Making a Bad Situation Badder

A few reporters across the pond see the financial problems in the U.S. as small potatoes compared to those of the U.K., and that Bernanke and Co. have somehow set us back on the right track. Well, as Bill Bonner explains, they couldn’t be more wrong.

This week, according to the Bloomberg report:

"Prime Minister Gordon Brown suspended a tax on buying some homes for the first time since 1991 and brought forward 1 billion pounds ($1.8 billion) of spending in an effort to revive the U.K. economy."

Brought forward? From where? In effect, the government will take money from renters and solvent homeowners to help a few people stay in houses they can’t really afford. Meanwhile, in the United States, private lenders have grown wary, but the feds’ money still flows like free beer. Fannie Mae and Freddie Mac face combined losses of up to $100 billion – much of which will have to be swallowed by the taxpayer. Next in line at the bar are the automakers, asking for $25 billion – at negative interest rates, of course.

"The response to this sad situation is unfortunately simple," wrote Marc Touati, in the new French version of MoneyWeek magazine. "The United States is doing everything it can to promote growth and employment, knowing that as soon as the economy improves its economic policies can be less accommodating. "

Mr. Touati is an admirer of America’s financial activism. Looking back over the past 10 years, he sees two episodes when U.S. financial authorities acted aggressively and apparently, successively. In 1995, for example, economists thought the United States was headed into a prolonged slump while Europe was poised for a period of dynamic growth. Instead, it was America that surprised to the upside. Again, in 2002, same situation. The U.S. seemed to be in for a tough time, while Europe had the wind at its back. But again, America sailed ahead, while the Old World couldn’t seem to catch a breeze.

Now, in 2008, here we go again, he seems to say: "Once again, the consensus is wrong. Thus, the American economy has avoided the much-announced serious, prolonged recession, while the euro zone is threatened…"

Fortunately for you, dear reader, we do not have the space to describe in detail where Mr. Touati goes wrong; we can only summarize: each time the U.S. consumer threatened to stop spending more than he could afford, the feds gave him more credit on easier terms. The U.S. economy "grew," but it grew worse off.

George Magnus, writing in the Financial Times on Tuesday, also looks with favor on U.S. monetary and fiscal policies: "[T]he Fed has been obliged to do unusual things to avert a systemic financial meltdown. I see nothing [in its] operations that is irreversible and cannot be undone as the sense or crisis evaporates."

Mr. Magnus ought to take a look at the Fed’s books. Hardly more than 12 months ago, the American central bank’s vaults were so full of U.S. Treasury debt that anything else in there wasn’t worth talking about. But at the end of last year, the bank began buying up the flotsam and jetsam from sinking Wall Street ships. Now, the Fed’s assets look like a poor man’s attic – including $106 billion of junk in a category known as "other." What exactly is in these credits, we don’t know. But we know they weren’t there a year ago and they are only there now because other financial institutions were desperate to get rid of them. The Fed, serving as chump of last resort, was the only player dumb enough, or rich enough, to take them on.

If Mr. Magnus is right – if the crisis "evaporates" – perhaps these soggy credits will be crisp and saleable again. And perhaps the British government will make a profit on Northern Rock. Then again, maybe the markets are wrong about oil too. Perhaps it will sell for $10 a barrel again next year…just like it did in ’98. And maybe the Russians will reconsider; maybe they’ll hoist the old hammer and sickle and go back to standing in lines to buy a can of peas.

We don’t know. We have tried to look into the future. Maybe if we could do it, we too would be tempted to improve it before it happened. But we’ve never gotten the hang of it. Instead, we turn to the past…

"Unusual events merit unusual solutions, especially when systemic risk is present," concludes Mr. Magnus. On this point, he is surely mistaken. There is nothing unusual about these events, nor about the solutions. Every bubble in history was followed by a bust. And the feds always use a crisis like a whale uses a beach. Emperor Diocletian, like Richard Nixon and Robert Mugabe, washed up on wage/price controls. Troubled by inflation, their economies got worse when they tried to stop it with price controls. Philippe d’Orleans, Regent for the young Louis 15th, turned to Beau Wilson’s killer to save the monarchy from the Sun King’s debts. John Law, with his funny, paper money, soon beached the entire country, and himself too. And now, the world turns its weary eyes to Ben Bernanke. The price Mr. Bernanke seeks to the control is the most important of all – the price of credit. He holds it down in order to try to keep other prices moving up – and to keep the consumer spending!

Mr. Magnus says the "erosion of the consumer’s purchasing power from shrinking access to credit and dwindling housing wealth has only just begun. This is true in the U.S. and the U.K…" Elsewhere in the FT comes word that another $96 billion in risky home loan chickens are coming home to roost in the next two years, citing a Fitch report that estimates an average increase of 63% – or $1,053 extra per month. This comes as late payments and defaults are already as high as 24% for these make-believe mortgages. Too bad, but no thanks are given to the feds for sending the birds off in the first place.

Enjoy your weekend,

Bill Bonner
The Daily Reckoning

September 05, 2008 — Los Angeles, California

Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis.

Bill’s latest book, Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics, written with co-author Lila Rajiva, is available now.

Bill is still off at his publisher’s ‘jamboree’ in Annapolis, but no matter – today, there is another kind of jamboree all together. That’s right, it’s what our good friend Chuck Butler has coined Jobs Jamboree Friday! Get out the party hats!

The Labor Department reported today that the United States lost more jobs than forecast for August and that the unemployment rate rose to a five year high. The data also indicated that home builders, financial firms and the service industry has trimmed down their payrolls – a clear sign that the effects of the housing slump and subsequent credit crisis are being felt.

"We’re losing jobs in all kinds of industries now," Roger Kaubarych, chief U.S. economist at UniCredit Global Research in New York, said in an interview with Bloomberg Radio. "This is the clearest recessionary signal we’ve seen."

The rest of the world is getting the signal as well…markets across the globe are sinking. Apparently, they still had some hope in a speedy U.S. recovery, but no such luck.

Last Friday marked the 10th U.S. bank failure of 2008, as regulators took over Integrity Bank (ah, the irony). How anyone believed the U.S. was on the road to recovery is beyond us.

Bill Gross of Pimco didn’t do much to squash these global fears as he made a plea for further government intervention (i.e., releasing more cash). "This rarely observed systematic debt liquidation is what confronts the U.S. and perhaps even the global financial system at the current time," Gross wrote on Pimco’s website. "Unchecked, it can turn a campfire into a forest fire, and a mild asset bear market into a destructive financial tsunami."

Amidst all of this, the U.S. dollar is holding its ground. This morning, the greenback hit an 11-month high versus the euro following news of slumping industrial output from Germany, and that the ECB cut back its growth forecasts.

"The dollar is strong, and getting stronger everyday," writes Chuck Butler in today’s issue of The Daily Pfennig.

"This dollar strength has all been orchestrated by the U.S. government…and that’s fine and legal. Too bad they didn’t let us all in on it so we could book profits and look to buy at cheaper levels, eh?

"As I said when the 2nd QTR GDP report printed, it looks like the markets ‘believe’ in the miracle of 2nd QTR growth. But if that’s the case, then why is everyone still of the belief that there will be a global slowdown? If the U.S. is hitting on all 8, why would we see a global slowdown? And if there’s no global slowdown, then commodities should be the belle of the ball once again, gold would be back to $1,000, and the dollar circling the bowl once again.

"You can’t have it both ways. You can’t say that the U.S. is outperforming the rest of the world, and there won’t be an collateral global growth because of it.

"But, I don’t believe it. Which would mean the dollar buying is all being done with smoke and mirrors.

"Let’s go back to mid-July… The euro has hit $1.60 again and there’s just not a lot of love going around for the dollar. What the markets are feeling (in July) is the weight of the world on their shoulders, because of the rot on the vine with financial institutions…

"Then, almost miraculously the dollar got up from its death bed… And the weight was lifted, but by whom, and why? We found out just last week that it was a coordinated intervention by the central banks of the U.S., Japan, and Eurozone to prop up the dollar. And once the dollar buying got up some momentum, the Big Boy Brokerages were all touting the return of the greenback! But why did the U.S. feel it needed to intervene? OK, here’s what I think…

"’The Boys’ saw the list of banks and brokerages on the ‘dead man walking’ roster. And they saw the dollar circling the bowl. If the you-know-what hit the fan with financial institutions, it would have sent the dollar down the drain, and who knows, it could have been the end of the greenback as we know it. So, they intervened to prop up the dollar in ‘preparation’ of what was to come, which would allow it to begin its decline from a higher level.

"That’s my story and I’m sticking to it!"

*** As Chuck illustrated, the rise in the dollar doesn’t have everyone convinced – and Outstanding Investment’s Byron King is no exception. He recently appeared on the FOX Business Network to discuss the latest developments surrounding the energy markets. Byron steered the conversation to what he believed is the REAL story: the dollar strengthening for 8 weeks.

We all know the story: For most of the summer, oil was on an epic rise, as were most other commodities. The dollar was tumbling…

"Then in mid-July, it all changed. Overnight," says Byron, echoing Chuck’s thoughts, above. "There was no big announcement from the Federal Reserve or the European central bank. Nobody said ‘We’re tanking the Euro.’ But it’s pretty clear that they decided that enough was enough. The falling dollar and rising Euro was killing exports from European countries. It was putting Germany and France into recession.

"So the central banks of the world started buying dollars. The U.S. buck strengthened. Oil fell from $145 into the $115 range. And even the Russian invasion of Georgia, or Hurricane Gustav, could not cause oil to rise. Stay tuned as this drama unfolds.

"And while you are tuned-in, don’t give up on the long-term prospects for energy, precious metals and resources. The dollar is rising? This too shall pass.

"Really, is the U.S. economy strong and getting stronger? No. Is the U.S. tax code becoming friendlier to investment and long term capital creation? No, again. Are the demographics of the U.S. labor force changing towards a long period of increasing productivity? Nope. Has the U.S. solved its problems in banking, finance, housing, energy, trade deficit, government spending? No, no, a thousand times no.

"So it’s frustrating to watch as falling oil prices, falling gold prices…but have faith over the long haul.

"Over the long haul, go with companies that own real stuff. Like oil reserves, or mine reserves, or critical technology in advanced resource industries. Go with the hard-stuff. Avoid the fluff. Or come the next financial hurricane, you might get blown away."

*** Still not convinced that the strong second quarter growth was nothing more than a mirage? Here’s something that may change your mind: A report released by the Mortgage Bankers Association today shows that a record 1.249 million homes were in foreclosure during the second quarter.

In addition, from the end of March to June 30, 2.9 million homeowners were delinquent on their mortgage payments – up 25% from the same time period last year.

Our friends at Strategic Investment warn that there is an even bigger property bust on the horizon – in commercial property.

The bust could be worse for banks, stocks and the U.S. economy as a whole than the current residential debacle…an almost unbelievable notion. Bloomberg says that the United States could see the worst drop in commercial property since the 2001 recession and Morgan Stanley is calling for a 15% drop over the next 2 years.

And on that happy note, we’re signing off. Enjoy your weekend,

Short Fuse
The Daily Reckoning