Professor Mulligan: A Housing Recovery Is Inevitable

A steady stream of mostly positive data over the past 90 days is convincing more academics and analysts that the housing bust has reached its conclusion. Chicago economic professor Casey Mulligan writes in the New York Times that the current data suggests that a housing recovery is basically inevitable. Dan Rafter from Mortgage Roadmap has more.

A growing number of economists are joining the chorus: A housing recovery has begun.

To that, we can all add a hearty "Hallelujah!"

The latest economic type to opine that the housing recovery is now in progress is University of Chicago economics professor Casey Mulligan. In a column printed in the New York Times, Mulligan says that all the latest reports on housing starts, home sales and housing prices point to the beginning of a housing comeback.

Mulligan says that basic laws of supply and demand pretty much made a recovery an inevitability. For instance, the U.S. population has continued to grow. At the same time, homebuilders during the housing slump basically stopped building new homes. This leads to an increased demand. Sure enough, housing starts have finally begun to rise again.

As demand for housing increases, Mulligan says, we'll finally see housing prices stop their steep fall. This will lead to an eventual rise in national housing prices again. Mulligan does say, rightly so, that housing prices will not return to their 2005 levels. But that was the height of a very unsustainable period of housing-value appreciation.

Reading a column like this is a soothing way to start your morning. Much of my income is tied into the housing industry because I write for several publications that cover the mortgage and real estate businesses. I'm thrilled to see things finally start to improve.

Personally, I'll know that the housing slump is history once all those real estate trade magazines begin assigning me stories on a regular basis again.

This article has been republished from Mortgage Roadmap.

Unemployment Danger Still Hasn't Passed

Unemployment is still rearing its ugly head as the initial jobless claims increased slightly at the end of July, giving more credence to a jobless recovery. What does the uptick in unemployment mean for the prospects of economic recovery? James Picerno from The Capital Spectator has more on this.

Today's update on initial jobless claims reminds that the threat of economic contraction isn't vanquished. There's been progress, but the dark forces of decline are still lurking.

For the week ending July 25, the advance figure for seasonally adjusted initial claims was 584,000, an increase of 25,000 from the previous week's revised figure of 559,000. A rise in new fillings for unemployment benefits is unsettling at this precarious stage in the economic cycle. Still, there's nothing in today's numbers that convinces us to alter our view that the technical end of the recession is near. For the moment, last week's jump looks like statistical noise.

That's not to say that all danger has passed—it hasn't. But as our chart below reminds, the general trend in initial jobless claims remains one of decline. Then again, let's not forget that new filings have risen for two weeks running, albeit off of a relatively low base by the standards of this year. Another week or two of this behavior and it may be time to rethink our otherwise favorable outlook that the cycle's trough is unfolding right about now. We'd become more anxious if initial claims jumped above 600,000 in the coming weeks.



Meantime, weekly jobless claims are still signaling that the recession is about to end, if it hasn't already. Having peaked back in March at 674,000, the decline since then suggests that the worst of the economic contraction is behind us. Then again, history is only a guide, not a guarantee.

There's only one way to resolve the debate of whether we're past the worst of this recession: More data. Jobless claims have been suggesting for several months that there's light at the end of this tunnel. The only question is timing. The numbers of August, it seems, will be critical.

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

Top 5 Short-Term Real Estate Investments

Although real estate investment often requires a long-term view, the recent chaos in property markets throughout the world have produced some attractive opportunities for short-term return. Liam Bailey recently shared his top 5 short-term real estate investments at Overseas Property blog.

1. Repossessed Properties in Florida

Some people frown on what they see as profiteering from other people’s misery, but the way I see it is: these properties have already been repossessed and whether someone buys them or not the banks are not going to sympathetically give them back to their original owners. That aside we can look at the potential profit.

Florida has always been a massively popular place with overseas property buyers, but in recent years property had become so expensive that it was out of reach for most people. Florida in the present reality has been one of the worst affected regions by the housing crisis in the US and there are currently thousands of repossessed properties being sold at up to 50% less than their market value.

3, 4 and 5 bedroom (mansions) villas with private pools; the properties that you or I could only dream of are now within reach of the masses. Buying a property with 50% instant equity leaves buyers with only one question: will they ever regain their market value. In Florida’s case the answer is a resounding yes.

When we can talk about the international downturn and housing crises in past tense once and for all, Florida will regain its popularity with international buyers, and as things recover Florida residents will once again be buying houses in the normal way.

This isn’t going to happen overnight, the property is not going to regain its market value immediately after the recovery. But 2-3 years down the line you should be able to resell quite easily for a 20-30% profit, and possibly more and sooner on the particularly special properties in the most popular areas.

2. Repossessed Properties in Spain

These are pretty much the same as Florida; Spanish properties being sold at up to 50% less than their market value.

In Spain’s case though, the question of whether they will regain their true value needs to be looked at more closely. Spain was massively over-developed in the last few years; at the height of the boom more properties were built in Spain than in Italy, the UK and Germany put together. This has translated to massive over-supply problems that will plague the Spanish market for many years to come.

You simply need to consider who is going to buy the property from you when it is time to sell. If you are buying in one of the areas most popular with expats, and plan your exit strategy based on expatriate buyers, then you must avoid the most over-developed areas; sunbathing is not a spectator sport, and most people will want a half-decent view on at least one side of their holiday properties.

Negatives out of the way: Spain remains one of the most popular countries with overseas property buyers. Several major portals have put it in the top 5 most popular in the last few months, including Property Abroad.com (2nd, 1st in May), The Move Channel (2nd) and Prime location (2nd), and this is expected to start turning back into sales by the end of the year. So if you choose carefully, you should be able to resell a property you buy now for at least a 30% profit in 2-4 years.

3. Repossessed UK Property

You wouldn’t expect to find me recommending the UK for property investment, as I usually favor emerging markets. But over the long-term UK house prices are on an upward trend, and during the last boom prime properties, especially in London grew in value faster than emerging market property. The problem was it was out of reach of most people then.

Now that the downturn has caused thousands of UK properties to be repossessed, you can get some real bargains that are almost guaranteed to be worth their true market value within 5 years. That means a profit of 30% - 50% in five years depending how big a bargain you get.

Repossession became such a big problem in the UK that we attracted the major US repossessed auction house, the Real Estate Disposition Group, REDC, who have come to stack our properties high and sell em cheap. However I went to one of their auctions and wrote an article for First Time Buyer magazine comparing REDC to the other UK auction houses selling repossessed property, and found that the latter offered the biggest bargains.

4. Luxury Off Plan Property in Emerging Cities

Off plan property in emerging markets is usually sold at a discounted price, in lieu of the potential risk that exists when buying a property that only exists on paper. So, this always meant that potentially a profit could be made on the property immediately after its completion. This is why so many people got stung in Dubai; people were buying off plan property and then selling it weeks later for a profit, as prices grew exponentially the potential profit when the properties were completed was immense, until it emerged that some would never be completed and those left holding the hot-potato got their fingers burned.

The purchase of property off plan has been marred by the sudden onset of the international credit crunch, but if you do your own due-diligence and go to great lengths, it is still potentially one of the most profitable investments around.

Suggested steps to take include several trips to the country to make sure that the development is not funded by proceeds from off plan sales, research the developers’ track record and make sure that all the proper permissions are in place and that building is kept to what is permitted.

Buying an absolutely luxurious off plan property, i.e. a penthouse overlooking a waterway, in an emerging city like Kuala Lumpur, Rio de Janeiro or Panama City has the potential to grow in value immensely, both upon completion and as the city grows apace during the international recovery.

5. Off Plan Luxury Resort Property in Emerging Tourism Destinations
Some people will find it unbelievable that I have included this, because it is these that many of the people who lost out to the crunch had put money into. This is because on these investments you are putting all your eggs in one basket; you are reliant on foreign buyers when it comes time to sell.

For the people who tried to resell their properties off plan when the crunch set-in, it was worse; they were reliant not only on foreign buyers, but on foreign investors, which had all but disappeared.

Even at the worst point in the downturn, popular tourism markets like the Turks and Caicos were being kept afloat by foreign lifestyle buyers, who have remained active throughout. Lifestyle buyers are of course looking for completed property, not off plan.

That said, with high risk comes high reward: when you invest in a luxury resort property off plan in an emerging tourism market, you are buying a very special property at a knock down price. When it is completed it will be a high luxury property on a world class resort, which in a few years may well also be a world renowned resort. If you buy such a property now, you should be able to sell to a lifestyle buyer for at least twice what you paid when the resort is established 5 years down the line.

Article written by Liam Bailey of Property Abroad.com

This article has been republished from Overseas Property Blog, an international real estate investment blog.

The Flaw In The Government's Mortgage Modification Program

Although the government has attempted to help homeowners stay in their homes by modifying their mortgage, this has done little to slow the flood of foreclosures. Andrew from the blog Blown Mortgage explains a critical flaw in the government's loan modification program. Continue reading to learn more:

Despite the governments efforts to provide loan modifications for individuals and families in financial difficulties that are at risk of foreclosing on their loans the mortgage aid seems to be moving too slow for all the families to benefit from it.

This has made many experts to question why banks are moving so slowly to take advantage of a program that is designed to help both the borrower and the lender. The idea is that mortgage modifications benefit both borrowers and lenders as they allow banks to receive payments they would not get if the mortgage foreclosed in a buyers market where the security (normally the house itself) is in negative equity.

However recent research quoted in today´s Washington Post indicates that this only holds true with a certain kind of borrower, the type of borrower that truly can´t pay the monthly mortgage payments at the current level but would be able to pay them if the monthly payments were reduced. This is only one of three types of borrowers though. It seems that with the other two types of borrowers, loan modifications are just not cost effective.

These two types comprise:

1) Borrowers that are in such financial strife that no loan modification or mortgage refinance is going to help in the long run, ultimately they are going to have foreclose their loan.

2) Borrowers that can meet the payments even though this might mean serious financial difficulties, even losing their life savings.

Banks and lenders have little incentive to help either of these demographics of borrowers.

To illustrate imagine if you were a lender, a bank or even a private company that provided loans for a profit. Obviously you demand some sort of security to protect your investment in case the borrower cannot or will not pay, this could be jewelry, thee deeds of a property or a car. Then one day the borrower tells you he is going through financial hardship and needs a break in his payments, a reduction in his debt or his monthly payments. However you realize that this borrower is not going to be able to pay his loan whether you help him now or not. Negotiating with him now is just going to cost you money in time, work and whatever reduction or break you provide for his loan. On the other hand you could simply foreclose his loan and claim the security without losing nearly as much. What would you do?

Even the kindest philanthropic can see the negative incentive that such a lender would have to actually negotiate a solution with the borrower.

Could this explain why loan modifications are moving so slowly despite the huge incentive programs the government is providing to encourage loan modifications on mortgages that risk foreclosure.

It seems that Obama´s administration has also seen this flaw in their system and is currently negotiating with banks for further incentives for the provision of loan modifications to the most vulnerable borrowers.

This article has been republished from Blown Mortgage, a mortgage news and analysis site.

More Good Numbers From The Housing Market

Dan Rafter at Mortgage Roadmap describes recent numbers that suggests that housing is on the path to recovery. Although it is too soon to tell, June sales numbers in the US are encouraging. See the following post for the latest numbers.

You can practically hear the real estate agents screaming for joy. Yes, there is yet more evidence today that the housing market is in the midst of a recovery. Yes, it's early in the process. And, yes, again, it's still a fragile recovery. But it is a recovery, and that means that real estate agents may soon be seeing fatter paychecks.

Of course, consumers aren't too concerned about whether real estate agents make enough money to take that winter trip to Hawaii. They're more concerned about whether they can sell their homes and if they can sell them for a high enough figure. According to the Associated Press, housing prices are still suffering when compared to last year. But they are rising fairly steadily. Home sales, too, are increasing in most parts of the country.

Here's the good news in a nutshell: According to the Associated Press, home sales rose 3.6 percent to a seasonally adjusted annual rate of 4.89 million last month. That's up from a pace of 4.72 million recorded in May. And the sales increases were spread out; they were up in all four regions of the country.

If you're really looking for reason to cheer, June's home sales were as high as sales had been since way back in last October.

Housing prices are still a bit weak. The median sales price of an existing home stood at $181,800 in June. That's down 15 percent from a year ago. However, it is up a bit from the $174,700 median sales price that we saw in May.

Of course, it's not time to get too excited yet. We need to see several more months of this. We also need to see home values continue to increase. Talk to me next winter. Then we'll see just how strong this particular recovery is.

This post has been republished from Mortgage Roadmap.

Home Price Index Increases For The First Time In 3 Years

According to the S&P Case-Shiller Home Price Indices, US real estate prices increased for the first time since the housing decline started. Could this mark the turning point in the housing market? See the following article by Tim Iacono on the latest numbers on US real estate prices.

The May report(.pdf) for the S&P Case-Shiller Home Price Indexes showed the first monthly increase in three years, however, prospective home buyers and sellers should heed whatever few warnings they might hear today about reading too much into monthly data, especially around this time of the year.



"One month does not a trend change make" and this reality is quite easy to see in the chart above where there were many monthly price decreases prior to all 20 cities putting in their price peaks between 2005 and 2007.


For example, after a long string of monthly gains, Portland reported its first monthly price decrease in October of 2006 but didn't reach a peak until the following May - look for a similar occurrence as the beginning of a home price bottom starts to take shape.

From April to May, the 20-city index rose 0.5 percent while the 10-city index rose 0.4 percent, however, you can see in the chart below that there is a strong seasonal component to the data, monthly price changes improving around this time of the year regularly - look for more of the same in next month's report.



Conversely, price declines have their strongest seasonal influence during the winter, so, it will probably take another six or eight months to see another complete cycle for this pattern.

As shown below, both Los Angeles and San Diego have fallen out of the group of cities with annual price declines of 20 percent or more (indicated in blue) while Phoenix and Las Vegas improved only marginally, both maintaining 30+ percent declines as indicated in red.



David M. Blitzer, Chairman of the Index Committee at Standard & Poor's notes:

The pace of descent in home price values appears to be slowing. There is a clear inflection point in the year-over-year data, due to four consecutive months of improved rates of return, after the steep decline that began in the fall of 2005. In addition to the 10-City and 20-City Composites, 17 of the 20 metro areas also saw improvement in their annual returns compared to those of April. Looking at the monthly data, 13 of the 20 metro areas reported positive returns; and the 10-City and 20-City Composites reported positive returns for the first time since the summer of 2006.

To put it in perspective, these are the first time we have seen broad increases in home prices in 34 months. This could be an indication that home price declines are finally stabilizing. While many indicators are showing signs of life in the U.S. housing market, we should remember that on a year-over-year basis home prices are still down about 17% on average across all metro areas, so we likely do have a way to go before we see sustained home price appreciation.

The next few months of data should be pretty interesting, but, given the seasonal patterns in the second chart above, don't be surprised if home prices disappoint again later this year.

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

Why Bernanke Is Campaining

With many Americans critical over the Fed's aggressive monetary policy and a pending bill to audit the Federal Reserve, Bernanke has begun a public relations offensive to clear his name. James Picerno, author of The Capital Spectator, discusses why this is baffling behavior for a Fed chairman.

Your conventionally minded editor isn't used to seeing a Federal Reserve chairman take his monetary policy show on the road. Then again, we're from the old school, and we're not used to seeing pigs fly either. But we're obviously out of touch in the 21st century.

Ours is a world where formality gives way to "transparency," which comes in an ever-widening rainbow of colors. Fed chairman Ben Bernanke's "publicity tour" is certainly something new in the bag of central banking tricks. We thought that participating in so-called town hall forums and taking questions from the audience was an art reserved for politicians and talk-show hosts. We're wrong. It's also now just another tool in the otherwise dull business of managing money supply.

The old veneer of banking ceremony is fading, giving way to a penchant for empathy and personality tours. Imagine our surprise when we discovered that Mr. Bernanke was "disgusted" by some of the Fed's recent actions, as he explained to an inquiring member of the audience in yesterday's PBS television episode. Speaking of the various bailouts last fall, the Fed head confessed: “Nothing made me more angry than having to intervene, particularly in a few cases where companies took wild bets." Perhaps he might have simply said that the devil made him do it. Personally, we'd have like to see some tears to make the confession more convincing.

In any case, at least we know our Fed chairman is now sympathetic to the working man. Sure, the central bank has made some tough decisions, but it also has a heart. Expressing compassion of a sort for the little guy when setting interest rates and engaging in other activity looks to be the new new thing. Big, impersonal banking institutions are out; warm and fuzzy I-feel-your-pain monetary policy is in.

Is any of this surprising in the media-infested 21st century? Perhaps not. Indeed, Mr. Bernanke, whose term is up next year, is running for re-election to the Fed and of course he's intent on pulling every lever available on his behalf. Of course, before we can decide if his campaign is worthy of support we'll need to see his monetary policy platform. If it's superior to the plans of the rival candidates vying to run the Fed, well, perhaps Ben deserves another term.

To get the word out, Mr. Bernanke may want to consider running television ads in key districts. Sure, it'll be hard to capture viewers' attention by proclaiming to have a better monetary policy than the other guy. Television, it seems, just wasn't made for dispensing the finer points of quantitative easing and the value of watching M1 vs. M2. But, hey, that's a minor obstacle. Ben needs to speak to the man on the street, especially in those swing-voter districts that could tip the balance in what promises to be a tight race.

Actually, there's a bigger problem. Fed chairman aren't popularly elected, at least not yet. And last we checked, there are no obvious rival candidates openly campaigning for the Ben's position, at least not yet. Instead, the Fed chief is appointed by the President and confirmed by the Senate, or so we're told.

As a result, any resemblance between Mr. Bernanke's campaign for re-election—sorry, we meant reappointment—and a political campaign is merely coincidental.

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

Photo from Wikipedia commons.

11 Percent Rise In New Home Sales Is Highest Jump In 8 Years

According to the Census Bureau, June was a strong month for new home builders. Tim Iacono from The Mess That Greenspan Made, takes a deeper look at the latest numbers from the new home market. Continue reading to learn more.

The Census Bureau reported(.pdf) an 11 percent increase in new home sales last month, the sharpest rise in eight years, as homebuilders attempt to mount a recovery from all-time record low sales levels earlier in the year.



Sales rose from an upwardly revised annual rate of 346,000 units in May to 384,000 units in June, the highest level since last November. Interestingly, sales in March and April were revised downward, not upward, as might be expected during a market bottom.

Inventory decreased as sales rose, the number of new homes on the market dropping to 281,000, the lowest level since 1998, and the months of supply metric fell from 10.2 months in May to 8.8 months in June.

Though sales prices for new homes are heavily influenced by incentives and are often quite misleading, builders appear to be slashing prices, the median price plunging 5.8 percent in June to $206,200, now down 12.0 percent from a year ago.

Once again, it's important to maintain a proper perspective on this news and the most important bit of data is that home prices continue to plunge - clearly not a sign that the housing market is springing back to life.

There is good news, however, for homebuilders in that sales may now have bottomed and the outlook for their industry may improve further after sales reached historic lows earlier in the year, lows that make all previous declines pale in comparison.

As noted here months ago when all-time record lows were first being made, in population-adjusted terms, the current housing downturn is without precedent. The pre-2009 all-time low of 338,000 in September of 1981 works out to a population-adjusted rate of about 460,000 today, meaning that, even after the recent "surge" in new home sales, another 20 percent increase is required just to get back to the previous record low!

While there has clearly been steady improvement in new home sales in recent months, recent increases are akin to your favorite 2000 technology stock rising 8 or 10 percent during a few months in 2001 after plunging 80 percent in 2000.

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

Should Obama Bring Bernanke Back?

There is widespread debate on whether Bernanke should be reappointed. While Bernanke receives his share of criticism, Economist Mark Thoma explains why it would be in the country's best interest for Obama to bring him back for a second term. See the following post from Economist's View to learn why.

Nouriel Roubini says:

Ben Bernanke ... deserves to be reappointed. Both the conventional and unconventional decisions made by this scholar of the Great Depression prevented the Great Recession of 2008-2009 from turning into the Great Depression 2.0.

Anna Schwartz has a different perspective:

As Federal Reserve chairman, Ben Bernanke has committed serious sins of commission and omission — and for those many sins, he does not deserve reappointment.

Here's how I see it. It's true that we failed to notice that the patient was getting sick. The signs of disease were there, but we either didn't see the signs or they were misdiagnosed. In fact, there's a case to be made that we saw some of the changes in the patient as signs of improving health. Had we made the correct diagnosis early enough, maybe we could have prevented the patient from getting sick (though it's not clear the patient would have taken our advice, so stronger measures than mere advice may have been required).

And once the patient showed up in the office and was clearly sick, we didn't get it right initially either. We thought the patient needed fluids - liquidity as they say - and the patient did need some of that, but we didn't immediately see that there were also some key nutrient deficiencies and chemical imbalances that were threatening to cause further problems.

Bu we kept at it with tests and other diagnostics, and eventually got a handle on the problem. Once we did, we began to administer the medicine the patient needed. The patient will get better, the deterioration was rapid and turning it around will be difficult - it won't happen fast enough to suit any of us - but what has been done prevented a complete collapse, and is helping to move the patient towards recovery.

So I'm with Nouriel, Bernanke should be reappointed. It's true that the progression of the underlying disease was largely missed, but that's pretty much true across the board, all the doctors missed it. It's also true that there was some dispute over how to interpret the initial symptoms and test results, and what to do to cure the patient. But again that was largely true across the board in the tumultuous period just after the patient began to exhibit clear and serious problems. It's not like everyone except the patient's doctors knew exactly what to do. The uncertainty in that initial period created fear, and the fear made the patient - who needed calm above all else - even worse off.

But as just noted, the doctors who were put in charge - Bernanke in particular - persevered and began to understand more precisely what was going wrong and what was needed, and that allowed them to save the patient from a much, much worse fate. They deserve credit for that. The patient will live, and that wasn't always so clear. In the initial confusion they did what you need to do - they administered wide spectrum drugs and other procedures that were known to abate the symptoms they were observing, and these did help, and that gave them time to find more targeted remedies. They used the time wisely to find and structure better remedies, and once those remedies were ready they used them to attack the various ways in which the disease was shutting down vital systems (not everything they tried worked, but the things that did work helped quite a bit).

There was one scary point, however, and that was when they thought the patient had become strong enough to go without the medicine, and they withdrew it too soon (the Lehman episode). The result was that they almost lost the patient completely, and only quick action saved the day. That's the one point where I think the doctors could have done better. I understand the concerns over the side effects of this medicine, but it was too soon and it created too much unnecessary uncertainty and fear.

But overall, they did the things that needed to be done to make sure the patient did not suffer an even worse, prolonged, debilitating collapse, and those efforts were successful. Failing to diagnose a disease is different from not knowing what to do once you figure it out. The disease was a difficult one to diagnose or it wouldn't have missed so widely, and it wasn't clear at first precisely what was wrong, but in every case, once they understood the problem, they took the proper course of action.

Here's the question I ask myself. If I were to suddenly come down with the same disease, would I want the current group with it's current leadership in charge of bringing me back to health, or would I want a different group led by someone new who thinks they know what to do, but has never actually been through it? I'd want this group, the one with experience. They're likely to have learned enough to spot the disease the next time and head it off all together, one hopes so. But if not and I get the disease, they are also likely to know just what to do - while avoiding the missteps they took the first time - to get me back on my feet as fast as possible (and please don't let politicians second guess them).

This post was originally published on Mark Thoma's blog, Economist's View.

Warren Buffet Wrong On Stock Market Prediction

The Oracle of Omaha may have made a rare incorrect prediction when he encouraged investors to buy stocks 9 months ago when the Dow was at 9,000. Today, the Dow is still at about 9,000 so Buffett went on record to reiterate his faith in US stocks. See the following post by Tim Iacono for more.

Don't get me wrong, Warren Buffet is admired around here quite a bit - more so than just about any other billionaire investor - but, going on CNBC this morning and being portrayed as a raging bull probably didn't do him any good in the eyes of those who are a bit more skeptical of the current market rally than is the CNBC staff.

His appearance today comes nine months after his memorable op-ed piece in the NY Times urging investors to buy shares. Coincidentally, the Dow was at about 9,000 back then too.



It's kind of hard to reconcile the "buy when there's blood in the streets" mantra that sounded so good last fall (even though the results weren't so hot) with a similar recommendation today, given the bubbly nature of stock markets around the world where, after the early-July bounce, investors appear to be loaded with optimism once again.

From CNBC this morning:

Warren Buffett tells CNBC that the economy still isn't showing any signs of life but that doesn't mean investors should stay away from stocks for the long-term.

In a live interview on Squawk Box this morning, Buffett says "business is still flat." But he stresses that doesn't mean he's negative on stocks, predicting the market will revive before the economy does.

"The market is very, very likely to turn up before business. But I don't try and time stocks. I try to price stocks."

He repeats his advice from his "Buy American" op-ed in The New York Times last fall: don't wait to buy stocks until the economy improves. By then, he says, you will have missed the biggest stock gains.

Even with the Dow hitting highs for the year around 9000, Buffett repeats his belief that stocks will outperform cash investments, such as Treasury notes, over the long-term. "I would much rather own equities at 9000 on the Dow than have a long investment in government bonds or a continuously rolling investment in short-term money."

From last year's editorial:

THE financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.

So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.

At least he's done a heck of a lot better with his Goldman Sachs shares than most retail investors have done with their mutual funds since last fall.

This post was republished from Tim Iacono's blog, The Mess That Greenspan Made.

What The Shape Of The Recovery Will Most Likely Look Like

What will the recovery look like? While there is still strong debate on the shape of the recovery, economist Mark Thoma explains how a structural change in the economy can change the trajectory of the recovery. From Mark Thoma's blog, Economist's View:

With unemployment rates still headed north, it is tough to see the Fed tightening within the next twelve months, if not longer. But will the job market surprise us? No clear indications can be gained from initial unemployment claims data which, although battered by unusual seasonal patterns, overall remains consistent with further drops in nonfarm payrolls. Indeed, this would be consistent with recent patterns of recession. David Altig declares:

...I'm quite sympathetic to DeLong's theme that the dynamics of U.S. labor markets coming out of recessions appear to have changed starting with the 1990–91 economic contraction. And it might be hard for many people to argue with DeLong's point that the U.S. economy is likely headed toward another so-called "jobless recovery." But until more facts are in and we're able to look back on what transpired, I think we still, at this point, must reasonably count the current run-up in the unemployment rate as a puzzle.

In the comments from my last piece, reader Spencer takes a different perspective, noting that forecasters have tended to underestimate the strength of recoveries, and further notes that recent moderate recoveries have followed atypical mild recessions. The current recession, however, is more typical of the pre-1990 variety, and, as such could be expected to yield a rapid recovery. A logical analysis from a long-time observer of business cycles; as always, one should have such an outcome on their continuum of possible events, but I tend not to be particularly sympathetic to the mild recession, mild recovery, big recession, big recovery analogy. It seems to be that a cursory look at the data suggests something very different is happening in the labor market and thus the strength of recoveries since the early 1980s. Look, for example at the pattern of durable goods manufacturing payrolls:



Previous to 1990, durable good jobs snapped back quickly, but that began changing after the 1980 recession, first with a muted rebound, than a slow return after the 1990 recession, and then with no return after the 2000 recession. That lack of rebound alone cost the recovery roughly 2 million jobs - and it seems that if the downturn was only mild, we should have expected these jobs to return. We will lose another 2 million at least by the time the current downturn is complete. Does anyone think these jobs are coming back? Anyone?

Likewise, nondurable goods manufacturing tells an even worse story:



In previous cycles, a rapid bounce, but simply an outright cliff dive since the mid 1990s. Again, do we think this trend will be reversed in the upcoming recovery? Another, albeit smaller sector:



To be sure, information services was coming off a bubble, but stability in the sector remained elusive even at the peak of the recent cycle.

These patterns suggest to me that the last fifteen years has seen intense structural change such that even mild recessions result in permanent dislocations. I have trouble that in the midst of such ongoing structural change a deeper recession will result in a less permanent dislocation. No, I suspect many of these jobs are gone for good, placing an additional weight on the job market during the recovery. Simply put, the danger is that in even a moderate recovery, the remaining expanding sectors will lack sufficient strength to compensate for these permanent losses.

Anticipating the comments, another way some might describe the patterns in the labor markets during recent recessions is that a variety of economic policy decisions by both Democratic and Republican administrations have had the impact of dismembering the industrial base of the US without encouraging the growth of sufficient replacement jobs, thereby throwing the American middle class under the train. That, however, is such a dark interpretation, as opposed to say, cheering the efforts of policymakers to lessen the burden of work on Americans by encouraging foreign nations to forsake their own consumption to provide goods for our citizens.

Bottom Line: I am not convinced that the equity run up confirms much more than the power of low expectations. Indeed, the bond market has yet to follow suit (when I would actually expect it to lead the way). I increasingly think that the debate between V and other shaped recoveries is really a debate over the degree of structural change occurring in the economy. If you believe this is a typical cycle, and that what was demanded and how it was produced is roughly the same after as before the recession, a V-shaped recovery is your likely candidate. If you believe that the current recession is simply intensifying a period of intense structural change, than you are looking for a U or L-shaped recovery. Notably Bernanke, by acknowledging that the US consumer is in no shape to continued its 25 year role as a shaper of global economic trends, seems to be siding with the structural change side of the coin.

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

The Dark Side Of The Spike In Housing Starts

The unexpected spike in the annual pace of new home starts, boosted confidence in the housing market. But what if the housing market is not ready for more new homes? Constantine von Hoffman from Blown Mortgage discusses why developers should not be adding new inventory right now.

Last week the Commerce Department announced an unexpected 3.6% increase in housing starts in June. The 582,000 units started last month is a solid gain from May’s 562,000 and much more than the 532,000 analysts had been expecting.The increases were concentrated in single-family homes which were up 14% — the biggest rise since December 2004. Housing permits were also up; the 8.75% increase was the largest gain in a year.

This would seem to be good news. A sign that more people are buying or commissioning homes and that developers expect this trend to continue. However, developers have guessed very wrong in the very recent past. (See Florida, Phoenix, Las Vegas and the Case/Schiller index for examples.)

Many economic indicators suggest developers haven’t suddenly become a lot better in predicting the economy:

• The nation currently has more housing stock than it needs. That is why the price of existing houses is going down. More stock continues to be placed on the market at lower prices each month by investors desperate to get anything back on their investments.

• While the increase in the number of people claiming unemployment benefits nationally has slowed slightly (up only .1% in June) it is difficult to see that as a reason to build more homes.

• Mortgage delinquencies have continued to increase. The most recent FHA numbers showed approximately 71,700 more loans became 60 days or more delinquent in April. Loans 60-plus-days delinquent increased approximately 7% that month to 1.2 million.

• Commercial real estate prices dropped 7.6% in May. So it hardly seems that businesses are about to expand or staff back up.

• Companies that sell to the construction trade are not optimistic about the coming year. Caterpillar announced dealer inventories had been cut $1.5 billion in the first half of 2009 and the company expects that to continue. The reasons: “Factors depressing construction included high inventories of unsold homes, lower selling prices and continued stringent standards for mortgage qualification.”

So why the increase? As with so much economic activity these days the cause seems to be wishful thinking. Developers think first time home buyers are going to flood the market before the Dec. 1 end to a federal program offering first-timers an $8,000 tax credit.

While there are undoubtedly a number of wise families who have kept their financial powder dry and will be able to take advantage of the federal aid, why would they buy a house that has either just been completed or is about to be? They are understandably going to want to get the most for their money. Why would they choose brand new construction over very recently brand new – for less money?

Housing starts are frequently referred to as a leading economic indicator. Perhaps we should change that to a leading economic prayer.

This article was republished from Blown Mortgage, a mortgage news and analysis site.

Decoding The Erratic Jobless Claims Data

What should we make of the erratic swings in jobless claims which recently increased by 86,000 before dropping by 50,000. Examining historic trends can often spread light on what is going on. Tim Iacono from The Mess That Greenspan Made explains what factors could be influencing the job numbers.

The latest weekly jobless claims data will be released tomorrow morning and, after last week's strange report, it could offer even more interesting surprises.

Recall that, last week, seasonally adjusted jobless claims dropped almost 50,000 to 522,000, the lowest level since January, a development that was in stark contrast to changes in the raw data showing an increase of more than 86,000 from the week before, all of this prompting a good deal of head scratching for those who were interested in looking beyond the headline number.

To help understand just what happened, the jobless claims data going back some 20 years is shown below. Since this graphic contains so much data, there was no alternative than to create a much larger image - you'll have to click on it to make much sense of it.



Click to enlarge

The first thing you notice when comparing adjusted and unadjusted jobless claims data is that this data series really does need seasonal adjustment.

The most pronounced features are the January layoffs that come right after the holiday shopping season when, even in a booming economy, jobless claims double or triple at the start of every year.

The other big seasonal events are the summer layoff for autoworkers that normally occur during the first two weeks in July. These can also be seen clearly in the graphic above - jobless claims spike up early in July and then they go far below the seasonally adjusted data until they get ready to spike up again the next year.

The labor department tries to account for these patterns, applying seasonal adjustments to the incoming data, however, the system is not perfect, even less so during times of economic upheaval associated with recessions.

But, what's really intriguing about this data is the area to the right of the chart above, an enlarged version of which is reproduced here.

You can see the red and blue curves diverging dramatically over the last two weeks. The red curve, representing the seasonally adjusted claims fell from 617,000 to just 522,000 during this period while the unadjusted data rose from 559,857 to 667,534.

The fact that actual claims for unemployment insurance did not spike up much higher is the reason that most have cited for why the seasonally adjusted claims plunged - layoffs earlier in the year as GM and Chrysler entered and exited bankruptcy were said to have drawn from the pool of planned layoffs over the summer.

But, what's striking about this is that the downward move in seasonally adjusted claims (the plunging red curve) seems to be an extraordinary response to the rise of the unadjusted data (the blue curve).

Simply looking at the relationships between the January and July surges in unadjusted jobless claims over the last twenty years shows that the relative size of the two this year is not unusual in any way but, at no other time do the seasonally adjusted claims drop so sharply during the summer.

Around the year-end holidays much wilder moves are seen, even more so during recessions, but, in a data series that goes back to 1967, never has there been a bigger divergence between the adjusted and unadjusted data during any two week period of the summer and fewer auto related layoffs doesn't appear to explain this difference.

The Labor Department will likely be fielding more calls about this data tomorrow.

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

Anti-Federal Reserve Sentiment On The Rise

No one is immune from blame for the financial crisis, including the Federal Reserve, which is facing renewed anti-fed sentiment. This has reintroduced the debate on whether the role of the Federal Reserve should be part of the reform of the financial system. Mark Thoma from Economist's View discusses this issue in the following post.

Continuing the recent discussion here and elsewhere on Fed independence, this is not the first time audits and other threats to independence have been seriously considered:

On the mend, The Economist: It has been a long time since comments on the economy by an official of America’s Federal Reserve comments could be described as cheerful. Yet there was no denying the upbeat tone of Ben Bernanke’s testimony to Congress on Tuesday... His fingers may be crossed but it is clear that Mr. Bernanke thinks the recession, if not over now, soon will be.

That is a far cry, though, from seeing a threat from inflation and Mr. Bernanke made it clear that the federal funds target rate, now near zero, will remain there for a long time. On Wall Street, most reckon that means until well into 2010 at least.

Yet the Fed is already under pressure to explain how it intends to tighten monetary policy, even by congressmen who usually want nothing of the sort. ... Whether inflation [occurs] depends on if the Fed raises interest rates in time and thereby curbs the appetite for credit. Mr. Bernanke spent much of his testimony explaining how he can do just that. ...

Politics could ... interfere with the Fed’s willingness to tighten monetary policy in time. Congress’s nonpartisan investigative arm, the Government Accountability Office, can now audit the Fed with the exception of its monetary policy, lending programs or relations with foreign central banks. A bill in Congress would lift those prohibitions. Mr. Bernanke argued that the threat of such audits would lead investors to question the Fed’s willingness to do unpopular things, like tighten monetary policy, unsettling them and driving up long-term interest rates.

This is not idle speculation. Anti-Fed sentiment was also strong in the 1970s, when Congress first sought to have the GAO audit the central bank. Arthur Burns, chairman at the time, fought back, and a compromise was struck to allow audits, but with the current prohibitions. Mr. Burns later reflected that the effort of “warding off legislation that could destroy any hope of ending inflation” involved “political judgments” that may have weakened his anti-inflationary resolve.

For all the discussion, any tightening of policy is a long way off. ...

I think one of the problems that people are trying to get at when they want to take away the Fed's independence is the concentration of power within the Board of Governors (the view by some that the Board represents special rather than public interests, e.g. Wall street, also plays a role), and they see devices such as audits from the GAO as a check on that concentration of power. Here's an edited version of part of an old post:

While the Fed was initially structured to balance competing interests and to share power, the system has evolved into an institution with centralized rather than shared power. The intent to share power and balance competing interests is evident in the structure of the Federal Reserve system. For example, individual district banks are overseen by a board of nine part-time directors. These directors come in three types. Three of the nine are type A and are bankers, and three are type B and represent the business community. Legislation prohibits type B board members from being bankers. In a further attempt to make the process representative, type A and type B directors representing banking and business interests are elected by member banks within each of the twelve Federal Reserve districts. Type C directors are appointed by the Board of governors and are intended to represent the public interest within the district banks.

Thus, the districts themselves provide geographic representation that is population based, while control of the district banks balances public, banking, and business interests. Initially, the district banks functioned as twelve cooperating banks and each district had considerable control of monetary conditions within the district. It was very much a shared power arrangement. As one example of the power district banks had, each bank had full control of the discount rate for its district (the discount rate was the only tool available for controlling the money supply when the Fed was formed, open-market operations were not well understood until later and there was no provision for the Federal Reserve system to control reserve requirements, another way to affect the money supply).

The shared power arrangement within the Federal Reserve system changed after the Great Depression when monetary authorities failed to respond adequately to crisis condition. The problem, or so it seemed, was the shared power nature of the system. The deliberative, democratic nature of the institution prevented it from taking quick, decisive action when it was most needed. Furthermore, the Fed did not have the tools it needed to deal with system-wide disturbances, it was mostly equipped to deal with problems at individual banks (the discount window is well-suited to help individual banks, but not system wide disruptions; on the other hand, open-market operations can inject reserves system-wide and hence is a better tool for systemic problems).

The solution to this was to concentrate power into the hands of the central bank so that should a crisis occur, they can act quickly. There are risks, of course, to concentrating power so narrowly, but in the aftermath of the Depression we were quite willing to take that risk if it helped to avoid another catastrophic outcome (as it may well have done).

Thus, after the Great Depression power was concentrated. For example, banks no longer control the discount rate in their districts. They can propose a change in the discount rate at an FOMC meeting, but the Board of Governors must approve the rate and they will only approve one rate, the rate they decide. So while the rates are still formally set in the districts, they are essentially set by the Board of Governors. When all such changes in the concentration of power over time from the districts to the Central Bank in Washington D.C. are considered, it becomes very clear that the Fed has evolved from a very democratic, shared power arrangement at its inception to one where it functions, for all intents an purposes, as a single bank in Washington, D.C,. with twelve branches spread across the U.S.

*****

I am not at all in favor of lessening the degree of independence that the Fed currently has, but I do think we need to make changes in the way the President and Boards of the district banks are chosen. As it stands, the Board of Governors in Washington has considerable influence over who is appointed to key positions such as the President of the district banks, and those Presidents represent five of the twelve votes at the meetings where monetary policy is set. More independence of the district bank Presidents and other district bank personnel from the Board of Governors would be a healthy change (there is also a question of whether geographic representation through district banks is the best way to capture the public interest, but I'll leave that aside for now).

This article was republished from Mark Thoma's blog, Economist's View.

Infamous Watergate Hotel Is On The Market

The owners of the historic Watergate Hotel have defaulted on their loan and the building was put up for auction. In a sign of the times, the auction received zero bids. For more on this, see the following article from HousingWire.

The Watergate Hotel, a Washington, DC landmark brought to international prominence by the 1972 burglary of the Democratic National Committee headquarters — which ultimately led to the resignation of President Richard Nixon — is on the auction block.

Owner Monument Realty defaulted on its loan for the building, and a 30-day city notice of foreclosure that expired Thursday lists a $40m outstanding balance.

The Watergate Hotel has seen better days. It’s been closed since 2004, and while Monument fought with neighbors over its original plans to convert the building into luxury co-ops — a fight Monument ultimately lost, leaving the firm resigned to redevelop the site as a hotel —partner and equity investor Lehman Brothers went bankrupt, and the recession hit, putting the project in turmoil.

Now, auction firm Alex Cooper is accepting bids for the 12-story, 251-room building. The winning bidder will be required to make a $1m down payment.

The auction comes after failed negotiations between Monument and lender PB Capital.

The auction of such a high-profile piece of commercial property could be a defining moment in what some see as the next phase of the recession. Market observers have their sights set on the commercial real estate market over concerns that it could face similar difficulties as the housing market.

What does it say about the state of commercial real estate when the owner of the famed Watergate Hotel, whose name and infamy gave rise to major political scandals getting the “–gate” suffix applied to it — Bill Clinton’s Whitewatergate, George W. Bush’s Lawyergate, the 1970s Koreagate, just to name a few — can’t refinance its outstanding debt?

In his appearance before the House Financial Services Committee Tuesday, Fed Chair Ben Bernanke fielded questions on the state of the commercial real estate market, and unfortunately, the chair couldn’t provide many definitive answers.

Clearly, this issue will linger as the country navigates through economic recovery.

This article has been republished from HousingWire.

Ben Bernanke's Plan To Prevent Inflation

Ben Bernanke outlined his plan to prevent inflation in an article in the Wall Street Journal. While this plan sounds good on paper, economist Mark Thoma from Economist's View warns that the Fed can not raise interest rates too soon and risk sending the economy back into recession. See the following post on this topic.

Ben Bernanke says that when the economy starts to recover, the Fed will take the steps needed to prevent an outbreak of inflation (the substance of the arguments can be found in the full version):

The Fed’s Exit Strategy, by Ben Bernanke, Commentary, WSJ: The depth and breadth of the global recession has required a highly accommodative monetary policy. Since the onset of the financial crisis nearly two years ago, the Federal Reserve has reduced the ... federal-funds rate ... nearly to zero. We have also greatly expanded the size of the Fed’s balance sheet through purchases of longer-term securities and through targeted lending programs aimed at restarting the flow of credit.

These actions have softened the economic impact of the financial crisis. They have also improved the functioning of key credit markets...

My colleagues and I believe that accommodative policies will likely be warranted for an extended period. At some point, however, as economic recovery takes hold, we will need to tighten monetary policy to prevent the emergence of an inflation problem... We are confident we have the necessary tools to withdraw policy accommodation, when that becomes appropriate, in a smooth and timely manner.

The exit strategy is closely tied to the management of the Federal Reserve balance sheet. When the Fed makes loans or acquires securities, the funds ... ultimately appear in the reserve accounts held at the Fed by banks and other depository institutions. These reserve balances now total about $800 billion, much more than normal. ...

But as the economy recovers, banks should find more opportunities to lend out their reserves. That would produce faster growth in broad money (for example, M1 or M2) and easier credit conditions, which could ultimately result in inflationary pressures—unless we adopt countervailing policy measures. When the time comes to tighten monetary policy, we must either eliminate these large reserve balances or, if they remain, neutralize any potential undesired effects on the economy. ...

[W]e have two broad means of tightening monetary policy at the appropriate time: paying interest on reserve balances and taking various actions that reduce the stock of reserves. We could use either of these approaches alone; however, to ensure effectiveness, we likely would use both in combination. ... [T]hese policies would help to raise short-term interest rates and limit the growth of broad measures of money and credit, thereby tightening monetary policy.

Overall, the Federal Reserve has many effective tools to tighten monetary policy when the economic outlook requires us to do so. As my colleagues and I have stated, however, economic conditions are not likely to warrant tighter monetary policy for an extended period. We will calibrate the timing and pace of any future tightening, together with the mix of tools to best foster our dual objectives of maximum employment and price stability.

As I've said many times, I'm not particularly worried about inflation, reserves can be removed or neutralized as described. The worry is not so much that they will be too slow at removing reserves, it's that they will get trigger happy and start raising interest too soon potentially stalling the recovery or perhaps even sending the economy back downward. The Fed will need to be sure that things are getting better before beginning to raise interest rates, that's why it's good to hear them use the phrase "extended period" twice when describing how long interest rates will stay low. But there are long lags associated with monetary policy, and by the time the Fed knows for sure that economy is heading solidly in the right direction, it won't have much time left to reverse course and begin removing reserves. Even so, they need to be patient and avoid the more serious mistake of raising interest rates too soon.

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

Inflation Down But Not Out

Although the risk of an imminent surge in inflation looks low and projected inflation still remains low, the threat of inflation in the future will not be going away. James Picerno discusses why we should not forget about this threat in the following post from The Capital Spectator.

The ascent in the yield on the 10-year Treasury Note during this past spring took a breather after rising to nearly 4.0% by mid-June. That prompted some to claim that the underlying source for the rise—worries about future inflation—were overbaked.

Perhaps, but we beg to differ, and have for some time. Even when the crisis of last fall was exploding with all its ignominious power, we were of a mind to expect a return of inflation at some point. The CPI report last week suggests that such expectations are still valid.

To be sure, the risk an imminent surge in inflation to lofty levels still looks low. Although deflationary forces are fading, the blowback from the financial crisis and the lingering effects of the current recession will reverberate for some time and so pricing pressures are still muted. Nonetheless, it's always been clear that the Federal Reserve's primary goal was to return the system to an inflationary bias. A mild one, if possible, but inflationary just the same. We never doubted the Fed's capacity for success on that front, and neither it seems does the bond market. The question is whether the central bank can let the genie out of the bottle just a little?

The genie already has his nose out. One example comes by way of the outlook for inflation based on the yield spread between the nominal and inflation-indexed varieties of the 10-year Treasury Notes. As our chart below shows, the market's 10-year inflation forecast is creeping up, again. Yes, it's still quite low—under 2.0%. But it's the directional momentum that's the issue. Having elevated the market's inflation expectations from zero to roughly 2% in the last six months, the Fed must soon begin to pull back on the liquidity injections, if only just slightly. Raising Fed funds to 0.5% would be reasonable at some point in the near future, up from the 0-0.25% range that currently prevails, if only to send a signal to the markets about intent.

One reason the message needs to be made is that traders don't think that's likely any time soon, based on Fed fund futures. The September 2009 contract, for instance, is trading at an implied 0.2% Fed funds rate.

A fair chunk of keeping inflationary pressures under wrap is a task of managing expectations, through time. There's currently no danger that expectations are set to run amuck, but neither can we afford to ignore the creeping rise in inflation expectations, even at low levels. Perhaps it's a false alarm, perhaps not. We just don't know. Waiting for definitive confirmation is too risky. Hedging the bet by slowly moving rates up over time--short of more compelling data to do something else--seems reasonable.

The future is undoubtedly full of surprises. But this much is clear: dismissing inflation as yesteryear's worry is asking for trouble.

This post was republished from The Capital Spectator.

JPMorgan Creates Illusion Of Profits

While reports of profits by JPMorgan Chase may have boosted the mood on Wall Street, the so called "profits" are merely an illusion created by an accounting loophole and does not mark the beginning of a banking recovery. To find out how the mega bank was able to conceal their massive losses with accounting slight of hand, see the following article from Money Morning.

It takes more than two to make a trend.

JPMorgan Chase & Co. (NYSE: JPM) yesterday (Thursday) became the second major U.S. investment bank – following Goldman Sachs Group Inc. (NYSE: GS) – to this week report windfall profits for the second-quarter. That’s helped fuel a four-day advance in U.S. stocks that’s seen the Dow Jones Industrial Average surge 7%.

Unfortunately, these two decidedly positive developments don’t necessarily indicate that better days have arrived for the U.S. banking sector.

To the contrary, many analysts – including Money Morning Investment Director Keith Fitz-Gerald – say these profits are merely a mirage created by an obscure accounting rule that allows banks to transform “toxic debt” on their balance sheets into income.

JPMorgan, the second-largest U.S. bank, said that that second-quarter profits were $2.7 billion, a jump of 36% from a year ago and 27% from the previous quarter.

A $1.1 billion, one-time reduction that resulted from the decision to repay $25 billion in Troubled Asset Relief Program (TARP) funds was offset by strong gains at the firm’s investment banking division.

Profit at JPMorgan’s investment banking division more than tripled as a result of record investment-banking fees and the strong performance in the fixed-income market. The investment-banking operations generated $1.47 billion of profit, almost quadruple the amount earned in last year’s second quarter.

Investment-banking fees – which zoomed 29% from a year ago and 62% from the first quarter – totaled $2.2 billion, and were a "record for any investment bank in any quarter," according to JPMorgan Chief Financial Officer Michael J. Cavanagh.

JPMorgan’s earnings in the first half of 2009 grew 11% to $4.86 billion, or 68 cents a share, from $4.38 billion, or $1.20 a share, in the first six months of 2008. Revenue jumped 43%, reaching $50.6 billion, from $35.3 billion last year.

JPMorgan’s announcement follows an equally impressive earnings report by rival Goldman Sachs, the largest investment bank in the country. Goldman said Tuesday that its revenue in the three months ended June 26 was $13.8 billion, compared with $9.43 billion in the first quarter and $9.42 billion in the second quarter a year earlier. Net income rose to $3.44 billion, or $4.93 a share.

Still, despite these banks’ stellar results, analysts are hesitant to say that the U.S. financial sector has bottomed, meaning that a rebound is under way.

Fitz-Gerald said last month that large investment banks like Goldman Sachs and JPMorgan would almost certainly generate record profits in the first half of the year as a result of less competition, favorable interest rates, and relaxed accounting standards.

Indeed, the Financial Accounting Standards Board has made it possible for the biggest U.S. banks to book profits on loans that have not been fully repaid.

“Called ‘accretable yield,’ these mega banks will book income on loans that have ‘reduced credit quality’ by recognizing the value of the bonds on their balance sheets and the cash flow those securities are expected to earn,” Fitz-Gerald said. “Please understand, we’re not talking about cash that’s already been earned, and not cash in the bank … we’re talking about cash flow those banks are expected to earn.”

In JPMorgan’s case, the firm took on $118.2 billion in toxic debt when it acquired Washington Mutual Inc. last year. As a receiver of that debt, JPMorgan was allowed to mark that debt down to “fair value,” or $88.65 billion. But now, the bank says that those same debts may appreciate by some $29.1 billion over the life of the loans. And as those loans are paid back, that money is booked as profit.

Of course, this distorts banks’ earnings and camouflages the deterioration in other banking segments.

For instance, consumer-loan losses continued to rise, as did losses on businesses loans. Retail banking earnings of $15 million were down sharply from earnings of $474 million in the first quarter, and $503 million in the second quarter of 2008. The consumer lending division reported a net loss of $955 million, compared with a net loss of $171 million in the prior year and $389 million in the prior quarter.

Home equity charge-offs jumped 4.61% to $1.3 billion. The bank warned that prime mortgage losses may be $600 million “over the next several quarters,” and that subprime losses may be $500 million.

Credit cards lost $672 million, compared to income of $250 million in the second-quarter last year. The bank warned that losses in its Chase credit-card portfolio may be 10% next quarter and will be “highly dependent” on unemployment after that. The unemployment rate rose to 9.5% in June, its highest level in two decades.

The managed charge-off rate, which generally tracks unemployment, climbed to 10.03% from 7.72% in the first quarter and 4.98% in the year-earlier period.

“For JPMorgan Chase, the challenge going forward is going to continue to be deterioration of credit,” Gerard Cassidy, a banking analyst at RBC Capital Markets, said in a Bloomberg Radio interview.

This article has been republished from Money Morning.

Could Regulation Have Prevented The Housing Bubble?

If the proposed financial regulation existed years ago, would it have been enough to prevent the financial crisis? Yale economist Robert Shiller explains why regulation like the Consumer Financial Protection Agency would not have averted the subprime mortgage bubble but could discourage innovation. Then economist Mark Thoma from Economist's View, provides his rebuttal.

Robert Shiller says that while a Consumer Financial Protection Agency is a good idea, it wouldn't have prevented the housing bubble:

Financial Invention vs. Consumer Protection, by Robert J. Shiller, Commentary, NY Times: James Watt, who invented the first practical steam engine in 1765, worried that high-pressure steam could lead to major explosions. So he avoided high pressure and ended up with an inefficient engine. It wasn’t until 1799 that Richard Trevithick ... created a high-pressure engine that opened a new age of steam-powered factories, railways and ships.

That is how innovation often proceeds — by learning from errors and hazards and gradually conquering problems through devices of increasing complexity...

Our financial system has essentially exploded... We need to invent our way out..., and, eventually, we will. That invention will proceed mostly in the private sector. Yet government must play a role, because civil society demands that people’s lives and welfare be ... protected from overzealous innovators who might disregard public safety and take improper advantage of nascent technology.

The Obama administration has proposed a ... Consumer Financial Protection Agency, which would be charged with safeguarding consumers against things like abusive mortgage, auto loan or credit card contracts. The new agency is to encourage “plain vanilla” products that are simpler and easier to understand. But representatives of the financial services industry have criticized the proposal as a threat to innovation...

If a consumer agency had been set up 20 years ago, would the subprime mortgage crisis have been prevented? We don’t know, but it seems improbable. Such an agency would most likely have slowed some abusive practices... That ... would have reduced the severity of the crisis, and that is no small thing.

On the other hand, unless these regulators were extremely vanilla in approach and just said no to any innovation, or unless they had an unusually deep understanding of speculative bubbles, I think they would have allowed most of those subprime mortgages. And they probably wouldn’t have had the detailed knowledge they would have needed to halt the decline of lending standards on prime mortgages in a timely way. In all likelihood, we would still be in this financial crisis.

In short, the new agency seems a good idea, and, if it is created, it should ... support innovation and ...be staffed by people who know finance..., including some who appreciate that human behavior must be understood and factored into financial design.

But that leaves us with the deeper quandary: Our society needs financial innovation, and still seems vulnerable to ... speculative bubbles that create truly big problems. Even if they can be mitigated, periodic crises may not be preventable, at least not by banning abusive credit cards or even by throwing the bad guys in jail. ...

The effectiveness of our free enterprise system depends on allowing business people to manage the myriad risks — including the risk of asset bubbles — that impinge on their operations in the long term. And this process needs constant change and improvement.

Complexity is not in itself a bad thing. ... A laptop computer is an immensely complex instrument... Yet it can be designed well so that it seems plain vanilla to the ultimate user.

And as for steam engines, the modern turbine high-pressure versions are not plain vanilla in any sense. They are sophisticated triumphs of engineering. They help generate most of our electric power with very few accidents.

I'm not sure his example works. If a modern turbine engine fails, it doesn't threaten the broader economy. If the engines were interconnected, so interconnected that the failure of one could bring them all down (beyond a single set at a given geographical location), then they might threaten the entire economy and be more like financial innovation.

The point is, because the costs of a steam or turbine engine blowing up are mostly localized, we can allow innovation to occur with very little regulation within the private sector without too much concern. Of course, we need to make sure that, say, a steam engine blowing up in a garage doesn't harm the neighbors, or harm any employees who might be there, and we also want to protect the inventors from themselves to some extent, but since the threat from an explosion is localized, we can allow innovation to proceed in the private sector under relatively light regulation without incurring great risks.

Suppose, however, that the turbine engines were interconnected and the failure of a single engine anywhere in the system could bring the whole system down, and not just for a day or two, but for months and months, and that the loss of so much power for so long would wreck the economy. In such a case, how much trust would you be willing to place in an unregulated private sector development of a new engine type for the grid? How much complexity would you be comfortable with? How much testing would you want the engines to undergo before being allowed in use? Would the fact that they have "very few accidents" as Shiller notes be of comfort?

When the dangers are great, we need to be careful. The financial grid is interconnected in just this way, and we need to do all that we can to ensure that new innovations do not become engines of destruction yet again.

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

Why The Government Must Keep Their Hands Off The Fed

Some people may place some of the blame of the financial collapse on the shoulders of the Fed but it would be a mistake for the government to take away the central bank's independence. See the following post from Economist Mark Thoma that explains why congress must keep their hands off the central bank.

Mark Gertler says the Fed's independence should not be compromised:

Congress must not touch the Federal Reserve, by Mark Gertler: The economy was experiencing the worst recession since the war. In Congress, members were beginning to wonder whether the Federal Reserve’s intervention strategy was extracting too great a toll on the economy. Some started to suggest publicly that it may be time to rein in the central bank’s independence.

Sound familiar? Though they bear a strong resemblance to ... today, the events I refer to in fact happened in the early 1980s, in the midst of what was then the most serious economic crisis since the Depression. The head of the institution under threat of losing its independence was none other than Paul Volcker.

Of course, Mr Volcker would go on to be recognised as one of the great central bankers of modern times. He would do so by standing firm against political pressures. By continuing on the course he set out, the economy recovered and a new era of price and output stability began. ... In the Volcker era, the political outcry occurred in the midst of the economic contraction that the Fed had engineered to tame inflation. The costs of the policy were plain to see, but the long-term benefits that would eventually emerge were difficult for many to imagine at the time.

The Fed’s role has been different this time round. Rather than trying to slow the economy, it has been acting to contain the damage brought on by the most complex financial crisis of modern history. By the accounts of many, the Fed has acted masterfully under difficult circumstances. ...

Given that hard times remain, nonetheless, it is natural that Congress is questioning the Fed, just as it did in the early 1980s. ... Unfortunately, the Fed cannot demonstrate what would have happened to the economy if it had not intervened in the way it did. Many observers agree that the situation would be far worse than it is today. Yet discussions of reining in central bank powers proceed as if the financial system would have stabilised itself without any Fed intervention.

The Fed well understands the lesson from the Volcker era that it can be effective only when it resists political attempts to influence its decisions. One can only hope that sober voices in Congress who appreciate the importance of central bank independence will help keep Capitol Hill from taking any measures that do permanent damage to the Fed.

A more constructive route for Congress would be to proceed with regulatory reform that would prevent a repeat of the current situation. At the core of the crisis is an antiquated regulatory system that permitted large financial institutions to take excessive risks. By giving the Fed the ability to monitor risk-taking by these institutions, Congress would diminish greatly the likelihood the central bank would again need to intervene directly in private credit markets.

The Fed may not have been perfect in its response to this or previous crises, but that doesn't mean that a less independent Fed would have done better. Taking away Fed independence - including subjecting the Fed to audits by the GAO - would be a mistake. In addition, if we are going to strengthen regulatory authority so that we can better monitor and reduce systemic risk that threatens the financial system - and we should - that authority needs to be in the hands of an independent entity, and the Fed is the natural place for this. Finally, its role in regulating system-wide risk is complementary to many of its other activities. For example, its role as a systemic risk regulator would involve monitoring risk within large institutions. Should a bank get into trouble, that would be helpful in assessing whether the bank should be granted access to the discount window in its capacity as lender of last resort.

We need to maintain an independent Fed, to give the Fed the powers it needs to monitor and regulate the level of overall risk, and to give the Fed the authority it now lacks to put banks through an orderly bankruptcy process so it can avoid bailing out financial institutions that are in trouble and a threat to overall the financial system.

Update: See Willem Buiter for a longer, more detailed version of many of the same points, e.g.:

Probably the single most damaging failure of the US Treasury, the US Congress and the US financial regulators was there inability/unwillingness to create a special resolution regime (SRR) with structured early intervention and prompt corrective action for all systemically important financial institutions (those too big, too complex, to interconnected, too international or too politically connected to fail in the ordinary Chapter 11 or Chapter 7 way). ...

But however weak its past performance and credentials, they are rock-solid compared to those of the other candidate institutions. ...

Only the Fed can fulfill the macro-prudential regulator-supervisor role. That is because it has the short-term deep pockets. It is the source of the ultimate, unquestioned liquidity in the economy, through its monopoly of the issuance of base money. Without the short-term deep pockets, a macro-prudential regulator/supervisor cannot act as lender of last resort, market maker of last resort or provider of enhanced credit support. It would be ... toothless...

He also makes this point:

The problem with this solution of the macro-prudential regulator/supervisor problem is that it is incompatible with central bank operational independence as interpreted since 1989 or thereabouts. ... When the central bank plays a quasi-fiscal role, as the Fed has been doing on an unprecedented scale in the current crisis, the fullest possible degree of accountability to the Congress, the tax payer and the citizens is essential. The Fed has no mandate to engage in quasi-fiscal operations, even when it is for a good cause. ...

If the same institution, the central bank, has to be in charge of both normal monetary policy and systemic risk regulation (albeit jointly with the Treasury for the systemic risk role), there is no elegant, first-best solution. Either monetary policy will be driven by politicians whose macroeconomics is limited to a partial understanding of the Keynesian cross and whose monetary policy views can be summarised by the proposition that the have never seen an official policy rate so low they would not want it even lower, or the central bank continues to act as an off-budget, off-balance sheet special purpose vehicle of the Treasury.

You pick.

Okay. As much as possible, monetary policy should be kept out of the hands of politicians.

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

How Median Home Prices Can Be Misleading

The median can be a deceptive statistic when it comes to real estate growth. Often home sellers will point to an increasing median and say that home prices are increasing, but they can actually be decreasing. For more on this see the following article from Tim Iacono from The Mess That Greenspan Made.

Unless we see another big leg down in credit markets and financial markets (which is entirely possible), it could well be that the worst of the median home price declines are now behind us in many parts of the country.

However, that doesn't mean that home prices are going to stop falling anytime soon.

A good example of this dynamic - where an increase in the number of higher price homes in the sales mix pushes the median price up as prices, generally, continue to decline - can be seen in the latest Dataquick report on June real estate sales for Southern California.

Fortunately, most news outfits seem to be addressing this issue up front and they are to be commended for that. Both the DataQuick report and this story in the LA Times were quick to attribute the increase in the median price to a changing sales mix.

But, how real estate sales agents use this information is an entirely different matter. As a good salesman will always look for ways to "motivate" a prospective buyer, it would seem that this is all too easy a piece of data to be used in a less than honest manner.

Here's what median home prices look like for all six Southern California counties:



At this point, it's important to remember that, while median home prices have now risen for two or three months according to DataQuick, the S&P Case-Shiller Home Price Index for the Los Angeles area is still falling - down almost one percent from March to April, according to the most recent data, and almost 22 percent below year-ago levels.

The DataQuick data is showing a sharp decline in year-over-year home price declines, ranging from -11 percent in Orange County to -42 percent in San Bernardino County where, apparently, they just don' t have enough higher priced homes to sell.



Foreclosures accounted for just 45.3 percent of all sales in June, down from over 50 percent in recent months, an indication that while conditions are still very far from normal, they are "less bad" than they were earlier in the year.

Since Marshall "almost all if not all of those gains are here to stay" Prentice is now retired, new DataQuick President John Walsh provides this month's commentary:

The rising median should still be viewed mainly as a sign the market’s moving back toward a more normal distribution of sales across the home price spectrum. Sales in many higher-cost neighborhoods couldn’t have gotten much lower, so this recent uptick in activity should come as no surprise. The recession and problem mortgages are fueling more high-end distress, hence more high-end ‘bargains.’ What’s missing, still, is a wide-open financing spigot for the would-be buyers of these more expensive homes.

It would be nice if they would just come out and say, "Prices are not going up even though median prices are rising. In fact, home prices are still going down".

But, clearly that would be too much to ask.

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

The Best Opportunity To Make Money In Real Estate In 20 Years?

With prices back to 2003 levels and the general consensus that prices are near bottom, this could be the best time to invest in real estate in years. Real estate investment firms are looking to get back in the US real estate market, which one real estate investment executive calls "the new emerging market". See the following post from Overseas Property Mall.

Property vultures are circling to pick the bones clean of deals as the US property clock has wound prices back to the same levels as they were in 2003, according to financial researchers Standard and Poor’s.

House prices fell 18% in April in S&P’s 10 and 20 city indices.

Commercial property has crashed alongside home prices registering a 20% decline, with market expectations of another good way to go - perhaps another 20%.

“Now that the meltdown has happened, the new emerging market is the United States,” Tom Shapiro, president of real estate investment firm GoldenTree InSite Partners, said at the Reuters Global Real Estate Summit in New York.

“I think there’s going to be the best opportunity to make money in the last 20 years in real estate in the US.”

GoldenTree InSite pulled the plug on US real estate investment in 2006 and focused attention and cash on Brazil instead, with investment in residential and office properties.

The company has a war chest of about a $1 billion to sink in to property, and is ready to return to the US market and take advantage of the right projects that need or will need money when they come up short.

“We are just at the point now where we are seeing some very interesting entry points on certain transactions,” he said.

New York-based GoldenTree InSite invests institutional funds.

Shapiro said his firm likes big cities, such as Los Angeles and New York where struggling commercial real estate markets tend to rebound strong.

“San Francisco right now is a pretty interesting place to think about because San Francisco is a very diversified economy,” he said.

Meanwhile, residential property prices fell - but the rate of decline is beginning to show signs of holding steady fueling hopes that the market will soon hit rock bottom.

“While one month’s data cannot determine if a turnaround has begun; it seems that some stabilization may be appearing in some of the regions,” said David Blitzer, chairman of the committee in charge of S&P’s index. “We are entering the seasonally strong period in the housing market, so it will take some time to determine if a recovery is really here.”

Phoenix posted the largest annual decline of 35.3%, while Las Vegas slipped 32.2% from last year and San Francisco fell 28%. Denver, Dallas and Boston posted the best performance in terms of annual declines, down 4.9%, 5% and 7.7%, respectively. On a month-on-month basis, Dallas saw 1.7% gain from March while Las Vegas lost 3.5%.

This post was republished from Overseas Property Mall.

Most Homeowners Optimistic (Or Oblivious) About Home Values

A study by the University of Chicago and Northwestern University found that only a quarter of Americans believe that their homes will lose value in the next year. I find it quite surprising that American's have so much faith in the short-term growth of real estate, despite the historic housing crash we are currently experiencing, and the record number of foreclosures. Perhaps the reason behind this optimism is similar to why most Americans think they are better than average drivers. The following post from Mortgage Roadmap, has more on this story.

Maybe there is something to that old "American Dream," after all. How else to explain that even as the residential real estate industry suffers through a catastrophic slump, U.S. residents still profess faith in the value of housing?

You'd think that most homeowners today — and potential homeowners — would have a rather dim view of housing in general. But a new study by economists at the University of Chicago and Northwestern University show the opposite. The study, which you can read about in this story in the Wall Street Journal, shows that just a quarter of U.S. residents expects the value of their homes to drop in the next year.

That's a big improvement from six months ago, when almost half of all survey respondents said they expected their home prices to fall.

Some respondents even said that they thought the value of their homes would rise in the next year.

What accounts for this optimism? There has been some good housing news lately. Home sales rose during the Spring. But when you compare the number sales of this year to the number last year, there's still a big drop. Housing prices, too, have been slowly inching upwards again. But again, home values are far lower now than they were just one year ago.

Maybe it's in our nature to be optimistic. Or maybe we're all taking a long-term view. Historically, housing prices have risen. You just have to hold onto your house long enough. During the housing boom, people bought homes and then tried to sell them in a year or two for big profits. That's no longer a possibility.

This is actually good. Housing was never meant to be a get-rich-quick scheme. It's an investment that takes years to mature and pay off. But if you're patient, and if you can wait out any future housing slumps, you should make a solid profit when it's time to sell your home.

This article has been republished from Mortgage Roadmap.

Top 5 Reasons You Should Be Concerned About Inflation

Inflation may be the single greatest threats to your investments, and there seems to be many more reasons that inflation will occur than there are reasons it will not. Tim Iacono gives 5 reasons why the threat of inflation is real. See the following post from The Mess That Greenspan Made.

While the debate rages over whether the years ahead will be dominated by in-flation, de-flation, or some combination of the two, a quick look at the reasons why so many people are so terrified of inflation is in order.

This is not meant to be an all-inclusive discussion, simply an overview.

1. They've been printing so much money, it's got to go somewhere

Yes, I know, the newly created trillions of dollars that monetary authorities around the world have sent out to failing banks, auto companies, insurance companies, and others - much of that money is currently just sitting there as bank reserves, not entering the economy in the form of new bank loans that would have this sum leveraged up to who knows how many tens of trillions of dollars.

Of course, that's today's story.

Tomorrow's story (probably sometime next year) will be one of economies that have hit bottom, at which time, banks will be more willing to lend and consumers more willing to borrow. That's when all the newly printed money starts to create inflation.

The doubling of oil prices seen earlier this year is just a teaser for what's to come since central banks quickly lose control over where the money goes once it starts to move again. Of course, if there is no economic recovery, that money will just sit there and there will be little or no inflation. But, if we do manage to pull ourselves up out of this mess, we'll see the highest inflation in generations as policymakers will be loathe to repeat the mistakes that led to the 1937 recession, following the Great Depression.

2. The government's inflation numbers are bogus

When inflation does come roaring back, you probably won't see too much of it showing up in the government's Consumer Price Index (CPI) data since this measure has been systematically neutered over the last thirty years to make rising prices seem as though they're not all that bad compared to what we saw back in the 1970s.

You hear a lot about how economic policies have "defeated" inflation over the last few decades when, in fact, much of the lower inflation numbers have to do with cheap oil from the Middle East, cheap imported goods from Asia, and, most importantly, changes in the way the Bureau of Labor Statistics calculates the inflation statistics.

Since home prices were stripped out of the index in 1983, it's hard to imagine how we could ever see inflation over ten percent again since housing rental costs now account for more than 30 percent of the index. With the glut in housing due to the recently popped bubble (a bubble that would not have been possible if home prices had not been stripped from the inflation data), we'll have downward pressure on rents for years to come.

The bad news is that domestic services and energy will keep on rising and this will feel like 20 percent inflation even when the government says it's only six.

3. Peak oil is real and it is near

The ongoing recession/depression has been a boon to those who have long scoffed at the whole notion of Peak Oil - that cheap energy, fossil fuel that comes gushing up from out of the ground with little or no effort and has served as the very foundation of the world economy over the last 80 years or so, will soon be a thing of the past.

Of course, the fact that economic growth is now declining for the first time since the Great Depression puts a whole new spin on things, albeit, just a temporary one.

That is, unless what we've seen over the last nine months is what we'll be seeing for years and years and years.

Since changes in global energy consumption are inextricably tied to changes in economic growth, the only way that peak oil is not going to be a problem in the years ahead is if the global economy grows at a much slower pace. Slow growth means less jobs which mean lots of people have lots of idle time on their hands and governments don't generally like that.

Look for item #1 above to solve many of the world's economic problems in the near-term while creating even bigger inflation problems in the long-term as a return to world-wide economic growth once again stresses the relatively limited energy production capacity as it did last year.

4. Rich, smart people are buying gold

I don't know about you, but when I hear about people like John Paulson of Paulson and Company buying billions of dollars in gold bullion for his hedge fund and when stories begin to circulate about very wealthy individuals buying bullion by the truck load, apparently OK with the whole idea that it neither earns interest or pays a dividend - then I start to worry a little bit.

Most of the rich people in the world are rich for one very good reason - because they're smart.

And even though most of the investment world still doesn't have much of a clue about the nature of money and how, after almost four decades, a very long experiment with a world overflowing with fiat money is now going horribly wrong, a lot of smart people with a lot of money have figured it out.

In private clubs, board meeting rooms, and social gatherings all around the world, the likes of which neither you nor I will ever experience, they are swapping stories about how to buy and store gold because rich, smart people know the long history of paper money.

Paper money, issued by government fiat and backed by nothing other than confidence in the issuing government to act responsibly, has never endured. Governments always abuse this power and to think that it will be different this time is not only not very smart, it is naive.

5. The central bank does not fear inflation

The single most important reason to fear inflation is that the Federal Reserve and its minions of economists, accountants, and ne'er do wells do not fear it.

Never before have there been so many signs of impending financial calamity that have been missed by so many central bankers, economists, and policy makers around the world that there is absolutely no reason to think that they will be any better able to spot early signs of rip-roaring inflation than they were able to spot signs of a stock market bubble, a credit bubble, or a housing bubble.

In fact, even if there are indications of monstrous price increases on the horizon, the Federal Reserve and others will likely embrace the arrival of rising prices since what they really fear is de-flation. On this side of the Atlantic, they are determined to avoid a repeat of the 1930s when a sound money system had a completely different set of dynamics and they are loathe to do anything substantive to combat inflation until they are sure that they have vanquished their nemesis - de-flation.

Sure, they'll keep talking about "exit strategies" and how to "remove the accommodation" that has been provided over the last year or so in the form of trillions of newly created dollars, but they don't really mean it.

In the next few years we'll be creating a whole new chapter of economic history, one where inflation will play a central role. When the historians look back at 2009 they'll wonder, "Why wasn't anyone worried about inflation back then? When they could have done something about?"

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

What We Should Make Of Goldman Sachs Record Quarter

Despite a $3.4 billion profit by Goldman Sachs in the second quarter, analysts are warning that Goldman's results are not representative of the larger market. But how could Goldman make a record profit if the banking sector is as bad as it is claimed? The following post from Money Morning examines this question.

Goldman Sachs Group Inc. (NYSE: GS) said yesterday (Tuesday) that it posted record earnings in the second quarter, but that’s not necessarily an indication that better days have arrived for the U.S. banking sector.

Goldman’s revenue in the three months ended June 26 was $13.8 billion, compared with $9.43 billion in the first quarter and $9.42 billion in the second quarter a year earlier. Net income rose to $3.44 billion, or $4.93 a share.

But analysts say investors should consider those results to be uniquely Goldman’s and not indicative of what we’ll be seeing from the greater financial sector. Traders said Goldman made several key moves during the quarter. The bank:

• Played the whipsaw volatility in the global credit markets by trading bonds to generate part of its quarterly fortune.

• Properly played a similar pattern in U.S. stocks this year, profiting as an early-year plunge reversed course and turned into one of the most-powerful short-term.

• Capitalized on such commodities as oil, while also trading volatile currencies.

• And made the most of its position as one of the few remaining heavyweight-investment-banking firms willing and able to service the deal-making market. It reaped lucrative fees from the high-margin business of underwriting stock offerings, which have surged anew this year as other more-troubled financial institutions raced to raise capital.

“What’s so intriguing about Goldman Sachs is that there are all these levers there,” says David Wintergreen of the Wintergreen Fund, which owns Goldman shares told BusinessWeek. “There are so many ways this company can win.”

A look at a common risk-taking measure - so-called “value at risk,” or VAR - shows that while other investment banks were playing it conservative, Goldman was clearly game to take risks. VAR, an estimate of what an institution could lose in a single day, zoomed by more than 20% in the first quarter and jumped 33% during the second quarter, hitting another record high.

Fixed-income trading remained strong, with second-quarter revenue rising to $6.8 billion from $6.6 billion for the first three months of the year. It was up 186% from the second quarter of 2008.

The bank also saw a massive bump in equity trading where revenue jumped 110% over the past quarter, to $2.2 billion.

However, there is a question about whether or not these profit-making opportunities will disappear in the year’s second half - which looks much more challenging. Part of that challenge will be for the company to deal with the heightened group of regulations it is now subject to after having converted from an investment bank to the more-heavily regulated bank-holding company.
This post was republished from Money Morning.

Adjustable Rate Mortgages Storm Is Brewing

A storm of adjustable rate mortgage foreclosures could be on the horizon according to the Wall Street Journal. In April 36.9% of these loans are at least 60 days delinquent, which means a large number of foreclosures may soon strike the housing market. See the following post by Tim Iacono.

The chart below was promptly whipped up after reading this report($) in today's Wall Street Journal about just how fast Option-ARMs are souring as compared to subprime loans.



It's not so much that the default rates for Option-ARMs have exceeded that of subprimes loans for three months running, but that the absolute numbers are so high.

More than one-third of all Option-ARMs (called Pick-A-Pay loans below) are in default and most of these are likely to make it to the foreclosure stage eventually.

Option ARMs were typically issued to creditworthy homeowners and allow borrowers to make a range of monthly payments. The payment options include a partial-interest payment that adds the unpaid interest to the loan's balance. On many such loans, balances have risen while values of the underlying properties have plummeted amid the housing crisis.

As of April, 36.9% of Pick-A-Pay loans were at least 60 days past due, while 19% were in foreclosure, according to data from First American CoreLogic, a unit of Santa Ana, Calif.-based First American Corp. In contrast, 33.9% of subprime loans were delinquent, with 14.5% of those loans in foreclosure, the figures show.

Payment-option mortgages are heavily concentrated in the worst-hit regions in the housing market, including California and Florida, making borrowers inordinately vulnerable to declining property values. The deepening loan turmoil could mean higher-than-expected losses for Wells Fargo & Co., J.P. Morgan Chase & Co. and the Federal Deposit Insurance Corp.'s own insurance fund.

"The realization of the issues related to option ARMs is just beginning," said Chris Marinac, director of research at Atlanta-based FIG Partners.

If memory serves, the wackiest thing about Option-ARMs a few years ago was that banks could book the interest and principal payments as income even though they weren't actually receiving the money - the vast majority of borrowers were only making the lowest payment that didn't even cover the full amount of the interest due that month.

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

Downpayment Requirements Stifles Demand

According to a survey by the National Association of Realtors, the number one factor discouraging first time home buyers is the downpayment requirements asked for by most lenders. Downpayment requirements were too high for 82% of survey respondents. The following post from The Mortgage Roadmap, discusses how this is stifling demand in the market.

If you're a first-time homebuyer, there's probably one factor that's preventing you from buying a home: the downpayment.

It's always been a struggle for buyers to scrape together enough money for a downpayment. After all, homes aren't cheap. Who has $10,000 or more just lying around for a downpayment?

During the housing boom — which ran through a portion of 2006 — many lenders required borrowers to put down as little as 3 percent of a home's purchase price. Others didn't require any downpayment at all. This made life easier for borrowers, but helped push a slew of mortgage lenders into bankruptcy once the housing crash hit.

Today, lenders are more careful. Many of them are asking for higher downpayments. Some are asking for 20 percent down. It's a reason why so many potential homebuyers are now looking to obtain FHA financing: These loans only require a downpayment of 3-and-a-half percent.

Each year, the National Association of Realtors releases its National Housing Pulse Survey. It's always a fascinating read. This year's survey, for instance, revealed that coming up with a downpayment is is too much of an obstacle for 82 percent of today's homeowners.

The survey also revealed a home buying public that is terrified by the nation's weak economy. According to survey, two-thirds of U.S. residents consider job layoffs and unemployment as serious problems. A total of 80 percent of respondents pointed to them as serious impediments to buying a house.

It's a bit of a shame to see these numbers. Housing prices have dropped significantly from just one year ago. This means that housing is more affordable than ever. Unfortunately, at the same time, more U.S. residents are losing their jobs or seeing their annual income reduced. This sort of negates the benefits of increased housing affordability.

This article has been republished from The Mortgage Roadmap.

How Recessions Can Be Good

Are there any positive benefits of a recession? That is the question that Christopher Hayes explores in an article in The American Prospect. The argument that some economists have proposed is that a depression can clear out inefficient firms, similar to a forest fire that clears out the undergrowth, resulting in a stronger economy in the long-term. See the following post from Economist's View, that discusses this idea.

Chris Hayes takes up a notion I've never been very fond of, that recessions are necessary and healthy since they clear out inefficient firms, and spur the development of new innovation during the recovery phase. (Why do I think this is unnecessary? The entry and exit of firms driven by innovation and the development of new products can be part of a full employment equilibrium, that is, cycles are not needed to clear out old firms and spur innovation. Imagine an economy where a new idea allows a slightly more productive firm to enter a market and displace a less productive firm, and the workers migrate from the old to the new firm over time. If this happens at a constant rate in aggregate over time, there won't be any cycles at all, but we still manage to clear out the inefficient firms and replace them with more innovative rivals. The displaced workers from the the innovation driven structural adjustment are part of the natural rate of unemployment in such an economy):

Are Depressions Necessary?, by Christopher Hayes, The American Prospect: ...Are economic contractions, like the one we're currently experiencing, a good thing? ... It would be career suicide for any elected official to suggest that the widespread stress, misery and heartache being wreaked by ... contraction were are a good thing. But scratch the surface a bit and you'll find a surprisingly vibrant school of thought, one that reaches back all the way back to the Great Depression, that holds precisely this view.

Famed economist Joseph Schumpeter said that "a depression is for capitalism like a good, cold douche," one that rinses off accumulated dysfunction. Robber baron Andrew Mellon (who served as Herbert Hoover's treasury secretary) welcomed the Great Depression with these infamous words: "It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people"

It's not hard to find this same view among bankers, financiers and sundry Wall Streeters today. ...

The stakes for this argument are very high: if steep economic contractions are like forest fires, a necessary part of the system's self-calibration, we should more or less let them burn. If they are more like five-alarms raging through dense city neighborhoods, we should call in the fire department.

Newsweek and Washington Post columnist Robert Samuelson is perhaps the most prominent and outspoken Mellonist writing today...

Paul Krugman, to put it mildly, disagrees. ... What animated much of this advice was not just a rigid and dogmatic economic consensus, but also the puritanical normative assessment that a wicked economy must now pay its penance. (Of course said penance was never paid by those who caused the crisis: It was paid out of the pockets of the starving, the poor and working class.)

It's exactly this notion that Krugman seeks, above all, to dispel. ...

"...The ... business cycle may have little or nothing to do with your more fundamental economic strengths and weaknesses. [B]ad things ... can happen to good economies."

...More broadly, Krugman's point is that, contra Samuelson, recessions, and depressions and assorted downturns are not useful, cleansing opportunities to "purge the rottenness out of the system," but more often vicious cycles, auto-catalytic processes that result in massive amounts of human suffering, and waste human capital and an economy's productive capacity. More like the forest fire caused by a careless camper than the natural cleansings produced by mother nature.

The technical implication of this view for crisis management is that when an economy is stuck in a deep recession, like the one in which we are now mired, normal bromides of Chicago-style economics, those to which Samuelson clings so closely, cease to apply. ... Krugman ...[believes] deft and active management is necessary. Suffering is no badge or courage, but a sign of failure. ...

As Krugman persuasively argues, economies need management and policy to ... be saved from their own tendency to spiral into disaster, to cycle through booms and busts... Samuelson and those of the Mellonist school have an innate distrust of politics; meddlesome and vulgar and prone to demagoguery. Lately the political system as seemed to be working over-time to confirm their worst fears.

But ultimately there is not economics without politics, and as terrifying as this may be, economists can't save us from this crisis. Only politicians can.

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

The Allure Of Beachfront Property In Recife, Brazil

The spectacular white sands and attractive prices of real estate in the port city of Recife, Brazil make for a compelling location for investment. As Brazil's economy continues to grow, there will be many opportunities for appreciation in the real estate market. See the following post from Overseas Property Mall to learn more.

While the East Coast of Brazil has steadily seen some fantastic growth over the last few years, places like Recife have lured buyers to a lifestyle of sand, sun and beaches according to NY Times.

While the Port city of Recife is certainly classed as a city, it has an attraction of a different kind for the countless new home buyers who have flocked to the area over the last few years. Here, the lifestyle is relaxed. People are friendly and only too happy to help each other out.

Besides being able to enjoy some spectacular beaches and year-round sunshine you will also see a relaxed pace of life in the streets of the city. As the second largest urban metropolis on Brazil’s North-eastern coast, Recife boasts a little more than 1.5 million residents. Add to this another 2 million people who live in the surrounding suburbs and you’ve got a modern, yet relaxed society of happy-go-lucky people.

A 2-bedroom city apartment in neighboring Olinda will set you back a mere $790/month in rent.

The real estate boom in the area is very much alive, despite the global meltdown elsewhere. Regionally produced commodities such as ethanol have certainly helped to put Brazil on the spot as a hard-to-refuse property heaven.

One of Recife’s best kept secret is the 6.5-kilometer stretch of seafront in Boa Viagem, south of the city. Many residential towers are being built along the stretch right now and where once were old style homes you can now find modern, glistening towers of wealth and statue.

Offshore reefs are responsible for the many natural pools next to the beach which invite people to leisure and swim in safety and comfort.

However, there is also a serious side to the paradisaical appearance of Recife. Serious crime, resulting from poverty is still a problem that affects everybody living in the area. In the first 5 months of this year alone more than 400 murders have taken place in Recife.

Unfortunately the reputation for violence is what keeps many would-be buyers away from the city. Instead they opt for safer environments on other areas of the East Coast of Brazil.

However, if you want to and can look part these issues you can snatch a new apartments with uninterrupted ocean views for around $244 to $342 a square foot. The top end market has largely been sold already with many million dollar properties sold near instantly.

Many overseas investors have seen the value in these properties and buyers from Italy and Portugal especially are flocking to Recife as if there is no tomorrow. If you were lucky enough to snatch a bargain back in 2004 chances are that today your real estate portfolio would have appreciated 100%.

Despite the long standing Brazilian property boom it is still not too late to buy your own paradise bargain if you act soon enough.

This article has been republished from Overseas Property Mall, an international real estate website.

Is The US Economy On A Death Spiral?

Is the economy on a death spiral or simply evolving? Former Secretary of Labor and author of the book Supercapitalism, Robert Reich, says that the US economy may never return to where it was before the financial meltdown. Instead we may see a new economy that is more sustainable and more closely aligned with the new global environment. For more see the following post from Economist's View.

One of the reasons I've argued this recovery will be slow is that we cannot simply bounce back to where we were before the problems started as we could in some past recessions. We need to move resources out of housing, out of finance, and out of autos, and those resources need to find productive employment elsewhere in new or growing industries, and that is not very likely until things improve. Consumers need to save more and consume less, as they are starting to do, and this too will require adjustment. So does this mean we should expect a U-shaped recovery instead of a V-shaped recovery? Robert Reich says it's neither, this is an X-recovery:

When Will The Recovery Begin? Never., by Robert Reich: The so-called "green shoots" of recovery are turning brown in the scorching summer sun. In fact, the whole debate about when and how a recovery will begin is wrongly framed. On one side are the V-shapers who look back at prior recessions and conclude that the faster an economy drops, the faster it gets back on track. And because this economy fell off a cliff late last fall, they expect it to roar to life early next year. Hence the V shape.

Unfortunately, V-shapers are looking back at the wrong recessions. Focus on those that started with the bursting of a giant speculative bubble and you see slow recoveries. ... That's where the more sober U-shapers come in. They predict a more gradual recovery...

Personally, I don't buy into either camp. In a recession this deep, recovery ... depends on consumers who, after all, are 70 percent of the U.S. economy. And this time consumers got really whacked. Until consumers start spending again, you can forget any recovery, V or U shaped.

Problem is, consumers won't start spending until they have money in their pockets and feel reasonably secure. But they don't have the money, and it's hard to see where it will come from. They can't borrow. Their homes are worth a fraction of what they were before, so say goodbye to home equity loans and refinancings. ... Unemployment continues to rise, and number of hours at work continues to drop. Those who can are saving. Those who can't are hunkering down...

Don't expect businesses to invest much more without lots of consumers hankering after lots of new stuff. And don't rely on exports. The global economy is contracting.

My prediction, then? Not a V, not a U. But an X. This economy can't get back on track because the track we were on for years -- featuring flat or declining median wages, mounting consumer debt, and widening insecurity, not to mention increasing carbon in the atmosphere -- simply cannot be sustained.

The X marks a brand new track -- a new economy. What will it look like? Nobody knows. All we know is the current economy can't "recover" because it can't go back to where it was before the crash. So instead of asking when the recovery will start, we should be asking when and how the new economy will begin. ...

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

Are The Green Shoots Of Economic Recovery Turning Brown?

James Picerno thinks that we are still headed toward the technical end of the recession, although risk of a second slump has increased in recent weeks. While the first stimulus may have averted a total economic collapse, thought leaders like Warren Buffett argue that more stimulus is needed to help the economy recover. For more on this, see the following post from The Capital Spectator.

Forecasting is tough, especially about the future, runs the old joke. But the dark art of prognosticating these days is no laughing matter.

Case in point: the burning question at the moment is whether the so-called green sheets of economic recovery turning brown? It's getting harder to answer "no" these days. It's not clear if we're headed for a second slump, but the risk has gone up a bit in recent weeks. The hope that the economy had at least stabilized looked increasingly persuasive over the past several months, a trend that inspired the hope that the recession might soon end.

That's still our view, although the transition from the end of the contraction to robust economic growth threatens to be a long and rocky period, as we've discussed, including here. But the outlook on the economy is in continual flux. As new information arrives, strategic-minded investors adjust their forecast and perhaps their asset allocation. No wonder, then, that expected risk premiums vary through time. Unfortunately, the current view for the economy looks a bit less encouraging these days; or, if you prefer, the future is a bit more problematic relative to what looked likely from June's vantage. In any case, the green shoots have wilted, if only slightly.

But it's too early to expect the worst (again). Indeed, the catalysts that brought us the first round of optimism are still alive and kicking, namely, massive liquidity injections on the fiscal and monetary fronts. What's more, it's clear that these twin doses of stimulus have been critical in stabilizing the economy, which is to say keeping a deep and protracted deflationary virus from spreading. But as we've discussed all along, pulling the economy back from the precipice is one thing. As policy prescriptions go, that was relatively easy. Figuring out how to play the game in the second half, however, promises to be much more nuanced and therefore difficult.

Promoting economic growth, in short, is quite a bit harder than staving off implosion of the financial system. All the more so in the deepest recession since the 1930s. No wonder, then, that as we move into the next phase of this crisis, the signals emanating from the economy won't seamlessly dispense rising doses of good news.

One example comes in today's Wall Street Journal, which advises that the generally encouraging decline in initial jobless claims in recent months may not be as potent this time around. The reason: new fillings for unemployment benefits "typically fall fairly sharply after peaking. Instead, they have hovered above 600,000 for an unprecedented 22 consecutive weeks," writes the Journal's Mark Gongloff. The implication: this data series may not be signaling the recession's end after all, as it has in business cycles over the past 40 years.

But shortly after the Journal article appeared this morning, the Bureau of Labor Statistics offered its weekly update, reporting that seasonally adjusted claims fell by a hefty 52,000 for the week through July 4, dropping to 565,000. That's the lowest since January. Of course, last week's fall may simply be a one-time drop tied to the Independence Day holiday. Stay tuned.

More broadly, the recent readings of economic activity have been sagging. One example comes by way of the Aruoba-Diebold-Scotti Business Conditions Index, published by the Philadelphia Fed. The latest reading of the index, based on data available as of July 2, shows a notable downturn relative to previous weeks.

Meanwhile, the yield on the 10-year Treasury and the price of oil have both fallen in recent weeks, suggesting that the economic outlook has softened.

Or perhaps markets have just gotten ahead of themselves. Since March, the capital and commodity markets have been pricing in economic stability if not recovery. The question, then, is whether these trends signals something more troubling, or merely represents a pause that refreshes?

Warren Buffett favors the former interpretation, arguing that more stimulus is needed. Yet it's not clear if the White House or the Congress agrees…yet.

The transition from the apocalypse to the post-apocalypse world was always sure to be a confusing, perhaps more so than some of us thought. Nonetheless, we're still optimistic that the technical end of the recession is near. Unfortunately, we're a bit less optimistic these days. At the same time, we're more confident that reaching the promised land of recovery will be a tougher trek than it appeared last month. Rest assured, this outlook too will change. Let's hope it changes for the better.

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

Overleveraged Economy Not To Blame For Financial Crisis

According to MIT economics professor Ricardo Caballero, leverage is not the real problem that led to the financial collapse, but rather excessive concentration of risk. If he is right, could policy makers be chasing the wrong culprit as they create new regulation for the financial system? The following post from Economist's View, discusses this alternative view.

Ricardo Caballero hasn't given up on his argument that it was the excessive concentration or risk, not leverage, that caused problems in financial markets (and it's an argument I'm sympathetic to):

Economic Witch Hunting, by Ricardo Caballero, Commentary, Economists Forum: Perhaps one of the economic phenomena most akin to witch-hunting is the diagnostic and policy response that develops during the recovery phase of a financial crisis. Understandably, pressured politicians and policymakers rush to find culprits... All too often they find a ready supply of these in preconceptions and superficial analyses of correlations. This time around the scapegoats are global imbalances and leverage.

Global imbalances are the victim of preconceptions: Many economists and commentators argued before the crisis that large global imbalances would lead to the demise of the U.S. economy... The crisis indeed came, but rather than destabilizing the US economy, capital flows helped to stabilise it, as flight-to-quality capital sought rather than ran away from US assets. ...

The fact that the actual mechanism behind the crisis had nothing to do with that which was used to explain the forecast of doom has long being forgotten, false idols have been erected,... global imbalances have been indicted for witchcraft, and ever more exotic rebalancing and currency proposals make it to the front pages of newspapers around the world.

Leverage is the victim of superficial analyses of correlations: In my view one of the main factors behind the severity of the financial crisis was the excessive concentration of aggregate risk in highly-leveraged financial institutions. Note that the emphasis is on the concentration of aggregate risk rather than on the much-hyped leverage. The problem in the current crisis was not leverage per se, but the fact that banks had held on to AAA tranches of structured asset-backed securities which were more exposed to aggregate surprise shocks than their rating would, when misinterpreted, suggest.

Thus, when systemic confusion emerged, these complex financial instruments quickly soured, compromised the balance sheet of their leveraged holders, and triggered asset fire sales which ravaged balance sheets across financial institutions. The result was a vicious feedback loop between assets exposed to aggregate conditions and leveraged balance sheets.

The distinction emphasized in the previous paragraph may seem subtle, but it turns out to have a first order implication for economic policy... The optimal policy response to this problem is not to increase capital requirements (or to deleverage), as the current fashion has it, but to remove the aggregate risk from systemically important leveraged financial institutions’ balance sheets. This should be done through prepaid and often mandatory macro-insurance type arrangements, which can accommodate valid too-big or too-complex to fail concerns, but without crippling the financial industry with the burden of brute-force capital requirements. ...

We shouldn't assume that the next potential financial crisis will be identical to this one in terms of how it comes about or how it expresses itself, so we need to ensure that the system can withstand different types of financial shocks. Given that these shocks can come from unexpected places, it's not clear to me that insurance discussed above will stop all of the ways in which financial market problems can lead to harmful deleveraging. Hence, we may want to put the type of insurance plan Ricardo Caballero would like to see instituted in place, and then buttress that protection with enhanced capital requirements to safeguard against unexpected causes of harmful deleveraging.

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

The Climate Bill Will Be A Disaster

The climate bill will make a mess of the economy and do little to fight global warming according to Martin Hutchinson from Money Morning. In addition it will not raise any net revenue although it creates huge economic costs for businesses. See the following post that discusses some of the consequences if the cap-and-trade bill passes.

The Waxman-Markey Bill, the much-ballyhooed clean energy legislation passed recently by the U.S. House of Representatives, is an economic and political mess.

It introduces huge new distortions in markets, imposes onerous new regulations on a number of industries, requires a large addition to bureaucracy and risks a trade war.

And it does very little to fight global warming.

At this point, however, investors really only need to know two key things about this legislation in order to set themselves up for profit, while avoiding any losses from the bill’s fallout:

• From a political standpoint, Waxman-Markey is likely to become law in something close to its current form, meaning investors can craft a plan of attack with a fairly high degree of confidence.

• And, from an economic standpoint, it seems to define a pretty clear set of winners and losers, enabling us to flesh out that plan.

A “Good” Tax?

I’m not sure whether I believe in global warming. We clearly seem to be producing more carbon dioxide than we used to, but it’s not clear how much of an effect that’s having on global climate. Equally, the effects of extra carbon dioxide are long-term and largely irreversible, so even if the warming effect is limited in our lifetime, we probably owe it to our grandchildren not to leave them living in a steam bath.

To the economically minded who share my skeptical-but-cautious view, the optimal policy is pretty obvious: We should enact a carbon tax. Government operations have to be funded somehow, and there’s no obvious reason why a carbon tax should be any more economically damaging than any other kind of tax.

A carbon tax has two advantages over other alternatives:

• First, it can be varied easily, as we get new information and become more worried or less worried about global warming.

• Second, it allows investment and purchase decisions to be made by the market, just tweaking the price mechanism a bit to reflect our concerns about carbon emissions.

We’re not going to get a carbon tax, because it has the politically deadly word “tax” as part of its name. Still, during the presidential campaign, then-candidate Barack Obama showed off a pretty sensible “cap-and-trade” program. All the carbon emissions permits were sold, so the market was able to work properly, with no freebie giveaways to politically favored recipients. Further, there were no “offsets” by which companies could satisfy domestic permits by persuading the Chinese not to build a dirty coal-fired station, for example (these have given rise to innumerable scams in the European Union cap-and-trade system).

Such a system would have raised lots of revenue, helping to close the budget deficit and pay for healthcare reform, which ought to be one of its major objectives, given the United States’ now-dire fiscal position.

The Lowdown on Waxman-Markey

That’s not what we’re getting with Waxman-Markey, under which 85% of the emissions permits will be given away for free. That depresses the amount of carbon emissions saved, because with so many free permits available, the price of permits will be low.

Also, Waxman-Markey forces new buildings to use 30% less energy by 2012, intruding the U.S. federal government into yet another business previously regulated at the state level. It allows “offsets” for 2 billion tons of carbon emissions a year - 50% domestic and 50% international.

Finally, it doesn’t even raise any net revenue, because the giveaways and administration costs match the fairly paltry revenue raised through selling permits; according to the Congressional Budget Office (CBO) it’s just barely “revenue neutral” in the 2010-2019 time frame. That’s a major problem for President Barack Obama’s budget, which had assumed $624 billion in revenue from cap-and-trade in that same period.

This post was republished from Money Morning. You can view the entire article at Money Morning's investment news and analysis site.

What Really Caused The Real Estate Bubble?

What exactly caused the collective irrational behavior that led to real estate prices rising to unsustainable levels? That is the question that Harvard economist Ed Glaeser and University of Oregon economist Mark Thoma attempt to answer. See the following post from Economist's View for their hypotheses.

Ed Glaeser says that if people were as smart as he is, they would have realized housing price increases were unsustainable and there wouldn't have been a housing bubble:

In Housing, Even Hindsight Isn’t 20-20, by Edward L. Glaeser: ...[Is] the housing market ... starting to hit bottom? ... One major point of economics is that predicting asset prices is extremely hard... Moreover, the last seven years should make everyone wary about predicting housing price changes. ...

The housing price volatility of the last six years has been so extreme that it confounds conventional economic explanations. Over a four-year period — from February 2002 to February 2006 — the Case-Shiller index increased ... about 50 percent in constant dollars.

Certainly, those price increases cannot be explained by increases in average income. Income growth was quite modest from 2002 to 2006. Nor can the boom be explained by a dearth of new housing supply. Construction rose dramatically during the boom...

A number of pundits place the blame for the bubble on ... Alan Greenspan. They argue that loose monetary policy caused housing prices to rise. While lower interest rates are correlated with higher prices, the relationship is far too weak to explain the price explosion that America experienced. ... To get a 50 percent real increase in housing prices, real interest rates would have had to decline by more than ...10 percentage points..., which is not what happened. ... Real rates actually rose slightly between 2002 and 2006.

While low interest rates, on their own, cannot make sense of the bubble, perhaps the increased availability of credit to subprime borrowers has more explanatory power. ... Yet the correlation between housing price growth and subprime lending across markets is as likely to indicate that lenders took more risks in booming markets as that those risks caused markets to boom. ...

The most plausible explanations of the bubble require levels of irrationality that are difficult for economists either to accept or explain.

For many years, the creators of the housing index, Chip Case and Robert Shiller, have argued that housing bubbles were fueled by irrationally optimistic beliefs about future housing price appreciation. More recently, Monika Piazzesi and Martin Schneider have documented the rise in optimistic beliefs about housing price appreciation over the recent boom. Using some elegant algebra, they suggest that overly optimistic beliefs could cause a boom even if those beliefs were held by only a small share of the population.

It is hard to argue with this view. The only way that anyone could justify spending bubble-level prices in Las Vegas was by having the incorrect belief that those prices would increase.

I once thought that the Las Vegas housing market was so straightforward (vast amounts of land, no significant regulation) that no one could be deluded into thinking that prices could long diverge from construction costs, but I was wrong. I underestimated the human capacity to think rosy thoughts about the value of a house.

Yet even if ridiculously rosy beliefs are a major part of bubbles, we cannot say that we understand those bubbles until we understand the sources of such beliefs. Economists like to link beliefs to reality, but these views weren’t grounded in sound statistics. The housing boom was a great wildfire that spread from market to market, but it is hard to make sense of its flames. ...

I don't think people believed that housing prices would never, ever go down, what they thought is that housing prices would go up in real terms, on average, over time - that housing was a good long-run investment. They knew there would be variation around that trend, but they expected the variation to be relatively mild, they didn't expect the severe variation in prices and associated problems that actually occurred.

But as Shiller argues, the belief that real housing prices rise over time is false, the evidence suggests that real housing prices are relatively flat over the long-run. Because people expected prices to rise on average when they should have expected them to remain flat, the correction - the variation in prices - was far larger than anticipated and many homeowners weren't able to simply ride out the short-run variation like they thought they would be able to do.

But this still leaves a question unanswered. Why did people have this false belief about the long-run trajectory of prices? Shiller explains that this happened because people believed that both land and building materials were becoming relatively more scarce over time, a belief he says is false, but that just pushes the "but why did they believe that" question back one step from housing prices to the prices of land and raw materials.

So let me take a quick stab at an explanation (I'm not pushing this, it's just a quick thought). People are told (or were at that time) that stock markets are a great long-run investment. If you have the time to ride out the short-run fluctuations you can earn 8% per year. Just dump your money in an index fund that duplicates the market portfolio, and forget about it until many, many years later and you will do fine. Risk adjusted real returns on assets ought to equalize across markets through arbitrage, so shouldn't housing yield a real return similar to stocks (adjusting for risk)? Shouldn't there be a real return on housing just like in stock and other asset markets, and if so, doesn't that mean real prices will rise on average over time? This still requires beliefs about long-run prices at odds with (Shiller's) evidence though.

One more note. I may be wrong to assert that people thought that housing prices would rise forever. If you know that there is a bubble in an asset market, but you believe you can sell fast enough once the market hits a turning point to still make a profit, or at least not lose much in any case, then you may be willing to make an investment that tries to exploit the short-term surge in prices. But while I think that may apply to stock markets, or other markets where assets can be sold quickly (the belief that is, the reality is quite different when everybody tries to sell at once), I'm not sure this applies to housing where sales can be notoriously slow. But it's still possible that people would know there is a bubble in housing prices, but still be willing to make an investment because they believe that housing prices would fall so slowly that, if necessary, they could sell their house before taking a loss. It just doesn't seem to me that this explanation works as well in housing as it does in stock markets.

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

Commodities: The Asset Class Of The Future?

Although commodities only make up a small fraction of most funds, there is growing interest in this new asset class. While some investors don't think commodities should be considered an asset class, the growing demand and shrinking supply of the world's resources should make commodities a very interesting space to watch. For more, see the following post from Tim Iacono's blog.

With the price of oil now plummeting - just $62 a barrel as this is written - the commodity bulls of the world may need some "positive reinforcement" regarding the longer-term picture for this asset class and the Financial Times is happy to supply such in this report.

Commodities: Cinderella class slowly gains allure
The world of commodities, encompassing everything from gold to pork bellies, emerges as a real Cinderella asset class in the Watson Wyatt survey. Of the $872bn (£527bn, €621bn) held in alternative assets on behalf of pension funds by the 100 largest managers, a meagre 0.4 per cent resides in commodities.

David Hoile, head of asset research at Watson Wyatt, believes the asset class is not quite as unloved an ugly sister as it first appears; the survey only picks up direct exposure to commodities, whereas many pension funds will also have exposure via vehicles such as multi-strategy and global macro hedge funds.

“Pension funds are likely to have a 5-10 per cent allocation to commodities,” says Mr Hoile, with North American funds much keener than their European counterparts. A slice of funds’ equity allocation will also be in commodity-related stocks, providing another element of exposure.

The low allocations are, in part, simply a result of history; commodities are a newer asset class than, for example, real estate or private equity.

It is notable that, with all the hand-wringing over endowment fund losses and the many asset allocation changes that resulted, there seems to be an almost unwavering commitment to the natural resource sector in general and commodities in particular.

Of course, upcoming changes to the regulatory environment and tarnish on the Goldman Sachs/JP Morgan stars may change all that.

I'll never forget an email I received about a year ago, something to the effect of, "I have been on the Street for 20 years and I know to stay away from commodities".

Well, that's changing, despite the protestations by some that it is not a real asset class.

Philippe Comer, head of commodity investor solutions for the Americas at Barclays Capital, says it is only in the past decade that financial investors have entered a market still dominated by the producers and consumers of commodities.

Mr Hoile adds: “The financialisation of commodities by institutional funds was something we only really started to see from 2001-02. The modest allocation currently reflects that fact that we are at the start of a trend.” But there are also deeper forces at play that even a particularly benevolent fairy godmother would struggle to wish away; both the rationale for investing in commodities, and the mechanics of how any exposure should be generated, are questions still up for debate.

Mr Comer reports that institutional interest has been driven by a desire to increase diversification and to hedge against the risk of higher inflation.

There's much more in this very good piece on historical cycles, the difficulties with yield roll, active management, and a number of other topics.

One of the big differences between the 1970s and today is that, back then, the returns on commodity investments also benefited from high interest rates as most investor money was directed toward fixed income investments, futures contracts typically costing 10 percent or less of the face value of a futures contract.

With today's freakishly low interest rates, that works against investors.

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

Is France's Stimulus Package More Effective Than The US Stimulus?

France's approach to stimulus spending contrasts pretty sharply with the US approach. Instead of spending on long-term infrastructure projects designed to stimulate the economy in both the short and long-term, France is focusing on getting funds out quickly to citizens with public works projects like restoring famous landmarks. The French minister in charge of the stimulus says their strategy is better, but is it? Economist Mark Thoma examines this question in the following post.

The "cheese-eating surrender monkeys" say that when it comes to stimulus programs, “The country that is behind is the U.S., not France.”:

France, Unlike U.S., Is Deep Into Stimulus Projects, by Nelson D. Schwartz, NY Times: French workers normally take off much of the summer, but this month,... throngs of tourists will be jostling alongside stonemasons, restoration experts and other artisans paid by the French government’s $37 billion economic stimulus program.

Their job? Maintain in pristine condition the 800-year-old palace of more than 1,500 rooms where Napoleon bid adieu before being exiled to Elba and where Marie Antoinette enjoyed a gilded boudoir.

Besides Fontainebleau, about 50 French chateaus are to receive a facelift, including the palace of Versailles. Also receiving funds are some 75 cathedrals like Notre Dame in Paris. A museum devoted to Lalique glass is being created in Strasbourg, while Marseilles is to be the home of a new 10 million euro center for Mediterranean culture.

All told, Paris has set aside 100 million euros in stimulus funds earmarked for what the French like to call their cultural patrimony. It is a French twist on how to overcome the global downturn, spending borrowed money avidly to beautify the nation even as it also races ahead of the United States in more classic Keynesian ways: fixing potholes, upgrading railroads and pursuing other “shovel ready” projects.

“America is six months behind; it has wasted a lot of time,” said Patrick Devedjian, the minister in charge of the French relance, or stimulus. By the time Washington gets around to doling out most of its money, Mr. Devedjian sniffed, “the crisis could be over.” ...

As it turns out, France’s more centralized, state-directed economy ... is proving remarkably effective at deploying funds quickly and efficiently in bad times. ...

It is easier to find money for castles and cathedrals, of course, in a country that believes “art is equal to other investments, not secondary,” as Mr. Devedjian puts it. But the largess is driven as well by President Sarkozy’s support for more spending to combat the recession, even if it means borrowing more and running up big deficits.

That contrasts sharply with the commitment by the German chancellor, Angela Merkel, to hold down stimulus spending and move as quickly as possible to curb her government’s budget deficit.

So what about the criticism that Europe is not being as aggressive as the United States in combating the global slowdown, with only tepid stimulus packages? That’s not the way the French see it.

“You lost time with changing a president and no decisions were made in the last three months of 2008,” Mr. Devedjian jibed. “Nothing happened in January 2009, and in February, there was just a speech.”

“The country that is behind is the U.S.,” he said, “not France.”

While the scale, $37 billion versus close to $800 billion, is a bit different and probably ought to be accounted for in the comparison, there does seem to be a difference not just in the speed of deployment, but also in the focus of the policy. It will be interesting to see how that difference, which seems to place somewhat more emphasis on boosting employment and aggregate demand immediately than on long-run growth in France as compared to the U.S., translates into a differential response to the fiscal policy boosts in the two countries.

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

Las Vegas Real Estate Horror Stories

Talk about bad timing. 1,500 individuals put down significant deposits to buy pre-construction real estate in the $8.4 billion City Center project in Las Vegas during the height of the housing boom. Now their properties have lost about half of their value before they have even been finished. See the following post from The Mess that Greenspan Made for more on this.

Having visited Las Vegas last fall as financial markets were crashing, it was odd to see how remarkably cheery the City Center sales staff were in peddling condos for what will probably rival the construction boom in Dubai as the great White Elephant of a now bygone era.

In fact, when asked about plunging real estate prices and global financial markets that were following suit back in late-September, the sales staff almost appeared to be living in some parallel universe where asset prices only go in one direction - UP.

The response to this query was either a "deer-in-the-headlights" look or a brief moment of agitation before a well-honed sales instinct could wrest control back from what was clearly a more emotional (and more genuine) reaction.

Well, apparently, those who signed on the bottom line for condos a couple years ago (with move in dates this fall rapidly approaching) are all too aware of what's been happening in the local real estate market and they're none-too-happy about it.

According to the latest data from the Case-Shiller Home Price Index, Las Vegas property values are down some 33 percent from a year ago and a stunning 52 percent below the peak in 2006, around the time that many of the City Center sales were made.

The Wall Street Journal provides the following update on the project and the plight of the soon to be none-too-proud owners of some of these condos.

One of the costliest and highest-profile condominium developments in the country -- the $8.4 billion City Center project in Las Vegas -- is facing a revolt from some early buyers.

Some buyers who signed contracts are demanding significant price reductions, and have hired a law firm to take their grievances to the project's principal developer, gambling company MGM Mirage. Others want their deposits back. Some are using a Web site, citycentercondodepositgroup.blogspot.com, to air their grievances.

So far, buyers have put down $313 million in deposits on 1,500 units in the 2,440-unit complex. Those who agreed to buy early on now fear they will take possession of condos whose market values are far below what they agreed to pay. Many of the contracts were signed in 2006 and 2007, when Vegas was booming.

"It is simply not possible by any stretch of the imagination to close on the units at the contracted price," said Mark Connot, a partner with Hutchinson & Steffen, a Las Vegas law firm hired to represent a handful of buyers demanding price reductions. "Our position is they need to adjust the price to market value. And until that's done I don't think they will find any buyers."

It's funny how contract law is seemingly being ignored these days and how those who are clearly not "too big to fail" think they're entitled to be bailed out somehow.

Well, maybe funny isn't the right word there.

Perhaps disturbing would be a better one.

While the group of disgruntled owners may be able to negotiate from a position of collective power, they seem like a rather sad lot in the process. Most people who put down $100,000 on a million dollar condo that might now be worth only about $500,000 would surely just walk away and chalk that $100K up to experience.

What surviving mortgage company would lend $900,000 against that condo anyway?

Then again, what do the buyers really have to lose at this point?

Their entire downpayments have surely been sucked into the asset deflation abyss already, along with another $10 trillion or so of supposed "wealth" around the world, and if they walk away now, they may never get to ride the monorail.

The 67-acre project, due to open in November, includes 5,000 hotel rooms and 2,440 condos rising in sleek towers over the Las Vegas Strip. The development will have a public parks system, its own monorail, fire department, mall and theater.
...
The City Center condos range in price from $600,000 for a smaller studio unit to more than $9 million for an expansive penthouse suite built atop of the Mandarin Oriental hotel. So far, the most expensive unit under contract is a 3,910-square-foot suite at the Mandarin for $9.4 million, or $2,392 per square foot.

It is unclear how many buyers are agitating for better deals or for deposit refunds, but real-estate analysts in the area have raised fears that a good portion of them may no longer be able to secure financing and could just decide to walk away, leaving their units empty.
...
"You have 1,500 condo buyers right now who wish they'd never put this thing into contract and most of them have some kind of relationship with MGM Mirage," said one buyer who put a $600,000 deposit on a $3 million unit, and would like to get his deposit back. "It's tricky for MGM Mirage. You make your best customers angry."

This should be interesting to watch this fall.

Any word on how Donald Trump is doing these days?

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

Real Estate Decline Boosts Population In Urban Areas

The housing boom and subsequent bust has meant a redistribution of the population in certain areas of the country. Many families migrated to areas where the values were quickly rising, but may have lost their home and been forced to relocate to an urban apartment. This could account for the significant population growth in some US cities. For more see the following post from Blown Mortgage.

The housing slump has certainly had some unforeseen consequences. For instance, it may have actually helped boost the number of people living in New York City, Los Angeles and Chicago.

A story by Bloomberg News theorizes that falling home values in the suburbs of California and Florida may have helped cities such as New York City grow.

During the housing boom, home values in parts of Florida and California skyrocketed. This attracted a lot of people to these states, many of whom were hoping to cash in on the real estate gold rush. Of course, things are different now. Home values in these two states have fallen dramatically, as much as they have in any other state.

Suddenly, not as many folks are rushing to these sun-soaked communities.

This has benefited the three biggest cities in the United States. According to Census Bureau reports, New York City's population increased by 53,000 residents from July 1, 2007, to July 1, 2008. During the same period, the population increased by about 27,000 in Los Angeles and about 21,000 in Chicago.

The Bloomberg story says that the country's migration bubble has burst. This means that people are no longer flocking to states such as California or Florida that benefited from unrealistic housing appreciation.

This story is fascinating because it clearly shows how significant of an impact the housing market has on not just our economy, but on where people live and work and play. I've always known that the housing market's impact is huge. But sometimes, you need a reminder.

This article was republished from Blown Mortgage.

Homeowners Seek Adjustments In Property Taxes

With home values falling significantly all over the country, it only seems fair that home owners should pay lower property tax bills. For 63 year-old Peggy Tombro of New Jersey, the property tax bill for this year will be $53,000 although her house lost over 25% of its value. For more see the following post from The Mess That Greenspan Made.

Those of you who were around during the late-1980s/early-1990s real estate boom/bust will surely remember all the homeowners who requested that their property taxes be reduced after home values declined. The situation seems much more dire this time around as detailed in this story in the New York Times and codified in the caption for the photo below.

What struck me as very surprising, something that, here on the West Coast, falls into the category of "unthinkable", were the exorbitantly high tax rates in places like New Jersey.

I've long heard of people fleeing to Pennsylvania to escape property taxes to the east, but the figures for Ms. Tombro's tax situation detailed below are just mind-boggling.

New Jersey, which has the nation’s highest property taxes, has been besieged by tax appeals from homeowners like Peggy Tombro, whose rambling home in Bound Brook is assessed at a value of $1.8 million but is languishing on the market with an asking price of $1.3 million. Her taxes are increasing to $53,000 a year.

“I don’t know what else to do,” said Ms. Tombro, 63, who has gone back to work selling antiques to pay her tax bill.

She's going to have to sell a lot of antiques...

With entire neighborhoods populated by million dollar homes quickly vanishing, the days of plentiful $25,000 a year property tax bills also appear to be numbered, boding ill for the spendthrift ways of many local and state governments.

Surely, the case of New Jersey property taxes is an extreme one.

For example, in California, the tax bill that comes after the purchase of a $1.3 million home would be around $16,000 rather than an amount that approaches the national median household income.

Of course, the State of California also has a bit of a budget problem these days, so maybe that's not the best example to use.

Perhaps even more intriguing than the ongoing adjustments being made by typical Americans as a result of the new economic reality that has arrived on all our doorsteps will be the changes that state and local governments are forced to undergo, kicking and screaming all the way, most likely, a process that has just begun.

Naturally, the biggest and baddest adjustment of them all will someday come at the Federal government level where spending beyond ones' means has not only become accepted practice, but a way of life.

That too will change someday...

This post was republished from Tim Iacono's blog, The Mess That Greenspan Made.

When Is The Obama Stimulus Going To Start Creating Jobs?

With the unemployment rate reaching the highest level in 26 years, the obvious question is: when is the Obama stimulus going to start creating some jobs? Shouldn't the funds be used to put people to work immediately rather than investing in long-term infrastructure projects that could take months to start? The following post from Economist's View discusses this topic further.

The stimulus package had two components, new spending and tax cuts. Everybody knew that the spending component would take time to put into place, six months or more for a lot of the infrastructure projects, and that meant that we needed something to increase demand and provide a bridge until the new spending comes online.

Enter the tax cuts that the GOP insisted upon, tax cuts that were a larger part of the stimulus package than I thought justified. These cuts were to come online immediately and stimulate demand until the spending could begin taking up some of the slack later in the year. I would have preferred targeted, non-infrastructure spending that could have been put in place almost as fast as the tax cuts (particularly those that simply require making existing programs more generous), but that type of spending was considered wasteful because it didn't add to our long-run capacity for growth and hence had little chance of being part of the stimulus package.

The problem was partly bad luck. A crisis hit and we had the bad luck of having an administration that opposed active intervention and though there was a bit of a stimulus attempt through a one time tax rebate, a strategy theory predicts won't do much to help, the real action in terms of stimulating the economy was left to the new administration. So nothing was done, nothing could have been done until the new administration took over, and given the insistence that any new spending be on infrastructure projects with clear benefits, tax cuts were the main hope for an immediate effect.

So if the policy has failed at this point, it is not the spending component since, fully consistent with predictions when it was enacted, it was going to be months before it could be of any help. What failed is the GOP's insistence that tax cuts be used to provide an immediate boost to the economy. Increasing food stamps, unemployment compensation, payments to help states with declining revenues and increasing demands for social services, payments to help unemployed workers maintain health care, digging (needed) holes, there were many, many other ways to provide more immediate relief and stimulate the economy at the same time, but no, it had to be tax cuts or nothing.

Finally, I want to note that what we maximize matters. For example, we can maximize GDP growth over the next ten or twenty years, or we can maximize employment over the next few months. Which we choose to maximize has a big effect on the policies we put in place. If we use the stimulus money to maximize GDP and growth - which is essentially what we did - that will have a much slower effect on employment than if we maximize employment directly. The efficiency argument always leads you to maximize output, and efficiency prevailed in the structure of the current package, but I think an argument can also be made that maximizing employment provides social benefits that are just as large, or larger.

Just noticed this, which makes a surprisingly similar point:

A Message to President Obama: Stop Priming the Pump, Hire the Unemployed, by Pavlina R. Tcherneva: Many have called President Obama’s stimulus plan a return to Keynesian policy. Some of us who like reading Keynes professionally or for leisure have already been scratching our heads. I have wondered in particular whether the plan isn’t set up to work in a manner completely backwards from what Keynes himself had in mind when he advocated economic stabilization by government.

There are two things to remember about Keynes’s fiscal policy proposals: 1) government spending was always linked to the goal of full employment... and 2) to achieve macro-stability and full employment, the government had to employ the unemployed directly into public works.

By contrast, most modern economists believe that 1) there is some natural level of unemployment that includes the structurally unemployed, which governments cannot generally tackle, and that 2) public employment is an inefficient use of public resources.

So, when the government is called to action, the economic profession has replaced Keynes’s “fiscal policy via public works” with a “leaky bucket pump-priming mechanism.”

How is the latter policy supposed to work? Instead of employing the unemployed directly, the idea is to generate large enough government expenditures to produce a level of economic growth that would, in turn, gradually reduce unemployment. For example, the government could spend money on various private sector contracts, stimulate different private industries, offer investment subsidies and tax cuts, and increase unemployment insurance payments, in hope that it will boost GDP sufficiently to reduce unemployment to desired levels. This is essentially the underlying logic behind President Obama’s stimulus package. But it is also a bit of a gamble.

Not all of these injections will be effective because the fiscal stimulus enters the economy through “a leaky bucket”. Some of the money will be lost in transit (because of administrative costs, for example) and much of it will have no direct job creation effects (e.g. the tax cut component of the recovery act). Nevertheless, despite this leaky bucket, the theory goes, sooner or later, large enough government expenditures will produce the kind of growth that would reduce unemployment. ...

All of this is ... why Keynes never had any “leaky bucket” or “pump priming” idea in mind. For him “the real problem fundamental yet essentially simple…[is] to provide employment for everyone” (Keynes 1980, 267) and the most bang for the buck from fiscal policy would be achieved via direct job creation. This he called “on the spot” employment via public works.

As I have argued elsewhere, it is useful to think of Keynesian fiscal policy, not as aggregate demand management, but as labor demand management. ...

Commentators often call this a policy of “make work” but Keynes didn’t advocate digging holes, burying jars with money and digging them out, or any other similarly worthless projects. The key was to marry the two goals: to employ the unemployed directly and to make sure that they do useful things. Once they are put to work on a particular project, Keynes argued, “there can be only one object in the economy, namely to substitute some other, better, and wiser piece of expenditure for it” (Keynes 1982, 146). We might as well ask a very basic question: is there really a shortage of useful things to do?

If we insist on calling ourselves Keynesians again, and more importantly, if President Obama’s plan for economic stabilization should generate rapid reduction in unemployment, it would help to set fiscal policy straight. Instead of relying on “leaky fiscal buckets” we could return to “labor demand management” a la Keynes that provides immediate employment opportunities to the unemployed via bold and creative public works projects, which generate useful output and services for all.

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

Water: The World's Most Valuable Resource

It may be hard to believe that the stuff that flows freely from our kitchen faucets is one of the most valuable resources in the world. However, as the world population approaches 9 billion people in 2050, this limited resource will become tremendously more valuable. See the following post from Daily Wealth to learn how you can profit from the opportunities in water investment.

If you're interested in water investing – like I am – Steve Hoffmann is someone you need to pay attention to.

I recently picked up Hoffmann's new book, Planet Water: Investing in the World's Most Valuable Resource. Hoffmann is well known in water circles. He's the founder of WaterTech Capital, a private group focused on water investing. He's also the creator of the Palisades Water Index, which many water funds use as a benchmark.

I've been researching water investments for years now. I believe that as the developing world becomes richer over the coming years, it's going to spend enormous amounts of money to secure clean water supplies. This means terrific opportunities to make money investing in water stocks.

Hoffmann's book has some good information and research on water issues, if dryly presented. Hoffmann is not the best of writers. Still, it's nice to have it all between the covers of one book. There are certainly many opportunities in the water sector for investors. It's one of the most exciting areas of the market to be a part of.

For one thing, it is an incredibly large sector. Water is the third-largest industry in the world, behind only oil and gas and electricity generation. For another, some of the drivers of water use are only getting bigger as this human drama unfolds. Hoffmann points to these three, among others:

· Industrialization. As a country develops, its water use expands even faster. As people earn more money, they wear better clothes and buy more consumer products. All of these things have a high water content. Not too many people understand how much water we use to make a pair of blue jeans, for instance. (It's about five gallons.) Yet this water use is all too real. Then there is the matter of diet. As people make more money, they shift to eating foods that have a much higher water content or that take more water to produce – fruits and vegetables and meats.

So all of this is a tremendous source of growth for water demand. India alone, for instance, expects water demand to double between now and 2025 – and industrial water demand should triple.

· Urbanization. More and more people around the world live in cities. And more are moving to cities with each passing year. In 2007, more than half of the world's population lived in cities for the first time in history. Our cities are also bigger than ever. For example, some 9% of the world's population lives in cities of more than 10 million people.

Well, people in cities use more water than those not in cities. To support all that water use requires a lot of pipes, pumps, and more. As Hoffmann writes, the infrastructure needed to support urban water use is "staggering."

· Globalization. When goods can more easily travel across borders, water use tends to increase. Suddenly, you can build cities in areas where older human societies would never have thought to build a large city. Basically, we've created a sort of virtual water trade.

"Countries with a relative abundance of water," Hoffmann writes, "can grow food and trade it to water-stressed countries." The sheiks in Dubai are grateful, no doubt.

As I've pointed out, water is big business. And Hoffmann goes through a variety of sectors, highlighting the issues facing each and compiling tables of companies in each space. Let's walk through a few of them.

The biggest part of the water industry – and the one everybody thinks of first – is the water utility group. There was a time when I liked the water utilities. I can say I've never lost money on a water utility. For years, investing in water utilities was an easy way to beat the market. But things are changing.

I've come to think that the water utilities have to support an enormous investment going forward. And they have to do that in a political environment not favorable to water price increases. Bad mix, that. Hoffmann agrees. "Public policy will dictate rate increases," he writes, and "water utilities will then [see] increasing pressure on profit margins."

For this reason, I'd pass on the water utilities. There are far better opportunities in the water industry's "picks and shovels" providers... the companies that provide products and services needed to supply clean water.

Take water treatment, for example... As Hoffmann writes: "The fundamentals of the [water] treatment sector... are extremely compelling. Virtually all global water quality issues come down to treatment in one form or another." Water treatment means taking raw water and purifying for some use, either industrial or for human consumption.

My favorite water treatment company is Nalco Holding (NLC), a company my readers have owned for a long time. Warren Buffett recently joined us as the firm's largest shareholder. Hoffmann gives a nod to Nalco as "the preeminent publicly held water treatment chemical company in the world.

Infrastructure is another great picks and shovels play on water. This is one of my favorites, because it is easy to understand and there are several good ideas in the space. Infrastructure covers all the pipes, pumps, valves, and more that make up the physical framework that supports water delivery. As Hoffmann says, the importance of this sector "cannot be overemphasized."

This is why I've recommended several of the best players in water pipe and water pump manufacturing. I expect their sales and profits to enjoy a huge tailwind over the coming years.

To sum up, if you're looking for long-term water investments, keep in mind the pressure water utilities will face to keep their profits down. Avoid it. The "picks and shovels" of the water boom offer much bigger opportunities.

This post was republished from dailywealth.com.

Why You Shouldn't Listen To George Soros

When you hear legendary investors like Soros or Buffett make positive comments about the economy, that doesn't necessarily mean you should go all in. Keith Fitz-Gerald from Money Morning discusses how you should interpret the comments from people like Soros or Buffett and what you can learn from their approaches to investing.

Billionaire investor George Soros thinks the worst of the global financial crisis is behind us.

In a June 20 interview with Polish television, the Hungarian-born Soros acknowledged that this has been the most serious crisis he’s seen in his lifetime, but said, “Definitely, the worst is behind us.”

For those that like to interpret “Soros-speak,” that’s as powerful a sign as any that one of the world’s most successful investors is “going long.”

But is he wrong?

On one hand, the World Bank is busy roiling the markets with recently updated figures that project a 2.9% decline in global economic activity this year. Then there are the signs that the “green shoots” (how I’ve come to detest that term) may be more like weeds. Debt is devastating the developed world and the once-mighty G-7 looks more like a G-1 every day.

On the other hand, I wouldn’t bet against him. When it comes to financial influence and acumen, Soros is about as powerful and prescient as they come. He’s made billions over the years speculating on things that others simply couldn’t see or, more often, didn’t want to believe. He’s as iconic as he is legendary for making big bets on market timing even if, by his own admission, he’s not always right.

For the millions of investors who are tempted to interpret Soros’s comments as bullish, that admission forces me to urge caution. In fact, my advice to proceed with caution extends to any comments that might be made by such other investment legends as Warren Buffett, or even Soros’ former investment partner, noted author and commentator Jim Rogers.

I preach caution for three reasons:

• Despite the fact that each of these men is fabulously successful, the typical retail investor has no idea how much money they’re betting on the upside, or what percentage of their wealth is involved in any publicized position.

• It’s not clear what - if any - protective stops are being used so you don’t know whether the positions they’ve taken represent core portfolio holdings or speculative trades.

• These revelations - disclosures - are usually made after the fact, which means that investors who may want to tag along for the ride are put in the risky position of having to make “me too” investments.

So if you’re a savvy investor, what steps can you take to translate moves being made by three of the best investors of our time into profits of your own?

A good place to start is by taking the time to understand precisely what drives these guys. Even though Rogers hunts for opportunities around the world, Soros tends to pursue investment plays involving currencies and macroeconomic trends, and Buffett is a deep value guy, they are more alike than they are different. That’s especially true since the core elements of the strategies these three investors use to win and profit usually run counter to Wall Street’s conventional wisdom.

Take the very concept of profits, as an example. Most people are surprised to learn that none of these gentlemen sits around over coffee in the morning, rolling his hands with an evil laugh as he wonders aloud how much money he’s going to make on that day. But nearly all have gone on record at one point or another talking about the importance of not losing money in the first place. They’ve also repeatedly stressed the importance of waiting until the really compelling opportunities develop before they put their money at risk.

Rogers, once Soros’ partner at the Quantum Fund, a hedge fund that’s often described as the first real global investment fund, goes a step further. He describes his investment process as a little like waiting until somebody else puts money down in the corner, then “walking over and picking it up.”

Another common trait is that not one of these three investors believes that you have to take big risks to make big money. In fact, all three gentlemen believe, as I do, that it’s how you concentrate your wealth that matters.

This flies in the face of what Wall Street would have you believe which is that you need to diversify your assets to get ahead. Diversification as Wall Street practices it is a complete misuse of the math and a proxy for an entire establishment that doesn’t know what it’s doing.

The thinking is that by spreading your money around willy nilly, some of your holdings will rise in value, even as other parts of the portfolio fall. Even so, by diversifying, Wall Street says that you will be better off for it over the long run. Granted, there are some instances where taking steps to “diversify” leaves you better off than if you’d done nothing at all, but one of the critical problems with diversification as Wall Street has practiced it is that it doesn’t work when everything goes down at once - as so many investors who had been led to believe they were protected found out the hard way in 2000 and again in 2007.

That’s why, for example, I’m a proponent of concentrating my efforts on a few relatively high-probability choices, especially when it comes to trading services, such as the Geiger Index or the New China Trader, for example. It’s a strategy that individual investors should consider, as well.

But what matters most is that people put the comments they hear from these guys into perspective and think for themselves. It’s important to remember that neither Buffett, nor Soros nor Rogers care about what other people think. That’s one of their real strengths. Nor do they care what the markets will or won’t do.

In fact, none of the three - as least as far as I can tell from the research that I’ve done - subscribes to the “random walk” or “efficient market” theories I’ve mentioned as complete bunk in recent months.

The bottom line is that Soros, Buffett and Rogers have demonstrated time and again that they’ll only make a move when they’re darned good and ready - when they’ve done all they can to scope out the situation at hand, and done everything possible to make sure that the percentages are in their favor.

That, alone, is a terrific lesson for retail investors to learn. Wall Street tries to push investors into action with advertisements that portray “real” people making trades from their kitchens, or getting the latest quotes on their mobile phones. They show attractive retired couples who’ve achieved their dreams with big sailboats, or antique cars, or on expensive vacations. Ignore those messages and you’ve effectively elbowed aside the artificial sense of urgency that Wall Street is trying to create.

Not only is this manufactured urgency designed to separate more of you from your money, but they wouldn’t do it if they knew that most investors got it “right” more often than they got it wrong.

Buffett, Soros and Rogers act only when they believe the time is right. Buffett has referred to this as waiting for the Sunday pitch. If you’ve never heard that term before, it’s one that dictates extreme patience while all the spitballs, knucklers and sliders go by. You only take action when the one pitch you know you can hit out of the park is on its way - then you swing from the heels, giving it all your effort.

There’s one final task that these guys do better than almost anyone - and that’s to keep everything in perspective. They assemble their portfolios carefully with diligent planning, attention to detail and an emphasis on the objectives they expect to achieve. They make investments based on a clearly defined set of expectations and do not hesitate to cut their losses if they find out they were wrong.

In that sense, every investment choice they make fits a specific role in their portfolio. Nothing, if they can help it, is left to chance. So to the extent there’s any action to be taken right now, let me leave you with one final thought.

No nation in the history of mankind has ever bailed itself out by doing what we’re doing now, which means that placing bets on a “recovery” is really a fool’s errand. On the other hand, making choices that capitalize on the trillions of dollars now being injected into the world’s financial system is the place to be. History shows that it’s better to be generally long resources, inflation-resistant choices, and real companies with real earnings.

Not only will these types of profit plays fall less than others if the markets stumble and fall from here, they’ll also rise faster and farther once the capital infusions start to work their way through the global financial system and the rebound gets under way.

And I’ll bet my bottom dollar that George Soros knows it.

This article was republished from Money Morning, an investment news website.

PPIP May Have Succeeded Before It Was Ever Launched

Although the Public-Private Investment Program may never launch with its promised luster, it may have already achieved its goal. An interesting article by Noam Scheiber suggests that the idea of PPIP may have improved Wall Street's spirits enough to allow banks to raise private capital on their own. Mark Thoma from Economist's View discusses this in the following post.

The Treasury view, Free Exchange: ...Noam Scheiber has a nice post up examining the view of PPIP—the plan to sell subsidised toxic assets at auction—from inside the Treasury. Here's a quote from a Treasury official:

...If you had asked--I don’t want to speak for the secretary--what’s problem number one? I think he'd say capital. Problem two? Capital. Problem three? Capital. Everything was in the service of that view. The legacy loans program was meant to help clean balance sheets. It was not an independent good in itself. It was seen as friendly to equity raising. Now people say the legacy loans thing is not gaining as much traction, so is that a failure? But because we had a good outcome in terms of raising equity, [the banks] were able to raise equity without shedding assets ... you should be okay with that.

Mr Scheiber also reprints a quote from a Goldman Sachs employee, originally in the Wall Street Journal, noting that PPIP is "the greatest program that never occurred... [because it] created confidence in the markets so banks can raise equity capital".

I don't know that I buy the Treasury spin—that they saw that banks needed more capital than the government could provide, and so they crafted an incredibly generous asset purchase plan understanding that it would boost Wall Street spirits, allowing banks to raise private capital and thereby making actual deployment of the plan unnecessary. Remember just how dire things appeared at the time of the plan's construction, and recall how many defenders of the plan—myself included—argued that there were no other options with tolerable risk levels available. Meanwhile, it's not clear that PPIP (as opposed to other interventions or the natural resolution of the crisis) had anything to do with the market's rebound, which began well after the initial description of the administration's proposal and well before the release of key programme details.

Which isn't to say that no one in the administration foresaw this possibility or planned for it. I would argue, however, that the current state of affairs was not really the expected outcome, and that the banking plan benefitted enormously from events outside of Treasury's control.

I don't disagree with that. But if it's true that the plan inspired confidence, intended or not, and that caused private investors to put capital into these institutions based upon the assumption that the banks would be made healthier by ridding themselves of toxicity through the PPIP, and now the government says "just kidding," isn't that a double-cross? Would the private investors have still put capital into the banks had they known the double-cross was coming? And if they wouldn't have, doesn't the continued presence of these assets on the books mean there's more risk present than we ought to be comfortable with?

This article was republished from Mark Thoma's blog, Economist's View.

Why National Health Care Insurance And Cap-And-Trade Are Terrible For The Economy

Is this the right time for the government to pursue ambitious and potentially expensive new reform to healthcare and the environment? Peter D. Schiff argues that such action are not only detrimental to the economy, but have little chance of achieving success. See the following post from Money Morning.

Misguided government policies have already dealt vicious body blows to our economy, but that hasn’t stopped politicians last week from launching two new kicks to the recovery - a national health insurance plan and a carbon emissions regulation system called “cap-and-trade.”

Even if these plans could achieve their desired ends, which is highly unlikely, I would have hoped Washington would refrain from throwing more monkey wrenches into the economy until it shows some signs of resurgence. The last thing we need right now is to further encumber our economy with higher taxes and additional regulations.

The meteoric rise in healthcare costs, which has become an unending nightmare for U.S. businesses and consumers, is not an accident. This painful condition arose from excess government involvement in the system, tax provisions that encourage the over-utilization of health insurance, and government support of an out-of-control malpractice industry. Rather than allowing more bad policy to drive healthcare costs further upward, we should be looking at ways to allow market forces to reign them back in.

If left alone, the free market drives quality up and costs down. Government programs produce the opposite result. Despite the president’s claim that a federal plan will bring costs down, there is no historical precedent for such faith.

Simply providing more widespread health insurance, as the Obama administration plan offers, is not a solution. In fact, it will aggravate the problem. Since consumers no longer pay for routine medical expenses out of pocket, comprehensive health insurance creates a moral hazard for both patients and doctors. To maximize the value of the health insurance “benefit,” most workers opt for low deductibles and co-pays. Therefore, doctors learn that their patients are not concerned with the cost of care, and so they are free to bill insurance companies at the maximum allowable rates.

Given our current tax code, the simplest way to bring down medical costs would be to fully tax healthcare benefits as wages and simultaneously increase the personal deduction by an amount significant enough to neutralize the effect of the tax increase.

This would do two things: First, the uninsured would get a huge pay increase, enabling them to buy reasonably priced catastrophic policies. Second, those currently insured could opt out of expensive employer-provided plans, trading premiums for extra wages, then buy a more economical plan. The savings would go right into their pockets.

The bottom line is that aggregate medical costs won’t come down unless services are rationed more wisely. Rather than being used as a pre-payment plan for routine care, insurance should only cover unpredictable, catastrophic costs.

As a comparison, homeowners often carry fire insurance, but seldom maintenance insurance. You buy fire insurance to guard against a catastrophic loss, which is a low probability but high cost event. As a result, fire insurance is relatively affordable, since premiums paid by all those homeowners whose houses do not burn down more than pay for the losses on those few whose houses do.

On the other hand, no one carries home maintenance insurance to pay for a clogged drain or broken garage door. If insurance paid for the plumber visit every time a toilet overflowed, we would now have a plumbing crisis, and Congress would be looking to reign in runaway plumbing bills with “national plumbing insurance.”

In his press conference, U.S. President Barack Obama claimed that government insurance would not drive private providers out of business. This is absurd. As the government provider will not have to produce a profit or accurately account for its contingent liabilities, it will provide insurance on an actuarially unsound basis.

With taxpayer subsidies, the government provider can run losses indefinitely. If private insurers did this, they would either be shut down or go bankrupt. Therefore, the cost of government provided health insurance will not be confined to the premiums paid, but will include the taxpayers’ bill to continually bail out the government provider.

When Medicare was first proposed back in 1966, it cost $3 billion per year, and the projection was for inflation-adjusted annual costs to rise to $12 billion by 1990. The actual cost in 1990 was $107 billion, and the 2009 estimate is a staggering $408 billion! So much for government estimates on health care.

As if this were not bad enough, the House of Representatives voted to pass the American Clean Energy and Security Act, otherwise known as the “cap and trade” bill. Disguised as an environmental bill, this proposal is merely another gigantic tax.

The lion’s share of the new revenue is already committed to politically connected special interests that will reap windfalls at everyone else’s expense. To make matters worse, the bill before Congress amounts to a blank slate, with the Environmental Protection Agency (EPA) empowered to draft the details in any manner they see fit. If Congress is going to shoot the economy in the knee, they should at least be required to pull the trigger themselves.

“Cap and trade” will do nothing to reduce pollution, yet it will drive up production costs throughout the economy - rendering us even less globally competitive than we are today. In addition to the huge cost of paying the tax, its enforcement involves the creation of an entire new bureaucracy, the costs of which will be borne by American consumers in the form of higher prices.

Years of reckless borrowing and spending have left us in a gigantic hole. Getting out of it requires that we make the most effective use of all available resources. We need labor and capital to operate as efficiently as possible so we can save and produce our way back to prosperity.

Unfortunately, national health insurance and “cap and trade” are two steps in the wrong direction. Rather than getting us out of this hole, they will merely cave in the walls around us.

This post was republished from Money Morning. You can also view this post at Money Morning, an investment news website.

Data Shows Housing Market Improving

The latest from the S&P Case-Shiller Home Price Indexes shows that price declines are slowing down with some metropolitan areas showing slight growth in property values in April. See the following post from The Mess That Greenspan Made for more on the latest numbers from the housing market.

The April report(.pdf) for the S&P Case-Shiller Home Price Indexes showed an easing of home price declines across the country after months of record declines. From March to April, the 20-city index fell just 0.6 percent, its "least bad" reading since last June, and the annual rate of decline improved from -18.7 percent to -18.1 percent.

Note that the top-to-bottom end-positions of the curves on the right of the chart correspond to the order in the legend in the upper left to aid in viewing the data.



Poor Detroit continues to plumb new lows, the index falling from 71.67 in March to just 69.2 in April, well off the bottom of the chart.

As shown below, Phoenix maintained its leadership role in year-over-year price declines with an astonishing 35.3 percent plunge, only slightly improved from last month's 36.0 percent decline. Conditions worsened in Las Vegas, however, April's annual decline of 32.2 percent exceeding the 31.2 percent drop seen in March.

San Francisco moved from the 30+ percent decline group (indicated by red underlines) back to the 20+ percent decline group (indicated by blue underlines), however, there were no similar moves out of the 20+ percent decline group which now numbers seven.



David M. Blitzer, Chairman of the Index Committee at Standard & Poor's notes:

The pace of decline in residential real estate slowed in April. In addition to the 10-City and 20-City Composites, 13 of the 20 metro areas also saw improvement in their annual return compared to that of March. Furthermore, every metro area, except for Charlotte, recorded an improvement in monthly returns over March. While one month’s data cannot determine if a turnaround has begun; it seems that some stabilization may be appearing in some of the regions. We are entering the seasonally strong period in the housing market, so it will take some time to determine if a recovery is really here.

The stock market bottomed in March and measures of consumer confidence have turned upward. This report shows that these better spirits are also appearing in the housing market.

Mr. Blitzer doesn't appear to be quite convinced yet - "some stabilization may be appearing in some of the regions" is not exactly a ringing endorsement of a return to normalcy.

It will take at least a few months of actual increases in prices before a bottom can reasonably be called. When exactly that happens is anyone's guess - my guess is that it won't be this year.

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