The R Word

Some really bad US job statistics hit the news this Friday. Non-farm payrolls were -4000 jobs instead of the expected +100,000. This is the first time in four years that job growth was actually negative. On top of that the preliminary figures for June and July were revised downwards substantially. And, to make matters worse, 592,000 people left the workforce, meaning that they have probably given up trying to find a job. Now the "R word" is sure to come any day soon - recession.

Treasury Secretary Henry Paulson's comments on the job statistics are priceless. He's desperately trying to instill comfort when this news has probably convinced even the most hardened optimists that the US economy will make a hard landing, and pessimists now predict a crash landing. Some quotes:

"it takes a while for confidence to return"

"A while" - ha - it will probably take years to sort this mess out.

"The economy will continue to grow in the second half of the year"

Oh yeah? That would be sensational. First this "unexpected" drop in jobs, and then he expects us to get another surprise when we suddenly see job growth again in September or October. Does he actually believe this himself?

Paulson, who had a regular breakfast meeting with Fed Chairman Ben S. Bernanke today, said he had "great confidence'' in the central bank.

"Helicopter Ben" is probably glad to hear that there's still at least one person who has not lost confidence in him.

"But I feel quite strongly that we have a resilient economy."

Well, let's hope that, but don't bet on it. Things might break quicker than Paulson can say "resilient economy".

The Mortgage Situation
Higher unemployment will of course lead to more people falling behind on their mortgage payments. Foreclosures have already hit an all-time high of 0.65 percent during the second quarter of this year, making this the third consecutive quarter in which a record is set. Delinquencies are also up - 14.82 percent of subprime loans are behind in their payments, but delinquencies in the prime area are also up from 2.58 to 2.73 percent. Expect this to turn worse.

Housing prices are sinking, partly because it has become much more difficult to get a loan. More foreclosures will also mean more houses for sale on an already saturated market. Expect housing prices to sink much more.

To make matters worse for the poor foreclosed home-owners, if the house sells below the amount of the loan, and the rest of the loan is forgiven by the lender, the amount forgiven is taxed as income for the borrower. This could lead to really serious problems for many people who are already in trouble.

There have been proposals (notably from George W. Bush) to bail out home-owners in some way to alleviate the effects of the current housing mess. However, with a recession coming on, where is the government going to find funds for such a bailout? A recession means less tax money coming in, so the only alternative is to borrow money. But borrow from whom? Most Americans don't have any surplus to put into US bonds, and foreign investors will be unwilling to invest more in US government paper if there is a major inflation risk. And that brings me to the subject of...

Inflation
Apart from moving the stock markets down, the bad jobs news on Friday also took the US dollar down by more than 0.6 percent. The US dollar index (against other currencies) is now definitely below 80 and has now broken its 15-year low. Expect it to fall further unless some miracle news turns up. This means that all imported stuff will be more expensive in the USA.

To counter this bad trend for the US$, the only thing the FED could do would be to increase the interest rate, but what's really needed to alleviate the current domestic economic situation is an interest rate cut, which is what everyone expects the FED will announce on September 18. So the FED basically has its hands tied behind its back when it comes to fighting inflation.

Besides, there are two inflation factors over which the FED has no control - food and energy. I know that the "core inflation" figures the FED prefers to watch exclude food and energy, but in the real world food and energy prices have strong effects on the economy. People just cannot live without them. Food prices are rising sharply, as I have said before, due to a global shortage of wheat and other grains. President Bush could do something about this inflation factor, however, by cutting all subsidies to the grain-to-ethanol business. Of course this would mean a disaster for that business, but it would probably be a big help in fighting inflation. Though I don't expect him to do this, since he's too committed to it.

Oil prices are also rising, in case anybody failed to notice. On this Tuesday (11 September) OPEC will have a meeting to decide their production quotas. It is highly improbable that they will increase their production, since they probably cannot (this has been thoroughly analysed at The Oil Drum). OPEC will probably keep production at the current level, thereby keeping world market prices high. This means that the slightest disruption in this tight market could send oil prices upwards. Goldman Sachs already expects oil prices to hit $95/barrel this year (they're at about $75 now).

Many Companies in (Potential) Trouble
The current credit crunch is also a severe threat to the economy. Even if the FED lowers its rates, many loans (commercial and private) are tied to the LIBOR. The 3-month LIBOR is currently up to 5.70 percent, thereby increasing interest payments for all loans tied to it. It has also become much harder to actually get a loan. Outstanding commercial paper has contracted by nearly $300 billion over the last four weeks (source: Credit Bubble Bulletin). So many businesses will have a hard time due to either higher interest payments, lack of funding, or both.

Of course, all businesses connected to the housing boom are in even worse trouble. For example home builder Beazer received notices of default this week from a bondholders' group, while luxury home builder Hovnanian reported losses for the fourth quarter in a row.

For mortgage lenders you can watch the Implode-o-meter to see them going down one by one. The biggest one, Countrywide Financial, announced on Friday that they will cut 12,000 jobs (20% of their workforce).

Countrywide also seem to have been into some shady stuff too. They even seem to have neglected sending required paperwork to the IRS. Is this the beginning of another Enron-style scandal?

It is also getting harder for mortgage lenders to get funding. Citigroup announced that their First Collateral Services unit won't accept new clients for "warehouse" credit lines, which provide cash to mortgage banks so they can fund home purchases and refinancings. Does this also imply that Citigroup sees problems with their current clients? How many bad housing loans are actually connected to Citigroup in some way?

Citigroup also might have other troubles. Like many other banks, they have so-called SIVs (Structured Investment Vehicles) and conduits, which operate separately from the bank and are not on its balance sheet, but generate investment profit (hopefully) for the bank. According to Wall Street Journal, Citigroup "owns about 25% of the market for SIVs, representing nearly $100 billion of assets under management". If these SIVs start going bad Citigroup might have to help them out or take on some of their losses. Now according to Wikipedia, Citigroup, apart from being the world's largest bank is also the world's largest company (by assets), so hopefully they can sort out quite large amounts of problem debt.