Rate Hike Shows Expectation of Debt Repayments

Perhaps as a bluff to strong-arm the markets into optimism, or perhaps as a sign that they do know something useful in that pile of information that they’re keeping secret from the markets, the Federal Reserve has announced that they’ll be slightly raising the rate they change banks to borrow money.  Of course, banks will still be paying less than 1% while we have student loans that average 10% and credit card rates closer to 20%, but that’s what we call a “free market” for some strange reason.

But absent real financial and political reform, it is unlikely that consumer wages will be able to maintain the demand for most economic activity.  The problem we’re encountering is actually a relatively simple one:  Labor hasn’t enjoyed the benefits of increased productivity, and they’re starting to learn that they have nothing to gain from being so productive.  Further, since wages haven’t kept pace with the cost of living, individuals have to choose between making the mortgage on an underwater house or buying things that keep the future economy running.  Without seriously writing down the expected value of the financial sector’s mortgage loans, there’s just no way that American workers can support both sides of the economy – the fictional paper pushing one, and the real manufacturing and transportation one.

Its likely that this move will be remembered as a tragic act of hubris – one last attempt to prove that the economy could recover with just a bit of academic hocus pocus and the old trickle-down theory of printing more money for the ones who already had the biggest share.  Not only will a lot of houses be hitting the market this year, but so will a lot of mortgages reset triggering the next wave of defaults in high-end residential and commercial real estate.

Severe Weather Warning

Regardless of what business you’re in (well, unless you’re a banker I guess) you should probably hold on tight and get ready for one heck of a ride.  All signs point to sharp deflationary contractions through the coming year, but that won’t stop the supply of dollars from growing at the same exact time foreign demand for them falls.

Inflation or Deflation?

Yes, the deflation vs. inflation debate is over.  We can indeed have both and here’s how it will happen:

The value of American owned assets will deflate, and this will be followed up by the Federal Reserve releasing more money into the economy in an attempt to compensate or even that first effect out.  Since the only mechanism the Federal Reserve & Treasury use to put money into the economy is to transfer it to chartered banks, they’ll continue to hold this free cash in reserve so they can stay in business at all.

Since the aggregate money supply doesn’t actually “correct” the original over-pricing of American assets, foreign investors lose their appetite for dollar-denominated assets.

So what happens in the end?

The number of dollars doesn’t change, but the home-owning middle-class has fewer of them and the investors and bankers have more of them.  All of the dollars buy fewer raw materials, or food items, or manufactured products than they used to (except in that technological and production improvements cause real prices to drop.)

So energy and food and medicine and tuition all continue to skyrocket at the exact same time that people are losing jobs or working fewer hours.

Misery loves company

Is there any kind of hope or silver lining?  Well, as bad as America has screwed up its finances, places like Greece, England, Iceland, and Spain might just be worse off than we are.  The fact that other nations also got caught up in the bubble frenzy might actually protect us from some of the worst consequences.  Or, because of how much the internet allows us to do business across borders and how we rely on foreign sales to balance out our budgets, it could just be the next feedback mechanism for a deep and prolonged economic crisis.

From March to September, U.S. equities markets enjoyed a nice recovery.  But was this six month rebound based on fundamental valuations, or a reflex reaction to all the cheap money being thrown around by various government institutions?

Now, I’m not saying that a government can’t provide valuable public investment, I’m just saying they didn’t accomplish it this time around.

Remember a year ago when there was a lot of talk about high speed rail, a complete healthcare overhaul, and a new investment in education?  Well, it turns out that most of the bailout and stimulus is going to maintenance – its going to cover bills and existing obligations that were relying on unending annual tax growth.

Even as major banks hand out another round of record bonuses, our social safety nets are unraveling.  Social Security is on the brink of deficit, and the FDIC is finally admitting that its out of cash.

So despite the quantitative easing, despite the interest rates and federal guarantees, investors are starting to wonder if buying in to this economy is actually a good deal.  For the millions of Americans who lost jobs during the latest run in stock prices, I’m sure they’d vote against having too much confidence…

Unpaid debt hangs over your potential spending choices.  If America wants to really invest in the things we’ve decided are valuable:  technology, education, good health, then we’re just going to have to pay off the Humvees and oversized houses first.  Otherwise, we leave interest payments to chunk away our income despite never affecting the principle.  There’s a lot of bad debt and unproductive consumption that still has to be accounted for before we can think too much about other possibilities.

Magic wand economics won’t save us either, dollar inflation requires willing participants victims who will continue to buy debt despite an implicit guarantee that it carries a negative return.  China has been an on-and-off ally of America for quite a while now, but they’re not going to ignore the most shameful chapters of their national history by letting foreign interests dominate their own domestic economy.  From Latin America to Russia, there are repeated calls for a new global monetary order – and no one is calling for America to lead the way.

Congress is currently in the process of discussing and debating a piece of legislation that would fully and completely audit the Federal Reserve bank – for the first time in the institution’s history.

Despite wielding overwhelming influence on the financial and monetary standing of the United States, no elected politician has even been allowed to take a look at what they’re actually doing with our money.  Several of the Fed’s board members are appointed by the private banks who own shares in the Fed, but a slim majority of the board is nominated by the president.  Once they’re in there though, all we can do is hope they’re doing the right thing.

Now, can you imagine a job that gives you immense power and influence without ever having to answer to anyone’s complaints and criticisms?  This is at the root of all the conspiracy theories – power and secrecy is a dangerous mixture for those stuck on the outside.

The Argument Against Truth

Defenders of the Fed are out there, even if they’re few and far between.  Of course, the best way to get defenders and supporters is to buy them – and one of the most telling defenses is being propagated by the Fed’s top lawyer.  He claims:

We’re concerned that [revealing the truth of our activities] would cause the markets and the public to lose confidence in the independence and judgment of the Federal Reserve

There are also plenty of professional economists who will repeat this or a similar argument.  And it should be no surprise, as this article explains exactly what it means to be a professional economist in a financial world dominated by secretive central banks.

Editors of academic journals, mainstream media pundits, professors – many of these experts work for the bank that doesn’t want us to see its books.

Want a more detailed idea of what’s going on?  Check out this excellent book:  Deception and Abuse at the Fed

Driving through my neighborhood, this is the story of housing written on the front-yard signs and plastered to the walls of crumbling homes.  There’s no way to exaggerate this:  a full half of the houses between mine at the main road are abandoned. And this isn’t some “main road” out in the middle of nowhere, it is about five miles to the beach, downtown, or the financial center of the city.  This is a main road for a city with an NFL team and almost a million residents.

Even during the bubble, this neighborhood wasn’t too popular unless people were coming in to build expansions.  The houses were originally built in the 1950s as military housing for the nearby naval base.  The construction is solid but the space is modest:  concrete blocks apportion a meager 1,000 square feet.  During the construction boom, people were more willing to buy 3,000 square feet worth of plywood and chinese drywall.  I always wondered why people bought weak-walled homes in the middle of a hurricane zone, but I suppose the entire housing situation has been an exercise in insanity.  Credit was plentiful, exuberance was irrational, and no one was really thinking of the future.

That future is today, and the “For sale, for rent, foreclosed” signs don’t come down:  they just devolve to the next level of seller desperation.  When they realize the house won’t sell, they try to rent it out at a loss.  At least they’ll be able to avoid foreclosure, right?  Not yet – every house that goes empty here is soon bank owned.

The first empty house is a fixture on our street.  Its two houses down and its one of the bigger ones on the block at a stately three bedrooms and 1,700 square feet.  It even has.. er.. had a pool.  This one has been empty since we moved in nearly three years ago.  It seems to be owned by some trust fund, but the only ones living there are raccoons, wild weeds, and mosquitoes.  Every applicance, piece of hardware, and inch of copper pipes has long been stripped, and the windows are boarded up with a cheap plywood that is now also starting to rot.  The online listing claims the property is for sale at the low price of $60,000, but the city posted notices on the front door announce that the structure has been condemned as unfit for human habitation.  Of course, the city doesn’t have funds for demolition…

Two doors down again, there’s a jungle of weeds where one of the street’s nicest gardens used to be.  A more modest and average house, this one is two medium bedrooms and a small screen porch.  One day, we realized our neighbors weren’t outside tending the yard (it really was a nice yard…).  A week later, there was still no sign and the weeds had sprouted a few extra feet.  The court records say foreclosure, the family must have been forced out.  This was two years ago, and there’s no for sale sign, no listings online, and no visible maintenance.  What good does this do the bank, the neighborhood, or the crafty gardener who used to call this place home?

A corner house sits “For Sale or Rent.” The new job they moved for must have paid well if they’re able to sit on an extra mortgage for the last few months.  But again, there’s no real estate agents showing the place off or curbside shoppers slowing down to take a second look.  Next to them, there’s another empty house for just $29,000.  The bank kicked out the mortgage borrower when he was almost done paying, and you could buy his home instead for a fraction of what the other houses cost.  You even get the shed and the garage he spent all those afternoons and weekeneds building.

A few blocks down the other way, my friends just walked away from a mortgage.   They each had a home, so when they got married they had to rent one out.  After years of sucking up the loss on tenants who would not pay the bills or keep the place clean, real estate agents were not even willing to attempt a sale in this market.  So my friends are at least fighting back:  They’re taking the risk back to the bank.  State laws will, of course, give the banks a chance to sue for their losses, but we’ll see if the courts find anything but profit and bailouts in the bank’s books.

It could go on and on…

This isn’t an economic story or a financial abstract that informs your investing patterns:  this is a human story and an utter failure to act humanely. As we throw people on to the streets, we let resources sit idly and ultimately decay.  Rather than write down the value of our debts and assets to a realistic and sustainable level, we’re watching those assets drop to zero and the debts spiral due to a mix of fines and eventual demolition costs.

It would appear, however, that the insanity of our financial system didn’t end with the boom…

Our leaders are infinitely optimistic about economic issues – and they should be, since the modern economy is mostly a confidence game.

We’ve moved well past fundamentals into an economic world driven by faith – not a faith in raw numbers or sustainable economic systems – but a faith in the authority of the experts who specialize in snuffing out panic and public doubts.

In the last week, bond markets have shifted around radically. Despite Federal Reserve efforts to keep interest rates low, investors are demanding higher returns on “safe” investments like U.S. government debt. With so much debt hitting the markets at the same time investors are seeing their existing capital deflate, it almost surprises me that the offerings would sell at all – at any rate of return.

For the mortgage market, the creep up of rates could lead to extra complications when adjustable loans reset. And even without rising rates, the option-payment ARMs will lead us down another path of defaults and unwinding of leveraged investments based on questionable bubble-era mortgage pricing.

Trust me – I don’t want to be pessimistic! I would love to see hosting sales return to 2008 levels. It seems like despite how many new coupons and discounts I offer, the sales just can’t keep up any more. There’s even some indication that college enrollment has slowed down or even stopped growing – fewer students are signing up for scholarship & financial aid services, even when adjusted to seasonal slowdowns that accompany summer semesters.

For some banks with access to near-zero government loans, the recovery might be as real as the price increases in commodities over the last few months. As long as the value of those dollars continues to fall, they’ll continue to turn out a profit at the expense of generally higher costs. Wages stink and employment is still falling – and sure, unemployment is a lagging indicator, so we’re only seeing the effect of the last wave of mortgage failures and bank defaults. The next one is still brewing – inevitably on the horizon.

Got into a lengthy discussion, I want to republish it since it touches on a lot of political, social, and economic realities that have to be addressed in a short time.

“I am reminded of Iraq during the Bush 43 years, just before the Surge. Many on the left were seeing quagmire. Those on the right did not want to admit failure (with cause, given hindsight) and accused the left of hoping for failure and perhaps seeking to cause failure.

The shoes seem to be on the other foot, with the Obama supporters wanting to stay the economic course while the opposition is anticipating disaster.

I’m not particularly strong on economics. Spend to stimulate in very bad times while buying down the debt in good times is about as far as I go. (Well, I don’t like tax breaks to the bubble blowing class, either.) What we saw through much of the 3T was deficit spending in good times to extend the good times. What I’m hearing now from Obama’s critics is a recommendation for austerity in bad times, which was Hoover’s approach.”

Which seems backwards. It might fool some of the people some of the time, but I am dubious. It may be that the 3T economic policies were so bad that there is no clean way out. I hope not.

I dunno, Hoover didn’t exactly slash the budget and stay out of the market. Tariffs (buy American) and immigration crackdowns were part of a plan to manage unemployment – federal spending also reached peace-time highs as he introduced some expanded federal public works ambition. Some of his more radical ideas, like old age pensions, were rejected by Congress.

Anyway, the big problem I see with our current federal spending is a) where it is aimed b) how it is financed and c) how it limits our ability to respond to future mini-crises like the inevitable option ARM default wave coming.

The a) part was mostly organized under Bush & Paulson & Bernanke – Geithner was at the NY Fed at the time and that his policies suggest he’s interested in continuing that path. This is the majority of the trillions in spending & guarantees, and it is aimed to protect the “bubble blowing classes” from the consequences of their actions.

The b) part is a little troubling too. FDR financed his spending explosion with confiscatory monetary policy – an effective tax on everyone holding dollars. Even though we’re borrowing cheap, we’re still borrowing, now faster than ever, at a time when total public + private debt rivals any point in our history.

And c) relates to the current global economic scene. Borrowing money so as to hire someone to bury that money and dig it up again won’t bring back jobs from India – its not going to make us a competitive place for businesses to invest in new jobs, research, etc. The next mortgage default wave is practically inevitable, and between now and then China is in the process of working out bilateral trade deals to bypass use of the dollar. We seriously risk the loss of the USD as the international reserve of choice, especially if we print up too much money without investing in properly in our future earning potential. If demand for dollars falls on a global scale at the same time we increase supply into the trillions to pay off investing losses, our job & debt situation could be fixed at the cost of global purchasing power. Wages would hold flat nominally, but costs of living would increase (housing could fall even further under this scenario simply by virtue of oversupply and worker income until foreign investors buy it up and put a floor under it)

The crashing purchasing power destroys working class wealth, but it makes exports suddenly competitive. Unfortunately, a rapidly devaluing currency is also disincentive to work harder than what’s required for subsistence – trying to save gets risky.  This means plenty of work available, but people earning very little for it and unable to build it up over time.

Of the trillions spent on stimulus & bailouts, only Obama’s $700B can really be counted as investment spending. Even some of that is more like “emergency money” to keep states solvent.  We’re literally bailing out banks and closing schools.. so spending alone cannot persist forever.  Solutions have to be built in the form of new institutions and paradigms of doing business.

Class structure should be flattening, but the top crust has been and continues to be the primary benefactor of our tax system and spending policies. As I posted in the Economy thread, our current futures market guarantees a profit to all the institutions & investors who can acquire low-cost loans from the government – at the cost of building a new commodity bubble in the hope that it will buoy home prices & the derivative investments.

“We seem to be at a place where people’s politics are reflecting their ideas of how economics works. I’m not sure how to proceed here other than waiting to see how the economy really goes.

But I think Brian laid out a plausible rhythm in his recent long post. If Obama holds the economy together he is echoing the S&H general pattern. Problems will be attacked now. Some transformation will take place. It doesn’t seem to me, though, that enough is being pushed in energy and ecology. It is not clear that the pull out from Iraq and stabilization of Afghanistan will be smooth. I am by no means certain that the economy will hold together. The possibility of a wild card surprise or two can’t be ignored.

But some of us seem to be in the ‘sip tea and cuss That Man In The White House’ phase. I’m not quite sure we are fully into the ‘blood, toil, tears and sweat’ phase. Sure, there have been some policy shifts. I’m not sure, however, that we have well and truly rolled up our sleeves and started to push.”

Someone mentioned this around here, “the risk in a 4t (crisis) is that you don’t go far enough.” From an economic perspective, I’d say Obama’s response is marginally better than Bush’s, but still headed in the generally wrong direction that began long before either of those two.

I would have liked to see the large banks fail under their own mistakes – and it would have been about the same cost to pay all those FDIC-covered deposits as it has been to keep them in business. Now that we’ve already paid in big time, we should be acting like the primary owner & investor of these banks. If we’re going to “save the system,” we should not go in half way and we should have investors near the bottom of the list of claim-holders since their “risk” was saved from zero by the taxpayer.

Nationalizing the banks wouldn’t be so insane either, controlling the money (and credit) supply is one of the very few enumerated powers of Congress.  The Federal Reserve system is most certainly outdated, probably corrupt, and even possibly unconstitutional.  Obama said “transparency” more than once during the campaign, and this would be a great place to start looking.

And don’t get me started on Universal Healthcare. I’m going to be royally pissed if they institute a mandatory insurance scheme over the single-payer model.

The consequences of these decisions will affect entire generations of Americans who haven’t been born yet. There’s no magical manifest destiny that says whatever we do is going to bring net happiness and opportunity and freedom. No country grows in leaps every 1T unless you’re looking solely at America – the nation with the shortest history.

If we use 4T momentum to institutionalize the latest goals of the bubble-blowing class, we could be in for the beginning of a long fall…  Bush set us on that trajectory, and the economics have seemed more like an acceleration than a change in direction & ultimate intent..