Mish's Global Economic Trend Analysis

Citigroup Bailout Terms of Agreement

MishShedlock — Mon, 24 Nov 2008 20:04:39 GMT

In spite of insisting it is "well capitalized", a Citigroup Bailout Agreement was negotiated involving the Fed, the Treasury, and the FDIC.

Here are the Summary of Terms. Following is a lost of some of the more important terms. Click on the link for complete terms.

Size: Up to $306 bn in assets to be guaranteed (based on valuation agreed upon between institution and USG).

Deductible: Institution absorbs all losses in portfolio up to $29 bn (in addition to existing reserves). Any losses in portfolio in excess of that amount are shared USG (90%) and institution (10%).

USG share will be allocated as follows: UST (via TARP) second loss up to $5 bn; FDIC takes the third loss up to $10 bn;

Financing: Federal Reserve funds remaining pool of assets with a non-recourse loan,
subject to the institution’s 10% loss sharing, at a floating rate of OIS plus 300bp. Interest payments are with recourse to the institution.

Preferred Stock: Institution will issue $7 bn of preferred stock with an 8% dividend rate (under terms described below). $4 bn of preferred will be issued to UST. $3 bn will be issued to the FDIC.

Management of Assets: USG will provide institution with a template to manage guaranteed assets. This template will include the use of mortgage modification procedures adopted by the FDIC, unless otherwise agreed.

Risk Weighting: Institution will retain the income stream from the guaranteed assets. Risk weighting for assets will be 20%.

Dividends: Institution is prohibited from paying common stock dividends, in excess of $.01 per share per quarter, for 3 years without UST/FDIC/FRB consent.

Executive Compensation: An executive compensation plan, including bonuses, that rewards longterm performance and profitability, with appropriate limitations, must be submitted to, and approved by, the USG.

That is a partial list of terms. Click on the above link for complete terms. Note the restriction on dividends for three years and the restrictions on executive compensation.

Taxpayers are conceivably on the hook for 90% of ($306 billion - $29 billion), in other words about $249 billion. But where does this money come from? Congress did not appropriate $249 billion for this.

This bailout represents a huge taxpayer risk. Yet it's important to note that not all of the collateral will go bad. The percentage that might go bad depends on the valuation and selection of assets.

Transparency is an issue in light of Bloomberg's freedom of information lawsuit against the Fed for refusal to disclose how it has used the $350 billion in TARP funds allocated by Congress. Thus, inquiring minds are questioning how the valuation and selection of assets will occur, but so far there are no answers.

Nonetheless, if Citigroup really believes that it is "well capitalized", the Citi may not be happy with these terms, especially the loss in ability to pay dividends.

Originally posted at: http://globaleconomicanalysis.blogspot.com/

Fed Cuts 50 Basis Points, Another Bernanke Theory Blows Up

MishShedlock — Fri, 31 Oct 2008 15:03:14 GMT

As expected the Fed cut the Fed Funds Rate 50 basis points to 1.0% Here is the FOMC Press Release.

The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 1 percent.

The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures. Business equipment spending and industrial production have weakened in recent months, and slowing economic activity in many foreign economies is damping the prospects for U.S. exports. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit.

In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate in coming quarters to levels consistent with price stability.

Recent policy actions, including today’s rate reduction, coordinated interest rate cuts by central banks, extraordinary liquidity measures, and official steps to strengthen financial systems, should help over time to improve credit conditions and promote a return to moderate economic growth. Nevertheless, downside risks to growth remain. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.

In a related action, the Board of Governors unanimously approved a 50-basis-point decrease in the discount rate to 1-1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Cleveland, and San Francisco.

When the Fed follows up with any additional cuts, a new low in Fed Funds Rate will be set. Remember that Bernanke wanted to put a floor in rates at 2%.

Part of the bailout package passed by Congress was to allow the Fed to pay interest on reserves. Paying interest on reserves was supposed to put a floor in on rates. It did no such thing. The effective Fed Funds Rate heading into the meeting was substantially under 1%. Thus another Bernanke academic theory bites the dust. It is not the first and it won't be the last.

Originally posted at: http://globaleconomicanalysis.blogspot.com

C.A.R. Median Home Prices Down 47% From Peak

MishShedlock — Wed, 29 Oct 2008 18:24:15 GMT

The following chart is from "TC" who has been monitoring California Association of Realtors (C.A.R.) and DQNews data. C.A.R. data contains resale single family residences and new homes. DQNews data contains resale single family residences and new homes.

click on chart for sharper image

"TC" Writes

The speed and depth of this decline in CA housing amazing! Even for a housing bear like myself, I'm astonished each month. While I fully expected nominal price declines at the 40% level (check my old site TheBubbleBuster.com for details), I thought the nominal price decline would play out over a matter of a 1/2 decade followed by another 1/2 decade of stagnant prices leading to a real price decline around 60%.

Instead median nominal prices in CA are now down 47% according to CAR and 42% according to DQNews - and those declines are in less than 18 months! Additionally, these are September 2008 closings, which indicate that these homes were sold in July/August 2008. By the time October sales (December closings) numbers come through we will likely be down more than 50% nominally and 60% in real prices - in LESS than 2 years. Amazing!

Lastly, it is now easy to see that the CA home price decline is hitting all neighborhoods - even the wealthy. In fact, the price declines in many of these areas are now becoming some of the steepest and are all the shortest duration. Monterey is a perfect example of where price declines have only been reported for 13 months, yet percentage declines are around 60% or $500k!

Remember that Case-Shiller is a more accurate way of looking at home prices than median prices. I will have a post from TC on Case-Shiller soon. Thanks TC!

Originally posted at: http://globaleconomicanalysis.blogspot.com/

S&P 500 Crash Count Compared To Nikkei Index

MishShedlock — Fri, 24 Oct 2008 16:20:04 GMT

This article features a long term comparison between the S&P 500 Index and the Japanese stock market as measured by the Nikkei Index. The Nikkei peaked almost two decades ago.

Here is the first chart to consider.

Nikkei Monthly Chart

click on chart for sharper image

The period from 1990 to 2000 has often been called "Japan's Lost Decade". It's now just a year away from becoming two lost decades. And except for one brief point in 2003, The Japanese stock market is lower than it has been at any time in the last 25 years dating all the way back to 1983.

In 1990 the Nikkei peaked at 38,900. It is sitting at 8,438 as I type. After 19 years of ups and downs including one big rally of 140%, the Nikkei is down a whopping 78%!

Think That Can't Happen Here?

If you think that can't happen here, then consider this chart of the S&P 500 over the same period.

click on chart for sharper image

Someone buying the S&P 500 in 2000 is down 40% nine years later. Buy and hold dollar cost averaging has been an absolute disaster. You would be behind on nearly every addition no matter when you started.

Note the blue circle in the above chart is roughly 15 years ago. That represents one and a half "lost decades" in time. I circled that zone because it just happens to coincide with an S&P 500 Elliot Wave Count of the decline we are in.

S&P 500 Crash Count

click on chart for sharper image

Please see S&P 500 Crash Count for an explanation of the count and its likely meaning.

Possible Pattern

click on chart for sharper image

Update:

The first S&P chart above is an update from the original article. The main difference is that it is now clear that we have finished wave 3 of 3 down and are in wave 4 of 3 up or possibly wave 5 of 3 down depending on what happens in the market next.

The important point is that we are still on track for a downside target of 450-600 on the S&P 500. That does not mean we get there, it just means it is a likely target.

If we do get to the 450-600 target area, do not expect to see the stock market blasting to new highs for as long as two decades, just as happened in Japan. Indeed, from the current look of things, Japan can still be decades away from new highs.

If this scenario seems farfetched, please consider a few fundamentals.

S&P 500 Fundamentals

The period from 2003 to 2008 was the biggest credit bubble in history, not just in the US but worldwide. It is unrealistic to expect the bust to be anything other than the biggest credit bust in history.
Unemployment is 6.1% and rising. My unemployment target is 8% for 2009 and continuing higher into 2010.Think what rising unemployment will do to foreclosures, defaults on credit cards, bankruptcies, commercial real estate, and corporate earnings.
Banks and brokerages made immense profits being leveraged 30-1 to 50-1. However, brokerages are now under control of the Fed. Leverage is still unwinding and will be lowered to 10-1 or possibly lower. Reduced leveraged means less risk, but also reduced lower profit opportunity.
Boomers are heading into retirement, and a portion of their retirement plan (rising home prices) has been wiped out. Another portion of boomer retirement plans are being wiped out in the stock market crash.
As a result of the above, those boomers will be doing less spending and more savings. Don't expect retail sales or store profits to come soaring back anytime soon.
Peak Credit has been reached and a secular shift to frugality and risk aversion has begun.
Stock markets returning from extreme conditions do not just drop to the trendline, they overshoot it.
Children who have seen their parents wiped out in bankruptcy or foreclosed on are going to have a completely different attitude towards debt than their reckless parents did. Expect to see more frugality from parents and their children alike.

It is impossible to predict the future of course, but fundamentally as well as technically there is every reason to believe lower lows are coming, and the rebound off those lows will be anemic compared to past recoveries. Those looking for an L shaped recession are likely looking the right direction.

Originally posted at: http://globaleconomicanalysis.blogspot.com/

Something For Nothing vs. Paradox of Deleveraging

MishShedlock — Wed, 22 Oct 2008 15:35:12 GMT

Earlier today, in Keynesian Claptrap From PIMCO I spoke of the ridiculousness of the paradox of thrift. Here two more articles worth your time reading that rebut the seemingly never ending Keynesian Claptrap coming from the likes of Bernanke, Paulson, PIMCO, Roubini, and Krugman.

I make the above statement with one reservation. Nouriel Roubini has called this economic disaster as well as anyone. I commend him for many brilliant calls. However I simply cannot sit back and say nothing about the barrage of bad economic thinking in regards to the solution to this crisis coming from everyone in the group above.

With that out of the way, let's continue with a review of an article by Austrian economist Frank Shostak about the paradox of deleveraging. Had I seen it earlier, it would have been included in my previous analysis. Shostak is asking Is Deleveraging Bad for the Economy?

Is it true that if every bank were to attempt to "fix" its balance sheet, the collective outcome would be disastrous for the real economy?

On the contrary, by adjusting their balance sheet to true conditions, banks would lay the foundation for a sustained economic recovery. After all, by trimming their lending, banks by implication also curtail the expansion of credit "out of thin air." As we have seen, it is this type of credit that weakens wealth generators and hence leads to economic impoverishment.

Contrary to the proponents of the "paradox of deleveraging" we can only conclude that if every bank were to aim at fixing its balance sheet, in the process curtailing the expansion of credit "out of thin air," this would lay the foundation for a healthy economic recovery.

I ask everyone to please read the entire article by Shostak. He is among the few consistently brilliant economic thinkers that one can find.

Trying to get Something for Nothing

Inquiring minds are also reading Steve Saville's article Trying to get Something for Nothing.

As if Paul Krugman winning the Nobel Prize in economics isn't reason enough for us to be less-than-sanguine about the future, everywhere we look we see well-respected analysts advocating increased government regulation and spending -- effectively the same policies that transformed a financial crisis into a drawn-out depression during the 1930s -- while completely ignoring the root of today's problems. ....

Whether the advocates of increased government spending and the various other re-inflation policies realize it or not, at the root of their proposed 'solutions' to the crisis is the idea that it is possible to get something for nothing. It is axiomatic that an increase in production must precede a sustained increase in consumption; that saving is the basis of long-term economic growth; that no individual can become rich by spending more than he earns; and that no country can become wealthy, or recover from a recession, by consuming more than it produces. And yet, most commentators have deluded themselves into believing that you can get around the problem of inadequate real savings by simply increasing the supply of the medium of exchange, and that you can bypass the need for increased consumption to be funded by increased production by simply getting the government to spend like a drunken sailor.

Please read the entire article. I promise you that it will be time well spent.

Bush's Conference of Losers Revisited

Recently, president Bush called for a summit to discuss the problems and solutions to the ongoing economic crisis. I wrote about that conference in Bush to Host Summit of Losers.

Here are a couple of snips.

In response to the Credit crisis president Bush is gathering up all the people who did not see what was coming, denied what was happening, and then failed to see the implications of what was indeed happening.

...

Instead of holding a summit of losers, why not hold a summit for those who saw the mess coming and are far more likely to know what to do than those who did not see this mess coming.

There is one more gotcha to the summit of winners ideas. That problem is that a few of the people that did indeed see this crisis coming are proposing the same failed Keynesian policies that brought about this crisis in the first place.

Krugman and Roubini need to be excluded from the summit of winners.

Saville Added To Circle Of Winners

Something For Nothing is a very compelling explanation of what Keynesian economics is all about. Thus Steve Saville belongs in my list of winners.

Such clear thinking from Steve is actually not news to me. Rather I simply did not have a recent article of his at hand to point readers to when I complied my list.

Kevin Depew Added To Circle Of Winners

Minyanville Professor Depew has been on the right side of understanding what is going on and why for as long as I can remember.

I nominate Professor Depew to the winners circle for Five Things You Need to Know: Deflation... And the Headstones Climbed Up the Hills.

One Last Thing

Of course, there is a last resort, one final tool policymakers can deploy. The Fed and Fiscal Policy could come together to help foster a continuation of the game, as Bernanke says:

"[I]n lieu of tax cuts or increases in transfers the government could increase spending on current goods and services or even acquire existing real or financial assets. If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets."

Yes, that would help... but the costs are not mentioned, and here we are not referring to the "dollar costs," but something more severe; a steeper price - the nationalization of financial markets.

In plain English, that paragraph is saying that, if all else fails, a government can issue public debt, financed by the Federal Reserve, to purchase private assets. And that is precisely what is taking place right now.

At that point the very question of whether capitalism survives becomes irrelevant, because a government, by issuing public debt to buy private assets, will have effectively concluded it.

Mr. Practical Added To Circle Of Winners

Minyanville Professor Mr. Practical has likewise been on the right side of understanding what is going on and why for as long as I can remember.

Here are two articles from Mr. P. worthy of reading. Minyan Mailbag: Too Much Debt and Borrowing on Our Future.

Circle of Winners

Ron Paul
Marc Faber
Peter Schiff
Frank Shostak
Steve Saville
Kevin Depew
Mr. Practical

I am sure there are many other worthy candidates. I cannot name them all.

Unfortunately I can state that maintream press articles and Bush administration bureaucrats are dominated by the thinking of the giant collection of Keynesian losers.

The Japanese Deflation Fighting Experiment

There are those who think that serial bubble blowing is a good idea and that the Fed always comes out on top eventually. I disagree and the great depression should be proof enough.

Additional proof comes from Japan whose Nikkei stock market close to 40,000 decades ago and is languishing at 9000 today.

click on chart for sharper image

Peak Credit Review

Eventually there comes a time when all such stimulus fails to produce a bigger credit bubble. That time comes once Peak Credit is reached for the cycle.

Peak credit has been reached. That final wave of consumer recklessness created the exact conditions required for its own destruction. The housing bubble orgy was the last hurrah. It is not coming back and there will be no bigger bubble to replace it. Consumers and banks have both been burnt, and attitudes have changed.

It took nearly 80 years for people to get as reckless as they did in 1929. 80 years! Few are still alive that went through the great depression. No one listened to them. That is the nature of the game. The odds of a significant bout of inflation now are about the same as they were in 1929. Next to none.

Children whose parents are being destroyed by debt now, will keep those memories for a long time.

Contrary to popular belief, the stimulus and government intervention during the great depression were massive. Please see an Interview with Paul Kasriel for an analysis. Likewise, the current intervention by Congress, Paulson, and Bernanke is without a doubt causing lasting damage.

The more damage inflicted now by the Keynesian fools, the greater the chance the US stock market indices end up looking like the chart of the Nikkei above.

Before the barrage of responses about Japan even begins, let me end that barrage in advance. I am well aware of differences between the US and Japan and have written about them many times already. The key point is that Japan headed into its deflation with net savings to draw on, while the US is entering deflation deep in debt. That makes the situation in the US all the more dire.

Attempts to prop up the stock market, housing prices, and to stimulate lending, etc., are all doomed to fail for the exact reasons outlined by Shostak and Saville above: The pool of real savings is depleted and you can't get something for nothing.

Ironically, Greenspan, Bernanke and others lorded over Japan on how the Japanese banks needed to write of bad debts before Japan could have a sustainable recovery. 20 years of malaise suggests that Japan would have been better advised to take its medicine sooner rather than later.

Ironically, flawed economic thinking is gaining ground when it should be losing it. Economics is like physics: Austrian economics embraces sound principals where the pool of real savings, created from production and income, dictates the price of lending. Keynesian economics is like alchemy, trying to change the real into something else. It is based on short term manipulations affecting the price of lending. These manipulations create imbalances that must be corrected. Unfortunately government policy tries ever harder to keep the alchemy going.

The greatest socialist institution every created is a central bank given the authority to create money. Instead of the price of lending being dependent on production and income, the price of lending is determined by bureaucrats incented to make that price as cheap as possible at all times. This does not create wealth, only imbalances. Real wealth is created only by production and production is a function of the real market seeking profit.

In short, the simple truth is that Keynesian economic theory is based on the same failed something for nothing theory of perpetual motion. Attempts to get something for nothing are a complete waste of both time and resources and thus can only make matters worse.

Originally posted at: http://globaleconomicanalysis.blogspot.com/

Shipping Stats, Long Beach CA, Los Angeles CA, Portland OR

MishShedlock — Mon, 20 Oct 2008 18:50:23 GMT

Container shipping stats at the Ports of Long Beach, LA, and Portland are all down. This is consistent with the Collapse of the Baltic Dry Shipping Index.

Inbound container stats year to date are down 9.0% year to date at LA, 10.8% at Long Beach, and 9.9% at Portland. This does not portend well for expected consumer demand headed into the all important Christmas season.

And based on The New Age Of Consumer Frugality with Frugality to Appear In State Budgets as well, I expect this trend towards lower TEUs to last far more than one year. It's payback time for massive numbers of years of over-consumption on housing financed debt and loose lending standards.

With that backdrop, let's take a look at a few container shipping charts.

Port of Long Beach California

Long Beach Container Trade in TEUs

click on chart for sharper image

TEUs: 20-foot equivalent units or 20-foot-long cargo container.
The size of cargo containers range from 20 feet long to more than 50 feet long. The international measure is the smallest box, the 20-footer or 20-foot-equivalent unit (TEU).

Yearly TEUs

click on chart for sharper image

The charts show exports are up, imports way down, and the year to date TEUs are negative. At the Port of Long Beach, this will be only the second decline in TEUs since 1995. The last decline was in 2001, during the last recession.

Port of LA

Port of LA TEU Stastics

click on chart for sharper image

Port of Portland Monthly Statistics

Marine Shipping Statistics From the Port of Portland.

NUMBER OF CALLS BY OCEANGOING VESSELS -4.1% CHANGE CALENDAR YEAR-TO-DATE
TOTAL TONNAGE 4.5% CHANGE CALENDAR YEAR-TO-DATE
BREAKBULK TOTAL TONNAGE -8.6% CHANGE CALENDAR YEAR-TO-DATE
NUMBER OF CONTAINERS (TEUs) TOTAL, LOAD + DISCHARGE -6.6% CHANGE CALENDAR YEAR-TO-DATE
NUMBER OF CONTAINERS (TEU) LOAD -9.9% CHANGE CALENDAR YEAR-TO-DATE
NUMBER OF CONTAINERS (TEU) DISCHARGE -2.1% CHANGE CALENDAR YEAR-TO-DATE
GRAIN TONNAGE 10.2% CHANGE CALENDAR YEAR-TO-DATE
AUTO UNITS -2.8% CHANGE CALENDAR YEAR-TO-DATE
MINERAL BULK TONNAGE 8.1% CHANGE CALENDAR YEAR-TO-DATE

Grains and minerals are up at Portland (exports), everything else is down. Indeed, imports are down and exports are up across the board at all three ports. This is additional evidence that the vaunted US consumer has at long last thrown in the towel.

Retailers to watch at Christmas include Walmart (WMT), Target (TGT), Sears (SHLD), and JC Penny (JCP) . Home Depot (HD) and Lowes (LOW) also have popular gifts for men. If the season shapes up as expected, sales and especially profits will be down at most of these stores as competition increases for fewer and fewer consumer discretionay spending dollars.

Originally posted at: http://globaleconomicanalysis.blogspot.com/

Empire State Manufacturing Collapses

MishShedlock — Thu, 16 Oct 2008 16:07:35 GMT

Inquiring minds are looking at the Federal Reserve Bank of New York Empire State Manufacturing Survey.

The Empire State Manufacturing Survey indicates that conditions for New York manufacturers deteriorated significantly in October. The general business conditions index dropped 17 points to a record-low -24.6. The new orders index also fell to a record low, and the indexes for shipments, unfilled orders, and inventories all declined sharply. The prices paid index eased significantly, to its lowest level of the year, while the prices received index also fell, although less sharply. Employment indexes were negative. Future indexes declined markedly with exceptionally large declines in the future new orders and shipments indexes.

Roughly 22 percent of respondents in the current survey said that their need for borrowed funds had increased over the past year, but a larger proportion, 31 percent, indicated that their need had decreased.

I keep asking "Why would any corporation want to expand into this environment?"

There is simply no good reason to do so. Overcapacity is rampant. Yet Paulson is attempting to Compel Banks to lend at Bazooka Point and Bush wants to take over banks in a Brave New World To "Preserve" Free Markets . In the meantime, widely respected economists are cheering this rapid march towards fascism.

That is the current sad state of affairs.

Originally posted at: http://globaleconomicanalysis.blogspot.com/

Fed Announces Unlimited Borrowing

MishShedlock — Mon, 13 Oct 2008 14:53:17 GMT

This morning the Fed issued a Press Release On Unlimited Borrowing.

In order to provide broad access to liquidity and funding to financial institutions, the Bank of England (BoE), the European Central Bank (ECB), the Federal Reserve, the Bank of Japan, and the Swiss National Bank (SNB) are jointly announcing further measures to improve liquidity in short-term U.S. dollar funding markets.

The BoE, ECB, and SNB will conduct tenders of U.S. dollar funding at 7-day, 28-day, and 84-day maturities at fixed interest rates for full allotment. Funds will be provided at a fixed interest rate, set in advance of each operation. Counterparties in these operations will be able to borrow any amount they wish against the appropriate collateral in each jurisdiction. Accordingly, sizes of the reciprocal currency arrangements (swap lines) between the Federal Reserve and the BoE, the ECB, and the SNB will be increased to accommodate whatever quantity of U.S. dollar funding is demanded. The Bank of Japan will be considering the introduction of similar measures.

Central banks will continue to work together and are prepared to take whatever measures are necessary to provide sufficient liquidity in short-term funding markets.

Federal Reserve Actions

To assist in the expansion of these operations, the Federal Open Market Committee has authorized increases in the sizes of its temporary swap facilities with the BoE, the ECB, and the SNB, so that these central banks can provide U.S. dollar funding in quantities sufficient to meet demand.

These arrangements have been authorized through April 30, 2009.

Information on Related Actions Being Taken by Other Central Banks
Information on the actions that will be taken by the other central banks is available at the following websites:

Bank of England
European Central Bank
Bank of Japan
Swiss National Bank

On October 9th I wrote that You Cannot Patch a Busted Dam With Water.

Nonetheless, it seems the Fed is determined to try, and I even have a picture to prove it. Photographer Keith Taylor was present at the Fed's announcement this morning and captured this rather amazing image of the event.

Nationalization of banks and announcements of unlimited liquidity measures are not good things. However, but we have seen this playbook before. The futures are jumping once again during options expiration week.

It is likely the move off Friday's low started wave 4 of 3 up. Please see S&P 500 Crash Count for a reference.

Originally posted at: http://globaleconomicanalysis.blogspot.com/

S&P 500 Crash Count

MishShedlock — Mon, 13 Oct 2008 14:52:10 GMT

In Elliott Wave terms The S&P 500 is in wave 3 of 3 down. I will attempt to explain this in terms those not familiar with Elliott Wave can understand. Here goes:

Wave 3's are long and strong and unrelenting. They can be in either direction. When wave 3 is headed up, everyone is waiting for a pullback to get in. That pullback never occurs.

When wave 3 is down everyone wants a rally to either get out or get short. Those rallies either occur intraday or they do not occur at all.

Wave 3 of 3 is where everything you do is right or everything you do is wrong, depending on whether you are long or short. Playing for countertrend moves is highly unlikely to be a winning move for anyone but the extremely nimble.

With that backdrop, here is a chart of the S&P 500 with the wave 3 of 3 "crash count" highlighted.

S&P 500 Weekly Chart

click on chart for sharper image

In Elliot Wave theory, "impulsive" waves trace out in patterns of 5 and corrective waves in patterns of 3. Note 5 clearly distinct waves down off the October 2007 high until the March 2008 bottom (the big red 1).

Wave 2 up, a corrective wave(the big red 2) peaked in May. When wave 2 ended, wave 3 began. In theory, wave 3 like wave 1 should subdivide into 5 clearly distinct waves. Indeed that is how it seems to be playing out.

Wave 3 of 3 Down

Wave 1 of 3 ended in July, Wave 2 of 3 ended August, and we are now in the unrelenting 3 of 3 down where every attempt to play for a bounce has been like "catching knives".

I have a small blue 3 labeled, but that is not final. We do not know where 3 of 3 down finishes. Here are the implications.

Given that we are in a 5 wave impulsive pattern, wave 3 of 3 has to end first before we can think about the 4 of 3 up. 4 of 3 up will be followed by 5 of 3 down. If this sounds complicated, just look at the chart above with waves (1 of 1, 2 of 1, 3 of 1, 4 of 1, 5 of 1) all distinctly visible with blue numbers, ending with a big red 1 down.

Wave 4 of 3 UP

Where to from here? Wave 4 of 3 up has not started yet. Technically I expected wave 4 of 3 to start at 960. However we blew right through that number to the downside.

I do not expect wave 4 of 3 up to be a strong up although it could be reasonably long (2-3 months) in duration. Here is the reason to NOT expect a big bounce:

Sentiment in a wave 2 up is often very strong as it is accompanied by big short covering rallies. In wave 2 up, people still believe “we are off to the races again”. No one is convinced the bull market is over. Indeed, I received more than a few taunts about the S&P only being down 10% for the year. Most had expectations that a new high would soon be forthcoming.

In wave 4 of 3 up, sentiment will be more of “suspicion” as opposed to “we are off to the races again”. Consider the big 3 of 3 down as the “recognition” phase where everyone finally realizes all is not OK.

If we continue heading south as it looks, the 960 target for 3 of 3 we blew past on the downside, could serve as huge overhead resistance in any corrective wave up.

Wave 5 of 3 Down

If the pattern plays out like it is setting up, wave 5 of 3 down will reverse all of the gains of 4 of 3 up and then some. Once wave 5 of 3 down ends, we can then put in a big red 3 on the chart.

See the chart below for how this may look.

Wave 4 Up

Wave 4 up will begin after 5 of 3 down finishes. Look for wave 4 up to be choppy and overlapping (ups and downs in seemingly random patterns). 4 up will be tough to play. It is best to avoid it unless you are extremely nimble.

Once again, "suspicion", as opposed to “we are off to the races again” will be the overriding sentiment.

Wave 5 Down

Wave 5 down will be the washout phase where everyone throws in the towel who is going to. Pessimism will reign supreme and many will swear off the stock market for good. Given that we blew straight past 960 without so much as a pause, the likelihood that wave 5 down blows right through the 2002 bottom is quite high.

Possible Pattern

click on chart for sharper image

Notice that in the grand overall scheme of thing we are likely in wave 3 of 3 of C down, clearly nasty stuff. The target of 600 is an estimate based on an approximate retrace of 62% of the peak of Wave B (.38 * 1576 = 599).

A 50% retrace would stop close to the 2002 bottom of 775-800. Unfortunately, we are running out of time for that to be a likely target. That is one of the implications of blowing past 960 without so much as a pause.

The Theory And The Man

I have taken a lot of flack for many years about Elliott Wave. Nonetheless, I think it is a valid tool. I tend to use E-Wave when the patterns are clear. However, E-Wave is not the be all or end all of anything. No tool is.

Here is a word of caution: If you are determined to find patterns of 3 and 5 you can easily find them, even when they are not really there. Much of this is subjective. However, if one just steps back without a goal of forcing patterns, the clear valid counts will scream right at you.

The charts above are screaming. Those are the charts you want to pay attention to.

Much of the malignment of E-Eave is on account of its founder, Robert Prechter. This is where it is important to separate the tool from the man. As many know, Prechter has been calling for a crash for decades. He has also called for gold to retest the lows near 250. Time and time again Prechter has given conditions in which he would proclaim a new bull market in gold. Time and time again he has failed to do so.

Prechter needs to come out and say "I was wrong about gold" and "I was hopelessly early on my crash call". Instead, his personal wave counts have frequently been convoluted. Many E-Wave practitioners do not pay attention to much of what he is saying.

However, that is a slam against the man, not a slam against the methodology.

Socioeconomic Theory

It is important to note that Prechter has led the way in aspects of socioeconomic theory such as attitudes change first and price follows. Prechter is correct and here is a prime example:

Think back to the Summer of 2005. People were camping out overnight hoping for the chance to buy a condo in Florida. Overnight sentiment changed. It was many months before there were significant price declines in housing. Yet, you still hear today ideas such as "consumer sentiment is down because house prices are down". Such statements are clearly backwards.

Home prices will not go up until sentiment changes, not the other way around.

Right now, people are still walking away from homes. That is one reason why liquidity measures by the Fed and Treasury are doomed to fail. More philosophically, You Cannot Patch a Busted Dam With Water.

The Fed and the Treasury could probably learn a lot from Robert Prechter. There is almost no chance they will listen.

Originally posted at: http://globaleconomicanalysis.blogspot.com/

You Cannot Patch a Busted Dam With Water

MishShedlock — Mon, 13 Oct 2008 14:51:04 GMT

The global economic dam has now cracked wide open. Water is pouring everywhere. The bursting of the dam is a fitting tribute to Paulson's and Bush's $700 billion boondoggle to add liquidity to banks.

The public was overwhelmingly against the plan (and rightly so) as were close to 200 economists. Paulson, Bush, Trichet, and Brown all goaded Congress to waste $700 billion of taxpayer money on grounds there would be a global meltdown if the plan was not passed. Congress had it right the first time. The $700 billion bailout helped bust the dam.

Neither the Bush administration nor the fools in Congress voting for the bailout bothered to figure out you cannot patch a failing dam by adding water.

Liquidity measures cannot and will not work, when the disease is the Fed, reckless Congressional spending, and fractional reserve lending carried to extreme. I talked about this earlier today in Cancerous Activity of the Fed and Treasury.

Too Big To Bail

I have written about this on many occasions. I called it "Too Big To Bail". It is too big to bail. Look at the share price of GM and Ford. Look at the stock market. What about all those Credit Default Swaps on Lehman that still have not been sorted out? What about the currency crisis in Latin America? Let's stop mid-rant and take a look at the Currency Crisis.

Currency Intervention In Latin America

Banks in Brazil and Mexico have stepped in with currency interventions in foolish attempt to strengthen their currencies vs. the US dollar. Chile is expected to follow suit.

We have now come full cycle. Money poured into Latin America and places like Iceland driving their currencies to insane levels vs. the US dollar. Capital flows are now reversing.

Earlier today Iceland took over its biggest bank and closed its stock market. Iceland’s Prime Minister stated: "What we have learned from this whole exercise over the last few years is that it is not wise for a small country to try to take a leading role in international banking.”

In my opinion, currency intervention is exactly the wrong thing to do. For more on Iceland and currency intervention, please consider Latin American Banks Attempt to Save Currencies.

Potential For Bond Market Revolt

Because Paulson has stepped into overdrive attempting to pour water on a busted dam, there is a potential beginning of a bond market revolt.

Treasury yields have climbed for three straight days showing unwillingness of investors to finance this mess. The long bond is still at 4.10, close to historic lows, but yields on the 10-year treasury have shot up close to 50 basis points. Obviously, this will not help the housing market one bit.

$50 billion in treasuries were auctioned in the past three days. What about financing the remaining pieces of this boondoggle?

Global Coordinated Rate Cuts

On Wednesday, the Fed, ECB, Bank of England, Bank of Canada, and Sweden's Riksbank all cut rates by 50 basis points. My response is Global Coordinated Rate Cuts Won't Solve Economic Crisis.

Fed Scared To Death Over Libor

One of the reasons central bankers panicked into mass rate cuts is a huge mass of adjustable rate mortgages is about to reset. The rate cuts were a big attempt to force down LIBOR.

Rate cuts failed big time to stem the surge in LIBOR. Inquiring minds can see a chart of the TED spread in Cancerous Activity of the Fed and Treasury.

Most ARMs mortgages are tied to LIBOR or 1-year treasuries. The latter is no problem but LIBOR based mortgages are another matter indeed.

One Year Treasuries

One Year Libor

One Month Libor

The above charts courtesy of MoneyCafe.

The charts are a bit stale. The current 1 year treasury rates is down to 1.26% and LIBOR rates are slightly higher than the above charts.

Interest only loans are typically tied to 1-month LIBOR, while those in most other ARMs are tied to 1-year LIBOR.

Those in LIBOR based ARMs with teaser rates about to reset are going to be obliterated.

Torrent of Waterfalls

There are simply too may waterfalls to list but let's take a look at a few of the more recent ones.

Russell 2000 Small Cap Index Weekly Chart

click on chart for sharper image

In Elliott Wave terms the index in an impulsive wave 3 down. At some point there will be a corrective wave 4 up, with still more down to follow in wave 5. A lower low can be expected.

GM Weekly

click on chart for sharper image

Liquidity works until it doesn't and the above chart is stunning proof. There was no legitimate fundamental reason for GM to rally from 16 to 42.

The market is acting as if GM's debt is worthless, which of course it should be and will be unless the government (taxpayer) steps in to guarantee it. It's important to remember there is something like $1 trillion bet on GM credit default swaps should GM go under. Who is going to cover that bet, if and when it blows up?

For more on GM and the failed rescue attempt by Kirk Kerkorian, please see GM's Last Fatal Mistake.

Ford Weekly Chart

click on chart for sharper image

Ford and GM are both down close to 50% in less than a week. Can there be a bailout of GM without Ford, or vice versa? Who wants to pay for that?

Note that there are many stock funds that cannot hold stocks under $5. Those funds will now have to toss Ford and GM.

$CRB Commodities

click on chart for sharper image

There was no fundamental reason for commodities to explode upward like they did. The global economy has been weakening for quite some time. However, leverage kept flowing into the last thing that was "working".

This is what it takes to form a blowoff top.

Future Is Frugality

The world is on the backside of Peak Credit. The backside is deflation and The Future Is Frugality.

Global Recession Headed Our Way

I wish to end with what I said in Global Coordinated Rate Cuts Won't Solve Economic Crisis.

The world is heading for a global recession and a sure bet is that it will be blamed on a subprime crisis in the US. The reality is the greatest liquidity experiment in history is now crashing to earth.

The root cause of this crisis is fractional reserve lending, and micromanagement of interest rates by the Fed in particular and Central Banks in general. The Fed started the party by slashing interest rates to 1%, but Central Banks everywhere drank the same punch to varying degrees.

The Greenspan Fed lowering interest rates to 1% fueled the initial boom, but like an addict on heroin, the same dose a second time will not have the same effect. The Fed, the ECB, etc. could have slashed rates to 0% today and it would not have mattered one bit.

The reason is simple: There is no reason for banks to go on a lending spree with consumers tossing in the towel, unemployment rising, and rampant overcapacity everywhere one looks with the exception of the energy sector.

Consumers are tapped out, not just in the US, but in nearly every country on the planet. We had our party, and a fine party it was. However, the party is over and the bill is now past due. The price is a global recession. That price must be paid no matter what Central Banks do.

You Cannot Patch A Busted Dam With Water.

Originally posted at: http://globaleconomicanalysis.blogspot.com/

Global Coordinated Rate Cuts Won't Solve Economic Crisis

MishShedlock — Wed, 08 Oct 2008 17:18:01 GMT

This morning the Fed, ECB, Bank of England, Bank of Canada, and Sweden's Riksbank all cut rates by 50 basis points. Japan is on the sidelines cheering.

US Futures that were down as much 4% are now in the green. Short term perhaps the market was due for a bounce, perhaps not as the day is young, but longer term one cannot cure a solvency issue with rate cuts.

Let's take a look at some of the Central Bank statements. I have additional thoughts following the Central Bank statements.

Joint Statement

Throughout the current financial crisis, central banks have engaged in continuous close consultation and have cooperated in unprecedented joint actions such as the provision of liquidity to reduce strains in financial markets.

Inflationary pressures have started to moderate in a number of countries, partly reflecting a marked decline in energy and other commodity prices. Inflation expectations are diminishing and remain anchored to price stability. The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability.

Some easing of global monetary conditions is therefore warranted. Accordingly, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, Sveriges Riksbank, and the Swiss National Bank are today announcing reductions in policy interest rates. The Bank of Japan expresses its strong support of these policy actions.

Fed Statement

The Federal Open Market Committee has decided to lower its target for the federal funds rate 50 basis points to 1-1/2 percent. The Committee took this action in light of evidence pointing to a weakening of economic activity and a reduction in inflationary pressures.

Incoming economic data suggest that the pace of economic activity has slowed markedly in recent months. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit. Inflation has been high, but the Committee believes that the decline in energy and other commodity prices and the weaker prospects for economic activity have reduced the upside risks to inflation.

The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

Bank of Canada Statement

The intensification of the global financial crisis is having a marked impact on all countries. In recent weeks conditions in global financial markets have deteriorated sharply, the U.S. economy has weakened further, and commodity prices have fallen abruptly.

As a result of these developments, credit conditions in Canada have tightened significantly, despite the relative health of our financial institutions. Weaker growth in the United States and other important trading partners will increase the drag on the Canadian economy coming from net exports. The deterioration of our terms of trade will act to moderate the growth of domestic demand. While the recent depreciation of the Canadian dollar will help cushion the effects of the weaker global outlook on the domestic economy, it will not completely offset them.

Below-potential growth in aggregate demand through 2009, combined with a lower profile for commodity prices, will significantly ease inflation pressures in Canada. Inflation expectations remain well anchored.

In view of these developments, the Bank of Canada decided to join other major central banks and lower its target for the overnight rate by 50 basis points today. This action will provide timely and significant support to the Canadian economy. The Bank will continue to monitor carefully economic and financial developments, along with the evolution of risks, in judging whether any further action might be required to achieve its 2 per cent inflation target over the medium term.

Bank of England Statement

In the United Kingdom, CPI inflation rose to 4.7% in August, reflecting increases in food and energy prices. Inflation is likely to rise further to above 5% in the next month or two, in large part as the full effects of already announced increases in the price of domestic energy are felt. But inflation should then drop back, as the contribution from retail energy prices wanes and the margin of spare capacity in the economy increases. Pay growth has so far remained subdued and commodity price pressures have eased, with oil prices down substantially from their mid-summer peak.

Conditions in international credit and money markets have deteriorated very markedly. Many markets are closed. In the United Kingdom, the supply of credit to households and businesses is clearly tightening further as banks seek to adjust their balance sheets. The Committee noted that cuts in official interest rates could not be expected to resolve the current problems in financial markets and that a significant increase in the capital of the banking sector would be required. The Committee therefore welcomed this morning’s announcement of a Government programme to recapitalise the major UK banks.

Data released over the past month indicate that the outlook for economic activity in the United Kingdom has deteriorated substantially, reflecting a sharp monetary contraction. Output growth slowed to a halt in the second quarter, business surveys point to further weakening during the second half of this year, and the labour market has softened. Consumer spending growth has slowed, in part as a result of the squeeze on real incomes, while business and dwellings investment have declined. Equity prices have fallen, and the further tightening in credit conditions will also weigh on domestic demand growth. The depreciation in sterling over the past year should support net exports, but the prospects for demand growth in the UK’s main export markets have worsened. The weakness in output growth at home will open up a growing margin of spare capacity that will over time bear down on inflation.

The Committee remains focussed on setting Bank Rate in order to meet the 2% inflation target. In doing so it continues to balance two risks. On the downside, there is a risk that a sharp slowdown in the economy, associated with weak real income growth and the tightening in the supply of credit, pulls inflation materially below the target. On the upside, there is a risk that above-target inflation this year and next raises inflation expectations so that inflation persists above the target for a sustained period. During the past month, the balance of those risks to inflation in the medium term has shifted decisively to the downside. In the light of that outlook, the Committee judged at its October meeting that an immediate reduction in Bank Rate of 0.5 percentage points to 4.5% was necessary to meet the 2% target for CPI inflation in the medium term.

Swiss National Bank Statement

The Swiss National Bank (SNB) has decided to ease conditions in the money market by 50 basis points in a bid to bring down the Swiss franc three-month Libor from its most recent level of 3% to 2.5%. To this end, the SNB is lowering the target range to 2–3%.

The global financial crisis has intensified and is having a considerable impact on the international economy. The slowdown in economic activity in the US and Europe is more severe than what the SNB had forecast at its last monetary policy assessment of 18 September 2008.

The Swiss economy is also affected by these developments. Economic growth for 2009 will be weaker than expected at the last assessment. In view of the improved inflation outlook, as a result of the economic downturn and the low oil prices, the SNB is now able to loosen its monetary policy reins.

The Swiss National Bank will continue to provide the Swiss franc money market with liquidity in a generous and flexible manner. It will keep a close watch on developments in the financial markets, so as to assess their impact on economic activity and the inflation outlook and be able to react swiftly, if necessary.

Sweeden's Riksbank Statement

The Executive Board of the Riksbank has today decided to cut the repo rate by 0.50 percentage points to 4.25 per cent. The global financial crisis threatens to reinforce the current slowdown in economic growth with diminished inflationary pressures as a result. Several central banks are today announcing reductions in policy rates in a coordinated action to dampen the consequences of the ongoing financial crisis.

Weaker economic growth in Sweden

The Executive Board of the Riksbank makes the assessment that economic growth in Sweden is slowing down and that inflationary pressures are diminishing as an effect of the financial crisis. This has led to higher interest rates for companies and households, lower capital wealth and increased uncertainty. The Riksbank’s forecast for both inflation and GDP will therefore be revised down.

The labour market is also showing clearer signs of weakening. The downturn in economic activity and lower oil and other commodity prices indicate that inflationary pressures will be lower in the future.

Although developments in Sweden to some extent differ from those in other countries, a cut in the repo rate is warranted here. The fact that the cut is a joint action together with other central banks increases confidence and the likelihood that it will have positive effects. Closer analyses and forecasts of developments in Sweden will be presented after the Executive Board’s next monetary policy meeting, which will take place on 22 October.

ECB Statement

The Governing Council of the ECB, by means of teleconferencing, has taken the following monetary policy decisions:

The minimum bid rate on the main refinancing operations of the Eurosystem will be reduced by 50 basis points to 3.75 %, with effect from the main refinancing operation to be settled on 15 October 2008.

The interest rate on the marginal lending facility will be reduced by 50 basis points to 4.75 %, with immediate effect.

The interest rate on the deposit facility will be reduced by 50 basis points to 2.75 %, with immediate effect.

In the euro area, upside inflationary risks have recently decreased further. It remains imperative to avoid broad-based second-round effects in price and wage-setting. Keeping inflation expectations firmly anchored in line with our objective and securing price stability in the medium term will support sustainable growth and employment and contribute to financial stability.

Bank of Japan Statement

The Bank of Japan welcomes the policy decisions made by six central banks and
hopes that these actions will contribute to securing the stability of both the
financial systems and economies of these countries.

In Japan, policy interest rates are very low and the monetary conditions remain
accommodative. On top of that, the Bank has engaged itself in decisive actions
of liquidity supply, ranging from the uninterrupted provision of ample yen liquidity
in the market to the introduction of US dollar liquidity operations. Against this
background, Japan’s financial market has been stable in comparison with those in
other industrialized countries.

It is of utmost importance for every central bank to maintain stability of financial
markets amidst the ongoing financial turmoil. The Bank of Japan will continue to
do its best to secure the stability of financial markets through money market
operations while staying in close cooperation with other central banks. From this
perspective, Governor of the Bank of Japan has instructed its staff to swiftly
examine possible ways to further enhance the effectiveness of monetary
operations, including those pertaining to BOJ reserve system.

Global Recession Headed Our Way

The world is heading for a global recession and a sure bet is that it will be blamed on a subprime crisis in the US. The reality is the greatest liquidity experiment in history is now crashing to earth.

The root cause of this crisis is fractional reserve lending, and micromanagement of interest rates by the Fed in particular and Central Banks in general. The Fed started the party by slashing interest rates to 1%, but Central Banks everywhere drank the same punch to varying degrees.

The Greenspan Fed lowering interest rates to 1% fueled the initial boom, but like an addict on heroin, the same dose a second time will not have the same effect. The Fed, the ECB, etc. could have slashed rates to 0% today and it would not have mattered one bit.

The reason is simple: There is no reason for banks to go on a lending spree with consumers tossing in the towel, unemployment rising, and rampant overcapacity everywhere one looks with the exception of the energy sector.

Consumers are tapped out, not just in the US, but in nearly every country on the planet. We had our party, and a fine party it was. However, the party is over and the bill is now past due. The price is a global recession. That price must be paid no matter what Central Banks do.

Originally posted at: http://globaleconomicanalysis.blogspot.com/

Thoughts On The Commercial Paper Funding Facility

MishShedlock — Wed, 08 Oct 2008 17:17:05 GMT

Boldly going where no Fed has gone before, the Fed has announced the creation of the Commercial Paper Funding Facility (CPFF).

The CPFF will provide a liquidity backstop to U.S. issuers of commercial paper through a special purpose vehicle (SPV) that will purchase three-month unsecured and asset-backed commercial paper directly from eligible issuers. The Federal Reserve will provide financing to the SPV under the CPFF and will be secured by all of the assets of the SPV and, in the case of commercial paper that is not asset-backed commercial paper, by the retention of up-front fees paid by the issuers or by other forms of security acceptable to the Federal Reserve in consultation with market participants. The Treasury believes this facility is necessary to prevent substantial disruptions to the financial markets and the economy and will make a special deposit at the Federal Reserve Bank of New York in support of this facility.

The commercial paper market has been under considerable strain in recent weeks as money market mutual funds and other investors, themselves often facing liquidity pressures, have become increasingly reluctant to purchase commercial paper, especially at longer-dated maturities. As a result, the volume of outstanding commercial paper has shrunk, interest rates on longer-term commercial paper have increased significantly, and an increasingly high percentage of outstanding paper must now be refinanced each day. A large share of outstanding commercial paper is issued or sponsored by financial intermediaries, and their difficulties placing commercial paper have made it more difficult for those intermediaries to play their vital role in meeting the credit needs of businesses and households.

By eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing commercial paper obligations, this facility should encourage investors to once again engage in term lending in the commercial paper market. Added investor demand should lower commercial paper rates from their current elevated levels and foster issuance of longer-term commercial paper. An improved commercial paper market will enhance the ability of financial intermediaries to accommodate the credit needs of businesses and households.

Commercial Paper Funding Facility (CPFF) Terms and Conditions

Academic Wonderland Expands Again

Already, there is a need to expand the final paragraph in my article earlier this morning called Pushing on a String In Academic Wonderland. Here is the revised text.

The credit markets are choking on credit, yet Bernanke is attempting to force more credit down everyone's throats. Logic dictates the solution cannot be the same as the problem.

Trapped in academic wonderland, such simple logic is far too complex for Bernanke to understand. Sadly, we are all forced to watch Bernanke flop about like a fish out of water attempting to solve a solvency problem with liquidity schemes like the TAF, PDCF, TSLF, TARP, ABCPMMMFLF, and now the CPFF.

Bernanke is pushing on a string. None of these measures can accomplish much other than to delay the inevitable and slow the recovery. I suppose it is possible Bernanke understands this (although I doubt it) and is simply scrambling for time, hoping to prevent a global crash now.

If Bernanke's mission is to buy time, the very best he can hope for is a long prolonged "L" shaped recession similar to what Japan went through in the so called "lost decade". Regardless of what the mission is, the Fed is not in control of the global meltdown, and the continued launching of new facilities, none of which has worked, proves it.

Originally posted at: http://globaleconomicanalysis.blogspot.com/

Bailout Bill Passed, So What Happens Now?

MishShedlock — Mon, 06 Oct 2008 14:42:14 GMT

Congress passed a $700 billion bailout package today. It was a total and complete waste of $700 billion. It further depletes the pool of real funding.

Yes, the Fed has started a monetary printing campaign. Yes, the SEC will suspend mark to market accounting. So what happens now?

Pretending Is Not Reality

What happens now is that pretending does not alter reality. I can pretend all I want that Madame Merriweather's Mud Hut is worth $1 trillion and I can pretend my pet rock is worth the same. The reality (sorry Madame), is that neither is worth the book value I place on them.

Suspension of the mark to market rules will accomplish nothing but further mistrust of banks and bank stocks. Everyone will know banks are lying. No one will know by how much. What we still know is that Citigroup alone holds $1 trillion in off balance sheet SIVs.

Pretending those SIVs are worth $1 trillion will not make it so. Yes, $700 billion is a lot of money. But let's see just how fast it comes and let's see if all of it comes.

The countless $trillions in total bank assets that are not marked to market and will not be purchased by the Treasury, are realistically still going to see credit contraction (on a marked to market basis, and that is what counts).

Foolish Effort To Spur lending

Bernanke and Paulson think that the Fed buying toxic garbage will spur institutions to start lending. It won't. Banks will still be holding more garbage than the Fed can possibly buy. The market will be able to smell that garbage, even if the rules allow banks to pretend that garbage is a rose.

Banks have no reason to lend in a world of overcapacity, rising unemployment, and increasingly sour consumer attitudes. It was disingenuous at best to suggest this would free up lending for main street as it was packaged.

Rescue The Market?

All hopes were that action by Congress would "rescue the market". It can't and it won't. No jobs are being created by this bill, salaries are not going to rise, outsourcing is not going to stop, and foreclosures are going to rise.

If there was a $700 billion jobs package was passed instead of this monstrosity, especially if Davis-Bacon was scrapped like I wanted, tens of thousands of jobs would have been created and at least the US taxpayer would have gotten something for their money. Note: I am not arguing for $700 billion for jobs per se, I am merely pointing out that we would have at least gotten something out of it.

It was not to be. Stupidity won out as it usually does, but I am holding my head high for the effort that readers of this blog and others put in to kill this boondoggle.

Will Printing Lead To Hyperinflation?

Many have asked if the actions of the government would lead to hyperinflation. Others mockingly told me that it would. Nope. The answer is the same: Deflation.

There has never been hyperinflation in history with falling home prices. And home prices will continue to fall. Wasting $700 billion will not do the stock market any good either. The bottom is not in. Today's close proved it. There are new lows on the S&P 500, the Nasdaq, and the Dow.

Yes the Fed will print, but the money will sit, just as it did in Japan. Wasting $700 billion will only make things worse. Banks will still hoard cash.

Hyperinflation Dreams Are Way Down The Road

I am not the only one who has come to this conclusion. Please consider this audio with Austrian Economist Frank Shostak on Mises.

Shostak refers to Money AMS in the audio. An complete explanation of Money AMS can be found in Money Supply and Recessions.

A more recent update of Money AMS is in TMS: A Truer Money Supply? Unfortunately I cannot update that chart because a falling out with the person who created that chart for me.

Proper Definitions of Inflation and Deflation

Those who believe inflation is measured by the CPI, the PPI, or price increases of any kind desperately need to read Inflation: What the heck is it?, Interview with Paul Kasriel, and Deflation American Style.

The definition of inflation I am using is "A net increase in money supply and credit". Deflation is the opposite "A net decrease in money supply and credit".

Looking at deflation in terms of money supply (money that is actually lent) and credit (marked to market), the proper conclusion is the bailout bill does not change the picture, and that picture remains deflation.

I have said many times the fed can print but it cannot force banks to lend or consumers and businesses to borrow. We are about to find out who is right.

Originally posted at: http://globaleconomicanalysis.blogspot.com/

Jobs Contract 9th Consecutive Month

MishShedlock — Mon, 06 Oct 2008 14:41:07 GMT

Before taking a look at the monthly jobs data, let's take a look at weekly claims. The US Department of Labor is reporting Initial Unemployment Insurance Claims continue to rise.

Seasonally Adjusted

In the week ending Sept. 27, the advance figure for seasonally adjusted initial claims was 497,000, an increase of 1,000 from the previous week's revised figure of 496,000. It is estimated that the effects of Hurricane Gustav in Louisiana and the effects of Hurricane Ike in Texas added approximately 45,000 claims to the total. The 4-week moving average was 474,000, an increase of 11,500 from the previous week's unrevised average of 462,500.

Unadjusted

The advance number of actual initial claims under state programs, unadjusted, totaled 390,837 in the week ending Sept. 27, a decrease of 7,233 from the previous week. There were 255,431 initial claims in the comparable week in 2007.

Jobs Decline 9th Consecutive Month

This morning, the Bureau of Labor Statistics (BLS) released the August Employment Report. Jobs were negative for a 8th consecutive month. My target of 6% or higher stated unemployment by the end of the year, made in December 2007 when the unemployment rate was 4.8% was reached last month. In December I also predicted a jobs disaster every month this year. That prediction is now 9 for 9.

Here is a synopsis of the BLS report.

Nonfarm payroll employment declined by 159,000 in September, and the unemployment rate held at 6.1 percent, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. Employment continued to fall in construction, manufacturing, and retail trade, while mining and health care
continued to add jobs.

Establishment Data

click on chart for sharper image

Highlights

35,000 construction jobs were lost
51,000 manufacturing jobs were lost
40,000 retail trade jobs were lost
82,000 service providing jobs were lost
27,000 professional and business services jobs were lost
25,000 education and health services jobs were added
17,000 leisure and hospitality jobs were lost
09,000 government jobs were added

A total of 77,000 goods producing jobs were lost (higher paying jobs), and for the third time this year service sector jobs were lost. Government, the last pace one wants to see jobs, added 9,000 jobs or the service sector would have contracted more. Note: some of the above categories overlap as shown in the preceding chart, so do not attempt to total them up.

These are clearly recession totals.

Birth/Death Model In Outer Space

Once again was a very weak jobs report. And once again the Birth/Death Model assumptions are absurd. In July the birth/death adjustments were back in orbit somewhere near Mars. Last month they returned to deep outer space where they have been every month this year except for January and July.

click on chart for sharper image

Every month I say the same nearly the same thing. The only difference is the numbers change slightly. Here it is again: The BLS should be embarrassed to report this data.

However, there is a startling difference this month. The Birth-Death Model shows that leisure and hospitality jobs are contracting for the first time since January.

Otherwise, repeating what I have been saying for months now, virtually no one can possibly believe this data. The data is so bad, I doubt those at the BLS even believe it. But that is what their model says so that is what they report.

There is simply no way in a real estate crash that net new construction businesses are added. Note that are there net new professional and business services when mortgage and financial activity is collapsing.

A quick check on the Mortgage Lender Implode-O-Meter shows that 287 Major US lending operations have imploded. The best thing we can say is the rate of change in the mortgage lending implosions is improving. Last month the total was 280, this month it increased slightly to 287. However, even if fewer lenders are going under, there is still decreasing activity in the sector and many small 1-5 person shops that have to be throwing in the towel. Those small 1-5 person businesses are not properly accounted for in the Birth-Death Model in my estimation.

BLS Black Box

For those unfamiliar with the birth/death model, monthly jobs adjustments are made by the BLS based on economic assumptions about the birth and death of businesses (not individuals). Those assumptions are made according to estimates of where the BLS thinks we are in the economic cycle.

The BLS has admitted however, that their model will be wrong at economic turning points. And there is no doubt we are long past an economic turning point.

Here is the pertinent snip from the BLS on Birth/Death Methodology.

The net birth/death model component figures are unique to each month and exhibit a seasonal pattern that can result in negative adjustments in some months. These models do not attempt to correct for any other potential error sources in the CES estimates such as sampling error or design limitations.
Note that the net birth/death figures are not seasonally adjusted, and are applied to not seasonally adjusted monthly employment links to determine the final estimate.
The most significant potential drawback to this or any model-based approach is that time series modeling assumes a predictable continuation of historical patterns and relationships and therefore is likely to have some difficulty producing reliable estimates at economic turning points or during periods when there are sudden changes in trend.

The important point in this mess is that both the job data and employment data are much worse than appears at first glance (and the first glance looked horrid).

Table A-12

Table A-12 is where one can find a better approximation of what the unemployment rate really is. Let's take a look

click on chart for sharper image

I predicted privately that unemployment would rise this month by .2% to .4%. The official rate was flat. However, if you start counting all the people that want a job but gave up, all the people with part-time jobs that want a full-time job, etc., you get a closer picture of what the unemployment rate is. That number is in the last row called U-6. It reflects how unemployment feels to the average Joe on the street. For the first time U-6 hit 11%. Note that it was 8.4% a year ago. Both U-6 and U-3 (the so called "official" unemployment number) are poised to rise further. And as noted earlier, my 6% target by the end of the year for the official number was reached in August.

Looking ahead, I expect the service sector to continue to weaken. Mall vacancy rates are rising and a huge contraction in commercial real estate is finally started. There is no driver for jobs and states in forced cutback mode are making matters far worse.

Mass Layoffs Rise

One measure of future unemployment can be found by looking at mass layoff announcements. These are mass layoffs that have been announced, and are coming down the road, but are not yet reflected in the unemployment numbers. Please note that U.S. September Job Cuts Rise 33% From Year Ago, Challenger Says

Job cuts announced by U.S. employers climbed 33 percent in September from a year earlier, led by reductions at computer- and automakers, according to a private placement firm.

Firing announcements rose to 95,094 last month from 71,739 in September 2007, Chicago-based Challenger, Gray & Christmas Inc. said in a statement today. Hewlett-Packard Co., the world's largest computer-maker, said last month it would eliminate 24,600 jobs, accounting for much of September's increase, Challenger said.

Economic data continues to suggest the Credit Crunch Has Reached Critical Mass and is rapidly picking up steam. Unemployment is poised to soar still higher. There is no driver for jobs, nor will the misguided $700+ billion bailout plan of Paulson provide any.

Originally posted at: http://globaleconomicanalysis.blogspot.com/

Weekly Economic Potpourri

MishShedlock — Fri, 03 Oct 2008 15:53:20 GMT

The jobs report comes out tomorrow and the overwhelming odds are it will be the 9th consecutive month of job losses. Here are some interesting headlines and quotes from the past week.

Asian Stocks Fall to Three-Year Low, Led by Toyota, Hang Seng

"In my adult lifetime I don't think I've ever seen people as fearful, economically, as they are right now," billionaire Warren Buffett said in an interview with PBS's Charlie Rose yesterday. "They are not wrong to be worried."

Ford, Honda U.S. Sales Plummet as Credit Tightens

Sales at Ford, the second-largest U.S. automaker, fell 35 percent from a year earlier, the Dearborn, Michigan-based company said in a statement today. Honda reported a 24 percent drop.

Industrywide sales probably will fall for the 11th month in a row, the longest slide in 17 years. Ford said its sales fell to 120,788 cars and trucks from 184,612 a year earlier, the 22nd decline in the past 23 months.

U.S. dealership closures to increase into 2009

The number of U.S. car dealerships closing is expected to increase into 2009 with as many as 3,800 dealerships at risk of closure because of dwindling sales and tighter credit, according to a newly released study by Grant Thornton LLP on Wednesday.

"An increasing number of dealers are simply closing their doors because sales have plummeted, credit has dried up, the overall retail environment is increasingly challenging and potential investors are sitting on the sidelines," said Paul Melville, a partner with Grant Thornton LLP.

Bill Heard Enterprises Inc, one of the biggest General Motors Corp Chevrolet dealerships, filed for bankruptcy on Sunday, citing operating losses, decreased demand for vehicles and lack of credit.

U.S. September Job Cuts Rise 33% From Year Ago, Challenger Says

Job cuts announced by U.S. employers climbed 33 percent in September from a year earlier, led by reductions at computer- and automakers, according to a private placement firm.

Firing announcements rose to 95,094 last month from 71,739 in September 2007, Chicago-based Challenger, Gray & Christmas Inc. said in a statement today. Hewlett-Packard Co., the world's largest computer-maker, said last month it would eliminate 24,600 jobs, accounting for much of September's increase, Challenger said.

Major Insurance Company On Verge Of Bankruptcy: Senator Reid

Credit-default swaps on Hartford jumped 165 basis points to a mid-price of 675 basis points, according to broker Phoenix Partners Group. Contracts on Prudential rose 125 basis points to 617 basis points, while MetLife climbed 97 basis points to 583 basis points, CMA Datavision prices show.

"We don't have a lot of leeway on time," Reid told reporters after a luncheon in Washington. "One of the individuals in the caucus today talked about a major insurance company -- a major insurance company -- one with a name that everyone knows that's on the verge of going bankrupt. That's what this is all about."

CalPERS loses $24.9 billion but stays strong, analysts say

The California Public Employees' Retirement System, the pension fund used to pay the retirements of millions of government employees, has lost $24.9 billion over the last three months. The 10.4 percent loss is less than the Standard & Poor's 500, which dropped 13.6 percent in that time.

If the losses continue, California taxpayers could be faced with demands to make up shortfalls in funding the giant pension system. On Monday alone, a dive in the stock markets wiped out $7.8 billion of the pension fund's investments.

UBS Cuts 2,000 Investment Bank Jobs, Reposition Unit

UBS AG, the European bank hardest hit by the credit crisis, said it will cut 2,000 more jobs from its investment banking unit and reposition the division to reduce costs and improve efficiency.

The reductions will bring job cuts at the unit to around 6,000 since the third quarter of 2007, the Zurich-based bank said today in an e-mailed statement. At the end of the year, the investment bank will have around 17,000 employees, UBS said.

UBS said it will exit commodities, apart from precious metals, scale back real estate and securitization as well as proprietary trading. Chairman Peter Kurer "categorically" ruled out a sale of the securities unit yesterday

Office Space Is Emptying Out

Businesses are dumping office space at the fastest pace since the months after the Sept. 11 attacks, increasing the financial stress on commercial-real-estate owners and their lenders, many of them already ailing financial institutions.

Nationwide, rents on office properties -- including landlord concessions and discounts -- were flat in the third quarter, the worst result for office-property owners since late 2004 -- when commercial real estate began to emerge from a prolonged slump, according to Reis Inc., a New York real-estate research firm.

Rent stagnation and increasing vacancies put "strain on borrowers to make payments on mortgages," said Sam Chandan

Asian Money Market Rates Advance on Bank Collapse Concerns

Asian banks' borrowing costs rose to the highest levels in nine months or more after the collapse of lenders in the U.S. and Europe deepened a global credit freeze.

Hong Kong's three-month interbank rate jumped 41 basis points this week to 3.81 percent, and Tokyo's increased 1 basis point to 0.87 percent, both the highest since December.

``The interbank lending market remains clogged up as banks hoard cash,'' said Joshua Williamson, a senior strategist at TD Securities in Sydney. ``Funding pressures look likely to remain high and the longer they stay up there the greater the chance banks will pass on those costs to clients.''

Icelanders Worry 'House of Cards' May Collapse After Glitnir

The government bailed out Glitnir after the bank was unable to secure short-term funding. Glitnir had a deposit-to-loan ratio of about 30 percent, the lowest among Iceland's biggest banks, meaning it had to rely on money markets for financing.

``Because Iceland is so small and because there are extensive cross-shareholdings, if one part collapses, the rest follows like a house of cards,'' said the 48-year-old Glitnir customer.

France, Germany Clash Over Proposal to Bail Out Banks

France and Germany clashed over whether to create a fund to bail out banks pounded by the global credit crunch, kicking off a European version of the debate that has been raging in the U.S. for two weeks.

The conflict between the two biggest euro-region economies undermined efforts to build a consensus European response to the financial crisis as a recession looms. Other fissures emerged, as Ireland's decision to guarantee bank deposits and debts prompted criticism by British bankers yesterday that it "distorted competition."

Before we throw $700 billion down a black hole, someone ought to be asking how it will solve anything. Unfortunately the urge is for Congress to "do something quickly" because of the Bush, Bernanke, and Paulson statements scaring people to death with impending economic mushroom cloud warnings.

Not a single job will be created in the Paulson bail out plan, now renamed by the media as the "rescue plan". Close analysis shows the taxpayer was tossed the anchor in an attempt to give wall street the lifeboat.

Originally posted at: http://globaleconomicanalysis.blogspot.com/

Sheila Bair "commercial banking system in the US remains well capitalized"

MishShedlock — Mon, 29 Sep 2008 17:05:31 GMT

Today the FDIC announced Citigroup Inc. to Acquire Banking Operations of Wachovia.

Citigroup Inc. will acquire the banking operations of Wachovia Corporation; Charlotte, North Carolina, in a transaction facilitated by the Federal Deposit Insurance Corporation and concurred with by the Board of Governors of the Federal Reserve and the Secretary of the Treasury in consultation with the President. All depositors are fully protected and there is expected to be no cost to the Deposit Insurance Fund. Wachovia did not fail; rather, it is to be acquired by Citigroup Inc. on an open bank basis with assistance from the FDIC.

"For Wachovia customers, today's action will ensure seamless continuity of service from their bank and full protection for all of their deposits." said FDIC Chairman Sheila C. Bair. "There will be no interruption in services and bank customers should expect business as usual."

Citigroup Inc. will acquire the bulk of Wachovia's assets and liabilities, including five depository institutions and assume senior and subordinated debt of Wachovia Corp. Wachovia Corporation will continue to own AG Edwards and Evergreen. The FDIC has entered into a loss sharing arrangement on a pre-identified pool of loans. Under the agreement, Citigroup Inc. will absorb up to $42 billion of losses on a $312 billion pool of loans. The FDIC will absorb losses beyond that. Citigroup has granted the FDIC $12 billion in preferred stock and warrants to compensate the FDIC for bearing this risk.

In consultation with the President, the Secretary of the Treasury on the recommendation of the Federal Reserve and FDIC determined that open bank assistance was necessary to avoid serious adverse effects on economic conditions and financial stability.

"On the whole, the commercial banking system in the United States remains well capitalized. This morning's decision was made under extraordinary circumstances with significant consultation among the regulators and Treasury," Bair said. "This action was necessary to maintain confidence in the banking industry given current financial market conditions."

Commercial banking system remains well capitalized

That's great news Sheila. Given that the banking system is well capitalized, it should not need an infusion of $700 billion of taxpayer money.

Originally posted at: http://globaleconomicanalysis.blogspot.com/