Tuesday, February 22, 2011


Though overwhelmed by negative geopolitical issues, today's economic data was positive.

February consumer confidence at 70.4 came in well ahead of consensus (65.5) and also far better than January's 64.8 reading. The print was the best in two years and compares against a year-ago reading of 46.4. Importantly, most of the improvement was in forward-looking components (with a month-to-month rise of 8 points). Indeed, the current reading of future conditions rose to the best level since year-end 2006.

The Richmond Fed manufacturing index for February came in at 25, 7 points better than expectations and in the prior month. Shipments, backlogs and new orders all improved.

Of late, foreclosures have begun to reaccelerate, and the shadow inventory will continue to weigh on housing activity throughout the year.

Housing, from my perch, is scrapping along the bottom even though production has been well under household formation for some time.

If one is looking for a sector that will be the beneficiary of pent-up demand, look at cars not homes.

The problems associated with the muni debacle are several-fold:

* the underfunded and misstated pension liabilities;

* the imbalance between state and local tax receipts and expenses;

* the high amount of debt to service at all levels of our government; and

* attacks on collective-bargaining rights could worsen the schism between the Democrats and Republicans, serving to reduce the chance of movement on the federal deficit.

Consider, for the sake of comparison, how private corporations, in measuring the value of the assets in their pension systems, are required to use real portfolio market prices. Government accounting standards, in contrast, allow public pension systems to measure their assets based on average values looking back over a period of years. In most instances those average values add up to a figure that is much higher than the amount of money the pension plan actually has.

Public pension funds are also allowed to make assumptions about future investment returns that many of us would regard as overly optimistic. And since those assumed returns are incorporated into measurements of the fund's status, as if they had already been realized, states that come up with the most rosy market forecasts look, on paper, to be better financed....

To make matters worse for state budgets, hidden underfunding of public employees' health retirement costs is even greater than that of their pensions....

Accounting is inevitably an artificial language that can distort some economic truths. But at the least, government accounting should aim for greater transparency and consistency, allowing outsiders to compare one jurisdiction against another. At the same time, the social contracts that exist today in many places among taxpayers, beneficiaries of public services and public employees need to be renegotiated before a crisis arrives.

-- Orin Kramer, "How to Cheat a Retirement Fund," The New York Times (Sept. 10, 2010, op-ed)

An article in Friday morning's Financial Times reports that Fitch Ratings is considering downgrading ratings on city and state municipalities because the firm is planning to change the way in which it account for budget deficits.

Wisconsin has become ground zero for the union debate as public workers in Wisconsin and around the country protest lower benefits, which are the outgrowth of an imbalance between revenue and expenses. The risk is increasing that the "Wisconsin Power Play" becomes a focus of renewed political partisanship and a resurgence in the sort of populism that led to the 2008 Democratic Tsunami. Polarization could even end up being disruptive to a budget compromise (and "shared sacrifice"), as the debate in that states widens the fundamental schism between the two parties in the months ahead (as I have suggested would occur leading up to the 2012 election).

Today, Ohio apparently has protest plans to do the same as Wisconsin. Other states, including Florida, Indiana, Iowa, Michigan, New Hampshire and New Jersey, are planning the same legislation.

Many states, such as Illinois, will be cutting spending. Illinois can't avoid big spending cuts.

Higher taxes are inevitable.

As an example, over the past 10 days, the Governor of Minnesota has proposed to raise the state's top individual tax rate temporarily to 13.95%. In addition, he is proposing a higher property tax on homes valued greater than $1 million. Minnesota Governor Mark Dayton, heir to the Dayton Hudson fortune, might have the luxury to be able to afford much higher taxes, but the screwflation of the middle class is more than just a distraction. Multiply this by every state in the U.S., and we get a huge contraction force from this nontraditional headwind to growth.

In this context, the screwflated consumer (already pressured by stagnating wages and the rising costs of necessities of life) now faces the trials and tribulations of our city, state and federal government, forming a serious challenge to the foundation of smooth and self-sustaining growth. With the consumer already on an anemic slope, any further exogenous or systemic shock -- such as the turmoil of the Middle East, which has raised the price of oil over the last 24 hours by $7 a barrel -- could serve as an economic tipping point.

No comments: