On March 30, 2011, reserve balances with Federal Reserve banks, a good proxy for the amount of excess reserves in the commercial banking system, almost reached $1.5 trillion!
This total is approximately $450 billion more than was on the Fed’s balance sheet on September 1, 2010 which was soon after Chairman Ben Bernanke announced the advent of Quantitative Easing 2, or QE2, at a Federal Reserve conference in Jackson Hole, Wyoming.
The Fed’s basic plan was to purchase $900 billion in United States Treasury securities during QE2, $600 billion of the purchases were to be a net addition to the Fed’s portfolio of securities held outright and $300 billion were to replace maturing Mortgage-backed securities and Federal Agency securities.
Between September 1, 2010 and March 30, 2011, the Fed has achieved a net addition of about $550 billion to its holdings of Treasury securities which has resulted in a net addition of around $360 billion to its securities held outright. About $190 billion has run off from the Fed’s portfolio of Mortgage-backed securities and Federal Agency securities.
The plan was that the Fed would add about $2 in bank reserves to it’s balance sheet for every $3 it purchased in U. S. Treasury securities. Since September 1, the Fed has added about $3 for every $5 in Treasuries it has purchased.
However, over the past four weeks, the Fed has added about $4 for every $5 in Treasuries it has purchased.
In the first three months of this year the Fed has added, on average, approximately $100 billion in United States Treasury securities to its balance sheet every month.
However, securities purchases are not the only thing changing on the Fed’s balance sheet. Since September 1, 2010, the Fed’s net purchases of securities have supplied almost $325 billion in reserve funds to commercial banks.
The other $125 billion of the total $450 billion increase in reserve balances has come from the other side of the balance sheet. Here the primary contributor to the increase in reserve balances has been a $195 billion decrease in the Supplementary Financing Account of the United States Treasury.
In effect, the Treasury had $200 billion in deposits at the Fed in this account on September 1, 2010. The Treasury has withdrawn $195 billion of this $200 billion and when the Treasury spends out of its account at the Fed it creates bank deposits…or reserve balances at the Fed.
About $70 billion of this decrease has been offset by an increase in currency in circulation which draws funds out of commercial bank accounts and an increase in the Treasury’s General Account at the Fed. Currency in circulation rose about $55 billion since September 1 and the General Account of the Treasury rose by about $15 billion.
After about two years of almost total turmoil, the Federal Reserve’s accounts have settled down and are very open and straight forward. About all that is going on at the Fed right now is the activity related to QE2. And, the Fed is doing exactly what it said it was going to do.
The reason for QE2, we are told, is that the Fed is creating this excessive amount of liquidity to spur on bank lending in order to get the economy growing at a faster pace.
We are told that QE2 will be over by the end of June, 2011.
The average year-over-year growth of real Gross Domestic Product over the past three quarters has been 3.0 percent. Analysts have predicted that economic growth will probably end up around 3.0 percent for the whole year of 2011. Usually the American economy comes out of a recession at a faster rate of growth than this, but this rate of growth is very consistent with the compound rate of growth of real GDP over the past fifty years.
The point is, the economy is growing. It is not a spectacular rate of growth but it shows that the economy is growing at a rate that is close to its long run average. The growth rate is not rapid enough to cause a dramatic decrease in the unemployment rate, but this may be a result of the fact that the United States economy needs to restructure and restructuring a large economy takes time.
Does the fact that the economy is only growing around 3.0 percent warrant the injection of $1.5 trillion in excess reserves into the banking system? Will all this liquidity really cause economic growth to accelerate and with this acceleration bring down the unemployment rate?
It is here, I believe, that we have a disconnect between the story the Fed is trying to tell and the way that the economy is performing. To me, the facts just don’t seem to mesh with the urgency of the Fed’s expressed concern. And, this disjunction of words and economic behavior is made even muddier by the contradictory statements made by members of the Fed’s own Open Market Committee this past week.
But, Chairman Bernanke is going to make things exceedingly clear in the future by holding a press conference after four future meetings of the Open Market Committee.
The results of QE2 to this point: in terms of the purchase of U. S. Treasury securities, the Federal Reserve is doing exactly what it said it was going to do; in terms of economic activity, the economy is behaving just about the way it was behaving at the time QE2 was introduced.
Lots of activity on the part of the Fed and little or no reaction on the part of the economy.
In terms of understanding what the Fed is doing and what it hopes to accomplish…confusion.
Up to this point, the walk and the talk just don’t seem to coincide. My problem is that I was taught to watch the hips…not the lips. What the hips are doing, in this case, however, don’t make a lot of sense.
Thursday, March 31, 2011
Why Bet on Treasury Securities?
First Warren Buffet and now Bill Gross, of Pacific Investment Management Company, have publically stated that buying United States Treasury securities is not a good bet. (See http://www.bloomberg.com/news/2011-03-31/gross-echoes-buffett-saying-treasuries-have-little-value-on-debt-dollar.html.)
Gross wrote, in his most recent monthly investment outlook, that Treasuries “have very little value.”
One could couch this in other terms: “What is the probability that long term interest rates will go up over the next twelve months?”; and “What is the probability that long term interest rates will go down over the next twelve months?”.
How many people do you know that believe that the higher probability can be applied to the second of these two questions?
Most people I know and respect are arguing over whether the probability that long term interest rates will go up is 75% or 80% or higher.
The only significant argument I hear about falling interest rates on long term Treasury issues is that the Eurozone might collapse and there will be a “run to quality”, a run to United States government securities. Almost all other arguments go the other way.
The economic recovery, however weak, is continuing. The banking system (and the housing industry) is not going to collapse even though the banking industry is going to continue to grow smaller and smaller in terms of the number of commercial banks that are in the system while the biggest banks, including large foreign banks, are going to control more and more of the banking industry itself. The Federal Reserve will continue to keep money flowing into the banking industry so as to keep banks open while the FDIC makes sure that the banking industry shrinks in an orderly fashion.
Are we going to get QE3? Depends upon the rate at which insolvent banks can be closed without disrupting the financial system. The strength of the economic recovery is not the issue. The issue, to me, depends upon what the FDIC can achieve.
The federal government is going to continue to add more and more debt to the total already outstanding.
There just is no credibility in Washington, D. C. concerning the reduction in the cumulative deficits over the next ten years or so. I still believe that the government will add another $15 trillion or more to the federal debt outstanding over the next ten years.
The Libyan situation is a case in point. The federal government is so over-extended fiscally that other demands on its resources are just going to stretch budgets even further and keep the cumulative deficits at near-record levels. Then the government ends up doing two things, neither desirable: the government is limited in what it can do in very important situations; and even if the government cannot do much, whatever it does will increase the cumulative deficit.
Then there are other issues, like the boom in commodity prices worldwide, the acceleration of the merger and acquisition business in America, Europe, and the emerging countries, and currency speculation throughout the globe.
As a consequence, I see no reason to back off my earlier thoughts on the future of the interest rate on long term U. S. Government securities. See http://seekingalpha.com/article/250838-long-term-treasury-yields-and-inflationary-expectations. This post was written when the yield on the 10-year Treasury security was 3.48 percent, roughly two months ago at the beginning of February. Yesterday the 10-year Treasury closed at about 3.46 percent.
At that time I claimed that a forecast of 5.00 percent to 5.50 percent was not out of reason for a Treasury security of this maturity somewhere in the next 12 to 18 months.
The basic reasoning for this: my estimate of the expected long run “real” rate of interest is roughly 3.00 percent, (Similar, I found out, to the belief of the Wharton School’s Jeremy Siegel.)
I further believe that investors will come to build in a premium for inflationary expectations in longer term interest rates in the neighborhood of 2.00 percent to 2.50 percent.
How strongly do I feel about this prediction? I believe that the odds are in the neighborhood of 3- or 4-to one that rates will move into this range over the next 12 to 18 months.
Thus, I would have to agree with Bill Gross (and Warren Buffet) that Treasuries “have very little value” and are not a good “buy and hold” at this time.
Gross wrote, in his most recent monthly investment outlook, that Treasuries “have very little value.”
One could couch this in other terms: “What is the probability that long term interest rates will go up over the next twelve months?”; and “What is the probability that long term interest rates will go down over the next twelve months?”.
How many people do you know that believe that the higher probability can be applied to the second of these two questions?
Most people I know and respect are arguing over whether the probability that long term interest rates will go up is 75% or 80% or higher.
The only significant argument I hear about falling interest rates on long term Treasury issues is that the Eurozone might collapse and there will be a “run to quality”, a run to United States government securities. Almost all other arguments go the other way.
The economic recovery, however weak, is continuing. The banking system (and the housing industry) is not going to collapse even though the banking industry is going to continue to grow smaller and smaller in terms of the number of commercial banks that are in the system while the biggest banks, including large foreign banks, are going to control more and more of the banking industry itself. The Federal Reserve will continue to keep money flowing into the banking industry so as to keep banks open while the FDIC makes sure that the banking industry shrinks in an orderly fashion.
Are we going to get QE3? Depends upon the rate at which insolvent banks can be closed without disrupting the financial system. The strength of the economic recovery is not the issue. The issue, to me, depends upon what the FDIC can achieve.
The federal government is going to continue to add more and more debt to the total already outstanding.
There just is no credibility in Washington, D. C. concerning the reduction in the cumulative deficits over the next ten years or so. I still believe that the government will add another $15 trillion or more to the federal debt outstanding over the next ten years.
The Libyan situation is a case in point. The federal government is so over-extended fiscally that other demands on its resources are just going to stretch budgets even further and keep the cumulative deficits at near-record levels. Then the government ends up doing two things, neither desirable: the government is limited in what it can do in very important situations; and even if the government cannot do much, whatever it does will increase the cumulative deficit.
Then there are other issues, like the boom in commodity prices worldwide, the acceleration of the merger and acquisition business in America, Europe, and the emerging countries, and currency speculation throughout the globe.
As a consequence, I see no reason to back off my earlier thoughts on the future of the interest rate on long term U. S. Government securities. See http://seekingalpha.com/article/250838-long-term-treasury-yields-and-inflationary-expectations. This post was written when the yield on the 10-year Treasury security was 3.48 percent, roughly two months ago at the beginning of February. Yesterday the 10-year Treasury closed at about 3.46 percent.
At that time I claimed that a forecast of 5.00 percent to 5.50 percent was not out of reason for a Treasury security of this maturity somewhere in the next 12 to 18 months.
The basic reasoning for this: my estimate of the expected long run “real” rate of interest is roughly 3.00 percent, (Similar, I found out, to the belief of the Wharton School’s Jeremy Siegel.)
I further believe that investors will come to build in a premium for inflationary expectations in longer term interest rates in the neighborhood of 2.00 percent to 2.50 percent.
How strongly do I feel about this prediction? I believe that the odds are in the neighborhood of 3- or 4-to one that rates will move into this range over the next 12 to 18 months.
Thus, I would have to agree with Bill Gross (and Warren Buffet) that Treasuries “have very little value” and are not a good “buy and hold” at this time.
Wednesday, March 30, 2011
Merger Trend Heats Up
For the last 18 months or so, I have believed that one of the most important factors affecting the American (and world) economy would be a growing number of mergers and acquisitions. Individuals at Credit Suisse Group AG estimate that “The value of global takeovers may increase 15 percent to 20 percent this year, extending a 27 percent rebound in 2010.” (http://www.bloomberg.com/news/2011-03-30/new-deal-rush-pushes-takeovers-to-most-expensive-since-lehman.html) Not only is the economy growing (however modestly) but the better off corporations have lots and lots of cash assets, borrowing costs are exceedingly low, and there are lots of other corporations that are not so well off and whose best outcome is to be acquired by someone larger and healthier. Last week the AT&T and T-Mobile deal was announced. Recently we have also had deals announced by Duke Energy Corporation and Deutsche Boerse AG. And, yesterday, Canada’s Valeant Pharmaceuticals International put out a hostile offer for Cephalon, Inc. General Electric has engaged in a string of acquisitions, the most recent one was just announced, a $3.2 billion deal for GE to acquire the French company Converteam. And, there are many others. Deals are also taking place in the commercial banking industry. Although there were 157 banks closed in 2010, the number of banks in the industry fell by 310 indicating that lots of acquisitions were going on behind the information relating to the regulatory closures taking place. And, the big companies are getting bigger. The prices of an acquisition are rising. In the first quarter of this year, the price of an acquisition reached the highest level since before the collapse of Lehman Brothers Holdings, Inc. There are three aspects of this activity that are important for our future. First, consolidations are taking place across virtually all industries. There are many targets “out there” and companies with lots of cash and lots of borrowing power are “on the prowl.” This activity will have two effects on economic growth. In the short run, consolidations slow down economic growth because they lead to a rationalization of industry where plants and offices are closed and people are let go. Over the longer run, productivity increases as organizations become more efficient and effective producers of goods and services. Second, companies that have built up too much debt are in the process of deleveraging and, at the same time, are spinning off some of the subsidiaries they acquired with the debt. Thus, firms are getting back to more manageable levels of debt in their capital structure and they are also returning their operational focus to their core businesses. Both of these moves will also tend to keep economic growth from speeding up in the near future. The reduction in the debt of these companies will not be replaced in the near future and this will moderate the increase in bank lending and other corporate borrowing. Furthermore, the return of companies to their core businesses tends to result in the closing of plants and offices and the reduction in the number of people these companies employ. Third, investors will have the opportunity to participate in the restructuring of the economy that is now taking place. However, investors must be careful because not all acquiring companies are equal and not all acquisitions will turn out well. The current merger and acquisition boom is still in its early stages. As such, premiums received by selling companies are low, “the lowest since the third quarter of 2007.” Premiums are always low at the start of an M&A boom! Yet, not all deals are attractive to investors. Whereas AT&T stock has climbed 7.6 percent since it disclosed the T-Mobile deal and Valeant Pharmaceuticals stock jumped 15 percent late yesterday on the news of its bid for Cephalon, other transactions have not fared so well. If there is a chance to participate in this investment swing, it is now, when the purchase premiums are low. These will rise, and in the typical cycle, the rise will approach a level in which all new M&A deals are suspect. How soon the rise will occur is, of course, problematic. With so much cash on company balance sheets and the Federal Reserve holding market interest rates so low, one could imagine that the bidding could become pretty hot. But even if the bidding becomes “hot” this will not do much good for the economy in the short run because consolidations and the rationalizing of companies will result in plant and office closings and the laying off of people. It will also result in big companies (and big banks) getting bigger.
Friday, March 25, 2011
Who Needs $1.4 Trillion in Excess Reserves?
On August 27, 2010, Fed Chairman Ben Bernanke gave the world the first news about QE2. (See my post, “Bernanke in the Hole”, http://seekingalpha.com/article/222704-bernanke-in-the-hole.)
His explanation left something to be desired.
I had just made the comment:
"The Federal Reserve has two basic problems right now. First, those running the Fed don’t know what they are doing. Second, they are doing a terrible job explaining this to the world.
Never have I seen such confusion in such an important institution. Never have I seen such inadequate leadership.
We have experienced the end of the Fed’s exit strategy, the effort undertaken by the Fed to reduce the size of the Fed’s balance sheet. The exit strategy was designed to reduce the massive amounts of reserves pumped into the financial system by the Fed so that a period of hyper-inflation would not result. That exit strategy saw the Fed’s balance sheet grow by $331 billion over the twelve-month period the “exit” strategy was in place. Excess reserves held by the banking system rose by 38% during the same time period. (Details here.)"
Guess what?
Things really haven’t improved.
Guess what again?
The Fed is now going to hold a press conference on a regular basis, four times each year after selected meetings of the Fed’s Open Market Committee, the committee that sets monetary policy for the nation.
The purpose of these press conferences? To explain monetary policy to the nation and to make things “more clear” about what the Federal Reserve is trying to do.
This, to me, would be really funny if the Fed did not have such a crucial role to play in our lives.
Why don’t we just let Alvin and the Chipmunks sing four times a year after meetings of the Fed’s Open Market Committee?
Why does the banking system need $1.4 trillion in excess reserves?
In August 2010, the banking system averaged a little more than $1.0 trillion in excess reserves.
So, excess reserves have gone up about $400 billion.
Since August 25, 2010, two days before Bernanke’s Jackson Hole speech, the Fed has added a net of $520 billion of Treasury securities to its Treasury securities portfolio. The Fed’s portfolios of Federal Agency issues and Mortgage-backed securities has declined by $183 billion.
Thus, the Fed has added a “net” of $337 billion to its “total” securities holdings since just before the speech. This compares with the proposed “net” increase in Treasury purchases of $600
billion.
Overall, “Reserve balances with Federal Reserve Banks”, a proxy for excess reserves in the commercial banking system, has increased by $358 billion over this time period to $1.4 trillion.
So, operationally, the Federal Reserve has done exactly what it said it would do.
By the end of June, therefore, excess reserves in the banking system should be between $1.6 and $1.7 trillion.
And, bank loans? Usually when the Fed puts reserves into the banking system, bank loans increase.
Loan and leases at commercial banks in the United States has declined by roughly $130 billion during from the time from August to the early March.
Although Commercial and Industrial (business) loans have increased slightly (about $18 billion), Real Estate loans have dropped precipitously by almost $95 billion. Consumer loans have also decreased by a little more than $65 billion.
In the real estate area, the big drop has been in commercial real estate loans which fell by almost $75 billion. Revolving home equity loans declined by another $20 billion with residential loans remaining roughly constant on bank balance sheets.
Again, one can ask the question, why does the banking system need $1.4 trillion (going to $1.7 trillion?) in excess reserves?
In explaining the reasoning for “throwing so much spaghetti against the wall” we are told that the Fed is acting in this way to spur on economic growth.
Are four more press conferences per year going to throw any more light on the rationale for these Fed actions than we already have?
Let me just reiterate something I said in the early blog post: “Never have I seen such confusion in such an important institution. Never have I seen such inadequate leadership.”
My take on the story? See my March 24 post, “Banking and Real Estate Loans: the Problems are Still There” (http://seekingalpha.com/article/259867-banking-and-real-estate-the-problems-are-still-there). I believe that the banking statistics presented above capture a part of this story. I am not sure it justifies a banking system with $1.7 trillion of excess reserves. But, then, maybe those banks smaller than the 25 biggest banks in the country are more insolvent than I believe they are. But, the Fed isn’t telling us this and four more press conferences a year is not going to shine, in my mind, any more light on the issue.
His explanation left something to be desired.
I had just made the comment:
"The Federal Reserve has two basic problems right now. First, those running the Fed don’t know what they are doing. Second, they are doing a terrible job explaining this to the world.
Never have I seen such confusion in such an important institution. Never have I seen such inadequate leadership.
We have experienced the end of the Fed’s exit strategy, the effort undertaken by the Fed to reduce the size of the Fed’s balance sheet. The exit strategy was designed to reduce the massive amounts of reserves pumped into the financial system by the Fed so that a period of hyper-inflation would not result. That exit strategy saw the Fed’s balance sheet grow by $331 billion over the twelve-month period the “exit” strategy was in place. Excess reserves held by the banking system rose by 38% during the same time period. (Details here.)"
Guess what?
Things really haven’t improved.
Guess what again?
The Fed is now going to hold a press conference on a regular basis, four times each year after selected meetings of the Fed’s Open Market Committee, the committee that sets monetary policy for the nation.
The purpose of these press conferences? To explain monetary policy to the nation and to make things “more clear” about what the Federal Reserve is trying to do.
This, to me, would be really funny if the Fed did not have such a crucial role to play in our lives.
Why don’t we just let Alvin and the Chipmunks sing four times a year after meetings of the Fed’s Open Market Committee?
Why does the banking system need $1.4 trillion in excess reserves?
In August 2010, the banking system averaged a little more than $1.0 trillion in excess reserves.
So, excess reserves have gone up about $400 billion.
Since August 25, 2010, two days before Bernanke’s Jackson Hole speech, the Fed has added a net of $520 billion of Treasury securities to its Treasury securities portfolio. The Fed’s portfolios of Federal Agency issues and Mortgage-backed securities has declined by $183 billion.
Thus, the Fed has added a “net” of $337 billion to its “total” securities holdings since just before the speech. This compares with the proposed “net” increase in Treasury purchases of $600
billion.
Overall, “Reserve balances with Federal Reserve Banks”, a proxy for excess reserves in the commercial banking system, has increased by $358 billion over this time period to $1.4 trillion.
So, operationally, the Federal Reserve has done exactly what it said it would do.
By the end of June, therefore, excess reserves in the banking system should be between $1.6 and $1.7 trillion.
And, bank loans? Usually when the Fed puts reserves into the banking system, bank loans increase.
Loan and leases at commercial banks in the United States has declined by roughly $130 billion during from the time from August to the early March.
Although Commercial and Industrial (business) loans have increased slightly (about $18 billion), Real Estate loans have dropped precipitously by almost $95 billion. Consumer loans have also decreased by a little more than $65 billion.
In the real estate area, the big drop has been in commercial real estate loans which fell by almost $75 billion. Revolving home equity loans declined by another $20 billion with residential loans remaining roughly constant on bank balance sheets.
Again, one can ask the question, why does the banking system need $1.4 trillion (going to $1.7 trillion?) in excess reserves?
In explaining the reasoning for “throwing so much spaghetti against the wall” we are told that the Fed is acting in this way to spur on economic growth.
Are four more press conferences per year going to throw any more light on the rationale for these Fed actions than we already have?
Let me just reiterate something I said in the early blog post: “Never have I seen such confusion in such an important institution. Never have I seen such inadequate leadership.”
My take on the story? See my March 24 post, “Banking and Real Estate Loans: the Problems are Still There” (http://seekingalpha.com/article/259867-banking-and-real-estate-the-problems-are-still-there). I believe that the banking statistics presented above capture a part of this story. I am not sure it justifies a banking system with $1.7 trillion of excess reserves. But, then, maybe those banks smaller than the 25 biggest banks in the country are more insolvent than I believe they are. But, the Fed isn’t telling us this and four more press conferences a year is not going to shine, in my mind, any more light on the issue.
Thursday, March 24, 2011
State and Local Governments and Real Estate: The Problems are Still There
“Moody’s Investors Service, the ratings agency, said in a report last week that many states ‘are increasingly pushing down their problems to their local governments.’ The Moody’s report warned that this would be “the toughest year for local governments since the economic downturn began.” (See “States Pass Budget Pain to Cities,” http://www.nytimes.com/2011/03/24/us/24cities.html?hp.)
“The state budget squeeze is fast becoming a city budget squeeze, as struggling states around the nation plan deep cuts in aid to cities and local governments that will almost certainly result in more service cuts, layoffs and local tax increases.”
Homes, over the last fifty years, served as the piggy-bank for the middle classes and the working classes as the rising price of houses during this time served as the major source for these people to increase their wealth. We are learning more and more that the inflated values of land and commercial real estate and the growing wealth of these classes also served as a piggy-bank for other sectors of the economy, such as state and local governments.
And, this piggy-bank was the source for increasing employment, rising wages, and other benefits in the public sectors of the economy.
Now the piggy-bank is broken and state and local governments are feeling the pain as have home owners, small commercial banks and small businesses over the past three years. (See my post http://seekingalpha.com/article/259867-banking-and-real-estate-the-problems-are-still-there.)
People are learning that those that “live” by inflation, “suffer” by deflation.
Ben Bernanke and the Federal Reserve are trying as hard as they can to create inflation once again so as to preserve the banking system, the housing market, and, now, state and local governments.
The economy, however, may not be responding as the Fed might want it to.
In a real sense there are two economies. There are the better off, those that benefitted from the credit inflation of the last fifty years, the people that learned how to use inflation and who have the resources to protect themselves against changes in prices. Then there are the others, those who can’t protect themselves from changing prices.
One result of this is that the income distribution in the United States is skewed more toward the wealthy than ever before in the history of the country.
The history: in the early 1960s, there were many intellectuals and policy makers who believed that inflation was beneficial to the worker because a little inflation was not a bad trade off for higher levels of employment. This trade off was captured in something called the Phillips Curve.
Although the Phillips Curve was intellectually contested by the end of the 1960s, the myth of the Phillips Curve lived on in many official circles and some still believe in it to this day.
Yet, the credit inflation that was supposed to be a ‘boon’ to the blue-collar worker and the middle class resulted in a withering of American manufacturing capability in steel, autos, and then other industries. It resulted in substantial amounts of under-employment for working age people. It decimated the housing industry. It has made many of the smaller commercial banks in the United States insolvent. And, it has now bankrupt the American system of local government.
We have had a bailout of the steel industry. We have had two bailouts of the auto industry. Labor unions in the manufacturing industries are so week that union leaders are now training people to go into other countries and build up labor unions there. We have had a bailout of the banking industry. We are now going through a workout and possible bailout of state and local governments.
Labor unions in the public sector, teachers unions, are now acting in much the same way as did the auto unions and the steel unions before them, as the economic base for their benefits have faded away.
People and organizations can only live beyond their means for so long and credit inflation can create the “good days” for only so long. And, when the good days are over, people must return to a more controlled and disciplined life style. The pain of the ‘return’ is not easy to bear.
The efforts by Mr. Bernanke and the Federal Reserve to create another round of credit inflation is, unfortunately, producing a further bifurcation of American society.
While the middle class and the blue collar workers continue to suffer and continue to restructure their budgets and balance sheets, those who have more are taking advantage of the Federal Reserve’s actions to further strengthen their position.
Large commercial banks are bigger than they were when they were “too big to fail” in 2008. Payrolls and bonuses at financial institutions are exceeding earlier years.
Large corporations are sitting on “tons” of cash and possess immense borrowing power at miniscule interest rates. And, we see one large merger taking place here and another large merger taking place there: AT&T and T-Mobile; Deutsche Bőrse and the NYSE Euronext; Warren Buffet and Lubrizol, and Caterpillar and Bucyrus. The projection is for more of this to take place in America...and in the world.
And, the wealthy? Consumer spending is picking up but the strength is not at the lower end of the value chain. Manufacturing is picking up but for higher end goods. Overall, the pickup is just modest because it is not supported throughout the income spectrum.
I raised the question earlier, in such an environment “Will the Financial Industry Dance Alone?” (http://seekingalpha.com/article/255748-will-the-financial-industry-dance-alone) The answer to this question seems to be “No, the financial industry will not dance alone. Big corporations will dance along too as will the wealthy.” There was concern in the 2000s that the benefits of the economic growth at that time were not spread evenly throughout the economy.
My feeling is that you haven’t seen anything yet.
The efforts by the Federal Reserve to inflate the economy are not going to be spread evenly throughout the economy. State and local governments are going to have to re-structure and downsize. The people in these bodies are going to have to lower their expectations as well as the people that have been served by them.
Similar to the situation with the smaller banks, one hopes to get through this adjustment period without major disturbances. That is, government officials and regulators are working overtime to keep a lid on things so that insolvencies and bankruptcies do not overwhelm the system. The efforts to contain these problems seem to be having some success. Ever Meredith Whitney, the financial analyst who predicted massive defaults in the municipal bond area still contends that there will be a large number of defaults although not as many as she first feared.
Still, things are changing and will my guess is that in many areas of the society we will not return to the “plush” years experienced in the last half of the twentieth century.
“The state budget squeeze is fast becoming a city budget squeeze, as struggling states around the nation plan deep cuts in aid to cities and local governments that will almost certainly result in more service cuts, layoffs and local tax increases.”
Homes, over the last fifty years, served as the piggy-bank for the middle classes and the working classes as the rising price of houses during this time served as the major source for these people to increase their wealth. We are learning more and more that the inflated values of land and commercial real estate and the growing wealth of these classes also served as a piggy-bank for other sectors of the economy, such as state and local governments.
And, this piggy-bank was the source for increasing employment, rising wages, and other benefits in the public sectors of the economy.
Now the piggy-bank is broken and state and local governments are feeling the pain as have home owners, small commercial banks and small businesses over the past three years. (See my post http://seekingalpha.com/article/259867-banking-and-real-estate-the-problems-are-still-there.)
People are learning that those that “live” by inflation, “suffer” by deflation.
Ben Bernanke and the Federal Reserve are trying as hard as they can to create inflation once again so as to preserve the banking system, the housing market, and, now, state and local governments.
The economy, however, may not be responding as the Fed might want it to.
In a real sense there are two economies. There are the better off, those that benefitted from the credit inflation of the last fifty years, the people that learned how to use inflation and who have the resources to protect themselves against changes in prices. Then there are the others, those who can’t protect themselves from changing prices.
One result of this is that the income distribution in the United States is skewed more toward the wealthy than ever before in the history of the country.
The history: in the early 1960s, there were many intellectuals and policy makers who believed that inflation was beneficial to the worker because a little inflation was not a bad trade off for higher levels of employment. This trade off was captured in something called the Phillips Curve.
Although the Phillips Curve was intellectually contested by the end of the 1960s, the myth of the Phillips Curve lived on in many official circles and some still believe in it to this day.
Yet, the credit inflation that was supposed to be a ‘boon’ to the blue-collar worker and the middle class resulted in a withering of American manufacturing capability in steel, autos, and then other industries. It resulted in substantial amounts of under-employment for working age people. It decimated the housing industry. It has made many of the smaller commercial banks in the United States insolvent. And, it has now bankrupt the American system of local government.
We have had a bailout of the steel industry. We have had two bailouts of the auto industry. Labor unions in the manufacturing industries are so week that union leaders are now training people to go into other countries and build up labor unions there. We have had a bailout of the banking industry. We are now going through a workout and possible bailout of state and local governments.
Labor unions in the public sector, teachers unions, are now acting in much the same way as did the auto unions and the steel unions before them, as the economic base for their benefits have faded away.
People and organizations can only live beyond their means for so long and credit inflation can create the “good days” for only so long. And, when the good days are over, people must return to a more controlled and disciplined life style. The pain of the ‘return’ is not easy to bear.
The efforts by Mr. Bernanke and the Federal Reserve to create another round of credit inflation is, unfortunately, producing a further bifurcation of American society.
While the middle class and the blue collar workers continue to suffer and continue to restructure their budgets and balance sheets, those who have more are taking advantage of the Federal Reserve’s actions to further strengthen their position.
Large commercial banks are bigger than they were when they were “too big to fail” in 2008. Payrolls and bonuses at financial institutions are exceeding earlier years.
Large corporations are sitting on “tons” of cash and possess immense borrowing power at miniscule interest rates. And, we see one large merger taking place here and another large merger taking place there: AT&T and T-Mobile; Deutsche Bőrse and the NYSE Euronext; Warren Buffet and Lubrizol, and Caterpillar and Bucyrus. The projection is for more of this to take place in America...and in the world.
And, the wealthy? Consumer spending is picking up but the strength is not at the lower end of the value chain. Manufacturing is picking up but for higher end goods. Overall, the pickup is just modest because it is not supported throughout the income spectrum.
I raised the question earlier, in such an environment “Will the Financial Industry Dance Alone?” (http://seekingalpha.com/article/255748-will-the-financial-industry-dance-alone) The answer to this question seems to be “No, the financial industry will not dance alone. Big corporations will dance along too as will the wealthy.” There was concern in the 2000s that the benefits of the economic growth at that time were not spread evenly throughout the economy.
My feeling is that you haven’t seen anything yet.
The efforts by the Federal Reserve to inflate the economy are not going to be spread evenly throughout the economy. State and local governments are going to have to re-structure and downsize. The people in these bodies are going to have to lower their expectations as well as the people that have been served by them.
Similar to the situation with the smaller banks, one hopes to get through this adjustment period without major disturbances. That is, government officials and regulators are working overtime to keep a lid on things so that insolvencies and bankruptcies do not overwhelm the system. The efforts to contain these problems seem to be having some success. Ever Meredith Whitney, the financial analyst who predicted massive defaults in the municipal bond area still contends that there will be a large number of defaults although not as many as she first feared.
Still, things are changing and will my guess is that in many areas of the society we will not return to the “plush” years experienced in the last half of the twentieth century.
Wednesday, March 23, 2011
Banking and Real Estate: The Problems Are Still There
Fed Chairman Ben Bernanke just informed Congress that people were not anxious to buy homes. He commented that “there’s no demand for construction to build homes and so the construction industry is quite reduced.”
As a consequence, the Fed will continue to purchase Treasury securities up to some $900 billion, $300 billion to replace maturing mortgage-backed securities that have rested in the Fed’s portfolio and an additional $600 billion to expand reserves in the banking system.
My feeling has been that this injection of reserves into the banking system has been to protect the banking system, especially the smaller banks, and keep failing institutions open for as long as possible so that the FDIC can close these insolvent banks in an orderly fashion.
This, of course, is different from what the Fed has been telling us. The Fed has argued that their reason for the injection of liquidity into the banking system has been to help spur on bank lending and help accelerate economic growth.
The data that continues to come in from the real estate sector does nothing to convince me that the Fed’s statement is the correct one.
Data coming in from the real estate sector, I believe, continues to support my contention that the loan portfolios of many smaller financial institutions remain seriously underwater.
The median sales price of a house sold in February, the Commerce Department has just reported, was $202,100, down from $221,900 a year earlier. This is a drop of almost 9%.
Just one added piece of information: last month’s price was at it lowest level since December 2003 when the median sales price stood at $196,000.
This just exacerbated the problem of “underwater” mortgages. CoreLogic, Inc., reported in early March that about 23%, or roughly one out of every four, mortgages in the United States had outstanding balances that were higher than the reported value of the secured properties.
In addition, a record 2.2 million homes were in foreclosure in January of this year. The number of homes in foreclosure had slowed down in the last half of 2010 because of all the fuss being made about how banks had not used proper methods to foreclose on many properties. This slowdown seems to have ended.
Furthermore, the purchases of new homes declined to the slowest pace on record.
Housing starts dropped in February to an annual rate of 479,000, the lowest level since April 2009.
And, construction permits slumped to a record low.
The commercial real estate sector is now getting hit with a new phenomenon…state governments and municipalities that are under tremendous budget pressures are downsizing and cutting back on office space. As a consequence, a lot of commercial office buildings are standing empty and their owners, who are not the states or municipalities, are faced with the task of trying to fill up the empty space.
The banking system holds the paper on a lot of this real estate.
The question is, how big a write-down is the commercial banking system going to have to take…and how fast is it going to have to take it.
The credit inflation the Federal Reserve is trying to create, I don’t believe, will cause housing prices to turn around any time soon in the magnitude needed to save their asset values.
Sooner or later these asset values are going to have to be written down.
Therefore, the efforts of the Fed are just allowing banks to stay liquid enough so that the assets do not have to be written down precipitously. In that way the regulators can control the situation and close the banks that must be closed in an orderly fashion.
But, this raises another question. This question pertains to the length of time the Fed will need to continue to provide liquidity to the financial markets? That is, how long will QE2 be maintained?
The original plans of the Federal Reserve were to call an end to QE2 in June. But, will we need to add on QE3?
My guess is that the Fed will need to continue some kind of program to maintain the “peace and quiet” on the banking front for an “extended period.”
This is a “good news” and “bad news” situation. The “good news” is that events in the banking sector are relatively quiet. The FDIC continues to close banks in an orderly fashion.
The “bad news” is that events in the banking sector are relatively quiet. The Fed must continue some kind of financial support to the banking industry because there are so many real estate related assets in the banking system that are troubled and are in need of a “write down.”
It would seem that as long as there are problems like the ones described above in the real estate sector, there will continue to be problems in the banking sector.
And, as long as there are problems in the real estate sector and the banking sector of this magnitude, the desired pickup in the economy will not be forthcoming.
Tuesday, March 22, 2011
Bigger is Happening!
AT& T and T-Mobile. The strategic merger activity of 2011 and 2012 continues.
As I have argued for a long time, the environment for a crucial restructuring of the economic world is right in front of us.
There is lots of cash around.
Interest rates are ridiculously low.
There are a lot of people, businesses, and governments “defensively” in debt.
There are a lot of companies that are “behind”, technologically and culturally, that have “good” products or good market niches.
And, there are a lot of nations in the world, like China for example, that have a lot of United States dollars that want to buy United States companies.
What about the anti-trust aspects of strategic mergers like AT&T and T-Mobile?
First, I don’t think the executives at AT&T and T-Mobile would try a combination like this if the probability of getting the deal approved were low.
Second, we are in a period of time when the “limits” of what can be done are going to be pushed. Thus, we will see more and more deals “push the edge.”
Third, if it ain’t AT&T and T-Mobile, it will be someone else and, I believe, the crucial issue is going to be how far the regulators are behind-the-times and out-of-date rather than the fact that they are enforcing some coherent program or policy.
Fourth, this is more “global” than it is “local” United States. Regulators, attempting to live up to some historical norms of anti-trust behavior, can stifle deals and leave the United States lagging in world competition. If the members of Congress and the regulators want to continue to fight “past” wars, as they tend to do, then so much the worst for us.
The thing is that Congress and the regulators have already “taken their eye off the ball.”
A report released just the other day indicated not only that banks are big and doing much of what they did before the financial crisis, the large banks are actually bigger and doing even more things than they did before the financial crisis.
The meltdown in the financial system came in the fall of 2008. I was posting blogs in late Spring of 2009 that the large commercial banks were not only getting bigger, but they were far ahead of the Congress and the regulators writing new rules and restrictions for them.
Now the large banks are even further ahead of the government than they were back in the spring of 2009.
But, this is the scenario for the future.
And, the people creating the environment for such a development are…
You guessed it…Ben Bernanke, Tim Geithner, Barack Obama, Barney Frank, and so on and so forth!
No wonder the income distribution in the United States gets skewed more and more toward the wealthy. The wealthy could not have written a better script for their advancement than that being written by the liberals and the progressives!
And, the more these people try and help their “constituencies” the more and more they hurt them. Paul Krugman, stand up and take a bow!
The best investments in the next year or so, I believe will be made in the companies that are best positioned to make “deals” that will help them expand markets, expand into slightly larger product spaces, and move to restructure industries and markets.
I wouldn’t always argue that this is a good strategy, but the world has changed and we are moving into that future. There are many companies that are well positioned, they are operating very effectively in their “core” products and markets, they don’t have much debt, and they have lots of cash.
Furthermore, prices are low since there are many more companies that are not well positioned, companies that are not operating very effectively, companies that are into too many products and markets, and companies that have way too much debt.
And, we are in that part of the cycle where sound economic deals can be struck. In a year or two, premiums will start to rise as people look back and see the transactions made in 2010 and 2011 and as these people move to try and skim some of the icing off the cake themselves.
This always happens as the euphoria in the market picks up due to the previous successful deals that were cut.
So, keep your eyes open and look for the action taking place. Look not only at the companies that are operating very well and have lots of cash and/or borrowing power but look at the nations that have United States dollars and are looking to play a bigger role in the world. Look for executives that do not buy companies too different from the ones they operate now.
Also, look for the leaders that are starting to make a name for themselves in terms of “prudent” yet aggressive deals. Who is going to take on the mantel of the next Jack Welch?
As I have argued for a long time, the environment for a crucial restructuring of the economic world is right in front of us.
There is lots of cash around.
Interest rates are ridiculously low.
There are a lot of people, businesses, and governments “defensively” in debt.
There are a lot of companies that are “behind”, technologically and culturally, that have “good” products or good market niches.
And, there are a lot of nations in the world, like China for example, that have a lot of United States dollars that want to buy United States companies.
What about the anti-trust aspects of strategic mergers like AT&T and T-Mobile?
First, I don’t think the executives at AT&T and T-Mobile would try a combination like this if the probability of getting the deal approved were low.
Second, we are in a period of time when the “limits” of what can be done are going to be pushed. Thus, we will see more and more deals “push the edge.”
Third, if it ain’t AT&T and T-Mobile, it will be someone else and, I believe, the crucial issue is going to be how far the regulators are behind-the-times and out-of-date rather than the fact that they are enforcing some coherent program or policy.
Fourth, this is more “global” than it is “local” United States. Regulators, attempting to live up to some historical norms of anti-trust behavior, can stifle deals and leave the United States lagging in world competition. If the members of Congress and the regulators want to continue to fight “past” wars, as they tend to do, then so much the worst for us.
The thing is that Congress and the regulators have already “taken their eye off the ball.”
A report released just the other day indicated not only that banks are big and doing much of what they did before the financial crisis, the large banks are actually bigger and doing even more things than they did before the financial crisis.
The meltdown in the financial system came in the fall of 2008. I was posting blogs in late Spring of 2009 that the large commercial banks were not only getting bigger, but they were far ahead of the Congress and the regulators writing new rules and restrictions for them.
Now the large banks are even further ahead of the government than they were back in the spring of 2009.
But, this is the scenario for the future.
And, the people creating the environment for such a development are…
You guessed it…Ben Bernanke, Tim Geithner, Barack Obama, Barney Frank, and so on and so forth!
No wonder the income distribution in the United States gets skewed more and more toward the wealthy. The wealthy could not have written a better script for their advancement than that being written by the liberals and the progressives!
And, the more these people try and help their “constituencies” the more and more they hurt them. Paul Krugman, stand up and take a bow!
The best investments in the next year or so, I believe will be made in the companies that are best positioned to make “deals” that will help them expand markets, expand into slightly larger product spaces, and move to restructure industries and markets.
I wouldn’t always argue that this is a good strategy, but the world has changed and we are moving into that future. There are many companies that are well positioned, they are operating very effectively in their “core” products and markets, they don’t have much debt, and they have lots of cash.
Furthermore, prices are low since there are many more companies that are not well positioned, companies that are not operating very effectively, companies that are into too many products and markets, and companies that have way too much debt.
And, we are in that part of the cycle where sound economic deals can be struck. In a year or two, premiums will start to rise as people look back and see the transactions made in 2010 and 2011 and as these people move to try and skim some of the icing off the cake themselves.
This always happens as the euphoria in the market picks up due to the previous successful deals that were cut.
So, keep your eyes open and look for the action taking place. Look not only at the companies that are operating very well and have lots of cash and/or borrowing power but look at the nations that have United States dollars and are looking to play a bigger role in the world. Look for executives that do not buy companies too different from the ones they operate now.
Also, look for the leaders that are starting to make a name for themselves in terms of “prudent” yet aggressive deals. Who is going to take on the mantel of the next Jack Welch?
Subscribe to:
Posts (Atom)
