Jolting Factoid de Jour

Driving up to the Whole Food Store in Tigard, Oregon, what did I see but an large placard advertising 'great prices'. Now, I've never thought of the Whole Food Store as competitive on price. Not for nothing is it called the Whole Paycheck Store. But no one goes there to save money. Of course, you save money but eating at home instead of eating out, but there are cheaper ways of buying groceries to feed yourself at home.

Then, I read in the David Rosenberg (Merrill Lynch) piece claiming that the economy is already in a depression. He buttresses his argument by claiming that there is evidence of a substitution effect in grocery price trends (affluent households substituting an inferior good like chicken for veal, less affluent ones substituting Spam for canned tuna).

Now, anyone who took economics in the middle of the last century will recall that argument. But it has been since sometime in the last century that, in affluent America, any substitution effect was discussed in response to rising food costs. The substitution that has been occuring for the last generation has consisted of eating at home instead of the higher cost, more convenient alternative of eating out. Rise of the two income family, both spouses working, who wants to come home and cook and all that.

If people have started playing with the menu at home, we're in a new environment. If the Whole Paycheck Store has decided to compete on price, we're in a new environment. Anybody know a fancy name for mac and cheese?

It's Different This Time

Perhaps the most dangerous words in the English language when used in economic forecasting.

Nonetheless, let me argue for a moment, that the current financial crisis is, in one interesting way, different from any other since the Great Depression.

Here's the difference--in all other post-War recessions, the brunt of the loss was borne by those on the margins of society, those who were over-leveraged, the less educated, blue collar workers, unskilled labor, the non-geographically mobile, etc. The affluent, the professional classes, the corporate, political and media elite could pontificate and observe the costs of globalization and the wonders of creative destruction, without feeling any particular impact.

This time it's different. The difference is in who is going to bear the brunt of this episode.

The economically marginal who've tumbled into the hell of part time hourly work without benefits had already hit bottom before this mess started. Those people weren't buying new cars, sending kids to college off the home equity ATM, and socking away six figure balances in 401k's. And we do have a frayed and tattered social safety net in this country that to some extent ameliorated and ameliorates their distress. That safety net isn't going to disappear, and is likely to improve substantially over the next couple of years, to the benefit of the economically marginal. They will suffer, but they actually face the possibility of improved circumstances.

This puppy has put those with something left to lose squarely in its cross hairs. The affluent, the professional classes, the economic elite, are the ones most at risk.Say you are an opinion leader with a major media organization, or a partner in a national law firm, or a corporate vice president with a publicly listed company. You have a six figure income, a house once worth seven figures, sizeable retirement savings, and various other financial assets.

Hopefully, you've still got the job. But everything else has taken a major hit in the last 18 months and God forbid you lose the job, because the pickings are slim, and more likely than not, whatever you can find will pay significantly less (and you'll be worth less, since part of your value at the old place was tied up in your organization specific knowledge, skills and contribution.

And if you have leverage that previously seemed modest, it will be looming major larger in the new order of things.

Here comes the Prussian Officer Corps

Following World War I, among other challenges Weimar Germany faced was a large cohort of disciplined, well-trained aristocrats mired in a military tradition, left defeated, disillusioned and unemployed following the war. They were, to put it mildly, a source of social instability, and the Junkers famously thought they could use an Austrian corporal to manage the country, with catastrophic consequences not just for Germany.

We are about to see a similar deluge of talent coming off Wall Street. Ivy League graduates with inflated expectations, impossible salary requirements, and utterly no skills useful in the brave new world following the collapse of the financial services sector. These people are, not to put too fine a point on it, a potential cadre of explosive discontent.

In the United States, structural unemployment has generally afflicted those without voice, less well educated workforces dispersed far from media centers and major metropolitan areas. The Good and the Great could smugly counsel retooling and retraining, oblivious to what is involved for a 45-year-old head of a household trying to reorient his job skill set to an entry level position for which he or she is likely to be a less preferred candidate. This time, the crowd getting the sack will be more vociferous, more visible, and (incidentally) more hated. Nobody hated a laid off autoworker the way people are going to hate former Masters of the Universe held responsible for destroying the American Way of Life.

Temperate Question

A spot of temperance in the holiday conviviality may be appropriate.

So what?

So, we have the following American phenomena that are indisputable.

1. Housing prices are in freefall. Disputes center on whether the decline will abate in late 2009 or sometime in 2010.

2. Through mismanagement, our money center banks have decapitalized themselves and are insolvent. Okay, this is slightly arguable, apologists would prefer to talk about perfect storms, risk management failures, bailouts, restructurings, etc. Fact of the matter, the banking system is not currently functional.

3. The general economy is, and has been for a year, in a recession. Thank you, NBER.

4. The pattern this recession will take is, at present, unknowable. Pretty clearly, the following are in serious trouble: anyone dependent on consumer spending, the real estate sector, the auto sector, any heavily leveraged organization. It's probably safe to assume that trouble in on its way for anyone whose principle customers fall into any of those catagories, and also for any public sector entity dependent on property or sales tax revenues.

How this will play out is anybody's guess. Typically, a stable banking sector would buffer the healthier parts of the economy from the troubled part. But, basically, the financial services sector is where the whole mess started (yes, subprime lending and a residential real estate bubble were the triggers, but a healthy financial services sector would have buffered the general economy from, rather than amplified and transmitted those problems to, the general economy.

We got a Christmas Card a few days ago wishing us a healthy and a happy 2009, and noting that a prosperous 2009 did not appear to be in the cards. I wish you the same.

Zombie Banks

Death to financial institutions!

The only justification for the extraordinary privileges enjoyed by lightly regulated banks, the extraordinary leverage available to essentially unregulated hedge funds and the mere existence of the so-called shadow banking system was that they served a greater social purpose than the personal enrichment of the participants.

It turns out that they do not.

So they should, collectively, exit the scene. Their corporate existence should be terminated. Whether the institutions are regulated out of existence, their activities are taxed to destruction or their leaders taken out and summarily shot is a matter of national taste, cultural and legal tradition.

Let's face it. Collectively, the major banks are zombies, as in, walking dead. Their problems simply overwhelm their capitalization, currently--and with any conceivable level of government support. One can argue specific cases, but there are also a couple of inarguable cases, starting with Citi.

You can't bring a zombie back to life. You can bury it.

And once buried, before the stench of the corpse has fouled the entire community, you can approach the next step of the dialectic. The resources currently being put at risk to salvage of the current system should be allocated with a strategy that will assure that, rather than being frittered away in a futile exercise, their placement will facilitate that next stage in the dialectic.

Houses in Richistan

The market for houses financed by jumbo mortgages is about to enter a death spiral. There are four reasons:
1. Jumbo financing has died up. The government efforts to get mortgage lending moving again are focused on conforming loans. The interest rate relief that has driven down the price of a conforming mortgage has opened up historically unprecedented spreads between conventional and jumbo financing.
2. Houses north of, say $500,000, are move up houses. The whole idea of moving up has been one of the prime casualties of the current housing crisis. Extracting one's equity from a middle class residence to apply towards the down payment on a larger home is harder than it's ever been.
3. The more affluent families that are the principal purchasers of these houses tend to have more financial assets than the general public. They have, therefore, felt more severely the impact of the collapse of the financial markets. They have less in the retirement plans, less in their brokerage accounts and, even if still employed in high paying jobs, are far poorer than they were a year ago.
4. The decision to buy a house has also been an odd decision--one part an investment decision, one part of matter of personal consumption. The more expensive the house, the bigger the investment component. The idea that rich people are different, and are indifferent to losses on their real estate, is ridiculous, and piously repeating it as part of the wealth worship liturgy, doesn't make it any less ridiculous. In any event, to the extent that buying a house is an big investment decision, the willingness to go long an expensive house in a declining real estate market, is markedly diminished.

And that's the mumbo jumbo.

Madoff

A spectacular crime.

A rich tapestry.

I like the thread woven by those who, believing Madoff to be a crook, nonetheless entrusted him with their money because they thought he was stealing for them, not stealing from them (i.e., front running, not running a Ponzi scheme).

I like the three-person accounting firm's ability to evade peer review by certifying every year for 30 years that it was conducting no audits. The cool thing about the certification is that, at least as far as the books, records and financial statements of the Madoff organization are concerned, it was true.

I love the masters of Hedgistan (fund of fund variety) whining that this was a failure of governmental regulation, losing sight the the fundamental point that hedges funds are definitionally lightly regulated investment pools, and that half the justification for the fees of the fund of funds managers was their careful scrutiny and sophisticated monitoring of the managers into which they fed their investors capital.

Will the Madoff Affair have consequences? Quite possibly. He fleeced enough of the right people. In tandem with Mr. Dreier they are extremely attractive poster children for the proposition that the whole game was a crooked business, and needs to be shut down.

So shut it down. Start with the bonus culture. Turn the banks into public utilities every bit as exciting as Con Ed. Tax the investment pools out of existence. Then move onto exemplary justice. Executions at midfield in the Yale Bowl aren't part of the American Tradition. Not yet.