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U.S. Housing Price Forecast: Double-Digit Percentage Decline Still Ahead

“Housing rebound still fragile; St. Louis sales down 16% from May ‘08”

-St. Louis Post-Dispatch, June 23, 2009

“Option ARMs reset threatens housing rebound”

-Seattle Times, June 27, 2009

“Housing rebound continues, barely”

CNN Money.com, July 1, 2009

From headlines like these, I apparently slept through the U.S. housing bottom. Then again, maybe not. From Reuters today:

U.S. housing prices will fall by a double-digit percentage from already beaten-down levels, resulting in an overall 40 percent plunge by the time foreclosures peak in the second half of 2010, Barclays Capital economist Michelle Meyer said.

Meyer issued her forecast two days after the Standard & Poor’s/Case-Shiller Home Price Indexes showed for April an 18.1 percent year-to-year decline, compared with 18.7 percent in March, in the rate of home price declines in 20 major U.S. metropolitan areas.

The indexes have tracked the prices of U.S. single-family homes since 1987.

“While the early signs of improvement are in place for housing, the market will likely remain out of balance for some time, given the flood of foreclosures,” Meyer wrote.

“Home prices are likely to continue to fall, albeit at a slowing pace, even after the economy technically emerges from the recession.” Home prices have fallen 32.6 percent from their peak three years ago, S&P/Case-Shiller said.

On that basis, they would need to fall another 11 percent for an overall 40 percent peak-to-trough decline. Further declines could imperil metropolitan areas that have yet to experience the worst of the nation’s housing slump.

According to S&P/Case-Shiller, New York was the only major market to have above-average, month-over-month housing price declines in both March and April and also have a below-average decline for the year ended in April.

Home prices in that market fell 12.5 percent from a year earlier. The Denver area had the smallest drop, 4.9 percent.

Bloomberg’s Oshrat Carmiel talked more about the Manhattan residential real estate market today. Carmiel wrote:

Manhattan apartment prices dropped for the first time since 2002 in the second quarter as the collapse of Lehman Brothers Holdings Inc. and Bear Stearns Cos. caught up to property owners in the nation’s most expensive urban market.

The median price fell 18.5 percent from a year earlier to $835,700, New York appraiser Miller Samuel Inc. and broker Prudential Douglas Elliman Real Estate said today. The number of sales plunged by half, the most since Miller Samuel began keeping data in 1989.

“The standstill that existed after Lehman Brothers has been broken, and it was the sellers that cried uncle,” Pamela Liebman, chief executive officer of New York-based property broker the Corcoran Group, said in an interview.

Values are falling broadly in Manhattan for the first time in the almost four-year U.S. housing recession, with declines now seen in co-operatives and condominiums of every size and price. Private-sector employment in the city dropped by 91,200 jobs, or 2.8 percent, in the 12 months through May as Wall Street losses and asset writedowns topped $1.4 trillion.

The price of studio apartments declined 16 percent from a year ago to a median of $405,000, according to Miller Samuel. One-bedrooms dropped 17 percent to $650,000 and two-bedrooms fell 23 percent to $1.27 million. Three-bedroom units fell 37 percent to $2.35 million and four-bedrooms plummeted 47 percent to a median of $3.92 million.

Wake me when the housing bottom arrives, please.

Sources:

“US Home Prices Seen Falling 40% Overall: Analyst”
Reuters, July 2, 2009

“Manhattan Apartment Prices Drop as Lehman Hits Home (Update1)”
Oshrat Carmiel
Bloomberg, July 2, 2009

CNBC Broadcast: Financial Markets Manipulated By Washington?

(Hat tip, Signs Of The Times):

From CNBC feed out of Chicago this past Monday (2 minutes in):

SecretsOfTraders.com’s Larry Levin: This market continues to be propped-up by government intervention, and manipulation, and, unfortunately, as that continues to happen, I think this market can go higher. The government’s been doing a good job of keeping it that way no matter what the real underlying current is, unfortunately…

You’re gonna have to… right on Obama and his staff as basically trying to prop this market up on a daily basis. They’re doing a good job…

But it really is a situation where, every single day, we have some kind of backstop from the government. I mean, these markets are not free markets anymore. You know, this whole year has been absolutely ridiculous…

CNBC’s Rick Santelli: Well, I think Larry’s doing a darn good job. I tend to agree with most of what he’s saying…

Too Much Hopium?

If Washington, in its regulatory mood these days, wants to clamp down on something, it might want to take a good look at Hopium.

You’d be tempted to think the U.S. financial system and markets were back to “normal” after listening to what some had to say to the financial media today.

From Bloomberg’s Jeff Kearns:

“The market has run out of fantastic reasons to sell,” said Stephen Wood, who helps manage $136 billion as chief market strategist for North America at Russell Investments in New York. “Those Armageddon, Great Depression, worst-case scenarios being priced in a few months ago are now a low probability, and the recovery reflects that.”

“We think we’re in a recovery stage and there’s a lot of government support for growth,” said Hayes Miller, who helps manage $33 billion at Baring Asset Management Inc. in Boston. “When summer is over and we all come back in the fall we’re going to be seeing some positive economic news.”

Positive, or less-worse news? And from CNBC:

Federal Reserve Chairman Ben Bernanke deserves to be reappointed, because he did a great job in saving the US banking system from collapsing, Jack Welch, author of “Winning” and “Straight from the Gut,” told CNBC Thursday.

“I think he saved the system, I think he’s a national hero,” Welch said. “I think Bernanke seems to be a guy operating on a clear intellectual framework. This guy’s done a hell of a good job.”

“Abracadabra!”
Source: Inner City Press

I’m not so sure I’d like to watch a baseball game with Mr. Welch. He’d be calling the outcome of the game while it was still in the early innings.

Sources:

“U.S. Stocks Gain as Data Boosts Optimism Economy Is Recovering”
Jeff Kearns
Bloomberg, June 18, 2009

“Reappoint Bernanke, He’s a ‘National Hero’: Welch”
CNBC, June 18, 2009

Congress Scrutinized For Potential Conflicts-Of-Interest

Washington lawmakers are receiving more attention these days for possible conflicts-of-interest relating to the taxpayer bailouts and the proposed health care system overhaul. From the Washington Post’s Paul Kane and Carol D. Leonnig last week:

Top House lawmakers had considerable holdings in major financial institutions that took billions of dollars in taxpayer bailouts at the end of last year, according to annual financial disclosure reports released yesterday.

From stock holdings to retirement funds to mortgages, more than 20 House leaders and members of the House Financial Services Committee had large personal stakes in the Wall Street powerhouses whose collapse last year led to an unprecedented government intervention in the marketplace. In some instances those lawmakers, like millions of other investors, sold their holdings at steep losses while others retained the stocks at greatly diminished value.

House Speaker Nancy Pelosi (D-Calif.) and her husband lost hundreds of thousands of dollars investing in American International Group, which has received $170 billion in government loans and cash injections, making it by far the largest recipient of federal bailout dollars. Republican Whip Eric Cantor (R-Va.) and his wife held stock, retirement plans and other investments worth at least $183,000 and as much as $495,000 in firms benefiting from federal government rescue efforts, including Goldman Sachs and Morgan Stanley.

At least 18 members of the House Financial Services Committee — which oversees the banking and housing industries at the core of the economic meltdown — held stock last year in firms that received federal bailout assistance, according to a review of the forms that were available yesterday.

As President Obama pushes his universal health care program, more potential conflicts-of-interest involving lawmakers have surfaced. From the Associated Press’ Larry Margasak and Sharon Theimer last Friday:

Influential senators working to overhaul the nation’s health care system have investments and family ties with some of the biggest names in the industry. The wife of Sen. Chris Dodd, the lawmaker in charge of writing the Senate’s bill, sits on the boards of four health care companies.

Members of both parties have industry connections, including Democrats Jay Rockefeller and Tom Harkin, in addition to Dodd, and Republicans Tom Coburn, Judd Gregg, John Kyl and Orrin Hatch, financial reports showed Friday.

Jackie Clegg Dodd, wife of the Connecticut Democrat, is on the boards of Javelin Pharmaceuticals Inc., Cardiome Pharma Corp., Brookdale Senior Living and Pear Tree Pharmaceuticals…

Other publicly available documents show Mrs. Dodd last year was one of the most highly compensated non-employee members of the Javelin Pharmaceuticals Inc. board, on which she has served since 2004. She earned $32,000 in fees and $109,587 in stock option awards last year, according to the company’s SEC filings.

Mrs. Dodd earned $79,063 in fees from Cardiome in its last fiscal year, while Brookdale Senior Living gave her $122,231 in stock awards in 2008, their SEC filings show. She earned no income from her post as a director for Pear Tree Pharmaceuticals but holds up to $15,000 in stock in Pear Tree, which describes itself as a development-stage pharmaceutical company focused on the needs of aging women.

Sources:

“Lawmakers Invested in Bailed-Out Firms”
Paul Kane, Carol D. Leonnig
Washington Post, June 11, 2009

“Key health care senators have industry ties”
Larry Margasak, Sharon Theimer
Associated Press, June 12, 2009

A Plea From Michael Moore

“Save our CEOs”
YouTube Video Link

Ron Paul Gives Update On ‘Audit The Fed’ Bill

Momentum is growing with the “Audit The Fed” bill. Congressman Ron Paul (R-TX) talked about House Resolution 1207, the Federal Reserve Transparency Act, earlier today:

“Audit The Fed Update”
YouTube Video Link

Stephen Webster, of the alternative news site “The Raw Story,” discussed Paul’s take on the legislation yesterday and wrote:

Congressman Paul, in defense of his proposal to audit the bank which controls America’s currency, argues not just for transparency. He wants to close it down.

“Detractors have [...] argued that the Fed must remain immune from the political process, and that that more congressional oversight would distort their very important decisions,” Paul wrote in an editorial titled, [4] ‘Audit the Fed, Then End It!’ “On the contrary, the Federal Reserve is already heavily entrenched in the political process, as the Fed chairman is a political appointee. High-level officials routinely make the rounds between positions at the Fed, member banks, Treasury and back again, taking care of friends and each other along the way.”

He continued: “As far as the foolishness of placing complex monetary policy decisions in the hands of politicians – I couldn’t agree more. No politician or central banker, no matter how brilliant, is smart enough to know more than the market itself. The failure of central economic planning has been witnessed over and over. It is frankly beyond me why we ever agreed to try it again.

“To understand how unwise it is to have the Federal Reserve, one must first understand the magnitude of the privileges they have. They have been given the power to create money, by the trillions, and to give it to their friends, under any terms they wish, with little or no meaningful oversight or accountability. Thus the loudest arguments against greater transparency are likely to come from those friends, and understandably so.”

Source:

“US House to debate Ron Paul’s ‘Audit the Fed’ bill”
Stephen C. Webster
RawStory.com, June 12, 2009

Advice For The Hotshot Fund Manager

Investor, commentator, and author Jim Rogers was recently interviewed by staff of the Economic Times (India) website. One statement from the former partner of George Soros stood out in particular:

What will you tell a confused fund manager who seeks your advice?

Become a farmer. The world has tens of thousands of hotshot fund managers right now. If I am correct, the financial community is not going to be a great place to be in for the next 30 years. We have many periods in history when financial people were in charge, we had many periods when people who produced real goods were in charge — miners, farmers, etc.

The world, in my view, is changing and is shifting away from the financial types to producers of real goods, and this is going to last for several decades as it always has. This may sound strange but it always happens this way.

Ten years from now, it may be farmers who will drive the Lamborghinis and the stock brokers will drive tractors or taxis at best.

Source:

“Fund Managers can become farmers: Jim Rogers”
Economic Times (India), June 3, 2009

Boom2Bust Turns Two Years Old

Memorial Day Weekend 2007. Sure seems like yesterday….

Friday, May 25, 2007.

The Dow Jones Industrial Average closed out the week at 13,507.28. The S&P 500 index finished up at 1,515.73.

The median house price is $222,700, according to the National Association of Realtors.

Family net worth is at an all-time high of $64.36 trillion for the quarter.

The number of unemployed persons is 6.8 million and the unemployment rate is 4.5 percent.

Total public debt outstanding in the United States is $8.8 trillion.

Talk of the “Goldilocks economy” rules the day, and Washington and Wall Street are in “don’t worry, be happy” mode.

Federal Reserve chairman Ben Bernanke doesn’t believe the nation will slip into a recession, and he rejects the notion raised by his predecessor, Alan Greenspan, that the economy’s expansion could be in danger of fizzling out…

The Fed chief testified on Capitol Hill amid growing concerns that problems with risky mortgages and a painful housing slump could send the economy into a tailspin. Greenspan recently said there’s a one-in-three possibility of a recession this year.

But Bernanke — while acknowledging there are risks — told Congress’s Joint Economic Committee that the Fed does not see such negative forces pushing the economy into a recession.

“I would make a point, I think, which is important, which is there seems to be a sense that expansions die of old age, that after they reach a certain point, then they naturally begin to end,” Bernanke said. “I don’t think the evidence really supports that. If we look at history, we see that the periods of expansions have varied considerably. Some have been quite long.”

-Associated Press, March 29, 2007

…a new SUV in every McMansion’s garage

Fast forward to today…

The Dow Jones Industrial Average closed at 8,473.49. The S&P 500 index finished up at 910.33.

The median house price in the first quarter of 2009 is now $169,000, according to the National Association of Realtors.

Banks and businesses worldwide have lost $1.47 trillion in write-downs and credit losses in the past 22 months stemming from the collapse of the subprime-mortgage market.

Household net worth dropped a record 9 percent in the fourth quarter of 2008, pushing total net worth down to $51.48 trillion. It was the sixth straight quarterly decline from the peak of $64.4 trillion in the second quarter of 2007. Also, the drop in net worth in the fourth quarter of 2008 was the largest drop in dollar terms on record, going back to 1951, when the U.S. government began keeping quarterly records. The 9 percent drop was also the largest drop as a percentage change on record.

In April (the last month data is available for), the number of unemployed Americans reached 13.7 million persons and the unemployment rate was 8.9 percent. According to the Bureau of Labor Statistics, 5.7 million jobs have been lost since the recession began in December 2007.

The total public debt outstanding in the United States is now $11.3 trillion. Furthermore, as Bloomberg’s Mark Pittman and Bob Ivry pointed out on March 31:

The U.S. government and the Federal Reserve have spent, lent or committed $12.8 trillion, an amount that approaches the value of everything produced in the country last year, to stem the longest recession since the 1930s.

New pledges from the Fed, the Treasury Department and the Federal Deposit Insurance Corp. include $1 trillion for the Public-Private Investment Program, designed to help investors buy distressed loans and other assets from U.S. banks. The money works out to $42,105 for every man, woman and child in the U.S. and 14 times the $899.8 billion of currency in circulation. The nation’s gross domestic product was $14.2 trillion in 2008.

Goldilocks made a fine meal for the bears.

But I’m convinced our fuzzy friends still want more.

Thank you all for reading and contributing comments to Boom2Bust.com, and for inspiring me to post about some of the financial research I come across on a daily basis.

Personally, I think that while we may get out of this recession soon enough, I fear all the additional obligations accrued since 2007 will only have made the house of cards that is the U.S. financial system weaker, thereby setting ourselves up for more pain when the eventual crash comes.

You can only kick the can down the road for so long before you have to call it a day.

Year three, here we come!

Christopher E. Hill
Editor

Quotes For The Week

“On Wall Street, there’s nothing like overcharged young men, or overcharged young women either I’m sure, that will lead you to losses through inexperience and exuberance. When I was a young investor on Wall Street I thought I knew everything. I learnt the hard way that I did not know everything. But you know, it’s hard to tell that to a 24 year-old or even a 34 year-old sometimes.”

-Legendary investor Jim Rogers to CNBC staff last week

“The stimulus is so great in the United States, China and the United Kingdom, it will kick the economy up. GDP will go back positive for two to three quarters. They’ll assume everything is settled, that throwing money at it has worked. But the long-term imbalance between overproducers [like China] and overspenders [like the U.S.] will continue. It’ll be a multiyear drag on growth…

If the problem is that we consume too much and borrow too much, does it make sense to borrow more and spend more? It doesn’t make sense to solve alcoholism by giving an alcoholic a quart of whiskey, but everyone believes that we must stimulate. So that’s why we feel this is a temporary cure. This is like when you revive the drunk, he staggers down a few blocks, then falls down again…

We’re not rich, and we’re undersaved and underpensioned. Those will be a real brake on economic growth. This will be a pretty long recovery period, longer than we’re used to, but hopefully not as long as Japan took. It will not be as long as the Depression, but it will be several years, and not just two. Lord knows we have had several fat years…

President Obama is not doing the right thing. I admired his appointments in many areas, certainly in the environmental area. But then he got these tired old retreads from the financial area that notoriously didn’t blow a whistle over the last few years. They’ve all been Rubin-ized [influenced by former Treasury Secretary Robert Rubin].”

-Well-known money manager Jeremy Grantham, in a recent interview with SmartMoney magazine that appeared on their website last week.

‘Fear Gauge’ Returns To Pre-Banking Crisis Levels

The VIX, a measure of market volatility that some associate with investor confidence, has returned to levels not seen since before the collapse of Lehman Brothers last fall. From MarketWatch’s Nick Godt this afternoon:

The Chicago Board Options Exchange’s volatility index, otherwise known as the market’s fear gauge, has slumped to levels unseen since before the collapse of Lehman Brothers…

On Tuesday, the VIX (VIX 28.61, -1.63, -5.39%) slumped 3% to 29.33, a level last seen in early September 2008, just days before Lehman Brothers shut down. The announcement had sent the VIX sharply higher, a move up that continued through December…

According to FactSet Research, the VIX spiked to record highs of between 81 and 96 in late October, as panic gripped markets worldwide. From 2003 to July 2007, readings below 20 were the norm.

Steven Sears wrote on Barron’s website today that a related volatility index had also pulled back. Sears pointed out:

VIX’s big brother — Realized Volatility — who almost no one but the options insiders mention because he complicates the investor-sentiment conversation — has been edging lower and lower. Implied volatility — essentially a view of the future — is influenced by what happens in the past, which is realized volatility. Like VIX, realized volatility has steadily declined since October, making it possible for implied volatility to decline, too.

So, will we soon be seeing big money returning to Wall Street? Maybe not. Sears added:

Volatility analysis is very complicated. The genius of VIX is that it expresses something very complicated into a simple number that anyone can understand.

But investors need to fight the urge to view VIX as the ultimate red or green light in the investment world…

One of the least understood parts of VIX is that it only offers a 30-day snapshot of expected volatility, which is a lot different than a flashing neon sign of oversimplified investor sentiment.

Sources:

“Is lack of fear such a good thing for stocks?”
Nick Godt
MarketWatch, May 19, 2009

“Don’t Get Euphoric About a Falling VIX”
Steven M. Sears
Barrons.com, May 19, 2009

Wall Street Pay To Be Dictated By Washington?

The Wall Street Journal reported today that the Obama administration is seriously contemplating changing compensation practices on Wall Street and throughout the financial services sector. The Journal’s Damian Paletta and Deborah Solomon wrote:

The Obama administration has begun serious talks about how it can change compensation practices across the financial-services industry, including at companies that did not receive federal bailout money, according to people familiar with the matter.

The initiative, which is in its early stages, is part of an ambitious and likely controversial effort to broadly address the way financial companies pay employees and executives, including an attempt to more closely align pay with long-term performance.

Administration and regulatory officials are looking at various options, including using the Federal Reserve’s supervisory powers, the power of the Securities and Exchange Commission and moral suasion. Officials are also looking at what could be done legislatively.

Among ideas being discussed are Fed rules that would curb banks’ ability to pay employees in a way that would threaten the “safety and soundness” of the bank — such as paying loan officers for the volume of business they do, not the quality. The administration is also discussing issuing “best practices” to guide firms in structuring pay.

At the same time, House Financial Services Committee Chairman Barney Frank (D., Mass.) is working on legislation that could strengthen the government’s ability both to monitor compensation and to curb incentives that threaten a company’s viability or pose a systemic risk to the economy.

Just more posturing, or another nail in the coffin for Wall Street as we know it?

Some, like legendary investor Jim Rogers, would say it really doesn’t matter, as they argue a new financial center is being established in Asia. They might have a point, considering that’s where the money is flowing to these days.

As usual, time will tell.

Source:

“U.S. Eyes Bank Pay Overhaul”
Damian Paletta, Deborah Solomon
Wall Street Journal, May 13, 2009

Some Investors Prevented From Withdrawing 401(k) Funds

Do you have a 401(k) retirement account? You might be interested in the following piece from the Wall Street Journal the other day. From Eleanor Laise back on May 5:

Some investors in 401(k) retirement funds who are moving to grab their money are finding they can’t.

Even with recent gains in stocks such as Monday’s, the months of market turmoil have delivered a blow to some 401(k) participants: freezing their investments in certain plans. In some cases, individual investors can’t withdraw money from certain retirement-plan options. In other cases, employers are having trouble getting rid of risky investments in 401(k) plans.

When Ed Dursky was laid off from his job at a manufacturing company in March, he couldn’t withdraw $40,000 from his 401(k) retirement account invested in the Principal U.S. Property Separate Account.

That fund, which invests directly in office buildings and other properties, had stopped allowing most investors to make withdrawals last fall as many of its holdings became hard to sell.

Now Mr. Dursky, of Ottumwa, Iowa, is looking for work and losing patience. All he wants, he said, is his money.

“I hate to be whiny, but it is my money,” Mr. Dursky said.

The withdrawal restrictions are limiting investment options for plan participants and employers at a key time in the markets. The timing is inconvenient for the number of workers like Mr. Dursky who are laid off and find their savings inaccessible.

Though 401(k) plans revolutionized the retirement-savings landscape by putting investment decisions in the hands of individuals, the restrictions show that plan participants aren’t always in the driver’s seat.

Unlike the money managers…

Source:

“401(k)s Hit by Withdrawal Freezes”
Eleanor Laise
Wall Street Journal, May 5, 2009

Gerald Celente: Green Shoots Will Wither As ‘Greatest Depression’ Approaches

“Bernanke sees ‘green shoots’ of US recovery”

-AFP, March 15, 2009

“Bernanke’s Green Shoots Seen By Markets”

-New York Post, April 30, 2009

“Keeping a Close Eye on Those ‘Green Shoots’”

-Voice of America, May 7, 2009

It’s been some time since I last posted about Gerald Celente, a trends researcher and director of Kingston, NY-based Trends Research Institute. Celente, who is said to have correctly forecast the subprime mortgage crisis, the dollar’s decline, and gold’s rise, also predicted a “Panic of 2008,” where he said the subprime fiasco would be the first “small, high-risk segment of the market” to collapse, along with derivative dealers, hedge funds, buyout firms, and other market players. The “Panic” would also result in massive corporate losses and a lower U.S. standard of living.

Celente wrote a piece that appeared on the Rense.com website on May 7, and argued that despite the “green shoots” being talking about in financial circles, we are still on the verge of “The Greatest Depression.” Celente said:

The financial fields replete with sprouting “green shoots” should be viewed with suspicion, if not alarm, warns Gerald Celente, The Trends Research Institute Director. “They are not a mirage, but they are ephemeral.”

“‘Green shoots’ may sprout,” said Celente, “but they will not flower. The economy cannot be coerced back into growth with tons of money manure.”…

“Green shoots” can only be brought to harvest through real productivity. Pumping gigantic sums of money into too-big-to-fail financial institutions to jump-start the lending/borrowing cycle is to perpetuate a failed economic model. (See “The Greatest Depression,” Trends Journal, Winter 2009.)

Celente, who specializes in analyzing world-shaping events and forecasting tomorrow’s trends, painted a bleak picture for the U.S economy. He wrote:

Trendpost: With so much money being dumped into the system, there will be money to made … and lost. The agile and the knowledgeable may be able to reap “green shoots” while they’re sprouted. But beware!

“The Greatest Depression” — that we forecast would begin to set in by the end of this year — may have been postponed, but it has not been averted. When it does set in, it will do so with enhanced intensity and at a pace accelerated by complex financial finagling … all under the guise of nation-saving action. Rather than let the failing industries fail and the failed banks go bankrupt, the government is deliberately bankrupting the nation.

The lesson to be learned from the financial crisis that began in the summer of 2007, is that nothing succeeds like failure. The greater their failure, the bolder they become. The more they lose, the more they take. The greater the chaos, the more control they exact. The bigger they fail, the harder we fall.

No act is too unthinkable or measure too draconian for the Washington-Wall Street Mob to concoct in order to maintain power, make money and cover their losses. While it is impossible to second-guess what the government will do next, it is absolutely certain that they will stop at nothing.

The “green shoots” will wither and conditions will deteriorate. Those who are prepared for the worst will not have been taken by surprise.

Source:

“Green Shoots Or Greatest Depression?”
Gerald Celente
Rense.com, May 7, 2009

That Which Didn’t Kill Could’ve Made US Stronger

Earlier today, I was doing research for Boom2Bust.com’s sister blog, Investorazzi.com, when I noticed Jeremy Grantham, the chairman of global investment firm GMO and advisor to such notable individuals as former U.S. Vice President Dick Cheney and U.S. Senator John Kerry, had just released his latest quarterly letter. The British-born investor set aside the last part of his May publication to lay into those responsible for the financial mess we find ourselves in today, as well as those who have traded in America’s long-term economic health to preserve the cancerous financial status-quo. From the piece:

It is ironic, by the way, that the U.S. would be less hurt than most given that Pied Piper Greenspan led all of us global rats off the cliff. And, yes, in this case the Maestro (well named) had an orchestra pit filled with Treasury and Fed officials (especially the NY Fed), and such a large supporting cast of dancing CEOs of financial firms and their reckless board chums that even Cecil B. DeMille would have found them sufficient. So we in the U.S. developed almost single-handedly the tech bubble of the late 1990s, and then engineered a U.S. housing bubble and a flood of excess dollars that almost guaranteed that global assets would follow suit. Yet, unfairly or not, the U.S. has some considerable advantages in this mess we created. First, we have an unusually low percentage of our labor force in manufacturing and export-oriented companies that will be the most immediately affected by the global downturn, unlike Germany and China, to name two. Second, the dollar plays an important role that may cushion U.S. pain by allowing U.S. authorities the flexibility to make their own rules where other countries such as Spain and Ireland have most decisions heavily constrained. More profoundly, the U.S. is in a position where necessary sacrifices will simply be less painful. We in the U.S. will have to buy two fewer teddy bears for our already spoiled four-year-olds. The third television set will be postponed as will the second or third car. We will have to settle for a slimmed down financial industry and fewer deal-oriented lawyers. Woe is us…

It may indeed be a better long-term solution to accept a more punishing decline and let foolish overleveraged banks go under together with weak players in other industries. Surely assets would flow to stronger hands with beneficial long-term effects. Indeed, the quick 1922 recovery from the precipitous decline of 1919-21 was so profound that the “Roaring Twenties” suppressed the memory of that earlier depression…

Current stimulus seems to be more about timing. We are unwilling to take a very sharp economic downturn even if such a downturn makes a quick, healthy recovery more likely. Rather, we seem to be making a desperate attempt to make the setback shallower, perhaps at the expense of a longer recovery period. What is likely to happen in the near term always has far more political influence than what may happen in the longer term. So we have been more decisively selecting the Japanese route rather than the 1921 or the S&L approach of a more rapid liquidation. Month by month we are voting for desperate life support systems – at the tax payers’ expense – for zombie banks and industrial companies that have been technically bankrupted by years of excess and almost criminally bad management.

I do think I know one thing, however. If a government invests directly, drawing employment from a large pool of the unemployed, and only invests in projects with a high societal return on investment such as hiring workers with well-stocked tool belts to install insulation, or repair bridges and transmission lines, or lay track to accommodate a respectably fast train from Boston to Washington (Yes!), it seems nearly certain that such a government will never have to regret it. Keeping banks, bankers, or even extra auto workers in business seems, in comparison, far more questionable. So questionable in fact that it must be justified by politics, not economics. We should particularly not allow ourselves to be intimidated by the financial mafia into believing that all of the failing financial companies – or very nearly all – had to be defended at all costs. To take the equivalent dough that was spent on propping up, say, Goldman or related entities like AIG (that were necessary to Goldman’s well being), as well as the many other incompetent banks and spending it instead on really useful, high return infrastructure and energy conservation and oil and coal replacement projects would seem like a real bargain for society. Yes, we would certainly have had a very painful temporary economic hit from financial and other bankruptcies if we had decided to let them go, but given the proven resilience of economies, it would still have seemed a better long-term bet. But, as I said, this is all just speculative theory and I don’t have to deal with Congress.

Let me end this section by emphasizing once again the difference between real wealth and the real economy on one hand, and illusionary wealth and debt on the other. If we had let all the reckless bankers go out of business, we would not have blown up our houses or our factories, or carted off our machine tools to Russia, nor would we have machine gunned any of our educated workforce, even our bankers! When the smoke had cleared, those with money would have bought up the bankrupt assets at cents on the dollar and we would have had a sharp recovery in the economy. Moral hazard would have been crushed, lessons learned for a generation or two, and assets would be in stronger, more efficient hands. Debt is accounting, not reality. Real economies are much more resilient than they are given credit for. We allow ourselves to be terrified by the “financial-industrial complex” as Eisenhower might have said, much to their advantage.

You can read the entire quarterly letter (in .pdf format) here.

Source:

“The Last Hurrah and Seven Lean Years”
Jeremy Grantham
Quarterly Letter
GMO, May 2009