A Crash Course in the World Credit Markets

“Substantial doubt,” say auditors at Deloitte & Touche. They’ve been studying GMs figures. The numbers make them wonder whether the automaker can continue as a “going concern.”

Here at The Daily Reckoning, we’ve got substantial doubt about a number of things.

As to GM, we share the auditors’ concern. The world is full of car factories. Most of them can make cars better, faster, and cheaper than GM. Meanwhile, demand for autos is not growing as quickly as the global growth in auto-making capacity – especially in America. Not that we’re trying to pass judgment. Let the Mr. Market do that!

But GM has friends in high places…ready to lean on the scales of Mr. Market’s justice. The automaker has already borrowed $13.4 billion. It is asking for another $30 billion. But what kind of a dope would lend $30 billion to a company whose own auditors say they’re worried that it might go out of business?

Then again, who would lend money to AIG four times in a row…after discovering each time that the company was in worse shape than before?

If you guessed anything but ‘the US government,’ you are not paying attention.

The rest of the world’s lenders are idiots too – but of a different sort.

Allow us to simplify the world’s credit markets circa 2009: the world’s lenders are eager to make loans to the world’s biggest debtor; they don’t trust anyone else. The world’s biggest debtor, meanwhile, lends to the people private lenders don’t trust – the borrowers who can’t pay the money back.

Meanwhile, sales are falling; profits are collapsing; dividends are disappearing; stock prices are plunging.

Yesterday, the Dow closed down 281 points. Oil held at $43. Gold rose $21. The correction in gold could be over.

One out of every five mortgaged houses in America is now underwater. And a record 5.4 million Americans are either behind on their mortgage payments or in foreclosure.

House prices are still going down. You have to be a Lloyd Bridges to explore the U.S. housing market now.

This unprecedented drop in house prices has put millions of households underwater too. Martin Feldstein estimates that U.S. households have lost $12 trillion. It will take a decade of savings at a high rate to replace this money, he says.

The savings rate has soared…from below zero in 2006 to over 3% now. Rising savings will take $500 billion a year out of the consumer economy, Feldstein believes.

No wonder retailers are reporting weaker and weaker sales. In February, only Wal-Mart reported higher sales. Wal-Mart benefits from the ‘trading down’ effect. Now, when people spend money, they want cheaper alternatives…

Meanwhile, the cop who had the Wall Street beat when the biggest heist in history was going on…and who engineered the loans to AIG and GM…is now the chief of police. Tim Geithner said he was working night and day on Obama’s rescue plan, “because we know how directly the future of our economy depends on it.”

But as our old friend Marc Faber points out, neither Mr. Geithner, Mr. Bernanke, nor any of the men who rule us, seems to have any idea what they are talking about. As Chairman of the New York Fed, writes Faber, Mr. Geithner “did not seem to ‘know,’ in the period preceding the crisis, how the future of the economy depends on a sound financial system!”

Faber goes on to explain that not only did the key players fail to understand what was going on – when it was obvious to him, us and millions of others – they then misdiagnosed the problem and prescribed the wrong treatment. They thought it was a liquidity crisis; so they threw billions in cash at dying institutions.

At every step of the way, the feds have been clueless, hopeless, and defenseless. It was the feds who lent money at negative real interest rates for more than five years. It was the feds who pretended to “regulate” and “control” the marketplace…claiming to protect investors from fraud and malfeasance. It was the feds who licensed the banks…set banking standards…blessed derivatives because they “distributed risk more widely” (Greenspan)…urged people to buy adjustable rate mortgages (Greenspan again)…praised sub-prime lending because it encouraged home ownership…and even told consumers to “go out and buy an SUV” in order to give the economy a boost (Fed governor Robert McTeer).

The feds piled up the tinder…poured on the gasoline…and lit the match. And now, what do you know…they’ve all joined the fire department!

*** One small step for the Bank of England; one giant step towards bankruptcy.

“QE”. It does not refer to the Queen of England…but the latest codeword in central banking – quantitative easing. The Bank of England said yesterday that it would buy government bonds itself. This is known to economists as “monetizing the debt.” Because the bank takes in debt…and turns it into cash. Just like that.

The European Central Bank took a little step too. It cut rates – as did the Bank of England – by half a point. That brings the BoE down to 0.5% and the BCE to 1.5%.

Mervyn King, head of England’s central bank, said he was going to quantitative easing because, in effect, nothing else had worked. They were already lending money to English banks below the consumer price inflation level…which is to say, at negative real interest rates. But the banks weren’t cooperating. They took the money…but there it sat. They didn’t lend it out.

That is why it is obviously NOT a liquidity crisis. The problem isn’t that the banks don’t have enough cash…or access to cash…it’s that they don’t know what anything is worth. They can’t make a loan, because they can’t be sure of getting the money back.

We’ve already laid this out for you, dear reader. We’re going to do it again, in case you weren’t paying attention: this is not a liquidity crisis…and not a recession either. It’s a depression. In a depression, the economy needs to adjust to a NEW REALITY…whatever it may be.

Martin Feldstein, mentioned above, provides more figures. In the new reality of 2009, there’s about half a trillion less in consumer spending…because consumers are saving money, rather than spending it. And you can take out another $250 billion just from the crack-up in the housing industry. No building…no construction jobs…no financing jobs…no selling jobs…no furnishings…etc. etc.

That’s $750 billion less each year to support American’s retail…and indirectly, wholesale…providers.

The Obama administration is trying to make up for this private spending with public spending. But his plan, as bold as it is, will only put back about $300 billion each year. That leaves a $450 billion shortfall…which could easily remain for the next 10 years.

This is the new reality that every business, investor and household in the country must live with. Revenues will go down. Sales will go down. Profits…earnings…dividends…you know where this leads.


Actually, none of knows where it leads…exactly. From today’s perspective, it appears to lead to a Japan-like slump…a long period of adjustment to the new reality…delayed, worsened and stretched out by the efforts of our leaders.

But then…there’s that QE.

We can’t read tomorrow’s headlines…but we can read the names on tomorrow’s tombstones – they’re our own. What has to happen will happen. The United States is now engaged in the most massive spree of Madoff financing the world has ever seen. It needs to borrow more and more just to pay for previous borrowing.

At some point in the not-too-distant future…this system must crack-up. Normally, Madoff would go broke and go to jail. But what would happen if he had a printing press in his basement…and the legal write to print up as many $100 bills as he wanted?

Would the story have ended differently? Would he have the integrity to avoid full-scale quantitative easing? As to that…as to so many things…we have ‘substantial doubt.’

The Daily Reckoning