Thursday, September 15, 2011

Today's links

1--Contracting Out Costs the Government Lots Extra, via economist's view

Excerpt: POGO Study: Contractors Costing Government Twice as Much as In-House Workforce....

The U.S. government’s increasing reliance on contractors to do work traditionally done by federal employees is fueled by the belief that private industry can deliver services at a lower cost than in-house staff.
But a first-of-its-kind study released today by the Project On Government Oversight (POGO) busts that myth by showing that using contractors to perform services actually increases costs to taxpayers.

POGO’s new report is the first to compare the rate that contractors bill the federal government to the salaries and benefits of comparable federal employees. The study found that while federal government salaries are higher than private sector salaries, contractor billing rates average 83 percent more than what it would cost to do the work in-house.

2--Soaring Poverty Casts Spotlight on ‘Lost Decade’, New York Times

Excerpt: Another 2.6 million people slipped into poverty in the United States last year, the Census Bureau reported Tuesday, and the number of Americans living below the official poverty line, 46.2 million people, was the highest number in the 52 years the bureau has been publishing figures on it.

And in new signs of distress among the middle class, median household incomes fell last year to levels last seen in 1997.

Economists pointed to a telling statistic: It was the first time since the Great Depression that median household income, adjusted for inflation, had not risen over such a long period, said Lawrence Katz, an economics professor at Harvard.

“This is truly a lost decade,” Mr. Katz said. “We think of America as a place where every generation is doing better, but we’re looking at a period when the median family is in worse shape than it was in the late 1990s.”

3--Obama Approval Plummets on Jobs Plan: Poll, Bloomberg

Excerpt: A majority of Americans don’t believe President Barack Obama’s $447 billion jobs plan will help lower the unemployment rate, skepticism he must overcome as he presses Congress for action and positions himself for re- election.

The downbeat assessment of the American Jobs Act reflects a growing and broad sense of dissatisfaction with the president. Americans disapprove of his handling of the economy by 62 percent to 33 percent, a Bloomberg National Poll conducted Sept. 9-12 shows. The disapproval number represents a nine point increase from six months ago.

The president’s job approval rating also stands at the lowest of his presidency -- 45 percent. That rating is driven down in part by a majority of independents, 53 percent, who disapprove of his performance.

“I don’t think he’s done as good a job as I think he could have,” said Paul Kaplan, 58, an unemployed Democrat from Philadelphia. “We were hopeful that things would improve in the economy and they’ve only gotten worse. People in Washington just don’t seem to want to cooperate with each other and work for the people.

4--Democrats See Perils on Path to Health Cuts, New York Times

Excerpt: As Congress opens a politically charged exploration of ways to pare the deficit, President Obama is expected to seek hundreds of billions of dollars in savings in Medicare and Medicaid, delighting Republicans and dismaying many Democrats who fear that his proposals will become a starting point for bigger cuts in the popular health programs.

The president made clear his intentions in his speech to a joint session of Congress last week when, setting forth a plan to create jobs and revive the economy, he said he disagreed with members of his party “who don’t think we should make any changes at all to Medicare and Medicaid.”

Few Democrats fit that description. But many say that if, as expected, Mr. Obama next week proposes $300 billion to $500 billion of savings over 10 years in entitlement programs, he will provide political cover for a new bipartisan Congressional committee to cut just as much or more....

Mr. Obama has said that “health care cuts” need to be part of any deal, and he has already given a preview of the cuts he is likely to propose next week. In April, he unveiled a framework for deficit reduction that he said would save $480 billion in Medicare and Medicaid by 2023.

In negotiations with Congressional Republicans in July, Mr. Obama went further. He indicated that he was willing to consider a gradual increase in the age of eligibility for Medicare and cuts in federal payments to states for Medicaid.

5--UPDATED: The American Jobs Act: Greater than Expected Impact,

Excerpt: Last week President Obama unveiled his much-heralded jobs plan, the American Jobs Act of 2011 (AJA 2011). It was bigger than expected, with a price tag of $447 billion. More than half the total ($245 billion) is in the form of temporary tax relief, with most of the balance in infrastructure spending. We estimate that if enacted promptly and assuming no monetary offset, the plan will:

•Boost GDP growth roughly 11⁄4 percentage points in 2012 by pulling growth forward, mostly from 2013.

•Raise payroll employment 1.3 million by the end 2012, 0.8 million by the end of 2013, and progressively smaller amounts thereafter.

•These estimates do not reflect jobs that might be created in response to tax incentives for hiring included in the plan. While an argument can be made for such effects, we believe them to be modest (more below).

•Our simulation does not include the effects of an initiative, under consideration by the Administration, to direct federal housing agencies to facilitate mortgage refinancing. We will publish a piece on this shortly.

•The President will recommend offsetting the cost of AJA 2011 over the coming decade. The “pay-fors” imply fiscal drag not included in the simulation, but this will be modest and most likely occur after 2013 when the economy is stronger and the Federal Reserve is better positioned to accommodate it.

•Our published forecast already assumes a one-year extension of the current employee payroll tax holiday. Hence, if the President’s plan was enacted in its entirety, we would revise up our forecast for GDP growth in 2012 by about a percentage point, not the full amount shown in this analysis.

6--Retail Sales flat in August, Calculated Risk

Excerpt: On a monthly basis, retail sales were flat from July to August (seasonally adjusted, after revisions), and sales were up 7.2% from August 2010. From the Census Bureau report:

The U.S. Census Bureau announced today that advance estimates of U.S. retail and food services sales for August, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $389.5 billion, virtually unchanged from the previous month and 7.2 percent above August 2010.

7--Increased Demand Gives Firms the Need to Hire, Not the Confiudence, CEPR

Excerpt: The NYT told readers that the Obama administration wants to increase the demand for goods and services, "which could then give employers the confidence to hire." Actually, an increase in the demand for goods and services forces employers to hire at the risk of losing business.

If a restaurant doesn't have enough staff to serve its customers, it will lose customers. If a factory doesn't have enough workers to fill its order then it loses orders. Increased demand forces businesses to use more labor.
Confidence may affect the extent to which firms actually hire more workers, as opposed to increasing the number of hours worked per worker. The latter still remains well below its pre-recession level. This is a strong piece of evidence that a lack of demand, not confidence, is the main factor impeding business expansion.

8--Rise of the Pawn Swan, FT.Alphaville

Excerpt: Hat tip to International Financing Review’s Christopher Whittall for directing us to this rather interesting article by Gareth Gore at IFR about the rise of collateral-swap type deals between European institutions and US investment banks, More…

Hat tip to International Financing Review’s Christopher Whittall for directing us to this rather interesting article by Gareth Gore at IFR about the rise of collateral-swap type deals between European institutions and US investment banks, seemingly to plug the financing gap created by the departure of the US money market funds from Europe.

The following paragraphs are especially poignant, we think (our emphasis):
US banks are exploiting the inability of European banks to fund themselves in dollars, charging much higher rates than normal – sometimes double that paid to money markets.

But they argue they are simply taking “conservative” steps to protect themselves.

Assets posted are subject to dramatic haircuts, meaning European banks can only generate cash equivalent to part of their full value.

“Repo markets have always been a source of funding, but the question has always been about whether the price points work for both parties,” said one US banker involved in such deals. “As the [money market] investor base started to shy away from some names, the foreign banks became more interested in getting deals done.”

Paris-based Societe Generale said that it had struck US dollar repo deals equivalent to €6bn against a portfolio of commercial mortgage-backed securities and collateralised loans with maturities longer than six months. US bankers say other banks have struck similar deals in recent weeks to generate cash.

There are two interesting points to pluck out here:

1) that US banks are charging ‘dramatic’ haircuts on what the European institutions in question describe (earlier in the article) as quality assets. Clearly a difference of opinion.

2) that such “quality” assets are now clearly limited with respect to how much they can be monetised, quite the contrast to Treasury debt, which can in some cases be monetised beyond its face value.

Interesting given Bernanke’s point about what made the Great Depression so great. As he has written:

A useful way to think of the 1930-33 debt crisis is as the progressive erosion of borrower’s collateral relative to debt burdens.

Nevertheless, as the article points out, there’s still a clear incentive to pawn repo your ‘quality’ assets rather than sell outright:

“Doing repo means you don’t have to sell and don’t have to take the loss on many of these assets upfront,” said another banker at a US bank, who has signed off on such deals in recent weeks. “You can do it privately, so nobody needs to know, and spread losses over the lifetime of the assets.” Repo desks are the financial market equivalent of pawnshops, allowing clients to generate cash for assets sitting on their balance sheets. Given that loans are secured against collateral, they are seen by lenders as less risky than other forms of lending, either private or through bond issues.

The flip-side, of course, is that because US banks are flush with cash — so much so that they’re having real trouble finding investments that can offer any reasonable return — they must consider this new found dollar-funding need of European institutions a god-send.

In fact, the worse the European crisis gets in terms of US dollar funding stress, the better for their returns. Though arguably, greater the risk it all blows up too.

9--Eurozone crisis porn, FT.Alphaville

Excerpt: For those who get a vicarious thrill from watching the eurozone sovereign debt crisis and imagining how it might end (like you – Ed.) will seriously enjoy Wednesday’s scribblings from David Zervos, the head of Global Fixed Income strategy at Jefferies and a former Fed official.

He believes a Lehman like even is about to unleashed on Europe that will trigger country by country socialization of their commercial banks and a splintering of the eurozone.

Realistic or not, it’s certainly a gripping read....

The bottom line is that it looks like a Lehman like event is about to be unleashed on Europe WITHOUT an effective TARP like structure fully in place. Now maybe, just maybe, they can do what the US did and build one on the fly – wiping out a few institutions and then using an expanded EFSF/Eurobond structure to prevent systemic collapse. But politically that is increasingly feeling like a long shot. Rather it looks like we will get 17 TARPs – one for each country. That is going to require a US style socialization of each banking system – with many WAMUs, Wachovias, AIGs and IndyMacs along the way. The road map for Europe is still 2008 in the US, with the end game a country by country socialization of their commercial banks. The fact is that the Germans are NOT going to pay for pan European structure to recap French and Italian banks – even though it is probably a more cost effective solution for both the German banks and taxpayers....

Picking winners and losers will be VERY HARD but let’s look at a few weak spots –SocGen 12b in market cap (-70% this year) with assets of 1.13 trillion BNP 31b in market cap (-55% this year) with assets of 2 trillion Unicredito 13b in market cap (-70% this year) with assets of 1 trillion Intesa 14b in market cap (-70% this year) with assets of 700b Compare this with the USA where we have – JPM 125b in market cap with assets of 2.1 trillion BAC 70b in market cap with assets of 2.2 trillion....

Importantly, France GDP is only 2 trillion and in bank balance sheets are some 400% of that number. The banks are dead men walking with massive leverage to both home country income as well as assets. The governments are about to take charge and Europe as a whole is about to embark on a sloppy financial market socialization process that has been held back for nearly 2 years by 3 bailouts.....

So what does all this mean for the US? We see the road map as similar to the Asian/Russian/LTCM crisis period of the 1990s. Back then Thailand, Korea, Indonesia, Malaysia, HK all detonated. Russia hit the skids and the financial system flirted with an LTCM systemic disaster. Of course even earlier Mexico and much of South America imploded, and Italy nearly collapsed in 1995/1996. All that time the “Maestro” kept the pedal to the metal with easy policy and bubble fuel! While the dips were severe, the trend was higher in risk assets and long term rates were basically range bound. There is no reason to assume gentle Ben will not push the pedal down and even bring in some new engine horse power for the bubble race—the balance sheet cometh with twist trades, DIC trades and expansion trades. In the end US risk assets are the only game in town as Fed reflation trumps all cards, even European detonation

10--David Rosenberg: "It's Time To Start Calling This For What It Is: A Modern Day Depression", Zero Hedge

Excerpt: You know you're in a depression when interest rates go to zero and there is no revival in credit-sensitive spending.

The economy is in a depression when the banks are sitting on nearly $2 trillion of cash and yet there is no lending going onto the private sector. It's otherwise known as a 'liquidity trap'.

Depressions usually are caused by a bursting of an asset bubble and a contraction in credit, whereas plain-vanilla recessions are typically caused by inflation and excessive manufacturing inventories. You tell me which fits the bill today.

When almost half of the ranks of the unemployed have been looking for a job fruitlessly for at least six months, you know you are in something much deeper than a garden-variety recession. True, we can't see the soup lines; the soup lines are in the mail — 99 weeks of unemployment cheques for over 10 million jobless Americans. Don't be lulled into the view that we are into anything remotely close to a normal economic cycle.

Basically, in a depression, secular changes take place. Attitudes towards debt, discretionary spending and homeownership are altered for many years, or at least until the scars from the traumatic experience with defaults and delinquencies fade away. That is why we saw existing home sales slide to 15- year lows and new home sales to record lows despite the fact that mortgage rates have tumbled to their lowest levels in modern history.

There is no economic model that would tell you that declining mortgage rates should lead to lower home sales.

More fundamentally, in a recession, the economy is revived by government stimulus. In depressions, the economy is sustained by government stimulus. There is a very big difference between these two states.

In a recession, everything would be back to a new high nearly three years after the initial contraction in the economy. This time around, everything from organic personal income to employment to real GDP to home prices to corporate earnings to outstanding bank credit are still all below, to varying degrees, the levels prevailing in December 2007.

Let's be clear: After all the monetary, fiscal and bailout stimulus, the economy should be roaring ahead, as would be the case if the economy were coming out of a normal garden-variety recession. The fact that there has been no sustained response to all these efforts by the government to turn things around is testament to the view that this is not actually a traditional recession at all, but something closely resembling a depression. That, my friends, is exactly what the bond market is signaling, with Treasury yields rapidly approaching Japanese levels. Just because the stock market embarked on a stimulus-led speculative two-year rally, which ended abruptly in April 2011— does not change that fact.

For all the chatter about whether the recession that started in December 2007 ended in mid-2009, here is what you should know about the historical record. The 1930s depression was not marked by declining quarterly GDP data every single quarter. In fact, the technical recessionary aspect to the initial period following the asset and credit shock goes from the third quarter of 1929 to the first quarter of 1933.

I can understand how emotional the debate can get over whether or not we have actually just stumbled along some post-recession recovery path or whether or not this is actually a depression in the sense of a downward trend in economic activity merely punctuated with noise that is influenced by recurring rounds of government intervention. The reality is that the Fed cut the funds rate to zero, as was the case in Japan, to little avail.

Then the Fed tripled the size of its balance sheet— again with little sustained impetus to a broken financial system. Government deficits of nearly 10% relative to GDP, or double what FDR ever ran during the 1930s, have obviously fallen flat in terms of providing any lasting impact to the economy.

This is going to sound like a broken record but it took a decade of parabolic credit growth to get the U.S. economy into this deleveraging mess and there is clearly no painless "quick fix" towards bringing household debt into historical realignment with the level of assets and income to support the prevailing level of liabilities. We are talking about $5 trillion of excess debt that has to be extinguished either by paying it down or by walking away from it (or having it socialized). Look, we can understand the need to be optimistic, but it is essential that we recognize the type of market and economic backdrop we are in.

The markets are telling us something valuable when (after a period of unprecedented government bailouts, incursions and stimulus programs) the yield on the 5-year note is south of 1% and the 10-year is down to 2%. Instead of contemplating over how attractively priced equities must be in this environment, market strategists and commentators would bring a lot more to the table if they tried to decipher what the macro message is from this price action in the Treasury market. Conducting stock market valuation analysis based on unrealistic consensus earnings assumptions does nobody any good, especially when these estimates are in the process of being cut, and at a time when the Treasury market is telling us we are the precipice of another recession.

If the Treasury market is correct in its implicit assumption of a renewed contraction in the economy, then we could well be talking about corporate earnings being closer to $75 in 2011 as opposed to the current consensus view of over $110. In other words, we may wake up to find out a year from now that whoever was buying the market today under an illusion of a forward multiple of 10x was actually buying the market with a 15x multiple.
How's that for a reality check?

This augers for capital preservation, defensive orientation in the equity market and a focus on income-yielding securities; something we've been advocating for some time.

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