Nice...AIG Is Paying $165 Million To The People That Ruined The Company

What is going on over at AIG? The latest fiasco coming from AIG is the news that $165 million in bonuses are scheduled to be paid out to the financial products unit. Oh, one other thing, that is the unit that basically bankrupted the company. How on earth are these people still even working for the company, let alone getting bonuses? Typically when someone screws up that much they get fired, not rewarded. Meanwhile the American public is left completely baffled at the situation. So far we have given AIG about $170 billion, — which kept the company in business — and now AIG is telling us that we have to allocate $165 million of this tax payer money to give to the people who caused us to have to pony up the $170 billion to begin with? I know they have some contract things in place and all, but as Laura Wilson from Information Security Resources points out in her blog post below, I'm sure there is a way for us to get around that contract considering the situation. Oh yeah, here is a thought too: how about we FIRE some of these people! There are a lot of good financial people looking for jobs right now, and a little shake up over there might not be such a bad thing.

The plaint that credit default swap-promulgating AIG (AIG) is contractually obligated to pay out millions in bonuses to the same pitted brass that led the company, the industry, and the entire economy off a cliff is a bunch of horse hooey.

If you are on the management team of a company that lays off workers, can’t pay its bills, leaves shareholders holding nothing, and has to take public bailouts, it’s your damn job to make a deal to restructure that company, or wind it down responsibly.

Your bonus is getting to keep porking up to the paycheck trough while other workers are losing salary, severance, and health care.

New York Times: The payments to A.I.G.’s financial products unit are in addition to $121 million in previously scheduled bonuses for the company’s senior executives and 6,400 employees across the sprawling corporation. Mr. Geithner last week pressured A.I.G. to cut the $9.6 million going to the top 50 executives in half and tie the rest to performance.

The payment of so much money at a company at the heart of the financial collapse that sent the broader economy into a tailspin almost certainly will fuel a popular backlash against the government’s efforts to prop up Wall Street. Past bonuses already have prompted President Obama and Congress to impose tough rules on corporate executive compensation at firms bailed out with taxpayer money.

A.I.G., nearly 80 percent of which is now owned by the government, defended its bonuses, arguing that they were promised last year before the crisis and cannot be legally canceled. In a letter to Mr. Geithner, Edward M. Liddy, the government-appointed chairman of A.I.G., said at least some bonuses were needed to keep the most skilled executives.

I sure would like to see those AIG contracts - I’ll bet I can poke a hole in the specious supposition that the company really, really wants to do the right thing, but its little hands are tied. Since the public bailout of AIG, we all have an ownership interest in where the money is going, and are entitled to ask probing questions.

New York Times: “We cannot attract and retain the best and the brightest talent to lead and staff the A.I.G. businesses — which are now being operated principally on behalf of American taxpayers — if employees believe their compensation is subject to continued and arbitrary adjustment by the U.S. Treasury,” he wrote Mr. Geithner on Saturday.

Still, Mr. Liddy seemed stung by his talk with Mr. Geithner, calling their conversation last Wednesday “a difficult one for me,” and noting that he receives no bonus himself.

“Needless to say, in the current circumstances,” Mr. Liddy wrote, “I do not like these arrangements and find it distasteful and difficult to recommend to you that we must proceed with them.”

I know contracts inside and out, at the real-world, down and dirty level, not the black-box, ivory tower, theoretical stratum that gets adjusted as the tectonic plates of business deals crash into each other.

Although I have chosen not to practice law anymore, I am really good at understanding the terms of these agreements, and evaluating when it would appropriate to reward corporate players for their performance.

And, when it is not.

New York Times: Of all the financial institutions that have been propped up by taxpayer dollars, none has received more money than AIG, and none has infuriated lawmakers (and Ben Bernanke per 60 Minutes) more, with practices that policy makers have called “reckless”

The bonuses will be paid to executives at A.I.G.’s financial products division, the unit that wrote trillions of dollars’ worth of credit-default swaps that protected investors from defaults on bonds which were backed in many cases by subprime mortgages.

The bonus plan covers 400 employees, and the bonuses range from as little as $1,000 to as much as $6.5 million. Seven executives at the financial products unit were entitled to receive more than $3 million in bonuses.

Any attorney who advises that these bonuses are appropriate ought to have his or her head checked.

Base salary, maybe, if not outrageous. No bonus. No severance unless everybody else also received proportionate assistance. Don’t care what the contract says - attack it in bankruptcy or wind down - I saw it many times in the Silicon Valley meltdown.

But the official also said the administration will force A.I.G. to eventually repay the cost of the bonuses to the taxpayers as part of the agreement with the firm, which is being restructured.

AIG’s main business is insurance, but the financial products unit sold hundreds of billions of dollars’ worth of derivatives, the notorious credit-default swaps that nearly toppled the entire company last fall. AIG had set up a special bonus pool for the financial products unit early in 2008, before the company’s near collapse, and when problems stemming from the mortgage crisis were just becoming clear.

There were concerns that some of the best-informed derivatives specialists might leave.the company. AIG then locked in $450 million for the financial products unit, and prepared to pay it in a series of installments to encourage people to stay.

This poignant issue is near and dear to me, as I have shut down management bonuses before, even when I would have received some of that money, and even when I really needed it.

I also have been lucky enough to work with one of the premier corporate governance experts in the country and with a bankruptcy and wind down expert whom I hope will end up on the federal bench.

In the past, I have known both of these gentlemen to express support for my assertion that it is appalling for a destitute company to pay out management and deal bonuses to the team that took the company under.

New York Times: A.I.G.’s main business is insurance, but the financial products unit sold hundreds of billions of dollars’ worth of derivatives, the notorious credit-default swaps that nearly toppled the entire company last fall.

Under a deal reached last week, A.I.G. agreed that the top 50 executives would get half of the $9.6 million they were supposed to get by March 15. The second half of their bonuses would be paid out in two installments in July and in September. To get those payments, Treasury officials said, A.I.G. would have to show that it had made progress toward its goal of selling off business units and repaying the government.

Nice. You just keep holding that moral compass you got there, guys.

Laura is a business consultant and an advocate for information security, consumer protection, long-term shareholder value, and better management decisions. Her specialty is finding and fixing risks and threats to sensitive data. Her experience includes international banking, credit card, and mortgage companies, venture capital portfolio companies, and software and technology providers. She practiced law in Silicon Valley during the tech boom and meltdown, handling corporate governance and information protection.

This post can also be viewed on yourmortgageoryourlife.wordpress.com.

Some Good Economic News!

Finally we have some good economic news to talk about. This good news comes from the retail sector in which higher than expected sales were reported. For more on this, read Tim Iacono's blog post below:

The Commerce Department reported a big upward revision to retail sales in January and a modest decline of just 0.1 percent in February as tumbling automobile sales were offset by higher spending at gasoline stations and clothing stores.

After a virtual free-fall since last September, retail sales in January were revised from a 1.0 percent gain to a 1.8 percent rise, the largest increase in three years, in what is more likely a bounce off of very depressed levels rather than a change in the underlying direction.

Consumer spending is expected to remain very weak as job losses continue to mount.

During February, automobile sales plunged 4.9 percent, the biggest monthly decline since last October, and they are now 26.0 percent below the level of a year ago.

Excluding autos, retail sales rose 0.7 percent last month, following an increase of 1.6 percent in January. The improvement was paced by gains of 2.8 percent and 3.4 percent in gasoline station sales in January and February, respectively, largely as a result of higher prices.

Recall that for much of last year, soaring gasoline prices had helped to mask the overall weakness in retail sales and, as the price at the pump fell last fall, the combination of lower prices and fewer miles driven exacerbated the overall decline.

Other areas with higher sales last month were clothing stores (up 2.8 percent), general merchandise stores (up 1.3 percent) and furniture stores (up 0.7 percent).

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

3 Straight Months Of 600,000 Plus Job Losses: When Will The Nightmare End?

We have seen 14 straight months of job declines and 3 months in a row now where the declines have exceeded 600,000. So when will the unemployment tailspin end? James Picerno from The Capital Spectator addresses that question, and looks closer at the latest employment numbers in his blog post below.

Another monthly employment update, another dismal report. So it goes in a vicious recession. The only question: When will it end?

We take a stab at some perspective below, but first let's recap this morning's ugly numbers. Last month suffered another sharp fall in nonfarm payrolls, the U.S. Bureau of Labor Statistics reports. The economy lost 651,000 jobs in February—the 14th consecutive month of payroll declines and the third month of losses above the 600,000 mark. In this year's first two months alone the economy has already shed nearly 1% of total nonfarm payrolls. Unfortunately, the outlook for March doesn’t look good either.

That brings us to the burning question: When will this nightmare end? We don't have the answer, nor does anyone else. That said, a fair reading of the economic data, including a review of past recessions through history, suggests that the bleeding will go on for some time. That's just a guess, of course. Can we do better than simply guessing?

Perhaps. One small effort on that front comes by considering the trend in initial jobless claims, which is a leading indicator of sorts in that it previews the state of the economy in the immediate future. If more workers file for jobless benefits today, the ranks of the unemployed next month will reflect the fact in official jobless tallies.

Looking to the trend in initial jobless claims offers some perspective on how the cycle is unfolding and where we are in the current cycle. Let's start by looking at the four-week moving average of weekly jobless claims from 1967 through yesterday's update, which shows that weekly claims fell substantially to 631,000 for the week ended February 28, 2009. That's a step in the right direction, but anything over 600,000 clearly suggests the recession fires are still burning hot.

But looking at jobless claims numbers alone can be misleading because the size of the labor pool changes through time. Generally, nonfarm payrolls expand, even if recent experience tells us otherwise. Nonetheless, over the long haul, the labor force increases, at least it has over the long stretch of history in the U.S. As such, we need to look at jobless claims in context with current nonfarm payrolls through time, as we do in the next chart.

Putting jobless into perspective with the overall level of nonfarm payrolls suggests that initial jobless claims will peak before the recession end, or at least peak as the recession ends. That's potentially valuable information if you consider that the official notice that the recession has ended won't coming for many months after the fact. That leaves us to look for other indicators in real time, and initial jobless claims are on the short list.

In the past six recessions, the four-week moving average of weekly jobless claims as a percentage of current nonfarm payrolls peaked either in the month the recession formally ended (as per NBER) or the month directly ahead of the recession's formal end. By this measure, in just one case since 1969 did the jobless claims peak arrive much earlier: the 1969-70 recession ended in November 1970; the jobless claims peak came in May 1970.

Where does that leave us currently? The latest bar in the far right-hand side in the chart above is simply the latest batch of numbers. The four week moving average of initial jobless claims through February 28, 2009 represents 0.48% of last month's total nonfarm payrolls. History suggests that we have a ways to go before the employment pain ends. That forecast is based on the following: The high point for the past 40 years is 0.75% in 1982—well above the current 0.48%. Adjusting for the fact that this is likely to be the worst recession since the Great Depression implies that we might go to well above 0.75% this time.

In short, there's more pain to come, or so we expect. We're probably beyond the halfway point in this process, although there's still too much uncertainty to say for sure. Perhaps we'll see some concrete evidence, one way or the other, in the coming months. But for the moment, the economy continues to bleed and there's not much reason to expect an imminent end to the pain. The recession, in short, roars on.

This post can also be viewed on capitalspectator.com.

We Are Giving AIG More Money? Say It Ain’t So...

After insurance giant AIG reported the biggest quarterly loss in history — $61.7 billion to be exact — the government is ready to give them another $30 billion to help maintain their operations. In addition the government is restructuring past bailout deals to ease the burden on AIG. This new $30 billion will bring the total bailout tab to around $180 billion. That is, and should be, a difficult number to swallow. We will have invested $180 billion in ONE company. There are only two U.S. companies that even have market caps above $180 billion (Exxon and Walmart). AIG’s market cap is about $1.2 billion, in case you were wondering.

I’d like to say I thought this would be the last bailout for AIG, but if I did I’d be lying. Right now we are simply plugging holes in AIG with taxpayer dollars, and once the $30 billion gets used up they are going to come crawling back for more. The worst part is after we have already invested $180 billion, how are we going to say no to a few billion more? What will the final tally be when all is said and done? Your guess is as good as mine.

Matthew Karnitschnig from the Wall Street Journal wrote a good blog post that goes over some of the restructuring pieces included as part of the latest bailout. If you want to become more depressed about this whole situation then you are right now, I’d encourage you to read it. Here is the link: http://blogs.wsj.com/deals/2009/03/02/aig-the-rest-of-the-story/

Just How Crazy Is The Stock Market Today?

So just how upside down is the stock market today? Kathy Lien pulled some interesting figures that will make you think a little bit about that question. Everyone knows that the market is down, but this really puts it into perspective. Check out Kathy Lien's blog post below:

Here is some interesting food for thought

It’s a sign of the times when …

The Sunday paper costs more than NYT stock
The Citi ATM fee costs more than C stock
The paper that a mortgage is written on costs more than FRE stock
A subscription to Sirius Satellite radio would cost more than SIRI stock
A gallon of gas costs more than F stock
One ride costs more than SIX (Six Flags) stock
A bottle of soda costs more than JSDA (Jones Soda) stock
A 5 minute long distance phone call costs more than VG (Vonage) stock
A 5 stick pack of gum costs more than RAD (Rite-Aid) stock
The strawberries in a smoothie cost more than JMBA (Jamba Juice) stock

This post can also be viewed on kathylien.com.

We Should Be Looking Out For American Jobs, Not Just American Companies

The protectionist movement has been growing in America, and with every new layoff announcement it only gets stronger. Only adding fuel to the fire is the billions upon billions of taxpayer money that the government is handing out to American companies. Naturally there would have been mass outrage if the U.S. government gave this money to foreign corporations. However, as Robert Reich explains in a recent article the country just might be better off if some of these foreign corporations received funds instead of some of the American companies. After all what good is it to unemployed American workers if these American companies take the bailout money and use it to expand operations in some foreign country? Reich's point is that we should be focusing on what will create the most American jobs, rather than just focusing on supporting American companies. Mark Thoma presents the article by Reich in his blog post below:

Robert Reich:

The Perils of Confusing American Companies With American Jobs, by Robert Reich: Do not confuse American companies with American jobs. The new stimulus bill, for example, requires that the money be used for production in the United States. Foreign governments, along with large U.S. multinationals concerned about possible foreign retaliation, charge this favors American-based companies. That's not quite true. Foreign companies are eligible to receive stimulus money for things they make here... For example, Alstom, the French engineering company, is eligible to receive stimulus funds for the power turbines it produces in Tennessee... On the other hand, U.S. Steel may not be eligible for stimulus money for the steel slabs it casts in Ontario, Canada.

I'm not defending the "buy American" provisions... I'm just saying they're not the same as "buy from American companies." And although these provisions skate close to protectionism and risk foreign retaliation, at least a case can be made that if American taxpayers are footing the bill..., the jobs should be created, well, here in America.

The same confusion haunts the debate over the auto bailout. Advocates of bailing out GM and Chrysler, and most likely Ford, say America can’t afford to lose "its" auto industry. But ... foreign-owned automakers, already producing cars here in the United States, employ – directly or indirectly – hundreds of thousands of Americans. ...

Meanwhile, the Big Three themselves are global. A Pontiac G8 shipped by GM from Australia has less American content than a BMW X5 assembled in the United States. ...

I’m not arguing against an auto bailout. But it ought to be focused on helping American auto workers rather than helping global auto companies headquartered in America. Why pay the Big Three billions of taxpayer dollars ... when, even after being bailed out, they cut tens of thousands of American jobs, slash wages, and shrink their American operations...?

That’s backwards. The auto bailout should help American autoworkers keep their jobs or get new ones that pay almost as well.

Whether it’s stimulus or bailout, policy makers must remember that American companies aren’t the same as American workers – and our first responsibility is to the latter.

"I'm not defending the 'buy American' provisions..." Neither am I.

This post can also be viewed on economistsview.typepad.com.

Stimulus Bill Now Being Debated In Senate

A new $819 billion stimulus bill was passed by the House earlier this week, and the debate has moved on to the Senate, despite major opposition from House Republicans. Not a single Republican voted in favor of the bill according to the Wall Street Journal, but to get the 60 votes necessary to clear the Senate, the bill’s supporters will need to garner at least some Republican votes without losing any of the 58 Democrat senators. To secure those necessary Republican votes, some concessions will likely need to be made. One way or another, it is expected that this bill will be passed, but it remains to be seen how much political capital Obama will have to spend to make it happen.

The major divide between the two parties on the bill basically boils down to the allocation of the funds. Both parties support a stimulus bill in principle, but Republicans want to see the funds going toward things such as tax-cuts where as Democrats prefer government spending. In reality, this debate isn’t new, and considering the heavy numbers advantage that the Democrats enjoy in the House, Senate and now White House, the bill should lean toward their ideology. However, it is likely that Republicans will get a bone or two thrown their way in the process. Obama has stated time and time again that he wants broad, bi-partisan support for this bill, but it is unlikely that Democrats will be willing to give up too much considering their steep numbers advantage.

As a side note, the Wall Street Journal reported the formation of a coalition which backs the stimulus bill and which includes labor and environmental groups. The purpose of the group is to raise pressure on senators—specifically Republican senators—to support the bill. They announced Thursday that they will air ads around the country to encourage Republicans, "to support the Obama plan for jobs, not the failed policies of the past." The ads will run in Maine, New Hampshire, Iowa and Alaska according to the Journal. You can be certain that Democrats will remind Republicans and their supporters that their policies have been nothing but failures of late. The public is largely on board with this sentiment, evidenced by numerous polls. If nothing else we should get a chance to see how these new policies actually work in today’s economic climate.

All States Are Suffering From Job Losses

A report issued by the Labor Department yesterday indicated that unemployment rose in every single state in December. When oil was still near record highs a few months ago, at least the big energy-producing areas were doing well, but now they are suffering like everyone else. This goes to show you that no area is being spared from economic turmoil. The states that lead the housing boom—such as California, Nevada and Florida—were the first ones to really feel the pain from the downturn. One would think that because they led the downturn they might also lead the rebound, but if that is the case then we still have more pain coming because things are still going from bad to worse in those states. According to the Wall Street Journal, California saw an increase in unemployment of 0.9 percent in November and December, while Florida and Nevada saw increases of 0.7 percent and 1.0 percent respectively.

The last 4 months of 2008 were especially bad. Around 2 million jobs were eliminated from September 2008 to the end of the year. Then on Monday this week—now dubbed “Black Monday”—over 70,000 jobs were cut on a single day. So when is the carnage going to end?

Certainly the new stimulus package won’t hurt the employment outlook, with early projections estimating that the bill will create or save around 4 million jobs, according to the Associated Press. The bill is being reviewed by the House and it is expected to be passed later in the day according to the Wall Street Journal. After passing the House, the bill will then make its way to the Senate. There is still some lobbying to change parts of the bill, but it is widely expected that it will pass in one form or another and arrive on the President’s desk within the next few weeks.

It remains questionable at best whether the bill will work as planned. This current economic environment is different than anything we have ever seen before, and we are really just guessing on the true impact of these initiatives. Will $825 billion be enough? Is the money being allocated to the appropriate places? Will borrowing the money to finance the programs cause problems in the debt markets? These are just a few of the many questions that lawmakers are trying to answer. The truth is, though, that no one knows the answer. They can make educated guesses at best. Let’s just hope that Obama knows what he is doing...and wishing for a little luck won’t hurt either.

An Increasingly Popular Alternative To Layoffs

Companies in the U.S. laid off over 2 million jobs in 2008, but another expense cutting measure which is less often utilized also saw a major increase. A growing number of companies are choosing to cut pay rather than cutting jobs. Layoffs are typically preferred over pay cuts because among other things firms are afraid it might lead to an exodus of top workers. However, in this job market that isn’t a big worry. The last time there were nominal pay cuts was back in the Great Depression according to Price Fishback, an economic historian at the University of Arizona, as stated in the Wall Street Journal.

Because they remove spending capital from consumers while fostering additional fear and uncertainty, pay cuts are bad for the economy just as layoffs are. By now, practically everyone knows someone who has been laid off or had a salary cut, and even if one believes that one’s job is secure, the threat of a pay cut is encouragement to spend less. That said, though pay cuts will always be painful—especially if they become more widespread—they are still preferable over layoffs for consumers and the economy. After pay cuts, workers still have a source of income and don’t need to claim unemployment, which saves taxpayer dollars.

The inauguration is tomorrow, and I’ve never before seen this amount of anticipation for a new President. The state of the economy has brought a great deal of excitement, as many Americans believe that Obama is the man to rescue us from this recession. The thinking seems to be that once Bush is out of the White House and Paulson is out of the Treasury, all will be well. It is great to get excited, and Obama just might be the man to bring us out of this economic darkness, but people should remember that these things take time. Obama isn’t a miracle man, and he isn’t going to magically fix the economy. There is a lot wrong with the economy and there is a huge amount of work that needs to be done. We can hope for a quick turn around, but don’t expect it because it is not likely to happen that way.

Why The "Bad Bank" Is A Bad Idea

There is a lot of momentum gaining right now behind the idea to create a so called, "Bad Bank." This bank would be set up by the government and would be used to take toxic debt off of the balance sheet of the banks like Citigroup and Bank of America. Paul Krugman thinks this "Bad bank" is simply a bad idea. Economics Professor Mark Thoma revisits Krugman's article in his blog post below.

Are policymakers about to take another wrong turn?:

Wall Street Voodoo, by Paul Krugman, Commentary, NY Times: Old-fashioned voodoo economics — the belief in tax-cut magic — has been banished from civilized discourse. The supply-side cult has shrunk to the point that it contains only cranks, charlatans, and Republicans.

But recent news reports suggest that many influential people, including Federal Reserve officials, bank regulators, and, possibly, members of the incoming Obama administration, have become devotees of a new kind of voodoo: the belief that by performing elaborate financial rituals we can keep dead banks walking.

To explain..., let me describe ... a hypothetical bank that I’ll call Gothamgroup, or Gotham for short.

On paper, Gotham has $2 trillion in assets and $1.9 trillion in liabilities, so that it has a net worth of $100 billion. But a substantial fraction of its assets — say, $400 billion worth — are mortgage-backed securities and other toxic waste. If the bank tried to sell these assets, it would get no more than $200 billion.

So Gotham is a zombie bank: it’s still operating, but the reality is that it has already gone bust. Its stock isn’t totally worthless — it still has a market capitalization of $20 billion — but that value is entirely based on the hope ...[of] a government bailout.

Why would the government bail Gotham out? Because it plays a central role in the financial system. ... Gotham has to be kept functioning. But how can that be done?

Well, the government could simply give Gotham a couple of hundred billion dollars... A better approach would be to do what the government did with zombie savings and loans at the end of the 1980s: it seized the defunct banks, cleaning out the shareholders. Then it transferred their bad assets to ... the Resolution Trust Corporation; paid off enough of the banks’ debts to make them solvent; and sold the fixed-up banks to new owners.

The current buzz suggests ... policy makers aren’t willing to take either of these approaches. Instead, they’re reportedly gravitating toward ... moving toxic waste from private banks’ balance sheets to a publicly owned “bad bank” or “aggregator bank” ... “The aggregator bank would buy the assets at fair value.” But what does “fair value” mean?

In my example, Gothamgroup is insolvent... The only way a government purchase of that toxic waste can make Gotham solvent again is if the government pays much more than private buyers are willing to offer.

Now, maybe private buyers aren’t willing to pay what toxic waste is really worth... But should the government be in the business of declaring that it knows better than the market what assets are worth? And is ... paying “fair value,” whatever that means,... enough to make Gotham solvent again?

What I suspect is that policy makers — possibly without realizing it — are gearing up to attempt a bait-and-switch: a policy that looks like the cleanup of the savings and loans, but in practice amounts to making huge gifts to bank shareholders at taxpayer expense...

Why go through these contortions? The answer seems to be that Washington remains deathly afraid of the N-word — nationalization. ...Gothamgroup and its sister institutions are already ... utterly dependent on taxpayer support; but nobody wants to recognize that fact and implement the obvious solution: an explicit, though temporary, government takeover. Hence the popularity of the new voodoo, which claims, as I said, that elaborate financial rituals can reanimate dead banks.

Unfortunately, the price of this retreat into superstition may be high. I hope I’m wrong, but I suspect that taxpayers are about to get another raw deal — and that we’re about to get another financial rescue plan that fails to do the job.

This post can also be viewed at economistsview.typepad.com.

Unemployment Rate Now 7.2 Percent And Rising

The U.S. Labor Department just released the latest jobs report, and—surprise!—it wasn’t pretty. For the first time in the history of the report, there were back-to-back monthly job losses in excess of 500,000—584,000 jobs lost in November, followed by 524,000 jobs in December—bringing the total for 2008 to 2.6 million—the largest yearly drop (by number) since 1945.

"We have a bigger economy now, but even on a proportional basis, the last months have been the worst since [1945]," said Kurt Karl, head of economic research at Swiss Re, according to CNNMoney . "It's just an enormous acceleration of job losses."

It doesn’t end there: In addition to unemployment, there is an increasing number of under-employed workers. The under-employed rate jumped to 13.5 percent, up from 12.6 percent, which is the highest level on record since measurement began back in 1994, according to CNNMoney.

Experts don’t envision things turning around anytime soon either. Tig Gilliam, chief executive of Adecco Group North America, a unit of the world's largest employment firm and Karl both expect about another 1 million jobs to be lost in January and February before the declines begin to shrink to about a 200,000 level in June. Both said stimulus will help, but they doubt that infrastructure jobs will have as quick of a boost as lawmakers hope, according to CNNMoney.

Obama is attempting to enact an economic stimulus plan that will create or save 3 million jobs. In addition to major tax cuts for businesses and consumers, the plan also calls for huge investments in infrastructure. This could help put to work the legions of unemployed construction workers, although experts think that benefits wouldn’t be heeded until the end of the year. Even if that is the case, "Putting money into highways won't by itself end the recession, but it will put a lot of skilled workers back on job," said Ken Simonson, chief economist for The Associated General Contractors of America in a CNNMoney article.

It is difficult not be pessimistic about the employment prospects for Americans, "We're seeing a complete unraveling of the labor market and are on track for getting beyond 10 percent unemployment," said Lawrence Mishel, president of the Economic Policy Institute in a CNNMoney article.

It is hard to envision the government allowing unemployment numbers to surpass 10 percent, but unless they act quickly it is a definite possibility. I think Obama will do everything he can to prevent unemployment from spiraling out of control, but will it ultimately be enough?

Obama's Stimulus Plan Will Fall Short

Surely the $775 billion stimulus plan being proposed by President-elect Obama involves a huge sum of money, but at least one expert thinks that it won't be nearly enough to fix our troubled economy. Economics professor Mark Thoma looks at a recent article written by Paul Krugman that attempts to answer the question of whether Obama's plan will be enough, in his blog post below.

Is the incoming administration's proposed economic recovery plan large enough to get the job done?:

The Obama Gap, by Paul Krugman, Commentary, NY Times: “I don’t believe it’s too late to change course, but it will be if we don’t take dramatic action as soon as possible. If nothing is done, this recession could linger for years.”

So declared President-elect Barack Obama on Thursday... He’s right. This is the most dangerous economic crisis since the Great Depression, and it could all too easily turn into a prolonged slump.

But Mr. Obama’s prescription doesn’t live up to his diagnosis. The economic plan he’s offering ... falls well short of what’s needed. ...

Earlier this week, the Congressional Budget Office came out with its latest analysis of the budget and economic outlook. The budget office says that in the absence of a stimulus plan, the unemployment rate would rise above 9 percent by early 2010, and stay high for years to come. Grim as this projection is, by the way, it’s actually optimistic compared with some independent forecasts. ...

[T]he C.B.O. says ... that “economic output over the next two years will average 6.8 percent below its potential.” This translates into $2.1 trillion of lost production. “Our economy could fall $1 trillion short of its full capacity,” declared Mr. Obama on Thursday. Well, he was actually understating things.

To close a gap of more than $2 trillion — possibly a lot more... — Mr. Obama offers a $775 billion plan. And that’s not enough.

Now, fiscal stimulus can sometimes have a “multiplier” effect... Standard estimates suggest that a dollar of public spending raises G.D.P. by around $1.50.

But only about 60 percent of the Obama plan consists of public spending. The rest consists of tax cuts — and many economists are skeptical about how much these tax cuts, especially the tax breaks for business, will actually do to boost spending. ... Howard Gleckman of the nonpartisan Tax Policy Center summed it up in the title of a recent blog posting: “lots of buck, not much bang.”

The bottom line is that the Obama plan is unlikely to close more than half of the looming output gap, and could easily end up doing less than a third of the job.

Why isn’t Mr. Obama trying to do more?

Is the plan being limited by fear of debt? There are dangers associated with large-scale government borrowing... But it would be even more dangerous to fall short in rescuing the economy. The president-elect spoke eloquently and accurately ... about the consequences of failing to act — there’s a real risk that we’ll slide into a prolonged, Japanese-style deflationary trap — but the consequences of failing to act adequately aren’t much better.

Is the plan being limited by a lack of spending opportunities? There are only a limited number of “shovel-ready” public investment projects... But there are other forms of public spending, especially on health care, that could do good while aiding the economy in its hour of need.

Or is the plan being limited by political caution? Press reports ... indicated that Obama aides were anxious to keep the final price tag on the plan below the politically sensitive trillion-dollar mark. There also have been suggestions that the plan’s inclusion of large business tax cuts, which ... will do little for the economy, is an attempt to win Republican votes...

Whatever the explanation, the Obama plan just doesn’t look adequate to the economy’s need. To be sure, a third of a loaf is better than none. But right now we seem to be facing two major economic gaps: the gap between the economy’s potential and its likely performance, and the gap between Mr. Obama’s stern economic rhetoric and his somewhat disappointing economic plan.

This post can also be viewed at economistsview.typepad.com.

U.S. Household Debt Declines For The First Time

Yes, that headline is correct. U.S. household debt actually decreased in the third quarter of 2008—the first time it has happened since the measurement started being tracked in 1952, according to The Wall Street Journal. While I knew that Americans have a grand propensity to spend freely, I certainly did not know that we have increased our debt load ever quarter of every year for over 50 years. Depending on one’s perspective, this news could be considered wonderful or a complete disaster. On the one side it is great to see Americans finally taking control over their ridiculous debt burdens, but on the other hand the economy desperately needs people to start spending again. Our economy is built on the willingness of consumers to borrow in order to finance the purchase of goods and services. If Americans keep this new found conservative nature, the economy is going to be in for a rough ride, and a serious adjustment period.

Along with decreasing debt loads, Americans are also saving more. Economists are projecting a savings rate between 3 and 5 percent in 2009 according to The Wall Street Journal, a far cry from the negative savings rates to which we have become accustomed to in the U.S. With people less willing to take on new debt to purchase goods and services—and those with money less willing to spend it—the economy will have difficulty rebounding. A majority of the nation’s GDP is generated from consumer spending, so you can bet that the GDP numbers will suffer whenever that consumer spending drops. Until the consumer regains the desire to spend, we are going to be hard-pressed to exit this recession, barring huge government spending of course.

While this news could be viewed negatively, I prefer to look at it in a positive light. It is simply unsustainable for us to continue increasing our debt loads as a way of growing the economy. This strategy is doomed to failure, because it can only succeed if credit is infinite. At some point, though, consumers have to hit their credit limit and the party will end. That time has come for many people thanks to the credit crisis, but even those who can still borrow are increasingly aware that it may not be the best option. The best way to have a sustainable, consumer-driven economy is to base spending on income and savings, not the use of debt. If we can’t afford something, then we shouldn’t buy it. It’s really that simple. For those visual learners here is a classic clip from Saturday night live that pretty much sums the point up:

Obama Plans To Stimulate Economy With Big Tax Cuts

President-elect Barack Obama’s plan to fix America’s ailing economy has become a little clearer with the latest announcements. It appears that the biggest cog in the plan will be around $300 billion in tax cuts. Last year President Bush offered around $130 billion in tax rebates, which only briefly helped spark spending. Obama hopes that his measure has a bigger impact, and is electing to structure it in the form of a tax cut than a tax rebate. Along with the consumer tax cuts, Obama is also planning to cut taxes for businesses as well in an attempt to ward off the increasing level of layoffs and hopefully once again spur business investment. In addition to the tax cuts, Obama’s plan calls for around $200 billion to go to cash-strapped states, according to Daily News.

In total, this new economic stimulus plan could cost as much as $775 billion according to the Daily News. I’ll refrain this time from talking about the potential impact of this plan on the ballooning debt load we will likely leave for our children, but we should always remember that in the end someone has to pay for all these bailouts/stimulus packages. What I want to address is whether or not this program stands a chance. I would love to say that I believe that Obama’s plan is going to fix everything, but I’m just not feeling too confident. This plan is an improvement over Bush’s because it is meant to be lasting, not temporary. The rebates spurred spending for a few months, but the economy just continued to slide once the money was gone. Taxpayers were left with a huge bill and little to show for it other than a delayed recession. Obama’s plan could spread the goodwill out over a much larger period, but the question is whether it will be enough to really push us up and out of this economic rut.

About half of the total stimulus package funds are meant to spur job growth, with a goal of 3 million new jobs. In my mind 3 million seems a little high, and a tad unrealistic for us to obtain, but it sure sounds good. If we can get anywhere close to that number we will be doing extremely well. The plan calls for jobs to be created in infrastructure, energy, education and health care according to ABCNews.com. A major concern here should be how past government job creation movements have panned out: “’Time and again history has proven government-centered job creation doesn't work. Under [President] Carter in the late '70s people had all sorts of plans and ignored larger economic realities,’ former House Speaker Newt Gingrich told ABCNews.com.”

“‘In Japan they spent 13 years building an airport no one [once used]. Under the Socialists the French tried over and over again to create jobs and it didn't work. We know what creates jobs and it isn't putting the Treasury Department at the center of American capitalism. We need an investment strategy that supports the private sector and small entrepreneurial businesses,’ he said.”

Will the plan work or not? If past performance is any indicator it seems likely that this will just end up being another futile—and expensive—attempt to rescue the economy. No one wants to sit idly by and do nothing in the midst of this economic turmoil, but we shouldn’t blindly throwing away money at the problem either. This plan is definitely better than the last one put together by President Bush, but will it be enough? I have my fingers crossed, but if they had odds on this in Vegas I wouldn’t be betting for its success.

The Media Shouldn't Be Blamed For The Financial Crisis

With retirement accounts shrinking across the country, everyone is trying to determine who is to blame for the financial crisis. After all, if we can place blame on somebody we can then burn them at the stake, and it will make us feel so much better, right? Recently the New York Times published a controversial piece that basically blamed the entire financial crisis on President Bush. Several publications have disputed this piece, including Newsbusters, and of course the White House. Surely President Bush had a hand in the economic carnage of 2008, but to say that he was solely responsible for it is pretty ridiculous. There are so many people that have a hand in economic matters of this country, and while the President is the figurehead, he most certainly is not the only one to whom blame is due. So what other names are being thrown out? Greenspan, Bernanke and Paulson are all likely candidates, but according to a recent survey by Opinion Research most Americans think a large portion of the blame falls on the media.

According to the poll 77 percent of Americans believe the media is to blame for stoking the financial crisis by spreading fear among consumers. My first reaction to this was a big, WOW. Yes, the media has spread a bit of fear and panic, and the stories of doom and gloom are certainly helping to sell more papers, but there is another reason why all you see are negative stories: Positive news is next to impossible to come by if you don’t just make it up. If the media had more positive news to cover, you can bet that they would do it.

Americans who wish to bury their heads in the sand can feel free to do so, but personally I want to know what is going on in the financial world and I want the truth, not some lame story meant to make me feel all warm and fuzzy inside. People hoarding their money out of fear fostered by what they have heard from the media may be making matters worse, but it is hard to blame reporters for doing their jobs and reporting the truth. It is falsifying information or misleading readers in some other way that we should scorn. Yet things are getting so bad that in the press release issued by Opinion Research, national expert on corporate liability and white collar crime issues Richard L. Scheff warns that members of the media could potentially be exposed to liability despite apparent constitutional protections.

This is of course absolutely ridiculous. What we are saying is that instead of the hard truth we want our media to report sugar-coated stories to make us feel good about the economy. If you want a bubble, that is one great formula right there: Get the public to buy into a bunch of hype so they can feel confident buying up overpriced assets, ignoring that the bubble will inevitably pop, bankrupting those who believed that everything was coming up roses when the market was really pushing up daisies. The media should be sued were they to feed false hope in this economic environment, but certainly not for reporting the truth. That defeats their entire purpose for existing. For the Americans who can’t handle this hard truth: Good luck to you, as you most certainly are going to need it.

Looking Back At 2008

2008 was a year to be remembered by investors, but certainly not in a good way. While most investors probably lost a substantial amount of money, hopefully they at least learned some powerful lessons. James Picerno from The Capital Spectator looks back at 2008 and some of the things investors should take away from it in his blog post below.

Two-thousand-and-eight is gone—and good riddance. But the blowback will be with us for some time, on a number of fronts. And that starts with reviewing the previous 12 months.

As our first table below shows, red ink was spread far and wide in 2008 in almost everything other than cash and bonds. Otherwise, double-digit losses were the rule last year. But if we look at the monthly tally for December, the view looks decidedly better. REITs, in particular, rebounded sharply last month, surging nearly 18% in December.

Most of the other asset classes followed suit, albeit with lesser although still robust gains for the month. The exceptions are cash and commodities. It's too soon to tell if the worst is over or if the rally is merely a fleeting affair in an ongoing bear market. But given the extent and breadth of the carnage, it's tempting to think that maybe, just maybe, positive returns await in asset classes other than cash.

Speaking of cash, a few words about last month's performance of 3-month Treasury bills (our proxy for cash) is in order. Although our table above lists December's performance for cash as zero, the number's in red because the return is slightly negative for 3-month T-bills if you carry the return out to two digits: -0.02%. In the grand scheme of the universe, no one will lose any sleep over this microscopic loss. But the fact that T-bills—the classic "risk-free" asset—posted a loss of any degree is extraordinary, and so it speaks to the times we live in.

Indeed, monthly losses in T-bills are so rare that it doesn't register in our databases, which admittedly only go back to the 1980s for "cash." That's not to say that it never happens, but you'll have to go back quite a ways to find monthly red ink in this corner of finance.

The source of last month's slight loss is no mystery, at least. The explanation starts by noting that the yield on a 3-month T-bill slipped to just about zero at the end of November—an astonishing state of affairs in and of itself. Then, in December, the T-bill yield rose a bit, albeit to a mere 0.11% by December 31 from roughly zero a month earlier. Slight as that is, it was enough to tip the monthly return to negative in the 3-month T-bill for two reasons. One, for much of December, the 3-month T-bill barely gave investors any yield to speak of, and since yield is the only source of return for these securities the pickings were fated to be slim at the end of November even under the best of circumstances. Add the fact that T-bill yields rose slightly set the stage for an ever-so-slight loss (rising yields translate into lower prices in bondland).

The fact that even cash could post a loss is a sign of the times, of course, although investors had bigger problems than worrying about miniature losses in T-bills. Indeed, as our second table below reminds, 2008 was a horrendous year for most asset classes. Horrendous, but not entirely surprising, at least in terms of how 2008 compared with previous years. Yes, the depth of the losses are shocking. But the reversal of fortune was overdue—long overdue in some cases.

click to enlarge

Consider emerging market stocks, which lost more than 50% last year. Shocking as the loss is, the volatility is not out of character for the asset class. Indeed, as the chart shows, emerging market stocks had been posting gains of 20% to 50% for each and every calendar year during 2003-2007. That extraordinary five-year stretch of price increases had to end eventually, of course, and for anyone who expected otherwise, well, they were living in a dream. Surely if an asset class can post a 50% gain in one year—as emerging markets did in 2003—something similar is possible if not likely on the downside.

A similar lesson applies to the formerly high-flying world of REITs, which also enjoyed an extraordinary bull market run that finally started coming apart in 2007 and continued in 2008.

Yet not everything was about losses in 2008, a year that witnessed potent gains for some corners of the bond world, which once again makes the case for owning a globally diversified portfolio. Foreign government bonds denominated in foreign currencies, for example, was an exceptionally bright light last year and so if you didn't own the asset class (via BWX, for instance), your portfolio probably paid a price.

The point is that cycles endure, even if the details aren't always 100% clear. What goes up in price eventually comes down. Meanwhile, lower prices precede higher prices. Although one must be extremely cautious about applying that view to individual securities, it generally works well over time when it comes to asset classes, which have a habit of surviving, which is more than one can say for some individual companies or certain bonds.

Timing, of course, is always debatable, even with broad asset classes, which is an argument for maintaining some mix of the world's capital and commodity markets through thick and thin. The question, as always, is how to structure the mix and manage the betas through time?

As it happens, that's the focus of a new monthly newsletter (The Beta Investment Report) that your editor will launch later this month (details to follow on CapitalSpectator.com). For the moment, though, we're simply gazing backward, in search of some basic perspective. Knowing where you've been and what history looks like is the foundation for looking into the future and assessing risk as well as opportunity. As always, a surplus of both awaits. The critical challenge is fleshing out the details, which is the mandate of our soon-to-be-launched newsletter.

This post can also be viewed on capitalspectator.com.

Home Sales Continue To Fall, But Sentiment Is Up

Home sales are continuing on their downward spiral, but for some reason consumer sentiment is heading up. Maybe it is the holidays inspiring optimizing, or maybe consumers just can't imagine things getting any worse. In light of all the negative news going around about the economy and real estate, it was a little exciting to hear something was heading in the positive direction. The bad news of course is that consumers have been up and down for months, and seem prone to mood swings. For now, though, consumers, possibly high on their cheap gasoline, are feeling better than they did last month. Tim Iacono from The Mess That Greenspan Made looks closer at the latest real estate reports and talks a bit about consumer sentiment in his blog post below.

The bottom that had been forming in the chart of existing home sales over the last year, aided by a growing number of foreclosure sales, developed a rather large hole during the month of November as reported by the National Association of Realtors.
It remains to be seen whether sales return to the 4.9 million rate average of the last year, the 8.6 percent tumble from 4.91 million in October to just 4.49 million in November helping to push the inventory level back up to the high for this cycle at 11.2 months of supply.

More importantly, the median sales price dropped a whopping 13.2 percent in November on a year-over-year basis, from $208,000 to just $181,300, the lowest level since early-2004. The AP reports that this is most likely the biggest annual price decline since the Great Depression (NAR records only go back to 1968).

Sales fell most in the Northeast (down 12.0 percent), followed by the South (down 10.9 percent), the Midwest (down 7.4 percent), and the West (down 4.3 percent). Existing home sales in the West were helped by the continuing high level of distressed home sales, the realtors' trade group estimating that 45 percent of all sales nationwide are either foreclosures or short sales.

Homebuilders aren't finding it any easier to sell real estate as the Commerce Department reported(.pdf) that new home sales also tumbled, falling 2.9 percent from an annualized rate of 419,000 in October to 407,000 in November, the slowest pace since 1991.
Sales have declined 35.3 percent from year-ago levels, the worst decline since April 1980 when new home sales plunged 50.5 percent. Inventory remains at historically high levels, averaging 11 months of supply over the last year, as builders continue to offer incentives and slash prices.

The median price dropped 11.5 percent on a year-over-year basis, from $249,100 to $220,400, however, these figures continue to be deceptively high due to the many financial incentives available to buyers that do not show up in the sales price.

In one of the few pieces of good economic news this week, the mood of the consumer, as measured by the Reuters/University of Michigan Consumer Sentiment Index, improved during the month of December, rising from the 28-year low seen last month.
The index rose to 60.1 from a mid-month reading of 59.1, up from November's historic low of just 55.3 as lower gasoline prices and some stability in financial markets helped to lift spirits.

The inflation expectations associated with this report are now getting very interesting. Survey respondents put the one-year inflation rate at just 1.7 percent, down from 2.9 percent last month, while the five-year rate came in at 2.6 percent as compared to 2.9 percent in November.

More than anything else, inflation expectations are driven by the cost of gasoline since these are the easiest prices for consumers to measure but, with food prices continuing to rise, it bears watching in the period ahead how inflation as reported in the government's consumer price index matches up with consumers' expectations of the same.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Strong Dollar: Taking Its Toll On Corporate Earnings

While savers and retirees are excited about the recent strength shown by the U.S. dollar, not everyone is happy about it. Since the dollar has strengthened, corporate earnings have taken a hit, and it is no coincidence. A stronger dollar means that U.S. goods sold overseas all of the sudden become more expensive, and as a result sales suffer. Currency expert Kathy Lien explains this phenomenon in more detail below.

I have spoke often about the consequences of a strong currency. In the case of the US, the weak dollar in the first half of the year has helped to contribute to Q2 and for some Q3 corporate earnings as well. However I strongly believe that Q4 earnings will be very bad. Partly because of the global recession and partly because of the strong US dollar.

There is an article in the Wall Street Journal today titled “Stronger Dollar Cools Sales in Overseas Hot Spots” that talk about this same theme.

But I want to show you their charts on US exports:

Source: WSJ

And now take a look at a chart of the Dollar Index:

Source: Bloomberg

Do you see the correlation?

Also, the strength of the Japanese Yen is a big reason why Toyota is forecasting their first loss in 7 DECADES!!

Source: WSJ

This post can also be viewed on kathylien.com.

America's Ponzi Scheme Era

There has been a lot of talk lately about ponzi schemes, and of course this can be directly attributed to the recent Madoff scandal. As Paul Krugman points out in his article, though, there isn't all that much difference between Madoff's actions and the actions of the entire investment industry. After all the end result was the same, the investors lost a bunch of money while the facilitators ran off with the spoils. Mark Thoma from The Economist's View shares the Krugman article in his blog post below.

The costs of "America's Ponzi Era":

The Madoff Economy, by Paul Krugman, Commentary, NY Times: The revelation that Bernard Madoff — brilliant investor (or so almost everyone thought), philanthropist, pillar of the community — was a phony has shocked the world, and understandably so. The scale of his alleged $50 billion Ponzi scheme is hard to comprehend.

Yet surely I’m not the only person to ask the obvious question: How different, really, is Mr. Madoff’s tale from the story of the investment industry as a whole?

The financial services industry has claimed an ever-growing share of the nation’s income over the past generation, making the people who run the industry incredibly rich. Yet, at this point, it looks as if much of the industry has been destroying value, not creating it. And it’s ... had a corrupting effect on our society as a whole.

Let’s start with those paychecks. ... The incomes of the richest Americans have exploded over the past generation, even as wages of ordinary workers have stagnated; high pay on Wall Street was a major cause of that divergence.

But surely those financial superstars must have been earning their millions, right? No, not necessarily. The pay system on Wall Street lavishly rewards the appearance of profit, even if that appearance later turns out to have been an illusion.

Consider the hypothetical example of a money manager who leverages up his clients’ money..., then invests the bulked-up total in high-yielding but risky assets... For a while — say, as long as a housing bubble continues to inflate — he (it’s almost always a he) will make big profits and receive big bonuses. Then, when the bubble bursts and his investments turn into toxic waste, his investors will lose big — but he’ll keep those bonuses.

O.K., maybe my example wasn’t hypothetical after all.

So, how different is what Wall Street in general did from the Madoff affair? Well, Mr. Madoff allegedly skipped a few steps, simply stealing his clients’ money rather than collecting big fees while exposing investors to risks they didn’t understand. ... Still, the end result was the same (except for the house arrest): the money managers got rich; the investors saw their money disappear.

We’re talking about a lot of money here. In recent years the finance sector accounted for 8 percent of America’s G.D.P., up from less than 5 percent a generation earlier. If that extra 3 percent was money for nothing — and it probably was — we’re talking about $400 billion a year in waste, fraud and abuse.

But the costs of America’s Ponzi era surely went beyond the direct waste of dollars and cents.

At the crudest level, Wall Street’s ill-gotten gains corrupted and continue to corrupt politics... Meanwhile, how much has our nation’s future been damaged by the magnetic pull of quick personal wealth, which for years has drawn many of our best and brightest young people into investment banking, at the expense of science, public service and just about everything else?

Most of all, the vast riches ... undermined our sense of reality and degraded our judgment. Think of the way almost everyone important missed the warning signs of an impending crisis. How was that possible? ... The answer, I believe, is that there’s an innate tendency on the part of even the elite to idolize men who are making a lot of money, and assume that they know what they’re doing.

After all, that’s why so many people trusted Mr. Madoff.

Now, as we survey the wreckage and try to understand how things can have gone so wrong, so fast, the answer is actually quite simple: What we’re looking at now are the consequences of a world gone Madoff.

This post can also be found on economistsview.typepad.com.

Crazy Or Genius?

It is starting to become big news now, but a prestigious resort company, Elite Island Resorts, is running a promotion right now that allows customers to pay for their accommodations with stocks. Not only that, but they are allowing customers to use the stock based on the value back on July 1^st of this year. In case you’ve been in a cave somewhere the stock market has fallen off a cliff since then, so this potentially offers a tremendous value for customers. Is this move craziness, or pure marketing genius?

Before you come to judgment you should know that there are certain restrictions. For one only about 100 stocks are accepted as part of the promotion, so they retain control over the stock that is accepted. They aren’t going to take Lehman stock, or stock from Freddie Mac and Fannie Mae. They have selected around a hundred solid companies, although some, like American Express have seen their stock halved since July. In addition they have capped the program at $10 million in total, and $5,000 per individual stay. In order to qualify, reservations must be made by the end of this year and travel dates must be before the end of 2009. The CEO for Elite Island Resorts, Steve Heydt, was also quoted MSNBC as saying, "The vacation business has gotten hammered probably as much as the stock market."

The last quote is quite revealing: Business is down considerably and vacant rooms are worthless to a resort. They could have simply discounted the room rates like most firms do in this situation, but instead choose a much wiser path. They still discounted the rooms, but did it in a way that created a ton of free publicity. The publicity alone that they have received is probably worth the $10 million set aside for the program. In my mind Heydt is a marketing genius. When the recession ends, his company will be positioned to benefit from newfound clients that could return year after year, and there is always the chance the stocks could rebound and make this slump incredibly profitable for Elite Islands in the long-term.

Retail Sales Disappoint, U.S. GDP To Drop Significantly

The pattern of gloomy economic reports keep coming, and this isn't going to be any different. Retail sales were down sharply in October, and are expected to take another big hit when the November numbers are released as well. With all the economic problems going on right now some economists are predicting huge hits to the U.S. GDP in Q4 of this year, and well into next. As this recession continues it is becoming clear that we could be in for the worst economic slide since the great depression. Although most experts won't dare say that this recession will be worse, or even close to as bad as the great depression, however, who knows how that outlook might change come next year if things don't improve. Kathy Lien investigates the retail sales numbers, and talks a bit about America's growth prospects in her blog post below.

The two biggest inputs into GDP are consumer spending and trade. Therefore the 2.8 percent decline in retail sales and the surprise widening of the trade deficit in the month of October suggests that GDP growth could take a big dive in the fourth quarter.

Word on the street is that some economists are calling for GDP to decline as much as 4 to 6 percent in Q4, which would be the largest contraction in growth since the 1980s. In the first quarter of 1982, GDP fell -6.4 percent. A 4 to 6 percent drop in GDP would not be out of the ordinary given the current conditions in the US economy. In the fourth quarter of 1990, GDP contracted by 3 percent and in the first quarter of 1991, it contracted by 2 percent.

If you agree that the current recession is worse than the one in the 1990s, then it would be logical to expect a contraction in growth exceeding 3 percent.

Don’t Expect Retail Sales and Producer Prices to Help

Retail sales and producer prices for the month of November are due for release tomorrow. Another large decline in consumer spending will only support our thesis that GDP will see a big contraction in the fourth quarter. All of the leading indicators for retail sales that we follow point to very weak consumer spending last month despite stronger Black Friday sales. SpendingPulse, the retail data service of MasterCard Inc. reported that retail sales excluding autos dropped by the largest amount in 5 years. Chain store sales as measured by the International Council of Shopping Centers also dropped by 2.7 percent last month, the largest decline in at least 8 years. Don’t forget that November was also the month that non-farm payrolls fell 533k. Americans were more worried about keeping their jobs last month than spending liberally.

The Treasury market is already pricing in the possibility of deflation and depression with yields in zero to negative territory for the first time since the Great Depression. Although we don’t think that the US will fall into a depression, the data certainly supports tougher times ahead for the US economy.

This article has been reposted from KathyLien.com. The full post can also be viewed on KathyLien.com.

More Troubling Employment News

At this point it is hard to remember the last time we say positive employment news, and the latest batch isn't helping anything. Initial jobless claims continue to rise, and no end is yet in sight. James Picerno from The Capital Spectator takes a look at the latest report in his blog post below.

Another update on the labor market and another reason to worry.

The offending statistics today come in this morning's news on initial jobless claims, which rose sharply last week to 573,000. At this point, no should be shocked to learn that the lines at the unemployment offices around the country are growing longer by the week. Nonetheless, the rapid increase in striking, as our chart below shows.

Even by the negatively skewed standards of late, last week's 58,000 rise in new filings for unemployment was unusually large —the highest weekly advance, in fact, in more than three years.

No less worrisome is the ongoing advance for continuing jobless claims. The advance number for the week through November 29 is 4.429 million: up 338,000 from the previous week and up 68% from a year ago.

In short, more people are losing their jobs and more people are collecting jobless benefits for longer periods of time.

The obvious message here is that the negative momentum in the labor market has a head of steam and looks set to run on. The good news, if we can call it that, is the possibility that "technical factors" boosted the numbers last week. As MarketWatch.com reports today,

Several technical factors could have boosted initial claims last week, a Labor Department spokesman said. The week after Thanksgiving is traditionally the one with the biggest increase in first-time claims, and the government's seasonal adjustment factors may be overstating the increase this year.

Even so, no one should mistake the larger trend underway: broad and deep job destruction in the U.S. economy and increasingly throughout the world. The ramifications are being felt everywhere, from lower retail sales to falling commodity prices. As Reuters reports, retail sales in November suffered their biggest drop in five years. Meanwhile, the International Energy Agency now predicts global oil demand will contract this year for the first time since 1983, via Bloomberg News.

The basic connection is clear: Job destruction ultimately leads to demand destruction, which in turn brings lower prices. This is an especially potent relationship in economies that depend heavily on consumer spending, as the U.S. does. The primary fuel for consumer spending is, of course, employment income. Given the magnitude of the labor pains, it's assured that lower prices and lower demand will be the norm for some time. There's a lag effect, after all. The men and women who sign up for unemployment benefits today are sure to cut their spending tomorrow, and for as long as they're out of work.

Today's varied economic ills are the byproduct of events from the past weeks and months. By that logic, the continuing layoffs today will bring negative reverberations to the economy well into 2009.

At some point the negative momentum stops and a new equilibrium for the economy emerges. The various efforts by the government, now and in the future, will bring that day of a new equilibrium and stability closer than it would otherwise be sans intervention. But it's too soon to make reasonable assumption about timing. It's still unclear how much power this tidal wave has, although even casual observation suggests this is one heck of a perfect storm.

This article has been reposted from The Capital Spectator. The full post can also be viewed on The Capital Spectator.

What Is The Point Of Bailing Out The Automakers If We Don't Want Their Cars?

The big decision looming right now is whether or not we should bail out the big three American automakers, and if so how should it be structured? There is a lot of talk about why we should, and why we should not bail them out, but little is made of one very important fact: we don't want the cars they are making. Why should we bail out automakers if we don't even like the product they are making? Mark Thoma from the Economist's View looks at this problem in his blog post below.

Labor costs aren't the biggest problem automakers face, the problem is making cars people want to buy:

$73 an Hour: Adding It Up, by David Leonhardt, NY Times: Seventy-three dollars an hour. That figure — repeated on television and in newspapers as the average pay of a Big Three autoworker — has become a big symbol in the fight over what should happen to Detroit. To critics, it is a neat encapsulation of everything that’s wrong with bloated car companies and their entitled workers.

To the Big Three’s defenders,... the number has become proof positive that autoworkers are being unfairly blamed for Detroit’s decline. “We’ve heard this garbage about 73 bucks an hour,” Senator Bob Casey, a Pennsylvania Democrat, said... “It’s a total lie...”

So what is the reality...? ... The calculations show ... that ... the ... $73 ... is the combination of three very different categories. The first category ... includes wages, overtime and vacation pay, and comes to about $40 an hour. ... The second category is fringe benefits, like health insurance and pensions. ... At the Big Three, the benefits amount to $15 an hour or so.

Add the two together, and you get the true hourly compensation of Detroit’s unionized work force: roughly $55 an hour. ... Honda’s or Toyota’s (nonunionized) workers ... make in the neighborhood of $45 an hour, and most of the gap stems from their less generous benefits.

The third category is the cost of benefits for retirees. These are essentially fixed costs... — dividing those costs by the total hours of the current work force, to get a figure of $15 or so — and end up at roughly $70 an hour.

The crucial point, though, is this $15 isn’t mainly a reflection of how generous the retiree benefits are. It’s a reflection of how many retirees there are. The Big Three built up a huge pool of retirees long before Honda and Toyota opened plants in this country. ...

These retirees make up arguably Detroit’s best case for a bailout. The Big Three and the U.A.W. had the bad luck of helping to create the middle class in a country where individual companies — as opposed to all of society — must shoulder much of the burden of paying for retirement. ...

[L]abor costs, for all the attention they have been receiving, make up only about 10 percent of the cost of making a vehicle. ...[T]he Big Three already often sell their cars for about $2,500 less than equivalent cars from Japanese companies... Even so, many Americans no longer want to own the cars being made by General Motors, Ford and Chrysler. ...

There is good reason to keep G.M. and Chrysler from collapsing in 2009. ... The economy is in ... recession... You can think of the Detroit bailout as a relatively cost-effective form of stimulus. It’s often cheaper to keep workers in their jobs than to create new jobs.

But Congress and the Obama administration shouldn’t fool themselves into thinking that they can preserve the Big Three in anything like their current form. Very soon, they need to shrink to a size that reflects the American public’s collective judgment about the quality of their products. ... If we had wanted to preserve the Big Three, we would have bought more of their cars.

With demand falling, carmakers somewhere will have to shrink, at least until the world economy recovers. And as the market tightens, automakers in other countries are beginning to ask for their own bailouts:

Volkswagen: if the American carmakers can get bailout funds, so can we, Credit Writedowns: It seems that the bailouts are now turning into a “Beggar Thy Neighbor” policy of aid for specific sectors of the global economy. First, it was finance as the banks were savaged by massive writedowns to their property and derivative holdings — with each nation competing with the next for the largest handouts to this vital sector of the economy.

Now, as the real economy has started to plummet, it is the auto sector. While all eyes are peeled on Washington and Detroit after the $15 billion bailout there, Volkswagen has quietly been lobbying the German government for its own bailout.

This is looking a lot like competitive bailout schemes as Daimler wants in as well. I can only imagine what Honda, Nissan and Toyota are thinking. Is this the 21st century version of competitive currency devaluations?

Below is my translation of a “Die Welt” article published just yesterday detailing Volkswagen’s manoeuvrings. ...

As you can see from this blurb, Daimler feels disadvantaged by the free money that VW is looking to get and I am certain all foreign car makers want to level the playing field with Detroit after they Americans have received massive injections of state aid. It looks like this process is just beginning. ...

Speaking of Germany:

Paul Krugman: ...Everyone here seems to be talking about two things: the fate of the auto industry, which is in almost as much trouble in Sweden as it is in the United States, and the German problem. At a time when expansionary policies are desperately needed, the leaders of Europe’s largest economy seem to have their heads in the sand. This is a huge problem: there are large spillovers in fiscal policy among EU nations — that is, a significant fraction of, say, French fiscal expansion ends up promoting employment in Germany or Italy rather than France. So there’s a crying need for a coordinated policy. But the Germans aren’t participating.

It will be interesting to see how coordinated the world response will be (for both monetary and fiscal policy), and how many countries will free-ride on the stabilization effort of their trading partners. If enough countries free-ride — and there is an incentive to low-ball the effort and let other countries do the heavy lifting — the total stimulus may be insufficient and undermine the recovery effort.

This article has been reposted from the Economist's View. The full post can also be viewed on the Economist's View.

Sorry, Kids...Santa Is Cutting Back This Christmas

According to a CNN poll released this morning, more Americans plan to cut back on holiday spending than any other expense. 67 percent of Americans polled will spend less than they originally planned. This could mean more store closures and layoffs after the New Year, and that’s certainly not the kind of holiday cheer we were hoping for. Of course, it’s also bad news for the kids. Though it is heartbreaking to hear stories about how some children might get nothing this year, most American kids can just expect less of—or knockoff versions of—what they wanted, so I don’t so much pity them for a disappointing Christmas as much as the crippling debt they face in the future of this country.

As for this holiday season, there are a growing number of children who might get nothing at all. Over the years families who haven’t had enough money to buy toys for their children have been able to turn to charities like Toys for Tots for assistance, but this year things are different. Donations to these charities are down considerably, and it has happened at a time when the number of people in need is much higher than in the past. These children, who have always been able to count on Santa to deliver on Christmas, might be disappointed this year. To see the faces on these kids will be heartbreaking, to say the least.

My daughter was born in January of this year, so this will be her first Christmas. At this point she is a little too young to even realize what Christmas is, but if she were a little older, as a father I couldn’t even imagine how I’d feel if I had to tell her that Santa wasn’t coming this year. I think these charities are not only for the children, but also for the parents of those children as well.

I know that many Americans are preparing to cut back this holiday season, but in reality most of us still have so much. Whether you were planning to cut back this holiday or not, I think most of us can find a few extra bucks in our budget to help out these families in need. To find the nearest Toys for Tots drop off location, click here.

People And Businesses Get Creative To Get By

I happened to read two separate stories this morning on CNN.com, both of which made me do a double take. These are two great examples that show just how bad things are in the economy right now, as well as the creativity that people have. The first article was about a school teacher who had his budget cut so dramatically that he could no longer afford to print out tests and quizzes, but using his creativity he was able to make. The other article talks about the dire condition of the auto industry, and specifically what local dealerships are doing in order to scrape by.

The first story is both an example of innovation in the face of desperation and the poor state of our educational system. The title of the article sums up the story fairly well: “Cash-strapped teacher sells ads on tests.” A teacher in California saw his printing budget cut so dramatically that he no longer could afford to print out quizzes and tests for his class. Instead of simply cutting back on the number of tests, thereby dropping the quality of education, he chose to do something about it and approached parents and local business owners to sponsor quizzes and tests. By placing ads on the tests the teacher was able to raise more than enough money to cover the printing costs for the tests.

While I applaud the creativity of this teacher, and his willingness to go above and beyond to ensure his students receive the best education possible, it is frustrating that it had to come to this. How is it that the richest country in the world can’t even afford to pay printing costs for tests? We are throwing billions—if not trillions—of dollars around like it is nothing, but we can’t spare a few hundred bucks per classroom to make sure our kids get a proper education? Children already have a hard time concentrating, and putting advertisements on their tests, when they should be focusing the most, is not the answer. Talk about a horrible time to be a child—Merry Christmas, kids. This year you get $8 trillion in debt and a sub-par education. Good luck!

The second story is titled, “Car dealers get creative as brethren shutter shops.” This article talks about all the creative things local dealerships are doing to stay in business. One of the most widely talked about offers was by a car dealership in Miami that is offering a buy-one-get-one-free promotion. Interest in new cars has fallen so much that dealerships are doing whatever it takes to drum up business.

I have my doubts that they will be able to sustain these types of promotions for long. Dealerships take out millions of dollars in loans to stock their lots, and at this point nothing is moving, forcing them to take these extreme measures just to avoid shutting down entirely. In addition there are the problems with the big three U.S. automakers to worry about. If these companies are forced to start restructuring, some dealerships fear that banks will not be so willing to lend them the money they need to continue to operate.

Loan Loses Continue To Mount: A Look At FDIC Graphs

You're probably not surprised to hear that loan losses are continuing to mount at financial institutions, but just how bad are things getting? Anthony Freed from Your Mortgage or Your Life looks a little closer at some FDIC graphs and helps paint the grim picture in his blog post below.

More Institutions Report Declining Earnings, Quarterly Losses:

Troubled assets continued to mount at insured commercial banks and savings institutions in the third quarter of 2008, placing a growing burden on industry earnings. Expenses for credit losses topped $50 billion for a second consecutive quarter, absorbing one-third of the industry’s net operating revenue (net interest income plus total noninterest income). Third quarter net income totaled $1.7 billion, a decline of $27.0 billion (94.0 percent) from the third quarter of 2007. The industry’s quarterly return on assets (ROA) fell to 0.05 percent, compared to 0.92 percent a year earlier. This is the second-lowest quarterly ROA reported by the industry in the past 18 years. Evidence of a deteriorating operating environment was widespread. A majority of institutions (58.4 percent) reported year-over-year declines in quarterly net income, and an even larger proportion (64.0 percent) had lower quarterly ROAs. The erosion in profitability has thus far been greater for larger institutions. The median ROA at institutions with assets greater than $1 billion has fallen from 1.03 percent to 0.56 percent since the third quarter of 2007, while at community banks (institutions with assets less than $1 billion) the median ROA has declined from 0.97 percent to 0.72 percent. Almost one in every four institutions (24.1 percent) reported a net loss for the quarter, the highest percentage in any quarter since the fourth quarter of 1990, and the highest percentage in a third quarter in the 24 years that all insured institutions have reported quarterly earnings.

Lower Asset Values Add to the Downward Pressure on Earnings:

Loan-loss provisions totaled $50.5 billion in the quarter, more than three times the $16.8 billion of a year earlier. Total noninterest income was $905 million (1.5 percent) lower than in the third quarter of 2007. Securitization income declined by $1.9 billion (33.0 percent), as reduced demand in secondary markets limited new securitization activity. Gains on sales of assets other than loans declined by $1.0 billion (78.7 percent) year-over-year, and losses on sales of real estate acquired through foreclosure rose by $518 million (588 percent). Among the few categories of noninterest income that showed improvement, loan sales produced net gains of $166 million in the third quarter, compared to $1.2 billion in net losses a year earlier, and trading revenue was up by $2.8 billion (129.2 percent). Sales of securities and other assets yielded net losses of $7.6 billion in the third quarter, compared to gains of $77 million in the third quarter of 2007. Expenses for impairment of goodwill and other intangible asset expenses were $1.8 billion (58.6 percent) higher than a year ago.

Loan Losses Continue to Mount:

The industry reported year-over-year growth in net charge-offs for the seventh consecutive quarter. Net charge-offs totaled $27.9 billion in the quarter, an increase of $17.0 billion (156.4 percent) from a year earlier. Two-thirds of the increase in charge-offs consisted of loans secured by real estate. Charge-offs of closed-end first and second lien mortgage loans were $4.6 billion (423 percent) higher than in the third quarter of 2007, while charged-off real estate construction and development (C&D) loans were up by $3.9 billion (744 percent). Charge-offs of home equity lines of credit were $2.1 billion (306 percent) higher. Charge-offs of loans to commercial and industrial (C&I) borrowers increased by $2.3 billion (139 percent), credit card loan charge-offs rose by $1.5 billion (37.4 percent), and charge-offs of other loans to individuals were $1.7 billion (76.4 percent) higher. The quarterly net charge-off rate in the third quarter was 1.42 percent, up from 1.32 percent in the second quarter and 0.57 percent in the third quarter of 2007. This is the highest quarterly net charge-off rate for the industry since 1991. The failure of Washington Mutual on September 25 meant that a significant amount of charge-off activity was not reflected in the reported industry totals for the quarter1.

Growth in Reported Noncurrent Loans Remains High:

The amount of loans and leases that were noncurrent (90 days or more past due or in nonaccrual status) increased to $184.3 billion at the end of September. This is $21.4 billion (13.1 percent) more than insured institutions reported as of June 30 and is up by $101.2 billion (122 percent) over the past 12 months. The percentage of total loans and leases that were noncurrent rose from 2.04 percent to 2.31 percent during the quarter and is now at the highest level since the third quarter of 1993. The growth in noncurrent loans during the quarter was led by closed-end first and second lien mortgage loans, where noncurrents rose by $9.6 billion (14.3 percent). Noncurrent real estate C&D loans increased by $6.9 billion (18.1 percent), while noncurrent loans secured by nonfarm nonresidential properties rose by $2.2 billion (18.1 percent). Noncurrent C&I loans were up by $1.8 billion (13.7 percent) during the quarter.

Nine Failures in Third Quarter Include Washington Mutual Bank:

The number of insured commercial banks and savings institutions fell to 8,384 in the third quarter, down from 8,451 at midyear. During the quarter, 73 institutions were absorbed in mergers, and 9 institutions failed. This is the largest number of failures in a quarter since the third quarter of 1993, when 16 insured institutions failed. Among the failures was Washington Mutual Bank, an insured savings institution with $307 billion in assets and the largest insured institution to fail in the FDIC’s 75-year history. There were 21 new institutions chartered in the third quarter, the smallest number of new charters in a quarter since 17 new charters were added in the first quarter of 2002. Four insured savings institutions, with combined assets of $1.0 billion, converted from mutual ownership to stock ownership in the third quarter. The number of insured institutions on the FDIC’s “Problem List” increased from 117 to 171, and the assets of “problem” institutions rose from $78.3 billion to $115.6 billion during the quarter. This is the first time since the middle of 1994 that assets of “problem” institutions have exceeded $100 billion.

Failure-Related Restructuring Contributes to a Decline in Reported Capital:

Total equity capital fell by $44.2 billion (3.3 percent) during the third quarter. A $14.6-billion decline in other comprehensive income, driven primarily by unrealized losses on securities held for sale, was a significant factor in the reduction in equity, but most of the decline stemmed from the accounting effect of the failure of Washington Mutual Bank (WaMu)2. The WaMu failure had a similar effect on the reported industry totals for tier 1 capital and total risk-based capital, which declined by $33.6 billion and $35.3 billion, respectively. Unlike equity capital, these regulatory capital amounts are not affected by changes in unrealized gains or losses on available-for-sale securities. Almost half of all institutions (48.5 percent) reported declines in their leverage capital ratios during the quarter, and slightly more than half (51.2 percent) reported declines in their total risk-based capital ratios. Many institutions reduced their dividends to preserve capital; of the 3,761 institutions that paid dividends in the third quarter of 2007, more than half (57.4 percent) paid lower dividends in the third quarter of 2008, including 20.7 percent that paid no dividends. Third quarter dividends totaled $11.0 billion, a $16.9-billion (60.7-percent) decline from a year ago.

Source FDIC: http://www2.fdic.gov/qbp/index.asp

For more on what the graphs are telling you, read What are CAMELS ratings? Is My Bank Okay?

Graphs From Q2-2008: Graphs - Not Laughs - From the FDIC Report

More: Graphs show Gaffes - More from the FDIC Report

This article has been reposted from Your Mortgage or Your Life. The full post can also be viewed on yourmortgageoryourlife.wordpress.com.

Citigroup Bailout, Deflation And The Worldwide Financial Epidemic

The news of Citigroup's $300 billion bailout seems like déjà vu, and the scary word "deflation" that is being thrown around seems distant compared to everything else we are dealing with. The U.S. is not the only country with problems either, this is without a doubt a global financial epidemic. James Picerno from The Capital Spectator wonders, though, if the cure might be worse than the disease.

Have we seen this movie before? It certainly sounds familiar.

Once again, the government steps in to bail out a financial institution and Mr. Market takes kindly to the idea. Initially. But then reality sets in and the process starts anew. Perhaps it'll be a true sign of a bottom when the Feds engineer a bailout and the market tanks on the news.

But not yet. The latest installment of rescue revolves around the once mighty Citigroup. A giant among giants, this behemoth of financial behemoths surely fits the bill as too big to fail. If such a thing exists as a financial institution that must be saved at any cost, Citigroup looks like the poster boy for this idea.

Total assets for Citigroup were a bit more than $2 trillion in September. For those who like to keep score, that's roughly 14% of the annualized value of U.S. GDP for this year's third quarter.

The days of pulling another Lehman and letting a big bank fail are history. Better to bailout more rather than less and deal with the consequences later. The grand strategy here is that if the government bails out enough banks (and perhaps an auto company or two) while spitting out stimulus in various forms as far as the eye can see, the system will correct itself, or at least stop bleeding. At a time when deflationary risks are rising, this plan is considered prudent and timely by a growing swath of economists and voices from the peanut gallery, including yours truly. The risk of an even deeper implosion of prices and confidence must be avoided lest the vortex of deflation pull everything down the rat hole. Preventing deflation is the last battle in this horror film because once the big "D" takes hold, in sentiment and prices, the challenge becomes much, much tougher.

The problem is that no one's really quite sure if deflation with a big "D" is on our doorstep. Quite possibly it is, or so one could reason after witnessing consumer and wholesale prices fall last month on a scale unmatched since the government began keeping tabs on such things in the late-1940s. Waiting for definitive signs risks letting the monster out of the cage. Decisions, decisions. Nonetheless, there's a strong case for assuming deflation is coming. If we're wrong, we'll have more inflation on our hands than we otherwise would. But the world knows how to fight inflation, even if the political will is sometimes lacking. Attacking deflation, on the other, is another story.

Any way you slice it, there's bound to be more than a little disappointment and finger pointing in the months and years ahead. Indeed, no one should think that the necessary but risky strategy of preventing deflation is destined to end in triumph, or quick results. The stakes are high, in part because the government's moving quickly toward betting the house on a fiscal/monetary solution. On the opposing shore is the unwinding of excess, some of which has been decades in the making. When an immovable force meets government printing presses, the outcome isn't entirely clear.

All the more so if the world is looking for signs, one way or the other, by next Wednesday. It's difficult to gauge expectations as we run from one crisis to another. But this much is clear: the financial and economic problems will take time--years--to solve, and to the extent that the crowd thinks otherwise, the seeds of disenchantment have been planted.

The U.S. economy is sick, and getting sicker. Europe has the disease and Asia is at risk of contracting the same, albeit in a milder form. Looking back on the past five decades offers no clue for what may be coming. Growth has been a constant, according to GDP numbers from economist Angus Maddison, emeritus professor, University of Groningen (Netherlands). As the chart below shows, outright contraction is unknown in the postwar era.

Fifty years is a long time, virtually an eternity for mere mortals studying the past in search of clues about the future. It's all too easy to look at this track record and conclude that real declines in global GDP aren't possible, or are so unlikely as to be unworthy of considering. The IMF forecast, for one, still imagines more of the same with next year's estimate for real global GDP rising by a respectable if not impressive 2.4%.

Of course, the crowd used to think in persistent-growth terms for housing prices, and how they never fall on a year-over-year basis. Oh, sure, that happened in the Great Depression, but such episodes were dismissed as a thing from the past.

Perhaps it's time to consider the unthinkable. We've all received a crash course in just that over the last few months. But has the education so far been sufficient? Or do we still need to spend more time studying?

There are many dangers stalking the global economy, and at the top of the list is the assumption that the governments of the world can spend their way out of the slump on our collective doorstep. In the U.S. alone, the government now stands at the ready to spend $7 trillion--yes trillion with a "t"--to bring financial salvation to the system, according to Bloomberg News. That's the equivalent of three-and-a-half Citigroups, or half the U.S. economy. Scale no longer looks to be a stumbling block.

By spending enough money, governments are likely to keep inflation-adjusted global GDP floating somewhere above zero, if only slightly. That would still bring a fair amount of pain and repricing, but embedded in the expectation is the notion that a floor can be built under the crisis.

Perhaps, although at some point one might wonder if the cure will be worse than the disease. There are some awkward questions that will accompany the mother of all spending sprees now underway. First up: Is there some point at which additional government spending becomes counterproductive because a) it encourages future inflation on a scale that will be excessively burdensome; and/or b) the prospect of the government owning ever-larger chunks of the economy risks institutionalizing mediocrity or worse in the economy?

There are two great episodes of deflation in modern history, and each continues to raise questions about the associated lessons. Yes, spending is the only hope of sidestepping the beast, and if that means artificially engineered demand from the government, so be it. But it's not clear that the strategy leads to happy results all around. Meantime, there's more than one way to fight deflation.

That's not to say we shouldn't try to spend our way out of a deflationary trap. We should. We must. And we will. The risk is real this time, unlike the previous worries over deflation in 2001-2003. But the details of how we engage our anti-deflationary war may matter as much, if not more, as the decision to wage the war in the first place.

The dismal science has precious little experience with fighting deflation and so we must recognize that we may soon be caught up in an economic experiment on a scale that has little or no precedent. By all means, let's fight this war ferociously. But it also needs to be fought intelligently. What exactly do we mean by "intelligently"? We can't say for sure. No one can, and therein lies the greatest risk.

This article has been reposted from The Capital Spectator. The full post can also be viewed on The Capital Spectator.

Does Anyone Know How To Fix This Financial Crisis?

I read a couple interesting articles this morning that I thought I’d share. One article talks about how no one, including President-elect Obama, knows how to fix the financial crisis. The other offers a potential solution that will cost more than $1 trillion. I’ll summarize the two articles below:

The first article was written by Russell Roberts, economics professor at George Mason University, and published in Forbes. In his article, Roberts equates this financial crisis to raising children, saying that each one is different and there is no official manual on how to raise the perfect child. He goes through the measures that have already been enacted, saying how each one thus far has failed miserably. Many people have this belief that Obama will miraculously save the day, but Roberts points out that the only solution Obama has really posed thus far is to offer another stimulus package, and idea that has already been tried and failed. Paulson is lost at this point, and he doubts Obama will be the answer either. He ends his article saying:

“What if doing whatever it takes means doing less, rather than more?

That is the conundrum for Obama and the successor to Paulson. The more options there are, the harder it is to know which one is the right one. The more options you try, the more uncertainty is injected into the economy, and the more cautious are investors and employers and consumers.

Nobody knows what it takes to move the economy forward right now.”

The second article was written by Neha Singh and published by Reuters. This article is about the findings of Paul Miller, an analyst for Friedman Billings Ramsey. Miller has come up with a plan to save the U.S. financial system, and it will cost only $1 trillion to $1.2 trillion in additional capital. Basically, he says that in order to restore confidence and improve liquidity in the credit market, this injection needs to happen. In addition, rather than the investments being made via preferred shares or long term debt mechanisms, Miller thinks that in order for the plan to work the investments need to be common equity injections. The following is a quote from Miller: “Debt or TARP capital is not true capital. Long-term debt financing is not the solution. Only injections of true tangible common equity will solve the current crisis.” Miller says that even his plan will take a few years to fix things.

Obviously these two articles have very different views, but one thing they have in common is that they agree that the solutions proposed or enacted thus far have failed.

Of the two views, I tend to side with Roberts, author of the first article. I think that pretty much we are lost in the forest and going around in circles trying to get out, and as they teach you in Boy Scouts, when you get lost sometimes it is best to wait it out.

Miller’s suggestion, on the other hand, I find completely ludicrous. So instead of the government (i.e., taxpayers) getting preferred treatment for their extremely risky investments into struggling companies, they should settle for common equity investments that would surely lose a ton of taxpayer money? Sorry, but that sounds pretty dumb to me. And I’m certainly not willing to lose $1 to $1.2 trillion of taxpayer money to find out that this crazy idea isn’t going to work. There are a lot of ways that we can help the economy with that kind of money that would have a bigger impact. Besides, there is no way that plan would ever get approved without people rioting in the streets and threatening rebellion. People are already outraged at the current investments we are making into these companies, and if we were to take even lesser terms in exchange, look out. The only people who would support this plan would be shareholders in these institutions, and I don’t think anyone feels bad for them at this point.

The OECD Employment Projections Look Very Optimistic

The Organization for Economic Co-Operation and Development (OECD) released updated economic projections on several countries late last week, and while some are calling the projections grim, they look extremely optimistic to me. The report projects different economic variables through 2010, but the one I want to specifically focus on is employment. In their report they see the U.S. capping out with an unemployment rate of 7.6 percent in the first quarter of 2010. Considering that we are already at 6.5 percent, and news of mass layoffs keep coming with no end in sight, it is hard to believe that we won’t easily surpass 7.6 percent next year.

The big headline in the papers this morning is the 50,000+ people that are getting laid off by Citigroup, on top of previous layoffs the company has already announced this year. Things certainly are not getting better in the financial industry, and really the outlook is not the great anywhere else, either. If the automakers don’t get a big bailout we will soon see tens--if not hundreds--of thousands more people laid off there, not to mention all the vendors and suppliers who would also be forced to lay off workers. Nearly every industry you can think off, short of medical and a few others, is in belt tightening mode right now, and more layoffs are all but imminent.

The OECD projected the unemployment rate to be 6.5 in Quarter 4 of this year; considering that we are already at 6.5 after October’s announcement, we are sure to beat that number. In addition, we must also remember that the Labor Department has been drastically underreporting jobless claims in initial reports. I blogged about this recently, but if they keep the underreporting ratio intact from the past couple months, we could see up to 200,000 more jobs lost than was originally announced for October. That would be scary, considering that the numbers for November look like they are going to be bad, too. We could very well end up with an unemployment rate over 7 percent by the end of the year, a number the OECD is not projecting us to top until Quarter 2 of 2009. By then we might be over 7.6 percent--who knows?

Really, I don’t see how we won’t top 7.6 percent unemployment before 2010, short of an amazing government intervention orchestrated by President-elect Obama. However, that of course would have its own set of ramifications for us to deal with. This problem isn’t going to get better any time soon, and this recession will be deep and hard felt. We can hope for the best, but just make sure to prepare for the worst. The way people have been talking about this OECD report as being overly grim, I just don’t think enough people truly see the big picture.

How Long Will Labor Markets Continue To Struggle?

The biggest worry most people have during a recession is that they may lose their job. With major layoff announcements happening daily now, the labor market is certainly struggling. But how long will labor markets continue to struggle? Economics professor Mark Thoma looks closer at this dynamic, and offers valuable insight, in his blog post from Economist's View.

How long will the recession last? I don't know for sure, but we may be able to say something about how long labor markets will continue to struggle even after output growth begins to increase. The next two graphs show the unemployment rate and the employment to population ratio since 1948:

Notice that in the last two recessions, unlike those that came before, these measures of labor market performance continue to deteriorate even after the official end of the recession (as dated by the NBER). The delayed recovery can be seen more clearly in a graph of the two series since 1985:

This means that once the trough of the recession in output growth is reached - and we are not there yet - then there will be a considerable period of time before the labor market recovers if this downturn is like the last two. How long of a time period?

Output growth troughs very near the NBER assigned date for the end of recessions:

Focusing on the last two downturns, the trough of the 1990-91 recession was in March 1991. However, the peak unemployment rate wasn't until June, 1992, 15 months later. The employment to population trough was a bit earlier, December, 1991, but it was still 9 months later (and there is a second, slightly higher trough a few months later - see the red line in the second graph above).

The 2001 recession has a trough in November, 2001, but unemployment doesn't peak until 20 months later in July, 2003. The employment to population trough is 22 months later in September, 2003. Summarizing:

Recession	Trough	Unemp Peak	Emp to Pop Trough
1990-91	Mar., 1991	June, 1992 (15)	Dec., 1991 (9)
2001	Nov., 2001	July, 2003 (20)	Sept., 2003 (22)

Thus, once the recession has officially ended, the average number of months until unemployment peaks is 17.5, and the average time until the employment to population ratio troughs is 15.5 months.

So, if the past two recessions are a reliable guide, expect around five quarters or so of additional labor market problems even after output growth turns around.

Is the past a reliable guide? I wish I could answer, but as far as I know the exact reason for the increased time until the labor market recovers observed in the last two recessions is unknown (there has always been some delay, but lately it has increased considerably). One reason could be that labor hoarding has increased due to higher training costs or some other reason. With firms retaining more labor through the downturn and hence more excess capacity than in the past, they can expand output once the recovery starts for a longer period of time without increasing the labor force, or at least not increasing it by much. With employment growing slower than population, and also growing slower than the number of people looking for jobs, the measures above would increase for awhile even after the economy turns around. If firms also install labor saving equipment at a greater rate than in the past as the recovery begins, or if the equipment is installed at the same rate but it is even less labor intensive than in the past, the growth in employment could be even slower. But as I said, even though there has been lots of research into this question, the exact reason for the change in labor market behavior is not known with certainty.

This article has been reposted from Economist's View. The full post can also be viewed on Economist's View.

Retail Sales See Record Declines

In case you needed further proof that the economy is struggling, the latest report on retail sales for October was not good. In fact October saw the biggest monthly drop since this data started being tracked in 1992. Tim Iacono from The Mess That Greenspan Made takes a closer look at this report in his blog post below.

The Commerce Department reported record declines in retail sales during the month of October in another dim reminder that the economic slowdown continues to worsen.
Retail sales in the U.S. dropped for the fourth consecutive month in October, down 2.8 percent overall, the biggest monthly decline since record keeping began in 1992. This exceeded the previous record set in November of 2001, just after the terrorist attacks.

The decline was paced by a 5.5 percent plunge in auto sales, following last month's 4.8 percent drop, however, declines were widespread with purchases excluding automobiles down 2.2 percent, also a record.

As shown below, auto sales are now down a whopping 22.2 percent from year ago levels with little hope of a significant rebound in the months ahead.
Nearly every sales category declined in October - furniture sales were down 2.5 percent, electronics sales fell 2.3 percent, and sporting goods sales fell 1.6 percent - however, gasoline station sales dropped more than any other, down 12. 7 percent for the month, bringing the year-over-year increase to just 0.4 percent.

Note that earlier in the year, when prices at the pump were rising, gasoline station sales had increased tremendously, lending support to the overall retail sales figures as other categories declined.

Since gasoline prices have plunged, these sales are now detracting from the headline number and should have an even bigger impact in the November report.
Some argue that excluding automobile and gasoline station sales paints a less dour picture of retail sales - down just 0.5 percent in October versus the headline 2.8 percent decline - however, this really is wishful thinking.

With the exception of food and health care, retail sales have slowed markedly over the last year, down about four percent in inflation adjusted terms even when excluding auto sales.

The tightening of credit and the pull-back in spending on discretionary items will continue to impact retailers for months to come.

This article has been reposted from The Mess That Greenspan Made. The full post can also be viewed on The Mess That Greenspan Made.

Initial Jobless Claims Report In...And It's Not Good

It probably does not come as a surprise to many, but the initial jobless claims report that came in this morning was not an encouraging sign for the economy. It looks like things are going to continue to get worse from here. James Picerno from The Capital Spectator takes a closer look at the report and adds some additional insight in his blog post below.

This morning's update on initial jobless claims is both sobering and clear: the economy is contracting and the trend has legs.

There's no debate on this point now, nor is there much to be done in the short term to alter the fate that now awaits the U.S. The wave is crashing and the unwinding will have its way. Yes, government can and should soften the blow, particularly for the least fortunate. But in macroeconomic terms, there's no stopping the recessionary forces now unleashed.

Unfortunately, this process is still in its early stages and so the pain has only just begun. Indeed, for the first time in this cycle, last week's new filings for unemployment benefits--a forward-looking indicator--rose above 500,000, as the chart below shows. The nation's unemployment rate, as a result, is sure to rise further in the months to come.

For all the bearish news of the past year or so, much of it has been finance related. The fallout is now taking its toll on the broader economy, which is to say consumers, who collectively represent about 70% of GDP. If nothing else, everyone needs to recognize what awaits. The storm is here and will blow for some time.

The last time initial jobless claims moved above 500,000, the event was short-lived. The economy won't be so lucky this time around. After the tech bubble burst in 2000, the blowback on consumer spending was virtually nil. Indeed, Joe Sixpack kept spending, in part because the Fed dropped its benchmark interest rate to a mere 1%. The central bank has done so again, but low interest rates won't help this time. Even a 0% Fed funds rate, which can't be ruled out in the near future, won't do much to stimulate demand.

The system must be purged of the excess and it will be purged, and this time the man on the street agrees. There's no other way to reach equilibrium for asset prices and supply and demand in the economy generally. Policy makers, in turn, must focus on how best to deploy future stimulus efforts so as to maximize the benefits. That's not going to be easy, for several reasons.

The biggest challenge is the magnitude of the correction/recession. For the past generation-plus, economic corrections have been mild and infrequent, and so there's been limited attention cast on dealing with deeper, longer recessions. That's changing, of course, as current events are pushing policymakers to undertake a crash course in pain management.

That leads to the second problem, which is figuring out what to do without throwing money down the drain. Some issues are clear cut, like extending jobless benefits. We don't need a Congressional hearing to understand the reasoning for this action. It's a different story when it comes to the more innovative plans afoot, starting with the $700 billion bailout package enacted last month that gives the U.S. Treasury authority to, well, spend a lot of money in an effort to prop up the financial system and by extension the economy. Alas, there's no consensus on the most efficient and effective way to spend the money, as yesterday's volte-face announcement by Treasury Secretary Paulson suggests.

Are we making it up as we go along? Yes, at least to a certain extent. Like FDR in the 1930s, the U.S. government in the 21st century is engaged in a massive experiment in macroeconomic policy intervention. Some of the efforts will work, some won't. Ultimately, we'll learn a lot when this is over, but the education will come at a price.

Brace yourself.

This article has been reposted from The Capital Spectator. The full post can also be viewed on The Capital Spectator

Haven’t We Already Bailed Out AIG Twice? Well, Here We Go Again…

This morning the federal government announced that it is was going to inject additional capital into AIG and restructure the existing debt as part of a new bailout to save the troubled insurance giant AIG. For those not familiar with the situation, the government had originally offered AIG a lifeline loan of $85 billion, only to later pony up an additional loan of $37.5 billion when it became clear that the company needed more. Now the government is giving them another loan, this one nearly $30 billion. In addition, as part of the deal, the government is lowering the interest on the previous loans and extending the repayment term from two years to five years, according to the Associated Press. What it boils down to is that AIG didn’t want to have to fire sell their assets in order to pay back the government loan, so instead of forcing them to do so, the government offered up even more money and agreed to ease the terms on the previous loans. Is your head spinning on this one, too?

This would essentially be the equivalent of me going to the bank and saying I’m not going to be able to pay my mortgage anymore, so can I get a loan to stay afloat for awhile till things get better? They say yes, but then a little while later, I go back for more and they again say yes. But that still isn’t enough, so I go back a third time and when they ask me about other assets, I tell them sure, I have a 2008 Escalade fully paid for, but I wouldn’t dare sell it right now because the SUV resale market just isn’t good. Because the bank didn’t want to force me to make this sacrifice, they decided to give me yet another loan and make the terms easier on my previous ones. Does this scenario sound a little farfetched? I certainly don’t know any banks that would ever agree to terms on the first loan, let alone more down the road; that would be bad business. Now obviously in the real world, the AIG scenario isn’t quite as simple, considering how huge the company is and the fact that the government now has ownership interest in it, but the decision to inject the business with additional taxpayer capital when there are alternative ways the company could have raised the money is concerning to me.

I was just reminded of a Saturday Night Live clip from a while back, after AIG was infused with the second loan of $37.5 billion. In the segment “Oh Really” on Weekend Update, which skewers the news, they drill AIG about the executive retreat and then transition into the “Oh My God Are You Serious?” segment, where they are completely dumbfounded at why the government would give AIG more money. The clip is funny and definitely applicable to the situation at hand. The clip below is for the entire Weekend Update segment, but if you skip to about 2/3 of the way in--when there are around 2 minutes remaining--that is where the “Oh Really” portion starts.

Unemployment Rate Soars, And It Is Going To Get Worse

The job report released by the Labor Department this morning was dimmer than most people had projected. The expectation had been that we would see around 200,000 job cuts, according to the Associated Press (AP), so the actual number that came in--240,000--was a little surprising. That wasn’t the biggest shocker, though: The biggest surprise came in the updated numbers from September’s job loss report. Previously, it was reported that we had lost 159,000 jobs in September, but that number was revised to 284,000 in the newest report. These numbers helped push the unemployment rate to a 14-year high of 6.5 percent and put the total number of jobs lost this year at 1.2 million, and it doesn’t appear that things are going to get better anytime soon.

One thing to keep in mind is that the Labor Department has been consistently under-reporting initial jobless claims. In August, the initially reported 73,000 was later revised to 127,000. It looks like their initial numbers have been coming at around 56 to 57 percent of the actual numbers, so with that in mind, the real numbers for October might end up closer to 420,000. Before we get too caught up in that number though, what about November and December?

If the automakers aren’t rescued, as I discussed in my blog post yesterday, we could be looking at huge number of job losses as a result of one or more of the major carmakers failing. A report issued by the Center for Automotive Research said potential job losses stemming from a major failure in the U.S. auto industry could be as high as 2.5 million. Add even a fraction of that number to everything else that is going wrong in the economy right now and you can see how unemployment could quickly spiral out of control.

This holiday season looks like it is going to be a painful one for consumers and retailers alike. The way almost all economic and financial numbers are coming in worse than projected right now, I shudder to think what the numbers are going to look like for retailers. Of course it doesn’t stop there, though; if retailers struggle, that will trickle down via more layoffs and store closures. Store closures are bad news for commercial landlords, and so on and so forth. This is unlikely to end anytime soon, and it is doubtful that president-elect Obama is going to be able to magically make everything better. We are in a recession and it is going to take time to rebound, so be prepared.

Falling Gas Prices Aren’t Making Everyone Happy

Most of the country is ecstatic that gas prices are falling. Just the other day I was able to fill up my car for less than $50--I know I certainly was ecstatic. But while most of the country is happy to see gas prices fall, there are certain pockets that are going to suffer for it. Texas is the energy capital of the country, and when gas prices are up, cities such as Houston and Fort Worth boom. This was certainly the case of late. These energy hubs continued to boom despite the rest of the country suffering from the credit crisis; it seemed as if they were immune. But now that gas prices are falling, these places are starting to feel the pinch--and it is likely to get worse.

Unemployment is rising in these areas as energy companies start to cut back. Projects that made since when oil was at $140 a barrel just don’t look as good now that it is less than $70 per barrel. It isn’t just unemployment either; many residents in these areas lease their land out to energy companies and depend on these payments to support their lifestyles. You can bet that as these energy companies continue to cut back, businesses in the area--along with the local real estate markets--will suffer. While many of these places avoided the big run-ups in housing prices that were so prevalent throughout the rest of the country during the housing boom, the real estate prices here never really experienced the falls, either. I would suspect that they will begin to fall a bit now, although not nearly as heavily as in most other places in the country.

As jobs dry up and the real estate and business markets contract, investors need to be extra careful when dealing in these areas. The numbers may look attractive right now thanks to low unemployment, low vacancy and real estate prices that have stayed study despite the economic turmoil, investors need to look beyond past performance and into the future. Now that Obama is president-elect, things could get even worse for some of these energy hubs. He wants to make a huge push for alternative energy, which could very well push the price of oil down even further. While some of these places are focused entirely on oil and gas, others are diversified into alternative energy, which would obviously be a preferable place to invest at this point. If you want to invest in these areas, look hard at diversification. Are there many jobs outside the oil industry? If the area is completely dependent on oil and gas, I would suggest you move on (think Fort McMurray in Alberta, Canada).

Unemployment Will Be The Next Blow To Real Estate

Every day we are hearing about a new round of layoffs from some business, and that trend is unlikely to change anytime soon. Unemployment rose from 4.5 percent in 2006 to 6.1 percent last month, according to Inman News, and it continues to trend up. The financial crisis is forcing businesses to cut expenses and in some cases even merge with competitors in order to survive. Either way, the end result is layoffs and the prospects for new job hunters are grim. Once the money from their severance packages run out, which should be happening soon, these people are going to be in a world of hurt. During a recession the most painful thing is the high unemployment that typically accompanies it. Since this recession is geared up to be a big one, we should expect nothing less than a high level of unemployment to come with it. What does this mean for the real estate market? It means that things could get even worse.

People who are unemployed cannot buy homes, and people who are scared that they could join the unemployed ranks are unlikely to make big purchases--especially a new home. As unemployment continues to rise, we can also expect foreclosures to mount, which brings about a bad combo: more houses added to the market and fewer people able to buy them.

Some industries are being hit harder than others, but for the most part, businesses are going to struggle in the near future. Consumers lack confidence right now, as evidenced by the lowest-ever consumer confidence rating of 38 percent collected in a poll by The Conference Board this month. Consumers aren’t buying, which is going to hurt businesses that sell directly to consumers (B2C), and businesses that sell to businesses (B2B) are going to feel the pain next as the B2C businesses cut back their orders from the B2B businesses. This recession is going to hurt all over, and you can bet that we haven’t seen the worst of it yet.

The moral of the story is to be cautious if you are in the market to buy a new home. Realistically, your best bet is probably to wait it out a little longer, but if you absolutely need a new home now, just understand what could be looming. Only buy what you can comfortably afford. That should go without saying, but you would be surprised at what people can still get in terms of new loans, and what they are willing to sign on for. Also, pay close attention to what rents are going for in relation to what you would have to pay for a mortgage. If buying a home is considerably more expensive than renting in your area, then hopefully big red flags are going up in your head. Investors need to pay close attention to that comparison because there could be opportunity in those few areas which actually offer affordable homeownership. In that case, pay really close attention to the employment prospects in the area, because no matter how affordable homes look, you still are going to need a tenant base to rent to, and tenants with jobs are always preferable.

Small Business Activity Shows Indicators Of Slowdown

Many of those who are watching the economy closely keep their eyes open for new reports, data and analysis from major sources. But another place to look for clues about the economy is in anecdotal and statistical evidence from small business owners--the ones who are seeing the effects of immediate the numbers in their day-to-day lives.

Nelson Villanova, for example, owns Eddie's Shoe Repair, a 15-year-old business that sells shoe and luggage shines at $4 a pop. Since August--when the economy started its rapid shift from bad to worse--he has seen a sharp drop-off in business of 25 to 30 percent.

Other declines showing that businesses are clamping down on their wallets are widespread. Office supply sales have declined every month since December 2007, FedEx shipped 10 percent fewer overnight envelopes this summer than last and business jet take-offs and landings were down by 18 percent in August.

Damon Bae, general manager of Manhattan-based Fancy Cleaners, has seen an uptick in customer preference for bulk dry cleaners rather than boutique dry cleaners as consumers try to stretch their dollars to the max.

Sales at Andrew's Ties, a Madison Avenue shop which sells handmade Italian silk ties at $49 to $99 each, have been declining since March, according to general manager Yannis Tselepidis. The start of the sales drop-off coincides with the collapse of Bear Stearns.

Michael Ingbar, owner of New York-based MFI Art Company, has seen corporate buyers cutting back in the past 12 to 18 months. Companies laying people off, he said, are not in a position to buy art.

And in San Francisco, Jack Mardack, marketing director of Eventbrite--a company that handles online registrations for events and conferences--has seen less interest in large, formal, industry-wide events and increased interest in smaller, local events. Networking events priced at $100 or less are particularly popular.

Source: BusinessWeek

WWWBD: What Would Warren Buffett Do?

When all else fails, ask WWWBD, or "What would Warren Buffett Do?" What are the Oracle of Omaha’s thoughts on the current state of the financial markets and the economy? Well, according to Buffett, we are looking at an economic Pearl Harbor. While that probably doesn’t sound too reassuring, he is also optimistic. In fact, he is so optimistic that he is one of the few people actually buying right now. He recently invested $5 billion in Goldman Sachs and $3 billion in GE. Buffett said the current bailout plan isn’t perfect, but he pushed for it to get passed nonetheless. In a Fortune article, he also proposed a bailout plan of his own.

In Buffett's bailout plan, he recommends that the government involve private investors in the mix by loaning up to 80 percent of the purchase price to hedge funds and the like to buy up the distressed mortgage assets. Buffett said that this would create less risk for taxpayers, and also provide better management of the assets. The biggest advantage, though, is that this would overcome the potential problem of the government paying too much for the assets, as many are worried will happen under the current bailout proposal. Since these sophisticated investors are going to have 20 percent equity in the game, you can bet they will make sure to not overpay for the troubled securities.

I definitely prefer Buffett’s plan to the one that the house just passed, but it is still hard to predict what the ultimate impact would be to taxpayers.

Another point that Buffett made in the article--and that is being echoed elsewhere, too--is that $700 billion probably isn’t going to be enough to fix this problem. The Buffett proposal would bring in private money to help shoulder the burden, but the big problem with it is that we don't know that private investors will even be interested. If they are interested, are banks going to be willing to sell the toxic assets at the prices investors demand? Will prices ultimately get pushed down even further, making things that much worse? It is hard to say, but at the same time, that echoes the main fear of the current bailout plan. How do we know that we are getting a good deal? I don’t know about you, but somehow I have a feeling that if the government is left to their own devices, we are going to end up paying a hefty premium for these assets and taxpayers will get stuck with the bill.

Typical investors, who, unlike Buffett, don’t have billions lying around, need to be smart with their investments right now. Make sure to protect yourself in the event things don’t turn out as planned. Also be aware that there is no guarantee that things are going to get better even now that the bailout has passed. We are likely still heading to recession, and things are still going to get ugly.

Bailout Plan Stalled; Is There Hope?

In a surprising turn of events, the bailout plan that seemed so certain to get bipartisan approval yesterday was held up during negotiations. Republicans suddenly decided to take a stand against the bill and are trying to push for alternative measures that involve less taxpayer money. The main idea on the table right now is for the government to insure these toxic mortgages rather than to buy them outright. It seems that these politicians must have received a heavy dose of taxpayer complaints over the last couple days in order to make such a drastic shift.

The other big news from yesterday, of course, was seizure of Washington Mutual, which earned the distinction of becoming the largest bank ever to fail. But you can rest assured that if some sort of major bailout plan is not agreed upon, Washington Mutual probably won’t keep that title for long. The state of the financial industry is so bad right now that there will surely be many more bank failures to come if the government doesn’t intervene.

I should add that I’m not advocating for government intervention; I’m actually overjoyed that the current bailout plan is being held up. Buying up $700 billion of toxic assets with taxpayer money doesn’t sound like a good idea to me. You might be able to sell me on the importance of saving the financial industry and all that jazz, but you’re not going to convince me that the only way to do this is by taking all this bad debt off the books of failed companies and adding it to the government's books. Personally, the insurance idea sounds much more reasonable to me, but I would want to know a little more about the proposal before I gave it my support.

I was reading a New York Times piece this morning about the bailout’s stall, and I found it humorous--and suspicious at the same time--that at one point during negotiations, Treasury Secretary Henry Paulson got down on his knees and begged House Speaker Nancy Pelosi to support the bill. It made me think, what would make Paulson feel so strongly about the bill that he would stoop to such levels? Either he truly feels like this bill is the only thing that can save the country he loves so dearly, or he wants the bill to pass so badly because he has a huge financial stake in the outcome. I don’t have the information on all of Paulson’s holdings, but since he was the former CEO of Goldman Sachs, I would venture to say that he probably still holds a substantial amount of his wealth in that stock. If this is the case, it would certainly make one wonder about his motivations.

It will be interesting to see how things end up shaking out. How are the markets going to perform if the bailout talks continue to drag out? How many more banks will fail? I’m still not sold on any sort of bailout, but I’m adamantly opposed to the one that was on the table. I also hope that the politicians opposing the bill are doing so because they recognize the flaws in the bill rather than just using it as a political ploy for John McCain, as some Democrats are suggesting.

Lehman Brothers Declares Bankruptcy: Taxpayers Spared

Is it possible that the government has finally learned their lesson? After Lehman Brothers spent a weekend trying to find a buyer, the interested parties withdrew when the government said they would not offer any financial support to a potential buyer (as they did with Bear Stearns). That left Lehman Brothers with little choice but to file for chapter 11 bankruptcy protection this morning. This bankruptcy becomes of the largest in history, with $613 billion in debts, according to the Wall Street Journal. While a bankruptcy of this magnitude is certainly not a good thing, the fact that the government allowed it to happen should be looked at as a breath of fresh air by taxpayers.

There was a lot of speculation heading into the weekend that the government would do what they have been doing all along through this financial crisis and step in to save the day when push came to shove. Surprisingly, though, the government held its ground after attempting to help piece together a deal between Lehman and Barclays; when the government refused to provide additional backing, Barclays backed out. Since the government was more than willing to step in and provide assistance for J.P. Morgan to purchase Bear Sterns, this news definitely came as a shock to me. I can say that I’m glad the government finally took a stand, and if nothing else we will get a chance to see what life looks like after a major investment bank failure.

With Lehman and Bear Sterns gone, and Merrill Lynch agreeing to be sold to Bank of America, the only major investment banks left are Goldman Sachs and Morgan Stanley. Who knows whether or not these two companies will be able to make it through the financial crisis intact, but I feel much better that a new precedent has been set that we will allow the markets to take their due course with them. If the government had chosen to bail out Lehman, after doing so for Bear Sterns, then the other two brokerages would all but expect the same to be done for them if needed. Lehman’s bankruptcy will show them that this is not the case, and that they need to take matters into their own hands.

Sure, this is going to be painful in the short term; the markets are going to tank. Over the long haul, though, by taking a stand, the government is telling Wall Street that they can’t assume a government bailout. This will lead to better business decisions and risk management by these financial institutions, a more stable U.S. economy and less of a burden for taxpayers.

No More Bailouts: Let Lehman Brothers Fail

I just read an opinion piece by James Conrad on Seeking Alpha that made some great points about the government bailouts that have already happened (i.e., Freddie, Fannie and Bear Sterns) as well as one that may happen with Lehman Brothers. His point is that we shouldn’t be bailing out any of these companies, and the notion that the economy will tank if we don't is unfounded. He believes that we should let these companies take due course toward chapter 11 bankruptcy and fulfill their self-made destinies.

The following are some excerpts from the article:

"There is nothing that differentiates Lehman Brothers from any other big company except the fact that its debt, including a lot of counter party debt arising out of various derivatives, is held, mostly, by other Wall Street players."

"There is always systemic risk whenever a large company fails. There were also systemic risks to the energy markets when Enron, a huge energy trader, went bankrupt, but we got through that. That is what Chapter 11 bankruptcy exists to do."

"They do not have the best interest of the nation at heart. There is no reason why a company, like Lehman, cannot unwind properly, using the bankruptcy tools available, rather than being placed upon the backs of innocent taxpayers. Hank Paulson’s company, Goldman Sachs (GS), stands to lose billions on a Lehman collapse."

"Seeking to abuse the public coffers, in support of private interest, is not unique. PIMCO, one of the biggest bondholding institutions in the world, stood to lose tens billions of dollars on Fannie/Freddie bonds if the two GSEs collapsed without a bailout. So, Bill Gross, its Chairman, wrote, again and again, on the need to have those two institutions bailed out by the federal government, and lobbied to make it happen."

"Lehman Brothers is a private company. It is not a charitable institution, or a government agency. Its purpose is to make money, like its counter parties. In its day, it earned huge profits, and a very large percentage was paid out to its top management, in the form of salary and yearly bonuses. That top management is still in power."

Conrad goes on to bring up several other points as well, which lead one to question the logic behind using taxpayer funds to rescue these companies. I'm not a big fan of bailouts myself, so I tend to agree with many of Conrad’s points. I understand why the Freddie and Fannie bailout happened (even though I didn't really support the original debt guarantee), but I question the idea that Lehman Brothers is "too big to fail." I really hope the government sees the light on this one and lets Lehman Brothers fall to its own fate. If nothing else, an example needs to be set for these Wall Street investment firms that they need to do a better job of risk management, or else they will pay the price.

Time For The Next Wave Of Loan Defaults And Bank Failures

If you thought we were almost through the subprime mess and that things are going to start getting better, you might want to consider this news: According to some financial experts, the subprime problems are only the beginning. Alt-A (low document and stated-income-type loans) and even prime mortgages are starting to see dramatic upticks in their default rates. Alt-A loan defaults have quadrupled to 12 percent from April 2007 to April 2008, and delinquencies on prime loans doubled during that same period, according to the New York Times. The chairman of JP Morgan Chase, James Dimon, called the outlook for these mortgages “terrible” and said he expected losses on the company’s prime loans to triple in the coming months, according to the New York Times. Economist and New York University Professor Nouriel Roubini went so far as to say in a Reuters article that hundreds of banks were going to fail, and the ultimate price to tax payers would likely be between $1 and $2 trillion.

If these Alt-A and even prime mortgages start to go bad, we are going to be in for financial trouble far worse than we’ve seen so far from the subprime meltdown. Subprime mortgages make up only a small percentage of total mortgage loans, and the government was hardly on the hook for any of them. If prime loans start going bad in large numbers, though, we had better watch out. Now that Fannie Mae and Freddie Mac have an unlimited line of credit--and official backing of the U.S. government--taxpayers could potentially have to foot the bill on trillions of dollars of mortgage loans. Worse, though, if either one of these companies--or any of the big banks for that matter--have to seek government assistance it will likely send a tremor through the entire financial industry and economy. How many foreign governments, or anyone, are going to feel good about buying U.S. treasuries when our financial system is falling down around us? And we have to take into account that the government has been trading U.S. treasuries for mortgage debt in order to prop up these financial institutions, so now our economy and dollar are being supported by these mortgage instruments. Not exactly the pillar of safety and security that we would like be supporting our currency.

Jobs are declining, inflation is rising, and now this. I’m not sure exactly how we are going to get out of this mess, but I’m sure the ol’ government has something up their sleeves. I’m sure it will involve some sort of bailout and printing of money, so basically some variation of the status quo. The good news for us is that the world is addicted to U.S. debt, the same way we are addicted to being in debt, and as long as we have our foreign friends paying our way, we will be good. Kind of like the former movie star or sports hero who never has to buy their own meals. We all know what happens to them when they get too old, though, and people stop remembering their greatness. How much longer our run will go on, I don’t know, but I can tell you I certainly am not buying treasuries or financial stocks right now.

So What Happens Now With IndyMac?

Yesterday I wrote about the failure of IndyMac bank and how it was seized by federal regulators on Friday, but I didn’t cover the “what’s next?” aspect. There are a couple of things in particular that investors who have IndyMac loans need to know, and for those without IndyMac loans it is still good information to understand in case you deal with other bank failures in the future.

Some of the most important things that could be impacted by IndyMac’s failure are construction loans. For those who are not familiar with construction loans, typically banks pay out the loans based on certain milestones. So, after a builder gets the foundation done, they receive a payment which covers the expenses until the next milestone, and so on. Well, now all the builders who rely on these distributions to fund the construction of their homes might have some problems. Because the FDIC (who now controls IndyMac) has certain protections, they are able get out of these loans if they so choose.

One developer’s concern was captured in The Wall Street Journal: "’I don't know what's going to happen,’ says Raymond Pacini, chief executive of Hearthside Homes, a small builder based in Irvine, Calif., that has two loans totaling $34 million from IndyMac. ‘We are just waiting for the dust to settle.’” According to the same article, a FDIC representative was quoted as saying the FDIC was prepared to do a case-by-case review of the construction loans. So, if you are a developer with an IndyMac loan, you had better cross your fingers and hope for the best. But if I were you, I would start looking for a backup plan just in case.

Another interesting development, which is not necessarily part of a typical FDIC bank seizure, is that the new IndyMac is putting all foreclosures on hold. The FDIC chairman Sheila Bair has been one of the most outspoken parties about how banks should cut borrowers some slack and really try to work things out before proceeding to foreclosure. Now that the FDIC has taken control of one of the biggest mortgage lenders in the country, Bair has a chance to test out some of her ideas and seems ready to do so. They didn’t specify whether or not they were willing to work out deals with investors who have bad loans with them but, chances are, if you were ever going to be able to cut a deal now is the time. The FDIC is actively trying to sell off IndyMac’s assets and it is very likely that the purchasing party will not be as friendly as Bair wants IndyMac to be.

Lastly, it appears that the FDIC is prepared to let depositors withdraw up to 50 percent of their uninsured deposits at this time according to the Wall Street Journal. This is probably a welcome surprise to most depositors, given the circumstances. The FDIC is hoping that the balance of those deposits will be covered eventually, but that is not guaranteed.

College Graduates Get Mixed Messages From Job Market

If most people had to guess about the employment prospects for recent college graduates, they would probably paint a pretty dim picture. The economy is certainly not hitting on all cylinders right now, and there are more companies laying off folks right now than there are companies hiring. Coupled with the timid business investment environment, you can see why most have this view. Yet things might not be so bad after all, at least for some graduates, according to a press release from the National Association of Colleges and Employers (NACE).

NACE reports that, while job opportunities for college graduates are down in number, salaries for college graduates have actually increased 7.1 percent over last year. So for those graduates lucky enough to get a job, they are in great shape. The rest are probably doomed to spend some more time living with Mom and Dad.

On the surface, this wage increase may seem like a surprise, but at the same time it really shouldn’t be. In this competitive job market, companies are enjoying the luxury of selecting only the best and the brightest. For the increased productivity they are going to get from these individuals they are willing and able to pay more. During the last several years, businesses have been focusing a lot on increased productivity. Ideally, businesses want to have as few people as possible producing as much possible, while still being economically beneficial, of course.

If you happen to be in college, know that it is now more important than ever to set yourself apart. The best of the best have great prospects, and the rest do not. Moral of the story: Make sure you are one of the best.

On another note, if you have the right skill set and aren’t interested in corporate America, then maybe you should consider starting your own business. More than ever, young people are making a name for themselves as entrepreneurs. It is hard work, loaded with risk, but just take a look at Bill Gates or Michael Dell (of course, they both dropped out of college, though I don't necessarily recommend that path), or any number of other young entrepreneurs to see the potential rewards.

Extreme Makeovers For Commercial Real Estate Buoy A Struggling Market

Though some sectors of commercial real estate remain stable and profitable, many retail and hospitality spaces are sitting vacant as poorly-performing tenants shut their doors. Beyond the lack of cash flow, commercial real estate investors with vacant spaces face a vicious cycle much like the Broken Windows effect in foreclosure-struck neighborhoods, wherein the vacant space may attract crime, loiterers and vandalism, which further decreases traffic and eventually compels existing tenants to move when the lease is up. However, some commercial real estate investors are overcoming this problem by turning to unconventional tenants to fill these spaces.

A recent AP article highlights some interesting examples of this trend. My favorite:

“In November, mall owner Pennsylvania Real Estate Investment Trust snagged New River Community College as a tenant for a former theater space in its New River Valley Mall in Christianburg, Va. The satellite location features seven classrooms, four computer labs, a science lab, two auditoriums, testing and conference rooms and office space."

A cinema complex seems difficult to convert successfully, but using theatres as auditoriums with plenty of study space just outside in the lobby and a concession stand is honestly quite brilliant. I like it much better than my idea to convert an abandoned Chuck E. Cheese into a funeral home (though I still insist that a ball-pit and an animatronic band would improve any wake).

Shopping malls and strip malls especially are facing high vacancy rates as larger chains begin to falter in leaner economic times. Levitz, Zales, Ann Taylor, PacSun and Foot Locker are closing hundreds of stores this year. Linens 'N Things and Sharper Image have already filed for bankruptcy protection. I guess radio-controlled backscratchers and self-cleaning plungers aren’t quite recession proof.

To generate income from vacant stores, larger malls are leasing empty storefronts as billboards while they search for new tenants. Malls large and small are also courting first-time and independent business owners by offering short-term leases with attractive rates, according to the AP article.

This may be bad news for many corporate retailers and their employees, but it isn’t necessarily bad news for commercial real estate investors in the long term and it is certainly good news for small business owners. Larger companies with more overhead will continue to suffer in a recession, but savvy entrepreneurs in control of their own expenses can still come out on top. Meanwhile, their landlords will still enjoy a regular income and a more diverse use of their property, which could guard against future fallout like that of Sharper Image.

Beyond all of that, this sea-change could even benefit the consumer, as erstwhile interchangeable chain shops become inoculated with local talent and independent ventures. In years to come, some malls may have a local flavor beyond the bland corporate spumoni that one customarily finds. The times may be sour for some retailers, but as in all upheavals, there could be sweet results for those who can adapt—most of all, investors and entrepreneurs.

Small Businesses Attempt To Tackle Inflation Creatively

This just in: Inflation is real and the Fed may not be able to stop it. That’s the reality for small businesses as they are forced to deal with the strain caused by rising food and energy costs.

The dramatic growth of the suburbs, as a result of rising home prices, combined with $4 per gallon gasoline is creating significant pressure for businesses with employees who commute. “Emerging suburbs and exurbs -- commuter towns that lie beyond cities and their traditional suburbs -- grew about 15% from 2000 to 2006, nearly three times as fast as the U.S. population,” according to the Detroit Free-Press.

This hits small businesses the hardest, since they tend to employ a greater percentage of employees at entry level salaries, and thus may have more employees who have moved further away to find affordable housing. This leaves many small employees in a bind when combined with an economy that may not support price hikes to consumers.

Some business, however, are finding creative ways to deal with the problem:

Virginia Commonwealth University Health Systems gave away $1 million to its 7,200 employees as a one-time bonus to help ease the burden of rising commuter costs, according to the Richmond Times Dispatch.

Du-West Foundation Repair recently moved 90 workers to a 10-hour, four-day workweek, according to the Dallas Morning News. Du-West is not alone. The city of Birmingham, Alabama will move to a four-day workweek for more than 4,000 employees July 1, according to Inc. magazine

Other solutions have been adopted by various businesses, including:

• Offering incentives for riding mass transit, including purchasing bus or train passes for employees.

• Offering carpool incentives, such as prime parking spaces or cash incentives for carpool riders/drivers.

• Offering additional work from home days for employees capable of telecommuting.

At NuWire, we’ve decided to explore the possibility of transitioning many of our positions so employees can telecommute. This creates a unique set of challenges but also offers the potential of a win-win for employer and employee. Having fewer employees in the office would allow us to reduce office space and some office costs. Employees would save money on gasoline, car maintenance and insurance and time lost commuting.

Although it remains to be seen whether we can create a telecommuting plan that will work for all involved, it is clear that we are not the only small business looking to retain good talent by finding creative (and proactive) ways to tackle inflation without raising prices (or in addition to raising prices).

Fuel Strike In Spain

In response to high fuel costs truckers in Spain have decided to go on strike. The truckers want the government of Spain to pass a law establishing a minimum price for their services, and to make sure that their contracts better reflect the fluctuating cost of fuel, which has risen by more than 20 percent since the beginning of the year, according to BBC News.

This fuel strike, which involves around 90,000 drivers--most of whom are self-employed--has the potential to cause some serious problems for Spain and its inhabitants. Already people are lining up at grocery stores and gas stations around the country, trying to get as many supplies as they can before stores start running out of goods. The striking truckers have warned the public that stores will only be able to last a couple days, according to the BBC article.

The truckers know that the country can’t run without them and they are making their voices heard, but are they going to be successful in their campaign? Part of the problem is that the Spanish government has a limited number of options available to it thanks to its arrangement with the EU. For example, it is required by the EU that member countries place at minimum a 15 percent value add tax (VAT) on fuel. In addition, the EU restricts the use of certain fuel subsidies, according to the BBC.

What the truckers want is more money to account for the business cost increase of more than 20 percent, and one way or another, they are going to have to get it. "We have no more solutions. We can't afford diesel any more. It's as simple as that," Jean-Claude Ferrand told Spanish national radio, according to the BBC.

If the government can’t offer subsidies what they might have to do is help negotiations between the truckers and the suppliers. Ultimately, either the government offers a subsidy or the suppliers are going to have to pay more to have their goods delivered. Looking at the options available it appears that likely the suppliers will be the ones fronting the costs, which of course will be represented in price increases and in the end borne by the consumer. Either way, though, it was going to come down to the consumer; they were going to pay for it either through their tax dollars or through increased goods prices.

Spain is making the headlines now, but with the way fuel costs keep rising, they are unlikely to be the last ones with this problem. Look for more and more truckers to substantially raise their prices or go on strike--or else out of business. Either way, supply and demand pressures are going to push prices higher to account for the increase in transportation costs.

Unemployment Rate Hits 5.5 Percent: Largest Increase In 22 Years

The national unemployment rate surged a half a point to 5.5 percent in May, signaling the largest increase since 1986 and far surpassing analysts' expectations, according to Bloomberg. To show how surprising these numbers were, not a single analyst forecasted the unemployment rate to go this high, and the consensus among the analysts was an unemployment rate of 5.1 percent, according to a Bloomberg news survey.

The funny part about this is that just yesterday, people were starting to feel better about the prospects for the economy. In fact, this was the headline on YahooFinance yesterday afternoon: “Wall Street shrugs off spike in oil and finds solace in upbeat jobs data, retailer sales.” Yesterday the Dow was up almost 214 points, the biggest one-day gain since April 18, according to the Associated Press. The great jobs news everyone was excited about was the drop in number of laid-off workers seeking unemployment benefits. Oh, how the economic winds can change.

After today’s job data, and with the price of oil continuing to surge, the markets shed (in less than an hour, I believe) all of yesterday’s gains and then some. Once again this is evidence of how traders cling to every little glimpse of good news and look past the big picture. If people would have just sat back and thought things through, they would have seen that the jobs outlook in the U.S. is not a rosy one. The data that was reported yesterday is a bit misleading. Just look at report after report after report about how business owners are hesitant to add jobs right now and how many of them are actually planning to cut staff. Read about how consumer confidence continues to slide and how housing prices continue to tumble. A report from CNNMoney stated that Americans lost $1.7 trillion from their collective net worth in the first quarter of 2008 alone. Does any of this news seem to make a case for businesses to bring on additional workers? All I’m seeing are reports of pending layoffs. Am I missing something?

GM is cutting 19,000 workers by July 1; Ford and the other auto companies are also trimming staff, according to Bloomberg. While the government actually added 17,000 employees, cuts are on their way in the local governments (see the previous post: Pension Plans Could Lead More Cities To Bankruptcy), and of course home builders are continuing to cut workers as they fend for their livelihood. These are just a few of the headlines. So the fact that people were getting excited because one piece of data was published tells me they so desire good news that once they have it, they lose sight of everything else.

While it might be okay to believe the economy is coming around and is on the right track (not my belief, but hypothetically speaking), even if that is true, it is going to still require some time. Problems like we have now don’t just disappear overnight, and the investor reaction to yesterday’s news was way overblown. As an investor, make sure you understand and can see the big picture. I’m not saying, you shouldn't invest, but that you should do so with your eyes open. Don’t be like everyone else out there throwing your money into the market at the first glimpse of hope, only to pull it out the next day when things don’t look so hot anymore. Investing with a long term focus can help solve this problem for the most part, and overall is a great strategy, but don’t lose sight of the big picture.

Forget Talk Of A U.S. Recession, What About Canada?

In the first quarter this year, Canada’s economy shrank by 0.3 percent, according to Bloomberg. So while all the talk is about a U.S. recession, surprisingly, Canada may just beat us to the punch.

This news came as a shock to me because of how strong Canada’s economy has been, including their oil industry. The biggest problem area apparently was the auto industry. If the auto- and auto-related industries were removed from the, calculations then Canada’s economy would have actually still grown, according to Bloomberg. The biggest importer of Canadian automobiles, of course, is the U.S. and we just aren’t buying too many cars right now. Not only is Canada suffering from the drop in consumer confidence in the U.S., which is the number one importer of Canadian goods, but more importantly, Canada is suffering from their strong currency.

Ever since the Canadian dollar surged against the U.S. dollar, the trade balance between the countries has changed. Canadians are buying more U.S. goods and the U.S. is buying fewer Canadian goods because the U.S. goods are comparatively cheaper thanks to the weak U.S. dollar. Now the Bank of Canada is likely to cut interest rates in response. This should lead to the Canadian dollar dropping against the dollar, as it already has begun to do.

Is The American Dream Out Of Reach?

So American Airlines has started charging $15 for checked luggage. Wednesday, it was the lead story on the “Nightly News.” Thursday, an ABC headline read, “Checked Bag Fees: Money for Nothing.”

What’s the big story? Is it the same as taxes, where once they start charging, there’s no turning back? Or is it just that sensational statements draw readers?

Who knows, but frankly, I’m getting a little tired of the media bashing the airline industry. If it’s not incessant coverage about scheduling delays or lost luggage, it’s about security. Today it’s about charging for luggage. As I write this, the price of oil is topping $130 a barrel and is projected to exceed $200 by the end of the summer. That’s the story, and it’s way bigger than the airline industry trying to stay afloat--or should that be aloft?--by adding $15 to the price of a flight. But I think it goes beyond that.

I think people love to complain and the media gets paid by giving people what they want to hear.

Does this sound familiar? For the last 20 years, most people have agreed that airline food sucked. They’d say things like, “all three of the coach entrée choices were inedible.” Then, all of a sudden, the elimination of free food service is seen as huge disappointment. “Oh no, I won’t be getting ‘Something Over Rice’ on my two-hour flight home?”

It’s similar to people in Seattle, where I live, who, when we finally get a sunny, 80-degree day after nine months of rain, whine, “ Put on the air-conditioner, it’s too hot.” But I think it goes beyond the weather weenie mentality.

Here’s my theory about why the $15 per bag issue is so hot: The story is not about the cost of flying going up, it’s about the reality that the average Joe is getting squeezed out of the American dream. Ever since the inception of commercial airlines, flying has been a hallmark of living large. Images of pretty flight attendants, macho pilots and wealthy travelers became icons of the glamorous American lifestyle that created the “jet-setter” as an American model. Today, the air travel experience has lost its sizzle. You go through security, do what you’re told, wait for a couple of hours to board, stay seated with the buckle fastened, don’t use the toilet facilities in the front of the plane--for security reasons--and de-board without a welcome.

The whole flying experience today is threatening the average American’s chance to feel like a jet-setter, and they don’t like it. Except for when you were boarding and had to shuffle your way through the first class gauntlet, flying always allowed Americans to feel like someone special. Today, the flying experience is more like taking a bus. Airlines have always charged us for the mysticism of flying. Americans just miss the allusion in the old slogan, “It’s The Ooooonly way to fly.” Today it’s more like, “Pay up, sit down, and get out--it’s the only way to fly.”

Then again, you can always drive.

This was a guest post by James Krieger. If you want to read more from James check out his blog www.nicaraguarealestateinvestment.org.

Hispanic Culture: Embrace It And Prosper

America is embracing Hispanic culture, and investors should too. The Hispanic population is the fastest growing segment of the U.S. population, and according to the most recent Census Bureau release Hispanics now comprise 15 percent of the total population or some 45 million people. Furthermore, it is projected that by 2050 Hispanics will make up 25 percent of the total U.S. population. There are numerous ways in which investors can embrace and profit from the emergence of Hispanic culture in America. I will mention a couple.

Real estate investors in particular can capitalize on this trend is by making their rental properties more Hispanic-friendly. Advertise and use signage with both English and Spanish. If you are having a property manager service your property, why not find one that is bi-lingual? A bi-lingual property manager would be able to capitalize on both English and Spanish speaking tenants, offering you more coverage. Depending on your location—California and Texas in particular—you might think about pulling out all the stops to make your rental Hispanic-friendly.

There are many businesses one could start that take advantage of this growth. One of the more interesting ones to my mind was included in our Business Ideas article, namely the creation of bi-lingual call centers in Latin America that service the U.S. population. There is a plethora of bi-lingual natives in Central America in particular that offer cheap labor. How long do you think it will be before U.S. companies stop outsourcing call center business to places like India, where labor is rapidly becoming more expensive? In addition to rising costs in places like India, there is also the difference in time zones, which isn’t a problem in Latin America. Labor might be a tad more expensive, but it is well worth it when you can have employees who speak the top two languages in the U.S. and who reside in the same time zone as you.

No matter what business or type of investment you’re in, there is probably a way which you can better cater to the Hispanic population. Investors who embrace this culture stand to do well in coming years, while those who ignore it could have serious regrets.

Costco And Sam’s Club Memberships: Are They An Investment?

Typically I would shy away from calling things such as Costco and Sam’s Club memberships “investments,” but in light of recent events they might just be entering into that category. I read an article from the Wall Street Journal yesterday that opened my eyes to the concept. In the article, it is explained that food prices are increasing by so much that it makes sense for people to stock pile non-perishable food rather than put that money into savings or money market accounts.

According to the article, food inflation for the average American household is running around 4.5 percent right now. Many foods are seeing price increases much higher than that. Cereal prices are rising by more than 8 percent a year, and flour and rice are up more than 13 percent. Milk, cheese, bananas and peanut butter are all up by more than 10 percent. Eggs have increased 30 percent in the past year and ground beef and chicken prices are up 4.8 percent and 5.4 percent respectively.

It is obviously not possible to stock up on perishable items such as milk and eggs, but you can buy extra cereal, rice and flour. You certainly aren’t going to make 13 percent on any bank account, so in actuality using some of your savings to purchase extra food might not be such a bad idea, or investment, for that matter.

That is where the Costco and Sam’s Club memberships come in. These warehouse stores offer much better prices than typical grocery stores; the catch is that you have to buy large quantities of the items. If you are planning to stock up on certain staple goods, you can save money by buying at these stores. So let's say you can save 5 percent off of the items you purchase at Costco or Sam’s Club over your neighborhood grocery store (though, in my experience, buying in bulk at these stores should save you much more than that)--now your “investment” looks that much better. Instead of making a 13 percent return on your money, purchasing your rice now actually could earn you 18 percent. Obviously those numbers don’t take into account the cost of your membership, or any subsequent storage or other costs which may be associated with holding the extra food, but I think you get the picture.

Also, as an added bonus, you will be in good shape in the event of a complete economic collapse, as many Ron Paul supporters are predicting.

Pawn Shops: Profiting In Times Of Financial Hardship

Pawn shops are ringing up big profits in the midst of a faltering U.S. economy. As people struggle to make ends meet, they have increasingly turned to pawn shops for fast cash. Pawn shops historically do not offer the best terms on loans, or the best prices for sold items, so it is ominous that people are turning to pawn shops en masse. This is a trend that is very typical in times of financial hardship though.

Investors who wish to profit from this trend could invest in stock of a large pawn shop company, such as Cash America (CSH) which is traded on the New York Stock Exchange, buy an existing pawn shop, or open a new pawn shop.

Online pawn shops are an emerging trend, as even brick and mortar pawn shops are now selling inventory for a higher amount on EBay. Low overhead can mean higher profits for online pawn shops, and also allows them to offer customers more money for their valuables or better terms on loans. In addition online pawn shops are able to offer their services to a wider geographic area. It appears clear to me that the future of pawn shops is on the Web.

If you ever were thinking of getting into the pawn shop business, then now is the time. If you prefer a brick and mortar business, and don’t want the added hassles of a startup company, there are also pawn shop franchises available. Two of these franchise opportunities are Cash America and PeoplePawn.

Investment Opportunities From “The Tourism Time Bomb”

International tourism is ready to explode with investment opportunities, according to an article published in the Harvard Business Review titled “The Tourism Time Bomb.” The writers--Paul F. Nunes, a research fellow at the Accenture Institute, and Mark Spelman, global managing director of Accenture’s strategy practice--state that international tourism is growing exponentially, and that this growth will soon lead to dramatic changes in major tourism destinations as well other locations which are likely to benefit from the resulting overflow

The following are important excerpts from the article:

“According to the United Nations World Tourism Organization, international tourist visits are expected to double soon, from roughly 800 million in 2008 to 1.6 billion by 2020.”

“First, most tourism-related prices, such as hotel room rates in popular cities, will continue to escalate as demand outstrips supply.”

“Second, rationing, and the resulting waiting lists, will become commonplace. Some groups, for example, are already calling for limits on traffic to ecologically sensitive destinations, such as the Incan ruins at Peru's Machu Picchu.”

“Finally, jaw-dropping prices and decades-long waiting lists will prompt the creation and the expansion of destinations in both developed and developing economies. The Chinese, for example, are developing Hawaii-like Hainan island and Macao, a gaming paradise on China's southern coast.”

“Companies and governments are also creating facsimiles of popular destinations.” (for an example read The Brink Tank’s post: How Do You Say Rocco In Arabic?)

“Just as sites and structures can be successfully replicated in new locations, so can institutions. If the swelling ranks of global travelers can't all come to you, you can go to them.”

“As the scarcity of places grows, many companies will find opportunities to profit by meeting new levels of demand for authentic, and inauthentic, experiences.”

“A billion or two additional international travelers represent both a massive potential headache and an opportunity for business.”

Real estate in both urban and suburban areas is one of many investments that may benefit from this explosion. As demand increases, tourism and hospitality businesses should also perform well, and there are many new businesses that could be created to cater to international tourists. An entrepreneur’s imagination is the only limit.

The Boutique Hotel Industry Enters Suburbia

The boutique hotel industry was created in response to demand for hotels offering unique, chic and intimate environments, with top-notch service. Demand has spread as vacationers and business travelers who have fallen in love with the boutique hotel industry want to be able to stay in boutique hotels even when visiting the suburbs. The boutique hotel industry has listened and is starting to deliver.

According to Jim Anhut of InterContinental as quoted in a USA Today article, business in the suburbs has really begun to thrive in the last 10 years. “More business is being done in the suburbs, and mass retailers such as Ikea, Pottery Barn and Target helped pave the way for ‘democratization of design,’” Anhut said. This means that more people, including business travelers, are visiting the suburbs than ever before. The suburbs have suddenly become an attractive market for the boutique hotel industry. And let’s not forget another big bonus for boutique hoteliers: Land is much cheaper in the suburbs.

There are several major boutique hotel operators building in suburbs across the country, but most of them are focusing on the suburbs of the 25 largest cities, according to the USA Today article.

Aspiring boutique hotel owners can follow suit and stick to the larger cities, or they can blaze their own trail in a smaller market. Personally, if I were looking to start a boutique hotel in suburbia, I would probably avoid competing with the larger companies. Larger hotel chains have the luxury of big marketing budgets and intercompany referrals. The suburb market is still fairly new and untested, and it could become saturated if too many boutique hotels enter the same suburb. New boutique hoteliers are probably better off focusing on the suburbs of the 26 to 50 largest cities. This would allow them to both enjoy a good-sized market and avoid major competition until they can at least establish their boutique hotel brand.

Business travelers and tourists are the lifeblood of the boutique hotel industry, and investors should analyze the numbers of both of those groups in a city when seeking a market. Some suburb locations are more business-oriented or tourism-friendly—or both—than others. Curious investors and entrepreneurs should read our article for more information: Boutique Hotels: Owning, Operating and Investing.

The Kenya Elections: Violence And Entrepreneurial Dreams

Violence brought about by the elections in Kenya has stymied—but not stopped—an inspiring story of entrepreneurial innovation and spirit. Kenya’s Youth Ministry was holding a business plan competition to inspire and support entrepreneurs and create new businesses. From an initial 5,000 participants, the best 100 were chosen for further training and judging. Kenya recognized the need for new businesses and the benefits that they bring to the economy. Some experts estimate that for every one person who receives work in Africa, 10 others will have food, clothing, shelter, school fees and other necessities. Unfortunately, six weeks after the competition began, so did the horrific violence which has claimed over a thousand lives and displaced hundreds of thousands.

But now the entrepreneur competition has brought about a new life, and there is a film already being made about the events which have taken place. The film is called “Kenya Stories”, and it was originally intended to be a simple documentary about the competition, but it has now become something much more important. On their website, they discuss the film and the 100 top entrepreneurs in greater depth. Their goal is to generate interest in what is happening right now in Kenya, tell more about these aspiring entrepreneurs, and hopefully create support for the cause. They are looking for mentors, angel investors, referral business, networking help, donations and so on.

In the midst of such tragedy, it is truly inspiring to see how people can rise up. I wish the very best for each of these entrepreneurs, and hopefully we will witness their business plans come to fruition someday. I also wish the best for the “Kenya Stories” film team, and I can’t wait to see the finished product.

For more background information on the violence in Kenya, read The New York Times’ article.