Tuesday, January 27, 2009

Why the economy is getting worse

As if to underscore the daunting financial mess confronting President Obama, on January 20, a new plunge in banking stocks dragged the market to just 400 points above its November 20 close. The index of 24 bank stocks tumbled 20% causing the Dow to fall 332.13 points, or 4%, to 7,949.09, its worst performance ever on the day of an inauguration. So far, November 20 marked the bottom of the bear market that began more than a year ago.

Although the sell-off was triggered by anxiety about the depth of the banking crisis and its effect on the economy, I have read and heard some far-right-wing dunderheads try to blame the most recent stock market decline on President Obama’s Inaugural speech in which he warned that the economic recovery would be difficult and that the nation must choose "hope over fear, unity of purpose over conflict and discord" to overcome the worst economic crisis since the Great Depression.

It’s the banking crisis, stupid: Disillusioned investors fled financial companies as fresh evidence mounted that the industry's problems are larger than previously understood, larger than the response so far mustered by the government and perhaps larger than the resources remaining in its rescue program. This latest phase of bank stock sell-off began after New Year's Day and intensified when Citigroup and Bank of America reported huge fourth-quarter losses and the government invested an additional $20 billion in Bank of America.

Britain has just officially announced that it is in a deep recession. The possibility of bank nationalizations, in which governments take direct control of financial institutions, is happening in Britain and elsewhere, as some of the world's biggest banks report surprisingly dire results. The industry's plight, intertwined with the ongoing recession, is the greatest challenge presently confronting not only our President but many leaders of the world.

The news that's coming out is staggering:

Shares of State Street Corp., a Boston-based financial giant that had been viewed as a relatively safe harbor amid the industry pandemic, plunged 59% after the institutional money manager disclosed sizable fixed-income trading losses. Bank of America tumbled 29% after analyst Paul Miller at Friedman, Billings, Ramsey & Co. predicted the bank would have to raise at least $80 billion in new capital. Wells Fargo slid 24% after Miller said the company might slash its dividend. PNC Financial Services, a major regional banking company based in Pittsburgh, nose-dived 41%. Citigroup fell 20%, and JP Morgan Chase lost 21%. Shares in the sector have been crushed by fears that spiraling loan losses could force the industry to seek billions of dollars in additional capital. That could lead in effect to a nationalization of the industry because, with private investors afraid to step in, the government has been the only supplier of funds. The government now controls these banks in a “de facto” nationalization.

Britain on Monday undertook a second round in its bank bailout and said it would boost its stake in Royal Bank of Scotland to more than two-thirds. The company's American shares, which didn't trade Monday because of Martin Luther King Day, plunged 70% on Tuesday. Ireland has moved closer to nationalizing its third-largest bank, which has suffered from scandal as well as losses, but the government said it wouldn't take control of its two largest financial institutions.

Don’t blame the little guy

Those who blame the little guy must realize that although some borrowers knowingly bought more house than they could afford with the idea they would flip it in two years, unscrupulous lenders steered the majority of mortgage holders into these loans. These unsophisticated, fiscally uneducated borrowers did not understand the small print, but instead, listened to and trusted the lenders. Evidence shows that many who would have qualified for fixed-interest loans were steered into sub-prime mortgages such as adjustable rate mortgages where the interest increases every few years with resulting astronomical house payments or ARMs where the entire mortgage is due in full in five years (called a balloon). These dishonest lenders refused to re-negotiate the loans and foreclosed on hundreds of thousands of homes nationwide because they thought they could resell them at a profit. The market became flooded with homes, the housing bubble burst, home prices plummeted, and down the economic house of cards went.

The global banking industry, which has written off more than $1 trillion of mostly mortgage-related holdings, now is being crushed by losses in areas such as credit cards and commercial real estate that are tied to the faltering economy. For the past decade, lenders offered credit cards, at low teaser rates, to everyone, even to those who had little to no income. Fiscally unsophisticated borrowers ran up huge balances because the “monthly payment” was “affordable”. Then using the borrowers lowered credit score, sometimes even their health records, as an excuse, banks pushed the interest rates as high as 35%, locking these people into a cycle of increasing debt.

Not to be outdone, the check cashing, title loan, and quick loan industry preyed on seniors who faced unbudgeted bills they could not pay (extra large utility bill, medical bill, etc) and whose Social Security checks barely cover the basics. These businesses make short term, one month loans to these seniors for a large fee. Once the elderly person cannot pay off the loan at the end of the month, the balance owed starts to climb exponentially. The state of South Carolina has one of the worst records in this area with thousands of seniors losing everything they have due to the state not regulating these predatory loan sharks.

So, although some far-right-wingers are already blaming the latest downturn on President Obama, the root of our economic dilemma is a too long unregulated banking, investment, and mortgage industry. This deregulation was a fundamental part of the trickle-down, laissez-faire economic policies pushed by the Republicans over the last 35 years. Then, fourteen months ago on Bush’s watch, while he was telling us that the fundamentals of the economy were strong, the house of deregulated cards began to fall, taking many other countries with it because these countries invested heavily in American stocks and bonds. Already, Iceland has become insolvent as its banks crashed and the government dissolved.

I hope I am wrong on this prediction: Obama can gather together as many highly intelligent, experienced experts as he wants and put their suggestions into policy, but the train left the station long ago. Already having gathered much speed as it feeds on itself in a downward spiral, I do not think it can be stopped. This is going to get much, much worse. I think we are looking at several years of deep world-wide recession, and if not actually sinking into a depression, it will at least border on one.