International Forecaster Weekly

Big Shrinkages In Economy Thwarts All Efforts To Fix It

no end to the demands of privileged borrowers, no recovery without investment, the system teeters on insolvency, revenues plunge as the deficit rises, more felony charges on Wall Street, lack of new investment will kill new infrastructure, subprime loans are done

Bob Chapman | May 23, 2009

US Treasuries and gold have waged a silent fight for dominance in investors’ flight to safety over the past 22 months. Gold has been suppressed over that period by manipulation by the President’s “Working Group on Financial Markets,” via the US Treasury and the privately owned Federal Reserve. In spite of this ongoing intervention into what are supposed to be free markets gold has held its own.

Since the beginning of the year when the 10-year Treasury note yielded 2.35% it has steadily lost ground. It recently rose to 3.36% and is currently at 3.27%. That is a lot of ground lost in spite of manipulation of that market by the Federal Reserve. The Fed’s efforts have been hindered by an enormous amount of debt issued by the Treasury in order to meet funding operations as well as to assist in funding commercial banks’ balance sheets. This is our Treasury taking funds from responsible Americans to finance and subsidize those in the financial world who turned our financial system into a vast gambling casino. In the process the Treasury and the Fed have crowed out commercial investment, which has led our economy into depression. You cannot have recovery without investment. When history studies what has gone on over the past 22 months it will be aghast that those who created the problem have been designated to fix it. These are the greedy, corrupt destroyers of capital that are about to serve us up hyperinflation as part of a cure to gain time in a senseless effort to save the unsavable, our financial system. A system that teeters on the edge of insolvency. Not only have shareholders and bondholders been wiped out, but so have depositors. If you are patient you will see what we mean. This charade cannot go on indefinitely. Sooner or later Murphy’s Law will come into play. That untoward event that no one expects takes place. The money has already been spent and the only way to continue is to issue more money and credit. That issuance currently is about 18% and climbing, and as a result daily the US dollar loses ground to other currencies and to gold. The sale of Treasury securities are absorbing domestic and foreign savings so much so that the Treasury has the Fed buying its bonds, notes and bills directly from the Treasury and from out of the market, along with collateralized debt obligations. The problem with that is that the Fed with limited assets has to create money and credit to do this, and in this process monetize the debt, which is very inflationary immediately.

Then there is another $900 billion to purchase CDOs, collateralized mortgage obligations, better known as toxic waste. These are also purchased by creating money out of thin air. When the Fed purchases these CDOs they are removed from the sellers’ balance sheets and replaced with cash. That cash is then deposited with the Fed and now earns interest. It sits there sterilized until used. When it is eventually used it is very inflationary. On the other hand rather than keep the money on deposit the banks can use the funds to buy Treasuries, which becomes immediately inflationary. The bottom line is the Treasury meets its deficit with manufactured money, the banks improve their balance sheets and the Fed’s balance sheet looks like a garbage pit.

What this means is that either way any recovery is at risk because the absorption of government debt will push interest rates higher, monetary velocity will increase and hyperinflation will ensue. That unfortunately is underway as we write. The die is cast and again as in 2002 there is no turning back. The point of no return has past. There can only be one reason for this unsound monetary policy and that is the financial companies have to be bailed out at any cost and the public must foot the bill. The only time we know of that this has been attempted on this scale was in the Weimar Republic and we all know what happened in that experiment. Trillions of dollars of investment are being crowed out of the market stopping any recovery. There is no chance as well that excess liquidity will be withdrawn from the system. If it is withdrawn deflation will overwhelm inflation and collapse will ensue. As a result of monetization the liquidity is already in the system. When more liquidity is needed the exercise has to be done over and over again, unless sufficient savings are available. Even at 4.2% of GDP that is not nearly enough. The economy hasn’t improved one bit in the last 22 months and we see nothing that tells us that this is going to change for the better.

Once it starts there is no end to the demands. The National League of Cities has asked the US Treasury for a $5 billion interest free loan to capitalize a new municipal bond insurer it plans to create. This would be the first publicly owned US financial guarantor. Fascism marches on. It would be bigger than MBIA $3.8 billion and $11 billion of current market leader Assured Guaranty. The new entity would only insure general obligation and revenue bonds. It would insure $168 billion over five years. This will be another failed enterprise for government, which is hopelessly inept. They just don’t get it.

The G-7 admit to recession, corporate earnings continue to fall, we see minus growth of perhaps 4% into the end of the year, industrial production has fallen quickly and deeply as has trade, unemployment mounts monthly and excess capacity plagues every nation. Some economists see minus 8% or 10% by yearend. Growth stops as federal debt rises.

All of the above were exacerbated by cessation of interbank lending. No one trusted anyone any more. Due to lying by banks and others regarding their balance sheets banks stopped lending, which brought commerce to a standstill. That eventually was solved by the Federal Reserve guaranteeing everyone’s lending, not only in the US, but worldwide – particularly in Europe. How else could 3-month Libor rates have fallen from 4-5/8% to 0.75%?

Making the underlying problems worse American fiscal debt has risen from $368 billion to an estimated $2 to $2.5 trillion for fiscal 2009 ended 9/30/09, as revenues plunge. This is further complicated by the severity of the recession, which began in February of 2007 and in February 2009 graduated into depression. No one but us is willing to admit that, but that is really the way it is. All the comparisons with 1931, 1973, 1981, 1991 and 2001 do not do the current depression its due. It can more easily be compared to the early 1870s, the madness encountered after the Civil War.

As we know the Federal Reserve Act of 1913 was legislated into being as the solution to recessions, panics and depressions. As you can see they have been emminately unsuccessful. That is why we champion the passage of Rep. Ron Paul’s B ill HR 1207, the Federal Reserve Transparency Act of 2009 - a Bill with 179 co-sponsors. The Bill would cause a congressional Audit of the privately owned Fed, which we believe would lead to its demise and with its functions being returned to the US Treasury, which our Constitution provided for.

We are in today’s horrible situation because the Fed encouraged, as a matter of policy, that banks use 40 to 60 times leverage in lending instead of the historically sound ratio of 8 to 10 to one. For each dollar on deposit 8 or 10 could be prudently lent out. Due to the economy at the time subprime real estate loans were encouraged, where borrowers were ill suited for loans. the result was a real estate bubble followed by collapse. This is solely the responsibility of the banks and the Fed. This is a story of excess leverage and greed.

The magnitude of the recession was underscored by the latest numbers from the U.S. Treasury: last month’s individual income tax receipts dropped 44% and corporate tax revenue plunged 65% compared to April 2008. Alarming news, as April is historically the biggest collection month of the year and usually results in a sizable budget surplus for the month.  

Every “green job” created with government money in Spain over the last eight years came at the cost of 2.2 regular jobs, and only one in 10 of the newly created green jobs became a permanent job, says a new study released this month. The study draws parallels with the green jobs programs of the Obama administration.   

  President Obama, in fact, has used Spain’s green initiative as a blueprint for how the United States should use federal funds to stimulate the economy. Obama's economic stimulus package, which Congress passed in February, allocates billions of dollars to the green jobs industry. 

But the author of the study, Dr. Gabriel Calzada, an economics professor at Juan Carlos University in Madrid, said the United States should expect results similar to those in Spain: 

"Spain’s experience (cited by President Obama as a model) reveals with high confidence, by two different methods, that the U.S. should expect a loss of at least 2.2 jobs on average, or about 9 jobs lost for every 4 created, to which we have to add those jobs that non-subsidized investments with the same resources would have created,” wrote Calzada in his report: Study of the Effects on Employment of Public Aid to Renewable Energy Sources.

  Obama repeatedly has said that the United States should look to Spain as an example of a country that has successfully applied federal money to green initiatives in order to stimulate its economy.

  “Think of what’s happening in countries like Spain, Germany and Japan, where they’re making real investments in renewable energy,” said Obama while lobbying Congress, in January to pass the American Recovery and Reinvestment Act. “They’re surging ahead of us, poised to take the lead in these new industries.”

A Wall Street brokerage firm collected $6.2 million in illegal fees by duping hundreds of investors into buying stocks at inflated prices, a prosecutor said Wednesday.

An indictment charged the two founders and 15 former employees of the now-defunct Joseph Stevens & Co. Inc. with enterprise corruption, grand larceny and other felony counts. They were to be arraigned later Wednesday in state Supreme Court in Manhattan.

About 800 people were victimized by the scheme involving 5,000 trades between 2001 and 2005 that totaled $151.3 million, District Attorney Robert Morgenthau said at a news conference. Many of the victims were retirees, doctors and other professionals who lost much of their life savings, he said.

Prosecutors allege brokers would commit to buying a large block of shares at a discount, then wait until the stock ticked up in value before buying it for clients at the higher price.

"The brokers never told their customers that their primary reason for recommending the stock was to earn additional undisclosed compensation, rather than because of the quality of the investment," Morgenthau said.

Many times, the investments took a dive in the weeks or months following the fraudulent trades. The district attorney said because of the heavy loses, some elderly investors "were forced back into the work force to survive."

If convicted, the defendants face up to 25 years in prison. The names of their attorneys were not immediately available.

A federal judge says the United States can continue to hold some prisoners at Guantanamo Bay indefinitely without any charges.

U.S. District Judge John Bates' opinion issued Tuesday night limited the Obama administration's definition of who can be held. But he said Congress in the days after Sept. 11, 2001 gave the president the authority to hold anyone involved in planning, aiding or carrying out the terrorist attacks.

Bates' opinion comes amid increasing debate over whether President Barack Obama is going to release anyone from Guantanamo. Obama has promised to close the prison by January, but Senate Democrats say they will block the move until he comes up with a plan for the detainees.

Bates' opinion came in the case of several Guantanamo prisoners who are challenging their detention. ACLU attorney Jonathan Hafetz said the opinion "flouts the Constitution's prohibition against indefinite detention without charge."

"The decision wrongly concludes that terrorism suspects at Guantanamo may continue to languish in military detention rather than being prosecuted in our civilian courts," Hafetz said. "Like the president's recent decision to revive military commissions, this ruling perpetuates rather than ends the failed experiment in lawlessness that is Guantanamo."

Earlier this year, Bates ordered the Obama administration to give its definition of whom the United States can continue to hold at Guantanamo. The administration responded with a definition that was largely similar to the Bush administration's, drawing criticism from human rights advocates.

Harvard President Drew Gilpin Faust yesterday backed federal legislation that would clear the way for illegal immigrant students to apply for legal residency, an endorsement that stunned students and drew criticism for a president who has largely steered clear of fierce debates.

In a letter this week to federal lawmakers, Faust expressed "strong support" for legislation known as the Dream Act, which would allow students who have been in this country since they were 15 to apply for legal residency under certain conditions. She acknowledged that students with "immigration status issues" attend Harvard, and said the bill would be a "lifeline" to such students.

More Americans than forecast filed claims for unemployment insurance last week, and the total number of workers receiving benefits rose to a record, signs the job market continues to weaken even as the economic slump eases.

Initial jobless claims fell by 12,000 to 631,000 in the week ended May 16, from a revised 643,000 the prior week that was higher than initially estimated, the Labor Department said today in Washington. The total number of people collecting benefits rose to 6.66 million, a record reading for a 16th straight week, and a sign companies are still not hiring.

The four-week moving average of initial claims, a less volatile measure, decreased to 628,500 from 632,000.

The derivatives market shrank for the first time in the second half of 2008 as the global financial crisis curbed trading, the Bank for International Settlements said in a report.

The amount of outstanding contracts linked to bonds, currencies, commodities, stocks and interest rates fell 13.4 percent to $592 trillion, the Basel, Switzerland-based bank said yesterday. That’s the first decline in 10 years of compiling the data. The amount of credit-default swaps protecting investors against losses on bonds and loans fell 27 percent to cover a notional $41.9 trillion of debt.

Manufacturing in the Philadelphia region contracted in May at the slowest pace in eight months as shipments and employment improved.

The Federal Reserve Bank of Philadelphia’s general economic index climbed to minus 22.6 this month from minus 24.4 in April, the bank said today. Negative numbers signal contraction.

U.S. life insurers, a group led by MetLife Inc. and Prudential Financial Inc., face “pain” on more than $300 billion invested in mortgages tied to commercial property and multifamily homes, Standard & Poor’s said.

“As the recession rolls on, we believe that there is an increasing possibility of distress for commercial real estate owners and for those that hold their mortgages,” said S&P analysts led by Kevin Ahern in a statement today.

North American insurers have posted more than $200 billion in writedowns and unrealized losses tied to the collapse of the U.S. mortgage market. The losses, concentrated in home loans, corporate debt and derivatives, may expand into commercial mortgages as borrowers default or let loans go into foreclosure, S&P said.

“The foreclosure rate of commercial mortgages in life insurance portfolios is virtually zero,” S&P said. “But we believe that this will not necessarily be the case over the course of this economic cycle.”

Commercial mortgage delinquencies in the U.S. climbed to the highest level in at least 11 years in April as scarce credit made it difficult for landlords to refinance loans, according to property research firm Trepp LLC. Commercial property values fell 21.5 percent through February from their October 2007 peak, according to Moody’s Investors Service.

The April index of leading indicators suggested the U.S. economy has moved slightly closer to recovery. The leading index rose 1.0% after a revised 0.2% drop in March, the Conference Board reported Thursday. March's drop was originally reported as 0.3%.

Economists surveyed by Dow Jones Newswires had expected an increase of 1.0% in the April index.

The April gain was the first increase in seven months.

"The leading indicators suggest that while the recession will continue in the near term, the declines will be less intense," said Ken Goldstein, economist at the Board.

Stock prices, interest-rate spread and consumer expectations made positive contributions to the April index. Real money supply and building permits were negative contributors.

The coincident index fell 0.2% in April, after a revised drop of 0.6% in March. March's decline was first reported as 0.4%.

The lagging index dropped 0.5% in April, after a revised 0.5% decline in the prior month. The March drop was originally reported as 0.4%.

The Federal Reserve will include legacy assets for the first time in a $1 trillion program to revive credit markets, expanding the effort to commercial real estate securities issued before the start of this year.

The central bank also expanded the number of credit-ratings companies permitted to rate assets for the Term Asset-Backed Securities Loan Facility to five after Connecticut Attorney General Richard Blumenthal told the Fed that the three initial eligible companies helped fuel the global credit crisis.

There is some good news on the Massachusetts foreclosure front, but don't celebrate yet, housing specialists say.

Statewide, foreclosures plunged to 755 in April, the first time they have dropped below 800 in six months. Foreclosures were down 20.8 percent from March - when 953 homeowners lost their homes, according to data released yesterday by Warren Group, which tracks real estate transactions.

Year-to-date, foreclosure numbers also improved.

For the first four months of 2009, the number of foreclosures fell 15.9 percent to 3,510, compared with the same period in 2008.

And petitions to foreclose, the first step in the process, dropped 39.5 percent to 2,013 last month, compared with April 2008.

Despite the improving numbers, Grace Ross, coordinator of the Massachusetts Alliance Against Predatory Lending, said, "The foreclosure crisis isn't over."

"All of the bigger trends are still not good," Ross said.

It has become one of the staples of modern, hi-tech life: using satellite navigation tools built into your car or mobile phone to find your way from A to B. But experts have warned that the system may be close to breakdown.

US government officials are concerned that the quality of the Global Positioning System (GPS) could begin to deteriorate as early as next year, resulting in regular blackouts and failures – or even dishing out inaccurate directions to millions of people worldwide.

The warning centres on the network of GPS satellites that constantly orbit the planet and beam signals back to the ground that help pinpoint your position on the Earth's surface.

The satellites are overseen by the US Air Force, which has maintained the GPS network since the early 1990s. According to a study by the US government accountability office (GAO), mismanagement and a lack of investment means that some of the crucial GPS satellites could begin to fail as early as next year.

"It is uncertain whether the Air Force will be able to acquire new satellites in time to maintain current GPS service without interruption," said the report, presented to Congress. "If not, some military operations and some civilian users could be adversely affected."

The report says that Air Force officials have failed to execute the necessary steps to keep the system running smoothly.

Subprime is done. All the teaser rates are over, the interest rates have reset and the writing is on the wall.

But in the coming quarters, the scenario will play out with other exotic mortgages, Option ARM (pick-a-pay), Alt-A, etc. The homebuyers may have had better credit, but they had the same strategy: Get a low interest rate upfront, and then deal with the reset down the road, by either refinancing or selling the home. But, whoops, home values are way lower and the economy sucks. Plan derailed.