Digging Out of the Hole

Hurricane season has blown in, and the fear is that a string of hurricanes lined up like airplanes at LaGuardia, as Fox anchor Neil Cavuto quips, will act as a lead blanket on an already distressed stock market dealing with an epic subprime meltdown and a historic credit crunch.

Yes, hurricanes actually create economic activity. Just watch the action in stocks of Wal-Mart (WMT), Home Depot (HD) and Lowe's (LOW) after a hurricane blows in, as homeowners race to these companies to buy products to batten down the hatches.

However, the U.S. economy shed 84,000 jobs in August, as the unemployment rate jumped to a five-year high of 6.1%. That's still a rate government stewards who have dealt with past downturns would have longed for, though the trend line going south faster than a goose in winter here is not good.

The U.S. economy is hanging in, it is not headed for a national nervous breakdown as recent GDP numbers report (caveat here too, the high price of oil imports weirdly inflated the GDP result). I still say the estimate that 1.8 billion more people will enter the middle class worldwide by 2012 can only be a positive for economic growth.

But for now, there's talk of increasing public infrastructure spending to create jobs, on the radar screen on both sides of the political aisle. It's a hot debate given new valence due to Republican vice presidential candidate Sarah Palin's take on the Alaska "Bridge to Nowhere." Palin evidently first said yes to this useless bridge, an iconic example of wasteful, Supersize-me government spending, but then was against it, keeping the bridge funds for other state needs.

Democratic presidential hopeful Senator Barack Obama (D-Ill.) has proposed a federal infrastructure program to spend $60 billion over 10 years on highways and other projects to create two million jobs. Republican presidential contender John McCain has also endorsed similar plans in the past.

However, a review of independent studies of past government programs boosting infrastructure spending shows they do not create anywhere near the jobs politicians say they will. Instead, most of the jobs go to government bureaucrats to dig holes and refill them. More on that in a minute.

The economy is, at its base, dealing with an increasingly weakened taxpayer wrestling with rising food and energy costs who is likely to be hit up to pay for a chaotic government bucket brigade racing to put out stock market fires with taxpayer money especially the problems at two giant sinkholes, the mismanaged Fannie Mae (FNM) and Freddie Mac (FRE), now threatening to suck in the entire economy as they've been posting record losses from the housing downturn. The two were buying subprime securitizations even while the housing bubble blew up last year, the equivalent of smoking in bed while the house is on fire.

I've already told you that when it comes to tax dollars, Congress should be tight as a miser's fist and have zero tolerance for how they spend your money.

Instead, what has the U.S. economy teetering on the precipice are the maniacs in Congress who have done nothing about the $64 tn in unfunded liabilities for Medicare and Social Security but have done everything to get their mitts on your Social Security funds (the Democrats changed that law letting Congress do so in the ‘60s) and your money via higher taxes.

"I've never met a Democrat who prepared his or her own tax return," New York City private banker Frazier Rice quips astringently.

But the question is, when can the markets and the U.S. economy pull itself out of this mess?

First off, the experts don't have a clue, as they appear increasingly ad hoc with their calls for a housing bottom. Former Federal Reserve chairman Alan Greenspan first called for a real estate bottom in late 2006.

"I suspect that we are coming to the end of this downtrend, as applications for new mortgages, the most important series, have flattened out. I don't know, but I think the worst of this may well be over," Greenspan said at the time, a call he repeatedly made thereafter.

Similarly, Federal Reserve chairman Ben Bernanke stated in July 2007 that subprime problems probably would not seriously spill over to the broader economy or the financial system. Still, he said at the time: "That is something we are very alert to." A month later the subprime and credit crisis blew in with gale-force winds.

Wall Street is continuing to blow many an economic circuit from its stupefyingly ludicrous bets in the housing crisis. The financials are set to report third-quarter results in a few weeks, scrambling to groom to a champion-show finish battered profit results they hope to grease with new (and if not cash injections, highly dilutive equity offerings) capital raises.

Goldman Sachs analyst William Tanona is forecasting $10 billion in total writedowns for Lehman Brothers (LEH), Morgan Stanley (MS), JPMorgan Chase (JPM) and Citigroup (C) in the coming quarter. Lehman has already taken $8.2 billion in writedowns, Morgan Stanley $14.4 billion and JPMorgan $14.3 billion. New estimates out for Merrill Lynch (MER) show similar expected losses and writedowns.

There are new glimmers that mortgage delinquencies are fractionally abating, but any indication that problem loans are subsiding are not a clear sign of a market turnaround.

During the S&L crisis of the late '80s and early '90s, problem loans didn't abate in the U.S. until November 1991, after that downturn started to subside. Same holds true for the economic and lending crisis in Sweden of '90 to '93 and the one that caused Japan's economy to seize up in its zombie decade of the lost ‘90s (Japan didn't pull out of its crisis until earlier in this decade, and problem loans only really subsided thereafter).

So the question is, what are the best laid plans from politicians to increase jobs in the U.S.?  

As noted, Democratic presidential contender Obama has proposed a federal infrastructure program to spend $60 billion over 10 years on highways and other projects to create two million jobs.

Yet claims that infrastructure spending can immediately create jobs and kick start the economy are dubious, according to findings of decades of independent academic studies by the likes of the Congressional Budget Office and the Government Accountability Office. "Claims that highway spending can quickly create jobs and jump start the economy are highly questionable," says Dr. Ronald D. Utt of the Heritage Foundation, a conservative think tank.

I dusted off a December 1986 GAO report that looked at the economic results of the $9 billion Emergency Jobs Act of 1983, an infrastructure spending program passed by Congress to create jobs after the worst economic recession of the post-World War II era (unemployment hit 10.7%, with 12 million out of work). The results were illuminating, bringing to mind the complaint about federal spending on jobs, that the money is often spent hiring people to dig holes and then other workers to refill them.

The GAO found that "relatively few jobs were created," that "unemployed persons received a relatively small proportion of the jobs provided," and that by the time the act became law 21 months after the recession began, the recession was over and the unemployment rate had already dropped.

Moreover, much of the public funds were spent slowly, they were not spent before June 1984, and when they were spent, the money was spent mostly on bureaucrats handling public services programs, like welfare, employment and job training programs--not on public works programs that build highways or bridges. The GAO found that the act created only 35,000 jobs by June 1984, when about eight million were unemployed.

Overall, the GAO found the infrastructure spending act created less than 1% of the 5.8 million jobs created by the economy when the legislation passed. And the jobless were not helped, as only 35% of the people employed in the programs the GAO reviewed were previously unemployed.

What happened? "Some local officials made no effort to provide employment opportunities to the unemployed, while others required that those hired be certified as unemployed by state employment agencies," the GAO's December 1986 report said, adding that "no more than half of the project officials surveyed in seven programs made a moderate or greater attempt to provide employment to unemployed persons."