We're Still Sinking

For now, it may all be pigs killing people and elephants becoming donkeys, but in case anyone was under the impression that we're all allowed to stop fearing economic apocalypse and commence with our more familiar expressions of outrage at such paltry and pedestrian matters as, say, officially sanctioned torture, well then think again, Lefty! The newest GDP figures are out and they're enough to make anyone overlook a little water-boarding.

GDP fell 6.1% q/q annualized in 1Q well below consensus expectation of -4.6% and even below BAS ML forecast of down 5.5% (Source: Zero Hedge)

A caveat and then another. First, annualized gives us the growth figure as if the trend for the first quarter of 2009 were to remain constant for the next three. That means that in absolute terms GDP shrank by about 1.5% between January-March. Which, don't get me wrong, still sucks. But most people assume Q2-Q4 figures will not be quite so nasty. But then again, the assumptions of most people have been mostly wrong lately, so who knows.

Which brings me to the second caveat. Apparently, "consensus expectations" were overly optimistic in their predictions. I don't know who this Mr. Consensus is, but if he's anything like Mr. WallStreet, that isn't particularly surprising. As for Mr. BAS ML, I don't know him either, but he sounds foreign.

Is there a silver lining to any of this? First, the basic decomposition of GDP growth (or negative growth as it may be), plays out as follows: Consumption, Investment, Government Expenditure and Net Exports (the difference between exports and imports). So did anything improve?

The one bright note in the report was the consumer which posted a 2.2% quarterly annualized gain, in the first upturn since 2Q 2008. (Same Source)

Sweet! People are starting to spend more again. People just like you and me. People who are frantically trying to crawl out from under mountains of debt. People who are still being laid off and therefore have a decreasing amount of money to spend. Sweet?

Early tracking into 2Q however, suggest that this positive pace will not be sustained – not surprising amid the steadily climbing unemployment rate. (Same Source)

How are people spending more when by all accounts they have less? The only explanation I've been able to find so far is that so many people tightened their belts so much in the winter of 2008 (maybe, given expectations of further deterioration, a bit more than was justified by the so-called fundamentals of real income decline) that the 2.2% increase is a positive readjustment off the bottom of the barrel. For example, if I lose my home, my job, all of my friends and most of my teeth in March, but then in April, I forge some new dentures out of the chewing gum and cigarette butts that I scrape off the bottoms of my slowly deteriorating potato-sack shoes, my living standard has increased in April. But that isn't saying much, is it?

But what do the figures say about long-term trends?


(Source: Calculated Risk)

According those in the know (Calculated Risk, hopefully), empirically speaking, recessions tend to pass on through in a fairly predictable manner. Consumption tends to be first to drop off (and the first to recover), while large-scale commercial and industrial investment projects tend to be the most hesitant to jump back as the overall economy recovers. As as the graph may or may not demonstrate, consumption has already "bottomed out." Which is to say, we the economy as a whole may be in the process of bottoming as well. But as the graph shows, nothing else is showing any sign of improvement, so even if we want to start calling this a bottom, it's going to take some time before we can start crawling back up in any serious way.

And on an unrelated note, this is a pretty big story in my mind. As America's largest banks (many of whom declared bullshit profits this month, but that's a different story) continually exemplify the economic and political danger in allowing "too big to fail" financial centers to exist, the key regulatory approach adopted by the Obama Treasury Department is not to break them up, but to indirectly provide them with even more market share.

According to Naked Capitalism, the Treasury Stress Test of the banking system will evaluate home and other consumer loans as significantly more dangerous (and therefore less valuable in risk-adjusted terms) than more complicated/sophisticated financial assets. In other words, if you are a regional bank that has, as text-book banks tend to, made many different loans to people who are trying to buy homes or cars or education, you will be regarded as significantly more at-risk than a multinational financial conglomerate that as, as multinational financial conglomerates tend to, purchased a lot of complex asset-backed securities and derivative products. The result of such an implicit bias is that when the stress-test results are officially published, smaller banks will be condemned as risky while bigger banks will be seen as safer. This will in the short run push risk-averse capital away from the regional and towards the already unhealthily and impractically engorged center. In the longer-term, this may even result in further FDIC seizures of small banks, leaving the big banks to devour the remainder of the market.

Why is being hard on loans but not on securities a distortion? Many structured products (and most of the troubled securities fall in that category) have what is known as embedded leverage. That means an increase in defaults, or other fall in cash flow can have a disproportionate impact on the value of the instrument. That's why, for instance, some CDOs were downgraded from AAA to junk in an afternoon. That's an impossible occurrence with a loan book, absent a catastrophe like the Yellowstone caldera blowing up. Even when loan books decay, they do so in a linear fashion. Complex securities often decay much faster (with structured securities, particularly when certain levels are breached).

Of course, the tacit assumption may be that enough of this dreck can be dumped on the Fed via the TALF that it doesn't mater (yes, the TALF technically makes loans, but the TALF, like the public private investment partnership, can serve to validate phony valuations).(Source: Naked Capitalism)

In short, the very banks that should be splintered apart in the spirit of Standard Oil are now being further bulked up with the tacit support of the government.