Global Economic Crisis

The American housing industry is once again in free fall. The latest figures, just released, indicate that in July existing home sales plunged by 27%, reflecting an annual pace of 3,830,000 home sales, according to the  National Association of Realtors. This is a fifteen year low, which had only been temporarily delayed by the Obama administration’s deficit-financed home purchase tax credit, now expired.

These figures are a disaster for the American economy of such a staggering level, not even Timothy Geithner or Ben Bernanke can put a positive spin on it. The housing industry is the center of gravity for the entire American economy, and its earlier demise was what unleashed the current global economic crisis. The gloomy data now out on existing home sales is another flashing red light, warning not only of a double-dip recession, but even more ominously, a prolonged economic depression.

Within the past  few days, two of the four most important economic advisors and policymakers within the Obama administration have resigned. They are Peter R. Orszag, budget director at the U.S. Office of Management and Budget, otherwise known as OMB, and Christina Romer, who chairs the Council of Economic Advisers. Remaining on the economics team is Treasury Secretary Timothy Geithner and Larry Summers, Director of the White House National Economic Council. Supposedly, Romer and Orszag are leaving of their own accord, to pursue “other opportunities.” Some speculate that policy differences with Larry Summers and even President Barack Obama were a factor. My own sense is that the worsening economic crisis in the U.S. as well as the overall global economic crisis were leading factors in their resignations, amid the increasing evidence that massive increases in public debt by Washington has not only failed to end the recession and restore robust economic growth; the risk of a sovereign debt crisis in the United States is now a reality.

The resignations of Romer and Orszag are the first ramifications of a failed economic policy. The more tangible result will be the upcoming midterm congressional elections in the U.S., which will almost certainly witness the Democrats losing control of the House of Representatives. From there, things will get worse, as America enters a double-dip recession, while Congress is mired in gridlock and imposes paralysis on the remaining two years of Obama’s presidential term.

As the economic clouds darken in America, it is likely that the resignations of Orszag and Romer are the crest of a wave.

As the  American dollar slides inexorably downward  in value relative to other major currencies, there are those heralding this  development as marvellous news. Many of these cheerleaders can be found within the camp of the Federal Reserve and U.S. Treasury, despite their public protestations that they are true believers in a strong U.S. greenback. But away from the T.V. cameras and open microphones, these guardians of American finance and economics believe that a weak dollar means an improved balance of payments. American exports are helped by being cheaper for overseas customers, while imports become more expensive, dampening the American appetite for goods originating from foreign sources.

Actually, a balanced dollar is good for the American and global economy, but a weak dollar in the long-term is not such good news. True, American exports become cheaper, initially. However, commodities and value add derived from overseas sources comprise a large component of American exports, so in the long-term a weak dollar does not provide a permanent advantage in terms of cost-competitiveness.

More important than exports, the center of gravity of the American economy is foreign-sourced oil and natural gas. With more than two thirds of American oil consumption based on imports, a collapsing dollar will raise energy prices in the United States to a level that is not sustainable for many consumers. Now, Messrs Geithner, Bernanke and Summers; tell me how this benefits the U.S. economy?

Larry Summers, Timothy Geithner and Ben Bernanke may be fated to go down in history as the three horsemen of the global financial and economic apocalypse. Though Fed Chairman Bernanke was inherited by the Obama administration, Geithner, Summers et al were the chosen economic team of the Obama administration. In effect, their selection was the single most important decision made by President Barack Obama  in response to the Global Economic Crisis. Regrettably, thus far their performance has been found wanting. Most disconcertingly, many of their public statements are Bush 43 redux, a smorgasbord of overly-optimistic platitudes utterly dichotomized from economic realities. Perhaps the one phrase that is most likely to haunt the Obama administration is one uttered originally by Ben Bernanke in the spring; those perennial “green shoots” that the Fed Chairman could see sprouting amid the recessionary quicksand engulfing the global economy.

Like a barbershop quartet, other senior Obama economic policymakers and advisors sang the happy melodies of these enigmatic green shoots. This happy talk was not without its effect; in large measure the bear market rally on Wall Street, what others have referred to as a “dead cat bounce,” was a by-product of investor optimism fuelled by the green shoots serenade flowing from the banks of the Potomac.

As Yogi Berra would say, “it’s déjà vu all over again.” George W. Bush’s economic team was also full of joyful verbiage, until the floor literally collapsed from under them with the disintegration of Lehman Brothers. In the case of the Obama economic crisis management team, however, this theory of hope triumphing over reality has been executed with even more creative dexterity. With all credible mathematical indicators revealing that most of the largest U.S. banks are functionally insolvent, the Treasury Department concocted a totally cosmetic set of so-called “stress tests” to “prove” that these insolvent banks were, actually, “solvent.” In addition, by forcing changes in the FASB rules through political intervention, some of these banks were even able to show a profit in their Q1 results.

The June unemployment numbers, however, are throwing a cold dose of reality in the direction of the pontificators of ephemeral green shoots. With the publicly released U3 Labor Department jobless report showing the level of U.S. unemployment having risen to 9.5%, and the less publicized but far more accurate U6 report showing actual unemployment and underemployment now at a staggering 16.5%, it is quite clear that the American economy, along with most of the planet, is still undergoing a painful contraction. The fact that one in six Americans is either unemployed or trapped in low-paying part-time employment due to the lack of full-time positions, is a far more significant economic indicator than short-term gyrations on Wall Street or periodic upward anomalies confronting an otherwise downward economic trend.

Amid all the green shoots fantasizing, it must be recalled that the United States economy depends on the spending of the U.S. consumer for more than 70% of its aggregate demand. The real significance of rising unemployment, exchanging full-time jobs for part-time employment and the fear factor inhibiting spending by those who think they may lose their jobs, is a radical contraction in consumer spending. It is this reality more than any other that is weighing heavily on the nation’s economic superstructure. Not only is joblessness rising. After years of American consumers spending more than they earned, they have now shifted radically towards a high level of savings. Transitioning from a negative savings rate, the U.S. wage earner now banks nearly 7% of his/her declining take- home pay, despite virtually zero interest being offered to savers due to the Federal Reserve’s zero interest monetary policy.

The American consumer is scared, and is not being seduced by talk of green shoots emanating from Washington. With consumer spending undergoing significant contraction not only in the United States but in virtually all major economies throughout the globe, increasing pressure will bear on securitized investments based on loan portfolios directly or indirectly linked to consumer spending. Retail and shopping mall mortgages will witness higher levels of defaults, in conjunction with the already virulent afflictions  hammering sub prime and prime residential mortgages, commercial office space mortgages, consumer loans and credit card debt.

The Obama administration apparently believed that the original $700 billion TARP Wall Street bailout passed by Congress in the last weeks of the Bush administration, and President Obama’s $800 billion stimulus spending bill, would suffice to stabilize the economy and put the brakes on the free fall in employment numbers. However, jobs are still being shredded each month by the hundreds of thousands, while banks still suffer from balance sheets saturated with toxic assets. The FDIC has already closed more U.S. banks this year than in all of 2008.

As I indicated in a recent piece, there is already serious discussion occurring in the corridors of power in Washington on the necessity of a second stimulus spending package. This is an acknowledgement that the Obama economic crisis team, thus far, has been an abject failure. However, with so much money already having been borrowed by the U.S. government on a variety of schemes supposedly aimed at saving the economy, further large doses of public debt bring along very dangerous negative implications of their own.

In a recent column in the Financial Times of London, Mohamed A. El-Erian, chief executive and co-chief investment officer of PIMCO, the world’s largest bond trading firm, offered the following observation:
“The bottom line is a simple yet powerful one. The global crisis is morphing again. Having already contaminated (in a sequential and cumulative manner) housing, finance and the consumer, it is now threatening the potency and credibility of the economic policy making apparatus. As far as I can see, there are no first best policy responses that are readily available and easy to implement. Instead, the economy will continue to struggle, navigating both the adverse implications of last year’s financial crisis and the unintended consequences of the experimental policy responses. Given the inevitable socio-political dimensions, this story will play out well beyond the realm of the economy, policymaking and markets.”

Mohamed El-Erian is not offering green shoots, but he does speak the truth. Unfortunately, the truth is so bitter, it is unlikely that President Obama’s principal economic advisors will face up to the harsh and even brutal realities of the Global Economic Crisis until it is far too late for any policy response to be effective.

The ancient Greek philosopher, Plato, constructed a political theory based on the royal lie or myth. As described in Plato’s Republic, the ruling elites of a political entity have the right to lie to their citizens-but not vice versa. The rationalization is that a royal lie and deception maintains social cohesion and prevents the collapse of the state. Thus platonic logic gives rise to the so-called stress test for American banks, the royal myth conceived by Treasury Secretary Timothy Geithner and Fed Chairman Ben Bernanke, in order to deceive investors, market sentiment and the American people as to the true state of the nation’s financial institutions.

When Congress approved the massive $700 billion bailout of U.S. banks and Wall Street firms last October, the justification was that without this massive indebtedness being incurred by the American taxpayer, the U.S. and even global financial system would collapse. Yet, from this perilous state of only a few months ago, a stress test is concocted by the Obama administration to “prove” that these same banks are relatively healthy, well capitalized, with only a few banks requiring a collective total of $75 billion to cover probable losses that can be anticipated during the months ahead as unemployment continues to rise. Furthermore, this $75 billion capital infusion can be generated directly from private investors, without the injection of additional taxpayer support, so says Geithner & Company.

What is going on here? I think the prophet of doom of this unprecedented global financial and economic crisis, NYU economics professor Nouriel Roubini, summed it up best when he wrote recently, “Geithner’s hope is that he can subsidize banks long enough for them to earn their way back to health. But the public isn’t keen on more bailouts, so Geithner’s challenge is to convince us that banks are solvent.”

However, as Roubini and other economists and financial analysts have pointed out, much of the U.S. banking sector is functionally insolvent, stress test or no stress test. Roubini himself estimated that U.S. financial institutions will incur $3.6 trillion in losses from the ongoing economic crisis, while the IMF calculates that global exposure to toxic assets is over $4 trillion, more than half this sum related to losses in the United States. These figures far surpass the current capitalization of U.S. banks, making Geithner’s $75 billion figure a fantasy number, unrelated to actual economic and financial realities. In other words, a royal lie, straight out of Plato’s Republic, with suitable accoutrements customized for the Global Economic Crisis.

The stress test is a public relations exercise on a grand scale. Originally, word “leaked” out that all the major U.S. banks would pass the stress test. Markets reacted skeptically, leading Treasury and the Federal Reserve to come up with a compromise number; big enough to look credible yet not so large as to suggest there is an insolvency danger afflicting the nation’s banks.

A mythological approach towards the Global Economic Crisis, especially as it relates to financial institutions, will insure that an already dire situation becomes inevitably calamitous. The most dangerous flaws in the U.S. and global banking system are not even hinted at with Treasury’s stress test. They have to do with a volatile man-made financial toxin, otherwise known as derivatives.

The oracle of Omaha, billionaire investor Warren Buffet, once described derivatives as “financial weapons of mass destruction.” As regards the world of credit and finance, he is absolutely correct. What exactly are these nefarious derivatives? Though conceived of as complex financial instruments, in essence they are private contracts between financial counterparties, which have the characteristics of a bet, in effect gambling on a range of financial and economic activity. This can include price direction of commodities, equity markets and global currencies, among many other “derivatives” of financial and economic activity. Banks, investment firms and insurance companies loaded up on derivatives until their balance sheets choked on them, driven by what was seen as an easy way to generate cash flow-and significant cash bonuses for the supposed geniuses who devised these monstrosities. Then came the collapse of the subprime mortgage market in the United States, and the fragile derivatives empire began to unravel.

AIG was the first demonstration of how dangerous derivatives had become to the global financial system. A small branch of the insurance giant, based in London, bet heavily on a form of derivatives paper known as a credit default swap, in effect insurance based on gambling about the stability of securitized mortgages. When the U.S. housing market collapsed, AIG lacked the capital to pay off the bets it had lost heavily on with its CDS paper, forcing the U.S. government to come to the rescue. The tab so far, just for this one company, is nearly $200 billion. I would not be surprised if AIG’s credit default swap losses ultimately top half a trillion dollars, all of which the American taxpayer will be expected to make whole. And by no means is AIG the only derivatives bomb waiting to explode, a terrifying truth completely veiled by the mythology of the stress test.

How dangerous is the derivatives toxin to the U.S. and global banking system? To give just one example, Geithner’s stress test claims that Citigroup, the country’s third largest bank, only requires a mere $5 billion in additional capitalization to maintain its financial health under the worst anticipated economic storms that may still arise. However, Citigroup has a derivatives exposure equal to nearly three times its total assets

of $1.2 trillion. Most of the other U.S. banks have equally threatening levels of derivatives exposure; in the case of J.P. Morgan Chase its exposure is nearly four times its assets of $1.7 trillion.

What makes derivatives so frighteningly dangerous is that they are almost totally devoid of government regulation. Their opacity makes it virtually impossible to gauge the exposure of U.S. and foreign banks to these destructive financial instruments with any degree of precision. However, it is currently estimated that the combined value of all derivatives contracts in the world equals a sum of money that seems impossible to fathom: $1.2 quadrillion! That number exceeds the total GDP of the entire planet by many dozens of times. In effect, the developed world, led by the United States, has created a vast, unregulated shadow economy based entirely on risky paper and exotic casino-style capitalism, with actual bets being placed by the major actors within the U.S. and global banking system as though they were roulette wheel patrons in Las Vegas.

It is the fear of the derivatives toxin that has frozen credit markets, leading to the Global Economic Crisis. Geithner’s stress test, along with the phony Q1 “profits” reported by these same insolvent U.S. banks, can in no way alter the darkening truth about the calamitous state of the U.S. banking sector.

It appears, unfortunately, that the Obama administration has bought into the royal lie as the best solution to the nation’s perilous financial and economic crisis. They are desperately playing for time, hoping somehow that markets will be fooled into regaining confidence, and that things will revert to some level of normalcy, without the added expense of further bank bailouts and nationalization of key financial institutions. Sadly, by taking what appears to be the easy way out, I fear that the economic policymakers in Washington have embarked on path that can only offer a financial and economic apocalypse that may defy our worst nightmares.

A few weeks before these antics a more sober assessment of America’s banking health was delivered at the National Press Club in Washington by Dr. Martin D. Weiss, the head of Weiss Research, a global investment research firm. Previously, Weiss had accurately forecast the demise of Bear Stearns and the implosion of the U.S. investment-banking sector. However, at the National Press Club he offered a more chilling prediction: 1,568 U.S. banks and thrifts risk failure. Included in that number are several of the largest American banks, including J.P. Morgan Chase, Goldman Sachs, Citigroup, Wells Fargo, Sun Trust Bank and HSBC Bank USA. The numbers and depth of the banking problem highlighted by Dr. Weiss are far larger and much more ominous than has been portrayed by the Federal Reserve, Treasury Department and FDIC. He backed up his dire analysis with documentation and precise mathematical modeling. For example, he refers to the government’s justification for a hideously expensive taxpayer bailout of AIG, based on the firm’s exposure to the fragile investment vehicles known as Credit Default Swaps, or CDS. The policymakers maintain that AIG’s $2 trillion in CDS exposure represented an unacceptable systemic risk, meaning AIG was “too big to fail.” However, Weiss points out that Citigroup alone holds a portfolio of $2.9 trillion in Credit Default Swaps, while J.P. Morgan Chase possesses a staggering $9.2 trillion of these toxic instruments, about five times the exposure that led AIG to demand that the government rescue it, or see the global financial system implode.

The essential point Dr. Weiss made at his press conference is that the degree of exposure U.S. banks have to a variety of toxic assets is beyond what the U.S. government and, by extension, the American taxpayer is financially capable of rescuing. Continued bailouts of insolvent banking institutions will not repair a broken financial order, but may very well cripple the overall economy.

Earlier, NYU economics professor Nouriel Roubini had already gone on record as declaring that much of the U.S. banking sector was functionally insolvent, and that bailing out zombie financial institutions would only replicate the Japanese “lost decade” of the 1990s, when Tokyo’s preference for keeping alive insolvent banks instead of closing them down led to a prolonged L-shaped recession. Roubini and other critics of both Bush and Obama administration policies on bank bailouts have looked to the Swedish model for resolving a profound banking crisis, which involved temporary short-term nationalization, closing down insolvent banks, while those banks that can be salvaged are cleaned up of their toxic assets, recapitalized and then sold back to the private sector. “You have to take them over and you have to split them up into three or four national banks, rather than having a humongous monster that is too big to fail,” Nouriel Roubini has argued.

According to the International Monetary Fund, the global financial and economic crisis has already created more than $4 trillion in credit losses due to toxic assets. If nothing else, the IMF estimate on the scale of the economic and financial disaster thus far should compel the Washington political establishment to face the painful yet necessary truths regarding America’s precarious situation. However, it appears that fantasy is preferred over reality within the corridors of power.

The procrastination of policymakers in Washington in facing dark reality, and preference to avoid any public takeover of troubled banking institutions while simultaneously subsidizing these financial dead men walking with almost unlimited taxpayer funds, at the same time maintaining the fiction, as Timothy Geithner has just done, that all is basically fine with the “vast majority” of U.S. banks, is to insure the inevitability of a systemic banking collapse in the United States. The conglomeration of reckless, greed-induced banking practices by the oligarchs of finance and inept, reality-denying policymakers is sending much of the American banking sector on a Wagnerian death ride into a financial apocalypse. Many of the U.S. banks are in fact doomed to fail, and no contrived stress test or Geithner speech can alter that outcome. And that isn’t even the worst part. For when mass banking failures occur in the United States and overseas, a global economic depression will be an irreversible outcome.

There are apparent to me several signposts that clearly point to a downward spiral of accelerating velocity. One of these signposts involves the worsening statistics chronicling the effects of the Global Economic Crisis. Japan’s Q4 of 2008 growth figures show GDP contraction of 12.7%, with every indication that this measure of economic deconstruction will grow even more dire in Q1 of 2009. We already have figures indicating that in January, Japan’s exports declined by almost half from a year ago.

America’s tottering economy is receding so severely, the statisticians cannot keep track of the staggering rates of decline. The Commerce Department had to revise the Q4 of 2008 GDP figures from negative 3.8% to more than 6% GDP contraction. Unemployment numbers are swelling at an alarming rate, while the public and private debt ratios are entering into astrophysical red shift territory, so rapid is their spread from any realistic possibility of fully servicing them.

Beyond the fiscal doomsday being portrayed by the macroeconomic data, there is the looming banking apocalypse that is now gripping almost every economy on the globe, major and minor. In both the U.S. and U.K., almost the entire banking sector is insolvent, being kept on life support by massive infusions of government IOUs that are being backed by what amounts to an intergenerational commitment from the taxpayers. The banks of the European Union have on their balance sheets, according to a leaked secret European Commission document, $24 trillion of toxic assets. Iceland is already bankrupt, with Eastern Europe about to follow down the path of national insolvency.

All the dire news I just chronicled cannot be viewed in isolation, but must be seen as a devastating continuum, in which the negative news emerging from one economy impacts another, creating a destructive chain reaction that is close to achieving the point of irreversible criticality. And with the global economic order about to undergo nuclear fission, the policy makers are reacting in thoughtless panic and hysteria, stampeding into a rush of Keynesian irrational excess. Despite the fact that unsustainable debt was a principal driver of the Global Economic Crisis, the sovereigns of the world are replicating the worst habits of the consumer and private sector. Staggering levels of deficit spending are being enacted into policies, unmindful of the inability of the global financial world to absorb and sustain such stratospheric levels of unfunded spending. Neither are the policy makers cognizant of the inconvenient fact that with so many economic actors swamping the global credit markets to fund levels of deficit spending that defy the human imagination, it is inevitable that interest rates will rise to crippling levels, choking off private capital. In their frantic efforts to rescue the global economy and bailout irresponsible financial institutions and ineptly run conglomerates at any price, the politicians are planting the seeds of a bitter harvest for all.

The world is facing the equivalent of a world war, with the Global Economic Crisis playing the role of the Axis. It is humanity’s misfortune that instead of Winston Churchill or Franklin Roosevelt to lead and inspire us, we are left with the likes of Timothy Geithner and Nicholas Sarkozy. It may be our fate to be led down the path of economic perdition, with the highway to hell being paved with mediocrity and ineptitude.