Category: Economy

Economics Update

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The Consumer confidence index has dropped to 75, the lowest number since 2003, the expectations Index, which is on hop people see the future declined to 57.9, the lowest number since 1991.

In real estate, January foreclosures are up 57% from one year ago, the fall in house prices is accelerating, with the Case-Shiller home price index falling 9.1% year over year.

It appears that home improvement is stalling, with Home Depot having its first drop in sales ever. People don’t want to improve a depreciating asset.

Inflation (stagflation) is rearing its ugly head too, with Wholesale prices rising 1% for the month of January, and 7.4% in 2007.

In insurance, MBIA will stop writing policies for asset based securities for at least the next 6 months. Additionally, it is looking at spinning off its municipal bond business, and announced that it had eliminate its quarterly dividend.

In general investment news it appears that yet another complex obscure financial instrument will give the world heartburn, something called a “variable interest entity” (VIE). It appears to be another asset structured to keep sh&^ty investments off the balance sheets.

Economics Update

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It looks like the US dollar is trending downward on the expectation of further weakness in the US economy.

And in the late to the game category, business economists are finally predicting a recession.

This is not surprising, as Fed rate cuts are no longer effecting longer term rates, because people are expecting inflation to pick up, and do not wish to be repaid in devalued dollars.

It won’t help that bond insurer Ambac may be downgraded even if it manages to raise $3 billion in new capital.

The problem is that people are increasingly unable to sell their homes, as shown by a 23.4% year-over-year drop in existing home sales. That’s a collapse in the market.

So now, investors are lawyering up to go after corporate boards, on the theory that the guys on the boards are supposed to be professionals and to show a modicum of competence.

Pass the popcorn on this last one.

Economics Update

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In local finance, we have King County, Washington potentially losing all of a $207 investment, the county claims that they will “only” lose 83 million, the state says all of it.

This will be repeated, and given that the auction rate bond market has collapsed, and localities are fleeing that instrument, their ability to issue bonds will be significantly diminished.

Don’t expect any new money to spent on roads, schools, water, sewer, fire, or police for the next 5-10 years.

In real estate we should note that 8.8 million homeowners, or 10.3% of all home owner are under water. They owe more than they can sell their houses for.

Gas prices hit are way up, which is an ill wind for consumer spending, which counts for 70% of the US economy.

Analysts are warning of risks to Fannie Mae and Freddie Mac, which makes the decision to allow them to finance even larger mortgages appear even stupider.

Fitch Ratings is saying that life insurance companies may take an $8 billion dollar hit on subprime and alt-A real estate investments.

It also looks like we will be seeing downgrades on the monoline insurers within a week or so.

And in hedge funds, we have D.B. Zwirn & Co. seemingly on the path to shutting down. It has shuttered its Special Opportunities Fund, a $4 billion hedge fund. Once it unwinds this, and it may take a while, they have less than $1 billion under management.

We also have Clifford Asness’ AQR Capital Management showing that mathematics based strategies are not working:

Asness’ AQR Capital Management has notified investors that its Absolute Return Fund, long one of Wall Street’s most stellar performing quantitative hedge funds, lost 15 percent of its value through mid-February. The slide follows an 11.9 percent drop through the end of November.

Bloomberg reported Friday that AQR flagship hedge fund now manages $2.9 billion, down from $4 billion.

I think that its clear, and should have been clear after LTCM went belly up nearly a decade ago, that these model based hedge funds don’t work.

The models break down when you get significant swings.

The Obama-Nixon Connection, and it’s a Good thing

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I got this quote from The Economist:

As Mr Crook observes, Mr Obama is far from a centrist. His voting record suggests that, if elected, Mr Obama would be the most economically left-wing American president since … well, it’s hard to say. Richard Nixon?

He means it as an insult, I’d take it as a compliment, and there is an argument to be made that Nixon in terms of the economy and regulation was more liberal than any of his successors.

I think, however, that the author of the piece overestimates Obama’s liberalism.

Supreme Gives 401(k) Participants Standing for Lawsuits

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It was a unanimous decision.

The facts of the case are that James LaRue lost $150K after his 401(k) managers ignored his orders to move his holdings to a different account. The lower courts said that only the plan had standing, but SCOTUS said that the participants do to.

Frankly, I’m surprised. I would have figured that one of the court Neanderthals would have taken the side of the incompetent money managers.

Economics Update

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Well, let’s start off with real estate:

First, we have an article asking whether the Federal reserve is refilling the housing bubble. Normally this would not merit comment, but look at the link. Look at the author. Look at the title. It’s Lawrence Yun, chief economist for the National Association of Realtors, and it has the word “bubble” in the title.

When the NAR is calling it a bubble, it’s a bubble.

We also have reports that people are defaulting on subprime loans before they reset, which implies that these people so overbought their houses, that they can’t even afford the “teaser” rates.

We also have single family home starts dropping to a 17 year low, though there has been a pickup in condo and apartment construction (not sure how much is the former, and how much is the latter).

We also have Mortgage applications plummeting 22%, as rates rise in the face of the fed cuts, because no one trust to lend anymore.

The fed is “pushing on a string”.

Finally, we are starting to see Foreclosure tourism, with bus tours of foreclosed homes becoming a regular event in Florida.

It’s an attempt by some realtors and speculators to get the market moving again. Isn’t gonna happen.

In terms of more personal finance, we have an explosion of people tapping their 401(k) accounts for living expenses.

Yep, those private accounts to replace social security sound like such a good idea. As I’ve said before, it’s like eating your seed corn, which is what these folks are doing.

On a more general macroeconomic note, inflation is up, with the CPI rising 4.3% in 2007, and prices rising at a 5% annual rate in January.

On top of all this, the Federal Reserve has cut its forecast for economic growth.

Considering the fact that the official CPI understates inflation, we are probably closer to an 8% inflation rate (prices doubling every 9 years), so I’m calling stagflation, which seems a no brainer, even without oil hitting another record, with it peaking at trading at $101.32/bbl and closing at $100.74/bbl….No…wait….that’s two records.

In terms of the financial establishment recognizing that the problems are far deeper and broader than previously understood, we have Martin Wolf of the financial times saying that, “America’s economy risks mother of all meltdowns“, and we have Portfolio.com wondering if the basic model used to evaluate the complex instruments in the big sh$#pile, or more generally, the prices of options, the Black Scholes Pricing Model, is simply inaccurate, which would render their prices unknown. It’s literally look at the chicken entrails to figure out the prices time.

Basically, the model falls apart, and has always fallen apart:

Good theory. The glitch was discovered only after the fact: When a market is crashing and no one is willing to buy, it’s impossible to sell short. If too many investors are trying to unload stocks as a market falls, they create the very disaster they are seeking to avoid. Their desire to sell drives the market lower, triggering an even greater desire to sell and, ultimately, sending the market into a bottomless free fall. That’s what happened on October 19, 1987, when the sweet logic of Black-Scholes was shown to be irrelevant in the real world of crashes and panics. Even the biggest portfolio insurance firm, Leland O’Brien Rubinstein Associates (co-founded and run by the same finance professors who invented portfolio insurance), tried to sell as the market crashed and couldn’t.

This is what has happened with investment banks and leveraged loans, where they have been left holding the bag on $197 billion in loans to people like private equity buyout specialists that they cannot resell.

In the ever popular world of the bond insurers collapsing, we have Moody’s predicting a $7-$10 billion hit for banks as a result, though I would add at least one zero to that total.

As a result, a unit of private equity firm KKR cannot refinance, and has delayed repaying loans as a result.

Compounding this is the fact that the proposals to split the insurance companies into separate Municipal bond insurance and sh&^pile insurance is making it much more difficult for them to raise the capital they need to stay afloat.

Oil Above $100 Following Refinery Explosion

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While oil has broken $100 in the course of a trading day, this is the first time that it has closed above $100, $100.01/bbl, with a peak of $100.10 hitting in the middle of the day.

Gas is above $3.00 again.

I understand how a refinery fire can get gasoline prices to jump, but I am not sure why the explosion and fire at Alon USA’s Big Spring, Texas, refinery would drive up oil costs. It seems to me that a reduction in refinery capacity would reduce the demand for oil.

Perhaps this facility is one of those tuned to the Venezuelan “sour” crude, and so it’s increased demand for light sweet crude.

Economics Update

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It appears that US banks have borrowed massive amounts of money from the Federal Reserve, over $50 billion, using assets that have very little value in the market right now. They get money for shovels of the big sh&#pile

Credit Suisse will be writing down $2.8 billion because of “pricing errors” of assets (also here), and has suspended the traders involved.

Errors, my ass. If these were “errors” as opposed to fraud and/or bad systems, the net would be closer to $0.

The Forthcoming “Jingle Mail” Tsunami: 10 to 15 Million Households Likely to Walk Away from their Homes/Mortgages Leading to a Systemic Banking Crisis

It is now expected that the U.K. government will keep British home mortgage giant Northern Rock nationalized for years, in order to avoid a massive exposure to the taxpayer.

In the increasingly dire world of insurance, we have predictions that bond insurer splits may lead to an explosion of lawsuits, as the separation valuable (municipal) side and the insolvent (big sh$%pile) side involves a lot of loss for the holders of non-municipal paper. Additionally, MBIA’s CEO has stepped down, and has been replaced by his predecessor.


Deck chairs, Titanic.

In the lawsuit category, we have investor activists calling for more accountability in management, which is generally a prelude to shareholder suits and the like.

Finally, we have inflation in China hitting an 11-year high, 7.8%. It’s likely that this will drive interest rates up in China, placing downward pressure on the US dollar.

And if that doesn’t make you think that it will soon be raining brokers in Wall Street, Noriel Roubini is predicting between 10 and 15 million home owners simply walking away from their homes, because they will be underwater with their mortgages, and cannot afford their resetting mortgages.

Economics Update

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After not receiving what they considered to be adequate bids, Britain is nationalizing Northern Rock Bank, which was one of the top home mortgage providers in the UK. The bids received, “failed to meet the government’s criteria for protecting taxpayers.”

I think that we will see more of this in the UK, which is suffering from the Anglo-Saxon contagion much as its American counterparts are. We won’t in the US, substituting instead ruinous (for the taxpayer at least) bailouts, because the American body politic will not accept this solution.

In a related note, it appears that there is a lucrative business developing aiding banks in finding people who have skipped out on mortgages. With the costs of foreclosures typically nearing $100K, it makes sense to find and cut a deal with these people, but they leave without providing a forwarding address.

From September 2005 to August 2007, 53 percent of the loans backed by Freddie Mac that went into foreclosure involved borrowers who could not be reached.

As an insight as to just how bad this has gotten, some lenders are allying with ACORN, an organization with a mission that is seriously at odds with those of banks, to find the mortgage holders.

In much higher finance, we have signs of trouble in credit default swaps, a complex derivative whose market is estimated to be twice that of the stock market.

These instruments are largely unregulated, to the degree that the exact size of the market is not known.

Basically, it’s an agreement between two parties. One pays the other a fee, and if something bad happens, such as a default, the second party pays off the default.

How flaky and unregulated is this market?

But during the credit market upheaval in August, 14 percent of trades in these contracts were unconfirmed, meaning one of the parties in the resale transaction was unidentified in trade documents and remained unknown 30 days later. In December, that number stood at 13 percent. Because these trades are unregulated, there is no requirement that all parties to a contract be told when it is sold.

One out of 7 people did not know who owed them money.

Economics Update: Real Estate Edition

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Swiss banking giant UBS is looking at a $26.6 billion exposure to toxic mortgates, in addition to whatever hit that they might take on subprime, so these are A and alt-A mortgages. It reported a loss of $11 billion in Q4.

In the Dallas-Ft. Worth Metroplex, foreclosure postings are up 27%, effecting 13,000+ residences, an all time record. The scary quote is, “Out of the homes posted, at least 20 percent are underwater and probably more” .

And everyone’s favorite subprime whipping boy, Countrywide Financial, has had delinquencies rise to 7.47%. That’s about one out of every 14 loans that is delinquent, which is clearly unsustainable.

If banks had to consider this rate of delinquencies as a normal cost of business, mortgage rates would probably be in excess of 12% just to break even.

It now looks like Royal Bank of Scotland is the latest institution in line to see significant losses from mortgage backed securities.

Economics Update: Insurance Edition

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Bond insurer FGIC has asked regulators to break it up into two separate divisions/a>, one which insures minicipal bonds, and the other that insures the structured finance deals (aka the big sh$#pile).

This is likely a reflection of their dire position following Moody’s down grade of them from AAA to A3.

UBS is saying that banks are at risk of an additional $203 billion in losses from the bond insurance crisis.

Government Shutting Down Economic Indicators Website

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Due to budgetary constraints, the Economic Indicators service (http://www.economicindicators.gov) will be discontinued effective March 1, 2008.

Economic Indicators.gov is brought to you by the Economics and Statistics Administration at the U.S. Department of Commerce. Our mission is to provide timely access to the daily releases of key economic indicators from the Bureau of Economic Analysis and the U.S. Census Bureau.

You may link to the most recent release by clicking on the report name in the table below. You may also subscribe to our *free Subscription Service to have these files emailed or faxed directly to you as soon as they are released.

Barry Ritholtz, of The Big Picture, rightly asks, “WTF? Feds Shutting Down Economic Data Site.”

He then suggests that, much like eliminating the release of the M3 Data, this was done because the data is inconvenient, and I agree.

Economics Update

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Note that this has been, for whatever reason, a busy news day, so this does not include news related to real estate or to the bond insurance crisis. Those will be posted later.

We have downward pressure on the dollar, because additional Fed rate cuts are anticipated.

Basically, the thought is that Fed rate cuts lead to lower interest rates, which make the dollar less attractive, because rates of return are less.

If I had the money, I would bet against this, because, as the latest rate cuts have showed, the Fed can no longer move rates down. We are in a Japan style liquidity trap.

We also have a type of investment that I have never heard of before, auction rate securities, which were sold as being as liquid as cash. They work by regularly re-auctioning the securities on a fairly frequent basis, allowing for people to sell easily, and for the rates to adjust to suit market conditions.

These are now becoming increasingly illiquid, with thousands of auctions failing, and Goldman Sachs refusing to let investors withdraw money from their investments when auctions fail to attract buyers.

UBS has notified its 8200 US brokers that it will not support these securities if the auction fails either.

FWIW, Paul Krugman has a very good editorial, even by his own ordinarily high standards, describing what is going wrong, and the consequences of this failure in terms that a layman like me can understand.

Related is the news that Citigroup is suspending withdrawals from its CSO Partners hedge fund.

In terms of the real economy, as opposed to high finance, we have the New York Federal reserve reporting that its Empire State Manufacturing Index fell nearly 21 points, from +9.03 in January to -11.72 in February. It was expected to fall, but only to +5.75.

The Financial Times is reporting that banks are being advised to walk away from the private equity deals that they are funding, because the penalties are far lower than the potential losses.

This would stop private equity buyouts in their tracks.

Obama’s Presents Economic Plan

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Contrary to complaints, we actually have a decent bit of detail here.

  • Payment for program by elimination of upper class tax breaks and ending Iraq war.
    • My comment: I still think that you need more, at least a thorough review of the Byzantine system of tax credits and deductions to get enough money.
  • A National Infrastructure Reinvestment Bank, spending about $60 billion over the next decade repairing infrastructure.
    • My comment: Good, but we probably need to spend more. Unsure of the amount that states would have to match. Also, should include a similar amount for mass transit and/or freight rail, both of which save energy, etc..
  • Ending tax breaks for moving jobs overseas.
    • My comment: This one has almost become a cliche, but there are also programs that subsidize this in the US that need to be addressed (Ex/Im bank comes to mind).

Generally it’s pretty good. Generally, it’s also pretty similar to Hillary Clinton’s too.

However, there is something else that I found both interesting and laudable, which accompanies his speech (H/T to the other Matthew for the catch), specifically a credit card bill of rights:

  • Ban Unilateral Changes: Currently, credit card companies can unilaterally change the terms of a credit card agreement at any time for any reason with only a 15-day notice to the consumer. Barack Obama will ban these unilateral changes in credit card agreements unless companies have obtained written consent from consumers and have followed the rules and terms of the agreement.
  • Apply Interest Rate Increases Only to Future Debt: Credit card companies often apply increased interest rates to both new debt incurred by the cardholder, as well as previously incurred debt. Barack Obama will require increased interest rates to apply only to future credit card debt, and not to debt incurred prior to the increase.
  • Prohibit Interest on Fees: Credit card companies often charge interest on transaction fees, such as late fees or paying a bill by telephone. Barack Obama will prohibit credit card issuers from charging interest on transaction fees.
  • Prohibit “Universal Defaults”: “Universal defaults” are a practice in which a credit card company raises an individual’s interest rate based on failure to pay a different creditor on time. Barack Obama will prohibit this practice.
  • Require Prompt and Fair Crediting of Cardholder Payments: Barack Obama will require credit card issuers to apply payments first to the credit card balance with the highest rate of interest and to minimize finance charges.

This is interesting for a number of reasons:

  1. It’s very good policy.
  2. This is a proposal where there is actually a loser, the credit card issuers, which is a change from his typical proposals where the policy is not a zero sum game.
  3. This is actually a fairly specific refution of the Washington DC/DLC/Milton Friedman orthodoxy that financial services need to be completely deregulated in order to provide maximum benefit. This may be more important than the first two in revealing his attitude on such matters. Much of the credit crunch today is due to the repeal of Glass-Steagel, which was driven by this ideology.

All in all, a solid B+ to my mind.

Economics Update

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Well, we have Bernanke and Paulson acknowledging that the economy is in trouble, but denying that there will be a recession in 2008.

The thing is, we are already in a recession. Let’s seem consumer spending is flat, with a false increase being driven by increasing food and fuel prices, and the growth rate is less than the real inflation rate.

In bond insurance, we have NY governor Elliot Spitzer saying that the Monolininers have 4-5 business days to recapitalize, or they will lose their AAA ratings, and regulators will have to, “have to step in and separate bond insurers’ municipal businesses from their more troubled structured finance units”.

Bet that offer from Warren Buffet does not look so awful now.

In mortgage loans, banks are lobbying hard to put off their bad investment choices on the US tax payers, which is not surprising, considering that house prices took their biggest quarterly drop ever, a national median price drop of 5.8% in Q4 of 2007.

Annually, that comes to about 23%/year.

The credit crisis is extending further, with delinqencies in assets backed by auto loans surging.

The Trade deficit fell in 2007, for the first time since the 2001 recession.