Greenspan Reloaded

Heir Greenspan said today that the GSEs have gotten too big - that Fannie Mae's and Freddie Mac's portfolios should be limited in size because they pose a systemic risk to the U.S. financial system. They have been using their "implied government guarantee" as an advantage over their competitors, and this has allowed them to grow to a size that is now dangerous.

Well, what did he think was going to happen?

Excesses like this happen during bubbles - and mortgage lending is a bubble - made possible through Fed monetary policy. A completely different bubble than the last bubble, with a different set of participants - in fact, the real estate/mortgage lending bubble is for all the people that didn't get to participate in the last bubble!

Can you imagine Franklin Raines watching the Pets.com commercial during the 2000 Superbowl, monitoring the rise of WebVan, or trying to get in on the VA Linux IPO, and somehow feeling left out? He was stuck in boring real estate, and real estate wasn't going anywhere.

Or, how about your typical 401k investor? Many of these people didn't fully commit to their plan's Aggressive Growth fund until after full year 1999 results were in and the dangers of Y2K had passed - they were assured that this "new economy" thing was for real ... I guess you could say they participated in the last bubble, but, not in a good way.

Or, how about real estate professionals, builders, and construction workers? Many of them didn't own any stocks during the last bubble because of an innate distrust for "paper" things - they preferred tangible assets like real estate, even if real estate was boring

For years, millions of people were reluctantly getting accustomed to jargon like IPOs and burn rates, while at the same time observing absurdities like the AOL purchase of Time-Warner - they didn't understand it ... they felt left out. During this time, instead of buying tech stocks these people were waiting, building demand - longing for a bubble that they could participate in. And, this pent-up demand was unleashed when the Federal Reserve lowered interest rates to levels not seen in 40 years, and then held them there for a "considerable period of time".

Somehow, the problems at the GSEs seem almost normal ... in a dangerous sort of way.

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Light Sweet Greenspan

While everyone else is anxiously awaiting Heir Greenspan's appearance on Wednesday before the Senate Banking committee, where, among other things, they will discuss Fannie Mae's accelerating death spiral, poor Greg Robb of CBS MarketWatch was assigned the task of reporting on today's energy speech to the National Petrochemical and Refiners Association Conference in San Antonio, Texas.

Greg's report Fed chair sees oil price frenzy ending uses the familiar technique of plucking a few excerpts, translating a few paragraphs into human readable form, then applying a snappy, upbeat headline. So, a complex passages such as this:

"Reflecting a low short-term elasticity of demand, higher prices in recent months have slowed the growth of oil demand, but only modestly. The slowdown in the growth of demand coupled with expanded production, which the price firmness has induced, has required markets to absorb an increased pace of inventory investment. The markets' response has been a shift in the spread between spot prices and near-term futures that has facilitated inventory hedging. Futures prices for delivery of both West Texas Intermediate and Brent crudes for the summer exceed spot prices."

is reduced to a more digestible form such as this:

"Greenspan noted that inventories are likely to build because futures prices for delivery of oil for summer delivery exceed spot prices."

and the money line is simply quoted:

"If sustained, these market technicals could encourage enough of an inventory buffer to damp the current price frenzy."

So, where did that headline come from? There was never a prediction of an end to the price frenzy here - in fact, there are two qualifiers ("If sustained" and "could encourage") and then the prospect of "damping" a "frenzy", which according to my Webster's translates to "diminishing the intensity" of "a temporary madness". So, was this wishful thinking? It sounds like the headline should have said "Fed chair sees chance of a slightly less intense madness in the oil market" - this sounds a whole lot worse than the original and is probably closer to what was intended.

Note that CNN/Money applies the same sort of upbeat headline Greenspan: Oil prices should cool even though it was based on a more accurately titled Reuters story Greenspan: Markets May Cool Oil Frenzy. It seems that if the words are sufficiently ambiguous, they can be interpreted as desired by the news organization ... how convenient.

Two other things of note:

• It was almost a year ago, when oil first surged past $40, that high energy prices were regularly referred to as "transitory" factors - this language appeared in numerous Fed statements and was dropped soon after it was clear that $40+ oil was here to stay, so the Fed's track record on predicting the future of oil prices leaves a lot to be desired.
  

• Since in the short term, the supply is basically fixed, the most important factor determining the price of oil today is demand, and in particular, demand from the world's fastest growing economies in Asia - China in particular. This demand would not be near what it is today, had we not so stimulated their economies with debt fueled consumption from across the Pacific ... all made possible by historically low interest rates from the Fed and lending practices that now seem well out of control. You'd think that would be worth mentioning sometime - that maybe Fed policy and American consumerism are big factors contributing to higher energy prices.
  

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The Mailman and the Housing Bubble

There is something to be said for traditional magazines delivered by regular mail - everyone should have a few magazine subscriptions. The daily anticipation of opening up your mailbox, retrieving, then examining the contents - odd sized envelopes, unruly junk mail, magazines ... there is something nostalgic and good about this daily ritual.

For many years, BusinessWeek has faithfully delivered their weekly recap of business news and insights to my mailbox - not once (in recent memory, at least) has it failed to arrive at its final destination. Most weeks it appears on Friday, sometimes Saturday - on a few rare occasions it has lingered, arriving on Monday ... but Monday delivery is quite unusual.

Late last week, through various internet sources, it became known to me that this week's cover story, After the Housing Boom, would shed light on some of the odd goings on in today's real estate markets. It is co-authored by one of my favorite BusinessWeek writers, Kathleen Madigan, who has been mentioned previously on this blog. After having peeked at the post-apocalyptic magazine cover online, a conscious decision was immediately made to resist the so-easily-obtained instant gratification made possible via the online edition, and to wait ... to savor this sure-to-be classic analysis in its more natural form.

Several hours ago, with heightened anticipation, I approached my mailbox, inserted the key, and let the door slowly swing open to reveal what appeared to be the usual assortment of items - yes, there was a magazine on the bottom ... the wait was worth it. Grabbing the bundle, securing the door, and turning for home, the items were casually inventoried with little doubt as to what lay at the bottom of the pile.

Now, National Parks Magazine is a fine publication, and the work that they are doing today should be commended in light of the resistance by our Federal Government to deficit-spend on anything worthwhile, but, given the expectations that had been building all weekend, this was, alas, another huge disappointment to be denied once again. Since Tuesday delivery is unprecedented, and because this ordeal had gone on long enough, it was time to acknowledge defeat. At some point, you must accept the fact that you are powerless over certain things - recourse will be pursued, but at least this ordeal is over.

My only hope after this experience, is that somehow, some good might have come from this situation - that perhaps my mailman spotted the bold cover story title and ominous cover artwork, then deftly stuffed the magazine in his lunch pail, only to study it carefully later. That maybe this would lead to a re-evaluation of a real estate purchase decision that he was about to make ... that maybe he would put his foot down with his slightly-too-emotional wife who has hopelessly fallen in love with Plan C in the new housing development down the road. That maybe he will reconsider the long term implications of their chosen financing - interest only, adjustable rate, 35 years ... that maybe he will think that $795,000 is too much money for a 2600 square foot home on a postage stamp size lot in an ordinary neighborhood.

Perhaps some good will come of this.

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Snow Job!

Hey, there's nothing to worry about with that jobs report - here it is, straight from the treasury department:

Department of Treasury
FROM THE OFFICE OF PUBLIC AFFAIRS

April 1, 2005
JS-2351

Statement of Treasury Secretary John W. Snow on March Employment Report

This week, the announcement of two vital economic indicators continues to show America's economy is on the right path. Today's announcement that the unemployment rate fell to 5.2% and 110,000 new jobs have been created is good news for the direction of America's economy. That makes for over 3 million new jobs since May 2003. For 2004, the Gross Domestic Product was 3.9 percent, which is yet another sign that America's economy is flourishing.

President Bush is committed to keeping the economy on the path of healthy growth by cutting the deficit in half, enacting an energy policy, and strengthening social security. The President's leadership on economic policy is clearly moving the economy in the right direction.

It is difficult to resist natural instincts to dive right in here, it was so enjoyable for last week's Fed Policy Statement, but that would be too easy (and a bit repetitive), so instead, here are some insights from across the pond - a few choice excerpts from a recent Economist article discussing our federal government's economics team:

"In theory, Mr Bush's economic team is headed by John Snow. The president was on the point of sacking his treasury secretary at the end of last year; he then pulled back-but only apparently to keep Mr Snow as a travelling salesman for his pension-reform scheme. The former railroad boss has recently visited such well-known global financial centres as San Antonio, Albuquerque and New Orleans.

There are two growing suspicions about Mr Bush's approach to economic policy... The first is that he sees it mainly as a question of salesmanship... The second suspicion is that loyalty is more important than knowledge.

What would Mr Bush's team do if there was some sort of international economic crisis, such as a dollar crash?

Iit would all come down to Mr Greenspan... But the Fed chairman is due to step down early next year. There are three front runners to replace him... None of these men has recent experience of dealing with financial crises. Mr Bush should be crossing his fingers that nothing goes wrong."

Yes, that's a good idea, we should all cross our fingers.

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Kudlow and the Jobs Report

If you ever get a chance to see CNBC do the jobs report analysis at 5:30 AM PST / 8:30 AM EST on the first Friday of every month, it's really quite a show - Larry Kudlow gets up early and joins Mark Haines and Jim Liesman on Squawk Box. Kudlow's guest appearances remind me of one of those 80's prime time shows (Fantasy Island?) where at the end of the opening credits, after introducing the regular cast, and after a dramatic pause, they go full screen with "and Guest Starring Lee Majors".

This morning's jobs report came in at +110,000 - the mind-numbing raw data is available at the Bureau of Labor Statistics with summary data here. Conventional wisdom is that it takes 150,000 new jobs each month just to keep pace with the increase in population. Expectations were in the 220,000 range, and given that we are supposedly in an economic recovery, this number was a bit disappointing - given that recent initial unemployment claims have ticked up, perhaps this number is a bit worrisome.

Mark Haines seems to be the only one on this show who does any real thinking, as demonstrated when Kudlow is first asked to pontificate:

Kudlow: "I myself believe, and have long believed, that we put much too much stock in these numbers when we start to parse them through, because the economy is very sound".

Haines: "Suddenly, when the number is not what you want, it doesn't matter"

Kudlow: "I've said this all along, look, we could play games - the household number was up 357,000 - the trend is in place, you've averaged 198,000 for the last twelve months, this number may bring that down a tad, but it is statistically insignificant. Wages were higher, unemployment was lower at 5.2. This is a very healthy number, whether it meets the expectations of the economic consensus, in my economic opinion, is not nearly as important as the fact that the economy is healthy."

Haines: "The unemployment rate is a different survey though, isn't it?"

Liesman: "It's a different survey, we're providing that number that Larry just gave us - 357,000. The thing that I like to look for Mark, is minus signs and plus signs, and I have to say I did not see a lot of minus signs..."

Well, that was interesting. It goes on like this for a while - Haines being the lone thinker who is consistently and forcefully refuted by Kudlow and Liesman spewing statistics then concluding their argument with something like "the fact is that the economy is healthy" ... bubblevision at it's best.

Relevant to the discussion, but conveniently omitted, are the declining quality of jobs and the general agreement that the unemployment report (5.2% unemployment rate and 357,000 new jobs - the positive news for the day) is fundamentally flawed and shouldn't be used at all ... Haines may have been trying to bring this up but was quickly cut off by Liesman.

Also not mentioned in the CNBC coverage is the birth/death model adjustment that is made by the BLS. If you look at the adjustment that is used this month it comes in at a whopping +179,000. No one really understands how this adjustment works and the BLS ain't tellin' - on their FAQ, about the only thing that they do tell you is that this goes into the reported number (110,000 this month), but you can't just subtract it from the reported number to find out the result of last months phone survey - it's much more complicated than that. Argghh!

Note: The birth/death model methodology was significantly altered about eight months before the 2004 election, after the White House publicly complained that the payroll statistics didn't accurately reflect the jobs created by new businesses - I'm sure there's no connection between these two events.

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