Two Consecutive Negative Quarterly Growth Rates in Business Earnings say we’re in a Recession

Posted by PITHOCRATES - March 9th, 2013

Week in Review

Business earnings drive everything in the economy.  Every dollar a person spends in the economy came from a business.  From someone spending their paycheck.  To someone spending their government assistance.  Because business provides every tax dollar the government collects.  Whether from the business directly.  Or from their employees.  So business earnings are everything.  If they’re not earning profits they’re not creating jobs.  And the fewer people that are working the less tax revenue there is.

Lakshman Achuthan with the Economic Cycle Research Institute (ECRI) looks at business earnings and has found a direct correlation between the growth rate of business earnings and recessionary periods.  Finding that whenever there were 2 or more consecutive quarters of a falling growth rate in business earnings we were in a recession.  Business Insider has reproduced his chart showing this correlation as well as quoting from his report (see CHART OF THE DAY: A Stock Market Trend Has Developed That Coincided With The Last 3 Recessions by Sam Ro posted 3/6/2013 on Business Insider).

This is a bar chart of S&P 500 operating earnings growth going back a quarter of a century on a consistent basis, as we understand from S&P. Others can choose their own definitions of operating earnings, but this is the data from S&P. In this chart, the height of the red bar indicates the number of consecutive quarters of negative earnings growth.

It is interesting that, historically, there have never been two or more quarters of negative earnings growth outside of a recessionary context. On this chart, showing the complete history of the data, the only times we see two or more quarters of negative growth are in 1990-91, 2000-01, 2007-09 and, incidentally, in 2012. This data is not susceptible to the kind of revisions one sees with government data. The point is that this type of earnings recession is not surprising when nominal GDP growth falls below 3.7%. So, even though the level of corporate profits is high, this evidence is also consistent with recession.

Follow the above link to see this chart.

The stock market is doing well now thanks to the Federal Reserve flooding the market with cheap dollars.  Investors are borrowing money to invest because of artificially low interest rates.  So the rich are getting richer in the Obama recovery.  But only the rich.  For an administration that is so concerned about ‘leveling the playing field’ their economic policies continually tip it in favor of the rich.  Who can make money even if the economy is not creating new jobs.  Which it isn’t.

All of these recessions can be traced back to John Maynard Keynes.  And Keynesian economics.  Playing with interest rates to stimulate economic activity.  The 1990-91 recession was made so bad because of the savings and loan (S&L) crisis.  Which itself is the result of government interventions into the private economy.  First they set a maximum limit on interest rates S&Ls (and banks) could offer.  Then the Keynesians (in particular President Nixon) decoupled the dollar from gold.  Unleashing inflation.  Causing S&Ls to lose business as people were withdrawing their money to save it in a higher-interest money market account.  Then they deregulated the S&Ls to try and save them from being devastated by rising inflation rates.  Which the S&Ls used to good advantage by borrowing money and loaning it at a higher rate.  Then Paul Volcker and President Reagan brought that destructive high inflation rate down. Leaving these S&Ls with a lot of high-cost debt on their books that they couldn’t service.  And while this was happening the real estate bubble burst.  Reducing what limited business they had.  Making that high-cost debt even more difficult to service.  Ultimately ending in the S&L crisis.  And the 1990-91 recession.

Fast forward to the subprime mortgage crisis and it was pretty much the same thing.  Bad government policy (artificially low interest rates and federal pressure to qualify the unqualified) created another massive real estate bubble.  This one built on toxic subprime mortgages.  Which banks sold to get them off of their books as fast as possible because they knew the mortgage holders couldn’t pay their mortgage payment if interest rates rose.  Increasing the rate, and the monthly payment, on their adjustable rate mortgage (ARM).  Fannie Mae and Freddie Mac bought and/or guaranteed these toxic mortgages and sold them to their friends on Wall Street.  Who chopped and diced them into collateralized debt obligations (CDOs).  Sold them as high-yield low-risk investments to unsuspecting investors.  And when interest rates rose and those ARMs reset at higher interest rates, and higher monthly payments, the subprime borrowers couldn’t pay their mortgages anymore.  Causing a slew of foreclosures.  Giving us the subprime mortgage crisis.  And the Great Recession.

In between these two government-caused disasters was another.  The dot-com bubble.  Where artificially low interest rates and irrational exuberance gave us the great dot-com bubble.  As venture capitalists poured money into the dot-coms who had nothing to sell, had no revenue and no profits.  But they could just as well be the next Microsoft.  And investors wanted to be in on the next Microsoft from the ground floor.  So they poured start-up capital into these start-ups.  Helped by those low interest rates.  And these start-ups created a high-tech boom.  Colleges couldn’t graduate people with computer science degrees fast enough to build the stuff that was going to make bazillions off of that new fangled thing.  The Internet.  Even cities got into the action.  Offering incentives for these dot-coms to open up shop in their cities.  Building expansive and expensive high-tech corridors for them.  Everyone was making money working for these companies.  Staffed with an army of new computer programmers.  Who were living well.  The brightest in their field earning some serious money.  So they and their bosses were getting rich.  Only one problem.  The companies weren’t.  For they had nothing to sell.  And when the start-up capital finally ran out the dot-com boom turned into the dot-com bust.  As the dot-com bubble burst.  And when it did the NASDAQ crashed in 2000.  When it became clear that all of President Clinton’s prosperity in the Nineties was nothing more than an illusion.  There would be 4 consecutive quarters of negative growth in business earnings before the dust finally settled.  One quarter worse than both the S&L crisis and the subprime mortgage crisis recessions.

And now here we are.  With 2 consecutive quarters of negative earnings growth under our belt.  Based on this chart this has happened only three times in the past 3 decades.  The 1990-91 recession.  The 2000-01 recession.  And the 2007-09 recession.  Which if his theory holds we are in store for another very nasty and very long recession.  No matter what the government economic data tells us.

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FT122: “Japan’s Lost Decade helped the Clinton economy by reducing imports while the global slowdown does nothing for the Obama economy.” -Old Pithy

Posted by PITHOCRATES - June 15th, 2012

Fundamental Truth

The Japanese Government made Money Cheap and Plentiful to Borrow creating a Keynesian Dream but an Austrian Nightmare

Once upon a time Americans feared the Japanese.  Their awesome might.  And their relentless advances.  One by one the Japanese added new properties to their international portfolio.  They appeared unstoppable.  Throughout the Eighties everything was made in Japan.  Government partnered with business and formed Japan Inc.  And they dominated the world economy in the Eighties.  A U.S. Democrat nominee for president held up Japan Inc. as the model to follow.  For they had clearly shown how government can make the free market better.  Or so this candidate said.

But it didn’t last.  Why?  Because in the end the Japanese just interfered too much with market forces.  Businesses invested in each other.  Insulating themselves from the capital markets.  Allowing them to make bad investments to sustain bad business planning.  All facilitated with cheap credit.  Government made money cheap and plentiful to borrow.  And they borrowed.  A Keynesian dream.  But an Austrian nightmare.  Because they used that money to make even more bad investments (or ‘malinvestments’ in the vernacular of the Austrian school of economics).  Creating a real estate bubble.  And a stock market bubble.  Bubbles are never good, though.  Because they can’t last.  They must pop.  And when they do it isn’t pretty.

The U.S. just went through real estate bubble that peaked in 2006.  Money was so cheap to borrow that people were buying $300,000+ McMansions.  Anyone could walk in and get a no-documentation loan with nothing down.  People were buying houses and flipping them.  And people who couldn’t qualify for a mortgage could get a subprime mortgage.  Further pushing house prices higher.  Not because of real demand.  But because of this artificial tweaking of the free market by the government.  Making that money so cheap to borrow.  And when all that cheap credit caused inflation elsewhere in the economy the Fed finally tapped the brakes.  And increased interest rates.  Raising monthly payments on all those subprime mortgages.  Leading to a wave of defaults.  The subprime mortgage crisis.  And the Great Recession.

Japan’s Deflationary Spiral gave American Domestic Manufacturers a Huge Advantage

This is basically what happened in Japan during the Nineties.  The government had juiced the economy so much that they grew great big bubbles.  Ran up asset prices to incredible heights.  But then the bubble burst.  And those prices all fell.  They fell for so long and so far that Japan suffered a deflationary spiral.  Throughout the Nineties (and counting).  The Nineties were a painful economic time.  After a decade or so of inflation the market corrected that with a decade of recession.  And deflation.  A decade of economic activity the Japanese just lost.  The Lost Decade.  But it wasn’t all bad.

At least, in America.  There was still some Reaganomics in the American economy.  Producing real economic growth.  But there was also a bubble.  In the stock market.  The dot-com bubble.  The Internet was brand new and everybody was hoping to be in on the next big thing.  The next Microsoft.  Or the next Apple.  Also, unable (or unwilling) to learn from the mistakes of the Japanese real estate bubble the Clinton administration was making it very uncomfortable for banks to NOT approve mortgage applications for people who were unqualified.  Putting more people into houses who couldn’t afford them.

So while the Clinton administration was trying to change America (during the first 2 years they tried to nationalize health care against the will of the people) the economy did well.  For awhile.  Irrational exuberance was pushing the stock market to new heights as investors poured money into companies that didn’t have a dime of revenue yet.  And never would.  Clinton had to renege on his promise on the middle class tax cut because things were worse than he thought when he promised to make that middle class tax cut.  (Isn’t it always the way that when it comes to tax cuts some politicians can’t keep their promise because they were too stupid to know how bad things really were?)  Added into this mix was Japan’s Lost Decade.  Their deflationary spiral increased the value of the Yen.  And made their exports more expensive.  Giving the American domestic manufacturers a huge advantage.  The economy boomed during the Nineties.  For a mix of reasons.  They even projected a budget surplus thanks to the economic woe of the Japanese.  But then the dot-com bubble burst.  Giving Bill Clinton’s successor a nasty recession.

When a Recession ails you the Best Medicine has been and always will be Reaganomics

The Left always talks about fair trade.  And about the unfair practice of foreign manufacturers giving Americans inexpensive goods that they want to buy.  So their answer to make these unfair trade practices fair is to slap an import tariff on those inexpensive foreign goods.  To protect the domestic manufacturers.  For they believe it’s that simple.  And plug their ears and sing “la la la” when you discuss David Ricardo’s Comparative Advantage.  Ricardo says countries should specialize in the things they’re good at.  And import the things others are better at.  When everyone does this we use our resources most efficiently.  And the overall wealth in the international economy increases.  Making the world a better place.  And increases our standard of living.  But the rent-seekers disagree with this.  They want high tariffs.  And obstacles for foreign imports.  To protect the domestic businesses that can’t sell as inexpensively or at such high levels of quality.

Some would point to Japan’s Lost Decade as proof.  Where their deflationary spiral removed a lot of foreign competition to American manufacturing.  Allowing them to sell at higher prices and lower quality.  All the while protecting American jobs.  And, yes, Japan’s woes did help the American domestic manufacturers during the Nineties.  But it wasn’t because they could raise prices and lower quality in the face of low foreign competition.  It was because there was still enough Reaganomics in the country to produce some vibrant economic activity.  That encouraged entrepreneurs to take chances and bring new things to market.  Which is a huge difference from the current economic picture.

The Eurozone sovereign debt crisis has plunged Europe into a recessionary freefall.  Much like the Japanese suffered in the Nineties.  Yet the American domestic manufacturers aren’t benefiting from this huge decline in foreign competition.  Why?  Because the Obama administration has excised any remaining vestiges of Reaganomics out of the economy.  Everything the rent-seekers could ever hope for they have.  Only without tariffs.  And yet the Obama economy still lingers in recession.  Because irrational exuberance and barriers to free trade don’t create real economic growth.  And an administration hostile to capitalism doesn’t inspire entrepreneurs to take chances.  No.  What encourages them to take chances are low taxes.  And less costly and less punishing regulations.  For programs like Obamacare just scare businesses from hiring any new employees.  Because they have no idea the ultimate costs of those new employees. 

Now contrast that to the low taxation and relaxed regulatory climate of Reaganomics.  That produced solid economic growth.  And this growth was BEFORE Japan’s Lost Decade.  Which just goes to show you how solid that growth was.  And proved David Ricardo’s Comparative Advantage.  For both Japan and the United States did well during the Eighties.  Unlike Clinton’s economy in the Nineties that only did well because Japan did not.  But the good times only lasted until the irrational exuberance of the dot-com bubble brought on an American recession.  Which George W. Bush pulled us out of with a little Reaganomics.  Tax cuts.  Proving yet again that higher taxes and higher regulations don’t create economic activity. Tax cuts do.  And fewer regulations.  In other words, when a recession ails you the best medicine has been and always will be Reaganomics.

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China’s State Capitalism has the Monetary Policy Firepower for a Soft Landing

Posted by PITHOCRATES - January 22nd, 2012

Week in Review

The Big Government Keynesians love to point to China as how state capitalism should be done (see Analysis: China has multiple choices to avoid hard landing risk by Zhou Xin and Nick Edwards posted 1/18/2012 on Reuters).

China faces what could be its worst year of growth in a decade with policy firepower that developed nations can only dream of.

A record-breaking tax take expected to top 10 trillion yuan ($1.6 trillion) in 2011 gives Beijing fiscal scope to support growth and financial system liquidity, while monetary policy is perfectly poised for easing after a near two-year tightening cycle.

Contrast that with deep deficits across Europe and the United States and the orthodox policies forced upon central banks on both continents in a desperate bid to avoid a slide into economic depression…

Twin bubbles in real estate and local government debt are still being battled by Beijing, and are arguably the only — if significant — policy constraint faced as the world’s second-biggest economy faces another economic slowdown.

Of course, we mustn’t forget that China is a manufacturing powerhouse.  And why is that?  They have no unions.  Are the Big Government Keynesians suggesting that the US do away with our unions?  It’s that cheap labor that makes all the difference in China.  It is the only reason why they are the world’s second largest economy.  It’s just not that currency manipulation.  It’s that cheap labor makes their export goods inexpensive.

But can it last?  With not one but two bubbles?  No other nation ever fixed a bubble without a long and painful recession.  Let’s not forget that a real estate bubble started the current US recession.  Which burst.  And became the subprime mortgage crisis.  And the Japanese Lost Decade also started with a real estate bubble.  Bubbles aren’t good.  Because they always burst.  And when they do painful recessions follow.

China will collapse.  As all state-run economies do.  Because any suspension of market forces never ends well.  At least, they haven’t yet.  Other than the latest try.  China.  But they will.  Because they always do.  The countries who allow free market capitalism are the ones that stand the test of time.  Just look at Britain and the US.  They’ve had centuries of success.  While China has only had a decade or two.  The odds are on free market capitalism.  Not state capitalism.  As time will no doubt tell again.

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A Skyscraper Boom may be an Early Recession Indicator

Posted by PITHOCRATES - January 14th, 2012

Week in Review

It takes a long time to build buildings.  Especially tall ones.  It takes large sums of money.  Environmental impact studies.  Lots of time to design it and produce contract documents.  Then there’s the bidding process.  Contracts.  All of this before they even break ground.  So it’s a very long process.  Then the building starts.  Which can take years.  So that’s a lot of years between financing commitments and occupancy.  This is why the construction industry is typically the last industry to enter a recession.  And the last to emerge from a recession.  So knowing this what can we learn from a skyscraper boom (see Skyscrapers ‘linked with impending financial crashes’ posted 1/10/2012 on BBC News Business)?

There is an “unhealthy correlation” between the building of skyscrapers and subsequent financial crashes, according to Barclays Capital…

“Often the world’s tallest buildings are simply the edifice of a broader skyscraper building boom, reflecting a widespread misallocation of capital and an impending economic correction,” Barclays Capital analysts said…

Investors should be most concerned about China, which is currently building 53% of all the tall buildings in the world, the bank said.

A lending boom following the global financial crisis in 2008 pushed prices higher in the world’s second largest economy.

In a separate report, JPMorgan Chase said that the Chinese property market could drop by as much as 20% in value in the country’s major cities within the next 12 to 18 months.

We get skyscraper booms during good economic times.  When interest rates are low.  And real estate bubbles are beginning to grow.  Cheap money gives us housing booms and high housing prices.  Then the inflation kicks in.  Inflating those real estate bubbles.  As inflation fears build they increase interest rates.  This increases the cost of buying those new homes.  Which, of course, leaves a lot of those new homes unsold.  With more homes for sale that there are buyers looking to buy only one thing can happen.  Prices fall.  Bubbles burst.  And recession sets in to correct prices.

While the economy collapses into recession those skyscrapers limp along.  Too late to stop.  And too costly to cancel.  Instead they’ll complete them.  On the exterior, at least.  And there they’ll stand as monuments to the folly of cheap money.  With thousands of square feet of empty office space.  Or rents slashed to get enough people into them to at least pay for the maintenance of these great buildings.

China has some problems.  Some big ones.  They have a shrinking trade surplus thanks to the weak demand in Europe and America.  Some inflation fears.  And now what looks like a real estate bubble being primed to burst.  Which may very well bring a recession China.  And it will be an economic crash heard round the world.

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The Great Housing Bubble and The Subprime Mortgage Crisis

Posted by PITHOCRATES - December 27th, 2011

History 101

Putting People into Houses trumped Sound Monetary Policy, a Sound Currency and good Lending Practices

Housing has for a long time been the key to economic prosperity.  Because to build a house you need a lot of economic activity.  Industries produce lumber, concrete, sheetrock, brick, shingles, door frames, doors, windows, glass, flooring, plumbing pipes, plumbing fixtures, sump pumps, furnaces, heating ducts, insulation, air conditioners, electrical wiring and fixtures, carpeting, tile, linoleum, etc.  The bigger the house the more of this stuff there is.  Once built people have to buy them (stimulating the mortgage banking industry) and then furnish them.  This triggers a monsoon of economic activity.  Drapes, shades, blinds, paint, washers, dryers, stoves, refrigerators, freezers, microwave ovens, toasters, blenders, food processers, plates, dishes, knives, silverware, ceiling fans, televisions, home theaters, sound systems, computers, cable and internet services, utilities, shelving, furniture, beds, cribs, art, etc.  And, of course, the exterior of the house creates further economic activity.

This is why one of the most important economic indicators is new housing starts.  For each new house we build we create a whirlwind of economic activity.  So much that it boggles the mind trying to think about it.  That’s why governments do whatever they can to stimulate this particular economic activity.  They encourage borrowing by allowing us to deduct the interest we pay on our mortgages.  They use monetary policy to keep interest rates as low as possible.  They’ve created federal programs to help veterans.  To help low income people.  And to remove risk from lenders to encourage more risky lending (as in Fannie Mae and Freddie Mac).  They’ve even used the power of government to force mortgage lenders to qualify the unqualified (Policy Statement on Discrimination in Lending).

You see, putting people into houses trumped everything else.  Sound monetary policy.  A sound currency.  Good lending practices.  Everything.  Because that was the key to a healthy economy.  A happy constituent.  And healthy tax revenue.  Not to mention you can score a lot of points with the poor and minorities by helping them into houses they can’t afford.  So this coordinated effort to put people into houses did two things.  Made money cheap and easy to borrow.  And created a boom in new housing starts.  Which resulted in a third thing.  A housing bubble.

Subprime Mortgages were for those who didn’t have Good Credit or Stable Employment with Reliable Income

Builders couldn’t build enough houses.  People were buying them faster than they built them.  And the houses they bought were getting bigger and bigger.  As they qualified for ever larger mortgages.  Poor people and people with bad credit could walk into a bank and get approved without documenting income.  House flippers could walk in day after day and get loans to buy houses.  Fix them up.  And put them back on the market.  Without using any of their own money. The market was soon flooded with new McMansions.  And refurbished smaller homes that people were moving out of.  Demand for homes was high.  And interest rates were low.  So the supply of homes swelled.  As did home prices.

Interest rates were low.  But they didn’t stay low.  All this coordinated effort to put as many people into homes as possible created a lot of artificial demand.  Heating up the economy.  Increasing prices higher than they had been.  Leading to inflationary worries.  So the Federal Reserve began to raise interest rates.  To temper that inflation.  Which didn’t sit well with those low income house owners.  Who got into their homes with the help of the Policy Statement on Discrimination in Lending.  Which forced lenders to get creative in qualifying the unqualified.  To avoid undo federal attention.  And legal actions against them.  So a lot of poor people had subprime mortgages.  As did all of those house flippers.  People who used little of their own money.  Who put little down.  And had little to lose.

What is a subprime mortgage?  In a word, risky.  It isn’t a 30-year fixed-rate mortgage at a good interest rate.  No, for those you need a good credit score and years of stable employment with reliable income.  And enough money saved up to put close to 20% down.  Subprime mortgages were for those who didn’t have a good credit score.  Years of stable employment with reliable income.  Or any savings.  These people didn’t get the ‘prime’ mortgages.  They got the expensive ones.  The ones with the higher interest rates.  And the higher monthly payments.  Why?  Because risk determined the interest rate.  And the higher the risk the higher the interest rate.

In their Effort to sustain Economic Activity the Government caused the Worst Recession since the Great Depression

But this posed a problem.  Because of the Policy Statement on Discrimination in Lending.  Making loans available to the unqualified was no good if the unqualified couldn’t afford them.  Enter the adjustable rate mortgage (ARM).  These mortgages had lower interest rates.  And lower monthly payments.  How you ask?  By making them adjustable.  A fixed-rate mortgage has to account for inflation.  And adjustable-rate mortgage doesn’t.  Because if there is inflation and the interest rates go up the ARM resets to a higher value.  Which is what happened right about the time housing prices peaked.

When the ARMs reset a lot of people couldn’t make their monthly payments anymore.  Having put little down and having made few monthly payments, these homeowners had little to lose by walking away from their homes.  And a lot of them did.  Including those house flippers.  And that was just the beginning.  With higher interest rates the new home market contracted.  Those artificially high house prices began to fall.  And when the ARMs reset they caused an avalanche of defaults and foreclosures.  The market was correcting.  There were far more houses for sale than there were buyers looking to buy.  Home values began to fall to reflect this real demand.  People who bought the biggest house they could afford because they thought real estate prices always went up soon discovered that wasn’t true.  People were making monthly payments on a mortgage that was greater than the value of their house.  Some walked away.  Some got out with short sales.  Where the lender agreed to eat the loss equity.

The housing market was imploding.  Thanks to a great real estate bubble created by the government.  In their quest to put as many people into houses as possible.  By making mortgages cheap and easy to get.  Relaxing lending standards.  And encouraging risky lending.  None of which would have happened had they left the housing market to market forces.  Where the market sets interest rates.  And housing prices.  The irony of the subprime mortgage crisis is that in their effort to sustain economic activity the government caused the worst recession since the Great Depression.  The Great Recession.

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LESSONS LEARNED #79: “Tax cuts stimulate. Not tax hikes.” -Old Pithy

Posted by PITHOCRATES - August 18th, 2011

With Bubbles the Ride Down is never as Enjoyable as the Ride Up

Bill Clinton dealt George W. Bush a horrible hand.  Clinton enjoyed the irrational exuberance.  He rode the good side of the dot-com bubble.  Saw the treasury awash in cash.  Dot-com people cashing in their stock options and paying huge capital gains taxes.  There was so much money pouring in that projections showed a balanced budget for the first time in a long time.  As long as the people stayed irrationally exuberant.  And that damn Alan Greenspan didn’t raise interest rates.  To rain on his parade.

But he did.  The days of free money were over.  (For awhile, at least).  Because people where bidding up stock prices for companies that hadn’t produced a product or provided a service.  Money poured into these dot-coms as investors were ever hopeful that they had found the next Microsoft.  These companies hired programmers.  Colleges couldn’t graduate enough of them.  To program whatever these companies would eventually do.  But with the spigot of free money turned off these companies ran out of startup capital.  As most of these businesses had no revenue they went out of business.  By the droves.  Throwing these programmers out onto the street.

And then the great contraction.  Which follows a bubble after it is a bubble no more.  Prices fell as deflation replaced inflation.  And as prices fell, unemployment went up.  The phantom prosperity at the end of the Nineties was being corrected.  And the ride down is never as enjoyable as the ride up. 

Easy Monetary Policy and lack of Congressional Oversight of Fannie Mae and Fannie Mac

And then there was, of course, 9/11.  Which further weakened an already weakened economy.  So that’s the backstory to the economic activity of the 2000s.  A decade that began with the aftermath of one bubble bursting.  And ended with an even worse bubble bursting.  The subprime mortgage crisis.  It was a decade of government stimulus.  George W. Bush used both tax cuts (at the beginning of his presidency).  And then a more Keynesian approach (tax rebates and tax incentives) at the end of his presidency.  In other words, tax and spend.

But the subprime mortgage crisis was so devastating that the 2008 stimulus urged by Ben Bernanke (Chairman of the Federal Reserve) to ward off a possible recession failed.  The easy monetary policy and lack of Congressional oversight of Fannie Mae and Freddie Mac caused big trouble.  And put far too many people into houses who couldn’t afford them.  The housing bubble was huge.  And because Fannie and Freddie were buying these risky mortgages and repackaging them into ‘safe’ securities, the fallout went beyond the housing market.  Pension funds, IRAs and 401(k)s that bought these ‘safe’ securities lost huge swaths of wealth.  The economic fallout was vast.  And global.

And then came Barack Obama.  A Keynesian if there was ever one.  With the economy in a free fall towards a depression, he signed into law an $800 billion stimulus package.  Not surprisingly, it turned out that about 88% of that was pure pork and earmarks.  Making his ‘stimulus’ stimulate even less than the George W. Bush $152 billion stimulus package.  And worked about as well.

Home Ownership was the Key to Economic Prosperity in the U.S.

So let’s look at the numbers.  Below is a chart graphing GDP, the unemployment rate and the inflation rate for the 2000s.  GDP is in billions of 2005 dollars.

(Sources: GDP, unemployment, inflation.  *Average to date (GDP – 2 quarters, unemployment rate – 7 months and inflation – 7 months).)

You can see the fallout of the dot-com bust.  The decade opens with deflation and a rising unemployment rate.  GDP, though, was still tracking upward.  After the bush tax cuts in 2001 (Economic Growth and Tax Relief Reconciliation Act of 2001) and 2003 (Jobs and Growth Tax Relief Reconciliation Act of 2003) you can see improvement.  Unemployment peaks out and then falls.  Inflation replaces deflation.  And GDP grows at a greater rate. 

Things were looking good.  But lurking in the background was that easy credit.  And federal policies to qualify unqualified people for mortgages.  To put them into houses they couldn’t afford.  All because home ownership was the key to economic prosperity in the U.S.

Which makes the rising rate of inflation a concern.  Rising inflation (i.e., expansionary or ‘easy’ monetary policy) created the dot-com bubble.  A rising inflation rate can be bad.  But at least during this period the growth rate of GDP is greater than the growth in the inflation rate.  Which indicates real economic growth.  Accompanied by a falling unemployment rate.  All nice.  Until…

Bernanke and Company Crapped their Pants

Those people approved for mortgages they weren’t qualified for?  Guess what?  They couldn’t make their mortgage payments.  And because Fannie and Freddie bought so many of these risky mortgages, these defaults weren’t the banks’ problems.  They were the taxpayers’ problems.  And anyone who bought those ‘safe’ securities.

Long story short, Bernanke and company crapped their pants.  He urged the $152 billion Economic Stimulus Act of 2008 to ward off a possible recession.  This was a Keynesian stimulus.  Remember that summer when you got those $300 checks?  This was that stimulus.  But it didn’t stimulate anything.  People used that money to pay down debt.  Because they were crapping their pants, too.

The good times were over.  That huge housing bubble was bursting.  And nothing was going to stop it.  Certainly not more of the same (Keynesian stimulus).  GDP fell.  Unemployment rose.  Inflation became deflation.  And Bernanke stepped in and turned the printing presses on.  Desperate not to make the same mistake the Fed made during the Great Depression.  When bad Fed policy caused all of those bank runs.

An Inflation Rate Greater than the GDP Growth Rate may Return us to Stagflation

The Obama administration (all Keynesians) pushed for a massive stimulus to fix the economy.  The best and brightest in the administration, Ivy League educated economists, guaranteed that if passed they could hold the unemployment rate under 8%.  So they passed it.  And Bernanke kept printing money.  In other words, more of the same.  More of what gave us the dot-com bubble.  And more of what gave us the housing bubble.  Inflationary monetary policy.  And more government spending.

Didn’t work.  It took a year for the deflation to end.  As the market corrected prices.  And readjusted supply to match actual demand.  The unemployment rate maxed out around 10%.  And the Obama stimulus didn’t move it much from that high. 

GDP growth resumed.  However, the growth of inflation is now greater than the growth of GDP.  A very ominous sign.  Indicating that GDP growth is not real.  And will likely collapse once the ‘free money’ Fed policies end.  Or the growth of inflation coupled with high unemployment return us to the Jimmy Carter stagflation of the Seventies.

Keynesian Stimulus is the way to go if you want Deflation and Recession 

Further Keynesian stimulus may only make a bad situation worse.  And prolong this economic ‘recovery’.  These policies make bubbles.  Which are fine and dandy until they burst.  Giving us deflation and recession.  And the bigger the bubble, the greater deflation and recession that follows.

Tax cuts stimulate.  They ended the dot-com recession.  All Keynesian attempts during the 2000s have failed.  Proving again that tax and spend doesn’t work.  Easy monetary policy and government spending does not end well.  Unless you want deflation and recession.  Then the Keynesian way is the way to go.  But if you want to stimulate economic activity.  If you want real GDP growth.  Then you have to go with tax cuts.  As their track record of success shows.

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It Ain’t 1996 – Obama’s path to Reelection isn’t Quite the same Road Clinton Traveled

Posted by PITHOCRATES - January 24th, 2011

Obama Doesn’t have the Healthcare and Economic Edge Clinton Had

Clinton was lucky.  Hillarycare (Clinton’s attempt to ‘nationalize’ healthcare) was a disaster.  It crashed and burned.  So it was off the table come reelection time.  And he had a smoking hot economy.  He had both a real estate bubble and a dot-com bubble.  Now, strictly speaking, bubbles aren’t good things.  Because they burst.  And recessions follow the bursting.  But until they burst, you got a smoking hot economy with low unemployment numbers.  Just the kind of things that gets presidents reelected.  REDSTATE has a list of other things, but let’s focus on items 3 & 4 in their list (see Why 2012 Is Not 1996 by Dan McLaughlin posted 1/24/2011 on REDSTATE).

3: Obamacare passed; Hillarycare didn’t: As unpopular as the Clinton Administration’s health care plan was, it wasn’t a major issue in the 1996 campaign because it had failed and, with Republicans controlling both Houses of Congress, it wasn’t coming back…Not so Obamacare, which remains very much a live issue.

4: The Economy: The unemployment rate is the most obvious of numerous economic indicators showing the U.S. economy in bad shape in 2011: unemployment, as low as 4.3% when voters elected the Democrats to control Congress in November 2006, was 6.5% when Obama was elected and 8.5% when he was inaugurated, and he expended much political capital arguing that his “stimulus” package would fix this with federal spending on “shovel-ready” projects; instead it peaked at 10.6% in January 2010, and remains above 9% a year later. These are very high numbers historically; since 1960, the unemployment rate has been above 6% on election day five times, and the only time the party in power wasn’t booted was 1984, when the 7.2% rate was the lowest it had been since before President Reagan took office and had plunged more than three points in two years. By contrast, the unemployment rate in 1996 was 5.4%, down from 7.4% when Bill Clinton was elected. If Obama can’t make the argument that Presidents Reagan and Clinton made – that they were not only making major headway on unemployment but in better shape than they were when elected (in Reagan’s case, the slight drop in unemployment was accompanied by an enormous drop in interest rates and inflation and a stock market boom) – he’ll face an electorate that is much more suspicious of entrusting him with the economy for four more years.

Historically speaking, history will favor who is not Obama in 2012 on these two issues.  And they’re about the biggest issues you can have.  A recession that just keeps on keeping on.  And a massive explosion in new spending.  Which can’t possibly help anything economic.

Old People and Jobs:  One Unpleasant Tradeoff

And there you have the ultimate showdown.  Obamacare versus the economy.  More spending and even more taxes.  Or less spending, less taxes and more jobs.  On one side you have emotional tugs of the heartstring (we have to help those poor uninsured people).  The other you have reality (we can’t raise taxes or borrow anymore without ending up like Greece).   

Obama may go Clinton.  And Clinton scored some big points with Welfare reform.  Obama has a chance to reform Medicare.  It is, after all, a part of Obamacare.  Gutting Medicare.  But Medicare is not welfare.  Those old people are a powerful voting bloc.  Will anyone, especially a Democrat, throw himself onto that ‘third rail’ (see Health care and the contest of credibility by Michael Gerson posted 1/25/2011 on The Washington Post)?

With Jack Lew and Gene Sperling in charge of its economic policy, the administration’s Clintonian direction is clear. It will seek higher revenue, cuts in defense, spending caps and more aggressive health-care price controls. When measuring deficit reduction, the last is the most important. It is the combination of cost inflation, an aging population and expansive health entitlements that push America toward the fate of Greece. Unless this problem is addressed, no tax increase or cut in discretionary spending will cause federal outlays to flatten at a sustainable percentage of the economy.

Higher revenue means higher taxes.  This is why Obamacare ‘reduces’ the deficit.  It has more new taxes than new spending in it.  But it’s a poor way to reduce the deficit.  If you have a problem because you’ve spent too much on your credit cards, what’s the easiest way to fix that problem?  Increase your revenue (i.e., your salary)?  Or cut your spending?  Of the two, you have far more power over spending cuts than you do on increasing your revenue.  So the smart money always goes on spending cuts to cut any deficit.  If you’re spending too much you just stop spending so much.  Pretty simple and straight forward.

But the 800 pound gorilla in the room is spending on old people (Medicare and Social Security).  We’re spending a fortune on increasing the life of the old so they can keep on collecting social security.  You’d have to be an idiot to not see the problem with that in an ‘entitlement-based’ government.

“The fact is,” says Yuval Levin of the Ethics and Public Policy Center, “Medicare is going to crush the government, and if Republicans leave it unreformed then the debt picture is very, very ugly. They might never – literally never – show the budget reaching balance. Not in the 10-year window and not if they take their graphs out a hundred years. Obama could probably show balance just past the budget window in the middle of the next decade because of the massive Medicare cuts he proposes, even if in practice they will never actually happen.”

Incidentally, those “massive Medicare cuts” he proposed was how he got CBO to favorably score Obamacare.  Without those cuts Obamacare would never have gotten any traction because of the massive cost.  Even with the massive tax increases.

So you see the grim picture? 

The Democratic approach to Medicare cuts would give doctors and providers less and less money while expecting them to cover the same services. “In reality,” says Levin, “providers won’t just provide the same care for less money – some will stop taking Medicare patients, some will go out of business, and some will reduce the level of care or amenities. That’s what we see in every system that takes this approach to cost control: waiting lines, dirty, unsafe hospitals with horrible food and amenities.”

And this is nationalized healthcare.  Healthcare for everyone.  All at an equally horrible standard.  Unless you’re in the government, of course.  Or are affluent enough to fly somewhere where there still is quality healthcare.

Pity the Poor Democrat son of a bitch Running in 2016

Obamacare benefits don’t really kick in until after the 2012 elections.  So when rationing kicks in and the ‘death panels’ start thinning the herd, it will be after the 2012 elections.  This may help.  The quality of our healthcare (Medicare and Obamacare) won’t really really suck until later.  However, taxes, regulations and mandates (and waivers) are kicking in before the benefits.  So the economy will still be in the toilet.  There might still be some tricks in the election bag to pull off reelection.  Who knows?  But one thing for sure.  Pity the poor Democrat son of a bitch running in 2016.  Because he or she will have to answer for the unprecedented mess their predecessor gave us.  Perpetual recession.  And horrible healthcare.

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The Anatomy of a Subprime Mortgage Crisis

Posted by PITHOCRATES - October 17th, 2010

Old Time Politics – Buying Votes

There’s a lot of lying going on about the subprime mortgage crisis.  How it happened.  Who was responsible for it.  Was it the banks and their predatory lending?  That’s who Barney Frank blames.  Well, them and Republicans.  Or was it some more of that irrational exuberance that led to a real estate bubble?  It created a dot-com bubble in the 1990s.  Which in turn caused a recession.  Was it just a little history repeating itself?  Perhaps they both played a part.  But if they did, they were minor supporting roles.  They weren’t the star of the crisis.  For neither could have done anything had it not been for their enabler.

The Boston Globe’s Donovan Slack writes about one of the enablers backpedaling on his previous rosy statements about the two companies at ground zero of the crisis (see Stance on Fannie and Freddie dogs Frank on boston.com).  Fannie Mae.  And Freddie Mac.  Frank is running for reelection.  And his words are coming back to haunt him.

America is a center-right nation.  To counter that, the Left courts a coalition of special interests and single-issue voters.  Federal workers, teachers, unions, gays & lesbians, pro-choice feminists, environmentalists, socialists, minorities, etc.  Each taken by themselves is a very small percentage of the voting population.  But taken together it’s a sizeable percentage.  Then add in one more very important Democrat constituency.  The poor.  Now with all of these firmly in the Democrat’s camp, it’s just a matter of getting enough of the moderate and independent vote to win an election.  Of course, this is a moot point if they DON’T lock in the Democrat base.  And they do this by giving away as much free stuff and favorable legislation as possible. 

Give Me Your Tired, Your Poor, Your Huddled Masses Yearning for a House They Can’t Afford

The key to locking in the base is, of course, the poor.  There are a lot of them.  So the Left courts them.  Engages in class warfare.  They paint the Republicans as rich fat-cats who want to take their welfare, social security, food stamps, etc., away from them.  That they want to keep them in slums or throw them onto the street.  In contrast, they, the Democrats, want to provide for them.  To help them.  And they give them a lot of things.  To earn their gratitude.  And their votes at the election booth.  And the grandest of all the things given to them?  Affordable housing.

Poor people don’t have a lot of money.  That’s pretty straight forward but it needs to be said.  Because people who don’t have a lot of money can’t afford to buy a house.  Again, that’s pretty straight forward.  But it needs to be said.  Now, when these people apply for a mortgage and get denied, why do you think they got denied?  Here’s a hint.  Re-read this paragraph.  They get denied because they don’t have a lot of money.  You see, if you don’t have a lot of money, you can’t buy expensive things.  Again, straight forward.  But it needs to be said.  Again.  And often.

Now, what do you think a politician thinks the reason was for these poor people getting their mortgage applications denied?  Red-lining.  Racism.  Classism.  Unfairism.  (Yeah, that isn’t a word.  But it works.)  A large percentage of those denied mortgages are from the inner city poor.  And because of previous white-flight, that inner-city poor also happens to be primarily minority.  Hence the charges of racism.  And that’s just gold to a political party who needs poor minorities to vote for them.

The Siren Song of Affordable Housing

Now Barney Frank is running for reelection.  His Republican challenger is using Frank’s own words in his campaign.   And they’re causing some damage.  For Frank sat on the House’s Financial Services Committee (the oversight committee for Fannie Mae and Freddie Mac) throughout the time the crisis built.  And now he’s answering some very uncomfortable questions (this and all quotes are from Stance on Fannie and Freddie dogs Frank).

Frank, in his most detailed explanation to date about his actions, said in an interview he missed the warning signs because he was wearing ideological blinders. He said he had worried that Republican lawmakers and the Bush administration were going after Fannie and Freddie for their own ideological reasons and would curtail the lenders’ mission of providing affordable housing.

Ideology trumped responsibility.  The Left cries foul when the Right doesn’t reach across the aisle, but the Left never reaches out when they have power.  It’s us against them.  Pure partisanship.  Even when there’s great danger brewing.  It’s their interests first.  Then the country’s.  So he protected Freddie and Fannie.  And enabled them to cause greater harm.

Freddie and Fannie are in the secondary mortgage market.  They don’t write mortgages.  They guarantee them (so banks are more willing to take risks with less credit-worthy people).  And they buy these risky mortgages from the banks.  This further reduces a bank’s risk in approving very risky loans to people who are not credit-worthy.  Which is what the Democrats want.  More affordable housing for people who can’t afford to buy houses.  Frank’s committee sets the rules Freddie and Fannie must follow to keep them from approving mortgages that are crazy-stupid.  But that’s exactly what they encouraged.  Subprime loans.  Adjustable Rate Mortgages (ARMs).  Interest only mortgages.  No documentation approvals.  Any bank that didn’t have enough of these mortgages on their books (i.e., risky loans to poor people who couldn’t afford to buy houses) was in trouble.  The federal government would investigate them for red-lining, racism, classism, etc.

The more mortgages Freddie and Fannie bought, the more cash banks had to make more risky loans.  They then dumped these risky loans onto Wall Street.  You see, before the day of subprime loans, ARMs, interest only mortgages and no documentation approvals, mortgages were very safe loans.  But these subprime loans weren’t.  But they looked safe when Wall Street sold them.  I mean, buyers didn’t see the mortgage applications.  They had no idea what a credit risk these people were.  They just knew mortgages were traditionally safe investments.  So they just bought them.  And Freddie and Fannie made it all possible.

Known as government-sponsored enterprises, they didn’t provide mortgages themselves, but rather bought loans from banks and mortgage brokers, freeing up cash so the lenders could make more loans. Fannie and Freddie held or bundled the loans and sold them to investors as mortgage-backed securities.

Investors bought these very ‘profitable’ securities.  This demand just fueled the crisis in waiting.  Because Freddie and Fannie could dump these on Wall Street, they wrote more and more risky loans.  This made everyone happy.  Everyone was making money.  And more people who couldn’t afford to buy houses were buying houses.  And this was, after all, Freddie and Fannie’s mission.  Affordable housing.

In an effort to increase homeownership, the Clinton administration in the late 1990s and the Bush administration in the 2000s pushed Fannie and Freddie to meet growing quotas for buying affordable home loans. Those pushes, combined with a drive for more profits at the enterprises, drove Fannie and Freddie to take on more risk and more debt. They backed subprime and other risky loans, including mortgages for borrowers without proof of steady income.

Even the Republicans got on the band wagon.  New homes sales drive the economy (because of the stuff people have to buy to put into those houses that they can’t afford).  And you make points with the poor and the minorities.  There was just no down side in affordable housing.  Or was there?

But the director of the federal office responsible for overseeing Fannie and Freddie, Armando Falcon, began noticing their expanding portfolios and increasing reliance on risky investments. In early 2003, Falcon warned Congress in a 118-page report of the companies’ potential for a catastrophic failure that could jeopardize the economy.

Okay.  Five years before the crash someone was taking notice.  And he warned Congress.  Thank god someone was looking out for America’s best interests.

But Frank and other Democrats still opposed tighter regulation, Frank most notably in his public statements saying there was nothing wrong with Fannie and Freddie. He and other House Democrats also sent a letter to President George W. Bush in June 2004, saying the proposed crackdown could “weaken affordable housing performance . . . by emphasizing only safety and soundness.’’

Frank and the Democrats were saying that it was more important to put people who couldn’t afford houses into houses than it was to provide oversight.

So he initially supported a Republican measure in 2005 that would have imposed stricter standards on the lenders. But he voted against it in the full chamber because it did not include funding for affordable housing, he said. The bill passed the House.

Frank came around.  He supported a Republican measure to provide stricter oversight.  But he changed his mind.  Once again, affordable housing was more important than the oversight he was supposed to provide.  Then, in the summer of 2008, Treasury Secretary Henry Paulson warned Frank again.  Now Frank chaired the House’s Financial Services Committee.  Now, more than ever, it was his responsibility to reign in Freddie and Fannie.  To provide the oversight that was his committee’s responsibility.  But he still didn’t.  Like Nero, he fiddled as the crisis burned out of control.

In July 2008, then-Treasury Secretary Henry Paulson called Frank and told him the government would need to spend “billions of taxpayer dollars to backstop the institutions from catastrophic failure,’’ according to Paulson’s recent book. Frank, despite that conversation, appeared on national television two days later and said the companies were “fundamentally sound, not in danger of going under.’’

A few months later, Freddie and Fannie would cause the worst recession since the Great Depression.  On Frank’s watch.  And he kept denying that there was any problem until the very end.

Lots of Blame to Go Around – On the Left Side of the Aisle

Barney Frank is not the sole cause of the subprime mortgage crisis.  He was just one of the leading players.  Ultimately, it was an ideology.  Affordable housing.  Putting people into houses who couldn’t afford to buy houses.  This is what caused the worst recession since the Great Depression.  And, yes, the Bush administration did partake in the affordable housing mania.  But if you want to assign real responsibility, ask yourself this question.  Which party do you think of when it comes to affordable housing for the poor and minorities?

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