Has the U.S. Economy Rebounded From the “Bad Winter” GDP Decline?

by the Curmudgeon with Victor Sperandeo



This article examines recently released U.S. government economic reports for May and June to determine if the widely predicted economic bounce back is actually happening.  Next, we provide comments from two noted contrary economists - John Williams and David Stockman.  (We especially urge you to read quotes from the latter- below).


Victor then weighs in with his thoughts on the most important economic development of the week – Department of Justice (DoJ) threatened criminal lawsuits against the banks involved in the mortgage security debacle that led to the 2008 financial crisis.  The economic impact from the DoJ and related civil lawsuits are also addressed in Victor's closing comments.


Pulse of the U.S. Economy:


The U.S. economic slowdown began in the fall of 2013 when GDP growth fell from 4.1% in the third quarter to 2.4% in the fourth quarter.  It then plunged to negative (-2.9%) in the first quarter of this year.   Economists almost unanimously blamed the -2.9% decline in first Quarter GDP as due to severe winter weather.  We've tried to refute that assertion in many previous Curmudgeon posts, but we are the minority view or "voice in the wilderness" that few people listen to.   Let's look at what mainstream economists said about the negative first quarter GDP.


“Not as Bad as It Sounds,” a “One Off,” and “Ancient History” said several erudite economists.   “I do not think that the first-quarter GDP report is a reflection of the economy’s underlying health,” said Russell Price, Senior Economist at Ameriprise Financial Inc.  He added: “The employment numbers have been pretty solid, we’ve seen early signs of growth in wages, and that is really what’s going to drive demand. That will bring the rest of the economy with it.”


Economists are virtually unanimous in their insistence that growth would rebound very strongly in the second quarter.  They say that pent-up demand from the winter months, when consumers couldn’t go out to spend due to bad weather, would add to the normally strong spring buying season.  That would be especially true for housing, where demand was expected to pick up sharply this spring and summer.   Corporations were said to be restocking inventories in anticipation of a stronger economy.   Have those forecasts been on or off the mark? Let's review the recent evidence (economic reports) and then you can draw your own conclusions.


How is the U.S. Consumer Doing?


Consumer spending accounts for 66% of the U.S. economy, with home purchases driving consumers biggest expenditures.   Let's look at the current state of the housing industry, retail sales, and consumer confidence. 


·         Last month, the U.S. Census Bureau reported that new housing starts fell 6.5% in May.  That has now been revised down from the originally reported 1.0 million to 985,000. 

·         June housing starts tumbled 9.3% in June to an adjusted annual rate of 893,000 vs a consensus forecast of 1.02 million. That was the slowest pace in nine months (since Sept 2013), led by drops for single-family homes and apartments.  It left second-quarter housing activity down by 4.4% from the level of fourth-quarter 2013.

·         Privately-owned housing units authorized by building permits in May were revised to be down 5.1% from April, to a seasonally adjusted rate of 1.005 million.

·         Building permits in June were at a seasonally adjusted annual rate of 963,000, which was 4.2% (±1.5%) below the revised May rate of 1,005,000.

·         Mortgage applications fell sharply in June, down double-digits for the month, and this week it was reported they fell sharply again in the first week of July.

·         Retail sales (unadjusted for inflation) are increasing, but at a lower rate each month.  They were up almost 1.5% in March, but only 0.5% in April, 0.5% in May, and a disappointing 0.2% in June.  The consensus forecast was for retail sales to be up 0.6% in June, but the actual 0.2% increase was the slowest gain in five months.  The meager June number was tempered by declining sales at auto dealerships (-0.2%) and building material stores (-1.0%) with only a minor offset from increased sales at gasoline stations (0.3%).

·         Friday, it was reported that the University of Michigan/ Thomson/Reuters Consumer Sentiment Index fell from 82.5 in June to 81.3 in July- a four-month low.

The above noted reports on housing, spending and consumer confidence certainly don't indicate a big bounce back in the economy to us.  But Wall Street evidently thinks differently!


What about the U.S. Industrial Economy?


·         New orders for manufactured goods (often referred to as the Factory Orders Report) decreased $2.6 billion or 0.5% in May to $497.7 billion. That followed a 0.8% April increase. Excluding transportation, new orders decreased 0.1%.

·         Industrial Production rose at a slower than forecast 0.2% pace in June vs a higher 0.5% in May.

·         Capacity Utilization was 79.1% in June- unchanged from May's reading.

·         Producer Price Index jumped 0.4% in June up from -0.2% in May (thus adding to the inflationary concerns from the Consumer Price Index which has accelerated above the Fed's 2% target).

·         Leading Economic Indicators came in at 0.3% for June vs 0.7% in May.

Source: For last week's economic reports is at this link.     


Do the above numbers indicate the U.S. economy in a significant recovery uptrend?  We don't think so!  After considering the evidence above, what do you think?


The unfettered optimism of economists, who in the aggregate are always late to recognize a new trend, seems to be a smoke screen to make the public believe economic conditions are better than they really are!  The commentators cherry pick the economic reports to highlight the positive ones and ignore or rationalize away the negative or disappointing numbers.  Wall Street loves that huge cover up, as it creates the illusion of economic growth and improved corporate profits that keeps the bull market alive and well.  But not everyone is fooled.....


Contrarian Voices on the U.S. Economy:


ShadowStats John Williams commented on the disappointing housing start numbers released last Thursday:


"As with retail sales and industrial production, headline June growth in housing starts came in below market expectations.  Against unrevised first-quarter activity, second-quarter housing starts activity was higher, but it also turned lower against fourth-quarter 2013 activity."


Williams will provide ShadowStats subscribers with his assessment of June economic reports in his next Commentary (No. 643 on July 22nd); along with an overview of the upcoming GDP benchmark revisions and the pending first estimate of second-quarter 2014 GDP on July 30th.  We are very much looking forward to that report!


John is alone amongst economists in forecasting negative GDP for the second quarter, which would fit the classical definition of recession (two consecutive quarterly declines in GDP)1. 


Note 1.  The first quarter's -2.9% GDP reading was the 17th-largest quarterly GDP contraction since 1945 and the second since the great recession "ended" in June 2009.   All of the other 25 largest quarterly declines in GDP were part of a recession.  Will this time be different?


David Stockman (Director of the Office of Management and Budget under the Reagan administration) in his Contra Corner blog:  


"Furious money printing by the world’s major central banks is not generating real growth and prosperity—but professional economists never seem to get the word..... And in the U.S. after the disastrous first quarter, along with what is shaping up to be a tepid second quarter, real growth will not achieve any kind of velocity, “escape” or otherwise. In fact, consensus real GDP has already been marked down to 1.4%—the lowest rate of expansion since the financial crisis. Accordingly, it is only a matter of time before the global forecast for 2014 is marked down even further."


"It is no mystery as to where all the central bank “stimulus” is going. Since early 2013 fully fourth-fifths of the 40% rise in the S&P 500 is due to (P/E) multiple expansion, not earnings growth from a tepid economy.   This is clearly the effect of massive central bank injections of cash into Wall Street and other financial markets, yet it is especially perverse under current circumstances. Given the massive instabilities and headwinds afflicting the global economy—from the house of cards in China, to the failing retirement colony in Japan, the welfare state fiscal crunch in Europe and the faltering growth of breadwinner jobs and real investment in productive assets in the US—the capitalization rate of future earnings should be down-rated. That is, future corporate earnings are now worth far less than the historical P/E norm, not more.  Accordingly, the massive expansion of P/Es is yet another expression of the vast financial deformations being caused by monetary central planning."


Victor's Comments:


Last Monday, Citigroup agreed to pay $7 billion to the Dept. of Justice.  It was one of the largest-ever monetary agreements (i.e. penalties) to settle a U.S. government probe into the bank's trading of mortgage-backed securities in the run-up to the 2008 financial crisis.  Last year, J.P. Morgan’s $13 billion settlement over its sale (before the financial crisis) of mortgage-backed securities was the largest settlement ever between the U.S. government and a U.S. corporation.


Editor's Note:  Erika Eichelberger, writing in Mother Jones asks if Citi got off easy with its $7 billion settlement.  She provides six arguments from consumer advocates that say yes it did.


That was followed on Wednesday by a U.S. Department of Justice (DoJ) official issuing a thinly veiled threat to Bank of America Corp, saying that banks under investigation for shoddy mortgage securities they sold before the financial crisis must admit to misconduct and pay substantial penalties or face lawsuits from the agency.


The DoJ threat of criminal lawsuits against major banks involved in the sub-prime mortgage debacle may effectively extort an estimated $100 billion from all the banks involved (my estimate). 


The threatened DoJ law suits are proceeding without the government telling U.S. citizens where the money will be going.   Speculation is that a big part of what's to be collected will be for "executive needs,” since it will go to the U.S. Treasury without directives on what the money should be used for.   Restitution for victims is rare, and constitutes a trivial amount of what the DoJ brings in. In 2011 the DoJ took in $2 billion in judgments and settlements, and only $116 million went to restitution.


Moreover, the criminal threats may entice the bank CEO's to settle with the DoJ.  To me, that really isn't much different than when the mob "sells you protection" (AKA extortion).  If the banks lose to the DoJ in court, the CEO may do jail time and since the money paid is generally tax deductible and comes from retained earnings or capital, it would not likely harm the stock price (considering the way people value stocks today). 


Let's assume banks settle with the DOJ rather than go to court.... Now there are the civil lawsuits. The banks being sued include units of U.S. Bank, Citibank, Deutsche Bank, Wells Fargo & Co., HSBC, and Bank of New York Mellon.  Representatives for the banks declined comment or did not immediately respond to requests for same. 


Last Wednesday, institutional investors (BlackRock and Allianz SE's PIMCO) sued six of the largest bond trustees, accusing them of failing to properly oversee more than $2 trillion in mortgage-backed securities that were issued just before the 2008 financial crisis.  These civil lawsuits, filed in New York state court, claim the trustees breached their duties to investors by failing to force lenders and sponsors of the securities to repurchase defective loans. The institutional investors are seeking damages for losses that exceed $250 billion and relate to over 2,200 residential mortgage-backed securities trusts issued between 2004 and 2008, according to a person familiar with the cases.  The aforementioned lawsuits are described by Reuters in this article.


Other lawsuits may be coming that could wipe out some banks capital. All indicted banks will have to hold increased reserves against potential fines or out of court settlements.  That could have a very negative economic impact.  Let me explain why.


The U.S. economy has experienced the slowest growth in an economic recovery since 1945.   To achieve more growth, the economy needs credit (i.e. bank lending to corporations, small business and individuals).  With these lawsuits pending, the banks must hold huge reserves against possible court specified fines.  That implies bank credit will contract as fewer loans will be made.  If you are a small business that needs credit (to expand operations and hire more employees), apply at a bank and are declined, perhaps now you can understand why.   The upshot is that economic growth may be further reduced as a result of these lawsuits. 


As an aside, the reader should consider if these strongly regulated banks caused the 2008 financial crisis?  Or was it the actions of Fed Chairman Ben Bernanke and Secretary Treasurer Hank Paulson? 


In my contrary point of view, the banks were not responsible for the collapse of Lehman Brothers, which had an avalanche effect on the global financial system.   The blame directly goes to the aforementioned "keystone cops of finance" who were appointed and overseen by President George W. Bush.


[While he writes about it extensively in his book: Stress Test: Reflections on Financial Crises, Tim Geithner was not a decision maker in letting Lehman Bros fail.  As head of the New York Fed at that time, he was involved in the attempt to save Lehman, but subordinate to Fed Chair Ben Bernanke in any decision.]


In March of 2008, the Fed saved (or bailed out) Bear Stearns - an investment bank whose assets are still on the Fed's books. Why didn't they rescue Lehman Bros. - a much larger investment bank- in September?  Bernanke says he did not have the tools.  But he did for Bear Stearns?  A decade before, the Greenspan led Fed arranged the bail out of "too big to fail" (and way over leveraged) hedge fund Long Term Capital Management (LTCM)2 in September, 1998.


Note 2.  The Federal Reserve Bank of New York President William J. McDonough convinced 15 banks to bail out LTCM with $3.5 billion, in return for a 90% ownership of the fund. In addition, the Fed started lowering the Fed funds rate as a reassurance to investors that the Fed would do whatever it took to support the U.S. economy. Without such direct intervention, the entire financial system was threatened with a collapse.


Source: IMF, World Economic Outlook, Interim Assessment, "Chapter III: Turbulence in Mature Financial Markets December 1998; IMF Report: International Contagion Effects from the Russian Crisis and the LTCM Near-Collapse, April 2002; European Central Bank, Financial Stability Report-December, 2006.


Here's the key issue:  When the decision was made to allow Lehman Bros. to fail why did Ben or Hank not know the liability and financial repercussions?  I think it would've only taken one and half hours of "work” by making 12 phone calls to the derivative institutions which sold credit default swaps on Lehman (the biggest was AIG).  They had $180 billion in liability alone.  It would've taken approximately $60 to $70 billion to save Lehman.... Failing to do so was not a good decision as it resulted in weeks of frozen credit markets, which drastically worsened the financial crisis.  I think that the U.S. federal government jumped on the financial crises to get more power over the banking industry and thereby more political donations -- which is the real desire for government regulations, in my opinion.


Ayn Rand's quote "sanction of the victim" seems to be very relevant here.  It's the willingness of the innocent for not speaking out at the hands of the ‎accuser and accepting the role of sacrificial victim for the "sin" of creating values and doing their job. In this case, the banks that allowed themselves to be painted as the "bad guys" by not speaking out against big government that was trying to blame someone else for their own mismanagement of the financial crisis.  That has cost them a new compliance law (Dodd - Frank) and an unknown liability (from the aforementioned law suits).  


More importantly, the goal of power and money may backfire on those who promote this type of strategy.  The totality of the regulations and lawsuits may weaken the banks and the entire financial ‎system such that the U.S. economy is mortally affected.  Blame will then be placed where it rightfully deserves to be: on those that control the system, i.e. "the U.S. government."


Till next time........................


The Curmudgeon

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

Copyright © 2014 by The Curmudgeon and Marc Sexton. All rights reserved.

Readers are PROHIBITED from duplicating, copying, or reproducing article(s) written by The Curmudgeon and Victor Sperandeo without providing the url of the original posted article(s).