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Thursday, September 28, 2006

I Am Not A Newt

If the new home sales report was good news, I'm a newt. And I'm not a newt. I don't even bear the slightest resemblance to a newt.

The new home sales number is always subject to substantial revisions, usually downward. August's number came out slightly higher (1,050,000) than the analysts' estimates (1,040,000), but the numbers for prior months were revised substantially downward. If you compare the original July number (1,079,000) to August's estimate, there would be a drop instead of a revision. NJ RE Report (Grim's new blog) has an excellent post on the numbers. Remember, though, that the error rate in this survey is incredibly high - 15.5%. The reason why the revisions are so off the original numbers is because the original numbers use imputed data. See the Census page for more info.

We can have more confidence in the revised GDP for the second quarter, but that went from 2.9% to 2.6%. My guess is that we would be doing great if the fourth quarter eventually comes in anywhere above 1.8%.

The purchase money mortgage application index as reported by the MBA survey is a very reliable number, and it has been running twenty percent below a year ago in recent months. Over the last few weeks, it has been inching higher. The latest release still shows it hanging in that same -20% range year-over-year.

Five of the Fed banks do industrial surveys. The Philly Fed's latest survey for September showed expected future in all categories of future business activity, summarized in this paragraph as:
Expectations for future manufacturing growth fell sharply this month. Indicators for future activity, new orders, shipments, and employment all declined from their August readings. The future general activity index fell from 7.4 to -0.2, its first negative reading since January 2001...
Other Fed districts that do manufacturing surveys are Kansas, whose September survey says that growth is slowing but that plant managers remain optimistic about future growth, Richmond, whose September survey shows brightening prospects and stronger growth, and New York, which also shows stronger growth expectations. The bottom line is that the weaknesses in the economy right now are autos and housing, but that they are pretty big weaknesses.

This is one interesting forecast of housing starts over the next six months (scroll down and see the graph). The debate has really turned to how many jobs will be lost over the next six months, and estimates vary widely. It's probably over 400,000, though. From CNN's August article:
In the second quarter of 2005, investment in residences added 1.11 percentage points to the gross domestic product, the broad measure of the nation's economic activity. But in the second quarter it subtracted an estimated 0.4 percentage points.
In addition, the Labor Department estimates that more than 3 million people work directly in residential construction, and that the sector was responsible for about 10 percent of the nation's overall gain in employment in all of 2005.

But the sector has already trimmed nearly 25,000 jobs since January, according to Labor Department figures, and the slower housing starts and permits suggest even more slowing is ahead.
Calculated Risk thinks about 600,000 jobs will be lost, although he doesn't give a timeframe. I'm guessing about 250,000 by March, with the bottom falling out through summer and a 2007 difference of about 850,000 total jobs gone. However, the impact will not be as severe as that sounds, because a lot of those are illegals. The real punch to the economic gut will come from the contraction in consumer spending that had been fueled by HELOCs and cash-out refis, which will come into full bloom next summer.

Construction layoffs really hurt the US automotive industry, especially with regard to pickups and vans, but heck, the automotive industry in the US already seems to be in deep trouble. Chrysler announced that it would cut US production by 16% in the second half of the year. Ford had announced a 21% cut. GM had projected a 12% cut in the fourth quarter, year over year. Delphi is closing 21 of its 29 US plants over the next few years. When you figure the ripple-through, this is going to cost a lot of high-paying jobs with benefits in the US. My guess is well over 100,000 in the next year, although this is only a worsening of a long-term trend (see this from 2005 about the losses in the industry since 1995).

Figure at least another 20,000 in the financial services industry (realtors, brokers, loan officers, etc). Figure about 15,000 in supply outfits. Figure over 15,000 in luxury industries that are taking a hit, such as as all those furniture stores and jewelry stores that are closing or laying off. It doesn't look pretty to me.

Boeing continues to do well, and the gas price drops are helping. Somehow I don't think it is quite enough, although anything is certainly welcome. Oil is now rising, because people are predicting that bulging fuel inventories will cause OPEC to cut production sooner rather than later:
OPEC president Edmund Daukoru, who is also Nigeria's oil minister, said Tuesday oil prices are 'very low' and that action is needed in light of an anticipated 'colossal' 1.8 mln bpd oil glut by the second quarter of next year.
Do cuts in production to fend off a "colossal" oil glut really translate into higher oil prices, much less gas prices? We won't know for some time. The article continues:
...the cartel is in a difficult position. If it chooses to defend a price level that is too high, this could exacerbate the US economic slowdown and hurt global oil demand.

According to O'Callaghan, the market downtrend remains intact despite the recent gains. He said the market knows OPEC is concerned about the US economic slowdown and it will therefore look to 'test OPEC's resolve'.
Huh. In other words, prices must stay low or worldwide recession will force prices to drop because of an oversupply? Howard predicted the other day that oil prices would go higher, and his prediction came true. When fuel prices are low, the US economy does well. When they are high, it slumps. This has been true since I was a kid. The difference this time is the staggering levels of public debt which are beginning to place pressure of their own on the American consumer.

Afternoon Mama; With things so bad, why are Equities so strong, and the Yield Curve so flat?

BBB- CDX's are 19 wider today...
They're not bad now. They are just heading that way. Looks to me that things are pretty good now.

OK, let me amend that. In Michigan, things are bad now.

Money's heading into the market because it's not going anywhere else, I think. I wouldn't be surprised to see a mini tech bubble develop.
Public Debt: I'll confine my comment to the "interest only" mortgages and other devices designed only to reduce payments for a the first few years of the mortgage. I'd say 90% of these loans face default because when the principal is tacked onto rising rates the people who "bought" homes are going to be on the street. The problem will be that banks will own a huge amount of real property, property that they will not be able to dispose of. We could have a banking crises of nearly unprecedented proportions (Great Depression was worse). Remember, all real estate loans are "non recourse," meaning there is no way to collect if the house goes into default. Now, there is another element in this. All mortgages are "securitized" which means that they are packaged together in a bundle and turned into bonds. These types of bonds are traded in world markets and are listed in Barron's each week. When one of the mortgages in the package "defaults" another loan replaces it, thus the value of the bond remains stable. This depends on a slow default rate that allows an occasional "substitution." I don't know the breaking point of this system, all I can tell you is if the bond market dives the entire financial system dives. This is a very serious situation, one that the Fed is aware of and is warning banks about.
Howard, not all RE loans are non-recourse. It depends on state laws, note provisions etc.

For instance, refis in CA are not non-recourse. I think in CA though you can seek civil recovery or go the foreclosure route, but not both.

As for the bonds, that's the truly huge question. The big changes in the mortgage financing system over the last five years have left us with no understanding of what's out there.

I agree that the worst problem are the high LTV ratios in many areas. Any pricing downturn produces a much higher level of defaults when the borrower doesn't have an equity cushion.
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