The Mess That Greenspan Made: 2008-08-31

Friday afternoon banking update

Friday, September 05, 2008

Let's see, it's Friday afternoon. What's the banking world up to? No commercial bank failures yet, though it's still early. Oh, here's some news:
IMAGE NAME So much for Hank Paulson's Bazooka vs. Peashooter theory on how to save the mortgage giants. The original WSJ report is available in the public section of their website.

Some highlights:

Precise details of Treasury's plan couldn't be learned. The plan is expected to involve a creative use of Treasury's authority to intervene in the two companies, which it won earlier this year, and could involve a capital injection into the beleaguered giants.

The plan also includes a management shakeup at both companies, according to one person familiar with the plans. Daniel H. Mudd, chief executive of Fannie Mae, and Richard Syron, his counterpart at Freddie Mac, are expected to step down from their posts.
...
On Friday afternoon, Messrs. Syron and Mudd were summoned to a meeting at the offices of the agency. Also attending were Mr. Bernanke and Treasury Secretary Henry Paulson.

The meetings Friday were in part aimed at getting Messrs. Mudd and Syron to agree to the plan, though their approval was not necessary, these people said.

Mr. Mudd arrived for the meeting at 2:50 p.m., flanked by the company's general counsel, Beth Wilkinson, and Rodgin Cohen of Sullivan & Cromwell, one of the country's top banking lawyers. A few minutes later, Mr. Bernanke followed with security escorts.

"We are making progress on our work," said Treasury spokeswoman Jennifer Zuccarelli, who declined to comment further. Spokesmen for Fannie and Freddie declined to comment on the expected Treasury moves.

Look's like he's going to have to use the Bazooka.

The dollar and commodity prices: someone please explain

Time and again you hear things like, "In commodity markets today, a stronger dollar pushed oil and gold lower...", and everyone seems to accept that relationship as if it were somehow a law of nature. As if it were causation rather than correlation.

But, does it make any sense?

The commonly heard explanation is that commodities such as crude oil and gold are denominated in dollars on commodity exchanges around the world, so when the dollar strengthens against other paper money, these commodities become more expensive in terms of other paper money, making them less appealing.

But does this even make any sense?

While it may be true over a period of hours or days, over weeks or months, it is certainly not true. For example, if you bought an ounce of gold on August 1st using euros, this would have cost you 590 euros, since gold sold at about $915 per ounce and one euro could be exchanged for $1.55.

At the moment, that same ounce of gold would cost just 560 euros ($800 per ounce with the euro at $1.42) meaning that since the time that European traders sold gold because it was getting too expensive, it has actually become five percent cheaper.

Looked at another way using the PowerShares US Dollar Index ETF (UUP) along with the iPath Crude Oil ETN (OIL) and the SPDR Gold Shares ETF (GLD) in the chart below, in the last seven weeks, the trade weighted dollar has gained about eight percent versus other freely traded currencies while the price of oil and gold have fallen more than double that amount.
IMAGE NAME A one-to-one relationship might make sense, but to say that the dollar rose by x percent and, as a result, oil and gold fell by 2x or 3x percent doesn't make sense.

The idea that the dollar is strengthening against the euro, the pound, and other currencies because their economies now look to be getting much weaker, much faster than the U.S. economy which will result in lower demand for commodities makes a lot of sense, though only the brighter reporters in the mainstream financial media seem to make this connection with near the regularity of the dollar up/commodities down meme.

But even this argument works only when economies, in general, are weakening.

If, for example, the global economy was booming and growth in the U.S. surged, this would cause the dollar to rise against other currencies, but would this be a signal for commodity prices to be pushed lower?

Perhaps someone could enlighten me on the relationship between the dollar and commodity prices which, in the past, I've referred to as nothing more than a "Pavlovian" response by traders which, incidentally, didn't work out so well in 2005 when both the dollar and commodity prices rose.

Importantly, note that 2005 was the only year of the last six when the dollar rose.

Just wait til they revise the data

If you think the recent jobs data looks bad now, wait until they do the revisions - the birth death model shows a net creation of almost a million jobs over the last year, many of which are not likely to persist when they begin looking at real data. As it is, year-over-year job growth is now plunging headlong into negative territory.
IMAGE NAME The Labor Department reported a decline of 84,000 for nonfarm payrolls in August including downward monthly revisions for June (from -51,000 to -100,000) and July (from -51,000 to -60,000).

Also making news was a five year high in the unemployment rate at 6.1 percent.

As usual, job creation in health care and government provided some support to the overall jobs picture with manufacturing and professional and business services leading the way down. Job growth for food services and drinking establishments, a stalwart in recent years, yielded only 2,300 new positions.
IMAGE NAME It appears that temporary help is being reduced at accelerated rates, employment services payrolls reduced by 54,000 in August and temporary help (a subcategory of employment services) letting go a net 37,000 workers.

Fed funds futures now reportedly indicate a chance of a short-term interest rate cut sometime in in 2009.

Friday morning links

Maybe economic theory is wrong

Thursday, September 04, 2008

In looking up some data for the previous post on initial jobless claims, this little FAQ about the Consumer Price Index was stumbled upon at the Labor Department. It doesn't say how long it's been there, but it was apparently updated today.

Here's the part that explains the rationale for owners' equivalent rent being included in the inflation statistics in lieu of anything having to do with actual home prices.

The CPI used to include the value of a house in calculating inflation and now they use an estimate of what each house would rent for -- doesn't this switch simply lower the official inflation rate?

No. Until 1983, the CPI measure of homeowner cost was based largely on house prices. The long-recognized flaw of that approach was that owner-occupied housing combines both consumption and investment elements, and the CPI is designed to exclude investment items. The approach now used in the CPI, called rental equivalence, measures the value of shelter to owner-occupants as the amount they forgo by not renting out their homes.

The rental equivalence approach is grounded in economic theory, receives broad support from academic economists and each of the prominent panels, and agencies that have reviewed the CPI, and is the most commonly used method by countries in the Organization for Economic Cooperation and Development (OECD). Critics often assume that the BLS adopted rental equivalence in order to lower the measured rate of inflation. It is certainly true that an index based on home prices would be more volatile, and might move differently from other CPI indexes over any given time period. However, when it was first introduced, rental equivalence actually increased the rate of change of the CPI shelter index, and in the long run there is no evidence that the CPI method yields lower inflation rates than some other alternatives. For example, according to the National Association of Realtors, between 1983 and 2007 the monthly principal and interest payment required to purchase a median-priced existing home in the United States rose by 79 percent, much less than the rental equivalence increase of 140 percent over that same period.

The approach is grounded in economic theory that may be looked back upon someday as one of the greatest blunders in the history of economics - kind of like like after the Great Depression when Austrian Economics, popular at the time, was discredited for the rest of the century.

And that last part about the National Association of Realtors - that probably needs a little looking into. Something smells awfully fishy about that conclusion.

Also see: The complete and utter failure of owners' equivalent rent

------------------------------------------------

UPDATE - Sept 4th, 10 PM PST

I was going to put this in the comments section but figured it would be better here...

I verified that OER from 1983 to 2007 has risen 140 percent.

The January 1983 median home price was $73.5K which, with a 90% LTV 30-year fixed loan at 13.25% works out to a PITI of $745 per month.

The January 2007 median home price was $254.4K which, with a 90% LTV 30-year fixed loan at 6.22% works out to a PITI of $1405 per month.

This works out to an increase of about 90 percent, which is close enough to the 79 percent figure cited by the BLS, so there's no need to call them.

This is more a story of interest rates than it is anything else and what's much, much more important than the last 25 years is the last ten years or so. It could be that OER worked well for the first ten years or so until we got "innovative" financing in the last decade. For example, a quick check shows OER increased 29 percent from 1997 to 2007 but mortgage payments increased by about twice that amount.

I'll do a follow up on this sometime soon. As long as the BLS and NAR brought this up and seemed to poo-poo the whole idea of a flawed OER, I'm now curious to see how PITI versus OER looks like over time - my guess is that you'll see a big disconnect between the two once interest rates leveled out in the late 1990s and home prices took off.

Sources:
Census Bureau Home Prices (.pdf)
Federal Reserve Interest Rates

Still just a "mental" recession

Well, if the economists and politicians don't think we're in a recession, the labor market and stock market certainly seem to be leaning that way, at least, as demonstrated by today's report on initial jobless claims and the subsequent sell-off in equities.
IMAGE NAME Tomorrow's labor report should be a barrel of fun.

Inflation "nutters" and financial tsunamis

Paul McCulley and Bill Gross at Pimco are on quite a roll so far this month.

The duo write widely read monthly commentaries that appear around the first of the month and, given their latest offerings, they were probably both chomping at the bit earlier this week, perhaps bickering over which one would appear first.

It really wasn't a close call. Coming off of the heels of last year's coinage of the term "shadow banking system", now in broad usage, McCulley seeks to recharacterize Federal Reserve inflation hawks as something less flattering.

After attending the Kansas City Fed's annual Jackson Hole Symposium, McCulley penned In the Fullness of Time, taking aim at the "inflation nutters" (a.k.a., inflation hawks) at the Fed who can't see past (or, "through" would probably be a better word) their inflation data, failing to "get" the underlying problems in the U.S. and world economy.

The hawks scream that the Fed must tighten sooner rather than later, so as to burnish the Fed’s anti-inflation credibility, but do so without any discussion whatsoever of the monetary policy transmission mechanism; they simply look at the negative prevailing real Fed funds rate and say it’s too damn low and should be raised.

Really, that is essentially their entire story. The only good thing about their story is that it is so easy to refute using standard macroeconomic and finance theory. But unfortunately, not even that seems to get them to shut up.

All sensible discussion of the “right” real Fed funds rate logically must begin with the proposition that the putative “neutral” equilibrium real Fed funds rate is not constant, but rather time varying, a function of financial conditions, notably whether levered financial intermediaries – conventional banks, as well as shadow banks, a term I coined last year at Jackson Hole – are ramping up or ramping down their leverage. The former will lift the “neutral” real rate while the latter will reduce it. Thus, a high Fed funds rate may not be restrictive at all while a low Fed funds rate might not be stimulative at all.

This should be a self-evident truth, but somehow, it hasn’t penetrated the gray matter of the inflation nutters, who view a negative real Fed funds rate as prima facie evidence of monetary laxity at best, and moral bankruptcy at worst. It is not.

Well, monetary laxity in the current era is a given, not even worth arguing over, really, and moral bankruptcy should probably be left to the historians. What's at issue here is looking past the inflation data in an attempt to avoid a global economic downward spiral that seems to get worse, not better, every month. Perhaps a better measure of "inflation" would help (see The complete and utter failure of owners' equivalent rent).

In There's a Bull Market Somewhere?, Gross once again advocates the use of taxpayer money to help prop up the asset-based financial economy that we have all grown to love so. Home prices that continue to fall and the dearth of new money to provide a backstop are problems that are getting worse not better.

This rarely observed systematic debt liquidation is what confronts the U.S. and perhaps even the global financial system at the current time. Unchecked, it can turn a campfire into a forest fire, a mild asset bear market into a destructive financial tsunami.
...
To ultimately stop this asset/debt deflation, a fresh and substantial new source of buying power is required. This became all too obvious as the Treasury’s attempt to entice additional capital into Freddie and Fannie came up empty. Yet this same dilemma is and will continue to confront all highly levered institutions in the throes of asset liquidation.
...
If we are to prevent a continuing asset and debt liquidation of near historic proportions, we will require policies that open up the balance sheet of the U.S. Treasury – not only to Freddie and Fannie but to Mom and Pop on Main Street U.S.A., via subsidized home loans issued by the FHA and other government institutions.
...
The bill for our collective speculative profligacy, obvious in the deflating asset markets, can be paid now or it can be paid later.

Where the Treasury gets the money is a problem left for another time, apparently.

Interestingly (and related to the question of where the Treasury gets the money), the Bond King references Jim Grant of Grant’s Interest Rate Observer to assist in answering the question posed in the title, namely, "there's a bull market somewhere?"

Mr. Grant argues that government solutions for the current economic and financial market woes, such as the ones proposed, are likely to lead to a new bull market in ... gold.

Thursday morning links

World made by hand

Wednesday, September 03, 2008

Over the last two weeks, amongst other reading material, I had the pleasure of reading "World Made By Hand" by James Howard Kunstler, also the author of "The Long Emergency", one of the many very good books about Peak Oil.

Mr. Kunstler's latest effort is a fascinating tale set in a "post-oil" world of the next decade or so which, more than anything else, resembles a 19th century world where only memories and scrap from the 20th century remain.

The book now moves on to three others who have asked for it after briefly discussing its contents. In all three cases, their reaction was the same as my own, something along the lines of, "All things considered, maybe the 19th century was better than the 20th century, particularly in light of how the 21st is shaping up so far".

It really makes you think about things you do every day in a historical context and that maybe, in the broad sweep of time, it's a good thing that the era of cheap energy may soon be over.

The detailed accounts of a how a New York community reverts back to a simpler way of life are engrossing and, while the last hundred pages will not allow you to stop until you've seen it through to the end, they contain some rather shocking developments that, presumably, were a reminder of just how harsh life could be more than a hundred years ago.

But, not surprisingly, the parts of the story that really grabbed my attention when the subject turned to money. When discussing the $5 million purchase of an old high school to house a new group settling in the community, there was this exchange.

"And what the hell is that five million going to be worth in ten years?" Ned Larmon said. "Why five thousand bucks'll barely buy a wagon wheel now."

"Fiat currency: that's what did us in," Fod Sauer said.

"I don't believe there's going to be any U.S. dollar in ten years, way things are going," Jason LaBountie said. "I do almost all barter these days, myself. Unless someone has hard silver."

In this new world, both U.S. dollars and silver serve as money with the relationship between the two being far different than it is today.

"Now, how do you boys propose to pay for your rooms and meals? Paper dollars or real money?"

"Silver coin good enough?" Joseph said.

"We take that here. Two bits each, bed and a meal. One dollar for the horses. Drinks are extra, of course."

Joseph took out a leather drawstring purse and dropped a handful of old quarters and half-dollars on the wooden bar, where they rang musically. Slavin looked impressed. Whatever the other failures of the U.S. government were, it had managed to print an excess of dollars which, combined with the collapse of trade and communication, had severely eroded the currency's value. People always liked silver better, if it was offered. Gold, on the other hand was rarely seen. People tended to hoard it.

Based on the aforementioned $5,000 wagon wheel and room and board at two bits per person (one pre-1965, 90 percent silver quarter each), I'd peg the price of silver substantially higher than it is today.

Anyone wanting to do the calculation, please leave a comment.

This is highly recommended reading and my only regret is that I couldn't get to it sooner.

And, by the way, for those of you who don't already know, Jim Kunstler writes a nice little blog titled, "Clusterfuck Nation".

Rick Santelli is making sense

This was up at Barry's Big Picture blog earlier today. It is well worth four minutes of anyone's time to better understand the current market environment.

The money quote by Santelli, directed toward CNBC's "Senior Economics Reporter" Steve Liesman appears about three minutes in, "The reality of making money is different than what you write in a textbook".

This is an all too common problem for economists and those pretending to be economists (i.e., the important differences between the real world and textbooks/models), which inadvertently begs the question, "Could there be anything worse than pretending to be an economist?"

Now that's really funny...

It it at times like this that you realize how difficult it would have been to just follow the simple investment advice of buying commodities in the '70s, then buying Japanese stocks in the '80s, then U.S. stocks in the '90s, and commodities again in the '00s.

We are probably only about half-way through the current secular bull market in commodities, yet with news of a high profile commodity hedge fund shutting down and twitchy traders exiting the natural resource sector en masse, you'd think it's the end of the world.

And the funny part about the recent slide in commodity prices is that much of the big move down is being attributed to a stronger dollar. The recent revelation that, during the summer of 2008, the U.S. dollar is not the worst paper money in the world has caused traders to salivate like Pavlov's dogs, pushing the sell button on all sorts of natural resource investments with no knowledge or care that underlying supply and demand fundamentals are still out-of-whack.

Of course, the current conventional wisdom is that the underlying imbalances are being corrected by "demand destruction" of biblical proportions. Despite the conventional wisdom of just a few months ago, emerging economies around the world aren't going to need all that extra energy, metal, and food after all.

They'll just go back to what they were doing in the 1980s.

Whew!

That's a relief.

Problem solved.

It used to be that new supply coming onto the market would end commodity bull markets, but apparently, this time it's different.

Thank goodness.

We've all had about enough of that $4 a gallon gasoline!

But, by far, the funniest part about the latest conventional wisdom that "a global economic recession will lead to $50 oil" is the underlying assumption that governments around the world, who have already proven to be quite adept at printing up more paper money as the need arises, are going to just sit idly by and watch things deteriorate into a 1930s style jobless rate and bread lines photographed in black-and-white to better capture the mood.

With the power to print as much money as they want to in order to try to solve as many economic problems as they can, governments around the world will simply watch as the entire planet (and nearby solar systems) slides into an economic abyss.

Now that's really funny...

Wednesday morning links

And ... we are back

Tuesday, September 02, 2008

Somehow, the words in the title above don't have the same feel as they did in years past now that Tim Russert is gone. The long-time host of Meet the Press would utter those words each time he welcomed back viewers after long commercial breaks and the same has been done here after long vacation breaks.

The time off was a welcomed diversion, but it's good to be back home - the usual schedule will resume beginning later today or tomorrow. In the meantime, there are a couple of photos to share beginning with this view of the Jasper town site from Old Fort Point.

Click to enlarge

This is a huge panorama, so you really have to load the whole image. From left to right are Mt. Edith Cavell (shrouded in clouds), the Athabasca River, Jasper, the Jasper Park Lodge (and golf course), and a supine Indian traced out by the mountain tops.

Below is Lake Louise - a sight that everyone should see.

Click to enlarge

There's lots to catch up on and we're off to Las Vegas in less than a week where I'll be speaking at the Hard Assets Investment Conference - time's really flying.

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Friday afternoon banking update

Friday, September 05, 2008

The dollar and commodity prices: someone please explain

Just wait til they revise the data

Friday morning links

Maybe economic theory is wrong

Thursday, September 04, 2008

Still just a "mental" recession

Inflation "nutters" and financial tsunamis

Thursday morning links

World made by hand

Wednesday, September 03, 2008

Rick Santelli is making sense

Now that's really funny...

Wednesday morning links

And ... we are back

Tuesday, September 02, 2008

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Friday, September 05, 2008

Thursday, September 04, 2008

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Tuesday, September 02, 2008