Probable Future Outlook for the United States

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Guest Blogger: Trevor Gauntlett from 'Running the Gauntlett'

What concerns me most is looking at the highly probable future outlook for the U.S. …

The government is taking over Freddie and Fannie, which will help out new, but not existing home buyers. By assuming responsibility for their debt, the gov’t is using inflation adjusted tax dollars to keep these companies operating . However, a $500 billion dollar short fall is projected this year in the budget and the U.S. national debt is already at about 9.7 trillion and growing ever so rapidly. If we tack on unfunded liabilities, we are talking anywhere from 50-70 trillion in obligations. Effectively the government is insolvent. Now what happens when government revenues begin to decline due to the slowing economy, baby boomers start to take money out of social security and access Medicare when they retire, and the continuation of the Iraq war / Afghan war / maybe Iran war?

I’m failing to see the light at the end of the tunnel.

During the housing boom, U.S. consumers purchased houses because money was cheap. Everyone felt rich so they purchased more consumables for immediate gratification. These weren't investments with productive value that would add to the economy in the future and they experienced immediate depreciation. Once U.S. consumers could no longer get money out of their homes through refinancings and HELOCs (home equity lines of credit), we started using our credit cards. Look at who is producing and who is consuming… we in the USA are primarily guilty of the latter and it is all funded through the rest of the world’s savings. At some point other countries are going to refuse to continue supporting the U.S. spending binge - this might already be taking place.

As for housing it will have to come back down to reasonable values. If we encounter a period of hyperinflation then housing could be a good asset to hold onto (although this was not the case during the hyperinflation in Wiemar Germany in the early 1920s). On the other hand, if we have a depression I could argue the opposite.

People are already losing their HELOCs because banks are worried that consumers won’t be able to afford them. Legal or not this is happening. I also heard from a Real Estate agent in Seattle that banks are asking for 25% down on new mortgages. In an earnings call in late January 2008, Bank of America executives said credit card delinquencies in California, Florida, Arizona, and Nevada—states with high foreclosure rates—increased five times as fast as in other states, suggesting that consumers struggling with their mortgage debt are also finding their credit card bills hard to pay. “We’re focused on getting paid for the risk we take,” said Joe Price, chief financial officer. - US News and World report 2/28/2008.

What happens if the United States dollar loses its status as the reserve currency? Then everyone with dollars will flood the market to get rid of them. The dollar is a commodity just like gold and silver, but unlike gold and silver any amount of it can easily be created. It has no intrinsic value and is a exchangeable commodity and legal tender because of government fiat (hence paper money is fiat money or fiat currency). If people want dollars, the price rises and as people desire them less, the price falls. Loss of reserve currency status would mean the demand for U.S. dollars would fall significantly. Why would anyone want dollars when you look at the future for the US economy except because of necessity or political reasons?

The GSE bailout will help to prolong the issues that the financial industry is facing. The United States government will do everything in its power to support the system through money creation and taxation, giving individuals and institutions more time to pull their money out of the dollar. An immediate collapse would make that very difficult and costly.

I’m getting the sense that things could get a whole lot worse than any of us imagine.

NEXT: The Banks and Brokers Most Likely to Fail - The Big Players

Daryl Montgomery

Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Bailout to Bailout: The Bear Stearns Bailout and Its Aftermath

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video for this posting can be found at: http://www.youtube.com/watch?v=G8Mn67rNCFQ

It was soon realized that the temporary loan given by the Federal Reserve to Bear Stearns would not be enough to keep the company afloat. Indeed this was probably already known before the loan's announcement was made on the afternoon of the 14th. The Fed, particularly the New York regional division, worked feverishly all weekend to find a definitive solution to Bear's insolvency. They decided to have JP Morgan take over Bear at a price of $2.52 a share, a rather sharp haircut to the Friday closing price of $30 a share ... and an even steeper discount to the official book value of $84 to $97 a share for Bear stock, which the CEO had announced was unimpaired only two days earlier.

Not only did JP Morgan get Bear Stearns essentially for free, but the Federal Reserve further guaranteed $30 billion (later reduced to $29 billion) of Bears troubled mortgage bonds. JP Morgan was by no means just a lucky bystander in this transaction. Its CEO sat on the board of governors of the New York Fed and got to influence the decision that proved highly favorable to them - in more ways than one it turned out. JP Morgan was a counter party to a large number of derivatives on Bear Stearns books and Bears failure would probably have sunk JP Morgan shortly thereafter. So the Fed's giveaway bailout of Bear Stearns was also an indirect bailout of JP Morgan. Membership (in the Fed) obviously has its privileges. Bear Stearns not being a Fed member wound up being thrown to the wolves.

While JP Morgan and the Bear Stearns bondholders were winners because of the Fed arranged bailout, stockholders and credit default swap (CDS) holders wound up being the big losers. If Bear Stearns had actually declared bankruptcy, the CDS holders would have had a big payday. However, once again the Fed's interference in the market turned winners who had made the correct investment decision into losers by changing the rules of the game at the last moment.It turned out that the stock holders had more clout and wound up successfully agitating for an increase in the takeover price to $10 a share. Even at that price some of the 'smart money' lost big, including British investor Joe Lewis, who lost over a billion dollars, and renowned mutual fund manager Bill Miller whose fund had large holding of Bear stock. The American taxpayer, as per usual, was put on the hook and would also wind up paying for Bear Stearns mismanagement and the Fed's gifting to JP Morgan.

As a result of being blindsided by Bear Stearns failure, the Fed set up the Primary Dealer Credit Facility (PDCF) in March of 2008. For the first time in its history, the Fed allowed broker-dealers to also borrow from them, not just commercial banks. Lehman Brothers was an immediate beneficiary of this new program, which probably kept it from failing shortly after Bear Stearns did. The legality of this new Fed operation was at best tenuous, but the Fed seemed to have little concern for following its mandate of controlling inflation or restricting its activities to those specifically granted to it by the U.S government. After all why should the Fed be concerned about such things since it knew the government was unlikely to try to keep it from doing whatever it wanted to do - legal or otherwise.

NEXT: Run on the Bank, 2008 - Indymac

Daryl Montgomery

Organizer, New York Investing meetup

http://investing.meetup.com/21