In The Consumer We Trust
As we were bombarded with Black Friday ads and CNBC pundits were pumping consumers to use their last breath spending, we wondered if almighty consumers can ignore basic fundamentals.
Just a few data points:
- The annual survey from the National Retail Federation estimates a 1.0% year-over-year decline in holiday sales (after last year dismal performance of a 6% drop from the year before!).
- The Conference Board pre-holiday survey indicates that U.S. households will spend $390 on Christmas gifts this season, down 6.7% from last year’s estimate of $418.
- Initial Black Friday reports indicate that more consumers hit the stores, but they adhere to a budget and spent less on average (about 8% less -- $343 vs. $372 a year ago).
- Outstanding consumer credit is lower by $123 billion in the past year and availability continues to go down limiting consumer’s ability to put the expense on credit cards.
- Gasoline prices are 70 cents higher than a year ago, producing a cash drain in favor of oil producers of about $100 billion per year (or 1% of income).
The bottom line is that consumers will not bring the U.S. out the recession during the holiday season. Higher saving rates in a multi-year process of consumer de-leveraging guarantee a continuation of the economic malaise or a very weak recovery when it comes. It seems more like the 1930s.
Lower year-over-year corporate revenues are a major concern that points to continuous deflationary risks. The stock market will be negatively surprised as actual information flows through during the season given its delusional assumptions that earnings can grow while revenues go in the opposite direction.
Political Complications in 2010
After the limited impact of the massive bailout and economic package of 2009, in 2010 the Obama administration will try to throw everything they can at the problem in order to keep their majority in the midterm elections. We argue that they have used most of their firepower and that public opinion will limit their options. A strong political resolve is needed given the latest signals of upcoming economic distress in the world: The Dubai default, the Mexico downgrade, the Dong devaluation, CDS widening for Greece and Japan, FX interventions in Russia and Switzerland, etc.
Recently, there has been a tectonic shift in political circles calling for action to tackle the unemployment issue for instance. A few days ago an amendment cleared the committee to audit the Fed, signaling a major lack of trust in Bernanke. In addition, Tim Geithner was aggressively and angrily grilled by Congress.
There is an underlying discontent from the general public captured by politicians regarding the perceived-unconditional bailout to financial institutions and the administration ineffectiveness to solve the basic problems (employment, credit, etc.)
The support of independents that voted for Mr. Obama last year is quickly vanishing as he drops below the 50% approval rating in the polls. There are clear reasons for it. For instance the decision to increase troops in Afghanistan goes against pre-election promises alienating some voters. Other promises have yet to be fulfilled.
One outcome we foresee is that someone will be sacrificed in the Obama administration early next year. The first candidate on our list is Tim Geithner (he is already facing trouble from the AIG bailout, was in charge of the NY Fed during the bubble years and has a questionable record paying his personal taxes).
The clear and immediate challenge for the administration is the health care reform. If it does not pass before the end of the year (chances are it may not), then Obama would have spent a full year without a major change approved or implemented.
The implications of political complications for the markets are higher risk premiums, lower consumer and business confidence, massive fleeing from the dollar, etc. with the inevitable economic pain that follows.
Domestic Brady Plan
As many of our readers may remember, the Brady plan was a solution to the debt default of emerging countries that started in 1982 with Mexico’s moratorium. The plan was part of the larger push for the Washington Consensus that favored neoliberal economic policies teamed with democratic political transitions. The plan had two major innovations: a) the haircut on the debt in present value terms to sustainable levels with a guarantee of principal in some cases, and b) the fact that the new instruments were tradable providing liquidity to bank’s balance sheets.
We are reminded of this as one in four homeowners in the U.S. is now underwater in their mortgages creating a similar situation to emerging markets -- unsustainable debt, mounting losses for lenders, etc.
We suggest a massive Brady-like plan available to all homeowners underwater subject to a set of criteria like year of origination, unemployment rate in the state in which the property is in, etc. A range of options should favor to reduce short term cash payments while lowering present value and/or nominal value.
The losses should be taken by the financial system first, whipping equity and then by the federal government. Banks and other institutions should be selectively nationalized to avoid a bank run. And finally a major overhaul of the financial system should take place at the same time, starting with a modern Glass-Steagall-type act (deposit taking institutions should not engage in securities business).
Other major reforms should take place starting with strong corporate governance requirements for publicly traded corporations, additional reporting requirements for large investors (hedge funds, pension funds, wealthy individuals, etc.).
The plan will improve the financial position of many families increasing consumption while it provides a fresh start for a broken financial system. Needless to say that many will go into foreclosure in any case as the shortfall can prove to be too large for some or their income too low for such asset.
Many will be critical of the idea as it goes against the free enterprise religion, but developments over the last few years prove that laissez-faire is simply not an option. Furthermore, cut-throat capitalism has failed in the perception and experience of the average citizen. The need for action is imperative.
Disclosure: Short QLD