What if the temporary jobs weren’t there in the first place? In that case, seasonal adjustment wouldn’t apply; the normal December-to-January tick would be swamped by the structural change. It’s sort of like seasonally adjusting rainfall patterns during Noah’s flood.

I don’t think that government statisticians are faking the data; they simply are running the old statistical routines out of the canned econometrics program to generate seasonal adjustment factors which are–to put it mildly–a lot less meaningful in the present environment than in a nomral economy.

Own Treasuries vs. gilts.

Own Bunds vs. PIGS (Portugal, Italy, Greece, Spain).

Sell protection on Texas and buy protection on New York.

The world is discovering through a myriad of ways that the attempts by the US and other governments to pump up the economy through spending simply won’t work. I have been an employment bear all along and view the last two weeks’ higher-than-expected claims data as vindication of what was a pretty lonely position in early December.

1) Fannie and Freddie are likely to put back $10 billion of residential loans to banks that packaged them;

2) Harrisburg, Pennsylvania may declare bankrupty;

3) The Bank of England is ending its bond buying program because the British budget is out of control;

4) Obama is proposing to soak the rich (just what you want to do to encourage investment at the depth of a recession) in order to make it look like he is controlling the US budget;

5) The Social Security system is running in the red on a cash flow basis for the first time since 1982;

6) State and local governments, whom Obama bailed out with most of the stimulus money during 2009, cannot expect the same kind of help as they digest a $200 billion budget deficit during 2010;

7) Securitized asset spreads have blown out as the TALF program reaches expiration and the Fed’s trillion-dollar backing for the credit markets comes to an end;

and so on, and so on. This parrot is dead, as I wrote a month ago.

Everything looks bad, so buy the less bad (and short the worst against it).

470,000 new unemployment claims, for that matter, doesn’t quite make it as an employment recovery.

Excerpt:

 

Obama hasn’t been retooled, of course, but he decked himself out in new trim: a spending freeze (that affects only 17 percent of the budget, $50 billion worth of accelerated depreciation for capital investment (extending his own 2009 extension of part of the Bush stimulus), a bit of middle class tax cuts, and the obligatory pork in the form of teaching and transportation subsidies. Didn’t Bill Clinton veer to the right and confound his critics?

Clinton slyly positioned himself to claim credit for the Great Expansion launched in 1983 by the Reagan tax reforms. Employment roared after 1995—the economy added five million jobs in the next two years. Clinton’s theft of welfare reform from the Republicans was a gimme. It was easy to push people off welfare into a booming labor market. Cutting the capital gains tax in 1997 helped the tech boom at the decade’s end.

In his attempt to emulate Clinton’s success, President Obama resembles nothing so much a the New Guinea aboriginals who built model airfields complete with straw control towers and airplanes after the Second World War and the departure of the American army. The Americans had summoned cargo from the sky through such magical devices, so thought the aboriginals, and by building what looked like airfields, so might they. But Obama can no more conjure up an economic recovery by doing things that look like what Clinton did, than the natives of New Guinea could draw cargo from the sky with straw totems. Marx’s crack about history repeating itself—the first time as tragedy and the second as farce—comes to mind.

France’s regulator was “open to further negotiations” to discuss the possibility of concessions by AIG counterparties Societe Generale SA and Credit Agricole SA’s Calyon unit, in November 2008, Neil Barofsky, the special inspector general for the Treasury Department’s Troubled Asset Relief Program, said in prepared remarks for a House oversight committee hearing today.

New York Fed General Counsel Thomas Baxter wrote to Barofsky last year that the regulator declined to demand concessions from U.S. banks partly because “it would not have been appropriate” when rivals in other nations were unwilling or “legally barred” from giving discounts. Baxter, Barofsky and Treasury SecretaryTimothy F. Geithner, who was New York Fed president during the rescue, are scheduled to testify today before the House panel reviewing the $182.3 billion bailout.

The appropriate authorities should pursue the matter ruthlessly. What laws might have been broken is a matter for the relevant investigators and, ultimately, juries to decide. But the credibility of the Federal Reserve has been damaged to the point that drastic measures are required.

Add to this the New York Times story this morning that two members of the Federal Reserve Board of Governors, Donald Kohn and Kevin M. Warsh, warned that the 100-cents-on-the-dollar payment to Goldman Sachs and other banks “might be a gift” to AIG’s trading partners. Fed Chairman Bernanke, who rubber-stamped the New York Fed decision, as well as Treasury Secretary Tim Geithner, who was president of the New York Fed when the payments are made, are compromised.

First of all the Fed needs spotless hands. Whether or not actual wrongdoing occurred, the Fed is guilty of miscommunication so egregious that it smells of coverup.

Drastic steps are required to restore credibility and confidence.

1) Ben Bernanke should withdraw from consideration for a second term as Fed Chairman. President Obama should appoint former Fed Chairman Paul Volcker in his place. If Volcker, who is 82 years old, feels unable to accept the nomination for a full term, he should serve as Interim Chairman and head a search committee including bipartisan Congressional representation to find a permanent successor. If Bernanke insists on pursuing a second term, the Senate should vote him out.

2) Treasury Secretary Geithner should resign. Whether or not he engaged in wrongdoing, his capacity to execute his office is damaged beyond repair.

I took issue with Paul Volcker’s proposal to ban bank proprietary trading, but that is a minor issue. Volcker’s distinguished career and unimpeachable integrity make him the man of the hour. I’ll take Volcker’s worst moments over Bernanke’s best.

This is not a partisan issue. The alleged malfeasance occurred under the previous administration, and Volcker became Fed Chairman under the Carter Administration. America can’t afford to heap onto the present economic crisis yet another crisis - of integrity.

The world (as the late Fr. Richard John Neuhaus was fond of saying) is more in need of reminder than instruction, and here’s a little reminder:

Oct. 22, 2008 (Bloomberg) — Employees at Moody’s Investors Service told executives that issuing dubious creditworthy ratings to mortgage-backed securities made it appear they were incompetent or “sold our soul to the devil for revenue,” according to e-mails obtained by U.S. House investigators.

The e-mail was one of several documents made public today at a hearing of the House Oversight and Government Reform Committee in Washington, which is reviewing the role played by Moody’s, Standard & Poor’s and Fitch Ratings in the global credit freeze.

“The story of the credit rating agencies is a story of colossal failure,” Committee Chairman Henry Waxman, a California Democrat, said at the hearing. “The result is that our entire financial system is now at risk.”

Moody’s and S&P in recent months had to downgrade thousands of mortgage-backed securities, many of which were originally given top AAA ratings, asdelinquencies on the underlying loans soared well beyond the companies’ estimates and home values fell faster than they expected. The downgrades contributed to the collapse of Bear Stearns Cos. and Lehman Brothers Holdings Inc., and compelled the U.S. government to set up a system to buy $700 billionof distressed assets from financial companies.

The Securities and Exchange Commission in a July report found the credit-rating companies improperly managed conflicts of interest and violated internal procedures in granting top rankings to mortgage bonds.

An e-mail that a S&P employee wrote to a co-worker in 2006, obtained by committee investigators, said, “Let’s hope we are all wealthy and retired by the time this house of cards falters.”

The fact that no-one has gone to jail for market rigging tells us how toothless and gutless the regulators are.

The ratings agencies take the position that their ratings are “opinions” with the same legal status as a newspaper editorial. Newspaper editorialists, though, aren’t paid pro rata by big advertisers for endorsing their products! The Fed let the ratings agencies take responsibility for measuring risk, and the ratings agencies declared that they are not responsible in the slightest.

The fact is that there are plenty of good risk models out there. The Moody’s analysts cited in the stor above knew perfectly well what they were doing. The way to fix the problem is to rate risky securities with full transparency.

Here’s how to do it:

1) Require large financial institutions to provide their internal data for default and delinquency. The big banks have long histories of default with a great deal of detailed characteristics of defaulting companies.

2) Create a publicly available, downloadable data set with the merged data (suitable sanitized to remove company names, but including detailed borrower data such as balance sheet, sales, capital structure, and so forth.

3) Charge the Federal Reserve staff with constructing empirical default models to predict defaults based on company histories as well as market observations (my old favorite its the implied volatility of options on the stock of publicly traded companies).

4) Publish the Fed’s model along with the data set.

5) Convene an annual conference to allow academics and private analysts to critique the Fed’s model, so that the Fed staff has to answer to extensive criticism.

6) Use the Fed model to establish reserve and other risk criteria for securities.

7) Allow the private sector to take the same data and sell alternative risk models to investors who think that private analysts might do a better job than the Fed staff.

On the strength of transparent and universally accessible data, criteria can be established for capital adequacy of large banks.

By making the process open to any academic or commercial contender, the corruption inherent in the ratings process is eliminated.

This, of course, would pretty well kill the business of the ratings agencies. They should feel fortunate to get off so easily.

We don’t want to stop the banks from investing for their own account. In market panics, we want big institutions with broad shoulders to step in and buy securities that other investors are forced to sell. But we want this to happen in full light of day, in a way that the regulators and investors can understand.

Proprietary trading is what SAVED the banking system earlier this year. I laid this out in advance exactly a year ago — on Jan. 23, 2008 — in an essay for Asia Times entitled, “Fixing the bank crisis is the easy part.” I wrote:

Today’s problem is far worse than the previous two system insolvencies, to be sure. It is so large that nationalization the banking system very well might crush the credit of the United States. But with close to zero-percent funding from the Federal Reserve, American banks can acquire cheap assets that pay yields of 15%-20%. The cash flow available on non-agency mortgage bonds, credit card bonds, structured bonds backed by corporate loans, and other high-yielding assets is big enough to provide banks with positive cash flow despite mounting losses on real estate, mortgages and consumer loans.

At that point credit markets had broken down, as I observed:

What has happened, rather, is that the market’s willingness to buy credit-sensitive American bonds has collapsed. Between the first quarter of 2007 and the third quarter of 2008, mortgage-backed securities issuance dropped by roughly half, corporate bond issuance by three-quarters, and asset-backed issuance by more than nine-tenths.

$US bn	Municipal	Treasury	Mortgage Related	Corporate	Agency	Asset Backed
Q107	107.6	188.5	540.4	305.6	265.4	323.2
Q2	123.6	184.4	628.2	345.8	234.1	329.1
Q3	93.4	171.1	485.4	239.4	185.8	139.3
Q4	104.7	208.3	396.3	236.7	256.5	110.0
Q108	85.0	203.8	391.5	213.1	432.4	59.7
Q2	144.5	219.8	437.8	333.3	387.9	69.7
Q3	89.6	244.8	286.6	82.6	198.8	23.5

The banks earned outsized cash flows by stripping the dead on the battlefield through an enormous proprietary bet. If they hadn’t done so, the economy would be in far worse shape than it is now.

The banks have government support and deep pockets, and can afford to step in when everyone else is in full-tilt panic.

If you want to limit proprietary risk, there are several obvious things to do:

1) Limit the amount of risk banks can take on their books (through Value at Risk and similar models)

2) Take into account the embedded leverage in derivatives as well as actual balance-sheet leverages. This requires modeling, but there are thousands of unemployed hedge fund risk managers who know how to do this, and the models are fairly generic

3) Fix the ratings system. This is an area in which the enormous Fed staff of academics might do a better job than Moody’s, S&P and Fitch, who have lost a great deal of credibility.

The Federal Reserve allowed the banks to put on massive off-balance-sheet leverage during the lead-up to the banking crisis, through Special Investment Vehicles and such like. The regulators simply can take a more conservative approach to leverage.

All this is sensible. But the idea that one can separate proprietary from customer trading is silly to begin with, and undesirable in the extreme. When there’s panic, you want the banks to take proprietary risk as the buyer of last resort.

Today’s dismal jobs claim number, including news that 600,000 Americans joined the supplemental employment insurance rolls, confirms the bleak employment forecast I issued in December. The argument for employment recovery boiled down to the observation that changes in employment appeared to be correlated with changes in inventories. With the inevitable rebound of inventories from extremely low levels, employment supposedly would recover. As I showed in the linked report, there does appear to be a relationship between changes in employment and changes in inventories:

Closer examination of the data, however, shows that the correlation is one-sided. When inventories are falling, changes in employment are highly correlated with changes in inventories, because in recessions, companies reduce inventories and fire workers. But the correlation breaks down completely in recoveries.

That’s because the old jobs at big companies never come back; new jobs are created by smaller startups. And just what sort of startups are supposed to provide jobs today? Not tech, which outsources everything; not construction; not finance; not retail; and surely not state and local governments, which must close a $200 billion budget deficit in 2010.

With 22% unemployment (including long-term “discouraged” workers), where do American households stand? Dean Baker at the Democratic-leaning Center for Economic and Policy Research assembled a few interesting factoids:

● Baby boom cohort is in its peak saving years (ages 46-64)

● Defined benefit pensions are disappearing

● Most have little savings

Median 45-54 -@$50,000

Median 55-64 -@ $60,000

● Housing equity vanished with crash (Many underwater)

Median 45-54 -@$30,000

Median 55-64 -@$70,000

At least one Democratic think-tank is warning that the world of American households is going pear-shaped. Baker’s conclusions:

1. Saving rate is rising back to normal levels

2. Housing wealth is likely to decline further

3. Demographics are hugely tilted towards savings

4. High unemployment will deter consumption

5. Excess capacity will restrain investment

6. Over-valued currencies create uncertainty

Obama gets part but not all of the joke. Here are extracts from his interview yesterday with George Stephanopoulos on ABC News:

The same thing that swept Scott Brown into office swept me into office.

People are angry, and they’re frustrated. Not just because of what’s happened in the last year or two years, but what’s happened over the last eight years.

You’ve got really hard-working folks all across the country, who have seen their wages flat line and their incomes flat line.

They feel more secure than ever. Then suddenly you’ve got this bank crisis in which their 401Ks are evaporating, their home values — their single-biggest investment — is collapsing.

And here in Washington — from their perspective — the only thing that happens is that we bail out the banks.

STEPHANOPOULOS: But you’re in charge, now.

OBAMA: No — well — absolutely. No, keep in mind the point that I’m making here.

It was the right thing to do for us to salvage the financial system, and I make no apologies for that, at all. But we knew at the time how politically toxic that was.

What it gave people a sense of is, “We’re spending all this money, but I’m not getting any help.”

And, “Gosh — I wanted Obama to come in there to start making sure that I was getting help; not the big special-interest and the institutions.”

Now if I tell them, “Well, it turns out that we will actually have gotten TARP paid back and that we’re going to make sure that a fee’s imposed on the big banks, so that this thing will cost taxpayers not a dime,” that’s helpful. But it doesn’t eliminate the sense that their voices aren’t heard, and that institutions are betraying them.

And I think that’s been expressing itself all year. And they’ve gotten increasingly frustrated over the course of the year.

So I take complete responsibility for the fact that — A — we had to salvage a financial system that could have made things much worse. We had to take the steps that we did at the beginning of the year, in order to stabilize the economy.

And I am actually glad to see that the economy’s now growing again, and we have the prospect of a much better economy in 2010. But that doesn’t negate the anger and the frustration that people are feeling.

With the gift of an obstructionist Senate—an obstructionist Senate minority, of all wonderful political gifts—he has ten months in which he can pass large parts of his agenda while bemoaning the naysayers who thwart him. Thank Scott Brown for this possibility: We might even be spared some of the anti-bank, anti-Wall Street, anti-business demagoguery that has been looming in Obama’s recent rhetoric. The president now has something else to run against.

When Reagan took office in 1981, the baby boomers were in their 20s and 30s, America had a 10% savings rate, the current account was in surplus, and America was the world’s largest net creditor nation. Reagan was able to cut taxes and finance an enormous budget deficit because the world’s demand for US Treasury securities was correspondingly large. In 2010, the baby boomers are in their 50s and 60s, America has saved nothing for a decade, the current account remains in severe deficit and the world is choking on the existing supply of Treasury securities. Cutting taxes to stimulate the economy is not as simple this time round.

Professor Reuven Brenner and I argued in the December 2009 issue of First Things that fundamental changes in American economic policy are required to emerge from the Great Recession. We proposed that the United States fix the dollar to the Chinese yuan and other currencies in order to re-orient trade flows to the developing world. We added, “We have been borrowing in order to consume; we need now to save in order to invest. We need to shift the tax burden, moving it away from savings and investment and toward consumption. We should replace individual and corporate income taxes with consumption-based taxes.”

Americans need to be told that they will need to invest before they can consume, and that the cure will take years rather than months to take effect. It’s not a happy message, and no one in politics is willing to deliver it - if indeed anyone in politics understands it.

“For the first time, the market has started to price in a bigger probability of default among industrialised countries than among investment grade companies.

More specifically, it now costs more to insure the combined risk of default of Europe’s developed nations, including Germany, France and the UK, than it does the combined risk of Europe’s top 125 investment grade companies, according to the Markit indices.”

“Markit’s iTraxx Europe index of 125 companies was yesterday trading at 63 basis points, or $63,000 to insure $10m of debt over five years. This compares with 71.5bp, or $71,500, for Markit’s SovX index of 15 European industrialised nations. This development reflects the market’s current obsession with sovereign risk.”

“The UK, a Group of Seven nation, has seen the cost to insure its debt rise to double that of some of its leading companies. The UK CDS has jumped by 40bp to 83bp since September, which compares with Unilever at 29bp and BP which is 38bp.”

This is peculiar. If states get to the verge of bankruptcy, they will tax corporations aggressively (Obama’s proposed $90 billion tax on big banks is a short across the bow of sorts). Large multinational corporations can insulate themselves against a Greek bankruptcy or even a UK bankruptcy, but not against the bankruptcy of a large number of sovereigns.

The very high cost of credit default protection against sovereigns may reflect the risk management requirements of banks who are increasing lending to weaker sovereigns and buy credit protection as a matter of course against some part of their book. Nonetheless, the explosion of risk premia on some sovereigns, e.g., Greece, if extended to the UK and other major players, could bring down the whole financial system.

If hypothetically the US sovereign began to show risk premia like those of Greece–a most unlikely event–the enormous and rapidly-growing bank portfolios of government securities would be devaluated and bank capital would collapse. This is, once again, a most unlikely eventuality. But it is at least conceivable that the world might go not with a whimper, but a bang.

On Jan. 14, I posted an analysis entitled “Why Financials Will Continue to Underperform,” arguing that increased reserves for loan losses would eat into bank earnings. That’s the picture from JP Morgan this morning.

On Jan. 5, I wrote, “The US Economy is Pining for the Fjords.”

The recovery camp gives too much emphasis to the improvement in industrial production. Inventories fell so far during the third quarter of 2009 that some increase in output is required merely to keep the pipeline going.

Far more indicative of the state of the economy are today’s 16% drop in pending home sales and the jump in foreclosures on prime mortgages. You can’t run an economy with a 22% effective unemployment rate without sustained hemorrhages in consumer credit. And you can’t get a recovery in employment as long as the main providers of new jobs — small business and state and local governments — remain prostrate.

Since then, we had

1) The December employment report showing that more than 600,000 workers had been dropped from the labor force (that should have pushed the unemployment rate up to 10.4%);

2) A drop in December retail sales;

3) A drop in December factory output (overall industrial production was up only due to cold-weather electricity utilization;

4) a 16% drop in pending home sales;

and other indications that the US economy is not in recovery mode.

The dead-cat bounce in the industrial sector is remarkably small given the sharp devaluation of the dollar and strong comepttiive advantage for American goods. After falling by 30% from a 2007 peak of $230 billion to only $160 billion in early 2009, manufacturers’ new durable goods orders have risen to the princely level of $168 billion.

The collapse of small business and the continued deterioration of the consumer balance sheet are the operative factors here. You can’t run the U.S. economy with 22% effective unemployment (including “long-term discouraged workers,” as the Shadow Government Statistics website reports.