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The Government's Effort Has Failed

Karl Denninger
Market Ticker
Sep 10, 2009

The Federal Reserve's latest (through July) G19 update is out, showing consumer credit.

To say that these figures are ugly would be an understatement.  In fact, there is simply no way you can spin this - while this contraction in credit has to happen it has horrifying implications if our Washington policymakers don't get on the stick and deal with the underlying issues here and now instead of pretending that everything is ok or worse, try to "borrow our way to prosperity."

Let's start with the "Full Monte"; this is the "de-noised" version of The Fed's "annualized" rate of change chart (click for a larger version of any of these):

The important point is that we have never been here before in the post-Depression era.  Any and all claims that "The Consumer has reached a bottom", or "The Recession is over" (based on July data) or any such is pure nonsense.  There is not only no sign of a bottom there is no change in the second derivative - that is, the rate of change continues to be essentially straight down!

(By the way the method I use to "de-noise" the figures is simple - I have Excel computing a percentage change .vs. 12 month prior numbers rather than annualizing monthly changes as The Fed does in its headline release.  Their method is extremely noisy and difficult to draw conclusions from without waiting for a number of months in sequence to indicate a trend shift, where going y/o/y very effectively highlights true trend shifts almost immediately and yet is not subject to this problem.)

Looking at the same de-noised figures for revolving and non-revolving debt is even worse:

I had taken a (small) amount of comfort in the fact that non-revolving credit looked to be well behind its cousin the credit card.  Well, not so much any more.  Yes, its behind, but its catching up fast and in fact the slope has matched its brother now.  With "Cash for Clunkers" partially in July that we saw non-revolving credit (car loans) continue to decline is an extremely ominous sign.

Here's the close-up of the last couple of years, corrected per The Fed's latest release.  Note that credit card debt went negative on a rate-of-change basis at the end of 2007 and the actual peak of non-revolving debt was a couple months earlier!

The total consumer credit amount outstanding fell by an astonishing five times what economists were predicting.  Here's the current outstanding graph:

There were significant revisions in this release, the most important of which appear to be that the credit peak was actually not in January of this year, but rather in July of 2008!  The impact of this is very material in that we have been deflating our credit system on a consumer level for six months longer than The Fed was disclosing just last month.

Accident or something more?  I have no idea.

Now let's add to the misery:

The Social Security Trust Fund reported an August net deficit of $5.865 Billion. This is the largest monthly deficit in nineteen years.

The problem here is twofold - the long-term financial shortfall for Social Security sounds awful, and it is.  But its a "kick the can and turn your head" thing and has been for more than 20 years.

This problem is more acute - the long-term deficit incurred by the $6 billion that had to be borrowed is some $17 billion dollars, not $6 billion.  More important is the fact that we have to borrow that $6 billion now, where Social Security has for years run a surplus that has gone to the "credit" side of the balance sheet (at least in the short term, screwball though that accounting is.)

The entire premise of the claim that "we have stabilized the banking and credit system" rested on the following three legs of the stool:

1. Unemployment would reach only 8.9% this year and top 10.3% in 2010.  We have already exceeded that.

2. The economy would contract by 3.3% this year and remain flat in 2010.  Not a snowball's chance in hell on a private activity basis; we're running pretty close to double that rate.

3. Housing prices would fall another 22%.  We might be ok there for the moment, but only because of foreclosure moratoriums, game-playing by the banks (refusing to actually foreclose and resell REO property) and similar tactics.  This delays but does not change the outcome.

The problem is that nobody modeled in credit contraction like this on a consumer basis. 

Simply nobody, despite the screaming that I (and a few others) did going back two years which demonstrated that the consumer was in the process of hitting the wall with their credit capacity - it was evident back in 2007 as the mix of credit shifted from HELOCs and similar toward credit cards.  That this would result in a disastrous contraction in both lending and spending when the end of the rope was reached was obvious - and ignored.

Yet a huge part of being able to "earn your way out of the hole" - the entire premise of the "banking rescue" - required that you be able to soak people who have credit with higher rates and fees. 

Banks can't do that when the credit base is contracting, and it is. 

What these figures tell you up above is that those who can borrow are refusing and those who want to borrow are unable (not credit-worthy.) 

There is no other interpretation.

At the same time the supposed "official" statistics say we lost 216,000 jobs. [pdf]  Unfortunately the household survey, in the same release, says something different.  Their "official" numbers on the household survey say 466,000 fewer people were working, not 216,000.  But it gets even worse than that when you dig into the actual data.

If you look on page 10 in the Household Survey you see the line "Employed."  July to August that number declined not 216,000, not 466,000, but a staggering nine hundred and eighty-one thousand people.

So where did the rest go?  They gave up.  Note that the counted "unemployed" actually fell by 378,000 people.  Those are people who simply aren't looking any more - they have deduced that there is no point to searching for a job.

The BLS doesn't count those people as "unemployed" but the merchant on the corner and the bank next door sure as hell do.

These aren't "seasonally adjusted" numbers, they're raw counts from the household survey.  They reflect "boots on the ground", or in this case, "butts on the sofa" instead of "hands on the assembly line."

In summary:

We were told that the consumer would be stabilized this summer: False.  Same-store sales numbers say no, sales tax numbers say no, employment tax receipts by the IRS say no and consumer credit numbers say no.

Unemployment is vastly worse than statistics show.  Those who give up may not be added to government official reported numbers but the merchants who are trying to sell things and the banks who are trying to collect debts all count those who give up as "unemployed" when it comes to being able to buy or pay, and we lost five times the number of people from those getting a paycheck when actually counted compared to the official government claims.

The bank "stress tests" were predicated on not exceeding levels already blown through.  They're invalid.  Period.

We know banks are lying about asset values.  We know this to be a fact because lots of them are failing and when they do, in essentially every case, we're discovering 20, 30, even 40% losses that were undisclosed just days prior.  It is a near certainty that the big banks that are "too big to fail" have similar losses on their books.

"Extend and pretend" isn't making things better.  It is in fact making them worse.   We have done nothing about the "too big to fail" banks except make them bigger, with two now beyond the federal deposit concentration cap!  We must stop this now and use what credit capacity the nation has left to protect depositors.

If you model the existing trends forward 12 months you get unemployment rates approaching 20% and GDP contraction exceeding 10%.  Since we have no evidence of a trend change in these credit metrics and in fact tax receipts (one of the best indications of actual consumer and employment activity) validate these trends, there is every reason to believe there is a reasonable possibility this outcome will occur.  Absolutely nobody in the mainstream media is talking about this, but the numerical facts are "in your face" in this regard - if you look.

The big banks must be broken up, forced to mark to reality, forced to take all their SIVs and other trash back on their balance sheets and reveal the truth.  I'm very certain the truth is bad - catastrophically so - but it will only get worse the longer we wait.  President Obama and Treasury have a nice market rally to do this into, which will blunt its impact.  If we wait and there is another precipitous decline we will instead be forced to do it under much-less-benign circumstances.

The consumer is not coming back any time soon.  Give up folks. Spending power doesn't come from a government statistic, it comes from a paycheck in the hand, and those who give up looking because the job situation is so horrible its a waste of time have no paycheck. The government can no more replace consumer spending on a durable basis than I can fly.  The "bridge" concept that underpinned Paulson's, Bernanke's, Bush's and Obama's plan has failed; we have simply thrown $2 trillion dollars into a black hole and our creditors will realize that has happened soon enough.  We must have taken care of the bad banks and their assets before that happens or we will suffer a catastrophe.

Hiring isn't coming back any time soon either:

SAN FRANCISCO (MarketWatch) -- Employers' hiring plans for the upcoming fourth quarter dropped to their lowest level in the history of Manpower's Employment Outlook Survey, which started in 1962.

That needs no further explanation.

President Obama is trying to kick the can again:

The Senate must move legislation to raise the federal debt limit beyond $12.1 trillion by mid-October, a move viewed as necessary despite protests about the record levels of red ink.

I know The Senate almost certainly will, but they and the administration must instead grow up and do the right thing, or we risk...

Sep 9, 2009
Karl Denninger


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