THE BARRICADE

Below is the memo in support of Bloomberg’s MSJ, which was granted and is now subject to a stay pending appeal. This is a very sound and well reasoned legal and policy argument that persuaded the District Judge. We will see what the Government comes up with when they file their appellate briefs, but based on the Government’s REPLY BRIEF, I predict it will be something along the lines of, “if you don’t let the Fed operate in secrecy, then it will reignite a financial crisis, create a banking panic worthy of Hoover, and the Deathstar will destroy Alderan.”

From Hugh Hendry’s Latest Letter, and with comment from Barricade Contributors:

Good people are becoming desperate. I know a man who is planning to capitulate and buy stocks. He cannot comprehend what is happening today. He is, to employ Churchill, a fanatic; he won’t change his mind and he can’t change the subject. But, fearing the loss of his franchise, he will change his portfolio.

He laments that it is as though last year’s events never happened. Rhetorically, he asks whether we have all been sent through time to invest in equities at the end of the 1970s when stocks were cheap and society had thoroughly deleveraged (the opposite of today). “Why do other investors not contemplate the prospect of further household deleveraging when building their profit forecasts?” he fumes. “Can they not see that the private sector’s deleveraging is more than offsetting the public sector’s expansion?” Despite such ranting my Minskian friend remains a most entertaining and charming individual.

Now I know I have not covered myself in glory these last few months. Stock markets have gained 50% from their lows and the Fund has little to show for it except a modest reversal and no wild swings in our monthly NAV. Nevertheless, I would contend that this game of playing “chicken” with the market is not for us. Our ambition has been modest. To survive the onslaught of a positive change in social mood without being forced to capitulate in the face of a frenzy of optimism; so far so good, I think?

In this regard we have been helped immensely by a quote from Robert Prechter in early April. Having correctly called for a counter-trend rally in stock prices in late February, he then described the most likely nature of the advance, “…regardless of its extent, it should generate substantial feelings of optimism. At its peak, the President’s popularity will be higher, the government will be taking credit for successfully bailing out the economy, the Fed will appear to have saved the banking system, and investors will be convinced that the bear market is behind us.”

So far his prophecy reads well. It is reminiscent of Warburg’s line that the business cycle is “a subject for psychologists” rather than economists. Bernanke is already being compared favourably with Volcker. Continental Europe has apparently “escaped” from recession. Positive economic growth across the world for the remainder of the year seems certain. And yet Prechter went on, “Be prepared for this environment: it will be hard for most investors to resist. But beware… [the next move] will be the most intense collapse in stock prices”

This seems hard to reconcile with the determination of governments to resist the bear market; the more plausible Cassandra scenario remains something more akin to the long drawn out agony of the Japanese stock market. Nevertheless, let us assume that he is right, what could possibly generate such a black turn of events as to send stock prices back to challenge their March lows?

Not withstanding, of course, a tapped out private sector, lingering high levels of unemployment, capacity utilisation levels which never rally sufficiently to raise industry profitability, a speculative orgy in China which is likely to burst at some indeterminate moment and the complete uselessness of fundamentals in determining turning points.
Apologies, I am susceptible to my friend’s ranting after all.

Rain, rain, go away…

In attempting to answer the question of what could reignite a sell off in risk assets I have found myself returning time and again to my February 2006 investment report in which I drew the obvious parallels between the economic circumstances of the 1920s and today. The paper had the title, “Trees don’t grow to the sky”, and focused on the economic consequences of those periods when one country or region dominates world trade.

In the 1920s it was America in the ascendancy but something similar arose in the 1950-60s with the recovery in continental Europe, in the 1980s with the rise of the Japanese economy to preeminent creditor nation status and, of course, today with the rise in China. The one constancy is that unbalanced world trade has a tendency to pit domestic monetary policy considerations against international and, as a result of this tension, credit is created which fuels asset price bubbles and their resulting busts.

I want to spend some time reviewing such periods because I believe they suggest an outcome which challenges today’s near universal fears concerning the US dollar. I believe they reveal something distinctly non-consensual: that weakness in global economic demand can force the most painful adjustments not on the “sinful” low savings trade deficit countries but rather on the “virtuous” high savings trade surplus economies.

Consider for a moment the economic disequilibrium left behind by WWI. Europe was saddled with debt and America had become both a creditor nation and a net exporter. If economic orthodoxy had prevailed, the US should have imported more and the Europeans, especially the Germans, should have exported more. Under this scenario, gold, the international reserve currency, would have flowed from the US to Europe, and financed the latter’s reconstruction.

Ground Control:

The Federal Deposit Insurance Corp.’s fund that protects more than $4.5 trillion in U.S. bank deposits fell to just $10.4 billion at the end of June, as the banking industry continues to struggle with souring loans and regulators brace for pain in trying to clean up the mess.

The level of the FDIC’s fund, the lowest since the savings and loan crisis, almost guarantees that the government will have to hit the banking industry with another special fee to recapitalize its reserves. The agency said it had 416 banks on its “problem” list at the end of the second quarter, up from 305 at the end of March.http://online.wsj.com/article/SB125137695691263385.html?mod=djemalertNEWS

Pigpen: this is from a friend of mine who works for an private equity group in the US. he has been trying to buy small community and regional banks for the last year. here is his latest missive regarding our FDIC accounting and valuations.

OK, it’s a competitive world for bad banks:

Just got off the phone with another ibanker pitching a massively broken bank here in Chicagoland.  10% nonperforming/past due, mostly in land/dev loans.  Which we all know are going to be worth something like…well, not much, at best.

100% certain that this is another FDIC failure….someday, over the rainbow.

Here’s the kicker as to “Why you should think about this OPPORTUNITY”:  The bank has an $8MM note from a regional bank on it’s books….”If you put in equity capital, of course that note can be renegotiated.”

Really?  Hasn’t it already marked it down by both firms?  To a FMV close to, I don’t know…zero?

“Oh, no, they’re both holding it at par.”

This is the kind of insanity that is not in the news.  Banks holding loans to ‘walking dead’ banks…at par.

Green shoots!

Thought you’d love this:

I’m continuing to wade through the ‘zombie pools’ of small banks for sale, and came across a deal in Florida that is my current poster child for the mess we’re in.

Bank is a mortgage lender that has ~$10MM in equity.

They have $30MM–yes, $30MM!!–in past due and nonaccrual loans.

Their ibanker calls me up, tells me there is going to be the ‘opportunity’ to invest.  “Via the FDIC?” I ask.

Nope, as a minority stake investor at a premium to tangible book!  Management and the board will, of course, stay on, as they are ‘victims of the economy’.

Wow, such a deal….while I look for my checkbook, can you tell me why haven’t the regulators put these folks in leg irons yet?

Oh, not to worry, they’re switching regulators over to the FDIC!

This is what’s going on…..from the trenches.
Obviously, if the FDIC actually made the banks do anything that resembled real accounting, the banking system would be strewn with hundreds of critically undercapitalized banks.

My take is that the Feds know how bad the books are, but choose to look the other way in hopes that time (forebearance) will help some of the banks raise capital or earn their way out of the mess.

Of course, the number of salvageable banks is really small–most I’ve seen have no chance in hell of raising cash.

Here’s a rule of thumb:  if a bank only needs $5MM, they might be able to raise it locally via HNW investors.  If they need more than $5MM, they have little statistical odds b/c they need PE type money, and the PE guys can’t do most of the smaller deals b/c of ownership limitations and want to deploy sizable amounts of capital.

What you get is a system where the VAST majority of banks have no realistic chance of raising capital, and are either going to be closed, or will remain at the mercy of the FDIC and it’s Soviet-style accounting policies.

Community banks are toast–regulatory compliance costs and capital standard charges make $100MM firms worthless.  Minimum scale now thought to be $500MM ish….which makes a big percentage of the banks in this country targeted for extinction.

Also running:

Barney Frank Says Ron Paul’s Audit The Fed Bill Will Pass In October. Stunning. (Mish)

Inflation-Deflation Discussion Continues (Minyaville)

Expert Who Warned Levees Would Burst Fired

It has become clear over the summer that we are in a new stage of our long emergency.  Now is a good time to regard the signposts on this strange road.  The road to ruin or to redemption?  I don’t know yet, after all, sometimes it takes a truly ruinous crisis to change bad behaviour.  But for sure, social and political foundations are shaky, and we are ripe for some movement, some shock.  It looks more like Japan out here every day.  The imbalances are building up, and becoming more and more apparent. As my neighbor Carville said, “its the economy, stupid.”  But, of course, economic problems are the symptoms, not the disease.  The disease is a society devoid of values, and based on consumption.  And at this spot on the road, policy makers are doing whatever it takes to get more consumption going.  James Kunstler, author of  2005’s  The Long Emergency wrote in this week’s post:

“The greatest danger this society faces is its inclination to gear up a campaign to sustain the unsustainable at all costs — rather than face the need to make new arrangements for daily life.

So, what are we doing? Well, its two years since the “credit crisis.” What has changed?  We have fully socialized the risk of the biggest financial institutions, while allowing them to privatize their gains. Two years on, we see a system completely unreformed, returning to its old ways and habits fueled by government giveaways. We also see that none of the underlying problems: the housing market, leverage, securitization, moral hazard, exotic instruments, regulatory and political capture, debt and credit, fraud, and transparency and real accounting have even been touched. We have a system that is even more concentrated, where the books are more cooked, and where government and consumers are being ripped off to the tune of trillions by the most corrupt, least productive, and most wealth destroying sector of the economy. We are hearing a lot about an end to the recession, greenshoots, and recovery, but does anyone seriously think this can happen under these conditions?

Let’s start with the very first sign that we ever saw on this road, back in 2007: residential real estate.  Deutsche Bank (DBK GY) predicts 48% of US mortgages will be underwater by Q1 2011 vs. 26% Q1 2009, along with 61% of subprimes. So, the worst is not over, and we haven’t got to the bottom of the “L,” but don’t look for that to be reported by the most visible journalists. Dave Rosenberg wrote in today’s “Breakfast With Dave:”

The homeownership rate surged to nearly 70% during the bubble and has since fallen back to 67.4%, but still well above pre-bubble norms. A just-released study by the University of Utah shows that the rate of homeownership in the U.S.A. is poised to decline to 63.5% by 2020 (where it was in 1985). At a time when there are still some 800,000 units in excess that are vacant AND for sale, this secular decline in demand spells one thing and one thing only a secular deflation in residential real estate. The periodic months of “green shoot” stability will very likely prove to be little more than noise along a fundamental downtrend in pricing.

This analysis is simply being ignored by the mainstream, because their job-description has now become “cheerleader.”  The house-prices problem–not to mention the general real estate depression that includes more CRE properties every day–is only one aspect of the bigger problem: there is overcapcity in almost every part of the economy, almost everywhere in almost every business.  That means prices have to come down, that means that we need deflation, we need a downward adjustment.  Only by lowering “living standards” (read, consumption standards) across the board can we inhabit a system that is stable. Deflation is the solution, because it efficiently cures the gross economic imbalances that caused our viscous problems in the first place. A great post at Minyanville addressed the phenomenal overcapacity yesterday:

…I’m referring to the need to bring US economic capacity down to a much lower level of long-term domestic demand. Choose just about any industry in America and you will see too much capacity. Our debt excesses enabled it and now our debt destruction will require the elimination of it.

Just look, for example, at what’s underway with General Motors (GMGMQ), Chrysler, and Ford (F): Their entire supply and distribution chains are being downsized by at least one-third. And I’d offer that what’s happening at the auto companies is just the tip of a much larger economic iceberg. For what’s ahead, I think we need less, not more manufacturing; less, not more distribution; and particularly less, not more retail.

And it goes beyond typical industries. At the risk of encouraging hate mail, consider the current oversupply in private education, religion, golf courses, art museums – I could go on and on. There’s simply too much supply – and that’s even before one considers the changes in demographics and technology that are afoot.

What we’re seeing is the end of an 80-year expansion fueled by debt.  The current policy response injects more debt than ever into the system, to keep the  expansion going.  Growth for the sake of growth: the ideology of the cancer cell.  We will paper-over all problems with cheap money, while giving a big healthcare head-fake. This is creeping New Dealism.  But I don’t think it will continue to creep much longer–it will roar.  Exhibit “A” is the Clunkers.   Rosenberg:

We couldn’t believe this when we saw this quote from the U.S. Transportation Secretary (Ray Lahood) in yesterday’s NYT (page B3) on the “Cash for Clunkers” program: “There obviously is a real pent-up demand in America … people love to buy cars, and we’ve given them the incentive to do that. I think the last thing that any politician wants to do is cut off the opportunity for somebody who’s going to be able to get a rebate from the government to buy a new vehicle.”

Are you kidding me? If there is pent-up demand for autos why do we need a rebate? If there are 20% more vehicles than there are licensed drivers, why the need to perpetuate this cycle of overspending? Why is it a politician’s job to create incentives to spend? Shouldn’t they be focusing their attention on health, education, defense, infrastructure, public safety, job skills and productivity growth (and perhaps the youth unemployment rate of around 20%)? We’re not exactly espousing an Ayn Rand libertarian view but at a time when the deficit is running at 13% of GDP, at what point is enough? These rebates are not manna from heaven ? it’s a future tax liability to hasten a decision that the auto buyer would have made in any event.

This is just a desperate form of bubble reflation and it will prevail as none of the current policy makers will allow the necessary deflationary forces to take hold.  Quite the opposite.   As Paul Krugman told RTVE:

“We have the money to invest in another bubble, and sincerely, a bubble right now would help us a lot even though we would have to pay the price later. This would be a good time to invest in another bubble, and I think we have the resources to do so, and because there is a massive unemployment right now.

That pretty much sums up what Congress, the President, and the Fed are doing now, and expect it to ramp up steadily.  Why? Because, to follow the lesson of history would be politically unpopular in the short term.   After all, its the economy, stupid.  We need another bubble because we have no national savings, so we are attempting to create wealth by inflating asset prices and devaluing debt.  That ends poorly.  That ends in collapse.

At this point on the road, its more clear than ever that our country has failed its savers.  We need savers, yet we won’t raise interest rates to induce savings.  We keep rates low so week can speculate with damning leverage on houses, cars, and pure shit.  So leverage and specualtion are our national occupation, while our national motto has become “asset prices uber alles”

So, where are we going? Kunstler:

Attempting to maintain anything on the gigantic scale will turn out to be a losing proposition, whether it is military control of people in Central Asia, or colossal bureaucracies run in the USA, or huge factory farms, or national chain store retail, or hypertrophied state universities, or global energy supply networks….

Anything can happen now.  I certainly wouldn’t rule out international mischief as we arc around into fall.  The air is so full of black swans that the white swan now seems like the exceptional thing. Whatever else happens, it sure will be interesting to see the public’s reaction to Wall Street’s announcement of Christmas bonuses.  The folks at Rockefeller Center better be thinking about getting a fireproof tree.

We’ll see where we end up.  But where ever we do, its doubtful that we will get there without seeing the barricades go up, then aflame.  You know its bad when the Whitehouse is acknowledging that BLS UE will go over 10%.  What do you think that means for the real unemployment rate? Would you believe 16.5%?

Redux: Some  UE signposts:

Prehaps the best out there from Mish today: Dismal Unemployment Situation in Chart Form. See also, Bloomberg: American Incomes Heading Down.

The unemployment numbers are being manipulated, as its a critical part of the game of creating impression in the mind of the general public.  Joe Six Pack doesn’t analyze the numbers, he just hears them and takes them at face value.  However, you can keep telling everyone that things are getting better, that things will be fine, but as the real economy become more and more disconnected from the electronic one and the one presented on TV, then people will just get more saddended and discouraged by such incredulous dissonance.

For instance, how do we keep having net job losses and the unemployment rate drops? Who are they leaving off here? Are unemployed folks being exterminated to lower the rate?  No, they just stopped counting millions of them because that would make the numbers–and therefore the general perception–worse.  My vanilla ice cream tastes like chocolate because its brown. Unemployment fell by 267,000 to 14.5 million. The labor force declined by 422,000, which means the jobless rate fell because people dropped out of the work force, not because they got jobs.  There are just many millions of people out there who are not reporting to the unemployment offices but are yet jobless.

From the ZH chat board:

So what’s this slush bucket? Another 3 million not counted? And going up. Y/o/Y by 1mil. And Now we got the BO every day interpreting the economic news. With this much leeway getting an estimate so close to the numbers as GS did, is highly unlikely?

BLS:
About 2.3 million persons were marginally attached to the labor force in July, 709,000 more than a year earlier. These individuals, who were not in the labor force, wanted
and were available for work and had looked for a job sometime in the prior 12 months. They were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey.

Among the marginally attached, there were 796,000 discouraged workers in July, up by 335,000 over the past 12 months. Discouraged workers are persons not currently
looking for work because they believe no jobs are available for them. The other 1.5 million persons marginally attached to the labor force in July had not searched for work in the 4 weeks preceding the survey for reasons such as school attendance or family responsibilities.

This is not the Great Depression–its something more insidious.