Global Economic Crisis

The number of bank failures in the United States continues to climb. Over the weekend, the FDIC closed the 95th failed bank this year. The Federal Deposit Insurance Corporation is on track to shut down more than 100 before the year is done, versus a couple of dozen in all of 2008.

While U,S, taxpayers mortgaged their futures to prop up the “too big to fail” banks, those financial instituitons that don’t meet that threshhold are falling like autumn leaves. And Bernanke claims the recession is over. What planet is he living on?

When President Barack Obama, flanked by his leadership colleagues attending the G20 Summit in Pittsburgh, made his dramatic announcement regarding Iran’s covert second site for uranium processing, he did so with a high degree of credibility. Not wishing to follow the fanciful nuclear allegations made by the Bush administration to justify its invasion of Iraq, President Obama and his advisors deliberated for several months with  the U.S. intelligence community before being persuaded of the true purpose underlying a secretive underground facility being constructed by the Iranian regime outside the holy city of Qom.

The carefully worded statement by the president telegraphs an unambiguous message to the international community, and especially to those nations most concerned with the dangers of nuclear proliferation. The configuration of the Iranian nuclear facility, apparently built in violation of Tehran’s commitments to the International Atomic Energy Agency, makes it unsuited for any possible civilian purposes. However, once in operation, it would be ideally suitable for constructing at least one fission nuclear warhead per year.

Once the Iranian ruling elite realized that their secret facility was about to be unveiled, they hurriedly informed the IAEA that, apparently, they had regrettably forgot to inform the UN’s nuclear watchdog that a second uranium processing plant was being built. The fact that it was being constructed underground, below a mountain, was in no way indicative that this was anything other than a peaceful nuclear project, so claim the Iranian authorities.

No serious government believes the Iranian rationalizations, not even the Russians, who up till recently were opposed to imposing severe economic sanctions on Tehran. However, the apparently unassailable intelligence data on the nature of the nuclear facility near Qom has convinced even Moscow that sanctions may be warranted. That apparently is the hope of Washington, with the momentum now in place for a deadline that would place Iran under a sanctions regime by December, unless it is in compliance with all UN resolutions regarding her uranium enrichment program.

As laudable as President Obama’s intentions are on resolving the Iranian nuclear issue through diplomacy, I believe recent history does not leave grounds for optimism. Economic sanctions are only effective if they are imposed on a regime that is susceptible to domestic public pressure. In the case of  a Iran, the fixing of the recent presidential election and brutal suppression of public protest at having their votes disregarded  is clear evidence that the theocratic elite in Tehran does not factor in public opinion when formulating policy. Furthermore, the scope of and immense financial investment being made on the Iranian nuclear project, at a time when that nation’s economy is experiencing high unemployment and rampant inflation, is incontrovertible proof that acquiring nuclear weapons, and the missile technology to deliver atomic warheads to distant targets, is that regime’s top priority.

For more than a decade, the international community has imposed draconian  economic sanctions on North Korea in an effort to contain Pyongyang’s nuclear weapons program. The North Korean economy is a basket case, yet that reality has in no way restrained the nuclear ambitions of a regime that sees nuclear weapons as its best insurance policy for survival. The North Korean example would seem to suggest that when a dictatorial regime, immune to internal public opinion, is determined to develop nuclear weapons, economic sanctions are an ineffective policy response. There is every likelihood that Iran’s theocratic leadership is similarly immune to economic pressure, and sees diplomacy as merely a delaying tactic, to buy time while Tehran rushes forward with its covert uranium enrichment activity.

If in fact sanctions do not  impede Iran’s nuclear goals, what is likely to happen? Based on Israel’s aggressive non-proliferation policy  in the Middle East, and how they perceive the Iranian nuclear threat, it is unlikely they will remain passive if it appears that Tehran is on the verge of becoming a nuclear power. If the only alternative to an Iranian nuclear weapon is an Israeli attack on Iran, there should be no illusions about the Iranian reaction. They are likely to strike back not only at Israel, but at every Western country, most probably by mining the straits of Hormuz and attacking oil tankers in the Persian Gulf. The economic crisis the world is currently enduring will be massively exacerbated, with oil prices rising through the stratosphere. It is not inconceivable that a long-term regional war will erupt, while the global economy enters a tailspin.

It is not pleasant to contemplate the strong possibility that economic sanctions will fail to thwart Iran’s nuclear weapons program. However, the real world of geopolitics is often unpleasant, and frequently ugly. As painful  as it is, I hope that Washington is contemplating other options besides economic sanctions.  Otherwise, the Obama administration and the international community will, in effect, make a decision that the Israelis should handle the Iranian nuclear problem, and allow all the horrific yet predictable consequences to ensue.

Japan’s Finance Ministry has released trade figures for August, and is spinning a massive contraction in exports as “good” news. Well, perhaps Tokyo believes the latest data is evidence of good news, as imports declined even more, creating a modest trade surplus. However, the reality both figures present is that global trade remains weak, hardly an auspicious indicator of an end to the global economic crisis.

In August, Japan’s exports declined by 36% from August of 2008. Looking at the export figures in detail, shipments to the United States declined by 34.4%; to China by 27.6% and to the European Union by 45.9%. In spite of the clear collapse of Japan’s export machine, Tokyo still reported GDP growth in the last quarter, evidence that the recession has ended in Japan, or so the Finance Ministry would lead one to believe. However, those GDP growth figures only exist due to massive pump-priming by the government, which presides over the largest sovereign debt in the world, measured as a proportion of GDP.

In other negative signs that Japan’s economy remains moribund, the nation’s largest  air carrier, Japan Airlines, in on the verge of bankruptcy. JAL is on its knees, appealing to the new government in Tokyo to provide a bailout. It will be interesting to see if the new political power center in Tokyo will abide by its campaign promise to restrict corporate welfare in exchange for more public welfare, or cave in to the prospect of a major corporate failure.

Two contradictory financial trends are in evidence, in effect the Ying and Yang of the global economic crisis. The NYSE has experienced a steep Bear Market rally from its March lows, setting the stage for the Dow Jones to pass above the 10,000 level. On the other hand, the American greenback is plunging to new lows, having previously demonstrated impressive strength as a safe haven when the global economy imploded after the demise of Lehman Brothers.

Actually, there may be less of a contradiction than meets the eyes. If the U.S. national debt and annual budget deficits continue to expand with reckless abandon, it is inevitable that global market forces, especially the bond market, will set in stage a deep contraction in the U.S. dollar’s relative value. The apparent replacement of the Japanese yen by the U.S. dollar as the preferred vehicle for the carry trade seems to point in the direction of growing weakness. In that scenario, equities may, for a time, become the new flight to safety for investors.

The rise in equity prices may reflect an inverse relationship to the decline of the value of the American dollar, as opposed to a realistic market appreciation of economic fundamentals. Now, when the value of both the dollar and the Dow Jones plummet, what would that convey?

A global economic depression, most likely. At present, however, the inverse relationship of the U.S. dollar and NYSE merely reflects a synchronized global recession.  The dangerous moment will come when the world’s central banks begin to engage their long-speculated exit strategies. Then, I think, we will witness volatility with both the American dollar and equity prices.

To paraphrase  Winston Churchill, never in the field of sovereign finance have so many British taxpayers  been compelled by their government to assume so massive a debt to pay for the sins of so few. The UK has probably incurred the greatest collateral damage to its financial and banking system due to the subprime mortgage meltdown in the U.S. compared with any other country except for America itself.

According to the latest Treasury figures emanating from London, the United Kingdom’s national debt now stands at  £804.8 billion, compared with £632.8 billion just one year ago. According to official statistics, the proportion of UK public debt to GDP now stands at more than 57%, compared with 44% in Augusts 2008. The primary driver of this massive inflation of public debt has been the costly bailout of the UK’s banking sector.

As bad as these number are, they are bound to deteriorate further. For one thing, the toxic assets still sitting on the balance sheets of British banks guarantee the need for more costly bailouts down the road. In addition, UK tax revenues are plummeting while economic stimulus packages and unemployment relief are further expanding government expenditures.

Where doe this end? A growing possibility is national insolvency.

Yukio Hatoyama, whose Democratic Party won a landslide election over the long-serving Liberal Democratic Party, has been officially elected by the Japanese Diet as the nation’s new Prime Minister. His number one priority is the ailing Japanese economy. Accordingly, his selection for the pivotal post of Finance Minister was clearly an appointment of the greatest importance.

The new Finance Minister of Japan is Hirohisa Fuji, a 77 year-old veteran politician and Finance Ministry bureaucrat, who had previously served as Finance Minster in the 1990s. He is reputed to be a fiscal conservative, who seeks to reduce government spending and bring Tokyo’s massive public debt under control. His challenge will be confronting the election promises emanating from his own political party, which has promised to increase social spending. Though this promise is based on the belief that economies can be found by eliminating wasted spending and massive stimulus allocations on behalf of corporate Japan, there are risks involved in pursuing this policy course.

With Japan’s export machine badly hurt due to the global contraction in trade, the agenda of the new power elite in Tokyo risks a double-dip recession.  Furthermore, the challenge of tackling a debt to GDP ratio of nearly 200% seems overwhelming. With one of the most rapidly aging populations on earth and a very low birth rate, it seems nothing short of draconian spending cuts will succeed in reducing Japan’s debt burden to manageable levels. But in order to pursue that course, Prime Minister Yukio Hatoyama will have to jettison most of his campaign spending promises.

Perhaps Japan’s new Prime Minster may seek economic advice from his wife, who has publicly claimed she was transported to the planet of Venus during one of her dreams. I raise this suggestion, as it appears that a solution to Japan’s deep and apparently insoluble economic crisis requires both a dreamlike state and an out-of -this-world solution if there is to be any prospect of a resolution without the dire risk of national insolvency.

The G20 will be convening this month to no doubt boast about their cooperative efforts to reign in the global financial and economic crisis. The reality is that, at the price of saddling future generations with an immense debt burden, they have temporarily stabilized the financial system. But at what price?

While government deficits are artificially showing quarterly GDP growth or stability after the free fall in Q1 of 2009, consumer spending is contracting due to massive unemployment and stagnation or reduction in real wages.

The head of the IMF, Dominique Strauss-Kahn, recently told the French newspaper LeMonde, “Who will replace the U.S. consumer to power global growth? We have left the financial crisis, but we are still in the economic crisis. ”

The IMF head is correct about the economic crisis. As for the financial crisis, it will be back, with vengeance.

The New York Times had a scary headline in today’s issue: the prospect of Tishman Speyer and BlackRock defaulting on $4.4 billion in loans. I took the news somewhat personally, as I was once a resident of one of the properties involved; Stuyvesant Town. This massive complex, and its sister set of apartment buildings, Peter Cooper Village, were constructed after World War II by Metropolitan Life, right in the heart of Manhattan, to provide affordable rental homes for returning veterans.

Under New York City’s bizarre rental laws, massive market distortion reigned. Apartment rents in Manhattan were by far the highest  in the U.S., but many apartments, including much of these two complexes, were rent stabilized, meaning they were leased out at far below the market rent. However, various avenues allowed rent stabilized apartments to eventually be leased out at full market rent. That was the logic behind the purchase from Metropolitan Life of Stuyvesant Town and Peter Cooper Village for a record $5.4 billion by Tishman Speyer and BlackRock. This deal was done when the market was at its peak in Manhattan, so the investment seemed like a no brainer. It was a no brainer, but for the wrong reason.

A leading credit agency now values these two iconic Manhattan residential properties at a mere $2.13 billion, representing a 60% decline in valuation. Rents have receded 25% from their peak, and Tishman Speyer and BlackRock are confronted with a $4.4 billion obligation, with the sands of time slipping away before they are faced with default.

If these two properties are stricken with default, the repercussions in New York City will be massive, but not confined  to that one city. This may be only the beginning of a trend afflicting large scale apartment rental complexes throughout the United States.

On September 15, 2008 the supposedly safe, perpetually prosperous world of post-industrial capitalism blew itself up when Lehman Brothers filed for Chapter 11 bankruptcy. The iconic Wall Street investment bank was forced into this act of extremis when the collapse of the subprime mortgage market in the United States turned the securitized mortgage backed debt obligations engineered by the wizards on Wall Street into toxic assets, in the process extinguishing most of the storied investment banks in the United States, including Bear Stearns and Merrill Lynch. In those previous cases, Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke cobbled together a pseudo rescue, whereby these two firms were absorbed by JP Morgan Chase and Bank of America respectively, with massive financial aid and guarantees against bad debt generously provided courtesy of the American taxpayer. However, when Lehman Brothers stood on the precipice, the economic policymakers in Washington were confronted by the issue of moral hazard, and the growing public distaste with the concept of “too big too fail,” the justification previously issued by Paulson and Bernanke to prop up failing Wall Street firms.

The U.S. Treasury and Federal Reserve made a decision to allow Lehman Brothers to fold, assuming its demise would not pose a systemic risk to the global financial system.  Shortly afterwards, AIG was also on the verge of bankruptcy, due solely to the exposure of its Credit Default Swap operation spearheaded from its London office. Treasury Secretary Paulson stated that AIG was so large a factor in the global financial system, its business liquidation could not be allowed to occur, regardless of the subsidies required to keep it afloat. Through the middle of 2009, the U.S. government would inject in excess of $180 billion dollars into AIG.

The calculation made by Bernanke and Paulson that Lehman Brothers was expendable, especially in light of the measures taken to save AIG, Merrill Lynch and Bear Stearns, not to mention Fannie Mae and Freddie Mac, was destined to be proved fatally flawed, and in rapid order. As with so much else about the Fed and Treasury Department in terms of assessing the systemic impact of the collapse of the subprime mortgage market and its related financial derivatives, they badly underestimated the destructive forces that had been unleashed upon the global financial system by the collapse of Lehman Brothers. When Lehman Brothers imploded, its debris virtually froze the entire global interbank lending mechanism, and brought the flow of credit to a virtual standstill.

An immediate consequence of the disintegration of Lehman Brothers was the accelerating rise in the LIBOR and Ted Spreads, reflecting frozen global credit markets saturated with counterparty risk aversion. Money market funds were being depleted at a dangerously rapid pace, and economic indicators across the globe were heading south at a pace that soon became a free fall. The possibility of another Great Depression was openly being talked about, as it became abundantly clear that Lehman Brothers and its derivatives were far more embedded with the global financial system than the supposedly smart men of finance and economics who ran the Treasury and Federal Reserve had led themselves and the public to believe.

The rest was history. Paulson and Bernanke, in a state of panic, compelled a terrorized Congress to borrow $700 billion and hand it over to Treasury, supposedly to buy up toxic assets polluting the balance sheets of the nation’s banks, under the auspices of a program that came to be known as TARP. Once Paulson got his money, he changed direction, choosing to inject the TARP funds directly into the banks, as opposed to buying toxic assets. The Fed engaged in an unprecedented degree of monetary measures, becoming the lender to Wall Street and corporate America of last resort.

The collapse of Lehman Brothers undoubtedly was a major factor in the November 2008 presidential election, which witnessed the historic triumph of Barack Obama. The new president maintained many of the policies put in place by Paulson after the collapse of Lehman Brothers, reappointed Ben Bernanke as Federal Reserve Chairman, and brought in a $787 billion economic stimulus package, also based on borrowed money, to help reverse the worst recession the United States has endured since the Great Depression.

One year after Lehman Brothers disintegrated, the entire world is in the grips of the most severe synchronized global recession since World War II. We are told, however, that things could have been much worse, if the “brilliant” policymakers who had initially misjudged the extent of the economic and financial crisis had not taken such radical steps, all of which have involved an unprecedented level of public debt, and the bailouts generously awarded to the most reckless Wall Street firms. Also, one year afterwards, the extravagant executive bonuses are still being sprinkled on the Wall Street crowd, at levels that rival pre-meltdown levels.

Unquestionably, the demise of Lehman Brothers was a seminal point in global financial and economic history. I do not believe, however, we have witnessed the full consequences of its collapse. I fear that the worst is yet to come.

Back in July,  Neil Barofsky, special inspector general for the Treasury Department’s Troubled Asset Relief Program, better known by the acronym TARP, warned that the vast amount of taxpayer money already spent on banking and corporate bailouts, with the addition of guarantees and backstops for the financial industry, meant that in a worst case scenario, the United States would face $23.7 trillion in liabilities. In the weeks since this apocalyptic estimate was uttered by Barofsky before a congressional committee, scant attention has been paid by the public and mainstream media. But they owe it to themselves to be more attentive.

The number presented by Barofsky dwarfs the annual GDP of the U.S., currently at $14 trillion. It is double the national debt of the United States, standing at present at around $11.7 trillion. Now, many will suggest that this is just a worst case scenario, and things will probably never get this bad. But what if they did? Already, trillions of dollars have  been committed by the Treasury, Federal Reserve and Congress to repair the severe damage to the banking and financial system, bailout Detroit automakers and fund economic stimulus packages. And yet, despite official boasting about economic “green shoots,” the global economy remains very fragile and susceptible to future shocks.

If the commercial real estate sector implodes as many of us believe it will, than Barofsky’s worst case scenario is no longer just a marginal possibility. If the ultimate cost to the United States  of the global economic crisis  approaches anywhere near the sum of $23.7 trillion, than it will be Washington that is in need of a bailout. Only problem with that scenario, the IMF is nowhere near big enough to take on the debt crisis of the United States.