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Editorial See other Editorial Articles Title: No questions Sir A SHAKY TRESTLE Our problem is procrastination. Most of our lives are routine. We do not get too far away from a comfortable routine. Most of the time this routine works. Some people call this being in a rut. Others call it staying on track. Sometimes the trestle is wobbling. I have no objection to routines. My routine keeps me on track in my rut. But part of my routine is to look down the tracks to see if there is anything out of the ordinary. Today, the economy is out of the ordinary. The trestle almost collapsed a year ago. The question is: Will it collapse next time? Also, when might this next time be? There are signs that the trestle is missing pillars. Every Friday afternoon, after the stock market closes, the FDIC closes five more banks. Investors shrug it off. "No problem." Then, the next Friday, five more banks get closed. How long can this go on? Not much longer. The number of closings will increase. A man whose firm buys busted banks says that he expects 1,000 banks to close. (www.cnbc.com/id/32581463) "No problem." Then there is unemployment. Every month, the number of jobs declines by 200,000 or more. The rate of unemployment jumps. Investors immediately buy more shares. Why? Because they see unemployment as a cost-cutting tactic. Therefore, "corporate earnings will go up soon." They don't think that an S&P price-earnings ratio of 129 (August 31) is a danger signal. It has never been this high before. It has never reached 50 before. "No problem." They think that profits will rise to bring the P/E back to something like 15, which would be a buy-and- hold signal. Then there is the Federal deficit. It will end up on September 30 in the range of $1.6 trillion. The administration has offered an estimate of $9 trillion between now and 2019, meaning $900 billion a year. Social Security is officially expected to go into the red in 2017. One Congressman thinks this could happen before the next Presidential election. He is on the House Committee for Financial Services. When this happens, the Social Security Trust Fund will have to cash in some of its Treasury bonds in order to get money to send to people on the rolls. The Treasury will have to sell enough debt to the public (including the Federal Reserve System) to cover these transactions. In 2008, Medicare's Hospital Trust Fund went negative. It received less money from Medicare taxes than it spent. Thus, it had to sell its nonmarketable Treasury bonds back to the Treasury. Its press release admitted that the program was negative, but it spoke of the Trust Fund as solvent. It is solvent legally. It has government-issued IOU's in it. But not for long. The Trustees report that Medicare's Hospital Insurance (HI) Trust Fund will become insolvent earlier in 2019 than reported last year. HI expenditure growth is estimated to average 7.4 percent each year over the next 10 years, a higher rate than either Gross Domestic Product (GDP) or Consumer Price Index (CPI) growth. This year the HI Trust Fund will spend more than its income, and from 2009 through 2017, about $342 billion will need to be transferred from the Federal treasury to cover beneficiaries' hospital insurance costs. That's a nice, precise figure: $342 billion. The key words are these: "will need to be transferred from the Federal treasury." From the empty Federal Treasury. "We need to act quickly and effectively to address Medicare's fiscal health, including enacting the steps proposed in the President's budget, which would postpone the insolvency date of the Part A trust fund for ten years," said Health and Human Services Secretary Mike Leavitt. "Congress should also act immediately on the smart changes put forward by the Administration after last year's funding warning, which would allow the program to be modernized and transformed." I love this phrase: "Congress should also act immediately." Congress did nothing except run up the general deficit by another $750 billion (minimum) in October. Then it did it again this spring. The Medicare hospital insurance program is bankrupt, but nobody in government except Ron Paul uses this word to describe government programs. CALM IN THE EYE OF THE HURRICANE Most people know little or none of this. They go through their daily routines. They are oblivious. The government has deliberately disguised these matters. The average citizen thinks that someone at the top has a solution. He cannot conceive of the possibility that experts who run the system are making things up as they go along. Most of the time the system lumbers along. But then, once in a while -- such as a year ago -- the system grinds to a halt. Then the response is the same: create money and increase the Federal deficit. The average guy thinks this will solve the problem at no cost to him. It feels like no cost, but the debt level rises. This year, the Federal deficit has added another $17,000 per household. No one seemed to care. Few even noticed. As we watch these things going on around us, and when we perceive that those around us perceive none of this, we remain calm. The calm serenity of those around us calms us, as well. We see the trestle ahead. We see the engine disappear from sight. We suspect what is going to happen to us if we don't get off the train. But no one around us is moving toward the exit. No one even seems to notice. The problem is, the trestle has wobbled before. It has looked as though the engine has disappeared, but it always reappears on the far side of the trestle. So, we assume that this time it will not go over the edge into the blackness below. But there are lots of trestles between here and our final destination. We are calmed by the calm of those around us. They seem to know what they are doing. Yet they didn't know a year ago. Henry Paulson was frantic. He nationalized the mortgage market on his own authority exactly one year ago. The markets remained calm. Within weeks, the bailouts of the big banks began. Goldman Sach's rival, Lehman Brothers Holdings, went bust over a weekend. Merrill Lynch was swallowed by Bank of America. The underlying causes of the problem, namely, toxic assets, have not gone away. There are lots more of them ahead of us: Alt-A mortgages (liars' loans), option ARMs (folks too poor even to lie loans), and commercial real estate. The re-sets will hit families that will not be able to qualify for loans. There are no more liar loans available. Lending standards have tightened over the last year and a half. The loans that were easy to get in 2007 and earlier are now ancient history. The re-sets will mean busted loans. They will end. Some of them will not be replaced. No one knows how many. The lending agencies will not be able to hide these re-set loans. They die on schedule. They must be replaced. They will not be replaced. The lenders will have expired loans on their books. The lenders have been playing "let's pretend" with bad loans. They have not reported these loans as being in default. They have pretended that there is hope to get the owners paying again. A re-set mortgage does not offer wiggle room. Unless the regulators change the rules, these loans will have to be written down as soon as the re-set date arrives. Example: my son-on-law bought a new home in a nice neighborhood. He bought a bank-foreclosed house in a bank- foreclosed development. It was $100,000 less expensive than a few months before. The houses sold fast because the bank priced the houses to sell. Recently, his next-door neighbor lost his job. He moved back to northern Illinois to get a seasonal job. His wife and family stayed behind. Now she has been laid off. This is not a poor neighborhood. It is middle class. Unemployment climbs relentlessly. This is having fall-out effects on housing. The summer season for selling houses ended in late August. The reports on home sales will turn negative as the percentage of foreclosure sales increases in relation to total sales. Yet people in the know are calm. The average Joe is calm until the guy across the street loses his job. THE IMPLICATIONS Have you sat down with a pencil and paper to outline your situation? If you were in the market for a new mortgage, what could you present to the lender to prove that you are a low-risk debtor? If you were in the market for a new job, how much wiggle room would your finances allow you? Where are you vulnerable? Your job? Where is your employer vulnerable? People assume that corporate management knows what it is doing. Then they are amazed when they are told that their services are no longer needed. Managers don't warn people whose jobs are at risk. They hold out hope that a turnaround is imminent. They want to believe that it really is imminent. They don't want to lose anyone because of a premature warning to him that his job is coming to an end. So, they don't tell a targeted employee until there is just no wiggle room remaining. Are you seeing this at your firm? Is there a drip- drip-drip phenomenon going on, the way it is with insolvent banks? If there is, what have you done to see to it that your job is safe? Anything new? If not, you should assume that your job is not safe. What about your company's market? Is it stabilizing? Talk to someone in sales. That's where the first signs of recovery will occur. Here is a strategy you can quietly use to assess your firm's line of credit. Which bank is its main lender? You need to know. Once you know, check what the bank is paying on time deposits. If it's 2% or higher, the bank is probably in trouble. It is offering rates way above the federal funds rate of 0.15% that the Federal Reserve is paying on excess reserves. It is buying time at a loss. That bank is a candidate for an FDIC take-over. The problem then will be this: a new set of managers will be in charge of rolling over old loans. They will examine every business loan on the dead banks' books. Your firm may be at risk along with the bank that supplies the credit. The looming decline of commercial real estate threatens local banks. A recent "Wall Street Journal" article shows why. In contrast to home loans -- the majority of which were made by only 10 or so giant institutions -- thousands of small and regional banks loaded up on commercial property debt. As a result, commercial real estate troubles would be even more widespread among the financial system than the housing woes. At the present, more than 3,000 banks and savings institutions have more than 300% of their risk-based capital in commercial real-estate loans. When these loans go bad, this will force more of these banks out of business. It will be crunch time for local lines of credit. CONCLUSIONS Does any of this raise some questions in your mind? Have you thought through your answers? If not, why not?
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