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The Little Engine That Can’t
John Schettler - Feb 09
Most economists will say
that the US Gross Domestic Product is largely driven by “consumer spending,” as much as 72% of GDP depending on our sorties to the shopping malls by some estimates. For decades we have been a nation of spenders, with scant savings, largely relying on credit cards and loans to buy what we needed. The interval between desire and fulfillment grew ever shorter due to easy financing, tapping of artificially inflated home equity, and painless lending terms. It was said that American consumers never cared all that much about the long term price of a thing they wanted to buy. If they did they would never slap down plastic at 19% to 29% interest to make a purchase. Instead, what really mattered was how much they had to put down and how low the monthly payments were. Sometimes this even became nothing down with no payments until some future date, a tactic furniture stores often used. No interest or payments for a year? The aim was to get the expensive sofa out of their showroom and into your living room by any means possible. It was buy now, pay later in the extreme.
For things like homes and autos, most beyond the ability of the average family to purchase outright with cash, such loans are really an absolute necessity. Without them, buying comes to a complete stop, which is what we have seen in both the housing and auto industries as credit vanished in the last 6 months. Foreclosures now lead new housing sales, and most sales traffic is now bottom feeders picking up on distressed properties. They will be surprised to find the “bottom” is still nowhere in sight on housing. Here’s a look at the damage so far in the nations #1 state for real estate shenanigans, California.
 Ah California, the home of Countrywide and other quick trick home
loans where the Option ARM and interest only loan schemes were born and bred in neighborhood after neighborhood. The enormous erosion of prices in the data above is largely due to the wild
speculation in the California RE market that made the state, along with places like Florida and Arizona, the “Flip that House” capitol of the nation. But no
more. Expect another 20% to 30% erosion of house prices in California before we can even begin to talk about a bottom. Don’t expect any rapid rebound either. We are not
returning to the real estate game for at least the next ten years. That’s how bad the present situation is, and how severe and long lasting this depression could be if not
handled correctly by ‘the powers that be.’ The chart above also makes it easy to see why people can no longer play the refinance game to extract “equity” dollars from their
homes. The equity is gone. Many now owe more than the current value of the home, and the bottom is nowhere in sight.
 In the auto industry one manufacturer after another is being forced to shutter factories and lay off workers. January followed a bleak
December with these latest sales figures:
The auto industry has come up against an unmovable roadblock to any future growth or profitability—if you can’t get your customers financed, you can’t sell them a car.
End of story. The Auto dealerships that find some pool of financing available for their customers, even those with ‘less than perfect credit,’ will survive. Those who sit
around waiting for a 720 FICO score to step into the showroom will continue to see their sales plummet, dragging them to inevitable bankruptcy. Then they will join the
ranks of the ‘sub-prime’ as well. How ironic. If you had told someone in 2004 that all three major US auto companies would be at the edge of bankruptcy in just a few
years time they would have laughed at you. Who’s laughing now?
 For retail sales, January figures were as grim as December. Target fell another 3.3%, JC Penny was down 16.4%, Kohls fell 13.4%,
Macy’s was off 4.5%, and scores of clothing retailers like The Gap, Old Navy, Saks, American Eagle Outfitters, and others reported steep sales declines. Saks was off 23.7% at the high end of the retail scale.
Only Wal-Mart, at the low end, was able to post a modest 2.1% gain, as shoppers look for cheaper discounted goods. Now add in the fact that credit card
delinquencies reached a record high in January as the Christmas bills came due, and you begin to see the picture quite clearly. Late payments surged 18% and charge offs
due to defaults were up 40%. The debt revolt I predicted at the level of revolving credit is well underway.
Credit cards have been the engine driving consumer spending for years. There was
even a concerted effort by the credit card companies to create a mindset that the only way to spend was by using the plastic. It was associated with status, ease, and
convenience, and littered with little bonus plan incentives and other gimmicks. TV commercials showed a line of consumers at checkout chafing and rolling their eyes in
disapproval as the person in front fumbled through the process of writing a check, or took an extra three or four seconds to pull cash out of their wallets instead of the
typical swipe and run that characterized “good” consumer behavior. The banks pushed out plastic to anyone with a pulse, sometimes extending lines of credit,
accumulating in five to ten credit cards, that exceeded a person’s annual income! (And they knew exactly what they were doing. They could see all the debt and income
each person presently had in their credit reports, but they still overextended credit because it was so profitable to do so. How were they different from any typical loan
shark when they now charge people 30% interest on these card balances?)
 Is it any wonder that people used this credit, responding
reflexively to the millions of advertisements they get bombarded with daily, all urging them to spend, spend, spend? The two most broadcast words in history are “call now!” (Just read “Advertising Lullaby” by George Carlin in the sidebar. Operators are standing by to take your order!) People did use
the credit, and they are now in debt up to and well beyond their eyebrows. They were spending 125% of their annual income, using credit for the overage, and saving virtually nothing.
Consider also that a typical home equity loan of $50 to $100 thousand dollars would pump more money into the economy that a normal person would spend in five years
time, and it would often do this in a matter of months. I personally know people who borrowed, and spent, $50,000 in three months time…$90,000 over five months. Some
used the money to consolidate other bills or pay off credit cards, then went to work buying clothes, TVs, granite counter tops, new ovens, beds, furniture, computers and
electronic gizmos, or just eating out in restaurants. In just a few months time they jolted the economy with a spending spree that would have taken them five years
otherwise. This is what was driving our GDP in recent years, and keeping the retail cash registers ringing, particularly during the run-up years of the housing boom, 2002
-2006. Now all that credit has vanished.
The credit card game is ending as well, as beleaguered banks, fearing rising default
rates, are now lowering credit lines, raising interest rates, and doing a lot of praying that things don’t get worse. Late payments and defaults are rising fast, and things will
get worse. Statistics showed that as the housing crunch leveled equity loans, people surged in their use of credit cards. Old habits die hard. A population conditioned to
always swipe the plastic, never use cash, never annoy anyone by writing a check, found itself like a heroin addict without a fix. Their reflex was to continue old spending
habits, and use of credit to augment income so that they could maintain the excessive standard of living that credit allowed. Geoff Colvin of Fortune is correct when
he writes: “It may be that the standard-of-living bubble finally has to deflate. Sustainable increases in living standards have to be earned, not borrowed, and that
means performing ever higher value work that can't be outsourced. We haven't been meeting that challenge very well; doing so will probably require much more and better
education for millions of Americans, which takes time and money.”
James Howard Kunstler comments on the enormous change sweeping the retail sector now, and the futility of trying to restart our old spending habits.: “The attempt to
restart "consumerism" will be equally disappointing. ... That seventy percent of the economy is over, especially the part that allowed people to buy stuff with no money.
From now on people will have to buy stuff with money they earn and save, and they will be buying a lot less stuff. For a while, a lot of stuff will circulate through the yard
sales and Craigslist, and some resourceful people will get busy fixing broken stuff that still has value. But the other infrastructure of shopping is toast, especially the malls,
the strip malls, the real estate investment trusts that own it all, many of the banks that lent money to the REITs, the chain-stores and chain eateries, of course, and,
alas, the non-chain mom-and-pop boutiques in these highway-oriented venues.” The “stuff” stores are a dying breed.
 The Little Engine that once could buy virtually anything, the American
Consumer, is done for. The engine was running on this credit, which is nothing but debt disguised as free money. The credit gas tank is now empty, and the wheels of the economy have come to a grinding halt. Ten
percent of the nation is already on government food assistance programs, and no wonder—more than 10% are unemployed if the numbers are tabulated correctly. Real unemployment is actually 13
.6% now (U-6), and will probably reach 17% to 20% (U-6) by year’s end. But costs pushed up by the commodities speculation have remained stubbornly high in key
areas like Food, college tuition, health care, and people are locked into high mortgage prices from the boom years.
Food for a single month, even for one person eating modestly, can run between $400 to $500 these days. As unemployment sweeps the nation, homelessness is following
in its wake. Some take refuge with friends and family, and multi-family living situations are becoming more common. Others end up in their last refuge, a car they can barely
afford to keep running. Cities have begun taking an informal census of the homeless on their streets—all this in the good old U.S.A. It’s been with us for decades, really,
but we only tend to notice it now that the trips to Home Depot have ended and it is happening to more and more formerly middle class people. The little engine that
always could has finally faltered and failed, and as the American ‘consumer’ goes, so goes the economy. The outlook remains bleak.
Business Week reported on Feb 4: “With incomes pinched, access to credit tightened, and nest eggs dramatically shrunken, Americans are poised to save more
and spend less. Consumers ran squarely into the perfect storm last year, and the wreckage will be washing ashore for some time. The three supports that prop up
spending have been devastated: income growth, credit availability, and wealth. Spending, adjusted for inflation, dropped for the second quarter in a row at the end of
last year, and another decline this winter is likely. Consumer buying has not fallen for three consecutive quarters since record-keeping began in 1947.” Clearly the Little
Engine of the economy has piled up in a train wreck of debt, job loss, falling home equity, and evaporating credit. It will take a miracle to get the spending train ‘back on
track’ in this economic climate. These two charts from the Federal Reserve show the basic problem—over consumption leading to staggering debt, while savings rates plummeted.
Notice how the savings rate bottomed between 2005-2007, at the height of the
housing boom spending spree, then began to tick upwards in 2008 as the economy began to collapse. People will continue to save, because they must. Buy now, pay
later, is history, and this is a good thing in spite of the hardship it may create in the retail sector.
What to do about all of this? The Fed has been focusing its energy at the top of the
financial pyramid—on the banks. Between Fed programs, loans, balance sheet expansion, easing, rate lowering, and with the billions in bailout money, we have already thrown a cumulative $9.5 trillion dollars at the banking system, and still it
remains insolvent, because derivatives positions held be even one of the larger banks dwarf the entire GDP of the nation as a whole! The banks and the Alpha Plus Wizards on Wall Street created the problem with irresponsible lending and leveraging, they
perpetuate the problem by hiding bonds and securities off balance sheet, and now they are choking the debt ridden consumers they created to death by restricting the
flow of money in the real economy. With money velocity slowing to a crawl, companies lay off workers, unemployment skyrockets, loan defaults worsen, and the
bankers sit there scratching their heads wondering when the next truckload of free taxpayer money will arrive. The crisis was entirely self made by the financial community. Why should we pay for their misdeeds?
Increasingly, it seems the only solution is what I call the HAL-9000 maneuver. When the super-intelligent computer from 2001 A Space Odyssey detected a fault reading
on the antenna, and no one could confirm it or figure out what to do, the solution was to simply put the unit back online and see what happens. If it was faulty, then let it fail
. That’s what we need to do with our banks now—simply let them fail. The notion that a bank is too big to fail is false. Nations have failed, empires have failed, entire
species have failed. And when these insolvent banks go down they take with them all the bloated CEO salaries, preferred and common stock equities, and hocus pocus
‘assets’ hidden in level three accounting tables, wiping the slate completely clean. The government protects only the FDIC insured deposits, which will be a Herculean
task in and of itself. The Big Boyz who made all these bad bets just take their losses. Period. Then we start over, using any funds we can then manage to scrape together
to ensure proper capitalization of the banks, all under new management, and with stringent new rules and regulations to prevent this from ever happening again. It
means the end of an era of greed and corruption on Wall Street and in the board rooms of the banking system that boggles the mind every time I think on it, and good riddance.
Nobel Prize winning economist Joseph Stiglitz agrees. Speaking about the dire situation for UK banks, the UK Daily Telegraph reported: “The Government should
allow every distressed bank to go bankrupt and set up a fresh banking system under temporary state control rather than cripple the country by propping up a corrupt edifice
, according to Joseph Stiglitz, the Nobel Prize-winning economist.” His argument follows the same logic as my own: “Should the British taxpayers have to lower their
standard of living for 20 years to pay off mistakes that benefited a small elite?”
Instead of the dramatic and final solution proposed above, we are getting half
-measures all aimed at somehow preserving the existing system and “arrangements” already made by the Big Boyz. They don’t want the trillions in derivatives bets they
made to be discounted to real market levels, preferring to believe they have the same bloated values as they did at the height of the housing boom. So I would not be
surprised to see ‘mark-to-market’ accounting rules suspended so that they can continue the fantasy indefinitely. Next we have proposals to insure this bad debt, or to
somehow siphon it off to a new ‘bad bank’ where the toxin can no longer spread--a bad bank paid for by the public. Some of the ‘troubled’ mortgage backed securities
will be purchased by the Fed, who announced it was putting JP Morgan Chase in charge of administering this program. That bank has derivatives positions that exceed its real asset base by 400 times, the greatest bad risk exposure of any financial
institution in the world. Talk about the fox guarding the hen house! The bank will now be the ‘custodian’ of the government's program to buy mortgage-backed securities.
Need we ask which portfolios will get preferential treatment first?
Under such a plan certain securities would be held to maturity and propped up by a
government guarantee. Intrepid financial blogger Mike Shedlock (MISH) characterizes it this way: “Here's the deal. The government will buy the worst assets, dramatically
overpay for them, stick taxpayers will the losses, and only reduce bonus pools of the banks by 40%. It's a horrid deal for everyone else.”
Mike Larson of Money & Markets realizes that pouring on more bailout funds at the top of the system is fruitless. The real dilemma is how to regenerate the stalled little
engine—consumer spending. “The big debate is: How in the heck can we get the money into the hands of people who will spend it and put it back into the economy?
That’s the real challenge. If they give it to companies, it’s socked away to improve their balance sheets. If they give it to rich people, it just goes into their bank accounts
. If they give it to the middle class, it goes into their rainy day funds. If they give it to lower income people, they spend it at Wal-Mart and most of it goes to China.”
My solution is elegantly simple. If consumer spending is 72% of the economy then pour on the bailout funds at the bottom, on Main Street, not on Wall Street. Why use
taxpayer money to pay off bad securities bets made by the banks? Instead, use it to help taxpayers. The worries Larson has about the money going into rainy day funds, or to China, can be easily circumvented.
 $825 billion is a lot of bailout money. It could put $5500 into
the budget sheet of every family in the US, (about 150 million families)—but in the form of a voucher, not cash, a voucher good for 6 months from the date of issue. The government
voucher would be redeemable in only three ways: 1) to buy a home, where it could be applied directly to the down payment; 2) buy a new or used car, again a substantial down payment
that lowers the monthly payment on a new car, buys a used car outright, or pays off the balance due on an existing car loan; 3) used to retire any
existing consumer loan or credit card balance with a US financial institution. That’s it. Period. The ‘stimulus’ to home and auto sales would stabilize or reverse the declines,
stopping defaults and foreclosures. It could stop the domino effect now underway as falling car sales kill off suppliers, parts manufacturers, dealerships, and push up
unemployment. People who aren’t in the market for a home or car would have to use the money to pay down their existing debt, and all this money would then flow directly
into beleaguered banks, but from the bottom, after first benefiting the taxpayer who provided the money in the first place, by easing their debt burden.
A sum of $5500 would cut the average household credit card debt in half. It would probably retire, or vastly reduce, balances owed on most existing car loans,
thus removing that payment from the household monthly budget and stopping the cascade of loan defaults. It would ease the debt load and lower monthly payments, freeing up more cash (not credit) for other consumer spending. Those retired credit
card balances would eliminate a big stack of a monthly bills most people are carrying. This would help the banks restore realistic credit limits for people, and while we’re at it
the government should mandate that banks can charge no more than 10% interest on such accounts. This targeted spending would restart the economy, relieve consumer
debt and rescue the banks all in one. It would not be any more hyperinflationary than the present scheme of just shoveling all the money at the banks to buy off their worthless assets.
Stimulate the economy from the bottom up, not the other way around. Not through “tax breaks” to buy a car or house. If the government promises a person a nice tax
break if they buy a car, they have to wait until April of 2010 to realize any benefit when they file their 2009 tax return. Ditto for the $15,000 tax break planned for home buyers
. That will simply be too late. The ‘consumer’ needs the stimulus now, in a more negotiable and direct way. The Little Engine needs fuel. A future tax break will not
convince people to spend money they just don’t have now. If you can’t come up with a 20% down payment to buy a house, and have to wait until April of 2010 for your tax
credit, how does that help you buy a house this year? Don’t these politicians think at all before they enact policy? People without cash, or credit, cannot buy. Period. Now
add rising unemployment that will continue to suppress incomes all across the nation, and it’s easy to see why there will be no quick recovery for the train wreck of the US consumer.
But a plan like the one I suggest has no chance. If people paid off their credit card debt with a government voucher the banks would lose all that lovely interest. So
instead, the solution we will finally see will probably involve a combination of additional bailout bank guarantees, government purchase of bad bank assets, and tax breaks for
Average Joe redeemable at some future date if Joe can somehow find the money to spend now. Well, he can’t and he won’t. The Little Engine is out of steam and dead
on the tracks. I predict the new stimulus plan will fail as miserably as the TARP program failed, because it serves the interest of the banking elite, and not the interests of the people.
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And the chart above doesn’t yet cover the massive losses of Q4-2008. The Fed’s
solution to the train wreck of consumer spending is another program called “TALF,” or term asset-backed securities lending facility. Marketwatch.com reported: “The asset
-backed securities market for consumer loans has come ‘to a near standstill,’ the Fed said. In particular, the Fed will set up a special-purpose vehicle to purchase and
manage the assets and the Treasury will invest in the program to protect the Fed from losses. Under the plan, the Fed will lend up to $200 billion to owners of certain AAA
-rated asset-backed-securities backed by auto loans, credit-card loans, student loans and small business loans.” Again, the idea is to is to shovel easy money at banks
holding securities resting on these auto and consumer loans, so they will suddenly gain “confidence” and start lending in those areas again. Don’t hold your breath.
Trouble Ahead
Hang on to your hats, folks, the winds of this storm are just getting started. Here’s where Martin Weiss of Money & Markets think we are now, and it’s a very cogent
summation: “When you add everything up, it all boils down to falling (corporate) income — millions of paychecks gone with the wind; interest income slashed to
virtually nil; dividend income delayed, reduced or canceled; capital losses from stocks; home equity, gone. For many Americans, the scene is ugly: Bills piling up;
homes, cars — everything they’ve worked a lifetime for — repossessed; a giant wave of personal bankruptcies; the shame of becoming a charity case, dependent on their
families or government handouts.”
Again, James Kunstler is one of many who see trouble ahead as Americans realize
their old way of life is not returning: “Many observers have noted lately how passive the American public is in the face of their dreadful accelerating losses. It's a tragic
mistake to tell them that they can have it all back again. We'll see a striking illustration of ‘phase change’ as the public mood goes from cow-like incomprehension
to grizzly bear-like rage. Not only will they discover the impossibility of getting back to where they were, but they will see the panicked actions of Washington drive what
remains of our capital resources down a rat hole.”
One day, the masses of people will wake up and demand that their money be used to
offset their personal financial problems, not to shore up bank balance sheets and cover for their bad securities deals. As MISH said above, the banks will benefit, and
everyone else is getting bilked. The public sits idly by, willing to underwrite these titanic sums of money for bailouts and financial shock therapy to try and restart a
dead system. Why? An Article on CreditWritedowns.com phrased the question this way: “Here you have the financial services sector being bailed out left and right. Large
automakers are lining up for handouts. The steel industry has successfully inserted itself into the stimulus package by appealing to economic nationalism and “Buy
America.” Meanwhile, ordinary Americans lose their jobs, their homes, and their retirement investment. There is a deep sense of apathy in the United States regarding
this massive economic implosion that remains stunning.”
Are Americans so pacified by the endless infotainment broadcast at them every day
that they have lost their ability to organize and catalyze meaningful social action in response to the unfolding crisis? One might say that the sweeping election victory of
Barak Obama, flipping 10 formerly “red” states blue in the process, was ample evidence of the fact that Americans want things to radically change. Yet while
Europeans and Asians take to the streets, American’s have thus far remained passive.
In his article “It’s Not Going To Be OK,” Chris Hedges interviewed Political
Philosopher Sheldon. S. Wolin, and others to probe this issue. Wolin’s remarks were quite telling: “The American left, (Said Wolin), has crumbled. It sold out to a bankrupt
Democratic Party, abandoned the working class and has no ability to organize. Unions are a spent force. The universities are mills for corporate employees. The
press churns out info-entertainment or fatuous pundits. The left, he said, no longer has the capacity to be a counterweight to the corporate state. He said that if an
extreme right gains momentum there will probably be very little organized resistance.”
While Wolin may have some valid points, I don’t really think Americans ever have
been organized socially or politically much beyond the Church Social level. Wolin is correct in pointing out the apathy on today’s university campuses. In my day, when
national guardsmen fired on protesters and killed four students at Kent State, there were immediate and massive demonstrations on campuses all over the US. The
political protests at the Democratic National convention of 1968 made those mounted during recent conventions look like tea parties by comparison. When my generation,
(The Baby Boomers), first took to the streets in opposition to the quagmire of Vietnam, it did so with a boom indeed, by the millions. Now the boomers are all in their late
forties and early fifties, worried about their bloated mortgages, staggering household debt, and diminishing 401k portfolios. Someone else will have to lead the charge for
this generation. The Boomers are tired, worried, and worn out, just like the Little Engine.
And I think that gets us closer to an understanding of why we have not seem more
public anger at what has happened to the economy. The pain is getting closer to the bone for most people, but they are still in a coping mode. It’s not a question of
whether they approve of these multi-trillion dollar bailout packages or not, certainly they do not approve. Instead they just seem preoccupied with simply getting through
each week, servicing the revolving round of monthly bills, getting to the market for food, and trying to squeak by with the threat of a job layoff ever in the back of their mind.
When people go into this psychologically guarded state, a kind of hunkering down, it is no wonder that discretionary spending has died on Main Street and taken all the
steam out of the Little Engine That Once Could. People aren’t about to take to the streets just yet, like their counterparts in Europe and Asia. For one thing, stories
about the rioting and sweeping protests in Russia, China, Greece, France Lithuania, Bulgaria, Iceland and the UK will not get much air play here. The corporate media
doesn’t want to give anyone over here the wrong idea, do they? Instead we see the stress of the crisis starting to translate into more property crime, higher suicide rates,
and a slowly rising level of violence in general crime stats. People will prey on each other before they get the gumption to organize against the “system” itself in any meaningful way.
The blogosphere has been echoing this issue as well, where one wrote on Kenny’s Sideshow: “We have the numbers but no organization. On the street the talk is cheap
and continuous. Everyone knows they are being lied to and stolen from but the talk doesn't do a thing. There are many who would rather steal from their neighbor than to
try and take back our country from the criminals on high. We worked hard living in the illusion of eternal prosperity and now that we are about to see the illusion for what it is
, we are to lazy or scared to do anything about it. There's no rage. At least not enough to take any action. It's exactly as the controlling elites planned. We limp off to
death with our heads down and our children wondering why we left them with such disarray.”
I predict things will eventually reach a boiling point, however. After the coping
strategies of this hour prove to be inadequate, people will be forced to try something else. Unemployment will translate into despair, and desperate people do desperate
things. The powers that be know this, and they are worried. A contract for another six detention centers was reported in January, all facilities to be built on abandoned US
military bases. They will be added to the 22 FEMA detention facilities already in place. This is just silly, but someone is hedging yet another bet about the long term
prospects for civil order here in the US of A, and wondering just what Joe might do after he finishes his last sixpack. Because this isn’t going to get better anytime soon.
We’re still near the top of the sliding board. Real estate isn’t coming back to the good old boom times, gas and energy prices aren’t going to stay this low for very much
longer, and the half a million lost jobs each month aren’t coming back soon either, stimulus or no stimulus.
As I read daily on the net, I am seeing an ever rising awareness of this inevitable
outcome creeping into the narratives in one site after another. Like this little opening swing by Eugene Robinson of TruthDig: “Earth to Wall Street: It’s over, people. You
had a terrific run, better than you deserved, but now you’d be wise to pay attention to those citizens outside, the ones with the pitchforks and the torches.” I said long ago
that for every Rich Dad in his security gated estate there would be ten thousand hungry, angry Poor Dads out there in the cold. It doesn’t take a genius to figure out
who will win that battle if it ever starts. And if it does start, the entire US army and all of FEMA’s detention centers will not be able to stop it. We’ve seen that in Iraq, where
the army could not subdue or pacify a small population of 23 million in over seven years. There are 300 million over here, and the army is still over there.
The sad thing is that we’ll all be the losers if this issue ever does go to the streets, and none of this had to happen if good men had held the line against the graft, greed,
and corruption that swept this nation to the edge of the abyss in the last eight to ten years. Good men, I believe, are finally back in control of our government. The question
remains… What will they do now? What can they do? And what will the American public do if all their efforts cannot stop or reverse this ongoing economic collapse?
I’m not sure I want to find out.
Article By: John Schettler
Feb 2009
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