by Calculated Risk on 9/10/2009 10:15:00 PM

From the WSJ: Ross Gets Nod for a Bank Charter

Real-estate mogul Stephen M. Ross and the two other partners in his company, Related Cos., have been granted preliminary approval by regulators to charter a new bank, a move that would allow them to bid on failed institutions seized by the government.

The approval comes at a time that Related, a national real-estate developer known for such high-profile projects as Time Warner Center in New York, vies with a stable of private-equity and real-estate firms to buy the assets of condo lender Corus Bankshares Inc.

Although the FDIC was apparently soliciting bids for both the bank and the condo projects separately, the WSJ suggests the FDIC might prefer to sell to one bidder. According to published reports, bids for the assets of Corus were due last Thursday, so the bank will probably be seized some Friday this month.

I'll take tomorrow.

by Calculated Risk on 9/10/2009 06:36:00 PM

This speech is a review of an academic paper (and a bit wonkish) ... here are some excerpts on two key topics: 1) how well the Fed followed the precepts of Walter Bagehot, and 2) if the Fed should target a higher inflation rate in a liquidity trap.

From Federal Reserve Vice Chairman Donald Kohn: Comments on "Interpreting the Unconventional U.S. Monetary Policy of 2007-2009"

... In designing our liquidity facilities we were guided by the time-tested precepts derived from the work of Walter Bagehot. Those precepts hold that central banks can and should ameliorate financial crises by providing ample credit to a wide set of borrowers, as long as the borrowers are solvent, the loans are provided against good collateral, and a penalty rate is charged.
..
The liquidity measures we took during the financial crisis, although unprecedented in their details, were generally consistent with Bagehot's principles and aimed at short-circuiting these feedback loops. The Federal Reserve lends only against collateral that meets specific quality requirements, and it applies haircuts where appropriate. Beyond the collateral, in many cases we also have recourse to the borrowing institution for repayment. In the case of the TALF, we are backstopped by the Treasury. In addition, the terms and conditions of most of our facilities are designed to be unattractive under normal market conditions, thus preserving borrowers' incentives to obtain funds in the market when markets are operating normally. Apart from a very small number of exceptions involving systemically important institutions, such features have limited the extent to which the Federal Reserve has taken on credit risk, and the overall credit risk involved in our lending during the crisis has been small.

In Ricardo's view, if the collateral had really been good, private institutions would have lent against it. However, as has been recognized since Bagehot, private lenders, acting to protect themselves, typically severely curtail lending during a financial crisis, irrespective of the quality of the available collateral. The central bank--because it is not liquidity constrained and has the infrastructure in place to make loans against a variety of collateral--is well positioned to make those loans in the interest of financial stability, and can make them without taking on significant credit risk, as long as its lending is secured by sound collateral. A key function of the central bank is to lend in such circumstances to contain the crisis and mitigate its effects on the economy.
emphasis added

Clearly the Fed believes - except in a few special circumstances - that they did not take on significant credit risk.

And on monetary policy in a liquidity trap:

Ricardo notes that the theoretical literature on monetary policy in a liquidity trap commonly prescribes targeting higher-than-normal inflation rates even beyond the point of economic recovery, so that real interest rates decline by more and thus provide greater stimulus for the economy. The arguments in favor of such a policy hinge on a clear understanding on the part of the public that the central bank will tolerate increased inflation only temporarily--say, for a few years once the economy has recovered--before returning to the original inflation target in the long term. Notably, although many central banks have put their policy rates near zero, none have adopted this prescription. In the theoretical environment considered by the paper, long-run inflation expectations are perfectly anchored. In reality, however, the anchoring of inflation expectations has been a hard-won achievement of monetary policy over the past few decades, and we should not take this stability for granted. Models are by their nature only a stylized representation of reality, and a policy of achieving "temporarily" higher inflation over the medium term would run the risk of altering inflation expectations beyond the horizon that is desirable. Were that to happen, the costs of bringing expectations back to their current anchored state might be quite high. But while the Federal Reserve has not attempted to raise medium-term inflation expectations as prescribed by the theories discussed in the paper, it has taken numerous steps to lower real interest rates for private borrowers and keep inflation expectations from slipping to undesirably low levels in order to prevent unwanted disinflation. These steps include the credit policies I discussed earlier, the provision of forward guidance that the level of short-term interest rates is expected to remain quite low "for an extended period" conditional on the outlook for the economy and inflation, and the publication of the longer-run inflation objectives of FOMC members.

There are both interesting topics. If the collateral is mostly solid (or the haircuts appropriate), then the Fed will be in decent shape when they start to unwind current policy positions. However Reis (no link) apparently argues that the Fed will suffer significant losses, and the borrowing from the Treasury will make the Fed's monetary policy less independent.

by Calculated Risk on 9/10/2009 02:50:00 PM

Professors Atif Mian and Amir Sufi (both University of Chicago Booth School of Business and NBER) published a new paper: The Household Leverage-Driven Recession of 2007 to 2009 This is related to their paper earlier this year: House Prices, Home Equity-Based Borrowing, and the U.S. Household Leverage Crisis, See: MEW, Consumption and Personal Saving Rate

A cross-sectional analysis of U.S. counties shows that areas with modest increases in leverage from 2002 to 2006 have experienced only a minor economic downturn, whereas counties with large increases in household leverage from 2002 to 2006 have experienced a severe recession. Our findings suggest that the process of household de-leveraging is likely to be the major headwind facing the economy going forward.

The authors have written a brief discussion of the paper at NPR Money: Lessons From The Fall: Household Debt Got Us Into This Mess

The Economist has a recent review of the paper: Withdrawal symptoms

More than a third of new defaults in 2006-08 were because of home-equity-based borrowing. Default rates for low credit-quality homeowners rose by more than 12 percentage points in places where housing was scarcest and prices had risen most. In “elastic” cities, by contrast, the increase was less than four percentage points. This suggests huge over-borrowing. Prospects for a sustained recovery look dim if households that are most inclined to spend are mired in negative equity.

Here are three graphs from the paper (posted with permission from the author):

Click on graph for larger image.

The first graph is figure 5B from the paper. Looking at the left panel, note that the x-axis is the change in debt to income, by County, from 2002 to 2006. And the y-axis is for the period 2006 - 2008. This shows that the change in the debt to income ratio was a good predictor of default rates.

From the authors:

Correlation across Counties of Default Rates and House Prices during Recession with Leverage Growth from 2002 t0 2006

The left panel presents the correlation across U.S. counties of the increase in the household debt to income ratio from 2002 to 2006 and the increase in the default rate from 2006 to 2008. The right panel presents the correlation across U.S. counties of the increase in the household debt to income ratio from 2002 to 2006 and the decline in house prices from 2006 to 2008. The sample includes 450 counties with at least 50,000 households as of 2000.

The second graph is figure 6A from the paper. From the authors:

Auto Sales and Unemployment Rates in High and Low Leverage Growth Counties

High leverage growth counties are defined to be the top 10% of counties by the increase in the debt to income ratio from 2002 to 2006. Low leverage growth counties are in the bottom 10% on the same measure. The left panel plots the growth in auto sales for high and low leverage growth counties since 2005, and the right panel plots the change in the unemployment rate in high and low leverage growth counties since 2005. Auto sales decline and unemployment increases by significantly more in counties that experience the sharpest increase in debt to income ratios from 2002 to 2006.

The third graph is figure 6B from the paper. From the authors:

Correlation across Counties of Auto Sales and Unemployment during Recession with Leverage Growth from 2002 to 2006

The left panel presents the correlation across U.S. counties of the increase in the household debt to income ratio from 2002 to 2006 and the decline in auto sales from 2006 to 2008. The right panel presents the correlation across U.S. counties of the increase in the household debt to income ratio from 2002 to 2006 and the increase in unemployment rates from 2006 to 2008. The sample includes 450 counties with at least 50,000 households as of 2000.

This analysis, comparing high and low leverage counties, is very revealing and shows that the high leverage areas are also the hardest hit (not surprising to those of us who felt mortgage equity extraction was a significant driver of consumption growth). The authors conclude:

[T]he initial economic slowdown was a direct result of an over-leveraged household sector unable to keep pace with its debt obligations.

by Calculated Risk on 9/10/2009 11:39:00 AM

From the Census Bureau:

The U.S. Census Bureau announced today that real median household income in the United States fell 3.6 percent between 2007 and 2008, from$52,163 to $50,303. This breaks a string of three years of annual income increases and coincides with the recession that started in December 2007.

The nation’s official poverty rate in 2008 was 13.2 percent, up from 12.5 percent in 2007. There were 39.8 million people in poverty in 2008, up from 37.3 million in 2007.

Meanwhile, the number of people without health insurance coverage rose from 45.7 million in 2007 to 46.3 million in 2008, while the percentage remained unchanged at15.4 percent.
...
•Income inequality was statistically unchanged between 2007 and 2008, as measured by shares of aggregate household income by quintiles and the Gini index. The Gini index was 0.466 in 2008.

Here are some interesting stats on income: Annual Social and Economic (ASEC) Supplement

Note: for the house price to household income chart I graph every quarter, I assumed a "2% increase in household [nominal] median income for 2008 and flat for 2009". That was too optimistic.

by Calculated Risk on 9/10/2009 11:02:00 AM

From Diana Golobay at Housing Wire: Federal Incentives Coming for Short Sales, Deeds-in-Lieu

US Treasury Department sources confirmed to HousingWire the Treasury expects to issue details on the short sale and deed-in-lieu program later this month.
...
[Federal Housing Administration (FHA) commissioner David Stevens said, in prepared remarks, at a House Financial Services subcommittee hearing yesterday:] “Because we know that the MHA program will not reach every at-risk homeowner or prevent all foreclosures, on May 14th the Administration announced the Foreclosure Alternatives program that will provide incentives for, and encourage, servicers and borrowers to pursue short sales and deeds-in-lieu (DIL) of foreclosure in cases where the borrower is generally eligible for a MHA modification but does not qualify or is unable to complete the process.”

He said the program will simplify the process of pursuing short sales and deeds-in-lieu, which will encourage more servicers and borrowers to participate in the program. The program will standardize the process, documentation and short performance timeframes.

“These options eliminate the need for potentially lengthy and expensive foreclosure proceedings, preserve the physical condition and value of the property by reducing the time a property is vacant, and allows the homeowners to transition with dignity to more affordable housing,” Stevens added.
emphasis added

This program is aimed at borrowers who would be "generally eligible for a MHA modification", but are probably too far underwater ... or owe too much.

by Calculated Risk on 9/10/2009 08:46:00 AM

The Census Bureau reports:

The ... total July exports of $127.6 billion and imports of $159.6 billion resulted in a goods and services deficit of $32.0 billion, up from $27.5 billion in June, revised.

Click on graph for larger image.

The first graph shows the monthly U.S. exports and imports in dollars through July 2009.

Imports were up again in July, and exports also increased. On a year-over-year basis, exports are off 22% and imports are off 30%.

The second graph shows the U.S. trade deficit, with and without petroleum, through July.

The blue line is the total deficit, and the black line is the petroleum deficit, and the red line is the trade deficit ex-petroleum products.

Import oil prices increased to $62.48 in July - up about 50% from the prices in February (at $39.22) - and the fifth monthly increase in a row. Import oil prices will probably rise further in August.

It appears the cliff diving for U.S. trade might be over, although recent port data shows some weakness in traffic.

by Calculated Risk on 9/10/2009 08:31:00 AM

The DOL reports weekly unemployment insurance claims decreased to 550,000:

In the week ending Sept. 5, the advance figure for seasonally adjusted initial claims was 550,000, a decrease of 26,000 from the previous week's revised figure of 576,000. The 4-week moving average was 570,000, a decrease of 2,750 from the previous week's revised average of 572,750.
...
The advance number for seasonally adjusted insured unemployment during the week ending Aug. 29 was 6,088,000, a decrease of 159,000 from the preceding week's revised level of 6,247,000.

Click on graph for larger image in new window.

This graph shows the 4-week moving average of weekly claims since 1971.

The four-week average of weekly unemployment claims decreased this week by 1,250 to 570,000, and is now 88,750 below the peak in April.

It appears that initial weekly claims have peaked for this cycle. However it seem that weekly claims are stuck at a very high level; weekly claims have been in the high 500 thousands for 10 weeks. This indicates continuing weakness in the job market. The four-week average of initial weekly claims will probably have to fall below 400,000 before the total employment stops falling.

by Calculated Risk on 9/09/2009 09:12:00 PM

From Eric Dash at the NY Times: In Florida, Vestiges of the Boom

On the corner of Flamingo Road and Pink Flamingo Lane ... a soaring monument to the great condominium bust bakes under the Florida sun.

The Tao Sawgrass ... built on the western fringes of Fort Lauderdale with easy money from the now tottering condo king of American finance: Corus Bancshares of Chicago. Only about 50 of the 396 units have been sold.

... The primary regulator of Corus, the Office of the Comptroller of the Currency, failed to sound the alarm until Corus was deeply troubled. ... Corus will go down as the great enabler of condo madness, and its travails are a harbinger of the pain yet to come in the troubled world of commercial real estate.

...regulators are moving to cleave the bank in two and sell its banking operations and condominium loans separately. The hope is to clinch a deal by the end of the month.

This article touches on several key points - the speculative activities of Corus, the slow response of their primary regulator, the FDIC trying to split the bank in two to sell the banking operations (not worth much) separately from the "monuments to madness" condo towers (also not worth much), the coming losses from C&D and CRE loans for other banks, the coming hit from Corus to the Deposit Insurance Fund (DIF) and more ...

Also, this article suggests Corus might have until the end of the month. However the bids for assets were due last Thursday, and I think it is likely that Corus will be seized this week.

by Calculated Risk on 9/09/2009 08:05:00 PM

YouTube live feed (ht bANK fAILURE) or Link Here for large image.

Note: Embed removed. Here is the text for the speech.

by Calculated Risk on 9/09/2009 07:21:00 PM

There seems to more and more concern about the deficit and the increases in the National Debt. It is definitely scary, and I've been writing about this issue for a number of years.

Back in late 2000 and in 2001 (I started this blog in January 2005) I focused on the deficit - and the long term fiscal damage I felt the Bush policies would cause.

President Bush argued in February 2001 that his fiscal policy "returns ... the surplus to the American taxpayers". In his 2001 testimony to Congress, then Fed Chairman Alan Greenspan supported President Bush by offering projections of "an on-budget surplus of almost $500 billion ... in fiscal year 2010". The National Debt would soon be retired and the Boomer's retirements secure. Greenspan offered a projection of "an implicit on-budget surplus under baseline assumptions well past 2030 despite the budgetary pressures from the aging of the baby-boom generation, especially on the major health programs."

Mr Bush also said in February 2001: "After paying the bills, my plan reduces the national debt, and fast. So fast, in fact, that economists worry that we're going to run out of debt to retire. That would be a good worry to have."

I disagreed strongly with President Bush and Mr. Greenspan's projections. I argued the surpluses were a mirage, and the tax policies would create a significant structural deficit.

I became even more adamant about the Bush structural deficits in 2004 and 2005, when it became obvious that the small improvement in the annual deficit was because of the housing bubble. I wrote in March 2005 about why I was so concerned about the housing bubble:

If we slide into a global recession, we have limited tools available to stimulate the economy. Interest rates are already very low (although the Fed has recently put some arrows back into the quiver), and we are already running general fund budget deficits of close to 6% of GDP.

In 2006, Professor Samwick (who served as Chief Economist on the Staff of President Bush's Council of Economic Advisers) wrote: First Things First

CR writes:

Everyone should agree that the most immediate fiscal problem is the structural General Fund deficit. Excluding future health care costs, the structural deficit is around 4% to 4.5% of GDP. This serious problem has been caused almost exclusively by Bush's policies. And imagine if the economy slows next year, as many people expect, adding a cyclical deficit on top of the huge Bush structural deficit.

So isn't it reasonable to suggest that Mr. Bush and the GOP fix the structural deficit first, before addressing other long-term issues? Of course.

CR is correct in his diagnosis of the immediacy and the size of the problems of the General Fund deficit. As I have discussed in earlier posts ... the appropriate target for the General Fund deficit is for it to average to zero over a business cycle. A corollary to that is that the General Fund should be in surplus during the non-recessionary parts of that business cycle. (A slightly weaker target that I would also accept is that the Debt/GDP ratio not trend upward over time.)

Today I believe some people are getting upset about the wrong thing at the wrong time. As Samwick noted, during a recession the deficits will increase - from falling tax revenues, automatic stabilizers and stimulus spending. Maybe some people disagree with the stimulus package, but that isn't going to change (except additions like extending unemployment benefits again).

Eliminating the recessionary deficit requires the economy to recover, and unfortunately the recovery will most likely be choppy and sluggish, but eventually a recovery will happen. Eliminating the structural deficit will be much more difficult and will require hard choices, but now is not the time.

The time to concerned about the structural deficit was in 2001 through 2006, and hopefully again starting in 2011 or 2012.