Headed For a Double-Dip Recession?

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
July 6, 2010

IN THIS ISSUE:

1. Outlook For US Economic Recovery Dims

2. UnemploymentRateFalls But May Rise Again

3. Most Recent Economic Reports Are Not Encouraging

4. Bank Lending Still in the Dumps

5. Financial Reform Bill (Or Government Takeover?)

Introduction

This week, we focus on the latest outlook for the US economy. As you are no doubt aware, the consensus view of the economic recovery has dimmed over the last month, especially with the latest disappointing 1Q GDP report on Friday, June 25. While consumer spending increased very modestly in May (latest data available), bank lending remains in the tank. Unless lending improves, the economic recovery will be disappointing at best, and a double-dip recession is clearly a possibility in 2011.

Following that discussion, we will look into the new financial regulatory bill which is expected to be passed by Congress any day now. While I have been an outspoken advocate for financial regulatory reform (see my April 20 E-Letter), the huge new reform bill is lacking and even negative on several fronts. It will not eliminate “too-big-to-fail” and it will not preclude an even more serious financial crisis in the years ahead. About all it does is to greatly increase the size of government. Surprise, surprise!

Hopefully, this will make for an interesting E-Letter. Let’s get started.

Outlook For US Economic Recovery Dims

The consensus opinion regarding the US economic recovery has taken a clear turn for the worse over the last month or so. You may recall that the US economy turned the corner in the 3Q of last year when Gross Domestic Product rebounded to an annual rate of 2.2% following the financial crisis of 2008 and first-half 2009. Then in the 4Q of 2009, GDP jumped robustly to an annual rate of 5.6%.

The big jump in GDP in the 4Q of last year prompted many economists and analysts to increase their forecasts for 2010 to GDP growth of 4% to 5%. But in late April, the Commerce Department released its first estimate of 1Q GDP which came in at only 3.2%. In late May, the government’s second estimate of 1Q growth was revised downward to only 3.0%.

On June 25, the final estimate was again revised down to only 2.7%, well below pre-report expectations. The final 1Q GDP reduction was attributed to a slowdown in inventory rebuilding, reduced exports and reduced spending by state and local governments that are struggling to balance their budgets as required by law.

The final 1Q GDP number basically laid to rest the forecasts of 4%-5% economic growth for 2010, and these rosy estimates are being downgraded across the board, for the most part, as this is written. Now the discussion is increasingly turning to the question of whether or not we could be facing a double-dip recession in 2011.

Now let me state the obvious: the fact that GDP growth slowed from 5.6% in the 4Q last year to only 2.7% in the 1Q of this year does not suggest definitively that we are headed for a double-dip recession in 2011. What it does largely dispel are the earlier forecasts that this will be a strong “V-shaped” economic recovery. Whether we are headed for a double-dip recession for sure remains to be seen, but I have been suggesting this for the last several months.

UnemploymentRateFalls But May Rise Again

We often hear that this is a “jobless recovery,” and thus the troubling unemployment situation is on virtually everyone’s mind. The official unemployment rate for June unexpectedly fell to 9.5%, down from 9.7% in May. The pre-report consensus suggested the rate would rise to 9.8%, so the decline came as quite a surprise.

But as has been the case for a long time, a closer look at the actual jobs numbers reveals that the headline unemployment number of 9.5% is not nearly as positive as it looks. Breaking down the latest Labor Department unemployment report released last Friday, we find that the economy actually lost 125,000 net jobs in June.

So how could the unemployment rate drop from 9.7% in May to 9.5% in June? Because 652,000 people gave up on their job searches and left the labor force last month. People who are no longer looking for work aren’t counted as unemployed. By now, you’ve probably heard President Obama and administration spokespersons crowing about how the unemployment rate is finally coming down significantly. But they fail to mention that the official rate came down mainly because over 650,000 Americans stopped looking for work in June.

The real unemployment rate that includes those no longer looking for work and those who are “under-employed” (working a lesser job than they are qualified for or working part-time because they can’t find a full-time job) was 16.5% in June.

There is a good chance that the official unemployment rate will go back up in the next several months. Why? Most of the new jobs created this year were government jobs, including the hiring of apprx. 500,000 temporary census workers. As the census winds down, most of these temporary workers will lose their jobs in the months ahead and many will be added to the unemployment rolls once again.

In fact, the latest jobs report noted that some 225,000 census workers were terminated in June, and more terminations will be coming in July and August as the census winds down. Many analysts believe this will cause the unemployment rate to climb again just ahead.

In addition, the weekly “initial claims” – the number of new persons filing for first-time unemployment benefits – has continued to hover above 450,000 per week for the last several weeks. The economy continues to shed jobs, even though the Obama administration claims that we are adding jobs.

According to the latest Labor Dept. report, there were 14.6 million people looking for work in June. The nation still has 7.9 million fewer private payroll jobs than it did when the recession began. It takes about 150,000 new jobs a month to keep up with population growth. The economy needs to create jobs at least twice that pace to bring down the jobless rate significantly.

Since the Senate failed to pass another extension of unemployment benefits on June 24, there are some who believe that a significant number of the unemployed will soon accept jobs they would not otherwise consider. Some economists suggest this will cause the unemployment rate to fall just ahead. That could be true, but probably not until most or all of the temporary census workers are terminated.

Furthermore, I don’t for a minute agree that another extension in unemployment benefits is dead. President Obama wants it extended and the Democrats and some Republicans want it extended. My bet is they’ll repackage the measure and pass it before long. Bottom line: expect the unemployment rate to remain high for at least the rest of this year.

Most Recent Economic Reports Are Not Encouraging

While there were a few bright spots in the recent economic data, most indicators suggest that the recovery is slowing down. With consumer spending accounting for upwards of 70% of gross domestic product, the level of consumer confidence is of utmost importance. The government’s Consumer Confidence Index, which had been on the rise for three consecutive months, declined sharply in June, well below expectations. The Index plunged a huge 9.8 points in June to 52.9, down from 62.7 in May.

Retail sales fell 1.2% in May (latest data available) and early reports suggest that sales were soft again in June. Walmart, the world’s largest retailer, reported that sales in its US stores fell for the fourth consecutive month in May. Durable goods orders (big ticket item purchases) fell 1.1% in May. The ISM manufacturing index, which has been up most of this year, edged lower to 59.7 in May, down from 60.4 in April.

On a positive note, personal income rose 0.4% in May, in line with expectations. But that same report noted that the personal savings rate was up to 4% in May, the highest figure since September 2009. This means that wary Americans are socking away more of what they make instead of spending it in the economy.

On the housing front, the news was not good in May – as was expected following the end of the government tax credit benefits for first-time home buyers on April 30. But the slowdown was even worse than expected. New home sales fell off a cliff in May. While expected to come in around 430,000 units sold, the actual number came in at only 300,000 – down 33% to the lowest monthly number since records have been kept.

Existing home sales, which were expected to rise in May, fell 2.2%. Housing starts and building permits were also down in May. There is mounting evidence that a large number of homes will come onto the market this summer as speculators who bought houses late last year and earlier this year are now looking for the exits. Needless to say, the housing market is not out of the woods and could get even worse, especially if the economic recovery sputters.

All in all, the US economy is slowing down and growth in the second half of this year will almost certainly be disappointing, as I have suggested for several months. Gone for the most part are the earlier predictions of 4% or higher GDP growth this year. As noted above, it remains to be seen if we are headed for a double-dip recession in 2011, but if most of the Bush tax cuts expire at the end of this year (a huge tax hike), the odds of a second recession go up significantly as I have suggested often recently.

Bank Lending Still in the Dumps

Bank lending has plunged since the recession and the credit crisis began. Despite TARP and the Obama administration running trillion-dollar budget deficits, bank lending continues to fall. As I and others have suggested, the 5.6% (annual rate) jump in 4Q GDP was largely due to inventory rebuilding. As that effort has largely wound down, the economy slowed down with it.

As I have said for months, one of the keys to getting our economy growing at a normal rate of 3-4% a year is to get the banks lending again. I reprinted the Fed chart below a few months ago. As you can see, the situation has not gotten better; in fact, it’s gotten worse. Bank lending is down almost 25% since late 2009.

Commercial and Industrial Loans

The government has repeatedly urged banks to step up their lending, but the banks are reluctant. Yet the banks claim that there is not much demand on the part of individuals and small businesses to borrow money. I suspect that the continued decline in bank lending is a combination of the two.

As I will discuss below, the massive financial regulatory reform bill that is expected to be passed by Congress any day now could well have the effect of reducing bank lending even further when it goes into effect.

Finally, an excellent editorial appeared in the Wall Street Journal last Friday by economist and author Allan Meltzer. The eye-opening piece entitled “Why Obamanomics Failed” can be read at the first link in SPECIAL ARTICLES below. This is a “must read,” in my opinion.

Financial Reform Bill (Or Government Takeover?)

The House/Senate Conference Committee reached an agreement on the massive financial regulatory reform bill in the wee hours (5:30 a.m.) on Friday, June 25. The massive bill is over 2,200 pages long, and its co-author Senator Chris Dodd admitted publicly that he and the other committee members don’t know what all is included in the reform bill. But they passed it anyway, on a party-line vote.

Later that day, President Obama called it “the most sweeping financial reform since the Great Depression” and urged the members of the House and Senate to pass the compromise bill in time for him to sign it by July 4th. The Wall Street Journal provided a nice summary of the compromise financial reform bill which you can read in the second link in SPECIAL ARTICLES below.

The compromise bill that the Conference Committee passed on June 25 looks very much like the Senate version. I wrote at length about the financial reform bill in my April 20 E-Letter when the Senate passed its bill, so I won’t go back over all the ugly details. However, there are a few important things that have come to light since late April that all Americans need to understand about the financial reform bill.

First, the 10-member Financial Stability Oversight Council (FSOC) that will be created by the reform bill will have the unchecked authority to decide which companies are deemed to have so-called “systemic risk.” This will include banks and non-banks, which means that almost any large company could be subject to their scrutiny.

Second, that scrutiny can include seizing any company’s books and records without a subpoena. Further, they can seize any company’s assets and liquidate them at will, which is a violation of the Fifth Amendment to the Constitution.

Third, the reform bill does not end “too-big-to-fail;” rather, it institutionalizes it! While the compromise reform bill puts some restraints on government-funded bailouts, the Fed and the Treasury Department still have the authority to bail out large firms that are deemed to have systemic risk, at their discretion. This may encourage more risk taking by large firms and will indirectly penalize small firms that are not deemed to have systemic risk and will not be bailed out if they get into trouble.

Fourth, the financial reform bill does not apply to Fannie Mae and Freddie Mac. The two giant agencies that control more than $5 trillion in mortgages are exempted from the financial reform bill. The takeover of Fannie and Freddie in late 2008 has already cost the government over $150 billion in taxpayer money, and the CBO estimates a total cost of over $400 billion over the next few years. Others believe the cost could top $1 trillion, especially if home prices continue to fall.

Fifth, the compromise reform bill included a new tax of $19-$20 billion on large banks, financial institutions and large hedge funds in order to fund the cost of the new reform agencies. Yet some supporters in Congress balked at this new tax, noting that the banks and others would simply pass this cost on to consumers (true).

So, as this is written, lawmakers are considering ending the $700 billion Troubled Asset Relief Program (TARP) early and using some of that money to fund the huge reform agencies that are to be created. TARP was never intended or authorized to fund new government agencies, but I have maintained from the beginning that it would ultimately become a government slush fund.

Sixth, and finally, the massive financial reform bill will put the government in the position of controlling virtually everything associated with credit. Because of the increased rules and regulations on all financial and many non-financial firms, the availability of credit will decrease and the costs will increase. None of this will be good for consumers or the economy.

My conclusions in my April 20 E-Letter are exactly the same today:

“Put simply, President Obama and the Democrats are all about growing the size of government and increasing their control over our money. And this is the perfect opportunity for them to create another giant federal bureaucracy.

While I very much agree that the financial industry needs reform, I do not believe that another huge new bureaucracy – that will ultimately have tens of thousands of government employees – is the answer. In fact, I might suggest such an entity could make things worse. I certainly do not believe that these hand-picked regulators will have the ability to peer into the future and see problems and bubbles and be able to stop them before they blow up.

It is my strong opinion that we have enough regulatory agencies already: SEC, CFTC, OCC, FDIC, FHFA, FINRA, etc. Plus, each state has its own securities agency with broad regulatory authority. We don’t need more regulators; we need the existing regulators to do their jobs. I would actually prefer that we revisit Glass-Steagall, and break up the too-big-to-fail companies if need be, rather than create a huge new bureaucracy.”

There probably are some who would say that, since I own a financial/investment firm, I would be automatically opposed to the massive financial regulatory reform bill. Yet the fact is, we don’t know yet just how the reform bill will affect our company, especially given that we have less than 50 employees.

But I can tell you this: I have read dozens of articles and editorials on the financial reform bill over the last week or so, and negative articles are running about 10 to 1 over articles that are positive or neutral.

What follows is a portion of an excellent editorial from the US Court of Appeals, Seventh Circuit judge, Richard Posner, on the financial reform bill. He echoes my sentiments on why we don’t need this massive new federal agency, and why existing regulators should do their jobs. It first appeared in Bloomberg on June 29. There is a link to the entire article at the end of this E-Letter. I highly encourage you to read it in its entirety.

QUOTE:
“Financial Overhaul Is Politics in Worst Sense
by Richard Posner

The most sensible legislative response to the financial collapse of September 2008 would have been to do nothing until the causes of the collapse were fully understood.

There is no urgency about legislating financial regulatory reform. The existing regulatory agencies have virtually total authority over the financial industry. And because they were asleep at the switch when disaster struck, they are now hyper- alert to prevent a repetition of it. Indeed, bank examiners have become so fearful of condoning risky practices that they are making it difficult for banks to lend to small businesses and consumers and thus are retarding the economic recovery.

The principal factors in the recent economic collapse were:

No. 1. Incompetent monetary policy, which under former Federal Reserve Chairman Alan Greenspan and his successor Ben Bernanke produced the housing bubble that burst, bringing down the financial industry, which was heavily invested in the mortgage market.

No. 2. The inattention of the Fed and the Securities and Exchange Commission, which didn’t understand the changing nature of the banking industry, particularly the rise of so-called nonbank banks dependent on short-term, noninsured capital.

No. 3. The over-indebtedness of the American people and government, which has hampered the restoration of credit.

No. 4. The failure of the Treasury Department under former Secretary Henry Paulson and the Fed under Bernanke to rescue Lehman Brothers Holdings Inc. They didn’t realize that Lehman’s bankruptcy would trigger a run on the banking industry, causing a global credit freeze.

Not Paying Attention

Barack Obama’s main economic officials -- Bernanke, Treasury Secretary Timothy Geithner, and National Economic Council Chairman Lawrence Summers -- were implicated in the regulatory oversights that precipitated the crisis, as were key legislative officials, such as Senator Christopher Dodd and Congressman Barney Frank. None of them wants to shoulder blame for the crisis. Instead, they blame the banking industry.

Banks did take risks that were excessive from an overall social standpoint, but businesses will always take the risks that government permits them to take, especially if the brunt of any harm falls on others.

The costs of the collapse have been borne largely by people and firms that had nothing to do with finance. Some banks took a hit, but the big ones are doing well. The government saved them from bankruptcy and the Fed is allowing them to borrow at interest rates close to zero, thus enabling them to return to profitability without doing much lending and thus without meeting urgent credit needs.

Political Response

But just as politics requires that President Obama be seen to be doing something about the oil leak in the Gulf of Mexico, though there is nothing he can do, so politics requires that Congress be seen to be doing something to prevent another economic disaster, though there is nothing it needs to do.

The same political imperative led to the reorganization of the intelligence community in the wake of the Sept. 11 terrorist attacks, a move now widely regarded as a failure. Reorganization is a favorite response to a governmental failure because it is visible, easily explainable, and can be done without ruffling too many feathers among interest groups and bureaucrats. It also buys time, since no one expects such reshuffling to be effective immediately.

The new financial overhaul bill is about 2,300 pages long, and though they are pages of large print and broad margins, I defy any single person to claim to have read and understood it all. So far as I can judge, though, much that the bill ordains is within the existing powers of the financial regulatory agencies and is therefore superfluous.” END QUOTE

The editorial quoted above goes on to make several other important points regarding why we don’t need this massive financial reform bill and how existing regulatory agencies just need to do their jobs. To read the rest of this excellent editorial, click on the link below:

http://www.bloomberg.com/news/2010-06-30/financial-bill-is-politics-in-worst-sense-commentary-by-richard-a-posner.html

Wishing you well in this slumping market,

Gary D. Halbert

SPECIAL ARTICLES:

Why Obamanomics Failed (must read!)
http://online.wsj.com/article/SB10001424052748704629804575325233508651458.html

Wall Street Journal summary of Financial Reform Bill
(click on the four buttons on the left side of the article)
http://online.wsj.com/article/SB10001424052748704569204575329211031691230.html?KEYWORDS=dan+fitzpatrick#project%3DFINREG100625%26articleTabs%3Dinteractive

Treasury, Dodd Sell Out To Wall Street on financial reform
http://www.forbes.com/2010/06/24/chris-dodd-barney-frank-markets-bob-lenzner-financial-reform.html?boxes=Homepagelighttop

Financial Reform: Triumph of the Regulators
http://online.wsj.com/article/SB10001424052748703615104575328993006115992.html