The Great Bailout Debate.

The great bailout debate.

Tim Geithner, claims that bank bailouts were a critical part of getting the economy running again, while Neil Barofsky, says the Obama administration should have spent more time bailing out underwater homeowners who were crushed by the housing bust. Who’s right?

Well, like it or not, the banks had to be bailed out, the same way you’d bail out electrical utilities rather than let everyone go without electricity. They’re just too important to the rest of the economy. They clearly should have been more punitive but frankly, given the speed at which the tide rose back in the closing chapter of the Bush administration, there wasn’t time to structure anything. Morally right or wrong, we needed to spend a ton of money to rescue the banks, and stop the bleeding. Did they do what anyone would do if someone handed over a bag of money? Of course they did.

On the other hand, Mr. Barofsky makes a good point: consumer debt overhang has been hobbling the recovery ever since 2008, and it’s outrageous that so little money was spent rescuing consumers right along with the bankers. Obama should have pushed a lot harder for “cram down” legislation; Fannie and Freddie should have been enlisted to rewrite mortgages; money should have been airlifted into consumer pockets, either to spend or to pay down debt; and schemes should have been set up for homeowners who were too far gone, that allowed them to rent their homes back from the banks that foreclosed on them. In fact, my earlier proposal was and still is, force the banks to re-finance all mortgages at current assessed market values without owner qualification.

So, they are both right, but neither of them can get us out of this mess. The only way we are going to start this thing up again is for the US Government to force banks to open their credit spigots, ignore strategic mortgage defaults, start loaning money to sub-700’s again, and re-write all of the existing mortgages, essentially marking them to market (lovely irony here).

And we need to do this before Europe crashes and burns next year. How? We have leverage. What do the banks want more than anything? Where is their greatest source of potential profit? Investment banking. We make a devil’s bargain. The banks come to the credit and mortgage table, and the Government lets them continue to operate as a single entity, with commercial and investment combined.

We stop talking about Glass-Steagall, and we stop threatening to regulate derivatives. The banks open their checkbooks to small business, and they re-write all of the underwater mortgages. That stops the bleeding in housing, jump-starts the small-ball economy, and boosts consumer confidence.

Short of such a drastic measure, we head into 2013, sailing a doomed ship following a doomed course on a fatal journey into the abyss. 

U.S. Growth Quickens in Q4, but 2012 Looks Awful.

The U.S. economy grew at its fastest pace in 1-1/2 years in the fourth quarter, but a strong rebuilding of stocks by businesses and weak spending on capital goods hinted at slower growth in early 2012.

U.S. gross domestic product expanded at a 2.8 percent annual rate, the Commerce Department said on Friday, a sharp acceleration from the 1.8 percent clip of the prior three months and the quickest pace since the second quarter of 2010.

It was, however, a touch below economists’ expectations for a 3.0 percent rate.

“The economy ended 2011 on a fairly positive note, but the composition of growth in the last quarter is not favorable for growth early this year,” said Ryan Sweet, a senior economist at Moody’s Analytics in West Chester, Pennsylvania.

Sweet made the comments before the report was released. For the whole of 2011, the economy grew 1.7 percent after expanding 3 percent the prior year.

Growth in the fourth quarter got a temporary boost from the rebuilding of business inventories, which was the fastest since the third quarter of 2010, after they declined in the third-quarter for the first time since late 2009.

Inventories increased $56.0 billion, adding 1.94 percentage points to GDP growth. In other words, excluding inventories, the economy grew at a tepid 0.8 percent rate, a sharp step-down from the prior period’s 3.2 percent pace. So, take out the inventory re-build and what do we have? Less than 1% GDP growth in 4Q.

The robust stock accumulation suggests the recovery will lose a step in early 2012.

Also pointing to slower growth, business spending on capital goods was the slowest since 2009, a sign the debt crisis in Europe was starting to take its toll.

Expectations of soft growth led the Federal Reserve on Wednesday to say it expected to keep interest rates at rock bottom levels at least through late 2014.

Fed Chairman Ben Bernanke said the central bank, which forecast growth this year in a 2.2 percent to 2.7 percent range, was mulling further asset purchases to speed up the recovery.

The Fed warned the economy still faced big risks, a suggestion the euro zone debt crisis could still hit hard.

“The Fed is attempting to shield the economy from a potentially more severe recession in Europe,” said Sweet. “Even though the economy improved last quarter there are a number of headwinds and a lot of uncertainty surrounding Europe, emerging markets and also U.S. fiscal policy.”

Treasury Secretary Timothy Geithner told the World Economic Forum in Davos the U.S. economy still faced big challenges.

“We’re still repairing the damage done by the financial crisis. On top of that we face a more challenging world. We have a lot of challenges ahead in the United States,” Geithner said.

Consumer spending, which accounts for about 70 percent of U.S. economic activity, stepped to a 2 percent rate from the third-quarter’s 1.7 percent pace – mostly driven by pent-up demand for motor vehicles. Take that out and you have a unsustainable 1% growth rate.

The Japanese earthquake and tsunami had disrupted supplies early in the year, leaving showrooms bereft of popular models.

Spending was also lifted by moderate inflation.

A price index for personal spending rose at a 0.7 percent rate in the fourth-quarter, the slowest increase in 1-1/2 years, after rising at a 2.3 percent pace in the July-September period.

A core inflation measure, which strips out food and energy costs, increased at a 1.1 percent rate after rising 2.1 percent in the third quarter.

The increase last quarter was the smallest in a year and put this measure well below the Fed’s 2 percent target. We need to become realists, not optimists. These prediction shortfalls are not healthy to the collective zeitgeist.

SLUGGISH INCOME GROWTH

Sluggish income growth amid an 8.5 percent unemployment rate, which has prompted households to tap savings and credit cards to fund their purchases, is expected to weigh on consumers as the new year unfolds.

The saving rate came in at a 3.7 percent rate in the fourth quarter, slowing from the prior period’s 3.9 percent pace.

“Though the unemployment rate has improved, the jobs market remains a major challenge. Part of the decline in the unemployment rate is due to the fact that … people have stopped looking for work,” said Adolfo Laurenti, deputy chief economist at Mesirow Financial in Chicago.

“The high level of people out of the workforce and underemployed people show there isn’t really much income generation to contribute to a better spending pattern.”

About 23.7 million Americans are either out of work or underemployed.

The shrinking labor force suggests the economy’s long-term growth potential has slipped below 2.5 percent.

A sustained growth pace of at least 3 percent would likely be needed to make noticeable headway in absorbing the unemployed and those who have given up the search for work.

Business spending grew at a sluggish 1.7 percent rate, pulling back sharply from the third-quarter’s 15.7 percent pace. WOW. 15.7% down to 1.7% – doesn’t that scare anyone?

Though exports held up despite slowing global demand, an increase in imports left a trade gap that sliced off 0.11 percentage point from GDP growth.

Despite an anticipated slowdown in growth this year, analysts do not believe the economy will fall into recession. Really???

“The United States has enough momentum to offset the losses coming from Europe,” said Laurenti. Come-on, Man.

Unseasonably mild winter weather helped home construction post its fastest growth pace since the second quarter of 2010, with much of the increase going to meet rising demand for rental apartments.

Spending on nonresidential structures fell. Government spending shrank for a fifth consecutive quarter, reflecting a large decline in defense and still weak state and local government outlays. Really uplifting news, eh?