MOTS

Capital Markets Update

By Louis S. Barnes   Friday, June 29th, 2012

Reading media reports of economics is usually an exercise in decoding political bias and trying to find the center of things. Today we’re in enough trouble that to understand “news” we must also strip away hope and pessimism.

Big week for all of that.

First thing first: the US has lost some forward momentum, but is not entering recession. Consumer spending did not rise at all in May, dead flat, but orders for new durable goods doubled the forecast. New claims for unemployment insurance are running 385,000 weekly, up 15% from last year’s best run since 2008, but not spiking. There are some flickers from housing, but that’s all (more below). Definitive reports for June come next Monday and Friday, purchasing managers and payrolls.

Europe… we have another “relief rally” underway today (Dow up 220, gold up $55), as yet another Brussels summit has delivered yet more fibs to buy time. However, this time is different. After all prior can-kicking, markets took the bait, believing that Europe intended actual material progress. This time a lot of people (including me) had talked themselves into believing the euro zone was about to pull its own plug, maybe as soon as this weekend. Today’s relief rally does not reflect any belief whatever in European progress; it is instead a cynical, tired, shoulder-slump at the sight of people without the courage to take the Luger to a quiet spot and do the honorable thing.

The tell-tale as always in these last years: the 10-year T-note. The sum-total extent of relief is a rise in yield from 1.57% to 1.65%. Mortgages high-threes, unchanged.

Housing is improving, but in a 17-step program to recovery has reached perhaps stage two. Case-Shiller found a 0.7% rise in prices in April to a level about even with one year ago. The FHFA House Price Index (which I much prefer) found a 3.0% price increase year-over year, essentially all of it in the first four months of 2012, the most recent data from April (housing data suffer terrible lag, especially the accurate stuff).

Today’s greatest mystery: where is the distressed inventory? www.lpsvcs.com has the best data: the number of homes in foreclosure somewhere has not changed in a year. Serious delinquency (90-days late or in foreclosure) has fallen from 7.86% of all homes to 7.37%, a huge swamp draining imperceptibly. Total foreclosure sales were only 66,000 in April versus 4.5 million shadow inventory in terminal distress, outflow not significantly larger than inflow.

For descriptive amusement, visit www.fhfa.gov and scroll to pages 36 and 37 of the HPI, the 20-Best and 20-Worst markets of 303 total MSAs. My home town, very-low-inventory Boulder, CO ranks as the 10th best of all, and we feel like it, although our one-year price gain is only 2.35%, and 5-year plus 1.60%. Bend, OR ranks third-best with 4.85% appreciation last year; however, its overall 5-year result has been minus-43%. The 20-Worst: #4 Las Vegas has lost 60% of value in five years, including 8.79% last year. #16 Atlanta: minus 23% 5-year overall, including 6.33% lost last year.

We have a long way to go before housing will lead the economy up.

Speaking of leading… the economic stories this week and year are dwarfed by events in leadership often responsible for the economic results. The principal reason that housing is unable to lead the economy: there is no public policy. Congress is entertained by gridlock on the subject, the Right hating any federal assistance whatever, and the Left amused by hating all bankers. Mr. Bernanke, the leadership hero of this time, in January orchestrated the finest housing-policy recommendations of the decade and got no response from any other office of government.

Competing theories of leadership: great people appear and then move events; alternately, deeply troubled times call great people forward. Look around the world, and it’s hard to figure by either theory how the supply could be so thin.

Then from nowhere, a man granted high station and for seven years in office amounting to nothing, from that nowhere somehow found greatness. Thank you, John Roberts. Not for saving ObamaCare, but for showing the way beyond partisanship.

Waiting For The Next Episode Of "As The Euro Turns"

Capital Markets Update

By Louis S. Barnes                          Friday, June 22nd, 2012

Markets show justifiable concern at a steady flow of soft data all over the world, but it’s hard to figure disappointment that the Fed did nothing dramatic this week.

The Fed’s QE operations have been designed to pull down long-term interest rates, to prevent runs on banks, and to ease credit. In the last 80 days the run from Europe has accomplished Jobs One and Two, cutting 10-year T-note yields by one-third, and all but drowned the US system in cash. The general shortage of credit is a different matter, a regulatory failure to which the Fed has formally objected repeatedly, yet compounded by its contribution to the national mania to over-regulate.

Broad policy here is in European-quality disarray, the stimulus-austerity conundrum just as unresolved as there. Economic conditions here are far better, banks immeasurably healthier, our whole situation improved by our wise decision to form a national government before issuing national currency.

If we’re in stimulus-austerity gridlock, what to do? What resource to draw upon? I have an idea, but you’ll have to wait through a parable and a true story.

An unemployed economist at last gave up on finding a new position, swallowed his pride and took a construction job. His first-day task: to carry a pile of bricks down from the roof of a new 2-story building. After humping the first load, invention came to mind.

He tied one end of a long rope to a tree, pulled the other end to the roof-top, threaded it through a pulley on a beam at roof-edge, tied it to a barrel found there, and filled the barrel with bricks. Pleased with his plan to lower the bricks instead of carrying, he fairly danced down the stairs to the anchor tree.

In retrospect, he felt that his sole mistake was to hang on to the rope as he untied it from the tree. The loaded barrel, three or four times the weight of the economist, as it descended lifted him rapidly toward roof-top, and bashed him as they passed each other. Just as the man’s fingers crushed into the pulley, the barrel struck ground, bricks breaking through the bottom, and the physics of the affair reversed, barrel whacking economist on its way back up and his transit down.

Onlookers felt the economist did make one further error. After landing on the pile of bricks… he let go of the rope.

Just a story. Another begins with the Great Society formation of Medicare and then Medicaid. Initial costs were trivial: in 1970 Federal health programs were 0.7% of GDP. Today, about 4% of GDP, $769 billion last year. But in the ’80s as costs spiraled, Congress moved more and more of the burden to the states via “un-funded mandate”: Thou Shalt Spend, But Thou Shall Find Thine Own Revenue. Cumulative state health spending now runs another $400 billion, still growing at triple CPI.

ObamaCare put all of its chips on coverage, nothing but argle-bargle to address cost. US healthcare spending, public and private combined, is about 18% of GDP, only about half supported by tax revenue. Our peer nations spend about 10% of GDP and get the same results that we do (see T.R. Reid’s “The Healing of America”). If we could cut costs by 6% of GDP, that would cut the overall Federal deficit by 80%.

Unanticipated physics… Here in Colorado, health spending is now 33% of the budget; 40% goes to K-12, 14% to public safety, and higher education has been chopped to 8% (headed to zero). The higher-ed cuts have been displaced to tuition increases running quadruple CPI (the Corleones should have had it so good), in turn displaced to student loan debt, the only category of credit growing, actually exploding as in good ol’ subprime days, a burden on youth without precedent.

The second half of Mr. Obama’s unfortunate “The private sector is fine” paragraph lamented job cuts by state and local government. Skinflints are not at fault: runaway health care is the problem. Whether the Supreme Court cans ObamaCare doesn’t matter. It will fail of its own weight.

Back to the austerity-stimulus conundrum, and one public resource sitting in plain sight, untapped: if we would use our silly damned heads we might get somewhere.

Waiting On Greece

Capital Markets Update

By Louis S. Barnes                                                   Friday, June 15th, 2012

Now we wait. At 2:30 ET Sunday come Greek election results and who-knows-what explosion at the opening of Asian markets Sunday night. More likely: a few more frozen days to digest the results, and any number of empty cans kicked into nearby walls.
     The biggest event next week will be the Wednesday conclusion of the Fed's meeting. The stock market this week began to trade up on bad news (a small rise in unemployment claims, a dinky drop in industrial production) on the assumption that bad news would mean QE3 from the Fed, which must be good news for stocks no matter how ugly the reality might be.
     Last week I compared this market-think to trained seals, and today I apologize to seals everywhere. Pick a more appropriate critter. If you took Psych I, you discovered that you could get a lab rat to sell its soul for a dozen Rice Krispies. Rats conditioned to central bank action are found not just in neckties at the NYSE, but all over the globe.
     Since WW II, the immense economic strength of the US combined with reslove at all central banks to avoid a Depression replay has enabled rescue from all severe financial crises. All rats and non-rats assume that rescue is just a flip of switch. An unpleasant crew on the Right and righteous Libertarians think that rescue corrupts the morals of rats, but given the raw material, why worry? Rescue when we can is right and proper.
     Europe's situation today is different from all other financial crises in the last 70 years. Some day a crisis was bound to come along that could not be rescued, and this one has a crucial marker: tectonic strain has built ever since the misbegotten euro rolled out, and efforts to meliorate have resulted only in more strain.
     What will the ultimate breach look like, and what is the hazard here?
     I may be the only optimist alive!
     There is a small chance that Europe, looking over the precipice will decide that the whole can adopt German behavior, and that Germans can become Californians. However, that adaptation would take many, many years, and might well inflict greater drag and hazard on the world than an all-at-once reset.
     The vastly more likely fault-line lurch would take place in one of two general ways. The orderly way: one Friday afternoon after US markets close, announce a euro-wide bank holiday, then a skip-Monday re-open in local currencies. The disorderly: stay in denial until markets pull the plug, and then a holiday.
     Chaos and losses follow, especially to anyone who expected repayment in euros by non-Ger/Neth/Aus/Fin entities. However, healing would  begin instantly. Local currencies would trade wildly for a few weeks, but find levels; all local central banks still exist; all senior business management knows local-currency trade and hedging; and all local political structures can again make local decisions.
     As most of Europe will devalue, exporters to Europe will either have to devalue or to sell less and slow. China would feel the worst bind: devalue versus the dollar to stay with Europe, and risk US trade war? Or keep the dollar-peg, slow, and begin to reform?
     Japan might be the worst exposed, but its vulnerabilities are local: its banks and citizens own 95% of government debt, and its ultimate default will be internal.
     Emerging nations -- Brazil-Russia-India -- would feel the breakdown in the unsustainable global-trade conveyor. However, the good-news effect: pretense exposed, rationalize their economies to reality as best they can.
     Here. Here? Falling commodity prices remove any threat of inflation, and free the Fed to take any measures necessary. Our banks are not at run-risk: they are drowning in stable deposits. We are less reliant on exports than any large nation. Our housing market is turning, applications for purchase loans up 13% last week. New data are on the flat side, but the economy is more uncertain than foreshadowing rollover.
     A euro-breakup would mark the end of a painful and irrational time, and resolution to the paired plagues of the last twenty years: unsustainable sovereign debt funding unsustainable trade. Long past due, inevitable, and a good, good thing.  

Lost A Little Ground This Week

Capital Markets Update

By Louis S. Barnes　　　　　　　　　　　　　　Friday, June 8, 2012　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　

　　　　 The world's financial markets now behave like not very bright but exceptionally well-trained seals, barking and clapping their flippers whenever they hear the words, "central bank."
　　　　 On Wednesday these circus performers talked themselves into belief in an ECB/European rescue of Spain's banks, and a new QE round by the Fed, and faith that these efforts would work. Dow up 280, 10-year T-note up from all-time bottom one week ago at 1.41% to 1.70%, mortgage borrowers startled by the run-up.
　　　　 Two days later, no mackerel from their trainers, the seals are back in the tank. The European end of this is straightforward: no one but Germany can float Europe, but it cannot unless all the rest of Europe accept German discipline, and the ability of non-German economies and societies to adapt is more in doubt every day. Spain needs help, but wants to retain sovereignty, fearful that Europe will do for it what it has done for Greece. In terminology from another time, in order to save the village it became necessary to destroy it. So, wait on a Greek election that doesn't matter, wait on a variety of other meetings and standoffs, wait until something breaks.
　　　　 In his first interview with Western media in five years, the Chairman of China's sovereign wealth fund, China Investment Corp's Lou Jiwei (no relation): "There is a risk that the euro zone may fall apart, and that risk is rising." Senior Chinese officials are not given to casual comments, not even once in five years.
　　　　 The overall central bank situation is more complicated and indefinite. Herewith an explanatory parable, told to rookies by generations of scarred　 merchandise managers.
　　　　 The president of a large departments store noticed the extraordinary profitability of household furnishings, and marched with his entourage to the seventh floor to congratulate the manager. That honest person said it was　 not her doing, all the work of the young man in charge of lighting fixtures. The parade moved on to his desk.
　　　　 The president offered praise, a raise, and promise of promotion, and asked the young man to describe the mechanics of his profitability. "Well, sir, when we have inventory that's not selling I mark it down and get it sold, and to avoid the loss I mark up the prices of the rest of the inventory." More congratulations, and the presidential crowd moved on, but -- one Deputy Assistant caught an elbow on a table lamp and knocked it flying. The young lighting manager leapt through the air, landing flush-and-thud on the tile floor, just in time to catch the lamp before it crashed.
　　　　 The president, not known for personal compassion: Good heavens! Your devotion to duty is admirable, but you could have been badly hurt saving an ordinary lamp!
　　　　 "Sir, you don't understand. That's the million-dollar lamp."
　　　　 The central banks of Europe, the UK, the US, and Japan have since the global, wholesale bank run began in July 2007 increased their aggregate ownership of various government IOUs from $3.5 trillion to $9 trillion. All bought with invented money, and not counting a similarly vast sum of government IOUs held by these banks as collateral; all with the sensible, defensible purpose of putting down the bank run and preventing firesales of assets of all kinds until economies recover.
　　　　 Good plan. However, in the aggregate global economies are no closer to recovery now than in 2007. The US is in much better shape, although too weak to pull the rest, all of whom are deteriorating. Why the US is still too weak, and what it might do are questions eluding leadership and most observers. Certainly central: the 20-year undercut of US wages by overseas competition, fair and not.
　　　　 But, another, more easily released drag jumps from the pages of the Fed's Z-1 released yesterday. In the first 90 days of 2012, residential mortgage credit contracted by $90 billion, $262 billion year-over-year. Some of course from write-down and foreclosure, but the beneficial effect of record-low rates is strangled by garroted supply and too-high standards. The mania to make banking safe is resulting in a global shortage of credit, making the world safe from economic growth, as well.

What A Difference A Week Makes!

Capital Markets Update

By Louis S. Barnes   Friday, June 1st, 2012

Tough day. The details will be media-inescapable; work on context instead.

US job data for May were poor, and April’s revised so. However, jobs are growing, incomes are rising (a paltry 0.2% monthly, but rising), and the NAPM for May arrived 53.5, a little off from April’s 10-month high but a healthy distance above 50 breakeven.

The US concern is delicate: until this newest data there had been good reason to hope that the US locomotive could begin to pull the world; now the chance has risen that global drag may stall us, too. Take heart: that’s a risk, far from a done deal.

The global picture and financial flows have been widely misdescribed — partly from ignorance, partly confusion, partly salespeople trying to rile their herds, and everybody trying to jam a genuinely new situation into old models and experience.
Since the dawn of central banking 135 years ago, the fundamental prescription during an economic meltdown and bank run has been to flood the economy with cash and government guarantees. Since 2007 we have suffered serial bank-on-bank “wholesale” runs, but all-ee same-ee.

The global monetary system has worked to perfection: clearing transactions and currencies, central banks smoothing panic after panic. And those central banks have also deployed the most basic medicine for recovery: knock interest rates to the floor, and promise to keep them there. Low rates stimulate economies, and over time convince investors that holding cash is stupid, and instead to take risk.

All of that is out the window now. Today.

Begin at the beginning: the cash in your wallet is an IOU from a government, and the IOU is as good as that government’s tax revenue versus expenditure over time. “Hard” backing for paper “fiat” currencies — metal, sea shells, whatever — is a primitive and failed means to keep government IOU-issuance under control. The painful and unresolved reality: it is up to us. Nearly all Western democracies began by the 1960s to borrow instead of resolving fiscal disagreement, and gradually lost their safety margin of revenue versus debt service.

There was no telling who or what accident would snap an over-stretched system, and it has turned out to be the misbegotten euro. This week we see the endgame of meltdown-fighting. The ECB has injected several trillion euros into the European banking system — which is still open, no domino closings — but the cash has run through the 17-nation euro zone like grass through a goose. To escape repayment of IOUs in new lira, peseta, and francs, euro out-runners have today bid the German 2-year to a negative yield, hoping for repayment in deutschmarks; and to US 10s not as an investment at 1.46% today, but a liquid place of safety; and to bonds and banks of Denmark, Norway, Sweden, the UK… anywhere to get out of the lunatic asylum.

The hard money boys have told us forever that the result of ECB liquidity would be inflation, and exactly the opposite is happening, inflation falling throughout Europe. Zero-percent interest rates that were to drive investors from cash have been unable to stop a stampede to cash. Cries for government guarantees, Germany or somebody, or for more government spending — desperate to continue the failed 50-year game — cannot comprehend the result of faith lost in revenue adequate to pay bills.

The euro is toast, no solution but to break up and let local currencies find levels allowing growth. A fantastic destruction of wealth is underway, inevitable, and social stability at risk. Elsewhere… embrace the lesson! Do not waste Europe’s disaster.

Here, and in China, and in the emerging world we still have time. All face the same chore: focus, pull together, and restructure away from any impediment to economic growth. Drop every cherished notion from China’s state industries to India’s “license Raj” to US regulatory paralysis (all remarkably close cousins). If it’s not productive, drop it — no more “A small price to pay for protecting ____.” Bust up profiteering cartels like health care and higher education. Live within our means, and be competitive in the world, or be Europe.