by Calculated Risk on 9/21/2009 08:43:00 AM

"We could be facing a triple whammy at the end of the year: the expiration of the tax credit, the end of the Fed mortgage-buying program and rising foreclosures.”
Thomas Lawler, housing economist

From Bloomberg: Housing Suffering Relapse Confronts Bernanke Credit Conundrum (ht Mike in Long Island) A few excerpts:

The Fed’s purchases of mortgage-backed debt so far this year have dwarfed net issues of such securities by Fannie Mae, Freddie Mac and government-run mortgage-bond insurer Ginnie Mae, which totaled about $440 billion through the end of August, said Walt Schmidt, a mortgage-bond strategist in Chicago at FTN Financial.

Once the Fed exits the market, the spread between yields on mortgage-backed debt and Treasury securities will have to rise, perhaps by a half percentage point, in order to attract other buyers, he said.
...
The impact of terminating the tax credit will show up first in the new-home market, said David Crowe, chief economist of the home-builders’ association.

“It takes at least four months to build a house, and you need to buy it before Dec. 1 to qualify,” he said. “If you haven’t started building it by now, it’s too late.”
...
Residential construction and home sales led the way out of the previous seven recessions going back to 1960, according to David Berson, chief economist of PMI Group, a mortgage insurer in Walnut Creek, California.

These excerpts make three key points:

The spread between Mortgage rates and treasuries will increase when the Fed stops buying MBS (my guess is about 35 bps),

the end of the housing tax credit will probably show up in new home sales data first, and

housing is usually one of the key engines of recovery (along with consumer spending). The overall recovery will probably be sluggish because both housing and consumer spending will be under pressure for some time.

by Calculated Risk on 9/20/2009 11:46:00 PM

From Paul Krugman on financial reform: Reform or Bust

I was startled last week when Mr. Obama, in an interview with Bloomberg News, questioned the case for limiting financial-sector pay: “Why is it,” he asked, “that we’re going to cap executive compensation for Wall Street bankers but not Silicon Valley entrepreneurs or N.F.L. football players?”

That’s an astonishing remark — and not just because the National Football League does, in fact, have pay caps. Tech firms don’t crash the whole world’s operating system when they go bankrupt; quarterbacks who make too many risky passes don’t have to be rescued with hundred-billion-dollar bailouts. Banking is a special case ...

Inferior goods in Japan! From the NY Times: Once Slave to Luxury, Japan Catches Thrift Bug

Across the board, discount retailers are reporting increases in revenue — while just about everyone else is experiencing declines, in some cases, by double digits.

As a result, the luxury boutiques, once almighty here, are reeling.
...
In the 1970s and ’80s, and even as the economy limped through the ’90s, a wide group of consumers spent generously on Louis Vuitton bags and Hermès scarves — even at the expense of holidays, travel and, sometimes, meals and rent.

Now, the Japanese luxury market, worth $15 billion to $20 billion, has been among the hardest hit by the global economic crisis, according to a report by the consulting firm McKinsey & Company.

Futures are off slightly ...

Futures from barchart.com

Bloomberg Futures.

CBOT mini-sized Dow

CME Globex Flash Quotes

And the Asian markets are mixed.

Best to all.

by Calculated Risk on 9/20/2009 08:41:00 PM

Earlier today I posted a couple of bullish views and I disagreed with the projections of an "Immaculate Recovery". Former IMF chief economist Michael Mussa suggested that consumer spending wouldn't lead this recovery, but that business investment would be strong.

This graph shows the general relationship between capital spending and consumer spending (ht Jan Hatzius, Capital Spending: The Caboose of a Slow Train). Note: Consumer spending lagged two quarters for best fit.

Click on graph for larger image in new window.

This suggests that consumer spending needs to pickup to above 1.5% year-over-year growth rate for business investment in equipment and software to be positive. If businesses expects consumer spending to pick up sharply, maybe they'd invest more - but few business owners expect a sharp pickup.

There might be a boost in capital spending because of a replacement cycle, but with all the slack in the economy (capacity utilization is near record lows and almost double digit unemployment), I definitely don't expect business spending to lead the recovery (as Mussa suggested).

by Calculated Risk on 9/20/2009 04:11:00 PM

From a NY Times Editorial: Facts and the Financial Crisis

The Financial Crisis Inquiry Commission, created by Congress to examine the causes of the crisis, held its first public meeting last week. ... the meeting was a long time coming, and thin on substance.

The NY Times asks some good questions:

In the run-up to the crisis, what did regulators, particularly the Federal Reserve, know and do in response to unconstrained lending? What were their thoughts about the way banks and investors worldwide increasingly disregarded risk?

Publicly, they did not act to curb the excesses. But internally, was there contrary analysis or dissent? Were there chances to take another course that we may learn from now in hindsight?

Answers to these questions are in files that are not public and in the heads of the people in positions of responsibility at the time. The commission must be aggressive in its pursuit of documents and unflinching in taking testimony at even the highest levels of government and business.

It will be interesting to read the 2004 FOMC transcripts to see if there was any discussion of lending standards, house prices and a credit bubble. It makes no sense that we have to wait 5+ years for the transcripts ...

I suspect we will find some concerns expressed in 2004 - perhaps something similar to what Fed Economist Michael Prell said at the Dec 21, 1999 FOMC (about the stock market):

To illustrate the speculative character of the market, let me cite an excerpt from a recent IPO prospectus: ... “We do not expect to generate sufficient revenues to achieve profitability and, therefore, we expect to continue to incur net losses for at least the foreseeable future. If we do achieve profitability, we may not be able to sustain it.” Based on these prospects, the VA Linux IPO recorded a first-day price gain of about 700 percent and has a market cap of roughly $9 billion. Not bad for a company that some analysts say has no hold on any significant technology.

The warning language I’ve just read is at least an improvement in disclosure compared to the classic prospectus of the South Sea Bubble era, in which someone offered shares in “A company for carrying on an undertaking of great advantage, but nobody to know what it is.” But, I wonder whether the spirit of the times isn’t becoming similar to that of the earlier period. ... At this point, those same people are abandoning all efforts at fundamental analysis and talking about momentum as the only thing that matters.

If this speculation were occurring on a scale that wasn’t lifting the overall market, it might be of concern only for the distortions in resource allocation it might be causing. But it has in fact been giving rise to significant gains in household wealth and thereby contributing to the rapid growth of consumer demand--something reflected in the internal and external saving imbalances that are much discussed in some circles.
emphasis added

I wouldn't be surprised to see something similar in the 2004 transcripts, but about housing and the credit markets.

by Calculated Risk on 9/20/2009 01:07:00 PM

From James Grant in the WSJ: From Bear to Bull

Knocked for a loop, we forget a truism. With regard to the recession that precedes the recovery, worse is subsequently better. The deeper the slump, the zippier the recovery. To quote a dissenter from the forecasting consensus, Michael T. Darda, chief economist of MKM Partners, Greenwich, Conn.: "[T]he most important determinant of the strength of an economy recovery is the depth of the downturn that preceded it. There are no exceptions to this rule, including the 1929-1939 period."

Growth snapped back following the depressions of 1893-94, 1907-08, 1920-21 and 1929-33. If ugly downturns made for torpid recoveries, as today's economists suggest, the economic history of this country would have to be rewritten.
...
"At the business trough in 1933," Mr. Darda points out, "the unemployment rate stood at 25% (if there had been a 'U6' version of labor underutilization then, it likely would have been about 44% vs. 16.8% today. . . ). At the same time, the consumption share of GDP was above 80% in 1933 and the household savings rate was negative. Yet, in the four years that followed, the economy expanded at a 9.5% annual average rate while the unemployment rate dropped 10.6 percentage points."
...
Our recession, though a mere inconvenience compared to some of the cyclical snows of yesteryear, does bear comparison with the slump of 1981-82. In the worst quarter of that contraction, the first three months of 1982, real GDP shrank at an annual rate of 6.4%, matching the steepest drop of the current recession, which was registered in the first quarter of 2009. Yet the Reagan recovery, starting in the first quarter of 1983, rushed along at quarterly growth rates (expressed as annual rates of change) over the next six quarters of 5.1%, 9.3%, 8.1%, 8.5%, 8.0% and 7.1%. Not until the third quarter of 1984 did real quarterly GDP growth drop below 5%.

And from McClatchy Newspapers: Ex-IMF chief economist has rosy recovery view

[Michael] Mussa, the former chief economist of the International Monetary Fund, presented a decidedly upbeat economic forecast last week that turned heads in the nation's capital. ...

"The recession is over and a global recovery is under way," he began, unveiling a pile of data and historical charts to support his view that forecasters regularly underestimate recoveries – and are doing so again.

Where the IMF foresees just 0.6 percent year-over-year growth in 2010 in the U.S. economy and 2.5 percent globally, Mussa sees 3.3 percent growth in the U.S. economy next year and 4.2 percent growth globally. He projects a U.S. growth rate of 4 percent from the middle of this year through the end of 2010.

"All forecasts tend to underpredict the recovery. … I think that's what we are seeing this time," said Mussa, now a senior fellow at the Peterson Institute for International Economics, a leading research organization in Washington.
...
Mussa pointed to forecasts made at the end of the 1981-1982 recession, the closest approximation to today's deep downturn. ...

The Reagan administration projected a growth rate from December 1982 to December 1983 of 3.1 percent, as did the Federal Reserve. In fact, the real growth rate turned out to be 6.3 percent.
...
Mussa concurs with most mainstream forecasters that consumers won't lead this recovery, and that Americans will sharply boost their savings to a 7 percent annual rate by the end of 2010.

What, then, will drive growth? Business investment, Mussa said ...

I disagree with these views.

First, I expect a decent GDP rebound in Q3 and Q4 because of an inventory correction and exports. However this boost will be temporary.

But what will be the engine of growth in 2010? Usually consumer spending and residential investment lead the economy out of recession. Although I started the year expecting a bottom in new home sales and single family housing starts (and it appears that has happened), there is still too much existing home inventory for much of an increase in the short term.

And even Mussa agrees that consumers will remain under pressure as they repair their household balance sheets - yet he expects growth in business investment?

Goldman Sachs put on a research note on Friday: Capital Spending: The Caboose of a Slow Train (no link). Although the analysts noted a possible equipment replacement cycle, they also noted:

Few businesses will step up capital spending sharply unless they see a meaningful improvement in end demand for their products. Since the most important component of end demand for US companies is the domestic consumer, our cautious view of the outlook for personal consumption also implies a cautious view of capital spending, other things being equal. In essence, capital spending is the caboose of recovery, not the locomotive.

There is already to much capacity, and until end demand absorbs some of that unused capacity, there won't be a meaningful increase in capital spending.

And on the comparison to the early '80s recession (both Grant and Mussa made this comparison), Krugman had some comments in early 2008: Postmodern recessions

A lot of what we think we know about recession and recovery comes from the experience of the 70s and 80s. But the recessions of that era were very different from the recessions since. Each of the slumps — 1969-70, 1973-75, and the double-dip slump from 1979 to 1982 — were caused, basically, by high interest rates imposed by the Fed to control inflation. In each case housing tanked, then bounced back when interest rates were allowed to fall again.

... Post-moderation recessions haven’t been deliberately engineered by the Fed, they just happen when credit bubbles or other things get out of hand.

And that means that the Fed can't just cut interest rates and boost housing. This recession is very different than the early '80s.

This time housing will remain under pressure until the number of excess housing units (both owner occupied and rentals) decline to more normal levels.

So I think an "Immaculate Recovery" is very unlikely.

by Calculated Risk on 9/20/2009 08:49:00 AM

From Carolyn Said at the San Francisco Chronicle: $30 billion home loan time bomb set for 2010

From 2004 to 2008, "one in five people who took out a mortgage loan (for both purchases and refinancing) in the San Francisco metropolitan region ... got an option ARM," said Bob Visini, senior director of marketing in San Francisco at First American CoreLogic, a mortgage research firm. "That's more than twice the national average.

"People think option ARMs (will be) a national crisis," he said. "That's not really true. It's just in higher-cost areas like California where you see their prevalence."
...
First American shows more than 54,000 option ARMs issued here with a value of about $30.9 billion. Fitch shows more than 47,000 option ARMs here with a value of about $28 billion. Both say their data underestimate the totals.
...
Fitch said 94 percent of borrowers elected to make minimum payments only.
...
Unlike subprime loans, which were more commonly used for entry-level homes, option ARMs started out with high balances. In the five-county San Francisco area, option ARMs average about $584,000 and were used to buy homes averaging $823,000, according to an analysis of First American data.

That means they'll spawn foreclosures among upper-end homes.
...
"The average option ARM borrower is significantly underwater, so much that they don't think they'll get out," Sirotic said. On average nationwide, option ARM borrowers ... owe is 126 percent of their home's value, based on depreciation and not including the effects of negative amortization, Sirotic said.

The article has much more.

Option ARMs were used as affordability products in mid-to-high priced areas of bubble states like California. Now most of the borrowers are significantly underwater, and this will lead to more foreclosures, and falling prices, in the mid-to-high end areas.

by Calculated Risk on 9/19/2009 10:47:00 PM

From the NY Times: Leading Senator Pushes New Plan to Oversee Banks

[Sentator Dodd] is planning to propose the merger of four bank agencies into one super-regulator, an idea that is significantly different from what President Obama envisions.

... the bill Mr. Dodd is preparing to make public in the coming weeks would be more ambitious and politically risky than the plan offered by the White House, which considered but then decided against combining the four banking agencies — the Federal Reserve, the Office of Thrift Supervision, the Federal Deposit Insurance Corporation and the Comptroller of the Currency — into one superagency.
...
In the House, Representative Barney Frank of Massachusetts, a Democrat and the chairman of the Financial Services Committee, has been working on legislation that is closer to the Obama plan on consolidation of the agencies.
...
Mr. Dodd has also rejected the administration’s proposal to have the Fed play the leading role as a so-called “systemic risk” regulator that examines the connections between regulated and unregulated companies for trouble spots that could disrupt the markets.

There is no question that the regulatory agencies reacted slowly to the obvious increase in risky loans in 2003 and 2004. I think any proposal should explain how a new "superagency" would have caught these problems earlier.

by Calculated Risk on 9/19/2009 06:51:00 PM

From the Chicago Sun Times: Capone lodge up for auction

Al Capone's "hideout retreat" in Wisconsin [is up for auction] minimum bid required: $2.5 million.

"Located in the beautiful Northwoods of Wisconsin" near Couderay, the property includes 407 acres with a 37-acre private lake, according to an ad placed on the property announcing the foreclosure sale by Chippewa Valley Bank.

The buyer will get the original 1920s main lodge made of native fieldstone and featuring a massive split fieldstone fireplace. The sale also includes an eight-car garage renovated into a bar and restaurant, a bunkhouse, year-round caretaker's residence, guard tower and other outbuildings ...

A nice little hideaway ... maybe there is a secret vault ... hey, paging Geraldo!

by Calculated Risk on 9/19/2009 11:55:00 AM

From Kenneth Harney at the LA Times: Homeowners who 'strategically default' on loans a growing problem

National credit bureau Experian teamed with consulting company Oliver Wyman to identify the characteristics and debt management behavior of the growing numbers of homeowners who bail out of their mortgages with none of the expected warning signs, such as nonpayments on other debts.
...
[Some results:]
...

The number of strategic defaults is far beyond most industry estimates -- 588,000 nationwide during 2008, more than double the total in 2007. ...

Strategic defaulters often go straight from perfect payment histories to no mortgage payments at all. ...

Strategic defaults are heavily concentrated in negative-equity markets ...

This fits with recent research from Guiso, Sapienza and Zingales: See New Research on Walking Away and here is their paper: Moral and Social Constraints to Strategic Default on Mortgages

by Calculated Risk on 9/19/2009 08:36:00 AM

I've been asked many times what people should do financially during a recession. My first answer has always been "Keep your job if you can!"

Earlier this week, David Leonhardt at the NY Times wrote: Wages Grow for Those With Jobs, New Figures Show

Even though unemployment has reached its highest level in 26 years, most workers have received a raise over the last year.

That contrast highlights what I think is one of the more overlooked features of the Great Recession. In the job market, at least, the recession’s pain has been unusually concentrated.
...
People who have lost their jobs are struggling terribly to find new ones. Since the downturn began in 2007, companies have been extremely reluctant to hire new workers, and few new companies have started. The economy and the job market are churning very slowly.
...
Try thinking of it this way: All of the unemployed people in the country are gathered in a huge gymnasium that’s been turned into a job search center. The fact that this recession is the worst in a generation means that there are many, many people in the gym. The fact that the economy is churning so slowly means that there is not much traffic into and out of the gym.

If you’re inside, you will have a hard time getting out. Yet if you’re lucky enough to be outside the gym, you will probably be able to stay there. The consequences of a job loss are terribly high, but — given that the unemployment rate is almost 10 percent — the odds of job loss are surprisingly low.

From an earlier post, here is a graph of hires and separations from the BLS "Job Openings and Labor Turnover Survey" (JOLTS) survey. The difference between JOLTS hires and separations is similar to the CES (payroll survey) net jobs headline numbers.

Note: Remember the CES (Current Employment Statistics, payroll survey) is for positions, the CPS (Current Population Survey, commonly called the household survey) is for people. See Jobs and the Unemployment Rate for a comparison of the two surveys.

The following graph shows hires (Green Line), Quits (blue bars) and Layoff, Discharges and other (red bars) from the JOLTS. Red and blue added together equals total separations. Unfortunately this is a new series and only started in December 2000.

Click on graph for larger image in new window.

Notice that hires (green line) and separations (red and blue together) are pretty close each month. When the green line is above total separations, the economy is adding net jobs, when the green line is below total separations, the economy is losing net jobs.

Total separation and hires have both declined recently - the lower "churn" that Leonhardt discusses, and the reason so many people are stuck in the "gymnasium".