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Monday, October 3, 2011

Mon Post #2: This crisis is a long way from over


Faithful readers know that I am fond of saying that the 2008 Great Financial Crisis is not over.

We suffered a financial earthquake in September 2008, the depth and breadth of which many of us still do not understand nor appreciate.

The western world has been on a credit binge for the last 40+ years and we have put off dealing with the effects of this binge over and over again the past four decades. Rather than deal with difficult recessions, Government has constantly intervened with 'stimulus' to avoid the pain of dealing with inherent problems.

The result?

As noted by the Boston Consulting Group in a recent report, the developed world currently has $20 trillion in debt over and above the 'sustainable threshold'.

The definition of "stable threshold" is a debt to GDP of 180%.

This $20 trillion in debt encompasses household, corporate and government debt and you read that correctly... that's $20 trillion over and above a debt to GDP ratio of 180%! 

Since 2008 all attempts to eliminate the excess debt have failed. 

This includes that US Federal Reserve's relentless pursuit of inflating our way out this insurmountable debt load... which after adding $3 trillion to the US National Debt have been for nothing.  Inflation has not worked so far because of the pressure to deleverage and because of the low demand for new credit.

And looming on the horizon is the elephant in the room that no one wants to acknowledge.

While everyone today is focused on the European sovereign debt problem right now, the debt problems of the PIIGS (Portugal, Italy, Ireland, Greece, Spain) et al are nothing compared to what looms in America.

US states have spent nearly half a trillion dollars more than they have collected in taxes, and face a $1 tillion hole in their pension funds. California alone is a bigger problem than the 'PIIGS' (less Spain) combined. Then throw in Illinois which has spent twice as much money as it has collected and is about six months behind on creditor payments.

From 2002 to 2008, the individual states had piled up debts right alongside their citizens’: their level of indebtedness, as a group, had almost doubled, and state spending had grown by two-thirds. In that time they had also systematically underfunded their pension plans and other future liabilities by a total of nearly $1.5 trillion. In response, perhaps, the pension money that they had set aside was invested in ever riskier assets. In 1980 only 23% of state pension money had been invested in the stock market; by 2008 the number had risen to 60%. To top it off, these pension funds were pretty much all assuming they could earn 8% on the money they had to invest, at a time when the Federal Reserve was promising to keep interest rates at zero. Toss in underfunded health-care plans, a reduction in federal dollars available to the states, and the depression in tax revenues caused by a soft economy, and you are looking at multi-trillion-dollar holes that can be dealt with in only one of two ways: massive cutbacks in public services or a default—or both.

At the municipal level, the financial health of American cities is in even greater deplorable shape.

Meanwhile there is consumer debt.

American Households are still more indebted than their counterparts in Austria, Germany, Spain, France and even Greece. Tens of millions of citizens remain burdened with mortgages they can no longer afford, in addition to soaring credit card bills and sky high student loans.

Trillions of dollars in outstanding consumer debt is stifling demand for goods and services and that's why the demand for new credit is so low. And without the consumer demand, cash-rich U.S. companies are reluctant to hire and unemployment remains stubbornly high.

As of June 30, roughly 1.6 million homeowners in the U.S. were either delinquent on mortgages or in some stage of the foreclosure process, according to CoreLogic. And the real estate data and analytics company reports that 10.9 million, or 22.5%, of homeowners are underwater on their mortgage — meaning the value of their homes has fallen so much it is now below the value of their original loan. CoreLogic said the figure, which peaked at 11.3 million in the fourth quarter of 2009, has declined slightly not because home prices are appreciating but because a growing number of mortgages are entering foreclosure.

America's banks, meanwhile, still have more than US$700-billion in home equity loans and other so-called second lien debt outstanding on those U.S. homes, according to SNL Financial.

Debts owed by American consumers account for almost half of the nearly US$9-trillion in worldwide bonds backed by pools of mortgages, car loans, credit card debt and student loans, which were sold to hedge funds, insurers and pension funds and endowments.

And that doesn’t include the US$4.1-trillion in mortgage debt sold by government-sponsored finance firms Fannie Mae and Freddie Mac.

Kenneth Rogoff, professor of economics and public policy at Harvard University and former chief economist at the International Monetary Fund, has said the ongoing crisis should be called the “Second Great Contraction” because households remain highly leveraged. He says the high level of consumer debt is what distinguishes this from other recessionary periods.

Meanwhile American banks also have their own big debt burdens to deal with. Next year alone, banks and financial institutions must find a way to either pay off or refinance US$307.8-billion in maturing debt, compared to the US$182-billion that is coming due this year, according to Standard & Poor’s.

This maturing debt for banks comes at a time when they must start raising capital to deal with new international banking standards.

Beyond bank debt, hundreds of billions of dollars in junk bonds sold to finance leveraged buyouts also are maturing soon. S&P says “the biggest risk” comes in 2013 and 2014, when US$502-billion in speculative-grade debt comes due.

The problems you see in the news today about Bank of America and Morgan Stanley are only the tip of the iceberg.

The issue of this decade is Debt.

And the issue hasn't even begun to be dealt with yet.

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