Monday, December 27, 2010

Today's links

1--The Finite World, Paul Krugman, New York Times

Excerpt: ... the primary driving force behind rising commodity prices isn’t demand from the United States. It’s demand from China and other emerging economies. As more and more people in formerly poor nations are entering the global middle class, they’re beginning to drive cars and eat meat, placing growing pressure on world oil and food supplies.

And those supplies aren’t keeping pace. Conventional oil production has been flat for four years; in that sense, at least, peak oil has arrived. ... Also, over the past year, extreme weather ... played an important role in driving up food prices. And, yes, there’s every reason to believe that climate change is making such weather episodes more common.

So what are the implications of the recent rise in commodity prices? It is, as I said, a sign that we’re living in a finite world, one in which resource constraints are becoming increasingly binding. This won’t bring an end to economic growth, let alone a descent into Mad Max-style collapse. It will require that we gradually change the way we live, adapting our economy and our lifestyles to the reality of more expensive resources.

2--Economic Letter—Insights from the Federal Reserve Bank of Dallas, FRB of Dallas

Excerpt: In the mid-1990s, the public policy goal of increasing the U.S. homeownership rate collided with a huge leap in financial innovation. Lenders shifted from originating and holding mortgages to originating and packaging them for sale to investors. These new financial products enabled millions of Americans who hadn’t previously qualified to buy a home to become owners. Housing construction boomed, reaching a postwar high—9.1 million homes were built between 2002 and 2006, a period when 5.6 million U.S. households were formed.

The resulting oversupply of homes presents policymakers with a formidable challenge as they struggle to craft a sustainable economic recovery. Usually a driver of economic recoveries, the housing market is foundering as an engine of growth....

One factor inhibiting the new-home market is a growing supply of existing units. The 3.9 million homes listed in October represent a 10.5-month supply. One in five mortgage holders owes more than the home is worth, an impediment that could hinder refinancings in the next year, when a fresh wave of adjustable-rate mortgages is due to reset. The number of listed homes, in other words, is at risk of growing further. This so-called shadow inventory incorporates mortgages at high risk of default; adding these to the total implies at least a two-year supply....

A study found that in a best-case outcome, 20 to 25 percent of modifications will become permanent....Without intervention, modest home price declines could be allowed to resume until inventories clear. An analysis found that home prices increased by about 5 percentage points as a result of the combined efforts to arrest price deterioration.[7] Absent incentive programs and as modifications reach a saturation point, these price increases will likely be reversed in the coming years. Prices, in fact, have begun to slide again in recent weeks. In short, pulling demand forward has not produced a sustainable stabilization in home prices, which cannot escape the pressure exerted by oversupply...

About 3.6 million housing units, representing 2.7 percent of the total housing stock, are vacant and being held off the market. These are not occasional-use homes visited by people whose usual residence is elsewhere but units that are vacant year-round. Presumably, many are among the 6 million distressed properties that are listed as at least 60 days delinquent, in foreclosure or foreclosed in banks’ inventories....

With nearly half of total bank assets backed by real estate, both homeowners on the cusp of negative equity and the banking system as a whole remain concerned amid the resumption of home price declines.[8] This unease highlights the housing market’s fragility and suggests there may be no pain-free path to the eventual righting of the market. No perfect solution to the housing crisis exists. The latest price declines will undoubtedly cause more economic dislocation. As the crisis enters its fifth year, uncertainty is as prevalent as ever and continues to hinder a more robust economic recovery. Given that time has not proven beneficial in rendering pricing clarity, allowing the market to clear may be the path of least distress.

3--Question #7 for 2011: State and Local Governments, Calculated Risk

Excerpt: 7) State and Local Governments: How much of a drag will state and local budget problems have on economic growth and employment? Will there be any significant muni defaults?....

The good news is it appears state and local government revenue has stabilized. The bad news is the budget gaps will still be huge in 2011. The National Conference of State Legislatures (NCSL) released a report earlier this month, "State Budget Update: November 2010," forecasting
an increasing majority of state legislative fiscal directors are reporting that the revenue outlook for the remaining seven months of FY 2011 looks promising. At the same time, however, most states also are forecasting significant budget gaps in FY 2012. ... Funds from the American Recovery and Reinvestment Act (ARRA) have helped support state budgets since FY 2009. States will face a $37.9 billion loss in federal funds in FY 2012 compared to FY 2011, according to the Federal Funds Information for States. This is expected to make big holes in state budgets, what many state officials call the "ARRA cliff effect."

Including the loss of the ARRA funds, the state budget gaps are expected to total around $110 billion in 2011, down from $174 billion in 2010. This suggests further budget cuts for states.

4--Lessons from the Muni Bond Market in 2010, The Big Picture

Excerpt: When Meredith Whitney talks about Munis, I turn down the sound.

Both in September and recently on 60 Minutes, Meredith Whitney – without giving any supporting numbers – predicted widespread municipal defaults. She forecasted $50-to-$100 billion in 2011.” We disagree and would like to debate her.

Many municipalities, local and state, just printed their third quarter in a row of rising tax receipts. In the past eight quarters, state and local governments swung a collective $115 billion in budget balance, from $65 billion deficit to $50 billion surplus (source Strategas). “State spending fell 3.8 percent in the 2009 fiscal year and 7.3 percent more in the 2010 fiscal year” said the lead editorial in the Sunday New York Times (December 26). They are making tough decisions on budgets and expenses. Our take is that not all situations can be painted with the same broad brush. The Harrisburg, PA incinerator has NOTHING to do with the Kansas Turnpike Authority. Ms. Whitney is not the only person who has been fanning flames without the facts. CNBC and the Wall Street Journal have also added to the hype. Security for most general-obligation and essential-service revenue bonds is very strong. There are difficult choices for state and local governments – and most are making them by adding forms of austerity to their budget lines....

Build America Bonds (BABs) were a good thing.

BABs will end 2010 with approximately $186 billion in issuance. The program, which began in April of 2009, is that rare program crafted in Washington, DC that actually WORKED the way it was intended to. It provided lower financing (through a 35% Federal subsidy of the interest paid) to municipal bonds issued for SHOVEL-READY projects. While it currently has not been renewed for 2011, there is talk that a bill will be introduced in the new Congress to extend BABs, albeit at a lower subsidy rate. The existence of BABs subtracted from new tax-free supply. That put downward pressure on tax-free bond rates until this November. It also opened up the municipal marketplace to a newer and broader scope of investors: pension funds, foundations, IRAs, Keogh plans, and foreign buyers. Expanding the base of buyers of municipal debt was one of the BAB goals and it was VERY successful.

5--Economists: Expect No Home-Price Growth in 2011, Wall Street Journal

Excerpt: Home prices won’t show any year-over-year appreciation in 2011, according to the latest average of 110 forecasts from economists and housing analysts surveyed by MacroMarkets LLC....

Some 96 analysts surveyed made their forecasts public. Of those, 30 expect prices to fall next year, and another 30 are calling for annual home price appreciation of no more than 1%. The most bearish forecaster, A. Gary Shilling, president of A. Gary Shilling & Co., calls for prices to fall by 11% in 2011.

6--Growth to improve. Housing? Jobs? Not so much, CNN Money

Excerpt: Economists are getting more bullish on U.S. economic growth. But the benefits of the stronger economy are going to take a while to reach job seekers and homeowners.'s survey of 23 leading economists forecasts a 3.1% annual growth rate for the final three months of the year.

That estimate is up from the 2.5% growth rate economists were predicting just three months ago. It's also an improvement over the third quarter, when the economy grew by 2.6%, according to the government's final reading released Wednesday.

And economists now expect 2011 growth to be stronger as well -- 3.3%, up from their earlier estimate of 2.8%. And they expect to continue that trajectory into 2012, predicting growth of 3.4%.

7--Home loan demand drops, lowest in nearly 1 year, Yahoo News

Excerpt: Mortgage applications tumbled to their lowest level in nearly a year as a six-week-long rise in interest rates took a significant toll on demand, an industry group said on Wednesday.

The Mortgage Bankers Association on Wednesday said its seasonally adjusted index of mortgage applications, which includes both purchase and refinance loans, for the week ended December 17 decreased 18.6 percent, reaching its lowest level since the week ended January 1.

The four-week moving average of mortgage applications, which smooths the volatile weekly figures, was down 9.8 percent.

The drop in demand last week was largely a reflection of the lack of interest by homeowners to refinance their existing home loans.....

Borrowing costs on 30-year fixed-rate mortgages, excluding fees, averaged 4.85 percent, up 0.01 percentage point from the previous week. Interest rates, however, were below their year-ago level of 4.92 percent.

8--Rosenberg: "Era Of Green Shoots Over", zero hedge

Excerpt: It was fun while it lasted but if the latest set of data couldn't kybosh the 'green shoot' theory, then FedEx sure did when it posted earnings results that fell well short of target and the CEO announcing that the economic backdrop was "extremely difficult". On top of that, UAL stated that its 2Q traffic is expected to drop as much as 10.5% YoY on a 9.0% decline in available seats. Not only have the transports rolled over but so have the banks — the group that led the rally since early March — with a huge 3.3% loss yesterday (and now the group is down 20% for the year). Due to mounting concerns over commercial real estate exposure, S&P cut the ratings and/or outlooks on 22 banks yesterday (the regional banks of course — the ones that the Fed, Treasury and White House don't believe are too big to fail......

Screening for the CPI

The consumer price index rose by a much lower than expected 0.1% in May and this, like the PPI, took the YoY trend to a five-decade low, of -1.0%. We are going to see some larger monthly prints due to higher gasoline prices but because of the huge base effects of a year ago, when oil hit $150/bbl, we could still very likely see the YoY headline inflation rate sink to as low as -2.0% by the end of the summer. It is very clear that we are either in an extremely benign inflation environment or on the precipice of a deflationary environment. Either way, pricing power is confined to relatively few sectors.

Who has Good Pricing Trends at a time of -5.0% PPI?

We also ran sector screens on actual pricing power using the PPI, which is deflating at a 5.0% YoY pace, the most pronounced deflation rate in 50 years.

9--Federal Reserve Blocks New Foreclosure Regulations, Zach Carter, Huffington Post

Excerpt: Top policymakers at the Federal Reserve are fighting efforts to rein in widely reported bank abuses, sparking an inter-agency feud with the FDIC and the Treasury Department. The Fed, along with the more bank-friendly Office of the Comptroller of the Currency, is resisting moves to craft rules cracking down on banks that charge illegal fees and carry out improper foreclosures. The FDIC supports such rules, according to an FDIC official involved in the dispute.....

The new regulations would rein in debt collection, loan modification and foreclosure proceedings at bank divisions called "mortgage servicers." Servicers have committed widespread fraud in the foreclosure process....

Servicers have also failed to live up to the rules proposed by the Treasury Department under President Obama's Home Affordable Modification Plan. According to a recent report by the Congressional Oversight Panel, a full 29,000 borrowers have been in temporary payment plans for more than a year without being granted permanent relief. The temporary modifications are supposed to last just three months under Treasury Department rules.

Regulators at all federal banking agencies are aware of the problems...

Mortgage servicing sprang into existence with the invention of mortgage securitization markets in the 1970s and became a major part of the banking business as the housing bubble ballooned over the past decade. Servicers do not own the loans they handle. Instead, they make their money by skimming from interest payments they forward to mortgage investors who own the loan and by charging fees to delinquent borrowers. Critics argue that the arrangement encourages servicers to take actions that hurt both borrowers and investors, pushing homeowners into unnecessary foreclosures in order to reap bigger fees.

On Tuesday, more than fifty economists, banking experts and consumer advocates sent an open letter to banking regulators demanding action on mortgage servicers. Many of the proposed rules are simple standards of banking conduct, like appropriately crediting borrower accounts when they make payments. But most mortgage servicers are effectively unregulated at the moment.....

"Widely reported servicer fraud, whether in the foreclosure process or in the systematic assessment of illegal fees against homeowners, is . . . a serious problem," the letter reads, noting that, "problems of this magnitude are a threat not only to the economic recovery, but to the safety and soundness of all insured depository institutions."

The Wall Street reform bill signed into law by President Barack Obama this summer requires regulators to craft new rules to ensure the securitization market functions properly. The FDIC wants those rules to include standards for mortgage servicer conduct and hopes to have rules ready by the end of next month.

Nevertheless, the Fed and the OCC are pushing back, according to a source at the FDIC. Spokespeople from both the Fed and the OCC said their agencies support new mortgage servicing standards but declined to comment on the new rules being advocated by the FDIC....

Reform advocates say that regulators can take action under so called "skin-in-the-game" or "risk-retention" requirements in the Wall Street reform bill. Banks that package and sell mortgage securities would be required to keep at least five percent of the credit risk from those securities on their own books, in an effort to prevent banks from scoring profits by selling garbage securities. The FDIC is on board.

"The FDIC believes that the risk retention rules are an appropriate vehicle permitted by the statute that would establish serving standards for the industry as a whole, and we should not miss this opportunity to set quality servicing standards for the future," FDIC General Counsel Michael Krimminger told The Huffington Post.

Under the new rules, banks will not have to maintain credit risk for top-quality mortgages, which regulators must define. Reformers hope to include mortgage servicing standards in the definition of a top-quality mortgage. The result, reformers say, would be a new industry standard that banks adopt as a matter of course to limit their own potential losses.

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