Yellen's Answer for the National Debt: More Taxes
Janet Yellen on the debt... 'I don't think the budget needs to be balanced'... Concern about commercial real estate... Bank crisis: Round 2?... This Fed program will end next month... Unrealized losses are still a problem...
If there was any doubt Uncle Sam's $34 trillion debt will keep growing...
Treasury Secretary Janet Yellen shut the door on even the most optimistic of people yesterday...
There is no hope.
At least, that's what I (Corey McLaughlin) took away from Yellen's scheduled testimony on the state of the U.S. economy before the House Committee on Financial Services yesterday.
A member of the House cited a report that falls under Yellen's umbrella – the U.S. Financial Stability Oversight Council's 2023 annual report – which said that...
Higher interest rates and slowing economic growth have increased nonfinancial corporate credit risk. If credit quality significantly worsens, a potential wave of debt defaults could lead to large redemptions at investment funds with significant liquidity mismatches and in turn disrupt bond market functioning. Moreover, such defaults may also have a cascading effect across broader financial markets.
Tell me your viewpoint, Texas Congressman Pete Sessions said... "At what point does this become a problem?"
This exchange followed...
Yellen: It's critically important that the U.S. be on a fiscally sustainable path. And President Biden has put forward a series of budget proposals...
Sessions: Spending proposals.
Yellen: No, and also tax proposals and investment proposals that would, I believe, guarantee that we are on a fiscally sustainable path.
Sessions: Does that mean ever attempting to balance any one particular year over the next 50 years?
Yellen: Well, I don't think the budget needs to be balanced.
There you have it. The truth is not hidden.
At that point, Sessions interrupted and pointed out the cost of the U.S. debt and the risk it poses to financial stability. The Congressional Budget Office, which advises members of Congress, recently said interest on debt could reach $800 billion this year alone, nearly 7% of annual GDP, about the same as national defense.
Yellen said she agreed the country needed to reduce deficits – projected to be around $1.5 trillion this year – coupled with making investments (i.e., more spending) that are "critical to ensure that we grow and collect tax revenues that are..."
Then her voice trailed off.
Sessions picked up talking about other problems that he felt were mismanagement of government resources. What tax revenues do, in Yellen's mind at that moment, we'll never know... except that they are wanted because Uncle Sam will keep spending.
Apart from that, Yellen made some other news...
I wanted to share the above anecdote because I think it's emblematic of the idea that leaders in Washington, D.C. don't seem to care all that much about what has recently happened with the U.S. economy (trillions of stimulus dollars and 40-year-high inflation).
Admittedly, though, skyrocketing U.S. government debt isn't a new problem. And to be fair, no matter what side of the aisle you might favor, there has been plenty of blame to go around over the past decades.
What might matter more for investors in the near term and regarding market direction is another topic Yellen addressed: commercial real estate.
She sounded the alarm about weakness in the sector, given high interest rates and the fact that the entire commercial real estate industry has taken a hit from the pandemic and a shift to more remote work.
I turned the hearing off after Yellen's comments about the debt, but according to global news service Reuters, she later said that refinancing of commercial real estate loans coming due soon, paired with interest rates and high vacancies, "is going to put a lot of stress on the owners of these properties"...
I'm concerned. I believe it's manageable, although there may be some institutions that are quite stressed by this problem.
We've warned about the stresses in the economy that could show as loans of all kinds are refinanced at nearly 15-year-high rates.
Last year's regional-banking crisis may have just been the preview...
Bank crisis: Round 2?...
Last week, the stock price of New York Community Bancorp (NYCB) fell 38% in a day after the company reported terrible fourth-quarter earnings ($260 million net loss) and announced it was cutting its quarterly dividend by 70%.
In part, investors are fearing NYCB's exposure to the commercial real estate market in New York.
About 56% of NYCB's total loans are tied to commercial real estate, Goldman Sachs reported. The dividend cut will help build up about $550 million for potential loan losses.
The stock fell another 11% in a day last week, and it's down another 25% this week. If nothing else, this should serve as a reminder: When you think a stock can't go lower, it always can.
This is a reminder of why we recommend stop losses so strongly at Stansberry Research. Our Income Intelligence newsletter stopped out of NYCB in October for an 8% loss. That was a disappointment... But if you'd ignored the stop loss and hoped for a turnaround, you'd now be down about 60%.
And we could see more trouble for bank stocks...
The Fed's latest 'emergency' program will end in March...
After Silicon Valley Bank and Signature Bank failed last March, the Federal Reserve launched the Bank Term Funding Program as essentially a liquidity pool for banks at low rates. It's scheduled to stop making new loans on March 11.
The central bank announced this rather quietly at 7 p.m. Eastern time on a Wednesday night late last month.
In the meantime, the Fed also raised the interest rate on the program, which was effectively ending an easy way for banks to make money. At the very least, more talk about the lapse around this program could stoke volatility in the banking sector – again.
The unrealized losses are still a problem...
Many banks are still in precarious positions, sitting on large losses in their bond portfolios that stem from the Fed's interest-rate hiking spree.
As Stansberry's Investment Advisory lead editor Whitney Tilson wrote in his free daily newsletter recently, bank-stock valuations are generally "back to their 10-year average price-to-tangible-book-value multiple... but in reality, the situation is even worse."
According to Whitney...
[That's] because banks' book values are inflated due to the fact that they aren't required to do fair-value marks on their held-to-maturity ("HTM") securities and loan portfolios.
If banks had to mark both down by a mere 5%, this would reduce their tangible book value by 33%!...
Whitney went on to show research from a friend who runs an investment fund that only invests in bank stocks. His research showed that the "Big Four" banks – JPMorgan Chase (JPM), Bank of America (BAC), Wells Fargo (WFC), and Citigroup (C) – are not immune to these problems.
He also pointed out that mergers and acquisitions ("M&A") activity in the industry – typically a way to make money owning shares of smaller banks – has largely dried up, plunging to multidecade lows... And in an earlier issue, he showed how and why net interest margin ("NIM") of all banks has compressed as the cost of bank deposits has risen.
Now, it's not all bad news in banks – Whitney's friend sees one "good value" in particular among the big banks – but it is certainly conceivable to see a shakeout of the weakest banking businesses yet to come. As Whitney ended...
Lastly, here are my friend's conclusions:
For much more detail, check out Whitney's recent series of reports on the banking sector in his free daily newsletter. He covers NYCB specifically here and here.
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In today's mailbag, we answer a question about inflation... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.
"I hope to see Corey's thoughts on this [opinion column] from the Orange County Register. California probably has the highest numbers but the numbers might not be too far off than the other 49 states. Our country has a long way to go to recover.
Fed can't fix 27% surge in California grocery prices
No bureaucratic action will get 2019-like prices back on the grocery shelvesSometime in 2024, the Federal Reserve will declare it won its war on inflation.
Fears of a recession will ease. The news should boost stock prices. Lower interest rates likely will be a boon to house hunters.
Yet, any grocery shopper who's paying attention at the checkout counter will ask, 'What are they talking about?'"
– Subscriber Norman B.
Corey McLaughlin comment: I totally agree. While the rate of inflation may have eased – and that's what the market (and the Federal Reserve) have been responding to and why I wrote about it the other day – so long as fiat currency and the money printer exist, there will always be inflation.
Prices everywhere are indeed up 20% or higher on all kinds of things than they were in 2020. And I think that's why polls show that Americans think the economy is in terrible shape... even if the Fed passively declares the inflation fight over by cutting interest rates sometime this year.
All the best,
Corey McLaughlin
Baltimore, Maryland
February 7, 2024