Per Cale: May 2008

May 31, 2008

Banks Gorging On Fed Assets

Banks continue to borrow from the Federal Reserve by the billions.

Total Fed borrowing, excluding the Term Auction Facility (TAF), is running about $30 billion per day. TAF borrowing is over $150 billion.

Fed holdings of U.S. Treasuries has plummeted.

Despite all the doom and gloom speak by Fed officials, it seems like letting banks trade bad investments for the Fed's U.S. Treasuries is bad policy. Of course it's a fantastic deal for the banks.

Source

Federal Reserve Bank of St. Louis. U.S. Financial Data.
May 30, 2008.
http://research.stlouisfed.org/publications/usfd/20080530/usfd.pdf

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Rep. Kanjorski

Remember that the Democrats were going to end the war in Iraq and lower gas prices?

Well Representative Kanjorski (D-PA), in a moment of clarity that is all too rare for politicians, admits that they "stretched the facts".

And if you were a "good student of government" you would have known that what they were saying was not true.

Silly voters. If only they were better students.

http://www.youtube.com/watch?v=Nc5lHXkrdQ8

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Greitner On Bear Stearns

New York Fed President Tim Greitner testified before the Senate Banking Committee last month. He describes the rationale for the Bear Stearns bailout.

It is a classic tale of an asset bubble bursting, which puts those who have borrowed in order to purchase overpriced assets in dire straits.

By the early part of March, the threat of a disorderly adjustment was growing.

What we were observing in U.S. and global financial markets was similar to the classic pattern in financial crises. Asset price declines - triggered by concern about the outlook for economic performance - led to a reduction in the willingness to bear risk and to margin calls. Borrowers needed to sell assets to meet the calls; some highly leveraged firms were unable to meet their obligations and their counterparties responded by liquidating the collateral they held. This put downward pressure on asset prices and increased price volatility. Dealers raised margins further to compensate for heightened volatility and reduced liquidity. This, in turn, put more pressure on other leveraged investors. A self-reinforcing downward spiral of higher haircuts forced sales, lower prices, higher volatility, and still lower prices.

This dynamic poses a number of risks to the functioning of the financial system. It reduces the effectiveness of monetary policy, as the widening in spreads and risk premia worked to offset part of the reduction in the Fed Funds rate. Contagion spreads, transmitting waves of distress to other markets, from subprime to prime mortgages and even to agency mortgage-backed securities, to commercial mortgage-backed securities, and to corporate bonds and loans. In the current situation, effects were felt in the municipal and student loan markets.

The most important risk is systemic: if this dynamic continues unabated, the result would be a greater probability of widespread insolvencies, severe and protracted damage to the financial system and, ultimately, to the economy as a whole. This is not theoretical risk, and it is not something that the market can solve on its own. It carries the risk of significant damage to economic activity. Absent a forceful policy response, the consequences would be lower incomes for working families, higher borrowing costs for housing, education, and the expenses of everyday life, lower value of retirement savings, and rising unemployment.

So according to Geithner, our banking system is so fragile that the failure of a single bank would lower incomes of working families, etc.

This is ridiculous. The best solution for a firm that is leveraged 30:1 with bad investments should be allowed to disappear with it's managers and shareholders paying the cost for their irresponsible decsions.

Would this cause losses at other banks? Yes. Would the cost of credit go up? Possibly. Would the economy collapse? No.

This shows that the Fed's primary concern is the banks and bankers.

Source

Timothy Geithner. Testimony before Senate Banking Committee.
April 3, 2008.
http://banking.senate.gov/public/_files/OpgStmtGeithner4308Testimony.pdf

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May 26, 2008

California Town Considers Secession

Residents of the town of Needles, California are considering leaving the state for either Arizona or Nevada. But they aren't leaving their town. They want their town to leave California.

Needles residents are fed up with the high taxes and slow economic growth produced by the heavy burden of state regulation.

"The building codes are stricter here, the taxes are higher," said Patricia Scott, a nurse. "I cross into Arizona and it's growing by leaps and bounds. We are the only community in the tri-state area that hasn't grown, and it's probably because we are in California."

Kohl's, Target and Sam's Club stand like beacons on the not-so-distant shore. Gas is almost a dollar a gallon cheaper across the river. Casinos beckon. Cities mushroom. And Needles slowly fades away.

The story notes that an act of Congress, literally, is required for Needles to accomplish this feat.

Source:

David Kelly. Needles casts an envious eye elsewhere.
Los Angeles Times. May 26, 2008.
http://www.latimes.com/news/local/la-me-needles26-2008may26,0,1537353,full.story

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Memorial Day - Remember

Happy Memorial Day. In between the burgers, hot dogs, and the occasional cold beverage, remember to take a moment and reflect on those who are no longer with us.

Former Navy SEAL Marcus Luttrell tells the story of some of our bravest in Afghanistan.

Luttrell's excellent book Lone Survivor is now out in paperback.

YouTube link: http://www.youtube.com/watch?v=2FPLCKdI_fs

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May 25, 2008

Global Warming Spreads To Jupiter

Maybe climate change is contagious.

Jupiter has a new red-spot storm visible in its atmosphere. This Hubble image, courtesy of National Geographic, shows a third red spot on Jupiter that is about the same width as the Earth.

Scientists estimate that rising temperatures on Jupiter are causing climate change.

The advent of yet another red spot in Jupiter's turbulent atmosphere may support the idea that the planet is undergoing climate change.

Fluid-mechanics professor Philip Marcus of the University of California predicted in 2004 that rising temperatures would destabilize Jupiter's jet streams and give rise to more vortices.

If only those folks on Jupiter would lay off the SUVs and coal-burning power plants, maybe they wouldn't have all these new hurricanes storms.

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Source
Anne Casselman. Jupiter Gains New Red Spot.
National Geographic News. May 23, 2008.
http://news.nationalgeographic.com/news/2008/05/080523-jupiter-spot-photo.html

May 22, 2008

Grammatical Follies

The blog Springbored's Springboard tries to point out a numerical inconsistency in the Navy's MV-22 program, but instead makes their own PR screw-up.

On the numerical issue, the numbers that don't add up to Springbored are a Jane's note in March that the MV-22 in Iraq had flown about 2,000 hours in three months and completed 2,000 air support requests. To Springbored, these didn't jive with a later statement in May.

Neither the number of sorties or the hours flown are inconsistent. An air support request (ASR) is not the same as a sortie and having more sorties than ASRs makes perfect sense in a counterinsurgency operation. The hours flown is also consistent - 2,000 hours in 3 months is an average of 667 hours while the May quote mentions the busiest month of the first seven months had 700 hours flown.

Springbored's folly is the final paragraph:

Argh. Does anybody associated with the MV-22 program ever get their info right? This is, again, the kind of PR screwup that looses a program credibility. Fix it.

Using the word loose in place of the word lose - now that's the kind of PR screw-up that loses credibility!

http://springboarder.blogspot.com/2008/05/mv-22-osprey-numerical-follies.html

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May 21, 2008

Vegas Starbucks Prices

If you are heading to Las Vegas (a.k.a. Crane Vegas) this summer, the good news is that there is no shortage of Starbucks. Many of the hotels on the Strip have more than one.

But don't expect the same prices as your local Starbucks.

This is an example of what you can expect to pay for your daily latte. This was from the store in the MGM in May.

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Bankers At The Pig Trough

Bankers lined up again for Fed loans.

This week, the Fed auctioned off another $75 billion as part of its Term Auction Facility (TAF). The Term Auction Facility is a mechanism where banks can exchange, well, let's say, less-than-shiny "assets" as collateral for a loan of shiny assets that have a positive return.

The $75 billion offered was not enough to meet demand. Banks submitted requests for over $84 billion in loans.

Last month, the two TAF auctions were $50 billion apiece. This month, both auctions were $75 billion apiece. This suggests that the credit crisis is not yet improving.

These 'loans' mature on June 19.

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Source:

Federal Reserve Board. TAF Auction Results.
Press Release. May 20, 2008.
http://www.federalreserve.gov/newsevents/press/monetary/20080520a.htm

May 20, 2008

Bank Balance Sheet Shampoo

The banks have gorged on too much debt for years. Now reality has set in.

Banks and securities firms, reeling from record losses resulting from the collapse of the mortgage securities market, are failing to acknowledge in their income statements at least $35 billion of additional writedowns included in their balance sheets, regulatory filings show.

Citigroup Inc. subtracted $2 billion from equity for the declining value of home-loan bonds in its quarterly report to the Securities and Exchange Commission on May 2 without mentioning the deduction in the earnings statement ¹

Complicit accounting rules allow the banks to writedown a bad asset (like a mortgage-backed security) and take the hit either on the income statement or the balance sheet.

Total asset impairment is estimated at over $300 billion. And it's not over yet.

The balance-sheet adjustments are in addition to $344 billion of writedowns and credit losses already reported on the income statements of more than 100 banks. ¹

Banks are continuing to raise capital from wherever they can in order to stay solvent as their bad investments decline in value. They are selling ownership, cutting dividends, tapping government credit, and issuing new shares.

Jeffrey Rosenberg of Bank of America likens this writedown then raise-capital cycle to bathing -

"It's like shampooing: lather, rinse, repeat -- write down, raise capital, repeat,''

Banks are shampooing, but it's shareholders and taxpayers that are taking a bath.

Source
1. Yalman Onaran. Banks Keep $35 Billion Markdown Off Income Statements.
Bloomberg. May 20, 2008.
http://www.bloomberg.com/apps/news?pid=20601109&sid=aRict1yTdiBo

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Leading Indicators Show No Signs of Improvement

We're not out of the woods yet.

Source

Asha Bangalore. Index of Leading Indicators ñ Premature to Rule out Recession.
Northern Trust. May 19, 2008.
http://web-xp2a-pws.ntrs.com/content//media/attachment/data/econ_research/0805/document/dd051908.pdf

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Previous Recessions Began With Positive GDP

From David Rosenberg of Merrill Lynch -

Recession is a reality, in our view, and yet it remains a hotly contested debate on Wall Street, simply because headline GDP was positive in the first quarter. Recessions officially started in Q1 1980 and Q3 1990, and both quarters saw a real GDP increase, not decline. The contraction came the following quarter, which is what we expect to happen this time. Not only that, the initial GDP report in the first quarter of 2001 (the onset of the last recession) was an estimated +2% at an annual rate in the Advance report, but has since been revised to -0.5%.

...in the last six months, aggregate hours worked have fallen at a 0.9% annual rate. This has always been a recession statistic and is actually more negative now than it was at the onset of the 1990 and 2001 downturns.¹

Source
1. David Rosenberg et al. Macro viewpoint: What has surprised us ... and what hasn't
The Market Economist. May 16, 2008.
http://www.realclearmarkets.com/The%20Market%20Economist%2004%2016%2008.pdf

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May 19, 2008

How Long Until a Rate Increase?

The Fed continues to hope that a slowing economy will subdue inflation. They have cut the target interest rate to a low level. At some point, they will have to raise it to fight accelerating inflation.

Note that the last time the Fed dropped the target rate significantly below the 2-year Treasury rate was during the recession of 2001.

The gray area on the chart indicates a recession. The official dates of the start of the current slowdown/recession will no be determined for some time. We may be in a gray area already; we just don't know it yet.

In 2004, the Fed was slow to raise rates, pumping excess liquidity into the economy. If Treasury yields move toward 3% or higher, watch to see how quickly the Fed follows with the target rate. Don't expect a repeat of 2004.

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May 18, 2008

Housing Crisis Will Last To 2010

According to a report by David Rosenberg of Merrill Lynch, the outlook for housing inventories may not improve until 2010.

Inventory situation has gone from bad to worse

The Census Bureau’s all-inclusive inventory data were released for the first quarter and showed that the total number of single-family and condominium units that are vacant and for sale rose 4.5% or at a near-20% annual rate – for the second quarter in a row – to a record 2.277 million units...At current sales rates, it would take almost two years to absorb that excess inventory backlog. Alternatively, single-family housing starts will have to slide a further 25% from their already-depressed levels and test their all-time lows of around 500,000 and stay there for a good four years. Either way, we are probably much further away from the bottom in starts and prices than is generally perceived – judging by the intractable unsold inventory backlog, the downturn could well last through to 2010. ¹

Keep watching those inventories.

Source:
1. David Rosenberg. Macro viewpoint: Debunking five myths.
The Market Economist. May 9, 2008.
http://www.realclearmarkets.com/The%2520Market%2520Economist%252005%252009%252008.pdf

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May 15, 2008

The Housing Bubble - Origins and Outlook

The San Francisco Fed has a good presentation on the current state of the housing mess.

Although the "lessons" from the housing bubble are typically understated:

Inadequate risk management by many sophisticated institutions.
Shortcomings in financial supervision and regulation.

In recounting the origins of the bubble, SF Fed President Janet Yellen does acknowledge the correct root cause of the crisis:

How did such a situation come about? To my mind, it represents a rapid and disruptive unwinding of a bubble-like situation that had developed in credit markets over a number of years. At the time, many observers noted that the world appeared to be “awash in liquidity.” The “bubble” was characterized by very low long-term real interest rates. ¹

Liquidity created by the Fed and interest rates set by the Fed.

There were other causes as well, including banks selling dubious financial products, off-balance-sheet shenanigans, banks setting overly lenient lending standards, and irresponsible borrowers gorging on too much debt.

In the panic to limit the effects of the bubble bursting, the Fed has committed about 45% of it's assets to keeping the banks solvent. Or in the words of Ms. Yellen:

Significantly, the Fed was compelled to open the discount window to investment banks because of the outsized risks some took and their significant interconnectedness with the financial market infrastructure.¹

The Fed felt compelled because they feared that the failure of a single large bank would tip the entire banking system into the "cascading cross defaults" scenario that Greenspan warned about during the LTCM² debacle.³

Such a public financial disaser would likely endanger the Fed's place of privilege and the careers of Fed officials.

Just today, Bloomberg reports that direct loans from the Fed to banks hit an all-time record last week.

I still don't see how it is good for the taxpayers to (indirectly) shovel money at banks that made terrible business decisions. Shouldn't these firms be allowed to fail? Isn't that part of the creative destruction that makes capitalism work so well? Well, yes, but then again, the Fed has never been very tolerant of capitalism.

So where do we go from here?

There will probably be even more Fed assistance to banks, but the majority of that lending has probably already been accomplished.

Banks will continue to write down bad assets. According to Bloomberg, we are up to $335 billion since the beginning of 2007.

In the short term, expect the average price-to-rent ratio to continue to decline. The most likely scenario is a decline below the mean before a recovery will take place.

Keep watching those housing inventories.

Source

1. Yellen, Janet. Credit, Housing, Commodities, and the Economy.
Speech to the Chartered Financial Analyst Institute. May 13, 2008.
http://www.frbsf.org/news/speeches/2008/charts.pdf

2. Long Term Capital Management. See http://en.wikipedia.org/wiki/Long_term_capital_management.

3. Greenspan, Alan. Private-sector refinancing of the large hedge fund, Long-Term Capital Management.
U.S. House Committee on Banking and Financial Services. October 1, 1998.
http://www.federalreserve.gov/boarddocs/testimony/19981001.htm

Charts courtesy of Janet Yellen's presentation.

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May 13, 2008

Crane Vegas

If you're planning on visiting Las Vegas this summer, make sure to bring your friends who love construction and those insanely tall cranes.

Construction of the new City Center.

Construction of the new City Center just south of the Bellagio is going full steam. Lots of noise and dust to go along with the too-narrow makeshift sidewalk on the west side of the Strip.

More City Center.

Across the street there is a section of lovely shops, pictured below. But at least the sidewalk is much wider, which makes it easier to get around those large, slow walking tourists.

Yet despite the troubles, Vegas is still a great place to visit, encompassing simultaneously the best and worst of the human condition.

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May 10, 2008

Where House Prices Are Falling

Not surprisingly, the locations with the highest increases in home prices over the last several years are now experiencing the largest declines in price.

http://www.federalreserve.gov/newsevents/speech/Bernanke20080505a.htm#ip1

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Las Vegas Tips Declining

Tip income for hospitality workers is slipping in Las Vegas.

The Sun estimates that 10% of Vegas labor force earns tip income. But that segment has seen a substantial drop in tip income, as well as an overall decline in tourist traffic. ¹

According to one salon worker -

The housing (problem), that is what is really hurting us. The people who were buying big houses with lots of money, they don’t come.¹

Earlier this week, Countrywide (CFC) frozen over 600,000 home equity lines of credit in Las Vegas and other markets, including Los Angeles, and Chicago.²

Chart courtesy of Stockcharts.com

I will be in Las Vegas next week with a report from the Strip - more to follow.

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Source
1. Brendan Buhler. True sign of the times: Vegas tips are slipping
Las Vegas Sun. May 8, 2008.
http://www.lasvegassun.com/news/2008/may/08/true-sign-times-vegas-tips-are-slipping/

2. 2. Vivien Lou Chen. Countrywide Takes Away Home-Equity Credit Lines in Las Vegas
Bloomberg. May 6, 2008.
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=adSiHtVyQXmc

Oil Bubble Larger Than Tech & Housing

Paul Kedrosky at Infectious Greed shows that the price move in crude has now gone higher and lasted longer than the tech bubble and the housing bubble.

Chart courtesy of Bespoke.

Although the move in crude seems to be driven more by supply and demand fundamentals instead of speculation.

Hat tip - http://paul.kedrosky.com/archives/2008/05/07/oil_just_outbub.html

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May 8, 2008

Taxing iTunes

Democrats in the California state legislature are aggressively seeking cash. Your cash.

New taxes under consideration are taxes for beer, grocery bags, iTunes music downloads,

[Democratic lawmakers] predict the public won't stand for painful cuts to schools and healthcare to close a shortfall the governor now pegs as high as $20 billion, and say anti-tax forces will ultimately have to accept that more revenue is needed to bring the state into the black.

So California taxpayers will "ultimately have to accept" higher taxes. At least according to their elected representatives.

Source:
1. Evan Halper. California tax proposals target beer-loving, pornography-watching yacht owners.
Los Angeles Times. May 9, 2008.
http://www.latimes.com/news/local/la-me-taxes9-2008may09,0,5137016.story

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May 6, 2008

Negative Interest Rates

Here we go again with negative real interest rates. I hope you weren't trying to earn any money on your savings.

Full chart:

Source: Monetary Trends St. Louis Fed.

Per Cale