Tuesday, September 25, 2012 - Fed Good at Growing Inequality

Fed Good at Growing Inequality

by Sinclair Noe

DOW – 101 = 13,457
SPX – 15 = 1441
NAS – 43 = 3117
10 YR YLD -.04 = 1.68%
OIL - .51 = 90.86
GOLD – 3.90 = 1761.60
SILV - .23 = 33.84
PLAT + 8.00 = 1634.00

Let’s start with a few economic reports. Case Shiller’s Index of existing home sales posted a 1.6% increase in July; all 20 cities in the index saw housing prices rise; it’s the fourth month of price increases, and the past 12 months are now showing increases. This is very positive news for housing. Pricesin Phoenix gained 2.2% to take the year-on-year increase to 16.6%, by far the strongest advance of any major metropolitan area. Los Angeles saw a 1.3% gain, and the year-over-year comparison has now turned positive by 0.4%.

The consumer-confidence index increased to 70.3 in September, the highest level since February. Generally when the economy is growing at a good clip, confidence readings reach at least 90. September expectations increased for employment and business conditions, while consumers’ views on the present situation also rose. One of the big factors affecting the optimistic outlook is the turn in the housing market.  In August, the dividend-reinvested S&P 500 was up some 18% year-on-year. The combination of positive returns on stocks and real estate hasn’t been this good since 2006. Any economic gains are still fragile but you take whatever positives you can find. Both consumer-confidence measures, the one conducted by the University of Michigan and the one done by the Conference Board, showed big pops in September.

Optimism is a marvelous thing but every party has a pooper, and today, the party on Wall Street fizzled when  Federal Reserve Bank of Philadelphia President Charles Plosser said the central bank's latest round of monetary easing was unlikely to help growth. Earlier this month, the Fed announced it would continue with Operation Twist, and they added a plan to buy $40 billion a month in mortgage backed securities; the plan was open-ended; the Fed would just keep buying until the employment situation improved.  But Plosser doesn’t think it will work; he says: “We are unlikely to see much benefit to growth or to employment from further asset purchases." 

Plosser’s comments weren’t a big surprise; he is considered hawkish among the Fed Presidents. Other Fed leaders have announced their support for QE to infinity and beyond. Still, Plosser drew some of the blame for the stock market’s sour mood this afternoon.

Central banks in the US, Europe and Japan may have come forward with stimulus measures in recent weeks to try to stimulate the global economy but not every country is cranking up the printing press. South Korea is buying gold; they added about 70 metric tons of gold to their reserves. Russia also added to reserves, but not as much as the Koreans. So the trend of central banks beefing up their gold reserves is alive and well.

Inflation is the most talked about risk of all this central bank money printing but there is still a lot of deleveraging in the US economy.  Bernanke is probably right to discount inflation as a short term danger. Meanwhile, we’ve heard nothing from the Federal Reserve or its assorted hawk and dove presidents about the impact of the Fed’s sustained easy-money policy on economic inequality. The Organization for Economic Cooperation and Development, the OECD says income inequality has been increasing in the US, to the point where the top 10 percent of our population earns 14 times more than the bottom decile; the OECD average ratio is 9 to 1.

You can’t blame the Fed. Well, you can blame them but not for everything. The world has changed, and you have to consider globablization, technological change, education, demographic patterns, and fiscal policy has been horrific in this country for at least the past 30 years, maybe forty.  Maybe the Fed cranking up the printing press will help create a few jobs, which might help the inequality problem. Workers pulling in a wage are doing better than workers pulling in an unemployment check or nothing at all.  The crazy part is how the Fed’s plan may or may not work. Bernanke’s plan is to push down interest rates across the board which should increase the value of assets such as stocks and real estate; then the people that own stocks and real estate will feel wealthier and they will be more likely to go out and spend money or borrow money to spend; rising demand will force businesses to hire new workers. We know that people are feeling more confident but that might not equate to feeling wealthier, much less result in actual spending 

Individual participation in equities has been on the decline for 10 years; institutional investors and high frequency traders dominate the stock markets. Families in the lowest 20 percent of the income distribution scale spend more than a third of their income on food. Households in the bottom fifth spend 10% of their annual income on gas, vs. 2.2% for the top quintile. Yesterday, Goldman Sachs predicted commodity prices will rise 18.2%, in large part because of QE. Ironic, isn’t it?

The Dallas Federal Reserve is a strange branch location; they’ve issued papers about splitting up the too big to fail banks. Now they’ve issued a research paper that examines the central banks role in increasing inequality. The paper says the Fed’s accommodative policy and bailouts have supported the financial sector and the result is the rich got richer and the poor got poorer, and the result is the US has more inequality than any other developed nation. Bernanke says he wants to help people get jobs, but the tools he has used over the years and continues to use today have only resulted in a lopsided economy.

Part of the blame has to fall at the feet of Congress. Bernanke is giving Congress at least a little cover for continuing to do nothing. In pop psychology that's known as being an enabler. Has he even considered the merits of holding Congress's feet to the fire by declining to perpetuate his policy of centrally-planned subsidized money and the accompanying systematic understating of risk?

What else is going on in the world? The Greek government is resisting a push by yhe IMF to impose additional austerity measures. The Greek people are increasingly angry over the prospect that public salaries and pensions will be cut again in a last-ditch bid to secure a new loan installment of $40 billion from Greece’s creditors.

Meanwhile, the Portuguese people have put up with one draconian package after another – with longer working hours, pay cuts, tax rises, an erosion of pensions, and the result is that the economy has contracted by a little over 10%.They have protested peacefully, but they finally said enough is enough and they have killed a plan to raise social security taxes. Portugal cannot recover under the policies in place. The government is destroying the Portuguese economy for no useful purpose. It is pain without gain.

As Spain tries desperately to meet its budget targets, it has been forced to embark on the same path as Greece, introducing one austerity measure after another, cutting jobs, salaries, pensions and benefits, even as the economy continues to shrink.  Once again, Spanish protestors took to the streets and encircled the main parliament building. Parliament took on the appearance of a heavily guarded fortress as about 1,400 police officers ringed the building to keep back demonstrators. The organizers of the latest protest said in a statement that they had no plans to try to occupy Parliament, but instead wanted to surround the building to show that “democracy has been kidnapped” and needs to be saved from the hands of inept Spanish politicians. Spain must still decide whether they want to accept the IMF bailout and its attendant demands, which can never be met.

The Bank for International Settlements says  German lenders have the highest exposure in Europe to Spain, at $139.9 billion, of which $45.9 billion alone is exposure to banks.

FEBRUARY, TUESDAY 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 4^th 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.

http://www.bloomberg.com/news/2012-02-27/wealthier-people-more-likely-than-poorer-to-lie-or-cheat-researchers-find.html

http://www.zerohedge.com/news/guest-postthe-existential-financial-problem-our-time