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Sunday, May 31, 2009

On Oil

CF turned me on to Zero Hedge. I noticed that on Friday there was a guest post on oil, TARP, etc.
$66 oil is a noose around the neck of this economy as the it was cheaper oil that helped us begin to recover as it stayed around $40 from November through the beginning of March. On a per barrel basis alone, that was $500M a day LESS than we are paying now but, despite the fact that oil is still 54% in price from this time last year, gasoline has gone up so fast that it’s only down 23% from the prices that knocked the wheels out from our economy. Including refined products, that extra $26 a barrel is costing US consumers $1Bn a day, $365Bn a year or 1/2 of the TARP money going straight out of our economy and back to the countries that fund terrorism through the very ugly hands of GS (who are partners in ICE) and other TARP recipients who have funded and coordinated this commodity "rally," screwing the American people over with our own tax dollars.

I don't agree with everything written in this post, because I think that it is not just speculation but true hedging against dollar losses that is causing oil and commodities to shoot up. However, it is a fact that a lot of the funds given to financials appear to have gone into speculation. ICE is also a problem, and Congress will do nothing about it. A shadow commodities exchange that is substantially unregulated makes a great vehicle for price-cranking.

Regardless, the money people pay for oil is going to come straight out of other funds, and oil at $70 implies a drop in real GDP of about 1.5-2% over the next year.

No serious analyst can possibly predict these prices, but the same folks last year were predicting oil at $200. I conclude, therefore, that integrity takes a backseat to profits at many of the big financials.

Not that it is just oil. The TALF program (use FDIC funds to guarantee profits, give private interests money to buy bad bank "legacy" loans and securitized loans) recently prompted the hilarious applications by some banks to both sell their loans into the program (for an artificially high rate) and receive funds under the program (at taxpayer and healthy bank's expense) to garner some of the profits.

Like I say, this was the shortest Democratic revolution in history. If anything, this administration appears more dominated by big banks and Goldman Sachs than the last. A lot of it is Congress, although there can be no excuse for the TALF program whatsoever. It's theft.

When I think that I ruled out voting for Hillary because of the Clinton record of being in bed with big bankers, I feel that the ironies of the situation are just too much to bear.

Friday, May 29, 2009

Busy Today, But....

Look at those commodity prices run!

As the dollar drops, they must rise. And so must Treasury yields, and therefore mortgages.

So that's another crimp in PCE, because consumers ain't gonna be feeling too good when they see what's about to happen in the stores.

So much for monetary policy. The only thing that would really shortcut this, given that the US ran a 900 billion dollar deficit in the freakin' first quarter of 2009, would be another massive global shock. I certainly hope we are not about to get one.

In the meantime, we can all feel good about the fact that the US dollar is still preferred to Argentina's peso.

Even US domestic investors with major stakes in the country are going to try to invest their money abroad. So what's going to boost gross private domestic investment? And if that doesn't go up, no real recovery!

This is what happens when you try to futz the market. It rebels. And when you make the rounds trying to establish an international framework that makes it difficult for US companies and individuals to move funds outside the country, you inspire angst, and a sudden desire to figure out what's possible in terms of fluidity.

Update: Tim Duy with a very long article discussing some of the dynamics:
In essence, the Fed's ZIRP policy combined with stable financial markets once again makes the Dollar carry trade attractive. Since old habits die hard, this should "force" foreign central banks to accumulate Treasury assets - and it has.
It is almost as if foreign central banks know that the endgame of everyone's behavior is inflation, and thus avoid longer dated securities. Not a particularly comforting thought - but one consistent with the steady rise in the 10 year Treasury-TIPS breakeven spread.
The important point Duy makes later on (in his long list) is that the US is dependent on capital inflows. It sure is. And that means that if you have a set of monetary and political policies that make it hard to earn money in US dollars, or impossible to both earn and repatriate, you drive the dollar down. Duy goes on:
US labor market weakness appears inconsistent with a sustainable inflation dynamic; thus, rising oil prices simply cut into domestic demand. Thus, the Fed will be inclined to hold policy steady, rather than exacerbating oil driven weakness by tightening. Tightening policy would also reverse the evolving stability in financial markets and threaten a new credit crunch. And given the Fed's willingness to accept a benign view of the yield increase, they are not likely to increase Treasury purchases. Policy on hold. This may again have the side effect of putting relentless downward pressure on the Dollar. This is probably necessary to achieve further rebalancing of economic activity, but I suspect in the near term it will be disruptive. Alternatively, the dynamic could be reversed again by a new crisis that drove flows back to Dollars. There may be so much directionless liquidity flowing through the global financial system that it just starts constantly shifting here and there, looking for a home.
That is a wonderful description of what appears to be happening. First, the weaker the US dollar becomes, the higher oil and other commodities go, and the weaker domestic US spending becomes. But this is not an endless process, because eventually the rise in oil forces more money into dollars, thus swinging the pendulum back.

The problem here is not just the US deficit - it is the US trying to write mortgages at way below market rates with the coinciding need to shove 1.5 trillion dollars worth of yucky, unattractive debt somewhere. The US can continue to buy mortgages only as long as it can sell Treasuries at low enough rates to cover the eventual losses as well as the servicing expenses. But foreign, especially Asian, countries had until recently been buying a lot of agency paper and recycling dollars that way.

So if the Fed lets long Treasury rates rise, mortgage rates must rise, which will choke off US house price gains. Also, the cost of servicing the US federal deficit will shoot through the roof. That will leave Treasury with the option of printing money to buy Treasuries, or induce the need to massively raise taxes.

The solution is the opposite of what current US policy now is, because US current policy is focused not on saving the economy, but on saving banks. The US should let US agency paper rise until the market wants it. This will further push home prices down, but it will cause US domestic home demand to jump because there are a lot of people with money sitting and waiting for home prices to drop enough to make it worth their while to buy homes with their cash. As prices drop, their cash contribution is relatively more of the home price, and so the rise in interest rates means less to these potential buyers. This would break some US internal money out of its sitting cycle, and increase domestic velocity.

It would also attract external money as a capital inflow into the US. You may think that foreigners won't buy this debt, but they will if it is the right risk at the right price. I'd love to buy mortgage passthroughs in USD with weighted average CLTVs of 60% at 6.75%, or weighted average CLTVs of 70% at 7.5%. Anyone who looks at some of the Asian exchanges must see that the infusion of money is producing some real valuation oddities, and I am willing to guess that quite a bit of that money would jump in the boat with me.

As it is now, buying oil futures contracts are a great way to hedge losses against the decline of the USD, and there are an awful lot of interests which need to hedge against USD losses because of pre-existing exposures, which tends to suggest that oil buying will not end until oil prices rise enough to induce another round of global contraction.

So I don't think stagflation covers this situation. I think a more appropriate term would be negflation, in which negative growth is joined at the hip with rising fundamental costs which induce inflationary pressures on the spending power of consumers sufficient to reinforce negative growth.

Thursday, May 28, 2009

Rosy Headlines And Few Read the Data

We are certainly past the point at which the rate of contraction in the US economy must slow, but near to the end of the recession? Are people crazy?

Take the chipper headline about durables
Durable-Goods Orders in U.S. Increase More Than Forecast on Autos, Defense. The article appropriately points out that the decline is not even bottoming (i.e. private business investment is sure to keep slowing).

Here is the durables advance report. From my perspective, we have a long way to go to get back to zero. I place most weight not on new orders, but on the shipment/inventory ratios. Those are uniformly negative, such as fabricated metals. YoY YTD shipments have dropped 11.7%, whereas inventories have only dropped 5.9%. That's not as bad as primary metals. Computers and electronic products - shipments have dropped 18.7%, and inventories have only decreased 0.7%. Transportation equipment - shipments have dropped 19.7%, and inventories have increased 9.2%. Motor vehicles and parts - shipments have dropped 31%, and inventories have dropped 18.6%. No sign of improvement in new orders, which have also dropped 31%.

As I read through the April advance, I figure we've got months and months to go before we hit bottom. Machinery shipments are down 18.7%. Inventories have only decreased 1.6%. How about capital goods? Ouch! Shipments down 11.7%, inventories up 5.9%.

All right. Let's just hunt for green shoots in a different place. How about the weekly unemployment report? Nice headline there Initial U.S. Jobless Claims Fall in Signal Biggest Rounds of Firings Over. So what does that mean? Looking at the last three weekly reports, one sees that NSA initial claims have run 537,xxx, 570,xxx, 536,xxx, and oh, gee, 536,xxx this week. That is hardly an improvement, especially since the numbers from the previous week are revised up each week (first two numbers are the upwardly revised versions, the last two are the original). On an SA basis, continuing claims keep growing rapidly, having increased over 100,000 last week. On an SA basis, continuing claims are now double last year's. Insured unemployment rates have risen to 4.6% (NSA) and 5.1% (SA).

This time in May is the strongest point for employment in an off year. Schools have not yet let out, whatever construction oomph is going to happen has happened, and the summer graduates are not yet beating the bushes.

The chirpy article:
Fewer job losses reduce the risk that consumer spending, the biggest part of the economy, will falter, delaying the economic recovery projected for later this year. Still, companies will be reluctant to add workers and increase production until sales show sustained gains.

“The pace of job declines is lessening,” Mickey Levy, chief economist at Bank of America Corp. in New York, said in an interview with Bloomberg Television. “This along with some other indicators points to a trough in the recession.”
No one seems to be worrying about the impact from the Chrysler/GM summer shutdowns, but believe me, they will be there. Unemployment is still escalating pretty rapidly. I strongly suspect that we are near to another "shelf", in which another round of retail layoffs will take place this summer as stores give up the ghost, malls empty out and lose traffic builders, and seasonal hiring and traffic for vacation/summer recreational travel and spending just doesn't happen at the expected levels. Durations in recessions matter, as organizations struggle to stay afloat and exhaust their credit resources to do so.

And consumer confidence? Yesterday we were all bright and chipper about a consumer confidence report that was not very encouraging. The present situation index remains extremely low at 28.9:
Consumers' overall assessment of current-day conditions improved again. Those claiming business conditions are "good" increased to 8.7 percent from 7.9 percent. However, those claiming conditions are "bad" increased to 45.3 percent from 44.9 percent. Consumers' appraisal of the job market was also more favorable. Those claiming jobs are "hard to get" decreased to 44.7 percent from 46.6 percent in April. Those saying jobs are "plentiful" edged up to 5.7 percent from 4.9 percent.

Consumers' short-term outlook improved significantly in May. Those expecting business conditions will improve over the next six months increased to 23.1 percent from 15.7 percent, while those anticipating conditions will worsen declined to 17.8 percent from 24.4 percent in April.

The employment outlook was also less pessimistic. The percentage of consumers expecting more jobs in the months ahead increased to 20.0 percent from 14.2 percent, while those anticipating fewer jobs decreased to 25.2 percent from 32.5 percent. The proportion of consumers anticipating an increase in their incomes edged up to 10.2 percent from 8.3 percent.
Did you catch that? The number of people expecting the job situation to worsen is still above the number of people expecting the job situation to improve. Consumers are probably more hopeful because they are reading a bunch of hopeful headlines, but where it comes closest to their pocketbooks, they remain net negative.

As far as I am concerned, we crossed a Rubicon when Costco same store sales fell so sharply in the quarter ending May 10th (-7%). Things weren't improving at the end of the quarter either, because April same store sales were down 8%. This demographic comprises a group of people who do have money to spend on a discretionary basis, and have decided not to spend it. Small businesses aren't spending either, as the Staples results show.

My guess is that the Costco demographic has decided to pay off its credit cards, and that they are diverting several hundred dollars a month to that purpose. The implication is that summer vacation and recreation spending will be substantially constrained.

I am guessing this will start to turn when about another 100 billion falls off the consumer credit outstanding. Hopefully, that will happen this year, so I have the earliest positive month currently at November. That would have to come from consumers - there is no other place.

Every time another retail outfit shuts down, another load of surplus supply rolls off onto the market. Much of that surplus will be recycled back into the stores-still-standing and small business markets, further deferring an improvement in gross private domestic investment.

However, if fuel prices increase much more, there will be a big problem come the cooling season as consumers contemplate their expected heating costs for the winter and adjust their spending accordingly.

By the middle of next summer, I would say that consumers would have paid off enough consumer debt to begin spending. So I have the real turn under close-to-current conditions (excluding further federal tax increases) between 11/09 and 6/10. It won't be epic when it starts, either.

Further substantial negatives for the US economy:
1) Cars. The dealer massacres and the summer shutdowns are going to hurt some communities very badly.
2) Banks. We are nearing the point at which bank failures will really pick up, which means that local bank lending pullbacks will start to inflict a negative shock on small businesses. Until now, they have been a positive, but higher FDIC insurance rates, growing commercial/retail defaults, and higher and intractable consumer defaults will begin to cut into their ability to lend.
3) Fuel and utilities, but I don't know just yet how negative it will be.
4) Local and state tax increases. Inevitable, but badly timed.
5) Q1 09 shock as some consumers discover that their tax credits were overcounted, and they owe more to the IRS than expected.
6) Generally higher consumer interest rates. We are past our low for this cycle, and it is merely a question of how high they will go.

Internationally, the European bank situation is still a big deal and a decisive downward vector, and worries over the US dollar are real and growing.

PS: From the comments on CR's post on today's unemployment release, this observation from RockyR:
Moving on, recent conversations with CEOs of SMBs have turned from ones of "sales are turning the corner" to "oh my god, my credit facility just got yanked!". The unemployment story isn't over.

Wednesday, May 27, 2009

Listen to Yo' Mama

Friends, Romans, countryman! Here is how to lose your a$$ writing creditworthy mortgages, or shall we call it Bernanke's Folly?

For the non-financial types, the important thing to remember is that bond yields rise as bond prices drop. Bond market prices on existing obligations will rise and fall to conform to differences between the face rate between the older bond and current market rates at for the remaining term, as well as to account for the risk of loss. As price drops, yield rises. Naturally, investors want to receive more in the way of yield when the risk of loss rises.

Treasury Yields for May. An alert reader will note that the yields have risen 50 basis points each for the 7 year, 10 year and 30 year. The six month and the 1 year are still flat to lower than the beginning of the month. Article:
“The markets are starting to grapple with the issue of what happens when the Fed exits and the Treasury needs to continue at the same pace,” said David Greenlaw, the chief financial economist in New York at Morgan Stanley, one of the 16 primary dealers that trade with the Fed and are required to bid at government bond auctions.
And investors don't want to be holding long dollar-denominated debt at this time for low returns.

The other thing non-financial types should know is that mortgage bond yields are most often compared to the 10 year Treasury. The face term may be 30 years, but in fact most houses are sold or refinanced long before that. Mortgages that have adjustments inherent in them may have effective maturities far lower than ten years, though, and one of the reasons that the recent crop of "innovative" mortgages was so favored were that the mortgages were structured to prepay very quickly, so real duration was very short, and the spread between short-term rates on the mortgage bonds and short-term rates in the money markets was very high, thus profits were very high. (Until the losses arrived.)

But no matter how they are structured, when you fiddle the marketplace to push mortgage bond face rates artificially low, you are baking in future losses on those bonds. If the government is holding them, the taxpayer gets another turn bent over the barrel. For one thing, your expected duration extends, because people who are holding a substantially below-market rate mortgage do not refi. The payouts you get are from foreclosures and sales, and in this market that is where you expect to take your losses. So you are looking at short-term losses and long-term losses, and consequently an urge arises to leave the burning building before the exits are jammed.

So of course the Treasury and Whiskey Rebellion of 2009 is causing havoc in the mortgage market:
Yields on Fannie Mae and Freddie Mac mortgage bonds rose for a fourth day, after exceeding for the first time yesterday their levels before the Federal Reserve announced it would expand purchases to drive down loan rates.
“Market participants may be asking themselves the same question as Scorpio in ‘Dirty Harry’: ‘Do I feel lucky?’ ” Rosenberg, the bank’s head of credit strategy research in New York, wrote in a report yesterday, referring to a character in the 1971 Clint Eastwood film who may be shot.
Funny, that. But nobody's laughing, because as Treasury yields rise, the value of those mortgage bonds is collapsing. So people are running to the exits trying to unload those hunks of junk, which is pushing up yields quite quickly.
The difference between yields on Fannie Mae’s current- coupon 30-year fixed-rate mortgage bonds and 10-year Treasuries narrowed to 0.92 percentage point today, from as high as 2.38 percentage points in March 2008, according to Bloomberg data. The Fed’s purchases drove the spread to 0.70 percentage point, the lowest since 1992, on May 22. The yield gap jumped from 0.71 percentage point yesterday.

Many investors who felt MBS spreads were too tight thought it might be time to take chips off the table,” Credit Suisse’s Swaminathan said. “This is something we anticipated would build up” as many mortgage-bond holders who were previously wary of lightening their positions on the view the Fed buying would continue to support the market finally decided to act.
This was strategy doomed to fail. Always. The more the government buys of these assets, the more inflation expectations grow. It's like playing russian roulette with five of the six chambers loaded.

The lesson is that one should not mess with market rates for mortgages, because if you do, you create another round of financial instability.

What do you think of this?
7 year Treasury yield:
5/1: 2.72
5/27: 3:22 (+ 18.3%)
10 year Treasury yield:
5/1: 3.21
5/27: 3.71 (+ 15.6%)
30 year Treasury yield:
5/1: 4.09
5/27: 4.59 (+ 12.2%)
I see chaos and disruption.

One sees much written about the power of monetary policy, but monetary policy in the Greenspan era acquired an aura of invincibility that was unrealistic. Monetary policy only works when it is exercised within realistic boundaries and when it attempts to get out ahead of current trends, in other words, when monetary policy is exercised to get the market to change earlier to adapt to the expected future trend. That keeps market adjustments smaller, increases confidence, and reduces unexpected "events".

I still want to know why and how investors are supposed to buy mortgage bonds with no government guarantees in light of the fact that Congress or some Congressionally-authorized authority may just decide to change the rules on the investor? Why? Why would anyone do it?

The Shortest Democratic Revolution In History

Emanuel, o Emanuel:
"There is a growing awareness of the need for fundamental tax reform," Sen. Kent Conrad (D-N.D.) said in an interview. "I think a VAT and a high-end income tax have got to be on the table."

A VAT is a tax on the transfer of goods and services that ultimately is borne by the consumer. Highly visible, it would increase the cost of just about everything, from a carton of eggs to a visit with a lawyer. It is also hugely regressive, falling heavily on the poor. But VAT advocates say those negatives could be offset by using the proceeds to pay for health care for every American -- a tangible benefit that would be highly valuable to low-income families.
Low-income families don't pay for insurance now, much less health care. Why would they be in favor of this? Why would older Americans, who are receiving health care through Medicare, be in favor of this?

Imposing a VAT of 10% would surely eliminate another 7-10 million jobs over two-three years. A bunch more people wouldn't be able to pay their mortgages, so mortgage defaults would rise. Credit card debts, likewise. DTI, baby. DTI RULES!

I know how to solve the problem, but it would strike at a key Democratic segment (the rich), which is why they won't do it. You have to widen our tax basis, and there is only one way to do that.

DU looked at this and reacted pretty negatively. Another thread, just posted.

Tuesday, May 26, 2009

And Nastier Yet

Uggh. Went to do retail checks again today. It just keeps getting worse.

What an awful set of correlations. I feel like stabbing my eyes out with a rusty fork to stop the pain.

The worst of it is that I decided to check my sample sites (hoping that they were biased badly) against the Fed maps of bank card and mortgage delinquencies. They were biased on the high side. Shoot me! Just shoot me!

Next up I'll pull call reports, but this ain't looking good. The number of banks doomed to fail has to have risen to at least 500.

The remarkably dismal rail reports agree well with primary retail.

I have a number of really strong ways I know to measure economic potential over the next 16 months, but none of them come up positively.

Monday, May 25, 2009

Memorial Day 2009

Over 1.1 million American soldiers have died in wars (see some counts here).

The National Moment of Remembrance is at 3:00 PM local time today. Sixty seconds of silence for over 1 million dead? It doesn't seem like enough, does it? That's why I always give a donation to a veteran's group for Memorial Day in memory of those fallen.

You can spare 1 minute 19 seconds for Taps at 3:00 PM.

According to a Gallup poll in 1999, about 40% of Americans said Memorial Day was about honoring veterans, and another 28% were able to correctly say that the day honored war dead. 17% of respondents could hazard no guess at all. Seventy-three percent of Berkeley residents found the question so distressing that they threatened to sue for harassment. One of these statistics is made up, but you'll have to use the link to figure out which one.

Thirty-six percent of DU respondents are willing to subscribe to the notion that nationalism is a mental illness, so it's a good guess that they don't approve of Memorial Day either.

So educate a child today about the meaning of the day. It's not about we the living - it's about the dead. It's to say they mattered, which they did. Given that Memorial Day, once Decoration Day, started as a move to honor the fallen of both sides in the Civil War, it's striking that the day is somewhat politicized now.

Fisher Of The Fed On Monetizing Debt

WSJ has a long interview with Fisher of the Dallas Fed. You shouldn't miss it. It's a little lively:
His bigger concern these days would seem to be what he calls "the perception of risk" that has been created by the Fed's purchases of Treasury bonds, mortgage-backed securities and Fannie Mae paper.
"I think the trick here is to assist the functioning of the private markets without signaling in any way, shape or form that the Federal Reserve will be party to monetizing fiscal largess, deficits or the stimulus program."
A difficult trick, since that is what we are doing.
It conjures up images of Argentina. ... He has just returned from a trip to China, where "senior officials of the Chinese government grill[ed] me about whether or not we are going to monetize the actions of our legislature."
Fisher is quoted on the role of the ratings firms, past low rates, weak regulation, and the dangers of monetizing the debt. This is from his Kennedy School speech:
Throughout history what the political class has done is they have turned to the central bank to print their way out of an unfunded liability. We can't let that happen. That's when you open the floodgates. So I hope and I pray that our political leaders will just have to take this bull by the horns at some point. You can't run away from it.
We're running, but it's like those nightmare running sequences. We run and run, and we can't get anywhere. WSJ notes:
Voices like Mr. Fisher's can be a problem for the politicians, which may be why recently there have been rumblings in Washington about revoking the automatic FOMC membership that comes with being a regional bank president.
The next election should be interesting!

A careful reader may develop the theory that although Mr. Fisher volunteered to wear the Fed Inflation Hawk suit, his differences with FOMC policy are not that great. He states that inflation is not a risk, that deflation is a risk, and that the FOMC as a whole just will not tolerate inflation, which is a position that other Fed governors have not espoused recently.

So I think this is another strategic appearance of the Fed Inflation Hawk.

The text of Fisher's February 23rd Kennedy School speech is here. On April 8th Fisher gave a speech in Japan. On April 17th Fisher gave a speech in China.

Excerpts From The Japanese Speech:
In light of this, the Federal Reserve has assumed a dramatically proactive and highly innovative role in seeking to restore vibrancy in the credit markets while stemming economic decline. This is an unaccustomed thing for our central bank. Ordinarily, the men and women of the Federal Reserve are the most shy and modest of economic agents. We prefer to move incrementally rather than exponentially, and we have historically treasured conducting our deliberations quietly and away from the public limelight. But confronted with a dysfunctional financial market and an implosion in our economy, in rapid order we have undertaken a series of very visible and widely broadcast initiatives. Over a period of a little more than a year, we:

* Established a lending facility for primary securities dealers, taking in new forms of collateral to secure those loans;
* Initiated so-called swap lines with the central banks of 14 of our major trading partners, ranging from the Bank of Japan to the European Central Bank and the Bank of England to the Banco de México to the Monetary Authority of Singapore and the Korean Central Bank, to provide these foreign central banks with the capacity to deliver U.S. dollar funding to financial institutions in their jurisdictions. We also have put in place swap agreements with four of our counterparts—the Bank of Japan, the European Central Bank, the Bank of England and the Swiss National Bank—to enable the Federal Reserve to provide up to 10 trillion yen, 80 billion euro, 30 billion in sterling and 40 billion in Swiss franc liquidity to U.S. financial institutions as a reciprocal prophylactic measure;
* Created facilities to backstop money market mutual funds;
* Initiated new measures in cooperation with the Treasury and the Federal Deposit Insurance Corp. to strengthen the security of certain banks;
* Undertook a major program to purchase commercial paper, a critical component of the financial system;
* Began to pay interest on bank reserves;
* Announced we stood ready to purchase up to $100 billion of the direct obligations of Fannie Mae, Freddie Mac and the Federal Home Loan Banks, then increased that sum to $200 billion;
* Announced we would buy $500 billion in mortgage-backed securities backed by Fannie, Freddie and Ginnie Mae, then increased that sum to $1.25 trillion;
* Announced, and just recently fleshed out, a new facility to support the issuance of asset-backed securities collateralized by student loans, auto loans, credit card loans and loans guaranteed by the Small Business Administration, a facility which we have since stated we were prepared to expand significantly to other types of securities and beyond our originally planned $200 billion to $1 trillion; and
* Began the process of purchasing up to $300 billion of longer-term Treasury securities over the next six months to help improve conditions in private credit markets.

And, in a series of steps, the FOMC reduced the fed funds rate to between zero and one-quarter of 1 percent, a process which I supported once it became clear that the immediate inflationary tide was ebbing. Simultaneously, at the request of the 12 Federal Reserve Banks, and again in a series of steps, the Board of Governors lowered the rate we charge banks to borrow from our discount windows, so as to lower the cost of credit to the economy.

All of this has meant expanding the Federal Reserve’s balance sheet. As of today, the total footings of the Federal Reserve have expanded to roughly $2 trillion—more than a twofold increase from when we started in 2008. It is clear that we will grow our balance sheet even more as we complete our programs of purchasing longer-term Treasuries, expanding our holdings of mortgage-backed paper and purchasing larger amounts and different forms of asset-backed paper.

Fisher then goes on to address concerns raised by all of this innovation and asserts that the Fed will not tolerate inflation, and launches into an outright sales pitch for T-Bills:

And yet, let me remind you that over the past year since we began in earnest the process of using the new tools I have just articulated, the dollar has appreciated 17 percent against the euro and 29 percent against the British pound. Among the major currencies, the dollar has depreciated against only one currency, Japan’s, and by 2.4 percent.
Here are some numbers for you to contemplate: If a Japanese investor had purchased a three-month U.S. Treasury bill in March 2008 and rolled it over every three months until the end of this past month, the return would have been slim to none—about –1.4 percent. That is hardly inspiring. But, had that same investor purchased and rolled over a three-month euro-area central government bond, the investment would have resulted in a loss of 16 percent. A Chinese investor investing in euro bonds would have had the same experience. A Korean investor investing in the same manner would have earned a return of 21 percent in euros but would have earned a 42 percent return in won terms had he invested in three-month Treasury bills.
As to the future, the underlying math becomes more complex: The net new supply of Treasury debt is predicted to expand by $2.5 trillion in the current fiscal year, versus $788 billion in the last fiscal year and only $145 billion in fiscal year 2007.[7] All things being equal, this would result in a move upward in yield and downward in price, providing negative returns absent any foreign exchange factor. But all things are not equal. For starters, the problems facing the largest competitive currency, the euro, are perhaps even more substantial than those confronting the United States. I will point to Spain and Ireland as examples of euro-area economies that led the European pack on the upside and now are cascading rapidly downhill. In the case of Japan, you are as aware as anybody of the economic and fiscal and political predicament you are faced with; I will say no more. My point is that demand for Treasuries and other official paper of U.S. government issuers will be determined by their attractiveness relative to alternatives, and they may well be judged more, rather than less, attractive under most reasonable future scenarios.
Moreover, both the fate of budget imbalances and the potential for total returns earned by investing in U.S. securities depend on the efficacy of the fiscal policies Congress has advanced. These policies are designed to jump-start the economy while laying the groundwork for permanent structural reform. Time will tell if they achieve this multipurpose goal. If they do, they will engender economic growth and concomitant confidence in the fixed-income and equity markets for private securities. In addition, tax flows will be restored and confidence boosted in the path of deficit reduction envisioned by the current administration in its budget projections. If these policies don’t jump-start the economy, then I am confident that the reaction within fixed-income markets will force those with the power to tax and spend, the Congress, to readjust their fiscal policies.
You may or may not find that credible. I see no beginnings of an attempt to grapple with reality in Congress.

Excerpts From The Chinese Speech:
The men and women who operate our businesses and create and sustain employment have assumed an uncharacteristic defensive crouch. Confronted by dyspeptic financial markets, they are doing the best they can to preserve their margins by cutting costs (most significantly, the cost of labor), and running tight inventories, rationalizing supply lines, deferring all but the most necessary capital expenditures and, in general, avoiding risk. The result is an American economy in stasis. Presently, nothing is being ventured, and nothing is being gained.

Of course, not helping matters is the implosion of our export markets, which are vital to the growth of an economy positioned to sell high-value-added goods and services—as well as agricultural and other basic goods—to others. The World Bank is predicting that global trade will contract by 6.1 percent in 2009.[2] The WTO is forecasting a 9 percent contraction.[3] This will be the first time since the 1940s that we have witnessed such a deep and synchronized retrenchment of global economic activity, and this makes tougher the task of growing the U.S. economy.
Fisher then repeats the list of steps the Fed has taken, and moves on to discuss the risks (this part of the speech closely parallels the Japanese speech):
This expansion of our balance sheet has given rise to concerns that we may be:

1. Planting the seeds of future inflation; and
2. Setting the stage for a demise of the dollar.
First, with regard to the potential inflationary consequences of our actions: Our assignment is to conduct monetary policy so as to engender sustainable, noninflationary job growth. Presently, the risk is deflationary job destruction. We have undertaken measures to counter that risk. And we seek to do so in a way that will not ignite the embers of either a future destructive inflation or a debasement of our currency.

I have a reputation for being the most “hawkish” participant in the deliberations of the Federal Open Market Committee. I do not particularly like ornithological nomenclature—I would rather be considered a wise owl (and I certainly do not wish to be anybody’s pigeon). But I have a record that substantiates that “hawkish” reputation, having voted five times against monetary accommodation during the commodity-driven price boom of 2008. I consider inflation an evil spirit that rots the core of economic prosperity and must never, ever be countenanced. But it is clear to me that in this environment, inflation is unlikely to present a serious threat given the pervasive bias in the U.S. economy toward wage cuts and freezes, rising unemployment, the widespread loss in wealth that has resulted from both the housing and equity market corrections, continually declining consumption and business investment, and the anemic condition of the banking and credit system, all of which reinforce downside price pressures in a global economy groaning with excess capacity.

For as far ahead as I trust my forecasting ability[5] (that is to say, the next couple of years), the problem with regard to maintaining price stability most certainly is not inflation.

With regard to the fate of the dollar and the willingness of others to continue purchasing dollar-denominated debt, we realize that by purchasing Treasuries in volumes and of durations that are atypical, we are at risk of being perceived as monetizing the fiscal largesse of our Congress. And we are acutely aware that by intervening in the mortgage-backed securities and other markets that we are at risk of being perceived as blurring the lines between fiscal and monetary policy. We realize that this may give rise to some apprehension among large holders of Treasuries and agency paper such as your government and others in the Asian-Pacific region.
Fisher then moves on to give virtually the same sales pitch for Treasuries as in Japan. This post is long enough, so I will end. But I really want to address some of Fisher's comments in his February speech at the Kennedy School.

Saturday, May 23, 2009

Green Shoots Or Leafhoppers?

Leafhoppers are a class of insects which are plant vampires. They can do a lot of plant damage. When I look at T-Bill movements so far in May, I see leafhoppers.

The left points are the average yields by each term from 5/1 to 5/6. The right points are the average yields for each term from 5/19 to 5/22.

The 6-mo, 1yr, 2 yr and 3yr yields are all falling, which strongly implies that the market expects a poor economy over that time frame. The 5 to 30 yr yields are rising, probably as a result of worries over US debt.

You can see current and past treasury yields at the Treasury site here, or you can pull them from the Fed's H.15 archive. Treasury yields are, IMO, pretty accurate measures of the current projected real demand for future money. That doesn't mean that they are always correct, but it does mean that they are a very fundamental indicator. ing smaller CDs in banks all over the nation.

If you doubt this, check out the movements of the 3M, 6M, 1Yr & 2Yr from the beginning of 1990 to mid 1991. The 1991 recession is dated by NBER as beginning in July 1990 and ending in March 1991.

At the beginning of 1990, yields were close to flat from 3 months to 5 years. Needless to say, this indicated a problem.

By March of 1990, markets had come to a depressed decision that life sucked, and 3 month yields had dropped comparatively, 6 month and 1 year yields were bickering but hanging together, and a healthy break had developed on the 2 year.

By June of 1990, 3 and 6 month yields had converged, there was a weak step up at 1 year, and the 2 year remained a civic booster.

In December of 1990 a big argument developed, with a week by week slugout fest in which a flat to rising range over the 3, 6 and 12 month bonds was negotiated.

The big change came between February and March of 1991. During later February and early March, a consensus emerged that spreads between the 1 and 2 year should be about 50-60 basis points, and by the end of March, the spread between the 6 month and 1 year (12 month) had suddenly more than doubled, signalling the end of this recession. April opened up with a 10-20-70 pattern of spreads between the 3M, 6M, 1Y & 2Y.

Any time the stock market is "forecasting" something different than T-Bills, it would be wise to dump LEI in favor of the Treasuries. What is important is not just the direction but the relative movements of the various maturities, and if anyone looks at the movements of the near-terms so far this year, it's clear that an unfavorable change in expectations occurred from March to May.

Friday, May 22, 2009

Yes, Women ARE Born "That Way"

Hey bro, I think you better have a son to even up the sex ratio in your house. Here's what you're in for! (Work safe video.)

Now here's why women are born "that way":

The Chief told me on Wednesday that he made the appointment for his blood work 10 days out "to have a chance to clear things up". When I inquired as to exactly what that implied, he got huffy and stated with austerely patient dignity that he needed to eat very healthily for the next ten days. This morning he rejected a zinc/B12/C lozenge because it was "too sweet". "I'm worried about all that sugar," he said dolefully, causing me to wonder just how bad it could be if two grams of carbs are going to be a problem for his blood tests. (Not to mention the sheer idiocy of trying to schedule your blood tests so that the doctor can't tell what you are really experiencing.)

Then he came back at lunch with a banana nut loaf. Mind you, I had cooked him a low sugar, high fiber orange bread, but I can assure you it does not taste nearly as good as what he bought, because it has very little sugar and almost no cholesterol.

Banana Nut Loaf:
Per serving 1 slice
160 calories,
60 calories from fat
7 grams of fat
14 grams of sugar
23 grams carb
2 grams protein
25 mg cholesterol

He has already eaten one slice, and has 9 to go. 140 sugar grams later (he'll probably eat it all by Sunday), will he still be worried about the sugars in a zinc lozenge? Worse yet, if the doc gets on him about his blood work, will the Chief claim it is due to being force-fed zinc lozenges by a hysterical female?

See? We need all that breath control and stamina just to keep you guys alive. That little sweetie was just practicing. She was probably trying to explain the dangers of ice cream and fast food to her dad.

Right now I am laughing too hard to explain his math problem to the Chief, or the use of those helpful little nutritional labels. I don't believe men can use those labels, and it is probably a genetic condition related to most males' total refusal to ever balance their checkbooks.

Wednesday, May 20, 2009

I'll Be Offline For A Few Days

It's an alphabet soup problem.

In the beginning of the second week in May, FRB published a final amendment to Reg Z effective for dwelling secured consumer loan applications as of June 30th, 2009. It also moved up some provisions from an earlier Reg Z amendment that were supposed to be effective October 1st.

In the tragic world of home loans, virtually no system can be reprogrammed in less than two months, and most of the provisions here have to do with timing of disclosures, and the timing of redisclosures, and the resulting waiting periods, and knotty topics such as the definition of "business days", and when a disclosure is deemed to have been received by a consumer.

It should not be so difficult as the bankers are finding it, but it is. To make matters worse, some very reputable compliance firms screwed up and have put the wrong information out there.

So.... I'll be busy for a few days making a thingie to handle it, because I am NOT spending the rest of my life answering questions about this.

If you know what I am discussing here, my deepest sympathies. I can't see why the Senate wanted to add the rule about carrying weapons in state parks to the credit card bill. Why don't do they something RELEVANT and add a federal RTKB workplace/training rule for compliance officers any time two different definitions of the same term are involved in the rules for one disclosure requirement? We all know that's about what it takes.

As To Yesterday's Question

Contained in this post, the answer of course is energy pricing. The speculative jump on oil and other energy sources such as coal and natural gas produced the synchronized and very sudden drop in economic growth at the end of 2008.

The credit crisis began in 2007, but various liquidity measures prevented credit problems, as such, from directly impacting the real economy.

The responses were very good, although some of you were thinking about the future rather than the recent past. My point is that we need to be accurate about the recent past before developing future policies, and this is the critical gap I saw in Prof. Brock's explanation of what had occurred:
First, what exactly caused the worst credit crunch the nation has arguably experienced since the depression of the 1930s? Second, how did the downturn in the US morph into a collapse in Planet Earth's GDP rate from nearly 5% in June 2008 to -0.5% in winter 2009? Third, can traditional macroeconomic policy suffice to turn around the economy? More specifically, will a killer application of classical fiscal and monetary policy truly restore the economy to a stable growth trajectory? Or is there an internal contradiction within macroeconomic policy that could prevent it from succeeding this time around?

To explain the "perfect storm" in the credit market, we drew extensively on the new Stanford theory of endogenous risk to demonstrate that there are three jointly necessary and sufficient conditions to predict and explain the perfect storm we have experienced: (i) A mistaken market forecast of some exogenous event that impacts security prices (in this case, a vastly higher than expected default rate on mortgages); (ii) A high level of Pricing Model Uncertainty bedeviling bank assets (the true cause of the "toxicity" of those complex securities that have clogged the arteries of the banking sector); and (iii) An unprecedentedly high degree of leverage in the financial sector (money center banks had off-and-on balance sheet leverage of about 40:1 in contrast to the socially optimal leverage of 10:1). The reader can tack "greed" and "incompetence" onto this triad, although doing so diverts attention from the real causes of today's crisis.

To explain the collapse of economic growth worldwide in an astonishingly short period, we utilized a game theory model that explained how the cessation of inter-bank lending amongst the principal money center banks of the world precipitated the first known case of global credit market emphysema: The availability of credit dried up almost everywhere in the course of six months, from Auckland to Iceland. We stressed that this credit contraction had little to do with "globalization" as properly understood, and had no counter-part in history.
See, central banks aren't everything. Central banks (and especially the massive extension of dollar credit facilities led by the Fed) did do a great deal to keep the collapse in interbank lending, which really occurred in 2007, from causing further drastic problems. That is why we didn't see the break in economic growth until about 12 months later.

What broke the global economy was the rise in energy prices. That rise made quite a bit of trade unaffordable and massively increased the need for credit lines for exports and working capital. Ocean transport costs more than doubled over less than 8 months for quite a few routes.

So I disagree with the second bolded statement above, although I think the analysis and discussion of policy measures on the whole has merit.

Now the rise of oil prices was speculative in nature, and clearly not founded in an accurate assessment of the prices that the global economy could then absorb. The proof is that the global economy seized up and then imploded. To my mind, this procession of events also raises another very important question:

Did the massive flood of liquidity injected by central banks in an attempt to defuse the impacts of the interbank lending crisis end up causing some of the speculative run-up for oil and other commodities?

My guess is that it did. Maintaining the flow of money, in the absence of other investment vehicles, appears to have provided the fodder for a speculative party launched partly in the attempt to defray losses on the bad securities. It also may have funded the party of the shorts, which led to the suspension of short trading on major exchanges around the world.

Note that if I am correct, then some of our current problem was caused by liquidity and governmental response.

I would argue that the Chinese are now reproducing a similar trajectory with some of their policies. The massive flood of bank lending and the authorization of margin trading on their exchanges sure seem to me to have produced some bubble-types of trading. I'm not the only one who's noticed. If I'm right, the problems will start showing up in 2010 for the Chinese.

More on this later, especially your comments. I'm running ragged today.

Tuesday, May 19, 2009

CA Votes Tonight

Update: If you are in a depressed mood, CA fiscal policy is not the correct prescription. Instead, you need to read the funniest car review ever by Jeremy Clarkson at the Times Online. I picked it up (on the Honda Insight), over at Anthony Watt's. It's the first time I've ever seen someone describe a car's problems as "vast and cancerous", but it gets better:
So you’re sitting there with the engine screaming its head off, and your ears bleeding, and you’re doing only 23mph because that’s about the top speed, and you’re thinking things can’t get any worse, and then they do because you run over a small piece of grit.
If you do not read this auto review, you are really cheating yourself. I have never driven a Honda Insight, but I will probably do so in order to work this out of my soul before I collapse in helpless laughter the first time I encounter one on the open road. And yes, "hairy-shirted eco-ism at its very worst" is definitely on topic for this post.
End update.

I've been following some of the CA news over at Rob's. For example, see this recent post.

He did, after being begged, put up a brief summary of the resolutions and the expected outcomes.

I asked him some questions. Non-Californians have a stake in this. California has about 12% of the nation's population, and accounts for a higher proportion of GDP. As far as I can figure out, the state is busted.

Tonight's election seems likely to result in rejection of most of the proposals to at least narrow the gap. What happens next?

What happens to the muni bonds? The public unions have done very well in CA, but the retirements are beginning, the pension and medical funds were never adequate to cover their expenses (and have obviously taken significant losses), and barring massive reform efforts, it looks like a lot of folks won't be getting their CA tax refunds next year either.

For anyone who's living in a state east of the Mississippi, and feeling smug about this, don't bother. Rail data continues to show very significantly better YoY results for the west as compared to the east. The times are so bad we can't afford to laugh at the troubles of others.

Also, NJ is probably close to being in as much fiscal trouble as CA. The CA legislature does seem nearly unique in its semi-psychotic inability to begin addressing its fiscal woes. The idea of borrowing from the localities to offset the lack of lending available to the state government seems to warrant a forced hospitalization for a mental evaluation under the normal guidelines.

Oh, Could We Deal With Reality?

I would like to discuss some pretty important stuff that is a bit of heavy going. It relates to monetary policy, economic policies, social policies and the constraints upon all three. Neil, in particular, has asked a number of questions about US debt. Obviously Medicare and Social Security are in the news, as are energy taxes and universal health care. So this is topical, but it is not exactly beach reading.

As a prelude, I'd like to invite you all to drop in at Frontline and read this edition of the investor newsletter.

I think some important issues are discussed, there are some nice tables showing the effect of different debt and GDP growth scenarios, and I think the presentation is not deliberately obfuscated.

However, I would also like to invite anyone who reads this to go through until the graph with the three intersecting circles forming the US recession, and then stop and ask yourself "What is missing?" Because something very basic is missing, and it's something quite essential for future policy.

It's quite frustrating to read so many genuinely intelligent, hardworking and ultimately pretty successful analysts and yet find oneself wondering if they can collectively produce much useful guidance to government in the absence of a little more attention to detail.

I'll explain the glaring defect I see in this analysis later. I am extremely curious about whether readers of this blog also see it.

Update: Answer tomorrow (and so far I am impressed by the responses). But does anyone want to change his or her answer after contemplating these excerpts:
In our 2008 research programme, we focused on three issues. First, what exactly caused the worst credit crunch the nation has arguably experienced since the depression of the 1930s? Second, how did the downturn in the US morph into a collapse in Planet Earth's GDP rate from nearly 5% in June 2008 to -0.5% in winter 2009? Third, can traditional macroeconomic policy suffice to turn around the economy?
To explain the collapse of economic growth worldwide in an astonishingly short period, we utilized a game theory model that explained how the cessation of inter-bank lending amongst the principal money center banks of the world precipitated the first known case of global credit market emphysema: The availability of credit dried up almost everywhere in the course of six months, from Auckland to Iceland. We stressed that this credit contraction had little to do with "globalization" as properly understood, and had no counter-part in history.
Before extrapolating from the past to the future one must accurately examine the past.

Sunday, May 17, 2009

Swine Flu Goes Pandemic

Update: Japan up to 120 odd cases, expects case count to reach at least 130. One bank employee has tested positive in Hyogo and in that branch all non-essential employees will be asked to work from home for a bit. 39 Osaka reported cases. Most of the cases confirmed so far are in Kobe. The likely candidates here for transmission vehicle into the country are ships. Anyone want to give a guess how long until this explodes in the floating ships-at-large fleet outside Singapore? From there, all of Asia. Also, the Netherlands reported a PB2 gene change in one case a few days ago. From what I've read, the current PB2 is avian, which may account for the warm-weather spread. End update.

That's pretty much it. Japan is up to 78 cases and thinks it will be reporting quite a few more. So that's the official stage six - community level in more than one region. The new pandemic stages were released in draft form last year.

People are currently underestimating this. In the Americas, where this has been running for a few months, the flu continues to spread at a time when normally flu activity is dropping quickly. The Japanese wave, currently detected in multiple high schools in multiple towns, is another counter-trend breakout.

The recent concern and attention had shifted to the southern hemisphere, which is heading toward their peak flu system. To have another emergence in the northern hemisphere at this time raises the stakes.

In "bad" flu seasons, the US can see 10,000 - 15,000 more deaths than normal. In pandemics, one could easily see 50,000 or more extra deaths even if the virus is not particularly lethal because of the higher penetration rate in the general population. If an extra 10-15% of the population gets the virus, that's an extra 30 million or so cases. The US is currently up to 5 deaths and the CDC estimates that half the flu cases in the US currently are swine flu. The US is seeing an unusual rate of flu at this time of the year, but quite a bit of it seems to be due to crappy weather. Global cooling strikes again. However, over half of subtyped A virus samples in week 18 were swine flu.

In terms of economics, it looks like swine flu will be a drag through 09/10. I think it is going to be much more of a problem for the emerging countries, but it may knock as much as a quarter of a percentage point off US GDP over next winter. That's assuming, of course, that the virus stays in its current form and that nothing nastier emerges. The virus appears to be pretty fixed right now, but one never knows. Even having one of these out there circulating in tandem with the normal flu strains greatly raises the probability of multiple crossovers, the regular flu shot becoming less effective, and more probability for individuals of getting sick from flu twice in one season.

Currently swine flu is a risk to pregnant women, probably young children, and anyone with health vulnerabilities.

I don't believe for one moment that this new swine flu just emerged a few months ago. It's too fixed and adapted.

So it's time for US citizens and businesses to ramp up on the old preparation thingie. There's nothing here to get hysterical about, but parents need to think how they'll handle daycare issues, especially in light of the high probability of a lot of schools closing next year, and businesses need to figure out manpower issues that may cause them problems. Individuals with higher risks need to contemplate their own personal risk control measures.

Friday, May 15, 2009

We Could Not Control Our Mad Craving For Arugula

After further reflection, I think that the NY Times has, as usual, shown us the way forward. We will blame the following results on Europe's sincere commitment to healthy living:

Eurozone Q1 GDP -2.5%. YoY: -4.6%.
EU 27: Q1 GDP -2.5%. YoY: -4.4%
(Note: a quarterly drop of -2.5% equates to an annualized drop of 9.63%)
Industrial production YoY (as of March) (ex-construction):
Eurozone: -20.2%
EU 27: -18.8%
Retail sales YoY (as of March)
Eurozone: -4.2%
EU 27: -3.1%
Q1 GDP: -1.2%. Annualized -4.71%
Q4 GDP was revised down to -1.5%.
Q1 GDP: -3.8%. Annualized -14.36%
Q4 GDP was revised down to -2.2%.
Germany and France are the biggest EU economies. See further notes on Germany below.
Q1 GDP: -2.8%. Annualized -10.74%
YoY: -3.6%.
Q4 GDP: -0.4%.
See further notes on Austria below.
Q1 GDP: -2.4%. Annualized -9.26%
YoY: -5.9%
Q4 GDP: -2.1%.
Q1 GDP: -1.8%. Annualized -7.01%
YoY: -2.9%
Q4 GDP: -1.0%

Notes: The EU's rather sharp drop is bearing far more heavily on manufacturing and export-led economies. For example, as of January 2009, Finland's YoY GDP had dropped 9.8%. When recovery comes, these same economies will be the first out unless they are pulled down by debt problems.

Germany: Germany's household debt and government debt are still low. Of most concern in Germany is commercial debt. German businesses tend to rely on banks for more of their capital than businesses in many other countries. The Bundesbank's April Lending Survey showed that commercial lending standards were still tightening and spreads were widening. The Bundesbank publishes a monthly report which is very good, and in their last report, they noted that consumer spending had been successfully stimulated in the first quarter. Thus the -3.8% is a disappointing result. The report also noted that Germany had experienced far more of a drop in export orders for the area outside of the EU. The rather disappointing Q1 EU results would tend to suggest that there is further to drop on the EU orders. Given weakening consumer spending and EU order expectations, it is hard to see the second quarter as very good, and the earliest hope for a return to growth is probably 4th quarter. There is a tremendous amount of commercial debt in Germany that is maturing and must be rolled over this year, and after these results, I think the German government might need to step in and help with some of it.

Austria. Austria. What can one say? Austrian bank and credit union (Raiffeisen (both a generic name for credit-union like institutions and the name of a major financial) lending to consumers, businesses and countries in eastern Europe has created an awesome risk profile for Austria's banking sector. This is a cash-flow issue.

The case of the Eastern European countries is interesting. Consider Poland. Current estimates are relatively optimistic for 09, but with direct investment halved, export orders dropping and much higher debt payments looming, I cannot see it. Poland is the EU's seventh largest economy, but it seems to me that there are sharp limitations as to how long a deep European slump can run before the accumulated effect of foreign currency loans, currency devaluation and associated CPI increases, the industrial slump, and the sharp retraction in FDI cause a much sharper downturn. So this is now a race against time, IMO. But current estimates are that the Polish economy grew in Q1.

Poland is still the star of Eastern Europe. Hungary is contracting sharply (-5.8% on the year in Q1, quarterly GDP estimated at -2.3% or an annualized -8.89%. The Czech Republic is in similar but slightly better shape. However Q1 was supported by the cash-for-clunkers deal in Germany, and Q2 could be considerably worse. Again, the crucial factor is time, and no, this is not "unexpected":
"The Czech economy has sharply slowed down unexpectedly," said Helena Horská, an economist in Raiffeisenbank in Prague.
The -3.4% in Q1 is a YoY estimate. Analysts with a little more distance are now projecting -3% in 2009. We'll see. Czech imports and exports are down about 20%.

Bloomberg's Eastern European summary is worth a read. Then consider Raiffeisen International's Q1 results:
At the same time, the banks said its provisions for non-performing loans, mainly in Ukraine, Russia, Hungary and Serbia, rose by 379 percent year-on-year to -445 million ($605 million), up from -93 million ($126 million) during the first quarter of 2008.

"In the wake of the economic downswing and the currency situation, there was a significant increase of overdue loans in the first quarter of 2009, especially in the case of foreign currency loans, which meant provisions had to be increased sharply," Raiffeisen said in a statement.
It is hard to see precisely where this will end, but the sharp constriction in credit implied indicates that expected recovery trajectories in many of these countries might be quite disappointing, and that property values may fall for some time.

Wall Street Journal published an excellent article on this topic - read it quickly while it's free, if you don't have a subscription. Since about half of the banks in emerging Europe are owned by old European banks, the problem is not confined. Current chargeoff rates on loans in quite a few EE countries look more like credit card default rates than loan loss rates. The problem is very large and deeply significant to the European Union as a whole. Growth in Europe over the last decade has depended heavily on growth in these countries.

Either credit in these countries is sharply constrained, which would inevitably lead to massive collateral devaluations and a sharp retraction in internal growth, or Europe as a whole must greatly expand temporary funding to these countries and even some support of consumer credit in these countries. We are now seeing the leading edge of the problem.

Thursday, May 14, 2009

Yuppie Subprime: A Personal Story By A NYT Reporter

Update: Before you read the article, start up the soundtrack - Robert Palmer's "Simply Irrestible" "The woman is invincible... She's a natural law...The trend is irreversible... She's so fine, there's no telling where the money went."

Reading this made me feel weird. It should have been titled "We're all subprime now":
The icy slap of reality hit me two weeks after New Year’s Day in January 2005. We had been living in our new house for five months. I walked out of The Times’s Washington bureau, several blocks from the White House, and crossed Farragut Square to my bank. I had a bad feeling about what the A.T.M. would reveal about my balance, but I was shocked when I looked at the receipt: $196. We were broke.
Two more refis and over 50K of CC debt later, they are losing the house. It's as if this couple just OD'd on every easy credit gimmick of the 2000's:
The key was the overdraft protection — more accurately described as “bounced-check loans.” Every time I overdrew my checking account by even a few dollars, the bank would tap my MasterCard for $100, helpfully deposit the cash in my account and charge me $10 for the privilege.
My suspension of (dis)belief thingie broke when this was described as "unwittingly" tapping into their credit. If you are not making enough money to live on and pay the mortgage, which they knew they weren't when they bought the house, and if you don't balance your checkbook and figure out how to live on the income you have, there is nothing unwitting about it.

The timeline is something like:
August 2004: Buy house with no-ratio mortgage. (No income verification, no DTI computation.) This is necessary because the new wife just moved out to join the author of the article, she wants a house, they decide she "will" find a job, and they both blithely ignore the fact that he pays 4K a month in alimony and child support, leaving him with less than 3K a month take-home.
January 2005: Checking account drained - they were living partly off the sale of his NYT stock.
April 2006: 50K of CC debt? Huh? The wife had found a job for 60K annually by November 2005, and had found a lower paying job earlier. He had about $50 a week for walk around money after paying the mortgage and his alimony. How did they rack up 50K of CC debt in 16 months?
June 2006: Cash out refi with Fremont (classic subprime indeed) paying off CC debt.
October 2006: Refi again, this to get out of subprime interest rate mortgage (they'd paid off their CC debt and their credit scores had risen again). I'm guessing there were car loans and so forth in there that aren't mentioned. Mortgage was about $700 more a month than when they'd started.
October 10, 2006: The wife loses her 60K job. So here I am thinking, well, what's this about the closing - the final refi? Did they know about her job loss when they signed the papers, and what type of mortgage was it? Were they using both incomes? The way the article is written, you come up with the idea that these people had a while between the last refi and the wife's job loss, but that doesn't square with the dates.
May 2009: They are now 8 months behind on the mortgage, and they have called about a modification. Needless to say their servicer hasn't called back, because these people will not pay the mortgage no matter what happens. Giving a mod to this couple would be insane. He has written a book about the whole thing, and I guess they are banking the 2.5K mortgage payment each month to pay off other debts and their current bills so they can continue to live.

The good news: They are still together.
The bad news: They haven't hit the really bad part yet. They are going to lose the house, and once they lose the free rent, they're really going to be in trouble. This couple cannot jointly work out a budget and live within their income, and they appear destined to be lifelong trailor trash unless they hie themselves to a counselor and learn how to navigate this difficult topic. I am guessing the book is the latest bright spot on the horizon allowing them to ignore their underlying problem.

Let this be a lesson to all of you with spouses who cannot control their spending. That's an issue that has to be fought out, and the earlier the better. Life is pure hell when you are always sliding down the hill on a greased slide of your own making.

Sorry About That

I commented out Haloscan to see if it would take care some of the issues. The old Blogger comment system is functional and unmoderated for current posts. Please read that. I will let this stand for a couple of days to see the effect and then make a decision.

If anyone has tried JS-Kit and had good luck with it, let me know.

On employment: This week's initial claims report was negative due partly to seasonal adjustments. However, the seasonal adjustment really isn't that skewed. Officials said that part of the upward jump in initial claims was due to the Chrysler problems, but they did not say how much. Regardless, the Chrysler and GM problems are real and will result in long-term unemployment jumps. The prior week's initial claims were also revised upward.

Current NSA continuing claims stand at 6,166,785 versus the prior year's 2,845,952. That is an increase of about 3,300,000 - more than double. Initial claims rose by 27,856 on an NSA basis, and 32,000 on an SA basis. We are a long way from a turn in employment. I'd hope for a slackening in the rate of increase, but unemployment probably will continue to increase for another year. I think small businesses and service industries will continue to shed jobs for some time to come. There will also eventually be a cutback in state and local government employment, and that will slowly build.

There were a few comments I wanted to make about the monthly employment report to put that in perspective. And this is for you, Mark.

First, the error bar on the monthly household survey and the calculated unemployment rate is very high. Straight from the technical notes:
For example, the confidence interval for the monthly change in total employment from the household survey is on the order of plus or minus 430,000. Suppose the estimate of total employment increases by 100,000 from one month to the next. The 90-percent confidence interval on the monthly change would range from -330,000 to 530,000 (100,000 +/- 430,000). These figures do not mean that the sample results are off by these magnitudes, but rather that there is about a 90-percent chance that the "true" over-the-month change lies within this interval. Since this range includes values of less than zero, we could not say with confidence that employment had, in fact, increased.
The BLS survey is a very high quality survey, but all such surveys have their limits. The household survey is quite volatile month-by-month, and that is because of the broad survey 90% confidence range in comparison to the actual changes reported. Quarterly results are far more certain. A two-month result could give a higher degree of certainty.

Given that temporary employment agencies were reported quite negatively last month in the establishment survey, and that the number of long-term unemployed rose, and that retail employment was reported down again, I'm a bit skeptical. Hopeful, but skeptical. We know there was substantial Census hiring over the last few months, but unless the B/D model is overly negative at this point, it's hard to see how the total number of employed could have risen anywhere close to that much.

Having written that, I do think that number is likely to be close to true. I think the B/D model is underreporting financial/credit intermediation employment in April. But that's only a guess, and it should be taken as such.

Any marginal improvement in the total number of employed this spring is likely to be swamped by the knock-on effects of the Chrysler/GM fiasco this summer, and the likely effect of state and local government job attrition is due to snowball over the next year. This is an absolutely huge segment of total jobs.

For an excellent look at the situation in the government jobs market, please see Rebecca's post on the topic.

Wednesday, May 13, 2009

Don't Cry For Me, Argentina.....

Crude inventories: US crude up 17.6% compared to a year ago. Total stocks up 12.6%. Total product supplied for domestic use YTD -5.7% compared to YTD 08.

March business inventories
: Inventories down 1%. Green? No, because sales were down 1.6%, yielding this:

I understand the desire to inject a little optimism into the economy, but the danger of doing it too soon is that you get sideswiped by reality and lose credibility.

Fisher of the Dallas Fed logged some Green Shootz dissent yesterday:
"I think it'll be sometime in 2010 before we get to positive growth," he said in an interview Tuesday with the editorial board of The Dallas Morning News. "I hope we punch through to positive territory this year. I'd be surprised if we do. There's still a lot of uncertainty out there."
Or worse, the wrong kind of certainty - the kind that makes businesses pull back further on spending plans. Fisher had better watch out, or he will be voted the Fed Inflation Hawk at the next FOMC meeting, which would be a dire punishment indeed in these circumstances.

The Chinese recovery meme seems a little impaired lately. For one thing, an IMF official suggested that China should look to its loan loss reserves:
China’s policies to revive economic growth, including a 4 trillion yuan ($586 billion) stimulus package, are fueling lending for infrastructure projects rather than boosting consumption, Kotegawa said in an interview in Beijing.

“I’m afraid that will not change, and those investments could be a source of non-performing loans,” he said. “The Chinese government needs to set aside financial resources to address that issue.”
China is probably pulling back on its lending right now a bit, because some internal officials have been saying the same thing. However, with estimates of real Chinese unemployment running over 9%, and with an expectation that the credit money pump flow will slacken, and with the news that April Chinese exports fell far more YoY than March exports (-22.6 vs -17.1%), one is hesitant to call a bottom.

India is still moving downward. Here's a pretty comprehensive Times of India article. Industrial production fell 2.3% in March, largely due to a 33% fall in exports. Plenty of sources are predicting an industrial output pickup in April, but here's the worrisome stat:
The contraction in March has been mainly on account of a 3.3% fall in the manufacturing sector's output, which accounts for nearly 80% in the IIP. However, the main worry is the steep contraction in the output of capital goods by 8.2%. DK Joshi said that this clearly suggested that industry is not investing in the plant and machinery, which will impact the future growth. During the year as whole, the output of capital goods decelerated to 7 per cent from 18 per cent a year ago. Therefore, he said, the recovery will be slow.
That capital goods stat is also very bad for foreign high-end manufacturers, such as Germany and Japan.

If April Chinese exports were still falling, it's a bit difficult to forecast much of an improvement for India's. Trying to make up even a 25% drop in exports with infrastructure is extremely difficult. Industrial production figures in India will likely be revised upward, because electricity output in March rose 6.3%. However the exports figure is probably pretty good.

I've been following a blog about Indian retail pretty closely. The retail environment is still tight. Reliance is converting some of its stores to a discount grocery format.

In March, Japanese exports were down 46% plus on a YoY basis, but rose on an SA basis from February's exports. As it stands, Japan's current account balance is now very dependent on external earnings, and both exports and earnings are threatened if SE Asian conditions continue to worsen. This is a race against time. Background article.

In general, SE Asian countries do seem to have been helped by the Chinese stimulus plan, especially if their Chinese exports are concentrated in resources and commodities rather than lower-end manufacturing. So, for example, Indonesia's economy has done better relatively and is expected to do better relatively than Malaysia or Singapore. Asean Five. However all of them are being hit, and internal consumption drops could set up a nasty second-order effect before too long.

One thing in particular has unnerved me. For most of this spring, Japanese analyst chatter seemed to have been focused on Chinese activity, and the hope was that China would bail them out. Lately I am reading more along the lines of "waiting for Europe and the US". But consumer demand in both Europe and the US is still slowly weakening.

German March retail sales fell again, and April's Bundesbank report radiates a decisive note of grim accuracy. See page 7 in which they point out that the first quarter was worse than the previous quarter, which, at a seasonally adjusted -2.1%, was bad enough. They also note that the drop in fixed investment was partially offset by domestic consumption stimulus, leaving the implication floating in the air that there's another round of pain there.

Germany has better recovery trajectory hopes than many other nations. Compared to Japan, the UK, the US, Germany has low household debt and low government debt. Australia has very low government debt but has household debt problems. Japan has a huge government debt. The US is shooting for top gun status on both government and household debt, and the UK appears to be trying to edge out the US. (We will not discuss Spain and Ireland, because it would be equivalent to mocking a man on his deathbed.) Not only does Germany have the low-debt advantage, Germany has been on an upward cycle in its general economy. Yes, unemployment is rising, but overall employment levels compare favorably of those to even a few years ago.

Even with all of these relative positives, I cannot see how Germany's prospects are all that good for most of 2009. The relative impact of unemployment is rising even as the consumer stimulus is fading out, and that stimulus can't be repeated. The impact of increasing layoffs and decreasing investment is going to be a drag in second and third quarters. With capacity utilization at 76.2 in the first quarter, declining prospects for international sales, and a generally weakening Euro market (which was the bright spot for Germany in early 09), it's hard to project a real turn before late 09 at the earliest. That leaves Japan hanging.

The US is inflating when most of the actual stimulus to consumers has come from the effects of deflation. It might be time to rethink this strategy.

It would be hard, however, for the Fed to pull it off. The next appearance of a Fed official in the Inflation Hawk suit will have half the members of the audience believing it's an SNL skit.

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