Capital Markets Update

By Louis S. Barnes                                      Friday, July 20th, 2012

It is high summer, a scorcher, even mad dogs looking for shade. It's supposed to be a nothing-happening time. However, the anxious suspense in markets is as high and hot as the sun.
     Everyone knows that the US economy has lost momentum. Perfesser Bernanke on Tuesday twice in one page used "decelerated," followed by "…the generally disappointing tone of recently incoming data." Everyone expects that the Fed will do something, but nobody knows what or when, possibly not the Chairman.
     Bernanke vaguely mentioned use of the Fed's balance sheet, "QE3' the shorthand, but no one outside the Fed can tell if action is held up by internal politics (resistance by the regional-Fed hardheads), or by doubts of QE effectiveness, or by desire to keep powder dry for something more troublesome than a slow patch.
     The primary purpose of QE has been to knock down long-term rates, but markets have already done that, the 10-year T-note to 1.46%, and mortgages to 3.50% (if someone answers the phone). The secondary purpose has been to encourage risk-taking by investors and lubricate lending, but credit is choked by regulation and post-Bubble over-reaction. Bernanke: "…Prospective homebuyers cannot obtain mortgages due to tight lending standards." In the Fed's most-recent meeting minutes, the only group agreement in 12 pages was the plaintive wish for new ideas to help the economy.
     The Fed should hold something in reserve to meet two contingencies: a failure to defer the fiscal cliff now five months away, and/or a euro collapse. The fiscal cliff is actually nearer by. We are only three months from election. Mr. Obama has been unable to make a deal with the current Congress; whether he is re-elected or the lamest of ducks, Congress will remain the same until January.
     Europe is like watching the Liar on Saturday Night Live. Day after day after day after day leadership says everything is fine, going according to plan. Right. This week Finland's short-term sovereigns went to negative yield, and Spain's 10s rose to 7.20%. Marker: for the moment French debt is still receiving flight-to-quality cash, its 5-year down to 0.86%. When markets realize that French banks, budget, economy, and trade deficit are in sum no better shape than Italy, and French yields begin to rise….
     On to something understandable: US housing. For once, NAR has properly explained the  drop in June sales of existing homes, down 5.4% from May, up 4.5% from June 2011. The primary reason: a scarcity of the cheapest distressed inventory, the darling of cash-paying investors. Listed inventory is down 24% versus last year.
     Does this pattern mean anything? For the economy, or housing in general?
     No. Not yet.
     Listed inventory is merely apparent supply. The shadow supply lies off-shore like ocean swells not yet formed into waves. The most deeply distressed inventory, not yet seized in foreclosure, let alone listed, seems to be down from 4.5 million homes to 4.0 but replenished by constant inflow of new delinquency in shaky-economy feedback.
     Some especially favored local markets like mine in Boulder, like Saudi Dakota, and as in any IT paradise are doing remarkably well. The rest of the country… how can the inventory/sales ratio fall so far and prices not rise? Because we still have at least 15% of homes under water versus mortgage, most owners still making payments; many new sales merely recognizing the pre-existing loss, hardly encouraging to sellers or buyers.
     Supply/demand thinking by finance types when the Bubble blew was wrong then and still is. Prices crashed far below "clearing prices" and resulted in more sellers and fewer buyers; now it will take quite a while to work off immense but latent inventory.
     Media also focus on sales of new homes. Although rising a little, they are not particularly useful, except to the stock prices of builders. The GDP contribution of new construction even in good times is low-single digit. For a better economy we need home prices to rise to repair household balance sheets, and every percentage point will mean fewer homes under water. And for that, as ever since 2007, we need credit.