Authored by Nomi Prins via The Daily Reckoning,
Though it seems like only yesterday, it’s been a decade since my former employer, Lehman Brothers, went bankrupt, and in the process, helped instigate a massive global financial crisis.
That collapse catapulted the Federal Reserve on a mission to, in its own narrative, save the economy from further collapse. In fact, its creation of $4.5 trillion to purchase U.S. treasury and mortgage related bonds from the big private banks in exchange for continued liquidity was the biggest subsidy in U.S. history.
In some ways, we seem much better off now. Employment is at record highs in most developed nations outside the Eurozone. Global economic growth has picked up overall and stock markets have recovered.Indeed, many stock markets around the world have regained or passed their former record highs. Asset prices are booming.
But that only tells half the story.
That’s because the last financial crisis was about debt and debt levels have increased substantially since 2008. The entire “recovery” was built on debt.
From 179% before the financial crisis, the global debt-to-GDP ratio has jumped to 217% today. Companies and governments have piled on more debt than before. Emerging-market debt, led by China, is also at a record. The big banks are even bigger, and remain “too big to fail.”
Eliminating all that debt is the ultimate solution for avoiding another crisis. That’s because if interest rates drift higher, it can lead to problems in debt repayment, followed by defaults, followed by crisis as defaults spread like a contagion. But there’s no magic bullet for doing that.
First, you should know that no two crises are exactly the same. The last one was met with huge debt on the back of the Fed’s quantitative easing policy. Central bank credit, or what I call dark money, tended to go to the wealthy and into financial assets.
“Dark money” comes from central banks. In essence, central banks “print” money or electronically fabricate money by buying bonds or stocks. They use other tools like adjusting interest rate policy and currency agreements with other central banks to pump liquidity into the financial system.
That dark money goes to the biggest private banks and financial institutions first. From there, it spreads out in seemingly infinite directions affecting different financial assets in different ways.
Dark money is the #1 secret life force of today’s rigged financial markets. It drives whole markets up and down. It’s the reason for today’s financial bubbles.
On Wall Street, knowledge of and access to dark money means trillions of dollars per year flowing in and around global stock, bond and derivatives markets. Now, ten years after the financial crisis, there are major complications building with the deluge of debt created on the back of quantitative easing policy.
When the next shoe drops from our inflated bubble markets, it will be the debt markets that lead the way. Whether the financial bubble begins to pop in emerging markets, over-leveraged corporate sectors or from over-stretched consumers — the reality is that a storm is brewing.
All of this is a recipe for another crisis. Meanwhile, a new article lists ten warning signs of a recession by 2020.
Written by Nouriel Roubini, a professor at NYU’s Stern School of Business and CEO of Roubini Macro Associates and Brunello Rosa, co-founder and CEO at Rosa & Roubini Associates, shows why 2020 could be the year of the next financial crisis.
They range from the economic to the geopolitical triggers. They posit that the “current global expansion will likely continue into next year, given that the U.S. is running large fiscal deficits, China is pursuing loose fiscal and credit policies, and Europe remains on a recovery path.”
After that, however, they believe that conditions will lead to a financial crisis, and then a global recession. The main four reasons are:
Now, J.P. Morgan Chase, another of my former employers, sees a problem. The next crisis may become so serious a recent JPM report suggests, “that the next financial crash may be so cataclysmic that the Federal Reserve may have to enter the market to buy up stocks…”
So let’s get this straight. JPM has spent tens of billions of dollars over the past several years buying back its own stock to boost the price. Now they want the Fed to directly bail out the stock market — and JP Morgan stock by implication. Call it whatever you want, just don’t call it the free market.
What all of this means that the Fed will either stop its current tightening program, re-invoke QE, or get its central bank allies to do the same when necessary. It means that further rounds of quantitative easing (through various dark money ploys), in addition to all the help they’ve received, will continue. The banks can see no other option.
All of those options could prop up the market through volatile periods ahead and drive the current bull market even further.
In the long run, this is not sustainable. No one can say exactly when the next crisis will arrive, but there are lots of signs it may be getting close.
In the meantime, you can take steps to prepare yourself by taking profits and allocating money into cash or gold if signs of a crisis grow stronger. By staying diversified in your portfolio and watching stories like these you can be well prepared for market turmoil when it arrives.
While we aren’t there yet, I’ll be watching for signs of risks and opportunities along the way
Wasting The Lehman Crisis: What Was Not Saved Was The Economy
ZeroHedge.com Fri, 09/21/2018 - 20:25
Authored by Michael Hudson via Counterpunch.org,
Today’s financial malaise for pension funds, state and local budgets and underemployment is largely a result of the 2008 bailout, not the crash. What was saved was not only the banks – or more to the point, as Sheila Bair pointed out, their bondholders – but the financial overhead that continues to burden today’s economy.
Also saved was the idea that the economy needs to keep the financial sector solvent by an exponential growth of new debt – and, when that does not suffice, by government purchase of stocks and bonds to support the balance sheets of the wealthiest layer of society. The internal contradiction in this policy is that debt deflation has become so overbearing and dysfunctional that it prevents the economy from growing and carrying its debt burden.
Trying to save the financial overgrowth of debt service by borrowing one’s way out of debt, or by monetary Quantitative Easing re-inflating real estate, stock and bond prices, enables the creditor One Percent to gain, not the indebted 99 Percent in the economy at large. Therefore, from the economy’s vantage point, instead of asking how the banks are to be saved “next time,” the question should be, how should we best let them go under – along with their stockholders, bondholders and uninsured depositors whose hubris imagined that their loans (other peoples’ debts) could go on rising without impoverishing society and preventing creditors from collecting in any event – except from government by gaining control over it.
A basic principle should be the starting point of any macro analysis: The volume of interest-bearing debt tends to outstrip the economy’s ability to pay. This tendency is inherent in the “magic of compound interest.” The exponential growth of debt expands by its own purely mathematical momentum, independently of the economy’s ability to pay – and faster than the non-financial economy grows.
The higher the debt/income ratio rises, the more interest, amortization payments and late fees are extracted from the economy. The resulting debt burden slows the economy, causing defaults. That is what happened in 2008, and is accelerating today as debt ratios are rising for corporate debt, state and local debt, and student debt.
Neither legislators, academics nor the public at large recognize a corollary Second Principle following from the first: An over-indebted economy cannot be saved unless the banks fail. That means writing down the financial claims by the One to Ten Percent – in other words, the net debts owed by the 99 to 90 Percent. Wiping out bad debts involves writing down the “bad savings” that are the counterpart to these debts on the asset side of the balance sheet. Otherwise the economy will suffer debt deflation and austerity.
“Recovery” since 2008 has been much slower than earlier recoveries because debt deflation is siphoning off more and more personal and corporate income. To make matters worse, the bailout’s policy of Quantitative Easing to re-inflate asset prices has reduced rates of return for pension funds, insurance companies and employee retirement savings. This means that more state and local government income must be diverted to meet retirement commitments.
Something has to give, and it is not likely to be the savings of the donor class at the top of the economic pyramid. As a result, the economy at large is threatened with an exponentially expanding erosion of disposable income and net worth for most people and companies. Investment managers are warning of a financial meltdown, given today’s historically high price/earnings ratios for stocks and also for rental properties.
What is not acknowledged is that such a crisis is a precondition for today’s economy to recover from the rising debt/income and debt/GDP ratios that are burdening the United States, Europe and other regions. At least the United States has been able to monetize its budget deficits and subsidize banks to carry its rising debt overhead with yet new debt. The Eurozone has banned budget deficits of over 3 percent of GDP, imposing austerity that leaves the only response to over-indebtedness to be Greek-style austerity: depopulation, shrinking living standards, wipeouts of retirement income and pensions, mortgage defaults, shortening lifespans, and mass selloffs of public infrastructure to foreign financial appropriators.
None of this was spelled out in the September 15 weekend marking the tenth anniversary of Lehman Brothers’ failure and subsequent rescue of Wall Street. President Obama, Treasury Secretary Tim Geithner and their fellow financial lobbyists at the Federal Reserve and Justice Department are credited with saving “the economy,” as if their donor class on Wall Street was a good proxy for the economy at large. “Saving the economy from a meltdown” has become the euphemism for saving bondholders and other members of the One Percent from taking losses on their bad loans. The “rescue” is Orwellian doublespeak for expropriating over nine million indebted Americans from their homes, while leaving surviving homeowners saddled with enormous bubble-mortgage payments to the FIRE sector’s owners.
What has been put in place is not a restoration of traditional status quo, but a reversal of over a century of central bank policy. Failed banks have not been taken into the public domain. They have been enriched far beyond their former levels. The perpetrators of the collapse have been rewarded, not penalized for lending more than could possibly be paid by NINJA borrowers and speculators whose mortgage applications were doctored by systemic fraud at Countrywide, Washington Mutual, Bank of America, Citigroup and their cohorts.
The $4.3 trillion that could have been used to save debtors was given to the banks and Wall Street firms whose recklessness and outright fraud caused the crisis. The Federal Reserve “cash for trash” swaps with insolvent banks did not restore normalcy or the status quo ante. What occurred was a financial revolution by stealth, reversing the traditional responsibility of creditors to make prudent loans.
Quantitative Easing saved creditors and the largest stockholders and bondholders by lowering the interest rates by enough to make it profitable for new loans to inflate asset prices on credit. This revived the value of collateral backing bank loans and bondholdings. “Saving” the economy in this way actually sacrificed it. That is why our “recovery” is only “on paper,” a result of calculating GDP to include bank earnings and hypothetical homeowner windfalls as rents are soaring.
Among Democrats, the most extreme tunnel vision denying that debt is a problem comes from Paul Krugman:
Writing that “The purely financial aspect of the crisis was basically over by the summer of 2009, ”he criticized what he called the “bizarre Beltway consensus that despite high unemployment and record low interest rates, debt, not jobs, was the real problem.”
This misses the point that 2009 was the real beginning for most of the nine million homeowners being foreclosed on and evicted from their homes. Consumers found themselves with less income “freely disposable” after paying their monthly FIRE sector nut off the top of their paycheck – housing charges, credit card charges, medical insurance, student debt, FICA withholding and tax withholding. Krugman says that he would have solved the problem by more deficit spending to pump enough money into the economy to enable debtors to keep paying the banks their exponential growth of interest claims.
We are still living in the destabilized, debt-ridden aftermath of such pro-bank advocacy. In the New Yorker, John Cassidy celebrates a book by Columbia professor Adam Tooze promoting the idea that “the economy” cannot exist without the credit (that is, debt) provided by the financial sector. True enough, but does it follow that rescuing the economy must involve rescuing Wall Street and enriching the banks at the expense of the rest of the economy. That conflation is an Orwellian rhetoric of deception that has been introduced to the discussion of how the economy was “rescued” by locking in today’s Great Debt Deflation.
At the neoliberal/neocon Brookings Institution, Treasury secretaries Hank Paulson and Tim Geithner joined with the Federal Reserve’s Ben Bernanke to explain that the public simply didn’t understand how successful they all were in saving not only the banks, but non-bank financial institutions. Unlike Sheila Bair, they did not point out that behind these institutions were the bondholders, the One Percent of savers who held the rest of the economy in debt. Bernanke wrote a Financial Timespiece producing junk statistics purporting to show that there was no underlying debt or financial problem at all, merely a “panic.” To paraphrase, he said: “The crisis was all in the mind folks. Nothing to see here. Keep moving on.” It is as if, as Margaret Thatcher liked to insist, There Is No Alternative.
Can this bailout without debt writedowns really bring prosperity? Can economies achieve growth by “borrowing their way out of debt,” by creating enough new credit to cover the interest charges out of capital gains from the asset-price inflation fueled by new bank credit. That is the logic that has guided the Federal Reserve’s net $4.3 trillion in Quantitative Easing, and the parallel credit creation by the European Central Bank under Mario “Whatever it takes” Draghi. Ellen Brown recently published a review, “Central Banks Have Gone Rogue, Putting Us All at Risk, noting that the ECB has become a major stock buyer. The beneficiaries are the stockholders who are concentrated in the wealthiest percentiles of the population. Governments are not underwriting homeownership or the solvency of labor’s pension plans, but are underwriting the value of collateral backing the savings of the narrow financial class.
The GDP accounts report the widening gap between low government bond rates and the cost of credit to banks compared to the higher rates paid by mortgage borrowers, credit-card holders and student loan customers as “financial services.” What is extracted from the economy is added to the GDP statistic instead of being treated as a subtrahend. This absurd practice reflects the degree to which Wall Street lobbyists have captured economic statistics. The National Income and Product Accounts (NIPA) have been turned into a vehicle for deception. What is celebrated as growth of the GDP since 2008 has been mainly the growth in financial extraction, along with the health-insurance sector profiting from Obamacare.
Glenn Hubbard, chairman of the Council of Economic Advisors under George W. Bush, uses Orwellian doublethink to pretend that “Debt is Wealth.” He concludes a Wall Street Journal op-ed:
“An ability to recapitalize banks remains crucial and must be explained to a skeptical Congress and public,” so that wealthy bondholders and speculators will not suffer losses.
On a brighter side, Adair Turner pokes fun at the “Authoritative experts such as the IMF [who] explained how increased securitisation and trading activity made the financial system more efficient and less risky.” It was as if “options” and hedges can get rid of risk entirely, not shift them onto Wall Street victims such as the naïve German Landesbanks.
The aim of this week’s disinformation campaign is to prevent popular anger advocating what was done in classical antiquity. The ancients fought civil wars for land redistribution and debt cancellation. Today the demand should be for mortgage writedowns to bring their carrying charges in line with reasonable rent charges, limited to the former normal 25 percent of homeowner income – while rolling back the FICA wage withholding and allied taxes levied to bail out the creditor class.
An Athenian antecedent to today’s financial takeover
It is an old story, with a striking parallel in classical Athens. After losing the Peloponnesian war to oligarchic Sparta in 404, a Pinochet-style military junta – the Thirty Tyrants – was installed. During its eight months of terror its members killed a reported 1,500 democratic advocates whose land and other property they grabbed. Advocates of democracy took refuge in Thrace and other neighboring regions.
After the exiled democratic leaders reconquered Athens, they sought to restore harmony, going so far as to pay off all the debts that the oligarchic junta had run up to Sparta. To top matters, the subsequent 4thcentury obliged Athenian jurors and indeed, mayors in some Greek cities to swear an oath: “I will not allow private debts (chreon idiom) to be cancelled, nor lands nor houses of Athenian citizens to be redistributed.”
If no such pledge is needed today by public officials, it is because the financial administrators at the Treasury, Federal Reserve and other regulatory agencies already have shown themselves to be so tunnel-visioned from graduate school through their employment history that they can be trusted to find debt writedowns as unthinkable as enforcing laws against criminal financial fraud to punish individuals rather than their institutions. Academia joins in the deception that financial engineering can sustain a geometric growth in debt ad infinitumwithout imposing austerity.The bailout aftermath has demonstrated that corporations are not really “persons” if they cannot be given jail time.
The key financial principle is that this self-expansion of interest-bearing debt grows to absorb more and more of the economic surplus. The solution therefore must involve wiping out the excess debt – and savings that have been badly lent. That is what crashes are supposed to do. It was not done in 2008. That is why the status quo was not restored. A vast giveaway to the financial elites occurred, setting the rest of the economy on a road to debt peonage.
At stake is whether the U.S. and Western European economies are going to end up looking like those of Greece, Latvia and Argentina – or imperial Rome for that matter. Neoliberals applaud today’s victorious finance capitalism as the “end of history.” One such end has already occurred once, at the close of Roman antiquity. It is remembered as the Dark Age. Progress stopped as the creditor and landowning class lorded it over the rest of society. Trade survived only among the lords at the top of the economic pyramid. Today’s “End of History” dream threatens to unfold along similar lines. It is all about relative power of the One Percent.
California Tops National Poverty Rate As Prime Demographic Plans "Exodus" From State
ZeroHedge.com Sat, 09/15/2018 - 21:40
Despite efforts by state legislators at creating a socialist utopia, California still has the highest poverty rate in the nation at 19%, despite a 1.4% decrease from last year according to the Census Bureau.
Poverty and income figures released Wednesday reveal that over 7 million Californians are struggling to get by in the second most expensive state to live in, according to the Council for Community and Economic Research's 2017 Annual Cost of Living Index.
And while California has a "vigorous economy and a number of safety net programs to aid needy residents," according to the Sacramento Bee, one out of every five residents is suffering economic hardship - which is fueled in large part by sky-high housing costs, according to Caroline Danielson, policy director at the Public Policy Institute of California.
“We do have a housing crisis in many parts of the state and our poverty rate is highest in Los Angeles County,” she said, adding that cost of living and poverty is often highest in the state’s coastal counties. “When you factor that in we struggle.”
Silicon Valley residents in particular are leaving in droves - more so than any other part of the state. Nearby San Mateo County which is home to Facebook came in Second, while Los Angeles County came in third.
“They’re looking for affordability and not finding it in Santa Clara County,” said Danielle Hale, chief economist for realtor.com.
It's not just housing prices driving the exodus, of course. Punitive taxes - more than twice as much as some other states, are eating away at disposable income. Nearby Arizona's income tax rate is 4.54% vs. California's 9.3%, while the new tax bill may accelerate the exodus.
As Michael Snyder of the Economic Collapse Blog pointed out in May...
Reasons for the mass exodus include rising crime, the worst traffic in the western world, a growing homelessness epidemic, wildfires, earthquakes and crazy politicians that do some of the stupidest things imaginable. But for most families, the decision to leave California comes down to one basic factor…
As you may or may not be aware, we've mentioned the flood of various types of Californians fleeing the state for various reasons; be it wealthy families who want to keep more of their income safe from the tax man, or poor residents leaving the Golden State because they are being crushed by the high cost of living.
To that end, the Orange County Register notes a significant outmigration of people in their child-raising years - as the largest group leaving the state, some 28%, are those aged 35 to 44.
According to IRS data from 2015-2016, the latest available, roughly half of those leaving the state make less than $50,000 per year, while roughly 25% of those leaving make over $100,000.
What did the OC register conclude?
Thanks to unaffordable housing, California's moderate wage earners are going to have to leave the state, while only the wealthy and the impoverished residents will remain.
But the big enchilada in California — by far the largest source of distortion in living costs — is housing. Over 90 percent of the difference in costs between California’s coastal metropolises and the country derives from housing. Coastal California is affordable for roughly 15 percent of residents, down from 30 percent in 2000 and 30 percent in the interior, from nearly 60 percent in 2000. In the country as a whole, affordability hovers at roughly 60 percent.
Over time these factors — along with prospects of reduced immigration — will impact severely the state’s future. California is already seeing its population aged 6 to 17 decline. This reflects a continued drop in fertility in comparison to less regulated, and less costly, states such as Utah, Texas and Tennessee. These areas are generally those experiencing the biggest surge in millennial populations. -OC Register
And according to ULI, 74% of California millennials are considering an exodus.
As we noted in June, these are the top 10 California counties that people are leaving, and where they're headed (via the Mercury News):
1. Santa Clara County
Out of state destinations: Arizona, Nevada, Texas and Idaho
In state destinations: Alameda, Sacramento, San Joaquin, Santa Cruz and Placer counties
2. San Mateo County
Out of state destinations: Arizona, Nevada, Texas and Washington
In state destinations: Alameda, Contra Costa, Santa Clara, Sacramento, and San Francisco counties
3. Los Angeles County
Out of state destinations: Nevada, Arizona, and Idaho
In state destinations: San Bernardino, Riverside, Ventura and Kern counties
4. Napa County
Out of state destinations: Arizona, Idaho, Nevada, Florida and Oregon
In state destinations: Solano, Sonoma, Sacramento, Lake and El Dorado counties
5. Monterey County
Out of state destinations: Arizona, Nevada, and Idaho
In state destinations: San Luis Obispo, Fresno, Santa Cruz, Sacramento and San Diego counties
6. Alameda County
Out of state destinations: Arizona, Nevada, Idaho, and Hawaii.
In state destinations: Contra Costa, San Joaquin, Sacramento, Placer, and El Dorado counties
7. Marin County
Out of state destinations: Nevada, Arizona, Oregon and Idaho.
In state destinations: Sonoma, Contra Costa, Solano and San Francisco counties
8. Orange County
Out of state destinations: Arizona, Nevada and Idaho
In state destinations: Riverside, Los Angeles, San Bernardino, San Diego and San Luis Obispo
9. Santa Barbara County
Out of state destinations: Arizona, Nevada and Idaho.
In state destinations: San Luis Obispo, Ventura, Los Angeles, Riverside and Kern counties
10. San Diego County
Out of state destinations: Arizona and Nevada
In state destinations: Riverside, San Bernardino, Imperial, Orange County and Los Angeles
The Pension Crisis Is Bigger Than The World’s 20 Largest Economies
ZeroHedge.com Fri, 09/07/2018 - 16:35
Submitted by Simon Black of Sovereign Man.com
If your retirement plans consist entirely of that pension you’ve been promised, it’s time to start looking elsewhere. As you probably know, pensions are giant pools of capital responsible for paying out retirement benefits to workers.And right now many pension funds around the world simply don’t have enough assets to cover the retirement obligations they owe to millions of workers.
In the US alone, federal, state, and local governments, pensions are about $7 TRILLION short of the funding they need to pay out all the benefits they’ve promised.(** And that doesn’t include another $49 trillion in unfunded Social Security obligations…)
America’s private pensions are in bad shape too — a total of around 1400 corporate pensions are a combined $553 billion in the hole. Plus, 25% of those funds are expected to go broke in the next decade. But the pension problem is much bigger than just what’s happening (though the US problems are SEVERE).
In 2015, the total worldwide gap in pension funding was $70 TRILLION according to the World Economic Forum. That is larger than the twenty largest economies in the world combined.
And it’s only gotten worse since then…
The WEC said that the worldwide pension shortfall is on track to reach $400 trillion by 2050.
And what solutions did they suggest?
“Provide a ‘safety net’ pension for all.” You know, sort of like Social Security… which as we mentioned is $49 trillion in the hole. Not exactly a sound solution. Another solution the WEC offered was to increase contribution rates– in other words, forcing current workers pay more to support retired workers.
Only one problem with that… global demographics are awful. There just aren’t enough young people being born to pay out benefits for retirees. And that problem is coming to a head in South Korea, where about 13% of the population is currently of retirement age: 65 or older.By 2060, 40% of the population will be over 65.
And, you guessed it, there aren’t close to enough people being born to burden that load.
This is a nightmare scenario for pensions (in addition to fact that low interest rates have made the returns pensions need to break even basically unachievable).
But worry not, South Korea has an answer for the problem…
The government spent $113 billion over the past 12 years trying to get people to have more kids (I’m curious what this money was spent on… removing condom dispensers from bathrooms?).
But more importantly, this should give you a hint of how the government views you… Much like a dairy cow. Not enough milk? Breed more cows!
But for all the money and effort, South Koreans are actually having FEWER babies– a decline of 1.12 babies per woman in 2006, to just 0.96 this year. So when you look a few decades out, South Korea clearly isn’t going to have enough workers paying into the pension system to support all the retired beneficiaries.
Even the government acknowledges this. And they’ve already started managing expectations…
One of the government’s proposals is to slash retirement payments by 10%. At the same time, the government wants to increase current contributions (i.e. payroll TAX) by almost 50%.
These people have been planning their futures based on promises the government has been making for decades. Unfortunately, those promises have no basis in reality. And if you think higher pension contributions and lower payouts are contained to South Korea, you’re nuts.
Earlier this year, the US Office of Personnel Management proposed $143.5 billion worth of pension cuts for current AND already retired federal workers. But that’s a band-aid on a bullet wound… It won’t actually come even close to solving the problem. You know more cuts will come. Remember, US government pensions are $7 TRILLION in the hole. And the demographics are just as bad (the US currently has the lowest fertility rate on record).
Look, I’m not trying to be alarmist. These are just the cold hard facts that everyone needs to understand. We’re talking about long-term challenges to retirement. But it’s retirement… ergo we’re SUPPOSED to think long-term about retirement: years, decades out. Retirement requires having a plan. Or, in this case, a Plan B… as anyone depending on a pension or social security for retirement is out of luck.
Governments have lulled hundred of millions of people into a false sense of security based on financial promises they are not going to be able to keep. It’s not a political problem. It’s an arithmetic problem. And one they’re unable to solve.
But you can.
While you might not be able to fix the pension gap in your home country, you can definitely secure your own retirement. There’s no need to rely on empty promises and broken pension funds. With some basic planning, education, and a bit of early action, you can safely sidestep the consequences of this looming financial crisis that is larger than the world’s 20 largest economies combined.
Goldman's Bear Market Indicator Shows Crash Dead Ahead, Asks "Should We Be Worried?"
ZeroHedge.com Wed, 09/05/2018 - 15:30
One year ago, we reported that in its attempt to calculate the likelihood, and timing, of the next bear market, Goldman Sachs created a proprietary "Bear Market Risk Indicator" which at the time had shot up to 67% - a level last seen just before the 2000 and 2007 crashes - prompting Goldman to ask, rhetorically, "should we be worried now?"
While Goldman's answer was a muted yes, nothing dramatic happened in the months that followed - the result of Trump's $1.5 trillion fiscal stimulus which pushed the US economy into a temporary, sugar-high overdrive - aside from the near correction in February which was promptly digested by the market on its path to new all time highs (here one has to exclude the rolling bear markets that have hit everything from emerging markets, to China, to commodities to European banks).
At the time, Goldman wrote that it examined over 40 data variables (among macro, market and technical data) and looked at their behaviour around major market turning points (bull and bear markets). Most, individually, did not work as leading indicators on a consistent basis, or they provided too many false positives to be useful predictors. So the bank developed a Bear Market Risk Indicator based on five factors, in combination, that do provide a reasonable guide to bear market risk – or at least the risk of low returns: valuation, ISM (growth momentum), unemployment, inflation and the yield curve.
And, as Goldman's Peter Oppenheimer explained, while no single indicator is reliable on its own, the combination of these five seems to provide a reasonable signal for future bear market risk.
All of these variables are related. Tight labor markets are typically associated with higher inflation expectations. These, in turn, tend to tighten policy and weaken expectations of future growth. High valuations, at the same time, leave equities vulnerable to de-rating if growth expectations deteriorate or the discount rate rises, or, worse still, both of these occur together.
To aggregate these variables in a signal indicator, we took each variable and calculated
its percentile relative to its history since 1948. For the yield curve and unemployment
we took the lowest percentiles relative to history, while for the other indicators we took
the highest. We then took the average of these.
Fast forward to today, when one year later Goldman has redone the analysis (and after what may have been some prodding from clients and/or compliance, renamed its "Bear Market Risk Indicator" to "Bull/Bear Market Risk Indicator") where it finds that the risk of a bear market - based on its indicator - is now not only nearly 10% higher than a year ago, but well above where it was just before the last two market crashes, putting the subjective odds of a crash at roughly 75%, well in the "red line" zone, and just shy of all time highs.
Or as Goldman puts it, "Our Bull/Bear market indicator is flashing red."
While one can argue with the subjective interpretation of this heuristic, a tangential analysis shows that Goldman's indicator is inversely correlated with future returns, and as of this moment, Goldman is effectively forecasting a negative return from now until 2023.
Here even Goldman's Oppenheimer admits that "the indicator is at levels which have historically preceded a bear market. Should we take this seriously? It’s always risky to argue that this time is different but there are two most likely scenarios when we think of equity returns over the next 3-5 years."
Or, in other words, "how worried should we be about a bear market?"
Goldman's answer is two-fold, laying out two possible outcomes from here, either a sharp, "cathartic" bear market, or just a period of slower, grinding low returns for the foreseeable future. Naturally, Goldman is more inclined to believe in the latter:
i) Valuation is currently the most stretched of the factors in the Indicator – other factors such as inflation appear more reasonable. This is largely a function of very loose monetary policy and bond yields.
ii) Inflation and, therefore, interest rate rises have played an important part in rising bear market risks in past cycles. Structural factors may be keeping inflation lower than in the past, and central bank forward guidance is reducing interest rate volatility and the term premium. Without monetary policy tightening much, concerns about a looming recession – and therefore risks of a ‘cyclical’ bear market – are lower. So long as the Phillips curve remains as flat as it is now, strong labour markets can continue without the risk of a recession triggered by a tightening of interest rates. While this has not happened before in the US (and hence the economic cycle has not lasted more than 10 years), there have been examples of other economies experiencing very long economic cycles where the unemployment rate moved roughly sideways for many years.
Our economists have shown that there are good examples of long expansions, such as in Australia from 1992 to the present, the UK from 1992 to 2008, Canada from 1992 to 2008 and Japan from 1975 to 1992. Typically they find that a flatter Phillips curve, stronger financial regulation and a lack of financial imbalances are all good indicators that a long cycle is more likely. On this later point, the signs are quite positive.
In the case of the US, our economists point out that a passive fiscal tightening, tighter financial conditions and supply constraints are likely to leave growth at 1.6% in 2020, below potential, leaving a greater risk of at least a technical recession in 2020-2021. But this is not their base case and their model (which uses economic and financial data from 20 advanced economies to estimate recession odds) puts the probability of a US recession at under 10% over the next year and just over 20% over the next two years, below the historical average.
iii) Aligned to this point, we can see that inflation targeting and independent central banks have both contributed to lower macro volatility and longer expansion phases in economic cycles since the 1980s.
Illinois Breaks Pension-Debt Record For US States
Sat, 09/01/2018 - 13:00
Authored by Adam Schuster via IllinoisPolicy.org,
According to a new report by Moody’s Investors Service, Illinois’ unfunded pension liabilities equaled 601 percent of state revenues in 2017, a U.S. record.
Illinois’ pension debt has set a new record to which no state should aspire.
Credit ratings agency Moody’s Investors Service released a report Aug. 27 comparing unfunded pension liabilities across all U.S. states. According to the report, Illinois’ unfunded pension liabilities grew 25 percent in fiscal year 2017 to $250 billion. That equates to 601 percent of “own source” revenue, meaning money brought in by the state excluding federal funds. That ratio of pension debt to revenue is the highest on record for any U.S. state, according to Moody’s. The national median is 107 percent.
This matters much for the same reason banks look at an individual’s debt-to-income ratio when considering applications for a personal loan. Banks typically won’t issue a qualified mortgage to anyone with a debt-to-income ratio of more than 43 percent.
When a state’s pension debts far exceed its revenue, that means those debts are less likely to be repaid. Illinois’ inability to manage its pension system in a sustainable and affordable way is one of the main reasons both Moody’s and S&P Global Ratings put the Prairie State’s bond rating just one notch above “junk” status. The state’s credit rating has been downgraded 21 times since 2009, primarily due to runaway pension debt.
A low bond rating increases the cost of borrowing money for taxpayers and makes it difficult for state government to invest in core services residents want, such as needed infrastructure improvements.
Other measures of the state’s ability to repay pension debt tell a similarly bad story for Illinois. The state has the worst pension debt in the nation as a percentage of both GDP and personal income, which are broad economic measures that indicate how much money is being brought in by the funding sources for government expenditures: individual and corporate taxpayers.
A recent report from the Illinois Policy Institute, “Tax hikes vs. reform: Why Illinois must amend its constitution to fix the pension crisis,” details the threat of pensions crowding out core government services, which has led to calls for economically damaging tax hikes that can erode Illinois’ financial health. Annual state pension costs already exceed 25 percent of general revenue expenditures.
If tax hikes are off the table as a solution to this problem – as they should be given Illinois’ weak economy and already-painful total tax burden – lawmakers’ only remaining options are to structurally reform pensions so that they are in line with what taxpayers can afford going forward, or to allow pension spending to crowd out government services.
Crowding out effects can already be seen at the local level in Illinois. In Harvey, Illinois, pension obligations caused mass layoffs in the city’s police and fire departments. Because of a statutory provision that allows the state comptroller to intercept state money due to local governments that underfund their pensions, many other municipalities could soon find themselves in a similar situation. Over 50 percent of Illinois’ police and fire pension funds did not receive full payment in 2016, putting their municipalities at risk of facing the same choices as Harvey.
The city of Peoria on Aug. 15 and 16 sent layoff notices to 27 municipal employees, according to the Journal Star, after unions rejected a cost-saving plan requesting four furlough days. According to Peoria City Manager Patrick Urich, 85 percent of the city’s property tax revenue currently goes to pensions, rather than services. Urich told the Journal Star that the round of layoffs was necessary to close a $1.5 million deficit in the city’s budget.
Peoria’s 2018 budget warns, “[T]he growth in pension obligations is crowding out the use of property taxes for operations.” According to projections included in the document, the city will no longer be able to use any property tax dollars for operations starting in 2019.
Public employment data from the U.S. Bureau of Labor Statistics suggest this may be a statewide problem. Since the dramatic increases in pension expenditures began in 2008 – resulting from the Edgar ramp – Illinois state and local government employment has been decreasing.
The only way out, as Peoria’s city budget documents note, is a “comprehensive solution” from the Illinois General Assembly.
To achieve balanced budgets and a strong credit rating – without gutting core services or crushing the state’s economy with more tax hikes – Illinois must amend its pension clause to make clear that while already-earned benefits are protected, future increases in those benefits are subject to change to bring them in line with what taxpayers can afford.
To eliminate the pension liability, lawmakers should focus on the following reforms: