Stiffing the Professional Classes

Listening to a Bloomberg reporter interview Yale professor and housing guru Robert Shiller, I couldn't help detecting a certain anguish in her voice as she described the plight of jumbo mortgage borrowers, left out of the current version of the Obama administration's housing rescue package. Reading a Bloomberg article on soaring default rates among jumbo borrowers reinforced my sense that the interviewer actually knew, from personal exposure, something about the issue (not that she's personally in the situation, but her socio-economic cohort sure is). Sort of like the difference between living through a hurricane and watching the event on national televison.

There are going to be a lot of upside down homeowners with six figure incomes, seven figure real estate exposure, sufficient assets outside their homes and retirement accounts, etc. who are about to be awfully surprised the first time a major life event compelling recognition of a real estate loss occurs. I'm talking job loss, divorce, corporate relocation, retirement, etc.

Plowing through Obama's version of a bildingsroman (novel of a young man coming of age), I don't think he's going to personally have much sympathy for that group. Of course, others in his adminstration will, since it is the class to which they belong.

This promises cultural and social consequences as well as having economic implications. It may have political repercussions, as well, though it's going to take a while for the innate conservatism of those who believe themselves winners on the basis of merit to be punctured.

Consumer Spending Collapse

This is annectdotal to the point of personal.

Since the first of the year, my personal consumer spending has completely collapsed. Ignoring services for the moment, in the last six weeks I have personally spent more on maintenance and repair of existing possessions than I have spent acquiring new stuff. By maintenance and repair I mean tuning a piano, clothing alterations, replacing the broken glass in a picture frame. Most of the money I have spent on clothing represented cashing in a gift card received at Christmas.

This is neither me going broke in a cash since nor the traditional post holiday lull in consumption reflected satiation after the consumption excess of the holidays. We had a very light Christmas, and, though we're suffering with everyone else, we're not in a cash bind. No, as far as I can tell, I'm buying nothing because I'm simply not in the mood to spend. If I go shopping, its to buy groceries. If I go to Home Depot, it's for light bulbs. I am not tempted by the late winter pre-Season discounts on the propane grills. I have enough clothes and other crap to last me for the rest of the year, and then some.

Two slight qualifications. Obviously, we're still buying groceries, paying the utility bills, etc. And, the rest of my family is not quite as retrenched as I am. I think their psychological outlook is not quite so bleak, dark and forboding. I hope they are correct and I'm just over-reacting.

But the reaction is undeniable, and startling.

The casino, the cruise line and the utility company

Going into this financial crisis, the financial services sector has become one part casino, one part cruise line and one part utility, all unfortunately jumbled up and intertwined. The situation was dressed up and described in complimentary terms as the 'financial supermarket' model of the future. Citicorp was the exemplar.

Well into the mess, using summer 2007 and the time when innocence ended, we can now see that rolling those three kinds of activities into single entities, and, in effect, cross collateralizing the liabilities associated with each was, not to put too fine a point on it, insane.

The crying need de jour is to somewho unsort the jumble. Shut down the casino, leaving the players to bear (and bare) their losses. Let the cruise line sail away, to thrive or sink on the skills of its crew and the public's demand for asset management and investment advisory services. And nationalize the utility, so that deposits can be gathered, credit extended, transactions cleared, and so on, for the smooth functioning of the general economy.

Easier said than done.

Night of the Long Knives

for major law firms.

I suppose it is fair enough. The Wall Street and Beltway lawyers were the shock troops of financial deregulation, and to this day in the pay and under the thumb of their clients who prospered in the recent economic episode now ending in tears and terror for all involved.

But, if you're enough of a street fightin' man, when the times change, your ability to belt out the leider inevitably ends in the gurgle of a slit throat.

Law firms are interesting animals. Full of sophisticated people, they are themselves quite primitive. They tend to have one big long term liability--their real estate leases--and one big short term asset--their accounts receivable. They don't have any capital to speak of--in a partnership the capital accounts are kept minimal and in an LLC the shareholders equity is de minimus for a combination of tax and practical business reasons.

On top of that, the quarter to half of the attorneys who are the proprietors--the partners--tend to view their incomes, not as the firm's profits, but rather as their salaries/draws for their own law practices. So, in effect, the firms have Godawful operating leverage, even if they don't have much financial leverage (and even less of an equity cushion).

In a truly bad year, not an off year, a bad year, the firm's profits disappear. That means the partners have no incomes. In a horrible year, with losses, not only do the partners have no incomes, the firm has no equity cushion to absorb the losses.

Major law firms are a post WWII phenomena. The major firms of earlier eras were fundamentally different creatures. Most of the partners of those versions of today's power houses could go a year or so without income from the firm. I'm not sure that is still the case.

My guess is that you'll be seeing some chaos in the legal profession.

Tough times at the Barber Shop

Terry the barber reports people are spacing their haircuts further apart.

Terry cuts hair in downtown Portland, Oregon, in the basement of the local Wells Fargo headquarters. He's been around for a while and has a good client base. He isn't losing many customers (a few, but not many), but his business is down 20-25% and he attributes it to people letting their hair go a little longer between cuts.

He's philosophical. But he left my hair a little longer than last time. Maybe two weeks longer. No fool there.

Progress?

We may be seeing a few signs of progress.

New Realism. Only the politicians are still talking about getting things back to the way they were. Even with them, it is beginning to sink in that the People are Really Mad. You can get away with a lot when nobody's paying attention, not so much when they are. People are on the cusp of paying attention, and they don't like what they see so far.

Nationalization of the Banks. Even POTUS is publicly discussing the Swedish alternative for dealing with the financial crisis. He's giving the American people the choice of a Japanese or a Swedish outcome. He notes we have a different political culture and society than Sweden, but the last time I checked, the U.S. didn't look much like Japan, either. So, we'll be finding our own way, but with a due regard for the experience of others.

Socialism. Right now the social agenda of the new administration is completely on hold. Be interesting to see if health care reform gets lost in the shuffle. But if the public mood continues to shift, there will be a new focus of the strands in American culture that emphasizes collective effort, community action, fairness and equality, rather than those celebrating the free market efficiency, meritocratic individualism and personal freedom for anyone who is not a free-thinking pervert of color.

Remember the hung bridge loans of the LBO Boom?

They don't get much attention these days. This time last year, there was a school of thought that held that cov lite LBO financing posed a greater risk than structured finance product to the balance sheets of global capital markets institutions. Of course, this time last year, the SIVs and other off balance sheet arrangements hadn't been brought back onto those balance sheets.

Still, those loans were made, and they are sitting somewhere (in the case of Lyondell, on a bankruptcy schedule). But they aren't getting much attention, at least not publicly. I have to wonder if that's because they were quietly and successfully written down and placed while the media frenzy was focused on other issues, or if like landmines left over from some long ended conflict, they aren't still a lurking danger.

Tonight's prediction--this is going to be a long, variegated and unpleasant ordeal. The impact will fall unevenly, the sequencing of events will be uncertain (but interelated), and the closer you were to the point of impact the worse it will be for you.

In other words, for a change the American homeowner and the London investment banker are going to feel the impact more than the Japanese apartment dweller or the Brazilian shopkeeper.