The Perils of Leverage

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The Occupy Wall Street protestors have struck a chord among some unlikely suspects.
It figures. First we have the Great Recession. Then the Not-So-Great Recovery. That, in turn, gives way to the Great Stagnation. Which, as night follows day, is followed by what seems to have the makings of the Great Backlash in the form of the budding street protests against Wall Street.

All of which is bound to inspire the notion of a Great Conspiracy, whose unspoken aim is to quell the unrest by pumping up what the perps perceive as its root cause—the morbidly anemic stock market. A tortuous sequence, which nonetheless supposedly explains the welcome resurrection of share prices after the bloody pounding they absorbed during the third quarter.

Even the most delusional conspiracy fancier this side of a psychiatric ward might hesitate to suggest that fat cats, cunningly disguised as run-of-the-office working stiffs (and wearing polyester suits to further the misperception), gathered in the rear of some rancid beer joint on the lower West Side to collude. Fat cats are shrewder than that. And they also aren't overly fond of beer (makes their tummies bulge). Besides, they'd never have attained fat-cat status unless they knew instinctively what to do and when to do it.

We apologize for being slow on the uptake as to what, according to this strained scenario, made the market finally bounce last week, mostly because we erred grievously in assessing Occupy Wall Street. It appeared on hurried glance to be composed of such a ragtag bag of adrenaline-driven wastrels, we couldn't fathom how anyone could take them seriously. How wrong we were!

For however diffuse and even dubious their credentials, and for all their quixotic confusion in attacking a metaphor as if it were a living, breathing embodiment of malfeasance, they obviously have struck a nerve in the public at large, especially among that not-insignificant portion of the population that is suffering all the ills a costive economy can inflict. And, like disgruntled throngs everywhere these days, they have proved adept at enlisting that amorphous but powerful thing called "social media" in enhancing their numbers and propagating their cause.

Their plaints are various and fairly fuzzy, but seemingly boil down to this: The protestors are in a financial pickle and have been forced pretty much to fend for themselves, while banks and the rest of the financial sector, when mired in similar woes (mostly of their own making), had been bailed out by Uncle Sam.

Traders, analysts, brokers, portfolio managers, investment bankers and other ne'er-do-wells that we've encountered are more puzzled than dismayed by the mounting ruckus around Broad and Wall. Some even expressed sympathy, of a sort. Paul Brodsky, a principal in the hedge fund QB Asset Management, for example, whose sharp comments have spiced up this space from time to time, opined "that the kids downtown are credible" and "the vocal fringe" to which they belong actually represents a "disenfranchised majority that is quickly growing disenchanted" with our financial system and its workings.

Moreover, he argues, the protesters' beefs are not without merit. Money-printing, which the Federal Reserve has indulged in with gusto ever since the Great Recession, is what Paul calls "a terribly regressive tax on the working and middle classes."

Folks with higher incomes and access to credit, he points out, are able to maintain their customary standard of living and continue to shoulder their debts without much discomfort. But lower-wage earners and those with less access to credit, along with the 14 million or 15 million unfortunates who have lost their jobs, are really hurting.

Paul, we might add, is hardly your prototypical wild-eyed radical. A former bond trader, he's a free-marketeer, something of a closet gold bug, and a sound-money adherent who constantly rails against debasement of the dollar, aided and abetted by the quantitative efforts of the Fed. By his reckoning, the entire U.S. monetary system is now leveraged at about 20 to 1. Or, put another way, he says, "there's about $53 trillion in debt and not quite $3 trillion with which to repay it."

Worth noting is that neither the rest of the world, including our major creditors, nor the bond market have been noticeably atremble at the creeping devaluation of the dollar. Quite the opposite: the financial turmoil in Europe and fears of hard economic landings in China and most emerging markets have fueled demand for the greenback. Which perhaps tells you more about the rest of the world than anything else.

Be that as it may, Paul contends, leverage is exacting a serious toll by marginalizing real growth. We've reached a parlous state, he feels, when further asset-price increases can be catalyzed only by more of the hair of the dog that bit us—that is, by further infusions of credit or money.

A disturbing prospect that, all things considered, doesn't imbue us with confidence that this market can sustain any significant rally.

ANOTHER, AND PERHAPS MORE URGENT reason to doubt the capability of this wishy-washy market to stage a strong and reasonably enduring bull move is that the Europeans still seem very much at sea as they decide how to stanch the bleeding in their ranks. The European Central Bank, which has been all thumbs in tackling the worsening woes of its weaker members (and some of the supposedly stronger ones don't look all that great, either), once again last week failed to cut its interest rate of 1.5%. If nothing else, a reduction might have given the markets a momentary lift.

Meanwhile, Greece continues to skate on extremely thin ice in its attempt to avoid default, and it won't take all that much to launch it into a bone-chilling plunge. The credit agencies have been slashing ratings in the euro zone (Spain and Italy felt the knife last week) with something bordering on abandon, while in their tight little isle the Brits have been expressing their concerns with a hefty 75 billion-pound addition to their asset-purchasing facility, swelling the accumulated hoard to ￡275 billion.

Moreover, for what it's worth, in an interview on the BBC, a senior IMF advisor (so reports Mark Grant of Southwest Securities) ventures that there could be "a meltdown in sovereign debt" that might well spread throughout the European banking system and thence throughout the global financial system, including the U.S. Should that happen, he postulates, it could prove "more serious than the crisis in 2008."

The curriculum vitae of this gloomy prophet includes a Ph.D. from Harvard, and he served as U.S. undersecretary of commerce. None of that, of course, assures his forecast is on the money, but his credentials endow it as meriting consideration, and certainly didn't lessen our skepticism about the rally one whit.

"BETTER, BUT…" THAT RATHER SUCCINCTLY sums up the September employment report released Friday morning by the Bureau of Labor Statistics. Let's take the pleasant news first. Payrolls increased by a surprising 103,000, quite a contrast with the zero rise the previous month, which, it turns out, wasn't anywhere near as bad as originally reported. In fact, upward revisions of the previous two months were 57,000 in August and 42,000 in July.

The unemployment rate held steady at 9.1%. All of the gain in jobs and then some came via the private sector, which added 137,000, while local governments shed 34,000 or so slots. The workweek was up a notch, but aggregate hours worked climbed 0.4%, the best showing since February.

Even construction—nonresidential, need we say—posted a gain. But as Dean Baker of the Center for Economic and Policy Research notes, the 26,000 additions to some meaningful extent reflect repairs for damages caused by the hurricanes that raged through parts of the country, and he doubts that anything approaching that total will be sustained.

If nothing else, the upticks in the jobs report likely mean that a double-dip is not lurking right around the corner. But we can't honestly speak for the corner after this one. Or, as Philippa Dunne and Doug Henwood, who put out the dandy Liscio Report, slyly open their take on last month's modest job gains: "What a relief. Worries about the recession can be held at bay for a least another month."

Their enthusiasm is limited by, among other things, the fact that U-6, which embraces both underemployment and unemployment, was up 0.3 points to 16.5%, the highest since December 2010, owing to a sizable jump in involuntary part-timers who were unable to find full-time work. Not exactly evidence of a hiring binge.

As Doug and Philippa point out, at recent rates of employment and population growth, it would take until 2045 to get back to the 2007 employment/population ratio of 63%.

David Rosenberg, Gluskin Sheff's chief economist, shares their reservations. He admits that the jobs report caught him a bit by surprise, but on closer scrutiny he wonders how accurate it truly is. And, on that score, he's quick to mention that 45,000 Verizon workers, who had been on strike in August, were back on the job in September, and that obviously helped swell the employment total. Even so, he calculates, payrolls came in at roughly half the norm for this stage of the cycle.

He also fingers the decline in manufacturing employment, the first back-to-back contraction since this time last year, and the softness in durable-goods hires, the first two-month retreat since November/December 2009.

Dave also picked up on the fact that the bulk of the 398,000 gain in the Household Survey was contributed by part-timers, and the number of those working part-time for economic reasons shot up by an eye-popping 444,000, to 9.3 million—the most in a year.

In short, hold the hurrahs.