Echo

Back to basics: Global economic indicators look bad

Tuesday, September 30, 2008

In anticipation of the U.S. employment report that releases on Friday, I decided to look at labor market conditions for several key global economies. Unemployment is rising in key economies and leading indicators indicate a broad-based economic slowdown. A global slowdown is not a common occurrence; it will require a joint expansionary effort to jointly pull international economies out of this rut.

Here is a report about Japan’s labor market, released yesterday:

“Japan says the country's unemployment rate rose slightly in August, adding to growing evidence that the world's second-largest economy is faltering amid a global slowdown. The unemployment rate stood at 4.2% in August, the highest level in more than two years and up from 4.0% in July.”
This is a common release, one that states a negative trend in an economic indicator (labor), and then places the trend in the context of some record-breaking news.

Here is a similar report about the Irish economy:
“The economy had shrunk by 0.3% in the first quarter of the year. Technically, a recession is defined as two or more successive quarters of negative growth. It is the first time Ireland has experienced a recession since 1983.”
There are a slew of reports out there, especially about the U.K. and the U.S., but overall, the global economic sum is teetering on recession.

The Labor Market

The labor market is very important in defining a recession (which, by the way, is NOT simply defined as 2 consecutive quarters of negative GDP). The U.S. employment report on Friday is expected to bring some pretty grim news: -100,000 jobs lost and the unemployment rate sticking at 6.1%. This is a reasonable number since the auto industry’s problems have worsened, the unemployment claims are super elevated, and credit issues make it unlikely that jobs are being added. Thus, the report will show the ninth consecutive monthly decline in jobs, which has never happened during a non-recessionary period.

But enough about the U.S., what’s happening across the globe?

The chart above represents the unemployment rate across five key economies. The first thing to note is that global unemployment rates do not always move in tandem. It is completely feasible for Canada to be growing above potential (unemployment is low), and Germany to struggle with rising unemployment, as it was in the 2003-2004. A global unemployment slowdown is not a common event. In all of the economies, except for Germany, the unemployment rate has risen in the first half of 2008. Also note that the economic slowdown started long ago - in the first half of 2008 when unemployment rates were rising (ex Germany, who is seeing its labor market strengthen) - and is not the product of the latest two weeks of banking reports.

If I had to compare, I would say that Canada is in the best position relative to the other countries in the sample. With its strong Petrodollar (and commodity) inflows, Canada has been quite resilient in spite of its struggling manufacturing sector and economic debacle to its South. Further, the strong inflows have kept the Canadian dollar strong and put a lid on core inflation, which rests at 1.5% for four consecutive months.

A broader measure of economic strength: The Organisation for Co-operation and Development’s (OECD) leading economic indicators index (LEI):

I believe the LEI index to be a lagged composite of macroeconomic and financial indicators, rather than a forward-looking indicator, but it does offer a common measure of economic strength/weakness. It uses slightly different components for each economy, but the composition of the LEI for each country is similar that in the U.S. (the + or – means that the component improved or reduced the LEI for the latest data point, July):
  • Spread 10-yr to federal funds rate (+)
  • Michigan consumer sentiment: expectations (+)
  • S&P 500 (+)
  • Consumer goods orders (+)
  • Real M2 balance (money supply) (-)
  • Real non-defense capital goods orders (-)
  • Factory Workweek (-)
  • Initial Claims (-)
  • Building permits (-)
  • ISM (manufacturing) supplier deliveries (-)

Overall, the economies have moved into a slowdown phase, and this indicator is lagged (latest data point is July). However, it does confirm a joint economic struggle, which is not always the case (see late 2007), dating back to April 2008.

My conclusions

The U.S. labor report is one of the most important indicators followed by markets, politicians, and economists alike. It is the first data release for the month of September and is not expected to paint a pretty picture of releases going forward. With a weak employment report, consumption is likely to be measly, income is likely to be suffering, housing variables will surely struggle, etc.

The U.S. is not alone; however, it has led many economies into their own slowdowns. A global slowdown is an occurrence that will require joint expansionary policy (and some new regulations by some) on the part of global governments and central banks in key developed economies to jointly pull the sum economies out of this rut.

Rebecca Wilder

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My faves for the day

Monday, September 29, 2008

Selling decimates the markets; gold rallies, T-bill rates dive

“Calamity rules in markets today after the House, in a shocker, voted down the financial-system bailout bill.”

RW: Wait a minute, oh yeah, there is a market out there! Now market forces will fix the slew of internal problems efficiently without that pesky 'moral hazard' issue haunting us all.

Changes to FHA Policy Set For Oct. 1

“As part of the housing rescue bill passed this summer, the Federal Housing Administration is set to institute new regulations come October 1. The FHA will raise their minimum down payment amount to 3.5%, up from 3%. Buyers will no longer be able to seek down-payment assistance from the seller or non-profit organizations.”

RW: So the government is telling us – however implicit it may be - how much to save?

The Silent Economic Depression: Lessons from the Great Depression Part XIX: Revising the Economic Past.

“Wall Street created an addictive drug and pushed it on the American public. Now, they want to ensure the government gives them more money to funnel their debt crack on more Americans.”

US Treasury to rely on China and the Middle East to finance bailout?

“The bailout will not create any jobs. Instead, the bigger the bailout the smaller the pool of available funds for more worthwhile projects. And without jobs (real jobs not makeshift ones) there can be no recovery.”

RW: A sad truth – the $700 b plan’s lack of real economic stimulus

More extraordinary moves: $620 billion is real money, and it isn’t even for American financial institutions …

“When the current crisis ends, the regulatory structure for this global market will need to be rethought. And I would hope that the UK would also reconsider its aversion to making the investments needed to collect decent capital flows data — data that might have helped us understand the buildup of vulnerabilities in advance.”

RW: It is true. Better tracking of the cross-border TIC flows and making sense of them - especially when U.S. flows are outward and the trade deficit is rising? - would be a great place to start.

Model T Turns 100

“Ford's iconic Model T was built for the common man and began to transform the American landscape soon after it first rolled out of a Detroit factory a hundred years ago this week.”

RW: Some positive record-breaking news in the auto industry

What's the German Word for Schadenfreude?

“Meanwhile in Germany, the country's second-biggest commercial property lender has been supported by a shadowy cabal of other German institutions. It's a very European solution to financial crisis; it seems as if most institutions here don't bother to tell you what the crap they own is worth, so it shouldn't surprise that they don't bother to tell you who is saving their bacon. Hypo Real Estate's losses are being blamed on Ireland-based Depfa Bank; one wonders how the German Finance Minister will manage to blame this one on the Yanks. The market is voting with its feet; the front end of Europe, typified by the Schatz below, appears to be breaking out.”

RW: Oh, the crazy Deutsche (my husband is German, and I love to poke fun at the Germans). Macro Man is really good at it, too!

Flame War Parody #38 Water Conservation

“Peeing in the shower: Great water conservation technique, or efficient time management.”

RW: Crass, but I couldn’t keep myself from linking to this post.

Heather Locklear arrested in Calif. on DUI count

“Heather Locklear was arrested on suspicion of driving under the influence of a controlled substance in the upscale Santa Barbara area, authorities said Sunday.”

RW: Can it be? You have to click and see this picture! It brings my early-‘90s, tv-lovin’, Melrose-watchin', eyes to tears.

Rebecca Wilder

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An impressive list of Economists that protested TARP

From John Cochrane's website at the University of Chicago Graduate School of Business. 192 total economists signed the following mortgage protest:

"*To the Speaker of the House of Representatives and the President pro
tempore of the Senate:*

As economists, we want to express to Congress our great concern for the
plan proposed by Treasury Secretary Paulson to deal with the financial
crisis. We are well aware of the difficulty of the current financial
situation and we agree with the need for bold action to ensure that the
financial system continues to function. We see three fatal pitfalls in
the currently proposed plan:

1) Its fairness. The plan is a subsidy to investors at taxpayers’
expense. Investors who took risks to earn profits must also bear the
losses. Not every business failure carries systemic risk. The
government can ensure a well-functioning financial industry, able to
make new loans to creditworthy borrowers, without bailing out particular
investors and institutions whose choices proved unwise.

2) Its ambiguity. Neither the mission of the new agency nor its
oversight are clear. If taxpayers are to buy illiquid and opaque assets
from troubled sellers, the terms, occasions, and methods of such
purchases must be crystal clear ahead of time and carefully monitored
afterwards.

3) Its long-term effects. If the plan is enacted, its effects will be
with us for a generation. For all their recent troubles, America's
dynamic and innovative private capital markets have brought the nation
unparalleled prosperity. Fundamentally weakening those markets in order
to calm short-run disruptions is desperately short-sighted.

For these reasons we ask Congress not to rush, to hold appropriate
hearings, and to carefully consider the right course of action, and to
wisely determine the future of the financial industry and the U.S.
economy for years to come.


Signed (updated at 9/25/2008 8:30AM CT)

Acemoglu Daron (Massachussets Institute of Technology)
Adler Michael (Columbia University)
Admati Anat R. (Stanford University)
Alexis Marcus (Northwestern University)
Alvarez Fernando (University of Chicago)
Andersen Torben (Northwestern University)
Baliga Sandeep (Northwestern University)
Banerjee Abhijit V. (Massachussets Institute of Technology)
Barankay Iwan (University of Pennsylvania)
Barry Brian (University of Chicago)
Bartkus James R. (Xavier University of Louisiana)
Becker Charles M. (Duke University)
Becker Robert A. (Indiana University)
Beim David (Columbia University)
Berk Jonathan (Stanford University)
Bisin Alberto (New York University)
Bittlingmayer George (University of Kansas)
Boldrin Michele (Washington University)
Brooks Taggert J. (University of Wisconsin)
Brynjolfsson Erik (Massachusetts Institute of Technology)
Buera Francisco J. (UCLA)
Camp Mary Elizabeth (Indiana University)
Carmel Jonathan (University of Michigan)
Carroll Christopher (Johns Hopkins University)
Cassar Gavin (University of Pennsylvania)
Chaney Thomas (University of Chicago)
Chari Varadarajan V. (University of Minnesota)
Chauvin Keith W. (University of Kansas)
Chintagunta Pradeep K. (University of Chicago)
Christiano Lawrence J. (Northwestern University)
Cochrane John (University of Chicago)
Coleman John (Duke University)
Constantinides George M. (University of Chicago)
Crain Robert (UC Berkeley)
Culp Christopher (University of Chicago)
Da Zhi (University of Notre Dame)
Davis Morris (University of Wisconsin)
De Marzo Peter (Stanford University)
Dubé Jean-Pierre H. (University of Chicago)
Edlin Aaron (UC Berkeley)
Eichenbaum Martin (Northwestern University)
Ely Jeffrey (Northwestern University)
Eraslan Hülya K. K.(Johns Hopkins University)
Faulhaber Gerald (University of Pennsylvania)
Feldmann Sven (University of Melbourne)
Fernandez-Villaverde Jesus (University of Pennsylvania)
Fohlin Caroline (Johns Hopkins University)
Fox Jeremy T. (University of Chicago)
Frank Murray Z.(University of Minnesota)
Frenzen Jonathan (University of Chicago)
Fuchs William (University of Chicago)
Fudenberg Drew (Harvard University)
Gabaix Xavier (New York University)
Gao Paul (Notre Dame University)
Garicano Luis (University of Chicago)
Gerakos Joseph J. (University of Chicago)
Gibbs Michael (University of Chicago)
Glomm Gerhard (Indiana University)
Goettler Ron (University of Chicago)
Goldin Claudia (Harvard University)
Gordon Robert J. (Northwestern University)
Greenstone Michael (Massachusetts Institute of Technology)
Guadalupe Maria (Columbia University)
Guerrieri Veronica (University of Chicago)
Hagerty Kathleen (Northwestern University)
Hamada Robert S. (University of Chicago)
Hansen Lars (University of Chicago)
Harris Milton (University of Chicago)
Hart Oliver (Harvard University)
Hazlett Thomas W. (George Mason University)
Heaton John (University of Chicago)
Heckman James (University of Chicago - Nobel Laureate)
Henderson David R. (Hoover Institution)
Henisz, Witold (University of Pennsylvania)
Hertzberg Andrew (Columbia University)
Hite Gailen (Columbia University)
Hitsch Günter J. (University of Chicago)
Hodrick Robert J. (Columbia University)
Hopenhayn Hugo (UCLA)
Hurst Erik (University of Chicago)
Imrohoroglu Ayse (University of Southern California)
Isakson Hans (University of Northern Iowa)
Israel Ronen (London Business School)
Jaffee Dwight M. (UC Berkeley)
Jagannathan Ravi (Northwestern University)
Jenter Dirk (Stanford University)
Jones Charles M. (Columbia Business School)
Kaboski Joseph P. (Ohio State University)
Kahn Matthew (UCLA)
Kaplan Ethan (Stockholm University)
Karolyi, Andrew (Ohio State University)
Kashyap Anil (University of Chicago)
Keim Donald B (University of Pennsylvania)
Ketkar Suhas L (Vanderbilt University)
Kiesling Lynne (Northwestern University)
Klenow Pete (Stanford University)
Koch Paul (University of Kansas)
Kocherlakota Narayana (University of Minnesota)
Koijen Ralph S.J. (University of Chicago)
Kondo Jiro (Northwestern University)
Korteweg Arthur (Stanford University)
Kortum Samuel (University of Chicago)
Krueger Dirk (University of Pennsylvania)
Ledesma Patricia (Northwestern University)
Lee Lung-fei (Ohio State University)
Leeper Eric M. (Indiana University)
Leuz Christian (University of Chicago)
Levine David I.(UC Berkeley)
Levine David K.(Washington University)
Levy David M. (George Mason University)
Linnainmaa Juhani (University of Chicago)
Lott John R. Jr. (University of Maryland)
Lucas Robert (University of Chicago - Nobel Laureate)
Luttmer Erzo G.J. (University of Minnesota)
Manski Charles F. (Northwestern University)
Martin Ian (Stanford University)
Mayer Christopher (Columbia University)
Mazzeo Michael (Northwestern University)
McDonald Robert (Northwestern University)
Meadow Scott F. (University of Chicago)
Mehra Rajnish (UC Santa Barbara)
Mian Atif (University of Chicago)
Middlebrook Art (University of Chicago)
Miguel Edward (UC Berkeley)
Miravete Eugenio J. (University of Texas at Austin)
Miron Jeffrey (Harvard University)
Moretti Enrico (UC Berkeley)
Moriguchi Chiaki (Northwestern University)
Moro Andrea (Vanderbilt University)
Morse Adair (University of Chicago)
Mortensen Dale T. (Northwestern University)
Mortimer Julie Holland (Harvard University)
Muralidharan Karthik (UC San Diego)
Nanda Dhananjay (University of Miami)
Nevo Aviv (Northwestern University)
Ohanian Lee (UCLA)
Pagliari Joseph (University of Chicago)
Papanikolaou Dimitris (Northwestern University)
Parker Jonathan (Northwestern University)
Paul Evans (Ohio State University)
Pejovich Svetozar (Steve) (Texas A&M University)
Peltzman Sam (University of Chicago)
Perri Fabrizio (University of Minnesota)
Phelan Christopher (University of Minnesota)
Piazzesi Monika (Stanford University)
Piskorski Tomasz (Columbia University)
Rampini Adriano (Duke University)
Reagan Patricia (Ohio State University)
Reich Michael (UC Berkeley)
Reuben Ernesto (Northwestern University)
Roberts Michael (University of Pennsylvania)
Robinson David (Duke University)
Rogers Michele (Northwestern University)
Rotella Elyce (Indiana University)
Ruud Paul (Vassar College)
Safford Sean (University of Chicago)
Sandbu Martin E. (University of Pennsylvania)
Sapienza Paola (Northwestern University)
Savor Pavel (University of Pennsylvania)
Scharfstein David (Harvard University)
Seim Katja (University of Pennsylvania)
Seru Amit (University of Chicago)
Shang-Jin Wei (Columbia University)
Shimer Robert (University of Chicago)
Shore Stephen H. (Johns Hopkins University)
Siegel Ron (Northwestern University)
Smith David C. (University of Virginia)
Smith Vernon L.(Chapman University- Nobel Laureate)
Sorensen Morten (Columbia University)
Spiegel Matthew (Yale University)
Stevenson Betsey (University of Pennsylvania)
Stokey Nancy (University of Chicago)
Strahan Philip (Boston College)
Strebulaev Ilya (Stanford University)
Sufi Amir (University of Chicago)
Tabarrok Alex (George Mason University)
Taylor Alan M. (UC Davis)
Thompson Tim (Northwestern University)
Tschoegl Adrian E. (University of Pennsylvania)
Uhlig Harald (University of Chicago)
Ulrich, Maxim (Columbia University)
Van Buskirk Andrew (University of Chicago)
Veronesi Pietro (University of Chicago)
Vissing-Jorgensen Annette (Northwestern University)
Wacziarg Romain (UCLA)
Weill Pierre-Olivier (UCLA)
Williamson Samuel H. (Miami University)
Witte Mark (Northwestern University)
Wolfers Justin (University of Pennsylvania)
Woutersen Tiemen (Johns Hopkins University)
Zingales Luigi (University of Chicago)
Zitzewitz Eric (Dartmouth College)"
Rebecca Wilder

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Credit crunch still not evident in the data but is on the horizon

Recently, I argued that the Federal Reserve Bank loan data painted a picture that differs sharply from the mainstream media’s representation of the loanable funds market. I still am of the opinion that issued bank credit is not as bad as the media’s banter would have you believe, but going forward, anecdotal evidence suggests that a credit crunch may be on the horizon. Credit card companies are increasing rates on revolving credit significantly.

At the beginning of September, I reported this about bank loans:

Relative to their 2000-2008 averages, the 3-month average of total annual loan growth is consistent with its historical average, 9%, commercial and industrial loans are growing almost four times their average (5%), and consumer loans are fifty percent higher than their average (6%). Real estate loans are a big drag, which are growing 6% below their average (12%), but the point to hammer here is that they are still growing.
To date, bank loans continue to grow and still sugges that there is no "credit crunch." Weekly data published by the Fed – which is the most recent and up-to-date data available – tells me that Americans are indeed purchasing cars and starting businesses.

The chart illustrates consumer loans and commercial and industrial loans (business loans) in levels and in growth rates on a weekly basis spanning 2000-2008. Consumer loans are growing at a healthy rate, 8.8% four-week average, since June. Likewise, commercial and industrial loans are growing, 13% four-week average, but admittedly down from their peak (around 22%) and consistent with levels earlier in the year. Through 9/17/08, loan data for consumers and firms do not illustrate a credit crunch.

However, what is not depicted in the chart is the type of loan that is extended. Are these newly-originated loans? Or are consumers and firms simply drawing on lines of credit?

The chart illustrates weekly consumer loans broken up into revolving credit (credit cards) and "other" types of consumer loans. Revolving loans account for the smaller share of total consumer loans, roughly 40%, and have been accelerating since July. On the other hand, other loans account for the larger share of total consumer loans, roughly 60%, and have been either constant or falling since the end of July. Therefore, revolving credit has been the driving factor in recent consumer loan growth.

According to Fortune Magazine:
When John Dykstra got his September credit card bill from Advanta, a small-business card issuer, he was shocked: Dykstra says he has a good credit score and has never missed a payment, but his interest rate had jumped from 7.99% to 26%.

He was even more shocked by the explanation: A brochure in the mail told him he needed to be aware of the 'continually changing business environment.'

He's not alone. Card issuers from Bank of America to Capital One are using the economic crisis as a reason to raise rates. According to Consumer Action's 2008 survey of card companies, Bank of America, Citi, and Capital One have recently said that "market conditions" could cause them to increase APR's.
RW: Revolving lines of credit will start to fall with the rising cost of borrowing (rising credit card APRs). Going forward, the chart for consumer loan growth will look much more like what the mainstream media has been reporting all along:
Simply put, the meltdown on Wall Street has made it tough for many Americans to get a loan to buy a home, purchase a car, start a business or even send a kid to college.”…”And with all the talk of a credit crunch -- some are even calling it a credit freeze -- it may get even tougher.
RW: The story may be the same with commercial and industrial loan growth, which looks healthy in the data, but may simply be recording businesses drawing on already-in-place lines of credit. The Financial Ninja reported anecdotal evidence to this fact in Bank of America Not Lovin' It:
Can you say CREDIT CRUNCH?

McDonald's Says Bank of America Won't Boost Loans (Update3): “McDonald's Corp., the world's largest restaurant company, told some U.S. franchisees to seek other ways to finance store improvements after Bank of America Corp. declined to increase lending.

Store owners have exhausted financing used to pay for upgrades and equipment to make lattes and espressos, and Bank of America won't provide more money as it works on the planned purchase of Merrill Lynch & Co., McDonald's said in a memo that was obtained by Bloomberg News.”

Sorry, we can’t make productive loans because we are too busy digesting the toxic waste we’ve acquired…
Conclusions

Recently, rising prices have forced consumers to draw on their credit cards (revolving lines of credit) more and more to finance everyday purchases like gasoline and food, and increasing credit card APR’s will force consumers to cut back on their credit card borrowing; this will almost certainly curtail consumption. Further, evidence suggests that commercial and industrial lending is set to fall as lines of credit dry up, forcing businesses to cut back on investment. Get ready for a rocky fourth quarter.

I was much more positive about the economy in July, but the trends across several key indicators have worsened. Although it is unlikely that the U.S. economy was in a recession in July, it is becoming more likely that the National Bureau of Economic Research (NBER) will date the fourth quarter of 2008 as a recessionary period.

Rebecca Wilder

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A smart investor is informed about the investment and the economy: Don't just take Business Week's word for it

Sunday, September 28, 2008

I was reading Business week this week – ha ha, no pun intended – and came across the type of article that drives me absolutely bazonkers! Safe Investing in a Troubled Economy was published on September 25, 2008 (free access, but you must register) and lists the types of assets that the average investor should be looking at in times of economic stress.

“Places to stash cash and hedge against risks like inflation and a weak dollar range from plain-vanilla Treasuries to certificates of deposit denominated in euros. All of the options below rely on the backing of the U.S. government rather than private-sector promises.”
RW: Why these types of articles drive me crazy is that the investment advice is laid out without any regard to the economics that underscore the rationale for purchasing each investment. For example, why would I want to hedge against a weak dollar (in the article, using currency hedges)?

As of 9/26/08, the U.S. dollar was 1.46 against the euro and 1.84 against the pound and trading above its 100-day averages of 1.52 and 1.92, respectively. Further, the U.S. dollar has held up quite nicely throughout September (the peak of the banking crisis), trading down when Lehman filed for bankruptcy, but up following Paulson’s and Bernanke’s testimonies to Congress.

What does this tell me? Longer term, the dollar is weak, but has gained some value on the economy’s resilience. Shorter-term, markets believe that Congress is nearing an agreement on the Troubled Asset Relief Program (TARP), which MAY (and I stress may) stabilize the financial system. What the markets obviously haven’t priced in yet, and certainly will if the bill is passed, is that TARP will cost big bucks and cause big deficits (see this post that cites the IMF article that posits that deficits rise substantially net of returns in response to banking crises), and foreign exchange markets don’t like either.

Chris Farrell, the author of the Business Week article, gives the following investing tips for the current economic backdrop (whatever that is because he doesn’t mention the state of the economy except in passing):

1) Short-term Treasury securities: “The allure of safety was so strong late in the week of Sept. 15 that the yield on the three-month T-bill went negative at one point.”

RW: I love how he really thinks that the average person is going to run out and buy a 3-month T bill on the open market. Or for that matter, that he/she even can. The yield on a 3-month T bill was negative because there was NO supply on the secondary market! Am I to understand that I could actually go out there and find a T bill to buy if Bank of America could not? If you want safety, buy into a money market fund backed by Treasuries, which Chris fails to mention. Hit Fidelity, or something similar, and they’ll help you out.

He goes on to say that one should not jump for the 10-yr or 30-yr Treasury bonds – both have a much higher yield due to their longer maturity lengths – because the record 5.1% annual inflation rate; the real return is less than zero. This is true, but one is not required to hold these bonds to maturity. Again, buy into a fund, and the manager will buy and sell the bonds as the price (yield) fluctuates to maximize the portfolio’s return. You will pay fees, but that sure beats trying to do this on your own.

2) Treasury Inflation-Protected Securities (TIPS) “The fear over rising prices is why more investors are flocking to U.S. Treasury Inflation-Protected Securities (TIPS).”… “TIPS offer a "deflation floor" that protects principal value if the fear of falling asset values turns into a deflationary episode.”

RW: Unless you really believe that a period of high inflation is in the pipeline, then TIPS really isn’t the way to go. However, TIPS is one of the only assets that yielded a positive real return (the nominal yield minus inflation) over the first half of 2008. If you had it then, that was a great investment! But going forward, it depends on how you think prices will move.

Inflation has abated over the second half of 2008, and will likely continue through 2009. Therefore, TIPS may not be the best way to go because you give up a lot to hedge against the risk of inflation. First, the yield is lower, but that is a real return. Over the last 100 days, the average yield on a 10-yr newly issued T bond is 2.3% higher than its inflation-adjusted (TIPS) counterpart, but the TIPS yield is real and the T bond is nominal. Second (and as Farrell states in his article), you pay taxes on both the yield net of the inflation adjustments. However, if you must buy TIPS, purchase shares of a mutual fund that holds TIPS since, as with the T bills/bonds, you will likely not be buying TIPS on the open market yourself.

And by the way, I would like to remind you that the U.S. has not experienced deflation since the great depression. I assure you that the Federal Reserve Bank is much more conditioned to act to promote price stabilization than it was in 1933. The Fed will do everything in its power to avoid deflation, including pawning an anti-deflationary scheme off onto taxpayers in the amount of $700 billion, which consequently, is much more likely to cause inflation rather than deflation. Deflation is a disaster scenario, one that I’m not willing to bet on right now.

3) I Bonds – don’t know much about this one, so I won’t address it.
4) Money Market Mutual Funds – this type of mutual fund is usually backed by short-term commercial paper. If you want a good article about the specifics of the money market, see the Wall Street Journal last week (if you don’t have access to the article, email me, and I will make sure that you do). The article details why this short-term source of funding, worth roughly $3.4 trillion, is so important in the following illustration:

Source: Wall Street Journal

I get really annoyed when reporters are flat-out wrong. According to Farrell (on September 25),

"Nearly $200 billion cascaded out of money funds before stopping on Sept. 18 when the Treasury Dept. put the full faith and credit of the U.S. taxpayer behind the implicit 'don't-break-the-buck' pledge at money funds. The principal value of money-market funds—including tax-exempt ones—is now guaranteed.”

RW: Yes, there was a run on money market funds. Yes, there was an announcement on Friday (09/19/08) that the Treasury will insure money market funds for a year, but that term length was repealed on Sunday (09/21/08). Now, the Treasury provides “coverage to shareholders for amounts held by them in such funds as of the close of business on September 19, 2008.” I hope that his readers did not run out and purchase shares in a non-insured money market fund thinking that it was insured.

5) Bank Savings Accounts – “Investors can earn a good yield and enjoy FDIC safety at online banks. At ING Direct (ING), for instance, a savings account pays 3% and a 12-month CD, 4%. No one with an account of $100,000 or less has lost a penny from a bank failure since the government's insurance fund was created in 1933.”

RW: Why in the heck is this listed on the second page of the article (you have to click on a link to get there)? Putting your money in a fully insured bank account (up to $100,000) is by far the safest way to go, especially in a banking crisis. It is easy to set up, totally insured, and the return is reasonable (around 3% for the online-only saving account, but adjusts according to short-term rates).

My Conclusions

People tend to get very risk averse when the uncertainty surrounding the state of the economy rises, so if you must be ultra safe, I would suggest the fully insured by the FDIC CD or online saving account (there is more information here). However, if you are a little more daring (my husband will not let me be, but he did buy Goldman), there are a lot of bargains out there in real estate, equities, and even high-yield corporate debt. The potential gains are much higher, but alas, the risk is, too. See this article at the Bubble Meter, Why You Should Probably Invest in Stocks Now.

Does anyone have investing advice for our readers?

Rebecca Wilder

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Want to see non-prime mortgage conditions in your area?

Saturday, September 27, 2008

Federal Reserve Bank of New York hosts a super-cool dynamic map of non-prime mortgage conditions across the U.S. You can specify type of mortgage, sub-prim or Alt-A, and see the latest statistics (most current is August 2008) on:

  • number of foreclosures
  • share of loans per 1000 households
  • share ARMs
  • share of delinquencies
  • share in foreclosures
  • and a slew of other statistics, including share of high LTV loans (loan amount to value of home).

This is what I find for sub-prime market in my area, Boston, MA:

  • 19.5 loans per 1000 housing units
  • 1.9 foreclosures per 1000 housing units
  • 67.9% of the loans are ARMs (adjustable rate mortgages)
  • 15.1% of the loans are 90 days delinquent
  • 28.4% of the loans are resetting in 12 mo.

Now, let's compare that with the sub-prime market in Stockton, CA:

  • 34.3 loans per 1000 housing units
  • 4.6 foreclosures per 1000 housing units
  • 71.6% of the loans are ARMs (adjustable rate mortgages)
  • 9.9% of the loans are 90 days delinquent
  • 32.7% of the loans are resetting in 12 mo.

I expected that Stockton would be much worse than Boston, and it is with over two times as many foreclosures, but the sub-prime market sucks everywhere. There is an ongoing problem in these two markets: sub-prime and Alt-A.

The self-propelling downward spiral is amazing: sub-prime borrowers earn less income and pay a higher mortgage rate (the merits of sub-prime lending are not being challenged here); home values decline and defaults rise; escalating risk of default in the sub-prime market causes rates to surge relative to prime rates; rates reset, jobs are lost, sub-prime really can't pay now; foreclosures rise; the housing market deteriorates further; etc., etc.,..... and the cycle goes on until real price-discovery (a floor in the housing market) clears the foreclosure market at rock-bottom prices. Unfortunately, that hasn't happened yet.

Rebecca Wilder

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The real costs of the banking crisis will be high!

Friday, September 26, 2008

I am sorry that I did not post until now, but while fighting a slight fever, I have been catching up a bit on my knowledge of banking crises by reading an IMF working paper, Systemic Banking Crises: A New Database. This paper reports simple descriptive statistics for 42 systematic banking crises across 37 countries, including the current crises in the U.S. and U.K. It details information on the macroeconomic conditions at the start of the crises, the containment of the crises, and the resolution of the crises. After reading this paper, I see that the U.S. and U.K. will pay a high price, via high fiscal deficits or low output. Either way, we are in for a ride.

Across the 42 banking crises, a wide range of policies were used to contain and resolve the crises, including Troubled Asset Relief Program (TARP) – style reallocation of wealth. But a reallocation away from tax payers and toward debtors (banks) comes at a cost: The moral hazard associated with banks abusing government shelters can result in further mismanagement of risk and capital after the crisis is resolved. Point: Government intervention really doesn’t fix the problems at hand – the gross mismanagement of risk – but it alleviates the short-term economic pain of mass bank failure. And the Troubled Asset Relief Program (TARP) will be no different.

According to the paper, banking crisis can be broken down into its three phases, which I have summarized, and then comment on below:

(1) Initial conditions – macroeconomic conditions are usually weak before a banking crisis.
Fiscal balances are usually negative (-2.1% of GDP on average); current accounts are usually negative (-3.9% on average); inflation is high (137% on average); GDP growth is average (2.4% on average); non-performing loans – bank loans that are not earning interest and the borrower is likely to default - tend to be high (25% of total loans on average).

RW: In 2007, the annual fiscal balances as a % of GDP were negative in the U.K. (-0.29%) and the U.S. (-1.36%); the current account as a % of GDP was negative in the U.K. (-4.32%) and in the U.S. (-5.30%); GDP growth was 3.06% in the U.K. and 2.03% in the U.S. The macroeconomic statistics satisfied some of the average initial conditions for a banking crisis, with the exceptions of high inflation and a non-performing loans (4.8% in the U.S.).

(2) Crisis Containment – emergency liquidity support and blanket guarantees are commonly used. In the 42 banking crises, 71% were complimented by new liquidity measures, while 29% included blanket guarantees on deposits.

RW: The U.S. Federal Reserve Bank (Fed) has extended its liquidity facilities since December 2007 when the first Treasury Auction Facility (TAF) was announced. In addition, the Fed has opened additional funding measures, the Term Securities Lending Facilities (TSLF) and the Primary Dealer Credit Facility (PDCF); both facilities accept a wide range of collateral from Depository Institutions (regulated by the Fed) and Primary Dealers in exchange for Treasury bills or direct funding.

The Bank of England (BoE), the U.K. central bank, also extended its lending facilities in April 2008. Like the Fed, and under the Special Liquidity Scheme, the BoE now accepts a wide range of collateral, including mortgage-backed securities in exchange for government bills and bonds for a one year term. Further, the government offered a guarantee on deposits at Northern Rock (mortgage lender in the U.K.) during its collapse.

(3) Crisis resolution – reduced regulation is often a theme in the resolution phase, but strict regulatory standards follow the resolution. This does not usually solve the problem, and often, a restructuring of the banking system occurs.
In 86% of the 42 crises, despite regulatory forbearance, governments were forced to intervene directly by closing banks, facilitating mergers, or nationalizations.

RW: Sound familiar? In an effort to avoid marking illiquid assets at their current market values, regulators have turned a blind eye to potentially insolvent balance sheets. A quote from Naked Capitalism:

“So rather than follow the course of action that has been shown to work in Sweden and to a lesser degree in the US S&L crisis, namely, let asset prices fall, strip out bad assets and sell them, combine and recapitalize the good pieces, and sell those to the public too, we have clearly decided to go down the Japan path, of maintaining phony asset prices to keep institutions that would otherwise fail alive.”
RW: I agree, why not force the assets to be marked down to current market values (which is nothing), and let the banking system work it out; history has shown that regulatory forbearance doesn’t work! Eventaully, banks will fail. WaMu?

My final thoughts

After reading this paper, it is obvious to me that the current banking crises that are plaguing the U.S. and U.K. are not unusual in the world of banking crises. The difference is: The banking crisis is in developed, rather than developing economies. And in a developed world, a significant amount of capital is at stake. According to the McKinsey Institute, the value of global capital markets in 2006 was $US 167 trillion, where the U.S. held $56.1 trillion and the U.K. held $10 trillion. The current banking crises in the U.S. and U.K. puts $66.1 trillion, 40% of the world’s stock of capital, at stake.

Overall, the fiscal costs and real effects of banking crises are high.
  • On average, fiscal costs (RW: net of recoveries, meaning net of the potential profits earned from TARP) average 13.3% of GDP.
  • Using an asset management company to manage the portfolio of acquired assets by the government (again, TARP) may lower only slightly the fiscal cost by increasing the recovery rates.
  • Output losses (loss in aggregate production) average 20% of GDP during the first 4 years of the crisis.
  • RW: In the case of the U.S., there will likely be less output loss and higher fiscal costs, as the two are negatively correlated - higher fiscal costs lower output loss - across the sample of 42 banking crises. The TARP program illustrates a strong desire to go down the fiscal road.

The U.S. banking sector has hit the containment phase of this crisis and moved on toward the resolution phase. However, the banking crisis cannot be fully resolved until the housing market bottoms. I still see that U.S. home sales will bottom this year, followed by a trough in home prices next year, and the start of a healthy recovery in 2010. Once that happens, the mortgage-backed securities will likely assume some positive value, and the U.S. government will finally realize the costs of its interventions.

Overall, the outlook for the U.S. is not good. This paper indicates that ex post (after all is said and done), the costs – fiscal or reduced output – will be high.

Rebecca Wilder

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My faves for the day

Thursday, September 25, 2008

Still totally sick, but I had to keep up with the media today. Can't miss out on historic government intervention in the making!

A sneaking suspicion

“So I just did a Nexis search trying to find out when Paulson and Bernanke started talking about price discovery, which we’re now told are at the core of the plan’s logic. And the answer is …

Yesterday.”

How Bad Is This Bad Debt?

“He [Ben Bernanke] made clear that the government isn’t interested in overpaying for the assets, just returning the whole market to more sustainable, fundamental pricing.” RW: Huh? Isn’t that what the whole point of TARP is? To instill confidence in a broken asset market by paying more than the current equilibrium price?

That Flip-Flop Didn't Take Long

“September 16, 2008: Larry Kudlow praises Henry Paulson for his "courageous" opposition to bail-outs.
September 24, 2008: Larry Kudlow praises Henry Paulson for his bail-out plan.”

Jimmy Carter says bailout plan is 'extremely faulty'

“The Bush administration's $700 billion plan to bail out the financial industry is "extremely faulty," Former President Jimmy Carter said at a Tuesday night town hall-style meeting.” RW: Forget the swarm of economists that oppose the deal, if Jimmy says it, then it must be bad!

America's Sovereign Wealth Fund

“The market is not being irrational; the market is being forced to deleverage. The goal of America's sovereign wealth fund (the Troubled Asset Relief Program) is to stop the vicious cycle.”

Kazakhstan Plans Paulson Style Bailout: Borat?

“I can't believe it! Kazahkstan plans to implement their very own Paulson bailout. Those crazy Kazakhstanis! Insanity is a virus”

Credit Stress Evident In TAF, Ted Spread, Everywhere

“Inquiring minds just might be wondering how the Term Auction Facility (TAF) is performing. Let's take a look at the two most recent auctions.TAF Release Date: September 10, 2008On September 9, 2008, the Federal Reserve conducted an auction of $25 billion in 28-day credit through its Term Auction Facility. Following are the results of the auction:Stop-out rate: 2.530 percentTotal propositions submitted: $46.237 billionTotal propositions accepted: $25.000Bid/cover ratio: 1.85Number of bidders: 53TAF Release Date: September 23, 2008On September 22, 2008, the Federal Reserve conducted an auction of $75 billion in 28-day credit through its Term Auction Facility. Following are the results of the auction:Stop-out rate: 3.750 percentTotal propositions submitted: $133.562 billionTotal propositions accepted: $ 75.000 billionBid/cover ratio: 1.78Number of bidders: 85Note that the number of bidders soared from 53 to 85 and the yield went from 2.53% to a whopping 3.75%.”

RW: And that is why the Treasury is selling bonds for the Fed. The System Open Market Account (SOMA) account is falling by the day. The Fed owns just $480 billion in Treasuries, down from $800 billion in December 2007 (before the TAF auction was initiated).

RW: And a little humor for the day

Let’s Suspend the Whole Election

“But as usual John McCain is being entirely too cautious and humble by merely suspending his campaign and postponing the debates to get our economy running again. McCain is not by nature one to be rash and impulsive, but I think it’s time for him to throw caution to the wind for a change and ask Barack Obama to agree to suspend the entire election.”

Market Mood Swings — Revisiting Ben Graham

“When Matt Millen was a tough, hard-hitting linebacker for the San Francisco 49ers, he said it best, ‘Things are never as bad as they seem when you’re losing and never as good as they seem when you’re winning.’”

Rebecca Wilder

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Pushing back the inevitable: $25 b loan to US car makers costs $7.5 b to tax payers

I am totally sick today, so I apologize if there are grammatical mistakes, but here we go!

With a price tag equal to $25 billion, the House today voted for a package of loans to help the auto industry to finance “modernization” when capital markets are tight. This has clearly fallen on the backburner of the mainstream media, but the thorough Financial Times reported promptly.

Here are some bullet points from the FT article:

  • The Senate will likely pass the package; the House voted overwhelmingly affirmative 370-58.
  • Michigan and Ohio are two swing states for the election in November. RW: It is true that Michigan’s unemployment rate was the highest across the U.S. in August with 8.9% unemployed, but still, politicking definitely played its part in this one.
  • The loan is intended for the re-tooling of plants to produce more fuel efficient cars.
  • The loans will cost taxpayers $7.5 billion since the loans are offered well-below market interest rates.
  • The loans may be allocated as soon as 2009, but not until the energy department details its regulation over qualified uses of the loans.
  • All carmakers in the U.S. are eligible, but the plant must have been in operation at least 20 years (to boot the foreign car makers from the deal). RW: What’s to prevent Toyota from buying a plant that is at least 20 years old to access the loan?

Here are a couple of clearly retarded quotes from the article:

“Shelly Lombard, analyst at Gimme Credit, a corporate bond research company, told clients this week that ‘blue collar workers are more sympathetic victims than ‘rich’ investment bankers. So it’s easier to defend loans designed to save close to 100,000 jobs in the shrinking US manufacturing industry.’”
That’s just it: The manufacturing industry – strong export growth included – is shrinking. Industry destruction is a natural process, and should not be thwarted with taxpayer dollars. Those firms that saw the wave of fuel efficiency coming (Toyota), and made appropriate modifications to their business models in time, will survive. Those who did not (GM), will not. It’s as simple as that.

And another classic:
“The Detroit-based car­makers have insisted that the loans, known as the Advanced Technology Vehicles Manufacturing Incentive Programme, are not a bail-out because they must be repaid.”
I guess that they are confused about what a bail-out is; it’s a loan! The Federal Reserve financed an AIG loan up to $85 billion. And unless I am living in an alternate universe - one in which market forces are allowed to dictate firm failures - that was a bail-out.

Rebecca Wilder

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Canada’s housing market looks good to me: Merrill is too pessimistic

Canada could face housing woes, Merrill warns is what the Globe and Mail reports. Merrill Lynch produced an outlier report, suggesting that Canadian households are overly indebted and that eventually the housing markets and credit markets will tumble.

Merrill Lynch is known for its pessimism. David Rosenberg, an Economist for Merrill in New York, has predicted U.S. recession so many times that somebody should really sit him down and read the fable about the boy who cried wolf. I haven’t read the report, but I agree with the consensus, that the Canadian housing market is quite stable.

According to Action Economics, second quarter (Q2) household and business net worth rose 2.8%, up from the 0.5% rate in Q1. If net worth is rising, that means assets are rising relative to liabilities, and on the margin, households are putting themselves in a better position financially without reducing their debt liabilities. As net worth rises, consumption increases and consumers are better able to afford a down-payment on a home; both factors bode well for Canada’s housing and spending markets.

Further, if the U.S. Treasury’s Troubled Asset Relief Program (TARP) passes, the Bank of Canada (BoC) will feel less restricted in its policy options. Canada’s credit markets have remained quite resilient to the U.S. financial storm so far, but a possible spillover into the Canadian economy has remained on the BoC’s radar. If the TARP program passes and it works, the BoC will have more wiggle room to ease its target overnight rate that has been stuck at 3% since April.

According to the article, Prime Minister Stephen Harper assuages readers: “I think our housing market is in strong position [and] consumer markets, as well, are stronger in Canada than the U.S. and the position taken by our financial institutions.”

I can assure you that Canada’s housing and consumer markets are infinitely stronger than in the U.S. Let’s look at the housing market.

The chart lists housing starts in North America that are average in Canada and pathetic in the U.S. The latest report showed 211,100 starts in Canada, which is consistent with its longer-term average spanning 2002-2008, 224,680. However, the latest U.S. report showed 895,000 new homes started, which is just over half of the 2002-2008 average, 1.73 million.

The chart above lists the annual percentage change in existing home values in Canada and the U.S. The data are not exactly comparable, but the trend is overwhelming. The U.S. is experiencing record reductions in home values, which is pulling down U.S. net worth. In contrast, Canada’s home values have descended since 2006, but are still positive. In quarter 2, home values in Canada appreciated 4.5%, which is admittedly below the 2002-2008 average of 7.8%, but above the 3.5% record annual inflation rate. Real home values are declining in the U.S. and rising in Canada.

The U.S. housing market is crippled, and precipitously declining housing starts is just a small part of the whole story, but the Canadian housing market can only be described as weaker than average. Further, it is more likely that the the BoC will cut its interest rate target if the U.S. TARP bill passes; this should lower mortgage rates and stimulate the housing market.

Rebecca Wilder

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My faves for the day

Wednesday, September 24, 2008

Voters are nearly evenly divided on the proposed $700 billion financial sector bailout working its way through Congress.

“The poll also shows that wealthier voters support it by larger margins than lower income voters, with 48% of voters who earn $75,000 or more approving of the plan and just 12% of voters who earn less than $30,000 oppose the bailout.” Rebecca Wilder (RW): See, once you bring Congress into it, the politicking begins. Who cares about voters – it’s the taxpayers that they should be polling!

Banking Expert: Bailout Not Necessary, Industry Can Take Losses

“A banking industry expert, Bert Ely, who has a stellar track record in predicting crises and calling false alarms says that the banking industry can handle this mess internally and does not need subsidies.”

US home sales much worse than expected

“What happened to all this talk about the US housing market bottoming out?” RW: I know, and the housing market is the only mechanism by which the financial mayhem will end!

What we know for sure

“I have no doubt as we transition our economy to a new more equity-based model, the former scions of the now-discredited system will once again rise to the apex of power under a brand new flag.”

Joe Biden's history lesson off by 4 years and 1 president but otherwise pretty accurate

“Declared Biden: “When the stock market crashed, Franklin D. Roosevelt got on the television and didn't just talk about the, you know, the princes of greed. He said, 'Look, here's what happened.'”

What's wrong with that, some might ask?

Well, for starters Republican Herbert Hoover was president when the stock market crashed in October 1929. Second, Roosevelt didn't take office until four years later. And, not to be picky, but there were also no televisions in use at the time. Radio was Roosevelt's favored medium.”

Officials Seek To Cleanse Mortgage Market Fraud

“On both the consumer and corporate sides of the coin, fraud has truly begun to stain the mortgage market.”

RW: And my favorite, favorite of the day!

All Hail Paulson!

“Our ancestors fought for freedom- are we going to just throw it away?”

Rebecca Wilder

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The AIG bail-out that almost wasn’t

Today, I was reading through the AIG bailout terms from the Fed’s press release on September 16 (last Tuesday, seems like eons ago), and came across some fine print that could have killed the whole deal.

Here is the announcement:

“The Federal Reserve Board on Tuesday, with the full support of the Treasury Department, authorized the Federal Reserve Bank of New York to lend up to $85 billion to the American International Group (AIG) under section 13(3) of the Federal Reserve Act. The secured loan has terms and conditions designed to protect the interests of the U.S. government and taxpayers.”
And here is the key part of section 13(3):
In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may authorize any Federal reserve bank, during such periods as the said board may determine, at rates established in accordance with the provisions of section 14, subdivision (d), of this Act, to discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank: Provided, That before discounting any such note, draft, or bill of exchange for an individual, partnership, or corporation the Federal reserve bank shall obtain evidence that such individual, partnership, or corporation is unable to secure adequate credit accommodations from other banking institutions. All such discounts for individuals, partnerships, or corporations shall be subject to such limitations, restrictions, and regulations as the Board of Governors of the Federal Reserve System may prescribe.”
Normally there are seven members of the Board of Governors, where each member is nominated by the current President and ratified by Congress. Should be a seamless deal, right? Well, the political game of dodgeball that goes on between President Bush and the Democratic House and Senate almost scrapped the whole AIG deal.

Pres. Bush nominated two bankers to fill the last two seats on the Board of Governors in May 2007, Elizabeth Duke and Allan Klane. A stalemate between Bush and Congress left those two seats unfilled until August 5 2008, where just 3 weeks later, Frederic Mishkin resigned, leaving again just 5 Governors on the Board.

Good thing that Congress could finally muster up enough dignity to ratify the nomination of Elizabeth Duke – just 1.5 months ago – because if they hadn’t, the Board of Governors could not have satisfied the required 5-member affirmative vote (because there would have been just four) to bail out AIG.

Politicking: In this case, it really could have ruined the economy!

Rebecca Wilder

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Are the Republicans screwed?

In the wake of the announced monumental government bail out, the Troubled Asset Relief Program (TARP), the polls quickly turned to the Democrats. At the time, I wondered why voters believe that the Democrats would do a better job than the Republicans. Well, here is what I have figured out so far.

Voters don’t like negative economic growth.


The chart lists the third quarter growth rates (usually released in October) in an election year, where either there was a change of Administration or the incumbent Administration had completed its 8-year tenure. In 1980 and 2001, the incumbent party was ousted following a released third quarter of negative growth. In 1980.3 (third quarter of 1980), growth was -0.7%, and Carter (D) lost to Reagan (R). Again, in 2000.3, growth was -0.5%, and Gore (D) lost to Bush (R). Interesting that in both cases, the incumbent Democratic Administration lost to a new Republican Administration.

Voters like monster government deficits.

The chart illustrates the annual government balance as a percentage of GDP spanning the last six Administrations. The Republicans tend to run higher government deficits, either through reduced taxes or strong defense spending (in most cases). Voters like this because Republicans have held four of the six most recent Administrations, where the average deficit/GDP ratio spanning the four Administrations is -3.4% (including 2008.2).

Based on the fact that voters dislike third quarter contractions and strong deficit spending, McCain has got this thing wrapped up!

First, 2008.3 GDP is forecasted to be positive. Actioneconomics is forecasting 2.3%, Macroeconomic Advisers is forecasting 1.5% (which is what I used in the chart), and even Deutsche Bank, a forecasting group that is anything but sanguine about the U.S. economy, are projecting 0.7%.

Second, and especially if TARP passes, the government deficit is large, currently around 4% of GDP, and is approaching levels not seen since Bush, Senr. (-4.4%). The government has raised the debt once already this year, and will again if TARP is passes, which does not bode well for our deficit/GDP ratio.

I know that this is a little silly, but in all seriousness, the budget deficit is going to be a real problem for the next Administration.

Rebecca Wilder

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62.5%: The probability that the U.S. government bails-out its financial system

Tuesday, September 23, 2008

This is capitalism at its best! Now you can bet on odds that the Treasury Asset Relief Program (TARP) bill will pass by the end of this month. Today, Intrade.com, a prediction market platform that was founded in 1999, initiated one more asset on its prediction platform: the passing of TARP. You can buy the odds at 62.5% that the bill passes, down 2.5% from 65%.

I am just relieved that the number is less than 100%. I will hope, no pray, that the odds fall, rather than rise. However, after Paulson’s and Bernanke’s testimonies today, the bill would allow us to bypass a supernova economic threat…..all at the cost of $1,000,000,000,000!

Rebecca Wilder

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Lehman scratched from the primary dealer list – that leaves 18

Here is the NY Fed’s primary dealer list:

  1. BNP Paribas Securities Corp.
  2. Banc of America Securities LLC
  3. Barclays Capital Inc.
  4. Bear, Stearns & Co., Inc.*
  5. Cantor Fitzgerald & Co.
  6. Citigroup Global Markets Inc.
  7. Credit Suisse Securities (USA) LLC
  8. Daiwa Securities America Inc.
  9. Deutsche Bank Securities Inc.
  10. Dresdner Kleinwort Securities LLC
  11. Goldman, Sachs & Co.
  12. Greenwich Capital Markets, Inc.
  13. HSBC Securities (USA) Inc.
  14. J. P. Morgan Securities Inc.*
  15. Merrill Lynch Government Securities Inc.
  16. Mizuho Securities USA Inc.
  17. Morgan Stanley & Co. Incorporated
  18. UBS Securities LLC.

Lehman Brothers was removed – as of September 22 – and later in the year, Bear and J.P. Morgan will be consolidated into one dealer.

These are the 18 institutions that can access the lending program, the Primary Dealer Credit Facility (PDCF), directly. The commercial banking system, where consumer deposits are insured by the FDIC and regulated by the Fed, has access to a number of liquidity facilities: the Term Auction Facility (TAF), the Term Securities Lending Facilitiy (TSLF), and the Federal Reserve discount window.

Part of the problem that is plaguing non-commercial banking and non-primary dealer financials, like AIG, is that they have similar exposure to asset backed securities, but cannot access the Fed’s liquidity programs. Pension funds, insurance agencies, hedge funds, or any financial institution that is not explicitly insured under the Fed’s umbrella, can only appeal to the Fed for a direct loan. Hence, the Fed has been making a case-by-case judgment on whether a firm should access the Fed’s liquidity tap (e.g., AIG).

On Friday, the Fed threw in the towel and decided to tackle the whole kit-n-kaboodle. If the Treasury plan (modified heavily by key Congressional leaders) passes, then the U.S. government will hold the largest portfolio of asset backed securities in the whole world. Go USA! (I hope that you all can read that there is an abundant amount of sarcasm in that last phrase).

Rebecca Wilder

P.P. Michael Shedlock is asking us to send letters to our Congress asking them to vote against the bill. I already did, but you can look at his plea here.

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A break from finance: State personal income data cannot explain the housing bubble

As we wait for the outcome of the bill that gives the U.S. Treasury discretion over spending $700 billion, I decided to go back to economic posts. The Bureau of Economic Analysis released state personal income statistics for 2008.2 (the second quarter of 2008). Overall, the data is clouded by the Economic Stimulus Act of 2008, but Texas remains resilient with its strong oil and gas income growth.

As a primer, let’s first define Personal Income, which is the income received by all persons from all sources. Personal income is the sum of net earnings by place of residence, rental income of persons, personal dividend income, personal interest income, and personal current transfer receipts.

Source: Bureau of Economic Analysis (click to enlarge)

The highlights of the release in bullet points:

  • U.S. personal income grew 1.8% over the second quarter of 2008
  • Growth accelerated in all states except New Jersey, Minnesota, North Dakota, South Dakota, and Wyoming.
  • 2008.2 growth was highest since 2007.1 across all states (except for the five above), where the Economic Stimulus Act of 2008 accounted for almost all of the acceleration.
  • In the first quarter (release before the rebate program), growth contracted (negative) in the following states: Arkansas, Louisiana, Idaho, and Nevada.
  • Professional services, state and local government, and health services contributed the most to income growth, while reduced earnings in construction, and retail trade dragged down income growth.
  • The Southeast region grew the most (2.2%) above the national average (1.8%). The tax rebates had their largest impact here since the rebates were targeted to low-income households. Without the rebate program, the region grew 0.8%.
  • Net earnings in Texas (earnings less contributions for government social
    insurance, plus an adjustment to convert earnings by place of work to a place-of-residence basis) grew over twice the pace of the U.S. in 2008.1 and 2008.2; this is indicative of strong labor conditions in Texas stemming from growth in the oil and gas industry. Good place to go for a job, even in construction, since construction income contributed 0.11% to income growth in Texas but subtracted -0.06% from income growth nationally.
Going forward, expect more income contractions regionally in 2008.3 and 2008.4 as the labor market deteriorates further (national unemployment rate expected to rise slightly above 6.1% in the second half of 2008) and the Economic Stimulus Act of 2008 wears off. The regions with focus on manufacturing, esp. the Great Lakes region, will likely suffer the most.

Long-term income growth did not produce a housing bubble (click to enlarge).
The scatter plot lists income growth across two decades for 48 states, excluding outliers Wyoming and Nevada. Wyoming experienced a surge in growth in the 2000s (114%) and relatively low growth during 1990s (73%), while Nevada’s growth was high in both decades: 160% in the 1990s and 100% in the 2000s. The states highlighted in RED represent the 10 states with the highest number of foreclosures in August 2008.
Source (click to enlarge): Realtytrac.com

Except Nevada, there is no correlation between regional income growth over a longer time horizon and number of foreclosures. One would think that those markets with the strongest income growth – especially in the 2000s – would produce the most foreclosures if households perceived strong income growth as an incentive to leverage themselves into a high mortgage. However, this thinking is not evident. Even those states that experienced relatively low income growth spanning the 1990s and 2000s, e.g., Michigan and Ohio, are among the states with the greatest number of foreclosures. Clearly, there are size adjustments that need to be made (i.e., Texas’ population is much larger than Illinois’), but the lack of relationship between income growth and housing foreclosures is interesting.

Along with the U.S., regional income patterns are set to slow. However, if one must move for better labor market conditions, Texas is the best place to go. And as oil inventories continue to shrink and oil prices will remain high ($107.52/barrel at close on Sept. 22), Texas will continue to prosper.

Please leave comments. Rebecca Wilder

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G7 supports the U.S. bailout of asset-backed securities…duh!

Monday, September 22, 2008

Today the G7 released a statement regarding recent actions on the part of the U.S. government to stabilize the financial system (please see this post on my opinion of the disaster that we call a move toward stabilization).

“We strongly welcome the extraordinary actions taken by the United States to enhance the stability of financial markets and address credit concerns, especially through its plan to implement a program to remove illiquid assets that are destabilizing financial institutions.”
The fact that the G7 (U.S., Canada, Italy, France, Japan, Germany, and the United Kingdom) felt the need to make a formal statement makes me chuckle a bit. Of course the G7 support the plan; they are neck-deep in U.S. mortgage backed securities themselves! The Treasury plan, which is far from ready for a vote (see Dodd’s plan here at Politico), is essentially a plan to stabilize the financial system by creating “confidence” in a market that has none.

Europe is right up there with the U.S. (Americas) with losses totaling 235.3 $US as of 9/22/08 and counting. Of course they support a bill aimed at stabilizing this market (a.k.a., superficially creating a price above zero for the assets), it’s like a get-out-of-jail-free card. Even if the European banks derive no access from the U.S. bill directly, there are social gains that foreign banks would accrue as the U.S.-based ABS (asset backed securities) market stabilizes. Cost to U.S.: $1,000,000,000,000; explicit cost to G7 (as of now): $0. That's a no-brainer.


Please leave comments. Rebecca Wilder

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Election update: Democrats will do a better job responding to the financial pandemonium?

I am a little confused why, exactly, the public thinks that Barack Obama is in the better position to deal with the financial pandemonium at hand. It is uncanny how quickly the intrade statistics changed on the day that Lehman Brothers filed for bankruptcy.


Over the last two weeks, the Fed and the U.S. Treasury have pumped hundreds of billions of dollars into the U.S. financial system. And now, with the added $700 billion blank check for bad assets that is likely to pass Congress in some shape or form, the tally is over $1,000,000,000,000! That’s 12 zeroes!

Yup, the next President is in charge of managing $1,000,000,000,000 in new debt. Why do you all think that Barack Obama will be the best man for the job?

Please leave comments. Rebecca Wilder

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And the sell off begins: Manulife saves AIG shareholders

On Saturday, the Wall Street Journal publishes AIG Holders Seek Alternative to U.S. Plan .

Shareholders who are dissatisfied with the deal [the Fed’s $85 billion] are exploring ways to quickly pay off the loan, which gave the federal government the right to take 80% of the insurer. Under this scenario, AIG would not only sell assets, but also raise capital in other ways, potentially leaving shareholders better off. AIG had no choice but to accept the federal help last week, when large sums of private money weren't available.”
Well, that is exactly what they are doing. On Monday, the Globe and Mail publishes Manulife in talks for AIG assets. Manulife Financial Services, the largest insurance company in Canada and well-represented in the U.S., buying out John Hancock Insurance in 2003, is in talks to acquire a stake (the size is not specified) in American International Group (AIG). With such a presence across the U.S. and Canada, “Buying all of AIG, or big parts of it, would propel Manulife to the top rank of the global financial services industry.”

This is just a sad preview of what’s to come: the U.S. has (is) socialized the losses and privatized the gains. The Fed already made payments to AIG’s balance sheets; hence, taxpayer money has already been drowned. But if AIG sells of its assets, especially at a fair price, shareholders will make out, having avoided chapter 11 and earned a hefty sum from a potential suitor. All before the Fed acquires its 80% stake.

Rebecca Wilder

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A government-backed storm is brewing over the U.S. Financial System

Sunday, September 21, 2008

Our Congress, nor the current Administration, nor Ben Bernanke, nor Hank Paulson is qualified enough to deal with the current banking “crisis,” which I will now coin banking “pandemonium.”

Crisis: a stage in a sequence of events at which the trend of all future events, esp. for better or for worse, is determined; turning point. Pandemonium: wild uproar or unrestrained disorder; tumult or chaos.

The banking sector is now in a pandemonium, driven by lack of investor confidence, where its impact on the future of the banking system is widely speculated, and unless Hank, Ben, George, or Congress have resumes that include “extra sensory perception” in their previous experience sections, future events are not known; hence, a crisis cannot be determined until the event is over. However, by intervening, I believe that the government is creating a crisis, where future events are guaranteed to change with the passing of each day.

In one big swoop, the U.S. government has changed the financial system for decades to come over the course of just 2 weeks. Are they acting on theory and rational decision making? Or are they acting on pure instinct –like investors in the late 1990’s, described by Greenspan as irrational exuberance – and acting before thinking. It looks like the latter to me.

It was certainly easy to get caught up in the moment last week. I even found myself thinking irrationally once or twice, questioning all of the posts that I’ve written over the last several months regarding the state of the U.S. economy. The U.S. government took the path of least resistance without knowing what is waiting at the finishing line, and all the while, risking big bucks…bucks that belong with U.S. households and firms. How can the Treasury expect to slap a $1 trillion dollar band-aid on top of the financial system, pledge to regulate the system, and think that things are going to be okay? It is wrong for the Treasury to buy up the bunk debt in order to stabilize confidence in the U.S. financial system, especially since it doesn’t seem logical that the government can restore confidence with money. Can confidence really be bought?

Confidence: full trust; belief in the powers, trustworthiness, or reliability of a person or thing. Confidence will not be restored by flooding the system with $700 billion, buying truckloads of securitized assets off of the hands of those who brokered them in the first place, selling them off using an as-of-yet undetermined pricing mechanism, and then expecting the system to be healed. As Paul Krugman states in his Op-ed piece in the NY Times regarding the very tentative rescue plan:

“Here’s the thing: historically, financial system rescues have involved seizing the troubled institutions and guaranteeing their debts;… The Treasury plan, by contrast, looks like an attempt to restore confidence in the financial system — that is, convince creditors of troubled institutions that everything’s OK — simply by buying assets off these institutions. This will only work if the prices Treasury pays are much higher than current market prices; that, in turn, can only be true either if this is mainly a liquidity problem — which seems doubtful — or if Treasury is going to be paying a huge premium, in effect throwing taxpayers’ money at the financial world.

And there’s no quid pro quo here — nothing that gives taxpayers a stake in the upside, nothing that ensures that the money is used to stabilize the system rather than reward the undeserving.”

On of my colleagues said it best: “they are like two drunks dancing together.” This was in reference to the proposed merger of Morgan Stanley and Wachovia. But if you asked me, this whole crisis is full of dumb drunks running around the Santa Monica Pier at 2:15am just looking for someone to go home with. What needed to happen will now not happen: Drunken banks need to find their dancing partners in order to consolidate the banking system and build up capital enough to meet the mortgage market head on. The crisis is too big for regional and even smaller banks to take on, but a consolidated effort, with the help of liquidity from the Fed, may survive. And that train just left the station.

If you haven’t read David Wessel’s Wall Street Journal article, In Turmoil, U.S. Capitalism Sets Course on Uncharted Waters (they changed the title since Saturday to "In Turmoil, Capitalism in U.S. Sets New Course," but I liked it better yesterday), then you must; if you can’t get it, email me, and I will make sure that you can. He lists two weeks worth of government strong-holding that actually brought tears to my capitalistic eyes:
“But in the past two weeks, the U.S. government, keeper of the flame of free markets and private enterprise, has:
-- nationalized the two engines of the U.S. mortgage industry, Fannie Mae and Freddie Mac, and flooded the mortgage market with taxpayer funds to keep it going;
-- crafted a deal to seize the nation's largest insurer, American International Group Inc., fired its chief executive and moved to sell it off in pieces.
-- extended government insurance beyond bank deposits to $3.4 trillion in money-market mutual funds for a year;
-- banned, for 799 financial stocks, a practice at the heart of stock trading, the short-selling in which investors seek to profit from falling stock prices.
-- allowed or encouraged the collapse or sale of two of the four remaining, free-standing investment banks, Lehman Brothers and Merrill Lynch;
-- asked Congress by next week to agree to stick taxpayers with hundreds of billions of dollars of illiquid assets from financial institutions so those institutions can raise capital and resume lending.”
There you have it: We are talking about government intervention the size of a supernova, certain to lead a wave of bad regulation. According to Stephen Quinn, an economic historian at Texas Christian University, “Smart regulation looks forward to prevent the next regulation-circumventing ... idea from turning into a bubble without stymieing the flow of new ideas. Dumb regulation looks backward. You can guess which kind of regulation most crises produce.”

We depend on individuals that were elected into office, or nominated by ones that were elected into office, to both restore confidence in the U.S. financial system and to regulate it so that future generations will not find themselves at a similar crossroads...now that’s a sobering thought.

Why I think that the U.S. Treasury, the Fed, Congress, and Bush are on crack:

  • Bailing out Bear Stearns set a precedent that, going forward, will lead to broad-based moral hazard across all industries, not just finance. On the second page of Saturday’s Wall Street Journal, but resting daintily at the bottom, a troubling headline reads: “GM to Tap Rest of $4.5 Billion Credit Line”. Capital problems should lead to default, but now the government must add to its already long list of activities, the task of determining whether or not GM should fail. Are they too big or too small? Who knows, but since equity is ueber important to the U.S. Constitution, expect GM to tap the Fed, the U.S. Treasury, or both in the future.

  • What happened to autonomous fiscal and monetary policy? The fiscal (U.S. Treasury) and monetary (Federal Reserve Bank) sectors are too close on this one – nowhere in the Fed’s mandate does it call to stabilizing the financial system; actually, it was written to leave out such a goal. The un-anchoring of financial stability can bring obvious economic disarray in the near term, but it also brings a stronger long-term financial model. I appeal, once again, to the evolution metaphor: Only the fittest will survive, and that is a positive for long-term economic growth.

  • By intervening in the securitized asset market, which is what they are about to do at the cost of an additional $700 billion (at the very least), financial stability in the U.S. is far from certain. The government is assuming a truckload of bad assets in order to sell it off, and all the while, default rates that determine the value of the assets are not even falling a tick, so why in the heck would anybody rational investor buy it from the government unless the price was sufficiently low (likely lower than what the government paid for it)? Does the government really believe that a “backed by the U.S. government” sticker on top of a securitized asset will woo investors? We’re not talking about the U.S. dollar here.

  • And this is where is gets a bit blurry for me. $700 billion for the >>>> bill, $85 billion for AIG (which I read that they are in talks to prevent the government from assuming the 80% stake, which is funny), $120 billion in overnight repos on Tuesday and Wednesday (I believe), $180 billion in currency trades with Europe, Canada, and Japan, the $29 billion for Bear, and we are well over the $1 trillion mark. And that is just at the top of my head….there is more, especially in the repo market! How in the heck can we afford this without footing the bill to our children, grandchildren, great grandchildren, great great grandchildren, etc. It is simply mind-boggling, what the government will risk in order to prevent a fallout that may be un-preventable. Eventually, push will have to come to shove, and the U.S. economy will pay for it. See the U.K. Bubble for The US housing bail-out tab so far.

  • Which brings me to another thought: Where the heck is the Federal Trade Commission? Are no, and I stress no, anti-competitive laws being broken? It seems like the Fed, in its calm state of hallucination, has forgotten that the Bank of America, or any other merger (vertical or horizontal), may now have an anti-competitive share in some banking practice (take your pick). The government is promoting an auction by showcasing troubled banks (Citigroup and WaMu, for example). Anyone can bid, and the good old days of protecting competition has all-but faded away. Again, acting too quickly.

So where does this leave the rest of the U.S. economy? Should I expect that when I go bankrupt, the U.S. government will step in and save my ass? Well, if all of you out there believe in the essence of equity, then you better believe it. Tomorrow I will vow to spend every stinking dollar that I earn. I will go into debt and be happy, leading an awesomely hedonistic life, just because I know that the U.S. government will always be there to bail me out. Well, if I was GM or Washington Mutual, or even Barney’s, then I would be thinking this.

Now the precedent has been set. In the history of government interventions, this is the one that really defines the U.S. government as slightly, no ridiculously, crazy. No government should have such a broad-based stake in finance – money supply, insurance, investment banking, mortgages, taxes, spending – it’s just not the American way.

Did you [U.S. Treasury, Federal Reserve System, Congress, and the current Administration] ever stop to think – just once – that the pain associated with financial disarray would do more for the markets than your one-stop shop of government intervention? Hank says, “If it [the $700 billion bailout of Wall Street] doesn’t pass, then heaven help us all,” Well I say, If it does pass, then heaven help us all. You are playing with fire here boys – I hope that we are all wearing armor.

Rebecca Wilder

P.S. Hi Kashamere – does this do?

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