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.

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.

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.

Q1 GDP Contracts At A Much Faster Than Expected Pace

Just when investors were starting to feel better about the economy, the GDP report came out — and the news was really bad. According to a Dow Jones Newswire poll of economists, it was expected that the economy would contract at a rate of 4.6 percent in Q1. Naturally the 6.1 percent came as a huge surprise, and one that shows us that we might be getting ahead of ourselves thinking this recession is wrapping up. For more on this, read the following post from Tim Iacono.

The Commerce Department reported that the U.S. economy contracted at a pace much faster than expected during the first quarter as business investment posted a record decline and exports of U.S. goods experienced their biggest drop in more than 40 years.
Following the fourth quarter's 6.3 percent pace of contraction, the U.S. economy shrank at a seasonally adjusted annualized rate of 6.1 percent last quarter, surpassing the consensus estimate of minus 5.0 percent. This was the worst back-to-back performance in 60 years.

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

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.

Hong Kong Set To Take Off Thanks To Bernanke

Thanks to the chairman of the U.S. Federal Reserve — Ben Bernanke — Hong Kong is about to take off. It might seem a little weird that Bernanke could impact Hong Kong so drastically, but because Hong Kong's currency is so closely linked to the U.S. dollar they are forced to follow the Fed's every move. That — coupled with the fact Hong Kong's stocks are undervalued — is creating a perfect storm for Hong Kong's market. For more on this, read the following article from Dr. Steve Sjuggerud at Daily Wealth.

Ben Bernanke has cut short-term interest rates in the U.S. to essentially zero... the lowest rate we've ever seen.

He's doing this, of course, to "juice" the economy – to give it a jumpstart. He doesn't know (or care, actually) that this action will inadvertently (but undoubtedly) cause one particular stock market to go absolutely nuts.

This stock market I'm talking about is Hong Kong. Today, we have the ultimate recipe for stocks in Hong Kong to skyrocket. The Fed has cut interest rates to essentially zero (causing Hong Kong rates to be next to zero in its unique money system). And yet Hong Kong stocks are incredibly cheap. They bottomed a month ago at a single-digit price-to-earnings (P/E) ratio.

We've seen this before:

• In 1992-1993, the Hang Seng Index shot from 5,500 to 12,000. At that time, the Fed had cut interest rates below the rate of inflation. So "real" interest rates were below zero.
• The Fed did it again from 2003-2005. And in that time, the Hang Seng Index jumped nearly 7,000 points, from a low of 8,600 to 15,500. (It continued to rise... peaking over 30,000 in 2007. That's four times your money from 2003 to 2007.)

And it's happening again, right now... The Fed has cut interest rates to zero, and the uptrend in Hong Kong has arrived. It's time to get in.

While Ben Bernanke is trying to help the U.S., he's unwittingly creating havoc on the other side of the globe...

Hong Kong is quite an incredible place... With no natural resources, the standard of living has gone from subsistence wages to one of the highest in the world in just a few decades.

I believe two things contributed to Hong Kong's boom... 1) Hong Kong has been for decades one of the "freest" markets in the world, allowing entrepreneurs to succeed or fail. And 2) Hong Kong has had a stable currency, thanks to its unique currency system. For the last 25 years, the Hong Kong dollar has been worth about US$7.80, give or take a few pennies.

Hong Kong's unique currency system is called a currency board. A country that has a true currency board has one U.S. dollar in the bank for every dollar of its own currency that it prints. How does it keep the exchange rate equal? Through interest rates...

Interest rates in Hong Kong dollars are always higher than in the U.S. Depositors are willing to "take the risk" on the Hong Kong dollar for the slightly higher yield.

As a result, Bernanke essentially controls interest rates in Hong Kong. Whether Hong Kong is in a boom or a bust, he doesn't care. So Bernanke could be raising or cutting interest rates at precisely the wrong time in Hong Kong's business cycle.

Therefore, Hong Kong's stock market is subject to wild booms and busts, based on what the U.S. Fed is doing with interest rates.

As I said, today we have the ultimate recipe for stocks to skyrocket in Hong Kong. Interest rates are next to zero. And Hong Kong stocks are cheap, hitting single-digit P/E ratios a month ago.

I have two nearly guaranteed "rules" for making money in Hong Kong...

First is the "Hong Kong Can't Help It Rule." That's when the U.S. Fed cuts interest rates below the "market" rate. This means "real" interest rates are below zero. When this happens, buy Hong Kong... It can't help it. It soars.

The second rule is the "20/10 Rule." In short, you want to be a buyer of stocks in Hong Kong when the P/E ratio falls below 10. And you want to be a seller when the ratio rises above 20.

Hong Kong stocks often soar by hundreds of percent after they fall below a P/E of 10. And often they lose half their value soon after they rise above a P/E of 20.

Right now is an extraordinary moment... both rules are in play... AND we have an uptrend in Hong Kong stocks that started last month.

You should consider buying Hong Kong shares now... Triple-digit gains are possible... and you can limit your downside risk by using a trailing stop. Those are my kind of odds!

Dailywealth.com offers a free daily investment newsletter which focuses on contrarian investment opportunities.

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.

Is $250,000 A Year Really "Wealthy?"

President Obama keeps saying he plans to pay for much of his new spending with taxes on the wealthy, but what should be considered "wealthy?" According to Obama's campaign speeches "wealthy" means families earning more than $250,000 a year, but $250,000 isn't worth as much in New York City as it is in Des Moines, Iowa. Many of these families are challenging Obama's assessment of what should be considered "wealthy," saying how they make more than that but are struggling to get by. Tim Iacono doesn't offer these families much sympathy, but looks closer at the situation in his blog post below.

There have been more than a few comments left here by readers over the years about families with big salaries and/or bonuses carping about how tough it is to get by on just a couple hundred thousand dollars a year in income.

Always of modest means, never having had to foot the bill for little ones around the house, and having avoided living and working in the Bay Area, my view of things is probably a bit slanted in the other direction but, to me, a quarter million dollars a year looks to be a huge opportunity to sock money away for retirement.

Via the Wall Street Journal comes this tale of the difficulty some have in making ends meet.

Ellen Parnell and her husband, Donald Parnell Jr., seem like the kind of well-off couple President Barack Obama has in mind when he suggests raising taxes on families earning more than $250,000 a year. A surgeon at Fort Sanders Sevier Medical Center in Sevierville, Tenn., he drives an Infiniti. They vacation at a beach resort every year.

Yet, right now he is working seven days a week. The car is more than a decade old, the vacation home in Sandestin, Fla., comes at a moderate weekly rate because members of Ms. Parnell's extended family own it. Her family of five would like more room than they have in their 2,500-square-foot home, yet they can't afford anything larger. The downturn has them skittish about paying for renovations.

While not familiar with the local real estate market at all, clearly, you can get a lot of house for not too much money in Sevierville.

The story continues:

"I'm not complaining, but the reality is Obama may call me wealthy, but I thought we were just good old middle class," says Ms. Parnell. "Our needs are being met, but we don't have a load of cash to cover wants."
...
Wealth and comfort "depends on where you're coming from," said Lois Avitt, a sociologist and founding director of the Institute for Socio-Financial Studies in Charlottesville, Va. To a family earning $50,000, $250,000 is well off, but for the family earning $250,000, rising college and medical costs and dropping home values make the perception debatable.

The reasons for the insecurity are that net worth is declining at the same time that expenses like education and health care, two of the biggest concerns cited by members of that income group, are going up faster than wages and income, says Heidi Shierholz, an economist at the Economic Policy Institute in Washington. "Those are the biggies. They are huge parts of the set of middle-class aspirations, and the prices of those have increased way faster than income." The bursting of the housing bubble makes that more stark.
...
San Jose, Calif., Mayor Chuck Reed calls a family living in Silicon Valley earning $250,000 "upper working class." That is about what two engineers working at a technology firm can expect to make, but "a family earning $250,000 a year can't buy a home in Silicon Valley," he said.

James Duran owns a human-resources company in Silicon Valley and is president of the Hispanic Chamber of Commerce in California. He supported Mr. Obama, but is worried about the tax proposals. He has laid off some employees in recent months and has been wondering how he can fund an extension of those workers' health-care benefits.

Mr. Duran said he and his wife earn about $400,000 annually, but "I'm barely getting by." They have high property and state taxes, as well as college tuition and savings to cover. "I'm an Obama man, but this side of him is a difficult pill for me," he said.
...
For the Parnells, their perception of themselves is based on the math. The value of their house is down $60,000. Ms. Parnell says the couple's gross income last year was about $260,000. Taxes, premiums for medical care and deductions for Social Security and their 401(k) contributions cut the gross to about $12,000 per month. The family tithes $1,300 a month at their church. Their mortgage, second mortgage and payment on land they bought is nearly $4,000 a month. Other expenses, including their family car payment, insurance and college funds, as well as basics like food, utilities and donations to charities, leave them with about $1,200 left over each month.

"I'm not after sympathy. We are blessed. What I want is a reality check on what rich means," Ms. Parnell says. "I can pay my mortgage and I can buy some clothes. I'm not going without, but I'm not living a life of luxury."

The Parnells should probably take a basic personal finance class or two and many of their problems might quickly be solved - that $4,000 a month in mortgage payments for a house that's too small, and some other property, should have set off alarm bells long ago.

Also, that top line of $260K that erodes to $144K after 401k contributions, medical care premiums, and taxes sounds a bit excessive - you can quickly get to about $40K for the first two items leaving their tax hit at $75K.

Does that sound right?

It's a good thing Ms. Parnell is not asking for sympathy because she's not likely to get any.

This post can also be viewed on 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.

The Fed Is Running A "Laboratory Experiment" On What Drives Inflation

A former Fed governor says the Fed is basically running a laboratory experiment on what drives inflation. Of course that terminology probably doesn't sit well with most Americans, who are looking to the government to fix our economy, it is close to the truth. Beyond the laboratory experiment, though, there is a potentially bigger problem with the Fed. It is looking more and more like the Fed's independence is being squandered...again. There is a reason why the Fed was made independent, and it wasn't to succumb to every whim of the Federal government. For more on this, read the following article from Tim Iacono.

With growing optimism that the worst may now be behind it for the U.S. economy, a growing number of observers are starting to look at what sort of an economic landscape might take shape should the optimists be right, given all the money creation over the last year or so to bailout financial firms and effectively nationalize the mortgage lending industry.

According to Allan Meltzer, one of the world's foremost experts on U.S. monetary policy, the outlook is not good and it has much to do with the historical role of the Federal Reserve as an independent organization as described in this report at Bloomberg.

Meltzer says political pressure will prevent Bernanke, 55, and fellow policy makers from withdrawing liquidity quickly enough as the economy recovers. That’s similar to the pattern that occurred back in the 1970s, he says. Then-Chairman Arthur Burns allowed excessive money-supply growth because he was unable or unwilling to resist pressure from President Richard Nixon’s White House to hold down unemployment, leading to the “great inflation” of that era, he says.

Now, Bernanke and fellow policy makers have “squandered their independence” by becoming involved in bailouts of financial firms and by taking long-term and illiquid assets onto their balance sheet, Meltzer says. “They don’t have the political ability to control inflation.”

It really is too bad for the central bankers of the world that the labor market is a lagging indicator. During the latter stages of a recession, when other economic statistics begin pointing unambiguously upward, job losses generally continue at a healthy pace and this can make reining in easy money an exceedingly difficult task.

That's one of the most important reasons why the Federal Reserve was created as an independent organization - to do what's best for the economy in the long-term regardless of the political whims and wishes in Washington.

[Note: Yes, the most important reason for the Fed's independence is its unholy relationship with big New York banks, but that's an entirely different discussion.]

Anyway, with many now seeing "green shoots" all over the landscape, the inflation/deflation debate looks set to heat up once again, and Fed policy is right in the thick of things.

“All that money is going to find a home,” says Ken Mayland, president of ClearView Economics LLC in Pepper Pike, Ohio. He sees oil prices increasing to “$80, $90, $100 before the end of next year” from $52 a barrel now.

Commodity prices may be more prone to rise as the world economy recovers because tight credit and volatile pricing will discourage investment in new supplies, says Mark Zandi, chief economist at Moody’s Economy.com, in West Chester, Pennsylvania.
...
Some Fed policy makers seem more worried about deflation than they do about inflation. A sustained fall in prices can debilitate the economy by causing consumers and businesses to postpone purchases.

“For some time to come, disinflation, and even deflation, will represent greater risks than inflation,” San Francisco Fed President Janet Yellen said in a speech on March 25.

At the root of that concern is substantial and growing slack in the economy, which, according to White House chief economist Christina Romer, is operating 5 percent to 10 percent below potential. That means the economy will have to grow a percentage point above trend -- reckoned by the administration to be about 2.5 percent annually -- for five or more years before the slack is used up.

The Phillips curve -- developed by economist A.W. Phillips using Keynesian concepts -- posits that such excess will reduce inflation as firms stuck with idle capacity cut prices and workers facing layoffs accept smaller wage hikes.

Not everyone at the Fed buys into that argument. Noting that some economists forecast substantial slack will keep inflation low for several years, Richmond Fed President Jeffrey Lacker said in a March 26 speech that he would be “cautious about relying on this correlation.”

The Fed is “running a laboratory experiment” on what drives inflation: the money supply or the output gap, says Laurence Meyer, a former Fed governor and now vice chairman of St. Louis-based Macroeconomic Advisers

“How it turns out will do a lot to influence the economic debate,” he says, adding that his money is on Bernanke.

How it turns out will also do a lot to influence whether the Federal Reserve continues to exist in its current form and whether there are major revisions to current economic theory.

If the amount of inflation bears any resemblance to the size of recent asset bubbles or the volume of money printing deemed necessary to combat their bursting, there may be a wholesale rethinking of what a central bank is and what economists do.

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

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.

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.

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.

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.

Fed Ups Balance Sheet $1.2 Trillion: Irresponsible, Or Just What The Economy Needs?

With the recent announcement that the Federal Reserve plans to buy up $1.2 trillion in mortgage backed securities and other financial instruments, there has been a economic divide created. On one side Americans will benefit from reduced mortgage rates, however, opponents to the decision argue that this will lead to major inflation and devalue the savings of responsible Americans. It seems that anyone "responsible" is getting victimized in all these stimulus measures. Furthermore there is always the worry that the foreign buyers of our debt will be turned off by our actions and decide to stop buying these assets, or even worse sell off what they already own. For more on this, read the following blog post from Tony Straka.

Word has probably spread around by now that the Federal Reserve is going to buy everything in America that's not nailed down, throwing another $1,150,000,000,000 lifeline at markets. (Click here to see what a trillion looks like.)

The Federal Open Market Committee (FOMC) yesterday informed the public that it will expand its dominating position in the MBS market, throwing an additional $750 billion there. The buying spree does not end there. Having arrived at zero interest rate policy 3 months earlier the Fed now hopes to control interest rates by monetizing US Treasuries equalling $300 billion. Stirring still more Bourbon in the punch bowl the Fed will also up its portfolio of agency debt by another $100 billion.

Markets rallied on the news with Treasuries shedding up to 51 basis points. Gold outshone everything and spurted more than $50 on the FOMC's news that will ultimately lead to higher inflation rates despite the FOMC statement that said,

In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued.

Surprisingly chairman Ben Bernanke and his troops are more worried about possible deflation despite the Fed's balloning balance sheet that will pass the $3 trillion mark this year.

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.

Latest CPI figures show a different picture. Inflation rose to 0.5% (January: 0,4%) or 6% annualized in February.

GRAPH: Gold reacted with the biggest jump seen in decades, rising more than $50 after the Fed released more measures that are designed to fuel monetary inflation. Chart courtesy of kitco.com

Economists were up in arms about the Fed's measures. Stephen Stanley of RBS Greenwich Capital said via the WSJ blogs:

The agency MBS market is close to $4 trillion, so the Fed will end up owning almost one-third of the agency mortgage market. If this was a “rigged market” (to quote one of my learned colleagues on the mortgage desk) before, what should we call it now?! … $50 billion per month in Treasuries pales in comparison to new supply. Just to flesh that point out, we project that auctions of 2’s, 3’s, 5’s, 7’s, and 10’s will total $150 billion in March. In essence, even if all the purchases are limited to 2’s to 10’s, the Fed’s program will merely be a third of the new supply (and far short of one-third of the total market, as is the case for agency MBS).

Morgan Stanleys David Greenlaw said,

Even with energy prices having flattened The Fed’s Treasury purchases will absorb a very significant portion of the amount of gross issuance that we anticipate to occur over the next six months… The Fed’s announcement signals a clear intent to continue to drive mortgage rates lower and we expect them to meet this objective. This could represent a powerful source of stimulus for the household sector of the economy. In 2008, the average mortgage rate on the outstanding stock of loans was about 6.50%. So, if the Fed brings 30-yr fixed rate mortgages down to 4.50% and all homeowners are able refi, the aggregate permanent cash flow savings would be on the order of $200 billion per year.

Bloomberg summed it up in the lead of their coverage:

By committing to buy Treasuries and double his purchases of mortgage debt, Federal Reserve Chairman Ben S. Bernanke signaled his determination to avoid a repeat of the Great Depression and his willingness to pump as much cash into the economy as needed to end the current crisis.

I conclude nothing has changed in the Fed's perception that new fiat money will also solve this crisis. Taking gold's reaction as the canary in the coal mine markets will recognize that the Fed is on the way towards hyper inflation. As in the Weimar republic the US central bank spins up the presses to monetize the debt. At the end of the Weimar republic one percent of government income came from taxes and 99% came fresh from the printing presses.

President Barack Obama may have no other choice than to take this route as foreign investors grow wary about the capability of the USA to serve its debts and we may see less participation in Treasury auctions also for the reason that sovereign wealth funds will spend a bigger portion domestically as nearly every nation is confronted with the economic downturn. For the time being gold investments may turn out again to be the safest asset to hold.

UPDATE: Mint.com says one trillion greenbacks could fund an inflation-adjusted New Deal twice over. Check out their way of visualizing what one trillion can buy and be in for a dose of reality.

I especially liked this one. Do you still say this crisis is manageable? Illustration courtesy of Mint.com.

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

We Avoided Deflation Again: Soon Inflation Could Be Problem

The latest CPI reports showed that we once again avoided the dreaded "D" word — deflation. But as James Picerno points out while we are worried about deflation now, at some point here we are going to have to unwind all the policies that have been enacted to boost the economy. Since policy makers tend to be a little behind on the unwinding side in all likelihood we will experience hefty inflationary pressure before things balance out again. So while we are worried about deflation now, soon our concern needs to move to controlling inflation off the backend. For more on this, read the blog post below from James Picerno.

Today’s report on consumer price inflation (CPI) for February confirms yesterday’s news on wholesale prices for last month: deflation is on the run. For the moment, anyway.

That’s good news, but if it’s true, then monetary policy becomes increasingly tricky in the months ahead. We say if it’s true because it’s hard to make definitive conclusions on just a few months of data. At the moment, the case for arguing that deflation has been banished rests on January and February numbers. Deciding if that’s a trend with legs remains speculative, albeit less so than in the past several months. Only once it's clear that the economy is past its worst point in the current downturn will it be obvious that deflation is no longer a threat. Where and when that point lies, alas, isn't yet obvious, at least to this observer.

Meanwhile, the Labor Department reports this morning that consumer prices rose 0.4% last month on a seasonally adjusted basis. That’s up from January’s 0.3% and both numbers stand in sharp contrast to the previous three months (Oct through Dec), when CPI dropped sharply.

Core inflation (excluding food and energy) was up 0.2%, as it was in January, suggesting that overall prices, as defined by the Federal Reserve, are more or less stable. For the year through February, core CPI advanced 1.8%, roughly in line with where the Fed would like to see it remain through time.

Does this mean the all-clear sign for deflation worries is past? Perhaps, but it’s still too soon to say. There was never any doubt that a determined central bank can engineer inflation. Indeed, that’s the natural order of economic behavior and many a central bank has unwittingly fostered higher inflation without necessarily trying. The fact that the Fed has been working over time to generate higher inflation as an antidote to elevated deflationary risks should surprise no one when the effort bears fruit.

One clue that the reflation efforts are more than noise comes by noting that CPI’s major subcategories all posted higher prices last month save for food and beverages. The same was true for January, a month when food prices climbed as well. That’s a big and productive shift from 2008’s fourth quarter, when price declines were running hard. At the time, the fear was that the negative price momentum would build a head of steam and, left unchecked, would develop into sustained deflation.

As we write, there’s reason to think the Fed’s policy of nipping deflation in the bud is working. Is it time to pull the plug on the massive liquidity injections? No, not yet. There's still a strong, negative headwind blowing in the economy, starting with the labor market. Until we learn more about how the current business cycle is unfolding, the case for keeping Fed funds just above zero is compelling. One metric to watch closely in the coming weeks is initial jobless claims, which is one of several critical components for estimating the current state of the business cycle, as we’ve discussed.

Meantime, Bernanke and company begin their two-day gab fest today at the Fed. As we write, the Fed funds futures market is expecting more of the same: leaving the Fed funds rate unchanged at just over zero. For the moment, that’s prudent, but it may not be so for much longer. When it’s clear that deflation is no longer a clear and present danger, it’ll be time to start raising interest rates to keep the inflationary medicine from bubbling over down the road. That’s not going to be easy in an economy that, even in the best of scenarios, is likely to be struggling for the foreseeable future.

In short, we may be nearing the end of the heightened risk for deflation. That suggests that a new era for monetary policy is coming, and it promises to be a difficult one, which is to say that the risk of error will be quite high. As inflationary pressures return, albeit slowly and tenuously, the central bank will have to navigate a fine line of keeping prices under control without creating excessive drag for economic growth. The previous run of monetary policy decisions look like child’s play by comparison.

This post can also be viewed on capitalspectator.com.

Do You Believe Alan Greenspan?

Former Federal Reserve chief, Alan Greenspan, is towards the top of most people's lists for who had the biggest part in the creation of the current financial crisis. Ask Greenspan, though, and he'll tell you that he had nothing to do with it. Tim Iacono calls Greenspan out on this claim, and takes a deeper look into the origin of the financial crisis in his blog post below.

On the same day that his successor signaled dramatic policy changes that would see the Federal Reserve "take away the punchbowl" before inflating yet another asset bubble, radically altering the way financial market regulators operate in the process, former Fed chairman Alan Greenspan was readying yet another in a long series of op-ed pieces aimed at defending his legacy.

He didn't cause the housing bubble, or so he says.

After yesterday's commentary by David Leonhardt at the New York Times about how the central bank had been played like a fiddle by big financial firms who took on "excessive risk" knowing that the government would be there to bail them out, you'd have thought that maybe there would be some reluctance to go forward with the editorial.

Apparently not.

Still seemingly unfamiliar with the concept of "moral hazard" where, in the words of Mr. Leonhardt, big firms can "act as if their future losses are indeed somebody else’s problem", and having only confessed to being "shocked" last year after finding a flaw in his ideological framework about how "self-interest" works in the real world, the opinion piece made it into the Wall Street Journal this morning.

Alan Greenspan still hasn't got a clue.

After a long period of relative silence since the wheels fell off the global economy last fall and as his critics grew in number, his name often cited in public opinion polls as "the one individual" most responsible for the current mess (this term, admittedly, now failing to adequately describe the extent of the problems the world now faces), his defense has become defiant, if not desperate, the most recent example being provided today:

The Fed Didn't Cause the Housing Bubble
Any new regulations should help direct savings toward productive investments.
By ALAN GREENSPAN

We are in the midst of a global crisis that will unquestionably rank as the most virulent since the 1930s. It will eventually subside and pass into history. But how the interacting and reinforcing causes and effects of this severe contraction are interpreted will shape the reconfiguration of our currently disabled global financial system.
There are at least two broad and competing explanations of the origins of this crisis. The first is that the "easy money" policies of the Federal Reserve produced the U.S. housing bubble that is at the core of today's financial mess.

The second, and far more credible, explanation agrees that it was indeed lower interest rates that spawned the speculative euphoria. However, the interest rate that mattered was not the federal-funds rate, but the rate on long-term, fixed-rate mortgages.

Not surprisingly, the "easy money" thesis is dismissed out of hand - there is nothing further about fostering a culture of debt or being overly accommodating to the slightest of financial market stumbles over a period of almost two decades, all of which surely contributed to the prevailing attitudes and conventional wisdom of just a few years ago.

Having dispensed with that, it is on to the now-familiar, "I was powerless to do anything about long-term rates" retort, as if long-term rates really played a key role in the housing bubble during its bubbliest years.

With prices having risen to nosebleed levels during the middle of the decade, who could afford to buy a house with a 30-year fixed loan?

It was the tsunami of "innovation" in financial products - Pay Option ARMs, "liar loans", MBSs, CDOs, and CDSs - all of which were blessed by the central bank, that caused nearly all the damage, not 30-year fixed mortgages.

Next comes the "savings glut" rationale for why long-term rates were such a conundrum followed by the now-familiar, "our housing bubble was just average" angle:

That ex ante excess of savings propelled global long-term interest rates progressively lower between early 2000 and 2005.

That decline in long-term interest rates across a wide spectrum of countries statistically explains, and is the most likely major cause of, real-estate capitalization rates that declined and converged across the globe, resulting in the global housing price bubble. (The U.S. price bubble was at, or below, the median according to the International Monetary Fund.)

What follows is a rebuke of Stanford University Professor John Taylor' revisionist history (apparently, it takes one to know one) in which short-term interest rates were cited as the proximal cause for the current meltdown.

And after that, it's always handy to cite glowing criticism from someone who died back in 2006, before it became widely known just how bad things would get.

Given the decoupling of monetary policy from long-term mortgage rates, accelerating the path of monetary tightening that the Fed pursued in 2004-2005 could not have "prevented" the housing bubble. All things considered, I personally prefer Milton Friedman's performance appraisal of the Federal Reserve. In evaluating the period of 1987 to 2005, he wrote on this page in early 2006: "There is no other period of comparable length in which the Federal Reserve System has performed so well. It is more than a difference of degree; it approaches a difference of kind."

That's just pathetic when you think about it...

Even after the recent admonishment from the late Milton Friedman's long-time partner Anna Schwartz as documented in "A 92-year old finger pointed squarely at the Fed", he has the chutzpah to cite favorable words from 2006.

Lastly, the question of regulation and the lack of sophistication.

It is now very clear that the levels of complexity to which market practitioners at the height of their euphoria tried to push risk-management techniques and products were too much for even the most sophisticated market players to handle properly and prudently.

However, the appropriate policy response is not to bridle financial intermediation with heavy regulation. That would stifle important advances in finance that enhance standards of living.

Before getting to the big finale, it's worth noting that the book has not yet been written on these "enhanced standards of living". It seems that standards of living in most of the world, particularly in the U.S., are one big moving target right now, a target that is generally moving in the downward direction.

Come to think of it, "enhanced" is clearly not the right word choice here - it is premature at best and, at worst, it is a sad, almost mocking commentary on the rapidly changing lives of the vast majority of people in the world.

And, in conclusion...

If we are to retain a dynamic world economy capable of producing prosperity and future sustainable growth, we cannot rely on governments to intermediate saving and investment flows. Our challenge in the months ahead will be to install a regulatory regime that will ensure responsible risk management on the part of financial institutions, while encouraging them to continue taking the risks necessary and inherent in any successful market economy.

Maybe what the smartest economists in the world thought was "sustainable growth" wasn't sustainable at all and all that "risk taking" was just a way for bankers to enrich themselves.

People are beginning to sour on the whole idea of "prosperity", that is, if the current economic and financial market tumult is part of the package.

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

Obama's Budget Looks Great According To Krugman

President Obama at least has one big supporter of his new budget, famed economist Paul Krugman. Krugman believes that this budget is just what the country needs to turn things around and applauds Obama for his efforts. Mark Thoma looks at a recent article from Krugman in his blog post below.

Paul Krugman finds lots to like in Obama's proposed budget:

Climate of Change, by Paul Krugman: Elections have consequences. President Obama’s new budget represents a huge break, not just with the policies of the past eight years, but with policy trends over the past 30 years. If he can get anything like the plan he announced on Thursday through Congress, he will set America on a fundamentally new course.

The budget will, among other things, come as a huge relief to Democrats who were starting to feel a bit of postpartisan depression...: fears that Mr. Obama would sacrifice progressive priorities in his budget plans ... have now been banished.

For this budget allocates $634 billion over the next decade for health reform. That’s not enough to pay for universal coverage, but it’s an impressive start. And Mr. Obama plans to pay for health reform, not just with higher taxes on the affluent, but by putting a halt to the creeping privatization of Medicare, eliminating overpayments to insurance companies.

On another front, it’s also heartening to see that the budget projects $645 billion in revenues from the sale of emission allowances. After years of denial and delay by its predecessor, the Obama administration is signaling that it’s ready to take on climate change. ...

Many will ask whether Mr. Obama can actually pull off the deficit reduction he promises. Can he actually reduce the red ink from $1.75 trillion this year to less than a third as much in 2013? Yes, he can.

Right now the deficit is huge thanks to temporary factors (at least we hope they’re temporary)... But if and when the crisis passes, the budget picture should improve dramatically. ... So if Mr. Obama gets us out of Iraq (without bogging us down in an equally expensive Afghan quagmire) and manages to engineer a solid economic recovery — two big ifs, to be sure — getting the deficit down to around $500 billion by 2013 shouldn’t be at all difficult. ...

So we have good priorities and plausible projections. What’s not to like about this budget? Basically, the long run outlook remains worrying.

According to the Obama administration’s budget projections, the ratio of federal debt to GDP. ... will soar over the next few years, then more or less stabilize ... at a debt-to-GDP. ratio of around 60 percent. ... [S]ooner or later we’re going to have to come to grips with the forces driving up long-run spending — above all, the ever-rising cost of health care.

And even if fundamental health care reform brings costs under control, I at least find it hard to see how the federal government can meet its long-term obligations without some tax increases on the middle class. Whatever politicians may say now, there’s probably a value-added tax in our future.

But I don’t blame Mr. Obama for leaving some big questions unanswered in this budget. There’s only so much long-run thinking the political system can handle in the midst of a severe crisis; he has probably taken on all he can, for now. And this budget looks very, very good.

More on the budget:

• Finally a Progressive Budget, Robert Reich
• Higher Taxes: Will The Republicans Cry Wolf Again? - Bruce Bartlett
• Obama’s Budget Plan Sweeps Away Reagan Ideas, by David Leonhardt, New York Times

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

Fourth Quarter GDP Much Worse Than Originally Reported

The 3.8% decline in GDP for the fourth quarter of 2008 wasn't too bad — or so we thought — under the circumstances, but things were much worse than we originally thought. The new revised fourth quarter GDP shows that the economy actually fell 6.2%. James Picerno from The Capital Spectator looks closer at the report and talks a bit about the new culture of the American consumer in his blog post below.

No one expected good news, and the expectations were met.

Today's update on 2008's fourth-quarter GDP was ugly, the ugliest in 25 years, in fact. The economy contracted by 6.2% at a real, annualized seasonally adjusted pace in the last three months of 2008. That's much deeper than the 3.8% decline originally estimated by the government.

Painful, but no one should be shocked, given the general economic and financial climate. But let's be clear: the embedded message in today's revised numbers from the Bureau of Economic Analysis is sobering. The principal reason it's sobering is that the main driver of economic activity has stumbled and the prospect for a quick turnaround is about as likely as waking up on the surface of Neptune tomorrow.

It's not an exaggeration to say that consumer spending has hit a wall and crumbled as a result. Perhaps the only surprise is that it took so long for a retrenchment in consumer spending habits. But fate can only be delayed so long. The willingness, bordering on obsession for borrowing in 2002-2007 has finally come back to haunt Joe Sixpack, and by extension the wider economy, which is heavily dependent on personal consumption expenditures. The implosion of the financial industry has, of course, exacerbated the trend, as has the collapse of the real estate bubble. In short, a perfect storm, the effects of which are only now being fully realized.

America has long been a nation of consumers, and there's much to cheer about on that front. Consumption generates economic growth and spending has been no small part over the generations in powering the American dream of building wealth and prosperity. But there's a limit to everything, and at some point even a good thing becomes excessive. At some point in the recent past that limit was breached.

Excess certainly looks like an appropriate label for consumer borrowing in 2002-2007, when the household balance sheet became laden with debt to an extent that was as shocking as it was fated for a day of reckoning. The details are there for anyone willing to take the time and pore over the Federal Reserve's Flow of Funds Report.

The reaction to the mountain of debt is now underway. As our chart below shows, consumers are finally facing facts and cutting spending. If a purchase can be delayed, it will be; if spending can be minimized, it is. No wonder, then, that durable goods spending—the so-called realm of "big ticket" items like washing machines and refrigerators—is falling rapidly. If you don't need it, you don't buy it—the new mantra of for a new generation of consumers who've been dragged kicking and screaming to this revelation of unvarnished necessity. Only services spending has been spared, which is largely a function of essential services like medical purchases in this category.

The bottom line: consumers are aggressively repairing their balance sheets after a long stretch of doing the exact opposite. The front line in the restoration is cutting spending, anywhere and everywhere. This process has only just begun. Given the magnitude of the former excess levels of spending and debt creation, the mending of household balance sheets will run on for some time, probably for far longer than is widely expected. The repercussions will be far and wide. It's not the end of the world, but it is the start of a new era that will reorder the consumer mindset.

Exactly how long this pullback rolls on is the question. For now, it's clear that the unwinding is upon us, and the worst of it is going to roll on for several quarters, perhaps several years. It's a process that's long overdue, fundamentally necessary and destined to be painful. Coming to terms with reality is never easy, but it is refreshing and healthy…eventually.

This post can also be viewed on capitalspectator.com.

Buying Stocks For The "Long run" Isn't Always Smart

A lot of investors have the same potentially misguided advice ingrained into their heads — stocks over the long run always go up. While that indeed might be the case, how long will you have to wait to see those returns? It may be a good strategy for young people just getting started in life, but it certainly is not the right strategy for everyone. For more on this read Tim Iacono's blog post below:

I don't know. I suppose that if most of what I did over the last few decades revolved around compelling individual investors to buy stocks for the long run, come what may, it might be difficult to look at things objectively.

Denial is a powerful force in the world and perhaps one of the most under-appreciated.

These days, a lot of people are having a very hard time with the whole idea that individual ownership of stocks (and now real estate) is not the panacea that they once thought.

That doesn't, however, stop them from encouraging individuals to just "tough it out", likely knowing that, eventually, their advice will pay off - whether or not that advice will pay off in time to fund the retirement of a generation of baby boomers is another question entirely.

Word comes this morning from the Wall Street Journal's always-interesting Jason Zweig that it might be some time before things are hunky-dory again.

In this story coming in advance of tomorrow's update of long-term investment returns by finance professor Elroy Dimson of London Business School, the news is decidedly unfriendly for your typical aspiring retiree with money in the stock market.

The good professor estimated that we'll have to wait nine more years before stocks have even half a chance of hitting their highs of 2007. That is, back when millions of baby boomers started eyeing their retirement account balances again as the housing bubble was meeting its pin.

Those aren't very good odds at all - a 50 percent chance in nine years? 2018?

Who knows what the condition of the U.S. or global economy will be by then?

If you're still sticking with the program of "stocks for the long run", maybe this report at Money Magazine will cheer you up. In one of the daffiest assessments of equity markets that have crossed my computer screen in quite some time, Paul J. Lim, a senior editor at Money Magazine explains how the lost decade that just occurred, really wasn't such a loss.

Yes, it's true that the Dow Jones industrial average sits more than 1,000 points below where it was 10 years ago. But that's irrelevant to your investing strategy for three reasons. First, it's an arbitrary amount of time. We're hung up on it because 10, as University of California-Berkeley finance professor Terrance Odean notes, "is a nice round number we can all relate to."

Second, the market's performance over the past decade is a red herring because the period you're judging starts near the absolute pinnacle of irrational exuberance, when stock valuations - as measured by price/earnings ratios - were absurdly high. If you measure from the end of the last bear market, in October 2002 - when stock prices were still higher than average, by the way - you'll see that the Dow has returned 4.5% a year (including dividends) while the Standard & Poor's 500 index has gained 3.4% annually.

Third, as T. Rowe Price financial planner Stuart Ritter notes, "The only people the lost decade accurately applies to are those who invested absolutely nothing before the late 1990s, put all of their money in at the market peak and invested absolutely nothing ever since." If such an unlucky soul does exist, history suggests that he'll be rewarded.

And, the moral of the story is, of course, stick with the plan - stocks for the long run.

Eventually they'll all be right again... time uncertain...

I'll never forget that info-session back in 2001 when I was first coming of age with this whole stock market/retirement planning trip when the Fidelity rep hemmed and hawed when he was asked why we should continue to invest in stocks after an eighteen year run had just come convincingly to an end the year prior.

I asked, "Don't these markets move in long 'secular' cycles of 15 or 20 years? If so, doesn't that mean that we're due for a 'secular' bear market?"

He didn't really know what to say - he was just a twenty-something trying to stick to the script before a crowd of thirty- and forty-somethings who were starting to think seriously about their retirement planning.

Some, more than others, obviously.

Jason Zweig is a fabulous writer and Money Magazine is great for evaluating whether or not you should upgrade your kitchen, but I stopped listening to their investment advice years ago.

That was a good decision.

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

Currency Market Update: Look To The Australian Dollar

Yesterday's market rally got a lot of investors excited, but the rally was short lived. Currency expert Kathy Lien points out 3 reasons why investors should have been suspicious of the rally in her blog post below. In addition Lien offers some insight into the future of currencies, and suggests that the Australian Dollar might be a great investment opportunity right now.

The currency and equity markets are turning lower after a strong rally on Tuesday. In my Daily Currency Focus, I talked about the 3 reasons why the currency market rally was suspicious. None of the reasons for Tuesday’s jump delivered real solutions. The market only rallied because Bernanke delivered no surprises. President Obama’s attempt at reassuring Americans also failed to comfort investors.

Instead we are faced with a weakening economy that is only confirmed by this morning’s plunge in existing home sales. Sales of existing homes plunged 5.3 percent to a 12 year low in the month of January. The housing market remains the Achilles heel of the US economy as prices fall and demand wanes. The median price of a home sold dropped 14.8 percent compared to the year prior. Such disappointing numbers are not much of a surprise given the big decline in housing starts and building permits. With banks and mortgage lenders reluctant to lend, even potential homeowners with sufficient capital have found difficulty attaining loans.

The British pound has been hit the most because Bank of England member Barker said that the weak sterling is helpful. UK officials have taken every opportunity to talk down the currency.

USD/JPY on the other hand remains an animal. Despite weak economic data and a turn in equities, the currency pair continues to rise.

My favorite is still the Australian dollar because of strong M&A flow, higher gold prices and the prospect of the country remaining recession free. The AUD/USD is also prime for a breakout.

This post can also be viewed on kathylien.com.

Secret TARP Bailout Details To Be Released By Court Order

It appears that we finally (hopefully) will be able to see where our tax dollars are going, thanks to a recent court ruling. This court order will force the Treasury to release some of the information that they have been concealing from the American public in regards to the massive bailout of the country's financial system. Anthony Freed provides us with more information on this development in his blog post below:

Advocates of an open Government and transparent allocation of taxpayer funds celebrated the news late Friday afternoon (2-20-09) that the U.S. District court has moved to enforce a Freedom of Information Act (FOIA) request to release more details about exactly how TARP bailout funds have been and are being used.

The TARP was passed in early October, 2008, in an effort to stem the damage to the nation’s financial industry incurred during a decade of lax risk-abatement that pervaded the banking culture after the legislative emasculation of the Glass-Steagall Act.

FOX Business sued Treasury on Dec. 18 over failure to provide information on the bailout funds or respond to FBN’s expedited requests filed under the FOIA. The initial request, filed on Nov. 25, sought actual data on the use of the bailout funds for American International Group (AIG) and the Bank of New York Mellon (BK), and an additional request, filed on Dec. 1, sought similar data on the bailout funds for Citigroup (C).

FBN asked the Treasury Department to identify, among other issues, the troubled assets purchased, any collateral extended, and any restrictions placed on these financial institutions for their participation in this program.

The Treasury Department - along with the other banking regulators like the FDIC, OTS, and the Federal Reserve - are notoriously secretive concerning the data they collect and their subsequent analysis of the viability of any particular institution, preferring to operate instead behind closed doors.

This tendency often leaves investors in the dark, which generally tends to work in the banks’ favor. Regulators would argue that they are not in the business of moving markets, and that some data may be misinterpreted and inadvertently cause a run on funds at named institutions, evidenced by Schumer’s now infamous disclosure of details that may have led to the collapse of Indy Mac Bank in 2008.

That argument may have held some water until the TARP bailout effectively made the U.S. taxpayer a shareholder in any number of as yet identified institutions, and the owner of any assortment of exotic financial instruments which have proved toxic to Global capital markets.

Judge Richard J. Holwell of the U.S. District Court for the Southern District of New York said in a decision Friday that the government is directed to comply with FOX Business’s request under the FOIA “within 30 days and to produce a Vaughn index with 45 days.” That means Treasury must comply with FOX Business’s request by Monday, March 23, and must produce a Vaughn index by Monday, April 6.

The Treasury will have the chance to withhold some documents and information they deem too sensitive, but now have to provide an itemized “Vaughn index” of which documents and information have been redacted, and for exactly what reason.

“A Vaughn Index must: (1) identify each document withheld; (2) state the statutory exemption claimed; and (3) explain how disclosure would damage the interests protected by the claimed exemption.”

This may open the door to further FOIA challenges to release the remaining information if the Treasury fails to convince the courts that their vetting of information was reasonable.

I don’t think Treasury has realized that they are not the only ones who have new powers and responsibilities in the implementation of this historic bailout - the courts have yet to weigh-in on much of this, including who is ultimately going to be held responsible for the mess that is the economy, even if it is still taxpayers who have to foot the bill to clean it all up.

My guess is that the courts feel very differently about full disclosure than does the insider Wall Street elite who regulate themselves from Washington D.C. in seeming perpetuity.

Frank Rich of the New York Times wrote a good op-ed piece called What We Don’t Know Will Hurt Us, which helps further the argument that it is time to get to bottom of exactly what is going on with our economy, and why their seems to be so little consequence for the perpetrators of so much devastation.

Americans are right to wonder why there has been scant punishment for the management and boards of bailed-out banks that recklessly sliced and diced all this debt into worthless gambling chips. They are also right to wonder why there is still little transparency in how TARP funds have been spent by these teetering institutions. If a CNBC commentator can stir up a populist dust storm by ranting that Obama’s new mortgage program (priced at $75 billion to $275 billion) is “promoting bad behavior,” imagine the tornado that would greet an even bigger bank bailout on top of the $700 billion already down the TARP drain.

Remember, the fundamental point of the TARP bailout is to funnel incredible amounts of taxpayer money - debt, actually - to the very institutions and people who are responsible for driving the markets off the cliff in the first place.

And they got paid handsomely for doing it.

It is time for our nation’s financial machine to drop the self-righteous arrogance they have cloaked themselves in for too long, for all of those paper-pushing money lords to release their false sense of entitlement, relinquish their ill-gotten wealth from the last 10 years, and to return to their proper place in the economic landscape as facilitators of capital creation, not the creators of capital.

Accountability in the largest disbursement of public funds in history is not only a good idea, it is essential to our democracy, as is ending the revolving door between corporate boardrooms and the regulatory offices of our government.

The Fox Business FOIA request and the court’s decision to release more information should serve as a warning to the Wall Street good ol’ boys that their orgy of omnipotence is truly over, and that the era of accountability is in.

This post can also be viewed on yourmortgageoryourlife.wordpress.com.

Should We Create Government Sponsored Shadow Banks?

According to Paul McCulley from Pimco, to revive the economy the government simply needs to create government sponsored shadow banks. Naturally this idea is a little controversial, especially considering the recent demise of this type of system. Tim Iacono from The Mess That Greenspan Made looks at an article written by McCulley in his blog post below:

Paul McCulley of Pimco thinks the new kind of shadow banking system is just swell:

The United States government now has both the tools and the will to save the private banking system, and more importantly, the real economy, from its own debt-deflationary pathologies. Not that it will be easy. But it can be done, notwithstanding the catcalls that greeted Secretary Geithner last week.

And the essential game plan is clear: use the power of the Fed, the FDIC and the Treasury to create government-sponsored shadow banks, such as the Term Asset-Backed Securities Lending Facility (the TALF) and the Public-Private Investment Fund (the P-PIF).

The formula? Take a small dollop of the Treasury’s free-to-spend taxpayer money (there is still $350 billion left) to serve as the equity in a government sponsored shadow bank, and then lever the daylights out of it with loans from the Federal Reserve, funded with the printing press.
...
Yes, there will be subsidies involved, sometimes huge ones. And yes, the process will seem arbitrary and capricious at times, reeking of inequities. Such is the nature of government rescue schemes for broken banking systems, while maintaining them as privately owned.

You might not like it. I don’t like it, because regulators should never have let bankers, both conventional bankers and shadow bankers, run amok. But they did.

So it’s now time to hold the nose and do what must be done, however stinky it smells, not because it’s pleasant but because it is necessary.

Pragmatism takes on a whole new meaning at Pimco.

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

Gold Prices And US Dollar Both Rising

Those who keep up with gold and currency prices have probably noticed that things are a little strange right now. Typically the gold prices work inversely, however, right now they are rising almost instep. Currency expert Kathy Lien explains more about this phenomenon, and offers some insight into what is likely causing it in her blog post below:

If you haven’t caught it already, in my Daily Currency Focus on FX360, I talked about What the Rally in the US Dollar and Gold is Telling Us. As both the Dollar Index and Gold Prices press higher, it important to know what this means:

It is not very often that we see the US dollar and gold prices move in the same direction. Since gold is priced in dollars, the value of the yellow metal tends to fall when the dollar rises and rise when the dollar falls. However this has not been the case since January 14th as the rally in the US dollar corresponds with the rise in gold prices, which closed today at a 7 month high of $970 an ounce.

The last time we saw this traditionally negative correlation turn into a positive one was in 1982. At that time, recession hit many countries including the US. Although the rise in gold prices can be partially attributed to future inflation problems, the cohesive movement in the value of gold and the US dollar suggests that central banks around the world are losing credibility. There are growing concerns that a time bomb could explode in Europe leading to more troubles for the region as a whole. If that is the case, there may not be any safer form of investment than gold.

The rally in the US dollar and gold is telling the market that investors are worried about global economic stability outside of the US and therefore they are preparing for the worst.

This post can also be viewed on kathylien.com.

Why The Government Can’t Fix The Housing Crisis

It appears the government is ready and willing to do whatever it takes to fix the housing crisis, but there is one little problem: They can’t. As part of the new stimulus package, there will likely be a $15,000 homebuyer tax credit, and not just for first-time homebuyers, but for all homebuyers purchasing a primary residence. In addition, the government will likely attempt to drive mortgage rates down to around 4.5 percent and work particularly hard to modify troubled loans to keep homeowners out of foreclosure. With these new measures in place the housing market will surely recover…right?

The answer to that question depends on your definition of recovery. Will it be enough to stop prices from falling, and possibly even help them start going up again? It’s definitely possible, but the problem won’t be fixed even if prices do turn around. Artificially inflated prices caused the housing crisis in the first place. Homeownership became an attractive option for more people than ever before through financing options that were cheap and widely available—a little too widely available, we are now discovering. ARMs, interest-only and other creative loan programs kept monthly payments low, and people could suddenly afford a more expensive house—or so it appeared. When interest rates started rising and ARMs reset, housing values stopped climbing and all hell broke loose.

So why would we believe that artificially boosting housing values will be sustainable this time? What do we think will happen when mortgage rates rise again and the tax credits expire? We won’t have to worry about ARMs resetting this time around because they are now shunned by banks for the most part, but the fundamental problem remains that housing is just too expensive compared to income. Interest rates can’t stay this low forever, and the tax credit will expire after the end of the year. Then homebuyers will only have their personal income to rely on to pay for their homes. This is how it has always been (minus government intervention), and it is how it should be. People making $50,000 a year shouldn’t be living in a $400,000 house—It’s that simple. People need to live within their means, but the government doesn’t seem to grasp this and keeps pushing measures to modify home loans. We can try to modify people’s loans all day long, but if they can’t afford their homes, then they can’t afford their homes. According to the Wall Street Journal, over 40 percent of borrowers were at least 60 days past due eight months after their loan was modified. It seems to me that these loan modifications are just delaying the inevitable and costing banks and taxpayers more money.

Before the housing crisis can truly end, housing prices must come into balance with incomes. When this happens, the problem will solve itself. When buying a home starts to make more sense than renting, people will start buying again. It isn’t that hard to figure out. Spending taxpayer money to prop up housing is not only a waste, but an unethical perpetuation of the problem. It is completely unfair to renters as well as our youth. Unfortunately, those groups represent the minority, so their voice isn’t likely to be heard. If these measures are passed, expect to pay handsomely for it and to see another bubble burst a few years from now. At least this time no one should be able to use the excuse that they didn’t see it coming.

Tax Cuts Could Deepen The Recession

There has been non-stop debate between Republicans and Democrats for the past couple weeks regarding how the economic stimulus bill should be structured. Republicans want a majority to go towards tax cuts, and the Democrats want to see high levels of spending. It appears that the Democrats are going to win out in this debate, thinks to their heavy numbers advantage, but according to the New York Fed's Gauti Eggertsson that is a good thing. He wrote a paper theorizing that in today's economic environment tax cuts have the potential to backfire, and possibly even deepen the recession. Economics professor and author of the Economist's View blog, Mark Thoma, looks at this closer in his blog post below.

Justin Wolfers summarizes a paper that suggests government spending would be better than tax cuts at reviving the economy:

Tax Cuts vs. Government Spending, by Justin Wolfers: As the Senate and the House look to reconcile competing stimulus plans, the big debate is whether to emphasize government spending or tax cuts. A new paper by the New York Fed’s Gauti Eggertsson argues that the risk of deflation should tilt the balance to government spending.

Our current problem is deficient aggregate demand. The government can raise total spending either by buying more stuff, or it can lower taxes and hope that consumers take their tax breaks to the mall. ...

But that’s not the whole story. Tax cuts stimulate both aggregate demand and aggregate supply. If taxes are temporarily lower, they make working today more attractive than working tomorrow, and thus increase labor supply. This boost to the nation’s productive capacity means that a tax-cut-based stimulus doesn’t do as much to narrow the gap between output and what we can produce.

Under normal circumstances, this doesn’t present a problem, because the Fed can lower interest rates to close this output gap. But right now, the Fed has set interest rates as low as they can go, and so different principles apply. Eggertsson’s concern is that a big output gap will lead inflation to fall, leading real interest rates to rise in the middle of the recession. These higher real interest rates further dampen economic activity, and with the Fed powerless to offset this, there’s the very real risk of a deflationary spiral. And so a tax-cut-based fiscal stimulus might actually backfire. In fact, Eggertsson reckons there’s a chance that tax cuts could even deepen the recession.

Is Eggertson’s conjecture right? Unfortunately the historical record can’t tell us: there’s never been an episode in which we’ve tried reducing taxes when interest rates were this low. When we’re in uncharted waters, we’ve got nothing but economic theory to guide us. And the theory says it’s safer to stick to a spending-based stimulus plan.

I'd like to be able to rely on this as one more piece of evidence for government spending over taxes, but I have doubts that the aggregate supply (labor supply) effect would be large enough to make much of a difference. The author also suggests caution:

I am bit hesitant to draw the lesson from this paper that it would be ideal to raise payroll taxes to stimulate the US economy today, although this clearly is a direct implication of the analysis

And he also says:

What should we take out of all of this? ...[One] lesson is that policymakers today should view with great deal of skepticisms any empirical evidence on the effect of tax cuts or government spending based on post war US data. The number of these studies is high, and they are frequently cited in the current debate. The model presented here, which has by now become a workhorse model in macroeconomics, predicts that the effect of tax cuts and government spending is fundamentally different at zero nominal interest rates than under normal circumstances.

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

Total Financial Crisis Commitment Nearing $10 Trillion

Bloomberg has been fighting with the government in an attempt to gain visibility into the Federal Reserve's recent lending practices, however, to this point they have been unsuccessful. Of course the fact that the government is denying the request has only brought ramped speculation about what they are hiding. One thing that we do know is that the price tag for this financial crisis keeps growing and growing, with no end in sight. Most people are only aware of the $700 TARP package, and the new $800+ billion stimulus package nearing completion as we speak. The truth of the matter is that the real price tag is much more than that. Tim Iacono looks at the Bloomberg report in his blog post below that shows us the real price tag is close to $10 trillion (that is not a typo).

It looks like Bloomberg v. Board of Governors of the Federal Reserve System is moving along nicely with arguments to be heard as soon as this month.

Recall that Bloomberg sued the central bank after their Freedom of Information Act request about Fed lending to distressed banks was denied. They simply wanted to know what kind of assets they were getting in exchange for their pristine Treasuries, how much and from whom.

The Fed wouldn't tell 'em. The Treasury Department isn't talking either.

In the meantime, the staff at Bloomberg is taking an increasingly skeptical look at both the sums of money involved and how it is being authorized and spent, as seen in this report:

The stimulus package the U.S. Congress is completing would raise the government’s commitment to solving the financial crisis to $9.7 trillion, enough to pay off more than 90 percent of the nation’s home mortgages.
...
Only the stimulus bill to be approved this week, the $700 billion Troubled Asset Relief Program passed four months ago and $168 billion in tax cuts and rebates enacted in 2008 have been voted on by lawmakers. The remaining $8 trillion is in lending programs and guarantees, almost all under the Fed and FDIC. Recipients’ names have not been disclosed.

“We’ve seen money go out the back door of this government unlike any time in the history of our country,” Senator Byron Dorgan, a North Dakota Democrat, said on the Senate floor Feb. 3. “Nobody knows what went out of the Federal Reserve Board, to whom and for what purpose. How much from the FDIC? How much from TARP? When? Why?”

You have to wonder why Congress even bothers going through the arduous task of passing legislation for a measly trillion or two when so much money can be made available without the approval of elected officials - about four times as much by my math.

And the best part about doing it that way is that you don't have to tell anybody where it went.

Of course, Congress might want to know and you might get sued.

The Bloomber report goes on to put the total amount of money in perspective just like when Senate Republicans were talking about the stimulus package the other day with images of hundred dollar bills stacked 600+ miles high and/or laid end to end, circling the earth 40 times.

That was for just $800 billion.

Somehow, for $10 trillion, this doesn't sound nearly as impressive.

The $9.7 trillion in pledges would be enough to send a $1,430 check to every man, woman and child alive in the world. It’s 13 times what the U.S. has spent so far on wars in Iraq and Afghanistan, according to Congressional Budget Office data, and is almost enough to pay off every home mortgage loan in the U.S., calculated at $10.5 trillion by the Federal Reserve.

Maybe it is impressive, but $1,430 doesn't really sound like a lot of money.

Remember when they talked about $30 or $50 billion for Iraq and then it turned into hundreds of billions of dollars and that was such a big deal?

Now, even a hundred billion dollars doesn't sound like much anymore.

Soon, one trillion might not sound like a lot either.

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

Concerns About The Economic Stimulus Package

The Senate is expected to vote on the new economic stimulus bill on Tuesday, according to the Wall Street Journal, and it appears it will be able to squeak through. Once the Senate passes the bill it will need to go through House-Senate negotiations, but it should just be a matter of time before the bill ends up on the President’s desk for signing. The bill has not seen the sweeping bi-partisan support that President Obama was hoping for, but could we honestly expect anything but controversy? Senate Democrats only needed a couple Republican votes to make it happen, and that is exactly what they were able to get. So what exactly about this bill has Republicans up in arms? And do their concerns have any merit?

The biggest complaint coming from the Republican side is that the bill is full of wasteful spending. According to an analysis in the Washington Post, the new version of the bill is 78 percent spending and only 22 percent tax cuts. Naturally this type of break down isn’t going to sit well with most Republicans. To make matters worse, the urgency with which supporters want to pump money into the economy has many questioning how well this massive spending will be regulated—if at all. According to the Post, “The stimulus plan presents a stark choice: The government can spend unprecedented amounts of money quickly in an effort to jump-start the economy or it can move more deliberately to thwart the cost overruns common to federal contracts in recent years.”

“’You can't have both,’ said Eileen Norcross, a senior research fellow at George Mason University's Mercatus Center who studied crisis spending in the aftermath of Hurricane Katrina. ‘There is no way to get around having to make a choice.’”

The objections to the spending portion of the bill prompted Obama to make the following statement at a recent House Democratic retreat, according to the Wall Street Journal: “So then you get the argument, ‘Well, this is not a stimulus bill, this is a spending bill.’ What do you think a stimulus is? (Laughter and applause.) That's the whole point. No, seriously. (Laughter.) That's the point. (Applause.)”

The Republicans continue to claim that tax cuts are more efficient than many of the spending proposals being included in the bill. If you are interested in hearing more about that, here is a good opinion piece recently published in the WSJ.

The way that I look at it, we have already tried tax cuts, and they didn’t work out quite as well as we had hoped. Though I don’t think that means we should give up on them all together, I am willing to give other things a try. What I don’t like is the lack of oversight on the spending. If we are going to spend $600 billion, I sincerely hope that we can spare a few million to ensure that these billions are used effectively. I don’t want to see us squander this stimulus money the way that we have the in past. This article in the Post gives a good walk-through of the potential problems with spending oversight as it sits now. Leaders would do well to read this and think hard about how they can ensure that we stimulate the economy in the most efficient and cost-effective manner possible.

Unemployment Surges Again. Stimulus Debate Continues.

In an alarming trend, the recent unemployment report was yet again worse than economists expected. January nonfarm payrolls fell by a seasonally adjusted 598,000, according to the Bureau of Labor Statistics (BLS). Economists surveyed by MarketWatch expected to see 525,000 job losses, considerably less than what was actually reported. In addition to the 598,000 job losses reported for January, the BLS also revised the job loss tally for December from 524,000 to 577,000. Sadly people are growing accustomed to this sort of news, but that doesn’t make this latest report any less grim. "The only 'positive' of today's report is that these ugly numbers put even more pressure on policymakers to finally agree on fiscal measures to stop the downward spiral of the economy," wrote Harm Bandholz, economist for UniCredit Markets as reported by MarketWatch.

This latest report just might be what is needed to get the new stimulus bill passed. I for one did not expect there to be as much debate as there has been. Although Democrats are only a couple votes away in preliminary projections, they want to ensure that the bill is in a form that is guaranteed to pass when it’s time to vote. It will be interesting to see how the bill evolves as the parties negotiate. Both sides want to see something passed, and so eventually something will get passed in one form or another. Senate Majority Leader Harry Reid has given the group of 20 bipartisan senators working to put this bill together a deadline of today to resolve their differences, according to CNN.

President Obama is pushing the Senate hard to get something passed, stressing that time is of the essence. “If we do not move swiftly to sign [the act] into law, an economy that is already in crisis will be faced with catastrophe," Obama was quoted as saying by CNN. "This is not my assessment. This is not Nancy Pelosi's assessment. This is the assessment of the best economists in the country. This is the assessment of some of the former advisers of some of the same folks who are making these criticisms right now."

Obama’s goal has been to have the legislation on his desk and ready to be signed into law on Presidents Day, February 16^th, according to CNN. There is still a lot of work to be done on the bill, but I imagine that they will have something ready by the end of the weekend, if not by the end of the day.

Brits Blame Greenspan For Global Financial Crisis

Everyone is looking for the person responsible for the economic mess the world is in, or at least a fall guy we can blame everything on. According to a recent web poll, Brits believe that former Fed chief, Alan Greenspan, is the man. Truth is no one person is solely responsible for all our economic problems, however, it is still interesting to see who people think the biggest culprits are. Tim Iacono from The Mess That Greenspan Made looks closer at this poll and adds some thoughts of his own, in the blog post below.

It is not at all clear what, if any, significance the survey results attached to this story in the U.K.'s Times Online hold but, when asked which of ten individuals to blame for the current financial mess, fingers were pointed squarely across the Atlantic Ocean at the guy who ran the Federal Reserve for almost two decades.

Are the British that attuned to monetary policy in the U.S. or are they, perhaps, more willing to look overseas for a culprit rather than on their own soil?

(BTW - that little radio button thingy is my vote, just in case anyone was wondering.)

The much better known local boy, Gordon Brown, comes in a distant second (for very good reason, actually) and George W. Bush is even further back in third place.

Interestingly, the three individuals who were probably more responsible than any politician in the world - Fuld, Paulson, and Mozilo - filled the next three spots.

As for the other four, the British are probably about as familiar with the name Hank Greenberg as Americans are with Sants, Goodwin, and Corbert, though, after reading the descriptions provided, these three clearly deserved more votes than they received.

Here's what they had to say about former Fed Chairman Alan Greenspan:

Alan Greenspan was feted for his management of the US economy while he stood in charge of the US Treasury, but has since been put under the spotlight. He was responsible for cutting interest rates to near zero in the US in the aftermath of September 11, flooding the world with cheap and easily available money. Did this pave the way for a “once-in-a-century credit tsunami"? In October last year he said: “I made a mistake in presuming that the self-interest of organisations, specifically banks and others, was such that they were best capable of protecting their own shareholders.”

Allan Meltzer is a professor of political economy at the Carnegie Mellon University in Pittsburgh, said: “Alan Greenspan was much too afraid of a slowdown or other recession…he allowed the credit to expand too rapidly."

The confusion about the Fed chairman heading up the U.S. Treasury Department may be understandable as we Americans are often confused by the British position of Chancellor of the Exchequer which we'd be just as likely to say headed up the Bank of England.

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

What Does February Have In Store For Currencies?

January was a great month for the USD, and even better for the Japanese Yen, but what does February have in store for the currency market? Investors should pay close attention as currency expert Kathy Lien attempts to answer that question in her blog post below. Investors should know that past performance doesn't necessarily represent future performance, but it certainly can help investors make educated decisions.

In the beginning of January, I highlighted the effect of seasonality on the EUR/USD. At that time, I talked about how the EUR/USD has a natural bias to sell-off in the first month of the year as investors reverse their year end flows. Since 1997, the EUR/USD has sold off in the month of January 72.7 percent of the time. If we include the currency pair’s price action in 2009, the EUR/USD has now sold off 75 percent of the time in January. The combination of falling interest rates in the Eurozone, recession and a flight to safety into US dollars has led to the strongest January sell-off in the EUR/USD in more than a decade.

February Performance

Now that January is behind us, many forex traders may be wondering if there are any unique characteristics in the currency market for the month of February. Taking a look at more than 30 years worth of data, we have found that on average the trading range in USD/JPY tends to compress in the second month of the year. In fact, of all 12 months, the average trading range in USD/JPY is lowest in February. Lower volatility could mean stability for USD/JPY because high volatility hurts Yen crosses (A Turn in USD/JPY?).

Currency Performance Since January

The final chart (after jump) illustrates how all of the major currencies have performed against the US dollar in January. So far, the Japanese Yen has been the only currency to outperform the greenback.

This post can also be viewed on kathylien.com.

How To Prevent Another Depression

We are no where near a depression yet, but many people are worrying that we are heading for one. So what can the government do to prevent another depression? According to Brad DeLong we have 4 options. Mark Thoma from The Economist's View looks at DeLong's 4 options in his blog post below.

What can governments do to try to keep the economy out of a depression?:

Depression economics: Four options, by J. Bradford DeLong, Commentary, Project Syndicate: When an economy falls into a depression, governments can try four things... Call them fiscal policy, credit policy, monetary policy, and inflation.

Inflation is the most straightforward to explain: The government prints lots of banknotes and spends them. The extra cash in the economy raises prices. As prices rise, people don't want to hold cash... - its value is melting away every day - so they step up the pace at which they spend... This spending pulls people out of unemployment..., and pushes ... production up to 'potential' levels.

But sane people would rather avoid inflation. It is a very dangerous expedient, one that undermines standards of value, renders economic calculation virtually impossible, and redistributes wealth at random. ... But governments will resort to inflation before they will allow another Great Depression. We just would very much rather not go there, if there is any alternative...

The standard way to fight incipient depressions is through monetary policy. ... The problem with monetary policy is that ... the ... nominal interest rate on government securities is zero. ... And this is too bad, for if we could prevent a depression with monetary policy alone, we would do so, as it is the policy tool for ... stabilisation that we know best and that carries the least risk of disruptive side effects.

The third tool is credit policy. We would like to boost spending immediately by getting businesses to invest... Risky projects are at a steep discount today... No one is willing to buy assets and take on additional uncertainty... Although the world's central banks and finance ministries have been devising many ingenious and innovative policies to stimulate credit, so far they have not had much success.

This brings us to the fourth tool: fiscal policy. Have the government borrow and spend, thereby pulling people out of unemployment and pushing up capacity utilisation to normal levels. There are drawbacks: the subsequent dead-weight loss of financing all the extra government debt..., and the fear that too rapid a run-up in debt may discourage private investors from building physical assets...

But when you have only two tools left, neither of which is perfect for the job - credit policy and fiscal policy - the rational thing is to try both, at the same time. That is what the Obama administration ... and other governments are attempting to do right now.

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

Stimulus Bill Now Being Debated In Senate

A new $819 billion stimulus bill was passed by the House earlier this week, and the debate has moved on to the Senate, despite major opposition from House Republicans. Not a single Republican voted in favor of the bill according to the Wall Street Journal, but to get the 60 votes necessary to clear the Senate, the bill’s supporters will need to garner at least some Republican votes without losing any of the 58 Democrat senators. To secure those necessary Republican votes, some concessions will likely need to be made. One way or another, it is expected that this bill will be passed, but it remains to be seen how much political capital Obama will have to spend to make it happen.

The major divide between the two parties on the bill basically boils down to the allocation of the funds. Both parties support a stimulus bill in principle, but Republicans want to see the funds going toward things such as tax-cuts where as Democrats prefer government spending. In reality, this debate isn’t new, and considering the heavy numbers advantage that the Democrats enjoy in the House, Senate and now White House, the bill should lean toward their ideology. However, it is likely that Republicans will get a bone or two thrown their way in the process. Obama has stated time and time again that he wants broad, bi-partisan support for this bill, but it is unlikely that Democrats will be willing to give up too much considering their steep numbers advantage.

As a side note, the Wall Street Journal reported the formation of a coalition which backs the stimulus bill and which includes labor and environmental groups. The purpose of the group is to raise pressure on senators—specifically Republican senators—to support the bill. They announced Thursday that they will air ads around the country to encourage Republicans, "to support the Obama plan for jobs, not the failed policies of the past." The ads will run in Maine, New Hampshire, Iowa and Alaska according to the Journal. You can be certain that Democrats will remind Republicans and their supporters that their policies have been nothing but failures of late. The public is largely on board with this sentiment, evidenced by numerous polls. If nothing else we should get a chance to see how these new policies actually work in today’s economic climate.

GDP Falls Sharply, But It Could Have Been Worse

The GDP report for the fourth quarter of 2008 showed a steep decline, however, experts thought it was going to be even worse than it was, so that is positive news. There are certainly some indicators that show we should be alarmed about the economy right now, but there are also some positive sparks coming out of these reports that we shouldn't overlook either. James Picerno from the Capital Spectator looks closer at the report and shines some light into what this all means in his blog post below.

Today's report on last year's fourth-quarter GDP wasn't good. In fact, it was quite ugly. But it could have been a lot worse.

Even so, the 3.8% contraction in the economy in 2008's final three months was the steepest decline since 1982. The previous recession in 2001 never came close to what's unfolding now. The 1990-91 slump was deeper, but even that will look mild by the time the current downturn has run its course.

In other words, we're now in the thick of the worst recession since the early 1980s. That said, the crowd was expecting a far deeper loss. The consensus forecast for Q4 GDP was -5.5%, according to Briefing.com. By that standard, the reported 3.8% retreat was a surprise.

Of course, today's GDP report is the first of three estimates from the government and so we must brace ourselves for the possibility of downward revisions. But for the moment, it's fair to say that the recession isn't quite as bad as some had feared, at least if we're using GDP as a benchmark.

That's a thin reed, of course, since it's likely that the pain will run on for some time. Meanwhile, no one should be complacent about the trend. Last year's third quarter posted a mild -0.5% setback, but the wealth destruction became materially worse in Q4. The first three months of this year are likely to be no better and even money says it's likely to get worse for a quarter or two.

Indeed, there's no way to put a positive spin on the fact that consumer spending—the main engine of economic growth for the U.S.—continued to decline at a robust pace in Q4. Personal consumption expenditures fell a hefty 3.5% in last year's final three months, almost as fast as Q3's 3.8% decline. The pain is especially acute in durable goods spending, the so-called big ticket items such as appliances. The huge 22% fall in durable goods spending in Q4 is certainly humbling; it's also a sign of just much has changed in the consumer mindset.

Yet there was a bit of good news. Spending in services by consumers actually rose in Q4, advancing by 1.7%. That compares favorably to Q3's marginal loss. Given the heft of services in the economy, the growth is particularly important to offset weakness almost everywhere else.

Alas, the export machine that had offered so much hope last year as a buffer to economic pain elsewhere is now in full retreat. Exports fell 20% in Q4, the deepest drop in many a moon. Imports slid as well, although not quite as fast.

Overall, today's GDP report is a reminder that we're now in the midst of what promises to a deep recession, perhaps the worst since the Great Depression. The great question is how all the government stimulus will affect GDP this year. The monetary stimulus is only now starting to filter through the economy, and it will be soon followed by another round of fiscal stimulus. Stay tuned.

This post can also be viewed on capitalspectator.com.

What Will The Fed Do To Stimulate The Economy Now?

Bernanke and the Fed already played their last interest rate card, so if they can't lower rates what else can they do to get the economy back on track? There is a lot of speculation going around right now about what they might do, but we shall find out for ourselves later today. James Picerno from The Capital Spectator talks about the Fed meeting and the economy in general, adding some valuable input in his blog post below.

The press release that follows the Fed's FOMC meeting today may offer clues about how the central bank will proceed now that it's out of conventional monetary policy ammunition. Then again, maybe not. We're all trapped in gray zone of trial and error about what to do next and the Federal Reserve is also now faced with grasping at straws.

Typically, an afternoon FOMC press release attracts interest for an update on where short-term interest rates are headed. Today, and probably for some time to come, everyone already knows the answer. The Fed controls short rates, starting with the all-powerful Fed funds, but with the effective Fed funds at roughly 0.16%, the mystery about what comes next is, like the price of money, virtually nil.

Yet Bernanke and company may yet surprise us by dropping fresh clues about how the Fed plans to practice unconventional monetary policy from here on out—quantitative easing, to use the phrase of the dismal science. The details are a work in progress, although the immediate goal is still clear: stabilize general price levels.

We won't belabor the issue of deflation today, in part because we've discussed it often in recent months, including here and here. Let's just say that the D risk is still very much with us, and so the Fed has a fair amount of work to do in the months ahead.

The market appears to understand this, at least by way of monitoring Fed funds futures. For the year ahead, all the contracts are expecting Fed funds to remain under 60 basis points, and quite a bit lower for the immediate future.

Long rates remain in a holding pattern as well. The yield on the benchmark 10-year Treasury Note is in the 2.5% range and it may go lower yet, depending on what the next round of inflation reports reveal, although those won't arrive for several weeks.

Meantime, there's plenty of guesswork about what the Fed's next move. "With rates going nowhere for some time, the market's focus will be on whether the Fed will be looking to buy government (or corporate) securities in the near future," Sacha Tihanyi, an analyst at Scotia Capital, opines via AFP.

John Authers in today's FT argues that the critical variable is housing prices. What can the central bank do on that front? "The Fed can give details on quantitative easing— the ugly phrase for the art of buying bonds so as to push down the yields they pay, and stimulate the economy with lower rates, especially for mortgages," he writes. "If there is a single key variable to determine when the crisis in the US banking system can be brought under control, it is house prices. The further they fall, the higher the likely default rate on the mortgage-backed securities that banks now hold on their balance sheets."

Unfortunately, the news on housing prices is still discouraging, even after several years of a falling market. One of the latest bits of housing data shows that prices fell again last month even as sales perked up. Existing home sales rose 6.5% in December, albeit driven by distressed sales at bargain prices, the National Association of Realtors reports. Nonetheless, the median national price of existing homes in the U.S. still dropped by a hefty 15.3% last month.

Even if the Fed is successful in fending off deflation, which we expect it will be, that by itself isn't a cure for what ails the economy. "Ben Bernanke is rightly concerned about deflation right now," Desmond Lachman of the American Enterprise Institute explains in The Christian Science Monitor. But that's merely step one in a multi-step recovery program. "Getting inflation back into the system … is not going to be sufficient," Lachman notes.

Convincing banks to lend and consumers and businesses to borrow is arguably the next big step beyond containing the deflation risk. Solving the latter will be easy by comparison. The real challenge will come later this year in trying to promote growth. But first things first, and so we await today's Fed commentary.

This post can also be viewed on capitalspectator.com.

What Is Going On In The Forex Market Right Now?

The currency markets have been going crazy lately, with several currency pairs forming new, or close to new, records. With all this volatility what are currency investors to think? Currency expert Kathy Lien attempts to answer this question in her blog post below.

There has been a lot of volatility in the foreign exchange market this morning, driving currencies to historic levels:

GBP/USD - 23 Year Low
USD/JPY - 13 Year Low
NZD/USD - 6 Year Low
EUR/JPY - 6 Year Low
CAD/JPY - 13 Year Low
GBP/JPY - Record Low
NZD/JPY - 8 Year Low

The most significant moves have been in the British pound, which fell to a 23 year low against the US dollar and in USD/JPY, which fell to the lowest level in 13 years. Comments from former Fed Chairman Volcker triggered a wave of risk aversion that led to a technical break in the currency market. He said “we are in serious recession, with no end clearly in sight.” Although there is no question that the US economy is in trouble, by saying that there is no end in sight means that there is no hope which coming from the chairman of Obama’s newly formed Economic Recovery Advisory Board is significant. By saying that he does not an end to the recession is certainly not good advice. Treasury Secretary Nominee Geithner expects an Obama economic stimulus plan to be released in the next few weeks but unfortunately Volcker’s comments overshadowed the prospect of a stimulus plan. Yesterday’s sharp sell-off made investors nervous but Volcker’s comments pushed them over the edge.
We are continuing to see flight to safety into the US dollar and Japanese Yen. Investors are looking to hide in the lowest yielding currencies.

We also had comments from ECB President Trichet and SNB President Hildebrand. Trichet defended the ECB’s monetary policy and said they haven’t decided if 2 percent is the lowest level for rates.

Intervention by Swiss National Bank?

The Swiss franc collapsed after SNB Hildebrand said that the central banks is considering selling francs to halt the currency’s gains. With interest rates already at 0.5 percent, they have no room to ease monetary policy. Therefore they may have to resort to fixed rate currency intervention.

This post can also be viewed on kathylien.com.

Welcome President Obama: Now About The Economy...

Yesterday was basically one big party, everyone it seemed was excited to welcome in our new President. Now the party is over and it is time for Obama to get to work, and he had better act fast. The economy is struggling mightily and Americans expect, albeit a tad unfairly, that Obama's administration is going to be able to fix the problem. James Picerno from The Capital Spectator paints a dreary picture for the economy over the coming months, while holding out some hope for a recovery, in his blog post below.

Today is the first full day of President Barack Obama's administration and, as everyone knows, the new commander in chief has his work cut out for him. With a fresh start before us in Washington the question on the home front remains: What's up (or down) with the economy?

In broad terms, the answer is obvious, and the numbers only lend statistical support. Clearly, tough times lie ahead, with the next 6 months or so looking set to be the toughest. But how does that square with our proprietary measure of U.S. economic activity (CS Economic Index), which bounced sharply higher in November, the last month with the full compliment of data pieces for calculating this benchmark? What's more, based on preliminary data for December, the November bounce looks set to hold.

Alas, the rise is something of an illusion for the time being since only two factors out of the 17 in our economic index are driving the bounce skyward. Granted, the pair is on steroids trying to bring aid and comfort to the ailing economy. Statistically, the changes in those two factors are enough to push the entire index upward. Even so, those two lone bullish factors alone, unfortunately, aren't likely to spark a recovery of any substance for the foreseeable future. Looking out later in the year offers some hope, but first let's talk about the immediate future.

The two factors doing all the heavy lifting in our economic index are money supply and the interest rate spread. Both were in overdrive in November in terms of generating pro-recovery fuel to an otherwise shrinking economy. The rate spread was particularly bullish, although the growth-oriented bounce from money supply was robust too. Collectively, the pair overwhelmed the negative energy elsewhere in the economy, at least when measured on an average basis.

By rate spread we're talking of the difference between the yield on the 10-year Treasury Note less the effective Fed funds. Thanks primarily to the dramatic fall in Fed funds in November, which continued in December, the rate spread widened sharply and thereby moving definitively into positive territory, which generally is a bullish signal for the economy. Why? Because a positive sloping yield curve—rates are higher as bond maturities lengthen—historically accompanies economic growth. By contrast, a negatively sloping yield curve—rates fall as maturities lengthen—is a sign of distress/economic contraction.

Based on the rate spread, this measure went negative in July 2006 and stayed negative until February 2008, when the spread moved back into positive territory. Looking back, it turns out that the recession warning posed by the arrival of a negative yield curve in mid-2006 was an accurate forecast of an approaching recession, which officially began in December 2007.

Fast forward to November 2008 and the rate spread is telling us that it's now in high gear as an economic stimulus. That is, short rates are extremely low relative to long rates—despite the fact that long rates are also bouncing around at historically low absolute levels. Based on this measure alone, one might be bullish on the immediate future, assuming this was a normal cycle. But as we know, the times are anything but normal and so even the unusually bullish stimulants coming from the money supply and interest rate factors aren't yet dispensing their usually pro-growth influence. The reason is that the negative drag from everything else is, for the moment, still too much to overcome. Indeed, the lagging and coincident factors in our broad economic index are either flat lining or still declining.

The good news is that at some point all the monetary stimulus will take root and promote expansion. All the money has to go somewhere and eventually it'll go into corners of the economy other than banks accounts and T-bills. Banks will one day lend and businesses will borrow. In addition, now that the Obama administration is at the helm, we expect a fresh round of fiscal stimulus to compliment the monetary efforts now running at full speed.

Guessing when all this will produce some measurably positive change in the economy proper is the great question. Given the depth and magnitude of the economic headwind, we're not expecting much for the first half of this year, perhaps longer. Even when signs of growth, or at least stabilization emerge, they're likely to be tenuous, slipping temporarily back into negative territory and keeping everyone on pins and needles.

Recovery worth the name is going to take time, and perhaps a fair degree more time than we've come to expect over the past generation, when growth returned fairly quickly after a downturn.

As such, strategic-minded investors should pace themselves and use the next several quarters productively to restructure their portfolios for the day when the storm passes. As we'll discuss in more detail in the February issue of The Beta Investment Report, the ongoing economic and financial turmoil is wrenching but it also offers substantial opportunities for dynamic asset allocation strategies.

That said, the next several months are undoubtedly going to be rough, replete with surprises, false starts and lots of noise in the markets. Economically speaking, there are still a number of big unknowns lurking in the near-term future too. Investors should brace themselves for more volatility, and at the same time prepare to take advantage of it.

Risk management, in other words, has never been more important, or potentially more rewarding.

This post can also be viewed on capitalspectator.com.

Most Americans Support New Stimulus Proposal

House Democrats released the latest version of a new stimulus package meant to turn our struggling economy around. Most notably, the stimulus package swelled from $775 billion to $825 billion with a proposed $550 billion in spending and aid to states and $275 billion in tax cuts, according to CNNMoney. Despite the large price tag, Americans are generally perceived to be on board with the plan, according to a recent Wall Street Journal/NBC News poll. 43 percent of the people surveyed called the plan a “good idea,” while 27 percent said it was a “bad idea.” The remaining portion had no opinion either way.

The most pressing concern for the people surveyed was unemployment, followed by the federal budget deficit which came in at a distant second. 63 percent of the surveyed individuals felt that government spending should be the biggest priority of the bill, while 33 percent felt that tax cuts should be the main catalyst.

It would be interesting to compare this current poll to how people felt about these priorities prior to the last stimulus package. I have a sneaking suspicion that more people would have been in favor of tax cuts back then. Because those didn’t work as planned, people are turning to a different strategy to fix the problem.

President-elect Obama is enjoying unprecedented support for his plan and his administration as Americans look to him to get us out of this mess, but if Obama’s stimulus plan doesn’t get succeed, it will be interesting to see how quickly that support wanes. President Bush once had the highest approval rating ever (90 percent in September 2001), and now has the second lowest approval rating ever, only bested by Richard Nixon after the Watergate scandal. The American people are ready for results, and Obama may learn, as George W. did, that opinions can change drastically and quickly.

Division Mounts Among Fed Officials

The swelling balance sheet at the Federal Reserve is causing problems in more ways than one. One Fed official, Philadelphia Fed bank president Charles Plosser, recently went public with his objections against current Fed policies. Plosser’s main objections concern the ballooning balance sheet and the apparent endlessness to the madness. Fed chief Ben Bernanke doesn’t think that the balance sheet is a problem, but Plosser does, and he is ready to take his argument to whoever will listen. The following are excerpts from a MarketWatch article that detail some of Plosser’s concerns:

“Plosser said that the growth of the Fed's balance sheet was a key metric. ‘It is not appropriate to ignore quantitative metrics in this new policy environment,’ Plosser said.”

“Fed officials who pay attention to the money supply believe that the Fed's current policy of printing money never ends well and the danger of inflation is very high. They believe the Fed must withdraw the stimulus before there is any sign of inflation or it is too late.”

“Plosser also argued that the Fed has put its independence at risk by buying long-term assets. He worried that some "interest groups" will try to use political persuasion to stop the Fed from selling these longer-term assets even if the central bank has decided it makes sense.”

“‘We will need to have the political fortitude to make some difficult decisions about when our policies must be reversed or unwound,’ Plosser said. Bernanke said that he would watch this situation closely but didn't expect it to be a ‘significant problem.’"

Plosser isn’t the only one expressing concerns. William Poole, who recently left his position as president of the St. Louis Fed, has also been outspoken about issues with current Fed policies. The following are experts from a MarketWatch article:

“Poole said the expansion of the Fed's balance sheet is unprecedented and research suggests that a surge of inflation is sure to follow. ‘I would say if the policy is not reversed, there is a high probability that the unpleasant risk (of inflation) materializes,’ Poole said in an interview.”

“‘I believe that the Fed should set a hard number—a target that they take seriously for the overall size of the balance sheet,’ he said.”

“Poole said he was very concerned that the Fed could simply lend money to anyone, without constraint.”

“In the Soviet Union and Eastern Europe during the Cold War era, economies were inefficient because they had a soft-budget constraint. If a firm got into trouble, the banking system would give them more money, Poole said. The current situation at the Fed seems eerily similar, he said.”

"’What is discipline—where are the hard choices—when does Fed say our resources are exhausted?’ Poole asked.”

Bernanke seems content to continue on the current path, but it should at least be a little concerning that the opposition inside the Fed is becoming more vocal. I would venture to guess that there are others that oppose Bernanke, but they do not have the guts to stand up publicly against him. If things continue to worsen, it will be at least interesting to see how much the opposition ranks swell.

U.S. Exports Continue Their Downward Trend

Last year, while the U.S. dollar was down, manufacturers were joyfully experiencing one of the the loan bright spots in the U.S. economy, increased exports. Oh, how things can rapidly change for the worse. The latest trade report showed that U.S. exports were down again, for the fourth consecutive time. Is there any bright spots left in the economy? If so they are hiding pretty well. James Picerno from The Capital Spectator looks closer at the latest trade report in his blog post below.

The trade boom is fading. That's no great surprise, given the weakening state of the global economy. But the slippage in export-related activity comes at an especially challenging moment for the U.S.

Exports remained a bright spot for the U.S. economy last year. As other areas weakened in 2008, the American export machine bucked the trend. It was a timely boost, offering some hope that the approaching recession might be mitigated and perhaps even sidestepped altogether.

The high point came in last year's second quarter, when real (inflation-adjusted) export activity soared 12.3% on an annualized basis while GDP advanced 2.8%. That took some of the sting out of the drop in durable goods spending and a growing sense of unease otherwise in the GDP trend. In the third quarter, the export boom slowed but remained robust, rising 3.0%, in sharp contrast to the 0.5% decline in GDP.

The long-suffering dollar was no small advantage for juicing exports. As the greenback declined, the price cuts on American goods and services became increasingly attractive to foreign countries. Then in July 2008, the dollar began to rally. Although the U.S. Dollar Index has been trading in a range recently, it's still up sharply from its summer lows.

It was a tempting notion to think that exports would save us, although we warned last summer about expecting too much from the trend. "There's a limit to how much economic gain any nation can enjoy through a weakening of its currency," CS wrote in July. "Devaluation may offer short-term benefits, but the U.S. can't devalue its way to prosperity for very long."

The dollar's recent strength at the moment surely isn't helping U.S. exporting activity, nor is the credit crisis or the general economic turmoil blowing through economies around the world. Few analysts expected the fourth quarter GDP report to deliver anything other than a negative number. Today's trade update for November only strengthens that forecast. Exports dropped nearly 5.8% last month, the fourth consecutive montly decline.

No one will be shocked by the trend, although it's a humbling reminder that the economy has nowhere to hide. Employment, consumer spending, and so on have each fallen victim to the ill winds of recession. Exports are no exception. As we discussed on Friday, this is the eye of the economic hurricane and, as a result, all news from the dismal science is likely to be discouraging news for the time being. Not forever, but for a few quarters at least. Time moves slowly when you're waiting for a bottom.

This post can also be viewed on capitalspectator.com.

"Millionaire" Redefined Yet Again

The financial crisis has seemingly spared no one, including the once ballooning number of millionaires. Millionaires are becoming a rare commodity, and it could be said that the title once again means something. While millionaires still worry about the same things normal people do, sometimes we can elevate them to a higher level than they should be. Tim Iacono looks at this phenomenon a little closer in his blog post below.

One of the many deleterious effects of the many recent financial market bubbles was that the meaning of the word "millionaire" was severely diminished.

The efforts of Regis Philbin and crew notwithstanding, the word had maintained the same weighty connotation early into the new century as gains in stock market wealth, while significant, were not nearly as broad based as what was to follow - housing market wealth.

A few years back, virtually any long-time homeowner in one of the housing bubble states who had also squirreled away a decent sum in their retirement savings could legitimately call themselves a millionaire, though, the value of one's primary residence is typically excluded in the official definition by those who study millionaires.

No matter.

All of that has changed so much over the last two years that, today, few argue that the definition of the word should be expanded to include home equity since there is so much less of the stuff today than there was back in 2006.

Combined with the more recent plunge in equity markets, it seems that one of the few bright spots in the current downturn is that some of the cachet of the word "millionaire" is being restored.

This report in CNN/Money explains:

Millionaires? More like $700,000-aires
While it may be hard to feel sympathy for America's millionaires, they're feeling the economic crunch, too - nearly a third of their assets have disappeared in the downturn, according to a consulting firm's report released Tuesday.

Spectrem Group said U.S. households worth $1 million or more - excluding their primary residence - have seen their assets decline by 30% during the financial crisis.

Almost one-fifth of the asset declines were greater than 40%, the report said.

"There's a huge amount of anger," said George Walper, president of Spectrem Group.

Nearly all the millionaires surveyed - 90% - said they "fear a prolonged economic downturn," the report said. On average, they believe it will last for another 22 months.

Maintaining their current lifestyles is also of concern, as 55% of respondents said they are worried they will not have sufficient assets to do so.

Don't let that last part about the lifestyles of millionaires throw you.

Despite what you may have been led to believe by Robin Leach and his ilk, it's not all "champagne wishes and caviar dreams".

One of the most important books out there, a book that every high school student should be required to read, is "The Millionaire Next Door". You can get the gist of the entire work simply by reading the first two pages that are conveniently reproduced below:
Ironically, this book was first published in the year 1998, the same year that the popular game show "Who Wants to be a Millionaire" debuted.

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

A Christmas Wish For Your 401(k) Account

Most people lost a good portion of their 401(k) this year, but will next year be any better? Most people would have to say yes, if for no other reason than it would be hard to comprehend anything being worse than 2008 was. Already analysts are predicting much stronger earning next year, but then we are hearing reports about how horrible this holiday has been, and how that is going to kill some companies. So can we expect a Christmas gift this year for our 401(k) and other retirement accounts? James Picerno from The Capital Spectator offers up his insight below.

U.S. corporate earnings have been under pressure for some time, based on reported operating earnings for the S&P 500. Indeed, the bloom fell off the rose a year ago, when S&P earnings took a dive in 2007's fourth quarter from the formerly plush levels.

A lower level of earnings has prevailed ever since, as our chart above shows. But bottom-up estimates (as per Standard & Poor's as of December 16) are decidedly upbeat for 2009. If the forecast proves accurate, by this time next year S&P 500 operating earnings will return to the record levels posted in 2007. If such an earnings rebound is coming, the S&P 500 looks inexpensive based on the forward earnings multiple of 10.6, as per the full-year 2009 earnings estimate of $83.44.

Reuters reports that a key source of the expected earnings turnaround next year will come from none other than the ailing financial sector. That would be no trivial rebound, considering the current depth of earnings red ink weighing on the financial sector. But that will give way to positive earnings next year, or so we're told.

Consumer discretionary sector earnings are also thought to be poised to soar next year, rising 46% for full-year 2009 earnings, based on bottoms-up predictions. That's nearly twice the S&P 500's predicted earnings rise. In fact, only the energy, industrials and materials sectors of the S&P 500 are expected to suffer lower earnings in '09 vs. this year. The other 7 sectors for the S&P are on track for higher elevations.

It sounds like just the holiday treat we've been waiting for. Yet we must be wary of analysts bearing gifts. Indeed, bottom-up analysts as a group tend to be more optimistic relative to top-down analysts. Even so, the top-down crowd sees earnings growth for next too. The high end of forecasts among top-down calls for a rich $100 for 2009 S&P earnings, vs. $60 on the low end for this group's prediction, The Wall Street Journal recently noted.

For what it's worth, your editor is also confident that next year's earnings for the S&P will rise above this year's dismal results. But that's like saying Wall Street's bloodbath won't be so bad in 2009 vs. the last few months.

One of the few bright spots about life after the apocalypse is that a rebound of sorts is virtually guaranteed. Timing is always a question, of course, but rebounds eventually arrive. But no one should confuse a bounce off the bottom as a sign that a return to trend is imminent for corporate earnings. The economic headwind promises to be quite stiff next year, and it remains to be seen who'll have the stamina and the savvy to weather the storm.

Yes, government stimulus will be an increasingly positive force as next year unfolds. But unless you're expecting miracles, it's best to keep the celebratory champagne on ice for the foreseeable future. It took us years to get into this mess, it'll take more than a 2 or 3 quarters to get us out. That doesn't preclude a bounce, but repairing the damage this time will take more than running the printing presses at full speed.

This post can also be viewed on capitalspectator.com.

Understanding The Federal Reserve System

Are you completely confused by the whole Federal Reserve system? If so you are not alone, but you really should at least attempt to understand it. The Federal Reserve plays a huge part in how our economy runs, and every American should be concerned with that right now. While most explanations I've read about the Federal Reserve would probably be confusing for most non-economists to read, a recent one published by James Hamilton on Econbrowser does a fabulous job explaining how the Federal Reserve works.

As a bonus Hamilton also explains all the new and creative things the Fed is doing to help get us out of the financial mess we are in, as well as the present state of the Fed's balance sheet. If you are at all interested in how the Federal Reserve works, and what is going on there today, I strongly recommend that you read his article.

Click here to read the full article.

America's Ponzi Scheme Era

There has been a lot of talk lately about ponzi schemes, and of course this can be directly attributed to the recent Madoff scandal. As Paul Krugman points out in his article, though, there isn't all that much difference between Madoff's actions and the actions of the entire investment industry. After all the end result was the same, the investors lost a bunch of money while the facilitators ran off with the spoils. Mark Thoma from The Economist's View shares the Krugman article in his blog post below.

The costs of "America's Ponzi Era":

The Madoff Economy, by Paul Krugman, Commentary, NY Times: The revelation that Bernard Madoff — brilliant investor (or so almost everyone thought), philanthropist, pillar of the community — was a phony has shocked the world, and understandably so. The scale of his alleged $50 billion Ponzi scheme is hard to comprehend.

Yet surely I’m not the only person to ask the obvious question: How different, really, is Mr. Madoff’s tale from the story of the investment industry as a whole?

The financial services industry has claimed an ever-growing share of the nation’s income over the past generation, making the people who run the industry incredibly rich. Yet, at this point, it looks as if much of the industry has been destroying value, not creating it. And it’s ... had a corrupting effect on our society as a whole.

Let’s start with those paychecks. ... The incomes of the richest Americans have exploded over the past generation, even as wages of ordinary workers have stagnated; high pay on Wall Street was a major cause of that divergence.

But surely those financial superstars must have been earning their millions, right? No, not necessarily. The pay system on Wall Street lavishly rewards the appearance of profit, even if that appearance later turns out to have been an illusion.

Consider the hypothetical example of a money manager who leverages up his clients’ money..., then invests the bulked-up total in high-yielding but risky assets... For a while — say, as long as a housing bubble continues to inflate — he (it’s almost always a he) will make big profits and receive big bonuses. Then, when the bubble bursts and his investments turn into toxic waste, his investors will lose big — but he’ll keep those bonuses.

O.K., maybe my example wasn’t hypothetical after all.

So, how different is what Wall Street in general did from the Madoff affair? Well, Mr. Madoff allegedly skipped a few steps, simply stealing his clients’ money rather than collecting big fees while exposing investors to risks they didn’t understand. ... Still, the end result was the same (except for the house arrest): the money managers got rich; the investors saw their money disappear.

We’re talking about a lot of money here. In recent years the finance sector accounted for 8 percent of America’s G.D.P., up from less than 5 percent a generation earlier. If that extra 3 percent was money for nothing — and it probably was — we’re talking about $400 billion a year in waste, fraud and abuse.

But the costs of America’s Ponzi era surely went beyond the direct waste of dollars and cents.

At the crudest level, Wall Street’s ill-gotten gains corrupted and continue to corrupt politics... Meanwhile, how much has our nation’s future been damaged by the magnetic pull of quick personal wealth, which for years has drawn many of our best and brightest young people into investment banking, at the expense of science, public service and just about everything else?

Most of all, the vast riches ... undermined our sense of reality and degraded our judgment. Think of the way almost everyone important missed the warning signs of an impending crisis. How was that possible? ... The answer, I believe, is that there’s an innate tendency on the part of even the elite to idolize men who are making a lot of money, and assume that they know what they’re doing.

After all, that’s why so many people trusted Mr. Madoff.

Now, as we survey the wreckage and try to understand how things can have gone so wrong, so fast, the answer is actually quite simple: What we’re looking at now are the consequences of a world gone Madoff.

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

Flurry Of Fed Moves Could Lead To Hyper Inflation

In what was a surprising move yesterday, the Fed dropped the Fed funds rate basically to zero, surpassing market expectations. Everyone fears deflation, and the Fed is willing to do whatever it takes to avoid it. But as Toni Straka from The Prudent Investor points out, these drastic moves could soon lead us to hyper inflation.

Share and bond markets rallied on Tuesday after the Federal Reserve announced that it will give away new money for almost free, lowering the Fed Funds target range to a historical low of 0% to 0.25%. The Fed had cut the Fed Funds rate in late October by 50 basis points. The new record low rate is a reaction to to the de facto status quo in treasury securities where short maturities of up to 6 months trade at yields below the upper end of the target range.

In a most unusual move the Fed provided publishable background on its decision, writes the WSJ blog, detailing it all here. The Fed has not held press briefings until now.

While markets welcomed the bold move, gold, the canary in the mine of inflation, advanced as well, piercing the important resistance at $850. Investors are obviously pricing in that all Treasuries yield less than the inflation rate of currently 3.7% YOY.

But the move to a zero interest rate policy will come at the cost of higher inflation in 2009 and 2010, it can be safely predicted. Chairman Ben Bernanke and his fellow Federal Open Market Committee (FOMC) members pulled out all stops in order to jumpstart the economy and assured market participants that the Fed would continue to engage in the dubious game of printing fresh money for collateral it does not want to talk about.

Once more proving their image of inflationistas par excellence the FOMC said the Fed can be expected to hold on to its free money policy for quite some time and use all tools to promote a return to growth.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

But money for nothing alone will not help, the Fed reasoned, preparing markets for more growth in the Fed's balance sheet after it has exploded from $800 billion to $2.2 trillion since last summer. Expect the Fed to continue to buy more worthless MBS (mortgage backed securities) while substituting the banking sector in the commercial paper market.

The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

I translate this into "we will throw (fiat) money (that costs us next to nothing) on every problem as we did in the past 2 decades." See more worthless money created that will be exchanged for more MBS that are valued on a theoretical basis, i.e. not the market price which may be only a tiny fraction of the initial face value.

The announcement that the Fed is looking into buying longer term US Tresuries raises immediate fears that the Fed will be monetizing the federal debt again after a portfolio shift towards MBS in the recent past. Any talk about deflation misses the point of unprecedented monetary inflation that will show up in the real economy 2009/10.

Eric de Carbonnel argues at DollarDaze that monetary inflation does not even have to pump up money supply - my favorite theory - but that it is a loss of confidence that increases the velocity of money, resulting in the dange of hyper inflation.

The record low official Fed Funds rate may be elusive though. Jake at EconomPicData sees a disconnect between municipal bonds and Treasuries, reflecting the horrendous outlook for cash strapped communities which had invested heavily in property debt. Now they are broke.

GRAPH: The yield spread between Munis and 5-year Treasuries soared to a record high of 325 basis points. Graph courtesy of EconomPicData.

DollarDaze draws a historical comparison that shows deflation can be a hazy illusion.

As an example of deflation leading to hyperinflation, consider the case of the Weimar Republic. In 1920, Germany experienced a deflationary collapse, with the average citizen finding it harder and harder to get enough money for necessities. Banks, short of money, could not honor checks, and businesses were strapped for cash to buy materials and meet payroll. Fearing a collapse that would throw millions of workers out on the street, the German government desperately printed money in an attempt to re-inflate the economy. During this period, despite the government's money printing, the mark actually gained in value against foreign currencies, so that prices of imported goods fell by some 50%.

Eventually, as a result of the money supply's rapid expansion, the nation's massive foreign debt, and the shrinking economy, German citizens lost all confidence in their currency, and the Weimar Republic experienced one of the worst cases of hyperinflation in modern economic history.

Check out the time series of the Weimar hyper inflation - with the interim "correction" before it went parabolic - here.

The new policy to lend money to banks for free shows that the Fed is obviously willing to monetize all debt problems that come along. With its seven new financing tools introduced since the beginning of the crisis in August 2007 the Fed is already intervening in MBS markets and tries to keep the commercial paper market afloat.

But after all these attempts are nothing more than new fiat money with a different ribbon. The road to hyper inflation is clearly visible as were most problems already more than 3 years ago.
Time will show whether the Fed has been correct in its view of current conditions. Taking it from the past 15 months the Fed has been behind the curve despite its fast moves. It is to be doubted that the increasing readiness to prop up all markets with new money will mitigate the crisis. It will rather delay it but the point of no return comes closer with every day. Central banks have a bad record of containing inflation once they set the process into motion willingly.

But these facilities have not brought the liquefying effect the Fed had hoped for. So far all attempts to revive credit markets have failed, observes not only Bloomberg, which has all the details on Tuesday's rate decision.

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

Consumer Prices Show Record Fall: Fight Against Deflation Heats Up

Consumer prices are continuing to fall, even setting new records. This is of course heating up discussion about deflation, which is a horror no one wishes to see. Bernanke and the Fed are going to do everything they can to prevent deflation from coming, but with this crazy economy who knows if they will have the wherewithal to do so. James Picerno from The Capital Spectator dives deeper into the issue in his blog post below.

For the second month running, consumer prices fell. And by more than a little, invoking the specter of deflation once again.

CPI slumped by a hefty 1.7% in November on a seasonally adjusted basis, the government reports today. That follows October's 1.0% fall. More dramatically, last month's tumble is the deepest monthly decline in CPI since the Labor Department began keeping records on this series in 1947. Meanwhile, MarketWatch.com reports that the 1.9% non-seasonally adjusted fall in CPI is the steepest monthly rate since January 1932—the height of the Great Depression.

Meanwhile, core CPI (which strips out food and energy) is unchanged, following a slight decline in October. As this is the Fed's preferred measure of inflation, even a central banker can't deny that inflationary pressures have evaporated, at least for the time being.

Looking at the more familiar year-over-year calculation of headline CPI, consumer inflation is still positive, running at 1.0% for the 12 months through November. Even so, that's down sharply from October's annual rate of 3.7%. At this rate, CPI will soon be falling on an annual basis too.

As striking as the news is, a decline of some magnitude in CPI was expected, partly based on the earlier report of the ongoing decline in producers prices. Nonetheless, the sight of broad price indices sinking month after month in both the consumer and wholesale markets raises the question of whether this is merely a temporary state or something with more endurance?

We've been writing about rising deflation risk for some months now, and it's clear that the beast is here. It's still unclear how long it lasts, and so for the moment one can be optimistic that an unhealthy downward spiral in prices isn't fate.

Keep in mind that the massive monetary stimulus engineered by the Fed has only partly filtered into the economy. Monetary policy has a fair amount of lag time, perhaps a year or more. With each passing month, the aggressive liquidity injections will work deeper into the consumer and business sectors. Few expect a sudden rebound in spending and lending, but at this point simply keeping prices steady would be no small accomplishment.

Another reason to think that prices may soon stabilize comes from the fact that heavy drops in energy prices are currently leading CPI's descent. The energy component of consumer price inflation has lost ground for four months straight, with November's whopping 17% fall the biggest so far. But energy prices can't keep falling off a cliff month after month. Yes, the world economy is headed for tough times, which is paring demand for oil, gasoline and other fuels. But the lion's share of the price cutting relative to the highs of last summer is behind us.

There may yet be more declines in energy coming. In fact, we expect as much. But the magnitude of future declines, if any, will almost surely be smaller. Nor is it unreasonable to expect that energy prices generally will soon tread water, albeit at substantially lower levels compared with recent history.

As for the other components of CPI, well, that's another story. The transportation slice of consumer prices retreated by nearly 10% last month—the fourth month in a row of red ink. Housing prices are weakened last month, although just barely. But not every is posting price discounts. Prices for food, apparel, education/communication and medical care all managed to rise last month. Deflation hasn't yet infected everything, and therein lies more reason for hope.

Still, no one will wonder why Fed funds futures are pricing in a 50-basis-point cut at the Fed's FOMC meeting later today. If accurate, that would bring the target Fed funds down to 0.5%. As extraordinary as a 0.5% will be in historical terms, at this point it's something of a formality to reflect reality since the effective Fed funds (which is based on actual banking activity) is already at a scant 0.14%.

In sum, the war to head off inflation is in full swing. The Fed can't afford to fail in this battle. Allowing deflation to build a head of steam at this point is tantamount to economic suicide. It must be stopped, even at the risk of letting inflation out of the bag down the road. Controlling inflation, after all, is well understood, even if the political will isn't always there. Fighting deflation, by contrast, is far tougher and so preemptive medicine is preferred.

The challenge before us is defeating deflation with unconventional monetary policies, supported by aggressive fiscal stimulus. Since there's not a lot of precedent for the former, one might reason that the fiscal side of the ledger will have to do the heavy lifting, which necessarily depends on the political process. 'Nuff said.

Yet the task is not insurmountable. Indeed, monetary and fiscal policies will be that much more effective if consumer prices merely stabilize in the coming months, or at least stop dropping so rapidly. But that, as they say, is a big "if." Stay tuned.

The full post can also be viewed on capitalspectator.com.

Seriously…Madoff Investors Want A Bailout?

Bailout seems to be the word in 2008: Everyone is getting one, or is giving their case for why they need one. In the latest bailout request, the Alternative Investment Management Association (AIMA) is asking for aid for the investors burned in the $50 Madoff investment scam according to Reuters. On the news we have heard heartfelt stories of retirees who lost everything, but then again these were supposed to be sophisticated investors. What should we do?

For those who are unfamiliar with the Madoff investment scandal, Madoff Securities is a hedge fund which set up a big ponzi scheme and scammed investors out of approximately $50 billion. To invest in hedge funds, investors are required to be accredited, which means they have at least a net worth of $1 million or make at least $200,000 a year ($300,000 if married). These types of investments require accreditation because they are considered riskier and more complicated and they are not bound by the same SEC regulations as common investments are.

The fact that these accredited investors would even ask to be bailed out by American taxpayers is preposterous. Considering that millions of people are out of work and millions of retirees already have nothing to live on aside from their social security checks, how can these wealthy people possibly want hardworking Americans to cover their losses? The government didn’t bailout investors in traditional stocks that went bankrupt. They didn’t bailout the workers in Enron who had their entire retirement account invested in Enron stock and lost everything. Sure, it sucks that these people were scammed, but it is hard to feel sorry for them when they have a lot to begin with and they knew that their investment was inherently risky.

Compounding that, I was blown away to learn that some of these people invested every penny of their wealth in these funds. If someone has $2 million and plans to retire on that money, how can one possibly think that it is okay to invest it all in the same fund? That is just ridiculous. I wouldn’t even invest all my money in U.S. treasuries, let alone some hedge fund. This should be especially true for people nearing retirement: The closer you get to retirement, the less risk you should be taking with your money. This means that diversification is absolutely vital, and very, very little of your portfolio should be invested in things like hedge funds. I do feel for these scammed investors, but, firstly, they should have known better, and secondly, they are now in a situation similar to that of millions of other retirees, except that these investors probably have other assets of value and are still better off than most.

If we aren’t willing to spend $15 Billion to bailout the auto industry, then we can’t spend billions to bailout wealthy hedge fund investors who got burned. The AIMA had to know that there was no way they would get it. This action will only cause a PR problem for hedge funds and might lead to increased regulation in the industry. This is could be a good thing or a bad thing depending on your perspective, but it is safe to say that most hedge funds would rather not deal with more regulation or scrutiny. At the end of the day, though, if so-called “sophisticated investors” are making stupid mistakes like this, then I would have to question the criteria being used.

The Next Big Bubble To Burst: U.S. Treasuries

Everyone in the world knows that the U.S. has a huge debt, and that the U.S. economy is performing poorly. Yet, people are flocking to U.S. treasuries like never before driving yields down to record lows. The U.S. has no plans of stopping the debt train, though, so who knows how high it will go. We are on uncharted ground right now, and all it would take to push this train off the tracks is one major debt holder to start selling. Lots of other bubbles have burst recently, so why not possibly the biggest one of all? Needless to say if this happens there will be serious ramifications for the U.S. and the rest of the world, which is probably why it hasn't happened already. Toni Straka from The Prudent Investor looks closer at this looming problem in his blog post below.

Having seen most of the bubbles bursting I had listed in this post from 2005 the world may soon be in for the mother of all bubbles. With a size of $10 trillion the US government debt market has remained the world's #1, now that MBS have shed the better part of their initial values.

US treasuries have long been hailed as a safe haven for money fleeing from other overheated markets. Massive losses in more or less all other asset classes in the past 15 months have shown that investors followed Pavlov's reflexes, driving the 10-year yield to a record low of 2.55% last week.

CHART: The yield for 10-year US Treasury debt fell to a record low of 2.55% last week. This chart may see a sudden reversal based on the fundamentals.

It may be questioned whether this trust into the Federal Reserve's ability to contain long term inflation is justified, given the fact that chairman Ben Bernanke will enter history as the fastest money printer of all times.

While the Fed has reduced its federal debt holdings by $290 billion to $484 billion (buying doubtful MBS instead) in the last 12 months it was foreign investors TIC data and Treasury statistics show.

This has driven yields across the curve to record lows, leaving investors with a negative real yield when discounting inflation. US Inflation was 3.7% YOY as of October.

Institutional investors have been allocating more money into US treasuries recently, citing the safe haven status of American government bonds. But this era may be coming to an end as so many things do nowadays.

There appears to be a split of opinion. While European and American investors follow the old rule of buying US debt with a questionnable AAA rating their Asian counterparts see themselves trapped with US debt holdings they cannot sell in order to avoid a panicky stampede out of the biggest market of all.

The deficit outlook justifies a skeptical approach. Barack Obama will have to finance a budget deficit of an estimated $1 trillion in 2009, the biggest in American history. If Mr. Obama will not manage a U-turn in foreign policy which was mainly based on ignorance and arrogance under Bush, he could run into financing problems. China has urged other countries to replace Federal Reserve Notes with their own currencies in bilateral trade and voiced its concern about US fiscal policy repeatedly.

The global downturn may bring a different borrowing climate too. Losses in all asset classes across the board and record low yields will result in lower reinvestment amounts overall, it can be safely projected.
The borrowing needs will skyrocket as both the federal government and bankrupt local communities will scramble for funds to replace sudden drops in tax revenues.

Bets On A US Default Become More Expensive
While still being a mainstay for investors from all around the world, not everybody is confident about the future of a USA in the grip from the biggest financial crisis ever. Some wary souls are increasingly buying insurance against a default of the US government. According to a Reuters report from November 26, credit default swaps involving Treasuries reached a record high.

Ten-year U.S. Treasury CDS widened to 54.7 basis points from Tuesday's close of 50.0 basis points, credit data company CMA DataVision said.
Five-year Treasury CDS jumped to a record 52.0 basis points from Tuesday's close of 47.50 basis points, it said.

In plain language this means investors were willing to pay $54,700 to insure a portfolio of $10 million 10-year debt paper.

Summarizing the fundamentals such as no end to new debts, tax shortfalls, higher social and military expenditures, a central bank willing to monetize the debt and flooding the world with fresh Federal Reserve Notes, it can be safely bet that this bubble will end like all bubbles: In a gigantic burst that will unsettle everything we have learned about investing in the past.

A hat tip to Econbrowser who undug this paper by Stanford economics professor John Taylor on the failures of the Fed in the current crisis and why it all became worse this autumn.

I stand by my opinion that monetary inflation is in the early stages worldwide and will have seeped through into the real economy in 2009/10.

This article has been reposted from The Prudent Investor. The full post can also be viewed on The Prudent Investor.

The Fed Seeks Ability To Issue Own Debt

The Fed can't get enough money from the Treasury to fund all their ventures, so what do they do? Simple, they request the authority to issue their own debt. If Congress approves this measure it would give the Fed even more power, an idea that should be at least a little scary to taxpayers. Tim Iacono from The Mess That Greenspan Made looks closer at this new development in his blog post below.

One of the great mysteries of our debt-fueled financial system in general and central banking in particular is exactly when it is that "money is printed", a phrase that is thrown around quite casually by far too many people when maybe it shouldn't be.

Our fractional reserve banking system effectively "prints money" each time a new loan is made. That much should be clear. With a ten percent bank reserve ratio, each new $1,000 in deposits can generate $10,000 in loans. Where does this extra money come from? It is created "out of thin air". That's the way banks work.

Up until late-2007, Wall Street's "shadow banking system" did something similar, however, it apparently had what amounted to a zero percent reserve ratio which is one of the major reasons that we have the crisis that we have today.

As for the U.S. government, "printing money" is performed by the Federal Reserve when it buys Treasury bills (or any other assets of questionable quality) and in return provides money that it creates "out of thin air".

This is generally frowned upon for obvious reasons.

Largely as a result of the willingness of our Asian trading partners to do so, the Fed has not needed to buy much U.S. debt in recent years, its balance sheet remaining fairly constant at around $800-$900 billion up until a few months ago when Lehman Brothers was allowed to fail and the downward spiral commenced.

As most everybody knows, the Fed's balance sheet is now almost $1.5 trillion bigger, prompting the question of where exactly this $1.5 trillion came from.

Well, some of it came from the Treasury Department but, as discussed last week, a good portion of this was simply "created out of thin air" and then exchanged with companies like AIG for one toxic asset or another.

It is all adding up very quickly and, with no end in sight for the current crisis, it should come as no surprise that the central bank is looking for ways to get even more money into the system without people all around the world wondering about where all the money is coming from.

According to this report in today's Wall Street Journal, it seems the Fed is now looking at issuing its own debt in order to bypass that cumbersome Congressional approval process for issuing Treasuries.

The Federal Reserve is considering issuing its own debt for the first time, a move that would give the central bank additional flexibility as it tries to stabilize rocky financial markets.

Government debt issuance is largely the province of the Treasury Department, and the Fed already can print as much money as it wants. But as the credit crisis drags on and the economy suffers from recession, Fed officials are looking broadly for new financial tools.

Fed officials have approached Congress about the concept, which could include issuing bills or some other form of debt, according to people familiar with the matter.

It isn't known whether these preliminary discussions will result in a formal proposal or Fed action. One hurdle: The Federal Reserve Act doesn't explicitly permit the Fed to issue notes beyond currency.

Just exploring the idea underscores many challenges the ongoing problems are creating for the Fed, as well as the lengths to which the central bank is going to come up with new ideas.

As Andre Agassi used to say, "Image is everything".

Why look bad when the rest of the world remains scared to death of global financial markets, more than willing to continue gobbling up U.S. debt at ridiculously low yields, and your only real problem is that your government can't authorize enough spending fast enough?

This article has been reposted from The Mess That Greenspan Made. The full post can also be viewed on The Mess That Greenspan Made.

Haven’t We Already Bailed Out AIG Twice? Well, Here We Go Again…

This morning the federal government announced that it is was going to inject additional capital into AIG and restructure the existing debt as part of a new bailout to save the troubled insurance giant AIG. For those not familiar with the situation, the government had originally offered AIG a lifeline loan of $85 billion, only to later pony up an additional loan of $37.5 billion when it became clear that the company needed more. Now the government is giving them another loan, this one nearly $30 billion. In addition, as part of the deal, the government is lowering the interest on the previous loans and extending the repayment term from two years to five years, according to the Associated Press. What it boils down to is that AIG didn’t want to have to fire sell their assets in order to pay back the government loan, so instead of forcing them to do so, the government offered up even more money and agreed to ease the terms on the previous loans. Is your head spinning on this one, too?

This would essentially be the equivalent of me going to the bank and saying I’m not going to be able to pay my mortgage anymore, so can I get a loan to stay afloat for awhile till things get better? They say yes, but then a little while later, I go back for more and they again say yes. But that still isn’t enough, so I go back a third time and when they ask me about other assets, I tell them sure, I have a 2008 Escalade fully paid for, but I wouldn’t dare sell it right now because the SUV resale market just isn’t good. Because the bank didn’t want to force me to make this sacrifice, they decided to give me yet another loan and make the terms easier on my previous ones. Does this scenario sound a little farfetched? I certainly don’t know any banks that would ever agree to terms on the first loan, let alone more down the road; that would be bad business. Now obviously in the real world, the AIG scenario isn’t quite as simple, considering how huge the company is and the fact that the government now has ownership interest in it, but the decision to inject the business with additional taxpayer capital when there are alternative ways the company could have raised the money is concerning to me.

I was just reminded of a Saturday Night Live clip from a while back, after AIG was infused with the second loan of $37.5 billion. In the segment “Oh Really” on Weekend Update, which skewers the news, they drill AIG about the executive retreat and then transition into the “Oh My God Are You Serious?” segment, where they are completely dumbfounded at why the government would give AIG more money. The clip is funny and definitely applicable to the situation at hand. The clip below is for the entire Weekend Update segment, but if you skip to about 2/3 of the way in--when there are around 2 minutes remaining--that is where the “Oh Really” portion starts.

Lehman Brothers Declares Bankruptcy: Taxpayers Spared

Is it possible that the government has finally learned their lesson? After Lehman Brothers spent a weekend trying to find a buyer, the interested parties withdrew when the government said they would not offer any financial support to a potential buyer (as they did with Bear Stearns). That left Lehman Brothers with little choice but to file for chapter 11 bankruptcy protection this morning. This bankruptcy becomes of the largest in history, with $613 billion in debts, according to the Wall Street Journal. While a bankruptcy of this magnitude is certainly not a good thing, the fact that the government allowed it to happen should be looked at as a breath of fresh air by taxpayers.

There was a lot of speculation heading into the weekend that the government would do what they have been doing all along through this financial crisis and step in to save the day when push came to shove. Surprisingly, though, the government held its ground after attempting to help piece together a deal between Lehman and Barclays; when the government refused to provide additional backing, Barclays backed out. Since the government was more than willing to step in and provide assistance for J.P. Morgan to purchase Bear Sterns, this news definitely came as a shock to me. I can say that I’m glad the government finally took a stand, and if nothing else we will get a chance to see what life looks like after a major investment bank failure.

With Lehman and Bear Sterns gone, and Merrill Lynch agreeing to be sold to Bank of America, the only major investment banks left are Goldman Sachs and Morgan Stanley. Who knows whether or not these two companies will be able to make it through the financial crisis intact, but I feel much better that a new precedent has been set that we will allow the markets to take their due course with them. If the government had chosen to bail out Lehman, after doing so for Bear Sterns, then the other two brokerages would all but expect the same to be done for them if needed. Lehman’s bankruptcy will show them that this is not the case, and that they need to take matters into their own hands.

Sure, this is going to be painful in the short term; the markets are going to tank. Over the long haul, though, by taking a stand, the government is telling Wall Street that they can’t assume a government bailout. This will lead to better business decisions and risk management by these financial institutions, a more stable U.S. economy and less of a burden for taxpayers.

IndyMac Bank Failure: The Latest Casualty Of The Subprime Fallout

On Friday federal regulators seized IndyMac Bank, making it the third largest bank failure in U.S. history according to the Wall Street Journal. The largest bank failure in U.S. history was the $40 billion failure of Continental Illinois Bank & Trust Co. back in 1984. IndyMac Bank held about $32 billion in assets, and it is estimated that the failure will cost the Federal Deposit Insurance Corp. (FDIC) between $4 and $8 billion, amounting to around 10 percent of the fund’s total reserves according to the Wall Street Journal.

If you were to ask why the bank failed you might get various answers, but here is what a couple key players had to say as reported by the Wall Street Journal:

“The director of the Office of Thrift Supervision, John Reich, blamed IndyMac's failure on comments made in late June by Sen. Charles Schumer (D., N.Y.), who sent a letter to the regulator raising concerns about the bank's solvency. In the following 11 days, spooked depositors withdrew a total of $1.3 billion. Mr. Reich said Sen. Schumer gave the bank a ‘heart attack.’”

Schumer responded by saying, “’If OTS had done its job as regulator and not let IndyMac's poor and loose lending practices continue, we wouldn't be where we are today,’ Sen. Schumer said. ‘Instead of pointing false fingers of blame, OTS should start doing its job to prevent future IndyMacs.’”

Personally, I prefer the idea that the bank is reaping the rewards of all the dumb loans they made. How can one possibly justify making high LTV loans to people without verifying their income? Do you think people might stretch the truth a bit if they know you aren’t going to double-check their numbers? Duh. If they actually had proof of their income, then they wouldn’t even need to come to IndyMac: They could get a better loan somewhere else.

The question now looms of whether IndyMac is just one more in a line of many banks which are to fail, or if the carnage is done. If the outlooks of banking regulators are any indication, it is worth noting that they are hiring more examiners and prepared to take a tougher line towards risky banks according to the Wall Street Journal.

I don’t believe that IndyMac will be the last bank to fall at the hands of the subprime crisis, but they very well may be the largest. If you start dealing with anything much larger than IndyMac, the government would likely get more involved in fixing problems before it came to this. I said it after the NetBank failure, and I’ll say it again: If you are depositing money in a bank right now, then make sure that it is an FDIC insured account. Not all deposit accounts are FDIC insured, and the insurance only covers the first $100,000 (and $250,000 for retirement accounts). About 10,000 depositors of IndyMac, with deposits of approximately $1 billion, learned that lesson the hard way, and may receive little if anything. If you have more than $100,000 sitting in a smaller bank deposit account, I would suggest transferring the excess over $100,000 to either a very large bank, or several insured accounts at different banks. Really though if you are going to put your money at risk, you might as well invest it in something that will return a little more than deposit accounts do.

Odds Of Recession At 45 Percent, Down From 90 Percent Last Month

Identifying a recession is a tricky thing, and that was never more apparent than in the flip-flopping of many economists’ opinions on the state of the economy and its odds for a recession. It wasn’t too long ago that 71 percent of economists believed we were already in a recession, and even more thought a recession inevitable. Wachovia, which last month put the odds of recession at 90 percent, just downgraded those odds to 45 percent, according to The Wall Street Journal. Is the economy really turning around, and can we begin to be a little optimistic about the future?

Recent data released by the government has been a little better than expected, but I think we are missing some things. Perhaps we are clinging to any last ray of hope we can find, but the bottom line is we should look at the facts for what they are, not coat them in sugar. One example is that yesterday everyone was elated that the CPI came in at only a 0.2 percent increase, compared to the expected 0.3 percent. This surely is good news--I don’t want to discount that--yet at the same time we can’t take this to mean that our inflation fears are over and that everything is peachy. First off, I have my concerns that the numbers being reported by the government aren’t all that accurate to begin with. In addition, while inflation might be taking a little break, so to speak, I don’t think it is gone.

Another piece of irrational exuberance in my book was how the market treated the recent earnings reports from Freddie Mac and Fannie Mae. Fannie Mae reported a loss of more than $2 billion, much more than was anticipated, yet their stock skyrocketed that same day. Something just doesn’t seem right about that. Then this week, Freddie Mac actually beat estimates and reported a loss of only around $150 million. That seems great compared to the $2 billion loss over at Fannie, but in order to cut their losses to only $150 million, Freddie Mac had to alter their accounting methods. I’m no accounting expert, but any time I hear of companies altering their accounting practices, and voila, their books suddenly look better, I get suspicious (if anyone has more knowledge about this, I’d love to hear your take). As we saw in the foreclosure numbers reported this week, the housing problems are far from gone. More and more people are losing their homes, and to me that doesn’t spell good news for Fannie and Freddie, or the housing market in general.

We also saw reports this week that more companies are laying workers off--typically not a positive sign at all--yet for the most part the markets shrugged off this news in favor of celebrating the fact that inflation was only at 0.2 percent last month. While it certainly is good news to see the economy rebounding somewhat, and for the economic news to come back better than we expect, I urge investors not to get their hopes up too much at this point. It is possible that the interest rate cuts and the economic stimulus package will come together to bring our economy out of the rut it’s been in, but I certainly wouldn’t put those chances as high as 55 percent. I still think a recession is coming, and whether it is officially here now, or whether we are able to delay it, it will surely come. Our economy has too many serious problems to fix with a few Band-Aids.

If Bernanke discovered the magic recession avoidance elixir, that is just fabulous, and we all should be ecstatic.

At the same time it has always been my belief that you plan for the worst, so that’s what I’m doing. Jump on the U.S. economy is great wagon if you will, but be careful, because I’m pretty sure the axel is loose.

Federal Reserve Meeting Today: BYOB, Pizza Will Be Served

The Fed is meeting again today and tomorrow. To mark this diminishingly historic occasion, I have composed the following ditty. Ahem...

There once was a man named Bernanke:

For the banks, an immaculate flunky.

When their assets all failed

with our money he bailed

them all out like a good little monkey

Thank you. Thank you.

As the Fed disappears behind the curtain yet again, ‘O we of little faith’ are bracing for yet another quarter percent drop in interest rates. Soon it will be official: You will likely see more appreciation on kitsch from the Franklin Mint than anything that comes out of the U.S. Mint. My friends all laughed when I plunked down 100 smackers for my Mystical Dreamcatcher Pocketwatch, but who’s laughing now?!

For those of you who didn’t have foresight enough to invest in chilling likenesses of dead royalty and zirconium encrusted daggers, allow me to predict what the Fed is planning to do. Just let me look into my Dragon of Lore Crystal Ball (a steal at 5 payments of only $39.99!)...

Abra-cadabra!

~~Ah yes...I scry a rather stoned-looking Bernanke telling the table that he knows exactly what needs to be done. Well! That’s good news!~~

~~Oh. He wasn’t talking about the economy. He was suggesting that they order pizza.

But still...based on his track record, that’s one of his more reasonable suggestions.~~

~~Now someone else at the table is telling him that no one there can afford to have a pizza delivered

because food and gas prices have soared again.~~

~~Bernanke insists that “Referendum Deepdish” be passed as they can just print more money

in the office next door. The motion is passed.~~

~~Someone raises a new motion: Will the Reserve lower interest rates again despite the fact that it has done nothing to mitigate the housing crisis or prevent a recession? They ask the chairman directly.~~

~~Bernanke teeters in his seat for a moment, opens his mouth...and then passes out on the floor.

The attendees concur with the chairman’s motion to drop the interest rate again. Motion is passed.~~

~~The pizza arrives. The delivery fellow receives a lousy tip.~~

As we can see, it’s all business as usual at the Federal Reserve. But before I go off to polish my collection of Elvis Head Silver Dollars, I leave the Fed with three bits of advice:

1. These are tough, confusing times, and I do in fact sympathize with anyone tasked with sorting this out, but your methods have proven to be the financial equivalent of bloodletting for the ailing economy. Try something new for once, PLEEEEEEEASE!
2. We know the banks own you (literally), but at least pretend that you have the interest of the American people in mind. You know, we love a good circus act. And if you piss us off, then...
3. Don’t stiff the pizza boy: He knows where you live.

Money Markets Paying More Than CDs

Bank of America recently rolled out a money market savings account paying a higher interest rate than their four month CDs. What that tells me is that Bank of America is counting on further interest rate reductions from the Federal Reserve.

Perhaps now that B of A owns Countrywide, they have an ever better crystal ball for seeing the extent the subprime shakedown. They are casting their bet that the Fed will continue to drop rates. Where are you casting yours?

Hire A CPA: Life Is Too Short To Do Your Own Taxes

Those of you who recently completed the painstaking process of filing your income taxes might want to rethink that strategy next year and instead hire a CPA. According to an article by MSNBC, the average person spends more than $200 and 26.5 hours of their time because of tasks ranging from record keeping and studying the tax law to preparing and sending their tax forms. Obviously those numbers are just averages, and are likely influenced by extremes on both ends of the spectrum, but I think they make an interesting point.

Investors in particular are probably better off hiring a CPA than doing their own taxes because their tax returns can get complicated. Keeping up with the latest deductions and changes to tax law is probably better left to professionals anyway. Turbo Tax is great, but I would rather trust my taxes, finances and sanity to a CPA. For me, doing taxes is about up there with going to the dentist, and not having to deal with it is alone worth the $800 bucks a year I pay my CPA. Even if I liked doing my taxes (a twisted concept), it would probably take me the 26.5 hours, at least, to do them considering all the crazy things I’ve got going on. I can assure you that my CPA charges more than the $30 an hour equivalent here, but what takes me 26 hours to accomplish he can finish in just a few.

Instead of sitting at my desk, pulling my hair out and complaining to my wife that I can’t concentrate because the baby is crying, I can go to the park or on some other outing with my family which is worth way more than $30 an hour. Life is too short to spend it doing taxes, so next year spend a few bucks, hire a CPA and then go enjoy your life. If you aren’t a family person, then just think of it as an investment: If you can make more than $30 an hour (or whatever the equivalent hourly rate for a CPA would be in your case) doing something else, then do that instead of your taxes. You will make more money, and assuming that you enjoyed working on the other activity more than you did your taxes (shouldn’t be too hard), you also are adding to your overall happiness.

Do We Really Want Increased Government Oversight Of The Mortgage Industry?

The Bush administration is calling for a major overhaul of how we monitor the financial industry in what would be the largest financial regulatory makeover since the Great Depression. It isn’t as much oversight as many Democrats are demanding, but it is fairly substantial.

I am generally against added government regulation, so this doesn’t sit well with me. The government has a way of making things more complicated and costly than they need to be, and it is taxpayers who bear the burden. Increased regulations in the financial and mortgage industries will only make lending tougher. It seems that people want the government to protect them from themselves and from lenders who might take advantage of them. If the government gets involved, some people may be protected, but fewer people will receive mortgages. In an already struggling market in which it is increasingly difficult to find funding, the last thing we need to do is to make it even more difficult.

I expect that the regulatory agency will, at a minimum, call for increased documentation and transparency on the part of the lenders. I’m all for transparency, but the documentation is already overdone. When I signed the docs for the last house I bought, my hand started to cramp halfway through signing all the paperwork. If increased paperwork is all they do, and they do not become too restrictive, then the legislation shouldn’t have much negative impact, though it will mean more work for the loan officers, processors, lenders and escrow agents. If they start modifying loan qualifications and guidelines, or imposing penalties on lenders, it might scare many lenders out of even remotely related programs. If lenders become even more hesitant and restrictive, this only spells more bad news for the housing market.

The Fed Cut Interest Rates Again; Prime Rate Down To 6 Percent

The Fed cut the key interest rates again yesterday, this time by 0.5 percent, following a 0.75 percent cut last week. For alternative investors that means a couple things:

1) The prime rate is now down to 6 percent, the lowest it has been in three years. Investors who are utilizing HELOCs and personal or business lines of credit are probably pretty happy right now, as borrowing is now much cheaper than before. Investors who were not utilizing this type of variable credit in favor of fixed rates are probably much less enthusiastic and might want to think about switching. The U.S. economy is not going to be recovering any time soon, so investors might as well take advantage of these low rates while they can. Chances are they will continue to go even lower before things turn around and the Fed starts hiking them back up again.

2) If you haven’t already started doing so, get out of the dollar now. What was left of the U.S. dollar was burned at the stake this week; the government has shown that they are willing to let the dollar die in favor of the chance that they might be able to fend off a recession. Things are likely only going to get worse though, as the U.S. is probably still going to see a recession, and inflation is going to start eating up people's U.S. dollar savings. If you want to learn more about the importance of the dollar's decline, see yesterday’s blog post: Ron Paul And The Fight To Save The U.S. Dollar.

If a recession does come, which it certainly appears it will, investors need to be prepared. There are profits to be made in good times, and even more profits to be made in times of recession--if investors know where to look. If you are trying to figure out some good places to put your money in the event of a recession, check out our Top 5 Recession Investments.

Fannie Mae And Freddie Mac Loan Limits To Rise In Economic Stimulus Package

As part of the new economic stimulus package being pushed through the House, the loan limits for Fannie Mae and Freddie Mac are set to be raised substantially in certain areas across the U.S. The new limit--anywhere from $625,500 to $730,000, depending on how the finalized legislation turns out--would be set for one year, according to The Wall Street Journal.

Fannie Mae and Freddie Mac are government-sponsored mortgage buyers, the two largest such companies in the world. These new limits are likely to have a positive impact on the mortgage markets in the affected high-cost areas because they could enable many people in these areas to qualify for conforming loans. The difference between the pricing on a conforming loan and a jumbo loan (loans with values in excess of conforming limits) it is typically substantial.

Furthermore, in today’s mortgage environment, banks are becoming less and less willing to even do jumbo loans: They are considered risky, and risky loans are being avoided like the plague by many investors and subsequently by banks. The previous conforming limit of $417,000 is simply a joke in places such as San Francisco. A single-family home in the San Francisco-Oakland-Fremont metro area has a median price of $825,400, according to the National Association of Realtors.. While these new limits could very well help stimulate some of these high-cost stagnant, or even declining, real estate markets, it is no guarantee that it will end up helping significantly.

For the people who can now qualify for conforming loans, they will probably save money on their mortgage. In addition, some people who couldn’t otherwise qualify for a mortgage will now able to do so. Any time buyers can get more house for their money, the potential number of buyers is increased, which tends to reflect positively on real estate prices. Thus there is certainly potential for good things to happen in those markets. However, we must also remember that many of these high-cost markets have bigger problems that won’t be cured simply by raising these limits, especially considering the country's overall economic situation. While this news can only be seen as good thing for these high-cost markets, people in these markets shouldn’t get their hopes up for a dramatic turn around simply because of it.

Fed Interest Rate Cut Unlikely To Make Borrowing Easier

When people hear that the Fed cut interest rates by 0.75 percent, many think it is a wonderful thing, and that now they will be able to borrow the money they need. Unfortunately, it doesn’t quite work out that way, especially in today’s financial climate. The Fed funds rate is simply the rate at which banks lend money to each other at the Federal Reserve Bank, that’s it. It is true that the prime rate goes up and down along with the Fed funds rate, but the problem right now is not that interest rates to customers are high, but that many customers who want credit can’t get it. These Fed interest rate cuts are unlikely to change that.

Right now, banks are turning their backs on any kind of loan that smells at all risky. That means low down payment, low documentation, small business and start up loans, along with others considered “risky,” are still unlikely to get funded.

Loans that have little risk, such as conventional real estate loans, should continue to get funded with little to no problem. The main thing to watch for with those loans is that traditional 30-year mortgages could possibly start seeing rates go up. Even though the Fed is lowering rates, the rates on long term mortgages can still go up because they are tied to bonds. Since these are long term bonds, inflation rates are more important than short term Fed interest rates, and inflationary pressure will begin to rise when the Fed drops interest rates this quickly.

The Wall Street Journal recently published an article that covered some problems that small business owners were having getting loans: “A recent survey by the National Federation of Independent Business found that 7 [percent] of the small-business owners surveyed in December said they were having problems getting financing, up from 4 [percent] in November. ‘I'm sure that everybody is being a little more careful. Certainly the banks that were aggressive are being more careful now,’ says William Dunkelberg, the federation's chief economist.”

So, while the Fed lowered the funds rate by 0.75 percent and is likely to cut the rate again at the next scheduled meeting, investors shouldn’t get overly excited. The stock market will do better than it would have otherwise, and the economy might get a slight overall boost; lending, however, is unlikely to get any easier. Interest rates aren’t the problems in this case, so dropping the rates won’t solve the problems. Instead of investors getting excited about the rate cut, they might want to start getting concerned about inflation. Inflation is already higher than it has been in recent memory, and it might only get worse from here. The Fed is making it clear that they are more concerned about appeasing the market and limiting recession fears than controlling inflation.

Wondering How The Latest Fed Interest Rate Cut Will Affect Your Mortgage?

The Fed just lowered interest rates by .75 percent, one of the single largest cuts in the history of the Fed. Naturally, many people are wondering just how this interest rate cut will affect their mortgages. Unfortunately most people are likely to be disappointed by how the system really works and are likely to receive little to no help with their mortgages. If you are curious about how this works, read through our previous blog post, “How do the Fed Interest Rates Really Affect Mortgages.”

Government Inflation Numbers Not Suitable for Retirement Calculations

If you are calculating your future retirement needs using the government’s inflation numbers, the consumer price index (CPI), or using the CPI for other calculations, you should keep reading. According to John Williams, an economist who runs a website called shadowstats.com, the government has been fudging the inflation numbers since the 1980s.

Since then, the government has changed how they calculate the CPI numbers several times, with each new method lowering the resulting numbers. The logic used in making these changes is flawed, and if people knew how the numbers were calculated, they would almost surely hesitate to use them.

Why would the government want to orchestrate this scam? Williams points to their Social Security obligations. The government’s Social Security payments to individuals are indexed to the CPI, and the higher the CPI, the more the government has to pay out. When one considers how huge the government’s Social Security debt is, along with the fact that there is little to no hope of them being able to pay it without some help, it makes complete sense.

People can choose whether to believe Williams or not, but he makes a convincing case that is certainly worth listening to. If you are looking for a better inflation number to base your calculations upon, Williams recommends that you add about 7 percent to the CPI. On shawdowstats.com, there is a CPI calculator tool that might be helpful. On the site Williams also discusses in more depth the various changes to the CPI calculation and their subsequent flaws.

To demonstrate the difference 7 percent can make during the course of a career, the value of the portfolio of a person contributing $5,000 a year for 40 years would take a hit of around $1,000,000 in terms of true buying power. Remember, this 7 percent is on top of the approximate 2 to 3 percent inflation number being published by the government. That means that you need to be making 9 to 10 percent in return on your money just to stay even with inflation.

How do the Fed Interest Rate Changes Really Affect Mortgage Rates?

Wondering why your mortgage payment hasn’t gone down even though the Fed has lowered rates? It is a common misconception that mortgage rates are directly tied to the federal funds rate. In fact, mortgages in general are not directly tied to the federal funds rate at all. Here are some quick pointers to keep in mind when considering how concerned you should or shouldn’t be about the decisions of the Federal Reserve Bank:

The market, not the federal funds rate, determines mortgage interest rates. Mortgage Backed Securities are bonds sold on public exchanges by Freddie Mac, Fannie Mae and the like. More than any other factor, the prices of these securities have the most impact upon mortgage rates.

Fixed rate mortgages are long term interest rates, while the fed funds rate is short term. Investors in fixed rate mortgages are much more concerned with factors such as inflation than they are with the short term federal funds rate. In some cases, mortgage rates will actually go up when the fed lowers the funds rate because the market fears future inflation may result from the cut.

Adjustable Rate Mortgages (ARMs) are tied to indexes, not the federal funds rate. The most common indexes are the London Inter Bank Offered Rate (LIBOR), the 11th District Cost of Funds Index (COFI), and the Constant Maturity Treasury (CMT). There are various factors that determine the movement of these various indexes. For example, the LIBOR is tied to interest rates in London, not the U.S.

Home Equity Lines of Credit (HELOC) are the mortgage type most closely tied to the fed funds rate. Most HELOCs are priced on some margin above the prime rate. While the prime rate is not the federal funds rate, it does track it almost exactly at 3 percent above.

In many cases the lowering of the federal funds eventually (albeit indirectly) makes its way to mortgages. However, this is far from a certainty and generally takes some time. As a holder of an ARM, or someone looking to get a new mortgage, don’t hold your breath expecting the looming fed rate decrease to save you money on your mortgage any time soon. In fact, it may cost you in the short term if investors in mortgage backed securities think more rate cuts will equal more inflation.

Evaluating The Latest U.S. Jobs Report

From Bloomberg:

“Jobs proved to be one of the few bright spots in a year when home prices plunged the most in at least four decades, energy costs hit a record and mortgage-bond losses roiled financial markets. Gains in wages and employment may help prop up spending as the economy struggles to avoid its first recession since 2001.

‘It buys the economy time and allows the Fed to lower rates without panicking,’ said John Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina, who forecast payrolls would rise by 90,000. ‘The economy is slowing down in the fourth quarter, but not so rapidly that you're going to have a big down-draft in consumer spending.’”

From Forbes:

“By itself, the job growth will likely not be enough to dissuade the Federal Reserve from cutting interest rates. Peter Morici, a professor of business at the University of Maryland, explained that the November job growth still showed strains from spiking subprime defaults.

‘Residential construction, financial services, and manufacturing displayed weakness, indicating growth is slowing significantly in the fourth quarter and further raising prospects for an interest rate cut at the Dec. 11 meeting of the Federal Open Market Committee,’ said Morici. At the meeting, the Federal Reserve's policy-setting panel is widely expected to cut its federal funds target rate by at least 25 basis points from the current 4.5%.”

From The Daily Reckoning:

“ADP uses the same birth/death model that the Bureau of Labor Statistics uses, which automatically voids this report in my mind. You see even the BLS admits that the birth/death model exaggerates the wrong way when cycles turn.

And the ISM non-manufacturing (service sector) Index fell yesterday, and their jobs portion of the index fell to just above the expansion level of 50, to 50.8… So, the ISM doesn't agree with ADP either…

But, as I said, this information was quickly swept under the rug, and those that were betting on a 50 BPS cut from the Fed next week, quickly removed those bets, and bought dollars… And stocks thought this news was just marvelous, but then they thought bad employment numbers were marvelous too, which means… carry trades went back on yesterday!”

Subprime Rates To Be Locked For 5 Years

From the East Valley Tribune:

“The Bush administration has hammered out an agreement with industry to freeze interest rates for certain subprime mortgages for five years in an effort to combat a soaring tide of foreclosures, congressional aides said Wednesday.

…Another person familiar with the matter said the rate-freeze plan would apply to borrowers with loans made at the start of 2005 through July 30 of this year with rates that are scheduled to rise between Jan. 1, 2008, and July 31, 2010.”

From Bloomberg:

“Treasury Secretary Henry Paulson is finalizing the deal as the housing recession enters a third year, threatening the economic expansion. Paulson and Housing and Urban Development Secretary Alphonso Jackson will hold a press conference tomorrow at 1:45 p.m. in Washington to discuss the plan, Treasury said in a statement.”

From WNBC:

“Congressional aides said the Bush administration has worked out an agreement with the mortgage industry to freeze some mortgage rates.

Interest rates for certain subprime mortgages would be frozen for five years in an effort to deal with a rising number of foreclosures.

The sources said it's a compromise between banking regulators who wanted a longer time frame of as much as seven years and industry arguments that the freeze should just last a year or two.”

Objections To Subprime Rate Freeze Legislation

From CNBC:

“Many hedge funds, along with other institutional investors such as mutual funds, money market funds and retirement plans, are invested heavily in mortgage securities. Some hedge funds in particular made strategic bets on the decline of the subprime mortgage market, and they could argue that the government-backed plan is unfair meddling that will cheat them out of money.”

From The Wall Street Journal:

“Even some subprime borrowers object to the plan. Justin Miller, a 27-year-old mortgage broker in Coral Springs, Fla., says he made a bad investment decision when he bought a $600,000 oceanfront home last December with two subprime loans. But he's committed to making the $6,000 in monthly payments -- and the higher payments once the rates go up.

‘A lot of people are trying to point fingers and get themselves out of something they put themselves into,’ he says. ‘I put myself in this position. I need to find a way to make it work.’

Mr. Miller says that the rate-freeze proposal reminds him of a television commercial: The announcer asks, ‘Do you owe back taxes?’ A client responds, ‘I settled for half of what I owe.’ Says Mr. Miller: ‘How's that fair? Everything seems to be backward.’”

From City Journal:

“The Paulson plan’s flaws are manifold—and fatal. First, it will reward and encourage irrational behavior by future home buyers. It wasn’t logical for people to take on mortgage obligations that they couldn’t afford, but it will become logical in the future if they can reasonably expect that the government and their lenders will bail them out when the going gets tough.

Second, the deal will thwart the market by keeping home prices artificially high. In recent years, laughably easy credit has allowed many people to ‘buy’ homes who otherwise couldn’t have. We’ve had ‘liar’ loans, in which people could claim a false annual income without fear that their mortgage lenders would confirm the figure. We’ve had ‘Nina’ loans (short for ‘No Income, No Assets’). And we’ve had ‘Ninja’ loans, for ‘No Income, No Job or Assets.’ Consumers, armed with the easy money provided by these lenient arrangements, have pushed home prices to record levels as measured against personal income. The decline of home prices, then, was both inevitable and healthy. But Hope Now, by placing an artificial floor under home prices, will penalize first-time buyers who did the right thing: not taking out mortgages that they knew they couldn’t afford, but renting instead until prices fell and they could afford homes with more conventional mortgages.”

Dollar May Be Ready For A Turn Around

From The Wall Street Journal:

“If economies outside the U.S. slow, the U.S. may no longer seem like such a bad place for foreign investors to put their money, especially given how much further a euro or yen will go in the U.S. than they do at home. That could restrain the dollar's fall. More immediately, troubled U.S. financial firms may need to sell foreign-currency-denominated assets to shore up their balance sheets before they close their books at year end. Repatriating that money will mean buying dollars, and that could boost the currency.

Meantime, hedge funds and other speculative investors have placed heavy bets on the dollar continuing to lose ground against other currencies. If the dollar starts to rise, they will be forced to unwind those bets, and the dollar's rebound could be fierce.”

From International Herald Tribune:

“The U.S. budget and trade deficits are narrowing in tandem for the first time since 1995, when the dollar gained 8 percent as measured by the Federal Reserve's U.S. trade weighted dollar index. The economy will expand 2.4 percent in 2008, compared with 1.9 percent for Europe, according to surveys conducted last month by Bloomberg News.

‘I am confident that the dollar will have a significant rally next year, especially against the euro and the pound,’ said Stephen Jen in London, the head of currency research at Morgan Stanley. Jen said that he expected the U.S. currency to strengthen to $1.35 against the euro by December 2008 from $1.4633 last week. ‘The deficits are shrinking fast.’”

From Bloomberg:

“The median forecast of strategists is for a 5 percent gain to $1.40 against the euro in 2008. Redtower Ltd. in Aberdeen, Scotland, is the most bullish, calling for the dollar to gain to $1.23 by the end of next year.

Jim O'Neill, chief economist in London at Goldman Sachs Group Inc., the most profitable securities company, said last week the narrowing trade deficit will help revive the dollar's allure. Goldman had predicted that the dollar would weaken as U.S. growth slowed while the rest of the world expanded.”

Lenders And Bush Administration Are Getting Closer To Subprime Rate Freeze Agreement

From The Wall Street Journal:

“The plan is being negotiated between regulators including the Treasury Department and a coalition of mortgage-related companies including Citigroup Inc., Wells Fargo & Co., Washington Mutual Inc. and Countrywide Financial Corp. People familiar with the talks say the individual members have agreed to follow any agreement reached by the coalition, which is called the Hope Now Alliance.

Details of the plan, which could be announced as early as next week, are still being worked out. In general, the government and the coalition have largely agreed to extend the lower introductory rate on home loans for certain borrowers who will have trouble making payments once their mortgages increase.”

From Conde Nast Portfolio:

“American Banker reports that the plan being discussed among Bush administration officials and the financial institutions involves extending the introductory interest rates for five years on nondelinquent subprime hybrid adjustable-rate mortgages. Financial institutions have been pressing for a three-year time frame, American Banker says.”

From Bloomberg:

“Paulson, who will address a housing conference on Dec. 3, presided over a one-hour gathering at the Treasury Department in Washington with federal regulators, bankers and lobbyists. Citigroup Inc., Wells Fargo & Co. and Washington Mutual Inc. executives attended, said a person present, who spoke on condition of anonymity.”

Regulation On The Way For Mortgage Industry?

From Contra Costa Times:

“The bill, passed Thursday evening by a 291-127 vote, garnered support from 64 House Republicans. No Democrats were opposed.

Many other Republicans, though, echoed banking industry criticisms, calling the bill an overreaction to the mortgage market's woes and warning of a flood of lawsuits if it becomes law.

They also said the mortgage market has already pulled back from lax lending practices common during the tail end of the housing boom.

‘Have no doubt, this bill will limit credit availability and options for thousands of Americans who want to grab their share of the American dream of homeownership,’ Kieran Quinn, chairman of the Mortgage Bankers Association, said in a statement. The American Bankers Association said it has ‘serious concerns’ with the bill, arguing that it would add more regulations for banks.”

From The Wall Street Journal:

“Rep. Frank's bill creates a national registry for mortgage brokers and bank employees who originate mortgages. The bill stops loan originators who get in trouble with authorities in one state from setting up shop in another. It also sets standards for states to apply in licensing mortgage brokers. In addition, the measure makes investment firms that create mortgage securities liable if they fail to take reasonable steps to ensure that the loans they acquire comply with the law.

Trade groups for home lenders opposed the bill, arguing that it is too vague and exposes lenders to bigger legal risks. They also are unhappy because the bill doesn't set a national standard that would pre-empt states from passing their own tougher legislation.”

From CQ Politics:

“Still, the lending industry, many Republicans and the White House have concerns about the bill. They argue that increased federal oversight could hurt borrowers if it further dries up already tight credit. Critics also say the industry would be forced to deal with a patchwork of state-by-state regulations because the bill would not pre-empt tougher state mortgage laws.

On Wednesday, the White House said in a statement of administration policy that the measure would ‘unduly restrict access to credit for potential homebuyers and reduce refinancing opportunities for current homeowners.’”

Fed Says No More Rate Cuts In 2007?

From Bloomburg:

“Federal Reserve policy makers won't cut their benchmark interest rate on Dec. 11, spurring a sell-off in U.S. stocks and a rebound in the dollar, according to Bear Stearns & Co.

Central bankers signaled in their Oct. 31 policy statement that the Fed `is most likely done cutting rates for the time being,’ Bear Stearns Chief Investment Strategist Jonathan Golub wrote in a research note today. Surging commodity prices and a weak U.S. currency will prompt the Fed to keep its rate target for overnight loans between banks at 4.5 percent to contain inflation, Golub wrote.”

From The Wall Street Journal:

“A Federal Reserve official sent one of the clearest signals yet the central bank isn't inclined to cut rates further, even when stocks sink and economic data turn sour.

‘The current stance of monetary policy should help the economy get through the rough patch during the next year, with growth then likely to return to its longer-run sustainable rate,’ Fed Governor Randall Kroszner said in prepared remarks before the Institute of International Finance in New York.”

From MSNBC:

“However, Vincent Reinhart, a fellow at the American Enterprise Institute, says investors may be misreading the Bernanke Fed. Mr Reinhart says the Bernanke Fed has taken a ‘principled decision’ not to talk directly about the likely path of interest rates.

Investors may be misinterpreting the lack of an explicit challenge to market expectations in a speech or leak to a newspaper as a sign that Mr Bernanke is happy with them, he says.

Yet it is also possible that the Fed itself is not being clear enough about its message, perhaps because between meetings there is not a single Fed position.”

Should the Loan Limits for Freddie Mac and Fannie Mae be Raised?

From Bend Weekly News:

"’Why should someone who lives in South Dakota be able to buy a 10,000-acre ranch for the same amount of money and get that subsidized, but I can't buy a 1,000-square-foot, three-bedroom, one-bath (home) in the (San Francisco) Bay Area?’ asked Colleen Badagliacco, president of the California Association of Realtors.

Sen. Charles Schumer, D-N.Y., is trying to revive the moribund Senate effort to force an increase in the loan limit. He would like to raise it as high as $625,500 in high-cost areas for one year as well as increase the size of the Fannie Mae and Freddie Mac mortgage portfolios.”

From Forbes:

“Federal Reserve Board Chairman Ben Bernanke today reiterated that Congress should be careful when considering whether to raise the non-conforming loan limit on mortgages that securitizers Fannie Mae and Freddie Mac can purchase.

Testifying before the House-Senate Joint Economic Committee, Bernanke indicated he does not support raising the loan limit, now at 417,000 usd, and said if this step is taken, it should only be temporary.”

From The Dallas Morning News:

“Fannie Mae is pushing federal regulators and lawmakers to allow it to provide funding for more and higher price loans to help overcome the credit crunch.

The Federal Housing Administration, which provides government-backed insurance for home loans, is also seeking federal approval to modernize and provide more financing.”

Lenders are Ready to Make Concessions

From the Wall Street Journal:

“There is a loud effort by the Bush administration to cajole the industry into moving beyond case-by-case efforts and to enlist nonprofit groups to reach out to suspicious homeowners. With more vigor and specificity than others (enough to make some officials uneasy), the FDIC's Ms. Bair has urged the industry to extend the two- or three-year initial interest rate permanently for homeowners who are current and whose income indicates they can pay at that rate.

‘Public cajoling was needed to bring more pressure to bear, and we decided to come out with a specific example of how to do it,’ she explains. She says three of 10 top mortgage services are quietly doing what she suggested, although she won't name them.”

From Smart Money:

“So when Countrywide Financial, the U.S.'s largest mortgage lender, announced on Tuesday that it was launching a program aimed at helping cash-strapped homeowners by canceling rate resets or modifying their loans, you could almost hear a collective sigh of relief.

After all, lenders are facing a glut of foreclosures, so it's no surprise that they're warming up to the idea of helping delinquent borrowers by, for example, restructuring a mortgage so the homeowner can catch up on missed payments. However, the actual act of a lender like Countrywide reaching out to people who have yet to miss a payment — but are likely to do so because of a pending rate reset — is something new.”

From CNN Money:

“Some of the workouts would allow borrowers to make larger monthly payments until they catch up. For those deeper in trouble, modifications may include higher payments over the full term of the loan. Others could have their loan refinanced into a low cost, fixed-rate NACA loan, which recently carried a reasonable 5.25 percent interest rate.

Another, powerful, solution is loan restructuring. That could mean freezing an ARM interest rate at its initial level for several years.”

Mortgage Fraud Problems in Southern Florida

From Reuters:

“But Doug Dewitt, a real estate broker contracted to work with several lenders on the valuation and disposal of foreclosed properties, said nearly 70 percent of the sales or closings at the Club over the last 18 months were questionable.

That works out to more than 200 possibly shady deals in a single building, he said.
The dubious transactions all fit a pattern that Theobald said should trigger ‘bells and whistles’ for law enforcement anywhere -- time and time again properties that failed to sell for months when listed at around $450,000 were pulled from the market and then suddenly sold for more than $800,000.

Florida leads the nation when it comes to mortgage fraud, according to the Virginia-based Mortgage Asset Research Institute, a group that works closely with the U.S. Mortgage Bankers Association.”

From South Florida Business Journal:

“The U.S. Attorney for the Southern District of Florida said investor Hugo Rodriguez, 52; Ronald Gordan Lichte, a 65-year-old mortgage broker; and his loan processor, Connie Marie Cullifer, 58, worked a scheme where Rodriguez would locate luxury condominiums and residential properties that were available for purchase, and Rodriguez and Lichte would then recruit and pay straw buyers and use their names, credit histories and signatures on mortgage loan documents to obtain financing to purchase the properties. John C. Kelley, 67, of Tampa, was also charged for allegedly acting as a straw buyer.”

From Miami Herald:

“Mayor Carlos Alvarez's Mortgage Fraud Task Force met Wednesday to discuss progress in the war on real estate fraud in South Florida, including draft legislation that would protect innocent homeowners from artificially high property taxes and the wiles of predatory lenders.”

Mortgage Rates are Dropping, Offering Some Good News

From The Associated Press:

“Rates on 30-year mortgages fell for the third straight week, dropping to the lowest level in five months.

Freddie Mac, the mortgage company, reported Thursday that 30-year, fixed-rate mortgages dipped to 6.24 percent this week, down from 6.26 percent last week.

It was the third straight weekly decline after rates hit 6.40 percent. Analysts attributed the decreases to mounting evidence that the economy is starting to slow.”

From MarketWatch:

“’With mortgage rates remaining low, approximately 38% of applications were for refinance transactions in the third quarter, down from 42% in the second quarter of this year. According to Freddie Mac's third quarter cash-out refinance report, approximately 87% of refinanced loans were for loan amounts that were 5% or more higher than the original balances,’ he said.”

From Reuters:

“Short-term mortgage rates experienced more pronounced declines following the U.S. Federal Reserve's cut of the benchmark federal funds rate by a quarter-percentage point to 4.5 percent last week.”

Inflation for Christmas

From the Wall Street Journal:

“If crude oil prices stay at current levels, U.S. consumer price inflation could hit a 16-year high of 5% by the end of the year, an analysis by London-based Capital Economics has concluded…”

“Inflation at that level, if sustained, could be both a wallop to consumer purchasing power, and a warning light to the Federal Reserve which has signaled it is paying more attention than usual to the inflationary implications of energy.”

From MSNBC:

“A number of regional Fed presidents feel particularly strongly about inflation risk. They acquiesced in the initial 50 basis point cut, but signalled serious reservations about the latest rate cut.

The October 31 Fed statement says ‘recent increases in energy and commodity prices, among other factors, may put renewed upward pressure on inflation’.”

Also from MSNBC:

“’The Fed is caught between a rock and a hard place as the dollar weakens and the economy faces headwinds from higher oil prices and financials tightening credit standards,’ said Gerald Lucas, at Deutsche Bank…”

“…’It puts the Fed in the box over cutting rates,’ said Marc Pado, chief market strategist at Cantor Fitzgerald. ‘How do you cut rates to save the financials when the dollar is getting killed? That's the crux of the whole matter.’”

From Forbes:

“… Warsh sees equally-real inflation threats. The recent readings have been 'favourable,' he said but the higher prices of crude oil and other commodities 'will likely put upward pressure on overall inflation in the short run.'”

The Latest Lending Bill

From The Wall Street Journal:

“Opponents said the legislation would make it harder for borrowers to obtain a house and increase the cost of credit. But supporters said the problems in the mortgage-finance system allowed excesses and abuses to hurt homeowners. They said lenders were able to exploit a patchwork of state and federal laws to trap borrowers in unaffordable loans using questionable underwriting practices.”

From Forbes:

“But the bill has a dark side: It could prevent people who would normally qualify for mortgages from getting one. How many? It's unknown. In addition, the legislation, if passed, may drastically increase the number of lawsuits surrounding the subprime mortgage industry if borrowers somehow prove lenders steered them into loans they couldn't repay.”

From Mortgage News Daily:

“HR3915, which is strongly opposed by some segments of the lending community, sets minimum standards for loans including a reasonable assumption that the borrower will be able to repay the loan. It also mandates a mechanism for licensing mortgage brokers who are not appropriately regulated by the states or by agencies such as the Comptroller of the Currency. The bill also proposes liabilities for those who securitize potentially risky loans.”

From ConsumerAffairs.com:

“Rep. Brad Miller (D-NC), one of the bill's co-authors along with Rep. Mel Watt (D-NC) and Committee chairman Barney Frank (D-MA), said the measure would ‘be the most significant consumer legislation in more than a dozen years.’‘Thousands of middle-class homeowners could be saved from foreclosures should the bill become law,’ Miller said.”

Is the Euro Becoming the Favored Reserve Currency?

From The Wall Street Journal:

“Observers credit the ECB and its head, Jean-Claude Trichet, with making a trenchant decision that calmed markets. The move shored up confidence in the bank's ability to keep markets functioning for the U.S. dollar's most significant rival. With its boosted credibility, the ECB could enhance the euro's standing in world markets. Continued confidence in the currency could ultimately come at the expense of the dollar, the current favorite of big world investors thanks in part to the size, liquidity and stability of U.S. markets.”

From The Seattle Times:

“Gisele Bündchen wants to remain the world's richest model and is insisting she be paid in almost any currency but the U.S. dollar.

Like billionaire investors Warren Buffett and Bill Gross, the Brazilian supermodel is on a growing list of rich people who have concluded the currency can only depreciate because Americans led by President Bush are living beyond their means.”

Mortgage Restructuring Encouraging the Wrong Behavior?

From The Wall Street Journal:

“Consider Sharon Cooper of Lynn, Mass., who wants to sell her home. The problem: She now owes more than the house is worth, so she asked her lender to allow a ‘short sale’ -- selling it for less than the amount due, and forgiving the rest -- to avoid foreclosure.

She says the lender, Countrywide Financial Corp., in August told her she would first need to fall two months behind on payments. So last month, she stopped paying. ‘I don't have any option but to stop paying,’ she says.”

From CNN Money:

“… one subprime borrower had a riskier hybrid adjustable rate mortgage (ARM) with a rate of just under 7 percent that was going to reset in December to 10.5 percent. But last month, as part of a new bailout plan from Countrywide Financial, the lender gave him a rate reduction to 5 percent on his loan, saving him hundreds of dollars a month.

Nelson feels cheated and has little sympathy for people who she believes weren't as careful as she was. ‘Everybody was seeing dollar signs,’ she said, ‘and let their greed get the better of them. So, no. No bail-out, no assistance with my tax dollars. Not one red cent.’"

From Forbes:

“Committee Chairman Barney Frank of Massachusetts agreed with this, saying that Congress would not appropriate money to bail out all lenders, and instead is focused on finding ways for qualified homeowners to restructure their mortgages and make them more affordable.”

Fed Injects Cash into Financial System

From the AP:

“The Federal Reserve Bank of New York, which carries out the central bank's open market operations, moved Thursday to inject $41 billion in temporary reserves into the U.S financial system. It came as part of ongoing efforts designed to ensure that the markets -- which have suffered through a period of turbulence over the last few months -- function smoothly. The cash infusion came in three separate operations. A New York Fed spokesman said it was the largest single day of operations since $50.35 billion was pumped into the system on Sept. 19, 2001, following the terror strikes on New York and Washington. He declined further comment.”

From Reuters:

“The total on Thursday surpassed the $38 billion the Fed injected on Aug. 10, which was generally seen as the beginning of a global credit crisis. At the time, the Fed and the European Central Bank ramped up temporary liquidity operations with the intent of alleviating strains in short-term lending markets.”

From Bloomberg:

“The Fed today added $41 billion in temporary reserves to the banking system, the largest one-day cash infusion since the terrorist attacks of September 2001. The amount reflects the central bank's effort to push the effective rate lower after policy makers reduced their target yesterday.”

Will a Fed Rate Cut Affect Mortgage Rates?

From the Seattle Times:

“Wall Street has experienced many scares lately, from a global credit crunch to big mortgage-related losses for top banks, so it's fitting the Federal Reserve's latest decision on interest rates comes on Halloween.

Many investors hope for a treat, in the form of another rate cut, rather than a trick.

The hope is a lower target for the benchmark federal funds rate would prompt banks to cut rates on mortgages — a boon to homeowners with adjustable rates due to reset — as well as credit cards.”

From The Wall Street Journal:

“…mortgage rates actually follow the bond market, not the Fed-funds rate. The interest rate on a 30-year fixed-rate mortgage tracks the yield on the 10-year Treasury note… Lenders typically set their base mortgage rate around two percentage points higher than the 10-year bond yield.”

From the Associated Press:

"’The problems in the housing market, the problems in the credit markets are not easily solved by the Fed cutting rates,’ said Steve East, chief economist for investment bank Friedman Billings, Ramsey & Co. in Arlington, Va., who sees the Fed making three quarter-point cuts by January and puts the odds of a recession in 2008 at 60 percent.

The thinking is that lenders can improve battered balance sheets if they have to pay less for money they borrow short-term while the rate they charge borrowers for long-term loans holds steady or moves higher. Yet analysts say problems in the credit markets extend beyond the benefits of small rate cuts.”

From the New York Post:

“When the Fed attempted to rescue the housing industry in August by cutting its funds rate and reducing the discount rate for the second time in a month, the financial markets became spooked and punished mortgage seekers.

According to BankRate.com, the average rate on an adjustable rate mortgage went up from 6.53 percent right before the latest round of Fed rate cuts to 6.64 percent soon afterwards.”

Is it Time to Refinance?

From Realty Times:

“We used to have a rule of thumb that one should refinance only when rates drop at least 2 percent from your current mortgage. With the tremendous volatility of the financial marketplace, this 2 percent rule of thumb does not always makes sense.

More importantly, there are many other reasons to refinance other than lower mortgage payments. As of January of this year, credit card companies increased their minimum monthly payment from 2 to 4 percent of the outstanding balance. Mortgage interest is deductible while credit card charges are not. If, for example, you currently owe $5000 on your charge card, consider increasing your refinance mortgage by that amount and pay off the credit card debt.”

From the Navato Advance:

“Refinance now. Lock in a low rate. Save yourself from crippling mortgage debt. Ever since the Federal Reserve cut the federal funds rate mid-September, mortgage companies have been encouraging homeowners to heed these calls. Meanwhile, consumer advocates are warning against debtors falling prey to predatory lending schemes, and financial and real-estate professionals caution that many people in trouble may not qualify for new fixed-rate loans.”

From The Sydney Morning Herald:

“As interest rates rise, some borrowers are seeking to fix their loans while others are looking to refinance, in hot pursuit of lower rates. Saving even half a per cent on your mortgage repayments may help you sleep easier at night. However, if your home loan is reasonably small, it may take some time before the savings of a lower interest rate actually make up for the cost of refinancing…

…Before you jump from one loan to another, make sure you understand just how much it will cost to refinance. Depending on the terms and conditions of your current home loan contract, this may be an expensive exercise.”

From The Austin-American Statesman:

“Subprime guidelines have been rolled back about three years… You're going to have to save up your money, document your income, maybe wait a little bit. Understand that it's going to be OK for someone to look at your bank statement. Depending on the loan amount, consider an FHA loan. That's not subprime, but their credit guidelines are relaxed. Of course, that is also a full-doc loan.”

Money Market Funds May be at Risk

From The Wall Street Journal:

“Complex investments known as SIVs are roiling Wall Street and the world of high finance. But the investment vehicles also are threatening trouble in a seemingly unlikely place: money-market funds, the choice for many individual investors seeking safety.”

From Fortune:

“Money market funds are often the safest investments offered by fund companies, but several large money market funds own securities that were issued by structured investment vehicles (SIVs), the large, offshore funds that have recently made it into the headlines because the U.S. Treasury, along with Citigroup (Charts, Fortune 500), Bank of America (Charts, Fortune 500) and JP Morgan Chase (Charts, Fortune 500), are working on a plan to shore up them up."

"Money market funds are supposed to the safest fund investments of all. They're not supposed to get involved in liquidations. That sort of event is a nightmare for a money market fund."

From the San Francisco Chronicle:

“Despite all the problems in the financial sector, most experts say that as long as you keep your deposits at any one institution under the insurance limit, you shouldn't lose any sleep…

…The basic insurance limit is $100,000 per customer per type of deposit, although there are ways to get additional insurance by opening different types of accounts - such as retirement, joint and trust accounts.”