Friday, March 27, 2009

Where Do We Go From Here (regrets for forgotten hap tips)?

Is it possible President Obama is more clever than he appears?  That just as he baited and ultimately defeated the Democratic Party machine dominated by the vicious Clintons, that he will bait the oligarchy with a bank bailout plan that is bound to blow up badly (see previous post), only to turn on them and ride a wave of public support for a return to truly law-based, democratic, fair, Constitutional government?

One can only hope.  True, the “animal spirits” continue to hover at generational lows, but a return to denial and business as usual as they begin their forecasted climb will only make the final collapse worse.  Obama promised radical change, but he waffled on his stimulus (didn’t need a tax cut, needed more targeted spending on the unemployed and productive investments) and has proved to be a total wimp in confronting the banking crisis (a tool of Goldman Sachs, to be explicit). 

Okay, President Obama, do it your way, but the time to get radical on finances is slipping away.  You’re going to waste valuable taxpayer dollars that you’d rather spend on building up the American people and their productive powers bailing out investors that should be wiped out—to make room for new investment!

Don’t wait too long.  The people are for the radical changes, are sick at heart at the bailouts and the rich slopping at the government trough.  Congress will do what you tell them, just as Reagan’s Congress did, but you’ve got to stop listening to Wall Street.  It’s your Achilles heel.  Cut them loose after the “public private” banking bailout fails.  Put Volcker or someone from business who’s run a big budget in at Treasury.

Clean up your act, or you’re going to be viewed as “W2,” pun intended.  The economy is out of control, everyone knows it.  You were elected for your temperament, your seeming sense of fairness, your ability to see things from a broad point of view.  Right now the most important thing Americans want to see is fairness from their government in dealing with the economic crisis.  If they don’t perceive that in you (and you can fool some of the people some of the time…), you’re toast.

Wake up, Barack.  America’s burning.


Wednesday, March 25, 2009

Reality Check

How many times have you heard that “the banks have stopped lending—something has to be done to get the toxic assets off their books”? 

There may be a few large banks that have a load of crap on their books, who have stopped lending and have their hands out to the government for a bailout, but the effect does not extend to the industry.  The industry slowdown in lending is a cyclical phenomenon.

I decided to go the Federal Reserve Bank of St. Louis’s FRED database to see what the data says.  I’m not going to burn up a lot of bandwidth (the link above takes you to the page the graphs below come from—you can customize them to be levels or year-over-year percentage changes or other forms):



Note that commercial and industrial loan volume fell after the last two recessions were over, and can be expected to do so again in the current climate of deleveraging.  You can almost tell from their behavior in the fourth quarter of 2008 who’s got crap on their books:


So the experience of the Summers-Geithner plan will likely be this:  banks will reduce their lending after getting the new bailout money, some private equity-hedge fund types will get richer, and American taxpayers will have a bigger stone on their backs.

If a Treasury auction fails and short-term rates have to rise after Bernanke has blown yet more high-powered money into the long end of the yield curve—in other words, if the yield curve inverts between now and, say, November 2011—we can safely predict that Obama will be a one-term president.  Our “animal spirits” forecasting model will give ample warning of the next recession, as it appears to be calling some sort of recovery pretty well about now.

Monday, March 23, 2009

Cash for Trash

The government is counting on the mind-numbing fatigue of the depression of “animal spirits” this past nightmarish year or more to push through their latest welfare bill for bankers that act like hedge fund managers, hedge fund managers, and the assorted at-liberty investment banker and wealth-diminished high net worth individual or private equity fund.

Paul Krugman, Leo Kolivakas at and others have pretty well stated my views.

It comes down to massive moral hazard as a national ethos.  Everyone is equal, but some are more equal than others.  There are really no bad decisions, only unfortunate outcomes that the government can fix.  We don’t hold grudges against the same crowd of people who feathered their nests creating this mess, and now would like to feather them again “cleaning it up.”

The way capitalism works is that when a bank’s management screws up, among claimants equity holders take the first hit, then debtors.  Then if the bank is insolvent, you ask the government to step in.  In the old days, as Krugman says, heads would roll, the feds would come in and take the place over, then sell it off to competent managers.

The markets for toxic assets are frozen because they’re waiting for their bailout.  The commercial banks couldn’t afford to mark their toxic assets down or sell them.  Now the feds are going to provide for the banks to get somewhat higher than “market value” prices with their non-recourse leverage, but as Rolfe Winkler points out, who else without access to the funny money will be able to afford to pay the same prices?  This newly liquid market could calcify quickly.  Thus, the feds will have to pump up all the markets for the next several years to help the hedge funds find suckers to sell this stuff to.  Lots of luck.  The current market prices are probably entirely rational, looking ahead to the tsunami of rate resets and probable defaults over the next twenty-four months.

This is financial fascism, perpetrated by the New York and Washington financial oligarchy centered on Goldman Sachs.  If history rhymes, as these folks bankrupt the country and send the vast majority of Americans into heavily taxed wage-slave immiseration, with no sense of control whatsoever over their country’s government, the oligarchs will be looking for a war to send the youth of America off to fight and die in.  Look for that in about ten years.  But they may get themselves a revolution instead.

We now know that Barack Obama is no Franklin Roosevelt.

Friday, March 6, 2009

‘Animal spirits’ update

The Panic of 2008 is almost over. American confidence levels will rebound in 2009 from generational lows as Americans become adapted to the new realities of the economy. Americans will feel as if they've "been down so long it looks like up to me."

The forecast is for a return to stabilization or positive real GDP growth likely to be slow. The model has been accurate in back-testing for over 50 years and has called the last three turning points in real time well ahead of consensus.  The prestigious scientific journal Nature cited the model’s forecast in advance of the 2001 recession at a time when the consensus saw no recession in sight.  The model also accurately foresaw the current slump as early as 2006, although not its severity.

The "animal spirits" of Americans can be modeled accurately by

A = - (U - UMEAN)/Stdev(U)

where U is the current unemployment rate, UMEAN is an exponential moving average over the past three years, and Stdev(U) is the standard deviation of U over the past three years. This measure correlates highly with the Michigan consumer sentiment index (green; blue is forecast based the unemployment rate forecast below).


"Animal spirits" hover at very low levels. However, continued increases in unemployment will have little negative effect on confidence. We are at or very near the nadir of "animal spirits" for this cycle that typically coincides with the end of the recession.

To understand why we are at or within a few months of the confidence low it is important to understand that after rises in the unemployment rate, people get used to it. In the 1980s, when unemployment began to drop from its highs over 10 percent, confidence soared. The adaptation level is now catching up with the current rate. Other things equal, confidence will increase as the difference between the two decreases. The blue line below is the adaptation level.


The blue line below represents a one-year unemployment rate forecast, which is not meant to be indicative, but to gauge the response of “animal spirits.”  Even under quite pessimistic assumptions about unemployment, confidence increases.


The other thing impacting confidence in the model is how much volatility people are used to. In part due to excessively accommodative efforts to "stabilize" the American economy in recent years, unemployment volatility fell to very low levels. The risk of over-insuring a society is that it loses the ability to respond coherently to perturbations. The blue line in the graph below represents what will happen to volatility over the next 12 months if unemployment rises to over 9 percent over the next 12 months as shown above.


The net result of the adaptation level rising to catch up with current unemployment and volatility rescaling perceptions of the gap between adaptation level and current unemployment is that even if unemployment increases as shown to over nine percent in 2009, confidence will turn up. And this generally signifies the end of a recession in the American economy.

The "animal spirits" variable can be combined with the slope of the yield curve, a powerful forecasting tool in its own right, to create a recession forecasting model that gives an estimated "probability" of a recession occurring from a full year in advance without forecasting any explanatory variables. This model has forecast the onset of the last two recessions in real time well ahead of the consensus of professional economic forecasters, and now forecasts an end to the current recession in early 2009.  Here is the current recession “probability” forecast (blue)—no recession in sight:


This model has an excellent record over the past 55 years as the next graph shows.


The model's forecasts are qualitative, of the sort generally found most useful by practical people. As one of my professors in graduate school used to say, "It is better to be approximately correct than precisely wrong." There is a rough proportionality between the size of the forecasted recession's probability and severity of the ensuing recession, but not much should be made of this in light of the current global slump in economic activity. The parameters of the model worked well over the postwar period, but the parameters may have changed. If there is a recovery in GDP growth in 2009, it will be from a far lower level for the simple reason that much of recent GDP (especially consumption) was debt-financed, and much of that isn't happening any more (“home equity ATM”). The best we can expect is an "L-shaped" recovery at a much lower run rate of GDP in 2009, probably. But a depression does not seem to be in the cards.

The unemployment rate will probably remain elevated for some time as it has tended to lag the cycle the last two cycles. In the opinion of this commentator, the government should make income support for the involuntarily unemployed its top priority. Most are the victims of a systemic credit crisis not of their own making. Also, income support to the unemployed is guaranteed to be spent. It will enter the spending stream faster than any other fiscal stimulus. Extending unemployment insurance benefits is not enough. There needs to be a livable poverty-level dole for the unemployed.

The ratio of private domestic spending for productive investment also responds to “animal spirits”:


In the current context increased savings by Americans might be plowed directly back into aggregate demand if “animal spirits” pick up and businesses begin to invest for future production.  Government infrastructure spending would be an additional investment-type stimulus independent of confidence-induced private investment spending.  The cloud hanging over any investment spending is the heavy debt load being carried by the U.S. economy.

Of course, the current debt deflation is unlike anything that occurred in the sample period used to develop this model.  However, if the adaptation level theoretic response of Americans to the unemployment rate remains intact, a forecast of increasing confidence and domestic investment is plausible, within financing constraints.  Bad debts need to be written off to make room for new lending that, one hopes, will be more oriented toward productive purposes than recent domestic investment has been.



Middleton, Elliott, ‘Animal spirits’ and expectations in U.S. recession forecasting,, 8 August 2001.
This paper provides citation for Middleton (1996) "Adaptation level and 'animal spirits'", JEconPsych.

Ball, Philip, “Hard times ahead: depressions caused by lack of economic confidence might be predictable,” Nature,, 15 August 2001.

Thursday, March 5, 2009

Surviving social collapse

  Dmitri Orlov on what it took to get through the collapse of the Soviet Union.  I watched the whole thing. 

Wednesday, March 4, 2009

Banks are signaling

It has been noted widely that JP Morgan slashed their dividend, but what they have not declared is an intention to repay the government its TARP money. 

In the Upper Midwest, TCF Financial and U.S. Bank (which also slashed its dividend to a nickel)  have expressed a desire to repay the government’s money as soon as possible. 

Of course, the feds get to say who can repay, but after the stress test, which all banks are expected to pass, the ability to repay the government may provide material information about a bank’s capital position and future prospects.

ANALYSIS-Some US banks find TARP a bother, give money back

Tuesday, March 3, 2009

“Modern finance”

A comment entered over at :

The problem is that the lessons of the Depression were tossed aside by the "true believers" in modern finance (financial tricksters) through deregulation and leverage, and investment banks and commercial banks and hedge funds and basically almost every variety of financial intermediary except credit unions blew it.

The investment banks and rating agencies conspired to fleece the public with the mortgage securitizations that some of the banks were just stupid enough to hold (or dumb enough to make bad RE loans and portfolio them--or unethical enough to book bad loans to get rich quick).

I am impressed with the Canadian model, a banking system run as a public utility under strict regulation. We're much more likely to be able to get there in the short run than to yet another fast-buck market solution.

Leave investment banking to the investment banks, and let them go bust when they screw up. Keep the balance sheets of the commercial banks clean and conservative, so that they don't freeze up when risk premia rise.

By their fruits shall ye know them--I don't trust "modern finance" to solve this problem. Modern finance has hosed the banking system up with deregulation and CDSs and other derivative crap they've pushed so bad the government is going to have to take it over to sort out the mess sooner or later, and the longer they wait, the worse the problem gets.

The AIG bailout is mostly to prevent triggers on CDSs from triggering, as I understand it, so we're bailing out the derivative holders before we bail out the banks. This makes sense?

I'd declare all CDS contracts null and void unless held as hedge against an owned asset, for starters. On net, that's supposed to be a zero sum game, but it will impact the pigs like AIG who sold these things thinking it was free money--and they're the ones who should be expropriated, not the taxpayers. The losses on the underlying securities aren't going away--why recognize them twice?

Summers and Geithner have got to go, or change their tune quickly to restore confidence.

Monday, March 2, 2009

Geithner’s delaying tactics

As a practical matter, putting C into receivership would have approximately the same effects on the banking system as the BK of Lehman.  Further systemic paralysis.  And it's all because of the web of off balance sheet CDSs that banks and insurance companies sold thinking they were free money.  Now these financial neutron bombs have turned many--not all--big banks into zombies.  Left in place as zombies, the big banks will crumple as the oncoming waves of rate reset driven CDO defaults cause the CDS provisions to become payable.

The first step toward unlocking the banking system will be to put daylight on CDS contracts--all of them, in a searchable public database.  Then watch the market action!  We'd find out pretty quickly who's BK and who isn't.

The stress tests don't touch any of this, and are pure delaying tactics.  The financial crisis has yet to be resolved.