The US Trade Deficit: Fort Sumter...And The U.S. Trade Deficit US Recession: By far the Weakest Recovery
The Daily Reckoning
Tuesday, February 16, 2010 The Daily Reckoning - Special Reports:
Tuesday, 16 February 2010
Joel Bowman, reporting from Taipei, Taiwan...
A man fired a rocket into our building last night. He just stood there, in the middle of the street, and launched it into the air. The thing whistled right past our face before ricocheting off the concrete above and bursting in the night sky.
It was only a bottle rocket, to be honest, but it was almost enough to scare the cocktail out of your editor's hand...almost. All week we've been watching the Chinese New Year celebrations from our balcony here in Taipei. During the day, the streets are pretty much deserted. The markets in the laneway adjacent to our building are closed. The vendors are all home for the holidays. Everyone is off work, it seems. Yesterday we picked up the local paper. It was eight (8) pages "long." The business section was half a page. Even the local Starbucks pulled its shutters at 6 PM. If it weren't for the faint murmur of karaoke songs off in the distance, we'd think we had the city to ourselves. But that's just the daytime. Later, things get more interesting.
Every evening, around the same time, a group of old men emerge from their apartments on the ground floors of the surrounding complexes. They march, armed to the teeth with firecrackers and various other explosive devices, into the streets. Their wives shake their heads and pull the curtains, but the men don't seem to care. They gather in a small group, chatting and comparing their arsenals. Then, with cigarettes hanging from their mouths, they take turns launching their firecrackers into space. The rockets' glare lights up their faces and they roar with laughter, like a bunch of middle-aged college boys. They believe they are warding off the evil spirits. The Year of the Metal Tiger is here.
Americans took the day off yesterday too, to honor the memory of their dead presidents. (We can't think of a living one they'd want to celebrate...but people will clap hands and pop corks at the strangest of things.) Their stock markets were closed, too. Meanwhile, here at The Daily Reckoning, we just kept on reckoning. We reckoned on the fate of the Greeks and that of the currency they cling to. The euro is plumbing the depths of a nine-month low. How low can she go? More on that later in the week...
Bill Bonner, our Reckoner-in-Chief, reckoned over the rampant proliferation of lobbyists and the "final stage" for the US economy (a reckoning he continues today, below). And David Walker, former comptroller general of the US, reckoned on the most pressing issue of our day: escalating deficits and debt, a threat Americans saw as more serious than global warming or declines in education and manufacturing. In his column, Mr. Walker wondered aloud whether President Obama might "put a process in place to achieve a 'grand bargain' or to seriously reform federal spending programs and tax policies." At the time he penned the words, Obama hadn't yet released his fiscal 2011 budget proposal. Now he has...and here it is.
We wanted to know what our fellow reckoners thought about Mr. Obama's budget. Does it look like a "grand bargain" to you? Does it look like a serious effort to "reform federal spending programs and tax policies?" Here's what a few readers had to say:
From John I. in California: "Obama could not make worse decisions for America...even if it were his intention to hurt the country, not help it. I can only conclude that either his head is empty or his heart is filled with Malice."
War veteran, Mike V., writes: "I'm no expert in the field, but from what I have read, the process of 'socializing' a nation requires that the people become so poor that they will consent to whatever the government dictates. If that is the intent of the 'powers that be,' then they really have no intention of reducing debt or cutting spending!"
And this thoughtful scribe from James in Ontario, Canada: "The people whom President Obama has around him are the same people who created this mess in the first place. Ben Bernanke, Larry Summers and Hank Paulson [are] all Wall Street bankers...
"Most of the global problems can be traced to the policies of the US Federal Reserve and the Washington consensus... A nation's money supply is its most valuable resource since it represents the wealth creation, the productivity, industry and thrift of its people. Since the borrower is servant to the lender, nations who insist on borrowing from a cartel of private bankers, loading the people up with debt, are no longer sovereign."
And, lastly for today, here's John F: "There is no real plan for the benefit of the good old US of A. The only plan in DC is for the politicians to stay in power. There are a few who know the way home, but most only want 'their way.'
"I am 75 years old, a volunteer veteran, and one who has lived within my means and taught my children to do likewise. BUT, our country is on a downhill slope that our 'leaders' are not smart enough to notice.
"Sorry to say: Goodbye America the Great."
Lest the reader think we've merely cherry-picked the above emails, let it be noted that, of the many responses we received, not a single one endorsed Mr. Obama's budget. If you would like to comment, write us here: joel@dailyreckoning.com
And now for today's essay...
The Daily Reckoning PRESENTS: From exploding federal deficits to unmanageable debts on a personal level, the State of the Union is clearly not good. In the column below, David Galland of Casey Research interviews an industry insider to get the real story on commercial real estate. If you missed Part I of David's interview, you can access it here. Enjoy..
.
An Insider's View of the Real Estate Train Wreck, Part II
By David Galland, The Casey Report
Right now there are an awful lot of banks that do an awful lot of commercial real estate lending, and for about a year now you've been telling me that you saw the first and second quarter of 2010 as being particularly risky for commercial real estate. Why this year, and what do you see happening with these loans and the banks holding them?
MILLER: It's an educated guess, and it hasn't changed. I still think that it's second quarter 2010.
The current volume of defaults is already alarming. And the volume of commercial real estate defaults is growing every month. That can only keep going for so long, and then you hit a breaking point, which I believe will come sometime in 2010. When you hit that breaking point, unless there's some alternative in place, it's going to be a very hideous picture for the bond market and the banking system.
The reason I say second quarter 2010 is a guess is that the Treasury Department, the Federal Reserve, and the FDIC can influence how fast the crisis unfolds. I think they can have an impact on the severity of the crisis as well - not making it less severe but making it more severe. I will get to that in a minute. But they can influence the speed with which it all unfolds, and I'll give you an example.
In November, the FDIC circulated new guidelines for bank regulators to streamline and standardize the way banks are examined. One standout feature is that as long as a bank has evaluated the borrower and the asset behind a loan, if they are convinced the borrower can repay the loan, even if they go into a workout with the borrower, the bank does not have to reserve for the loan. The bank doesn't have to take any hit against its capital, so if the collateral all of a sudden sinks to 50% of the loan balance, the bank still does not have to take any sort of write-down. That obviously allows banks to just sit on weak assets instead of liquidating them or trying to raise more capital.
That's very significant. It means the FDIC and the Treasury Department have decided that rather than see 1,000 or 2,000 banks go under and then create another RTC to sift through all the bad assets, they'll let the banking system warehouse the bad assets. Their plan is to leave the assets in place, and then, when the market changes, let the banks deal with them. Now, that's horribly destructive.
Just to be clear on this, let's say I own an apartment building and I've been making my payments, but I'm having trouble and the value of the property has fallen by half. I go to the bank and say, "Look, I've got a problem," and the bank says, "Okay, let's work something out, and instead of you paying $10,000 a month, you pay us $5,000 a month and we'll shake hands and smile." Then, even though the property's value has dropped, as long as we keep smiling and I'm still making payments, then the bank won't have to reserve anything against the risk that I'll give the building back and it will be worth a whole lot less than the mortgage.
MILLER: I think what you just described is accurate. And it's exactly a Japanese-style solution. This is what Japan did in '89 and '90 because they didn't want their banking system to implode, so they made it easier for their banks to sit on bad assets without owning up to the losses.
And what's the result? Well, it leaves the status quo in place. The real problem with this is twofold. One is that it prolongs the problem - if a bank is allowed to sit on bad assets for three to five years, it's not going to sell them.
Why is that bad? Well, the money tied up in the loans the bank is sitting on is idle. It is not being used for anything productive.
Wouldn't banks know that ultimately the piper must be paid, and so they'd be trying to build cash - trying to build capital to deal with the problem when it comes home to roost?
MILLER: The more intelligent banks are doing exactly that, hoping they can weather the storm by building enough reserves, so when they do ultimately have to take the loss, it's digestible. But in commercial real estate generally, the longer you delay realizing a loss, the more severe it's going to be. I can tell you that because I'm out there servicing real estate all day long. Not facing the problems, and not writing down the values, and not allowing purchasers to come in and take these assets at discounted prices - all the foot-dragging allows the fundamental problem to get worse.
In the apartment business, people are under water, particularly if they got their loan through a conduit. When maintenance is required, a borrower with a property worth less than the loan is very reluctant to reach into his pocket. If you have a $10 million loan on a property now worth $5 million, you're clearly not making any cash flow. So what do you do when you need new roofs? Are you going to dig into your pocket and spend $600,000 on roofing? Not likely. Why would you do that?
Or a borrower who is sitting on a suburban office property - he's got two years left on the loan. He knows he has a loan-to-value problem. Well, a new tenant wants to lease from him, but it would cost $30 a square foot to put the tenant in. Is the borrower going to put the tenant in? I don't think so. So the problems get bigger.
Why would the owner bother going through a workout with the bank if he knows he's so deep underwater he's below snorkel depth?
MILLER: It's always in your interest to delay an inevitable default. For example, the minute you give the property back to the bank, you trigger a huge taxable gain. All of a sudden the forgiveness of debt on your loan becomes taxable income to you. Another reason is that many of these loans are either full recourse or part recourse. If you're a borrower who's guaranteed a loan, why would you want to hasten the call on your guarantee? You want to delay as long as possible because there's always a little hope that values will turn around. So there is no reason to hurry into a default. None.
So that's from the borrower's standpoint. But wouldn't the banks want to clear these loans off their balance sheets?
MILLER: No. The banks have a lot of incentive to delay the realization of the problem because if they liquidate the asset and the loss is realized, then they have to reserve the loss against their capital immediately. If they keep extending the loan under the rules present today, then they can delay a write-down and hope for better days. Remember, you suffer if the bank succumbs and turns around and liquidates that asset, then you really do have to take a write-down because then your capital is gone.
So here we are, we've got the federal government again, through its agencies and the FDIC, ready to support the commercial real estate market. They've taken one step, in allowing banks to use a very loose standard for loss reserves. What else can they do?
MILLER: Well, obviously nobody knows, but I can guess at what's coming by extrapolating from what the federal government has already done. I believe that the Treasury and the Federal Reserve now see that commercial real estate is a huge problem.
I think they're going to contrive something to help assist commercial real estate so that it doesn't hurt the banks that lent on commercial real estate. It'll resemble what they did with housing.
They created a nearly perfect political formula in dealing with housing, and they are going to follow that formula. The entire US residential mortgage market has in effect been nationalized, but there wasn't any act of Congress, no screaming and shouting, no headlines in The Wall Street Journal or The New York Times about "Should we nationalize the home loan market in America." No. It happened right under our noses and with no hue and cry. That's a template for what they could do with the commercial loan market.
And how can they do that? By using federal guarantees much in the way they used federal guarantees for the FHA. FHA issues Ginnie Mae securities, which are sold to the public. Those proceeds are used to make the loans.
But it won't really be a solution. In fact, it will make the problems much more intense.
Don't these properties have to be allowed to go to their intrinsic value before the market can start working again?
MILLER: Yes. Of course, very few people agree with that, because if you let it all go today, there would be enormous losses and a tremendous amount of pain. We're going to have some really terrible, terrible years ahead of us because letting it all go is the only way to be done with the problem.
Do you think the US will come out of this crisis? I mean, do you think the country, the institutions, the government, or the banking sector are going to look anything like they do today when this thing is over?
MILLER: I know this is going to make you laugh, but I'm actually an optimist about this. I'm not optimistic about the short run, and I'm not optimistic about the severity of the problem, but I'm totally optimistic as it relates to the United States of America.
This is a very resilient place. We have very resilient people. There is nothing like the American spirit. There is nothing like American ingenuity anywhere on Planet Earth, and while I certainly believe that we are headed for a catastrophe and a crisis, I also believe that ultimately we are going to come out better.
Regards,
David Galland
for The Daily Reckoning
Joel's Note: Andy Miller is the co-founder of the Miller Frishman Group, which includes three companies serving different sectors of the real estate market - from mortgage brokerage and banking, to the building, management, and marketing of commercial real estate across the United States. His firm is currently deeply involved in the distressed real estate business, assisting lenders across the nation with their growing portfolios of non-performing loans.
Obviously, research like this is extremely valuable to those seeking a deeper understanding of what's really going on out there. You can believe dot.gov hype, of course...or you can take a closer look. For more of David Galland's excellent work with Casey Research, click here.
---------------------------------------------------------------
And now over to Bill Bonner with today's reckoning from London, England...
Markets in the US were closed yesterday. In the rest of the world, the noise continued.
European investors still have their eyes on Greece...a welcome diversion from their own sins and errors. More on this later in the week...
Asian investors still have their eyes on China. The powers-that-be in the Middle Kingdom seem to have begun tightening credit... If it continues, China's bubble will burst... Perhaps the most remarkable thing about this is that no one seems to know who the powers-that-be are. Ben Bernanke may be a fool. At least he's predictable. China's real leaders are unknown...and unpredictable. More on that sometime in the future too...
But for today...let's focus on the good news. Well, our first item is good news if you were fool enough to follow our "Trade of the Decade."
We suggested that buying Japanese stocks could be the best investment you can make in the next 10 years. We immediately heard from dozens of friends and enemies. The friends were concerned because they thought we'd made a bad bet. Enemies were delighted that we'd lost our grip completely. After all, they remarked, who in his right mind would buy Japanese stocks?
Well hardee, har, har... Guess what market is leading the world so far this year? That's right... Japan. Below, colleague Alex Green explains why Japan hasn't been such a bad bet after all.
We're six weeks into the new decade, we'll claim victory now...and change the subject. Who knows what will happen in the next 514 weeks.
Meanwhile, here comes more good news: the US federal government may not go broke after all. Rep. Paul Ryan, who hails from the sovereign state of Wisconsin, has come up with a solution.
Before we get to the solution, however, let us take a minute to describe the problem. In short, the feds are spending too much money they don't have. The Obama administration says it doesn't see any balanced budgets anywhere in America's future. The Congressional Budget Office, a far-sighted group if ever there was one, looks all the way to 2080. It sees no hint of fiscal equilibrium either. Just deficits and debt. By its estimate the US budget grows to 50% of GDP and the official US debt rises to 7 times GDP.
This exercise by the CBO is not a forecast. It is merely an extrapolation. If present trends continue, that is where we would end up by the time your author is 131 years old. Of course, there is no way present trends could continue that long. Even at 2 times GDP...debt cannot be sustained. It would cost more than half of all America's tax revenues to the pay the interest on such a large debt. Already, depending on how things go in the economy, as much as 30% of the money borrowed by the US could soon be necessary just to pay the cost of past borrowing.
Fortunately, Mr. Ryan has a solution. He calls it a "Roadmap for America's Future." After studying it for all of 30 seconds, we're convinced that Mr. Ryan should get a GPS. His roadmap is a series of squiggles, dodges and twists to US tax laws...along with a few torques to the spending side too... that leads the country to a dead end. Most of his effort has been concentrated on bringing health care outlays under control. No effort is made, on the other hand, to cut military spending. Typical. Weak, limp, pusillanimous. The benefits now; the costs later. That's why America's residual respect for Congress is just about exhausted. The institution is incapable of correcting its own mistakes. Instead, it just makes them worse. Even with Mr. Ryan's roadmap, America drives in the wrong direction for the next half a century. It is only sometime after 2050 that the federal budget deficits finally stop.
Any solution that doesn't pay off until we're all dead is no solution at all. It's a way of avoiding a solution...which is what Congress desperately wants to do. A real solution will come. But not from Congress. Instead, it will come unbidden. And unwelcome. Like the plague.
At least, that's our reading of history. Once the system tips out of control it stays out of control until it finally blows itself up.
It would be fairly easy to get the budget under control...that is, if there were no political system to prevent you. The US government shouldn't be in the business of giving out drugs or regulating heart transplants. It also shouldn't be in the business of telling the rest of the world what to do. The solution is simple: abandon the imperial agenda...let people take care of themselves, both at home and abroad...and downsize the federal government.
But that is not going to happen. We may be on the road to ruin...but too many people are enjoying the ride. We're not going to stop any time soon. More than 40 million people on food stamps...thousands of military contractors...millions of government employees... People who want the government (other citizens) to pay for their gall bladder operations. People who pay no taxes. GM executives. AIG bondholders. University administrators. Lobbyists.
It is a wholly rational and completely foreseeable trend. People always seek to improve their wealth and status in the easiest way possible. What's the easiest way? Take wealth from someone else. That's why criminals are still in business...after thousands of years of trying to stop them.
But common criminals lack status - except in the ghetto. So, the smarter, better connected and better educated of their ilk go into government. Or they use government for their own ends. That way, they get other peoples' money. But they also get respectability...even an elevated social status.
Congress is supposed to confront the problems of the nation...and solve them. But with more people getting something from the government than supporting it, Congress is not likely to change course. It responds to the perverse will of the people...and to its own corrupt predilections. We are all victims of democracy now...
The government grows...deficits become unstoppable...and the empire sinks under the weight of so many parasites.
And more thoughts...
Alex Green on Japanese shares:
"Here's a handy way to know when to sell your investments: everyone is talking about them.
"There is an obvious corollary to knowing what to sell. If you want to know what to buy, consider what no one is talking about.
"And that brings me to investing in Japan...
"From a high near 40,000 in 1989, the once-mighty Nikkei 225 - the equivalent of our S&P 500 - fell over 80% and hit a 27-year low early last year. It's still more than 70% below the highs of 21 years ago.
"The main culprit - aside from a real estate bubble that made the one here in the United States look bush-league - was misguided government policies. Japan waited too long to clean up its ailing banking system and spent trillions on public works projects that simply weren't needed.
"However, Japan has a new government that has promised to shrink the country's massive bureaucracy and cut wasteful public spending. It also intends to end more than 20 years of economic stagnation by cutting taxes and focusing on small and mid-sized businesses.
"Japanese stocks have rallied off the lows of 10 months ago. In fact, the Tokyo Exchange is one of the world's best-performing bourses so far in 2010.
"But it's still among the cheapest and most unloved in the world. Virtually no one is enthusiastic about Japanese stocks."
Virtually no one? Hey...that's us!
Another colleague, Merryn Somerset Webb, says it's time to buy Toyota. "You don't get a chance to buy companies like Toyota at book value very often," she says.
Regards,
Bill Bonner,
for The Daily Reckoning
---------------------------------------------------------------
Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com
Posts
