Friday, August 02, 2013 - Jobs and Side Bets

Jobs and Side Bets

by Sinclair Noe

DOW + 30 = 15,684
SPX + 2 = 1709
NAS + 13 = 3689
10 YR YLD - .11 = 2.60%
OIL - .95 = 106.94
GOLD + 4.60 = 1314.50
SILV + .26 = 19.99

The stock market started lower, with tepid news on the jobs front, but managed to claw back into positive territory, confirming the perverse Wall Street logic that bad is good. The weakness in the jobs market was seen as proof positive the Fed will continue with QE to infinity and beyond, and talk of taper can be set aside for the next Fed Chairman, whoever he or she may be.

The economy added 162,000 jobs last month; that was less than the estimates of 185,000 and less than the recent averages of about 192,000. Also, May and June payroll gains were revised down by 26,000.

The unemployment rate dropped to 7.4% down from 7.6%. This is the lowest level for the unemployment rate since November 2008. Most of the decline in unemployment was due to more people getting jobs but part of it was due to a slight fall off in the labor force, a signal of not-too-strong labor demand, as 37,000 workers dropped out of the labor market. In July, the number of unemployed fell by 263,000 but the number of employed increased by only 227,000. 

The participation rate ticked down one-tenth, to 63.4%, lower than it was a year ago at 63.7 %. The participation rate is at its lowest levels in 35 years and well below the 66% to 67% rate that was normal over the past 20 years. The workforce can shrink when more workers retire or go to school, but it also contracts when people give up the job hunt. The lower participation rate is partly demographics, as the baby boom generation moves into retirement, whether they want it or not. So, if we look at the participation rate for working age population, generally ages 25 to 59, we see the participation rate unchanged at 75.9%. Also, it's estimated that many people slip into the underground economy, which is not as sinister as it sounds; it simply means many people are working in an unreported cash economy.

Most industries added jobs last month; manufacturing added 6,000 jobs in July, after declining slightly in the prior two months. Over the past year, factory employment is up only 18,000.  Construction was off 6,000 last month. Professional and technical services added 21,100 jobs, almost exactly in line with its 20,000 average over the last year. Wholesale trade added 13,700 jobs, somewhat above its 7,000 average for the last year.  Health care added just 2,500 jobs, the smallest gain in a decade. 

Retailers added 47,000 jobs and restaurants and bars added 38,000. So, the composition of jobs is not great; retail and restaurants are generally lower-paying sectors, and they accounted for more than half of all job growth last month. In a weak job market, workers will be more likely to take even lower paying jobs. A recent paper by Canadian researchers suggests that many of the people taking these jobs are relatively over-educated. The authors argue that, since 2000, globalization and technological advancement have reduced the demand for "high-skilled" workers. Desperate for employment, these workers ended up pushing the "lower-skilled" out of the job market entirely. This may help explain why the share of people aged 25 to 54 counted as being in the labor force has declined by 3.5% since 2000.

Government employment was flat overall last month, but state and local governments have slowly started adding jobs in recent months, up 42,000 since January; this might be misleading because many government jobs have experience fewer hours because of furloughs brought on by sequestration.

Weekly hours ticked down 0.1% in July, and weekly earnings are up in nominal terms by 1.9 percent over the past year, about the rate of inflation; this means that most wages are not growing in terms of buying power.

The number of part-time workers increased slightly in July to 8,245 million. Those workers are included in the alternate measure of labor under-utilization, known as U-6, which decreased from 14.3% in June to 14% in July. By that measure, roughly 22 million people are unemployed or underemployed. There are about 4.2 million workers who have been unemployed for more than 26 weeks and still want a job; this is down form 4.3 million in June and is at the lowest level since May 2009. Long-term unemployment is trending down but is still very high; this number should be closer to 2 million in a healthier economy.

The economy has been adding jobs for the past 41 consecutive months, adding 7.3 million jobs since February 2010; it's just not enough. Despite 41 months of private-sector job growth, there were still 2.0 million fewer jobs on nonfarm payrolls and 1.5 million fewer jobs on private payrolls in July than when the recession began in December 2007. The analogy is that we are stuck in second gear, which is better than reverse, or better than driving into a ditch, but at this rate we'll never get to the destination of a strong jobs market.

Let's compare, and I'll try to keep it non-partisan. If we combine the Bush and Obama administrations, we can go back over the past 151 monthly jobs reports and the economy has added 3.46 million jobs in that time; that works out to about 23,000 jobs per month on average. Just to keep up with population growth, we needed to create about 135,000 jobs per month, or a little over 20 million. By way of contrast, under 8 years of the Clinton administration, the economy added just over 23 million jobs in 96 months, for an average monthly gain of 241,000.

According to analysis from  the Federal Reserve Bank of Chicago, at the current pace it would take another five years to return to full employment. This estimate includes aggressive assumptions about aging, immigration and the birthrate that make the "employment gap" smaller than many others believe. The return to full employment could take even longer if those assumptions are wrong, or if growth slows down sometime over the next five years.

With this kind of jobs shortfall, we should be able to put the idea of the Fed taper to rest for a while, and indeed, after its FOMC policy meeting earlier this week, the Fed slightly downgraded its economic view and didn’t offer any signals as to when it would start tapering asset purchases, currently set at $85 billion a month.

Still, today we heard from St. Louis Fed President James Bullard saying he believed the Fed should be careful about basing its decisions on forecasts and that policymakers should wait to see more data before deciding to taper bond purchases.

Other data today showed a slight gathering of inflationary pressure, with the 12-month reading of the Commerce Department's gauge of core inflation rising to 1.2 percent in June from 1.1 percent a month earlier. So, inflation is still nowhere near the Fed's target.

Earlier in the week, the GDP report showed Gross domestic product, a measure of the nation's economic output, grew at a mere 1.4 percent annual rate in the first half of the year, down from 2.5 percent in the same period of 2012. Most economists expect GDP will accelerate in the second half of this year, which would make it more plausible for the current hiring trend to continue, but the fact that the jobless rate has fallen steadily despite weak output might point to a frightening possibility: perhaps the economy's growth potential has fallen. Maybe this is the new normal, a structural shift to slower growth, where less output is needed to create jobs, but also slower income growth over time.

Absent significantly stronger economic data in the next few weeks, we can forget the misconceptions that the Fed will look to taper in September.

Meanwhile, fiscal policymakers should be screaming for jobs, but they aren't and it looks like the best we can hope for on the fiscal side is that they don't drive the car into the ditch. Don't forget, there will be a battle over the debt ceiling, expected to hit by around November. So, on the monetary policy side, the Fed has little economic data to support a taper, and on the fiscal side, there seems little that would encourage taper.

The new, fun parlor game for the summer is to pick the next head of the Fed; pick a candidate and place your bets. Topping the list of contenders to replace Bernanke we have Larry Summers and Janet Yellen, but there are some other names to consider as well, the dark horse candidates. Larry Summers is the front runner; he is President Obama's former chief economic advisor, but he also goes back to the days of Clinton, and Summers actually was a proponent of deregulation and Gramm-Leach-Bliley, which ended up gutting Glass-Steagall; so there is some baggage. Janet Yellen is the current vice chair at the Fed; considered very intelligent and steeped in both the practice and theory of central banking, but some think she might be soft on inflation fighting.

There are indications that Mr. Summers and Ms. Yellen disagree on a pressing issue before the Fed:  how much longer and how much harder to push for economic growth.” They share a conviction that the Fed can and should seek to stimulate the economy during periods of slack demand. Summers appears to have less confidence in the tools available to the Fed at the moment, and greater concern about the potential consequences. Yellen defends the Fed's policies as safe and effective.

The dark horse candidates to replace Bernanke include Donald Kohn, a former Fed vice chair. Then, don't forget that former Treasury Secretary Tim Geithner is helping in the selection process, so there's a slim chance he might toss his hat in the ring. Longer shots include Robert Reich or Joseph Stiglitz; interesting, but yea, that's not going to happen.

Fabulous Fab, or more precisely Fabrice Tourre, the junior level Goldman Sachs trader was convicted yesterday of misleading investors on a derivative called Abacus, which was set up to gamble on the mortgages behind the housing market run-up, but turned out to be rigged full of sub-prime. Confused?

The important thing to understand is that the securitization at issue in no way helped to create capital for anything. It was a pure gamble. One side bet that the mortgage market would collapse. The other bet it would not. 

Consider the mortgage securitization market. First, there are mortgages, which help people buy homes. Those mortgages are packaged in a securitization and sold to investors. Some investors buy tranches that give them low yields with little chance of loss. Others get tranches with higher yields, but will lose their principal if enough borrowers default. The money put up by the investors helped to finance home buyers, which is the kind of thing a financial system should do. (It did it badly, but that is not the issue here.)

The next level of security packaged a bunch of tranches from different deals and sold securities based on those assets. By raising money to finance tranches in the first level of securitizations, it indirectly helped to finance home buyers.

Note that nobody needed to bet against either of those securitizations. The money put up by the buyers was going to homeowners, or at least to those who had previously lent to those buyers.

But the securitization that Mr. Tourre helped to create was “synthetic.” It did not raise money that went, directly or indirectly, to homeowners or to those who had lent money to them. Instead, it picked a bunch of tranches from previous securitizations — tranches that no one involved in this deal had to own — and fashioned a new securitization in which one set of investors bet those securities would work out and another set bet they would not.

Goldman Sachs was the bookie.

And this is why we need Glass-Steagall. There is no reason for the banks to be bookies. Restore the separation between commercial and investment banking, let the investment banks play bookie with partners' capital, and put the commercial banks back into the lending business. After the dust settles, put the banks not only in the lending business but make mortgages "make and hold" loans that stay in the banks' loan portfolios rather than being securitized and sold off to investors.

It is then that we will see what all of the property in the country is worth. Long after we get the government out of the mortgage market and investment bankers out of the government-guaranteed market where they issue securities on the securitized property.

If you want to gamble, you're welcome to do so, but banks that have access to insured deposits and get bailed out if they get into trouble, should not be using those insured deposits to put together a betting book and taking the bookie's cut.

And so that's the main reason why I oppose Larry Summers as the next chairman of the Federal Reserve, but I wouldn't bet on it.