Joe and JoAnn Take a Romantic Walk on the Beach while Analyzing Gov Spending

Right now the US Congress is spending money like a lottery winner in Vegas. (Joe High Roller) Congress is spending 185% of what it takes in (1), and there's currently no relief in sight. (Joe Sahara) This spending spree is leading us down the path of one or two inevitable consequences, neither of which is appealing:

• High Interest Rates: The current spending habits in Congress are simply not possible to sustain. Right now we have plenty of buyers of debt in the form of treasury auctions. However, as the national deficit increases, so does the risk of default, which will cause buyers to flee from the treasury auctions. (Joe bug from Joe Orkin man) Since the US is so heavily in debt already, we depend on the issuance of new debt to cover the principal and interest on the outstanding notes. If the buyers' appetite for our bonds cools off, the government will need to raise bond yields to attract more buyers. Since bond yields go hand in hand with interest rates, (Joe and JoAnn, hand in hand for a romantic walk on the beach....in Joe's head) higher bond yields will consequently raise interest rates of all kinds, including business loans, car loans, and mortgages, and could be a repeat of the 1970's and 80's when interest rates soared to double digits.



• Hyper-Inflation: The government can tap the Fed to just print more money to pay the national debt right? The consequences of simply printing money would be rising prises of goods and services as the national money supply grows. (Joe and JoAnn, romantic walk on the beach....but unable to buy hyper inflated drinks from vendors along the way) Inflation slows the flow of economic growth like a rollover accident during rush hour; and increasing the national monetary supply and inflation are extremely tightly correlated. (Anorexic Joe and diet coke).

How long will the "Risk Free" Rate be risk-free?

The US T-Bond has traditionally been the most trusted investment in the world. It's used as a benchmark for many return-on-investment (ROI) opportunities when companies and individuals compare various investment options. (Joe MBA) Although traditionally a lower yield offering than other methods of investing, (stocks, bonds, commodities, etc) the US T-bonds offer a guaranteed yield, hence the name "risk free", and the investor knows that without exception the interest and principle will be paid with perfect regularity. The problem, as mentioned above, is that we're financing old debt with new debt. Currently, China, India, Japan, Germany, and other countries regularly pitch in to feed our congress' appetite for spending by buying these treasuries. However, if we continue on our current course of spending, the US could face a problem of insolvency as wary investors back off, creating a problem of re-paying the debt that we already owe. If this happens, the "risk-free" rate may not be as the name suggests, and the possibility of default could emerge.

What is to be done? Americans need to voice their concerns about the current federal budget, and the sooner the better. Last week the White House raised its ten year budget deficit estimate to 9 trillion. That's nearly doubling the already astronomically high deficit. At an average of 25-40% taxation rate, Americans are doing our part to pay down the national deficit; but we desperately need Congress and Prez Obama to stop spending money we don't have. (Taxpayer Joe fighting the current) If the government doesn't stop the recklessness, talk of an endangered "risk-free" rate could emerge as more of a realistic problem than anyone wants to admit. All one needs to do is to look at California's insolvency crisis as proof (Joe Shareholder in LA, purchasing drinks for the walk on the beach with Joann....still in his head.....but only from vendors accepting state issued IOU's)

Super Ben Saves the World from Collapse

While speaking to a group of economists and policy makers on Friday, Federal Reserve (Fed) Chairman Ben Bernanke proudly announced that the aggressive monetary policies implemented by the Fed and the Treasury department “saved the world” from a financial meltdown. (Joe Superman) While markets have indeed responded positively since early March ‘09, it’s not clear whether the rally has been based simply on Fed intervention or on strengthening fundamentals. While some economic indicators have shown signs of bottoming, we have yet to see real sustained growth. (Joe Rogaine) Super Benny has, however, managed several accomplishments which we’d like to discuss below.

He screwed small banks
Late last year, when many large banks were insolvent and broken, Super Benny wielded his power and influence over congress (Joe pull down the wool) and served up a large dish of TARP salad (Joe next Food Network Star), with side dishes of PPIP and TALF from the Treasury (Joe “Bam! Kick it up a notch!”). The central banksters and clueless bureaucrats in Washington not only approved immediate TARP funds and monetary injection into large financial institutions, but also pledged to continue to infuse money should the need arise in the future. Even though the Fed and large banksters helped shape this economic crisis due to lax policies and excessive risk taking in the first place, they have been granted the safety net of taxpayer funds while the smaller institutions continue to struggle on their own. (Joe upside down roly-poly) Additionally, nervous depositors at small banks are pulling funds and fleeing to the safety of the too-big-to-fail empire. (Joe Titanic)

He screwed China
Each week the US Treasury auctions off new debt in the form of Treasury bonds and notes. As demand on the bonds increases, the yield, or interest rate decreases. (Joe Econ 101) Therefore, buyers want as little competition as possible to get the best rate. The Fed announced a plan in March to buy 300 billion of US treasuries in an effort to keep US interest rates low. (The housing mortgage rates closely follow the 10 year bond, for more on this China situation click here) This Fed purchase plan undoubtedly angered China, who is the largest foreign purchaser of US debt. In other words, with each dollar of debt the Federal Reserve purchases, the interest rates on Chinese investments drop. This situation of the Fed buying from the Treasury is similar to when Joe Shareholder asked his Mexican investor friend Jose to help bid up the price on the diamond ring he placed on eBay after JoAnn shot him down. (Joe false start)

He screwed the US Dollar….and Taxpayer…..and Saver
Ben’s plan to avoid another depression is to induce inflation to combat the dreaded economic forces of deflation, which he claims caused the Great Depression. (For reasons why click here) The best way to induce inflation is to crank up the printing press and dump it onto the economy - hence the nickname Helicopter Ben. (For his own words on the topic, click here). Since Ben took the reigns in 2006, the US dollar has slipped roughly 16% and 20% to the Japanese Yen and Euro respectively, with both trading near all-time lows. Inflation on the dollar is essentially a tax on anyone saving money. In Ben’s defense, however, he’s had plenty of dollar destruction help from politicians loading debt on the back of the fragile/exhausted US dollar. The Congressional Budget Office announced on Tuesday that the budget deficit earlier estimated at 7.1 trillion by 2019 has been raised to 9 trillion. Can the US dollar sustain such levels of debt or will it begin a free fall? (Joe Petty, brother of Tom) Will countries continue buying our debt even while it’s climbing to new highs daily? If there comes a time when debt investors decide it’s just too risky to hold US debt, there could be a massive sell off which could get quite scary. (Joe, “stay behind the yellow tape kids, nothing to see here. ”)

So the Fed and Super Benny have stabilized the large financial institutions…..but at what cost? Only time will tell (Joe crystal ball) whether the negative impact on these periphery entities will come back to haunt him (Joe October 31st…..2010, 2011, 2012???). Speaking of Halloween, Joe Shareholder likes this time of year because he offers JoAnn his protection from anything scary that might be lurking out there. JoAnn insists that nothing bad ever happens in Joetown, Ohio. This year, however, Joe can remind her that as long as Super Benny is in charge, plenty of scary things could happen.

Why your Bank Won't Survive the Coming Depression

Okay, okay, I realize the title is a little gloomy (Joe, glass half empty), but you're reading this right? So it worked? Anyway, I'm not really that negative (Joe glass half full), okay maybe I am a little bit, so read on and we'll find out together what's going to happen to your bank in the next 3-5 years.

Rewind back to the first week of March '09 - all US stock indexes were at 15 year lows, negativity was ever-present in the markets, and investors worldwide were fearing a government takeover of troubled financial institutions including Citigroup and Bank of America. During this doom and gloom era, in which the only safe investment seemed to be ibuprofen/aspirin producing drug companies (Joe Migraine), embattled Citigroup CEO Vikram Pandit shocked the world by declaring that Citi was going to have its best quarter in over two years! (Joe get out of here!) Well, he was almost right, Citi still reported a loss, but it was a good start. Since that week, Citi (C), and Wells Fargo (WFC) stock prices are both up over 400%, and Bank of America (BAC) has shot up over 600%! So is it too late to join the party? Maybe so, and here are a few reasons why.

1. New stock issue

Outstanding common stock shares don't help a company raise cash, they're simply traded on stock exchanges. So if a company needs to raise funds, one method is to issue new stock. Since March, the government has emptied the treasury on Citi and seized 34% ownership in the company in the form of new common stock; Bank of America has issued about 14% new common stock, and Wells Fargo has increased its shares by about 8%. Since a company's value is determined by the number of outstanding shares multiplied by the share price, these new stock issues should theoretically dilute the share price, not boost it. In this case, investors have shrugged off the new issues and the stock prices have shot up rapidly. While these new stock issues haven't negatively impacted the stock prices yet, if conditions further deteriorate, investors will most likely figure the new issue into the stock price and it could get very ugly. (Joe, hope no kids are watching, and if they are, hope their mommas are nearby to cover their eyes)

2. Mark to Market accounting changes

Before the financial crises erupted, banks loaded up on trendy Mortgage Backed Securities and Collateralized Debt Securities (bundled home loans and equity loans). As home prices appreciated, the values of these bundled securities increased rapidly and made the banks' books look incredible. However, as home prices dropped off the cliff the value of these bundled assets crashed as well, causing balance sheet heartache for the banks. (Joe tums extra strength). No problem, however, easy solution. Just hire a bunch of expensive DC lobbyists to wine and dine the FASB (Federal Accounting Standards Board) into changing the rules. Instead of marking the assets to market value, the rules were changed to allow banks to mark the assets to book value, or the value at which the banks purchased the assets. How was this fair? Good question. Banks are valuing these assets at their purchase price instead of the current market price, which is very misleading. The result? Nobody really knows the value of these mystery assets on the books of banks. (Joe, driving a brand-new sleek black Lincoln Towncar limousine with dark tinted windows) Had the accounting rules not changed from market value to book, there's a good chance all the banks that reported earnings during quarters one and two would have reported heavy losses. What's worse, the FASB is currently considering reversing these accounting changes to allow for more transparency. (Joe El Camino clunker - she ain't pretty, but at least you can see what's in the back).

3. Foreclosures are still increasing

Oops, this problem was supposed to be solved with the stimulus bill. Guess what? RealtyTrac announced two weeks ago that "home foreclosure activity in the first half of the year continued its upward trajectory". There's also a growing concern within the financial industry about commercial and industrial foreclosures, which up to this point have been minimal. These loan default/foreclosures are expected to peak sometime in 2011. Scott Sprinzen, a credit analyst for Standard and Poor said "During the next few quarters we will see a sharp acceleration of weakening on the commercial side". Add these conditions to continued job losses and the picture gets even uglier (Joe, now glass neither half empty nor half full, but the glass has been shattered and water is spilling down his shirt). Okay, enough of the negativity and pessimism.

Is it really that bad? Is there any hope? Sure, there is always hope. Both the unemployment rate and the housing price plunge seem to have either moderated or come close to reaching bottom. These two statistics will be very important to watch over the next several months, as the economy is trying to stabilize and markets are searching for sustained hope. JoAnn, who was inexcusably left out of the last post, has returned and has given Joe a plastic cup from which to drink so he no longer has to clean glass up off the floor and change his shirts. Hopefully his bank exposure in the future won't cause him to change his shorts also.

Joe Shareholder meets Football

Football season is back! Fans everywhere are making sure their HDTV’s are in fine working order, cleaning their BBQ grills, and reviewing rosters and schedules, hopeful that their team will win it all this year, or in some cases, win any of their games (Joe-Detriot Lion). In football, a team is assessed a penalty if one of the offensive lineman moves prior to the ball being snapped to the quarterback. The lineman then looks embarrassed, shakes his head like he’s done nothing wrong, and the team moves back five yards. Metaphorically speaking, politicians and banking executives (does anyone really trust either source anyway?) may be guilty of a false start in calling for an end to the recession of 08-09. Sure, the stock market is up roughly 50% since March, and the 200 day moving average of the Dow appears to be on it’s way northward for a change. The housing market appears to have turned the corner, and July’s jobs report came in with fewer unemployment claims than Wall Street expected. (Click here for more on the unemployment report) Attention Joe Shareholder: Break out the champaign and let the partying begin! Ah… wait a second… What I meant to say was ah… see what had happened was…

Enter Joe False-Start
July also saw the largest number of home foreclosures in the history of America, and although values have ticked up slightly in parts of the country, there’s no guarantee that the trend of foreclosures will slow in the near future, as more Americans become unemployed. The up-tick in housing and auto sales is likely a direct result of legislation including the tax credit for first time home buyers and Cash for Clunkers, which can’t and shouldn’t last forever. These programs are great for the beneficiaries, but they worsen the budget deficit and consequently put a strain on the value of the dollar. (Click here for more on the budget deficit) Current and future foreclosures could lead to further devaluation of real estate in November when the tax credit is scheduled to expire, due to more aggregate supply on the market (Joe econ 101). Banks, Credit Unions, and home improvement and home furnishing industries will likely continue to suffer as a result. On Friday August 14th, five more banks were shut down by the FDIC, bringing the total for 2009 to nearly 80 failures. Fannie Mae and Freddie Mac, the secondary mortgage agencies who sell and package mortgage backed-securities will also continue to feel the strain of home foreclosures, as well as those who buy these MBS instruments (Joe’s Wall Street firm).

Joe’s Stimulus Package
Much of the credit for America’s ability to pull out of the great depression in the 30’s is given to government spending… perhaps too much. In the 1930’s, government spending helped the economy recover from the depression as the United States was forced to prepare for World War 2 by plowing money into defense. By contrast, a lot of this current stimulus package goes to bizarre funds like government pet projects and special interest groups. Instead of putting a short term, economic band-aid on the economy under the guise of a "stimulus package", America needs to focus on balancing the budget, stabilizing the dollar, and decreasing the national debt. A government option for health care would be nice, but we cannot afford it right now, especially since funding for the proposal is completely up in the air. This has the potential to send the current budget deficit completely out of control…(Joe hang glide during Hurricane Katrina). Finally, the Fed needs to keep interest rates low (Joe Bernanke) to stimulate lending and encourage business and entrepreneurial investment, and this will help to sustain a long term approach to creating and keeping jobs that really build and stimulate the economy. (Joe teach- a-man-to-fish-instead-of-giving-him-a-fish).

Are we optimistic for the future? Absolutely. Unnecessary pessimism depresses markets (Joe or Johnny Rain Cloud), and is unhealthy for an economy. It will likely be a long and slow recovery, as many economists predict. America has shown resilience that has helped us become the world economic leader for nearly 100 years. There’s not a more suitable country that fosters economic opportunity to create jobs and businesses. We’ve repeatedly shown that when we trust in capitalism, we can pull ourselves up after getting knocked down (Joe Austrailian one-hit wonder band), dust ourselves off, and look forward to a better future. But before you quit your day job to invest in the stock market and drink Coronas at the beach (Joe Commercial guy), pay attention to the warning signs lurking beneath the surface. Let’s give the stock market a five yard false-start penalty, and then let’s trust in capitalism to run its course so that relatively soon we’ll be able to enjoy a nice long economic touchdown drive!

Joe Uncovers Gov Conspiracy over Unemployment Report

According to the Bureau of Labor Statistics, July’s unemployment rate dropped to 9.4% from 9.5% in June. Meanwhile, the economy shed 247,000 jobs during the month. Say what? You mean we can actually lose jobs and decrease the unemployment rate at the same time? This is great news. You mean during the first part of the year, when we were losing half a million jobs per month, we could have actually been lowering the unemployment rate at the same time? Why didn’t we do this earlier? (Joe, late to the party, but at least Joe’s at the party now….right)

According to the report, the labor force actually decreased during the month as frustrated job seekers stopped looking; and to be included in the job force, you have to be actively searching for a job. (Joe, searching frantically for the party, but not finding) This is the reason the unemployment rate dropped.

It gets stranger, however. In June, the US economy shed 443,000 jobs, and the unemployment rate increased a paltry one basis point from 9.4 to 9.5%. In July the US economy slashed 247,000 jobs and the unemployment rate simply dropped back down to 9.4%. So, in the period of two months, the US economy has lost almost 700,000 jobs and the unemployment rate remains unchanged at 9.4%. That’s almost a million jobs (Joe march in Atlanta) and we are still at 9.4%. Why didn’t I think of this first? (Joe Patent pending)

Just to give you some historical perspective, in January of ’09 the US economy lost 598,000 jobs and the unemployment rate increased from 7.2 in December to 7.6%. In February, the US economy slashed 651,000 jobs, and the unemployment rate increased from 7.6 to 8.1%. This was a fairly common pattern through the first half of 2009 - lose half a million jobs, unemployment rate climbs 4 to 5 basis points.

So what’s going on? Is the economy improving or is this simply a conspiracy to make the numbers look better? (Joe contemplating gov offered kool-ade) What does Wall Street think of the unemployment report? Initially this was great news, as the market leaped almost two hundred points by midday on Friday. However, since that point, the market lost 89 points by the end of the day. On Monday, August 10th - Dow down 34 points. Tuesday the 11th - down 94 points. Where’s the party now? Is the punch bowl, or rather kool-ade bowl empty? The music is still playing but there’s no more dancing? “But the unemployment rate dropped you guys”, says Joe with a glass full and dancing by himself.

JoAnn warned Joe of this however. As Joe walked in the front door JoAnn was leaving and told him the kool-ade needed more sugar, because it had turned sour and slightly bitter. Joe had been sprinting to get to the party in time, however, and his thirst too join the party was overpowering so he brushed off her advice and ignored the warning signs. We’ll see what the future holds. Until then, hold off on the kool-ade, will ya Joe? Drink at your own risk.

Real Cost Analysis - Cash for Clunker

Cash for Clunkers. And no.......we're not referring to investing in stocks in today's market. We're referring to the cash for clunkers program offered by the US government. Trade in your clunker and get $4500 cash. Cash for Clunkers. Are well-running cars that are paid for really considered clunkers? Some are, Joe's car is a clunker, and he is very excited about this new program since his '85 Ford truck backfires and stalls out in busy intersections. However, the cash for his clunker comes at quite a cost. (Joe turn out the pockets)

The cost ultimately paid by the taxpayer for Joe's clunker is actually well above $4500. How so? Economists always include opportunity costs in the total cost analysis of any project. What are opportunity costs? The cost of not doing something. For example, if last fall Joe Shareholder wanted to invest $1000 in a US car company, he had two choices - GM and Ford. GM's clunker stock price was trading at about $5, while Ford's clunker shares were trading at about $2.

If Joe invested $1000 cash, here's what his investment would be worth today under the two scenarios.

Invested in Ford = $4000 (Ford stock ended at 8.03/share on Friday 8/7/09)
Invested in GM = $100 roughly (Clunker company went bankrupt)

Suppose Joe invested in GM - his actual loss would have been $900. Because he could have made $3000 if he invested in Ford (opportunity cost), his true cost would be the sum of these two, or $3900.

Now, back to cash for clunkers. The government - inefficiency and bureaucracy clunker extraordinaire - is paying $4500 cash for Joe's clunker. Since the clunking government is broke, this $4500 comes from debt auctions (see this post on treasuries) with interest. Right now the US 10 year treasury yield is running about 4%. This 4% interest is paid yearly to the owners of the debt. So the new cost is $4500 plus $1800 for interest over the 10 years, and you have an actual cost of $6300. (Joe - this is not all)

Suppose the government did something else with the $4500, like invest it in a fund earning 4% interest each year. Now the $1800 is also an opportunity cost, and the total cost of paying cash for Joe's clunker is $8100. Wow, this is a large cash payout for Joe's clunker. Add in the other costs of car disposal, lawmakers' time, program maintenance, website support, paperwork, government inefficiency multipliers, etc, and the total could be easily over $10,000 cash per clunker. (Digital Camera Joe, rummaging the garage for possible eBay listings)

So how does this affect Joe? Joe drives off the lot with a brand new car and heads directly over to JoAnn's house to show off. JoAnn is deeply discouraged, however. Not only did she love Joe's '85 Ford pick up truck, and the excitement it provided her when it stalled out in intersections, (remember, she's a trader, she loves the thrill of risk) but she also realizes she's going to help pay back this loan for Joe's new car.....via her taxes. (Backfire Joe………ironically in his new car)

Ben Bernanke Vs. Joe Shareholder, inflation vs. deflation

Who is Ben Bernanke and why do we call him "Helicopter Ben"?

Ben Bernanke is the current chairman of the Federal Reserve Bank (Fed), or the Central Bank of the United States. The Fed is responsible for establishing monetary policy, and specifically the interest rate at which banks can borrow money. Currently the rate sits at 0 percent so banks can actually borrow from the Fed at zero percent interest and charge you whatever they want for your housing loans. (Joe, ask not what your bank can do for you, ask what you can do for your bailed-out bank) The Fed holds the rate low during recessions because low interest rates stimulate economic activity.

Inflation vs. Deflation:
One thing the Fed watches closely in determining monetary policy is inflation. Inflation is simply the increase in prices for goods and services. This means that the purchasing power of each dollar you own goes down because your dollar buys fewer goods. Conversely, deflation means prices are falling so your purchasing power actually increases. Therefore, each dollar you have can buy more stuff. (Joe, Manwich by the case-load, emphasis on Manwich by the way)

Deflation can be dangerous however for those in debt. Suppose there's a nice house in Joetown, Ohio that Joe Shareholder would love to purchase for JoAnn someday. In a period of 10% deflation, if Joe buys this house for $100,000, deflation reduces his value to $90,000 while he still makes payments on the original loan of $100,000. We've seen this occur as housing prices nation-wide have fallen. Not only housing, but every outstanding business loan takes a hit as values fall while business owners are paying off loans assumed at higher prices. Meanwhile, these businesses must deal with shrinking revenue because the prices of their goods and services are falling. This scenario increases the chances of defaulted loans and causes a downward spiral within the economy. (Joe, covered slide for kids at the city park)

Ben Bernanke, a leading scholar on the causes of the Great Depression, claims a deflationary spiral was the catalyst for the extended depression in the 1930’s. To avoid another depression, he promotes the idea of flooding the economy with money, or inducing inflation in order to combat the dreaded forces of deflation. (G.I. Ben Bernanke) Will it work? We don't know but we’ll find out over the next couple years. This has never been tried before so we’re in unchartered waters. Is it possible that an entire economy can simply be flooded with printed and borrowed money to avoid a depression? (See previous treasuries vs. Economic growth post)

Economics 101 teaches that prices are established where supply meets demand. If there's low demand for a product then prices need to naturally adjust downward. The resulting deflation, although painful, might be necessary for the economy to fix itself. If demand is manipulated, through cash for clunkers, home credits, energy credits, etc, then the result could just be a delayed recovery at the expense of a huge debt burden to be repaid later. (Joe Beckham…. kick the can down the street)

Currently, Joe is hoping for a nice bout of deflation since he doesn’t own the home yet and couldn’t be happier to see its price fall. Not only that, but Joe figures ring prices should drop too with the onslaught of deflation. Joe has a good friend that sells diamond rings (Joe Weller) that could certainly offer him a good deflationary discount should the need arise. Upon realizing this however, JoAnn is hoping for inflation. Ben Bernanke is suddenly her hero!