Expected support for Freddie and Fannie delays equity selloff on employment plunge

The markets were in the midst of an adverse reaction to the August surge in the unemployment rate on Friday when reports surfaced of a possible US Treasury bail-out of Fannie Mae and Freddie Mac. That was enough to turn a sharp equity market selloff into a small gain and reverse a flight to the safety in Treasuries. But, unfortunately, those late Friday reactions are temporary.

The Treasury will certainly attempt to bolster the two mortgage entities sufficiently to keep them afloat and their debts liquid, but it is highly unlikely to want to nationalize them and then go on the major expansion necessary to revitalize the housing market. That would make too much sense in the midst of the worst financial crisis since the great depression. After all, the Treasury Secretary headed up Goldman Sacks when that firm, along with the rest of the financial community, inept regulators, including the Fed, and Congress, was contributing to the irresponsible financial engineering that Warren Buffet has called "weapons of mass destruction". And mass destruction they have wrought. But the process of distruction is far from over.

What forced the Treasury to act were signs that an international central bank flight from Fannie and Freddie paper to US Treasuries was beginning. There is an international agreement that each country is responsible for stemming a domestic financial meltdown that could disrupt the functioning of the international financial market. And a collapse of the $10 Trillion plus housing paper market would certainly fit that definition, and then some.

Even with Treasury action, US and global financial problems will persist. Thus far, the recognized financial institution losses and writedowns have totaled some $500 billion globally. The total will probably reach at least twice that, some one trillion dollars or more. That will certainly put a crimp in credit availability and thereby dampen economic global growth, what there will be left of it. It is my view that as credit availability goes, so goes economic growth. I know that for monetarists it borders on heresy to say that it is not money growth, but credit expansion that is the key determinant of economic growth. Milton Friedman misspecified early credit data as money. But it makes little differnce. Both money and credit growth will slow sharply as a result of the reckless squandering of our financial integrity for what, short-term profits. Foreigners sold us televions and cars that are still functioning in exchange for our financial toxic waste.

What should we do now? We should recognize that first and foremost it is necessary to stem the plunge in home prices. Focus on that objective. As unpleasant a prospect as Government purchase of private assets may be in a capitalist society, that is one solution. Increase Federal grants to state and local governments to purchase vacant properties to be made available for purchase on favorable terms to needy families. There should also be a halt to foreclosures on any occupied home that the owner is making a good faith effort to keep. This was the approach taken by the FDIC when it was first organized. Banks should no longer be forced to quickly sell homes they have acquired or mark down to market assets for which there is virtually no market. Both requirements are counterproductive in this environment. They only serve to further depress home and financial asset prices. Unless and until such actions are taken the losses will continue to mount, forcing more and more financial institutions to the wall, increasing investing caution to the point of decision making paralysis.

The signs of a deepening US and global recession are proliferating. The jump in the unemployment rate to 6.1% in August from 5.7% in July reflected a 342,000 drop in August employment in the household survey. That usually more reliable indication of employment loss in recessions suggests the Bureau of Labor Statistics officially estimated 84,000 August drop in nonfarm payrolls, after a 100,000 drop in June and 60,000 in July, grossly understates the actual deterioration in the labor market. One reason: this latest nonfarm payroll estimate is after deducting an assumed 125,000 quessed rise in nonsurveyed employment at new small businesses. Thus, without this wrongheaded guess, there was actually a 209,000 August drop in surveyed nonfarm payrolls.

By some measures, the unemployed, underemployed and discouraged workers in aggregate constitute more than ten percent of the labor force, and rising towards 11 percent. Commodity demand and prices are in a recessionary retreat. That may improve the earnings outlook for some stressed manufacturers squeezed between consumer price resistance and rising commodity costs. But, the realty remains that despite that positive, the overall corporate earnings outlook will continue to fade amidst a deepening recession.

The dollar will continue to strengthen. Not because our recession is ending, far from it. But, rather because the UK, continental european and Japanese recessions are just beginning, with the economy of Russia and Asia at the very least slowing. Commodity prices will continue retreating. That will produce a significant slowing in inflation and inflation expectations. The equity market will trend lower, not only retesting, but piercing the previous cyclical lows, along with Treasury yields. The Fed will remain on hold until the pace of bank failures intensifies, probably leading to at least two quarter percentage point Fed easing moves. There is much financial pain still to come.


Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport New York 11731

Email address: philipbraverman@Gmail.com