Oct 13. A sense of distrust

Here’s a paragraph from Yale Alumni magazine (Sept/Oct 2009), in an article by David Leonhardt who interviewed Robert Shiller (of housing market bust fame). 

“What is the thing that should be on our mind now?” as Shiller put the question.  “It’s how to preserve this sense of justice and good feeling that we have in this country-this feeling that I am willing to operate and do business in good faith because I feel that’s what people are doing and that’s what a good citizen should be doing.” Survey data from around the world have shown that countries grow more quickly when people trust their fellow citizens.  But the financial crisis and the recession have left many Americans with a sense of distrust, Shiller said.  A prolonged period of high unemployment-which now appears to be the most likely scenario-could aggravate the situation.  The United States, in other words, may be heading into a period of irrational pessimism.  Figuring out how to avoid this outcome is Shiller’s new project.

 

And here’s an excerpt from a Washington Post interview (Oct 9) with Congressional Oversight Panel’s Elizabeth Warren:

Somewhere, that began to change in the late 1970s, early 1980s, and the middle class instead became like a resource to be pulled from, and you know, they became the turkey at the Thanksgiving dinner. Who could who could carve off a piece? Who can get this little piece? Who could make a profit from this piece and that piece or squeeze down on the wages? And the middle class has gotten shakier and shakier, hollowed out.

The consequences of that are far more than economic. The middle class is what makes us who we are. It’s affects the poor. A strong and vital middle class is a middle class that can offer a helping hand to the poor. A strong and vital middle class is a middle class that has room, is creating new jobs to basically to suck the poor up out of poverty and into middleclass positions. The middle class is what gives us political stability. It’s what gives us an America that’s all bought into the whole process that what we do is not just about a handful of folks at the top who profit from it. We all profit from it, and that’s why we work, and that’s why we vote, and that’s why we accept that the outcome of elections. And that’s why we’re safe to walk our streets, because we have a middle class for which this ultimately works, this country.

And every time we hollow that out, every time we take away a little piece of that, we run the risk that some of what we understood at America, some of what we know as America begins to die. That’s what scares me.

The sense of distrust that Shiller talks about and that Elizabeth Warren alludes to are becoming large economic headwinds in the US economy.  I believe this sense of unfairness is the main factor behind Tea Party movements and town hall melees ostensibly against health care “reform”.  The groundswell of angst about basic fairness and opportunity runs into direct confrontation with Keyne’s ‘animal spirits’.  When thoughtful people openly voice powerful concerns about core American values, we should all pause a moment to consider the ramifications.

The current policy prescription in the US (and the UK) seems to be to prop up the housing market by essentially doubling down on the bet with public funding.  In other words, replace private credit with government funding and guarantees, and allow poor credit risks to make 3.5 to 5% downpayments on these now lower priced properties and hope they don’t default.  But the experience of the FHA indicates these borrowers are defaulting anyway (8% delinquent or in foreclosure by the end of June).  Because of the enormity of excess valuation of real estate relative to income, there is no way that policy makers can do better than halt the real estate slide, and even then, the fix is likely to be only temporary.  From a recent presentation by Edward DeMarco, Acting Director of FHFA, “The serious delinquency rate is 3.1% at FRE and 4.2% at FNM.  These rate are disturbing both in their magnitude and in the fact that they continue to increase.” 

There is a sea change in consumer behavior and psychology.  Consumer credit is imploding, down over $33 billion in July and August.  From an October 9 Business week article. “Only 46% of people aged 16-24 had jobs in September, the lowest since the government began counting in 1948.”   Here’s a thought from my 14 year old nephew Julian Manzara (we are running a mock portfolio) “More inexpensive stores may be a smart move, or an interesting addition to our mock portfolio. I agree that people will turn away from stores like A&F not only because of the high prices, but because they don’t like the idea of these high prices. What I mean is that being thrifty is “in”. In fact I have been made fun of for wearing brands such as Hollister. Keep in mind that by “people” I have teens in mind, that these thoughts are based on my experiences at a single high school and may not portray a tendency, but might…even the popular kids are wearing mainly unmarked clothing. As for adults I’m not sure, but if they are the ones spending the money, and you’re correct about the economy, then your thoughts seem spot on.” 

Though the federal government is trying to plug holes left by declining household spending, state budgets are struggling in the other direction.  In NY Gov Paterson ordered spending cuts as income tax revenue has declined by 36%.  In CA, the new budget has already been busted.  (Bloomberg, Oct 10) “Revenue in the three months ended Sept. 30 was 5.3 percent less than assumed in the $85 billion annual budget.”  There was a $1.1 billion drop in revenue.  In Illinois, (AP) “Comptroller Dan Hynes said the backlog of unpaid bills has reached $2.9 billion — a record for this stage in the fiscal year. At this point last year, the backlog was just $1.8 billion.”

Equity markets have been cheered by government backstopping of financial institutions along with extremely low funding costs for financial and other large corporations.  The decline in the dollar has also been a factor, making US assets attractive to foreign buyers.  But if a domestic sense of distrust and unfairness begins to gain critical mass, the domestic equity market is sure to reflect that sentiment. 

Posted on October 12, 2009 at 3:55 pm by alexmanzara · Permalink
In: Eurodollar Options

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