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March 19, 2009

Economy: In the Eye of a Hurricane
by Richard Benson

The $20 trillion of wealth in America that has gone up in smoke from falling stock prices, real estate, and other asset values, is being engulfed by rapid job loss. These combined losses have dealt a catastrophic blow to the consumer whose willingness and ability to spend has, in turn, caused the American and world economy to come to a screeching halt.

Job destruction is a relentless force behind this economic downturn. Unfortunately, real unemployment is grossly underreported almost every month because of the government's Birth Death Model (see: www.bls.gov), which magically adds jobs for firms that are estimated to have been started. For example, in the February 2009 job release, the Birth Death Model added 134,000 imaginary jobs. (How silly is that?) Therefore, the actual job loss in February was 758,000 not the 651,000 reported.

The mainstream financial press also fails to report that only 60 percent of people who lose their jobs are eligible to file for unemployment. Many millions of workers are independent contractors or private business owners who don't qualify for unemployment benefits. Even if you're a real estate agent, mortgage banker, insurance salesman, etc., good luck trying to file for unemployment. So, when initial claims are reported as being 600,000 for a week, you can safely assume one million people actually lost their jobs that week.

When it comes to forecasting the unemployment rate, sophisticated modeling isn't necessary. All you need to do is a little arithmetic: First, take out half a million "imaginary" jobs created from the Birth Death Model, and add a million or so a week to the unemployed number reported. Then, assume that only two-thirds of the people searching for work will actually find a job that pays any money.

Before the summer is in full swing, the national unemployment rate (now at 8.1 percent) will top 10 percent by August, and may rise to 12 percent or higher by early 2010. That means that the number of people officially unemployed will rise from 12 and a half million in February, to 15 million in August.

The unemployment data in our country is designed to keep the reported number as low as possible (our government likes to show the rest of the world how much better off we are). In Europe, for instance, workers are counted as unemployed if they are discouraged, working a menial part-time job, or otherwise marginally attached to the labor force. The closest thing we have to a normal measure of unemployment is the Bureau of Labor Statistics U-6, which shows an unemployment rate of 14 percent in January, or 16 million non-workers on an actual and non-seasonally adjusted basis. This could top 20 million by the fall. There are also currently 32 million people on food stamps, and that number could increase to 37 million by the end of 2010.

Not only are workers being pounded by the loss of jobs and falling incomes, as the downward spiral continues the newly-unemployed will deplete their meager savings, stop shopping all together, and struggle to pay their credit cards, auto loans, and mortgages. Adding insult to injury, banks and other lending institutions are slashing credit card spending limits, closing accounts, slashing rewards, raising interest rates, and increasing fees. In other words, America is being forced to live on cash, not credit.

Why should we be concerned about these pesky numbers? Well, the popular press is finally reporting that lending on mortgages to sub-prime individuals has brought the financial system of America and the world to its knees. The press is also willing to remind us that home prices are down about 19 percent in the past year, and the value of stock portfolios have been cut in half in just 16 months. But we rarely read about the turmoil in the lives of the 20 million people with no real job prospects, assets or income, or the shame felt by the 32 million people collecting food stamps, or the 16 million (and climbing) homeowners on the brink of foreclosure living in houses worth less than the mortgage. In America, if you combine massive unemployment with household stock portfolios cut in half and home equity virtually eliminated, and add to that a desire to save and pay down debt, what do you get? To start, a major fall in retail sales, corporate profits, and declining cash flow to service debt. The affects of this recession on consumer businesses from restaurants, clothing stores, casinos, to taxis, are already profound. We are facing a gargantuan national tragedy that, sadly, could have been avoided if our country had honest corporate management and a responsible government.

A client of mine in Las Vegas who leases gaming equipment to the casinos there expects that every casino in Las Vegas will need to "restructure", which is a euphemism for bankruptcy. In York City recently a cabby mentioned his earnings were down by at least 30 percent compared to a few months ago and as we zigzagged along the avenue, traffic was much lighter than usual. The press has already reported that between November 2008 and March 2009, price expectations for commercial and high-end residential real estate in New York City have dropped 30 to 40 percent.

I do believe the reason that Citibank was only partially nationalized in its third but not last bailout, and 20 of the largest banks are going through "stress testing", is because the government is attempting to hide the magnitude of the bankruptcy problem. The U.S. Treasury wants to buy some time as they try and handle crisis after crisis sequentially, rather than all at once. So, by the time the Treasury finishes doing the stress tests, it will be clear that unemployment will exceed the worst case scenario used in the test. It will also be obvious that the rest of the major insurance companies - besides the criminally negligent AIG - will need government bailouts. In 2009, the bankruptcies of corporations and major property owners will be filling the news and, in the end, consumer and corporate bad debts will destroy more wealth than financial de-leveraging has.

So, what will mark the bottom of the chasm? The recovery plan will not be enough to sustain the economy and more stimulus will be needed. It will take at least six months for the world to realize how bad the world economy really is, even though many investors want to play the recent bounce in stock prices as a testament that the worst is over. But with so much uncertainly in the stock market, we don't want to touch the stock market or risk credit markets with a ten foot pole until the intensity of this storm is clearly understood. Living in Florida we have been in the inside of the eye of a hurricane and for a brief period everything seemed fine, until the storm came back and blew the roof off of our neighbor's house.

But not everyone is at risk. If you have lived modestly and saved money, have no debt and actually own your home, you can sit back and watch the show without being asked to get up on stage and play a role in the tragedy. However, it won't be easy avoiding getting stuck with the bill as a result of your neighbor's mortgage fraud, or from the Wall Street criminals who stole bonuses, or from the proposed tax increases and lower interest rates you'll be receiving on your savings accounts for months to come. Screwing the prudent saver and sticking it to the taxpayer is becoming the new national sport. I wouldn't be surprised if the government's actions led to a taxpayer and saver revolt down the road.

Richard Benson
Benson's Economic & Market Trends
Specialty Finance Group, LLC

Prior to founding the Specialty Finance Group in 1989, Mr. Benson acted as a trading desk economist for Chase Manhattan Bank in the early 1980's and started in the securitization business in 1983 at Bear Stearns, and helped build the early securitization businesses at Citibank and E.F. Hutton.

Mr. Benson graduated from the University of Wisconsin in 1970 in the Honors Program in Math, and did his doctoral work in Economics at Harvard University. Mr. Benson is a member of the Harvard Club of New York and Palm Beach.

The Specialty Finance Group, LLC is a Florida Limited Liability Company and is registered with the NASD/SIPC as a Broker/Dealer.

Copyright © 2004-2009 Richard Benson

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