Italian Bank Stress Test Results

On July 29th I spoke with David Asman on Fox Business concerning the results of the Italian Bank stress tests along with Adam Shapiro, Charles Payne and Steve Forbes. The recent vote in the UK to leave the European Union put a good deal of pressure on the banks in the remaining European Union, with the banks in Italy struggling the most.  Like any good Italian drama, this is likely to be a tight ride until the very end… at which point tutti bene, at least for the next few months!

Recovery or is the worst yet to come?

Recovery or is the worst yet to come?

I attended FreedomFest last week in Las Vegas where I had the pleasure of meeting incredible people like Steve Forbes, John Mackey, Mark Skousen, Burt Malkiel, Stephen Moore, and Nathaniel Brandon, and caught up with some folks from the Cato Institute that I’m honored to call friends, Dan Mitchell and Richard Rahn.  The big question these days is, “Are we in a recovery, or is the worst yet to come?”  This was much talked about, and in a shocking turn of events, I have an opinion, (note wry grin for those of you who know me well.)

To answer that question, we first need to identify how we got ourselves into this recent pickle.  There were a myriad of different factors contributing to the mess, but I would argue that one of the most significant, most fundamental was Greenspan’s addiction to low interest rates.

The artificially low interest rates induced more borrowing than would have otherwise occurred.  This resulted in projects being funded with debt that would not have been funded, had the cost of borrowing been higher.  Think of it this way, are you more likely to buy that new car with a 0% loan than a 10% loan?  Are you more likely to buy a house as an investment and flip it at a 2% rate mortgage than at 8%?  Interest rates are a bit like a sanity check.  They help clarify if something is a good idea, marginal idea or just plain bad idea.  With exceptionally low interest rates, more bad ideas get funded.  We got drunk off Greenspan’s cocktail and most everything seemed like a great idea, for clarification, see the movie The Hangover.

Now we have countless empty homes, office buildings, warehouses and factories standing as monuments to the devastation of this potent cocktail.  It isn’t easy to repurpose invested capital.  How do you repurpose a tractor or a building built in a poor location?  But the hangover doesn’t end there.  All these investments employed people.  The demand for more and more labor in these malinvestments pulled labor away from the truly good ideas and with that excess demand for labor, bid up the price of labor which at the time, seemed like one hell of a party as the paychecks rolled in.  Once the music stopped, as it inevitably must, the labor that had been misappropriated was left unemployed.

But it gets worse.  The now unemployed labor was seduced by the low rate party as well and bought homes they could not afford in a sane world, but with paychecks always going up and home values always going up, why not!?  And hell, Frannie and Freddie are eager to get you into that fantastic new 4 bedroom with a Jacuzzi tub, no questions asked, just sign here and we’ll give you the money.  Just put 5% or 0% down and equity in your home will quickly grow like crazy and voila, you have an ATM machine in the form of a home equity line.  So buy that beautiful new car, go on that luxurious vacation, you deserve it and as for savings, who would ever dream of that as the ever rising home values will be all the savings you’ll ever need!

But then the crash came…  Now people have the choice of either walking away from their home with only some damage to their credit thanks to non-recourse mortgages, or staying in a home that is deeply underwater with no jobs in site to give them hope of ever recovering from the Greenspan hangover.  Enter the Fed to use tax payer money to make the banks whole on all those ridiculous loans that have gone bad.  Your tax dollars hard at work ensuring that the ramifications of bad decisions are spread out among the 50% of us that actually pay taxes, while the lunatics who decided those loans were a good idea continue on as if they were the victims.

So where are we now?  Have we cleaned the bad loans out of the system, errrh, no.   Have we returned interest rates to anything near sanity, hmmm, no.  So where are we then?

  1. Unknown level of bad loans still outstanding with a kick the can mentality.  Mortgages still messy and we have yet to work through the commercial real estate fiasco.  Be wary.  Opportunity abounds, but these are shark infested waters.
  2. Significant excess production capacity built up during a seriously overheated market continues.  Not good for growth – don’t need to invest in new capital with over capacity and less labor is required.
  3. Continued high unemployment.  It is generally estimated that 125,000 new hires per month are necessary to provide jobs for the growing labor market.  If we want to get the eight million or so that lost their jobs in the past 18 months back to work within the next three years, that’s another 230,000 new jobs per month as well, meaning we need 355,000 jobs added per month to get back to full employment within 3 years.  Don’t hold your breath.  P.S. The Health Care Reform bill, which makes labor more expensive makes this even more unlikely.
  4. Deficit spending has given our nation a higher and higher debt load, with little growth in GDP to pay for it.  We keep increasing our nation’s mortgage at an alarming rate, while the paycheck is barely growing.  This is unsustainable at best and hamstrings the private sector from growing GDP.
  5. We are set to have the largest tax increase in our nation’s history on January 1st, 2011, which will put a big wet blanket on growth.  We’ve all heard the mantra, you cannot tax your way to prosperity.
  6. We have a now relatively impotent Fed, in that interest rates cannot realistically go any lower.  We’ve dropped rates and spent like drunken sailors with a barely perceptible effect!  I guess that just means we need to double down and spend more.  If you wake up with a hangover, it is because you stopped drinking too soon you fool!
  7. Increased regulation and sporadic and unpredictable application of the now frighteningly flexible law has left businesses wary of making any growth plans.  It is better to hunker down, grow your cash balance and keep a wary eye out.


So are we headed for another downturn?  Quite likely I’d say.  At the very least, don’t expect strong GDP growth in the near future.  Do expect continued volatility as politicians around the globe flail about trying to save their jobs, acting ever more irrational and unpredictable.