On the Prospects of G

The chart below shows the annual change in government spending and investment since 1960 (left hand side) and contribution to overall GDP growth (right hand side).

The takeaway? The government sector has been a consistent source of growth (positive in 36 out of 37 years), but with states acting like Europe (i.e. austerity) and the need to cut back, expect this to reverse course in the years to come.

Source: BEA

Goods Producing vs. Government

Tim from The Mess that Greenspan Made (great blog by the way) showed a rather astounding chart detailing that for the first time (ever?) the number of individuals employed by the government is larger than the number employed within the manufacturing sector.



However, in this instance, this is not a story about "bigger government". Rather, it is a story of a long in the making shift from manufacturing to servicing (as anyone who has lived or visited an old manufacturing city [think Detroit or Cleveland] can attest to).



For all the hype of big government, the number of individuals employed by the government is actually smaller as a percent of the civilian institutional population than it was in the mid-1970's (9% vs. 10%).

Source: BLS

More on U.S. Manufacturing

In response to my post on lost jobs in manufacturing, I was asked to provide manufacturing output as a percent of US GDP.



What we see is a manufacturing sector that has been on the decline, relative to the broader economy, going on 60+ years. This in itself this doesn't mean much. All it means is the manufacturing sector has not grown as fast as the broader economy. In theory (ignoring everything else for the time being), this is logical. At a certain point, we should not be consuming goods (durable and non-durable) at a level that grows as fast as the broader economy. 20 years from now, do we really need to consume twice as much as we currently do? (Unless it means those not fortunate enough finally have the necessities that most of us take for granted, then no... we don't. )

But, our past few generations HAVE consumed that much more than previous generations (in fact consumption has grown substantially faster than the broader economy reaching more than 70% of GDP). To put this in perspective, one recent study showed that the average number of cars owned in the United States is now 765 vehicles per 1000 people (including every man, woman, and child), or about 5x more than the global average. So... the consumption was there. The manufacturing just happened to be done outside of the United States.

The chart below shows just that. Net export of goods (ignores services) as a percent of GDP, went from a small positive figure until the 1970's (i.e. we manufactured for the world), to a large negative figure since (i.e. we consume for the world).



So the answer to the question of decreased jobs in the manufacturing sector was likely three-fold:

• Productivity increased
• The manufacturing sector grew slower than the broader economy
• The U.S. outsourced a large portion of that sector to other counties

Here's some additional perspective. The manufacturing sector now adds less to our broader economy then... wait for it... the government itself.

And while I understand that outsourcing is not really an option with regards to the government, shouldn't we expect the same productivity gains and slower growth (than the broader economy) from the government sector as the manufacturing sector?

Source: BEA

We're All Euro Now: Government Spending at 45% of GDP

Chuck Dietrick with the details:

One of the more disconcerting statistics is government spending as a percentage of GDP. In 1903, the figure was 6.8% for the U.S. In 2009, it's projected to be 44.72%—a greater than 8% increase over the average of the previous 5 years—not particularly encouraging. Less encouraging are the comparisons with major Western European countries. In 2007, France was at 61.1%, Sweden and Denmark 58.1%, Italy 55.3%, the UK 50%, and Germany 48.8%. Yep, we're on the march to be the equal of those paragons of economic stagnation.

The below chart details this run up since the early 1900's (Federal, State, and Local as a percent of GDP); government spending is now projected to be at the highest level as compared to GDP since WWII.

Source: US Government Spending

The One Recession Proof Area Within Finance

Lobbying paid for by the financial sector continued to grow in 2008 despite the turmoil.



As Boston.com reports, the trend continues:

Major recipients of federal bailout money spent more than $10 million to lobby lawmakers in the first three months of 2009, including arguing against pay limits for corporate executives, according to newly filed disclosure records.

The biggest spenders among major financial firms and automakers included General Motors Corp., which spent nearly $1 million a month on lobbying so far this year, and Citigroup and J.P. Morgan Chase & Co., which together spent more than $2.5 million in their efforts to sway lawmakers and Obama administration officials on a wide range of financial issues.

"Taxpayers are subsidizing a legislative agenda that is inimical to their interests and offensive to what the whole TARP program is about," said William Patterson, executive director of CtW Investment Group, an activist group affiliated with a coalition of labor unions. "It's business as usual with taxpayers picking up the bill."

Source: Open Secrets (idea via Charting the Economy)

Personal Consumption Holding Steady

WSJ reports:

Americans spent at a slower rate in February as their income fell and they saved money at a historically elevated level to cushion against the recession. Personal consumption rose 0.2% compared to the month before, the Commerce Department said Friday. Spending had increased a revised 1.0% in January; originally, spending was seen up 0.6%.

Personal income in February fell at a seasonally adjusted rate of 0.2% compared to the month before. Income increased a revised 0.2% in January; originally, income for that month was seen 0.4% higher.

Personal saving as a percentage of disposable personal income was 4.2% in February, the Commerce Department said. It was 4.4% in January. The last time the saving rate exceeded 4.0% two straight months was August and September 1998, up 4.3% and 4.2%, respectively.

How is it possible to spend more, save more, all the while earning less? Taxes paid down and social benefits up...

Source: BEA

Banks Buying Assets to Sell Through Gov't Programs... Does It Even Matter?

FT Alphaville (via Zero Hedge):

Shows Goldman’s estimates for how banks are carrying assets like commercial mortgages and consumer loans on their books. According to the table, they’re carrying those assets at ludicrously optimistic averages of between 89 per cent and 96 per cent of their original purchase price. Yeah. Right.

That preposterous positivity has huge implications for Tim Geithner’s toxic asset plan, or PPIP.

The chart below details one such asset, commercial mortgages, are still priced at or near par, which I'll agree is a joke...



BUT, (fortunately or unfortunately), I don't think this will have any impact on the Public Private Investment Program "PPIP". Why? Because it turns out banks may have no intention of using the program for these assets. Dealbook with the details:

The Treasury Department recently unveiled its plan to lift mortgage-linked securities off banks’ balance sheets. But Citigroup and Bank of America have been buying those assets in a hurry from the secondary market, The New York Post reported.

The two banks, which have each received $45 billion in federal bailout money, have been buying up AAA rated securities, including some based on alt-A and option adjustable-rate mortgages, the paper said.

One trader told The Post that Citi and Bank of America were sometimes paying higher than market rate for the securities. A Bank of America spokesman said that the purchases would help increase liquidity in the mortgage market.

But does it even matter? Lets visit both sides.


"Yes... it Does matter!" Camp

Yves at Naked Capitalism has a view similar to my initial reaction:

It certainly looks as if Citigroup and Bank of America are using TARP funds, not to lending, which was one of the primary goals of the program, but to scoop up secondary market dreck assets to game the public private investment partnership.

And it fleeces the taxpayer a second way: the public has spent enough money on both banks so that in an economic sense, they ought to have been nationalized, yet for reasons that are largely ideological and cosmetic (the banks' debt would need to be consolidated were nationalized), they remain private. So not only are they seeking to extract far more than was intended even with the already generous subsidies embodied in this program, but this activity is also speculating with taxpayer money.

While I do understand why Yves is so critical and my personal distaste for the system (and banks in particular) is growing each and every day, lets go to the opposing camp as played by my alter-ego...


"Only Injecting Liquidity and Propping Up Prices" Matters Camp

According to the Treasury, the goal of the PPIP is:

To restart the market for legacy securities, allowing banks and other financial institutions to free up capital and stimulate the extension of new credit. The resulting process of price discovery will also reduce the uncertainty surrounding the financial institutions holding these securities, potentially enabling them to raise new private capital.

How can this be accomplished by banks selling legacy assets at above market value and not by banks buying assets at above market value, only to sell to investors at an even higher value (all made possible by subsidized loans)? My view is it works in either or neither scenario. In both cases the PPIP is able to transfer liquidity into the market, which props up asset prices. The main difference is whether the process is contained in the banking system or not. In the latter, if a pension plan and/or mutual fund can sell assets at an above market price to the banks, then those pension plans and/or mutual funds were provided "liquidity". If this results in a higher clearing price and additional cash to spend on new issues... great!

As detailed at the start of this post, in either scenario banks weren't going to sell assets held on their books for remotely their fair value. In the first scenario, the clear winners involved were:

• Banks (they were provided a way to recapitalize via selling assets at above market prices)
• Investment managers (they get to market a new revenue generating fund to investors)
• Wealthy investors (they receive a taxpayer subsidized loan - I say wealthy because like investing in a hedge fund, to qualify you will likely need to be wealthy)

It is clear who were not the big winners. The average investor who owns a lot of these "toxic assets" in their pension plan or in a mutual fund. They likely would have only seen the benefit if and when the PPIP helped increase the performance of the security via secondary effects to the broader economy.

In other words, this only shifts around when and where the money is going, not the mechanism created to add liquidity. Assuming the banks aren't just buying / selling from each other (I don't see the benefit of that), but accumulating these assets for the PPIP, then it may also result in the following:

1. The liquidity in the market increases (i.e. it becomes not only a one-way seller's market)
2. The market value of these securities increases (more buyers = increased demand = higher prices)
3. The banks will in turn sell these new assets at a premium through the PPIP to those that would not have been natural buyers of these securities
4. Rinse repeat, until asset values reach a new equilibrium price
5. Marginal assets previously overstated on balance sheets are now closer to the new equilibrium (refer back to #2)

Trust me, things will never work out this perfectly, but why should the banks and "wealthy" investors have all the fun?

Private Public Partnership: Cheap Financing = Lower Discount Rate = Higher Asset Prices

Before I dive in, I am not making the case that the Private Public Partnership likely to be announced Monday morning will in fact work. In addition, I am not making the case that the government should be providing a subsidy to private investors. What I am attempting to do is detail how it can work.

Thus, while I don't typically disagree with Yves from Naked Capitalism, her post Investor on Private Public Partnership: "One would have to be a criminal to participate in this" misses a HUGE detail of the plan (to be fair, I believe she nails it in a previous post here). First the basic assumptions in her example:

• Citi holds $100mm of face-value securities, carried at $80mm.
• The market bid on these securities is $30mm.
• Say with perfect foresight the value of all cash flows is $50mm.
• The investor buys the assets for $75mm, putting only 3% down and borrows the rest from the government (FDIC and Treasury) at a low rate.

Yves makes the case that this investment will no doubt result in a loss of $25mm. The line "say with perfect foresight the value of all cash flows is $50mm" combined with Yves stating the example “did not allow for time value of money” reveals her example is oversimplified to the point of missing what I feel is the most important part of the plan... that the plan reduces the rate at which the cash flows of the assets are discounted, which increases the present value of those cash flows.

Cheap Financing = Lower Discount Rate = Higher Asset Prices

In the example, the securities will only have $50mm in total cash flows, which equals the present value of those cash flows due to the ignoring of the time value of money. That makes the Private Public Partnership seem like a loser... if there are only $50mm in cash flows and an investor pays $75mm, the plan would be foolish.

However, even at low market prices, cash flows are MUCH HIGHER than $50mm. A current $30mm market bid doesn't mean that the security will have $30mm (or $50mm) in cash flows. It means the present value of all future cash flows discounted at the required rate of return on capital is $30mm. A security that pays $5 each year for 10 years and $50 in year ten may be worth close to $30 if discounted at 16%, but the cash flows are the full $100.

Visually, the chart below details the present value of a security that pays out that $5 per year for 10 years and then $50 in year 10 using a variety of discount rates. While the present value of these cash flows (i.e. the price of the security) is close to $30 assuming a 15% required return, it becomes clear that the value changes based upon the required return of the investor.



And that is the point of the Private Public Partnership. The government has a VERY low required return on investment, which it is providing to the private sector via the partnership. How low? As of Friday, the U.S. government was able to borrow over 5 years at 1.64% and over 10 years at 2.63%. Thus, if the government makes a return above these levels on an investment, it MAKES money. On the other hand, a private investor (or bank) requires a substantially higher return (let's call it 15% in the case of these bad assets) from an investment or asset because their cost of capital is substantially higher.

The Mechanism; 97% Cheap Financing

Calculated Risk reports that:

The FDIC plan involves almost no money down.

The FDIC will provide a low interest non-recourse loan up to 85% of the value of the assets. The remaining 15 percent will come from the government and the private investors. The Treasury would put up as much as 80 percent of that, while private investors would put up as little as 20 percent of the money ... Private investors, then, would be contributing as little as 3 percent of the equity, and the government as much as 97 percent.

Thus, rather than discounting the cash flows at the required rate the private market requires (i.e. 15%), cheap government financing allows the cash flows of the security to be discounted at a much much lower rate (a weighting of 3% at the private rate and 97% at the government's much lower rate). This lower rate in turn props up the present value of all those cash flows (i.e. the asset price) AND makes it possible that BOTH the private investor and government can make money paying $75mm for assets currently priced significantly lower.

Is the program perfect? Not at all. For starters, I'd prefer the government go ahead and buy 100% of the assets and take 100% of the upside, but I understand the preference is to keep the assets in the hands of private investors. The important thing to remember is THERE IS NO PERFECT SOLUTION in the current environment and it is important to analyze how and why these plans may work before completely dismissing them.

The Emerging... 'Emerging Market' Crowd Out

The Financial Times via Naked Capitalism details the issues Emerging Market countries may face

Record volumes of government bonds from the industrialised nations – intended to reverse what could be the worst recession since the Great Depression – threaten to curb access to credit markets by emerging economies.

Analysts warn that emerging market borrowers could be crowded out of the credit markets by $3,000bn of government bonds expected to be issued by the big developed economies in 2009 – three times more than in 2008. The US alone is expected to issue about $2,000bn next year....

How dependent are Emerging Market countries to credit markets? Well, as can be seen below BRIC countries alone have~$3.5 trillion in External Debt Payments to make in 2009.

We're All Socialist Now...

Reported GDP would have been much worse had the government (Federal and State) not stepped in with spending and balance sheet. Per the BEA release:

Real federal government consumption expenditures and gross investment increased 13.8 percent in the third quarter, compared with an increase of 6.6 percent in the second. National defense increased 18.0 percent, compared with an increase of 7.3 percent. Nondefense increased 5.1 percent, compared with an increase of 5.0 percent. Real state and local government consumption expenditures and gross investment increased 1.3 percent, compared with an increase of 2.5 percent.

And this was only through Q3, before trillions of dollars in guarantees and cash were put into the system. As can be seen below, government spending at both the Federal and State level has continued its steady climb over the past 8 years.



Get ready for a spike. How large will it be? Well, according to the UPI:

With government spending accelerating with financial bailout funds and a possible economic stimulus package on the way, government's share of the economy is projected to exceed 25 percent of the nation's $14.4 trillion economy in 2009, USA Today reported Thursday.

The previous record in the post-World War II era was 23.5 percent, set in 1983. In 1943 and 1944, government spending hit 44 percent of the total economy.

Source: BEA

McDonalds More Credit-worthy than the U.S.?

Source: Naked Capitalism

Auto Bail Out... What's Another $25 Billion?

When I called this the Ener-GM Bail... I Mean Energy Bill earlier this month (guaranteeing the debt of poorly managed / failing auto companies is somehow good for the environment), U.S. Representative (surprisingly from Michigan) John Dingell was asking for a measly $25 Billion.

It looks like the big three (GM, Ford, and Chrysler) need a little more these days to stay afloat; per Bloomberg:

General Motors Corp., Ford Motor Co., Chrysler LLC and U.S. auto-parts makers are seeking $50 billion in government-backed loans, double their initial request, to develop and build more fuel-efficient vehicles.

The U.S. automakers and the suppliers want Congress to appropriate $3.75 billion needed to back $25 billion in U.S. loans approved in last year's energy bill and add $25 billion in new loans over subsequent years, according to people familiar with the strategy. The industry is also seeking fewer restrictions on how the funding is used, the people said today.

Another $25 Billion? Fewer restrictions on how it's used? So $50 Billion for auto markers when it was approved as part of an Energy Bill (i.e. hardly any connection) and it should be LESS restrictive??? Sounds more and more like a pure bail out, but can't be right?

Well, Global Insight's Aaron Bragman doesn't even pretend the loans are meant to help the big three transition to new energy efficient technology:

"We've seen these kinds of bailouts for the financial companies, why not the automakers?'' said Aaron Bragman, a Troy, Michigan-based auto analyst for Global Insight Inc. `"The big problem is that a lot of people in Washington don't see a value in the U.S. auto industry because they have a foreign plant in their district that is doing just fine.''

So foreign plants are doing just fine? Isn't that the EXACT reason the failed U.S. Auto Industry should NOT get $50 Billion in unappropriated loans?

U.S. Budget Deficit Indicates Recession

The Age reports:

The United States federal budget deficit soared in July, pushed higher by stimulus payments and outlays to protect depositors at failed banks. The Treasury Department reported that the deficit for July totaled $US102.8 billion, nearly triple the $US36.4 billion deficit recorded in July 2007.

Lets take a deeper look...

The first chart below shows historical receipts, outlays and the deficit over twelve month rolling periods, while the second shows the year over year change in receipts and outlays over these periods, along with the difference between the two YoY changes.

Interestingly, this difference has turned negative in all of the four recessions (yes I'm calling this a recession!) since this data has been released...

$330,000 per Capita National Debt

Bill Walker points us to a speech made by President and Chief Executive Officer of the Federal Reserve Bank of Dallas, Richard W. Fisher. According to Mr. Fisher:

Add together the unfunded liabilities from Medicare and Social Security, and it comes to $99.2 trillion over the infinite horizon. Traditional Medicare composes about 69 percent, the new drug benefit roughly 17 percent and Social Security the remaining 14 percent.

On a per capita basis (that is for each U.S. citizen) the amount is a staggering $330,000 each, about 10 times higher than government released numbers.