S & P Joins the U.S. Budget Debate

Morris Segall      austerity programs, bailout, business confidence, business landscape, Capital Markets, consumer sentiment, consumer spending, Economic Growth, economic recovery, federal deficits, future trends, GDP, national debt, politics, recession, tight credit

This morning, Standard and Poor’s downgraded the U.S. credit rating outlook from stable to negative. The rating agency cited the high level of public debt as a percentage of GDP and the uncertainty that adequate actions to significantly reduce the U.S. debt level and maintain it at manageable levels would be undertaken in the forseeable future. The negative outlook and the reasoning behind it portend a “one in three likelihood of a lower long-term credit rating on the U.S. within two years” according to the text of the S & P release. Standard and Poor’s states the leverage on the U.S. balance sheet and accumulating annual deficits are higher than other countries with sovereign debt ratings of AAA.

We are not surprised by the S & P action. Indeed, in our website article of September 8, 2008, “Stocks, Recession and the Bail Out” we cautioned that the massive federal bailout of the housing and banking industries would add billions to annual deficits and the national debt. We further stated “The cumulative effect of ballooning annual federal deficits, the secular pressure on the federal budget from increasing entitlement spending and the continuing balance of trade deficit may lead to a downgrade in the U.S. government credit rating and a further aversion to U.S. dollar denominated assets longer term”. The extended decline in the U.S. dollar versus other currencies has reached historical proportions in the first four months of this year, even against the financially questionable euro. 

While we are not surprised by the S & P action, we are surprised at the timing of the ratings outlook. Why now in the heat of the budget debate between Congress and the President? Why didn’t Standard and Poor’s wait until mid May after some decision on the federal budget and increase in the debt limit would have been forthcoming? It is our opinion that by releasing this downgraded credit outlook now, it would have a significant impact on the budget deliberations and possibly tilt the argument in favor of more draconian spending cuts as advocated by the Republicans in Congress. It is not unreasonable to believe that outside credit analysts, rating agencies and economists have come to the conclusion that the U.S. must adopt an austerity spending program similar to those adopted by the European Union as a solution to its excessive debt burden. By using a time frame of three years (similar to that employed in the European austerity programs) to measure progress, S & P makes the same mistake such a short time period has created on the countries in Europe. It is simply too short a period of time to deleverage sovereign balance sheets without stifling critically needed economic growth to provide the means to paydown debt (See out website articles of December 17, 2010 and March 15, 2011).

Today’s ratings outlook release by Standard & Poor’s misses important differences between the U.S. economic situation and those of Ireland, Greece, Portugal and Spain. The U.S. economy is in recovery led by manufacturing, exports and more recently consumer spending. Employment gains have accelerated since last November. While the recent surge in inflation has slowed U.S. economic growth coming out of the first quarter of this year, the recovery trend is not aborted. It will be if the Federal government is forced to make drastic spending cuts which will reverse its role as an economic stimulant to an economic depressant at this sensitive point in the U.S. economic recovery. We argued in our economic articles on Europe and once again, that longer periods of time are required to deleverage these balance sheets. A longer period of time will allow the national economy to grow at a rate to raise tax receipts and pay down debt. We have long been advocates for greater fiscal discipline by the U.S. government that includes large spending cuts and higher taxes. However, a nation in recession cannot reduce its debt to GDP ratio.

By releasing its downgraded U.S. ratings outlook today, Standard and Poor’s has entered the political debate and abandoned its role as a neutral and impartial arbiter of credit conditions. Furthermore, the surprising timing of this release has caused capital markets here and around the world to decline significantly, further eroding asset values and wealth and business and consumer confidence already battered by overseas events in Japan, the Middle East and Europe. Declining capital markets and consumer and business confidence will lead to tighter credit conditions at a time when credit was just beginning to “loosen up”. This in turn will lead to investment and spending retrenchment, threatening the nascent economic recovery here in the U.S. The worries of a deteriorating U.S. financial condition in 2012 and beyond could be self fulfilling as a result of what we believe is an ill timed alarm. We will have to see in the coming days if the S & P action is transitory or longer lasting in its impact. 

Morris R. Segall

The Budget Wars: Now beginning

Morris Segall      bailout, budget deficits, democrats, financial Armageddon, fiscal wars, national debt, national economic philosophy, new fiscal discipline, obama, politics, republicans, U.S. government default, U.S. government shutdown

Last week’s melodrama leading up to the eleventh hour avoidance of a Federal government shutdown is just the beginning of the new fiscal wars over the U.S. budget for this fiscal year and beyond. The discussion of U.S. fiscal policy has now turned from stimulus, bailouts and economic recovery to debt reduction and redefining the role of the Federal government in the economy. Starting with the release of the Republican led House Budget Committee’s aggressive plan for deficit reduction, followed by steadfast demands for major reductions in federal spending  to avoid the government shutdown, the Republican party has now shaped and defined the fiscal discussion and taken the lead from the President and the Democrats in Washington. The President, on the defensive, will reveal tomorrow evening his plan for reducing projected federal deficits going forward and lowering the level of the national debt as a percentage of our GDP.

In arriving at their compromise last week on nearly $39 billion in spending cuts for this fiscal year, the President was fortunate in being able to utilize a number of “one time” program reductions, cost cuts already approved by Congress and unused funds from previously adopted appropriations. This “low hanging fruit” may be as much as $20 billion of the $38.5 billion compromise. The President and the Democrats in Congress will not be so fortunate going forward. The President knows he must propose a credible deficit reduction program in an attempt to get Republican cooperation in raising the federal debt ceiling by early May. Such a plan will likely include tax increases as well as significant spending reductions. The President and his party will try to salvage as much of their fiscal and social agenda as possible.

Given the strong philosophical differences between the parties, we believe the President’s submission tomorrow evening will be rejected as insufficient and inclusive of unwelcome taxes by Republican hard liners in the House of Representatives. Another period of gamesmanship between the Republicans in the House and the President and the Democratically controlled Senate will ensue between now and early May, when the government will run out of money, to attempt a budget compromise and avoid a federal government default. The parties will use this period to blame each other for taking the country to financial Armageddon. We are optimistic neither party want to be held responsible for that and last minute concessions will avert disaster.

We have long warned of deteriorating federal finances, long before the recent recession, and been critical of the burgeoning federal debt, unsuccessful fiscal “ bailout” and excess liquidity programs to the extent we have been steadfastly pessimistic in regards to the long term U.S. financial and capital markets outlooks. We are in the process of examining the federal financial situation and the proposed solutions in an upcoming website article. However, the current chain of events and resulting dialogue represents a sea change in our national economic thinking and philosophy. The potential economic changes resulting from a new fiscal discipline in Washington will have profound impacts on all of us, our children and grandchildren.

Morris R. Segall

The President’s Financial System Overhaul: It’s Time

Morris Segall      2009 economy, bailout, banking system, business landscape, economy, The new Fed actions

After a year of speculation and discussion, President Obama released his plan for reform and regulation of the nation’s financial system. There were few surprises. With more oversight and control centered in the Federal Reserve and augmented with newly created boards, the plan brings under new regulation and supervision virtually all major sectors and products of the financial services industry.

Born out of the cataclysmic financial losses of the current recession, the President’s plan seeks to avoid a repetition of the circumstances and events that led to the recent financial system meltdown. It is the quid pro quo for the federal government bailing out the U.S. credit system and nobody should be surprised at the far reaching reform and regulation embodied in the plan.

In the most sweeping regulation of the financial sector in this country since the Great Depression, it creates unprecedented power to seize banking institutions and intercede in the transaction systems in the financial marketplace. This would include the “breakup” of large financial conglomerates that pose a heightened risk to the functioning and integrity of the financial system.

Critics are bemoaning that the increased intrusion of the federal government in the affairs of the financial marketplace may cause restriction and higher costs of credit to borrowers. With all due respect, that has already occurred as a result of the massive debt losses sustained by the nation’s credit intermediaries and its investors and placement firms.

Like it or not the financial marketplace and its players are going to have to deal with more stringent governmental oversight and regulation to protect the country from another financial meltdown from insufficient credit risk underwriting.  The constriction of credit, the inability to conduct market transactions in asset backed securities and consumer and banking failures necessitate the comprehensive overhaul of the nation’s financial system.

The mandating of increased oversight of the nation’s banks including higher capital and liquidity standards and the assumption of prudent risk and the offering of high risk products will force the banking system to adopt a more stable lending and responsible posture. The regulation of credit card companies and mortgage brokers and other financial intermediaries serving consumers is required to also enforce higher standards of professional conduct, better risk underwriting and most of all, consumer protections from fraudulent and abusive practices.

Importantly, the overhaul plan includes regulation of the “paper” created around the asset based lending that leveraged and securitized these transactions and have been a major contributor to investor and lender losses as the value of such paper eroded more than the assets they backed and became illiquid.

Unfortunately, the President’s plan does not use this opportunity to streamline the regulatory system. We believe there are still too many agencies involved in the new regulatory framework and may lead to inefficiencies and inconsistencies in industry oversight. However, no new regulatory plan of this magnitude was going to be perfect and the overall benefits will outweigh the organizational faults. We also believe industry participants will adapt and operate successfully in the new environment and/or exit the more risky sectors of the financial marketplace. This will inure to the benefit of lenders and borrowers in providing a safer and fairer financial system.

The credit industry over the 2004-2007 period lost its way and its mistakes in the extension of credit to poor credit risks and the leveraging of those risks would have plunged us into a massive depression were it not for the Herculean federal rescue. It’s time we got this critical industry and system back under control.

Morris R. Segall, CFA, CIC

In the Global Fight Against Recession, Is the U.S. a Party of One?

Morris Segall      bailout, banking system, economy, government, The new Fed actions, their implications and political fallout, treasury

Today the Federal Open Market Committee voted to increase the stimulus to the credit markets by keeping the Fed Funds rate in a 0%-.25% target range. In addition they voted to have the Fed purchase:

• Up to $300 billion of long-term Treasury securities
• Another $100 billion of U.S. Government Agency debt making a total of $200 billion
• An additional $750 billion of mortgage backed securities making a total of $1.25 trillion

In addition the Open Market Committee voted to launch the Treasury’s TALF program to purchase consumer and business asset backed securities. This program will start at $200 billion but could expand to a $1 trillion.

The Fed’s actions are based on what the Open Market Committee states are continued recessionary pressures in the U.S. economy. With today’s actions, the balance sheet of the Federal Reserve is estimated to have expanded to approximately $3 trillion. This compares to assets of less than $1 trillion six months ago. It would seem the Fed is throwing in the towel on a recession bottom in 2009.

This compares to Chairman Ben Bernanke’s testimony on February 14th before the U.S. Senate Banking Committee in which he forecast an end to the recession by the end of this year. Clearly there is some disconnect between the Fed’s current actions and the Federal Reserve Chairman’s outlook.

Indeed, the most recent economic data released this month and recent corporate announcements from several large banks indicate there is some hope the pace of economic and earnings contraction may be slowing. We have communicated to our clients and audiences that we felt the worst of the current recession would be felt in the first quarter of this year. If we and Chairman Bernanke are correct, today’s Fed actions are too much at the wrong time and will have negative consequences intermediate-longer term. We warned in our last blog posting, “Is There a Plan Here?” the increasing concern among international creditors about the future creditworthiness of the U.S. government given the outsized spending of the current bailout programs. It is noteworthy that the Chinese government just last week expressed misgivings about their large holdings of U.S. Treasury debt and further purchases going forward. Today’s massive new spending by the Fed will cause further alarm in international financial circles. While today’s announcement of Fed purchases of long term Treasuries suppressed interest rates on government debt and provided fresh fodder for further stock market gains, it is important to note today’s large decline in the value of the U.S. Dollar in currency future markets and the simultaneous large increase in the price of gold futures in commodity markets.

The Federal Open Market Committee is preoccupied with deflation as a result of the current recession. Yet the price of oil has moved to nearly $50 per barrel from approximately $35 per barrel a month ago. In addition the most recent reports on consumer prices for January and February show an annualized rate of inflation of 2.5% excluding food and fuel and inflation and rates much higher in key non discretionary spending categories. The recent rise in energy and service prices belie a chronic deflationary environment or outlook. The unbridled U.S. government and Federal Reserve spending on the multitude of stimulus and bailout programs has been rejected by our overseas trading and financial partners despite this government’s pleas for more foreign government stimulus spending. These governments are afraid of the inflationary bubbles and sovereign balance sheet erosions that will result from such unfettered spending. So the Treasury Dept. and the Fed plot their own course of uncapped spending as their answer to the current credit and economic dilemmas.

Speaking of dilemmas, President Obama is feeling the heat on what is clearly a botched bailout of AIG and an erosion of confidence amongst economists and politicians in Treasury Secretary Geithner. The public is angry and very stressed over the recession. The economy is President’s Obama’s and the Democratic Party’s problem now and the public wants to see results from the hodgepodge programs the government is implementing. The current scandals regarding executive bonuses and the perceived inadequacies of the Treasury leadership will in our opinion start to erode the President’s poll numbers adding a further difficulty to the current social and economic environment.

Morris R. Segall, CFA, CIC

If you think it is bad here…

Morris Segall      bailout, economy

As bad as economic conditions are here in the U.S. they are worse overseas. In our website articles, “The Economy, Bailout and the Capital Markets“, December 8, 2008 and “… The Virus Has Spread”, August 6. 2008 we project the U.S. recession spreading overseas with more dramatic negative impact. In our December 8 article we highlight the fall of foreign economies into recession making the current recession worldwide in scope.  We were not pessimistic enough. The rapid erosion of overseas economies into deep recessions has been a surprise to most analysts and economists. The just announced decline of the Japanese economy in the calendar fourth quarter of 2008 at a nearly 13% annualized rate is the latest in a series of economic contractions recorded in the fourth calendar quarter of last year, including most of the countries in Western Europe and the U.S. It confirms our analyses in previous articles that the worldwide recession would be led by the mature, export oriented economies of Western Europe and Japan. The worsening economic conditions in the industrialized world would telescope back into the export dependent economies of Asia, Africa, Eastern Europe and Latin America. These emerging market economies have also been severly wounded by the collapse of oil and other industrial commodities which had been major stimulants to the accelerated growth of these economies.

The combination of collapsing commodity prices, virtually zero import demand from major trading partners, the bursting of overbuilt and overpriced real esate and manufacturing projects has caused a rapid increase in foreign unemployment and a deepening banking credit crisis in many foreign countries. Without the countervailing strength of healthy domestic consumption sectors, most emerging industrialized countries are joining the mature, industrialized economies in deepening recession which have further to go given the 6-12 month time lag of overseas economic trends to those of the U.S.

As economic trends get worse and last longer overseas in 2009-10, unemployment, currency values, industrial production, bank losses and corporate profits will worsen and are already resulting in credit downgrades of foregn sovereign debt. The latter is particularly worrisome in that it has already increased the cost of funding for foreign governments and is chasing money out of foreign currencies into the U.S. dollar which is near its November, 2008 highs. In newly industrialized economies in Eastern Europe and Latin America, credit downgrades may also lead to credit defaults by some governments. World banking organizations are working overtime to forestall such defaults but there may be too many “leaks in the dike” to be succesful. The erosion of foreign soverign debt ratings, the flight from foreign currencies and economic contractions more severe than in the U.S. will be another move from collateral damage of the U.S. recession to another contributor to the extension of our own by keeping exports suppressed and putting more pressure on the international banking system and credit markets.

Morris R. Segall, CFA, CIC

Market Observations

Morris Segall      bailout, debt, government

In my next article on the website regarding the economy and the government bailout measures I will postulate the following.

1.    The recession and credit crisis cannot end until the consumer is made financially sound and creditworthy again. Pumping dollars into banks, credit card companies, insurance cos. and auto cos. will not solve the recession until the consumer starts spending and begins to move goods off retailers’ shelves.

2.    That can’t happen as long as the consumer is losing his job (this Friday’s unemployment numbers will be between 300,000-400,000 lost jobs largely from white collar positions and an unemployment rate approaching 7%).

3.    If the government is going to spend another trillion dollars they should do a massive consumer rebate program with the emphasis on consumers paying down debt and getting current on their financial obligations, including mortgage, credit card and auto loans. If the consumer gets current on his debts, the financial system won’t have to write down consumer debt obligations.

4.    The government needs to invest in new industries that actually will re-employ the increasing number of unemployed. That includes energy, biotech, agriculture. Please see our PowerPoint slide presentations that highlight industries that we believe offer growth opportunities. For example, there is a 25,000 person shortage in technicians for wind farms. We can cross train unemployed factory workers including unemployed auto workers to be wind farm turbine technicians. Those jobs pay $25 per hour.

5.    We need to go back to removing bad debts from the books of banks and other credit intermediaries AND giving those institutions capital infusions to essentially take them back whole to where they were almost 2 years ago. At that point they will be in a position to lend again and in conjunction with the previous steps 3 and 4, we can create the environment for renewed consumer spending and lending.

6.    The government steps so far have been uneven and have not gotten to the root of the problems. In addition, the recession has spread overseas so there is not outlet of demand coming from exports. Please re-review our articles on the website under the ECONOMY category. There are predictions in those articles going back to last January that are relevant to today’s circumstances, including the prediction of onset of the current recession and the failure of the government bailout proposals

The Real Cost Of The Bailout

Morris Segall      bailout, banking system, obama

I’ve said publicly in the past that that I thought the cost of rescuing the banking system and the economy would easily be $2 trillion. It now looks like the Obama administration has a $700 billion stimulus package in the works on top of the current bailout package and the cost of bailing out banks and Wall St. so far.

If the $700 billion price tag of the Obama program is true, we are there.

This will likely not be the end and we could be looking at more than $2 trillion before this is all over. The impact on the Federal budget deficits and national debt will be enormous.

It also appears a major public works/infrastructure program will be part of the stimulus program. I have also been quoted by the Philadelphia Inquirer that I did not believe such a program will have the desired effect the government assumes. In an economy where more unemployed are white collar workers and state and local governments are slashing transportation and infrastructure programs, it is dubious the federal public works spending will have the multiplier stimulus impact.

We really need to have a whole new approach to this economy that is nothing like the historic post-war economy we have grown up with. Look what is happening to auto dealerships as a result of the demise of the big 3 auto makers. Historic solutions to recessions have already not worked, i.e. lowering interest rates alone. Bailing out sick companies is not the answer. Uncapped public spending to bail out companies will cost us dearly down the road.

The government’s strategy must be to put consumers back on their feet.  If the government wants to help consumers get back on their feet, they need to find jobs publicly or in the private sector for all of the white collar workers from finance, trade, business services, etc. that are chronically unemployed and are not finding ready re-employment.