Another quick thought

Does anyone else find it a bit weird that banks are being asked to pony up money to shore up the capital position of monoline insurers? The same monoline insurers who are insuring dubious financial instruments currently held on (or near) the balance sheets of banks?

Seems like a circular firing squad to me (and what does it say about the true value of the bank assets?).

Super busy

but here's a quick thought. The Fed can cut rates as much as it would like (hell, they're already negative in real terms) and it won't make a bit of difference as to whether we are moving into recession (btw - I think we're there already). The reason is simple - Americans can no longer fund their profligate spending by extracting equity from their homes. They can no longer prime the auto and credit card pumps through rising home prices. It doesn't matter if you make it cheaper for them to borrow, because they can't borrow anymore. The well is dry.

Ditto on a bullshit $300/family tax rebate (or whatever the final deal is). We are in for a long structural economic change that will take years to play out. Things are going to be pretty dismal until people readjust their habits to incorporate the new financial realities, like living reasonably within their means. That takes time.

Like 2010.

With that, I'm back to work.

What the hell is wrong with Martin Feldstein?

He has an amazing Op-Ed in today's WSJ called "How to Avert Recession". I'm not sure he gives a way to avert recession in the piece, but he sure does give a few ways to completely fuck the country.

When you read it, you'll likely be lulled into a false sense of security. He starts out sounding very reasonable and reasoned, making one sound non-controversial statement after another. Then this happens:

What's really needed is a fiscal stimulus, enacted now and triggered to take effect if the economy deteriorates substantially in 2008. There are many possible forms of stimulus, including a uniform tax rebate per taxpayer or a percentage reduction in each taxpayer's liability. There are also a variety of possible triggering events. The most suitable of these would be a three-month cumulative decline in payroll employment. The fiscal stimulus would automatically end when employment began to rise or when it reached its pre-downturn level.

Are you kidding me? He wants to reduce tax rates at precisely the same time that the government is going to realize falling tax revenues (falling corportate profits, personal incomes, investment gains)? What would that do to the dollar? Falling interest rates and massive amounts of borrowing to close a spiraling deficit due to increased fiscal expenditures and decreasing revenues would kill the dollar, reserve currency or not, this would be a dollar bloodbath.

Later:

Even if the Fed decides that it should not cut rates further at the present time, (HA! Good luck with that. - Jim) it would not raise rates to offset the stimulus effect of the fiscal change. From the Fed's point of view, the tax cuts can provide a desirable short-run stimulus without the inflationary impact that would result from a lower interest rate and an increase in the stock of money. Some reliance now on a fiscal stimulus rather than easier money would also take pressure off the exchange-rate adjustment. While further declines of the dollar are necessary to shrink the massive U.S. trade deficit, continued rapid declines might lead to counterproductive retaliatory actions by some of our trading partners.

"[T]he tax cuts can provide a desirable short-run stimulus without the inflationary impact that would result from a lower interest rate and an increase in the stock of money." Is he serious? A plunging dollar would again make oil prices surge and that would flow through to the rest of the economy. And for those of you who still insist on looking at "core inflation" only (for whatever reason), $200/barrel oil would flow through the entire economy. Lower interest rates with massive borrowing is an economic disaster in the making.

And the final part of the quote above makes no sense to me either. Announcing this would lead to "counterproductive retaliatory actions" by some of our trading partners who would be forced to start and reallocate foreign exchange portfolios away from dollars.

It seems like we are currently playing a global game of chicken with the world saying, in effect, we don't think that you will move away from dollars in the near future because doing so would seriously impact the value of of your own reserves, that is, you can't afford to move away from dollars. I wouldn't be so sure. If our trading partners become convinced that the dollar is going to continue its decline, why wouldn't they start to get out now while they can? It's a dangerous game we're playing.

Housing and the Economy - Chapter 35

In which Jim links to Nouriel Roubini who solidifies Jim's current biases:

In this regard, evidence is mounting that a debt-burdened and saving-less US consumer – that until recently used its home as an ATM and borrowed against its housing wealth - is now on the ropes and at its tipping point.

Roubini's post is long, but worthwhile to read in its entirety.

Markets?

Monday the market went up. It's up again right now. Apparently and obviously I know nothing about the market. I do wonder though how people are going to keep spending and what happens once people internalize the fact that housing is in real trouble.

Uh-Oh

Market down big today, but fasten your seatbelts for Monday:

Rumors were flying during the last hour of trading of problems at Merrill and Bear. The Merrill rumor was of a special board meeting this weekend with possible additional writedowns - we will see.

Oh boy.

Uh-oh

In some work I do for my day job, one of the things I looked at recently was California's GDP vs. the US GDP over time. Two trends emerged: (1) CA GDP is more volatile than the US GDP (2) CA typically leads the country in and out of recessions. With that, this can't be a good sign:

Based on sales tax revenue, it now appears that the California economy is in recession.

I've been saying for a while that the economy is going into the shitter, CA is just getting there first.

It's got to stop sometime

And when it does, it's going to be a doozy:

Outstanding U.S. consumer debt rose at an annual rate of 5.9% in August, pushed higher mostly by a hefty gain in credit-card debt, the Federal Reserve reported Friday...Revolving debt such as credit cards was the biggest driver behind the overall rise in August, the data show. That debt climbed by 8.1% in August, or by $6.1 billion.

I talked about this back in July. With no home equity to pull out of their houses and no bankruptcy protection to shed credit card bills, people are in for a world of hurt. Looking forward to the Christmas season, people have essentially two choices - plunging further into credit card debt and committing financial suicide or restraining their spending and killing retailers. Smart money's on the former.

Look out!

August jobs data:

Investors were unpleasantly surprised by the Labor Department's report that payrolls fell by 4,000 in August, the first decline since August 2003, while the unemployment rate held steady at 4.6 percent as expected.

June and July were also revised downward. Without the ability to extract wealth from their houses, people cannot fund lifestyles that are built upon a negative savings rate. Credit at all levels is evaporating.

At some point corporate profits will have to suffer because at some point people will have to stop buying things. I'd predicted a Q3 '07 recession and I'm becoming more convinced that will be a correct statement.

This is disturbing

I (stupidly) assumed that as the housing market cooled, people would be forced to reduce their spending. I still think that's right, but it may be wrong in the near term:

Revolving credit, mainly credit-card use, rose in May at an annual rate of 9.8% to $894.8 billion.

That's bad for any number of reasons, the two primary being (1) consumers can't use equity to pay off credit cards anymore and (2) as of last year it's much harder to wipe these debts clean through bankruptcy (and please note that I'm not advocating #2 as a strategy, but stating that people will be saddled with these debts for a looooong time since they can't get rid of them).

Cheerleading

From the WSJ:

U.S. employment posted a solid rise last month on strong hiring in health care and government and previous months' gains were revised sharply higher, suggesting labor market conditions remain very supportive of economic activity at midyear.

[...]

Nonfarm payrolls increased 132,000 in June, after swelling 190,000 in May and 122,000 in April, the Labor Department said Friday. Previous reports showed job growth of just 157,000 in May and 80,000 in April. Monthly job growth has averaged a robust 145,000 so far this year. The unemployment rate was unchanged last month at 4.5%. Average hourly earnings increased $0.06, or 0.3%, to $17.38. That was up 3.9% from a year earlier, suggesting tight labor markets still aren't putting much pressure on labor costs.

[...]

The data provide further evidence that the economy has picked up considerable steam after several subpar quarters. Gross domestic product advanced just 0.7% in the first quarter. However, economists expect that to mark a low point of the current cycle with growth likely exceeding 3% in the second quarter.

Let's take a deep breath for a second. First of all, a job creation of 132,000 in June, although "solid" still doesn't keep up with population growth. That over/under number is about 180,000. Job growth of 145,000 can't shouldn't be called "robust" if we fall further behind our growth in population every month. Second, the job gains were based on growth in government hiring? This continues to be the biggest untold story of the current economy - job growth is being fueled largely by growth in the government sector. Finally, I'm not sure how much steam the economy has picked up. We know from prior reports that inventories were depleted so there is some catch up being done there. We also know that housing is on the verge of a collapse, retail stores are starting to report weaker sales results and people, in general, are starting to get the heebie-jeebies.

Let's all just keep clapping though and maybe this pig really will gussy itself up and dance.

Intellectual Honesty from the WSJ Editorial Pages

I've never seen it. Here is the latest example:

The next time Democratic leaders lament the decline of American industry, please refer them to the current Congressional brawl over auto fuel-efficiency standards. Nancy Pelosi, Harry Reid and most of their colleagues are siding with upscale environmental lobbies over American carmakers and workers. Call it their Drive-a-Toyota Act... The United Auto Workers warned that even a small mileage increase could cost more than 65,000 jobs.

Yes, that's the Journal, looking out for their old friends, the UAW. It continues:

Detroit has made its share of mistakes, but refusing to compete with smaller, more fuel-efficient cars isn't one of them. GM tried and failed with its Saturn project.

First off, I don't believe the Saturn project was designed to compete with smaller, more fuel-efficient cars primarily but was a way for GM to try to induce more people to buy their cars while cutting out their dealer network (remember "No haggle pricing"?). Second, Saturn didn't succeed because they made shitty cars. The Ion was widely criticized for it's huge gaps in the body panels, its cheap feel and lackluster performance. GM had a chance to revive the brand with a re-badged Opel mid-sized sedan, but it introduced it as a Cadillac instead. It sold barely at all as a Cadillac, but as a Cadillac it looks like what a Saturn should look like. Finally, Saturn was a risky bet anyway. GM was trying to, essentially, create a new car company and it failed.

Here's the rest of that paragraph:

And one reason for that failure is that the main competitive reality facing Detroit for a generation has been the burden of its worker pension and health care costs. The consensus is that those costs add about $1,500 per vehicle compared to Japanese or Korean competitors. The best way to recoup those costs is by making larger vehicles that earn more profit per sale than smaller cars do. Making trucks (protected by a 25% U.S. tariff) and SUVs was entirely rational, and failing to do so would have meant more financial trouble earlier.

Here the WSJ appears to be on the side of tariffs. Pro-union and pro-tariff, from the WSJ? Something's afoot.

Of course there are other ways to extract more value out of a vehicle other than to hide behind tariffs and make 'em bigger. You could, of course, provide a vehicle that would command a premium in the marketplace. By being out in front of R&D rather than continually riding yesterday's wave. You'd think the US auto makers would have learned something from the 70's.

And finally, there's this:

If Mr. Reid truly cared about cutting gas consumption, he and his party would increase the gas tax. But voters are already steamed about $3-a-gallon gas, and Mr. Reid's commitment to lower carbon consumption doesn't go as far as the personal sacrifice of losing Democratic Senate seats.

Imagine, just imagine the response from the right (including, I presume, the WSJ editorial pages) should Reid even think about raising gas taxes.

The WSJ is a great paper with a breathtaking bad editorial section. They should be embarrassed by columns like this one.

It's all about the revisions

First quarter GDP was revised down:

The economy grew at a 0.6% annualized pace in the quarter, revised down from the initial estimate of 1.3%, the government said in its second estimate of quarterly gross domestic product. It was the slowest growth since late 2002.

This is due primarily to a rundown in corporate inventories and a large uptick in consumer spending. Since we know that consumer spending is going to go into the tank, I think we will have a rough time of it as business work to restock inventories that consumers don't buy, putting downward pressure on both top line revenue growth and quarterly profits. But MasterCard is at $150. today, so what the hell do I know.

The other shoe starts to fall

It's like watching a slow motion video of a car sliding into a wreck:

After years of piling debt on their homes, Americans are becoming more cautious about using them as a piggy bank. A cooling housing market and higher interest rates have made homeowners more reluctant to tap the equity they may have built up in their residences. The amount borrowers owe on their home-equity lines of credit has slipped in the past six months, to $561 billion at the end of March, the first such decline since 1999, according to new data from Equifax Inc. and Moody's Economy.com Inc. Although that decline was partly offset by a pickup in fixed-rate home-equity loans, total home-equity borrowing rose just 9% in the 12 months through March, well below the 21% average annual growth rate of the past five years.

That was from yesterday's WSJ. The last sentence is particularly amazing to me - the growth in equity extraction was 21% per year over the last 5 years?! This is bad news for the economy. Not unexpected, but bad news for sure. If people stop extracting equity from their homes, they will be unable to pay off their credit cards which is the funding mechanism they've been using to continue their consumption beyond any reasonable or rational limit (the current US savings rate in negative for the first time since the Great Depression). If they can't pay off their credit cards, they can't spend because they have no other method to pay for it. Net-net, the economy comes screeching to a halt.

This is from today's WSJ:

The U.S. economy slowed sharply in early 2007, retreating to its weakest pace in four years under the weight of the housing slump, while inflation accelerated... The surprisingly anemic pace lagged the fourth quarter's rate of 2.5% and reflected the slowest growth in GDP since 1.2% during the first quarter of 2003. Price-inflation gauges rose sharply in the first quarter. For instance, the price index for personal consumption expenditures rose by 3.4% after decreasing 1.0% in the fourth quarter. The PCE price gauge excluding food and energy grew 2.2%, after increasing 1.8% in the fourth quarter.

This is a double-whammy. With the economy slowing, job gains and income gains will likely cool as well, but at the same time the Fed, being laser-focused on inflation will feel some pressure to raise interest rates, which would ripple though the, yes, the housing market raising everyone's adjustable mortgages and lines of credit. It's a very tough place to be in when you simultaneously have a slowing economy and rising inflation because the levers that can help one will harm the other.

This is going to get really, really ugly.

Bad Idea

Circuit City:

Circuit City spokesman Bill Cimino said the 3,400 layoffs follow a market-by-market review of wages for similar jobs. The review, by the company with help from outside parties, identified workers paid "well above the market-based salary range for their role," the company said. Circuit City had 42,359 employees as of Feb. 28. Those workers will be given severance packages, and Circuit City said it intends to replace them with employees compensated at "the current market range for the job." Mr. Cimino wouldn't provide specifics on the changes but called the practice "not an uncommon occurrence" among retailers.

I really don't know how this helps them in the long run because it effectively destroys employee morale. In a world where people are looking for assistance with TV's, computers, etc. having a demoralized sales force would have to be seen as a hindrance. Instead of firing them, why not offer them their jobs at reduced salaries?

This is another illustration of where I think the pendulum has swung too far in favor of corporations over employees. The Walmart flexible schedule system is another example. The key is going to be how employees begin to regain some clout in the places they work.

Housing and Spending

From today's WSJ:

With subprime mortgage lenders pulling back, some working-class Americans are already finding it harder to buy a new home or refinance the one they already own. The big question now for the nation's economy: Will it also get harder for these consumers to buy cars, shop at the mall and dine out?

The answer, of course, is yes. But don't worry:

Even if the poorest customers curtail their spending, it shouldn't be enough to shake the economy off of its trajectory of moderate growth. In the cold science of economics, rich people who have more to spend matter more to the economy than the poorer folks who don't. According to the Labor Department's 2005 consumer expenditure survey, the lowest 40% of earners represent about $1.1 trillion, just a fifth of total consumer spending.

I refer you to this.

Something to keep in mind

I have to take the housing implosion in small parts because there's a ton of moving parts. Here is something to keep in mind though:

The Fed is focused on inflation (producer prices were up over 1% in February, CPI was up more than expected as well). They are going to be in something of a quandary because if they raise interest rates to quell inflation, they are going to put the hurt on anyone with an adjustable mortgage, and could really drown those with exploding ARM's. Will they focus on homeowners or stable prices?

I suspect that the housing debacle may take care of those inflation fears all on its own.

Housing

OK, I'll admit that I've predicted 12 of the last 3 housing corrections so my track record may seem a bit alarmist. As such I've restrained from commenting on the latest news until now. Last week, when New Century was imploding, analysts were all saying that the sub-prime market may be in a bit of trouble, but everything else is fine. I didn't, and don't see how that could be so - it's not like sub-primes are the only mortgages that are on properties whose prices have risen meteorically over the last few years. Prime borrowers can get themselves under water as easily as sub-prime borrowers can if they extend themselves enough. Where is this going? Guess:

Most economic forecasters in a new WSJ.com survey believe recent turmoil in the subprime mortgage market is likely to spread to the broader mortgage market and they expect a widely followed index of home prices to fall this year. But they still think the U.S. will avoid a recession and even a significant rise in unemployment.

It's a depressingly familiar story that appears again and again in (bad) crisis PR: minimize the problems until they pass you by. In this case, it goes like this, "The sub-prime market is toast, but the prime market will be fine. Whoops, what I meant to say is that the sub-prime market is toast, the prime market is toast, but you know what, spending is fine, we won't go into recession. Whoops again, what I meant to say is that of course the implosion in the housing market pushed the country into recession, after all housing appreciation was the engine that drove consumer spending. Once that dried up, where was the spending going to come from? What were you thinking listening to us?"

And here's why I think it'll happen: Banks have been too loose in their lending (knowing that they can sell many of the mortgages on the open market) and as these loans start to go bad they will tighten lending requirements. Being human, they will over correct the other way and dry up the mortgage market. If people can't buy, then people can't sell. If people can't sell, they are stuck in a house where they've (likely) extended themselves though equity lines of credit or they had anticipated moving on before the term on their ARM expires. If they get stuck, they're screwed. If they're screwed, they aren't going to spend any money. If they aren't spending any money, the economy tanks.

I also think it will happen much more quickly than people think. Recession by Q3 2007. Bank on it. I've called 28 of the last 6 of those.