Gonna be here awhile? Yes, we are. Some people look around and think they see "green shoots" springing up in the economy--you know, the same way pilgrims to religious shrines swear they see tears running down the cheeks of Mother Mary. Look at an inert object long enough, and you will eventually see what you want to see. The human brain, after all, is hard-wired to look for change.
The graph above is an ill omen for an economy built on rampant consumerism. It says that stuff is just not selling. While business inventories in the U.S. fell in February by 1.3% (a welcome precursor to recovery), sales fell as well, leaving the inventory-to-sales ratio virtually unchanged. That ratio needs to come down before businesses decide to ramp up orders. The best that can be said about the economy, according to Paul Krugman in today's N.Y. Times, is that "things are getting worse more slowly."
Bank stocks have rallied furiously in the last six weeks, leading some to believe that better times are just ahead. This morning Citigroup (trading at just a buck not too long ago) reported a lower-than-expected loss. Earlier this week Goldman Sachs and JPMorgan Chase also posted decent results. But can those profits be replicated in quarters to come? I say no, and here's why. First, last year's fourth quarter was a "kitchen-sink" quarter for the banks, which all took massive write-downs to make this year's Q1 look good by comparison. In fact, Goldman, in a clever piece of bookkeeping legerdemain, orphaned its hideous month of December by changing its fiscal year!
Second, most of the recent profits were generated by trading activity, where the firms either placed bets on securities themselves or collected fees from other investors doing the same thing. Heightened volatility in the stock market enabled these players to harvest sizable short-term gains. When the market takes its next leg down--and it will--volatility will get crushed, along with the trading positions. Then the banks' investment divisions will get back to doing what they did all of last year: taking losses.
Third, banks will be forced to write down heavily, perhaps as early as the second quarter (the one we are in now), for looming losses in home mortgages, credit-card debt, and commercial loans. Anticipating more pain ahead, JPMorgan increased its loan-loss reserves by $10 billion, or over 50%. Goldman is getting ready for the next wave of defaults by issuing $5 billion in new stock, signaling both that it will need the cash and that it does not expect its stock price to advance from here. Betting on a recovery is betting against Goldman.
Mainers were just reminded of a fourth headwind facing the economy: imminent corporate bankruptcies. Yesterday Portland's television reporters, as they usually do when they want "hard" news on the economy, went to the Maine Mall to talk to shoppers, who were asked about the announcement that the mall's owner, General Growth Properties, Inc., was filing for Chapter 11 bankruptcy protection. None of the shoppers knew that GGP was being pushed to walk the plank by bondholders. Normally bondholders avoid the courts for fear of a haircut, but no longer. As the Financial Times reports, those protected by credit default swaps (CDS) are now highly motivated to push for bankruptcy, which triggers face-value payouts on the bonds. That default insurance was written by the AIGs of the world.
Which means that, thanks to the TARP bailout, you and I will be paying it.
At an auction last week to settle the credit default swaps on GGP's bonds, the secured debt was priced at $0.43 on the dollar, which would seem to put federal taxpayers on the hook for the other $0.57. Worse, the discount signals no visible end to the crash in commercial real estate.