“Only” 36,000 jobs lost in February. That is relatively good news. The storyline was the following. Given all the snow, we should have lost more jobs. 36,000 was a relatively good number because if there was no snow we would have seen growth. But we didn’t see growth. In addition, there is a lot riding on the March numbers which will be released April 2. Assuming no more snow, this argument predicts a big positive gain.

The real issue here is what the recovery will look like. Are we stuck in a quagmire of persistently high unemployment (the plank) or are we going to see a sharp rebound (the hockey stick).

I vote for the plank.

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Risk has greatly increased this week. There are two reasons.

First, the Euro-bomb could explode anytime.

Second, the U.S. government dropped a bomb in telling us that the employment losses during the current recession are far worse than people had believed.

The Euro Bomb

The EU is in a lose-lose situation. If they rescue Greece, then other countries will have their hands out like Spain, Portugal, and Ireland. There could be others too. I doubt the main players (Germany and France) will have the stomach to bailout so many countries. The fundamental problem is that it is very difficult (near impossible) to have a currency union without a political union. While Euroland rules were established (size of deficit, government debt), they were (and are) routinely violated and there is no way to enforce – because of the lack of political union.

You create moral hazard problems. Countries will borrow and spend with the expectation that the system will bail them out. Sound familiar? If the large countries even marginally violate the rules (size of deficit, debt), then this energizes the smaller countries to brazenly violate the rules of the game.

If the EU does nothing, then the Euro will likely fall apart (or at least lose some member countries)

The real question is how deep Germany and France will want to reach into their pockets to keep the Euro going.

The Jobs Bomb

Unemployment dropped by 0.3% to 9.7%. Good news, right?

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Why don’t we just admit that the current financial and regulatory system is dysfunctional?

We face two fundamental problems.

First, we need to clean the financial system — close weak banks more aggressively, encourage bankruptcies/foreclosures, and free good assets held by poorly financed owners. Small and medium sized businesses with quality projects are not getting loans. This problem will not be solved by tax breaks or targeting some incentives. We need structural change.

Second, the current regulatory system failed us. It needs to change. Our system is comprised of three federal agencies: the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Federal Reserve, as well as 50 state banking departments! I am not even including the Office of Thrift Supervision and all of the Savings and Loan Institutions nor the National Credit Union Administration which supervises all the credit unions.

There are state chartered banks as well as national chartered banks. As a result of the historical maze of changing regulations, we have over 7,000 banks. There is no economic reason for 7,000 banks. It is inefficient both for the bank in providing the lowest cost and highest quality services to their customers. It is a nightmare to regulate.

What is most alarming is that none of our leaders have stepped up with bold proposals to revamp our financial and regulatory system.

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The economy is in much more serious trouble than news reports, policy makers and pundits might lead you to believe.

The Spin

It is amazing that most jobs stories featured upfront the revision to November’s Non-Farm Payrolls. November was revised to +4,000 from the original -11,000. A net gain. However, October was revised downwards – a complete wash.

The fact is that we lost a surprising 85,000 Non-Farm Payroll jobs. A widely respected economic consulting group expected +50,000. The market expectation was about flat.

I am convinced the situation is much worse than we are led to believe.

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There are two key questions: (1) is the improvement in the job picture sustainable and (2) if it is, how long will it take get back where we started in December 2007? While there is considerable disagreement in terms of general economic policies, most agree that jobs are the key to the economic recovery.

Summary of the release

In November, the Establishment Survey showed that only 11,000 jobs were lost. There were some favorable revisions to October and September data.

The BLS also reports Household Data and there can be big differences between the Household and Establishment Surveys. For example, October, the Establishment Survey showed a decrease in nonfarm payrolls of (revised) 111,000. However, the Household data suggested a staggering increase of 558,000 to the ranks of the unemployed. In November, the news was much better on the Household Survey. The Household Survey showed that unemployment decreased by 325,000.

To get the unemployment rate, you take the Household Survey unemployment (15.375 million) and divide by the civilian labor force (153.877 million) and you get 10.0% (actually, 9.9992% — so we technically lost the ten-handle!)

There was other good news. The all-in unemployment rate (U-6) dropped from 17.5% to 17.2%. Temporary hiring (a good leading indictator continued to increase (adding 52,400 to the rolls). Finally, the average work week increased by 0.2. This means more money in the pockets of consumers.

All of this is good. However, there are some issues (which I am sure you expect from me). Read the rest of this entry »

Amazing the difference one day makes in the employment outlook. Yesterday, the market shot up because “only” 512,000 applied for initial claims — down from 532,000 the previous week. We saw banners: “Employment Situation Improvement,” “We Have Turned the Corner”, and “Jobs Fuel Market Rally”.

Today we learn that 190,000 jobs were lost in October. That’s about 40,000 worse than widely expected. The unemployment rate rose to a 26 year high, 10.2%.

Understanding the numbers

For those of you that subscribe to my twitter, you know that I was critical of the analysis of the Initial Claims release on November 5. The media noted two pieces of good news. First, the level of claims decreased by 20,000. It is true that is good news. Second, Continuing Claims decreased by 68,000. It is not clear that is good news.

The reason is simple. Many people drop off the regular program not because they get a job — but because the program expires for them. These job-seekers then have a chance to apply for extended benefits or emergency benefits. Hence, you need to look a little deeper.

While the reporting of Extended Benefits and the Emergency program (EUC) is delayed, the recent numbers show an increase of 25,000 in Extended Benefits and a surprising 90,000 in the EUC.

The bottom line is that people are not getting jobs.

Let me give you some perspective on how serious this is. We have lost 7.3 million jobs in this recession. The last really bad recession began in 1981. Many don’t remember this was a time of considerable turmoil with some short term interest rates going above 20%! On a population adjusted basis, the jobs lost in the recession that began in 1981 was 4.3 million. At the time, that was really bad.

In addition, it is not over.

Yes, it is true that the rate of job loss is slowing. That is good news. However, we really need to get at least +100,000 in non-farm payrolls to stop the rate of unemployment from rising. We need about +200,000 to start recovering jobs. That is hugely different from where we are today.

Now, you are used to me saying negative things. I did see three pieces of good news in the employment report. First, temporary employment rose by 33,000. That is often a leading indictor of employment bottoming out. Second, the amount of overtime slightly increased. Again, this is a leading indictor. Finally, the revisions of the previous two months were also good news.

My guess is that the temp employment and the overtime are completely overlooked by market observers. Read the rest of this entry »

Do you remember that iconic banner? Yes, we had 3.5% real GDP growth last quarter. However, it is premature to declare “Mission Accomplished”. We are facing the specter of double digit unemployment lingering throughout 2010.

Short-term versus Long-term

The growth that we have seen is largely a result of government moving economic activity from the future to the present. The most visible example of this was the cash for clunkers program. Consumers could get up to $4,500 for trading their car in before the deadline. This attracted a lot of people that probably would have bought new cars anyways in the future (and now they won’t).

Indeed, 1.7% of the 3.5% GDP growth was vehicle related. Would we see the headlines, “Economic Growth in Third Quarter Heralds End of Recession“, if the GDP print was 1.8% [actual 3.5% minus auto contribution 1.7%=1.8%]?

This is but one example of the short-term stimulus spending. Another example which has been in the press recently is the phase out of the homebuyer tax credit which has likely accounted for some of the action in the housing market. “Existing home sales have largest percentage jump since 1983“. Again, we are just shifting consumption from the future to the present. Oh, by the way, even though was saw one piece of good news, 8.3% increase in existing sales, let me remind you that new and existing sales are still way below their peak. More seriously if you track housing starts, permits and mortgage applications, they all spell even worse news.

I have mentioned this before. There appears to be a bias in the news to report good news and sweep the less favorable news under the carpet. Let’s look at “New Privately Owned Housing Units Authorized by Building Permits” seasonally adjusted. In September 2009, the number was 575,000. The peak was September 2005 with 2,263,000 units. So we have dropped a staggering 75%!

Some more perspective. The last time we were below one million units was the 1991 recession where we hit a low of 786,000 units in January 1991. The low in the double dip recession of the early 1980s was 731,000 units. In the oil recession of 1975, we dropped to 726,000 in January 1975. Remember, the population has grown. Note that the data begins in 1960. The numbers we are experiencing are historic lows.

If we population adjust these numbers, today’s permits look even worse. The graph below shows “population-scaled” building permits. This is an apples to apples comparison. Essentially, it allows us to look at the permit activity in 1960 and ask, what would permits be in January 1960 if we had the population of September 2009?

There are three points here.

1. The government programs may be able to shift some activity from the longer term to the shorter term. However, this will not necessary “jump start” the housing market. This market has a long way to go before recovering.

2. The housing market will provide a continued drag on economic growth both directly (less construction and associated activity) and indirectly (negative wealth effect, i.e. people will not spend as much if their wealth decreases).

3. The depth of the housing crisis will likely cause a second wave of financial crisis as more an more people default on their “prime” mortgages. I have mentioned this before. If there is a significant housing recovery, this could mitigate the second wave. However, I just don’t see the data to make the case for a strong recovery in the housing market.

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By Paul Zipkin

Here we are in early fall, 2009. It was a fairly calm summer. There were no major financial disasters. The stock market revived somewhat. The economy is still troubled, but compared to the unremittingly awful news during the previous year, it’s been a good time. I believe some credit for this happy turn of events is due to the bank stress tests conducted by the government during the spring.

The tests calculated what would happen over the next couple of years under two scenarios, a base-case scenario and a bad scenario reflecting worse economic conditions. They considered each bank’s entire position, not just standard deposits and loans but also fancy mortgage-backed securities and swaps. The question was, how much capital would each bank need to continue operating normally under the bad scenario?

The method itself is not at all novel. Many businesses, military forces and other organizations do this sort of scenario planning all the time. No one knows exactly what will happen in the future, so it makes sense to simulate several possible futures, to estimate whether the organization’s plans are robust.

But, amazingly, this was the first time the government conducted such a test of our financial system. We do have elaborate financial regulations, but those specify procedures and check whether they have been followed. In other words, they look backwards, not forwards. To look ahead at several plausible scenarios, the exact same ones for all banks, and to include all the banks’ exposures – that was unprecedented. Of course, the inspiration for the stress tests was the sequence of ugly surprises in 2008. Nobody knew how dire the situation was at Lehman and the others until it was too late.

Banks are supposed to do this sort of thing for themselves, of course, but it’s not clear how seriously they take these “risk management” exercises. Anyway, they are not required to use the same methods and certainly not to make the results public.

Before the results were revealed, many observers criticized the tests. The tests were not rigorous enough, the bad scenario was too tame, they said. (The Treasury invited some of this carping by calling the bad scenario the “worst-case” scenario. It was not that.) But the criticism largely fell silent once the tests were complete and the results announced on May 7.
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Is anybody listening out there? Those ‘in the know’ expected 180,000 job losses. Some thought 150,000. Optimists thought job gains. In the end, we bled 283,000 jobs.

It was no surprise to me. The message has been clear in the past two Duke-CFO quarterly surveys. Companies are still in cutting mode. Employment is not going to significantly improve when we have 551,000 new claims for unemployment insurance. So what if the four-week moving average of claims has decreased by 6,250 to 548,000. We need some three handles to stabilize employment and we are way far from that territory.

What to Watch For

The following are very important for those of us that carefully track employment:

• Forget continuing claims. They are misleading. Any headline like “Good News, Continuing Claims for Unemployment are Down” is likely written by someone who doesn’t really understand the data and the Federal programs. Continuing claims might be lower because people roll off the standard unemployment program and hit extended benefits and the emergency program (EUC). You need to count correctly. Notice that the extended benefits and EUC are reported with a two week lag. The most recent data showed that the number of people on emergency programs increased by 99,832 to 3,275,213.
• Extended benefits and EUC are important to watch because we have a problem with the duration of unemployment. It is taking longer to find jobs and this is another sign that the economy is not coming around.
• Watch the average number of hours worked in a week. The number of hours worked has been decreasing. People are sometimes voluntarily working fewer hours to save their jobs (or fellow workers’ jobs). Working fewer hours is a “shadow” unemployment that is not counted in the official numbers.
• I like the Bureau of Labor Statistics measure “U6″. This measure looks at total unemployment by considering unemployed, “marginally attached” workers as well as people working part-time that really want to work full time. This rate is a staggering 17%. It has never been this high.
• Initial claims as mentioned above need to be in the 300,000 range to stabilize employment. We are nowhere near that.
• The scale of the unemployment problem is important because we are approaching no-man’s land. What I mean is all the data to analyze the impact of unemployment comes after 1947. We are already in a recession situation worse than any other since WWII. Yes, this is not the Great Depression – but we don’t really have good data on the Great Depression. It is a challenge to quantitatively analyze some problems (I have an example below). To be clear here, we have lost 7.2 million jobs during this recession. We will lose more. How about this comparison? If we lose an additional 1.7 million jobs, i.e. go to 8.9 million losses from 7.2 million, the loss of jobs on a population adjusted basis will equal the losses in the past four recessions — and that includes the nasty double dip of the early 1980s.

What Worries Me the Most

Suppose you statistically examine the relationship between unemployment and mortgage defaults. There is a moderate positive association as you might expect (higher unemployment leads to higher defaults). Indeed, this moderate positive association forms the basis for the stress tests that banks have (finally) done.

What if this model is flawed? What if the financial institutions have underestimated the number of defaults? Here are the reasons why the models could be wrong:

• The estimates are largely based on mild recessions. This is not a mild recession. We have not seen anything like it in all of the available data. Essentially, we are extrapolating outside of historical experience. Usually when this occurs, we explicitly account for the extra uncertainty by being more conservative. I have my doubts that the financial institutions have factored in this extra uncertainty.
• While first point is important, the second one is more important. There is a critical omitted variable in the analysis. People statistically analyze default versus unemployment — but you must take housing values into account. If your house is worth less than what is owed on the mortgage, you are far more likely to default than if your house is worth more than the mortgage. In most of the data used in the standard analysis, houses are worth more than the loans. In other words, the fact that potentially 50% of houses with mortgages are under water, greatly increases the sensitivity of default to unemployment. This suggests that there is much more downside than financial institutions have prepared for. It suggests a second wave of credit crisis.
• Even the financial institutions know that defaults have not peaked yet. People are still holding on. Expect a surge in defaults, foreclosures and bankruptcies to happen next year.
• The social stigma attached to defaulting on your mortgage is gone. Keeping up the Jones’ means you get to default too. Anyways, those banks took all that government money making it easier for them to be the bad guys.

Other Tidbits

• As predicted, the Cash for Clunkers simply shifted car purchases. GM sales down 42%. In the end, the problems in the auto industry remain. Any bets on Chapter 22?
• There is a lot of push back on basic financial regulatory initiatives – like the requirement to offer vanilla mortgages. A lot of the push back is from small financial institutions who cannot compete in such a market against the likes of BAC and Citi. The real issue here is why do we need 7,000 banks in the U.S.? It would be far better for both customers and the economy to have a massive shakeout. In addition, it is completely dysfunctional to have different banking regulations depending upon the state that the bank resides in.
• The FDIC is bankrupt. For the last year, I have said that there are 1,000 banks that need to go down. Now we are in the odd situation where the FDIC cannot close down so many banks because they simply don’t have the funds.

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See below my monthly employment graph that standardizes the job losses (based on the size of the labor force) across different recessions.

There is a lot of finger pointing going on one year after Lehman declared bankruptcy. Most of those fingers are pointing to Lehman and the way the bankruptcy was handled. However, that is a very simplistic view of what happened a year ago. The crisis was transformed into a panic — not because of the Lehman filing, but largely because of the bungling policy known as TARP.

Setting the Record Straight on Lehman

Lehman deserved to fail.

Here is the real story.

Then Treasury Secretary Paulson was getting a lot of pressure to help Lehman. Paulson wisely asks for the following information. He wants to know how they are valuing a list of illiquid assets. He requests the same valuations from Goldman and J.P. Morgan. The data come back quickly. The values that Goldman and J.P. Morgan are carrying on their balance sheet are deeply discounted and quite close to each other. The values that Lehman has on their balance sheet aren’t even close. Angry, Paulson is determined that the firm will go down. Why bail them out? It would be a colossal waste of taxpayer money.

This was the correct thing to do. Any bailout would have probably taken many rounds of taxpayer help.

Of course, the execution of the bankruptcy was a problem. Surely, arrangements could have been made for a more orderly transition. This would have given counterparties more time to unwind Lehman linked positions.

It is ironic that the disorderly bankruptcy of Lehman poisoned the possibility of the government letting other large firms file. As a result, the government adopted the terrible policy of “too big to fail.”

Trashing TARP

Let’s summarize the events:

• Paulson comes to Congress with a three-page term sheet asking for close to $800 billion
• The American people (rightfully) assume that the Treasury Secretary and Fed Chairman have inside information on the gravity of the financial crisis.
• They stoke uncertainty by their vague reasons for needing the $800B the apparent lack of strategy.
• They cause outrage on Main Street when it is revealed that toxic assets will be purchased at premium prices — essentially bailing out bad trades with tax payer money.
• TARP fails on first vote.
• TARP eventually passes.
• TARP is never TARP. That is, the money was not used for Trouble Assets. Instead, money was used to inject equity into big banks.
• Essentially, no questions were asked before the banks got the TARP money — remember the famous “Stress Test” came after the money was given to the banks.
• Government guarantees the big 19 banks.
• Good TARP money went to many firms that were essentially in Lehman’s situation. The TARP money was used to reduce risk rather than create new loans to pull us out of recession.
• Banks realize that they can’t pay bonuses at the same rate with TARP. As a result, they begin to give money bank. This results in even less money for lending – completely defeating the purpose of the original equity injection.

Now let’s speculate about some future events in 2010:

• Toxic assets still remain on the balance sheets.
• TARPless banks return to paying big bonuses.
• Defaults peak some time in 2010.
• Banks and policy makers are not surprised by the large number of defaults in Commercial Real Estate.
• Banks and policy makers are surprised by the large number of prime mortgage defaults.
• 1,000 banks are in trouble in 2010.
• Banks go back to the trough, err, TARP.

Already the FDIC is out of money — and they will need a lot more. 92 banks have failed this year and there are hundreds more to go. I made the 1,000 forecast last year. I noticed today that John Mauldin (who I high recommend reading) quoted some unpublished analysis from Institutional Risk Analytics that grades 2,256 banks in the “F” range. If less than half go under, you are at the 1,000 number.

There is more pain to come. Again, the decrease in new claims for unemployment insurance was spun as “good” news. Claims dropped by 12,000 to 545,000. However, to get the unemployment rate to meaningfully decrease, we need to reduce claims by about 300,000 — not 12,000. We are not even close to that. As I have written, the continued high umemployment will be the prime driver of prime defaults.

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