Financial RealityRobert F. Kennedy Jr on the Collapse of Trust in the Government & Media
“When my uncle left office in 1964, 80% of Americans trusted the government and even more trusted the media…Today 22% of Americans trust the government and those are people who I would say are not paying attention.”
Trust is essential to a functioning economy. Inflation and hyperinflation are symptoms of a loss of trust.
Scott McNealy, CEO of Sun Microsystems, a couple of bubbles ago:
Well I left the original title. But ended up with nine Horsemen of the Apocalypse. Some or all of these Horsemen are likely to drag us into a global depression.
1. Commercial real estate
Office occupancy across the country is down about 20% from pre-pandemic levels, but much more in the big cities, especially the Democrat-run ones where crime, homelessness and drugs make office workers unwilling to come downtown. Office buildings in big cities like San Francisco and New York are selling at small fractions of their previous purchase prices, and then re-entering the rental market at cut-rate prices.
Retail malls and big boxes have been suffering from online shopping and a glut of retail space. For places like France, Germany, the United Kingdom and Japan, average retail space is less than 5 square feet per person. In the U.S., that number is more than 23. This year is on track to be the worst year for retail bankruptcies since 2020, with strip-mall mainstays like Bed Bath & Beyond, Tuesday Morning, Party City and David’s Bridal all filing for bankruptcies. Notably Home Depot, Target, The Container Store all warning of negative trends. Shopping malls are seeing the same kind of drop in valuations as the heavily impacted office buildings.
2. Banks
A Hoover Institute report calculates that more than 2,315 US banks currently have assets worth less than their liabilities. The market value of their loan portfolios are $2 trillion lower than the book value. And remember this is before the fall of the asset values which is still to come. These banks are insolvent, even though their financial reporting may not disclose the fact due to “held to maturity” accounting rules.
(Egon von Greyerz on Twitter.)
Nervous bankers don’t want to take risks and so pull back on lending. The Senior Loan Officer Opinion Survey provides information on this tendency, otherwise known as a credit crunch. Quoting the Fed:
“In a set of special questions, the April SLOOS asked about banks’ reasons for changing standards or terms for loans across all loan categories over the first quarter. Overall, major net shares of banks reported that a less favorable or more uncertain economic outlook was an important reason for tightening, as well as reduced tolerance for risk, deterioration in customer collateral values, and concerns about banks’ funding costs and liquidity positions.”
3. Federal government
The Federal Government’s interest expense, on its $32 trillion in debt, now exceeds that of the former elephant in the room, military spending. Also, misleadingly, called “defense”. As of the first half of FY2023, The Federal government is spending 50% more than it takes in. An uncontrolled spiral is underway and will result in hyperinflation if not quickly brought under control.
4. Residential real estate
Recent years have seen an explosion of Short Term Rentals (STR) as Debt Service Coverage Ratio (DSCR) loans have made it easy for people with relatively little in the way of income or assets to acquire large numbers of properties to be deployed with AirBnB, VRBO and others.
You probably thought that, after the GFC, NINJA (No Income No Job or Assets) loans became unthinkable. Well you thought wrong. They came back in as Debt Service Coverage Ratio (DSCR) loans. Basically a NINJA loan for the purchase of rental properties, DSCR loans enable real estate investors to get a loan because it takes into account cash flow from investment properties rather than pay stubs or W-2s, which many investors do not typically have. Lenders use DSCR to evaluate a borrower’s ability to make monthly loan payments. DSCR is simply the ratio of gross rental income to debt service expense, Needless to say, any hiccup in the income stream can turn quickly into default. DSCR requirements are typically 1.0 to 1.25, although some lenders will accept ratios as low as 0,75 with a 12-month cash buffer. Of course these loans are used to acquirte traditional rental properties, but the volume has been in STRs, This will not end well.
Large Investors – hedge funds and institutions – have been buying wholesale quantities of single family rental properties (SFRs), often buying whole developments from builders. Now they have started to sell, presumably as their financing is floating rate lines of credit rather than traditional mortgages. While the selling is subdued so far, it could become an avalanche.
Also see the China section
5. Consumer spending
Consumer spending will be negatively impacted by the increasing burden of debt service and layoffs.
Leading off is the end of student loan forbearance. This is no small matter with student loans now totaling $1.7 trillion, averaging $28,850 per borrower. Reportedly many borrowers have taken advantage of forbearance to add indebtedness for cars, vacations and a myriad of other purposes and will now be facing daunting monthly payment obligations. All of this will have a negative impact on consumer spending.
Consumer debt now amounts to about $4.8 trillion, bad enough, but the re-instatement of student loan repayment adds a sudden 35% to the burden.
This cycle, layoffs started with the highest paid workers. Elon Musk cut the workforce at Twitter by 75% and nothing much happened. The lights stayed on, development continued. Other “tech” bosses followed suit, tentatively. It became clear that some of these companies were basically adult daycare where little was demanded of employees. With generous severance plans, the hit to consumption has been muted so far but can be expected to build momentum, even as those still employed adopt more cautious approach to their spending plans. As noted above, retail businesses are signalling a downtrend in consumer spending. Fed Chair Powell has made it clear that he intends to keep hiking interest rates until the unemployment rate climbs significantly. This could easily snowball.
Res ipsa loquitur.
6. Inflation
See preceding post, “I Have To Laugh“.
7. Climate Initiatives
What a mess. Nothing damages an economy as much as an unreliable or intermittent energy supply. Widespread use of wind and solar energy requires a complete re-engineering and replacement of the transmission grid, including use of batteries or other energy storage technologies. This will take decades and staggering costs. Governments trying to shortcut this process will cause economic havoc, as has already started in Europe. There is a better solution – nuclear – and a few enlightened governments may have consulted actual engineers and started down this path. But never underestimate the stupidity of governments pandering to vocal activists. And even if CO2 really is at fault (the historical record says it is a result, not a cause) the US is a drop in the global bucket.
Then there is the electric car fantasy. California has already had to ask electric car owners to suspend charging for fear of overloading the grid. Gas stations and tank trucks distribute enormous amounts of energy. The elcctricity industry is nowhere near able to generate or transmit this energy, but radical governments are calling for the elimination of gasoline and diesel powered vehicles. Way to cripple the economy, folks.
8. China
The Chinese housing bubble is collapsing as desperate speculators “want to cry without tears.” The government is attempting to prop up the market but it isn’t working. This is the largest asset class in the world and defaults will have worldwide impact, not only on foreign investment but also on Chinese trade with the rest of the world. China has propped up the global economy in the past. It now appears that it will drag it down.
9. Russia and Ukraine
Obviously the big risk here is continued escalation, possibly resulting in a nuclear Armageddon or, more likely, a land war in Europe. Again the stupidity of politicians make these outcomes a significant risk.
Inflation numbers, like most economic data, are noisy in the short term and highly dependent on the weighting of the various components. That’s why we have both CPI and PCE, “headline” and “core” and even “supercore”. There are many other measures like “trimmed-mean”, “median”, “sticky” and so forth. The St. Louis Fed’s list of inflation charts – just the headings – runs to 30 pages. But financial commentators cannot resist the temptation to cherry-pick the data that supports their personal thesis and throw out the data that doesn’t (must be “transitory”) and declare imminent victory over inflation. Yes, the economy is quickly rotting from the inside. But there is no historical basis for believing that a recession will bring inflation down, at least without a financial crisis much bigger than the 2008 GFC. This is not to say that such a crisis won’t happen, but that is a separate matter from re-arranging the tea leaves to extract the desired prediction from the current data.
Credit John Hussman to use actual data and observe that the best predictor of inflation is… (drum roll) year over year inflation. But you don’t need to know that. All you need to know is that the Federal deficit for the first six months of FY2023 was $1.1 trillion. Federal revenue for the whole year is budgeted at $4.71 trillion. This means the Federal government is spending roughly 50% more than it takes in. That, ladies and gentlemen, is where inflation comes from. To make matters worse, its partner in crime, the Federal Reserve, is no longer converting that deficit into interest-free cash (QE) but is letting its Treasury portfolio roll off at maturity(QT). Now the Feds have to issue new interest-bearing debt, plus replace the existing debt as it matures. As of Q1, the interest bill alone was $929 billion, up 54% from the same quarter of 2022. Roughly half of all $32 trillion in federal debt matures in five years or less and must be re-issued at then-current rates.
I may laugh at the data manipulators, but this is a picture of a slow-motion train wreck where you and I are the passengers. The train driver sees no problem and is unwilling to even discuss applying the brakes, although brakeman Powell has started to turn the wheel. I am reminded of an incident that happened when I was in high school. I had a summer job working on a maintenance crew for a property developer. One morning I came in and the boss called me over “Grab your lunch and one of those folding chairs and come with me. You’ve got a watch, right?” “Yes,” I said and did as told. We drove out into the countryside and stopped by the side of the road. There was a buried concrete vault with steel doors on top, which we opened to reveal a large pipe and valve with an equally large wheel. You could hear a rushing noise. “This,” said the boss, “is a 36-inch water main. As you can hear, it is in use but we need to shut it down to do some work on it. Your job is to turn that wheel one quarter-turn every 15 minutes. If you turn it too fast that pipe is going to jump right out of the ground. Understood?” I acknowledged and he demonstrated and left, saying he would pick me up for quitting time. (IIRC I was being paid $0.80 an hour. but saved enough to buy my first car, a $1895 Mini Cooper with parental matching funds.)
Back to the subject. Powell is turning his wheel a quarter point at a time. Is he turning it too fast? We’ll only know if the financial system has a heart attack. Is he turning it too slow? According to Bloomberg, Venezuela is raising its interest rate to 97% on Monday. That’s what happens if he is too slow. When is quitting time?
Sources: https://fred.stlouisfed.org/tags/series?t=inflation&et=&pageID=1, https://www.washingtonexaminer.com/policy/economy/deficit-soars-to-1-1-trillion-for-first-half-of-fiscal-year-2023, https://fred.stlouisfed.org/series/GFDEBTN/, https://fred.stlouisfed.org/series/A091RC1Q027SBEA
Borrowing short and lending long is catching up with banks that have forgotten (or never learned) the need to match maturities. This is banking 101. I can only assume that these banks had other things on their minds when they hired or promoted their executives. There is a shibboleth that says, roughly, those who do not study history are doomed to repeat it. The most recent history here is of course the failure of 32% of S&Ls between 1986 and 1995. And here we go again. Any properly managed bank could readily avoid or hedge interest rate risk and, fortunately, many seem to have done so. MBS, CLOs, CDOs, etc., the ways to offload are legion. Instead, managers chose to speculate. Unfortunately, stupidity is not a crime.
Edit: One can argue that rate increases played a role in the 2008 GFC, but in my view the main cause was poor credit quality leading to a vicious circle of defaults.
The US Federal deficit spend was $1.1 trillion for the first half of the 2023 financial year. This means that $1.1 trillion in new money was pumped into the economy, about 10% of GDP for the same period. This is where inflation comes from and why it is not going away, barring a collapse in the private sector where defaults – which destroy money – offset the spend. Debt limits must call a halt to this casual disregard for the consequences of inflation.
I was just reading that Ukraine was now receiving its first Patriot air defense systems. Well of course it just money down a rathole as the recent document leak exposes. But what staggered me is that Patriot missiles cost $4 million each. That is completely insane. Talk about asymmetrical – the enemy can send a $10,000 suicide drone which then costs probably 7 or 8 million to down when manpower, training, launcher, etc. costs are taken into account. This “defense” spending has to stop, it is bankrupting the country.
Of course, this is what happens to empires, Roman, British, etc. Their economic model stops working. Then it’s over.
Obviously it’s a bit out of date at this point, but at least in San Francisco’s case, there is little evidence of recovery as the office vacancy rate is now 30%.
Financial Reality 
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