Tuesday, July 31, 2012

Tuesday, July 31, 2012 - Waiting on Godot, Draghi, Bernanke, DeMarco, the Flood, and For The Lights to Come Back On

Waiting on Godot, Draghi, Bernanke, DeMarco, the Flood, and For The Lights to Come Back On
-by Sinclair Noe

DOW – 64 = 13,008
SPX – 5 = 1379
NAS – 6 = 2939
10 YR YLD -.01 = 1.49 
OIL – 1.78 – 89.89
GOLD – 7.00 = 1615.90
SILV - .18 = 28.10
PLAT + 1.00 = 1421.00

We wrap up the month of July. Let's look at the scorecard; for the month, the Dow Industrial gained 128 points; the S&P 500 index gained 17 points; the yield on the 10 year treasury note dropped 9 basis points. 

S&P Case Shiller index of home prices rose  2.2% in May. All 20 cities in the index saw monthly gains. On a year-over-year basis, prices are down 0.7% nationally, the smallest fall in 18 months. Phoenix prices have climbed 11.5% - the strongest in the nation, while Atlanta’s have dropped 14.5%. Meanwhile, Corelogic reports there were about 60,000 completed foreclosures in June, down from about 80,000 in the same month last year. According to the report there were roughly 3.7 million homes lost to foreclosures since  2008. 

Ed DeMarco, the acting chief of the regulator for Fannie and Freddie, the Federal Housing Finance Agency, said in a letter to the top Republican and Democrat on the Senate Banking Committee that “after much study,” he has concluded that Fannie and Freddie’s participation in the Obama administration’s program to cut the amount owed by underwater borrowers would “not make a meaningful improvement in reducing foreclosures in a cost effective way for taxpayers.”

Treasury Secretary Tim Geithner criticized the decision in a response letter, writing: “I am concerned by your continued opposition to allowing Fannie Mae and Freddie Mac to use targeted principal reduction in their loan modification programs.” Roughly 56% of all US mortgages are owned or guaranteed by Fannie and Freddie and about 11 million homeowners owe more than their properties are worth. Geithner said in his letter that allowing Fannie and Freddie participation in the White House principal-reduction program could help up to half a million homeowners and result in savings to the two mortgage giants of $3.6 billion when compared to other loan-modification programs. Geithner added that the Treasury’s estimate is based on FHFA’s own analysis which was provided to the Treasury. There is even a Treasury program that provides subsidies to investors of 18% to 36% of the amount forgiven depending upon the loan value. 

One might wonder why DeMarco is being so intransigent. You might further wonder why the administration doesn't just fire him. Turns out he's the head of an independent agency and he can't be fired. And then, even if he resigned, the administration would have to make an appointment which would have to be confirmed by the Senate.  In any case, deciding whether debt relief is a good policy for the nation as a whole is not DeMarco’s job. If households can't get help repairing their balance sheets, then the recovery, such as it is, will be even slower. Banks got the help they needed with their balance sheet problems, but households have not received as much attention. There is simply no way that it makes sense for an agency director to use his position to block implementation of the president’s economic policy, not because it would hurt his agency’s operations, but simply because he disagrees with that policy. This guy needs to go. 

The Commerce Department reports personal spending fell less than 0.1% in June. Spending for May was revised down slightly to a 0.1% decline. It’s the first time consumer spending has fallen two straight months since early 2009, near the end of the last official recession.

Personal income rose 0.5% last month , mainly the result of employees working longer hours. Incomes increased by at least that amount in four of the first six months of 2012 after doing so only once last year.

What’s more, consumers had significantly more buying power in June than they did at the start of the year when inflation is factored out. Real disposable income, or money left over after taxes, has increased 1.7% over the past 12 months, largely because of lower gasoline prices.

So, that means people were spending less and saving more. The savings rate increased to 4.4% in June, up from 4% in May, and up from a two year low of 3.2% last November. 

Meanwhile, the Conference Board's consumer confidence index rose to 65.9 in July, the highest level since April, and up from a revised 62.7 in June. This is not a sign of strong confidence, because that would be readings closer to 90. Still, the report indicates there was greater confidence about short-term business and employment prospects. 

In Washington DC, House and Senate leaders managed to do the unthinkable; they agreed on something, and they struck a deal to fund the government for six months. The deal sets a funding level of $1.047 trillion; in other words, they raised the debt ceiling and the government is expected to hit its $16.4 trillion debt limit, or debt ceiling, sometime after the November elections. The deal will have to be approved before the end of September. And then there is still the issue of the fiscal cliff, which refers to expiring tax cuts, automatic spending cuts, debt limit increases and other year-end deadlines. 

Unless Congress and Obama can reach a deal by January 2 on a new formula for deficit reduction, $109 billion in spending cuts, also known as sequestration, will fall into place as a first down payment on more than $1 trillion in spending cuts over a decade. Those are to be divided equally between defense and domestic programs. The automatic spending cuts are the result of a deficit-reduction deal struck last August by Obama and Congress that also raised Treasury Department borrowing authority to avoid a credit default. Congress would like to replace the automatic spending cuts with a series of more targeted, well-thought-out reductions and/or revenue increases. Lawmakers are hopeful they can revisit the matter.

This is the backdrop for this Friday's monthly jobs report. Most estimates are calling for a gain of 110,000 jobs in July, compared with 80,000 net new jobs in June. 

And Federal Reserve Federal Open Market Committee, or FOMC is meeting today and tomorrow to try  to figure out what they can do to fulfill their dual mandate of price stability and maximum employment. The price stability part has been under control lately. Inflation is right in line with Fed expectations, a little below targets actually. The economy grew at a feeble 1.5% clip in the second quarter and unemployment remains stuck at 8.2%. Job growth has only averaged 75,000 per month in the second quarter. Fed officials have indicated that this pace is unacceptable. But the unemployment rate doesn't tell the whole story. For example, the national unemployment rate doesn't take into account people who want to work but haven't looked for a job in the previous four weeks because they figured none were available. The national unemployment rate also doesn't account for people in part-time jobs who would prefer full-time work. The U-6 unemployment rate includes under-employed, marginally employed, and long-term unemployed; that rate stands at 15.3%, but in California, the U-6 is 20.3% and in Nevada the rate is 22.1%. Clearly the Federal Reserve is a failure when it comes to maximum employment. 

So what will the Fed do? The widely anticipated move is “not much”. Look for the Fed to announce they are willing to extend the ZIRP, the Zero Interest Rate Policy. There might be a move to reduce payments to banks for holding excessive reserves with the Federal Reserve. Yes, the Fed pays the banks to NOT lend money.  That might change but the Fed might just sit back and wait. 

Wait for what?  They might be waiting for Godot, or possibly Draghi. The European Central Bank is also holding meetings this week and ECB President Mairo Draghi has promised to do whatever it takes to protect the Euro-union. There is a chance we could see a bond purchase plan announced by the ECB; there is a chance we could have a big coordinated convergence of central banks all cooperating and working together as an irresistible force. But don't count on it; more likely, small, incremental steps. The more news comes out, the more it looks like Mario Draghi’s pledge that the ECB would do all it would take to save the Euro was a bluff. The best guess is that he hopes to appease the market gods until September 12, when the German Constitutional Court will render its decision on whether the “permanent” rescue mechanism, the ESM, is permissible. 

While Draghi will likely dither as long as he can, Spain is heading for insolvency as big chunks of debt come due later this year. Events are moving fast. The relevant issue is no longer whether this will happen, but whether it is better for Spain to restructure its debt inside or outside the Euro-union.

Inside the euro and without financial resources, a debt reduction is pointless. The Spanish economy would have to go into deepening internal deflation, with cuts in prices and salaries, to restore competitiveness. This is impossible, or at least improbable. What we know is that the Spanish economy is contracting and unemployment is crazy high and it is foolish to expect the Spanish people to put up with this much longer. Outside the Euro-union, the Bank of Spain would be able to act as a lender of last resort again and eliminate the risk of future debt restructurings. The country would at least have a sporting chance of avoiding protracted depression. Or maybe there will be a Euro-zone rescue, with attendant austerity. Nothing is preordained at this point, except if Spain leaves the Euro, then the union isn't worth a hill of beans. 

Hundreds of millions of people have been left without electricity in northern and eastern India after a massive power breakdown. More than half the country was hit by the power cuts after three grids collapsed - one for a second day. Hundreds of trains have come to a standstill and hospitals are running on backup generators. In Delhi, Metro services were halted and staff evacuated trains. Many traffic lights in the city failed, leading to massive traffic jams. In eastern India, around 200 miners were trapped underground as lifts failed, but officials later said they had all been rescued. The internet, banks, hospitals, and businesses of all sorts were closed. Electric service is being restored and fairly quick, but the outage has been a huge embarrassment for the Indian government and has revealed the infrastructure is a mess.

The same could be said for the  infrastructure in the US. By some estimates the US electric grid will need more than $2 trillion in investments over the next 20 years. 

Just last week, the Alliance for American Manufacturing issued a report that recommends a two-part solution. First is restoring America's infrastructure lifelines: its electrical grid, its public water and sewer systems, its railroads and dams. And second is doing it with American-manufactured steel and concrete, glass and aluminum; all American components and all American labor.

The result would be a nation more capable of fending off and recovering from natural and man-made disasters. And it would be a nation with a stronger economy based on a solid manufacturing base.

The Preparedness report was written by two security experts. One is Tom Ridge, the former Republican governor of Pennsylvania and former head of Homeland Security. The other is Robert B. Stephan, a former Assistant Secretary of Homeland Security for Infrastructure Protection.

"The American way of life is dependent upon a vibrant economy, the existence of which is based upon a skilled work force, innovation and a world-class critical infrastructure. Much of this critical infrastructure is vulnerable to attack, catastrophic weather events and obsolescence and deterioration. Immediate national security, preparedness and economic needs require an equally strong domestic manufacturing base which, for many reasons, has eroded over the years."

The Preparedness report warns of depending on foreign sources for recovery:

". . .we can no longer rely on global suppliers - many of whom may not have our best interests at heart at a time of crisis. . .or come to our rescue in the midst of an emergency."

Critical to both psychological and physical recovery, it says:

"is a robust, diverse and resilient domestic manufacturing sector. In fact, there is a direct nexus between a strong domestic manufacturing sector and America's ability to prevent, mitigate, recover from and rebuild quickly in the wake of catastrophic events."

Ridge and Stephan devoted a whole section of the Preparedness report to the threats to dams and the nation's water supply. These are vulnerable to both natural and terrorist-caused disasters. And they're already in poor shape, receiving a D grade in a review by the American Society of Civil Engineers (ASCE). Dams, the ASCE said, need more than $50 billion in repairs.

The ASCE recommended in 2009 that the nation invest $2.2 trillion to repair critical infrastructure. Americans want that work, with unemployment stuck at 8.2 percent. And America needs that economic development. And it's never been cheaper to raise the money. 

Over 60% of the nation is in some form of drought. Areas affected include West Texas, North Dakota, Kansas, Colorado and Pennsylvania, all of which are part of the recent boom in North American energy production. That boom is possible partly by hydraulic fracturing or fracking. Fracking uses lots of water. Energy production uses more water than agriculture. The drought is now pitting oilmen against farmers. The farmers used to sell water to the oilmen; now they can't afford to sell, and the oilmen can't drill without the water. 

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