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Even With Bailout, Talk Of Additional Intervention

Well, it’s official. The U.S. government bailout of Wall Street and the financial system is now law. From the Wall Street Journal’s Greg Hitt and Deborah Solomon today:

President George W. Bush signed into law an unprecedented $700 billion plan to rescue the U.S. financial system, one of the largest-ever government interventions in the nation’s economy — and almost certainly not the last.

The Treasury Department is expected to move quickly to start buying distressed assets from struggling financial institutions, although any impact might not be felt for some weeks. Many details — such as who will administer the program and how — are still to be worked out.

Even with the massive bailout, there is already talk of additional government intervention. Hitt and Solomon wrote:

It will likely be followed by other moves. The Federal Reserve could cut interest rates and take further steps to ensure there are enough funds coursing through the financial system. Congress has already beefed up jobless benefits and is expected next year to push for new stimulus efforts, such as spending on infrastructure.

Looking to next year, Democratic lawmakers are planning to revamp financial-system regulations, with hedge funds, private-equity funds and investment banks all likely to come in for tighter scrutiny. House Speaker Nancy Pelosi (D, Calif.) portrayed the legislation as “only the beginning” of the legislative response to the faltering economy…

“We will be back next year to do some serious surgery,” said House Financial Services Chairman Barney Frank (D., Mass.). Mr. Frank wants legislation to rewrite housing finance — including the roles of mortgage giants Fannie Mae and Freddie Mac – and overhaul regulation of financial services.

More intervention? Can’t wait…

Call me skeptical, but Congress has a habit of rendering things F.U.B.A.R. Speaker Pelosi may
want to pay heed to something one of her predecessors said many years ago:

One of the greatest delusions in the world is the hope that the evils in this world are to be cured by legislation.

-Thomas Reed, Speaker of the House of Representatives (1886)

Sources:

“Historic Bailout Passes As Economy Slips Further”
Greg Hitt, Deborah Solomon
Wall Street Journal, October 3, 2008

U.S. Bailout Plan For Dummies

Obviously, there’s a lot of info on the proposed U.S. government bailout of the financial system circulating around cyberspace this Monday morning. Filtering out the noise, I tried to get at the nuts-and-bolts of what is being proposed in this post.

For those of you who prefer a short, multimedia-based breakdown of the bailout proposal, John Bussey of the Wall Street Journal talks about what’s at stake in a 3-minute MarketWatch video:

MarketWatch Video Link

For an in-depth, print-based explanation of the $700 billion scheme, this morning the Journal’s Deborah Solomon picked apart the proposed legislation and talked about its components:

The Troubled Asset Relief Fund:

The bill authorizes $700 billion for the fund in installments. Treasury will first get $250 billion, with an additional $100 billion immediately accessible. Congress would have the option of blocking the final installment of $350 billion by issuing a joint resolution within 15 days of any requests.

How it works:

Treasury plans to hire asset managers to determine how to buy bad loans and other ailing assets from financial institutions. Many of the details, including pricing and purchase procedures, will be worked out between those managers and Treasury. The legislation requires Treasury to set guidelines within 45 days for pricing methods and setting the value of troubled assets, as well as mechanisms for purchasing assets, procedures for selecting asset managers and criteria for identifying troubled assets to buy.

The legislation requires Treasury to purchase assets at the lowest price, and allows the government to buy through auction or direct from institutions.

Treasury expects to start buying the simplest assets first — mortgage-backed securities, for example — followed by more complex securities. Treasury likely will publish a list of the assets it is seeking to purchase. Banks and other institutions are expected to submit bids in a competition to sell bad loans and securities.

Executive compensation:

The legislation places restrictions on executive compensation for certain companies that sell assets to Treasury. If Treasury buys assets from a company directly — something it would do if a firm were failing — then no “golden parachute” exit payments could be made during the period when Treasury has an ownership stake in the firm. Companies that sell assets to Treasury through an auction process will be subject to some limits. Firms that sell more than $300 million of assets to Treasury won’t be allowed to make any new golden-parachute payments to top executives. A tax-deduction limit on compensation above $500,000 also will apply.

Equity stakes:

The legislation requires Treasury to receive warrants in companies that participate in the program. If a company sells its assets through an auction, Treasury will get a nominal amount of nonvoting warrants. If Treasury buys assets directly, it could get a majority equity stake.

Oversight:

The Troubled Asset Relief Fund will be overseen by a bipartisan congressional commission that will receive reports from Treasury every 30 days. The program will also be overseen by a board comprising the heads of Treasury, the Federal Reserve, the Securities and Exchange Commission, the Housing and Urban Development Department and the Federal Housing Finance Agency.

The office of accountability will have an inspector-general office within Treasury.

Treasury will have to submit a written report to Congress no later than April 30 on the overall financial regulatory system and “its effectiveness at overseeing the participants in the financial markets, including the over-the-counter swaps market and government-sponsored enterprises” and recommend improvements.

Protecting taxpayers:

If after five years the government has a net loss, the president will be required to submit a legislative proposal to seek reimbursement from the financial institutions that participated.

Help for homeowners:

Treasury will buy mortgage-backed securities, mortgages and other assets secured by residential real estate. The legislation requires Treasury to use its position as the investor in those loans and securities to “encourage the servicers of the underlying mortgages” to help minimize foreclosures.

It also calls for Treasury to “identify opportunities” to acquire “classes of troubled assets” that will improve the ability of Treasury to help modify and restructure loans. The idea is that Treasury would be more patient with homeowners who have fallen behind on their payments than commercial lenders.

Insurance:

The bill would require Treasury to establish, alongside the asset-purchase plan, a program to insure mortgage-backed securities. Financial institutions that want to participate would essentially pay the government a fee and, in return, the government would insure their assets against any future losses.

Accounting:

The legislation would require the Securities and Exchange Commission to study so-called mark-to-market accounting standards, which require that firms reflect the market value of assets on their books. Such accounting has culminated in many financial institutions writing down big losses as the value of certain assets has fallen in price. The SEC would have to study the accounting rule’s effect on balance sheets and report to Congress within 90 days of its findings.

The bailout legislation (in .pdf format) can be accessed here.

Sources:

MarketWatch Video
MarketWatch, September 28, 2008

“Shape of Massive Bailout Bill Starts to Develop Definition”
Deborah Solomon
Wall Street Journal, September 29, 2008

Lenin Would Be Proud

… and in other news, Yakov Smirnoff is making plans to flee the country.

Yakov Smirnoff Miller Lite Commercial (1985)
YouTube Video Link

Why Gold Will Prevail

This afternoon, I listened to the most recent broadcast of the “Financial Sense Newshour” when guest John Williams of “Shadow Government Statistics” fame made the following statement about the recent activity surrounding gold:

I can’t prove that intervention took place in the gold market. But you sure can make a very strong circumstantial evidence case for it, especially considering that the system was on the brink and they were trying to contain the panic. One way to do it is to discourage the owning of gold. And that’s been a traditional sore point for central banks and governments over time. It’s usually when gold is soaring it’s a good sign that they’ve been doing a bad job. And I think a lot of what happened with that, not only the selling of the gold, but the buying of the dollar, was very much orchestrated, very much supported with heavy intervention. Again, the underlying fundamentals haven’t change a bit. If anything, they’ve gotten worse. And the fundamentals for the dollar couldn’t be more negative. And the fundamentals for gold couldn’t be more positive. And those fundamentals, will in the end, dominate the markets. And, irrespective of whatever intervention, games-playing, jawboning, whatever’s done, in the end the gold price will prevail on the upside. And, unfortunately, for most of us living in the United States, the dollar is going to come under very heavy selling pressure.

Source:

“Other Voices with John Williams, Shadow Government Statistics”
Third Hour
Financial Sense Newshour, September 20, 2008

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FREE 5-MINUTE VIDEO FOR GOLD TRADERS:
“Where gold is headed in the next 6 months”

Traders: Stock Market Crash Narrowly Avoided

This weekend, Michael Gray of the New York Post wrote:

The market was 500 trades away from Armageddon on Thursday, traders inside two large custodial banks tell The Post.

Had the Treasury and Fed not quickly stepped into the fray that morning with a quick $105 billion injection of liquidity, the Dow could have collapsed to the 8,300-level - a 22 percent decline! - while the clang of the opening bell was still echoing around the cavernous exchange floor.

According to traders, who spoke on the condition of anonymity, money market funds were inundated with $500 billion in sell orders prior to the opening. The total money-market capitalization was roughly $4 trillion that morning.

The panicked selling was directly linked to the seizing up of the credit markets - including a $52 billion constriction in commercial paper - and the rumors of additional money market funds “breaking the buck,” or dropping below $1 net asset value.

The Fed’s dramatic $105 billion liquidity injection on Thursday (pre-market) was just enough to keep key institutional accounts from following through on the sell orders and starting a stampede of cash that could have brought large tracts of the US economy to a halt.

Source:

“ALMOST ARMAGEDDON”
Michael Gray
New York Post, September 21, 2008

Former Fed Governor: Financial Crisis Worse Than Great Depression

CNBC’s Andrew Fisher wrote today:

Economics scholar and former Federal Reserve Governor Frederic Mishkin says the shock that continues to rip through the nation’s economy is actually worse than what was felt during the Great Depression.

“The difference is, we have people on the ball,” the Columbia University professor told CNBC.

Mishkin said he was impressed by the way his former colleagues at the Fed handled crises.

“During all these episodes… everybody stayed very cool, calm, and collected,’ he recalled. “Chairman Bernanke is someone who sits down, is very analytical, thinks through, doesn’t get excited, just, ‘Let’s do the job,’ the staff operated that way, the rest of the board operated that way.”

I, for one, sure hope Mr. Bernanke’s problem-solving skills are a lot better than his forecasting abilities.

Anyone recall the following statements from “Helicopter Ben” over the last couple of years?

Housing Bubble

Testimony given at a Congressional Joint Economic Committee hearing in October 2005 (as reported by Nell Henderson of the Washington Post):

Ben S. Bernanke does not think the national housing boom is a bubble that is about to burst, he indicated to Congress last week, just a few days before President Bush nominated him to become the next chairman of the Federal Reserve.

U.S. house prices have risen by nearly 25 percent over the past two years, noted Bernanke, currently chairman of the president’s Council of Economic Advisers, in testimony to Congress’s Joint Economic Committee. But these increases, he said, “largely reflect strong economic fundamentals,” such as strong growth in jobs, incomes and the number of new households…

Bernanke’s testimony suggests that he does not share such concerns, and that he believes the economy could weather a housing slowdown.

“House prices are unlikely to continue rising at current rates,” said Bernanke, who served on the Fed board from 2002 until June. However, he added, “a moderate cooling in the housing market, should one occur, would not be inconsistent with the economy continuing to grow at or near its potential next year.”

Derivatives

Testimony given at a U.S. Senate hearing, November 15, 2005:

I think, generally speaking, they are very valuable. They provide methods by which risks can be shared, sliced and diced and given to those most willing to bear it. They add, I believe, to the flexibility of the financial system in many different ways.

And, with respect to their safety, derivatives, for the most part, are traded among very sophisticated financial institutions and individuals who have considerable incentive to understand them and to use them properly.

Subprime Crisis

Testimony given at a Congressional Joint Economic Committee hearing in March 2007:

At this juncture, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.

The big question: Can Bernanke and the Fed fix something they never saw coming in the first place?

Sources:

“Top Economist Mishkin: Worse Than the Depression”
Andrew Fisher
CNBC, September 23, 2008

“Bernanke: There’s No Housing Bubble to Go Bust”
Nell Henderson
Washington Post, October 27, 2005

Quote For The Week

From the office of U.S. Senator Jim Bunning (R-K.Y.) last week:

Bunning Declares The Free Market Dead

Washington, DC
Friday, September 19, 2008

U.S. Senator Jim Bunning today issued the following statement regarding the Treasury Department’s bailout of Wall Street.

“Instead of celebrating the Fourth of July next year Americans will be celebrating Bastille Day; the free market for all intents and purposes is dead in America,” said Bunning. “The action proposed today by the Treasury Department will take away the free market and institute socialism in America. The American taxpayer has been misled throughout this economic crisis. The government on all fronts has failed the American people miserably.

“My great grandchildren will be saddled with the estimated $1 trillion debt left in the wake of this proposal. We have gotten to this point because nobody has been minding the store. Both Secretary Paulson and Chairman Bernanke should be held accountable for their inaction – and now because of that inaction – the American taxpayer is left with bill.”

“We must take care of Main Street. Small businesses in Ashland, Bowling Green, and Paducah are hurting because of high taxes, and energy costs. Those small businesses are the economic engines that fuel our economy. I hope in the closing days of this Congress we can pass legislation to help those good people on Main Street rather than helping the power brokers on Wall Street.”

U.S. Economy Headed Towards Doom And Gloom?

This morning I came across two pieces which were notable in that they painted a gloomy picture for the U.S. economy going forward. Jonathan Burton of MarketWatch talked about TCW Group’s Jeffrey Gundlach’s economic outlook, and wrote:

An influential investment strategist has a dire forecast for U.S. stocks, credit markets and the continued independence of some of the nation’s top financial institutions.

Jeffrey Gundlach, chief investment officer at Los Angeles-based mutual-fund company TCW Group Inc., told clients on a conference call late Wednesday that the crisis in credit and housing may not abate for several years and is actually getting worse.

In the deteriorating climate he sees unfolding, Gundlach said, the Standard & Poor’s 500 Index could fall another 30%, giant Citigroup could become an “AIG-sized debacle,” Morgan Stanley would merge with a banking company, Wachovia won’t be able to stand alone, default rates on even prime mortgages could soar, and European banks’ woes are just beginning.

“This is no market for old men,” said Gundlach, who also manages TCW’s flagship Total Return Bond Fund . “This is no market for old-school thinking.”

Gundlach based his assessment on a belief that housing prices still face several more years of decline, a protracted slump, he said, not seen since the Great Depression. Moreover, Gundlach said it’s possible that home prices could be sluggish until 2022.

“If it’s like the Depression experience — and it sure is shaping up that way — it could take several years. Maybe we won’t see a bottom in home prices until 2014,” he said.

Burton talked about Gundlach’s credentials for making such statements. He wrote:

As a forecaster, Gundlach didn’t just climb aboard the gloom-and-doom wagon. He was early to spot the cracks that subprime loans were making in the financial system, and among the first to warn that an era of easy money would come to a bad end.

The MarketWatch reporter noted:

Expect loan default rates to rise, Gundlach said, not just in the subprime market, but among the top-drawer prime borrowers as well. The prime default rate could approach 10% from a current 2% before the carnage is over, he said…

Accordingly, financial institutions may suffer write-offs that could surpass $1 trillion before conditions improve, he said…

The breakdown will take a further toll on U.S. stocks, Gundlach added. The S&P 500 will tumble below 800, he said, about 35% below its 1156 close on Wednesday.

Said Gundlach: “None of us have ever seen this, and it’s no market for old men, but risk aversion is the order of the day.”

Someone else who sees massive problems ahead for the American economy is Harvard economic professor and former chief economist of the International Monetary Fund Kenneth Rogoff. He wrote on the Financial Times (UK) website last night:

Were the financial crisis to end today, the costs would be painful but manageable, roughly equivalent to the cost of another year in Iraq. Unfortunately, however, the financial crisis is far from over, and it is hard to imagine how the US government is going to succeed in creating a firewall against further contagion without spending five to 10 times more than it has already, that is, an amount closer to $1,000bn to $2,000bn.

In other words, $1 to $2 trillion. Rogoff continued:

True, the US Treasury and the Federal Reserve have done an admirable job over the past week in forcing the private sector to bear a share of the burden. By forcing the fourth largest investment bank, Lehman Brothers, into bankruptcy and Merrill Lynch into a distressed sale to Bank of America, they helped to facilitate a badly needed consolidation in the financial services sector. However, at this juncture, there is every possibility that the credit crisis will radiate out into corporate, consumer and municipal debt. Regardless of the Fed and Treasury’s most determined efforts, the political pressures for a much larger bail-out, and pressures from the continued volatility in financial markets, are going to be irresistible…

The Ivy League professor talked about the potential fallout from allocating so much money to deal with the escalating financial crisis. He wrote:

It may prove to be possible to fix the system for far less than $1,000bn- $2,000bn. The tough stance taken by regulators this past weekend with the investment banks Lehman and Merrill Lynch certainly helps.

Yet I fear that the American political system will ultimately drive the cost of saving the financial system well up into that higher territory.

A large expansion in debt will impose enormous fiscal costs on the US, ultimately hitting growth through a combination of higher taxes and lower spending. It will certainly make it harder for the US to maintain its military dominance, which has been one of the linchpins of the dollar.

The shrinking financial system will also undermine another central foundation of the strength of the US economy. And it is hard to see how the central bank will be able to resist a period of allowing elevated levels of inflation, as this offers a convenient way for the US to deflate the mounting cost of its private and public debts.

It is a very good thing that the rest of the world retains such confidence in America’s ability to manage its problems, otherwise the financial crisis would be far worse.

Let us hope the US political and regulatory response continues to inspire this optimism. Otherwise, sharply rising interest rates and a rapidly declining dollar could put the US in a bind that many emerging markets are all too familiar with.

A new banana republic?

Sources:

“The worst is yet to come”
Jonathan Burton
MarketWatch, September 18, 2008

“America will need a $1,000bn bail-out”
Kenneth Rogoff
Financial Times (UK), September 17, 2008

What Housing Bottom?

Haven’t you heard? We’ve reached a bottom in the U.S. housing market? Or, at least, we’re almost there. Don’t believe it? Well, read what CNBC’s Diana Olick wrote back on September 9:

Yesterday on “Power Lunch,” the CEO of the National Association of Home Builders, Jerry Howard, talked about the boost to the builders that an easing of credit would provide. It makes sense; if mortgage rates fall, people will be able to buy more homes. But Howard took it a step further. When asked by Sue Herera about the housing market: “So you’re calling a bottom?” He replied emphatically, “Yes, ma’am.”

That goes for home prices too. Take a look at this, which I saw in the Chicago Tribune last weekend:

“The Evidence”
Real Estate Section Ad

And now, a reality check, folks. Reuters’ Glenn Somerville reported this afternoon:

Federal Reserve Vice Chairman Donald Kohn said on Thursday there was no clear evidence the plunge in U.S. house prices was coming to an end.

“The jury is still out on whether housing prices are close to finding a bottom,” Kohn said in prepared remarks for delivery at a Brookings Institution conference where he was commenting on a series of academic papers.

He said some researchers have noted some easing in the pace of home price declines in some markets but said mortgage conditions have tightened since spring and that may have a further impact on prices since it makes it harder for buyers to qualify.

Sources:

“Fannie And Freddie ‘Bailout’: Is There Housing Bottom–Or Not”
Diana Olick
CNBC, September 9, 2008

“Fed’s Kohn says no sign home prices stabilizing”
Glenn Somerville
Reuters, September 11, 2008

—

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World’s Highest Paid Investment Adviser: U.S. Faces Hyperinflation Or Depression

I don’t think I’ve ever mentioned this, but I am extremely grateful to Peter Brimelow over at MarketWatch. Without his column, I wouldn’t have access to the insights of Harry Schultz, the highest paid investment consultant in the world. For those readers not familiar with Mr. Schultz, I talked about him back on December 13. From that post:

Have you ever heard of Harry Schultz? I sure have, and to this day I am still in absolute awe of the money this man earns. Mr. Schultz, publisher of the International Harry Schultz Letter, is the highest paid investment consultant in the world at $3,500 an hour (or $4,900 an hour if you require his services during the weekend).

Brimelow talked about Schultz’ latest U.S. economic forecast this past Monday on MarketWatch. He wrote:

Harry Schultz’ The International Harry Schultz Letter was posted last night right about the time the Fannie Mae-Freddie Mac bailout was reported. But Schultz anticipated it, writing sarcastically:

“Flash: As we go to press, the US Government reveals plan to take over Freddie Mac and Fannie Mae, the biggest bail-out by taxpayers in history. It also wipes out the shareholders! Sunday selected to avoid stock market action same day, just as bank closures are told after market close Friday. That tells you what shape markets are in when government and CEOs hide behind holidays.”

Schultz had earlier made his overview clear (I’m translating slightly from of his text-message style):

“Fed maneuver room approximately gone. Any $US injection big enough to avert a depression triggers runaway inflation. If not big enough: depression. US on knife-edge. Gold helps you either way.”

This apocalyptic vision is consistent with his earlier predictions, such as one I discussed in a February 18 post. Brimelow stated back then:

Schultz writes: “It’s a derivative crisis, stupid!… 9,000 U.S. banks failed in 1929-1932; look for new records… Hyper-inflation is a distinct possibility; stay awake!”

Among his more colorful recommendations: “Buy a few local non-rare gold coins of whatever country you are in for emergency/barter use, smallest denominations… Keep 6-12 months cash at home/office/ lawyer-doctor office. Pretend an emergency is coming, because it may be.”

…and from that December 13 post:

Among other interesting ideas raised by Schultz in his intense, somewhat terrifying introduction: recession, possibly depression; bank failures; exchange controls; housing prices down by 50%; credit card company failures; money market fund dangers; tripling of U.S. jobless numbers; federal bail-outs for Fannie Mae.

Note the bailout prediction for Fannie Mae.

Fast forward to Schultz’s latest forecast. Brimelow wrote:

Schultz suggests just two alternative scenarios, both equally appalling:

“If Bush bails them all out, the die would be cast for inflation unseen in the West since 1923 Germany. If no bail: Hello, 1929.”

Gee, thanks.

Brimelow talked about what Schultz thought was going to happen next, and what those hoping to be one step ahead of the herd should do about it. He wrote:

In his latest issue, Schultz summarizes:

“Widespread stagflation will probably now build more inflation than stagnation, then gradually morph into more stagnation than inflation. Then, deflation takes over, and ultimately, depression. All this over next 9 years.”

“For the moment, seal off major wipe-out risks. Exit all money funds and currency time deposits, step up gold & oil positions, move into 1-2 year government bonds (non-US $) in First World nations. Swiss first choice. Think not of yield; think of an ark’s life preserver around your neck.”

Schultz, notes Brimelow, is currently negative on the U.S. stock market. But, the Swiss-based investment adviser predicts an upside target of $1,600 an ounce for gold as he believes its recent plummet in price is merely a correction.

Source:

“Unraveling according to schedule”
Peter Brimelow
MarketWatch, September 8, 2008

Quote For The Week

Financial analyst Eric King talked about gold and silver on the Financial Sense Newshour this weekend, and warned listeners:

But I want people to listen carefully to what I’m about to say to them. Do not listen to statements made from this government. Ignore them. Ignore statements made by Paulson, who is retiring in November right after the election. They have been consistently wrong in all of their statements. They have lost control of the system, in my opinion, and the system is breaking right now. The United States banking system is insolvent, and they are trying to keep this hidden from people and try to get more suckers to put more money into these banks, but the suckers are not lining up anymore. A big tax bill is going to be laid on the American public, and as Greenspan stated in Belgium, the Federal Reserve, and even the Treasury, stands ready to create money without limit. We are about to go into that phase now where we are going to have very serious money printing, and the Fed knows it, Paulson knows it, the Treasury and Bernanke know it, and because of that they had to crush these metals ahead of that…

Worrisome News From The Fed

From the Wall Street Journal’s Real Time Economics Blog yesterday:

U.S. banks continued to tighten their standards on loans to households and businesses in the second quarter, said a Federal Reserve study that also shows that many banks think the credit tightening trend could continue into the first half of 2009…

About 60% of the domestic banks surveyed reported having tightened lending standards to large and middle-market businesses. That’s up slightly from what was reported in the last Fed survey conducted in April and released in May. About 65% of the institutions, a percentage that is also up from the previous survey, also said they had tightened their lending standards on so-called commercial and industrial loans, also known as C&I loans, to small firms over the same period…

In addition, a significant portion of the banks surveyed reported having tightened their lending standards on prime, nontraditional and subprime residential mortgages over the previous three months. About 75% of domestic respondents, which is up from 60% in the previous survey released in May, said they had tightened their lending standards on prime mortgages. Also, six out of seven respondents that originated subprime mortgage loans, which is a higher proportion than what was reported in the previous survey, indicated that they had tightened their lending standards on those loans over the past three months.

Turning to the results of the survey’s consumer lending questions, about 65% of domestic banks indicated that they had tightened their lending standards on credit card loans over the past three months, which is up remarkably from the 30% reported in the survey released in May.

From Reuters’s John Parry earlier today:

U.S. economic growth is expected to slow more sharply in the coming months than previously forecast with employers shedding staff into next year, according to a Philadelphia Federal Reserve survey released on Tuesday.

Economists lowered their forecasts for third-quarter gross domestic product growth to a 1.2 percent annual rate from the previous 1.7 percent estimate, according to the bank’s quarterly Survey of Professional Forecasters.

“Growth in U.S. real output over the next few quarters looks slower now than it did just three months ago,” the Philadelphia Fed said on its Web site.

In the fourth quarter, the U.S. GDP growth forecast was slashed to 0.7 percent growth, from the previous 1.8 percent forecast…

The current survey also forecast the U.S. unemployment rate would be 5.7 percent in the third quarter, above its previous 5.4 percent forecast, then rising to 5.8 percent in the fourth quarter.

“A weaker near-term outlook for the labor market accompanies the outlook for slower output growth,” the Philadelphia Fed said.

From MarketWatch’s Rex Nutting today:

The U.S. economy faces a prolonged period of anemic growth, but that’s no reason to get complacent on inflation, said Dallas Fed President Richard Fisher in an interview with the Dallas Morning News published Tuesday. “I expect that in the second half of this year we will broach zero growth,” he said. Fisher, a voting member of the Federal Open Market Committee who’s been on the losing side on the past five votes on interest rates, said the credit crunch is worse than the S&L crisis of the late 1980s.

Sources:

“Fed Study: Banks Tighten Credit on Households, Businesses”
Night Editor
Wall Street Journal (Real Time Economics Blog), August 11, 2008

“UPDATE 1-US economy seen slowing more sharply-Philly Fed”
John Parry
Reuters, August 12, 2008

“Fed’s Fisher expects close to zero growth this year”
Rex Nutting
MarketWatch, August 12, 2008

Oops! U.S. Debt Almost $100 Trillion

Back on July 22 I wrote a post about a San Francisco Chronicle article which stated the U.S. government is $53 trillion in debt (factoring in long-term liabilities), which translates to $455,000 per U.S. household.

Turns out, the situation might be worse. A lot worse. To the tune of $99.2 trillion, to be exact.

On August 7, a piece appeared on LewRockwell.com referencing a speech about the debt by Richard W. Fisher, the President and Chief Executive Officer of the Federal Reserve Bank of Dallas. Fisher told the Commonwealth Club of California in San Francisco back in May:

In the distance, I see a frightful storm brewing in the form of untethered government debt. I choose the words—“frightful storm”—deliberately to avoid hyperbole. Unless we take steps to deal with it, the long-term fiscal situation of the federal government will be unimaginably more devastating to our economic prosperity than the subprime debacle and the recent debauching of credit markets that we are now working so hard to correct.

How did the head of the Dallas Fed come up with a number like $99.2 trillion? First, he accounted for Social Security liabilities:

Now, fast forward 70 or so years and ask this question: What is the mathematical predicament of Social Security today? Answer: The amount of money the Social Security system would need today to cover all unfunded liabilities from now on—what fiscal economists call the “infinite horizon discounted value” of what has already been promised recipients but has nofunding mechanism currently in place—is $13.6 trillion, an amount slightly less than the annual gross domestic product of the United States.

Then, he worked out Medicare entitlements:

Please sit tight while I walk you through the math of Medicare. As you may know, the program comes in three parts: Medicare Part A, which covers hospital stays; Medicare B, which covers doctor visits; and Medicare D, the drug benefit that went into effect just 29 months ago. The infinite-horizon present discounted value of the unfunded liability for Medicare A is $34.4 trillion. The unfunded liability of Medicare B is an additional $34 trillion. The shortfall for Medicare D adds another $17.2 trillion. The total? If you wanted to cover the unfunded liability of all three programs today, you would be stuck with an $85.6 trillion bill. That is more than six times as large as the bill for Social Security. It is more than six times the annual output of the entire U.S. economy.

Fisher adds it all up, and, voila:

Add together the unfunded liabilities from Medicare and Social Security, and it comes to $99.2 trillion over the infinite horizon. Traditional Medicare composes about 69 percent, the new drug benefit roughly 17 percent and Social Security the remaining 14 percent.

And just to make his prediction a little bit more personal:

Let’s say you and I and Bruce Ericson and every U.S. citizen who is alive today decided to fully address this unfunded liability through lump-sum payments from our own pocketbooks, so that all of us and all future generations could be secure in the knowledge that we and they would receive promised benefits in perpetuity. How much would we have to pay if we split the tab? Again, the math is painful. With a total population of 304 million, from infants to the elderly, the per-person payment to the federal treasury would come to $330,000. This comes to $1.3 million per family of four—over 25 times the average household’s income.

Somehow, $455,000 per household seems a lot more manageable at this point…

Source:

“Storms on the Horizon: Remarks before the Commonwealth Club of California”
Richard W. Fisher
Federal Reserve Bank of Dallas, May 28, 2008

Quote For The Week

When I was down at the University of Illinois at Urbana-Champaign in the early nineties, I used to read the The Onion, a fake newspaper chock full of satirical articles, every once in a while. Apparently, the publication’s still going strong. From their July 14 issue:

Congress is currently considering an emergency economic-stimulus measure, tentatively called the Bubble Act, which would order the Federal Reserve to begin encouraging massive private investment in some fantastical financial scheme in order to get the nation’s false economy back on track.

Current bubbles being considered include the handheld electronics bubble, the undersea-mining-rights bubble, and the decorative office-plant bubble. Additional options include speculative trading in fairy dust—which lobbyists point out has the advantage of being an entirely imaginary commodity to begin with—and a bubble based around a hypothetical, to-be-determined product called “widgets.”

The most support thus far has gone toward the so-called paper bubble. In this appealing scenario, various privately issued pieces of paper, backed by government tax incentives but entirely worthless, would temporarily be given grossly inflated artificial values and sold to unsuspecting stockholders by greedy and unscrupulous entrepreneurs.

“Little pieces of paper are the next big thing,” speculator Joanna Nadir, of Falls Church, VA said. “Just keep telling yourself that. If enough people can be talked into thinking it’s legitimate, it will become temporarily true.”

Why is there a lurking suspicion that this story might not be so fake after all?