Obama's Budget Looks Great According To Krugman

President Obama at least has one big supporter of his new budget, famed economist Paul Krugman. Krugman believes that this budget is just what the country needs to turn things around and applauds Obama for his efforts. Mark Thoma looks at a recent article from Krugman in his blog post below.

Paul Krugman finds lots to like in Obama's proposed budget:

Climate of Change, by Paul Krugman: Elections have consequences. President Obama’s new budget represents a huge break, not just with the policies of the past eight years, but with policy trends over the past 30 years. If he can get anything like the plan he announced on Thursday through Congress, he will set America on a fundamentally new course.

The budget will, among other things, come as a huge relief to Democrats who were starting to feel a bit of postpartisan depression...: fears that Mr. Obama would sacrifice progressive priorities in his budget plans ... have now been banished.

For this budget allocates $634 billion over the next decade for health reform. That’s not enough to pay for universal coverage, but it’s an impressive start. And Mr. Obama plans to pay for health reform, not just with higher taxes on the affluent, but by putting a halt to the creeping privatization of Medicare, eliminating overpayments to insurance companies.

On another front, it’s also heartening to see that the budget projects $645 billion in revenues from the sale of emission allowances. After years of denial and delay by its predecessor, the Obama administration is signaling that it’s ready to take on climate change. ...

Many will ask whether Mr. Obama can actually pull off the deficit reduction he promises. Can he actually reduce the red ink from $1.75 trillion this year to less than a third as much in 2013? Yes, he can.

Right now the deficit is huge thanks to temporary factors (at least we hope they’re temporary)... But if and when the crisis passes, the budget picture should improve dramatically. ... So if Mr. Obama gets us out of Iraq (without bogging us down in an equally expensive Afghan quagmire) and manages to engineer a solid economic recovery — two big ifs, to be sure — getting the deficit down to around $500 billion by 2013 shouldn’t be at all difficult. ...

So we have good priorities and plausible projections. What’s not to like about this budget? Basically, the long run outlook remains worrying.

According to the Obama administration’s budget projections, the ratio of federal debt to GDP. ... will soar over the next few years, then more or less stabilize ... at a debt-to-GDP. ratio of around 60 percent. ... [S]ooner or later we’re going to have to come to grips with the forces driving up long-run spending — above all, the ever-rising cost of health care.

And even if fundamental health care reform brings costs under control, I at least find it hard to see how the federal government can meet its long-term obligations without some tax increases on the middle class. Whatever politicians may say now, there’s probably a value-added tax in our future.

But I don’t blame Mr. Obama for leaving some big questions unanswered in this budget. There’s only so much long-run thinking the political system can handle in the midst of a severe crisis; he has probably taken on all he can, for now. And this budget looks very, very good.

More on the budget:

• Finally a Progressive Budget, Robert Reich
• Higher Taxes: Will The Republicans Cry Wolf Again? - Bruce Bartlett
• Obama’s Budget Plan Sweeps Away Reagan Ideas, by David Leonhardt, New York Times

This post can also be viewed on economistsview.typepad.com.

Fourth Quarter GDP Much Worse Than Originally Reported

The 3.8% decline in GDP for the fourth quarter of 2008 wasn't too bad — or so we thought — under the circumstances, but things were much worse than we originally thought. The new revised fourth quarter GDP shows that the economy actually fell 6.2%. James Picerno from The Capital Spectator looks closer at the report and talks a bit about the new culture of the American consumer in his blog post below.

No one expected good news, and the expectations were met.

Today's update on 2008's fourth-quarter GDP was ugly, the ugliest in 25 years, in fact. The economy contracted by 6.2% at a real, annualized seasonally adjusted pace in the last three months of 2008. That's much deeper than the 3.8% decline originally estimated by the government.

Painful, but no one should be shocked, given the general economic and financial climate. But let's be clear: the embedded message in today's revised numbers from the Bureau of Economic Analysis is sobering. The principal reason it's sobering is that the main driver of economic activity has stumbled and the prospect for a quick turnaround is about as likely as waking up on the surface of Neptune tomorrow.

It's not an exaggeration to say that consumer spending has hit a wall and crumbled as a result. Perhaps the only surprise is that it took so long for a retrenchment in consumer spending habits. But fate can only be delayed so long. The willingness, bordering on obsession for borrowing in 2002-2007 has finally come back to haunt Joe Sixpack, and by extension the wider economy, which is heavily dependent on personal consumption expenditures. The implosion of the financial industry has, of course, exacerbated the trend, as has the collapse of the real estate bubble. In short, a perfect storm, the effects of which are only now being fully realized.

America has long been a nation of consumers, and there's much to cheer about on that front. Consumption generates economic growth and spending has been no small part over the generations in powering the American dream of building wealth and prosperity. But there's a limit to everything, and at some point even a good thing becomes excessive. At some point in the recent past that limit was breached.

Excess certainly looks like an appropriate label for consumer borrowing in 2002-2007, when the household balance sheet became laden with debt to an extent that was as shocking as it was fated for a day of reckoning. The details are there for anyone willing to take the time and pore over the Federal Reserve's Flow of Funds Report.

The reaction to the mountain of debt is now underway. As our chart below shows, consumers are finally facing facts and cutting spending. If a purchase can be delayed, it will be; if spending can be minimized, it is. No wonder, then, that durable goods spending—the so-called realm of "big ticket" items like washing machines and refrigerators—is falling rapidly. If you don't need it, you don't buy it—the new mantra of for a new generation of consumers who've been dragged kicking and screaming to this revelation of unvarnished necessity. Only services spending has been spared, which is largely a function of essential services like medical purchases in this category.

The bottom line: consumers are aggressively repairing their balance sheets after a long stretch of doing the exact opposite. The front line in the restoration is cutting spending, anywhere and everywhere. This process has only just begun. Given the magnitude of the former excess levels of spending and debt creation, the mending of household balance sheets will run on for some time, probably for far longer than is widely expected. The repercussions will be far and wide. It's not the end of the world, but it is the start of a new era that will reorder the consumer mindset.

Exactly how long this pullback rolls on is the question. For now, it's clear that the unwinding is upon us, and the worst of it is going to roll on for several quarters, perhaps several years. It's a process that's long overdue, fundamentally necessary and destined to be painful. Coming to terms with reality is never easy, but it is refreshing and healthy…eventually.

This post can also be viewed on capitalspectator.com.

Buying Stocks For The "Long run" Isn't Always Smart

A lot of investors have the same potentially misguided advice ingrained into their heads — stocks over the long run always go up. While that indeed might be the case, how long will you have to wait to see those returns? It may be a good strategy for young people just getting started in life, but it certainly is not the right strategy for everyone. For more on this read Tim Iacono's blog post below:

I don't know. I suppose that if most of what I did over the last few decades revolved around compelling individual investors to buy stocks for the long run, come what may, it might be difficult to look at things objectively.

Denial is a powerful force in the world and perhaps one of the most under-appreciated.

These days, a lot of people are having a very hard time with the whole idea that individual ownership of stocks (and now real estate) is not the panacea that they once thought.

That doesn't, however, stop them from encouraging individuals to just "tough it out", likely knowing that, eventually, their advice will pay off - whether or not that advice will pay off in time to fund the retirement of a generation of baby boomers is another question entirely.

Word comes this morning from the Wall Street Journal's always-interesting Jason Zweig that it might be some time before things are hunky-dory again.

In this story coming in advance of tomorrow's update of long-term investment returns by finance professor Elroy Dimson of London Business School, the news is decidedly unfriendly for your typical aspiring retiree with money in the stock market.

The good professor estimated that we'll have to wait nine more years before stocks have even half a chance of hitting their highs of 2007. That is, back when millions of baby boomers started eyeing their retirement account balances again as the housing bubble was meeting its pin.

Those aren't very good odds at all - a 50 percent chance in nine years? 2018?

Who knows what the condition of the U.S. or global economy will be by then?

If you're still sticking with the program of "stocks for the long run", maybe this report at Money Magazine will cheer you up. In one of the daffiest assessments of equity markets that have crossed my computer screen in quite some time, Paul J. Lim, a senior editor at Money Magazine explains how the lost decade that just occurred, really wasn't such a loss.

Yes, it's true that the Dow Jones industrial average sits more than 1,000 points below where it was 10 years ago. But that's irrelevant to your investing strategy for three reasons. First, it's an arbitrary amount of time. We're hung up on it because 10, as University of California-Berkeley finance professor Terrance Odean notes, "is a nice round number we can all relate to."

Second, the market's performance over the past decade is a red herring because the period you're judging starts near the absolute pinnacle of irrational exuberance, when stock valuations - as measured by price/earnings ratios - were absurdly high. If you measure from the end of the last bear market, in October 2002 - when stock prices were still higher than average, by the way - you'll see that the Dow has returned 4.5% a year (including dividends) while the Standard & Poor's 500 index has gained 3.4% annually.

Third, as T. Rowe Price financial planner Stuart Ritter notes, "The only people the lost decade accurately applies to are those who invested absolutely nothing before the late 1990s, put all of their money in at the market peak and invested absolutely nothing ever since." If such an unlucky soul does exist, history suggests that he'll be rewarded.

And, the moral of the story is, of course, stick with the plan - stocks for the long run.

Eventually they'll all be right again... time uncertain...

I'll never forget that info-session back in 2001 when I was first coming of age with this whole stock market/retirement planning trip when the Fidelity rep hemmed and hawed when he was asked why we should continue to invest in stocks after an eighteen year run had just come convincingly to an end the year prior.

I asked, "Don't these markets move in long 'secular' cycles of 15 or 20 years? If so, doesn't that mean that we're due for a 'secular' bear market?"

He didn't really know what to say - he was just a twenty-something trying to stick to the script before a crowd of thirty- and forty-somethings who were starting to think seriously about their retirement planning.

Some, more than others, obviously.

Jason Zweig is a fabulous writer and Money Magazine is great for evaluating whether or not you should upgrade your kitchen, but I stopped listening to their investment advice years ago.

That was a good decision.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Produce The Note: A New Way To Fight Foreclosure

Thanks to a recent TV spot on Good Morning America (along with other press exposure) banks are going to be hearing these words a lot, "Produce the note." A new movement is under way that is causing banks a lot of pain and grief. Essentially how it works is that a homeowner in foreclosure will submit paperwork requesting that the bank produce a copy of the original note. Sounds easy enough, but with the number of times these notes have been bought, sold and transferred, the paper trail can be hard to follow. Desperate homeowners are finding that if nothing else this tactic is buying them a little more time in their home. Tim Iacono looks at this new tactic in his blog post below:

The little guy fights back by making a simple request - prove that the borrower owes the money to the bank before foreclosing.

It really is hard to have much sympathy for the borrower, at least in this case - the lady borrowed $140,000 against a house for which she paid just $39,000.

It does, however, add great irony to the situation.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Currency Market Update: Look To The Australian Dollar

Yesterday's market rally got a lot of investors excited, but the rally was short lived. Currency expert Kathy Lien points out 3 reasons why investors should have been suspicious of the rally in her blog post below. In addition Lien offers some insight into the future of currencies, and suggests that the Australian Dollar might be a great investment opportunity right now.

The currency and equity markets are turning lower after a strong rally on Tuesday. In my Daily Currency Focus, I talked about the 3 reasons why the currency market rally was suspicious. None of the reasons for Tuesday’s jump delivered real solutions. The market only rallied because Bernanke delivered no surprises. President Obama’s attempt at reassuring Americans also failed to comfort investors.

Instead we are faced with a weakening economy that is only confirmed by this morning’s plunge in existing home sales. Sales of existing homes plunged 5.3 percent to a 12 year low in the month of January. The housing market remains the Achilles heel of the US economy as prices fall and demand wanes. The median price of a home sold dropped 14.8 percent compared to the year prior. Such disappointing numbers are not much of a surprise given the big decline in housing starts and building permits. With banks and mortgage lenders reluctant to lend, even potential homeowners with sufficient capital have found difficulty attaining loans.

The British pound has been hit the most because Bank of England member Barker said that the weak sterling is helpful. UK officials have taken every opportunity to talk down the currency.

USD/JPY on the other hand remains an animal. Despite weak economic data and a turn in equities, the currency pair continues to rise.

My favorite is still the Australian dollar because of strong M&A flow, higher gold prices and the prospect of the country remaining recession free. The AUD/USD is also prime for a breakout.

This post can also be viewed on kathylien.com.

Why We Should Break Up The Big Banks

Last week there was a lot of speculation that the US government would privatize mega banks, Citigroup and Bank of America, but now it appears that they are going to be happy with large stakes in the banks. The government believes that nationalizing the banks would ultimately cause more harm than good, and would like to avoid that path. Simon Johnson has a different view, though, he believes that the best course of action is to nationalize the big banks causing us so much grief, and then sell them off again in smaller pieces. This would ultimately remove much of the political power these monsterous institutions have over the government and our economy as a whole. Mark Thoma from the Economist's View looks at Johnson's article and adds some thoughts of his own in his blog post below:

Simon Johnson:

Privatize The Banks Already, by Simon Johnson: ...In some important and not good ways, we have already nationalized the financial system.

There’s the direct ownership that the government received through TARP and the reupping with Citi, BoA and some others. These stakes are obviously not (yet) voting stock, but the taxpayer certainly has capital at considerable risk.

Then we have the lines of credit provided by the Federal Reserve which, without a doubt, were instrumental to the survival of almost all major banks during the fall - and arguably remain critical today. The taxpayer has further downside risk here.

And, most importantly perhaps, we have the expansion of the Fed’s balance... In effect, the Fed is becoming a commercial bank as well as a central bank.

The government is essentially taking over the role of intermediation - take funds in and lend them out - for the US economy. This is a form of nationalization, and it will lead to all the lobbying and politically directed credits we have seen in other nationalized financial systems; taking away this credit once the economy starts to recover will not be easy. We have state control of finance without, well, much control over banks or anything else - we can limit executive compensation (maybe) but we don’t get to appoint directors (or replace entire boards) and we have no say in who really runs anything. Responsibility without power sounds accurate. ...

How then do we really privatize? By exercising leadership: take over insolvent banks and immediately reprivatize them. ... The taxpayer retains a significant number of shares (or the option to buy common stock) as a way to ensure upside participation...

Above all, we need to encourage or, most likely, force the large insolvent banks to break up. Their political power needs to be broken, and the only way to do that is to pull apart their economic empires. It doesn’t have to be done immediately, but it needs to be a clearly stated goal and metric for the entire reprivatization process.

No argument here. If there are good reasons to have banks so large their failure could bring down the entire system, a situation that gives them quite a bit of political leverage, I haven't heard them. There are questions about whether having many small banks as opposed to a few big banks reduces systemic risk, and if not, whether having lots of small banks makes policy intervention to stabilize and clean up the system more difficult when problems do arise - having just a few banks might be easier. But breaking up the banks does reduce political and economic power and I see no reason not to make this "a clearly stated goal and metric for the entire reprivatization process."

This post can also be viewed on economistsview.typepad.com.

Secret TARP Bailout Details To Be Released By Court Order

It appears that we finally (hopefully) will be able to see where our tax dollars are going, thanks to a recent court ruling. This court order will force the Treasury to release some of the information that they have been concealing from the American public in regards to the massive bailout of the country's financial system. Anthony Freed provides us with more information on this development in his blog post below:

Advocates of an open Government and transparent allocation of taxpayer funds celebrated the news late Friday afternoon (2-20-09) that the U.S. District court has moved to enforce a Freedom of Information Act (FOIA) request to release more details about exactly how TARP bailout funds have been and are being used.

The TARP was passed in early October, 2008, in an effort to stem the damage to the nation’s financial industry incurred during a decade of lax risk-abatement that pervaded the banking culture after the legislative emasculation of the Glass-Steagall Act.

FOX Business sued Treasury on Dec. 18 over failure to provide information on the bailout funds or respond to FBN’s expedited requests filed under the FOIA. The initial request, filed on Nov. 25, sought actual data on the use of the bailout funds for American International Group (AIG) and the Bank of New York Mellon (BK), and an additional request, filed on Dec. 1, sought similar data on the bailout funds for Citigroup (C).

FBN asked the Treasury Department to identify, among other issues, the troubled assets purchased, any collateral extended, and any restrictions placed on these financial institutions for their participation in this program.

The Treasury Department - along with the other banking regulators like the FDIC, OTS, and the Federal Reserve - are notoriously secretive concerning the data they collect and their subsequent analysis of the viability of any particular institution, preferring to operate instead behind closed doors.

This tendency often leaves investors in the dark, which generally tends to work in the banks’ favor. Regulators would argue that they are not in the business of moving markets, and that some data may be misinterpreted and inadvertently cause a run on funds at named institutions, evidenced by Schumer’s now infamous disclosure of details that may have led to the collapse of Indy Mac Bank in 2008.

That argument may have held some water until the TARP bailout effectively made the U.S. taxpayer a shareholder in any number of as yet identified institutions, and the owner of any assortment of exotic financial instruments which have proved toxic to Global capital markets.

Judge Richard J. Holwell of the U.S. District Court for the Southern District of New York said in a decision Friday that the government is directed to comply with FOX Business’s request under the FOIA “within 30 days and to produce a Vaughn index with 45 days.” That means Treasury must comply with FOX Business’s request by Monday, March 23, and must produce a Vaughn index by Monday, April 6.

The Treasury will have the chance to withhold some documents and information they deem too sensitive, but now have to provide an itemized “Vaughn index” of which documents and information have been redacted, and for exactly what reason.

“A Vaughn Index must: (1) identify each document withheld; (2) state the statutory exemption claimed; and (3) explain how disclosure would damage the interests protected by the claimed exemption.”

This may open the door to further FOIA challenges to release the remaining information if the Treasury fails to convince the courts that their vetting of information was reasonable.

I don’t think Treasury has realized that they are not the only ones who have new powers and responsibilities in the implementation of this historic bailout - the courts have yet to weigh-in on much of this, including who is ultimately going to be held responsible for the mess that is the economy, even if it is still taxpayers who have to foot the bill to clean it all up.

My guess is that the courts feel very differently about full disclosure than does the insider Wall Street elite who regulate themselves from Washington D.C. in seeming perpetuity.

Frank Rich of the New York Times wrote a good op-ed piece called What We Don’t Know Will Hurt Us, which helps further the argument that it is time to get to bottom of exactly what is going on with our economy, and why their seems to be so little consequence for the perpetrators of so much devastation.

Americans are right to wonder why there has been scant punishment for the management and boards of bailed-out banks that recklessly sliced and diced all this debt into worthless gambling chips. They are also right to wonder why there is still little transparency in how TARP funds have been spent by these teetering institutions. If a CNBC commentator can stir up a populist dust storm by ranting that Obama’s new mortgage program (priced at $75 billion to $275 billion) is “promoting bad behavior,” imagine the tornado that would greet an even bigger bank bailout on top of the $700 billion already down the TARP drain.

Remember, the fundamental point of the TARP bailout is to funnel incredible amounts of taxpayer money - debt, actually - to the very institutions and people who are responsible for driving the markets off the cliff in the first place.

And they got paid handsomely for doing it.

It is time for our nation’s financial machine to drop the self-righteous arrogance they have cloaked themselves in for too long, for all of those paper-pushing money lords to release their false sense of entitlement, relinquish their ill-gotten wealth from the last 10 years, and to return to their proper place in the economic landscape as facilitators of capital creation, not the creators of capital.

Accountability in the largest disbursement of public funds in history is not only a good idea, it is essential to our democracy, as is ending the revolving door between corporate boardrooms and the regulatory offices of our government.

The Fox Business FOIA request and the court’s decision to release more information should serve as a warning to the Wall Street good ol’ boys that their orgy of omnipotence is truly over, and that the era of accountability is in.

This post can also be viewed on yourmortgageoryourlife.wordpress.com.

Nationalizing Banks Will Harm The US Dollar

The buzz in the financial industry right now is whether or not the government is preparing to nationalize Citigroup and Bank of America, the two largest US banks. The government denied that they are even considering this measure, however, we wouldn't expect them to say anything else. The amount of liabilities that these banks have is staggering, and as Kathy Lien explains in her blog post below, a nationalization of these banks will have a dramatic impact on the US dollar.

I want to share my piece on How Nationalization of Citigroup and Bank of America could impact the US dollar if you haven’t caught it already (so I’m am posting his before I head to the NY Traders Expo).

The rally in gold prices tells us one thing and one thing only, which is that the fear has returned to the market. There is currently a lot of speculation that Citigroup and Bank of America could be nationalized by the US government. Although this would drive equities lower, it could also trigger capital flight out of the US dollar.

When Northern Rock was nationalized by the UK government in February of 2008, the British pound fell from 1.9638 to a low of 1.9363 over the course of 3 trading days. Although the dollar initially rallied on the news that the US government was taking over Fannie Mae and Freddie Mac in September 2008, it quickly gave back those gains to end the week lower against the Japanese Yen.

Nationalization will ultimately be negative for the US dollar because it increases the debt and liabilities of the US Federal Reserve and hence taxpayers. Nationalization is by no means a foregone conclusion especially since it is not a part of the US Treasury’s Financial Stability Plan. Senate Banking Committee Chairman Christopher Dodd floated the idea of short term nationalization around but it will probably be the last option for the US government if the Financial Stability Plan fails to work quickly. In fact, the rebound in US equities was triggered by speculation that the Treasury could release more details regarding their plan to rescue the financial system next week. Also keep an eye on Bernanke’s Humphrey Hawkins Testimony on the US economy and Monetary Policy.

This post can also be viewed on kathylien.com.

Should We Create Government Sponsored Shadow Banks?

According to Paul McCulley from Pimco, to revive the economy the government simply needs to create government sponsored shadow banks. Naturally this idea is a little controversial, especially considering the recent demise of this type of system. Tim Iacono from The Mess That Greenspan Made looks at an article written by McCulley in his blog post below:

Paul McCulley of Pimco thinks the new kind of shadow banking system is just swell:

The United States government now has both the tools and the will to save the private banking system, and more importantly, the real economy, from its own debt-deflationary pathologies. Not that it will be easy. But it can be done, notwithstanding the catcalls that greeted Secretary Geithner last week.

And the essential game plan is clear: use the power of the Fed, the FDIC and the Treasury to create government-sponsored shadow banks, such as the Term Asset-Backed Securities Lending Facility (the TALF) and the Public-Private Investment Fund (the P-PIF).

The formula? Take a small dollop of the Treasury’s free-to-spend taxpayer money (there is still $350 billion left) to serve as the equity in a government sponsored shadow bank, and then lever the daylights out of it with loans from the Federal Reserve, funded with the printing press.
...
Yes, there will be subsidies involved, sometimes huge ones. And yes, the process will seem arbitrary and capricious at times, reeking of inequities. Such is the nature of government rescue schemes for broken banking systems, while maintaining them as privately owned.

You might not like it. I don’t like it, because regulators should never have let bankers, both conventional bankers and shadow bankers, run amok. But they did.

So it’s now time to hold the nose and do what must be done, however stinky it smells, not because it’s pleasant but because it is necessary.

Pragmatism takes on a whole new meaning at Pimco.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Gold Prices And US Dollar Both Rising

Those who keep up with gold and currency prices have probably noticed that things are a little strange right now. Typically the gold prices work inversely, however, right now they are rising almost instep. Currency expert Kathy Lien explains more about this phenomenon, and offers some insight into what is likely causing it in her blog post below:

If you haven’t caught it already, in my Daily Currency Focus on FX360, I talked about What the Rally in the US Dollar and Gold is Telling Us. As both the Dollar Index and Gold Prices press higher, it important to know what this means:

It is not very often that we see the US dollar and gold prices move in the same direction. Since gold is priced in dollars, the value of the yellow metal tends to fall when the dollar rises and rise when the dollar falls. However this has not been the case since January 14th as the rally in the US dollar corresponds with the rise in gold prices, which closed today at a 7 month high of $970 an ounce.

The last time we saw this traditionally negative correlation turn into a positive one was in 1982. At that time, recession hit many countries including the US. Although the rise in gold prices can be partially attributed to future inflation problems, the cohesive movement in the value of gold and the US dollar suggests that central banks around the world are losing credibility. There are growing concerns that a time bomb could explode in Europe leading to more troubles for the region as a whole. If that is the case, there may not be any safer form of investment than gold.

The rally in the US dollar and gold is telling the market that investors are worried about global economic stability outside of the US and therefore they are preparing for the worst.

This post can also be viewed on kathylien.com.

Energy Prices, And The Fight Against Deflation

All the talk about deflation has falling off considerably, and a lot of that has to do with energy prices. Will energy prices continue to go up? How will they continue to impact consumer prices? Do we still need to worry about deflation? James Picerno from the Capital Spectator attempts to answer these questions and more in his blog post below:

Producer prices rose last month. That's good news in the war on deflation.

The news wasn't totally unexpected, as we discussed on Tuesday. The partial rebound in energy last month—heating oil and gasoline—is a key reason for the return of inflation to wholesale prices in January. The same forces suggest that tomorrow's update on consumer prices will also post a mild gain for last month.

Producer prices rose 0.8% in January on a seasonally adjusted basis, the Labor Department reported this morning. That's the biggest gain since July—in fact, it's the only gain since July. From August to December, wholesale prices fell in each and every month. That makes today's news of higher prices welcome since it suggests that price stability may be near. It's too soon to be sure, but for today, at least, there's fresh reason for hope.

The source of the last month's rise was the 3.7% pop in the energy component of the producer price index (PPI). It's not clear that energy prices won't resume their decline. Crude oil, as we write, is trading at around $35 a barrel in New York, well below its January average of roughly $40. Heating oil, natural gas and gasoline are also losing ground so far this month.

To the extent that the January's rebound in prices depends on energy, there's probably further deflationary worries ahead. In fact, you can just about count on it. Heating oil and natural gas prices no longer have seasonal support of winter and so as the warmer weather approaches, lower prices are likely. Meanwhile, the economic weakness that's still pulsing through the American economy is likely to bring another leg down in the demand for crude oil and gasoline.

Nonetheless, the heavy losses in energy are likely behind us. That doesn't mean that prices won't go lower. But expecting another 50% in crude oil, for instance, requires an exceptionally bearish outlook that looks excessive from your editor's vantage at the moment.

Maybe, just maybe, there's a bottom lurking in energy prices in the near future. That's the view of the energy team at Bernstein Research in London. In a research note sent to clients today, Bernstein opines with contrarian flair: "The outlook for the energy space now seeming as grim as it can be in 2009 and increasingly in 2010, we believe there is limited downside to the beta energy names and therefore it is the right time to make a relative valuation call for the North American energy stocks." Bernstein recommends that investment portfolios should be "increasingly overweight energy as the year progresses…"

We're not particularly fond of dramatic changes to portfolios based on industry trends and so we remain agnostic on such recommendations. Rather, we're intrigued by the fact that some energy strategists are starting to think that the great decline in energy prices, if not over, may be close to ending.

Although Bernstein's not predicting a new bull market in oil, the shop observes that spare production capacity is still "relatively tight." Meanwhile, Bernstein estimates that oil and gas are close to their "cash cost." The firm advises that "over time [oil and gas] prices cycle around the marginal cost of supply dependent on near term supply/demand dynamics." If we're at or near cash cost, that implies that a bottom is, if not imminent, close, as suggested by the chart below, which comes via today's Bernstein report.

Even if energy prices begin treading water, that would go a long way in helping keep deflation at bay. Meanwhile, the aggressively loose monetary policy is only starting to seep into the economy. As the year goes on, the substantial reflation efforts engineered by the Fed should start to show results. The big question is whether the broad economic environment continues to deteriorate and overwhelm the reflationary trend.

Yes, 2009 is the great year of transition, with negative and positive forces battling one another in an epic struggle to claim the future. Today's price report is but a small skirmish in a larger war. Then again, victory in war comes one battle at a time. Score one for the anti-deflation army. Just don't celebrate for too long. There's still plenty of fighting ahead.

This post can also be viewed on capitalspectator.com.

Defaults By Developing Countries Could Be Next Economic Timebomb

Just in case we needed one more thing to worry about, economic struggles in developing countries could cause them to default on their loans. This would have an effect on most developed countries, including the US. According to research compiled by Kathy Lien, though, the most vulnerable countries look to be in Western Europe. These countries lent a ton of money to developing countries, especially in Eastern Europe where unfortunately they are experience some very serious economic problems. Kathy Lien exposes more about this in her blog post below:

A time bomb is waiting to explode in the Eurozone with Western European banks at risk of defaults on Eastern European loans. This leads me to wonder how much the US and the UK are exposed to developing countries. So I compiled the following charts from the latest Bank of International Settlements data (as of September 2008).

Euro area loans to developing nations are heavily skewed towards Eastern Europe while UK lends predominately to Asia, Africa and the Middle East. The US on the other hand lends primarily to Asia and Latin America.

Default risk in Asian nations are lower than Eastern European nations, which makes the UK and US less vulnerable if a time bomb explodes in Eastern Europe.

Meanwhile USD/JPY hit a 6 week high this morning after President Obama announced a foreclosure program.

Follow the jump for Eurozone and Switzerland charts

This post can also be viewed on kathylien.com.

We Should Be Looking Out For American Jobs, Not Just American Companies

The protectionist movement has been growing in America, and with every new layoff announcement it only gets stronger. Only adding fuel to the fire is the billions upon billions of taxpayer money that the government is handing out to American companies. Naturally there would have been mass outrage if the U.S. government gave this money to foreign corporations. However, as Robert Reich explains in a recent article the country just might be better off if some of these foreign corporations received funds instead of some of the American companies. After all what good is it to unemployed American workers if these American companies take the bailout money and use it to expand operations in some foreign country? Reich's point is that we should be focusing on what will create the most American jobs, rather than just focusing on supporting American companies. Mark Thoma presents the article by Reich in his blog post below:

Robert Reich:

The Perils of Confusing American Companies With American Jobs, by Robert Reich: Do not confuse American companies with American jobs. The new stimulus bill, for example, requires that the money be used for production in the United States. Foreign governments, along with large U.S. multinationals concerned about possible foreign retaliation, charge this favors American-based companies. That's not quite true. Foreign companies are eligible to receive stimulus money for things they make here... For example, Alstom, the French engineering company, is eligible to receive stimulus funds for the power turbines it produces in Tennessee... On the other hand, U.S. Steel may not be eligible for stimulus money for the steel slabs it casts in Ontario, Canada.

I'm not defending the "buy American" provisions... I'm just saying they're not the same as "buy from American companies." And although these provisions skate close to protectionism and risk foreign retaliation, at least a case can be made that if American taxpayers are footing the bill..., the jobs should be created, well, here in America.

The same confusion haunts the debate over the auto bailout. Advocates of bailing out GM and Chrysler, and most likely Ford, say America can’t afford to lose "its" auto industry. But ... foreign-owned automakers, already producing cars here in the United States, employ – directly or indirectly – hundreds of thousands of Americans. ...

Meanwhile, the Big Three themselves are global. A Pontiac G8 shipped by GM from Australia has less American content than a BMW X5 assembled in the United States. ...

I’m not arguing against an auto bailout. But it ought to be focused on helping American auto workers rather than helping global auto companies headquartered in America. Why pay the Big Three billions of taxpayer dollars ... when, even after being bailed out, they cut tens of thousands of American jobs, slash wages, and shrink their American operations...?

That’s backwards. The auto bailout should help American autoworkers keep their jobs or get new ones that pay almost as well.

Whether it’s stimulus or bailout, policy makers must remember that American companies aren’t the same as American workers – and our first responsibility is to the latter.

"I'm not defending the 'buy American' provisions..." Neither am I.

This post can also be viewed on economistsview.typepad.com.

Don't Worry, The Economy Is Having This Effect On A Lot Of People

In a very embarrassing display, the Finance Minister of Japan attended a press conference clearly under the influence of alcohol. He was later forced to resign of course, but can we really blame him for needing a little drink? Kathy Lien talks more about this recent development in her blog post below. In case you want to witness the event, you can also see a YouTube video of the press conference at the bottom of the post.

For Japan and Prime Minister Aso, it was a big embarrassment today that the Finance Minister Nakagawa resigned after acting drunk at the G-7 news conference.

He slurred his speech, was sleepy eyed, very disoriented and at one point, mistakenly responded to a question on interest rates that was intended for the governor of the Bank of Japan, who was seated to his left.

He will be replaced by Economy Minister Yosano.

Here is a video of Nakagawa’s performance. It is in Japanese, but just watch his facial expressions. Nakagawa is on the left, BoJ Governor Shirakawa is on the right.

This post can also be viewed on kathylien.com.

American's Worth Less Than In 2001, And It Is Getting Worse

According to a recent Federal Reserve report American's are actually worth less today than they were in 2001. Well known economist Paul Krugman blames the American tendency to spend instead of save for limiting our net worth growth, which should be of little surprise. Now it appears that this trend is ready to reverse, which will only exacerbate the economic problems the country is facing. Krugman also makes an interesting comparison to the Great Depression, and how we eventually were able to escape it. At the end of the day, though, he doesn't see the outlook for the economy as very good at all. Economics professor Mark Thoma looks at Krugman's article in his blog post below.

Do we have what it takes "to boot the economy out of a debt trap"?:

Decade at Bernie’s, by Paul Krugman, Commentary, NY Times: By now everyone knows the sad tale of Bernard Madoff’s duped investors. They looked at their statements and thought they were rich. But then, one day, they discovered to their horror that their supposed wealth was a figment of someone else’s imagination.

Unfortunately, that’s a pretty good metaphor for what happened to America as a whole in the first decade of the 21st century.

Last week the Federal Reserve released the ... latest ... report on the assets and liabilities of American households. The bottom line is that there has been basically no wealth creation ... since the turn of the millennium: the net worth of the average American household, adjusted for inflation, is lower now than it was in 2001.

At one level this should come as no surprise. For most of the last decade America was a nation of borrowers and spenders, not savers. ... Why should we have expected our net worth to go up?

Yet until very recently Americans believed they were getting richer, because they received statements saying that their houses and stock portfolios were appreciating in value faster than their debts were increasing. ... Then reality struck... The surge in asset values had been an illusion — but the surge in debt had been all too real.

So now we’re in trouble — deeper trouble, I think, than most people realize... For this is a broad-based mess. Everyone talks about the problems of the banks... But the banks aren’t the only players with too much debt and too few assets; the same description applies to the private sector as a whole.

And as the great American economist Irving Fisher pointed out in the 1930s, the things people ... do when they realize they have too much debt tend to be self-defeating when everyone tries to do them at the same time. Attempts to sell assets and pay off debt deepen the plunge in asset prices, further reducing net worth. Attempts to save more translate into a collapse of consumer demand, deepening the economic slump.

Are policy makers ready to do what it takes to break this vicious circle? In principle, yes. ... In practice, however, the policies ... don’t look adequate to the challenge. The fiscal stimulus plan, while it will certainly help, probably won’t do more than mitigate the economic side effects of debt deflation. And the much-awaited announcement of the bank rescue plan left everyone confused rather than reassured.

There’s hope that the bank rescue will eventually turn into something stronger. ... But even if we eventually do what’s needed on the bank front, that will solve only part of the problem.

If you want to see what it really takes to boot the economy out of a debt trap, look at the large public works program, otherwise known as World War II, that ended the Great Depression. The war didn’t just lead to full employment. It also led to rapidly rising incomes and substantial inflation, all with virtually no borrowing by the private sector. By 1945 the government’s debt had soared, but the ratio of private-sector debt to G.D.P. was only half what it had been in 1940. And this low level of private debt helped set the stage for the great postwar boom.

Since nothing like that is on the table, or seems likely to get on the table any time soon, it will take years for families and firms to work off the debt they ran up so blithely. The odds are that the legacy of our time of illusion — our decade at Bernie’s — will be a long, painful slump.

[Note: James Kwak has balance sheet calculations based upon the Federal Reserve report showing the severe deterioration in household balance sheets.]

This post can also be viewed on economistsview.typepad.com.

An Idea To Break The California Budget Stalemate

The situation in California is bordering on ridiculous. Something has to be done to close the $41 billion budget deficit, but thanks to the inability of Republicans and Democrats to agree on a solution, nothing is happening. This stalemate has been going on for sometime now, and even after a 3o hour meeting this weekend they still can't agree on anything. The state is getting close to disaster and the parties need to figure out how to make this work. Tim Iacono looks at the situation more in depth in his blog post below, and even proposes a solution that might help light a fire under the legislators.

Could there be a better image than the one below from this LA Times story to symbolize the state of the California State legislature?

Apparently, they were up all night trying to get a new budget bill passed in order to close the gaping $41 billion deficit, but they were not able to produce the desired result.

The proposed plan is about an even mix of spending cuts and tax hikes, but the Republican minority doesn't seem to like the tax hikes much and, since budget bills require a two-thirds majority (which the Democrats don't have), nothing gets done until a few Republicans get on board.

In a situation that is not all that different from the U.S. Senate where a couple Republican votes are required to remove the filibuster threat, it is those few lawmakers from across the aisle that become all powerful.

What a way to run a government...

In California last night, Democrats came up one vote short of getting the three Republican votes needed to get the job done so they are set to resume talks at 11 AM today.

The deal appeared done at the weekend's start. Democrats already had sprinkled the budget with concessions to recalcitrant legislators, including more money for Orange County to please Sen. Louis Correa (D-Santa Ana), who had promised during his campaign not to raise taxes.

And two Senate Republicans were expected to vote for the package -- Dave Cogdill of Modesto, who played a role in negotiating the deal, and Roy Ashburn, a Bakersfield Republican in his final term. Among the concessions Ashburn won was a proposed $10,000 tax break for new home buyers.

Another key GOP senator, Dave Cox of Fair Oaks, was counted on by his own party's leaders to join the majority Democrats to win the two-thirds vote needed for passage. But Cox balked at the big tax bite.
...
In a bid to build pressure on balky Republicans, Schwarzenegger was ready to launch the notification process that could lead to the termination of 10,000 state workers in coming months, according to budget negotiators.

"That is a very real possibility," said Aaron McLear, the governor's spokesman.

The termination notices were intended to be sent Friday, but the governor delayed them because a budget vote appeared imminent.

They really ought to just stop paying elected officials on the first day after a new budget is due and it hasn't been passed.

A hit to the pocketbook can work wonders.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

$15,000 Homebuyer Tax Credit Trimmed In Negotiations

The Senate’s version of the economic stimulus package included a $15,000 homebuyer tax credit that would have been made available to all homebuyers. As I expressed in a blog post earlier this week, I didn’t think that it was such a good idea, and definitely not at the cost of almost $40 billion in taxpayer money. Thankfully, this credit was cut in House and Senate negotiations. The final version of the bill includes an $8,000 tax credit, which will be available to only first time homebuyers. A previous version of this tax credit was for $7,500, and was required to be paid back. This new tax credit will not need to be paid back as long as the homebuyer lives in the home for at least 3 years. The cost for this version should only cost taxpayers around $6.6 billion according to CNNMoney.

I’m not one to support any amount of artificial support for the real estate market, because I see it as unsustainable. However, if anyone is going to get a tax credit to buy a home, it should be first time homebuyers. These are the people that are entering a real estate market where prices are too high to begin with, and they need all the help they can get. I would have preferred a minimum ownership timeframe longer than 3 years, though. Anyone who was able to sell their home during the bubble should qualify. Turn that 3 years into 6 or 7, and that should do the trick.

Will this $8,000 tax credit be enough to turn the real estate market around? I doubt it, but at least taxpayers are only going to lose $6.6 billion instead of almost $40 billion, and the people getting the money will be more deserving. It is a small victory, but better than nothing I suppose.

What The Central Bankers Are Saying...

Central bankers wield a lot of power in today's economies. Their mistakes can make a profound impact on the economy of their country, and even other countries. When these powerful figureheads talk the economic world listens. The slightest slip of the tongue can crash markets or send them shooting through the roof. James Picerno from The Capital Spectator takes a look at some recent quotes from Central bankers from across the world in his blog post below.

Central bankers aren't gods, even if a few of them sometimes think otherwise. For proof of their mortal status one need only survey the various errors linked to this group in the 21st century. Yes, many central bankers made good, even superb decisions. But there were also some rather large lapses in judgment in matters of monetary policy and related matters in recent years. Arguably the ill-advised decisions overwhelmed the brilliant ones. A number of central bankers tell us so.

Of course, the private sector made more than a few errors too. In sum, the blame for the current troubles stretches far and wide. But when it comes to concentrated power, and the capacity for generating pain or pleasure, central bankers are second to none. They're an influential lot—influential on a grand scale. For that reason alone, listening to what they say is productive, or shocking—especially when they're deconstructing what went wrong in the run-up to the crisis now pummeling the global economy.

With that in mind, here are a few choice quotes (courtesy of The Bank for International Settlements) from recent speeches by members of world's most elite and potent financial club. We don't necessarily agree with all that follows, but we're listening closely.

Mario Draghi, governor, Bank of Italy, 16 December 2008
One striking aspect of the crisis is precisely how its unfolding has continued to catch both policy makers and private sector players by surprise. It started with defaults in a marginal segment of the financial services industry, then quickly spread to virtually all assets. From being a US-only event, it has become global, and in fact it is forcing and accelerating the redressing of world macro imbalances that have been with us for 15 years. The current recession is the result.

Amando M Tetangco, Jr., governor, Central Bank of the Philippines, 2 February 2009
The roots of the US financial crisis can be traced back to the early years of this decade when the United States aggressively eased its monetary policy to facilitate recovery from the dotcom bubble and the September 11 terrorist attacks. If you will recall, the US Federal Reserve began a cycle of cuts in the Fed funds target rate from 6.5 percent in May 2000 to as low as one percent by June 2003. On the fiscal front, large public deficit spending beginning in 2001 was pursued to prop up the economy which was then on the brink of recession. The low interest rate regime fueled a boom in mortgages, including among borrowers with doubtful credit histories or those fancifully called NINJA loans – that is, loans to No Income, No Job or Assets loans. Thus, house prices in the US began rising in 2000, surpassing the growth of disposable income. The excessive lending itself would not have brought in such great financial distress because if the borrowers turned out to be poor borrowers, then foreclosures would just have followed. However, what made this risky behavior turn into a crisis event was the bundling of mortgages by various financial institutions into complex securities such as collateralized debt obligations (CDOs) which were largely unregulated.

Hervé Hannoun, acting general, manager, Bank for International Settlements, 7 February 2009
The global financial crisis and its macroeconomic fallout have dramatically changed the agenda of the central banks, fiscal authorities and supervisors and regulators. The change is illustrated by a remark surfacing repeatedly in the current economic debate: “We are all Keynesians now.” In some sense, indeed we are. But history teaches us that, in designing economic policies, policymakers always need to look beyond the short time horizon that crises seem to impose on us. In my view, current expansionary policy responses risk a failure to capture two crucial and interrelated facets of the present crisis. The first is that it is part of an underlying adjustment towards more sustainable macroeconomic conditions. The second is that it is a crisis of confidence which requires a recognition of the rational expectations of economic agents and of the behavioral effects associated with expansionary fiscal policies. To restore confidence in a sustainable way, policy actions should be credible from a medium-term perspective, address existing economic imbalances and pay attention to economic agents’ expectations.

José Manuel González-Páramo, member, executive board,
European Central Bank, 6 February 2009
The start of the financial crisis was triggered in the summer of 2007 by the realisation that the risks associated with the US market for sub-prime mortgages were not properly reflected in the price of related instruments, particularly mortgage-backed securities. A market-wide reassessment of financial risk led to sharp increases in premia and spreads across all segments of the credit market. The rapidly falling market values of credit instruments hit both the net worth and the profitability of the banking system.

Philipp Hildebrand, vice-chairman, governing board, Swiss National Bank, 5 February 2009
Financial markets react to incentives, and these incentives were misplaced in the past. It is in our power to start lobbying for clearly defined and risk-limiting conditions. If the responsible authorities wish to enact more stringent regulation, we ought to give them our unconditional support.

Christian Noyer, governor, Bank of France, 11 December 2008
In many respects, the current crisis is about valuation. To be sure, the factors underlying and accounting for the crisis are numerous. However, one of its significant features is that the uncertainty surrounding the “true” value of complex financial instruments has undermined the confidence of global markets, increased uncertainty about counterparty risk and led to contagion across asset classes, financial markets and economic regions. The crisis has highlighted the fact that the valuation of financial instruments is not only a question of accounting. It raises issues about risk measurement and management by financial institutions, prudential issues via the definition of capital requirements and, more widely, financial stability issues. However, valuation is also without any doubt an accounting issue. It is therefore hardly surprising that the debate about the application of accounting standards to financial instruments is a highly topical one.

Jürgen Stark, member, executive board, European Central Bank, 10 December 2008

For too many years financial market participants were used to a macroeconomic environment with high global output growth, low inflation and very low interest rates. Macroeconomic policies led to global and domestic imbalances which became increasingly unsustainable with debt financed over-consumption in one region and high savings in other regions. An overall benign macroeconomic environment led to (i) a general carelessness or a tendency to under-price risks and (ii) to a search for yield which in turn accelerated financial innovation.

Lorenzo Bini Smaghi, member, executive board, European Central Bank, 9 December 2008
When analysing the current financial crisis the temptation might arise to attribute all the responsibilities to the excesses of the US financial system. I think this would be a mistake. While excessive debt creation and risk mispricing are clearly the root cause of the crisis, we should not forget that in order to make a market you need buyers and sellers. And this crisis is as much a crisis of sellers as of buyers.

This post can also be viewed on capitalspectator.com.

Geithner's Misstep

Treasury Secretary Timothy Geithner's recent speech failed to inspire investors, and if anything spread more doubt. The market's expected a clear solution to be laid out, and that just did not happen. One thing was for certain, though, huge numbers were being thrown around by Geithner. As James Picerno details below in his blog post, Geithner is promissing to release more details about the rescue plan in the coming weeks. We'll have to wait and see if he actually delivers as promised this time?

It's big, it's bold, but it's also vague. And that's the problem.

Treasury Secretary Timothy Geithner yesterday explained the new new plan to solve the financial crisis that ails America. Alas, as articulated yesterday, the plan is short on solution details and long on general notions of what needs to be done.

The challenge is figuring out how the latest effort will work and, more importantly, deciding if it'll fare any better than its misguided predecessors. At the moment, that's a challenge with no immediate answer. As the David Byrne and Brian Eno audio montage intones, "America is waiting for a message of some sort or another."

Certainly the size of the announced plan is a bold stroke. How could $2 trillion be otherwise? We know that some of the money will go to buying up the so-called toxic securities that weigh heavily on the health of banks, and that's a step in the right direction, as the experience with the Resolution Trust Corp. suggests. Taking some of illiquid assets off banks' balance sheets should, in theory, help increase lending, which remains tight even at low interest rates. But the details matter, and it's not yet clear what the fine print will say.

“We need more details from Treasury on how exactly it plans to remove bad assets while protecting the taxpayer,” Senator John Kerry, a Democrat and a senior member of the Senate Finance Committee complains via The New York Times. “We have zombie banks that are weighed down because their liabilities exceed their assets. Without a precise mechanism for addressing toxic assets, it will be difficult to increase lending.”

Similar opining can be heard from economists, including a former IMF economist who now teaches at Harvard. “Tim Geithner did a great job in painting the broad strokes of the problem and laying out general principles, but it was a big disappointment not to have more details,” Ken Rogoff tells Bloomberg News.

Yes, Geithner promised to "flesh out the details" soon, presumably within the next few weeks, maybe in the next few days. Unfortunately, in the current climate, the only thing the secretary managed to do was to stoke more anxiety by introducing yet another strain of uncertainty into the marketplace. The last thing we need now is more indecision and ambiguity.

Sure, the government needs to act, but it needs to act intelligently. If yesterday's Geithner show is an indication, the latest round of talking points isn't quite ready for prime time. We feared as much when we learned over the weekend that the Treasury Secretary's scheduled speech to the Congress would be delayed 24 hours. As it turns out, Geithner should have delayed it a few more days, perhaps by a week or even more. As we learned yesterday, in the wake of a sharp selloff in the stock market, it's better these days to say nothing than to make broad comments that leave much to the imagination.

Meanwhile, the administration has been at fault by lifting expectations over the past week that it was going to announce a solution. The President has been talking up Geithner's big debut in Congress. But the optimist talking points, as much as they're welcome, were premature. No wonder, then, that the markets suffered an attitude adjustment as the reality set in that the big solution was really just another bout of talking without backing up the chatting with a concrete plan of action.

The good news is that the Geithner has only lost the first battle rather than the war. But time's running out, and so is patience. Certainly he'll have another chance to repair some if not all of the damage. But neither the Obama administration nor the economy can afford another halfway effort at explaining what happens next. The stakes now are higher than they were on Monday for bringing clarity and intelligence to the fore. Another stumble may result in even bigger financial pain, and not just in the price of equities.

"The uncertainty the government has created has made it nearly impossible to price many securities," says Douglas Dachille, chief executive of First Principles Capital Management, tells The Wall Street Journal.

At this point, no one's sure how the money will be deployed or what the rules are that will govern its usage. That's a problem. Yes, the White House is talking to Congress about just those details and a clearer plan will undoubtedly be hammered out, perhaps within a few days. Meanwhile, this is water torture, and the Obama administration probably recognizes the misstep in speaking out before a sufficient level of specifics was available for public consumption. Meanwhile, we're told that the plan was intentionally vague. Really? The White House reportedly says it wanted to be warm and fuzzy on the plan so as to give everyone an opportunity to put their two cents into the $2 trillion idea. So much for good intentions.

"First, we're going to require banking institutions to go through a carefully designed comprehensive stress test," Geithner advised yesterday. Apparently he's not kidding. But stressing out the financial industry with half-formed commentary isn't helping.

So far, however, the damage is still minimal, at least in terms of the term spread in government bonds, which is one measure of the credit crunch that's taking a toll. Nonetheless, the spread in the 10-year Note and 3-month T-bill is still over 250 basis points while the 10-year/2-year spread is just a hair under 200 basis points. By comparison, a year ago the 10-year/3-month spread was 130 basis points and the 10-year/2-year spread was 169 basis points. At the extreme low levels of interest rates generally in 2009, a wider spread would reflect running for cover into the arms of short-term government paper. That's a sign of distress in this climate if the spread is primarily a function of near-zero rates on the short end, which basically describes the current situation.

One test of the Obama administration's success on its bailout plan in the coming weeks and months will be to convince investors to move assets out of T-bills and into risky assets. An indication of that will be higher yields in T-bills, which are just hovering above zero. So far, no one's budging.

This post can also be viewed on capitalspectator.com.

Why The Government Can’t Fix The Housing Crisis

It appears the government is ready and willing to do whatever it takes to fix the housing crisis, but there is one little problem: They can’t. As part of the new stimulus package, there will likely be a $15,000 homebuyer tax credit, and not just for first-time homebuyers, but for all homebuyers purchasing a primary residence. In addition, the government will likely attempt to drive mortgage rates down to around 4.5 percent and work particularly hard to modify troubled loans to keep homeowners out of foreclosure. With these new measures in place the housing market will surely recover…right?

The answer to that question depends on your definition of recovery. Will it be enough to stop prices from falling, and possibly even help them start going up again? It’s definitely possible, but the problem won’t be fixed even if prices do turn around. Artificially inflated prices caused the housing crisis in the first place. Homeownership became an attractive option for more people than ever before through financing options that were cheap and widely available—a little too widely available, we are now discovering. ARMs, interest-only and other creative loan programs kept monthly payments low, and people could suddenly afford a more expensive house—or so it appeared. When interest rates started rising and ARMs reset, housing values stopped climbing and all hell broke loose.

So why would we believe that artificially boosting housing values will be sustainable this time? What do we think will happen when mortgage rates rise again and the tax credits expire? We won’t have to worry about ARMs resetting this time around because they are now shunned by banks for the most part, but the fundamental problem remains that housing is just too expensive compared to income. Interest rates can’t stay this low forever, and the tax credit will expire after the end of the year. Then homebuyers will only have their personal income to rely on to pay for their homes. This is how it has always been (minus government intervention), and it is how it should be. People making $50,000 a year shouldn’t be living in a $400,000 house—It’s that simple. People need to live within their means, but the government doesn’t seem to grasp this and keeps pushing measures to modify home loans. We can try to modify people’s loans all day long, but if they can’t afford their homes, then they can’t afford their homes. According to the Wall Street Journal, over 40 percent of borrowers were at least 60 days past due eight months after their loan was modified. It seems to me that these loan modifications are just delaying the inevitable and costing banks and taxpayers more money.

Before the housing crisis can truly end, housing prices must come into balance with incomes. When this happens, the problem will solve itself. When buying a home starts to make more sense than renting, people will start buying again. It isn’t that hard to figure out. Spending taxpayer money to prop up housing is not only a waste, but an unethical perpetuation of the problem. It is completely unfair to renters as well as our youth. Unfortunately, those groups represent the minority, so their voice isn’t likely to be heard. If these measures are passed, expect to pay handsomely for it and to see another bubble burst a few years from now. At least this time no one should be able to use the excuse that they didn’t see it coming.

Tax Cuts Could Deepen The Recession

There has been non-stop debate between Republicans and Democrats for the past couple weeks regarding how the economic stimulus bill should be structured. Republicans want a majority to go towards tax cuts, and the Democrats want to see high levels of spending. It appears that the Democrats are going to win out in this debate, thinks to their heavy numbers advantage, but according to the New York Fed's Gauti Eggertsson that is a good thing. He wrote a paper theorizing that in today's economic environment tax cuts have the potential to backfire, and possibly even deepen the recession. Economics professor and author of the Economist's View blog, Mark Thoma, looks at this closer in his blog post below.

Justin Wolfers summarizes a paper that suggests government spending would be better than tax cuts at reviving the economy:

Tax Cuts vs. Government Spending, by Justin Wolfers: As the Senate and the House look to reconcile competing stimulus plans, the big debate is whether to emphasize government spending or tax cuts. A new paper by the New York Fed’s Gauti Eggertsson argues that the risk of deflation should tilt the balance to government spending.

Our current problem is deficient aggregate demand. The government can raise total spending either by buying more stuff, or it can lower taxes and hope that consumers take their tax breaks to the mall. ...

But that’s not the whole story. Tax cuts stimulate both aggregate demand and aggregate supply. If taxes are temporarily lower, they make working today more attractive than working tomorrow, and thus increase labor supply. This boost to the nation’s productive capacity means that a tax-cut-based stimulus doesn’t do as much to narrow the gap between output and what we can produce.

Under normal circumstances, this doesn’t present a problem, because the Fed can lower interest rates to close this output gap. But right now, the Fed has set interest rates as low as they can go, and so different principles apply. Eggertsson’s concern is that a big output gap will lead inflation to fall, leading real interest rates to rise in the middle of the recession. These higher real interest rates further dampen economic activity, and with the Fed powerless to offset this, there’s the very real risk of a deflationary spiral. And so a tax-cut-based fiscal stimulus might actually backfire. In fact, Eggertsson reckons there’s a chance that tax cuts could even deepen the recession.

Is Eggertson’s conjecture right? Unfortunately the historical record can’t tell us: there’s never been an episode in which we’ve tried reducing taxes when interest rates were this low. When we’re in uncharted waters, we’ve got nothing but economic theory to guide us. And the theory says it’s safer to stick to a spending-based stimulus plan.

I'd like to be able to rely on this as one more piece of evidence for government spending over taxes, but I have doubts that the aggregate supply (labor supply) effect would be large enough to make much of a difference. The author also suggests caution:

I am bit hesitant to draw the lesson from this paper that it would be ideal to raise payroll taxes to stimulate the US economy today, although this clearly is a direct implication of the analysis

And he also says:

What should we take out of all of this? ...[One] lesson is that policymakers today should view with great deal of skepticisms any empirical evidence on the effect of tax cuts or government spending based on post war US data. The number of these studies is high, and they are frequently cited in the current debate. The model presented here, which has by now become a workhorse model in macroeconomics, predicts that the effect of tax cuts and government spending is fundamentally different at zero nominal interest rates than under normal circumstances.

This post can also be viewed on economistsview.typepad.com.

Total Financial Crisis Commitment Nearing $10 Trillion

Bloomberg has been fighting with the government in an attempt to gain visibility into the Federal Reserve's recent lending practices, however, to this point they have been unsuccessful. Of course the fact that the government is denying the request has only brought ramped speculation about what they are hiding. One thing that we do know is that the price tag for this financial crisis keeps growing and growing, with no end in sight. Most people are only aware of the $700 TARP package, and the new $800+ billion stimulus package nearing completion as we speak. The truth of the matter is that the real price tag is much more than that. Tim Iacono looks at the Bloomberg report in his blog post below that shows us the real price tag is close to $10 trillion (that is not a typo).

It looks like Bloomberg v. Board of Governors of the Federal Reserve System is moving along nicely with arguments to be heard as soon as this month.

Recall that Bloomberg sued the central bank after their Freedom of Information Act request about Fed lending to distressed banks was denied. They simply wanted to know what kind of assets they were getting in exchange for their pristine Treasuries, how much and from whom.

The Fed wouldn't tell 'em. The Treasury Department isn't talking either.

In the meantime, the staff at Bloomberg is taking an increasingly skeptical look at both the sums of money involved and how it is being authorized and spent, as seen in this report:

The stimulus package the U.S. Congress is completing would raise the government’s commitment to solving the financial crisis to $9.7 trillion, enough to pay off more than 90 percent of the nation’s home mortgages.
...
Only the stimulus bill to be approved this week, the $700 billion Troubled Asset Relief Program passed four months ago and $168 billion in tax cuts and rebates enacted in 2008 have been voted on by lawmakers. The remaining $8 trillion is in lending programs and guarantees, almost all under the Fed and FDIC. Recipients’ names have not been disclosed.

“We’ve seen money go out the back door of this government unlike any time in the history of our country,” Senator Byron Dorgan, a North Dakota Democrat, said on the Senate floor Feb. 3. “Nobody knows what went out of the Federal Reserve Board, to whom and for what purpose. How much from the FDIC? How much from TARP? When? Why?”

You have to wonder why Congress even bothers going through the arduous task of passing legislation for a measly trillion or two when so much money can be made available without the approval of elected officials - about four times as much by my math.

And the best part about doing it that way is that you don't have to tell anybody where it went.

Of course, Congress might want to know and you might get sued.

The Bloomber report goes on to put the total amount of money in perspective just like when Senate Republicans were talking about the stimulus package the other day with images of hundred dollar bills stacked 600+ miles high and/or laid end to end, circling the earth 40 times.

That was for just $800 billion.

Somehow, for $10 trillion, this doesn't sound nearly as impressive.

The $9.7 trillion in pledges would be enough to send a $1,430 check to every man, woman and child alive in the world. It’s 13 times what the U.S. has spent so far on wars in Iraq and Afghanistan, according to Congressional Budget Office data, and is almost enough to pay off every home mortgage loan in the U.S., calculated at $10.5 trillion by the Federal Reserve.

Maybe it is impressive, but $1,430 doesn't really sound like a lot of money.

Remember when they talked about $30 or $50 billion for Iraq and then it turned into hundreds of billions of dollars and that was such a big deal?

Now, even a hundred billion dollars doesn't sound like much anymore.

Soon, one trillion might not sound like a lot either.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Geithner's Financial Stability Plan

This morning the new plan to rescue the financial system was unveiled by Treasury Secretary Timothy Geithner, but so far the markets have not reacted very positively to the news. It is still early, but it appears investors are not sold on the proposed government actions. In his speech Geithner threw around numbers as high as $1 tillion, which represents the expansion of a key Federal Reserve lending program, according to the Associated Press. But even that failed to impress investors. Kathy Lien talks more about the new rescue plan and the impact to currency and financial markets in her blog post below.

The Treasury Secretary has finally spoken and the markets are disappointed!

The price action in the currency markets suggests that investors are disappointed by the lack of details from the Treasury’s new Financial Stability Plan and are skeptical about the effectiveness of getting the private sector involved. Furthermore, investors are not happy about being apart of an experiment (although I think this is the only way to go because all of the old measures have proven effective).

Geithner announced a cocktail of initiatives using “things we haven’t tried before” and warned “that we will make mistakes.” If the Treasury Secretary is not 100 percent confident in his own plan, how could investors be?

Traders have plowed right back into the US dollar on the fear that the US government is rolling the dice once again. Equities have also fallen as much as 300 points.

The Treasury’s Super TARP plan, which is now renamed as the Financial Stability Plan has 3 core components:

1. More Capital for Healthy Banks

2. New Financing for as Much as $1 trillion of Consumer and Business loans

3. Public Financing for Private Investors Willing to Buy Distressed Debt (details of private/public investment fund have not been released)

Read the rest of this analysis on FX360.com

This post can also be viewed on kathylien.com.

Krugman Rips Into Senate Centrists

If you have read a newspaper, or watched the news, recently you are probably aware of the difficulties that Republicans and Democrats have had in coming to a consensus on the new stimulus bill. It appears that Democrats have been able to win the vote of at least a few Republicans, enough to get the bill passed, however, at what cost have those votes come? According to well known economist Paul Krugman, the price was extremely high. Mark Thoma from The Economist's View, looks at Krugman's article in his blog post below.

President Obama's net return on his investment in bipartisanship isn't very good:

The Destructive Center, by Paul Krugman, Commentary, NY Times: What do you call someone who eliminates hundreds of thousands of American jobs, deprives millions of adequate health care and nutrition, undermines schools, but offers a $15,000 bonus to affluent people who flip their houses?

A proud centrist. For that is what the senators who ended up calling the tune on the stimulus bill just accomplished.

Even ... the original Obama plan — around $800 billion ... with a substantial fraction ... given over to ineffective tax cuts — ...wouldn’t have been enough to fill the looming hole in the U.S. economy... Yet the centrists did their best to make the plan weaker and worse.

One of the best features of the original plan was aid to cash-strapped state governments... But the centrists insisted on a $40 billion cut in that spending.

The original plan also included badly needed ... school construction; $16 billion of that spending was cut. It included aid to the unemployed, especially help in maintaining health care — cut. Food stamps — cut. All in all, more than $80 billion was cut..., with the great bulk ... falling on ... measures that would do the most to reduce the depth and pain of this slump.

On the other hand, the centrists were apparently just fine with one of the worst provisions in the Senate bill, a tax credit for home buyers...: it will cost a lot of money while doing nothing to help the economy.

All in all, the centrists’ insistence on comforting the comfortable while afflicting the afflicted will, if reflected in the final bill, lead to substantially lower employment and substantially more suffering.

But how did this happen? ... Mr. Obama ... offered a plan that was clearly both too small and too heavily reliant on tax cuts. Why? Because he wanted the plan to have broad bipartisan support...

Mr. Obama’s postpartisan yearnings may also explain why he didn’t do something crucially important: speak forcefully about how government spending can help support the economy. Instead, he let conservatives define the debate...

And Mr. Obama got nothing in return for his bipartisan outreach. Not one Republican voted for the House version of the stimulus plan...

In the Senate, Republicans ... decried the bill’s cost — even as 36 out of 41 Republican senators voted to replace the Obama plan with $3 trillion, that’s right, $3 trillion in tax cuts over 10 years.

So Mr. Obama was reduced to bargaining for the votes of those centrists. And the centrists, predictably, extracted a pound of flesh — not, as far as anyone can tell, based on any coherent economic argument, but simply to demonstrate their centrist mojo. They probably would have demanded that $100 billion or so be cut from anything Mr. Obama proposed; by coming in with such a low initial bid, the president guaranteed that the final deal would be much too small.

Such are the perils of negotiating with yourself.

Now,... it’s possible that the final bill will undo the centrists’ worst. And Mr. Obama may be able to come back for a second round. But this was his best chance to get decisive action, and it fell short.

So has Mr. Obama learned from this experience? Early indications aren’t good.

For rather than acknowledge the failure of his political strategy and the damage to his economic strategy, the president tried to put a postpartisan happy face on the whole thing. “Democrats and Republicans came together in the Senate and responded appropriately to the urgency this moment demands,” he declared on Saturday, and “the scale and scope of this plan is right.”

No, they didn’t, and no, it isn’t.

This post can also be viewed on economistsview.typepad.com.