Hey, where's my free cheese?

From the looks of what appeared in newspapers today, that sucking sound you may have heard yesterday afternoon, shortly after the formal announcement of the Bush Administration's mortgage rate freeze plan, was apparently the noise that is made when the nation's newspaper reporters scour the land, eliciting opinions from citizens on a controversial subject.

In this case, it appears that nearly everyone felt wronged in some way.

While confessing to not having read the entirety of the reactions to the mortgage bailout plan, it doesn't appear that any reporter was able to find anyone who would benefit from it.

Here's a compilation of the reaction to yesterday's "tease freeze" plan:

• Mortgage relief program a slap in the face to some - LA Times
• Some Needing Mortgage Aid Won’t Get It - New York Times
• A Raw Deal for those Who Avoided Risk - Washington Post
• Icy Response To Rate Freeze - San Franicisco Chronicle
• Bush's mortgage plan leaves many behind - Miami Herald
• Mortgage relief on way, but not for all - Arizona Republic
• A Buffer? Or a Bailout? - Washington Post
• ‘Simply not enough' - Bush mortgage plan falls short - Boston Herald
• Rate freeze called too little, too much - Chicago Tribune
• A 'Christmas present' for some people - Rocky Mountain News

Your humble scribe was the subject of one such inquiry for one of the above reports and offered his opinions forthrightly, however, none of these comments made it into print.

Apparently the plight of a retired couple in their mid-40s who already swapped their overpriced California house for some dumb old gold coins a few years ago and who wait patiently in a quiet mountain resort community for home prices to return to more normal levels so they can transition from renters back to homeowners while, in his now ample spare time, the man of the house makes fun of the whole mess on his blog and writes a very serious investment newsletter - well, somehow this just didn't fit in with all the other views on the subject.

Maybe next time.

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Like a broken record - "modest job creation"

The Labor Department reported another month's worth of modest job growth that should just about guarantee a quarter-point rate cut from the Federal Reserve next week.

November payrolls increased by 94,000 after an upwardly revised gain of 170,000 in October and a downwardly revised increase of 44,000 in September. Notably, while the October revision was +4,000, the September revision was quite large at -52,000.

On a year-over-year basis, a distinct multi-year downward trend continues, however, despite a recent uptick in initial claims for unemployment and a slightly dimmer jobs outlook in consumer confidence surveys, distress in the labor market is largely absent.

When viewed by category, in addition to all the usual areas for job growth - education and health services, leisure and hospitality, and government - both trade and professional services posted strong gains last month.

As expected, construction, manufacturing, and financial activities all saw steep declines and, in general, the November data seems to be just a continuation of the well-established trend of modest, but declining, employment growth led by service industries.

The birth-death adjustments totaled 51,000 for the month, however, since this adjustment is applied to the non-seasonally adjusted increase of 240,000 new jobs for November, there is little reason to think that it skewed the data much.

Over the last year, over 300,000 jobs have been lost in construction, manufacturing, and financial activities, but gains in other categories have more than offset these losses resulting in over 1.4 million new jobs.

This figure is likely to be move downward, perhaps significantly, as part of the annual revision to the Labor Department data in the months ahead, but it will still likely result in "modest" job creation during 2007.

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Why home prices are so important

The chart below hasn't appeared here in quite some time - it has been updated with fresh third quarter data from the Federal Reserve's Z1 Flow of Funds report, released earlier today, to help explain why home prices are so important to the U.S. economy.
Those four arrows demarcate the last "difficult" period here in America - when stock prices stopped rising in 1999 and began to fall in 2000. If not for real estate, things would have been much worse as most of the $6 trillion decrease in stock market wealth (in blue) was offset by a $4 trillion increase in real estate wealth (in red) from 2000 through 2002.

[Note: this is all year-end data, so what was really a $9 trillion stock swoon appears as only $6 trillion since equity markets peaked in mid-2000 and bottomed in late 2002.]

In retrospect, the bursting of the stock market bubble was really just a little bump in the road - total household assets declined only slightly over those years and, in the last seven years, the value of household real estate has gained more than twice the amount that stocks lost between 2000 and 2002.

That is, after freakishly low interest rates in 2002 were followed by freakishly lax lending standards and freakishly exotic investment products from Wall Street.

As never before, the U.S. economy is dependent upon rising asset prices that enable the public to either sell those assets or borrow against them to fund consumer spending.

When the stock market bubble burst, real estate was there waiting to be inflated.

Look for that red area on the top of the chart to begin contracting in the next quarterly report from the Fed - that's when things will really get interesting.

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UPDATE: Thursday, Dec 6th, 4:30 PM PST

A chart of the U.S. Dollar Index over the same time period.

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We're all Greenspanians now

Martin Feldstein typifies the response of many economists these days when asked about Federal Reserve policy amid what appears to be another collapsing asset bubble - lower interest rates and do it fast.

Click to play in a new window

When Nixon closing the gold window in 1971, forever severing the link between the U.S. currency and gold, this led to deficit spending and trade imbalances the likes of which the world had never seen.

When Alan Greenspan began ignoring (some would say encouraging) asset bubbles, forever severing the link between monetary policy and asset prices, this led to one financial bubble after another.

In both cases it may have seemed as though there was no other choice, but there was.

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From nine months ahead to three months behind

At the height of the housing boom in the U.S. a few years ago, when it was clear to some of us that, despite what many were eager to believe, there still was no such thing as a free lunch and that a bill would surely come someday, the U.K. housing market was thought to be about nine months ahead of the U.S. housing market.

That is, while home prices in the U.K. began soaring toward the heavens almost a year before those in the U.S., they appeared to be leveling off and perhaps heading back toward terra firma.

Initial indications of flattening home prices and flagging retail sales were seen in early 2005 leading to a rate cut by the Bank of England later that year in an attempt to ward off a housing-induced economic slowdown.

The central bank's short-term rate was cut from 4.75 percent to 4.5 percent.

To the surprise of many, home prices then resumed their ascent (along with many other prices) and a year later the quarter point cut was reversed followed by a series of Alan Greenspan like baby-steps until the short-term rate stood at 5.75 percent in early 2007

During this time, inflation in the U.K. reached highs of near 10 percent for retirees while the government's overall measure of consumer prices remained lower, but not low enough for BOE President Mervyn King to avoid having to write an embarrassing letter to the Prime Minister.

Now, late in 2007, home prices appear to be faltering again, down for the third month in a row despite posting year-over-year gains of near 20 percent in London and almost 10 percent nationwide.

As a result of stalling home prices and when combined with ongoing difficulties in credit markets, the Bank of England has seen fit to cut interest rates once again this morning.

This puts the U.K. about three months behind the U.S. in the interest rate cycle.

As for the U.K. housing market, who knows where price will go from here - everyone seems to be quite worried about it though, at least according to this report in The Economist.

On Wednesday a survey of the big services sector reported an unexpectedly sharp slowdown in business activity, which weakened in November to its lowest level since May 2003. Arguably, the CIPS survey highlighted the central bank’s dilemma, since it also showed a pick-up in price pressures. But it came on the same day that the housing market became enveloped in yet more gloom. House prices fell by 1.1% in November, according to the Halifax index compiled by HBOS, a bank. It was the third month running that prices had slipped.

The resilience of household spending over the past year despite slower growth in real disposable incomes has had much to do with the housing market. Rising house prices have emboldened consumers to save much less than usual. The saving ratio has slipped to 3.1% of disposable income, at the latest count. The underlying position is even worse. Strip out the impact of more employer contributions to pension schemes and the saving ratio turned negative this year—ie, people spent more than they earned.

The danger is that a downturn in the housing market will prompt a snap-back in the saving ratio as consumers become thriftier and spend less. The sharper the downturn, the more spending will slacken. In 2005, when house prices stalled for a few months, consumption growth slowed to 1.5% and the economy grew by only 1.8%. If house prices fall next year, the damage is likely to be greater.

This week’s decision by the Bank of England will do something to restore confidence. But next year looks increasingly likely to see a serious setback to growth.

As note here a number of time before, the U.K. is very much like the U.S. - a huge housing boom, a massive trade deficit, a very large budget deficit, and a very low saving rate.

They are still very much like America - now they're just three months behind instead of nine months ahead.

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Here comes the freeze

Well, it looks like they're going to do it.

According to this report from the Associated Press, the Bush Administration will announce tomorrow that an agreement has been reached to freeze the interest rates on certain adjustable subprime mortgages for five years in what will probably amount to the first of many fingers being stuck in the "housing dike", formerly known as the "housing boom".

You don't seem to hear the White House marveling at the homeownership rate much anymore - it's about time they got back around to talking about the nation's housing market.

Will this plan help to reduce the number of those pesky "FORECLOSURE" signs now dotting neighborhoods all around the country?

Probably not.

But, it makes it look like the government is doing something about the problem.

In my brief (and, thankfully, unsuccessful) foray into management many years ago, one of the things that I learned was that you never want to be accused of doing nothing, no matter how intractable a problem.

It matters little how hopeless the task may really be on closer inspection - people like it when it looks like you're trying to solve their problem even when you know you can't.

The Bush administration has hammered out an agreement with industry to freeze interest rates for certain subprime mortgages for five years in an effort to combat a soaring tide of foreclosures, congressional aides said Wednesday.

These aides, who spoke on condition of anonymity because the details have not yet been released, said the five-year moratorium represented a compromise between desires by banking regulators for a longer time frame of as much as seven years and industry arguments that the freeze should only last one to two years.

Another person familiar with the matter said the rate-freeze plan would apply to borrowers with loans made at the start of 2005 through July 30 of this year with rates that are scheduled to rise between Jan. 1, 2008, and July 31, 2010.

The administration said that President Bush will speak on the agreement at the White House on Thursday and the Treasury Department announced that Treasury Secretary Henry Paulson and Housing and Urban Development Secretary Alphonso Jackson would hold a joint news conference Thursday afternoon with officials of the mortgage industry.

If this is a sign of things to come, I can't wait to see what they do next year - when the election season gets into full swing.

And if you're one of those lucky homeowners who, just a couple of years ago, took a chance on one of those risky adjustable rate loans with a teaser rate to get into a house that you really couldn't afford - while your neighbor opted for a fixed-rate loan and settled for a house they could afford - well then, CONGRATULATIONS!

It looks like you're going to get bailed out.

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The biggest mess since 1929

There was some surprisingly good economic news today, but still, only the perpetually positive business news shows and the supply-side crowd seem to think that we're going to be able to avoid a recession next year.

In John Hussman's latest commentary, he described how, before an appearance on CNBC last week, he was asked "to put a positive tone" on his comments lest the masses run for the hills in fright.

That might help ... a little bit ... for a while.

Martin Feldstein wrote an op-ed piece in the Wall Street Journal describing "How to Avert A Recession". It seems that a more accommodative monetary policy and fiscal stimulus (i.e., more easy money and more government debt) are the key ingredients to his plan.

If international dollar holders begin to complain, he recommended less of the former and more of the latter.

But, in today's Washington Post, Steven Perlstein seems to have written the most insightful (and frightening) summary of where we might be right now, that is, from a broader historical perspective.

Any mainstream media news report that starts out with a reference to Charles Mackay, author of Extaordinary Popular Delusions and the Madness of Crowds, immediately grabs my attention, as it should yours.

It's Not 1929, but It's the Biggest Mess Since
It was Charles Mackay, the 19th-century Scottish journalist, who observed that men go mad in herds but only come to their senses one by one.

We are only at the beginning of the financial world coming to its senses after the bursting of the biggest credit bubble the world has seen. Everyone seems to acknowledge now that there will be lots of mortgage foreclosures and that house prices will fall nationally for the first time since the Great Depression. Some lenders and hedge funds have failed, while some banks have taken painful write-offs and fired executives. There's even a growing recognition that a recession is over the horizon.

But let me assure you, you ain't seen nothing, yet.

What's important to understand is that, contrary to what you heard from President Bush yesterday, this isn't just a mortgage or housing crisis. The financial giants that originated, packaged, rated and insured all those subprime mortgages were the same ones, run by the same executives, with the same fee incentives, using the same financial technologies and risk-management systems, who originated, packaged, rated and insured home-equity loans, commercial real estate loans, credit card loans and loans to finance corporate buyouts.

It is highly unlikely that these organizations did a significantly better job with those other lines of business than they did with mortgages. But the extent of those misjudgments will be revealed only once the economy has slowed, as it surely will.

He goes on to talk about CDOs and all the other financial alchemy on Wall Street and why the Federal Reserve is about to make its third rate cut in three meetings when labor markets appear to be sound, inflation is tame, and the dollar is plunging overseas.

Not much makes sense these days and by almost all accounts, 2008 is shaping up to be one of the most exciting years for financial markets in quite some time.

Mr. Pearlstein probably shouldn't hold his breath waiting for any phone calls from CNBC asking him to appear.

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Cheaper oil, cheaper money

The Financial Times filed this report from Abu Dhabi on OPEC's decision to leave short-term rates unchanged. The oil cartel rebuffed repeated calls from the U.S. for an increase in production, but the world's most powerful oil group vowed to monitor incoming data closely to assess the prospects for both output levels and prices prior to their next meeting in February.

Wow. That sounds eerily similar to a Fed meeting.

It seems that, in many ways, the U.S. is to OPEC as Wall Street is to the Federal Reserve. Both the U.S. and Wall street want something cheaper - the U.S. and much of the West want cheaper oil to fuel the world economy and Wall Street wants cheaper money to, well, fuel the world economy.

If, in that first paragraph above, you substitute "cheaper oil" for "an increase in production" and "cheaper money" in place of "lower rates" for next week's Fed meeting, they are virtually the same thing with the important difference that the Bernanke Fed is sure to make money cheaper next week.

The Opec meeting in Abu Dhabi, the first one in the United Arab Emirates in 29 years, was dominated by a struggle between the cartel’s moderates and the prices hawks.

While Saudi Arabia and other moderates, such as Kuwait, had been working behind the scenes in Abu Dhabi to placate consumers’ fears, the price hawks, led by Algeria and Venezuela, opposed any output increase and said a price of $100 a barrel was fair.

Delegates said ahead of Wednesday’s meeting that the cartel was considering two options: either increasing its official production limit by at least 500,000 b/d or leaving it unchanged. But the proposal for an increase was not formally tabled at the critical meeting of the ministers at the Emirates Palace hotel in Abu Dhai.

The price hawks gained the upper hand after moderate Gulf producers dropped their desire to raise production following a price drop of about 10 per cent last week. Worries about the strengh of demand among the moderate countries of the Gulf, including Saudi Arabia, finally tipped the outcome towards maintaining the current official quotas.

And the similarities, perhaps, continue...

Hasan Qabazard, Opec chief economist, said: “There is going to be some extra crude oil from Angola and also from Iraq.” He added that the return of the United Arab Emirates’ largest oilfield following a period of maintenance will also raise the real production level.

“A bit of cheating does not hurt anyone,” a senior official said ahead of Wednesday’s meeting. Another delegate added: “The important figure is not the official quota but the real volume already being supplied to the market or that is on its way.”

If only it were as easy to boost the production oil as it is to boost the production of dollars.

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Jim Rogers has a new book

If you're looking for another stocking stuffer this holiday season, you might want to pick up a copy of Jim Rogers' new book A Bull in China. If it's half as good as any of his first three books, it will be well worth the money. Here he is on Bloomberg:

It's funny to think that he really is serious when he responds to the question, "What should Ben Bernanke do right now?"

With a very straight face comes the reply, "Abolish the Federal Reserve and resign."

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Mr. Freeze's b-u-r-e-a-u-c-r-a-t-i-c n-i-g-h-t-m-a-r-e

David Gaffen of the Wall Street Journal MarketBeat blog and Caroline Baum at Bloomberg have both weighed in on the "Hope (for a Bailout) Now Alliance".

Thanks to David, the image of Arnold Schwarzenegger, in his 1997 role as Mr. Freeze in the fourth Batman movie, is now indelibly etched into my brain and will forever be associated with the proposed plan to prevent introductory interest rates from adjusting upward on many subprime borrowers' home loans.

California's Gubernator was one of the "rate freeze" pioneers here just a few months ago, apparently recalling what must have been many long hours in the makeup chair and one or two of his three lines from his co-starring role in Batman and Robin along with George Clooney and Chris O'Donnell.

Or, maybe it was a fond recollection of Alicia Silverstone as Batgirl that got him thinking about reprising his role in an attempt to save the California housing market.

Anyway, Mr. Freeze orignally appeared at the MarketBeat blog last Friday:

If the still-in-formation “Entity” (the super-conduit for SIVs) was supposed to weigh in at around $80 billion, then what do we call a massive, monolithic structure designed to freeze interest rates for subprime borrowers for a good lot of time and essentially introduce a mortgage-rate-by-fiat system that short-circuits the market? Is it The Matrix? Either way, Hank “Mr. Freeze” Paulson, as he will now be known (in the footsteps of the real Mr. Freeze, Arnold Schwarzenegger), is taking an awful risk on something that hasn’t worked just yet on its smaller scale, especially considering that there are others who are going to presumably have to foot the bill for the bad loans taken by borrowers and originated by lenders.

More recently, following yesterday's group therapy session hosted by the Treasury Department, David wrote:

Talk up finding a solution for funding troubles once, and the equity market loves it. Chat about it a second time, and suddenly investors don’t care so much about potential solutions. The stock market caught up with the credit markets today with regard to its collective opinion of Treasury Secretary Hank “Mr. Freeze” Paulson’s plan to freeze certain teaser rates as a means to alleviate the pain experienced by homeowners, selling the brokerages, the GSEs and key mortgage lenders as Mr. Paulson continues to prattle on about his plan to save the world.

Not surprisingly, Caroline Baum had an opinion on the subject as well commenting in her Bloomberg column after studying the sketchy outlines of the proposal.

According to the broad outlines of the plan, the Treasury will divide subprime borrowers into four groups.

Group 1 includes those who can afford the higher mortgage reset rate. "These homeowners need no assistance," Paulson explained at a housing conference in Washington yesterday.

Check.

Group 2 consists of the folks who haven't been able to pay the teaser rate, not to mention the higher reset rate. Implicit in Group 2's specifications is the fact that these people couldn't afford their mortgage in the first place, lied or were encouraged to lie about their income, got a no-doc, no-questions- asked loan or were victims of fraud. They were counting on higher home prices and refinancing as a way out.

"Some of these homeowners will become renters again," Paulson said.

Check.

Group 3 consists of the homeowners who might "choose to refinance their mortgage," Paulson said. (See Group 1 above for Treasury's commitment.)

Misplaced Incentives

Group 4 includes those who can continue to make their mortgage payments if the teaser rate stays in effect or the maturity of the loan is extended. For this category, and this category alone, help is on the way.

How do you spell b-u-r-e-a-u-c-r-a-t-i-c n-i-g-h-t-m-a-r-e? If fraud was widespread during the housing bubble, the current plan has its own set of incentives.

"People will come up with eight ways of rearranging their finances to stay in Group 4," said Ram Bhagavatula, managing director at Combinatorics Capital LLC, a New York hedge fund.

More to the point, "this policy solution smells of the tenets of Marxism: from each according to his ability to each according to his need," he said.

A few years ago, when Alan Greenspan was being praised for engineering another economic rebound founded on rising real estate values and George Bush was marvelling at the dramatic increase in the rate of homeownership, could anyone in California or Washington have imagined where it would all lead?

Mr. Freeze's b-u-r-e-a-u-c-r-a-t-i-c n-i-g-h-t-m-a-r-e?

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China, gold, and the West

Dismiss gold if you will as an irrelevant artifact of a much simpler time, but do so at your own peril. Paper money and "innovative" financial products in the West are looking more shaky every day and the phrase "like a run on the bank" is being heard with alarming regularity. Even the word "freeze" has crept back into the financial vocabulary in ways very different, but even more alarming, than it did in the 1970s.

Three reports over the last two days tell yet another part of the story about how the yellow metal is becoming more important and more popular in China while Western countries seem to have little use for it.

Amid talk that the Chinese government may try to buy mining giant Rio Tinto comes word that there is at least one abundant natural resource on the mainland.

China may pass South Africa as leading gold producer
Australia’s leading gold production monitor, Surbiton Associates, believes China may take South Africa’s historic position as the leading global gold producer by the end of this year. Australia will hold third ranking because of sliding production in the US.

For the first nine months of 2007, China's gold production totalled 191.5 tonnes, which was just behind South Africa's declining total of 192.7t, and could overhaul the latter in the final quarter of the year.

If you were a hard-working people who labored endlessly in exchange for a currency that was essentially pegged to the U.S. dollar, you'd probably want to exchange some of that paper money for something more tangible too.

China Gold Jewelry Demand Surges Ahead of U.S.
China's demand for gold jewelry may increase by about 20 percent this year as rising personal incomes help it to race ahead of the U.S. as the world's second- biggest market, researcher GFMS Ltd. said.

Gold use in jewelry in China jumped 24 percent from a year earlier to 221 metric tons in the first nine months, GFMS analyst Veronica Han said by phone from Beijing yesterday, citing data compiled for the World Gold Council. That compares with 515 tons in India, the biggest consumer, and 165 tons in the U.S.

Increased jewelry purchases by consumers in China and India, the world's fastest-growing major economies, may help to support the price of gold, which reached a 27-year high of $845.84 an ounce on Nov. 7 and is headed for its seventh annual gain.

Meanwhile, the West continues to sell gold, seeing little need to keep the stuff in their vaults even after the evolving melt-down of modern-day financial products backed by modern-day paper money.

ECB Sells 42 Tonnes of Gold in November
The European Central Bank (ECB) surprised the market today with the announcement that it had completed the sale of 42 tonnes of gold on Friday with no previous indication. After announcing sales of 60 tonnes in the last agreement year, the ECB was thought to have concluded gold sales for the time being.

“It wasn't previously announced, though they have sold gold in December before,” said Matthew Turner, commodities analysts at Virtual Metals.

The sales were in conformity with the Central Bank Gold Agreement of 27 September 2004, which limits combined annual sales by E.U. central banks to 500 tonnes a year until 2009.

According to the World Gold Council, 103 tonnes have been sold thus far in the fourth agreement year.

Maybe Jim Rogers is right when he says: Put Your Money Where His Mouth Is: in China.

To learn more about investing in natural resources using commonly traded ETFs, stocks, and mutual funds, see this description at Iacono Research. Or, sign up for a free trial.

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Angelo Mozilo is a moron

Geez, you only have to get about two minutes into this video from Bloomberg before you realize how screwed up the housing and credit markets really are as the head of the nation's largest mortgage lender explains the cause of the current problems.

Click to play in a new window

Following the group therapy session hosted by the Treasury Department where more details of the "Subprime Rate Freeze" were hammered out, Angelo Mozilo was asked by moderator Maria Bartiromo where we are in the current housing cycle.

I don't know where we are in the cycle. I wish I did. But I think we're dealing primarily with the results - and I think all these (Treasury Department) initiatives are very important to avoid foreclosures - but I think we're clearly dealing with the results and not with the cause.

Nobody's addressing the cause and that's what has to be addressed ultimately and that's the fact that values of homes continue to go down and as they go down, the problem gets exacerbated. And until we stop that cycle, we'll continuously be dealing with this break in the damn. And the cause in the deterioration of values is the lack of liquidity.

Honestly, say what you want about what can or should be done at this point, but don't insult the audience's intelligence by talking about falling home prices being the cause of the current housing and mortgage mess.

Home prices in many parts of the country are still at levels that only make sense when you are in the middle of a speculative bubble and we are clearly past that point, now dealing with the aftermath of one of the largest speculative bubbles the world has ever seen.

Falling home prices as the cause?

Geez!

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Lest we not forget the national debt

With the mess that has been made of the credit and housing markets lately, its easy to forget about the national debt and other seemingly intractable problems that just keep getting pushed further and further into the future for someone else to solve.

The Gross National Debt

[Did these debt counters actually go in reverse back when we had those phony budget surpluses because borrowing from Social Security wasn't included?]

The whole idea of the national debt getting paid down without a serious debasement of the currency seems increasingly unlikely.

In fact, it looks like we'll continue to pile up even more debt with an even weaker currency - some day our foreign creditors will wise up and it probably won't be pretty.

The national debt doesn't seem to be getting too much attention from the presidential candidates these days, what with people losing their homes in record numbers and the pace set to pick up in 2008.

Maybe it's better that way.

Maybe it's better if the only attention the $9+ trillion national debt gets is from the occasional story like this one in today's edition of USAToday:

U.S. Debt: $30,000 per American
Like a ticking time bomb, the national debt is an explosion waiting to happen. It's expanding by about $1.4 billion a day — or nearly $1 million a minute.

What's that mean to you?

It means almost $30,000 in debt for each man, woman, child and infant in the United States.

Even if you've escaped the recent housing and credit crunches and are coping with rising fuel prices, you may still be headed for economic misery, along with the rest of the country. That's because the government is fast straining resources needed to meet interest payments on the national debt, which stands at a mind-numbing $9.13 trillion.

And like homeowners who took out adjustable-rate mortgages, the government faces the prospect of seeing this debt — now at relatively low interest rates — rolling over to higher rates, multiplying the financial pain.

So long as somebody is willing to keep loaning the U.S. government money, the debt is largely out of sight, out of mind.

But the interest payments keep compounding, and could in time squeeze out most other government spending — leading to sharply higher taxes or a cut in basic services like Social Security and other government benefit programs. Or all of the above.

It sounds like they might have to get "innovative" in financing the government debt at some point - just look what "innovation" did for the housing market.

Maybe if house prices had kept going up, homeowners could have come up with $30,000 or so apiece and whittled the debt down, but with home values declining, that plan probably won't work now.

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Special report on the mess in Florida

Check out Bloomberg's Special Report on the evolving mess in Florida - the result, apparently, of money managers trying to get a little better return on their fixed income investments during an era that, in retrospect, was clearly a "Wild West" in credit markets.

The most recent articles suggest that the "unstoppable force" of investors wanting their money back is now meeting the "immovable object" of a fire sale of assets.

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For the National Museum of American History

There is more fine work today by the WSJ graphics department in this story about the growing tentacles of the subprime mess (well, actually, the tentacles aren't growing anymore - the major growth occurred a few years ago and now it's more like the tentacles are being chopped off all around the country).

Click on the graphic to go to the interactive version at the WSJ

Someone really ought to find an original New Century rate sheet and submit it to the National Museum of American History - they probably have one of those sock-puppets from Pets.com, why not one of these?

The report details how, earlier in the decade, borrowers increasingly found themselves in subprime loans for one reason or another, such as, they had no money for a down payment or they really couldn't afford the place that they were going to "flip" in six months anyway.

An analysis for The Wall Street Journal of more than $2.5 trillion in subprime loans made since 2000 shows that as the number of subprime loans mushroomed, an increasing proportion of them went to people with credit scores high enough to often qualify for conventional loans with far better terms.
...
The surprisingly high number of subprime loans among more credit-worthy borrowers shows how far such mortgages have spread into the economy -- including middle-class and wealthy communities where they once were scarce. They also affirm that thousands of borrowers took out loans -- perhaps foolishly -- with little or no documentation, or no down payment, or without the income to qualify for a conventional loan of the size they wanted.

The analysis also raises pointed questions about the practices of major mortgage lenders. Many borrowers whose credit scores might have qualified them for more conventional loans say they were pushed into risky subprime loans. They say lenders or brokers aggressively marketed the loans, offering easier and faster approvals -- and playing down or hiding the onerous price paid over the long haul in higher interest rates or stricter repayment terms.

Just another example of what Treasury Secretary Hank Paulson characterized as "innovation outrunning the government's ability to deal with it".

If the rate sheet were to be accepted by the museum, they could probably find a place for it near this display showing one of the alternative forms of "money" used during The Great Depression as seen on our last trip eastward.

Surely there are some interesting parallels between depression-era clamshell money and the troubles that are being seen with the mortgage mess today - none seem to come to mind at the moment.

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The topsy-turvy new world of retirement planning

After a short walk around the neighborhood earlier today it occurred to me that if retirement planning wasn't already difficult enough, the roller-coaster ride of the recent housing boom (that is now undergoing a painful bust) is making things even more complicated for some people.

[No, the picture to the right is not our neighborhood - that lucky homeowner has a view of El Capitan in Yosemite National Park and you can rent it for a weekend if you want to.]

As most of the places in our neighborhood are second homes, many of them initially purchased as empty lots with homes constructed later, quite a few of these homeowners own two properties today - their primary residence in the Bay Area and one in the mountains.

A few years ago this was a great circumstance to find yourself in, but not today - especially if you live in California.

With retirement drawing near for some, the math of financing a life of leisure must be getting awfully complex (and maybe a bit frightening) given what's happening to home prices in the state. If, a few years ago when doing some retirement planning, you had figured in the value of your primary residence close to work and then you also figured that you'd be able to sell it at 2005 prices (or better) in 2008 or 2009, well, you may have quite a surprise in store.

If you were just a few years away from retirement and you decided to work another couple years to sock away, say, another $20,000 or so a year figuring that your combined real estate equity and retirement savings would be sufficient, what have plunging real estate prices done to all your meticulous calculations?

The aspiring retirees still need to sell that first house and pocket the gains before they can move on to a slower pace of life that is sufficiently funded.

What happens if the price of that house close to work is falling faster than the future retiree is adding to their retirement savings - it would appear to be a losing proposition to work those extra few years if your house loses, say, $50,000 or $100,000 a year while you're only adding $20,000 or $30,000 a year to your bottom line through conventional savings.

You'd probably have been better off selling a couple years ago when everyone was falling all over themselves trying to become a homeowner rather than waiting until next year or the year after when the only thing that will be falling are home prices.

Of course, it didn't used to be that way - in recent years, housing appreciation has been doing the heavy lifting in retirement savings for many. The word "savings" was even redefined by dimwitted economists who figured that home equity was as good as "old-fashioned" savings like money in the bank or company shares that now also look a bit precarious.

As if it wasn't already difficult enough, the housing boom is making a mess of many peoples retirement plans - hopefully, not too many of them were counting on real estate prices maintaining their lofty levels for years and years to come.

ooo

This week's cartoon from The Economist:

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The week's economic reports

More dismal reports on the nation's housing market and strong third quarter economic growth highlighted the week's economic data. Stocks and bonds ended with the S&P 500 Index up 2.8 percent to 1,481, now up just 4.4 percent for the year, and the yield of the 10-year U.S. Treasury note fell 4 basis points to 3.97 percent.

Consumer Confidence: The mood of the consumer continues to darken as the Conference Board's measure of consumer confidence confirmed what was revealed in the Reuters/University of Michigan consumer sentiment index in recent weeks - the outlook of consumers is at lows not seen since immediately following Hurricane Katrina in 2005. Rising energy prices and falling home prices appear to be taking their toll.

Consumer confidence plunged from a downwardly revised 95.2 in October to 87.3 in November and, perhaps more importantly, the 12-month inflation outlook jumped from 5.1 percent to 5.7 percent. This is terrible news for the Federal Reserve who look increasingly likely to cut rates again in ten days - this is one of the two major gauges of "inflation expectations" that they are keen to keep in check (the other "inflation expectations gauge" is the difference in yield between inflation protected treasuries and fixed rate treasuries).

Durable Goods Orders: Orders for goods designed to last three years or more fell 0.4 percent in October following an upwardly revised drop of 1.4 percent in September. This is a volatile series due to the transportation category that is dominated by sometimes wild month-to-month swings due to aircraft orders, but, there is a clear slowdown in progress when looking at the year-over-year changes throughout 2007. From year-ago levels in the latest report, durable goods orders are now up only 1.0 percent after last month's year-over-year decline of 6.2 percent. Overall, this measure of future factory production is growing at a rate that, while still positive, lags reported inflation.

Existing Home Sales: The National Association of Realtors (NAR) reported lower sales of existing homes, dropping 1.2 percent in October to a seasonally adjusted annual rate of 4.97 million, the lowest monthly total since 1999 when this series began. More importantly, inventory continues to grow as both the numerator (inventory) and the denominator (sales rate) of the Months of Supply statistic continue to head in the wrong direction - the current 10.8 months of supply is more than double the normal rate of between four and five months.
Lower sales are now beginning to affect even the NAR's price statistics as the median home price fell to $207,800, a 5.1 percent decline on a year-over-year basis. At these levels of sales and inventory, there is ever-increasing downward pressure on home prices - it is likely that lower prices will be seen in the months ahead and well into 2008 even if there is no further deterioration in the sales and inventory data.

Gross Domestics Product: Third quarter real economic growth was revised upward a full percentage point from the "advance" estimate of 3.9 percent last month to a "preliminary" estimate of 4.9 percent. The third and "final" reading on Q3 GDP will be released in one month and the first look at Q4 GDP will be available at the end of January. In the chart below, growth appears to be surging recently, after a mild slowdown in late-2006 and early-2007, but that is anything but the case.

The upward revision to the very strong third quarter growth was primarily due to higher inventory levels, an indication of softening consumer demand ahead, and a continuation of the recent export surge resulting from a weaker U.S. dollar. Combine these factors with an energy price related statistical quirk that produced an annualized inflation rate of just 0.9 percent during July-August-September and you get what appears to be a healthy economy.

As indicated by the many downward projections for Q4 economic growth, some of which are close to zero, nearly all these factors are set to reverse in the final months of the year. Not only will consumer price inflation (used to convert "nominal" growth to "real" growth) be much higher due to soaring energy prices, but the impact on consumer spending, by far the most important component of economic growth, is at this time still a big unknown. Seasonal adjustments during a time of year when energy prices are generally declining and consumer spending is generally surging could result in some surprisingly weak fourth quarter data.

New Home Sales: There were a total of four housing reports last week and all of them were bad. In addition to continuing weakness in existing home sales reported by the National Association of Realtors (see above), the S&P Case-Shiller Home Price Index showed a year-over-year price decline of almost five percent and the OFHEO housing price index showed quarter-to-quarter price declines for the first time since the mid 1990s.

New home sales were similarly depressed even without factoring in cancellation rates that continue at extraordinarily high levels. The Commerce Department reported October new home sales at a seasonally adjusted annualized rate of 728,000, slightly above last month's revised total, but the more important elements in this report were the revisions of prior data - August sales were revised from 757,000 to 717,000 and September sales fell from 770,000 to 716,000. On a year-over-year basis sales are now down 24 percent, a number that would likely be even greater after next month's expected downward revision to this data.

The inventory of unsold new homes dropped marginally, from 9.0 months in September to 8.5 months in October, but there is little indication that this is the beginning of a trend toward more normal levels - builders continue to slash prices and offer larger incentives to an increasingly skittish public. Prices fell 8.9 percent from September to October and were down 13.2 percent on a year-over-year basis - once again, remember that these price drops do not factor in builder incentives. More and more analysts are already looking past 2008, figuring that housing won't start to improve until 2009.

Personal Income and Spending: Personal income and spending rose less than expected in October, both gaining only 0.2 percent following gains of 0.4 percent and 0.3 percent, respectively, in September. The personal savings rate fell from 0.7 percent in September to 0.5 percent in October and the PCE price index rose 0.3 percent, up 2.9 percent from year-ago levels.

Summary: While economic growth during the third quarter was surprisingly strong, unfortunately this is old news and reflects little of the post-credit crunch realities of recent months. Ignoring this one bright spot in last week's reports leaves a slew of negative news, the most important of which were the four dismal reports on the nation's housing market.

Add to this more evidence of plunging consumer confidence, a slowing manufacturing sector, along with a spike higher in initial jobless claims and it becomes clear why Federal Reserve members began changing their outlook on future interest rate policy last week, "opening the door" to another rate cut in December after having resisted that stance in prior weeks.

The Week Ahead: The week ahead will be highlighted by a much anticipated labor report on Friday. Also scheduled for release are the ISM manufacturing index on Monday, four reports - the ISM Non-Manufacturing index, ADP employment, productivity and costs, and pending home sales - on Wednesday, and both consumer sentiment and consumer credit on Friday.

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