Tuesday, February 28, 2012


DOW + 23 = 13,005
SPX + 4 = 1372
NAS + 20 = 2986
10 YR YLD +.01 = 1.93%
OIL – 1.96 = 106.60
GOLD + 15.80 = 1784.90
SILV +1.47 = 37.03
PLAT + 11.00 = 1723.00

Dow at 13,000 for the first time since May of 2008.

I never really liked the Conference Board's Consumer Confidence Index. First, it reduces people to the role of consumers. I consume, but I do much more. I don't consider myself a consumer, at least not first  and foremost. Second, it isn't really trying to measure our confidence, it is trying to determine if we will loosen our steadfast grip on the purse-strings, and if we will buy something. Apparently we will. The Consumer Confidence Index jumped to 70.8 from 61.5 in January. A nationwide average of $3.78 a gallon was trumped by a stronger jobs market and a mild winter that left many people with more work and lower heating bills. Consumer confidence resulted in a 3% increase in chain store sales for the week. Meanwhile, the durable goods orders dropped 4.5% in January. Part of the drop may be the expiration of a tax break which pushed demand forward into December.

The Case-Shiller report on sales of homes in 20 major metropolitan areas across the country shows that house prices continued to drop in December, down 1.1%, for the 4th quarter, prices dropped 3.8%, and for the year, prices dropped 4%. For the Phoenix market, prices have been going up the past couple of months.

So, while we are seeing some signs of improvement in the economy, and confidence is up and the jobs market is showing very modest signs of improvement, the housing market, nationally is still in a mess. Purchases of new homes are down 77 per cent from their 2005 peak. They dropped another 0.9 per cent in January. Home sales overall are still dropping, and prices are still falling – despite already being down by a third from their 2006 peak. January’s average sale price was $154,700, down from $162,210 in December. 

For most people, their home is their largest purchase. The house is a large component of net worth, and one in three homeowners are underwater on their mortgages. Nationally, home inventories are declining in relation to sales, but there may still be about 5 million houses with delinquent mortgages or in the foreclosure process that will soon be added to the inventory. And the inventory numbers don't include 3 million or so vacant houses. Vacancies are up one million from 2006. Some of those vacancies will never be filled.

Phoenix may have hit bottom but we still face challenges. Last year we had the sixth highest foreclosure rate in the nation. Those properties are still moving into the  inventory pipeline. Half of all Arizona homes with mortgages are underwater; that compares with about 25% nationally. For investors, the inventory is tighter and demand is growing. Normal resales in the Phoenix market aren't seeing higher prices, not yet.

The negative wealth effect, homeowners who are underwater, combined with a lethargic labor market and declining real wages means the economy has not truly recovered. We are seeing signs of improvement but I believe the economy is still in a small 'd' depression. The implication is that the housing market is one of the big spots that could still use a jolt of economic stimulus. Actually, the housing market has been neglected. While the Fed has a Zero Interest Rate Policy, that rate hasn't filtered to the typical homeowners; so, monetary policy has stopped with the Wall Street banks, and fiscal policy – well, if it wasn't for dysfunctional fiscal policy, there wouldn't be any fiscal policy. Today, the FHA announced it would increase upfront mortgage insurance premiums by 75 basis points on new financing, not refi's.

Homeowners have been hung out to dry, but this is an election year, and there are changes. The biggest is the HARP refinance program, which should allow underwater homeowners to refinance at lower rates. On January 4, the Federal Reserve released a white paper titled, “The U.S. Housing Market: Current Conditions and Policy Considerations,” which offered ideas for fixing the housing mess. Almost 6 years into the housing bust and this was the first such report from the Fed. The Fed report falls woefully short of addressing the housing market problems in a rich and robust manner. Many of the suggestions seem designed to benefit the bankers as opposed to the homeowners.

I know a lot of you guys like Warren Buffett; there's no question he is a successful investor but he is also a banker, the biggest shareholder of Wells Fargo, the largest mortgage lender in the country. In this role, he tends to be shameless or perhaps clueless or possibly just mercenary. In the annual letter from Berkshire Hathaway, Buffet says banks were victimized by some homeowners who refinanced their loans before getting evicted.

Buffett writes: “large numbers of people who have ‘lost’ their house through foreclosure have actually realized a profit because they carried out refinancings earlier that gave them cash in excess of their cost.” Buffet claims that: “In these cases, the evicted homeowner was the winner, and the victim was the lender.”

While I don't doubt that some people scammed the system in this way, Buffett doesn't give us a number, and the reason he doesn't give the number is because it is inconsequential. And whatever the number is, it would pale compared to the number of homeowners victimized by the banks. Buffett blaming people who lose their homes to foreclosure is kind of like Satan complaining that jaywalkers are evil.

Last July, Berkshire Vice Chairman Charlie Munger criticized bankers for contributing to the housing bubble. Munger blamed the boom on megalomania, insanity, and evil in investment banking and mortgage banking. Charlie got it right last summer, Warren got it wrong this week. The banks are not the victims.

The housing market is going through a radical and fundamental change. For many years, the home was the main component of a family's net worth. What will replace houses as the major investments of the middle class? Will anything? If the housing market can be revived, it will go a long way to lifting the entire economy. This is the plan of the Federal Reserve; this is the plan of the administration; this is the game plan for economic stimulus this year. Hold on, it promises to be an interesting ride.

A combination of unusual and unsustainable forces has pushed the cost of borrowing as low as it has ever been, so low that many investors effectively are paying to lend money to the government.

Investors buying five-year federal debt are accepting such low interest rates that inflation is on pace to reduce the value of their investments by more than 1 percent each year. Yet demand for United States Treasuries remains much greater than the supply.
The glut of cheap money has allowed the government to keep its annual deficits much smaller than it had expected, holding down the growth of the federal debt.
The Treasury may start issuing debt with negative interest rates, making investors pay for the privilege of lending money to the government.
 The average rates that the government pays to investors in its debt have declined in each of the last five years, from 4.92 percent at the end of 2006 to 2.24 percent at the end of 2011. Rates have edged even lower so far this year. Adjusting for inflation, the government is borrowing at virtually zero cost.
As a result, while the size of the public debt more than doubled over the last five years, from less than $5 trillion to more than $10 trillion, the government’s annual interest payments remained about the same. In 2006, the bill was $226.6 billion. Last year, the bill was $227.1 billion.

The basic reason to expect higher rates is that investors usually demand compensation as a borrower’s debts increase. And the government projects that its debt will grow rapidly in coming years. At some point the party has to end, right? Maybe, but for now, the bull run in Treasuries continues unabated.

The United States also has benefited from concerns about the health of European governments. The International Monetary Fund estimates that the benefits of investors fleeing Europe to buy Treasuries have roughly offset any other damage to the American economy from the struggles of the euro zone.

So while Europe fiddles, Treasury debt remains hot. It's a flight to safety, and investors are willing to pay for protection. This month, when the government auctioned off one-year debt, Treasury agreed to pay 14 cents for every $100 that it borrowed, or 0.14 percent. Last week at the most recent auction of five-year debt, it agreed to pay 88 cents a year for every $100 that it borrowed. At a 2 percent inflation rate, investors would need to be paid $2 for every $100 they lent just to keep pace.

Maybe risk aversion has gone too far. Would you pay to park money with the Treasury? Of course, at some point, the pendulum will swing, investors will demand higher rates, bond prices will drop; nothing lasts forever. And when the low rate position unwinds, it will be ugly, but not today. Maybe not today. The problem is that there is no exit strategy from a Zero Interest Rate Policy. How does the Fed back out of this parking lot without destroying the bond market? The simple answer is that they can't.

The World Bank warns that China is headed for collapse. Imagine China crashing. The country holding over a trillion of America’s debt. The World Bank warns that China must essentially overhaul its entire economic structure if it wants to avoid a "crisis". It all sounds very urgent, but it is a part of a report of what might happen over the next 20 years.

The export-driven, state-investment model is producing diminishing returns. According to the World Bank, China's growth rate will slow to 5 percent by 2030 unless China changes its strategy. Remember, South Korea and Japan both went through severe financial crises in the 1990s. And China is already displaying some of the telltale symptoms: A fragile banking sector, companies engorged with debt, and unwise investments in real estate.

The World Bank is calling for a sweeping overhaul, but then the World Bank always calls for sweeping overhauls. That's what they do. Still, BusinessWeek came out with an editorial comparing the situation in China with the years running up to the 2008 meltdown.

The National Association for Business Economics forecasters have raised their expectations for employment, new home construction and business spending this year. But they held on to their average prediction that America’s gross domestic product, or GDP, will grow at a rate of 2.4 percent. That’s a slight improvement from 2011, when economists believe the economy grew 1.6 percent. Final economic growth numbers for 2011 are due out tomorrow. NABE economists see the unemployment rate sticking at 8.3 percent this year, matching January figures. Panelists are also still forecasting strong business spending growth this year. They’ve slightly raised their forecast to 8.1 percent growth this year.

Yesterday, we told you about the Wikileaks dump of Global Intelligence Files from StratFor, the private, intelligence firm that operated as a kind of shadow CIA. Wikileaks claims to have more than 5 million emails that were apparently hacked from StratFor; so far, they have published about 200. It will take some time to go through those emails, but we are already finding some interesting stuff. Osama bin Laden was in routine contact with several senior figures from Pakistan's military intelligence agency while in hiding in the country. Apparently this info came to StratFor after the killing of bin Laden. The e-mail, from a Stratfor analyst, suggested that up to 12 officials in Pakistan's Inter-Services Intelligence (ISI) agency knew of bin Laden's safe house.

The internal email did not name the Pakistani officials involved but said the US could use the information as a bargaining chip in post raid negotiations with Islamabad.

Other e-mails included the suggestion that Hugo Chavez, Venezuela's president, may have less than a year to live after his cancer spread to the colon and bone marrow. Other revelations were statements that Israel had last year carried out a successful covert attack on Iran's secret nuclear facilities.
Apparently the key to intelligence gathering is to state the obvious after the fact.



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