Thursday, December 27, 2007


The holidays are bringing more Christmas cheer to the economy. Holiday shoppers are out in droves, in spite of the high gas prices. And so economists are revising fourth quarter growth estimates upward.

Year end figures show a U.S. economy that is red hot, rather than in danger of grinding to a halt. Not only are consumers spending as if there is no tomorrow, but industrial production is straining at full capacity and it is pushing up the inflation rate.

Retail sales, which account for half of all consumer purchases, surged 1.2 percent in November and are up 6.3 percent in 12 months. These are numbers reminiscent of boom times, and should raise 4th quarter GDP growth to more than 2 percent from the 1 percent consensus forecast.

Industrial production is also growing, in part because of surging exports. Production is up 2.1 percent in one year, and operating at 0.5 percent above its 1972-2006 average capacity level, according to the Federal Reserve. ‘Real’, or after-inflation Gross Domestic Product has grown 2.8 percent in 12 months, which is close to its maximum growth potential.

This means supply bottlenecks, and bottlenecks mean higher prices. As a consequence, November wholesale (PPI) and retail (CPI) prices rose sharply, mostly due to scarcer gas and oil supplies. Producer prices are up 7.2 percent, and consumer prices have risen 4.3 percent in 12 months.

And, although home sales continue downward, the Federal Reserve reports that household wealth—the value of household assets minus liabilities—rose $625 billion in the third quarter. It is below the average $1 trillion increase of recent quarters, but still huge.

And disposable incomes and spending, a key indicator of economic health, continued upward in November. Real disposable incomes (after taxes and inflation are deducted) are actually exceeding 2006 levels.

This may explain why consumers still feel wealthy enough to continue spending, even though housing starts fell 3.7 percent in November. And though the Conference Board’s Index of Leading Economic Indicators (LEI) is down 1.2 percent in 6 months, its components are evenly balanced between strengths and weaknesses.

In addition, Martin Feldman, president of the National Bureau of Economic Research—the agency that determines the beginning and end of business cycles—recently said that the 4 indicators used to determine business cycles--employment, wholesale and retail sales, real personal income, and industrial production— indicate no oncoming recession. So, it looks like economic growth may continue to exceed everyone’s expectations!

Copyright © 2007


The Federal Reserve Open Market Committee lowered its interest rates one-quarter percent, causing a stock market selloff. Why didn’t the Fed’s action cheer the markets? Because it believes there is no recession looming on the horizon, while Wall Street sees the danger of a recession next year. Therefore the rate drop disappointed investors and resulted in a flight to the safety of Treasury bonds. This means longer-term fixed rates could continue their recent descent.

The FOMC statement said, “Incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending. Moreover, strains in financial markets have increased in recent weeks. Today's action, combined with the policy actions taken earlier, should help promote moderate growth over time.”

Part of the problem is the confusing signals put out by the markets. For instance,

the Mortgage Bankers Association put out a highly deceptive headline, “US Mortgage Foreclosures at Record High.” There were 1.69 percent of homeowners somewhere in the foreclosure process in Q3, while 5.59 percent of all mortgages were more than 30 days late on their mortgage payments.

Although this is clearly a sign that many borrowers are in trouble, 1 percent is the historical average for foreclosures of conventional loans, and 4.25 percent the average for those at least 30 days in default of their payment. So foreclosure rate are up by one-third, or 50 percent.

But 43 percent of all new foreclosures are in subprime adjustable-rate programs, and they comprise just 6.8 percent of all outstanding mortgages. So if we take out the recent spate of subprime originations, the majority of which occurred over the past 2 years, then we are back to historical averages for so-called prime mortgages!

The debate is whether the ongoing credit crunch--precipitated by the subprime debacle—will brake the overall economy. Economists are predicting just 1 percent GDP growth for the fourth quarter, a very drastic slowdown from Q3’s 4.9 percent growth. This is because they believe consumer spending will also grind to a halt.

But in fact spending was rising 5.2 percent in Q3, and consumers in October borrowed $6.4 billion more on their credit cards, a 2.5 percent jump, according to the Federal Reserve. Top this off with same-store retail sales rising 4 percent in November, and we see much better growth closing out this year.

We also had a good employment report in November, with 94,000 more payroll jobs created and the jobless rate holding at 4.7 percent. The household survey that actually determines the jobless rate showed a huge 696,000 job increase, including the self-employed. The unemployed and out of the labor force totals also shrank, indicating increased activity, rather than an impending slowdown.

The credit crunch seems to be largely self-induced by Wall Streeters that has the potential to affect their bottom line for several quarters, but not the overall economy.

Copyright © 2007


Two revisions last week decreased the chances of a recession in 2008. Both indicators showed a huge increase in economic growth through the third quarter. Firstly, the revision of Q3 GDP growth, the amount of all goods and services produced domestically, was raised to 4.9 from 3.9 percent, the fastest growth in 4 years.

Second was the revision of third quarter labor productivity from 4.9 to 6.3 percent, also the strongest gains in 4 years. Both signal that not only is the economy continuing to grow, but labor costs which make up two-thirds of production costs are actually declining—down 2 percent in Q3 after declining 1.1 percent in Q2, according to the Labor Dept.

So the efficiency of our economy is actually increasing at a time of trouble in the real estate and financial sectors, higher energy costs, and greater geopolitical risks. If this economy can perform in the worst of times, what will it do when conditions improve?

Top this off with 94,000 payroll jobs added in November’s employment report and we see almost no possibility of a recession next year. In fact, calculating a recession is left to the National Bureau of Economic Research, who always announces it after the fact. It is considered to be 2 quarters of negative GDP growth, negative jobs growth, as well as shrinking retail sales and personal incomes. Current economic growth would therefore have to do more than slow down. It would have to literally reverse course and that is not very likely in the near term, given a business-friendly administration and Federal Reserve willing to print enough money to support their banks’ credit problems.

The huge upward revision in GDP growth was because exports and inventories were actually higher than initially estimated. Exports surged because the rest of the world is now growing faster than the U.S. The International Monetary Fund estimates 2007 worldwide economic growth at 5.1 percent and 2008 growth at 4.8 percent. These countries can therefore afford to buy more U.S. goods.

Higher business investment is spurring the increased productivity. Investment is rising 9.4 percent in Q3 after an 11 percent rise in Q2. Productivity is measured in output per hour of work. Output of all goods and services surged 5.7 percent while hours worked dropped 0.6 percent, hence the fantastic 6.3 percent productivity rate in Q3.

This is while consumer spending actually increased from Q2, as did disposable incomes. In fact, November retail chain-store sales—a crucial indicator of consumer behavior—exceeded expectations by rising a robust 4 percent, according to Thomson Financial. Department stores led with a 9.2 percent surge.

That leaves us with the housing question. October existing and new-home sales were basically unchanged, while new-home sales rose slightly. The problem is with so-called “sticky” prices that homeowners are notoriously reluctant to drop when sales slow, which in turn cause inventories to pile up. But with this kind of economic growth, does anyone doubt that sales will pick up in 2008? I don’t.

Copyright © 2007

Wednesday, December 5, 2007


Fed Chairman Ben Bernanke recently made a promise that the Fed will be “flexible” in doing what needs to be done to bolster the financial markets. This is after he and other Fed Governors had hinted at the October FOMC meeting that they were done with lowering interest rates this year. But news of further hemorrhaging of the credit markets and plunging stock prices have alarmed the Fed enough to reverse their stance.

“These developments have resulted in a further tightening in financial conditions, which has the potential to impose additional restraint on activity in housing markets and in other credit-sensitive sectors.” said Bernanke, in a speech to his home state North Carolinians.

“Needless to say, the Federal Reserve is following the evolution of financial conditions carefully, with particular attention to the question of how strains in financial markets might affect the broader economy.”

Yet overall economic activity hasn’t slowed to date. In fact, it has picked up with third quarter GDP growth revised upward from 3.9 percent to 4.9 percent after 3.8 percent growth in Q2, and consumer spending increasing at a 5.2 percent clip. New home construction and sales also rose slightly in the latest October surveys.

What has tipped the Fed’s thinking is perhaps its most recent Beige Book report, an anecdotal survey of activity in the 12 Federal Reserve Bank Districts. It basically announced that the slowdown has arrived, noting that 7 of the 12 districts reported a slower pace of growth, with the remainder describing conditions as moderate or mixed.

What probably alarmed Fed officials most was evidence that the financial market turmoil is impacting the credit markets. Business loans were down and standards for consumer loans were up. The report found soft retail sales and pessimism about the holiday season from retailers, who were also concerned that goods were beginning to pile up on store shelves.

But real estate had some good news in October, as it showed a leveling out of activity.

HOUSING STARTS—A 3 percent rise in new-home construction was mostly due to a surging demand for apartment units, as rental rates rise. But many of these renters will eventually go back to buying homes when housing prices have stabilized.

NEW-HOME SALES—New home sales rose 1.7 percent, probably because builders are offering plenty of incentives, including lower prices. The Midwest region increased a whopping 14.2 percent, 6.8 percent in the South. Sales dropped 15.7 percent in the West, however.

EXISTING-SALES—Sales fell just 1.2 percent in October, while the median price declined 5.1 percent, the largest year-over-year price drop ever recorded, according to the NAR.

NAR chief economist Lawrence Yun said, “I don’t anticipate any further major sales declines,” unless there is further overall economic deterioration. Yun expects 5.67 million in existing home sales in 2007, the fifth best year ever for real estate sales. There is already a pent up demand from so-called Generation X and Y buyers, said Yun. Generation Y buyers born in 1980-1996 are the children of the baby boomers who fueled the last housing boom, and will have as much buying power as their parents when they come of age.

We are now all waiting for the Fed’s December 11 FOMC meeting. The financial markets are anticipating at least a quarter to one-half percent rate drop at that time.

Copyright © 2007


The mortgage market is regaining its health. The Mortgage Bankers Association (MBA) reported that its Applications Survey for the week ending November 30, 2007 surged 22.5 percent on a seasonally adjusted basis from one week earlier. On an unadjusted basis, the Index increased 51.5 percent compared with the previous week-which was a shortened week due to the Thanksgiving holiday-and was up 24.2 percent compared with the same week one year earlier.

The Refinance Index increased 31.9 percent from the previous week and the seasonally adjusted Purchase Index increased 15.2 percent from the earlier week. On an unadjusted basis, the Purchase Index increased 37.3 percent from the previous week. The seasonally adjusted Conventional Index increased 21.9 percent from the previous week, and the seasonally adjusted Government Index increased 27.8 percent in a week.

Some of the increase was because of the shortened Thanksgiving week, but also because interest rates are plunging. Even short-term rates that control ARM indexes have fallen approximately 20 basis points in the past month, perhaps in anticipation of another Federal Reserve rate cut on December 11, the Fed’s last FOMC meeting this year.

The more stable four week moving average for the seasonally adjusted Market Index is up 4.5 percent, up 3.1 percent for the Purchase Index, while this average is up 6.7 percent for the Refinance Index.

The refinance share of mortgage activity had the biggest jump, increasing to 56.0 percent of total applications from 51.4 percent the previous week. The adjustable-rate mortgage (ARM) share of activity decreased to 11.6 from 14.6 percent of total applications from the previous week, reflecting the rush to refinance ARMs to fixed rate mortgages, as rates have fallen.

The average contract interest rate nationally for 30-year fixed-rate mortgages decreased to 5.82 percent from 6.09 percent, with points unchanged at 1.07 (including the origination fee) for 80 percent loan-to-value (LTV) ratio loans, according to the MBA survey. But it has fallen as low as 5.50 percent in some regions, such as California.

The average contract interest rate for 15-year fixed-rate mortgages decreased to 5.38 percent from 5.69 percent, with points decreasing to 1.12 from 1.13 (including the origination fee) for 80 percent LTV loans.

The average contract interest rate for one-year ARMs increased to 6.28 percent from 6.24 percent, with points increasing to 0.99 from 0.96 (including the origination fee) for 80 percent LTV loans.

Does this signal the beginning of the end of the credit crunch that is bedeviling real estate? It will, if this gives a boost to home sales, which have leveled out of late after falling 25 to 30 percent this year.

Copyright © 2007

Monday, December 3, 2007


All eyes are now on the fourth quarter. This is make or break time for both consumers and the Federal Reserve, whose Dec. 11 meeting is the last of the year. Consumer spending has been holding up, even if much of it is spent on gas, heating oil, and groceries. So economists are watching holiday retail sales closely to gauge whether consumers (and the economy) will stay healthy.

Consumers’ health depends in part on whether the credit crunch continues for mortgages. Lenders are again offering a full range of jumbo loan programs with stated income, the segment most affected by the crunch, though jumbo rates are still high. This could signal some easing of the mortgage crunch.

But it really is up to Congress to raise the conforming lending limits on Freddie Mac, Fannie Mae, and FHA. Even Treasury Secretary Hank Paulson is urging action, since the so-called GSE’s (Government Sponsored Enterprises) were set up to be lenders of last resort when banks cut back on their lending.

He has called the Senate's failure to pass legislation overhauling mortgage giants Fannie Mae and Freddie Mac "very frustrating," saying that the two government-sponsored entities need to be playing a bigger role in the housing market.

"If we ever need them it's during times like today, and they're most valuable when there is distress in the mortgage market," he said. "I'd like to see them playing an even bigger role."

The Fed has just come out with the first of its quarterly reports designed to make its decisions more transparent. Inflation is expected to remain contained. Headline inflation, as measured by the PCE index, is expected to slow to 1.8-2.1 percent in 2008, down from around 2.95 percent this year. Core inflation will remain steady in a range of 1.7-1.9 percent. It is expected to plunge below 2 percent by 2010, another reason for the Fed to cut interest rates further in Dec.

Inflation is subsiding in part because Fed officials cut their growth forecast in 2008 to a range of 1.8 percent to 2.5 percent next year, down from the previous forecast of 2.5 percent to 2.7 percent released last July. This is why consumer spending is so important, since it makes up some two-thirds of economic growth.

New-home construction and sales are firming, as Oct. new-home sales actually rose 3 percent on higher apartment construction. And the NAR’s Oct. pending home sales index was unchanged for the first time in a year.

The Conference Board’s Index of Leading Indicators (LEI) that attempts to predict future economic activity has been somewhat of a mystery this year. The LEI has been essentially flat in 2007, continuing the yearlong pattern of alternating monthly increases and decreases, and it has gradually returned to its August 2006 level.

“Meanwhile, real GDP grew at a 3.9 percent annual rate in the third quarter, moderately stronger than the 2.2 percent average annual rate in the first half of the year,” said the release. “The behavior of the composite indexes so far continues to suggest that risks for economic weakness persist, but economic growth should continue in the near term, albeit at a slower pace.”

Consumer sentiment indexes, another closely-watched indicator, are less reliable. But they also measure consumer attitudes towards inflation, and it is the consumers’ perception of inflation that determines how tightly they control spending.

The U. of Michigan Consumer Sentiment index was 76.1 in November, down from 80.9 in October, and "significantly" below the 92.1 during the same period in the prior year, according to the Reuters/University of Michigan Surveys of Consumers.

"Rising prices for fuel and food had a devastating impact on household budgets, and falling home prices have diminished consumers' sense of financial security," said Richard Curtin, director of the survey.

The Conference Board’s confidence survey also declined for the third consecutive month, “and continues to hover at 2-year lows”, said its press release. But a more recent spending survey was more upbeat. "Consumers are in a festive mood heading into the Thanksgiving holiday," says Lynn Franco, Director of The Conference Board Consumer Research Center. "And, it appears they are willing to spend more than last year, though retailers can still expect a fair share of bargain hunters will be lining up for the traditional kickoff this Friday."

Copyright © 2007

Saturday, November 17, 2007


Remember irrational exuberance, the creator of asset bubbles? Well, we may now have irrational pessimism, the creator of panic selling in the credit markets. We know this because many of the assets being written off, or sold at a discount by banks and hedge funds, are AAA-rated. It is the highest credit rating possible—the rating of Treasury bonds as well.

This belies the underlying strength of the economy. Consumers are still buying—with retail sales up 5.2 percent annually in the latest October survey. So the credit crunch is not yet affecting overall consumer spending, just what they are buying. Inflation is up slightly, but not what one would expect with soaring oil prices.

A famous 2001 research paper on “Herd Behavior in Financial Markets” stated that “Intuitively, an individual can be said to herd if she would have made an investment without knowing other investors’ decisions, but does not make that investment when she finds that others have decided not to do so. Alternatively, she herds when knowledge that others are investing changes her decision from not investing to making the investment.”

Much of it is generated by media pundits, who love to dramatize the adversity without doing the hard work of actually analyzing the numbers. And it sells ads. Human nature is controlled in large part by emotions, and during crises the motivating emotion can be fear. It magnifies all events. The glass is then half empty instead of being half full, in a word.

One example is predictions that banks may suffer upwards of $250 billion in writedowns before the dust has settled. Yet the top 5 banks’ revenues—banks such as Citicorp, JP Morgan/Chase, Wachovia, and Bank of America that are writing off those losses—have had record-breaking revenues this year. Business Week reports that their revenues could be up 7 percent from last year’s high of $127 billion.

The S&L crisis cost banks and taxpayers some $160 billion in the early 1990s, and helped to cause the 1991 recession. But this was when total Gross Domestic Product was 44 percent of what it is today. Banks were also not in the greatest shape then, with much lower capital and loan loss reserve requirements. Add to this the worldwide glut of savings that has poured into our stock and credit markets, and we see that this credit crunch may mostly be motivated by fear, rather than fundamentals.

And so in the words of a famous radio commentator, we should be looking at “the rest of the story”. What is it? Labor productivity jumped a huge 4.9 percent in Q3, mainly because the business investment that brings new technologies is up almost 8 percent. This will boost incomes while counteracting the high energy prices.

PPI/CPI—Overall wholesale inflation (PPI) rose just 0.1 percent in October, and retail prices (CPI) rose 0.3 percent. But PPI/CPI prices are up 3.5 percent and 6.1 percent, respectively, in 12 months. Still, with oil prices over $90 per barrel and gas above $3 per gallon, this is remarkable.

PENDING HOME SALES—This is signed contracts only, and attempts to predict existing-home sales that will close. The Pending Home Sales Index (PSHI), a forward-looking indicator based on contracts signed in September, rose 0.2 percent to a reading of 85.7 from an index of 85.5 in August, according to the National Association of Realtors. This was the first rise in one year, even though it was 20.4 percent lower than the September 2006 level of 107.6. “Even with relatively low fourth quarter sales, 2007 will be the fifth highest year on record for existing-home sales. The median existing-home price in 2007 will have fallen by less than 2 percent from an all-time high set in 2006,” said the NAR’s chief economist Lawrence Yun.

We know that the concept of irrational exuberance was first trumpeted by Fed Chairman Alan Greenspan in 1996. It wasn’t until 2000 that the stock market bubble burst. Now we are hearing dire predictions that are more due to the herd behavior of media pundits than economic fundamentals. Most of it is based on unfounded fears. This is no substitute for a better understanding of the complex factors that determine economic growth.

Copyright © 2007

WEEK OF October 29, 2007—Third Quarter Growth Robust

The U.S. economy is booming, in spite of the credit crunch. The ‘Advance’ estimate of third quarter GDP growth came in at 3.9 percent, higher even than Q2’s 3.8 percent and the best performance in the past 6 quarters. The Federal Reserve dropped its fed funds and discount rates another 0.25 percent on the same day, so that the Prime Rate is now 7.5 percent.

In spite of the good growth rate, the Fed’s quarter percent rate drop was far too timid for the job at hand. Third quarter foreclosures are up 40 percent over the second quarter in California alone, according to DataQuick Information Services. So interest rates have to come down further to ease the credit problems caused by the Fed’s rate increases of the past 2 years.

The Fed’s press release said that “economic growth was solid in the third quarter, and strains in financial markets have eased somewhat on balance. However, the pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction.”

Yet the FOMC release added that the upside risks to inflation “roughly” balanced the downside risks to growth. Such wording usually means the Fed is done with any more rate reductions for the present. This is even though the Congressional Budget Office estimates that a possible 2,000,000 subprime loan holders may lose their homes nationwide through 2008!

Six Southern California Counties had 13,314 foreclosures in July, August Sept., versus just 1,960 foreclosures in the third quarter of 2006. They are particularly pervasive in San Bernardino and Riverside counties, the working-class exurbs of Los Angeles and Orange County, and the fastest-growing counties in the state.

But overall, the surge in economic activity has easily outweighed the effects of the credit crunch to date. Business investments and exports led the way, growing 7.9 and 16.2 percent per year, respectively, in Q3. Disposable, or after tax, income grew a whopping 4.4 percent, which seems to be fuelling consumer spending. So-called real final sales—after inflation and inventory expansion are taken out—rose 3.5 percent. And yet inflation, via the GDP price index, rose just 1.6 percent, versus 3.8 percent in the second quarter.

Meanwhile, residential investment (ie, new-home construction) is “nowhere near a historic low”, according to the Economic Policy Institute—in fact, it remains close to the post-1979 average of 4.6 percent,. Though housing inventories are at historic highs, new-home construction would have to drop by another one-third—to 3 percent of GDP growth—to approach its historic low last reached in 1991. But new-home construction rose 4.8 percent in Sept., and inventories shrank to an 8.3-month supply.

The GDP price index assesses the costs of all goods and services produced domestically. So where is the inflation with the index so low, and why is the Fed so worried about it? That is the mystery, and why we believe they will in fact continue to lower rates come Dec. 11, the last meeting of the year.

Copyright © 2007


Dr. Edward Leamer, UCLA economist, gave what may be the best analysis of housing’s affect on the business cycle at this year’s Jackson Hole economic symposium. Housings’ effect is negligible on current business activity, in a word, though it may be a predictor of future activity. And so we believe that economic growth will continue to increase at or near its current 3 percent rate into next year, before slowing down in late 2008.U.S. Gross Domestic Product has grown a very robust 3.1 percent since 1970. Residential real estate contributed one of the smallest segments to that growth—4.2 percent of the total, or just 0.13 of the 3 percent average growth rate over that time—below even equipment and software sales, according to Dr. Leamer.

In fact, housing's share of the economy is too small to cause a recession without other factors coming into play, such as the S&L banking crisis of 1989, or bursting of the stock market bubble in 2000. As a predictor of future growth, housing’s wildest swings tend to come just before a downturn, but housing also recovered before the rest of the economy in 8 of the last 10 postwar recessions, says Dr. Leamer. And though residential sales continue to decline, they have not reached levels that affect overall activity, since overall activity is powered by other sectors.

Real estate activity would have to subtract approximately 1 percent from GDP growth, and it is now subtracting approximately three-quarters percent from the GDP growth rate. The housing industry employs a lot of workers, from construction to insurance, to banking, to of course sales. And when sales decline, so does the employment of those workers. Conversely those workers are the first to be hired during the recovery cycle.

Right now, the most important housing statistics to watch are housing starts (construction) and existing home sales. Starts fell 10 percent in September, while existing sales dropped 8 percent. Overall starts are down to 1.19 million units, from its 2005 high of 2 million, a 40 percent drop. Existing-sales are down to 5 million from 7 million units in 2005, a 29 percent drop.

Yet we are seeing very little effect of the housing downturn on employment, which has dropped from 4.5 to a 4.7 percent rate. This is because the service sector of our economy continues to generate the most activity, followed by exports, durable and nondurable goods, and equipment and software. They cumulatively have averaged 3.36 percent growth from 1985 through 2006. (Imports, which subtract from domestic sales, contributed a negative -0.81 percent to growth over that time.)

Business investment and commercial real estate investment are two sectors still growing robustly, as well. And consumer spending has increased 3 percent since 2005. Exports, meanwhile, are supporting the manufacturing sector, thanks to robust growth in the rest of the world. In fact the IMF says that global economic growth was a huge 5.2 percent this year, and will be 4.8 percent next year.

So, as much as real estate is contributing to the credit crunch, we do not believe that it will bring down the rest of the economy. In fact, it is because overall growth is so strong that we see sales stabilizing by the end of this year. Real estate prices are notoriously “sticky”, according to Dr. Leamer, meaning sellers are reluctant to drop prices to levels that buyers can afford.

In fact, new-home sales are stabilizing, as builders have been cutting back on production. Sept. sales increased 4.8 percent, while inventories fell to an 8.3-month supply. The median price also rose 5 percent to $238,000. It goes to show that reducing inventories is the key to restoring stability to the real estate market.

Copyright © 2007

Friday, October 19, 2007


The 2007 Nobel Prize in the Economic Sciences was just awarded to three U.S. economists, all mathematicians, in what is part of a watershed movement to bring back economics that benefits public institutions, as well as private individuals. Their research into “mechanical design theory” has made financial markets more workable for the many, rather than leave them to the devices of the “invisible hand” of Adam Smith, our first free market economist.

Also, major banks have agreed to set up a $200B fund to increase liquidity in non-subprime commercial paper markets. Why? The credit crunch is caused by mortgage lenders unable to sell their non-conforming, jumbo loans into the secondary market. And so by providing liquidity to the short end of the secondary market (i.e., 90-day commercial paper has the cheapest rate.) that buys shorter-term consumer loans, it should ease the credit crunch and make more money available.

What is the real cause of the credit crunch? Fed Chairman Bernanke claimed in his most recent speech it was the fault of sloppy underwriting of subprime loans: “The rate of serious delinquencies has risen notably for subprime mortgages with adjustable rates, reaching nearly 16 percent in August, roughly triple the recent low in mid-2005. Subprime mortgages originated in late 2005 and 2006 have performed especially poorly, in part because of a deterioration in underwriting standards.”

Yet the Fed has raised short-term interest rates 4.25 percent over that time in chasing the phantom of inflation. This in fact has doubled mortgage payments in many cases; something that no borrower (or maybe lender) could have anticipated—whether prime or subprime loan. Therefore, the Fed should be shouldering much of the blame. It created the problem, not faulty underwriting.

The economics prize Nobel press release stated that “Whether one considers auctions, elections or the taxes we pay, our lives are governed by mechanisms which make collective decisions, while attempting to take account of individual preferences. Such mechanisms are designed to deliver the greatest social good despite the fact that individual participants may act for their own gain, rather than for the general well-being of society.”

This is bringing us back to a form of Keynesian economics that sees a role for government and regulation. The latest research is moving economics away from libertarian or so-called supply-side economics, in a word, which had enshrined unregulated, free markets that tended to cause greater income inequality.

What is the research? It is a branch of Game Theory (remember the film, “A Beautiful Mind”?) that helps to determine the best market outcomes for the “general well-being of society”, in the words of the Nobel committee.

Markets do not do this automatically. For example, those with insider information tend to profit more from market information that is not readily accessible to all. So government regulation does not have to be a bad thing. That is why we have the Federal Reserve, whose charge is to regulate banks and the money supply. Without the Fed, recessions would be deeper and inflation swings more volatile. Hence one of its mandates is to “manage” inflation.

Copyright © 2007


We know that third quarter economic growth will be good to very good, in spite of the credit crunch. Why? Prices are still rising at a healthy rate. And some inflation is good for economic growth, contrary to what the Federal Reserve may say.

The September Producer Price index for wholesale goods and services rose 1.1 percent, but most of the increase was in food and energy—no surprise in a growing economy. The so-called core rate without food and energy prices rose just 0.1 percent and is up just 2 percent in 12 months. This means that the extreme fluctuations in energy and food prices (due to seasonal demand factors) are not being passed on to other goods and services. What would happen if prices actually began to fall? That is one of the official definitions of a recession!

Here are some reasons we will see good growth for the rest of this year. The September employment report showed 110,000 jobs added to private and government payrolls, while another 118,000 jobs were added in revisions to prior months’ estimated job growth by the Labor Dept. The 4.7 percent unemployment rate means the U.S. economy is still at full employment.

Then retail sales, the main indicator of consumer spending, continue to be healthy. Overall consumer spending is averaging 3 percent and retail sales, its main component, soared 5 percent annualized in September, the strongest showing in at least 2 years. The biggest spending was in health care, as well as catalogs and online sales, each up 1 percent.

In spite of this, growth could be slowing in Q4. Third quarter job growth was half that of 2006, and private sector payrolls are growing at slowest pace in three and one-half years. This alone should keep another interest rate cut on the table at the Fed’s October meeting, says CBS Marketwatch economist Irwin Kellner.

Interest rates have barely budged since the Fed’s September rate cut. ARM indexes, such as the Cost of Funds, or Treasury, or LIBOR indexes are still hovering around 5 percent, which means it could be months before holders of adjustable rate mortgage will see any payment relief. Why? Investors are asking for higher returns until the extent of ARM defaults is known. Most of the negatively amortized Option ARMs were issued in the past 2 years, and so they won’t reach their full payment for at least another year. It is that uncertainty that is keeping short-term interest rates high.

How do we know when property valuations return to more normal levels? A measure of housing value used by economist Robert Shiller of Irrational Exuberance fame, is the growth of median incomes. Housing prices over the long term tend to approximate the average increase in household incomes. No surprise, since that is what determines affordability.

Household incomes have increased 5.6 percent per year over the past 35 years.

Yet average home prices have risen more than 50 percent just over the past 6 years, according to the National Association of Realtors. This means housing values have risen 15-20 percent over the historical norm in those years, and so must fall by that amount to return to the historical norms.

Copyright © 2007


The key to a recovery from the subprime debacle is the health of consumers. And so consumer spending is the most closely watched indicator at present, with the Federal Reserve now waiting to see whether its one-half percent rate cut will keep consumers, and so the economy, humming. Surprise, surprise. August consumer spending is the highest in 2 years; probably because the labor market is still creating jobs.

It is a pleasant surprise, given all the bad news in August. It means the Fed has room to cut rates further at its October 31 FOMC meeting should real estate sales continue to decline. August new and existing-home sales dropped 8.3 and 4.3 percent, respectively, and for sale inventories are up to a 10-month supply. Another surprise is that median prices are still holding, as higher-end homes continue to sell.

The drop in the Prime Rate that determines most credit card rates could also spur more consumer spending over the holidays. August credit card debt rose a whopping 8.1 percent, or $6.1 billion, according to the Federal Reserve.

September’s unemployment report also generated optimism. Though the jobless rate rose from 4.6 to 4.7 percent, 110,000 new payroll jobs were created and past months’ employment was revised upward. Health care and food services are responsible for one-half of all payroll jobs created this year, according to the Labor Department. Mortgage lending, its related services, and construction continue to lose jobs, however.

The good jobs picture is encouraging consumers to continue to shop. Real consumer spending increased a large 0.6 percent, while the inflation rate is back down to early 2004 levels. The Personal Consumption Expenditure index, the major inflation indicator, is up just 1.8 percent in 12 months. Average hourly earnings are rising 4.1 percent—double the inflation rate. The fact that incomes are rising faster than inflation has to make consumers feel more secure.

"Consumers -- so far -- are taking the recent financial turbulence in stride," said economists for Credit Suisse in their weekly outlook. They look for a 0.4 percent increase in September sales, boosted by moderate growth in general merchandise sales, and sales growth in restaurants, building materials and apparel.

But others think the retail numbers won't be so rosy. "Sluggish chain-store suggest that September was a disappointing month for retailers," wrote economists for Global Insight, who expect only a 0.1 percent gain in sales. "Consumers have become more cautious and resistant to outlays on big-ticket items," such as building materials and durable household goods.

For the third quarter as a whole, consumer spending increased at a 3 percent annual rate, double the growth recorded in the second quarter, economists said. This could mean that third quarter economic growth will exceed 3 percent, following the 3.8 percent Q2 final estimate of GDP growth, since consumer spending accounts for two-thirds of economic growth.

Copyright 2007

Saturday, September 15, 2007


It is perhaps fitting that Fed Chairman Ben Bernanke on the anniversary of 9/11 should be making a speech in Berlin that attempts to clarify why we have run up such a trade deficit—of approximately $1 trillion last year alone.

Chairman Bernanke made the speech on the 9/11 anniversary for several reasons. It is consumer spending and borrowing since 9/11—fueled by record low interest rates—that enabled the huge trade deficit, and the trade deficit in turn has enabled the huge federal budget deficit—up to $8 trillion at this writing.

Those twin deficits are a major headache for Bernanke. They happen at the same time that “the U.S. has already reached the leading edge of major demographic changes that will result in an older population and more slowly growing workforce,” said Bernanke in his speech.

This explains why the Fed has been reluctant to drop consumers’ interest rates as it finally did for its banks last month. It wants to discourage consumer spending and encourage more savings, which would reduce the twin deficits.

There is also a second reason behind the Fed’s reluctance. Too much money in consumers’ pockets tends to cause higher inflation. Bernanke and many other Fed Governors, apparently, believe that part of their mission is to discourage consumers from any inflationary tendencies. I.e., if consumers believe the Fed is hawkish and vigilant concerning any inflation, then consumers might shop more carefully. It is only if consumers believe the Fed is serious about controlling prices, in other words, that consumers will control their spending.

In fact, a famous speech Bernanke made when the Fed’s Vice Chairman in 2001 outlined this philosophy. He claimed it was the Fed’s anti-inflation vigilance in the 1980s that caused a period he called the “Great Moderation”, when inflation was subdued. Inflation began to moderate in the 1980s after such draconian Fed measures as raising their fed funds rate to 19 percent in 1981. This caused 2 recessions within 3 years, needless to say.

However, Bernanke is only giving us part of the story. Consumers are over indebted not only due to the Fed’s very accommodative credit easing, but the federal tax cuts of 2001 and 2003 put a huge amount of money back into consumers’ pockets. This encouraged the borrowing binge, and caused the dollar’s value to fall to a 15 year low. It has also caused the price of imported oil—which is paid in dollars, let us not forget—to rise to $80 per crude barrel of devalued dollars at this writing.

The influx of foreign savings also had a hand in the double-digit housing price rises of the past several years. For it is foreign savings that have been the main cause of lower long-term interest rates (i.e., bonds), at the same time the Fed was raising short-term interest rates. This became a disconnect that could not last. It is the rise of short-term, adjustable rates that has fueled the huge number of defaults, hence the current credit-crunch.

The latest news continues to be mixed. Retail sales are still growing at a 3.9 percent annual clip, but only because of deep discounts on last year’s models in August. Industrial production fell, while the U. of Michigan’s preliminary Sept. survey of sentiment edged up slightly, and inflation expectations declined. That is a good sign. There certainly is not yet a credit squeeze on credit cards or car loans. But there’s the rub, to borrow from Shakespeare. If and when the Fed does begin to drop consumers’ short-term rates, this will encourage more borrowing and spending, not more savings.

Consumers tend to save more when interest rates are higher, in other words—such as in the 1980s. But that hurts economic growth. A much better way to cure the twin deficits is to raise taxes on the wealthiest, those making more than $200,000 per year, as was done during the 1990s. Cutting taxes neither cuts deficits nor helps retirees’ benefits, period.

Copyright © 2007


The markets jitters come from more mixed news. July’s unemployment rate remained at 4.6 percent, but payrolls shrank by 4,000 for the first time in 4 years—as opposed to the 100,000 plus monthly jobs average of late. The NAR’s pending existing-home sales index fell, as did construction spending. But both manufacturing and service sector activity continue to expand. And retail sales are robust, especially at the high end.

All of this makes it virtually certain that the Federal Reserve will begin to reduce short-term interest rates sometime this month—maybe this week. Their mandate is not only to fight inflation, but nurture “sustained economic growth”. And any jobs uncertainty is a sure sign that employers are holding off on hiring until the real estate market settles down.

Lawrence Yun, NAR senior economist, said abnormal factors are clouding the existing-home sales picture. “It’s difficult to fully account for mortgage disruptions in the index, and our members are telling us some sales contracts aren’t closing because mortgage commitments have been falling through at the last moment,” he said.

These temporary problems are primarily with jumbo loans, and there are continuing issues for subprime borrowers. But new lenders are stepping into the breach to replace those who have stopped lending—contrary to the early 1980s, when the disparity between short and long term interest rates caused even the largest banks to stop mortgage lending. This is not the case today, as banks are flush with profits from the 5-year expansion.

The economy as a whole seems to be doing quite well of late, including consumers. One such indicator is consumer spending, which had declined but now is rising again along with personal incomes, as I have said. The government’s latest figures show that personal incomes jumped 0.5 percent in July, while real consumption expenditures have averaged 3 percent annually, indicating that third quarter economic growth could also be above 3 percent. Q2 GDP was revised to a 4 percent growth rate.

UNEMPLOYMENT—July’s unemployment rate was unchanged at 4.6 percent because the same number left the workforce as lost their jobs—more than 300,000 in each case, according to the telephone survey of households. There was a 68,000 plunge in construction and manufacturing employment, while education and health services’ employment rose 63,000, according to the payrolls survey. This balancing act is keeping the economy chugging along.

What about real estate sales? Interest rates are already plunging, with conforming 30-year fixed rates now at 5.875 percent for slightly more than a 1 point origination fee. And if the Fed drops its short-term fed funds rate, the Prime Rate and other ARM indexes would follow its lead.

“Some consumer concerns remain, but since mid-August the market has been stabilizing somewhat,” said the NAR’s Yun. “If lenders focus on the essentials of creditworthiness and adjusted valuations based on comparable sales, and ignore speculation on what might happen in the future, broader stabilization will come sooner rather than later,” Yun said.

By not acting sooner, the Fed seems to be trying to downsize the largest issuers of jumbo subprime and Option ARMs, who can no longer sell these loans on the secondary market. Neither consumers, nor these lenders will see any relief until the ARM indexes, including the Prime Rate at 8.25 percent, begin to decline.

Copyright © 2007

Sunday, August 19, 2007



In order to understand the abrupt changes in mortgage interest rates, it helps to understand what is going on in the secondary mortgage markets. The so-called secondary market is where most mortgages are sold by banks, mortgage banks, thrifts, and anyone else who funds loans, so they can lend another day. And events this week caused the Federal Reserve to radically shift its bias—and monetary policy—from an inflation danger to the growing danger of slower growth and higher unemployment.

The credit crisis was triggered by borrowers defaulting on their loan payments. This in turn meant that the investors who bought those pools of mortgages—usually in the form of bonds—lost income. Their investments were then worth less, which caused many to want to take their money out of the investment funds.

And when many clamor to withdraw funds, it is much like a run on the bank. Since such funds generally have a limited amount of cash on hand to pay those wanting refunds, they borrowed from their banks. And since banks also have a limited amount of cash on hand, they turned to the Federal Reserve to borrow more money.

Because of the turmoil, secondary market investors (usually mutual, hedge, or pension funds) have been reluctant to buy more mortgages. Why? Until it is known exactly how many mortgages will default, investors cannot measure the risk and so price of their investment. But that won’t happen until we work through more of the $1 trillion in adjustable rate mortgages (ARMs) on the books as their payments continue to adjust upward.

In light of these facts, it is hard to understand why the Fed has taken so long to lower interest rates—as it did Friday with a one-half percent cut in its overnight discount window rate. The damage to economic growth and consumers’ pocketbooks by the credit shortage is far more than that inflicted by a small jump in the inflation rate. It is borrowers not being able to meet their mortgage payments—which are as high as 8.5 percent for even prime borrowers with ARMs—that is causing the squeeze in the first place. And lowering short-term interest rates will help to lower the mortgage payments on those ARMs.

The inflation news has been benign of late, as gas prices have fallen. Both wholesale and retail prices rose slightly, while industrial and service sector production fell. Also, the NAHB/Wells Fargo housing market index fell two points in August to 22, which means about one fifth of builders nationwide think the market is "good." A year ago, the index was at 33. Two years ago it was at 67.

The Commerce Dept. also reported that housing starts (construction) and permits continued to decline. Residential Construction is down 37 percent from their peak of last year, while commercial construction continues to hum along.

PPI and CPI—Wholesale (PPI) prices rose 0.6 percent, but the core rate rose just 0.1 percent without food and energy. Finished wholesale goods are up 4 percent in a year, mainly due to 2.5 percent rise in energy prices. Meanwhile July retail (CPI) prices rose just 0.1 percent, core rate rose 0.2 percent. This is because energy prices fell 1 percent (read gas prices) at the retail level!

HOUSING STARTS--U.S. home builders cut back again in July, starting construction on the fewest number of new homes in more than 10 years, the Commerce Department reported Thursday. Housing starts fell 6.1 percent to a seasonally adjusted annual rate of 1.381 million, the lowest since January 1997. Meanwhile, authorized building permits dropped 2.8 percent in July to a seasonally adjusted annual rate of 1.373 million, the lowest since October 1996.

The Fed only cut the more expensive loan rate to banks, but has not yet acted on the fed funds rate that controls the Prime Rate and ARM indexes of mortgage holders. But Friday’s cut is a sign that central banks may begin to lower interest rates in earnest. In fact, this writer believes a fed funds rate cut sometime before the next September 18 FOMC meeting is now a foregone conclusion, as I have said.

Copyright © 2007

Monday, August 13, 2007


Last week’s unemployment report confirmed that “moderate” economic growth will continue for the rest of this year. It also confirmed the Federal Reserve’s decision not to change interest rates at its August FOMC meeting. But fast changing conditions in the credit markets could cause the Fed to lower their rates come September. “Economic growth was moderate during the first half of the year. Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing,” said the FOMC press release. “Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.”

The Fed’s inaction disappointed some analysts who had been calling for the Fed to acknowledge the plight of homeowners caught in the credit crunch. Some lenders are now only offering conforming mortgages that fit Freddie Mac and Fannie Mae guidelines. But good jumbo fixed and adjustable interest rates and programs are still available at lending institutions that did not leverage themselves too highly.

The July unemployment rate rose slightly to 4.6 percent, but that is still considered full employment. This may be one reason the Fed is reluctant to lower interest rates at this time. Fed officials are still seeing strong growth, in other words. Payrolls added just 92,000 jobs, below the 136,000 monthly average for 2007, but wages are rising and the consumer is still borrowing as if there is no tomorrow.

In fact, two crucial sectors in real estate—construction and financial services—have not had a net loss of jobs in 2007 to date, while two other sectors—insurance and securities—have continued to add jobs. This is not surprising in view of the fact that commercial real estate is booming, as new construction is finally catching up to the demand from the continued business expansion.

CONSUMER CREDIT—Consumers borrowed another $13 billion, up 6.5 percent in June. Credit card debt has averaged a whopping 10 percent jump in May and June, biggest increase since 2006, which means the housing slump hasn’t done much to diminish consumers’ so-called wealth-effect!

ECONOMIC GROWTH—The initial estimate of real (inflation adjusted) second quarter Gross Domestic Product (GDP) growth jumped 3.4 percent, showing the economy had recovered from near zero growth in Q1. And inflation was tame, with the PCE core inflation that measures all consumer prices up just 1.9 percent. The growth spurt was mainly due to surging exports, which is helping to keep the U.S. economy at full employment.

We still have a ‘goldlilocks’ that is not too hot or too cold, in other words, and as we have said in the past. This GDP estimate also included revisions over the past 3 years, which showed that consumers had actually saved more and spent less than previously thought. In fact, the revisions show that our personal savings rate has been positive over the past 2 years. This is another reason to be optimistic about future economic growth (with little inflation).

The Federal Reserve has already begun to inject additional monies into the banking system as of this writing to ease the credit crunch--$38 billion as of this writing—while European banks have injected almost $200 billion. This is an early sign that several central banks may begin to lower their interest rates. In fact, the odds continue to grow that the Fed will begin easing even before the September 18 FOMC meeting. This writer believes it now is a foregone conclusion.

Copyright © 2007

Where Is the Corporate Conscience?

August 12, 2007


Other Voices Submission

I applaud Leo Hindery’s August 13 Other Voices commentary in Barron's Magazine, “A Plea For Corporate Conscience” for putting corporate responsibility back into play. It shocked me to learn that corporate CEOs—of the Business Roundtable, at least—felt that maximizing shareholder wealth (and so their own) has become the only job of business!

The fact that wages and household incomes have not kept up with productivity gains since the 1970s is just one result of such a shortsighted policy that has resulted in a “growing divergence between its (U.S.) national interests and the interests of those U.S. multinational corporations that seem bent on moving everything but consumption offshore,” says Hindery.

We see the result of the broken contract with the middle class. We know that the massive resulting Federal budget deficits have pushed us back to inequality levels last seen in the 1920s—at the expense of a decent health care system (for our veterans as well), and declining educational system (our elementary and high school children rank lower in math and reading skills than those in Japan and other developed countries).

U.S. citizens now have much longer working hours than in other developed countries, fewer benefits including paid vacations and sick leave, a greater incidence of major diseases, shorter life spans, and higher infant mortality than in some developing countries (including Cuba).

The increase in major diseases was documented in a major British-American study published in the May 3, 2006 AMA’s Journal of the American Medical Association. Using well-respected national survey data on the health and lifestyles of more than 6,400 Americans and 9,300 English people aged 40 to 70, the researchers found that U.S. citizens aged 55 to 64 are twice as likely as their peers in England to be diabetic (12.5 percent of Americans surveyed vs. 6.1 percent of British); 10 percentage points more likely to have high blood pressure (42.4 percent vs. 33.8 percent); 6 percentage points more likely to suffer from heart disease (15.1 percent vs. 9.6 percent); and at nearly double the risk for cancer (9.5 percent vs. 5.5 percent). Americans also had higher rates for heart attack, stroke and lung disease when compared to the British.

Leo Hindary’s initial recommendation to link corporate tax rates to the productivity of a corporation’s U.S. employees will do nothing to encourage workers to produce more, however, unless employees receive their ‘fair’ share of its benefits. And who is to say such savings will be passed on to employees?

A much better idea is to improve the health and security of all U.S. workers by guaranteeing basic health care for all, as in all other industrialized countries. We should also strengthen our retirement system, so that workers do not have to worry about their old age. Treasury Secretary Paul O’Neill was fired for suggesting that $1 trillion of the Clinton budget surplus be set aside to rescue social security and Medicare, instead of using it to finance the drastic tax cuts that have caused much of the current budget deficit (i.e., $8 trillion in public debt, 45 percent of which is owed to foreign investors).


Harlan Green,


Friday, August 3, 2007

What Tax Cuts Helped Economy?

July 14, 2007



Other Voices Submission

J.T. Young’s “Other Voices’ (July 16) essay, “Tax Cuts Helped Economy Stay Afloat,” is but a repetition of what has become the Bush Administration’s mantra: “…cutting taxes under any circumstances and for any excuse, for any reason, whenever it's possible.” (as originally coined by economist Milton Friedman). Simply put, Young’s assertion that the 2001 (and 2003?) tax cuts “produced the best recession/recovery cycle of the past 60 years” was given the lie by the 2006 elections, in which much of the Democrats success was attributed to voters’ dissatisfaction with the economy.

There is almost no dispute among economists that the 2001 recession was one of the shallowest in history. But that was mainly due to the fact that the Fed dropped interest rates too low for too long—a policy that resulted in the printing of limitless amounts of money that powered the greatest housing boom on record (and bursting of the subsequent housing bubble), as well as a credit bubble based on fraudulent subprime loans that is bursting as we speak.

But the strength of the recovery is another matter. Most Americans did not benefit, just the top 10 percent of income earners—i.e., those who now control almost 80 percent of the wealth of this country. These numbers are corroborated by everyone from the Federal Reserve Bank to the Congressional Budget Office, to the international Organization for Economic Co-operation and Development (OECD).

Nobelist Joseph Stiglitz and fellow economist Peter Orszag said it best in a Business Week essay of that time: “The administration’s (tax cut) package largely ignores the central feature of a recession: lack of demand. The primary problem is that the nation’s firms face a reduction in demand for their products—not that they lack available workers, equipment, or anything else needed to produce goods and services. Indiscriminately injecting cash into such firms through tax breaks, without linking the tax breaks to new activity, would do little if anything to address the underlying difficulty.”

What did Drs. Stiglitz and Orszag recommend? They recommended a temporary extension of unemployment insurance and cut in income taxes for salaried workers, which directly benefits those who spend the largest portion of their income. This is classical Keynesian economics, of course.

Supply-side economists (conservatives one and all), on the other hand, swear by Say’s Law that says demand is never the problem, only an adequate supply of goods and services. Let wages fall where they may (though wage levels are the major determinate of aggregate demand). Allow workers to work for next to nothing, in other words, and eventually any economy will recover!

That certainly happened during this administration. By not giving tax cuts to those who could most use it—rather than investment tax breaks on capital gains and dividends--real average household incomes for working age households under 65 fell 5.4 percent 2000-2005, after inflation. Incomes have only begun to recover over the past three quarters, too late to prevent the lowest personal savings rate since the Great Depression. Consumers’ personal savings rate has been negative for more than 2 years.

The conservatives’ tax cuts were in fact a calculated shift of wealth from the lower and middle classes to the already wealthy and their supporters. The massive resulting Federal budget deficits have pushed us back to inequality levels last seen in the 1920s—at the expense of a decent health care system (and our veterans), and declining educational system (our elementary and high school children rank lower in math and reading skills than those in Japan and other developed countries).

These results are confirmed by scientific studies. U.S. citizens now have much longer working hours than in other developed countries, fewer benefits including paid vacations and sick leave, a greater incidence of major diseases, shorter life spans, and higher infant mortality than in some developing countries (including Cuba).

What should be some remedies that a majority of Americans already advocate, but that recent administrations and a congress beholden to lobbyists have not had the courage to adopt? Spend more tax dollars on domestic programs than the military, for starters. Our defense expenditures now make up half the federal budget. And military expenditures only benefit the military-industrial complex (and its supporters) when we are already the sole military super-power.

Then use some of those savings (military spending is notoriously wasteful) to take health care out of the hands of the HMOs, drug, and insurance companies, and replace it with a national health care system for all U.S. citizens, like every other industrialized country in the world!

The current policy of lavishing our tax monies on the military ignores the economic advantages our neglect of domestic spending has given Japan, Asia and our European allies who use their tax monies more wisely. They choose to invest their citizens’ money in improving their human capital, which after all, is the real basis of any nation’s wealth.

Otherwise, continuing such blatantly unworkable tax policies means not only will we fall back further in the competitive global race for economic supremacy, but winning hearts and minds in the global war on terror as well.

“Cutting taxes under any circumstances and for any excuse, for any reason, whenever it's possible,” is really a formula for disinvestment in people. It puts the United States of America on a dangerous course of decline in both status and the power to influence worldwide events.

Harlan Green, Editor

What Do We Mean by Fair Taxes?

July 16, 2007

Harvard Professor N. Gregory Mankiw believes the rich pay their “fair share” of taxes in his July 15 op ed piece, “Fair Taxes? Depends What You Mean by Fair’.” But using President Bush’s pronouncement that, “On principle, no one in America should have to pay more than a third of their income to the federal government,” is not a very believable standard. This is a president, after all, who has run up the largest federal budget deficit in history and a federal debt load that exceeds $8 trillion, much of it owed to foreign investors.

We can think of a better definition of ‘fair share’. For example, the fact that the poorest fifth of our population (20 percent equals 60 million people!) have an average annual income of $15,400, is below what the U.S. Census Bureau has deemed the poverty line. Why should they be taxed at all? And we are supposed to be the richest country in the world?

Why not make the measure of what is ‘fair’ how our taxes are spent? For taxation policy is really a mechanism for the redistribution of wealth. Maybe there would be little debate on taxation policy, or the need to raise or lower taxes, if we had a balanced federal budget, for example. Half of our ‘unbalanced budget’ is now spent on the military. And so it is the military-industrial complex and its supporters—the likes of VP Cheney’s Halliburton, the Carlyle Group, and oil companies—who benefit most from our tax monies. Much less is now spent on the much more important human capital that determines our standing and competitiveness in the world—like education and health care.

We are falling behind the rest of the developed world in many categories of human capital: a decent health care system (including for our veterans) would not allow more than 40 million uninsured. An adequate educational system would not allow our elementary and high school children to rank lower in math and reading skills than those in Japan and other developed countries.

These results are confirmed by scientific studies. U.S. citizens now have much longer working hours than in other developed countries, fewer benefits including paid vacations and sick leave, a greater incidence of major diseases, shorter life spans, and higher infant mortality than in some developing countries (including Cuba).

So why not concentrate on a ‘fair’ distribution of our wealth? Other developed countries spend their tax monies more wisely—i.e., on their citizens rather than war-making ability. And that increases their ability to compete globally. Libertarian philosophers and economists such as Milton Friedman like to cite the ‘freedom to choose’. But we know from evolutionary psychologists and behavioral economists, among others, that the wealthy are freer to make intelligent choices than the 60 million of our poorest members.

Harlan Green, Editor


Popular Economics Weekly

Lower inflation numbers combined with rising personal incomes are lifting consumers’ spirits. This is reflected in the 5 percent rise in pending home sales for July, which are for signed contracts that take from 30-60 days to close. June new-home sales also rose slightly. The improving conditions are beginning to show up in consumer confidence surveys.

The Pending Home Sales Index based on contracts signed in June, was 5.0 percent higher from the downwardly revised May index of 97.5, though still below June 2006 when it stood at 112.0. This 5.0 percent monthly gain is the largest in more than three years, since a 6.1 percent increase in March 2004.

Lawrence Yun, NAR senior economist, said it is encouraging that the increase occurred in all four major regions. “However, it is too early to say if home sales have already passed bottom,” he said. “Still, major declines in home sales are likely to have occurred already and further declines, if any, are likely to be modest given the accumulating pent-up demand.” The West had the biggest increase, up 8.6 percent for contracts signed in June.

More good news this week was the increase in personal income, which didn’t cause prices to rise. Core consumer inflation has increased just 1.9 percent over the past year, within the Federal Reserve’s acceptable range. The reason is consumers are earning more and spending less, which has caused the personal savings rate to improve to 0.6 percent.

This is showing up in rising consumer confidence. The Conference Board’s Consumer Confidence index rose to the highest level in 6 years. "The rebound in Consumer Confidence has catapulted the Index to 112.6, its highest reading since August 2001, (at 114.0),” said Lynn Franco, Director of The Conference Board Consumer Research Center:

“An improvement in business conditions and the job market has lifted consumers' spirits in July. The Present Situation Index is also at a near six-year high. Looking ahead, consumers are more upbeat about short-term economic prospects, mainly the result of a decline in the number of pessimists, not an increase in the number of optimists. This rebound in confidence suggests economic activity may gather a little momentum in the coming months," she said.

The U. of Michigan consumer sentiment survey also rose in July to 90.4, the highest reading since February. Lower gas prices and higher stock prices fueled the increased optimism.

A higher second quarter GDP growth estimate of 3.4 percent, up from 0.6 percent in Q1, is also lifting economists’ spirits. The wide fluctuation in growth was in part because businesses had to rebuild product inventories after letting them run down in Q1. Exports were also higher, as manufacturing activity has increased.

And lastly, our fully employed economy is certainly behind much of the rising consumer sentiments. Employment is up mostly in the service jobs of restaurant workers (consumers eat out more when feeling good), health care (an older population mix), and construction.

Construction jobs are holding steady because the need for office and industrial commercial real estate is still growing robustly. But housing construction starts also upticked 2.3 percent in June. All in all, it shows consumers in a cautious (thriftier), but optimistic mood at the moment. This might even encourage Federal Reserve officials to think about easing interest rates this fall. The August 7 FOMC meeting should tell us if there is a shift in the Fed’s sentiment, as well.

Copyright © 2007

Tuesday, July 31, 2007


The Mortgage Corner

The National Association of Home Builders’ chief economist lowered his forecasts for new construction as the market has weakened further on subprime-mortgage problems and tighter lending standards, even though June housing starts rose 2.3 percent to 1.5 million annualized units.

"It's fair to say the performance of the housing market during the first half [of 2007] and the outlook for the second half and next year are a lot weaker than six months ago," said David Seiders, referring to his last semi-year forecast.

One reason for Seiders’ downgrade is that sales of new homes in the U.S. declined more than expected in June, falling 6.6 percent to a seasonally adjusted annual rate of 834,000, the Commerce Department estimated Thursday. Sales are down 22.3 percent compared with June 2006. The sales pace in June was the lowest since March's 830,000 and is the second lowest since 1999.

His outlook for 2007 single-family housing starts is now 9 percent lower than it was at the beginning of the year, while his 2008 forecast has been slashed by 15 percent, Seiders said on a conference call. His forecast is for housing starts of 1.42 million this year and 1.45 million in 2008.

The key reason is the "unanticipated and sudden turmoil in the subprime-mortgage sector" which has resulted in more stringent lending requirements for home buyers, and also spread into other higher-quality loans. This is because the Federal Reserve had raised short-term rates 17 consecutive times June 2004 to June 2006, even though it has kept rates unchanged since then. This resulted in ARM interest rates (and payments) surging to above 8 percent, beyond the capacity of many borrowers’ incomes.

Another reason for the slowdown in housing starts is surging inventories in both new and existing-homes, up to 7.8 and 8.8 months’ inventories, respectively. Combined new and existing home sales fell 4.2 percent to 6.58 million annualized, the lowest since September 2002.

Consequently, delinquencies and foreclosures are rising and the market is "still dealing with problems and that creates massive uncertainty over where we're going," Seiders said. "Financial markets are clearly correcting dramatically as it becomes clear what loans were made earlier and their performance."

He said the repricing of mortgage-backed securities and collateralized debt obligations represent "strong signals from the securities markets." Meanwhile, financial regulators "are now in the game" and establishing stricter lending standards. Also, major ratings agencies, which he said were "behind the curve," are "finally in the game in earnest" and "downgrading securities all over the place."

The economist said the housing downturn was the result of the unsustainable boom when home prices and sales rocketed higher. The euphoria was also driven by "overly aggressive monetary policy" and new types of loans. At the same time, there was an unprecedented level of buying by investors and speculators who flipped homes for profit, while the correction was unique in that it wasn't caused by higher interest rates or a weakening economy.

His prediction is that single-family housing starts will fall 23 percent this year, but recover next year and rise 2 percent. He thinks a "reasonable" rate is 1.5 million housing starts, which the market is now well below. Seiders said it will be "a slow climb out of this hole" with no expected surge in job growth or lower interest rates, so it make take several years to reach the 1.5 million level.

Further home-price declines are needed to "get markets back in balance" and make houses more affordable for buyers. However, one risk of price erosion is that buyers might wait on the sidelines to see if prices drop further, according to Seiders, which tends to make it a self-fulfilling prophecy.

Copyright © 2007

Friday, July 27, 2007



With worries about credit quality and availability mounting, futures markets are once again pricing in a rate cut by the Federal Reserve by the end of the year, several news sources report. The federal funds futures market at the Chicago Board of Trade now sees a 96% chance of a rate cut by Dec. 31, up from about 47%. That’s almost 100 percent, which means it is a virtual certainty, according to the futures markets.

The odds of a rate cut at the Oct. 31 meeting rose from 18% to about 40%. The Fed has kept its overnight lending rate target at 5.25% for more than a year. Officially, the Fed is still "biased" toward raising rates, with officials judging that the risks of higher inflation outweigh the risks of a slower economy.

Fed Chairman Bernanke started the rate downturn last week at his semi-annual Humphry-Hawkins congressional testimony on the state of our economy, when he downgraded predicted GDP growth rate to 2.25 – 2.75 percent from 2.5 – 3 percent. Why? Bernanke stated that the real estate downturn could be deeper and last longer than earlier thought. This raised fears that subprime worries could spread into other credit markets, making credit for prime borrowers harder to obtain as well.

“The pace of home sales seems likely to remain sluggish for a time, partly as a result of some tightening in lending standards and the recent increase in mortgage interest rates,” said Bernanke in his testimony. “However, even if demand stabilizes as we expect, the pace of construction will probably fall somewhat further as builders work down stocks of unsold new homes. Thus, declines in residential construction will likely continue to weigh on economic growth over coming quarters, although the magnitude of the drag on growth should diminish over time.”

But there is good news in the bad news. Mortgage rates are declining in tandem with long-term Treasury bond rates, and this could cause real estate to turnaround sooner. The10-year benchmark T Bond yield that pegs most fixed rate mortgages has fallen to 4.78 percent, after remaining above 5 percent for several weeks.

Recent data showed the 30-year fixed-rate mortgage averaging 6.69% for July 20-26, down from the previous week's 6.73% average. The mortgage averaged 6.72% a year ago. The 15-year averaged 6.37%, down slightly from last week's 6.38% but above 6.34% a year ago.

The softening rates came after further evidence of sluggish housing demand, Freddie Mac vice president and chief economist, Frank Nothaft, said Thursday.

"For example, building permits fell last month to the slowest pace in a decade, and more recent data on June sales of existing home showed a fourth consecutive monthly decline," he said in a news release.

EXISTING-HOME SALES—June sales dropped 3.8 percent to the lowest pace in 5 years. Inventories also declined, as some sellers are taking their homes off the market, according to the NAR. The median price rose slightly, but Moody’s economist Mark Zandi attributed it to the subprime “debacle”, as fewer qualified lower-income buyers are skewing the median price higher.

NEW-HOME SALES—New-home sales dropped 6.6 percent. The June median price was down 2.2 percent and new-home inventories rose to a 7.8-month supply. More noteworthy was that it now takes 6 months to sell a unit upon completion, whereas average time was 4.3 months last year.

In other news, Wells Fargo Home Mortgage, the second-largest holder of subprime loans said this week it will close its nonprime wholesale lending business, which processes and funds subprime loans for third-party mortgage brokers. In 2006, the business represented 1.6% of Wells Fargo's total residential mortgage loan volume of $397.6 billion.

The Federal Reserve should contemplate dropping short-term rates this year. Their actions since June 2004 have pushed the real, underlying interest on ARMs above 8 percent to payment amounts that many middle-income, as well as lower-income, homeowners can no longer bear in many regions with today’s elevated loan amounts.

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