Captain's Quarters -

Will Corporations Get The Next Bailout?

After the subprime crisis erupted and began taking a large toll on the entire credit market, the American government rushed to rescue those hardest hit. Stimulus packages and bailouts ensued, attempting to limit both the economic and political damage. Now another crisis might soon arrive, and Washington might find it more difficult to address:

U.S. and European banks, already reeling from persistent losses on mortgage investments, are facing a new hit as the global financial crisis spreads to deteriorating corporate debt.

UBS AG and Credit Suisse Group last week announced the write-down of a combined $400 million in the value of leveraged loans as part of their fourth-quarter earnings reports. That signals more misery right around the corner for banks that barreled into these low-rated corporate loans -- typically issued by banks and sold to investors like junk bonds -- and now are stuck holding them on their books. Leveraged loans served as buyout-related debt that fueled a merger boom until the credit slowdown. ....

The credit crisis that has gripped global financial markets since last year has been centered on the plunging value of securities tied to subprime mortgages extended to the riskiest borrowers in the U.S. Write-downs of more than $100 billion on subprime mortgage holdings has forced some of the world's largest commercial and investment banks to raise billions of dollars in capital from the Middle East and Asia.

Now, the crisis looks to be entering a new phase as the value of corporate loans and bonds that banks hold comes into question. The extent of the damage is likely to emerge as banks file their annual reports next month and report first-quarter results in April.

Normally, this would get resolved by finding new investors to alleviate the debt. Unfortunately, the banks holding the paper have already tapped into these investors to survive the subprime crisis. They may not find enough liquidity left to avoid the kind of write-downs that could shake the markets again in the coming weeks.

If corporate debt rattles the economy, will the government give the same response it did to mortgage lenders? The Bush administration and the Democratic-controlled Congress don't agree on much, but both Republicans and Democrats rushed to find ways to avoid large-scale foreclosures through government action. Homeowners get a lot more sympathy from the press than corporations, however. A bailout for corporations will not get nearly the amount of support, even if the potential damage to the economy could be significant.

A corporate-debt crisis will certainly test the populist rhetoric being heard now in the presidential primaries. Barack Obama and Hillary Clinton have challenged each other in demonizing corporations over the last few weeks. If corporations suddenly have to start cutting costs to deal with debt overload, it will throw plenty of people out of work. Will they use that to even further castigate corporations, or will both have to work on a corporate bailout in the Senate?

Payroll Levels Drop In January

For the first time since August 2003, payroll levels decreased in the US in January. The loss of 17,000 jobs did not increase the unemployment rate, which remained at 4.9%, but it sends a signal to the economic markets that trouble still brews on the horizon:

Nervous employers cut 17,000 jobs in January — the first such reduction in more than four years and a fresh trouble sign that the economy is in danger of stalling.

The Labor Department's report, released Friday, also showed that the unemployment rate dipped slightly to 4.9 percent, from 5 percent, as the civilian labor force shrank slightly.

Job losses were widespread. Manufacturers, construction firms and a variety of professional and business services eliminated jobs in January — reflecting the toll of the housing and credit debacles. The government cut jobs, too. All those cuts swamped job gains in education, health care, retailing and elsewhere.

Wage growth also slowed, another indication that employers are tightening their belts amid the economic slowdown.

The shrink in the civilian work force could have come from a number of sources. Perhaps the attrition of illegal workers has left the workforce smaller than expected. It could also be older boomers moving out of the group faster than expected. The former would also tend to reduce jobs as consumers decline in specific areas.

However, the bottom line is that our economy needs to add somewhere between 50,000 - 100,000 jobs a month to keep up with our population growth, and anything less eventually starts moving us backwards. Now we have crossed a Rubicon of sorts by seeing negative numbers in jobs for the first time in 53 months. The economic markets will see that, rightly, as a sign of continuing weakness in the economy, despite employment gains in most industries outside of residential housing and associated lending.

Expect to see the markets take a moderate hit today. The big question will be whether the Fed will wait six weeks until its next meeting to take any further action.

Slow Fourth Quarter, Fed Cuts Rate Again

The nation posted an anemic growth rate of 0.6% in the fourth quarter of 2007, hampered by the residential housing market and halving expectations from 1.2% GDP annual growth. In response to the slowdown, the Federal Reserve dropped its lending rate a half-point for the second time in eight days. It underscores the analysis that inflation has now become a secondary concern for the Fed:

The Federal Reserve reduced short-term interest rates on Wednesday for the second time in eight days, meeting widespread expectations by investors on Wall Street for a big rate cut.

In lowering its benchmark Federal funds rate by half a point, to 3 percent, the central bank acknowledged that it is now far more worried about an economic slowdown than rising inflation, and it left open the possibility of additional rate reductions.

“Financial markets remain under considerable stress, and credit has tightened further for some businesses and households,” the central bank said in a statement accompanying its decision. In addition, it said, recent data indicated that the housing market is still getting worse and the job market appears to be “softening.”

Taken together, the back-to-back rate cuts totaling 1.25 percent amounted to the Fed’s most aggressive effort in years to head off a recession. By comparison, the Fed under Alan Greenspan reduced the overnight rate by only a half-point after the terrorist attacks on Sept. 11, 2001.

The markets didn't respond much to the announcement. It kicked off a short-lived rally, but it became apparent that traders had already factored in an expected Fed move. It might show the global markets that the US takes the economic slowdown seriously and keep them from panic selling, but otherwise, the rate cut looks like business as usual at the moment.

King Banaian of SCSU Scholars takes a look at the underlying issues in the slowdown:

If you just took the headline number -- 0.6% growth in the fourth quarter, worst quarter in five years, versus a market expectation of 1.2% -- you would think the GDP report today lays the foundation for believing recession is imminent and that the Fed's expected move to cut interest rates another 50 bp would be more in line with what one would expect in a recession (though it might not yet meet the Taylor rule expectation.) But some are noting that the disappointment is more than made up by the housing sector and a very sharp selloff from inventories (knzn refers to a near-3% growth rate in " nonresidential final sales", which I think I know what that means.)

Well, nice try. Without the foreign sector, gross domestic purchases rose only 0.2% in the quarter, and real final sales decelerated from 4% in the third quarter to 1.9%. (Which means, btw, that real final sales to domestic purchasers -- not overseas -- was lower at 1.4%.) So while we might have some explanation for missing the expectation of 1.2%, you could hardly say we should have beaten it. The very best interpretation would be that the numbers generated little new information about the state of the economy.

I'll be talking with King later today (special time of 1 pm CT) at Heading Right Radio to dissect the numbers. The economics chair of St. Cloud State University will walk us through the numbers, explain their meaning, and we'll talk about the impact of the report on the political races of 2008.

A Solution In Search Of A Problem?

As Congress and the White House continue to work together on a bipartisan stimulus plan to avoid a predicted recession, the Congressional Budget Office claims that the problem won't exist anyway. The CBO predicts that 2008 will not have a recession, and that left to its own devices, the economy will recover from the housing bubble and the credit crunch:

The slowing U.S. economy is unlikely to sink into an election-year recession and an economic rebound could begin as early as next year as housing and financial market turmoil fades, the Congressional Budget Office forecast on Wednesday.

In the meantime, the U.S. budget deficit will grow to $219 billion this year, up from the $163 billion registered last year, according to a CBO report submitted to Congress.

But that forecast by Congress' nonpartisan budget analyst does not include the cost of an economic stimulus measure that is quickly moving through Congress and could cost around $150 billion or more. The deficit projection for fiscal 2008, which ends September 30, also does not include more money Congress is likely to approve this year for the war in Iraq.

While CBO noted an elevated risk of recession, its outlook was weighted more toward the United States working through its current economic problems and escaping a full-blown recession.

Meanwhile, Wall Street apparently also came to its senses today:

Blue chips rallied Wednesday afternoon, with the Dow bouncing back from a more than 300-point loss earlier in the session, while the Nasdaq erased losses sparked by Apple's profit warning.

The Dow Jones industrial added almost 300 points, after having fallen more than 300 points earlier in the session. The Standard & Poor's 500 (SPX) index rose 2.1 percent.

Where did the boost originate? The banking sector added across the board, with JP Morgan Chase up 11% and a number of others up 5% or better. Even BofA, which showed a huge hit on profits earlier this week, rose on today's trading.

Obviously the Fed's rate cut helped out the bankers. Now one has to ask whether the $145 billion stimulus package will do more damage than it repairs. It will push the deficit higher and only give a short-term boost to an economy unlikely to slide backwards. It appears to address political concerns rather than economic need, and the only beneficiaries in the long run will be the politicians who buy a momentary uptick in their approval ratings.

Fed Acts Quickly To Stall The Bear

After watching a tsunami of sell-offs in the overseas markets, Fed chair Ben Bernanke acted rapidly this morning to quell a big downturn on Wall Street. The Fed lowered the interest rate by 0.75, taking the rate from 4.25% to 3.5%, hoping that will convince investors to stay in the market:

The Federal Reserve, confronted with a global stock sell-off fanned by increased fears of a recession, cut a key interest rate by three-quarters of a percentage point on Tuesday, the biggest one-day move by the central bank in recent memory.

The Fed said it was cutting the federal funds rate, the interest that banks charge each other on overnight loans, to 3.5 percent, down by three-fourths of a percentage point from 4.25 percent.

The Fed action was the most dramatic signal it can send that it is concerned about a potential recession in the United States. It marked the biggest one-day move by the central bank in recent memory.

The Fed decision was taken during an emergency telephone conference with Fed officials on Monday night. Those discussions occurred after global financial markets had plunged Monday as investors grew more concerned about the possibility that the United States, the world's largest economy, could be headed into a recession.

Welcome to the activist Fed. Analysts expected action last week, and when that did not occur, expected nothing to happen until the next Fed meeting in two weeks. Bernanke took a page from the bipartisan interest in DC in the apparent recession, as the Fed's action comes as a piece with the stimulus package making its way through Congress.

Some may argue, though, that the Fed will make matters worse. This crisis started with a credit meltdown that came from poor loan decisions made when credit was cheap. Rather than lowering the price of credit as the Fed dramatically did here, analysts have argued that tightening credit and liquidity would be the better long-term strategy to resolve the actual problem, rather than addressing the symptoms.

That kind of strategy would force the country -- and the globe -- to suffer a recession as a corrective. That might be an effective economic strategy, but not a political strategy. In an election year, no one in either party wants to explain why they think a recession would be good for the soul. That is why we see short-term strategies like one-time tax rebates and credit-price drops.

Hopefully, that strategy works as intended. However, we could be seeing a repeated cycle of cheap-credit damage that we are inadvertently reinforcing.

UPDATE: Michelle Malkin has more thoughts on government using our money to stimulate the economy. Why not just let us keep it in the first place, and cut out the middlemen?

When Everyone Sings Kumbaya ...

Many people talk about the virtues of bipartisanship, but in practice it usually results in essentially meaningless or damaging policy. The announced stimulus package appears more the former than the latter, but it could lead to disengagement on broader, longer-term and more meaningful policies, such as making permanent the Bush tax cuts that resulted in a four-year expansion:

President Bush called yesterday for a $145 billion stimulus package centered on tax breaks for consumers and businesses to rejuvenate the lagging U.S. economy, a move that drew unusual bipartisan praise on Capitol Hill but did not boost confidence on Wall Street.

The principles outlined by Bush opened a path to an agreement with congressional Democrats that could come as early as next week and put as much as $800 in each taxpayer's pocket by spring, according to both sides. Bush dispensed with one of the thorniest obstacles to a quick deal by agreeing not to link it to his longstanding quest to make permanent his first-term tax cuts. ...

Indeed, officials on both ends of Pennsylvania Avenue were using the term "kumbaya" to describe the rare consensus developing after a year of partisan warfare. At day's end, the contours of a possible accord were coming into focus. Both Bush and the Democrats want a one-time tax rebate, and officials said a compromise package could include the tax incentives for business investment that the president wants, as well as the social welfare spending, such as extended unemployment benefits, that the Democrats want.

In principle, I support any effort to return tax money to the people who pay it. The structure of the rebate created criticism from John Edwards, who complained that it didn't benefit those who pay no taxes. Edwards wants a handout, not a rebate, and the Bush administration wisely chose the latter. The last thing this economy needs is another mechanism for redistribution of wealth.

Otherwise, this looks like nothing more than an election-year sop. Americans pay too much tax, and that keeps investment and savings suppressed. A one-time rebate only gives temporary relief, and while families will welcome the check, it gives them no long-term reason to plan for investment or significant purchases. Stabilizing an economy requires giving people reason and confidence to invest in it for long-term growth, and a single $800 check doesn't cut it.

It does help the politicians, however, and that's the main goal. The incumbents running in 2008 need to go home and show that they did something about the economy, even if it doesn't do any real good. In the end, this is a Beltway bailout -- and by the time Congress gets it in the hands of the taxpayers, the crisis will likely have passed.

A California Emergency Means Grab Your Wallets

Arnold Schwarzenegger will declare a fiscal state of emergency in California after badly miscalculating the deficit condition in the Golden State. Last August, he predicted that the state would have a $4.1 billion reserve at the end of this fiscal year, but a legislative analyst predicted in November that California would have a $10 billion deficit. Schwarzenegger now says it's even worse than that:

Gov. Arnold Schwarzenegger said Friday he will declare a "fiscal emergency" in January to give him and the Legislature more power to deal with the state's growing deficit.

Schwarzenegger made the announcement Friday after meeting with lawmakers and interest groups this week to tell them California's budget deficit is worse -- far worse -- than economists predicted just a few weeks ago.

The shortfall is not $10 billion, but more than $14 billion -- a 40 percent jump that would put it in orbit with some of the state's worst fiscal crisis, those who have met with him said.

Four years after ousting Gray Davis in a recall race, Californians may consider giving Arnold the heave-ho. How can any responsible Governor get budget deficits so wrong in such a short period of time? The change from $10 billion in the red to $14 billion is bad enough, but in four months, Arnold missed it by $18 billion. That alone is more than the annual budget for some states. It's like being off by a factor of six Nevadas.

How did this happen? It started when the Governator decided to play nice with the Democratic legislature and start caving on every single spending program they suggested. Despite the already-extant fiscal crisis in California's government, state spending has increased a whopping 40% since Arnold took office. California didn't need more spending, they needed spending cuts and a rational budget process that restrained the big spenders in Sacramento.

That's what Arnold promised, but he retreated after his first bloody nose. He rashly tried to jam fiscal constraints through in a special election set of referenda, and lost. After that, he declared that he would work with the Democratic majority that had created the problem in the first place, and his popularity soared -- as did the red ink.

Now Arnold will declare an emergency, which will force the legislature back into special session. Will that mean cuts in the state budget? Surely you jest. It means Californians will have to grab their wallets, because they can expect a raft of new taxes to float out from Sacramento. It's an "emergency", after all! It gives the legislature and their enabler-in-chief a great excuse to jack up the tax bill while protecting their pet interests.

Unfortunately, Arnold has proven himself wildly incompetent. Not only has he failed to show enough backbone to stand up to a term-limited legislature, he apparently can't do math, either. That recall mechanism may need a new workout.

Economy Still Steaming

The rumors of impending economic death still appear to be exaggerated. According to the Labor Department's figures, spending rose sharply in November as consumer confidence increased. The price of gasoline figured in some of that increase, but even with that factor removed, the rise of spending increased three times from October:

Wholesale prices and retail sales jumped in November and jobless claims fell last week.

Wholesale prices shot up 3.2 percent, the biggest jump in 34 years, propelled by a record rise in gasoline prices. Meanwhile, consumers put aside worries about the weak economy in November to storm into the shopping malls, pushing up retail sales by the largest amount in six months.

The Labor Department reports that new claims filed for jobless benefits dropped to 333,000 last week, an encouraging sign that the job market is holding together despite problems in the economy. ....

Half of the November increase came from a big jump in gasoline pump prices and therefore was not seen as a sign of strength in consumer demand. But there were widespread gains across a number of other areas from department stores to appliance and furniture stores.

Not only is the sky not falling, it seems to be in the same firm place it has always been. The increase is the largest since May. Economists expected only half of that increase even with gas prices figured into their predictions. It appears that the Black Friday numbers were not an anomaly, but indicative of greater confidence by consumers in the market.

Yesterday, the Fed took action to bolster confidence even further. They cut the interest rate and infused significant new cash into the credit system, hoping to stabilize lending while the fallout from mortgage-lender woes continues. That led to a rally on Wall Street, pushing the Dow Jones index above 13,400 again. Not everyone believes that the world has come to an end, apparently.

King Banaian has more on the interesting and complex solution put into place by the Fed. King tends to be more pessimistic than me, but he has excellent and clear-headed analysis at SCSU Scholars.

Democratic Fecklessness On Entitlements

The Washington Post calls out Democrats on their inability to address entitlement reform in today's editorial. After noting that Congress has shown signs of backing away from the containment of health-care inflation for the third year in a row, they puzzle over Democratic resistance to means-testing for Medicare:

The second announcement was that the richest 4 percent or so of retirees will face steep increases in Medicare premiums. Until now, all patients have paid a premium equal to 25 percent of the value of the benefits that the average retiree receives. In the future, the most affluent will pay more, though they will still be paying less in premiums than they take out in benefits. This modest reform, which won't affect the premiums 96 percent of retirees pay, is expected to raise an extra $20 billion for Medicare over the next decade. That's a fraction of the program's long-term funding shortfall, but it's still worth having.

That's not the way some Democrats see it, however. Rep. Nita M. Lowey (D-N.Y.) is pushing a bill that would repeal the higher premiums, arguing that rich retirees should not be hit with increases because they have already contributed generously to Medicare via higher taxes. This is like arguing that the tax code is in danger of becoming too progressive -- a strange position for a Democrat. Ms. Lowey also worries that premium hikes may be extended to a broader swath of retirees, perhaps even to those with incomes of $30,000 or $40,000. That might raise harder questions. But we are not there yet, and it's worth remembering that retirees with that sort of income still are among the richest third of Medicare beneficiaries.

The entitlement programs are not going to be fixed without some hard decisions. If Democrats oppose modest changes that hit only the rich, how will they find the courage to support far-reaching reforms?

Neither party has made much effort to pursue entitlement reform of late, but at least the Bush administration had the courage to attempt a national dialogue on the crisis facing Social Security. While his partial privatization didn't win many converts, he told Congress that he would be willing to discuss a wide range of solutions, if they bothered to develop any at all. Republicans in the end could not overcome a refusal from Democrats to consider the issue, as well as resistance from within their own ranks to expose themselves politically on a touchy issue, even in a non-election year.

So while neither political force appears willing to address entitlement reform in a larger sense, the Democrats refuse to address it even in moderate measures intended to incrementally lessen the coming catastrophe. Lowey's argument reveals entitlements for the Ponzi scheme they've become; she refuses to raise the premiums for those most able to pay because they've paid enough through higher income taxes, an interesting take regarding progressive tax codes, but one which Democrats might regret later. As the Post notes, the higher premiums still remain less than the benefits it buys, which means that succeeding generations are still subsidizing present-day care, only not quite as much. Lowey wants the deficit to remain as is -- because these people are entitled to that level of contribution.

Entitlement programs will go broke over the next couple of decades thanks to this kind of thinking. The available solutions to deficit spending are very limited: either spend less or find more revenue. Lowey refuses to do either, which demonstrates the entire problem with the Democrats on entitlements. Unfortunately, we have no Plan C to address deficits, and the Democrats refuse to adopt either Plan A or Plan B.

Thinking Dynamically In DC

Imagine that the federal government almost never took into account the market reactions to the economic and tax policies it proposed. Instead of calculating the changes to behavior due to the regulatory changes, imagine that Washington based its presumptions of revenue and economic impact on the notion that people would never change their habits to meet the new environment. Politicians might make those presumptions of change, but the bureaucracy responsible for analyzing the effects of the change never took them into account.

If you can imagine that, then you've just identified the way DC has conducted economic analysis -- until now. William Beach at the Heritage Foundation points out that the new Bush budget proposal contains funding for a new office in the Treasury for what the government calls "dynamic analysis", or what Beach calls "economics":

So why is this news? Hasn’t the government been studying the effects of tax policy on the economy all along? Aren’t Washington policymakers routinely advised about how tax changes will affect jobs and output and how those, in turn, will affect government revenues?

Surprisingly, the answer is often no. Until very recently, no official Washington agency produced estimates of the economic and tax-revenue effects of proposed tax policies. ...

Dynamic scoring might not prevent bad tax policy from becoming law, but it would help. Furthermore, reporting the economic consequences of tax proposals will be enormously helpful in redesigning the tax system. The President has called for fundamental tax reform, and he and Congress will find fundamental reform a much easier exercise if routine and sophisticated dynamic scoring is in place when that task is tackled.

Meaningful tax reform cannot take place unless people understand the true consequences of the policies they propose in relation to the policies they would replace. It's amazing that Treasury didn't have anyone responsible for this kind of analysis in the past, but at least the Bush administration recognizes its significance now. Instead of sitting around and inagining what tax incentives, increases, and cuts might do to the economy -- in other words, pulling numbers out of thin air -- Treasury will have solid analysis to help develop positive economic policy in the future.

Sounds like progress to me!