by Calculated Risk on 12/07/2009 06:35:00 PM

From NY Fed President William Dudley: Still More Lessons from the Crisis

The entire speech is worth reading. Dudley discusses a number of topics including his economic outlook, how the Fed should respond to bubbles, and why he believes the Fed should retain supervisory authority.

Dudley offers a mea culpa for the Fed:

With the benefit of hindsight, it is clear that the Fed and other regulators, both here and abroad, did not sufficiently understand some of the critical vulnerabilities in the financial system, including the consequences of inappropriate incentives, and the opacity and the large number of self-amplifying mechanisms that were embedded within the system. Likewise, we did not appreciate all the ramifications of the growth of the shadow banking system and its linkage back to regulated financial institutions until after the crisis began.

It didn't take "hindsight" to see that the Fed was failing to properly regulate the financial system - many people were pointing out the problems in real time, and the Fed simply chose to ignore the warnings.

On bubbles:

[I]dentifying asset bubbles in real time is difficult. However, identifying variables that often are associated with asset bubbles—especially credit asset bubbles—may be less daunting. To take one recent example, there was a tremendous increase in financial leverage in the U.S. financial system over the period from 2003 to 2007, particularly in the nonbank financial sector. This sharp rise in leverage was observable. Presumably, this rise in leverage also raised the risks of a financial asset bubble and the impact of this bubble on housing certainly raised the stakes for the real economy if such a bubble were to burst. This suggests that limiting the overall increase in leverage throughout the system could have reduced the risk of a bubble and the consequences if the bubble were to burst.

Turning to ... how to limit and/or deflate bubbles in an orderly fashion, the fact that increases in leverage are often associated with financial asset bubbles suggests that limiting increases in leverage may help to prevent bubbles from being created in the first place. This again suggests that there is a role for supervision and regulation in the bubble prevention process. ...

Whether there is a role for monetary policy to limit asset bubbles is a more difficult question. On the one hand, monetary policy is a blunt tool for use in preventing bubbles because monetary policy actions also have important consequences for real economic activity, employment and inflation. On the other hand, however, there is evidence that monetary policy does have an impact on desired leverage through its impact on the shape of the yield curve. A tighter monetary policy, by flattening the yield curve, may limit the buildup in leverage.
emphasis added

We are making progress on bubbles.

And on the economic outlook:

My views about the outlook have not changed much recently and do not differ much from the consensus. The situation is slowly improving. We are having a recovery in terms of output and the pace of job losses has slowed substantially. In the second half of this year, real GDP growth will likely fall in a 3 percent to 3.5 percent annualized range. 2010 will probably be slightly weaker than that, mostly because some of the current sources of strength are temporary. The inventory cycle is providing lots of support right now and the fiscal stimulus—which is very powerful right now — will abate as we go through 2010.

2010 is also likely to be a more moderate growth period because we still face quite a few headwinds generated by the hangover of the financial crisis. ...

If growth is subdued, this implies that the unemployment rate will stay high and inflation will stay low. If this outlook is broadly correct, this suggests that it will be appropriate to keep the federal funds rate target exceptionally low for an extended period.

It is very unlikely that the Fed will raise the Fed funds rate in 2010.

by Calculated Risk on 12/07/2009 05:02:00 PM

From Diana Olick at CNBC: Bank of America: 2/3 of Borrowers May Lose Mods (ht montas ankle)

[Jack Schakett, credit loss mitigation strategies executive at B of A.] told me that of the 65 thousand trial modifications set to expire Dec. 31st with B of A, a full two thirds of the borrowers, while current on their payments, have not submitted the full documentation required to turn a trial mod permanent under the HAMP guidelines.

"We don't really know the major reason why the customers are not returning the documentation," Schakett claims.

Borrowers are complaining that the banks are losing documentation and that they have to submit it multiple times. Ms. Olick also suggests the possibility that some borrowers can't document their income.

BofA's Mr. Schakett said it was too soon to know why the documentation is incomplete, but this suggests that the number of permanent modifications announced this week will be very low (in the 10s of thousands).

by Calculated Risk on 12/07/2009 03:00:00 PM

The Federal Reserve reports:

Consumer credit decreased at an annual rate of 3-1/4 percent in the third quarter of 2009. Revolving credit decreased at an annual rate of 7-1/4 percent, and nonrevolving credit decreased at an annual rate of 1 percent. In October, consumer credit decreased at an annual rate of 1-3/4 percent.

Click on graph for larger image in new window.

This graph shows the year-over-year (YoY) change in consumer credit. Consumer credit is off 3.6% over the last 12 months - and falling fast. The previous record YoY decline was 1.9% in 1991.

Consumer credit has declined for a record 9 straight months - and declined for 12 of the last 13 months. It is difficult to get a robust recovery without an expansion of consumer credit - unless the recovery is built on business spending and exports (seems unlikely).

Note: The Fed reports a simple annual rate (multiplies change in month by 12) as opposed to a compounded annual rate. Consumer credit does not include real estate debt.

by Calculated Risk on 12/07/2009 12:45:00 PM

From Fed Chairman Ben Bernanke: Frequently Asked Questions. Dr. Bernanke discusses four questions:

1. Where is the economy headed?
2. What has the Federal Reserve been doing to support the economy and the financial system?
3. Will the Federal Reserve's actions lead to higher inflation down the road?
4. How can we avoid a similar crisis in the future?

On inflation, Bernanke says he expects "inflation to remain subdued for some time." On the economy:

Where Is the Economy Headed?
... Recently we have seen some pickup in economic activity, reflecting, in part, the waning of some forces that had been restraining the economy during the preceding several quarters. The collapse of final demand that accelerated in the latter part of 2008 left many firms with excessive inventories of unsold goods, which in turn led them to cut production and employment aggressively. This phenomenon was especially evident in the motor vehicle industry, where automakers, a number of whom were facing severe financial pressures, temporarily suspended production at many plants. By the middle of this year, however, inventories had been sufficiently reduced to encourage firms in a wide range of industries to begin increasing output again, contributing to the recent upturn in the nation's gross domestic product (GDP).

Although the working down of inventories has encouraged production, a sustainable recovery requires renewed growth in final sales. It is encouraging that we have begun to see some evidence of stronger demand for homes and consumer goods and services. In the housing sector, sales of new and existing homes have moved up appreciably over the course of this year, and prices have firmed a bit. Meanwhile, the inventory of unsold new homes has been shrinking. Reflecting these developments, homebuilders have somewhat increased the rate of new construction--a marked change from the steep declines that have characterized the past few years.

Consumer spending also has been rising since midyear. Part of this increase reflected a temporary surge in auto purchases that resulted from the "cash for clunkers" program, but spending in categories other than motor vehicles has increased as well. In the business sector, outlays for new equipment and software are showing tentative signs of stabilizing, and improving economic conditions abroad have buoyed the demand for U.S. exports.

Though we have begun to see some improvement in economic activity, we still have some way to go before we can be assured that the recovery will be self-sustaining. Also at issue is whether the recovery will be strong enough to create the large number of jobs that will be needed to materially bring down the unemployment rate. Economic forecasts are subject to great uncertainty, but my best guess at this point is that we will continue to see modest economic growth next year--sufficient to bring down the unemployment rate, but at a pace slower than we would like.

A number of factors support the view that the recovery will continue next year. Importantly, financial conditions continue to improve: Corporations are having relatively little difficulty raising funds in the bond and stock markets, stock prices and other asset values have recovered significantly from their lows, and a variety of indicators suggest that fears of systemic collapse have receded substantially. Monetary and fiscal policies are supportive. And I have already mentioned what appear to be improving conditions in housing, consumer expenditure, business investment, and global economic activity.

On the other hand, the economy confronts some formidable headwinds that seem likely to keep the pace of expansion moderate. Despite the general improvement in financial conditions, credit remains tight for many borrowers, particularly bank-dependent borrowers such as households and small businesses. And the job market, though no longer contracting at the pace we saw in 2008 and earlier this year, remains weak. Household spending is unlikely to grow rapidly when people remain worried about job security and have limited access to credit.

Inflation is affected by a number of crosscurrents. High rates of resource slack are contributing to a slowing in underlying wage and price trends, and longer-run inflation expectations are stable. Commodities prices have risen lately, likely reflecting the pickup in global economic activity and the depreciation of the dollar. Although we will continue to monitor inflation closely, on net it appears likely to remain subdued for some time.

by Calculated Risk on 12/07/2009 11:55:00 AM

From Professor Duy: Structural and Cyclical

For several months, I have been telling stories that decompose US economic activity into what I think of as cyclical and structural dynamics. I believe the distinction is very important to firms, markets, and policymakers who need to be aware when one dynamic is clouding their view of the other.

The cyclical dynamics, in my opinion, are the most spectacular, the most visible. The real cyclical fireworks began in the second half of [2008], as the energy price shock decimated household budgets, quickly followed by a financial shock that triggered an additional pullback in demand. Firms unexpectedly found they had far too much excess capacity in this environment, and began the process of "rightsizing." [Job] losses mounted even as falling energy costs and lower interest rates for those not credit constrained began to put a floor under spending.

Eventually, firms would realign capacity with the new level of demand, and job losses would taper off. That would mark the early stages of the cyclical bottom, the point at which growths returns. The initial growth spurt could be very rapid, as firms restock inventory and pent-up demand comes into play. The additional of government stimulus will add additional fuel to the fire.

Once the early stages of recovery are complete, the story shifts from cyclical to structural. The boost from inventory correction, pent-up demand, and government stimulus fade, and the underlying growth rate, the fundamental rates of activity, becomes evident. Now your expectations about the nation's economic direction depend on the weight you place on the structural factors. If you place nearly zero weight on those factors, then growth remains fairly high as the economy rapidly returns to potential. In effect, cyclical dynamics dominate your story; the Fed is simply flipping a switch that shifts the economy from high to low states and back again, a traditional post-WWII business cycle. If you place heavy weight on structural stories, you talk about the inability to revert to past patterns of consumer spending growth due to excessive household debt, a reversion to global imbalances that supports outsized import growth, lack of an asset bubble to compensate for these structural problems, etc. With these stories in your toolkit, you expect a low underlying growth rate - barely at potential growth - in which case the gap between actual and potential output remains distressingly high for possibly years to come.

A nice summary of the differences between those who expect a "V-shaped" recovery, and those that believe the recovery will be sluggish. I think growth will be sluggish primarily because of the overhang of excess housing inventory (slowing any recovery in residential investment), and because consumers will increase their saving rate to repair their household balance sheets. There is much more in Dr. Duy's post.

by Calculated Risk on 12/07/2009 08:57:00 AM

From Bloomberg: No Escape From TARP for U.S. Banks Choking on Real Estate Loans

... mounting defaults on commercial property may keep regional lenders from repaying bailout funds until at least 2011.

... regional banks ... are almost four times more concentrated in commercial property loans than the nation’s biggest lenders, according to data compiled by Bloomberg on bailout recipients.

The concentration makes regulators less likely to let regional lenders ... leave the Troubled Asset Relief Program, analysts said.
...
The stakes for taxpayers include whether they’ll get back $36.6 billion held by 35 of the largest regional lenders that received TARP money.
...
Among 35 of the biggest regional lenders that retain TARP funds, commercial real estate and construction loans average 37 percent of total loans, compared with 9.5 percent at Citigroup Inc. and Wells Fargo & Co., the two biggest U.S. banks that haven’t announced plans to repay the government, according to data compiled by Bloomberg....

Basically small and regional banks were over concentrated in C&D (Construction and Development) and CRE (Commercial Real Estate) loans - and those areas are still under severe stress (CRE will get worse). This is why the FDIC is busy every Friday, and also why many of these small and regional banks will be stuck with TARP for some time (or even fail owing money to the Treasury).

by Calculated Risk on 12/07/2009 12:16:00 AM

From the NY Times: U.S. Forecasts Smaller Loss From Bailout of Banks

The Treasury Department expects to recover all but $42 billion of the $370 billion it has lent to ailing companies since the financial crisis began last year, with the portion lent to banks actually showing a slight profit, according to a new Treasury report.

The new assessment of the $700 billion bailout program, provided by two Treasury officials on Sunday ahead of a report to Congress on Monday, is vastly improved from the Obama administration’s estimates last summer of $341 billion in potential losses from the Troubled Asset Relief Program. ...

The officials said the government could ultimately lose $100 billion more from the bailout program in new loans to banks, aid to troubled homeowners and credit to small businesses.

And from the WSJ: Estimated TARP Cost Is Cut by $200 Billion

The article notes that this will reduce the deficit significantly this year.

by Calculated Risk on 12/06/2009 09:18:00 PM

From Lucian Bebchuk, Alma Cohen, and Holger Spamann in the Financial Times: Bankers had cashed in before the music stopped

According to the standard narrative, the meltdown of Bear Stearns and Lehman Brothers largely wiped out the wealth of their top executives. ... That standard narrative, however, turns out to be incorrect. ... our analysis ... shows the banks’ top five executives had cashed out such large amounts since the beginning of this decade that, even after the losses, their net pay-offs during this period were substantially positive.
excerpted with permission

It appears these executives were incentivized to gamble.

Mark Thoma has more excerpts Did Bank Executives Lose Enough to Learn their Lesson?

by Calculated Risk on 12/06/2009 04:52:00 PM

Based on the recent trend in the employment report, the U.S. economy might start adding net payroll jobs soon. This post looks at payroll employment vs. the change in real GDP, and estimates the unemployment rate in 12 months for several growth scenarios.

Credit: This idea is from a recent research note by Jan Hatzius.

Note: This is similar to Okun's relationship between GDP and unemployment.

Click on graph for larger image.

The first graph shows the four quarter change in real GDP and the four quarter change in employment, as a percent of payroll employment (to normalize for changes in payroll over time).

The second graph shows the same data in a scatter graph.

There is a clear relationship - the higher the change in the real GDP, the larger the increase in payroll employment.

This shows that real GDP has to grow at a sustained rate of about 1% just to keep the net change in payroll jobs at zero.

A 3% increase in real GDP (over a year) would lead to about a 1.5% increase in payroll employment. With approximately 131 million payroll jobs, a 1.5% increase in payroll employment would be just under 2 million jobs over the next year - and the unemployment rate would probably remain close to 10%.

The following table summarizes several growth scenarios. The unemployment rate is from the household survey and depends on the number of people in the work force - so it cannot be calculated directly. The table uses a range of unemployment rates based on 1.6 to 2.1 million people entering the workforce over the next 12 months (a combination of population growth and discouraged workers reentering the work force).

Real GDP Growth	Percent Payroll Growth	Annual Payroll Growth (000s)	Monthly Payroll Growth (000s)	Approximate Unemployment Rate in One Year
6.0%	3.5%	4,563	380	8.0% to 8.3%
5.0%	2.8%	3,684	307	8.6% to 8.9%
4.0%	2.1%	2,806	234	9.1% to 9.4%
3.0%	1.5%	1,928	161	9.7% to 10.0%
2.0%	0.8%	1,049	87	10.3% to 10.6%
1.0%	0.1%	171	14	10.8% to 11.1%

I expect a sluggish recovery in 2010, and I think the unemployment rate will stay near 10% for the next year. Those expecting a sharp drop in the unemployment rate are clearly expecting real GDP growth of 5% or more.

Obviously higher growth rates would mean an even quicker decline in the unemployment rate, and a decline in real GDP would mean much higher unemployment rates.

by Calculated Risk on 12/06/2009 12:00:00 PM

Scheduled data for the coming week include the trade report (Thursday) and retail sales (Friday). Also the Treasury is expect to release the Making Home Affordable Program data for November this week and include additional metrics such as the number of permanent modifications and the number of failed trial modifications.

The number of permanent modifications is expected to be in the 10s of thousand.

Also, the Federal Reserve will release the Q3 Flow of Funds report on Thursday.

And a summary ...

Employment Report (a few selected graphs)

The employment report showed a decline of 11,000 payroll jobs in November and a decline in the unemployment rate to 10.0% (from 10.2%). The smaller number of payroll jobs lost was surprising because other indicators (like the ADP report, weekly initial unemployment claims, ISM reports) suggested a larger number of job losses.

From Employment Report: 11K Jobs Lost, 10% Unemployment Rate.

Click on graph for larger image.

This graph shows the job losses from the start of the employment recession, in percentage terms (as opposed to the number of jobs lost).

For the current recession, employment peaked in December 2007, and this recession is the worst recession since WWII in percentage terms, and 2nd worst in terms of the unemployment rate (only early '80s recession with a peak of 10.8 percent was worse).

Note: The total number of jobs lost does not include the preliminary benchmark payroll revision of minus 824,000 jobs. (This is the preliminary estimate of the annual revision that will be announced early in 2010).

From Seasonal Retail Hiring, Employment-Population Ratio, Part Time Workers

Retailers are hiring seasonal workers at slightly above the pace of last year ...

Typically retail companies start hiring for the holiday season in October, and really increase hiring in November. Here is a graph that shows the historical net retail jobs added for October, November and December by year.

Retailers only hired 54.2 thousand workers (NSA) net in October. This was essentially the same as in 2008 (59.1 thousand NSA). However retailers hired 321.3 thousand workers in November (NSA), an increase from the 233.7 thousand last year. This suggests retailers are a little more optimistic than last year.

From Unemployment: Record number Unemployed over 26 Weeks, Diffusion Index

The blue line is the number of workers unemployed for 27 weeks or more. The red line is the same data as a percent of the civilian workforce.

According to the BLS, there are a record 5.887 million workers who have been unemployed for more than 26 weeks (and still want a job). This is a record 3.8% of the civilian workforce. (note: records started in 1948)

Other Employment posts:
If the Economy lost Jobs, why did the Unemployment Rate decline?

Temporary Help

ISM Reports

Manufacturing showed slower expansion: From the Institute for Supply Management: November 2009 Manufacturing ISM Report On Business®

Economic activity in the manufacturing sector expanded in November for the fourth consecutive month ...

Services showed contraction: From the Institute for Supply Management: November 2009 Non-Manufacturing ISM Report On Business®

Economic activity in the non-manufacturing sector contracted in November after two consecutive months of expansion ...

Construction Spending Flat in October

This graph shows private residential and nonresidential construction spending since 1993. Note: nominal dollars, not inflation adjusted.

Residential construction spending increased in October, and nonresidential spending continued to decline.

Private residential construction spending is now 63% below the peak of early 2006.

Private non-residential construction spending is 20.6% below the peak of last October.

Auto Sales at 10.9 Million SAAR in November

This graph shows the historical light vehicle sales (seasonally adjusted annual rate) from the BEA (blue) and an estimate for November (red, light vehicle sales of 10.93 million SAAR from AutoData Corp).

Obviously sales were boosted significantly by the "Cash-for-clunkers" program in August and some in July.

Excluding July and August, this was the strongest month since October 2008 (12.5 million SAAR) before sales fell off the final cliff.

The current level of sales are still very low, and are below the lowest point for the '90/'91 recession (even with a larger population).

Other Economic Stories ...

From the American Bankruptcy Institute: November Consumer Bankruptcy Filings Drop 18 Percent from Previous Month

HUD's Donovan: "Next Steps" for FHA

Fed's Beige Book: Economy "improved modestly"

Restaurant Index Shows Contraction in October

Hotel RevPAR off 8.4 Percent

Unofficial Problem Bank List, Dec 4, 2009

Best wishes to all.