Financial hurricane brewing In South Florida, we are accustomed to hearing about hurricanes and usually – well at least sometimes – we take notice of the impending danger. The usual fare in South Florida is sunshine and warm weather. It draws lots of tourists and businessmen awash in money. We have abundant wealthy retirees, trust babies living on accounts set up by former family members, and a great number of 30 - 50 year olds who have made a fortune somewhere else and have moved to the Sunshine state. They all seem to ignore problems plaguing the rest of the country, so they continue to buy luxury automobiles, dine in fine restaurants and enjoy the good life. But there is danger brewing – danger of gigantic proportions – not far ahead. Those who do not participate actively in the financial news on a daily basis – like Pompano Beach city officials (and especially those preparing the FY 2009 budget) – should take notice, because a serious financial hurricane is brewing and will start making landfall this year. Local taxpayers should be just as concerned because city bureaucrats may set up a formula to spend tax dollars, but it’s your money, your community, and your future that they’re screwing around with. The spending that has taken place in Pompano during the past eight months would be akin to the spending level that takes place by the inebriated US Navy sailors during Fleet Week in Fort Lauderdale. Brian Donovan, chief budget officer and assistant to City Manager Keith Chadwell, told me this year’s budget will be challenging because of the expected lack of funding of uncertain proportions. There is a good chance that the City could be faced with eliminating services, and will certainly have to cut back on hiring. It may have to ask for salary reductions. The unions will have a field day with that, and I wonder if our commissioners will set the example. McGinn was the only one who ‘needed’ commission pay, so I suppose it is now at least in the realm of possibility. Around other areas in the state, the facts are already into play and are being dissected and analyzed. The state’s budget is being cut $512 million, while Broward County’s budget is being trimmed by $100 million. What the figure will be in Pompano Beach is anyone’s guess. Wasteful spending and unnecessary contractual services have been a mainstay of my column in recent weeks. Employees’ salaries and new hires are a major component of recent fiscal irresponsibility. This series has not gone unnoticed by residents. “It’s unacceptable that city hall officials had not taken any action to the findings of special contracts and the excessive costs associated with them,” said Bill Carlson, an Atlantic Blvd businessman. “Where is their level of responsibility and what action do they plan to eliminate these abuses? I don’t comprehend their lack of understanding of those words in your columns,” he told me. “Words are dangerous as well as useful,” wrote Aldous Huxley in his essay, A Few Well-Chosen Words. He continued, “&ldots; they have made it impossible to think except in terms of language.” “Unfortunately, government at all levels, can be cancerous and the cancer can spread to all departments." When you think about it, I believe in Pompano Beach there has been a massive failure of outrage,” Carlson said. “I don’t understand why others can’t see it, or if they do, why they haven’t hammered the city commission for its lethargic inaction.” This looming financial crisis is not only hanging over Pompano Beach, but also over the whole nation. For those of you who don’t keep up with complicated financial news, market conditions are the worst anyone in the industry can ever remember and nobody has a recollection of a total disappearance of liquidity. There are billions (maybe trillions) of dollars worth of assets out there for which there is just no market. That won’t stop governments from taxing those phantom values and in Pompano Beach that will ultimately mean residents will pay more taxes than they should. If we face reality, there will be a forced reduction in the revenue stream, which in turn means officials will need to pay close attention to where the money will come when preparing the upcoming FY 2009 budget. This strengthening hurricane began brewing with subprime mortgages, and has swept through the credit markets, wreaking havoc on municipal bonds, hedge funds, complex structured investments, and agency debt (such as Fannie Mae). Now the first gusts from the gales are touching down in the real economy where the damage is expected to be widespread. Conditions that we are all accustomed to living under have changed and probably won’t return in our lifetime. Again, that’s why we need to be prepared to take a serious look at the FY 2009 Pompano Beach budget and grapple with the problems. All retirees are not completely aware of the current problems and while younger residents are busy living the dream, many face complete financial annihilation due to circumstances beyond their control. Housing is in its deepest, most rapid downswing since the Great Depression, and the downward momentum on housing prices appears to be accelerating. Fuel and food costs, taxes and cost of living are escalating while unemployment continues to grow. Nationally, home sales are down 65 percent from their peak in 2005. Inventory is stacked a mile high. Vacant homes now number about 2 million, an increase of 800,000 since 2005. Demand is weak and prices are plummeting. The US Labor Department has reported employers cut 63,000 jobs in February, the biggest monthly decline in five years. The cut in payrolls added to the 22,000 jobs that were lost in January. Fifty-two thousand jobs were cut in manufacturing, while 331,000 have been lost in construction since September 2006. When productivity is off; labor costs go up, which adds to inflationary pressures. That makes it harder for the Fed to lower rates to stimulate the economy without inviting the dreaded “stagflation” – slow growth and rising prices. The news on commercial construction is equally bleak. The Wall Street Journal reports, “For the second month in a row, the Commerce Department reported a decline in spending on nonresidential construction” – which includes everything from hospitals to office parks to shopping malls. As credit markets have tightened, office space sold in the fourth quarter dropped 42 percent from a year earlier, and sales of large retail properties declined 31 percent. If spending continues to slow, construction workers, who are reeling from the housing slowdown, face more layoffs. Commercial real estate is the next shoe to drop. There’s a tremendous oversupply of retail space nationwide and the bloodletting has just begun. Like lemmings rushing to the sea, builders have continued to put up shopping malls and office buildings, seemingly oblivious to the fact that residential real estate has fallen off a cliff. Now battered banks will have to repossess thousands of empty buildings in strip malls with no chance of leasing them out in the near future. It’s a disaster. From December 2007 to January 2008 spending on commercial construction took its steepest drop in 14 years. The sudden downturn is adding more and more people to the unemployment lines. So, what does it all mean? Unemployment is up, productivity is down, inflation is increasing, the dollar is under water, commercial real estate is in the tank, and the country is sliding inexorably into recession. One thing for sure is that Pompano Beach is dead center of its own pending financial hurricane. While recently reading financial newsletters, I noticed that banking giant USB reported credit woes that will end up costing financial institutions $600 billion, three times more than their original estimate of $200 billion. But that forecast does not take into account the $6 trillion of lost home equity, if housing prices fall another 30 percent in the next two years, which is very likely. Nor does it account for the potential losses in the structured finance market where $7.8 trillion of loans (which are presently in “pooled securities”) have gone into a deep freeze. There’s no way of knowing how much capital will be drained from the system by the time all of this plays out, but if $7 trillion was lost in the dot.com bust, then it should greatly exceed that figure. As the number of foreclosures continues to soar, the aversion to risk will intensify, triggering a savage unwinding of leveraged bets in the hedge funds as well as a wider paralysis in the financial markets. There’s absolutely no doubt now that the storm that is currently ripping through the financials will soon bring Wall Street to its knees. It may be a good time to remember that on March 24, 2000, the NASDAQ peaked at 5048. On October 9, 2002, it bottomed out at 1114; a loss of nearly 80 percent. Could it happen again? You bet. Many expect to see the Dow hovering around 8,500 by year’s end. Whoever ends up, as President, won’t make any difference. The Wall Street Journal also ran an article two weeks ago that outlined how the banks changed standards at the Basel meetings in Switzerland to give them greater autonomy in deciding issues that should have been governed by strict regulations: “Some of the world’s top bankers spent nearly a decade designing new rules to help global financial institutions stay out of trouble. Their primary tenet: Banks should be given more freedom to decide for themselves how much risk they should take on, since they are in a better position than regulators to make that call.” [“Mortgage Fallout Exposes Holes in New Bank-risk Rules,” Wall Street Journal] It is a classic case of the foxes deciding they should oversee the henhouse. The Basel Committee on Banking Supervision is an industry-led group comprised of the central bank governors from the G-10 countries: Belgium, Canada, France, Italy, Japan, the Netherlands, Sweden, Switzerland, Britain and the US. Basel is supposed to establish the rules for maintaining sufficient capitalization for banks so that depositors are protected. But it’s a sham. It appears to be more focused on maintaining US and European dominance over the developing world and making sure the levers of financial power stay in the manicured hands of Western banking mandarins. Now that the financial system is in terminal distress, many people are questioning the wisdom of handing over so much power to organizations that don’t operate in the public interest. Thomas Jefferson anticipated this scenario and issued a warning about the perils of abdicating sovereignty to un-elected, profit-oriented bankers. He said, “If the American people ever allow private banks to control the issue of our currency, first by inflation, then by deflation, the banks and the corporations that will grow up will deprive the people of all property until their children wake up homeless on the continent their fathers conquered.” Read the financial pages – the FDIC has begun to increase staff at many of its regional offices to deal with the anticipated rash of bank failures in states hardest hit by the housing bust. California, Florida, and parts of the southwest will definitely need the most attention. These states are undergoing a housing depression and many of the smaller banks, which issued the mortgages and commercial real estate loans, will get hammered. They simply do not have the capital cushion to withstand the tsunami of defaults and foreclosures that are coming. Depositors should make sure that all their savings are covered under FDIC rules; no more than $100,000 per account. Remember – money markets are not insured. With oil, gold and food prices soaring, the Fed has been roundly criticized for cutting rates and risking further erosion to the value of the dollar. We are at the beginning of a consumer-led recession; characterized by weakening demand, lack of personal savings, declining asset-values (particularly homes) and over-indebtedness. The Fed’s increases to the money supply via low interest rates will not affect the dramatic economic slowdown that will be evident within the year. Trillions of dollars of derivatives, over-leveraged subprime assets, and otherwise bad bets are all unwinding at the same time, draining an ocean of virtual capital from the economy. If credit keeps getting destroyed at the present pace, the country will be in the grips of a depression-like slump before the end of the year. Temporary price increases are not the result of shortages, nor of increased production costs, nor of fundamentals, but rather because of speculation. If there is a ray of sunshine, demand for petroleum products has been down by 3.4 percent over the last six weeks compared to the same time last year, which means that prices will probably drop steeply once the commodities frenzy runs out of steam. Investors are simply looking for somewhere to put their money rather than in shaky corporate bonds or overpriced equities. Commodities are the logical alternative. But as soon as consumer spending stalls, all asset-classes will fall accordingly, including gold and oil. (And, yes, the dollar should recover some lost ground, however temporary.) Regardless, greed and ideology can win over sound advice. The result is a crisis that, if mishandled, will be calamitous. Pompano Beach bureaucrats need to pay attention and be prepared. The gravy train, they have been used to, has run out of track.