Much Ado About Nothing
By: Brian Hague, CFA
Yes, I’m talking about the budget deal. But I’m not trying to make light of the importance of funding our government or maintaining our ability to pay our debts with that title. It’s more about the theatre that Washington puts Americans – and the world – through every time we face this situation. And, tragically, we’ve faced that situation all too often of late.
The scaremongers tell us that the global economy will collapse if we don’t raise the debt ceiling (not true). And that it costs our economic growth dearly for every day the government is shut down (true, but if our economic growth is dependent on “non-essential” government functions being inoperative, shouldn’t that tell us something about the true strength of our economy?).
The deal that was reached in the wee hours of Wednesday night was terribly flawed, and should do little to restore confidence in U.S. fiscal policy worldwide. Indeed, we’re left to wonder how we didn’t get downgraded over this, and surprised that money came back into the Treasury market. My advice to those investors would be, “Be afraid – be very afraid.”
Stocks didn’t think much of it, either. We saw major selling as the stalemate unfolded, with the markets bouncing back on optimism that a deal would be reached in recent days. However, you’d think that once the deal was done, we’d see the market recover to its pre-standoff levels, if not higher. But the Dow is still below that threshold, and actually fell on Thursday. And while the S&P was touted as hitting a record high, it only rose 11 points – less than 1%.
In part, this is undoubtedly due to one of the major flaws of the “agreement”: it’s very temporary. The government is only funded through January, and the debt ceiling is only lifted through February. So we’re going to go through this again in just a few months. At least we get to enjoy the holidays. The short time frame of this deal alone should warrant a downgrade.
The markets should also anticipate that with another round of wrangling coming in a few months will mean that Fed policy will remain accommodative at least until then, which should also have sparked a bigger rally. But perhaps investors and traders are beginning to see the house of cards for what it is (a house that keeps getting bigger and bigger, because the players are able to just print more cards to add to the square footage).
Other flaws in the deal? Well, with all apologies to “non-essential” government employees, they’re getting back pay for the 16 days they were furloughed. Gee, where can I land a gig like that? Most of us could use an extra 16-day paid vacation.
And so much for addressing Obamacare. I liken this to a football game: the GOP had the ball, but couldn’t get a first down, though they did grind out a few yards. (Reminds me of former Kansas City Chiefs head coach Marty Schottenheimer, whose “Martyball” offense was marked by his affinity for “three yards and a cloud of dust.” Do that three times, and guess what? It’s fourth and one.) So the GOP lined up, and QB Boehner tried a hard count. The Dems held the line, and didn’t flinch. So Boehner looked to the sideline, stepped back, took the snap … and pooch-punted. But not very far.
But for all the Dems’ insistence that a “clean” bill be passed, only funding the government and raising the debt ceiling, with no strings attached, this thing had as much pork as a McRib:
- $2.2 billion goes to fund a dam in Kentucky that was originally budgeted at less than a third of that, but has faced cost over-runs.
- $450 million was allocated to rebuilding efforts in flood-stricken Colorado, which is more than four times the amount allowed for by the Disaster Relief Appropriations Act (although this one, I can get okay with, given the severity of the flooding).
- A number of agencies are getting big increases in allocations, including “a watchdog group meant to guard Americans’ right to privacy against overreach by government cyberintelligence,” according to CNN. (Wait a minute – taxpayers have to pay money to a government group to protect them from another government group? Has the Russian mafia infiltrated Congress?)
- $174,000 was allocated to pay the widow of late Senator Frank Lautenberg. Now, the Senate has a long-standing tradition – though it’s not law – of paying a year’s salary to the spouse of a deceased Senator. But Lautenberg had a net worth of nearly $60 million when he passed. You’d think the poor widow might be able to live out her years on that.
At least Congress didn’t vote themselves a pay raise (but if a long-time Senator can amass a $60 million fortune, that’s not much of a sacrifice).
After the deal was done, the blame game continued. But that’s akin to a game of Aunt Sally, a British pub game where one sets up a target only to knock it down (similar to a straw man). This was the fault of a system that has become polarized because that’s what we the people seem to want. Whether we’ve caused it ourselves, or it’s been fueled by cable news and talk radio, or whether our elected officials have foisted it upon us, is irrelevant, and trying to argue that either side is solely to blame is a fool’s errand.
The real question is who won this round? I don’t have the answer, but I’m pretty sure I know who lost: America.
Brian Hague has more than 26 years’ experience in financial institutions and the capital markets. His career has included work as an S&L examiner during the thrift crisis; trading futures for and valuing the mortgage derivatives portfolio of a $16 billion financial institution with offices on Wall Street; advising financial institutions regarding portfolio and risk management; serving as Chief Economist for a $50 billion financial institution; and serving as President/CEO of a national institutional brokerage and investment advisory firm for more than 15 years.
Brian has been a featured columnist and contributor for several trade publications, and has authored daily and weekly economic commentary, as well as two books for institutional investment managers. He has also been a frequent speaker and trainer at regional and national conferences. He holds a BA in Psychology and an MBA from Pittsburg (KS) State University, as well as the CFA charter and numerous FINRA securities licenses.
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The Heart of the Matter
By: Brian Hague, CFA
So the government funding deadline has come and gone, and … the government has indeed shut down. The impasse over the Affordable Care Act (ACA, more commonly known as “Obamacare”) was the line in the sand, drawn by the GOP-controlled House as a condition to extending funding, which the Democrat-controlled Senate rejected.
A friend of mine put it this way in a recent message board post:
“Realistically, this has happened before, and it will happen again … it is politics. In recent memory, Ford had a shutdown, Carter had 5, Reagan … had 7, Bush I had 1, and Clinton had 2 shut downs. And guess what … Grandma is still alive, the troops never starved or ran out of bullets, and except for National Parks and the Smithsonian being closed for a few days and messing up some school field trips, these are just blips in the radar, which usually ended up with some level of compromise … and we may need something like a shutdown for a pig-headed man in the White House who won’t let his ACA be touched, and some idiots in the GOP to moderate their stances a little and come to some agreement.”
The last part of his post correctly places the responsibility for this fiasco on the shoulders of both parties equally (for the record, my friend is a fellow Independent who voted for President Obama in the last election). But it is the first part of his post on which I want to focus our attention, because in it lies the true heart of the matter; not whose fault it is that we’ve reached this point (and yes, using the government’s status as a going concern as a political football is childish error), but why we keep facing this situation – first having to approve annual funding, and then having to raise the debt ceiling – in the first place.
The reason we have to approve funding for the fiscal year that began October 1 is that, since 2009, our government has failed to produce an annual budget – something that few businesses could get away with. Next up is the debate over raising the debt ceiling in a few weeks, which will prove just as contentious.
We have indeed had numerous government shut-downs over the course of the past several presidencies, and all resulted from political gamesmanship. And, as my friend noted, none resulted in the kind of calamity the media have been predicting in this latest instance (you can blame 24/7 cable news and an increasingly divided populace for that).
But what was the game about? In each instance, it was ultimately about raising the debt ceiling, something that has happened 74 times since 1962, with exactly half of those increases coming since 1981. President Reagan’s two terms saw the ceiling raised a total of more than 100% (adjusted for inflation); President Bush Sr.’s one term, 23%; President Clinton’s two terms, 17%; President Bush Jr.’s two terms, 52%; and President Obama’s tenure thus far, 34%.
Now, before we draw any partisan conclusions from this data (after all, we must also consider the party in control of Congress), let’s point to the real issue at hand:
Under Reagan, the debt limit went from 35% to 55% of GDP. Under Bush I, from 57% to 65%. Under Clinton, it actually fell from 74% to 60% of GDP. Under Bush II, it rose from 58% to 79%. All of those are reasonably manageable numbers, though the trend is far from comforting.
More recently, however, the debt ceiling has been raised from 88% to more than 100% of GDP since 2009. And now, the White House is seeking to raise it again. Lest this key point be lost on the reader, consider the graph below (courtesy of Wikipedia):
Of course, this graph does not include the two most recent increases. Our debt ceiling is now $16.7 trillion. Our outstanding public debt is more than that, but not all of it is subject to the limit. U.S. GDP was about $15.7 trillion as of the end of the second quarter (I had to get that from a private website, because the BEA’s website is shut down as of today).
If you’re reading this, you’re probably a small business owner (but if not, consider this analogy in terms of an individual with a credit card). Could you run your business this way? Could you just keep running to the bank and asking for an increase in your line of credit every time you were about to max it out? Could you continue to do that time and again, even when your indebtedness exceeded your output?
Of course not. That’s no way to run a household, a business or a government (see Greece, et al). And that is the heart of the matter, not whether the national parks are open today, or the BLS jobs report gets released on Friday, or whose fault the impasse is.
Until we get a handle on our federal spending and debt, we are on course for catastrophe, a catastrophe far worse than any that could result from the current situation. Yet that point seems to get lost in all the noise of sound bites and finger-pointing.
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By: Brian Hague, CFA
The much-anticipated FOMC meeting scheduled for September 17-18 concluded with a whimper, not a bang: the Fed decided not to begin tapering asset purchases. The central bank will continue to buy $85 billion worth of bonds a month, meaning its balance sheet will continue to swell beyond the $4 trillion threshold, more than four times the level of just five years ago.
The Chairman made some interesting comments following the announcement:
- The Fed cut its forecasts for economic growth: 2.0-2.3% this year, 2.9-3.1% next year, and 2.5-3.3% by 2016.
- “Most” of the improvement in the jobless rate is due to payroll gains (not true – most of the improvement is due to the continual slide in the labor force participation rate, to 30-year lows). He also stated that the central bank wouldn’t begin raising rates until the unemployment rate falls “well below” 6.5% (from the current 7.3%).
- Bernanke appeared to back off the likelihood of tapering this year, and intimated that it might be 2015 before tightening begins.
Bernanke also stated that “we can’t let market conditions dictate our policy actions.” Yet that’s precisely what the Bernanke Fed has done throughout his tenure as Chairman, a tendency he picked up from his predecessor. He said that it wasn’t the Fed’s intent to surprise the markets with today’s announcement, which appeared contrary to Fedspeak over the last two months. Yet the Dow, the S&P and the Russell 2000 soared to record highs, and the more bubble-prone NASDAQ hit a 13-year peak.
Asked about the impact of the tussle over who the next Fed Chair will be on the central bank’s image, Bernanke said, “I think the Federal Reserve has strong institutional credibility.” We’ll let history be the judge; the most accommodative policy in the history of the U.S. is unlikely to end well – and it’ll only become more accommodative under the front-runner to succeed him, Janet Yellen.
Finally, Bernanke punted the ball (or tossed the hot potato) back to the fiscal side, chiding Congress for its continual toying with the debt ceiling. With the September 30 deadline to raise the ceiling looming, and the GOP holding Obamacare hostage in the debate, he urged lawmakers to raise the ceiling further.
Little wonder: if Helicopter Ben intends to keep printing money, he needs Congress’ help.
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A Bullet Dodged
By: Brian Hague, CFA
Last Sunday, Larry Summers withdrew his name from consideration as the next Fed Chairman.
Summers, the subject of my last column, would have been an unmitigated disaster in the role. He withdrew because he felt his approval process would be contentious, and he’s right: no one on the right would vote for him, and many on the left would oppose him as well. President Obama doesn’t need that at this point in his second term; he’s already got that situation with Syria.
So we’re now left with former San Francisco Fed Bank President Janet Yellen. Yellen isn’t a good choice either – she’s more dovish than Bernanke, and we don’t need even easier monetary policy than we already have. That “medicine” will at some point become poison that will kill the patient.
Another reason to oppose Yellen is that former Fed Vice-Chair Alan Blinder named her as the best choice for the job. Blinder, another easy-money advocate, was tabbed by President Clinton as Vice-Chair of the central bank, under a deal that would see him succeed then-Chair Alan Greenspan in the role. But Clinton remembered the sage advice, “It’s the economy, stupid,” that he received during his initial campaign, and re-appointed “Bubbleman” Greenspan. Blinder hit the bricks and returned to Princeton.
At the time of Blinder’s appointment as heir to the throne, I penned a column entitled “The Blinder Leading the Blind,” noting his propensity for easy money. Of course, Greenspan later turned dove, claiming that the “new economy” was different due to technological advances that changed the fundamental laws of economics. As I’ve often said, those laws haven’t changed since we were wearing animal skins and trading rocks, and the dot-com and housing bubbles proved that to be true.
So whom would I pick as the next Fed Chair? My first choice would be Nouriel Roubini of NYU. He’d be seen as too much of a perma-bear by most, but his call on the housing bubble was spot-on (as was mine, but I’m sure that my lack of a PhD would disqualify me). Other solid choices would be Ken Rogoff, co-author of “This Time It’s Different” (in which he clearly states that it’s not different, echoing my animal skins and rocks theme), or Robert Shiller, who also predicted the housing bubble and is the architect of the widely-followed S&P/Case-Shiller Home Price Index.
One key factor in Obama’s preference for Yellen is the criticism he’s received for not including enough women in top government roles. (That also played into the opposition from the left to Summers, who once suggested that innate differences between men and women were a factor in their difficulty in obtaining many science- and math-related jobs.)
Either way, it looks like Yellen will get the nod. She’ll be roundly opposed by the right (but the right would oppose any Obama appointment at this point), but ultimately, I’m betting she’ll be confirmed. Then money will likely become even easier, and it’ll be time to short America.
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Coming Next Year: The Summers of Our Discontent?
By Brian Hague
Fed Chairman “Helicopter” Ben Bernanke, that champion of money-printing, will step down from his role next year – not soon enough for those of us who’ve been appalled at the grossing-up of the central bank’s balance sheet from its historical average of less than a trillion dollars from 1999 through late 2007, to nearly $4 trillion now.
The two candidates most often mentioned for the role are former San Francisco Fed Bank President Janet Yellen, and former Treasury Secretary, Chair of the Council of Economic Advisors, and Harvard University President Larry Summers. Either would be an unmitigated disaster, but at least Bernanke’s legacy as the worst Fed Chairman ever would be eclipsed.
Yellen is more dovish than Bernanke, always falling on the side of stimulus to boost employment vs. tightening to fight inflation. And the Fed can ill afford to be more accommodative, lest we trigger an inflationary spiral that could make Weimar Germany look austere.
But at least with Yellen, we know what the risk is: monetary policy would be too easy, in whatever environment we might face. Life with Summers as Fed Chair would be like Forrest Gump’s box of chocolates: you never know what you might get.
When Summers was Chief Economist of the World Bank, he signed a memo that said, “the economic logic behind dumping a load of toxic waste in the lowest wage country is impeccable … I’ve always thought that under-populated countries in Africa are vastly underpolluted.” The co-author of the memo said that it was an internal document that was leaked, and that it was intended as sarcasm. But do we really want a head of the central bank of the world’s largest economy who – even sarcastically – calls for dumping pollutants in poor African nations?
As Clinton’s Treasury Secretary, Summers championed the misguided Gramm-Leach-Bliley Act and fought regulation of derivatives, both factors in the financial melt-down of 2008. Then, in the wake of that crisis, as Obama’s top economic advisor, he pushed for bank bailouts, fought limits on bankers’ bonuses, and persuaded the President to not listen to the smartest economic advisor on his team, Paul Volcker, an advocate of fiscal and monetary responsibility and a return to Glass-Steagall separation of banking and trading. Let’s not forget that, besides setting monetary policy, the Fed is the nation’s top bank regulator. Do we really want a Fed Chairman who’s in the bankers’ hip pockets?
Finally, as President of Harvard, Summers sought to finance a campus expansion with interest rate swaps at the worst possible moment in the market cycle, which ultimately cost the university nearly a billion dollars. At a minimum, a Fed Chair should not be a riverboat gambler, especially when it comes to interest rates.
Larry Summers lacks the requisite discipline, restraint, and independence to chair the world’s most important central bank. Yet the bankers will lobby for him, as will Wall Street. And, if approved, his tenure could well produce many summers of discontent.
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By: Brian Hague
The Chinese have a saying: “May you live in interesting times.” Actually, it’s a curse, a telling point for those of us who have lived through the economic travails of the past several years.
From my own experience, it’s been a lasting curse. I began my professional career as an examiner in the savings and loan industry during the thrift crisis of the 1980s, then I spent four years working for one of the largest, most innovative, S&Ls in the nation.
Following that experience, I worked as an institutional investment advisor during the mortgage market whipsaw of 1993-1994. I followed that experience as an economist during the period leading up to the dot-com bubble of 1998-2000. Then, I managed an institutional broker/dealer and investment advisor through the housing bubble and its aftermath.
Over the course of that career, I have indeed seen my share of interesting times, and it’s certainly felt like a curse at times. No more so than today, when we see unprecedented central bank accommodation.
For those of us who are grounded in Biblical principles of thrift, stewardship and generosity, this unprecedented government largesse is anathema. In the U.S., our own central bank has undertaken a program of prolific money-printing, grossing up its balance sheet to nearly $4 trillion, quadrupling its previous size.
This week brought us the minutes of the latest FOMC meeting. The markets have been hanging on the Fed’s deliberations for months now, with a curious trading pattern previously unforeseen.
Positive economic data is supposed to buoy the markets, but these days, it leads traders to believe that the Fed may begin to withdraw the crack that is stimulus to the junkie markets (underscoring just how weak the fundamental economy is). Negative data produces rallies on speculation that the Fed will maintain its bond-buying program, keeping the crack flowing. As the Kinks sang, “It’s a mixed-up, muddled-up, shook-up world.”
It’s mindful of a visit to my office by my daughter a number of years ago, when she was eight years old. I had a crystal ball in my office, an artifact of my profession. She asked what it was for, and I told her, “I use it to see the future.” She peered at it, and noticed that images on the other side of a solid glass sphere are inverted. She said, “Well, it says your future is upside down,” proving herself to be a better economist than most.
Back to this week’s Fed minutes release. Reading the tea leaves, I anticipate tapering of stimulus will begin in September. However, what that likely means is a shift from the Fed buying $85 billion of bonds a month to $75 billion – hardly a radical move toward austerity.
The resultant impact on bond yields will probably be a move toward about 50 basis points on the two-year Treasury (from about 34 basis points now), and maybe 3% on the benchmark ten-year (from 2.82%-ish now). That will push mortgage yields higher, which will have an adverse impact on traditional home buying activity (more on that in a future post), and will thus translate into subdued overall economic growth. Equity traders will probably continue to find reasons to sustain a rally, until that bubble bursts.
Interesting times, indeed.
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