Dear Trader,
Financials crushed the market today with FRE and FNM leading the pack, down 25% and 22% respectively. Coming in a distant third was Lehman Brothers (LEH) losing 7% on the day. Causing the freefall was an article in Barron's that suggested your tax dollars will be bailing out FNM & FRE, and the Wall Street Journal posited the notion that LEH will lose another $1.8-billion this quarter.
In my last update I said, I have often written how the BLS is full of BS, but I found an article that follows how politicians on both sides of the isle have distorted government figures for their own political gain. Since it is a long article I will present it in two parts. Here is part two - enjoy.
Numbers Racket: Why The Economy Is Worse Than We know.
By Kevin P. Phillips, on Harper's Magazine online.
It was left to the Clinton Administration to implement these convoluted CPI measurements, which were reiterated in 1996 through a commission headed by Boskin and promoted by Federal Reserve Chairman Alan Greenspan. The Clintonites also extended the Pollyanna Creep of the nation's employment figures. Although expunged from the ranks of the unemployed, discouraged workers had nevertheless been counted in the larger workforce. But in 1994, the Bureau of Labor Statistics redefined the workforce to include only that small percentage of the discouraged who had been seeking work for less than a year. The longer-term discouraged-some 4 million U.S. adults-fell out of the main monthly tally. Some now call them the "hidden unemployed." For its last four years, the Clinton Administration also thinned the monthly household economic sampling by one sixth, from 60,000 to 50,000, and a disproportionate number of the dropped households were in the inner cities; the reduced sample (and a new adjustment formula) is believed to have reduced black unemployment estimates and eased worsening poverty figures.
The present Bush Administration has yet to match its predecessor in economic revisions. In 2002, the administration did, however, for two months fail to publish the Mass Layoff Statistics report, because of its embarrassing nature after the 2001 recession had supposedly ended; it introduced, that same year, an "experimental" new CPI calculation (the C-CPI-U), which shaved another 0.3 percent off the official CPI; and since 2006 it has stopped publishing the M-3 money supply numbers, which captured rising inflationary impetus from bank credit activity. In 2005, Bush proposed, but Congress shunned, a new, narrower historical wage basis for calculating future retiree Social Security benefits.
By late last year, the Gallup Poll reported that public faith in the federal government had sunk below even post-Watergate levels. Whether statistical deceit played any direct role is unclear, but it does seem that citizens have got the right general idea. After forty years of manipulation, more than a few measurements of the U.S. economy have been distorted beyond recognition.
America 's "opacity" crisis
Last year, the word "opacity," hitherto reserved for Scrabble games, became a mainstay of the financial press. A credit market panic had been triggered by something called collateralized debt obligations (CDOs), which in some cases were too complicated to be fathomed even by experts. The packagers and marketers of CDOs were forced to acknowledge that their hyper-technical securities were fraught with "opacity"-a convenient, ethically and legally judgment-free word for lack of honest labeling. And far from being rare, opacity is commonplace in contemporary finance. Intricacy has become a conduit for deception.
Exotic derivative instruments with alphabet-soup initials command notional values in the hundreds of trillions of dollars, but nobody knows what they are really worth. Some days, half of the trades on major stock exchanges come from so-called black boxes programmed with everything from binomial trees to algorithms; most federal securities regulators couldn't explain them, much less monitor them.
Transparency is the hallmark of democracy, but we now find ourselves with economic statistics every bit as opaque-and as vulnerable to double- dealing-as a subprime CDO. Of the "big three" statistics, let us start with unemployment. Most of the people tired of looking for work, as mentioned above, are no longer counted in the workforce, though they do still show up in one of the auxiliary unemployment numbers. The BLS has six different regular jobless measurements-U-1, U-2, U-3 (the one routinely cited), U-4, U-5, and U-6. In January 2008, the U-4 to U-6 series produced unemployment numbers ranging from 5.2 percent to 9.0 percent, all above the "official" number. The series nearest to real-world conditions is, not surprisingly, the highest: U-6, which includes part-timers looking for full-time employment as well as other members of the "marginally attached," a new catchall meaning those not looking for a job but who say they want one. Yet this does not even include the Americans who (as Austan Goolsbee puts it) have been "bought off the unemployment rolls" by government programs such as Social Security disability, whose recipients are classified as outside the labor force.
Second is the Gross Domestic Product, which in itself represents something of a fudge: federal economists used the Gross National Product until 1991, when rising U.S. international debt costs made the narrower GDP assessment more palatable. The GDP has been subject to many further fiddles, the most manipulatable of which are the adjustments made for the presumed starting up and ending of businesses (the "birth/death of businesses" equation) and the amounts that the Bureau of Economic Analysis "imputes" to nationwide personal income data (known as phantom income boosters, or imputations; for example, the imputed income from living in one's own home, or the benefit one receives from a free checking account, or the value of employer-paid health- and life-insurance premiums). During 2007, believe it or not, imputed income accounted for some 15 percent of GDP. John Williams, the economic statistician, is briskly contemptuous of GDP numbers over the past quarter century. "Upward growth biases built into GDP modeling since the early 1980s have rendered this important series nearly worthless," he wrote in 2004. "[T]he recessions of 1990/1991 and 2001 were much longer and deeper than currently reported [and] lesser downturns in 1986 and 1995 were missed completely."
Nothing, however, can match the tortured evolution of the third key number, the somewhat misnamed Consumer Price Index. Government economists themselves admit that the revisions during the Clinton years worked to reduce the current inflation figures by more than a percentage point, but the overall distortion has been considerably more severe. Just the 1983 manipulation, which substituted "owner equivalent rent" for home-ownership costs, served to understate or reduce inflation during the recent housing boom by 3 to 4 percentage points. Moreover, since the 1990s, the CPI has been subjected to three other adjustments, all downward and all dubious: product substitution (if flank steak gets too expensive, people are assumed to shift to hamburger, but nobody is assumed to move up to filet mignon), geometric weighting (goods and services in which costs are rising most rapidly get a lower weighting for a presumed reduction in consumption), and, most bizarrely, hedonic adjustment, an unusual computation by which additional quality is attributed to a product or service.
The hedonic adjustment, in particular, is as hard to estimate as it is to take seriously. No small part of the condemnation must lie in the timing. If quality improvements are to be counted, that count should have begun in the 1950s and 1960s, when such products and services as air-conditioning, air travel, and automatic transmissions-and these are just the A's!-improved consumer satisfaction to a comparable or greater degree than have more recent innovations. That the change was made only in the late Nineties shrieks of politics and opportunism, not integrity of measurement. Most of the time, hedonic adjustment is used to reduce the effective cost of goods, which in turn reduces the stated rate of inflation. Reversing the theory, however, the declining quality of goods or services should adjust effective prices and thereby add to inflation, but that side of the equation generally goes missing. "All in all," Williams points out, "if you were to peel back changes that were made in the CPI going back to the Carter years, you'd see that the CPI would now be 3.5 percent to 4 percent higher"-meaning that, because of lost CPI increases, Social Security checks would be 70 percent greater than they currently are.
Furthermore, when discussing price pressure, government officials invariably bring up "core" inflation, which excludes precisely the two categories-food and energy-now verging on another 1970s-style price surge. This year we have already seen major U.S. food and grocery companies, among them Kellogg and Kraft, report sharp declines in earnings caused by rising grain and dairy prices. Central banks from Europe to Japan worry that the biggest inflation jumps in ten to fifteen years could get in the way of reducing interest rates to cope with weakening economies. Even the U.S. Labor Department acknowledged that in January, the price of imported goods had increased 13.7 percent compared with a year earlier, the biggest surge since record-keeping began in 1982. From Maine to Australia, from Alaska to the Middle East, a hydra-headed inflation is on the loose, unleashed by the many years of rapid growth in the supply of money from the world's central banks (not least the U.S. Federal Reserve), as well as by massive public and private debt creation.
The U.S. economy ex-distortion
The real numbers, to most economically minded Americans, would be a face full of cold water. Based on the criteria in place a quarter century ago, today's U.S. unemployment rate is somewhere between 9 percent and 12 percent; the inflation rate is as high as 7 or even 10 percent; economic growth since the recession of 2001 has been mediocre, despite a huge surge in the wealth and incomes of the superrich, and we are falling back into recession. If what we have been sold in recent years has been delusional "Pollyanna Creep," what we really need today is a picture of our economy ex-distortion. For what it would reveal is a nation in deep difficulty not just domestically but globally.
Undermeasurement of inflation, in particular, hangs over our heads like a guillotine. To acknowledge it would send interest rates climbing, and thereby would endanger the viability of the massive buildup of public and private debt (from less than $11 trillion in 1987 to $49 trillion last year) that props up the American economy. Moreover, the rising cost of pensions, benefits, borrowing, and interest payments-all indexed or related to inflation-could join with the cost of financial bailouts to overwhelm the federal budget. As inflation and interest rates have been kept artificially suppressed, the United States has been indentured to its volatile financial sector, with its predilection for leverage and risky buccaneering.
Arguably, the unraveling has already begun. As Robert Hardaway, a professor at the University of Denver , pointed out last September, the subprime lending crisis "can be directly traced back to the [1983] BLS decision to exclude the price of housing from the CPI. . . With the illusion of low inflation inducing lenders to offer 6 percent loans, not only has speculation run rampant on the expectations of ever-rising home prices, but home buyers by the millions have been tricked into buying homes even though they only qualified for the teaser rates." Were mainstream interest rates to jump into the 7 to 9 percent range-which could happen if inflation were to spur new concern-both Washington and Wall Street would be walking in quicksand. The make-believe economy of the past two decades, with its asset bubbles, massive borrowing, and rampant data distortion, would be in serious jeopardy. The U.S. dollar, off more than 40 percent against the euro since 2002, could slip down an even rockier slope.
The credit markets are fearful, and the financial markets are nervous. If gloom continues, our humbugged nation may truly regret losing sight of history, risk, and common sense.
Today's Trading Tip:
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