Interest Rate Roundup

Wednesday, April 30, 2008

Fed cuts 25 bps, shifts to "neutral"

The Federal Open Market Committee cut the federal funds rate by another 25 basis points to 2%. That brings the cumulative tally of easings to date to 3.25 percentage points. The post-meeting statement read as follows:

"The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 2 percent.

"Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.

"Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.

"The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

"Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Gary H. Stern; and Kevin M. Warsh. Voting against were Richard W. Fisher and Charles I. Plosser, who preferred no change in the target for the federal funds rate at this meeting.

"In a related action, the Board of Governors unanimously approved a 25-basis-point decrease in the discount rate to 2-1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Atlanta, and San Francisco."

It's worth nothing that both Plosser and Fisher disagreed with the FOMC majority again. Both wanted no cut at the meeting. Also, the Fed stripped out a sentence from the March 18 post-meeting statement that read: "However, downside risks to growth remain." This seems to validate market expectations that the Fed has moved to a more neutral stance on interest rates. However, I'm surprised the Fed didn't use today's meeting as an opportunity to send a stronger signal about inflation and the dollar.

UPDATE: On an unrelated note, I have now enabled commenting on the blog. For certain reasons, I have chosen to do so on a moderated basis. So try to play nice! Thanks ...

Mortgage apps down, GDP/Chicago PMI roughly in line

Sorry for the late start -- my eldest is going to be starting kindergarten in the fall, so today was orientation day. I can't believe she's at that age. Talk about time flying! Anyway, here's the scoop on today's batch of economic data:

* Q1 GDP managed to come in positive -- +0.6% vs. expectations for +0.5% and a Q4 reading of 0.6%. Personal consumption was a bit stronger than expected, at 1% vs. a Bloomberg forecast of 0.7%. But that was still the smallest rise since Q2 2001 and down sharply from 2.3% a quarter earlier. Also, inventory building added 0.8% to growth ... not necessarily an indicator of strength. If inventories rise, but spending cools, it leaves businesses with unwanted stockpiles, leading to future cutbacks in production and employment.

Residential construction activity plunged at an annual rate of 27%, the worst decline since 1981. Also noteworthy: Investment in nonresidential structures fell 6.2%, down sharply from 12.4% a quarter earlier and the worst reading since Q3 2005. This could be evidence the credit crunch and real estate downturn has spread to the commercial market, as I've been expecting for some time.

Lastly, a key price index embedded in the GDP report came in at 2.6%, up from 2.4% in Q4, but below forecasts. A separate reading on core inflation was up 2.2%, down from 2.5% a quarter earlier.

* The Chicago-area PMI index inched up to 48.3 in April from 48.2 in March. That topped expectations for a 47.5 reading. A subindex measuring production rose to 53 from 50.4, while an index measuring new orders dipped slightly to 53 from 53.9 and an index measuring employment fell sharply to 35.3 from 44.6. Speaking of jobs, the ADP report (PDF link) says the private sector added 10,000 jobs in the month of April, up slightly from 3,000 in March.

* Mortgage application activity is slumping, a troubling trend I discussed recently. The refinance index tanked 16.7% after falling 20.2% a week earlier, while the purchase index fell 4.8% (after declining 6.4% in the prior week). The purchase index, at 340.1, is now the lowest it has been since all the way back in February 2003.

Tuesday, April 29, 2008

S&P/Case Shiller Index for February: -12.7%

The latest S&P/Case-Shiller figures show home prices falling (PDF link) at an ever-faster rate. In the month of February ...

* Prices fell 2.7% between January and February in 20 major U.S. metropolitan areas. Prices were off 12.7% from a year earlier. That was worse than the 10.7% decline reported in January and the biggest decline so far for the monthly index, which was first published in 2001.

* The 10-city index has a longer history. It declined 13.6% year-over-year. That was worse than the 11.4% drop in January and the worst since S&P started tracking in the late 1980s.

* Prices fell from year-ago levels in 19 out of 20 cities. The biggest declines were found in Las Vegas (-22.8%), Miami (-21.7%), Phoenix (-20.8%), and Southern California (-19.4% in L.A. and -19.2% in San Diego). The only metropolitan area showing a gain was Charlotte (+1.5%).

Weary home sellers won't find much comfort in the latest home price numbers. We're seeing significant year-over-year price declines in many of the metropolitan areas that saw the most speculative buying during the boom. Meanwhile, even formerly strong markets like Seattle, New York, and Charlotte are starting to deteriorate.

I suspect we'll see further home price weakness in 2008 and early 2009 for many markets. Ultimately, that will prove to be "good" news because it will prompt bargain hunters to step off the sidelines, and help shrink the glut of inventory for sale.

Monday, April 28, 2008

U.S. housing vacancy rate sets a record high

Every quarter, the Census Bureau releases a broad snapshot of the U.S. housing industry -- specifically, it tallies up the U.S. homeownership rate and the U.S. vacancy rate (what percentage of U.S. homes are sitting empty). The latest figures (PDF link) for Q1 2008 show:

* The homeowner vacancy rate rose to 2.9% from 2.8% in both Q4 2007 and Q1 2007. This is the highest vacancy rate in the nation's history. Prior to the housing bust, this figure never rose above 2%, as you can see in the chart above. The Census Bureau estimates there are 2.277 million housing units for sale, up 4.5% from a year earlier to a record high.

* The rental vacancy rate also climbed somewhat. It hit 10.1% vs. 9.6% in Q4 2007 and 10.1% a year earlier. The recent peak was 10.4% in Q1 2004.

* Meanwhile, the seasonally adjusted homeownership inched higher to 67.9% from 67.7% a quarter earlier. That was down from 68.5% a year earlier. The boomtime high was 69.3% in Q2 2004.

More Fed policy chatter ...

Great story at Bloomberg about the dilemma the Fed faces as it heads into this week's meeting. It largely mirrors some thoughts I shared late last week. Here's an excerpt:

"Federal Reserve Chairman Ben S. Bernanke may have to start talking and acting more like Paul Volcker if he wants to avoid being remembered as another Arthur Burns.

"With oil and food prices surging, Volcker told the Economic Club of New York on April 9 that 'there are some resemblances between the present situation and the period in the early 1970s,' when then-Fed Chairman Burns let an inflation psychology take hold. 'here was some fear of recession, the oil price went skyrocketing up, the dollar was very weak.'

"It took Volcker's effort as Fed chief to push the overnight lending rate to 20 percent in 1980 and drive the economy into its deepest decline since the Depression to break the inflation he inherited. To avoid squandering the gains Volcker made, Bernanke may need to stop his all-out effort to prop up the weakening economy and start paying more attention to countering price pressures.

"'You have to take the risk of the possibility of a small recession if you want to avoid ending up with a big one,' says Allan Meltzer, a Fed historian and professor at Carnegie Mellon University in Pittsburgh.

"As policy makers meet this week to decide on interest rates, Bernanke has one big thing going for him that Volcker, 80, didn't: Polls show Americans, for the most part, are still convinced the Fed will do what it takes to keep inflation down.

"That may become a self-fulfilling prophecy, as workers refrain from demanding big wage increases they don't think they'll get, and companies limit price increases for fear of losing sales.

"Consumers expect inflation to average 3.2 percent during the next five to 10 years, according to a Reuters/University of Michigan survey this month. That compares with the 9.7 percent long-run inflation rate they expected in February 1980, seven months after Volcker took office."

And here's some more commentary from a Reuters story, largely on the same topic:

"If the U.S. Federal Reserve Board wants to restrain oil and food prices and help downtrodden consumers, the best thing it can do is stop cutting interest rates.

"That is the view emerging on Wall Street, among some economists, and even a handful of Fed officials who worry that the world economy is getting only limited benefit from deep rate cuts, but all of the unwanted side effects.

"Ending the string of rate reductions that began in September would be welcome news for the European Central Bank, which has held borrowing costs steady while its U.S. counterpart cut, driving the euro to a record high.

"Stopping the rate cuts may also be good for developing countries struggling to pay for increasingly expensive food and fuel, and for rich nations worried about inflation eroding economic growth."

A money quote I can't help pulling out?

"'As central banks pump in liquidity to help bail out the financials, the result so far seems to be ever higher commodity prices,'" said Andrew Lapthorne, an analyst with Société Générale in London."

Meanwhile, with regards to the whole "negative real interest rates" discussion, I thought I would share this chart I put together. It computes the real (inflation-adjusted) level of the federal funds rate, using three different measures of inflation (the year-over-year change in import prices, in PPI, and in CPI). You can see that rates are negative no matter which indicator you use. Negative real rates are inflationary/expansionary, and I fully believe they are exacerbating the commodity price rise. In other words, the Fed is accommodating price increases, rather than fighting them.

Friday, April 25, 2008

Chatter heading into the Fed meeting

There's a lot of interesting chatter about what the Fed might do next week. Most of it seems to center on whether the Fed will finally stop cutting rates, or just cut rates one last time by 25 basis points and then signal a pause.

Here's an excerpt from a WSJ story on the topic yesterday:

"The Federal Reserve is likely to cut its short-term interest rate by a quarter of a percentage point next week -- but then may be ready for a breather.

"The Fed, meeting Tuesday and Wednesday, is likely to make what would be its seventh cut in eight months. The reason: Some officials see a case for more insurance against a deeper recession.

"But others are concerned a cut could contribute to inflationary pressure with little benefit for growth. That means the option of standing pat will likely also be on the table. If it does cut rates, the Fed could signal in the statement accompanying the decision an inclination to pause and assess the impact of its cuts, which have lowered the federal-funds rate to 2.25% from 5.25% since last year.

"Officials say the case for lowering rates further rests primarily on the value of additional insurance against a worse-than-anticipated economic scenario."

And here is a column from long-time Fed watcher John Berry at Bloomberg:

"Federal Reserve officials are wondering how long consumer-price inflation can stay in the neighborhood of 4 percent without undermining their credibility as inflation fighters.

"Over the 12 months ended in March, the cost of energy in the consumer-price index shot up 17 percent and food items rose 4.5 percent. The remaining three-fourths of the index, the so-called core CPI, was up a modest 2.4 percent.

"Like everybody else, Fed policy makers have been surprised by the repeated surges in world oil prices and more recently by record costs for corn, wheat, rice, soybeans and dairy products. And they have taken comfort that all that's needed to bring the overall inflation rate down is for key commodity prices to stabilize.

"Except that hasn't happened.

"The prospect of elevated inflation and the risk to Fed credibility make it likely that if the Federal Open Market Committee chooses to reduce its 2.25 percent target for the overnight lending rate at its meeting April 29-30, the cut will be only a quarter-percentage point after a series of larger ones.

"Fed funds futures contracts indicate investors yesterday put about an 80 percent probability on such a 25-basis-point cut next week.

"The contracts also put a 20 percent probability on the FOMC's leaving the target unchanged, which would be the better policy choice at this point because of the threat to the Fed's credibility."

My take: The Fed should stand pat (a course of action also suggested by James Hamilton over at the Econbrowser blog). I could even make a case for a 25-point rise, though I know that will never happen.

The fact of the matter is, REAL (inflation adjusted) interest rates have been driven well into negative territory (for more on this topic, click here). Negative real rates are inflationary. The last time the Fed drove interest rates deeply into negative territory -- in the wake of the dot-com bust -- it helped create a housing bubble.

It also helped set the stage for the long-term run up in commodity prices that we're all suffering under. Yes, there are plenty of other economic and fundamental reasons why oil, gold, and grains prices have risen. But the Fed has essentially thrown gasoline on the fire by slashing rates willy-nilly and driving the dollar into the gutter. A tougher approach to interest rates, while it could hurt the economy in the short term, could help quite a bit in the longer term by getting inflation back under control.

Thursday, April 24, 2008

March new home sales a disaster

Sorry this post is a little bit late. It is "Take Our Daughters and Sons to Work" day and I've got the five ... I mean, five and a half ... year old with me today! She's having a good time. The housing industry? Not so much. March sales were an unmitigated disaster. Here's the scoop ...

* Sales plunged 8.5% to a seasonally adjusted annual rate of 526,000 in March from a revised 575,000 in February (previously reported as 590,000). That was much worse than the forecast of 580,000 home sales. From a year earlier, sales tanked 36.6%. That leaves them at the lowest since October 1991 (524,300).

* The supply of homes for sale dipped again to 468,000 from 473,000 a month earlier and 548,000 a year earlier. But because the pace of sales fell much faster, the months supply at current sales pace indicator of inventory ballooned to 11 months from 10.2 a month earlier. That's the highest since September 1981 (11.3 months).

* Median home prices dropped 6.8% on the month to $227,600 from $244,200 a month earlier. They year-over-year drop was a hefty 13.3%, the worst decline of the down cycle and the biggest drop since July 1970 (-14.6%).

When you get numbers like these, it's hard to find words to describe them. Awful? Atrocious? Take your pick. New home sales fell to their lowest level in more than 16 years. Prices were in veritable free fall. And while the absolute number of homes for sale dipped, sales fell even faster, causing the "months supply at current sales pace" supply indicator to worsen.

Of course, this is March data -- and we all know that was the month where the credit markets imploded. The key question is whether a turning point has been reached. Have lenders finally put the worst losses behind them? Will the trend toward tightening mortgage standards reverse? Are government (and Federal Reserve) efforts to stabilize the market working?

We won't know the answer for a while, and I'm not convinced that's the case yet. April and May data will give us a clearer picture. In the meantime, a new threat has emerged in the past few weeks -- rising interest rates. Both long-term Treasury yields and long-term mortgage rates have started to climb. That has helped send the Mortgage Bankers Association's purchase index to within a hair of its 2008 lows. This development bears watching in the weeks ahead, because the last thing potential home buyers need is higher financing costs.

Wednesday, April 23, 2008

Higher interest rates and the possible impact on housing

Sorry for the lack of posts today -- been pretty busy at the day job. One thing that I couldn't help comment on, however: Have you noticed that mortgage rates have been ticking higher lately? And that this has had an impact on purchase applications?

The Mortgage Bankers Association's weekly purchase application index dropped 6.4% to 357.30 in the week of April 18. This index has only been lower once this year -- 356 in the week of March 28. The MBA also said its measure of 30-year fixed-rate loan rates popped back above 6% (6.04%) for the first time since the beginning of March.

Now I don't want to make too big a deal out of this. But if we were to break down out of the recent range in purchases (let's say, below 350) and/or break out to the upside in interest rates (let's call it above 4% in the 10-year Treasury note yield, or 6.4% on 30-year mortgages), it'll be something to pay attention to.

The culprit for this recent upside move appears to be inflation fears, spurred by record-high commodity prices, and the flight of money out of bonds and into stocks, spurred by greater risk-taking behavior on the part of investors.

Tuesday, April 22, 2008

$119.90 and counting

Punch up a crude oil futures quote, ladies and gentlemen, and that's what you would have seen a few moments ago for the price of a barrel of black gold. Even the "see no inflation, hear no inflation" Federal Reserve crowd can't seem to ignore this market action any more. Bloomberg just ran with a story called "Fisher says inflation beginning to burden consumers." The money quote from Dallas Fed President Richard Fisher: "I'm concerned that we might be on a path of higher inflation that we would otherwise have had."

My general stance is simple: Even the best-intentioned moves can have unintended or unforeseen consequences. The Fed slashed rates to the bone to save the economy after the dot-com bust. That helped cause a housing bubble. Now, it has slashed rates to the bone again to save the economy after the housing bust. What's that doing? Helping fuel (pun definitely intended) a brand new boom/bubble in commodities. And yes, I realize other forces are also at work, such as the "turning-food-crops-into-ethanol" phenomenon and rising wealth and consumption in countries like China and India.

Are we ever going to get off this bubble-bust-new-bubble treadmill? Maybe only when the Fed takes a Volcker-esque approach to monetary policy. In other words, a "tough love" approach where rates are raised or held higher than they otherwise should be to crush commodity speculation/long-term inflation once and for all -- even if it means the economy suffers a deeper short-term recession.

Would that cause more banks to fail? Probably. Would it drive unemployment higher? Yes. But the alternative seems to be "rice riots," a further gutting of the U.S. dollar, $6-a-gallon milk, and $3.50-and-rising gasoline prices ... despite a weak economy. We're all getting hit in the wallet ... and the Fed's inflation-flighting credibility is going up in smoke ... as a result.

I found this story on Kimberly-Clark's earnings to be particularly illustrative of how corporations and consumers are being forced to adapt (emphasis mine):

"Chairman and Chief Executive Thomas J. Falk called the first-quarter results a good start to the year despite "unrelenting inflationary pressures," especially for fiber and energy. He said the company was reducing costs where it could but increasing the marketing of its brands.

Falk said the company underestimated its exposure to inflation by $100 million to $200 million.
He said the company will try to offset the increases with more revenue instead of more cost-cutting, and that if inflation continues at its current rate, Kimberly-Clark will raise prices.

Kimberly-Clark pushed through price increase of 4 percent to 7 percent in February on diapers, training pants, bathroom tissues and paper towels, yet saw no loss of market share to cheaper private-label brands, Falk said.

"That would say the consumer is holding up pretty well in this environment," he said, adding that female shoppers are looking to give their families "little luxuries that don't cost that much more," such as premium tissues.

Kimberly-Clark has been more aggressive in raising prices on commercial customers, such as office buildings -- sometimes twice a year. Executives said they would pave the way for even faster increases by changing contracts to allow price increases any time, not just when the contracts expire."

In other words, we're facing stagflation-lite. Is that really better or worse for the economy and Americans in the long term? Maybe someone should ask Ben Bernanke.

March existing home sales slump

Everyone can stop mourning now -- I'm back from vacation. What's that? You didn't even notice I was gone. Oh. LOL. Seriously, though, we took the kids for a nice long weekend trip to Jamaica, and that's why you haven't seen any posts until now. Things will be back to normal going forward.

And with that out of the way, let's take a look at what the March existing home sales figures looked like:

* Sales fell 2% to a seasonally adjusted annual rate of 4.93 in March from 5.03 million in February. That was roughly in line with the forecast of 4.92 million home sales. Sales were down 19.3% from the year earlier reading of 6.11 million, but slightly above the cycle (and record) low of 4.89 million units in January.

* By region, it was a mixed bag. Sales rose 2.2% in the Northeast and 2.2% in the West, but fell 3.5% in the South and 6.5% in the Midwest. By property type, sales fell 2.7% in the single-family market but rose 3.6% in the condo arena.

* The supply of homes for sale climbed to 4.058 in March from 4.018 in February (previously reported as 4.034 million) and 3.806 million a year earlier. On a months supply at current sales pace basis, inventory rose to 9.9 months from 9.6 months in February and 7.5 a year earlier.

* Median home prices rose 2.6% to $200,700 in March from $195,600 in February. They fell 7.7% from $217,400 a year earlier, the seventh month of year-over-year declines in a row.

Housing market conditions remain unsettled. The minor improvement in sales we saw in February largely faded last month, and the inventory situation deteriorated slightly. If there's a bright side to the latest figures, it's that they aren't relentlessly negative like they were in 2007. We're seeing more of a sideways chop.

At the same time, there is scant evidence of a recovery. Tighter lending standards, increased competition from motivated sellers (think banks that have foreclosed property they want to move) and elevated levels of inventory should keep the pressure on home prices for the balance of this year at least.

Thursday, April 17, 2008

April Philly Fed: Slow growth, elevated inflation

The Philadelphia Fed index for April was just released. It told the same story as other indicators recently -- namely, that growth is weak and inflation is elevated ...

* The overall index came in at -24.9 vs. -17.4 in March and expectations for a reading of -15

* The new orders sub-index slumped -18.8 from -9.3, while the employment sub-index fell to -11.1 from -4.7.

* What about inflation? The prices paid index dipped to 51.6 from 54.4, but the prices received index (an indicator of inflation pass-through) rose to 30.9 from 21.2. That's the highest this sub-index has been since November 2005.

If there was something positive in the report, it's that the business outlook improved. The index that measures how survey respondents feel about the future rose to 13.7 from -0.5 a month earlier.

By the way, we're seeing some more follow-through selling in long bonds this morning after yesterday's technical breakdown. I continue to believe this may be an important shift in the Treasury market -- one that bears close watching. Could the "bond vigilantes" finally be waking up from their long slumber?

Wednesday, April 16, 2008

"Where will the next bubble be" mystery solved?

This is getting out of control -- oil prices got within a nickel of $115 a barrel on the futures market recently in the wake of some bullish inventory figures. Steel prices are rising fast. Gold is on the move again (+$18 and change) after a recent pullback. And the euro is setting a marginal new high against the buck.

Looking at an intraday chart, you can see buyers stepping in every time EUR trades to about 1.5950-1.5970 against the dollar. I wouldn't be surprised in the least if that was the ECB trying to hold the line here, because a break of 1.60 could really open the floodgates for a move higher. For more on what's going on in currencies, see my recent post on the G-7.

The bottom line: When does the Fed say "Enough is enough" and decide commodity inflation is worse than housing deflation? Because clearly, attempting to thread the needle (cutting rates and liquefying the mortgage market to support housing and jawboning -- but taking no real action -- to tamp down commodity inflation) isn't working. The housing market continues to stagnate, while pipeline inflation and inflation expectations are surging.

This goes back to my long-held view that trying to reflate/protect against an asset bust by pumping money into the system only inflates a fresh bubble somewhere else. When the dot-com bubble burst, the Fed slashed rates and threw money at the market. That helped create a housing bubble. Now, the housing bubble has popped and the Fed has responded in the same way. Lo and behold, we're now seeing a rapidly inflating bubble in commodities. When does it all end?

UPDATE: There go the bonds. That uptrend line I mentioned earlier has given way, with the long bond futures recently off 1 13/32 in price.

Consumer inflation hot, but in-line

The other big piece of economic data this morning was the March Consumer Price Index. The details:

* The headline CPI rose 0.3% in March, up from 0% in February. That was in line with expectations. The overall CPI is now rising at 4% year-over-year rate, the same as in February. The high-water mark in recent history remains 4.7% in September 2005, a reading that followed the landfall of Hurricane Katrina that year.

* Core CPI, which excludes food and energy, rose 0.2%. That was up from no change a month earlier, but also in line with forecasts. Core CPI is rising at a 2.4% rate, up from 2.3% in February. The high-water mark for core CPI is 2.9%, set back in September 2006.

* Within product categories, energy prices rose 1.9% on the month, education and communication prices gained 0.3% and recreation costs rose 0.3%. Apparel prices, on the other hand, dropped a rather sharp 1.3%, while medical care cost growth was tame for a second month at 0.1%.

Looking at the bonds, I think we're on the verge of a potentially serious price breakdown. This long bond futures chart shows an uptrend line that goes all the way back to last June, when the credit crisis began to unfold.

If we were to break below it ... and especially if that break were accompanied by a large upside move in stocks and a collapse in volatility gauges, like the VIX ... it could be a sign that the tentative, short-term improvement in credit market conditions is starting to stick. Why? In my view, the only reason bonds are holding up this well in the face of dismal inflation news is because Treasuries have been receiving billions of dollars in "flight to safety" money. A technical breakdown would signal to me that those money flows are reversing.

March housing starts, permitting activity plunge

March residential construction data was just released, and the numbers were pretty awful:

* Overall housing starts (see chart above) came in at a seasonally adjusted annual rate 947,000 in March, down a sharp 11.9% from February's 1.075 million units . That was also far below the 1.01 million units the market was expecting, and off 36.5% from the year-earlier reading of 1.491 million.

* Building permit issuance also dropped quite a bit -- 5.8% to 927,000 units from 984,000 in February. That's down 40.9% from the year-earlier reading of 1.569 million units.

* Breaking it down by property type, single-family starts were off 5.7% while multifamily starts plunged 24.6%. Single-family permitting activity dropped 6.2%, while multi-family permits fell just over 5%.

* These figures leave housing starts at the lowest level since March 1991 (921,000) and a hefty 58.7% off their January 2006 high (2.292 million units). Building permits are at the lowest since April 1991 (916,000), and down 59% from the September 2005 high (2.263 million units).

The free fall in home construction continued in March, with sharp declines in both permitting and starts. The declines were widespread geographically, too -- construction activity dropped in all four regions of the country, while permitting fell in two out of four, and was essentially unchanged in one other (the South at +0.4%).

If you combine today's data with the figures from the NAHB yesterday, you see a housing market that's still struggling to find a bottom. Builders are more positive about the future than they've been recently. But buyer traffic and current sales remain weak, and construction activity is falling off a cliff.

If there's a bright spot out there, it's this: The painful contraction in housing starts will help alleviate the overhang of excess inventory. Eventually, that will restore some pricing power in the housing market. But we have to get from here to there. And it'll take further price cuts by both new and existing home sellers to clear the supply glut and move us in that direction.

Tuesday, April 15, 2008

NAHB index still stagnating

The latest National Association of Home Builders survey was just released. The data for April showed ...

* The overall index held steady at 20, the same as in March and February

* The sub-index measuring current home sales dropped 2 points to 18, the lowest since November. However, the sub-index measuring expectations about future sales rose 4 points to 30, the highest since August. The sub-index measuring prospective buyer traffic was unchanged at 19.

* Regionally, the index ticked up to 22 from 21 in the Northeast and to 17 from 15 in the West. It declined to 15 from 16 in the Midwest and to 24 from 26 in the South.

The latest figures from the NAHB show a housing market that's still groping for a bottom. Builders are more optimistic about the future than they've been recently. But readings on buyer traffic and current sales remain weak. In other words, while hope springs eternal, there is little concrete evidence of a rebound in activity. Tighter lending standards, a slumping economy, and worries over future price declines remain very real obstacles.

PPI: Up, up, and away ...

Those of us who actually eat food and drive know that inflation is a serious issue (except in housing, that is). The latest Producer Price Index figures just confirm it. Some details:

* The overall PPI surged 1.1% in March, almost twice the 0.6% forecast and almost four times the 0.3% increase in February. That pushes the year-over-year rate of wholesale inflation to 6.9% from 6.4% -- just shy of January's 7.4%, which was the biggest rise since 1981.

* The "core" PPI also gained 0.2%. That was in line with expectations, and it leaves the core PPI up 2.7% YOY, an increase from 2.4% in February. This is the biggest YOY increase since July 2005 (2.8%).

* Meanwhile, further up the production food chain, intermediate goods prices jumped 2.3% in March vs. 0.8% in February. Core intermediate prices were up 1.1%, vs. 0.6% a month earlier. Crude goods prices surged 8%, compared with 3.7% in February. Core crude goods were up 3.5% vs. 3.3% in February.

The good news on the economy? The Empire Manufacturing index popped up to 0.6 from -22.2 in March. That was much better than the -17 reading that was expected. The dollar is popping on this news, while long bonds are getting hit (down 20/32 at last count on the futures). Stock futures are up about 6 on the S&P.

Monday, April 14, 2008

March local home sales, prices drop

Every month, we get a smattering of reports on home sales in various regions before the "official" data comes out from the National Association of Realtors. In my neck of the woods, a real estate brokerage firm called Illustrated Properties releases some numbers on local sales. March figures shows sales down and prices off rather sharply:

* Sales fell 35.8% YOY to 707 units from 1,102 in March 2007.

* The inventory of homes for sale rose 3.6% to 24,891 from 24,029. That means we had roughly 35 months (or just under three years) of supply on the market.

* The median price of an existing home fell 19.3% YOY, or $55,000, to a new cycle low of $230,000.

If there's any good news, it's that the year-over-year rate of change in sales has improved somewhat. The "months supply at current sales pace" figures aren't as dreadful as they were a couple months earlier, either. But prices continue to free fall and the supply glut remains extremely large. So if you're a home seller, don't expect any miracles.

Wachovia takes a big loss, hits the markets up for $7 billion

I never understood why Wachovia bought California-based Golden West Financial after the housing market was already showing signs of topping out. Golden West's star product is the option ARM, or "pick a payment" mortgage. A large percentage of those loans were made in California, one of the states with the most bubbleicious housing markets. But acquire GDW it did ... and now, it's paying a heavy, heavy price. Because of problems at the former GDW, and its own credit issues, Wachovia announced today that:

* It would lose $393 million, or 20 cents per share, in the first quarter. That's a gigantic swing from the year-ago period, when Wachovia earned $2.3 billion, or $1.20 per share. It's also well below the 40 cents in earnings per share that analysts were expecting. The firm increased its provision for credit losses to $2.8 billion from $408 million a year earlier.

* Net charge-offs jumped to 0.66% of average loans from 0.15% from a year ago. Nonperforming assets as a percentage of loans, foreclosed property and loans held for sale quadrupled to 1.7% from 0.42% in Q1 2007.

* Wachovia is also slashing its quarterly, per-share dividend to 37.5 cents from 64 cents. And it's hitting the market up for about $7 billion by selling common and convertible preferred shares.

G-7 -- All hat, no cattle?

The G-7 made a big splash late Friday when it revised its statement on the dollar, saying:

"Since our last meeting, there have been at times sharp fluctuations in major currencies, and we are concerned about their possible implications for economic and financial stability. We continue to monitor exchange markets closely, and cooperate as appropriate."

I was intently curious, then, to see how the currency markets would react when trading in Asia opened. The verdict: The euro sank as low as 1.5672 against the dollar from a pre-statement level of about 1.5850. Other currencies also sank in value vs. the buck ... for all of a few hours. As I write, those moves have essentially been retraced in their entirety, or close to it. The euro is back up to 1.5871.

Why? The currency market is rendering a verdict that the G-7 is "all hat, no cattle." In other words, traders are saying: "Sure, you can talk up the greenback all you want. But the U.S. economic fundamentals are still weak. Moreover, you're not willing to back up your 'verbal intervention' with actual, coordinated intervention (dollar buying). So we're going to sell the dollar until you step up to the plate."

Friday, April 11, 2008

Import inflation explodes; Confidence tanks

Look, there's no way to sugarcoat the import price figures that were released today. They stunk to high heaven. Some details:

* Overall import prices surged 2.8% in March, well above the 2% rise that was expected. If you strip out petroleum, you still get a very large 1.1% rise. Strip out all fuels? Prices were up 0.9%, the biggest since this data category started being reported in 2001.

* The year-over-year rate of import inflation is up to a whopping 14.8%. That is up from 13.4% a month earlier and the highest rate in U.S. history (data goes back to 1982; chart above).

* Another key reading buried in the figures: Chinese import prices were up 0.7%. That continues a multi-month string of increases after persistent declines. In other words, emerging markets and countries like China have gone from exporting deflation to exporting inflation. The Wall Street Journal had a good story to this effect yesterday.

We keep hearing from the Ivory Tower economics crowd that inflation is a lagging indicator, that we shouldn't care about the increases, blah, blah, blah. Yet almost every month, the dollar loses more value, commodity prices climb, and import price inflation surges. Eventually, the Fed may be forced to pick its poison -- keep targeting growth by cutting rates and flooding the system with money or putting its foot down and targeting inflation. Alternatively, the dollar will need to bottom out and turn around -- something we haven't seen happen yet (the Dollar Index is down another 32 bps as I write)

Wall Street has been talking about an improved tone to the market lately. But consumers apparently aren't seeing it in their everyday lives. The University of Michigan's consumer confidence index dropped even further in April -- to 63.2 from 69.5 a month earlier. That's the worst reading going all the way back to March 1982.

Moreover, inflation expectations are rising. Consumers expect inflation to come in at 4.8% over the next year, the highest reading since October 1990 (a tie at 4.8%). Consumers haven't expected a higher inflation rate since July 1982. More proof of stagflation? Sure looks like it.

Corporate bankruptcies starting to hit the tape

Slowly but surely, we're seeing the economic slowdown and higher debt loads catch up to corporate America. The Wall Street Journal is reporting this morning that home furnishings retailer Linens 'n Things could file Chapter 11 in the next few days. The company has roughly 590 stores and 17,000 employees. Here are some more details:

"Linens would be one of the largest buyouts to go bust since the credit crisis took hold last summer. In February 2006, Apollo Management LP acquired Linens for $1.3 billion. The housing crisis made the home-furnishings space ultracompetitive, and the debt on the company's balance sheet gave it diminished flexibility to ride out the downturn.

"In a recent letter to investors, Apollo founder Leon Black acknowledged that the company was troubled, explaining that while it had made operational improvements, its financial results "remain challenged." Apollo filed to go public in a share offering this week."

It's worth noting that during the recent private equity/LBO mania, several deals were done at excessive valuation ratios and with very high levels of leverage. So it's unlikely LNT will be the only bankruptcy.

Meanwhile, airlines continue to drop like flies. Discount carrier Frontier Airlines Holdings just filed for Chapter 11 protection today, making it the fourth company to do so in a matter of weeks (the others were Skybus, Aloha, and ATA). For the credit markets, rising corporate bankruptcies could be another significant challenge -- bad news considering consumer loan losses and mortgage foreclosures are through the roof.

Thursday, April 10, 2008

Student loans the latest credit crisis "mole" to pop up

A handful of observers have used the "Whac-A-Mole" metaphor to characterize the credit markets today. In other words, just when you beat down a crisis in some corner of the credit market, another pops up somewhere else. The latest "mole," in case you haven't been following things closely, is the student loan market.

Just like auto loans, credit card loans, residential mortgages, commercial mortgages, and leveraged buyout loans, student loans are originated, then bundled together and sold as securities to fixed-income investors. And just like they did with RMBS and CMBS, investors have now decided they don't want to hold student-loan asset-backed securities (SLABS). So liquidity is drying up in the student loan market.

As the Washington Post noted this morning:

"Nearly 50 student lenders, including some of the industry's biggest names, have stopped issuing federally guaranteed loans in recent weeks because of paralysis in the credit markets, confronting students with higher borrowing costs just as they are starting to apply for financial assistance for the coming school year.

"These companies represented 12 percent of the market before they left, and analysts say this is just the beginning of an exodus. That is because virtually all student lenders have been shut out of their traditional funding sources on the debt markets. Dozens of other lenders that offer private loans, which have no federal backing, have also dropped out.

"The escalating problems have persuaded the Education Department to prepare a "lender of last resort" program, which would provide emergency funds to a few dozen lenders designated to help students who are unable to secure federally backed loans."

This excerpt gives some more color on the magnitude of the problem:

"The tumult is likely to push hundreds, if not thousands, of firms out of the student lending business, said Mark Kantrowitz, publisher of FinAid, a Web site that provides financial advice for students. Of particular concern is the number of firms leaving the business of making federally guaranteed loans, which, besides parents, are the primary source of financing for students' higher education.

"The list of dropouts includes such major players as College Loan Corporation, HSBC Bank, CIT Group and Washington Mutual. Among the 100 largest lenders, which represent 92 percent of the federal loan market, 19 have left. In addition, firms have cut nearly 2,300 jobs."

How is the industry responding? It's asking the Fed to start accepting SLABS as collateral for Fed borrowings (on top of everything else, including CMBS). Here's a Reuters story from a few days ago ...

"The financial services industry has urged the Federal Reserve to accept as collateral triple-A rated student loan asset-backed securities as collateral for firms seeking to borrow from new Fed facilities aimed at thawing frozen credit markets.

"The American Securitization Forum and the Securities Industry and Financial Markets Association wrote Fed Chairman Ben Bernanke and New York Fed President Timothy Geithner on April 2, saying those securities are safe and should be among those financial firms can pledge to borrow from the central bank.

"Given the very limited credit risk inherent in triple-A rated government guaranteed and private (student loan asset-backed securities), we believe this proposal appropriately balances managing federal government risk exposure and meeting with urgent need for additional sources of liquidity to help fund student loan originations," the industry groups' senior officials wrote."

I understand the urge to help the credit markets and certainly, we don't want Americans to suddenly be unable to go to college. But at some point, I think we have to start asking: "Where does it all end?"

Is the Fed going to start buying more credit card-backed paper if it becomes less liquid? What about auto loan ABS? Demand is pretty weak there. Or what about other assets that are losing value? REO property? Risky stocks? Former Fed Chairman Paul Volcker already noted this week that some of the things the Fed is doing are on dangerously thin ice in terms of legality. Others are setting dangerous long-term precedents. Some key quotes:

“The Federal Reserve has judged it necessary to take actions that extend to the very edge of its lawful and implied powers, transcending in the process certain long-embedded central banking principles and practices.”

and (in regards to the Bear Stearns transaction) ...

“What appears to be in substance a direct transfer of mortgage and mortgage-backed securities of questionable pedigree from an investment bank to the Federal Reserve seems to test the time-honored central bank mantra in time of crisis: lend freely at high rates against good collateral; test it to the point of no return.”

One thing is certain: We are definitely living in interesting times.

Wednesday, April 09, 2008

So much mortgage news, so little time

Ever feel like you're drowning in news -- and you don't have enough to cover it? That's where things stand here this morning. So I'm going to just try to hit on the major items of the day ...

*Citi is reportedly going to lay off $12 billion in leveraged loans and bonds to some private equity buyers. Like other banks, Citi is trying to shrink its balance sheet and raise capital to offset rising losses on a variety of instruments.

* The New York Times notes that while everyone wants the Federal Housing Administration to save the mortgage day, it's got its own budget problems. The agency is losing big bucks on mortgages made with the help of down payment assistance programs. Those programs allow borrowers to skirt the down payment requirement built into the FHA program. Personally, I think these programs make zero sense because they're too risky and they allow people who can't really afford homes to buy them. I agree with those who believe they should be banned.

A key excerpt from the Times story:

"Housing officials say the agency will face a deficit for the first time in its 74-year history, starting in the fiscal year that begins in October. And they blame a rapidly growing and increasingly troubled sector of the F.H.A.’s mortgage portfolio, known as the seller-financed down payment loan program, which has suffered from high delinquency and foreclosure rates in recent years.

"Under the program, a home seller arranges to cover the buyer’s down payment — using financial help from a nonprofit company — but typically adds that sum or more to the total cost of the house. The arrangement has been particularly attractive to financially struggling buyers and to owners in depressed housing markets, according to Congressional officials.

"In 2000, such mortgages made up less than 2 percent of F.H.A.-insured loans, officials say. By 2007, statistics show, they accounted for 35 percent of F.H.A. loans.

"Housing officials say these mortgages have foreclosure rates two to three times those of others, leaving the agency reeling from the losses.

"If the program continues without any changes, Congressional officials say, the F.H.A. would face a $1.4 billion shortfall in fiscal 2009. This would mean that Congress — and American taxpayers — would have to subsidize the F.H.A. for the first time."

* Speaking of FHA, the Wall Street Journal notes that the Bush administration wants to expand the FHASecure program. The idea is to head off the more aggressive Dodd/Frank principal-writedown-then-refi-into-FHA-mortgage plan (some more details are available in this post from a few days ago). Here's an excerpt:

"Though more modest than the proposals pushed by Democrats, the expansion would be funded by premiums paid by borrowers whose loans are backed by the Federal Housing Administration, the government's mortgage insurer, instead of by taxpayer funds, officials said. By contrast, efforts advanced by the Democratic-controlled Congress could have an upfront cost of between $10 billion and $20 billion.

"The expansion would allow the FHA to insure a new mortgage if a lender voluntarily writes down the mortgage principal to a maximum of either 90% or 97% of the new value, depending on the borrower's risk profile. If a loan and home was originally valued at $110,000, for example, and fell to $100,000, lenders could reduce the principal to either $97,000 or $90,000 to qualify for FHA insurance.

"Borrowers can qualify if they had some late payments over the previous year, but are otherwise reliably creditworthy and want to remain in their homes. Existing FHA underwriting standards still apply, and the home must be owner-occupied, so speculators, high-risk borrowers and owners of vacation homes wouldn't be allowed."

As a reminder, a hearing in the House Committee on Financial Services about possible FHA reform will be getting underway momentarily. You can see the list of speakers and/or watch the hearing live by following this link.

Tuesday, April 08, 2008

February pending sales drop

The National Association of Realtors just released its latest snapshot of the existing home market -- February pending home sales. Here's the scoop:

* Pendings dropped 1.9% in February, slightly worse than the forecast for a 1% decline. January's reading was revised to +0.3% from no change, however.

* Regionally, pending sales fell in two out of four regions -- the Midwest (-3.7%), the South (-5.5%). Sales rose 3.2% in the Northeast and 2.1% in the West.

* The index level was 84.6 in February, down 21.4% from a year earlier. The February reading is the worst on record, taking out the previous low of 85.8 in August 2007.

February was another poor month for housing, with pending sales down in many parts of the country. We know the reasons why: Lending standards have tightened. Speculative buying has dried up. And the economy is on the verge of recession, if not in one already.

If there is a bright side out there, it's that lower home prices have started to bring out some buyers in some areas. Or stated another way, there appears to be some "bottom fishing" going on now that houses have gotten noticeably cheaper. But we'll have to see if these pending transactions can actually close -- my concern is that stingier lending standards are leading to more deals falling apart.

Indeed, Washington Mutual provided more evidence today that lenders are still in retrenchment mode. The largest S&L in the U.S. said it would slash 3,000 jobs, shut down 186 home lending offices, and completely exit wholesale lending (making loans through mortgage brokers).

The NAR corrected their figures for the West region to +2.1% on the month from -9.8%. This post has been updated as well.

IMF: Credit Crisis Could Cost $945 billion

The International Monetary Fund isn't known for exaggeration and hyperbolic predictions. So the group's latest report on the credit crunch really caught my eye. The IMF says that falling U.S. home values and rising mortgage delinquencies could ultimately cause $565 billion in losses. If you throw in losses on commercial real estate securities and other corporate and consumer losses, you get as much as $945 billion in crisis-related costs, according to the group. Bloomberg pegs asset writedowns and losses to date at only $232 billion, meaning much more could be coming down the pike.

A key quote from the IMF release on this report:

"Financial markets remain under considerable stress because of a combination of three factors," said Jaime Caruana, head of the IMF's Monetary and Capital Markets Department. "First, the balance sheets of financial institutions have weakened; second, the deleveraging process continues and asset prices continue to fall; and, finally, the macroeconomic environment is more challenging because of the weakening global growth," he added.

If you want to read the full report, by the way, make sure you have broadband. The PDF file clocks in at 211 pages.

Monday, April 07, 2008

What are technicals telling us about the credit crunch?

Is the credit crisis over? No one knows the answer for sure. But for those of us who like to follow technical indicators, in addition to fundamental ones, we're approaching/testing some key levels that could tell us which way the wind is blowing.

Take the CBOE SPX Volatility Index, or VIX. It's testing an uptrend line that dates back to mid-May. Since the VIX is a good gauge of market "fear," this indicates that investors are getting more sanguine/complacent about risk. See the chart above.

Meanwhile, the S&P futures are closing in on the 1,390 level -- a key area of chart resistance. And long bond futures are down almost a point and a half in price ... and testing an uptrend line that dates back to June 2007. If all of these areas of support/resistance give way, you could interpret that as a technical signal that the worst of the credit market problems are behind us (at least for a while).

The VIX tested, but held its uptrend. Similarly, long bond futures rallied back to a decline of -25/32, meaning the uptrend remains intact. S&P futures finished the day with modest gains.

Reports: Wamu to get a $5 billion infusion

From Bloomberg this morning:

"Washington Mutual Inc., the largest U.S. savings and loan, rallied in New York trading as a group led by private-equity firm TPG Inc. considers a $5 billion investment in the Seattle-based company.

"Negotiations with the TPG group are at an advanced stage, said a person familiar with the discussions, who declined to be identified because an agreement hasn't yet been reached. Washington Mutual needs the funds after reporting more than $3 billion of home-mortgage writedowns and loan losses.

"At least 14 banks and securities firms have sought cash from outside investors in the past year after more than $230 billion of markdowns and losses caused by the collapse of the U.S. subprime mortgage market, data compiled by Bloomberg show. Washington Mutual Chief Executive Officer Kery Killinger told shareholders in January he expected a ``dramatic'' increase in loans that will need to be modified to avert defaults."

The bad news? Banks, S&Ls, and investment banks continue to need to raise billions and billions of dollars to offset losses and write-downs. The good news? They're finding the money.

Friday, April 04, 2008

States to Feds: If you won't act quickly, we will

There's an interesting story in today's Wall Street Journal about state efforts to help stem the foreclosure problem. The gist? Many states are frustrated by the slow pace of federal efforts to combat rising foreclosures, so they're taking the law -- literally -- into their own hands.

Here's an excerpt ...

"State governments are acting more aggressively to help homeowners avoid foreclosure, frustrated by what they view as the federal government's inadequate response to the mortgage crisis. But some of the programs are putting states at odds with mortgage lenders.

"Ohio officials announced Tuesday that they had enlisted more than 1,000 local attorneys to work with certain borrowers free of charge to try to block foreclosures.

"Wednesday, an Illinois lawmaker introduced a bill, backed by the state's governor, that would impose a moratorium of as long as 60 days on foreclosures. The measure would apply only to borrowers who enter housing counseling and is meant to give them more time to work out a deal with lenders.

"Maryland Gov. Martin O'Malley signed emergency legislation Thursday to give borrowers at least 150 days to cure defaults, effectively creating a short-term moratorium on foreclosures. The state also is requiring mortgage-servicing companies to provide the names of borrowers whose adjustable-rate mortgages are about to reset to higher rates, and it is asking companies to stop levying late fees and other charges on borrowers whose request for a loan workout is being evaluated.

"The state actions come as Congress considers a variety of plans to aid the housing market, including a $15 billion plan that includes a tax credit to buyers of properties facing foreclosure and grants for communities to buy and refurbish foreclosed properties. But there is little in the plan that would help individual borrowers facing foreclosure, and state officials say they can't wait for federal help.

"Foreclosures push down property values and tax revenues and create problems not only for borrowers in financial distress, but also for their neighbors and communities.

"We have a crisis in mortgage foreclosures, and this seemed like the boldest way that we could respond to the problem," said state Sen. Ellen Anderson, a sponsor of a Minnesota bill that would let some borrowers with subprime loans or negative amortization mortgages defer paying a portion of the amount owed, without being considered delinquent. A negative amortization mortgage is one in which the loan balance can grow even if the borrower keeps up with the payments.

"The Minnesota legislation would require a mortgage lender attempting to foreclose on a home to honor a borrower's request for a 12-month deferment. During that time, the borrower would have to continue paying either the monthly payment due on the loan at the time it was made, or 65% of the monthly payment at the time of default, whichever was less, though the borrower would eventually have to make up the deferred payments. The bill has passed committees in the Minnesota House and Senate, but the governor has said he probably will veto it. Wednesday, the bill's sponsors sent to the governor a letter suggesting that lawmakers work with him to craft a compromise."

Of course, Congress CAN move quickly if given the proper motivation. All you need, apparently, is to is threaten to stop donating money to Congressional re-election efforts. Then you too can get hundreds of millions of dollars in tax breaks.

March jobs report: Another stinker

The just-released March jobs report was another stinker -- no two ways about it. Here are the key details:

* Nonfarm payrolls dropped by 80,000, worse than the -50,000 number economists were expecting. February's number was revised to -76,000 from -63,000, while January's was also cut to -76,000 from -22,000. The March figure was the worst since March 2003, when the economy shed 212,000 workers.

* The unemployment rate jumped to 5.1% from 4.8% in February. That's the worst reading since September 2005 (a tie at 5.1%). The unemployment rate hasn't been higher than 5.1% since March 2005.

* By industry, manufacturing lost 48,000 jobs and construction lost 51,000. Retail jobs were down 12,000 ... financial jobs were down another 5,000 ... and temporary help employment was off 22,000. The bright side? Education and health jobs were up 42,000, while leisure and hospitality hiring popped 18,000.

* Average hourly earnings were up 0.3%, in line with estimates. The diffusion index (which measures industries cutting jobs against industries adding them) improved to 47.6 from 43.6 in February. That means job cuts were slightly less widespread by industry than a month earlier.

These figures essentially confirm that the economy is either in recession already, or right on the verge of it. I'm very interested to see how the markets react, however. Credit spreads have been tightening somewhat, Treasury bond prices have been falling, and the stock market tone has improved -- all signs that investors are betting the worst news is behind us. Yet the very latest WEEKLY indicators -- mortgage applications, jobless claims, etc. -- have actually worsened a bit, and there's no evidence of a turn in these March jobs figures. So today could be a real test of the optimistic scenario.

Thursday, April 03, 2008


National Association of Home Builders press release, 2/12/2008:

Brian Catalde, president of the National Association of Home Builders (NAHB), today issued the following statement regarding disbursement of PAC money to federal congressional candidates:

“Today, the National Association of Home Builders’ Political Action Committee, BUILD-PAC, and its 150-member Board of Trustees representing all 50 states, agreed to cease all approvals and disbursements of BUILD-PAC contributions to federal congressional candidates and their PACs until further notice.

“This extraordinary action was taken because the NAHB BUILD-PAC Board of Trustees felt that over the past six months Congress and the Administration have not adequately addressed the underlying economic issues that would help to stabilize the housing sector and keep the economy moving forward. Housing and related industries account for more than 16 percent of the Gross Domestic Product. More needs to be done to jump-start housing and ensure the economy does not fall into a recession. This action will remain in effect until further notice.”

Washington Post story, "Housing Accord Puts Builders First," 4/3/2008 (emphasis mine):

"Senate Democratic and Republican leaders rushing to address the nation's housing crisis reached agreement yesterday on a package that would provide billions of dollars in tax rebates to the slumping home-building industry while offering little to homeowners threatened with foreclosure.

"After working through Tuesday night to flesh out a bipartisan agreement, lawmakers unveiled a bill that rejects the most ambitious plans for aiding distressed homeowners, including a Democratic proposal to permit bankruptcy judges to modify the mortgage on a person's primary residence.

"Instead, lawmakers settled on a sharply scaled-back array of measures that would provide $4 billion in grants for cities to buy foreclosed properties, temporary tax breaks worth up to $7,000 for home buyers who purchase foreclosed properties, and new tax deductions for almost every American who owns a home. The package, which would cost about $15 billion over the next 10 years, also would jump-start stalled legislation to streamline the Federal Housing Administration, one of the top priorities of the Bush administration.

"Families who cannot afford to repay their home loans -- the group at the heart of the mortgage meltdown -- would benefit mainly from $100 million to expand foreclosure counseling services and greater latitude for local housing authorities to use tax-exempt bonds in refinancing subprime loans.

"Home builders and other businesses suffering losses in the flagging economy, meanwhile, would get the lion's share of federal spending in the bill: $6 billion in tax rebates."

I wonder if those PAC donations will start to flow again now.

UPDATE: For more interesting reading on this subject, check out what Fil Zucchi had to say over at Minyanville. Here's an excerpt:

"In essence, taxpayers will give back to the Robert Tolls and Ara Hovnanians of the world millions of dollars to prop up their closely held companies, i.e. companies in which they have majority interest and/or control, whose stocks these individuals had the magic foresight to dump by the millions of shares right before the whole Ponzi scheme collapsed.

"If ever there was an action that should undermine investors' confidence in the U.S. market system and reinforce the view that the government exists to grease the palms of those who pay their way into influencing the government, this is it."

Wednesday, April 02, 2008

Thoughts on the latest reform proposals from Washington ... and my take on the Fed's response to Bear Stearns

There have been so many housing and mortgage proposals and counterproposals released in the past few weeks that it has been hard to keep up. It doesn't help that I've been busy in my day job, or that the wife needed to get a wisdom tooth pulled (In other words, I've been pressed into nursing duty!)

But I'm going to try to get caught up now, and share my thoughts on the latest developments ...

Let me start by saying that today's Wall Street Journal pretty much sums up the state of the housing and mortgage markets.

One key headline: "Fannie Mae Tightens Rules for Mortgages"

The other: "Senate’s Housing Gridlock Eases"

The first story talks about the latest goings-on at Fannie Mae. The upshot of the story:
Fannie Mae is now establishing a minimum required credit score of 580 for most loans it will buy. It’s also reducing loan-to-value ratios for some types of mortgages. And it’s extending the post-foreclosure credit rebuilding period that borrowers have to go through before their loans are eligible for Fannie Mae purchase to five years from four.

In other words, Fannie Mae is making moves that have the effect of tightening lending standards — and it’s not alone. Several banks have cut back on the wholesale loan programs they offer through brokers. Meanwhile, Wachovia is reportedly considering an end to option ARM lending in parts of California.

The second Journal story points out that Congress is closer to passing a mortgage relief bill, despite intellectual and philosophical differences among Congressional Republicans, their Democratic counterparts, and the executive branch.

Put simply: The battle royale between deflationary market forces in housing and government intervention continues to rage ... and intensify. So what exactly are the latest salvos in this ongoing fight? Here's my CliffsNotes version ...

Salvo #1: Consolidating the "Alphabet Soup" of regulatory agencies — Treasury Secretary Henry Paulson introduced a mega-plan earlier this week called the "Blueprint for a Modernized Financial Regulatory Structure." Right now, different parts of the financial markets and different types of financial institutions are regulated by an alphabet soup of government agencies.

The Commodity Futures Trading Commission (CFTC). The Securities and Exchange Commission (SEC). The Office of Thrift Supervision (OTS). The Federal Reserve. The list goes on and on. And for industries like insurance, supervision and regulation is essentially in the hands of the states, with little to no federal oversight at all.

The focus of the regulatory plan is to sort this whole mess out by consolidating agencies and responsibilities. In Paulson’s words:

"Intermediate-term recommendations focus on eliminating some of the duplication in our existing regulatory system, but more importantly they offer ways to modernize the regulatory structure for certain financial services sectors, within the current framework. Recommendations include eliminating the thrift charter, creating an optional federal charter for insurance and unifying oversight for futures and securities

"The long-term recommendation is to create an entirely new regulatory structure using an objectives-based approach for optimal regulation. The structure will consist of a market stability regulator, a prudential regulator and a business conduct regulator with a focus on consumer protection."

This stuff is great for debating around the campfire. But it doesn’t look like many of these reforms will be instituted any time soon. Longer term, some heads will undoubtedly have to roll for what happened during the bubble days — and this blueprint could provide some guidance on where the axe will fall.

Salvo #2: FHA reform/foreclosure prevention programs — Of all the mortgage reform programs being discussed, one in particular is gathering momentum in Congress. It’s a bill that would potentially:

* Boost by $10 billion the amount of bonds that states can sell to fund mortgage refinance programs. They’re designed to get people out of bad subprime loans and into more stable financing.

* Fund $200 million more in counseling programs designed to help borrowers facing foreclosure

* Give home builders a tax incentive that allows them to offset past profits with current losses in order to bolster their financial state

* Offer buyers of foreclosed or vacant homes a tax credit, possibly as much as $15,000

Meanwhile, a plan from House Financial Services Committee Chairman Barney Frank and Senate Banking Committee Chairman Christopher Dodd may be gaining broader acceptance. They envision a program where the outstanding loan balances of borrowers would be written down. This would ensure the existing lenders book some losses.

Then the borrowers would be refinanced into loans insured by the Federal Housing Administration, or FHA. Those loans would have smaller monthly payments because less principal would be owed. Borrowers would also be encouraged to stay put and try to pay off their homes, rather than walk away, because they would no longer be left "upside down" — owing more than their homes are worth.

But the borrowers wouldn’t get a free lunch. They would be required to offer the government "soft second" liens on their properties. What that means is the government would get a portion of its money back upon the sale of the homes down the road. The presumption is that by then, home prices will have gone back up and everyone will "win."

To make it all work, FHA would be granted the ability to fund an extra $300 billion in mortgages.

Salvo #3: Making the Fed a "Supercop" — A more troubling move underway in Washington is to make the Fed even more of a market "Supercop" than it has been acting like already. As the Wall Street Journal noted a few days ago:

"The Fed would retain, for now, authority to write consumer-protection rules on things such as credit-card disclosures and the terms of high-cost mortgages — despite accusations from consumer groups and Democrats that its failure to do so allowed many homeowners to get subprime mortgages they couldn’t afford.

"In Mr. Paulson’s ‘optimal’ scenario, the Fed eventually would surrender its supervision of state-chartered banks and bank-holding companies to the new agency and become a ‘market stability regulator. The Fed, Mr. Paulson said in an interview Saturday, ‘would have broad powers so they could go anywhere in the system they needed to go to preserve that authority.’

"In that role, it would be able to lend to any important institution while seeking information from them, which Mr. Paulson considers more reflective of a financial system spread among brokerages and other nonbanks as well as traditional, commercial banks."

So in my humble opinion, what’s good, what’s bad, and what’s ugly in all of this?

First off, the policy of the Fed over the past several years has been to take a "hands off" approach to asset bubbles and regulation during the boom times. I've talked about the problems of this in detail before. But to quickly recap:

There was no move to raise margin requirements during the tech stock bubble. And as the housing bubble expanded, Fed policymakers spent more time questioning the very existence of a bubble rather than aggressively lambasting lenders and speculators for helping inflate it. They didn’t sharply jack up interest rates to calm things down, either. Instead, they used measured, clearly telegraphed, 25-point hikes over a span of several quarters.

On the regulatory side of the ledger, the Fed and the other key agencies issued a bunch of "guidances" on high-risk lending. But they had no teeth and essentially no on-the-ground impact.

But now that things have gone to you-know-what in a hand basket, it’s suddenly time for an "all hands on deck" approach. The Fed is slashing interest rates dramatically, and throwing huge helpings of money at some of the very same companies and individuals that helped cause the mess in the first place. And all those high-minded principles we’ve been hearing about — you know, like Larry Kudlow’s favorite slogan: "Free market capitalism is the best path to prosperity?" They get thrown out the window in the interest of expediency.

Heaven forbid someone raises his hand in objection to some of the ideas being thrown around, either. Those folks get labeled as "Herbert Hoover" wannabes. Or worse, they’re told that they sound like Hoover’s Treasury Secretary Andrew Mellon. He believed a hands-off approach to the stock market crash and the subsequent recession was appropriate, and was famously quoted as saying "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate" in order to "purge the rottenness" in the system.

Instead, we are told to just all rally behind the Fed — let it pull every lever and bend (or break) every rule to save the world. Or in simple terms: "The ends justify the means. Stocks can’t be allowed to suffer a short-term crash. Recession must be avoided at all costs. Get over it."

Look, I am NOT averse to offering targeted aid to deserving borrowers. I have talked about some of the ideas that make sense to me before. I’m pleased to see that despite all the pressure coming to bear on them, Fannie Mae and Freddie Mac actually seem to be keeping standards relatively tight ... and even tightening them ... to reflect the very real risk of further price declines. And the Frank/Dodd proposals make sense in many ways. That’s because they would require lenders to take some losses, while also making borrowers who receive help pay FHA back for that aid by surrendering a chunk of any future appreciation.

But let’s stop and take a deep breath here about some of these other steps. Maybe, just maybe, Wall Street is getting its just desserts for throwing an easy money bacchanalia the past few years. Maybe, just maybe, we should allow the bad debts to be purged and yes, allow the firms that took on the most risk to suffer the worst consequences.

Ben Bernanke clearly does not agree. He had this to say today about the Fed's dramatic intervention to save Bear Stearns:

"On March 13, Bear Stearns advised the Federal Reserve and other government agencies that its liquidity position had significantly deteriorated and that it would have to file for Chapter 11 bankruptcy the next day unless alternative sources of funds became available. This news raised difficult questions of public policy. Normally, the market sorts out which companies survive and which fail, and that is as it should be. However, the issues raised here extended well beyond the fate of one company. Our financial system is extremely complex and interconnected, and Bear Stearns participated extensively in a range of critical markets. With financial conditions fragile, the sudden failure of Bear Stearns likely would have led to a chaotic unwinding of positions in those markets and could have severely shaken confidence. The company’s failure could also have cast doubt on the financial positions of some of Bear Stearns’ thousands of counterparties and perhaps of companies with similar businesses. Given the current exceptional pressures on the global economy and financial system, the damage caused by a default by Bear Stearns could have been severe and extremely difficult to contain. Moreover, the adverse effects would not have been confined to the financial system but would have been felt broadly in the real economy through its effects on asset values and credit availability. To prevent a disorderly failure of Bear Stearns and the unpredictable but likely severe consequences of such a failure for market functioning and the broader economy, the Federal Reserve, in close consultation with the Treasury Department, agreed to provide funding to Bear Stearns through JPMorgan Chase. Over the following weekend, JPMorgan Chase agreed to purchase Bear Stearns and assumed Bear’s financial obligations."

I look at it this way: Would we have seen a 1,000-point down day in the Dow if the Fed hadn’t arranged a shotgun wedding for Bear Stearns over that fateful weekend? Maybe. But you know what? Maybe that would have been just the cleansing we needed to flush out the last of the $%^# and get on with a healthy, rebuilding process. At the very least, a good flush would have created some real bargains for investors who have acted prudently in the past several months, who didn’t load themselves up with vulnerable financial stocks, and who were sitting on hefty cash levels.

And let me ask a few somewhat-out-of-left-field questions: If Bear Stearns was truly "too big to fail," then how in the heck was it allowed to get that way? Where were the regulators? Why did they allow it to build up so much counterparty risk, or so much trading risk, or any other kind of risk that a failure could allegedly bring about the end of Western civilization as we know it? Why are any institutions allowed to get too big to fail, for that matter? Shouldn't we pass some kind of law tomorrow that says "Any institution above $XX billion in assets now needs to be split up so that we never, ever end up with another TBTF firm bailout?" That idea has a roughly 0% chance of ever coming to fruition. But I couldn't help but throw it out there.

In short, I have real reservations about the longer term impact of many of the things being done today ...

For starters, the Fed has done a poor job of preventing and fixing bubbles over the past several years. It failed to recognize and/or tame the dot-com bubble in advance. Then it reacted to the bursting of that bubble in such an aggressive manner that it created an even bigger bubble in housing.

Despite that track record, some are now considering deputizing the Fed as a financial markets Supercop? Am I the only one who thinks there’s something wrong here?

Second, there’s the whole moral hazard risk of this Bear Stearns transaction. The term refers to the risk that bailouts just embolden people to take even bigger risks down the road, knowing the Fed will save their bacon if they get into trouble.

Critics say there’s just no time for this kind of argument. Their view: Desperate times call for desperate measures. But let me ask you a question: Has each successive crisis that the Fed has tried to paper over (Orange County, Long-Term Capital Management, the dot-com bust, and so on) been bigger or smaller than the one before it? I think the answer is clear: Bigger. And I think one -- though certainly not the only -- reason for that is clear: Investors know that the Fed ultimately "has their backs."

Third, we have to consider the law of unintended consequences. Did the Fed mean to create a housing bubble to replace the dot-com bubble? I doubt it. Policymakers probably thought they were doing the legitimate, proper thing to cushion the economy from the impact of the dot-com bust.

But the reality is that while the Fed can CREATE excess liquidity and cut interest rates, it can’t CHANNEL that liquidity to specific markets. So we seem to be caught in this "rolling bubble" trap, where the "cure" for the popping of one asset bubble ends up creating a fresh asset bubble "disease" somewhere else.

The bottom line: Policymakers need to carefully consider the details of any and all bailout plans — and the long-term consequences of their actions. It’s not "Mellon-esque" to let economic nature run its course, to the furthest possible extent. That’s what capitalism is supposed to be all about, right?

Phew. Sorry it took a while, but I had to gather my thoughts before unloading.

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