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Week of August 4, 2008

Sunday, August 10, 2008, 2:07 PM
08/04/2008

States are leasing and
selling public assets for some temporary budget relief, the WSJ gives
some good advice on FDIC insurance but paints a stronger picture of
safety than is warranted, the next big wave of mortgage trouble is
starting, and TrimTabs estimates far higher job losses than the BLS. No
surprises there, eh?


August 4

Roads, airports on the block as budgets tighten (Aug 1 - Reuters NEW YORK)

Cash-strapped U.S. state and city governments are
likely to sell or lease more highways, bridges, airports and other
assets to investors desperate for stable returns after being frazzled
by the credit crisis.

The trend is set to pick up speed given worsening budget deficits in state capitals and city halls nationwide.

It
will also be welcomed by Wall Street bankers hoping to help create and
market so-called "infrastructure" transactions at a time many debt
markets remain paralyzed, and after major U.S. stock indexes fell into
bear market territory.


I realize
that states are going to perform all kinds of stunts in an effort to
raise cash, but I find this route to be unacceptable. For a one-time
cash infusion, the revenue rights and maintenance responsibilities for
roads, bridges, airports, and other assets will go to private
companies.

This is a terrible idea, for two reasons.

First, because
public money (taxes) was used over the years to build these assets.
They are public assets built with public money and they belong to the
public. The idea of selling or leasing them off for a one-time cash
infusion is simply short-sighted and wrong. However, never
underestimate the desire of a public official to avoid raising taxes or
cutting spending in an election year, which are the other options
besides selling off the public trust.


Second,
because often these assets are effectively monopolies. I trust private
companies to keep prices low and maintenance up when they have to
compete. So if there were two side-by-side bridges over the same river
going to two separate companies, I’d probably say, “Okay, lease ‘em,”
and see how it goes. But if a company buys a portion of I-90 and jacks
up the prices, then leaves it full of craters, what are you going to
do, take I-40?


This whole concept is a bad idea borne of desperation.


Protect Yourself From Bank Failures (Aug 3 – WSJ)

Can you bank on the safety of the money you've got stashed in banks?

Some
consumers are worrying as banks report billion-dollar losses from bad
loans and in the wake of the seizure of IndyMac Bank, the third-largest
bank failure in U.S. history.

The good news is that you can
eliminate the risk of losing money in a bank failure -- by making sure
none of your accounts exceed the limits of federal deposit insurance.

Many people have not been diligent about doing that, however.

Well, I suppose
it’s good that the WSJ is out there raising consciousness about the
FDIC and bank account insurance limits. But I take exception to the way
they’ve worded this, “…you can eliminate the risk of losing money in a
bank failure…”


Eliminate?

No, it’s not
possible to eliminate that risk. You can reduce it, but the FDIC is
really only a few good failures away from trouble itself, and nobody
knows quite how that might turn out.

Otherwise, this
is a fine article for those wanting to know about how to stay as safe
as possible, at least as far as things stand right now.


Housing Lenders Fear Bigger Wave of Loan Defaults (Aug 4 – NYT)

The first wave of Americans to default on their
home mortgages appears to be cresting, but a second, far larger one is
quickly building.

Homeowners with good credit are falling
behind on their payments in growing numbers, even as the problems with
mortgages made to people with weak, or subprime, credit are showing
their first, tentative signs of leveling off after two years of
spiraling defaults.

The percentage of mortgages in arrears in
the category of loans one rung above subprime, so-called alternative-A
mortgages, quadrupled to 12 percent in April from a year earlier.
Delinquencies among prime loans, which account for most of the $12
trillion market, doubled to 2.7 percent in that time.


If you were
reading this site a year ago, you read then that ALT-A loans were going
to be the next big problem. Their time has arrived. However, even I am
shocked that they’ve managed to hit a 12% delinquency rate so early in
the game. This implies that the ultimate rate is going to be closer to
20% or more, when all is said and done. Fannie and Freddie are
surprisingly exposed to this type of mortgage, and I am thoroughly
comfortable stating that the $25 billion bailout estimate is far too
low.
To put that number in perspective, I just read today that a
group of materials scientists believe that it would require $1 billion
over the next ten years to create the next generation of low-cost solar
cells that could be used to generate electricity for home use. But they
are not sure where that kind of money will come from…


Is BLS understating the "true" job losses? (Aug 1 – The Skeptical Capitalist)

TrimTabs employment analysis, that uses real-time
daily income tax deposits from all U.S. taxpayers to compute employment
growth, finds that the U.S. economy shed 169,000 jobs in July.
Meanwhile, the Bureau of Labor Statistics (BLS) reported today that the
U.S. economy lost only 51,000 jobs in July. In addition, we estimate
total job losses for the year have reached 734,000 while the BLS
estimates that only 463,000 jobs have been lost, a difference of 37%.
We believe the BLS is seriously underestimating the harm high oil
prices are inflicting on the U.S. economy. The BLS' flawed methodology
will finally report that the U.S. labor market was in trouble in 2008
sometime next year.


The stock
market was recently cheered by the BLS announcement that job losses
were ‘only’ -51,000 rather than the expected -70,000. As anybody who
has attended my seminar knows, the BLS uses highly questionable
practices to derive their numbers. If not fraudulent, then their
reports are perplexingly self-delusional.


But there’s
this private company that actually tracks tax receipts and then uses
that info to estimate actual employment, since all reported earnings
are taxed. What a clever idea!  Actually using hard data that can be
tracked, rather than estimation models so complicated to deploy that
the BLS won’t fully reveal how they actually work.

In short, I
trust the tax receipt numbers much, much more than I trust the BLS and
their mysterious methods. One test of whether there is anything
systematically wrong with a model is to determine if it misses high
just as often as it misses low. The BLS misses on the high side by such
a huge amount on a monthly basis that if their employment data were a
freshman statistics class project, they’d get an “F”.



08/06/2008

Detroit automakers are in serious need of capital. And who isn't these days? Here I explore the issues.


Detroit 3 ask up to $40 billion in loans (Aug 5 - Detroit Free Press)

Detroit's three automakers are urging Congress
to make as much as $35 billion to $40 billion in low-cost loans
available during the next two to three years to assure that the
companies survive long enough to retool and build a new generation of
fuel-efficient vehicles.

While I agree that our
"big three" automakers are also going to need a bailout, and, in the
interest of fairness, they deserve one more than Wall Street's careless
mortgage masters, there's a problem here.

And I am not referring
to my concerns that the last semblances of a "free market" and
"capitalism" are disappearing before our very eyes (did they ever
really exist?), but rather, my concern centers on the borrowing ability
of the US Government.

It's true that LOTS of
borrowing room exists for the US Government, because long-term Treasury
Bond interest rates remain below the rate of inflation by 2%-9%,
depending on which representation of inflation you happen to believe.
But let's add this up:

  1. The 2009 fiscal year deficit for the federal government is now pegged at ~$500 billion.
  2. The Fannie/Freddie bailout is probably going to be an incremental $100 billion to $200 billion next year.
  3. The hit to the FHLB (you heard it here first)
    for the junk loans they snapped up last August as part of a stealth
    bailout is probably going to be another $15 to $20 billion.
  4. The FDIC is going to need anywhere from $10 billion to $100 billion, depending on who goes belly up next year.
  5. Don't forget, the wars are mostly "off budget,"
    so the $500 billion deficit is really more like $800 billion, giving us
    an extra $300 billion which which to contend.

Adding up the high end of these estimates give us a 2009 borrowing figure of more than a trillion dollars for the US Government.

On top of this, let's
factor in state, municipal, corporate, and banking borrowing needs that
will all be contending with US Government borrowing for a limited pool
of funds.

Action: If you have the decision of taking either an adjustable or a fixed rate of interest on any borrowing, choose the fixed rate. All this borrowing has a very high probability of driving up interest rates.

Next, there's a
very high chance that much, or all, of this vast need for additional
money will be met with new money creation by the Fed. Expect inflation to continue,
if not accelerate, if all the listed government fiscal needs are to be
met with borrowing only and not through tax hikes (a near certainty
during an election year when spending cuts are O.F.F. the table).

Note: I am *not* a fan of tax hikes. I am a fan of spending cuts and living within our means.



08/07/2008

August 7


To follow up on the
latest Crash Course chapter, I present an article from a university
economist who also calls ‘shenanigans’ on a suspiciously low GDP
inflation measure. Pending home sales reported higher; no word from the
NAR on the impact of foreclosures on their happy report. Anatomy of a
bank failure. A spectacular amount of risk for a tiny bank.


The GDP Illusion (August 06 - The Free Liberal)

Note: Article by Dr. Fred Foldvary who teaches
economics at Santa Clara University The federal government is using a
GDP inflation index of only 1 percent, while the consumer price index
(CPI) is now 5 percent. With an inflation index of 5 or even 4 percent,
the economy would be calculated as having been in recession since
fourth quarter 2007. Thus, the small 1 percent GDP index is suspicious,
and will most likely be revised upward, just as it was revised up for
the fourth quarter 2007.

The Government is inflating the GDP
data with its misleading inflation index, and the government is
inflating output by borrowing and spending. Maybe that game can
continue until the November elections, but eventually economic reality
will hit home and the revised data will show lower real growth. Few
people question authority, and both political parties have an interest
in making the voters think that the government is “doing something.”


I’m posting
this as a follow-up to the latest Crash Course Chapter (Fuzzy Numbers).
I want you to see that there are some in the economics profession who
are not taken in by the ham-handed statistical manipulations that pass
for economic reporting in this country.


Regrettably,
most still are, although they possibly represent living examples of
this quote by Upton Sinclair, “It is difficult to get a man to
understand something when his job depends on not understanding it.”


Pending home sales index rises 5.3% in June: NAR (Aug 8th Marketwatch WASHINGTON)

In a sign that the U.S. housing market may
strengthen in coming months, an index of sales contracts on previously
owned U.S. homes rose 5.3% in June from the prior month, the National
Association of Realtors reported Thursday.

The index, which is
considered to be a leading indicator of existing home sales, reached
its highest level since October, but was still down 12.3% from June
2007.

Pending home sales increased in June in all four
regions, with a gain of 9.3% in the South, 4.6% in the West, 3.4% in
the Northeast and 1.3% in the Midwest. Despite the monthly gains, all
four regions remain below year-ago levels.


I am deeply
skeptical of the NAR’s reporting here. First, they only ‘sample’ about
half of all Realtor office to obtain this reported number, and there
are lots of ways such sampling can be biased or erroneous.


I am openly
critical of the NAR because they utterly and completely lost their
credibility with me back in 2006 and 2007 when they consistently made
upbeat estimates of prospective future activity that were, without
exception, revised downward month after month.

But here’s the
main problem. Foreclosures are wrapped up in this data. So an uptick in
pending home sales could be a good thing, or it could be a bad thing.

Good: More people are buying homes
Bad: More people are losing homes.


Which is it?
The NAR is decidedly mum on the issue. In the end, I view the NAR as a
self-interested sales organization and I treat their proclamations with
about as much regard as, say, those of a used car salesman regarding
the activity on his lot.


Tempest for a Bank That Bet on Risky Loans (Aug 6 - NYT CORAL GABLES, Fla.)

A cheerful sign outside the glistening offices of
Bank United beckons consumers to tap into “Mortgage-ade.” Another
promises a “59 Minute Mortgage.” But easy money, it turns out, has
created enormous problems at Bank United, Florida’s biggest regional
bank.

By aggressively peddling a popular type of high-interest
loan to risky borrowers, the bank tripled its profits in 2006 as real
estate on Florida’s Gold Coast peaked, only to lose nearly $100 million
in late 2007 and early 2008 as the market cratered. Now, its chief
executive, Alfred R. Camner, is scrambling to raise $400 million in
capital, an amount nearly eight times the bank’s shriveled value on the
stock market.


This bank is
toast. Raising capital in excess of 8 times market capitalization is
probably not possible. The interesting question to ask is, “where were
the FDIC regulators when this bank was amassing such an aggressive and
risky portfolio?”


They
observed this phenomenon; they wrote about it; but they did not
regulate it. I was shocked in 2006 when I read an FDIC report that
calmly observed that the entire bank capital in the entire southeast
region was exceeded by some 300% by commercial and Industrial real
estate loans. The above article is about one of the victims of that
excess.



08/08/2008

August 8


Central Banks
intervene to prop the dollar, CA foreclosures shatter all records, and
consumers tap credit cards at a faster rate.


Mystery Solved (7 August 2008 — GoldMoney Alert from James Turk)

So what happened to cause the dollar to rally over
the past three weeks? In a word, intervention. Central banks have
propped up the dollar, and here's the proof.

When central
banks intervene in the currency markets, they exchange their currency
for dollars. Central banks then use the dollars they acquire to buy US
government debt instruments so that they can earn interest on their
money. The debt instruments central banks acquire are held in custody
for them at the Federal Reserve, which reports this amount weekly.

On
July 16, 2008 (the closest date of the weekly reports to the July 15th
low in the Dollar Index), the Federal Reserve reported holding $2,349
million of US government paper in custody for central banks. In its
report released today, this amount had grown over the past three weeks
to $2,401 million, a 38.4% annual rate of growth. To put this
phenomenally high growth rate into perspective, for the twelve months
ending this past July 16th, assets in the Federal Reserve's custody
account grew by 17.3%, which is less than one-half the growth rate
experienced over the past three weeks.


To
summarize, foreign central banks followed up their ‘words’ over the
past few weeks with $52 billion of direct dollar support over only a
three-week period. And this represents only the purchases we know
about. The BIS (Bank of International Settlements, the ‘bankers bank’)
has several openly published research papers that explore the best ways
for central banks to manipulate currencies using proxy banks to hide
their tracks.


At any rate,
they are desperately trying to manage the poor effects of their past
decisions by manipulating the dollar, and, by extension, commodities,
stocks, and bonds. So far, they’ve succeeded by driving paper assets in
a positive direction and commodities in a steeply negative direction.

My view? I think
this level of intervention and central-style planning is destined for
failure and that the central banks are ill-advised in their efforts.
Instead of helping to reduce the very imbalances and moral hazards that
brought us to the brink of systemic collapse, they are now encouraging
a deeper foray into those territories.

Yet, despite all
of these high-level market interventions, houses are still being
foreclosed at record rates and consumers are plunging deeper into debt.
It would seem that the central banks are stuck in the past and are
trying to wag the economic dog with the market tail.


Record Foreclosures Sweep CA in July (Aug 7 – Mr. Mortgage Market)

July was another record month for foreclosures in
the state of CA with all hell breaking lose and banks taking back
roughly 26,500 homes for $12.5 billion. ’Record-breaking’ is not a good
thing in the foreclosure universe. This 25% increase breaks all records
ever posted and all foreclosure estimates.

This $12.5 billion
in foreclosures were from Notice-of-Defaults (NOD) from the February
time frame. It takes roughly 140 days in CA to go from NOD to
foreclosure auction currently due to the back log. In Feb we had a drop
in NOD’s to about 37k due to Feb being a short month. But from March
through June we saw NOD’s shoot back up to record levels of about 43k
per month (see chart below). This means that the number and dollar
amount of foreclosures from Sept through Oct at least should be even
greater than July by 10-20% depending on fluctuating cure rates.


This is the
reality on the street. The largest state with the highest house prices
is experiencing foreclosure rates that are beyond all previous records.
These will translate into massive dollar losses and declines in
economic activity. As Mr. Mortgage makes clear, there is worse in
store, as foreclosures are preceded by so-called Notices of Default
(NODs).


Against
this, we are to believe that “investors” have suddenly decided to sell
yen in vast quantities in preference for the dollar, and to go on a
stock buying spree that saw Home Depot advance 8% today.


What’s next?
Unemployment at 15% and the Dow at 20,000? I wouldn’t put it past the
desperate bankers as they seek to paper over reality using whatever
tricks they can.


Consumer Debt Grows At Fastest Rate in 7 Months

U.S. consumer credit expanded at the fastest rate
in seven months in June as Americans turned to their credit cards to
keep up spending in the face of rising food and energy costs, a report
Thursday showed. June consumer credit rose $14.33 billion, or at a 6.7
percent annual rate, to $2.586 trillion, the Federal Reserve said.


The vaunted
US consumer, cut off from Refi money and HELOC borrowing, has turned
back to credit cards as the fuel to maintain consumption. This shows
two things. First, that we are addicted to living on borrowed money,
and second, that this behavior won’t change until it is forced to
change. This is why I am so dead-set against the propping of the US
imbalances by foreign central banks. It enables exactly the wrong sort
of behaviors that created this mess in the first place.


It is time
for us to stop consuming beyond our means, both individually and as a
nation. As we saw with gas prices, practically nobody changed their
habits until prices forced the issue. Here, too, the cure for excess
borrowing is to hike the cost of borrowing.


I roughly
calculate that US borrowing costs would be twice as high if we didn’t
have foreign central banks buying tens of billions of dollars worth of
US debt each week, serving both to drive down their currencies in
relation to the US dollar and to keep US interest rates low, thereby
enabling a nation of over-consumers to continue digging at the bottom
of a very deep hole.

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