Bearish News

Karl Denninger’s reaction to Dennis Kneale’s attack on bloggers would have made Bruce Banner proud. Kneale’s snarky comments were aimed largely at ZeroHedge, but Denninger seized on them as an opportunity to highlight just how flawed the Kneale/Kudlow perma-bull argument is. And he did a damn fine job.

Karl’s response was classic Market Ticker. He picks apart Kneale’s argument piece-by-piece, demonstrating superior knowledge and experience. And he offers to debate any time, in the unlikely event that Dennis’ producers take him up on the offer.

But as usual, Mr. Denninger pulled no punches. He titled his post, “To Dennis Kneale: You’re An Idiot“. This  likely turned off some readers to the meat of the article. That’s a shame, because it’s one of the best summaries I’ve seen on why the Kudlow/Goldilocks/Green-Shoots argument is flawed. First, he addresses misconceptions about savings rates:

The consumer is 70% of our economy, give or take a few points.  The consumer’s “savings rate” (which government blithely declares as income minus spending), which was in fact negative (that is, consumers were spending more than they made through taking on more and more debt), but is now solidly positive at 6.9%.

The impact of this (6.9% X 70%) is an immediate 4.83 decrease in real GDP. Fudge the numbers all you want (and government will), but this is the math, and the math is never, ever wrong.

Consumers are not saving, they are paying down debt in a furious attempt to avoid defaulting on nearly $1 trillion in outstanding credit card balances that have gone from 11% interest to 29.6% along with OptionARMs that are experiencing a tripling of payments while the home’s value is underwater and precludes refinance, all while consumers are being laid off by the hundreds of thousands monthly.

Karl: 1, Goldilocks: 0. He goes on, discussing comparisons to Japan and overall flaws in the Keynesian/Inflationist case:

Japan tried what we’re doing in the 1990s and failed.  The Nikkei never recovered its former highs, in fact, it never even got close.  Japan’s economy never managed to get materially out of deflation and is now back in it as a direct consequence of their refusal to force the bad debt into the open and default it.

We are going to suffer the precise same fate for the precise same reason unless our government and economic leaders stop hiding the bad paper and force it out into the open where it will default and be removed from the economy.

Your network has fawned all over Bernanke when in fact he is acting exactly backward compared to what must be done – he is hiding bad assets on his balance sheet, allowing banks to hide bad assets on theirs, and refusing to expose the liars, cheats and frauds (along with their phony “assets”) so they will default and clear the system of bad debt.  He is doing this because he is protecting those who wrote all that bad paper, mathematics be damned, and if it doesn’t stop we will at best play Japan and at worst have a Depression far worse than the 1930s, as our systemic leverage ratios still, to this day, are higher than they ever were in the Great Depression!

Well done, Mr. Denninger. If you don’t already read The Market Ticker, check it out. The only thing I would add is that Japan’s crises occured during a sustained period growth period worldwide. Our problems are coinciding with what looks like a sustained worldwide r/depression. So they’ll be worse, and result in a completely different outcome than the deflation experienced by Japan. Not to mention the drastic differences in demographics and economies, which Jesse points out in an insightful post.

Santelli and Larry Levin try to talk some sense into Steve Liesman. Really good clip. CNBC isn’t all fluff:

Edit: Looks like CNBC removed the clip. Apparently it wasn’t kosher with the powers that be.

The San Francisco Fed recently published a dreary outlook. The unemployment commentary was particularly negative (for the Fed, at least). But if the past is any sort of guide, in a few years these Fed “worst cast scenarios” will look like rosy pipe-dreams. More on that later. Here are some excerpts from the FRBSF:

The long and gradual return to pre-recession unemployment levels implied by the Blue Chip consensus forecast is consistent with a labor market recovery that is slightly weaker than that experienced in 1983 and slightly stronger than that experienced in 1992. However, should labor market conditions instead proceed along the path taken in the 1992 recovery, the unemployment rate could peak close to 11% in mid-2010 and remain above 9% through the end of 2011.

They also provide this handy alternative unemployment chart, which includes involuntary part-time workers (people who want to be full-time, but can only get PT):

Not Pessimistic Enough

As dire as these predictions seem, they all assume growth is right around the corner. Look at the graphs, they all assume a few more months of recession at most. What if we’re in the modern equivalent of 1930? A rebound in consumer spending is always just a few months away, according to most analysts/economists. But spending and revenue are staying down, for the first time in a long time. And I don’t think it’s temporary shift, nor is it enough to turn the tide. While saving is up from negative territory, to 6%+ last month, it’s still not nearly enough to pay off our tremendous debts (public and private).

If the spending-bubble does stop here, we still have a lot more pain coming. The traditional Keynesian solution is more debt and unsustainable bailouts. That worked for a long time, but our decades-long debt spree is finally catching up with us. We  may be at the breaking point. Discretionary spending has never seen a pullback like the current one.

Gov intervention is the only thing preventing a total collapse. Such a collapse would arguably be preferable in the long-run, as it would solve the horrendous moral hazards and “reverse darwinism” we face, as Peter Schiff says. But that doesn’t change the fact that a collapse is highly unlikely, as I argue in this piece. The Gov will fight it tooth and nail, using whatever means necessary. So even bigger deficits are in the cards, and sustained inflation is very likely.

Those who think the Fed will start sopping up liquidity from the system are delusional. That would just pull the rug out from under the “recovery”, causing another crash and resulting in more bailouts and Keynesian magic (unless there were somehow a huge shift in philosophy among the economic powers that be).

There are just too many negative catalysts near-term.  State governments going broke (or getting bailed out), pensions doing the same, CRE’s awe-inspiring collapse, dwindling tax revenue at both the Federal and State level. When unemployment benefits start to run out, consumer spending will plummet further.

And with Summers, Bernanke, and Geithner as top-dogs in the administration, the most likely outcome is inflation. Those who doubt their ability to encourage inflation ignore history. They’ll find a way. Unless they let a collapse happen, wiping out debt via devaluation of the dollar will be the only option at some point. If that’s the “growth” green-shooters are harping about, count me out. Omnisan Investment posed an excellent question to those who advocate an inflationary outcome:

After all, if the Dow hits 30,000, but you’re celebrating by drinking a $150.00 coke… are you really any richer?

No position in any stocks mentioned. This is not investment advice, posted for informational purposes only.

Some juicy details are emerging about the Government’s meddling in Bank of America’s takeover of Merrill Lynch. This issue hasn’t gone away quietly, as many skeptics thought it would (myself included).

Potentially Huge Break – Fed Emails About the Deal Leaked

These emails, assuming they’re real, provide a peek into internal Fed discussions about the deal.  More importantly, they reveal that Fed employees clearly knew how toxic Merrill was. Mac Alfried, Senior VP at the Richmond Fed, had this crude assessment of ML, “Merrill is really scary and ugly”.

It seems clear that the Fed knew, at least suspected, how bad the Merrill situation was. Yet they pushed ahead, even  threatening Ken Lewis’ job if he didn’t seal the deal. Bank of America was buying a hot toxic mess in Merrill Lynch, and apparently everybody knew it. So why did the deal go through?

Under the contract, Bank of America seems to have had an out. Scuttling the deal under the Material Adverse Change clause was an option (once they found out how horrific Merrill’s books were). But they were strong-armed into not evoking theMAC clause. Why? The official line was likely, “to prevent a collapse of confidence in banks.” The end result may be the exact opposite.

This excerpt is another shocker:

Just had a long talk with Ben [Bernanke, presumably]. Says they think the MAC threat is irrelevant because its not credible. Also intends to make it even more clear that if they play that card and then need assistance, management is gone. (Forgot to tell him KL [Ken Lewis] is near retirement.) Hopes a Citi-like deal can be done w/o us taking 3rd loss, but if we get away w/ the gov just backstopping $74 that would be cheap given the size of the companies. He’d be surprised if that’s all it takes though.

I’m still digesting all of this, and suggest everyone read the whole thing. Docs like this need as many eyes on them as possible. So scan for nuggets if you’re so inclined.

On a more light-hearted note, Jesse’s Cafe posted their entertaining take on how things went down:

Shotgun Wedding (click to enlarge)

Moving on…  Zero Hedge also posted another juicy tidbit earlier today:

Tim Geithner, Treasury Secretary, supposedly emailed telling BofA that they couldn’t back out of acquiring Merrill Lynch, according to CNBC.

An email by Geithner telling BofA to close the deal would be a proverbial smoking gun, since BofA honcho Ken Lewis has said he was forced into buying the bank and not publicly revealing the poor financial shape that Merill Lynch was in, in the wake of pressure from the government.

If accurate, I don’t see how Geithner can last much longer at Treasury. How could the administration justify action like this by their pick for Treasury Secretary (who was President of the NY Fed at the time)? I wouldn’t worry too much about Mr. Geithner’s prospects, though. It seems inevitable that a bank/hedge-fund would take pity on him (and offer a fat multiple of his old paycheck).

If T3 (turbo-tax timmy, as ZH refers to him) does get canned, it seems likely that he’ll go down as the villian in this mess, or at least the baffoon. A scapegoat is sorely-needed to take the heat for the Bank of America debacle. While he seemingly does deserve part of the blame, the problem surely goes much higher up the food chain than a bureaucrat like Tim.

This is not to say that Ken Lewis is innocent in the matter (of poor judgement, at least). He chose to buy two of the most toxic books on the planet, Countrywide and Merrill Lynch. His eagerness to expand into lucrative markets blinded him to risk. It does appear that he was eventually pressured to follow through with the Merrill deal, after problems became evident. But Lewis was lusting after ML’s wealth-management biz for a while.

Paulson to testify Before Congress

Today brought yet another key development in this case, when it was announced that Henry Paulson will testify before Congress next month. He’ll be grilled on record (and presumably under oath) about about BAC’s acqusition of Merrill. Warning: Don’t get your hopes up. Paulson has a thick teflon coating to protect him from political heat. Goldman Sachs is too entrenched and politically connected for anything serious to happen to one of their own like Henry.  (bloomberg piece)