Consumer Confidence Shows Drastic Improvement

In past recessions consumers may have already started to rush back to the malls, but this time might be different. Instead of going back to the shopping centers, consumers may instead be sending their money to credit card companies to pay back their high levels of debt. So what should we make of consumer confidence increasing the most in six years? Tim Iacono from The Mess That Greenspan Made explains why a sudden improvement in consumer confidence may not be as significant as it first appears.

Reuters reports on the sharpest increase in U.S. consumer confidence in more than six years. But, don't get overly excited (like the stock market currently is), the American shopper is still quite depressed by historical measure.

The Conference Board, an industry group, said on Tuesday its index of consumer attitudes jumped to 54.9 in May from a revised 40.8 in April, the biggest one-month jump since April 2003. Economists had been looking for a much smaller rise to 42.0.

Fewer Americans said jobs were "hard to get," the survey found, with that measure slipping to 44.7 percent from 46.6 percent. Those saying jobs were plentiful climbed to a still meager 5.7 percent, but that was still higher than April's 4.9 percent.

"Consumers are considerably less pessimistic than they were earlier this year," said Lynn Franco, director of The Conference Board's Consumer Research Center.

Once again, less bad is the new good, the "considerably less pessimistic" assessment being cause for some to get out the bubbly and celebrate, at least for a little while.

More details...

The survey offered mixed messages regarding Americans' propensity to spend money. The proportion of those who said they planned on buying a car over the next six months rose to 5.5 percent, its highest in at least a year.

But fewer intended to buy homes -- only 2.3 percent, a tough break for one of the hardest hit sectors in the country's economic crisis. A separate report on Tuesday revealed U.S. home prices dropped 18.7 percent in March compared to a year earlier.

Here's a graphic from the Wall Street Journal showing how the expectations index has surged past the present conditions index in a manner similar to the 2003 bottom. Since confidence had sunk to such historic lows in recent months, like many other economic indicators, comparing recent developments to patterns seen in previous recessions may not provide all that much relevant insight.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Should Historic Deflation In Britain Be A Concern?

Could deflation be the next big road block on the road to economic recovery? News out of Britain indicates that significant deflation has hit Britain's economy which can lead to things getting worse rather than better. What does the lowest Retail Price Index since they started keeping records mean for Britain's economy? Tim Iacono from the blog The Mess That Greenspan Made, shares his view on the significance of record deflation in Britain.

The British have succumbed to the scourge of deflation and about all the rest of the world can do now is bid them a fond farewell - they've entered the abyss, as reported by the Telegraph.

Britain sinks into deepest deflation since 1948
The British economy sank deeper into deflation last month to the lowest level in more than 60 years as the effect of falling house prices and lower mortgage repayments escalated.

Inflation on the Retail Prices Index (RPI) measure, which includes housing costs, dropped sharply to -1.2pc in the year to April, from -0.4pc in March, the Office for National Statistics (ONS) said on Tuesday.

It was the lowest RPI figure since records began in 1948, and weaker than economists had expected.

The number of times that economists have been taken by surprise over the last few years has been increasing at such an astonishing rate that, sometimes, you have to stop and wonder why we even keep them around.

Maybe we'd be better off with no forecasts and no expectations for the future at all.

More importantly, you have to wonder why their counsel continues to be sought in order to remedy the ills that took them by such great surprise.

Anyway, on the subject of de-flation, the British method of measuring the changes to consumer prices appears to be even more dysfunctional than the one used in the U.S. as central bank lending rates have a direct impact on their broadest measure of inflation which happens to include interest paid via mortgage payments.

So, all other things being equal, if interest rates are slashed, inflation goes down, whereas, if the bank hikes lending rates, inflation goes up.

The main driver of the fall was lower mortgage interest payments following the Bank of England's decision to cut interest rates by half a percentage point to 0.5pc in March, the ONS said.
...
Although in the short term falling prices will appeal to consumers, RPI is used to calculate wage increases so the sharp fall in April is likely to add to downward pressure on salaries already caused by higher unemployment and falling corporate profits.
"As a result, many workers are likely to get wage freezes or even pay cuts," said Howard Archer, chief UK economist at IHS Global Insight.

Deflation poses a further threat to the economy if people expect prices to fall further and put purchasing plans on hold which can, if the trend persists, lead to lower output and even more job losses.

There's the real evil of inflation - right there in that last paragraph...

If people see negative numbers showing up in the government's measure of inflation, they'll stop obsessing about the ongoing financial market meltdown and how it must ultimately lead to the end of life as we've known it and promptly cut back on their already sharply curtailed spending plans in hopes of getting a better deal sometime in the months ahead.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Phoenix Real Estate Market Showing Signs Of Life

The Phoenix real estate market was one of the hardest hit when the housing bubble popped, and it looks like it might be one of the first to rebound. Buyers are beginning to show heightened interested in the market, with one of the most attractive features being that buying is basically as cheap as renting. Typically when buying is cheaper than renting, people will buy — if they are able. However, with a tightened lending market, millions out of work and many with tarnished credit, the buyer pool is seemingly shrinking. Despite that, the Phoenix market appears to be on the right track, though, Tim Iacono cautions that this could be a small boom created by artificially low interest rates. Foreclosures are continuing to flood the market, and once interest rates go back up the new quasi-bubble could pop.

Evidence is mounting that when home prices tumble by more than 50 percent and the Fed keeps mortgage rates at freakishly low levels, people will buy houses. This report from the LA Times talks of a resurgence in home buying where prices have fallen the furthest.

After four years of renting because they were priced out of the real estate market, Jamia Jenkins and Scott Renshaw concluded the time had arrived for them to buy.

They saw that home prices had dropped so fast here -- faster than in any other big city in the nation -- that mortgage payments would be less than the $900 they paid in rent. The city is littered with foreclosed houses, so the couple figured they could easily snatch up something in the low $100,000s.

Three months later, they're still looking. They have submitted 13 offers and been overbid each time. "It's just pathetic," said Jenkins, 53. "Investors are going out there and outbidding everyone."

While many now cheer the arrival of a housing market bottom this year - more likely in real estate sales than in prices paid - you have to wonder what's going to happen in another year or two when long-term interest rates are much higher.

For example, at today's artificially low mortgage rates, you can get a 30-year loan of $170,000 for about $900, similar to what the couple above is planning. But at the far more typical rates of seven or eight percent, that payment moves up by one-third to about $1,200.

Stated another way, that same $900 payment only buys $130,000 worth of housing - not the $170,000 as indicated above - absent the freakishly low interest rates, something that is a near certainty in the years ahead.

Naturally, that doesn't stop people from buying, as the 2006 fever seems to have returned...

Phoenix's housing bust has turned into a quasi-boom, a sign that its market may have hit bottom and a sneak preview of what a national housing recovery could look like.

More homes are selling than at any time since 2006. Prices are slowly stabilizing. Buyers are once again finding themselves in frantic bidding wars -- only this time over foreclosed houses selling at deep discounts rather than ranch homes listing for vast sums.

"The free market is at work," said Shannon Hubbard, a real estate agent and blogger here. "Prices got driven down so much that people said, 'I'm going to come out and play.' "
Home prices continue to plummet or tread water in much of the nation, but there have been tentative signs of life. Pending home sales rose 3.2% nationally in April, the second month of increases after a record low in January.

John Burns Real Estate Consulting in February identified Phoenix as "the most unique market in the nation," where affordability was better than at any time since 1981 and buying a house was once again cheaper than renting.

It should be an interesting summer as waves of new foreclosures battle waves of new buying interest from a bargain hunting public that is still fearful of more job losses.

This post can also be found on themessthatgreenspanmade.blogspot.com.

Is The Obama Administration Covering Up What Really Happened In Treasury Meeting?

One watchdog group is accusing President Obama's administration of covering up what really went down during the major Treasury meeting that ended with 9 major banks selling equity stakes in their companies to the government for $250 billion. The Treasury originally stated that it had no documentation from the meeting, however, some documents were later obtained. The watchdog group insists some documents — potentially implicating current Treasury secretary Timothy Geitner — are being withheld. Who knows what is true and not in all this, but it will certainly be interesting to see how it all plays out. For more details about the meeting, along with what the watchdog group thinks happened, read the following article from Money Morning.

Despite promises of open government, the Obama administration tried to “cover up the very existence of smoking-gun documents” prepared for a meeting in which former U.S. Treasury Secretary Henry M. Paulson allegedly coerced major banks to allow the government to take equity stakes, according to conservative watchdog group Judicial Watch.

Judicial Watch said the Treasury initially said it had no records about the meeting. It didn’t release a transcript of discussions between government officials and bankers.

However, documents obtained under a Freedom of Information Act request confirm that Paulson and other Treasury officials gave nine major banks no options other than allowing the government to take $250 billion in equity.

Judicial Watch said on its Web site that after it made inquiries, the Treasury insisted on Feb. 4 it had no documents about the historic meeting.

Furthermore, “the cover-up continues, as the Obama administration protects Timothy Geithner by withholding a key document about his role in this infamous bankers meeting,” Judicial Watch president Tom Fitton said in a statement.

The group says suggested edits of the “talking points” for the meeting by Treasury Secretary Tim Geithner, then President of the New York Federal Reserve are being withheld by the Obama administration.

Saying the nine U.S. banks were “central to any solution” of the credit crisis, Paulson told their leaders in the meeting in Washington on October 13, 2008, to take the government aid voluntarily or be forced to by regulators.

“We don’t believe it is tenable to opt out because doing so would leave you vulnerable and exposed,” the document said, citing Paulson talking points. “If a capital infusion is not appealing, you should be aware your regulator will require it in any circumstance.”

Within four hours of the start of the meeting the CEOs wrote by hand the names of their institution and multibillion dollar amounts of “preferred shares” to be issued to the government, the documents show.

“These documents show our government exercising unrestrained power over the private sector,” Fitton said in a statement.

The banks were represented by Vikram Pandit of Citigroup Inc. (NYSE: C), Kenneth Lewis of Bank of America Corp. (NYSE: BAC), John Thain of Merrill Lynch & Co., now part of BofA, Jaime Dimon of JP Morgan & Co. (NYSE: JPM), Richard Kovacevich of Wells Fargo (NYSE: WFC), John Mack of Morgan Stanley (NYSE: MS), Lloyd Blankfein of Goldman Sachs Group Inc. (NYSE: GS), Robert Kelly of Bank of New York Mellon Corp (NYSE: BK), and Ronald Logue of State Street Corp. (NYSE: STT).

A spokesman for the Treasury, Andrew Williams, didn’t return calls seeking comment from Bloomberg News.

The Treasury has invested $199.1 billion in the bank-preferred share program, with $1.2 billion since returned by 12 institutions, according to government data, Bloomberg reported.

Despite his heavy-handed nature, Paulson succeeded at stabilizing the financial services industry, J.P. O’Sullivan, an SNL Financial bank analyst in Charlottesville, Va., told Bloomberg.

“It was a calming mechanism,” O’Sullivan said.

This isn’t the first time Paulson has been accused of strong-arming bankers to bend to his will.

As previously reported in Money Morning, Bank of America CEO Kenneth Lewis said in testimony before New York’s attorney general that Paulson and Federal Reserve Chairman Ben S. Bernanke pressured him not only to move ahead with a merger with Merrill Lynch despite reservations, but also to stay quiet about the mounting losses at the crumbling investment bank.

Lewis went on to testify that he felt Paulson threatened him with losing his job if he didn’t go along with completing the Merrill Lynch deal.

“I can’t recall if he said, ‘We would remove the board and management if you called it [off]‘ or if he said ‘we would do it if you intended to.’ I don’t remember which one it was,” Mr. Lewis said.

This article can also be viewed on moneymorning.com.

New York Post Writer Goes Off On Greenspan And NAR

As we talked about a couple of days ago, Greenspan's speech for NAR was obviously biased, and no weight whatsoever should be given to what came out of Greenspan's mouth. That being said, it is disturbing to see the depths that NAR has fallen to — as well as Greenspan. This display was so ugly that a writer from the New York Post had to publicly condem it. Tim Iacono looks at this writer's article — and adds some input of his own — in the blog post below.

John Crudele of the New York Post goes off on both the National Association of Realtors and former Fed chairman Alan Greenspan in this commentary from yesterday.

WHO the hell would be stupid enough to pay to hear Alan Greenspan's opinion of anything!

Notice, that isn't a question because I already know the answer. Rather, it's a statement with one of those exclamation points to show that my voice is being raised in a mix of bewilderment and anger.

The National Association of Realtors, which is probably suffering from combat fatigue, asked the former Federal Reserve chairman and the chief suspect in the destruction of the US economy, to address its Washington conference Tuesday and tell real estate people what they want to hear -- that things are getting better.

So Greenspan did just that.

Did anyone see the video clip of this speech that CNBC had up yesterday? I watched about the first minute or so and began feeling nauseous.

Apparently, so did Mr. Crudele...

"We are finally beginning to see the seeds of a bottoming" in the housing industry, Greenspan told the gathering. Adding, according to Bloomberg News, that the US is "at the edge of a major liquidation" in the stock of unsold houses.

Applause, applause. Here's your check, Alan.

I figured it was worth knowing how much Greenspan gets these days for defending his own indefensible actions at the Fed while also trying to pull the wool over the eyes of would-be homeowners.

So I asked someone named Lucien Salvant, managing director of the NAR's public affairs department.

His answer in an e-mail: "None of your business. How much is the NY Post paying you to ask that question?" Whoa! Calm down, Lucien.

It gets a little ugly from there, the NAR rightly accused of "shoveling crap to the press" which gets passed along to unsuspecting potential home buyers all for the greater good of the real estate profession.

And, of course, there's another litany of errant predictions from the Maestro.

This is just sad in so many ways - like two zombies embracing each other.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

NAR Calling For Expansion Of First-Time Homebuyer Tax Credit

The National Association of Realtors (NAR) is pushing lawmakers — yet again — to expand the first-time homebuyer tax credit. NAR hopes that lawmakers will make the tax credit available to everyone, rather than just first-time homebuyers — among other things. For more on this, read the following article from HousingWire.

NAR today called for expansion of the $8,000 first-time home buyer tax credit to include all home buyers at all income levels.

The push for a broadened tax credit comes after US Department of Housing and Urban Development secretary Shaun Donovan announced home buyers pursuing Federal Housing Administration-insured mortgages may soon use the tax credit as a down payment at the closing table.

An expanded tax credit, combined with HUD’s initiative to make the credit available at the closing table for down payment purposes — called ‘monetization’ of the tax credit in the industry — would make federal assistance available to anyone pursuing a government-insured mortgage.

NAR, from its legislative summit this week, also urged Congress to make the ‘08 loan limit increase formula and loan limit caps permanent, and to “fortify” mortgage giants Fannie Mae (FNM: 0.7867 +2.17%) and Freddie Mac (FRE: 0.8166 +2.08%) to ensure the continued availability of capital for mortgage lenders.

“Housing is the engine of economic growth, and real estate is the road to economic recovery,” says Charles McMillan, NAR president and Dallas-based broker, in a statement today. “With many of the country’s current problems resting on a wobbly foundation of declining home prices, rampant foreclosures and increasing job loss, our members will be asking Congress to pass further legislation that moves the housing market forward.”

This article can also be viewed on housingwire.com.

Could The Yuan Become The World's Next Reserve Currency?

The U.S. dollar has faced some serious attacks lately, and our economy here in the U.S. is struggling, but have things really gotten so bad that the USD could lose its place as the world's reserve currency? And even if it did, wouldn't the Euro be next in line to take its place? According to Nouriel Roubini, the next world reserve currency could in fact be the Chinese Yuan, and the transition could happen sooner than we think. For more on this, read the following blog post from Mark Thoma which looks at Roubini's recent article on the subject.

Nouriel Roubini is worried that the dollar will lose its status as a reserve currency if we don't change our ways:

The Almighty Renminbi?, by Nouriel Roubini, Commentary, NY Times: ...While the dollar’s status as the major reserve currency will not vanish overnight, we can no longer take it for granted. Sooner than we think, the dollar may be challenged by other currencies, most likely the Chinese renminbi. This would have serious costs for America, as our ability to finance our budget and trade deficits cheaply would disappear. ...

The... downfall of the dollar may be only a matter of time. But what could replace it? The British pound, the Japanese yen and the Swiss franc remain minor reserve currencies, as those countries are not major powers. Gold is still a barbaric relic whose value rises only when inflation is high. The euro is hobbled by concerns about the long-term viability of the European Monetary Union. That leaves the renminbi. ...

At the moment,... the renminbi is far from ready to achieve reserve currency status. China would first have to ease restrictions on money entering and leaving the country, make its currency fully convertible for such transactions, continue its domestic financial reforms and make its bond markets more liquid. It would take a long time for the renminbi to become a reserve currency, but it could happen. ...

We have reaped significant financial benefits from having the dollar as the reserve currency. In particular, the strong market for the dollar allows Americans to borrow at better rates. We have thus been able to finance larger deficits for longer and at lower interest rates, as foreign demand has kept Treasury yields low. We have been able to issue debt in our own currency rather than a foreign one, thus shifting the losses of a fall in the value of the dollar to our creditors. Having commodities priced in dollars has also meant that a fall in the dollar’s value doesn’t lead to a rise in the price of imports. ...

This decline of the dollar might take more than a decade, but it could happen even sooner if we do not get our financial house in order. ... For the last two decades America has been spending more than its income, increasing its foreign liabilities and amassing debts that have become unsustainable. A system where the dollar was the major global currency allowed us to prolong reckless borrowing.

Now that the dollar’s position is no longer so secure, we need to shift our priorities. This will entail investing in our crumbling infrastructure, alternative and renewable resources and productive human capital — rather than in unnecessary housing and toxic financial innovation. This will be the only way to slow down the decline of the dollar, and sustain our influence in global affairs.

This post can also be viewed on economistsview.typepad.com.

Why You Can't Listen To Greenspan Or NAR On Housing Prices

Greenspan opened up his mouth again and told the world that the U.S. is nearing a bottom for the real estate market. Those who remember back to 2006, might remember that Greenspan made another market bottom call, and he turned out to be horribly mistaken. In both accounts his statements were backed by the National Association of Realtors (NAR) who offer up all sorts of real estate data. Investors can't listen to anything that NAR says, for obvious reasons, and history shows us that we should give much more weight to what comes out of the former Fed chief's mouth either. For more on this, read the following blog post from Tim Iacono.

Should anyone be surprised that former Fed chairman Alan Greenspan reaffirmed his "early-2009" housing market bottom call yesterday before the National Association of Realtors?

From Bloomberg:

Former Federal Reserve Chairman Alan Greenspan said that the decline in the U.S. housing market may be bottoming and it’s “very easy to see” financial markets continuing to improve.

“We are finally beginning to see the seeds of a bottoming” in the housing industry, Greenspan said today during a conference of the National Association of Realtors in Washington. The U.S. is “at the edge of a major liquidation” in the stock of unsold properties, which may help to stabilize prices, Greenspan said.

At "the edge of a major liquidation"? What newspapers has he been reading? The headline in my newspaper today says "Foreclosure filings hit record for second month".

Back to the Bloomberg story:

While the housing bottom may not be obvious in prices, it is becoming clear in “significant regional differences,” where some of the hardest-hit areas are starting to show signs of improvement, he said.

While it is certainly true that, in some of the hardest hit areas, home prices just can't go much lower (think Detroit), there are lots of other areas where the descent is ongoing and moving up the socio-economic ladder as Option-ARMs and Alt-A loans sour in record numbers.

Ironically, the realtors' trade group had reported earlier in the day that home prices had just declined by a record amount during the first quarter.

A quick search on housing market predictions during 2008 shows that the former "Maestro" made a few very public calls for a housing market bottom in early-2009, so you'd have to think that, with six weeks left to go, the odds are working against him at the moment.

Despite all the recent cheerleading, it is doubtful that the "seeds" of a bottoming in housing that are now seen will turn into the required "green shoots" in the near-term.

Interestingly, when the NAR joined forces with the former Fed chairman back in November of 2006, this is what they produced:
The advice DON'T DELAY was offered two and a half years ago.Wow! Homebuyers who heeded these words back then would be down about 30 percent today, according to the latest data from the Case-Shiller Home Price Index.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

What Is The Likelihood Of The U.S. Losing Its AAA Credit Rating?

A few months back — after Moody's issued a warning — there was a lot of talk about the possibility of America losing it's AAA credit rating. Of course that never materialized. Now after a recent report on the health of Social Security and Medicare, the talk is resuming. The question still remains though of whether all this talk, is just talk, or if there is any merit to it. Kathy Lien looks closer at the question in her blog post below.

In today’s Financial Times, there is an op-ed article by David Walker, the CEO of the Peter G. Peterson Foundation pondering the possibility of the U.S. losing its prized AAA credit rating. The paper focuses on a warning that was issued by rating agency Moody’s months ago. Moody’s has not issued a new warning, yet Walker and in turn, the FT has decided to re-inject uncertainty into the financial markets by resurrecting this fear. What has prompted this article is most likely the recent comments about the insolvency of the Social Security and Medicare systems. According to the trustees for the systems, the Social Security trust fund could be depleted by 2037 while Medicare could be insolvent by 2017. These dates of insolvency have been pushed up as the weak labor market reduces contributions. The Obama Administration has pressed the importance of gaining control of the growth in Medicare costs and their desire to tackle Social Security insolvency once health care reform is passed.

According to Walker, if the health care reforms strains finances further or if the federal government fails to monitor spending, tax or budget control, rating agencies could strip the U.S. of its credit rating.

Is Losing AAA Rating that Big of a Deal?

But is losing the AAA rating that big of a deal? Yes. A credit rating reflects the risk of default. Therefore a lower credit rating means that a country is at greater risk of defaulting on their debt. Some global funds are mandated to invest only in AAA debt and therefore if the U.S. loses its AAA rating, we could see a massive outflow of foreign investment. Also, a credit rating downgrade is the perfect excuse to push through an alternative reserve currency to replace the dollar because it would strip the confidence of sovereign funds like China that have been buying dollars to prop up the U.S. economy. Yes, investors will still buy U.S. Treasuries, but their purchases will be less. It could also have a spillover effect on corporate debt and will raise the cost of borrowing for the U.S. government.

How Real is the Risk?

Now with the risk in mind, I think that ratings agencies talk a good game but they will face problems following through. The consequences of downgrading U.S. sovereign debt is huge both politically and economically. Therefore Moody’s or any rating agency for that matter may be reluctant to the first to pull the trigger. Downgrading the U.S. is very different from downgrading Ireland. Based upon how the rating agencies have handled the credit derivatives bubble, chances are they will be behind the curve once again.

With that in mind, U.S. finances are deteriorating significantly, raising the concern of Asian nations. However if President Obama is successful at turning around the U.S. economy, America will be well equipped to meet its debt obligations.

This post can also be viewed on kathylien.com.

So What Is The Fed's Next Move?

With the growing number of positive economic reports coming out, many people are questioning whether the economy has turned a corner. Have we really turned a corner, though, or are we seeing a temporary upswing? The Federal Reserve is playing a difficult game right now. If they leave rates low too long we could be faced with inflation, but if they raise them too quickly it could hamper the recovery. With this in mind, the Fed has some challenging decisions ahead of them. How are they going to respond? Mark Thoma looks at a recent article from Tim Duy that addresses this in his blog post below.

Turning Which Corner, by Tim Duy: Is the economy turning a corner? And, if so, which corner is it turning? In my view, economic activity has been influenced by two separate trends since 2007. One is the structural response to an over-leveraged household sector that pushed the US economy into what was initially a mild recession. The second trend is the sharp cyclical recession that began in earnest in the second half of 2008 as the commodity price shock decimated already weakened households and the deepening credit crunch cut financing for a broad swath of firms. Excess capacity emerged throughout the economy, triggering the familiar phenomenon of rising unemployment. Difficult though they may be, the cyclical dynamics do not last indefinitely - generally speaking, output declines stop well short of zero GDP and unemployment will not rise to 100%. Market participants are rightly anticipating the economy is turning the corner on the cyclical trend. But I suspect we have a long path ahead of us on the structural challenge poised by overleveraged households - suggesting that the green shoots we hear so much about will yield little more than stunted growth. This is why Bernanke and Co. are more likely to fertilize the fields than plan for the next harvest.

If there is one picture that sums up the cyclical story of the past year, it is the path of real consumption:

The sharp deceleration has come to an end, of that there can be little doubt. Nor should there be much surprise. The collapse in commodity prices, lower interest rates to allow mortgage refinancing for those homeowners still above water, and tax cuts all joined to provide powerful support for household budgets allowing consumption to stabilize despite the massive job losses experienced in recent months. The stabilization in consumer demand will eventually slow the pace of job cuts. Indeed, this is already evident in the data - analysts have pointed topeak of initial claims as a key hurdle in the race to recovery. To be sure, it is difficult if not impossible to characterize the data flow as "good." But it is certainly less "bad." The path to Great Depression II has hit something of a speedbump. And seeing that, market participants have priced out some of the most cataclysmic scenarios, supporting equities and commodities while pushing bond yields higher.

There will be more opportunities for euphoria - do not underestimate the power of pent-up demand to trigger bursts of positive data. There is a portion of the population who are not credit constrained, biding their time for the perfect moment to buy a new car or schedule a vacation. Indeed, such bursts of data are more likely than not following a sharp decline in activity (the 2.2% gain in consumption spending in 1Q09 is such an example). I believe, however, that those bursts of data will not be sustainable. Far from it - at a minimum, the ability of households to carry activity forward is at its end, which by itself would leave the economy floundering .

I think it is difficult to ignore the implications of the growth of consumer dominance in defining patterns of economic activity:

The story of the last 25 years has been an increasing role for household spending, rising to perhaps a peak of conspicuous consumption, with the motto "a filet mignon in every stainless steel oven, a RV in every garage." Patterns of economic development - more to the point, capital formation - have favored taking advantage of this trend. Countless business plans are based on the expectation that this trend will continue. The baby boomers have endless wealth (not so anymore, if it ever was), there is a never ending supply of equity rich Californians to support our [insert locality] housing market, etc. Those plans will be stressed, to say the least, if the trend stalls. The implications for a reversal are even more significant. And for those that believe reversal is necessary, note that the reversal has really not even begun. What took 25 years to build may take another 25 years to destroy.

How sure are we that the trend is at an end? My thought is that the factors that supported the trend - a steady march down in the saving rate to zero and a steady march up in household debt, coupled with monetary policy that had room to go from 15% short rates to zero over nearly three decades, are at an end. Even if you believe that savings rates will not rise to 12%, the inability to sustain below zero rates puts a limit on household spending growth (as well as debt accumulation). And with underwriting conditions tightening - a permanent tightening, given the changing regulatory environment - the role of debt financing in the life of the consumer is sure to stagnate.

The challenge then is to transition the economy away from the debt-supported consumption trend that looks no longer viable to a trend more reliant on investment and external spending. This, however, is easier said then done. How quickly can 25 years of growth directed at consumer spending be reversed? And reversed to what, especially if the rest of the world continues to struggle? I see little hope of an "immaculate conception" of a fresh, sustainable pattern of economic activity. Until the transition path reveals itself, fiscal policy will be necessary to fill the economic hole likely to exist if the savings proclivities of households continue to exceed the investment intentions of firms.

Ironically, the "best" road to growth is also the riskiest from a policy perspective - a rapid expansion of emerging market activity. Such an expansion, however, would once again place the US in competition for global resources, and threaten a reversal of the commodity and interest rate trends that have been so important to supporting US consumers. Indeed, just the whiff of recovery has supported oil prices, promising an abrupt end to one of the factors supporting US consumers. In the worst case scenario, a flight of capital away from the Dollar (in response to more promising investments abroad) would generate an inflationary and structural shock that would leave the Fed juggling between renewed recession and higher inflation. In short, the optimal external shock would be one only partially supportive; anything more would push the globe to a revisiting of the commodity price surge of early 2008. Looking for a decoupling story now, however, seems like almost a naïve dream.

What is the Fed's next move? One email crossed my inbox after the April employment report suggested some thinking that the Fed could hike rates as early as November. Such a scenario (absent a stability threatening run on the Dollar) must come from a spectacularly optimistic take on incoming data. Data, I might add, that is a reflection of the massive crutch provided by the Federal Reserve and US Treasury, not necessarily a sea change in the underlying economic environment. Look too how quickly bond rates began to climb after the Fed declined to expand Treasury purchases at the last FOMC meeting. More generally, consider this tidbit on Federal Reserve Chairman Ben Bernanke's thinking back in 2003:

The 2003 FOMC transcripts showed then-Governor Ben Bernanke very tuned into financial markets as he pressed for earlier release of Fed forecasts and a willingness to lower interest rates to zero.
From the June 2003 FOMC meeting, when the Fed lowered the target fed funds rate to 1%:

“I wonder if you might give some thought to whether or not it would make sense tactically to say publicly that we are willing to lower the federal funds rate to zero if necessary…I think it would have a beneficial effect on expectations in that there would no longer be a feeling in the market that we had reached the end of our rope.”

“It’s extremely important that we do what we can to maintain the supportive configuration in financial markets. That means continuing our easy monetary policy and, even more important, using our statement to signal our willingness to keep policy easy so long as there is a risk of further disinflation and continuing economic weakness."

A year and a half after the end of the 2001 recession, Bernanke was looking at the possibility of lowering rates to zero in order to maintain support for financial markets. And comparatively, financial markets were leaps and bounds healthier in 2003 than now. Is a rate hike really feasible this year - or even next - given the current state of dependence of the financial system on government largess? Moreover, consider the disinflation worries in 2003 and fast forward to last week:

Even after a recovery gets under way, the rate of growth of real economic activity is likely to remain below its longer-run potential for a while, implying that the current slack in resource utilization will increase further. We expect that the recovery will only gradually gain momentum and that economic slack will diminish slowly. In particular, businesses are likely to be cautious about hiring, implying that the unemployment rate could remain high for a time, even after economic growth resumes.

In this environment, we anticipate that inflation will remain low. Indeed, given the sizable margin of slack in resource utilization and diminished cost pressures from oil and other commodities, inflation is likely to move down some over the next year relative to its pace in 2008. However, inflation expectations, as measured by various household and business surveys, appear to have remained relatively stable, which should limit further declines in inflation.

Now consider the output gap over the last decade:

The current gap already far exceeds that of the last disinflationary scare, and Bernanke expects it to continue to expand further, and then diminish only gradually. As long as the gap continues to expand, Bernanke's bias will be in favor of additional easing. The only question is whether he remains content to allow TALF funds to slowly trickle into the economy, or speeds the pace of policy with expansions of longer dated Treasury purchases. Given Bernanke's past behavior, expecting patience on his part seems unrealistic. Moreover, the last jobs report provides less room for optimism than observers suggest. Importantly, Jim Hamilton notes the decline in hours worked appears unabated; threat of a currency collapse aside, there will be no policy tightening, only easing, until hours worked moves unquestionably and sustainably in a positive trajectory.

Bottom Line: The economy looks to be turning a corner relative to the downward cyclical force of last year. But this is only a partial victory, as the factors that that started us down this path - namely, a debt-supported consumer spending dynamic - remain in play, and will likely remain in play for years, arguing for a long period of slow growth, punctuated by short-lived bursts of positive data. In such an environment, and considering the importance of government support to sustain financial stability, the odds favor continued policy easing. Those looking for a more positive scenario are pinning their hopes on either an unlikely rapid return to past patterns of consumer behavior, an unlikely rapid evolution in patterns of economic activity that are not consumer dependent, or a decoupling of emerging market economic activity from the US (which could pose a different set of policy challenges).

This post can also be viewed on economistsview.typepad.com.

Could Legalizing Marijuana Help Solve California's Budget Problems?

The budget problems in California are well known across the nation, but one desperate idea to help balance the budget is sure to meet opposition from the rest of the country. California's governor, Arnold Schwarzenegger, has apparently requested a full debate on the legalization of marijuana. The benefit — of course — to California if marijuana is legalized is that they can tax sales of the substance. According to a recent public opinion poll of California voters, a majority favor legalization of marijuana. Perhaps citizens feel that compared to the other budget cuts — and new taxes — on the table to shrink the deficit, legalizing marijuana might not be so bad. For more on the situation in California, read the following blog post from Tim Iacono.

It appears as though we'll be getting out of the Golden State in the nick of time as the fallout from the likely rejection by voters of most May 19th ballot initiatives is set to make things a whole lot worse for California's budget.

The Sacramento Bee reports on the relentless deterioration in the state's finances since the last budget bill was passed a few months back, one that really just forestalled the inevitable.

California's projected budget deficit has grown as large as $21.3 billion through next June because of a sharp economic decline, Gov. Arnold Schwarzenegger disclosed Monday in a letter to legislative leaders.

The latest projection means lawmakers will have to negotiate deep spending cuts in education, corrections and welfare as well as consider borrowing and new fees or taxes.

The announcement comes less than three months after the Legislature and the governor closed $34 billion of a then $40 billion state budget deficit with tax hikes and spending cuts and asked voters to eliminate the rest in next week's special election.

These "new" estimates will probably turn out to be just as overly optimistic as every previous forecast and once again, the state of California is blazing a trail for the rest of the country, this time on the road to insolvency.

There is more than a little irony in the Gubernator being voted into office some six years ago when his predecessor had similar problems that, in retrospect, look like a walk in the park by comparison, unless of course another housing bubble is in the offing.

New plans are being prepared to close the new budget gaps.

The governor did not disclose his solutions Monday. But he warned groups last week he will consider borrowing $2 billion from cities and counties, releasing low-level offenders in state prisons and reducing school funding by $3.6 billion. The state also could eliminate its planned $2 billion reserve.

"It's well beyond triage," said Senate President Pro Tem Darrell Steinberg, D-Sacramento. "We're talking about painful and difficult decisions. You can't just finesse your way through $15 billion or $21 billion."

It's odd how $15 billion or $20 billion really doesn't sound like a lot of money anymore...

Here's one way the state might be able to generate new revenue. After having been talked about for some time now, momentum is building to somehow find a way to tax marijuana (presumably, after legalizing it) as reported by the U.K. Guardian.

Arnold Schwarzenegger has never apologized for smoking pot – and loving it — at the height of his bodybuilding career in the 1970s. Now, as a struggling Republican governor of California reaching a crossroads in his political career, he might yet become America's most visible advocate for legalizing marijuana.

The actor-turned-politician gladdened the heart of every joint-roller and dope fiend across the Golden State earlier this week when he said it was time for a full debate on legalization.

Schwarzenegger was careful not to say too much – he stopped short of saying he was in favor of legalizing cannabis now – but his words broke a long-standing taboo among both Republicans and Democrats who have previously felt obliged to say marijuana must remain illegal, and marijuana users and pushers be subject to criminal prosecution.

The governor spoke in response to a new public opinion poll showing that 56% of registered voters in California favor legalizing and taxing marijuana – in part to help the state out of the worst budget crisis in its history.

If they ever do such a thing, this California trend is likely to meet with some resistance in many other parts of the country.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Job Loss Report Beats Expectations Thanks To Government Jobs

For the first time in a long time, job loss numbers came in better than expected. A large part of this is thanks to a huge run up in government jobs as the country prepares for the upcoming census. That being said we still saw over 500,000 jobs lost in April, and the unemployment rate went up to 8.9 percent for the nation. For more on this, read the following blog post from Tim Iacono.

The Labor Department reported that fewer jobs were lost in April than in any month since last October, but that the unemployment rate continues to rise sharply, an indication that laid off workers are finding it increasingly difficult to find new employment.
Nonfarm payrolls fell 539,000 in April after losses of 681,000 in February and 699,000 in March. Total revisions for the two prior months were -66,000 as the February and March data were revised downward from 651,000 and 663,000, respectively.

Over the last six months, a total of 3.9 million jobs have been lost and, since the recession began in December of 2007, the U.S. economy has shed 5.7 million jobs.

The jobless rate jumped from 8.5 percent in March to 8.9 percent in April, reaching its highest level since the September 1983 mark of 9.2 percent and the total number of unemployed now stands at 13.7 million, up from 13.2 million in March. The post-WWII high for unemployment came in December of 1982 at 10.8 percent.

If laid off workers who have stopped looking for a job are included in the unemployment figure along with those currently employed but settling for part-time work, the jobless rate would have been 15.8 percent, a 15-year high.

While job losses may have peaked with January's decline of 741,000 (though, next year's benchmark revisions to the payrolls data could radically change this), the jobless rate is likely to continue higher until the economy begins to improve and companies are more willing to hire.

One part of the economy that was hiring last month was the government where total payrolls rose by 72,000. This was driven by a the addition of some 140,000 temporary workers that will begin work on the 2010 census. A total of 1.4 million workers will be hired over the next year to conduct the population count that happens every ten years.

Elsewhere, job losses continued, but at a slightly slower pace than in previous months, manufacturing leading the way down with a decline of 149,000 and the trade, transportation, and utilities category not far behind at minus 126,000.
The birth-death model added a total of 226,000 jobs in April, a new high for the year.

Since this data is used to adjust the raw totals prior to seasonal adjustments, you can't just subtract it from the headline seasonally adjusted data to determine its impact, but it is important to note that the entire 65,000 increase in professional and business services payrolls (which was then seasonally adjusted to -122,000) was contributed by the birth death model - it's hard to imagine that there were so many new businesses formed in April.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Obama Pushes For $17 Billion In Budget Cuts...That's It?

In what seems like joke, President Obama has sent lawmakers a proposal that aims to cut over a hundred programs, and save us $17 billion. When you look at the fact our deficit this year will be a projected $1.85 trillion, you can start to see that $17 billion in cuts is next to nothing. It's almost as if Obama is simply trying to appear like he is making an effort to trim spending. The worst part is that it appears Obama will be fought tooth and nail to get these cuts through. If he can't manage to get $17 billion cut off the budget, what hope does this country really have forbalanced budget? For more on this, read the following article from Money Morning.

President Barack Obama sent lawmakers a budget package today (Thursday) that proposes to shrink or eliminate 121 federal programs and save almost $17 billion in the fiscal year that begins Oct. 1. But the budget plan contains cuts that will face vigorous opposition in Congress and fierce resistance from special interest groups.

The package of proposed reductions fills in the fine print of a $3.55 trillion budget outline approved by lawmakers in April that contains Obama’s top agenda items, including a health care overhaul, a push for renewable, clean-energy sources and changes in education funding.

The President wants to cut or end a number of programs that he feels are wasteful or ineffective to take the first toward getting spending under control. But the administration’s attempt at bringing fiscal discipline to Washington has already been met with skepticism by analysts.

“Every government program - no matter how wasteful - will be defended by its recipients and congressional champions,” Brian Riedl, a budget expert at the Heritage Foundation, a Washington-based research group told Bloomberg News. “Unless Obama puts the weight of the White House behind his spending cuts, Congress will ignore them.”

The cuts are miniscule compared to the overall budget package and deficits that will be ushered in the next few years. The $787 billion stimulus package Obama pushed through Congress combined with the $700 billion Troubled Asset Relief Program (TARP) bank bailout will come on top of the $1 trillion deficit the administration inherited when he took office in January.

Total savings from the cuts, even if they were accepted by Congress in their entirety, would represent a paltry 0.4% of the overall budget. The Congressional Budget Office projects the deficit will be $1.85 trillion this year, about four times the previous record, and $1.38 trillion in fiscal 2010.

“Even if you got all of those things, it would be saving pennies, not dollars. And you’re not going to begin to get all of them,” Isabel Sawhill, a Brookings Institution economist who waged her own battles with Congress as a senior official in the Clinton White House budget office, told the Washington Post. “This is a good government exercise without much prospect of putting a significant dent in spending.”

Only about 80 of the proposed cuts are new - the others had been previously revealed. And most of the cuts will be from the “discretionary” budget, avoiding the so-called untouchable “third-rail” entitlement programs of Social Security and Medicare.

Those two programs account for more than 40% of government spending, meaning the more difficult work on deficit reductions has been left for another day.
“More serious efforts at deficit reduction are going to require entitlement and tax reform - that’s where most of the money is.” Marc Goldwein, policy director of the bipartisan Committee for a Responsible Budget, a Washington-based research group, told Bloomberg. “To really get the deficit under control, we’re going to have to start thinking bigger,” he said.

But some in Congress defended the administration’s approach, saying the list of program reductions is just the start of a more comprehensive effort to cut spending and pull the reins on the skyrocketing deficit.

“It depends on what it means over the scope of five and 10 years.” Representative John Larson (D-Conn.) told Bloomberg. It’s a “deep, cavernous hole where we have been left, we’re looking a long way up but it’s a steady climb” using the budget plan agreed to by Obama and Congress, he said.

This post can also be viewed on moneymorning.com.

Economy Rebounding: Truth Or Lies?

We certainly are hearing a lot of positive economic press lately, but is this really the truth, or is the government and media simply putting a positive spin on it? Tim Iacono looks at a recent article that talks about several of the recent positive announcements, and then shows us the opposite end of the spectrum with a satiric piece in his blog post below.

We will find out soon enough - say, by the end of summer - whether headline writers in the mainstream financial media or those working at The Onion are correct in their assessment of the state of the U.S. economy. Here's an example of the former that appeared on the front page of Yahoo! yesterday for a few hours.
That SOLD sign is a compelling image for anyone thinking about the future. prices have been and continue to be at the center of our problems and their is near universal agreement that the economy won't improve until the housing market improves.

Just how does the story behind this compelling image figure that's happening?

Prepare to be underwhelmed.

8 Signs of Hope for the Economy
Are we on the brink of a rebound, or is it a false spring? Fortune looks at the evidence for an imminent recovery.

Is the economy looking up, or at least bottoming out? Lately there has been much talk about "glimmers of hope," in President Obama's words, and "green shoots," a phrase du jour used by the likes of Fed Chairman Ben Bernanke.

Meanwhile, many economists have warned about a false spring, pointing to numbers that are still getting worse, like the unemployment rate. Fortune takes a closer look at the upbeat news to assess whether how strong a case they make for an imminent recovery.

1. Housing Starts
The government reported that the overall number of housing starts fell in March, but those for single-family homes during the month came in unchanged from the February figure of 358,000.

IHS Global Insight noted that this suggests single-family home construction may be stabilizing and is "testing the bottom."

2. The Stock Market
The S&P 500 was up 9.4% in April, its biggest monthly rally since March 2000. The Wilshire 5000 Total Market Index ended the month at 8,962.96, up 849.85, or 10.48%. This is the best monthly return since December 1991, when the index was up 10.72%.

"The initiatives of the federal government and some of the improvements in the credit markets are making investors more confident," said Thomas Cowhey, chief investment strategist at Hirtle Callaghan.

3. Consumer Confidence
Preliminary figures for the Conference Board's Consumer Confidence Index showed a jump of more than 12 points during April, to 39.2. The reading, which measures consumer views on the economy, beat analyst expectations and was the highest so far in 2009.

Lynn Franco, director of the organization's research center, attributed the rise in confidence to "significant improvement in the short-term outlook."

4. Single-Family Home Prices
The S&P/Case-Shiller Home Price Indices showed that while 20-city and 10-city Composite Home Price figures declined through February 2009 (down 18.6% and 18.8%, respectively, from a year ago), for the first time in 16 months the annual decline did not set a new record.

While it signals that the market may be showing some stabilization, or at least what Chairman of the Index Committee David Blitzer called "deceleration in the rate of decline," Blitzer warned that we "need a few more months of data before we can determine if home prices are finally turning around."

Meanwhile, the Pending Home Sales Index rose for the second straight month in March and was up more than 1% over the year-ago figure. The index from the National Association of Realtors (NAR) increased 3.2% during the month, to 84.6%.

"This increase could be the leading edge of first-time buyers responding to very favorable affordability conditions and an $8,000 tax credit," wrote Lawrence Yun, the NAR chief economist.

They go on to talk about earnings, jobless claims, new orders, and credit markets arriving at no real conclusion other than the one stated in the title.

It really is hard to be swayed by stabilization in housing starts at current levels as new home construction is at such freakishly low levels, some 25 percent below the all-time population-adjusted low of 1980.

As for the stock market predicting the recovery, an important related statistic might be something like, during the Great Depression, the stock market predicted 5 of the first zero recoveries (i.e., huge bear market rallies failed to produce an "economic" recovery).

Consumer confidence rebounding from all-time lows going back more than 40 years is a good thing, but by no means sufficient for a sustainable rebound, and annual home price declines that did not set a new record for the first time in 16 months is only an indication that the rate of change in home prices is improving - from an annual rate of -34 percent to -26 percent.

Quoting the Chief Economist at the National Association of Realtors harkens back to 2005.

Haven't we learned anything in the past four years.

No, the nation's leading satirical newspaper probably has it right in their take on things.

Nation Ready To Be Lied To About Economy Again
WASHINGTON—After nearly four months of frank, honest, and open dialogue about the failing economy, a weary U.S. populace announced this week that it is once again ready to be lied to about the current state of the financial system.

Tired of hearing the grim truth about their economic future, Americans demanded that the bald-faced lies resume immediately, particularly whenever politicians feel the need to divulge another terrifying problem with Wall Street, the housing market, or any one of a hundred other ticking time bombs everyone was better off not knowing about.
In addition, citizens are requesting that the phrase, "It will only get worse before it gets better," be permanently replaced with, "Things are going great. Enjoy yourselves."

"I thought I wanted a new era of transparency and accountability, but honestly, I just can't handle it," Ohio resident Nathan Pletcher said. "All I ever hear about now is how my retirement has been pushed back 15 years and how I won't be able to afford my daughter's tuition when she grows up."

"From now on, just tell me the bullshit I want to hear," Pletcher added. "Tell me my savings are okay, everybody has a job, and we're No. 1 again. Please, just lie to my face."

Nathan Pletcher probably speaks for millions of Americans.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

How The European Central Bank Is Different

The European Central Bank (ECB) made several important announcements today, and the reaction from currency traders was much different than how they have reacted to similar moves from other central banks. Currency expert Kathy Lien looks closer at the recent announcements, and talks a bit about what sets the ECB apart from the Bank of England and Federal Reserve, in her blog post below.

Both the European Central Bank and the Bank of England announced asset purchases today, but the Euro skyrocketed while the British pound fell, leading many currency traders to wonder What Sets the ECB Apart from Fed and BoE?

Read Boris’ take on the Bank of England Rate Decision

Before talking about why the euro recovered, here are the 4 key announcements made by the ECB today:

1. Cut Repo Rate from 1.25 to 1.00%
2. Narrow Rate Corridor by 50bp (Marginal Lending Rate Cut by 50bp to 1.75%)
3. Extend maturity of refinancings to 12 months
4. Announced purchases of up to EU60 billion in euro-denominated covered bonds

There is no question that these are unprecedented measures for the European Central Bank. Everyone expected the quarter point rate cut to a record low of 1.00 percent, the decision to increase the maturity of refinancings to 12 months and also the narrowing of the rate corridor by 50bp, but the chance of purchasing euro-denominated covered bonds was low.

Nonetheless, Trichet has resorted to what many consider Quantitative Easing (even though he explicitly denied that this is QE) and rather than punishing the euro, currency traders are applauding the ECB for being flexible and realizing that there is no longer a stigma attached to asset purchases. Also, the amount of bonds that the ECB is purchasing is nominal compared to the rest of the central banks. The ECB plans on buying up to EU60 billion, which is less than half of the BoE’s Quantitative Easing program. More importantly however, Trichet suggested that they may sterilize the liquidity impact of bond purchases, which would limit the impact on the money supply and the pressure on the euro. The Fed and the BoE’s purchases are unsterilized. Finally, this is only an initial announcement. Further details on the bond plan will be released in June. Although rates are appropriate for the current time, the central bank could still take interest rates below 1 percent based upon Trichet’s comment that they have decided if rates have hit their lowest point.

This post can also be viewed on kathylien.com.

Bank Demolishes Foreclosed Homes In Victorville

You know things are bad when it makes more sense for banks to demolish foreclosed homes than to keep them. In the case of the Texas bank who destroyed 16 homes in Victorville California, the homes were not yet finished, but the loss the bank is taking on these has to be outrageous regardless. For more on this, read the following blog post from Tim Iacono.

The story about a Texas bank deciding to demolishing foreclosed homes in California was everywhere yesterday, but it shouldn't be that surprising - they needed a lot of work.

When they start bulldozing finished houses into the ground because they just can't sell them, then that will be real news.

Some details are provided in this report at the Wall Street Journal:

A Texas bank is about done demolishing 16 new and partially built houses acquired in Southern California through foreclosure, figuring it was better to knock them down than to try selling them in the depressed housing market.

Guaranty Bank of Austin is wrecking the structures to provide a "safe environment" for neighbors of the abandoned housing tract in Victorville, a high-desert city about 85 miles northeast of Los Angeles, a bank spokesman said.

Victorville city officials said the bank told them the cost of finishing the development would exceed what they could sell the homes for.

The bank also faced escalating city fines as vandals and squatters took over the sprawling housing project, leaving behind graffiti and drug paraphernalia, city officials said.

"It's unfortunate," said George Duran, the city's code-enforcement manager. "We would have hoped for these houses to be finished. But it's up to the owner to see what is best for them."

We've driven through that area many times on the way from Southern California to Las Vegas, a few times when the bubble was at its peak, and almost every time we wondered why anyone would ever pay $300,000 or more to live in Victorville.

There's also a related story in the LA Times.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Job Loss Numbers May Come In Better Than Expected

Continuing the trend of remotely positive news, it looks like April's job loss numbers could potentially come in a little better than expected. That being said we are still looking at a half a million more people out of work — that number just isn't as bad as prior months. For more on this, read the following post from Kathy Lien.

Speculation that Bank of America may need $34 billion of capital has triggered fresh concern about the results of the stress tests on banks, which are due for release on Thursday. However despite these fears, there is growing evidence that job losses may have tempered with non-farm payrolls likely to see the smallest decline in 6 months. The 4 week moving average of jobless claims have moderated and yesterday, there was an impressive rebound in the employment component of service sector ISM.

This morning, Challenger Gray & Christmas reported the smallest increase in layoffs since September. According to payroll agency ADP, private sector payrolls declined by -491k last month, the smallest increase since October. Although the ADP report has been a poor predictor of non-farm payrolls, it has been relatively reliable directionally and therefore confirms our suspicion that payrolls declined by less than 600k last month.

source: Bloomberg

Yet we still expect the U.S. economy to have lost at least 1/2 million jobs in April and for the unemployment rate to hit a 25 year high. This is indicative of weakness from nearly all perspectives, but it is a start because companies need to slow firing before they can even consider hiring. This is a step in the right direction towards a labor market recovery and why I believe the dollar will trade lower against the higher yielding currencies today.

This post can also be viewed on kathylien.com.

How Is The Economic Medicine Working?

The government has been injecting trillions of dollars into the economy, but how has it been working so far? James Picerno looks at recent events and attempts to answer that question in his blog post below. In addition Picerno takes a look at what lies ahead for the U.S. economy, and offers some words of wisdom for investors.

In late-March, we asked: Is the medicine working? By medicine we meant the massive injection of liquidity into the economy as a cure for fending off deflation and laying the groundwork for recovery. At the time, we were mildly encouraged, in part due to the rising inflation forecast as derived from the spread between the nominal and inflation-indexed 10-year Treasuries.

More than a month later, there's still reason for optimism, perhaps more so, thanks to the so-called green shoots that suggest better days ahead. Yet the rate spread, which is to say the market's inflation outlook, hasn't changed much since late-March. The current forecast is for inflation of 1.4% for the next 10 years, just barely up from around 1.3% from the end of the first quarter. In both cases, that's a healthy change from expecting flat pricing, as was the case at the end of 2008. Low inflation as far as the eye can see would be nice, but is that a reasonable expectation?

In the months ahead there will be a thin line between a healthy rise in inflation expectations and the potential for burdensome pricing pressures later on. Deflation is a hazard to be avoided for a number of reasons. Although we can't quite shut the book on the danger, the odds look increasingly in favor of mild inflation for the foreseeable future, as the chart above suggests. Behind this reasoning is the growing sentiment that the recession is at or near a bottom. Is it time for the Fed to begin tightening? Or are the green shoots still too tentative?

"We're seeing more indications of perhaps a bottoming in the economy," Bill O'Neill of LOGIC Advisors tells Dow Jones. "So there is an increasing—and it will continue to increase—concern surrounding inflation potential."

Gold, the perennial inflation hedge, seems to be considering the possibility, although this market hasn't quite made up its mind. The price of the metal has been hovering around $900 for much of this year, just below its all-time high of $1,033, set back in March 2008. The 10-year Treasury yield, meanwhile, has been climbing, recently bumping up against 3.2% on renewed worries that inflation may now be the bigger risk. Even so, a 10-year yield of 3.2% is still quite low.

None of the inflation anxiety is worrying the stock market, which has now reversed the selloff in the first quarter. Indeed, the S&P 500 is now marginally up on the year, as of last night's close, on expectations that by the end of this year the economy will be sitting up and prepared to get out of bed.

The big question is whether all the renewed hope that the worst is over is really just the byproduct of a bear market bounce in markets and inflation expectations? Given the extreme waves of selling last year and into March, a rebound was all but assured if the world economy didn't collapse. As we now know, it didn't. There are still lots of problems, but we'll all be here next year and so it was time to reprice assets upwards to reflect a humbled but otherwise enduring economic climate.

Investors have cheered the signs that the U.S. economy no longer seems to be contracting at an accelerating pace. Given the fears of what could have happened, that's certainly a reasonable response. Deciding that you're not going to fall into the abyss is always encouraging. But that's still a long way from arguing that growth is imminent, or that the economy won't tread water for a year or two.

The first phase of the post-apocalyptic visions that prevailed six months ago may be over. If so, now we're faced with the more difficult chore of deciding how to repair and rebuild the economy to foster growth while containing inflation. The hardest days are yet to come. Unless you're expecting a seamless transition, keeping some cash at the ready still makes sense, albeit less so than in past months. Volatility isn't banished, it's only hibernating, which suggests another round of value-oriented pricing opportunities in the major asset classes.

This post can also be viewed on capitalspectator.com.

Wages Are Falling Across America

We have been hearing a lot about unemployment, but there is another equally disturbing trend happening at the same time. In order to avoid layoffs some companies are asking employees to take wage cuts. While wage cuts might seem like no big deal — the employees still have their jobs after all — they can be devastating to the economy. For more on this, read the following blog post from Mark Thoma that looks at a recent article from Paul Krugman.

Are we doing enough to reduce the risk that we’ll face a sustained period of deflation and stagnation?:

Falling Wage Syndrome, by Paul Krugman, Commentary, NY Times: Wages are falling all across America. Some of the wage cuts, like the givebacks by Chrysler workers, are the price of federal aid. Others, like the tentative agreement on a salary cut here at The Times, are the result of discussions between employers and their union employees. Still others reflect the brute fact of a weak labor market: workers don’t dare protest when their wages are cut, because they don’t think they can find other jobs.

Whatever the specifics, however, falling wages are a symptom of a sick economy. And they’re a symptom that can make the economy even sicker.

First things first: anecdotes about falling wages are proliferating, but how broad is the phenomenon? The answer is, very.

It’s true that many workers are still getting pay increases. But there are enough pay cuts out there that, according to the Bureau of Labor Statistics, the average cost of employing workers ... rose only two-tenths of a percent in the first quarter of this year — the lowest increase on record. Since the job market is still getting worse, it wouldn’t be at all surprising if overall wages started falling later this year.

But why is that a bad thing? After all, many workers are accepting pay cuts in order to save jobs. What’s wrong with that?

The answer lies in one of those paradoxes...: workers at any one company can help save their jobs by accepting lower wages, but when employers across the economy cut wages at the same time, the result is higher unemployment. ... So there’s no benefit to the economy from lower wages. Meanwhile, the fall in wages can worsen the economy’s problems on other fronts.

In particular, falling wages, and hence falling incomes, worsen the problem of excessive debt: your monthly mortgage payments don’t go down with your paycheck. America came into this crisis with household debt as a percentage of income at its highest level since the 1930s. Families are trying to work that debt down by saving more ... but as wages fall, they’re chasing a moving target. ... Things get even worse if businesses and consumers expect wages to fall further in the future. ...

Concern about falling wages isn’t just theory. Japan ... is an object lesson in how wage deflation can contribute to economic stagnation.

So what should we conclude from the growing evidence of sagging wages in America? Mainly that stabilizing the economy isn’t enough: we need a real recovery.

There has been a lot of talk lately about green shoots and all that, and there are indeed indications that the economic plunge that began last fall may be leveling off. The National Bureau of Economic Research might even declare the recession over later this year.

But the unemployment rate is almost certainly still rising. And all signs point to a terrible job market for many months if not years to come — which is a recipe for continuing wage cuts, which will in turn keep the economy weak.

To break that vicious circle, we basically need more: more stimulus, more decisive action on the banks, more job creation.

Credit where credit is due: President Obama and his economic advisers seem to have steered the economy away from the abyss. But the risk that America will turn into Japan — that we’ll face years of deflation and stagnation — seems, if anything, to be rising.

Here's a graph of the Phillips curve over the last two and a half years (2006:Q3 - 2008Q4) as measured by the year over year percentage change in the employment cost index (total compensation) versus the civilian unemployment rate:

Artificially restraining wages from falling is not the correct response, the key is to drive the unemployment rate down so that the labor market tightens and wages rise in response. That is why it's essential that stimulus programs provide a boost to employment, and I've wondered from the start if the stimulus programs we enacted have focused enough on providing employment opportunities. Building new infrastructure does provide long-term benefits, and that gives political cover to the large government expenditure and tax cuts that were enacted, but infrastructure projects alone do not give the maximum possible boost to employment. Providing jobs - some of which may not directly boost long-run productivity - is an essential component of short-run stabilization policy, and there is more that we could do to give unemployed workers opportunities for employment until jobs begin to reappear in the private sector.

This post can also be viewed on economistsview.typepad.com.

Fed Delays Release Of Bank Stress Test Results

The Federal Reserve has decided to delay the release of results from its recent stress test on banks. It appears that the Fed is trying to limit damage to the banks who will appear weak based on the results, and allow them more time to figure out how they will raise the necessary funds. It will no doubt be interesting to see how investors react to the information provided by the stress test. For more on this, read the following article from Money Morning.

The results of the bank stress tests are in, but instead of releasing them today (Monday), the U.S. Federal Reserve is holding them close to its chest until after the markets close Thursday.

The amount of information awaiting disclosure seems to have grown, as have the reasons to postpone the potentially damaging data.

Not only will the government unveil which banks require more capital, it will also disclose potential loss estimates for certain loan categories and the banks’ ability to “absorb those losses” assuming economic conditions worsen through 2010, a government official told The Wall Street Journal.

Negative results could deal a huge blow to both the banks and government, as a sub-par grade may be viewed as an indictment not only of the failed management of the banks, but the government’s decision to loan them billions of taxpayer money. The banks also are concerned that anything but a tactful release of the results will cause internal and investor panic.

Government and banking industry officials told Bloomberg that both sides needed the extra time to debate preliminary results, as well as plans regarding how banks can recover capital.

On April 24, the government showed the tests’ preliminary results to the 19 U.S. firms it reviewed – from behemoth banks like Bank of America Corp. (NYSE: BAC) and Citigroup Inc. (NYSE: C) to the smaller GMAC LLC (NYSE: GMA) and MetLife Inc. (NYSE: MET). The banks involved in the stress tests hold more than half the loans in the U.S. banking system and two-thirds of the assets.

“Everybody understands they’ve got a tiger by the tail here,” Mark Tenhundfeld, a senior vice president at the American Bankers’ Association in Washington, told Bloomberg. “If they don’t let him go gently, there will be a lot of mauling going on.”

Already, reports have leaked that two specific banks need more capital, and reaction hasn’t been pleasant.

After showing Bank of America and Citigroup test results, the government told the banks to raise more capital despite receiving a combined total of $95 billion in bailout loans.

At least three more banks need more capital, either from converting common shares to equity and/or receiving more government cash, sources told Bloomberg.

Sensing blowback from Congress, as well as the public, Federal Reserve chairman Ben S. Bernanke said that banks requiring more capital will have to attempt to raise it on their own before receiving another lifeline loan from the government.

Confusion On Evaluation’s Methodology

Debate over the results isn’t the only reason for the postponement. Disputes and confusion over the Fed’s methodology has also erupted.

According to a Fed’s test criterion, common shareholder equity should be the “dominant” portion of Tier 1 capital. Officials favor tangible common equity of about 4% of a bank’s assets and Tier 1 capital worth hovering around 6%.

But The Wall Street Journal reported last week that some bank executives got mixed signals during a meeting with regulators.

The regulators are asking “a million questions” and it’s “very unclear what they’re aiming at,” a senior executive told The Journal. “We can’t discern a pattern.”

Citigroup officials argued that regulators haven’t given the bank enough credit for its efforts to offload large asset chunks, such as Smith Barney and its Japanese brokerage arm Nikko Cordial Securities.

On Friday, Citigroup agreed to sell Nikko Cordial Securities, its Japanese brokerage arm to Sumitomo Mitsui Financial Group (OTC: SMFJY) for about $5.5 billion. The deal, which is to be completed by Oct. 1, also includes a transfer of about $2 billion in excess cash from Nikko Cordial to Citigroup.

The deal will boost the bank’s Tier-1 capital ratio by approximately 27 basis points.

Individual Result Releases

One insider told Reuters that the government is leaning toward releasing individual results for each bank involved in the stress test – a move away from issuing a summary of results.

The source said the plan “is not very far along,” and that regulators also aim to disclose a lot of confidential supervisory information about the banks.

One analyst says that test results could be so specific to a bank’s portfolio that it’s not wise to use them as a litmus test for the overall health of the banking sector.

“Once you try to take that information and extrapolate it, it gets very complicated and it’s dangerous," Kevin Petrasic, who served at the Office of Thrift Supervision from 1989 to 2008 and is now an attorney at law firm Paul Hastings in Washington, told Reuters.

Whatever the results – or how they are disclosed – Money Morning’s Shah Gilani, a former Wall Street hedge fund manager, said the evaluation process has several flaws.

“What’s missing, unfortunately, is an assumption of how much additional capital would be necessary to facilitate credit expansion – which, in turn, would serve to fuel economic growth. That, after all, should be the ultimate stress-test objective,” he wrote.

And the end result is more stress added to an already stressed banking sector, as too much information and/or misinformation only makes a sound assessment more difficult.

Money Morning’s Stress Test

The government’s pushback of stress test results only made the public more hungry for the their release. But you don’t have to wait until Thursday to know which of the 13 biggest U.S. banks are diamonds or duds.

Last week in “Money Morning’s Bank Stress Test,” Martin Hutchinson highlighted the four secrets that will let you separate the winners from the losers in the U.S. banking system

• Banks that made profits in the very difficult fourth quarter of 2008 and first quarter of 2009 are probably in good shape, especially if their loan-loss provisions exceeded their charge-offs (the amount actually lost.)
• Banks that lost money in the fourth quarter and first quarter may or may not be in terminal trouble; it depends on the amount of those losses and whether the red ink is expected to continue to flow going forward.
• With the run-up in bank stocks in recent weeks, there’s been an accompanying rise in the ratio of share price to book value (stock price per share/book value per share). If that ratio is still below 30% - even after the recent price increases - the market lacks confidence in the bank’s ability to solve its own problems. Unfortunately, the market currently appears to be overly optimistic about some of the banks that still have considerable ongoing problems.
• Management’s dividend policy is less of an indicator than it was just a few short months ago; several banks have sharply cut their dividends in order to repay the Troubled Assets Relief Program (TARP) capital they got in late 2008. Reasonably, profitable banks don’t want the government meddling in their business or compensation structures

Hutchinson also gave an individual analysis of each bank, highlighting their strengths and pulling a curtain on their weaknesses.

This article can also be found on moneymorning.com.

Fed Holds Steady...For Now...

Earlier this week the Fed decided to hold steady with their previous policies, however, it is still likely that they will need to provide additional easing in the months ahead. Mark Thoma looks at an article from Tim Duy, in his blog post below, that talks more about the economy and what's likely in store for Fed policy.

Despite Green Shoots, Odds Favor More Easing, by Tim Duy: The Fed took an interesting risk by holding policy steady on Wednesday.With green shoots all the rage, policymakers are ready to step to the sidelines as they monitor the progress of their many programs. And clearly, they must have known that the 3% level on 10-year Treasuries was dependent on the expectation that policymakers would expand the pace of outright purchases of those assets, but are betting that economic conditions will remain sufficiently weak to prevent a crippling increase in rates. Still, given that policymakers still see the economy in decline, albeit at a slower rate, the odds favor additional easing in the months ahead, especially considering expectations of a widening output gap. Recall that labor markets, and the threat of deflation, kept the Fed easing well past the end of the recession in 2001.

Short of an outbreak of inflation, or a unexpected and unlikely surge of growth, there is little reason to think that the Fed is ready to bring policy to a sustained pause. And an imminent rise in inflation remains an outside risk for the Fed; the focus remains consistently on disinflation or, worse yet, outright deflation. A key paragraph is:

In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

Policymakers are counting on a rising output gap (both here and abroad) and lags in the price setting process to keep inflation at bay. Indeed, this must be the case, as some of the current numbers are really not all that comforting. I am not inclined to place too much focus on headline inflation - oil prices appear to have found a bottom around $50 a barrel, and sustained hints of a firming of global economic activity would promise to send prices higher, thus offsetting the strong disinflationary impact of falling energy prices since the middle of 2008. In contrast to low year-over-year headline numbers, the personal income and outlays report for March revealed that core PCE prices gained by 0.2% in each of the past three months, pushing the annualized three month trend back above 2%:

And note that near-term inflation expectations have climbed back up into a normal range:

From this perspective, policymakers have done a good job anchoring inflation expectations against the possibility of deflation. Is this enough, however, to unsettle FOMC members? Despite these inflationary hints, it is simply unlikely that the Fed would ignore the disinflationary implications of the output gap. One way to ignore the gap is to argue that the US will revert to an emerging market inflation dynamic. I think such an argument requires a steady depreciation of the Dollar to hold - which could happen, but a Dollar crisis looks, for the moment, unlikely given relative global weakness. One could also argue that estimates of potential output are optimistic and don't reflect the importance of structural change in the economy. This is the issue that Nick Rowe at the Worthwhile Canadian Initiative attempts to tackle:

Even in the short run a good banking and financial system will be important in re-allocating capital between growing and declining sectors, if there are shifts in relative demand. If people want fewer cars and more restaurant meals, but banks cannot shift loans from car manufacturers to restaurants, the Short Run Aggregate Supply curve may shift left, because the restaurants won't be able to expand to meet demand, and car manufacturers' prices or wages may be sticky downwards.

If you see the financial crisis as causing the recession by shifting the SRAS curve left, then monetary and fiscal policies, which shift the AD curve right, are not the appropriate cure. Even if you see leftward shifts of the SRAS curve as only part of the story, you will see limits on what monetary and fiscal policy can achieve. When expansionary monetary and fiscal policies start to cause excessive inflation, before output and employment have returned fully to normal, you will know that purely AD policies have reached the limit of what can be expected from them.

Nick is slapped down by Brad DeLong:

But if bad banks have shifted the AS curve inward, then right now we should have stagflation: depression and inflation, as output falls and prices rise. We don't. The argument that fiscal and monetary policies won't reduce unemployment to normal levels because we have a supply side problem is completely incoherent in an AS-AD framework.

Brad is correct that in a traditional AS-AD framework, bad banks are demand shocks, not supply shocks. There is still something about Nick's argument that is important - the financial system redirected capital investment into housing and consumption related activities. Presumably, potential output includes the ability to build and sell as many houses the US economy produced at the height of the housing bubble. But what good is that output if we don’t want to build and sell that many houses in the future? How do we redirect capital away from those sectors? And how long does it take? Arguably, the narrowing of the US trade deficit is pushing that adjustment forward, as the US economy can't focus entirely on producing nontradable goods. Recall Brad DeLong from 2005:

There is an alternative scenario, one in which foreigners'--including foreign central banks'--desired holdings of dollar-denominated assets shortly hit the wall, and the asset price shifts that result from desired holdings' hitting the wall reduce, or do not increase, confidence in the dollar.

In this alternative scenario, the U.S. has to move about ten million workers out of currently-favored sectors--construction, home-equity-credit financed consumer expenditures, and so on--into export and import-competing manufactures. How much structural unemployment does such a sectoral shift require, and how long does the structural unemployment last? Other countries have to shift up to forty million workers out of export manufactures into other industries, and to generate demand for the products of those industries (without destabilizing their own monetary systems and asset prices, as Japan appears to have done at the end of the 1980s). The U.S. Federal Reserve would have to cope with whatever inflationary pressures are generated by rising import prices. Foreign central banks would have to cope with whatever stresses on their own asset prices are created by enormous losses of value in the stocks and bonds of their exporting companies.

If structural unemployment is rising - not because banks are currently bad, but engaged in bad behavior in the past - attempts to reduce unemployment back to pre-recession levels will yield higher inflation. This problem is minimized if labor resources can be quickly redirected into other sectors, a process that Nick above is implying is hampered by the existence now of bad banks. But, as Brad suggested in 2005, getting to inflation in the current environment seems to require a Dollar collapse - a story that for now is difficult to tell.

All of which is interesting, but even if you believe that structural unemployment is rising, I don't think anyone believes it is near the 8.5% rate for March (not to mention the underemployment rate of 15.6%). Nor does anyone expect that recent green shoots are sufficient to keep unemployment from rising further. Moreover, note that the Employment Costs Index released today reveals the continued slide in employee compensation costs - consistent with the FOMC's concerns about economic slack. Indeed, the ECI highlights the risks of the Fed's move to hold steady policy: Declining wage growth, coupled with higher interest rates, would play havoc with household efforts to reduce balance sheets and intensify the need to boost saving rates. Hence why the risks still favor additional policy easing - especially if programs such as TALF and PPIP are less successful than imagined.

In short, the shoots are much too green and the output gap much too wide to stimulate much discussion on Constitution Avenue that the end of easing has conclusively been reached. A pause to assess, yes. But Fed officials will be looking for clear and convincing evidence that economic activity is both self sustaining (not likely to fade after the initial burst of federal stimulus moves through the pipeline) and sufficient to substantially reduce the output gap before they sound the all clear signal. An end to the rapid pace of job loss is very different from a return to steady job growth. Again, recall the sustained pattern of easing in the wake of the 2001 recession - we need to go a long way up from -6% GDP growth before the job engine is started. To be sure, there should be some lingering concern that the Fed will act quickly (or at least the markets will act quickly), if there is a perceived need to withdraw monetary accommodation. But the data are well short of what would be necessary to justify such a shift in policy in the near future.

This post can also be viewed on economistsview.typepad.com.

Recession Bottom Near, But Could Last For Awhile

There are a lot of signs pointing to the fact that the bottom of the recession is a least near — if not hear already. Before everyone gets excited, though, it is more than likely that the bottom will last for awhile. For more on this, read the following blog post from James Picerno.

The main point of optimism in yesterday's first reading of Q1 GDP is the jump in consumer spending. But as today's update on personal income and expenditures for March reminds, there's still quite a bit of uncertainty left as to whether consumption is truly on the mend.

Much of what registered as increased consumer spending in this year's first quarter came in January. A convincing follow-through still awaits. As our chart below shows, the bump just ahead of March 2009 was a first-of-the-year rise in both disposable income and personal consumption spending. It was a welcome reprieve from the crushing setback in late 2008. But the trend is fading and last month's consumption dropped relative to February. Disposable income, meanwhile, was flat in March.

The main question is whether the realities of the broader economic climate are finally weighing on American households as they ponder the toxic combination of falling housing values, fewer jobs, higher unemployment and burdensome debt levels built up over the years. The government's massive stimulus efforts over the past year have helped slow the tide, but the correction in consumption and consumer attitudes will roll on.

Adding to the challenge is the recent uptick in the 10-year yield. The Fed has been working overtime in trying to keep long rates low, which is to say below 3%. But now Mr. Market is rebelling. The 10-year closed above 3% for the third day running yesterday. That's the first time it's run above that level since the Fed announced on March 18 that it would buy long-dated Treasuries outright in order to keep rates low. Immediately following the news, the 10-year yield dropped by an extraordinarily steep 50 basis points to around 2.5%. Now the yield's above 3%. And the higher rates come at a time with little or no worries about inflation.

Of course, one could argue that the apparent topping out in new jobless claims suggests that the recession may be at or near a trough. We've suggested as much recently, including here, and our reasoning is here. And today's update on new filings for jobless benefits offers a fresh datapoint to argue that the business cycle may have bottomed.

But we must distinguish between a bottom to the recession and the renewal of economic growth. If we have an "L" recession, the bottom could last quite a bit longer than the crowd expects. All the more so given the depth and magnitude of the current downturn.

In short, there's reason for optimism and its counterpart. Deciding which one has the upper hand will still take more time.

This post can also be viewed on capitalspectator.com.

Are Real Estate Prices Stabilizing?

Real estate prices are still falling across the country, but for the first time in over a year the monthly declined failed to set a new record. This is leading some analysts to believe that the real estate market just might be stabilizing. This is potentially good news, but investors should remember that while prices might be stabilizing, it could still be awhile before prices stop dropping altogether. For more on this, read the following article from HousingWire.

Home prices in major metropolitan areas continued to fall in February; however, for the first time in 16 months, the annual decline did not set a new record, possibly suggesting early signs of market stabilization.

The S&P/Case-Shiller 10-City and 20-City Home Price Indices released Tuesday recorded nationwide, annual declines of 18.8% and 18.6%, respectively. This is a slight improvement from the returns reported for January, which fell by 19.4% and 19.0%.

“While the declines in residential real estate continued into February, we witnessed some deceleration in the rate of decline in some of the markets,” says David M. Blitzer, chairman of the Index Committee at Standard & Poor’s. “All 20 metro areas recorded a monthly decline in February, but 16 of the 20 metro areas saw an improvement in their monthly returns compared to January.”

Still, the indices show an ongoing, broad-based decline in the prices of existing single family homes across the United States, with 10 of the 20 metro areas studied showing record rates of annual decline, and 15 posting declines in excess of 10%.

In terms of annual declines, the three worst performing cities as of February are once again, located in the Sunbelt, each reporting negative returns in excess of 30%. Phoenix was down 35.2%, Las Vegas declined 31.7% and San Francisco fell 31.0%. Dallas, Denver and Boston faired the best, down a significantly lesser 4.5%, 5.7% and 7.2%, respectively. Dallas also holds the distinction of being the best performer for the month, returning -0.3%, according to the report.

As of February 2009, average home prices across the United States are at levels similar to those seen in third-quarter 2003. And despite the deceleration in home price declines seen in February, from the peak in mid 2006, home prices are still down over 30%.

Standard & Poor’s Blitzer says, “we will certainly need a few more months of data before we can determine if home prices are finally turning around.”

This article can also be found on housingwire.com.

We Need A Root-And-Branch Reorganization Of The Financial System

Some people are open to the government handing over trillions of dollars to the banks, but no taxpayers want the money handed over without proper controls in place that will ensure it goes to good use. This has been one of the biggest issues the public has had with the bailout efforts thus far. For that reason Steve Waldman is calling for a root-and-branch reorganization of the financial system. For more on this, read the following blog post from Mark Thoma.

Steve Waldman says "we need a root-and-branch reorganization of the financial system":

Value for value, Steve Waldman: Would it have been better if Timothy Geithner had had the power to guarantee all bank debt early on? As James Surowiecki reminds us, that was part of the Swedish solution. Justin Fox plausibly suggests that we might have avoided a lot of pain with a fast, full guarantee.

But that's not the point. The question isn't whether we could have avoided this crisis, if only we had cut a big check. We could have, and that was not lost to any of us debating these issues more than a year ago. (See e.g. me or Mark Thoma.) Had we done so, the near-to-medium term fiscal costs might have been less than they probably will be now. So, with 20/20 hindsight, would it have been a good idea?

How you answer that question depends upon how you view the crisis. Is it an aberration, a shock to a basically sound financial system, or is it a painful symptom of an even more dangerous condition? ...

If you think that our financial system just needs some tweaks, some consolidation of regulators' organizational charts and sterner supervision, then you should prefer that we had just cut a check, passed Sarbanes/Oxley Book II, and moved on. But that is not what I, or most proponents of temporary receivership for insolvent banks, believe.

If you believe, as I do, that we need a root-and-branch reorganization of the financial system, which must necessarily involve the dismemberment and intrusive restraint of deeply entrenched institutions, does that mean pain is the only way forward, "the worse the better" in the old revolutionary cliché? It need not mean that. But it does mean that palliative measures, like giving the banks money, would have to be attached to curative measures, like enacting capital requirements and imposing regulatory burdens that would force financial behemoths to break themselves up or become boring narrow banks. For almost two years, policymakers at the Fed and the Treasury, including Secretary Geithner, have offered bail-out after bail-out and asked for nothing serious in return.

Do I regret that Henry Paulson was not empowered to issue a blanket guarantee of bank assets early on, as the Swedes did? No, I don't regret that at all. Why not? Because I think that "Hank the Tank" was a crappy negotiator... He would have offered the financial system sugar without requiring it to make the medicine go down. He may believe, quite sincerely, that a cure would be worse than the disease. He may believe that, but he is wrong. ...

You may believe that we have learned our lesson, that if we can just get some stability and comfort for a while we are prepared to do what must be done. That's a respectable position. But I don't share it, and neither do the majority of Americans who are unwilling to allow their representatives to sign off on any more expensive aspirin. We want value for value, an ironclad commitment of root and branch reform in exchange for the unimaginable sums of money we are being asked to hand over. ... Congress would, because the public would, support large, explicit transfers, if they were attached to reforms sufficiently radical to prevent a recurrence, and suitably punitive towards the people who managed the system that brought us here. Value for value. ...

I ... would be willing to hold my nose and tolerate a Swedish-style guarantee of bank creditors. I'd acquiesce to that even without formal nationalization. Nationalization is ... a means to an end, and the desired end is a world in which too big to fail is too big to exist for any financial institution that originates or holds credit risk in any form. Secretary Geithner could send a bill to Congress today that would put all banks with a balance sheet of over $50B into run-off mode... I'd fax my Congressman and support a $2T on-budget buyout of bank creditors as part of that bill, as long as it had teeth. ("Teeth" would imply making sure that off-balance-sheet and derivative exposures were included in the size cap, etc.)

It's not that us pitchfork-totin' populists are unwilling to pay the bill. It's that we want to know that in exchange for writing a very, very large check, the people that we are paying will actually deliver the goods. Given the behavior of bankers before the crisis and of shifty policymakers during, we have every reason to watch warily and to insist upon every precaution while we hand over suitcase after suitcase of freshly printed Federal Reserve notes.

This post can also be found on economistsview.typepad.com.

Gold And Silver Update

Last week we saw some big news come out of China regarding gold, and investors are paying close attention. China almost doubled their gold reserves, and after a stretch of falling prices, this news sent prices up. For more on this, read the following post from Tim Iacono.

Big news for the precious metals markets came from China last week when the Xinhua News Agency published comments made by Hu Xiaolian, head of the State Administration of Foreign Exchange, indicating that China's gold reserves had increased by 454 tonnes since 2003. Apparently, they were required to report the new total to the IMF and made a public disclosure at the same time, however, it is not at all clear why there were no previous updates in recent years.

This almost doubled their previous reserve total of 600 tonnes and vaulted China into sixth place on the World Gold Council's list of official gold holdings as noted in this item last week. With almost $2 trillion in foreign exchange reserves and an increasingly vocal dislike of the U.S. dollar in recent months, this big gain comes as no surprise to most analysts, however, the magnitude of the increase in dollar terms was mostly overlooked in media reports.

This addition amounts to only $13 billion - less than one percent of their foreign exchange reserves - and boosts their "percent of reserves held as gold" from 0.9 percent to just 1.6 percent. The "rule of thumb" for western central banks is a stockpile of 15 percent, about ten times the new total, and most analysts expect thousands more tonnes to be purchased.

Prices for both gold and silver were buoyed by the news late in the week but, after two months of mostly lower prices, the metals were due for a rebound. For the week, the price of gold rose five percent to end at $913 an ounce and spot silver surged nine percent to close at $12.89 an ounce.

As a result of this move back up above the $880 level, buy indicators for both gold positions in the model portfolio - Gold Bullion and the SPDR Gold Shares ETF (GLD) - have been changed from green back to yellow.

It will be important to keep an eye on the world's most popular gold ETF since, for the first time this year, metal recently exited their vaults as shown to the right. Inventory has declined by 23.2 tonnes since April 16th after an impressive addition of almost 350 tonnes since the first of the year.
Interestingly, mainstream financial media outlets such as Reuters and Bloomberg now routinely report changes in GLD inventory in their gold reports and also compare their stockpile to official country holdings around the world, something that I've been doing for years. In fact, I remember being disappointed early last year about not being mentioned in an article in the Wall Street Journal after a reporter called to follow up on one of my articles about the GLD inventory passing China's official holdings of 600 tonnes.

It's was ironic to see these two items in the news together last week.

Buying in India has supported the gold price in recent days as the world's most price-sensitive buyers have been on strike for most of the year, only appearing when sub-$900 an ounce prices were to be had as Monday's important Akshaya Tritiya festival neared. This is one of the four most important days of the year for Hindus and is considered an auspicious day for buying long-term assets such as gold, a legend stating that any venture begun on Akshaya Tritiya will bring prosperity.

The recent surge in enthusiasm for the gold price, while welcome, should be tempered by the knowledge that, according to GFMS, about 500 tonnes of scrap gold entered the market during the first quarter of 2009. This is the equivalent of an entire year's worth of scrap metal and exceeds the record 469 tonnes added to gold ETFs around the world over the same period. While I'm sure that prices for precious metals will go much higher at some point, making such a move in the near term will be difficult absent another flight to safety, something that is now looking more likely than it did a few weeks ago.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Stress Tests Reveal Three Banks In Need Of Additional Funding

The controversial stress tests commissioned by the government on the 19 largest financial institutions have revealed at least 3 in need of additional funding. These stress tests were meant to ensure that banks have enough capital reserves to last through the recession. For more on this, read the following article from Housing Wire.

At least three of the 19 financial institutions with assets in excess of $100bn may face pressure to build up capital reserves after failing to meet desired operational projections through the government-mandated stress tests, unnamed sources told the Wall Street Journal. The identities of the three firms remained confidential at the time this story went to press, but analysts told the Journal they likely include regional banks with commercial real estate exposure in the Midwest and Southeast.

The stress tests aimed to determine whether major US banks retain enough capital to weather even the more adverse economic projections. Federal officials offered three alternatives to banks that lack sufficient reserves: raise private investor funds, receive additional government aid or convert the government’s existing preferred shares into common shares, effectively placing part of the firm in government ownership.

The Federal Reserve, in reporting stress test methods late Friday, say most banks retain enough capital to weather a longer, more severe recession, although deteriorating economic conditions affect the reserve capital held among some banks.

This article can also be found on housingwire.com.

"Historically Low" Fails To Adequately Describe New Home Sales

New home sales were down again last month, but people are under appreciating just how bad these numbers are. Once you factor in population growth into the mix — new home sales have fallen off a cliff compared to past economic downturns. Tim Iacono looks closer at this latest report, and offers some insight, in his blog post below.

The Census Bureau reported that new home sales fell 0.6 percent last month, from a seasonally adjusted annual rate of 358,000 in February to 356,000 in March, still at a level that the phrase "historically low" fails to adequately describe.
Though the current sales level is up from the January low of 331,000, to put the March sales rate in its proper historical context, consider that the pre-2009 all-time low of 338,000 in September of 1981 works out to a population-adjusted rate of about 460,000.

The March total is still a full 23 percent below this pace!

While a bottom may indeed be forming after the relative stability of the last four months, these are the lowest levels of sales in the 46 years since this data series began and an improvement of some 29 percent from the current level is required just to equal the worst reading since JFK was sitting in the White House.

You can almost see the headlines later this year - New home sales surge 20 percent.

What will most likely be omitted from the story is that sales will have to increase by almost another ten percent just to better the level seen at the depths of the economic downturn in Ronal Reagan's first term.

Lower mortgage rates and tax credits for first time home buyers spurred sales in March helping to reduce builder inventory as the months of supply metric fell from 11.2 months to 10.7 months. This is down from a high of 12.5 months in January but still almost triple what would be considered normal.

Still highly distorted by sales incentives and other give-aways by increasingly desperate homebuilders, the median price fell from $208,700 in February to $201,400 in March, down 12.2 percent on a year-over-year basis, and is now at its lowest level since late-2003.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

How Long Will The Recession Last?

Answering that question is nearly impossible — especially given our current precarious economic situation. While no one is going to know for sure when this recession will end, we can look at the data we are provided with and make educated guesses as to when the end may be nearing. James Picerno analyzes the recent initial jobless claims report, and explains how the report has typically related to recession timing in the past, in his blog post below.

It's too soon to declare that the worst of the recession has passed, but it's also premature to dismiss the idea. We are, in short, in a never-never land of waiting and watching, and this game may roll on for many a moon.

To help pass the time, we're watching the data as it comes in, including initial jobless claims. As we've written, this is one of several metrics that may offer clues about when the business cycle reaches a trough. Like any one statistic, it can't be fully trusted, and so we must look to a range of data points. But history suggests that as single measures of broad economic trends go, this one's unusually useful in trying to peer into the future, or so it's been in the past.

With that in mind, we turn to yesterday's update on new filings for jobless benefits. As the chart below shows, the encouraging drop through the week of April 11 has since given way again to the forces of darkness via last week's seasonally adjusted rise of 27,000 new filings. But the hope that we've seen a top isn't lost yet.

History suggests that initial claims will top out concurrently or perhaps even slightly ahead of the recession's formal bottoming. Yes, we must look to other signals for context before we make any definitive conclusions. For the moment, the jury's still out, but the good news is that it's not yet clear that the recession's getting worse, or so the trend in initial jobless claims suggests.

The question is whether we're due for another surge in bad news for the labor market? The economy is still too precarious to rule out the possibility. On the positive side, despite the robust rise in claims last week, the trend in the chart above still doesn't preclude the possibility that we've seen a peak. Deciding if in fact that's true will take another month or two of data. Meanwhile, evidence that we're not peaking requires only one weekly surge skyward.

This post can also be viewed on capitalspectator.com.

Don't Fall For Housing Recovery Talk, More Pain Is On The Way

More and more people are jumping on the housing recovery bandwagon, but the excitement is a little premature. There are many signs pointing to the fact that the bottom is still far off in the distance. For more on this, read the following blog post from Tim Iacono.

This report by Ben Rooney at CNN/Money takes a few rather ambivalent comments by impartial analysts and combines them with more drivel from a National Association of Realtors shill, interpreting it all as a hopeful sign for the housing market.

Despite last month's decline, existing home sales appear to be stabilizing, according to Ian Shepherdson, economist at High Frequency Economics.

"Sales are volatile month-to-month, but the trend appears to be flattening off," Shepherdson said in a research note.

Yes, and they flattened out last year too before falling off a cliff (see chart from previous post), back when distressed sales accounted for a much smaller portion of overall sales.

By the way, what's with the characterization of distressed sales accounting for "just over half of all transactions in March" in the latest report? In the past, the NAR has cited percentages or a range of percentages, last month putting that figure at between 40 and 45 percent.

The phrase "just over half" could be anywhere between 51 and 60 percent, perhaps higher....

Here's the comment from the realtors' trade group:

First-time buyers made up 53% of existing home sales in March. Charles McMillan, NAR's president, said first-time buyers are "crucial" to a recovery in the overall housing market.

"The housing market always heals from the bottom up, and with large numbers of first-time buyers entering the market it will become a little easier for sellers to trade up or down," McMillan said in a statement.

Between this sort of optimism and word of bidding wars on foreclosed properties (discussed here yesterday and reported again in the Wall Street Journal today), this is probably a very good indication that there is much more pain to come in the housing market.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Geithner's New PPIP Plan Looks Too Much Like Failed TALF Program

Hopefully Geithners new PPIP plan that was created to deal with toxic assets works out better than the TALF failure, but unfortunately it looks eerily familiar. For more on this, read the following blog post from Mark Thoma.

The TALF program intended to increase auto loans, student loans, and credit card lending has a lot in common with the Geithner public private investment plan to remove toxic assets from bank balance sheets, including the valuable non-recourse loan feature. The fact that the TALF program is not living up to expectations - not even close - leads to questions about whether the Geithner plan will encounter similar problems:

Federal Program to Boost Private Lending Struggles to Get Money to Consumers, by Neil Irwin, Washington Post: In its first two months, the government's signature initiative to support consumer lending has fallen well short of expectations, deploying only a fraction of the amount officials had hoped to extend to stimulate auto loans, student loans and credit card lending. ...

Under [the Term Asset-Backed Securities Loan Facility, or] TALF, private investors ... put up a relatively small amount of money to be matched with a larger loan from the Federal Reserve. The combined funds are then used to purchase newly created, highly rated securities, which in turn fund a wide range of consumer and business lending.

If the securities become more valuable, the private investors stand to repay their government loans and make a healthy profit; if the securities plummet in value, the investors can lose only what they put up originally...

Officials envisioned TALF supporting tens of billions of dollars a month in new lending, saying it could eventually total $1 trillion. But in March, when it was launched, it backed only $4.7 billion in auto loans and credit cards. For April, it logged only $1.7 billion.

Sources involved in the program said private investors have been reluctant to work with the government, which they view as an unreliable business partner. ... There are restrictions on the business activities of participants in the program. ... But perhaps more significant ... is a fear that the government could retroactively change the terms, exacting new limits on what investors can pay their executives, for example, or trying to claw back profits that firms make in the program. ...

Federal Reserve officials have privately urged President Obama and congressional leaders to publicly state that the government views investors in voluntary programs such as TALF differently than it does companies that need a federal bailout.

Investors are not the only ones who need comforting, though. The Fed relies on primary dealers, or brokerage houses, to play a key role as intermediaries in TALF...

But the primary dealers have been extremely cautious..., hobbling the program's progress... Lawyers at the New York Fed ... have been working to help the brokers and investors work through the issues, and government officials are hopeful about the program's future. ...

The Public-Private Investment Program, designed to buy loans and securities from banks, is structured similarly to TALF. ...

And the differences between the PPIP and TALF programs that I can think of, e.g. that the PPIP has toxic assets as part of the bargain, and some of the banks will need a bailout so the reassurances about executive pay, etc. can't be made in these cases, are additional factors working against the PPIP's success.

This post can also be viewed on economistsview.typepad.com.

U.K. Budget Met With Fierce Opposition

If we thought things were bad over here in the U.S., at least we might be able to take some comfort in the fact it is looking as bad or worse in the U.K. Alistair Darlings just released the 2009 budget for the U.K., and while it does not look pretty, the IMF thinks he is being way too optimistic in his projects. From the looks of things the U.K. is going to be adding an incredible amount of debt to their already enormous deficit, and growth is unlikely to come for a few more years. For more on this, read the following blog post from Tim Iacono.

The new U.K. budget announced a short time ago is being greeted with boos and catcalls as taxes are being raised and debts continue to mount - they sound a bit like the state of California with the important distinction that the Golden State doesn't own a printing press.

This report in the Telegraph provides the details:

Alistair Darling has pledged to hit Britain’s richest workers and savers with a smattering of new taxes to help support the UK through its worst recession since the 1930s.

In what is likely to go down in history as the most downbeat and depressed Budget in peacetime history, the Chancellor pledged to raise the income tax rate for those earning over £150,000 to 50pc, hearkening back to the high tax rates imposed by Governments in the 1960s and 1970s.

He also confirmed that the Government will be forced to borrow £175bn this year and £173bn the next, and would have to increase the size of the national debt from recent levels of below 40pc to almost 80pc within the next five years.

It seems that almost every developed nation in the world is now in the process of turning Japanese in that national debt relative to GDP is rapidly approaching parity. In the U.S., we'll reach that point before you know it.

There's a complete summary of the new U.K. budget here.

If this video clip is any indication, it's getting a bit testy across the pond.

Darling has already downgraded his economic forecasts from just a few months ago which, as is the case for nearly all government projections, were overly optimistic for 2009. He now pegs economic growth at minus 3.5 percent this year with a rosier outlook for 2010.

In something of an embarrassment for U.K. government economists, the IMF cast a bit of cold water on their updated forecast for next year, predicting another period of contraction according to this report in the Guardian.

Britain will be stuck in recession for another year as consumers reeling from the housing crash cut back their spending, the International Monetary Fund warns today – undermining Alistair Darling's budget claim that growth will resume at the end of the year.

In its twice-yearly World Economic Outlook, the IMF predicts that recession in the UK will be "quite severe", with the economy shrinking by 4.1% this year, and continuing to contract, by 0.4%, in 2010. In the budget, Darling forecast 1.25% growth in 2010.

Somehow, given the way things have deteriorated over the last six months, it wouldn't be surprising to see even the IMF forecast prove to be too optimistic.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Deflation Taking Hold In Europe

We have been hearing a lot about deflation here in the U.S., but so far we have been able to hold it off for the most part. It appears that Europe is not having as much luck though. Deflation can be an economic killer as we saw during the Great Depression and more recently with Japan's Lost Decade. For more on this, read the following blog post from Tim Iacono.

Spain, the U.K., Luxembourg, Portugal, Ireland - who's next to succumb to the scourge of deflation? Yesterday, the New York Times reported that Spanish merchants have been slashing prices with abandon, auguring in the possibility of a dreaded "deflation death spiral".

Prices dipped everywhere, from restaurants and fashion retailers to pharmacies and supermarkets in March.
...
With the combination of rising unemployment and falling prices, economists fear Spain may be in the early grip of deflation, a hallmark of both the Great Depression and Japan’s lost decade of the 1990s, and a major concern since the financial crisis went global last year.

Deflation can result in a downward spiral that can be difficult to reverse. As unemployment rises sharply and consumers cut spending, companies cut prices. But if sales do not pick up, then revenue can decline further, forcing more cuts in workers or wages.

Once again, falling prices are characterized as the potential source of much bigger problems ahead, as if the world had something even remotely close to "sound money" where currency maintained its value over long periods of time as it did in the U.S. prior to the creation of the Federal Reserve in 1913.

To review -- in the hundred years prior to the Fed, inflation rounded to zero, whereas, in the nearly hundred years since 1913, the U.S. dollar has lost 96 percent of its value.

Policies that have resulted in this loss of value, now accepted as conventional wisdom by central bankers around the world, make real deflation (the minus 10 to 15 percent per year variety, not the -0.1 percent Spanish version) a near impossibility today.

But, that doesn't stop dimwitted dismal scientists from looking there instead of at the bursting of the biggest asset bubble in the history of Mankind when identifying villains in the current economic and financial market maelstrom.

“It doesn’t mean it will spread here to the U.S., but we need to look closely at Spain and other places to understand the dynamic,” says Simon Johnson, a professor at the Sloan School of Management at the Massachusetts Institute of Technology and a former chief economist for the International Monetary Fund. “It’s like the front line of a new virus outbreak.”

If only economists would spend more time examining how they failed the world so miserably over the last few years instead of at a 19th century phenomenon, we'd all be better off.

In the U.K. too there is much gnashing of teeth where annual deflation is running at a whopping four times the rate now experienced to the south - minus 0.4 percent.

The funniest thing about English deflation is that it is, in large part, directly caused by central bank actions. The broadest measure of consumer prices includes mortgage costs, the vast majority of which are variable rate loans, and, as short-term rates have been slashed, these consumer costs have tumbled as detailed in this report in the Telegraph.

The Retail Prices Index (RPI) measure of inflation fell to -0.4pc in March, indicating that prices paid by consumers last month were lower than a year ago - a trend not seen since March 1960.

RPI inflation, which includes housing and mortgage costs, has been driven down by the the series of aggressive interest rate cuts from the Bank of England which have triggered lower variable rate mortgage repayments .
...
The economy is expected to remain in deflationary territory for many months, which will mean pensioners will receive the lowest possible increase of 2.5pc next year, adding just £2.40 to the full weekly pension, an amount criticized as "derisory and pathetic" by campaigners.

If health care costs in the U.K. are anything like those in the U.S., there are probably a lot of irate senior citizens.

A related story explains why we should all be fearful about deflation beginning with the moronic example of how, after television prices have been falling for the last 20 years, additional price declines will cause consumers to think twice. Really!?

1. It causes consumers and businesses to feel concerned about spending. Why buy that £400 television this week when you are confident it will be cut in price to £350 next month? The same applies to businesses – why invest in new machinery, or software when you think it will fall in price? Deflation can, if it becomes entrenched, cause the whole economy to grind to a halt.

2. Deflation causes wage cuts. Employers can argue that they do not need to give their staff a pay rise, because their staff can buy more goods with the same salary. Many companies are freezing pay and started cutting wages in some cases.

3. In theory, falling wages should not matter if the price of goods and services fall as well. But in practice it is very damaging psychologically. People paid £30,000 one year do not like being paid £29,000 the following year even if they can buy the same amount of goods. Everyone feels less wealthy, especially home owners whose main asset is falling in price. And when they feel less wealthy, they spend less, causing a vicious downward spiral in the economy.

4. Deflation causes the value of people's debts to mount. A £100,000 mortgage might cost £4,000 to service each year, but the value of the house could fall by £4,000 or more – a dispiriting experience, but you will still need to keep on servicing the debt.

Wage cuts, tumbling asset prices, and making debt service more expensive are all legitimate arguments but falling consumer prices really don't belong in this discussion unless it's something more than volatile energy prices and, in the case of the U.K.-style deflation, lower interest rates caused by the central banks that, ironically, are desperately trying to avoid seeing consumer prices move lower.

For a more complete discussion on this subject, see Seven key points on deflation or the many other items categorized under "deflation" at this blog.

This post can also be viewed in themessthatgreenspanmade.blogspot.com.

Roubini Says Financial Gloom Not Going Anywhere

There has been a lot of positive momentum lately in the markets, and people are starting to think that the end is near for the financial crisis. However, Nouriel Roubini warns that this optimism is not based on facts. The facts say that we still have much longer to go with this recession, and getting one's hopes up that the end has arrived will just lead to disappointment, and likely a loss of capital. For more on this, read the following blog post from Mark Thoma that looks at Roubini's latest article.

Nouriel Roubini cautions not to get your hopes up too high:

End of economic gloom?, by Nouriel Roubini, Project Syndicate: Mild signs that the rate of economic contraction is slowing in the United States, China and other parts of the world have led many economists to forecast that positive growth will return to the US in the second half of the year, and that a similar recovery will occur in other advanced economies. ...

Investors are talking of 'green shoots' of recovery... As a result, stock markets have started to rally... This consensus optimism is, I believe, not supported by the facts. Indeed, I expect that while the rate of US contraction will slow ... in the last two quarters, US growth will still be negative .... in the second half of the year... Moreover, growth next year will be so weak ... and unemployment so high ... that it will still feel like a recession.

In the euro zone and Japan, the outlook for 2009 and 2010 is even worse... Given this weak outlook for the major economies, losses by banks and other financial institutions will continue to grow. My latest estimates are $3.6 trillion in losses for loans and securities issued by US institutions, and $1 trillion for the rest of the world. ...

By this standard, many US and foreign banks are effectively insolvent and will have to be taken over by governments. The credit crunch will last much longer if we keep zombie banks alive despite their massive and continuing losses. ... So, while this latest bear-market rally may continue for a bit longer, renewed downward pressure on stocks and other risky assets is inevitable.

To be sure, much more aggressive policy action (massive and unconventional monetary easing, larger fiscal-stimulus packages, bailouts of financial firms, individual mortgage-debt relief, and increased financial support for troubled emerging markets) in many countries in the last few months has reduced the risk of a near depression. That outcome seemed highly likely six months ago, when global financial markets nearly collapsed.

Still, this global recession will continue for a longer period than the consensus suggests. There may be light at the end of the tunnel -- no depression and financial meltdown. But economic recovery everywhere will be weaker and will take longer than expected. ...

Let's hope the end is near, but if you are a monetary or fiscal policymaker, it's far to soon to let down your guard and declare victory. You have to assume it won't be over for some time yet, and plan accordingly. If things turn out better than expected the plans can stay on the self, and existing programs can be scaled back accordingly, but that can't happen until we are certain that recovery is around the corner and we are nowhere near that point yet.

[Also see the commentary surrounding the IMF's World Economic Outlook from Yves Smith, Dani Rodrik, and Real time Economics.]

This post can also be viewed on economistsview.typepad.com.

Initial Jobless Claims Down: Is The End In Sight?

The big news this morning was that initial jobless claims fell. While this is great news, the bigger question we are all hoping to have answered is whether or not this signifies that the end to the recession is near. Along with the initial claims report, James Picerno looks at some other data, and tries to address the big question in his blog post below.

This morning's news that new claims for jobless benefits fell last week is the best news yet for thinking that the recession has peaked. It's still too soon to break out the champagne, as we'll explain. But for the moment, a collective sigh of relief is in order. Maybe.

As the chart below shows, new filings for jobless benefits tumbled by 53,000—the biggest weekly drop since December. More important is the trend. Since reaching a seasonally adjusted high for this cycle of 674,000 for the week through March 28, new jobless claims have fallen in each of the subsequent two weeks, lowering the total to 610,000 last week. That's still an unmitigated sign of recession, but the recent fall also begs the question: Does the downshift have legs?

This is a critical question because, as we've written, initial jobless claims are a valuable forward-looking indicator for estimating when recessions bottom out. In our March 6 piece, we looked at the historical record and found that initial jobless claims peaked concurrently with, or sometimes ahead of the formal end of recessions since the late-1960s. That's valuable information since identifying the end of the business cycle downturn is much easier after it's obvious to the crowd. The National Bureau of Economic Research, which officially dates the start and end dates of recessions, makes its proclamations long after the fact. Meanwhile, most of the popular metrics for gauging the state of the economic cycle, such as the unemployment rate, are lagging indicators and so they're among the last to reveal when the recession has turned, much less ended.

Initial jobless claims, then, are a better albeit less-than-perfect metric to watch for gauging when the cycle may turn. There are other leading measures to watch as well. Indeed, the stock market's upturn of late has arguably been signaling that the worst of the recession has passed.

But while it's tempting to pronounce the cycle has turned, such thinking is still premature for a number of reasons. That includes the view of some economists that last week's numbers should be ignored because it came during a holiday week following Easter. Meanwhile, the war on deflationary pressures is still raging and key sectors of the economy are still bleeding quite heavily. The latest clues include yesterday's news that consumer prices posted a modest decline in March. Meanwhile, the government advises today that housing starts continue to sink (falling nearly 11% last month vs. February), as did new building permits (down 9% last month), a signal that the outlook for a rebound in construction remains dim.

Let's also recognize that even if the recession has bottomed out, that's a long way from saying that a return to growth is imminent. It's likely that the economy will tread water for several quarters at the least once the economy stops contracting. And while the stock market appears inexpensive, or at least fairly priced, it's still too early to expect that profits are set to rebound any time soon—for reasons we'll be discussing in more detail in the next issue of The Beta Investment Report.

Still, it's not too early to begin elevating risk exposures in those asset classes and their subcategories that are most attractively priced. If we were supremely confident what was coming, we'd be more aggressive in our adjustments to asset allocation. Alas, we're only mortal, and so we continue to act accordingly.

Meantime, we're watching the leading indicators and trying to figure out if the apparent dawn is real or false. Coming to something more than a guess will take a few more weeks, perhaps a few more months. Let's hope it doesn't require several more quarters.

This post can also be viewed on capitalspectator.com.

What Will The Government Do With Goldman Sachs?

Storied investment banking firm, Goldman Sachs, is preparing to pay the government back around $5 billion in borrowed TARP funds, but whether or not the government will allow it to happen is the real story. Goldman no longer wants to be burdened with the rules and regulations being imposed on them by the government, and thanks to a $12 billion windfall from the AIG bailout the firm is in a position to return the funds. If they are allowed to return the funds, though, there is worry that it will put the other bailed out banks in a precarious position. For more on this, read the following article from Money Morning's Shah Gilani.

Not a fan of socialism? Me either. But, if the federal government has to backstop free market excesses with taxpayer dollars, how will it eventually unravel the veil, or tarp of intervention? Or should it? The answers are about to unfold before our eyes.

In the case of the government and Goldman Sachs Group Inc. (GS), a decision on whether Goldman can repay government bailout money and be freed to pay its employees whatever it wants, may determine the winners and losers coming out of this financial collapse, and what kind of government Americans will end up with.

In her extraordinary 1999 book, “Goldman Sachs the Culture of Success,” Lisa Endlich vividly chronicles the “history, mystique and remarkable success of the world’s premier investment bank.” That same year, the storied partnership structure of Goldman was junked in a wildly successful initial public offering (IPO).

I still keep three pages of notes distilled from Endlich’s book on how to create and foster a culture of success, a la the Goldman model. They now seem quaint in light of the winner-take-all at the expense of the shareholders mentality that eviscerated the old-school standards.

That’s not to say that Goldman isn’t still wildly successful. On Monday, Goldman pre-announced first quarter net income of $1.81 billion. Record net revenue of $6.56 billion from trading fixed income, currencies and commodities was offset by losses in stock trading, real estate, investment banking and money management. Nonetheless, earnings were almost twice analysts’ expectations.

Yesterday (Tuesday), on the heels of its good performance, Goldman announced that it had priced a public offering of 40,650,407 shares of common stock at $123 per share. Goldman will be its own sole underwriter and total gross proceeds are expected to yield approximately $5 billion.

Ironically, $5 billion is what Goldman needs to pay back the U.S. government in order to escape the salary and bonus caps imposed on bailout recipients.

A brief history.

On the remarkable day of September 15, 2008 Lehman Brothers Holding Inc. announced its intention to file a Chapter 11 bankruptcy petition. On the same day, venerable investment bank Merrill Lynch disappeared into the waiting arms of Bank of America Corp. (BAC). Six short days later, on a Sunday afternoon, the U.S. Federal Reserve announced approval of expedited applications by Goldman Sachs and Morgan Stanley (MS) to change their status from investment banks to bank holding companies. The rapid approval of their applications would, the Fed said, “provide increased funding support” allowing both banks to borrow directly and permanently from the Fed’s Discount Window and its other capital liquidity enhancing facilities.

But that wouldn’t be enough. As the crisis mounted, on Sept. 23, Goldman raised $5 billion from billionaire investor Warren Buffet’s Berkshire Hathaway Inc. (BRK.A, BRK.B). And with the storied investor now onboard, Goldman rushed to raise another $5.75 billion in a common stock offering.

On Oct. 14, with the mushrooming cloud of the crisis enveloping seemingly every major bank in the country, then-Treasury Secretary Henry M Paulson (formerly Goldman Sachs’ Chairman and CEO) and Federal Reserve Chairman Ben S. Bernanke summoned the nine largest bank chief executives to Washington where they were told that they would each take a piece of government capital. Only Wells Fargo & Co. (WFC) is on record as saying it didn’t need the money, but the handout was forced on it too. Goldman itself took $10 billion.

On Wall Street, and nowhere more so than at Goldman, it’s about compensation. But recipients of bailout money are now facing the full disclosure of their executive compensation deals, as well as having to obtain nonbinding shareholder voting on compensation issues.

The Treasury is advocating a salary ceiling for recipient senior executives of $500,000 and any additional compensation to be paid in restricted stock that vests only when government funds have been entirely repaid. And there are restrictions on golden parachutes and threats that Congress will impose a 90% bonus tax.

It’s enough to make Wall Street quake in its canyon.

With the public backlash against the taxpayer-funded bonuses paid to executives and traders at crippled firms, banks are desperate to return government bailout money so they can be freed from government salary and bonus oversight.

But unfortunately for many of these banks, oversight is mandated for any recipient of “exceptional assistance,” which is defined as assistance of more than $5 billion.

No wonder Goldman wants to pay back $5 billion of the $10 billion it got.

I have nothing against the free market setting compensation benchmarks, or private companies paying successful executives whatever their shareholders vote to be acceptable. And I’m not singling out Goldman Sachs. But, nowhere else in the U.S. economy - or at the highest levels of government - is there anything like Goldman’s visible and invisible hands at work. And they’re working in the open and more insidiously, behind the scenes and through lobbyists, to make themselves a lot of money.

There is simply not enough space in any book, let alone any article, to list the power, placement and influence of current and former Goldman Sachs alumni pulling the levers of hedge funds, corporations, politicians and governments. If you want to enlighten yourself about what you don’t know about these players, simply Google: “List Goldman Sachs alumni.”

Goldman, as much as any investment bank, got its hands dirty in the subprime securities business and the credit default swap business. As to its influence and its claim to premier bank status, the first question that comes to my mind is: Would Goldman even exist today if Hank Paulson hadn’t had Goldman’s current CEO Lloyd Blankenfein in on meetings about saving American International Group Inc. (AIG)?

Out of the $185 billion that AIG received from taxpayers, Goldman got $12.5 billion for exposure it had to credit default swaps written by AIG. I’ve been told by some of my hedge fund and investment banking friends that Goldman deserved that money and that the entire counterparty structure related to almost every credit default swap was a risk.

But I like to point out that Goldman is only smarter than its peers because its trading desks are lighter on their feet. I remind them that Goldman stuffed the pipelines with toxic structured collateralized debt obligations (CDOs), and then was nimble enough to cover themselves better by buying credit default swaps to hedge their exposure to their own toxic slime and institutions that are too-big-to-fail, exactly like AIG.

What happens now with Goldman Sachs will set the precedent for everything else that the government will do or allow in the future with bailout recipients and industries. Will Goldman be freed up to overpay its risk takers and to make greater wagers as it also seeks to become too-big-to-fail? Will impositions be made on the corporate level, industry level, systemic level? Will free markets be free to leverage taxpayers indefinitely?

The argument, most recently made in yesterday’s Wall Street Journal op-ed page by Jonathan Macey, a law professor at Yale, that “demonetizing executive pay will also drive the best managers out of private companies and into hedge funds and other boutique investment firms” implies that there is a limited amount of talent available in America, which is a supposition that I find myopic, at best.

Besides, aren’t these the same people that got us into this mess?

And while letting public companies be run by shareholders - as Macey suggests - is supposed to work in principle, shareholders have been marginalized by the same Wall Street system that protects the institutions whose stocks and bonds they sell, trade and profit from.

All eyes should be on the curious relationship between government and Goldman for clues as to what shape the landscape will take when we eventually exit this calamity.

I don’t want our companies, our institutions or our economy socialized any more than Adam Smith would. But I do want to see the public tail wagging the dogs of Wall Street and government.

This post can also be viewed on moneymorning.com.

From Money Morning:

"I'd rather have this than gold." That's what one well-known fund manager recently told Barrons. Why? This special group of investments is set to pay out $4,201 guaranteed cash next month. And they pay out juicy cash sums all year long. But they're not income trusts, corporate bonds, or foreign bonds. In fact, only Martin Hutchinson is talking about them. Read his full report here...

Depression Looms Without More Stimulus

Do we really need more economic stimulus? We have already spent trillions of dollars attacking this financial crisis, and unfortunately we also have seen billions apparently wasted by poor policy decisions and implementation. All that aside, according to famed economist Robert Shiller, we need more economic stimulus or else we are likely facing another depression. For more on this, read the following blog post from Mark Thoma.

Robert Shiller says we need to continue with the monetary and fiscal policies we are pursuing, but both efforts need to be larger:

Depression Lurks Unless There’s More Stimulus, by Robert Shiller, Commentary, Bloomberg: In the Great Depression ... the U.S. government had a great deal of trouble maintaining its commitment to economic stimulus. “Pump- priming” was talked about and tried, but not consistently. The Depression could have been mostly prevented, but wasn’t. ...

In the face of a similar Depression-era psychology today, we are in need of massive pump-priming again. We appear to be in a much better situation due to the stronger efforts to date. Still, there is a danger that, because of a combination of faulty economic theory and inadequate appreciation of human psychology, as well as deep public anger, we will not continue with such stimulus on a high enough level. ...

In our analysis of the current economic crisis, we conclude that the government should have two targets. One would be a joint fiscal-monetary policy target. The same kind of expansionary policies embodied in the government expenditure stimulus and tax cuts that are already being tried have to be done on a big enough scale and for a long enough time in the future. ...

The government should also have a credit target. Once again, we are calling for more of the same kinds of existing policies... Achieving this requires new approaches, like those announced by the Bernanke Fed and the Obama administration, but on a continuing and even larger scale. ...

In this crisis, acceptance of these measures is being replaced with outrage. It is increasing the blood pressure of the public, and that can’t continue without damage to our system. ... It is time to face up to what needs to be done. The sticker shock involved will be large, but the costs in terms of lost output of not meeting either the credit target or the aggregate demand target will be yet larger.

It would be a shame if we are so overwhelmed by anger at the unfairness of it all that we do not take the positive measures needed to restore us to full employment. That would not just be unfair to the U.S. taxpayer. That would be unfair to those who are living in Hoovervilles...; it would be unfair to those who are being evicted from their homes, and can’t find new ones because they can’t find jobs. That would be unfair to those who have to drop out of school because they, or their parents, can’t find jobs.

It is now time to keep our eye on the ball and set clear targets to fix a system that broke when our animal spirits got out of bounds.

This post can also be viewed on economistsview.typepad.com.

Treasury Yield: What Does The Future Have In Store?

A lot of people have been turning to Treasuries as the investment of choice in these unpredictable and rough economic times, but will it ultimately prove to be a good move? While widely considered "risk free" investments, that is far from the truth. There are many things that perspective Treasury investors need to keep in mind when weighing their investment options. The following blog post from James Picerno offers some insight into what is going on right now in the Treasury market, and hopefully will help investors make an a better informed decision.

It's hard to dismiss the ongoing news about China's anxiety over its massive holdings of American debt. What's worrisome for China is ultimately a concern for the U.S., with fallout that may come sooner than we think.

“We have lent a huge amount of money to the U.S. Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried," Chinese prime minister, Wen Jiabao, said last month. It was a rare public admission of apprehension by a high-ranking Chinese official on the delicate and increasingly precarious lender-borrower relationship that describes the U.S. and China.

Yesterday came word that China's purchases of U.S. bonds slowed in the first two months of this year, according to new data from China's central bank, The New York Times reports. "Chinese reserves fell a record $32.6 billion in January and $1.4 billion more in February before rising $41.7 billion in March, according to figures released by the People’s Bank over the weekend," the Times notes. The trend may now be reversing, although the notion that a pivotal point in the U.S.-China financial relationship may be near remains intact.

The fear is that China will slow (cease?) buying new Treasuries, a decision that's likely to force up interest rates in the U.S. For the moment, there's no reason to dismiss that scenario, at least when it comes to the recent trend in the yield on the benchmark 10-year Treasury Note. As the chart below shows, the march upward to the 3% mark is alive and well.

What makes the rising yield in the 10-year so striking is that it comes in the wake of the Federal Reserve's announcement last month that it would directly target lowering rates on long Treasuries. The market's initial reaction was to buy Treasuries, which resulted in one of the biggest one-day drops in interest rates on record. For a time it looked like Bernanke and company had struck gold. But confidence that the central bank has complete control over the long end of the curve has been evaporating in recent weeks.

As the above chart shows, the 10-year yield collapsed by around 50 basis points on March 18, down to around 2.5%. As of April 9, the 10-year's yield had climbed by to roughly 2.9%, just under the level where when the Fed made its bombshell announcement last month.

High interest rates in the U.S. necessarily make the dollar more attractive, at least for a time. No wonder, then, that the buck's value is rising in forex markets in recent weeks, in sympathy with higher interest rates on the 10-year. The U.S. Dollar Index is just about at the highest level since the Fed's March 18 disclosure, a news event that had initially sent the buck tumbling. Meanwhile, commodity prices generally have been inching higher as well, as per the CRB Index. Commodities are generally priced in dollars, so it's no surprise that a strong dollar equates with higher commodity prices.

Higher interest rates are almost surely the path of least resistance in the years ahead, in part because the U.S. deficits are sure to be large in the wake of all the monetary and fiscal stimulus of late. The problem is that the arrival higher interest rates now, this week, next month, next quarter come at an especially inopportune time: before the economy has sufficiently recovered. The Fed surely seeks to keep long rates below 3% for the rest of the year, or so one might speculate. But it's not clear that the markets are willing to go along for the ride.

In the old days, the Fed's powers were such that it had more control over keeping interest rates low and thereby providing the economy with ample monetary stimulus until the forces of growth rose anew. Engineering that scenario this time may be tougher, much tougher. One reason is that much of the control over future rates has been transferred to foreigners, courtesy of holding large quantities of U.S. debt. That may not be fate that rates will rise. Indeed, China surely wants to keep U.S. rates low in order to boost growth here, which will promote imports of Chinese goods. But no one really knows how these forces will play out.

Perhaps the cycle will be salvaged if the economy rebounds quicker than the crowd expects. Alternatively, the Chinese and other foreigners decide to buy large quantities of Treasuries in the months and quarters ahead. There are solutions to the current dilemma, but no one should expect that they're a forgone conclusion.

This post can also be viewed on capitalspectator.com.

Retail Sales Down More Than Expected

Amidst all the increasingly positive reports, it appears that we might have become a little too optimistic. The latest retail sales report came in significantly worse than analysts had anticipated. For more on this, read the following blog post from Tim Iacono.

To the surprise of most analysts, the Commerce Department reported retail sales fell 1.1 percent in March following an upwardly revised gain of 0.3 percent in February, the most recent decline paced by tumbling sales of electronics, appliances, and automobiles.
On a year-over-year basis, retail sales were down 9.4 percent, an improvement from the December low of minus 10.5 percent, but worse than February's 7.9 percent annual decline.

Excluding automobiles, retail sales fell 0.9 percent in March after a gain of 1.0 percent in February and, from year ago levels, retail sales ex-autos are now down 6.0 percent.

The higher jobless rate was blamed for the most recent downturn, lower prices and other incentives at clothing stores and auto dealers failing to spur buying interest from the public, however, a relatively late Easter holiday may have also had an impact.

Sales at electronics and appliance stores tumbled 5.9 percent, automobile dealers saw a 2.5 percent reduction in overall sales, and spending at clothing stores fell 1.8 percent.

With the exception of modest increases at food and beverage stores and for health and personal care items, receipts for every other retail category declined. The 1.4 percent drop in spending at food services and drinking places was the sharpest decline in three years.

The effect of the long, slow decline in housing continues to be felt in the home furnishings industry as sales fell 1.7 percent in March and are now 13.1 percent lower than a year ago.
The year-over-year decline in furniture sales is exceeded only by the 34 percent decline in gasoline station sales (mostly due to lower prices) and the 26 percent decline in automobile sales (mostly due to fewer sales).

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Protectionism And The Global Economy

Coordinating a global response to the financial crisis is proving increasingly difficult, and the growth of protectionism is not helping. The global economy is set to shrink for the first time since 1945, and shockingly enough 200 million additional people could be facing poverty. It is clear something needs to be done, but with so many voices, and so many agendas, what hope do we have? For more on this, read the following post from Mark Thoma.

Lots of worry about the global economy, the lack of an internationally coordinated policy response to the downturn, and about the imposition of protectionist measures. First, Joseph Stiglitz:

A globally coordinated stimulus package needed, by Joseph E Stiglitz, Project Syndicate: This year is likely to be the worst for the global economy since World War II... Unless something is done, the crisis will throw as many as 200mn additional people into poverty.

This global crisis requires a ... globally coordinated stimulus package... [W]hile it is recognized that almost all countries need to undertake stimulus measures (we’re all Keynesians now), many developing countries do not have the resources to do so. Nor do existing international lending institutions.

But if we are to avoid winding up in another debt crisis, some, perhaps much, of the money will have to be given in grants. And, in the past, assistance has been accompanied by extensive “conditions,” some of which enforced contractionary monetary and fiscal policies – just the opposite of what is needed now – and imposed financial deregulation, which was among the root causes of the crisis.

In many parts of the world, there is a strong stigma associated with going to the International Monetary Fund, for obvious reasons. ... It is thus imperative that assistance be provided through a variety of channels, in addition to, or instead of, the IMF...

At their November 2008 summit the G-20 leaders strongly condemned protectionism... Unfortunately,... 17 of the 20 countries have actually undertaken new protectionist measures, most notably the US with the “buy American” provision included in its stimulus package.

But it has long been recognised that subsidies can be just as destructive as tariffs – and even less fair, since rich countries can better afford them. If there was ever a level playing field in the global economy, it no longer exists: the massive subsidies and bailouts provided by the US have changed everything, perhaps irreversibly.

Indeed, even firms in advanced industrial countries that have not received a subsidy are at an unfair advantage. They can undertake risks that others cannot, knowing that if they fail, they may be bailed out. While one can understand the domestic political imperatives that have led to subsidies and guarantees, developed countries need to recognize the global consequences, and provide compensatory assistance to developing countries. ...

And the US dollar reserve-currency system – the backbone of the current global financial system – is fraying. China has expressed concerns, and the head of its central bank has joined the UN Commission in calling for a new global reserve system. ...

Such reforms will not occur overnight. But they will not occur ever unless work on them is begun now.

Next, Charles Wyplosz argues that, in general, quantitative easing is a "beggar-thy-neighbor" policy:

One fiscal initiative not worth emulating, by Charles Wyplosz, Project Syndicate: When the Swiss National Bank (SNB) recently brought its interest rate down to 0.25 percent, it announced that it would engage in “quantitative easing,”... More surprising was the simultaneous announcement that it was intervening on the foreign-exchange market with the aim of reversing the appreciation of the franc. Will this be the first salvo in a war of competitive devaluations? ...

Like most other central banks confronted with the recession, the SNB has reduced its policy interest rate all the way to the zero lower-bound. Once there, traditional monetary policy is impotent...

This is why central banks are now searching for new instruments. Quantitative easing represents one such attempt. ... However, an important issue is rarely mentioned: In small, open economies — a description that applies to almost every country except the US — the main channel of monetary policy is the exchange rate.

This channel is ignored for one good reason: Exchange-rate policies are fundamentally of the beggar-thy-neighbor variety. Unconventional policies that aim at weakening the exchange rate are technically possible even at zero interest rates, and they are quite likely to be effective ... by switching demand toward domestically produced goods and services.

The risk is that countries that suffer from the switch may retaliate and depreciate their currencies. That could easily trigger a return to the much-feared competitive depreciations that contributed to the Great Depression.

The first casualty would be whatever small scope remains for international policy coordination. The second would be the world international monetary system. In fact, one key reason for the creation of the IMF was to monitor exchange-rate developments with the explicit aim of preventing beggar-thy-neighbor policies. ...

Alternatively, it may be that the SNB mostly wishes to talk the franc down to break the safe-haven effect. Having promptly achieved depreciation, it may have succeeded. In that case, the franc will not move much more in any direction, and there will be no need for further interventions. ...

Other central banks have not expressed any view, which may suggest that they do not intend to retaliate, at least at this stage. ... It may also be that notice has been taken of the precedent, and that those authorities that intend to use it to justify future moves are loath to criticize it. In that case, the generalized silence could indicate that all other central banks entertain the possibility of using that option, which would be most worrisome.

And:

The worst of all worlds, by Joseph S. Nye, Project Syndicate: The world economy will shrink this year for the first time since 1945, and some economists worry that the current crisis could spell the beginning of the end of globalization. Hard economic times are correlated with protectionism... In the 1930s, such “beggar-thy-neighbor” policies worsened the situation. Unless political leaders resist such responses, the past could become the future.

Ironically, however, such a grim prospect would not mean the end of globalization, defined as the increase in worldwide networks of interdependence. Globalization has several dimensions, and though economists all too often portray it and the world economy as being one and the same, other forms of globalization also have significant effects — not all of them benign — on our daily lives.

The oldest form of globalization is environmental. For example,... Bubonic plague, or the Black Death, originated in Asia, but its spread killed a quarter to a third of Europe’s population in the 14th century. ... The spread of foreign species of flora and fauna to new areas has wiped out native species, and may result in economic losses of several hundred billion dollars per year. Global climate change will affect the lives of people everywhere. ... The rate at which the sea level rose in the last century was 10 times faster than the average rate over the last three millennia.

Then there is military globalization, consisting of networks of interdependence in which force, or the threat of force, is employed. ... Finally, social globalization consists in the spread of peoples, cultures, images and ideas. Migration is a concrete example. ...

The danger today is that shortsighted protectionist reactions to the economic crisis could help to choke off the economic globalization that has spread growth and raised hundreds of millions of people out of poverty over the past half century. But protectionism will not curb the other forms of globalization. ...

This post can also be viewed on economistsview.typepad.com.

Longing For The Days Of Boring Banking

When the financial industry gets too creative, bad things tend to happen. The current financial crisis was not the first example of this either. If you look all the way back to before the Great Depression, whenever the financial industry was loosely regulated, and overly creative, things would eventually blow up. Paul Krugman is calling for us to return to the days of boring banking, but wonders if that is going to happen anytime soon. For more on this, read the following blog post from Mark Thoma.

Does congress have the will to pursue serious financial reform?:

Making Banking Boring, by Paul Krugman, Commentary, NY Times: Thirty-plus years ago, when I was a graduate student in economics, only the least ambitious of my classmates sought careers in the financial world. Even then, investment banks paid more than teaching or public service — but not that much more, and anyway, everyone knew that banking was, well, boring.

In the years that followed, of course, banking became anything but boring. Wheeling and dealing flourished, and pay scales in finance shot up... And we were assured that our supersized financial sector was the key to prosperity. Instead, however, finance turned into the monster that ate the world economy. ...

Thomas Philippon and Ariell Reshef ... show that banking in America has gone through three eras over the past century. Before 1930, banking was an exciting industry featuring a number of larger-than-life figures, who built giant financial empires (some ... based on fraud). This highflying finance sector presided over a rapid increase in debt: Household debt as a percentage of G.D.P. almost doubled between World War I and 1929.

During this first era of high finance, bankers were, on average, paid much more than their counterparts in other industries. But finance lost its glamour when the banking system collapsed during the Great Depression.

The banking industry that emerged from that collapse was tightly regulated, far less colorful than it had been before the Depression, and far less lucrative.... Banking became boring, partly because bankers were so conservative about lending: Household debt ... stayed far below pre-1930s levels.

Strange to say, this era of boring banking was also an era of spectacular economic progress for most Americans.

After 1980, however, as the political winds shifted, many of the regulations on banks were lifted — and banking became exciting again. Debt began rising rapidly, eventually reaching just about the same level relative to G.D.P. as in 1929. And the financial industry exploded in size. By the middle of this decade, it accounted for a third of corporate profits.

As these changes took place, finance again became a high-paying career... Indeed, soaring incomes in finance played a large role in creating America’s second Gilded Age. Needless to say, the new superstars believed that they had earned their wealth. ... And many economists agreed.

Only a few people warned that this supercharged financial system might come to a bad end. Perhaps the most notable Cassandra was Raghuram Rajan... But other[s]..., including Lawrence Summers..., ridiculed Mr. Rajan’s concerns.

And the meltdown came.

Much of the seeming success of the financial industry has now been revealed as an illusion. ... Worse yet, the collapse of the financial house of cards has wreaked havoc with the rest of the economy, with world trade and industrial output actually falling faster than they did in the Great Depression. And the catastrophe has led to calls for much more regulation of the financial industry.

But my sense is that policy makers are still thinking mainly about rearranging the boxes on the bank supervisory organization chart. They’re not at all ready to do what needs to be done — which is to make banking boring again.

Part of the problem is that boring banking would mean poorer bankers, and the financial industry still has a lot of friends in high places. But it’s also a matter of ideology: Despite everything that has happened, most people in positions of power still associate fancy finance with economic progress.

Can they be persuaded otherwise? Will we find the will to pursue serious financial reform? If not, the current crisis won’t be a one-time event; it will be the shape of things to come.

This post can also be viewed on economistsview.typepad.com.

Why Dropping "Mark to Market" Rules Won't Solve Anything

In an effort to shore up the balance sheets of banks the government decided to drop the "mark to market" rules that have been causing so much trouble in the financial industry. As Peter Schiff points out in his article, though, this won't solve anything. The rule was created in order to give investors a better idea of the true value of bank assets — basing the valuations on market activity rather than arbitrary assessments by the bank's accountants. Letting the banks decide how much their assets are worth, rather than the market, is a recipe for deception and ultimate failure. Read about what Schiff has to say in the article below from Money Morning.

When elementary school kids want to escape the confines of their circumstances, they pretend to be pirates, princesses and Jedi knights. Now, with the relaxation of "mark to market" valuation rules announced by the accounting trade’s self-regulatory body, our bankrupt financial institutions can escape their own reality by pretending to be solvent.

The unraveling of our fairytale economy over the last few months has not yet convinced us that the time has come to put away childish things. The applause that greeted the Financial Accounting Standards Board’s (FASB) ruling on Wall Street is a clear sign that we still have some growing up to do.

The imaginative conceit that lies behind the accounting change is that the toxic assets polluting bank balance sheets are not really toxic at all. They are in fact highly valuable assets that for some irrational reason no one wants to buy.

Using the "mark to market" accounting method, mortgage-backed securities were valued relative to the latest prices fetched by the sale of similar assets on the open market. Currently, those bonds are being sold at deep discounts to their original value. By "marking" their unsold bonds down to those prices, the insolvency of our financial institutions had been laid bare. But the new accounting changes will allow the nervous owners to assign more "appropriate" (i.e. higher) values. Problem solved.

It is important to note that the FASB made its rule modifications only after both Washington and Wall Street applied intense pressure. In their heart of hearts, I can’t imagine that there are too many bean counters happy with the outcome.

The banks and the government have argued that the assets should be valued based solely on current cash flow. Most mortgages, after all, are not delinquent. Therefore, a few bad apples should not spoil the whole bunch, and those that are not yet delinquent should be valued at par. This method assumes we have no ability to look into the future and make assumptions about what is likely to happen, which is presumably what the market is already doing by valuing the assets lower than the banks wish.

All kinds of bonds (corporate, government and municipal, etc.) that are not in default frequently trade at discounts. In fact, the reason agencies such as Moody’s Corp. (MCO) and Standard & Poor’s rate bonds is to assess the probability of default. The higher that probability, the lower the value placed on the bonds, regardless of their current cash flow.

For example, General Motors Corp.’s (GM) 10-year bonds currently trade for only 8 to 10 cents on the dollar, despite the fact that GM is current on all interest payments. The 90% discount reflects investor awareness that GM will likely default long before the bonds mature. By the new logic, financial institutions with GM bonds on their balance sheets should be able to ignore the market and value these bonds at par.

Some argue that the comparison is invalid because GM’s bonds are liquid while mortgage-backed securities are not. However, if sellers of GM bonds were holding out for 70 or 80 cents on the dollar, those bonds would be illiquid too. The reason GM bonds are trading is that sellers are realistic.

The same should apply to bonds backed by mortgages. To assume that a 30-year, $500,000 mortgage on a house that has declined in value to $300,000 has a high probability of remaining current to maturity is ridiculous. The borrower could lose his job, his adjustable-rate mortgage (ARM) might reset higher, or he may simply tire of paying an expensive mortgage for a house that is unlikely to be sold at a profit.

Any bond investor with half a brain will factor in these probabilities and look for deep discounts. The only way to accurately assess a real present value is to let the market discover the price.

Despite the pleas from bankers and politicians, mortgages are not plagued by a lack of liquidity but a lack of value. If sellers would be more negotiable, there would be plenty of liquidity. Who knows, at the right price I might even buy a few. The problem is that putting a market price on these assets would render most financial institutions insolvent, which is precisely why they do not want to let that happen.

Simply pretending that all these mortgages will be repaid does not solve the underlying problems. It may keep some banks alive longer, but when they ultimately do fail, the losses will be that much greater. In the meantime, solvent institutions are deprived of capital as more funds are funneled into insolvent "too big to fail" institutions - hiding their toxic assets behind rosy assumptions and phony marks.

Going from the sublime to the completely ridiculous, in a speech at the just-concluded Group 20 summit in London, President Barack Obama urged Americans not to let their fears crimp their spending. It would be unwise, he argued, for Americans to let the fear of job loss, lack of savings, unpaid bills, credit card debt or student loans deter them from making major purchases.

According to the president, "we must spend now as an investment for the future." So in this land of imagination (where subprime mortgages are valued at par), instead of saving for the future, we must spend for the future.

I guess Ben Franklin had it wrong too – apparently a penny spent is a penny earned.

This post can also be viewed on moneymorning.com.

Bahrain's Economy Is Holding Up Well

Not many Americans have even heard of Bahrain, let alone thought about investing in the country, but while Dubai has been faltering badly, Bahrain is holding up well. Investors interested in the Middle East might want to give Bahrain a closer look, especially if they are considering investing in Dubai. For more on this, read the following article from Overseas Property Mall.

Bahrain has long been the forgotten little brother of glittery Dubai in the housing investment industry. For years we have been told countless stories on why we had to buy property in Dubai and all the while Bahrain has quietly sneaked up in the housing stakes.

Since reports of a falling Dubai have become stronger every month, Bahrain has only suffered “small damage”. After having spent many years in its bigger brothers shadow, Bahrain is ready to raise the stakes and claim back some of its past status as a strong and reliable financial business center in the Arabian world.

The Bahrain Economic Development Board’s chief operating officer Kamal Ahmed said:

“In tough times, people want to be in the most stable place. Of course, nobody is immune to the crisis, but we have certainly shown we are less exposed.”

The CBB (Central Bank of Bahrain) has established itself as one of the better regulators if we are to believe the latest news reports from the Middle East due to the lack of available finance overall. Some even say that Dubai’s loss has resulted into being Bahrain’s gain but clearly it is early days at the moment. Signs are positive though and industry watchers are positive that Bahrain might attract more investors in the next year due to its stable economy despite the global crisis elsewhere.

Ahmed further stated that it wasn’t the banks fault that Bahrain has lacked the attention it supposedly deserves but more so the lack of media attention overall.

The World Bank also helped to establish Bahrain as a strong business center by ranking it 18th in the world for doing business with last year. Another encouraging sign of a stable economy is the number of new lending institutions licensed in 2008. There were a total of 44 new start ups compared to 38 start ups in 2007.

Bahrain’s financial specialty if one could say that is Islamic finance. The launch of the Bahrain Financial Exchange in 2010 will also see the position of this small emirate strengthened overall.

But even so Bahrain’s economy is relative stable, the emirate has experienced plenty of heartache in the banking sector too. Profit margins of banks declined by 17.6 percent in 2008. During the same time, retail banks saw a surge of 112 percent in loan to deposit ratios.

Some financial organizations are also being scrutinized by the Bahrain government. With over 400 institutions in the country, there are too many right now to satisfy the lack of demand while showing healthy growth over time so eventually some of them will take the fall for sure.

This post can also be viewed on overseaspropertymall.com.

The Debt Lessons We Hopefully Have Learned

It is no secret that millions of Americans have put themselves in an unmanageable debt situation thanks to easy credit over the past few years, and while it is unfortunate, hopefully we all can learn from this. Tim Iacono talks about some of the lessons we should have learned, and offers additional insight in his blog post below.

Since credit cards were first issued and automobiles were first financed, bankers and car salesman have been more than happy to assist individuals in realizing their full borrowing potential. Realizing their full potential, that is, by borrowing more money than they really should.

For young adults, perhaps living independently and with their first full-time job, this could lead to important life lessons about managing debt and living within their means. After many months or years of credit card and automobile payments, the initial thrill having long since worn off leaving only the payments, valuable lessons about borrowing too much money have often been learned - lessons that are not quickly forgotten.

When purchasing homes, on the other hand, it used to be quite difficult to take on more debt than would seem reasonable - there, the bar was set higher. Years ago, couples would walk out of their mortgage broker's office disappointed and dejected because their dreams had been thwarted by a loan officer without a heart.

These too were valuable lessons about debt.

Maybe it seemed unfair, but someone who was presumably older and wiser had determined that the dream home so coveted by the young couple was simply beyond their means. Maybe when the couple later reflected on their denied attempt to purchase their dream home, they realized that the lender probably knew best.

But, the financing of real estate purchases has changed dramatically in recent years. Now that home financing has become as easy as getting a credit card or buying a car, valuable lessons about debt learned early on, are being unlearned later in life - this is probably not a good thing.

Credit Cards

Everyone has stories of their first credit cards or a friend’s initial experience with credit cards. It is probably still fairly common for young adults to get a new VISA or MasterCard with a $1000 credit limit, immediately go out and spend the $1000, then begin paying $20 per month to service this debt. Of course the debt never seems to get paid down - but, initially at least, it is easily serviced.

After a while a new credit card would be acquired - You're Pre-Approved!

The process would then be repeated. Another $1000 in debt and another $20 debt service. Many young adults have ended up going back to their parents when this process had been repeated many more times - when the debt service rose much more rapidly than their income and the funds to service the debt began coming up short at the end of the month.

The debt service payment had been multiplying along with the number of credit cards, and was now in the hundreds of dollars per month. Then an emergency arose, and it was game-over - back to the parents, a little groveling, some stern warnings, a few promises, and problem solved.

A valuable lesson was learned.

Automobiles

The purchase of a first automobile can result in a similar learning experience. This one, however can be much more personal - the memory of the car salesman may accompany the monthly payments. Many years ago, a roommate car salesman would occasionally come home and announce, "We buried this guy!” This was invariably a reference to some poor schmuck that came in off the street, and despite his best effort to resist, ended up driving off the lot with a car that he really couldn't afford.

Apparently, there is something both magical and legal about driving the vehicle off the dealer's lot - even if the paperwork was not quite right or the loan wasn't quite approved, you just bought a car - one way or another. You've just made a multi-year commitment to repay many thousands of dollars in both principle and interest in return for that shiny new car that maybe you really can't afford.

Missing too many car payments carries serious consequences - this could be an excellent learning experience if a new car owner needs to be taught this lesson. However, most borrowers who buy more car than they should just live with the strain of seemingly never ending monthly payments until the loan is paid in full. Then they can look back and reconsider the decision that was made on that fateful day. Was it a good decision? Was it worth it?

Another lesson was learned.

[Unfortunately, automobile leases today have given many people the impression that it is completely normal to make car payments forever. Individuals who will never experience the joy of owning automobiles outright and not having any car payments - these people do not know what they are missing.]

Houses

That brings us to today's wild world of home mortgage finance and housing appreciation. If either of the above two lessons about debt were learned earlier in life, it is understandable how they may be quickly forgotten when confronted with a force as powerful as today's global real estate boom.

With lending standards relaxed and home prices rising, debt has taken on an entirely new character - monthly payments now have a much friendlier air about them. Much friendlier in that the underlying asset seems to rise in value at a rate many times the debt service payment.

That never happened with credit cards or automobiles!

If you pay $2000 per month in debt service, and the home value rises by $5000 or $10,000 during that month, and this gets repeated month after month, and you also get a nice place to live in - this seems like an excellent kind of debt.

What lessons are there to learn here? Maybe the lesson is that more debt would be better.

But we are reminded that these are not normal times. We are living in what The Economist magazine calls "the biggest financial bubble in history" - the global real estate bubble. What happens if current trends do not continue? What happens when real estate appreciation regresses to the mean - slowly with stagnating prices or quickly with price declines?

Would there perhaps be some valuable lesson about debt to be learned at that time?

Is the entire Anglo Saxon world about to be taught a valuable lesson about debt?

[This was originally written and published almost four years ago...]

This post can also be viewed at themessthatgreenspanmade.blogspot.com.

Why March's Rally Does Not Mean We Already Hit Bottom

March was certainly an interesting month. The stock market rally was of historic porportion, and investors seem to have a new since of optimism. Once reality sets in, though, that optimism may soon be lost. Tim Iacono points out why March's rally probably doesn't signify a market bottom in his bog post below.

It has been quite a month.

The newspapers were full of stories last week about how March was the best month for stock markets in six years and that the last four weeks were the best stretch for equities since either 1933 or 1938, depending upon the source.

The distinction is unimportant as investors have gotten the message - stocks are on a tear.
Broad indexes have risen between 20 and 30 percent over the last month and recent reports have shown a deceleration in the rate of decline for some economic indicators and tentative signs of a bottom for others, leading many to believe that the worst is now behind us.

The move up in equity markets since the early-March low has officially entered "bull market" territory after a flurry of government actions, pronouncements of profitability from Wall Street firms, and optimism that global leaders at the G20 meeting are taking steps to tackle the financial crisis. All of this has convinced more than a few investors and traders that this is the time to buy riskier assets with the potential for a greater return and stock prices have been bid higher.

The important question becomes, "Is this a sucker rally with lower lows ahead or is this an enduring new bull market?"

That is the question that some people have been asking over the last few weeks, however, with each passing day of stock market gains, fewer and fewer people seem to wonder about it, opting instead to go with the flow, to add to the momentum.

In my view, recent lows for U.S. stocks are likely to be retested again this year, probably making new lows in the process, and equity markets around the world will likely move down with them.

It really boils down to two factors - the U.S. economy and corporate earnings.

The question of decoupling - the idea that emerging markets can ignore recessions in developed economies such as the U.S., Europe, and Japan - will be addressed in a subsequent update as it is deserving of its own lengthy consideration. There is more and more promise that growth in China, Brazil, India, and elsewhere can continue despite continuing troubles in developed nations and this is a critical factor in anyone's investment approach.

For now, the discussion will be limited to the United States.

The U.S. Economy

As has been the case for most of this decade, the future of the U.S. economy is dependent on housing. While financial markets and commerce may be dependent on the banking system and credit flows, the U.S. economy is soundly based on consumer spending and consumer spending, today, is driven in large part by the value of peoples' homes. Until home prices stabilize, consumers will not reemerge in big numbers to borrow and spend and, despite all the recent government initiatives, home prices are going to continue to fall this year. There is simply too much inventory in the pipeline.

As noted last week when discussing the latest report on existing home sales, it is a straightforward predicament, "the red curve and the blue bars in the nearby chart must draw much closer to each other before the downward pressure on prices abates".
Despite what the NAR (National Association of Realtors) might say or what the talking heads on CNBC might offer, that is not likely to happen anytime soon as foreclosure rates continue to break records, more and more homeowners throwing in the towel, walking away from homes where they owe more than the homes are now worth. Banks continue to struggle with their growing inventory of properties and, importantly, the bulk of these bank owned properties have not yet been listed for sale.

In the most recent data from both the NAR and the S&P Case-Shiller Home Price Index, home price declines continue to accelerate, largely driven by distressed property sales which, in many areas, account for more than half of all sales.

The foreclosure market is the market in many areas and defaults are now increasing fastest among prime loans made to borrowers with strong credit. The next wave of mortgage defaults will be the Alt-A and Option ARM loans where borrowers bought property with little or no documentation of income or assets, often times making only minimum payments that did not even cover all the monthly interest due. In contrast to the subprime debacle in 2007 and 2008, many of the Alt-A and Option ARM loans were used to purchase higher priced homes, a good example of this being the area where my wife and are I moving to next month - Bend, Oregon.

This is an area that, for years, has been regarded as overpriced since buyers from Portland and Seattle bid up home values earlier in the decade when the second-home buying frenzy was in full swing. In Bend, during the first quarter, notices of default almost tripled from the level of a year ago. This is in contrast to other parts of the country where foreclosure rates have leveled out at historically high levels over the last year as many of the low-priced homes with subprime mortgages have already been repossessed. Real estate prices in New York City are now starting to tumble and defaults are moving up the socio-economic ladder.

Interestingly, the expected increase in distressed sales at higher prices may have a big impact on some of the median home price statistics to be reported this year. Remember that the median price is highly dependent on the "mix" of home sales and that the sale of more higher priced homes will push up the median price even if these sales occur at steep discounts to what was paid for the same house a year or two ago. This will likely be misinterpreted as a sign of recovery.

With loan modifications souring quickly as job losses mount, housing is in no position to begin a recovery this year. While new and existing home sales may make a bottom by year-end, prices will continue to tumble and, absent any wholesale move by the government to buy up tracts of houses and bulldoze them into the ground, the supply/demand picture will not normalize until prices are much lower, probably sometime in 2010, perhaps not until 2011. Clear signs of this stabilization in prices are a prerequisite for the economy to reach a bottom and we have yet to see that.

Corporate Earnings

Reports last week indicated delinquencies increased to record highs in almost all consumer loan categories as falling home prices have now combined with job losses to create a vicious cycle downward. This only adds to the distress in the consumer sector and while both retail sales and automobile sales have shown signs of stabilizing, they remain at very low levels. Simply stabilizing at these depressed levels is not enough to support an economic rebound.

Commercial real estate defaults are now beginning to appear in large numbers, delinquent loans increasing some 41 percent from $46 billion in the fourth quarter of last year to $65 billion in the first quarter of 2009. In Los Angeles alone there are now almost $8 billion in distressed properties, nearly triple the level of late last year, and Las Vegas recently saw a 54 percent increase to $6 billion.

All of this will weigh on equity markets in the weeks and months ahead as first quarter earnings are announced.

Based on the number of warnings that have been issued thus far, bottom lines for the first quarter are likely to be almost as bad as the abysmal results seen in the fourth quarter when operating earnings for the S&P 500 overall were in the red. Importantly, there may be some big improvements in the banking sector due to "mark-to-market" changes approved last week which allow "significant" judgment in valuing assets, including mortgage-backed securities.

Total operating earnings for the S&P500 are expected to be down almost 40 percent from a year ago but it is the outlook for the future that is more important for stock prices than last quarter's results.

It will be comments by company officials about business conditions and projections of future earnings that investors will look to in order to value their shares.

Since stock prices are "forward looking" - taking into account both estimated future earnings and the health of the economy from which those earnings derive - it will be the prospects for the economy later in the year that will most influence stock prices in the near-term.

Conventional wisdom over the last fifty years or so is that, during recessions, stocks make a bottom at around the same time that monthly job losses peak and, in some cases during the second half of the 20th century, stocks put in their lows in advance of the worst of the labor market downturn.
If past is precedent and if the recent January decline in nonfarm payrolls of 741,000 turns out to be the peak for this cycle, then it is reasonable to believe that the March low in equity markets could be a lasting bottom.

However, if either of those are untrue - that this downturn will be different than previous recessions or that job losses have not yet reached their peak - then we are more likely to see new lows sometime later this year. In my view, that is the most likely scenario - one of those two conditions will not be met.

It wouldn't be the first time that stock market investors came too early to the party.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

More Economists Predicting A Depression

According to a couple economists our present financial crisis looks like a recipe for a depression. The main difference they see between a normal recession and a depression, is that a depression originates in consumer debt. If these economists are correct in their theory, the recent positive market movement will only be a suckers rally. Tim Iacono looks closer at the recent article published by these economists, and adds some of his own thoughts, in his blog post below.

In this commentary in today's Wall Street Journal, economists Steven Gjerstad and Vernon Smith offer a theory about why we could again be going from a bubble into a depression.

Over the years, there have been quite a few bubbles, but not all of them cause the sort of economy-wide damage that was seen in the 1930s or over the last year or so. Why?

Why does one crash cause minimal damage to the financial system, so that the economy can pick itself up quickly, while another crash leaves a devastated financial sector in the wreckage? The hypothesis we propose is that a financial crisis that originates in consumer debt, especially consumer debt concentrated at the low end of the wealth and income distribution, can be transmitted quickly and forcefully into the financial system. It appears that we're witnessing the second great consumer debt crash, the end of a massive consumption binge.

Most people forget that it wasn't just a stock market bubble in 1929 that led to America's last lost decade. There was an enormous housing and credit bubble in the mid-1920s during which Groucho Marx and others lost a good deal of money on Florida swampland.

As has been the case thoughout history, you can't get a really good bubble going until you get broad participation from the public - preferably lots of people at the lower end of the socio-economic scale levered up courtesy of a banking system that is gushing with easy money.

That pretty much described the situation in the 1920s and in the 2000s.

The entire piece is worth a look as they go through the recent history of financial bubbles in the U.S., a sequence that really accelerated about 20 years ago when you-know-who started sitting in the big chair at the Federal Reserve boardroom.

Interestingly, they touch on one of my all-time favorite subjects since this blog began a few years ago - how owners' equivalent rent duped the Fed.

During the 1976-79 and 1986-89 housing price bubbles, the effective federal-funds interest rate was rising while housing prices rose: The Federal Reserve, "leaning against the wind," helped mitigate the bubbles. In January 2001, however, after four years with average inflation-adjusted house price increases of 7.2% per year (about 6% above trend for the past 80 years), the Fed started to decrease the fed-funds rate. By December 2001, the rate had been reduced to its lowest level since 1962. In 2002 the average fed-funds rate was lower than in any year since the 1958 recession. In 2003 and 2004 the average fed-funds rates were lower than in any year since 1955 when the rate series began.

Monetary policy, mortgage finance, relaxed lending standards, and tax-free capital gains provided astonishing economic stimulus: Mortgage loan originations increased an average of 56% per year for three years -- from $1.05 trillion in 2000 to $3.95 trillion in 2003!

By the time the Federal Reserve began to slowly raise the fed-funds rate in May 2004, the Case-Shiller 20-city composite index had increased 15.4% during the previous 12 months. Yet the housing portion of the CPI for those same 12 months rose only 2.4%.How could this happen? In 1983, the Bureau of Labor Statistics began to use rental equivalence for homeowner-occupied units instead of direct home-ownership costs. Between 1983 and 1996, the price-to-rental ratio increased from 19.0 to 20.2, so the change had little effect on measured inflation: The CPI underestimated inflation by about 0.1 percentage point per year during this period. Between 1999 and 2006, the price-to-rent ratio shot up from 20.8 to 32.3.

With home price increases out of the CPI and the price-to-rent ratio rapidly increasing, an important component of inflation remained outside the index. In 2004 alone, the price-rent ratio increased 12.3%. Inflation for that year was underestimated by 2.9 percentage points (since "owners' equivalent rent" is about 23% of the CPI). If home-ownership costs were included in the CPI, inflation would have been 6.2% instead of 3.3%.

Yes, "an important component of inflation remained outside the index" - that sort of thing almost always ends badly as noted here on many occasions before.

After years of writing on this subject, yours truly still comes out high in a simple Google search on the phrase owners' equivalent rent - right there in second place, behind the Bureau of Labor Statistics with "How owners' equivalent rent duped the Fed" and then again in fifth place with the memorable "The complete and utter failure of owners' equivalent rent".

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

China Is Trapped In The Dollar

There has been a lot of talk lately about China's desire to diversify out of the dollar, however, unfortunately for them they are trapped. The worst part for China is that this entrapment was self-inflicted as Paul Krugman points out in his recent New York Times article. For more on this, read the following blog post from Mark Thoma.

It's time "to face up to new realities":

China’s Dollar Trap, by Paul Krugman, Commentary, NY Times: ...The big news last week was a speech by Zhou Xiaochuan, the governor of China’s central bank, calling for a new “super-sovereign reserve currency.”

The paranoid wing of the Republican Party promptly warned of a dastardly plot to make America give up the dollar. But Mr. Zhou’s speech was actually an admission of weakness. In effect, he was saying that China had driven itself into a dollar trap, and that it can neither get itself out nor change the policies that put it in into that trap in the first place.

Some background: In the early years of this decade, China began running large trade surpluses and also began attracting substantial inflows of foreign capital. If China had had a floating exchange rate — like, say, Canada — this would have led to a rise in the value of its currency, which, in turn, would have slowed the growth of China’s exports.

But China chose instead to keep the value of the yuan in terms of the dollar more or less fixed. To do this, it had to buy up dollars as they came flooding in. As the years went by, those trade surpluses just kept growing — and so did China’s hoard of foreign assets. ...

Aside from a late, ill-considered plunge into equities (at the very top of the market), the Chinese mainly accumulated very safe assets,... U.S. Treasury bills... T-bills are as safe from default as anything on the planet... But ... any future fall in the dollar would mean a big capital loss for China. Hence Mr. Zhou’s proposal to move to a new reserve currency along the lines of the S.D.R.’s, or special drawing rights, in which the International Monetary Fund keeps its accounts. ...

S.D.R.’s aren’t real money. They’re accounting units whose value is set by a basket of dollars, euros, Japanese yen and British pounds. And there’s nothing to keep China from diversifying its reserves away from the dollar, indeed from holding a reserve basket matching the composition of the S.D.R.’s — nothing, that is, except for the fact that China now owns so many dollars that it can’t sell them off without driving the dollar down and triggering the very capital loss its leaders fear.

So what Mr. Zhou’s proposal actually amounts to is a plea that someone rescue China from the consequences of its own investment mistakes. That’s not going to happen.

And the call for some magical solution to the problem of China’s excess of dollars suggests something else:... China’s leaders haven’t come to grips with the fact that the rules of the game have changed in a fundamental way.

Two years ago,... China could save much more than it invested and dispose of the excess savings in America. That world is gone.

Yet the day after his new-reserve-currency speech, Mr. Zhou gave another speech in which he seemed to assert that China’s extremely high savings rate is immutable, a result of Confucianism, which values “anti-extravagance.” Meanwhile, “it is not the right time” for the United States to save more. In other words, let’s go on as we were.

That’s also not going to happen.

The bottom line is that China hasn’t yet faced up to the wrenching changes that will be needed to deal with this global crisis. The same could, of course, be said of the Japanese, the Europeans — and us.

And that failure to face up to new realities is the main reason that, despite some glimmers of good news — the G-20 summit accomplished more than I thought it would — this crisis probably still has years to run.

This post can also be viewed on economistsview.typepad.com.

Unemployment Rate Rises To 8.5 Percent

The latest job loss information was reported this morning, and the news was not good. Most were expecting the numbers to be bad, though, considering that the recent ADP job loss report showed over 740,000. With that in mind it is possible that the Labor Department's report could later be revised, and end up with even worse numbers. For more on the job loss report, read the following blog post from Tim Iacono.

The Labor Department reported a net job loss of 663,000 during the month of March and an increase in the unemployment rate from 8.1 percent to 8.5 percent.
In a break from previous monthly reports, downward revisions to prior data were limited to an 86,000 decline in the January payrolls, from -655,000 to -741,000, making January the worst month for job losses since October of 1949.

Adjusted for the size of the workforce, the January decline was the worst since 1974.

At 8.5 percent, the unemployment rate reached its highest level since 1983 as the total number of unemployed people rose to 13.2 million. If those working part-time for "economic reasons" and those too discouraged to continue looking for work are included, the unemployment rate would have been 15.6 percent in March, the highest since this data series began in 1994.

Job loss was widespread in March, only the stalwart education and health services category able to muster a modest net gain of 8,000 new jobs. Employment in manufacturing declined by 161,000, professional and business services payrolls fell 133,000, and construction lost 126,000 jobs. Temporary help declined by 72,000, an indication that employers are still slashing jobs aggressively.
Total job loss since the beginning of the current recession that began in late-2007 now stands at 5.1 million, a full 3.3 million of this decline coming in just the last five months.

Remember that employment is a lagging indicator. While the last recession ended in late-2001, net job loss continued for almost two more years, the "official" end to the recession following shortly after the worst of the monthly declines in nonfarm payrolls.

It remains to be seen whether or not the worst of the job losses in the current recession are already behind us.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

An Alarming Number Of Americans Receiving Food Stamps

One in ten Americans are now receiving food stamps, and that number is set to increase. This should be shocking, but in reality it probably isn't considering the state of the economy. It is somewhat comforting to know that these people in need are getting food, but the problem is scary nonetheless. For more on this, read the following blog post from Tim Iacono.

Wow, where do you go from here? Fifteen percent?

The Associated Press reports that more than 32 million Americans now sheepishly pull food stamps out of their purse or wallet in the checkout line and the bad news is that things are likely to get worse from here.

Given that labor markets are a lagging indicator, likely to get much worse before any net job creation begins, the number of food stamp recipients may go much higher this year.

Food stamps are the major U.S. antihunger program and help poor people buy groceries. The average benefit was $112.82 per person in January.

The January figure marks the third time in five months that enrollment set a record.

"A weakened economy means that many more individuals are turning to SNAP/Food Stamps," said the Food Research and Action Center, an antihunger group, using the acronym for the renamed food stamp program, Supplemental Nutrition Assistance Program.

Well, if the government can't do anything about the underlying causes of families not being able to put food on the table, at least they have a new "snappy" acronym.

Tomorrow's labor report is likely to provide a pretty good indication of whether they'll have to add another shift for the food stamp printing presses. If economic reports so far this week are any indication - new highs for weekly jobless claims and new lows for the ADP employment report - they might want to start placing some help wanted ads.

Food stamp enrollment rose in all but four of the 50 states during January, said Agriculture Department figures. Vermont, Alaska and South Dakota had increases of more than 5 percent. Texas had the largest enrollment, 2.984 million, down 65,000, followed by California at 2.545 million, up 43,000, and New York with 2.211 million, up 37,000.
Food stamp benefits get a temporary 13 percent increase, beginning with this month, under the economic stimulus law signed by President Barack Obama. The increase equals $80 a month for a household of four.

If those statistics and my math are both correct, benefits for a family of four go from a little over $600 a month to almost $700 a month.

You can actually buy a lot of groceries for that amount of money, particularly the high-calorie, processed variety.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Geithner's Bank Bailout Plan: Privatizing Gains And Socializing Losses

There is no shortage of opposition to Treasury Secretary Timothy Geithner's new bank bailout plan, and while some arguments are unfounded, Joseph Stiglitz does make a good point. According to Stiglitz the worst part about the bailout plan is that it will privatize gains while socializing losses. With this in mind it makes it an overall losing proposition for taxpayers. In addition to this argument Stiglitz makes several others against the bailout plan in his article below as presented by Mark Thoma.

Joseph Stiglitz is not a fan of the Geithner bank bailout plan:

Obama’s Ersatz Capitalism, by Joseph E. Stiglitz, Commentary, NY Times: The Obama administration’s $500 billion or more proposal to deal with America’s ailing banks ... is based on letting the market determine the prices of the banks’ “toxic assets”... The reality, though, is that the market will not be pricing the toxic assets themselves, but options on those assets.

The two have little to do with each other. The government plan in effect involves insuring almost all losses. ... This is exactly the same as being given an option. ...

Under the plan by Treasury Secretary Timothy Geithner, the government would provide about 92 percent of the money to buy the asset but would stand to receive only 50 percent of any gains, and would absorb almost all of the losses. Some partnership! ...

But Americans are likely to lose even more ... because of an effect called adverse selection. The banks get to choose the loans and securities that they want to sell. They will want to sell the worst assets, and especially the assets ... the market ... is willing to pay too much for...But the market is likely to recognize this, which will drive down the price... Only the government’s picking up enough of the losses overcomes this “adverse selection” effect. ...

The main problem is not a lack of liquidity. ... The real issue is that the banks made bad loans... They have lost their capital, and this capital has to be replaced.

Paying fair market values for the assets will not work. Only by overpaying for the assets will the banks be adequately recapitalized. But overpaying for the assets simply shifts the losses to the government. In other words, the Geithner plan works only if and when the taxpayer loses big time.

Some Americans are afraid that the government might temporarily “nationalize” the banks... What the Obama administration is doing is far worse than nationalization: it is ersatz capitalism, the privatizing of gains and the socializing of losses. It is a “partnership” in which one partner robs the other. ...

So what is the appeal of a proposal like this? Perhaps it’s the kind of Rube Goldberg device that Wall Street loves — clever, complex and nontransparent, allowing huge transfers of wealth to the financial markets. It has allowed the administration to avoid going back to Congress to ask for the money needed to fix our banks, and it provided a way to avoid nationalization.

But we are already suffering from a crisis of confidence. When the high costs of the administration’s plan become apparent, confidence will be eroded further. At that point the task of recreating a vibrant financial sector, and resuscitating the economy, will be even harder.

This post can also be viewed on economistsview.typepad.com.

Brace Yourself For More Horrible Employment Numbers

Job losses continue to mount, but you might be surprised by just how bad things were in March. We are going to get the official report in a couple days, but preliminary data is not good. As Kathy Lien points out in her blog post below get ready to see some horrible employment numbers.

For each of the past 3 months, non-farm payrolls has fallen by more than -650k. In December, payrolls dropped 681k, which at that time was the biggest single month contraction in job growth since 1945. Based upon the ADP employment report, the Challenger layoffs report and weekly jobless claims, traders should brace for an even sharper decline in March payrolls.

Private sector employment fell by 742k this month and the scary thing is that ADP historically underestimates payrolls. According to Challenger, layoffs rose 180.7 percent while weekly jobless claims exceeded 650k three out of the past four weeks. The only silver lining would have to come from the public sector, but there is little chance that the increase in government jobs would be more than 10k or 20k.

This time around, we do not have the luxury of using the employment report of service sector ISM as a leading indicator for NFPs, but everything else points to the biggest contraction in the labor market in more than 6 decades.

If payrolls fall by more than 700k, the dollar could actually rally because the dollar is trading on risk appetite and not economic data. I will be publishing a Non-Farm Payroll Preview tomorrow on FX360.com

This post can also be viewed on kathylien.com.

The Fundamental Problem Behind The Housing Crash

To understand why we got into this housing mess, there is no need to look further than the recent findings from the "Future of Finance Initiative." It took awhile for these geniuses to figure it out, but they found that in order to avoid mass foreclosures — lenders to make sure borrowers can actually pay back the loans. Wow, just think, if they could have figured that out sooner we never would have ended up in the situation we have today. I guess we know for next time, right? Tim Iacono looks closer at the report and adds some insight in his blog post below.

There's a special 14-page report in today's Wall Street Journal presenting the findings of last week's Future of Finance Initiative, a gathering of 100 of the "brightest minds in finance" tasked with the job of charting a path forward from our precarious current position.

No, former Fed chief Alan Greenspan was not included.

Astonishingly, not once, not twice, but at least three times, the fixing of one of the most fundamental errors of the last six or seven years is prominently featured in the many recommendation sections, what would have undoubtedly stopped the global credit bubble in its tracks years ago if someone other than "crazy housing bubble bloggers" and a few rogue economists would have brought attention to it and been able to do something about it.

This recommendation appears in Principles for Change, an interview with Peter Fisher of BlackRock Inc., it is a key element of Princeton Economic Professor Alan S. Blinder's recommendations enumerated in The Future of Banking, and it is featured as number one in a list of of almost two dozen "principles for rebuilding the financial system" in a summary section (no link found).

It's pretty simple - borrowers must be able to repay loans from income.

Gussied up a little bit for the paper it looks like this:

Minimum Underwriting Standards. Bank management and bank examiners must enforce the banks' minimum underwriting standards, focused on the borrowers' ability to repay debt from income. The bank supervisors' authority must extend beyond banks to all bank agents, such as mortgage brokers.

Maybe it's just me, but, to some of us who could see this all developing back in the first half of the decade - when Fannie and Freddie first starting having problems in 2002 and 2003, then when Wall Street got involved in a big way in 2004 and 2005, and then in 2006 when everyone laughed about "all you have to do to get a home loan is to fog a mirror" - this is just about the most ridiculous example of how maybe these guys aren't all the bright after all.

What were they saying five years ago and why did it take them so long to have this epiphany?

Alan Blinder was singing the praises of the former Fed chairman up until the housing bubble had unquestionably burst, and now he's charged with charting the new course for banking?

In just about every interview that I ever did back around the time that the housing bubble was peaking and popping, I'd always say something like the following:

All anyone has to do is spend some time in a mortgage loan office and you'll quickly see that there's no way these people are going to pay this money back. When the median home price is ten times the median income, the only way that money is getting paid back is if they sell the house at a profit and that will only work so long as home prices keep going up.

What does it say about policymakers that they couldn't see this simple truth?

When the former and current Federal Reserve Chairmen - the position that was once considered to be the second most powerful in the world behind only the U.S. president - dismiss out of hand the possibility of home prices ever declining, what hope do we have that they'll not do something equally as stupid next time?

Were they all so deluded by the apparent prosperity of our late, great asset-based economy that these wizards of the financial world were unable to see something so simple, only now realizing just how huge this simple error was?

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Profiting From Reflation: A Bet On Economic Recovery

I read an interesting article in the Wall Street Journal this morning that I thought I should share. There are a lot of people who have been making a great deal of money during this economic crisis by shorting the economy, or specifically betting that it would get worse. Many of these same traders are now making a different bet. They are betting that not only are these exorbitant stimulus measures going to stimulate the economy, but they are also going to lead to high inflation.

Right now the Federal Reserve is so concerned with preventing the dreaded D words (Deflation and Depression), that they are basically ignoring the threat of inflation. Once the economy gets going again, though, they are going to have to react incredibly fast in order to prevent a massive run up in inflation. Chances are the government will be slow to react, and if anything they prefer to error on the side of inflation — opposed to prolonging the recession.

What this means is that as the economy starts to recover those investments which typically do well in inflationary environments, stand to do very well. Commodities specifically have proven to be the investment of choice for many successful investors.

To read the full Wall Street Journal article click here.

America's Tarnished Reputation Threatens Global Response To Financial Crisis

One of the biggest casualties from the financial crisis — and our handling of it — has been the loss of America's reputation on financial matters. As far as most of the world can tell we are the ones who started this financial mess — which is enveloping much of the world — and even worse we have appeared incompetent to fix it. Why then would the rest of the world listen to us when we try to piece together an effective global response? As Paul Krugman points out in his recent article, America quite possibly could have lost one of its most valuable assets — its reputation — right when they — and the world — need it most. For more on this, read the following blog post from Mark Thoma.

The financial crisis has damaged our global authority, credibility, and leadership, and that will make it much harder for the world to accomplish the essential task of coordinating a common response:

America the Tarnished, by Paul Krugman, Commentary, NY Times: Ten years ago the cover of Time magazine featured Robert Rubin,... Alan Greenspan,... and Lawrence Summers... Time dubbed the three “the committee to save the world,” crediting them with leading the global financial system through a crisis..., although it was a small blip compared with what we’re going through now.

All the men on that cover were Americans, but nobody considered that odd. After all, in 1999 the United States was the unquestioned leader of the global crisis response. ... The United States, everyone thought, was the country that knew how to do finance right.

How times have changed..., ... our claims of financial soundness — claims often invoked as we lectured other countries on the need to change their ways — have proved hollow.

Indeed, these days America is looking like the Bernie Madoff of economies: for many years it was held in respect, even awe, but it turns out to have been a fraud all along. ...

Simon Johnson..., who served as the chief economist at the IMF..., declares that America’s current difficulties are “shockingly reminiscent” of crises in places like Russia and Argentina — including the key role played by crony capitalists.

In America as in the third world, he writes, “elite business interests — financiers, in the case of the U.S. — played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive.”

It’s no wonder, then, that an article in yesterday’s Times about the response President Obama will receive in Europe was titled “English-Speaking Capitalism on Trial.”

Now, in fairness ... the United States was far from being the only nation in which banks ran wild. Many European leaders are still in denial about the continent’s economic and financial troubles, which arguably run as deep as our own... Still, it’s a fact that the crisis has cost America much of its credibility, and with it much of its ability to lead.

And that’s a very bad thing... I’ve been revisiting the Great Depression,... one thing that stands out ... is the extent to which the world’s response to crisis was crippled by the inability of the world’s major economies to cooperate.

The details of our current crisis are very different, but the need for cooperation is no less. President Obama got it exactly right last week when he declared: “All of us are going to have to take steps in order to lift the economy. We don’t want a situation in which some countries are making extraordinary efforts and other countries aren’t.”

Yet that is exactly the situation we’re in. I don’t believe that even America’s economic efforts are adequate, but they’re far more than most other wealthy countries have been willing to undertake. And by rights this week’s G-20 summit ought to be an occasion for Mr. Obama to chide and chivy European leaders, in particular, into pulling their weight.

But these days foreign leaders are in no mood to be lectured by American officials, even when — as in this case — the Americans are right.

The financial crisis has had many costs. And one of those costs is the damage to America’s reputation, an asset we’ve lost just when we, and the world, need it most.

This post can also be viewed on economistsview.typepad.com.

The Mess That Is The State Of California

California is an absolute mess right now — there really is not any other way to put it. Unemployment is incredibly high — and getting higher — the real estate market has fallen off a cliff, and of course their government is completely inept — to put it nicely. If you thought there was a lot of doom and gloom going around in regards to the U.S. economy as a whole, it is even worse in the state of California. The truth is the U.S. badly needs California to get better — and soon. The state owns the largest economy in the union, and so goes California so goes the country. Tim Iacono looks at a recent Forbes article that details out some of the issues facing California in his blog post below.

This report in the current issue of Forbes Magazine is chock full of aphorisms about the tarnish now building up on the Golden State. Importantly, more than just the weather moves eastward from California - economic and social trends head that way as well.

There has been many a time in California's history when it seemed to outsiders to be barreling toward a cliff and to insiders as a place for unbounded optimism. A favorite Silicon Valley bumper sticker says, "Dear God, one more bubble before I die."

Is it just me or is it fast becoming conventional wisdom that we need a new bubble to take up the slack created by the bursting of the last two?

Despite the rhetorical flair of the new President on the subject of future bubbles, it seems clear to me that, given the deleterious effects of the current bubble's demise, the entire nation would jump headlong into a new bubble of any kind if some asset prices somewhere would start to rise and if job losses would ebb.

Anyway, back to the troubles in California.

Tent cities of displaced homeowners have sprung up in the state's Central Valley--even in the capital, Sacramento. Anthony Sanders, a professor of real estate finance at Arizona State, terms the huddles Mozilovilles, after the former Countrywide Financial chief executive. "Fresno is a nuclear wasteland. I wish there were a nicer way to say it," says Patrick Lashinsky, chief executive of ZipRealty in Emeryville.
The squatters living in abandoned homes are a greater threat to the economy than unemployment and crashing housing, Lashinsky says. "The damage done to the homes makes the ultimate resolution of foreclosed properties even more expensive to investors and banks." In Riverside suburb Lake Elsinore, families of bobcats have taken up residence in vacant homes. The cats miss just as many mortgage payments, but at least they don't steal copper pipes.

Not all businesses are struggling. Bank Repo Bus Tour, whose red-topped buses cruise the Central Valley's foreclosed-home cul-de-sacs, is doing a land-office business selling tickets to people looking for speculative buys. Thanks to sales of statuettes of Saint Joseph, the patron saint of home sellers, revenue from California customers is up 25% from a year ago at Catholic Supply, a firm in St. Louis, Mo.

Santa Cruz, along with larger cities like Los Angeles, San Diego and San Francisco, helped lead the screwball state to its worst performance ever in our annual rankings of Best Places for Business and Careers. Without Flint, Mich. competing, California would have had a stranglehold on the bottom six positions on our list. High business costs, negative job-growth projections, high unemployment and high crime make this a scary place. California has 36 million people and 480 incorporated cities and as recently as two years ago fielded four metro areas in the top 100. This year only Riverside cracked the top half.

"If I even mention California, they throw me out of the office," says Ronald Pollina, president of relocation firm Pollina Corporate Real Estate in Park Ridge, Ill. "Every company hates California."

The airwaves are full of advertisements urging residents to make that automobile purchase before next Wednesday when the sales tax goes up by a full percentage point - in some parts of the state, the tax will top 10 percent.

If all goes well, we'll be leaving California on a permanent basis in exactly two months.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

New Home Construction Starting To Pick Up

Yet another piece of good news relating to the housing sector was released this week. This time we learned that housing starts were up considerably last month. Again it is way to soon to call an end to the housing crisis, but the sliver of good news is welcomed by the real estate industry. For more on the report, read the following post from OverseasPropertyMall.com.

Latest reports from the US show a renewed sense of hope in the housing starts department as figures showed a 22 percent rise in February from the month of January. New work on some 583,000 homes is seen to be a positive sign and indication that maybe the worst of the US housing slump is over.

While the warmer weather is partially responsible for the jump in new construction, analysts do not believe this new rate will be sustained in the future. Most of the new housing starts are apartments and condominiums.

Plus, there still are hundreds of thousands of unsold properties on the market, keeping the recession tight. Despite the non shifting property market, economists think that “the worst of the contraction may have passed.”

Another indication that the US decline has come to a slowdown are the increased retail figures for the month of February.

Narimah Behravesh, chief economist at IHS Global Insight was saying: “You get the sense from a lot of the data coming out now that we’re beginning to get to a bottom. We’re not quite there yet.”

However, despite these positive signs, future construction might not be taking off like a rocket as new building permits weren’t increasing as much as the new starts. They rose by 3 percent.

Projected figures indicate that starts are thought to be around the 450,000 houses annually.

The Northeast is Leading the Pack

A powerful 89 percent surge was seen in the US Northeast in new housing starts, giving them the run of the pack for sure. With low interest rates and plans to further reduce mortgage cost to help resurrect the US property market, the Obama administration is working hard on putting systems in place to make this happen in the near future.

As long as US banks can keep the credit flowing there might be hope. Since the recession start there were some 4.4 million job losses in the country.

Obama’s pledge of a $275 billion rescue plan is supposed to help current home owners keep their houses in order to avoid foreclosures.

In February alone foreclosures increased by a whopping 30 percent from the year previous. Since foreclosures are cheap properties to attain by investors, property developers are finding it hard to raise their capital for new development.

This post can also be viewed on overseaspropertymall.com.

The Big Difference Between Our Recession And Japan's Lost Decade

There has been a lot of talk about how we are heading down the same path Japan did with their "lost decade." Before anyone gets to excited about that proclamation, though, they should understand there is one major difference. Tim Iacono looks at a report in his blog post below that details this dissimilarity.

Rich Toscano and John Simon of Pacific Capital Associates filed this report about changes in Japan's money supply during the 1990s and how the U.S. compares as we enter what some are also calling a lost decade.

Here's the chart that gets directly to the bottom line.
We appear to be trying a lot harder than they ever did.

The entire piece is well worth a look. A few excerpts...

In our prior article on the government's willingess and ability to create inflation, we noted that Japan is often held up as an example of a country that was unable to inflate despite having a fully paper-based monetary system. But while the crash of Japan's credit-fueled stock and real estate bubbles resembles our own situation, the monetary policy responses in each case have been markedly different.

It's true that the Japanese authorities did not create any enduring price inflation after their credit crash. But a quick look at the data shows that this is because they opted not to do the one thing that can reliably create eventual inflation: rapidly grow the supply of money in circulation.
...
It is widely understood and agreed upon that substantially increasing the amount of money in the economy will eventually lead to inflation. Yet the Japanese authorities did not take this course. Did they not think to even try it? Did it just never come up at any Bank of Japan meeting for an entire decade?

We think a more plausible explanation stems from the fact that Japan was a nation of savers. Forcing up inflation via broad currency debasement would have harmed Japanese voters by undermining the purchasing power of their savings. As a result, accepting the mild (if lengthy) deflation was likely a more politically viable option than flooding the economy with money.

While bad for savers, inflation is good for debtors because it reduces the purchasing power-adjusted burden of debt. Here in the United States, the authorities face exactly the opposite constraints as those faced in Japan in the 1990s. Our nation is highly indebted and has a low savings rate. In this situation, deflation is a lot more painful than inflation. Politics demanded that Japan avoid inflation - and politics now demand that the United States embrace it.

Whatever the reason, it's very clear that the policy response being pursued by the US is vastly different from what took place after Japan's credit bust. Those predicting a repeat of the Japanese experience should take note.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

More Good Economic News: Is The Crisis Finally Winding Down?

We are finally starting to see some positive economic reports — and it is very tempting to say that the economic crisis is winding down — but is it to soon to call an end to this mess? James Picerno from The Capital Spectator looks at some of the recent news and offers his opinion in the blog post below.

The first order of business in repairing the economy is reestablishing a stable rate of inflation, ideally a small dose just above zero. There's inherent danger in targeting higher inflation, but it's a necessary evil at the moment, and there are signs that the effort is working.

Exhibit A is the yield spread between the nominal and inflation-indexed 10-year Treasuries. The spread is considered the market's inflation forecast. Although no one should confuse this outlook with perfection, it does reflect market sentiment to a degree and it's also monitored by the folks at the Federal Reserve, among countless other statistics.

As our chart below shows, this spread continues to exhibit an upside bias, and in the current climate that's encouraging. As of last night's close, the Treasury market is forecasting a 1.3% inflation rate for the next 10 years—up from virtually zero late last year. Certainly the extreme lows of last November and December appear to be history, at least for the moment. That's heartening because it suggests that the market's modestly encouraged that deflation's threat is passing.

Insuring that deflation doesn't take root has and remains the priority for stabilizing the economy and laying the foundation for recovery, as we've been discussing in recent months, including here and here. The good news is that progress in this battle continues to accumulate, and the above chart is but one example.

A more general measure of the improvement in the reflationary war is suggested by today's update on new orders for durable goods, which posted a healthy seasonally adjusted rise of 3.4% last month—the first monthly rise since last July.

The jump in new orders, although not consistently positive across the board, was broad enough to suggest that the gain wasn't a statistical fluke. A few examples: new orders for machinery advanced more than 13% last month while new orders for computers and electronic products climbed nearly 6%. Excluding defense department-related items, new orders increased 3.9% in February.

No one should read too much into this report, of course, as one month could easily be statistical noise. After six months of declines, durable goods were due for a pop even if the recession roars on. Deciding if it's the start of stability vs. a pause in the ongoing contraction will take time and a fair amount of corroboration from other economic and financial measures. But one implication is that businesses are starting to react to lower prices by taking advantage of the bargains.

In other words, we can't dismiss the prospect that the massive liquidity injections engineered by the Fed and Congress are starting to work. Once there's more confidence on that front, it's time to adjust monetary policy and begin soaking up all the excess dollars floating about. Timing is always a gray area of course, but it's certainly prudent to go on heightened alert at this point.

Consider the latest new from Britain, which reported that inflation took a surprising jump higher last month. Consumer prices climbed 3.2% for the year through February, raising fresh questions about whether monetary policy in England is too loose. Alas, it's unclear if the inflation news is a sign of things to come or just a "hiccup along the way" to more falling prices generally, as one economist tells Bloomberg News. Of course, with many economists forecasting more economic weakness for Britain, the inflation report raises the specter of stagflation.

In short, there's still plenty of volatility harassing the global economy. The idea that the worst is behind us is tempting, but it's not yet convincing. Stay tuned.

This post can also be viewed on capitalspectator.com.

Geithner's Comments Are Moving The Currency Markets

Timothy Geithner should quickly learn that currency traders take everything he says literally. Recent comments he made caused the dollar to take a nose dive. Geithner quickly followed those comments up with a retraction of sort, which left the markets unsure of his true intent. Currency expert Kathy Lien address this matter further in her blog post below.

How long will it take for Treasury Secretary Tim Geithner to realize that his comments move markets? When he first took office, he mistakenly threatened to brand China as a currency manipulator. This caused a wave of volatility in the currency market and sharp criticism about the experience of the new Administration. And now, Geithner has done it once again (Geithner Comments send Dollar for a Ride).

Even though President Obama said that the dollar is strong and there is no need for a reserve currency, Geithner suggested this morning that the U.S. is “quite open” to China’s suggestion of moving towards a Special Drawing Right (SDR) linked currency system. But just as quickly as he made those comments, he retracted them probably because an aide told him that the U.S. dollar is tanking. Minutes later, Geithner said there is “no change in dollar as world’s reserve currency and likely to remain so for long time.”

These contradictory statements are clearly the act of an amateur Treasury Secretary that is forced to eat his words.

Why has the dollar had such a big reaction to these comments? Because if the world adopts the SDR, which was created by the IMF as an international reserve asset, it would mean less demand for U.S. dollars.

source: eSignal

This post can also be viewed on kathylien.com.

The Circle Of Blame For The Housing Crisis

There are a lot of people who deserve blame for the housing crisis, but who are these people exactly? Dateline recently took it upon themselves to expose the key individuals that they feel are behind the mess. Some are easy to see, while others are a little more abstract in their involvement. Scott Wilson looks closer at the Dateline piece, and adds some of his own input in his blog post below from Your Mortgage or Your Life.

Sunday March 22, 2009, Dateline NBC aired a piece called “Inside the Financial Fiasco,” in which Chris Hanson finally takes a break from exposing sexual predators to take a closer look at the current housing mess.

NBC attempts to assign blame for the mortgage meltdown, and also tries to make it seem like they have finally identified the handful people who were the “only ones who knew” what lay in store for the economy when Wall Street embarked on the derivatives end-run that fueled the crisis.

So let’s go down the list of people that are prime candidates in the vicious circle of blame, and what their role where in the making of this fiasco.

Let’s start at the top. Back in the mid ‘90’s, The Government loosened credit guidelines and required lenders to make mortgages available to more to minority buyers.

By doing this, they gave the lenders an open check book to write questionable loans, all the while knowing that they would be able to sell them on the secondary market (Wall Street).

This was the creation of the infamous “Subprime” loans which later morphed into Alt-A and Expanded Approval loans.

Next, let’s look at the Product Managers who wrote the underwriting guidelines for the toxic loans known as SISA’s and NINA’s, which required little or no documentation of income and assets. The SISA loans are highlighted in the Dateline piece.

Do you think that these product managers had no idea that these types of loans may be misused, or did they only see the underlying profit that was possible from billions of dollars of loan fees collected by creating millions of loans that were virtually just ticking time bombs?

Yes, there are some cases where these loans were appropriate, such as for the business owner who had a lot of write offs, or the borrower whose spouse may not have the best of credit, but will nonetheless contribute towards the monthly mortgage payments.

But the types of borrowers who where actually put into these loans were completely unqualified, as mentioned in the NBC piece.

People like Delores Parker Jackson, who took out multiple loans on four condos totaling over $1.3 million with a negative (-$6000) shown on her tax returns.

Mrs. Jackson, who claims to have run a profitable daycare, and says that she is not to blame, but is actually the victim of predatory lending.

REALLY? She took out multiple mortgages on four different properties totaling over a million dollars with a payment of more than $10k a month, and she claims she had no idea that she could not afford the terms. Now she wants to pretend that she is not culpable, and that the mortgage company committed fraud?

Come on, do seem we that stupid?

Thirdly, let’s look at another “innocent” party: The CEO’s of all the banks and mortgage companies.

These people should have overseen the product managers and acted as the final line of defense by looking out for the company’s long term interests by saying “Hey, stop! These loans may be too risky.”

But the CEO’s saw only a “pot of gold” in the form of billions in loan fees, and where slaves to the corporate bottom line.

Do you think that Angelo Mozilo, the former CEO of Countrywide who earned over $400 million during his last five years at the company, had absolutely no idea that SISA and NINA loans with zero money down would backfire?

Chris Hansen attempts to talk to Mr. Mozilo, but to no avail.

Since he quit Countrywide and the mortgage mess started to blow up, Mozilo has been hiding out at his palatial estate in Southern California, ala Howard Hughes. Chris tried to get the guard at Mr. Mozilo’s gate outside his house to let him in, but was turned away.

Also to blame are the former CEO’s at places like Bear Stern’s and Lehman Brothers, who ended up driving their companies into the ground by buying up these toxic securities. And none of these guys saw the writing on the wall?

I think they did, but also saw big dollar signs in the racket, and choose to ignore the hazards.

Next up for their heaping of blame are The Borrowers. I was an LO for 15 yrs, and used Countrywide as a purchaser for many of my loans.

I knew that some of my borrowers were “less than qualified,” but the underwriting said to “make the loan.”

Like when I would be working for a builder, and a borrower would come to me and asked what loan amount they qualified for, my reply often was, “How much can you afford?”

I told them that I could tell them all day how much they can and cannot get approved for, but only they could tell me how much they really afford.

I could tell them on paper or with calculator that you could qualify to pay, but only the borrower could tell me if they could actually maintain that payment.

I cannot tell you how many times I was told by borrowers, “Don’t worry about me affording it. You just write that mortgage.”

This is where I move on to include the next culprit in this mess, The Loan Officers.

How many LO’s wrote loans for people that they knew would end up in foreclosure?

Many borrowers who I turned down for a mortgage would come back to me later to say, “See, I knew I could get approved. Thanks for nothing.”

At the height of the bubble, there were so countless mortgage brokers who were willing to do anything to write a loan and collect a fee.

They would falsify the numbers to make them work if they had to.

In the Dateline piece, they showcase a woman who was employed as a personal trainer, and who claimed to of told the LO at People’s Choice that she only made $1600/mo.

She was approved for a $259k loan.

Even after she was told that the payment would be over $2100/mo, she figured that she would just have her sister move in and help with the payment.

Do you think that the LO at People’s Choice had any idea that she may NOT be able to make the payment on this house? When Chris Hansen looked at the original paperwork, it stated that she made $7300/mo, which surprised the woman.

She claims she never provided that figure to the LO.

How many LO’s committed fraud because the commissions that they were going to make on each loan they closed could be well into the tens-of-thousands of dollars?

Even though my job was commissioned based, I only made loans if I had some degree of certainty that the borrower had both the ability to pay the mortgage payment and that they completely understood why I was giving them a SISA or NINA loan product.

I did not want a former borrower hunting me down in the parking lot some night after work because I put them in a loan that that left them flat broke.

Next in line is a major player, one who no one seems to put much blame on or even mention much, The Appraiser’s. I believe these guys had a huge impact on the housing explosion, and no one seems to want to bring them up.

As the appraisers continued to inflate the values of the properties, the mortgage companies continued to write mortgages to cover the obscene appraisals.

I knew that if a borrower told me that they were short on funds to close, I could call the appraiser and ask him to “bump up” the value of the property a bit, so that I could give the borrower the money cover closing costs.

This was considered a legitimate practice because real estate only increases in value, remember? But in reality, the value of that house did not go up $5k in the 2-3 weeks since they had done the actual appraisal.

I also found out the hard way how much of an “opinion” an appraisal really was.

Prior to working for the builder, I worked for a short time as a mortgage broker. I only did one loan at the place. , and it was for a gentleman who was doing some renovations on his house, but did not have enough money to finish the project.

Less than a year earlier, the value of the house came in at $85k. When he wanted to do another cash-out refinance a year later, but the new appraisal came in again at $85k. So when I went to my boss and told him that I did not have the value to support the loan, he handed me a business card and said, “Call him.”

Two weeks later, I had an appraisal for $115k, enough to cover the loan.

Was there that much movement in the values of the house? Did it really go up $20k in three weeks, or did the new appraiser just want more business?

What do you think? I know when I worked for one of the big mortgage companies and did a ton of refi’s, every time I had to put an initial value of a home on an application (which typically came from the borrower) nine times out of ten, the appraisal came back with the exact same value.

Curious.

Another big part of the mess, the people who were supposed to catch any fraud or mistakes, were The Underwriters.

They were the final check points in the mortgage process, and when they were presented with a SISA loan that showed that a “house cleaner” made $12k/mo, they should have sounded the alarm.

Like the appraisers, the underwriters are merely mentioned in the piece on Dateline.

Ilene Lanacano, who worked for “People’s Choice,” says that when she brought up some of these problems with the questionable loans, she was often overruled by the CEO of the company.

She states that she was often offered “incentives” by loan officers (money, jewelry, even a car) to approve loans. Ilene says that she never took any of these incentives.

She also claimed that there was harassment and intimidation if you did not approve loans, such as flattened tires and physical threats.

Ilene finally left “People’s Choice” for a consulting firm whose business was to analyze the loans to be pooled in Mortgage Backed Securities (MBS’s). When she raised some flags, she ended up getting in trouble by management.

Next, let’s look to good old Wall Street. You would think that one of the supposed guru’s of Wall Street could have seen the possibility that at least some of these loans were destine fail. But they too, only saw the bottom line, and they sold these MBS to everyone: investors, pension funds, municipalities and other countries.

And then there is China, who bought up trillions of dollars in MBS in an attempt to control the US. By owning all these MBS, China has a huge stake in our mortgage meltdown.

They were only briefly mentioned in the “Dateline” piece, and no real repsonsibility was levied on them. If China had not been so greedy, there wouldn’t have such a demand for MBS, which would have cut down the toxic loans being written.

And the Chinese are smart, shouldn’t they have seen some of the signs?

Next ones to heap some blame on are the Bond Rating Agencies, such as Standard and Poors, who was also briefly mentioned in NBC’s piece.

As Dateline explained, they were hired to give credit ratings to these MBS, which are supposed to indicate their level of risk to investors. “AAA” was the highest rating that they could give a security, and 80% of MBS received that top stamp of approval.

They suggested that most MBS would perform well, despite the fact that the agencies did not have any historical data to back the ratings up. Richard Gufliota of S&P, stated that they were so over inundated with securities to rate that most were not examined to the extent that they should have been.

It should also be mentioned that they made their money in volume too. More quantity over quality.

Finally, a lesser acknowledged culprit of this financial fiasco is The Media itself.

If it wasn’t for the greed of the media (TV, Radio and Newsprint), rolling out with advertisement after advertisement for these mortgage companies and their products, borrowers would not have been so encouraged to accept some of these toxic loan.

In years leading up to this mess, there wasn’t a commercial break that did not produce a mortgage ad.

Often advertised were the No Closing Cost, Stated Income, No Income Verified, and so forth.

There wasn’t a Radio host in the nation who didn’t have at least one mortgage company in their back pocket paying them to be their spokesperson.

Did any of them look into the products that they were pitching to their listeners? Nope. I think they just laughed all the way to the bank.

And what is strange about the media’s role, is that I have yet to see anyone try to add them into the equation. Now, all you hear out of radio talk show hosts spewed crap about how everyone else is to blame. None have come forward to say, “Hey, I guess I had a hand in it too.”

All in all, it is going to be a vicious circle of blame.

There is plenty of blame to go around, and I think when it comes down to it, we can sum it all up with one little word: “GREED;” the Greed of the Government, the greed of the Product Managers, the greed of the CEO’s, the greed of the borrowers, the greed of the Loan officers, the greed of the Appraisers, the greed of the Underwriters, the greed of Wall Street, the greed of China, the greed of the Bond Raters, and greed of the media.

This post can also be viewed on yourmortgageoryourlife.wordpress.com.

Existing Home Sales Up: NAR Says Buy Now

Existing home sales rose in February giving another possible sign the housing market is nearing bottom. The National Association of Realtors (NAR) has also undertaken an ambitious marketing push to convince Americans that now is the time to buy. Naturally the NAR is going to take this data and use it to further their message, but what can we believe? On one hand the NAR has made some valid points, but then again they are obviously a biased source. Tim Iacono advises us to be weary of what the NAR is telling you, and looks closer at the recent data release in his blog post below.

The National Association of Realtors reported that existing home sales rose from a seasonally adjusted annualized rate of 4.49 million units in January to 4.72 million units in February, almost half of the sales being either foreclosures or short sales.
Though not too much should be made of any of the housing data during the winter months since sales are just a fraction of what they are during the summer months, the inventory of unsold homes remains quite high, rising 5.2 percent in February to 3.8 million units, representing 9.7 months of supply at the current sales rate.

This is about double the normal inventory and, excluding distressed sales from the calculation, this would be about four times typical levels.

Lawrence Yun, NAR chief economist, noted the following:

Because entry level buyers are shopping for bargains, distressed sales accounted for 40 to 45 percent of transactions in February. Our analysis shows that distressed homes typically are selling for 20 percent less than the normal market price, and this naturally is drawing down the overall median price.

The median price for an existing home fell to $165,400 in February, down 15.5 percent on a year-over-year basis and Mr.Yun attempts to dismiss this decline:

Given the downward distortion in price comparisons due to distressed sales, it’s important for owners to keep in mind that this doesn’t equate to a similar loss of value for traditional homes in good condition.

The national data in the most recent report(.pdf) on the Case-Shiller Home Price Index showed an annual home price decline of 18.2 percent, so Mr. Yun is probably seeing things through glasses that might be a bit rosy here.

What a surprise!

It's probably a great time to buy a home...

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

The Toxic Asset Problem: In Layman's Terms

More and more people are starting to pay attention to the economy, and specifically the actions the government is taking to rectify it. One problem that many people are running into, though, is that things in the financial world are getting pretty complicated. We have these things called toxic assets that are destroying banks, but how did they get to be toxic? Furthermore why are they causing so many problems? When most Americans hear about the plans to fix the toxic asset problem, their heads are probably spinning. Economics professor Mark Thoma to the rescue. In his blog post below, Thoma does a great job of breaking the problem — and several of the proposed solutions — down into layman's terms using a car analogy.

Imagine a car lot that has 100 cars on it. However, some of these cars have problems. Half of them will have engine troubles that total the cars - the engines blow up and the cars are then worthless - and this will happen just after purchase. The other half are perfectly fine. Unfortunately, there is no way to tell prior to purchase which type of car you will get no matter how hard you try. Thus, half of the assets on the car dealer's "balance sheet" - the cars on its lot - are toxic, and lack of transparency makes it impossible to tell which ones are bad prior to purchase.

If all the cars were in perfect shape, they would sell for $20,000 each. Thus, there are (50)*($20,000) = $1,000,000 in assets on the books according to one way of doing the accounting, but that doesn't necessarily represent the true value of the cars on the lot.

The town where this dealership is located relies upon this business for jobs, it is essential, but, unfortunately, business has fallen off to nothing. Nobody is willing to risk losing $20,000 by purchasing a car that might die just after purchase, so the price has fallen. The expected value of a car is $10,000, but it's an all or nothing proposition, the car runs or it dies, and since people are risk averse nobody is wiling to pay the $10,000 expected value. In fact, the highest price they are willing to pay, $6,000, is lower than the minimum price the dealer is willing to accept (I've assumed a reservation price of $7,500 for illustration, and a horizontal supply curve to make the illustration easier):

So how could the government fix the problem?

1. Government purchases of toxic cars

The government could buy the cars itself, say at $7,500 per car, or $750,000 total for the lot, drive them around a bit (stress test them), wait for the bad ones to blow up, then sell the 50 good cars back to the public (who will no longer be fearful since the bad cars are out of the mix). If they can get anything more than $15,000 for each good car, they will make money on the deal (well, there would be overhead and other costs to cover, but let's abstract from minor details). But if cars end up selling for less than $15,000, they will take a loss.

(In the graph, the government intervention shifts the demand curve outward until it intersects at the kink in the supply curve at Q=100).

The problem with this option is knowing what price to offer for the cars. There is no market, and the firm's reservation price may be too high, i.e. paying the reservation price will eventually lead to a loss. And it's worse. In this example the percentage of bad cars is known, but the percentage of bad cars would also be unknown in a more realistic example, so there's no way to know how many good cars there are for sure, and what price they will sell for after the defective cars have been culled out of the herd. If the government pays $7,500 per car, and more than 62.5% of them go bad (not that much more than the 50% estimate), then taxpayers will lose money even if they sell for $20,000. With the percentage unknown, there's no way to know for sure what the breakeven price will be.

This is, in essence, the original Paulson plan. The only twist is that the price - the $7,500 in the example above, would be determined by an auction among many dealers with the government accepting the lowest bid (which could be $7,500 in this example since that is the price the firm is willing to accept). As you can see by thinking this through, there are questions about what price such an auction would reveal.

One danger in this plan is that if you overpay for the cars, e.g. give $7,500 when the breakeven price was, say, actually $5,000, then you have given the owner of the car lot $250,000 more than the cars were actually worth (this will be the loss to taxpayers). The dealer may need this money to stay solvent and stay in business, but, nevertheless, it is a windfall.

There are a lot of uncertainties here, and lots of ways to lose money. But it's possible to make money too.

2. Subsidies and Public-Private partnerships

Here, the government offers a subsidy to private sector buyers. Suppose that the demand curve intersects the vertical line in the graph (at Q=100) at a price of $4,000. Then in order to sell 100 cars, the government must subsidize buyers by $3,500 so that the $4,000 offer is raised to the $7,500 the firm is willing to accept (notice that the buyer willing to pay $6,000 gets a $2,000 windfall, so, except at the margin, this plan gives surplus to people purchasing the assets - as with the first plan, this shifts the demand curve out until it intersects at the kink in the supply curve).

However, once again, the government will not know if it is getting this right or not. Suppose it offers a $1,000 subsidy thinking that is generous enough. In this example, that won't bridge the gap between the highest offer of $6,000, and the reservation price of $7,500. Thus, the subsidy would be too small to restart the market and the plan would fail. So the answer is to make the subsidy large enough to encourage buyers, but the problem is that if it is too large, the government will be giving money away unnecessarily.

And there's another problem. If there's a large gap between what people are willing to pay and what dealers are willing to accept(the gap between $6,000 and $7,500 in the example), this would be problematic politically since it would require subsidies that are unacceptably large.

And I should note that it doesn't have to be a subsidy. That's one way to do this - as a giveaway - but another way is through a no recourse loan (what is being called a partnership). Suppose that the government gives (up to) a $3,500 loan to a private sector buyer to purchase the car for $7,500. If it's a good car and the value rises above $7,500, say to $15,000, then government will get paid back (with interest) since the asset can be sold profitably (another option is for the government to demand a share of this profit through warrants or other means). But if it's a bad car, the price falls to zero and the loan is forgiven - it does not need to be repaid. So the private sector agents only have to put up a fraction of the price to control the asset, and their losses are limited to the amount they put up while the gains are potentially large.

This is, in essence, the Geithner Plan. If many of the loans are not repaid, or if the subsidy is too large, it could lose a lot of money, but it could also make money too.

3. Nationalization

Now for the Saab story. Another option is for the government to simply take over the car dealership. The dealership is essential to the economy of the town, without it people will struggle, and the government - for that reason - might consider temporarily taking over the dealership to prevent failure. In doing so, it would make an evaluation of the company's assets, pay off the people who loaned the business money up to this amount, which may require having them take a haircut, i.e. accept some percentage of what they are owed on the bad loans they made, and the owner would simply be wiped out (which is a benefit since the business is insolvent and this allows the owner to escape the loans that cannot be paid through liquidation).

After taking over, the government would stress test the cars it now owns, put the bad ones in the junk pile, and sell the rest back to the public. So long as it didn't pay the creditors too much when it took over, i.e. the haircut is sufficiently large, it ought to make money on the deal. But it could lose money here too.

The Point

But, and I want to stress this, the point of these plans is not to make money, the point is to keep the economy of the town going, to keep people employed. If people place a large value on security, then even if the government takes a loss on paper, it may not be an economic loss. That is, we must put a value on the jobs that are saved and the security it brings (simply imagine that the utility function has risk as one of its arguments - by lowering the risk of job loss and the associated household disruption, you have made the agent better off, and this must be counted against any loss from any of the programs above). There is value in economic stability and security over and above whatever the government makes (or loses) on the actual financial transactions, and this must be factored into the evaluation of the policy.

This post can also be viewed on economistsview.typepad.com.

Fire The AIG Traders: It Worked In The 90's Asian Financial Crisis

Most American's are up in arms about the bonuses paid out to the very AIG traders that caused the company to fail. The company has been defending the bonuses saying that they need to retain the traders due to their exclusive knowledge of the financial products they are trying to wind down. This same argument was made during the Asian financial crisis of the late 90's, and the countries that didn't listen to it ended up much better off then the ones that did. For more on this, read the following post from Mark Thoma.

James Kwak and Simon Johnson say the arguments made to support paying bonuses at AIG - that the bonuses are needed to retain people with specialized knowledge - do not withstand closer scrutiny. Not only can the "discredited insiders" be replaced, it's best when they are:

Off With the Bankers, by Simon Johnson and James Kwak, Commentary, NY Times: A.I.G. can hardly claim that its generous bonuses attract the best and the brightest. So instead, it defends the payments by arguing they’re needed to retain employees who are crucial for winding down transactions that are “difficult to understand and manage.” ... There is no reason to believe this.

Similar arguments made during the 1997 Asian financial crisis ... turned out to be a smokescreen to protect the executives who were partly responsible for the mess. Recovery from that crisis required Indonesia, South Korea and Thailand to close or consolidate banks. In all three countries, bankers protested, claiming that their connections with borrowers were critical to recovery. ...

The leaders of Thailand and South Korea did not listen to such arguments, and thank goodness. Some of the leading Thai banks were taken over by the government. After the crisis, a civil servant in charge of one such bank noted that its bad loans were much bigger than had been indicated before the takeover, largely because of an internal coverup. Only when outsiders took over did the public discover the full scope of the losses. ...

But these reforms made all the difference. Banks became healthy and resumed lending within a few years after the crisis broke. ...

Indonesia did not respond to the crisis so wisely, and the costs were severe. ... The lesson of all this is that when insiders have broken a financial institution, the most direct remedy is to kick them out. Traders are hardly in short supply, and you don’t need to rely on the ones who made the toxic trades in the first place. Companies must always plan around the potential departure of even their star traders, or they are certain to fail. ...

If A.I.G. wants to argue that complex transactions, hedging positions and counterparty relationships require employees who are intimately familiar with those trades, it should at least provide evidence that the arguments for doing so are sounder than the ones made in Indonesia in 1997, when leading bank-owning conglomerates claimed that only they understood their financing arrangements... We heard variants of the same idea in Poland in 1990, Ukraine in 1994 (and in the Ukrainian crises subsequently), and Argentina in 2002.

Any grain of truth in these arguments must be weighed against the costs of allowing discredited insiders to manage institutions after they have blown them up. Even if the conclusion is that a few experts need to be retained, offering guaranteed bonuses to virtually the entire operation is hardly the way to achieve the desired results. We should not let people think that the best way to guarantee job security is to lose lots of money in a really complicated way. The argument that A.I.G.’s traders are the people that we must depend on to save the United States economy is ... weak and self-serving...

This post can also be viewed on economistsview.typepad.com.

The Las Vegas Real Estate Horror Show — In Graph Form

We all know that things have been bad in the Las Vegas real estate market, but just how bad is it? A vast majority of the sales happening now are foreclosures, and the exact numbers might be frightening — even to those who don't own a house there. For a graphic depiction read the the following blog post from Tim Iacono.

This report from the Las Vegas Sun carries one of the better graphics that have crossed my computer screen lately depicting the extent to which distressed sales have impacted the local real estate market in and around "Sin City".

Of course, conditions are much worse in Nevada than in most other parts of the country, but large swaths of California, Florida, and Arizona probably have real estate sale figures that are not too different from these. The report by Chris Morris and Alex Richards contains just the following commentary.

When Nevadans started to realize they were at the epicenter of a full-blown foreclosure crisis in 2007, riding a rising wave of loan defaults that eventually turned into auctions and bank repossessions, they didn't really understand what was in store for the real estate market. In the valley today, foreclosure sales largely outpace regular sales, and they drive the median price of single-family homes down considerably — by roughly $25,000 in February.

The graphic really tells the story:

Nice work.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.