oil/hydrocarbons? I have revised my estimates of oil production downward, and will buy more energy related stocks at my next rebalancing.

10) Though I am not a dollar bull, there is no easy replacement for the US Dollar on the global scene. Euro, too experimental. Yen, too small. I have not advocated that the Chinese currency could replace the Dollar (as some have), because their economy would have to become far more open. They aren’t willing to do that.

11) It’s tough being a corporate director. No, it’s altogether too easy, which leads to complacency. Consider the situation at the banks, or at the FHLBs. Years of leverage expansion, where the livin’ was easy, made them lazy, and unwilling to challenge their managements. No surprise that their reasons for existence are being challenged now.

12) Though Samuelson misses the point that trust fund exhaustion is not the trouble point, his article is a welcome addition to the discussion. Time is not on the side of the social insurance programs of the US Government, but as I have stated, that trouble comes when revenues are less than expenses, because the trust funds, invested in Treasuries, are a farce. The only way the US government can pay off on those is through taxation, borrowing, or inflation.

13) What are implied breakeven levels of inflation implying from TIPS? That many people fear that inflation will run out of control, given the reckless actions of the Fed and the US Government.

Comments

[fxmaven:]

Can someone please slay the GM and AIG beasts? How much do average people have to pay for complete and utter incompetence?

May 27 12:10 PM

[conceptwizard:]

Point 7 Response:

In a May 22 article in Time titled “Billions in the Red: Fiscal Reckoning in CA,” Juliet Williams reports that since California voters have now vetoed higher taxes and further state government borrowing, Gov. Arnold Schwarzenegger has indicated that he intends to close the budget gap almost entirely through drastic spending cuts. The cutbacks could include laying off thousands of state workers and teachers, ending the state’s main welfare program for the poor, eliminating health coverage for about 1.5 million poor children, halting cash grants for about 77,000 college students, slashing money for state parks, and releasing thousands of prisoners before their sentences are finished. Schwarzenegger bemoaned the fact that the state could not print its own money but said it could only spend what it had.

Only three of fifty states are now solvent, meaning they have the revenues to meet their state budgets; and one of them is North Dakota. It is an unlikely candidate for the distinction. It is a sparsely populated state of less than 700,000 people, largely located in isolated farming communities afflicted with cold weather. Yet since 2000, the state’s GNP has grown 56%, personal income has grown 43%, and wages have grown 34%. The state not only has no funding issues, but this year it actually has a budget surplus of $1.2 billion, the largest it has ever had.

North Dakota boasts the only state-owned bank in the nation. The Bank of North Dakota (BND) was established by the state legislature in 1919. The Fed can print its own money, so can the states. This is the way out for California.

May 27 12:18 PM

[Sober Realist:]

"The Fed can print its own money, so can the states. This is the way out for California." --- concept wizrd.

Please elaborate.

May 27 12:25 PM

[Thomas J. G...:]

A lot of people state that the payout yield of a tip is the "real" interest rate. I am skeptical of that. I can see all kinds of distortions if we see signs of inflation. People will flee to tips for a "real" return (even if it's low) and that will distort the price.
Sober Realist - I'm sure there's some vestige of the constitutioni that allows state banks to print money. Here's a discution of it: www.ronscurrency.com/r... It was common in the 1800's. But we don't want California printing money. I rant and rail that the federal gov't can spend more than the tax take. Imagine what it would be like if the 50 states could do so too.

May 27 01:36 PM

[wws:]

"The Fed can print its own money, so can the states. This is the way out for California."

a laughably bad and foolish idea - is if the only thing wrong with California's budget is that they don't have enough printing presses. Ask Zimbabwe how that plan works in practice.

May 27 02:45 PM

[wws:]

in addition - I think the poster was suggesting that California issue "scrip" to pay for it's bills. The state could do that, but it could *not* restrict the use of US dollars for legal tender, and it cannot mandate that local business take scrip instead of dollars. So, instead, the scrip would mainly be collected by those wishing to pay state taxes with them, which is how all state taxes would soon be paid. The state would be getting nothing for nothing, and the budget hole would become a yawning chasm that would destroy Cali's economy for a generation or more.

Just imagine the riots that would break out when everyone with a California pension starts getting monthly payments in worthless scrip rather than dollars.

May 27 02:53 PM

[derryl:]

Legislative jurisdiction for banking remains with the states, not the federal government, so California could set its own terms for its state bank. A "State Bank of California" (SBC) could lend US$ to Sacramento by creating a deposit, which is what commercial "banks" do. The SBC could use extreme leverage to essentially create and lend as much money as the state needed.

The state would capitalize the bank by selling itself shares in the bank on an IOU, then once the bank was chartered it would use that pledged capital to lever out loans to the state, some of which the state would use to pay in its capital commitment. This is how the US Federal Reserve got started, on IOUs from member banks, so it's not as if it's 'fraudulent' or anything like that.

Once the bank is up and running there is no limit to its asset-to-capital ratio as long as it does not accept FDIC insured deposits. So 10:1, 50:1, 100:1, the sky's the limit in money creation land. Ben Bernanke's doing it. Arnie can too.

May 27 11:22 PM

[mdmrjsds:]

Thanks for the article. I especially liked this quote from the peak oil article you linked.
...
Much of it relies on the basic economist’s assumption that rising prices will inevitably inspire the discovery of more supplies or the substitution of another fuel source, which is infallible truth only within the cozy confines of a self-contained economic model that assumes the earth can provide limitless bounty. So much remains unsaid, so few implications fully examined.
...

May 28 12:59 PM