paul1307

Bernanke Seems Clueless About the Real State of the Economy

Someone asked, "How did this happen?" I'll tell you; it's really a fairly simple chain of events that improbably occurred.

9/11 happened; the government lowered short-term interest rates to stimulate the economy. They continued lowering them as time went on. The administration decided that falling interest rates "were good for the economy" because the dollar began to decline, citing "increasing exports due to the more favorable exchange rate." On January 1, 2002, you should have taken your money (let's use $100,000 just for example) and taken it to a European bank, exchanged it for Euros and put the Euros in a safe deposit box.

The stock market was heading South, bounced briefly in the fall of 2002 when it became clear that the US was going to invade Iraq regardless of what weapons inspectors found or the UN decided. At the time of the invasion, March, 2003, the stock market turned upwards. Here you should have bought stock in Ceradyne (maker of ceramic body armour) or some shoe company whose name I've forgotten because they made combat boots. As ridiculous as it was, you would have made a fortune on these sorts of stocks; it was a bubble.

The dollar, as measured against a basket of European currencies traded from a high of 120 plus on 1/1/2002, plummeting downwards in 2003 and beyond, while the administration, obsessed with the stock market as a supposed proxy for the economy, smiled greasy grins and stated "We're for a strong US dollar" while, rather than intervene to prop the dollar up, let it continue its slide. As the dollar slid, pundits stated that multinational corporations were seeing increased profits "due to increases in productivity." Nonsense. As the dollar slid, productivity in dollars soared because of the escalation of the exchange rate.

Because the dollar became weaker, Mid-East oil producers insisted on more dollars for oil; their yachts are usually built in Europe where the eroding dollar was buying much less with each passing year.

In the meantime, "the carry trade" was using cheap Yen and cheap dollars to loan to American homebuyers, who, if they could fog a mirror could get a mortgage. And why not? If they could make payments, then banks and mortgage lenders made out well on 6+% mortgages while short-term money was lending for 2% and less. If the buyer couldn't make payments, that was okay too. In places like FL where housing was appreciating 3% PER MONTH, foreclosing was a great way for banks to flip houses and profit on both sides of the situation, loans and initiation fees on the one side, and profits on foreclosures as housing went up 30% per year.

Not to forget oil. During wars in the Mid-East, historically since WW II, the price of oil rockets upwards: 1954, 1973, 1979, 1992, etc. As oil went up, so too did the expense of war. The US military uses 1/2 of the oil imported into this country, and consumes more oil than the other top 10 users in the world. With oil shooting upwards towards the eventual high of about $147/bbl from the lows of about $28//bbl circa 2001 or so, and 50% of our imported oil going into the war effort, something had to give, and it did.

Eventually, the low income buyers at the bottom of the housing food chain got pinched when their budgeted $50 per month for gas became $250 for gas and it was either eat or lose their houses. What would you choose? So did they and began to begin slipping on house payments in about late 2003 and early 2004. By the end of 2004, housing in outlying areas of DC and other long-commute parts of the country were seeing 25% drops in prices for houses in the long-commute communities where traditionally first-time buyers go for a lot of house for a lot less money. Their long commutes also slammed their gas budgets. The slide began.

Banks used to foreclosing and making money found that the houses they were foreclosing on were becoming difficult to sell precisely for the same reasons that their buyers were defaulting: long commutes and high gas prices. Banks held tight to their non-performing assets because young bankers didn't believe that housing prices ever went down, or went down for so long that they would lose money on their foreclosed houses. They were however somewhat prudent in that rather than continue to foreclose on every bad loan, they filed liens, but didn't foreclose, leaving the houses in their owners name while the owners were barred from living in them. Bankers also don't pay homeowners dues (liens were placed by home owners' associations) and bankers stopped paying real estate taxes (no money coming in; none going out). Meanwhile, they were sitting on powder kegs of declining value assets and no money coming in.

Crude oil soared reaching $147/bbl on price hikes by oil-rich countries and speculation by "investors" pushing prices to the limit. Houses in the long-commute areas spiraled downwards while banks held them expecting "future profits," "once housing recovers." Bad bet bankers.

We're now in 2007. Take those Euros you put in the safe deposit box and exchange them for dollars. The DXY, having slid from a high of about 120 was now down to about 70 something. Your Euros were now worth $154,000 in exchange, a cool 54% profit on the sliding dollar. The stock market was peaking or close to it based on that 54% windfall associated with the decline of the dollar against European currencies that made a constant profit when measured against the Euro look like sheer genius when converted to dollars. Again, 54% profit for nothing more than the declining dollar. Sweet, no?!!

Bankers in 2007 are now really scared. Nobody holds mortgages; they all hold bonds linked to pools of mortgages. The meltdown in subprime was the canary in the coal mine I like to say. Those buyers were on the margins to begin with, sold mortgages by mortgage brokers and builders who simply sold the mortgages off while the ink was still wet. What did anyone care when they weren't going to make a lifetime commitment to holding the paper? No one actually. But the banks were holding assets depreciating almost daily on diminishing house prices, down as much as 35% or more in parts of the country where the boom was biggest. Where it's biggest, of course, when the bubble bursts, it also hurts the worst. Problem was that banks in Podunk that had for many years held only local mortgages they sold had few to no local mortgages anymore, instead, holding "collateralized debt obligations" in the form of pooled mortgages from all over the country, including those outlying long-commute areas near DC and other large cities that Podunk was not simply hundreds of miles from, but philosophically continents away from.

So that's it. Simple story, law of unintended consequences and all that. Who knew that in promoting American exports by letting the dollar slide at the same time we had a war on two fronts sucking more oil out of the Mid-East than at any other time in history that rising oil prices - five-fold or so - would strain housing bottom-feeders (the Krill of the housing boom and bust) with unexpectedly high gasoline prices that caused them to choose between eating and making house payments would cause the single-largest housing bust in 75 years, saddling every bank in the country with CDOs on houses hundreds or thousands of miles away from them, with prices falling like a stone and making their balance sheets run red? Well, not many people, as it turns out, or we wouldn't have the banking crisis - they're all insolvent, don't you know because of the CDOs they hold in lieu of local mortgages they've traditionally held - and death-spiral in housing prices that are killing us right now.

Don't blame me; I only analyze this stuff. But I will say this: when you want to fight a war and lower taxes at the same time; then fail to prop up a falling dollar because letting the dollar fall increases the earnings of multi-nationals and causing a bubble in the stock market because only fools believe that the economy and the stock market are synonymous, you're taking a mighty big chance. At the very least you're hoping the bubble will burst on the other guy's watch. Didn't Cheney say "Reagan proved deficits don't matter?" Didn't the administration say that "gas prices won't really affect the economy until they hit $4 per gallon?" Ooops! I guess they forgot that the military uses oil too, and the law of unintended consequences let the rest of it fall into place.

Where or when will it end? I can't tell the future, only piece together the pieces of the past that flow logically together. They sort of do, don't they? But, we could see DOW 4,000 this year, pretty easily, the way things are going (not that that is tied to the economy, but it isn't pretty, and it is tied to personal wealth). Gold goes up when there's inflation, not simply because stock markets are tanking, lest why isn't it already $2000 per ounce the way some folks think it should be already? Gold may be a "safe haven" but you can't eat it and you can't build houses of it. The stock market has already lost $10 Trillion, housing $3 Trillion, so far, and we're still counting. DOW 4,000 would cost another $3 Trillion.

Another sobering thought or two from Mr. Sunshine here: the DOW peaked in Aug, 1929, bottomed in 1932, down 90%. It took three years to bottom. Of course, if you're "in it for the long-term," not to worry. The DOW hit the Aug, 1929 highs again - in 1954. Let's see. That means we'll probably hit DOW 14,000 again in, well, 2020 at the very earliest, which seems doubtful. More likely 2026, maybe not until 2030.

The lesson is this: the next time a politician says "(anybody) proved that deficits don't matter" and they try to rescue the economy by letting the dollar go into free-fall, take your money and start to put it under your mattress. Is helicopter Ben right, could we see the bottom this year? In the stock market maybe, DOW low 4,000 (or lower), and if it continues to drop, 1400 in 2010. But the economy is another story altogether; housing won't bottom until 2011, and not forgetting that one out of every new job created in the last eight years was in construction, the economy won't bottom and begin to grow again until the "Krill" of the real estate economy, those first-time buyers and buyers of houses on the fringes of both commuter distances and low prices start to buy houses again. We'll need stable oil for three or four years before that starts up again, and as long as our military uses 50% of every drop of oil we import instead of the more usual 40% during non-wartime, oil will remain high, and due to emerging economies, international use will continue to grow even if our use stabilizes. Hybrid cars? You've got to get serious. We need a serious way to get off oil or we'll have no recovery. Ever.

By the way, the reason the stock market won't recover quickly is that like following the '29 crash, the buyers of a whole generation, having been plucked and stuffed, screwed, blued and tattooed, tagged and bagged and permanently separated from their money, will not be investing in the markets again, if my guess is correct, for a whole generation, 20 years or so. Besides, $10-15 Trillion of wealth will have evaporated. When you lose 50%, you don't get back even by getting a return of 50%; you need returns of 100%. If you've seen your markets decline 90%, you don't need returns of 90% to get even, you need returns of 1000%. Think about that, and ask yourself just where is that money going to come from??? I'm sorry; I just don't have that much under my mattress, and neither do George Soros, Warren Buffet and Bill Gates combined. It only gets uglier from here on; we haven't even seen ugly yet, imho...