Great Depression

Dear Mr. President,

I am writing to withdraw my name for consideration to be Chairman of the Federal Reserve.

It has been a privilege to work with you since the beginning of your Administration as you led the nation through a severe recession into a sustained economic recovery built on policies to promote employment and strengthen the middle class. This is a complex moment in our national life. I have reluctantly concluded that any possible confirmation process for me would be acrimonious and would not serve the interests of the Federal Reserve, the Administration, or ultimately, the interests of the nation’s ongoing economic recovery. I look forward to continuing to support your efforts to strengthen our national economy by creating a broad based prosperity and to reform our financial system so that no President ever again faces what you and your economic team faced upon taking office in 2009.

Sincerely yours,

Lawrence Summers

Five years after the collapse of Lehman Brothers triggered the largest global financial crisis since the Great Depression, outsize banking sectors have left economies shattered in Ireland, Iceland, and Cyprus. Banks in Italy, Spain, and elsewhere are not lending enough. China’s credit binge is turning into a bust. In short, the world’s financial system remains dangerous and dysfunctional. Worse, despite years of debate, no consensus about the nature of the financial system’s problems – much less how to fix them – has emerged. And that appears to reflect the banks’ political power. Unfortunately, despite the enormous harm from the financial crisis, little has changed in the politics of banking. Too many politicians and regulators put their own interests and those of “their” banks ahead of their duty to protect taxpayers and citizens. We must demand better.

Until six days before Lehman Brothers collapsed five years ago, the ratings agency Standard & Poor’s maintained the firm’s investment-grade rating of “A.” Moody’s waited even longer, downgrading Lehman one business day before it collapsed. How could reputable ratings agencies – and investment banks – misjudge things so badly? Regulators, bankers, and ratings agencies bear much of the blame for the crisis. But the near-meltdown was not so much a failure of capitalism as it was a failure of contemporary economic models’ understanding of the role and functioning of financial markets – and, more broadly, instability – in capitalist economies. Yet the mainstream of the economics profession insists that such mechanistic models retain validity.

For the right answer, we look to the past....

Investors need to stop listening to the happy talk coming from the economists, and start focusing on what banks and other lenders are saying and doing operationally to adjust for the mortgage market of 2014 and beyond.  

Political analysts over the next year or so, and historians well into the future, are likely to point to the fall of 2013 as a fundamental inflection point in American politics. That period, they will say, is when the American people forced a major new direction in American foreign policy. Before the events of this fall, the country’s electorate largely delegated foreign policy to its political elite—and largely supported that elite as it projected American military power with more abandon than the country had ever before seen. Even as the government steadfastly expanded the range of international problems that it said required U.S. military action, the electorate accepted that expanded international role and that increasingly promiscuous use of force. Those days are gone now.

The last time the top 10% of the US income distribution had such a large proportion of the entire nation's income was the 1920s - a period that culminated in the Great Depression and a collapse in that exuberance. As AP reports, the very wealthiest Americans earned more than 19% of the country's household income last year — their biggest share since 1928, the year before the stock market crash. And the top 10% captured a record 48.2% of total earnings last year. Analysis by Emanuael Saez shows that, based on IRS data, in 2012, the incomes of the top 1% rose nearly 20% compared with a 1% increase for the remaining 99%. Economists point to several reasons for widening income inequality including globalization and technology. However, as John Taylor explains in his recent WSJ Op-Ed, using this as a lever for Obama's "middle-out" policies - higher tax rates, more intrusive regulations, more targeted fiscal policies - will not revive the economy. More likely they will perpetuate the weak economy we have and cause real incomes—including for those in the middle—to continue to stagnate.

Today we got yet another indication that the smartest money was not lying when it said to "sell now" and is eyeing the rapidly shutting window on public equity investment exits, when news broke that TPG and Warburg Pincus, the firms who LBOed Neiman Marcus in October 2005, have decided to pull the luxury retailer's IPO filed in June, and instead will sell the company in yet another LBO, this time to Ares and the Canadian Pension Plan Investment Board. This is a hit to Neiman's proposed valuation: according to JBN it had been reported that the equity funds could price, or rather thought they could price, the retailer at $8 billion. Instead they will opt for a cash check of $6 billion, or a solid 25% reduction in expected return. Still don't cry for the PE giants: as the back of the envelope analysis below shows, net of the sponsor equity investment of $1.2 billion, and adding the $435 million dividend from March 2012, assuming the return to sponsors is $3.4 billion ($6 billion price less $2.6 billion in net debt), the generated XIRR over the 8 years holding is a decent 15.6% XIRR.

If ever there was an investor reaction that summed up just how much the Federal Reserve has broken the markets it was yesterday morning's post-dismal-jobs-report surge. As John Phelan notes, we now appear to be in a position where the interests of financial markets are precisely at odds with the interests of the rest of the economy; where the good news for us is bad news for them and bad news for us is good news for them. The one way bet of the Greenspan Put maintained, so far, by Ben Bernanke, has created a market of monetary-punch-drunk liquidityholics. On its 100th birthday the Federal Reserve has the tricky task of sneaking the punch bowl out of the party, a task it seems they’ll struggle to manage without starting a riot. They may have printed themselves into a corner.

The most likely path of collapse to take place within the U.S. includes economic destabilization caused by a loss of the dollar's world reserve status and petro-status.  This fiscal crisis event will likely not occur in the midst of a political vacuum.  The central banks and international financiers that created our ongoing and developing disaster are not going to allow the destruction of the American economy, the dollar, or global markets without a cover event designed to hide their culpability.  They need something big.  Something so big that the average citizen is overwhelmed with fear and confusion.  A smoke and mirrors magic trick so raw and soul shattering it leaves the very population of the Earth mesmerized and helpless to understand the root of the nightmare before them.  The elites need a fabricated Apocalypse. Enter Syria...

Despite trillions of dollars of interventions and zero interest rates by the Federal Reserve, combined with numerous bailouts, supports and assistance from the Federal Government, the economy has yet to gain any real traction particularly on "Main Street."  Are we currently experiencing the second "Great Depression?"  That is a question that we can continue to debate currently, however, it will only be answered for certain when future historians judge this period. One thing is for sure.  With the lowest rate of annualized economic growth on record there is a problem currently that is not being adequately recognized. The depression may indeed be on "Main Street" once again with the only difference being that the "breadlines" are formed in the mailbox rather than on street corners. And while many are quick to dismiss comparisons to the Great Depression, there is one important difference: the rate of population growth which, as opposed to the depression era, has been on a steady and consistent decline since the 1950's.

There has been much discussion as of late about the need for interest rates to rise as they have been historically way too low for too long.  However, is that really the case? The average long term interest rate in the U.S. has been 5.49%  (median is 4.91%) since 1854.  However, that average rate would be much lower if the "spike" in interest rates in the 1960's and 70's were removed which would mean that the current long term interest rate is likely more aligned currently with historical norms.  This is particularly the case when compared to the much slower rates of economic growth that currently exists. What we find find most interesting currently are the ongoing discussions about whether or not the U.S. is in a recession.  The reality is that such discussions are relatively pointless in the broader context.  The "Great Depression" was not just one very long "recessionary" period but rather two recessions that "bookended" a period of relatively strong economic growth.

Russia may reinforce naval grouping in Mediterranean in response to U.S. buildup - expert http://t.co/gtOai0LqqU #Russia #interfax #news

— Interfax News (IFAX) (@IFAXnews) August 24, 2013

BREAKING. @CBSNews has learned that the Pentagon is making the initial preparations for a Cruise missile attack on Syrian government forces

— Charlie Kaye (@CharlieKayeCBS) August 23, 2013

"So far, inflation has fallen only slightly and remains in positive territory. Fears in early 2009 that rapid deflation might break out and  cause the economy to collapse as in 1929 to 1933 proved unfounded, luckily. I have advanced the hypothesis that rampant price-cutting has failed to appear because businesses are in equilibrium and perceive that price-cutting has bigger costs than benefits. If the hypothesis is wrong and businesses are finally responding to five years of slack by cutting prices, the generally optimistic tone of this section could be quite mistaken. The bottom could fall out of the economy as it did in the Great Depression."