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Obama Seeks Multi-Trillion Dollar Bailouts

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
February 3, 2009

IN THIS ISSUE:

1.  The Recession Continues To Deepen

2.  So, How Deep & How Long?

3.  Multi-Trillion Dollar Bailouts In The Works

4.  Obama’s $825 Billion “Stimulus” Package

5.  Obama’s Next “Big Bang” Bank Bailout

6.  Fed Gearing Up To Buy Treasury Bonds

Introduction

We are witnessing the most aggressive government intervention into the US private sector in history, and I am not simply referring to President Obama’s massive $825 billion so-called “stimulus” package passed last week by the House of Representatives.  As we will discuss as we go along, there are also plans in the works to borrow and spend trillions more, which will result in the government owning even more of the private sector, starting with the banking system.

We should all recognize that President Obama and most of the Democrats in Congress have no problem whatsoever with the government owning (and eventually controlling) much of the private sector.  What we are, and will be, witnessing is unprecedented and is being planned under the guise of the economic and financial crisis, when in fact there is a much larger political agenda ongoing now that the Democrats have control of the White House and the Congress.

Speaking of the economic and financial crisis, the US recession continues to deepen as does the global economy.  The Commerce Department reported on Friday that US GDP slumped at an annual rate of 3.8% in the 4Q.  Most of the other economic reports of late have also been on the negative side.  Most forecasters now predict that 1Q GDP will also be down at least 3-4%.  This week, we look at the latest data and some forecasts of what lies ahead for 2009.

Following that, we will examine the latest $825 billion stimulus package that was passed last week by the House.  While initially touted as a way to jump-start the banks and unfreeze the credit markets, the final bill is loaded with pork-barrel spending and has nothing for the banks.  Following that, we will discuss new government plans totaling $1-2 trillion to bail out the banking system.  There is so much to talk about, I don’t know where to start, but let’s begin with the economy.

The Recession Continues To Deepen

As one analyst put it, there is still no light at the end of the tunnel for the US economy, which officially entered this recession in December 2007 (with the benefit of hindsight).  As noted above, US Gross Domestic Product fell at an annual rate of 3.8% in the 4Q, the largest quarterly decline since 1982.  The latest GDP number was not as bad as pre-report expectations, but it does reflect the reality that holiday retail sales plunged over 8% in December according to MasterCard.

The Consumer Confidence Index dropped to another all-time low in January, falling to a reading of 37.7, down from 87.3 one year ago.  Consumers remain very pessimistic about the state of the economy and about their earnings.  Those saying business conditions are “bad” increased to 47.9% from 45.8% in December, while those saying business conditions are “good” declined to 6.4% from 7.7% in December.  These are the lowest readings since the Consumer Confidence Index has been in existence.

In what was initially thought to be a bright spot, the Conference Board announced last week that the Index of Leading Economic Indicators (LEI) rose 0.3% in December.  However, the Conference Board was quick to point out that the increase in the LEI was almost entirely due to the large surge in the money supply in December.  The economic component of the LEI was actually down -0.5% in December.  The LEI has declined for the last seven months in a row.

The unemployment rate rose more than expected in December, to 7.2%, when every state in America saw its unemployment rate rise.  The nation lost apprx. two million jobs in the last four months of 2008 alone.  Employment data for January will be released this Friday, and analysts expect the unemployment rate to rise to 7.5%.  At the rate major layoffs are being announced, the unemployment rate could approach 9% by the end of the year.

On the manufacturing side, most reports were worse than expected.  The ISM Index fell to 32.4 in December, down from 36.2 in November, and worse than pre-report estimates of a decline to 35.4.  This morning, the ISM Index for January showed a modest increase to 35.6, which was higher than expected.  But keep in mind that any figure below 50 indicates an economy that is contracting. 

Industrial production fell 2.0% in December, twice the pre-report consensus.  Durable goods orders fell 2.6% in December following a decline of 3.7% in November.  Factory orders plunged 4.6% in November (latest data available).

On the housing front, there finally were some encouraging reports. Sales of existing homes rose 6.5% in December to an annual sales pace of 4.74 million units according to the National Association of Realtors, although the NAR noted that many of the sales were “distressed sales” in an effort to avoid foreclosure. 

Thanks to the unexpected home sales increase, the inventory of homes for sale decreased 11.7% in December to 3.68 million units. That represents a 9.3-month inventory of unsold homes at the current pace of sales, down from a 11.2-month supply in November. The median home sales price fell to $175,400 in December, which was down 15.3% from the same period in 2007.

New home sales, on the other hand, fell more than expected in December to apprx. 331,000 units.  Housing starts fell more than expected in December to apprx. 550,000 units – this is actually a good thing.  Building permits also fell more than expected in December to apprx. 549,000 units, also a good thing from an economic standpoint, though not so good if you are or work for a builder.

So, How Deep & How Long?

The truth is, no one knows for sure how long this recession will last or how bad it will get.  As noted earlier, most forecasters are predicting that GDP will fall by 3-4% in the 1Q.  Among the analysts and forecasting groups I read and respect, there are basically two camps.  One camp believes that the recession will get worse, perhaps considerably worse, the credit markets will remain very tight all year, and that a mild recovery will not begin until sometime in 2010.

The other camp is less pessimistic and believes that the economy will begin a slow recovery and the credit markets will unfreeze in the second half of this year.  Most in this camp believe that the vast sums (trillions as we will discuss below) the government and the Fed are throwing into the economy will fill the void left by contracting consumer spending.  Some in this camp are optimistic that the unexpected upturn in existing home sales in December will have marked the bottom of the housing slump.

Personally, I have been leaning more toward the first camp.  However, as we will discuss in the pages that follow, if the Treasury and the Fed are prepared to throw an additional $1-$3 trillion of liquidity into the economy, perhaps the outcome is somewhere between the two camps noted above.  In either case, we will not be out of this recession any time soon.

Multi-Trillion Dollar Bailouts In The Works

As I noted earlier, I do not wish for this week’s E-Letter to be considered a political piece, but there are some political realities that sophisticated investors must consider.  The question for me is where to start.  I choose to start this discussion with a quote from President Obama’s Chief of Staff, Rahm Emanuel, shortly before Obama took office.

Rahm Emanuel, who was a senior political advisor to former president Bill Clinton, and most recently a member of the House of Representatives from the state of Illinois, is one of the most powerful (and foul-mouthed) members of the liberal Washington elite.  Interestingly, Emanuel supported Hillary Clinton in the campaign, but Obama picked him as Chief of Staff anyway.

As President Obama’s Chief of Staff, Emanuel is essentially the second most powerful politician in Washington.  Mr. Emanuel stated the following to the Wall Street Journal after Barack Obama named him as Chief of Staff prior to his inauguration (read carefully):

“You never want a serious crisis to go to waste. What I mean by that is that you have an opportunity to do things you could never do before. Things that we had postponed for too long, that were long-term, are now immediate and must be dealt with.”

Let me interpret this political message that Emanuel unintentionally stated: We are in an unprecedented financial crisis that will pave the way for the implementation of the liberal policies that we believe in, including things that the American people would not otherwise tolerate.  And some of those things are now in the pipeline as I will elaborate below.

You have no doubt heard about President Obama’s estimated $825 billion “stimulus” package that was passed by the House last week (with not a single Republican voting yes).  As you probably also know, that “stimulus” package was loaded with pork-barrel spending that, during the campaign, Obama said he would not tolerate. 

What you probably do not know is that Obama has an additional stimulus plan to recapitalize the banks and financial institutions that could total $2 trillion or more, and will mean that the government gains substantially more equity ownership of the major banks and financial institutions, as well as others.

Should President Obama run into problems financing these huge bailout initiatives, the Federal Reserve has let it be known that it stands ready to purchase a trillion or more in long-term bonds in order to keep interest rates low and keep the credit markets from seizing up, according to recent statements from his new Treasury Secretary, Timothy Geithner.

We will look in more detail at Obama’s breathtaking plans in the pages that follow, beginning with the latest $825 billion “stimulus” package passed by the House last week.  Then we will look into the potentially $2 trillion rescue package for the banks and the possibility that the Fed will be buying hundreds of billions of Treasury bonds, if needed.

Obama’s $825 Billion “Stimulus” Package

Unless you are politically tone-deaf, you know that President Obama has proposed another so-called ‘economic stimulus package’ of apprx. $825 billion, on top of President Bush’s $700 billion “Troubled Asset Relief Program” (TARP) last year, of which only apprx. half has been spent so far.  Obama will now get to decide how the other half is spent.

Oh, and let’s not forget the additional $800 billion that the Fed intends to spend in an attempt to further unfreeze credit markets for homebuyers, consumers and small businesses.  Never mind that the Fed’s plan aims to do the very things that Secretary Paulson initially planned for TARP – buy up troubled mortgage securities – but then said there were better uses for the money.

Many analysts have argued for several months now that Bush’s TARP program was not enough to keep our nation’s largest banks afloat, and that much more in the way of rescue funds would need to be made available by the Treasury.  Plus, most analysts also agreed that any such new stimulus package should include tax breaks and incentives to get consumers spending again to revive the plunging economy.

As a result, many of these same analysts welcomed the idea of the additional $825 billion Obama requested.  That is, until they saw how Obama planned to spend the money.  Most analysts figured that the $825 billion would go to banks in the form of loans or other capital injections, and to consumers in the form of tax cuts, rebates or other tax incentives to put money in their pockets.

But when the Obama administration finally released the substance of the $825 billion stimulus package, most analysts (your editor included) were shocked.  The latest enormous stimulus package is loaded with pork.  Around two-thirds of the $825 billion is liberal pork-barrel spending, with little for infrastructure rebuilding; only around one-third is tax cuts and credits for consumers; and there is nothing in the bill for helping the banks. 

Remember, this was Obama’s proposal.  The House tweaked it a little, but not much in the end.  The plan passed by the House last week totaled $819 billion, with only $275 billion for tax cuts and a whopping $544 billion in new spending programs as outlined below.  The Senate, which has yet to vote on the bill, reportedly has plans to increase it to apprx. $900 billion.  For discussion purposes below, I will simply refer to it as the $825 billion stimulus package.

As reported last week, the liberal spending components in Obama’s plan include an estimated: 1)  $92.3 billion for education, labor, etc.; 2) $88.9 billion for Medicaid to help out state budgets that are in the red; 3) another $79 billion for states that are running budget deficits; 4) $59.5 billion for transportation and urban development; 5) $48.9 billion for the Energy Department; 6) $27 billion for the Agriculture Department; and 7) $15 billion for the environment – just to name a few.

If your blood is not already boiling, get this.  Obama’s $825 billion bailout also includes over $5 billion that is targeted for low-income housing assistance organizations that prominently includes Chicago-based ACORN, which is really a left-wing political group that Obama worked for in his early days after law school.  ACORN could be a big recipient of this money, even though it is under federal investigation for voter fraud.  Hmmm.

As you can see, the bulk of Obama’s $825 billion stimulus package is targeted toward government agencies – not consumers or banks – and is estimated to result in at least 600,000 new federal employees.  So Obama’s first major legislative initiative – supposedly a stimulus package to jump-start the economy – is a bloated spending package to increase the size of government, with only about one-third going directly to help consumers.   

The Democrats in the House were surprised initially at the makeup of the bill, but quickly passed it last week with few changes.  As you have likely heard, Obama’s giant “stimulus” package was voted against by every Republican in the House of Representatives and even a number of Democrats.  Assuming the Senate passes it (or something even larger) in the next week or two, it will soon become the law of the land.

Making matters worse, precious little of the spending and tax breaks will occur in 2009.  According to the Congressional Budget Office, only apprx. $93 billion of the $825 billion will be spent in fiscal 2009, the time we need it most, and only apprx. $225 billion would be spent in fiscal 2010.  The balance reportedly doesn’t get spent until after that time, when we should be out of the recession.

Instead of giving the economy a “targeted, timely and temporary” injection as Obama had promised, the plan has been larded with spending on existing social programs or hastily designed new ones, with much of it permanent - and not enough of it likely to create new jobs.  The Obama administration says that it wants 75% of the money to “spend out” within 18 months. But the Congressional Budget Office estimates that, under the House bill, only 64% of the spending and tax cuts will hit the economy by 2011.

Also troublesome is the likelihood that the bill will become a vehicle for new protectionism policies.  The House added “Buy American” protectionism provisions for iron, steel and textiles, and the Senate seems bent on expanding the list of products.  The Obama administration seems unconcerned about the danger these measures pose.  The protectionism provisions insisted on by the Democrats could undo whatever measured job creation the stimulus plan achieves by provoking US trading partners to reduce purchases of American-made goods.

And finally, there is the question of whether or not these large new amounts of spending will be counted toward the “baseline budget” for all of the government departments receiving funds under Obama’s $825 billion spending plan.  For example, will the $92.3 billion going to education, labor, etc. mean that their baseline budget going forward is permanently $92.3 billion higher?

The $825 billion stimulus plan is supposed to be a “one-time” expenditure.  But we will have to wait and see if this is true, or if all the departments getting this new money will try to say that their budgets should be increased by that amount permanently in future fiscal years.  In Washington, it is easy to give money away, but it is next to impossible to scale it back.

Obama’s Next “Big Bang” Bank Bailout

In addition to the $825 billion stimulus package discussed above, Congress also approved the release of the remaining $350 billion from the TARP program to the Obama administration last week.  Late last week and over the weekend, Obama and his spokespersons promised that new Treasury Secretary Geithner will soon be announcing their plans for how to spend the remaining $350 billion of TARP monies – plus a whole lot more.  What could this mean?

The Wall Street Journal reported on Thursday of last week that the Obama administration is planning another $1-$2 trillion bailout aimed at restoring the financial health of US banks.  What, you haven’t heard about this yet?  Surprise, surprise.  This may explain why none of Obama’s $825 billion stimulus plan, and apparently none of the remaining $350 billion of TARP funds, will be targeted to banks and financial institutions that are teetering on the brink.  

The Wall Street Journal noted the following last Thursday, January 29:

“Government officials seeking the revamp the U.S. financial bailout have discussed spending another $1 trillion to $2 trillion to help restore banks to health… The potential size of the rescue efforts being discussed suggests the administration may need to ask Congress for more funds [a trillion or two]… The administration is expected to take a series of steps, including relieving banks of bad loans and securities.

The so-called ‘bad bank’ that would buy these assets could be seeded with…as much as $1 trillion to $2 trillion raised by selling government-backed debt or borrowing from the Federal Reserve.”

Wow – another $1-$2 trillion bailout of the banks!  The question that arises, of course, is how will the government make these enormous funds available to the banks?  Will they be in the form of loans or direct giveaways?  New Treasury Secretary Geithner said last week that such new money would be loaned to the banks.  Thus far, government loans to the big banks have been made in return for non-voting “preferred shares” in these banks.

Yet given the magnitude of the loans they are talking about – $1-$2 trillion – it is entirely possible that the government will have to take collateral in the voting “common stock” of the banks, potentially giving the government some element of control over the banks and their operations.  This sounds like the first step toward “nationalizing” the banks.

On Wednesday of last week, Treasury Secretary Geithner said that he wants to avoid nationalizing banks if possible.  He stated: “We’d like to do our best to preserve that [banking] system.”  Read that quote very carefully.  I read it as follows: We’ll try to avoid nationalizing the large banks, but if we feel we have to, we will.  This is very scary!

As I have stated twice over the last two months, President Obama comes from a political persuasion that has no problem with the government owning – and eventually controlling – large parts of the private sector.  Many Americans who voted for Obama had no idea, or ignored the fact that he embraces this ideology.

So we should not be surprised if the government ends up owning big equity stakes in our nation’s largest banks over the next year or so.  And there is even the chance that the government will actually nationalize the banking system before it’s over.  Hello Europe!

Fed Gearing Up To Buy Treasury Bonds

The massive bailouts we have already seen, plus those outlined above to follow soon, lead to one pivotal question: How is the US Government going to pay for all of this?  Since we’re already running a trillion-dollar deficit, the new spending would have to be funded by selling even more Treasury debt.  Thus, this leads to additional questions such as: 1) Who is going to buy these trillions in new government debt? Will foreigners continue to buy US Treasury securities as they have in the past; 2) Or will these trillion-dollar deficits spook them away; and 3) Will the US dollar plunge as a result and lose its status as the world’s reserve currency?

It is impossible to know the answers to these questions, and the Obama administration knows this.  Therefore, the Federal Reserve is gearing up to be the “lender of last resort” as Obama’s massive bailout programs move forward.  The Wall Street Journal reported last Thursday that the Fed is gearing up to purchase long-term US Treasury securities on a massive scale.

This has never happened in the post-Great Depression era.  Yet the Fed is reportedly now gearing up to directly buy US Treasury bonds in case Obama’s bailout plans for the banks don’t work.  Supposedly, the Fed has the legal authority to directly buy long-term US Treasury bonds, but it has never done so on a massive scale before.

Government officials are trying to put lipstick on this pig by claiming that the Fed’s action to buy Treasuries will help to reduce long-term interest rates and thus facilitate more business and mortgage borrowing.  However, the real reason is that there’s likely not going to be anyone left to buy our Treasuries, especially if the Dems pursue idiotic protectionist measures that would harm the very trading partners we rely on to buy our debt.

And if the government usually sells Treasuries to finance its operations, where will the money come from to buy its own Treasury securities?  That’s right, folks.  They’ll just keep the printing press running until they have enough.  As I have noted before, Obama and our monetary authorities are scared to death about deflation, and they will do anything within their power to avoid a debt deflation (a la: Japan) from unfolding in the US, regardless of the inflation implications down the road.

Fed chairman Ben Bernanke has recently stated in public that the possibility of the Fed buying Treasuries is real.  The latest policy statement from the FOMC made it clear that the Fed “is prepared” to take such a step as a result of the “evolving circumstances” in the credit crisis.  I interpret these developments to mean that the Fed will fire up the printing presses immediately if Obama has problems raising the trillions of dollars he plans to spend.

Conclusions?

I have always tried to tackle the complicated issues of the day and explain them in ways that most anyone could understand.  Yet the current economic and financial crisis defies a simple explanation.  Yes, we know what lead us into this crisis – home mortgages were made available to millions who had little or no chance of being able to make the payments.

Pundits can argue as to who is to blame for this.  Conservatives can make a strong argument that the incentives for giving home loans to people who could never make the payments go back to the Clinton presidency, which is true.  But liberals can argue, rightly so, that these sub-prime lending practices continued, and even increased, during the Bush administration.

Yet where to place the blame largely misses the point, in my opinion.  We are now in what looks to be the worst economy since the Great Depression.  Not even the best thinkers of our time suggested that we would be in such a broad-based financial crisis a year ago.  But here we are.

It is clear that President Obama prefers a Keynesian approach to solving this crisis – that is by spending trillions of dollars and substantially increasing the size and scope (control) of government.  This should not have come as a surprise to anyone who has read this E-Letter for long – I warned you about this on numerous occasions well before the election in November.

Interestingly, we learned yesterday that the Republicans in Congress are busy crafting their own economic stimulus package to counter President Obama’s.  There are few specific details known about this GOP rescue package as I prepare to hit the “send” button, but it appears that the Republicans’ stimulus package will focus on numerous tax cuts and spending that might help the economy in the near-term.  Depending on what the Republicans come up with, I might write about that next week – we’ll see.

Getting back to the economic discussion at the beginning of this letter, this recession is clearly worse than even the naysayers predicted.  As discussed above, it could last a few more months, or it could last well into 2010.  Whatever proves to be the case, it will not be good news for the stock markets, which are flirting with new lows as this is written.

In recent weeks, I have emphasized that the mantra of “buy-and-hold” investing is going the way of the buggy whip.  Investors around the world have seen their portfolios crushed by the bear market.  And it may not be over. 

Over the last couple of months, we have seen a significant increase in interest for our actively managed investment programs that have the ability to move to cash (money market) or hedge long positions, and especially our more aggressive programs that will “short” the market.  It seems that more and more investors are coming around to my views on risk management.

If your investment portfolio has been hit hard over the last year or so, maybe now is the time to reallocate some or all of your portfolio to professional money managers and strategies that have the potential to get out of the way of bear markets.  Call one of my Investment Consultants at 800-348-3601 if you are interested in learning more about these strategies.

Wishing you profits,

 

Gary D. Halbert

SPECIAL ARTICLES:

Obama Should Fix the Flawed Stimulus Package
http://www.washingtonpost.com/wp-dyn/content/article/2009/01/31/AR2009013101535.html

Lessons from the Stimulus Fight
http://www.weeklystandard.com/Content/Public/Articles/000/000/016/100dyjdy.asp

Public mixed on stimulus package.
http://www.usatoday.com/news/washington/2009-02-02-poll-stimulus_N.htm


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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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