We Have NOT Yet Avoided a Repeat of the Great Depression

Posted by Michael A. Kamperman on May 30, 2009

With long Treasury Yields rising, fears of inflation on the verge of returning in a big way, commodities markets surging, and green shoots everywhere, the message from the media and the markets is clear: we have avoided the threat that the economy could slip into a new great depression.  Nothing could be further from the truth.  The main reason longer dated Treasury yields have risen is that the Fed blinked and didn’t show up with a very large quantitative easing buy of Treasuries when rates started rising.  This caused the markets to question exactly what was the rationale in the quantitative easing program and when would it be applied.  If interest rates are not being targeted, then what is the target?  The very large supply of federal government debt coming to market is facing a deleveraging world, and there is not enough capital to easily meet demand.  The federal government needs to either print more money, drastically cut spending, or dramatically raise taxes to fund the deficit.  With housing on its back and the country hemorrhaging jobs, cutting spending or raising taxes will only make the depression worse.  The fears of inflation returning in a big way are just that, fears.  The real economy has deflation, not inflation.  History does not support the view that brief periods of deflation give way to massive inflation.  Just ask modern day Japan why prices have barely budged in the last 20 years despite the constant stimulus programs and printing of money by their government?   Commodities markets are surging because the dollar is falling based on fears the U.S. might monetize the debt stoking the return of significant inflation.  Ironically, the British pound is one of the safe havens being sought to escape from a government that prints money—oops.  Real demand for most commodities remains weak and supply remains high.  The reason is that the green shoots are a myth created to instill confidence in the hopes the economy will miraculously come back on its own without further real efforts from Washington.  The myth feeds into the commodities surge, which feeds into the fears of inflation, which has led to a rise in Treasury yields when the Fed blinked.

To understand when we could come out of the depression, you first have to understand why we are in the depression in the first place.  The economy for the last few years had been driven by a speculative bubble in credit.  Two years ago people with poor credit and shaky income prospects could get a mortgage or a new car loan.  This was because the credit rating agencies rated asset-backed securities AAA even if they were backed by junk.  When the world discovered the AAA paper it was sold was backed by no money down mortgages to people with bad credit and no jobs, then the world lost faith in the ratings system.  The loss of faith in the ratings system has killed the asset-backed securities market creating huge losses of capital, which has led to massive deleveraging.  This AAA dependant leveraged market fueled the shadow banking system that supplied in recent times up to 75% of the credit in the U.S.  This market is broken, not frozen.  Nothing has been done so far to fix it.  Hence, if you have a subprime credit score good luck trying to get a mortgage or a new car loan.  Over half of our population now has a subprime credit score.  Unless these people can get access to capital we won’t have enough buyers to absorb all of the homes on the market for a long time. 

It doesn’t matter how long it’s been since someone has bought a new home or a new car, they can only buy if they can access the cash to make the purchase.  Most econometric models do not have the inability to access cash as part of their equations in forecasting economic growth.  The U.S. consumer has represented 70% of the U.S. economy.  The U.S. economy has been the final source of demand in the world for exports from all over the globe.  There are only two ways out of the global depression.  Either restore the U.S. consumer, or find a new source of final demand.  So far neither has happened and the depression won’t end until at least one of these things takes place.  The financial crisis will not heal itself, unthaw, and go away on its own.  At this point in time worrying about defending the dollar and avoiding inflation is absolutely the wrong course of action for the Ben Bernanke Fed to be taking.  They need to up the program of quantitative easing and aggressively purchase U.S. Treasury bonds.  No one needs to worry about how they unwind the program.  When the program stops the U.S. will simply have less debt.  Just because our grandchildren will have less of a debt burden in the future isn’t going to cause everyone to run out the door today and buy a home when they can’t qualify for the mortgage.  Quantitative easing is not enough on its own, Washington needs to re-imagine and re-invent the credit markets.  Green shoot myths won’t fix anything.  However, belief in the myth could cause the wrong policy actions to be taken.

What’s Up With the 10 Year Treasury Yield?

Posted by Michael A. Kamperman on May 28, 2009

The Fed has a tiger by the tail.  It had best not let go.  The bond market has pushed the yield on the 10 year Treasury up to 3.75% today.  This has caused 30 year fixed rate mortgages to move back above 5%.  The data on housing says that 12% of all U.S. mortgages are now either delinquent or in foreclosure.  Rising interest rates will only drive the value of homes lower.  So the Fed is faced with how to handle interest rates that are getting pushed up by the Wall Street re-inflation crowd and speculators while real prices for homes and cars are getting pushed down on Main Street.  It is now gut check time for Ben Bernanke and the Fed. 

The dilemma faced by the Fed is multi-faceted.  First and foremost the huge budget deficit is requiring a record amount of U.S. Treasury bonds to be issued in the coming months.   This comes at a time when real wealth and profits are not being generated by most companies and by most foreign governments.  So the question needs to be answered whether or not there is enough capital out there to absorb all of the new supply.  The rising yields also come at a time when the re-inflation crowd is pounding the table that hyper-inflation is just around the corner.  Since the Fed is printing money and you had better grab all the hard assets you can to protect yourself.  Ironically, the higher these interest rates go the longer it will take to get out of the deflationary depression the country has entered.  Yet the more the Fed prints the more the inflation hawks squawk.

Getting yields back down needs to be the primary focus of the Fed.  But the gut check comes because the Fed will have to decide what they think the real reason is that rates are rising.  Is it because there is plenty of capital in the world and a recovery is near, creating a legitimate fear that the Fed doesn’t have a clear strategy to drain liquidity from the system?  Or is it because there is a shortage of capital in the world, hence the supply of Treasuries is competing with other investments forcing yields higher.  The Fed needs to choose the true answer and not the perceived answer.  If the economy is about to recover and the Fed ups its printing schedule, we will see a return of inflation.  But if the economy is not on the verge of recovery and the Fed stops quantitative easing, then the economy will crash further with even more severe bouts of deflation.  With 1 in 8 homeowners behind on their mortgages and no sign that unemployment rates are abating, I believe there is a shortage of capital in the world and the Fed needs to increase its rate of quantitative easing and slam the yield on the 10 year Treasury back down.

Fears of Hyper-Inflation are Unfounded

Posted by Michael A. Kamperman on May 27, 2009

Hyper-inflation would be very destructive and

would cause its own depression, one of a different sort. Hyper-inflation

infected Germany after World War I in the early 1920’s, and it

infects Zimbabwe today. Zimbabwe is a small, civil war-torn country

with an extremely corrupt government. Its situation is not applicable

to that of any major industrialized country, especially to that of the

United States. However, Germany in the post-World War I era was

a major industrialized nation, and as such, the hyper-inflation that

occurred in Germany should serve as a caution to the leaders of

all industrialized nations. The fear of needing wheelbarrows full of

money to buy a loaf of bread is still deeply ingrained in the modern

German psyche.  It serves as a major obstacle to Europe’s finding a

satisfactory solution to its own asset-bubble, debt-induced, deflationary

depression.

Hyper-inflation is a condition that exists when inflation runs out

of control with almost no end in sight. Many economists will

concede hyper-inflation exists in an economy once annual inflation

reaches 50 percent or more. Hyper-inflation is almost always

accompanied by a collapsing currency. In the Weimar Republic of

Germany, hyper-inflation took hold after World War I. Prior to

World War I, Germany had a stable currency and had been on the

gold standard. At the end of the war Germany signed the Treaty

of Versailles. By signing, Germany was forced to make war reparation

payments to the victorious allies. Initially Germany was able

to use gold-backed marks to pay its war reparations. Germany

had experienced a normal cycle of higher inflation between 1914

and 1921 due to the costs of fighting and losing World War I. In

1914, 4.2 marks were convertible into 1 U.S. dollar. By the middle

of 1921, it took 60 marks to buy 1 U.S. dollar. The war reparations

paid by Germany exhausted the country of most of its gold reserves

before the end of 1922. Germany insisted it could not make the

war reparations demanded. However, the U.S. pressured France to

make its debt payments for the money it borrowed to fight World

War I. France and Belgium in turn insisted that Germany make

the war reparation payments it had agreed to in the Treaty of Versailles.

Since Germany had run out of gold as its primary source of a

hard currency, the German government resorted to printing money

to run its economy and make its war reparation payments. By the

end of 1923 it took 4,200,000,000,000 marks to buy 1 U.S. dollar.

This event has scarred the memory of Germans, many other Europeans,

and many Americans ever since.

The cause of hyper-inflation in Germany had its roots in a psychology

of high inflation that was already built into the psyche of

German expectations after World War I. Additionally, there was

social upheaval in Germany after World War I. The loss in World

War I led to instability in the government, and there were many

short-term changes in leadership. Revolutions and riots had to

be put down. There were fears that worker rebellions would turn

into a full-blown communist revolution similar to the one in the

Soviet Union. So in addition to allocating a portion of the budget

towards making war reparation payments, the German government

also focused on employment. There was a belief in Germany that if

unemployment rates were allowed to rise too high, the communists

would be able to take over the government. Germany made its initial

payments for war reparations backed by gold. However, the government

eventually ran out of gold and other hard currencies to meet

its obligations. Germany resorted to printing money with abandon

and offered to pay its war reparations with printed money. Because

of the collapse of the mark on world currency markets, the allies no

longer wanted to receive the free-falling mark as an acceptable form

of payment. France and Belgium sent their troops into the Ruhr

region of Germany to take control of German coal mines to gain

repayment in a hard asset; coal. When France and Belgium confiscated

the coal mines in the Ruhr region, they deprived Germany of

one of the few exports it had that could earn other currencies. This

led to the situation’s growing even worse. Germans were cashing

in their life savings to buy bread. Germany printed a one hundred

trillion mark note. Finally, at the end of 1923 Germany established

a new currency. One trillion paipermarks were convertible into

1 rentenmark. The German government backed the rentenmark with

the German real estate it owned, and the monetary and currency

panics ended. The world once again accepted the German mark as

an adequate store of value, and the German currency stabilized on

the world markets.

The specter of another German Weimar Republic-style hyperinflation

has been held over the heads of all who seek to print

money as a solution to their economic problems. But is our situation

actually comparable to early 1920’s Germany? It hardly seems so,

even through a casual analysis. First and foremost, Germany owed

other countries pounds and francs, not marks. When Germany

ran out of gold, the value of the mark was no longer backed by the

value of gold. This led to a crash in the value of the mark relative

to the value of other currencies. As Germany started printing more

money for repayment, currency speculators drove the mark lower

and lower. This forced Germany to print more and more marks in

order to convert the mark into either pounds or francs. The cycle

seemed endless. The U.S. does not owe people gold, pounds, euros,

yen, rubles, pesos, yuan, or any other currency. We owe people dollars.

Therefore, we will not have to print a never-ending amount

of dollars to meet our obligations to others. For example, the

U.S. government will have to print exactly one trillion dollars plus

interest to repay China the one trillion dollars we owe. Secondly,

Germany had a cycle of high inflation during and after World War

I that built inflationary expectations of German citizens into the

economy prior to the hyper-inflation of the early 1920’s. Wealthy

Germans were already seeking ways to convert their money into

hard assets such as real estate or works of art. We have deflation in

the U.S. Our wealthy citizens are looking to hide their cash under

the mattress in Treasury bonds. Wealthy Americans are not currently

looking to put their money into more real estate. We would welcome

people driving up the prices of real estate. Thirdly, Germany had

significant political instability after the war. There were riots, coup

attempts, and rebellions. The U.S. just experienced another peaceful

transition of power from the Republican Bush administration and

the Democratic Obama administration. Finally, the major difference

between the U.S. and the defeated Weimar Republic is that France

was able to send troops into Germany in 1923 and confiscate its

coal mines. Obviously this humiliation would lead to a collapse of

confidence in a country. It is presently unimaginable that any army

could confiscate one inch of U.S. soil in North America. The key

differences between the U.S. and the Weimar Republic of Germany

are that the U.S. does not owe others in a currency it cannot print,

the U.S. is not in an extended period of inflationary expectations like

we were in the 1970’s, the U.S. is not in a post-war period of political

instability, and the U.S. is not under the threat of its hard assets being

confiscated by a foreign army. Once we perform a simple analysis we

can easily see that we are not facing the circumstances that Germany

faced in the early 1920’s that led to hyper-inflation. Misconceptions

concerning the root causes of hyper-inflation in Germany have prevented

us from realizing that our situation is markedly different. We

can and need to print more money to solve our problems. Because

we are in a deflationary depression, the outcomes of printing more

money will be very different for us than the outcomes were for

Germany when it printed money in the early 1920’s.

Excerpted from How America Can Escape the New Great Depression

Case-Shiller Home Index Kills Green Shoots

Posted by Michael A. Kamperman on May 26, 2009

The S&P/Case-Shiller home index showed national home prices in March 2009 declined 18.7% from a year earlier.  What is significant is national home prices had already started falling well before March of 2008.  Anecdotal evidence indicates the decline is still going on.  On my block in Central Texas there are two very nice homes that have sat on the market for over a year.  In March the asking price was $419,000.  Now both homes are listed for $399,000.  Still there are no takers.  I was fortunate to be able to play golf on Monday and I met a young man around 30 named Joe.  He is a much better golfer than I am.  Joe just moved from our area due to a promotion with his company to Katy, Texas.  This community is about 30 miles east of Houston on I-10.  Joe told me he and his wife were looking at homes built in the 2000’s with 3,500 to 4,000 square feet with granite counter tops.  This is comparable to my neighborhood.  Joe told me they looked at 6 to 7 homes and they were priced in the $150,000 range and were going in the $40’s per square foot.  I looked at the real estate offerings in Katy and discovered there are over 700 foreclosures on the market.  Homes that cost over $100 to build a few years ago are now selling for less than half of construction costs near Houston.

This means almost everyone who built a home in the last few years in this area is now severely underwater.  Texas real estate had been holding up and the Texas economy had been holding up.  But the jobs report for April indicated Texas was now shedding jobs.  The economic crisis is spreading with no end in sight.  Joe was fortunate that our area remained reasonably strong and he was able to sell his home for a fair price a few weeks ago.  Hence, he will be a buyer very soon in Katy.  But with homes selling at these prices most Americans who purchased a home in the last few years are underwater and their ability to transfer to follow job opportunities is very limited if they own a home.  Furthermore, those that do move will be hesitant to lock themselves into home ownership which could limit future job change options.

Washington needs to wake-up.  Their efforts so far may have prevented imminent collapse of a major bank, but little else.  If this trend is not reversed it is only a matter of time before the big banks face a new crisis.  These homes are selling at these prices because not enough Americans can access mortgages.  The only solution available to the country is massive quantitative easing.  Without it assets prices will continue to deteriorate and job losses will continue to mount.  Those afraid of runaway inflation need to contemplate whether or not that is preferable to runaway deflation.

The Fed’s Richard Fisher Needs to Read Irving Fisher Again and Again

Posted by Michael A. Kamperman on May 24, 2009

Misconceptions about the concept of creative destruction could deepen the depression as the global economic collapse continues unabated.  The WSJ just ran an article quoting Dallas Federal Reserve Board Governor Richard Fisher saying “At heart, Mr. Fisher says he is an advocate for letting markets clear on their own.  ‘You know that I am a big believer in Schumpeter’s creative destruction,’ he says referring to the term coined by the late Austrian economist. ‘The destructive part is always painful, politically messy, it hurts like hell but you hopefully will allow the adjustments to be made so that the creative part can take place.’ Texas went through that process in the 1980s, he says, and came back stronger.”  Mr. Fisher’s world view is also formed by his experiences at the Treasury in the late 1970’s where he witnessed first-hand how high inflation rates wrecked the Presidency of Jimmy Carter.  This combination of belief and experience means unfortunately that Fed Governor Fisher is nothing but a general fighting the last war who is to slow to see how the world has rapidly and dramatically changed around him.  My purpose is not to pick on Mr. Fisher who I’m sure is a good man.  It is to highlight the mindset he has that is currently pervasive in elements of our leadership.  We are not in the midst of a near return to high inflation rates.  What we are witnessing in the economy with companies such as GM is not creative destruction.  And the Texas experience of the late 1980’s can only serve as a guide to the severity of our situation, not as a guide on how to weather the storm and steer the ship safely into port.

This is no time for laissez-faire thinking.  We are not witnessing the positive innovative process of creative destruction where new technologies like a refrigerator replace ice boxes.  Take for example the auto industry.  GM has seen a series of poor management decisions over the last three decades lead it to a weakened state.  But the reason GM is on the verge of bankruptcy is not because someone has invented a replacement for the automobile.  It is not even because someone has developed a superior version of the automobile.  GM is in trouble because we are in the collapsing phase of a debt-induced asset bubble and the credit market GM relies on to sell cars is broken.  Only half the people that qualified for a new car loan two years ago can qualify for one today.  Sales for GM’s large foreign competitor Toyota are down over 40% from a year ago and Toyota is now hemorrhaging money as well.  If we were witnessing creative destruction, then Toyota’s sales would be up to replace the GM sales that are down.  In fact, the broken credit markets are severely limiting access to fresh capital for entrepreneurs delaying the next innovation that could provide true creative destruction.  Inflation is the product of too many dollars chasing too little supply.  We currently have massive oversupply in the world of autos and shrinking access to dollars to drive demand.  We are in a deflationary environment and we are not on the verge of re-inflation despite the cries of wolf from the same crowd that assured us less than two years ago the economies of the world had decoupled from the U.S. economy.

Irving Fisher is the economist who introduced the concept of connecting the downward spiral of asset prices in a high debt society to the eventual downward spiral in goods prices primarily from the natural economic urge to hoard money thereby reducing the velocity of money in the economy.  We are living in the Irving Fisher world of the 1930’s and not the Richard Fisher world of the 1970’s.  According to Jeremy Grantham a couple of years ago it is estimated that approximately $50 trillion in U.S. asset prices supported $25 trillion in U.S. debt.  Today, the assets are worth closer to $30 trillion.  Texas went through this debt-induced asset bubble popping in the late 1980’s and lived to tell about it.  But that was because Texas had vibrant businesses that had growing customer bases outside of Texas.  I know this for a fact because I was a banker in Texas in the 1980’s and witnessed 9 of the 10 largest banks go out of business.  Also, people flocked to Texas from California and New York to scoop up cheap real estate.  Texas received a life line that wasn’t available to the U.S. in the 1930’s.  Similarly Japan has received a life line of global trade from growing economies in the U.S. and China that wasn’t available in the 1930’s either.  Where is our life line Fed Governor Fisher?  The German and Japanese economies are in worse shape than ours.  Mexico is in a serious depression.  We cannot export our way out of this crisis and massive amounts of foreign money will not be coming to our shores to snap up bargains.  They have bargains in their own backyards.  In short, the only way out of this crisis is to monetize the debt.  We need massive quantitative easing and we need it yesterday.  If we don’t monetize the debt the federal government will have to reduce spending.  If that happens then we could see asset prices in aggregate fall below the amount of the total outstanding debt.

Plunge in Housing Starts Signals Long Term Supply Glut

Posted by Michael A. Kamperman on May 19, 2009

This morning multiple analysts cheered the worst housing start numbers in 50 years as a sign shrinking supply will finally begin to align with demand.  Houses are 60 to 100 year assets on average.  Currently the U.S. has 19 million vacant housing units including both single family homes and apartments.   The simple idea is that if we build fewer homes we will be able to absorb the excess inventory on the market.  People like to build and buy new homes.  Therefore one natural conclusion is the weakness in prices for existing homes is causing those that were thinking of buying a new home to purchase an existing home at a bargain.  This could mean that many markets are now priced well below construction costs and building makes no financial sense.  It is also possible that the plunge in housing starts indicates financing is getting tighter, especially for commercial apartment projects.

However, there could be something more going on with the data than meets the eye.  It could be that despite a plunge in housing starts supply is continuing to grow.  If this is the case, then home prices are not close to bottoming out.  Evidence is mounting that the number of Americans occupying the same dwelling is growing.  During the Great Depression it was common for three, and sometimes four or five, generations to live in the same home.  It was common for those with homes to rent out rooms for income.  Finally multiple roommates were the norm.  We already know that many kids graduating from High School and College have no job and are either staying or moving back in with mom and dad.  With unemployment rising it is reasonable to assume that those without jobs and meaningful income are moving in with relatives and friends.  It is also reasonable to assume that many that are foreclosed upon have to move in with someone as well.  Also, the loss of construction jobs probably means many immigrants from Mexico are returning since there are fewer jobs available in America right now.

This pattern would represent a reversal of the transient go it alone society we have built in modern times.  A return to more communal living arrangements means that we will not absorb the glut in housing anytime soon.  In fact, we could see the glut grow despite a steady drop in new housing starts.  If this new trend picks up steam the credit markets will get even tighter and the overall economy could fall much further from here.

After 27 Days on Top, Then What?

Posted by Michael A. Kamperman on May 17, 2009

On September 19, 1928 Walter Chrysler broke ground on a dream to own the tallest building in the world.  He was not the only one with such ambitions and in 1929 the Bank of Manhattan commissioned 40 Wall Street to be two feet higher than the known architectural plans of the Chrysler Building.  “The Great Skyscraper Race” was on.   On April 30, 1930 40 Wall Street opened as the world’s tallest building.  Unbeknownst to the building designers of 40 Wall Street, their rivals building the Chrysler Building changed the plans and secretly raised the height.  27 days later the Chrysler Building opened as the tallest building in the world.  Less than one year later the Empire State Building took the title.  But by the time the Empire State Building opened in May of 1931 the country had already entered the early part of the Great Depression.  The Empire State Building was 77% unoccupied in the 1930’s and didn’t turn a profit until 1950.  In its first year the Empire State Building took in more revenue from people visiting its observation deck than it did in rent.  It would be more than 40 years for the confidence and ambition of men to once again seek to go bigger, better, faster, and higher.

What happened during the Great Depression was that as projects wound down new projects did not emerge to take their place.  Why would anyone build a new building if it might have a 77% vacancy rate?  Hence, it became very difficult to find a job a new job to replace one that was lost.  When the Empire State Building was completed there were no new major construction jobs to take its place.  Companies weren’t looking to expand they were looking to hunker and down and conserve cash.  Almost every industry suffered from over-capacity.  In the U.S. industrial capacity is now 69.1% and falling.  Commercial and residential real estate is over-built in almost every major market in the country.  As the projects that were conceived a year ago wind down new ones are not emerging to absorb the workers and suppliers.   Slowing the rate of decline is not a green shoot, because the economy is still declining.  We need ambitious people once again to try to build something new that will be bigger, better, faster, and higher.

It is ironic that the Chrysler Corporation was so strong at the start of the last Great Depression it could attempt to build the tallest building in the world.  Today, it is wounded to the point it has been forced into bankruptcy and is closing hundreds of dealerships wiping out yet thousands of more jobs that will soon show up on the unemployment rolls.  Many remain oblivious to an uncomfortable economic truth.  Our global economy is mirroring the decline experienced during the Great Depression.  As long as access to new capital remains limited, companies will continue to seek to conserve cash.  The dominoes are falling into each other just as they did in the 1930’s.  Unless real steps are taken to fix the credit markets and stimulate demand we will continue to mirror the Great Depression and the spring of 1931 may eventually turn in to the spring of 1933.

America Needs Access to Auto Credit

Posted by Michael A. Kamperman on May 13, 2009

With all the focus on auto bail-outs it seems Washington can’t see the forest for the trees.  It is true that General Motors, Ford and Chrysler have long-term legacy employment costs that render them less competitive than foreign auto manufacturers that do not bear those same costs.  It is also true that General Motors and Chrysler were financially unprepared to weather the severe downturn in the economy forcing them to go hat in hand to the federal government.  But Washington is missing the point in its handling of the auto industry.  Right now even foreign auto makers without legacy costs are losing money.  The reason is American citizens, and others around the world, do not have adequate access to available auto credit on reasonable terms.  How can we know whether or not GM, Ford, or Chrysler can become competitive if the environment is such that no one can succeed?

It is possible total auto sales in the U.S. will be close to 8 million units in 2009.  This would be only half of the number of cars that were sold in 2007.   Washington’s auto task force should be focusing on restoring access to auto credit for businesses and consumers rather than on their current myopic focus of cutting costs to the bone on the backs of workers, retirees,  and bond holders at GM and Chrysler.  The goal of the auto task force should not be trying to figure out how GM and Chrysler can survive in an environment where less than 10 million cars and light trucks are sold in the U.S.  It should be to create access to affordable auto credit for consumers and businesses.  Currently over half of the country has a subprime credit score.  If we don’t find a way for these borrowers to access auto credit we may sell even fewer cars in 2010.  Every auto dealership in the country knows this.  The solution is to increase the pie and not ration slices.

What Washington should do is offer guarantees on newly issued auto-backed securities allowing lenders to sell their auto loans into the marketplace.  When a lender sells an auto loan they then have the cash to make a new auto loan.  This simple process greatly expands the availability of auto credit.  But the asset-backed securities market has been virtually closed due to the scandalous AAA ratings given to subprime borrowers who put no money down and had no verification of income or assets.  Right now the market doesn’t accept AAA ratings as a reason to invest in newly issued auto-backed securities.  The federal government needs to step up and place the ultimate sign of safety on newly issued auto-backed securities, which is the guarantee of the full faith and credit of the United States.  We already do this with mortgage loans.  For some people owning a car is more important than owning a home because it represents their only mode of transportation to work, to receive an education, and to receive health care.  Taxpayers would prefer to subsidize auto-backed securities that help someone go to work instead of bail-outs for businesses that are uncompetitive.   Let’s focus on creating an environment where an auto company has a chance to succeed before we decide who is and isn’t worth rescuing.

Mom! Dad! I’m Home!

Posted by Michael A. Kamperman on May 12, 2009

This year unlike any year in recent history college and high school graduates with grandiose dreams will find themselves moving back home with mom and dad.  A recent survey of college career placement counselors indicates 22% fewer of this year’s graduates will have landed a job by graduation compared to last year.  Most companies have hiring freezes even if they haven’t actually laid workers off yet.  While companies will replace a key experienced employee they are not generally hiring new workers.  In fact the anecdotal evidence is much worse.   At some colleges 20% of graduates have jobs, 20% are heading off to grad school, and 60% have no set opportunities.  This will have a significant impact on both upcoming unemployment and the housing market.

In the Great Depression not nearly as many young people attended college, junior college, or professional training schools as do today.  Many didn’t even graduate high school in the early 1930’s.  This means there was not as large of a major move at one time of workers into the labor force.  This June the Labor Department number crunchers will make a seasonal adjustment to unemployment that assumes the same percentage of these graduates will have found employment opportunities as in previous years.  Later in the year the unemployment survey will begin to pick up that many of these new workers seeking full-time work are unemployed.  But importantly it will count as employed those working part-time yet living at home with mom and dad.  This is because part-time workers are counted in the commonly reported U-3 unemployment rate as employed even if they are seeking full-time work.

In addition to a rise in unemployment there will not be the natural absorption of rental apartments and new starter homes that normally comes from recent graduates.  We have reached the point where the rising unemployment rate is impacting industries.  With kids moving home that mom and dad thought would be on their own I look for some moms and dads to tighten the belt as well.  In order to get out of the depression we have entered we will not only have to stop losing jobs, but we will have to start creating them as well.

How to Get From Here to There

Posted by Michael A. Kamperman on May 10, 2009

No doubt President Obama inherited these problems and is not the cause of them.  But many people run for the presidency with an idea of what they would like their tenure to be like and wind up with a presidency dictated by unforeseen events out of their control.  Like it or not President Obama is responsible for fixing the economic crisis.  Additionally, Washington does not mean liberal, moderate, nor conservative.  It also does not mean Democrat or Republican.  It means collectively the will of the representatives of the people whether they align themselves with the Democratic or Republican Party.  My economic ideas are not aligned with any group whether Democratic or Republican.  They do not fit into sound bites like Capitalism or Socialism.  My ideas are designed to benefit all Americans and not pick winners and losers.  I am simply observing the economic facts on the ground and describing the solutions that I believe are necessary.  However, the solutions I am about to briefly mention are highly controversial.  If you want a complete response you can find it in my book linked above on this site.   I will not attempt to recreate all 160 plus pages in this post.

I first diagnosed the cause of the economic crisis and then I formulated the solutions necessary to solve the problem.  I wound up down a path rarely traveled and not planned or foreseen by me.  The cause of this crisis is the credit rating agencies rated garbage loans pooled into asset-backed securities AAA.  The loss of faith and trust created by this massive fraud killed the non-federal government backed asset-backed securities market.  This market was the key cog supporting the shadow banking system which accounted for up to 75% of the credit extended in the U.S. in the last few years.  It doesn’t matter if the banks stay the same if they only supplied a quarter of the credit.  What about the other three quarters.  If you have a subprime credit score you will have an extremely difficult time getting a mortgage even if you have a job and a little money down.  This catapult of a giant stone was hurled at a financial system built of glass.  The financial system was built on massive leverage, improper risk/reward lending structures and flawed mathematical models that led to flawed perceptions about the economic world we lived in.  We are no longer in the post World War II inflationary economic expansion.  That period of history, from which all of us gather our personal experience from, ended in August of 2007.  We are now in a new debt-induced deflationary depression akin to the 1930’s.  Unless the federal government takes much more drastic action than it has to date we will see the 1931 economic situation we are now in turn into a 1933 economic situation in a year or two.

How do you solve a problem of a huge hole in purchasing power and large scale permanent unemployment?  You have to think way outside the box.  If this crisis was solvable by an existing theory championed by the left or the right it would already have been solved.  First and foremost purchasing power has to be returned to the bond market.  There are three ways to get there from here.  First, take the time to earn and save the trillions and trillions of dollars that have been lost.  This will take a very long time in a depression.  Second could be to return to a system of a highly risky financial system supporting 30 to 1 leverage.  Finally, the federal government could create more money by printing it.  By my calculations the federal government needs quantitative easing of at least $10 trillion focused on purchasing U.S. Treasury bonds.  No this will not create hyper-inflation despite the cries of the sky will be falling crowd as informed on history as Chicken Little.

Next, the U.S. government needs to replace the lost trust in AAA ratings by explicitly backing the asset-backed securities markets for jumbo mortgages up to at least $2 million and auto paper.  They also need to include proper loans to subprime borrowers that have a job and can make a small down payment.

We need a real solution to the banking crisis by creating a “bad bank” that will take the troubled assets off of the books of the banks and we need unlimited FDIC insurance.  This is because the banks need to absorb a large portion of the creation of credit formerly done by the shadow banking system, much of which has been lost for good.

Finally, we need a real solution for the millions that will remain unemployed.  We should lower the eligibility age for full Social Security and Medicare to 60 and give everyone on Social Security a 20% raise.  Rather than having millions of 30 year olds unemployed we should let millions of 60 year olds retire and open up the jobs for the younger people.  This will be the ultimate form of stimulus for the economy.  Yes, despite what you’ve been told the country can afford it.  It will cost less than $400 billion per year which is paid for from the savings from interest payments on the national debt.  The inflation in health care costs will need to be brought in line with the overall inflation rate whether or not the age of eligibility for Medicare is lowered.

World War II ended the Great Depression.  The U.S. government generated spending in the economy equivalent to an $8 trillion stimulus plan for 4 years in a row.  Unless something similarly large is carried out a downward path comparable to the 1930’s is inevitable.  Despite the New Deal unemployment in the U.S. at the end of 1939 was still over 15%.  Now does the political will exist in Washington to face this crisis head on?