The Crisis Beneath the Bailout

Against the Current, No. 137, November/December 2008

Jack Rasmus

IN EARLY SEPTEMBER, 2008 the Department of Labor reported that the U.S. economy in August had lost another 84,000 jobs. This was followed on October 2 with an announcement that officially recorded September job losses accelerated to 159,000. That made nine consecutive months of increasing unemployment, adding up to well over one million jobs lost over the past year.

At the end of August, however, another government agency, the Department of Commerce, reported revised Gross Domestic Product (GDP) figures for the U.S. economy for the second quarter, April-June 2008. The revisions showed the economy growing during the second quarter at a very strong 3.3% annual rate, even faster than a first estimated 1.9% rate. Even more extraordinary, the 3.3% followed a first quarter 2008 growth rate of 0.9% and a decline in the fourth quarter of 2007 of -0.2%.

To believe the Commerce Department then, the U.S. economy has not only been growing over the past year, but was beginning to accelerate faster in 2008. But how can it be that the economy is moving into high gear while even official estimates of unemployment are registering nine consecutive months of rising job losses and a million more Americans without work? In every instance since 1945, that kind of job loss has clearly coincided with undeniable recessionary conditions.

Which government source is then telling the truth? Is the U.S. economy continuing to deteriorate? Or is it in recovery? Which paints the more accurate picture of where the economy has been and where it’s heading?

“Modulated” Unemployment Rate

Answers lie in understanding how the government manipulates and statistically massages or “modulates” data – to dampen down statistics that indicate problems; to pump up statistics that indicate improvement. To smooth out the extremes and swings in actual data; to make poor conditions appear less so, and marginal results look better.

In a previous article in the July-August issue of this publication (Against the Current 135), this writer pointed out how government unemployment statistics are significantly underestimating true levels of current job loss. Even the one million jobs lost over the past year are in fact an underreporting.

Here’s just one of several ways unemployment has been underestimated this year. In the first half of 2008 the U.S. economy was clearly heading into recession. As an economy initially enters a recession cycle, businesses typically lay off fulltime workers and hire more part-time employees. That way business saves costs but keeps workers on hand until it is clearer where the economy is headed.

A part timer, only working half time, should be considered a “half-unemployed worker.” But the government counts part-time workers just as fully employed as fulltime workers. That means the converting of hundreds of thousands of previously fulltime workers to part-time status this past spring, or the hiring of additional part-time workers, partially offset the total number of fulltime workers laid off in the second quarter.

In April more than 200,000 part timers were “hired,” thus minimizing the officially reported job losses. It appeared that unemployment was moderating when in fact it was simply being “modulated.”

In September the Department of Labor reported officially a job loss of 159,000. But another 337,000 part-time workers were “hired.” Thus the actual job loss for September should have been around 250,000 at minimum.

What the September data mean is that job losses are now so significant that both official layoffs as well as part-time “hiring” are taking place simultaneously. Some employers are converting fulltime to part-time jobs, but even more are just directly laying off full timers and part timers. Were the huge numbers of part-time workers and others who wanted to work full time but couldn’t find jobs added to unemployment calculations this year, the current unemployment rate would now be at least 12% instead of the current official 6.1%.

Once mass layoffs begin to emerge late in 2008 and into 2009 – as will occur in the wake of the September financial crisis and worsening credit crunch – fulltime and part-time workers will both become victims of joblessness. The part-time worker hiring effect will likely no longer play an “offsetting” statistical role, as it had through the summer of 2008.

GDP Statistical Legerdemain

A similar manipulation of the GDP data is responsible for the extraordinary second quarter upward revision of GDP from 1.9% to 3.3%. In the case of job losses, the manipulation results in a dampening of the rate of layoffs. In the case of GDP data, manipulation results in a false pumping up of the GDP number. Let’s see how the GDP gets “modulated” and overestimated.

Nearly all of the revised 3.3% GDP growth in the second quarter was due, according to the government’s Commerce Department, to a dramatic upward revision of the exports component of GDP calculation. Exports alone made up 3.1% of the 3.3% GDP revision announced in late August.

If nearly all the growth is attributable to exports, it means that the approximately $91 billion of the total fiscal stimulus package of $168 billion spent by consumers as of June 30 had no effect at all on the economy. (Alternatively, one could argue the $91 billion just offset the decline in GDP due to collapse in residential housing and auto sales.)

Here’s a further interesting contradiction: the raw data for exports show that exports for the second quarter exceeded the first by about $24 billion on average. That means only a net gain of $24 billion. Yet that $24 billion is alleged to have contributed nearly three times more to the GDP revision than the $91 billion spent by consumers from the tax rebate and stimulus package.

But exports in the normal sense don’t really mean exports as defined by the government. Exports in the normal sense, or what one might call in this case “actual exports,” represent goods and services produced in the United States and then sold abroad. According to the government’s own methodology, to add to GDP goods and services must be produced in the United States before being sold abroad. That means U.S. workers are actually making the goods and getting paid for making them. That’s an increase in GDP.

To the government, however, exports mean “Net Exports,” subtracting the value of goods made in other countries and brought to the United States and sold here – i.e. imports – from goods produced here and eventually sold abroad (actual exports). Net exports may increase simply because fewer imports are bought by American consumers, due to a decline in consumers’ wages and incomes, loss of jobs, home foreclosures and other clear indicators of a declining, not a growing, economy.

The drop in import purchases more accurately reflects a declining economy. Removing the imports factor from GDP calculation would reduce GDP growth from the 3.3% to about 1.5%. Removing the two other contributing factors to GDP in the second quarter – inventory adjustment and the effect of the one-time economic stimulus package – would effectively reduce the GDP growth rate from the 3.3% to zero.

Thus in the second quarter of 2008, the $24 billion growth in actual exports and the fiscal stimulus together only managed to prevent the economy from slipping further into recession. More important, by late summer 2008 it now appears both the fiscal stimulus and the growth in actual exports have come to an end. Neither of the two temporary boosts will therefore be available in the remainder of 2008.

That is because of two important developments in recent months. First, the value of the U.S. dollar, which had declined significantly during the first half of the year, is now rising once again, making U.S. exports relatively more expensive and less competitive. Second, the foreign economies into which U.S. exports were selling well are themselves dramatically slowing down, in particular the European Union, Britain, Canada and Japan. Some have already slipped into recession. Global economic slowdown abroad will reduce U.S. exports.

New export orders in July showed a sharp reversal from second quarter growth trends, according to economists from both Citigroup and Merrill Lynch. This was followed in September with the manufacturing sector in the United States, the source of much of the value of exports, registering a decline in its index from 49.9 to 43.5. This precipitous drop, the worst since the 2001 recession, was totally unpredicted by analysts and reflects a very sharp contraction of manufacturing production, and thus future exports.

Jobless Recession As Better Indicator

Indicators and statistics associated with job creation, unemployment claims and total unemployment are much better representations of the true recessionary state of the current U.S. economy, even given their often underestimation, than are GDP data.

For example, new unemployment insurance claims have remained steady in recent months at around the 440,000 per week. Historically, levels above 400,000 are clearly associated with recession conditions. The rate at which the jobs markets are deteriorating is also currently the worst in decades. The 1.3% percentage rise in the unemployment rate over the last six months is the steepest rise in a six-month period since 1982.

Among the hardest hit sectors in September was manufacturing (which is also at the largest contributor to exports), where 61,000 jobs were lost. Moreover, independent surveys show the largest source of new job creation, i.e. small business, is adding no new jobs at all over the past three months.

Long-term unemployment is also at levels associated with deep recession. More than 800,000 workers currently receiving unemployment benefits are projected to run out of such benefits by the end of September 2008 unless Congress passes another extension. It all adds up to a picture of not only recession but deepening recession – in stark contrast to those GDP figures showing an accelerating recovery.

The U.S. economy has been in a “jobless recession” for nearly a year now. Jobless recession is an alternative concept and definition to traditional “GDP-defined recessions.” Jobless recessions are defined as the period of months from which total jobs in the economy begin to decline, until such time as the original peak level of employment is regained.

Jobless recessions predate by months the onset of a “GDP-defined” recession. Unfortunately, they also drag on after the end of a GDP-defined recession many months as well.

An important long-term trend in the U.S. economy is that jobless recessions are getting longer in duration. In the first George W. Bush GDP recession that officially began in the second quarter of 2001, it took 48 months for the economy to recover.  In contrast, the job recovery following the 1974 recession took 28 months, following the 1981 and 1990 recessions it clocked in at 31 months each.

 Today’s emerging jobless recession, already roughly 12 months long, will likely last even longer than Bush’s first recession’s 48 months. It is an indication of a decades-long deterioration in the U.S. economy.

Financial and Global Connections

Two additional, critical differences characterize the current recession compared with previous ones. The first is that it is being driven by the worst financial crisis since the 1930s.

The financial blowup in the subprime mortgage market in mid-2007 has led to an historic contraction of the housing sector. But the subprime mortgage crisis rapidly spread to the “prime” residential mortgage market and in recent months to commercial property markets as well.

The subprime-prime residential collapse lies behind the early September U.S. Treasury bailout of the quasi-government agencies Fannie Mae and Freddie Mac, while the decline of the commercial property markets is a fundamental cause of the fall of the Lehman Brothers investment bank a few weeks after the Fannie/Freddie bailout.
The construction sector crash, residential and commercial, has spread and is currently driving a general credit contraction throughout the entire U.S. economy.

Highly likely candidates for defaults and bankruptcies are now the 8600 regional and community banks for which the government’s Federal Deposit Insurance Corporation (FDIC) is liable. Of those 8600 banks, with total deposit and debt assets of more than $13 trillion dollars, it is projected that 800 to 1000 of them will default, enter bankruptcy or reorganization and require FDIC funds to cover depositors.

The FDIC, however, has only $35 billion on hand. Its bailout this past summer of IndyMac bank cost $8 billion. It will no doubt have to borrow at minimum hundreds of billions more to cover the coming regional bank failures.

Continuing failures and bailouts of mainline banks will no doubt continue as well. Here the “action” will likely shift more to Europe in coming weeks. Banks in Spain, Italy, Iceland, Ireland and Britain are particularly exposed, having bought up the worse of U.S. subprimes in 2005-06. The large Netherlands-Belgium bank, Fortis, has already required bailout. European banking giants like the Swiss UBS are also at risk, as well as Japanese banks that were especially hard hit by the Lehman Brothers collapse.

The failures of U.S. financial institutions will likely now shift to major hedge funds, those unofficial “banks” and totally unregulated financial intermediaries that have played a particularly large role in speculation and driving down of stock prices of recent giants like Lehman, Merrill and others that recently went under. Their sources of funds are drying up. Their speculative tactics, sometimes referred to as “short selling,” has been temporarily suspended by the SEC.

Many big U.S. hedge funds will now begin closing down. The impact remains to be seen. But it is already having major repercussions on other financial sectors, including money market funds and pension funds. Defaults and bankruptcies can also be expected to rise for other highly visible non-financial corporations and those “credit subsidiaries” of non-financial companies, such as General Motors Acceptance Corp (GMAC) and General Electric Credit..

High on the list of non-financial corporations likely to default and go bankrupt are the auto company Chrysler (and perhaps even GM) and various auto parts companies. Auto sales fell off the cliff in September, declining almost 30% in one month alone. Retail giants like Sears, Airlines and Trucking companies, Sprint, the telecommunications company, and others will populate front page news in 2009. As defaults and bankruptcies rise, other companies will pull back to defensive operations with deep cost cutting, resulting in mass layoff announcements.

The second major force driving the U.S. recession is the accelerating decline of other major global economies. For the first time since the Second World War, there is now emerging a truly “synchronized” global downturn. Britain and other major European economies like Germany and France have recently clearly slipped into recession, with euro-periphery economies such as Spain, Italy and Ireland in even worst shape.

The Japanese economy has once again slipped into decline, with Canada and New Zealand quickly following suit – and that is just a “short list.” Moreover, the rate at which European and other economies are contracting is startling, accelerating even faster than had initially been the case for the United States.

In past months economists, media pundits and government officials floated the erroneous argument that the fast-growing economies of China, India, Brazil and Russia would continue growing even though the United States descended into recession, and their growth would mute and soften the U.S. decline. This view was nonsense, then and now.

Even in the case of China, the fastest-growing emerging market, signs are now proliferating that it may be on the verge of a major commercial property bust. Chinese commercial property prices have in recent months begun to collapse. Its equity (stock) market is in freefall. It is largely unknown how much of “toxic” subprime U.S. mortgages the central Bank of China now holds. The United .States buys $300 billion of China imports every year and China recycles back hundreds of billions in purchases of U.S. securities, which include unknown massive amounts of “bad” mortgage bonds from Fannie Mae and Freddie Mac. That is at risk.

A credit crunch is also beginning to hit China’s corporate bond markets. In short, the China scenario looks very much like a lagged replay of 12-24 months of what has been happening in the U.S. and European economies. In the immediate months ahead, therefore, China’s economic growth rates may decline from double-digit to low single-digit levels faster than predicted.

The slowing global economy will now “feed back” on the U.S. economy, exacerbating the financial crisis and further depressing U.S. economic growth in the coming months. Credit card companies and once-solid consumer credit companies like GE credit and GMAC credit are already in trouble.

A brief survey of the economic indicators for September show a dramatic falloff in virtually every indicator. Forecasters’ and analysts’ estimations missed their marks in nearly every case. For example, the official consensus forecast for Industrial Production was -0.3%, but it fell -1.1%. For durable goods orders the consensus was -1.6% but it plummeted -4.5%, for retail sales -0.2% vs. -0.9%. Housing starts and new home sales forecasts were off by 60,000, new jobless claims by 50,000. Business inventories rose twice as fast as projected and consumer credit spending, projected at $8.8 billion, came in at $4.5 billion.

The Bailout: “Reverse Socialism”

All this occurred largely before the tsunami of credit contraction swept over the economy in the wake of $700 billion TARP bill passed at month’s end. As the contents of that $700 billion bailout and handout of taxpayer money to the big banks and investors are better understood, it will become increasingly clear that the bailout is designed to do nothing to check the collapse of housing and other property prices, and general asset deflation, that has been driving the financial crisis for more than a year.

The bailout is simply an interim transfer of bad debt from the balance sheets of banks and financial institutions to the “public balance sheet,” for which taxpayers will have to pay. Some have aptly called the bailout “reverse socialism” for the banks and wealthy investors. If so, perhaps their class motto should now be: “From each according to his balance sheet; to each according to his Portfolio”!

During the first year of the financial crisis, the U.S. financial and economic crises were in effect “exported” abroad and precipitated the global downturn. The United States exported its financial crisis by selling bad subprime mortgage bonds throughout the world to countless foreign banks, central banks, sovereign (government) wealth funds, and wealthy foreign investors’ funds. Soon after, it began exporting its recession by rapidly lowering interest rates, causing a devaluation of the U.S. dollar in global markets, which in turn provoked a speculation-driven rise in global oil and commodity prices.

Foreign central banks responded in turn by raising their interest rates and consequently driving their economies into recession as well. In a completion of the circle, those declines will soon begin feeding back on the U.S. economy, causing its further decline.

It is all leading to what this writer elsewhere has termed an Epic Recession, a downturn unlike any since the 1930s, with some characteristics of a typical recession and other characteristics of a classic Depression as in 1929-1933, the 1890s and the 1870s. It is not a typical postwar traditional recession, nor yet a true global depression, but an unstable condition with a tendency to evolve from the former to the latter.

Copyright by the author.

ATC 137, November-December 2008