A periodic blog dedicated to providing commentary and encouraging debate on topics in Economics and Finance.

About Me

Age: 26 Occupation: Private Equity

Wednesday, October 31, 2007

Feddie Krueger Cuts'em again!

OKAY.... Given that it is Halloween today, I just had to work Freddy Krueger into the mix... and the Fed has made that quite easy by slicing and dicing the federal funds rate and discount rate with all due ferocity.

Why is Mr. T in there? Well, Mr. T rules... more on that later.

Today, the Fed reduced its target federal funds rate (the rate at which banks borrow from each other) to 4.5%. How do they do this? They print money and lend to banks at 4.5% as much as is necessary to "defend" their target rate (Just trying to educate, so Mr. T does not pity you.)

All in all, I have to say that I'm in favor of the recent move, despite my distaste for artificially low interest rates, and I am most impressed with the Fed's strategic maneuvering over the last few months.

Why do I applaud their maneuvering?

First, they shocked the market in August by cutting the discount rate by 0.5%, which stopped the bleeding from August's "global margin call" or as some would call it a mini "Minsky moment." They also stepped up to the plate with loads of liquidity to make sure the credit markets didn't totally explode.

Second, the Fed cut the funds rate by a more-than-expected 0.5% in September, which (i) dramatically reduced pressure in the credit markets by lowering borrowing costs for struggling banks and making existing yields more attractive, (ii) helped sure up bank income statements due to reduced interest expense and (iii) aided interbank liquidity, continuing to ensure that the credit markets didn't totally explode.

Finally, they made sure that, after today, they wouldn't be "forced" into lowering rates again by setting proper expectations from the outset. The key phrase in their statement released today:
"The Committee judges that,
after this action, the upside risks to inflation roughly balance the downside risks to growth."

This is a clear signal (as clear as you can get from the Fed) that the committee believes that, while not the case for this particular cut, any further cuts will cause inflation to become of greater concern than slow growth, meaning that they don't plan on cutting rates again unless it gets uglier out there.

BRAVO! The Fed has finally BECOME AN EFFECTIVE TOOL, moving from a reactionary implement of Chinese water torture that simply drips down the economy's forehead 0.25% at a time to a proactive hammer with the capability to shape and mold (and maybe even do a mean "typewriter"). As you see, Feddy Krueger is acting more like Mr. T and our dear friend M.C.
I have far more confidence in Bernanke than our buddy "easy Al." Greenspan's fed "Can't touch this" one.

Another reason why I love the rate cuts is the devaluation of the dollar. Other countries have been devaluing their currencies to prop up their economies for quite some time (instead of, you know, improving productivity or leveraging comparative advantage or investing in capital). It's about time we get to use this easy way out of economic distress. They can buy the living daylights out of our artificially cheap stuff and send all of their jobs here for once. After all, we're looking at probably 2-4 more years of housing pain... we need the help.

Will the new Fed hammer, a sizzling global economy and a sickly dollar be enough to keep us out of a recession despite years of reckless lending and misallocation of capital? Will it be able to overcome the fact that millions of debt slaves (oops, I meant "people") are being stretched thin by their retarded mortgages because they paid too much for their slowly rotting boxes (oops, I meant "homes")? I don't think so, but Bernanke, I believe, will aid in us achieving the best outcome possible given the cards we've been dealt.

Full text of the Fed's statement:

Release Date: October 31, 2007

For immediate release

The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 4-1/2 percent.

Economic growth was solid in the third quarter, and strains in financial markets have eased somewhat on balance. However, the pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction. Today’s action, combined with the policy action taken in September, should help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and promote moderate growth over time.

Readings on core inflation have improved modestly this year, but recent increases in energy and commodity prices, among other factors, may put renewed upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Charles L. Evans; Donald L. Kohn; Randall S. Kroszner;
Frederic S. Mishkin; William Poole; Eric S. Rosengren; and Kevin M. Warsh. Voting against was Thomas M. Hoenig, who preferred no change in the federal funds rate at this meeting.

In a related action, the Board of Governors unanimously approved a 25-basis-point decrease in the discount rate to 5 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Richmond, Atlanta, Chicago, St. Louis, and San Francisco.

Wednesday, October 24, 2007

Home Sales in Full-Fledged Rout: Disaster Continues

Courtesy of the Wall Street Journal... I guess it turns out that people really didn't plan on paying these ridiculously high mortgage payments after all. The market dried up after buyers ran out of "greater fools" to unload houses to. Oh yeah... and people actually have to pay something up-front to buy after all the piggyback (second mortgage) lenders croaked... (Can I put that 20% down-payment on my credit card?)

If you are thinking about buying - don't try and catch a falling knife - you'll probably end up with a nasty cut. Most analysts are not expecting housing to stabilize until 2009 at the earliest. The length of the "down-cycle" has a lot to do with the length of the "up-cycle," which leads me to believe that even these estimates are too optimistic. We had a 4-year boom... we may have 3 years left in a 4-year bust.

Why? Unlike stocks, people are very slow to take losses on their houses. They'll just "rent it out" until the market "comes back." These people represent "phantom inventory" that will jump into the market at the first sign of strength... creating even more downward pressure on prices. By not getting out when the can, these people end up riding the market all the way down to the bottom. To add insult to injury, they usually can't cover more than 60% of their "carrying costs" with rent, so they are losing money every month even as their house declines in value.

Let's make this another chapter in the vanquishing of the "housing tragedy" that locks young families out of homes in order to further enrich baby-boomers, whose national debt we'll have to repay in addition to funding their retirement.

Existing-Home Sales Tumble 8%

October 24, 2007 10:04 a.m.

WASHINGTON -- Demand for previously owned homes slid more than expected in September amid continued problems in the mortgage market, with single-family sales hitting their lowest sales pace in nearly 10 years.

Overall home resales declined to a 5.04 million annual rate, an 8.0% decrease from August's downwardly revised 5.48 million annual pace, the National Association of Realtors said Wednesday.

The August existing-home sales level came in well below Wall Street expectations for a 5.25 million rate.

The 5.04 million pace is the lowest since the association started accounting for combined single family and condo sales in 1999. Based on single-family sales of 4.38 million, the September figures are the weakest since January 1998.

"The credit freeze in August definitely impacted sales in September, particularly the jumbo [loan] side, so we have seen a large sales decline in the upper end of the market," NAR senior economist Lawrence Yun said.

The median home price was $211,700 in September, down 4.2% from $220,900 in September 2006. The median price in August this year was $224,400.

Mr. Yun said conditions in the jumbo loan market have improved, so he still expects 2007 to rank as the fifth-best year in terms of existing home sales. Prices are expected to ease about 1.5% from record high of last year of $221,900.

Inventories of homes rose 0.4% at the end of September to 4.40 million available for sale, which represented a 10.5-month supply at the current sales pace. There was a 9.6 month supply at the end of August, revised down from a previously estimated 10.0 months.

Existing-home sales tumbled in all regions. Sales dropped 7.0% in the Midwest, 10.0% in the Northeast, 9.9% in the West, and 6.0% in the South.

The average 30-year mortgage rate was 6.38% in September, down from 6.57% in August, according to Freddie Mac.

Write to Tom Barkley at tom.barkley@dowjones.com

Tuesday, October 2, 2007

NAR - Worst - Ever Showing for Pending Home Sales

In another shocker, the Pending Home Sales Index released by the NAR reached its lowest point ever (even lower than September 2001).

(Click on the chart for a larger image.)
It's not too often that you see a chart (of real data) with a trend as clean as this one. According to the NAR, the problem now stems from borrowers with "good credit" who can't get loans due to the credit crunch. My only response to this is: Balderdash. As we can see, the downward trend in house sales was firmly in place before the August credit crunch.

There is a term for this: Market Failure - when transactions cease to occur because buyers and sellers cannot come together and agree on a price.

The Buyers' Issues

Now that the Ponzi scheme is up, buyers are facing a brave new world where, if they want to buy a house, they have to:

1. Make a down payment (What is that?)

2. Pay a bloated mortgage bill for a long time (You mean this initial 2% rate is not a real mortgage rate? You mean I have to pay this back? I'm so confused!)

3. Accept subpar returns or declines in the value of their housing.

When you put it that way, forking over $35,000 for the right to pay $2,500 per month, or $30,000 per year (PITI) for a $350,000 townhouse doesn't seem so great, does it? This is especially true when you are getting a lousy return on your house because (i) you bought high and (ii) houses don't go up too much in value under normal conditions anyway.

The Sellers' Issues

This is easy. "What? I can't get the bubble price that Billy Jones got up the street? No way I'm selling for less."

Or "that's not even what I paid for my house!"

Why Prices Have to Fall Further

Eventually, something has to give. In many markets, buyers can't realistically pay the prices sellers are asking for, while a large portion of sellers (at the urging of their agents desperately trying to keep prices high) are simply being stubborn.

Time to address one "myth" commonly used to combat the notion that prices will fall materially: "Nobody will sell for less than he bought his house for."

1. Some people simply have to sell if they can't afford to pay the bills or really need to move. These people will sell for a "buyer's" price and swallow the hit to their down payment or built-up equity, busting comp sets.

2. Most importantly... not everybody bought their house in the last few years. If these sellers have to go, they'll still make a good gain if they sell for 10, 20 or even 30% below the prices they could have gotten in 2005 or 2006 (however reluctantly).

Unfortunately for sellers, their stubbornness has to yield to impossibility (buyer's inability to afford asking prices) if they want to sell their home.

Oh, and by the way, I didn't even mention that the competition for buyers is about to get a lot tougher over the next year as a new wave of inventory sweeps through the markets.

- eternitus