Leeds on Finance

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The next update will be sent on Wednesday morning.


Today’s update has some of the data that I’ve recently come across related to the housing market.

Part 1: The Data

New home sales hit a record low in May. Sales of new homes declined 32.7% from April to May!  Only 28,000 new units sold in the month, the lowest May total ever and the lowest seasonally adjusted annual rate since the data series started in 1963.


You could argue that new home sales don’t matter. New home sales are approximately 8% of home sales.  With that said, there’s no reason to believe that the new home sales results are much different than existing home sales.  In addition, because of the way that existing home sales data is collected (see below), new home sales data is more current.


Existing home sales are also dropping. Existing home sales in May dropped from April, but since existing sales are counted at the time of closing (rather than signing), this was actually falling before the credit expired.

Existing homes are approximately 15% – 20% cheaper than new ones.


The National Association of Realtors said that completed resale’s of homes in May were down 2.2% from April, an increase of 19% from a year earlier.  The SAAR is 5.66 million units.  This index measures completion of sales, most of which were based on contracts signed in March or April.


Mortgage applications for home purchases are now at a 13-year low.  Purchase applications have decreased for six of the past seven weeks.  They are down 30% from April.


May construction starts on single-family homes fell 17% to an annual rate of 468,000, the lowest level in a year.  Building is slowing because May and June sales have been horrible.  Residential investment (home building) is just 2.4% of GDP.


The anecdotal evidence supports the idea that the market continues to be very weak. Many firms have estimated that home purchases are now down approximately 20% from a year earlier.  We don’t have the stats yet, but brokerage firms are telling us this.


There is anecdotal evidence that many more real estate deals are falling apart. Buyers are more demanding.  They feel that sellers must be desperate and should be willing to do anything to sell.


The drop in home prices has been continuous. Home prices (Case-Shiller) have declined for six consecutive months.


Interest rates are very low. The average rate on a 30-year fixed-rate mortgage fell to 4.69% this week from 4.75%.  This is the lowest level since Freddie Mac started tracking the data in 1971.  We’re seeing that low rates don’t always drive the real estate market.


Housing is more affordable now. Falling prices and historically low mortgage rates have lowered monthly payments to approximately 15% of household income – down from 21% in 2007.


Expectations are dropping. MacroMarkets monthly report found that 56% of the 106 economists and other analysts surveyed expect home prices to decline this year.  That is up from 40% a month ago.


In some areas, there are a lot of people underwater. Approximately one-third of the seven million California households with a mortgage are underwater.


Economists from the New York Federal Reserve Bank calculated that only 15% – 19% of Las Vegas homeowners have any equity left in their house.  In San Diego, the number is between 35% and 39%.




Part 2: California Legislation

Interesting California legislation. California is considering a bill that would prevent lenders from suing borrowers for the amount that they originally borrowed.  In other words, it would mean that the amount of your original loan was non-recourse.  Currently, California is basically a non-recourse state UNLESS you have refinanced.  If you refinanced, you can be pursued for the deficiency (the difference between what you borrowed and what the house is worth).  Part of the justification for this law is that it doesn’t make much sense to penalize homeowners for refinancing.


In reality, lenders in California rarely pursue deficiency judgments.  But, the threat of this litigation is an important negotiating tool in loan modification negotiations and short sales (selling for less than the house is worth).


The problem is that passing this law could lead to more strategic defaults.  The bank lobby wants to limit this law to new loans. Otherwise, the law will be altering existing contracts.


In effect, the bankers are facing off with the borrowers and real estate agents. Bankers are pushing to hold borrowers liable for their debt.  Real estate agents are pushing to have the debt released – so that the homeowners will return to the market.




Part 3: Strategic Default

There is a huge fear of strategic default becoming a contagion.  As a result, the government is trying to discourage it. Fannie Mae said that it would “lock out” borrowers from getting a new loan for seven years if they strategically default (defaulting on a mortgage that they could afford to pay).  Clearly, this shows the fear that strategic default is starting to cause.  They also said that they are going to pursue deficiency judgments in states where this is allowed.  Approximately 25% of homeowners with a mortgage are underwater.  A Morgan Stanley report said that approximately 12% of all mortgage defaults in February were strategic.


Previously, Fannie would not make loans to borrowers who had been foreclosed upon in the last five years.  Now, unless you can document “extenuating circumstances” must wait seven years to get a loan.  If you can show a hardship or that you attempted a workout with the lender, you can get a loan in three years.  This is probably making the rules EASIER for many people (who can show job loss, etc.).  If you complete a short sale or do a “deed in lieu of foreclosure”, you can get a loan again in two years.


There has been strong demand for Fannie, Freddie and Ginnie debt. Thirty-year agency bonds yield approximately 1.5% more than Treasury bonds.  Central banks have become big buyers because it seems like the government has guaranteed this debt.  In addition, banks can borrow cheaply and buy this debt.  In addition, there is a shortage of new debt being issued.  There is also less prepayment risk, since homeowners have already refinanced.  Some buyers are looking at this as an overbought market.




Part 4: Final Thoughts

1. The tax credit simply shifted the time in which people bought houses.


2. The short-term future does not look promising (although I personally believe that real estate will prove to be a good long-term investment from these levels).  We have huge inventory levels because of overbuilding and huge foreclosures.  We have millions underwater.  Unemployment is 9.7%.  The tax credit didn’t change any of this.


3. It’s amazing to see the market so weak when mortgage rates are so low.  This shows the effect of uncertainty in the job market, damaged credit ratings and the home-for-clunkers program that we just finished.


4. With 25% of homeowners (with mortgages) underwater, it won’t take much to push more people under water (in other words, there are many who are close) and to push the “already underwater” to the point at which they consider strategic default.

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Hi All,

Please forward this to others who may be interested.  If you want to sign up to receive these emails, see the instructions at the bottom of this article.


I’m doing some traveling right now and I’m behind on my reading.  Today, I caught up on some articles about the Fed, the financial sector, the bailout and a few other random things.  I will probably be blogging a fair amount next week, as I have articles that I need to get through about housing, employment, BP, EU and China.  I’ll probably do almost one per day plus add in some other stuff.  Enjoy.


1. Fannie and Freddie took over a foreclosed house every 90 seconds during Q1.  By the end of Q1, they owned 163,828 homes.


2. So far, taxpayers have spent $145.9 billion on Fannie and Freddie.  The CBO predicts that it could reach $389 billion.


3. On average, Fannie and Freddie recoup less than 60% of the money that is owed to them by a borrower.


4. So far this year, 68.4% of buyers (of houses sold by Fannie) have certified that they would use the house as their primary residence.  Investors are not allowed to buy during the first 15 days of listing.  Buyers may not resell a house for a profit within 90 days.


5. Since the “Making Homes Affordable” program was launched last year, 340,000 homeowners have received a permanent loan modification (lowering their loan payment for five years).  Approximately 436,000 have been dropped from the program (because they miss a payment during the time when there is a temporary modification or because they can’t prove that they qualify for mortgage assistance).  Approximately half of those dropped from the program received another type of modification from their bank.


6. Congress is considering a plan to make $3 billion of loans to unemployed homeowners who are having trouble paying their mortgage.


7. In reconciling the Financial Reform bill, it looks like the GAO (which is overseen by Congress) will not be given the authority to audit the Fed’s interest rate decisions.  The GAO would have authority to scrutinize the Fed’s crisis decisions and the Fed would disclose discount window borrowers with a two-year lag.  My view has not changed on this issue…the Fed is far from perfect, but politicizing it and giving Congress a say is not the solution.


8. It looks like Congress will instruct the SEC to set up a government panel to parcel out security offerings to ratings agencies (in order to stop the rated company from directly paying the rating agency).  This will be done after a two year study in which they determine whether there is a better alternative.


9. The House and Senate are reconciling their respective financial reform bills and are trying to decide whether mortgage lenders should have to retain a stake in even the most conservative mortgage loans (30-year or shorter fixed rate loans with income documented and no right to defer payments).  With riskier loans, the lender will definitely have to retain 5% of the credit risk on loans that they securitize.


10. Federal Reserve Vice-Chairman gave the WSJ an interview prior to his retirement.  His key comments:

1. Greenspan’s interest rate decisions were good, but he will not be remembered well for his bank supervision.
2. The stability of the economy (and infrequency of recessions) made people less careful.  We believed home prices could not drop.
3. The regulation of the financial system did not keep up with the changes in the financial sector.  Supervision did not keep up with the shift from bank-oriented to market-oriented intermediation.
4. Bank supervision is a better tool than monetary policy in regulating bubbles.

11. The IMF’s first Deputy Managing Director (John Lipsky) said that the financial crisis showed that fixing weaknesses in supervision is at least as important as the efforts to reform financial regulation.  Yet, very few people are focused on supervision.  He also said that supervisors did not seem to understand new sophisticated products and didn’t do a good job of ensuring that management and boards understood them.


12. The top six credit-card lenders (including JPM, BAC and Capital One) said that loans at least 30 days late dropped to 4.22% in May, compared with 4.4% in April.  This is the lowest since July.  This is considered a leading indicator of write-offs.  Write-offs also fell, except at BAC and Discover.


The reduction in accounts that are 30 days delinquent:

American Express 2.9% (April 3.1%)

Capital One 4.8% (April 5.07%)

Bank of America 6.39% (April 6.73%)

Citi 5.59% (April 5.85%)

Discover 4.95% (April 5.3%)


Selected Write-offs:

American Express dropped from 6.7% to 6.3% (lowest levels)

BAC increased from 12.71% to 13.33% (highest levels)


13. The Fed adopted new rules showing that they will exert more power over compensation.  They now have the right to reject compensation structures which they feel promote unnecessary risk-taking.  They said that they had found deficiencies at many large banks, including the inability to determine which employees can expose a bank to risk and pay structures that don’t adequately mitigate risky behavior.  This new policy will apply to banks regulated by the FDIC, the Office of the Comptroller of the Currency and Office of Thrift Supervision.  The rules apply to senior executives and other who are responsible for oversight of firm-wide activities or material business lines.


14. Some banks (like Citi) are apparently more concerned about the new Basel regulations which would require them to hold more capital instead of lending it out.  This would result in safer banks (larger buffer) but it would mean less money is being loaned out in the world economy.  The Institute of International Finance estimates that banks in the US, EU and Japan would need to raise $700 billion of common equity and issue $5.4 trillion of long-term debt from 2010 to 2015 in order to meet the Basel capital and liquidity requirements.


15. Alan Greenspan wrote a piece in the WSJ.  I think that the key takeaways are:

1. investors’ willingness to buy Treasuries (and finance our deficits) has allowed us to continue our spending
2. rates can rise very quickly
3. we will not be able to grow our way out of our problems
4. we need fiscal restraint right now (and we have no record of this)

16. Geithner told the Congressional Oversight Panel that banks had repaid about 75% of the bailout money they received, but that we would likely have a loss from AIG.  The CBO estimates that loss will be $36 billion.


17. Many states are realizing that their pensions are in huge trouble.  They are implementing changes – such as later retirement or capped retirement pay.  The problem is that they are only doing this for new hires.  It doesn’t solve the problems.


18. In an effort to raise tax revenue, NY is considering raising the taxes on cigarettes.  Including the NYC tax, the price for a pack of cigarettes in Manhattan could be $11 if this goes through.


19. As mentioned earlier this year, Social Security will pay out more than it takes in for the first time this year.  The program is taking in less money because more people are unemployed and it is paying out more money because more people are applying for benefits early.


20, Credit default swaps on California and Illinois cost more than swaps on Portugal and Ireland.


21. GS estimates that the unemployment rate in Q4 2011 will be 9.7%.


22. Since May 26, the Baltic Freight Index has dropped 48%.  This is a very volatile index, but it’s at its lowest level for the year.


23. According to a WSJ poll:

-       62% of Americans think the country is on the wrong track

-       1/3 think the economy will get better over the next year

-       57% would prefer to elect a new person to Congress than to re-elect their current representative


24. Consumer prices in May fell for the second month in a row.  Prices are lower than they were in January.


25. The Fed said that short-term interest rates would stay near zero “for an extended period.”  They also said that “financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad.”  The Fed said that the recovery is “proceeding”, a notable change from April’s comment that the recovery “continued to strengthen.”


26. The KC Fed President (Thomas Hoenig) dissented for the fourth time this year.  He wants to raise rates.


27. A new Fed research paper concluded that the Fed is likely to wait until 2012 before it starts to raise interest rates.  The author wrote that there was a statistical relationship over the last twenty years between core consumer price inflation and the gap between actual unemployment and the natural, or normal, rate of unemployment.


28. The paper also argued that if rates were raised too soon, it would be hard to reverse course.  On the other hand, if tightening is started too late, the Fed could catch up by raise rates quickly.


29. Does the market want the savings rate to increase or consumer spending to increase?


30. Geithner is calling on G-20 nations to continue spending and to worry about deficits later.  He urged member nations to stabilize their debt levels, enact new rules for financial regulation and reduce their reliance on fossil fuel.  It’s easy for Geithner to say this stuff because we don’t share any of these issues…


31. The average weekly hours of private workers rose for the third month in a row, from 34.1 to 34.2.  This is the highest since January 2009 and the longest streak of monthly gains since before the recession.  Paying overtime is cheaper than benefits for new employees.  In addition, it gives the employer the flexibility to cut the hours if things slow down.


32. A Portland massage therapist accused former Vice President Al Gore of “unwanted sexual contact” at a hotel during an October 2006 visit.  I’m sympathetic to the former Vice-President, as Jenny has made this accusation against me with some regularity.
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This week, I plan on putting out two or three single-issue blogs (this being the first).  Please forward this to others who may be interested.  If you want to sign up to receive these emails, see the instructions at the bottom of this article.


Background: China to Be More “Flexible”

The Chinese central bank (the People’s Bank of China) said that they would be more flexible with their currency (known as either the renminbi or the yuan).   For the past two years, the currency had been pegged to the dollar (in other words, the exchange rate had been fixed).  They said that the recovery and upturn of the Chinese economy has become more solid with the enhanced economic stability.  They will not make a one-time adjustment.  Rather, they simply said that they will “increase the renminbi exchange-rate flexibility.”


China had previously stopped pegging their currency to the dollar in July 2005.  They managed a float against a group of currencies and the renminbi appreciated 21% in three years.  Then, they went back to the peg against the dollar.  (You could argue that they did this in 2007 because they expected the dollar to weaken during the recession and they thought that this would help their export driven economy.)


Last summer, the IMF (in an internal report) identified the Chinese currency as at least 20% undervalued.  Now that their trade is more in balance, it’s hard to know how undervalued it is.


Some Key Facts About Their Plan

1. We have no idea how much “flexibility” is planned.  Personally, I don’t expect anything significant.
2. China said that they would have continued emphasis “reflecting market supply and demand with reference to a basket of currencies.”  In other words, they will no longer be solely tied to the dollar.  The bottom line is that China doesn’t like the strengthening of the dollar (the EU is their largest trading partner) and they will allow their currency to appreciate if the euro appreciates.

Why Did They Do This?

1. They did this a week before the G-20 meeting in order to avoid getting beaten up over this issue. China is now saying that discussing the currency is off limits at the G-20.
2. There was tremendous pressure from the US. This will help Geithner to avoid having to label China a “currency manipulator.”  He has postponed putting out his report on this issue.
3. China just reported 3.1% inflation and a more valuable currency will help to curb this inflation.
4. The WSJ immediately published a piece arguing that this reflects the strength of the Chinese economy and this is great for risk assets.  I believe that this is the exact knee-jerk reaction.  But, over time, we might also decide that China is growing too fast and has rising inflation and that this is an attempt to slow their economy.
5. This may be the start of China’s effort to increase consumer demand (at home), so that they can lessen their dependence on exports.

What Will Happen Next?  (Not Much)

1. On Monday at 9 AM (EST), the Chinese government will set the initial benchmark for renminbi trading in the Shanghai currency market.
2. In recent months, China’s trade deficit has been $19.5 billion (May), $1.68 billion (April) and a deficit of $7.24 billion (March).  This has been a decrease and means that China will not allow their currency to appreciate much.
3. After China’s announcement, they later reassured the Chinese people that any rise would be gradual.  Of course, US politicians will not rest.
4. The renminbi has already appreciated 15% this year (because the dollar has strengthened versus the euro), so China is not about to allow their currency to appreciate much more.
5. If the euro continues to decline, the renminbi will actually decline relative to the dollar.  It makes no sense for the Chinese currency to be pegged just to the dollar.  They trade with many other nations.
6. Now, Geithner is going to be pressuring China for “vigorous implementation,” which we will not see.

What Will the Long-Term Effects Be?

1. Commentators are saying that this will hurt exports and drive China to be a more “consumer driven” economy, rather than an export driven economy.  (The exchange rate is being mentioned along with the fact that that Chinese wages are rising and this will lead to more consumer spending.)  But, don’t forget that exports rose 48% last month!
2. It may become even tougher for us to lecture China on their currency.  They can (and will) lecture us on our debt problem.  China owns $900 billion of Treasuries and is our largest creditor.
3. The funny thing is that this probably will have little impact on the US, other than the unintended consequence – that it will have a small inflationary impact here.

Once again, China is calling the shots.  They’re doing this partly for political reasons and partly to slow their own economy.  But, there is domestic pressure on the government and the changes will be minimal.  They are finding themselves handcuffed by the fact that their currency has already appreciated due to their peg to the dollar.

_______________________________________

If you want to be on my email list:

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3. you will receive an email which will require you to click on a link to confirm that you want to be on the list

IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.

Hi All,


It’s been a busy week.  I presented to the Pension Review Board on Monday and the Texas County Investment Officers on Wednesday in Corpus Christi.  I actually spent Tuesday through Thursday in Corpus because one of my children came with me.  It was three days of swimming, bumper boats, go-carts, miniature golf, the USS Lexington and the Texas State Aquarium.  It was loads of fun.  It confirmed two things: (1) one-on-one time is really special; and (2) I’m old.


I’ve been doing a lot of speaking recently and one of the things I’ve realized is that the “single issue” blogs are really helpful in putting my presentations together.  I say this all the time, but I hope to write more single-issue blogs.  Today, I’m doing it out of necessity – I just got home, I want to watch game seven (I’m hoping both teams lose) and I’m exhausted.


One quick basketball comment for those of you who have watched the series.  Ron Artest reminds me of myself when I was single and hanging out in bars.  He’s never seen a shot that he didn’t want to take and most shots are out of his range.  (The key difference is that every so often, Artest gets lucky.)


Today, I’m thinking about an important piece that was in the WSJ, “Rethinking Part of the American Dream.”  It was written by David Wessel.  He argues that our approach to home ownership has failed.  In addition, I read a couple of related articles by Daniel Indiviglio (a former Forbes writer and former banker who now writes for The Atlantic).   I’m going to touch upon several issues below, including:

1. shorter mortgages
2. prepayment penalties
3. mortgage interest deductibility
4. non-recourse loans

Wessel argues that the US has overemphasized the virtues of home ownership.  In addition, we’ve promoted thirty-year mortgages (and this has created the need for Fannie and Freddie to guarantee payments).  He’s also bothered by the fact that we have no prepayment penalties and this results in homeowners having an option to refinance.


Home ownership has been promoted as accomplishing several goals:

1. promoting social stability
2. providing a hedge against inflation
3. a way to save for retirement

Wessel argues that we have mistakenly measured the success of our “home ownership programs” by the home ownership rate.  In the 1940s, this was 40%.  In the 1960s, it was 60%.  In the 1990s, it reached 65% and by 2004 it reached 69.4%.  (Now, it’s back down to 67.2%.)  But, Wessel argues that a better way to judge the success of the home-financing system is to analyze whether the system can absorb shocks.  Of course, if that is our metric, our system is a complete failure.


Wessel advocates for shorter mortgages.  He explains that mortgages used to be 3 – 5 years.  I think that if we start talking about ten year mortgages, this has pros and cons.  It would force people to buy houses that are more within their price range and many people would end up better off financially (in effect, they would be forced to “save” more).  It may result in larger downpayments.  On the downside, we’d be mismatching the duration of the asset and the liability (an issue that has caused many problems throughout this crisis) and it could result in refinancing risk.


I disagree with Wessel’s complaint that we should have prepayment penalties on our mortgages.  The ability to refinance if rates go down is what lets me pull the trigger on a home purchase when rates are high.  Lenders know that I have this right and they (hopefully) price this into the rate I pay.  I’m more bothered by the fact that pre-payment penalties existed in approximately 70% of subprime mortgages and virtually no prime mortgages.  The only distinction is that it’s easier to put these penalties on the least educated members of society.  If the fear is refinancing when rates are low, prime borrowers are equally likely to do this.


In an older article, Indiviglio asks whether we should be promoting home ownership through the use of the interest rate deductibility of mortgages.  I might ask this differently: do we want to set up a system where the common man does leveraged buyouts?  Ultimately, that’s the system we’ve set up with homes.  You put a little money down, you use other people’s money, you refinance if rates go down and you walk away if the asset loses value.


My opinion is that while people always talk about interest deductibility, there’s another issue that is equally important in causing problems with home ownership.  They are the various laws that protect homebuyers – whether they are “non-recourse” laws in some states or laws in other states which make it easier for a lender to foreclose on property if the lender simply takes the property.


The bottom line is that we’ve set up our system so that homebuyers have an option.  As I’ve said a million times in class, an option is “the right, but not the obligation to do something.”  Is that a good system…where a homebuyer has the option to pay his loan, but not the obligation?


At the same time, I believe that a bankruptcy judge should have the right to restructure real estate debt.  (There’s a big difference between letting an experienced bankruptcy judge make a decision, as opposed to giving homebuyers the right to simply walk away.)  Maybe lenders would also make better decisions if they knew that a bankruptcy judge would examine not only a borrower’s ability to pay, but the appropriateness of the loan that a lender put them in.


I’ll end by saying that there are so many other issues to think about with the mortgage market.  We could argue about the role (and regulation) of mortgage brokers, the principal / agency issue caused by securitization of loans, whether we should allow homeowners to lower their taxes when we have a huge deficit, etc.   But, I can’t write about all of them right now.  The Lakers just won and I’m being forced to listen to hero worship of Kobe Bryant.  I need to go throw up.


One last thought about the game.  There’s one guy crying.  It’s Gasol.  It’s a sport.  You’re playing with men.  Go get some Kleenex out of your purse and get control of yourself.
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If you want to be on my email list:

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IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.

Today’s update is long because there has been a lot of interesting news.  In addition, I didn’t blog on Friday.  My next blog will come out this Friday.


Here’s what I read this past week.


1. A WSJ survey showed that Americans are starting to worry more about the deficit and debt problems. This ranked as the second most important priority that respondents thought that the federal government should give attention to.  It was only surpassed by job creation and economic growth.  Hopefully this will force our politicians to act.  We better get scared before investors become scared of the US.


2. Democratic pollster Mark Mellman described it well when he said that the debt represents wasted money, lack of discipline and long-term economic decline.


3. The World Bank warned that we could have a double dip recession if markets lose confidence in governments’ willingness to pay off their debt.  Nearly half the increase in global demand will come from developing nations.  More mature countries have weak financial sectors.


4. The IMF says that risks to the global economic outlook have risen significantly and policy makers have limited room to provide support for growth.


5. Bernanke testified before the House budget committee and  said that “unless we as a nation make a strong commitment to fiscal responsibility, in the long run, we will have neither financial stability nor healthy economic growth.”


6. Bernanke said that the budget deficit is a big problem, but it’s a bigger problem that the workforce isn’t growing nearly fast enough to pay for all the people who stand to retire over the next two decades.  He said that there must be some plans for restoring fiscal balance.


7. The state of New York (and local municipalities) is having trouble making their required payments to the state pension fund.  As a result, they are going to borrow $6 billion over the next three years.  They are borrowing it from the state pension fund.  In other words, they are meeting the funding requirements, but it is identical to having an unfunded liability.


8. Banks have returned $194 billion in TARP fund and there is $190 billion outstanding.  In other words, more has been returned than is outstanding.  In all, 707 banks received $205 billion and another $331 was committed to other programs (including GM, Chrysler, and expanded bailouts of Citi and BAC).


9. Some TARP money will never be repaid (e.g., $50 billion to provide cash incentives to banks t modify mortgages).  The President has proposed a tax on the banks to recover the losses.


10. The Administration is now estimating losses of only $105 billion from the TARP program.  The Congressional Oversight Panel said taxpayers still “remain at risk for severe losses” due to AIG.  There was $182 billion given to AIG from the Fed, but Treasury committed $70 billion of TARP money to the company.


11. Municipal bond yields may not be reflecting the risk that they hold.  Yields on munis maturing in 2020 are at 3.15%.  While yields have gone down, the cost of credit default swaps has increased.  With that said, just 223 out of 40,000+ issuers defaulted on their debt payments in the past year.  That represented just $6.4 billion  or .002% of outstanding municipal debt.  Of course, we now know that the ratings agencies are not going to help.  In addition, there is a huge amount of unfunded pension liability out there.


12. Household ownership of municipal bonds went over the $1 trillion mark for the first time ever (in Q1). This is 35% of the $2.83 billion market.  In additional, foreign investors have a $71.9 billion position (mostly taxable Build America bonds).  This is 80% higher than the end of Q1 2009.


13. Global corporate default rates declined from 9% in April to 7.5% in May.  Rates have fallen significantly from their peak of 13.5% in November 2009.  On the downside, spreads on junk bonds have increased in the past month.


14. Some argue that the slowdown in bank lending is the result of increased government regulation and taxation.  In other words, banks don’t want to lend to a business that may change significantly.  Unknown regulation makes it impossible to price risk.


15. Bank examiners have also become much more conservative in valuing banks’ assets.  The result is the need for increased reserves.


16. Some people are deciding to pay their credit card off, but not pay their mortgage. The Fair & Isaac Company reports that high FICO score borrowers are defaulting more on mortgages than on credit cards for the first time ever.  For consumers with FICO scores of 760 – 789, .3% defaulted on mortgages in 2009, while only .1% defaulted on credit cards.


17. Transunion reports that in Q3 2009, 6.6% of borrowers were delinquent on their mortgage but current on their credit card.  Only 3.6% were current on their mortgage but delinquent on their credit card.


18. TrimTabs tracks the jobs picture in real time by monitoring income tax deposits at the Treasury.  These have suddenly started falling.  They are actually predicting that the economy will lose up to 200,000 jobs in June.  If correct, it will be interesting to see how the market reacts to this news.


19. Average hourly earnings were up 1.9% YOY.  But, workers were 2.8% more productive (so they got some of the benefit and the company received some of the benefit).  Consumer prices increased 2.2%, so workers didn’t keep up with inflation.


20. The average growth rate of non-census jobs over the past three months has only been 130,000.   That’s about what is needed to keep up with the normal growth in the work force.  It won’t lower our unemployment.


21. Everyone talks about the impact of the stimulus (~$300 billion per year), but almost half of this has been offset by cutbacks (in services) and tax increases at the state and local level.  State and local tax increases will grow after July 1 (when the fiscal year begin).


22. The census currently has provided over 500,000 jobs.  These will be eliminated in late summer.


23. Only 41,000 private jobs were created last month.  It has been estimated that 20% of the 41,000 private sector jobs may be workers hired to clean up the oil spill.


24. What matters more to you: stimulating the economy or controlling the deficit (and living with high unemployment)?


25. In May, 11.3% of workers believed they would see their income rise in the following six months, while 16.6% thought they would see it decline. This is the first time in over forty years that more people believe they will be worse off than better.


26. More people quit their jobs in the last three months than were laid off.  In April, two million people quit their jobs and 1.75 million were laid off.  Quitting a job is a sign of confidence.   (Of course, it may also be a sign of being crazy.)  There is also a backlog of people who have wanted to quit for some time.


27. Purchase mortgage applications fell 5.7% last week.  They’re down 43% since the tax credit ended in April! They are at their lowest level since April 1997.  Think about that…we have historic low interest rates and applications are way down.  This shows the effect of uncertainty in the job market, damaged credit ratings and the home-for-clunkers program that we just finished.


28. Banks repossessed 94,000 homes in May, a 44% increase YOY.  But, the good news is that notices of default (the first step in the foreclosure process) fell 22% YOY.  Some analysts say that this is misleading.  Rather than good news, it merely reflects the fact that banks are full of inventory and are waiting.  There are still five million loans more than 90 days past due.


29. Only 2.6% of borrowers with subprime loans backing 2007-issued bonds who had never missed a payment ended up missing a payment in the past three months.  This is down from 3.7% in February.  Of course, we’re starting to look at a smaller pool of people (2007 subprime borrowers who have never missed a payment).


30. The monthly rate of new delinquencies among all loans in non-agency mortgage bonds fell to 1.2% in May.  That’s the low since 2007, down from more than 2.5% early last year.


31. More than 27.4% of mortgages underlying the $1.5 trillion of non-agency securities were at least 60 days late, in foreclosure or already turned into seized property.


32. French and German banks have lent nearly $1 trillion to the most troubled European countries and are far more exposed to the debt crisis.  French banks had lent $493 billion to Spain, Greece, Portugal and Ireland.  German banks had loaned $465 billion.  In total, Spain, Ireland, Portugal and Greece owe nearly $1.6 trillion to banks in the 16 country euro zone.  This is a combination of government debt or credit to companies and individuals.  The big problem is that we don’t know what banks are at risk.  As a result, no one wants to lend to any of the banks.


33. French banks had $106 billion of Greek debt.  This tells you why they wanted to support Greece.  Private debt is problematic because of austerity measures (which may lead to recession).  The US has less than $200 billion of exposure to Spain, Greece, Portugal and Ireland.


34. It will be interesting to see the impact of Europe on the US.  Combine Europe’s austerity measures and the strength of the dollar and you have to believe that our exports will be hurt. It used to be that people would argue that you wanted to own stocks which had exposure to Europe.


35. Approximately 73% of investors still believe that Greece will default.  Only 23% believe that the $1 trillion bailout will both keep the EU together and prevent a default.


36. Gene Epstein (Barron’s) argues that consumer spending looks okay.  Over the past three months (March through May), every single major category of retail sales rose from the previous three months (up 2.6% overall) and they were above the level of the same period a year earlier (up 8.1% overall).  He also argues that the numbers coming out of the Census Bureau are less reliable than the positive numbers coming out of the Commerce Department.


37. Lance Roberts supplied some reasons to worry about consumer spending and GDP: (A) less stimulus money; (B) the end of the inventory correction; (C) increased savings rate; (D) further decline in real estate; (E) Europe and China slowdown; and (F) cutbacks at the state and local level.


38. China is investing in ports and distribution centers in Greece.  They are using this opportunity to make investments which will help trade.  As a result, the Greeks have a favorable opinion of China.  One deputy minister expressed his view that Chinese invest in real assets while Wall Street is only interested in pushing paper securities.


39. China’s exports increased 48.5% YOY in May, while imports increased 48.3%.


40. With elections approaching in November, politicians are anxious to go after China.  Geithner recently said that the distortions caused by China’s exchange rate spread far beyond China’s borders and are an impediment to the global rebalancing that we need.  It’s hard for Americans to have unemployment near 10% and see China grow faster than 10% (to some extent due to their cheap currency).


41. China’s CPI increased 3.1% YOY in May.


42. From 1994 – 2008, Chinese productivity increased 21% and labor costs increased 13%, meaning that there has been a decrease in per unit labor cost.


43. China’s huge surge in exports will not change their currency thoughts:

1. the dollar has since appreciated against the euro and this will make it harder for China to export
2. these orders were placed before the deepening of Europe’s debt crisis
3. higher wages will make their exports less competitive
4. higher wages will increase Chinese demand for imports

44. In China, new construction starts in May were double last year’s levels, and are up 72.4% so far this year, while developers’ purchases of land were also up 44.1% in May.


45. Only two companies in the S&P 500 have done a stock split this year.  In an average year, there are 49.  Of course, most stock prices are well below their 2007 levels, so it’s unclear to me why we should be surprised by the lack of splits.


46. So far this year, 135 members of the S&P 500 have raised, initiated or reinstated dividends, while only two companies have cut them.  This nets out to a $10.4 billion increase in dividend payouts for the year.  Last year, dividend payouts dropped $39.8 billion.  So far this year, 310 companies have announced buyback programs.  Last year, 253 did this (when stocks were cheaper).


47. All exchanges will now halt trading in an individual stock when its price moves 10% or more, up or down, in the previous five minutes.


48. California passed Proposition 14.  Starting in 2011, California will have general elections (rather than primaries) and then the top two vote getters will face off.  They could be members of the same party.  The idea is that it will force candidates to appeal to everyone.  One other threat is that one party will run only two people and another party will run many candidates and split the vote.  The state of Washington has a similar approach.


49. The government estimate was that 25,000 – 30,000 barrels per day were flowing into the Gulf of Mexico.  Wow, and I really had believed that it was 5,000.  (Note: a barrel contains 42 gallons.) Then, on Friday the federal government said that the oil leak may be 40,000 barrels per day.  When this started, BP’s original estimate was 1,000 barrels per day.


50. As I mentioned in the past couple of weeks, I don’t expect a US company to acquire BP.  My main argument is that I think that the political issues are too great.  British shareholders would truly feel like we had done them wrong.  I think that we’re starting to see evidence that this argument may be right – British sentiment has turned against us and the comments by President Obama (where he has railed against BP).   Personally, I even believe that there is a good chance that the British government would step in and provide a bailout, rather than allowing BP to declare bankruptcy.


51. An interesting article in the NY Times pointed out that Florida has prohibited offshore drilling for many years in order to promote tourism and keep their beaches safe. They haven’t received the financial benefit of drilling, yet it turns out that they share the risk.  A recent study argues that Florida’s gulf coast could lose 195,000 jobs and $11 billion this year alone if the spill cuts tourism in half.


52. Apparently, BP is going to announce that they are suspending their dividend in order to guarantee that they will have the funding available to pay damages for the oil spill. As I’ve said before, I think that the United States has the right to request this.  Put in personal terms…you wouldn’t like it if someone injured your family and then distributed his assets to someone else before you could get a judgment imposed on him.


53. President Obama is getting ready to compel BP to set up a multi-billion dollar escrow account to pay damages.  Apparently, the administration has legal authority under the federal oil pollution act.


54. BP is going to fight the Administration’s demand that BP pay all of the unemployed rig workers who have lost their jobs because of the six month moratorium on off-shore drilling.  The idea that “you caused a spill that caused us to ban offshore drilling and now you’re responsible for everyone who lost their jobs” is absolutely absurd.


55. We almost saw a replay of the AOL / Time Warner merger! If you remember, AOL turned their overpriced stock into real assets by merging with Time Warner.  Time Warner shareholders were killed by this deal.  This past week, the Pac 10 tried to do the same thing.  The Pac 10 tried to acquire some of the best Big 12 teams at a time when the Pac 10’s best team (USC) has lost a tremendous amount of value (due to NCAA probation).


56. While Texas and nine other Big 12 teams decided late Monday to stay put, this whole deal was a true debacle.  We lost two “big name” teams in Colorado and Nebraska.  I love Texas, but it gets old watching them play Baylor, Iowa State, Kansas, etc.  Then, you add in nonconference games against powerhouses like Rice and you’ve got quite the schedule.  The bottom line is that losing Colorado and Nebraska made a weak conference even weaker.  I’m hoping that there is going to be news released about adding some teams that will strengthen the Conference.  With that said, I will be shocked if anything good like that happens.


57. Was I the only one wondering if I England’s goalie was exposed to BP’s oil? That might explain the American goal.

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Hi All,


My next two blog posts will be Tuesday (June 15) and Friday (June 18^th).  In other words, you won’t receive anything for six days.  But on Tuesday, you’ll hear everything I’ve been thinking about for the week.  I have to put together a couple of presentations (as well as give them), so I’m a little tight on time.


Now, on to what I’ve read in the last couple of days…


1. A very weak recovery. Bernanke said that we will have a continued recovery, “but it won’t feel terrific.”  Growth will not be enough to drive unemployment down.


2. Deleveraging. Consumer borrowing increased .5% in April (up $954.8 million to $2.44 trillion).  But, March was revised down, showing a decline of $5.4 billion (2.7%).  Previously, the March number had been a $2 billion increase.


3. Small business optimism increased 1.6 points to 92.2 in May, according to the National Federation of Independent Business.  The good news is that this is the highest reading since September 2008.  The bad news is that this low reading is not a sign of a strong recovery.


4. Slight improvement for the job market. For the first time in a year, the number of unemployed workers per job opening fell below five (it went down to 4.96).  This is the right direction, but it’s still a dismal number.


5. Domestic outsourcing. In 2005, the government estimated that 31% of U.S. workers were contingent workers – temporary or contract workers. Experts say that number could increase to 40% or more in the next 10 years.  I have been referring to this trend as domestic outsourcing.


6. Stimulus or deficit reduction? Here’s a ten second summary of this past week’s G-20 meeting.  Think about this argument: should we increase government spending to stimulate the economy or should we cut government spending so that the lower deficit will encourage investors?  Increasing spending creates risk that the market will get fearful over the debt.  Cutting spending could increase unemployment.


7. We may start pushing for deficit reduction. We are starting to see the ramifications of having so much debt.  We are faced with low growth and high unemployment, yet we can’t stimulate the economy.  Political sentiment is turning to cutting our deficit and promoting growth by promoting stability.


8. A quarterly poll by Bloomberg (of investors, traders and analysts) found that 39% said the US was the most promising place to invest for the next year, followed by Brazil (29%), China (28%) and India (27%).  In January, China was the favorite (and that wasn’t a good pick).  Forty-two percent think that the world economy is deteriorating, while only 21% felt that way in January.


9. The European Financial Stability Facility was finalized. It has the potential to sell bonds worth $524 billion with guarantees from member nations and loan the money to weaker countries.  They will issue debt only after an aid request is made by a country.  It strikes me that this is problematic – you want to raise money when investors aren’t thinking the worst about the EU.  I think that they are trying to signal safety without having to act.  Of course, it reminds of being told that you never pull a gun unless you’re ready to use it.


10. Germany announced spending cuts of $95.7 billion by 2014. They are trying to reduce their deficit and protect the euro.  They plan to cut social spending and reduce the number of civil service jobs.  They will not increase income taxes or VAT.


11. As a result of the recent turmoil in Europe, credit spreads have increased, interbank lending has become more costly and commercial paper issuance has slowed down.  In addition, the dollar has appreciated relative to the euro.  This means that the Fed is less likely to raise rates anytime soon.


12. Another result of the European turmoil is that the 10-year Treasury is yielding 3.18%, its lowest level since May 2009.  Thirty-year fixed rate mortgages are costing 4.79%.  A 15-year mortgage is 4.20%.


13. Some investors think that there is a bond bubble. Of course, it’s really strange to think of a bubble that is caused by risk-aversion. In 2009, bond funds saw a record $375 billion of new money, bringing the total to $2.2 trillion in assets.  Stock funds saw $40 billion leave and they ended the year with $3.7 trillion of assets.


14. From 1985 – 2009, average bond fund returns have been negative only three times, with losses in 1994 (4.7%), 1999 (1.2%) and 2008 (7.8%).  US stock funds had six losing years.


15. Another possible bubble.  Great description of the next bubble: the buyers think that what they’re buying will appreciate in value (making them rich in future), the product is growing more elaborate and expensive and the expense is offset by easy credit.  Buyers see everyone else taking on debt to buy the product and this makes them more willing.  What product / industry is the author talking about?  Education!  Say it’s not so!  Certainly, most of you wouldn’t mind taking on $100K of debt to sit in a class and hear some of my bad jokes?  Remember, you can’t walk away (or strategically default) from student loans.

http://www.washingtonexaminer.com/opinion/columns/Sunday_Reflections/Higher-education_s-bubble-is-about-to-burst-95639354.html


16. It’s interesting to ask how much of education is (A) learning to think; or (B) practical skills; or (C) signaling (that you can be admitted to a certain caliber college); or (D) building a network? I saw a great comment from an unrelated article (in The Chronicle of Higher Education) where someone asked whether you could currently pass a test in your undergraduate major and whether you use anything from what you studied.  You may not have retained that material, but you still have your debt.


17. In my last blog, I mentioned my disbelief that BP would be acquired. But, the NYT reports that Shell and Exxon would love to acquire BP.  There is talk about how BP could enter bankruptcy and separate into two entities: the cleanup entity and the good assets.  I should also say that a very good friend who has A LOT of experience in the energy industry emailed me on Monday morning (after he read my blog) and said that he really thought that Exxon could acquire BP.  Personally, I think that the politics would be very tricky – if an American company scoops up the good assets of a British company.  But, I’ve been surprised before.


18. Credit Suisse estimates that BP’s cleanup costs could run as high as $23 billion.  In addition, BP could face $14 billion of claims from fisherman and the tourism industry. The company has $12 billion in cash and short-term investments.  Of course, this doesn’t mean that they can’t sell assets, raise more money or get bailed out by the British government.


19. Is anyone happy about the BP oil spill? Possibly GS.  As breakingviews points out, we only have the capacity to hate one villain at a time.


20. The Financial Crisis Inquiry Commission is complaining loudly that GS delayed in responding to their requests for information and then dumped millions of pages on them. The Commission has now used their subpoena power to make further “requests” of GS.  The Commission says that GS has given them hundreds of millions of pages of information.  It would be enough to fill up 6,386 CDs.


21. China is losing its labor advantage.  Controversy over working conditions (and suicides among factory workers) and high profile strikes (such as a Honda plant in China) are leading to higher wages.  There are fewer young workers (age 15 – 25), they have higher expectations because they have seen the generation before them, they are more aware of their rights.  The number of 15 – 24 year olds in China is expected to fall by a third over the next dozen years from 225 million today to 150 million in 2022.  At the same time, demand is increasing (more factories).  Higher wages could help China transition from an export-driven economy to a consumer-driven one.


22. I find it amazing that Apple’s new iPhone announcement has garnered such media coverage. Apple has 15.8% market share in the smartphone market, trailing Nokia and RIMM.  The iPhone accounts for 40% of Apple’s revenue.


23. The most important article that I read this week was not a finance article.  It was “Hooked on Gadgets, and Paying a Mental Price” by Matt Richtel (NY Times). http://www.nytimes.com/2010/06/07/technology/07brain.html?src=busln Here are some of the key ideas (lifted almost directly from the article):

1. Our ability to focus is being undermined by bursts of information.  Scientists say juggling e-mail, phone calls and other incoming information can change how people think and behave.
2. We have a primitive impulse to respond to immediate opportunities and threats.  The stimulation provides excitement – a dopamine squirt – that researchers say can be addictive.  In its absence, people feel bored.
3. These distractions can limit creativity and deep thought, interrupting work and family life.
4. Research shows that multitasking is very difficult.  Heavy multitaskers actually have more trouble focusing and shutting out irrelevant information, scientists say, and they experience more stress.
5. Scientists are discovering that even after the multitasking ends, fractured thinking and lack of focus persist.  In other words, this is also your brain off computers.
6. In 2008, people consumed three times as much information each day than they did in 1960.
7. Computer users at work change windows or check e-mail or other programs nearly 37 times an hour.
8. At home, people consume 12 hours of media a day on average, when an hour spent with the internet and tv simultaneously counts as two hours.  That compares with five hours in 1960.
9. Computer users visit an average of 40 websites a day.
10. Multitaskers tend to search for new information rather than accept a reward for putting older, more valuable information to work.  In other words, they are more sensitive than non-multitaskers to incoming information.
11. The chime of incoming email can override the goal of writing a business plan or playing catch with the children.
12. It’s difficult to shut off multitasking tendencies when you’re no longer multitasking.
13. People interrupted by email reported significantly more stress than those left to focus.
14. While there were workaholics in other generations, nowadays we can multitask anyplace, anytime.
15. Digital stimulation may create attention problems for children with brains that are still developing, as they already struggle to set priorities and resist impulses.
16. Technology may diminish empathy by limiting how much people engage with one another, even if they are in the same room.

All I can say about this article is “guilty as charged.”  I’m just glad that they didn’t put my picture in the paper.


Have a great week.  You’ll hear from me on Tuesday.
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In today’s blog, I’ve listed twenty interesting stories that I read this weekend.  Enjoy.


1. BP said that they collected 6,000 barrels of oil in 24 hours from the Gulf leak. The most significant takeaway is that it’s really impressive to collect 6,000 barrels when you claim that you’re only leaking 5,000 per day.  Of course, the government estimate increased last week and this 6,000 capture rate lets us know that there’s a lot more being leaked.


2. BP has lost 36% of its value – a drop of $75 billion. They have agreed to pick up the government’s bill to clean up this mess.  Some politicians have called on BP to halt their dividend.  Other commentators have argued that the government shouldn’t be dictating BP’s dividend policy.  Here’s my opinion…if you injured me and we don’t know how much it’s going to cost to make me whole, I really don’t want to see you spending money elsewhere.  I don’t care how rich you are.  I have one concern – making sure that you are able to pay me.  Of course, there’s no telling what would happen to BP’s stock price if they halted their dividend.


3. Fitch downgraded BP from AA+ to AA and Moody’s downgraded BP from Aa1 to Aa2.


4. There are rumors that BP will be acquired or merge with another company. This strikes me as shocking.  If anyone is thinking about acquiring BP, they should probably take a few minutes to looking at BAC’s acquisition of Countrywide.  It may help to understand what you’re actually buying and what liabilities exist.


5. The jobs report was dismal, as we added 431K jobs. While that number sounds high, the market was expecting 515K jobs.  Most importantly, there were only 41K jobs created by the private sector.  The Census Bureau hired 411K – but most of those jobs will end in a few months.  We really are becoming Greece – everyone works for the government now.  Apparently, the basis of our recovery is that everyone is going to spend their time counting everyone else.


6. Nearly half of the unemployed (46%) have been out of work for longer than six months. This is the highest percentage since the Labor Department started collecting these stats in 1948.  This amounts to seven million people and 4.7 million of them have been out of work for more than one year.  Obviously, this brings incredible anxiety and stress.  We risk creating a class of permanently unemployed.


7. On the positive side of the jobs report, manufacturers hired 29,000 workers last month. Hours worked increased.  Factory employment has increased by 126K jobs over the past five months.


8. If you want to see a really scary chart and commentary, go to http://www.consumerindexes.com/index.html .  They are predicting that GDP will shrink 2% in Q3.  The scary thing is that their indicator seems to have done a great job in the past four years.


9. There are $700 billion of commercial mortgage-backed securities (CMBS) outstanding. This is more than the combined value of securitized credit-card, student-loan and car-loan debt.  The delinquency rate in June (for CMBS) reached 8.4%, more than triple one year earlier.  In the past, when these mortgages ran into trouble, investors have lost 37% of principal.  But, Fitch just released a report that said the loss-severity rate averaged 57% last year (an all-time high).


10. Foreign banks and other financial companies have lent $2.6 trillion to public and private institutions in Greece, Spain and Portugal. No one knows who actually holds the debt and is at risk.  As a result, there is fear in lending to European banks.


11. The euro hit a four-year low, trading for less than $1.20.  The euro has dropped 15% in 2010.  There was fear about Hungary after a senior official there warned that they could be the next Greece.  Many Hungarian mortgages are denominated in the swiss franc (which has been appreciating) and are becoming expensive.


12. Spreads between Spanish and Italian bonds against German bonds have reached their highest level since the start of the euro in 1999.  With that said, yields are still relatively low in nominal terms (e.g., Italian bonds were yielding 4.29%).


13. Germany is planning austerity measures in order to shrink their deficit to 3% of GDP (from 5%). This is going to increase the anger that Germans have with respect to the bailouts of other countries that are protesting against austerity measures.


14. PIMCO’s Bill Gross referred to US Treasuries as “the least dirty shirt.” In other words, all sovereign debt looks bad, but ours looks least bad because the dollar is the reserve currency and we have low inflation and low growth.


15. As inflation slows, we move closer to deflation. Some measures of credit growth are shrinking.  If deflation becomes persistent, it creates even larger problems than inflation.  Consumers wait for lower prices, spending slows and debt is paid back with more valuable dollars.


16. KC Fed President Tom Hoenig said that the FOMC should be prepared to raise the fed funds rate to 1% by the end of the summer. He said this in a speech on Thursday (prior to the jobs report).  In this speech and other discussions, he has cited the strengthening economic recover, the possibility of inflation and the risk of creating other bubbles.  He said that the FOMC should first eliminate their commitment to maintain rates at “exceptionally low levels” and then raise the rate.


17. Buffett warned that municipal debt could be the next disaster. He said that it may be easier for public officials to default on insured debt rather than push through tax increases.  The recession has obviously hurt tax collections.  In addition, pension funds are far underfunded.  The question will be whether we have a federal government bailout of municipalities.


18. How will Warren Buffett be remembered? Last week, Buffett defended the credit ratings agencies and their way of doing business.  He said that he would be much more inclined to come down hard on the CEOs of institutions that needed to be bailed out by taxpayers.  Of course, he didn’t come down hard on Lloyd Blankfein (GS) when he supported him at the Berkshire shareholder meeting (in May).   This past Wednesday, he said that Moody’s managers made the same mistake that 300 million other Americans made.  The problem is that the 300 million of us weren’t paid to study these securities, didn’t have the same information they did and didn’t get compensated to give inflated opinions on these securities.   So, I’m not really sure that I see it.


19. Race and ethnicity are becoming less important to us. Approximately 14.6% of all new marriages in 2008 were between spouses of a different race or ethnicity from one another.  In 1980, this was 6.7%.


20. Apparently, discretion is also becoming less important to us. Two different men claim to have had affairs with the woman who is the leading candidate for the Republican nomination for governor of South Carolina.  She claims that both men are lying.  Where do we come up with these people?  I have no idea who is telling the truth and who is lying, but I have a pretty good feeling that someone is lying.  I will say that I’m suspicious that the accusations are true since there are phone records of 700 phone calls between the woman and one of the men and many of the calls were in the middle of the night.  Given their record, South Carolina should replace the Governor’s mansion with the Governor’s trailer.

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Part I: Background and Idea

People often say to me, “you’ve identified some serious problems…so how do you think we should fix them.”  That’s an interesting question.  I wish that I had an easy answer to solve a $52 trillion unfunded liability.  Most of the things that I tell people involve structural changes (term limits, changing the credit ratings agencies, etc.).  They do not involve answers such as “decrease spending by 2%.”


The reason for this is that telling people that I think we should increase taxes or cut spending just gets into huge political issues.  They are difficult to implement.  Even if they are implemented, they are often changed by the next administration.  My best analogy would be that you could either tie your child’s shoes or you could teach him how to tie his shoes.  Tying his shoes for him solves the problem now, but problems will return when the shoes become untied again.  When it comes to dealing with the government, the best solution is to simply replace the shoelaces with Velcro so that anyone could get the job done…


So today, I want to tell you what would make me happy and more optimistic about the future direction of our country.  It involves structural changes.  I’ll start with the big picture.  Then, I’m going to discuss an article that my ideas really evolved from and then I’ll conclude.


I would feel confident about our future if we implemented the following:

1. put together an independent board (similar to the Fed or similar to the federal judiciary) that had long tenure (or even lifetime tenure) to oversee the entitlement programs (particularly Social Security and Medicare / Medicaid)
2. require this board to put together a plan every five years (using the average balances for the past five years so that we’re not affected by one major move in the market or the budget) that balanced these programs (so that they were fully funded)
3. this board would have authority to cut the spending on these programs (limiting benefits, raising the age, means testing, etc.) or raise the amount we pay into these programs

In other words, all I’m asking for is a plan.  I’m simply saying that we can’t keep kicking the can down the road.  GM kicked the can down the road.  Greece used their little legs to do the same thing.  We know how it ends and how it will eventually end for the US, even if we can print our own currency.  We know that problems become worse.


Sometimes we just can’t afford things.  Life sucks.  Or sometimes, we have to save more and spend less.  Again, life sucks.  But ignoring the problem is not the solution.  We also know that Congress is incapable of making hard decisions.  We’re going to have to make serious changes, even if it requires a Constitutional amendment that grants this taxing and spending power to this board.


I’ll talk a bit more about this idea later.  But first, let me tell you about the article that triggered these thoughts.


Part II: Economic Growth and Institutional Innovation

On Tuesday, I read “Economic Growth and Institutional Innovation: Outlines of a Reform Agenda” by William A. Galston.  It was published this week by the Brookings Institute.  Below, you will find some of the main ideas from the article (and note that I am only covering the part of the article that relates to our unfunded liabilities – my main fear).


We Need to Change Institutions, Not Policies

1. Policies are political suggestions, such as higher taxes or spending cuts.
2. Examples of institutions are the Defense Department, the Congressional Budget Office and the Department of Homeland Security.

To Have Sustained Economic Growth, We Need to Solve Three Deficits

1. Fiscal Deficit
2. Savings Deficit
3. Investment Deficit

The author has many suggestions as to how to solve these problems – some of which I either don’t agree with, don’t understand how they would work or are outside of my interest.  But, he recognizes that our polarized political system is an obstacle to reform.  He suggests that we try two suggestions that resulted from collaboration between Brookings and the Hoover Institution:

1. alter redistricting authority so that state legislatures can no longer practice gerrymandering
2. experiment with compulsory voting (in a few willing states) so that politicians have to attempt to appeal to everyone, rather than just their political base

I’ve discussed the political problems (such as gerrymandering) in the past.  Some countries have “nonpartisan” authorities in order to determine voting districts.  With respect to compulsory voting, this seems like an interesting idea, but it seems like it would be difficult (and expensive) to implement.  Just look at how much trouble we have getting people to complete the Census form.  The bottom line is that we have political problems, but I’m distrustful that Congress will ever be able to solve the problem of our unfunded liabilities.  Don’t forget, they caused this problem.


Regardless of the political issues, he mentioned a suggestion for fiscal sustainability.  Apparently, the suggestion came from a bipartisan group that included three former CBO directors.  The idea is to require a review of our entitlement programs every five years to determine whether projected revenues and outlays are in balance.  If not, Congress would be required to restore balance through dedicated revenue increases, benefits cuts or a combination.  Again, I think that this is a great idea – I simply don’t believe Congress is capable of getting this done.  (If you have faith in Congress, why don’t we let them control the money supply too…)


He further promotes the idea (of several other writers) that we should have a VAT that would be dedicated to paying the federal share of health care programs.  That way, Congress would have to either raise taxes or cut benefits.  Personally, I’m not a fan of the VAT, but the intuition is good – simply forcing Congress to address the problem, rather than kick the can down the road.


Another suggestion (based on how we do base closures and trade agreements) is to have an independent commission with members from both political parties that could submit proposals in designated areas of fiscal policy.  Each proposal would require a super-majority of the Commission.  Each party in Congress would then have the opportunity to offer only one amendment to the proposal.  Again, I’m not a big fan of this.  California has a supermajority vote requirement for their budget and it’s been a disaster.  It simply gives more power to the minority party.


He also described the idea of empowered commissions as similar to federal judges and the Fed.  Federal judges have lifetime employment and their salaries can not be reduced by Congress.  Fed Governors have a 14-year appointment.


In sum, those were his thoughts and I agree with the basic intuition.


Part III: Conclusion

Now you know my thoughts and where they evolved from.  Here are my final thoughts:

1. We can disagree on a lot of things, but I don’t understand how any of us can disagree that we should have a plan that inflows should equal outflows.  We need to have a plan.
2. Political polarization has become so intense that I have lost all trust in Congress to handle these important issues.
3. I’m sick of the fraudulent accounting that the Executive and Legislative branches engage in.  One recent example is the Bush tax cuts.  When President Bush was in office, we were told that his tax cuts would have little impact on our long-term deficit because they would be eliminated in ten years (once he was out of office).  Whether you like or dislike tax cuts, it’s unfair to say that we’ll have low taxes while I’m in office and then tax rates will jump back up for the next guy.  I can easily see our Congress putting together a plan where we do nothing in the next ten years but we assume that the tax rate goes up to 90% in year 11 (and thus, we’re in balance).  We need independence.
4. An independent Board comes from a promise of employment (either for life or a long term).  I wouldn’t even have a problem if the board was comprised of federal judges – these are largely smart individuals.
5. I haven’t studied what it would take in order to give an independent Board this spending and taxing power.  My guess is that it would take a Constitutional Amendment (which is very unlikely).

The bottom line is that I will not be optimistic until we address our problem and come up with a plan as to how we’re either going to spend less (on Social Security and Medicare / Medicaid) or fund these programs.  If we don’t, I’m not sure how we’re any different than the migrant worker who makes $20,000 per year and bought an $800,000 house in California.  He lived well for a while, but eventually it had to end.

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Below is a summary of stories that I read during the past few days.  I think that the most important story is the conflict that we are seeing in the EU.  But, before I get to that, I have updated you on some of the other news about the EU.


1. News From the EU

On Friday, Fitch downgraded Spain from AAA. Apparently, Spain’s fiscal crisis is being worsened by a political crisis, as citizens are very unhappy with the government.  Of course, this will make it very difficult to implement austerity measures.


If Greece can’t solve its problems, they may need to restructure their debt (that’s a fancy way of saying “default”) or leave the EU.  This could create fears about other countries.  Greece needs to cut wages to make its goods more competitive.  There is also need to deregulate parts of the economy that do not have competition and simply protect workers.


France’s budget minister said that France should not take for granted its AAA rating. France forecasts that its deficit will be 8% of GDP this year.  They don’t expect to have it down to 3% until 2013.


Germany’s finance minister said that Germans need to be ready for higher taxes. The government is considering raising the VAT to 19% on certain items that currently benefit from a lower rate of 7%.  Germany’s deficit is expected to be 5% of GDP.


The European crisis is resulting in a slowdown in lending in Europe. Libor has increased and deposits with the ECB have increased (because banks don’t want to loan money to other banks).


The ECB has made clear that they consider inflation to be their top fear.  But, many economists think that they are missing the bigger threat: deflation. When the ECB bought government bonds in May, they simultaneously took in more deposits from banks (showing that they were not adding liquidity to the market) and some economists think that this was a mistake.  Deflation is a big concern because:

1. it causes consumers to delay purchases (waiting for lower prices)
2. delayed purchases (by consumers) can cause a downward spiral of lower demand and production
3. debtors are paying debt back with more valuable currency

In April, prices fell in Ireland.  Inflation was less than 1% in five other euro zone countries.  For the entire euro zone, inflation is running at 1.5%.  Many countries are going to try to cut wages to become more productive (since they don’t have their own currency to devalue).  There is less fear of deflation in the US because we have kept interest rates near zero and pumped large amounts of credit into our economy.


Europe’s banks will have to write of $237 billion of bad debts by 2011 and their ability to sell bonds may be curtailed as governments finance fiscal deficits, the ECB said.




2. Dissension in the EU

One of the things that I’ve been speaking about recently has been the fact that the EU has bailed out European banks, not Greece.  One of the most significant conclusions that central bankers have reached as a result of America’s crisis was that a banking crisis is much worse than a normal recession.  We don’t want any more banking crises.  As a result, if banks own crappy securities, the government will buy them.  Ultimately, that’s what happened in Europe.


This obvious issue (that the bailout is for the benefit of “non-Greek” banks) is felt very strongly by Germany.  It really irritates the Germans that the ECB is buying Greek bonds even though Greece is already getting money from an EU rescue fund.  The Germans believe that this is just a ploy to allow the French banks to liquidate their Greek bonds.  Of course, ECB President Jean-Claude Trichet is French.  This is leading some to believe that the independence of the ECB has been compromised.  Imagine how irritated the Germans are – the German banks had committed to holding their Greek bonds until 2013.


The ECB has already spent $50 billion buying bonds issued by Greece, Spain, Portugal and Ireland.  When Greece’s debt loses value (prices are artificially high because of the ECB purchases), the ECB’s capital will be crushed.  Member nations will need to inject more capital.  That should go over pretty well.


Tensions between ECB and Germany seem to continue to escalate.  ECB executive board member Lorenzo Bini Smaghi said that “in one large euro-area country it was thought that public support for swift action could be achieved only by dramatizing the situation, for instance, by telling the public that the euro is in danger or by considering the possibility of expelling a country from the euro area.”  Obviously, this was a dig at Germany.


Germany and Bundesbank leader Axel Weber have openly criticized the ECB purchase of government bonds.  There is fear that the ECB is simply financing spendthrift countries (or bailing out other countries).  But, Weber has not been as vocal as we might expect.  The reason that he has held back is that he wants to lead the ECB once Trichet’s term is done.  I can’t help but think that Weber replacing Trichet will be like President Regan replacing President Carter (and this is not a dig at President Carter).  The world very quickly realized that there was a new sheriff in town.  I’m just not sure that all of the Europeans can handle a new sheriff.


The bottom line is that Germany is very different than much of the EU.  We’re starting to see the problems from this.  I think that this will get significantly worse over time.




3. BP

Was this the range or simply the lower boundary? On Thursday, the U.S. Geological Survey said that BP’s well was leaking between 12,000 and 19,000 barrels per day.  They said that this was “the overall best initial estimate for the lower and upper boundaries.”  Now, some of the researchers who worked on this are saying that this was simply the lower boundary.


One of the worst stories from the BP debacle is that several newspapers reported that workers were bussed in to clean up the beaches prior to the President’s arrival and then they were gone once the President left.


We hate you…please save us. Americans tend to distrust government, yet we want the government to be able to solve the BP leak.




4. Economy

Consumer spending didn’t increase for the first time in six months. At the same time, personal income rose .4%, as more people had jobs.  The core price index for personal-consumption expenditures rose .1% for April.  On a YOY basis, it’s up 1.2%.


Straight from the Economist (and similar to some of my recent speeches):  Consumer spending seems unsustainably strong given weak income growth, shrunken wealth and tight-fisted banks.  It will be hard to rely on exports as Europe weakens (austerity measures and weakened currency).  We have used all of our bullets and we could be in trouble if the economy weakens again.  Most importantly, we continue our longstanding tradition of having no direction for solving our long-term deficit problem.


Scary news for consumer spending:

1. consumer spending didn’t grow in April
2. Target and Gap described spending at their stores as volatile and unpredictable
3. The stock market has gyrated, partly because of Europe, and this has made consumers less certain

A possible explanation as to why consumer spending has held up?  The NY Times had an interesting article describing people who are not paying their mortgage and are simply waiting to be evicted.  The average borrower in foreclosure has been delinquent for 438 days before actually being evicted, up from 251 days in January 2008.  This is all consistent with a theory that this is what has supported consumer spending – the millions of homeowners who are not paying their mortgages.  Apparently, this is particularly prevalent in states which require judicial foreclosure.  Other states (such as Texas and California) allow lenders to pursue foreclosure outside of the courts (call in the sheriff).

http://www.nytimes.com/2010/06/01/business/01nopay.html?th&emc=th


Consumer sentiment rose from 72.2 in April to 73.6 in May according to Thomson Reuters / University of Michigan.


Both Bernanke and Trichet (the leader of the ECB) said that emerging markets are the key to the world economy.  That should make you feel good.


The chief economist at China International Capital Corp. (CICC) said that China’s inflation would peak at 4% this summer.  Last week, the government said that they would monitor prices, punish “irregular” trading activities and increase supply to agricultural markets.


China is now signaling that they will levy a tax if you hold more than one apartment – in order to stop speculation.  The tax may be .8% of the market value of second homes.  Of course, they will need to build the infrastructure necessary to collect this tax.




5. The US Problems

The Economist blasted Congress:

1. Congress has been unable to pass its annual budget resolution, which sets out deficit and spending totals with which individual bills must comply.
2. Earlier this year, Congress passed a “Paygo” rule prohibiting new spending or tax cuts from widening the deficit.  But $79 billion of the latest stimulus bill is deemed “emergency” spending and is exempt.  Suspension of scheduled cuts to Medicare reimbursement rates is also exempt.
3. With taxes, Congress closed foreign-income loopholes for multinationals and taxes carried interest for fund managers.  But, they haven’t addressed the expiration of the Bush tax cuts.

The Economist says that our long-term fiscal challenge is huge – maybe bigger than Europe’s.  The IMF says that by 2015, we will have a structural deficit (one that will prevail at full employment) of more than 6% of GDP, compared to 4% for the EU.

We are being saved by favorable demographics (we still have time before the baby boomers kill us) and the fact that crazy people see the dollar as the safe reserve currency.  But of course, that is allowing us to continue our horrible habits.


The NYT had a great piece recommending some questions to ask the credit rating agencies in Wednesday’s government hearings:

1. given the obvious failures, why should the major ratings companies retain the competitive advantages bestowed upon them by the SEC?
2. what changes to your policies and procedures have resulted from the financial crisis and your role in it?
3. How can you defend the issuer-pay model?
4. In 2004, the FBI issues a warning of “an epidemic of mortgage fraud coursing across this country.”  Were you aware of it?  What did you do?
5. William Ackman (hedge fund manager) suggests a “wait to rate” policy where agencies wait 60 days to rate a bond.  This would require early investors to do their homework.  What do you think of this?
6. Ackman also suggests a pay-for-performance model that would reward accurate ratings.  What do you think of this?
7. What do you think of each issue being randomly assigned to a rating agency, so that they conflict of interest is eliminated?
8. Why did Moody’s wait two months before revealing that they had received a Wells notice from the SEC?
9. On the day that Moody’s received the notice, Moody’s CEO sold $4.3 million of shares through a previously scheduled plan.  Did he consider not selling?

10. Did Moody’s alert Mr. Buffett of the Wells notice?  He sold $30 million of shares the next week.


The Washington Post asked what will happen to mutual funds and pension funds if they are wrong about their purchase of Treasuries?

http://www.washingtonpost.com/wp-dyn/content/article/2010/05/31/AR2010053103456.html




6. Random

This was the worst May since 1940 for stocks. The Dow dropped 7.92% this month.  (In 1940, stocks dropped 22%.)


An AP poll found that 46% of Americans said that they’re suffering from debt-related stress and half of that group described their stress as a “great deal” or “quite a bit.”  The other 53% of Americans said that they fell little or no stress.


Telemarketers take 75 cents of every dollar they raise.  This is according to an investigation done in Oklahoma.   This is very consistent with what I found when I researched this in the past.  The bottom line is that we all want to help groups like veterans and retired police and firefighters, etc.  But, I NEVER give money to anyone that calls on the phone.  If you won’t send me information, I don’t believe that your legitimate.  I have zero interest in providing income to a telemarketer.




7. A Teaser For Friday

I’m often asked “what would make you optimistic?”  While I won’t tell you what I said when Jenny asked me that question, I will give you my economic answer on Friday.  It’s a very simple idea that I read last night.

Have a good week.

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Market Update – May 28^th


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DUE TO MEMORIAL DAY, MY NEXT BLOG WILL BE ON WEDNESDAY, JUNE 2.

Then, we’re headed to summer hours.  I’m going to blog on a less regular basis.  As I’ve said several times, my goal is to start writing some shorter blogs (more issue-based).  My kids are out of school for the summer and I need to make the most of that time.  But, I will still be blogging.


Have a great holiday weekend.


Now, on to what I have been thinking about…


Greetings from the resident pessimist. The markets had a big rally on Thursday.  People are attributing this to two factors:

1. China denied reports that they are moving out of European debt.  This gave support to the euro.  Investors sold Treasuries and bought risky securities.
2. Stocks had dropped 11% from their recent highs and a bounce was overdue.

Regardless of the reason, China’s announcement did not solve the structural problems in Europe or the US.  Because I can apparently only see the glass as 1/80^th full, here are some of the things that I’m thinking about today:

1. China doesn’t like the stronger dollar (because the yuan is pegged to the dollar).  China enjoys the benefits to their export-driven economy that result from a weaker currency.  As a result, it makes sense that they would support the euro.  This shouldn’t surprise anyone.
2. Q1 GDP was lowered from 3.2% to 3.0%. Even before this minor downward adjustment, this growth rate is low by recovery standards.  When you break the GDP number down, it is mostly inventory adjustment (which is not that unusual).  But, the bottom line is that sales growth is closer to 1.6% to 1.7%.  So, after inventory adjustments are done, that’s our best indication of where we are.
3. Growth of 1.7% will not do anything for our unemployment problem.  For that matter, 3% growth will not solve our unemployment problem.
4. We saw more miserable numbers with the first time claims for unemployment insurance.  There were 460,000 filings in the past week.  These numbers are relatively high for a recovery.
5. Geithner was in Europe lecturing the Europeans on continuing to stimulate the economy and following through on their commitments.  Apparently, the flight attendants must be serving the whacky weed on Geithner’s flight.  The idea of our government lecturing any other government (even the Europeans) about fiscal policy is somewhat amusing.

On the positive side of today’s news, corporate profits increased 9.7% in Q1 accelerating from the 8.2% rate in Q4. Year-over-year, profits increased 42.7%.  Obviously, this has been good for stocks.  Of course, when a company operates with fewer employees, it’s easy to improve profits.


More good news…this time about housing. Fannie Mae said the amount of loans at least 90 days behind fell to 5.47% in March from 5.59% in February. The prior-year rate was 3.15%. The last time the rate fell on month was March 2007.


Here’s some news that I think we all already knew, but it’s still painful to hear. Government scientists now say that oil is spewing from the Gulf leak at a rate 2.5X to 5X faster than previous estimates.  Now, scientists are saying that somewhere between 18 million and 39 million gallons of oil have leaked.  While this has obviously been a big news story, it strikes me as deserving even more attention.  We’re losing a tremendous amount of fishing resources and we’re at risk of losing some of the nation’s most beautiful beaches.  People are losing their livelihood.  And, of course, I’m not ignoring the fact that eleven people lost their lives from the explosion.


It seems like we have a government response to disasters, regardless of whether they are man-made (terrorism) or naturally occurring (e.g., hurricanes, tornadoes, floods, etc.).  Yet, with this disaster, we’re relying on BP to solve the problem.  It’s really alarming.


Commodity prices rose 4% on Thursday. The Financial Times attributed this to a report by the US National Oceanic and Atmospheric Administration that predicted a really strong hurricane season.  I’d like to think that commodities rose as a result of investors moving back to risky assets.  The idea that the market responds to a prediction like this is somewhat scary.  (It doesn’t seem like these predictions have a high accuracy rate.)


A survey said that nearly one in five drivers could not pass a written driving exam if they had to take it today. New Yorkers fared the worst.  Of course, I’m not sure that they need to know the laws – it’s rare that they get to drive more than 5 MPH.


Apple vs. Microsoft. Apple’s market cap passed Microsoft’s this week ($230 billion vs $227 billion).  When I heard this, I looked up the annual revenue and I was surprised to see that Apple’s was $42 billion and Microsoft’s was $58 billion.  I had actually expected to see that Microsoft’s was much larger than Apple’s.


THIS IS REALLY IMPORTANT (and yes, capital letters mean I’m screaming)…please click through on the link below and take five minutes to read David Einhorn’s editorial from Thursday’s New York Times.  For any of you who have heard me speak in the past year, you know that I am in 100% agreement with what he said.  (He even uses the same GM analogy that I use.)  I could have written this – just not as well as he did.  I think that this is really important for people to think about.


http://www.nytimes.com/2010/05/27/opinion/27einhorn.html?pagewanted=print

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