By Richard Beales in New YorkMon May 7, 12:56 PM ET
The dollar slipped against leading currencies yesterday as traders looked ahead to three central bank interest rate decisions due on Wednesday and Thursday.
The euro took a modest boost from the victory of market-friendly Nicolas Sarkozy in the French presidential elections, analysts said.
With a London holiday contributing to subdued activity, most traders were focused on this week's central bank meetings. US, UK and eurozone rate decisions are expected to deliver a combination of news that is negative for the dollar, already softer after a below-par US jobs report on Friday.
"The softness of US employment data has spurred some talk that the [Federal Open Market Committee] will acknowledge the economic slowdown in more concrete terms and again soften its risk assessment," said Marc Chandler, global head of currency strategy at Brown Brothers Harriman.
The FOMC meets on Wednesday and is expected to keep the overnight Fed funds rate steady at 5.25 per cent.
Any hint that the Federal Reserve is becoming more worried about decelerating growth, or less concerned about persistent inflation, is likely to weigh on the dollar.
In Europe, the stronger economic growth picture and potentially rising interest rates could lift sterling and the euro against the dollar. The Bank of England is widely expected to lift UK rates by a quarter point to 5.5 per cent on Thursday.
On the same day, most analysts expect the European Central Bank to foreshadow a June rate rise while leaving rates unchanged at 3.75 per cent.
"Note that the ECB is comfortable with a strengthening euro to the extent that it helps combat inflation as long as it poses no challenges for exporters," said Ashraf Laidi, chief foreign exchange analyst at CMC Markets.
The euro rose 0.2 per cent against the dollar to $1.3618 by late morning in New York, still short of the all-time high of about $1.3680.
At $1.9952, the pound was less than 0.2 per cent higher compared with Friday's close. The yen strengthened more than 0.2 per cent to trade at Y119.90 to the dollar.
Commodity-based currencies were among Monday's biggest gainers, with the Australian dollar, South African rand and Canadian dollar all outperforming.
The loonie, the Canadian currency, was nearly 0.5 per cent up on the dollar at $1.1027. The currency has gained about 7 per cent in the past three months.
The strength stems from the commodity-driven economy and a shift in thinking on Canadian interest rates, according to Alan Ruskin, chief international strategist at RBS Greenwich Capital.
"The market was thinking about rate cuts, but now it has started to toy with the idea of rate hikes," he said.
Whenever somebody complains about "the lies that George Bush & Co. told to get us into the Iraq war" (as Frank Rich did in The New York Times on Sunday), I wonder how those lies compare to the lies that the American public tells itself every day -- for example, that we could run America without oil from the Middle East, or that hybrid cars will save Happy Motoring, or that we can have an economy without producing anything of value.
Meanwhile, the Dow Jones index went up over a hundred points the same day that 32 people were massacred on a university campus. And bear in mind that the massacre did not occur late in the day but literally around the same time that the New York Stock Exchange rang its opening bell -- so that as the body counts mounted through mid-day, the stock markets only went higher! They must have liked what they saw. Then, the rest of the week, while the cable news Mommy-Daddies went through the familiar rituals of bewildered hand-wringing, and NBC released the trove of farewell videos sent in by shooter Seung-Hui Cho between killings, the Dow piled on another 250 points to close at an all-time record high just under 13,000.
Could the financial markets be more detached from reality, from life on the ground (or in a free-fire-zone classroom) in this nation?
Doug Noland over at Prudent Bear.com is right: we've entered a euphoric phase of financial arbitrage capitalism with extreme Ponzi overtones, a pyramid scheme of revolving credit rackets and percentage spread plays completely abstracted from any reality of fruitful activity. The reason we don't even call "money" by its former name anymore is precisely because we realize at some semi-conscious level that "liquidity" is not really money. Liquidity is a flow of hallucinated surplus wealth. As long as it flows in one direction, into financial markets, valve-keepers along the pipeline, like Goldman Sachs, Citibank, or the hedge funds, can siphon off billions of buckets of liquidity. The trouble will come when the flow stops -- or reverses! That will be the point where we will rediscover that liquidity really is different from money, and if we are really unlucky we'll discover that our money (the US dollar) is actually different from real wealth.
Noland and others recognize the severe distortions in the finance sector, and they are surely correct to flag the implied dangers. But even these clear-eyed observers survey the disturbing finance scene without factoring the global energy situation. In a nutshell: world oil production seems to have peaked about 10 months ago. Being just past peak, there is still a huge amount of oil going into world economies. But being just past peak we are now seeing how complex systems proceed toward instability and breakdown when the underlying energy flow turns toward contraction.
The situation in finance is particularly sensitive and acute because an overall contraction in available energy means the end of industrial expansion (a.k.a. "growth") at "normal" rates of three to seven percent annually. More to the point, it means that certificates, contracts, deals, plays, and rackets pegged to the expectation of growth will lose their legitimacy. Meaning, stocks, bonds, collateralized debt obligations, hedges -- anything that represents the hope and expectation for more-of-anything -- will no longer be understood to represent real value.
The current euphoric hysteria should therefore be viewed as a form of disorder in its own right. The players in the markets are making their moves based on misunderstood signals. They think the world is awash in energy and prosperity. They believe Cambridge Energy Research Associates (CERA) and the Chairman of the Federal Reserve. They believe that the mortgage fiasco and the associated imploding housing bubble are just a couple of temporary zits on the handsome WASPy face that Wall Street presents to the world. In the background, though, feedback loops are aligning to rock the systems we depend on for daily life in the real world. Capital will become unavailable. Food will grow scarce. Trade will be interrupted. Mobility will be constrained. And an awful lot of pissed-off people will be poised to fight over the table scraps of industrial civilization.
While I am greatly appreciative of the blogosphere for the wide selection of thought - whether left, or right - it is getting to be quite redundant. The mantra of "Democrats evil, Republicans good" and vice versa gets a bit old. I find it to be constant and tiresome sniping while the world flies by and problems all around us become worse and remain uncorrected and literally unattended. Beyond politics there's a nascent but snowballing financial collapse in the making. It should be rooted in the core of political discussion, but ends up being widely ignored because of the complexities involved.
There's no shortage of coverage for our biggest national disaster: The War in Iraq. Every day lives are being wasted with no solution, or end in sight. I'm not here to discuss my opposition to the war which is a subject that has been well covered by pretty much anyone with functional brain cells. We're losing, or have lost and if the stars become aligned in the wrong direction we'll likely go after Iran and probably see our first aircraft carrier sunk since 1945. But I'm not going to get into the war and politics since it's so well covered already.
What concerns me, because of lack of coverage, is the growing financial storm that's occuring in this county with so many (unless they've lost their house) unaware. While subprime meltdown has made the nightly news, something that doesn't make the news to give widescale sense of appreciation and urgency is the sagging fortunes of the U.S. dollar and the near insolvency of our county.
That's why I and this diary will be here. Folks need to be jolted out of the mindless, partisan bickering to understand that great structural problems threaten to tear the country apart from the inside. The question needs to be asked - "Why are we letting this happen to ourselves, and Why are we allowing our politicians to perpetuate the problems by allowing them to do nothing?"
The dollar this year has tumbled vs major currencies with the exception of the Yen where the Yen has also slumped. The Treasury and even Fed Chairman Ben Bernanke have warned of future liabilities from social security, medicare, pensions, etc in excess of $50 TRILLION dollars. The country is pretty much bankrupt, yet all I hear on the radio whether its Rush or Air America, or read on the web is that one side is evil vs the other side.
It goes even deeper. The U.S. has lost its edge in many ways - China, for example, is on the verge of becoming the top exporter in the world and already is to Europe. European markets have overtaken our markets in value, etc. The U.S. has suffered a major fade economically just since the turn of the century - yet we're led to think that the Bush economy is "best ever".
I have a blog where I chronicle events in the markets:
I hope you will take a look. You will see that the chart of the dollar looks like a bankruptcy chart.
The next 3 to 6 months will be crucial. In all likelihood, we're headed for recession. How many realize that?? Most are so overly complacent, really clueless, and thus feel they have the luxury or being able to engage in the usual partisan discourse when they should be removing the wool from their eyes provided by liars like Bernanke and Paulson that all is well. All is not well. Will the body politic do something?
Half the battle is to recognize there's a problem. The present power base - both dems and repubs - don't want you to know what can hurt you. But there's a lot out there that can hurt you financially. I hope to shed some light and keep you informed.
By Dina ElBoghdady Washington Post Staff Writer Saturday, March 31, 2007; A01
DEARBORN HEIGHTS, Mich. -- Janet Laitis leaned on a chain-link fence in her front yard, dragged on a cigarette and pointed to the homes on her block that lenders have seized in just the past two weeks.
"There. There. There," said Laitis, 70, pointing across the street, down the street and then to the modest ranch house next door. "This neighborhood is deteriorating before my eyes."
Within a square mile of Laitis's house in this bedroom community outside Detroit, more than half the 96 homes on the market are foreclosed properties. The situation is not uncommon in pockets of the industrial Midwest, where a record number of people are missing their mortgage payments and losing their homes.
While lax lending policies have been blamed for the unfolding home-mortgage crisis across the country, the distress in the Midwest has been exacerbated by fundamental problems with the economy. The region has been devastated by a severe drop in manufacturing jobs as the U.S. automobile industry shrinks.
"There's a structural shift going on that's undermining the unionized, industrialized states, and Michigan is leading the way," said Donald Grimes, a senior research specialist at the University of Michigan. "When you talk to people in Michigan, you can tell from their voice and their demeanor that they are just depressed."
The housing bubble of recent years has burst and home prices are under pressure in many parts of the country. How far they fall will be determined in large measure by the strength of the economy, experts say, since job and income growth ultimately determine how much people can pay for housing. The U.S. economy is growing, but the pace of growth has slowed markedly of late.
States like Michigan and Ohio, struggling with their particular economic problems, illustrate just how bad things could get in the housing sector if the national economy falls into a recession. They are, moreover, politically important swing states; rising anger there over the housing situation could help determine the outcome of the 2008 presidential election.
Michigan has lost 305,000 jobs since 2001. Economists estimate that 40 percent of the cuts came from automakers and their suppliers, who have shed jobs each of the past six years as they have tried to regain their competitive edge.
About 65,000 people moved out of Michigan from July 2005 to July 2006, the U.S. Census Bureau reported. The migration eroded already weak demand for houses, which in turn hurt prices. In the last three months of 2006, Michigan was the only state in the nation where home prices fell, dropping 0.4 percent from the same time in 2005.
Even during the first half of the decade, when home prices jumped in most of the country, Michigan's stagnated. Dana Johnson, chief economist at Comerica Bank, said home prices typically outpaced income in most of the nation during the housing boom. But in Michigan, income plummeted and dragged housing down with it.
Cash-strapped homeowners could no longer sell their homes or refinance their way out of trouble. Many got stuck with adjustable-rate mortgages offering low teaser rates that spiked in later years. Now many borrowers are struggling.
"It's been a spillover from the weak economy to the housing sector," Johnson said. "What we've seen here is a one-state recession."
Losing Jobs and Value
Brian Minjares, 40, is living that recession first-hand. His story is proof that no one in Michigan is immune to the state's financial woes.
Three years ago, he left his job at a financial services firm to start his own practice with a partner in the Detroit suburb of Southfield. Minjares took out a home equity line of credit to finance the business. At the time, his house was appraised at $350,000 and he owed $275,000, he said. The bank gave him a loan equal to 100 percent of his equity.
As the housing crisis worsened, the value of his home dropped to $260,000. Minjares could not afford to sell it because he owed more than it was worth. He could not afford to keep it because, as the rates on his loans adjusted, his monthly payments jumped to $3,000 from $2,100.
Meanwhile, his client roster was drying up. With the auto industry in decline, many of his customers' businesses crumbled. "So they had no money to give me to invest for them," Minjares said. He coped by running up credit-card debt.
But he fell behind on his payments and the bank foreclosed on his Colonial in Flat Rock, not far from Detroit. Minjares shut down his business and now sells cleaning products. He rents a condominium from his brother.
"You just have to cut your losses and run," Minjares said. "You have to take into consideration your marriage and your health and you say to yourself: 'It's just a house.' "
Ralph Newkirk, an agent with the Michigan brokerage Real Estate One, hears similar stories every day. The foreclosure situation is so extreme that his firm created a division two years ago with 25 agents who sell only foreclosed homes; Newkirk heads it.
Back then, the average sales price on foreclosed homes was about $70,000. Since then, the price has more than doubled, suggesting the problem is no longer confined to low-income neighborhoods in Detroit. "The problem is moving out to the suburbs," Newkirk said. "It's spreading like a cancer."
A Tangible Form of Pain
Michigan's strong tie to the auto sector has been a source of pain before. Strikes damaged its economy in 1967 and high oil prices crippled Detroit in the 1980s.
But Michigan's most recent trouble is "the most severe crisis in the state's existence," defying the pattern of past economic cycles, when Michigan bounced back quickly, said David Littmann, senior economist at the Michigan's Mackinac Center for Public Policy.
This time, the rest of the country recovered from the 2001 recession, but Michigan's per capita income remains 7 percent below the national average, Littmann said. For the first time since the Great Depression, Michigan is a poor state relative to the rest of the nation.
"This is not a cyclical problem anymore, and housing is the most tangible form of the pain," Littmann said.
For most of the past year, Michigan has ranked among the three states with the highest percentage of late mortgage payments and foreclosures, surveys by the Mortgage Bankers Association show. In the fourth quarter, it came in third, behind Ohio and Indiana, with 2.39 percent of its loans in foreclosure.
Many economists say, and union officers agree, that those hardest hit are not auto workers who lost jobs. Many received buyouts that should keep them afloat for a while. And because they tend to be older, some have paid off their mortgages.
Those feeling the worst squeeze, rather, are workers at the auto supply companies, such as Max, 44, an engineer who spoke on condition that his last name not be used because he is embarrassed by his situation.
Max bought a condominium in the Detroit suburb of Plymouth using a traditional fixed-rate mortgage more than five years ago. But three years later, his firm took away company cars from its workers, hiked insurance premiums and cut raises and bonuses -- raising Max's monthly living expenses and reducing his pay.
Max responded by refinancing his condo twice. Though he did not realize it then, the second loan was adjustable. Over time, his monthly payments rose from $1,500 to $1,800 to $1,950.
"I wasn't even reading the paperwork," said Max, who makes $106,000 a year.
Weeks ago, Max turned in his keys to his lender. The bank paid him $500 and took possession of the condo earlier than it otherwise could under Michigan law.
In fact, across the country, official foreclosure numbers do not capture the full scope of the mortgage problem, since many people are doing what Max did. Others are signing over their deeds to the bank in lieu of foreclosure to lessen the damage to their credit records. Some have been granted permission from their lenders to sell the property for less than they owe on the loan.
Signs of Trouble
As the problems grow, at least one type of business is booming in Michigan -- those that help manage foreclosed property. Take the case of Property Maintenance Inc., which changes keys, mows lawns, shovels snow and repairs foreclosed-upon homes in Michigan so that they are ready for sale.
Deanna Simmons, who created the company in 2002, said the revenue of her six-employee firm shot up from $20,000 in the first year to $1.6 million last year.
Driving through the streets of a working-class neighborhood in Dearborn Heights, Simmons points out the tell-tale signs of a foreclosed house: mail boxes overflowing, fliers piling up, shades drawn.
Once inside, she can tell which people left angry. They're the ones who leave all the water faucets running or take the door knobs with them. "They do anything they can to make it difficult for the mortgage companies, like they're trying to get back at them," she said.
Simmons spots the home next door to Laitis, the Dearborn Heights resident alarmed by the foreclosures on her street. The white ranch house is not for sale yet, but the tell-tale signs are there.
Laitis said her neighbors, a couple in their 40s, left recently after they learned their house would be foreclosed upon. The husband, a carpenter, had lost his job. The wife did not work. They crammed what they could into their white Bonneville and drove off without saying goodbye.
Laitis said the house was paid for at some point but the couple took out a $75,000 home equity line of credit to buy a car and build a garage, now half-finished.
Lots of people can't afford their mortgage or can't afford rising property taxes, Laitis said. For her, the taxes have become onerous. She wondered aloud if she could lose her house for failure to pay them. She could.
"Maybe I'm going to be the next one out of here," she said.
Whether one believes in the “price stability” policies of our nation’s central bank, or believes such policies have caused countless economic problems, the onus is on the Federal Reserve. It is a strange, quasi-secret public/private agency with little or no accountability.
It is the Fed, which since 1913 has had an exclusive monopoly over the money-making power, that must be held accountable. Its overall record is a sorry one despite all the ballyhoo, whoop-it-up stories, and books about how Alan Greenspan supposedly performed miracles in the 1990s.
Acclaimed as the greatest central banker of our time by Bob Woodward, Greenspan actually practiced legerdemain. He began as a young economist defending the ideas of Ayn Rand and the gold standard, but one of his early political benefactors, President Richard Nixon, broke the federal government’s last link to gold in 1971. Thus, Greenspan ended up running a central bank divorced from the gold standard, which is a key reason that today’s economy may be heading for the double-digit inflation rates of the 1970s, or the recession of the early 1980s, or the bear market crash of 2000–2002.
In 1971, Nixon’s “closing of the gold window” effectively devalued the dollar, causing untold financial losses to foreign investors who had trusted the U.S. government by holding dollars in their reserves.
Even worse, breaking the link with gold was combined with other disastrous economic policies. These included wage and price controls and surcharges. The results brought shorter-term political gain: Nixon was reelected in 1972. But they also caused long-term economic damage, not to mention anger and resentment among foreign central banks that had lost untold amounts of money as a result of the dollar devaluation.
Until 1971, the quasi gold standard — one in which foreign central banks could still redeem dollars for gold — had been one of the few remaining brakes on the Fed’s almost unlimited ability to create more and more new money. Post–1971, nothing could stop the Fed. It could, and did, flood the markets with dollars, which meant less and less buying power for those holding this diluted currency. In the short term, cheap money tricked Americans into thinking that the economy was strong when it wasn’t.
Thirty-five years of failure
The Fed’s record since 1971 has been one of numerous recessions preceded by booms. We have had a stop-and-go economy, one that inevitably misleads investors and damages retirees. An example of the former were those investors during the stock market run-up in the 1990s who were led to believe that business cycles were history and that bull markets were now permanent. An example of the latter is the elderly person who, 10 years ago after the beginning of retirement with a seemingly adequate amount of fixed savings, now finds himself struggling to maintain a lifestyle that it took a lifetime to achieve.
“All such savings are prejudiced by inflation. Thus saving is discouraged and extravagance seems to be indicated,” wrote economist Ludwig von Mises more than half a century ago. Mises had personally witnessed the horrible damage wrought by inflation during the Weimar Republic.
Thus, the average American who saved for retirement now finds his well-earned lifestyle threatened by the unanticipated pace of price increases that come as a result of inflation. For example, suppose a person retired in 1996 with $1 million. Ten years later, figuring the damage of relatively “comfortable” inflation, that $1 million is worth just $803,748. And imagine how much worse it will be if we return to the high inflation numbers of the 1970s.
Inflation has also brought about adverse structural changes in our lives and in the economy. I speak of the permanent acceptance of inflation at “comfortable” rates by many economists, politicians, and even ordinary people who have lived with inflation all their lives and thus know nothing else. This inflation-can-be-good philosophy appeared at the same time as the post–Great Depression Keynesian encouragement of excessive consumption, especially among lower income groups, as a way of preventing depressions. This is a culture, backed by tax policy, that virtually destroyed thrift in our country and encouraged private debt at the same time that government red ink was hitting record levels.
In recent times, savings rates in America sometimes have been recorded at less than zero. Why save today when tomorrow your money will be worth much less, owing to the inexorable power of inflation? Worse than that is the psychology of never-ending inflation. Few in the financial or consumer markets expect that inflation will ever be stopped. So, again, why save? Saving is difficult. It is denying oneself a higher standard of living in the expectation of a future reward. The Austrian economists call this time preference.
And why save when you can borrow at artificially low interest rates? And why pay off debts when there is plenty of credit around and refinancing is always available? Why not consume now, since everyone “knows” that prices will always rise?
Here is the triumph of an inflationary policy pushed for generations. It is a policy that has become a virtual article of faith. It can no more be seriously questioned than the supposed benefits of fiat money, or mandatory social insurance programs, or an interventionist foreign policy.
The Fed’s easy-money policies also explain why both public and private debt levels have been rising for generations, with fewer and fewer protests. Indeed, spendthrift ways are embraced along with inflationary values. So the average American household today carries a credit card balance of $8,000.
Inflationary addiction
One of the biggest problems with inflation is its seductive power. In its beginning phases, or when one is in its “comfort” zone, it seems harmless. Like strong drink or other drugs, it produces a temporary euphoria. In fact, in some cases, as Austrian economist F.A. Hayek pointed out, inflation actually seems beneficial to business at the outset. That’s because sales in certain sectors rise at a faster rate than they would have if free-market forces were operating. Inflation, Hayek wrote, distorts how the businessman views the economy and his business.
“It is this which creates the general state of euphoria,” he warned, “a false sense of well-being, in which everyone seems to prosper. Those who without inflation would have made high profits make still higher ones. Those who have made normal profits make unusually high ones. And not only businesses which were near failure but even some which ought to fail are kept above water by the unexpected boom.”
Hayek, who was describing the stop-and-go monetary policies of Britain’s central bank of the 1970s, could be explaining any of the boom-bust policies employed by our own central bank. Inflation has a long lamentable history nearly everywhere.
For example, by 1973, after a period of money expansion that helped reelect Richard Nixon and most of a Democratic Congress, the United States went into a brutal period of stagflation. This lasted for about a decade and produced double-digit inflation along with slow growth rates. This included a period in which the Fed battled inflation by raising interest rates.
The Fed, which had ignored inflationary signs in 1971 and 1972, had overexpanded the money supply. By the mid 1970s and early 1980s, it paid for that policy with skyrocketing interest rates that topped 20 percent. These unprecedented rates threw parts of the nation into a virtual depression. Tens of millions of jobs were lost. Certain interest- rate-sensitive industries, such as the housing and automobile industry, went through terrible times. Mom-and-pop businesses felt the ripples. Hardship reached into millions of homes.
This vicious and destructive downward economic spiral ended in the early 1980s. Then, the Fed’s stop-and-go economy started all over again. The Fed began to inflate again in the early 1980s.
The Fed’s boom-bust cycle has continued over the last 20 years or so. But the cycle of boom and bust seems to be worse every time. The recessions are deeper. The inflation required to continue the boom requires more and more money creation accompanied by higher and higher levels of private and public debt.
Austrian economists describe how inflation pumps up markets, creating a bubble. “One of its consequences,” warned Mises, “is that it falsifies economic calculation and accounting.” Examples of the latter were the artificial, Fed-induced, bull markets of the late 1990s. While they lasted, they seemed great. But when the bubble burst, millions of dreams went with them.
When I was a student in college in the 1970s, I was told by a Keynesian economics professor not to worry about the U.S. government’s Treasury borrowings. “It’s only money that we owe to ourselves,” he assured me. My professor was ignoring a hard fact. He forgot that one group — the taxpayers — would be in debt to another group — the bondholders — for generations to come. Moreover, today large amounts of Treasury instruments are owned by foreigners, who might be inclined to be less willing to hold dollars than Americans are if the dollar starts rapidly losing value.
But they’re not the only ones worried about currency manipulation as well as huge federal and trade deficits that induce the Fed to print money at a faster and faster pace. The illusions created by inflation are not fooling the smart money. For example, in 2002, noted value investor Warren Buffett announced that, in order to hedge his bets, a significant amount of his assets would no longer be in dollars. “If we have the same policies, the value of the dollar will go down,” Buffett announced. Nothing has changed since then.
Another successful investor, money manager John Templeton, is also concerned. He has warned that the U.S dollar is overvalued by 40 percent. Templeton will no longer invest in U.S stocks. One of the great problems that will face investors in the future will be persistent inflation, Templeton predicted in 1980 in a book called The Money Masters.
Templeton, Hayek, Mises, and others who have documented the damage done by inflation and warned against its dangers are unrecognized sages in an inflationary age. Those who ignore such warnings do so at their financial and economic peril.
March 26 (Bloomberg) -- A slowdown in business investment that the Federal Reserve expects to end without much damage to the economy may instead linger long enough to hurt job growth.
Business spending may be a significant overlooked risk to the Fed's forecast of moderate economic growth this year, economists say. When spending growth tapers off, a slowdown in hiring almost always follows, according to researchers at Commerzbank AG.
``The weakness in capital spending is alarming,'' says Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York. ``If capital spending is weak and getting weaker, the next thing companies will do is slow hiring.''
Fewer new jobs would mean less consumer spending, deepening the malaise in a U.S. economy already burdened by slumping housing demand. The combination might force the Fed to shift its focus more toward shoring up growth.
Fed policy makers, led by Chairman Ben S. Bernanke, last week stuck to their view that the economy will keep expanding ``at a moderate pace.'' Their most recently published minutes, from the January meeting, indicated that while business investment had proven weaker than anticipated, they still expect improvement before year's end.
Private economists may not be so sanguine. They have cut their forecasts of business spending three times since December, and now expect it will grow this year at the slowest pace since 2003, according to surveys by Blue Chip Economic Indicators. That's after expenditures on equipment and software fell last quarter by the most in four years.
`Under the Radar'
``With so much attention on the housing market, this is perhaps a serious risk that's flying under the radar,'' says Brian Sack, a former Fed economist and now vice president of Macroeconomic Advisers LLC in Washington. ``We still think business spending will grow at a solid pace this year, but recent data has alerted us to the risks.''
The Fed's statement last week said inflation remains the main risk to the economy, even as policy makers dropped their bias toward raising interest rates. The change gives them room to maneuver in case the economy slows more than they expect.
Some suppliers of business equipment say the Fed's optimism about investment may yet be borne out.
Optimism
``I've seen a significant change in optimism recently,'' says Roland Chalons-Browne, chief executive officer of Iselin, New Jersey-based Siemens Financial Services Inc., the commercial- finance unit of German engineering company Siemens AG. ``The hesitancy that has been in the marketplace is disappearing.''
U.S. businesses have no shortage of funds to invest, thanks to a five-year surge in earnings that took profit margins at non- financial corporations to the highest level in 37 years in the third quarter of 2006, according to the Commerce Department.
Some companies would rather use their cash to purchase their own shares than invest it in new plants or expanding payrolls. Last year, non-financial companies retired a record $602.1 billion of equity through buybacks and other means, according to Fed statistics. That's up 66 percent from $363.4 billion retired in 2005.
Houston-based ConocoPhillips, the third-largest U.S. oil company, plans to quadruple share buybacks this year to $4 billion while cutting its capital budget 25 percent.
This year, profit growth is slowing as margins shrink. Analysts surveyed by Bloomberg News see per-share earnings growth among S&P 500 companies slowing to 6.8 percent this year from 16.6 percent in 2006.
Seattle-based Amazon.com Inc., the world's biggest online retailer, announced this month that it will slow spending on technology after its profit margin fell to the lowest since 1999.
Defending the Economy
``When earnings growth slows and margins narrow, American business is very quick to cut back on expenses,'' says Allen Sinai, chief global economist at New York-based Decision Economics Inc. ``If this turns out to be a case of business- sector-initiated weakness, the Fed will be late in defending the economy.''
Interest-rate futures show a 28 percent chance the Fed will lower its target lending rate a quarter percentage point to 5 percent by June 28, compared with 10 percent odds a month ago.
Deutsche Bank's LaVorgna says the Fed's latest statement shows policy makers are ``acknowledging risks to the economy. But they're still not going to leap to cut rates.''
The Blue Chip survey shows business fixed investment may rise 4.3 percent this year, the slowest pace since 2003. That forecast is down from a 6.2 percent rise estimated in December.
Job Growth
``Once investment spending slows, job growth tends to follow,'' says Patrick Franke, an economist at Commerzbank in Frankfurt. He says capital spending is ``decisive'' in any change in direction for the economy ``because it is closely connected with trends in the labor market.''
LaVorgna says he expects monthly payroll growth to slow to an average 50,000 to 75,000 by year-end, from 189,000 in 2006, pushing the unemployment rate up to 5 percent from 4.5 percent now. A Manpower Inc. survey of 14,000 companies this month showed employers plan to slow hiring next quarter. Construction companies and makers of durable goods plan to trim hiring the most, according to Milwaukee-based Manpower, the world's second- largest provider of temporary workers.
The U.S. economy will probably avoid a collapse in capital spending like the ones that occurred in 1982, 1991 and 2001, says Franke. Still, ``a significant flattening'' is likely, with investment growth of around 4 percent this year, he says.
Offsetting the Slowdown
For the global economy, increasing business investment in Europe and Japan may offset the slowdown in the U.S.
Japan's largest manufacturers, encouraged by the lowest interest rates in the industrial world, plan to spend the most this quarter since 1991, according to the Bank of Japan. Sharp Corp., the country's largest maker of liquid-crystal displays and mobile phones, is spending 200 billion yen ($1.66 billion) to triple output of the panels.
``Companies have yet to spend as much as they want,'' says Yasuo Yamamoto, an economist at Mizuho Research Institute in Tokyo. ``Business investment will remain solid.
European companies are also spending more amid signs the economy of the 13 euro nations will sustain its best expansion since the single currency began trading in 1999. The European Central Bank reported in January that business demand for fixed investment loans was the strongest since it began surveying banks in April 2003.
``The business investment cycle has been slow to get going, but is now firmly positive,'' says James Nixon, an economist at Societe Generale SA in London and a former ECB forecaster. ``We're pretty upbeat about the outlook.''
Even some U.S. companies that have cut spending at home are still investing abroad. Rajiv Gupta, chief executive officer of Philadelphia-based Rohm & Haas Co., the world's biggest maker of acrylic paint ingredients, says half the company's capital spending will be overseas, and it will boost its global workforce while cutting U.S. jobs.
``Demand has been very robust in Asia and we have been positively surprised by the turn in Europe,'' he says. ``We have seen a slowdown in the U.S.''
Stock markets world-wide have sold off the past few weeks over concerns the collapse of the subprime mortgage industry could prolong and deepen the housing slump and threaten the health of the U.S. economy. Federal Reserve officials and most economists believe the problems in the subprime mortgage market will remain relatively contained, but there is compelling evidence that the failure of subprime loans may be the start of a painful unwinding of a housing bubble that was fueled by easy money and loose lending practices.
***
The fact that Congress is now holding hearings on the fallout from the second major asset price bubble in the last decade should prompt some broader questions. For example, what role did the Fed's loose monetary policy from 2002-2004 play in fueling the housing bubble? Should the Federal Reserve reexamine its policy of ignoring asset bubbles?
Asset bubbles are harmful for the same reason high inflation is: Both create misleading price signals that lead to a misallocation of economic resources and sow the seeds for an inevitable bust. The unwinding of today's housing bubble is not merely an academic question; it is likely to inflict real hardship on millions of Americans. To reduce the risk of a similar outcome in the future, it is important that policy makers, economists, and policy analysts properly diagnose the root causes of the current housing bust, not just its symptoms.
***
Federal Reserve officials and most economists believe the problems in the subprime mortgage market will remain relatively contained, but there is compelling evidence that the failure of subprime loans may be the start of a painful unwinding of a housing bubble that was fueled by easy money and loose lending practices.
Whether measured in absolute terms or time-tested metrics such as price-to-income or price-to-rent ratios, the rise in U.S. home prices during the past six years is unprecedented. What's more, not only has mortgage debt doubled during this time, but loans have been offered on imprudent terms (for instance, a no down payment, no income verification loan to a borrower with a checkered credit history).
***
Far from being limited to the subprime market, the data show these risky loan features have become widespread. According to Credit Suisse, the number of no or low documentation loans -- so-called "liar loans" -- has increased to 49% last year from 18% of purchase loans in 2001, a nearly three-fold increase. The investment bank also found that borrowers put up less than a 5% down payment in 46% of all home purchases last year. Inside Mortgage Finance estimates that nontraditional mortgages -- mostly interest-only and pay-option ARMs that allow the borrower to defer paying back principal or even increase the loan balance each month -- which barely existed five years ago, grew to close to a third of all mortgages last year.
***
Foreclosure losses as a share of the economy will be small and most homeowners have a comfortable amount of equity in their homes. In fact, about one-third of homeowners have no mortgage and own their homes outright, but they are not the reason home prices have been driven to the stratosphere. Home prices -- like all prices -- are set at the margin.
It was the marginal buyer, particularly the subprime borrower and housing speculator, who drove prices higher. The easing of lending terms increased the demand for homes, and since the supply of homes is relatively fixed (or inelastic), this increase in demand quickly translated into higher prices. As the loose lending practices are inevitably reversed -- and there is a wide chasm between current lending practices and prudent lending terms -- fewer people will be able to afford to buy a house, which will reduce demand and push home prices lower.
***
It's not the size of foreclosure losses as a share of the economy that matters, it is the effect those losses have on the availability of credit. When banks (and investors in mortgage-backed securities) begin suffering losses, they inevitably pull back. This is why so many subprime companies have gone bankrupt virtually overnight; investors balked at buying subprime loans except at a steep discount, which produced immediate losses. In effect, their ability to profitably finance new loans was eliminated.
***
Asset bubbles are harmful for the same reason high inflation is: Both create misleading price signals that lead to a misallocation of economic resources and sow the seeds for an inevitable bust. The unwinding of today's housing bubble is not merely an academic question; it is likely to inflict real hardship on millions of Americans. To reduce the risk of a similar outcome in the future, it is important that policy makers, economists, and policy analysts properly diagnose the root causes of the current housing bust, not just its symptoms.
After the January World Economic Forum I expressed some concern about the remarkable optimism - nay, complacency - manifested there about the course of the world economy. Earlier in the month I had quoted Herb Stein, an adviser to President Nixon in the 1970s (on economics, not burglary or cover-up). The quotation was: 'If something can't go on forever, it will probably stop.' An alert reader challenged the 'probably' (which originated via an American economist 'correcting' Professor Wynne Godley, who had used the quotation without 'probably'), and sent me an article written by Stein himself, in which 'probably' does not appear, and 'cannot' (rather than 'can't') does.
You pays your money and you takes your choice. It often happens with famous quotations. Incidentally, Stein quotes Nixon as having once said: 'Honesty may not be the best policy, but is worth trying once in a while.' That may explain quite a lot. Anyway, Stein tells us that 'Stein's Law' was first pronounced in the 1980s, and elaborates thus: 'This proposition, arising first in a discussion of the balance-of-payments deficit, is a response to those who think that if something cannot go on forever, steps must be taken to stop it - even to stop it at once.'
The implication, I take it, is that policymakers don't necessarily have to do anything about what will stop anyway. One does not know whether former Federal Reserve chairman Alan Greenspan had this in mind when saying last week about the so-called 'carry trade' (the huge amounts of money converted from yen to other currencies to take advantage of differentials between interest rates, which have driven the yen down and made Japanese exports more competitive than ever) that 'at some point it's got to turn'. But recent shenanigans in the financial markets seem to indicate that riskier investments are not as popular as they were.
So far, most of my fellow commentators seem to be relaxed about stock markets and the outlook for the world economy, and dismissive of Greenspan's assessment that there is a possibility of a US recession later this year.
The difference between Greenspan now and Greenspan when the great man was chairman of the Fed is that he can now say what he thinks, as opposed to what he thinks he ought to say. The reason for the insouciance of many financial market operators and commentators is that there is an assumption that the central banks (considered all-powerful except by central bankers themselves) can be relied upon to bail the US and other economies out as soon as trouble appears. There is empirical evidence for this in the past decade, and it is quite a contrast with the pre-Keynesian days of the inter-war years.
This is all very well as long as the central banks do not panic about inflation. There has been precious little reason to do so in recent years, because the weakening of the unions and the impact of 'globalisation' have together produced what is known in the trade as a 'benign' inflationary environment. Why, in Japan they have even been trying, without much tangible success, to inject a little inflation into the system.
As Professor Lord Desai puts it in his compulsively readable Marx's Revenge - The Resurgence of Capitalism and the Death of Statist Socialism: 'Democratic power can push the bargaining strength of the worker up to a certain point. If it threatens profitability too much, then capital withdraws or migrates .... Social-democratic parties everywhere [at the end of the 1980s] saw that restoration of profitability mattered once capital became mobile. But once it had become mobile, it demanded co-operation from the workers, not conflict. And it got that co-operation.'
It has become clear in recent months that trade unions are beginning to think they have been far too co-operative. One sees this in the bitter outbursts about the behaviour of hedge funds, private equity groups and senior corporate executives by such models of moderate trade unionism as John Monks, former general secretary of the TUC and now representing the much wider group of European trade unions.
One also sees it in the sporadic outbursts of discontent about low wage deals, not least in the UK public sector. But apart from the factors highlighted by Desai (whose book was published in 2002), we have witnessed the additional disinflationary factor in recent years of the remarkable influx of Continental workers to the UK - and not just from eastern Europe. French is rapidly becoming London's second language.
The small inflationary bubble of recent months has been associated with the lagged impact of earlier rises in the price of energy. Now the prospect is of lower energy prices later this year, and, according to the Governor of the Bank of England, Mervyn King, there is the possibility of quite a sharp fall in inflation. Yet there continue to be noticeable worries among central bankers about 'asset bubbles' - not least in housing.
A vogue phrase among financial regulators has been 'the underpricing of risk'. The convenient reaction to recent upheavals in the financial markets is that there has been a 'healthy and necessary correction'. Has been? All over? One wonders. The problem with the modern phenomenon whereby it is assumed that the central banks will always bail the system out is that there is an inherent bias in favour of bubbles and the traditional excesses of capitalism. There is an uneasy feeling in the air that all is not quite right.
By Craig Torres and Carlos Torres Bloomberg News Denver Post Article Last Updated:03/08/2007 10:00:37 PM MST
Federal Reserve Chairman Ben Bernanke and other policymakers were warned that rising mortgage foreclosures are likely to get worse, as the central bank on Thursday reported the slowest pace of loan growth in four years.
The Federal Reserve Board's Consumer Advisory Council, including consumer advocates and banks, met in Washington, with Bernanke and Fed Governors Susan Bies, Randall Kroszner and Frederic Mishkin in attendance. Home-mortgage foreclosures were the first agenda item, and the officials heard anecdotes of default and families at risk.
"We have found neighborhoods with abandoned homes, 200 at a shot," said Louise Gissendaner, senior vice president and director of community development in Cleveland at Fifth Third Bancorp, the 10th-biggest U.S. bank by assets. She said abandoned housing has "devastated our city to a great degree."
Mortgage borrowing rose by $792.5 billion last year, the smallest gain since 2002, according to the Fed's quarterly Flow of Funds report. The increase last quarter was the smallest since 1998, as two years of Fed interest-rate increases depressed loan demand and slowed the housing industry.
The Fed raised its benchmark rate to 5.25 percent in June, compared with an average target of 3.2 percent in 2005, a year when net new mortgage borrowing soared by a record $1 trillion. Economists surveyed by Bloomberg News expect the Fed will hold the rate through the third quarter, the median estimate shows.
Fed officials heard stories from Denver, Cleveland, Philadelphia and New York, where neighborhoods are deteriorating as borrowers struggle to pay loans or abandon their homes in foreclosure, a process where lenders take possession of property.
Bernanke and the other governors didn't comment on interest rates, the economy or the direction of regulatory policy. They listened to comments from advocates and bankers, who indicated that foreclosures are likely to increase further.
"We feel like a canary in a coal mine," said Stella Adams, executive director of the North Carolina Fair Housing Center in Durham. "It is sad for us to know that there are 1.2 million families at risk from foreclosure."
Some 1.2 million foreclosures were reported nationwide last year, up 42 percent from 2005, according to Irvine, Calif.-based RealtyTrac, which has a database on foreclosed properties.
Delinquency rates on real-estate loans rose to 2.11 percent for all banks last quarter, the highest in four years, according to Fed data unadjusted for seasonal patterns.
Much of the deterioration in mortgage quality was the result of subprime loans, or credits to borrowers with little or poor credit history. Banking regulators on March 2 issued proposed guidance on subprime mortgages.
Consumer advocates at Thursday's meeting said poor underwriting standards in the subprime market were behind the rising foreclosure rates.
"We are facing a foreclosure crisis in this country," said Adams. "There is a distinct problem in the subprime market that is contributing to the foreclosures."
If there is a major stock market tumble, it won't be the fault of the overall U.S. economy. Instead, point the finger at too much risk-taking in the debt market.
By Jim Jubak
After Federal Reserve Chairman Ben Bernanke's Feb. 28 testimony, one member of the House Budget Committee asked him whether the sell-off in global stock markets a day earlier -- and in particular the 416-point drop in the Dow Jones Industrial Average ($INDU) -- had changed the Fed's thinking. --MORE--
March 6 (Bloomberg) -- Former Federal Reserve Chairman Alan Greenspan said there's a ``one-third probability'' of a U.S. recession this year and the current expansion won't have the staying power of its decade-long predecessor.
``We are in the sixth year of a recovery; imbalances can emerge as a result,'' Greenspan, 81, said in an interview yesterday at his office in downtown Washington. ``Ten-year recoveries have been part of a much broader global phenomenon. The historically normal business cycle is much shorter'' and is likely to be this time, he added.
Greenspan's outlook contrasts with the prediction of his successor Ben S. Bernanke, who told Congress last week that the economy may strengthen this year. Bernanke's upbeat assessment helped steady stock markets on Feb. 28 after a plunge the day before that some traders attribute partly to Greenspan's musing that a recession couldn't be ruled out.
Financial markets took the comments in stride today. The Standard & Poor's 500 Index was up 1 percent at 12:30 p.m. New York time, following stock-market gains in Asia and Europe. Ten- year U.S. Treasury notes fell 5/32, lifting yields 2 basis points to 4.51 percent. A basis point is 0.01 percentage point.
``It is possible that we can have a recession at the end of this year,'' said Greenspan, who ran the central bank for 18 years until January 2006. Bernanke, 53, declined to comment.
Capturing the Trend
Little more than a year after leaving the central bank, Greenspan is returning to economic forecasting, a role he enjoyed before entering government service in 1974, during the administration of President Gerald R. Ford. He isn't trying to predict a number for gross domestic product or inflation: He's trying to capture the trend and when it might be about to change.
Private-sector economists and policy makers are calling for the expansion, which began in 2001, to continue. The Fed expects the economy to grow between 2.5 percent and 3 percent this year, and 2.75 percent and 3 percent next year, according to forecasts presented to Congress last month.
Greenspan said he has been careful to avoid making life difficult for his successor.
His contracts with clients stipulate that there will be no reporters present and no recordings. He said he tries to have an exchange with an audience, where he often learns something that helps him hone skills he has worked on for 50 years.
Seeking Anonymity
``I was aware of the problem that if I stayed public, I could make it difficult for Ben,'' he said. ``For the most part it has worked. I was beginning to feel quite comfortable that I was fully back to the anonymity I was seeking.''
``I was surprised at this recent episode,'' he added.
Investors may have taken notice of his comments on Feb. 26 because they considered them prescient. The day after he mentioned the risk of a recession to a Hong Kong audience on Feb. 26, a Commerce Department report showed sales of non- military capital goods excluding aircraft dropped 2.7 percent in January, the biggest decline since September 2001. Orders slumped by the most in three years.
Broader capital spending is also weakening. Corporate purchases of equipment and software declined at an annual rate of 3.2 percent last quarter, the biggest decline since the final three months of 2002, according to separate Commerce Department figures.
Greenspan said he doesn't believe that so-called point forecasts, where economists hone their outlook down to decimal points, can be accurately made in the near-term. ``We really can't forecast'' the economy over the next two years, he said.
Investors said financial markets are playing down Greenspan's recession risk message today.
Assuaging the Market
``It's not the message we're getting from the Fed,'' said Bernd Wuebben, senior bond market strategist at BNP Paribas New York. ``All Fed speakers have tried to assuage the market.''
Greenspan worked for what is now the Conference Board, a New York-based business group, as an industrial-metals analyst from 1950 to 1953. Tracking inventories, he was able to come up with a model of final demand. He expanded that model to textiles, aluminum and oil.
He found that large-scale models that used aggregate data averaged out the nuances and changes he could pick up at an industry level. Finally, some of the assumptions of firms' pricing power simply didn't hold as the post-war years unfolded.
``I realized I was trying to see how the world works in the context of individual entities,'' Greenspan said.
Under his chairmanship, the Fed staff began surveying firms directly from the Board of Governors' building in Washington on how their businesses were doing.
Anecdotal Information
``We certainly devoted some resources to our own gathering of anecdotal information,'' said Michael Prell, former head of the Division of Research and Statistics, the central forecasting unit at the Fed. ``Every other week, we would contact some subset of a sizeable group of firms.''
Greenspan's unique discipline both frustrated and amazed Fed colleagues, especially those trained in sophisticated economic modeling.
``His great value is that he has an idiosyncratic approach,'' said Laurence Meyer, a Fed governor from 1996 to 2002 who often sparred with the chairman over the outlook. ``The reason why Greenspan gets and deserves disproportionate weight is that he doesn't get caught up in all the themes that tie together in a consensus forecast. He is looking at all the different strands of data.''
Ingots
Once, Meyer said, he was sitting in a meeting with the Fed staff discussing the inflation implications of import prices. Out of nowhere, he recalled, Greenspan asked about steel-ingot prices. Meyer said he wasn't even sure what an ingot was.
``Why would I ever even ask that?'' Meyer, a founder and vice chairman of the model-based forecasting firm Macroeconomic Advisers LLC in St. Louis, said in an interview.
Macroeconomic Advisers isn't forecasting a recession this year, and Meyer said markets ``over-responded'' to what the former chairman said.
``Who wouldn't agree that it is possible we could have a recession?'' says Meyer. ``I think we are closer to the middle of an expansion than the end of an expansion.''
To contact the reporter on this story: Craig Torres in Washington; or ctorres3@bloomberg.net
SINGAPORE, Feb 28 (Reuters) - Most Southeast Asian stocks suffered their biggest one-day declines since Asia's 1997 financial meltdown, as investors sold off shares in a panic, following the slump in global markets.
Singapore's benchmark Straits Times Index <.STI> fell 5.63 percent by 0341 GMT and Malaysian shares tumbled 5.95 percent.
The Philippine index lost 7.3 percent, while Indonesian stocks fell 3.22 percent. Thai shares were down 1.64 percent.
Dealers said the selloff in Southeast Asian markets followed a near 9-percent plunge in Chinese stocks on Tuesday
"China's the culprit. We have a lot of listed Chinese companies, so we're dependent on China," said a dealer with a regional brokerage in Singapore.
Singapore-listed Chinese companies -- which make up more than 100 of about 700 listed firms on the city-state's bourse -- sank sharply on Wednesday.
Shipbuilding and repair firm Cosco Corp. , controlled by China's top shipping firm, plunged 8.9 percent, which reduced its market cap to below US$ 4 billion.
Several other big-cap China plays also fell more than 7 percent, including food groups People's Food and Pine Agritech . More than 20 small- and midcap China plays fell between 10 and 19 percent.
Dealers said the Singapore market was also rattled by the slump in U.S. stocks on Tuesday, with the Dow Jones industrial average <.DJI> in its worst slide since the aftermath of the Sept. 11 attacks.
Losses in Southeast Asia's largest and most liquid bourse were led by DBS Group , Singapore's biggest bank, which fell 6.2 percent, and United Overseas Bank , the country's second-largest bank, which also tumbled 6.2 percent.
Index heavyweight Singapore Telecommunications , Singapore's largest listed company, was down 5.5 percent.
Genting International sank 11 percent after Singapore said the Malaysian gambling firm's successful bid to build a casino in the city-state would not automatically qualify it for a casino licence. Sister company Star Cruises also slumped 14.5 percent.
Analysts have long warned of an imminent correction in Southeast Asian markets, many of which have recorded record or multi-year highs in the year to date.
"Singpore has been at an all-time high, and there's the law of gravity -- investors are getting nervous and are locking in profits," said Winson Fong, who manages $2 billion as chief investment officer at SG Asset Management in Singapore.
"For the short-term, stocks which have gone up strongly will see sharp corrections; investors will look at underlying fundamentals before going in," Fong said.
But other analysts said the selldown in the Singapore market would be temporary.
"We anticipate the market will recover from this selloff within the next 10-15 trading days. Leading the resumption of the rally would be the blue-chips," said OCBC analyst Ritesh Menon in a research note, who added that his mid-year technical target for the index is at 3,350.
In Kuala Lumpur, Malaysian power utility Tenaga Nasional Bhd led losses, sinking 5.7 percent. Malayan Banking , the nation's biggest lender, fell 5.4 percent.
In Jakarta, Indonesia's largest telecommunications firm PT Telekomunikasi Indonesia fell 3.3 percent. PT Bank Mandiri Tbk lost 7.4 percent.
In Bangkok, PTT PCL , Thailand's biggest energy firm, fell 1.9 percent. Advanced Info Service PCL , Thailand's top mobile phone firm, slipped 2 percent.
In Manila, PLDT , the Philippines' largest telecoms group, fell 8.2 percent, and Ayala Land , the country's top property developer, lost 6.1 percent. (Additonal reporting by Doreen Siow and Jamie Lee)
DURHAM, N.C., Feb 20 (Reuters) - Federal Reserve Board Governor Susan Bies said on Tuesday that there still was a high potential for a correction to occur in the housing market and said that made it hard for the Fed to assess conditions.
"There's a lot of vacant housing out there right now,' Bies said during an address at the Duke University Fuqua School of Business.
"The potential for inventory correction is still very high," she added.
While supply is hard to judge, Bies said that a downturn in demand for housing may be nearly over.
"We may be near the floor in terms of demand," Bies said.
Feb. 12 (Bloomberg) -- It was bound to happen sooner or later, an out-of-the-blue reminder that the froth or the boom or the disconnect between prices and fundamentals in the housing market would have a financial after-shock.
HSBC Holdings Plc, Europe's biggest bank, dropped a small bomb last week when it announced that it was setting aside more money as a cushion against the accelerating pace of loan delinquencies. Yes, Virginia, subprime mortgages -- home loans to folks with a spotty credit history -- do carry some risk after all.
In addition to making those loans, HSBC bought packages of subprime and second-lien loans from other mortgage originators. It seems the best models HSBC's quants could design didn't adequately reflect the inherent risk in lending to deadbeats when house prices stop soaring.
Before folks could say, ``sell,'' New Century Financial Corp., the No. 2 subprime lender in the U.S., delivered its bad news, saying it would have to restate 2006 earnings because of an increase in loan-loss provisions. The stock lost 40 percent of its value.
Isolated examples? Probably not. Confined to the subprime market? Doubtful.
``There is no way the conditions that existed in the subprime market between borrowers and lenders weren't a multiple of what went wrong,'' said Michael Aronstein, chief investment strategist at Oscar Gruss & Co. ``The incentives are perverse. You're paid for volume, not for being a schoolmarm.''
Sub-Zero
Subprime loans carry rates 2 or 3 percentage points higher than those extended to prime borrowers. They accounted for about 20 percent of new mortgages last year and 13.5 percent of the total home loans outstanding, according to the Mortgage Bankers Association.
The issue isn't whether loans defined as risky carry risk; they do. The real question is whether the risk was priced correctly; whether rising delinquency rates on subprime loans, sometimes made without proper documentation, will spill over into the rest of the home-loan market; whether borrowers will default when teaser rates on adjustable-rate mortgages reset higher at a time when home prices are falling; and -- the big kahuna, the one that matters to the Federal Reserve -- whether any of the bad- loan problems will affect financial institutions' ability to lend.
In its January survey on bank lending practices, the Fed said that a net 15 percent of domestic banks reported tightening credit standards on residential mortgage loans over the past three months, the biggest net increase since the early 1990s. That was the last time banks were saddled with -- guess what? -- bad real-estate loans. More banks and thrifts failed in the early '90s than at any time since the Great Depression.
Ripple Effects
The Fed's survey also found that a net 37 percent of the banks reported weaker mortgage demand to purchase a home. (It's not clear based on the limitations of the survey whether weaker demand was a result of tighter standards.)
The ripple effects of the housing slowdown aren't confined to the financial sector, according to Asha Bangalore, an economist at the Northern Trust Corp. in Chicago.
``Production in housing-related industries has dropped sharply in the past year,'' she says. ``For example, production in furniture, household appliances and carpeting has fallen for five straight quarters.''
A reasonable person might conclude that layoffs in these industries will compound the declines in residential construction, Bangalore says.
Job Losses
``Housing and housing-related employment made up a little over 40 percent of all payroll employment from November 2001 to April 2005,'' she says. ``Employment in residential construction declined in nine out of the 10 months ended January 2007,'' with 104,000 jobs in residential specialty trade contracting lost since the February 2006 peak, according to the Bureau of Labor Statistics.
The residential job losses were more than offset by gains in non-residential contracting, the BLS said.
Falling employment in one sector of the economy or one region of the country is not an expansion killer in and of itself. The Southwest oil patch was depressed when oil prices slumped to $10 a barrel in 1986 even as the economy logged four more years of strong growth. The Northeast real-estate market was slower to recover from the 1990-1991 recession than other sectors.
The danger comes when the financial system is impaired, as it was in the early 1990s in the U.S. and during the 1990s and part of the current decade in Japan.
Sage Advice?
That's when the Fed would start to get concerned about the ramifications, which so far have been limited to a decline in the prices of subprime mortgage bonds and the stocks of mortgage lenders.
It's too soon to know the extent of the problem from all the option ARMs (the interest is optional, but the principal is not!). Only three years ago, former Fed Chairman Alan Greenspan said homeowners could have saved a heck of a lot of money had they opted for adjustable-rate mortgages during the past decade.
Ex post, that was good advice. Ex ante, it's not looking good.
``American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed- rate mortgage,'' Greenspan said in a speech to the Credit Union National Association in Washington.
Lenders took his advice. Borrowers jumped at the opportunity. Everyone may suffer the consequences.
(Caroline Baum, author of ``Just What I Said,'' is a columnist for Bloomberg News. The opinions expressed are her own.)
To contact the writer of this column: Caroline Baum in New York at cabaum@bloomberg.net .
Part 3 by Jacob G. Hornberger, Posted January 19, 2007
It is impossible to overstate the significance of the Franklin Roosevelt administration’s confiscation of gold and its nullification of gold clauses in contracts. It is one of the most sordid episodes in American history. To get an accurate sense of Roosevelt’s actions, it would not be inappropriate to compare what he did with the domestic economic policies of a later 20th-century ruler, Cuba’s socialist president, Fidel Castro.
On April 5, 1933, newly inaugurated President Roosevelt issued Executive Order 6102, which prohibited the “hoarding” of gold by U.S. citizens. Americans were required to turn their gold holdings over to the federal government at the prevailing price of $20.67 per ounce.
Pursuant to Roosevelt’s executive order, anyone caught violating the law was subject to a federal felony conviction, 10 years’ confinement in a federal penitentiary, and a $10,000 fine. Soon after the confiscation, U.S. officials announced that the government would sell its gold in international markets for $35 an ounce, thereby devaluing the dollar by almost 70 percent and immediately “earning” a potential profit of almost $15 an ounce on the gold it had confiscated.
Two months later, Congress enacted legislation nullifying gold clauses in both government and private contracts, thereby requiring creditors in such contracts to accept devalued paper money in payment of such contractual obligations, even though the contract itself stipulated payment tied to gold.
Reflect for a moment on the significance of what Roosevelt did. Gold coins and gold bullion were private property, just like a person’s automobile, clothing, home, and food. On the mere command of the president of the United States, federal authorities simply confiscated gold holdings that were the private property of the American people and made it a grave federal offense to own such property in the future.
The gold seizure was no different in principle from Fidel Castro’s seizure of homes and businesses more than 25 years later in Cuba, an episode that U.S. officials still rail against while praising what Roosevelt did. Sure, Roosevelt paid Americans more money for the gold he seized than Castro paid Cubans and American companies for the property he seized, but the principle was the same: the rulers in both Cuba and the United States could appropriate people’s property at their whim.
What was Roosevelt’s justification for the gold seizure? He said that it was necessary to battle the Great Depression. Now, think about that for a moment. How in the world could the seizure of people’s gold relieve the consequences of the Great Depression?
Let’s say that I have $10,000 in gold coin in my house. The Depression hits. Prices plummet. Unemployment soars. How is my delivering my gold to the federal government in return for depreciated paper money going to relieve anyone else’s distress?
No, the real reason for Roosevelt’s gold seizure was twofold: First, he seized people’s gold for the same reason that Castro later seized people’s homes and businesses — to enrich the coffers of the federal government. Second, but more important, he did it to prevent the American people from protecting themselves from the onslaught of ever-depreciating paper money that he planned to use to finance his ever-extravagant welfare-state programs.
Keep in mind that the Framers had implemented a gold standard so that the American people would be forever protected from the destructiveness of inflation. It was the gold standard — that is, the requirement that the federal government redeem all its paper notes and bills in gold — that had operated as a restraint on government’s ability to print ever-increasing amounts of paper money. The gold standard’s positive effect on capital markets was also one of the primary reasons that the United States rather quickly became one of the most prosperous nations in history.
With his seizure of gold, Franklin Roosevelt revolutionized the monetary system of the United States — and without even the semblance of a constitutional amendment. It is instructive to understand how he pulled this off in a legal sense.
Roosevelt’s rule by decree
In issuing his executive order, Roosevelt relied on the Trading with the Enemy Act, which had been passed in 1917 as part America’s war against Germany in World War I. Yes, World War I, the infamous war that was supposed to make the world safe for democracy! This “temporary emergency” law, which should have expired with the end of the war, had instead been left on the books through the 1930s. This is the law that Roosevelt relied on in issuing his executive order confiscating people’s gold.
There’s another significant aspect to the executive order — the issuance of the order itself. That is, Congress did not enact a law expressly authorizing the gold seizure. Instead it was accomplished simply through a decree issued by the president.
What the Congress had done is delegate its power to make certain laws to the president, essentially vesting Roosevelt with dictatorial powers. In March 1933, Congress amended the Trading with the Enemy Act to vest the president with the power to declare “national emergencies” and then issue necessary decrees to deal with such emergencies, including even setting criminal punishments.
It was a type of executive power — rule by decree — that had characterized dictatorships throughout history. Thus, it shouldn’t surprise anyone that one of Roosevelt’s biggest admirers was Adolf Hitler, who was dealing with the Depression in Germany in much the same way that Roosevelt was dealing with it in the United States. As John Toland pointed out in his biography Adolf Hitler,
Hitler had genuine admiration for the decisive manner in which the President had taken over the reins of government. “I have sympathy for Mr. Roosevelt,” he told a correspondent for the New York Times two months later, “because he marches straight toward his objectives over Congress, lobbies and bureaucracy.” Hitler went on to note that he was the sole leader in Europe who expressed “understanding of the methods and motives of President Roosevelt.”
Nullifying the gold clauses
Roosevelt and his Congress did not stop at seizing the gold of the American people and making it illegal for them to protect themselves from the ravages of inflation. They also nullified every clause in every contract, both government and private, that tied the financial obligation to gold.
How did these gold clauses operate? Let’s say a corporation issued a 100-year bond for $20, promising to pay 3 percent interest. Any lender would ask himself the obvious question, “Why wouldn’t this bond be worthless in a hundred years because of inflation?” To ensure that that wouldn’t happen, the note would contain a “gold clause” which stipulated that the company had to repay the bond, both principal and interest, in the same standard of gold that existed at the issuance of the note.
So let’s say, for simplicity’s sake, the $20 bond was issued in 1885, with $20 equal to a one-ounce gold coin. Let also say that because of inflation, when the bond became due 100 years later, it would take $100 in paper notes and bills to buy one ounce of gold. With the gold clause in the $20 bond, the debtor would have to pay the creditor either a one-ounce gold coin or $100 in paper notes (plus interest). With the gold clause nullified, all the debtor would have to pay would be $20 in paper money (plus interest), even though it would purchase only one-fifth of an ounce of gold at the time of repayment.
It’s not difficult to imagine the adverse effect that Roosevelt’s actions had on long-term capital markets.
The Supreme Court
The constitutionality of Roosevelt’s gold-confiscation decree was never addressed by the U.S. Supreme Court. There were few federal prosecutions, possibly because Roosevelt didn’t want to take the chance that the Supreme Court would declare his confiscation unconstitutional. Better to simply let the lambs who were meekly complying with the law continue filling the government’s coffers with gold and leave the ones who weren’t obeying the law alone.
The gold-clause cases did reach the Supreme Court. Unfortunately, a majority of the Court declared the nullification of the gold clauses in private contracts to be a constitutional exercise of the president’s power. While it declared the nullification of gold clauses in government notes to be unconstitutional, the Court also held, in a twisted form of logic, that the holders of government debt had suffered no damage because gold was then illegal to own anyway.
The Supreme Court’s opinions in the gold-clause cases are worth reading. (See Norman v. Baltimore & O.R. Co.). The most persuasive arguments, not surprisingly, were published by the dissenters — McReynolds, Sutherland, Van Devanter, and Butler, who often voted to declare much of Roosevelt’s New Deal unconstitutional:
Just men regard repudiation and spoliation of citizens by their sovereign with abhorrence; but we are asked to affirm that the Constitution has granted power to accomplish both. No definite delegation of such a power exists; and we cannot believe the farseeing framers, who labored with hope of establishing justice and securing the blessings of liberty, intended that the expected government should have authority to annihilate its own obligations and destroy the very rights which they were endeavoring to protect. Not only is there no permission for such actions; they are inhibited. And no plenitude of words can conform them to our charter....
Under the challenged statutes it is said the United States have realized profits amounting to $2,800,000,000. But this assumes that gain may be generated by legislative fiat. To such counterfeit profits there would be no limit; with each new debasement of the dollar they would expand. Two billions might be ballooned indefinitely — to twenty, thirty, or what you will.
Loss of reputation for honorable dealing will bring us unending humiliation; the impending legal and moral chaos is appalling.
The aftermath
What was the reaction of the American people to Roosevelt’s gold seizure? By the 1930s, most of the United States had been under systems of public (i.e., government) schooling for at least three decades. After years of such indoctrination, even though Americans had not yet become dependent on the federal government’s welfare dole that Roosevelt was initiating, most of them nevertheless now deferred to the wisdom of federal officials to deal with such complicated subjects as economics, depressions, and monetary policy.
Thus, when Roosevelt issued his decree, it was not met with massive protests and demonstrations but rather with the same degree of meekness and submission that many (but certainly not all) of the Cuban people would display when their homes and businesses were confiscated by Castro several decades later.
The additional value of the public-school indoctrination was that it effectively immunized federal officials from having to bear responsibility for the consequences of their own wrongful conduct. For when U.S. officials announced that the 1929 stock-market crash and the resulting Great Depression were all the fault of “free enterprise” and that such things as the gold seizure and the New Deal were necessary “to save free enterprise,” entire generations of public-schooled Americans had no idea that they were being misled. If Americans had known the truth — that the stock-market crash and Great Depression, along with all the financial devastation and unemployment — had actually been the fault of the Federal Reserve, there would have been considerable anger, perhaps even violent revolts, against the federal government.
In 1974 Congress made it legal to own gold once again, providing Americans the means to protect their wealth from the inflationary propensities of the federal government.
Is there a possibility, however, that federal officials could confiscate gold again and make it illegal to own it? You bet your bottom gold dollar there is. For one thing, the Trading with the Enemy Act is still on the books and is still being used as the basis for presidential decrees. For another, ever since the Roosevelt administration, federal officials, assisted by the Federal Reserve, have never desisted from issuing ever-growing quantities of paper money, an inflationary process that has ravaged people’s savings. Finally, federal officials hate gold because its rising price in the face of inflation provides a public and an easily readable market message to the citizenry that government officials are destroying the currency.
And make no mistake about it. If another U.S. president issues a gold-confiscation decree, it will be enforced violently and brutally by federal officials. In the climate of the perpetual “crisis” known as the “war on terrorism,” combined with an “economic emergency,” it is not difficult to imagine that federal officials would conduct warrantless raids on banks to search bank records and safety deposit boxes and prosecute dangerous “enemy combatants” and “terrorist sympathizers” who show they “hate their country” by violating the law against the ownership of gold.
The ultimate solution to this financial chaos, destruction, and morass lies in sound money. The ideal is a free market in money, as the Nobel Prize-winning economist Friedrich A. Hayek observed. The second-best solution is the type of gold standard established by the Framers, where gold and silver coin are the official money and where the federal government is required to redeem all bills and notes in such money.
Both solutions would necessarily entail the abolition of one of the most powerful engines of financial destruction in American history — the Federal Reserve System — as well as the repeal of all legal-tender laws.
