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Archive for May 27th, 2010
Geithner on "Sustaining the Unsustainable"; Bill Gross, Robert Mundell say Sovereign Default Likely Inevitable
May 27th, 2010 | 
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Sustaining the Unsustainable
Treasury Secretary Tim Geithner had me laughing out loud over his statement yesterday in Beijing where he took part in the two-day U.S.-China Strategic and Economic Dialogue.
“European leaders face the difficult challenge of trying to restore sustainability to an unsustainable system.”
Yes Tim, that challenge would indeed be “difficult”, in fact, impossible by definition.
It is a contradiction in terms and thus logically impossible to suggest it is possible to “sustain the unsustainable”. Geithner needs math lessons or logic lessons, most likely both.
Sovereign Default Inevitable
With Geithner focused on the impossible, others have a more practical outlook. For example, Bill Gross and Noble Prize winning economist Robert Mundell say Sovereign Default May Prove Inevitable for Nations.
Pacific Investment Management Co.’s Bill Gross said restrictive lending rates and austerity measures that slow growth may leave default as the “only way out” for some sovereign borrowers dealing with mounting debt and deficits.
“Credit and equity market vigilantes are wondering if in many cases sovereigns haven’t already gone too far and that the only way out might be via default or the more politely used phrase of ‘restructuring,’” Gross wrote in his June investment outlook today on the Newport Beach, California-based company’s website. “It may not be possible for a country to escape a debt crisis by reducing deficits.”
“At the now-restrictive yields of Libor plus 300-350 basis points being imposed by the EU and the IMF alike, there is no reasonable scenario which would allow Greece to ‘grow’ its way out,” said Gross, co-chief investment officer of Pimco and manager of the world’s biggest mutual fund.
Nobel Prize-winning economist Robert Mundell said reworking debt may be “inevitable” for one or two countries that share Europe’s common currency in the next five years.
“Debt restructuring may be needed for one or two fiscally weak euro members,” he said today at a conference in Warsaw. “In five years it may be inevitable, but it doesn’t mean euro deconstruction, it just means debt restructuring.”
Geithner Pleads Bazooka Be Fired
As noted above, it is not only “difficult” it is impossible by definition to achieve the unachievable, thus extremely foolish to even attempt such a maneuver.
However, logical impossibilities did not stop Geithner’s plea to fire the $1 trillion European bailout bazooka. Please consider Geithner calls for action on EU crisis plan
“It’s a good program (and) has got the right elements. What markets want to see is action,” Geithner said at a joint news conference in London on Wednesday with his British counterpart George Osborne.
It was the U.S. Treasury that initiated this month’s G7 emergency conference calls that led to the massive rescue fund for the euro zone but there is rising concern that this may not have been enough and markets are still falling sharply.
For Europe, $1 trillion is not enough, nor would $10 trillion. There is no plan that can possibly work. But that will not stop politicians from trying. Politicians do not care about math or logic, or the fact that piling on more debt cannot possibly be the cure for a problem of too much debt with no possible way to pay it back.
White House economic adviser Christina Romer, who accompanied Geithner on his flight to London from China said “We absolutely agree on the need to reduce the deficit over time, but for a country like the U.S., there is still space and need for targeted actions.”
History suggests the time will not come until the entire global economy implodes in debt that cannot and will not be paid back.”
Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List
Posted in Corruption, Debt, Economic Crisis, Economy, Federal Reserve, Financial System, Fraud, Government, Money, Sovereign Debt, Sovereign Default, Sovereign Risk | 
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Why buying a home today makes little financial sense. 3 reasons why taking on a mortgage in today’s market is deep in speculation. Are homes still over valued? Tax benefit not as big as you would expect.
Posted by mybudget360
It is hard for many to believe that home prices in many of our largest cities are still overvalued. Part of this distortion has to come from living in a decade long housing bubble that has adjusted the perception of value and price. But in many areas home prices are still much too high relative to the income of local families. When disconnects occur here, bubbles are produced. The stock market is experiencing this since price to earnings ratios are still much too high for what businesses are drawing in through revenues. The housing market is off by 30 percent from its 2006 peak and weakness is now appearing once again now that the tax credit has expired and the Federal Reserve is finished with their mortgage backed security buying campaign. It only took a few weeks once artificial measures were taken off the table.
Home prices relative to income are still too high nationwide:
Source: Visual Economics
In fact, if we look at recent data the numbers are still too high:
Median Household income: $52,029
Median U.S. home price: $173,100
Yet on a nationwide basis, we are getting closer to the ratio of the 1970s. But on a more narrow level of cities and states, some areas are still very much in bubbles including California. It is a fascinating case of consumer behavior post-housing bubble. Since most of us have now been conditioned over the past decade that the only way to buy a home is to take out an enormous mortgage and leverage each penny of net income to a home payment, we have forgotten sounder times. In light of this, it might appear that home prices make more financial sense in today’s climate but they do not in many areas. Let us look at a few reasons why buying a home today is not a good idea.
Reason #1 – Smaller mortgage with higher interest rate better than big mortgage with small interest rate
One argument you hear those in the housing industry continually make is “you should buy today because rates will rise.” What they don’t tell you is that higher rates usually mean cheaper home prices and buying a less expensive home with a smaller mortgage and higher interest rate makes much more sense than buying an expensive home with a big mortgage and cheap interest rate. Before we walk through an example, let us look at historical mortgage rates:
Over 40 years of history shows an average 30 year mortgage rate of 9 percent. The current average that is lower than 5 percent is an anomaly. If we run a few scenarios, you will see that a cheap mortgage rate and an expensive home actually give buyers less power when it comes to paying down their mortgage.
We’ll run two scenarios with the current interest rate and the average to show why this occurs. We’ll assume a same monthly payment since this is usually what is used for debt-to-income qualifications so the home price will reflect this.
Low interest rate scenario – 5% 30 year fixed
Home price: $250,000
30 year mortgage: $237,500 (using a 5% down payment)
Monthly principal and interest: $1,274
Total interest over life of loan: $221,482
High interest rate scenario – 9% 30 year fixed
Home price: $165,000
30 year mortgage: $156,750 (using 5% down payment)
Monthly principal and interest: $1,261
Total interest over life of loan: $297,298
On the surface, this appears to be a good deal. By paying more with a lower rate you have more flexibility. But let us assume this family is able to contribute $300 more per month. What happens then?
Low interest rate scenario $300 additional monthly payment (239 payments – 19 years)
Total interest over life of loan: $137,388
High interest rate scenario $300 additional monthly payment (188 payments – 15 years)
Total interest over life of loan: $135,437
Here is the big difference. With $300 more per month, the person with the high interest rate can pay off their loan 4 years faster and save on their interest payments as well. This is the leverage of having a higher interest rate and a lower priced home. Also, the requirement for down payments is shifted lower since the price is moved lower. This is good if the person ever decides to sell their home in the future because more people can qualify for the home. The heavily exotic mortgage market simply caters to the idea that home price is the most important factor in housing. It is not. Affordability is the most important factor for long-term sustainability.
Tax benefits over sold?
One of the oddest pitches about buying a home is the tax deduction. The fact of the matter is, most homeowners live in cheap enough housing that the standard deduction is all that is needed without the mortgage interest deduction being taken. In fact, only a handful of states like California benefit from this tax deduction even though most think this helps them (probably from not understanding the complicated tax system). To be honest, the mortgage interest break actually helps out the wealthiest in our country.
“(Tax Foundation) For tax year 2008, a little over one quarter of the nation’s tax returns claimed the mortgage interest deduction, 26.8 percent of the nation’s 143 million tax returns. Rates of home ownership are much higher than this, but many home owners don’t claim the deduction. Often they live in low-cost homes for which the deduction isn’t large enough to make a tax difference, so they don’t itemize deductions on their tax returns. In addition, home owners who have paid off their mortgages make no interest payments to deduct.
The average tax return in the U.S. deducted $3,279 in mortgage interest; that includes all tax returns, even the non-homeowners and non-itemizers. Counting only the tax returns that deducted mortgage interest, the average amount was $12,221.”
This is a stunning revelation. The homeownership rate is approximately 67% but only 26.8% claimed the mortgage interest deduction. So much for that sacred cow of housing right?
Reason #2 – Price to earning potential of home is still unsupported by long-term trend
Home prices in many cities are still in mini-bubbles relative to the income of families in those areas. California is a prime example:
According to the California Association of Realtors the median home price in California is $306,000. However the median household income is $60,000. This means the home price is 5 times the annual household income of a family in the state. Take for example the following:
Median household income:
1969: $9,302
2008: $57,000
California median home price:
1969: $24,640
2008: $500,000
So back in 1969, the ratio was 2.6 and at the peak it was close to 10. Today even at 5, it may appear to be lower relative to the peak but it is still too high. Expect this ratio to come back in line in the 3 to 4 range. This has historically been the case for most areas across the United States. Many states are actually back in line but many cities still think they are somehow immune to this trend.
Reason #3 – Mortgage rates will go up
The U.S. Treasury and Federal Reserve have been systematically pushing mortgage rates lower. For example, the Federal Reserve just finished buying up $1.25 trillion in mortgage backed securities. The Fed balance sheet is already overfilling with mortgage backed securities, loans taken from banks, and other items which never were intended to fall under their prevue:
Source: Zero Hedge
This is not normal. Historically we have never been in a position like this. It is unwise to think that mortgage rates will stay low for an indefinite amount of time. Already the credit markets are starting to push rates higher because of the risk inherent in the current debt riddled system. Buying today assumes and is a bet that we can go into trillions of dollars of debt with no interest rate repercussions. This is a giant gamble and the markets are acting like a volatile casino.
To buy today is a big bet. There is too much that makes this market volatile. Aside from the above, there is also a large amount of shadow inventory which will keep a lid on price appreciation for years to come. Betting on housing today is probably the biggest gamble many will make.
Posted in Debt, Economic Crisis, Economy, Housing, housing market, Housing Prices, Money |
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US Money Supply Plunges at 1930s Pace as Obama Eyes Fresh Stimulus
US Money Supply Plunges at 1930s Pace as Obama Eyes Fresh Stimulus
The M3 money supply in the United States is contracting at an accelerating rate that now matches the average decline seen from 1929 to 1933, despite near zero interest rates and the biggest fiscal blitz in history.
By Ambrose Evans-Pritchard
The M3 figures – which include broad range of bank accounts and are tracked by British and European monetarists for warning signals about the direction of the US economy a year or so in advance – began shrinking last summer. The pace has since quickened.
The stock of money fell from $14.2 trillion to $13.9 trillion in the three months to April, amounting to an annual rate of contraction of 9.6pc. The assets of insitutional money market funds fell at a 37pc rate, the sharpest drop ever.
“It’s frightening,” said Professor Tim Congdon from International Monetary Research. “The plunge in M3 has no precedent since the Great Depression. The dominant reason for this is that regulators across the world are pressing banks to raise capital asset ratios and to shrink their risk assets. This is why the US is not recovering properly,” he said.
The US authorities have an entirely different explanation for the failure of stimulus measures to gain full traction. They are opting instead for yet further doses of Keynesian spending, despite warnings from the IMF that the gross public debt of the US will reach 97pc of GDP next year and 110pc by 2015.
Larry Summers, President Barack Obama’s top economic adviser, has asked Congress to “grit its teeth” and approve a fresh fiscal boost of $200bn to keep growth on track. “We are nearly 8m jobs short of normal employment. For millions of Americans the economic emergency grinds on,” he said.
David Rosenberg from Gluskin Sheff said the White House appears to have reversed course just weeks after Mr Obama vowed to rein in a budget deficit of $1.5 trillion (9.4pc of GDP) this year and set up a commission to target cuts. “You truly cannot make this stuff up. The US governnment is freaked out about the prospect of a double-dip,” he said.
The White House request is a tacit admission that the economy is already losing thrust and may stall later this year as stimulus from the original $800bn package starts to fade.
Recent data have been mixed. Durable goods orders jumped 2.9pc in April but house prices have been falling for several months and mortgage applications have dropped to a 13-year low. The ECRI leading index of US economic activity has been sliding continuously since its peak in October, suffering the steepest one-week drop ever recorded in mid-May.
Mr Summers acknowledged in a speech this week that the eurozone crisis had shone a spotlight on the dangers of spiralling public debt. He said deficit spending delays the day of reckoning and leaves the US at the mercy of foreign creditors. Ultimately, “failure begets failure” in fiscal policy as the logic of compound interest does its worst.
However, Mr Summers said it would be “pennywise and pound foolish” to skimp just as the kindling wood of recovery starts to catch fire. He said fiscal policy comes into its own at at time when the economy “faces a liquidity trap” and the Fed is constrained by zero interest rates.
Mr Congdon said the Obama policy risks repeating the strategic errors of Japan, which pushed debt to dangerously high levels with one fiscal boost after another during its Lost Decade, instead of resorting to full-blown “Friedmanite” monetary stimulus.
“Fiscal policy does not work. The US has just tried the biggest fiscal experiment in history and it has failed. What matters is the quantity of money and in extremis that can be increased easily by quantititave easing. If the Fed doesn’t act, a double-dip recession is a virtual certainty,” he said.
Mr Congdon said the dominant voices in US policy-making – Nobel laureates Paul Krugman and Joe Stiglitz, as well as Mr Summers and Fed chair Ben Bernanke - are all Keynesians of different stripes who “despise traditional monetary theory and have a religious aversion to any mention of the quantity of money”. The great opus by Milton Friedman and Anna Schwartz – The Monetary History of the United States – has been left to gather dust.
Mr Bernanke no longer pays attention to the M3 data. The bank stopped publishing the data five years ago, deeming it too erratic to be of much use.
This may have been a serious error since double-digit growth of M3 during the US housing bubble gave clear warnings that the boom was out of control. The sudden slowdown in M3 in early to mid-2008 – just as the Fed raised rates – gave a second warning that the economy was about to go into a nosedive.
Mr Bernanke built his academic reputation on the study of the credit mechanism. This model offers a radically different theory for how the financial system works. While so-called “creditism” has become the new orthodoxy in US central banking, it has not yet been tested over time and may yet prove to be a misadventure.
Paul Ashworth at Capital Economics said the decline in M3 is worrying and points to a growing risk of deflation. “Core inflation is already the lowest since 1966, so we don’t have much margin for error here. Deflation becomes a threat if it goes on long enough to become entrenched,” he said.
However, Mr Ashworth warned against a mechanical interpretation of money supply figures. “You could argue that M3 has been going down because people have been taking their money out of accounts to buy stocks, property and other assets,” he said.
Events may soon tell us whether this is benign or malign. It is certainly remarkable
Posted in Banks, Debt, Economic Crisis, Economy, Financial System, Government, Money |
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