Thursday, July 31, 2008

July 31, 2008: GDP growth slow; Employment Costs unchanged; Unemployment Claims jump

1. Gross Domestic Product for Second Quarter (Q2 Advanced report)
Expectations: +2.3% growth
Previous (Q1): +1.0% growth
Revised (Q1): +0.9% growth
Today’s release (Q2): +1.9% growth

The report came in below what economists had expected, but nevertheless, markets improved. The Advanced estimate of GDP includes six components: Consumption of durable and nondurable goods, Investment (residential and nonresidential), Government spending, Exports, Imports, and Changes in inventories. Consumption, government spending, exports, and imports all added (were a positive contribution) to economic growth. Investment and changes in inventories subtracted from economic growth – inventories drew down growth a whopping -1.92%, its largest subtraction from growth since Q2 of 2005.

A closer look

Economists will be looking at the future reports of Q2 GDP when more data is available. Not all of the data are in; exports, imports, inventories, consumption, and government spending are all out for June, and in some cases, for May. I will be paying close attention to the exports, imports, and inventories numbers, as they will likely determine the direction of the revisions to Q2 GDP that are released on August 28.

A note on revisions

As I explained, GDP goes through a long revision process. In this release, all of the GDP numbers were revised downward since January 2005; specifically, growth for Q4 2007 was revised down to -0.17% (a contraction) from +0.6%. As I still believe we are skirting a recession, revisions to GDP may tell a different story later on. Certainly the labor market is suffering with 6 straight months of job contraction.

2. Employment Cost Index (Q2)
Expectations: +0.7%
Previous (Q1): +0.7% growth
Revised (Q1): unchanged
Today’s release (Q2): +0.7%

The Employment Cost Index (ECI) is a quarterly index that “measure of the change in the cost of labor, free from the influence of employment shifts among occupations and industries.” It is broken down into wage and salary growth, and benefit costs growth. This month, wage and salary growth slowed to 0.7% from 0.8% due to reduced bonuses and commissions in the financial and housing sectors stemming from the credit and housing crises that have enveloped the U.S. economy over the last year. Benefit costs were unchanged at +0.6%.

A closer look

Economists will pay close attention to future ECI reports. They will be looking at the Q3 and Q4 reports to see if recent inflation pressures (higher prices) are passing through to worker compensations (wages, salaries, and benefits). If wages start to rise, the Fed will have a 1970’s-style inflation problem. I expect that the slowdown in economic growth will keep inflation pressures in check for the ECI and the CPI (consumer price index, used to measure inflation).

A note on revisions

Revisions to this series are mostly based on seasonal factor adjustments (trying to smooth the series over the year), and have not been revised significantly since last year.

3. Initial Unemployment Claims (week ending July 26)
Expectations: 393,000 new claims filed
Previous (7/19): 404,000
Revised (7/19)): unchanged
Today’s release (7/26): 448,000

Unemployment claims jumped +44,000 today. That means 44,000 more workers lost their jobs and filed for unemployment insurance in the week of 7/26 than they did the week before. This is a weekly series, and one should look at a longer-term trend. The 4-moving average jumped also by 11,000 new claims filed.

A closer look

This is not a positive sign for the August payroll numbers. The payroll report (for August, will publish on September 5) shows the difference between jobs added and jobs subtracted (net job growth). The initial claims report only gives half of the story, job subtraction, but that side of the story is certainly problematic.

A note on revisions

This series is revised weekly, and usually revised upward. Claims reports for the week often come in after the weekly number is published. Those late reports are back-counted as an upward revision.

Please leave comments. Best, Nontruths

Wednesday, July 30, 2008

Wines by the glass? I’ll send it back

I was reading my international headlines, and found an interesting article in the Globe and Mail, a Canadian Paper. The article, Wines by the glass? I’ll pass, caught my eye; well, because it is about wine! It addresses the quintessential issue of ordering just a glass of wine: Who knows when the bottle was corked?

If the bottle was opened an hour ago, you are in the clear. If it was opened the night before, then you run the risk of drinking a nice glass of vinegar. A quote by the author, Beppi Crosariol:

“The risk to unsuspecting drinkers is especially acute early in the evening, when half-empty bottles from the previous day's service are circulated for a second go-round, just like Saturday's unsold salmon repurposed as Monday's fish cakes (and shrewdly accompanied by a strong tartar sauce to mask any odours). Who, after all, is going to complain?”

As an economist, I will most definitely complain! I have many times done one of two things: (1) asked for a taster of the wine (they never say no, by the way), or (2) sent a bad glass of wine back to the bartender and asked for a fresher glass (again, they never say no). It’s all about marginal cost and marginal benefit (the ultra economic terms put here in real-life circumstance).

What is the marginal benefit of drinking the glass of wine? Well, I am a white wine drinker, so it is a combination of two things. A well-infused sugar mecca, plus the barbiturate feeling only alcohol can instigate; the combination is superb - only if the glass of wine is a freshie.

What is the marginal cost of drinking the glass of wine? If you get a tasty glass of wine that exudes no characteristics of being old, then it is simply the price of the glass, let’s say $8/glass. If you don’t get that freshie taste, then the marginal cost rises.

The marginal cost of the non-freshie glass of wine = (a) price per glass + (b) the pain of drinking a bad glass of wine. Cost (b) is the opportunity cost, where the pain of drinking the bad wine is defined by how delicious the alternative wine (the sent back and improved glass) would be.

For me, the marginal benefit > marginal cost each and every time that I have encountered a “bad glass of wine,” and I always send it back. Don’t be afraid, people, Economics demands that you send back the glass!

Please leave your comments. Best, Nontruths

Major economic data released on July 30, 2008

ADP Employment Survey (July)

Expectations: -60,000 jobs cut
Previous (June): -79,000 jobs cut
Revised (June): -77,000 jobs cut (an upward revision by just 2,000 jobs)
Today’s release (July): +9,000 jobs gained

The report was well-received by markets. The ADP survey was initiated in 2001 and is a privately funded survey of nonfarm payrolls in the private sector. Historically, it has been used to forecast the official government employment report that is released by the BLS during the same week. However, during 2008 the ADP private payroll survey has not predicted well the BLS private employment report; the ADP survey has underestimated job losses by an average of 104,000 jobs per month over the last six months.

A closer look

According to the ADP survey, the BLS’ report for July, which is released on August 1, will show a gain of 30,000 jobs; the 9,000 gain in private sector jobs (the ADP report for July) plus 21,000 gain in government jobs, which is the six-month average. We will see.

I personally side with the ADP report and expect just -1,000 jobs lost in July – a far cry from the consensus report of -72,000. Why? Industrial production rose during the month of June (and I expect that it rose in July) and the 4-week average of initial unemployment claims fell during the survey period ending July 12.

Tuesday, July 29, 2008

Major economic data released on July 29, 2008

1. S&P Case/Shiller index of home values Composite-20 for May
Expectations: -16.1% since last year
Previous (April): -15.3%
Today’s release (May): -15.8% since last year

The report was well-received by markets. A tenuous slowdown in price declines may now be at hand. On a month-to-month basis, housing prices declined less in May (-0.8%) than they did in April (-1.4%).
As seen in the chart, the rate of decline is slowing, and given that this trend continues, prices may (and I would like to emphasize the work may) have hit a bottom.

A closer look

Home values are starting to rise in some parts of the nation. Boston, Charlotte, Dallas, Denver, and Portland (5 out of 20 urban areas) saw at least two consecutive months of increasing home values. The data are not seasonally adjusted, and rising prices may simply be a function of higher spring demand in housing. However, this is a stark improvement over February’s release when home prices declined in all of the 20 urban areas.

Beware: This index is lagged by two months, and does not represent current market conditions.

Notes on revisions

This data is not revised.

2. Conference Board’s consumer confidence index for July
Expectations: 50
Previous (June): 50.4
Revised (June): 51
Today’s release: 51.9

The data shows a slight improvement in confidence. It is likely that waning gas prices (now $3.96 national average, down from $4.06) are improving consumers’ moods. This is the first improvement since December, while its competitor, the University of Michigan consumer sentiment index, saw two consecutive monthly improvements.

A closer look

Consumers remain quite gloomy in July with no significant increase or decrease in confidence. However, consumer outlook improved since last month. Business conditions are believed to be better next month by a rising, but still small, percentage of surveyees. The number of respondents that expect fewer jobs increased since last month; conditions in the labor market are looking bleak.

Notes on revisions

This is a preliminary result and will be revised next month. The June number was revised up from 50.4 to 51.

The Federal Reserve Bank’s policies are changing

Recent negative shocks to the housing, oil, and credit markets have forced the Fed’s hand, and in response, its policies are changing. The Fed developed three new policy tools that have curbed the financial crisis that peaked in March. The Fed will move toward an inflation target over the next five years. And finally, current and future policy will be based on headline, rather than core, inflation.

Ben Bernanke was sworn in as the Chairman of the Federal Reserve’s Board of Governors on February 1, 2006. One wonders whether he would have taken the job if he’d known the mayhem that would take over the U.S. economy in 2008. Over the year, the U.S. has been subject to the strong and negative forces of record oil prices, precipitously declining home values (wealth), spikes in gas prices, and a credit crisis that continues to elude stabilization. It is truly resilient to grow an expected 2.4% in the second quarter of 2008 (GDP growth in Q2 at an annualized rate) amid the turmoil that besets us.

Some say that the fiscal stimulus is the catalyst for the recent resilience. That is certainly true. Without the fiscal stimulus, Q2 growth may very well have been 1% (or worse, -1%) rather than the expected 2.4%. But that is not the whole story. The Fed has taken action to target the specific problems at hand. Because of innovative Fed policy, the U.S. economy has not suffered a deep and prolonged recession.

New and innovative Fed policies helped liquidity

Losses mounted from assets linked to bad mortgages, and banks needed to raise funds quickly. However, lack of transparency in bank balance sheets caused the flows of monies from lender to lender to halt and liquidity dried up. In response to the liquidity problems, the Fed doubled the number of policy tools available to it to aid the suffering banking sector directly.

The standard tool used by the Fed, Open Market Operations (lowering interest rates), would not have been effective in tackling the liquidity problem. The Fed saw this and changed its policy tools accordingly; it created 3 extra programs to allow a wide array of banks access to short-term funds at the Fed’s discount window (where banks borrow from the Fed). The new programs are:

Term Auction Facility (TAF) – allows lending using a wider range of collateral to banks; it is a substitute to interbank lending (federal funds market or the Libor market).

Primary Dealer Credit Facility (PDCF) – provides loans to primary dealers (investment banks that deal with the Fed on a regular basis), rather than just to the depository banks, with proper collateral.

Term Structures Lending Facility (TSLF) – provides loans to all financial entities (any bank, not just primary dealers and depository institutions) to access loans with proper collateral.

Since the peak of the credit crisis in mid-March 2008, these innovative programs have allowed for some general relief in the banking system. Liquidity is still dry, but flowing much more freely than it did in March.

Fed policy is changing to include explicit inflation targets

Inflation has been on the top of the Fed’s worry list, and I see the Fed’s objectives are changing in two ways:

1. The Fed will move toward an inflation target within the decade.
2. The Fed is likely to put more emphasis on headline inflation, rather than core, inflation when making policy decisions.

The inflation target

Globally, central banks are moving toward targeting inflation, or keeping inflation around 2%. Under an inflation target, a central bank will raise or lower interest rates if inflation moves away from the target. The Bank of Canada, Bank of England, European Central Bank, Reserve Bank of Australia, Bank of New Zealand, and other developed economy central banks, target inflation explicitly.

Inflation targeting is in stark contrast to Alan Greenspan’s era of discretionary policy: using policy to obtain stable prices and maximum sustainable growth, and whichever is currently at higher risk, the central bank will put emphasis on correcting that problem. Currently, inflation has accelerated to 5.2% (and is expected to continue) and growth is struggling; under these circumstances, discretionary policy can be a nightmare. The Fed must make a choice, and that choice has a price – the good-old Phillips Curve.

Ben Bernanke is a strong proponent of an inflation target. An inflation target is easy for the public to understand and sets a clear objective for the Fed. The Fed has already made efforts to become more “transparent” by offering its economic forecast at every other monetary policy meeting.

Members of the Fed have been outspoken in their support of an inflation target. Governor Frederic Mishkin, a voting member of the Fed’s monetary policy committee (at least until August), expressed his strong support of the inflation target:

“By establishing a transparent and credible commitment to a specific numerical inflation objective, monetary policy can provide a firm anchor for long-run inflation expectations, thereby directly contributing to the objective of low and stable inflation…. Thus, the establishment of an explicit numerical inflation objective [inflation target] can play an important role in promoting financial stability as well as the stability of employment and inflation….More broadly, it should be noted that central bank transparency contributes importantly to democratic accountability and economic prosperity.”

Point: an inflation target is the best method to anchor inflation expectations and find stability in current economic conditions (financial markets, employment, inflation, and growth).

Headline versus core inflation

As Gov. Mishkin indicated, a “firm anchor for long-run inflation expectations” is the key to maintaining low and stable current inflation. I have stated before my beliefs that energy price inflation will subside, and that core and headline inflation will converge. Thus, if the Fed tightened too much now, then the economy will suffer excessive unemployment and falling income.

However, if energy price inflation continues to rise, then headline inflation will further rise relative to core inflation (total inflation minus energy and food price inflation). Consumers will change their expectations over how future prices will change.

Governor Charles Plosser, President and CEO of the Federal Reserve Bank of Philadelphia and a voting member of the Fed’s monetary policy committee, argues that it is difficult to keep inflation expectations in check when consumers and firms are seeing energy and gas prices rise precipitously. If it were just the prices of, let’s say tractors that were rising quickly, then inflation expectations would not be in jeopardy. But it’s not. Energy is a key expenditure for most families, and surging energy prices can have a profound impact on inflation expectations – even while the prices of all other goods remain quite stable.

Governor Charles Plosser expressed his support for targeting headline, rather than core, inflation:

“Since energy price increases have been so persistent in recent years, I do believe more attention should now be paid to measures of headline inflation in setting monetary policy.” Note: This is a great speech to read for a nice introduction to core versus headline inflation.


The Fed: It is a changing.
Recent shocks to the housing, oil, and credit markets have forced the Fed’s hand. In response to these shocks, the Fed developed three new policy tools that have curbed the financial crisis that peaked in March.
The Fed will likely move toward an inflation target over the next five years.
Current and future policy will be based on headline, rather than core, inflation.
Please leave comments. Best, Nontruths

Sunday, July 27, 2008

Revisions to Macroeconomic Data: Do the initial releases tell the story?

From my email inbox or your comments: You ask and I respond. Aunt Jane emailed me the following question:

“Just thought of something.... The government (and other groups) come out with monthly/quarterly reports on different aspects of the economy like the jobs report, inflation, etc. Then, the next month they have a retake on the report and finally have a third take at it. We seldom get those last two revisits which can change the numbers drastically and the final call is benign or positive. Can you do a report on the reports and how much can we trust the initial ones? I used to be able to get it from Tom Sullivan when he was in Sacramento but, now that he is in NYC and has his own Fox Business show, I can't find them. Thanks for considering this.”

Is this (the picture) what you would expect from a U.S. labor market that has slashed 438,000 jobs since January? Many macroeconomics statistics are subject to large revisions - upward and downward.

Many of the most closely followed statistics, like employment or gross domestic product (GDP), are revised two to six times since their initial releases. Therefore, any individual following the statistics should be weary to put too much stock in any one initial release.

How much can we trust the initial releases? If the data is subject to revision (not all macro data are), then the initial release is a good indicator of the general trend. However, the data will change during the second or third revisions, so one cannot trust the initial release at all. One should not trust the initial release except to provide some insight in the general direction of the economy.

Data that are followed closely by the financial markets and the media:

GDP: an estimate of total domestic income/production that is released by the Bureau of Economic Analysis (BEA). It is subject to 3 consecutive revisions: Advanced, Preliminary, and Final, 3 annual revisions performed in July, and finally, 5-year revisions. Over the revision periods, the data change substantially.

Employment data: nonfarm payroll data is released monthly by the Bureau of Labor Statistics (BLS). It is subject to 3 consecutive monthly revisions, annual revisions, and some irregular revisions.. Over the revision periods, the data change substantially.

Consumer Price Index (CPI): is the data used to estimate inflation that is reported by the BLS. It is not subject to revision.

Industrial Production (IP): Industrial production and capacity utilization estimate production in the industrial sectors, mining, manufacturing, and utilities that are reported monthly by the Federal Reserve Board (Fed) and subject to 6 monthly revisions and annual revisions.

Personal Income (PI): Personal income and consumption expenditures are released monthly by the BEA and subject to 6 months of revisions, and the same revisions as in GDP (used to measure GDP).

Other data followed by the markets, trade (exports and imports), new home sales, surveys (e.g., University of Michigan consumer confidence survey), or even housing data (e.g., existing home sales), reported by the National Association of Realtors, are all subject to revisions. Non-revised data are few, and the revised data often are underreported in the media.

Employment data is subject to heavy revision

Nonfarm payroll employment continued to trend down in June (-62,000), while
the unemployment rate held at 5.5 percent, the Bureau of Labor Statistics of
the U.S. Department of Labor reported today”

That statement must be taken with a grain of salt, as the data will be revised two more times (1st release, 2nd release, and 3rd release). Since 2000, the absolute value (meaning everything is a positive number, or +62,000 for June) of the 3rd (final) nonfarm payroll release was on average 135,000 jobs. The average revision from the 1st release to that 3rd release was 44,000 jobs, ranging from 1 to 152,000.

One should expect that the initial release is trustworthy anywhere between +/- 152,000 jobs.

GDP data is subject to heavy revision

GDP data is one of the most important series reported: it tells us the value of overall production, and is used to measure economic growth. There are three successive releases of GDP growth: Advanced, preliminary, and final. The advanced estimate is usually released one month after the current quarter’s end.

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 1.0 percent in the first quarter of 2008 (that is, from the fourth quarter to the first quarter), according to final estimates released by the Bureau of Economic Analysis.“

Again, this statement must be taken with a grain of salt. Dennis J. Fixler and Bruce T. Grimm in 2002 find the following relationships between successive GDP revisions:

On average, the revision from the advanced release (1st) to the preliminary release (2nd) is 0.55%. That means, if the BEA estimate of Q2 GDP growth is reported at 2.5% (released this week), then the preliminary estimate (the second estimate) may be 3.05% or 1.95%. Note: the quarterly growth estimates are annualized; the quarterly GDP growth is converted to an annual growth rate.

On average, the revision from the preliminary release to the final release is 0.28%. The data are revised further annually, and then every 5 years with up to 1.1% change in the initial release.

One should expect that the initial release is trustworthy in the long term, but only in the range of +/- 1%. Compared to the average annual growth rate between 1983 and 2000, 3.6%, 1% is a significant revision.

Why is the data revised?

1. In the short run, the BLS and the BEA do not have all of the data when the reports are released. The BLS continues to gather payroll surveys after the end of the survey period (the 12th of the month), and the BEA gathers data that is released later than the advanced estimate. For example, trade data (used to estimate GDP) is released two months later than many statistics, and so the BEA has to wait until August to get the June trade data (still part of Q2), which is after the Advanced estimate of Q2 GDP has been released.

2. Seasonal factors change. Most data is adjusted for seasonal variations. For example, stores always hire new employees over the Christmas months; the BLS removes these seasonal factors so that the data can be compared across months. Seasonal factors change over time, and the data must be revised. According to the BEA, seasonal adjustments are the largest contributors to GDP revisions.

3. In the long run, the BEA and BLS may change their methodologies for estimating employment and GDP. Those changes are incorporated as revisions to earlier series.

In the end, what you see is what you get.

I take the initial release as an indication of the current trend (improvement or reduction), but wait until the second, or even third release, to attach any economic meaning to the number. Policy makers certainly wait until the final release numbers when making decisions on their policy moves.

Unfortunately, most revised data (except for GDP) is not reported in the widespread media; It is up to you to monitor the revisions.

If you would like, I can monitor the revised data for you and include it in my blog. Just comment below or float me an email if this is something that you want to see on a regular basis.

Please leave comments or suggestions. Best, Nontruths.

Thursday, July 24, 2008

Fannie and Freddie: House passes bill….in bullet points

House Approves Sweeping Effort to Help Housing is the reaction of the New York Times. Today, the House of Representatives passed a major housing bill worth…..well, that price tag has not yet been written.

The straw that broke Congress’ back was the imminent collapse of Fannie Mae and Freddie Mac, and the bill was put on the fast track. Some sell this bill as a bailout of the GSEs (government sponsored entity), but it is really much bigger than that. Billions and billions are on the table. With home values expected to fall through 2008 and foreclosure and mortgage delinquency rates at record highs, Congress moved both quickly and too hastily to pass this sweeping regulation bill.

The bill as passed in the House is:

1. An overhaul of the regulation of Fannie Mae and Freddie Mac.

This is long overdue. I argue, in Fannie Mae and Freddie Mac: Trouble doesn’t stop at $25 billion, that these two giants are grossly undercapitalized. They accrued duopoly profits (just two firms in one market) for decades (since 1968 when Fannie Mae was privatized), and the Office of Federal Housing Oversight (OFHEO) was not doing its job in regulating the two giants.

2. A permanent increase in the limit of conforming loans from $425,000 to $625,000 in some markets.

Fannie Mae and Freddie Mac, and their lower mortgage rates, were shut out of high-priced markets (a.k.a., California). Those who wanted a loan in excess of $425,000, no matter their credit rating, would be subject to a jumbo rate (usually a higher interest rate). Buyers in higher-priced markets will now be able to qualify for the low Fannie and Freddie loan rates.

I say, why have a limit at all? Spanning the years 2005-2007, Fannie Mae and Freddie Mac, and really the whole mortgage industry, was approving loans to anybody that appeared to be human. What does a limit really matter? Shoot, Roman, my cat, could have acquired a loan during that period, and he earns no income at all!

As long as the persons acquiring the loans are not subject to regulation, mortgage companies will always find a way. The incentive, profits, says that they will.

3. The Federal Housing Authority (FHA) will be able to insure up to $300 billion for homeowners in risk of foreclosure.

I would much rather see the U.S. government provide real-estate education with this money (actually, it would probably cost much less) so that home buyers are better informed when they apply for mortgages in the future. Why toss money at those who made a bad business decision in the first place?

Eventually, potential homebuyers and banks will pay attention to economic conditions. Prices will fall to levels where buyers can’t resist and banks are comfortable making the loans. No government-sponsored program will change that fact. Eventually, the housing market will rebound and the U.S. will be $300 billion further in the hole.

4. Funds summing to $3.9 billion will be allocated toward local governments to buy and rehabilitate foreclosed homes.

Tossing money into the wind…that’s what I say; I totally agree with Bush on this one. What can $3.9 billion really do? The federal government cannot simply put flowers in front of several homes in Stockton, CA and expect homebuyers to line up for a bit of the action.

If you really must spend the money, why not offer $50,000 in education scholarships for 68,000 lucky and talented American high-schoolers? At least that will provide a social benefit to the rest of the economy!

5. Roughly $15 billion in tax incentives – including a $7,500 tax break for first time buyers.

Sorry, if you bought your home last year, you don’t qualify.

6. A higher credit line extended to GSEs (a.k.a., Fannie Mae and Freddie Mac).

If Fannie Mae and Freddie Mac needed more than Congress says that the Treasury can loan, do you really think that the Treasury would say no? Enough said.

Mark my words, this bill will come back to bite us later on.

Please leave comments. Best, Nontruths

Wednesday, July 23, 2008

Fannie Mae and Freddie Mac: Trouble doesn’t stop at $25 billion

Fannie Mae and Freddie Mac: Two iconic firms that drive the mortgage market are in distress. The housing market is under and will continue to suffer duress, and the Fannie and Freddie debacle is serious, but the government will of course back the two giants if either were to become insolvent.

To that avail, the House of Representatives is voting on a bill to rescue Fannie Mae and Freddie Mac. The bill includes Secretary Paulson’s recommendations for a “bailout”, but certainly represents the old saying, “too little too late.” Fannie Mae and Freddie Mac have been subject to low standards relative to private financial firms, holding just barely enough capital to stay afloat. The government entity in charge of monitoring the mortgage giants, the Office of Federal Enterprise Oversight (OFHEO), has not done its job.

If home values do not stabilize soon, the U.S. Treasury may be forced to loan an obscene amount of capital to Fannie Mae and Freddie Mac, or to nationalize the firms all together.

The euphemistic calculations

According to the Congressional Budget Office (CBO), there is less than a 50% chance that the two mortgage giants would access the lines of credit approved by Congress to recapitalize their balance sheets. However, if the Treasury is forced to bailout Fannie and Freddie, it will cost $25 billion (to the taxpayers, of course). Further, there is a 5% chance that the cost of the bailout could total $100 billion.

I say, if it costs $25 billion, then let’s do it and move on. The sum of $25 billion is certainly a lot of money, but the Fed and the Treasury are used to tossing billions out on a whim.

The Fed loaned JP Morgan $28 billion to aid the buyout of Bear Stearns. The Federal Government sent out rebate checks totaling $114 starting in May 2008. $25 billion is pittance compared to the $1 trillion in estimated financial losses stemming from the U.S. mortgage market.

Now the euphemism is over

However, the delinquency rates on mortgage loans are high and rising, and Fannie and Freddie could be in much more trouble than the $25 billion CBO price tag.

The fare value market capitalizations of Fannie Mae and Freddie Mac are around $10 billion $5 billion, respectively . If Fannie Mae’s assets value dropped to zero (including mortgages), then it would have $11 billion to cover its financial obligations (liabilities). Um, problem.

As of Jan.1, 2008, Fannie Mae’s liability value was $839 billion, and $10 billion, or 1.3%, is not enough to cover the continued rising foreclosure rate as house prices fall through 2008 and into 2009. As long as home prices are falling, Fannie Mae and Freddie Mac are grossly undercapitalized.

According to the NY Times, Fannie Mae and Freddie Mac own $1.5 trillion in mortgage securities and home loans. Approximately 4% of all loans are grossly delinquent (90 days or more late), and that means losses of roughly $60 billion, or about $45 billion short of Fannie and Freddie’s current capital value. Since home values are expected to decline into 2009, delinquency rates will likely rise, and losses could be higher.

My point is that we could be in trouble here, and the price tag for a bailout may be largely excessive of $25 billion….perhaps too much for the government to bear. One option is that they could simply take on Fannie Mae’s and Freddie Mac’s troubled balance sheets and nationalize the mortgage industry. The media obviously does not deem this an option, since “bailout” is the only reported choice. But at least if the firms were nationalized, the taxpayers would own not just the liabilities (bailout) but the assets as well.

The key to recovery is home prices. As they start to stabilize, the outlook for Fannie Mae and Freddie Mac will turn from dismal to hopeful. But whatever the outcome, these giants need to be reigned in with more capital oversight.

Please leave comments. Best, Nontruths

Tuesday, July 22, 2008

Economic topic survey: What do you want to read about?

I look to you, my ardent readers, for your input. What is it that you want to know about?

I see that many of you search for information regarding currency issues. Is there another hot topic that is just burning in your head – some economic current event that you are just dying to hear about?

Comment below (or send me an email at with your questions or topics of interest. I will address them over the next week!

Best, Nontruths

Monday, July 21, 2008

Gay Bishop blames America for his woes

You know, between today’s multiple earnings reports and the headlines regarding Obama’s scavenger hunt in the Middle East, I was left with no blogging inspiration.

Don’t fret - I remembered an interview that I heard this morning while I ran around Pleasure Bay in South Boston (picture). My running show, the Takeaway with Adaora Udoji and John Hockenberry, interviewed Gene Robinson, New Hampshire-based gay Bishop. It was an interview that could have been inspirational, but ended in a tone of resentment and anger.

Beware: There is no economic content in the blog whatsoever!

Gene Robinson was the first openly gay man to be made Bishop in the Episcopal Church U.S.A. in 2003. At his consecration ceremony, Gene Robinson said: ''It's not about me; it's about so many other people who find themselves at the margins. Your presence here is a welcome sign for those people to be brought into the center.''

In the same article, the Archbishop of Canterbury, Rowan Williams released the following statement:

''The divisions that are arising are a matter of deep regret; they will be all too visible in the fact that it will not be possible for Gene Robinson's ministry as a bishop to be accepted in every province in the communion,'' the archbishop said in his statement. ''It is clear that those who have consecrated Gene Robinson have acted in good faith on their understanding of what the constitution of the American church permits. But the effects of this upon the ministry and witness of the overwhelming majority of Anglicans particularly in the non-Western world have to be confronted with honesty.''

Clearly, there is some contention between the gay Bishop and the international Anglican community. I am certainly not opposed to Gene Robinson’s being gay, but to fight the church on this one? I am not really seeing an upside. But he did, and he is.

Five years later, he is still being punished for his sexuality. His name was left off of the Archbishop’s invitation list to the Lambeth Conference that takes place once every ten years.

  • It is my opinion, as you will see below, that Gene Robinson has become hardened and resentful – not the humble or bubbly personality that is typical of a man of Christ.

Gene Robinson's interview on the Takeaway

I am not a stenographer, so I will do my best here. But you can hear the morning’s interview, “Sex in the Church,” on the Takeaway website. Start on time stamp 14:50 for the July 21 show. I will add my own commentary in blue between the italicized interview of John Hockenberry, a truly offensive reporter, with Gene Robinson, the first “openly gay man made Bishop.”

John Hockenberry: Is there some personal dimension to not being invited to Lambeth? Some tactical reason for doing that? Have you become a distraction??

Gene Robinson: I think that the Arch Bishop had it in mind that if he were to not invite me then he might win the participation of the most conservative elements of the Anglican Communion…ah, in fact that did not satisfy them and they are boycotting the conference anyway….ah, it, it does seem some times to us that the s-called traditionalists um can never quite get enough to be satisfied, and yet I’m here to witness to the joy I know in my life because of following Jesus Christ and if that is an affront to people, then it will just have to be.

I really don’t understand the point of him being on the show. From my understanding of Christianity, God says to turn the other cheek. Shouldn’t he simply be happy that he can worship God as a Bishop? More below….

Oh, in other words: Yes, I am a distraction.

John Hoceknberry: Do you think the splits that came following your consecration were inevitable and based on issues more demographic, linguistic, and ethnic than sexual and if so, how do you reach out to these groups that feel so alienated from the mother church?

Gene Robinson: I think this controversy started quite some time ago and I would date it certainly with the American church’s beginning to ordain women. Um the same people who were unhappy about that are unhappy about me…uh, I also think that in terms of the international ub, ub rowe (sp???, don’t know this word) of this, I think we have to understand that some, at least some of this energy behind it is comes from America’s place in the world right now…uh, in many parts of the world America is seen as a kind of drunken cowboy swaggering around the world and everyone else be dammed..and, and I think um there were there were people in the communion who saw my consecration as just another example of America doing America’s thing and so this is uh the it may seem like a simple uh controversy on the surface, but in fact beneath it are many issues.

No, Gene, I assure you that Archbishop of Canterbury, Rowan Williams, does not think that it is a simply controversy.

In fact, Gene Robinson never answered Hockenberry’s question about reaching out to “these groups.” Before he was saying “It's not about me; it's about so many other people who find themselves at the margins.” Now he is blaming it on Bush and America’s reputation around the world. It sounds tacky and not becoming of an Anglican Bishop. He is clearly angry.

John Hockenberry: Well, uh Bishop, thanks so much for joining us and that’s a very interesting uh sort of depiction of the complexity. I never really thought to put it in those terms, America uh slash this sort of sexual issue being about our sort of swaggering reputation in the world. It’s really quite interesting……….

Why John, do you try to make the man sound credible? It was a bitter and resentful remark, unfounded in any religious context. I am not fooled.

I do apologize for this completely non-economic discussion today. However, I was simply appalled that this interview was broadcasted nationally. Shouldn’t the Takeaway be more concerned with other issues, like how Denver is planning a vacation for its homeless during the Democratic convention?

I am happy to hear your comments. Best, Nontruths

Sunday, July 20, 2008

Americans and other nations are in debt, but it's not the banks' fault

The article, Given a Shovel, Americans Dig Deeper Into Debt, inspired me to look at international saving rates. All I hear about is how Americans dissave and Europeans are the big savers. In fact, Americans are in good company in the club of overindulgence.

The New York Times reports that Diane McLeod, like many other Americans, has amassed quite a hefty sum of debt. According to the article, “back-to-back medical emergencies threw her over the edge.” The article goes on to blame the lending practices of Citigroup, Capital One, and GE Capital for coaxing her into living outside of her means:

“Years of spending more than they earn have left a record number of Americans like Ms. McLeod standing at the financial precipice. They have amassed a mountain of debt that grows ever bigger because of high interest rates and fees.

While the circumstances surrounding these downfalls vary, one element is identical: the lucrative lending practices of America’s merchants of debt have led millions of Americans — young and old, native and immigrant, affluent and poor — to the brink. More and more, Americans can identify with miners of old: in debt to the company store with little chance of paying up.”

Financial negligence is not the banks' fault

The sob story is overwhelming. The article’s lead picture shows Diane McLeod talking on the phone, supposedly with her creditors. Also in the picture are the following:

- Diane’s fashion magazine that likely cost $5
- A pack of cigarettes that cost at least $5
- A Yohoo retailing $2 at the local convenience store
- A fourth of a $3.33 12-pack of Coke
- 3 ashtrays – clearly, she spends a lot of time smoking on the deck
- A Starbucks frappuccino that cost at least $2
- A local magazine that is not open to the job ads

Grand total for all of the crap on her table is at least $20. Is this the spending behavior of a woman who cares about her debt? Eventually she will just declare bankruptcy and move on. Then her bad habits will pose a cost to others.

Contrary to popular belief, Americans are not the only ones with low saving rates

The American personal saving rate (saving as a % of income) was just 0.4% as of March 31, 2008; that means for every dollar earned, the average American saved just 0.4 cents! Oh man, we really are bad.

However, what the American media does not tell you is that we are in good company. There are key developed economies that also have rock-bottom saving rates:

- Australians save just 0.5 cents of every Dollar earned
- Canadians save just 2.8 cents of every Dollar earned
- The Brits save just 1.1 cents of every Pound earned

In fact, the chart below shows that personal saving rates have fallen significantly for these countries – America is not alone. To be sure, however, there are countries with high saving rates.

Yes, the Germans are frugal

- The Germans save 11.2 cents of each dollar earned.
- The European Union countries save 10.60 cents of each dollar earned.
- Most Southeastern Asian countries, China, Malaysia, Singapore, Japan, are big savers.

With record gas and food prices, eventually consumers may cut back and save a little for the future. But for now and like our neighbors in Canada, we still buy Yohoos and cigarettes…living day to day.

Please leave any comments. Best, Nontruths

Saturday, July 19, 2008

Do Not Enter: US housing market still under duress

The collapse of the housing market is the main centerpiece of the U.S. economic duress. What originally was a crisis limited to sub-prime lenders has turned into a full-fledged financial panic. Home values have declined 15% since last year, U.S. household wealth fell 2.9% in 3 months, -257,000 construction jobs have been slashed since June 2007, and the Dow recently hit levels not seen since 2006. This could all change if the housing market would just rebound.

Others say that the path to recovery is afoot…

In the article, On the Path to a Housing Rebound, Shawn Tully argues that the housing market is on a path to recovery:

“The news that housing starts have fallen to their lowest level in 17 years sounds like one more reason to be depressed about the shrinking value of your home. In fact, it's an almost certain sign that the path to a housing recovery is finally in sight.”

In sum, he argues that as affordability rises (falling prices and interest rates), new buyers will get into the market and drive down the supply of homes for sale. Prices will start to rise, new homes will be built, and “things will get better.”

Others note that the onslaught of sub-prime lending has slowed in 2007. “Looking forward, this correction suggests a future mortgage and housing market that will be much better than today's.” This may be true, but the future mortgage market is still a long way off.

…But that path is long and windy

I see a housing crisis that is far from over. It is certainly relieving to see that sub-prime mortgage lending has been curtailed, and that the Federal Reserve Bank took action to reduce questionable lending practices. However, home prices are falling at unprecedented rates and according to the Fed, “house prices seem likely to continue to fall well into 2009”. There is simply too large and still growing a supply of homes for sale to predict any near-term recovery in the housing market.

Some data is encouraging. Home sales (pending, existing, and new) are down significantly over the year, but the rates at which they are falling is falling. As home prices fall and interest rates stay low for historical standards, affordability remains high. And according to many, buyers will not be able to ignore the 15%-off sale on housing. They will swoosh in and save the day.

Other housing data paints a very dreary picture. According to the Mortgage Bankers Association (MBA), mortgage delinquency rates (% of mortgages that have not been paid for 30, 60, or >90 days) have precipitously risen to their highest levels in 40 years. There are a rising number of prime and sub-prime customers that are simply not paying their mortgages.

The graph below shows the total delinquency rates for all mortgages, prime mortgages, and sub-prime mortgages (the data for prime and subprime start in Jan 1998). As expected, sub-prime delinquency rates skyrocketed as prices started to fall, but the sub-prime borrowers are not alone. Prime delinquency rates are concurrently rising. Customers with bad credit scores and those with good credit scores are walking away from their responsibilities….the mortgage.

As if that wasn’t bad enough. Banks are having difficulties unloading the delinquent properties, and vacancy rates have risen to unprecedented levels. Even with rock-bottom prices, the customer base in the housing market is seriously short; there are not enough homebuyers to keep up with the rate at which delinquent properties are coming on the market.

Given these troublesome statistics, it is hard for me to imagine how the housing market is going to recover in 2008. The delinquency and vacancy rates need to fall in order to see a dent in the reduction in the supply of housing.

Don’t forget the light at the end of the tunnel

Don’t’ worry, it’s not all doom and gloom. As long as there are bigger markets to counteract the struggling housing market, the U.S. economy will survive as the housing crisis runs its course. Exports are growing over 4 times the rate of the U.S. economy and are 3 times more important to U.S. economic growth than is total housing. Export growth alone can easily compensate for the negative economic impacts from the housing market. Good thing is that export growth is expected to remain strong with continued weakness in the value of the U.S. dollar.

A little bit of advice: If you own a home, stay in it and pay your mortgage; if you are buying a home, buy now for the good of the economy, but maybe wait a little while as home prices will likely fall further; if you are underwater (higher mortgage than your home is worth), well, you are not alone.
Please leave comments. Best, Nontruths

Wednesday, July 16, 2008

Inflation is surging, but it is too early for the Fed to respond

The Federal Reserve Bank of Boston (left building) is a great building. Notice how it towers over the main train station in Boston, South Station (immediate right of the Fed building). This picture represents monetary policy in the United States.

The latest economic data has been quite dreary. June’s employment report showed 62,000 in job loss, retail sales slumped to 0.1% growth, where higher gasoline prices were the only reason that it was positive at all, and overall economic growth came in at just 1% in the first quarter. It seems like everybody is calling a U.S. recession!

Today, the June inflation report was released. Headline inflation (the rate at which measured prices at the Bureau of Labor Statistics change) is up 1.1% over the month, and that is its highest level since 2005. Energy prices rose another 6.6% over the month, and food prices jumped 0.8%. If you are like the Fed and place a lot of stock in core inflation (headline inflation minus food and energy inflation), it rose 0.3% over the month. All in all it sounds quite gloomy, especially for the U.S. central bank, the Federal Reserve Bank. Why? Because weak economic growth + inflation = Fed nightmare.

The Fed’s goal

Inflation was already on the Fed’s radar. Yesterday, the Federal Reserve Chairman, Ben Bernanke, testified to Congress:

“Given the high degree of uncertainty, monetary policy makers will need to carefully assess incoming information bearing on the outlook for both inflation and growth. In light of the increase in upside inflation risk, we must be particularly alert to any indications, such as an erosion of longer-term inflation expectations, that the inflationary impulses from commodity prices are becoming embedded in the domestic wage- and price-setting process.”

In short: as people begin to expect higher prices (longer-term inflation expectations), there is a risk that firms will pass on some of the recent surge in energy costs to the prices of their goods and the wages they pay workers. In the end, all prices will start to rise.

The Fed, an academic institution, tends to focus it policy efforts on core inflation. Food and energy prices tend to be quite volatile, moving up and down very quickly, and distract from the overall price trends (up or down) of all other prices.

Is the Fed correct in targeting core inflation?

Many believe that the Fed’s objective of stabilizing core, rather than headline inflation (all prices, including food and energy), is misguided. First, core inflation is actually more volatile than alternative measures of inflation. A recent study shows that a measure of inflation that excludes just energy is more stable than the “core” measure that the Fed relies on; it is that measure of inflation that should be followed.

Second, others argue that ignoring food and energy is simply misleading. Energy prices increased 6.6% in June, and are bound to result in higher prices of all goods; it is a foregone conclusion.

It is difficult for me to think that firms are acting irrationally and not passing on energy prices for any reason except that it is not profitable to do so. The U.S. economy is struggling, and if firms raised prices, they would likely lose more customers than they would gain in the price increase. Profits would fall. Thus, it is not a foregone conclusion that food and energy inflation will reach other prices (core) unless it becomes profitable.

Here brings us to inflation expectations, which are important to the Fed and its policy decisions than any measure of current inflation. If consumer expectations over inflation were to rise, then it can be argued that consumers would then be more apt to pay higher prices. Therefore, if firms raise prices as expectations are rising, then they would not lose as many customers, and profit loss would be less than if expectations were well anchored. It does not matter whether the Fed is monitoring core or headline inflation if expectation adjustments are the only mechanism by which prices start to rise in the long run.

I believe that the energy and food price inflation will fall, and that the two measures of inflation, headline and core, will converge. However, in the near-term, consumers are strapped for cash when the price of gas rises 11% in June. So, what should the Fed do? Should it promote maximum sustainable growth (which is surely greater than the anemic 1% in the first quarter), or should it insure price stability (make sure that inflation is stable)?

Now it certainly does matter whether the Fed is looking at core inflation, which has remained quite stable in the 2-2.4% range over the year, or headline inflation, which recently hit its highest level since 1991 at 5.2%?

In my opinion, it should focus on core inflation. As long as energy and food prices are expected to recede back to some long-run level, then headline inflation will fall, too. Remember, inflation is a % change in prices, so as long as energy prices are not rising continuously, then inflation will not accelerate, inflation expectations remain in check, and core prices remain stable. Core is a better measure.

Outlook on energy prices

This all hinges on the fact that energy prices will recede (probably not back to where they were a year ago, but at least stop growing).

Most economists agree that Emerging market growth and tight oil supplies are the primary culprits of the recent surges in energy prices. According to Ben Bernanke, “Our best judgment is that this surge in prices has been driven predominantly by strong growth in underlying demand and tight supply conditions in global oil markets.”

Emerging markets (including China, Brazil, India, Indonesia, Russia, Taiwan, etc) are not expected to slow significantly and oil supplies are expected to remain tight. According to the IMF, emerging market growth is projected to remain strong through 2009 (6.6%). Further, oil supplies from key economies (Saudi Arabia, Venezuela, Canada) are not expected to expand significantly through 2013. It looks like strong demand and tight oil supplies are here to stay.

As of July 8 and based on measures of supply and demand only, the Energy Information Association forecasts that the annual average price of oil will be $127/barrel in 2008 and $133/barrel in 2009. That is high, but no higher than where the price sits today ($134/barrel on July 16th). As long as oil prices are high and not rising further, the inflation problem will go away.

Point: the increase in the price of oil, and thus energy, is expected to halt and inflationary pressures will fall.

As long as the Fed is targeting a measure of inflation that is based on stable inflation expectations, it doesn’t really matter if that measure is core or headline inflation. Further, by targeting headline inflation and energy inflation surges, the Fed may overcompensate. It would start taking money out of the economy too soon in order to control inflation, resulting in a guaranteed recession.

I am with the Fed on this one: as long as inflation expectations are reasonably anchored, actions countering inflation are a too extreme given the tenuous health of the U.S. economy.

A final note

As a final note, it occurs to me that there is no universal “best measure” of overall price adjustments. In the 1970’s, headline inflation was well above core inflation; in the 1980’s, core inflation exceeded headline inflation; in the 1990’s, both measures of inflation were stable and in line with each other; in the 2000’s, headline inflation is well above core inflation. High energy prices are likely here to stay, but are unlikely to keep growing so quickly. So, the Fed should remain cautious, but not act too quickly to tame inflation.

I am very interested to hear your comments. Please leave them below. Best, Nontruths

Tuesday, July 15, 2008

Why buy an Apple iPhone during a recession?

According to the media, the economy is doomed to fail. Consumer confidence is at its 16-year low for the fifth consecutive month. Gas is over $4.00/gallon, food prices are rising 5% per year, home values are down 15%, and consumers are strapped for cash. It is a wonder how anyone can survive in this economy. Actually, they do and America’s resilience in spending is impressive.

Yesterday I walked down Boylston Street by the Prudential Center in Boston. I looked across the street and saw a crowd lined up outside the new Apple store; they were waiting in line (some apparently for a while) to buy the new Apple iPhone 3G. Even though the labor market has slashed 438,000 jobs since January, people are still waiting in line to get the newest piece of technology that will be old news in less than a year.

How can the new iPhone 3G be worth a long wait in line? Mike Wendland in Detroit reports many of the 3G’s innovations that make up for the wait. I, however, am happy with my Blackberry that was far less expensive and content not to withstand the 80 degree humid weather in order to say that I own an iPhone. Do people actually miss work (a.k.a., not earn wages) in order to wait in line? I bet yes.

That being said, I remember the piece written by Russ Wiles at the Arizona Republic. He reports that credit card delinquency rates are stable; consumers have not run up debt in order to finance higher food and gas prices. In fact, the delinquency rates of all types of revolving credit in March (first quarter) are just 1%; that means only 1% of consumers with revolving lines of credit are not managing debt payments responsibly.

In previous recessions (grey bars), delinquency rates spiked as consumers used up credit to pay for daily purchases when employment was low and incomes sparse. In the 1980-’82 recessions, when inflation hit double digits (10%-12% in 1981), delinquency rates rose quickly and spiked around 3%. We are just not seeing that spike in this cycle. In fact, delinquency rates are staying in the 1%-range.

The American public is better able to deal with its debt. Prices have been relatively stable (inflation is around 4%), so consumers are better able to plan expenditures and use credit wisely.

The future is not predetermined and there are certainly risks. Prices may start to rise quickly (June’s data is out this week), consumer spending may decline (sales data are out today), and gas prices may hit the $6/gallon mark. The combination of the three would most certainly send the U.S. economy into a 2009 recession. However, the recession has not begun.
People still need and are able to responsibly buy the Apple iPhone 3G.

Sunday, July 13, 2008

There are always winners and losers when the economy struggles

Counter to the mainstream media’s representation of the economy, I believe that the economy is struggling, but not contracting (recession). I am in the minority since most of the headlines have the familiar recession ring, like “Obama: 'Little doubt' U.S. has moved into recession.” It is a wonder how anyone can leave the house if the so-called sky is falling. Sorry about the thick sarcasm, but what can a girl do?

Scooters Go Green

Yesterday, after I finished my Fannie Mae and Freddie Mac saga, I took a walk to Castle Island in South Boston. Along the way, I noticed an oddity for South Boston: a large “Scooters Go Green” store sign.

You know what they say about real estate: location, location, location. Clearly, the store owner of Scooters Go Green is not worried about the new store’s location on Old Colony; it is adjacent to a bar (the Stadium), across the street from several industrial factories (the Iron Works, for example), and just down the street from the projects.

Somehow, amid all the talk of credit crisis and recession, this store owner was able to acquire capital and start a business (sarcasm again). Further, he believes that the demand for scooters will be sufficient enough to create profits to support his family. Is this storeowner crazy? I think not.

There are always winners and losers in economics; as my Mom would say, when
God closes a door, he opens a window. Even with oil topping $145/barrel, gas at $4.11/gallon, housing wealth taking a beating, and the U.S. equity markets officially in bear territory, new business opportunities abound. There are stocks to buy, bonds to sell, businesses to start, and money to be earned.

It is true that this economic cycle has produced many casualties. Big losers include Nordstrom, Home Depot, Target, United Airlines, and Morgan Stanley (to name a few), who are all booking negative Q1 earnings. But contemporaneously, there is a long list of winners including Petrohawk (my Dad’s company), Schnitzer Steel, TiVo Inc., The Gap, and HP (to name a few) who are all marking positive Q1 earnings (Q2 earnings will soon be out). Just because the economy is struggling doesn’t mean that investment and money flow will come to a grinding hault.

Be smart in your business plans. Americans are looking for alternative modes of transportation, and a Scooter is the way to go if gas conservation and quick transportation are of upmost importance. The Scooter Store owner is not crazy – he just has good business sense. Why wait until scooters are in high demand to open up your shop? It is best to get in early on a good idea and rake in the dough while you are one of just a few scooter shops in the area.

A side note about Barack Obama

It is too bad that the self-proclaimed candidate of change, Barack Obama, does not speak of hope and opportunity. Instead, he touts struggle and hurt. Over the weekend, Senator Obama declared that there "little doubt we've moved into recession."
He wants to push his not-so new stimulus proposal, but only at the cost of America’s economic hope. I certainly don’t want to elect a President that is only willing to focus on the negative aspects of the economy.

I am not the only one on the internet that sees both good and bad news in the economy. I recommend that you read a great article written by Russ Wiles at the Arizona Republic, “Despite the economic worries, there are a few pieces of good news.” He maps out positive news that has clearly been overlooked in the mainstream media. Here is an excerpt from his article:

“Americans, lighten up a bit.

The national mood is clearly in the dumps these days amid worries over foreclosures, spiking fuel prices and other economic pressures.

Surveys portray a dispirited public, underscored by a massive drop in that most telling of opinion polls, the stock market. But not everything has unraveled on the economic front.

Here are a few examples of reasonably good news:” ….

You will have to read on to get all of the good details. Be happy, tomorrow brings a new day.

Please leave any comments or reactions to this article. Best, Nontruths

Saturday, July 12, 2008

Fannie, Freddie, Ginnie …What's going on in the mortgage industry?

I don’t know. Wall Street is once again pronouncing the end of the world. Shares of Fannie Mae and Freddie Mac have plunged 75% or more over the year. The U.S. banking system is now on the verge of failure….or so we are being told.

Certainly, this is not the first time that the banking sector has been under duress. The Saving & Loan Crisis of 1980 cost the Federal Savings and Loan Insurance Company (FDIC) $175 billion. The hope bandits in the media are rattling on about a revision to an accounting rule that could require Fannie and Freddie to add $5 trillion to their balance sheets. A move that would cripple Fannie Mae and Freddie Mac, who are the epicenter of the secondary U.S. mortgage markets.

In this article, I cover the last week’s events regarding Fannie Mae’s and Freddie Mac’s troubles. My conclusion is that the recent financial duress is based mostly on speculation, and that in reality, the macroeconomic consequences are limited. The government will guarantee the financial health of Fannie and Freddie, and at a lower cost than the $5.3 price tag that is blabbed about in the media. Further, the proposed change to accounting standards that started it all will not occur. The banking system will survive.

A little background

Who are Fannie Mae and Freddie Mac? Fannie Mae was created by the federal government in 1938 to insure that mortgage loans were available on a continuous basis. Until 1970 and under the direct control of the government, Fannie Mae guaranteed mortgage loans and purchased, held, or sold them on the secondary market. A local bank would loan money to a homeowner, and Fannie would buy the rights and risk of that loan, and in turn free up cash for the local bank to make more loans. In 1964, the federal government removed its explicit backing of Fannie Mae, and attached several benefits to the Fannie Mae in return for guaranteeing the mortgages it bought. In 1968, Fannie Mae split into Ginnie Mae with continued control by the government, and a new publicly owned Fannie Mae. Stock shares of Fannie Mae were issued, and Mortgage-Backed Securities (MBS) were created. Over the next 20 years, several regulation shifts, including the creation of Freddie Mac, led to the Office of Federal Housing Enterprise Oversight (OFHEO), which oversees the proper capitalization of Fannie and Freddie (make sure that they have enough of the right types of assets to insure a healthy institution – one free of large default risk). Fannie Mae and Freddie Mac enjoy benefits, like special capitalization requirements and tax incentives, not seen by other institutions.

Fannie Mae and Freddie Mac buy and sell mortgages by wrapping them up into assets called MBSs. This is the locomotive that keeps the loanable funds flowing to homebuyers like you and I. According to the New York Times, Fannie and Freddie jointly guarantee roughly $5.3 trillion (half) of all U.S. mortgages. How big is $6 trillion? It is 43% of $14 trillion, or U.S. total income….alot.

Here rests the worst-case scenario: Fannie and Freddie go under (default) and the mortgage market ceases to operate under a guarantee. There will be no secondary mortgage market, and many homebuyers will not be able to secure a mortgage (the risk to banks has become infinitely larger). Many potential homebuyers cannot secure loans, the demand for housing falls sharply, and the price of housing is further depressed. Home prices will be forever lower.

All of you out there with a mortgage, your net-worth will fall substantially. Many will default on their mortgage, and bank losses will mount quickly. A large-scale credit disaster will result and the the entire U.S. credit system will stop in its tracks (both nationally and internationally). Getting scared? I assure you that Wall Street is.

Back to the issue at hand

What happened over the last week to bring into question the health of the banking system (again)?

First, Lehman sent out its report

The FASB’s proposed revision to public accounting standards would require that assets normally considered off balance sheet would be added to bank balance sheets. Fannie Mae’s and Freddie Mac’s loan guarantees ($5.3 trillion), which are currently booked off of their balance sheets, would be counted as liabilities on their balance sheets. Fannie and Freddie would need to raise enough capital to offset the liability of $5.3 trillion in mortgage guarantees. An analyst at Lehman Brothers, Bruce Harting, speculates that the price tag would be $75 billion.

In an environment where banks are tight for cash, it is unlikely that Fannie Mae and Freddie Mac could raise that much capital. Banks are taking hits left and right. Citigroup, Merrill Lynch, UBS, Wachovia have all recorded losses (or soon will), and the IMF estimates that total mortgage-related losses could reach $1 trillion. Nobody wants to give money (via stock or bonds) to banks right now.

Second, the former Fed President, William Poole, stated the following:

Congress ought to recognize that these firms [Fannie Mae and Freddie Mac] are insolvent, that it is allowing these firms to continue to exist as bastions of privilege, financed by the taxpayer.

Essentially he vocalized that Fannie Mae and Freddie Mac are at risk of default, and that a government bailout is, but shouldn’t be, on the horizon. Already skiddish stockholders sold off shares of Fannie and Freddie at an alarming rate, confirming that the two firms could not raise the capital required to cover new standards.

If Fannie and Freddie can’t survive, how can the rest of the economy? A bit on the extreme side, don’t you think?

The economics of the Fannie and Freddie situation

In short, Harting and Poole created a whirlwind of speculation on the failure of two institutional giants. Although Fannie and Freddie are not explicitly backed by the U.S. government, it is widely believed that the government will step in if either Fannie or Freddie were in danger of failure. I agree with Poole, they shouldn’t be given special privileges, but they are, and those privileges will continue long past the credit crisis (or so called) is over.

What is the government to do? How will the fallout affect the U.S. economy?

First, the new standards requiring firms to raise new capital on off-balance liabilities will most certainly exclude Fannie and Freddie, or they will not be put in place at all. Sure, talk is tough, but when it comes down to it, the government will not let the mortgage giants go under. There is simply too much at risk…a.k.a, the whole housing market.

Second, if Fannie and Freddie are indeed insolvent (liabilities greater than assets), then the second option is for the U.S. government to nationalize the two firms: it’ll just be Ginnie Mae with no Fannie or Freddie. Share holders will suffer, but why shouldn’t they? The stock market is inherently risky. When you buy a stock, you buy an asset that is not “safe.” Banks should be allowed to fail.

Third, and assuming that all U.S. homeowners default on loans guaranteed by Fannie and Freddie, the U.S. government would add $6 trillion worth of loan guarantees to its current debt tab of $9.5 trillion. Such an increase in government debt would certainly reduce the U.S. government’s international debt ratings. But why couldn’t they simply sell the assets to some private entity? I am sure that Saudi Arabia or China would love a piece of the U.S. housing market. And if you think about it, it is highly improbably that the U.S. would acquire $5.3 trillion since most homeowners do not default on their mortgages. Currently, less than 6% of all mortgages are more than 60 days past due. Worst case is all of those 6% default, so 6% of the $5.3 trillion ($300 billion).

Which brings me back to my first point: Fannie and Freddie will be exempt from any new accounting standard over at the FASB, or if they cannot be exempt, the new standard will not go into effect.

I believe that this will blow over – what do you all think? I would certainly love to start a conversation here. Please leave comments. Best, Nontruths

Boston at dusk

Here is a cool photo of the John Hancock Building around 7pm. The lighting was amazing.

Just a little photo to tide you over until my post today.
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Wednesday, July 9, 2008

How to prepare for a TV interview: The unemployment claims report

Tomorrow I am scheduled to appear on Bloomberg TV in the Starting Bell segment. The best way to “not sound stupid on TV” is to be prepared. I have a Ph.D. in Economics, lots of teaching experience, and presented my work at conferences. However, all of that does not compare to appearance on live TV.

What you may not know is the mechanics of the interview process. I will talk to the host using a remote camera system; the interviewer will ask me questions from the comfort of my own office building. That is very convenient, as I do not need to fly to New York, but it is also slightly awkward. Conversing with the host in person is quite different from conversing with a camera. It’s just you, the phantom host, a report that just came out (the unemployment claims report at 8:30am), and a bunch of traders in the background.

As an act of preparation, I will write down the interview in script.

The premise: Economist (Nontruths) hears latest release of the initial unemployment claims report for the week ending in July 5.

The previous data: Initial claims 404,000; 4-week moving average (looks at more of a trend) 390,500; Continued claims (those who continue weekly benefits past the first week) 3.1 million

Consensus expectations for tomorrow: Initial claims 399,000

Unemployment claims are state-funded benefits that workers may accrue if they lose their job. As an example, Starbucks is expected to close around 600 stores and layoff up to 12,000 workers. The result will be an increase in the unemployment claims reports. This report is important because it is a precursor for July’s employment report.

Below are three possible outcomes of the claims report with 3 scripted responses.

Better than expected:

Angela (host): This just in, the unemployment claims for the week ending on July 5 is 385,000. This is down 19,000 from the previous unrevised number of 404,000. What is your reaction to this report?

Nontruths (me): My initial reaction, Angela, is that is a good report. The claims report is a weekly report and highly volatile, so it is better to look at the 4-week moving average, which fell for the first time in five weeks. We still have one more claims week to go before the next payroll survey, but if reduced claims continue, then we could be looking at a rather benign July employment report. However, a rise in next week’s claims report will signal another poor July employment report.

On the bright side, the report gives the U.S. economy some time to gather its thoughts. The job market has been tumbling, and although the July report is still likely to post further job loss, the labor market’s path is not predetermined. It is certainly possible that further claims reductions will occur, but if job creation is stronger than the increased claims reports, then the contraction of the job market will be short lived.

However, given the ongoing troubles in key sectors of the economy, problems are likely to persist. We will probably see claims adjust upward for a while, but eventually, the economy will turn around.

As a side note, the claims data are flirting with recession territory (last recession averaged roughly 414,000 claims per week), but the net job loss (payroll number) is rather light. Over the last six months, almost 500k jobs have been lost, or -73k average monthly jobs lost. Compare that to the 1.6million, or -181k monthly average jobs lost in the course of 9 months during the 2001 recession, and this cycle appears less gloomy.

Just as expected:

Angela: This just in, the unemployment claims for the week ending on July 5 is 400,000. This is down 4,000 from the previous unrevised number of 404,000. What is your reaction to this report?

Nontruths: My initial reaction, Angela, is this that we are playing with fire here. As the report came in at expectations, the 4-week moving average is up, or claims are up from one month to another. As long as this trend continues, we may be looking at a nasty July employment report, or 7 consecutive months of job loss.

The bright side (if there is any) is that some of the upward tick in claims is due to June’s floods in the Midwest; this will subside and the claims report should recede back to the 380k mark, which is still below recession level.

Repeat “As a side note,…” from above.

Worse than expected:

Angela: This just in, the unemployment claims for the week ending on July 5 is 420,000. This is up 16,000 from the previous unrevised number of 404,000. What is your reaction to this report?

Nontruths: My initial reaction, Angela, is that this is a bad report. The 4-week moving average is up and trending upward. The two-week upward tick in claims does not bode well for the July employment report.

However, I am not ready to jump off of the bridge just yet. The report does indicate that a further contraction of the labor market in July is likely, but the severity of the contraction has not yet met that seen in the 2001 recession.

Repeat “As a side note,…” from above.

For any of the above scenarios:

Angela: What does this report tell us about the U.S. economy?

Nontruths: The report is what it is: a high frequency labor market report that indicates a possible direction in job growth for the July employment report. The risks to the labor market are very real; the July report will likely post the seventh consecutive month of job loss.

However, the cards have not all been dealt. The weekly claims report only tells half of the employment story, job destruction. The job creation portion is told by labor productivity, which is still growing. So in the end, the employment report is more than simply job destruction, and can go either way. Eventually, the market will stabilize.

Beyond that and discussed in my previous blog, The U.S. economy: Not in a recession until the fat lady sings, the evidence does not indicate that we are in a recession. The claims report is simply a labor report indicating the state of the labor market, which is not good.

There are other macroeconomic indicators that are still growing: consumption being the largest. During a period of record falling housing wealth, record high gas prices ($4.11/gallon on average), and slight job loss, it is easy to forget that the health of the economy (expansion or recession) is measured using many variables, and not just the labor variables.

Angela: Thank you, Nontruths (you will find out my real name if you watch tomorrow).
Nontruths: Thank you, Angela, for having me.

Please leave your comments and/or opinions. Best, Nontruths