FedUpUSA

Archive for June 16th, 2010

While nearly everyone seems convinced that the economy is improving and buy-the-dip is the right strategy, the Fed is having increasing concerns about what to do if reflation does not take hold.

The Wall Street Journal discusses “What if?” scenarios in Fed Weighs Growth Risks.

Federal Reserve officials are beginning to debate quietly what steps they might take if the recovery surprisingly falters or if the inflation rate falls much more.

Fed officials, who meet next week to survey the state of the economy, believe a durable recovery is on track and their next move—though a ways off—will be to tighten credit, not ease it further. Fed Chairman Ben Bernanke has played down the risk of a double-dip recession and signaled guarded confidence in the recovery.

But behind-the-scenes discussions at the meeting could include precautionary talk about what happens if the economy doesn’t perform as well as expected.

“If events in Europe evolve so that they have a more severe and broad impact on financial markets, then the scope of the problems for the U.S. could be magnified,” Charles Evans, president of the Federal Reserve Bank of Chicago, said in a speech last week.

Brian Sack, the head of the New York Fed’s powerful markets group, has talked about “two-sided” risks to the economy—in other words, the risk that growth and inflation could turn out to be lower than expected, as well as higher.

“The European sovereign-debt situation is serious, and there are many unanswered questions about how events will unfold,” James Bullard, St. Louis Fed president, said in Tokyo on Monday.

Officials don’t rule out the possibility that markets could settle and the economy could produce a few months of strong job growth and solid consumer spending and business investment.

But there are other scenarios: if the recovery falters, or if inflation slows much further and a threat arises of deflation, a debilitating fall in prices across the economy. In such cases, there would be a few avenues the Fed could take.

One is asset purchases. During the financial crisis, the Fed purchased $1.25 trillion in mortgage-backed securities on top of buying debt issues by Fannie Mae, Freddie Mac and the U.S. Treasury. Mr. Bernanke has said the steps helped to lower long-term interest rates, including rates on mortgages.

In any case, a new report by the Federal Reserve Bank of San Francisco, based on projections for inflation and unemployment, suggests that the Fed may not need to raise short-term interest rates to curb growth or inflation until early 2012, later than is commonly expected on Wall Street.

The report cites a rule of thumb that the Fed tends to lower the federal-funds rate by 1.3 percentage points if inflation falls by one percentage point and by almost two percentage points if the unemployment rate rises by one percentage point.

Based on that rule, the federal-funds rate—now near zero—would be minus 2.9% under today’s conditions and wouldn’t need to move higher until the first half of 2012, according to San Francisco Fed economist Glenn Rudebusch. The analysis factors in the stimulus the Fed has provided with its mortgage purchases.

“It seems likely that the Fed’s exit from the current accommodative stance of monetary policy will take a significant period of time,” the report said.

Risks to Growth All on Downside

The reality is reflation has already failed and other than unsustainable government spending (and massive increases in public debt), the US economy would still be in recession.

Looking ahead, the risks to growth are all on the downside. Here are some of them.

• China overheats and has to step on the economic brakes
• Spain or Italy need Euro bailouts
• Property bubbles in China, Canada, Australia pop.
• Austerity measures throw the Eurozone back in recession
• Huge public worker layoffs in the US
• US housing demand weakens further, housing prices slip, construction dips, and inventory rises from already high levels
• US unemployment starts to rise
• UK heads bank in recession
• Congress starts huge trade wars with China by labeling China a currency manipulator and employs large punitive tariffs

I expect everyone of those to happen with the possible exception of labeling China a currency manipulator. Thus, this is not a case of what the Fed will do “if” the recovery fails, but rather what the Fed will do “when” the recovery fails.

Bear in mind that the only semblance of economic recovery is from government spending, nearly all of it wasted or taking from future demand, thus the reflation efforts have already failed.

Finally, given an expected dramatic shift in Congress this November coupled with increasing worry over deficits and public anger over bailouts to date, reflation round two will play out much differently than did round one.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

The dynamics for housing moving forward point to a very bleak future and a potential lost decade yet again from 2010 to 2020.  Housing has a treacherous path moving forward and deep down demographic shifts will keep a lid on any significant housing appreciation moving forward.  The economy is in the process of deleveraging from a market highly dependent on real estate.  Wall Street and the government are doing everything they can to bring back the economy of yesterday but have had little success.  This recession has shrunk the middle class so those looking to buy homes have declined simply because many can no longer afford to purchase a home even at today’s lower prices.  Focusing on housing first was a big expensive policy mistake where we should have focused on creating sustainable jobs.  The market is slowly shifting to a new housing paradigm.  Family growth rates, employment trends, baby boomers, and wages will all keep a lid on housing prices moving forward.

First we should break down the entire housing market:

Source:  Census

The U.S. has a large number of homeowners.  A total of 75 million Americans can lay the claim to owning their home.  23 million of this group (31 percent) actually owns their homes outright with no mortgage.  Of course not having a mortgage does not mean that these homeowners have no housing associated cost.  They still need to pay yearly property taxes, insurance, and all the cost in maintaining a home.  Another 37 million American households rent.  These are the basic dynamics of the housing market.

Of those homeowners with a mortgage, 7.2 million (14%) are in foreclosure or 30+ days late on their mortgage.  This practically guarantees a few years of cheaper housing hitting the market in a steady trickle.  This puts a herculean hold on any significant home building going forward.

From the recent Federal Reserve Flow of Funds Report, we find that current outstanding mortgage debt is $10.334 trillion.  We have to break out the renters and the homeowners with no mortgage and find that the average mortgage debt for homeowners is:

$10.334 trillion / 51.575 million mortgaged households =             $200,374

The current median home price comes in at approximately $170,000.  Now some would argue that housing will regain traction and go on to rising to new levels.  Yet this assumption assumes that middle class wages will be growing moving forward.  If we look closely at the data the only real winner so far in this economic crisis is Wall Street but average Americans have seen very little benefit from the current bailout measures.  Now those with big investment bank salaries can afford their piece of prime real estate in Manhattan or the Hamptons but this does not make up the bulk of the housing market.  The bulk of the housing market is highly dependent on how middle class Americans are doing.

If we look at the current unemployment levels by age group, we see that those in the household forming age ranges or those entering into these categories, are taking on the brunt of this recession:

You can see that up to age 34, the unemployment rate is trending much higher than the total national average.  These are prime age groups for forming households and if a family is not feeling safe financially, they will delay on purchasing a home.  The middle class young family is also delaying on having children so the necessity for a bigger home is also being pushed out.  This demographic shift is happening at the same time that baby boomers start entering retirement age and many will want to downsize.

And many of these people have a buffer for equity to sell since they bought prior to the housing bubble.  Take for example data on current owner households:

Moved in before 1989:                  20.5% of all homeowners

Moved in before 1990:                  40.9% of all homeowners

It is highly likely that in this group, you have many baby boomers that will sell to downsize in the years coming forward and the current decline in prices will only cut into their equity but not put them underwater given the decade long bubble.  They purchased before that.  Those that moved in before 1989 will have a much larger cushion.  So there is a large group of people that will sell regardless of market trends because they will have to simply because of life changing events.

And then on the other hand we have the fact that one-third of homeowners in certain states are underwater on their mortgages.  Take for example California:

California has a large renting population and most that own a home carry a mortgage (77 percent).  Of those that carry a mortgage a stunning one-third are underwater.  In other words 1.76 million mortgages in California are attached to homes that are worth less than the actual balance of the mortgage creating a large incentive to walk-away.  Many of these loans come from Alt-A paper and option ARMs.  These loans will impact the market at least until 2012 and hurt the state.  California isn’t immune and other states like Nevada, Florida, and Arizona have similar dynamics.  In fact, here is the amount of mortgage debt in a negative equity position according to a recent Deutsche Bank analysis:

California: $969 billion

Florida: $432 billion

Arizona: $140 billion

The only way that things would improve for banks is if prices moved higher.  But how can prices move higher if middle class Americans are dealing with high unemployment and stagnant wages?  The Federal Reserve and U.S. Treasury have really reached the end of options in terms of what they can do.  Even the 30 year fixed mortgage is at all time lows in the midst of all this turmoil:

The 40 year average for 30 year rates is closer to 9 percent. Today it is under 5 percent.  That is unsustainable and as we move forward with insurmountable levels of national debt, the rate will have to rise.  I know this seems impossible for many but as we have seen with other debt ridden countries, the market can turn on like a tornado and quickly change the dynamics of the situation.  For the housing market, this will mean even more pressure to keep prices muted.  

The only way home prices can rise in a healthy manner is if we start seeing wage inflation.  We saw some of this in the 1970s where wages went up in tandem with home prices.  In the last decade, wages moved sideways while home prices went into a bubble.  As far as the economy going forward, the big job sectors seem to be in low paying service sector jobs.  Certainly someone can purchase a house with these jobs but not at current prices even though they appear to be solid.

The Federal Reserve and the U.S. Treasury have done everything to slam the dollar and create some level of inflation.  Yet other central banks are doing the same.  So what happens is easy money flows to Wall Street for gambling while the real economy stagnates.  It is hard for many to believe that we will have another lost decade in housing but there is little reason to believe that prices will soon start to outpace inflation.  In fact, in the last year or two we have been dealing more with aspects of deflation.  We need to keep an eye on the real value of home prices adjusting for inflation/deflation.

My Budget 360

Barring an economic bailout of mammoth proportions, the economy of Spain is completely and totally doomed.  The socialist government of Spain is drowning in debt, unemployment is running rampant and everywhere you turn there are major economic problems.  So will Spain be the next Greece?  No.  When the economy of Spain implodes it is going to be a whole lot worse for the world economy.  The economy of Spain is more than four times the size of the economy of Greece.  Spain accounts for 11.5 percent of eurozone GDP while Greece only accounts for approximately 2.5 percent.  Spain is the 4th largest economy in the 16 nation eurozone and it is the 10th largest economy in the world.  If the economy of Spain fails it will cause a shockwave that will be felt in every corner of the globe.  In fact, there are quite a few analysts that believe if Spain defaults it would ultimately lead to the breakup of the eurozone.

So will the EU step up and bail out Spain?  Well, there are rumors that EU officials have begun work on a bailout package for Spain which is likely to run into the hundreds of billions of dollars, but on Monday the European Commission, the Spanish government and the German government all denied that the European Union was preparing a bailout for the Spanish economy.

Of course we all know that politicians don’t always tell us the truth.

So who knows what is going on over there right now.

But the reality is that the economy of Spain is not going to make it much longer without serious help, and some EU officials are already using apocalyptic language to describe what an economic collapse in Spain would mean.

For example, EU Commission President Jose Manuel Barroso recently warned that democracy could completely collapse in Greece, Spain and Portugal unless urgent action is taken to tackle the burgeoning European debt crisis.

So could democracy actually fail in those nations?

Well, considering the fact that Greece, Spain and Portugal only became democracies in the 1970s, and that all three of those countries have a history of military coups, such a scenario is not that far-fetched.

Without a doubt there would be serious public unrest in those nations if public services collapsed because their governments ran out of money.

So are there signs that the economy of Spain is about to collapse?

Well, yes, there are quite a few of them.

The following are 9 reasons why Spain is a dead economy walking….

#1) Even before this most recent crisis, unemployment in Spain was approaching Great Depression levels.  Spain now has the highest unemployment rate in the entire European Union. More than 20 percent of working age Spaniards were unemployed during the first quarter of 2010.  If people aren’t working they can’t pay taxes and they can’t provide for their families.

#2) In an effort to stimulate the economy, Spain’s socialist government has been spending unprecedented amounts of money and that skyrocketed the government budget deficit to a stunning 11.4 percent of GDP in 2009.  That is completely unsustainable by any definition.   

#3) The total of all public and private debt in Spain has now reached 270 percent of GDP.

#4) The Spanish government has accumulated way more debt than it can possibly handle, and this has forced two international ratings agencies, Fitch and Standard & Poor’s, to lower Spain’s long-term sovereign credit rating.  These downgrades are making it much more expensive for Spain to finance its debt at a time when they simply can’t afford to pay more interest on their debt.

#5) There are 1.6 million unsold properties in Spain.  That is six times the level per capita in the United States.  Considering how bad the U.S. real estate market is, that statistic is incredibly alarming.

#6) The new “green economy” in Spain has been a total flop.  Socialist leaders promised that implementing hardcore restrictions on carbon emissions and forcing the nation over to a “green economy” would result in a flood of “green jobs”.  But that simply did not happen.  In fact, a leaked internal assessment produced by the government of Spain reveals that the “green economy” has been an absolute economic nightmare for that nation.  Energy prices have skyrocketed in Spain and the new “green economy” in that nation has actually lost more than two jobs for every job that it has created.  But Spain so far seems unwilling to undo all of the crazy regulations that they have implemented.

#7) Spain’s national debt is so onerous that they are now caught in a debt spiral where anything they do will harm the economy.  If they cut government expenditures in an effort to get debt under control it will devastate economic growth and crush badly needed tax revenues.  But if the Spanish government keeps borrowing money their credit rating will continue to decline and they will almost certainly default.  The truth is that the Spanish government is caught in a “no win” situation.

#8) But even now the IMF is projecting that the Spanish economy is going nowhere fast.  The International Monetary Fund says there will be no positive GDP growth in Spain until 2011, at which point it will still be below one percent.  As bleak as that forecast is, many analysts believe that it is way too optimistic considering the fact that Spain’s economy declined by about 3.6 percent in 2009 and things are rapidly getting worse.

#9) The Spanish population has gotten used to socialist handouts and they are not going to accept public sector pay cuts, budget cuts to social programs and hefty tax increases easily.  In fact, there is likely to be some very serious social unrest before all of this is said and done.  On May 21st, thousands of public sector workers took to the streets of Spain to protest the government’s austerity plan.  But that was only an appetizer.  Spain’s two main unions are calling for a major one day general strike to protest the government’s planned reforms of the country’s labor market.  The truth is that financial shock therapy does not go down very well in highly socialized nations such as Greece and Spain.  In fact, the austerity measures that Spain has been pressured to implement by the IMF have proven so unpopular that many are now projecting that Spain’s socialist government will be forced to call early elections. 

So what is going to happen in Spain?

The truth is that nobody can predict for sure how things are going to play out over the coming weeks and months.

But what everyone can agree on is that the stakes are incredibly high.

Speaking at the World Economic Forum in Davos, Switzerland, world famous economist Nouriel Roubini put it this way: “If Greece goes under, that’s a problem for the eurozone. If Spain goes under, it’s a disaster.”

But right now the entire population of Spain (along with much of the rest of the world) is completely distracted by the World Cup.  As long as the Spanish team does well, that is likely to keep the Spanish population sedated.  But if the Spanish team gets knocked out of the tournament early that will put the entire Spanish population in a really, really bad mood and that could mean a really chaotic summer for the nation of Spain.

The Economic Collapse

By Karl Denninger

By Karl Denninger