Nowhere Man Please Listen

Nowhere Man Please Listen

He's as blind as he can be,just sees what he wants to see,Nowhere Man can you see me at all? – John Lennon / Paul McCartney


Noted NYU professor of economics, Nouriel Roubini published an article in the Financial Times explaining why, in his opinion, the U.S. economic recovery will me lengthy and gradual. Immediately, the bulls and equity market cheerleaders (stock jockeys) attempted to discredit Professor Roubini. I take umbrage (on Professor Roubini’s behalf) at the attempts to discredit and, in some instances, belittle his opinion. Judging by the statements I have heard on the opposite side of Mr. Roubini’s argument, I believe that many market bulls are “Nowhere Men”, seeing just what they want to see.

If it appears as though I give more credence to Professor Roubini’s arguments than to certain CNBC pundits and their guests it is because Mr. Roubini presents well thought out arguments to state is opinion. Many on the opposite side of the spectrum (predicting a v-shaped recovery) state that the economy has to recover sharply because of government stimulus, pent up demand, leading indicators say so or (I love this one) because it always has been this way. Of the arguments for a v-shaped recovery only leading indicators make a rational case. However, when one considers inventory replacement which is currently under way, strength as reported by leading indicators could evaporate once inventories have been built up to levels in line with consumer demand.

My biggest concern is that consumer demand will be at levels which are far below to what we have become accustomed. Remember, demand we experienced during the past to recoveries was mostly due to cheap, easy to obtain credit and the resulting rising real estate values. Although credit is currently historically cheap, the demand from credit from those who qualify to obtain credit is relatively low. For a credit-fueled recovery to materialize, banks would have to once again lower their lending standards. That is not going to happen.

Why won’t the banks take the risk and open the credit gates? After all, doing so could be a self-fulfilling prophecy. Banks open the credit spigot, consumers borrow, spend and create jobs and push wages higher, making everyone more credit worthy. Sounds good, right? Wrong. The truth is that banks never thought they were taking such risks before and they are not going to take such risks now.

If you have read Mr. Roubini’s article you may have noted that he stated:

“Fourth, the financial system – despite the policy support – is still severely damaged. Most of the shadow banking system has disappeared, and traditional banks are saddled with trillions of dollars in expected losses on loans and securities while still being seriously undercapitalised. “


The so-called shadow banking system (securitization) was very important for economic growth during the past two economic expansions. The ability to package loans and sell them to investors in the form of asset-backed securities, collateralized debt obligations and various conduits permitted than banks to open the credit spigots and lend to consumers who could not repay their debts. Once it was off their balance sheets the banks were insulated from any potential credit problems, or so they thought. Some actually believed their own, often manipulated, models and began holding some of these toxic loans on their balance sheets. With no way to move newly-created subprime loans off of their balance sheets and no desire to hold onto such loans, banks are not going to give credit to those whose ability to repay is suspect. That removes a substantial amount of consumer activity (pent up demand) from the equation.

Mr. Roubini is also correct about banks being seriously undercapitalized. Even traditional bank bull, Dick Bove’ is warning that approximately 200 banks (mostly regional banks) could fail in the near future. Mr. Bove’ is correct. There is at least one large bank which was technically insolvent if not for a government backstop and the charade of solvency put forth by moving Tier-1 capital to tangible common equity, but not raising a penny more of new equity capital.

The U.S. economy will recover. There is no economy which is as dynamic and has such creative participants, but head winds created by deleveraging, a weaker dollar (resulting in higher food and energy prices) and anti-growth tax and labor policies will buffet U.S. economic growth.