It's Still The Economy, Stupid

Thursday, August 21, 2003  

What a real recovery looks like

Jobless claims were down a tiny bit last week, but it doesn't stop the headlines from reading "down sharply" or "lowest since February". Not that it means much in the din of all this applause, but 389,000 new claims is still about 50% more EVERY WEEK than during the previous expansion.

Meanwhile, credit card delinquencies set a new high, MCI is going to lay off another 2400 workers, despite being the #1 computer maker Dell is cutting prices, and more services jobs are heading abroad.

Every tiny bit of positive economic news has been an excuse to jump on the recovery bandwagon, whether it's a company beating earnings estimates (never mind whether those earnings were better or worse than before), or an economic indicator rises into an arbitrary "good" region (new claims below 400,000!) in the previous month, or even whether some knucklehead on TV just says so.

Maybe it's because after three years in economic purgatory, we're still are optimistic to a fault. Maybe it's because we're desperate. But neither positive thinking nor prayer do a recovery make.

Here's what we should look for in a real economic recovery. First, consumers need to have fixed their overspending ways from the previous boom. In every recession in the 20th century, consumers have cut their ratio of debt to disposable personal income. This gave them a reservoir of money to increase spending when the Fed reduced interest rates. In this recession, consumer's debt to disposable income actually increased, so the wherewithal of consumers to abruptly increase spending is much smaller, if any. Even a fixation on monthly payments rather than debt levels can't camouflage that even monthly debt service is higher now than before the recession.

Secondly, businesses need to increase profits, and do so through increasing sales. Increasing profits by cutting costs is not stimulating the economy any more than consumers cutting spending would stimulate the economy. Sales growth in this quarter's earnings reports continues to be anemic and as I referred to earlier is much worse after the weaker dollar had been factored out.

Thirdly, the increase in sales and profits leads to higher employment. There has never been a recovery where total employment didn't surpass it's previous peak. Today, we're not even close. More than 2.5 million jobs need to be created to get to the level of February 2001, and at the rate they've been created over the past year, mathematically that will never happen. Even generating jobs at the rate of a strong economy, we would need ten months just to get back where were nearly three years ago.

Finally, the increase in employment leads to even more consumption growth. Again, we're not even close. Growth in personal consumption expenditures, year-over-year, has improved to 2.8%, but this is still below the 3% level for most of 2002, and nowhere near the improvement from 1991 to 1993, when consumption growth climbed from negative territory to over 4% a year.

I will grant we've seen somewhat of a recovery, albeit a very mild one. But it is a recovery that has shown no characteristics of being self-sustaining. On top of this there are significant roadblocks in our way. A costly foreign entanglement, massive state budget deficits, rising interest rates and a tottering currency all need to be overcome. Predictions of recovery now are little more than wishful thinking.

posted by Teddy | 10:52 AM |

Wednesday, August 20, 2003  

Uh, oh. Part Deux

Matthew Goldstein at has found that a big lender to the failed Capitol Commerce was uber-lender Countrywide Financial. Countrywide said that Capitol's failure "would not have a material impact on earnings". This is the same thing credit insurers like Ambac and MBIA were saying about the failure of National Century Financial late last year.

It is true that bad loans won't impact earnings that much. Lenders make steady quarterly contributions to a "bad loans fund" in the same manner they make pension contributions. If this fund runs low, the lender may need to increase their contributions and that will impact earnings. However, the lender has plenty of ways to shield themselves from having to do this. The first is that when bankrupt firms' assets are liquidated the lender is usually first in line and receives a portion of every dollar back. Lenders can estimate this amount and carry it on the books as a receivable. Secondly, if the lender has excess reserves on its balance sheet, the bad loan can be eat those reserves without ever dipping into the bad loan fund. Thirdly, much of the lending was probably already turned into asset-backed securities and sold off to other entities. These transactions are too complex for me, but the way I understand it, the bad loans effectively get written off gradually each year as extra payments to the security holders. In lower quality securities, the buyer is on the hook for the loss, but writes it off gradually in the same way.

In this way, even despite record numbers of personal and corporate bankruptcies, lenders can say they're doing just fine, even thriving, and something like an Enron or WorldCom will not put any lenders out of business, or even slow them down much. The chief danger is from a rising interest rate environment that slows lending coupled with a slow economy that keeps loans going bad. While loan default risk is diffused through the financial system, it still does accumulate, like fat deposits in the arteries. Couple this with a couch potato lending environment and suddenly a major lender might find themselves in a liquidity crisis that has been building for years.

posted by Teddy | 7:39 AM |

Tuesday, August 19, 2003  

Rate rise claims first victim

Capitol Commerce Mortgage became the first victim of the recent climb in interest rates. It announced Friday it was going out of business. This doesn't affect just the owners of the company, it hurts brokers and customers, too.

Meanwhile, the suspicion about the staying power of the economic recovery continues to get press. Could it be because of the new record in personal bankruptcies? Or maybe it's another jump in gas prices on top of the costs of the most recent blackout?

In the interest of being fair and balanced, housing starts are up for July.

Hope they can sell those houses when they build them. Our collective 'rainy day funds' are now stretched very thin. Even during the boom times, 50% of Americans had less than three months expenses available for emergencies and 25% had less than one month of expenses. It doesn't look like the recession and slow recovery have improved matters. People should rightly be asking, "What if this recovery doesn't happen?", and prepare for it. There will certainly be people who will say that if we all start cutting our spending to save and pay off debts, we are sealing our own fate. But hasn't this thinking already been stretched to its logical limit?

posted by Teddy | 9:32 AM |

Monday, August 18, 2003  

Remember, keep smiling!

While Peggy Noonan is sleeping off her Xanax, fellow San Diegan TBogg is now stalking Fox News airhead Neil Cavuto.

posted by Teddy | 9:29 AM |

Strong dollar policy returning?

The dollar is rising against the Euro. But is that really what U.S. companies need?.

More people are starting to ask questions about the sustainability of the recovery in this environment.

posted by Teddy | 8:46 AM |

Mortgage markets out of control

Gretchen Morgenson who has written a number of timely articles for the Times since the pre-Enron days:

Until 2000, the United States Treasury market was the world's largest and most liquid. Now the government bond market is overshadowed by the mortgage-backed securities market. Treasuries and corporate bonds each account for about 22 percent of the Lehman Brothers United States Aggregate Index, a measure of the whole fixed-income market; mortgage-backed securities make up almost 35 percent.

This would not be a problem if mortgage traders and managers of big loan portfolios, like Fannie Mae, did not typically hedge their holdings with Treasuries. Holders of mortgages hedge by selling short Treasury securities with maturities roughly equal to the average life of the mortgages in their portfolio.

Now, the hedgers' needs can swamp the market they tap. This exacerbates moves in interest rates, producing a snowball effect that can push rates far lower or higher, and faster, than in previous years.

From June 13th to July 31st, selling in the Treasury market drove 10-year Treasury yields from 3.07% to 4.49%. Five-year treasury yields went from 2.05% to 3.38% Ms. Morgenson queries James Bianco of Bianco Research, who thinks this doesn't bode well.

"If you look at the last 15 years of bond market derivative debacles, a lot of them involved mortgages. These things have killed more people than any other trade...We wouldn't see these wild undulations in interest rates if they had already been hedged."

posted by Teddy | 7:49 AM |