Central Banks Snap Up Gold At Historic Levels

As confidence in fiat currency continues to wane, central banks have been increasing their gold holdings at levels not seen since 1964. The historic significance of 1964 was the shift in monetary policy by the US that resulted in increased money printing that preceded an explosion in gold prices. See the following post from Expected Returns for more on this.

As the fundamental flaws of major currencies become more apparent daily, investors around the world will take on a defensive posture and buy gold. The shift away from a fiat currency system centered around the dollar is well underway, and the window of opportunity to buy gold at reasonable prices is closing. From Bloomberg, Central Bank Gold Holdings Expand at Fastest Clip Since 1964:

Central banks added the most gold to their reserves since 1964 last year amid the longest rally in bullion prices in at least nine decades, data compiled by the World Gold Council show.

Combined holdings rose 425.4 metric tons to 30,116.9 tons, an increase worth $13.3 billion at last year’s average price, according to the data. India, Russia and China said last year they added to reserves. The expansion was the first since 1988, the data from the London-based council show.

Central banks, holding about 18 percent of all gold ever mined, are expanding their holdings for the first time in a generation as investors in exchange-traded funds amass bullion as an alternative to currencies. Holdings in the SPDR Gold Trust, the biggest ETF backed by the metal, are at 1,115.5 tons, more than the holdings of Switzerland.

“There’s clearly been a renaissance of gold in central bankers’ minds,” said Nick Moore, an analyst at Royal Bank of Scotland Group Plc in London. “It’s not just been central banks taking on gold, but a general shift for physical gold in the investment sector.”

In a clear sign of what lies ahead, central banks are adding to their gold reserves at the fastest rate since 1964. In 1964, Charles De Gaulle was calling for a sweeping change in the international monetary system in which the U.S. was allowed to print as many dollars as it wished without affecting its value, at least relative to gold. De Gaulle was, quite justifiably, concerned about the growing trade imbalances between the U.S. and the rest of the world.

Once Charles De Gaulle started exchanging his dollars for gold, central banks around the world started following suit, which led to the eventual breakdown of the Bretton Woods system in 1971. Gold promptly rose from $35 dollars an ounce to $850 dollars.

What's telling about this time period is that economists universally believed that an upward revaluation in gold was unlikely. Remember, most of these economists only understood the de facto gold standard system in which imbalances in trade had no consequences. Most people were caught off guard by the rampant inflation that followed in the next decade.

The same skepticism pervades today as most economists can not fathom a move away from the dollar as global reserve currency. Every economist alive today has only lived through a period when the U.S. was the dominant global player both economically and politically. As such, no one questions the primacy of the dollar, even though gold has already risen from $250 dollars to over $1120 dollars in a stealth debasement of the dollar.

The dollar will eventually be revalued relative to other currencies and gold; there is no other way out of this debt crisis. The only question is how severe this revaluation will be. With Bernanke leading the way, I'm pretty sure there will be a stampede out of the dollar eventually.

This article has been republished from Moses Kim's blog, Expected Returns.

Inflation Remains Low In February

During February, the US economy posted zero percent inflation due, in large part, to falling costs for energy and apparel. In keeping with trends already in progress, health care and education costs continued to climb, and the year-over-year inflation rate was 2.2 percent. See the following post from The Mess That Greenspan Made.

The Labor Department reported zero inflation for the month of February as rising prices for medical care and education were offset by sharply lower costs for energy and apparel. This comes after a 0.2 percent increase in January and marks the eleventh straight month that the price index did not drop after a series of steep declines beginning in late-2008.



On a year-over-year basis, the overall consumer price index was up 2.2 percent following an annual gain of 2.7 percent the month before, however, we may not have seen the last of rising annual inflation as recently higher gasoline prices are not reflected in the most recent data.

By category, it was a familiar story as health care and education costs continued their relentless advance while prices for many other goods again fell. The closely watched shelter component (within the housing category) was flat in February after a decline of 0.5 percent last month and is now down 0.4 percent on a year-over-year basis.


Energy prices were down 0.5 percent in February after an increase of 2.8 percent the month prior and are now 14.4 percent higher than a year ago. Last month, gasoline prices fell 1.4 percent but they are still almost 37 percent higher than last year at this time.

Recall that gasoline prices did not move much above the $2 a gallon mark last year until May, so there will be a few more months of big energy price increases in the period ahead.

This article has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Rising Debt to GDP Poses Risk To US Creditworthiness

In a recent statement, Moody's Investors Service, one of the leading bond rating agencies, offered a sobering reminder that the United States' AAA bond rating could be in jeopardy in the future. The increasing level of US debt as a percentage of GDP, coupled with the continuing decline in foreign purchasing of US debt instruments, increases the chances of eventual default. See the following post by Moses Kim from Expected Returns for more on this.

A debt default in America, implicit or explicit, is one of the more obvious things that will happen in the years ahead. I honestly don't think calling for a U.S. debt default is radical- it literally happens all the time, especially following banking crises. Smart investors are trying to figure out how to protect themselves from a coming default; foolish investors are sticking their heads in the sand, just as they always do. From the New York Times, Moody's Warns U.S. Debt Could Test Triple-A Rating:

The gold-plated credit rating of the United States — an article of faith across America and, indeed, around the world — may be at risk in coming years as the nation copes with its growing debts.

That sobering assessment, issued Monday by Moody’s Investors Service, provided a reminder that even Aaa-rated United States Treasury bonds, supposedly the safest of safe investments, could be downgraded one day if Washington failed to manage the federal debt.

Well said. The AAA rating of the U.S. is an article of faith, not logic or facts. There is no law that states that those on top remain on top. In fact, the world seems to be governed by a universal law that guarantees those on top do idiotic things that undermine their country. America is no different.

Below is a graphic that shows the rising debt to GDP ratios in Western economies. Debt to GDP ratios are one of the fundamental metrics to determine creditworthiness.



The Downgrade Effects

A downgrade would affect more than American pride. The bigger risk would be to the country’s ability to keep borrowing money on extremely favorable terms, and therefore to keep spending more money than it takes in from tax revenue.

A credit rating lets lenders and investors know how likely it is that a borrower can pay back a loan. A sterling rating means there is little for lenders to worry about. A lower one typically results in bond investors demanding higher interest rates on debt.

Those higher rates, in turn, add to the country’s overall debt burden and can force the government to reduce spending, increase taxes or both. That difficulty has been well-illustrated recently in Greece and Portugal, with strikes and protests as citizens march in the streets to oppose tough austerity measures that directly reduce entitlements and state benefits.

Without question, foreigners are trying to figure out how to unload their debt at the best possible price. China, the largest investor in U.S. Treasuries, continues to reduce their holdings of U.S. debt. The waning demand from foreigners can only be balanced by direct government monetization (inflation). Our government officials will downplay the risks to monetization and claim that falling demand for our debt is a minor issue since we can "grow" our way out of this debt crisis.

I'm sorry to ruin the party, but we're not growing our way out of anything, especially since this growth will be induced by government spending. Government spending has taken on a mythical quality as something that has helped us avert a Depression. Economists will have you believe the miracle (read: delusion ) known as the Keynesian multiplier effect will allow our economy to magically grow at a torrid pace to infinity- all we have to do is print money and spend it!

This is just plain fiction. Using housing as an example, I'll try to simply explain why government intervention does not work in the real world.

The government is heavily subsidizing the housing market through its various programs. There is no doubt the government has been successful in subduing mortgage rates, most notably through its direct purchases of agency debt. Curious minds will be asking why historically low mortgage rates coupled with heavily discounted prices are not having a measurable effect on housing. The simple answer is because these artificial mortgage rates are not a reflection of true market conditions (i.e. inflation, organic demand for bonds etc.). This means that loans at this level are simply unprofitable for banks. Think about it: by government decree, mortgage rates can be brought down to 0%. But what bank in their right mind would lend in that environment, and what knowledgeable investor would invest when the rules of the game are constantly changing?

Our government officials, who have no idea how the real world works, believe our economy is so simple that if you just tweak one input you will get a measurable output. You are seeing in real-time that this is not the case. Our economy is getting immeasurably worse due to foolhardy government intervention, and I have little hope that this will change.

To close, here's Peter Schiff on CNBC talking about the crisis in U.S. government debt. It's always a joy to hear some of the nonsense spoken by CNBC anchors.

This post has been republished from Moses Kim's blog, Expected Returns.

Housing Prices Are Not Simply A Function Of Supply And Demand

A recent report issued by Standard and Poor's asserts that the large quantity of delinquent or foreclosed properties on the market will likely undo any potential coming increases in housing prices. However the problem with this argument is that it is based on the assumption that price in the housing market is a function of supply when, in truth, selling price is a function of the amount of income available for borrowers to service their mortgage debt. See the following post by Sean O'Toole from Foreclosure Truth to learn more on this.

While I’ve previously written about the confusion around the term shadow inventory, it is now increasingly used to refer to properties that are delinquent, or in foreclosure, rather than unlisted bank owned homes. Standard & Poors recently posted a well written analysis of shadow inventory, and has jumped to the conclusion it will likely “undo U.S housing price gains”.

They estimate that the current backlog of distressed mortgages will take just under 3 years to clear. They call that estimate conservative… I think it is likely optimistic given that delinquency rates are still climbing. Still it is a reasonable guess. Here in CA we have one million homeowners who are already delinquent, and we seem to be clearing about 25-30k a month based on foreclosures and short sales (which are the only “solutions” that are actually clearing the distress by eliminating negative equity). Divide one million by 30k, and you come to the same 33 month conclusion they reach.

Another interesting part of the report deals with recently cured loans… those no longer delinquent, primarily due to loan modifications. They suggest that these should be included in calculations of shadow inventory, as they have had a nearly 70 percent rate of recidivism – in other words, most become delinquent again because the loan mod failed to address the core problem of negative equity. Seems like a reasonable conclusion to me.

Where I take some issue with Standard & Poors assessment is there conclusion that liquidation will lead to lower housing prices. They come to this conclusion based on the simple idea that an increase in supply will lower prices. There is some truth in that notion. For example we certainly have seen some pricing strength recently due to efforts to slow foreclosures which have clearly constrained supply, while at the same time demand has been stimulated with low interest rates and tax credits.

But this simple supply/demand theory of housing prices fails to adequately consider the fact that housing is highly leveraged, and that price is primarily a function of income and loan terms, and only secondarily supply and demand. Worse, this over-simplistic supply/demand model has led many to believe that foreclosures cause price declines, when in fact it is exactly the opposite… price declines cause foreclosure.

Note that the foreclosure crisis started in earnest in late 2006, however, price declines did not start until lenders removed the ridiculous loan products that enabled people to over pay in August of 2007. At that point we had a precipitous drop in price… not due to foreclosures, but instead due to the fact that people simply couldn’t afford the prices reached during the bubble without those loan products.

Foreclosures and housing supply grew rapidly during the price correction, but those who think the correction was due to either these foreclosures or the growing supply are terribly mistaken. Instead it was simply a correction back to reasonable prices, that buyers could afford based on their incomes and the more traditional loan products that remained available.

Unfortunately the belief that foreclosures and supply caused those declines remains all too common as yet again evidenced by the conclusion of this report. It is a belief that is delaying our recovery as government works to artificially constrain supply by slowing foreclosures, leaving homeowners stranded in prisons of debt, and buyers with little available inventory to choose from.

The reality is that there is a bottom to housing prices. People need a place to live and are willing to spend a certain portion of their income on housing to do so. Investors need to find returns, and there is a point where buying homes as an investment make sense. In many parts of California we’ve returned to those prices levels. And in those areas that have already corrected withholding supply won’t return prices to prior levels… people simply can’t afford it. And contrary to Standard & Poors’ analysis increasing supply is just as unlikely to cause further price declines… people need a place to live, and investors are too desperate for reasonable returns.

This post has been republished from Foreclosure Truth, a foreclosure news and analysis blog.

No End In Sight For Low Interest Rates

The Federal Reserve kept interest rates extremely low and suggested that this would not change anytime soon. The cheap money is causing anxiety, even within the Fed, as the Kansas City Fed President expressed concerns about building an expectation of low rates for an extended period. See the following post from The Capital Spectator.

The key phrases in today’s FOMC statement from the Fed in reference to the outlook for interest rates: “exceptionally low” and “extended period.” Almost no one expected a change from the current zero-to-0.25% Fed funds target, although there was speculation that the wording might change. Not so. Bernanke and his crew want it understood that they’re going to keep rates low for quite a while, and they really do mean it.

The vote in favor of maintaining the status quo for the target Fed funds rate was nearly unanimous. There was one dissenting vote from Kansas City Fed president Thomas Hoenig. Although he voted against the FOMC’s let ‘er ride policy, the FOMC statement vaguely suggested that the dissent was over wording rather than the actual target rate. Maybe, maybe not. Here’s how the Fed release explained the matter: Hoenig “believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to the buildup of financial imbalances and increase risks to longer-run macroeconomic and financial stability.”

Does this mean that dissent on the FOMC has been reduced to debating rhetoric vs. rates? Maybe. In any case, it’s a moot point. Rates continue to hover just above zilch in the U.S. and look set to stay there for, well, an extended period.

Is that warranted? Hoenig seems to have his doubts. So does Joseph Carson, chief economist at AllianceBernstein, who says the Fed’s internal forecast anticipates 4% GDP growth this year and in 2011. “That growth expectation eventually has to follow through to their rate policy," Carson tells CNNMoney.com. "Hoenig's arguments are well founded; staying at a 0% funds rate while the economy is starting to grow will eventually lead to imbalances."

Perhaps, although it’s not top-line GDP growth that’s the problem so much as it is the ongoing weakness in the labor market. That doesn’t give the central bank a pass, of course. Unusually low rates left to roll on for an “extended period” may cause trouble down the road, even if job creation remains weak. In fact, we’d be surprised to find that the cheap money doesn’t come back to haunt the economy at some point. That doesn’t make raising rates any easier given the labor market; nor does it ease the anxiety about keeping the price of money at near zero. But it does remind that there are no easy decisions at the moment in the golden age of easy money.

This post has been republished from James Picerno's blog, The Capital Spectator.

The Great Contraction In Credit Is Hurting Small Business

The inability for small business to tap the credit markets is playing a significant role in the continuation of the recession. This problem is likely to remain until a number of smaller banks, who have traditionally served the small business sector, work out the bad debt that is still carried on their books. See the following post from Expected Returns.

While our government continues to borrow at a torrid pace to keep this house of cards from collapsing, small businesses and average consumers are experiencing a tight credit environment. This trend must reverse or there is no way we will find our way out of this recession. From the WSJ, Lending Squeeze Thwarts Small-Business Rebound:

For a recovery to take hold, hundreds of thousands of small businesses must find the confidence to expand and create jobs. But when they get to that point, the local banks they depend on—worried about borrowers' financial strength, scrutinized by regulators and slammed by souring real-estate loans—might not be willing or able to provide the credit they need.

While big companies have been able to borrow in bond markets, smaller companies rely mainly on bank credit, which has been shrinking. In 2009, total lending by U.S. banks fell 7.4%, the steepest drop since 1942. In all, the credit pulled out of the economy by banks since the downfall of Lehman Brothers in September 2008 amounts to about $700 billion, more than double the amount so far distributed under President Barack Obama's $787 billion stimulus program.

Small businesses are no doubt feeling the effects of the unprecedented contraction in credit. However, perhaps more telling is the lackluster consumer demand that is justifying the tightness in credit. If small businesses were bringing in robust profits, banks would be lining up to offer them credit.

Commercial Real Estate Bust

Getting banks to lend more won't be easy, given the rising tide of defaults on loans made to finance housing developments, office buildings, shopping malls and other commercial real estate. Deutsche Bank expects banks to suffer at least $250 billion in losses on such loans, with about half coming in the next few years. Together with an estimated $250 billion in further charge-offs on home mortgages, that's more than double banks' current reserves against losses on all types of loans.

The stakes are particularly high for community banks, which tend to be much more active in commercial real estate than their larger counterparts. As of December 2009, such loans comprised about 42% of all loans held by the 7,344 banks with less than $1 billion in assets, compared to about 17% for the hundred or so banks with more than $10 billion in assets.

Banks know something we don't about the toxic waste on their balance sheets. We can infer from their risk aversion that they are sitting on some real lemons that will result in huge losses. From the graph below, you can see that excess reserves are still rising at an unprecedented rate.



Due to the weakness in commercial real estate, no small number of banks will go under. After 140 bank failures last year, we already have had 30 bank failures in 2010. Expect credit to become tighter in the years ahead.

"Vicious Cycle"

"It's kind of a vicious cycle," he says. "Anytime you're in an economic environment like we are, bankers are going to be more conservative."

One of bankers' main concerns is the damage the recession has done to many companies' finances. Values of real estate and other things small business owners can put up as collateral for loans have fallen so far, so fast, that many businesses have little to offer. Also, a year or more of losses have eroded the value of owners' stakes in companies, leaving less of a cushion against bankruptcy.

There are really only two types of economies- those that are growing, and those that are contracting. A contracting credit environment induced by falling asset values used as collateral is evidence of the latter. These types of negative feedback loops are hard to reverse, which explains why the economy remains so weak even with an endless supply of government stimulus.

The government's attempt to stimulate the economy at the small business level has been an abject failure. Ultimately, small businesses will recover when there is an increase in real demand. This will take some time since so many Americans are unemployed, and those that are employed are focused on paying off debt. Our economic leaders must come to grips with the fact that the great secular expansion in credit has turned into a mammoth contraction in credit. These contractions take decades to play out- just take a look at Japan.

This article has been republished from Moses Kim's blog, Expected Returns.

Americans Would Have To Double Income Tax To Close 2010 Deficit

According to the Tax Foundation, the government would have to more than double income taxes to close the 2010 budget deficit. While an extreme tax hike is very unlikely, these claims show the severe imbalance of government revenue and liabilities. See the following post from The Capital Spectator for more on this.

Supply side economics guru Arthur Laffer co-authored a book recently whose title is anything but subtle: The End of Prosperity: How Higher Taxes Will Doom the Economy--If We Let It Happen. This provocative title came to mind after perusing some freshly minted numbers from the Tax Foundation, which estimates what it would take to close the U.S. government’s fiscal 2010 budget deficit by adjusting federal income tax rates for individuals. That's not going to happen, of course. Not even close. But it's an interesting way to consider what we owe and what it would take to pay off the debt solely on the backs of individual tax payers--in one year. In this make-believe world, the adjustment, of course, would be an increase in tax rates, and by more than a trifling amount. So it goes when liabilities exceed revenue by something approaching biblical proportions.

One can debate the Tax Foundation’s assumptions, of course. And in the real world there are other means of closing the budget deficit. In fact, there’s no legal pressure to close it this year, or any time soon, for that matter. Economic reality imposes its own restrictions and limits, but that’s another matter. Meantime, here’s how the Tax Foundation summarizes its theoretical experiment:

Assuming deductions, exemptions and credits were kept the same as they are now, Congress would have to raise each personal income tax rate by a factor of almost two and a half to erase the 2010 deficit. Even in later years when the President's Budget predicts that the deficit will be "only" in the $700-to-$800 billion range, the rates necessary to close the deficit are untenable.

The CBO projects a budget deficit for fiscal 2010 of $1.3 trillion. According to the Tax Foundation, blotting out that red ink by way of higher personal income taxes—all in one year—would require more than doubling the current tax rates. For the upper income levels, a near tripling of the tax burden would be required, as the table below shows.



The chances of Congress raising tax rates to close the deficit in one year, much less having the President sign off on the idea, is about as likely as waking up on Saturn tomorrow morning. The Beltway boys and girls don’t usually favor politically self-destructive legislation. If anything, they’re partial to the opposite spectrum of legislative activity, which is part of what got us into this deficit trouble in the first place.

Yes, higher tax rates are coming, and may already be bubbling before they're formally announced, as we discussed last week. But higher rates are likely to come quietly in the night, as opposed to dropping out of the blue on Monday morning with a formal press conference announcing the change on the front steps of the Capitol. No doubt there'll be other changes, too, including cutting back on certain spending projects that lack a large and influential constituency, i.e., something other than Medicare, Social Security, etc.

In any case, the Tax Foundation’s quantitative “what if” review is a reminder of just how deep a hole that’s been dug and what it would take to climb out. Assuming we even try. History suggests that printing money is the political path of least resistance. And for good reason: it works, at least until the next election. And even then, there are limits, which is to say that it works until it doesn’t.

For the moment, the bond market has a high level of tolerance for fiscal impropriety. That’s largely a function of the political cover that flows from the deflation/disinflation blowback generated by the Great Recession. But tomorrow, as Scarlett once said, is another day. So too is what passes for tolerance.

This post has been republished from James Picerno's blog, The Capital Spectator.

The Jobs Bill: Too Little, Too Late

Although the government was able to move quickly to pass legislation to protect large financial institutions, is has, as of yet, not been able to pass legislation to create jobs. Congress' inability to pass the current jobs bill, as small as it may be, has been caused largely by partisan bickering and obstruction on the part of the minority party. See the following post from Economist's View.

Legislation designed to stimulate job creation has been under discussion for months, but so far there hasn't been any action. It was an emergency when the big banks were about to fail, and we managed to put legislation into place relatively quickly in response. But when millions of individual households are failing, households that in total are every bit as important to the economy as a large bank, the sense of urgency isn't there. The fact the these households are struggling to get by until jobs reappear, and that every day that goes by without a job is another day of hardship, doesn't seem to register with legislators who seem more interested in playing political games than in helping people. Now, after all this time -- when it's nearly too late -- a meager, $15 billion dollar jobs bill (and only part of it is devoted to job creation) is about to move forward, but Republicans are threatening to hold it up even longer. I can't give Democrats much credit for a bill that is way too small and way too late to do much good, this should have been done months ago, but Republican attempts to delay it even further (and to oppose measures such as extending unemployment compensation), are inexcusable:

Make 'em Filibuster, Jobs Edition, by Jay Newton-Small: The Senate is bracing for a possible all-nighter as leaders have thus far failed to reach an agreement on the Hiring Incentives to Restore Employment (HIRE) Act. You may remember this as Harry Reid's relatively small $15 billion jobs bill that he introduced after yanking the Baucus/Grassley deal. The House then passed an amended version, and Reid is now hoping to pass this deal and send it to President Obama this week to be signed into law.

As he did the first time around, Reid again has refused to allow amendments (if the bill were to be changed in any way it would have to go back to the House -- resulting in a game of ping pong that has entrapped some pieces of legislation for years). Republicans last time were incensed that they couldn't amend the bill but 13 of them ended up still voting for it on final passage. This time around they are refusing to allow the Senate to proceed to the legislation in protest... This is essentially a GOP filibuster... -- a procedural tactic that will require a 60-vote threshold for a bill everyone knows will pass (the first version passed 70-28) and 30 hours of debate. Usually, such debates are wound out during civilized daylight hours. But, if Republicans refuse to pass the bill tonight, Dems are preparing force them to stay in session all night. ... Not quite a real filibuster, but at least one potential night sans sleep.

This builds on Senator Jim Bunning's five-day one-man filibuster of unemployment benefits. Dems seem increasingly prepared to force Republicans to publicly block popular, bipartisan jobs bills to demonstrate the degree of logjam in the Senate. Republicans, meanwhile, are accusing Dems of playing politics with important legislation. But if this "filibuster" goes anything like Bunnings', Democrats are coming to the table with the upper hand.

This post has been republished from Mark Thoma's blog, Economist's View.

The Economic Recovery Fairy Tale

Although many government sources have claimed that the economy has been in a recovery period, Moses Kim argues that the economy is an weakened state. Areas of concern are the ongoing government budget deficits, high levels of foreclosures, and low levels of optimism among small business people. See the following article from Expected Returns for more on this.

The propaganda about an economic recovery is reaching epic levels. It has gotten to the point where the government must conjure up ridiculous excuses for our economic perils, such as the pernicious phenomenon known as.... winter.

By my calculations, the phantom economic recovery has been dragging on for a year. In that time frame, economic conditions have clearly worsened. Fundamentally, and perhaps most prosaically, there are no jobs. Yet we are to believe the economy has recovered simply because the government says so. It baffles me that anyone still listens to the same people who led us off the cliff in the first place.

Recent economic reports suggest that the economy is still weak, and that this weakness is likely to persist.

Record Monthly Budget Deficit

The government just announced a record $221 billion dollar deficit for February, which brings the total deficit for the first 5 months of the fiscal year to $651.56 billion dollars. This puts us well on track to exceed last year's record $1.4 trillion dollar deficit. There is no doubt in my mind that we are on our way to fiscal ruin.

Government spending is fine as long as it helps the average person without imposing burdens on the taxpayer that exceed benefits. Unfortunately, the government has irresponsibly spent trillions of dollars of taxpayer money with the only measurable effect being outsized bonuses for bankers. Of course these bonuses were well-deserved, since according to Obama, resident banking gurus Dimon and Blankfein are "savvy investors." Sureeee. Savvy investors that can't survive without billions of dollars in implicit and explicit government guarantees. But I digress.

Foreclosures Slowing?

The latest spin is that foreclosure filings are increasing at a slower rate. Foreclosures were only up 6% from last year in a clear sign that "green shoots" are sprouting left and right.

While the 308,524 foreclosure figure is pretty horrific historically (for some perspective, 405,000 households lost their homes in 2007), the figure is actually skewed since many of the 1 million homeowners who qualified for a temporary modified mortgage under the Home Affordable Modification Program (HAMP) will not receive permanent modifications. We should be seeing many of these homes hit the market in the months ahead.

Unemployment Remains Elevated

Today the Department of Labor announced that 462,000 individuals filed for initial unemployment claims. The 4-week average increased by 5,000 to 475,000 in a sign that the unemployment picture remains weak.

Small Businesses Remain Bearish

The index of small business optimism fell in February to 88, with small business owners citing poor sales as their main concern. Due to the weak sales environment, more firms announced plans to cut jobs than to add jobs.

The optimism index has held below 90 for an unheard of 17 straight months, which in the past has suggested a recessionary environment.

It's logical to pay attention to what small business owners are saying, especially since they are responsible for over half of the employment in America. Because of their effect on hiring in America, and since in the real world a recovery cannot occur without an increase in hiring, small business owner sentiment serves as a reliable leading indicator.

At the very bottom of the 1982 recession, a net 47% of small business owners saw improving business conditions ahead. Currently, a net -9% see improved business conditions in the months ahead. It's pretty clear that the outlook is bearish on main street.

The fairy tale that our economy is improving truly defies logic. While another round of "less bad" economic statistics can potentially create the illusion of a recovery in the months ahead, I believe by the end of 2010 and into 2011, it will be nearly impossible for anyone (besides the government) to deny that we are in one serious economic downturn.

This article has been republished from Moses Kim's blog, Expected Returns.

Economists Confused On Cause Of Recession

If you ask economists what caused the recent recession you will likely get a wide range of different explanations that often reflect the economist's own world view. This disagreement makes it especially difficult to prevent the same scenario from happening again. See the following post from Economist's View for more on this.

Robert Shiller:

A Crisis of Understanding, by Robert J. Shiller, Commentary, Project Syndicate: Few economists predicted the current economic crisis, and there is little agreement among them about its ultimate causes. So, not surprisingly, economists are not in a good position to forecast how quickly it will end, either.

Of course, we all know the proximate causes of an economic crisis: people are not spending, because their incomes have fallen, their jobs are insecure, or both. But ... where and why did it start? Why did it worsen? What will reverse it? It is to these questions that economists have been unable to offer clear answers.

The state of economic knowledge was just as bad in the Great Depression that followed the 1929 stock market crash. Economists did not predict that event, either. ...

Late in the Great Depression, in August 1938, an article ... in The Christian Science Monitor reported an informal set of interviews with US “professors, banking experts, union leaders, and representatives of business associations and political factions,” all of whom were given the same question: “What causes recessions?” The multiplicity of answers seemed bewildering, and did not inspire confidence that anyone knew what was causing the deepest crisis of capitalism.

The causes given were “distributed widely among government, labor, industry, international politics and policies.” They included misguided government interference with markets, high income and capital gains taxes, mistaken monetary policy, pressures towards high wages, monopoly, overstocked inventories, uncertainty caused by the reorganization plan for the Supreme Court, rearmament in Europe and fear of war, government encouragement of labor disputes, a savings glut because of population shrinkage, the passing of the frontier, and easy credit before the depression.

Although economic theory today is much improved, if we ask people about the cause of the current crisis, we will mostly get the same answers. We would certainly hear some new ones, too: unprecedented real-estate bubbles, a global savings glut, international trade imbalances, exotic financial contracts, sub-prime mortgages, unregulated over-the-counter markets, rating agencies’ errors, compromised real-estate appraisals, and complacency about counterparty risk.

More likely than not, many or most of these people would be mostly or partly right, for the economic crisis was caused by a confluence of many factors, the chance co-occurrence of a lot of bad things...

Consider the question of predicting events like the January 2010 earthquake in Haiti, which killed more than 200,000 people....[I]f one went beyond trying to predict the occurrence of earthquakes to predicting the extent of the damage, one could surely devise a long list of contributing factors – including even political, financial, and insurance factors – that resembles the list of factors that caused the global economic crisis.

Indeed, the crisis knows no end to the list of its causes ... in a complicated economic system that feeds back on itself in many ways...

Weather forecasters cannot forecast far into the future, either, but at least they have precise mathematical models ... derived from the theory of fluid dynamics and thermodynamics. Scientists appear to know the mechanism that generates weather, even if it is inherently difficult to extrapolate very far. ... The mathematical models that macroeconomists have may resemble weather models in some respects, but their structural integrity is not guaranteed by anything like a solid, immutable theory. ...

Unfortunately, in 800 years of financial history, there is only one example of a really massive worldwide contraction, namely the Great Depression of the 1930’s. So it is hard to know exactly what to expect in the current contraction...

This leaves us trying to use patterns from past, dissimilar crises to try to infer the likely prognosis for the current crisis. As a result, we simply do not know if the recovery will be solid or disappointing.

Amazing - a whole column and not a single mention of his book. But that may be because after arguing that we don't know the cause of the crisis, it's kind of hard to promote a book that explains what caused the crisis:

As George Akerlof and I argue in our recent book Animal Spirits, the current financial crisis was driven by speculative bubbles in the housing market, the stock market, and energy and other commodities markets. Bubbles are caused by feedback loops: rising speculative prices encourage optimism, which encourages more buying, and hence further speculative price increases – until the crash comes.

Part of the confusion is the failure to distinguish between the question of what caused the crisis and the factors that made it much worse once it occurred. But it is rather striking that if you ask a simple question, "what is the single most important factor in explaining why the crisis happened," there is very little consistency in the answers given by economists. I find it a bit disturbing that, even after this much time to figure it out, there is little consensus on what caused the problems. Worse, those that hate government seem to find government at fault, those that think that the deregulation movement that began in the 1970s was an error point to regulatory failures, and so on, and so on.

The fact that the evidence always seems to confirm ideological biases doesn't give much confidence. Even among the economists that I trust to be as fair as they can be -- who simply want the truth whatever it might be (which is most of them) -- there doesn't seem to be anything resembling convergence on this issue. In my most pessimistic moments, I wonder if we will ever make progress, particularly since there seems to be a tendency for the explanation given by those who are most powerful in the profession to stick just because they said it. So long as there is some supporting evidence for their positions, evidence pointing in other directions doesn't seem to matter.

The economics profession is in crisis, more so than the leaders in the profession seem to understand (since change might upset their powerful positions, positions that allow them to control the academic discourse by, say, promoting one area of research or class of models over another, they have little incentive to see this). If, as a profession, we can't come to an evidence based consensus on what caused the single most important economic event in recent memory, then what do we have to offer beyond useless "on the one, on the many other hands" explanations that allow people to pick and choose according to their ideological leanings? We need to do better.

This post has been republished from Mark Thoma's blog, Economist's View.