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Five Things You Need to Know: America, The Banking Welfare State


When the going gets tough, it's self-reliance for the penniless, government aid for the rich


Kevin Depew's Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. When the Going Gets Tough, It's Self-Reliance for the Penniless, Government Aid for the Rich

"Self-reliance for the penniless and government aid to those who already had more than they could use was the plan."
- Nelson Algren, "A Walk On the Wild Side"

One full year. One full, impossible to believe stompdown screamer of a year. That's how long it's been since the credit machine on Wall Street suddenly slipped a gear, lost the chain and folded in on itself, howling with the awful grinding sound of metal chewing metal. The real tragedy of it, the outrageousness of it, is that this machine's tear down is still ongoing, happening in horrific slow motion.

And so it is that the central bank announced yesterday it is extending the fat teat of acronyms that allow investment banks to borrow from the Fed through January of 2009. "Healthy economic growth depends on well-functioning financial markets," Federal Reserve Chairman Ben Bernanke told lawmakers in testimony earlier this month. "Consequently, helping the financial markets to return to more normal functioning will continue to be a top priority of the Federal Reserve."

Meanwhile, as banks jostle one another for position suckling the government teat, homeowners will have to settle for the dregs of the trough. Brett Arends, in a piece in today's Wall Street Journal, runs the math on the Hope for Homeowners Act and - surprise, surprise - finds that once you tally the "annual insurance premium" added on top of each loan to help pay for the program's losses, your interest rate right now would come to 8.1% a year.

One of the strangest of American myths is the notion of "America: The Welfare State." Say that outloud. Then give it five minutes. Doubtless some self-appointed propaganda minister and "defender of self-reliance" will trot out a stat that purports to show the massive government spending programs "designed to subsidize the poor and lazy."

In the Age of Self-Evidence, anything shouted loud enough, forcefully enough, is almost certain to be etched into stone somewhere, engraved on a government building and hailed as truth. It is, after all, self-evident. Look around, the poor and lazy are everywhere, constantly scheming to worm their hands into your pockets and help themselves to the fruits of your hard labor.

That's the popular lie. But these welfare programs don't so much subsidize anything as institutionalize it, just as the real winner in the War on Drugs has always been the budgets of those units formed to "fight the good fight." Yes, they institutionalize and structure things, like so many moats surrounding the castles of the kingdom of the rich.

There is no Welfare State, not for people, maybe for banks run by the rich, but for people there is only a protectorate of programs designed to shield the Wealthy from a teeming mass of filthy rioters and thieves who, without their economic stimulus checks, just might become desperate enough to scale the castle walls in search of victims to rob.

The weird part about this con is that the rich, the wealthiest 2%, don't even pay for these programs. They show the remaining 98% of us the money in suitcases, whet our appetites, and then close them up and walk away after we eagerly promise to fund the operations ourselves; like a deranged lunatic throwing dice against himself in a dark alley, shifting pennies from one pocket to another.

Maybe the lone nugget of grim consolation is that at least we did it to ourselves.

2. Ranks of Part-Timers Swells

"Still and all times weren't as hard as some people grew fond of pretending. All that had happened really was a withdrawal from abnormal prosperity with business progressing on a downward grade toward new planes of normality and increasing equalization of opportunity. Only this time one exciting opportunity was precisely as good as the next exciting opportunity. Which was to say, simply, that nobody got paid anymore."
- Nelson Algren, "A Walk On the Wild Side"

Speaking of opportunity, the New York Times this morning reports that the number of Americans who have seen their full-time jobs slashed to part-time has swelled to more than 3.7 million, the largest figure since the government began keeping track in 1955.

The total number of people the government classifies as working part time involuntarily rose to 5.3 million in June, an increase of more than 1 million year-over-year.

Now that's just 3.7% of all those employed, which doesn't sound so bad. But once again, reality is poking through the thin protective veneer of surface statistics, like a spring in a rotting couch sticking in your back when you shift on it a certain way. Layoffs have yet to reach the levels seen during prior downturns. The unemployment rate is a relatively modest 5.5%. But, the Times notes, "that figure masks the strains of those who are losing hours or working part time because they cannot find full-time work - a stealth force that is eroding American spending power."

That's why this is a modern stealth depression. Everything about it operates just below the surface, from involuntary part-time employment, to declining real wages, to payday loan stores and pawn shops, all conveniently hidden by a constant barrage of data and images.

For example, exactly one year ago to the day, the United States stuck a hand deep into its national pants and pulled out a $20 bill it didn't even know it had. At least that's how I characterized it at the time. As of May 2007, the national Personal Savings rate had been negative for 26 consecutive months. Then, magically, the Commerced Department "revised" the data and discovered the Personal Savings rate had actually been positive for most of the prior two years, with only the third quarter of 2005 showing a negative rate.

See, that's how you do it. They're just numbers.

3. Why No Currency Crisis?


The Credit Crunch: What's Next? I'd like to get your thoughts on the following.

At the risk of asserting "it's different this time," I've been thinking about this as well. Not only has our manufacturing base been replaced by the service and finance sectors, but we now have the largest foreign-owned debt in history.

Forgetting for a second that public-works programs don't work (can't create economic recovery), is a second New Deal even an option? Is it not plausible that an attempt to initiate a massive public works program this time around would set off a currency crisis?

What source of funding/debt is available to us to finance trillions of dollars in public works or alternative energy investments? Do we expect foreigners to continue buying trillions more in Treasuries while their economies sink too? Or our own citizens to buy "save the USA" bonds with the money and savings they don't have?

Maybe I'm missing something, but I just don't see it.

Minyan JB

Minyan JB,

The dollar crisis camp misses two key points: 1) massive widespread reduction in debt requires accumulation of dollars to pay it down. 2) the government's balance sheet won't be simply the expansion of liabilities, but assets too. Not everything is going to zero.

I'm not defending the spending of taxpayer money on public works projects, but simply pointing out the reality, which is that whether one agrees with these projects or not, they often build up the asset side of the ledger as well. Infrastructure spending, research and development, military spending. These will all be projects we see going forward.

Also, which has been the main thing I want to point out, this is a multi-year, perhaps decade-long process. The key, for now, to avoiding the dollar calamity you mention, is in extending for as long as possible the unwind.

Everything the government is doing, everything the Federal Reserve is doing, everything the Treasury is doing, is taking place with that aim solely in mind: extending the unwind. By extending it for as long as possible, the potential for a currency crisis - which, by the way, no entity on the planet wants - is reduced in probability. It could still happen, but the probability of it is reduced.

As long as the unwind is extended, the deflationary process will occur as an orderly progression, people will see their wealth evaporate in slow motion, and on the other side of this "crisis" politicians will be free to resume their inflationary policies and the looting of the assets of the middle and lower classes.

4. Desperate Times Require Desperate Measures, But How Desperate?

I'm not saying it's necessarily likely, but given what might be in the file drawer containing the saying, "Desperate times require desperate measures," along with the precedents developing in front of our very eyes… how can we be confident that the next nearly unimaginable thing, (after LTCM, Bear Stearns, Fannie Mae (FNM) & Freddie Mac (FRE), homeowner bailouts, free checks in the mail), is that the government won't simply take bad debt from the banks and voila the banks are whole and ready to resume lending again? Or some even more brilliant scheme that is in essence the government creating new liquidity that they CAN get into the system." It is a fiat currency, right?

-Minyan JW

The banks are already doing this. But your larger point is a good one. We know - thanks to the historical record of governmental and the central bank's response to the Great Depression - exactly what these programs and "desperate measures" are, what they mean, and how they impact the financial system. But the wild card is what we haven't thought of that these bureaucrats conceive of themselves to slow down the process of deleveraging and unwinding debt. Never underestimate a desperate man.

I think much of this depends on how widespread the consumer asset liquidation becomes, and how quickly it accelerates. That is the area where the central banks have the least amount of control, because they can provide liquidity to banks, take onto the their balance sheets the bad assets, continue rolling over even non-collateralized loans to banks every 60-90 days almost indefinitely. But they can't very well buy the nearly $4 trillion in consumer durable assets on household balance sheets if those households decide to liquidate them.

We have made the point before that the consumer is absolutely critical to this process. One question that keeps coming up is "Will this be like Japan?" But most people when they ask that question are asking if the Federal government's and central bank's responses will be as sluggish, as this is what prolonged Japan's long-term deflationary debt unwind. From that standpoint, it appears the bureaucrats and politicians are intent on not delaying Wall Street and corporate rescues. But they have far, far less control over rescuing Main Street, even if it were their prerogative to do so, which, it has been demonstrated over and over again, it is not.

Another key difference between Japan consumers and U.S. consumers is the extraordinary relative divergence in their personal savings rates and personal balance sheet comfort levels.

Japan consumers entered a corporate balance sheet recession with very high savings rate, savings that never fell much below 3% even at the very heart of the quantitative easing policy that destroyed savings incentives.

The U.S. consumer is entering business conditions that are worse, their magnitude greater, with an almost 0% savings rate and a very thin household cushion.

Moreover, this debt unwind, so far, has largely been isolated to Wall Street and mortgage debt and mortgage-related leveraged instruments, but as we have seen with yesterday's announcements that the states of NY and NJ are selling off assets to cover budget shortfalls, it is a debt unwind that is quickly spreading to other areas of the economy.

Remember, this is just the first stage, the unwinding of the most obvious assets that are deflating, mortgages, houses, real estate. We have not yet even gotten to the commercial real estate shedding, the consumer credit and automotive debt unwind, collectibles. and so on and so on.

5. Socionomics of 'Living Large': Suddenly, it Seems Ridiculous

The rush to disassociate from the trappings of the bull market are in full swing. Today's LA Times observes that in Hollywood, which has never been known for its subtlety, downsizing usually means losing weight. "But with the economy in the doldrums, even this town built on excess is scaling back. Suddenly, living large seems ridiculous. Even gauche. Nevermind if you can still afford a jaunt to Europe or a really great pair of shoes, it's understood that you don't brag about it. Instead, people are proudly sharing their recessionary measures like a new kind of social currency. Whether driven by necessity, anxiety or even empathy, it's high time for a new mind-set on consumption."

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