Tales from a Bankrupt Economy

“Pssst…hey kid… You, in the red robe…


“You’re just graduating from college, right?

“You wanna make some real money?

“Then, rush to Detroit. Set up a law firm specializing in bankruptcy.”

(More of our advice to college graduates can be found here.)

Two auto-parts suppliers have already filed under Chapter 11. GM is expected to do so momentarily.

Too bad about GM. It was set up in 1916. If it had been able to hold together for another 7 years, it would have gone 100 years without having to declare bankruptcy.

All people die. All companies die, too. That’s why ‘buy and hold’ is wishful thinking. Buy and hold long enough and you are sure to go broke. And die.

Eventually the undertakers and bankruptcy lawyers get you. And today…business is good in Detroit. What cleared the way for the GM bankruptcy was a deal with the bondholders…in which they take equity in exchange for their debt and agree not to contest the bankruptcy filing. Still, the deal – and other deals relating to it…including the presence of one very big and very odd shareholder, the government of the United States of America – is so complicated, it’s bound to give bankruptcy lawyers plenty of work for many years.

But business seems to be picking up everywhere…at least, that’s the impression you get from reading the paper. The war against capitalism seems to be going pretty well, in other words.

Yesterday, the rally continued on Wall Street, with the Dow up 103 points. Oil rose too. It is trading at $65 a barrel this morning. And look at gold – the old yellow metal is at $963 and still going up.

Does this mean the feds are winning the war?

“Signs of life return to California market,” says the Financial Times.

Houses in many areas are selling for 60% less than they did two years ago. Two years ago, the average family couldn’t come close to buying the average house. In didn’t take a genius to figure out that that couldn’t last. Who were they going to sell the average house to if not to the average family? Well, now the $600,000 dump from ’07 has been foreclosed and is now on sale for $200,000. That means that the average family that still has a job can buy it.

And it doesn’t hurt that the feds make it easier – distorting the market with an $8,000 tax credit and EZ financing from the FHA.

Wait a minute! Wasn’t it easy financing that got us into this mess? Of course it was. But that little insight doesn’t stop the feds. They’re convinced that if they can just put out enough new credit, it will somehow make the problems caused by having too much credit before go away.

So here’s the deal. You can get the FHA to finance a house, long-term, at just 4.9%. That’s just 0.3% higher than the long-term Treasury yield. Even without opening the closet door, we smell a rat. How can lenders expect to make any money – after delinquencies, defaults, foreclosures, resales…to say nothing of legal and administrative work – on a 0.3% margin? And that’s assuming their cost of money is the same as the feds’ cost – the long term T-bond rate.

Maybe they should read the paper. John Authers, writing in the Financial Times:

“The latest US mortgage delinquency figures are horrendous, with more than 6% of prime mortgages in arrears – more than double the long-term norm. A quarter of sub-prime loans are delinquent.”

And although one in 6 homeowners is underwater…

“The peak of foreclosures has yet to come,’ Harvard historian Niall Ferguson adds. ‘They will go from 40 percent of all home sales to literally 100 percent by the end of the year.’”

Well, the bankers – as everyone knows – are a lot smarter than we are. They’re probably up to the old trick: borrowing short, lending long. The spread between the long rate and the short rate has never been great. We explained why yesterday. The Chinese don’t trust Tim Geithner to keep his word. For that matter, neither do we. They’ve switched from buying long bonds to buying short bills. So, the bankers – including those working for the FHA – can borrow very cheaply in the short-term market. And they can make cheap mortgage loans, long-term. And then, when the short rates go up…and they need to roll over their short-term loans…they can get in line at the courthouse, behind GM and the parts manufacturers…

…and pick out a gaudy casket too.

Jobless claims eased for the second week in a row. Hallelujah. The economy is still unloading jobs, but at least its not dumping them like it was earlier in the year. Which leads a number of economists to the old refrain: ‘the worst is behind us.’

Meanwhile, from Japan comes encouraging news. The Nippon economy is increasing its industrial output at the fastest pace in 56 years. And oil is signaling a global rebound, isn’t it?

“I don’t think so,” says MoneyWeek’s editor in Paris. “There is no increase in oil consumption. Instead, consumption is still going down. What we’re seeing is speculation. The central banks are adding to the funds available for speculation. So far, that money isn’t reaching the consumer economy…it’s mostly in the natural resources market betting on inflation.”

Everywhere you look, dear reader, is a war zone. Nothing is safe. The feds’ war against deflation does collateral damage to almost everyone and everything.

But you have to give the feds credit. Raw materials…gold…oil…emerging markets – all have seen big increases. Major stock markets too are showing big gains.

But the feds’ plan is not to reflate the asset bubble, but to reflate the economy. For that, they need rising consumer prices. Consumers need to borrow…and spend. They’ll do so, say economists, when prices rise and their dollars lose value. So far, milk and potatoes aren’t cooperating. The price of milk fell so low that farmers slaughtered their herds. As for potatoes…we don’t know.

In Europe, inflation has disappeared. This is the first time the euro zone has ever had flat and falling prices. In America, too, consumer price inflation is ebbing away.

In other words, the feds may be winning a battle but losing the war!

As usual, there’s a lot of smoke and fog on this battlefield. Consumer confidence is rising…but so is unemployment. The New York Times says US joblessness may soon pass Europe’s habitually-high rates. The Chinese are still buying America’s debt – but only the short-term stuff. America’s biggest industrial company goes broke…the government takes a key role in key industries…but investors buy more stocks!

If you look through your binoculars you will have a hard time figuring out who’s really winning. In the confusion of the battlefield, even a hardened veteran often fails to tell which way the fight is going. In fact, you might see rising stock prices and get the wrong idea…like watching the Yankees get chased back to Washington after the first battle of Bull Run; you might have thought that that was all there was to it. The war was over and the South had won.

Not quite.