Tuesday, February 1, 2011

Today's links

1--Home Prices Sink Further, Wall Street Journal

Excerpt: Home values are falling at an accelerating rate in many cities across the U.S. The Wall Street Journal's latest quarterly survey of housing-market conditions found that prices declined in all of the 28 major metropolitan areas tracked during the fourth quarter when compared to a year earlier.

The size of the year-to-year price declines was greater than the previous quarter's in all but three of the markets, the latest indication that the housing market faces considerable challenges. Inventory levels, meanwhile, are rising in many markets as the number of unsold homes piles up....

Market conditions could get worse in the months ahead. Millions of homeowners are in some stage of foreclosure or are seriously delinquent on their mortgages, and millions more owe more than their homes are worth....

Sellers spurn what they see as low-ball offers, while buyers are demanding discounts because they are "convinced prices will drop further, and they don't want to feel like suckers six months later," says Glenn Kelman, chief executive of Redfin Corp., a Seattle-based real-estate brokerage that operates in nine states. The result is that "it's high noon at the O.K. Corral on every single transaction."

2--Egypt and Tunisia usher in the new era of global food revolutions, Telegraph

Excerpt: Political risk has returned with a vengeance. The first food revolutions of our Malthusian era have exposed the weak grip of authoritarian regimes in poor countries that import grain, whether in North Africa today or parts of Asia tomorrow....

The surge in global food prices since the summer – since Ben Bernanke signalled a fresh dollar blitz, as it happens – is not the underlying cause of Arab revolt, any more than bad harvests in 1788 were the cause of the French Revolution.

Yet they are the trigger, and have set off a vicious circle. Vulnerable governments are scrambling to lock up world supplies of grain while they can. Algeria bought 800,000 tonnes of wheat last week, and Indonesia has ordered 800,000 tonnes of rice, both greatly exceeding their normal pace of purchases. Saudi Arabia, Libya, and Bangladesh, are trying to secure extra grain supplies....

France’s Nicolas Sarkozy blames the commodity spike on hedge funds, speculators, and the derivatives market (largely in London). He vowed to use his G20 presidency to smash the racket, but then Mr Sarkozy has a penchant for witchhunts against easy targets.

3--Life after Capitalism, Robert Skidelsky, Project Syndicate

Excerpt: It was only in the eighteenth century that greed became morally respectable. It was now considered healthily Promethean to turn wealth into money and put it to work to make more money, because by doing this one was benefiting humanity.

This inspired the American way of life, where money always talks. The end of capitalism means simply the end of the urge to listen to it. People would start to enjoy what they have, instead of always wanting more. One can imagine a society of private wealth holders, whose main objective is to lead good lives, not to turn their wealth into “capital.”

Financial services would shrink, because the rich would not always want to become richer. As more and more people find themselves with enough, one might expect the spirit of gain to lose its social approbation. Capitalism would have done its work, and the profit motive would resume its place in the rogues’ gallery.

The dishonoring of greed is likely only in those countries whose citizens already have more than they need. And even there, many people still have less than they need. The evidence suggests that economies would be more stable and citizens happier if wealth and income were more evenly distributed. The economic justification for large income inequalities – the need to stimulate people to be more productive – collapses when growth ceases to be so important.

Perhaps socialism was not an alternative to capitalism, but its heir. It will inherit the earth not by dispossessing the rich of their property, but by providing motives and incentives for behavior that are unconnected with the further accumulation of wealth.

4--Q4 2010: Homeownership Rate Falls to 1998 Levels, Calculated Risk

Excerpt: The Census Bureau reported the homeownership and vacancy rates for Q4 2010 this morning....The homeownership rate was at 66.5%, down from 66.9% in Q3. This is at about the level as 1998....

The homeownership rate increased in the '90s and early '00s because of changes in demographics and "innovations" in mortgage lending. Some of the increase due to demographics (older population) will probably stick, so I've been expecting the rate to decline to around 66%, and probably not all the way back to 64%.

5--Personal Income and Outlays Report for December, Calculated Risk

Excerpt: The BEA released the Personal Income and Outlays report for December this morning.

Personal income increased $54.5 billion, or 0.4 percent ... Personal consumption expenditures (PCE) increased $69.5 billion, or 0.7 percent....

Consumption picked up sharply in Q4.....This graph shows real personal income less transfer payments as a percent of the previous peak. This has been slow to recover - and is still 4.3% below the previous peak - but personal income less transfer payments is growing again.

Some of the increase in spending came from a decline in the personal saving rate that fell to 5.3% in December.....I expected the saving rate to rise to 8% or more. With a rising saving rate, consumption growth would be below income growth. But that 8% rate was just a guess. It is possible the saving rate has peaked, or it might rise a little further, but either way most of the adjustment has already happened.

6-- FCIC Report Misses Central Issue: Why Was There Demand for Bad Mortgage Loans?
Tom Adams, Naked Capitalism

Excerpt: Signs of recklessness were more visible in 2004 and 2005, to the point were Sabeth Siddique of the Federal Reserve Board, who conducted a survey of mortgage loan quality in late 2005, found the results to be “very alarming”.

So why, with the trouble obvious in the 2005 time frame, did the market create even worse loans in late 2005 through the beginning of the meltdown, in mid 2007, even as demand for better mortgage loans was waning? It’s critical to recognize that this is an unheard of pattern. Normally, when interest rates rise (and the Fed had begun tightening), appetite for the weakest loans falls first; the highest quality credits continue to be sought by lenders, albeit on somewhat less favorable terms to the borrowers than before.

In other words: who wanted bad loans?

The dissents’ explanation is that the GSEs drove demand for affordable housing, which was what weakened underwriting standards. This might explain why the GSEs bought bad loans (which, oddly did default at lower rates than private market crappy mortgages, and thus didn’t contribute significantly to the GSE losses), but it fails utterly to explain why “the market” outside of the GSEs BOUGHT bad loans.

In the market for private loans, who wanted bad loans?

The obvious answer is that good loans did not generate hugely excessive bonuses, but bad loans did.

What happened is that the benefits for originating bad loans exceeded the cost of these negative consequences – someone was paying enough more for bad loans to overwhelm the normal economic incentives to resist such bad underwriting....

Yet the FCIC learned from Gregg Lippman of Deutsche Bank, who was arguably the single most important individual in developing the market for credit default swaps on asset backed securities (which allowed short bets to be placed on specific tranches of mortgage bonds) and related “innovations”, such as the synthetic CDO (a collateralized debt obligation consisting solely of CDS, nearly all of which were on mortgage bonds) that he helped over 50-100 hedge funds bet against bad mortgages. Didn’t it seem obvious to anyone at the commission that this information meant that a tremendous amount of money was invested in the market failing? What was the impact of this pile of money?

The report also fails to connect the dots about how Lippman and these funds accomplished their investment objective. Doing so would have allowed the report to draw conclusions about how the next crisis could be avoided....

The normal expectation was that warnings and threats about bad lending would have some impact on curtailing the bad loans, but it had the opposite effect: it led to more CDOs and demand for more “product” to short.

Dozens of warning signs, at every step of the process, should have created negative feedback. Instead, the financial incentives for bad lending and bad securitizing were so great that they overwhelmed normal caution. Lenders were being paid more for bad loans than good, securitizers were paid to generate deals as fast as possible even though normal controls were breaking down, CDO managers were paid huge fees despite have little skill or expertise, rating agencies were paid multiples of their normal MBS fees to create CDOs, and bond insurers were paid large amounts of money to insure deals that “had no risk” and virtually no capital requirements. All of this was created by ridiculously small investments by hedge funds shorting MBS mezzanine bonds through CDO structures....

The Magnetar structure was roughly 20% cash bonds, 80% synthetics, so $560 x 20% is $112. In other words, the impact on the loan market of the Magnetar structure was over $100 for every dollar they invested. And looking across its entire program, we’ve estimated, when making allowance for the effect of lower tranche CDOs in their deals, that their program alone drove the demand for at least 35% of subprime bond issuance in 2006....

The public deserves to know why Goldman, Paulson, Magnetar, Phil Falcone, Kyle Bass, George Soros, Deutsche Bank and 50 or more others were so eager to make these investments, why they wanted to keep the bad lending machine going, why they wanted to keep their strategies secret (even now), and how they made so much money so quickly. After all, it’s the rest of us wound up holding the bag.


7--Davos: Two Worlds, Ready Or Not, Simon Johnson, Baseline Scenario

Excerpt: Many of the people who control the world’s largest corporations are quite comfortable with the status quo post-financial crisis. This makes sense for them – and poses a major problem for the rest of us.The thinking here is fairly obvious. The CEOs who provide the bedrock of financial support for Davos have mostly done well in the past few years. For the nonfinancial sector, there was a major scare in 2008-09; the disruption of credit was a big shock and dire consequences were feared. And for leaders of the financial sector this was more than an awkward moment – they stood accused, including by fellow CEOs at Davos in previous years, of incompetence, greed, and excessively capturing the state.

But all of this, from a CEO perspective, is now behind them. Profits are good – this is the best bounce back on average in the post-war period; given that so many small companies are struggling, it is reasonable to infer that the big companies have done disproportionately well (perhaps because their smaller would-be competitors are still having more trouble accessing credit). Executive compensation at the largest firms will no doubt reflect this in the months and years ahead.

In terms of public policy, the big players in the financial sector have prevailed – no responsible European, for example, can imagine a major bank being allowed to fail (in the sense of defaulting on any debt). And this government support for banks has translated into easier credit conditions for the major global corporations represented at Davos.

The public policy issue of the day, from the point of view of such CEOs, is simple. There needs to be sufficient fiscal austerity to strengthen public balance sheets – so that states can more effectively stand behind their banks in the future, and to keep currencies from moving too much. Leading bankers, in particular, insisted on the paramount importance of providing unlimited government support to their sector during 2008-09; now they insist with equal or greater vigor that support to all other parts of society be curtailed....

But it is reckless decisions by some in the financial sector that produced the crisis and recession – this is what accounts for the 40 percent of GDP increase in net government debt held by the private sector in the United States (to be clear: it’s the recession and mostly the consequent loss of tax revenue). And CEOs are happy to lead the charge both against raising taxes and in favor of deficit reduction.

8--Eurozone Inflation, Paul Krugman, New York times

Excerpt: Wolfgang Munchau agonizes over European inflation targets; he worries that rising German inflation may lead the ECB to raise rates, which would be disastrous for troubled peripheral economies.

I wrote about this a couple of weeks ago. Trying to keep German inflation low means imposing harsh deflation on the European periphery, as it tries to get costs and prices back in line.

I’d add that given what we know about price adjustment during persistent large output gaps (PLOGs), the reality is that keeping overall eurozone inflation at 2 percent would probably mean at best very slow deflation in the periphery — because prices really don’t want to fall — but a prolonged period of very high unemployment.

The point, as Munchau says, is that a monetary union of imperfectly integrated economies really needed a higher inflation target than the United States; having what amounts to a low-inflation target, and a central bank that’s always looking for reasons to worry about inflation, is really destructive.

9--Underappreciated Data, Tim Duy, Fed Watch via Economist's View

Excerpt: I must admit that I surprised by the tepid response to the advance release of the 4q2010 GDP data. Mark Thoma catalogs the most common critiques – the negative contribution from government spending and the minimal reduction in the output gap. My review of the data differs. In my opinion, this is the first GDP report since the recession “ended” that offers a certain optimism, a glimmer of hope that perhaps that light at the end of the tunnel is not simply an oncoming train. If it is an oncoming train, it not the train of sagging government spending, but instead a train of imports blasting forward.

A 7.1 percent gain is nothing to sneeze at.... This is exactly the kind of final demand growth needed to lift us out of this morass.

But is it sustainable? What is apparent from this report is the potential for external support to generate real improvement in the US economy. The sharp drop in imports meant that firms were forced to sharply reduce the pace of inventory growth....

Sadly, the story of this recovery continues to circle around the external accounts. Absent a resolution of the global rebalancing story, faith in fiscal stimulus is somewhat misplaced – much government spending will simply leak abroad as evident in previous GDP reports. Of course, the alternative, fiscal policy that ignores the recession, is not exactly an endearing policy course. If rebalancing continues to be delayed in the months ahead, US policymakers simply must accept the trade deficit will reduce the effectiveness of their efforts....

Bottom Line: The GDP report revealed what could be, the glimmers of hope of a V-shaped recovery. If final demand even near the 4q2010 could be maintained, Federal Reserve policymakers makers would be forced to take notice by mid-year. Still, setting aside the usual risk factors (including the fresh possibility that Mideast unrest triggers a fresh oil shock) the sustainability of this final demand is directly dependent upon the evolution of the external accounts. If this demand surge is satisfied with an import surge in coming quarters, we can expect the recovery will remain tepid in comparison to previous deep recessions. If rebalancing were to maintain some traction, this could be simply the first in a long-waited string of data that would proved a clear exit to the current period of relative economic stagnation.

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