The week's economic reports

The few economic reports released last week were all upbeat but, reporting on events just prior to the credit market tumult, they are all essentially meaningless - as of a few weeks ago, everything has changed.

Leading Economic Indicators: The Conference Board's index of leading economic indicators rose 0.4 percent in July after a decline of 0.3 percent in June. The increase was driven by lower initial claims for unemployment insurance, higher consumer confidence, and improved vendor performance while negative components included fewer building permits issued and higher yield spreads. Note that consumer sentiment had a significant reversal early in August and with the recent mortgage industry turmoil, unemployment claims are likely to increase in the weeks ahead so, the rebound in July may be reversed when the August data is reported next month.

New Home Sales: Sales of new homes exceeded expectations, increasing from an upwardly revised total of 846,000 in June to 870,000 in July. On a year-over-year basis, sales were down 10.2 percent, however, cancellations currently running at around 40 percent are not included in this data making the actual statistics far worse. Much of the overall reported gain came from a 22 percent jump in sales in the West, however, this was offset by a plunge of 24 percent in the Northeast while sales in the South and Midwest were about flat.

The inventory of unsold homes fell from a 7.7 month supply in June to a 7.5 month supply in July and the average time that a completed home sat on the market rose from 5.9 months to 6.1 months. The median price rose 3.9 percent to $239,500, up 0.6 percent from a year ago but down 8.8 percent from the early 2006 peak. The National Association of Home Builders reports that about three-quarters of builders are currently offering incentives, many of these worth tens of thousands of dollars, so it's important not to make too much of the apparent price stability lately - after accounting for increasingly lavish incentives, new home prices are down significantly.

This report comes before the recent credit market turmoil, so the next new home sales report will likely be worse, perhaps much worse, as a good deal of the aggressive builder financing evaporated along with other mortgage financing.

Durable Goods: Orders for durable goods rose sharply in July, up 5.9 percent after an upwardly revised gain of 1.9 percent in June. Excluding the volatile transportation category, new orders rose 1.3 percent in July after a 2.5 percent decline in June. Gains were spread across most categories led by orders for primary metals that increased 7.9 percent and computers and electronic products that rose 7.4 percent.

Orders for nondefense capital goods excluding aircraft, a closely watched indicator of spending for business equipment, rose 2.2 percent in July after declining 0.1 percent in June. It is likely that tighter credit conditions will have a dampening effect on business spending in the August report, however, the extent of the pull-back remains to be seen.

Summary: Since these few reports cover periods of time prior to the recent credit market melt-down, they don't offer any particular insight into the direction of the economy given the impact of recent developments. If anything, last week's economic reports indicate a small acceleration heading into the early August turmoil that will make month-to-month comparisons more difficult when they are reported in September.

The Week Ahead: The week ahead will be highlighted by the second of three readings for Gross Domestic Product for the second quarter on Thursday. Also scheduled for release are existing home sales on Monday, consumer confidence and the Fed meeting minutes on Tuesday, and four reports on Friday - personal income/spending, consumer sentiment, factory orders and the Chicago purchasing managers' index.

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Speaking of housing deflation...

This story from Reuters points to the growing realization amongst the common folk that home prices don't go up forever and there is no substitute for good old fashioned, traditional "savings".

More homeowners say house value declines: survey
NEW YORK (Reuters) - Homeowners across America were more likely to report declines in their home values than at any time since 1992, according to the The Reuters/University of Michigan Surveys of Consumers for August released on Friday.

Nearly one-in-four consumers in the August survey reported that the value of their home had declined during the past year, said Richard Curtin, director of the Reuters/University of Michigan Surveys of Consumers in a statement.
...
The data indicated housing wealth will provide less support for consumer spending as tighter lending standards and higher borrowing costs curtail cash-out refinancing during the year ahead. Though the survey indicates a significant slowdown in consumer spending, it will stop short of a recessionary downturn, Curtin said.

Among homeowners in the West, 33 percent reported in the August survey that the value of their home declined. That compared with 23 percent of homeowners in the Northeast, 18 percent in the Midwest reporting declines, and 15 percent in the South.

Some 21 percent of West and Northeast homeowners expected declines during the year ahead, with just 10 percent of Southerners expecting a decline in value.

As seen in many political polls, the tide of public opinion turns slowly, but once the change is set in motion, it's hard to stop - keep an eye on this chart going forward.

In case you are having trouble making out the color coding, from top-to-bottom on the rightmost side of the chart, the order is Miami, Los Angeles, Washington DC, San Diego, Las Vegas, Tampa, Phoenix, New York, San Francisco, Seattle, Portland, Boston, Minneapolis, Chicago, Denver, Atlanta, Charlotte, Dallas, Cleveland, Detroit.

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How owners' equivalent rent duped the Fed

Those of you who remember "Homeownership Costs and Core Inflation" from almost two years ago may be interested in seeing how the relationship between these two has developed since that time.

Recall that the crux of the issue, then as now, is the use of OER (owners' equivalent rent) to represent home prices in the CPI (Consumer Price Index) and the distortions that arise as a result - OER is one of the poorest proxies the world has ever seen as demonstrated by the comparison below with the Case Shiller Home Price Index.

As you can see, the year-over-year change in home prices has gone from almost 20 percent a few years ago to low single-digit negative numbers just a couple months ago. During this time OER has remained flat by comparison, effectively taking home prices out of the consumer price statistics.

So, what would happen to the consumer price index if real home prices were substituted for the much maligned OER?

You will see in a minute.

Keep in mind that the charts that follow are a simple substitution of Case Shiller home prices for OER and no attempt is made to include other important factors in homeownership costs, something that OER purportedly does. These other factors would include such items as prevailing interest rates, available mortgage products, property taxes, insurance, and the like.

A full-time economist at the Federal Reserve could extend these charts into a more proper analysis including a myriad of factors to arrive at a true representation of housing costs in the consumer price index and they would probably arrive at similar conclusions.

Given what's now happening in the housing market now and who's getting much of the blame, it may be in their best interests to get out "ahead of the curve" on this if it is their desire to continue as an institution - the calls for the abolishment of the Federal Reserve or a major overhaul regarding how they do business have become louder and more frequent as the housing mess continues to unfold.

And any economist who argues that OER better captures the "utility" component of housing or nonsense such as this, please, just stop it!

You've gotten us into enough trouble as it by ignoring home prices.

A Misleading Headline

So, the first chart is the overall consumer price index with the Case-Shiller Home Price Index substituted for owners' equivalent rent.

Two areas of the chart are important. First, in early 2002, when the Fed was worried about "deflation", home prices were increasing at a healthy pace and had they been included in the CPI, it would have fallen to only two percent instead of one percent. The "deflation scare" wouldn't have been so scary.

Second, in early 2004, while the Fed funds rate was still only one percent, home prices began to take off - the CPI would have been over seven percent using the Case-Shiller data instead of only about three percent with OER.

In summary, the Greenspan Fed didn't have to take rates as low as they did or leave them there that long.

Home prices were booming during this time and if they were properly accounted for in consumer prices, monetary policy would not have become too easy and stayed that way for too long - what an increasing number of observers are citing as the genesis of the current housing problems.

Trouble at the Core

Next is the Fed's preferred measure of inflation, core inflation, where food and energy prices are stripped out. For the overall CPI, owners' equivalent rent contributes 23 percent to the total index, but for core inflation, this goes up to 29 percent. Look what happens if that same simple substitution is performed for the core rate of inflation.

Here too, there are two important points. First, core inflation since the turn of the century that includes real home prices comes nowhere close to the magical two percent level targeted by the Fed - it averages closer to five percent when the Case Shiller data is used.

And, more importantly, the housing "deflation" that has recently arrived on the nation's doorstep would drive core CPI to nearly zero. This is much closer to outright deflation than the level of overall inflation that terrified the Fed back in 2002 - this is pretty close to Japan-style inflation.

If core inflation as presently calculated by the Bureau of Labor Statistics were to round to zero with a trajectory such as the one seen above, you'd bet that the Fed would be all hot and bothered, already slashing short-term rates with abandon.

When home price deflation is added to the consumer price calculation, it would appear that not slashing interest rates today is as big a blunder as what Alan Greenspan did earlier in the decade.

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Sounding more like dot-bomb everyday

Angelo Mozilo of Countrywide Financial took some time off from selling his Countrywide stock to talk with Maria Bartiromo at CNBC in a video that many of you have probably already seen by now. If not, here's a link.

Maria brought up the "R" word and Angelo was only too happy to drive home the point that things are probably going to get a lot worse before they get better:

"I don't see a light here at the moment."

"This is one of the greatest panics I've ever seen in 55 years in financial services."

"I can't believe that when you're having this level of delinquencies and foreclosures - home equity is gone - the tide has gone out - it will have a material affect on the psyche of the American people and their wallet"

However, more than anything else, the Countrywide chief appears to be talking like IBM, Microsoft, and Cisco about six or seven years ago - well into the acceptance phase of the process, trying to figure out how to emerge from the current crisis and pick up market share in a much smaller market.

"But at the end of the day, we could be doing very substantial volume with high quality loans because there's nobody else in town. Although the pie will be smaller, I think we'll get a bigger part of the pie".

Countrywide currently employs 61,000 less the 500 that were let go last Friday.

At the technology company that I worked for, about half the heads were lopped off over a period of about two years when dot-com turned into dot-bomb.

What's the Countrywide headcount likely to be a year or two from now?

Any word on all those Countrywide office buildings under construction in Ventura County?

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More buying leads to lower prices?

Is this the way markets are supposed to work? The more gold that the gold ETF buys on the open market, the lower the price goes? Strange.

Maybe they should start selling the stuff and see if the price goes up.

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An important point of reference

After the European Central Bank pumped another $50 billion or so into their banking system yesterday, the grand total of "liquidity injections" over the last two weeks by the Federal Reserve, ECB, Bank of Japan, and various other central banks around the world now stands at somewhere around $500 billion.

Half a trillion dollars.

Is that a lot?

How would anyone know?

What do you compare it to?

The Gross Domestic Product for the U.S. is over $11 trillion (most of which is consumer spending) and the U.S. government's annual budget is about $2.5 trillion, but any comparison to the greatest spenders the world has ever seen is inherently unfair.

Maybe it would be an interesting exercise to add up the value of all the gold reserves held by all the world's central banks to see how that figure would compare.

In the hypothetical (albeit very impractical) situation where central banks had to sell gold to pay for all these "liquidity injections", how much would depart the bank's vaults and how much would remain?


(This is not a photo of a central bank vault but, rather, gold held in trust for owners of the streetTRACKS Gold Shares ETF (AMEX:GLD). The world's most popular gold fund continues to set new records for inventory adding another 7 tonnes just three days ago.)

Here's the calculation based on the June data from the World Gold Council and yesterday's closing price of $659 per ounce:

• A total of 30,279 tonnes of gold are held by central banks, the IMF, and the BIS
  
  
• One metric ton equals 2,205 pounds x 14.583 ounces/pound or 32,155 ounces
  
  
• 30,279 tonnes x 32,155 ounces/tonne x $659 per ounce = $642 billion

The approximately $500 billion dollars of "injected liquidity" over the last two weeks is disturbingly close to the value of all the gold held by all the central banks in the world.

That's an important point of reference.

Full Disclosure: No position in GLD at time of writing, however, the author owns a hefty supply of shiny, one-ounce gold coins.

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Nice pecs

The photo on that last post was startin' to creep me out, hanging around at the top of this blog for the last six hours or so. Here's a change of scenery until tomorrow morning from an AP story on Russian President Vladimir Putin's summer vacation.

He's definitely sucking it in, but, that's still pretty damn good for a 54-year old - a little body hair might make him look less like a mole.

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"I did not say that"

Bloomberg reports on what former Fed chairman Alan Greenspan did not say:

Greenspan Denies Saying He Would Have Cut Key Rate
Aug. 22 (Bloomberg) -- Former Federal Reserve Chairman Alan Greenspan denied he told Deutsche Bank AG executives at a dinner that he would have lowered the benchmark U.S. interest rate by now.

"I did not say that,'' Greenspan said in an e-mailed response to questions.

Greenspan was hired by Deutsche Bank earlier this month to advise the securities unit of Germany's biggest bank. The former Fed chief, who left the central bank in January 2006, said last week that he took the job in part because he had enjoyed working with the unit's chief economist, Peter Hooper, a former Fed official.

"There was speculation in the markets that Greenspan had said at a Deutsche Bank dinner yesterday that he would have cut the fed funds rate by now,'' said Stephen Gallo, a market analyst at Real-Time Analysis & News Ltd. in London.

Fed Chairman Ben S. Bernanke and his colleagues have refrained from cutting the benchmark target rate for overnight loans between banks to address the upheaval in credit markets. Instead, the Fed on Aug. 17 reduced the discount rate, the cost of direct loans to banks, while indicating readiness to take further action.

Under Greenspan, the Fed cut the main rate three times in 1998 after currency and debt crises in emerging markets led to the collapse of hedge fund Long Term Capital Management LP.

Since retiring, Greenspan, 81, has been speaking to companies and business groups and working on a book scheduled for release next month. He served as Fed chairman for 18 years.

Just think of what sort of commotion would have been caused if he said he did.

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The housing bubble crisis counselers

Since moving far to the east a year or so ago to head up Morgan Stanley Asia, Stephen Roach hasn't been heard from much here in the West.

After years of criticizing Federal Reserve policy (see the classic "Batonless") and now that the mortgage lending meltdown and credit crunch of which he warned have arrived in full force, it seemed only fitting that Fortune Magazine include him as one of thirteen "Crisis Counselors" along with other favorites of this blog, Warren Buffet, Robert Shiller, Jim Rogers, and Jeremy Grantham.

Don't let the picture fool you - Stephen Roach has been one of the few level-headed thinkers over the last five years. When everyone was losing their heads over rising rates of homeownership, savings gluts, financial innovation, and real estate wealth, Mr. Roach was warning the world about the untoward and long-lasting effects of Fed policy under Alan Greenspan - nobody really listened back then, but more people are listening now.

The failure of central banking
Stephen S. Roach
Chairman, Morgan Stanley Asia

For the second time in seven years, the bursting of a major-asset bubble has inflicted great damage on world financial markets. In both cases--the equity bubble in 2000 and the credit bubble in 2007--central banks were asleep at the switch. The lack of monetary discipline has become a hallmark of unfettered globalization. Central banks have failed to provide a stable underpinning to world financial markets and to an increasingly asset-dependent global economy.

The current post-bubble shakeout is hardly an isolated development. Basking in the warm glow of a successful battle against inflation, central banks decided that easy money was the world's just reward. That set in motion a chain of events that has allowed one bubble to beget another--from equities to housing to credit.
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It is high time for monetary authorities to adopt new procedures--namely, taking the state of asset markets into explicit consideration when framing policy options. As the increasing prevalence of bubbles indicates, a failure to recognize the interplay between the state of asset markets and the real economy is an egregious policy error.

That doesn't mean central banks should target asset markets. It does mean, however, that they need to break their one-dimensional fixation on CPI-based inflation and also give careful consideration to the extremes of asset values. This is not that difficult a task. When housing markets go to excess, when subprime borrowers join the fray, or when corporate credit becomes freely available at ridiculously low "spreads," central banks should run tighter monetary policies than a narrow inflation target would dictate.

That seems to be an increasingly popular view - much more in Europe than here in the U.S., but the Bernanke Fed will probably figure this out eventually.

Most of the other crisis counselors offered similar views (not many easy solutions):

• Warren Buffett - Chairman and CEO, Berkshire Hathaway
• Wilbur Ross - Chairman and CEO, WL Ross & Co
• Henry M. Paulson - Secretary of the Treasury of the United States
• John Mack - Chairman and CEO, Morgan Stanley
• Bill Miller - Chairman and chief investment officer, Legg Mason
• Robert Shiller - Stanley B. Resor professor of economics, Yale
• Jim Rogers - Founder of the Rogers Raw Materials Index
• Jim Chanos - President and founder of Kynikos Associates
• Amy Brinkley - Chief risk officer, Bank of America
• Laura Tyson - Professor, Haas School of Business, Cal
• Jeremy Grantham- Chairman, GMO
• Ben Stein - Economist, writer, lawyer, and actor

Aside from Roach , Wilbur Ross had the some of the keenest insight as to how we got to where we are today and who's responsible:

I recently overheard two men arguing about who was better off. One boasted about his new car, the other about a plasma TV and so on, until one proclaimed, "I am better off because I owe more than you are worth." The second man conceded defeat. This anecdote summarizes the mortgage bubble. Americans spent more than they earned in 2005 and 2006 and borrowed the difference. The federal government did the same. Everyone secretly feared this was unsound but wanted immediate gratification, so there was applause for talking heads who said global liquidity would make these borrowings safe. Alan Greenspan went so far as to suggest that people take out adjustable-rate mortgages.

Don't forget that the former Fed chairman also marveled at the "financial innovation" otherwise known as subprime lending.

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My Housing Story - Part 3

This is part three in a five or six part series recounting my California home ownership experience. For the first two installments, see:

• Part 1 - The newlyweds and the new house (1989-1992)
• Part 2 - Becoming a renter and a landlord (1993-1994)

Part 3 - The new purchase and the lucky timing (1995)

After a few months as renters in tony Westlake Village, California and one horrifying morning during the 1994 Northridge earthquake, we began looking around to buy another house.

Our home in Palmdale had lost about a quarter of its value by this time - we were upside down by tens of thousands of dollars with a negative monthly cash flow, but we were ready for more.

We had no idea at the time, but, as it turned out, the middle of the 1990s was the bottom of the last Southern California real estate cycle. As a result of the Savings and Loan crisis and layoffs in the aerospace industry, foreclosures had soared and home prices had plunged.

Like most people, we were pretty much clueless about real estate cycles and didn't really wonder why the previous boom had gone bust and what the future might hold for real estate prices.

Like most people, we just wanted our own home again and we were ready, willing, and able to buy - the nesting instinct is very powerful for women and advances in power tool technology had turned an entire generation of young men into Tim "The Tool Man" Taylor wannabees.

In Ventura County, California what used to cost $400,000 back at the peak in 1990-1991 might have went for $300,000 in 1995 and what used to fetch $300,000 might go for only $200,000.

With a combined income far above the household median but still shy of the six figure mark, we were again looking at something priced at about three times our gross income which put us in the mid-$200,000 range.

Sounds quaint, doesn't it? Three times gross income. The mid-$200s.

The down payment options at the time were 5 percent or 10 percent, which translated to about $12.5K or $25k - a large chunk of money at the time. As we quickly found out, if you only put 5 percent down, the interest rate was a little higher and the debt service to income ratios more stringent because the bank was taking on more risk.

There were no such things as piggy-back loans at the time or we surely would have used one - we just wanted out of our rental and back into our own home.

After an hour with a mortgage representative we found out that we just couldn't get the numbers to work for the house that we wanted with the loans that were available. A five-year fixed at 7.75 percent was the most affordable option, but we just couldn't fit our new monthly debt service into the percent of gross income that the loan allowed - 28 percent PITI/42 percent total.

The mortgage rep said, "Sorry, I just can't do it".

That sounds quaint too.

So, we ate hotdogs and some Top Ramen, watching every penny, and came back with a bigger downpayment six months later.

We ended up buying a brand-new, two-story, 2,300 square foot home in a half-completed housing development in North Oxnard near the golf course. There were acres and acres of empty lots on one side of us, acres and acres of two and three year-old homes on the other side of us, and brand new empty houses for sale up and down our street.

The 15 or 20 new houses on our street stayed pretty much empty and for sale for a few years - once every few months, someone would move in.

We still didn't really have a clue, but, we did have our new home.

We had made what would turn out to be the single most important financial decision that would benefit the rest of our lives and we had no idea at the time.

The oldest investment advice in the book is to "buy low and sell high", but, until recently, most homeowners never viewed their home as an investment.

Some people got lucky, others didn't - people bought homes when they got married or when they moved and they sold them when they got divorced or were transferred.

It's probably better that way, given what's happened in the last couple years.

For decades and decades, all throughout the 20th century, when you wanted to buy a house you'd go out and buy the biggest one that the banks would let you buy.

This made the process simple and worked superbly up until about 2002.

Soon after we settled into the new place, our tenant in the Palmdale house informed us that she had been laid off from the bank where she worked and that she and her daughter were moving to Las Vegas in the hope of a better, more secure future.

The negative cash flow for the old house was about to increase sharply.

Next up: Part 4 - The short sale and the lucky tax breaks (1996)

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Ambrose is on a roll

The writing of Ambrose Evans-Pritchard of the London Telegraph is, if nothing else, provocative. As a lover of gold who is both skeptical of modern financial alchemy and wary of central bank complicity, he can always be counted on to provide a view of financial markets that is far from the mainstream.

After reports filed over the last two days, he is clearly on a roll.

Yesterday's story followed up on some of the details surrounding last week's about-face by Ben Bernanke - an about-face that led to a cut in the discount rate and an easing of the Fed's monetary policy stance.

We can presume that Ben Bernanke did not undertake this volte face lightly, given his determination to end the Greenspan practice of reflexive bail-outs - and to shake off his own image as an easy money man. I suspect Mr Bernanke now fears the economy is hurtling into a brick wall.
...
America is sliding into the worst housing slump since the Depression.
...
The bond markets know the fuse is already lit on mass default, which is why $2,000bn of US sub-prime and Alt-A debt packaged as securities is being marked down so violently on books - German, French and Dutch books as it turns out.

The hit to the real economy will follow soon. Americans now face wealth deflation on both the housing and equity markets.
...
In the end, the world's central banks can always reflate the markets - if they are willing to tolerate the side-effects. The 1930s liquidity trap has been overtaken by new methods of stimulus, as Mr Bernanke made all too clear in his "helicopter" speech in November 2002. "The US government has a technology, called a printing press, that allows it to produce as many US dollars as it wishes at essentially no cost," he said.

The Fed can "expand the menu of assets that it buys", he said, citing agency mortgage debt, a gamut of bonds and even use of "commercial paper" as collateral. The process began gingerly last week. The markets may come to know real fear before it is finished.

And now comes this one today on who should be blamed for the mess:

The witch hunt has begun. French president Nicolas Sarkozy has vowed to hunt down the "speculators". Germany's Angela Merkel is eyeing laws to curtail hedge funds.Brussels has launched a probe of the rating agencies, suspected of sticking "AAA" and "AA" grades on sub-prime debt for venal motives. The US Congress is orchestrating a show trial of "predatory lenders".

The blame-game was ever thus. Wall Street bankers were hounded after the 1929 crash: some went to prison. But if you track down the root cause of this credit bubble - now popped - the "blame" lies with Asian, European and Anglo Saxon central banks.

They created this mess, if that is what we now face. It was they - in effect governments - who intervened in countless complex ways to push down the price of global credit to levels that warped behaviour, as the Bank for International Settlements (BIS) has repeatedly noted. By setting the price of money too low, they encouraged debt and punished savings.
...
The central banks have said their task is to fight inflation, not to police asset prices. Critics retort that the US asset bubble in the 1920s and Japan's bubble in the 1980s both occurred at a time of low inflation. Belatedly the Bank of Japan, the ECB, the Swiss, the Scandies and the Bank of England are questioning the wisdom of ignoring asset prices, deeming it wise to "lean into the wind" to slow excesses. But it is very late in the day. The credit bubble is already with us.

Somehow, that smug look on Ambrose's face seems a bit less pretentious than it did about six months ago.

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Dodd: Fed gets it, Treasury doesn't

Senator Chris Dodd, chairman of the Senate Banking Committee and struggling Democratic presidential candidate, met with Fed Chairman Ben Bernanke and Treasury Secretary Hank Paulson this morning to talk about the mortgage lending and credit market mess.

Apparently, Hank Paulson developed a glazed-over look or began staring out the window when the subject turned to people losing their homes.

According to this MarketWatch report, Senator Dodd commented, "The Fed gets it and understands it, but the Treasury doesn't", referring to his strong desire to keep people from losing their homes and to improve his poll ratings - neither of which are likely to happen anytime soon.

As the high-end real estate market is still going gangbusters in much of the country, it's easy to see how the head of the Treasury would find it difficult to relate - he's worth about two hundred times the combined Bernanke/Dodd households and these two are no slackers, each with a net worth somewhere around $2 million (with nice pensions to boot).

Ben Bernanke pledged to use "all of the tools at his disposal" to restore stability and confidence in financial markets.

According to this Bloomberg story, Dodd said "he didn't specifically ask Bernanke to cut the benchmark federal-funds rate, and Bernanke didn't pledge to do so."

Well, that's a good thing because the Fed is supposed to be independent.

The central bank has a "dual mandate" of price stability and full employment - based on both of these metrics, the Fed is doing a fine job at the moment. According to government statistics, price increases are moderate and jobs are plentiful - just don't ask an unemployed mortgage lender what health insurance costs these days.

Of course, people may not like the whole idea that rate cuts may not be forthcoming - Wall Street expects three of them in the next four months.

The entire country has been trained like Pavlov's dogs, so it seems, expecting a bail-out when things get a little dicey - that's the legacy of former Fed Chairman Alan Greenspan and it will be hard to make the saliva glands of millions of people respond differently to financial market distress.

Though judgment on the new Fed chief is being reserved here in the hope that he will be more like Paul Volcker than "the Maestro", it's probably only a matter of time until Ben Bernanke caves in and starts cutting interest rates.

What else can he do when most of the country and its elected representatives think that you can have strong credit markets and cheap money at the same time, just like Senator Dodd.

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Gartman: Short stocks, long gold

Dennis Gartman of the Gartman Letter was interviewed at Bloomberg yesterday. While making clear that he is not a "gold bug", he makes an astonishingly simple case for why gold is a good investment.

But first, a few comments on the Fed cutting the discount rate:

They've signaled now that when they meet in September they will vote to move the Fed fund rate down for the first time in a very, very long time and it's long overdue. What I've learned in a mere 35 years of watching the Fed is that when the Fed changes direction it moves in that new direction for a long period of time and takes rates much farther than anyone wants to anticipate.

Will they move in December? That's not the important question.

The important question is that their next move, after they ease rates in September, will be to ease again. The move after that will be to ease again and the move after that will be to ease again. You can rest reasonably assured that the Fed funds rate will be markedly lower a year from now than it is now.

On his overall investment outlook:

Right now I am short of stocks, and got that way yesterday, and I am long of gold, and I intend to stay that way. I think the Fed has responded to disconcerting economic news by easing monetary policy and that disconcerting news in the mortgage market is not going to go away anytime soon.

A 25, 50, 75, or 100 basis point decline in Fed funds is going to be a very immaterial consequence to the reset home mortgage owner who's watching his teaser rate go from say, three percent to eight percent. Maybe it goes from three percent to seven percent, but that's not going to stem a large sum of foreclosures in the mortgage market next year.

The Fed has a big job ahead of it to take care of that problem.

On the outlook for gold:

I've been bullish on gold for some period of time simply because of reserve adjustments by the Central Bank of China and the Central Bank of India, Thailand, and Malaysia, all of whom are running large trade surpluses. They find themselves with rather more reserves of euros and dollars than they would like and rather fewer reserves of gold than those held by the central banks of the industrialized world, so they're going to be moving in that direction.

Just last week over at the investment website, Iacono Research, the same observation was made when looking at recently announced central bank sales and overall reserve statistics.

The price of gold has been resilient in recent weeks amid stepped up gold sales by central banks at a time when credit market turmoil seems to be spreading like wildfire. The historically strong Indian buying season will begin in about a month - Indians are, by far, the largest consumers of the metal, making most of their purchases in the fall, prior to the winter wedding season.

Last week it was reported that the Bank of Spain sold an additional 25 tonnes of their gold reserves in July after previously dumping 122 tonnes in this, the third year of the current CBGA. The Spanish Central Bank has been, by far, the largest seller of gold reserves this year and now holds just over 300 tonnes.

Some time ago, some economist somewhere determined that "prudent" central banks should keep 15 percent of their reserves in gold bullion - this is the closest thing to a rule of thumb I've heard and it is the approximate average of ECB member banks. Looking at the table to the right, you can see that Spain may have more to unload along with a few other European countries.

The more significant point to be gleaned from the table, however, is that if Asian central bankers were to develop such Western prudence, they would consume all the gold that the Europeans could offer - China could take all of the U.S. gold reserves and still not be at 15 percent.

This is certainly food for thought and adds to the bullish argument for gold.

Central banks and their gold, here in the early 21st century, is just a fascinating topic.

Do you think western economists and central bankers snicker when the bullion they are selling is scooped up by the central banks of emerging economies?

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There's that word again - 'unprecedented'

On Friday, Countrywide shuttered its Alt-A loan origination center and today it was Capitol One (NYSE:COF) doing the same. About 1,900 Capitol One employees where told where to pick up cardboard boxes and what time to meet for the "de-orientation" meetings.

Do they do those in the mortgage business?

They were all the rage back in 2001 and 2002 after the internet bubble burst

The Associated Press reports on the unprecedented use of the word "unprecedented", in the ongoing mortgage lending mess that just doesn't seem to want to get any less messy.

Capital One said it will shut down GreenPoint Mortgage and eliminate most of the jobs by the end of year. The company will "cease residential mortgage origination" effective immediately and close GreenPoint's Novato, Calif., headquarters and 31 locations in 19 states.

The company said it will honor commitments to customers with locked rates who have loans already in the pipeline.

"Over the past few months, we have experienced an unprecedented disruption in the secondary mortgage markets," Capital One Chairman and Chief Executive Officer Richard D. Fairbank wrote in an internal memo to employees. "I made the decision to wind down the business with a heavy heart."

GreenPoint specializes in no-documentation and Alt-A mortgage loans for borrowers with slightly better credit than subprime borrowers. In his memo, Fairbank said that market has seen a "significant reduction in liquidity and continuing volatility."

The Wall Street Journal also reported($) on the layoffs, noting a slight variation on the usage of the word.

Chairman and Chief Executive Officer Richard D. Fairbank said in an internal memo Monday to employees that the decision was "the function of an unprecedented set of market circumstances."

Each day this looks more and more like the bursting of the tech bubble - a Pets.com sock puppet showed up on CNBC today when they were talking about this latest layoff.

Full Disclosure: No position in Capitol One at time of writing.

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Chart of the week

It's not clear what can be learned from the chart below, but this is something that I've wanted to whip up for some time now - it's very colorful.

Note that there were major changes to the way inflation was calculated in both 1983 and 1996 and M3 statistics are estimated for 2006 since the Federal Reserve stopped publishing this data series.

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The rest of the world buys gold

A recent World Gold Council (WGC) report on gold supply and demand around the world resulted in some fascinating summary statistics as reported by the Middle East-North Africa Financial Network.

During the second quarter, gold demand soared in some parts of the world - in other parts of the world it did not.

• Saudi Arabia: +30 percent
• UAE: +15 percent
• Egypt: +9 percent
• Turkey: +15 percent
• China: +32 percent
• Russia: +27 percent
• U.S.: -4 percent

These figures are all based on year-ago levels when the price of gold was rising dramatically. Overall demand in 2006 didn't really fall off until after the price surge in the spring, so the year-over-year comparisons for the third quarter may be even more impressive.

Gold Demand Surges 30% in Saudi Arabia
Strong economies and stable prices in the Middle East region (Saudi Arabia, UAE, Kuwait, Bahrain, Oman, Qatar & Egypt) increased gold demand by 20 percent to 97.5 tons in the second quarter of this year, the World Gold Council (WGC) report released on Wednesday said.

In Saudi Arabia, Umrah pilgrims and tourists pushed up gold demand by 30 percent in the second quarter of this year compared to same period in 2006.
...
The WGC report said global demand for gold jewelry jumped 37 percent in the second quarter to reach a record $14.5 billion.

The figures, compiled independently for WGC by Gold Fields Mineral Services Limited (GFMS), showed total identifiable demand made a substantial recovery in the second quarter of this year, rising 19 percent in tonnage terms compared to the same period last year reaching $19.8 billion or a 27 percent increase in value terms year-on-year. Total demand reached 922 tons.
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Moaz Barakat, WGC's managing director in the Middle East, Turkey & Pakistan, said in a press statement: "We are pleased to report a very strong second quarter with demand for gold reaching unprecedented levels in a number of markets. A reduction in price volatility in 2007 has resulted in increased consumer confidence and, coupled with greater industry marketing activity, led to record levels of gold jewelry purchases in the region and globally in dollar terms."

The booming global economy was surely a big factor in the increased demand and, after the price surge in 2006, gold in the $600-$700 range must look cheap by comparison. Just as U.S. consumers have become accustomed to higher gasoline prices, in other parts of the world, consumers have become accustomed to higher gold prices.

Weird, huh?

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A revolving door at Countrywide

Not more than two weeks ago, Countrywide Financial (NYSE:CFC) began hiring laid off workers from other mortgage lenders who, for one reason or another (usually something bad), didn't need as many employees anymore.

Earlier today, it was reported that some of these "new hires" may not have stuck around long enough to even get a look at their new Countrywide business cards.

Countrywide laying off loan-origination staff: WSJ
SAN FRANICSCO (MarketWatch) -- Countrywide Financial Corp., reducing costs as part of its effort to weather a credit crunch, has begun laying off employees involved in originating loans, according to a media report Sunday.

The layoffs occurred in the company's Full Spectrum Lending unit, which handles many home mortgages in a category known as Alt-A, or mortgages between prime and subprime that often involve borrowers who don't document their income, The Wall Street Journal reported in its online edition, citing a Countrywide internal email.

The email, sent to employees Friday by a Full Spectrum senior official, discussed layoffs made that day but didn't specify the number, the Journal reported.
The company as a whole employs about 61,000 people and had a sales force of about 6,800 in Full Spectrum out of a total loan-origination sales force of about 18,000 as of June 30, the Journal reported, citing a filing with the Securities and Exchange Commission.

It sounds like that might be the end of the Alt-A loan business as we knew it. Who'd have thought that lending money to people who provide no documentation on how they were going to pay it back would turn out to be such a bad idea?

Interestingly, the original story($) at the Wall Street Journal had this nugget.

An auction of about 135 foreclosed homes in San Diego Saturday provided more sobering news for mortgage lenders. Ramsey Su, an investor and former real-estate broker who attended, calculated that the high bids for the homes averaged 67% of the prices they fetched when they were last sold, mostly in 2004 or 2005. At a similar auction in San Diego in May, the average was 73%. The auction was held by Real Estate Disposition Corp., Irvine, Calif., which promotes such sales on the www.usahomeauction.com Web site. REDC officials couldn't be reached to comment.

Ouch!

Full Disclosure: No position in Countrywide at time of writing.

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His predecessor overshot the mark

This commentary from The Economist says all the right things about the job Fed Chairman Ben Bernanke has been doing and what lies ahead for him. As it relates to interest rate cuts, the advice is to stand firm.

Investors should think twice, however, before assuming that Mr Bernanke will soon act to reduce the federal funds rate. While perspective may be in short supply on Wall Street, it is the job of the Federal Reserve to look beyond the behaviour of a limited sub-sector of the economy during a short timeframe.

It is not the Fed’s job to shield financial actors from risk, and Mr Bernanke no doubt realises that his credibility is at stake

While mortgage lenders and financial institutions heavily invested in American mortgage securities have struggled mightily, recent reports from the broader economy have been anything but uniformly negative. Employment numbers have held up even as home construction has collapsed. For the moment, conforming mortgages remain stable and large firms unconnected to the home-mortgage market have yet to experience serious trouble. Moreover, financial markets remain in positive territory for the year, despite the past week’s gyrations.
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It is not the Fed’s job to shield financial actors from risk, and Mr Bernanke no doubt realises that his credibility is at stake. If a quick rate-cut touched off a renewed episode of inflation, it would be difficult for the Fed to rapidly reverse course. Mr Bernanke must also be acutely sensitive to the common criticism that his predecessor, Alan Greenspan, overshot the mark by dropping the federal funds rate to 1% in the wake of the downturn of 2001, thereby encouraging the markets into a renewed phase of exuberance.

Mr Bernanke is well aware of the hats that belong to him and the ones that do not. If broader indicators begin to show weakness spreading throughout the economy, then the Fed may act to ease a forthcoming downturn. But do not expect Mr Bernanke to bend to the demands of overextended investors suffering through short-run volatility. As the chairman knows well, he must always keep a cool head even as others lose their shirts.

If only it were that simple.

ooo

This week's cartoon:

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