Direct look at the banking sector
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and we finish with a parable. I misspoke on Monday. This parable of Jesus is from Matthew 18, not Luke.
First let’s begin with some context, courtesy of New Deal Democrat. NDD blogging at Daily Kos. From his Dark Clouds, Silver Lining piece. This is last week’s data, but if you’re looking for the start of the recession, you should be looking in the rearview mirror.
Like a cascade from Imelda Marcos' closet, within the last week, the last shoes have dropped among the indicators used to forecast recession.
Retail sales, which had been holding up decently, tanked in January. Jobless claims have increased, layoffs have increased, payrolls have decreased. While manufacturing, which is now only 10% of the economy grew ever so slightly, the 90% of the economy representing services suddenly and dramatically contracted. And housing continues to sink into the depths like the Titanic.
This morning we found out that it wasn't just Wal-Mart customers who've been tightening their belts recently. The affluent middle class (the 80th-90th percentile of consumers), have also cut back, and stores like Macy's and Nordstrom felt the pinch:
Feb. 7 (Bloomberg) -- Limited Brands, Macy's and Nordstrom Inc said January sales declined while Wal-Mart’s gain trailed analysts' estimates as consumers facing the worst housing market in a quarter century avoided clearance sales and saved gift cards for future purchases.
Department stores and mall-based shops slashed prices on clothing and bedding to attract customers following the slowest holiday season since 2002. Consumers refrained from spending as median home values probably fell for the first time since the Great Depression and employers cut back on hiring.
Also February 7: first-time jobless claims for the second week in a row were over 350,000. Once there is an established trend of weekly new jobless claims over 350,000, almost certainly we are in a recession:
In the same report,
Private placement firm Challenger, Gray & Christmas Inc. said Feb. 4 that job cuts announced by U.S. employers jumped 19 percent in January to 74,986 from a year earlier.
And while the manufacturing sector, which is now so atrophied that it accounts for only 10% of employment in the US, grew ever so slightly as of the last report, on Tuesday we found out that the ISM services index suddenly and dramatically contracted:
The ISM's non-manufacturing index, which assesses banks, retailers and construction companies, slumped to 41.9 from 54.4 the prior month. A reading of 50 is the dividing line between growth and contraction.
Worse still, the ISM index is closely correlated with layoffs, meaning that in January 2008 it is likely that nationwide payrolls contracted substantially.
All of this is added to last week's report that in December nonfarm payrolls not only did not grow, but actually shrank by 18,000 jobs.
That from NDD, to whom we extend our appreciation.
Now let’s turn to the banking sector. A primary purpose of the Fed’s interest rate cuts has been to stabilize this sector. Bernanke has at times been explicit about it. Only secondary, in our opinion, has been the aim to promote economic activity. Stabilization is not working.
Banks and the shadow banking system are culpable for this economic crisis. They are insolvent as a result of their own mistakes and misdeeds. And they are desperate to find a way out. The Fed is helping them as much as it can, though Bernanke and colleagues cannot be pleased that at the same time rates TO banks are being cut, the banks themselves are turning around and jacking up the rates on their own customers, particularly credit card customers. This gives lie to the whole purpose of cutting Fed rates, as it will inevitably contract spending and further cut the legs out from under the retail economy.
The banks and hedge funds and others engaged in ludicrous — at least in retrospect — financial engineering, creating securities which got triple A ratings because they had the word mortgage in them. Then further engineered them into other securities to create total leverage of sometimes forty or fifty to one. So-called off balance sheet vehicles were created so banks did not need to follow prudent capital reserve requirements, but could own in a fashion the higher yield securities. Turns out they were still in house, they were just hidden in a closet.
As these securities and lending practices came home, the banks capital reserves disappeared. The Fed with a wink and a nod has suffered accounting standards to be flexed. In addition, it has set up a special auction facility which takes any paper as collateral for low-interest loans, thus giving value to the valueless and putting the taxpayer on the hook in the event of default. But we already knew they were too big to fail.
In a minute I will speculate on some possible ways of bailing them out. Necessarily imaginative.
Losses according to Nouriel Roubini for the financial sector are $250 to $300 billion. If a ten percent reserve requirement is in place, this contracts lending capacity by $2.5 to $3.0 trillion. The banks have already been around the world once with their tin cups out to the sovereign wealth funds. As above, they’ve tapped into the sovereign wealth of the U.S. Treasury. And now where possible they are squeezing their borrowers – as with the recent round of credit card rate increases.
Credit cards and equity loans have blurred the meaning of money. While I do not understand all the measures — M1 through M6 — I do know that practically speaking credit cards are the money of the retail economy. Look for a drastic cut-back in retail sales and a sharper dive into recession.
Financial markets do not regulate themselves. When they’re allowed to try, the result is a mess. The boom-bust has led to the worst housing recession in U.S. history.
Credit card, student loan, and auto loan defaults are on the way.
The so-called monoline insurers are not long for this world, as they are exposed to the toxic paper and have no standing once their triple A ratings dissolve. Which they are sure to do.
The bankruptcy of a large bank is if not inevitable, at least likely. Already Countrywide has been bailed out with a 55 billion dollar loan from the Federal Home Loan Bank.
So. Culpable. Insolvent. Desperate.
Which brings us to tonight’s parable, from Matthew Chapter 18. At the risk of sounding apocalyptic I’ll just read from the New English translation.
There was once a king who decided to settle accounts with the men who served him. At the outset there appeared before him a man whose debt ran into millions. Since he had no means of paying, his master ordered him to be sold to meet the debt, with his wife, his children, and everything he had.
The man fell prostrate at his master’s feet. “Be patient with me,” he said, “and I will pay in full;” and the master was so moved with pity that he let the man go and remitted the debt. But no sooner had the man gone out that he met a fellow-servant who owed him 100 denarii, and catching hold of him he gripped him by the throat and said, “Pay me what you owe.”
The man fell at his fellow-servant’s feet, and begged him, “Be patient with me, and I will pay you;” but he refused and had him jailed until he should pay the debt. The other servants were deeply distressed when they saw what had happened and they went to their master and told him the whole story. He accordingly sent for the man. “You scoundrel!” he said to him; “I remitted the whole of your debt when you appealed to me; were you not bound to show your fellow-servant the same pity as I showed to you?”
And so angry was the master that he condemned the man to torture until he should pay the debt in full. And that is how it will be with you, unless you each forgive your brother from your hearts.
Are these banks not doing the same thing as this hypocrite. The Fed is risking real debasement of the currency to attempt to heal them. Heavy inflation is virtually guaranteed. Yet the beneficiaries – the banks — are not joining in the attempt to get the economy going, but are turning on their own borrowers with no pity.
This is Alan Harvey from the Demand Side.