Be kind, rewind...

The term new normal is being has been used by PIMCO's manager Bill Gross to describe the new economic environment, it is misleading. What was normal before was in fact grossly abnormal and in fact utterly excessive.

125% LTV for Northern Rock's Together Mortgage? Was that normal? Was that sound lending?

The issue today is that politicians are trying to stimulate demand back to its past level, when excesses where legion. This is not sound and it is not the path to recovery.

Carmen Reinhart is a professor at the University of Maryland and Vincent Reinhart is resident scholar at the American Enterprise Institute. This is based on a paper presented at the Jackson Hole Symposium.

http://www.ft.com/cms/s/0/7b9bbc72-b460-11df-8208-00144feabdc0.html

"Part of these changed prospects after a crisis simply reflects the correction of expectations. During episodes of financial euphoria – from the diving bell, through the steam engine and thereafter – the old rules seem not to apply. Lenders provide easy credit, investors bid up asset prices, and businesses invest unwisely. Spending advances rapidly, and debt builds up. Yet recent discussions about the “new normal” leave the misleading impression that the pre-crisis environment was “normal”.

A prudent post-crisis policy, therefore, must be alert to threats both to supply and demand, not demand alone. But the bigger worry remains the assumption that dust has begun to settle; that the shock from the crisis is temporary, when it is likely to be deep and persistent. Today, as in the past, over-optimistic fiscal authorities are over-estimating tax revenues. Financial supervisors want to believe that troubled banks are temporarily illiquid, not permanently insolvent. And central bankers like Mr Bernanke may soon attempt to restore employment to unattainably high levels. If they do so, the road to recovery will be long, and the lessons of history will have been ignored once more."

Zombieland 2...The sequel...

Welcome to Zombieland 2, the Sequel !!!

The latest trailer featuring:

Zombie banks, zombie hotels, zombie rates, zombie returns and brainless politicians...



What is a zombie bank:

http://en.wikipedia.org/wiki/Zombie_bank

A zombie bank is a financial institution that has an economic net worth less than zero but continues to operate because its ability to repay its debts is shored up by implicit or explicit government credit support. The term was first used by Edward Kane in 1987 to explain the dangers of tolerating a large number of insolvent savings and loan associations and applied to the emerging Japanese crisis in 1993. Zombie institutions face runs by uninsured depositors and margin calls from counterparties in derivatives transactions

We had zombie banks now we have zombie hotels, like in Ireland for example:

http://noir.bloomberg.com/apps/news?pid=20601109&sid=aOKhxHd4Zk5c&pos=15

"At least 200 hotels opened during Ireland’s decade-long economic boom, leaving a glut of rooms and mountain of debt as the number of visitors dwindles. While some establishments cut their losses and shut, others are lowering prices to stay in business and avoid repaying tax breaks if they were to close.

Irish hotel occupancy slumped to about 54 percent in 2009, the lowest level since the early 1980s, as the economy fell into its worst recession on record, the hotels federation said. In 2007, the height of Ireland’s boom, the figure was 64 percent.

The numbers of trips to Ireland fell 20 percent in the two years through June 2010, the Central Statistics Office said on Aug. 27. Hotels have almost 7 billion euros ($9 billion) in bank borrowings, equivalent to about 111,000 euros per bedroom, according to figures from the industry group.

Sixty percent of hotel loans at Allied Irish Banks Plc, the country’s second-largest lender, are classed as “criticized,” either closely watched or in trouble, Managing Director Colm Doherty said Aug. 4. Britain’s Lloyds Banking Group Plc, among the biggest lenders to Irish hotels, said this month it’s pulling out of Ireland."

Ireland’s National Asset Management Agency, created by the government to purge banks of risky real-estate loans, has taken control of 48 loans secured on hotels. In the latest batch of loans, hotels accounted for 23 percent of the assets bought by the agency.

“The big problem that the industry faces at the moment is that banks are keeping hotels open that would not normally survive,” said Charlie Sheil, manager at Dublin’s four-star Gibson Hotel. “They are being propped up by the banks, which is causing major damage to a lot of the good hotels.”

And this is what happens in a zombie economy suffering from acute deflation.

The Irish banking system is indeed a very big black hole:

http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=axTNh79dJBPk

“Anglo Irish has proved to be an even larger black hole than anyone imagined,” said Bill Blain, joint head of fixed income at Matrix Group in London. “There are worries that the cost of banking recapitalization is now beyond the reach of the government.”

http://www.businessweek.com/news/2010-08-30/irish-bank-recapitalization-may-cost-eu39-9-billion-glas-says.html

"Aug. 30 (Bloomberg) -- Ireland’s bank recapitalization may cost a total of 39.9 billion euros, acccording to fixed-income specialist Glas Securities.

A total cost of 39.9 billion euros is a “reasonable forecast,” Dublin-based Glas said in a research note today. The final net cost to the government will probably be 32.9 billion euros after 7 billion euros invested in Bank of Ireland Plc and Allied Irish Banks Plc is recouped."

Allied Irish Bank this month reported a record loss for the first half, losing 2.03 billions Euros over 6 months largely as a result of continued losses on its lending on Irish real estate...and Anglo Irish a whooping 8.2 billions Euros.

Total support for Anglo Irish amounts to 22.9 billions Euros so far and will cost 25 billions to the Irish taxpayers according to its CEO Mr Aynsley but S&P put the figure at 35 billions Euros.

http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/7973829/Anglo-Irish-set-to-cost-taxpayer-25bn.html

"Yesterday's results also revealed that:

More state cash may be needed, depending on the discount placed on future loans going to NAMA.
About €600m of loans that went into NAMA are worthless as they were secured on nothing more than personal guarantees.
Deposits of €5.5bn have flowed out of the bank in just six months, with the turnover cut in half.
The bank gave €1.1bn of fresh working capital to developers to finish off schemes and developments.
It expects to be forced to take over more struggling businesses, like Arnotts, in Ireland, but also in the US."

Zombie banks often have a large amount of nonperforming assets on their balance sheets which make future earnings very unpredictable...ouch...



This year, Ireland budget deficit will amount to around 29% of GDP...



To conclude, please find below's an extracted comment from Brendan Brown, chief economist at Mitsubishi UFJ Securities International Plc, from a Bloomberg article:

http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=aWVk5qjMUYn4

"The biggest danger for European monetary stability is that the ECB pins interest rates near zero for too long. As the world economy rebounds, say, into 2011-12, the ECB will have its eyes on those mega-billions it lent to zombie banks and sovereigns. A significant increase in key money-market rates may be the trigger for an even more threatening round of credit quakes."

Fantasyland and the imaginary world of spending multipliers.

"The president still seems to believe in the imaginary world of spending multipliers — whereby each dollar of additional spending results in something in the order of $1.40 in additional output."

http://www.cato.org/pub_display.php?pub_id=11944

"Bury Keynesian Voodoo Before It Can Bury Us All"
by Kevin Hassett

http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=av8oanNvkBwY

"Aug. 23 (Bloomberg) -- Initial claims for unemployment benefits surged to 500,000 in mid-August, a level more typical of a recession than a recovery. The bad news confirmed what conservative economists have been saying for some time: The biggest Keynesian stimulus in U.S. history was a bust."

"A 2002 study by economists Richard Hemming, Selma Mahfouz and Axel Schimmelpfennig of recessions in 27 developed economies from 1971 to 1998 found that increased spending by government had, in almost all cases, a barely noticeable impact, and sometimes a negative one. Heavily indebted countries that spent more in recessions grew about 0.5 percent less, relative to trend, than countries that didn’t, the study found."

It is impossible to calculate the effect of deficit-financed government spending on demand without specifying how people expect the deficit to be paid off in the future, this is the very reason why the Keynesian inspired stimulus did not work. The theory of rational expectations can be used to support this:

http://en.wikipedia.org/wiki/Rational_expectations

"If the Federal Reserve attempts to lower unemployment through expansionary monetary policy economic agents will anticipate the effects of the change of policy and raise their expectations of future inflation accordingly. This in turn will counteract the expansionary effect of the increased money supply. All that the government can do is raise the inflation rate, not employment. This is a distinctly New Classical outcome."

The Policy Ineffectiveness Proposition (PIP) is a new classical theory proposed in 1976 by Thomas J. Sargent and Neil Wallace based upon the theory of rational expectations:

http://en.wikipedia.org/wiki/Policy_Ineffectiveness_Proposition

"If the government employed monetary expansion in order to increase output, agents would foresee the effects, and wage and price expectations would be revised upwards accordingly. Real wages and prices remain constant and therefore so does output, no money illusion occurs."

Marc Faber the author of the famous Gloom Boom & Doom Report also thinks QE will be interpreted as inflationay. Marc Faber sits in the Austrian camp and his latest comment is based on the theory of rational expectation. A self-fullfilling prophecy?

http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=a1TLO_pYLNHw

We have witnessed the impacts of a herd mentality and the effects on numerous occasions, such as bank runs. Also, people believing another recession is coming, and will be hoarding cash, which will trigger a deeper slump in consumption and another downturn.

The Macro picture is still very bleak and inflating air in a pierced balloon just doesn't work.

David Goldman on his excellent blog, accurately describe the terrible state of the US economy:

http://blog.atimes.net/?p=1550

"Pension funds will have umpty-zillion-dollar deficits once they recalculate their liabilities at a 3% rate of return rather than the fictional 8.5% return assumed by most of the defined-benefit plans during the 2000s. The equity risk premium will remain depressed for a generation. The banks can’t make money after the short-lived boom in distressed assets because demand for yield has flattened the curve to the point that their old trades are less economical. Hedge funds can’t make money because they are behind the banks in the queue for assets."

It is going extremely difficult going forward for pension funds to cover their liabilities. In conjunction with very severe headwinds with high unemployment and damaged balance sheets, you also have demographic issues in the coming years which will be painful to address.

Although Wall Street has been bailed out, Main Street is still ongoing the pain of unemployment and deleveraging. It is still very tough out there and balance sheets haven't been repaired.