Fine tuning our pessimism

Attention!
As we argued they would, markets are now paying attention to the economy. Boy are they. The prevalent question has become, 'how far is down?" And that's not an Expedia question about the location of Australia.

Europe in Spotlight's glare
Markets fell very sharply in the wake of a weaker-than-expected job report on Friday despite the US bailout package passing. But Monday was not so much 'US news day' or even 'react to Friday's US news day', as it was a day of chaos spreading to Asia but mostly to Europe.

Minimalism
The Europeans are trying a minimalist strategy since they can't agree on a real plan. It's a start but it may not be a good one. The EMU countries do have one currency. And EU countries have a lot rules harmonized. But when it comes to spending money, it's: to each his own. That's the problem in trying to put up a a safety net. They don't seem to be able to agree who will hold it or pay for it.

Ire for Ireland
Ireland put a specific deposit guarantees schemes in place and has been criticized for taking a stand that could commit it to expenditures that might widen its deficit and bust the Maastricht criteria. SOORRRY! But protecting people against loss...isn't that the point of it?

Coordinated rate cuts?
But Germany, France the UK and Italy have other issues. They can't agree what to do. Merkel made a statement about protecting depositors, then after seeing how the EC commission treated Ireland and after some anxious talks with UK officials that did not want to have to launch a formal plan of their own, Merkel declared her promise to be a political statement rather than a formal guarantee.

Tricks or Treats?
In the US when Paulson tried that TRICK with Fannie and Freddie he wound up having to seize them both. Verbal assurances when in a crisis mode usually do not work.

Leaderless Europe
Europe seems adrift. Policymakers want to do something but their structure is not conducive to it. There is talk of a coordinated rate cut, and given the global stress it is quite possible they will find a way to accomplish it. But it would be a hard thing for the ECB to do. At 3.6% headline inflation is just too far above its ceiling rate of 2%. The credit crisis is a clear and present world problem but a coordinated rate cut, that was the rumor that helped bring the US stock market back from the abyss on Monday is a bit of a stretch. But then at -800 points in one day the DJIA was a bit of a stretch, too. One thing we learned is that while the mood is poor and investors are selling they have an appreciation that value nonetheless lurks and with the right program in place...and they are right. The fight over Wachovia also cements that notion.

So while pessimism is stalking the markets so is opportunity.

Price your pessimism carefully.

Full Blown? Or Half Hearted?

Now time for some of the interesting questions


Financial crisis: Full blown or half hearted?
The US has a pretty major financial problem brewing. It has spread to Europe as we see Ireland and then Germany guarantees depositors in banks beyond what was their norm. We know about Libor and the interbank finding problems. We have seen various financial institutions in the US in the UK in Belgium and the Netherlands, in Germany in Denmark with their problems. Other banks have been hit with adverse speculation. But will this spread out of the financial sector and will it spread to the sovereign debt and lending markets?

Russia already is having severe stock market difficulties. That owes less to the credit crunch than to concerns over its actions in Georgia. plunging oil and commodity prices also will hit Russia hard. Its economy is more like that of a developing economy and it is going to be hit hard. The risk that this liquidity problem could spread is a clear one.

We have seen the problems hit stocks hard. Last week the S&P industrials sector fell sharply by 12% in the week. Companies with large financial operations such as the auto companies and GE have been hard hit. In the US auto companies have gotten with own special aid package. Even in Europe auto companies are looking for some help on the grounds that getting capital together to invest to meeting the new mileage and emissions standards will be too costly. Everyone is looking for money.

If it spills out into the international lending market it will become a bigger problem. It looks like it is headed in that direction.

US economic downturn: full blown recession or half-hearted slowdown?
The US downturn is looking more severe. That Sept employment report may have had some minor boost from hurricane disruptions. If so next month will certainly have more - jobless claims data tell us that. But beyond those short term technical factors wheat is really cooking with the recession and with job growth? Is it really getting much worse? With the spreading credit crunch betting on a worsening makes sense.

The unemployment rate topped out between 6% and 6.5% the last cycle. In 1991 the rate peaked just short of 8%. Since the late 1950s the unemployment rate has topped out in recessions at 8% on average and just above 7.5% in terms of the median result. But the last two recessions produced average to lower unemployment peaks. The recession's unemployment peak is usually lower if the inflation rate has been lower. But while headline inflation has been elevated in this cycle the core rate really has not. I am more inclined to worry about the financial transmittal and the impact on the economy from that channel than from inflation which has been under control... since I do not call the headline result of the CPI inflation. Core inflation has remained pretty well under control.

On balance the U-rate should peak out around 7% in this cycle. That keeps it short of the average but well above the mild recession mark. The greater role of the more stable service sector and the slowdown in population growth and aging of the population should help to keep the U-rate from surging in this cycle.

I'm from the goverment, I'm here to help you...

Former laugh-line becomes policy...

Ronald Reagan made the line, "I'm from the government, I'm here to help you,' a laugh line in his campaign to make government smaller. Of course his scheme which saw a stronger military, smaller deficits, a reduced role for government and lower taxes became known as Voodoo economics. We could use a little Voodoo right now.

Voodoo was merely a failure to express what would happen when push turned to shove...
The Reagan approach did not deliver on these promises so in the end there was no voodoo. There were instead much larger deficits, lower taxes, more military spending and a reduced role for government in some places. The pledge on deficits was the one that solved the riddle that the voodoo assertion was aimed at, namely that you can't do all those things at once.The pledge was, in fact one of mutually inconsistent promises. Still, Reagan had vision and and a keen grasp of politics. In the end he kept the promises people wanted most to be kept.

What do we learn from that as government comes to 'help us?'

Full Speed Ahead - Into Reverse, Please
So now the government has a pile of money it has handed over to treasury. We all assume treasury will be able to raise these funds since the US is the centerpiece in a global growth revival plan. The Fed plans to come forward by conducting 'reverse auctions'. We have no idea how speedily this process will move forward, how effective it will be, or what the Fed will do. We would expect it to start slowly since the Fed has never done this before. Unfortunately the economy and the financial mess is unraveling quickly and... THIS is the way we are supposed to stop it? With slow-acting medicine? Great solution. Expect a rate cut too.

Cracks in the facade of "help" - Meanwhile the economy seems to be getting worse (see my previous post). To make matters worse-still the government-brokered takeover of Wachovia by Citibank/Group is now a SNAFU as Wells Fargo has stepped in with a a superior offer private sector-only offering. The legal experts are very mixed on where this all stands. But Wachovia has 'welcomed' Citi to make a fresh offer. This is not to say that a private sector offer isn't good especially if it really is superior for the the taxpayers, as this one seems to be... but who will want to go along with the government's next arranged marriage if this one fails? So, in the end, is government really helping?

The European approach: I'm From the Government and I want to PRETEND TO HELP YOU -
In Europe the skein of yarn is bumping down the stairs leaving a huge tangled mess in its wake. While Europeans have gloated and chortled that they don't need a US-style plan. Still, Europe is beginning to unravel. At a Saturday summit all the Big-Four Euro-leaders could agree to was to coordinate not to have a real plan. EMU is a currency area. EU is a customs union and an area with certain harmonized rules including some fundamental free passage principles for residents. But fiscal policies are still separate. This is one of the great failings of EU/EMU. The states without dominate financial sectors do not want want bailouts for the states whose institutions are embroiled in trouble. In this matter Germany is to France what each is to the US. Their common euro-ness gets them nowhere- no greater coordination.

Meanwhile Europe has issues -
The consortium of banks cobbled together to bail out Hypo the second largest German property lender has fallen apart. The government had promised an injection of €27billion. In the original plan The consortium of banks was to put up some €10bln in the bailout effort. Hypo is now hanging by a thread and who knows where Europe/Germany stand?

Fortis, a Belgian-Dutch insurer/bank is also the object of public help. The Dutch government stepped in late Friday to break up and nationalize part of Fortis NV after the previous weekend's rescue plan failed to work. It's a lot like the situation we are seeing with Hypo...The plan is for the Dutch government to buy most of the bank's assets in the country for €16.8 billion ($23 billion) to contain the fallout. The deal follows an €11.2 billion rescue for Fortis funded by the governments of Belgium, Luxembourg and the Netherlands announced a week ago Sunday. The Dutch government said it plans to privatize the operations again after the financial turmoil subsides. The deal breaks up a company that was created by the 1990 merger of Dutch and Belgian insurers. What's left of Fortis will be a dramatically scaled-back version of a company that until recently had ambitions of becoming a major global financial player. Well it did or it had become a major global player and it got what other globals also got. Now Dutch central bank governor Nout Wellink says that ABN AMRO/Fortis integration must be completed before it can be privatized again. This depends on the length of the financial crisis he says. Fortis is a strong, well capitalized concern according to Wellink. Wellink also claims that Fortis suffered from big clients that didn't trust it anymore - but that has been the hallmark of this crisis. Surely Europeans, like Wellink, don't think that different rules apply to them? Wellink also says that, "we are in big shift in financial sector, will have consequences for real economy." I can agree with that. Look for the ECB to do the unthinkable sooner than expected and cut rates; it's no longer a matter of choice.

And then there was Dexia
The chief executive of Belgian-French bank Dexia SA said Friday he won't seek a golden parachute when he steps down from his post in the next few months after much pressure for him to shun his golden pillow. Dexia ran up huge losses in its U.S. operations, causing its shares to close nearly 30% lower last Monday and triggering emergency talks with government officials. This came barely two days after Belgium, the original Netherlands and Luxembourg moved to save Fortis on Sunday,a week ago. No Europe does not the the problems of US firms; it has its own. And because we wonder even more about Euro-transparency we wonder about what is being covered up...

Welcome to my world
So Europe has its hands full and seems to be interested only in giving us the pretense of supporting markets and their troubled players. As we see in the US with the Wachovia situation sometimes government arranged bailouts don't work. The failure in the US surrounding Wachovia may not have a bad repercussion; Europe's failures are having bad repercussions. As we saw previously in the US with the Fannie and Freddie and then Lehman stance's by policymakers, each spread their own ripples. The ripples are still spreading. The credit crunch is still severe and the economy is getting worse. It's not about the government as savior, but as the last source of capital when the private markets become dysfunctional or just too risk averse. Europe just doesn't get it.

Jobs fade and rate cuts looms

Good news is overtaken by reality
The bail-out plan is in. Job growth is out. So where's the good news?

Going in reverse...
We are now going to see how long it takes to put this new plan with its untried reverse auctions into practice.

Captain CRUNCH
While we wait for that, the credit crunch is busily crunching. Auto sales this past month were very weak and the crunch has not yet set in on that sector. Crunch. Crunch. The housing mess, as we have been saying is going to get worse. Crunch Crunch. Construction sector job losses got larger this past month. Crunch. Crunch. Overall job losses were out-sized last month and the length of the work week pulled back. Together these pull backs hint of a strong retraction of economic activity. And in the background you know what we have working against us...Crunch. Crunch.

Jobs??J
Job losses are in train. The service sector is seeing strong job losses in comparison with past recessions. The MFG sector usually unravels in recession and that has not really happened yet. Exports have helped cushion the MFG blow. But with the service sector impacted, construction losses growing and MFG losses in train (even if they are not as severe as in the past) the prognosis for income growth and consumer spending is pretty poor. The shortened work week will amplify that problem.

Is MFG getting a late srtart on its recession losses?
We can wonder if the sharp drop in the ISM and its key components signals a step up in the recession's impact on MFG. The ISM showed weakness that in some ways is unprecedented in the history of this venerable report that goes back to 1950s. If MFG does cave in, we could be in for something that is very severe, since the service sector is already so weak. Certainly there are some early warning signals out there.

Got rate cuts?
We have been opposed to Fed rate cuts up to now. Rate cuts will not cure the financial problems. But with economic weakness hitting a new low and a credit crunch emerging it is probably time for the Fed to do what it can. Rate cuts are no panacea. But with the credit crunch tightening last week, mortgage rates were squeezed even higher. A rate cut could keep that sort of pressure at bay. We do look for the Fed to chip in and act. The likely cut is 50Bp. The Fed has to do more than 25bp but we don't think it will want to cut by a full percentage point and put the Funds rate at 1% just yet.

Hey Man, It's not my job...

Buckle up. Friday should be a heck of a day.

To pass or not to pass that is the question
It is unclear whether the House will pass this bill from the Senate. A group of twenty-some 'no voting' Republicans is 'Mad as Hell' at all the pork attached to this bill and wants to cap the payout to the treasury at $250 bln with stipulation that the rest will be subject to a vote as needed. As the bill stands the money is allocated unless a vote rescinds the allocation. ANd then they want all that pork trimmed off, too. Good luck.

My pork is your bread and butter
Obviously all is not well in Congress-land as stupid legislative tricks are in swing.


Next the kids vote- really? If so who needs grown-ups?
While some jokingly refer to the Senate as the 'grown-ups voting', those grown-ups attached some real pork to the bill that the they did pass- money for a producer of arrows? Are you kidding me? What grow-ups are these?

Some in the House want to look into stripping this language out. It's getting messy already.

The BIG news is the BIG news not the manufactured news
The BIG NEWS on Friday, House bill or not, is the employment report. The House bill if voted down can be recast yet again. The government can go to "Plan D.' 'Plan A' was the Treasury Secretary's non starter 'Plan B' was rejected by the House. 'Plan C' is coming out of the Senate now. Whatever! The financial sector issues can be addressed as this has become a charade of Congress' own making.

As good as it gets, until it gets worse, of course
The employment report is real. The number could be revised. But the situation is whatever it is. Congress cannot just vote on it again if they don't like it. And signs are that things seem to be slipping. What's more is that the economic data we await and that other recent reports have embodied, are all basically from a period that precedes the credit problems, problems that have become more intense. I refer to the sharp fall in the ISM, the drop in auto sales, two straight monthly drops in retail sales, the drop in industrial output and so on.... So whatever we get from these reports it seem HIGHLY LIKELY THAT NEXT MONTH WILL BE WORSE.

So far so good except for the results
The cut off period for non-farm payroll jobs is the 'pay period' including the 12th. Lehman's problems were later in the month. The spike in jobless claims come from hurricanes that post- date this jobs survey. The jobs report and these past weak reports (except jobless claims) are relatively clean reads on the economy despite the proximity to these distortions. And so far the other 'clean' readings have been weak, very weak.

Suck it up boys and girls...
The upshot is that we can survive some more 'stupid pet tricks' from the House. But why suffer so? The dirty little secret is that a weaker economy --> weaker housing --> weaker prices --> weaker securities that are backed by house values (CDOs etc) --> more write downs for banks --> more financial chaos. So why dally in trying to deal with this? Things are not going to 'get better on 'their own' unless you wait a very long time. And if the banks aren't fixed first, things will get a lot worse before you can even think of them getting better.

Time bomb or time in a bottle?
C0ngress does not have time in a bottle. Once this vote is cast it will take some time to get these auctions going that the Fed so desperately wants to conduct. These have not been done before so it will take time to set them up. Don't expect the interbank market to unfreeze instantly even if the House bill passes untouched by revision. There is still a lot to do. The bill as it stands adds pork to something that already was not very kosher. It still may NOT pass in one wave of the voting wand. But if it does there is still a long road ahead and no assurances that EVEN AFTER bank balance sheets are wiped squeaky clean - if that can be done- banks will jump back into the markets with two-fisted lending. More like they will be like the guy with the hangover the morning after. Fit again but with legacy problem that will make him temper his own behavior.

Prepares for that.

RATE CUT ON THE TABLE!

Let's hope this WSJ report about the Fed considering a rate cut is true.

HAVE THEY SEEN THE LIGHT?
After all the very weak data we have witnessed we know that this is more than bad hair day for the economy. You can't just lick your hand and smooth this baby's hair back into place. Yesterday stock prices rose in the face of very weak vehicle sales, a stunningly weak ISM and news of continuing faltering in the construction sector. Why? are they so enamored of the idea that the Senate is doing the right thing? Will Congress see the light?

BLINDED BY THE LIGHT! or DARK?
Yes all eyes are on Washington and when you think that is where economic leadership is coming from you are in real trouble. Nothing there works fast enough or is quite right to really repair markets. You know its going to be a slap-dash fix. The economic support package from earlier in the year really 'worked' didn't it? Markets are too centered on events inside the overstuffed beltway while the economy is going to Hell in a hand basket. Heck we may already be there! having a devil of a good time yet?

RATE CUTS- A PANACEA?
Right-o, cuts are not a panacea but they might help. Rate cuts are hampered by the low level of rates. We KNOW the Fed does not want to cut FF below 1%... So at 2% rates have little downside. that means once you start cutting expectations will not get that far out in front of you and the impact of the cut might be blunted. A skeptical market might even respond by less than the rate cut if it does not think there will be follow though. All that argues for cutting by 50bp.

THE ECONOMY STUPID or VOODOO ECONOMICS?
The reason for a cut is the sudden deterioration in the economy, not financial strife. The Fed also should hold back until the House passes its side of the bill. The Fed should not look like it is stepping into the fray. It should cut rates soon and not wait until the next meeting that is too close to the election. This time a cut makes sense, but don't get your hopes up and remember rate cuts have brought some ill consequences for the dollar, for commodity prices, oil, etc. Let's hope IF the Fed does it the market approves. Jobless claims are hugging the 500K mark. There are reasons for concern. Are interest rates the right medicine? Well, things are so weak I'd try herbal medicine, acupuncture and look in the yellow pages under 'V' for 'Voodoo.' Gosh remember Voodoo economics? Could we bring it back? Already did? Rats! How about misdirection? 'Nothing up my sleeve!" Tried that one too, eh? What's left? triage...oohhh painful, but probably correct. Time to cull out the dead wood and stop pretending we can voodoo it back to life or pretend it's still alive like 'Mom' in the rocker at the Bates Motel. We know where that one leads.

Too late to resuscitate the dead

The key report is not yet in but the verdict is.

The economy is dead. Long live the economy.

The employment report on Friday will only serve to add its voice to the chorus of economic growth mourners.

ISM? How about...recessionism?
Today's ISM report is among the weakest of its kind, although we often see weaker headlines for this MFG report in recessions. The most stunning thing about this September report on manufacturing activity is not how low this index stands or how much its components have dropped, rather it is how much they have fallen in just one month's time. The severity of the drop in the ISM headline, in the new orders and employment barometers together is unprecedented in data dating back to 1955.

1955

Housing crisis is one in a century? ISM weakness is two in a century?

And many say we are not yet in recession.

That's interesting. We have been in recession on balance 14% or 15% of the time since 1995. So it would be odd if a twice in century event that exposed a swift decline in MFG activity was not part of a recession. Wouldn't it?

I doubt that many will continue to sing that tune.

Look for Gray's Papaya in NY to go back to running it's 'recession specials.'

Happy days are here again...

Recession? Really? Please pass the caviar...
One month ago we saw the rate of unemployment jump to 6.1% from 5.7%. We have since seen retail sales fall for two months in a row. We have seen industrial output fall by more than 1% in a month. We have seen great weakness in inflation-adjusted consumer spending (PCE -personal consumption expenditure, the broadest measure of real consumer spending). And while construction spending in August came up flat, in July it has been revised sharply lower. Moreover, residential spending is still declining at a rapid pace with little evidence that the slide is abating. Non-residential construction is losing some of its steam and showing signs of increased weakness. And, of course, if the economy is sliding into a more extreme phase of recession, housing and nonresidential construction spending will each weaken further.

...and that is a real risk, indeed, likelihood.

The bailout that is being considered has nothing in it directly to support the housing sector. Without supporting housing, all housing linked securities will get weaker. That will, of course, weigh on the banks that this legislation is supposed to help. Fiddle-dee-dee!

Treasury Secretary Paulson says that the housing sector is the issue. but banks are singled out by pending legislation.

There is a lot of weirdness about and surrounding this legislation.The suddenness of the request is striking. The masquerade before about troubled institutions that were mooted as possible acquirers of other troubled institutions. The abrupt demise of Fannie and Freddie and the discovery of accounting irregularities as a catalyst but not one that gets blame attached to the respective CEOs, who are allowed to bow out with grace. The blatant power grab that the initial bill seems to have been as offered by Paulson. The support of such a clear non-starter by a highly intelligent but perhaps politically naive Fed Chairman. The banking committee heads who let such stuff be presented to them in the first place. The rejection of the legislation even after substantial modification in the House and by the President's own party. This episode will make some great case study for political science students following the politics and horse-trading of legislation.

Meanwhile the Senate has passed its bill and now we await the House's second pass at it.

Meanwhile the garbage disposal is on and the economy is going through it.

Meanwhile what needed to be fixed looks like it is going to get fixed but it's not the only thing that needs attention.

Another day, another trillion dollars.