Wednesday, January 14, 2009

“The U.S. Just Isn't Going Anywhere Good”

With all the death and destruction in Palestine, it’s sometimes easy to forget that the North American economy is going down the toilet.
The pre-xmas bull market has now come to an end as retail sales numbers have come in (they stank twice as bad as everyone expected) and more major financials stand on the edge of a cliff and windmill their arms.
Citigroup, a massive financial services company operating in 107 countries and with 350,000+ employees, is in a seemingly endless tailspin, cannibalizing its business divisions in a desperate effort to raise cash. It has now sold a controlling stake in “crown-jewel” investment arm, Smith Barney to Morgan Stanley. Not that this stopped its stock dropping by 23 percent in one day.
“The bank is trying hard to bolster capital after suffering $20.3 billion in losses in the year ended September 30, 2008. Since the third quarter of 2007, Citigroup has booked $45 billion in writedowns. It has received $45 billion from the government's $700 billion Troubled Asset Relief Program, and another $20 billion in a government bailout announced in November. The US government also agreed to guarantee most of a $306 billion pool of troubled assets if losses exceed $29 billion in return of control over executive pay and limits on dividends.”
There’s an old saying that if you owe the bank $1,000, that’s your problem. But if you owe $1 million, that’s the bank’s problem. Well, apparently, if you invest in $300 billion worth of toxic debt, that’s the United States government’s problem.
And that should give Citigroup some comfort. Prior to Xmas General Electric tried to sell off its financing division for $30 billion but gave up because no one was interested. The chances of any private firms buying the toxically leveraged business components that Citi is trying to sell are next to nil. Look for the government to step in very soon to avoid a mega-Lehman's Brothers scenario unfolding.
The same day as Citigroup’s shares were digging their way to China, Nortel was declaring bankruptcy. Once Canada’s largest corporation and North America’s largest telecom equipment maker, with 95,000 employees and a value of $366 billion, it now has just 26,000 staff and a market value of $192 million.
At the peak of the tech boom, Nortel’s shares were worth $1,231. Before they were pulled off the market, they were worth 38¢. Bankruptcy protection could send the 110-year old company into a death spiral, according to analysts.
All this is happening before the US federal government announces phase two of its TARP bank bailout program – the release of another $350 billion, some of which might, finally, be used to help out drowning homeowners. With the collapse in retail spending in December, it is becoming clear that giving money to banks to stuff under the mattresses, isn’t really doing much to slow the decline of the economy. And it’s because banks are hoarding cash, rather than lending it, that any stimulus by Obama is unlikely to offset this deflationary effect. After all, the economy is dependent upon debt to keep the wheels in motion.
However, banks and consumers all face the same problem, which is that they are over-leveraged, ie. drowning in debt, and are now desperately trying to pay off credit cards, lines of credit, etc. That’s why Bush’s initial $150 billion stimulus plan, which amounted to sending cheques to taxpayers across the land had zero effect. People just plunked most of the cash against their debts, which did nothing to stimulate new growth.
And so the economy has continued to fall, losing 2.6 million jobs in 2008, the biggest annual drop since World War Two, pushing the unemployment rate to 7.2%. Here in Canada the Conference Board is predicting our unemployment rate will hit 8% by the end of this year and that house prices will fall by 10 percent.
But, since every prediction by the big wigs of the economy world has so far been way off the mark, I wouldn’t start planning your purchase of a sea-faring yacht for 2010 just yet.
Nouriel Roubini, who has so far been the most prescient of mainstream economists regarding the depths of the recession, predicting it in advance of everyone else, suggests that there is a decent chance of an “L-shaped” recession. That is, it bottoms out and stays there like the heart monitor on a dead man.
”The credit crunch will persist and spread beyond mortgages. Deleveraging will continue, as thousands of hedge funds -- many of which will go bust -- and other leveraged players are forced to sell assets into illiquid and distressed markets, thus causing price declines and driving more insolvent financial institutions out of business. Credit losses will mount as the recession deepens. And a few emerging-market economies will certainly enter a full-blown financial crisis.”
With US house prices predicted to collapse up to 40% and housing starts in utter freefall, it’s hard to see what it will take to end the present spiral. Certainly, Obama’s stimulus plan will help offset a total collapse in the economy but it creates its own problems by increasing the US debt to unimaginable levels. No one knows how that will effect confidence in the dollar, for instance, or whether major sovereign funds, like China, will start to get nervous about the solvency of the US government and sell its massive holdings in US debt.
If everything goes according to plan, which is what the economic thinktanks, economists and government bureaucrats base their estimates on, there will be another year of painful recession. But if things go awry – more major financials like Citibank fail, a series of big corporate bankruptcies add to the quantity of toxic debt and loss of consumer spending power – we could be facing something much worse.
This is a definite possibility. As one financial consultant put it: “I think there's going to be a tsunami of restructurings."
"I think the next three months will determine the fates of a lot of the major retailers," said Robert McMahon, managing director for restructuring at General Electric Co's (GE.N) GE Corporate Lending. "Casino and gaming will continue to feel stress, as will casual dining and newspapers," he added.
Whatever the final outcome of the present disaster, it hasn’t been so clear in a long time that capitalism is about the dumbest way to run an economy. The whole model of driving down wages over the past generation has meant that the only way to sustain economic growth has been on the basis of debt – whether government, corporate or consumer. That chicken is now coming home to roost.
A system that allocated resources and products on the basis of what is needed and where, something only possible with a fully democratized economy, would eliminate the absurdity of the global casino, which encourages dangerous speculative bubbles in housing, tech gizmos or even tulip bulbs.
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