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Tuesday, January 26, 2010

SOTU 2010: No Traction, No Roadmap

President Obama has been behind the wheel for just over one year. At the time he took over, the American economy had been skidding down an embankment for nearly a year, On January 27, 2010, he gets his chance to explain the trip route so far and outline where America is going next and how we're going to get there. In what has become an occasional tradition, here is an alternative summary of the State of the Union 2010 for the United States.


Before diving into any analysis of specific problems or proposed solutions, it's useful to start with a review of the dashboard -- the "idiot lights" that should be getting the attention of not only the driver but everyone in the car.

Component Jan 2009 Jan 2010
DOW: 8,228 10,173
Nasdaq: 1,470 2,287
S&P 500: 836.57 1,091.76
BLS Unemployment: 11.6 M (7.6 %) 15.3 M (10 %)
BLS Long-Term Unemployed: 2.6 M 6.1 M
BLS Involuntary Part-Time: 7.8 M 9.2 M
BLS Marginally Attached Workers: 2.1 M 2.5 M
Shadow Unemployment (*): 21.5 M (14.1%) 27.0 M (17.6%)

(BLS numbers taken from #1 and #2)

* Shadow unemployment = officially unemployed +
involuntarily part-time + long-term discouraged workers

If the flashing lights and warning tones from the dashboard are disconcerting, the view out the front windshield at other economies isn't very encouraging either. The words "sovereign default" have come up in conversations about Greece, Dubai, Iceland, Ireland, Portugal, Spain, France, Italy and Britain. Skyrocketing debt loads abroad make it more difficult to count on exports to boost domestic employment to ease our crisis.


Even a cursory glance at the American dashboard leads to one inescapable conclusion -- the American economy has achieved absolutely ZERO traction on any road to recovery. The zero traction metaphor has an important dual meaning as well. The skyrocketing official unemployment and involuntary part-time employment obviously mean consumer spending will not fuel a recovery for quite some time. The huge jump in long-term unemployment is more troubling. Americans had never saved much during the boom years and many of these long-term unemployed will be burning through savings, likely down to nothing. This will further destabilize home prices, further depressing construction jobs and durable goods. Most troublesome of all is it will continue to stress the books of major banks, who are only "sound" when asking if they are strong enough to pay billions in bonuses but are in no position to withstand another panic or continued downturn. In other words, the economy not only lacks any traction to resume climbing UP the hill, it hasn't gained any traction to prevent a further slide.

A Real Market Rebound?

The rebound of the American stock indexes is seen by many as some form of stabilization or recovery. However, a review of what happened in the market to tank the indexes and actions taken by the Federal Reserve during 2009 shows the rebounds are completely meaningless. First, much of the decline in the stock indexes was due to massive sell-offs in mega-banks, insurance firms and other capital intensive firms who were dependent upon lending for sales and complex derivatives to hedge default risks and currency fluctuations. The declines in the market didn't stop when Obama took office but continued until March 2009.

In March 2009, the Federal Reserve announced it would purchase up to $300 billion of long term Treasuries and a staggering $750 billion in mortgage backed securities on the books of Fannie Mae and Freddie Mac. This action bid up prices on 10-year Treasuries, effectively lowering interest rates by half a percentage point. It also soaked up large amounts of highly suspect MBSs off the books of Freddie and Fannie, allowing them in turn to soak up more junk from the vaults of the big banks, significantly reducing the perceived risk facing investors in these firms.

The Fed action obviously contributed over $1 trillion in liquidity to major banks but, more importantly, it publicly reiterated support for the Too-Big-To-Fail entities. At that point, all the investors who (rightly) fled these stocks in 2008 piled right back in, driving markets back up. But is anything different? The bad mortgage backed securities are still out there, they've just changed vaults and books.

Real Profits?

The Fed strategy also had the perverse effect of helping most megabanks to book substantial paper profits selling securities to the Fed and borrowing FROM the Fed at lower short term rates while not lowering most consumer / business loan rates. There are two major concerns with the nature of those profits. First, most of those profits were created by the Fed literally printing money to buy up the Treasuries and mortgage backed securities from the banks at inflated prices. It's easy to pay inflated prices, after all, when you own the printing press for dollars. These printed dollars will pose a huge threat to the economy once the massive contraction of credit stops producing de-inflation.

The paper profits produced by the Fed's printing spree have made it easier to mask the more pressing problem for bank health -- credit and loan loss provisions. These provisions are charges to earnings that reflect the likelihood of losses on revolving lines of credit and loans. Though most quarterly statements for 2009 show banks increasing their loan loss provisions throughout 2009, the worry is that those increases are not keeping up with the real level of impairment of those assets. In essence, the banks are reporting profits while failing to report the increase in water leaking into the boat that is erasing much or all of those profits.

How critical are these loan loss provision levels to the real valuations for the megabanks? Just look at what happens when investors get surprised by a change to these numbers. On January 15, 2010, JPMorgan Chase announced its 4Q2009 results that showed its allowance for loan losses for the year increased from $21.0 billion (3.62%) at the end of 2008 to $32.5 billion (5.51%) at the end of 2009. The 4Q adjustment was "only" an additional $1.1 billion but it appears many investors who viewed JPMorgan as best-in-breed looked at the final year-over-year delta with great fear. If the smartest guys in the room had to drastically increase their loss reserves, how healthy can the other players be? Here the 4Q2009 numbers for a few TARP recipients: (see #3 thru #9)

Bank Reserve Reserve% 2009 Profit
JPM $32.5 B 5.5% $11.7 B
BoA $37.2 B 4.16% $6.3 B
WFC $25.0 B 3.2% $12.3 B
Citi $36.0B 6.1% ($1.6 B)
Regions $ 1.2B 3.52% $(1.3B)

With the exception of Citi, already widely recognized as a risk management basket case for twenty years, the other big guys have lower loss reserve percentages than the geniuses at JPMorgan. Feel better? Neither did the market. JPM stock dropped 10 percent in the next four trading days -- shaving about $15 billion off its market capitalization. The Dow dropped 136 points the day the JPM earnings were announced.


By ANY objective measure, the Obama Administration inherited an unfathomable number of critical problems in virtually every segment of the economy and public policy.

* long term structural deficits reaching $400 to $500 billion with honest accounting
* a collapsing auto industry driven by flawed economic and energy policies
* a poorly regulated, unstable financial system
* parallel wars being fought with incoherent strategies by an overstretched, worn out military
* oh yea, some nut in a cave still managing to steer a loose affiliation of terror cells attacking western interests throughout the world

The oddest part about these problems is that despite being delivered multiple object lessons in their VITAL importance to nearly every single American, the vast majority of these issues still BORE THE LIVING DAYLIGHTS out of eighty percent of voters.

That's a huge problem for Obama whose preferred mode of public address is more akin to an extended philosophical discussion between people who may choose to continue disagreeing but appreciate a thorough examination of the issues. His target audience loathes such details and prefers to get their information in easily digested (but over-simplified) factoids (truth optional) and DON'T YOU DARE schedule a presidential address that conflicts with the season premier of the final season of Lost. Such a climate virtual assures all issues will ultimately be trivialized down to demagoguery.

The only hope of fitting into a sound-byte ADD addled culture is to identify a small, consistent, coherent set of policies that target the most elemental roots of the problems and provide two or three degrees of synergy with each other to strengthen their impact and provide some protection against roll-back.

Obama has succeeded at doing exactly NONE of these things.

Examples abound in financial regulation, anti-trust, privacy rights in the digital age, etc.

Meaningful Financial Regulation

In reality, the American economy operated on the absolute brink from roughly August 7 of 2007 when inter-bank credit markets seized up with no apparent warning or reason through March of 2009. We are now SIXTEEN MONTHS from the nadir of the crisis (so far…) yet not a SINGLE regulatory change regarding derivatives, mortgage backed securities, collateralized debt obligations, conflicts of interest between ratings firms and (ahem…) "clients" or separation of commercial and investment banking has been proposed, much less enacted. A great deal of commotion has been raised about "clawback" provisions on bonuses or surcharge taxes on TARP winners to recover funds to pay back TARP losses but the incentive powers of such changes are virtually nil. None improve the transparency of the markets involved and none reapply enough risk to the principals of the game to discourage undue amounts of leverage that inevitably melt the entire system down.

Meaningful Anti-Trust Enforcement

Many of the biggest bank mergers were already water under the bridge by the time President Obama took office. The herd psychology in the market is still irrational enough that one might not blame the Obama Administration for moving to immediately undo these mega-mergers or even impose new guidelines that would clearly block such mergers in the future, whether by choice or (ahem…) "persuasion" by the Fed and Treasury in a darkened conference room on a Friday night after a disastrous market close.

Ok, then look elsewhere.

The Obama Administration era DOJ has published perfunctory "concerns" regarding the purchase of NBC Universal by Comcast but there is zero doubt the purchase will be approved. On January 25, 2010, the DOJ announced approval of the merger of TicketMaster, seller of roughly 80 percent of all music concert tickets in the country, with Live Nation, which operates 135 venues (all seemingly named "Verizon Wireless Amphitheatre"…) in every major market in the country. Together, the combined company will control nearly every aspect of the music touring business except for the pot dealer outside the gates of the Bonnaroo Festival. Oh, but there was one condition imposed. The new Live Nation had to ensure competition by divesting an offshoot unit to competitor AEG Live and sell another affiliate Paciolan that handles smaller college and arts-oriented venues to..

…noted communications and entertainment underdog…


Privacy Rights in a Digital World

The Obama campaign was famously effective at harnessing email and social networking systems to identify and rally supporters. The Obama Administration has become notable for a very pro-corporate, non-transparent approach to virtually all matters related to digital technology. A treaty governing anti-counterfeiting measures first proposed by the Bush Administration but held in secret due to NATIONAL SECURITY claims (?????) was subsequently supported by the Obama Administration and access to the terms of the proposal further tightened under the same reference to Executive Order 12958. (#10)

What language in the treaty could possibly involve state secrets? News that the treaty offers American Internet Service Providers legal cover for adopting any deep packet inspection sniffing technology they choose on ALL customer traffic in the interest of preventing thirteen year olds from stealing Jonas Brothers MP3 files? Or confirmation that such data transmissions have already been undergoing monitoring at centralized "drain' points for years without legislative approval or legal justification?


Much ado was made about the Republican win of the open Senate seat in Massachusetts serving as a repudiation of Obama policies and an omen for the 2010 mid-terms. According to the theory, loss of the 60-seat filibuster proof majority in the Senate has finally shocked President Obama back to political reality and triggered a more aggressive rollout of populist strategies.

Uh huh.

Obama never had a 60-seat, filibuster proof majority in the Senate. Senator Lieberman, Senator Nelson and probably five other Senators saw to that. At any given time, any Senator sitting in the #60 chair on a particular issue is capable of switching sides at the drop of a hat (or drop of a bill in their campaign coffer).

If you want a real dose of political dark humor, Senator Kent Conrad (D) and Senator Judd Gregg (R) proposed a special "bi-partisan task force" of Senators to formulate budget cutting plans with rules requiring "super-majority" votes for all cuts to provide political cover for all the "hard choices" such a group would have to make. Yea, cuz the super-majority based process in the Senate has been such a huge help so far.

Their proposal died January 26, 2010. It seems they couldn't obtain a super-majority to allow the proposal to stay piggy-backed on pending debt-ceiling relief legislation, which of course is needed because super-majorities are needed to materially restructure government spending that has produced half-trillion dollar structural deficits.

You couldn't write material this thick with irony if Comedy Central paid you a trillion to do it.

The Obama Administration has publicized a series of proposals, never mentioned in the past twelve months as priorities, to begin helping the middle class. The proposals range from tax credits for elderly parent care, additional child tax credits, tax credits for new hires at small businesses and new taxes on banks to make up for losses on some of the TARP recipients.

Read that list a couple of times and count the number of changes that affect the basic rules of the game that encouraged unsafe levels of borrowing, masked broken auditing and risk rating processes in the financial world and nationalized all the downside to taxpayers.

Did you get zero? That's what I got too.



#1) http://www.bls.gov/news.release/archives/empsit_02062009.pdf

#2) http://www.bls.gov/news.release/pdf/empsit.pdf

#3) http://investor.bankofamerica.com/phoenix.zhtml?c=71595&p=irol-newsArticle&ID=1308706&highlight=

#4) http://files.shareholder.com/downloads/ONE/828416421x0x283416/66cc70ba-5410-43c4-b20b-181974bc6be6/2008_AR_Complete_AR.pdf

#5) http://files.shareholder.com/downloads/ONE/828416421x0x344208/e19957ae-9c36-4e7b-bd64-4d42e3ebd8e9/4Q09_Earnings_Press_Release_Final.pdf

#6) http://investor.bankofamerica.com/phoenix.zhtml?c=71595&p=irol-newsArticle&ID=1376998&highlight=

#7) https://www.wellsfargo.com/pdf/press/4q09pr.pdf

#8) http://www.citigroup.com/citi/fin/data/qer094.pdf?ieNocache=977

#9) http://phx.corporate-ir.net/phoenix.zhtml?c=65036&p=irol-newsArticle&ID=1378875&highlight=

#10) http://news.cnet.com/8301-13578_3-10195547-38.html