European Vacation

I'll be in Scotland for a few weeks - look for the next post on May 1st.

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Past, Present, and Future

They were all in the news in the last few days - Paul Volcker, Alan Greenspan, and Ben Bernanke - the past, present, and likely future Chairmen of the banking cartel more commonly known as the Federal Reserve. Volcker was screaming at the top of his lungs "Somebody do something - Now! Before this thing explodes!". Greenspan was pondering his legacy, while at the same time trying to distance himself from the GSEs. And, young Ben was just giddy - with the prospect of hanging out with Dubya and Dick and the rest of the Bush economic dream team, until it's time for him to take the con at the FRB and show us what he really meant when he said "helicopter money". Let's recap.

Paul Volcker (Fed Chairman from 1979 to1987)

So , what did Mr. Volcker have to say this week? Let's see ... last year he said "unless America changes course, there is a '75 percent' chance of an economic crisis in the next five years". This due to various global imbalances - international trade, savings rates, currency ... you know the story. Has his view changed at all in recent months? Well, I guess yesterday's Washington Post article An Economy On Thin Ice answers that question:

"Yet, under the placid surface, there are disturbing trends: huge imbalances, disequilibria, risks -- call them what you will.Altogether the circumstances seem to me as dangerous and intractable as any I can remember, and I can remember quite a lot. What really concerns me is that there seems to be so little willingness or capacity to do much about it."

Uh ... Paul, this is the second paragraph, and you're like, all gloom and doom already - come on, flip on CNBC or one of those swell Fox business shows, and get with the program. Baby boomers not saving, spending like there's no tomorrow, home ownership as a vehicle for borrowing ... la la la la la la la - I'm not listening.

Now, about half way through, Paul seems to come to his senses a bit:

"Some, such as China, depend heavily on our expanding domestic markets. And for the most part, the central banks of the emerging world have been willing to hold more and more dollars, which are, after all, the closest thing the world has to a truly international currency."

Yes, that's right - we are the hegemon, they need us, they would be nobodies without us - Japan, China, South Korea, and the rest of them. And, this will go on for as long as we say so ... end of story ... you can stop now.

"The difficulty is that this seemingly comfortable pattern can't go on indefinitely ... The clear lesson I draw is that there is a high premium on doing what we can to minimize the risks and to ensure that there is time for orderly adjustment. I'm not suggesting anything unorthodox or arcane. What is required is a willingness to act now -- and next year, and the following year, and to act even when, on the surface, everything seems so placid and favorable. What I am talking about really boils down to the oldest lesson of economic policy: a strong sense of monetary and fiscal discipline."

Well, you've really gone off the deep end now - you should have stopped when you were talking about how great we are compared to those Asian fellas. Not sure where you're going with this - "willingness to act now", "monetary and fiscal discipline"? I've read about this stuff ... just what decade are you from man? Oh, that's right, you're the guy who raised interest rates to about 20% back in the 80's when we had out-of-control oil prices, gas prices, and housing prices, and gold was like $800 an ounce ... uh ... but this is completely different now.

Alan Greenspan (Fed Chairman from 1987 to 2006)

Last week, almost the entire week was devoted to Alan Greenspan (see links above and to the right) - oil, Fannie and Freddie, consumer credit. To summarize: oil - hopefully not a problem, Fannie and Freddie - maybe a problem, and consumer credit - just can't get enough of the stuff. OK, done - now let's dig a little deeper, take a look back, see if we can figure out what Volcker's all bent out of shape about.

What can you really say about the last eighteen years - about the credit and money creation machine that has been built during the Greenspan years? In the mid nineties, we were helping to save the rest of the world from one financial crisis after another. Then in the late nineties, all of Wall Street was getting rich through the miracle of rising asset prices (equities this time) and traders worshipped little Greenspan dolls before the opening bell - Stuart and his boss "lit the candle" which was his new Amertrade account.

Never being able to identify an asset bubble while it was forming, the equities mania of the late nineties, that culminated in the bursting of the Nasdaq bubble in 2000, morphed with relative ease into a bubble in a different asset class (real estate this time). Real estate prices have been rising parabolically in the last few years, much like equities did years before. Although recently there has been an acknowledgement of "signs" of a housing bubble in "some areas", it's clear that in many parts of the country houses are being flipped like dot.com shares and pre-construction sales have taken the place of internet IPOs.

Interest rates at historically low levels, liquidity like Niagra Falls, and nary a sign of inflation (until recently), or trade deficit problems (until recently), or budget deficits problems (until recently). Eighteen years of unprecedented economic expansion, prosperity, wealth creation, and ... money creation.

That's right, none of this would be possible without pushing what was then a surprisingly respectable, pure fiat currency system left by Paul Volcker, to its maximum potential, using ever shrinking reserve requirements, ever lower interest rates, and other stuff like this and this that no one is supposed to know about. With one Asian country after another selling us cheap, high quality consumer goods to keep measured inflation at reasonable levels, it was a no brainer - just keep lowering interest rates for 18 years and see how many friends you can make!

No wonder Paul Volcker sounds a little bitter these days.

Volcker put an unstable pure fiat currency system back onto a path that could be sustained for some period of time - he brought on the pain, only to be upstaged when the Greenspan money creation circus came to town.

For the last deade or so, Greenspan has fooled many of us, but he certainly hasn't fooled these two men - Kurt Richebacher:

"In actual fact, in the past few years, the Greenspan Fed has systematically and deliberately fostered parabolic credit and financial excess with the explicit purpose of inflating asset prices. What manifestly is duping most people is the fact that the bulk of the credit excess poured into asset prices and the soaring trade deficit, rather than into the CPI, as had been usual."

And Hans Sennholz:

"The popular notion that an increase in the stock of money is socially and economically beneficial and desirable is one of the great fallacies of our time. It has lived on throughout the centuries, embraced by kings and presidents, politicians and businessmen. It has shattered numerous currencies, inflicted incalculable harm, and caused social and political upheavals. It springs forth again and again, no matter how often economists may refute it. American statisticians and economists want to make us believe that America is a new-paradigm exception in this respect, being miraculously able to generate unprecedented productivity growth with zero savings and record low fixed business investment. The consensus readily believes it. For us, this is macro economic rubbish"

Many more will write about the Greenspan Fed this year and next - expect to hear more from Paul Volcker as Greenspan's retirement draws nearer.

Ben Bernanke (Fed Chairman from 2006 - ?)

Ben hasn't been talking much lately - this is the quiet period before his public offering to Congress in the form of confirmation hearings for the post of White House Council of Economic Advisers. He is considered the favorite to become the new Federal Reserve Chairman next year, but first he needs to spend some time at the White House, where the economic future of the civilized world is being meticulously planned. The whole idea of borrowing money from the rest of the world to goose the stock market for the next decade (also known as Social Security reform) doesn't seem to be getting the traction that it needs - perhaps Ben can help with that.

But, Ben needs to be careful as he speaks more in public as part of his new duties at the White House - after many years of Greenspan Fedspeak, there is a danger of Ben stumbling out of the gate, saying something that might be misinterpreted, and having a destablilizing effect on markets:

"Bernanke possesses one credential crucial for any Greenspan replacement: The ability to translate econo-speak into plain language. "Bush is going to want to appoint someone who can sit down with him and speak in a language he understands," Beach said."

I'm not sure that's such a good idea - plain language about this economy from top government officials - using an approach of "simple solutions to complex problems" that has worked so well in foreign policy these last few years. Will this work when it comes to today's economy ... instead of nuances and hedges and equivocations that we've all gotten used to in the last eighteen years? Better think about that a bit.

Well, we'll have lots more to say about Mr Bernanke in the coming months, as the retirement party planning gathers pace. Ben will surely try to rid himself of his "helicopter money" label and we'll see just what he has in store for us after he starts work at the White House.

It does seem strange, though, when you look at the state of affairs when Volcker turned things over to Greenspan in 1987, versus what things will probably look like in less than a year, when Greenspan calls it quits - they say timing is everything, and Ben will probably learn that lesson the hard way.

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Hat Trick!

Greenspan Week concluded on Friday when the Chairman spoke about Consumer Finance at the Community Affairs Research Conference in Washington. CNN/Money neatly summarized the message in their headline Greenspan: More credit is a good thing, but they left out the most important, and most disturbing parts of the speech.

For those who say that the Federal Reserve controls interest rates and liquidity only, and that it has little or no influence on where the money goes - read on. Amazingly, in this speech, sub-prime lending is presented as a great success story, not a potential problem - the potential problem, as identified here, is that too many people are being excluded from acquiring credit!

"Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending; indeed, today subprime mortgages account for roughly 10 percent of the number of all mortgages outstanding, up from just 1 or 2 percent in the early 1990s."

So, Ameriquest is good for America - that's the message. Has he read any of the newspaper accounts about how sub-prime borrowers are surprisingly clueless about all things financial, and that, many of them, when they are told that they can have that nice house down the street, that they just sign on the dotted line?

"For some consumers, however, this reliance on technology has been disconcerting."

Disconcerting in that lenders are extending credit to people who ten years ago would never, ever been extended credit? No ...

"Consumer advocates contend that the lack of flexibility in the models can result in the exclusion of some consumers, such as those with little or no credit history, or misrepresentation of the risk that they pose."

You see the real problem is that some consumers are excluded or charged too high an interest rate - we must find a way to allow more people to borrow more money ... amazing.

"Home ownership is at a record high, and the number of home mortgage loans to low-and moderate-income and minority families has risen rapidly over the past five years."

Yes, the foundation for the house of cards we call the housing boom consists of lower income and minority families, many of them sub-prime borrowers, who are achieving the American dream that they once thought was impossible - making first time home purchases of overpriced real estate with loans that they do not really understand ... the most marginal of all borrowers seizing the day.

"The more credit availability expands, however, the more important financial education becomes. In this increasingly competitive and complex financial services market, it is essential that consumers acquire the knowledge that will enable them to evaluate products and services from competing providers and determine which best meet their long- and short-term needs."

Yes, we live in an ownership society and we must all educate ourselves - acquire the knowledge to evaluate different and better ways to go further into debt. Maybe as part of this educational process, people will at some point learn that while they thought "ownership society" meant owning their home - what it really means is owning the debt.

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Greenspan Reloaded

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

Well, what did he think was going to happen?

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

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

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

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

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

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

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Light Sweet Greenspan

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

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

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

is reduced to a more digestible form such as this:

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

and the money line is simply quoted:

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

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

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

Two other things of note:

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

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

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The Mailman and the Housing Bubble

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

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

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

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

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

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

Perhaps some good will come of this.

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Snow Job!

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

Department of Treasury
FROM THE OFFICE OF PUBLIC AFFAIRS

April 1, 2005
JS-2351

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

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

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

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

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

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

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

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

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

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