Andy Sutton's Extemporania

In an effort to get out ahead of the rush of year-end summaries, commentaries, and reviews, we’re going to try something a little bit different this year and leave 20 days of 2009 on the table. The themes discussed at the outset of 2009 were all longer-term in nature anyway, and it is unlikely that anything major will happen to unsettle those themes during the last few days of the year. Incidentally, a buffalo nickel goes to the first person to email in if I happen to be wrong on that last assertion. So without further delay..

Theme #1 for 2009 – The blowout federal deficit

“In a classic journalistic transgression, the Congressional Budget Office stole most of the thunder of our first theme for 2009 – a blowout in the Federal deficit as the government, almost out of options, pulls out all the stops and piles it on taking the national debt curve parabolic.”

I’ll readily admit I should have spent some more time on this, but the CBO had in fact just released a report on the projected 2009 FY budget that was actually carried in a spirit of journalistic honesty unrivaled in recent years. The media, for a week, became deficit hawks. After that they resorted to just gawking at the monthly Treasury shortfalls and commenting how it was ‘necessary’ to get the economy going again. The ending FY 2009 deficit was indeed massive: $1.4 trillion.

This year, we’re in a similar situation; the CBO came out this week with a report identifying a $292 Billion shortfall for the first two months of FY 2010. If this trend holds out, the FY 2010 shortfall would be in the $1.75 Trillion area. I’m inclined to go even higher and predict a greater than $2 Trillion deficit for several reasons:

1) Another stimulus is in the works. Reeking of Madison Avenue marketing, this third stimulus in just two years is not even being called a stimulus, but a jobs plan. If you read the fine print, however, you’ll see that it differs very little from its most recent predecessor. While details are sketchy at this point, I’ve been asserting for the past few months that they’d propose another stimulus and it would be a whopper: probably a trillion dollars or more. I’m sticking to my guns on this one.

2) The actual ‘cost’ of the existing programs is much higher than their price tags, resulting in a dramatic and spectacular piling up of shortfalls. For example, the 2009 stimulus carried a $787 Billion price tag, but a total cost somewhere in the neighborhood of $3.25 Trillion according to the CBO.

3) Healthcare Takeover. Again, details are sketchy at this point, but the nationalization of America’s healthcare system is likely to sport a price tag of near a trillion dollars, with the actual cost likely somewhere between here and Saturn since it is not a one-time program, but one that will run essentially in perpetuity. Don’t be fooled by assertions that this measure will prevent the insolvency of Medicare and Medicaid either.

All of these factors (and many others) point to a continued increasing slope of the public debt curve. Not to mention that at this point in the debt curve, which is essentially a mathematical function, deficits beget larger deficits as compounding kicks in. Another buffalo nickel goes out to whoever accurately predicts the year when we cross the $100 Trillion mark on the national debt. In truth, the currency system we’re under may well end before we reach that point, but it is an interesting study nonetheless.

Theme #2 for 2009 – States Circle the Wagons for bailouts

“California, New York, and as many as 29 other states are already in fiscal extremis as revenues plunge due to unemployment and decreasing tax receipts. States are faced with difficult choices in 2009. They can raise taxes, cut services, beg for a bailout, or in all likelihood all of the above. And in a typical ironic twist of fate, the market for municipal bonds is drying up just when the states are going to need the money most. To make matters worse, yields on municipal bonds blew out to nearly 2.2 times the yields on corresponding Treasury issues. This is more than twice the .96 historic level normally observed. Obviously, the message here is that the perception of security is gone. We pointed out this likely eventuality when MBIA and AMBAC came under duress and saw their credit ratings cut back in June. Not only are the bonds questionable, but their insurance is as well. The bottom line here is that if bond issues can be sold, investors will command much higher yields resulting in greater debt servicing costs. Initial forecasts for 2009 indicate that there will be a 6% decrease in new bond issues sold, taking the total down to around $364 Billion.”

Again, absent Madison Avenue marketing, we’d have seen this for what it was. The 2009 stimulus was largely a de facto bailout for many states that lined up to grab the federal dollars. However, several spurned the freebies in heroic fashion, realizing that there were too many strings attached. Granted, not much has been made of the downgrades of AMBAC and MBIA since they happened and on top of that muni bond yields have fallen so much that on many points along the yield curve, they’re actually bringing in less than their Treasury counterparts. However, if you adjust for the 28% tax rate equivalent yield, muni bonds are still sporting a hefty spread at the long end of the yield curve: 1.42X the 30-year Treasury bond.

As for the issue of cutting services and raising taxes, we were spot on. The media landscape in 2009 was littered with stories of cities, states, and municipalities cutting all sorts of services, even police, fire, and EMS in many cases. New Jersey, California, and Michigan were just a few states that gave public school teachers pink slips in 2009; a nearly unprecedented move. On the revenue side, many areas have resorted to increasing and adding fees as opposed to raising funds through the more traditional taxing systems already in place. NYC led the way in this regard, raising fees on everything from parking to taxi cab rides. And the rest of us haven’t been immune either. Fees and surcharges are being raised all over the country in an effort to patch broken budgets from Omaha to Oregon without raising broader tax rates, which are much more in the public eye.

The one portion of the municipal story that we seem to have been a tad early on is the overt purchase of muni bonds by the government. However, given the fact that California virtually begged the Treasury for TARP money and the Treasury’s CPP (Capital Purchase Program) has poured over $26 Billion into California banks, it is probably not a completely unreasonable assumption that at least some of that money went towards California ES and GO bonds held by the aforementioned banks.

Theme #3 for 2009 – Creative Financing to Induce Borrowing

“Creative financing will be back in 2009. And I don’t just mean 0% interest loans. Any machination that allows payment to be put off until a later date will do. 12, 24, and 36 months interest-free. No payments for 12 months. Partial payments for 12 months. No down payment and we’ll make the first 3 monthly installments for you. We’ve already seen these before, but they’ll become commonplace in 2009. Look for new ones as well with longer payments terms, which ironically means you’ll end up paying even more for the items. However, the focus will be on the ‘low monthly payments’. Stimulus checks may not be checks at all, but may rather have a requirement for consumption attached. All indications are that the framers of the last stimulus package were unhappy because not enough of the money was spent. Apparently some people actually paid bills and/or saved the money. Maybe Wal-Mart and Home Depot Gift Cards will be the delivery method for the next economic stimulus. I’m only half joking about this.”

Cash for Clunkers. Need I say more? On other fronts, the Fed has led the charge to induce home buying through the purchase of $854 Billion (to date) worth of mortgage bonds. Not to be outdone, the feds have thrown in their own incentive in the form of tax credits for first time home buyers. These folks will do anything to raise the dead and buried notion that home ownership is the epicenter of wealth and prosperity. There have been various incentives to purchase all manner of home improvements centered on energy efficiency. This might be perhaps the most innocuous of the government’s attempts to urge people to spend money. We were spot on with regards to cash handouts; they didn’t happen because the government wants to guarantee that people actually spend the money. So instead of mailing checks, the feds will give you a kickback if you spend your own money or even better, borrow and spend someone else’s.

Retail chains have done their part by slashing prices to induce spending. Creative financing arrangements are out there, but are not quite as prevalent as we had expected at the outset of the year save for the auto sector. Consumer spending has remained tame at best, and the consumer’s willingness to take on more debt to finance large living has diminished significantly. Consumer credit outstanding – one of my favorite indicators in terms of predicting consumption patterns and GDP growth ex government spending has seen 8 consecutive months of declines; the first such occurrence of a sustained decline since the series began in 1943. The mainstream has of late picked up on this storyline mostly because the declines in recent months have been less severe which fits into the mantra of ‘not as bad’ economic reports being spun as great news.

For sure as we close out the first decade of the new century and millennium, the spin will be on the increase. Few things will be as they appear. News reporting has already taken on a frighteningly 1984-ish aura complete with glitzy marketing props and plenty of subterfuge. Economic statistics released by the government will become more and more irrelevant. Even now, press releases from BLS and the Commerce Department in particular are littered with asterisks about changes in reporting, methodologies, and data gathering. It would seem those responsible for providing us with accurate data have hired the Enron crew to cook the numbers for them.

You can have all of this spin and subterfuge decoded for you each week on ‘Spin Cycle’. I host the show and debunk economic reports and bring on guests to talk about the important issues of day as they relate to media bias and misinformation. For more information or to listen, please visit Contrary Investor’s Cafe