A Closer Look At Home Price Increases

Is the Case-Shiller Home Price Index a good representation of actual home prices? The following post from The Mess That Greenspan Made, explains some of the possible flaws in the calculation of the index and why we should take the numbers with a grain of salt. Continue reading to learn more.

Mark Hanson's comments on the recent upswing in real estate prices as indicated by the highly regarded S&P Case-Shiller Home Price Indexes. It seems that, almost every few months now, there's a new wrinkle in how home price changes are reported and, coming as it does amid what millions of people think is a bottom for home prices, this one's a doozy.

Mid-to-High End Sales – Very Important.
Not Representative of True Market

More mid-to-high end sales are occurring this year than last. They are not anywhere close to the bubble years due to the catastrophic loss of affordability through exotic finance but they have increased as prices fell. They are occurring at significant discounts to list prices and previous year’s sales as I have highlighted many times. At the same time, foreclosure-related resales are falling as demand from first-timers and investors who have carried the market for a year has peaked.

This seasonal mix-shift is almost exclusively responsible for the significant house price appreciation in any CA MSA’s over the past 90-days. Mid-to-high end sellers and buyers are the most seasonal of all. As soon as the summer warm months are over and kids are back to school these sales will drop considerably allowing foreclosure resales, which are not seasonal, to reclaim this mix. This will drop reported median and average house prices as early as September, which will be reported in October.

Here's the interesting part.

At this point, you might be thinking that Mr. Hanson has the calculation of median prices confused with the paired-sales methodology used by Case-Shiller, but he does not.

While I haven't read the details of how the index is calculated recently, one can immediately understand how the index values can be affected by how long the seller has owned the home after reading the following:

Who is the Mid-to-High end Seller? Why Is This Important?

Now, think about those that are selling these mid-to-high priced houses. It is not the person who bought from 2005-2007 on a Pay Option ARM with 5% down because they can’t sell. It is the person who bought years ago that has enough equity to dump the price, sell, and have enough left over for the down payment on the house they plan to steal in the desert.

Even with the price dump, a person who bought in 1999 for $450k — who saw their house price rise to $1.5 million by 2007 and subsequently drop to $700k — realizes a price gain and so does CS. Even though CS reduces the weighting of pair sales the longer ago they occurred — when this is all you have selling — it carries most of the weight.

The bottom line is that Case-Shiller reports what sold, period. It is my opinion that the real estate market is so thin and bifurcated that what is selling today is not representative of the true real estate market.

It likely is not accurately representing properties purchased during the bubble years that are now worth a fraction of their purchase price because they are not transacting.

This is apparently part of a private letter to clients. If anyone has a copy and would like to share some more details, please feel free to do so in the comments section or via email.

Maybe, I'll drop Mark a line and ask him if he would like to share any more details about this because my interest is piqued. Then again, I haven't checked Calculated Risk yet today and Bill might already have an analysis on this subject posted.

Anyway, this all makes a good deal of sense to me - aside from a few price ranges in a few areas of the country that may have hit bottom, there is much more work to do to get home prices back to more normal levels - and then there's the typical "overshoot".

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

How An Idea That Spreads Could Lead To Global Economic Recovery

Economist Robert Shiller offers that the economic recovery may be more influenced by ideas that spread, rather than typical economic metrics. For instance the idea of "green shoots" spread throughout the world as a symbol of renewed confidence that could become a self-fulfilling prophecy. For more on this see the following post by Mark Thoma from Economist's View.

Robert Shiller says the global recovery in economic confidence is being driven by a social epidemic, the contagion of ideas, and huge feedback loops:

An Echo Chamber of Boom and Bust, by Robert Shiller, Commentary, NY Times: The global signs of a recovery in economic confidence seem puzzling.

It is a large and diverse world, after all, so why should confidence have rebounded so quickly in so many places? ... Economic analysts often turn to indicators like employment, housing starts or retail sales as causes of a recovery, when in fact they are merely symptoms. For a fuller explanation, look beyond the traditional economic links and think of the world economy as driven by social epidemics, contagion of ideas and huge feedback loops that gradually change world views. These social epidemics can travel as swiftly as swine flu: both spread from person to person and can reach every corner of the world in short order. ...

The popularity of the term “green shoots” shows the kind of social epidemic underlying our changing thinking. The phrase was propelled in Britain by Shriti Vadera, the business minister, in January, and mutated into a more contagious form after Ben Bernanke, the Federal Reserve chairman, used it on “60 Minutes” on March 15.

The news media didn’t need to change the term for different cultures around the world. With nothing more than a quick translation — brotes verdes, pousses vertes, grüne Sprösslinge, etc. — it is now recognized as a symbol of a revival coming soon.

All of this suggests that a social epidemic is supporting renewed confidence. This confidence can keep growing by contagion, as a kind of self-fulfilling prophecy, and we may see the markets and the economy recover further.

But in an economy that is still unstable, the stories could also morph into different forms, the price feedback could turn downward and the dynamic could turn ugly again — just as it has in the past.

It seems quite reasonable that the spread of information (wrong or right) can reinforce trends in economic activity, and hence magnify and propagate shocks, but as noted in a part of the article not included above, this doesn't help us much with the problem of predicting turning points in economic activity. Predicting when the stories suddenly "morph into different forms ... is actually very complex. And even when feedback mechanisms are straightforward, they can produce very strange outcomes, not predictable very far into the future..."

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

Why Fundamentals Of The Housing Market Are Ridiculously Strong

Dr. Steve Sjuggerud from Daily Wealth points out some keen insights about the fundamentals of the current housing market. He suggests that supply hasn't been this low is a long time, and yet housing is very affordable. These are some of the reasons that real estate could be one of the best places to put your money right now. Continue reading to learn more.

$800,000.

That's about what the median home in San Francisco sold for at the height of the boom three years ago. Then the bust came, and prices fell 45%, according to the Case-Shiller home price index.

But a funny thing has been happening lately... something people haven't really noticed...

Home prices in San Francisco actually bottomed in March. According to the Case-Shiller Index, they've been up every month since... up nearly 4% in the latest month.

On my side of the country in Florida, the same thing is happening. Again, people are almost refusing to notice... But for 11 consecutive months, home sales in Florida have INCREASED over the same period last year.

Meanwhile, homes in Florida are now ridiculously affordable.

The median home price in Florida is now $147,600. That's a mortgage payment of about $650 a month (at current mortgage rates with 20% down). The median household income in Florida is about $50,000, roughly $4,000 a month before tax. That's about 16% of your household income – way below any rules of thumb about how much to put toward a house.

From coast to coast, housing affordability is better than it's ever been, getting a big boost from two things: the housing bust and super-low mortgage interest rates. The pile of government incentives has helped, too.

As an investor, I'm seeing what I love... It's an ideal situation that's rare, but incredibly important if you can recognize it. It's when people's emotional opinions are clearly at odds with the reality of the numbers.

The numbers for housing are really great right now. But after three years of losses, people are sour on housing. Perfect!

Three years ago, we had the opposite situation... The numbers for housing were terrible. Housing was completely unaffordable, and builders were building at a frantic rate. But people were incredibly enthusiastic.

Today, the value is there. What will cause prices to climb again? When the supply of homes available for sale shrinks. It's Economics 101. And guess what? We're there...

Right now, fewer homes are available for sale than at any time in the last 40 years (adjusting the supply for the growth in the U.S. population). If I hadn't crunched the numbers myself, I wouldn't believe it. Take a look:

Economics 101: When the Supply Is Low, Prices Go Up



Even better, when you do the simplest, dumbest comparison – the price of homes versus the supply of homes – you get exactly what you'd expect: When the supply of homes gets low, home prices rise.

David Dreman agrees... In 1980, he literally wrote the book. It's called Contrarian Investment Strategies. In it, he recommended going heavily into stocks. In the current issue of Forbes magazine, Dreman recommends U.S. residential real estate:

If inflation hits hard, the chief culprit of the bear market – real estate – is likely to be one of the best investments in the years ahead. Buy a home if you don't already have one or a second home if you can afford one.

Time to buy a house. (Or two!)

This post has been republished from Daily Wealth, a contrarian investment analysis and advice site.

How The Inflation Monster Could Spoil The Party

The stock market has rallied, job losses are cooling down, and housing prices swung higher this summer. Just when it seemed like we might make it out of the recession, the inflation monster may arrive with a vengeance. Tim Iacono explains why multiple factors may conspire to summon the inflation monster in the not-so-distant future.

You hear a lot of talk these days about what could possibly stop the current stock market rally given that we've clearly passed the "acute" phase of the financial crisis and, quite literally, there is no place to go but up for many economic indicators.

The term "statistical recovery" is bandied about quite a bit by doubters of the recent move up for equities and for many very good reasons such as the following:

• home prices seem to be going up when they're probably really still going down
• consumers have dramatically cut back on their spending but no one seems to care
• current quarter GDP will print at +2 or +3 percent but it is completely unsustainable
• bank balance sheets appear healthy when they are really still loaded with bad loans

But, none of this really seems to matter when you have a chart that looks like this.




A 50+ percent move up over a period of five-and-a-half months will eventually make a believer out of almost anyone, a point that is proven again and again, day after day.

But, aside from some big new financial market brush fire developing somewhere that, having learned the lessons of 2008 well, the Treasury Department and Federal Reserve will no doubt quickly hose down with another few hundred billion dollars in money and credit (more if needed), is there anything out there on the horizon that might dampen the enthusiasm of the stock-buying public?

Well, the obvious one is housing.

While a growing number of pundits have all but declared the housing market healed, the latest evidence being offered the other day in the S&P Case Shiller Home Price Index, there is still clearly a ways to go before real estate stops being a drag on consumer psyches and far too many still believe that, somehow, we'll revert to our 2005 spendthrift ways.

There are millions of foreclosures still to come over the next year or two and most people seem all too willing to take their $8,000 tax credit and bid on a property, not seeming to know or care that home price bottoms are long drawn out affairs and that five percent 30-year fixed rates are the exception, not the rule.

As for the Case Shiller Home Price Index, as noted here previously, there's a pretty good chance that seasonal factors will result in the resumption of negative monthly price changes in another few months, though, with the sea-change in prices recently, anything could happen.



The reversal in home prices from a February-March decline of more than two percent to a May-June gain of almost 1.5 percent was the largest three-month swing in more than 20 years of data for the 10-city index - more than double the previous record.

Is that what's really happening in the housing market and, if so, how long can that possibly continue with the deluge of sellers that will now be entering the market, most importantly banks with their huge inventory of foreclosed homes?

Another month or two of rising home prices and then a swift return to negative numbers could dampen confidence very quickly later this year and millions of shareholders might realize that home prices have not yet hit bottom, despite the optimism everyone felt over the summer.

Turning to the labor market picture, it remains a bleak outpost where stock market bears can still gather to compare notes, however, it is not likely to scare off any bulls at this point.

Who would have thought that we'd ever "cheer" a quarter of a million jobs lost in just one month? But, that's what happened last month and it might happen again next week.

There is much more pain to come in the labor market but, from here on out, except for the low-profile, long-term unemployment statistics, it will continue to be a case of being "less bad" than what we've already seen.

In a world where "less bad is the new good", that's reason alone to bid stocks higher.

There is one thing, however, that could put the kibosh on investors' enthusiasm a few months down the road - inflation.

Inflation?

Hasn't inflation morphed into deflation - an annual rate of minus 2.1 percent as of July - and isn't everyone looking for consumer prices to be tame for the next year or two if, as it appears now, we are lucky enough to avoid that dreaded Great Depression malady of "de-flation"?

Surely, the now-docile CPI won't be spooking any shareholders this year.

Well, maybe it will...

Here's why.

Recall that the consumer price index breaks down into eight major categories as shown below, the two categories that contain energy costs - housing and transportation - both broken out into energy and non-energy components.

Here's the way things stand today, energy prices being the clear driver in the current negative annual rate of inflation which reached a 50+ year low last month.



Notice that, even through the distortion of hedonic adjustments and other nefarious measures that the Bureau of Labor Statistics uses to ensure that prices don't rise too much, nearly all non-energy categories are still up from a year ago, some of them a lot.

Though economists may still favor the dubious "core rate" of inflation, it is the year-over-year change in the "overall" rate of inflation that garners all the headlines and elicits concerned looks from investors of all stripes.

So, what happens later this year when, instead of comparing energy prices against $140 crude oil or even $100 crude oil, energy costs are compared to $40 or $50 crude oil?

Well, it may not be pretty.

Even though all energy components account for less than eight percent of the overall index, they have quite a large impact on the headline figure when you get changes of 30, 40, 50 percent or more and, importantly, this works in both directions.

According to Energy Department data, U.S. gasoline prices reached a low at about $1.61 a gallon last December and stayed below $2 a gallon until the spring. Today's average retail price of $2.62 represents a whopping 63 percent increase over last year's low, a full 30 percent above the two dollar mark. With the prospect that crude oil prices may not go down and, perhaps, might just head toward $100 a barrel between now and the end of the year, this sets the stage for some surprisingly high inflation rates.

Keeping all other categories in the CPI unchanged from year-over-year readings and throwing in a healthy increase for heating oil, piped gas, and electricity (which is something of a stretch for natural gas prices, but, anything's possible these days), all of a sudden you come up with three or four percent inflation again before Christmas, perhaps higher.



After the huge success of the Cash for Clunkers program, many now expect car prices to rise which could push that last red bar hanging below the x-axis into positive territory.

Now, I don't know about you, but it seems to me that inflation rates this high might set off all sorts of chain reactions in financial markets, especially with interest rates at zero percent and the Fed printing money furiously, and none of this is likely to be good for equity markets.

As the world learned painfully in the 1970s, stocks and inflation don't get along too well together and, while this surge in consumer prices might only last four or five months, it will nonetheless have the media talking about inflation again and those poor seniors who are getting no cost of living adjustments in their Social Security checks will again be calling their Congressmen to complain.

Believe it or not, a curve like the one you see below is quite possible as we enter 2010.



Now, the really bad news here is that, since the recent wave of liquidity has pumped up nearly every asset class, the price of oil is not likely to go down (making for tame inflation later this year) unless stock prices go down.

But, based on the much higher year-over-year rates of inflation that will show up later this year if oil prices do not go down, that, in itself may be enough to send the price of stocks down.

Either way, it looks like something has to go down.

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

Is The US Financial System Worth The Trouble?

One result of the US financial meltdown is that it has more people questioning whether the free market financial system is worth the costs. Here's a startling fact- in the first half of this decade the finance sector accounted for 34 percent of US corporate profits. This seems like far too much of our economic resources going into something that produces a relatively small economic output, even before you consider the mountains of tax dollars required to bail out the financial system when it failed. The following post from Economist's View discusses this important question.

Does the total cost of our financial system exceed the total benefits at the current scale of operation? Like Benjamin Friedman, I wish I knew the answer, though I suspect that much of the recent innovation would be difficult to justify on the margin:

Overmighty finance levies a tithe on growth, by Benjamin Friedman, Commentary, Financial Times:

...The crucial role of the financial system in a mostly free-enterprise economy is to allocate capital investment towards the most productive applications. The energetic growth and technological advance of the western economies suggest that our financial system has done this job pretty well over long periods. ... The financially triggered Great Recession of 2008-? blemishes this record but does not wipe it away.

Aside from the recession, it is important to ask what this once-admired mechanism costs to run. If a new fertilizer offers ... a higher crop yield but its price and the cost of transporting and spreading it exceeds what the additional produce will bring at market, it is a bad deal for the farmer. A financial system, which allocates scarce investment capital, is no different.

The discussion of the costs associated with our financial system has mostly focused on the paper value of its recent mistakes and what taxpayers have had to put up to supply first aid. ... The misused resources and the output foregone due to the recession are ... part of the calculation of how (in)efficient our financial system is. What has somehow escaped attention is the cost of running the system. ...

One part of that cost is ... much of the best young talent in the western world [going] to private financial firms. ... At the individual level, no one can blame these graduates. But at the level of the aggregate economy, we are wasting one of our most precious resources..., much of their activity adds no economic value.

In the US, both the share of all wages and salaries paid by the financial firms and those firms’ share of all profits earned have risen sharply in recent decades. In the early 1950s, the “finance” sector (not counting insurance and real estate) accounted for 3 per cent of all US wages and salaries; in the current decade that share is 7 per cent. From the 1950s to the 1980s, the finance sector accounted for 10 per cent of all profits earned by US corporations; in the first half of this decade it reached 34 per cent.

These wages and profits – and the office rents, utility bills, advertising and travel expenses – are all parts of the cost of running the mechanism that allocates our economy’s capital. To recall, what makes a new fertilizer a good deal for the farmer is not just that it delivers greater production per acre but that the added production is sufficient to buy the fertilizer and increase the farmer’s own return.

What makes a more efficient financial system worthwhile is not just that it allows us to achieve greater production and economic growth, but that the rest of the economy benefits. The more the financial system costs to run, the higher the hurdle. Does the increased efficiency our investment allocation system delivers meet that hurdle? We simply do not know.

Economic decisions are supposed to turn on weighing costs and benefits. It is time for some serious discussion of what our financial system is actually delivering to our economy and what it costs to do that.

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

Will Economic Recovery Be Behind Door V, U, or W?

Economist's say that there are three major possibilities for how the economy will exit the current recession, but the outcome remains highly uncertain. Some new information on the leading indicator of new orders for manufactured durable goods may provide some clues on what to expect. The following post from The Capital Spectator describes some factors that may shed light on the type of recovery that is most probable.

Is today's update on new orders for durable goods a sign of an approaching V, U or W? Translated: Is the economy poised to rebound sharply and deliver strong growth—a V recovery? Or is a U-type future, with slow to negligible growth, approaching? Even worse, could an imminent rebound be little more than a prelude to a second recession, a.k.a. the W cycle?

That summarizes the great questions that prevail as the world attempts to handicap the winding down of the Great Recession. As always, the central challenge is that we're left with a great unknown, even if today's news on durable goods suggests otherwise.

As monthly numbers go, July's update for the series is undoubtedly encouraging. New orders for manufactured durable goods in July increased 4.9%, the U.S. Census Bureau reports. That's the third increase in the last four months and the largest percent gain in two years.



No one can deny that such news constitutes progress. Ditto for the accumulating evidence in other economic reports that the economy, if not quite on the mend, is no longer contracting. A number of clues have been suggesting no less for months, as we've been discussing on these digital pages for some time, including the all-important weekly updates on initial jobless claims. Additional support for thinking the economy's stabilizing arrived in yesterday's upbeat news on consumer sentiment and housing prices: both are rising.

None of this is particularly shocking, although the timing was always in doubt. But surely no one expected the U.S. economy, still the world's largest, to remain in downsizing mode indefinitely. The emotional bias in the dark days of this year's first quarter may have convinced us to see a continually dire future. But the recession at that point was already more than a year old, by NBER's accounting, and the natural economic order tells us that recovery arrives eventually. Meanwhile, the massive countercyclical efforts of the Federal Reserve, plus the fiscal stimulus embraced back in February, was sure to have an impact. In fact, one might argue that President Obama's reappointment of Fed Chairman Ben Bernanke to a second term is formal recognition of the success in the central bank's aggressive actions intent on slowing if not ending the downturn.

What's more, the financial and commodity markets have reacted by elevating prices, in effect offering additional corroboration that the business cycle was turning. But while it's tempting to see us headed for a V recovery, the odds seem to favor a U. We've been forecasting just that future for some time by emphasizing that the "technical" end of the recession was imminent if not already here but it would be followed by a tepid recovery.

As welcome as that revised outlook is relative to what preceded it, there's a danger of overlooking the risk that follows this time around. Namely, a series of generational adjustments that threaten to conspire by leaving the economy in a weakened state for an unusually lengthy stretch. The most conspicuous risks: the likelihood that consumer spending growth will remain subdued for some time and the labor market will be slow to respond to so-called recovery.

There are any number of other challenges looming as well, starting with the nuances tied to the timing and magnitude of the Fed's so-called exit strategy. The challenge looks unusually bland at the moment, but it won't stay that way. Indeed, to the extent the economic recovery is stronger than expected, the exit strategy problems will be that much bigger.

Perhaps then the principal question is: Has the crowd priced in the post-recession risks that await? The first half of the business cycle has been unusual on a number of levels, as the last two years remind. We're probably just about midway, perhaps a bit more, through this extraordinary period. Thinking that the second half will be any less rocky and risky is asking for too much.

Still, it's easy to remain complacent. Looking at positive short-term changes in economic measures that are cut in half over longer stretches is reassuring. But climbing out of this hole will take time and the task faces many pitfalls. It's only human to minimize the potential hazards, but strategic-minded investors can't afford such luxuries. As we've arguing in The Beta Investment Report, the time for aggressive portfolio decisions was in this year's first quarter. From here on out, the money game is about to get much tougher.

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

Fed May Be Forced To Release Details Of Bank Bailout

Should the Fed be forced to release details of the $2 trillion bank bailout? That is what may happen if Bloomberg wins their lawsuit against the Fed. The following from The Prudent Investor discusses the implications of this landmark case.

Ben Bernanke did not have time to celebrate his reappointment for another 4 years as Federal Reserve chairman on Tuesday. The day before US president Barack Obama decided to keep Bernanke as Fed head information provider Bloomberg dropped a new bomb shell regarding a lawsuit initiated by the news agency under the Freedom Of Information Act (FOIA) against the Fed.

Bloomberg requires the Fed to publish who got the $2 Trillion in bank aid. Find all the details of the pending lawsuit in this post from November 7, 2008.

The Fed appealed this FOIA request last December, citing concerns that this information would endanger the borrowers of the $2 Trillion.

In a response to Bloomberg it then said,

"The U.S. is facing "an unprecedented crisis" in which "loss in confidence in and between financial institutions can occur with lightning speed and devastating effects."

But on Monday Bloomberg scored a second goal against the Fed:

Manhattan Chief U.S. District Judge Loretta Preska rejected the central bank’s argument that the records aren’t covered by the law because their disclosure would harm borrowers’ competitive positions. The collateral lists "are central to understanding and assessing the government’s response to the most cataclysmic financial crisis in America since the Great Depression," according to the lawsuit that led to yesterday’s (Monday) ruling.

The secretive Fed, a constitutionally questionable institution due to its hybrid public-private status has also come under fire from Republican Congressman Ron Paul who tries to win a majority in Congress and the Senate for an official audit of the Fed.

Bloomberg editor-in-chief Matthew Winkler commented the court`s decision this way:

"When an unprecedented amount of taxpayer dollars were lent to financial institutions in unprecedented ways and the Federal Reserve refused to make public any of the details of its extraordinary lending, Bloomberg News asked the court why U.S. citizens don’t have the right to know," he said "We`re gratified the court is defending the public’s right to know what is being done in the public interest."

David Skidmore, a Fed spokesman, told Bloomberg the Federal Reserve Board’s staff was reviewing the ruling and declined to comment on it at this time.

This ruling is certainly a milestone in the possible end game of the Fed which has come under fire from all sides due to its policy of showering irresponsible institutional lenders with Trillions while the rest of the economy is teetering on the brink of a major depression, induced by more than 2 decades of loose monetary policy.

Astute observers will remember the blunders of the Fed which does not know where $9.55 Trillion in unbacked Federal Reserve Notes went.

I end this post with the most important question of all: Who Owns the Federal Reserve?

Resolving this question may become the most important task in the coming era where the world will see more economic and political turmoil than ever before in history.

After all Bernanke is only the figurehead. His captains are the unknown Fed shareholders and for the time being the world economy`s fate lies in their hands.

His thank you to president Obama is only a PR stunt; I`d prefer to know who else decided to keep the biggest money printer of all times in the pilot`s seat. Get involved in this: Use the multitude of Fed inquiry forms on the Fed`s website here and mail me any answers you get. My former requests did not lead anywhere, but I am not a US citizen who has a constitutional right to be informed about the government`s actions.

This post has been republished from Toni Straka's blog, The Prudent Investor.

Obama Makes Safe Bet With Bernanke Reappointment

President Obama chose to go with the status quo and not shake things up at the Fed by reappointing Ben Bernanke. Despite widespread criticism, Obama praised Bernanke for helping the US avoid another Great Depression. Tim Iacono discusses how investors can be take advantage of from this latest development.

President Obama made it official this morning by nominating Federal Reserve Chairman Ben Bernanke to a second four-year term as reported by MarketWatch.

In a short statement in Martha's Vineyard with Bernanke standing at his side, Obama said Bernanke's background, temperament, courage and creativity helped to prevent another Great Depression.

"Ben approached a financial system on the verge of collapse with calm and wisdom; with bold action and outside-the-box thinking that has helped put the brakes on our economic free fall," Obama said.
...
In a brief statement, Bernanke said the goals of his second term at the central bank will be fostering stable economic conditions and financial markets. "We have been bold or deliberate as circumstances demanded, but our objective remains constant: to restore a more stable economic and financial environment in which opportunity can again flourish," Bernanke said.

"Mr. President, I commit today to you and to the American people that, if confirmed by the Senate, I will work to the utmost of my abilities -- with my colleagues at the Federal Reserve and alongside the Congress and the Administration -- to help provide a solid foundation for growth and prosperity in an environment of price stability."

While Bernanke may face some testy questioning during his confirmation hearings this fall, a result of last year's bait-and-switch bank rescue package and other questionable dealings with giant Wall Street firms while standing at the side of former Goldman Sachs CEO Hank Paulson at the Treasury Department, approval for a second term is a virtual lock.

This is good news for financial markets in general and will likely spur even higher prices for many commodities, one commodity in particular.

You see, Ben Bernanke has been a veritable one-man gold price appreciation machine.

References to the government's printing press earlier in the decade and his eagerness to use it as Fed chairman apparently have a way pushing the gold price higher.

Since his initial nomination in 2005, when gold was trading at only about $465 an ounce, the yellow metal has more than doubled, besting just about any other asset class during that time, so gold bugs should welcome today's news.

Let's just hope that the next four years are as good as the last four - $2,000 an ounce gold in the year 2013 when it comes time for his next re-nomination sounds about right to me.

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

Bad Assets Could Lead To Japanese Style Lost Decade

Mark Thoma from Economist's View makes the point that we need to address the bad assets that large banks are still trying to put off dealing with. Simply ignoring the problem could result in a Japanese style lost decade according to economist Keiichiro Kobayashi. See the following post for more on this.

[More Side of the road blogging - stopped for a moment at the Great Salt Lake.] When I talked to the senate's COP panel, one of many things that I emphasized was the need to develop plans in advance to deal with various contingencies. Without such plans policy actions - even justifiable ones - appear ad hoc and also face resistance that delays their implementation or prevents them from being put into place altogether.

For example, we need a plan on the shelf and ready to go for dismantling large banks that have failed, something that has received a lot of attention. It has received much less attention, but I also think we need a plan for disposing troubled financial assets when the need arises. I still believe that the crisis would have been much less severe if very early, prior to Lehman for sure, the government had moved aggressively to buy bad assets from bank balance sheets. it took far too long, and when they finally decided to do this (i.e. the original Paulson plan), they had no idea how to value the assets, there was considerable political resistance because nobody knew how the program would work (allowing lots of false information to enter the debate), and so on, and this program never really got off the ground. The assets are still there waiting for the miracle of rising asset prices to restore their value.

Having a plan ready in advance that specifies how assets will be valued, how taxpayers will be protected if the government overpays (overpaying can help with recapitalization, but it shouldn't be a gift), and so on, a plan that has been approved in advance by legislators (at least implicitly) so as to reduce political resistance, will overcome many of the technical problems and objections that prevented the bad asset removal programs from being used effectively in this crisis.

Keiichiro Kobayashi believes these toxic assets, many of which are still hidden on bank balance sheets, are still a problem and could result in a Japan style lost decade if the government does not remove them, and he calls for a new macroeconomic paradigm that puts these issues front and center (On his main point about whether financial sector recovery is necessary before the real economy can recover, I think we will recover either way, but agree that recovery would be faster if these assets were removed once and for all - but I should get back on the road...):

Why this new crisis needs a new paradigm of economic thought, by Keiichiro Kobayashi, Commentary, Vox EU

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

Foreclosure Numbers Going In Wrong Direction

As long as foreclosures keep climbing, the housing market will be poisoned with bank owned properties. Now it's not just sub-prime or ARM borrowers that are defaulting but the average American with solid credit who are now driving up foreclosure numbers. See the following article from Mortgage Roadmap that discusses the worsening foreclosure epidemic.

The news on housing foreclosures isn't getting any better. In fact, it's getting worse.

According to a story in the Wall Street Journal, one in every eight U.S. households with mortgages was either in foreclosure or behind on its mortgage payments in the second quarter of this year.

The most frightening thing about these new numbers is that many of these foreclosures on on households with good credit that took out safe, conservative mortgage loans.

The national economy, of course, is the culprit here. Too many people have lost their jobs during this economic slump. And they're not able to find new ones. Suddenly, a mortgage payment that was doable during good times is an impossibility.

The bottom line, unfortunately, is that the foreclosure crisis won't ease until the nation's unemployment rate starts seriously dropping. Homes became far too expensive during the recent housing boom. This means that mortgage loans, and the monthly payments that come with them, took up a greater percentage of homeowners' monthly income.

We are now seeing the results: When the economy is sailing along, and jobs are plentiful, homeowners can make their mortgage payments. When a bump occurs, though, and jobs start disappearing? Those mortgage payments are far out of reach for too many homeowners.

This article has been republished from The Mortgage Roadmap.

Letting The Stimulus Run Its Course

Local governments that cut their budgets may be undermining the efforts of the federal government to stimulate the economy and may kill the momentum that the stimulus has generated. The following post from the Economist's View discusses Cornell economist Robert Frank's argument on why we can't afford to let the stimulus fizzle.

Robert Frank makes two points. First, state and local governments facing budget problems due to the recession need more help from the federal government. Second, those who object to federal help for states, or to government spending to stimulate the economy more generally, "have not offered persuasive arguments":

Don’t Let the Stimulus Lose Its Spark, by Robert Frank, Commentary, NY Times: Encouraging economic news has been reanimating the critics of President Obama’s stimulus program. But heeding their admonition to end the program would be a grave mistake. We need more stimulus now, not less.

Even if the economy is improving, it is still very weak. Another quarter-million jobs were lost last month... Now we face an ominous new threat to recovery from sharp cuts in state and local government spending. ... These cuts were mandated by laws meant to stop politicians from spending beyond their means. While such measures may be beneficial on balance, sharply reduced government spending is exactly what the economy doesn’t need right now.

Through its legal authority to run deficits to stabilize the economy, the federal government can keep recovery on track by transferring revenue to states and cities. Of course, opponents of the original economic stimulus program have no desire to see it extended this way. Yet they haven’t made a persuasive case. The flaws in their arguments don’t rise to the absurd heights seen in recent town hall meetings on health care reform. But it is a difference in degree, not kind. ...

In a recent column in Forbes magazine, the economist Lee Ohanian of the University of California, Los Angeles, a stimulus opponent, explained why he believes that increased government spending wouldn’t help... The problem, he says, is that “the higher taxes on incomes or expenditures that ultimately accompany higher spending depress economic activity.” ...

His argument, and that of stimulus opponents generally,... boils down to this striking contention: As the government spends borrowed funds, consumers will start to realize that the resulting debt spells higher taxes in the future, which will lead them to curtail their current spending. Those cuts will offset increased government spending, leaving no net stimulus.

Although there may be people who would actually spend less now to hedge against uncertain future tax bills, it’s unlikely that you know any of them. As behavioral economists have been saying for decades, that’s just not the way most people act. Hardly any consumers even know how ... the national debt ... will affect future taxes.

More important, there are good reasons for believing that stimulus spending will make people’s future tax payments lower, not higher. Yes, government borrowing adds to the national debt. But if the stimulus also hastens the downturn’s end, it will accelerate the growth of future incomes and tax revenue. In that case, the net effect would be to reduce future taxes, compared with what they would have been without the stimulus. ...

The recent state and local spending cuts are a major setback to the stimulus program, which many economists have argued was much too small to begin with. A small minority disagrees but has not offered persuasive arguments.

The downturn threatens every goal we care about. Doing everything possible to limit state and local spending cuts will help end it faster.

Helping states is a good idea, and more help is needed. But that's not enough by itself to bring aggregate demand up to the necessary level, other types of spending are also needed (think of it this way - saving every state and local job that would be cut without federal aid is not enough to solve the employment problem).

However, a state that knows the federal government will step in and help if it gets into trouble may be unwilling to take steps to smooth the state's business cycle such as creating a rainy day fund (i.e., build the fund during boom times bringing output closer to its long-run trend, and spend the fund during the bad times also bringing output closer to its long-run trend). Because of this, if the federal government stands ready to backfill state budgets during recessions, we may want to require that states meet certain restrictions (such as having a rainy day fund of a particular size) before they can receive help.

Allowing state government to contract during a recession makes things worse, and I believe this recession will teach us that the federal government needs to provide much more help than it did this time around. But if the federal government does explicitly take on the responsibility to prevent state governments from contracting when the economy turns downward, then the obligations of local, state, and federal governments need to be clarified. We also need to make sure, as much as possible, that the states cannot game the system to their advantage.

Update: Brad DeLong adds, in reference to Lee Ohania's argument:

This is, as I say every day, simply wrong as a matter of very basic economic theory. Increased nominal government spending financed by future taxes is crowded out by a reduction in nominal private consumption spending if and only if what the government spends money on is a perfect substitute for what private consumers spend money on. That just is not the case.

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

The Changing Face Of Distressed Homeowners

With the majority of distressed homeowners shifting from subprime borrowers to prime borrowers, Blown Mortgage asks whether the Loan Modification Program is focusing on the wrong group. With as many as 13.2% of mortgages near foreclosure, do these troubled homeowners have the help that they need?

Loan Modification figures right now are scary. According to one survey one in eight U.S households that have a mortgage are in foreclosure or will be soon. This puts great pressure on Government Institutions that are trying to help ailing home owners while the numbers just add up. It is like trying to build a dam while the river is still flowing.

As it often happens the problems Loan Modification Programs face are changing. While the focus of Loan Modification programs is on subprime loans (high interest loans generally purchased by people with low credit rating) a new demographic of struggling home owners is appearing.

Foreclosures of Sub prime borrowers that by some accounts ignited the banking crisis are actually slowing down while borrowers with good credit records are deteriorating faster due to falling home prices and job losses.

The MBA (Mortgage Bankers Association reported last week that 13.2% of mortgages on homes with one to four units were at least a month overdue or actually undergoing foreclosure. This a rather steep rise from 12.1% in the first quarter.

These figures are disappointing as many expected foreclosures to drop as home sales have picked up in the last months. However some analysts have commented that we shouldn’t expect significant improvement until 2010 when the economy really starts to improve.

This shift from the decline of sub prime borrowers to prime borrowers is illustrated by the percentage of prime and subprime foreclosures in the last year. Last year 44% of foreclosures were from prime mortgages, now the figure is around 58%. Last year 49% of foreclosures were from sub prime mortgages, now it is 33%. While sub prime mortgages are recovering, prime mortgages are suffering even more.

What can we learn from this?

It could be good news for the measures the administration. We could read this shift as proof that the demographic the administration has chosen to focus their energies on is benefiting from that help and digging itself out of the whole while the demographic that is not highlighted in the programs measures continues to fall.

It is interesting that more than 235,000 borrowers have started a three month loan modification trial under the current administration under the effort of the administration to reduce monthly mortgage payments. But do these loan modifications target the real problems.

Most of these loan modifications target loans that reset to higher interest rates or to home owners with high debt to income ratios. In other words these loan modifications seek to help people who fell for high interest mortgages when the housing industry looked like it was going to soar forever. The idea behind the loan modification programs is to allow borrowers to benefit from the current low interest rates.

However prime borrowers that have gone through dire straits struggle to receive the benefits of this program.

This post has been republished from Blown Mortgage.

Bailout Nation: A Scathing Critique Of Greenspan's Fed

For a book that explores how we got into the current financial mess, check out Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy. Author Barry Ritholtz casts former Fed Chiarman Alan Greenspan as one of the villains for his flawed leadership and misguided policy. Tim Iacono from The Mess That Greenspan Made reviews the book:

For some time now, I've known that Barry Ritholtz's new book Bailout Nation was definitely not going to be kind to former Federal Reserve Chairman Alan Greenspan, but, had I known that it would offer the most damning critique of his term at the central bank, I certainly wouldn't have let the book sit on my desk for the last few weeks before finally picking it up the other day and polishing it off in record time.

With the subtitle How Greed and Easy Money Corrupted Wall Street and Shook the World Economy, it was natural to think the focus might be more on greed than easy money, but that's really not the case.

Greed is a constant on Wall Street and, for that matter, in most of the rest of the world, but financial systems don't implode unless generously lubricated with easy money, bailouts, and moral hazard - key elements of the Greenspan legacy.

Ironically, Fed economists and assorted hangers-on are meeting in Jackson Hole this week to deliberate on what's changed in the world of finance and monetary policy over the last year.

It was four years ago at that same gathering (i.e., before the housing and credit bubbles met their respective pins) that some were still lauding the former Fed chief as "the greatest central banker of all time" in something of a "going-away" party.

I wonder if his name will come up at this session...

Anyway, the book is not only fun-filled, thanks to the inimitable writing style of Mr. Ritholtz, but it's chock full of interesting little bits of information and perspective that, even to me, cast new light on what will surely be looked back upon as a disastrous period for central banking.

For example, it is common knowledge that Alan Greenspan was much more interested in asset prices than were his predecessors - they didn't coin the term "the Greenspan put" for nothing - but this passage gives the concept a bit more color.

History teaches us that the development of Bailout Nation, Wall Street edition, was not done in secret meetings. Rather, it occurred in the very public functions of the Federal Reserve, and the subsequent results of its policy actions.

The Greenspan Fed created an endemic culture of excessive risk taking. The U.S. central bank created moral hazard not by targeting inflation or the business cycle, but instead by focusing on asset prices. From the squishy focus on psychology, it was a short hop to asset prices. After all, when price go down, it negatively impacts sentiment, right? This was the Fed's fatal flaw under Greenspan's leadership.
...
The Fed's previous rate cuts had only implied a concern over asset prices; now, the chief explicitly affirmed the fact. The Fed was not concerned just about inflation and employment; asset prices were an "integral part" of its calculus, too.

This was revolutionary. Fed chiefs didn't usually care so much about stock prices; they were more concerned with the bond market. After all, it was the fixed-income traders - known as bond ghouls for their morbid affection for bad economic news - who set interest rates. Worries about deficits, inflation, and trade balances all found a receptive audience among the bond traders.

Once Wall Street figured out Greenspan was concerned about equity prices, it wasn't too long before it learned how to play the Fed like the devil's fiddle. When rate cuts did not materialize, the Street would have itself a hissy fit. It is always ill advised to anthropomorphize markets, but observing the market kick and scream when cuts weren't forthcoming was akin to watching a two-year-old throw a tantrum. It may be illegal to manipulate the markets, but no trader will ever got thrown in jail for manipulating Greenspan.

Unfortunately, the current Fed chairman seems to share this same trait.

Well worth reading...

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

How To Avoid The Coming Tax Bomb

One of the major consequences of the record federal deficit is that it will likely lead to a massive tax bomb in the future. And since the top 25% of American earners pay 87% of the taxes, you may want to pay close attention to the following article. Dr. Steve Sjuggerud from Daily Wealth explains how you can save thousands upon thousands by understanding a simple tax-saving tip.

A massive tax bomb will land on us soon...

You are foolish not to protect yourself from it. Today, I'll show you how to beat it.

Look, you know all about it... Our government has spent too much money. According to public awareness firm the Peterson Foundation, the government's debt was $184,000 per person in 2008. For my little family of four, that's $736,000 of government debt. And it keeps growing.

Take a look at the breakdown in 2008:



The government has to raise this money by taxing us, as citizens. But it doesn't tax all citizens, of course... Do you believe 43% of those filing returns pay no taxes at all? It's true.

So who does pay taxes? The top 25% of taxpayers (those with an income of $66,000 or higher in 2007) paid 87% of the taxes. Basically, the top 25% of taxpayers will be the ones paying this enormous debt.

In short, my "burden" is not just the $736,000 for my family... The government will use my taxes to cover its debts on three other families, too. So the government needs A FEW MILLION DOLLARS in taxes from me to pay its debts. Don't think it's just me... If you make $66,000 or more, you're in the same boat!

And that's just the old debt... New debts are ringing up every day. Literally. The national debt grows by a few billion dollars every day. I don't know about you... but I find it sickening.

So what can you do?

One big simple thing we can do to beat the tax bomb is convert our IRA to a Roth IRA...

The biggest difference between a Roth IRA and other IRAs is this: You put after-tax money into Roth IRAs... And because you've already paid taxes on that money, your future withdrawals, including gains, are tax-free.

Well recently, the rules have changed. Between the new rules and the coming tax bomb, you have to consider converting to a Roth IRA.

The government needs big tax dollars right now. So it's changed the rules on Roth conversions, in favor of big investors. Soon, regardless of your income, you will be allowed to convert your IRA to a Roth IRA. This is a foolish move for the government, but it raises money in the short term because you have to pay taxes upfront, so it's doing it.

The list of Roth IRA benefits is huge...

With a Roth IRA, your withdrawals are TAX-FREE. There are many positives to this:

1) If the government raises taxes (which it will), it doesn't hurt you.
2) You can pass it along to your kids or grandkids tax-free, where the assets will continue to grow tax-free.
3) You don't have to make any mandatory withdrawals like with a traditional IRA.

Heck, to me, the biggest risk – and I hesitate to even think about this – is that the government will change the rules again in the future. It shouldn't be able to... But hey, it's the government.

The rule change kicks in for 2010. The timing could be perfect...

You see, in order to convert your traditional IRA to a Roth, you do have to pay income taxes on the amount of the IRA for the year you convert. (That's what allows you to have it non-taxable forever.) You can convert under 2010 taxes, hopefully before tax rates go up. And at the same time, your tax bill for this could be smaller this year, as the stock market is still off of its highs.

Lastly, the government is giving you a special deal here (it needs your money!). If you want to convert, it'll let you stretch out the tax bill to convert over three years. So if you had a $100,000 IRA to convert, and your taxes due on that were $30,000, then you could stretch that $30,000 payment out for a few years.

I hope I didn't make it sound too complicated. Because it's not. In short:

Convert your traditional IRA to a Roth IRA. Pay the income tax at the current lower tax rates on that money. And then you (and even your heirs) will never have to pay taxes on that money again. Inflation won't hurt you, nor will higher taxes, and you get to keep all your profits, tax-free. Good stuff!

This post has been republished from Daily Wealth.

Preparing For The Consequences Of The Great Stimulus

While the aggressive action by the government may have prevented a depression, Warren Buffet is one of the many who are concerned about the future side effects on the economy. Is now the time for the Fed to start tightening monetary policy to prevent economic fallout? James Picerno from The Capital Spectator discusses why we should be shifting more attention to the future.

Warren Buffett advises in today's New York Times that the Great Stimulus must one day be clipped as the Great Recession fades. As the Oracle of Omaha explains, the "enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects."

We've been making a similar argument for some time, although the cause seemed lost when we advised in May that the crowd should recognize that the Federal Reserve must begin raising interest rates at some point. That future has been easily ignored, and perhaps for obvious reasons, given the economic events of the past year or so. But the arrival of Buffett's warning suggests that sentiment may be set to turn by focusing the crowd's gaze on the inevitable. If so, that's healthy, if only because recognizing the risks that loom, as opposed to the ones that just passed, is always a productive exercise in managing money and otherwise boosting one's odds of survival.

As we wrote in May, "At some point, the economic trends will shift and waiting too long to raise interest rates will be the primary hazard. We don't know if the turning point will come in a few months or a few years, but we shouldn't delude ourselves that it's never coming."

If more pundits and policymakers are on board with this outlook, chalk up another win on the side of progress. But lurking behind this rise in enlightened thinking is another problem, which can be summed up as the expectation that the central bank will begin tightening at a time when it's clear that the economy is on a sustainable path to recovery. A nice idea, but like fairy tales and campaign promises, danger lurks in accepting such notions without question.

For the same reason that mere mortals can't hope to sell exactly at market peaks or buy at bear-market bottoms, the Fed is destined to be early or late at the start of the next great change in monetary policy. This is a critical point because it belies the notion that the Fed will be able to tighten monetary policy at just the right time and keep everyone happy in the process. Wrong. Not only does the Fed face a tough challenge in purely monetary policy terms, the potential for political and even economic fallout are commensurately large as well.

Central banks, like the rest of us, are making real-time decisions with lagging data. Even worse, it takes time to assess if the decisions were timely, or not. The folly or fortune of policy choices made today will be evident a year or two hence. It's a bit like a surgeon working in the dark and then finding out a year later if the patient survived.

So be it. That's how running fiat currencies works: it's a job that's highly subjective in real time. The question is whether the crowd understands what's coming. Normally, the margin for error is relatively wide in the highly subjective business of central banking. These days, that margin has shrunk considerably, even if the ramifications won't be obvious for several years.

No one will ring a bell at the ideal moment for tightening. The fact that the Fed's timing wasn't perfect in the years running up to the Great Recession reminds that fallibility infects the institution, just as it does every other area of human decision making.

What's more, when the Fed launches the new monetary era, the criticism is likely to be deep and broad, from politicians and investors, businesses and the people on the street. No one has perfect information and insight, but that doesn't stop anyone from thinking (and speaking) as if they did. The net result: lots of noise and confusion.

With the benefit of hindsight at some point, it's a virtual certainty that we'll recognize that the Fed was too early, or too late. Heck, maybe they'll get it exactly right this time, although we're not holding our breath. In any case, such things can only be determined after the fact.

The stakes are high, perhaps unusually high compared with previous business cycles of recent vintage. But at least we know what the two main threats will be. On the one hand, the central bank runs the risk of choking off the incipient recovery by tightening too early. At the other extreme, the central bank may wait too long and thereby give inflationary pressures a foundation to pester the economy for some time after.

No, these risks aren't absolute. One or the other may arrive but in moderate form, which still leaves the natural forces of inflation-adjusted growth to dominate eventually. Nonetheless, let's not forget that one or the other still looms. Markets and economies are forever evolving, as are the embedded hazards and opportunities. Perhaps the biggest risk of all is thinking otherwise.

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

Chinese Investment In Silver Could Push Up Prices

Now that Chinese citizens are not only allowed to invest in silver, but encouraged to, there is reason to believe that this could push up silver values. The Chinese are savvy investors and are skeptical of the security of American dollars, which may mean a shift to greater investment in precious metals like silver and gold. The following article from Daily Wealth explains why an increase in Chinese demand for silver can have a significant impact on prices.

Two years ago on August 21, China's government allowed its citizens to invest in an entirely new asset. It allowed them to invest in Hong Kong-listed stocks.

Hong Kong is a special region of China. It's one of the most dynamic, capitalistic places on Earth. The move from the government was a move toward "investment freedom" for the Chinese people.

On that day, Hong Kong's benchmark stock index rose 8.74%. Over the next two and a half months, it skyrocketed from 11,000 to over 20,000. It was a chapter in a story that you should get used to over the coming years: When the Chinese decide to invest in something, it causes giant ripples across the world.

This sort of situation is starting to happen again: This time it's happening in precious metals... especially silver.

The Chinese have a centuries-old affinity with silver. It began in the 1500s with the explosion of trade with Mexico via the Spanish galleons. These sailing ships were the super-tankers of their age. They made one voyage per year, carrying tea, silks, and spices from Asia to Mexico. The ships returned to Asia with gold and silver. After the Chinese threw off imperial rule in 1912, the country used silver money. Today, the Chinese word for "bank" means, "silver movement."

And now that China is becoming one of the richest, most dynamic capitalistic countries on Earth, this story is about to take a modern twist. The Chinese want silver again.

Thanks to a decade of wealth accumulated by regular Chinese citizens, there is plenty of cash to chase good investments. As the famed global investor Jim Rogers points out, these people are the best capitalists in the world. They are great savers. Chinese people want their money to work for them... so they invest.

I recently watched a China Central Television piece on gold investing... According to the program, there are some 400 million households in China, with an average ownership of about 0.1 ounces of gold. The average gold ownership in most emerging countries works out to about 1 ounce per household. The Chinese are beginning to make up that gap. From 2006 to 2007, domestic demand for gold rose 60% to around 700,000 ounces. Experts continue to urge citizens to put 3% to 5% of their net worth in precious metals.

Chinese government statistics show the average urban Chinese household has about $1,300 in disposable income to invest. While that doesn't seem like much, when you add up all those households, there's about $36 billion that could move into the next big investment opportunity – precious metals.

The government is now actively encouraging its citizens to buy gold and silver. They recently unveiled silver bullion for investing (you can see the video here). The premise is that gold was 50 times more expensive than silver in 2007... but is now 70 times more expensive.

The government is promoting silver bullion as an investment for regular citizens. And remember, a bunch of Chinese students laughed at U.S. Treasury Secretary Tim Geithner this year when he claimed the dollar was safe. The Chinese know the value of real assets... real money like gold and silver.

What does this mean for silver prices? It's impossible to say. But here's a little math that interests me. According to the Silver Institute, demand for silver in 2008 (for industry, jewelry, and investing) was 832 million ounces. At today's price, that's an $11.5 billion market... or about 1/3 the capital available in China alone.

The most important thing to understand about this situation is the Chinese people become freer every time the government loosens up a restriction. These people couldn't legally buy silver bars before. Now, they can. They're becoming richer... and they will continue to do so for decades.

Add this to a world already waking up to the grand currency debasement you've read about in DailyWealth (like here and here), and you have a recipe for the continuation of the big bull market in silver and other precious metals.

This post has been republished from Daily Wealth, an investment analysis and advice site.

Why Mortgage Loan Modification Is Not Catching On

The government has invested a lot of political capital, in addition to actual capital, to help struggling homeowners stay in their homes through mortgage modification. However the government is finding little success with this program for a variety of reasons. The following post from Blown Mortgage explains some of the reasons for this.

Home loan modifications have been presented as the silver bullet that will kill the evil wolf scaring the living daylights out of investors and homeowners. The government does seem to be willing to place its money (or own money) where their collective mouth is. The White House has invested $75 billion of our hard earned bucks into the Making Homes Affordable with the hope that it will prevent 3 to 4 million Americans from losing their home to a bank foreclosure.

Unfortunately the plan is not exactly burning rubber and is off to a slow start. At the moment only 9% of eligible homeowners are taking advantage of the loan mod plan and have modified their loan terms. The government is not happy with these figures and have begun to pressure and arm-twist banks and lending institutions to get their finger out and start modifying. In a recent report the government named and shamed banks that were not pulling their corporate weight behind the mortgage modification program and are not facilitating the modifications borrowers need.

Why is this the case? Why are banks so slow to act?

There are various reasons, most of which we have already discussed in articles here at blownmortgage.com. These include:

1) Banks are not currently set up for loan modifications. They are set to sell loans and then collect the payments not reduce principals and reduce interest.
2) The large volume of loan mod applications in such a short period of time.
3) Lack of information and understanding about the program and how it works.
4) Mortgage backed securities.

Why mortgage backed securities?

Mortgage backed securities are products like futures and stocks companies can buy or sell. Obviously just like with the purchase of the stocks of a company the purchase of mortgage backed securities provides the owner with a say on how the mortgages are managed.

This is well illustrated by the story of many homeowners that cannot modify their loans because the company that has bought a security backed by their mortgage will not allow them. For instance Wells Fargo may say no to a loan modification you request even though they don’t own your mortgage.

This is caused by ambiguous rules and a rather shady web of interests and ownership. This is rather sad because it means that the group that is more likely to need help, those whose mortgages were sold or used as a security cannot receive the loan modification they need to stabilize their situation.

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

Why We Should Regulate Banks Immediately

Despite the banking sector's large role in crashing the economy there are still some who oppose increasing bank regulation. Harvard Economist Kenneth Rogoff, discusses why we need to regulate banks as soon as possible. Mark Thoma summarizes his commentary below.

Kenneth Rogoff warns us not to believe those who argue that the crisis was largely due to government failure, and hence that regulating the financial sector is counterproductive and unnecessary:

Why we need to regulate the banks sooner, not later, by Kenneth Rogoff, Commentary, Financial Times: When in doubt, bail it out,” is the policy mantra ... after the ... collapse of Lehman Brothers. With the global economy tentatively emerging from recession, and investors salivating over the remaining banks’ apparent return to significant profitability, some are beginning to ask: “Did we really need to suffer so much?”

Too many policymakers, investors and economists have concluded that US authorities could have engineered a smooth exit from the bubble economy if only Lehman had been bailed out. Too many now believe that any move towards greater financial regulation should be sharply circumscribed since it was the government that dropped the ball. Stifling financial innovation will only slow growth, with little benefit in terms of stemming future crises...

Certainly the US and global economy were already severely stressed at the time of Lehman’s fall, but better tactical operations by the Federal Reserve and Treasury, especially in backstopping Lehman’s derivative book, might have stemmed the panic. Indeed, with hindsight it is easy to say the authorities should have acted months earlier to force banks to raise more equity capital. The March 2008 collapse of the fifth largest investment bank, Bear Stearns, should have been an indication that urgent action was needed. Fed and Treasury officials argue that before Lehman, stronger measures were politically impossible. There had to be blood on the street to convince Congress. ...

[C]ommon sense dictates the need for stricter controls on short-term borrowing by systemically important institutions, as well as regularly monitored limits on oversized risk positions, taking into account that markets can be highly correlated in a downturn. ... There should also be more international co-ordination of financial supervision, to prevent countries using soft regulation to bid for business and to insulate regulators from political pressures.

...The view that everything would be fine if Hank Paulson, then US Treasury secretary, had simply underwritten a $50bn bail-out of Lehman is dangerously misguided. The financial system still needs fundamental reform...

I think that even if Lehman had been bailed out the economy would still have been bad, just not as bad, so either way there are substantial economic costs and a case for regulation.

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

Things To Look For In An Economic Tipping Point

Economist Mark Thoma from Economist's View discusses what to look for in an economic tipping point. He describes the specific conditions that will need to occur that will demonstrate that the economy is on solid footing and has the legs to generate self-sustaining growth. However, if these conditions do not occur, we may be looking at a double-dip recession. Continue reading to learn more.
One question I am asked fairly often is how we will know when the economy turns the corner and we are on our way to a solid recovery. My answer is that we will be able to detect upticks in the data, though this may come with a bit of a lag, the important but harder task will be to understand why the data are showing improvement.

In order to be convinced that the economy is on solid footing and headed to better times, I will want to see several things. First, though not necessarily foremost, that banks are being recapitalized with private sector funds, and that this is happening without the aid of government guarantees or other such programs that encourage capital infusions (which is hard to determine while the government programs are in place). Second, I will want to see private sector non-residential investment improving, another sign that private sector funds are moving back into circulation. Presently, this hasn't even started heading back upward, though there are signs the decline is slowing:



And there are other important factors too, e.g. consumption rebounding (though not to pre-crisis debt sustained levels), stabilization in housing markets, and so on. The point is that a self-sustaining recovery will require that the private sector be the primary driver of new economic activity, and that is what I will be looking for.

Once the economy does start to recover, the hard but critical part will be to determine how much of the recovery is self-sustaining (as it will be if private sector funds are driving the activity), and how much is being driven by government stimulus programs. If the recovery is self-sustaining, and we are fairly certain of that, then we can begin to carefully wind down the government programs supporting the economy. But if the recovery is mostly due to government stimulus and there is little sign that the financial and real sectors are attracting robust levels of private sector funds, then pulling back on government programs could be disastrous and plunge the economy right back into recession. In fact, in such a case, we may need to provide even more stimulus to fully bridge the gap until the private sector can support the economy on its own.

So, in answer to the question, we will have a pretty good idea when the economy turns the corner, but it will take awhile to determine why, and we cannot risk pulling back on government programs until we are sufficiently certain that the private sector can support normal economic activity without the government's help.

Update: Nouriel Roubini:

A Phantom Economic Recovery, by Nouriel Roubini, Commentary, Project Syndicate: Where is the US and global economy headed? ... Data from the US ... suggests that the US recession is not over yet. A similar analysis of many other advanced economies suggests that, as in the US, the bottom is quite close, but it has not yet been reached. ...

Moreover, for a number of reasons, growth in the advanced economies is likely to remain ... well below trend for at least a couple of years.

The first reason is...: Households need to deleverage and save more, which will constrain consumption for years.

Second, the financial system ... is severely damaged. Lack of robust credit growth will hamper private consumption and investment spending. Third, the corporate sector faces a glut of capacity... As a result, businesses are not likely to increase capital spending.

Fourth, the releveraging of the public sector through large fiscal deficits and debt accumulation risks crowding out a recovery in private sector spending. The effects of the policy stimulus, moreover, will fizzle out by early next year, requiring greater private demand to support continued growth. ...

There are ... two reasons to fear a double-dip recession. First, the exit strategy from monetary and fiscal easing could be botched, because policymakers are damned if they do and damned if they don’t. ...

A second reason ... concerns the fact that oil, energy and food prices may be rising faster than economic fundamentals warrant, and could be driven higher by the wall of liquidity chasing assets, as well as by speculative demand. Last year, oil at $145 a barrel was a tipping point for the global economy... The global economy, barely rising from its knees, could not withstand the contractionary shock if similar speculative forces were to drive oil rapidly towards $100 a barrel.

So, the end of this severe global recession will be closer at the end of this year than it is now, the recovery will be anemic rather than robust..., and there is a rising risk of a double-dip recession. ...

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

The Highest Real Yields For Treasuries In 15 Years

Treasury notes are looking very attractive due to the deflation of the consumer price index in the first half of the year. A nominal 10-year Treasury note at 3.5% would translate into a real yield of nearly 5.5%. However, if you believe that inflation is around the corner, treasuries may be a very unprofitable investment. James Picerno from The Capital Spectator explains.
The highest real (inflation-adjusted) yields in 15 years for Treasuries are boosting demand, Bloomberg reported at the end of last month.

Halfway through August, there's no reason to think otherwise. The 10-year's yield hasn't changed much in recent weeks, closing yesterday at roughly 3.59%. Meanwhile, inflation, as defined by the consumer price index, appears in no imminent threat of rising.

The July CPI report shows that inflation was flat last month, the Bureau of Labor Statistics tells us today. For the 12 months through July, CPI was negative to the tune of -1.9%, the steepest fall in 60 years.

On the surface, it looks like deflation is roaring. But this bite is worse than it appears. The year-over-year comparisons for CPI are troubling, but it's temporary. Recall that oil prices hit an all-time high in July 2008. The energy driven inflation wave, as it turned out, wasn't set in stone either. But the damage to the inflation numbers was done and that legacy remains intact. As a result, comparing overall prices today with those of a year ago is doomed to reflect sharp price declines.

Meanwhile, energy prices fell sharply after peaking in the summer of 2008, along with prices of virtually every thing else. A repeat performance isn't likely, or so the stabilizing global economy suggests. Indeed, the price of crude seems to have found stability too. The implication: inflation won't be falling on a year-over-year basis when we look at the numbers in the quarters ahead.

Barring a sudden reversal of the stability that seems to be settling into the economy, the year-over-year CPI change is likely to be showing more modest comparisons by the end of this year and through 2010. Why? Because, you may recall, the world fell apart in the second half of 2008, dragging broad price indices down the rat hole in the process. Once we get to December 2009's CPI numbers, however, we're likely to see the case for deflation on a 12-month basis looking a heck of a lot weaker if not evaporating completely, assuming we don't resume an apocalyptic decline, which looks unlikely at this point.

Meantime, adjusting the 10-year Treasury Note by 12-month changes in CPI makes for an alluring chart, as our graph below shows. For July, the 10-year's CPI-adjusted yield was 5.46%, up from September 2008's negative 1.25%.

By the available numbers, buying the 10-year looks like a no-brainer. Prices generally are falling by nearly 2% a year. Meanwhile a nominal 10-year Treasury offers well over 5% real. A great buy, right?

We're suspicious. Unless you're expecting deflation to roar on, which we don't, the real yield in nominal Treasuries looks like a trap. Here's our reasoning. First, only nominal yields are set in stone with nominal Treasuries, which means that real yields for this series of government bonds can and does fluctuate.

For instance, let's say you bought the nominal 10-year Treasury at last night's close of 3.59%. Using the latest CPI report for July, that translates into a real yield of 5.49%. Nice. But imagine a year from now that CPI's running at, say, a positive 2% year-over-year pace, which isn't beyond the pale. Net result: your current real yield of 5.49% evaporates to 1.59%. (Remember, the nominal yield of 3.59% at the purchase date is fixed; only the inflation rate changes.)

As it turns out, a 10-year TIPS currently offers a similar real yield—1.80% as of last night's close. The big difference: the 1.80% real yield for the TIPS is fixed whereas the real yield for nominal Treasuries changes.

The bottom line: unless you're expecting deflation to continue or get worse, the real yield in the nominal 10-year looks dubious. Does that mean you shouldn't own Treasuries? No, since government bonds serve various purposes in a multi-asset class portfolio. But buying solely for the high real yield of the moment is too speculative at this juncture, at least for this observer.

To be fair, no one can predict inflation with any certainty and so a passive investor would own TIPS and nominal Treasuries as a hedge. Otherwise, this is no time to bet the farm on conventional Treasuries. Sitting on huge gains over the past year—indeed, over the past generation, the hour is late for expecting continued success with "risk free" bonds sans inflation protection.

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

Deflation Risk Averted But Could Massive Inflation Be Around The Corner?

By creating nearly $4 trillion in new money and credit, representing the largest increase by the American federal government since the country's Civil War, the monetary system has been repaired and deflation is no longer an imminent risk. But a lack of political will and continued annual deficits in excess of $1 trillion through 2016, along with significant pressures in the economy, could likely lead to broad inflation over the next two years, with gold and strategic assets offering potential shelter from the expected storm. Porter Stansberry from Daily Wealth discusses this below.

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved.
– Ludwig von Mises

For most of 2009, I've had a friendly disagreement with several colleagues who believe a big deflation will be the end result of the 2008 financial crisis.

I knew they were wrong. I knew inflation would become a problem sooner, rather than later. And in the past several months, I've been proven right.

The mortgage and banking collapse of 2007-2009 saw total collateral values collapse between $5 trillion and $10 trillion. The response from our politicians and central bankers was massive: the largest creation of new money in credit since the Civil War.

The Federal Reserve created roughly $2 trillion in additional credit and loaned it against all kinds of dubious collateral, things like Bear Stearns' mortgage book. (There's a handy and simple guide to estimating the Fed's credit quality. The more acronyms in the lending programs, the worse it gets.)

The Federal government responded with a record annual deficit of at least $1.8 trillion. In the second half of 2008, the outstanding federal debt grew by roughly a 40% annualized pace (24% for the entire year). Thus, in only a few months' time, the roots – the money and credit – underlying our economy expanded at a record pace.

In the second half of last year and the first quarter of 2009, the main question in the world's financial markets was: Can the world's government print enough money, fast enough, to forestall a deflationary collapse?

I knew it was no contest. There is no way for an economy to outrun a printing press. The Fed has the power to create an unlimited amount of money or credit and the power to inject that money into the economy in any way it sees fit.

Let's look at the numbers. Let's assume the total collateral damage of the banking crisis turns out to be $5 trillion. Yes, that's a huge hit – roughly half the output of our economy each year. It's the equivalent of sending every American household a bill for $50,000 – due immediately. However, in less than a year, the Feds have already created nearly $4 trillion in new money and credit. The hole in the system has already been plugged. It only took a few months.

The fight between inflation and deflation is over. Deflation was knocked out in the first round.

The big risk is what happens next. Having turned on the presses to save the day, who will have the political clout and the desire to shut them off? Barack Obama's budget calls for annual deficits in excess of $1 trillion for the next eight years. Thus, by the end of this year, not only will all of the damage from the mortgage collapse ($5 trillion) be replaced by new money and credit, there will be significant inflationary pressures in the economy.

The good news in our economy this year, so soon after such a major collapse, means we will certainly have a massive inflation during 2010 and 2011. There's no such thing as a free ride. Bailing out the banks will carry a heavy price for anyone who doesn't have the resources or the knowledge to escape the dollar.

How can you "escape"? First off, make sure you own plenty of gold bullion. I also recommend owning assets that will run higher in an inflationary environment, like vital transportation and energy assets. Also, own some good farmland. Food and land prices will go higher.

Yes, the news is grim... but if you own gold and strategic assets, you'll survive and prosper in the coming inflation.

This article has been republished from Daily Wealth, a contrarian investment analysis and advice site.

Public Sector Versus Private Sector: Why We Need Both

The ongoing debates regarding private versus public service often references the presumed edge of the private sector regarding cost and innovation. This completely ignores times and ways the public sector can force the private sector to deliver innovation at minimal cost: a consideration integral to questions of health care in the US. Mark Thoma from the Economist's View discusses this very timely issue.

The public option for health care appears to be dead, so this is a bit late, but I keep hearing that there are no examples of public-private competition, let alone successful ones. But there are examples of this, and they have been successful.

We are used to the argument that the private sector can discipline and usually beat the government in terms of providing services at minimum cost (though I should note that is not always true). What is harder to find is anything written on how the government can do the same to the private sector, force them to provide innovative services at minimum cost (the point of the public plan in health care), partly because nobody ever seems to ask that question. Thus, an important part of this description of public-private competition to provide garbage collection services in Phoenix to note is that the discipline runs both ways, government forces the private sector to lower costs and be innovative, and the private sector forces the government to do the same (e.g. see the part at the end where the private firm loses the contract to the government and vows to win the next contract with its experimental truck).

This article was written in 1984, so it is untainted by the current debate, but this was also a time period when there was a lot of enthusiasm and interest in privatization. Hence, many of the articles written around this time are slanted toward examining how the private sector can discipline the government, not the other way around. Still, the story below makes clear that the city did force the private sector to continue to innovate and improve. Another interesting point is that the private sector contractor claims that the bidding process is much improved when the city is forced to participate (e.g. in specifying specs, see the full article for more on this point), a benefit of public-private competition that is often overlooked (I couldn't find much written on the Phoenix experiment more recently, so I don't know for sure how well the program has performed since the 1980s and 1990s when most of the articles on the Phoenix experiment appeared, but it does appear that currently the city won contracts in two of the three regions where private sector competition is present):

Entrepreneurs Can Do Everything Government Can Do, Only Better, by Eugene Linden, Inc., Dec. 1, 1984: Chuck Walbridge and Ron Jensen both see themselves as solid businessmen. There is a certain irony in this perception: Although both may be solid, Jensen is not a businessman at all, but a government bureaucrat.

That hasn't kept him from competing with Walbridge, however. Last year, for example, the two bid on the same contract, with Walbridge coming up the winner. Jensen has vowed that it won't happen again."We will be analyzing every cost to see where we might have gone wrong," he says. Walbridge, for his part, admits that Jensen is a tough competitor...

Jensen is director of the Public Works Department of Phoenix -- a city that regularly invites private companies to bid against its own agencies on various contracts. It was such a contract, the one for garbage collection, that was awarded in the summer of 1983 to Walbridge's company...

The ... concept behind privatization is not as new as it may seem. U.S. government administrations have long vacillated between providing services themselves and contracting them out. During the early 1800s, for example, privately operated bridges, tollroads, fire departments, and street lights were commonplace. Subsequently, gross abuses by both private contractors and public officials led to an outcry that caused governments to start providing the services themselves. Now the wheel has turned full circle, and privatization is seen as a solution to the problem of governmental bloat -- a way for governments to provide improved public services and reduce expenditures at the same time. ...

Walbridge's company, National Serv-All, is a 27-year-old, family-owned garbage-collection and -disposal business... It was Chuck Walbridge's father, Glen, who launched the family in the garbage business ... in Anderson, Ind...

Chuck Walbridge, who took over in 1979, concentrated on learning the business: how to deliver the service and how to keep the customers satisfied. ... Small as the company was, Walbridge was keenly interested in efficiency and innovation, and he constantly searched for ways to lower costs and improve service. Toward that end, he struck up a relationship with International Harvester Co.'s engineering division, which was located in Fort Wayne, and began testing Harvester's new trucks, making suggestions about improvements. He also began designing his own vehicles, trying out different bodies and control systems. In his quest to keep up-to-date with the latest advances in garbage collection, he made his first trip to Phoenix in 1975.

At the time, Phoenix had not yet begun to contract out its garbage collection, but it did use an innovative collection system designed to minimize labor costs and beat the desert heat. The system was built around a fleet of one-person trucks with mechanical arms that could pick up large, standardized containers. (Today, such containers are so big that transients occasionally take up residence in them, and Walbridge instructs his men to shake the containers before dumping them.) Walbridge was fascinated by the idea and inquired where it had come from. He was told that Phoenix was working with a system developed by a small Arizona company with the unlikely name of Government Innovators Inc.

Government Innovators is a story in its own right. Founded in 1971, it had grown out of the lunchtime bull sessions of a group of entrepreneurially minded bureaucrats in nearby Scottsdale, Ariz. For entertainment, they had often brainstormed about how they would improve their departments if they could keep the money they saved. Among the ideas they came up with was one for automated garbage trucks. The idea seemed like a natural -- so much so that they even designed the equipment and went looking for a company to produce the system. When they found no solid offers, they decided to do it themselves, building the nation's first automated garbage-collection system within the Scottsdale Public Works Department. Subsequently, some of them left public service and formed Government Innovators.

Curious about the possibilities of such a system, Walbridge purchased one of Government Innovators' trucks and took it back to Fort Wayne. Over the next few years, he experimented with various modifications, which he discussed with people at the company. They were duly appreciative. ... Walbridge's knowledge of equipment and systems stood him in good stead in 1983, when National Serv-All suddenly found itself competing nationwide against the giants of the garbage-collection industry. ...

Walbridge was ... impressed with the situation he encountered when he returned to Phoenix in 1982. There had been changes since his first visit seven years earlier. For one thing, the city had begun inviting bids for city contracts, largely in response to the budgetary constraints arising from the tax revolt of the late 1970s. That was a situation faced by government officials all over the country...

The center of privatization activity in Phoenix has been Ron Jensen's Public Works Department, which began inviting bids on garbage-collection contracts in 1978. From the beginning, the city stipulated that the Phoenix Sanitation Division would hold onto 50% of the business, to ensure that garbage collection would continue in the event that a private vendor proved unable to deliver service for one reason or another. The other 50% was put out for bidding, with the sanitation division competing against private vendors for two of the four available five-year contracts.

To keep the department's bids honest, Phoenix arranged to have them prepared by the city auditor, who made sure that they represented costs fairly on a basis comparable to those used by the private contractors. This task was easier in Phoenix than elsewhere because the city uses cost accounting. Thus, for example, the city's equipment fleet is centralized in one division of the Public Works Department and then "rented out" to various departments at a per-mile or per-hour rate calculated to reflect overhead. Management overhead is likewise apportioned among the department, right down to a fraction of the city manager's salary.

All of these systems were in place in 1982 when Walbridge returned to Phoenix... Walbridge believed National Serv-All would be in a strong position vis-a-vis other competitors, thanks to his own knowledge of the city's equipment and collection system. "I had helped to design the [Harvester] trucks Phoenix was using," he says."We knew more about them than anyone else. While Waste Management and the others buy their equipment, we custom design our own. . . . One of the reasons we beat [both the giants and the city] was that we planned to take their bodies off and put our [more efficient] bodies on." Although the city did have an advantage in knowing the actual costs of maintaining the equipment, says Walbridge, "I felt we had about a 15% advantage in productivity. Our system would load barrels faster, and our compactors gave our bodies more capacity."

In the end, that proved to be the difference. Walbridge's winning bid for contained garbage was a mere penny lower than the city's (on a unit-per-household-per-month basis). Waste Management came in third, SCA Services fourth, and Browning-Ferris Industries fifth. The thinness of the margin notwithstanding, the city conceded defeat and awarded the contract to National Serv-All. ...

National Serv-All might lose the Phoenix contract when it comes up for bid again in four years. Not that Walbridge expects to lose. "Phoenix is exceptional as far as cities go," he says. "They have a better understanding of business, and they are fair." But, in a fair contest, he believes he can usually underbid a government agency. "A city is hobbled by a low-bid requirement in the purchase of equipment, which sometimes forces them to take equipment that may not be the best. I can buy what I want." That means, for example, that a city might be unable to purchase Government Innovators truck bodies, which cost 10% more than other models, but reduce overall costs by about 20%. Adds Kevin Walbridge, "We're motivated, while cities are still cities. They will always be bureaucratic."

Marvin Andrews and Ron Jensen don't agree. They believe that government workers can be motivated to keep costs down, if only because they want to hold on to their jobs. "Quite frankly, we learn from the experience of going through the contracting process," says Jensen. "When we lose a bid, it's up to us to figure out why we lost it. Where were our costs too high? Was it equipment costs? Labor costs? And this whole feeling of competition gets to the unions, too."

This past August, Jensen's department demonstrated just how serious it was about the process, turning in the low bid on a major contract for both contained and uncontained refuse. The city's bid, moreover, was low by a substantial margin, thanks in part to its planned purchase of a fleet of new trucks. National Serv-All -- which came in fourth in the bidding -- was taken by surprise. "What they did," says Walbridge, "was to tighten up their specs on their trucks. It was smart on their part -- the new truck is a first-class piece of machinery." Walbridge says he is now working on an experimental truck that will allow National Serv-All to do better the next time around.

While stimulated by the competition, Walbridge is still not thrilled by the Phoenix approach to privatization. Granted, it works in Phoenix, but elsewhere -- he says -- it is subject to abuse. After all, many governments are less scrupulous than Phoenix's, and Walbridge would prefer not to spend $30,000 preparing a bid only to find that the competition is rigged, or that the process is so murky that he cannot figure out what is going on."I understand a private bid, but it is very difficult to know how a city formulates its bids."

Walbridge's cautions notwithstanding, it is precisely the competitive discipline imposed by Phoenix's system that makes the city an attractive place for National Serv-All to do business. Only by applying private-sector standards to its employees and departments -- and by subjecting them to competitive pressures -- is the city government able to keep track of its real costs, and thereby to come up with detailed job specifications. Without competition, privatization in Phoenix would be subject to all the problems and pitfalls that Walbridge encountered in other cities.

From that perspective, the Phoenix system -- a system of sound management leavened with a touch of entrepreneurism -- may well hold the key to the future of privatization in America. If it does, Chuck Walbridge is liable to find himself competing with government bureaucrats like Ron Jensen for years to come.

Update: I meant to include this 2003 article as an example of government's ability to innovate:

Ron Jensen, Phoenix's public works director, was the driving force behind the development of the first automated collection truck system “He actually is the one who started the privatization effort here as well,” Franklin says.

Tinkering with Equipment

Obviously, automation relies on equipment, which Franklin remembers vividly as the biggest hurdle. “I started as a mechanic in 1979 and worked on the stuff that the city was running. Most of the equipment was farm machinery hydraulics and stuff built in the basement,” he says. “We had a hydraulics shop that had eight or nine people working internally, building a lot of components. We built our own lifts and did those things to support ourselves because the industry wasn't mature enough.”

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

Statistical Evidence Mounting Of Economic Bottom

The economy appears to be leveling out and the Federal Reserve is optimistic that the economic slide has reached the bottom. James Picerno from the Capital Spectator credits the Fed with helping end the recession by pumping liquidity in the market, although the road to recovery will likely be very long and painful. See the following post for more on this.

The Federal Reserve's FOMC meeting yesterday was a bit of a yawn, although the boys at the bank did tell us that "economic activity is leveling out." But they also recognized that the leveling isn't likely to lead to growth any time soon and so the central bank announced that it would keep the target rate for Fed funds at an extraordinarily low 0-0.25% range, as widely expected.

Nonetheless, it's clear that Bernanke and company have turned optimistic, if only marginally and relative to the deep pessimism of the recent past. That's no surprise considering that the supporting clues have been bubbling for some time. We've been arguing for months that the recession was near a technical end, in part due to the encouraging signs from the declining trend in initial jobless claims. This data series tends to peak at or just ahead of business cycle troughs, as we discussed in some detail back in March, which so far remains the high point for new jobless claims. Much of the credit can go to the Fed, which has been aggressively pumping liquidity into the system to slow and ultimately halt the downturn. The jury's still out on how the central bank plays its cards from here on out--i.e., the so-called exit strategy. But for the moment, there's reason for mild optimism.

On that note, this morning's weekly update on jobless claims is a bit of a yawn too, advising that new claims rose a statistically insignificant 4,000 for the week through August 8. Still, the broader trend remains biased toward descent, if only marginally, as the chart below shows.

There are, of course, a number of other reasons behind our claim that the recession is at or near a technical end. From housing to credit spreads and beyond, the statistical evidence is mounting that the economic contraction has hit bottom. The Fed's FOMC statement yesterday constitutes formal recognition of what's been obvious to economic observers for some time.

But our standard caveat still applies: the end of the recession won't lead to growth any time soon in this cycle. What's more, we're still not sure that the crowd recognizes that the job of repairing the U.S. economy is going to be one hell of a long, tough slog. The big prize--employment growth—is still a ways off, and even when it does come it'll arrive meekly.

That doesn't necessarily mean that the stock market is set for dramatically lower levels. But the news cycle in the dismal science for the rest of the year into 2010 is likely to keep a lid on rallies. Having rebounded from apocalyptic pricing earlier in the year, equities are bouncing around at roughly fair value these days on a general basis. Elevating the market to sustainably higher altitudes is going to take more fundamental signs of economic recovery as opposed to what we've been getting lately, namely, indications that the economy is no longer contracting.

As we discuss in the August issue of The Beta Investment Report, strategic-minded investors should remain moderately exposed to risk to take advantage of the ensuing rebound. But they should also keep some amount of cash on hand as well to exploit the inevitable volatility that will arrive during the coming recovery, which threatens to arrive in fits and starts over an extended multi-year period. Our outlook for risk premia is still encouraging, although generally the expectations have fallen from this year's first quarter. The margin for error, in other words, is wearing a bit thin at the moment. Given the still precarious background, we're not yet convinced it's time to go cashless.

Indeed, there are more dark days ahead when the endurance and depth of the recovery will be questioned, perhaps rightly so. But today, the long-term outlook for risk still looks quite favorable for a multi-asset class portfolio, but the gains won't come easy to those who are impatient or easily frightened at the coming uptick in volatility. Then again, that spells opportunity for everyone else. But at a price, always at a price.

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

Cartoon by David Horsey

One Quarter Of Mortgage Holders Underwater

About one quarter of all mortgage holders in the US are underwater and this number is expected to continue to climb according to reports by Zillow and Deutsche Bank. This could put downward pressure on prices as homeowners and investors look to unload their negative equity. The following post from Blown Mortgage discusses these negative numbers.

Two reports out say if you’re thinking of buying, wait. The prices are going to continue to drop. The reason they offer are the same: Continuing increases in the number of homes worth less than their current mortgages.

Zillow reports that 23% of US mortgage holders owed more than their homes were worth in the second quarter of this year. This number is challenged, but not in a good way, by Deutsche Bank which says it’s actually 26%.

Both numbers are a stark contrast to recent upbeat spins on real estate news. National Association of Realtors report that pending home sales rose for a fifth straight month in June. (Remember, the NAR’s last chief economist admitted lying about his numbers.) And the most recent Case-Schiller numbers which were widely misreported as showing a price increase in May.

While the Zillow report makes the relatively sure prediction that underwater mortgages will increase to 30% by mid-2010, DB goes all in and says it will be 48% by 2011.

This will further decrease prices as it increase the amount of housing for sale. There were 3.8 million homes for sale in June which take 9.4 months to sell at the current pace of transactions, and those numbers are from the ever-optimistic NAR.

The number of homes for sale doesn’t (and perhaps can’t) include the huge number of shadow homes out there. These are homes being kept off the market by banks, investors and individual owners waiting for prices to improve before putting them on the market. “If” prices continue to descend look to these folks to hit the market in a big way as they try to get anything back on their investments. This, of course, will further depress the price of homes. That’s a helluva catch, that Catch-22.

This post has been republished from Blown Mortgage.

Reason To Abolish The Federal Reserve

Tim Iacono from The Mess That Greenspan Made, discusses some of the reasons that the Federal Reserve is bad for America. He suggests that the Fed punishes savers, enriches the banks, and fleeces the poor. See the following post to learn why the Federal Reserve may be doing more harm than good.

During the first few days of each month comes a task that is increasingly approached with dread around here and, unfortunately, that condition is likely to persist for some time.

Shortly after banks make their month-end update to various short-term savings accounts that we hold, these balances are queried, only to find that, almost without exception, interest credited is less than it was in prior months and far less than it was eight or ten months ago.

Why?

Largely as a result of the Federal Reserve keeping short-term interest rates pegged to zero.

You see, aside from some Certificates of Deposit that were locked up late last year which, today, provide the strangest of feelings during a very strange period in history (i.e., feeling lucky to get about 2.5 percent interest for a one-year CD), it's nearly impossible to get more than a two percent return these days on any kind of an FDIC-insured account and, more likely than not, you'll get less than one percent.

Speaking as one who knows from experience, there's a big difference between one or two percent and five or six percent, what used to be the "minimum" rate of return for a super-safe savings account backed by the government.

More importantly, if this is causing us angst every month, I can only imagine what it's doing to the budgets of other savers whose finances are far less comfortable than ours.

Put simply, the freakishly low short-term interest rates that the Federal Reserve is jamming down everyone's throat are immoral and, maybe, just maybe, a lot more people are beginning to see this, along with other practices of our central bank that are just not right.

Maybe, just maybe, something will finally be done about reforming (or, as suggested by Rep. Ron Paul, abolishing) this banking cartel - hopefully before the Fed celebrates its 100-year anniversary in a few years.

Just to be clear on the terminology here, Merriam-Webster offers the following:

immoral
adjective
not moral; broadly : conflicting with generally or traditionally held moral principles

moral
adjective
1a: of or relating to principles of right and wrong in behavior

Setting aside questions about the dark veil of secrecy surrounding who and how much the central bank has been helping with their problem loans, problem assets, and problems staying solvent, there are at least three ways that the organization David Wessel calls "the fourth branch of government" is acting badly these days - by punishing savers, by enriching the banks, and by fleecing the poor.

Of course, none of this is really new - it all just seems a whole lot more relevant today than ever before given the current state of affairs in this country and around the world.

Punish the Savers

As noted above, it used to be that you could always count on getting five or six percent interest in a "no-risk" savings account backed by the FDIC. In fact, going all the way back to 1955 (when the interest rate data at the Fed's website stops), the average short-term lending rate is right between those two marks - 5.66 percent.

Ever since I was a teenager, I can remember thinking, "If I could somehow amass a million dollars, that would surely generate enough money to live on for the rest of my life".

Well, welcome to the 21st century, where the asset bubbles keep a-poppin' and the interest rates keep a-droppin'.

Over most of the last hundred years, aside from the dollar losing more than 90 percent of its purchasing power (versus a loss of zero during the prior ten decades), there hasn't been too much to complain about in the Fed's management of money and interest rates but, since asset bubbles and the attendant "mopping up" process have become a way of life, the rate of return on savings has been abysmal.

With the exception of the "baby-steps" rate raising campaign a few years ago, the Fed funds rate has been below two percent since 2002 - after the decade's first asset bubble met its pin.

Now, if there was a good reason for keeping rates so low, this might all make some sense to senior citizens who have looked disappointingly at their bank statements for years, but given the fact that the low-rates in 2002-2004 led to the housing and credit bubbles forming and then bursting a few years later, and here we are with even lower rates today, all of this should make anyone with half a brain realize that there is something seriously wrong with the system as it currently operates.

In a nation in dire need of internal savings, the fact that savers are being punished as never before is just plain wrong - immoral - and the idea that we live in an era of "low inflation" is just salt rubbed in the wounds of senior citizens who, year after year, watch prices for health care and energy rise by some multiple of the one or two percent they can earn on their savings.

Twenty years from now (perhaps sooner), they'll look back on today's monetary policy and say to themselves, "What were they thinking, punishing the savers like that when the U.S. desperately needed savings?"

Enrich the Banks

As if it weren't bad enough that savers are cheated every time the Federal Reserve lowers interest rates, the worst part is that banks are the beneficiaries.

You see, in addition to buying up many of the bad assets previously held on bank's books over the last year or so - the result of waves of imprudent bank lending - when the Fed lowers interest rates it helps to make the business of banking much more profitable and, conventional wisdom has it that our financed-based economy will then begin to recover.

And when the banks can borrow at these super-low rates, that means that savers can't earn much more in interest.

Banks come first and savers are far down on the list.

Why does the system work this way?

Well, most people haven't got a clue what the Federal Reserve is or what it does (though, understandably, there is growing interest in this topic, ever since the wheels fell off of the global economy last fall), but the crucial bit of information that the now-slightly-more-curious public should learn quickly is that the central bank was not set up to help the people or the government, but, rather, to help the big banks.

In fact, according to G. Edward Griffin, who happened to write a whole book on the subject, the very reason that the Federal Reserve was formed back in 1913 was so that big banks could wrest back control of the banking system from the many small, fledgling, independent banks all around the country that were taking away their business.

Look around you today. You might see lots of little banks failing, but only a few large ones ever go under and none of the country's biggest banks ever fail.

The Fed was created by the big banks, for the big banks, and its unwritten "mission statement" is to do whatever it takes to ensure the survival and profitability of those big banks, getting the government to step in with public money when necessary for "the greater good", effectively socializing the losses while keeping the gains in private hands.

That's why what we have today - a wholly unsustainable system of ever-expanding credit and debt dominated by a handful of "too big to fail" banks - keeps getting propped up.

The masses are led to believe that credit is the "lifeblood of the economy" when, in fact, credit is the lifeblood of a banking system that has, over time, sucked the life out of the economy.

It's hard to imagine anything that is more immoral than the Federal Reserve's role in this process, now almost a hundred years in the making.

Fleece the Poor

In arriving at the third and final way that the Federal Reserve is immoral, clearly, that last thought in the previous section was premature.

In fact, there is one very good example of something being done today by the central bank that is even more immoral than a nearly century long wealth transfer from the public sector to the private banking system - the ongoing assistance being provided by the Fed in helping the banking system reach out and find new customers so that every possible dollar can be extracted from them.

You see, the country's big banks (along with the central bank that serves their interests) would much prefer that poor people all across the country not go to a place like you see to the right and, for a small fee, convert their paycheck into cash and forever live within their means.

Bankers would much rather see the nation's poor open up checking accounts and then venture further into the world of modern day banking, quickly learning to spend well beyond their means.

Left unsaid in the Fed's many efforts to reach out to the "unbanked" is that checking accounts are a sort of "gateway drug" for many people - a road to debt serfdom where, in addition to paying interest on money borrowed to buy stuff that they don't need, these "newly banked" poor will also be fleeced by a bewildering array of fees and charges in a system that is set up to systematically suck as much money out of as many people as possible.

Over the years, the Federal Reserve has made great efforts to attract new customers for banks, in some cases providing cartoon characters to make the whole idea of debt serfdom seem like a friendly sort of condition, much in the same way that Joe Camel once attracted new smokers.

Under the guise of "education" and with "consumer protection" as its goal, the Federal Reserve might seem to be "looking out for the little guy", but they're not. They've had the power to do this for many years now but, for obvious reasons, have exercised their "power to protect" the consumer only sparingly, allowing millions of subprime borrowers to give the housing bubble one last giant hurrah before it finally burst.

Fortunately, it appears that the Obama administration would like to see the American consumers' interests watched over by some other group and for good reason. A report earlier in the week in the Financial Times detailed how big banks in the U.S. plan to extract almost $40 billion in overdraft fees from American consumers whose balance sheets haven't been bolstered by government bailouts.

It seems that, with the collapse of the mortgage finance bubble, big banks are now reverting to a profit model that is driven more by extracting fees from their customers wherever possible and overdraft fees from the cash-strapped are "the mother lode".

A full 90 percent of overdraft fees come from just 10 percent of all checking accounts and most of this 10 percent have low credit scores and/or are recent entrants to the world of mainstream banking.

Not surprisingly, the highest overdraft fees come from the biggest banks - Citigroup, Bank of America, JP Morgan Chase, Wells Fargo, SunTrust, and Citizens Bank.

For banks, overdraft fees are a low risk, high profit part of their business, not something that is usually mentioned as part of the Fed's outreach programs. It is a sophisticated, large scale sort of "payday loan" system that many Americans fall prey to and, as long as customers have their payroll checks automatically deposited, the bank will always have first crack at the money and people will continue to spend more than they make because, when you get down to the very basics here, most people aren't very good at math.

But, banks are.

Maybe Ron Paul is right - the Fed should be abolished.

Then markets could set interest rates, banks would have to fend for themselves, and there would be one less group helping to extract what little money the poor have left.

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

Why The Dollar Is About To Rally

With the US is printing money like there's no tomorrow and national debt approaching $12 trillion, conventional wisdom states that the value of the dollar will decrease over time. However, Tom Dyson, from Daily Wealth, makes his case for the coming dollar rally. See the following post to learn more.

My mother has a perfect record of timing the market. She always buys and sells at exactly the wrong time.

She bought technology stocks a week before they collapsed in 2000, for example. And earlier this year, she sold her stock in Royal Bank of Scotland the same week it began a two-month, 300% rally.

When my mom called yesterday, she told me she'd liquidated her stash of dollars and converted them into pounds.

And it's not just her. The whole world, it seems, is bearish on the dollar...

The Daily Sentiment Index measures the percentage of bulls and bears among futures traders. Last week, the Daily Sentiment Index for the Dollar Index showed just 3% bulls... a level that's only been reached five times in the past 20 years, according to Robert Prechter's Elliott Wave Theorist.

Meanwhile, the Daily Sentiment Index showed 90% bulls for the Swiss franc, 91% bulls for the British pound, 96% bulls for the euro, and 98% bulls in the Canadian dollar.

When sentiment gets this lopsided, you can expect a massive trend change. For example, between March and July 2008, bullishness toward the foreign currencies and against the U.S. dollar reached similar levels to where it is today. At its worst, there were just 5% bulls on the Dollar Index.

These sentiment readings marked the start of the largest, most powerful rally in the dollar in 10 years. Here's the chart of the dollar index. It measures the performance of the dollar against a basket of the world's major currencies. Look at this powerful rally...


Now that sentiment has returned to similar levels, I expect we're about to see another huge trend change in the currency markets. The dollar will soar, and the major foreign currencies will decline.

Betting against the euro is my favorite way to play this. Sixteen different countries use the euro... and most of them are experiencing severe economic pain right now. Countries like Ireland and Spain are entering deep depressions. A cheaper currency would help these countries soften their recessions, ease debt loads, and stimulate exports.

Germany is the largest economy in the euro area. It's the world's largest export economy in dollar terms. A high exchange rate hurts the German labor market by making its products uncompetitive.

My bet is, politicians from all the different euro countries are about to put enormous pressure on the independent European Central Bank to ease monetary conditions and manage the euro's exchange rate lower. Some countries may even threaten to leave the euro if the European Central Bank doesn't oblige.

This political pressure will usher us into a new period of weak euro exchange rates. I wouldn't even be surprised to see this pressure push the euro to parity with the dollar again one day.

There's an exchange-traded fund (ETF) for the euro. The symbol is FXE. You can short it, or buy long-dated puts on it. Or you could buy the PowerShares DB US Dollar Index Bullish (UUP). This ETF rises when the Dollar Index rises. As the euro represents 58% of the dollar index's weighting, it's a close proxy.

This post has been republished from Daily Wealth.

What If The Government Had Saved Lehman?

Would saving Lehman have lessened the economic turmoil that followed when the investment giant went under? Harvard economist Kenneth Rogoff discusses what we can learn from the collapse of a "too big to fail" financial institution and where we should go from here. See the following post from Economist's View.

Ken Rogoff:

The Confidence Game, by Kenneth Rogoff, Commentary, Project Syndicate: Next month marks the one year anniversary of the collapse of ... Lehman Brothers. The fall of Lehman marked the onset of a global recession and financial crisis the likes of which the world has not seen since the Great Depression of the 1930’s. ...

The overwhelming consensus in the policy community is that if only the government had bailed out Lehman, the whole thing would have been a hiccup and not a heart attack. Famous investors and leading policymakers alike have opined that in our ultra-interconnected global economy, a big financial institution like Lehman can never be allowed to fail. ...

Unfortunately, the conventional post-mortem on Lehman is wishful thinking. It basically says that no matter how huge the housing bubble, how deep a credit hole the United States (and many other countries) had dug, and how convoluted the global financial system, we could have just grown our way out of trouble. Patch up Lehman, move on,... and nothing bad ever need have happened.

The fact is global imbalances in debt and asset prices had been building up to a crescendo for years, and ... there was no easy way out. The United States was showing all the warning signs of a deep financial crisis long in advance of Lehman...

The entire financial system was totally unprepared to deal with the inevitable collapse of the housing and credit bubbles. The system had reached a point where it had to be bailed out and restructured. And there is no realistic political or legal scenario where such a bailout could have been executed without some blood on the streets. Hence, the fall of a large bank or investment bank was inevitable as a catalyst to action.

The problem with letting Lehman go under was not the concept but the execution. The government should have moved in aggressively to cushion the workout of Lehman’s complex derivative book, even if this meant creative legal interpretations or pushing through new laws...

The right lesson from Lehman should be that the global financial system needs major changes in regulation and governance. The current safety net approach may work in the short term but will ultimately lead to ballooning and unsustainable government debts, particularly in the US and Europe.

Asia may be willing to sponsor the west for now, but not in perpetuity. ... Within a few years, western governments will have to sharply raise taxes, inflate, partially default, or some combination of all three. As painful as it may seem, it would be far better to start bringing fundamentals in line now. ...

The "hiccup not a heart attack" sets up a false comparison. Had Lehman been bailed out things might not have been quite so bad, or followed a slower downward trajectory, but it wouldn't have been just a hiccup. I don't think many people make the claim that "Patch up Lehman,... and nothing bad ever need have happened."

But the main thing I want to know is if he saying we should start balancing the budget and tightening monetary policy right now, at the trough of the cycle. It seems like that's the message at the end, but I must be reading it wrong.

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

Yes, The Stimulus Is Working

Although the stimulus package has attracted a fair share of criticism, Princeton Economist Alan Blinder wrote in the Washington Post, how the numbers show that the stimulus is having a positive effect on economic growth. Mark Thoma discusses Blinder's comments and whether the stimulus should be considered a success. See the following post from Economist's View for more on this.

Alan Blinder says the stimulus package is working according to plan:

Stay the Stimulus Course, by Alan S. Blinder, Commentary, Washington Post: Apparently not bothered by facts, some congressional Republicans are already claiming that President Obama's $787 billion stimulus package has failed and are even advocating that some of the remaining scheduled steps in the legislation be canceled. ... In reality, we need to stay the course.

The course now includes "Cash for Clunkers,"... an idea that I advocated more than a year ago. At first blush, "clunkers" seems to be the quintessentially successful stimulus program... But that's not quite right.

First, the images of car dealerships and crushed vehicles that have been blanketing newspaper pages and TV screens do not depict real stimulus. .... The stimulus to employment comes only when automakers respond to the higher sales and depleted inventories by boosting production. Everything takes time...

So it is with most of the stimulus measures in the American Recovery and Reinvestment Act. The effects are there, but they will take a while to be felt, and they don't usually lend themselves to photo-ops. One good example is fiscal relief for state and local governments... Just over 20 percent of the $174 billion in federal funds appropriated for the states has been spent, and that cash infusion is limiting -- though not eliminating -- ...cutbacks. The other 80 percent is on the way. But we won't see photos of public servants not being fired.

Critics claim that the stimulus program is running way behind schedule. Is it? Well, no. ... Spending ... is running pretty much in line with what the Congressional Budget Office projected...

These are still early days for a bill Congress passed only six months ago, but the stimulus has already had a notable impact. The average estimate of three private forecasting firms is that the stimulus added about 2 1/2 percentage points to the annualized GDP growth rate in the second quarter..., about half of the improvement from the first quarter to the second.

We are now in the third quarter, when the importance of the stimulus is likely to be even greater. In fact, its estimated growth impact (about 3 percentage points) actually exceeds the consensus forecast...

Cartoonists may scoff at lights at the ends of tunnels, but our economy does, finally, seem to be growing again. The Recovery Act is by no means the only reason. Chairman Ben Bernanke and his colleagues at the Federal Reserve have certainly done a great deal, and the economy's self-curative powers also have helped. But what six months ago looked like an economy plunging into an abyss is now an economy on the mend. And the stimulus deserves some of the credit.

I'm hesitant to put too optimistic a face on the current economy. The economy is declining slower than before (and policy has played a crucial role in putting on the brakes), but we haven't hit bottom yet. We are still in recession. Once we do hit bottom, there's no reason to believe that we are more likely to bounce back toward full employment immediately than we are to stay stuck at the bottom for awhile as we catch our breath and recalibrate. My view is that we are likely to remain at the trough of the cycle awhile before the economy takes a strong upward turn, but exactly how long we will remain stuck near the bottom of the cycle is hard to gauge. I hope it isn't long at all, but a sustained period of sluggishness is a possibility policymakers have to take seriously.

So we aren't at the bottom yet, when we do get there we could remain at the bottom for some time, and once the recovery phase finally arrives, the upward climb is almost always slower than the fall. I agree that stimulus deserves some of the credit for where we are, things could be much, much worse. But the economy has a long way to go before this is over, and it can still use all the stimulus help it can get.

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

Geithner Urges Congress To Raise $12.1 Trillion Debt Ceiling

Although the US debt ceiling currently stands at $12.1 trillion, the ceiling could be shattered by October as the national debt is rapidly approaching $12 trillion. Should the national debt be allowed to grow without limit? Tim Iacono from The Mess That Greenspan Made discusses this.

In a letter to Congress yesterday, Treasury Secretary Timothy Geithner urged elected officials to raise the $12.1 trillion debt ceiling since, according to current projections, that limit may be reached as soon as mid-October.

If there is a more inane concept than a U.S. debt "ceiling" - one that is moved upward, regularly, whenever necessary - someone please tell me what that inane concept is.

And, no, Geithner's justification for the higher level of U.S. government debt does not qualify since it is directly related to the ceiling itself.

It is critically important that Congress act before the limit is reached so that citizens and investors here and around the world can remain confident that the United States will always meet its obligations.

You see, in the twisted logic that passes for policymaking in Washington, it's critically important that the limit be increased before it is reached. Otherwise investors may lose confidence in the entire system - not so much because of the spiraling debt and the lack of any sort of realistic plan that would see the money be repaid, but because lawmakers hadn't paid close enough attention to the relationship between the debt and the debt ceiling, failing to move the ceiling upward when conditions required such action.

The debt ceiling was last raised just six months ago when the stimulus bill was passed.

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

The End of Unskilled Jobs?

While we saw a slight improvement in the historically high unemployment rate, economist Gregory Clark ponders the long-term consequences of a future in which machines replace more and more unskilled workers. What will the economy and society look like if unskilled workers are no longer needed? See the following summary of Gregory Clark's article to learn more.

Gregory Clark sees a bleak future for the unskilled:

Tax and Spend, or Face The Consequences, by Gregory Clark, Commentary, Washington Post: At some point, the Great Recession will end. ... Whenever it happens, we will see that the downturn was but a minor blip in the long story of the economy. In the next chapter, abundance beckons -- for some. Advances in technology drive economic growth, and there is no sign that they are slackening. The American economy is likely to continue unabated on the upward path that began with the Industrial Revolution.

No, the economic problems of the future will not be about growth but about something more nettlesome: the ineluctable increase in the number of people with no marketable skills, and technology's role not as the antidote to social conflict, but as its instigator.

The battle will be over how to get the economy's winners to pay for an increasingly costly poor. ... In a future with higher taxes, the divide between rich and poor would be the central economic challenge.

For much of the past 200 years, unskilled workers benefited greatly from capitalism. Before the Industrial Revolution, for example, skilled construction workers earned 50 to 100 percent more than unskilled laborers; today, that premium has fallen to 33 percent in the United States. ...

Why have the unskilled fared so well? ...[M]achines ... even today ... cannot replace many of people's manipulative abilities, language skills and social awareness. The hamburger you eat at McDonald's is still put together and delivered to you by human hands; even a fast-food "associate" deploys an astonishing repertoire of spatial and language skills.

But in more recent decades, when average U.S. incomes roughly doubled, there has been little gain in the real earnings of the unskilled. And, more darkly, computer advances suggest these redoubts of human skill will sooner or later fall to machines. We may have already reached the historical peak in the earning power of low-skilled workers, and may look back on the mid-20th century as the great era of the common man.

I recently carried out a complicated phone transaction with United Airlines but never once spoke to a human; my mechanical interlocutor seemed no less capable than the Indian call-center operatives it replaced. Outsourcing to India and China may be only a brief historical interlude before the great outsourcing yet to come -- to machines. And as machines expand their domain, basic wages could easily fall so low that families cannot support themselves without public assistance. ...

So, how do we operate a society in which a large share of the population is socially needy but economically redundant? There is only one answer. You tax the winners ... to provide for the losers. ...

The United States was founded, essentially, on resistance to taxes, and to this day, an aversion to the grasping hand of the state seems fundamental to the American psyche. ... The conflicts to come are foreshadowed in California, where popular anti-tax sentiment has forced substantial reductions in medical care for the state's poorest children.

How can we avoid or minimize such conflicts? The Obama administration seeks to do so in part through a more cost-effective health-care system. ... But ... this will at best buy time before an inevitable crunch.

Others see education as a way out of this dystopia. The root problem is, after all, the widening of the income gap between the skilled and the unskilled. Can expanded education give the poorest the tools to resist the march of the machines? I'm skeptical. Already, much of the supposed improvement in high school and college graduation rates has come by asking less of graduates. ...

In the end, we may be forced to learn to live in a United States where, by stealth, "from each according to his ability, to each according to his need" becomes the guiding principle of government -- or else confront growing, unattended poverty.

As the world develops in the long, long run, and as countries move from "developing" to "developed," I still see a chance that the growth in the demand for the services that the unskilled provide will outstrip the growth in the supply. That doesn't mean that the wealth gap won't continue to increase, and that there won't be any problems associated with the growing gap between those at the top and those at the bottom, but I'm not so sure that wages will fall such that absolute living standards will decline as predicted above. But nobody knows for sure what will happen, so what do you foresee?

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

The Decelerating Rate of Bad News

According to the Bureau of Labor Statistics the unemployment rate dropped for the first time in a year which may mean we have stopped the bleeding, but it may take a long time for the economy to heal. James Picerno from The Capital Spectator discusses why the economic healing process has just begun.

Optimists will seize on today's news that the unemployment rate slipped last month for the first time in more than a year. Good news, to be sure, if only because it breaks the formerly nonstop rise in the monthly jobless rate. But the modest decline to a 9.4% unemployment rate in July from 9.5% masks the ongoing job destruction that roars beneath this otherwise encouraging exterior.



Nonfarm payrolls were lighter by a still hefty 247,000 last month, the U.S. Bureau of Labor Statistics reports. That's reassuring only by the dire standard of the far deeper monthly losses between September 2008 and June 2009. Relatively speaking, the labor market appears to be healing, or bleeding less profusely, to be precise. But equating this with good news is a bit like discovering that your boat has only nine leaking holes instead of 12. Your still taking on water, albeit at a slower rate, but the end result will be the same unless the trend changes: the boat sinks.

Indeed, virtually every corner of the labor market was taking on water last month, including the major sectors of goods producing industries (which lost 128,000 positions in July) and the all-important services sector (which shed 119,000 jobs last month). Perhaps we should keep the buckets handy for a bit longer.

Nonetheless, it's important to recognize that the slowing pace of job destruction isn't chopped liver. Ideally, the trend continues and later this year we'll reach zero job loss. We expect no less in the coming months, short of a spectacular turn for the worse in the economy, which at this point looks unlikely.

The monetary and fiscal stimulus engineered by Washington since the crisis began has been helpful in slowing the recessionary forces, and some of that progress can be seen in the chart above. For another take on the improving picture in the labor market—i.e., the decelerating rate of bad news—take a look at the trend in ongoing fall in new filings for jobless benefits, as we discussed yesterday. Other encouraging clues include signs that the housing market may be bottoming out, if it hasn't already. These and some other trends suggest that Q3 2009 GDP will be flat and perhaps even post a small gain, thereby giving more support to the idea that the technical end of the recession is near.

But as we've been emphasizing for some time, the technical end of the recession threatens to be far less satisfying this time in the business cycle. To be clear, a jobless recovery of some magnitude may be looming on the horizon, and it may roll on for longer than the crowd expects. Robust growth in the labor market is essential at this point, considering that a towering 6 million-plus jobs have been lost since this recession began in December 2007. Without a revival in the jobs creation, the expected rebound in the economy is less than assured as a solution to what currently harasses.

Perhaps we're being overly pessimistic, although for the moment there's some reason for at least reserving judgment about the breadth and endurance of the approaching "recovery." Consider, for instance, our second chart below, which compares initial jobless claims and continuing jobless claims on an apples-to-apples basis. The divergence between the two in recent months is clear, namely, the decline in initial jobless claims has yet to be matched by a commensurate fall in continuing claims. The implication: while job loss is slowing, the mass of the previously unemployed are not yet finding work.

Granted, continuing claims tend to lag initial jobless claims, and so we shouldn't rush to judgment. There's still time for continuing claims to decline without yet raising warning flags. But the hour is late. This is already the longest downturn since the Great Depression and the economy's still bleeding jobs at more than 200,000 a month. At this late stage, even moderate bleeding digs us deeper into a hole that's already quite deep, making it that much more difficult to escape. The only solution is an even stronger recovery in the labor market, which at this point is open to some debate.

So, yes, we're happy to see that the unemployment rate fell a bit. But from where we stand, that's virtually irrelevant. As we've been discussing for some time now, the big challenge is still ahead of us. Staving off a deeper economic contraction was essential, and arguably that job is complete. But now comes the far tougher task of rebuilding what was lost. Unfortunately, quick and easy solutions total exactly zero.

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

Ethanol's Future In Doubt

Once touted as a key solution to America's energy problems, ethanol's future is very much in doubt. Pending regulation could make it more difficult to profit from ethanol fuel production which already faces many other challenges. To learn more see the following article, summarized by Mark Thoma from Economist's View.

Does corn ethanol have a future? Let's hope not:

Reality Pricks Corn Ethanol's Bubble, by Doug Struck, Miller-McCune: ...Corn-based ethanol was seen as such an ideal solution for our transportation fuel that Congress leaped to write it into law. In ... 2007, Congress mandated a fivefold increase in biofuels — 42 percent of it from corn — in 15 years.

An industry quickly sprang up: Nearly 200 ethanol refineries have been built..., and an estimated 70 percent of gas sold in the United States contains at least some ethanol.

But as its limitations became clearer, the long-term future of corn ethanol has been clipped. Investors have concluded the industry can only be a niche player, engineers question the practicality of the fuel, scientists doubt its usefulness in reducing global warming, and the federal government is seeking to stop the industry's growth. ...

[T]he first real splash of cold water on ethanol fever came from the market. Last summer, the price of corn peaked above $6 a bushel, and many ethanol producers were locked into high-priced contracts for their raw material. Then the price of gasoline plummeted..., and suddenly ethanol refiners found themselves struggling to break even. As the deepening recession cut off business credit, the industry plunged into wholesale bankruptcies. ...

Even as the survivors in the industry slowly begin to emerge from last year's squeeze — gasoline prices are inching up and their input costs have eased — ethanol faces a limitation from the "blend wall," a federal rule that limits ethanol to 10 percent of gasoline.

The alcohol in ethanol burns hot and is tough on gaskets, hoses and the computers of modern cars, a danger that prompted the 10 percent limit. That rule effectively caps ethanol production... Ethanol producers are lobbying Congress hard to increase the blend wall, but automotive engineers are raising red flags. ... Congress watchers say, at best, the ethanol industry will get a slight increase in the blend wall. ...

To add to its problems, the ... EPA has proposed a rule to enforce a congressional provision in the 2007 Energy Bill, largely ignored under the Bush administration, requiring any new biofuel to be at least 20 percent lower in greenhouse gas emissions than the gasoline it replaces. The rule requires that a new fuel, including ethanol, must account for all of its far-flung carbon impact, including that of forests cut down in distant lands by farmers replacing lost food crops.

It is a startlingly bold rule ... and the industry is crying foul. ... The administration has offered corn ethanol refiners ... a grandfather clause that will exempt the existing refiners from the rule... But new corn ethanol production ... would not pass the greenhouse gas test, according to EPA calculations. ... The EPA is following a path pioneered by California that reflects accumulating research that finds corn-based ethanol is unlikely to reduce greenhouse gases. ...

The ethanol industry complains the research counting indirect costs assumes too direct a link from U.S. corn growers to land cleared by farmers in, say, Africa. ... In a bow to that argument, the administration is setting up a scientific panel to review the question..., prompting head-shaking among environmentalists. ...

But cold-eyed Wall Street already has pronounced its verdict. While the administration's grandfather clause will prop up the value of the existing ethanol plants, financiers are not putting money into any further growth of the industry.

"I think what this does is really sets a defined end to the corn era," said Sander Cohan, transportation fuels analyst at Energy Security Analysis Inc., near Boston. "There's going to be a very active market in controlling and owning the plants that are grandfathered in. Those plants are going to have an enormous premium. But you can't build any more of these old corn ethanol plants."

The ethanol industry isn't giving up:

Ethanol producers have ... regrouped and are striking back by taking a page from the EPA’s playbook.

The EPA, charged by the U.S. Congress with calculating carbon pollution from fuels, maintains that the ethanol industry is responsible for more than just the emissions generated from producing ethanol and burning it in vehicles.

EtEthanol could have another environmental impact. That is, by taking corn out of the global food supply, ethanol producers are indirectly inducing people in other places, such as the Amazon rainforest, to clear forests to plant more crops to replace the lost corn. ...

Now the ethanol industry is saying oil-based gasoline has its own indirect effects in places like Canada’s oil sands, where oil companies burn through massive amounts of energy to extract and refine gunky oil.

In a recent report, the Renewable Fuels Association, ethanol’s main industry trade group, argues that the corn-based fuel’s environmental credentials should be measured against gasoline made with that kind of oil, not with the lighter and more easily refined crude grades, which are becoming scarcer. That comparison makes ethanol look a lot greener. ...

The issue is far from settled—the EPA is waiting for public comment before making its final determination...

Corn ethanol seems like an excuse to avoid conservation. This article has been republished from Mark Thoma's blog, Economist's View.

Pending Home Sales Hint At Housing Recovery

The increase in pending home sales for the fifth month in a row, suggests that the US housing market is gaining steam and may be on course for recovery. However, could the seasonal slowdown kill the momentum that the real estate market has has built over the past few months? Dan Rafter from Mortgage Roadmap, discusses the latest positive news from the housing market.

A rising number of U.S. residents in June signed contracts to buy homes. It's just one more piece of evidence that the U.S. housing market is finally recovering from its long slump.

And that's good news for the rest of the economy, too. Much of the fortunes of the U.S. economy are tied to the housing market. Simply put, if people are buying and selling homes — and taking out mortgage loans while doing it — the country's economy seems to hum along. When people are afraid to buy homes, and when sellers think they can't sell theirs for a fair price, the economy falters.

We've all seen that in a big way during the U.S. recession.

But, as a recent report on CNNMoney.com says, the increase in pending home sales — a pending home sale occurs when someone signs a contract to buy a home — is just the latest indication that the housing market is on the mend. We've also seen home sales rise in the last few months. We've also seen the first national rise in housing prices in three years.

Of course, this good news can all disappear quickly. Summer is nearing its end, and there's no guarantee that home sales will continue to increase through the fall and winter months. After all, home sales tend to fall a bit historically during these slower months. Will that traditional drop-off kill whatever momentum the housing industry is now seeing? Hard to tell.

We can all hope, though, that this recovery is a solid one, one that can withstand a few bumps in the road. There is a lot of pent-up demand out there for homes. That alone should be enough to propel the housing industry to a nice, steady recovery.

This post has been republished from Mortgage Roadmap, a mortgage news and analysis site.

1 in 10 Californians With Home Loan Are In Default

With California's default rate climbing to a staggering 9.5%, it makes you wonder how prices could rebound with the flood of foreclosures adding to the unsold inventory. Tim Iacono from The Mess That Greenspan Made, writes about a couple of prominent housing market experts that apparently don't fear the falling knife of home prices, having recently purchased property despite the scary housing climate.

I wonder if Peter Hong at the Los Angeles Times has any doubts or regrets about buying a house back in November as recounted here, a story that, surprisingly, shows up near the top in a Google search on Peter Hong buys a house.

It would be only natural to have at least a couple of weird thoughts rolling around in your head, especially when you have to write about stuff like this in order to pay your mortgage:

California's default rate soars to 9.5%
Delinquencies in June are up sharply from a year ago, when 6% of borrowers were behind on their loans.
By Peter Y. Hong

About 1 in 10 Californians with a home loan is now in default, and there's growing evidence that the mortgage meltdown is spreading to commercial real estate.

The home mortgage delinquency rate -- the percentage of borrowers who have missed several payments and are in the first stage of foreclosure -- climbed in June to 9.5% in California and 9.9% in Los Angeles County, according to First American CoreLogic.

The staggering number of home mortgage defaults probably will lead to large numbers of foreclosures through at least this year, housing experts say.

"It's probably a given we'll see a high number of foreclosures in the next couple of quarters due to the level of defaults plus the recession and jobs lost. There's plenty more pain to come," said Andrew LePage, an analyst for real estate research firm MDA DataQuick of San Diego.

At least he's not like the serial bankruptcy Edmund Andrews family of the New York Times...

Peter's story was actually quite interesting - about what he and his wife went through in buying a bank repo and their desire to simply have a place they can call their own after selling their condo back in 2005 and renting for a few years.

I wonder whether, if he knew then what he knows now, he'd have made the same decision.

If unemployment weren't such a pernicious problem in the entire state of California, maybe things would look a little different, but falling home prices and rising unemployment tend to feed on each other.

Foreclosures should pick up even more now that various government moratoriums and voluntary foreclosure freezes by lenders have expired.

But LePage said the rate of foreclosures may not reach the record level set last year if lenders increase loan modifications or approve more "short sales," in which homes are sold for less than their mortgage amounts.

The mortgage delinquency rate in June was up sharply from a year ago, when 6% of California mortgages were delinquent and 5.2% in Los Angeles County were in default.

Like Dean Baker, who reportedly bought a house recently so he could enjoy it before the summer ended, Peter may find that he could have bought an even better house for the same money or the same house for less if he'd just waited another year or two.

Dean Baker, the prominent Washington, D.C., housing economist who saw the bubble coming and sold his condo in 2004, recently bought a house. Baker said he thinks the market still has more room to fall, but he wanted to enjoy his backyard this summer and was willing to pay a premium if it comes to that. He said he's OK with a 5% to 10% further decline in his home value, but "if it goes down 20% I'll be upset."

With the prospect of housing price bottoms being such long and drawn out affairs, is it really that important to be able to paint a room the color you want? You can buy a lot of happiness for the probable tens of thousands of dollars that both Peter and Dean would likely have saved by waiting another year or so.

The falling knife of house prices is clearly not dropping as fast as it was a while back, but it is definitely still falling, despite what you may have read in the mainstream media this week.

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

Foreclosures Far Outpacing Mortgage Modifications

While the Obama Administration's foreclosure prevention efforts have been mildly successful at helping hundreds of thousands of homeowners to modify their loans, this is just a fraction of the 1.8 million foreclosures in the first half of 2009 alone. Dan Rafter, from Mortgage-Roadmap, discusses why jobs are the key to stemming the tidal wave of foreclosures in the US.

Pres. Barack Obama's foreclosure-prevention program has seen some successes: Mortgage companies have offered to modify more than 406,000 existing mortgage loans, hopefully to keep homeowners from losing their residences to foreclosure. The program seems to be on track to offer loan modifications to 3 million to 4 million homeowners in the next few years.

But there's one problem with all this: The rate of housing foreclosures is far surpassing the number of loan modifications, according to a story in BusinessWeek.

The BusinessWeek story cites data showing that there have already been 1.8 million housing foreclosures in the first half of this year. That makes that 406,000-plus loan-modification figure look a bit paltry. The story also says that the country will see anywhere from 3 million to 4 million new housing foreclosures during the next two years.

It's going to take an awful lot of mortgage-loan modifications to stem this tide. Of course, the real way to stop this wave of housing foreclosures is to get people working again. With the national unemployment rate nearing 10 percent, there are just too many people out of work these days.

When you don't have a job, it's awfully hard to make those mortgage payments. That's the big issue right now. And until this changes, all the government foreclosure-prevention programs won't really make a big dent in the record number of foreclosures now hitting the country.

This post has been republished from Mortgage Roadmap, a mortgage news and analysis site.

GDP Will Recover, But What About Jobs?

It is almost a foregone conclusion that the technical end to the recession is near and GDP will soon return to positive growth. However the real question is when job losses will turn into job creation. James Picerno from The Capital Spectator discusses why the path to recovery will be long and we are just at the beginning of the journey.

The recession continues to take its toll on the American consumer, new government data released today advises. Disposable personal income dropped a hefty 1.3% in June, reports the Bureau of Economic Analysis. On the other hand, consumer spending rose 0.4% in June. Alas, the pop in Joe Sixpack's willingness to spend is less than it appears.

But first, a closer look at the fall in personal income. One reason for the retreat was the fading of the one-time government stimulus checks (American Recovery and Reinvestment Act of 2009) sent in May. In fact, the loss wasn't nearly as steep once you ignore the government stimulus factor for the last two months. Excluding the checks from Uncle Sam reveals a far more modest 0.1% drop in personal income for June vs. the month before.

More troubling, however, is the ongoing decline in wages and salaries, which fell again in June vs. May by 0.4%. Indeed, it's been falling nonstop since last November. Therein is the frontline attack on the economic outlook. Ok, we all know that the labor market is critical for economic growth. Why, then, is consumer spending up 0.4% for June? One reason is that spending on gasoline rose for the month, thanks to a generally ascending price for fuel. Indeed, consumer spending on energy goods and services jumped a dramatic 8.3% in June, vs. just 0.2% for May, BEA advises in today's update.

But let's be optimistic and recognize that the deepest contraction in the business cycle since the 1930s is easing. There's a strong case for arguing that the technical end of the recession is near, if it hasn't already arrived. But the great question continues to be one of identifying more durable signs of growth, and the jury's still out on that treasure hunt. The end of the recession and the start of a rebound, as the crowd will discover, aren't synonymous this time.

Nonetheless, Ed Yardeni of Yardeni Research advises clients in a note yesterday:

If nothing changes during Q3, real GDP will be up 4.6% during the quarter. This isn’t our forecast. It is arithmetic. If there is no change in final sales to consumers, business, governments, and foreigners, and if nonfarm inventories are unchanged, that’s how much real GDP will increase. This is because nonfarm inventory investment was minus $144.4bn (saar) during Q2. If it is zero during the current quarter, real GDP will surge. The inventory investments component of real GDP has been negative for five consecutive quarters, the longest stretch since Q1-2001 through Q1-2002.

Yes, indeed, but the more pressing issue is not whether GDP will post a rise in the next quarter; rather, the great unknown is the labor market.

“We’ll see a weak economic recovery by past standards,” James O’Sullivan, an economist at UBS Securities, tells Bloomberg News. “For a sustained pickup in consumer spending, we need a clear-cut improvement in the labor market.”

Alas, the only clues to date are that the trend in jobs destruction is slowing, which no one will confuse with job creation.

Rest assured, the recovery will come. In fact, from an economist's perspective, the numbers in the second half of this year are likely to inspire. The deepest fears of six-to-nine months ago are proving to be exaggerated. So it goes in economic forecasting. But it's going to take a lot more a slowing contraction to convince Joe to start making fresh runs down to the local mall to pick up an extra wide screen television.

Yes, we've come a long way since last autumn, although in some ways—arguably in the most crucial ways—the journey has only just begun.

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

Tax Revenues Fall The Most Since The Great Depression

The economic recession has put the US on pace to lose 18% of tax revenue compared to last year while the federal deficit balloons to historic highs. For more on the government's budget problems see the following post by Tim Iacono from The Mess That Greenspan Made.

It's a good thing the U.S. government owns a printing press and knows how to use it because, from the looks of these revenue curves (hoisted from this AP story), the chance that new borrowing will cover all the nation's spending grows slimmer by the day.



A curve for the government's recently increased spending added to the ones for revenue above would make for an even more dismal looking chart.

Some details:

The recession is starving the government of tax revenue, just as the president and Congress are piling a major expansion of health care and other programs on the nation's plate and struggling to find money to pay the tab.

The numbers could hardly be more stark: Tax receipts are on pace to drop 18 percent this year, the biggest single-year decline since the Great Depression, while the federal deficit balloons to a record $1.8 trillion.

Other figures in an Associated Press analysis underscore the recession's impact: Individual income tax receipts are down 22 percent from a year ago. Corporate income taxes are down 57 percent. Social Security tax receipts could drop for only the second time since 1940, and Medicare taxes are on pace to drop for only the third time ever.

The last time the government's revenues were this bleak, the year was 1932 in the midst of the Depression.

"Our tax system is already inadequate to support the promises our government has made," said Eugene Steuerle, a former Treasury Department official in the Reagan administration who is now vice president of the Peter G. Peterson Foundation.

"This just adds to the problem."

Under the new worst case scenario for social security (which may already be outdated), the "trust fund" goes into deficit in just four years and runs out of money in 2029.

The current thinking is that we'll "grow" our way of our current problems...

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

Is Financial Industry Injustice Good For America?

Many American's are angry over the perceived injustice of the financial industry which caused the economic crisis, were bailed out by taxpayers, and are now paying out huge bonuses after earning record profits. But is this injustice necessary to improve the well-being of society? No, says Economist Paul Krugman, who argues that financial speculation by firms like Goldman Sachs actually make us worse off.

Is what’s good for Wall Street also good for America?:

Rewarding Bad Actors, by Paul Krugman, Commentary, NY Times: Americans are angry at Wall Street, and rightly so. First the financial industry plunged us into economic crisis, then it was bailed out at taxpayer expense. And now, with the economy still deeply depressed, the industry is paying itself gigantic bonuses. If you aren’t outraged, you haven’t been paying attention. ...

Consider two recent news stories. One involves ... high-speed trading: some institutions, including Goldman Sachs, have been using superfast computers to get the jump on other investors... Profits from high-frequency trading are one reason Goldman is earning record profits and likely to pay record bonuses.

On a seemingly different front,... Andrew J. Hall, who leads an arm of Citigroup that speculates on oil and other commodities ... has made a lot of money recently... Mr. Hall is owed $100 million.

What do these stories have in common?

The politically salient answer ... is that ... both ... firms ... were major recipients of federal aid. Citi has received around $45 billion...; Goldman has repaid the $10 billion it received..., but it has benefited enormously both from federal guarantees and from bailouts of other financial institutions. What are taxpayers supposed to think when these welfare cases cut nine-figure paychecks?

But suppose we grant that both Goldman and Mr. Hall are very good at what they do, and might have earned huge profits even without all that aid. Even so, what they do is bad for America.

Just to be clear: financial speculation can serve a useful purpose. It’s good, for example, that futures markets provide an incentive to stockpile heating oil before the weather gets cold...

But speculation based on information not available to the public at large is a very different matter. As the U.C.L.A. economist Jack Hirshleifer showed back in 1971, such speculation often combines “private profitability” with “social uselessness.”

It’s hard to imagine a better illustration than high-frequency trading. The stock market is supposed to allocate capital to its most productive uses... But it’s hard to see how traders who place their orders one-thirtieth of a second faster than anyone else ... improve that social function.

What about Mr. Hall? The Times report suggests that he makes money mainly by outsmarting other investors, rather than by directing resources to where they’re needed. Again, it’s hard to see the social value...

And there’s a good case that such activities are actually harmful. For example, high-frequency trading [is] ... a kind of tax on investors who lack access to ... superfast computers — which means that the money Goldman spends on those computers has a negative effect on national wealth. As ... Kenneth Arrow put it in 1973, speculation based on private information imposes a “double social loss”: it uses up resources and undermines markets. ...

And soaring incomes in the financial industry have played a large role in sharply rising income inequality.

What should be done? Last week the House passed a bill setting rules for pay packages at a wide range of financial institutions. That would be a step in the right direction. But it really should be accompanied by much broader regulation of financial practices — and, I would argue, by higher tax rates on supersized incomes.

Unfortunately, the House measure is opposed by the Obama administration, which still seems to operate on the principle that what’s good for Wall Street is good for America.

Neither the administration, nor our political system in general, is ready to face up to the fact that we’ve become a society in which the big bucks go to bad actors, a society that lavishly rewards those who make us poorer.

[See also Back to the Good Times on Wall Street: Looking at "nine large financial institutions that received substantial TARP support from the government," "the firms’ post-crisis pay policies appear to be ... even more lucrative to the firms’ employees than pre-crisis policies.]

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

Obama's Mortgage Aid Plan Will Pay Homeowners To Pay Their Mortgage

The latest mortgage aid plan proposed by the Obama administration seeks to encourage underwater homeowners to keep making mortgage payments by paying down a portion of their principal. This could prevent many homeowners from walking away from their mortgages when they owe much more than what their home is currently worth. The following article from Blown Mortgage, explains more details of the plan.

Home mortgage aid plans are hard to design. Because of how the ideologies behind open market and social responsibility are polarized no matter what you do with a mortgage aid plan pretty much half the nation is going to disagree with you.

Obama’s new mortgage plan is not perfect, not even his closest aides will say that. Its strongest opponents will point out that the new mortgage plan does not really cover for homes that have seriously dropped in value in the last months/years. Most of the families in trouble live in homes that have lost serious value, so there is a question mark in how effective this mortgage modification plan is going to be.

However the new plan has managed to incentivize the payment of mortgages and their previous modification so that it is worthwhile for banks and borrowers. This might not be enough to tip the scales on the millions of households that are at risk of losing their home this year but then again, it might.

If anything does help to tip the scales on the current crisis is to make it attractive for homeowners to pay their mortgage as well as reducing it’s principal and making it affordable on a monthly basis. Let’s face it, if your home is under water (it is worth less than what you owe on it) and there is no prospect of prices going up and you are struggling to pay the mortgage you might be inclined to cut your losses, give up and let the home go. Of course if someone is willing to give you some extra incentive to pay your mortgage and make it affordable, you might just give it a try.

What incentives does the Obama Mortgage Plan offer?
There are two main benefits or incentives homeowners that are in the red can take advantage of.

1. Once their mortgage has been modified and monthly payments begin the Treasury will pay an incentive for every mortgage payment a borrower pays on time that goes to pay the principal balance of the loan(The cash you actually borrowed, not the interest). This is interesting because it will help reduce the length of the loan and the amount of interest paid on it. Over a five year period this “incentive” could help reduce the principal on the loan by $5,000. Reducing the principal of the mortgage has of course even greater repercussions as years go by. If you have a 15 year mortgage and you reduce your principal by $5,000 in the first five years you will be actually saving yourself over $3,000 in interest by the end of your mortgage.

2.There is a trial period of three months before any modification is permanent. During those three months the homeowner must pay his mortgage on time. If he does he gets $1,000 from the government every year for next three years. If the mortgage isn’t paid on time there is no deal.

These are not huge benefits but they are something and they might just help people start thinking in a different way and help people dig themselves out of financial trouble.

This article has been republished from Blown Mortgage.

Does The US Need A Second Stimulus To Prevent A Jobless Recovery

One of the road blocks to economic recovery is the huge unemployment numbers that could make a recovery slow and painful. So why not use a second stimulus to create jobs immediately. That is what economist Mark Thoma suggests at his blog Economist's View.

Following up on some of the issues raised in the post above this one, here's a quote from today's NY Times that summarizes my view on whether we should intervene with policy:

Mark A. Thoma, an economist at the University of Oregon, says the financial crisis would have been worse if the government hadn’t rapidly intervened.

“I completely disagree with the idea that letting the markets heal themselves is the best idea,” he says. “We tried that in the ’30s, and it didn’t work out so well."

The second part of the quote doesn't express what I was trying to say very well. Brad DeLong expresses it a bit better:

[W]henever governments largely ... let financial markets work their way out of a panic out by themselves – 1873 and 1929 in the United States come to mind – things turned out badly. But whenever government stepped in or deputized a private investment bank to support the market, things appear to have gone far less badly.

And, since I'm quoting myself, here's one more from yesterday at CNN Money on whether the fiscal stimulus in place already has worked:

The true test of the stimulus package will come in the fall, when the government reports economic activity for the third quarter. The administration is working to get the money out the door quicker, as complaints mount that stimulus is not having its promised effect.

"The third quarter will be a critical time period for assessing the stimulus package," said Mark Thoma, an economics professor at the University of Oregon.

As to whether we need more fiscal stimulus, if we wait until we know for sure it will be too late. I've been worried that employment would lag behind output once the economy recovered, and that the fiscal stimulus package we put in place was not sufficiently devoted to the employment recovery problem for quite awhile now, and I haven't changed my mind. From last June at MarketPlace:

Fiscal policymakers should have recognized that employment has tended to recover sluggishly in recent recessions and implemented policies that are known to create jobs. But they didn’t...

We need policies that put people back to work immediately. Unfortunately, when the first fiscal stimulus package was being formulated, stimulus programs that hire people to do things that don't enhance long-run growth was a difficult sale politically, so we were left trying to stimulate employment largely with infrastructure projects that were difficult to bring online quickly (which will be even more true if there is another round). I would have preferred that more of the original stimulus package be devoted to projects that created immediate employment, and if we do another stimulus package, as we should given the shape that labor markets are in, I hope we pay more attention to the employment problem.

Update: Along these lines, recently, Brad DeLong wrote:

The Changing Nature of the American Business Cycle, by Brad DeLong: ...It used to be the case that businesses hoarded labor in recessions because they did not want their skilled workers to wander off and to have to train new ones....

Now it is really beginning to look as though businesses take recessions as opportunities to greatly slim down their workforces without making the workers they retain too angry and depressed. We saw this in 2002-2003. We saw it before in 1992-1993. The fact that productivity is no longer strongly procyclical in recessions is good news in the long run--it means that our average long-run rate of productivity growth is higher than we used to think. But it also means that there is more headroom for expansionary policy, and more need.

Thus statements like this one from the very sharp Allan Sinai:

Phil Izzo reports:: "The mother of all jobless recoveries is coming down the pike," said Allen Sinai of Decision Economics. But he doesn't favor more stimulus now, saying "lags in monetary and fiscal policy actions" should be allowed to "work through the system..."

make me pound my head against the wall. If as the policies we have now in train to support the economy work their way through the system we find that we still have "the mother of all jobless recoveries," then we should be acting now to provide additional government support. A jobless recovery is not a good thing. And we should avoid it if we can figure out how in time.

For more, see:

Productivity in the Recession and Going Forward, by Paul Bauer and Michael Shenk, FRB Cleveland In contrast to previous postwar recessions that tended to see sharply lower labor productivity growth, if not outright declines, the 2001 and the current recessions have had relatively strong labor productivity growth. In 2001, year-over-year productivity never dropped below 2.0 percent. In the current recession, productivity has remained over 1.9 percent. The sustainability of this productivity growth has implications for monetary policy, the affordability of the Federal deficit, and ultimately our living standards in the long run.

Gains in labor productivity (output per hour) come from three sources: increasing the amount of capital per worker (capital intensity); increasing workers’ average level of skill, education, and training (labor composition); and a residual (multifactor productivity) that picks up economy-wide gains in knowledge and organizational methods not captured by the previous two effects. Only annual estimates are available for the breakdown in labor productivity. The post-1995 resurgence in labor productivity has been spurred largely by capital intensity and multifactor productivity. However, the growth for 2007 to 2008 was fueled more by capital intensity and a bit less multifactor productivity. ... [full article]

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

What The Q2 GDP Report Means For Investors

GDP numbers for the second quarter showed significant improvement, but that doesn't necessarily mean the end of the recession is near. Consumer spending, which accounts for about two-thirds of GDP, actually fell. For more analysis of the recent GDP report, see the following post by James Picerno from The Capital Spectator.

It's official: the economic contraction slowed dramatically in the second quarter. By that standard, the government can claim a victory. But now comes the hard part, and progress won't come easily or quickly.

For the moment, however, there's reason to cheer. The annual real change in GDP in this year's second quarter was a relatively mild fall of 1.0%, the Bureau of Economic Analysis reports today. That's a massively improved number from the first quarter's huge 6.4% tumble.

The sharp slowdown in the rate of contraction isn't necessarily surprising. As we've been discussing for months, a number of economic clues have been suggesting that the recession may be coming to a technical end. At the same time, we've also been warning that the official end of the recession—as defined by NBER—isn't likely to lead to a rebound of any strength any time soon. Instead, we're looking at an extended period of flat to perhaps modestly negative GDP reports between the technical end of the recession and the start of the recovery. In that sense, the business cycle is different this time, and the risk of a double-dip recession is therefore higher than normal as well.

Today's GDP report suggests no less. Indeed, looking behind the big-picture slowdown in the economic contraction reveals quite a few reasons to wonder about what's coming in the quarters ahead.

Consider, for instance, that consumer spending resumed its decline in Q2 after rebounding a bit in the first three months of this year. Recall that in the second half of last year, personal consumption expenditures went into a tailspin amid the dire news of financial crisis and the widespread expectation that the economy was headed into the worst bout of decline since the Great Depression. Predictably, consumers responded by sharply curtailing spending, delivering two straight quarters of 3%-plus declines in personal consumption expenditures in the second half of 2008.

The trend was broken in Q1 of this year, when spending rebounded a bit, posting a 0.6% rise. But now we learn that consumer spending overall fell again in the three months through June, dropping 1.2%. What's more, the fall was across the board, in durable and nondurable goods. Only services managed to eke out a tiny but statistically insignificant gain.

Nonetheless, our forecast that consumer spending is headed for an unusual period of sluggish growth, if any, seems to be coming to pass. In an economy that draws more than two-thirds of GDP from Joe Sixpack's trips to the mall, the trend bodes ill for expecting a dramatic economic rebound anytime soon. Indeed, Joe's tapped out, struggling with various debts and the loss of job opportunities that are essential for repairing the household balance sheet.

Meanwhile, there's more bad news in today's GDP update on the private domestic investment front. This is a measure of the business sector's willingness to invest in new plants and equipment and so to some extent this is a leading indicator. Alas, the fact that private domestic investment fell sharply again in Q2—by more than 20%--suggests that corporate America continues to take a wait-and-see attitude. Unfortunately, this cautious behavior has been running continuously for seven straight quarters. The last time private domestic investment rose was Q3 2007.

So what accounts for the slowdown in GDP's Q2 decline? An acceleration in government spending. Government consumption expenditures rose by a hefty 5.6% during the April-June quarter, the highest rate in many a moon. The government's intervention has stemmed the tide of what would otherwise been an even deeper contraction. But moving beyond government handouts isn't going to be easy in the foreseeable future.

The apocalypse has been avoided, but the tougher challenge has only just begun.

This article has been republished from The Capital Spectator.