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Generational Dynamics Web Log for 16-Feb-2009
President Obama's smashing fiscal stimulus victory contrasts with Geithner's TARP disaster

Web Log - February, 2009

President Obama's smashing fiscal stimulus victory contrasts with Geithner's TARP disaster

Building a sand castle while the tide is coming in.

President Barack Obama claimed a major victory on Saturday, with the Congressional passage of the $787 fiscal stimulus package.

In Saturday's weekly address to the nation, he said:

"This morning, I’m pleased to say that after a lively debate full of healthy difference of opinion, we have delivered real and tangible progress for the American people.

Congress has passed my economic recovery plan – an ambitious plan at a time we badly need it. It will save or create more than 3.5 million jobs over the next two years, ignite spending by business and consumers alike, and lay a new foundation for our lasting economic growth and prosperity.

This is a major milestone on our road to recovery, and I want to thank the Members of Congress who came together in common purpose to make it happen. Because they did, I will sign this legislation into law shortly, and we’ll begin making the immediate investments necessary to put people back to work doing the work America needs done."

From the point of view of Generational Dynamics, Obama is quickly demonstrating that people in the "Nomad" generational archetype (like Generation-Xers) are pragmatic managers that lead the nation through the Crisis era.

(For information about generational eras and archetypes, see "Basics of Generational Dynamics.")

President Obama achieved this huge victory less than a month after taking office. Obama has translated his contempt for Boomer and Silent generation values and accomplishments into his own accomplishment, one of the most dramatic in American history -- a spending bill that dwarfs anything that could even be imagined a year ago.

The fiscal stimulus bill passage has given hope to many people that it will provide relief from the crashing economy, and the rapidly spreading unemployment that causing suffering among millions of people.

The TARP

Timothy Geithner, Secretary of the Treasury, testifying before Congress. <font face=Arial size=-2>(Source: WSJ)</font>

Timothy Geithner, Secretary of the Treasury, testifying before Congress. (Source: WSJ)

Unfortunately, those realities will be affected only marginally by the fiscal stimulus bill. Nothing has happened that will change anything that I described in "The outlook for 2009."

The euphoria over the passage of the fiscal stimulus bill contrasts sharply with the political disaster over the Troubled Asset Relief Program, or TARP. The TARP money is to be used to purchase "troubled assets" -- mortgage-backed securities (MBSs), collateralized debt obligations (CDOs), credit default swaps (CDSs) -- that have become near-worthless because of the collapse of the real estate and credit bubbles. Thus, it's the TARP that's most relevant to the realities of the economy for most people.

On Monday evening, President Obama gave a press conference to sell the fiscal stimulus package. He declined to discuss the TARP, saying that Treasury Secretary Timothy Geithner would provide all the details on Tuesday.

Well, Geithner gave a speech on Tuesday that provided almost no details at all. And there's a good reason why: Because there's no solution to the problem that the TARP is supposed to solve.

When the the Emergency Economic Stabilization Act became law in October of last year, I called it the "Bailout of the World" (BOTW), because it was huge -- a $700 billion bailout of the banks and other financial institutions. That $700 bailout was going to solve the economy's problems.

Then-Treasury Secretary Hank Paulsen spent half of that amount -- $350 billion -- on "saving the banks," and now the economy is worse than ever. People are wondering where the money went, and why bankers were continuing to give themselves fat bonuses.

This has made the political climate for the TARP much more toxic than it was in October.

The purpose of Geithner's speech, and subsequent testimony before Congress, was to justify spending the remaining $350 billion to "save the banks." He was supposed to explain in detail how he planned to spend that $350 billion, but instead he simply provided an outline that was no different than Secretary Paulsen might have provided.

There are good reasons why he couldn't have provided details: Because it's increasingly clear that the "troubled assets" have notional values in the trillions or even tens of trillions of dollars, far in excess of the $350 billion being discussed. And so, rather than provide details, he decided to bluff.

As I wrote last year in "One, Two, Three ... Infinity,") the amounts being demanded for bailouts keeps growing exponentially. A lot of people think that the $757 fiscal stimulus money is the same money as in the $700 BOTW, but it's not. These are two separate amounts, and there are demands for even more money.

Nobel prize winner economist Paul Krugman

A clear political statement criticizing the both the stimulus package and the TARP package for being too timid is given by Paul Krugman, last year's Nobel Prize winner in economics. This is my transacript of his interview on Wednesday, February 11, on BBC. The comments in brackets are from the interviewer, Matt Frei. The phrase "financial plan" refers to the TARP.

"The stimulus plan is a lot better than nothing, but it's not as big as it ought to be, and not as well-focused as it ought to be.

In the process of first a low initial bid by the White House and then it's been scaled down and somewhat degraded, it's not enough. It's enough to mitigate, but not enough to produce a full recovery. So it's disappointing. They'll have to come back for a second round.

As for the financial plan - if anyone can tell me what the financial plan is that would be a helpful sign. Everyone who sat down to look at it said, I don't get this - it's more of an outline, a plan for a plan, not a real plan.

It's not terrible, not a crazy outline, but it's not a real plan.

[They've had weeks to sort this out.]

It's very puzzling. We all have fears about what happened. But what's clear is that they have not actually bitten the bullet. They've not actually said, OK, here's what we really need to do.

For all of the talk, -- If you read the first few minutes of Secretary Geithner's speech, he was saying we need a dramatic plan, we need to act, we need to resolve this. And then he produced something that was more like a sketch of how we might possibly go about thinking about the thing.

[What is the bullet?]

The bullet is -- you need to go in to major financial institutions, take a serious look, and if they're not viable, you need to put them into government receivership. We've got to clean out those bad assets and the only way to do that is to take them under the government's wing, essentially, temporary nationalization is going to be. I predict that's what will happen in the end, but it depends on how long it takes.

[Why is it taking so long? Is it a philosophical question - this government just doesn't do nationalization? Is it the fact that in a broader spectrum we're stuck in an era where we think that tax cuts are the things that are finally going to get this economy going?]

Well, there's two things. First, on the stimulus -- these two things are really very different. One of the problems that Obama's having is that the public mushes these two things together. The stimulus by itself is probably very popular, but the bailout is deeply unpopular. But they get smushed together and you get something that isn't getting enough public support.

But there's a Republican party which is 87% committed to voodoo economics. That's the 36 out of 41 Republicans that voted for another round of Bush-style tax cuts. A large part of that party is just not ready to compromise, so Obama has to work on the narrow margin of basically three Republican senators you can talk to. That's a big problem.

Then, I think on the bank stuff, it's a failure of nerve. I have reason to believe that economists in the Obama administration actually have a model of what the problem is that's not very different from mine, but the political willingness to step out there and say that we hve to do something really, really radical is not yet there.

[What would you like to see in the stmulus package?]

First of all, it should be 50% bigger. It should be a $1.2 trillion, not an $800 billion package. And it should be more focused on spending. There should be more aid to states, not less, which was just negotiated. There should be more aid to education. There should be more health care - things that are both going to mitigate the pain of this recession and are also more bang for buck. Just, more stuff.

Right. You give somebody, particularly an affluent person a tax cut, then he or she may or may not spend it.

You repair leaks in the school roof, then you put somebody to work directly. That's more effective - you're just going to get more out of those things.

Now I understand there may be limits to that, but they clearly have not reached those limits."

The strong partisanship of this statement of both Krugman and the BBC interviewer (Matt Frei), calling the Republicans "committed to voodoo economics," destroys the credibility of the statement. (Krugman is still doing the job that the Nobel Prize committee appointed him last year to do: continue to bash George Bush and the Republicans.)

There's absolutely no reason why a tax cut to businesses, allowing them to avoid laying off workers, is "voodoo economics," while giving money to near-bankrupt state governments, allowing them to avoid laying off workers, is a brilliant plan.

The confusion becomes even greater when you look at another big bailout favored by Krugman and the Democrats -- the bailout of the big three Detroit auto makers. What is the brilliant economic reasoning that makes that bailout good, but a tax cut to other businesses bad?

The biggest problem that President Obama will have going forward is dealing with this kind of poisonous ideology. It's because of this kind of ideological attitude among Krugman and Democrats that the fiscal stimulus plan did not receive a single Republican vote in the House, and only three Republican votes in the Senate.

John Mauldin: Financial system is 'falling off a cliff'

Even if the fiscal stimulus and TARP programs had a chance of succeeding, they're only US programs. However, as I've discussed frequently, countries around the world have collapsing economies as well, and many are much worse off than the US. However, none of these countries (with the possible exception of China) has any kind of fiscal stimulus program comparable to the US. In particular, the European Union is completely bound up in multi-country politicans, and is effectively paralyzed, even in an emergency.

In the past, I've criticized John Mauldin for doing some excellent analysis, but failing to draw the correct conclusions. Like Nouriel Roubini, Mauldin describes a rapidly deteriorating global financial system, but then misleads readers into believing that everything will be ok anyway. If Mauldin told the complete truth about what was coming, he'd lose much income from many of his wealthy clients.

(For earlier discussions of Mauldin's newsletters, see "There's never before been a day like this on Wall Street," and "Blogger watch: Mish Shedlock goes gloomy, while John Mauldin gets muddled.")

However, I wish to call your attention to Mauldin's latest newsletter, in which he appears to be realizing that the world financial system is collapsing. The newsletter is a quick "survey of the rest of the world."

He has charts and tables discussing the following:

World trade is "falling off a cliff." He says, "We think that almost 2,000,000 lost jobs in the last three months in the US is a catastrophe. China lost a reported 20,000,000 jobs in the last quarter, and migrant workers came back to the cities after Chinese New Year to find factories and jobs simply gone. Unemployment is rising rapidly in Europe, as the demand for goods has clearly been falling since last October."

Leading economic indicators for countries around the world are much worse than those of the U.S. In particular, "China has seen its year-over-year exports drop by 17.5% and imports by 43%. These are not signs of a healthy economy."

European Bank Losses Dwarf Those in the US: "The problem revealed in the report is an estimated write-down by European banks in the range of 16 trillion pounds, or about $25 trillion dollars!" Now, keep in mind that we're talking about a $2 trillion bailout in the US, but Europe has to content with a $25 trillion writedown of assets."

He quotes Nouriel Roubini as putting US bank losses at a "mere" $3 trillion (a figure which seems very low to me).

He gives much the same reason that I did for why Geithner didn't provide any details about his TARP proposal last week: "You can't handle the truth!"

His newsletter is well worth reading, but keep in mind that when he reaches his final conclusions -- that he has "exciting news" about some "cool opportunities with world-changing technologies" -- it's to keep his own investors interested, and protect his own income.

Ambrose Evans-Pritchard of the Telegraph is the only mainstream media reporter that I'm aware of who regularly reports what's going on in the global financial crisis. I've quoted him a number of times in the past, especially for his grasp of what's going on in Europe and Asia.

His latest column discusses the European banking situation:

"Failure to save East Europe will lead to worldwide meltdown

The unfolding debt drama in Russia, Ukraine, and the EU states of Eastern Europe has reached acute danger point. If mishandled by the world policy establishment, this debacle is big enough to shatter the fragile banking systems of Western Europe and set off round two of our financial Götterdämmerung.

Austria's finance minister Josef Pröll made frantic efforts last week to put together a €150bn rescue for the ex-Soviet bloc. Well he might. His banks have lent €230bn to the region, equal to 70pc of Austria's GDP.

"A failure rate of 10pc would lead to the collapse of the Austrian financial sector," reported Der Standard in Vienna. Unfortunately, that is about to happen.

The European Bank for Reconstruction and Development (EBRD) says bad debts will top 10pc and may reach 20pc. The Vienna press said Bank Austria and its Italian owner Unicredit face a "monetary Stalingrad" in the East. ...

Not even Russia can easily cover the $500bn dollar debts of its oligarchs while oil remains near $33 a barrel. The budget is based on Urals crude at $95. Russia has bled 36pc of its foreign reserves since August defending the rouble. ...

Almost all East bloc debts are owed to West Europe, especially Austrian, Swedish, Greek, Italian, and Belgian banks. En plus, Europeans account for an astonishing 74pc of the entire $4.9 trillion portfolio of loans to emerging markets.

They are five times more exposed to this latest bust than American or Japanese banks, and they are 50pc more leveraged (IMF data). ...

Europe's governments are making matters worse. Some are pressuring their banks to pull back, undercutting subsidiaries in East Europe. Athens has ordered Greek banks to pull out of the Balkans. ...

The implications are obvious. Berlin is not going to rescue Ireland, Spain, Greece and Portugal as the collapse of their credit bubbles leads to rising defaults, or rescue Italy by accepting plans for EU "union bonds" should the debt markets take fright at the rocketing trajectory of Italy's public debt (hitting 112pc of GDP next year, just revised up from 101pc – big change), or rescue Austria from its Habsburg adventurism.

So we watch and wait as the lethal brush fires move closer.

If one spark jumps across the eurozone line, we will have global systemic crisis within days. Are the firemen ready?"

The crisis brewing in Europe is actually quite similar in nature to the one that's occupied the US for the last 18 months, but it's now reaching a crisis point, and Europe doesn't have anywhere near the infrastructure that the US has to handle this emergency.

In other words, Europe and Asia are having the same TARP disaster that we're having, with fewer tools available to handle it.

For those who wish to read more, a web site reader sent me a PDF file of a report written by Merrill Lynch analyst David A. Rosenberg, called "Some inconvenient truths." He says that we're in a new depression, and it's going to last 3 to 7 years.

What's new about this is that it's the first time that a major investment bank analyst is making such a prediction.

I put the PDF file on my web site for access to those who wish to read it.

While I'm mentioning other sources, you can check Nouriel Roubini's blog, Michael ("Mish") Shedlock's blog, the Calculated Risk blog (with Tanta), the Sudden Debt blog, the MinyanVille blog, Yves Smith's Naked Capitalism blog, and the Financial Times alphaville blog.

These bloggers are very useful at pulling facts together but, like Mauldin's newsletters, they fail to draw the right conclusions, for fear of getting people mad at them.

Will the fiscal stimulus plan work?

It depends on what you mean by "work."

As I've been saying on this web site for six years, we're headed for a new Great Depression, as can be seen simply by applying to the Law of Mean Reversion to the 'real value' of the stock market. This is not rocket science, and every prediction I've made based on this observation has turned out to be true, or is trending true. There is no web site in the world with anything approaching the predictive success of this web site.

Neither Congress nor President Obama have repealed the Law of Mean Reversion, so the stock market will still fall much farther, many more businesses will go bankrupt, and millions more people will be laid off, irrespective of the fiscal stimulus bill.

This is just as true today as it was when the credit crisis began in August, 2007. Each intervention, whether by the Fed, or by the Treasury Dept., or by Congress, was greeted with euphoria and relief, along with the belief that the the crisis was over. Each time, I explained that the credit crisis and real estate bubbles were so huge that no amount of money was available to blow them up again once they started leaking. There were hundreds of trillions of dollars in structured finance securities created, and many of those securities are now disappearing or becoming worthless. A couple of trillion dollars in a fiscal stimulus or TARP plan will not even make a dent.

This brings us back to the contrast between the fiscal stimulus victory and the TARP disaster that I referred to in the title of this article.

What the current Adminstration is doing is building a sand castle. The debate over the stimulus package is about how many rooms in the castle, and how many elegant turrets to add on. The failure of the TARP program is about the tide coming in to wash away the foundations of the castle, leading to its total collapse.

And this doesn't even take into account that countries around the world are going to collapse, some much faster and deeper than the US, and they're going to blame the US, because of the subprime mortgage debacle.

However, it's pretty clear that the fiscal stimulus package will "work" in the sense of helping some people, at least for a while.

What's going on today is a fiscal experiment with no parallel in history. It will definitely not save us from financial devastation or world war. And it's no help at all when Krugman and other Democrats call other people's ideas "voodoo economics," when they themselves have no idea what they're doing.

The question is whether it will make things better or worse, and I have no answer to that question. In that sense, it will "work," one way or another.

(Comments: For reader comments, questions and discussion, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (16-Feb-2009) Permanent Link
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