by Calculated Risk on 10/13/2005 08:17:00 PM

Back in April I offered a challenge: Pick the start of the next recession. The contest is still open.

I called it: "The Mug's Game Challenge"

NOTE: Here are the original rules. Unfortunately the comments disappear after a certain amount of time, so I will not be able to feature any comments from April. But I did keep all the entries (some are probably already wrong).

Here is a simple contest to predict the start of the next recession. The rules:

1) Enter a month and a year in the comments at any time right up to the recession being announced (one entry per person). Please feel free to state your reasons. I will feature those comments for the winners.

NOTE: You do not need to enter now. I am still waiting before I make my prediction. But early entries will be rewarded. I will update the contest every month as a reminder.

2) Scoring:

A) The Starting Month: The official starting month will be determined by the NBER. This usually occurs several months after the recession starts.

B) A pick will be considered correct if it is within +/- 2 months of the NBER determination (a 5 month window centered on the month picked). It is VERY difficult to pick the exact month, and being within a couple of months is quite an achievement.

C) All correct picks will be ranked by the number of months prior to the recession that the pick was entered. As an example, say the recession starts in Oct 2005: If someone correctly picks any month August 2005 through December 2005 (+/- 2 months) during April 2005, they will be rated a "6". This rewards picking the recession early.

All correct picks will be featured when the recession is announced and ranked by earliest picks.

Earlier I offered some thoughts on leading indicators for recessions. Several people have suggested other leading indicators to me. No one wants a recession, but we might as well have some fun!

Good luck to all!

UPDATE: Prize? The winners get their names mentioned, their comments featured, the admiration of their peers, and a free subscription to Calculated Risk!

Here are the picks from April:
Aug 2005 Kirk Spencer, wharf rat
Sep 2005 Vernon Bush
Oct 2005 BE, David Bennett
Nov 2005 David Yaseen, Fernando Margueirat, steve kyle, Nguyen Khuu
Jan 2006 Yusef Asabiyah, dryfly, Frank, redfish
Feb 2006 Mish, E.Robinson
Mar 2006 Colin H, ChasHeath, Alan Greenspend, Movie Guy, F.Hagan
Apr 2006 battlepanda
May 2006 Ken Houghton, navin
Jun 2006 DOR
Aug 2006 Jason Wright
Mar 2008 dilbert dogbert
Jul 2008 jl
Nov 2008 Elaine Supkis
March, 2011 Paul
NEVER Larry Kudlow's doppelganger

UPDATE: October Picks:
Sep 2005: Alexis
Nov 2005: OldVet
Dec 2005: reason, calmo, fatbear
Jan 2006: DF
Feb 2006: Tom Marney, Stormy, Ryanonthebeach, cariboo kid, semper fubar
Mar 2006: Vader, Fester
Apr 2006: Andrew, Dean
May 2006: Michael Cain
Jun 2006: Alex Norman
Jul 2006: Dr. Z, psh, David J
Sep 2006: Prudent Investor
Oct 2006: Kevin, Nanoking
Nov 2006: Uncle Jack, Tanta
Mar 2007: eightnine2718281828mu5
Aug 2007: OEE
Sep 2007: John Bott
Oct 2007: Nicholas Weaver
Jul 2008: op
Aug 2008: Lord
NEVER: dali lama
Posters can take the same month.

by Calculated Risk on 10/13/2005 03:32:00 PM

The NC Times reports: North County median home prices decline slightly

Median prices for existing North County homes eased downward in September, according to the monthly report from the North San Diego County Association of Realtors.

Single-family detached homes sold for a median price of $620,000 in September, down 2.8 percent from August's year-to-date high of $637,750.

This is a small one month decline and may not be a trend. Perhaps of more immediate interest is the market dynamics of price reductions and rising inventories:

More sellers appear to be lowering their asking price to reflect those conditions, said Kurt Kinsey, broker/owner of Blue Pacific Realtors.

Often, these properties are being sold by "flippers," people who buy homes with an eye to selling them for a quick profit, said Kinsey, whose firm specializes in Carlsbad and Oceanside real estate. Kinsey estimated that 20 percent of sellers in Carlsbad are flippers, and perhaps half that percent in Oceanside.

"There are as many homes for resale in Carlsbad as in Oceanside, which has more than double the population," Kinsey said.

Added to this abundance of resales are new homes being sold in Carlsbad in developments such as Bressi Ranch, La Costa Greens and Calavera Hills, Kinsey said. That gives Carlsbad buyers a strong bargaining position.
...
Jerry Kalman, a Realtor in the Fallbrook/Bonsall area, reported that September was notable for "an unusually high number of homes that were repriced lower and that eventually sold for less than their original listing price."

by Calculated Risk on 10/13/2005 08:30:00 AM

UPDATE: As always on Trade Deficit / Current Account issues, Dr. Setser has some great insights (on other issues too!): Relative prices do matter

The U.S. Census Bureau and the U.S. Bureau of Economic Analysis released the monthly trade balance report today for August:

"... total August exports of $108.2 billion and imports of $167.2 billion resulted in a goods and services deficit of $59.0 billion, compared with $58.0 billion in July, revised.

August exports were $1.8 billion more than July exports of $106.4 billion. August imports were $2.9 billion more than July imports of $164.3 Billion."

Note: all numbers are seasonally adjusted.


Click on graph for larger image.

August 2005 was 15% worse than August 2004. For the first eight months of 2005, the trade deficits is up 17% over the same period in 2004.

Imports from China set another record of $22,365 Billion. Imports from Japan were up slightly to $11,552 Billion.


The average contract price for oil set a new record of $52.65 per barrel breaking the old record of $49.03 in July.

The SA petroleum trade deficit set another record of $20.6 Billion.

With record imports from China and a record petroleum deficit, I'm surprised that the overall trade deficit wasn't a record; but it was close. The September deficit will be impacted by Katrina and most likely be another record.

by Calculated Risk on 10/13/2005 01:54:00 AM

Some more reading ...

Dr. Thoma reviews a new Fed Study: The Dallas Fed: Has the Housing Boom Increased Mortgage Risk?

CNN reports: Mortgages: Bracing for 6%

30-year mortgage rates look set to rise above 6 percent for the first time since July 2004, potentially helping set the stage for a slowdown in home sales.

And from the LA Times: Life on Financial Edge to Get Tougher

by Calculated Risk on 10/12/2005 06:21:00 PM

Economist Dr. Arturo Estrella of the NY FED provides some answers to Frequently Asked Questions about the yield curve in "The Yield Curve as a Leading Indicator"

Q. What does the evidence say, in short?

A. The difference between long-term and short-term interest rates ("the slope of the yield curve" or "the term spread") has borne a consistent negative relationship with subsequent real economic activity in the United States, with a lead time of about four to six quarters. The measures of the yield curve most frequently employed are based on differences between interest rates on Treasury securities of contrasting maturities, for instance, ten years minus three months. The measures of real activity for which predictive power has been found include GNP and GDP growth, growth in consumption, investment and industrial production, and economic recessions as dated by the National Bureau of Economic Research (NBER). The specific accuracy of these predictions depends on the particular measures employed, as well as on the estimation and prediction periods. However, the results are generally statistically significant and compare favorably with other variables employed as leading indicators. For instance, models that predict real GDP growth or recessions tend to explain 30 percent or more of the variation in the measure of real activity. See Estrella and Hardouvelis (1991). The yield curve has predicted essentially every U.S. recession since 1950 with only one "false" signal, which preceded the credit crunch and slowdown in production in 1967. There is also evidence that the predictive relationships exist in other countries, notably Germany, Canada, and the United Kingdom. See Estrella and Mishkin (1997) and Bernard and Gerlach (1998).

See the link for more FAQs. Dr. Estrella provides this graph to compare the yield curve to previous recessions.

Click on graph for larger image.

Yield curve inversions have preceded each of the last six recessions. To illustrate, the top figure shows the spread between ten‐year and three‐month Treasury securities since 1960, with shading to indicate NBER dated recessions. The bottom panel shows the probability of recession one year ahead, obtained by applying a probit model to the term spread as defined above.

The yield curve is still positive, but the spread has been decreasing. Therefore, according to Dr. Estrella, the probability of a recession is increasing.

by Calculated Risk on 10/12/2005 12:29:00 PM

UPDATE: Dr. Thoma excerpts speeches from Greenspan and Kohn too.

Reuters reports:

Bies warns on risky lending practices Federal Reserve Board Governor Susan Bies issued a warning on Wednesday on risky real-estate lending practices, saying banks could be hurt by higher interest rates or a decline in home prices.

"Banking supervisors have become concerned recently about apparent increased risk-taking in both commercial and real estate lending," Bies said in remarks prepared for delivery to the National Bankers Association annual convention in Beverly Hills, California.
...
"There is some concern that banks' home equity loan portfolios may be vulnerable to a rise in interest rates and, in some markets, a decline in home values," she said.
...
She said regulators were conducting a survey of banks' so-called affordability lending practices and said they might offer regulatory guidance on the subject in the near future.

Bies noted U.S. housing prices had jumped 13.4 percent in the second quarter from a year ago -- the biggest gain in more than a quarter century -- and said speculative buying appeared to be a factor behind the increase.

Here is the text of Governor Susan Bies speech: Regulatory Issues.

by Calculated Risk on 10/12/2005 11:36:00 AM

Bloomberg reports: U.S. MBA's Mortgage Applications Index Fell 2.6% Last Week

U.S. mortgage applications fell last week to the lowest level since April as higher interest rates slowed both refinancing and home purchases, according to a private group's survey released today.

The Mortgage Bankers Association's gauge of applications declined 2.6 percent to 694.8 in the week ended Oct. 7 from 713.5 the previous week. The last time the index was as low was April 15, when it was 672.6.

The average 30-year fixed mortgage increased to 5.98 percent, the highest since the end of March and the fifth straight rise, according to the bankers group. Higher borrowing costs have caused purchase applications to decline in each of the last four weeks, suggesting home sales are starting to cool.

According to the Mortgage Bankers Association (MBA) the refinance share of activity declined as did the share of ARMs:

The refinance share of mortgage activity decreased to 43.5 percent of total applications from 44.5 percent the previous week. The adjustable-rate mortgage (ARM) share of activity decreased to 29.5 percent of total applications from 29.8 percent the previous week.
...
The average contract interest rate for one-year ARMs increased to 5.26 percent from 5.13 percent one week earlier.

The spread between the 30 year interest rate and the 1 year ARM is now 0.72 basis points; the lowest spread since March 9, 2001.

The Riddles

With rising interest rates, why is the refinance activity so high?

With the narrow spread between fixed rate loans and ARMs (and rising rates) why is anyone using an ARM?

From Bloomberg: Bob Walters, chief economist at Quicken Loans Inc. said they are seeing more people refinance out of their adjustable rate mortgages to fixed-rate mortgages in anticipation of higher borrowing costs. That is a similar explanation as in the LA Times article, "Thinking long-term" that described similar motives of homeowners refinancing their variable rate loans to lock in the security of a fixed rate loan.

This can at least partially explain why refinance activity remains so strong, but I expect that activity to diminish rapidly. With both adjustable and fixed rates rising (and widely advertised to keep rising), those homeowners motivated by locking in a fixed rated will probably refinance soon.

But that doesn't explain the high level of ARM activity. Why is anyone using an ARM today?

Here are two possible explanations: 1) new homebuyers are continuing to stretch to buy a home and 2) existing ARM users are refinancing with ARMs to get a new low teaser rate.

If new homebuyers are using ARMs that is most likely a sign of speculation. With the current spread and direction of rates, I would expect new buyers to use fixed rate loans if they could afford the payments.

The second explanation was described in this LA Times article: Risky 'Exotic' Loans Fostering a Refi Cycle. Apparently many borrowers are desperately replacing existing ARMs and IOs with new ARMs and IOs to forestall higher payments. They are hoping the price appreciation in their homes will bail them out. This is a short term strategy and the day of reckoning is probably soon.

If the riddles are solved, the solutions are not healthy for the housing market. I expect the refinance activity to diminish rapidly and speculation (ARM users) to almost disappear as short term rates rise and the housing market slows.

by Calculated Risk on 10/11/2005 10:30:00 PM

The US Trade Balance for August will be released on Thursday. The concensus is for a deficit of $59.3 Billion or slightly less than the $60.4 Billion record deficit in February. The July trade deficit was $57.9 Billion.

My estimate for the SA petroleum trade deficit is $21.2 Billion or $2.6 Billion worse than the record petroleum deficit in July.

Imports from China will most likely set a record again based on traffic at the west coast ports. My estimate for imports from China (NSA) are just over $22 Billion. Exports to China will probably be under $3.5 Billion. SA this is about the same as July.

My guess for the August deficit: $60.5 Billion. A new record.

by Calculated Risk on 10/11/2005 11:35:00 AM

As a follow up to the previous post, DiMartino writes: Soft landing isn't in cards for U.S.

A report by Morgan Stanley chief economist Stephen Roach highlighted the differences between the rest of the world and us.
...
We're a lot more reliant on the consumer sector, Mr. Roach says:

"The U.S. stands alone in the excesses of consumerism, with personal consumption averaging fully 71 percent of GDP since early 2002 – well above the 67 percent norm that prevailed over the 25-year period, 1975 to 2000."
...
The British also had the benefit of having a cushion to fall back on. The personal savings rate in Europe is 14 percent. In Japan it's 8 percent, and in China it's too high – 35 percent.

And here? Well, it doesn't exist. The savings rate has been negative for three straight months.

"Not since 1933 – hardly a comforting comparison – have consumers spent this far beyond their means," Mr. Roach observed. "No other country or economy comes close to matching the American model of excess consumption and negative saving."

DiMartino concludes:

Where are we going?

Home prices have begun declining in some markets. National inventories of new homes are the highest ever recorded, and stocks of existing homes are following in the same straight line upward.

"As sure as night follows day, pricing will follow this inventory overhang," said David Rosenberg, chief economist at Merrill Lynch.

Higher energy prices could not hit at a worse time, and the Fed is still raising interest rates. A soft landing seems like a far-off dream.

"... as night follows day ..."

by Calculated Risk on 10/11/2005 01:30:00 AM

Bloomberg reports: U.K. Retail Sales Fell for a Sixth Month in September, BRC Says

U.K. retail sales fell for a sixth month in September, the British Retail Consortium said, a sign that a slowdown in consumer spending may be worsening.

Sales in stores open at least a year fell 0.8 percent from September last year, the BRC, a London-based lobbying group that represents 80 percent of U.K. retailers, said in an e-mailed report today. That followed a 1 percent decline in August.

It is possible that the UK is a leading indicator for the US, since the Bank of England started raising rates eight months before the Federal Reserve. The BoE started in November of 2003 and the Federal Reserve didn't start raising rates until June, 2004. The discussion now in the UK is of rate cuts:

"It is still too soon to say that things are improving," said Kevin Hawkins, director general of the BRC, in a statement. "The case for a reduction in interest rates is now as pressing as ever."

Investors have increased bets on a further quarter-point reduction by June 2006, interest-rate futures trading shows. The implied rate on the contract maturing that month was 4.25 percent late yesterday ...

Click on graph for larger image.

The graph shows the Fed Funds rate vs. the BoE Repo rate since the beginning of 2001. The question now is when the Fed Funds rate will be higher than the Repo rate.

Sales are especially difficult for the housing related sectors since the housing slowdown has already started in the UK:

MFI, Britain's largest furniture retailer, on Oct. 3 forecast an annual loss after sales dropped 31 percent in the period from Sept. 8. In the preceding 13-week period, sales fell 15 percent.

The average value of a house in the U.K. fell for a second straight month in September and annual home-price inflation slowed to a nine-year low, the Nationwide Building Society said Sept. 29.

Danielle DiMartino of the Dallas Morning News is writing on this topic this week. In Monday's column, she concluded with topics we have discussed:

"Sustained price appreciation has persuaded U.S. households to extract larger and larger amounts of home equity via cash-out refinancing, home-equity borrowing, and the housing turnover process in recent years," Jan Hatzius, senior economist at Goldman Sachs, said in a recent report.

"Judging from the decline in the personal savings rate, much of this mortgage equity withdrawal seems to have found its way into spending," he continued. "That implies a slowdown in house price appreciation is likely to depress mortgage-equity withdrawal and consumer spending."

So, we take our lumps. So, retail spending slows.

And, like Great Britain has just done, we emerge a bit wiser for the experience but relatively unharmed.

Or do we?

On Tuesday, DiMartino promises to outline some of the differences between the UK experience and the US. Hopefully some of the UK experts will critique her analysis!