Equities Aren’t a Bargain

Even if you don't buy my argument that there is plenty more downside to come as far as the U.S. economy is concerned, that doesn't necessarily mean you should acquire or own stocks.

Aside from the fact that revenues aren't keeping pace with profits and the latter are in many cases being pumped up by quick fixes that undermine future prospects -- as I noted yesterday in ""Wall Street's Gains Equal Main Street's Loss?" -- the reality is that equities simply aren't a bargain.

Indeed, the Pragmatic Capitalist says as much in a graph-filled post entitled "Is the Market Cheap":

I’ve compiled a few different measures of valuation for your consideration.   Regular readers know that I am not much a “value” investor.  Value, in my opinion is in the eye of the beholder.  Is Apple cheaper at a high PE than GE at a low valuation?   Perhaps yes, perhaps no.  Most valuation metrics are based on the guesses of the analyst community - something that I believe is entirely unreliable.  Nonetheless, here are a few measures to help you put things in perspective:

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My Latest Huffington Post Column: ‘Wall Street’s Gains Equal Main Street’s Loss?’

Below is my latest column for the Huffington Post, entitled "Wall Street's Gains Equal Main Street's Loss?":

Stock prices have been on a tear lately, bolstered by quarterly earnings reports that have in many cases outpaced expectations and growing optimism that the worst of the crisis-cum-downturn is behind us.

The S&P 500 index, for instance, is up more than 40 percent since its early-March lows, while the technology-laden Nasdaq Composite has scored a 13 percent gain -- and, through yesterday, a 12-session winning streak -- in the last two weeks alone.

Ordinarily, a bull run like this would be cause for optimism, on the belief that savvy investors see a light at the end of the tunnel. But in the currrent environment, could the good news that is powering share prices be bad news for the economy?

Consider the following recent reports from a cross-section of corporate America:

  • Microsoft announced that revenues declined more than 17 percent amid falling global demand for PCs and servers. According to the Financial Times, the world's largest software company "sounded a far more cautious note about the prospects for a recovery in the second half of 2009" and its CFO said 'it's going to be difficult for the rest of the year....We're really still not sure we're out of the woods.'"
  • The CFO of UPS, the 100-year old package delivery giant with a presence in 200 countries, warned the company didn't have "any confidence that either demand or activity is going to pick up substantially" in the next several months.
  • Diversified manufacturer 3M, with operations in 60 countries, cautioned that it's "still facing a challenging sales environment with no meaningful improvement in demand yet from several major industrial customers," the Wall Street Journal reported. "He added there is a risk that recent upticks in orders could be a 'false dawn' caused by an over-correction in inventory levels earlier this year by 3M's customers rather than a sustainable recovery in demand."
  • Texas Instruments, the second largest U.S. chipmaker, said "there's little evidence yet that real growth -- based on an improving market for cell phones, computers and other tech products, instead of inventory corrections -- is on the horizon."
  • The CEO of WPP, the world's largest advertising company, was less-than-diplomatic when he noted publicly that he saw "no green shoots", "no yellow shoots" and "no moss" in the global economy.
  • The Vice Chairman of General Electric, a company with 14 major lines of business and a presence in more than 100 countries, cautioned that "he isn't seeing an increase in orders even as U.S. economic statistics suggest the world's largest economy may soon shift to a recovery."

In sum, while a growing number of investors seem to believe that Main Street is on the mend, many of corporate America's senior executives -- who are normally not prone towards pessimistic outlooks -- are maintaining that they see no real evidence of a revival where it counts -- on the ground.

In fact, amid an almost single-minded focus on reported earnings results, many of which only appear favorable in comparison to the low-ball, company managed estimates that clueless analysts have come up with, Wall Street hasn't been paying much attention to just how dicey things look at the top of the income statement.

Yet as Karl Denninger of The Market Ticker and others have noted, many of the companies that have "beaten" expectations so far this season -- including several of those listed above and others such as United Technologies, Halliburton, AT&T, and Amazon -- have reported flat or falling revenues, with year-over-year declines in some cases of 30 percent or more.

One reason why so many businesses are apparently benefitting amid softening sales comes down to aggressive cost-cutting. They are slashing jobs, paring wages and benefits, scaling back capital expenditures and valuable R&D, and putting constant pressure on suppliers to reduce prices, forcing each of those in turn to do the same.

While such measures can provide a short-term boost to profits, it is revenues -- money coming in the door -- that keeps businesses growing -- and the economy humming. Morever, even where firms are seeing notable improvements on the bottom line, odds are that few will be looking to boost hiring without seeing solid evidence that sales are also picking up.

Finally, racy bull markets often provide a shot of growth-stoking confidence, encouraging owners and managers to think and act expansively, and investors and lenders to pony up funds that can help turn big plans into profitable opportunities. Not this time, however. The U.S. economy, slammed by the biggest financial crises this century, remains in a vulnerable state, and it is still exposed to numerous potholes and shocks, many of which are just now unfolding.

Among other things, the commercial real estate market is starting to implode, lending conditions are worsening and many credit markets remain frozen, no small number of financial institutions, including commercial lender CIT Group, are close to failing or are utterly dependent on continued public largesse, and, as noted above, employers are shedding jobs, not adding them.

Unfortunately, because stock market investors have decided to ignore reality in favor of false hopes and quick fixes, the euphoria they've spawned may inhibit at least some Americans from taking the steps necessary to cope with the challenging environment that companies like General Electric, Microsoft, UPS, WPP, Texas Instruments, 3M, and others still see around them.

Given all that, you might say that Wall Street's gain is their loss.


Another Crack Opening Up?

You see plenty of reports nowadays suggesting that financial Armageddon has been avoided. Meanwhile, "experts" in Washington and on Wall Street congratulate each other on their apparent success in preventing the crisis flood waters from breaching the financial system's levee walls.

In reality, all they've really done is plugged some of the initial gaps with funny money-filled sandbags -- just as a raft of other holes are beginning to open up. That's the thing about bursting credit bubbles: every time you think you've turned back the tide, more red ink suddenly starts flowing through the cracks.

What's more, these bubbling breaches aren't necessarily seen by those in charge as the spearheads of deadly surges to come. In many respects, in fact, that describes the miscalculation that occurred with Lehman Brothers.

Now, according to Dow Jones Newswires columnists Donna Childs and Sameer Bhatia, writing in CIT Poses Lehman-Like Risk," we may be poised to see it happen once again.

The implications of the capital crisis of CIT Group Inc. fill 24-hour news coverage and yet credit default swaps are near record lows and the markets appear calm, a peculiar disconnect given the events that followed Lehman Brothers' bankruptcy. What gives?

The century-old lender narrowly avoided a bankruptcy filing this week when it obtained $3 billion in loan commitments from its bondholders. Tuesday, documents filed with the Securities and Exchange Commission laid out steps that it will take to avoid bankruptcy, though it warned that any misstep likely would lead to a Chapter 11 filing. Who has correctly gauged the risk CIT poses to institutions, markets and the economy - the media, the markets or the government?

The market judged Lehman a serious matter. In the days preceding Lehman's bankruptcy, credit default spreads spiked. The Markit iTraxx Europe Senior Financials Credit Default Swap Index spread rose from 94 on Sept. 12 last year to 147 three days later, the date Lehman filed bankruptcy. The index spread peaked on March 6 this year, reaching 199, but it has since retreated to 114.

It appears anomalous that CDS spreads are near historic lows, despite a possible imminent collapse of an important commercial lender. So why haven't spreads moved significantly despite the media's scrutiny of CIT's crisis?

The likely reason is that markets clearly understood the systemic financial risk posed by Lehman's more than $350 billion counterparty exposure yet don't grasp the risks posed by CIT's exposure to the manufacturing, retail and commercial real estate sectors.

This may also explain why the U.S. government bailed out American International Group Inc., an entity it deemed too connected to fail given the significant counterparty exposure to other financial institutions, and yet appears unfazed by the risks posed by CIT.

Such a view is shortsighted. CIT factors the accounts of some 1 million small businesses, by which process it purchases their accounts receivable. In some cases, it advances cash against those purchases; in other cases, particularly with many Chinese institutions, it doesn't. Should CIT default, small businesses that believed they were borrowing from CIT would become unsecured creditors of CIT.

Many of those small businesses operate in the manufacturing, textile and garment industries. This appears to be a different type of risk exposure than that represented by Lehman or AIG yet it is nonetheless a real risk to the economy and by extension the global financial system.

The failure of Lehman precipitated a seizure in the credit markets from which the world has not yet recovered. The failure of CIT will likely precipitate similar seizures in both trade finance and commercial real estate markets. The attendant consequences will inevitably come back to haunt the larger financial institutions with exposure to these sensitive sectors.

The business news media correctly report that CIT has a 1% share of market for loans to U.S. small and mid-size businesses. Friday, The Wall Street Journal reported a pertinent fact: CIT services roughly 300,000 retailers and 1,900 manufacturers and importers, representing as much as $40 billion in receivables.

The CIT story is complex, mid-chapter and sometimes hard to read but it can't be ignored by the government, markets and financial institutions.


Is Fraud Really Bubbling?

As any savvy investor might, the first thing you should ask yourself when you come across or analyze an interesting data series is to try and figure out whether it is describing the past or hinting at the future.

Some economic indicators, like the unemployment rate, for example, have not been particularly helpful when it comes to identifying turning points in the economy.

One reason is because hiring and firing staff can have serious consequences for any business, and the point at which such decisions are made often comes when employers are forced -- or absolutely convinced they need -- to take drastic action.

However, as with the financial markets, that highly-charged moment when a lot of people are doing the same thing often represents the point at which much of the news -- whether good or bad -- has been factored in and a reversal is near.

There are other reasons, of course, why apparent trends aren't necessarily predictive in nature. In my view, one example likely includes the accelerating pace of growth of allegations of financial miscreancy detailed in the Economist article that follows, "Fraud Reporting."

While it is certainly possible that criminal activities of this sort are burgeoning, based on past history, at least, I reckon that a heightened focus by law enforcement agencies on financial chicanery, fears about the health of markets and the economy, and a generalized loss of trust in the wake of last fall's meltdown and the Madoff affair are probably the real reasons for the surge.

Given what's happened so far, one would naturally expect that more longstanding frauds would suddenly be exposed because time or the money has run out, while paranoia and uncertainty is probably spurring many individuals to suspect the worse in their various dealings with others.

I guess we'll know soon enough.

The rise in financial crime in America

Over 730,000 counts of suspected financial wrongoing were recorded in America last year, according to recent data from the Treasury Department's Financial Crimes Enforcement Network. Institutions such as banks, insurers and casinos are required by law to report suspicious activities to federal authorities under 20 categories. Financial institutions filed nearly 13% more reports of fraud compared with 2007, accounting for almost half of the increase in total filings. The number of mortgage frauds alone rose by 23% to almost 65,000. But not all categories saw an increase: incidents suspected terrorist financing fell. Just under half of all filings are related to money laundering, a proportion that is little changed in over a decade.

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The Tales of Today

"Takes no nerve to do something, ain't nothin' else you can do."
--"Tom Joad"

TomJoad

(Actor Henry Fonda as "Tom Joad" in The Grapes of Wrath; image courtesy of IMDb.)

Although I've argued in my books and at my blogs that I don't expect to see a repeat of the Great Depression, that doesn't mean there won't be hard times and tragic tales. In "Has Anyone Seen the American Dream?" the Toronto Star journeys through locales made famous in the 1940 film (and in John Steinbeck's 1939 novel), searching for the sad stories of today.

WEEDPATCH, Calif. – Like a latter-day Tom Joad, one of America's last Okies ponders a question that was 1,500 miles in the making. After a life spent climbing out of the Great Depression, perhaps he can tell us what has become of the American dream.

Still spry at 74, Earl Shelton is the most robust of a vanishing breed – one of the million-plus that scrambled out of the dust clouds of the American Midwest during the dirty thirties to seek salvation in California. His was the migration of desperation immortalized in the dark, foreboding Grapes of Wrath, John Steinbeck's telling of the fictional family Joad.

Shelton too has been wondering about then versus now. Wondering whether this formidable country still has the stuffing his kind had. The sheer stick-to-it-ive spirit to crawl back.

"Times were harder then. Way worse than now. That's a fact," says Shelton, who claimed his share of the American dream the old-fashioned way. Decades of hard work that began at age 7 here in the San Joaquin Valley, filling 23-kilogram sacks of potatoes. He married, bought a house that is now his, not the bank's, raised a family bound for what everyone thought was a better life. Until now.

"So you have to say since we came back before, we'll do it again. The American dream is still there. It is who we are."

But Shelton has his brooding doubts, and in this, he does not differ from all manner of Americans met by the Star during this Dust Bowl journey from the backroads of Oklahoma to California – the same path Shelton rode with his dad and brothers after their mom died of tuberculosis and the farm blew away.

Americans are confused.

The U.S. Treasury says the country owes $1-trillion, a lot of it to the Chinese. Job losses are horrendous: 467,000 in June alone. But Goldman Sachs and JPMorgan Chase are pulling in millions of dollars. The U.S. government has had to bail out General Motors and inject a $787 billion, two-year stimulus package into the economy. The housing market has tanked, but consumer confidence is improving. Is America in recession, or not?

"Something's different this time," Shelton says. "Americans are different. I call it the 'Instant Generation.' All these years, people want something, they just go get it, even with no money to pay for it. And now look at the mess we've got.

"All these years, and I still don't have a credit card. Makes it hard to cash a cheque sometimes, but can't say I'm sorry."

You can write them off as the words of a grumpy old man. But there's nothing grumpy about Shelton, who remains a living signpost to history.

In this first summer of Barack Obama's presidency, you won't find many dancing the 'Yes We Can-Can.' Instead, there is more scramble than dance – like that telling nanosecond in a game of musical chairs, when the music stops and everyone rushes for a seat.

And many aren't yet sure whether – and for how long – they'll be left standing. All they know is the answer is no longer in California, the once promised land.

It didn't seem nearly so bleak five states back, when we knocked on the door of "Uncle" Dick Mayo, the unofficial keeper of Great Depression lore in Sallisaw, Okla.

Mayo is seventy-something, yet too young to remember when Steinbeck passed through town in the 1930s, fixing Sallisaw as home to the fictitious family Joad, whose jagged travails would ultimately win the novelist both Pulitzer and Nobel prizes.

But he vividly recalls the fall of 1939, when Hollywood came to town to film a somewhat sanitized version, starring Henry Fonda, of what was then considered a very dangerous novel.

"Why did Steinbeck choose Sallisaw? We've always wrestled with that, because the truth is, our part of Oklahoma survived better than others. Did he just like the sound of the name?" Mayo wonders aloud.

Until Steinbeck accorded it literary fame, Sallisaw was best known as the hometown of Depression-era bank robber Charles "Pretty Boy" Floyd. Another Oklahoman, Woody Guthrie, would later romanticize Floyd in song, playing up his generosity to the poor with fight-the-power disdain: "Some will rob you with a six-gun and some with a fountain pen."

But you won't find even a whiff of such unrest in Oklahoma today. The farms are verdant, the soil is moist, and the living, if not easy, is as comfortable as any in America today.

On the open road, Oklahoma is a wonder of red clay and green harvest. Its panhandle hosts a forest of wind turbines that generate power to thousands of homes. The unemployment rate is about six per cent, compared with once-golden California's almost 12 per cent.

Mayo and others remind us that though the recession is biting gently in the Midwest, there was no housing bubble here waiting to burst. For whatever reason – collective memory? – middle America did not draw so deeply when the cheap credit flowed, inflating the coastal cities.

"We don't depict the Grapes of Wrath anymore. Now it's California's turn," said Judy Martens, executive vice-president of Sallisaw's Chamber of Commerce. "We're not saying it's perfect, but it is beautiful. There's hunting, fishing galore. And there are a pretty large number of nursing homes here that provide plenty of jobs. That's not slowing down, that's a growth industry."

Most people don't think Great Depression when they conjure Route 66, but long before Nat King Cole and the Rolling Stones sang "get your kicks," this quintessential American highway was the corridor of 1930s deliverance, even as its first concrete slabs were being poured (with the help of federal stimulus dollars). The term "Okie" never captured who they really were – not just Oklahomans, but destitute farmers from Kansas, Missouri, Texas and beyond – all spilling upon this road, Westward-bound, their worldly goods piled high on ancient jalopies wired together with hope.

In the 1960s, Route 66 evoked glamour: many boomers will recall the TV series, Route 66, in which two young men drove across America in a Corvette convertible.

But even then the highway's days were numbered. Someone was dreaming up faster routes, the Interstate Highway System.

Moving west into the Texas Panhandle, distress is soon found in Amarillo's burnt-out north end, where we encounter drifters by the dozens sheltering in the shade of the Tyler Street Resource Center. Here is an oasis the Joads never found 75 years ago – a place where those who wash up or wash out in Amarillo can go for a hot meal, a hot shower, and a gas voucher to get them somewhere else. Here's your hat, what's your hurry?

Talking to the drifters yields spasms of personal misery. Steve, 37, rode a 12-speed bike all the way from North Carolina. Bad eyesight, he tells us, cost him his driver's licence back home. And that's about when his house renovation work dried up. He sold his stuff, bit by bit, to pay rent. And when all that remained was a bicycle, he climbed on top and ended up here. "This is just a rest for me. I'm headed northwest, Oregon. I'm still young. I've got my BA," says Steve. "I figure I can make a life up there. It's gotta be better than where I've been."

Richard Ware, head of the Amarillo National Bank, has just crunched a new run of numbers that suggest his corner of Texas is weathering the downtown rather well. Texas' unemployment rate is two points below the national average, according to The Economist.

"We still have a circle-the-wagons mentality," says Ware, who notes 7-Eleven can't make a go of it in Amarillo because locals favour the homegrown chain of convenience shops, Toot `n Totum.

Ware estimates Amarillo's present downturn to be one-fourth as severe as that of the dirty thirties. More tellingly, he says the early 1980s recession was twice as bad as this.

"We learned a lot, not just from the `30s but from the pain we went through in the `80s," says Ware. "We try not to attract businesses that boom because whatever booms eventually busts. We don't bet the ranch, we don't speculate excessively – and so we entered this downturn with less debt and a lot more financial strength."

New Mexico, one state westward and several notches poorer. Another crossroads.

We enter the desolate ascent to Santa Fe. This is where the original Route 66 ran before it was rebuilt in 1937, when the Dust Bowl blew worst. Here, Steinbeck's family Joad blew a rod bearing in the '25 Dodge and found themselves stranded, without water. Where Ma Joad, fearing the family was about to break apart, seized the tire-iron and promised to go "cat-wild" on any in the clan who would dare go it alone. "All we got is the family unbroke," said Ma. "I ain't scared while we're all here, all that's alive. But I ain't gonna see us bust up."

What would Ma Joad make of today's Santa Fe: a multicultural bastion of liberalism, adobe art galleries, tony boutiques and cafes, dressed up and waiting for the tourists. Santa Fe is inoculated from the recession's worst ravages by the sheer surfeit of government jobs – but it depends also on the deep pockets of an international jet-set on the wane. A year ago, you might bump into an Italian race car driver in these parts, dropping thousands on a vintage wristwatch and retreating to his southwest vacation condo to admire the acquisition. It's that kind of place. Nowadays, the watchmakers are hurting like everyone else, victims of the credit crunch.

"Santa Fe looks like it's thriving, but right now it's terrible," said Paula Scarpellino, a United Way official who stresses she is speaking as a citizen, not on behalf of the agency.

The "galleries are hit real hard because the tourist dollars just aren't coming in," she added. "I don't think this is necessarily a bad thing. It's made us take a step back and think about our place in the world. It is scary when China owns almost all your debt. This is forcing us to reflect on what is really important, what we actually need to survive."

But away from Sante Fe, the going is less rosy. We veer left to the gritty workaday city of Albuquerque, where low wages have long been the prime attraction for new business, and the people we meet share fears that their grip on the bottom rung of the middle-class ladder is starting to loosen.

"I never called in sick a day in my life. And then I was laid off in November. Now I'm scared," says Gilbert Chavez, 49, a father of three who was accustomed to $27 an hour as a paint-and-body man, fixing fender-benders. We find him in Albuquerque holding a picket sign at a union protest site. He's not actually in the union, but he's getting $8 an hour to hold that sign and, barring anything better, it will do.

"Right now, people with skills will take whatever they can get. But you can't feed a family on $8 an hour. I could register for food stamps, but I'm too proud to ask the state to feed me. This is bad."

At Albuquerque's Storehouse food bank, a sign on the front door forewarns that demand exceeds supply, discouraging new applicants. But inside, aid workers arranging heaps of canned and dry goods say they are breaking their own rules to provide whatever help they can.

"The needs have been steadily increasing since 2008," says volunteer Dana Todd, 24, who deals with the hungry as they enter for help. "What we're doing is designed to take some pressure off the working poor – laid-off architects, teachers, all kinds of people. If we can take $30 of pressure off them with a bag of groceries, in some cases, that can be the difference between having a home or ending up on the streets."

Kitty-corner from the Storehouse, we find dozens of homeless men and women milling about, awaiting their turn at a church-sponsored soup kitchen. Most are from elsewhere. Joseph Forshee, 42, has been living city to city, mostly on the streets, ever since Hurricane Katrina blew him out of his hometown of Biloxi, Miss.

"I'm an experienced casino worker. And there are plenty of casinos around but nobody is hiring." He's going to try Denver next. He hears there may be work there.

California. The Promised Land. Where authorities this month began issuing promissory notes – IOUs – in lieu of hard cash. Already, these notes have made their way to Craigslist and other online sites, trading upwards of 80 cents on the dollar. The buyers believe "Governator" Arnold Schwarzenegger will make good, once he ferrets a way around that $26 billion state budget shortfall that has paralyzed politicians of all stripes. Deep cuts are inevitable.

Unemployment is at 11.5 per cent – crippling numbers for a $1.8-trillion California economy, larger than Canada's or any other state in the union. A full 40 per cent of respondents tell the L.A. Times they have "seriously thought about leaving Los Angeles," citing traffic, joblessness, crime and poor public schools.

And, adding insult to injury, drought. This is year three of the ongoing California water crisis, with rationing extending now to the San Joaquin Valley itself.

In Barstow, an early morning visit to a U-Haul shop provides anecdotal evidence to suggest the exodus has begun.

"Lots of people are going to Texas," says shop clerk Vernon Ausby Jr., 38. "Better chance of work there and cheap rent. Like $575 for a three-bedroom place. Pretty tempting."

Ausby was a plumber until three years ago, when the housing market went south. And then he burned through every dollar of his 401(k) retirement plan, making ends meet for his wife and four daughters, aged 11 to 18.

And now here he is at U-Haul, earning $8 an hour helping people flee the state. Ausby's voice rises as he describes the indignity of working for a third of his former salary. But he is grateful. "Without this, Lord knows where I'd be."

Our last Okie, Earl Shelton, is waiting at the gates of Weedpatch at the end of the road: Wide-brimmed Stetson on his head, a silver buckle beaming "Earl" from his belt for all the world to see.

This is the actual camp from which Steinbeck gathered the bulk of his reportage for Grapes. And the camp where Shelton stayed from age 7 till adulthood, tucked away in "class" isolation with fellow Okies. Despised by Californians, they were safe inside the federally protected tents and tin shacks. The local law couldn't enter without a warrant.

And though its name has been changed to Sunset, Weedpatch is still a migrant camp. Soon the mostly Mexican field hands will arrive to begin harvesting the valley's irrigated seasonal fare. Conditions are better now. The tin shacks are long gone, tidy single-storey, wood-framed cabins in their place.

Shelton remembers the journey with his father, Tom, and three brothers in the old Model A. Losing a wheel on the way to Needles. And pulling up short in Arizona, where his dad was down to his last nickel – only to be saved moments later with the offer of paid work as a ranch hand. The barriers eventually broke down, as they always do. The Okies spread out, married. And nearby Bakersfield took on a sound of its own in the hardscrabble country music inspired by the transplants, Buck Owens its best-known exponent.

"I don't have any answers about where this country is going," says Shelton. "But I know this: you don't need a lot to be happy in this world. And here at Weedpatch, we didn't have much – but we were happy. That's the thing I want to say most. This was a good place. It made me who I am."

This is the first in a series about Hard Times in America.


Cunning Realist Does It Again

The Cunning Realist has done it again: he's uncovered an oldie-but-goodie quote that seems to sum up the analytical capabilities of at least some of those who are charged with looking after our nation's economic interests.

"It's a safe banking system, a sound banking system. Our regulators are on top of it. This is a very manageable situation."

-Hank Paulson one year ago today.

One question: are these the words of a liar or a moron?


When Did We Agree to This?

Is it just me, or are people throwing around some mind-bogglingly large numbers without even thinking twice about it?

Otherwise, I know my memory is fading with age, but when did we agree to commit a sum equivalent to twice the size of our economy, as the Wall Street Journal reports in "Government Tab for Crisis Could Hit $23.7 Trillion, Official Says," to bail out the banks -- and the banksters -- who got us here to begin with?

Government support aimed at cushioning the effects of the financial crisis in the U.S. could reach $23.7 trillion, a special inspector general overseeing U.S. bailout efforts planned to tell Congress on Tuesday.

In prepared testimony for a hearing of the House Committee on Oversight and Government Reform, Special Inspector General Neil Barofsky said the figure included spending and commitments for several agencies that have implemented programs aimed at supporting the economy and the U.S. financial system.

"TARP does not function in a vacuum," he said, referring to the government's $700 billion Troubled Asset Relief Program--its most visible effort to counter the financial meltdown.

The top Republican on the oversight committee, Rep. Darrell Issa of California, blasted the figure provided by Barofsky, saying "If you spent a million dollars a day going back to the birth of Christ, that wouldn't even come close to just $1 trillion--$23.7 trillion is a staggering figure."

Mr. Barofsky provided a breakdown of the government's TARP expenditures in his testimony, saying Treasury has disbursed $441 billion of the nearly $700 billion authorized under TARP legislation.

The government has called the programs investments, but officials have conceded that some of those investments--such as $2.3 billion provided to CIT Group Inc., which is seeking last-minute rescue financing from bondholders--could result in losses for taxpayers.

All I can say is that by the time Washington is done destroying "fixing" the U.S. economy, our "leaders" will probably be needing lessons in fundraising from the young man featured in the following CNN report, "Ohio Boy Sells His Toys to Help His Family":

An 11-year-old Ohio boy is helping ease his family's financial burdens, one toy at a time.

Zach McGuire is selling his toys to raise money for his family, which like others across the country, has bills piling up and a home in jeopardy.

The youth said the idea came up during a conversation with his father.

"You can't live in toys, or eat toys," he told CNN television affiliate WNWO. "Even though they are fun, you don't need them."

Zach plans to use the proceeds for a good cause: helping his unemployed father.

Tom McGuire, a licensed contractor in Toledo, Ohio, has not had a job since December. The economy is partly to blame, he said, adding that he did a job last summer and never got paid.

As the general contractor on the job, he said, he was financially liable for materials and the work of two subcontractors. "I'm out $30,000," McGuire said.

The father said he is looking for work and is not relying on money from his son's toy sales. But he appreciates his effort.

"Zach has a big, giving heart," McGuire said. "He came to me with this idea. He wants to contribute."  Watch how Zach McGuire is helping his family »

It's not the first time Zach has helped those in need. In 2005, he sold Kool-Aid for victims of Hurricane Katrina and raised $400. A few years later, it was "Cocoa for California," which he sold to help wildfire victims.

"I am very proud of him," McGuire told WNWO. "He is an 11-year-old boy not living the life of an 11-year-old."

Zach said everyone can do something.

"Even though they don't feel like they could do anything, they could do a Kool-Aid stand, like me," he said. "It's what you're doing that matters and how you're helping people."


Nothing But the Facts

All we want are the facts, ma'am.
--
"Sergeant Joe Friday" (actor Jack Webb) in the TV series, Dragnet

Like most people, I prefer good times to bad. Even though I correctly anticipated that the imbalances and excesses of the past would lead to an unhappy ending, it is not something I wanted to happen. In fact, I've often said that I wish I'd been wrong. I have friends and family who've been hurt by the events of recent years and who may suffer even more as the Great Unraveling continues to play out.

Still, that doesn't make me suddenly want to close my eyes and imagine I can see things that aren't there. In the end, it doesn't do me or anybody else any good to paint a picture of the kind of world that exists in the minds of permabulls and certain TV pundits. Instead, it is better to try and see things for what they are, warts and all. With that in mind, it's hard to disagree with the facts or conclusion presented by my friend Barry Ritholtz, in a post at his Big Picture log entitled "7 Reasons Why Housing Isn’t Bottoming Yet":

Yesterday, I posted this chart and wondered why “Some people were calling for a housing bottom.” That generated a ton of emails asking about for further clarification.

The people I referred to were the usual happy talk TV suspects (and Cramer) who have been perpetually wrong about Housing for nigh about 3 years. I not only disagree with them, but don’t respect their opinion — essentially headline reading gut instinct big-money-losers. No thanks.

Then there were the slew of MSM who insist each month on reporting that 3% (+/- 11%) is a positive integer. We disposed of that silliness on Friday.

But the crux of the email was over this post. There are a handful of people whom I disagree with, but nonetheless have a great deal of respect for their methodology and process. Over the past year, these have included Doug Kass and Lakshman Achuthan and Bill of Calculated Risk. We may reach different conclusions about a given issue, or disagree on timing, but these are the folks whose opinions force me to sharpen my own.

When I tossed up that chart yesterday,  I had not yet seen Bill’s comments on the subject — but he is one of those people I can respectfully disagree with. We simply have reached different conclusions about the timing and shape of the eventual Housing lows.

There are a plethora of reasons why I believe we are nowhere near a bottom in Housing prices or activity. Here are a few:

Prices: By just about every measure, Home prices on a national basis remain elevated. They are now far off their highs, but are still remain about ~15% above their historic metrics. I expect prices will continue lower for the next 2-4 quarters, if not longer, and won’t see widespread Real increases for many years after that; Indeed, I don’t expect to see nominal increases for anytime soon;

Mean Reversion: As prices revert back towards historical means, there is the very high probability that they will careen past the median. This is the pattern we see after extended periods of mispricing. Nearly all overpriced asset classes revert not merely to their historic trend line, but typically collapse far below them. I have no reason to believe Housing will be any different;

Employment & Wages: The rate of Unemployment is very likely to continue to rise for the next 4-8 quarters, if not longer. This removes an increasing number of people from the total pool of potential home buyers. There is another issue — Wages, and they have been flat for the past decade (negative in Real terms), crimping the potential for families to trade up to larger houses — a big source of Real Estate activity.  Plus, more unemployment means more . . .

Foreclosures: We likely have not seen the peak in defaults, delinquencies and foreclosures. Many more foreclosures — which are healthy in the long run but wrenching during the process of dislocation — are very likely.  These will pressure prices yet lower. And Loan Mods are not working — they are redefaulting in less than a year  between 50-80%, depending upon the mod conditions themselves.

Inventory: There is a substantial supply of “Shadow Inventory” out there which will postpone a recovery in Home prices for a significant period of time. These are the flippers, speculators, builders and financers that are sitting with properties that they do not want to bring back to market yet. Given the extent of the speculative activity during the boom years (2002-06), and the number of foreclosures so far, my back of the envelope estimates are there are anywhere from 1.5 million to as many as 3 million additional homes that could come to market if prices were more advantageous.

Psychology: The investing and home owning public are shell shocked following the twin market crashes and the Housing collapse. First the dot com collapse (2000-03) saw the Nasdaq drop about 80%, then the Credit Crisis of 2008 saw the unprecedented near halving of the market in about a year. Last, Homes nationally have lost about a third of their value since the 2005-06 peak. Total losses to the family balance sheet of these three events are about $25 trillion dollars. These losses not only crimp the ability to make bigger purchases, it dramatically curtails the willingness to take on more debt and leverage. Speaking of which . ..

Debt Service/Down Payment:  Far too many Americans do not have 20% to put down on a home, have poor credit scores, and way too much debt. All of these things act as an impediment to buying a home. At the same time, to get approved for a mortgage, banks are tightening standards, including 1) requiring higher Loan to Values for purchases; 2) better credit scores to get approved for a mortgages; 3) Lower levels of overall debt servicing relative to income for applicants. Yes, the NAR Home Affordability Index shows houses as “more affordable,” but it conveniently ignores these real world factors.

Deleveraging: For the first time in decades, the American consumer is in the process of saving money and deleveraging their balance sheets. After a 40 year credit binge, its long overdue. The process is likely to go on for years, as a new generation is losing confidence in the stock market, Corporate America and their government. Think back to the post-Depression generation that were big savers, modest consumers, who eschewed credit and borrowing.  The damage is going to take a while to repair.

There are more reasons I expect the Real Estate market to remain punk for many years, but these are a good place to start when considering the question.

The Housing Boom & Bust, and the 2002-07 credit bubble created massive excesses. More than anything, it is going to take time to resolve them.


Rediscovering the Cooperative Spirit

I've written a number of posts over the past few years -- including "Signs of the Times," "Life on the Boulevard of Broken American Dreams," "Rediscovering Old Habits," "It's Not Just Consumers Who Are Making Adjustments," and "The New Three Rs" -- discussing how Americans are jettisoning old habits and adopting new ones that are more in keeping with the times. People are reusing, reclaiming, recycling, repairing, and cutting back, and as the Washington Post reveals in "Recession Lesson: Share and Swap Replaces Grab and Buy," they are also rediscovering the cooperative spirit.

The recession is reminding Americans of a lesson they first learned in childhood: Share and share alike. They are sharing or swapping tools and books, cars and handbags, time and talent.

The renewed desire to share shows up in a variety of statistics: A car-sharing service has had a 70 percent membership increase since the recession set in. Governments are putting bikes on the street for public use. How-to-swap Web sites are proliferating.

"I think what happens in a recession or any sort of economic contraction is that you have not only a loss of financial resources, but also you have a loss of emotional resources," said Shawn Achor, a Harvard University researcher and a consultant on positive psychology.

"You don't have as much of the money or security or confidence or pride that goes with financial success," he said. "Our brains try to seek out those resources that are lost. The financial resources are beyond our control, but the emotional resources are not. And we seek out each other. We rely on each other."

The economy reflects the way Americans have cut back, especially on discretionary items: Department store sales dropped 1.3 percent in June. People are not buying cars, and auto sales dropped 27.7 percent last month. They are not paying others to do what they can do themselves -- Home Depot reports increased attendance at in-store do-it-yourself clinics. And although paint sales are down in general, according to Sherwin-Williams, individual consumers are still buying.

When Tom Burdett needed to cut some tile at his home outside Annapolis, he refused to buy expensive tools. So he asked his neighbors and friends for help. Sure enough, someone had just what he needed. And when that friend needed help installing a satellite dish, Burdett volunteered.

"I'm not going to go out and buy a $500 tile saw just to do one project," said Burdett, a television producer who lives in Edgewater. "Just ask for help and help people out. I think the economy has kind of woken people back up to the old way of doing things instead of the crazy '90s of 'Oh just go out and buy it.' "

The sharing mind-set is not new to the American culture, but many Americans abandoned it when the nation shifted from an agricultural society to an industrial one, said Rosemary Hornak, a psychology professor at Meredith College in Raleigh, N.C. They moved farther from their families and did not have time to connect with new neighbors because they worked so much, she said.

Now that people are experiencing financial distress, they don't want to be alone.

"You can't change the economy. You can't change the recession. Maybe you can get a better job, but that won't be instantaneous. What do you do?" she said. "Sharing is one of the things that first of all makes you feel better about yourself. . . . We're moving into 'How can we establish these kinds of personal connections, this helping others, sharing, being a bit more neighborly?' "

Neighborhood conversations tell more of the story as the movement grows organically in communities across the Washington region and the nation. On one street in Arlington, for instance, neighbors are chipping in for mulch and dividing it among themselves.

Liz McLellan, a Web designer in Oregon, started a free yard-sharing community at Hyperlocavore (http://hyperlocavore.com/) in January. Friends, relatives or neighbors create a group, pool their resources and start a garden, then distribute the produce equally. The recession gardens, as she calls them, can save families with two children up to $2,500 a year.

"We have people who are foodies and have become accustomed to outstanding taste and freshness," she said. "We have people who simply are trying to make ends meet."

In February, Robert Morse of New York started DaveZillion.com -- named for a friend known for helping his neighbors before he died at age 43 -- to connect groups of people who want to help one another out on home projects or share tools.

"We hear stories about guys who have no money to go golfing anymore and are going to each other's houses and helping each other paint the house or fix the patio," he said.

Women have flocked to the Web site BagBorroworSteal.com to borrow or rent luxury bags and other accessories. Users of a book-swapping Web site, Bookmooch, have increased 30 percent to about 124,000 since the beginning of the year. The membership of the trading site SwapTree has grown tenfold in the past year.

"We're kind of coming out of an opulent time," said Mark Hexamer, co-founder of SwapTree. "People have seen the bad side of mass consumerism. Now everyone is kind of looking for ways to cut down on the family budget."

Since the recession started, car-sharing company Zipcar has had a 70 percent increase in membership to almost 300,000. Sixty percent of the new members said they had sold their cars or abandoned plans to buy them and decided instead to use Zipcar, which charges a small annual fee.

"The downturn in the economy has people thinking of buying less and sharing more," said Scott Griffith, chief executive of Zipcar.

Local governments and faith organizations are joining in. Arlington County runs Commuterpage.com to help residents carpool. For a $40 annual fee, the District offers access to 120 bikes at self-service racks around the city.

Chris Ganson, 35, a city planner, has embraced the sharing mentality in several ways. He has joined the city's Smart Bike program as well as Zipcar. "It's convenient and it saves money," he said.

Ganson also shares a house in Adams Morgan with five other people. He pays $955 a month for a room with a private bathroom, about $600 less than for most one-bedroom apartments in the neighborhood. "It's a great thing for times like these," he said.

Emily Richards, 27, a Falls Church marketing consultant, shares books with her mother-in-law, sister-in-law and friends. Whenever she visits her four sisters in Alabama, she uses their clothing so she does not have to pack a big bag and pay extra baggage fees. She also recently let a friend borrow the vases that were part of the centerpieces at her wedding. That friend is going to use them at her wedding.

"I think I'm very frugal by nature, but it's nice to know that other people have embraced that mind-set," she said.

When the economy started getting worse, a friend persuaded Burdett to join DaveZillion.com with him. Burdett and his neighbors used to hire a handyman for small home projects. That is now a luxury. "With the recession, no one has extra cash," he said.

Burdett's network grew to about 13 friends and friends of friends. In addition to the tile saw, he now has access to other tools such as air compressors. He also does his share of helping. He recently erected a fence around a friend's father's house.

"Almost everyone I know has lost a lot, I would say half of what they had as an investment," he said. "People are helping each other and getting back together. You're not the lone ranger anymore."

(Hat tip to JC.)


Persistent Ignorance

It's funny -- or sad, depending on your perspective -- how those who supposedly know best -- the highly paid "experts" on Wall Street -- keep misreading what is happening in the real economy.

For example, all signs point to the fact that what we have been going through these past few years is not just a garden-variety recession, but a full-fledged meltdown spawned by the bursting of the biggest credit/housing bubble in history.

Yet the "Wrong Way' Corrigans" who never saw the unraveling coming, who insisted that the crisis would remain "contained" or otherwise end quickly, who kept seeing rebounds and bottoms that never quite materialized, and who are now proclaiming an end to the "recession" -- their word -- persist in trying to mislead or confuse the masses with their profoundly ignorant assurances.

The latest delusion is the notion that allegedly "good" earnings from corporate America herald the beginnings of an economic recovery. In "The Thesis Continues To Validate: GE," The Market Ticker's Karl Denninger puts paid to this silly theory.

GE (NYSE: GE) was out this morning with earnings and continues to validate my central thesis: severe economic contraction.

Revenues were down 17% - another double-digit contraction, and this is particularly troublesome in what it says about the global economy, given GE's global reach.

Again, we continue to see the same sort of theme in industrial and consumer products reporting - Harley Davidson (NYSE: HOG) reported units shipped down 30% year over year yesterday, and now GE out with a 17% year over year revenue decline.

Stocks are, at their core, priced on earnings growth, with the most-common ratio used for such metrics being P/E/G, or Price-to-earnings-growth.

But earnings are not growing, they're contracting - dramatically - in percentage terms over year-ago levels.  How can it be otherwise?  Even with no inefficiencies due to firms having too many employees for the revenue contraction that is occurring, a 30% reduction in business done should lead to a 30% decline in profits earned.  Add to that the fact that firms are nearly always behind the curve and you have profit declines that are much larger - in some cases 100% or even going from a profit to a loss.

This is not a circumstance that will reverse in the immediate future; in order for it to do so, revenue must come back up, and in order for revenue to come back to pre-bust levels, we would have to re-inflate the credit bubble - which simply cannot happen.

Multiples are going to continue to contract.  Those analysts and market callers who are all over the momentum trade can in fact make a good buck trading the momentum, but that's all they're trading - they sure aren't trading earnings acceleration or even stabilization.

The move in the market off the 666 levels in March has been driven by a false premise, egged on by CNBC and the other "mainstream media" - that this is a typical recession, it is short-lived, and we will soon go back to previous spending and business patterns.

That is not going to happen, yet it is what everyone in the media and analyst community is looking for and basing their valuation and market timing calls on.

I don't know how long we have to continue to put up numbers like this before people wake up, but wake up they eventually will.  When Harley Davidson ships 30% fewer motorcycles, when GE sells 17% less "stuff" (including their financial cooking) and when company after company, including Intel, IBM and others come out with revenue numbers that are down double-digit percentages on an annualized basis, there is no possible way you can justify the multiples that these firms are selling at.

When The Port of Long Beach shows container shipments down nearly 30%, when freight carloadings are down nearly 25% year over year, when sales tax receipts are down in the double digits and when income tax collections, both personal and corporate have effectively collapsed there is simply no argument that "the recession is over" or that "trend growth is around the corner."

The fact of the matter is that port, rail and tax receipts are not subject to being "gamed" by government number-crunchers, they do not play "seasonal adjustments" (since they're year-over-year numbers), they do not represent wishes, dreams, or desires.

They represent real-time, high-frequency, "right now and in your face" economic performance metrics and are impossible to argue with.

If you, as an investor, are trying to use the market as a "forward indicator" of economic conditions, you need to look at these numbers to see whether or not what the stock market is telling you can be validated with actual economic performance - not in quarterly reports to be published in a few months (the typical economic lead-time cited for the market) but in the "right here and now" reality of economic activity.

What those high-frequency data sources are telling us, here and now, today, is that we are in the middle of a 25-30% economic contraction - exactly as I predicted would occur in 2007.

The problem with this level of indicated weakness in the economy is that we have shielded firms, especially banks, from taking the losses that should have come last year and in 2007 related to their over-extension of credit.  Now those institutions are going to have to live with the reality of a much smaller economy, meaning that they will be forced to turn to dramatically increasing credit costs to customers to avoid drowning (e.g. increasing credit card rates and spreads), which is exactly what they're doing.  This in turn will suck even more money out of consumers pockets, dragging consumption down even further and will force even more defaults.

This is a vicious cycle that can only be broken when the defaults that are being hidden behind the curtain of our financial institutions are forced into the open and disposed of.  Yes, this will likely cause those firms to go bust.  But the economic penalty we are and will continue to pay for allowing The Bezzle to continue in these firms will, if not stopped, soon choke off any hope of recovery, just as it did in 1930, and lead to precisely the same sort of economic result.

Everyone seems to be hollering about the "wonderful performance" of the banks that have reported thus far, but let's be honest - if you can borrow for nothing and charge 30% interest on plastic, you make a fortune, right?  Well, for a while - until the squeeze of contracting incomes and increasing interest charges force your customers to default, at which point the charge-offs and defaults this forces in the rest of your portfolio (e.g. mortgages) kill you dead.

I see exactly nothing in any of the reported numbers thus far this quarter suggesting that we've turned an economic corner or that there will be a recovery this year or even next.

We could be near or at the bottom, but we're not, and it is precisely because we have protected the financial institutions from the consequences of their own folly in preference to the borrower (to a large degree the consumer) that this has happened.  I have warned repeatedly that the actions of our regulators and government, on the path they are on, will make durable economic recovery impossible.

The anvil of these bad loans, being carried far above actual fair-market value, will remain as a millstone around the neck until we either earn them out or default them. 

Our government and regulators have chosen "earn them out".  The problem is that this path cannot succeed because "earn them out" requires that the economy return to trend growth - that is, 3-4% GDP - before next year.  That is not going to happen; the government backstop and artificial support only work so long as they continue, and we cannot continue to borrow two trillion a year for the purpose of propping up these institutions in excess of their natural earnings power in the economy.

Yet without defaulting the bad debt that's exactly what has to happen.

If Roubini's prediction of sub-1% growth (if that) for the next couple of years is correct the squeeze between available revenue and required cash-flow from operations to keep the numbers black at the bottom of the page will become python-like over the next 12-18 months, and as the grip tightens reportable earnings will continue to contract, ultimately leading to a collapse when cash flow is exceeded by expenses.

This is the dreaded "double dip", except that it won't be a "W" as Roubini has postulated - it will look like the first three legs, but the right side "/" will instead be a flat line as credit capacity on the borrowing side collapses, destroying the banks ability to profit - without borrowers there is no interest to charge and no money to make!

Bottom line: Those who bet on the market "going much higher" from here are going to find themselves once again holding a bag handed to them by the media and market callers, just like they did in 2000 when it was said "this is just a small correction in the market" as the Nasdaq came off 5,000.


Shining a Bad Light

Many people are upset -- rightly so -- about the lack of information coming from Washington detailing how and where -- and, perhaps, why -- taxpayer funds are being spent in an effort to "save" the economy.

That said, we do see the occasional ray of official sunshine -- if you can call it that -- describing the unwelcome fallout from the drunken orgy of spending that our leadership has been engaging in.

As an example, I refer to the post published this afternoon at the Congressional Budget Office's Director's Blog (a new discovery for me), entitled "The Long-Term Budget Outlook":

Today I had the opportunity to testify before the Senate Budget Committee about CBO’s most recent analysis of the long-term budget outlook.

Under current law, the federal budget is on an unsustainable path, because federal debt will continue to grow much faster than the economy over the long run. Although great uncertainty surrounds long-term fiscal projections, rising costs for health care and the aging of the population will cause federal spending to increase rapidly under any plausible scenario for current law. Unless revenues increase just as rapidly, the rise in spending will produce growing budget deficits. Large budget deficits would reduce national saving, leading to more borrowing from abroad and less domestic investment, which in turn would depress economic growth in the United States. Over time, accumulating debt would cause substantial harm to the economy. The following chart shows our projection of federal debt relative to GDP under the two scenarios we modeled.

Federal Debt Held by the Public Under CBO’s Long-Term Budget Scenarios (Percentage of GDP)

Federal Debt Held by the Public Under CBO’s Long-Term Budget Scenarios (Percentage of GDP)

Keeping deficits and debt from reaching these levels would require increasing revenues significantly as a share of GDP, decreasing projected spending sharply, or some combination of the two.

Measured relative to GDP, almost all of the projected growth in federal spending other than interest payments on the debt stems from the three largest entitlement programs—Medicare, Medicaid, and Social Security. For decades, spending on Medicare and Medicaid has been growing faster than the economy. CBO projects that if current laws do not change, federal spending on Medicare and Medicaid combined will grow from roughly 5 percent of GDP today to almost 10 percent by 2035. By 2080, the government would be spending almost as much, as a share of the economy, on just its two major health care programs as it has spent on all of its programs and services in recent years.

In CBO’s estimates, the increase in spending for Medicare and Medicaid will account for 80 percent of spending increases for the three entitlement programs between now and 2035 and 90 percent of spending growth between now and 2080. Thus, reducing overall government spending relative to what would occur under current fiscal policy would require fundamental changes in the trajectory of federal health spending. Slowing the growth rate of outlays for Medicare and Medicaid is the central long-term challenge for fiscal policy.

Under current law, spending on Social Security is also projected to rise over time as a share of GDP, but much less sharply. CBO projects that Social Security spending will increase from less than 5 percent of GDP today to about 6 percent in 2035 and then roughly stabilize at that level. Meanwhile, as depicted below, government spending on all activities other than Medicare, Medicaid, Social Security, and interest on federal debt—a broad category that includes national defense and a wide variety of domestic programs—is projected to decline or stay roughly stable as a share of GDP in future decades.

Spending Other Than That for Medicare, Medicaid, Social Security, and Net Interest, 1962 to 2080 (Percentage of GDP)

Spending Other Than That for Medicare, Medicaid, Social Security, and Net Interest, 1962 to 2080

Federal spending on Medicare, Medicaid, and Social Security will grow relative to the economy both because health care spending per beneficiary is projected to increase and because the population is aging. As shown in the figure below, between now and 2035, aging is projected to make the larger contribution to the growth of spending for those three programs as a share of GDP. After 2035, continued increases in health care spending per beneficiary are projected to dominate the growth in spending for the three programs.

Factors Explaining Future Federal Spending on Medicare, Medicaid, and Social Security (Percentage of GDP)

The current recession and policy responses have little effect on long-term projections of noninterest spending and revenues. But CBO estimates that in fiscal years 2009 and 2010, the federal government will record its largest budget deficits as a share of GDP since shortly after World War II. As a result of those deficits, federal debt held by the public will soar from 41 percent of GDP at the end of fiscal year 2008 to 60 percent at the end of fiscal year 2010. This higher debt results in permanently higher spending to pay interest on that debt. Federal interest payments already amount to more than 1 percent of GDP; unless current law changes, that share would rise to 2.5 percent by 2020.


The Darker Light

Once again, we have that same old disconnect: Wall Street and Washington say that things are looking up, while most Americans continue to believe otherwise, as CNNMoney.com's Paul La Monica reveals in "The Economy Feels Better. Why Don't You?":

Wall Street's celebrating "strong" earnings and the Fed thinks the recession may soon end. But consumers won't be confident until the housing woes are over.

The economy seems to be getting better. That's what Wall Street is telling us. Stocks soared Wednesday thanks to a slew of decent earnings reports.

That's also what C Street -- home of the Federal Reserve -- is telling us. In the minutes from the Fed's last meeting, released Wednesday afternoon, policymakers indicated that the recession could be over "before long."

But on Main Street, people seem to have a decidedly different view. It's hard to find things to be happy about when the unemployment rate is at a more than quarter-century high of 9.5% and the housing market remains in shambles.

The mess in housing -- foreclosures in the first half of the year were up 15% from the first six months of 2008 -- is something that some fear could keep a lid on an economic recovery.

So even though investors, CEOs and Fed chair Ben Bernanke may be seeing green shoots everywhere they look, many average Americans have to squint very hard in order to find them. Just try telling a Zillow.com-obsessed home owner who's watched the value of his home continue to plummet in recent months that the economy is getting better.

"The big unknown variable in the economy still is housing," said Haag Sherman, managing director with Salient Partners, an investment firm based in Houston. "The worst may be behind us with subprime loans, but I don't think housing has found a bottom. We could have a recovery in Corporate America that's much narrower than the recovery in the broader economy."

Sherman pointed out that banks are starting to experience waves of delinquencies and defaults with higher-quality mortgages such as alt-A loans and prime loans.

To that end, JPMorgan Chase, which posted strong second-quarter results Thursday morning thanks to healthy gains in its investment banking division, reported some fairly dismal numbers out of its consumer lending unit.

The bank said that net charge-offs, a figure that measures the amount of debt written off as bad, were $1.3 billion from home equity loans, double the $511 million of a year earlier. And net charge-offs related to prime mortgages quadrupled to $481 million from $104 million last year.

JPMorgan Chase is widely considered one of the healthier banks around. So if it's experiencing more difficulties in its home loan business, it's likely that two of the more troubled big banks, Citigroup and Bank of America, will also disclose more bad news from their mortgage units when they each report their second-quarter numbers Friday morning.

Rising delinquencies could lead to more foreclosures. If so, it's harder to envision a scenario where prices will rebound since foreclosed homes just add to the inventory of unsold real estate.

Steven Kyle, professor of applied economics at Cornell University, said the fear that prices will fall further is discouraging some homeowners from even putting their homes on the market because they're worried about the existing glut of homes.

Kyle added that with unemployment nearing 10% and likely to exceed that level before long, he worries many consumers won't be willing to buy homes -- even if prices stay relatively affordable and mortgage rates remain fairly low.

"Housing is not going to go rocketing off anytime in the near future. Interest rates are already low, so you won't get a boost from that. And unemployed people aren't buying houses," Kyle said.

Sherman said that, ironically enough, more talk of an economic recovery could actually hurt chances of a housing rebound, since it could lead to higher rates in the future.

That's because some fixed-income investors may start to fear inflation and start selling long-term bonds, which would drive up their yields. Bond rates and prices move in opposite directions.

In fact, it's already happened to some extent. The yield on the U.S. 10-year Treasury has surged from a low of about 2% in December to about 3.5% currently. Many fixed-rate mortgages are closely pegged to longer-term Treasury rates, so a further dumping of Treasurys won't help prospective home buyers.

"You can have housing stabilize for a bit and then take another leg down. Continued affordability is what we want to see, but if bonds sell off, that weighs on affordability," Sherman said.

0:00 /4:19Housing market's false hope
Nonetheless, there are some pieces of good news about the housing market. The National Association of Home Builders reported Thursday that builder confidence in July was it its highest level since last September.

In addition, finance professors Paola Sapienza of the Kellogg School of Management at Northwestern University and Luigi Zingales of the University of Chicago's Booth School of Business, said consumers are much more confident about the housing market now than they were just a few months ago. The professors run a quarterly survey of consumers that looks at their trust in the financial system.

Sapienza said that a majority of consumers polled in June thought that prices in their market would be stable over the next 12 months and that only 26% thought prices would decline. By way of comparison, nearly half of the consumers surveyed in December were predicting price drops, Sapienza said.

We'll find out even more about the state of housing Friday morning when the Census Bureau reports its latest figures on housing starts and building permits. Both numbers are key measures of potential demand for new homes.

Economists surveyed by Briefing.com are forecasting that the number of permits rose slightly in June to an annualized rate of 524,000 from 518,000 in May and that starts dipped a tad last month -- from a rate of 532,000 in May to 530,000 in June.

The consensus estimates for both permits and starts are considerably higher than the record lows set in April. So as long as the June numbers are close to forecasts, one could make the case that the housing market is stabilizing and that the worst may be over.

But as I pointed out in Wednesday's column about earnings, stabilization is not the same thing as a recovery. And even though Wall Street still seems willing to subsist on a diet of green shoots salad, consumers are hungering for more substantial evidence of a recovery.

"The end of the world didn't in fact happen so people got more optimistic earlier this year. But to say the end of the world was avoided doesn't mean we're now swimming in rose petals," Kyle said. "The real estate market is still looking rocky. The danger is we just bump along in this stagnating saggy state for awhile."

And as long as that's the case, consumers are unlikely to feel much better about the economy.

"People are still nervous. We haven't seen an actual turn in housing yet, just signs of bottoming," said Brad Sorensen, director of market and sector research with Charles Schwab. "This isn't rocket science but an improvement in the housing market will make consumers feel more confident and more willing to spend and that will have a trickle down effect on the overall economy."

While it is possible that the permabulls, pundits, and politicians are right and ordinary folks are missing the boat , the experience of the past several years suggests it has not made sense to bet against the masses when it comes to describing the true state of affairs.

In fact, some might argue, based on the following commentary from syndicated columnist Paul Craig Roberts, "Can the Economy Recover?" that the fundamentals are so bad that it won't take long before even the most deluded of establishment shills is forced to see the world in a darker, though more realistic light.

There is no economy left to recover. The U.S. manufacturing economy was lost to offshoring and free-trade ideology. It was replaced by a mythical "New Economy."

The "New Economy" was based on services. Its artificial life was fed by the Federal Reserve's artificially low interest rates, which produced a real-estate bubble, and by "free market" financial deregulation, which unleashed financial gangsters to new heights of debt leverage and fraudulent financial products.

The real economy was traded away for a make-believe economy. When the make-believe economy collapsed, Americans' wealth in their real estate, pensions and savings collapsed dramatically while their jobs disappeared.

The debt economy caused Americans to leverage their assets. They refinanced their homes and spent the equity. They maxed out numerous credit cards. They worked as many jobs as they could find. Debt expansion and multiple family incomes kept the economy going.

And now suddenly Americans can't borrow in order to spend. They are over their heads in debt. Jobs are disappearing. America's consumer economy, approximately 70 percent of gross domestic product, is dead. Those Americans who still have jobs are saving against the prospect of job loss. Millions are homeless. Some have moved in with family and friends; others are living in tent cities.

Meanwhile, the U.S. government's budget deficit has jumped from $455 billion in 2008 to $1 trillion this year, with another $2 trillion on the books for 2010. And President Obama has intensified America's expensive war of aggression in Afghanistan and initiated a new war in Pakistan.

There is no way for these deficits to be financed except by printing money or by further collapse in stock markets that would drive people out of equity into bonds.

The U.S. government's budget is 50 percent in the red. That means half of every dollar the federal government spends must be borrowed or printed. Because of the worldwide debacle caused by Wall Street's financial gangsterism, the world needs its own money and hasn't $2 trillion annually to lend to Washington.

As dollars are printed, the growing supply adds to the pressure on the dollar's role as reserve currency. Already America's largest creditor, China, is admonishing Washington to protect China's investment in U.S. debt and lobbying for a new reserve currency to replace the dollar before it collapses. According to various reports, China is spending down its holdings of U.S. dollars by acquiring gold and stocks of raw materials and energy.

The price of 1 ounce gold coins is $1,000 despite efforts of the U.S. government to hold down the gold price. How high will this price jump when the rest of the world decides that the bankruptcy of "the world's only superpower" is at hand?

And what will happen to America's ability to import not only oil, but also the manufactured goods on which it is import-dependent?

When the oversupplied U.S.
dollar loses the reserve currency role, the United States will no longer be able to pay for its massive imports of real goods and services with pieces of paper. Overnight, shortages will appear and Americans will be poorer.

Nothing in Presidents Bush and Obama's economic policy addresses the real issues. Instead, Goldman Sachs was bailed out, more than once. As Eliot Spitzer said, the banks made a "bloody fortune" with U.S. aid.

It was not the millions of now homeless homeowners who were bailed out. It was not the scant remains of American manufacturing — General Motors and Chrysler — that were bailed out. It was the Wall Street Banks.

According to Bloomberg.com, Goldman Sachs' current record earnings from their free or low-cost capital supplied by broke American taxpayers has led the firm to decide to boost compensation and benefits by 33 percent. On an annual basis, this comes to compensation of $773,000 per employee.

This should tell even the most dimwitted patriot whom "their" government represents.

The worst of the economic crisis has not yet hit. I don't mean the rest of the real-estate crisis that is waiting in the wings. Home prices will fall further when the foreclosed properties currently held off the market are dumped. Store and office closings are adversely affecting the ability of owners of shopping malls and office buildings to make their mortgage payments. Commercial real-estate loans were also securitized and turned into derivatives.

The real crisis awaits us. It is the crisis of high unemployment, of stagnant and declining real wages confronted with rising prices from the printing of money to pay the government's bills, and from the dollar's loss of exchange value. Suddenly, Wal-Mart prices will look like Neiman Marcus prices.

Retirees dependent on state pension systems, which cannot print money, might not be paid, or might be paid with IOUs. They will not even have depreciating money with which to try to pay their bills. Desperate tax authorities will squeeze the remaining life out of the middle class.

Nothing in Obama's economic policy is directed at saving the U.S. dollar as reserve currency or the livelihoods of the American people. Obama's policy, like Bush's before him, is keyed to the enrichment of Goldman Sachs and the armament industries.

Matt Taibbi describes Goldman Sachs as "a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money." Look at the Goldman Sachs representatives in the Clinton, Bush and Obama administrations. This bankster firm controls the economic policy of the United States.

Little wonder that Goldman Sachs has record earnings while the rest of us grow poorer by the day.


Suddenly Open to New Possibilities

Many people believe that Prohibition ended because it failed as a social policy. However, according to a July 2007 commentary by economist Donald Boudreaux, the real reason why the ban on alcohol sales was lifted in the 1930s was because of money -- money for a cash-starved government -- during a time of widespread economic woe. Writes Boudreaux:

From 1930 to 1931, income-tax revenues fell by 15 percent.

In 1932 they fell another 37 percent; 1932 income-tax revenues were 46 percent lower than just two years earlier. And by 1933 they were fully 60 percent lower than in 1930.

With no end of the Depression in sight, Washington got anxious for a substitute source of revenue.

That source was liquor sales.

Given current circumstances, it should be no surprise to anyone, as Reuters reveals in "States See $ Sign in Gaming, Analysts Skeptical," that moral issues are increasingly taking a back seat to harsh economic realities:

Staring at the video lottery terminal at New York's Yonkers Raceway, Diane sighed as $300 was reduced to $20 in less than a minute.

"I don't want my son to know; that's all the money I had," she said.

Diane and her friend Frances, two middle-aged gamblers, are core customers of the Empire City casino. Its 5,300 slot machines are a source of revenue for the state of New York which also wants to turn Long Island's Aqueduct Racetrack into a "racino" by adding thousands of slots.

A growing number of U.S. states are considering legalizing slots to try to generate revenue to plug budget gaps, even as the recession has hurt the country's gaming industry.

The warning signs for New York and other states considering expansion into gambling to fill their coffers is illustrated by Las Vegas, where the "win" -- the money a casino collects from gamblers minus the winnings it pays out -- has fallen for 17 months through May.

Gambling is just one revenue source for many of the 50 states but the money can add up quickly. Connecticut, for example, has garnered $5 billion from its two Native American casinos since they opened in 1993.

The problem for states is not merely a lack of demand among middle-aged and senior players. Diane comes to play about once a month and would come every day if she could afford it.

The question states are asking is whether younger players will find slots, reincarnated as video lottery terminals, as alluring as older players, and whether the new "Transformers" -- consumers who have morphed into savers during the downturn -- will return to gaming with their previous fervor.

Craig Parmelee, a Standard & Poor's analyst, said it could take three to four years for consumers to resume spending freely enough to rekindle gambling revenues.

MARKETING EFFORT

The Empire City casino, owned by the Rooney family, owners of the Super Bowl football champion Pittsburgh Steelers, said a new marketing effort had countered the downturn's effects.

All but about 40 cents of every $5 plunked into the video lottery terminals is returned to gamblers, Marketing Director Ryan Murphy said.

New York state collects about 66 percent of that 40 cents in taxes, while the lottery and breeder purses get another 7 to 8 percent, Murphy said. So the casino keeps about 10 cents.

The proliferation of new sites has put states at risk of cannibalizing one another's revenues. After years of failed attempts, Maryland legalized as many as 12,000 lottery terminals, partly to block Delaware, Pennsylvania and West Virginia from siphoning off gamblers.

Other states, including Kentucky and Ohio, are reviewing whether to legalize slots as neighboring Indiana has done.

Analysts, eyeing falling revenues around the country and ill-timed expansions in Las Vegas, Atlantic City and at some Native American casinos in Connecticut and California, said there might be too many venues or that growth may be limited.

"The pie will expand somewhat but the pieces of the pie will become smaller," said Michael French, a PricewaterhouseCoopers analyst based in Philadelphia.

The high cost of travel and Congress's criticism of corporate junkets hit Las Vegas especially hard. California's high jobless rate has also hurt.

Nevada Gaming Control Board Spokesman Frank Streshley saw some signs of relief, however: weekend gamblers were coming back, although they were spending less.

"Where the problem is, it's midweek," he said. Whether conventions, a major source of business, return will not be known until autumn.

GONE FOREVER?

Lottery ticket sales typically hold up during recessions as people want a shot at the big time. But it remains unclear how long the recession will choke gambling by the majority of players who are not high rollers.

Milton Pedraza, CEO of the Luxury Institute in New York, said that unlike the truly wealthy, people whose net worth was a million dollars or less may be hard to win back.

"Those people are gone -- and maybe forever," he said.

Ron Kurtz, an American Affluence Research Center principal in Atlanta, disagreed, saying gamblers would return once stock, credit and job markets recovered.

"Americans have a relatively short memory when it comes to adversity," he said.

Analysts agreed casinos would have to offer increasingly sophisticated video games to lure younger clients; other strategies include games based on television shows, such as "Deal or No Deal," and nightclub entertainers.

Joseph Tindale, a gerontology professor at Canada's University of Guelph, said casinos may have to "keep mutating" to woo younger clients. His research showed they preferred card games with friends or over the Internet, even if just for play money.

States may license slots only to find themselves weighing whether to next add table games, from dice to Baccarat.

Pennsylvania already has felt the pressure.

Just weeks after the May opening of a casino on the site of the headquarters of the former Bethlehem Steel, Innovation Group consultants from Denver told legislators that table games could create more than 16,000 jobs and raise nearly $1 billion of revenue by 2012.

That may be tricky to manage. Just getting approval from legislatures and voters for slot machines can take years; so can going from slot licensing to construction, Parmelee said.

Securing financing is tougher.

"The lending industry is certainly not getting in line to make loans to casinos these days," Parmelee said.

Some states have other potential gaming strategies. Hawaii's legislature proposed taxing Hawaiians who play other states' lotteries or "contests of chance." Delaware is hoping to add betting on football to its lottery by autumn.


Dark-Colored Glasses

Many conservative commentators, especially those whose words often grace the editorial pages of the Wall Street Journal, are seemingly incapable of speaking ill of the U.S. economy, even when the facts are so obvious that, to paraphrase the tagline of those humorous Geico commercials, even a caveman could do it.

In particular, I'm referring to permabull "economists" like Brian Wesbury or David Malpass, who never met a data point they couldn't transform into a thriving green shoot.

Imagine my surprise, then, when I stumbled across the following op-ed in today's Journal, entitled "The Economy Is Even Worse Than You Think," by Mortimer Zuckerman, the billionaire chairman and editor in chief of U.S. News & World Report.

Not only did the conservative real estate mogul and publisher forget to put his de riguer accessory, rose-colored glasses, on -- except when he wrote his last paragraph, where he pondered whether the maniacs running the asylum in Washington might change course before it's too late -- it appears that he slipped on the darkest-colored shades he could find instead.

The average length of unemployment is higher than it's been since government began tracking the data in 1948.

The recent unemployment numbers have undermined confidence that we might be nearing the bottom of the recession. What we can see on the surface is disconcerting enough, but the inside numbers are just as bad.

The Bureau of Labor Statistics preliminary estimate for job losses for June is 467,000, which means 7.2 million people have lost their jobs since the start of the recession. The cumulative job losses over the last six months have been greater than for any other half year period since World War II, including the military demobilization after the war. The job losses are also now equal to the net job gains over the previous nine years, making this the only recession since the Great Depression to wipe out all job growth from the previous expansion.

Here are 10 reasons we are in even more trouble than the 9.5% unemployment rate indicates:

 - June's total assumed 185,000 people at work who probably were not. The government could not identify them; it made an assumption about trends. But many of the mythical jobs are in industries that have absolutely no job creation, e.g., finance. When the official numbers are adjusted over the next several months, June will look worse.

- More companies are asking employees to take unpaid leave. These people don't count on the unemployment roll.

- No fewer than 1.4 million people wanted or were available for work in the last 12 months but were not counted. Why? Because they hadn't searched for work in the four weeks preceding the survey.

- The number of workers taking part-time jobs due to the slack economy, a kind of stealth underemployment, has doubled in this recession to about nine million, or 5.8% of the work force. Add those whose hours have been cut to those who cannot find a full-time job and the total unemployed rises to 16.5%, putting the number of involuntarily idle in the range of 25 million.

- The average work week for rank-and-file employees in the private sector, roughly 80% of the work force, slipped to 33 hours. That's 48 minutes a week less than before the recession began, the lowest level since the government began tracking such data 45 years ago. Full-time workers are being downgraded to part time as businesses slash labor costs to remain above water, and factories are operating at only 65% of capacity. If Americans were still clocking those extra 48 minutes a week now, the same aggregate amount of work would get done with 3.3 million fewer employees, which means that if it were not for the shorter work week the jobless rate would be 11.7%, not 9.5% (which far exceeds the 8% rate projected by the Obama administration).

- The average length of official unemployment increased to 24.5 weeks, the longest since government began tracking this data in 1948. The number of long-term unemployed (i.e., for 27 weeks or more) has now jumped to 4.4 million, an all-time high.

- The average worker saw no wage gains in June, with average compensation running flat at $18.53 an hour.

- The goods producing sector is losing the most jobs -- 223,000 in the last report alone.

- The prospects for job creation are equally distressing. The likelihood is that when economic activity picks up, employers will first choose to increase hours for existing workers and bring part-time workers back to full time. Many unemployed workers looking for jobs once the recovery begins will discover that jobs as good as the ones they lost are almost impossible to find because many layoffs have been permanent. Instead of shrinking operations, companies have shut down whole business units or made sweeping structural changes in the way they conduct business. General Motors and Chrysler, closed hundreds of dealerships and reduced brands. Citigroup and Bank of America cut tens of thousands of positions and exited many parts of the world of finance.

Job losses may last well into 2010 to hit an unemployment peak close to 11%. That unemployment rate may be sustained for an extended period.

Can we find comfort in the fact that employment has long been considered a lagging indicator? It is conventionally seen as having limited predictive power since employment reflects decisions taken earlier in the business cycle. But today is different. Unemployment has doubled to 9.5% from 4.8% in only 16 months, a rate so fast it may influence future economic behavior and outlook.

How could this happen when Washington has thrown trillions of dollars into the pot, including the famous $787 billion in stimulus spending that was supposed to yield $1.50 in growth for every dollar spent? For a start, too much of the money went to transfer payments such as Medicaid, jobless benefits and the like that do nothing for jobs and growth. The spending that creates new jobs is new spending, particularly on infrastructure. It amounts to less than 10% of the stimulus package today.

About 40% of U.S. workers believe the recession will continue for another full year, and their pessimism is justified. As paychecks shrink and disappear, consumers are more hesitant to spend and won't lead the economy out of the doldrums quickly enough.

It may have made him unpopular in parts of the Obama administration, but Vice President Joe Biden was right when he said a week ago that the administration misread how bad the economy was and how effective the stimulus would be. It was supposed to be about jobs but it wasn't. The Recovery Act was a single piece of legislation but it included thousands of funding schemes for tens of thousands of projects, and those programs are stuck in the bureaucracy as the government releases the funds with typical inefficiency.

Another $150 billion, which was allocated to state coffers to continue programs like Medicaid, did not add new jobs; hundreds of billions were set aside for tax cuts and for new benefits for the poor and the unemployed, and they did not add new jobs. Now state budgets are drowning in red ink as jobless claims and Medicaid bills climb.

Next year state budgets will have depleted their initial rescue dollars. Absent another rescue plan, they will have no choice but to slash spending, raise taxes, or both. State and local governments, representing about 15% of the economy, are beginning the worst contraction in postwar history amid a deficit of $166 billion for fiscal 2010, according to the Center on Budget and Policy Priorities, and a gap of $350 billion in fiscal 2011.

Households overburdened with historic levels of debt will also be saving more. The savings rate has already jumped to almost 7% of after-tax income from 0% in 2007, and it is still going up. Every dollar of saving comes out of consumption. Since consumer spending is the economy's main driver, we are going to have a weak consumer sector and many businesses simply won't have the means or the need to hire employees. After the 1990-91 recessions, consumers went out and bought houses, cars and other expensive goods. This time, the combination of a weak job picture and a severe credit crunch means that people won't be able to get the financing for big expenditures, and those who can borrow will be reluctant to do so. The paycheck has returned as the primary source of spending.

This process is nowhere near complete and, until it is, the economy will barely grow if it does at all, and it may well oscillate between sluggish growth and modest decline for the next several years until the rebalancing of excessive debt has been completed. Until then, the economy will be deprived of adequate profits and cash flow, and businesses will not start to hire nor race to make capital expenditures when they have vast idle capacity.

No wonder poll after poll shows a steady erosion of confidence in the stimulus. So what kind of second-act stimulus should we look for? Something that might have a real multiplier effect, not a congressional wish list of pet programs. It is critical that the Obama administration not play politics with the issue. The time to get ready for a serious infrastructure program is now. It's a shame Washington didn't get it right the first time.