njhousingbubble

New Blog

2008-03-15T09:53:00.000-07:00

As the housing bubble and the credit bubble have clearly popped, and the Federal Government is throwing good money after bad to try and support asset prices and the wall street elite, I have decided to post under a new blog name that I believe aptly describes the current policy attitudes/behaviors of our government. This is no longer a free-market, capitalistic society. Our society has turned back to a new version of feudalism. Financial Feudalism:

Financial Feudalism

An Old World Order!

2008-03-14T11:42:00.001-07:00

Today's Fed actions led me to further think about the current state of our economic system. I have gone over in my mind numerous time about one fundamental question. Under what kind of system are we living? Is it Capitalism, Totalitarianism, Fascism, Communism or Socialism? Today's action provides the most direct evidence that our system has devolved back to FEUDALISM, or FEDALISM as it could be more aptly called today. This remarkable act of bailing out one investment bank so that their derivatives wouldn't have to be marked to market proves the oligarchical nature of our society. The Lords of Wall Street are under the protectarate of the FEDal system. We the fifes must go about our daily lives and hand over increasingly large sums of our hard earned "money" to ensure the "stability of the markets". What bonus should Mr. Schwartz receive from the taxpayers largesse? As the new Sheriff of Nottingham, Ben Bernanke, and his sidekick, Hank Paulson, go about their daily adventures in destruction of our savings by debasing our currency, we the fifes can only look upon these actions with disbelief. This is a supposed to be a democracy, yet all these decision take place behind closed door under dubious circumstances and have unknown future consequences. This has gone far enough. We should demand the immediate resignation of Ben Bernanke and Hank Paulson, and start having some transparency in our markets. These ridiculous anti-Capitalism, anti-competitive, anti-free market, Save our Crony friends at any cost policies MUST STOP! Robin Hood, where are you?

Henry Blodget on the Bear Stearns Bailout

2008-03-14T11:18:00.000-07:00

Pathetic Bear Stearns Bailout: Who to Blame

Posted Mar 14, 2008 11:44am EDT by Henry Blodget in Newsmakers, Recession
Related: BSC, JPM

From Silicon Alley Insider, March 14, 2008:

Get ready. Now that Bear Stearns (BSC) has been forced to run hat in hand to the Fed and whimper that it's "too big to fail," the mewling is about to begin:

• It's not our fault! It's a run on the bank!

• We never could have seen this coming!

• Blame those jerks who stopped lending us money!

Give us a break. If Bear Stearns goes to zero, there will only be one party to blame: Bear Stearns management.

Yes, companies that live and die on short-term loans (such as every brokerage firm on earth, along with Enron) depend on the cooperation of third-parties. And, yes, when those companies can't roll over their short-term paper, the folks who actually deliver the death-blow are those that refuse to lend them any more money.

But the first responsibility of any brokerage firm management team is to ensure that under no circumstances can the firm be put in a position where its short-term financiers might lose confidence. This is why there is ultimately only one person who is responsible for the Bear firesale: Bear's CEO Alan D. Schwartz.

Meanwhile, who will pay for this bailout? Do you really have to ask?

You.

The Fed has promised Bear Stearns savior JP Morgan (JPM) that it will guarantee the value of whatever crap Bear has piled onto its balance sheet. In other words, the Fed is effectively assuming the liabilities of Bear Stearns. And the Fed's source of capital, ultimately, is you.

London Calling, your credit is not good here. No honor among thieves.

2008-03-14T11:09:00.001-07:00

LONDON (Reuters) - Financial market traders across London have been told by their firms to stop dealing with Bear Stearns, sources in several dealing rooms said on Friday.

At least six major institutions in London -- including Commerzbank, Royal Bank of Scotland and JPMorgan -- had stopped giving prices to the U.S. bank, a credit trader at one European institution in London, who declined to be identified, told Reuters.

Credit Suisse had also stopped trading with Bear Stearns, a London-based equities broker said.

None of the institutions named by the traders would comment on the subject when contacted by Reuters.

A London-based government bond trader said banks had been withdrawing from transactions with Bear Stearns since Thursday.

But the London Metal Exchange said that Bear Stearns remains entitled to trade on its electronic trading system Select.

"For as long as Bear Stearns remains a member of the LME and in good standing at the LME's clearing house, LCH. Clearnet, Bear Stearns will remain entitled to trade on LME Select," the LME said in a note circulated to its clearing members. Bear Stearns has more exposure to the U.S. bond markets than its competitors, and has a large mortgage-backed securities business. It was among the first to disclose the impact of the subprime mortgage market meltdown when two of its leveraged hedge funds collapsed last summer, losing $1.6 billion.

Counterparty risks have been steadily rising among the world's major financial institutions for months, distorting prices and leading to fears that other institutions could find themselves unable to trade securities they need to survive.

"You can safely assume that Bear is not alone here," said an interest rate strategist at one European investment bank in London, who declined to be identified.

"We have been setting prices in swaps markets in recent days that were designed to say 'no deal' and at least one other U.S. investment bank -- not Bear -- dealt. That is very worrying if they needed the cash that badly. We have been forced to review our counterparty limits ever since."

(Reporting by Natalie Harrison, Christina Fincher, Mike Dolan and Anna Stablum in London and Peter Starck in Frankfurt; writing by Nick Edwards)

CONFIDENCE WILL NOT BE RESTORED WITHOUT TRANSPARENCY! WHAT MARKET PARTICIPANT IN HIS RIGHT MIND WOULD TRUST BEAR STEARNS?

2008-03-14T08:07:00.000-07:00

WASHINGTON - The Federal Reserve said Friday that it has voted to endorse an arrangement to bolster troubled Bear Stearns Cos. and stands ready to provide extra resources to combat a serious credit crisis.

The Fed announcement came in a brief two-sentence statement that was issued as stocks were plunging on Wall Street over worries that a plan to ease a liquidity crisis at Bear Stearns Cos. might not work.

"The Federal Reserve is monitoring market developments closely and will continue to provide liquidity as necessary to promote the orderly functioning of the financial system," the board said.

The statement said that the board had voted unanimously to approve the arrangment announced by JP Morgan Chase and Bear Stearns earlier on Friday.

The plan will provide secured funding to Bear Stearns for an initial period of 28 days, seeking to provide short-term relief for Bear Stearns.

Treasury Secretary Henry Paulson praised the Fed's leadership and said that the country's financial system would be able to weather the problems.

"As we have been saying for some time, there are challenges in our financial markets and we continue to address them," Paulson said in a statement. "This is another challenge that market participants and regulators are addressing. We are working closely with the Federal Reserve" and the Securities and Exchange Commission.

Paulson said he appreciated the leadership of the Fed "in enhancing the stability and orderliness of our markets."

The action by the Fed board in Washington represented an endorsement of a rescue effort for Bear Stearns that had already been arranged by JPMorgan and the Federal Reserve's New York regional bank.

It was seen as a last-ditch effort to save the investment bank, which on Friday acknowledged its serious financial problems after a week of denials.

JPMorgan Chase is providing an undisclosed amount of secured funding to Bear for 28 days, backstopped by the Federal Reserve Bank of New York.

The Securities and Exchange Commission issued a statement saying it has been "in close contact" with Treasury, the Federal Reserve and the Federal Reserve Bank of New York during discussions concerning an agreement by J.P. Morgan Chase & Co. to provide a secured loan facility to The Bear Stearns Companies.

"We will continue to work closely together in a way that contributes to orderly and liquid markets," the SEC said.

___

Feldstein: Bad Recession to come (with inflation).

2008-03-14T06:43:00.000-07:00

The United States has entered a recession that could be "substantially more severe" than recent ones, former National Bureau of Economic Research President Martin Feldstein said

"The situation is very bad, the situation is getting worse, and the risks are that it could get very bad," Feldstein said in a speech at the Futures Industry Association meeting in Boca Raton, Florida.

NBER is a private sector group that is considered the arbiter of U.S. business cycles.

Feldstein said the federal funds rate is headed for 2 percent from the current 3 percent. He added that lower short-term rates from the Federal Reserve would not have the same impact in the current downturn, in terms of reviving economic activity.

"There isn't much traction in monetary policy these days, I'm afraid, because of a lack of liquidity in the credit markets," he said.

The Fed's new credit facility, announced on Tuesday, "can help in a rather small way ... but the underlying risks will remain with the institutions that borrow from the Fed, and this does nothing to change their capital," Feldstein noted.

Feldstein noted "powerful forces (that) will continue to drive inflation higher." And while inflation expectations are still relatively well contained, "you wonder how long that's going to last," he said.

Recession talk on WSJ, plus a few snipes at B.B. at end of story

2008-03-13T17:07:00.000-07:00

By PHIL IZZO
March 13, 2008
The U.S. has finally slid into recession, according to the majority of economists in the latest Wall Street Journal economic-forecasting survey, a view that was reinforced by new data showing a sharp drop in retail sales last month.

"The evidence is now beyond a reasonable doubt," said Scott Anderson of Wells Fargo & Co., who was among the 71% of 51 respondents to say that the economy is now in a recession.

The Commerce Department said Thursday that retail sales tumbled 0.6% in February; sales excluding volatile auto and parts decreased 0.2%. The decline reflected a sharp slowdown in consumer spending, the primary driver of U.S. economic growth, as Americans grapple with high gasoline prices and the credit crunch, as well as drops in home values and other asset prices.

The survey, conducted March 7 through March 11, marked a precipitous shift to the negative from the previous survey conducted five weeks earlier. For example, the economists now expect nonfarm payrolls to grow by an average of only 9,000 jobs a month for the next 12 months -- down from an expected 48,500 in the previous survey. Twenty economists now expect payrolls to shrink outright. And the average forecast for the unemployment rate was raised to 5.5% by December from 4.8% in the previous survey.

Much of the gloom stemmed from last Friday's employment report, which showed a loss of 63,000 jobs in February, the second consecutive monthly decline. "My recession call comes from the employment data," said Stephen Stanley of RBS Greenwich Capital. "It struck me as a recessionary number."

Twenty-nine of 55 respondents said they expect the economy to contract in the current quarter and 25 expect it to do so in the second. The average of all the forecasts is for meager growth -- just 0.1% at an annual rate in the current quarter and 0.4% in the second.

The Wall Street Journal surveys a group of 55 economists throughout the year. Broad surveys on more than 10 major economic indicators are conducted every month. Once a year, economists are ranked on how well their forecasts have fared. For prior installments of the surveys, see: WSJ.com/Economists.
Although the classic definition of recession is two consecutive quarters of declines in the gross domestic product, Mr. Stanley pointed out that the National Bureau of Economic Research, the nonpartisan organization that is the official arbiter of when recessions begin and end, doesn't necessarily follow that definition. "If you go back to the 2001 recession, there was only one negative GDP quarter, and there might not even be one negative quarter in this recession," he said.

A WSJ survey of economists reveals that 71% of those surveyed believe Americans are currently in a recession. WSJ's Phil Izzo discusses the findings with Kelsey Hubbard.
The economists also expressed growing concerns that a 2008 recession could be worse than both the 2001 and 1990-91 downturns. They put the odds of a deeper downturn at an average 48%, up from 39% in the previous survey. Mark Nielson of MacroEcon Global Advisors said that "we recognize the previous two recessions were mild and, if a recession does occur, it is likely to be slightly worse than the previous two."

Amid the concerns about the economy, respondents expect more action from the government and the Federal Reserve. Some 63% said the use of public money to deal with the housing crisis is now likely or certain, while on average they expect the Fed to lower its benchmark federal-funds rate to 2% by June from the current 3%.

Futures markets Thursday priced in certainty of at least a 0.5 percentage point cut in the Fed's rate target and up to 90% probability of a 0.75 point cut. Officials had, prior to this week, appeared unconvinced a 0.75 point cut was needed, given signs that inflation psychology is worsening. But those views may have been affected by continued upheaval in credit markets and the weak retail sales and employment data. Market participants say this would be a risky time to cut less than investors expect. The Fed will have to weigh the urgency of addressing the continued credit crunch against the risk of appearing unconcerned about inflation.

However, the Fed's job may be complicated by inflation concerns. The economists raised their average forecast for consumer-price increases to 3.5% by June, up from 2.7% in the prior survey. The change reflects persistently high oil prices and a 4.3% jump in prices last month from the year before. February's CPI data will be released Friday, and economists surveyed by Dow Jones Newswires expect a 4.5% increase from a year ago.

Even as the Fed has made clear that it is most focused at the moment on threats to economic growth, some central bank policy makers have continued to voice concerns about the possibility of resurgent inflation. The central bank has used unconventional methods to boost liquidity in the market; its goal is to limit the use of its bluntest weapon, interest-rate reductions, which can fuel price pressures.

Meanwhile, most forecasters expect a recovery to begin in the second half of this year, as the government's stimulus package and the Fed's interest-rate cuts begin to spur the economy. By the end of the year, the economists expect inflation still to be hovering at an uncomfortably high 2.7%, raising the question of when the Fed will start raising rates.

Some 84% of economists in the survey said the Fed was too slow to raise interest rates in 2003, and policy makers don't want to repeat that mistake. But "it's going to take some time even under the best of circumstances before the Fed can be comfortable that the economic situation has stabilized," said Bruce Kasman of J.P. Morgan Chase.

One thing is clear: The darkening economic outlook has made Ben Bernanke's job less secure, especially with a new president about to enter the White House. The economists gave the Fed chairman just a 59% chance of being reappointed in 2010. "If a Democrat is elected he won't be reappointed, and [presumptive Republican presidential nominee John] McCain may opt for another, too," said David Resler of Nomura Securities. "The problems occurred on his watch," added Ram Bhagavatula of Combinatorics Capital.

Some Critique of Chopper Ben

2008-03-13T16:48:00.001-07:00

How a lender bailout hurts the economy
The Federal Reserve's efforts to ease the credit crunch risk stoking inflation - and letting reckless, well-paid execs off the hook. By Colin Barr, senior writer

Bernanke's efforts to shore up troubled lenders may have some negative side effects.
Slippery oil politics

NEW YORK (Fortune) -- The government is showing considerable ingenuity in devising new tactics to fight the credit crunch. But some observers fear that the innovations risk making matters worse - by fueling inflation and insulating executives who made reckless bets from the full wrath of the market.

The Federal Reserve set off a ferocious stock market rally Tuesday with its plan to lend banks as much as $200 billion over 28 days later this month. The plan sent shares of hard-hit lenders such as Fannie Mae (FNM), Freddie Mac (FRE, Fortune 500) and Washington Mutual (WM, Fortune 500) soaring, because the Fed will allow borrowers to use privately issued mortgage-backed securities as collateral. Investors have fled those securities because they see a rising risk that mortgage bonds will become impaired as housing prices slide and defaults tick higher.

Tuesday's plan, dubbed the Term Securities Lending Facility, wasn't the first Fed move aimed at loosening up the debt markets. Late last year the Fed rolled out a similar plan called the Term Auction Facility that briefly succeeded in bringing down the interest rates banks charge one another for overnight loans.

"Think of Ben Bernanke as action hero," Felix Salmon wrote this week at Portfolio.com. "Every time the credit markets seize up and threaten to bring down the U.S. financial system, he pulls out a new weapon."

Not quite a fan club
Not everyone is a fan of Action Ben, however. David Rosenberg, chief North American economist at Merrill Lynch (MER, Fortune 500), wrote Wednesday that this week's Fed action will do little to counter the impression that Bernanke & Co. is struggling with problems that the Fed ultimately has little control over.

"This latest experiment, as with the others undertaken thus far, does not address underlying credit problems, does not materially improve the solvency of the institutions exposed to assets under stress, does nothing to put a floor under home prices," Rosenberg wrote in a note to clients. "We see no reason based on this for anyone to change their economic or earnings outlook despite the stock market's initial reaction to this latest initiative."

Rosenberg, who has been predicting for some time that the economy will slip into recession this year, expects the Fed to cut its fed funds rate to as low as 1% later in 2008, down from 3% now and 5.25% back in August. Observers expect the rate cuts to continue next week, with a cut as deep as 75 basis points at the Fed's regularly scheduled meeting. But there's little optimism that the cuts will do anything to stimulate demand for houses, which remain pricey by historical measures, or even bring down mortgage rates, which have been rising since the Fed's slashed rate by more than a percentage point over eight days at the end of January.

The fear is that by expanding its emergency lending programs and sharply cutting rates, the Fed will turbocharge already healthy parts of the economy - at the cost of reduced purchasing power by dollar holders. Meanwhile, the big problem - bad loans tied to houses whose value is now declining - continues to fester.

"We're in the helicopter phase now," says Howard Simons, a strategist at Bianco Research in Chicago. He references the nickname Helicopter Ben, which Bernanke got tagged with after a 2002 speech on how central banks can steer away from deflation by dropping money into the economy.

Simons says he appreciates the Fed's need to make sure the economy has sufficient liquidity. But with gasoline prices approaching an all-time inflation-adjusted high and the price of milk having jumped 12% last year, inflation "is a very real concern," Simons says.

Betting on inflation
He points to the action in Treasury Inflation Protected Securities - bonds whose principal amount is adjusted upward when the consumer price index shows inflation and drops when it shows deflation. The yield on five-year TIPS recently turned negative - meaning that investors buying the securities now are accepting a lower interest rater than they would get on comparable Treasury notes, in the expectation of making up the difference in coming years via the inflation adjustment. In essence, they are betting that buying TIPS will shield them from the loss of purchasing power they would suffer over time by holding nominal Treasurys.

David Merkel, chief economist at broker-dealer Finacorp Securities, agrees that inflation is worrisome but adds that the makeup of the current board of governors ensures the Fed will "err on the side of inflation." Along with Bernanke, Fed Vice Chairman Donald Kohn and governor Frederic Mishkin "are students of the Great Depression," Merkel says. "So you're going to see more loosening" of monetary policy when the economy runs into trouble.

Inflation isn't the only worry on the minds of Fed critics. Dean Baker, co-director of the Center for Economic and Policy Research in Washington, says the Term Securities Lending Facility and moves like it amount to a government bailout of corporate executives who made reckless bets - and who should be made to pay the tab with their jobs.

"The Fed's actions are keeping banks from having to write down large losses and quite likely go into bankruptcy," he writes on his blog at the American Prospect. "The result is that the bank executives, whose inept management pushed them into bankruptcy, get to keep their jobs and their salaries, which run into the tens of millions a year." Meanwhile, homeowners facing foreclosure - not to mention ordinary savers who are watching inflation erode the value of their nest eggs - remain quite unbailed-out.

Simons says the whole mess points up the limitations of the Fed. "They're not crisis managers," he says. "There's no playbook for this."

California Home Prices Plunge!

2008-03-13T14:46:00.001-07:00

LOS ANGELES - Median home prices plunged in many of California's most populous counties in February, with Southern California leading the slide with an overall drop of 17.9 percent compared to a year earlier, according to new housing data released Thursday.

The drops reflect a deepening housing crisis in the state, which saw home values soar during the housing boom then decline sharply in most areas.

Median home prices fell this year in 15 major counties, DataQuick Information Systems said.

The median price in a six-county area of Southern California fell to $408,000 — the lowest level since October 2004, when it was $402,500. That median is 19.2 percent below the region's peak price of $505,000 last summer, and it's 1.7 percent below January's median, the firm said.

In the nine counties of the San Francisco Bay Area, the median price fell 11.6 percent to $548,000 compared to a year earlier and 17.6 percent from the region's peak median price of $665,000 last summer. Bay Area prices were essentially flat from January.

Home sales volume also kept sliding last month.

Sales fell 39 percent from a year earlier in Los Angeles, Orange, San Diego, Riverside, San Bernardino and Ventura counties. In all, 10,777 homes were sold in February in those six counties, up 8 percent from January, DataQuick said.

Southern California's home sales volume has hit new lows every month since September.

The nine San Francisco area counties saw a similar slowdown, as sales dropped 36.7 percent last month from February 2007.

Some 3,989 homes were sold in San Francisco, Marin, San Mateo, Napa, Alameda, Sonoma, Contra Costa, Santa Clara and Solano counties. That was up 11.2 percent from January.

Even as prices fall, buyers remain slow to dive into the market, with many waiting for prices to fall further.

Others have been unable to find affordable financing because lenders stung by soaring mortgage defaults and foreclosures have cut back on the easy lending that helped propel the housing boom.

The dynamic has worsened the prospects for many homeowners desperate to sell as falling home values drain their equity.

Statewide figures were expected later Thursday.

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What financial market participant will act in today's credit markets without transparency? Only a fool!

2008-03-12T19:08:00.001-07:00

By Walden Siew

NEW YORK (Reuters) - This week's central bank efforts to unfreeze credit markets will offer only temporary relief and more pain can be expected before a market recovery, analysts said at a credit conference on Wednesday.

The U.S. Federal Reserve announced on Tuesday that it would inject up to $200 billion to strained credit markets as part of a coordinated effort with other central banks, including the Bank of Canada, Bank of England, European Central Bank and the Swiss National Bank.

That effort is likely a short-term solution. Credit markets will likely stay frozen until banks fully realize more losses as they write down their holdings of mortgage-related bonds after years of inflated values for loan and debt securities, panelists said at a credit conference in New York.

Buyers are unwilling to return to credit markets due to a mistrust of credit ratings and a lack of experience among managers of collateralized debt and loan obligations, which is contributing to opaque pricing, according to Janet Tavakoli, president of Tavakoli Structured Finance.

"Most CDO managers aren't worth what they are being paid," said Tavakoli, who referenced billionaire investor Warren Buffett's description of credit derivatives as "weapons of mass destruction" that have wiped out billions of dollars of value.

In addition, too many investors failed to properly analyze assets in collateralized debt structures that are now crumbling, she said during a conference sponsored by the Information Management Network.

Richard Field, founder of financial consulting firm TYI LLC based in Needham, Massachusetts, said greater transparency in pricing is needed before any recovery takes shape.

"Transparency will be the catalyst driving profitable trades," Field said. "The gold standard for transparency is easily accessible and usable real time, standardized loan details, over the life of the deal." While many market observers anticipate that loans may be the first market to recover, James Finkel, chief executive officer of Dynamic Credit Partners, mentioned some trader speculation that the next surprise may come from defaults in the loan market.

None of the speakers on a loan panel said they had immediate concerns about loan defaults.

Steve Odesser, a managing director at Sheridan Capital, however, said it might take years for stability to return to the bond insurer industry, which has been roiled by fears that the sector will be swamped by the collapse of structured debt that it guaranteed.

"My guess is that it will be a couple year process," Odesser said.

Dean Baker with a scathing criticism of Bernanke's Fed Cronies (The American Prospect)

2008-03-12T19:04:00.001-07:00

Media Overlook Fed Bailout in Plain View

Can’t the media find any economists who don’t think that handing hundreds of billions of taxpayer dollars to the big banks and the incredibly rich people who own and manage them is a good idea? Apparently not, given the coverage so far to the Fed’s proposal to lend $200 billion to the banks using mortgage backed securities as collateral.

The workings of the Fed and the financial markets can appear complicated, so let’s simplify matters a bit to make it more clear what is going on here. Suppose that it was suddenly discovered that much of the wealth held by the country’s leading financial institutions was in fact counterfeit. Instead of having hundreds of billions of dollars of real currency in their vaults, institutions like Citigroup, Merrill Lynch, and Bears Stearns actually had hundreds of billions of dollars of counterfeit currency. Suppose further that the public did not know exactly who held what in terms of counterfeit currency, only that all of them had a lot of it. (The point here is that these banks hold mortgage backed securities, many of which are only worth a fraction of their face value, and therefore can be viewed as the equivalent of counterfeit currency.)

In such circumstances, investors would be very reluctant to accept the credit of any of the major financial institutions. They couldn’t know whether most of their assets were in fact counterfeit, and they were dealing with a bankrupt institution, or whether the counterfeit currency was only a limited share of the wealth, which would not jeopardize the institution’s ability to meet its obligations.

This is in fact the credit squeeze that we’ve have recently witnessed. The spread between the interest rates on a wide variety of assets and the interest rate on safe assets (U.S. government debt) has soared. As a result, the Fed’s effort to stimulate the economy, by lowering the federal funds rate, has been largely unsuccessful because other interest rates have remained high.

In response to this situation the Fed today announced that it would lend $200 billion to banks and other financial firms, accepting mortgage backed securities as collateral. This is effectively the same as saying that the Fed is going to lend money to banks and accept the counterfeit currency as collateral, treating it just as though it were real money.

The intended effect of this policy is to convince other investors that the counterfeit currency is in fact real currency, or at the very least that there is a really huge sucker out there (the Fed) which is prepared to treat the counterfeit currency as real currency.

So how does this story play out? Well, insofar as the Fed is successful, the counterfeit currency retains its value for a while longer. This allows Citigroup, Merrill Lynch, Bears Stearns and the rest of the big boys more time to dump their counterfeit currency on suckers who haven’t figured out how the game is played.

It is possible that they won’t be able to find enough suckers, in which case these banks will end up defaulting on their loans and the Fed (i.e. the government ) has lost tens or hundreds of billions dollars paying good money for counterfeit currency. Alternatively, perhaps the big boys are successful and can offload enough of their counterfeit money to restore themselves to solvency before the music stops. Then the Fed is repaid, but the counterfeit money now sits in the hands of other, less informed, or less inside, investors.

Either way, this is a policy of dubious merit. Why wouldn’t we want the banks to be forced to come clean and eat their losses? This is always the policy that the economists advocate when the parties in question are not the big New York banks. Does anyone remember the East Asian financial crisis when the media was full of condemnations of crony capitalism and the IMF insisted imposed stringent conditions on South Korea, Thailand, and Indonesia as a condition of getting bailed out? At that time, everyone insisted on transparency. Aren’t there any economists who still have this perspective? If so, why aren’t their views appearing anywhere in the news?

There is one other issue that is extremely important that has been completely omitted from the media’s discussion of the Fed’s actions. There are people who have shorted the counterfeit notes (mortgage backed securities and related assets) because they recognized that these assets were in fact going to lose much of their value. While these short sellers were trying to make money, they were actually performing a valuable public service. They were pushing down the price of these assets towards their true level. If we had many such short sellers in the market we would not have seen the housing bubble grow to such dangerous proportions. The same holds true of the stock bubble.

However, if the Fed acts to sustain bubbles even after they have started to collapse under the pressure of their own weight, it makes it far more risky for short sellers. This means that even investors who realize that Citigroup has nothing but counterfeit currency will be reluctant to short its stock or other assets supported by counterfeit currency. As a result we can expect to see even bigger more dangerous bubbles in the future.

This is not a pretty story and there are economists who can make this point. The media should be talking to them, not just the cheerleaders for the housing bubble.

--Dean Baker

Bernanke and Paulson should let some banks fail, instead of propping them up and regulating them, as they are already heavily regulated.

2008-03-12T16:15:00.001-07:00

Paulson, Bernanke to Propose Tougher Scrutiny of U.S. Banks
By Jesse Westbrook

March 12 (Bloomberg) -- Treasury Secretary Henry Paulson, Federal Reserve Chairman Ben Bernanke and other U.S. regulators will propose tougher scrutiny of banks' capital in a report on lessons from the mortgage crisis, a government official said.

The results of the review by the President's Working Group on Financial Markets may be released as soon as tomorrow, two officials said on condition of anonymity. Paulson is scheduled to speak on financial markets at 10 a.m. in Washington.

Policy makers have said they aim to address deficiencies in how lenders make loans to homebuyers, then package the mortgages into bonds rated by credit ratings firms and sold by securities companies. Consumer advocates and legislators argue that the system failed to ensure that borrowers could repay the loans, and helped deepen a slump that has led to record foreclosures.

``There definitely needs to be broader oversight of the mortgage lending process,'' Paulson said in an interview with Bloomberg Television in Arlington, Virginia, on March 3. Last month, he said ``we need a strong policy response.''

One official, who read drafts of the report, said it will include proposals to strengthen supervision of banks' capital, amid concern they failed to protect against the risks they took investing in subprime securities.

Banks and securities firms posted more than $188 billion of credit losses since the start of last year as the mortgage meltdown rippled through financial markets. As lenders made it tougher to get loans and home values slid, delinquencies climbed.

Casting Blame

Blame for the debacle will be spread among bank supervisors, ratings companies and large banks and securities companies, the official said. Consumer advocates and congressional Democrats have blamed regulators for failing to halt abusive lending practices during the 2004 to 2006 mortgage boom that has now turned to bust.

The President's Working Group is chaired by Paulson and includes Bernanke, Securities and Exchange Commission Chairman Christopher Cox and Walter Lukken, acting chairman of the Commodity Futures Trading Commission.

Fed spokesman David Skidmore declined to comment, as did Treasury spokeswoman Brookly McLaughlin, SEC spokesman John Nester and Dennis Holden at the CFTC.

Marketing Securities

As the housing boom approached its peak, Wall Street firms marketed a new type of security backed by high-interest subprime mortgages issued to borrowers with poor or scant credit history. Standard & Poor's, Moody's Investors Service and Fitch Ratings often gave the assets top AAA ratings.

Investment banks including Bear Stearns Cos., Deutsche Bank AG and Lehman Brothers Holdings Inc. sold $1.2 trillion of the securities in 2005 and 2006, according to estimates by Brian Bethune, director of financial economics for Global Insight Inc. in Waltham, Massachusetts.

The working group will echo a report by U.S. and European regulators released last week, the official said. That release said supervisors are ``critically evaluating'' weaknesses in banks' risk management practices.

``Each supervisor is ensuring that firms are making appropriate changes,'' William Rutledge, head of bank supervision at the Federal Reserve Bank of New York, said in a statement March 6.

To contact the reporter on this story: Jesse Westbrook in Washington at jwestbrook1@bloomberg.net.

ECB on Eurozone Inflation.

2008-03-12T14:43:00.001-07:00

BERLIN, March 12 (Reuters) - European Central Bank policymakers are "particularly concerned" about inflation and do not see a serious slowdown in the euro zone economy, ECB Executive Board member Juergen Stark said on Wednesday.

Stark said the ECB's main priority was to deliver stable prices and that it did not cooperate with other central banks on monetary policy. "We don't have a double mandate. We have a mandate to guarantee price stability," he said.

"I and the Governing Council of the ECB are particularly concerned about the rate of inflation. This is a very unsatisfactory state of affairs," Stark said in a speech in Berlin on the economic and monetary outlook in the euro zone.

"Our highest priority remains maintaining price stability."

Euro zone inflation is running at a record high of 3.2 percent and the ECB, unlike its U.S. and British counterparts, has kept its interest rates unchanged since U.S. credit troubles started to spill across the Atlantic last summer.

Under its mandate, the ECB aims to keep inflation below but close to 2 percent.

Stark said the U.S. credit woes were rippling out from the United States but not hitting the euro zone too hard.

"So far there has only been a limited impact on the euro zone economy from the turbulence on financial markets," he said. "There is no credit squeeze." Last week, ECB staff raised their forecasts for euro zone inflation and cut the outlook for economic growth.

New staff projections put the Harmonised Index of Consumer Inflation for this year in a 2.6-3.2 percent range, raising the midpoint to 2.9 percent, from 2.5 percent in the last round of forecasts in December.

Growth in the 15-nation region was seen at 1.3-2.1 percent, for a midpoint of 1.7 percent in 2008.

"We are experiencing a slowdown in growth, but not a serious one," Stark said.

Most private-sector economists expect a worsening euro zone growth outlook to cause the ECB to cut rates to 3.75 percent from 4 percent currently before the end of June.

Stark urged trade unions and employers to show wage moderation in the latest pay negotiations and not to react to price rises by agreeing large raises.

"So the appeal to wage negotiators is not to generate second-round effects as this would lead to a wage-price spiral. In any case, the ECB would not tolerate such second-round effects," he said.

Berthold Huber, leader of German industrial union IG Metall, has dubbed 2008 "mega wage year" for Europe's largest economy.

Germany enjoyed its strongest growth in six years in 2006 and slowed only slightly last year, but it has seen virtually no real wage growth in the last two years. Stark took a swipe at politicians who question the ECB's independence.

"I certainly would like to warn against a continuation of any discussion among politicians that calls the independence of the ECB into question," he said.

"Some politicians are at different stages of the learning curve. There is always hope that they will make some progress."

Evolutionary Biologist's take on Spitzer and human monogamy. LA Times.

2008-03-12T10:40:00.000-07:00

Want a man, or a worm?

Among mammals, expecting monogamy tends to run against the grain of nature.
By David P. Barash
March 12, 2008
As an evolutionary biologist, I look at New York Gov. Eliot Spitzer's now-public sexual indiscretions and feel justified in saying, "I told you so."

One of the most startling discoveries of the last 15 years has been the extent of sexual infidelity (scientists call it "extra-pair copulations" or EPCs) among animals long thought to be monogamous. It's clear that social monogamy -- physical association and child rearing between a male and a female -- and sexual monogamy are very different things. The former is common; the latter is rare.

At one point in the movie "Heartburn," Nora Ephron's barely fictionalized account of her marriage to reporter Carl Bernstein, the heroine tearfully tells her father about her husband's infidelities, only to be advised, "You want monogamy? Marry a swan." Yet thanks to DNA evidence, we know now that even those famously loyal swans aren't sexually monogamous.

One species that is, and, significantly, perhaps the only one that could be reliably designated as such, is Diplozöon paradoxum, a parasitic worm that inhabits the intestines of fish. Among these animals, male and female pair up while adolescents; their bodies literally fuse together, whereupon they remain sexually faithful until death does not them part.

One of the most important insights of modern evolutionary biology has been an enhanced understanding of male-female differences, deriving especially from the production of sperm versus eggs. Because sperm are produced in vast numbers, with little if any required parental follow-through, males of most species are aggressive sexual adventurers, inclined to engage in sex with multiple partners when they can. Males who succeed in doing so leave more descendants.

A story is told in New Zealand about the early 19th century visit of an Episcopal bishop to an isolated Maori village. As everyone was about to retire after an evening of high-spirited feasting and dancing, the village headman -- wanting to show sincere hospitality to his honored guest -- called out, "A woman for the bishop." Seeing a scowl of disapproval on the prelate's face, the host roared even louder, "Two women for the bishop!"

On balance, the Maori headman had an acute understanding of men. He also reflected a powerful cross-cultural universal: Around the world, high-ranking men have long enjoyed sexual access to comparatively large numbers of women, typically young and attractive. Moreover, women have by and large found such men appealing beyond what may be predicted from their immediate physical traits. "Power," wrote Henry Kissinger, "is the ultimate aphrodisiac."

Power-as-pheromone is pretty much the default among mammals. Elk, elephant seal, baboon or chimpanzee, in a wide array of species, females eagerly mate with dominant males while disdaining subordinates. And they do so, more or less, in harems.

Not surprisingly, before the homogenization of cultures that resulted from Western colonialism, more than 85% of human societies unabashedly favored polygamy. In such societies, men who accumulate power, wealth and status gain additional wives and consorts. In avowedly monogamous cultures, successful males accumulate a wife and often additional girlfriends. Even if, thanks to birth control technology, they do not actually reproduce as a result (and thus enhance their evolutionary "fitness"), they are responding to the biological pressures that whisper within men.

Part of being successful, moreover, is a tendency to feel entitled and often to be uninhibited -- in part because one outcome of our species-wide polygamous history is that successful men have been those who took risks, which paid off. The losers were mostly found among the unsuccessful bachelors who, by definition, did not contribute very much to succeeding generations of men, or to their inclinations.

All of which contributes to the apparent sex appeal of such less-than-stunning physical specimens as Kissinger, Woody Allen and Bill Clinton, not to mention the persistence of sex scandals among the popular and powerful across the political and ideological spectrum, including Thomas Jefferson, JFK, Hugh Grant, Newt Gingrich, Larry Craig and a long list, receding almost to the infinite past as well as likely into the indefinite future. For men at the top -- rock stars, successful athletes, politicians, wealthy CEOs, the jet-set glitterati -- such opportunities are exceedingly numerous, not so much because they have insatiable sex drives but because they are dominant males in a biologically randy species.

Some readers may bridle at this characterization of Homo sapiens as EPC-inclined, but the evidence is overwhelming. That doesn't justify adultery, by either sex, especially because human beings -- even those burdened by a Y chromosome and suffering from testosterone poisoning -- are presumed capable of exercising control over their impulses. Especially if, via wedding vows, they have promised to do so. After all, "doing what comes naturally" is what nonhuman animals do. People, most of us like to think, have the unique capacity to act contrary to their biologically given inclinations. Maybe, in fact, it is what makes us human.

But even a smidgen of evolutionary insight suggests that maleness plus money plus political power isn't likely to add up to the kind of sexual restraint that the public expects. A concluding word, therefore, to the outraged voters of New York state: You want monogamy? Elect a swan. Or better yet, a Diplozöon paradoxum.

David P. Barash, an evolutionary biologist, is professor of psychology at the University of Washington.

Interesting Op-Ed in Washington Post by Steven Pearlstein. P.S. I did not request a bailout at this time.

2008-03-12T10:32:00.000-07:00

A Bailout. For Everyone.
Transcript: Pearlstein: Credit Turmoil
This week, it was a $200 billion bond-for-bond swap for the big investment houses.

If they keep this up, pretty soon you'll be able to walk into any Federal Reserve bank and hock that diamond brooch you inherited from Aunt Mildred.

Forget all that nonsense about the Bernanke Fed being too timid or behind the curve. In the face of what is turning into the most serious financial market crisis since the Great Depression, the Fed has been more aggressive and more creative in using its limitless balance sheet -- in effect, its ability to print money -- than at any time in history.

We can argue till the cows come home about whether this is a bailout for Wall Street. It is -- but only to the extent that it is also a bailout for all of us, meant to prevent a financial and economic meltdown that drags everyone down with it. In broad strokes, we're going through a massive "de-leveraging" of the economy, wringing out trillions of dollars of debt that had artificially driven up the price of real estate and financial assets, and, more generally, allowed Americans to live beyond their means. The Fed's goal has not been to impede that process, simply to make sure that it proceeds in an orderly fashion. But even that has required central bank intervention that is unprecedented in scale and scope. And despite yesterday's huge rally in the stock market, Fed officials warn that this de-leveraging is nowhere near finished.

The real action is on the credit markets, where, for the third time since last summer, the price of bonds and other complex securities fell and interest rates rose on everything but U.S. Treasury bonds.

Over the previous month, there had been fresh signs that the economy was sinking into recession: a slowing of the growth in corporate sales and profits, a decline in payroll employment and further deterioration in a housing market already in deep distress. Deeper cracks began to appear in the commercial real estate market. And out of the blue, municipalities and nonprofit institutions found that they could no longer roll over their short-term debt on the auction-rate market.

But the real problem began in late February, as several of Wall Street's biggest investment banks prepared to close their books for the quarter and realized they were looking not only at big declines in profit from issuance of new stocks and bonds and fees from mergers and acquisitions, but also another round of write-offs in the value of their holdings. In response, the banks began to hunker down, instructing their trading desks to raise margin requirements for hedge funds and other customers, requiring them, in effect, to post more collateral on their heavy borrowings.

Thus began a chain reaction in which hedge funds began selling what they could -- largely mortgage-backed securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae -- to raise the cash to meet their new margin calls. That wave of forced selling drove down the price of those bonds, which prompted more margin calls and more forced selling. By the end of last week, the interest rate spread on those securities -- the difference between their yield and that of risk-free U.S. Treasury bonds -- had jumped four, five, even 10 times the normal rate.

Among those caught up in the vicious cycle were hedge funds run by such blue-chip names as KKR and Carlyle Group, along with Thornburg Mortgage, a big mortgage lender. News of their troubles swept through Wall Street, heightening the sense of panic, as did rumors that Goldman Sachs was about to post big losses and Bear Stearns was about to run out of cash. Meanwhile, Lehman Brothers announced that it would lay off 5 percent of its staff in what was viewed by many as a first installment of a consolidation that would eventually eliminate 20 percent of the jobs on Wall Street. Analysts began to warn that financial-sector losses from mortgages, commercial real estate, failed takeover loans and other bad gets could reach as high as $1 trillion.

It was against this backdrop that the Fed announced Friday that it would auction $200 billion in additional loans to banks looking for cash to lend or use as reserve capital. By accepting AAA-rated mortgage-backed securities as collateral for the loans, the Fed aimed to restore confidence and trading in that beleaguered market and begin to put a floor under prices.

Then yesterday, the Fed announced that it would swap $200 billion worth of Treasury bills for $200 billion worth of mortgage-backed securities held by the major investment banks that are members of its "prime broker" network on Wall Street. The aim is to take some pressure off the investment banks to raise their margin requirements even more and put a halt to the vicious cycle of selling that begets more selling.

While all this may seem rather remote to most Americans, it has already had a profound effect on the real economy. It has reduced the value of the homes and stock portfolios of millions of American investors, led to a pullback in consumer spending and caused U.S. businesses to cut back on hiring and new investment.

The Fed hopes that by injecting $400 billion of liquidity, it can help restore the more normal functioning of credit markets and encourage banks to lend again rather than hoard their cash. For it is only when bank lending and credit markets have returned to more normal operations, say Fed officials, that the beneficial impact of their interest rate cuts can be transmitted to the economy. And they leave little doubt that, despite a heavy dose of monetary medicine already in the pipeline, they intend to add another dose at their meeting next week.

It's anyone's guess how long this credit crunch will last, but the chances are that we'll have several more market meltdowns and Fed rescues before it's over, probably in the fall. Until then, the dollar will continue to get hammered and stocks will continue their fitful decline. And if the last two financially induced recessions are any guide, it will be well into 2009 before the economy hits bottom, followed a couple of years of slow growth and "jobless" recovery.

Inflation Alert in WSJ

2008-03-10T10:29:00.001-07:00

Inflation Alert
By GERALD P. O'DRISCOLL JR.
March 10, 2008; Page A14
The 1970s was a decade of stagflation -- the concurrence of a rising inflation rate and stagnant economic growth. The U.S. economy has not now reached the double-digit inflation rate (almost 15% by 1981), or the 9% unemployment rate, experienced back then. But the early '70s, not the decade's end, offer the more ominous parallels to today's situation.

With "headline" consumer price inflation (CPI) at 4.3% for the last 12 months, we have now reached the inflation rate that spurred Richard Nixon to impose wage and price controls on Aug. 15, 1971. The controls were certainly the wrong remedy, but the intuition that such a high inflation rate cannot long be tolerated was correct.

Nixon acted because the inflation rate, though declining, remained stubbornly above 4%. What has changed to render 4% inflation tolerable today?

Nothing for those who earn, spend and save the dollar. What is different today is that the Fed now takes food and energy prices out of the inflation measure and instead reports what it calls "core inflation." Thus we're told inflation is only 2.7%.

The original rationale to exclude food was that the Fed should not try to offset weather-induced supply shocks. Energy prices were also excluded because the Fed decided it should not try to offset OPEC-induced supply shocks. The Fed wanted an inflation measure that excluded temporary changes and focused on persistent movements. But arbitrarily excluding major components is not the accepted way to remove volatility, and there is a lively debate among economists within the Fed on alternative techniques. Regardless of the outcome of that technical exercise, the core inflation measure has become a misleading statistic at best. The global food trade mitigates the effects of localized weather events. Rising energy prices are not the effects of one-time supply shocks, but the systematic result of global demand.

Dollar users do not experience "core" inflation. What people purchase every day is precisely what is excluded from the core measure. For parents with growing children, milk, eggs and bread are not optional purchases. For millions of Americans, especially in the West, a long daily commute by car is a reality.

The Bush administration and its supporters have long pondered why it has not received credit for good economic policies. Perhaps this is in part because the benefit of tax cuts has been offset by rising energy prices, and now rising food prices.

The use of the core rate has lulled both the administration and the Fed into complacency, disconnecting them from the experience of ordinary consumers. Until recently, inflation doves pointed to the flat yield curve (long-term interest rates close to short-term ones) to buttress their case that inflation and inflationary expectations are low. But the bond market was slow to pick up on the new era of inflation in the 1970s. Not until 1974-75 did the long-bond yield and the yield curve finally flash an inflation warning signal. From July 1974 to May 1975, the Fed funds/long bond yield spread went from negative 466 basis points to a positive 300 basis points.

Economists Manuel H. Johnson and Robert E. Keleher found that only in late 1977 and early 1978 were "all the key market price indicators [commodity prices, exchange rates and bond yields]" signaling "a significant deterioration of the value of money."

The bond market was late to the game in the 1970s and may once again be a lagging indicator. The retirement savings of millions are meanwhile gradually being confiscated.

The Federal Reserve now confronts a serious economic problem with limited scope for action. Asset prices, especially those linked to housing, are falling. Financial institutions are capital-constrained and risk-averse, and are not lending. Economic growth is flagging. The classic response would be first to reflate the banking system and then the economy. But current inflation is rising. Excess money creation will translate quickly into even higher inflation.

Yet Fed Chairman Ben Bernanke has in recent days promised further interest-rate cuts and monetary largesse. San Francisco Fed President Janet Yellen promised the Fed will tighten later at the right moment -- easier said than done. Charles Plosser, Philadelphia Fed president, was closer to the mark when he recently said "once the public loses confidence in the Fed's commitment to price stability, it is very costly to the economy for the Fed to regain that confidence."

The Fed needs to return to its mandate of controlling inflation. The first step is for the Fed to shed an inflation measure that misleads itself, other policy makers, and the markets. We do not need a rerun of the 1970s. Once is enough.

Mr. O'Driscoll, a senior fellow at the Cato Institute, was formerly vice president of the Federal Reserve Bank of Dallas.

TIPS investors don't trust the fed on inflation.

2008-03-09T19:00:00.001-07:00

TIPS Show Fed Loses Control of Inflation as Yields Go Negative
By Sandra Hernandez and Deborah Finestone

March 10 (Bloomberg) -- Bond investors have never been so sure that the Federal Reserve will lose control of inflation. They're so convinced that they're giving up yields just to buy debt securities that protect against rising consumer prices.

The yield on the five-year Treasury Inflation-Protected Security due in 2012 has been negative since Feb. 29, ending last week at minus 0.16 percent. The notes, which were first sold in 1997, have never before traded below zero. Even so, firms from Deutsche Asset Management to Vanguard Group Inc., the second-biggest U.S. mutual fund company, say TIPS are a bargain.

For the first time in a generation, money managers must come to grips with a central bank that's more intent on spurring the economy than restraining price increases. With oil above $100 a barrel, gold approaching $1,000 an ounce and the dollar at a record low against the euro, TIPS show investors aren't convinced Fed Chairman Ben S. Bernanke will be able to tame inflation once policy makers stop cutting interest rates.

``The way TIPS are trading now, investors believe headline inflation will stay lofty and are willing to give up the real yield for that,'' said Brian Brennan, a money manager who helps oversee $11 billion in fixed-income assets at T. Rowe Price Group Inc. in Baltimore. Prices for the securities indicate ``a real concern of a recession and high headline inflation,'' he said.

Because TIPS pay a principal amount that rises in tandem with the consumer price index, buyers accept lower yields in a bet the inflation adjustment will make up the difference.

Volcker Fed

Investors typically determine what they are willing to receive in interest by deducting the rate of inflation expected over the life of the securities from the rate on a comparable Treasury. Investors can still earn money from TIPS with sub-zero rates because the principal rises with the CPI.

Five-year TIPS yield 2.38 percentage points less than similar-maturity Treasuries. The so-called breakeven rate has risen from a four-and-a-half-month low of 1.89 percent on Jan. 23, the day after policy makers cut their target lending rate by three-quarters of a point to 3.50 percent in an emergency move.

The last time investors were so worried about faster inflation amid slowing growth, Paul A. Volcker presided over a Fed that would raise rates as high as 20 percent to end the stagflation crisis of the 1970s, according to Seth Plunkett, a bond fund manager at American Century Investment Management in Mountain View, California. The firm manages $20 billion.

Fed Forecast

Inflation ``is going to be higher than the Fed's targeted area,'' said Plunkett, whose fund owns a greater percentage of TIPS than contained in the index he uses to measure performance.

In forecasts released last month, the Fed said it expects inflation to accelerate 2.1 percent to 2.4 percent this year, and 1.7 percent to 2 percent in 2009.

TIPS have returned 6.2 percent this year, compared with 3.7 percent from regular Treasuries, according to indexes compiled by Merrill Lynch & Co. Mutual funds that specialize in inflation-linked debt attracted a net $2.87 billion in January, boosting their assets to $47.6 billion, according the latest data available from Financial Research Corp. in Boston. In all of 2007, the funds added a net $3.54 billion.

``TIPS are a really good buy,'' said Bill Chepolis, a money manager who helps oversee $9 billion at Deutsche Asset Management in New York. He bought five-year TIPS in the last six months. ``They're cheap with the Fed continuing to emphasize growth over inflation and inflation continuing to come in higher.''

Too Expensive

Investors seeking a haven from credit-market losses have pushed yields on all Treasuries lower, including TIPS. Five-year nominal notes have dropped 2.07 percentage points since Feb. 1 to 1.52 percent.

``It's crazy,'' said Richard Schlanger, a portfolio manager at Boston-based Pioneer Asset Management, which oversees $44 billion in fixed income. ``You're paying the government to buy five-year TIPS. People are hiding in Treasuries for liquidity's sake because of a lack of liquidity in other markets. Eventually this will pass.''

Record-low TIPS yields also reflect bets on surging commodities. Crude oil futures rose to $106.54 last week and are up 70 percent this year.

Growth in countries such as China and India mean that rising prices for goods including wheat, gold, and oil ``may be a permanent thing,'' said Paul Samuelson, the second recipient of the Nobel Prize in economics who helped popularize the term ``stagflation.'' ``This time it's primarily not made-in-America inflation.''

The Treasury stopped selling five-year TIPS between 1998 and 2003, and resumed auctions in October 2004. In addition to the current five-year security, seven other inflation-indexed notes with up to four years to maturity currently yield less than zero.

Should five-year TIPS continue to have negative yields when the Treasury holds its next sale April 22, federal rules state investors would receive a coupon of zero percent, said Stephen Meyerhardt, a Bureau of Public Debt spokesman in Washington.

``TIPS have performed really well for the right reasons and they will continue to perform well for the right reason,'' said Kenneth Volpert, a fund manager overseeing $14.7 billion in inflation-linked debt at Vanguard in Valley Forge, Pennsylvania.

To contact the reporters on this story: Sandra Hernandez in New York at shernandez4@bloomberg.net; Deborah Finestone in New York at dfinestone@bloomberg.net

Double Bubble Trouble by Stephen Roach in NYT op-ed.

2008-03-08T13:10:00.000-08:00

AMID increasingly turbulent credit markets and ever-weaker reports on the economy, the Federal Reserve has been unusually swift and determined in its lowering of the overnight lending rate. The White House and Congress have moved quickly as well, approving rebates for families and tax breaks for businesses. And more monetary easing from the Fed could well be on the way.

The central question for the economy is this: Will this medicine work? The same question was asked repeatedly in Japan during its “lost decade” of the 1990s. Unfortunately, as was the case in Japan, the answer may be no.

If the American economy were entering a standard cyclical downturn, there would be good reason to believe that a timely countercyclical stimulus like that devised by Washington would be effective. But this is not a standard cyclical downturn. It is a post-bubble recession.

The United States is now going through its second post-bubble downturn in seven years. Yet this one stands in sharp contrast to the post-bubble shakeout in the stock market during 2000 and 2001. Back then, there was a collapse in business capital spending, a sector that peaked at only 13 percent of real gross domestic product.

The current recession has been set off by the simultaneous bursting of property and credit bubbles. The unwinding of these excesses is likely to exact a lasting toll on both homebuilders and American consumers. Those two economic sectors collectively peaked at 78 percent of gross domestic product, or fully six times the share of the sector that pushed the country into recession seven years ago.

For asset-dependent, bubble-prone economies, a cyclical recovery — even when assisted by aggressive monetary and fiscal accommodation — isn’t a given. Over the past six years, income-short consumers made up for the weak increases in their paychecks by extracting equity from the housing bubble through cut-rate borrowing that was subsidized by the credit bubble. That game is now over.

Washington policymakers may not be able to arrest this post-bubble downturn. Interest rate cuts are unlikely to halt the decline in nationwide home prices. Given the outsize imbalance between supply and demand for new homes, housing prices may need to fall an additional 20 percent to clear the market.

Aggressive interest rate cuts have not done much to contain the lethal contagion spreading in credit and capital markets. Now that their houses are worth less and loans are harder to come by, hard-pressed consumers are unlikely to be helped by lower interest rates.

Japan’s experience demonstrates how difficult it may be for traditional policies to ignite recovery after a bubble. In the early 1990s, Japan’s property and stock market bubbles burst. That implosion was worsened by a banking crisis and excess corporate debt. Nearly 20 years later, Japan is still struggling.

There are eerie similarities between the United States now and Japan then. The Bank of Japan ran an excessively accommodative monetary policy for most of the 1980s. In the United States, the Federal Reserve did the same thing beginning in the late 1990s. In both cases, loose money fueled liquidity booms that led to major bubbles.

Moreover, Japan’s central bank initially denied the perils caused by the bubbles. Similarly, it’s hard to forget the Fed’s blasé approach to the asset bubbles of the past decade, especially as the subprime mortgage crisis exploded last August.

In Japan, a banking crisis constricted lending for years. In the United States, a full-blown credit crisis could do the same.

The unwinding of excessive corporate indebtedness in Japan and a “keiretsu” culture of companies buying one another’s equity shares put extraordinary pressures on business spending. In America, an excess of household indebtedness could put equally serious and lasting restrictions on consumer spending.

Like their counterparts in Japan in the 1990s, American authorities may be deluding themselves into believing they can forestall the endgame of post-bubble adjustments. Government aid is being aimed, mistakenly, at maintaining unsustainably high rates of personal consumption. Yet that’s precisely what got the United States into this mess in the first place — pushing down the savings rate, fostering a huge trade deficit and stretching consumers to take on an untenable amount of debt.

A more effective strategy would be to try to tilt the economy away from consumption and toward exports and long-needed investments in infrastructure.

That won’t be easy to achieve. Such a shift in the mix of the economy will require export-friendly measures like a weaker dollar and increased consumption by the rest of the world, which would strengthen demand for American-made goods. Fiscal initiatives should be directed at laying the groundwork for future growth, especially by upgrading the nation’s antiquated highways, bridges and ports.

That’s not to say Washington shouldn’t help the innocent victims of the bubble’s aftermath — especially lower- and middle-income families. But the emphasis should be on providing income support for those who have been blindsided by this credit crisis rather than on rekindling excess spending by overextended consumers.

By focusing on exports and on infrastructure spending, we might be able to limit the recession. Such an approach might also set the stage for a more balanced and sustainable economic upturn in the next cycle. A stimulus package aimed at exports and infrastructure investment would be an important step in that direction.

The toughest, and potentially most relevant, lesson to take from Japan’s economy in the 1990s was that the interplay between financial and real economic bubbles causes serious damage. An equally lethal interplay between the bursting of housing and credit bubbles is now at work in the United States.

American authorities, especially Federal Reserve officials, harbor the mistaken belief that swift action can forestall a Japan-like collapse. The greater imperative is to avoid toxic asset bubbles in the first place. Steeped in denial and engulfed by election-year myopia, Washington remains oblivious of the dangers ahead.

Stephen S. Roach is the chairman of Morgan Stanley Asia.

Price Controls in a Capatalist Society.

2008-03-06T19:26:00.000-08:00

So just what is the Federal Reserve doing in lowering interest rates in the face of sky-high inflation. Stated another way, why is the Fed debasing our currency? Who are they really trying to assist? It seems that we have entered a new type of economy, what I would like to call an Asset-Command Economy. I remember that for years, we would preach to the Soviet Union that price controls don't work, because only the market can set an efficient price and match production with demand. Yet here we are, less than 20 years after the collapse of the USSR, also establishing price controls. Only we are not setting price controls on shoes, tvs or oranges. The Fed is trying to establish price controls on Asset Prices. Don't believe me? Why is Henry Paulson stating that he doesn't believe that houses will return to "historical prices", i.e. they will not fall sufficiently to fall in line with incomes. What business does the Secretary of Treasury have in trying to state his beliefs or ideas about where r/e prices should be? Is he really any better than any communist trying to control the price of lettuce? Will he have a better result? Instead of trying to tip off his GS buddies about brewing trouble in the MBS market so they can go short, perhaps he should have been telling the people not to get so over indebted. But perhaps that is not good for the The Street. To get back to my original question, the answer is clear. The major beneficiary of Bernanke's ridiculous inflationary policies is the Wall Street Cartel. Capitalism without Capital is just an ism! Without the banking sector, obviously it would be nearly impossible to do business in the US; hence, goes the argument they should be bailed out AT ANY COST! It is written that Mr. Bernanke is a student of The Great Depression. But perhaps I can suggest to him that he should read how other countries were doing at that time. How did it go with Russia, Germany, France, Japan or Italy? During those turbulent time, other great nations turned to fascism, imperialism and communism, but we persevered! Before Mr. Bernanke goes full throttle with the printing machine to prove his pedagogical theses, perhaps he can consider how many regular Americans will be destroyed by his policies. To conclude I will leave with a few quotes by Lenin:

"There is no surer way to destroy a Capitalist than to debauch his currency"

"We will destroy the Bourgeoise by grinding them in the millstone between inflation and taxation"

Another Article about house price declines.

2008-03-06T19:22:00.001-08:00

By Joanne Morrison - Analysis

WASHINGTON (Reuters) - A decline in U.S. home prices is needed to attract buyers back and end the housing slump, but with no bottom in sight, more trouble lies ahead for an economy that may already be in recession.

This is a growing concern among Wall Street analysts and policy-makers, like Federal Reserve Governor Frederic Mishkin, that potential home buyers may wait on the sidelines for an extended period.

"If house prices fall more than expected, and that condition leads to more adverse expectations for future changes in house prices, then housing demand could fall as a result," Mishkin warned a group of key economists meeting in the Washington area this week in one of the bleakest public speeches by a Fed official during this business cycle.

Typically, falling home prices help stave off a downturn by boosting demand for homes and reducing the backlog of unsold homes. Even though U.S. home prices fell last year for the first time in a generation, sales continue to slow, only adding to the glut of inventories.

At the current sales pace for previously owned homes during January, there was more than 10 months' worth of homes for sale, according to the National Association of Realtors. "I think it's freezing the market right now," said Mark Zandi, chief economist at Moody's Economy.com in West Chester, Pennsylvania. "Home buyers are not going to catch that falling knife and that's going to weigh very heavily on the housing market through this year and next."

Home prices have indeed fallen according to the real estate group, which reported a nearly 5 percent drop in median prices for previously owned homes, the bulk of the housing market, in January from prices a year ago.

The group projects that prices for new homes will tumble 6 percent this year and 1.2 percent for previously owned homes.

Analysts warn that until there are signs the housing market has stabilized or bottomed out, buyers and lenders are likely to be very cautious.

"We're not near there yet so people are going to continue to wait on the sidelines," said JPMorgan economist Michael Feroli.

Since September, the Fed has slashed its benchmark interest rate by 2.25 percentage points in an effort to end a growing credit crisis and boost the economy. Economists are expecting the central bank will continue on this path even though there are signs of inflationary pressures.

Even with such price pressures, analysts believe the central bank needs to continue with rate cuts, saying this is key in bringing an end to what has been seen as the worst housing downturn since Great Depression.

"The Fed should forget about everything else now and just do whatever is necessary to bring a bottom for home prices into sight," said John Lonski, chief economist at Moody's in New York.

Timing is crucial because the Fed's latest data shows that the net wealth of U.S. households in the final three months of last year fell for the first time in five years as the value of real estate holdings and stocks weakened.

That was much more than the 6.5 months' supply available during the peak of the housing boom in 2006. That also comes as sales have slipped for the past six months, according to the real estate group.

NO BOTTOM SEEN

But economists fear there is no bottom in sight and that's making everyone jittery: the buyer, the lender and the investor. In that report, the percentage of equity that Americans have in their homes sank to the lowest since 1945.

"Not only have the fundamentals for housing shifted, but the psychology has shifted. Now it's pessimism with expectations of future price declines and this is not going to resolve itself quickly," said Zandi.

(Reporting By Joanne Morrison; Editing by Neil Stempleman)

Lovely bit of news about home equity levels.

2008-03-06T10:59:00.001-08:00

Homeowner Equity Is Lowest Since 1945
Thursday March 6, 12:50 pm ET
By J.W. Elphinstone, AP Business Writer
Federal Reserve Report Shows Homeowner Equity Dipping Below 50 Percent, the Lowest on Record

NEW YORK (AP) -- Americans' percentage of equity in their homes fell below 50 percent for the first time on record since 1945, the Federal Reserve said Thursday.
Homeowners' portion of equity slipped to downwardly revised 49.6 percent in the second quarter of 2007, the central bank reported in its quarterly U.S. Flow of Funds Accounts, and declined further to 47.9 percent in the fourth quarter -- the third straight quarter it was under 50 percent.

That marks the first time homeowners' debt on their houses exceeds their equity since the Fed started tracking the data in 1945.

The total value of equity also fell for the third straight quarter to $9.65 trillion from a downwardly revised $9.93 trillion in the third quarter.

Home equity, which is equal to the percentage of a home's market value minus mortgage-related debt, has steadily decreased even as home prices jumped earlier this decade due to a surge in cash-out refinances, home equity loans and lines of credit and an increase in 100 percent or more home financing.

Economists expect this figure to drop even further as declining home prices eat into the value of most Americans' single largest asset.

Moody's Economy.com estimates that 8.8 million homeowners, or about 10.3 percent of homes, will have zero or negative equity by the end of the month. Even more disturbing, about 13.8 million households, or 15.9 percent, will be "upside down" if prices fall 20 percent from their peak.

The latest Standard & Poor's/Case-Shiller index showed U.S. home prices plunging 8.9 percent in the final quarter of 2007 compared with a year ago, the steepest decline in the 20-year history of the index.

The news follows a report from the Mortgage Bankers Association on Thursday that home foreclosures skyrocketed to an all-time high in the final quarter of last year. The proportion of all mortgages nationwide that fell into foreclosure surged to a record of 0.83 percent, while the percentage of adjustable-rate mortgages to borrowers with risky credit that entered the foreclosure process soared to a record of 5.29 percent.

Experts expect foreclosures to rise as more homeowners struggle with adjusting rates on their mortgages, making their monthly payments unaffordable. Problems in the credit markets and eroding home values are making it harder to refinance out of unmanageable loans.

The threat of so-called "mortgage walkers," or homeowners who can afford their payments but decide not to pay, also increases as home values depreciate and equity diminishes. Banks and credit-rating agencies already are seeing early evidence of this.

On Tuesday, Fed Chairman Ben Bernanke suggested lenders reduce loan amounts to provide relief to beleaguered homeowners.

Richard Fisher; Dallas Fed President. The man has some integrity and seems to came more about inflation than being a Wall Street Whore!

2008-03-04T19:15:00.001-08:00

Fed officials debate recession risk
Dallas Fed President Fisher argues inflation greatest threat to economy, while Fed Governor Mishkin says recession risks are greater than central bank's forecast.
EMAIL | PRINT | DIGG | RSS
By Chris Isidore, CNNMoney.com senior writer
March 4 2008: 4:26 PM EST

NEW YORK (CNNMoney.com) -- Two members of the Federal Reserve's rate-setting body gave conflicting speeches Tuesday as to whether rising inflation or a recession is the greater risk for the economy.

Inflation risk greater Dallas Federal Reserve President Richard Fisher said Tuesday he believes inflation is a greater threat, saying he would accept a slowdown of the U.S. economy in order to keep price pressures in check. The remarks suggest that Fisher, a so-called inflation hawk, will keep pushing his Fed colleagues to stop cutting rates.

But Frederic Mishkin, a Fed governor and a close ally of Fed Chairman Ben Bernanke, argued in a speech to the National Association for Business Economics that the risks are so great that the economy will not be able to meet even the Fed's modest forecast, which essentially calls for little or no growth in the first half of the year. He argued price pressures remain in check and that the threat from inflation should wane in upcoming years.

The Fed made a 0.75 percentage point rate cut at an emergency meeting Jan. 21, and another half-point cut at the conclusion of the Jan. 29-30 meeting. Fisher, who joined the Federal Open Market Committee for the two-day meeting, was the sole vote against that cut.

The FOMC is next set to meet March 18, and investors are widely expecting another half-point cut at that meeting.

In remarks prepared for a speech in London, Fisher said that he's upset by talk that recent Fed rate cuts represent an "easy money" policy by the U.S. central bank.

"Talk of 'cheap money' makes my skin crawl," he said in his prepared remarks. "The words imply a debased currency and inflation and the harsh medicine that inevitably must be administered to purge it."

"So you should not be surprised that I consider the perception that the Fed is pursuing a cheap-money strategy, should it take root, to be a paramount risk to the long-term welfare of the U.S. economy," he added.

Fisher points out that yields on long-term bonds have risen, not declined, in the wake of the Fed rate cuts, a sign of growing concern about inflation - although he conceded that traders could be mistaken about the effect of the cuts on prices.

"Twitches in markets that have occasionally led me to wonder if they were afflicted with the financial equivalent of Tourette's syndrome," he said.

But Fisher said inflation readings have not been encouraging and that he believes price pressures can continue to build even in the face of an economic slowdown, an economic condition popularly known as "stagflation."

Fisher argues it's better to have the economy go into an economic downturn than to risk a pickup in inflationary pressure through low rates due to global forces.

"We cannot, in my opinion, confidently assume that slower U.S. economic growth will quell U.S. inflation and, more important, keep inflationary expectations anchored," he said. "Containing inflation is the purpose of the ship I crew for, and if a temporary economic slowdown is what we must endure while we achieve that purpose, then it is, in my opinion, a burden we must bear, however politically inconvenient."

Recession risk greater But Mishkin said he believes the economy is at greater risk than seen in the Fed forecast released last month which called for modest growth between 1.3% to 2% between the fourth quarter of 2007 and the end of this year.

"I see significant downside risks to this outlook," he said. "These risks have been brought into particularly sharp relief by recent readings from a number of household and business surveys that have had a distinctly downbeat cast."

The Fed governor argues that the housing prices are at risk of falling more than forecasts, and that if that happens, he believes it will put a crimp in both consumer confidence and their access to credit. He said that the declines also could create greater upheaval in the financial markets, which he argues "causes economic activity to contract further in a perverse cycle."

Mishkin also said he expects the problems in the economy to cause a rise in unemployment. And while he believes the Fed needs to keep an eye on inflation pressures, he doesn't believe they pose a significant threat anytime soon.

"By a range of measures, longer-run inflation expectations appear to have remained reasonably well contained even as recent readings on headline inflation have been elevated," he said.

"I expect inflation pressures to wane over the next few years, as product and labor markets soften and the rise in food and energy prices abates," he added. He also said he believes that inflation measures that strip out volatile food and energy prices should be close to 2% a year going forward, which is the upper end of what is generally believed to be the Fed's comfort zone that leaves the door open for further rate cuts.

Mortgage Principal Reduction. Great Idea. How can I sign up!

2008-03-04T14:07:00.000-08:00

By Barbara Liston

ORLANDO, Florida (Reuters) - Banks may have to swallow reductions in the principal of some troubled home loans to ward off greater losses that could result from outright default, Federal Reserve Chairman Ben Bernanke said on Tuesday.

Warning that mortgage delinquencies and foreclosures are likely to rise, with more declines in house prices, Bernanke called for active measures from both the public and private sectors to stabilize housing markets.

"This situation calls for a vigorous response," Bernanke said in a speech to the Independent Community Bankers of America, referring to government and private-sector initiatives to slow the rate of home loan failures.

"Measures to reduce preventable foreclosures could help not only stressed borrowers but also their communities and, indeed, the broader economy," he said.

U.S. government bond prices shed early losses and turned higher, while stocks extended their declines and the downtrodden dollar touched another all-time low against a basket of currencies.

Market bets of a Fed rate cut at its March 18 meeting ticked down slightly to roughly a 66 percent chance of a cut in benchmark interest rates by three-quarters of a percentage point from the current 3 percent.

Bernanke's comments come as the central bank grapples with the twin dilemmas of a slowing economy and rising inflation. U.S. economic growth slowed to a sluggish 0.6 percent at the end of 2007 and hiring declined in January. But inflation rose 4.1 percent in 2007, the largest 12-month rise since 1990.

Current housing difficulties differ from past housing market slumps because of the large number of homeowners who owe more on their loans than their homes are worth, Bernanke said. "In this environment, principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure" than reducing interest rates on troubled home loans, he said.

When a mortgage is "under water," a reduction in principal may boost the chances of pay-off by avoiding default or foreclosure, he added.

Analysts said the Fed chairman was advising bankers that it was in their best interest to resolve mortgage problems quickly and to cut their losses.

"The problems in the credit system and problems on consumer balance sheets are such that some of the losses will have to be socialized, either by the market or by the government," said Joseph Brusuelas, chief U.S. economist at IDEAglobal in New York. "And it's highly preferable that between the two, those losses be accepted by the market."

Bernanke also said government-sponsored mortgage finance enterprises Fannie Mae and Freddie Mac could do more to address problems in housing and mortgage markets.

"New capital-raising by the (government-sponsored enterprises), together with congressional action to strengthen supervision of these companies, would allow Fannie and Freddie to expand significantly the number of new mortgages that they scrutinize," he said. "With few alternative mortgage channels today, such action would be highly beneficial to the economy."

Bernanke added that giving greater latitude to the Federal Housing Administration to set underwriting standards and risk premiums for mortgage refinancing would extend help to more borrowers in trouble.

(Writing by Mark Felsenthal, Editing by Dan Grebler)

Fees: When you are in the fee business, it's not hard to see why people originate so many credit products.

2008-03-03T11:14:00.001-08:00

March 3 (Bloomberg) -- Five days after UBS AG reported the biggest quarterly loss in banking history on Jan. 30, Rick Leaman packed his black wheeled garment bag, headed to New York's LaGuardia Airport from his Connecticut home and flew off to meet with clients.

``Even if you aren't doing deals, you have to be on the road,'' says Leaman, the Swiss bank's joint global head of investment banking. ``You still have to be in front of clients, generating ideas.''

Leaman and the bankers who work for him led UBS to a company-record $5.54 billion in fees from advising on mergers and acquisitions and underwriting securities in 2007, according to data compiled by Bloomberg. The firm leaped to No. 1 in the world in arranging equity sales.

Yet UBS's investment banking team had little chance to congratulate itself. The unit's contribution was dwarfed by the $18.4 billion UBS wrote down after a disastrous foray into the U.S. subprime mortgage lending market. UBS stock has plunged 34 percent this year to a 52-week low as of Feb. 29.

In trading rooms throughout the U.S. and Europe, the spectacle has been similar: soaring fees amid punishing losses. For the fourth year in a row, securities firms set a record for fees, according to Bloomberg's annual ranking of the 20 best- paid investment banks.

Led again by Citigroup Inc., the banks collected $86.9 billion from advising on M&A and underwriting stocks and bonds. That was a 22 percent increase over 2006's $71 billion and 64 percent more than in 2005.

`Cheap Credit'

``It was an extremely active year,'' says Franck Petitgas, Morgan Stanley's co-head of investment banking. ``Plentiful and cheap credit allowed quick and large transactions.''

The bill for all of that speed and daring started coming due in June, and financial institutions that dipped deepest into mortgage-related debt are still paying. Since the beginning of 2007, banks around the world have written down a total of $181 billion in assets with exposure to subprime mortgages and leveraged loans.

From August to December, the value of announced leveraged buyouts, which pay millions in advisory fees to the biggest financial firms and provide fuel for the debt and equity markets, had plunged 68 percent compared with the same period a year earlier.

``A year ago, everyone thought trees were going to grow to the moon,'' Jamie Dimon, chief executive officer of JPMorgan Chase & Co., said in an interview on Jan. 27 at the World Economic Forum in Davos, Switzerland. ``Obviously, 2007 was a much tougher year than expected, and 2008 is probably going to be the same.''

Out-of-Control Risk

On today's chastened Wall Street, the watchword is risk management. Four of Dimon's colleagues at top investment banks lost their jobs because they let risk get out of hand. UBS CEO Peter Wuffli was the first to go, in July. Then Merrill Lynch & Co.'s Stan O'Neal retired and was replaced by New York Stock Exchange CEO John Thain. Shortly after joining Merrill in December, the former Goldman Sachs Group Inc. president put himself in charge of risk management.

In November, Citigroup CEO Charles Prince was replaced by Vikram Pandit, a former Morgan Stanley president. Pandit says he's considering selling off pieces of the bank, which has $2.18 trillion in assets.

At Bear Stearns Cos., CEO James ``Jimmy'' Cayne ousted Co- President Warren Spector and then, in January, was forced out himself, giving up his CEO job while remaining chairman. Bear Stearns, which ranked No. 19 in the Bloomberg 20 in 2006, fell off the 2007 list after a series of setbacks that in the third quarter saw the company post its steepest profit decline in more than a decade.

`Pockets of Strength'

Pandit and Thain, as well as competitors Lloyd Blankfein at Goldman Sachs, John Mack at Morgan Stanley and JPMorgan Chase's Dimon, will try to bolster fees in 2008 by focusing on traditional pockets of strength in battered markets, says Eric Weber, a managing director at New York-based Freeman & Co., a financial services consulting firm. Among them: restructuring faltering companies and investing in distressed debt, Weber says.

The banks' craving for ever higher fees helped lead them to disaster. They underwrote and invested in billions of dollars of collateralized debt obligations, or CDOs, packages of debt that bundle subprime mortgages, bonds and other loans. The securities, because they carried top ratings and higher yields, earned the banks bigger fees. When rising foreclosures gutted the value of the CDOs, the banks were forced to curtail other lending to hang on to capital.

Recession

Now the banks must struggle to drum up new business in the face of a U.S. economic downturn. The sinking housing market is sending the U.S. economy into recession, according to economists at Goldman Sachs. The Standard & Poor's 500 Index has tumbled 15 percent from its recent peak on Oct. 9.

And the Federal Reserve cut the overnight lending rate five times from September through mid-February, including a surprise 75-basis-point reduction on Jan. 20, in an effort to stimulate economic activity.

``We're all in 'stop, look and listen' mode to sort out 2008,'' UBS's Leaman, 45, says. He says he won't make projections for how his investment banking division will fare this year until the end of the first quarter. Then, he says, he'll have a clearer picture of whether a recession is under way and whether the $168 billion economic stimulus package passed by the U.S. Congress and signed by President George W. Bush in February will bolster the markets.

Pessimism for 2008

If recent history is any guide, Leaman and his peers could be in for a rough ride.

One gauge for how far fees may fall in 2008 is their drop in 2001 from '00, during the investment banking contraction triggered by the Internet bubble's pop. Nine of the top 10 banks in this year's Bloomberg 20 saw M&A fees decline at least 22 percent back in 2001, with Citigroup's fees falling 49 percent, according to Bloomberg data. Equity underwriting fees also declined in 2001 for eight of the top 10 firms, dropping 36 percent at Morgan Stanley and Credit Suisse Group.

This time around, bankers at Bank of America Corp., Lehman Brothers Holdings Inc. and JPMorgan Chase have all predicted that the overall value of M&A in 2008 is likely to fall by at least 20 percent from 2007. That means fees may take a similar tumble, says Roy Smith, a former Goldman Sachs partner who teaches finance at New York University. ``The market is lumbering through a long, painful liquidity situation,'' Smith says. ``Things are going to be moving very slowly for a while.''

Things were moving at warp speed at the start of 2007. In the first half, M&A volume trounced previous records. Companies were raising billions of dollars for ever larger deals.

KKR's Big Deals

In February, Kohlberg Kravis Roberts & Co. and TPG Inc. announced the biggest LBO in history, agreeing to pay $43 billion for Texas power producer TXU Corp. Then a group led by Edinburgh-based Royal Bank of Scotland Group Plc won a bidding war against London-based Barclays Plc and agreed to pay more than $100 billion for ABN Amro Holding NV, the biggest Dutch bank.

The first half of 2007 was Wall Street's busiest six months ever, with $2.4 trillion of announced M&A transactions.

H. Rodgin Cohen, chairman of Sullivan & Cromwell LLP, the No. 1 M&A legal adviser in 2007, according to Bloomberg data, describes the first seven months of 2007 as frantically busy.

``It was extraordinary,'' says Cohen, 63, who says he spent early 2007 pressing Sullivan & Cromwell's partner in charge of hiring for more staff to keep up. ``I had never seen anything with the breadth and depth of that time,'' he says. ``It's hard to imagine much of that coming back without a substantial easing of credit conditions.''

Citi No. 1 Again

Even in a year as eventful as 2007, the pecking order for Wall Street's best-paid investment banks didn't change. For the fourth year in a row, the top five were Citigroup, Goldman Sachs, Morgan Stanley, JPMorgan Chase and Merrill Lynch, all based in New York.

Citigroup brought in $6.88 billion in fees from M&A and securities underwriting, according to Bloomberg data, 19 percent more than the $5.79 billion in 2006. Goldman Sachs was second in total investment banking fees with $6.66 billion, up 18 percent from 2006.

Morgan Stanley, which placed third, recorded an estimated $6.36 billion, up 22 percent from $5.22 billion, Bloomberg numbers show. Rounding out the top five, JPMorgan Chase garnered $6.23 billion, up 33 percent from a year earlier, and Merrill Lynch brought in $5.55 billion, up 23 percent from 2006.

Citigroup held on to No. 1 by reaping more from fixed income than rivals did. Total fees from bond underwriting rose 30 percent to $18.8 billion in the year. Of that, Citigroup captured $1.69 billion, 13 percent more than in 2006.

Fixed Income Gains

JPMorgan Chase was also lifted by fixed income, collecting 49 percent more from underwriting debt than a year earlier, or $1.18 billion. Merrill Lynch placed third in fixed income with $1.16 billion, a 41 percent boost from 2006. Merrill's gains came in part from arranging the most sales of preferred stock, a blend of equity and debt. The company underwrote $13.5 billion of those transactions, generating about $293 million in fees.

Fixed income's stellar season was driven by M&A, especially the surge in private equity buyouts. Leveraged buyouts are typically based on a small amount of cash paid upfront and a host of agreements to raise money from investors. The purchase of Dallas-based TXU, for instance, included debt issues totaling $11.3 billion.

Total M&A fees came in at $42.4 billion, up 21 percent from 2006. Goldman Sachs earned the most for M&A advice for a third consecutive year, Bloomberg data show. The firm brought in $3.93 billion in fees for the year, up 34 percent from 2006. Morgan Stanley was second, with $3.23 billion, a 24 percent jump from 2006, and Citigroup moved to third from fourth, with a 16 percent gain, to $2.9 billion.

Goldman M&A Champ

Goldman Sachs raked in billions by working on the eight biggest M&A deals of the year. The firm, together with Lehman Brothers and Rothschild Bank, represented ABN Amro as a bidding war raged for the Amsterdam-based bank for six months. Goldman Sachs also worked for Rome-based Enel SpA in its $53.3 billion takeover of Spanish power company Endesa SA, which was completed in partnership with Madrid-based Acciona SA. It helped KKR and TPG buy TXU and helped private equity giant Blackstone Group LP scoop up Hilton Hotels Corp.

Goldman Sachs completed a total of 354 deals worth $1.2 trillion, more than any other firm last year. The firm advised on more than 50 M&A agreements of more than $5 billion -- about 40 percent of all mergers and acquisitions announced of that size.

Morgan Stanley was the leading adviser on transactions involving European targets or acquirers. The firm advised on 162 such agreements, generating about $1.5 billion in M&A revenue. Among its deals was Toronto-based Thomson Corp.'s $18.2 billion acquisition of London-based Reuters Group Plc. (Bloomberg LP, the parent of Bloomberg News, competes with Reuters and Thomson in providing financial news and data.)

Private Equity Boom

Citigroup's M&A bankers advised on the four biggest private equity deals, totaling $140 billion. Along with Goldman Sachs, it represented KKR and TPG in their purchase of TXU, now called Energy Future Holdings Corp. The bank was there when a group led by the Ontario Teachers' Pension Plan paid $42.4 billion for Canadian telephone company BCE Inc.

The bank also worked for KKR when it acquired First Data Corp. for $27.5 billion and advised TPG and Goldman Sachs on their $27.1 billion purchase of Alltel Corp. Citigroup's fees for those four deals alone were an estimated $175 million, according to Bloomberg data.

In equity underwriting, UBS leapt to the top of the fee list from fifth place a year earlier. The Swiss bank earned $2.45 billion in fees from stock sales, up 50 percent. UBS worked on the $5.4 billion initial public offering in October of Criteria CaixaCorp, the investment company of Spain's biggest savings bank, and the $5.4 billion stock offering of Electricite de France SA.

Stock Sale Surge

JPMorgan Chase jumped to second in equities from seventh on the strength of equity-linked issues. Those are deals selling securities whose return is determined by the performance of a basket of stocks or a stock index. The firm brought in $2.2 billion in fees from equity underwriting, up 69 percent from $1.3 billion in 2006.

Third place in fees from equity deals went to Citigroup, with $2.16 billion, up 20 percent from $1.8 billion a year earlier. Goldman slipped from first to sixth in fees for arranging stock deals. The firm's take in that area fell 7.3 percent to $1.91 billion from $2.06 billion, according to Bloomberg data.

Fees Less Important

Even when setting records, traditional investment banking fees typically represent less than 20 percent of revenue for the biggest financial firms. At Citigroup, with its huge consumer bank and credit card operation, M&A advice and underwriting accounted for about 8 percent of the bank's $81.7 billion in revenue in 2007.

At Goldman Sachs, whose $11.6 billion in 2007 net income made it the most profitable firm in Wall Street history, investment banking accounted for about 14.5 percent of its $46 billion in revenue.

Those figures understate investment banking's significance to these firms, NYU's Smith says. ``Investment banking has been a bridge to other business,'' he says. It burnishes long-term client relationships, he says, and has provided a steady, growing source of income to the firms since 2003.

For 2008, banks see lucrative opportunities in cleaning up their own tattered industry. As of mid-March, financial companies were among the most active customers in the capital markets. Merrill Lynch generated $205 million in fees, or 18 percent of its total bond fees, from its own deals. About 18 percent of Citigroup's bond deals were to raise capital for itself. ``The financial sector is in capital repair mode,'' Morgan Stanley's Petitgas says.

Microsoft-Yahoo

There's still money to be made in the M&A market -- as Microsoft Corp. made clear with its $44 billion hostile bid to buy Internet pioneer Yahoo! Inc. in February. That same month, Melbourne-based BHP Billiton Ltd., the world's largest mining company, upped its unfriendly bid for London-based Rio Tinto Group Plc, a producer of iron ore, copper, aluminum and energy, to $147 billion from $100 billion.

In January, Chicago-based CME Group Inc., which operates the world's largest futures market, announced it had had discussions about a merger with New York-based Nymex Holdings Inc., owner of the biggest energy market, that would value Nymex at about $11 billion.

Petitgas, whose bank is advising Microsoft on its bid for Yahoo, expects M&A activity to remain robust in 2008. Acquirers, though, may have a harder time financing their takeovers. ``Despite tighter credit conditions, big-event financing is still available,'' Petitgas says.

Looking Overseas

The big banks are also courting more non-U.S. clients and offering advice on crossborder mergers, Freeman's Weber says. Investment banking was more international than ever in 2007. About $31 billion, or 36 percent, of total investment banking fees were from Europe, Bloomberg data show, roughly equal to the $32.8 billion, or 39 percent, in U.S. deals.

M&A transactions in China and Hong Kong increased 38 percent in the year, contributing to $12.6 billion of fees from Asia.

Investment bankers might also find gold in the sovereign wealth funds that the banks have called on to shore up their balance sheets. The funds are government pools of capital accumulated from the sale of oil, gas and, in the case of Asia, consumer goods, to the U.S.

Citigroup collected $7.7 billion early in 2008 from a group led by the Kuwait Investment Authority, $6.8 billion from Government of Singapore Investment Corp. and $7.5 billion from the Abu Dhabi Investment Authority. Merrill Lynch took in more than $10 billion from Korean Investment Corp., Singapore's Temasek Holdings Pte. and Kuwait.

Blinkered Wall Street

The hard times that hit the banking industry could have been forecast as early as February 2007, when late payments on U.S. bank mortgages jumped to their highest level in four years, says Steve Bernard, head of merger analysis at Robert W. Baird & Co. in Chicago. He says Wall Street was blinded by its own euphoria over the flow of deals.

``What started out as a minor concern morphed into a major concern for the entire economy,'' he says. ``When there was speculation about a $100 billion deal, we should have said, 'Wow, things are looking a little excessive.'''

For the rest of this year, Bernard says, many CEOs won't be looking for strategic investments unless the stock market gathers strength and they're confident the economy is improving. Many corporate acquisitions are partially paid for with stock, a currency that's lost some of its heft since August.

Profit, Stock Swoon

``The outlook for sales affects CEOs' level of confidence,'' Bernard says. ``They don't want to buy something when their profits are falling, and now they have a less valuable currency, too.''

For UBS's Leaman, the company's role as the leading equity underwriter may provide a cushion in a rough year. Selling stock will be a better prospect for banks than advising on M&A, if the last economic downturn is any guide.

``It will still take a lot of time to clean up what happened,'' Leaman says. ``My guess is that I will be on a plane a fair amount this year.''

Underfunded Pensions say "let's turn to stocks". Perfect time to buy equities as country is entering recession. Can't wait to retire.

2008-03-03T07:41:00.000-08:00

March 3 (Bloomberg) -- Philadelphia's $4 billion pension deficit is causing the city's retirement-fund manager to shun Treasuries at a time when the Bush administration needs him most.

Yields on 30-year U.S. bonds that fell to a record low of 4.10 percent this year are forcing pension funds to favor equities, corporate debt and commodities in an attempt to cover unfunded liabilities and meet return objectives of about 8 percent. Even the federal government's own Pension Benefit Guaranty Corp. said on Feb. 19 that it plans to shift $15 billion to stocks from debt.

``The reality is there's not a lot we can do'' other than buy high-risk securities to close a pension shortfall in a short period, said Chris McDonough, chief investment officer of the Philadelphia Pensions Department. The sixth-largest U.S. city will probably also issue debt, he said.

Fixed-income holdings at 1,100 funds fell to 23 percent in 2006 from 27 percent in 2003, said Dev Clifford, a consultant at financial market research firm Greenwich Associates in Greenwich, Connecticut. Results of a survey covering 2007 will be released this month and likely show that funds own an even smaller percentage of bonds, he said.

Philadelphia's predicament couldn't come at a worse time for George W. Bush, whose administration forecasts a $410 billion budget deficit for this fiscal year ending Sept. 30, approaching the record of $413 billion set in 2004. The figure may eventually reach as much as $800 billion, according to Bill Gross, manager of the world's biggest bond fund at Pacific Investment Management Co. in Newport Beach, California.

Supply Swamp

The budget shortfall will force the Treasury Department to increase its borrowing by 145 percent from $163 billion, according to UBS Securities LLC, swamping the market just as longer-maturity debt turns into a money-loser for investors.

Treasuries due in 30 years, a favorite of the $7.8 trillion pension industry because they allow managers to best match assets and liabilities over time, fell 0.66 last month, after returning 2 percent in January and 10.4 percent in all of 2007, according to Merrill Lynch & Co. index data.

Pension funds hold about $44 billion, or 20 percent, of the $205 billion in Treasuries maturing in 20 years or longer, Greenwich Associates estimates.

``In the long run I don't know if there's going to be too much value'' in Treasuries, said Jeremy Wolfson, who oversees $8.5 billion as chief investment officer at the City of Los Angeles Department of Water and Power Pension Fund. He said the fund will pare its debt holdings to 25 percent from 35 percent and raise its holding of non-U.S. assets such as international stocks to 24 percent from 15 percent over the next four years.

Declining Demand

The yield on the benchmark 4 3/8 percent bond due in February 2038 fell 17 basis points last week to 4.40 percent after Federal Reserve Chairman Ben S. Bernanke told Congress that central bankers are ready to reduce interest rates further to keep the economy from a recession. The yield rose to 4.46 percent as of 10:17 a.m. in New York. The U.S. began regular sales of 30-year Treasuries in 1977.

More pension officials are hiring outside managers who favor alternative investments to run their funds, indicating ``the proportion in something like Treasuries would be going down,'' Clifford said.

The $240 billion California Public Employees' Retirement System, the largest U.S. pension plan, agreed at a Feb. 19 board meeting to hold between 0.5 percent and 3 percent of its assets in commodities, spokesman Clark McKinley said. Calpers, facing pressure from state and local governments to boost returns, would reduce its bond holdings to 19 percent from 26 percent.

$731 Billion Short

U.S. states owe an estimated $2.73 trillion in pension and benefit payments to retirees over the next 30 years, according to a December report from the Pew Center on the States. They are short almost 27 percent, or $731 billion, of that amount. The Government Accountability Office said last week that 58 percent of 65 large state and local pension plans were adequately funded in 2006, down from 90 percent in 2000.

Such studies may overstate the health of pensions because they are allowed to include expected returns in determining their funding gap, said Mark Ruloff, director of asset allocation at Arlington, Virginia-based consultant Watson Wyatt Worldwide Inc.

That gives them further motive to ``get rid of Treasuries'' and buy stocks, he said.

Credit Crisis

Declines this year in stocks, hedge funds and other investments make those assets too dangerous, said Chriss Street, treasurer of Orange County, California, which has a $2.3 billion plan that is 71 percent funded. The Standard & Poor's 500 Index is down 9.4 percent this year.

``This is the worst credit crisis in the last 25 to 30 years and that's not going to change,'' said Street, who has recommended the fund buy five-year Treasuries. ``It's a good time to own bonds.''

Falling Treasury yields have made other fixed-income investments more attractive, said Barbara Novick, vice chairman and head of the account management group in New York at Blackrock Inc., which manages $513 billion in fixed-income assets.

Investment-grade corporate bonds yield 2.47 percentage points more than Treasuries on average, up from 0.89 percentage point a year ago, according to Merrill Lynch indexes.

``Yield spreads have widened to such a great extent, this is exactly the time to go into other things,'' Novick said.

ISM down to 48.3 (Recession)

2008-03-03T07:39:00.001-08:00

March 3 (Bloomberg) -- Manufacturing in the U.S. contracted in February at the fastest pace in almost five years, pushing the economy closer to a recession.

The Institute for Supply Management's manufacturing index dropped to 48.3, the lowest level since April 2003, from 50.7 in January, the Tempe, Arizona-based group said today. Fifty is the dividing line between contraction and expansion.

The collapse in housing is rippling through the economy as consumers curb spending and factories reduce production of furniture, automobiles and appliances. Credit restrictions may continue to hurt economic growth, prompting Federal Reserve policy makers to lower interest rates again this month.

``The evidence is piling up that the economy is slipping into at least a mild recession,'' said Scott Anderson, senior economist at Wells Fargo & Co. in Minneapolis, who forecast the index would drop to 48. ``With the much higher food and energy prices and restricted credit, there are not a lot of avenues for consumers to continue to spend.''

Economists surveyed by Bloomberg News forecast the index would fall to 48, according to the median estimate of 68 economists. Economists' forecasts ranged from 45 to 51.

New orders decreased to 49.1 from 49.5, while a production measure dropped to 50.7 from 55.2, ISM said. A gauge of supplier deliveries fell to 50.1 from 52.8 in the prior month.

The group's measure of prices paid decreased to 75.5 from 76 in January. Economists had forecast the measure would fall to 73.

Fewer Inventories

The inventory index in today's ISM report slumped to 45.4 from 49.1. Figures less than 50 mean manufacturers are reducing stockpiles. ISM's employment measure declined to 46 from 47.1.

Today's factory survey corroborates other regional business polls in the past two weeks that showed factory activity, which accounts for about 12 percent of gross domestic product, contracted in February.

The National Association of Purchasing Management-Chicago reported Feb. 29 that business activity fell to the lowest level in more than six years. A Philadelphia Fed gauge showed the deepest contraction in seven years, while the Fed Bank of New York's economic index was the weakest in almost five years.

Government data also have pointed to a slowdown. Orders for durable goods excluding transportation equipment fell in January for the third time in the last four months, Commerce said last week. Factory production stalled in January, with car output falling, the Fed said Feb. 15.

Housing Slump

A third year of declining home construction will drag on growth again this year, costing jobs and undermining the consumer spending that accounts for two-thirds of the economy. As property values decline, Americans feel less wealthy and buy fewer televisions and cars.

Sales at General Motors Corp., Ford Motor Co. and Chrysler LLC, which account for about half of U.S. auto purchases, probably fell at least 14 percent in February from a year earlier, according to a Bloomberg survey of analysts before an industry report today.

Demand for cars is at the ``low end'' of the range forecast, said George Pipas, chief sales analyst for Ford, in Dearborn, Michigan, on a conference call last week.

The economy will grow at a 0.5 percent annual rate from January through March, capping the weakest six months since the last economic slump in 2001, according to the median estimate of economists polled by Bloomberg from Jan. 30 to Feb. 7.

The Fed, which has lowered the benchmark rate by 2.25 percentage points since September, is ready to continue cutting borrowing costs if needed, Chairman Ben S. Bernanke told Congress last week.

Growth Risks

He warned that risks to the outlook include ``the possibilities that the housing market or the labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further.''

One of the few bright spots is record exports as a weak dollar and growing economies in countries such as China, Brazil and Mexico stoke demand for goods to modernize their infrastructure and production capacity.

The ISM's measure of export orders decreased to 56 from 58.5, showing foreign demand is still growing, though at a slower pace.

``We certainly have seen among some of our customers and even in our own business some benefits from a weaker dollar in terms of increased strength in an export capacity,'' Frank MacInnis, chairman of in Norwalk, Connecticut-based EMCOR Group Inc., a construction and facilities-management company, said in a Bloomberg Television interview last week.

Buffet says "Recession"

2008-03-03T07:33:00.001-08:00

NEW YORK (Reuters) - Billionaire investor Warren Buffett said on Monday the U.S. economy is in recession and "stocks are not cheap."

Speaking on CNBC television, Buffett also said he is no longer offering to guarantee $800 billion of municipal bonds backed by MBIA Inc (MBI.N: Quote, Profile, Research), Ambac Financial Group Inc (ABK.N: Quote, Profile, Research) and FGIC Corp, three large bond insurers.

Buffett said that "from a common-sense standpoint right now, we're in a recession," though the U.S. economy has not yet recorded two straight quarters of declining gross domestic product, a traditional indicator of recession.

He said the environment is "nothing like '73 or '74 yet," referring to a deep economic downturn also marked by rising oil prices, higher inflation and falling stocks.

Still, he said investors should not rule out a significant economic downturn, and that Federal Reserve Chairman Ben Bernanke has a "very tough balancing act" in trying to boost economic growth without kindling inflation. Buffett said there is a fair chance that inflation may ignite in a "serious way."

On Friday, Buffett's insurance and investment company Berkshire Hathaway Inc (BRKa.N: Quote, Profile, Research) (BRKb.N: Quote, Profile, Research) reported an 18 percent decline in fourth-quarter profit. This stemmed in part from weakness in businesses linked to housing, including units that make bricks and carpet, and that offer real estate brokerage services.

Buffett said he is finding more buying opportunities in stocks following a 16 percent decline in the Standard & Poor's 500 .SPX stock index from its recent high in October.

"I find more things to look at now than I did six months or a year ago," Buffett said. But he acknowledged that conditions have changed "more dramatically" in the bond market. Berkshire last year spent $19.11 billion on stocks and $13.39 billion on bonds.

Falling security values and liquidity have pummeled bond insurers, which normally insure relatively safe municipal bonds but also guaranteed billions of dollars of riskier debt, often tied to subprime mortgages. On February 12, Buffett offered to reinsure $800 billion of municipal bonds, but only at a steep premium. The offer did not include the riskier debt. Bond insurers rejected the offer and have been seeking new sources of capital or possibly breaking themselves up.

Buffett on Monday said his earlier offer was "not on the table." In December, he started his own bond insurer, Berkshire Hathaway Assurance Corp.

Since 1965, Buffett has transformed Berkshire Hathaway Inc into a $216 billion conglomerate by acquiring out-of-favor companies with strong earnings and management, and investing in stocks. Berkshire said it has 76 operating companies that sell such things as insurance, ice cream, paint and underwear.

Berkshire's Class A shares closed Friday at $140,000. Through Friday, they had risen 32 percent in the last year.

(Reporting by Jonathan Stempel; Additional reporting by Kevin Plumberg and Dan Wilchins; Editing by Derek Caney and John Wallace)

Paul B. Farrell's American Expose.

2008-02-25T19:39:00.000-08:00

PAUL B. FARRELL
11 reasons Bernanke's recession lasts till 2011
Timing the next bull: Kick-start it in 2008? Or is it a long secular bear?
By Paul B. Farrell, MarketWatch
Last update: 7:32 p.m. EST Feb. 25, 2008
Print E-mail RSS Disable Live Quotes
ARROYO GRANDE, Calif. (MarketWatch) -- Remember that hot 1973 Stealer's Wheel song marking the end of the Nixon era? "'Cause I don't think that I can take anymore. Clowns to the left of me, jokers to the right, here I am stuck in the middle with you!"
It's still a perfect metaphor. Testifying before Congress: Fed Chairman Ben Bernanke on the left. Treasury Secretary Henry Paulson on the right. The American public stuck in the middle.
Last summer they assured us the subprime-credit crisis was "contained." We now know that was a big lie. They knew, had the facts, early warnings, lied and are still lying. More proof? They just told Congress: "America will avoid a recession." New data tells a different story.
Clowns to the left ... jokers right ... stuck in the middle ... can't take it anymore.
But we have to, we have to hang on at least 10 months more, praying they won't do too much more damage. But I'm afraid they will: more lies, blunders and incompetence will drag out this bear. Like the song says: "Got a feeling something ain't right."
Read the new InvestmentNews, a professional journal for financial advisers. The lead headline grabs you: "Bad times for stocks could last many years." A long secular bear.
Do you believe it? That's the big question today: When's the next bull? How long will the bear last? And forget Washington's rhetoric about "no recession." The truth is, you can call it a "bear," "slow growth," a "downturn," a "recession" -- call it whatever you want. Timing's the real question. How long will it last? When will it bottom? 2008? 2011?
Test your timing skill. You tell us, what'll drag this out 30 months, like in 2000-2002? Or shorten it? Here are 11 critical factors for your timing equation, things that could make this bear-recession shorter or longer. You tell us. Add a comment. What's your prediction: How long before the next bull?
1. Stagflation: Bernanke's no-win Achilles heel
Reading Fed-watcher William Fleckenstein's new book, "Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve," you get the feeling that for 18 years America's banking system was run like a "new age" hippy commune, by a Ayn Rand free spirit who believed "anything goes."
Now the Fed's run by a college professor and Fleckenstein says he's "in over his head." Except this is the real world, a $13 trillion economy in a $48 trillion world, not a college seminar on economic theory.
In the 1970s Nixon faced a similar problem, convinced then by Fed Chairman Arthur Burns: "No one ever lost an election on account of inflation." Wrong! Low rates generated inflation not growth. That stagflation triggered a bear/recession. Is Professor Ben trapped, repeating history?
2. Housing-credit meltdown: We've got a long way to go!
It's far from over folks and still spreading: Years of inventory, foreclosures, building slowdown, risky bond insurers, weak rating agencies, funds holding bad debt, freezing exits and fuzzy math on values. Yet Bernanke and Paulson still live in a Washington bubble of wishful-thinking fantasies.
Economic realists say what's needed is a massive $1.6 trillion demand-driven program (that's the record cash Corporate America's hoarding) not a dinky $160 billion supply-side "appease the voters" giveaway that ends up increasing the odds of a lengthy Nixon/Burns style bear-recession.
3. Commodities: World's new reserve 'currency,' not dollars
Forget paper money and IOUs. Commodities are the world's new "currency:" Hard stuff like oil, grains, metals, gold. And that means America is financing the growth of our enemies, surrendering our long-term economic power for short-term oil-guzzlers and plastic toys. We are responsible for making Russia and China into threatening world powers. Buffett warned us. We're selling the farm, piece by piece.
4. Toxic derivatives: World's $516 trillion ticking time bomb
Derivatives are great for deal-by-deal risk management in a $48 trillion GDP world. But leverage them 10 times over across the globe and we got a financial "weapon of mass economic destruction."
Bill Gross warns that the world's new unregulated "shadow banking system" is printing new money, now at $516 trillion, out of thin air, with no "central banks of last resort" backing up the "Frankenstein" monsters they've created.
5. Massive debt: Everywhere, trade, federal, states, local
America's Comptroller General David Walker, Congress's head accountant who is leaving his position next month, warns our government is "bankrupting America." Using unethical accounting worse than Enron's. Fiscal responsibility lost. He sees "striking similarities" with Rome. Both parties are gluttons in a spending orgy.
We spend-spend, load debt on future generations, then use accounting gimmicks to hide our greedy excesses: Hidden earmarks. Supplemental war appropriations. Meaningless IOUs after stealing from Social Security.
6. America's new 'pushers:' Banks feeding consumer addicts
Trader's Daily captured it perfectly: "Never underestimate the power of the superpsycho, hyper-spending American consumer. Where there is no cash, they will sell their soul. Or just charge it. Let's just not think about what it all means for credit-card debt down the road."
Meanwhile, the credit meltdown is making banks desperate for money. A recent Chase credit-card commercial fuels consumer addictions: Wife wants bigger television. Husband smiles. They shop to the pounding drumbeat of Queen's hit 80s song: "I want it all, I want it all, I want it all ... and I want it now!" Tag line: "Chase what matters!" Yes, Chase debt, all you addicts. Forget saving, spend like there's no tomorrow.
7. More wars: Pentagon predicts bigger, costlier conflicts
The Pentagon's internal studies see a perfect storm accelerating wars worldwide: Global population growth, limited natural resources and global warming. Our war machine is exploding. The Pentagon gets over 50% in the new federal budget. We're only 21% of the world's GDP, yet spend 47% of the world's total military expenditures.
Our power-hungry mindset is becoming self-destructive, suicidal. Remember Nixon strategist Kevin Phillips' warning: "Most great nations, at the peak of their economic power, become arrogant and wage great world wars at great cost, wasting vast resources, taking on huge debt, and ultimately burning themselves out."
8. Greed: Wall Street and Corporate America's defining 'value'
Values start at the top. But the top won't change for 10 months. Leadership, statesmanship and character are vanishing. Five short years ago Corporate America and the mutual fund industry were consumed by greed. How quickly we forget.
It's worse today. We see greed consuming not just Wall Street's clueless CEOs, but the entire industry: Outrageous bonuses of $38 billion amid mega-billion write-offs. Fire sales of billions more American equity to sovereign nations.
From the top down, greed is driving America from bubble to bubble. Wall Street's already fueling the next bubble, trading on a volatile market.
9. Democracy failing: America now run by 35,000 lobbyists!
Forget government "of the people, by the people, and for the people." Adam Smith's "invisible hand" is now a small group of 35,000 highly paid, greedy lobbyists demanding handouts. They run America from the shadows, for those at the top of the economic food chain and vastly outnumber Washington's 537 elected officials.
Nationally there's an estimated quarter million lobbyists, with hundreds of millions of dollars to buy favors in campaign contributions. Politicians talk "change," but America's lobbyists will still be working for their special interest clients in 2009. And they'll fight all "changes."
10. America's already in a recession, and in denial
This year's elections will be a huge factor in lengthening the recession. Our lame-duck government will delay action on critical issues. It reminds me of my days counseling addicts and alcoholics. Change never happens until they admit they have a problem. Same here.
Paulson and Bernanke cannot admit there's a recession. They'd have to take blame for America's failed policies. And congressional Democrats are weak co-conspirators in this meltdown. Nobody has the guts to take responsibility. They're all like addicts and alcoholics, in denial, giving lip-service to "change," while they blame the other guys and support ineffectual stimulus plans.
Vote for whomever, but this lame-duck mindset plus lingering partisan rancor will push any recovery at least into 2009, probably delay the next bull till 2010 or 2011.
11. Class warfare: Superrich vs. Main Street America
No matter who wins, the presidential campaign is warning us: A major battle's coming between "the rich and the rest;" over taxes, benefits, cuts, power.
For years the media collaborated with Wall Street and Corporate America, hyping "Ownership, the New American Dream," where everyone benefits, shares the wealth, gains a piece-of-the-action, ownership in "The Dream" through the magic of housing, stocks, growth, profits, retirement plans. But the housing-credit contagion killed the dream.
Yes, the superrich did get richer. But "the rest" didn't. And they're waking up to a widening gap. A backlash is brewing and will explode ... delaying a recovery and a new bull.
Clowns to the left, jokers right, we're stuck in the middle. Can't take it anymore? Add a timing comment. Tell us: When's the recovery? Next bull? Late 2008? Not till 2011?

California Dreaming (Wow)

2008-02-25T18:26:00.000-08:00

For release:
Monday, Feb. 25, 2008

C.A.R. reports sales decrease 29.8 percent, median home price falls 21.9 percent

LOS ANGELES (Feb. 25) – Home sales decreased 29.8 percent in January in California compared with the same period a year ago, while the median price of an existing home fell 21.9 percent, the CALIFORNIA ASSOCIATION OF REALTORS® (C.A.R.) reported today.

“This most recent decrease in the median price is yet another result of the liquidity crunch, which has choked off sales in recent months for nearly half of California’s housing market," said C.A.R. President William E. Brown. "Sales do appear to be edging up, but recent declines in the median price have been due to a lack of sales in the over $500,000 range, where funds are extremely scarce and jumbo loan rates are at near-record margins compared to conforming loan rates.”

Closed escrow sales of existing, single-family detached homes in California totaled 313,580 in January at a seasonally adjusted annualized rate, according to information collected by C.A.R. from more than 90 local REALTOR® associations statewide. Statewide home resale activity decreased 29.8 percent from the 446,820 sales pace recorded in January 2007.

The statewide sales figure represents what the total number of homes sold during 2008 would be if sales maintained the January pace throughout the year. It is adjusted to account for seasonal factors that typically influence home sales.

The median price of an existing, single-family detached home in California during January 2008 was $430,370, a 21.9 percent decrease from the $551,220 median for January 2007, C.A.R. reported. The January 2008 median price fell 9.7 percent compared with December’s revised $476,380 median price.

“The slight increase in sales predates the president's signing of an economic stimulus package including a temporary increase in the conforming loan limit, but that much needed reform could give the market some momentum,” said C.A.R. Vice President and Chief Economist Leslie Appleton-Young. “Let's hope congress and the president see fit to make the higher loan limit permanent.”

Highlights of C.A.R.’s resale housing figures for January 2008:

C.A.R.’s Unsold Inventory Index for existing, single-family detached homes in January 2008 was 16.8 months, compared with 7.6 months for the same period a year ago. The index indicates the number of months needed to deplete the supply of homes on the market at the current sales rate.
Thirty-year fixed-mortgage interest rates averaged 5.76 percent during January 2008, compared with 6.22 percent in January 2007, according to Freddie Mac. Adjustable-mortgage interest rates averaged 5.23 percent in January 2008, compared with 5.47 percent in January 2007.
The median number of days it took to sell a single-family home was 71.6 days in January 2008, compared with 68.7 for the same period a year ago.
Regional MLS sales and price information is contained in the tables that accompany this press release. Regional sales data are not adjusted to account for seasonal factors that can influence home sales. The MLS median price and sales data for detached homes are generated from a survey of more than 90 associations of REALTORS® throughout the state. MLS median price and sales data for condominiums are based on a survey of more than 60 associations. The median price for both detached homes and condominiums represents closed escrow sales.

In a separate report covering more localized statistics generated by C.A.R. and DataQuick Information Systems, 6.3 percent, or 16 out of 253 cities and communities, showed an increase in their respective median home prices from a year ago. DataQuick statistics are based on county records data rather than MLS information. DataQuick Information Systems is a subsidiary of Vancouver-based MacDonald Dettwiler and Associates. (The top 10 lists are generated for incorporated cities with a minimum of 30 recorded sales in the month.)

Note: Large changes in local median home prices typically indicate both local home price appreciation, and often, large shifts in the composition of housing market activity. Some of the variations in median home prices for January may be exaggerated due to compositional changes in housing demand. The DataQuick tables listing median home prices in California cities and counties are accessible through C.A.R. Online at http://www.car.org/index.php?id=MzgyOTM=.

Statewide, the 10 cities and communities with the highest median home prices in California during January 2008 were: Newport Beach, $1,250,000; Danville, $1,037,000; San Clemente, $923,500; Santa Barbara, $895,000; Yorba Linda, $807,500; Redondo Beach, $800,100; Redwood City, $757,500; San Ramon, $753,500; San Francisco, $744,500; and Sunnyvale, $708,500.
Statewide, the 10 cities and communities with the greatest median home price increases in January 2008 compared with the same period a year ago were: Redondo Beach, 11.1 percent; Danville, 6.9 percent; San Diego, 5.2 percent; Arcadia, 4.2 percent; San Clemente, 2 percent; Los Angeles, 1.5 percent; Sunnyvale, 1.2 percent; Walnut Creek, 0.8 percent; Thousand Oaks, 0.4 percent; and Redwood City, 0.3 percent.
Leading the way...® in California real estate for more than 100 years, the CALIFORNIA ASSOCIATION OF REALTORS® (www.car.org) is one of the largest state trade organizations in the United States, with about 200,000 members dedicated to the advancement of professionalism in real estate. C.A.R. is headquartered in Los Angeles.

January 2008 Regional Sales and Price Activity*

Regional and Condo Sales Data Not Seasonally Adjusted

German Bank sues UBS over CDO losses.

2008-02-24T15:58:00.000-08:00

HSH to sue UBS over subprime losses
By Bertrand Benoit in Berlin and Haig Simonian in Zurich
Published: February 24 2008 20:19 | Last updated: February 24 2008 20:19
UBS, the European bank worst hit by the subprime crisis, faced another blow after HSH Nordbank, the German public sector lender, said it would sue to recover subprime losses.

HSH said Sunday it would file a suit this week to seek repayment of “hundreds of millions” of losses on a portfolio of collateralised debt obligations structured and managed by UBS. UBS declined to comment.

The move comes days before an emergency UBS shareholders’ meeting, at which investors will be asked to approve measures to raise SFr19bn (€11.8bn), including SFr13bn from Singapore and Saudi Arabia.

Wednesday’s meeting in Basel will bring severe criticism of Marcel Ospel, the Swiss group’s veteran chairman, for his handling of the subprime affair, which has seen UBS take $18.4bn (€12.4bn) in writedowns. Many analysts expect UBS to post more writedowns in the first quarter on securities linked to US residential mortgages.

HSH said it aimed to recover losses on North Street 2002-04, a $500m portfolio of collateralised debt obligations linked to the US residential mortgage market. The CDOs were structured, sold and managed by UBS.

The portfolio was bought in 2002 by Landesbank Schleswig-Holstein before it merged with Hamburgische Landesbank to create HSH. HSH said UBS did not act in line with obligations under the contract and changes were made in the portfolio.

“Our investment in the North Street programme should have been managed conservatively,” HSH said in a statement. “We will show that UBS acted wholly against our interests in its management of the investment.”

HSH said UBS did not respond to requests last year to settle out of court.

The subprime crisis has taken a heavy toll on German public sector banks. SachsenLB was sold last year after it emerged the Saxon Landesbank and an affiliate held €43bn in risky investments. WestLB and BayernLB (the landesbanks of North Rhine-Westphalia and Bavaria) also recorded steep losses. IKB, a Düsseldorf-based lender, came close to bankruptcy in spite of two injections of funds and had to be bailed out by the federal government last month.

HSH said this month it would postpone a planned initial public offering in the fourth quarter of this year and instead ask shareholders for a €1bn capital increase.

Northern Rock Top Ten (Loser Edition)

2008-02-21T08:07:00.000-08:00

The top 10 Northern Rock losers
By John Gapper
Published: February 20 2008 18:42 | Last updated: February 20 2008 18:42

There are no winners from the British government’s decision this week to nationalise Northern Rock, the mortgage lender. There is, however, an embarrassment of losers.

Northern Rock is only one of many troubled banks. Even Credit Suisse, which seemed to have side-stepped the worst of the credit crisis, turns out to have had a hole in its balance sheet. But Northern Rock is the first British bank to suffer a run on its deposits since 1866. It is still hurting reputations across the financial and political world, right up to Gordon Brown, the prime minister.

So, with apologies to David Letterman, the US chat show host, here, in reverse order, is the list of Top 10 Northern Rock losers.

10. Mervyn King. The Bank of England governor has put on a fine rearguard action since September, when he topped the list of probable victims. He has since worked his way craftily down to the bottom.

He started out by rejecting calls for any intervention in financial markets and then had to do a U-turn. Five months on he has gained a second term as governor and is on firmer ground than the Treasury and the Financial Services Authority. The Treasury used to mutter about him being a head-in-the-clouds academic but now wants to give him extra powers, which suggests that he graduated in infighting.

9. Lloyds TSB. The bank made a bid (actually, three bids) for Northern Rock before things got out of control. That was rebuffed by the Treasury because Lloyds TSB wanted it to guarantee any shortfall in deposits. The Treasury is now taking what it calls “the last resort” of owning the Rock’s entire balance sheet instead. Maybe it should have taken the first one. Just a thought.

8. The investment banks. Well, it has been a long five months and Goldman Sachs, Merrill Lynch, Citigroup, Blackstone and Greenhill & Co, who advised various sides, have worked hard. Maybe that accounts for the £75m ($146m) bill that the advisers to Northern Rock submitted last Saturday, including one bank’s claim that it deserved a “success fee” for getting the Rock nationalised.

These are difficult times for bankers, given the credit crisis and the flow of mergers and acquisitions being reduced to a trickle, and you need chutzpah to get your bonus. Even so, if the Treasury seizing your client’s assets after rejecting your rescue plan counts as success, what would failure look like?

7. Sir Richard Branson. The bearded entrepreneur planned to slap his Virgin brand on the Rock, take a chance that his £1.25bn of new equity would not be wiped out by a housing recession, pay the government a modest fee to rent its AAA balance sheet and make a 20 per cent return on equity. He will have to find other chances to pull a fast one.

6. The shareholders. Hedge funds enjoy taking people to court and they may have to do just that if they are to get much out of the Treasury for their lost equity. I suppose we ought to sympathise with those lured to the City of London on the promise that New Labour had been converted to laisser faire, only to be clobbered by Old Labour-style nationalisation. But equity is known as risk capital for a good reason. My investment advice to them is: get over it.

5. The employees. Up to 3,000 jobs could be lost at Northern Rock as the new management under Ron Sandler shrinks its mortgage book and tries to stabilise it. There is no obvious reason why the staff should have known better than to work there but the lesson is to be wary of working for any institution that claims to have discovered a new form of financial alchemy. The problem is there have been a lot of those.

4. The Financial Services Authority. It was not very long ago that the initials FSA were whispered enviously around the world’s financial centres as the model for “light-touch” regulation. In practice, the FSA proved not so much a light-touch regulator of Northern Rock as an out-of-touch one.

Having vented its frustration on the Bank of England (see above), the Treasury seems now to have settled on the FSA as its official whipping-boy. Those who attended the negotiating sessions over the Rock’s future noted that the seats at the centre of the table went to Treasury officials, with Bank officials at their side. The FSA bods were shuffled to the end of the table and treated like embarrassing relatives.

3. Alistair Darling. You could view the chancellor of the exchequer’s decision to reject the Lloyds TSB offer, then guarantee the Rock’s deposits, then negotiate with private bidders and finally nationalise it as a statesmanlike mulling of less-than-perfect options culminating in decisive action. Or you could see it as pathetic dithering followed by the abandonment of all hope. Unfortunately, some Downing Street officials, while espousing the former view in public, seem privately to favour the latter.

2. Gordon Brown. Talking of Downing Street, there sits the prime minister formerly known as prudent. He has taken the advice of the Treasury and Goldman Sachs and punted on owning the Rock rather than off-loading it to Sir Richard. The good news is that, if anything goes wrong, he can ditch his chancellor for getting him into a mess. The bad news is that Mr Darling is the only equity he has left to burn.

1. Britannia. No, not the building society but the nation. Time was when the UK, with its 9.4 per cent of gross domestic product devoted to financial services, looked like the epitome of post-industrial, creative capital, economies. Less so now. Britannia ruled the waves of the global financial services industry but her Rock has had to be propped up and the waves lap around her.

john.gapper@ft.com

Another Great Idea! As the asset markets are getting negative returns, lets invest pension money there. Perhaps private equity will bail us out!

2008-02-20T09:51:00.000-08:00

Equities lure US pension guarantor
By Norma Cohen in London and Anuj Gangahar in New York
Published: February 18 2008 20:31 | Last updated: February 18 2008 20:31
The Pension Benefit Guaranty Corporation, the US government-sponsored guarantor for pensions, plans to step up its investments in riskier assets such as equities as it seeks to plug a $14bn deficit.

The move, quietly announced on the President’s Day public holiday in the US on Monday, will mean the PBGC will double its allocation of equity investments to 45 per cent of its total assets.
The PBGC, which in effect acts as a pensions insurance fund, guarantees the benefits of 44m workers and is currently paying benefits to 700,000 retirees. It holds approximately $55bn (€37.4bn, £28bn) in assets to invest under its new policy.

It has, however, no access to credit from the government. It relies only on insurance premiums paid by the companies whose plans it insures and the investment returns those premiums can earn. If it became insolvent, it would either have to slash benefits paid to retirees or seek a taxpayer bailout.

The PBGC did not have the resources to meet all its future commitments, Charles Millard, director of the corporation, said yesterday.

In view of the current deficit, Mr Millard, said: “We do want to make sure we do our best to avoid the need for a taxpayer bailout. The old strategy locks in the deficit.”

Mr Millard said he believed the long-term nature of its liabilities meant that the PBGC could withstand short-term market volatility.

He also announced that the scheme would make investments in private equity and real estate.

The PBGC altered its investment strategy in 2004 to tilt towards increased investments in low-risk bonds, which move with pension liabilities. The deficit rose and subsequent legislative attempts to increase the scheme’s funds failed.

The PBGC, which also holds pension scheme assets it takes over from insolvent employers, held 28 per cent in equities at the end of last year.

Under the new, higher-risk investment plan it will allocate 45 per cent of its total assets to a diversified set of fixed-income investments, down from about 72 per cent at the end of 2007. It will also invest 10 per cent in alternative investment vehicles, including hedge funds.

The move reflects widespread concerns about fixed-income investments amid the continuing fallout from the US subprime mortgage crisis. Last year the equity portion of the corporation’s investments returned 16.5 per cent while the fixed-income portion returned just 3.4 per cent.

Mr Millard said that the new strategy had a 57 per cent chance of eventually funding the PBGC fully, while the old strategy had only a 19 per cent chance of that.

The new policy was adopted after an extensive review, begun in mid-2007. This showed that the diversified portfolio adopted by the board would have outperformed the current asset mix 98 per cent of the time over rolling 20-year periods.

President George W. Bush announced a legislative proposal earlier this month allowing the PBGC to raise premiums it charges underfunded pension plans.

The proposal, included in the president’s fiscal 2009 federal budget, is aimed at helping the agency close the deficit in its single-employer programme.

Copyright The Financial Times Limited 2008

The 1990's, In Reverse.

2008-02-20T07:15:00.000-08:00

CITIGROUP SEELLS JAPAN HEADQUARETERS!
February 19, 2008: 02:15 PM EST

Feb. 19, 2008
NEW YORK (AP) - Citigroup (NYSE:C) Inc. has sold another one of its financial centers to raise cash. The bank said Tuesday that a Morgan Stanley (NYSE:MS) real estate fund bought its Japanese headquarters in Tokyo.

Citigroup would not disclose the value of the deal.

The bank has been shedding its real estate holdings for a couple years, even before the tight credit markets saddled the bank with billions of dollars in bad debt. Most recently, it sold the last two Manhattan properties on its books to SL Green Realty Corp. (NYSE:SLG PRD) (NYSE:SLG PRC) (NYSE:SLG) in December for about $1.58 billion.

As with these Manhattan office buildings, Citigroup remains a tenant of the Tokyo center, and leases the building instead of owning it.

'The sale-and-leaseback was intended to improve the efficiency of the usage of the balance sheet of Citibank Japan, as well as mitigate the risks of holding property assets,' Citigroup said in a statement.

Citigroup is considering selling other more significant assets -- both in the United States and abroad -- to build up its capital base and return to profitability. CEO Vikram Pandit is reviewing the banks' various global businesses, a process that Citigroup spokespeople say is still ongoing.

Crap Buyer of Last Resort Rides to the Rescue

2008-02-18T20:50:00.000-08:00

US banks borrow $50bn via new Fed facility
By Gillian Tett in London
Published: February 18 2008 20:34 | Last updated: February 18 2008 20:34
US banks have been quietly borrowing massive amounts of money from the Federal Reserve in recent weeks by using a new measure the Fed introduced two months ago to help ease the credit crunch.

The use of the Fed’s Term Auction Facility, which allows banks to borrow at relatively attractive rates against a wider range of their assets than previously permitted, saw borrowing of nearly $50bn of one-month funds from the Fed by mid-February.

US officials say the trend shows that financial authorities have become far more adept at channelling liquidity into the banking system to alleviate financial stress, after failing to calm money markets last year.

However, the move has sparked unease among some analysts about the stress developing in opaque corners of the US banking system and the banks’ growing reliance on indirect forms of government support.

“The TAF . . . allows the banks to borrow money against all sort of dodgy collateral,” says Christopher Wood, analyst at CLSA. “The banks are increasingly giving the Fed the garbage collateral nobody else wants to take . . . [this] suggests a perilous condition for America’s banking system.”

The Fed announced the TAF tool on December 12 as part of a co-ordinated package of measures unveiled by leading western central banks to calm money markets.

The measure marks a distinct break from past US policy. Before its introduction, banks either had to raise money in the open market or use the so-called “discount window” for emergencies. However, last year many banks refused to use the discount window, even though they found it hard to raise funds in the market, because it was associated with the stigma of bank failure.

The Fed has not yet indicated how long the TAF will remain in place.

But the popularity of the scheme is prompting speculation the reform will stay in place as long as the financial stresses last.

“Some Fed officials have expressed an interest in keeping and possibly expanding the TAF,” says Michael Feroli, economist at JPMorgan.

Nevertheless, Mr Feroli said banks now appeared to be using the TAF instead of other funding routes, meaning that the overall level of reserves in the system was remaining constant. “The banking system certainly has its problems, however the notion that . . . banks have trouble maintaining reserves stems from a superficial reading of the Fed’s statistical reports,” he said.

No Free Lunch for the Monolines.

2008-02-18T09:24:00.000-08:00

Bond Insurer Split May Trigger Lawsuits, Analysts Say (Update1)
By Cecile Gutscher

Feb. 18 (Bloomberg) -- Regulators' plans to break up bond insurers into ``good'' businesses covering municipal debt and ``bad'' businesses liable to subprime-related losses may trigger ``years of litigation,'' Bank of America Corp. analysts said.

New York Insurance Department Superintendent Eric Dinallo and New York Governor Eliot Spitzer said last week that insurers may need to be divided if they can't raise enough capital to compensate for losses on subprime-mortgage guarantees. FGIC Corp., the fourth-largest of the so-called monoline insurers, asked to be split on Feb. 15 after Moody's Investors Service cut the Stamford, Connecticut-based company's top Aaa ranking.

``Despite the regulatory interest in separating the exposures, the essential fact remains that all policy holders, whether municipal or structured finance, entered into contracts backed by the entire entity,'' analysts led by Jeffrey Rosenberg in New York wrote in a note to investors dated Feb. 15. A breakup is ``likely to lead to significant legal challenges holding up the resolution of the monoline issues for years.''

FGIC, owned by Blackstone Group LP and PMI Group Inc., insures about $314 billion of debt, including $220 billion in municipal bonds. The company said last week it applied for a license from New York state insurance regulators to create a standalone municipal company and separate the unit that guarantees subprime-mortgage bonds and related securities that led to rating downgrades.

New York-based Ambac Financial Group Inc., the second- largest bond insurer, may also seek a split, the Wall Street Journal reported today, citing a person familiar with the situation.

Credit-Default Swaps

``The fact that one group of policy holders' exposures has imperiled the policies of the other does not mean they should forfeit the value of their claims altogether,'' the Bank of America analysts said.

Investors in credit-default swaps based on the bond insurers may also seek damages to compensate for losses, according to the research note.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline, the opposite.

The cost of credit-default swaps on Armonk, New York-based MBIA Inc., the world's largest bond insurer, has soared to $1.7 million upfront and $500,000 a year to protect $10 million of bonds from default for five years, according to CMA Datavision. Ambac credit-default swaps were at the same level as MBIA at the close of trading in New York on Feb. 15. The contracts, which cost $25,000 a year ago, trade upfront when investors see a risk of imminent default.

Any breakup of the companies may cause ``significant widening'' in the credit-default swaps as the structured finance company is likely to be ``deeply distressed,'' the Bank of America report said.

To contact the reporter on this story: Cecile Gutscher in London at cgutscher@bloomberg.net

IT ONLY GETS WORSE. MUCH WORSE!

2008-02-17T18:14:00.000-08:00

U.K. government seeks power to buy companies
By Alistair Barr, MarketWatch
Last update: 5:09 p.m. EST Feb. 17, 2008
Print E-mail RSS Disable Live Quotes
SAN FRANCISCO (MarketWatch) -- The U.K. government will introduce legislation this week that will give it the power to acquire companies as it nationalizes troubled mortgage lender Northern Rock PLC.
U.K. finance minister Alistair Darling said the bill, which will be introduced to the House of Commons on Monday, will allow the government to buy the shares and assets of Northern Rock. (UK:NRK: news, chart, profile)
See full story on U.K. government's move to nationalize Northern Rock.
But the legislation would also give the government general power to acquire shares or assets and liabilities of other institutions too, he added.
"We have deliberately drafted the bill to ensure that a bank can only be acquired in certain tightly defined circumstances. And that power will only last for twelve months," Darling explained. "I've already announced a consultation which will lead to permanent legislation to deal with situations like this in the future."
Darling didn't provide any further information, but said details are in the Bill, which will be published on Monday.
Alistair Barr is a reporter for MarketWatch in San Francisco.

Q and A session with Chancellor Darling on BBC

2008-02-17T13:37:00.001-08:00

Q: What does this mean for Northern Rock shareholders?

The general consensus is that it is not good news for shareholders, who have already seen their shares - which were valued at over £12.50 this time last year - slump to be trading at 90 pence at the close of business on Friday.

So the beleaguered firm has gone from being worth £5.3bn to just £375m, and these shares will be suspended on Monday morning.

Shareholders will be compensated, with the amount of money they are to receive set by a government-appointed panel.

If shareholders are unhappy with the offer, there is the prospect of legal action, and Mr Peston says it is "inevitable" that the government will be sued by some of the largest stakeholders which are hedge funds.

They have reportedly written to the Treasury calling for 400p per share in compensation.

Private Profit, Public Losses in Banks (UK Edition).

2008-02-17T08:29:00.000-08:00

Northern Rock to be nationalised
By FT reporters
Published: February 17 2008 15:46 | Last updated: February 17 2008 15:46
The UK Treasury is to announce on Sunday that it is to nationalise Northern Rock, the troubled British bank, the Financial Times understands.

The decision ends months of efforts to find a private sector rescuer for the stricken mortgage lender, which ran into trouble as a result of the international credit squeeze.

It means that neither of the two bids for the bank, from Sir Richard Branson’s Virgin consortium and Northern Rock’s management team, have been successful.

Both bidders tendered revised offers on Friday after the government threatened that the bank would be nationalised unless their proposals were improved.

It is understood that the government believes nationalisation is now the best option, even though it is likely to spark a political storm, an angry reaction from some shareholders and big job losses in the north-east of England.

UPDATE: Part of Government Statement on the issue:
______________________________________________________

under public ownership the Government will secure the entire proceeds from the future sale of the business in return for bearing the risks in this period of market uncertainty.
We could have chosen to pursue either of the two private sector options. But I have always said that I was determined to protect the taxpayers' interest.
It is clear that the private sector alternatives do not meet this test, when compared with public ownership.
Accordingly, and taking all the wider considerations into account, I have concluded that this is the right approach.
Moreover, it is my clear assessment that under the approach we are taking the taxpayer will see its outstanding loans to Northern Rock repaid in full, with interest - and that the business can be returned to the private sector as financial markets stabilise.
Let me set out the next steps. Tomorrow, before the markets open, it is expected that the UK Listing Authorities will announce that the company's shares will be suspended from listing tomorrow prior to the opening of the London Stock Exchange.
Tomorrow, I am also publishing a Bill to bring the bank into a period of temporary public ownership. I will give full details of the legislation to the House of Commons.
The legislation will enable the Government to acquire the bank's shares and its assets. It will provide for compensation to be determined by an independent valuer.
It will allow for the running of the bank and for the eventual transfer back into the private sector as soon as it is right to do so. Because public ownership is a temporary arrangement.
The Bill gives the Government a general power to acquire the shares in, or assets and liabilities, of institutions.
But let me make it clear that this legislation is only being introduced now because there is a need to bring Northern Rock into temporary public ownership.
We have deliberately drafted the Bill to ensure that a bank can only be acquired in certain tightly defined circumstances. And that power will only last for twelve months.
I've already announced a consultation which will lead to permanent legislation to deal with situations like this in the future.
Further details of this arrangement are contained in the Bill which I will publish tomorrow morning when the House returns.
As you can see Ron has joined me today and is ready to answer any questions you may have.
He will want to consider carefully the options and will outline his proposals shortly including in relation to restructuring the business.
Ron expects to be in Newcastle tomorrow to discuss the business and meet staff and their representatives.
His proposals will also cover the Northern Rock Foundation, where he will commit to guaranteeing a minimum income of £15m per year in 2008, 2009 and 2010. This will be paid directly by Northern Rock, and would be a condition of any sale if it were sold in this time.
The new Board will be asked to identify a viable long-term future for the Foundation.
The new Board and the company will operate at arm's length from the Government, with complete commercial autonomy for their decisions.
As agreed in the memorandum of understanding all operational decisions will be made by the Board with no interference from the Government.
It is our expectation that the company can be moved into the private sector at the earliest and most prudent opportunity.
We are clear that this is the most effective way of continuing to support Northern Rock's business, its savers, the wider financial system and safeguard taxpayers' money.
At every stage the stability of the economy and the interests of depositors and taxpayers have been - and remain - our first concern.
This will continue to be the basis on which we will move forward in the coming months.
I will make a full statement to the House of Commons tomorrow afternoon.

"You've Got to Know When to Fold Them!"

2008-02-14T14:14:00.000-08:00

Banks advised to walk away from big deals
By Henny Sender in New York
Published: February 14 2008 22:03 | Last updated: February 14 2008 22:03
Leading banks are being advised that it would be cheaper to walk away from big buy-out deals than incur further losses on their funding commitments, increasing the chances that more high-profile private equity transactions will collapse.

This advice from lawyers contrasts with the conventional wisdom that banks would risk serious damage to their reputations if they were to drop out of deals.

But legal advisers argue that the break-up fees banks would owe in such cases would be far lower than the write-downs they would have to make on their loans, given the current cataclysmic conditions in the capital markets.

“It is the tipping point argument,” said a senior partner at one of the biggest private equity firms, who asked not to be named. “The banks have so many issues with their balance sheets that they are considering a new policy.”

However, such a radical shift could have a dramatic impact on the markets. The presence of private-equity buyers is one factor that has helped boost stock prices.

“If you want to come up with news that could make the Dow drop another 500 or 1,000 points, this would be it,” says one lawyer specialising in private equity issues for a major New York law firm. “But desperate times call for desperate measures.”

So far, leveraged buy-outs have usually collapsed when the private-equity firms involved – including Blackstone and Cerberus – have withdrawn from transactions.

Such moves have occurred as banks have been working behind the scenes to persuade private equity firms to abandon deals. Such indirect approaches are designed to prevent target companies from filing suits seeking to make sure deals close.

However, the chances of banks abandoning buy-out deals – such as those for Clear Channel Communications, the radio station owner and outdoor advertising company, and BCE, the Canada-based telecoms group – are growing as the market prices for the leveraged loans used in such transactions continue to fall.

US regulators are pressing banks to account for these loans at market prices while they keep them on their books.

Already, it is understood that one bank has marked down its share of the loan used in the Clear Channel buy-out to 85 cents on the dollar.

By contrast, lawyers are telling the banks that if they walk away from deals, their biggest liability would be equivalent to the so-called reverse break-up fee that private equity firms pay target companies when deals fail to close. These fees usually amount to about 2 per cent of the total value of a deal, or about $500m in a large buy-out.

Lawyers say there could be other costs for the banks, such as covering the expenses buy-out firms incur while doing their homework on bids.

Further, they do not rule out the possibility that banks could have to pay greater damages in litigation.

What is sure is that banks are giving greater thought to dropping out of deals. “We are already there in terms of the economic pain,” said the head of debt capital markets at one major Wall Street firm. “Banks sitting on $30bn of debt for one deal are looking at $4.5bn of losses. That is enough to play hardball.”

Copyright The Financial Times Limited 2008

Bill Gross on Monolines

2008-02-07T19:14:00.001-08:00

Rescuing monolines is not a long-term solution
By William Gross
Published: February 7 2008 18:14 | Last updated: February 7 2008 18:14
What is good for Ambac, the bond insurer, is good for the country. Well, perhaps in the short run if it prevents a run on the shadow banking system – our over-leveraged system of financial conduits that have provided the spending power to keep the US economy going in recent years. But not in the long run.

The Ambac business model is as faulty now as was chairman Charles Wilson’s forecast for General Motors more than a half century ago. Wilson’s response to a US Senate inquiry in 1955 implied that GM’s near monopolistic control was beneficial to the country. It was, until the domestic motor industry fell asleep at the wheel of innovation and became more concerned with placating its labour unions with outsized pay packages and long-term pension and healthcare benefits. Creative destruction and the incessant march of globalisation changed a GM chairman’s smile to a frown, and the US economy turned from industrialisation to financialisation in order to stay at the top of the global pecking order.

Those who put their faith in the ability of a finance-based economy to remain healthy are being similarly challenged today. A critic can find numerous examples of incredible, bubble-popping asset structures – from subprime mortgages to structured investment vehicles to collateralised debt obligations squared – that are threatening to reverse the expansion of the shadow banks and break our finance-based economy’s back. The most recent one, however, centres around the monoline insurers with Ambac as the most important link in the chain that presumably cannot be allowed to break.

Monoline insurers are so named because they originally covered just one line of business – municipal bonds. Today, however, because they do not insure lives, or automobiles or medical expenses, the name has stuck despite their additional reach into insuring financial assets of all varieties. In a real sense, the monolines have taken on their shoulders a supersized portion of the guaranteed solvency of modern asset structures. In combination with overly generous triple-A ratings on not only these assets but the monoline companies themselves, they have fostered a bubble of immeasurable but clearly significant proportions.

That the monolines could shoulder this modern-day burden like a classical Greek Atlas was dubious from the start. How could Ambac, through the magic of its triple-A rating, with equity capital of less than $5bn, insure the debt of the state of California, the world’s sixth-largest economy? How could an investor in California’s municipal bonds be comforted by a company that during a potential liquidity crisis might find the capital markets closed to it, versus the nation’s largest state with its obvious ongoing taxing authority? Apply the same logic to the gargantuan size of the asset-backed market it has insured in recent years – subprimes and CDOs in the trillions of dollars – and you must come to the same logical conclusion: this is absurd. It is as if Barney Fife, television’s Sheriff of Mayberry in The Andy Griffith Show, promised to bring law and order to the entire country.

As long as the illusion lasted, however, it is clear that monoline guarantees fostered an expansion of our modern shadow banking system and therefore an extension of US and even global economic prosperity. Because US consumers were able to borrow at “guaranteed” triple-A rates with an additional servicing/underwriting spread, their spending power was artificially elevated. In order to maintain those levels and avoid a nasty recession, authorities through both official and backdoor channels now endorse a rescue effort. What is good for Ambac, they reason, is good for the country – and by extension the world.

As stock markets rise on optimistic workout developments, it is clear that it is – in the short run. But like General Motors a half century back, the sense of stability imparted to an oligopolistic industry with visible flaws is not likely to last, nor may the hope for a return to economic growth of recent years. The modern US financed-based economy has a striking resemblance to Barney Fife, guaranteeing global prosperity without the productive industrial-based firepower to back it up. Neither ultra-low interest rates or tax rebates, nor investor-led and authority-based monoline bailouts are likely to change that significantly during the next few years.

The writer is founder and managing director of Pimco

Copyright The Financial Times Limited 2008

Great Op-Ed from SF Chronicle

2008-02-03T09:59:00.000-08:00

STIMULUS PLAN A SCAM TO BENEFIT THE RICH
Higher loan limits will lead to Fannie Mae, Freddie Mac bailout
Sean Olender
Sunday, February 3, 2008

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Congress is about to sell us the biggest fraud in American history.
It's been highly touted as an economic stimulus bill that will help millions of Americans - and has the backing of both President Bush and House Speaker Nancy Pelosi. In the coming year, individuals would receive rebates of up to $600 and families up to $1,200. There are other goodies, too, including tax write-offs for small businesses and an expansion of the child tax credit.
But, as the old adage goes, nothing comes for free. As part of the bill, Congress is set to rush through an increase in the mortgage loan limits for Fannie Mae and Freddie Mac (and Federal Housing Administration insurance, too) - from $417,000 to $729,750 - the first step toward a massive financial disaster in which taxpayers will end up paying through the nose.
Here's how we got to this point. Domestic and international investors hold hundreds of billions of dollars in bad debt, because U.S. investment houses sold them junk securities based on often fraudulent mortgages. Many of these mortgages were sold to unqualified buyers under terms that made widespread foreclosures a certainty once the housing market began to fall.
Investment banks and bond rating agencies sat down and tried to figure out how to describe Americans with insufficient incomes and little for a down payment as great credit risks on loans too big for their incomes. The new rules focused on credit scores, because it was a good excuse to avoid looking at income and down payment, factors that would have restricted this moneymaking fiasco.
Now, thanks to Congress, junk bond investors will be able to pawn off their bad debt to Fannie and Freddie, instead of suing the big investment houses for ripping them off. This shift will certainly doom Fannie Mae and Freddie Mac, so don't be surprised if we, the taxpayers, have to bail out poor Fannie and Freddie - to the tune of more than $1 trillion.
Why more than $1 trillion? If Goldman Sachs is correct in its recent projections that home prices in California are going to drop 35 to 40 percent, the state's losses alone would top $2 trillion, because California has a disproportionate number of jumbo loans. The irony here is that the collapse in housing prices could make Fannie insolvent even without raising the loan limit. Increasing Fannie's limit is like going on a spending spree with your credit cards because you know you are going to file for bankruptcy in a few months. Only here the taxpayer is left holding the bag. Our children will pay interest on this debt in perpetuity. It is our debt. It is inescapable.
In the coming months, Fannie and Freddie will buy up mortgages based on old, fraudulent appraisals and on loans with bogus inflated incomes. Unfortunately, many of these loans will still default.
But that's just the start. Brace yourself for another wave of faxes, phone calls and junk mail urging you to refinance at only 1 percent. With zero new regulation, the same bad actors that caused this crisis can once again inflate property appraisals and begin a new cycle of fraud.
There are firms that rent assets to people to help them fraudulently qualify for a mortgage - like loaning them money to keep in their bank account for a couple months so they can fool the lender with documented savings that evaporate the day after the mortgage is signed. Another popular ruse: The borrower pays an employer to pay him a lot of money in a fake job for a month or two so he can show a fat paycheck in his loan docs. Some real estate agents and mortgage brokers actually refer buyers to these services.
Contrary to popular myth, Fannie holds a lot of subprime debt, option ARM debt and other dodgy securities. Fannie and Freddie owned or guaranteed almost 45 percent of all mortgages in America last year. BusinessWeek noted in 2007 that Fannie and Freddie have "moved more prominently into low-documentation loans, which require little or no proof of the borrower's income." Expansion of Fannie and Freddie's reckless lending is exactly what Congress wants because it's plausibly deniable. Teary-eyed lawmakers can take to the airwaves a year from now and declare: "We had no idea Fannie could go under, but we can't cut and run now. We have to bail out Fannie and Freddie for the good of America! It's going to be a tough slog, but you're getting used to those, no?"
Those same lawmakers won't mention the fact that they get paid far more by real estate lobbyists than they do from our Treasury.
I've spoken with borrowers who stopped making mortgage payments seven or more months ago. None has received a default notice. Defaults may be much higher than banks are letting on. The data lags are growing suspiciously long. Nobody knows what's going on. Seven months without making a single payment! Will Fannie guarantee those loans because they aren't in formal default yet? Nobody wants to know, because if they know, they might be called to testify next year. That's why lawmakers want to raise the limits now and ask questions later.
This shortsighted plan poses a terrible risk to every American taxpayer, especially retirees, because Social Security money will be needed to bail out Fannie and Freddie. And even if you live in high-priced San Francisco, Los Angeles or New York - and stand to benefit from the increased loan limit - this is a horrible fraud on you, too, because raising the limit to $730,000 risks a systemic crisis that will cost far more than any temporary rebate check.
In support of the economic stimulus bill, Bush will have to face "working American families" and explain that some of their tax money is going to be spent guaranteeing $730,000 mortgages on $1 million homes. It's like some sort of upside-down communism where the poor pay the rich welfare. Why should taxes from families earning $48,000 a year be used to support expensive mortgages in New York, Los Angeles and San Francisco? Welfare for the hungry and homeless is evil, but welfare for million-dollar homeowners facing a tough refi ... well, that's called "helping the economy."
I can imagine the president's radio address playing in the heartland: "We have some families with million-dollar homes on the coasts who are really hurting and so we need you, the working families of America, to stand together with them and help them avoid the kind of home price depreciation that might leave them without a new Lexus for years."
I guess Congress' hope is that median-income families will be too busy using their rebates to buy much-needed groceries to notice that the rich folk are getting way with a new scam.
Several months ago, economist Nouriel Roubini of New York University's Stern School of Business suggested that the housing market has been effectively nationalized. At first it seemed crazy, but now it's fairly obvious. In August alone, Fannie and Freddie increased their loan portfolios by $62 billion, and the Federal Home Loan Bank by $110 billion. That total of $172 billion would come to just over $2 trillion annually - not much less than the entire federal budget.
Everyone seeking a loan, securitizing a mortgage, and buying or selling a mortgage security will now be dealing, in one way or another, with the U.S. government. This type of intervention is very expensive and will eat everything in its path, including Social Security.
If we're going to have a government-financed intervention, it should be to make sure that Social Security benefits go to those who paid for them, that the poor are fed and housed, or that the army of uninsured receive health benefits. If, as they say, we don't have enough money for those important things, then I think we don't have enough money to bail out banks and bond investors.
Don't let me down, my fellow Americans. Let's vote out anyone0 who dares to vote for this scam.
Sean Olender is an attorney in San Mateo. Contact us at insight@sfchronicle.com.

In case you forgot how inflation works OR When will the NEW Strong American Dollar be created

2008-01-02T20:03:00.000-08:00

Venezuela launches new currency to stem inflation
By Benedict Mander in Caracas
Published: January 1 2008 22:03 | Last updated: January 1 2008 22:03
In an effort to stem record-high inflation, Venezuela launches a new currency on Wednesday – the “strong bolivar” – by slicing three zeroes off the bolivar.

While President Hugo Chávez’s government is hailing the measure as an anti-inflationary measure that will help stabilise the economy, non-government economists fear the strong bolivar will be anything but strong.

“We’re ending a historical cycle of . . . instability in prices,” Rodrigo Cabezas, finance minister, said on Monday, adding that the change aimed to “recover a bolivar that has significant buying capacity”.

“It was necessary to leave behind the consequences of a history of high inflation,” Gaston Parra, central bank president, said in a televised year-end speech. He added that officials aimed “to reinforce confidence in the monetary symbol”.

However, in view of racing inflation, an increasingly unsustainable exchange rate and shortages of basic goods, José Guerra, a former chief economist at Venezuela’s central bank, said: “The monetary ‘reconversion’ is not going to stabilise prices. It’s not going to help reduce inflation, or anything of the kind,” arguing that the new currency could even trigger higher inflation. “It’s a dangerous move,” he said.

In 2007 inflation in Venezuela is expected to exceed 20 per cent, the highest in the region – far beyond the government’s target of 12 per cent.

“There will be confusion,” said Domingo Maza Zavala, whose term as a director of the central bank ended early in 2007. He argues that government campaigns proclaiming the advent of “a strong bolivar, a strong economy, a strong country” – have created the false impression the new currency will have a greater purchasing power than the old one.

“The strong bolivar is being born into an environment not only of monetary instability, but also ex-change rate, financial, economic and social instability. That is not the best climate for its success,” he said.

Although the strong bolivar will bring some benefits such as simplifying transactions and accounts, the cost of introducing it – updating computer systems, for example – has been greater than expected, and may lead companies to round up prices to cover costs.

Economists argue that currency reforms have only been successful when inflation is already under control.

Mr Maza Zavala said the currency reconversion should be accompanied by additional anti-inflationary policy, in particular ensuring the availability of popular goods, especially basic foods, as well as moderating government spending.

Imbalances in the exchange rate regime also threaten the new currency.

José Manuel Puente, an economist at the IESA business school in Caracas, says the exchange rate is at least 20-30 per cent overvalued. But the key problem, he argues, is the gap between the official and the “parallel” exchange rate for the dollar, which recently ex-ceeded triple the official rate of 2,150 bolivars.

Copyright The Financial Times Limited 2008

Money Well Spent!

2008-01-02T19:59:00.001-08:00

Independent trader claims $100 oil record
By Javier Blas in London
Published: January 2 2008 21:47 | Last updated: January 3 2008 01:11
With a single small deal, an independent trader on Wednesday secured his place in market history by pushing oil prices briefly to the unprecedented level of $100 a barrel.

Some observers questioned the validity of the price mark when it emerged that the peak was the result of a trader – one of the “locals” who trade on their own money – buying from a colleague just 1,000 barrels of crude, the minimum allowed, industry insiders said. The deal on the floor of the New York Mercantile Exchange was at a hefty premium to prevailing prices.

Insiders named the trader as Richard Arens, who runs a brokerage called ABS. He was not available for comment. Analysts said he may have been testing the ceiling of the crude price, but the premium he paid surprised the market.

Before the $100-a-barrel trade, oil prices on Globex were at $99.53 a barrel. Immediately after the trade, prices went down to about $99.40, suggesting a trading loss of $600 for Mr Arens.

Stephen Schork, a former Nymex floor trader and editor of the oil-market Schork Report, commented: “A local trader just spent about $600 in a trading loss to buy the right to tell his grandchildren he was the one who did it. Probably he is framing right now the print reflecting the trade.”

The transaction was not shown at first on the electronic Globex system, which carries the bulk of crude oil trading, leaving the market unsure about the price level. But Nymex said: “It is considered a valid trade.”

The Nymex February WTI futures contract traded about 204,600 lots, each of 1,000 barrels. Only one traded at $100 a barrel.

West Texas Intermediate crude oil closed in New York significantly higher at $99.64 a barrel, up $3.66 on the day.

Copyright The Financial Times Limited 2008

Predictions for 2008

2007-12-30T13:28:00.000-08:00

2007 was an interesting year. Prices came down a little bit in my area, but certainly there was no collapse. Probably about a 5-7% decrease. Because we live so close to Wall Street, and equities markets didn't bust, prices maintained their anchor to a large degree. Obviously in 2007 there were huge credit market dislocations with a resulting credit crunch, this crunch seemed to cause less damage to housing prices (so far) than I would have thought. I think because 2008 is an election year, there will be a lot of politically motivated fiscal decisions (a-la MLEC) this year. Anyway, here are my predictions for 2008:

1. R/E: Nationally, continue to slide 5-7%; Bergen County: down 3-5% if Wall Street has no bust, 7-11% if there is a bust.
2. Equities markets: flat to mildy down. (+4% to - 4%)
3. Commodities: Pull back/consolidation year, unless there is a major geopolitical event.
4. Fed: Continues to cut rates to about 3.5%, regardless of what the Chinese say.
5. Bonds: NO IDEA!

Would love to hear other peoples predictions/guesses

Another meeting another rate cut.

2007-10-31T18:11:00.000-07:00

A completely predictable, and rather banal 25 bp rate drop today by the reflators. The day the GDP came out at 3.9%, their assymetric approach to asset bubbles rears it's ugly head again. It won't save either the RE speculators, or the CDO/SIV peddlers' asses. It's become an amusing spectator sport to watch Paulson talk about the strong dollar, while the dollar continues to get pumelled. It's my understanding that there is a flight from all currencies into equities, which will be bullish for equities for some time. This is quite a paradox, since it seems to be a time of decreasing earnings growth and debt deflation. This can only lead to increasing multiples and yet another equities bubble, which will probably pop leading to another leg in the RE bubble. This waxing and waning of asset markets has become the single obsession of the central banks. Quite bizarre. And ultimately, it will fail. The only question is when. Maybe it will take 10-20 years. Perhaps 1-3 years. Who knows? It's getting boring waiting for the other shoe to drop, especially when the entire capatalistic world is propping that shoe up!

Credebility Lost!

2007-09-18T13:52:00.000-07:00

Bernanke's Fed has lost all credibility regarding inflation fighting. This "theme" has proven itself to be a joke. It is really just a ruse to beguile people into believing that they care about the purchasing power of their savings. In fact, they only care about Wall Street and the economic elite. Welfare for Wall Street. The Fed has systematically destroyed the life savings of millions of hard working Americans, though they may not know this fact yet. The Monopoly game continues, with the "bank" refinancing the players who overextended themselves. No society is just which uses false weights, scales and volumes. Bernanke should know this quite well! The only real question becomes, who will be America's first Trillionaire? The new adage for the 21st century: "The first Trillion is the hardest to make".

Greenspan Confesses!

2007-09-16T12:07:00.001-07:00

Greenspan alert on US house prices
By Krishna Guha in Washington
Published: September 16 2007 19:40 | Last updated: September 16 2007 19:40
US house prices are likely to fall significantly from their present levels, Alan Greenspan has told the Financial Times, admitting that there was a bubble in the US housing market.

In an interview ahead of the release on Monday of his widely-anticipated memoirs, the former chairman of the Federal Reserve said the decline in house prices “is going to be larger than most people expect”.

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But Mr Greenspan said that his successors at the Fed – who meet on Tuesday to set interest rates – would have to be careful not to ease rates too aggressively, because the risk of an “inflationary resurgence” was greater now than when he was Fed chief.

Mr Greenspan said he would expect “as a minimum, large single-digit” percentage declines in US house prices from peak to trough and added that he would not be surprised if the fall was “in double digits”.

Mr Greenspan said house prices were probably already down about 2-3 per cent from their peak on a national level.

However, he cautioned that it was very difficult to predict how large the ultimate decline would be.

As Fed chairman, Mr Greenspan had talked about “froth” in the housing sector, but never said there was a bubble in the market as a whole. His successor Ben Bernanke has also avoided the word “bubble”.

But Mr Greenspan told the FT that froth “was a euphemism for a bubble”.

He said he still thought froth – a collection of bubbles – was a better description, because of the variation in house price appreciation in different local housing markets. But he said “all the froth bubbles add up to an aggregate bubble”.

The former chairman said the current turmoil in financial markets was “an accident waiting to happen”.

He said the price of risk had fallen to unsustainably low levels beforehand, with investors addicted to asset-backed securities that offered some additional yield over Treasury bonds as if they were “cocaine”. Mr Greenspan said this demand induced the big increase in the origination of subprime mortgages by mortgage brokers.

The rise in defaults on subprime mortgages was only the trigger that set off a broad re-evaluation of risk, he argued.

Mr Greenspan said the off-balance sheet investment vehicles that issued much of the asset-backed commercial paper represented a “savings and loans disaster waiting to happen” because of the mismatch between their assets and liabilities. Mr Greenspan thought the issuance of asset-backed commercial paper ”is probably not going to get back to where it was.”

They had “five-year maturity assets financed with 30-day commercial paper”, he said.

The former Fed chairman said collateralised debt obligations – securities that slice up and repackage loans to meet the risk-appetite of different investors – “will never get back to the levels and structures that they were, because now everybody knows you cannot price them”.

He added that in an innovative financial market “there will always be products that fail”.

However, he said he believed that credit default swaps were “here to stay” and had demonstrated their capacity to diversify risk.

Mr Greenspan said the flexibility of the US economy would help it cope with the spill- overs from the financial crisis, but said the prospect of a negative wealth effect from housing meant this crisis was “trickier” to manage than financial crises that did not directly touch consumers.

In his memoirs, Mr Greenspan, a lifelong Republican, criticises his party for abandoning its small-government principles, and warns that the trade-off between inflation and growth is likely to worsen.

Copyright The Financial Times Limited 2007

Minsky Moment

2007-08-24T04:39:00.001-07:00

In Time of Tumult,
Obscure Economist
Gains Currency
Mr. Minsky Long Argued
Markets Were Crisis Prone;
His 'Moment' Has Arrived
By JUSTIN LAHART
August 18, 2007; Page A1
The recent market turmoil is rocking investors around the globe. But it is raising the stock of one person: a little-known economist whose views have suddenly become very popular.

Hyman Minsky, who died more than a decade ago, spent much of his career advancing the idea that financial systems are inherently susceptible to bouts of speculation that, if they last long enough, end in crises. At a time when many economists were coming to believe in the efficiency of markets, Mr. Minsky was considered somewhat of a radical for his stress on their tendency toward excess and upheaval.

RELATED READING

Hyman Minsky
"The Financial Instability Hypothesis" by Hyman P. Minsky, May 1992
"The Plankton Theory Meets Minsky" by Paul McCulley, March 2007
"Capitalism's Beast of Burden" by Paul McCulley, January 2001
Today, his views are reverberating from New York to Hong Kong as economists and traders try to understand what's happening in the markets. The Levy Economics Institute of Bard College, where Mr. Minsky worked for the last six years of his life, is planning to reprint two books by the economist -- one on John Maynard Keynes, the other on unstable economies. The latter book was being offered on the Internet for thousands of dollars.

Christopher Wood, a widely read Hong Kong-based analyst for CLSA Group, told his clients that recent cash injections by central banks designed "to prevent, or at least delay, a 'Minsky moment,' is evidence of market failure."

Indeed, the Minsky moment has become a fashionable catch phrase on Wall Street. It refers to the time when over-indebted investors are forced to sell even their solid investments to make good on their loans, sparking sharp declines in financial markets and demand for cash that can force central bankers to lend a hand.

Mr. Minsky, who died in 1996 at the age of 77, was a tall man with unruly hair who wore unpressed suits. He approached the world as "one big research tank," says Diana Minsky, his daughter, an art history professor at Bard. "Economics was an integrated part of his life. It wasn't isolated. There wasn't a sense that work was something he did at the office."

She recalls how, on a trip to a village in Italy to meet friends, Mr. Minsky ended up interviewing workers at a glove maker to understand how small-scale capitalism worked in the local economy.

Although he was born in Chicago, Mr. Minsky didn't have many fans in the "Chicago School" of economists, who believed that markets were efficient. A follower of the economist John Maynard Keynes, he died just before a decade of financial crises in Asia, Russia, tech stocks, corporate credit and now mortgage debt, began to lend credence to his ideas.

Following those periods of tumult, more investors turned to the investment classic "Manias, Panics, and Crashes: A History of Financial Crises," by Charles Kindleberger, a professor at the Massachusetts Institute of Technology who leaned heavily on Mr. Minsky's work.

Mr. Kindleberger showed that financial crises unfolded the way that Mr. Minsky said they would. Though a loyal follower, Mr. Kindleberger described Mr. Minsky as "a man with a reputation among monetary theorists for being particularly pessimistic, even lugubrious, in his emphasis on the fragility of the monetary system and its propensity to disaster."

At its core, the Minsky view was straightforward: When times are good, investors take on risk; the longer times stay good, the more risk they take on, until they've taken on too much. Eventually, they reach a point where the cash generated by their assets no longer is sufficient to pay off the mountains of debt they took on to acquire them. Losses on such speculative assets prompt lenders to call in their loans. "This is likely to lead to a collapse of asset values," Mr. Minsky wrote.

When investors are forced to sell even their less-speculative positions to make good on their loans, markets spiral lower and create a severe demand for cash. At that point, the Minsky moment has arrived.

"We are in the midst of a Minsky moment, bordering on a Minsky meltdown," says Paul McCulley, an economist and fund manager at Pacific Investment Management Co., the world's largest bond-fund manager, in an email exchange.

The housing market is a case in point, says Investment Technology Group Inc. economist Robert Barbera, who first met Mr. Minsky in the late 1980s. When home buyers were expected to have a down payment of 10% or 20% to qualify for a mortgage, and to provide income documentation that showed they'd be able to make payments, there was minimal risk. But as home prices rose, and speculators entered the market, lenders relaxed their guard and began offering loans with no money down and little or no documentation.

Once home prices stalled and, in many of the more-speculative markets, fell, there was a big problem.

"If you're lending to home buyers with 20% down and house prices fall by 2%, so what?" Mr. Barbera says. If most of a lender's portfolio is tied up in loans to buyers who "don't put anything down and house prices fall by 2%, you're bankrupt," he says.

Several money managers are laying claim to spotting the Minsky moment first. "I featured him about 18 months ago," says Jeremy Grantham, chairman of GMO LLC, which manages $150 billion in assets. He pointed to a note in early 2006 when he wrote that investors had become too comfortable that financial markets were safe, and consequently were taking on too much risk, just as Mr. Minsky predicted. "Guinea pigs of the world unite. We have nothing to lose but our shirts," he concluded.

It was Mr. McCulley at Pacific Investment, though, who coined the phrase "Minsky moment" during the Russian debt crisis in 1998.

Laurence Meyer, who served on the faculty with Mr. Minsky at Washington University in St. Louis, was a Federal Reserve Governor during those turbulent times. Mr. Meyer says that when he was an academic, Mr. Minsky's work didn't interest him very much, but that changed when he went into the real world. He says he grew to appreciate it even more when he was at the Fed watching financial crises unfold.

"Had Minsky been there, he probably would have been calling me and alerting me along the ride. And that would have been a good thing," Mr. Meyer says. "Every year that goes by, I appreciate him more. I hear myself sometimes and I think, oh my gosh, I sound like Hy Minsky."

Steven Fazzari, an economics professor at Washington University, says that Mr. Minsky would have supported the Federal Reserve's recent move to provide cash and cut the rate it charges banks on loans from its discount window to try to avert a financial crisis that could spill over to the economy. But he would probably be worried, too, that the moves might be bailing out investors who would all too soon be speculating again.

Having seen recent events unfold in the way his friend and former colleague predicted, Mr. Fazzari says, "I hope he's someplace saying, 'Aha, I told you so!'"

Treasury yields fall more than after 9/11 attacks.

2007-08-20T12:21:00.001-07:00

Treasury Bill Yields Fall Most Since 1987 on Money Fund Demand
By Deborah Finestone and Elizabeth Stanton

Aug. 20 (Bloomberg) -- Yields on U.S. Treasury bills fell the most in two decades on demand for the safest securities amid concern over a widening credit crunch.

Bill yields have fallen five straight days as money market funds dumped asset-backed commercial paper in favor of the shortest-maturity government debt. Three-month yields dropped the most since the stock market crash of 1987 and more than in the wake of the Sept. 11, 2001, terror attacks in the U.S, as funds shunned assets that may be linked to a weakening mortgage market.

``The market is totally, absolutely, completely in fear mode,'' said John Jansen, who sells Treasuries at CastleOak Securities LP in New York. ``People are afraid that lots and lots of mortgage paper and mortgage paper derivatives of all sorts is completely opaque and they can't price it.''

The three-month Treasury bill yield fell 0.82 percentage point to 2.94 percent as of 2:54 p.m. in New York. It's the most since Oct. 20, 1987, when the yield fell 85 basis points, or 0.85 percentage point, on the day the stock market crashed, and eclipses the drop of 39 basis points on Sept. 13, 2001, the day the Treasury market reopened after the attacks. The yield has fallen from 4.69 percent on Aug. 13. The bills yielded about 7 percent in mid-October 1987, and 3.2 percent in the days before the September 2001 attacks.

``The psychotic atmosphere that's gripped the markets recently is still in place,'' said Tony Crescenzi, chief bond market strategist for New York-based Miller Tabak & Co. ``This is quite evident in the way the T-bill market is acting.''

`Get into Treasuries'

The flight to government debt helped the U.S. Treasury sell $21 billion in three-month bills today at a high discount rate of 2.85 percent, the lowest since 2.8 percent on May 16, 2005.

Investors fled even money market funds, considered among the safest instruments, on concern that the funds, which hold $2.5 trillion, have invested in risky collateralized debt obligations backed by subprime mortgage loans.

``We had clients asking to be pulled out of money market funds and wanting to get into Treasuries,'' said Henley Smith, fixed-income manager in New York at Castleton Partners, which oversees about $150 million in bonds. ``People are buying T-bills because you know exactly what's in it.''

The Federal Reserve Bank of New York said in a statement it won't re-invest the $5 billion of Treasury bill holdings maturing on Aug. 23 through its System Open Market Account to give it ``greater flexibility'' to manage reserves. It is the first time the Fed redeemed the Treasury bills since the 2001 terrorist attacks. Crescenzi said the move shows the Fed expects banks to borrow that much at the Fed's discount window.

Job Cuts

Treasuries headed higher earlier after SunTrust Banks Inc., the seventh-largest U.S. bank, said it expects to eliminate 2,400 jobs by the end of next year as part of a plan to cut costs. That may signal the credit crunch in the U.S. will cost jobs and may slow the economy.

The yield on the benchmark two-year note fell 11 basis points to 4.08 percent. The price of the 4 5/8 percent security due in July 2009 rose about 6/32, or $1.88 per $1,000 face amount, to 101.

Investors' focus is turning to ``the amount of job cuts you're going to have from this fallout,'' said Sean Murphy, a Treasury trader and strategist in New York at RBC Capital Markets, the investment-banking arm of Canada's biggest bank.

Slower Economy

More than half of the 21 primary government security dealers that trade with the Fed now expect the central bank to cut its target interest rate by next month from the current level of 5.25 percent.

``The Fed is going to lower the funds rate, it's a question of when,'' said Thomas Tierney, head of U.S. Treasury trading at Citigroup Global Markets Inc. in New York. ``Credit's gotten tighter, and it's going to slow the economy.''

The Fed on Aug. 17 cut the rate it charges banks for direct loans to banks by 0.5 percentage point to 5.75 percent. It was the first reduction in borrowing costs between scheduled meetings since 2001. The central bank said in a statement that risks to the economy have risen ``appreciably.''

The move failed to revive demand for asset-backed commercial paper in Europe. Solent Capital Partners LLP, a London-based credit-fund manager, is seeking to draw on emergency financing after it couldn't borrow in the commercial-paper markets.

``There is a lot to roll over in the commercial paper market and that has people getting nervous,'' said Ian Lyngen, an interest-rate strategist in Greenwich, Connecticut at primary dealer RBS Greenwich Capital.

Interest-rate futures traders see a 100 percent change the fed will lower its overnight lending rate between banks by its next meeting on Sept. 18. Eighty-six percent of those bets are for rates to drop to 4.75 percent, while the balance is for a cut to 5 percent.

To contact the reporters on this story: Deborah Finestone in New York at dfinestone@bloomberg.net ; Elizabeth Stanton in New York at estanton@bloomberg.net

Are we there yet?

2007-08-19T09:17:00.000-07:00

How close are we to a true market dislocation. One that is severe enough to take out large players in the debt/credit pyramid. As I was watching Cramer's "meltdown"/carefully orchestrated demagoguery at the behest of some big credit players to get the attention of public/government, it became obvious that there was some real money being lost by real players. It is rather amusing that Cramer's antics were so widely ridiculed; yet it had the desired effect. Namely, The Fed cut the discount rate. Though largely symbolic, it shifts the bias of the Fed into "easing" mode. Surely cuts in the Fed Funds rate are nigh. Since the Fed is really a private bank with monopolistic currency printing power that is doing the bidding of the big Wall Street Firms/Political elite, rate cuts are a "sure thing". Despite Mr. Poole saying that only a "calamity" would force a rate cut, Goldman Sachs Alpha Fund is down some 25%. This "Star Fund" represents some big money, now taking big losses, and in the eyes of the Fed, this is a calamity. An acquaintance of mine told me that they are starting to serve free lunches at GS, an obvious attempt to soothe their people about their shrinking bonuses this year (no free lunch). NY real estate runs on bonuses, and thus by extension confidence. If there is a large market correction leading to a few thousand pink slips, this will sink the NY Real Estate market like the Bismarck (another unsinkable ship). We are really at the precipice now. If Bernanke keeps FF rates at 5.25%, the tsunami in the credit markets will roll through and take out many players quickly. If he lowers rates (which I believe he will as well as the EUCB), credit party continues for a while, but dollar/euro will get hurt. Yen carry trade probably finally unwinding and thus yen may be the most undervalued asset in the world.

Some more problems for "home builders"

2007-08-12T16:39:00.001-07:00

Missold loans are blow for US builders
By Doug Cameron in Chicago
Published: August 12 2007 18:42 | Last updated: August 12 2007 18:42
US homebuilders are facing a fresh bout of legal and regulatory challenges to their ability to rebound from sluggish demand and the fallout from the subprime loan crisis.

Some of the largest builders have been hit with class-action suits over their lending practices and at least two companies have been surrounded in recent weeks by speculation that they could be forced to file for bankruptcy protection.

The problems deepened after the market close on Friday when Beazer Homes USA said it would delay filing its second-quarter earnings with the Securities and Exchange Commission amid multiple probes into possible accounting irregularities.

The Atlanta-based group is already the subject of federal and civil actions into alleged misselling of home loans after cut-price offers led to a surge in foreclosures in North Carolina. DR Horton, the largest US builder, revealed last week that it had become the latest target of a class-action suit into its selling policies.

Beazer, the subject of a formal investigation by the SEC, said an internal accounting probe revealed possible problems with the recording of “reserves and other accrued liabilities” related to land-development and building costs, which may have deflated expenses.

The announcement came a week after Beazer’s share price slumped by more than 40 per cent in a single day amid speculation it could be forced to file for Chapter 11 protection. Shares in the seventh-largest US builder by revenues have slid by almost 70 per cent so far this year, weighed by the legal uncertainty and the weak demand which has spread through the sector over the past 18 months. Citadel, the hedge fund manager which has already snapped up some distressed subprime lenders, has since taken a 5.7 per cent stake in the group.

Beazer has insisted it does not face a liquidity squeeze, and banks have continued to extend credit, albeit halving the size of its current unsecured line.

Standard Pacific, a California-based builder with exposure to the overheated markets in Phoenix and Florida, was also hit by speculation last week that it could be forced to file for bankruptcy protection. The company said it had reopened talks with banks about easing its lending covenants.

Credit experts said banks were unwilling to push any of the leading builders into liquidation by enforcing the strictest covenants. Banks hope to remain primary lenders when the industry recovers – although this could take well into next year – and are also wary of ending up with a glut of foreclosed home assets at a time when excess inventory is pushing down prices in most parts of the US.

Copyright The Financial Times Limited 2007

Amusing "Educational" Video from EU Central Bank

2007-08-10T16:13:00.000-07:00

I don't know if I should laugh or cry. It reminds me of the nuclear power educational videos you see on The Simpsons. Interestingly, no where in the video is the price of real estate mentioned when they talk about the importance of "price stability".

Central Bank Propoganda

ECB injects more liquidity than after 9/11 attacks.

2007-08-09T18:12:00.001-07:00

Central banks’ aggressive moves stun markets
Published: August 9 2007 19:12 | Last updated: August 9 2007 19:12
The European Central Bank stunned markets on Thursday with its aggressive intervention to quash a brewing liquidity crisis in European financial markets.

The ECB move far exceeded in scale and scope the relatively modest steps taken by the Federal Reserve to sustain adequate liquidity in US markets.

After noting a sharp rise in overnight interest rates to 4.7 per cent – far above the target 4 per cent – the ECB put out a statement in the morning saying it stood “ready to assure orderly conditions in the euro money market”.

Within a couple of hours it acted: taking the unprecedented step of offering a pre-announced unlimited tender so that European banks could get as much cash as they wanted.

The last time it stepped in to provide large-scale liquidity in response to market concerns was in the aftermath of the September 11 terrorist attacks. But even then, it did not offer unlimited support.

Equally striking was the amount of money the 49 banks that took up the tender received: €94.8bn ($129bn). This was far above the €69bn banks took on September 12 and the €40bn the next day. By contrast, the Federal Reserve – which also saw overnight rates move up to above 5.75 per cent, compared with its target rate of 5.25 per cent – took less drastic action to support liquidity.

The New York Fed brought forward by a few minutes its normal daily open market operations, injecting a total of $24bn in overnight and 14 day repos during morning trading.

As of midday in the US, the Fed had not made any public statements.

The scale of US intervention – about twice the average for a normal day – is unusual, but does not suggest that the Fed is in full crisis-fighting mode.

It suggests that the Fed believes US markets are still functioning adequately – albeit in need of some additional liquidity support – rather than in danger of completely seizing up.

Martin Barnes, editor of the Bank Credit Analyst, an economic newsletter, said “We have a real role reversal here.”

The liquidity shortfall in Europe that caused the ECB to act was grounded in fears about US subprime mortgage securities held by European investors. Moreover, the Fed has traditionally been much quicker to ride to the rescue when markets encounter difficulties, with European central bankers adopting a more hands-off approach, concerned not to cause “moral hazard.”

This time, though, the ECB moved to inject unlimited liquidity only two days after the Fed retained its focus on inflation at its August policy meeting.

The stand-out nature of the ECB move was partly driven by the way it interacts with financial markets. Unlike the US Fed, it does not inject or withdraw liquidity every day, but instead conducts what it calls “fine-tuning” every now and then to regulate liquidity – and such actions were not scheduled for some time.

Many analysts applauded the ECB for its decisive action. Erik Nielsen, an economist at Goldman Sachs, said “This is outstanding central banking by the ECB and ought to provide a lot of comfort to the market.”

Bruce Kasman, an economist at JPMorgan, said the move sends two signals: first, that the ECB is “ready to provide liquidity to ensure the smooth operation of European money markets” and second, that for now it is happy doing so at its current interest rate.

However, some central bank officials fretted that the ECB move could cause market participants to worry more than they needed to.

“The aggregate liquidity conditions are usual even if there is a bit of turbulence. But there is the risk that banks may not really have needed this amount of liquidity and that the market therefore reads something into this action that they shouldn’t do,” says one ECB official.

Analysts pondered whether the ECB’s step indicated that there were more serious problems in the European financial system that were not yet public.

Meanwhile, the jury is out on whether the Fed is wise to adopt a relatively sanguine approach, keeping its powder dry for use in the event of a true liquidity crisis – or whether it is dangerously behind the curve and could be soon forced into an embarrassing reversal.

Copyright The Financial Times Limited 2007

Nice Video on Subprime Derivatives

2007-08-05T09:40:00.000-07:00

Subprime Derivatives

Current Market Conditions 07/05/07

2007-07-05T18:06:00.000-07:00

It's difficult to find things to write about because there are so many good blogs out there. But I will continue to periodically update the current market conditions in my corner of Bergen County NJ. As I live in the fall-out zone of Wall Street, prices are still sticky on the way down, however, they are declining modestly. Inventory is up, though not huge. Some houses are at 2003 prices, which is pretty amazing. I don't hear anybody talking about their house as a great "investment". Most people are stuck with the expensive POS they had to buy to live in this area. I still continue to believe it will take a bust on Wall Street to really drop prices in NYC and the fall-out areas of NJ/Westchester. I don't really look forward to it, because I think a lot of people I like will be really hurt. On the other hand, the massive transfer of wealth from savers to borrowers which has transpired over the last 10 years cannot continue. Giving away jobs to China and India in return for low interest rates/high asset prices is no way for a country to do business. "Fat, drunk and stupid is no way to go through life son" - Animal House.

Local Economic/Housing Observations. 5/23/07

2007-05-23T18:00:00.000-07:00

I just wanted to share some of my local housing/economic observations. I was out to dinner on Saturday night, and I noticed the restaurants were not nearly as full as they were last year. I thought it was a little bit strange, since eating out on Saturday night is like a religion in this area. So I started looking for some more signs of economic weakness. I called the hotel I like to stay in on the NJ shore, one that usually needs reservations in January for a summer vacation. Sure enough, they have plenty of rooms available this summer. Granted these are totally unscientific observations, but it still makes one think. Regarding the local housing market, things have not really changed dramatically. Inventory is up, but prices have basically hit a plateau. There is no more euphoria in the market, but there is no panic either. It will take a "market event" to really budge prices. Otherwise, this Chinese water torture of flat to mildy decreasing prices will continue. I am sure it's what the government wants.

More Greenspan Hypocrisy

2007-03-17T11:17:00.000-07:00

Greenspan says jump, Wall Street's peeved
Comments from the former Fed chief still rattle the markets, while many critics say he is contradicting previous statements.
March 16 2007: 6:04 PM EDT

NEW YORK (Reuters) -- Alan Greenspan is causing more of a stir in retirement than he did as Fed chairman, shocking many investors with a radical make-over: irrepressible optimist turned curmudgeonly bear.

Once the darling of Wall Street, many of his old buddies are now souring on Greenspan, seeing tinges of hypocrisy and opportunism in his newfound gloom.

Former Fed Chairman Alan Greenspan has angered many on Wall Street with his recent market-moving opinions.
Video More video

In the past week Bernanke and Greenspan expressed differing opinions on the outlook of the economy. Ali Velshi reports.
Play video
"I'm kind of disappointed with Greenspan," said Andrew Brenner, a market analyst at MAN Financial. "I find it unusual that he's been talking so much."

The Fed has its own March Madness
Making matters worse, his critics contend that many of the troubles facing the U.S. economy - including growing tumult in the housing market - are a direct product of his prolonged policy of rock-bottom interest rates.

His outlook was not always glum. On the contrary, Greenspan always seemed to be looking at the bright side when holding the economy together was part of his job description.

This is what he had to say back in 2005 about the subprime mortgage market, where rising default rates have now sparked concern about a broader economic crisis:

"Lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately," he argued at the height of the housing boom.

With many of those very same lenders now declaring bankruptcy, their efficiency in measuring risk now seems a lot less sturdy - making Greenspan's assessment seem off target.

It's not just housing that has suddenly yanked the former central bank chief off the pedestal where he once stood. For some, the biggest beef comes from his prediction that a U.S. recession was possible this year.

Coming at a difficult juncture for financial markets, his comments contributed to the biggest plunge in U.S. stocks since Sept. 11, 2001, and revived an aversion to risk from which global investors had yet to recover.

Again, this is a departure from statements near the end of his term at the Fed, when he endorsed the theory that growth was likely to slow moderately to a more sustainable pace.

Greenspan: Subprime risk may spread
"Now that he needs material for his $150,000 speeches, is he quoting studies he previously disagreed with?" asked Jim Bianco, president of research firm Bianco Research.

Pressed on the issue at a New York conference last week, Greenspan said he was surprised by the market's reaction, adding that he would like to continue making economic predictions now that he is no longer in public office.

Some analysts have also defended his right to express whatever views he pleases.

"It's not so much that Wall Street didn't like that Greenspan spoke, but that some people didn't like what he had to say," said Marc Chandler, senior currency strategist at Brown Brothers Harriman in New York.

"But should we say everyone has freedom of speech except former chairmen of the central bank?"

Loose-lipped Al
His detractors say freedom of speech is not the issue. They argue that public accountability and conflict of interest are the more important matters at hand.

Part of the discontent comes from the mere quantity of Greenspan's statements, which seem to be more plentiful than those of Ben Bernanke, his successor at the Fed.

The fact that these appearances have come as the markets are on a roller-coaster ride and as Bernanke is faced with difficult decisions about the course of monetary policy, only makes Greenspan's constant chatter more problematic.

Ironically, his latest remarks were filled with concern that the subprime mortgage meltdown could spread to other parts of the economy. That is a far cry from the days when he used terms like "creative" and "responsible" to describe the industry.

In part, Greenspan may be making a comeback because he simply missed the attention.

"This last speech suggested he kind of liked the limelight," said Mike Englund, chief economist at Action Economics.

But to the extent that Greenspan's words affect the markets, potentially making it tougher for the central bank to keep the economy humming along, his loose lips could be detrimental to the country.

Or as Brenner at MAN Financial, put it: "He's setting a very bad precedent."

Local Housing Market 3/16/07

2007-03-16T16:39:00.000-07:00

Despite all the bad news in the media regarding the problems with subprime mortgages, prices in bergen county remain high. The one exception being high end homes, where prices have definitely taken a hit. I believe prices have remained high because we are in the fall-out area of Wall Street money. The "talk" has definitely changed. Previously bullish people are definitely concerned about housing prices. We will see if the subprime defaults lead to a "contagion" in the rest of the credit markets. I still can not believe that the Fed will not lower rates if prices start falling significantly. Time will tell!

Predictions for 2007

2006-12-16T18:47:00.000-08:00

I have thought about this for some time now. Overall, the housing market has not behaved like I thought it would. It didn't "implode" like a lot of super bears predicted it might. Certainly, the market became tighter with the supply demand dynamic shifting slightly more in the buyers favor. However, prices are still very high and interest rates are still very low, though not rock bottom. Bill Gross of PIMCO recently said that he believes that the Fed will lower rates by 1% next year to soften the blow of the slowing real estate market. It's hard to argue with Mr. Gross. Furthermore, if England real estate market is any indication (it is supposed to be 6-12 month ahead of our market), then the US market is in for a rebound of some sorts. We have obviously reached a limit in terms of prices at these interest rates and incomes. But, the "animal spirits" could still be further released by interest rates cuts. So my predictions are as follows: The Fed will lower interest rates by about 0.5% in 2007. Prices will stabilize, as will inventories, and all the bulls will come out of hiding again. Price averages for 2007 will be about neutral to slightly positive compared to 2006. All this assumes that there won't be the "fat tail" rare event that will completely destablize capital markets. Then, all bets are off! It is obvious that high real estate prices are of national security intertest, because if prices colapse, the whole deck of cards that is the U.S. economy will go down with it. Therefore, it is logical to conclude that the government will do everything in it's power to keep prices relatively stable, even if this screws millions of people. Because, they would argue, it's in our national best interests. Time will tell.

Geenspan's Legacy?

2006-11-20T17:11:00.000-08:00

By Caroline Baum

Nov. 20 (Bloomberg) -- Alan Greenspan didn't go quietly from the global stage when he retired as chairman of the Federal Reserve in January. His speeches are still widely reported, his economic views and forecasts instantly disseminated.

It would probably be better if they weren't.

His latest ``forecast'' -- that the worst of the housing slump is over -- was rudely challenged Friday when the Commerce Department said October housing starts plunged 14.6 percent from the prior month to a six-year low. Starts were down 27.4 percent in October from a year earlier; single-family starts have fallen by more than a third since the start of the year. Housing permits declined for the ninth consecutive month, a record.

Having presided over the late 1990s stock-market bubble, and having cut interest rates aggressively to clean up the mess when it burst, Greenspan has a vested interest in the health of the housing market. If the residential real-estate boom ends badly, as all bubbles do, he could go down in history as a ``DBCB,'' or double-bubble central banker.

No wonder Greenspan is laying out a new framework for analyzing the once-soaring property market. In a speech to a private group in Canada last month, Greenspan said the housing boom wasn't a response to the ``1 percent fed funds rate or from the Fed's easing. It came from the collapse of the Berlin Wall.''

Let's just say it's good he's writing his own life story. His economic theories might not stand up under objective analysis.

Guilty as Charged

As for his legacy, the early assessment of Greenspan's role in recent asset bubbles isn't exactly exculpatory, according to economists who participated in the Cato Institute's 24th Annual Monetary Conference, ``Federal Reserve Policy in the Face of Crises,'' on Nov. 16.

``Among the consequences of the policy of maintaining interest rates at an inappropriate low level were credit and mortgage-market distortions, discouragement of personal savings, incipient inflation, and depreciation of the dollar foreign exchange rate,'' said economist Anna Schwartz.

Schwartz, who co-authored ``A Monetary History of the United States, 1867-1960,'' with the late Nobel Laureate Milton Friedman, was referring to the Fed's decision to leave the funds rate at 1 percent from July 2003 to June 2004, ``a policy unjustified in view of the economy's growth rate,'' and to raise it ever so slowly during the next two years.

Had the Fed been forward looking, it would have heeded the signs from leading indicators -- the yield curve was steep and getting steeper -- which had turned a solid green. Instead, policy markers were fretting over deflation, or a decline in the price level, just as the economy was taking off.

History Repeats

It makes you wonder if the Fed's harping on inflation risks right now won't, in retrospect, seem equally misplaced.

On the subject of the Fed's timing at turning points, don't forget policy makers had a bias to raise rates in November 2000, a quarter sandwiched between two in which the economy contracted. The Nasdaq Composite Index was already down 40 percent from its March high. I can only imagine the discussion at the time -- something like: ``The effects of such a huge loss of wealth are likely to be contained.'' (Sound familiar?)

Needless to say, no one at the Cato conference concurred with Greenspan's Fallen Walls Doctrine as the reason for the speculative housing boom over the last five years. Most of them advocated a do-nothing policy for the Fed in the face of fiscal crises, but as Harvard University's Jeffrey Frankel admitted, ``there are no libertarians in crises.''

Nothing makes a central banker -- even the most ardent Ayn Rand advocate like Greenspan -- hit the ``print money'' button as quickly as the hint of ``systemic risk.''

Overreaction

``Did the Greenspan Fed err by providing too much liquidity in 2001-2004?'' Frankel said. ``My answer is `probably yes.' I await Woodward's customary follow-up book.'' (Perhaps ``Plan of Attack'' is to ``State of Denial'' as ``Maestro'' is to ``Rookie?'')

Cato Chairman William Niskanen was no more complimentary of Greenspan's crisis management (no mention of risk management).

``Ben Bernanke's next major challenge will be to avoid the recession that may be a consequence of deflating the demand bubble that he inherited from Alan Greenspan,'' Niskanen said. The record of the past 20 years suggests the Fed's overreaction to financial crises raises the probability of recession, imposing a ``long-term cost'' on the economy.

The fourth panelist to address the role of the Fed in financial crises was St. Louis Fed President Bill Poole, who advocated prevention as the best medicine. By promoting ``price stability and general macroeconomic stability,'' the Fed can ``reduce the likelihood of conditions that would be conducive to financial instability,'' he said.

Big Question Mark

Poole, who has been on the Fed's policy-setting open market committee since 1998, obviously had nothing to say on the subject of Greenspan's legacy.

Legacies come in all shapes and sizes. Public servants would like to be remembered for their own good deeds, as well as their contribution to the institution they serve.

On the latter count, Greenspan comes up way short, according to Lawrence Wright, professor of economic history at the University of Missouri, St. Louis.

``At his confirmation hearing, Ben Bernanke told the Senate Banking Committee: `With respect to monetary policy, I will make continuity with the policies and policy strategies of the Greenspan Fed a top priority,''' Wright said. ``No doubt Bernanke meant to reassure us. Unfortunately, we never knew what Greenspan's policy strategy was.''

With each passing day, it's becoming increasingly clear.

(Commentary. 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 .

Helicopter Ben not interested in money supply! (Financial Times)

2006-11-10T18:42:00.000-08:00

Trichet and Bernanke differ on strategy
By Ralph Atkins in Frankfurt
Published: November 10 2006 18:44 | Last updated: November 10 2006 18:44
Transatlantic differences over monetary strategy erupted into the open on Friday as the European Central Bank sought to modernise its policy of relying on money supply measures as an inflation early-warning system.

Jean-Claude Trichet, ECB president, used a Frankfurt conference to stress the importance of indicators such as M3, the broad money supply measure.

But in contrast, Ben Bernanke, US Federal Reserve chairman, said a heavy reliance on money supply measures “would seem to be unwise in the US context,” although money growth data might still offer important signals about future economic developments.

Mr Trichet refused to comment on whether differences between the US and European economies justified a different approach to the use of money supply data. But he acknowledged the need for monetary analysis to become more sophisticated, taking into account financial innovation.

Lucas Papademos, ECB vice-president, signalled that at least some on the bank’s governing council would like to merge the monetary component and the ECB’s more general economic analysis into a single “fat pillar” of analysis and revealed that preliminary work that could lead to such a project was already under way at the ECB. “But this will be a larger pillar in which money will continue to play a prominent role in guiding our monetary policy decision making,” he said.

The ECB’s “monetary pillar,” largely inherited from Germany’s Bundesbank, is controversial among economists because of confusion about the implications of money supply for inflation. At the ECB-hosted conference, prominent officials from the Frankfurt institution made clear that they saw significant scope for refinements. Recent fast growth in M3 and in credit figures has encouraged speculation that the ECB will continue lifting interest rates further in 2007, after an expected quarter percentage point rise in its main rate to 3.5 per cent in December, even though inflation is currently within the central bank’s definition of price stability – a rate “below but close” to 2 per cent.

ECB research presented at the conference was open about the shortcomings of the bank’s monetary analysis in its eight-year history.

Mr Trichet said the monetary analysis had been instrumental in the ECB’s decision to start raising interest rates in December 2005. At the time many economists and politicians feared its actions were premature given the uncertainties then about the eurozone’s economic outlook. “Without our thorough monetary analysis, we could have been in danger of falling behind the curve,” he said.

Mr Bernanke pointed to larger methodological problems in the US. “The rapid pace of financial innovation in the US has been an important reason for the instability of the relationships between monetary aggregates and other macroeconomic variables.”

Changes in payment technologies and individuals’ behaviour had meant usage of different kinds of accounts “have at times shifted rapidly and unpredictably”.

America the Broke!

2006-10-28T20:04:00.000-07:00

By MATT CRENSON, AP National Writer Sat Oct 28, 6:54 PM ET
AUSTIN, Texas - David M. Walker sure talks like he's running for office. "This is about the future of our country, our kids and grandkids," the comptroller general of the United States warns a packed hall at Austin's historic Driskill Hotel. "We the people have to rise up to make sure things get changed."

But Walker doesn't want, or need, your vote this November. He already has a job as head of the Government Accountability Office, an investigative arm of Congress that audits and evaluates the performance of the federal government.

Basically, that makes Walker the nation's accountant-in-chief. And the accountant-in-chief's professional opinion is that the American public needs to tell Washington it's time to steer the nation off the path to financial ruin.

From the hustings and the airwaves this campaign season, America's political class can be heard debating Capitol Hill sex scandals, the wisdom of the war in Iraq and which party is tougher on terror. Democrats and Republicans talk of cutting taxes to make life easier for the American people.

What they don't talk about is a dirty little secret everyone in Washington knows, or at least should. The vast majority of economists and budget analysts agree: The ship of state is on a disastrous course, and will founder on the reefs of economic disaster if nothing is done to correct it.

There's a good reason politicians don't like to talk about the nation's long-term fiscal prospects. The subject is short on political theatrics and long on complicated economics, scary graphs and very big numbers. It reveals serious problems and offers no easy solutions. Anybody who wanted to deal with it seriously would have to talk about raising taxes and cutting benefits, nasty nostrums that might doom any candidate who prescribed them.

"There's no sexiness to it," laments Leita Hart-Fanta, an accountant who has just heard Walker's pitch. She suggests recruiting a trusted celebrity — maybe Oprah — to sell fiscal responsibility to the American people.

Walker doesn't want to make balancing the federal government's books sexy — he just wants to make it politically palatable. He has committed to touring the nation through the 2008 elections, talking to anybody who will listen about the fiscal black hole Washington has dug itself, the "demographic tsunami" that will come when the baby boom generation begins retiring and the recklessness of borrowing money from foreign lenders to pay for the operation of the U.S. government.

"He can speak forthrightly and independently because his job is not in jeopardy if he tells the truth," said Isabel V. Sawhill, a senior fellow in economic studies at the Brookings Institution.

Walker can talk in public about the nation's impending fiscal crisis because he has one of the most secure jobs in Washington. As comptroller general of the United States — basically, the government's chief accountant — he is serving a 15-year term that runs through 2013.

This year Walker has spoken to the Union League Club of Chicago and the Rotary Club of Atlanta, the Sons of the American Revolution and the World Future Society. But the backbone of his campaign has been the Fiscal Wake-up Tour, a traveling roadshow of economists and budget analysts who share Walker's concern for the nation's budgetary future.

"You can't solve a problem until the majority of the people believe you have a problem that needs to be solved," Walker says.

Polls suggest that Americans have only a vague sense of their government's long-term fiscal prospects. When pollsters ask Americans to name the most important problem facing America today — as a CBS News/New York Times poll of 1,131 Americans did in September — issues such as the war in Iraq, terrorism, jobs and the economy are most frequently mentioned. The deficit doesn't even crack the top 10.

Yet on the rare occasions that pollsters ask directly about the deficit, at least some people appear to recognize it as a problem. In a survey of 807 Americans last year by the Pew Center for the People and the Press, 42 percent of respondents said reducing the deficit should be a top priority; another 38 percent said it was important but a lower priority.

So the majority of the public appears to agree with Walker that the deficit is a serious problem, but only when they're made to think about it. Walker's challenge is to get people not just to think about it, but to pressure politicians to make the hard choices that are needed to keep the situation from spiraling out of control.

To show that the looming fiscal crisis is not a partisan issue, he brings along economists and budget analysts from across the political spectrum. In Austin, he's accompanied by Diane Lim Rogers, a liberal economist from the Brookings Institution, and Alison Acosta Fraser, director of the Roe Institute for Economic Policy Studies at the Heritage Foundation, a conservative think tank.

"We all agree on what the choices are and what the numbers are," Fraser says.

Their basic message is this: If the United States government conducts business as usual over the next few decades, a national debt that is already $8.5 trillion could reach $46 trillion or more, adjusted for inflation. That's almost as much as the total net worth of every person in America — Bill Gates, Warren Buffett and those Google guys included.

A hole that big could paralyze the U.S. economy; according to some projections, just the interest payments on a debt that big would be as much as all the taxes the government collects today.

And every year that nothing is done about it, Walker says, the problem grows by $2 trillion to $3 trillion.

People who remember Ross Perot's rants in the 1992 presidential election may think of the federal debt as a problem of the past. But it never really went away after Perot made it an issue, it only took a breather. The federal government actually produced a surplus for a few years during the 1990s, thanks to a booming economy and fiscal restraint imposed by laws that were passed early in the decade. And though the federal debt has grown in dollar terms since 2001, it hasn't grown dramatically relative to the size of the economy.

But that's about to change, thanks to the country's three big entitlement programs — Social Security, Medicaid and especially Medicare. Medicaid and Medicare have grown progressively more expensive as the cost of health care has dramatically outpaced inflation over the past 30 years, a trend that is expected to continue for at least another decade or two.

And with the first baby boomers becoming eligible for Social Security in 2008 and for Medicare in 2011, the expenses of those two programs are about to increase dramatically due to demographic pressures. People are also living longer, which makes any program that provides benefits to retirees more expensive.

Medicare already costs four times as much as it did in 1970, measured as a percentage of the nation's gross domestic product. It currently comprises 13 percent of federal spending; by 2030, the Congressional Budget Office projects it will consume nearly a quarter of the budget.

Economists Jagadeesh Gokhale of the American Enterprise Institute and Kent Smetters of the University of Pennsylvania have an even scarier way of looking at Medicare. Their method calculates the program's long-term fiscal shortfall — the annual difference between its dedicated revenues and costs — over time.

By 2030 they calculate Medicare will be about $5 trillion in the hole, measured in 2004 dollars. By 2080, the fiscal imbalance will have risen to $25 trillion. And when you project the gap out to an infinite time horizon, it reaches $60 trillion.

Medicare so dominates the nation's fiscal future that some economists believe health care reform, rather than budget measures, is the best way to attack the problem.

"Obviously health care is a mess," says Dean Baker, a liberal economist at the Center for Economic and Policy Research, a Washington think tank. "No one's been willing to touch it, but that's what I see as front and center."

Social Security is a much less serious problem. The program currently pays for itself with a 12.4 percent payroll tax, and even produces a surplus that the government raids every year to pay other bills. But Social Security will begin to run deficits during the next century, and ultimately would need an infusion of $8 trillion if the government planned to keep its promises to every beneficiary.

Calculations by Boston University economist Lawrence Kotlikoff indicate that closing those gaps — $8 trillion for Social Security, many times that for Medicare — and paying off the existing deficit would require either an immediate doubling of personal and corporate income taxes, a two-thirds cut in Social Security and Medicare benefits, or some combination of the two.

Why is America so fiscally unprepared for the next century? Like many of its citizens, the United States has spent the last few years racking up debt instead of saving for the future. Foreign lenders — primarily the central banks of China, Japan and other big U.S. trading partners — have been eager to lend the government money at low interest rates, making the current $8.5-trillion deficit about as painful as a big balance on a zero-percent credit card.

In her part of the fiscal wake-up tour presentation, Rogers tries to explain why that's a bad thing. For one thing, even when rates are low a bigger deficit means a greater portion of each tax dollar goes to interest payments rather than useful programs. And because foreigners now hold so much of the federal government's debt, those interest payments increasingly go overseas rather than to U.S. investors.

More serious is the possibility that foreign lenders might lose their enthusiasm for lending money to the United States. Because treasury bills are sold at auction, that would mean paying higher interest rates in the future. And it wouldn't just be the government's problem. All interest rates would rise, making mortgages, car payments and student loans costlier, too.

A modest rise in interest rates wouldn't necessarily be a bad thing, Rogers said. America's consumers have as much of a borrowing problem as their government does, so higher rates could moderate overconsumption and encourage consumer saving. But a big jump in interest rates could cause economic catastrophe. Some economists even predict the government would resort to printing money to pay off its debt, a risky strategy that could lead to runaway inflation.

Macroeconomic meltdown is probably preventable, says Anjan Thakor, a professor of finance at Washington University in St. Louis. But to keep it at bay, he said, the government is essentially going to have to renegotiate some of the promises it has made to its citizens, probably by some combination of tax increases and benefit cuts.

But there's no way to avoid what Rogers considers the worst result of racking up a big deficit — the outrage of making our children and grandchildren repay the debts of their elders.

"It's an unfair burden for future generations," she says.

You'd think young people would be riled up over this issue, since they're the ones who will foot the bill when they're out in the working world. But students take more interest in issues like the Iraq war and gay marriage than the federal government's finances, says Emma Vernon, a member of the University of Texas Young Democrats.

"It's not something that can fire people up," she says.

The current political climate doesn't help. Washington tends to keep its fiscal house in better order when one party controls Congress and the other is in the White House, says Sawhill.

"It's kind of a paradoxical result. Your commonsense logic would tell you if one party is in control of everything they should be able to take action," Sawhill says.

But the last six years of Republican rule have produced tax cuts, record spending increases and a Medicare prescription drug plan that has been widely criticized as fiscally unsound. When President Clinton faced a Republican Congress during the 1990s, spending limits and other legislative tools helped produce a surplus.

So maybe a solution is at hand.

"We're likely to have at least partially divided government again," Sawhill said, referring to predictions that the Democrats will capture the House, and possibly the Senate, in next month's elections.

But Walker isn't optimistic that the government will be able to tackle its fiscal challenges so soon.

"Realistically what we hope to accomplish through the fiscal wake-up tour is ensure that any serious candidate for the presidency in 2008 will be forced to deal with the issue," he says. "The best we're going to get in the next couple of years is to slow the bleeding."

Alarm bells are ringing.

2006-10-03T15:58:00.000-07:00

By MARTIN CRUTSINGER, AP Economics Writer
WASHINGTON - Housing prices, slumping after a five-year boom, are projected to decline in more than 100 of the nation's metropolitan areas, with the Northeast, Florida and California among the areas hardest hit.

The forecast by Moody's Economy.com, a private research firm, presents one of the starkest views yet of the housing slowdown that has been gathering force in recent months.

The West Chester, Pa., forecasting firm projects that the median sales price for an existing home will decline in 2007 by 3.6 percent, which would be the first decline for an entire year in home prices since the Great Depression of the 1930s.

The forecast is included in a 195-page report, "Housing at the Tipping Point," which The Associated Press obtained before its general release on Wednesday.

The report projected that 133 of the nation's 379 metropolitan areas would suffer price declines. Those metropolitan areas with declining prices account for nearly one-half of the value of the nation's stock of single-family homes.

The price declines represent quite a contrast from the past five years when low mortgage rates pushed sales to five consecutive annual records and prices in the hottest sales areas skyrocketed.

But this year, the once red-hot housing market has cooled significantly. Some analysts are worried that the slowdown could become so severe that it could drag the entire country into a recession, much as the bursting of the stock market bubble in 2000 led to the 2001 slump.

The housing report said the biggest percentage price decline will be in Danville, Ill., where prices have already fallen by 18.7 percent from the peak in the second quarter of 2005 to a low-point in the first three months of this year. That setback occurred because of layoffs in autos and other manufacturing industries, which depressed the local economy.

The second biggest decline is projected to occur in the Fort Myers, Fla., area, a fall of 18.6 percent from the peak in the final three months of last year to a low-point for prices that is projected to occur in the second quarter of 2007.

The 133 areas with slumping prices are concentrated in the states of California and Florida and the Northeast corridor from southern Maine to just south of Washington, D.C., as well as boom areas of Nevada and Arizona and some depressed sections of the Midwest such as Detroit.

Of the areas with falling prices, 73 were forecast to hit their low point by the end of this year with the rest seeing a trough for prices in 2007 or later.

But even in areas which have already hit a low point, the rebound in prices is not expected to occur quickly.

"Prices are going to go down and stay down for awhile. It will take at least a couple of years to work off the excesses of the last decade," said Mark Zandi, chief economist at Moody's Economy.com and the principal author of the report.

Not all parts of the country will experience price declines. The report said Texas, the Southeastern states other than Florida and much of the Midwest Farm Belt should be immune from price declines.

It projected that annual price gains over the next two years would average 4.2 percent in the Dallas area, 3.3 percent in the Charlotte, N.C., area and 3 percent in the Columbus, Ohio, area.

The report said the most vulnerable areas for price declines were those regions where red-hot markets attracted speculators known as "flippers" who purchased homes in hopes of selling them fast for a quick profit.

"Housing's downturn has turned even more dramatic with the rapid flight of the flipper from the market," the report said. "These investors have gone from sending home sales and prices shooting higher to driving sales and prices lower."

The report described the current environment as a "correction" and not a "crash," but it cautioned that there were downside risks that could make the slowdown more serious.

A big threat is that the fall in home prices could have a significant impact on consumer spending patterns. The so-called wealth effect pushed consumer spending higher during the housing boom as soaring home prices made homeowners feel more wealthy and thus more inclined to spend money. But falling home prices could have the reverse effect and depress consumer spending.

"We believe the housing downturn will weigh on the economic expansion but will not break it. But there are risks," Zandi said.

The slowdown in housing occurred as a result of a two-year campaign by the Federal Reserve to push interest rates higher as a way of slowing the economy enough to keep inflation under control.

The Fed has kept rates unchanged for the past two months and many economists believe the central bank has finished its rate hikes as long as inflation pressures keep falling.

The belief that the current economic slowdown is restraining inflation has helped push mortgage rates lower with the 30-year mortgage now at a six-month low of 6.31 percent, an improvement that is expected to help put a floor on housing's fall.

Is disaster brewing?

2006-09-22T10:08:00.000-07:00

One can only wonder what the outcome of this stupid housing bubble will be. It felt so good for the bulls and cheerleaders from 2003-2005. But things seem to be turning rapidly. Inventory in my part of Bergen County has skyrocketed, as many refuse to face the new reality of falling prices. If one was to use a Biblical allegory, I am not sure if it is the story of Noah or the story of Joseph. Do we have and Ark sufficiently large to ride out this storm? Have we prepared in times of plenty for times of famine? I am affraid that we may not be prepared for the ensuing difficulties. All of our credit cards are maxed out, we financed our over priced homes with Arms, or worse, and we have no net national savings. When hard times hit, as they alway do, what will happen? I see a lot of pain ahead for all. I pray we can get through it.

Current state of affairs.

2006-09-14T17:05:00.000-07:00

It's obvious that the housing bubble is slowly deflating. Record inventories on top of increased, though historically low, interest rates have spelled doom for the market. The only real question is to what degree prices will fall and over what length of time. I am sure that all the mandarins at the fed are closerly monitoring the situation. It seem somewhat surreal that our government is so obsessed with real estate prices, but I suppose it is just the zeitgist of the times. Legacy to Big Al. It's obviously impossible to predict the amount of housing deflation that will occur. Predictions range from no absolute losses to 50-60% in some "hot" areas. There are just too many variables, as well as unforseen events to make an accurate prediction, in my opinion. I am going with a middle of the road 20-30% absolute reduction in prices. I am not a big fan of high real estate prices. I think it's bad for business as well as for families. It's obviously been a disaster in terms of net national savings and personal debt loads. I am just hoping for an "orderly" adjustment. i.e. no bread/soup lines or mass unemployment. I look forward to the day to when this country can back to the business of business.

Some honesty, and wishful thinking, from Glenn Hubbard.

2006-08-27T18:51:00.000-07:00

Fed helped fuel own inflation headache: Hubbard
White House's former top economic adviser calls high inflation 'a present danger' to the U.S. economy.
August 26 2006: 3:49 PM EDT

JACKSON HOLE, Wyo. (Reuters) -- The Federal Reserve must act to head off high inflation that is "a present danger" to the U.S. economy, the White House's former top economic adviser said on Saturday, as he blamed the central bank for failing to act aggressively enough so far.

Glenn Hubbard, now dean of Columbia University's Graduate School of Business, said the threat of high inflation partly reflects the central bank's leisurely two-year string of "measured" rate increases.

"I do believe policy had been too accommodative for too long. And now the question is, How do we deal with the current situation?" Hubbard told Reuters on the sidelines of the Kansas City Fed's annual Jackson Hole retreat.

Hubbard was chairman of President George W. Bush's Council of Economic Advisers from 2001 to 2003. He was mentioned as a candidate to replace Alan Greenspan as Fed chairman, the job ultimately given to Ben Bernanke.

The policy-setting Federal Open Market Committee used 17 consecutive one-quarter percentage point rate hikes between June 2004 and June 2006 to raise benchmark interest rates to the current 5.25 percent from a low of 1 percent.

The U.S. central bank, under Bernanke's leadership since February, "still has enormous credibility with the public," which is helping to keep inflation expectations contained, Hubbard said.

But at this point, with economic growth being cut by a turndown in the housing market and the spillover effects of high energy prices, the Fed's job has become harder, he said.

"It is easier to tighten into strength than it is to tighten into weakness when you had a policy that was that accommodative," Hubbard said.

"It is a very difficult moment for the Fed to achieve both the desired fall in inflation and the soft landing in the real economy at the same time. It's easy to do one or the other; it's a little more difficult to do both."

Hubbard said the U.S. economy faced head winds from housing and energy, but seemed poised for a "soft landing" after years of solid growth.

"I still expect the economy to be able to grow in the 2.5 to possibly the 3 percent range by the time we get into next year," he said.

One risk to that outlook would be weakness in the capital goods sector at a time business spending has been seen as likely to pick up the slack as consumer spending softens, Hubbard said.

Something more certain is there likely will be limited relief from high energy prices, he said, because of strong growth in large emerging economies, decent growth in the United States and other industrial economies, and supply restrictions in many parts of the world.

"It's hard to see a lot of weakness in energy prices over the next year."

The Debt Generation! (Press of Atlantic City)

2006-08-27T14:58:00.000-07:00

Debtors on Borrowed Time
By JOHN FROONJIAN Special Reports Unit, (609) 272-7273
Published: Tuesday, August 22, 2006
Debt is becoming the American way of life.

Forty years ago, hardly anyone had charge cards. Mortgages financed homes, not vacations. Today, we borrow to buy groceries and fill our tanks. We borrow to go to college, to eat at McDonald's, to run our government. Credit offers clog our mailboxes. One credit industry estimate says there are four credit cards in circulation for every American. The average U.S. household has more than 11.

Average credit card debt has more than doubled since 1994. Consumer debt is at a record $2.2 trillion - not including home mortgages. Last year, Americans spent more than they took home. That had not happened since the Great Depression.

People are over-extended at a time of rising interest rates and incomes falling behind the cost of living. Bankruptcy lawyers, analysts and credit counselors are seeing more families in credit trouble. And they believe a lot more are going to get hurt.

Some people are borrowing to make ends meet. Russell Graves, who runs Consumer Credit and Budget Counseling in Marmora, Cape May County, said more low- to middle-income families are calling for help.

But increasingly, credit is financing a high lifestyle: luxury cars, mammoth SUVs, plasma TVs and ever-larger houses. Baby boomers want it all. They see credit as a way to have it.
Bill Wenz, 73, a Galloway Township retiree, winces when he hears what his grown children pay on their mortgages. After marrying in 1953, he and his wife lived in an attic apartment in Norfolk, Va. - "Oh, it was so hot," he recalled - until they could afford a down payment on a home.
"This generation wants everything right away: the house, the car, the air conditioning," he said.
Jeanette Gmitter, of Consumer Credit Counseling Service of South Jersey, remembered one client who had $80,000 of debt. "He said to me, 'Doesn't everybody?'"
In "Hamlet," Shakespeare's Lord Polonius said, "Neither a borrower nor a lender be." Today's consumer philosophy is closer to the 1980s bumper sticker: "He who dies with the most toys wins." Polonius would be laughed out of the home electronics superstore.
Money marketing
The credit card come-ons arrive in bulk at the Camden County mail processing plant. The envelopes, crammed into plastic and cardboard trays, stack 6 feet high on pallets carried by forklifts. Postal workers deliver the credit-card applications across southern New Jersey. Often the shipments arrive twice in a day.
"The banks and companies send them out thousands at a time," said Michael Behringer, a Post Office spokesman.
Nationwide, 5 billion applications went out last year. Many households receive several per week, along with mortgage refinancing and other credit offers. The mailings are so pervasive, even the son of an aide to U.S. Sen. Robert Menendez, D-N.J., received a credit card offer. The child is 2.
Eric Clayman, a bankruptcy attorney with offices in Atlantic City, marvels at the sophisticated marketing used by companies.
You're a bowler? Apply for the Bowling Platinum Mastercard. You like Philadelphia football? Show your true colors by using the Eagles Extra Points card. There are specialty cards for movie buffs, e-Bay users, L.L. Bean customers.
"These cards line up with your interests, your sports team, your favorite hobby," Clayman said. "The companies push that more than they explain what 19.9 percent compounded interest does."
Clayman has seen the effects of debt: bankruptcies, lost homes, emotional stress. His firm, Clayman and Jenkins, handles more bankruptcy cases than most others in New Jersey - a state where bankruptcies have soared 80 percent over the last decade. Nearly 50,000 were filed in the state last year.
"I've had a couple clients with $200,000 in credit card debt. And they have not accumulated a lot of assets," Clayman said.
How does that happen?
Clayman and Gmitter said problems start when people make only the minimum payment required on their bills. Almost all of their debt carries over, and they are charged interest on it. If they make only minimum payments for a while, they pay interest on that interest. They make little headway on the original charge and end up paying more than twice as much in interest. If the person keeps charging new items, the debt only grows.
But it gets worse.
If a payment is missed or late, an extra fee is charged. And the company raises the interest rate, sometimes as high as 30 percent.
But it gets worse.
A company might raise your interest rate even if you pay on time but miss a payment on a different credit card.
"It's called universal default," Gmitter said. "You can fall behind on one card. If another company pulls your credit report and sees that, they feel they can raise their interest rate.
"It starts a downward spiral," she said.
Nobody wants to talk about his or her failed finances. Debt may be the last bastion of shame in America. Counselors and lawyers asked numerous clients to be interviewed for this story. All refused. But credit-card horror stories fill Internet message boards, where the indebted can commiserate anonymously.
One woman on the Shopping Addicts Support board confessed: "While I make reasonably good money, I have absolutely no savings at all. In fact, I have accrued over $100,000 in debt in credit cards and school loans, from small purchases (in) $200-$300 shopping sprees."
"Jeni" said she opened credit accounts behind her husband's back. She charged $40,000 within three years.
Her problem with credit cards, she wrote, was that "when I would use them, I would not think of that as actually spending money. For some reason in my head, I couldn't relate that I would have to eventually pay that money back."
Cardweb.com, a credit-card industry Web site, says average debt per card-holding household more than doubled from $4,300 in 1994 to $9,300 in 2004. Most families' debt is much lower, the Federal Reserve says. But that high average suggests the families who do get into trouble are carrying huge debt.
And debt of only $2,000 to $3,000 can still hurt low- and middle-income families. Their debt is increasing; it grew 10 percent from 2001 to 2004. Meanwhile, median income declined 1 percent when adjusted for inflation during those years. Add soaring fuel prices to the mix, and it's no wonder Gmitter sees counseling clients come in frantic over debts of $3,000.
New federal rules require cardholders to pay at least 1 percent of their debt principal each month. The result: higher minimum payments.
"That requirement has caused a lot of people to pick up the phone and say, 'Help!'" said Graves of the Marmora counseling agency.
"Just in the last month, I've gotten more calls asking about bankruptcy," Atlantic City attorney Edward Thompson said. "People can't afford to pay their minimums."
Gmitter's counseling agency, with offices in Egg Harbor Township and Absecon, negotiates with lenders to lower interest rates and helps debtors create payment plans.
Clayman said credit card debts could be wiped out if a debtor declares bankruptcy. Record numbers of bankruptcies were filed last year. Debtors rushed to beat a new federal law that made it tougher to wipe out such debt.
But some homeowners can't escape credit card debt because they have turned it into mortgage debt. They took out home equity loans to pay off creditors. That's happened a lot. Nearly one-third of equity loans in 2004 went to pay off debt, according to the Federal Reserve.
Shifting credit debt to mortgage payments usually lowers the interest rate. It allows interest to be deducted on income tax returns. Still, draining equity out of a family's main asset may be a sign of credit problems. It's especially troubling if a family runs up its credit cards again.
Clayman and other attorneys say there are fewer bankruptcies when housing prices are high and interest rates are low. Higher equity helps manage debt.
Unfortunately, the lawyers look at mortgage and interest trends, and predict that more families' finances are living on borrowed time.
Home sweet home
Some buyers could not afford a big down payment in the roaring housing market of recent years. The mortgage industry created no-equity loans. The buyer keeps payments low by paying only interest until he sells the house at a profit. Some buyers took loans with "negative equity." They borrowed more than the house is worth.
Lenders also provided adjustable-rate mortgages, which start with a low interest rate that changes according to market trends. Seventeen percent of adjustable mortgages sold in 2004 and 2005 offered a starter rate of 2 percent or less.
Two problems have developed. Housing prices have started declining. And the Federal Reserve keeps raising interest rates to fight inflation.
Higher interest rates will affect millions of adjustable-rate mortgages. Rates are expected to increase on a quarter of all outstanding U.S. mortgages either this year or next, according to Economy.com.
Many recent buyers' adjustable mortgage payments could double.
Christopher Cagan, research director for First American Real Estate Solutions, studied the possible impact of rising interest rates. An increase from 1 percent to a 6 percent market rate could rocket a monthly payment from $965 to $1,800.
Even if it took a few years for rates to rise that high, Cagan said, many people would lose their homes. If a homeowner holds no equity and his house has lost value, he would make nothing if he sold it.
Cagan's report estimated that one in eight adjustable mortgages sold in the last two years could default. About 5 million households nationwide and $300 billion in loans could be affected.
"The safety net of home equity is not going to be there," attorney Clayman said. "The number of bankruptcy filings over the next couple of years will probably go up."
Nationwide, the number of foreclosures is running one-third higher than a year ago, according to RealtyTrak.com.
Cagan concluded that while individuals and families would suffer, the defaults would not hurt the $10 trillion-per-year U.S. economy. But one New Jersey economist, A. Gary Shilling, fears the damage could be significant.
Shilling studied 44 boom-and-bust housing cycles occurring in 18 countries since 1970. Inflation-adjusted prices rose an average 28 percent in the five years before a housing bubble burst. Home prices fell 22 percent in the five years afterward.
If housing values dropped 20 percent or more, Shilling said, "there's no question we could have a serious recession in the United States. Then it could spread globally. U.S. consumers are supporting the world.
"If the consumer pulls in his horns after he's been on a spending and borrowing binge for the last 20 years, the effects could be pretty dramatic.
"This is heavy duty stuff," Shilling said. "I think this huge debt level is going to be a serious problem."
Don't blame consumers too much for their spending habits. They're following the lead of their Uncle Sam.
The federal government has spent more than it has taken in all but four years since 1969. The U.S. public debt was less than $1 trillion in 1981. It was $8.4 trillion at the end of May. Foreign governments and investors own nearly one-quarter of America's public debt.
The red ink has seeped down to the state level. The debt of all state governments has increased by an average 11 percent in each of the last three years. New Jersey is third in state debt, having borrowed for years to finance highways, build schools and plug holes in the state budget. New Jersey taxpayers are directly responsible for $28.6 billion in debt, according to a Moody's Investors Service report.
New Jersey economist Allen Grommett of Cambridge Consumer Credit Index said government and consumer debt are linked. When government runs a deficit, more money becomes available. Consumer spending does stimulate the economy, Grommett said.
But just as the government has spent its surplus, consumers are dipping into savings. In the 1970s, Americans saved $1 of every $10 they earned. In recent years, that number has dropped to about 30 cents. Last year, the savings rate was negative 0.5 percent. That means Americans spent 0.5 percent more than they earned.
Half of all U.S. workers have less than $25,000 in their 401Ks, including 40 percent of workers age 55 and older.
Analysts distinguish between debt that grows in value and spending that doesn't. On a personal level, buying a house that appreciates or getting an education that helps your career are valuable investments.
On the other hand, if government borrows to buy "fuel and bombs, once it's spent, it's spent," Grommett said.
"There's no real long-term benefit to the economy. When it's spent on education and research, there is a long-term return. We need to get our one-time expenditures under control."
Having it all
When Bill Wenz was a young man, he wanted to finance a TV purchase. But credit was hard to obtain. His parents wouldn't co-sign a loan. Wenz couldn't provide a credit reference the store wanted.
"I showed them my checkbook and said that I could pay for that TV," he said.
Wenz, who is on the homeowner board at the Four Seasons at Smithville development in Galloway Township, recently discussed credit's role in society with other board members. They agreed: Times have changed.
"We were lucky if we had one TV in our house," Wenz said. "Now, they have one in every room."
Jerry Hauselt, 67, said he faced difficult choices while raising five children. Once there was enough money to either pay for insurance or buy one child a bicycle. His solution: Work a second job.
"That's the biggest difference," said Tony Annacone, 61. "Today they do both and go into debt."
Annacone said he believes baby boomers want their kids to have it all. "Unfortunately, this generation is racking up a lot of debt to do that," he said.
That is what author Shira Boss found when she researched her new book, "Green With Envy: Why Keeping Up with the Joneses Is Keeping Us in Debt."
"There was an attitude shift about raising children after World War II," Boss said. "Children became the center of the universe. It became about giving children everything.
"And this (debt) was the way we get everything," she said.
As baby boomers grew more comfortable with credit, they started using it to subsidize their lifestyle, she said. They charged restaurant meals, furnishings, clothes. News reports last year said some people cashed equity out of their homes to pay for big-screen TVs and vacations. The trend spreads because of social pressure, Boss said.
"We see the things people have, and we feel we need to have them. So we charge it," she said.
Bankruptcy lawyer Bruno Bellucci, of Linwood, agreed. He said medical problems or divorce drive many of his clients into debt. But he has seen people go broke trying to live the high life.
"We see stuff on TV and we want it," he said.
Boss said one difference from past generations is that people now accept large debt more casually, and some even expect to live in debt. For her book, Boss chronicled a well-to-do suburban family who bought a big house in a gated community, joined a country club and spent on lavish vacations. Their lifestyle was built on debt. They had $100,000 in credit card charges. They paid the debt down to $40,000, then ran their cards back up to $100,000 before heading into bankruptcy.
"I think the response should be: I can't believe people are such idiots," Boss said. "But nobody else seems to think that.
"People say to me, 'I can relate to that.'"
Al, a computer programmer in suburban Philadelphia, said his parents gave him whatever he wanted when he was growing up. "I was pretty spoiled as a kid." He got his first credit card while in college in 1978. Soon he owed $3,000.
"I would go to my parents' house. After dinner, I would well up the tears, say I couldn't pay my bills. And Dad would write me a check."
The pattern continued on and off for years. Al, who didn't want his last name identified, realized his spending was like an addiction when he began to steal from his father.
In 1993, Al's family began caring for his father after a stroke had partially paralyzed him. Al managed his father's finances. He filled out a credit application in his father's name - but didn't tell him. Soon he was purchasing computer equipment and meals with that card. Eight months later, Al's wife opened her father-in-law's credit card bill by mistake.
"She saw $4,000 in charges," Al said. "She asked how my father could charge that much while sitting in his bedroom all day."
Al's wife convinced him to attend Debtors Anonymous, a 12-step, faith-based program that helps people with spending compulsions. Today, Al is a trustee of Debtors Anonymous of Southeastern Pennsylvania and New Jersey. He repaid his father. He no longer uses credit cards. He saves out of every paycheck and pays cash for everything he buys. Al keeps reserves for emergencies.
"I saw a guy open his wallet and he had 15 credit cards. They were probably all maxed out. That's why he needs 15," Al said. "You're living to pay off your creditors. That's not a life."
Get out of debt
Al said he could not have gotten debt-free without Debtors Anonymous and help from a "higher power." There are many counseling groups, debt relief programs and Web sites that help debtors. But it's a case of buyer beware.
On May 15, the Internal Revenue Service said an audit of 63 credit-counseling companies showed that 41 of them existed mainly to profit off debtors. The IRS said it would revoke the unidentified groups' tax-exempt status.
Jeannette Gmitter said debtors looking for help should go to nonprofit agencies with counselors certified by the National Foundation for Credit Counseling. They should beware of companies that charge high fees.
U.S. Sen. Robert Menendez has proposed federal legislation to rein in credit card practices after hearing of college students becoming overwhelmed with debt and consumers being treated unfairly.
His proposals would:
* Ban random credit card solicitations to people younger than 21
* Prohibit companies from raising interest rates when a customer misses a payment to an unrelated account
* Require companies to use the postmarked date to determine when a bill payment is late
* And establish a financial literacy program in schools.
Graves, of the Marmora counseling agency, said education is needed because most schools don't teach money management. Graves said a grant from Chase and Bank of America has allowed his agency to offer financial literacy seminars in high schools, but few are signing up.
"I explain to students that the real permanent record for their life is not their high school transcript or SAT score," Graves said. "It's their credit score."
One exception is Ocean City High School, where all freshmen are now required to take a semester of financial literacy.
Al, of Debtors Anonymous, agreed that debt should be discussed, not treated as a dirty little secret.
"People will talk about their alcoholism. They will talk about their sex lives, their gambling. But they will never talk about their money problems," he said. "They're afraid people will think they're weak."
Shira Boss said Americans should talk more about the social reasons we overuse credit, and not envy those with more than us. But she admitted that even though writing her book clued her in to the dangers of debt, the lure of materialism can be strong.
She and her husband were shopping for a TV. Boss couldn't understand how people were able to afford thousands of dollars for a set. She asked her husband, "Why are we the only ones shopping in the picture tube aisle?"

Another gem from Stephen Roach

2006-08-25T18:03:00.000-07:00

Five and a half years ago the equity bubble popped. Within six months, the US economy went into mild recession, and the global economy was quick to follow. Today, America’s housing bubble is finally bursting. Is the die cast for another bubble-induced downturn in the US and global economy?

All asset bubbles are alike. Sure, there are obvious differences between equities -- a financial asset -- and homes -- a tangible asset. But to me, the Shiller definition says it all: A bubble is an outgrowth of powerful amplification mechanisms -- both real and psychological -- which create an unsustainable condition whereby “… price increases beget further price increases” (see Robert Shiller’s Irrational Exuberance, second edition, Princeton University Press, 2005). The rise and fall of the US housing market fits the Shiller script to a tee. House price appreciation surged to a 27-year high in 2005, and as of the first quarter of 2006, prices were still rising by 20% or higher in 53 metropolitan areas across the United States. Both pricing and demand were feeding on each other through classic Shiller-like amplification mechanisms.

As always, the upside of a speculative bubble lasts for longer than you think. But when it finally goes, it invariably unwinds with greater force than widely expected. That seems to be the way the chips are now falling in the US housing market. Demand for homes is falling like a stone and inventories of unsold dwellings are ballooning -- up 40% for existing homes and 22% for new homes in the 12 months ending July. These are the classic quantity adjustments that set the stage for price destruction -- the endgame of any asset bubble. So far, home values just seem to be leveling off at still lofty price points. As the bid-offer gap widens in an excess inventory and rising interest rate climate, price declines will come as they always do. This bubble is not different.

Construction activity is the last shoe to fall in a housing downturn. Due to sunk fixed costs of land and property acquisition by developers, homebuilding typically continues into the inventory overhang phase of the cycle. Such is the case today -- with residential construction activity still holding at relatively high levels through mid-2006. However, once this last gasp of project completions runs its course, the construction downturn should gather force. Given the magnitude of the current inventory overhang, the downside of the building cycle could be both deep and prolonged -- lasting possibly a couple of years and entailing peak-to-trough declines of at least 25%. For a sector that boosted US real GDP growth by about 0.5 percentage point per annum over the past three years, it is now poised to subtract about one percentage point per annum over the next couple of years -- a swing of 1.5 percentage points off the overall US growth rate.

Of course, the construction impact is only part of the story. There is also the wealth effect from the housing bubble to consider. Since the dawn of the Asset Economy in 1995, growth in real disposable personal income accounted for only about 85% of the cumulative growth in personal consumption expenditures. The balance came from wealth effects of a seemingly endless string of asset bubbles -- first equities, then property. The property-based wealth effect became especially important in driving consumer demand in recent years. Over the 2004-05 period, real personal consumption grew at a 3.7% average annual rate -- more than 50% faster than the 2.4% average annual gains in real disposable personal income over the same period. The gap between household incomes and spending is traceable to the extraction of equity from an increasingly frothy housing market. According to Federal Reserve estimates, mortgage equity withdrawal exceeded $700 billion (annualized) in the first half of 2006 -- more than enough to provide an “extra” stimulus to consumer demand as well as to provide a substitute for income-based saving. In the frothy house price climate of the past five years, the property-based wealth effect probably boosted growth in total consumer demand by at least 0.5 percentage point per year. In a stable to falling home price climate, that impetus could fade quickly to zero -- and possibly go into negative territory if saving-strapped American households elect to start saving out of labor income again.

All in all, a post-housing bubble shakeout could entail a haircut of at least two percentage points off the overall US GDP growth rate -- 1.5 percentage points via the construction effect and another 0.5 percentage point from the wealth effect. The overall impact could even be larger if households elect to rebuild income-based saving balances -- hardly unusual in light of the looming retirement of some 77 million baby-boomers. The repercussions of multiplier effects through construction-related hiring shortfalls could also compound the problem. For a US economy that has been growing at a 3.2% average annual rate over the past three years, a two percentage point haircut does not guarantee a recession. But it certainly could end up being a close-enough call that might trigger a recession scare in financial markets. The hope, of course, is for the exquisitely well-timed handoff -- a seamless transition from asset-dependent consumption to other sectors, such as capex and net exports. I remain suspicious of such claims of built-in resilience. If the US consumer slows, the demand expectations that typically drive capital spending will also weaken. So, too, will the growth dynamic of America’s export-led trading partners -- thereby undermining support for US exports, as well. In short, for a wealth-dependent US economy, the bursting of another major asset bubble is likely to be a very big deal.

It is also likely to be a big deal for an unbalanced global economy. In 2000, when the equity bubble burst, the gap between current account surpluses and deficits was less than 4% of world GDP. This year, as the housing bubble bursts, that same gap is likely to be around 6% of world GDP. The disparity between current account surpluses and deficits -- and the added point that the US accounts for about 70% of all the deficits in the world -- underscores the increased dependence of the rest of the world on the US. For that reason, alone, a bursting of the property bubble poses equally serious risks for America’s key trading partners and for the rest of an increasingly integrated global economy.

Ironically, at just the moment when it has become evident that the US housing bubble has burst, the key architects of this sad state of affairs -- America's central bankers -- are cavorting at their annual retreat in Jackson Hole, Wyoming. Denial has long been deep at this Fed love-fest. A year ago at this same conference, considerable adulation was heaped on the post-bubble legacy of the Greenspan Fed -- namely, that the US central bank was correct in dealing with the equity bubble after the fact (see Alan Blinder and Ricardo Reis, “Understanding the Greenspan Standard” available at www.kc.frb.org). This, of course, is consistent with Greenspan’s own self-professed verdict of vindication for the Fed’s post-bubble clean-up strategy (see his January 3, 2004 speech, “Risk and Uncertainty in Monetary Policy”) as well as a similar argument presented at an earlier Jackson Hole gathering by then Princeton professor Ben Bernanke (see the 1999 paper by Ben Bernanke and Mark Gertler, “Monetary Policy and Asset Price Volatility”). Missing in this self-serving depiction is an assessment of the consequences of aggressive post-bubble monetary easing tactics. The injection of excess liquidity is key in that regard -- sufficient in the current instance for one bubble to beget the next. In that important respect, the housing bubble was a direct outgrowth of the Fed's post-equity bubble defense strategy. And now the US, as well as a US-centric world economy, must come to grips with what its central bank has wrought -- yet another post-bubble shakeout.

Strangest downturn in 40 years according to Toll Brothers.

2006-08-09T13:49:00.000-07:00

NEW YORK (CNNMoney.com) -- Homebuilder Toll Brothers said the current slump in residential construction is unlike any it has seen in 40 years as it became the latest to warn of a glut in new homes for sale and a slowdown in the closely watched real estate market.

The builder of luxury homes also reported weaker than expected preliminary results for the just completed quarter and cut its outlook for the homes it will sell in the current period. Toll Brothers (Charts) shares fell 4 percent in premarket trading.

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The housing and homebuilding markets have helped drive the national economy during the past few years. Any downturns in these critical sectors could add to the problems of an already unsteady situation.

In a statement, company chairman Robert Toll warned there is a glut of supply of homes for sale in the market, as the building boom of recent years seems to be turning into a bust.

The slowdown "is the first downturn in the forty years since we entered the business that was not precipitated by high interest rates, a weak economy, job losses or other macroeconomic factors," Toll said in his statement.

"Instead, it seems to be the result of an oversupply of inventory and a decline in confidence," he added. "Speculative buyers who spurred demand in 2004 and 2005 are now sellers; builders that built speculative homes must now move their specs; and nervous buyers are canceling contracts for homes already under construction."

Markets where the company recorded big increases in cancellation rates included Orlando, Northern California, Palm Springs, Las Vegas and Phoenix.

The company's reported homebuilding revenues were approximately $1.53 billion in the quarter ending July 31, compared to the record of $1.54 billion a year earlier. Analysts surveyed by earnings tracker First Call had been forecasting a 7 percent increase in overall revenue at the company.

The Pennsylvania-based builder said it expects to deliver 2,500 to 2,800 homes in the current quarter, a cut of at least 14 percent from its previous guidance of 2,900 to 3,300. And the company announced signed contracts in the just completed quarter plunged 45 percent to $1.05 billion from a record of $1.92 billion a year earlier.

The company said it is not under as much pressure as many builders to cut prices because it builds relatively few homes on spec. But Toll said that much of the supply of finished and near-finished product is being marketed using advertised price reductions and increased sales incentives, which in turn is leading many potential buyers to delay their purchase decisions as they wonder about the direction of home prices.

But Toll said the company believes that, as there is a cutback in supply by builders, the housing market should be able get back on the growth track of recent years.

"With many potential buyers on the sidelines right now, we believe there is growing pent-up demand that will come into the market once buyer sentiment improves."

Toll said on a conference call Wednesday afternoon that he expects the slump to last at least through the end of the year, however, adding it could drag on for another two.

"But the market isn't dead," Toll said. "It's concerned with the direction of home prices and if it has reached the bottom. You might argue that this is the best time to buy a home, with comparatively low mortgage rates and incentives. It's very hard to pick a bottom and anyone who tries will probably have a problem."

Toll named some once previously hot markets as underperformers lately.

Florida has been fair or poor, for the most part, not an unexpected assessment during the summertime. Other down markets were Las Vegas and Reno, Chicago, Minnesota and the Maryland shore.

Stronger markets he named were Hoboken, Delaware, Colorado and Phoenix.

__________________________________________________________________________________________

It's amazing that even with very low interst rates, the housing market is tanking. It's no wonder that the bond guys believe the fed will be cutting rates soon. However, it seems that inflationary pressures are building and the fed may have to continue to raise rates some more to maintain the appearence of being inflation fighters.

The Fed is Done!

2006-07-29T09:08:00.000-07:00

For now, it seems obvious to me that the fed is done with it's rate raising campaign. With the GDP number showing a rapid slowdown in the economy, there is not the political will to continue raising rates. The fed, I believe, is operating under the premise that a slowdown in the economy, by itself, will be enough to decrease inflationary pressures. Whether or not this is correct remains to be seen. With the drop in long term yields lately, it is apparent that bond investors believe that the fed will in fact be lowering rates in the near future. I think that this belief has also permeated itself into the stock market with the pop last week after GDP numbers came out. However, the canary in the coal mine wil be the value of the dollar itself. If interest rate differentials become less attractive to foreign buyers, then dollar denomenated assets may be dumped, or at least purchased in much lesser quantities. The fed is walking a tightrope. They want to keep the dollar stable because of the dependance on foreign funding of our defecits, they want to keep inflationary expectations in check to keep long term rates down, they want to produce a soft landing in the housing market without a major systemic shock. Can they do it? I have my doubts. Previous credit binges have never ended well. And the fed, no matter how well intentioned, cannot protect us from our own follies forever.

The U.S. is going broke.

2006-07-17T18:52:00.000-07:00

Published in Federal Reserve Bank of ST. Louis July/August 2006 by Laurence J. Kotlikoff.

CONCLUSION:

There are 77 million baby boomers now rang-
ing from age 41 to age 59. All are hoping to collect
tens of thousands of dollars in pension and health-
care benefits from the next generation. These
claimants aren’t going away. In three years, the
oldest boomers will be eligible for early Social
Security benefits. In six years, the boomer van-
guard will start collecting Medicare. Our nation
has done nothing to prepare for this onslaught of
obligation. Instead, it has continued to focus on
a completely meaningless fiscal metric—“the”
federal deficit—censored and studiously ignored
long-term fiscal analyses that are scientifically
coherent, and dramatically expanded the benefit
levels being explicitly or implicitly promised to
the baby boomers.
Countries can and do go bankrupt. The United
States, with its $65.9 trillion fiscal gap, seems
clearly headed down that path. The country needs
to stop shooting itself in the foot. It needs to adopt
generational accounting as its standard method
of budgeting and fiscal analysis, and it needs to
adopt fundamental tax, Social Security, and
healthcare reforms that will redeem our children’s
future.

US Going Broke

Odds of recession increasing? (WSJ)

2006-07-15T13:14:00.000-07:00

Warning Signs
Consumer Caution, Oil Prices
Increase Risk of a Recession
Economy Is Still Expanding,
but Middle East Fighting
Shakes Market Confidence
A Slowdown in Retail Sales
By JUSTIN LAHART and RAFAEL GERENA-MORALES
July 14, 2006 11:38 p.m.; Page A1
With oil prices surging, financial markets gyrating and consumers turning cautious, the risks of recession are rising.

For now, the U.S. economy is still expanding, unemployment is a low 4.6% and most forecasters predict higher energy prices and interest rates will slow the economy -- not shrink it.

But this past week's fighting in the Middle East is shaking Wall Street's confidence. The Dow Jones Industrial Average fell 106.94 points Friday and was down 3.2% for the week, wiping out most of 2006's gains. (Read more.) Stocks of retailers and home builders, susceptible to rising interest rates and tight-fisted consumers, sagged. Yields on long-term Treasury bonds fell below short-term yields, a phenomenon often seen as a harbinger of recession.

A big worry is surging oil prices, which have contributed to several past recessions. Amid the Middle East turmoil and militant attacks in Nigeria, crude oil for August delivery rose 33 cents to close at $77.03 a barrel on the New York Mercantile Exchange on Friday, a new nominal record.

In all, oil prices were up 4% for the week, hitting stocks of auto makers, airlines and other oil-dependent industries. They also increased the chances that the retail price for a gallon of regular gasoline -- which averaged $2.96 on Thursday, according to the American Automobile Association -- could breach $3.

"Given that the U.S. economy is already under the weather, the [Middle East] conflict does carry the potential of bringing the economy into a recession," said Carlos Asilis, a Miami-based portfolio manager for hedge fund Vega Plus Capital Partners.

In another sign of a slowdown, the Commerce Department said Friday that retail sales in June slipped by a seasonally adjusted 0.1% to $363.80 billion, led by a 1.4% fall in sales of autos and parts. Excluding sales of autos -- and price-driven increases in gas-station sales -- retail sales were up just 0.1%, far short of the inflation rate. Total retail sales are up 5.9% over the past year.

A recession-warning gauge devised by Federal Reserve economist Jonathan Wright -- based on yields on the three-month Treasury bill and 10-year Treasury note and the Fed's current target for short-term rates -- calculates the odds of recession in the next year are now at 36%, up from 14% six months ago. (See Mr. Wright's paper.)

Merrill Lynch economist David Rosenberg put them even higher, at 40%, noting that a slowing economy could pose problems for business and consumer borrowers and deepen the slowdown. And Ian Shepherdson, chief U.S. economist at High Frequency Economics, a Valhalla, N.Y., consultant, sees a 50% chance of recession. "Hopefully, the Fed will recognize that risk and not be crazy enough to raise rates again next month," he said.

As the economy has perked up and the threat of deflation has faded, the Fed has taken short-term interest rates to 5.25% from an extraordinarily low 1% over the past two years. But with growth slowing at the same time that inflation is accelerating, the Fed faces a tough call at its Aug. 8 meeting.

As markets fell and oil prices rose Friday, futures markets were putting at 52% the odds of another Fed increase. That was down from 59% on Thursday. Markets hope for more clues to the Fed's thinking when Fed Chairman Ben Bernanke testifies before Congress Wednesday and Thursday.

Even those who don't foresee recession expect a significant slowdown. "I'm not bold enough to forecast a recession at this point," said Paul Kasriel of Northern Trust Co., Chicago. "But I do think that the economy has entered a very soft patch here."

Complaining About Gas Prices

Signs of that can be seen at Dunham's Department Store, in Wellsboro, Pa, where some shoppers are complaining about energy costs. John Dunham, the store's president, quoted one customer as saying: "You wouldn't believe -- it cost me $90 to fill up my tank the other day."

In June, sales at the 42-employee store fell 5% from a year earlier; revenue for the year is expected to be flat. "Everyone feels a little bit pinched" by high energy prices, Mr. Dunham said.

"Consumers are ... no longer simply willing to spend everything they have to sustain their lifestyles," said Joel Naroff, of Naroff Economic Advisers. They're more cautious and are now beginning to cut back on spending. That's what's beginning to show."

It's not only low-income consumers who are pulling back. Makers of boats and recreational vehicles say demand is softening. Fleetwood Enterprises, a maker of recreational vehicles, posted lower-than-expected earnings this past week.

Brunswick Corp., the world's largest maker of recreational boats, cited "significant declines in retail demand" -- unit sales were off 10% in the second quarter -- and pared profit predictions and production plans. The company said demand was weakest for boats costing between $100,000 and $250,000. "We believe the marine business is not alone in experiencing weakness," Chief Executive Dusty McCoy said in a conference call Wednesday.

The University of Michigan's midmonth report on consumer sentiment fell to a reading of 83 in July from 84.9 in June, according to those who saw the report Friday. Consumers' assessment of present conditions fell sharply. Consumers expect consumer prices to rise 3.1% in the next year, down from 3.3% last month, a development likely to please the Fed.

Anxiety about the housing market intensified as well, particularly after a profit warning from D.R. Horton Inc., which had been dubbed the Teflon builder because of the way it stood out for sticking with its guidance for the year. The Fort Worth, Texas, company, which had been expecting to close on 58,000 houses this year, said Thursday night that it now expects to close on only 50,000.

The company's bleaker earnings guidance raises questions about whether the housing market slowdown will prove more painful than many had predicted. Some analysts expect similar bad news from other builders in the coming weeks.

Of course, recessions are notoriously hard to predict, and early-warning gauges can be misleading. "You have to monitor movements among so many indicators," said Victor Zarnowitz, a longtime business-cycle watcher now at the Conference Board, a business-research organization in New York. "It's complex to find a consensus in economic activity."

The U.S. has shaken off a surprising number of shocks in the past few years. "We have found that the U.S. economy has been surprisingly resilient, surprisingly able to manage the increase in prices that we have already seen," Energy Secretary Sam Bodman said at a Friday news conference with Canadian government officials. "I am hopeful that it will continue to do so."

Lakshman Achuthan of the Economic Cycle Research Institute in New York, which tries to predict the turns in the economy, expects just that. "In terms of recession risk, we don't see that yet," he said. "Our leading indicators of growth, while they're down, are not in recessionary territory."

Welcome signs of life in the Japanese and European economies and continued vigor in China, moreover, suggest they might help sustain world economic growth as the U.S. slows.

But in a sign of concern over the economy, investors have been shifting money toward long-term Treasurys, as they often do during times of trouble. That has driven the yield on 10-year Treasury notes, which began the month at 5.15%, down to 5.07%.

That puts the 10-year yield below the Fed's 5.25% target for the federal funds rates, which banks lend to each other overnight, and below the 5.1% yield on two-year Treasury notes. Because investors usually demand higher returns for locking up money for longer periods, it's unusual for long-term interest rates to fall below short-term rates. When that happens, it's often a sign that investors believe the economy is about to slow, forcing the Fed to cut short-term rates.

When this phenomenon -- known as an inverted yield curve -- occurred last year, many economists dismissed its significance because the Fed was keeping rates extraordinarily low. But that's no longer true.

Retailer Shares Take Hit

On Wall Street, shares of retailers have been hit particularly hard, as investors worry that high energy prices will cut into shoppers' ability to spend on other items. Shares of Wal-Mart Stores Inc., whose many lower-income customers are especially sensitive gasoline prices, slipped about 2.5% on Friday after the retail data was released.

Also hit hard were shares of General Motors Corp. and Ford Motor Co., hurt in part by the view that high gasoline prices are cutting into the sales of sport-utility vehicles, their most profitable products. Investors have instead been favoring utilities and other companies whose earnings have held up in past downturns.

Stewart Pillette, head of Pillette Investment Management in San Francisco, said even fund managers who typically put their money into technology stocks and other traditionally high-growth areas, are loading up on defensive stocks. "They've turned extremely cautious," he said.

Though Byron Wien, chief investment strategist at hedge fund Pequot Capital Management, said he doesn't see a recession coming, he said his firm has taken a more defensive posture amid the tensions in the Middle East, rising oil prices and slowing corporate earnings.

"Our job is to make money when we can and protect capital when we can't," he said. "Right now, we're in capital-protection mode." But every downturn has its bottom. "When people get alarmingly pessimistic," he added, "that's when it's time to buy. It looks like that day is coming."

Additionally on Friday, the Labor Department reported that import prices were up 0.1% in June after rising 1.7% in May. Excluding oil, import prices climbed 0.4% last month.

Fed's Recession Risk Paper

Is the consumer starting to crack? From minyanville.

2006-07-14T21:39:00.000-07:00

consumer cracking?

One thing we Americans will never be accused of is self-restraint. Faced with entreaties to “eat all you can eat”, “shop til you drop” and “SuperSize It”, we are powerless to resist…and we’ve got the bloated balance sheets and physiques to prove it. After stuffing ourselves silly over the last few years, however, it appears some of us have finally had enough. The latest retail roundup reinforces what we suspected all along-- the U.S. economy is starting to get a little soft around the middle. Sure, things at the high-end are still quite firm. But our middle-class gut has definitely started to head south. As the nation’s midsection succumbs to gravity and the lower-income ranks begin to swell, mid-tier retailers and dining establishments are feeling the pinch.

After kicking and banging their household ATMs to deliver any cash still trapped inside it appears the jig is finally up. Combing through the Fed’s Commercial Bank Assets release last Friday (must reading for insomniacs) we made a most shocking discovery. Transaction deposits (aka checking accounts) at banks plunged -$30b in one week and are down -8.4% y/y, their lowest level since the last recession. Gee, might this evaporation in deposit balances foreshadow a slowdown in discretionary spending ahead? Sure looks like it…

Yep. Things are sure starting to look dicey on the consumer front. And no wonder, our promised safety net -- income growth -- is fraying before our eyes. Loath as we are to rain on the wage inflation parade, the surge in Average Hourly Earnings in last week’s Payroll Report likely owes more to mix shift than spontaneous beneficence on the part of Corporate America. The return of a handful of manufacturing jobs (which tend to be higher paid) buoyed earnings. The same thing happened in April only to reverse course in May. But this is a fairly minor quibble. The real issue is that wage growth continues to lag inflation. And that’s using the government’s inflation gauge. One shudders to imagine what the ‘real’ real wage picture looks like!

Interestingly, the last few times U.S. consumers found themselves in this infelicitous situation, housing booms were also providing an income cushion. In each case, asset inflation mooted lackluster wage growth…for a spell. Once the boom ended, however, the lack of wage growth began to matter and recession promptly ensued.

Which brings us to today. With no more equity to tap, day-laborers are struggling to finance larger mortgage payments, higher credit card minimums and $3/gallon gasoline with skimpy wage growth. And if you think they’ve got it bad, imagine how those with ZERO wage growth feel! I’m talking about the senior set. Trying to keep up with the rising cost of living (which is particularly punitive when you consume an outsized share of healthcare where inflation is most rampant) with the income generated from 40-year low interest rates has to be tough. One could forgive them for being a little crotchety. Just how strapped our fuddy-duddies have become was made clear in the MBA’s recap of 2005 mortgage activity released earlier this month. It revealed that reverse mortgage incidence mushroomed 45% in the latter half of 2005 from the first six months of the year! It is mind-boggling that this hasn’t received greater attention. I guess it’s naptime at the AARP. Zzzzzz…

No matter. The issue will take centerstage soon enough when the government finds itself forced to bail out strapped consumers in general and these retirees in particular. It was always inevitable that the baton would be passed from monetary to fiscal policy. As the fruits of Greenspan’s asset-dependent economy begin to sour, fiscal policymakers will hasten to provide alternate sustenance.
At a minimum, a slowdown in the 70% of the economy that the consumer represents will boost cyclical outlays. (I mean, having deposit balances contract -8.4% at a time when mortgage payments are up 15% is bound to take a toll). But we fear the spending won’t stop there. The housing bust may be met with more direct government assistance. After all, should homeowners find themselves owing more than their home is worth, they might decide to mail in their keys rather than their mortgage payments. This could seriously weaken the banking system. (As we’ve pointed out repeatedly, banks have record exposure to real estate via direct mortgage loans and MBS holdings). So, why take a chance? Why not just bailout those homeowners on the brink? Besides, the government surely feels some culpability since Fannie (FNM) and Freddie (FRE) helped put us in this situation. So, enjoy the budget celebration while it lasts. It won’t be long before this trend reverses…and meaningfully. The Great Housing Bubble will be followed by the Great Government Bailout and our budget deficits will go from bloated to morbidly obese.

As consumer spending slows and Washington grows, our financing needs will rotate…

The million-dollar question, of course, is: Will our foreign financiers care? Will they finance our expanding public sector liabilities with the same alacrity they did trade?? To the extent that the lion’s share of our capital flows are now coming from private sector institutions stretching for yield, the answer would seem to be ‘no’. After feasting on sophisticated asset-backed exotica and derivative delicacies it seems unlikely these folks will dull their palates with our public sector pork. Of course, when credit risk mounts its return this paper, too, will lose its allure.

Never fear, we’re assured, the return of risk will simply send our foreign financiers back to the ‘safety’ of Treasuries. After all, they’ve still got to put their forex dollars ‘to work’. Sigh. Such is the arrogant assumption made by most US-based investors. As if this were a binary decision---have dollars, must recycle. There are, in fact, two options for dollar holders: invest or spend. Increasingly our financiers are opting for the latter.
Topping the list of places to spend their dollars is oil. We’ve made the point repeatedly that a ‘cold war’ for energy resources would provide material competition for US financial assets. But perhaps now, after seeing oil stand unharmed amid the mayhem and destruction in May, the point will command more respect. So, let’s review: At the margin, dollars that used to be recycled into US assets are now being used to buy energy security. This is creating a feedback loop as, the higher oil prices go, the less compelling it is to vendor finance US consumers. (Because the marginal benefit of printing money to lend to US consumers is now being offset by the ‘tax’ associated with paying higher dollar-priced oil). In fact, we appear to be at a critical threshold. With a $10 annual increase in the price of oil sucking $300b from oil consuming nations’ pockets, it takes a $20 increase to offset the $600b global trade with the US. Over the last year, oil is up $18. Obviously, US import growth slows (as it is now), the math becomes even less compelling.

Oil isn’t the only thing our former financiers are spending their dollars on. They are also hard at work trying to create their own consumer-economies. This kind of change doesn’t happen overnight. Actually, with $900b in cash on hand (China’s forex reserves) it might! But, it clearly isn’t going to be accomplished by sending dollar reserves to the US Treasury.
At the same time our Asian financiers are starting to use their dollars to buy economic independence rather than US Treasuries, their consumers have also stirred to life. In Japan, consumer confidence is the highest in twelve years. Real wage growth is positive and bank lending just notched its largest increase since 1996. Meanwhile, in the US, confidence is generally eroding, real wage growth is negative and home equity lending is contracting year on year.
So, while the US has been the favored place to ‘put dollars to work’ over the last several years, that may be about to change. As the US housing boom turns to bust and our consumers downgrade from prosciutto to pork rinds, it seems unlikely our creditors will do the same.

End of "money for nothin"?

2006-07-14T06:51:00.000-07:00

TOKYO - Japan's central bank raised interest rates Friday for the first time in six years, ending an era of zero percent interest and sending the clearest signal yet that the world's second-largest economy has pulled out of a decade-long slump.

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The decision boosts the Bank of Japan's key overnight call rate to 0.25 percent from 0.069 percent — effectively zero.

The move was widely expected by analysts and investors, and puts Japan closer in line with monetary policy in the United States and Europe, where central banks are also tightening the reins on easy money.

It was "absolutely" the right move at the right time, said Jesper Koll, chief economist at Merrill Lynch in Tokyo.

"Zero interest rates were a necessary emergency policy," Koll said. "But Japan needs the beginning of a normalization process. Normality means money isn't free."

The zero percent interest policy did not mean Japanese consumers and businesses were able to get interest-free loans. Japanese banks still charged interest, albeit relatively low — mortgage rates were less than half of what they are in the United States — but did not have to pay interest on deposits.

The central bank's rate hike will likely nudge higher the rates consumers and small businesses are charged. This was widely anticipated, causing Japanese bank lending to grow at its fastest pace in over a decade in June, fueled in part by an "act now" mentality on the part of borrowers.

Japan lowered rates to zero in 2001 in an attempt to jump-start the beleagured economy and wipe out a destructive trend of sprialing price declines, known as deflation, that eroded corporate earnings and workers' paychecks.

Raising rates underlines that deflation is quickly becoming a distant memory and that the economic recovery is gathering speed.

"Today's decision will contribute to ensuring price stability and achieving sustainable growth in the medium and to long term," the BOJ said in a statement released after the policy board's unanimous 9-0 vote to raise rates at the end of a two-day meeting.

Prime Minister Junichiro Koizumi, in Jordan for a visit, said Japan hasn't yet emerged from deflation yet, but is close. "I hope we emerge from deflation as soon as possible, but that hasn't happened yet," he said.

In a nod to concerns that higher borrowing costs could stifle Japan's nascent economic comeback, BOJ chief Toshihiko Fukui emphasized that the bank will act cautiously with further interest rate movements.

"We are not embarking on so-called consecutive interest rate hikes," Fukui said at an afternoon news conference. "We will carefully study the state of the economy and prices to gradually adjust interest rates."

The bank's move links Japan with the other major economies in terms of monetary policy. In June, the European Central Bank raised its key interest rate to 2.75 percent, while the Federal Reserve has lifted the fed funds rate 17 times straight to 5.25 percent.

Some consumers will see immediate — albeit still meager — benefits as retail banks gradually lift interest paid on savings accounts. Tokyo-Mitsubishi UFJ Bank, the world's biggest bank by assets, announced it would lift the interest on basic savings accounts to 0.1 percent, from 0.001 percent, starting Tuesday.

Fukui also said he would not resign over an investment scandal that has eroded public trust in the central bank.

Fukui acknowledged last month he had invested in a fund run by Yoshiaki Murakami, a well-known shareholder activist who was arrested on charges of insider trading recently.

The investment wasn't illegal, but it has prompted questions about conflict of interest. It also sparked public outrage that Fukui's investment had more than doubled to 22 million yen ($190,000), while most Japanese were earning virtually no interest on their savings because of the Bank of Japan's zero interest rate policy.

Fukui has repeatedly apologized while denying any wrongdoing. He also has donated the entire investment to charity.

He stood his ground again Friday, reiterating his plans to stay on.

"I caused a fuss and worried many people, but I still have a duty to fulfill," he said. "There is no change in my intention."

In the weeks leading up to Friday's decision, several ruling party officials had urged the bank to hold off, worried that the BOJ would repeat the mistake it made in August 2000, when it lifted borrowing rates prematurely — and choked a recovery.

Fukui defended Friday's hike saying the economy is on firmer footing today.

"Objectively speaking, economic fundamentals are more robust and adverse to shocks than they were in 2000," he said.

Japanese stocks fell — but some of that was attributed to worries about soaring oil prices amid rising violence in the Mideast, traders said. Tokyo's benchmark index tumbled 252.71 points, or 1.67 percent, to 14,845.24 points.

Compared to six years ago, Japan's economy is much stronger, with corporate profits up, unemployment falling to eight-year lows and prices rising. The economy has turned in five straight quarters of growth, and forecasts call for up to 3 percent growth this year.

Proponents of a rate hike say it is need to head off inflation as Japan recovers. May's consumer prices rose 0.6 percent for the seventh monthly gain.

"In this environment, maintaining the previous level of the policy interest rate may result in large swings in economic activity and prices in the future," the central bank said, adding that Japan's economy continues to expand moderately and that consumer prices are in a general upward trend.

Koll said he expects the BOJ to raise interest rates by 0.25 percent each quarter over the next year so that the key rate stands at 1 percent next summer.

___

With reporting by Hiroko Tabuchi in Tokyo.

An open letter from Stephen Roach to Ben Bernanke!

2006-07-11T18:25:00.000-07:00

Dear Ben,

It’s time to take a deep breath. You are off to a rocky start as Chairman of the world’s most powerful central bank. Your policies are not the problem. Given the über accommodative legacy you inherited from your legendary predecessor, the three 25 bp rate hikes in each of the three policy meetings you have chaired have made good sense. The issue is more subtle —- your ability to send a consistent message to financial markets. This is a critical element of your job description. It defines your credibility as a policy maker as well as the credibility of the great institution you now lead. In the end, without credibility, a central bank is nothing.

You know this, of course. As one of the world’s leading academic apostles of inflation targeting, you have long stressed the merits of anchoring financial market expectations of monetary policy with a simple price rule. With price stability now widely accepted as the sine qua non of central banking and with core inflation rates in the US and around the world not all that far away from the hallowed ground of price stability, there is considerable merit in underscoring a determination to preserve the hard-won gains of the past 25 years. This could well be your golden opportunity.

With all due respect, Ben, you are close to squandering that opportunity. A transparent policy rule has real merit in minimizing unexpected and undesired swings in financial markets. But any such rule is as good as its disciplinarians — the central bankers who are charged with delivering the message to the public at large. It pains me to say this, but your message has been all over the place.

What I am alluding to are several reversals in your official pronouncements in the past couple of months. It all started with your 27 April testimony before the Joint Economic Committee of the US Congress, where you openly entertained the possibility of an “unjustified pause” in the Fed’s monetary tightening campaign. That was followed by your 5 June speech at an International Monetary Conference in Washington DC that sent a clear warning about your concerns over “unwelcome developments” on the inflation front. Then there was the policy statement immediately after the 28-29 June FOMC meeting, underscoring the Fed’s forecast that a “…moderation in the growth of aggregate demand should help to limit inflation pressures over time.” Nuanced or not, in this brief two-month time span, your official statements have gone from dovish to hawkish and back to dovish again. Such inconsistencies raise serious questions about your credibility as the world’s leading monetary policy maker.

Speaking of that, you and your colleagues at the Fed must be mindful of the international context and consequences of your posture. Your back-and-forth waffling comes at a critical juncture in the global monetary tightening cycle. Jean-Claude Trichet of the ECB surprised the markets with his own tough talk last week — in effect, pre-announcing another rate hike for August, a month when Europe is normally at the beach. At the same time, the Bank of Japan’s Governor Toshihiko Fukui has also been talking tough for several months, signaling the end of a seven-year zero-interest rate regime and the onset of a long-awaited normalization of Japanese monetary policy. His first step could well be imminent — most likely at the BOJ’s upcoming 14 July policy meeting.

Ben, that puts the consequences of your recent reversals in a very different context. Global investors are perfectly comfortable with the notion that the Fed, which began its tightening campaign long before other major central banks, would be the first to attain its objectives. The idea of the “policy catch-up” by foreign central banks has long been embedded in the consensus view of a cyclical dollar weakening. However, to the extent that the European and Japanese central banks stay on message while you do not, the monetary policy credibility factor could well shift away from the United States. Given America’s outsize current account deficit, a relative credibility erosion could spell sharp downward risks to the dollar — and equally sharp upside risks to real long-term US interest rates. That’s the last thing an asset-dependent, overly-indebted US consumer needs. A resumption of the greenback’s weakness in recent days suggests that you can’t take this possibility lightly.

It was always going to be difficult to wean the markets from the measured Fed tightening campaign that has unfolded without interruption over the past 24 months. When the federal funds rate was 1% in June 2004, the next move was a no-brainer. But now at 5.25%, it is obviously much trickier. The key for you is not to let your understandable sense of uncertainty over the economic and inflation outlook morph into an on-again, off-again assessment of policy risks. This was supposed to be the sweet spot in the policy cycle for inflation targeters like yourself. Lay out the metric you are targeting, provide a clear assessment of the risks, and then let the policy rule generate the unambiguous answer. Easier said than done, I guess.

I think the best thing you can do at this point is to borrow a page from the Greenspan era and make a simple statement of your policy bias. For example, as long as you perceive inflation risks to be on the upside of your tolerance zone, you and your colleagues can endorse a tightening bias. Conversely, if inflation risks tip to the downside, it may be appropriate at some point to announce an easing bias. The bias statement works best when the policy rate is near the so-called neutrality threshold. It is less appropriate when the overnight lending rate is far away from such an equilibrium. In the current context, the verdict would be clear — a tightening bias is in order until inflation risks recede. There’s nothing automatically actionable about such a bias that locks you into a move at each and every policy meeting. There is ample leeway to pass on a policy move and still maintain your concerns.

There may well be a silver lining in your unfortunate experience of the past couple of months. Central banking is as much art as it is science. In that vein, it is equally important to be mindful of one of the major pitfalls of the current financial market climate — seven years of one asset bubble after another, driven by the mother of all liquidity cycles. It is high time to bring this dangerous state of affairs to an end. These are the same bubbles that spawn wealth-dependent distortions to saving and massive global imbalances. Not only must you commit to price stability in the narrow sense of your CPI target, but you and your central banking colleagues in Europe, Japan, and China must be equally willing to commit to an orderly withdrawal of excess liquidity in order to put a seriously unbalanced world on safer footing. That underscores my recommendation to maintain a tighter policy bias at low rates of inflation than a strict price rule might otherwise imply. If that’s what it takes to break the moral hazard of the “Greenspan put,” it is a risk well worth taking.

I guess in retrospect we should have seen this coming. After all, history tells us that transitions to a new Fed Chairman invariably don’t go well. The “transition curse” saw the equity market quickly challenging Alan Greenspan with the Crash of 1987, the bond market promptly testing Paul Volcker, and a dollar crisis immediately confronting G. William Miller. The so-called risk reduction trade, which commenced in early May, could well go down in history as the Bernanke test. There’s nothing like unforgiving financial markets to find the Achilles’ heel of a new central banker.

The good news is that you have another important chance to recover your credibility — your midyear appearance in front of the US Congress slated for 19 July. The bad news is that this may be your last chance for a while. A third reversal could well spell a serious and damaging setback to Fed credibility. A serial bubble blower was bad enough — the last thing world financial markets need is a serial flip-flopper.

Sincerely,

Stephen S. Roach

Chief Economist

Morgan Stanley

Disaster averted at Freddie and Fannie?

2006-07-10T16:05:00.000-07:00

WASHINGTON - A potential financial disaster that could have shaken the housing market was averted because regulators discovered accounting failures at Fannie Mae and Freddie Mac, the new head of the agency that oversees the mortgage giants said Monday.
The government-sponsored organizations appear to have gotten the message that they need to reform, but it still will take years to repair their internal problems, James B. Lockhart said in an interview with The Associated Press.

"The housing market is so important to this country," said Lockhart, who has headed the Office of Federal Housing Enterprise Oversight for about two months. "And to have it built on what turned out to be a shaky foundation could have caused significant financial problems."

Problems were averted, he said, because the regulators acted to identify and order corrections at Fannie Mae and Freddie Mac, which together stand behind some 40 percent of the $8 trillion U.S. home-mortgage market.

"The good news is that it was caught in time and the remedies are starting to be in place, so that there was no major problem for the average American," Lockhart said.

Lockhart, a friend of Bush from prep school and college, became director of an agency whose previous leader had for years waged a quixotic battle against the two politically powerful companies. After serious accounting problems at Fannie Mae and Freddie Mac became known, a push by the administration to tighten the government reins on them gained ground in Congress.

Lockhart, 60, was executive director of the Pension Benefit Guaranty Corp., the federal agency that backs private defined-benefit pensions, in the administration of the first President Bush. He has worked in the private financial sector and was deputy commissioner of Social Security before taking his current job.

Like the White House and many lawmakers, he believes the mortgage holdings of Fannie Mae and Freddie Mac — totaling more than $1 trillion — should be reduced. He called legislation pending in the Senate "a very good starting point."

Fannie Mae, the second-largest U.S. financial institution after Citigroup Inc. and the second-biggest borrower after the federal government, is restating its earnings back to 2001 — a correction expected to reach at least $11 billion. The company was fined $400 million in a settlement in May with OFHEO and the Securities and Exchange Commission, one of the largest civil penalties ever in an accounting fraud case. It also agreed to make top-to-bottom changes in its corporate culture, accounting procedures and ways of managing risk.

The accounting failures and earnings manipulation at Washington-based Fannie Mae became known in September 2004 after the OFHEO regulators discovered them in a special review. No. 2 rival Freddie Mac had its own accounting crisis in mid-2003, when the company disclosed that it had misstated earnings by some $5 billion — mostly underreported — for 2000-2002 and ousted its top executives. Similarly, it was fined $125 million by OFHEO and ordered to make changes.

If either company should fail, there could be less money for consumers to borrow to get a mortgage, and interest rates on home loans could be forced higher.

Congress created Fannie Mae and Freddie Mac to inject money into the home-loan market. They buy mortgages from banks and other lenders and bundle the loans into securities for sale to investors worldwide.

"The risk has certainly been reduced by the remedial actions that the two management teams have put in place at our direction," Lockhart said. But it will take a number of years — two, three or more — for the two companies to get their financial houses fully in order, he cautioned.

In addition, he said, "There's still some arrogance in the culture. ... There are certainly people in both organizations that have retained and will retain some of that arrogance."

OFHEO's review found that current and former executives of Fannie Mae reaped hundreds of millions of dollars in bonuses in a deceptive accounting scheme from 1998 to 2004. Employees are said to have manipulated accounting to hit quarterly earnings targets so senior executives could pocket the bonus money.

Lockhart has promised that his agency will pursue some company executives to recover allegedly tainted bonus money if the Fannie Mae board fails to do so.

Pimco's Paul McCulley on Keynsian thought meeting Austrian thought!

2006-07-10T15:44:00.000-07:00

A Kind Word for the Austrian School
By Paul McCulley

Bill Gross teases me that I'm not just a Keynesian, but a religious Keynesian. There is an element of truth to that, as evidenced by the fact that the only major piece of art that I own is a portrait of Keynes by Salisbury, the preeminent portrait artist of Keynes' time. And it hangs in my office, presumably watching over me. So, Bill does have a point.

As a practical matter, however, I also have deep appreciation for other schools of economic thought. And, yes, that includes the Austrian School. Indeed, there is much overlap between Keynesian thought and Austrian thought, even though many think they are antithetical lines of thinking.

I was reminded of this recently when reading a brilliant essay by William White, of the Bank for International Settlements - Is Price Stability Enough? Mr. White's core thesis is that low and stable inflation in goods and services prices, presumably the holy grail of central banking, is not a guarantee of steady growth in real economic activity.

To be sure, that has been the case over the last two decades, at least in the United States, a dynamic known as the Great Moderation: lower volatility in both inflation and growth. There is a rich professional literature arguing the sources of this blessed outcome, with the consensus being that it has been the consequence of greater reliance on private markets - both in the United States and 'round the world in the allocation of resources; better macroeconomic policies, and in particular better monetary policy; and old fashioned good luck.

This consensus, at least in the United States and especially in the halls of the Federal Reserve, leads to the conclusion that monetary policymakers should:
Always and everywhere target - implicitly or explicitly - low and stable inflation and perhaps even more important, low and stable inflationary expectations.

Do nothing in response to changes in asset price valuations unless those changes imply an undesirable course for aggregate demand growth relative to aggregate supply growth, implying an undesirable path for the output gap and, thus, inflation and inflationary expectations.
Taylor's Austrian Constant

This is standard Keynesian stuff, married to a Phillips Curve. Or, for those who remember the jargon from school days, it's the IS-LM model married to NAIRU. It is also the foundation of the ubiquitous Taylor Rule, with one major exception: Mr. Taylor has a "neutral" real rate as a constant in his Rule.

And the concept of a "neutral" real rate is a very Austrian notion: there exists some unobservable interest rate (called the "natural" rate by Austrians) that perfectly matches the time preference of lenders and borrowers and in the absence of fiat currencies, free markets would find this rate (as if by Adam Smith's invisible hand), bringing about just the right amount of investment and savings.

In turn, Austrians argue that if fiat currencies do exist and if policymakers peg rates below the natural rate, there will be an excess of investment relative to that level which would generate returns consistent with the natural cost of borrowing, producing an investment bubble, which will be revealed when policymakers lift rates to or above the "natural" rate, generating an investment bust.

This is where the Austrian School is in direct opposition to the Keynesian School. For Keynes, investment was not a function of savings, but rather savings was a function of investment, which drives income, from which savings flow. Yes, after the fact, savings and investment must, as an accounting matter, equal each other.

But there was no a priori reason, Keynes argued, that savings and investment would ex post equal each other at full employment. For Keynes, what mattered was ex ante investment desires, which were driven by the state of confidence in long-term return expectations, summarized as animal spirits.

Thus, for Keynes there was no magical natural - or neutral - rate of interest. Indeed, Keynes actually put more emphasis on the role of stock prices than interest rates in eliciting the ex ante desire to invest. Yes, the great James Tobin found his Q in Chapter 12 of Keynes' General Theory!

Which brings us back to the ironic crossover between the Keynesian School and the Austrian School: if investment is a function of animal spirits and if animal spirits get their mojo from asset prices, then boom and bust in investment is endemic to the capitalistic system. That doesn't mean that it's not the best system ever devised for allocating resources. It is. But it is also inherently given to cycles of euphoria followed by doom.

For the Austrians, the solution to this problem was to kill fiat money systems and in the absence of that prescription, to resist using fiat money systems to soften periods of busts. For Keynes, writing at a time when the Austrian "solution" was de facto being applied, called the Great Depression, this made no sense at all. If investment and savings were equaling each other at 25% unemployment, then it was the duty of the sovereign to incite animal spirits with monetary ease, while even more important, boosting public investment.

Could this prescription lead to ex post maldistribution of investment, as the Austrians argued? Yes, Keynes acknowledged that; indeed, his very own work - Chapter 12 again! - implied this outcome. But for him, what mattered most was to achieve full employment. And he didn't trust unfettered markets to consistently deliver that outcome, as the Austrians argued.

One Step From Targeting Asset Prices

Which brings us back to the Taylor Rule, with its "neutral" real rate constant, a very Austrian concept. Recognizing that "flaw," many researchers, including at the Fed, have been empirically trying to model a time-varying "neutral" rate. I applaud that work. But once you take that step, you are only one step away from targeting asset prices, as the key variable driving fluctuations in the neutral rate are fluctuations in risk premiums, in response to changes in animal spirits. Thus, in my view, asset prices should matter for monetary policy and not just through the output gap-inflation channel.

Indeed, this is precisely the point of Mr. White's essay, as well as that of a speech I gave to the Money Marketeers Club of NYU in February: too much focus - and too much success - in stabilizing goods and services inflation on one- to two-year horizons is a prescription for boom and bust in asset prices and, from a starting point of low inflation, is actually a prescription for both increased volatility and deflation on longer horizons.

Ironically, Mr. Greenspan more or less said the same thing last September when he declared:
"In perhaps what must be the greatest irony of economic policymaking, success at stabilization carries its own risks. Monetary policy - in fact, all economic policy - to the extent that it is successful over a prolonged period, will reduce economic variability and, hence, perceived credit risk and interest rate term premiums."
This is especially the case when a central bank - such as the Fed - explicitly promises not to lean against bubbles unless they portend a negative impact on the inflation outlook for goods and services prices, while also having a clear track record of "mopping up" after bubbles burst. This asymmetric reaction function - commonly called the Greenspan Put - is a form of moral hazard, which actually makes bubbles more likely.

Mr. Greenspan rejects, of course, the notion that the Fed put a floor under asset prices during his tenure, notably the stock market, noting that if it was a floor, it was a floor in the cellar of a tall building. Narrowly, that is correct. But broadly speaking, it is an incontrovertible truth that the Fed under Greenspan ran an asymmetric reaction function, with market participants fully aware that was what the Fed was doing. By definition, such a policy should be expected to contract risk premiums and lift asset price valuations.

But, as Mr. Greenspan himself said last summer in his valedictory address at Jackson Hole, "history has not dealt kindly with the aftermath of protracted periods of low risk premiums." Thus, it is hard for me to avoid the conclusion that too much success in stabilizing goods and services inflation, while conducting an asymmetric reaction function to asset price inflation and deflation, is a dangerous strategy.

Yes, it can work for a time. But precisely because it can work for a time, it sows the seeds of its own demise. Or, as the great Hyman Minsky declared, stability is ultimately destabilizing, because of the asset price and credit excesses that stability begets. Put differently, stability can never be a destination, only a journey to instability.

Keynes knew that. The Austrians knew that. On that, they agreed. What they disagreed about was whether instability was caused by fiat money makers holding real rates away from the natural level. For Keynes there was no ex ante natural rate level, only an ex ante imperative for policy-makers to pursue full employment. And the key to that was maintaining investment - private and public. For Keynes, there was no natural rate of interest at which that would happen, because investment is inherently the product of animal spirits, which fluctuate in animal-spirited ways.

Thus, the notion that the Fed can ignore asset prices except to the extent they matter in a Taylor Rule framework is, to my way of thinking, loosing its moorings. The putative neutral real rate is indeed time varying, not a constant as Taylor assumed. Actually, I think most Fed officials agree with that proposition, including Chairman Bernanke.

What they haven't embraced, however, is that the dominant variable driving fluctuations in the neutral rate is fluctuations in risk appetites in the private sector, which have a pro-cyclical reflexive quality, fueled by moral hazard. And that is a prescription for both Austrian maldistribution of resources as well as long term deflationary risk.

To be sure, those outcomes haven't bitten either the U.S. or global economy in the bum yet. But that doesn't mean they won't. In fact, the logic of the serial-bubble game suggests that the longer it is played, the more difficult it is to play, as the number of under-levered assets declines every time the game is played.

How to get off this treadmill? First and foremost, I think, as discussed in my Money Marketeers speech, the Fed needs to set its inflation target - or comfort zone, as it is called - high enough so that the U.S. economy - and indeed the global economy - could absorb a shock to aggregate demand, perhaps from a bursting property market bubble, without generating palpable risks of deflation, triggering once again the Fed's asymmetric policy of aggressive easing. Second, I think policymakers should be more wary of excessive pre-commitments to the markets.

This is not, I want to stress, the same thing as reducing transparency. As New York Fed President Giethner articulated brilliantly in a speech last month, transparency involves candidly presenting what you know and also what you don't know. Acknowledging genuine uncertainty is not being opaque, so long as the sources and nature of the uncertainty is transparently communicated. In contrast, articulating certainty when uncertainty is reality is not transparency, but a disservice called moral hazard.

Bottom Line

Yes, I am a Keynesian. But more precisely, I'm a Keynesian wearing Minsky clothing, and doffing Austrian shoes. In the fullness of time, I expect Chairman Bernanke, a brilliant Keynesian, to rediscover that the Austrians were not all wet in their diagnosis of the potential for maldistribution of investment, even though they were soaking wet about what to do about it. The Austrians said let the asset price and credit excesses purge themselves. A much better way, I believe, is to lean against the excesses preemptively, using all available tools, including regulatory tools.

Yes, inflation targeting is fine. Myopic inflation targeting is not. Asset prices matter, and not just in the context of their influence on aggregate demand relative to aggregate supply and, thus, inflation. Asset prices matter in their own right, because wild swings in asset prices, even in the context of "stable" goods and services inflation, are a source of both volatility and maldistribution in investment.

And, in the long run, a source of deflationary, not inflationary risk.

Some more trouble for homebuilders.

2006-07-10T15:25:00.000-07:00

More pain for home builders
KB Home, Dominion Homes issue negative views on housing
E-mail | Print | | Disable live quotes
By John Spence, MarketWatch
Last Update: 9:17 AM ET Jul 10, 2006

BOSTON (MarketWatch) -- A pair of home builders said the U.S. housing market continues to soften, reflected by weaker orders and higher cancellations, and one of them warned that the downturn could continue into next year.
Despite a healthy backlog of homes awaiting construction, KB Home (KBH :45.12, -0.64, -1.4% ) said in a Securities and Exchange Commission filing Friday that its outlook is cautious "as conditions in many of the markets we serve across the U.S. have become more challenging in recent months."
The Los Angeles company added that several of its markets "have been affected by a buildup of new and resale home inventories, higher interest rates and higher cancellation rates, particularly markets that have experienced rapid price appreciation or substantial investor activity, or both, in the past few years."
For the quarter ended May 31, KB Home, the nation's No. 5 builder by 2005 deliveries, said net orders fell 19% from the year-ago period to 9,908 homes.
Although the company is positive on the long-term outlook for housing on strong demographics and job growth, it cautioned it expects "the current negative trends in the U.S. housing market to continue for the remainder of 2006 and, possibly, into 2007."
Another builder, Dominion Homes Inc. (DHOM :8.28, -0.45, -5.2% ) , also on Friday reported deteriorating order trends.
The Dublin, Ohio, builder said that for the second quarter ended June 30, it sold 356 homes with a sales value of $66.2 million, versus 655 homes and $123.1 million in the year-earlier period.
Deliveries and backlog also fell from the year-earlier quarter, reflecting "the difficult home sales conditions in the company's markets," Dominion said. The company focuses on first-time buyers in the Midwest.
Raymond James & Associates analyst Rick Murray on Monday lowered his 2006 and 2007 profit outlooks for the company after the disappointing report. He cut his 2006 forecast to a loss of $1.50 a share, from a loss of 85 cents, and the 2007 estimate went to a loss of $1.35 a share from a loss of 35 cents.
"Dominion continues to face challenging conditions in the Columbus [Ohio] market, to which there appears to be no relief in sight for the foreseeable future," said Murray, who reiterated his underperform rating on the stock.
"The earnings outlook remains unpromising at this juncture, as we do not anticipate an increase in demand for new construction in the near term," he added.
Home-building stocks have been punished as housing cools -- the Dow Jones U.S. Home Construction Index (DJ_3728 :0.00, 0.00, 0.0% ) is off about 30% year to date.
Much of the concern has been centered on higher interest rates. For the week ended July 6, the 30-year fixed-rate mortgage averaged 6.79%, approaching its most recent peak of 6.81% set in May 2002, according to Freddie Mac (FRE :58.14, +0.54, +0.9% ) .
John Spence is a reporter for MarketWatch in Boston.

Once More, congratulations to The Azzurri!

2006-07-09T18:44:00.000-07:00

It was an ugly game, and probably France outplayed Italy for a majority of the game. But, the Italian defence did not crack and won the game on penalties. Fabio Cannavaro was magnificent.

ECB and inflation.

2006-07-05T19:02:00.000-07:00

ECB May Toughen Tone on Inflation, Maintain Key Rate (Update1)
July 6 (Bloomberg) -- The European Central Bank will probably keep interest rates unchanged today, and policy makers may toughen their inflation-fighting rhetoric to pave the way for an increase as soon as next month.

ECB policy makers led by Jean-Claude Trichet will probably keep the benchmark rate at 2.75 percent, all but two of the 50 economists in a Bloomberg News survey said. The ECB will announce its decision at 1:45 p.m. in Frankfurt and Trichet will brief reporters at 2:30 p.m.

Investors have raised bets the ECB will step up rate increases to keep faster economic growth and surging oil costs from fueling inflation in the dozen euro nations. Policy makers lifted their key rate by a quarter point in the past three quarters. Producer prices are rising at the fastest in more than five years and unemployment is at the lowest since 2001.

``The ECB will express satisfaction at the outlook for growth but also underscore the risk of inflation and, to a degree, lay the groundwork for the next increase,'' said Kornelius Purps, an economist at HVB Group in Munich. ``I expect Trichet to intensify his hints to make the case for a rate increase.''

Economists at JP Morgan Chase & Co, ABN Amro and Barclays Capital last week said they expected the bank to move faster than they'd anticipated. JP Morgan Chief Economist David Mackie expects the bank to raise its rate to 4 percent by early 2007.

`Upside' Risk

Borrowing costs are rising globally as central banks seek to rein in inflation. In the U.S., the Federal Reserve on June 29 raised its main lending rate for a 17th meeting to 5.25 percent from 5 percent and said further increases depend on future information on growth and inflation. Economists expect the Bank of Japan to raise interest rates next week after keeping them near zero since March 2001 to end deflation in the world's second-largest economy.

Stronger growth is giving the ECB room for further rate increases. The European Commission said June 30 that the euro- region economy is expanding faster than it forecast in the previous month, with risks to the 2.1 percent growth estimate ``tilted to the upside.'' The ECB expects about the same pace this year after a 1.3 percent expansion in 2005.

European manufacturing expanded in June by the most since August 2000 and services grew at the fastest pace in six years. Euro-region unemployment declined in May to the lowest since October 2001, pushing the jobless rate to 7.9 percent.

`Higher Adjustment'

ECB council members have said they're concerned accelerating growth leading to more entrenched inflation as companies pass on higher costs and workers seek more pay.

``I would not rule out a higher adjustment to rates than 25 basis points,'' nor quickening the pace of increases from once every quarter, ECB council member Nicholas Garganas said in an interview on June 26. In another interview the same day, fellow council member Yves Mersch said the bank ``won't hesitate to act'' when needed and that rates are still ``historically low.''

``They have sent a clear message that they want to step up the pace and we will discover the word `vigilant' thrown about with abandon,'' said Charles Diebel, head of European rates strategy at Nomura Holdings Inc. in London. ``The market would take that as a sign they will move at the start of August.''

Trichet last used the word ``vigilant'' to prepare markets for the rate increase on June 8.

Rising Prices

Euro-region inflation held at 2.5 percent in May and credit growth grew at the fastest pace since the bank took charge in 1999. The ECB aims to keep inflation just below 2 percent.

Crude oil prices have increased 26 percent since early December when the ECB raised rates for the first time in 2 1/2 years. Crude touched a record of $75.40 a barrel in New York yesterday and was trading at $74.99 at 8:15 a.m. in Singapore.

Producer-price inflation in the euro region accelerated to the fastest pace in more than five years in May. Excluding energy, prices rose 2.6 percent from a year earlier, up from 2.2 percent in the previous month.

``ECB hawks can credibly claim that growth above trend, inflation above target and a run-away surge in credit justify a faster pace of policy firming,'' said Holger Schmieding, chief economist at Bank of America in London. ``The key risk to our baseline scenario of one 25 basis point rate hike each quarter remains that the ECB may accelerate the pace.''

Investors have increased bets the ECB will raise rates more rapidly. At 3.64 percent on July 5, the yield on the three-month futures contract for December shows investors have now almost fully priced in a further 75 basis points of tightening by the ECB this year, compared with 50 basis points on June 12.

The contracts settle to the three-month inter-bank offered rate for the euro, which has averaged 15 basis points more than the ECB's key rate since the currency's debut in 1999.

Interview with Ken Heebner from WSJ!

2006-07-05T18:58:00.000-07:00

MUTUAL FUNDS QUARTERLY REVIEW

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Surviving a Real-Estate Slowdown
A 'Loud Pop' Is Coming,
But Mr. Heebner Sees Harm
Limited to Inflated Regions
By GREGORY ZUCKERMAN
July 5, 2006; Page R1
The real-estate market shows signs of slowing. Is there deeper weakness ahead? Fewer questions are more important to mutual-fund investors. Many own funds with real-estate-related shares -- not to mention homes and vacation properties. And many economists believe a slowdown of the housing market could hurt the overall economy.

To get a lay of the land, we tracked down Kenneth Heebner, who since 1994 has managed the $1.2 billion CGM Realty Fund. It has the best 10-year record of all real-estate-focused mutual funds, according to fund tracker Lipper Inc., up an average of nearly 22% a year during the past decade, well more than double the broader market. The fund also has one of the best one-year records, up 32% through June 30.

THE JOURNAL REPORT

See fund performance by sector, plus the complete Mutual Funds Quarterly Review.
Mr. Heebner, 65 years old, is better positioned than many real-estate fund managers to speak about prospects for the housing sector. His fund has viewed its mission more broadly than most rivals, so he isn't shy about ditching real-estate stocks. Among big holdings for CGM Realty during the past year: coal-company stocks, a hot category that qualifies in Mr. Heebner's view because coal companies own a lot of land. He also runs three other mutual funds, including CGM Focus Fund, so he spends a lot of time looking beyond houses and hotels to other parts of the economy. These three funds have among the best five-year records in their categories.

Here is our conversation:

WSJ: How is the housing market?

Mr. Heebner: A significant decline in prices is coming. A huge buildup of inventories is taking place, and then we're going to see a major [retrenchment] in hot markets in California, Arizona, Florida and up the East Coast. These markets could fall 50% from their peaks.

WALL STREET JOURNAL VIDEO

Journal reporter Gregory Zuckerman discusses how concerns about a housing slowdown have investors shifting their money to hotel and apartment REITs.
TAKING QUESTIONS

PODCAST: Mr. Zuckerman interviews Ken Heebner of CGM Realty Fund to discuss investing in the real-estate market. Listen now or subscribe, plus see all the Journal's podcasts.
WSJ: What has you so concerned?

Mr. Heebner: I'm worried that more people will default on their mortgages. Risky mortgages such as interest-only and pay-option adjustable-rate mortgages require no principal amortization and in some cases payment of only a fraction of the interest due, have been widely used in the last two years. Some people got 100% financing for their homes. It made the tech bubble look like a picnic. When housing is going up rapidly and you can buy far more than your income can support, some people are eager to make big profits by extending themselves financially.

As housing prices fall more people will be under water, and these people are just going to walk away from their homes. They are going to say, 'I'm outta here.' You're going to see increasing foreclosures over the next several years. As [home] prices come down, it will create a difficult environment for home builders.

WSJ: What data have you most worried?

Mr. Heebner: We're seeing a huge increase in inventories of unsold homes. The role of incentives in selling a home is increasing so the weakness doesn't show up immediately in list prices. Large price declines will follow in inflated markets.

WSJ: More than 25% of homeowners don't have a home mortgage because they own their property outright. Won't this keep problems in check?

Mr. Heebner: Most people won't have problems and much of the country will be fine. I don't think anything will go wrong in places like Texas, Iowa City or Minneapolis. ... But prices are being set by a minority of participants in the market, [those who have borrowed the most and used the most aggressive types of mortgages]. There will be a loud pop in inflated markets. It's where prices were artificially inflated by people buying houses with risky mortgages that we'll see problems. ... The person who feels the pinch is the person who used an aggressive mortgage and is struggling to meet the mortgage payments.

WSJ: Given the big size of some of the markets that you see as inflated, won't the regional 'pops' reverberate throughout the economy?

Mr. Heebner: The pops will reduce the growth rate of the economy, but they won't precipitate a downturn. The economy only turns down when the Federal Reserve takes aggressive action to cause a downturn. I think the current pattern of higher interest rates reflects a decision to normalize rates after taking them to abnormally low levels to stave off potential deflation. When the extent of the housing slowdown becomes apparent, I think the Fed will pause, rather than take rates to a level that threatens an economic downturn. The only real threat to the economy is an overly aggressive Fed, and not a downturn in the housing market, which won't by itself push the economy down. In fact, it provides an insurance policy against the Fed becoming overly aggressive.

WSJ: Do you agree with economists who have described the individual consumer as a linchpin of the economy during the past few years, using refinancings to fuel the expansion?

Mr. Heebner: Borrowing against home equity has been overrated as a source of economic stimulus. While it has been a factor in the economic expansion, I don't think it's been the most important factor.

WSJ: How are you allocating investments in your real-estate fund?

Mr. Heebner: We define real estate broadly; it includes mining companies, because of the land they use. Today we have about 25% of the fund in mining stocks. The stocks are attractive, but I also see significant opportunity in real-estate investment trusts, which comprise 69% of the portfolio. We also have 6% in commercial real-estate brokers.

WSJ: What areas of real estate are you most excited about?

Mr. Heebner: We're investing in office and apartment REITs, like Archstone-Smith Trust, Essex Property Trust Inc., SL Green Realty Corp. and AvalonBay Communities Inc. Apartment rents are going higher [as rising interest rates makes homes less affordable for many consumers, and a strong economy encourages rent increases].

In many parts of the country, like Texas, when demand goes up, companies can do more building of rental apartments. But the greatest supply constraints are in parts of the Northeast and California. And that's where the apartment REITs we own are focused.

In the office sector we like Vornado Realty Trust as well as SL Green, which have great management and are in Manhattan, one of the most supply-constrained areas in the country.

WSJ: Many apartment-REIT stocks already have climbed. Aren't rent increases baked into the stock price?

Mr. Heebner: Yes, people assume rents are going up, but the question is the magnitude of the increases. Consensus appears to assume 5% increases in the next year but I think the increases will be a lot more than that. Demand will grow, but supply of apartments won't because construction costs are increasing significantly and supply constraints will limit new developments in California and parts of the Northeast.

WSJ: What's your take on home-builder stocks?

Mr. Heebner: At the end of 2001 we bought home builders. These stocks were trading at six times earnings, and people were worried that the stocks would be hurt by an economic downturn. I became positive when I saw the growth potential created by rising demand and market share gain by the public builders. But if 20% of purchases are for investment purposes and so many borrowers are subprime, that says to me trouble is coming. We started cutting back on home-builder shares at the end of the fourth quarter of 2004 and eliminated them during the first six months of 2005.

WSJ: Why are you buying hotel REITs?

Mr. Heebner: After the 9/11 attacks, hotel construction fell, and it has only slightly recovered. But demand is growing, as the global economy strengthens and leisure travel is strong, as is business travel. You'll see more tourism with the dollar weaker. During the next several years, there will be an inadequate supply of hotels and that makes for a healthy environment for REITs. We like Host Hotels & Resorts, LaSalle Hotel Properties and FelCor Lodging Trust.

WSJ: What sectors are you favoring in your other funds?

Mr. Heebner: Energy and steel. I believe that the global supply and demand imbalance for crude oil remains in place. Robust global demand for steel is outrunning the ability of steel producers to meet demand.

WSJ: Your 10-year record includes a tough period. In 1998, the real-estate fund lost 21%, worse than the REIT index and much worse that the big gains of the broader market that year. What did that period teach you?

Mr. Heebner: In 1998 I had an aggressive position in hotel REITs. ... I anticipated that more companies would use a REIT structure to shield their earnings from taxes. But Congress changed the law, and I didn't see it coming. The market was smarter than I was. The lesson is that, if I see legislative activity that could be negative, I should pay more attention.

WSJ: How much should ordinary individual investors have in real-estate stocks and funds, given they probably own their homes?

Mr. Heebner: Commercial real estate has a totally different outlook than residential housing, [so commercial REITs] represent diversification. ... I own all the funds I manage and I own the condo I live in.

Write to Gregory Zuckerman at gregory.zuckerman@wsj.com

Ugly win for the French.

2006-07-05T18:54:00.000-07:00

July 6 (Bloomberg) -- France will face three-time champion Italy in the July 9 World Cup final after Zinedine Zidane, playing in his last soccer tournament, scored from a penalty kick to give his team a 1-0 victory.

The 34-year-old Zidane, who got two goals in the team's 1998 final win over Brazil, slotted his kick past Ricardo in the 33rd minute at Munich's World Cup stadium yesterday to give France a shot at a second world title.

The French, who exited the 2002 World Cup without scoring, advanced to a rematch of the 2000 European Championship final, which they won 2-1. The final will be held at Berlin's Olympic stadium.

``Zidane affords the French public real dreams,'' France coach Raymond Domenech told reporters. ``That's always been the case with him for 10 years now.''

Zidane, who is quitting after the World Cup, knocked Portugal out of a tournament for the second time with a penalty kick after his sudden-death winning goal in the Euro 2000 quarterfinals.

The player nicknamed ``Zizou'' took two steps before drilling his shot past goalkeeper Ricardo, who got his fingertips to the ball without changing its course.

Ricardo Carvalho was adjudged to have tripped Thierry Henry for the penalty, a ruling the Portuguese disputed. Portugal coach Luiz Felipe Scolari remonstrated when the referee turned down a penalty appeal as Cristiano Ronaldo, jeered by fans with his every touch, fell in the area with France defender Willy Sagnol's arms raised next to him.

`Ugly Duckling'

``We were the ugly duckling of the final four,'' Scolari told SporTV.

Italy defeated Germany 2-0 yesterday with goals in the last two minutes of extra time in Dortmund. It's aiming for a European record fourth World Cup victory. Brazil has the most wins with five.

Portugal came closest to tying the score when goalkeeper Fabien Barthez scooped a dipping 35-yard free kick from Ronaldo into the air like in volleyball and Luis Figo headed the ball over the bar with 13 minutes left.

The French defense, shielded by midfielders Claude Makelele and Patrick Vieira, had mostly contained Portugal's attack as it secured a fifth shutout at the tournament.

Portugal had the better of the early play, with Deco forcing Barthez into a diving save and Maniche shooting just over the bar. Barthez also saved from Figo before France began to respond midway through the first half.

Fuming

Henry cut inside right-back Miguel and shot straight at Ricardo then minutes later turned Carvalho in the penalty area, catching the defender and falling to the ground with outstretched arms to win the penalty.

Scolari, fuming about the decision, protested again as Ronaldo fell in the area under Sagnol's challenge. Ronaldo was criticized by England players for urging the referee to dismiss Wayne Rooney in the previous round.

As the second half began, Ricardo scrambled to save a shot by Henry that crept under his body, deflected off his hand and span out of play. The Portugal goalkeeper then blocked a shot by Ribery with one hand.

Portugal striker Pauleta turned in the penalty box and fired into the side of the net in the 53rd minute, before former world player of the year Figo missed the best chance after Barthez's unorthodox save from Ronaldo.

`Party Continues'

France won its second World Cup semifinal in five attempts and ended Scolari's unbeaten run at the World Cup at 12 games after the coach led Brazil to the world title four years ago.

Scolari played seven minutes without a striker after taking Pauleta off in the 68th minute and only putting Helder Postiga on in the 75th. Maradona said: ``He paid for it.''

France's substitute striker Louis Saha will miss the final after receiving a second yellow card. In World Cup play, France and Italy are tied at two wins each.

``We hope the party continues,'' France defender Lilian Thuram told reporters. ``At the beginning of the World Cup we had a fixed objective. Now we want this to end with a good finish.''

The Portuguese were taking part in their first World Cup semifinal since 1966, when they lost to England. They will face host Germany in Stuttgart on July 8 in the third-place playoff.

Portugal had allowed only one goal in Germany before today and was unbeaten in 17 matches at major tournaments. France also beat Portugal in the semifinals of the 1984 and 2000 European Championships.

Congratulations to The Azzurri!

2006-07-04T18:17:00.000-07:00

Italy Beats Germany 2-0 on Late Goals, Reaches World Cup Final
July 5 (Bloomberg) -- Italy scored twice in the last two minutes of extra time to beat host nation Germany 2-0 and advance to the soccer World Cup final against Portugal or France, who play tomorrow.

Fabio Grosso curled in a left-foot shot from 15 yards in the 118th minute to send the entire Italian squad charging onto the field in celebration. With the final play of the game, Alessandro del Piero hit the ball past Jens Lehmann from 10 yards to hand Germany its only defeat in Dortmund in 15 matches.

``To beat the Germans in their own backyard is incredible,'' coach Marcello Lippi told reporters. ``Our team played such a good match in this atmosphere. The team was composed.''

Lippi's team moved within one victory of a European best fourth title and will play in its sixth final, one short of the record held by Germany and Brazil. The team shrugged off a match- fixing scandal back home to reach the final for the first time since losing to Brazil in 1994. Italy has never lost to Germany in a major tournament.

``It was an unforgettable game,'' former Argentina captain Diego Maradona told Spain's Cuatro TV station. ``Lippi played the game of his life. Italy deserved to win.''

It's the first time the Italians have won in extra time of a World Cup since they defeated Germany in the 1970 semifinal. They hit the frame of the goal twice in extra time yesterday and were indebted to a fingertip save by Gianluigi Buffon to keep them in the game. The Azzurri exited the past four competitions after taking the game beyond the regulation 90 minutes.

Fast Pace

In a match of high tempo in front of a sellout crowd of 65,000, each team mounted several attacks and created the clearer chances at the end of regulation play. After managing just three shots in the first half, Germany had 13 efforts in total in the match, two fewer than Italy.

Italy, which has reached the final every 12 years since 1970, twice came close to winning the game in the first period of extra time as Alberto Gilardino struck the post with a scuffed left-foot shot, and Gianluca Zambrotta hit the bar a minute later.

Germany's Lukas Podolski headed yards wide when he was unchallenged at the end of the first period, and later forced Buffon to tip his drive over the bar.

Compliments

``We both had our opportunities to settle it before the final whistle,'' Germany's Miroslav Klose, the tournament's top scorer with five goals, told broadcaster ZDF. ``My compliments go to Italy. They got the better of us and scored great goals in the end.''

Italy had 57 percent of possession and Andrea Pirlo, who forced Lehmann into a late diving save when the score was tied, was named man of the match.

Francesco Totti had the game's first shot on target after four minutes, testing Lehmann from a 30-yard freekick. The goalkeeper easily collected the ball, which deflected off Germany's defensive wall.

Germany's best effort in the first half came as Bernd Schneider fired over from 15 yards after receiving a pass from Klose on the edge of the area. He has scored only once in his previous 69 international matches.

Klose ran at goal near the start of the second half, accelerating past Gennaro Gattuso and Cannavaro, but failed to control the ball and Buffon came off his line to smother the attack. Lehmann cleared as Simone Perrotta raced in on goal in the 85th minute, felling him in the process, and the game went to extra time.

`Fantastic'

After only 38 seconds of extra time, Gilardino cut inside Michael Ballack and hit a close range effort against the post, before Zambrotta rattled the bar from 20 yards. Podolski headed wide from a David Odonkor cross and clutched his head in horror.

``I have to pay a huge compliment to my team for the way they played,'' Germany coach Juergen Klinsmann said. ``This whole World Cup was really fantastic.''

Germany becomes the seventh host nation out of eight to miss out on the final since Argentina won the title in 1978. The Germans last lost a semifinal that year and had won their past four straight before yesterday. They have never defeated Italy in five attempts at the World Cup.

Italy is unbeaten in 24 matches.

``The guys were great,'' Lippi said. ``They managed to roll the enthusiasm and love for football onto the pitch -- simply a fantastic performance.''

BOJ may raise rates.

2006-07-03T22:02:00.000-07:00

Bank of Japan May Raise Interest Rates Next Week, First Time in Six Years
July 4 (Bloomberg) -- The Bank of Japan will probably raise interest rates for the first time in almost six years next week after a report indicated companies plan to increase spending at the fastest pace in 16 years, a survey showed.

Governor Toshihiko Fukui and his policy-board colleagues are likely to increase the benchmark overnight call rate from near zero at the end of a two-day meeting on July 14, according to nine of 15 economists surveyed by Bloomberg News.

Fukui said last month his board will raise rates ``without delay'' should investment become excessive. Ending the zero-rate policy will give the bank tools to manage the pace of growth in an economy that is headed for its longest postwar expansion.

``The Tankan survey confirms the strength of the economy and backs up the case for a July rate increase,'' said Taro Saito, a senior economist at NLI Research Institute in Tokyo. ``The report is evidence that capital spending could start to become excessive.''

Japan's largest companies plan to increase spending 11.6 percent this year, the most since the year ended March 1991, when companies boosted investment 18.4 percent, the Bank of Japan's quarterly Tankan survey showed yesterday. The benchmark 10-year bond yield rose to 1.965 yesterday, the highest since yields touched 2 percent on May 16.

The Bank of Japan would join the U.S. Federal Reserve and the European Central Bank in raising rates as faster global economic growth and near-record oil prices stoke inflation. The Fed raised its benchmark rate a 17th straight time to 5.25 percent on June 29. The ECB may signal further increases in its key rate, now at 2.75 percent, when policy makers meet on July 6.

Government Opposition

Government opposition may prove to be an obstacle to a July increase, said Yasunari Ueno, chief market economist at Mizuho Securities Co. Prime Minister Junichiro Koizumi yesterday said the central bank should carefully assess the economy and help overcome deflation before raising borrowing costs. Chief Cabinet Secretary Shinzo Abe urged the bank to keep rates near zero to support the economy.

``We want the Bank of Japan to continue its zero-rate policy for some time,'' Abe told reporters in Tokyo yesterday.

The government asked the central bank to delay its decision in August 2000 to raise rates, allowing it to blame the bank when the economy slipped into recession three months later.

``It's natural to expect the government to exercise its right to object,'' said Ueno. ``The Bank of Japan will want to avoid a repeat of the nightmare of 2000, which would make it difficult to raise rates in July.''

Murakami Investment

Officials from the Ministry of Finance and Cabinet Office attend monetary policy meetings to express their views, without having the right to vote. Expectations for higher rates have pushed up yields in the world's largest sovereign bond market, forcing the government to pay more to fund its 749 trillion yen of debt.

The government's bargaining power was strengthened after Fukui's acknowledgment last month that he invested in a fund created by Yoshiaki Murakami, who was indicted for insider trading on June 23. Koizumi and other key policy makers said Fukui shouldn't resign over the investment, which he made in 1999 when he worked for a private research institute.

Fukui is scheduled to speak to central bank managers on July 6 in Tokyo, which will be his first formal opportunity to discuss the Tankan data.

Rising profits are prompting companies including Toyota Motor Corp. to increase spending and raise wages, ending seven years of deflation. A report last week showed that core consumer prices, which exclude fresh food and are the bank's preferred measure of inflation, rose at the fastest pace in eight years.

Reports on machinery orders -- a key indicator of future capital spending -- bank lending and producer prices are also due before the bank meets.

``A delay to the end of the zero-rate policy could be perceived as the bank caving into political pressure and would reflect unfavorably on the bank,'' said Hiroaki Muto, senior economist at Sumitomo Mitsui Asset Management in Tokyo.