Further results on income inequality

Now, is it really plausible that the top 0.01 percent got that much more productive in recent decades?  Or the top 1.0 percent?  Or could it have something to do with a clubby sort of atmosphere at the top in which one scratches another’s back in return for board seats, the right CEO job at the right time, and oh, don’t you know, it’s a small world up there and we are all very true to our class.  See Income inequality, debt, crisis and depressions for a sketch of the larger picture of how income inequality effects other social changes, especially the distribution of debt, and On the coming neo-feudalism for a rant I wrote in a bad mood about where the country might be going, a concern that Emmanual Saez, who is still in academia, shares while expressing himself in the sedate academic manner.  This a must read.  Hat tip Financial Armageddon.

How to change this?  Let’s start by raising tax rates on tippy-top incomes.  These people have taken enough.  There is no economic rationale for this kind of pay that is not laughable.  Saez addresses the issue of extreme income inequality creating great wealth inequality that is the essence of feudalism as America saw in the Gilded Age just over a hundred years ago.  We raise marginal tax rates on the super-rich not to raise revenue, because that hole is much too deep to fill that way, but to bring these high-rollers down to earth.  Look at the arrogance of Goldman Sachs and the other financial oligarchs paying themselves some of the biggest bonuses ever on the taxpayers’ tab—letting the Fed guarantee their debt! 

And the American people need to tell their politicians that they’ll see the “death tax” done away with over their dead bodies.  Little else stands between today’s extreme income inequality and a Gilded Age tomorrow.  An exclusion (non-taxable portion) of, say, $5 million in today’s dollars of any estate would enable a wealthy family to pass on a large amount to support to following generations.  A few fortunes of hundreds of millions or billion or more allowed to pass untaxed might pass a tipping point of wealth concentration, supporting untold generations of trust fund waste products, and depriving everyone else of income.

saez-UStopincomes-2007 -

Animal spirits in the stock market

This is research, not investment advice.  You invest at your own risk.

Below are the graph of the venerable Coppock Guide and my “animal spirits of the SPX” indicator (SPXAS2) that is calculated the same way as the “animal spirits” indicator for the unemployment rate (with a sign change).

Both indicators suggest that the stock market wants to continue to rally, sheerly on emotion and easy money.  I expect, along with Bob Prechter, for the market to break below the March lows in time.  However, this reading is consistent with the July 26 “buy” signal from the Dow theory.  This rally is testament to the power of easy money, even when most consumers are broke.  Buying into this market in these economic conditions may be damaging to your digestion.

Also, the Coppock gave a false signal in 2002 and might well do again.

The latest Fed bubble

Via:  Fortune  The answer to the question below is “yes.”  And this is appearing in the mainstream financial press!  That’s cause for some hope, although it’s doubtful the prostitutes in Congress will have the courage to sacrifice their rich financial donor dollars to do the right thing.  Can there be any doubt that “activist monetary policy” accompanied by complete ignorance of financial intermediary management skills can do no more than cause continuous consumer price inflation until consumers are tapped out, and then blow serial asset price bubbles?  The Federal Reserve System, our systemic risk Creator….  Alan Greenspan created the pre-conditions for this depression, Ben Bernanke will destroy our currency “fixing” it using his magic hammer.  Worse yet is that central banks throughout the world are imitating our idiots.  Monetary chaos looms.

Stocks: The latest Fed bubble

Are the government programs supporting the financial sector reinflating global stock markets even as economies stumble?

By Colin Barr, senior writer

Last Updated: August 12, 2009: 3:52 AM ET

NEW YORK (Fortune) -- The Federal Reserve has spent the past year cleaning up after a housing bubble it helped create. But along the way it may have pumped up another bubble, this time in stocks.

To head off the worst downturn since the Great Depression, the central bank has slashed interest rates while funneling money to banks.

The Fed has mostly won praise for its efforts. The pace of job losses has slowed, and there has been a modest recovery in output.

At the same time, stocks have bounced back with startling speed. Since global markets hit their bottom in March, the S&P 500 has jumped 51% -- even as the outlook for economic recovery remains dim.

"This is the most speculative momentum-driven equity market since the early 1930s," Gluskin Sheff economist David Rosenberg wrote in a note to clients Monday.

Of course, stocks have rallied in part because investors perceive the worst-case scenario -- a 1930s-style Depression -- is off the table. And while the gains have been remarkable, they come after an even bigger decline. The S&P is still down 16% since Lehman Brothers collapsed in September.

But while most people take the rise in stocks as a hopeful sign for the economy, some see evidence that the Fed has been financing a speculative mania that could end in another damaging rout.

Recent weeks have brought huge rallies in some of the lowest-quality stocks -- including firms such as AIG (AIG, Fortune 500), Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500) that are being propped up by the government and are unlikely to return to health any time soon.

What's more, this year has brought an 80% surge in emerging market stocks, while the dollar has posted a 10% decline since March. A declining dollar and surging emerging markets were the hallmarks of the credit-fueled bull run earlier this decade.

"We have put the band back together on a lot of this," said Howard Simons, a strategist at Bianco Research in Chicago. "That couldn't have happened without liquidity."

Though liquidity is admittedly a nebulous concept, there's no question that central bankers around the globe have poured huge amounts of money into the markets to ease the financial crisis. Given free money, investors' appetite for risk shoots higher and they gobble up stocks.

That's good, except when the outlook for economic growth doesn't seem to support the higher stock values.

"Many observers are wondering whether the strong stock market rebound since mid-March is already a forerunner of the next recovery or simply driven by a reflux of liquidity into riskier asset markets," Deutsche Bank Research analyst Sebastian Becker wrote in a report last month.

Rosenberg, who notes that consumer credit has dropped an unprecedented five straight months, said it's far from clear the recession is over. He says the risk of a market relapse later this year is high.

Simons said another factor that could work against recovery is that short-term interest rates could soon head higher, judging by action in futures markets. That could raise companies' borrowing costs at a time when policymakers have committed to holding rates near zero to restore economic growth.

Fed officials have stressed that they will start to unwind their financial support programs at the earliest sign of inflation. Given the cost of cleaning up after the last bubble, Becker writes that "this time, policymakers are unlikely to remain inactive should they suspect the formation of another asset price bubble."

But it's clear that bankers are loath to pull back on their support for the financial system before it's clear the economy has staged a stronger recovery. And the Fed has a long and painful history of ignoring asset price inflation.

"The central bankers have this textbook belief that the only inflation is the kind that appears in consumer price indexes," said Simons. "They don't believe what they're doing could cause an asset price bubble."

For now, Fed chief Ben Bernanke and other central bankers can console themselves for now with stable consumer price inflation readings in major economies.

But comparing the bankers with a driver pulled over for speeding for the umpteenth time, Simons said, "At some point, you have to say maybe your speedometer's broken."

The FDIC is in trouble

Via:  The Daily Reckoning   Nothing succeeds like failure in disciplining a financial system, an inconvenient fact that we’ve forgotten in our age of unlimited moral hazard or financial fascism.  The current administration could be called “The Dukes of Moral Hazard…,” with Tim Geithner as their poster boy.

As we all know, the Federal Deposit Insurance Corporation (FDIC) guarantees depositors that they'll get their money back if a bank fails, at least up to a certain amount. To fund its operations, the FDIC collects small fees from the banks that are held in reserve for the purpose of taking over troubled banks and paying off depositors.

Since the Great Depression, a period marked by widespread runs on banks, the FDIC has done a good job of fulfilling its mandate. So how are they doing in this crisis?

In a nutshell, they are in trouble.

The FDIC insures 8,246 institutions, with $13.5 trillion in assets. Not all of them are going bankrupt, of course. Yet as of late July, a disturbing 64 banks had gone belly up this year - the most since 1992 - costing the FDIC $12.5 billion. At the end of Q1, the agency was already asking for emergency funding.

And worse, much worse, is likely yet to come. The following chart shows the total assets on the books of the FDIC's list of 305 troubled banks. The list doesn't include the biggest banks that are considered too big to fail, as they are being separately supported with bailouts. By contrast, if the banks on this list fail, the FDIC is on the hook to have to step in and take them over and, of course, make depositors whole.

Other measures of how serious the losses at banks are becoming can be seen in the chart below, which shows charge-offs and non-current loans at all banks. You can see that the Net Charge-offs remain stubbornly high, with banks charging off almost $40 billion in bad loans in the last two quarters alone. And the number of non-current loans - loans where payments are not being kept up - is soaring.

Together, these measures indicate the potential for more big failures and more big bailouts coming down the pike.

Into the battle against bank insolvency the Fed brings a level of reserves that can best be described as paper-thin. From almost $60 billion last fall, the FDIC's reserves have been drawn down to only about $13 billion today, a 16-year low. A quick look at the FDIC's own data shows us how inadequate those reserves are compared to the deposits they are now insuring.

The chart below says it all:

As you can see, the Federal Deposit Insurance Corporation currently covers each dollar on deposit with a trivial 2/10ths of a penny.

And even that understates the seriousness of the situation: the $4.8 trillion in deposits the FDIC is providing coverage on doesn't include the expansion that now extends insurance coverage from $100,000 to $250,000 for normal bank accounts. That likely brings the exposure of the FDIC closer to $6 trillion. But that's pretty inconsequential at this point: using any reasonable accounting method, the FDIC is already bankrupt and will require hundreds of billions of dollars in government bailouts just to keep the doors open.

So, given the dire shape of its finances, what measures is the FDIC taking, you know, to batten down the hatches and all that?

For starters, they are expanding their mandate by guaranteeing bank loans - $350 billion and counting at this point. And the government has tapped the FDIC to play a pivotal role in guaranteeing the loans issued to buy toxic waste through the government's highly problematic and fraud-prone new Private Public Investment Partnership (PPIP). The FDIC's commitment to the PPIP is and may become limited based on its resources.

It is hard to draw any other conclusion but that hundreds of billions in new funding will be required to keep the FDIC operating. Given the catastrophic consequences of the FDIC failing, starting with a bank run of biblical proportions, there's no question it will get whatever funding it needs. By loading the new loan guarantee responsibilities and the PPIP onto the FDIC's back, the administration will go back to Congress and ask for the next large bailout.

Of course, in the end, all of this falls on the taxpayer, either directly in the form of more taxes or indirectly via the destruction of the dollar's purchasing power. Another bale of straw on the camel's back, and another reason to be concerned about holding paper dollars for the long term.

Troubled assets may still pose risk; dollar bottoming?

• Robert Prechter calls a bottom in the USD – Yahoo Finance  Prechter was early in calling the crash, but got it right.  Jesse has the opposite prediction.  I would guess Prechter is right.  This is not investment advice, but simply my opinion.  You invest at your own risk.

Via:  NYT  True or false:  the TARP program never actually bought any bank assets?

Troubled Assets May Still Pose Risk

By EDMUND L. ANDREWS

Published: August 11, 2009

WASHINGTON — The Treasury Department’s $700 billion bailout program has stabilized the banking system, but it has done little to prod banks to fully deal with the troubled loans on their books, a Congressional oversight panel said in a report to be released Tuesday.

The Troubled Asset Relief Program was originally conceived as a program for the government to buy troubled and unsalable mortgages and mortgage-backed securities.

But the Treasury has never actually used the program to buy assets, in part because it was faster to invest money directly into the nation’s banks and in part because banks have not wanted to sell their problem loans and book the loss in their value.

“The nation’s banks continue to hold on their books billions of dollars in assets about whose proper valuation there is a dispute and that are very difficult to sell,” the panel said in its latest monthly report.

As a result, it warned, many banks could find themselves short of capital if the economy suffered another downturn and their losses on troubled loans soared.

In an encouraging note, the panel said 18 of the 19 biggest bank holding companies would probably have enough capital even if economic and financial conditions deteriorated more than they have already. That conclusion essentially backed up the results of the Federal Reserve’s stress tests in April.

But it warned that thousands of small and medium-size banks, which it defined as those with assets of $600 million to $100 billion, might find themselves short a total of $21 billion if the conditions matched its worst-case assumptions.

The panel noted that other institutions had already estimated the amount of troubled assets on bank balance sheets that had yet to be written down. The Federal Reserve estimated in May that American banks still had about $599 billion in assets to write down. Goldman Sachs and the International Monetary Fund estimated the total at about $1 trillion. And RGE Economics, headed by Nouriel Roubini, has estimated the total at $1.27 trillion.

The panel urged the Treasury to either expand its current program to soak up troubled assets, the Public-Private Investment Program, “or consider a different strategy.”

The five-member oversight panel is headed by Elizabeth Warren, a professor at Harvard Law School. But one member, Representative Jeb Hensarling, Republican of Texas, dissented from the report.

The recommendations seem to advocate another bailout of a failed federal program with involuntary taxpayer capital, Mr. Hensarling said in a statement.

The Treasury, in a statement, said its efforts had already helped stabilize the banking system and that programs to buy problem assets could be expanded quickly if necessary.

Obama’s deal with big pharma

The United States government has agreed not to negotiate prices with Big Pharma in exchange for support of a health bill.

Here’s what Robert Reich, a Democratic team player, has to say about that.

…

We’ve got a liberal friend from Minnesota visiting who is still arguing that it’s going to be better under Obama because he’s not a Republican.  And I do agree that Bill Clinton and a Republican Congress did the best job in recent memory of managing the economy.

I keep trying to tell her there’s only one party in American politics, the Money Party, and it always wins because it owns the government. 

Sadly, it wasn’t enough that Obama could beat the system (and he really did, and beat the Clintons, too) by raising his own money over the Internet.  What must the man be feeling, if he actually believes anything like his campaign rhetoric?  He’s gone back on what he represented as his basic values, ramping up a stupid war and providing massive welfare for the rich and now caving in to Big Pharma.  Or was it all an act?  I don’t think so.

Head’s up people:  you got to support Congressional candidates with money who will honor your will.  

First, we have to figure out how to get them on the ballot…. I still like the idea of voting out all incumbents until they get the idea….

It’s the debt, stupid (reprise)

Via:  Comstock Partners 

Check out the charts.  Only when viewed in the this context can one understand the scale of the criminality of the financial institution bailouts that put the bad debt (bad bets) of financial speculators on the backs of the American taxpayers.  This is all stuff regular readers have heard before, but Comstock does a really nice job on it.

I expect this house of cards to collapse within five or so years in unprecedented defaults that will of necessity be upon private debts.  This implies further asset price deflation in the U.S., probably of both real estate and stock prices. 

The monetary and fiscal authorities can be expected to “panic” again (really, they just realize that they have no choices, that all their moves are forced moves, forced by the financial-military-industrial complex and its ownership of the government).  It might well be agreed that, historically, the quickest way to get an inflation going to reduce the government’s debt is to have a hot war.  The chances of a U.S.-initiated war starting in the next decade are pretty good.  A rapid inflation could ignite.  So could a world war, over oil resources, perhaps. 

God save us from our leaders, and our greed.

Deleveraging the U.S. Economy
Total Credit Market Debt as a % of GDP
H/H Debt relative to Disposable Income
Savings Rate
Personal Consumption vs. GDP
H/H Debt vs. GDP
Credit Conditions
Capacity Utilization
Net Worth

We are in the process of deleveraging the most leveraged economy in history.  Many investors look at this deleveraging as a positive for the United States.  We, on the other hand, look at this deleveraging as a major negative that will weigh on the economy for years to come and we could wind up with a lost couple of decades just as Japan experienced over the past 20 years.  It is true that Japan didn't act as quickly as we did but our debt ratio presently is much worse than Japan's debt ratios throughout their deleveraging process. 

Presently, the stock market is exploding to the upside, which you could say argues against the case we are attempting to make in this special report.  However, if you step back and look at the larger picture, you can see that the stock market is still down over 35% from the highs reached in 2007 and also down over 33% from the highs reached in early 2000.  In fact, the market now is acting in the same manner as it did in early 2000 at the peak of the dot com bubble and again in 2006 & 2007 at the combined housing and stock market bubble. 

This seems to us to be a "mini bubble" of stocks reacting to an abundance of "money printing" by governments all over the world since stocks are rising worldwide.  Of course, if the U.S. doesn't recover there will be no worldwide recovery since the rest of the world is still dependent upon the U.S. consumers' appetite for their goods and services (despite the so called growth of domestic consumption in China and India).   We, however, don't believe that the U.S. massive stimulus programs and money printing can solve a problem of excess debt generation that resulted from greed and living way beyond our means.  If this were the answer Argentina would be one of the most prosperous countries in the world.  This excess debt actually resulted from the same money printing and easy money that we are now using to alleviate the pain.

Most investors believe the bailouts, stimulus plans, and quantitative easing will lead to inflation.  In fact, almost all of the bearish prognosticators are negative because of the fear that interest rates will rise once the inflation starts to work its way into the economy.  They point to the doubling of the monetary base which they believe will soon lead to rising prices as more dollars are created chasing the same amount of goods.  We, on the other hand, are not as concerned about the doubling of the monetary base because we believe the excess money will need the money multiplier and increases in velocity in order to increase aggregate demand and eventually inflation.  As long as velocity (turnover of money) is stagnant we expect the increases in the monetary base and all the quantitative easing will lead to a stagnant economy and deflation until the consumer goes into the same borrowing and spending patterns that was characteristic of the 1990s through 2007.  

Remember, over the past decade (when we believe the secular bear market started) the total debt in the U.S. doubled from $26 trillion in 2000 to just over $52 trillion presently (peaking a few months ago at $54 trillion).  This consists of $14 trillion of gross Federal, State and Local Government debt and $38 trillion of private debt.  We expect the private debt to continue declining in the future as the deleveraging of America unfolds, while the government debt will very likely explode to the upside as the government tries to slow down the private deleveraging by helping out the entities and individuals in the most trouble with debt (such as over-extended homeowners).    

We wrote a special report in January of this year titled "Substituting Debt for Savings and Productive Investment" in which we explained why the U.S. economy historically prospered because of hard working Americans saving a substantial amount of their income which was used for productive investment.  Unfortunately, all of this changed over the past few decades and got worse over the past decade.  In fact, we stated in the report that it took $1.50 of debt to generate $1 of GDP in the 1960s, $1.70 to generate $1 of GDP in the '70s, $2.90 in the '80s, $3.20 in the '90s, and an unbelievable $5.40 of debt to generate $1 of GDP in the latest decade.  Over the past two decades, while most investors thought this trend could continue indefinitely, we have been warning them of the catastrophic problems associated with this ballooning debt. 

The attached chart of total debt relative to GDP shows exactly how much debt grew in this country relative to GDP (it is now 375% of GDP).  The total debt grew to over $52 trillion relative to our current GDP of approximately $14 trillion.  This is worse than the debt to GDP relationship in the great depression (even when the GDP imploded) and greater than the debt to GDP that existed in Japan in 1989.  Even if you took the debt to GDP when the U.S. entered the secular bear market in early 2000 and compared that to 1929 and Japan in late 1989, our debt to GDP still exceeded both (by a substantial margin relative to 1929).  The approximate numbers at that time were about 275% in the U.S. in early 2000, 190% in 1929, and about 270% in Japan in 1989. 

In fact, the similarities between Japan's deleveraging and the U.S. presently are eerie.  Japan's total debt to GDP increased from 270% when their secular bear market started to just about 350% 7 years later (1998) before declining to 110% presently.  The U.S. increased their total debt to GDP from 275% of GDP when our secular bear market started (in our opinion) to 375% presently (10 years later), and we suspect the total debt to decline similar to Japan's even though the Japanese government debt tripled during their deleveraging.  The government debt relative to GDP was about 50% in both the U.S. and Japan when the secular bear market started.  We also suspect that our government debt will grow substantially just like it did in Japan as the private debt collapses.  Also, the Japanese stock market doubled during the three years preceding their secular bear market in 1987, 1988, and 1989 while the U.S. market also doubled during the three years preceding the beginning of our secular bear market in 1997, 1998, and 1999. 

There also a few significant differences between the U.S. and Japan.  The private debt in Japan was almost the reverse of the U.S. where most of our excess debt was in the household sector and most of the excess debt in Japan was in the corporate sector.  The debt to GDP figures in Japan were not easy to come by from the typical sources until the mid 1990s and had to be estimated, but should be pretty close to the numbers used above.  Our sources on the above Japanese debt figures came from Ned Davis Research and the Federal Reserve Bank of San Francisco. NDR's report, "Japan's Lost Decade-- Is the U.S. Next?" have great statistics and information and the Fed's report "U.S. Household Deleveraging and Future Consumption Growth" is well worth reading.

The Fed study charted the peak of the debt related bubble of the stock and real estate assets in Japan in 1991 (1989 for stocks and 1991 for real estate) and overlaid it with the peak of U.S. debt associated with the same assets in 2008.  They concluded that if we are able to liquidate our debt at the same rate as Japan we would have to increase our savings rate from the present 6% (artificially high due to the recent stimulus paid to households) today to around 10% in 2018.  If U.S. households were to undertake a similar deleveraging, the collective debt-to-income ratio which peaked in 2008 at 133% (H/H debt vs. Disposable Personal Income) would need to drop to around 100% by 2018, returning to the level that prevailed in 2002.

If the savings rate in the U.S. were to rise to the 10% level by 2018 (following the Japanese experience), the SF Fed economists calculate that it would subtract ¾ of 1% from annual consumption growth each year.  We did a weekly comment about this very subject on June 25 of this year and came to a similar conclusion.  In that same report we showed that from 1955 to 1985 that consumption accounted for around 62% of GDP.  Because of the debt driven consumption over the past few years at the end of March 2009 consumption accounted for over 70% of GDP.  If the percentage dropped to the normal low 60% area of GDP it would subtract about $1 trillion off of consumption (or from $10 trillion to $9 trillion).  We also showed in that same report that H/H debt averaged 55% of GDP over the past 55 years and was 64% as late as 1995.  It has since soared to over 100% of GDP giving a big boost to spending that will be reversed as the deleveraging takes place over the next few years.

Other problems we have in the U.S. that will exacerbate the deleveraging are excess capacity, unemployment rates skyrocketing (putting a damper on wages), credit availability contracting, and dramatic declines in net worth.  The attached chart of capacity utilization is self evident that excess capacity in the U.S. has just dropped to record lows with the manufacturing capacity dropping to under 65% and total capacity utilization is just a touch better at 68%.  It is very hard to imagine corporations adding fixed investment at this time.  With unemployment rates close to 10% and rising, it is unlikely that wages will grow anytime soon.  The charts on credit availability and net worth reductions are self explanatory and will also put a damper on consumer spending rising anytime soon.

We expect that the U.S. deleveraging will follow along the path of Japan for years as real estate continues to decline and the deleveraging extracts a significant toll from any growth the economy might experience.  We also expect that, just like Japan, the stock market will also be sluggish to down during the next few years as the most leveraged economy in history unwinds the debt.