InvestorCentric

Is The US Economy On A Death Spiral?

2009-07-10T06:00:00.000-07:00

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

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

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

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

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

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

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

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

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

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

Are The Green Shoots Of Economic Recovery Turning Brown?

2009-07-10T05:58:00.000-07:00

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Overleveraged Economy Not To Blame For Financial Crisis

2009-07-09T06:00:00.000-07:00

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

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

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

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

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

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

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

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

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

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

The Climate Bill Will Be A Disaster

2009-07-09T05:58:00.000-07:00

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

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

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

And it does very little to fight global warming.

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

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

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

A “Good” Tax?

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

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

A carbon tax has two advantages over other alternatives:

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

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

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

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

The Lowdown on Waxman-Markey

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

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

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

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

What Really Caused The Real Estate Bubble?

2009-07-08T06:01:00.000-07:00

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Commodities: The Asset Class Of The Future?

2009-07-08T06:00:00.000-07:00

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

2009-07-07T06:00:00.000-07:00

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Las Vegas Real Estate Horror Stories

2009-07-07T05:59:00.000-07:00

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

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

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

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

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

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

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

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

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

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

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

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

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

Perhaps disturbing would be a better one.

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

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

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

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

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

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

This should be interesting to watch this fall.

Any word on how Donald Trump is doing these days?

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

Real Estate Decline Boosts Population In Urban Areas

2009-07-06T06:00:00.000-07:00

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

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

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

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

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

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

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

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

This article was republished from Blown Mortgage.

Homeowners Seek Adjustments In Property Taxes

2009-07-06T05:59:00.000-07:00

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

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

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

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

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

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

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

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

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

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

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

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

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

That too will change someday...

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

When Is The Obama Stimulus Going To Start Creating Jobs?

2009-07-03T06:00:00.000-07:00

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

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

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

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

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

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

Just noticed this, which makes a surprisingly similar point:

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

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

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

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

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

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

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

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

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

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

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

Water: The World's Most Valuable Resource

2009-07-03T05:55:00.000-07:00

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

This post was republished from dailywealth.com.

Why You Shouldn't Listen To George Soros

2009-07-02T06:00:00.000-07:00

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

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

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

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

But is he wrong?

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

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

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

I preach caution for three reasons:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

PPIP May Have Succeeded Before It Was Ever Launched

2009-07-02T05:55:00.000-07:00

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

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

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

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

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

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

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

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

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

2009-07-01T06:00:00.000-07:00

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Data Shows Housing Market Improving

2009-07-01T05:59:00.000-07:00

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

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

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

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

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

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

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

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

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

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

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

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

China's Economic Strategy To Become The World's Biggest Superpower

2009-06-30T06:00:00.000-07:00

China is taking advantage of the global recession to position themselves to eventually become the world's number 1 superpower. They are lending out massive amounts of money to countries like the US, and stockpiling gold in order to prepare for the possible fall of the dollar. Tony Straka from The Prudent Investor explains China's economic strategy and why we should all be watching very closely.

Shocked by the fact that lamestream media and Twitter are all about Michael Jackson's death from what appears to be a drug overdose, I enjoy being the spoiler for a world that seemingly does not know how to set its priorities anymore. While 33 of the 42 commercial media I regularly read headline with Jacko, it is Chinese media that published the truly important news of the day.

Here's the executive version of Chinese economic news picked from the English language People's Daily Online.

1. China takes public ownership as the main body and the other (issue) is to adhere to the common growth of economy belonging to diverse forms of ownership.
2. The People's Bank of China (PBoC) will stick to an appropriately easy monetary policy but will ensure reasonable growth in money and credit, the central bank said yesterday.
3. New credit in the first half of 2009 will definitely surpass 6 trillion yuan, and some experts even predict the figure to be up to 6.5 trillion yuan. This means that total credit in the first half of this year will be more than the total amount invested in any year since China was founded.
4. China should buy more gold because the dollar is poised for a fall and the metal is needed to support the greater international role envisaged for the yuan, a senior researcher with the ruling Communist Party said.

You can now go back to watch CNN's US propaganda broadcast and remain in the "don't worry, be happy" camp which still has a solid majority in the Western world. Or would you prefer to gather a little more intel on the next #1 power in the world? Then read on.
Bullet point #1 appears to point to a struggle of ideologies in the Chinese communist party. Chinese entrepreneurs certainly favor a more liberal business climate but one must not forget that there is still a gap as wide as the Amazon river between the Ferrari driving riches in towns and a rural hinterland where oxcarts and bicycles remain to be seen as signs of prosperity. In order to prevent social upheaval China needs to bridge this gap or it risks falling apart. The anonymous commenter in the People's Daily reminds the world that China still favors a hands-on approach:

Taking public ownership as the mainstay is a fundamental principle of socialism. In a socialist country like China, where people have become masters of their own destiny, it is imperative to keep public ownership of means of production as a basis of the socialist economic system. So, adherence to public ownership as the main body is of vital importance in giving play to the superiority of the nation's socialist system, increasing the nation's economic strength and promoting social harmony in the country.

Pointing out, that 26 of the 500 largest companies in the world as of 2008 are state-controlled Chinese corporations, the most populous nation on earth insists that it is not so much about ownership-ideology but about keeping up a harmonious people.

In a nutshell, it is imperative and essential to consolidate and develop the public ownership economy, to encourage, support and guide the growth of the non-public sector economy, and to maintain the right to equal access of property resources, so that a brand-new situation will emerge, in which all economic sectors will "vie with each other" on an equal footing so as to spur their economic activity for mutual advancement.

Confronted with a global economic downturn China's central bank made it clear this week that it will emphasize an easy monetary policy to keep its economy humming despite declining exports. In a stark contrast to the indebted western world China sits on roughly $2 trillion in assets, enabling it to conduct stimulus policies no country in the Western hemisphere could afford. Read their opinion on bullet point #2 in their own words as it also signals a concern about the environment:

In a summary of the conclusions drawn at its second-quarter monetary policy committee meeting, the central bank said yesterday that it would ensure reasonable growth in money and credit but would strictly control lending to polluting, energy-intensive industries...
"The top priority at the moment is to stop the explosive growth in lending at the end of the month and quarter," China Banking Regulatory Commission said in a recent notice to lenders, pointing to the phenomena of banks racing to offer loans before June to meet their half-year lending targets.

The Eastern dragon so far performs much better than any recession-stricken nation in the West, where money supply has rocketed to potentially fatal (hyper inflationary) levels. Covering bullet point #3 in their own words, China plays its monetary muscle.

People's Bank of China Monetary Policy Committee recently held a regular meeting on the second quarter of 2009. The conference studies the orientation of monetary policy and measures for the coming future, concluding that we need to implement moderately easy monetary policy and maintain the continuity and stability of policies to guide a reasonable growth in monetary credit.
It is learned that in the first five months, RMB loans increased by 5.84 trillion yuan. June figures have not yet been released, but according to past experience, new credit in the first half of 2009 will definitely surpass 6 trillion yuan, and some experts even predict the figure to be up to 6.5 trillion yuan. This means that total credit in the first half of this year will be more than the total amount invested in any year since China was founded.

2 Ways Through a Recession: China Can Afford It Because of Savings
Show me a Western country that could shell out a trillion Euros/dollars from its full pockets! There is no such thing. All stimulus packages Western politicians promise are only backed by the hope of future tax payments. China can dive through a recession on its savings whereas the so called first world has nothing else to show than debts that are enough of a burden for the two next generations.

Wouldn't we all love to have the same economic discussion as the Chinese where economists argue whether the economy has bottomed out at a growth rate of 6.1% in Q1 2008 or whether one should be skeptical about a possible GDP growth rate of 9%?

Diving into recent history (i.e. this blog's archive) China can actually see the global downturn as a benefit that helps keeping the economy from overheating. BTW, why are we actually concerned with "overheating" economies? Don't we all want to become rich by tomorrow? But I won't digress, this is an entirely different discussion best to be had over a bottle of good plum wine.

Let's better proceed to bullet point #4: China's growing role in forex markets.
Reuters staffers Zhou Xin and Alan Wheatley direct my attention to the fact that China sees a much bigger role of gold in global currency policy after surprising the world with the fact that it had domestically purchased gold and now sits on a hoard of 1,054 tonnes after publishing a figure of 660 tonnes since 2003.

Buy Gold Before China Buys It All

The communist party's chief economist told Reuters the following strategic goals (found on GATA's website):

China should buy more gold because the dollar is poised for a fall and the metal is needed to support the greater international role envisaged for the yuan, a senior researcher with the ruling Communist Party said on Thursday.
Li Lianzhong, who heads the economic department of the party's policy research office, said China should use more of its $1.95 trillion in foreign exchange reserves to buy energy and natural resource assets.
Speaking at a foreign exchange and gold forum, Li also said that buying land in the United States was a better option for China than buying U.S. Treasury securities.
"Should we buy gold or U.S. Treasuries?" Li asked. "The U.S. is printing dollars on a massive scale, and in view of that trend, according to the laws of economics, there is no doubt that the dollar will fall. So gold should be a better choice."

Following the nuances of Chinese official-speak it is clear that China sees itself superior in monetary policy but is left with a problem it shares with all creditors in the world: Its forex reserve stash consists mainly of unbacked Federal Reserve Notes (FRNs), a fiat currency backed by nothing else than the belief it will buy you the same amount of goods and services in the future as it did in the past.

China takes appropriate steps at its own rhythm to secure a bigger role for the Yuan in the future. Looking at the Yuan's slow revaluation so far China has made good on its promises to the bankrupt USA.

The Reuters story sums it up correctly:

Li cited the high share of gold in the foreign exchange reserves of the United States, Italy, Germany, and France to argue that China's gold holdings, which account for about 1.6 percent of its reserves, are too small.
China does not disclose the composition of its currency reserves, but bankers assume around 70 percent is held in dollar assets.
China is the largest single holder of U.S. Treasuries, with $763.5 billion at the end of April, according to U.S. Treasury data.
Analysts say this data set understates the true number as it does not capture paper bought through dealers in London or elsewhere.
Li said a second reason for buying more gold would be in anticipation of the yuan one day becoming a reserve currency.
The yuan is not convertible on the capital account, meaning it cannot be freely traded for other currencies for financial transactions that are not related to trade. This rules out the yuan's use as an international reserve currency, for central banks would not be able to convert it quickly if necessary.
But in a very preliminary step toward that goal, China is paving the way for greater use of the yuan beyond its borders.
The People's Bank of China has arranged currency swap deals with six countries since December totalling 650 billion yuan ($95 billion) so that trade and investment with China can be conducted in yuan, not dollars.
And China will soon allow selected firms in the southern province of Guangdong that trade with Hong Kong to settle their transactions in yuan, or renminbi.
"If the yuan should go international or become a reserve currency, China needs more gold to back that," Li said.

One must not forget that China's political state supports long term strategies for which Western leaders who want to get reelected every 4 years have no leeway.
Reuters fills in here very well too:

When the yuan does become an international currency, which Li acknowledged was a long way off, he said the composition of the SDR should be reformed to include the Chinese currency.
Ideally, in the long term, the SDR would be made up of the dollar, euro, sterling, yen, and yuan, each with a weighting of 20 percent, Li said.
The SDR is currently made up of the dollar (with a weighting of 44 percent), the euro (34 percent), the yen (11 percent), and sterling (11 percent)
The four currencies in the SDR, which must be convertible, are those issued by fund members with the largest share of global trade. The weights assigned by the IMF are based on the value of exports and the amount of reserves denominated in those currencies.
The composition of the basket is reviewed every five years. the next review is due in 2010.

Rest assured that the dragon will blow some hot air down the Western world's spine in the run-up to this review.

This was reposted from Tony Straka's blog, The Prudent Investor.

Obama's Proposal For Requiring Bank "Funeral Plans"

2009-06-30T05:59:00.000-07:00

An arguably much needed change outlined in the Obama administration's financial regulation overhaul proposal is the requirement of a "rapid resolution plan". This would provide the government with important information in the event that a systemically important financial institution faces collapse. For more, see the following post by economist Mark Thoma, author of Economist's View.

No disagreement with this. The failure to have dissolution plans for systemically important institutions on the shelf and ready to go turned out to be costly, so credible dissolution plans are certainly needed. However, the argument seems to assume that too big and too interconnected firms cannot be avoided, something I'm not ready to concede:

A sound funeral plan can prolong a bank’s life, by Anil Kashyap, Commentary, Financial Times: Buried within the 88-page Obama administration proposal to overhaul financial regulation is an overlooked option called a “rapid resolution plan”. It mandates that systemically important financial companies be required regularly to file a “funeral plan”: a set of instructions for how the institution could be quickly dismantled should the need to do so arise. ... It could be implemented now, without the need for legislative action. Regulators should do so immediately.

The first benefit is that regulators would gain a stronger negotiating position with a dying institution. Throughout this crisis the authorities have had to intervene without knowing exactly what hidden traps might emerge if a bank were to be closed down. The bankers know this and can exploit the fear of the unknown to press for bail-outs.

It is remarkable that such rules do not already exist. ... The crisis has shown us that the sudden unwinding of a large, complex financial institution is terrifying for the financial system. ...

A second immediate benefit would be to force bank managers to think much more carefully about the complex financial structures they have created. If bankers had to explain every single step needed (and the associated consequences) to shut down their subsidiaries in all the various jurisdictions in which they operate, they would have a big incentive to simplify their organisations. ...

Over the medium term, there would be additional benefits. The headline component of the plan would be the requirement for banks to estimate the number of days it would take to shut down. Banks that require longer to close would have to hold more capital. This would place management under serious pressure to improve their plans...

Senior members of the management team and the board would have to understand the funeral plan. Crucially, they would be forced to sign off on its accuracy. This might also lead to closer scrutiny of new products or lines of business if they jeopardised an orderly unwinding. ...

This proposal is far from a cure-all. One big problem is that resolution rules themselves, especially when multiple legal systems are involved, are quite complicated. But the plan has an extremely high benefit-to-cost ratio and could be put in place right away. ...

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

Is It Okay To Not Pay The Mortgage If You Are Significantly Underwater?

2009-06-29T06:00:00.000-07:00

With large numbers of homeowners in the US underwater on their mortgages, more individuals are choosing to walk away from their mortgage even if they can afford to pay it. It may make financial sense if mortgage principal is $500,000 when the home is valued at $400,000, but is it right to not pay back a loan under these circumstances? The following post from The Mess That Greenspan Made, explores that question.

The Economist looks at the phenomenon of U.S. homeowners who can pay their mortgage, but who choose not to. Apparently, changing cultural norms are playing as big a part on the way down as they did on the way up for the U.S. housing market.

New research based on a survey of 1,000 homeowners suggests that one in four mortgage defaults are “strategic”—by people who could meet their payments but who choose not to. The main drivers of strategic default are the scale of negative equity, and moral and social considerations. Few would opt to renege on their mortgage if the equity gap were below 10% of their home’s value, the authors find, partly because of the costs of moving. But one in six would bail out if loans were underwater by a half.
...
Anger about bail-outs of banks or carmakers does not weaken the moral barrier to default. But people who live in neighbourhoods where home repossessions are frequent are more likely to welsh on loans. Homeowners who know someone who has defaulted strategically are 82% more likely to say they would do so, too. The likelihood of strategic default rises more quickly once the rate of local home foreclosures reaches a critical level. That hints at a vicious cycle of foreclosures that both depress home prices and weaken the social and economic barriers to further defaults.

Cocktail party chatter sure has changed dramatically in the last four or five years - from discussions of "$10,000 a month in appreciation" to how to "walk-away".

This blog post can also be viewed at The Mess That Greenspan Made.

Are The Positive Economic Signs Artificially Created?

2009-06-29T05:55:00.000-07:00

Could the signs of economic improvement be a mirage created by the artificial propping up of the economy by unprecedented government intervention? James Picerno from The Capital Spectator explains why we should be suspicious of numbers like the 1.6% increase in disposable personal income.

One day we'll look back on 2009 and wonder what all the confusion was about. All will become clear and we'll know when the recession ended, when the bull market began anew and how and why the cycle turned. Meanwhile, we're wondering if the data du jour can be trusted.

Judging by the numbers of late, clarity is upon us, or so it seems. Income and spending are up among consumers. What's not to like? If this keeps up, we'll be back to the good old days by, oh, let's say the third week of September.

As for what we know today, disposable personal income jumped 1.6% last month on a seasonally adjusted basis, the Bureau of Economic Analysis reports this morning. That's the biggest monthly gain in a year. Not bad for what we've repeatedly been told is the deepest recession since the Great Depression.

That's only half the fun. The government also advises that personal consumption expenditures gained 0.2% in May, the best since February.

Is it a miracle? No, it's just your tax dollars at work. As the BEA noted in its press release today, "the pattern of changes in personal income and in DPI reflect, in part, the pattern of increased government social benefit payments associated with the American Recovery and Reinvestment Act of 2009." In other words, the guys and gals in Washington continue to print money and distribute it, creating a revival that otherwise doesn't exist. The extent of the government's intervention can be surmised once we recognize that wages and salaries actually fell by 0.1% last month.

There are two ways to interpret the news. The optimistic view is that the government's stimulus efforts will steady an otherwise anxious consumer. By putting more money into his pocket, the incentive to spend is heightened and the odds improved that a return to old consumption habits is near. The government payments are a bridge until the day when the private sector can resume more of the burden of financing consumption.

The darker view is that government-financed consumption is a tenuous lifeline that's a pale replacement for the real McCoy. As such, the burning question is one of asking when the labor market will revive? By that standard, there' still reason to be cautious about the remainder of 2009. The recession may be technically over, as we've discussed. But even making that leap of faith offers no short cut to good times.

The job market, after all, is typically the last to show convincing signs of recovery. For that reason, the National Bureau of Economic Research shuns employment trends for putting official dates on business cycle turning points. Minting new jobs, in other words, is usually the response to other economic stimuli. Conventional recoveries, then, don't begin with the labor market. Then again, this isn't a conventional business cycle.

Clearly, the government has moved heaven and earth to keep the economy afloat. Ours is an era of triumph for public-financed consumption. In both magnitude and timeliness, no government has ever acted with greater speed and depth in keeping the forces of contraction at bay. But that raises a question of whether Washington can keep the engineered consumption going long enough to wait for a bonafide economic recovery. We'll have an answer, perhaps soon. But at the moment we're still knee-deep in the first great macroeconomic experiment of the 21st century.

This blog post can also be viewed at The Capital Spectator.

Who Should Be Blamed For Big Bonuses

2009-06-26T06:00:00.000-07:00

Many Americans are outraged right now of the report that Goldman Sachs is planning to pay out record bonuses. Although Goldman Sachs denies the report, many are asking how this could possibly happen. Martin Hutchinson from Money Morning explains who deserves the blame.

It’s been in the news the last couple of days. Goldman Sachs Group Inc. (NYSE: GS) bankers are headed for record bonuses. The Financial Times reports that bankers’ pay in the London market is already right back to 2007 levels and going higher. Banks are poaching each others’ best staff, and are offering huge pay packages to staffers willing to make the leap.

It’s enough to make you succumb to the Two Minutes’ Hate.

But let’s face the truth. As egregious as salary escalation seems - coming as it does on the tail of the worst U.S. banking crisis since the Great Depression - the reality is that this is the U.S. government’s fault. After all, it was the U.S. Federal Reserve and the Obama administration that created all the bailouts and the special-loan-subsidy schemes for banks that would otherwise have been on their last legs.

In a truly free market, ex-Citibankers (NYSE: C) would be on every street corner of Manhattan - selling apples - and that would properly hold down the pay of those bankers still lucky enough to have a job.

The sudden rebound in demand for bankers is a symptom of overall market conditions right now. The U.S. stock market is way up from its lows, there are three Chinese initial public offerings (IPOs) due to come to market this week (one of them for a company with no earnings), the volume of home mortgage refinancing has been running at record levels, the FHA index of home prices has dropped only 0.3% this year and the volume of new corporate debt issuance is also high. Commodity prices are well off their lows, and oil prices are again close to $70 a barrel, which would have been considered an excessively high level only three years ago. That’s not a picture of a financial market - or a global economy - in deep recession.

Far from it.

To some extent, this is good news. A revival of the financial system and its ability to finance businesses and home purchases is exactly what the huge monetary and fiscal stimulus was meant to produce. A modest revival in world trade, as inventories cease being wound down and Chinese production ramps up again, is also a necessary precondition for economic recovery.

As the banking bonus news suggests, however, much of the activity is coming in some pretty funny places, where the excesses of the past decade were concentrated and where you wouldn’t expect to see such a quick revival.

That gives us a clear indication of just what the problem is. Because bankruptcies weren’t allowed to happen back in September and October - as they would have in a free market - there are more institutions in the market than there should be, Citigroup and Merrill Lynch most notable among them.

Moreover, in a true free market, the entire credit-default-swap (CDS) business - a product that caused $180 billion of losses to the financial system through American International Group Inc. (NYSE: AIG) - would be nothing but a smoking ruin. But in the market we are living in, those $180 billion worth of losses have been transferred to the tab of the taxpayers of America.

With Citigroup and Merrill Lynch bankers mooching around on street corners, financial sector salaries would be forced down to a more reasonable level. As it is, the few unemployed unfortunates who worked at Lehman Brothers are not enough to depress the market. Likewise, credit default swaps have caused huge pain to the unfortunate employees of Abitibi-Bowater Inc. (NYSE: ABH), General Growth Properties (OTC: GGWPQ), and Six Flags Inc. (OTC: SIXFQ), each of which went bust partly because their creditors were playing in the CDS market and had no incentive to find an alternative to bankruptcy. Had CDS caused the pain they should have to financiers, the product would no longer exist, to the considerable benefit of the rest of us.

Inevitably, we are going to have to pay the price for all the bailouts. The financial sector will eventually shrink to its proper size, as will its members’ earnings. CDS will eventually be sharply restricted, to prevent their holders from forcing random companies into Chapter 11. Interest rates will have to rise, to accommodate the huge debt-funding needs the government has incurred. Money will have to be kept tight, to pay for the indulgences that Fed Chairman Ben S. Bernanke granted during the bubble, as well as for the even greater-indulgences of the bust.

Which is probably why you don’t want to hold U.S. stocks right now.

This article was reposted from Money Morning. You can also view this article at Money Morning's investment news site.

Greenspan Says Stock Market Recovery Could Lift Economy

2009-06-26T05:59:00.000-07:00

Alan Greenspan, writing in the Financial Times, argues that a continued recovery by the stock market could lift up the economy. A healthy stock market helps supply banks with capital for lending, increases household spending, and spurs new capital investment, he argues. See below for more on Greenspan's thinking.

Maybe there was a Greenspan put after all?:

Inflation - the real threat to sustained recovery, by Alan Greenspan, Commentary, Financial Times: The rise in global stock prices from early March to mid-June is arguably the primary cause of the surprising positive turn in the economic environment. The $12,000bn of newly created corporate equity value has added significantly to the capital buffer that supports the debt issued by financial and non-financial companies. Corporate debt, as a consequence, has been upgraded and yields have fallen. Previously capital-strapped companies have been able to raise considerable debt and equity in recent months. Market fears of bank insolvency, particularly, have been assuaged.

Is this the beginning of a prolonged economic recovery or a false dawn? There are credible arguments on both sides of the issue. ...[T]he crisis will end when ...[there is] a stabilisation of home prices or a further rise in newly created equity value available to US financial intermediaries...

Global stock markets have rallied so far and so fast this year that it is difficult to imagine they can proceed further at anywhere near their recent pace. But what if, after a correction, they proceeded inexorably higher? That would bolster global balance sheets with large amounts of new equity value and supply banks with the new capital that would allow them to step up lending. Higher share prices would also lead to increased household wealth and spending, and the rising market value of existing corporate assets (proxied by stock prices) relative to their replacement cost would spur new capital investment. Leverage would be materially reduced. A prolonged recovery in global equity prices would thus assist in the lifting of the deflationary forces that still hover over the global economy.

I recognise that I accord a much larger economic role to equity prices than is the conventional wisdom. From my perspective, they are not merely an important leading indicator of global business activity, but a major contributor to that activity, operating primarily through balance sheets. ...

Stock prices, to be sure, are affected by the usual economic gyrations. But ... a significant driver of stock prices is the innate human propensity to swing between euphoria and fear, which, while heavily influenced by economic events, has a life of its own. In my experience, such episodes are often not mere forecasts of future business activity, but major causes of it. ...

He also gives his view of the future inflation threat. I'll just note that I quite agree with Greenspan's assertion that he accords "a much larger economic role to equity prices than is the conventional wisdom."

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

Why Are Republicans Attacking The Republican Fed Chairman?

2009-06-25T06:00:00.000-07:00

Why would Republican law makers want to attack Bernanke, a Republican appointed by President Bush? If Bernanke resigns, Obama could appoint a Democrat as Fed Chairman. Economist Mark Thoma from Economist's View, attempts to explain this counter-intuitive strategy.

The GOP is targeting Bernanke as "a champion of government intrusion and an ally of President Obama":

G.O.P. to Paint Bernanke as Ally of Big Government, by Edmund L. Andrews and Louise Story, NY Times: In a peculiar role reversal, Republican lawmakers are mounting a ferocious attack on the Republican chairman of the Federal Reserve, while Democrats are coming to his defense.

Ben S. Bernanke ... will be grilled on Thursday by the House Oversight and Government Reform Committee about his role in orchestrating Bank of America’s controversial takeover of Merrill Lynch late last year.

The House investigation is heavily colored by partisanship. President Obama is proposing to give the Federal Reserve formidable new powers to regulate giant institutions, including Bank of America, that could pose risks to the financial system.

Republicans, along with some Democrats, argue that the Fed already has too much power.

Unhappy about the huge bank bailouts that the Fed arranged with the Treasury Department during the Bush administration, many Republicans are even more displeased that Mr. Bernanke is now working hand-in-glove with the Obama administration.

The result is a set of dueling narratives and agendas, all of which will be on full display when Mr. Bernanke testifies on Thursday. ...

Despite Mr. Bernanke’s Republican roots, and the fact that President Bush nominated him to be Fed chairman, the Republican memo prepared for the hearing on Thursday describes Mr. Bernanke as a champion of government intrusion and an ally of President Obama. ...

I don't think this is an attempt to negatively influence Obama's decision on Bernanke's reappointment as Fed chair as some have been hinting because that would not be in the GOP's best interest. There are open positions on the Federal Reserve Board, so even if Bernanke didn't resign as is customary in the event he was not reappointed - and nothing says he must - Obama would still be free to appoint a new Fed Chair from outside the present Board membership.

Obama would certainly appoint someone who shares his regulatory vision, and that person would likely be confirmed (e.g. someone like Janet Yellen would likely be confirmed even if there was lots of grumbling), so I don't see how the appointment of a new Fed chair would do anything but strengthen the support for the type of regulatory oversight the administration envisions. That's not what the GOP wants.

Instead, this looks much more like an attempt to by the GOP to maintain its usual anti-regulatory, anti-government stance by arguing that the Fed should not to be trusted with the powers envisioned in the proposed regulatory reform legislation. So the real goal is the Fed as an institution, Bernanke is simply the target being used to make that the point. E.g.:

The vast extent of the Fed’s actions in the past two years to commit trillions of dollars in government money to support the economy has raised significant concerns on Capitol Hill, some of which will be aired on Thursday when Bernanke testifies before the House Committee on Oversight and Government Reform.

Congressional investigators have been looking into the Fed’s role in encouraging Bank of America to purchase Merrill Lynch... Rep. Darrell Issa (R-Calif.), ranking member on the Oversight Committee, said on Wednesday that the Fed engaged in a “cover-up” and hid details about the merger, completed in January 2009, from other federal agencies.

Meanwhile, lawmakers from both parties are raising questions about Obama’s proposal to grant the Fed broad new powers to prevent another crisis.

Those concerns could make the next confirmation process far more contentious than the six that have occurred in the last two decades.

And:

Sen. Jim DeMint (R-S.C.) said, “It won’t be my decision whether he is held over or not, but right now I’m concerned that they have lost their independence and are too cozy with Treasury.”

It looks like we are going to get some version of a strategy that has the GOP saying that given what happened to the financial system, of course we need more oversight and regulation of the financial system. But any particular piece of legislation that is proposed will be fought tooth and nail by the GOP as being far too intrusive, granting the government too much power, and generally going far beyond what is needed to solve the problem. The fact that the will for reform will diminish with time works in their favor, and if they can string things out long enough with this strategy, the result will be that the legislation eventually passes in a much weaker form, or it won't ever pass at all.

Just ignore them. Altering a few words:

The Republicans, with a few possible exceptions, have decided to do all they can to make the Obama administration a failure. Their role in the financial regulation debate is purely that of spoilers who keep shouting the old slogan — Government is always the problem, never the solution! — hoping that someone still cares.

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

Warren Buffett Shares His Wisdom On The Current Economic Environment

2009-06-25T05:50:00.000-07:00

The amazing Warren Buffett says he likes to spend $5 on lunch, but lunch with Buffett can cost much more. Last year a Chinese businessman bid $2.1 million to have lunch with Buffett. However, you can get some of Mr. Buffett's wisdom for free in the following post.

Berkshire Hathaway CEO Warren Buffett talks with FOX Business Network’s Liz Claman about expensive lunches, his Goldman Sachs investments, the economy, and more.

Some highlights from the Oracle of Omaha after a $5 hamburger...

On whether he will cash out of Goldman Sachs:

No, no, no. I will keep those Goldman warrants right through their full -- they've got four and a quarter years or so to run. But I think we'll make a lot of money out of those.

On the possibility of the United States losing its AAA Rating:

As long as you're issuing money and you're issuing debt in your own currency, you can print money. The U.S. -- no, I think we will have a AAA for not only as long as I live, but as long as you live, which is more important.

Here's part 2...

On whether unemployment will continue to rise:

It’s going higher—business has not bounced back. We have not come off the bottom yet. It will work out in the end. Since 1776 it’s been a mistake to bet against America . America solves its problems. How soon, nobody knows. But we have not come off the bottom yet. And it will work out in the end.

On inflation in the United States :

What we’re doing raises the probability significantly of very significant inflation down the road—not this year or next year or the year after that, but we’ve taken actions and they were appropriate actions… it will have consequences and nobody knows exactly what they will be and how effective we will be at draining a system we’ve been flooding, but the probability of significant inflation has gone up.

Housing Metrics Improved In May But Could Be Temporary

2009-06-24T06:00:00.000-07:00

There are some positive numbers coming out of the housing market from May. Sales of existing home prices rose, inventory decreased, and median sales price rose. But will this improvement last in the face of rising mortgage rates? Tim Iacono elaborates on the latest numbers.

The National Association of Realtors reported slightly higher sales of existing homes last month, up 2.4 percent to a seasonally adjusted, annualized rate of 4.77 units in May after a downwardly revised total of 4.66 million units in April.

Inventory declined modestly as the months of supply metric fell from 10.1 months to 9.6 months, still about double the historical average.

The median sales price rose 3.8 percent in May to $173,000, but the year-over-year change worsened to a decline of 16.8 percent. The realtors' trade group also reported a sharp decline in the number of distressed sales, falling to about one-third of all sales versus the 40 to 50+ percent in recent months.

The increase in sales was less than expected due to "poor" appraisals (i.e., ones that come in too low for the bank to confidently make a loan), NAR Chief Economist Lawrence Yun noting:

Lenders are using appraisers who may not be familiar with a neighborhood, or who compare traditional homes with distressed and discounted sales. In the past month, stories of appraisal problems have been snowballing from across the country with many contracts falling through at the last moment. There is danger of a delayed housing market recovery and a further rise in foreclosures if the appraisal problems are not quickly corrected.

It sounds as though not being familiar with the neighborhood might be a good thing if the aim is to get an objective appraisal and that using distressed sales is exactly the right thing to do since these dominate overall sales activity in many areas.

You just can't win as a real estate appraiser in the 21st century...

Importantly, the now two-month long move up in home sales has occurred during a time that mortgage rates were "freakishly" low. In May, the national average for a 30-year fixed-rate home loan was just 4.86 percent, up slightly from the 4.81 percent average in April, but significantly below the current rate of closer to 5.5 percent.

Next month's report should be full of intrigue regarding if and how higher mortgage rates are affecting the sales of existing homes.

This article can also be viewed at Tim Iacono's blog, The Mess That Greenspan Made.