American Madness

Intelligent Criticism in the Service of a Better Nation

We are not getting out of this mess quickly

Posted by Josh Friedlander | 4 Comments

Chart from U.S. News and World Report (included here to scare the hell out of you)

Many of the assorted pundits of the financial press are trying to call a bottom to the current market crisis.

Some of these pundits are just silly, but many others are willfully ignorant of how many hurdles we face. Also, a stock market bottom is not very meaningful, as I’ll explain below.

What we need to know is when we’ll be in a position to rebuild our economy based on something other than paper shuffling. But in any event, I can’t see clear to a bottom until a few events occur:

- The default rate on junk bonds rises a LOT higher from its absurd historic lows of the past few years. (Default guru Altman at NYU sees 2009 default rate doubling).

- More news of defaults of credit card debt, student loans, and car loans.

- High oil prices (when they fly high again in a few weeks/months) combined with a weak dollar (when it loses its current steam) kill the Chinese export phenomenon causing them to dump treasuries (or at least stop financing our profligacy), creating inflation in the U.S., and hurting stocks of companies pegged to an export model that only works when oil is cheap (not to mention, as WSJ pointed out yesterday, that the shipping companies overspent buying new tankers and are in trouble now).

- The tsunami of corporate fraud lawsuits related to stock declines and bond defaults leads a bunch of major companies, Wall Street issuers, bond raters and private equity firms to create and deploy huge litigation reserves.

Also, I think the bigger issue is that the notion of a bottom doesn’t mean very much when we’re likely to be living in a stock-market valley. It will take at least 5 years (very vague guess) to work out the structural issues (debt, labor, earnings models) that companies face.

But even if these companies work out their problems, it doesn’t necessarily mean that you should bother with the stock market. If you’re interested in buying stock, I think it’s very important to consider the real historical return of stocks relative to bonds. People love to say that the stock market earns about 7% “over the long-run,” a vague phrase if ever there was one. That 7% is just marketing, and having just enjoyed a massive run up from 1982 to 2000 and then a smaller runup from 2003-2008 (which now looks to have been a very large, cheap-money-fueled dead cat bounce), one can hardly expect another 36 years of stock market glory.

As noted in Maggie Mahar’s book Bull: A History of the Boom and Bust, Martin Barnes, author of The Bank Credit Analyst newsletter, wrote in March 2003 that “The ratio of equity returns to returns on 30-year Treasuries is now back to the level of September 1980. In other words, a buy-and-hold investor would have done just as well holding Treasuries as investing in the S&P 500 over the past 22 years.” He adds: “Wall Street’s dirty little secret is that in the 34 years from February 1969 to March 2003 stocks outperformed long-term Treasuries by a paltry 1% a year, on average. This is a dismally small gap, given the extra volatility in stocks.”

In terms of financial stocks, which investors would love to think of as being merely depressed, I have no idea what to think. Banks are clearly not as sexy as brokerage firms, but the bigger issue has always been cost. There needs to be some recognition on Wall Street (what’s left of it) that brokerage firms made huge profits (even before they used leverage of ~30:1 to run internal hedge funds) by offering a very costly and deliberately inefficient service. Securitization is not rocket science and electronic markets can replace most of the remaining highly-profitable otc BS. There’s also no call for 23-year-olds to be paid a $60k base salary and $40-$60k bonus in investment banking jobs to create pitch books. I’ll concede it’s possible that the global banking franchises could do well serving emerging economies. The success of global banks depends on a vast number of criteria and I will not hazard a half-vast guess at their prospects.

I think pundits are saying we’re nearly safe because they are ignoring all the above, and the consumer credit card issue, especially. As notes, the average American with a credit file owes $16,635 in debt, excluding mortgages, according to Experian (Source: U.S. News and World Report, “The End of Credit Card Consumerism,” August 2008). If there are fewer jobs, wages decline, and cheaper credit isn’t available, eventually the debt will come due. With bad headlines thrown in, and higher taxes (lord knows what kind of tax mugging we’re going to see from the next U.S. president, because he’ll have to raise taxes), and even if Bernanke offers free money again (a la 2003-4), consumers will feel poorer and they won’t spend and there goes the U.S. consumer-centric economy.

I guess the oil companies are still a good bet, because it would take a real miracle battery solution plus a multi-gazillin-dollar electric transmission grid project plus more effective green energy capture technology (e.g., better solar) before we can get off oil (unless someone develops individual-use cold fusion).

I’m thinking of moving to Mexico. Down there, my savings will last me 10 years if I eat nothing but rice and beans.


4 Responses to “We are not getting out of this mess quickly”

  1. Joel Friedlander
    October 11th, 2008 @

    Lets just look at one sentence in this article, “I’ll concede it’s possible that the global banking franchises could do well serving emerging economies.” Now why is that? The reason why that is a valid statement is that the real purpose of the Markets was supposed to be to provide capital for developing and sustaining enterprise.

    Now enterprise is not pushing paper around without purpose other than to generate paper profits. The concept of a new enterprise is to create a new business that makes something. In earlier times in this country that meant building a new factory to manufacture automobiles, washing machines, television sets, computers, stoves, refrigerators, chairs, shoes, tables, socks, shirts, suits, etc., etc. When we ditched that purpose and became a “Service Economy,” we sowed the seeds of our own destruction. We need to manufacture things in America, as unromantic as that may seem, and in America means within the borders of the fifty states. There is no benefit to the major part of society to have businesses going over to the Philippines to manufacture goods, or establish their phone call marketing, etc., there. We need to put Americans to work here, not other people elsewhere.

    If the financial markets begin funding things in America they will have plenty to do and perhaps we can move back to prosperity. It is true that perhaps the government will have to completely take over the health care industry so that we can take those massive costs off of the backs of our manufacturers, but that will be a benefit to everyone. We have been listening for years to how those costs made it impossible for GM, Ford, and Chrysler to compete in the world marketplace. It is time to remove that handicap.

    Its time to be able to go into a store and find garments that say “Made in USA,” instead of just made in China. I am just so sick of seeing “Made in China” on goods sold here.

    Also, the credit card companies have given credit to anyone who had an address they could send a bill to. It is time to create laws that prevent them from giving improper credit to people and it is also time to regulate the USURIOUS rates of interest that they charge for their products. If that changed it would be possible for people to pay off their credit card debt and then start either saving or investing the money that they have in useful enterprises. We also need to put an end to the size of the consumer portion of the economy and increase the production side to replace it. There is a store called Buy, buy bady. It is time to put the cap on that kind of thinking. It should be produce, produce, not buy, buy, or save, save, not use, use.

    If we don’t make those types of changes it will be forever, as Josh suggests, before we climb out of the hole that we have dug ourselves into.

  2. Joel Friedlander
    October 11th, 2008 @

    Oh, yeah, if you eat only rice and beans you’d better be prepared to spend your life farting.

  3. American Madness » Blog Archive » A basic problem of logic
    October 11th, 2008 @

    [...] NYTimes articless allow comments and others do not?), I wrote the author an email, adapted from my post of the other day: Sir, yours is a common but seemingly odd argument at this time, given that we’ve just [...]

  4. Connor
    June 14th, 2016 @

    Hey, thanks for quoting our stats page! As a heads up, we just redesigned that page, so the debt statistic can now be found here, if you have time to change the link:

    -Connor, on behalf of

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