Stimulus, Growth and Recovery: The Debate Continues

There is growing intelligent dissent to the administration’s stimulus policy.  Critics argue that recent growth is the result of market principles.  Edward P. Lazear wrote Monday in the WSJ, that he forecasted a return to growth without stimulus spending.  He goes on to argue, along with others, that  housing programs have had questionable results.  Lazear said that Uncle Sam is fibbing about job growth as well, reporting job retention as if it where job creation.  John Irons of the Economic Policy Institute agrees.  The administration has an incentive to report positive unemployment numbers- the most popular, but also misunderstood indicator.

Unemployment is only part of the overall picture.  Other improving indicators reported this week tell us that the economy is turning around-but for whom? It depends on how you define growth.  A technical definition says that growth is positive GDP.  That means little to most people.  Real growth, theoretically, is an improvement in living standards for the entire country.  That’s why Main Street understands the unemployment rate.  Accordingly, the media use it as the sole judge for growth.  The problem is, as Lazear mentioned,  job growth is the final component of recovery- behind financial stability and GDP growth.  Unemployment lags years behind an actual recovery.   If unemployment is a lagging indicator, Lazear cannot empirically link failed stimulus policy to persistent unemployment.  He says that the administration is ignoring job losses while inflating job creation numbers.  Isn’t he doing the same thing by ignoring market stabilization and GDP growth? 

BEA Released GDP Data This Week 

According to the BEA, GDP is up for a number of reasons.  Look closely at the report.  Exports rose 14 percent over last quarter and consumer spending rose 3.4 percent.  Market Watch reported that positive numbers where in part due to stimulus spending, but as I argued in the past, these gains are only temporary.  The purpose of the stimulus is to stabilize the economy so that private markets can function again.  There is no wider conspiracy.  The government will roll back stimulus as soon as it sees the return of private investment.  There is evidence of this already: government spending actually slowed by 3.5 percent.

Not all the news was good.  Personal income fell and prices rose.  Hopefully this is a temporary trend based on slight price increases and high unemployment.  However, as long as export growth remains positive, I see no need to fear 70s style stagflation.  

Savings and Long-Term Growth

According to the old Solow Model, a country’s savings rate is positively related to long-term growth.  Today, personal savings is around five percent, that’s up from around one percent just four years ago.  This bodes well for long-term growth in the US.  And now is a great time to invest.  As private investment (including people’s savings) replaces public spending in the next few years, markets will rebound.  Private investment will power an upswing in the business cycle, spark growth and reduce unemployment. The sooner the government rolls back stimulus, the better.  In the mean time, citizens can take advantage of great opportunities in real estate and other deflated markets.  This transfer of savings from a stock to a flow will jump-start the economy in way no stimulus could.  It would take tens of trillions of dollars in government spending to match the power of private investors.

Thomas J. Powell

Reno’s ELP Capital Seeks OK for Investment Vehicles

BY JOHN SEELMEYER

ELP Capital Inc. of Reno seeks regulatory

approval for two investment funds that will

target well-heeled sophisticated individual

investors.

Thomas Powell, the chief executive officer

of ELP Capital Inc., says the funds mark an

effort to jump-start the northern Nevada economy

by channeling local investment dollars

into local projects.

The company last week filed a notice with

the U.S. Securities and Exchange Commission

that it believes the two funds are exempt from

securities regulations because they will be sold

to a limited number of investors or to buyers

who meet the SEC’s standards for accredited

investors. (Those standards include net worth

and annual income for individual investors.)

The ELP Strategic Asset Fund LLC has

raised $450,000 so far, the company said in an

SEC filing. There’s no maximum size on the

fund, and minimum investments are set at

$250,000.

A second fund, ELP Opportunity Fund 1—

GBLL LLC, is planned to raised $2.3 million.

So far, $100,000 has been raised.Minimum

investment in the fund is $50,000.

ELP Capital, incorporated in 2004, has

managed debt and equity financing of real

estate. The company traces its beginnings to

IntoHomes LLC, a residential mortgage lender

launched by Powell in 1999.

Along with Powell, its board includes Jesse

Haw, president of Hawco Properties of Spanish

Springs, and Bob Barone, chairman of Ancora

West Trust Co. in Reno.

Powell, who’s also an author of books and

articles, has argued recently that private

investors can play a major role in getting the

construction and development markets moving

again if they’ll fund stalled quality projects.

“This recession … left a stockpile of quality

real-estate projects to collect dust.Without

proper funding, the projects remain undeveloped,

unproductive and severely underemployed.

Placing our private capital into quality

projects will bolster the number of available

jobs in our communities and get people

behind a meaningful cause,” he wrote in an

essay this month.

ELP Capital expects to charge an annual

management fee of 1 percent of the funds’

assets, and it also may collect a performance

fee.

Along with the two investment funds, ELP

Capital last week filed SEC paperwork for

exempt offerings of securities in two real estate

funds.

One of the filings covers ELP Mortgage

Fund III — The Ridges LLC. The company

said $2.1 million of the $2.5 million fund has

been sold to accredited investors.

The second filing covered ELP Acquisition

Fund—Citi Centre LLC, which has raised

about $3.28 million of a $4.5 million offering.

Proceed with Caution

 It is now evident that this recession has uncovered a number of substantial flaws in our country’s financial industry. The now-exposed wounds became so complex that it took a meltdown of this size to identify them and it will take a long, sluggish recovery for them to heal. The majority of the flaws in our financial system hit individual investors the hardest. Faced with frauds, unclear loan agreements, mislabeled ratings and much more; individual investors have felt the pain and are now changing their behaviors in order to wisely navigate through this new investment jungle.

 In this new, heavily-battered playing field, I have seen one group of investors disguised as two vastly different types of investors. They appear to have swapped each other spots on the risk spectrum, but the groups are really one in the same. The first type is the group that fears more losses so much that they are persuaded to stay out of the game. The second is the group of investors that has been chasing risky investments in an attempt to quickly recoup the wealth they lost in the crash. Once this type of investor wins back their losses, they pull out and leave the game; joining the first type of investor on the sidelines. These groups share a trait that makes them more similar than different: They both fear the current market.

Emotion and speculation fueled many investors before the bust and will certainly again fuel the masses during the next boom. The tendency to chase easy money is in our hardwiring and it is a difficult force to resist. Now, as is the case immediately following any recession, investors are cautious. But, this caution should do more than lead to rampant mattress stuffing. Investors should now be more willing to seek the knowledge that will allow them to make more informed decisions. The bust knocked the wind out of the majority of individual investors. Many were forced into being cautious but all can use this new caution to their benefit.

Rather than abandon investing, now is the time to be fine tuning your investment strategy by getting back to the fundamentals. Rebalance your portfolio in a way that makes sense. Hold stocks in companies with good business models. Learn to make informed decisions. Demand transparency. Get in the habit of practicing prudent due diligence or search for an expert who you trust will. Instead of letting the fear of uncertainty keep you on the sidelines, analyze your risks, lower your uncertainty and reestablish your place on the field.

Unleashing Small Business Horsepower

Small businesses have historically been the force that pulls our country out of tough economic times. Their ability to work more efficiently allows them to find innovative ways that spur job creation. But, without being able to find available capital, small businesses are restrained. A full recovery will not take hold until small businesses have access to adequate capital. The mega businesses have been propped up by the government, but small businesses heavily rely on the private-capital investments that are currently lacking.   

Investing in small businesses has many advantages. From a business stance, while larger corporations have strayed from their original initiatives, small businesses usually have focused business plans that detail their near-future commitments. Yet, small businesses still tend to be more flexible, which is a huge advantage considering the amount of ideas that small businesses produce. Without flexibility and the willingness to take educated risks, their ideas would have no Petri dish in which to grow. Another advantage is that small businesses usually carry less debt than large corporations; which use debt as a primary ingredient in their financial engineering. Less debt equals fewer obligations, and this can translate into quicker returns for investors.

No matter how simple or complex a small-business investment appears, it is important to always keep in mind a few basics. First, invest in small businesses that have solid business models that you believe in. Just because a company has filed with the state to sell its securities does not mean that the investment will be a success. Businesses succeed because of vision and follow-through. Remember that “publicly-traded” does not necessarily mean “better.” Second, do not let an employee of a company convince you that an investment is not risky, that is a lie. Companies will often have securities salespeople who work on a commission. This does not mean they are automatically corrupt, it just means do not let their promises replace your due diligence. Plus, investments ALWAYS carry some level of risk. Which brings me to my last point: Always carry through with proper risk analysis. There are registered investment advisors, lawyers and other financial professionals that can help take the headache out of the process. Do not pinch pennies early on in the investment process only to be burned later by a flaw that a professional could have identified and corrected.

These are terrific times for investing in small businesses. There are countless opportunities to invest your capital in quality projects that will produce high returns. With credit not rushing like it did before the bust, business owners are actively searching for ways to acquire capital. Our recovery will continue to look and feel like a false hope until small businesses have the means to expand, create jobs and put people back to work.

Hanging on by a Home-Buyer Tax Credit

The $8,000 first-time homebuyer tax credit, included in the economic stimulus plan passed in February, is set to expire next month. The credit is widely touted as having given the stagnant housing industry its first sales jolt after a lengthy lull following the housing market’s implosion. Now, with legislation in recess, officials will be forced to scramble if they wish to extend the tax credit.

With a fast-approaching deadline of November 30^th, many in the real-estate and construction industries have their fingers crossed that an extension will be filed and keep buyers approaching the market. Last month, some groups, such as the National Association of Home Builders, even launched newspaper advertising campaigns pleading for the extension of the credit. Several members of Congress have either drafted bills or showed support for bills in favor of extending and expanding the home-buyer tax credit. U.S. Senator John Isakson (R-Ga.) introduced a bill that would extend the program through 2010 and increase the amount to $15,000. Also, Isakson’s version would be available to all homebuyers, regardless of current ownership status or income level (the current tax credit is limited to first timers who make under $75,000 annually).

Nearly everyone agrees that the residential housing industry has been using the first-time homebuyer tax credit as a crutch; and therefore has managed to stay on its feet. However, not everyone agrees the tax credit should be extended. While many experts worry how the housing industry will fair when the tax credit expires, they also agree that a true housing-market recovery will be delayed until natural economic forces replace government support. Outside of the tax credit, the government currently provides support to home buyers in multiple ways. While attempting to thaw the credit freeze, the Fed has kept the interest rate at or around zero. This encourages lending, which includes home mortgages. Also, the current tax code already shows great support for home ownership by providing incentives such as deducting the interest on your mortgage.

A number of senators have been criticized that they support an extension because it would favor their states heavily. While this may be true for those states that have been badly bruised by the housing implosion, an extension is likely to benefit real-estate markets across the country. The general consensus is that extending the tax credit would continue to encourage buyers to explore the market. But, passing an extension depends on Congress giving attention to the matter before the November 30^th deadline—for there is no shortage of higher-profile issues waiting to be addressed in September and October.  

 

All My Best,

Thomas J. Powell 

 

 

 

             

Pulling the Unemployed off the Ropes and Into the Fight

As markets continue to produce signs of stabilization over the next quarter, it is unlikely that unemployment figures will show much improvement. With figures the highest they have been in more than 25 years, unemployment appears to have neared its peak. Lowering the rate to levels our economy can adequately support will prove to be a daunting task. But, with a little encouragement the corporate sector certainly has the power to handle it.
Last week, Federal Reserve Chairman Ben Bernanke was quoted by multiple major news sources after he told the Brookings Institute, “The recession is likely over at this point.” According to Bernanke, the economy appears to be growing, but not at a pace that will be sufficient for lowering the unemployment rate. Historically, economic upturns after recessions have been stamped with consumer demand. This time around, however, many Americans may not have the ability to help lead a recovery because they have been completely wiped out financially.
In order to spur consumer-led demand, the corporate sector will again have to make jobs readily available. The unemployed are not the kind of consumers that are needed to invigorate our economy and induce growth. We do not need to turn to an economics textbook to tell us that our broken economic cycle can be patched with more available jobs—this much we know.
Corporations large and small have been forced to adapt to this constricted economy and the majority of them were required to do so through downsizing. Now, company leaders are reluctant to increase their workforce until they are confident there is a significant increase in demand for their products and services. But, one strong possibility that could provide the encouragement needed to get company leaders hiring again is a temporary change in corporate tax policy.
A temporary tax break aimed at equaling the payroll costs of adding new employees would strip the risk for companies that are awaiting a full-blown recovery before they hire. Plus, according to a recent article published in The Wall Street Journal:
“The impact of a two-year program on the federal deficit would be relatively modest. Using a conservative set of assumptions, an $18 billion annual program, which represents 10% of estimated corporate tax receipts in the next fiscal year could create nearly 600,000 good-paying jobs …”

Before they commit to hiring, companies are waiting for consumers to spend. But, before consumers commit to spending, they are waiting for companies to hire. The cycle is stagnant and will remain so until one side is persuaded to change their behavior. A government-sponsored tax break for companies that agree to hire could be the first action taken during this recession that encourages our country’s government, companies and individuals to work together.

Capital River is Frozen; We Can Thaw it

Because of the severe impact of the recession, the stream of capital that once flooded our economy has been reduced to a trickle. The majority of the flow evaporated when banks were forced by the Fed to tighten their lending standards as delinquent loans polluted their books. Consequently, failing to restore the flow is making it extremely difficult for the Fed to take progressive measures toward recovery and has the potential to drop us back into another recession.
According to Bloomberg.com:
“The Fed’s second-quarter survey of senior loan officers, released Aug. 17, showed U.S. banks tightened standards on all types of loans and said they expect to maintain strict criteria on lending until at least the second half of 2010.”

With dropping values in commercial real estate, rising unemployment numbers and a seemingly unending onslaught of delinquent mortgages; banks are not lacking reasons to practice strict lending measures. Earlier this year, through a series of stress tests, the Fed found that 19 of the country’s largest banks needed $75 billion in new capital to protect themselves from mounting losses.
With all of my recent writings and blog postings concerning the benefits of getting our private capital back in the game, I am by no means hiding my agenda for restoring capital flow. The economy will only be repaired once the flow of capital is rejuvenated. It is much easier to lead capital tributaries back into the main stream if they are first flowing. Over the next couple of quarters, banks will continue to deleverage and work toward a balanced lending system. But, without raising more private capital, banks will not be able to establish a lending system that enables credit-worthy individuals and businesses to acquire reasonable loans; which puts an enormous restraint on economic progress.
Our economy is already positioned to attempt to force a jobless recovery, which will certainly create complications in sustaining a recovery. Trying to force a credit-less recovery will only exacerbate our struggles. Dragging our banks through a painful recovery without sufficient capital will only position them to break and lead us right back through more of the same. By identifying ways to put our private capital back into the equation we are positioning our financial system to rise from this recession stronger and more efficient. By investing in private enterprise, we are sparking long-term, mutually-beneficial relationships between capital-producing businesses and banks (while also earning gracious returns on our initial investments). Now is the time to put our private capital back to work.

Without Our Capital, Banks Get the Axe

Our private capital plays an integral part in our local economies—which then all collectively have crucial roles in our country’s financial stability. Because banks have become over-reliant on easy credit, they are now struggling to keep their businesses running by raising capital the old fashioned way. Without our capital, our banks (and more importantly our communities) cannot function properly. Not able to fulfill their debt obligations, banks are closing their doors and falling under the control of the FDIC; which “estimates bank failures will cost the fund about $70 billion through 2013.”
Banks are necessary to ensure that money circulates in our communities. They distribute the money of their depositors to borrowers who have a worthwhile purpose for the money. The banks secure our savings and lend the money to companies or individuals. Banks provide a convenient location for borrowers to acquire funds. Without banks, companies would find it very difficult to borrow large sums of money.
While banks perform their role as intermediaries, they also essentially increase the supply of money. By accepting deposits from its customers and loaning the money to worthy borrowers, banks “create” money. Consider the following simple example. Imagine a customer deposits $20,000 into her bank account. Even though the bills are no longer in circulation, the amount of money in our country does not change as a result of the deposit. Allowing the money to simply sit in the bank’s safe would not earn the bank anything. Therefore, the bank lends $10,000 to an entrepreneur in return for an additional interest fee. The depositor still has a $20,000 credit in her account and the entrepreneur has $10,000, therefore the money supply has increased by $10,000. The entrepreneur purchases supplies with the money and creates a product that he sells for a profit. As long as banks have depositors, they are able play their crucial role of increasing the money supply by making funds available to those looking to find backing for their ventures.
The word “bank” itself is derived from the Italian word “banca,” which referred to the table on which coins were counted and exchanged in the middle ages. “Bancarotta,” from which the word “bankrupt” was derived, means “broken bank.” Originally, if a banker was unable to pay his debts, the authorities arrived to smash his table in half with an axe. Today, the FDIC seizes failed banks and seeks buyers for their branches, deposits and faulty loans—all, for some reason, without smashing anything with an axe.

All my best,

Thomas J. Powell

 

 

Ghost of Recessions Past

Maybe this is all a bad dream, and like Dickens’ Ebenezer Scrooge, a voice from the past is warning financial regulators.
Former Fed chairman Paul Volcker testified in front of the House Financial Services Committee today. Look at the excerpt from his prepared statement. He warns that the Fed’s reaction to the recent crisis may actually increase the likelihood of future collapse. By creating a safety net for the too-big-to fail banks, Volcker argues, we are exposing the financial system to more risk!
Paul Volcker is no stranger to economic crisis. As head of the fed from 1979-1987, Volcker helped steer the economy out of the infamous ‘stagflation’ of the late 1970s. Stagflation was an economic anomaly: high unemployment combined with inflation and negative growth rates. Many hail Reagan’s deregulatory policies as the solution. But this was only a piece of the puzzle. Volcker headed the Fed at a time when the structure of the world economy was undergoing an historic shift. The international monetary system had collapsed and, like today, monetary policy was ineffective at solving the nation’s problems. Volcker oversaw a dynamic shift in how we value currencies and conduct monetary policy.
Why is all this important? Because 82-year-old Volcker is saying the same thing I am. Instead of looking at real changes to the system itself, like Volcker did, regulators continue to recklessly throw money at the problem. Fortunately for us, we are not facing stagflation. The problem today is the steady deflation of our wealth. However, the lesson is the same: let’s look at ways to change the system instead of perpetuating the cycle with safety nets. Volcker suggested re-instating Glass-Steagall. This should reduce big bank’s incentives to gamble our wealth away.
I also agree with his stance that smaller institutions are getting squeezed out of the economy. If the government only backs a small handful of participants, how will smaller private firms compete? Without those firms we will never return to prosperity.
So let’s take a minute to heed Volcker’s advice. It’s more than Obama is doing. Volcker may be one of the president’s chief advisors, but he’s not listening. Unlike Dickens’ tale, this is not a dream. I think Volcker’s advice will haunt the halls in Washington for a long time.

Tom

The Great Recession is not over

While Wall Street celebrates the apparent passing of systemic financial failure, there is a different reality on America’s streets. The Great Recession is not over. Millions of jobs have been lost, and most people’s incomes have fallen. So has America’s ability to consume and pay down debt. Because consumption is the most important component of GDP in America, without shoppers filling stores, production, income and job growth will remain weak.
A side effect of reduced incomes is falling prices. When consumers feel financially pinched, they become more frugal. Wariness to spend forces businesses to lower prices in an effort to entice shoppers. Rents, too, will continue to fall as massive home and commercial real estate supply compete for available renters.
For years, the answer to every income short fall was credit. Want some new $250 jeans – Charge it! Don’t have cash for the big ticket item? – Put it on an adjustable rate payment plan. Trillions of dollars were pulled out of homes as prices soared, with the money spent on improvements, trips, and a multitude of consumer goods. Now, this debt is coming due, and incomes are falling!
In short, the great boom of the last twenty years was a story of debt expansion. As long as credit kept growing, more money could be spent. Easy money created a multi decade spending boom, which created an illusion of affluence. But, the credit party is over. The only way out is to spend less and pay off debt. Unfortunately both society and our political process are in denial. History has shown that every debt bubble ends the same way – prices fall until existing incomes can support them. All of the debt spending in Washington only delays the inevitable deflationary pain, and that new debt weakens us as an international economic power.
To finish the story, lower income will, along with tight credit, push down a buyer’s ability to support high rents. Lower rents make real estate less enticing as an investment until the property prices fall far enough to align with the new lower rent levels. Here in Nevada, this saga continues.
On the bright side, many are rediscovering the simple things in life. Family and friends are more important than weekends in Las Vegas! Perhaps this reality check will bring us back to what made this country the greatest in the world, namely, hard work and entrepreneurship.
Matt Marcewicz
Robert Barone, Ph.D.
Robert Barone and Matt Marcewicz are Investment Advisor Representatives of Ancora West Advisors LLC an SEC Registered Investment Advisor. They are also a Registered Representatives of Ancora Securities, Inc. (Member FINRA/SIPC). Mr. Barone is a Principal of Ancora West Advisors and a Registered Principal of Ancora Securities.

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Best Wishes,

Thomas J. Powell

Too Big To Learn

With a bad habit of ignoring profound systemic problems, Federal Treasury officials are now securing a system that encourages the same careless risk-taking that originally got us into this mess. With this week marking the one-year anniversary since Lehman Brothers imploded, it is only appropriate to discuss the faulty system that protects and rewards failing financial institutions.
The talking heads in charge of the world’s financial practices are on path to deliver more of the pain and suffering we have been experiencing over the past 20 plus months. The Lehman Brothers’ collapse last year showed us how brutal a large bank failure can be. Now, because of the mess caused by Lehman’s demise, it is unlikely that our government would again allow an institution of similar size to fail. This essentially gives big banks a free pass to misbehave. If you owned a business that was referred to as “too big to fail,” and you knew the government would do all they could to keep your doors open, would you not be inclined to take risks? It is like giving a six year old the keys to a candy factory and a set of cavity-resistant teeth. All risk is stripped away, so why not have some fun?
By receiving government funds, big banks are allowed to carelessly take on high degrees of risk, knowing that there is a safety net underneath them. This recession has been gut-wrenching. It has badly battered our economy and exposed wounds that will not heal in our lifetimes. No one wants to experience a downturn of this size again. But, if officials continue to foster an environment that rewards carelessness by major financial institutions, we will inevitably get more rounds of the same. While we should be demanding big banks to practice prudent due diligence, we are instead enabling them to write off any level of accountability. This recession should have been a major wake-up call for all businesses, but those institutions deemed “too big to fail” have also been allowed to be “too big to learn.”

Top Five of the Bad, Bottom Five of the Good

Ravaged by the bursting of the real estate bubble, Nevada is among the states with the deepest wounds. Historically, our state has been in the top or bottom five of the most-unappealing statistically-compiled lists put out by major media. Unfavorable, sure, but we all choose to live here for one good reason or another. For instance, our tax structure keeps Nevada among the most business-friendly states in the country. For this reason, we have highly-competitive local markets and capitalism thrives here. Our state officials are somewhat handcuffed because of our demand to keep government out of our businesses as much as possible. By adopting and supporting this system, Nevadans have agreed to take on more personal responsibility when it comes to providing our own financial security—and we are now being put to the test.
Across our country, state officials are scrambling for ideas that will simultaneously better their state’s situation and put them in the position of being quality leaders. In Nevada, our elected officials have considered bringing in a pricey third-party consultant to advise them on how to progress the state. This means not only are the individuals we put in office to make vital decisions not carrying out their duty, but now we will also foot the bill for a new position. We elected these authorities to represent us; not lead us, by way of expensive consultation, in an undesirable direction. With that said, when we elect them we do not, in turn, remove ourselves from the equation. We are not reduced to waiting on our state leaders to be proactive.
These are extremely trying times for our country. The recovery is going to be led by us via our private capital and our private enterprise. The government does not have a weapon in its repertoire that comes close to matching the power of our collective private resources. Across the U.S., and particularly in our state, there is an abundant supply of quality projects that have been postponed due to insufficient capital. Because success requires both money and knowledge, every successful idea struggles with acquiring adequate funding at least once throughout the process. Every successful venture has to be properly backed and the majority of the backing comes from private capital. At the end of the day we, the people, are the engine that runs our country.
Nevada is riddled with quality projects that could be going forward with proper capital and qualified management. We now have to be proactive in matching the two. Being among the top five states in the country in foreclosures, troubled institutions and bank closures does not mean we cannot also be among the top five states to emerge from this recession.

Survival of the Government-Backed Banks

Even the banks that did not become entangled in the shaky investment strategies of Wall Street during the boom still indirectly had their knees taken out from beneath them throughout this meltdown. According to CNBC.com, 92 banks have failed in the U.S. through the first nine months of 2009; including three here in Nevada. As a comparison, in all of 2008 only 25 banks closed.
In any meltdown, the government’s focus is on the big banks that have the potential to buckle our country’s financial system if they go under. But, that focus leads to a distinct advantage for big banks over their competition. Having government support allows the bigger banks the power to go out and collect the majority of the available capital, while smaller banks are forced to scavenge. This crisis has presented terrible obstacles for banks to raise the capital lifeblood needed to remain in business. Without liquid capital, smaller banks are consumed by their debts. With losses on commercial real-estate loans rising, the smaller banks that feed credit into our communities are drowning.
When governments support the behemoth banks and allow the smaller banks to sink, they essentially help eliminate the competition needed to improve our financial system. Without intervention, smaller banks are generally able to pose a competitive threat to the large firms because they are more apt to find ways to be faster, smarter and more strategic. It has always been a staple in American capitalism to save a place in our economy for smaller businesses because they push against the bigger corporations and keep them honest.
Competition in the banking industry leads to a financial system that operates more efficiently. By helping to eliminate competition, our government is essentially allowing the largest banks to monopolize the industry. By supporting the large and abandoning the small, our government is positioning us to face a much weaker economic recovery than if the innovative smaller firms were allowed to compete fairly. We are essentially heading in the same direction as Europe, which has long had its bank assets heavily concentrated in massive firms. The tactic may make it easier for governments to regulate financial systems, but it also eliminates the capitalistic nature that has made our banking industry the strongest in the world.

NEXT WEEK: Banks as Intermediaries

All my best,

Thomas J Powell

Housing: “The Worst is Over” A Numbers Game

Many are touting “the worst is over” for the housing market, but I’m not ready to agree. We had some good news today. Housing starts are up, slightly, and prices are up a hair. In order to understand what’s really going on though, we have to take a look beyond numbers. There are a few good reasons for stabilization in the housing markets- low interest rates, good deals and the first-time homebuyer credit. Notice anything in common? None of these are permanent factors. Low interest rates have created an incentive to refinance as much to purchase new homes. As the Washington Business Journal states, two-thirds of new loans have been from refinancing. Once the glut of foreclosures has been gobbled up, there is little room for increased sales from cheap housing. Don’t get me wrong, this may be a good thing, point is, it won’t last forever. And finally, the tax credit for new homebuyers is set to expire in November, right around the time housing traditionally slows down.

Looking forward, I see the real possibility of another decline. The Deutsche Bank agrees. They expect a 10 percent correction in the US market. To make things worse, mortgage delinquencies are on the rise. Credit default is up across the board and as unemployment continues to rise, default will increase. As I mentioned before, unemployment will lag for a long time, even if the rest of the economy is humming. So don’t count on significant gains anytime soon.

If it seems like I’m preaching doomsday here, I’m not. I’m just hesitant to buy the administration’s optimism. Yes, Bernanke’s emergency loan facilities stabilized the system. Congress’ schemes have reaped small rewards. But these are emergency measures, not long-term fixes. They, like me, are waiting for the private markets to start flowing again.

Too Big to Fail? Here We Go Again…

Today marks the one year anniversary of the collapse of Lehman Brothers, one of the worst financial disasters of our time, as it nearly brought down the international financial system. Yesterday I was reading an article about how the big banks are showing signs of life with their actions and things are starting to move, signalling a possible economic recovery. This makes me wonder about the adage of being “too big to fail.” What is the right decision in this situation?

It appears to me that after the latest cycle, quite possibly and hopefully the worst we will see in our lifetimes, people are hoping that this time things will be different. That once we actually do reach a point of recovery, we won’t make the same mistakes that were recently experienced. This cycle has been painful; it has been gut-wrenching; it has been a lesson I surely don’t want to repeat, as I get it and don’t need to learn it again.

I am very nervous about this thought process. As the saying goes, history repeats itself, and that did not become a quote we all use without good reason. For generations, for decades, for centuries, the animal in human nature causes us to make the same decisions and choose the same paths as before.

Some of our largest banks, which the government determined were too big to fail, received billions in taxpayer TARP funds. Our money kept these institutions afloat and I understand the reasoning behind keeping their doors open, especially using the Lehman example. I am dismayed, however, at the actions of these institutions. By receiving government funds, they are able to continually take on high degrees of risk, knowing there is a safety net underneath them. Prudent due diligence has gone by the wayside with the knowledge of someone is there to catch them. I liken this to the casino industry. If you could borrow $1 Million dollars and gamble it, knowing you would get it back if you lost it PLUS knowing you would get to keep any winnings you made, why wouldn’t you do it? This is exactly the system we have allowed to be established.

And, what about the outrageous salaries and bonus payments we still continue to hear about? I am all for the entrepreneur earning as much as he or she can based on value and return to society, but I am not about taking from you and me, putting a chokehold on getting capital back into circulation while cutting off small business, and then handsomely rewarding the big bank players in the process.

The veritas, the truth, as I see it, is that nothing has really changed, that we are repeating ourselves and that we will all pay the price of the failure to learn what could be a valuable and useful lesson. As we continue through this cycle, which I believe still has more pain to come, I hope for and have faith in the success of the small business, for the will of the entrepreneur, and for the recovery of our great land.

Too big to fail? Ok, I’ll give the government that. But what about keeping the backbone of American capitalism healthy? I’m not saying the answer is in government bailouts for small business, as anyone who knows me knows I believe in complete personal responsibility. I’m only asking for the same access to capital for small business so that it can keep its doors open, giving it time to make the changes and adjustments necessary for its own success. In short, allowing business to help itself.

I have thoughts on how I believe this can be done without the banks, allowing history to repeat itself in the manner I believe will lead to our recovery. I will write more in the coming days, but in short I believe in private capital + private enterprise = economic recovery.

I look forward to sharing more of my thoughts and receiving your feedback.

All my best,

Thomas J Powell