Relationship Management 101

I received a phone call today from a professor of an esteemed university offering to teach a class on Relationship Management right here on this blog. I was initially skeptical, and it took a bit of persuasion on his part, but once I heard a synopsis from a few of the lessons, I agreed the topic was fine. Still, everything here is free, I insisted.

Eventually we came to terms and the professor agreed to teach a few lessons at the bargain basement price of zero. Without further ado, here is Professor Hardious Knocks of the prestigious School of Hard Knocks, teaching Relationship Management 101. Each lesson in this series is based on current events. There will be written assignment after each lesson. Class is now in session.

Lesson One
Get Your Agreements In Writing.

The stalled real estate market turned Stoneybrook at Venice into a very different community than its residents paid for: a half-built subdivision dotted with slow-moving construction sites and "For Sale" signs.

Many residents of the 560-acre east Venice subdivision said they are willing to weather those inconveniences. But the latest news -- that mega-developer Lennar will dump more than $6 million in costs on homeowners -- has Stoneybrook residents crying foul and preparing a lawsuit.

Lennar had asked the county for designation as a community development district, a special taxing district that issues bonds to pay for things such as drainage and roads. The commission's vote was 3-2 in favor of Lennar's request. The tax will add more than $700 a year to some residents' yearly payments.

Residents said they were under the impression they would only have to pay for future maintenance through their homeowners dues. But commissioners ruled the developer did everything by the book.

The decision, coupled with Lennar recent increase in some homeowner's dues by $200 a year -- another move residents say wasn't properly announced -- has a group of more than 150 Stoneybrook residents ready to take Lennar to court.

Stoneybrook residents loudly applauded a speech by Natiss, in which Natiss threatened a lawsuit and said the "only thing Lennar could be building in this county are license plates while they are wearing their little orange uniforms." Others cited a petition, with more than 150 signatures, protesting the levy. Many residents held signs with slogans such as "we have been Lennarred."

Lennar attorney Dan Bailey called the residents' claims "reckless allegations." He said Lennar made clear there would be more costs when it started selling homes in Stoneybrook.

Today, the complex is about 43 percent sold, which county staff said is less than two-thirds as far along as Lennar hoped. County staff said Lennar will fall almost $8 million short of its revenue goals for its first two years if the sales trend keeps up.

Homework Assignment One

• Discuss the needs to get it in writing and to read the fine print.
  
• Is "by the book" the best way to treat customers?
• Does Lennar care about its relationships once the closing is finished?
• If you have to enter a lottery to start a relationship, what can you expect out of the relationship down the road?
• Is the proposed relationship the homeowners have with a lawyer likely to be beneficial to anyone but the lawyer?
• Does the commission just want the work done regardless of who pays?
• Is the commission just acting to avoid a lawsuit by Lennar?
• Do you even know who your commissioners are?
  

Lesson Two
You are no longer needed. Goodbye.

Centex sees more layoffs to get to 'fighting weight'.
Centex Corp.(CTX) Chief Executive Tim Eller during the company's quarterly earnings call Wednesday said the home builder's headcount is down 17% since the beginning of its fiscal year. "There will be more reductions in the [fiscal] fourth quarter," the CEO said. "We're taking the necessary steps to get our balance sheet and our organization to their fighting weight," he added.

Homework Assignment Two

• You think you have job in an industry going gangbusters.
• You are a loyal employee in for the long haul.
• Does it matter?
• Who are golden parachutes for anyway?
• Do you have a plan in case you are fired?
• Should you?

Lesson Number Three
Blame The Auctioneer

Low bids take glow off property auction
One Cape Coral homeowner left an auction sponsored by the Miloff Aubuchon Realty Group Inc. elated her home fetched a $400,000 bid. Then the bottom fell out.

"The bid came over the Internet. They said there was a computer glitch," said Rosemarie Leibert, 79. "They put it back on auction and the bid was $250,000."
Leibert declined to take the bid. [She] was upset with the auction, calling it a "farce." She believes the bids were too low and the auction didn't deliver serious bidders.

Calling the effort a learning experience, Jeff Miloff, the realty group's sales manager, said another auction planned for March could have different rules.
The bids were so unrealistic the auction showed people didn't do their homework, Miloff said. "The next auction could have suggested opening bids," Miloff said. "People had no sense of what they were bidding. It made no sense."

Homework Assignment Three

• Is the auctioneer to blame for low bids?
• Will any bids come in if there are minimums?
• Who has no sense here, the bidders or the sellers?
• Exactly who was it that failed to do their homework?
• Assign the blame in percentages between the bidders, the sellers, and the auctioneer.
  

Lesson Number Four
Were All In This Together

Foreclosures put added burden on association-run communities.
If you think you're paying more to live in your condo, townhouse or gated community, consider this: It may get worse before it gets better.

Experts fear that with homes selling slowly, owners who can no longer afford payments may soon abandon them. If that happens, those left behind in communities run by associations must make up the missing share of money to maintain roofs, roads, landscaping and pools.

"We're seeing a 100 percent increase in the number of files turned over to us [by associations] for lien and foreclosure," said Gary Poliakoff, whose Fort Lauderdale-based law firm, Becker & Poliakoff, represents 4,200 associations in Florida.

An association's expenses are constant, so budgets are based on the community's number of homes and apartments. "Other owners have to make up the shortfall because service providers aren't going to say, `We feel sorry for you and will reduce the cost,'" said Poliakoff.

Homework Assignment Number Four

• If a condo tower is only 50% sold, who is going to pay those dues for the empty units?
• Should one believe that initial assessment the builder/developer stipulated?
• What happens if your neighbor defaults on his mortgage and the bank owns the property before the condo association failed to get a lien for assessments?
• How will increasing insurance rates affect your neighbor's ability to pay?
• What about the guy 18 stories up who you have never met?
  
• When the tuckpointing fails, how many new relationships will be formed?

Lesson Number Five
Who do you believe?

The 0.8 percent drop in sales in December came after two straight months of improving sales, the first back-to-back sales gains since the spring of 2005.

David Lereah, chief economist for the Realtors, said that even with the December setback, he still believes that sales of existing homes have hit bottom and will start to gradually improve.

"With fingers and toes crossed, it appears that we have hit bottom in the existing home market," he said.

In other economics news, the number of Americans filing applications for unemployment benefits shot up last week by the largest amount in 16 months, reversing two weeks of big declines.

The Labor Department reported that 325,000 newly laid-off workers filed claims for jobless benefits last week, an increase of 36,000 from the previous week. That was the biggest one-week rise since a surge of 96,000 claims the week of Sept. 10, 2005, when devastated Gulf Coast businesses laid off workers following Hurricane Katrina.

But economists said they believe the low point for housing has been reached and they are forecasting a slow rebound in 2007. Because of that optimism, analysts don't believe the slump in housing will drag the overall economy into a recession.

Homework Assignment Number Five

• Is Lereah believable?
• Is the NAR believable?
• Who do you believe?
• If you cross your fingers and toes does it help?
• What about wishing on a star?
• 36,000 more people formed a new relationship with their local unemployment office. Estimate the percentage of those above who were prepared for this new relationship.

Extra Credit Assignment
Lower Your Costs Or You're Fired

Faced with a $195.6 million loss in the fourth quarter, the Miami-based homebuilder is telling subcontractors that it wants further cost cuts or they'll be excluded for six months from future bidding.

Lennar Corp. is asking its homebuilding subcontractors to cut their current charges by 5 percent or more or face a minimum six-month ban on bidding for work, a company executive said late Tuesday.

"As our customers continue to pay us a lower price for our homes, we must in turn pay you a lower price for your services," said a letter circulated to subcontractors in Lennar's Orange Coast, Corona, Temecula and Palm Springs divisions. Roos said similar requests are being made of Lennar subcontractors nationally.

"Every builder is doing the same thing," added Roos, who works in the company's Western region office in Aliso Viejo. "Everybody understands that the market has softened. … I think everybody realizes in times like this … they need to manage their business accordingly."

Roos said 90 percent of the subcontractors in the region had a positive response to the letters.

Extra Credit Homework

• How likely is it that there was a "positive response" from the subcontractors when asked to cut prices?
• Will the subcontractors cut prices anyway?
• Find at least three more "special relationships" involving Lennar and report on them.

Hmmm. There seems to be some questions for Professor Hardious Knocks about this extra credit assignment.

Mr. Plumber: I can't cut my costs I have bills to pay.
Prof. Knocks: It seems you have a relationship problem with your bills. We cover that in Relationship Management 102. The first two lessons are "How to avoid paying your creditors" and "How to terminate expensive relationships."

Mr. Carpenter: This sounds like extortion. My inventory is stacking up and if I cut prices I will lose money on the bid.
Prof. Knocks: It does not matter what your costs are. You can lower your prices and lose money or not lower them and do no business.

Mr. Economist: You can't fool me. This extra credit assignment is really about deflation.
Prof. Knocks: Don't confuse falling prices with deflation or rising prices with inflation. I highly recommend that you take Deflation 101. The first lesson is how to put the horse in front of the cart. But if the Carpenters and Plumbers of the world go bankrupt or if too many of those new relationships at the unemployment line end up in bankruptcy court, then yes, we are talking deflation. I look forward to seeing you in class next semester.

Please email your finished assignments to HardiusKnocks@SchoolOfHardKnocks.Ed
Class Dismissed.

Mish Note: This post originally appeared in Whiskey and Gunpowder.
A few subtle changes since that posting.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com

Mr. Practical on the Yen, Carry Trade, and Credit Expansion

Over the past several years there has been an excellent series of articles on Minyanville written by "Mr. Practical". Today's post, A Letter From Mr. Practical: No Return sums up very nicely, many of the things I have been talking about on this blog. Here is the latest missive from "Mr. Practical":

I have been thinking a lot lately about the state of economics and markets. From an intellectual point of view it is fascinating; from an emotional point of view it is scary.

Oh don’t worry about me. I am parked over here in Japan, long the yen that everyone else in the world is short. I am happy to lend these yen back out at basically zero to speculators since I believe that one day they will be forced to buy them back from me at much higher prices. This will occur when the Bank of Japan will finally be forced by the market to raise interest rates from their ridiculous “free” money levels. When will this be? Well, I think we saw the first strains of rebellion by Thailand a few months ago when it raised margin requirements. Speculation is rampant and they seem the only ones out here with any common sense. Just because they were “cajoled” by their trading partners to reverse course doesn’t mean those strains are still not there.

I am willing to forgo the 5% interest I can earn on other currencies for the expected value of doubling my “money” in a few years or sooner.

The Bank of Japan is a laughing stock. They are inflationists that would make any central banker proud; a country naively being used by others, especially the U.S., to dump liquidity into markets. Yes folks, there is rampant inflation in asset prices. Not only do central bankers of all stripes understate the cost of living, but asset prices like stocks and houses are now in hyper-inflationary territory. Being long assets that are in such a state is like taking a picture of an egg at the height of its toss: it looks fine unless one ponders the inevitable state of it being splattered on the sidewalk. The egg has been going up and up and up and it may go up further, but gravity is doing its work and it will not fail.

In normal times a good deal of market liquidity comes from income and thus savings. Economic production produces excess in certain societies and that excess is saved and invested. A little debt thrown in makes some of those investments happen a little sooner and with a little more return. But that debt is used prudently by those with the brains to have accumulated the necessary capital. Money is precious to them.

But these are not normal times. With GDP growing at 2-3% (I believe this to be overstated) and M3 (broad money) growing at an astounding 13% for the world’s largest economy, we have our first clue that things are not normal. Money is free to any who want to take the risk. When money supply grows you can by definition be sure that debt is growing commensurately. Debt is not used prudently because it is created easily for anyone and everyone out of thin air by central banks. Almost all of the current liquidity is coming from debt creation. This is the definition of inflation.

We now have an amount of debt in the system that would scare a hedge-hog. The only place left of moderate leverage is in some corporate balance sheets (as long as we ignore contingent liabilities like pension obligations and health care benefits). Corporations rapidly de-levered after 2001 (causing asset prices to deflate) due to perceived high risk and now they are rapidly levering again due to perceived low risk. Of course these two things, leverage and risk, are tied at the hip so once this latest and last form of levering is complete the forces of deflation, created themselves by massive inflation, will most likely advance.

Total global debt issuance jumped 14.1 percent from 2005 to a record $US 6.948 TRILLION in 2006. Leading the way once again was the U.S. with total debt issuance in 2006 increasing by 10.1 percent to $US 4.085 TRILLION. With the US economy at about 20% of the global GDP, it has issued debt almost three times its own relative global economic size. The U.S. now has total debt of 3.7 times GDP, a level never seen before.

At some point debt becomes deflationary because there is too much of it and the debt has been used to create even more overcapacity. We are starting to see in the U.S. signs, like sub-prime lending losses and higher home foreclosures, that income cannot support the amount of debt. Has anyone lately driven by a new commercial complex that is half empty while they are building a brand new one right next to it? As a result, new debt begins to have less and less effect on creating growth: in 1980 it took $1 of new debt to create $1 of GDP; in 2000 it took $4 and today it takes $7. We seem to be pushing on a string.

So when people say “there is so much money out there” it is the same thing as saying “there is so much debt out there”. Debt issuance is fueling speculation as this “money” is searching for return, any return, regardless of risk. All rates of return are being driven lower and lower in the search.

So why even look for return? As everyone else searches harder and harder for return and taking greater and greater risk to do it, perhaps the best thing to do is search for lower risk. It looks to me like Sam Zell agrees. This is very hard to do and perhaps that is why only some of the world’s greatest investors like Sam Zell have the patience to do it.

So what can you do about it?

This does not mean short stocks, for that takes timing and I care not to “speculate” on the timing of deflation. Central banks are adamant, but they are wrong, and eventually their methodology of creating new debt to fight the forces of old debt will not work. Instead of getting in the way, I suggest just getting out of the way. First, be prudent. Look carefully at your risks. Deflation hates stocks so be careful there. It also hates debt, so pay it back if you can.

Sincerely,
Mr. Practical

Notice the one thing Mr. Practical is doing that most others are not:
Mr. Practical has his eyes focused on the curves, potholes, and ice on the road ahead rather than looking in the rear view mirror.

A Warning From Trichet

The Financial Times is writing Prepare for asset repricing, warns Trichet.

Current conditions in global financial markets look potentially "unstable", suggesting that investors need to prepare themselves for a significant "repricing" of some assets, Jean-Claude Trichet, president of the European Central Bank, warned at the weekend in Davos.

The recent explosion of structured financial products and derivatives had made it more difficult for regulators and investors to judge the current risks in the financial system, Mr Trichet said.

"We are currently seeing elements in global financial markets which are not necessarily stable," he said, pointing to the "low level of rates, spreads and risk premiums" as factors that could trigger a repricing.

One might look at the statements from Trichet and dismiss them as some sort of contrary indicator. The context in which the statements were made and how they were perceived is at least as important as what he was saying.

Davos Elite Brushes Off Trichet

Rather than perceiving Trichet as a contrary indicator, I am looking at this headline instead: Davos Elite Brushes Off Policy Makers' Warnings of End to Boom.

Bankers, investors, and executives last week arrived at the Swiss resort of Davos giddy about record profits and bonuses. After five days of hectoring by policy makers that they are too complacent, they left just as happy.

"The mood has been totally upbeat," Sunil Mittal, the billionaire chairman of Bharti Airtel Ltd., India's largest mobile-phone operator, said of the 37th annual meeting of the World Economic Forum. "I've never seen a mood like this."

Warnings by central bankers such as Jean-Claude Trichet were batted away by dealmakers like Michael Klein, co-president of Citigroup Inc.'s investment banking unit, and David Rubenstein, managing director at the Carlyle Group Inc. buyout firm. They were confident in their ability to cope with the inevitable slowdown of the world's strongest economic growth in three decades.

"The consensus here in Davos is everybody's thinking it'll be another booming year," Morgan Stanley Chief Global Economist Stephen Roach said.

Emerging markets, led by China and India, are fueling the global expansion and corporate borrowing has never been easier. The amount of debt used to finance European buyouts reached a record high in the third quarter. The risk of owning European corporate bonds dropped to the lowest ever last week, according to credit-default swap traders.

Bond Risk

"The business community, the financial markets, the world economies are all actually in quite good shape," according to John Thain, chief executive officer of NYSE Group Inc.

`Plummeting' Costs

Griffin, who oversees a $12.8-billion hedge-fund group, was more concerned that government policy or too much regulation may send markets south.

"The price of liquidity has plummeted around the world," Griffin said. "It would be heartbreaking if you were to see regulatory or other changes in the marketplace push up the cost of liquidity again because it's been such a boon for the global economy, particularly for capital formation in South East Asia, Latin America and India."

Central bankers such as Axel Weber, head of Germany's Bundesbank, were blunt in their warnings. He said interest-rate increases in Japan will mop up the global liquidity that has helped fuel the financial-market boom of the past four years.

What is really the contrary call?

"The consensus here in Davos is everybody's thinking it'll be another booming year," Morgan Stanley Chief Global Economist Stephen Roach said.

Nearly everyone is giddy and openly dismissing the possibility of stock market plunges even though we have just seen enormous plunges in Mid-East stock markets. The International Herald Tribune is reporting Saudi prince plans big investment in country's sagging stock market.

The Saudi stock market "has reached reasonable levels," Alwaleed said. The Saudi prince said he would invest another 5 billion riyals, or $1.4 billion, in real estate projects in the kingdom.

The Tadawul, the second-worst-performing gauge after Venezuela among global indexes tracked by Bloomberg, dropped on Jan. 24 below 7,000 points for the first time since Oct. 21, 2004. The measure has lost two-thirds of its value since reaching a record in February 2006.

The Saudi stock market has lost two thirds of its value since February 2006. Of course everyone thinks it is impossible for the US to lose even as much as one third, barring some sort of huge interest rate hike or regulatory change.

"The price of liquidity has plummeted around the world," Griffin said. "It would be heartbreaking if you were to see regulatory or other changes in the marketplace push up the cost of liquidity again because it's been such a boon for the global economy, particularly for capital formation in South East Asia, Latin America and India."

Final Thoughts

Mr. Practical and I look at yield spreads, volatility, and options premiums and note that although they may get lower still they are a lot closer to the absolute bottom than any kind of top. On the other hand, willingness to speculate as measured by massive increases in derivatives is certainly nowhere close to a bottom. It remains to be seen whether or not things in derivative land can get even more extreme than now, but what is certain that much of this risk taking is going to be unwound, and most market participants will not like the result. The outcome is not really in doubt. The timeframe, as Mr. Practical points out, is still in play.

Someone posted on my board on the Fool that we could not have deflation with all this "money" floating around. My reply was that a massive expansion of money and credit is actually a prerequisite for an asset based deflationary bust. Every deflationary bust in history was preceded by an enormous asset bubble and/or credit expansion bubble that bust. Today we have both and it is harder and harder to keep that balloon filled. In 1980 it took $1 of new debt to create $1 of GDP; in 2000 it took $4 and today it takes $7. All of that extra credit is serving no productive means. It is pure speculation and it will be unwound.

Mr. Practical is correct about the carry trade as well. It will eventually be unwound. Therefore long term bullishness on the Yen seems to be justified. Short term, however, I am still sticking with my idea that there may be a huge breakdown in the Yen that causes some mammoth problem somewhere. If that happens I think we will see an enormous whipsaw that I want no part of. Thus from a personal practical standpoint I am sitting on the sidelines. Nonetheless I will have a few charts out shortly, to discuss the Yen in closer detail.

I sense the same thing in interest rates. Very few seem to think long term rates are headed lower even as commercials are starting to build a nice long position in the long bond and are slowly unwinding the short position in the 10-yr note. Commercials are now net long the 2-yr, 5-yr, and 30-yr treasury futures according to the latest commitment of traders report.

I am not sure what will pop this global credit bubble, but I suspect it will not be higher US interest rates or a rising Yen. More that likely it will be either pure exhaustion, something totally off everyone's radar, or simply the reverse of some scenario that everyone expects.

Thanks to Minyanville for sharing the wisdom of "Mr. Practical".

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Vacancies Soar / Lending Standards Rise

The US Dept of Commerce released the Report on Residential Vacancies and Homeownership on January 29th.

The report shows national vacancy rates in the fourth quarter 2006 were 9.8 percent for rental housing and 2.7 percent for homeowner housing. A couple of charts better describes what is actually happening.

Homeowner Vacancy Rates



The above chart thanks to Empty Homes Everywhere by Mike Larson.

The following chart is from the Census Bureau.
The last two columns were added by me.

Total US Housing Inventory



A whopping 13% of housing inventory is currently vacant. The rate seems to be increasing at a fairly rapid clip as well. For those who think commercial and/or multifamily construction will pick up where individual residential home sales left off, please take a look at rental vacancies sitting at a 9.8%.

According to the Census Bureau ...
There were an estimated 126.7 million housing units in the United States in the fourth quarter 2006. Approximately 109.9 million housing units were occupied: 75.8 million by owners and 34.2 million by renters. Both the number of owner-occupied units and the number of renter-occupied units were higher than a year ago.

Approximately 1.67 16.7 million homes are sitting vacant in the US (also shown in the above chart). Mammoth supply is being added right as I type as evidenced by all of the homebuilding still going on, and all of the condo towers etc that are still under construction. [Mish note: typo corrected]

Inquiring minds might be asking "Who is going to be buying those homes?".

Lending Standards

Following is an email from a mortgage broker that I received just last week. He wishes to remain anonymous. Today seems to be a good day to post it.

Mish,

Here is the start of lenders getting more conservative when it comes to declining markets. This is Wells Fargo's new policy. This will mean any property in an area that is listed on their declining value list or the appraiser has noted it on the appraisal, the LTV (loan to value) will be cut by 5%. So in reality, if a property has been appraised at $500K and the borrower wants 100% financing the most he will get will be 95% LTV or less depending on the underwriter.

$500K - 5% is $475K a decline of $25K per loan amount on the minimum. Think of the borrowers that are already at 100%? I believe most if not all of San Diego County should be in the declining list. With this as well as appraisers having a hard time bringing in values as well as being very nervous not to push values anymore, there will be a lot of upside down people.

Let's see. Loan standards are tightening, subprime lenders are going bust, inventories are soaring, cancellations are high, prices are falling, and the bottom is in.

Hmmm. One of those does not seem to fit in. Dave Lereah, which one is it? One look at those whopping vacancies should be enough to convince anyone that there is massive and growing supply. One look at the changes in lending standards should be enough to convince anyone that the pool of eligible buyers is shrinking as well. Who now does not have a house that wants one and can afford one? Is there pent up demand or pent up supply? And the recession has not even officially hit... yet. Just who is going to be buying those homes?

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Unemployment - A Lagging or Coincident Indicator

In the last two recessions unemployment was a lagging indicator peaking approximately 18 months after the recession officially ended. In the four recessions between 1970 and 1982 unemployment was a coincident indicator, starting to rise with the recession and pretty much peaking as the economy was just starting to recover. In no instances was unemployment a leading indicator.

The chart speaks for itself.



The above chart thanks to Bart at NowAndFutures.
(Click on chart for an enhanced view)

Conclusion

Those expecting some sort of huge advance warning in unemployment stats in advance of the next recession are unlikely to find it.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Consumer Advocacy

Someone claiming to be a "consumer advocate" told the Senate Banking Committee that to make things "fair", There should be an annual fee on credit cards for those that do not carry a balance.

Let's take a look at the twisted logic:

In a Senate hearing targeting credit card practices, one consumer advocate suggests an annual fee might lighten the load on those who pay high penalties.

In most instances today, it would be silly to pay an annual fee for a credit card simply because most cards don't have them anymore. But in a Senate Banking Committee hearing examining credit card practices this week, one consumer advocate suggested those who pay their balances in full every month (about half of all cardholders) should pay a small annual fee to credit card companies.

Why? To pay their fair share.

Those who carry balances on which they pay interest and fees are subsidizing cardholders with no revolving balance who may even be in rewards programs, said lawyer Michael Donavan of Philadelphia-based Donavan and Searles. He represents those who have unwittingly fallen into many of the sandtrap fees and penalties embedded in hard-to-understand credit card agreements.

Restoring small annual fees on cards used by "non-revolvers" would bolster revenues for card issuers, who then in turn might not make life so expensive for those with revolving balances.

But, Donovan testified, "it's not a question of financial literacy and never will be." The problem as he sees is it is the ability of credit card issuers to change the terms of the agreement with just 15 days' notice.

"The credit card is one of the only contracts in common law anywhere in which the superior bargaining entity can change its terms at anytime for any reason," Donavan said. "If they can change the contract on an existing balance, then they will always have an unfair advantage."

What Donavan is proposing is nothing but socialist nonsense. A law requiring an annual fee would do two things:

1. Penalize the prudent
2. Reward the spendthrifts

Had it not been for Donavan's complaint about credit card companies being able to change contract terms at will for any reason, a reasonable person might have wondered if he was a banking industry shill rather than some sort of consumer advocate. His concern over contract changes seems to indicate otherwise. But if Donavan really wants to be a consumer advocate I think he should pursue the legality of those contracts and take a good hard look at current bankruptcy laws instead of attempting to punish the prudent. If anything, Donavan should be encouraging those with balances to pay them off rather than punish those who do.

There is no need to punish the prudent anyway. After all credit card companies make a profit off card transactions by charging merchants a processing fee on every transaction. Enough is enough.

Credit Card History

In 1996, the U.S. Supreme Court in Smiley vs. Citibank lifted the existing restrictions on late penalty fees. In response fees have soared.

Usury Laws

According to BankRate.com there are Few protections left for consumers.

Some states don't have usury caps, and in those that do, federal law usually supersedes state law when it comes to setting rates and fees.

This trend began in the late 1980s. Most big banks packed up and moved their credit card operations to "debtor-friendly" states such as Delaware, said Steven Palmer, managing partner and a specialist in usury law at Palmer, Allen & McTaggart, a corporate law firm in Dallas.

The lure was "being able to charge higher fees," Palmer said. "When some of the banks left Texas, several of the credit card operations were spun off. Mercantile National Bank became Mcorp and they transferred to Wilmington, Delaware. That became Lotmus, which is now FirstUSA. [Mish note: FirstUSA became Bank One in a merger. Then Bank One merged with JPMorgan/Chase].

No limit on rates in 26 states

There are 26 states that have no limit on what bank credit card issuers can charge for interest rates, according to the American Bankers Association. Issuers in 27 states have no limit on what they can charge for annual fees.

California, Delaware, South Dakota and Tennessee are among the states offering the least protection. These four states currently have no maximums on the following:

· delinquency fees
· cash advance fees
· over-the-limit fees
· transaction fees
· stop payment fees
· ATM fees
· mandatory grace period

Consumer Protection

If that was not enough "juice" to squeeze in and of itself, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 attempts to make consumers debt slaves forever. Some provisions of the new law as referenced in the above link are as follows:

• Increasing the amount of paperwork which must be filed by every debtor, requiring pre-filing Credit counseling and post-filing financial education for debtors whose debts are primarily consumer debts, increased filing fees, and increasing attorney obligations in a manner that, collectively, will increase the cost of filing for bankruptcy.
• Making it more difficult for individuals to receive a Chapter 7 discharge. A means test is to be imposed on would-be filers to test if they have enough disposable income to fund a Chapter 13.
• Making Chapter 13 less attractive by, amongst other things, requiring five year payment plans (for above median debtors) rather than the three year plans that were previously the norm.
• Allowing creditors to pursue collection remedies without court permission in various circumstances such as offsetting tax refunds, pursuing tax and domestic relations litigation in all respects except the final turnover of assets from the estate, establishing wage assignments in domestic relations actions, repossessing vehicles and personal property subject to loans or leases 45 days after the first meeting of creditors in cases where no court action has been taken regarding that property, and allowing evictions that completed the court process prior to the filing of the petition or involve endangerment to property or drug use to proceed.
• Requiring that debtor counsel conducts an investigation of their clients' filings and be personally liable for them, not present under prior law. In addition, bankruptcy filings will now be subject to audit in a manner similar to tax returns.

Exactly what consumer protections can anyone find in the above law? I suggest there are none. In fact, whenever "protection" of any kind is listed in any bill there is a near certain guarantee that it provides anything but protection for whatever is supposedly being protected.

Consumer advocates wanting to do something worthwhile might attempt to get the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 rewritten or better yet scrapped altogether.

That "consumer protection" law was as one sided as things can get. Not only do credit card companies get to charge rates that can only be construed as usury, they justify those high rates because of default risk, then they manage to get legislation passed to minimize the risk of default while still charging enormously high rates.

To top it all off, some "consumer advocate" comes along proposing socialist claptrap that things would be more "fair" if credit card companies would just charge everyone still more fees.

This sequence of events is exactly the kind of nonsense one sees when a problem is not rectified at the source. The source is poor legislation in the first place. In an attempt to fix problems with poor legislation, additional legislation cresting new problems (usually without fixing the original problem) is put on top of it. The process continues over years and years until someone comes along proposing a misguided "solution" that amounts to making everyone pay still more.

Two possible ways to fix the general problem

1. Eliminate all corporate lobbying and corporate campaign contributions
2. Eliminate the middleman

Number one should be self explanatory. If Senators and Congressmen did not get campaign contributions and wining and dining by corporate lobbyists, perhaps they could think on their own and do what is needed instead of what corporations want. As it stands now, bills may as well be written by the corporate lobbyists with the deepest pockets, because in practice that is exactly what is happening. That brings up solution number two.

Number two is not self explanatory but the middleman in this case is a bunch of Senators and Congressmen who can not think for themselves. Instead they pass legislation written by corporate lobbyists. Every bill is so loaded up with provisions written by lobbyists that those voting do not even understand what they are voting on. Heck, not only do they not understand what is in the legislation, in many instances they have not even read the bills they are passing in the first place. The way around this problem is to simply eliminate the middleman and instead directly elect corporate lobbyists. That way, when someone runs for office you know how they will vote.

To make idea number two idea work a full disclosure law would be needed. Such a law would require statements from candidates like the following: My direct sponsors are the NRA, Pfizer, and Exxon Mobil. My indirect sponsors are the "Citizens For Wonderfully Clean and Ozone Free Air" and the "Coalition for Fruitful and Responsible Gun Legislation". Please note that the former is 100% funded by Exxon Mobil and the latter is 100% funded by the NRA. Rest assured that any legislation I pass will be in the interests of my direct sponsors. If and only if my direct sponsors do not have a position on any particular issue, will I be allowed to vote according to my conscious. Should there be a conflict of interest between sponsors, the sponsor contributing the most money to my campaign will get the nod. "

Note: The above example in italics is pure sarcasm. There is no such thing as "Citizens For Wonderfully Clean and Ozone Free Air" nor is there a "Coalition for Fruitful and Responsible Gun Legislation". Any resemblance of those names to actual corporate names is unintended and purely accidental. Thus Exxon Mobil and the NRA support no such organizations that I am aware of.

Since neither of those solutions is likely anytime soon I simply ask those who purport to be consumer advocates take a position that actually benefits consumers. Is that too much to ask?

Mish addendum:
Those who agree or disagree with this post can email their comments to Donovan and Searles at their "contact us" form:

Please feel free to reference this blog
Consumer Advocacy
http://globaleconomicanalysis.blogspot.com/2007/01/consumer-advocacy.html

Or simply put this insanity in your own words.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Gold and the K-Cycle

This post is an attempt to explore the behavior of gold during each season in the Kondratieff Cycle. For newcomers, let's briefly review Kondratieff Cycle Theory.

The Kondratieff wave is about is a study of long cycles of debt buildup and repudiation. It is not exclusively about price inflation and deflation periods. Deflation is caused in part by the debt collapse. It is also a generational thing as the next cycle of debt buildup and collapse is renewed every 2-3 generations as the previous generation that went through comparable periods dies off.

Unlike others I do not think each season is fixed length nor do I think that a complete cycle is 54 years, but I am quite sure that we do go through four seasons and the seasons are generally long, from 15-25 years or so each.

Kondratieff Seasons

• SPRING - Inflation
• SUMMER - Stagflation
• AUTUMN - Disinflation
• WINTER - Deflation

Those descriptions do not exactly match those from the above link, but the ideas expressed are similar. Given that there are three seasons of positive inflation (disinflation is a positive but falling rate of inflation), by the time Winter approaches no one thinks deflation is remotely possible.

In order to make sense of pre-fiat gold prices, it is necessary to work out gold's "real price" from that period especially during deflationary eras. While perusing around for a historical chart that I could use, I stumbled on a chart of the CPI adjusted price of gold on sharelynx.com. The chart looked very familiar to me as a chart of interest rates. I asked Nick at sharelynx if he could take it back to 1920 and overlay the Fed Fund Rate on top of it. It wasn't anything he had tried before but he was happy to oblige. I then took his chart and added a few comments and a rough approximation of K-Cycle seasonality. Here is the result.

CPI Adjusted Gold vs. the Fed Fund Rate



(click on any chart for a better view)

Notice how the purchasing power of gold is inversely related to the Fed Fund Rate in Winter and Spring and directly related to the price of gold in Summer and Autumn. This is exactly as K-Cycle theory would suggest.

Spot Gold Prices



Those that thinks gold always acts as an inflation hedge are simply mistaken. One quick glance at the above chart should be proof enough. Did we experience inflation from 1980 to 2000? Did gold fall from over 800 to 250 anyway? Obviously the answer to both questions is yes, and that disproves the idea that gold is always some sort of inflation hedge. Yet the same statement is made by someone every day.

In Autumn, cash is trash and gold (like all currencies) are of little use. Asset prices like stocks and houses soar and everyone is spending every cent they have and then some, as fast as they can. A similar thing happened in the Roaring 20's and probably every other crack-up boom in history as well.

In the credit crunch of Winter deflation, gold and currencies are hoarded and the purchasing power of both rises. If anything, the CPI adjusted price as shown above during the Great Depression does not really do justice to the mammoth increase in assets such as land or stocks that gold could buy. Instead it reflects purchasing power on a general basket of goods and services. The same thing is likely to happen again.

This usually brings up the question of Japan and gold and why gold fell when Japan went into deflation. The answer is that Japan was one season out of sync with the entire rest of the world. When Japan was in deflation (Winter) the rest of the world was pretty much in disinflation (Autumn). It was the rest of the world that dictated what happened to the price of gold, not Japan.

Note the two red ovals on the first chart on the far right. One of them is wrong. Gold is signaling deflation (at least by K-Cycle theory) but the Fed Funds Rate is not. What the chart does show is the "False Spring" reflation when the Fed acted too soon to prevent K-Winter by slashing interest rates to 1%. All the Fed really accomplished was the creation of an even bigger debt bubble that is going to have to be deflated away. This was the greatest currency experiment the world has ever seen. It will end in failure.

Every bubble sows the seeds of its own demise. Wages are not keeping up with ability to service debt. Global wage arbitrage and outsourcing ensures that trend will continue. Housing is not affordable and has risen several standard deviations beyond wage growth and rental costs. People purchased homes they could not afford just because someone was dumb enough to lend them money. The result is rising bankruptcies and foreclosures at a massive annual rate of growth. That liquidation has just now started.

To see how gold shares might act in the upcoming credit crunch, please consider a chart of Homestake Mining in the 1930's courtesy of Gold Eagle.



Fast forward to today.

Weekly $HUI



Weekly Gold



Comments

The December-January correction in gold appears to be over and a major move higher may have begun.

Even though the action from last year’s high in May has been volatile, the index has more-or-less moved sideways over the past year. This consolidation is a long-term bullish sign that suggests there is much more upside to the gold bull market.

Notice how the recent decline retraced only part of the rally from last October’s low. This may be the last dip before the HUI breaks out of this sideways consolidation for good.

Thanks to Gold Eagle and Sharelynx for the charts in this post.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Dimes, Bulldozers, & Volatility

Todd Harrison at Minyanville had some interesting thoughts about volatility today and I am pleased to be able to share them.

Here goes from Todd:

While I'm not the resident volatility expert in the 'Ville---that distinction belongs to the honorable Mr. Succo--I wanna further some thoughts that he's been discussing for some time.

Over the last few days, we've seen a very large seller of 5-year S&P puts. That's done two things: one, it put a bid to the market (the buyer of those puts must buy stocks as a hedge) and two--perhaps more importantly--it's depressed vols from already compressed levels.

The proliferation of "income funds" is a familiar topic to Minyans and, for us old schoolers, offering a sense of deja vu. I remember back during my Mother Morgan days, I had accounts selling "eighths" and "tinis" (1/8th's and 1/16th's) in size, collecting dimes in front of the bulldozer.

They made money for a few years, paving the way to a conditioned acceptance of this "free money" strategy. And then the bulldozer came in the form of a market decline, shutting most all of their doors.

This evolution--coupled with a distinct lack of hedging/protection--has vols, as measured by the VXO, at decade lows (which, ironically, was just about the time I left Morgan). And while part of the "vol crash" is a function of the sloshing liquidity (which is inversely related to volatility), there is a much more compelling story in our midst.

There aren't many of us left who remember what real volatility looks like. It is our hope that by reading the 'Ville, you'll be prepared for the squall when it arrives. For by the time you see it in the mainstream press, it'll be too late to proactively position yourself.

Thanks Toddo!

Here is a chart of the VXO to which Todd refers.
(Click on any chart in this post for a better view)



Perhaps volatility can go lower but it sure isn't going negative.

The appetite for risk is also shown in corporate bond yields. As long as yields keep compressing the stock market is likely to be firm. Following is the chart of Baa yields from Credit Swaps And Bond Yields.

Moody's Baa Bonds


Above chart by sharelynx.com.
Moody's Baa Bonds

Baa - Bonds and preferred stock which are rated Baa are considered as medium-grade obligations (i.e., they are neither highly protected nor poorly secured). Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well.

Baa bonds are just one step above junk. Yields are close to 6%. You can get well over 5% on government backed CDs. Where is the risk reward?

Junk Spreads



The above chart is thanks to "orkrious" who posts on my board on Silicon Investor. The correlation is not perfect, nor is correlation the same as causation, but the stock market shows a tendency to sell off when yield spreads are widening. Note in particular the market selloff that started in May of this year just as spreads hit rock bottom.

These charts are not a sign of low risk but of a sign of willingness of investors to take nearly any risk to do better than the risk free returns on treasuries. Because of yield compression however, the size of the bets must increase to get the same actual returns. Think about that last sentence because it is part of what is driving insane increases in derivatives.

As yields compress the size of the bets (leverage) must increase to get the same returns. No one (especially me) knows when this is going to end, but betting on junk bonds, more yield compression, and/or betting on a further collapse in volatility is like picking up dimes in front of bulldozers.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Small Business Optimism & the Housing Recovery

On January 22nd the Chicago Tribune reported Small businesses profess optimism.

The Wells Fargo/Gallup fourth-quarter survey of small-business owners finds them the most optimistic in four years.

"While many economists are forecasting a weaker economic environment for 2007, small- business owners are, according to the results, expressing no signs of an economic downturn," said Scott Anderson, senior economist for the San Francisco bank.

"These optimistic findings indicate expectations for a rebound in activity this year, as the forces that have been inhibiting growth prospects, such as rising energy prices and interest rates and stagnant wage growth, reverse course."

The index set a record high of 114, up four points from the third quarter.

The quarterly index is calculated based on a nationwide survey of about 600 small-business owners conducted by the Gallup Organization and sponsored by Wells Fargo & Co.

That is interesting because the National Federation of Independent Business, the nation's leading small-business advocacy association suggests otherwise. On January 9th the Northern Trust reported on the NFIB Small Business Optimism Index.

The survey results from the small business sector are not encouraging. The Small Business Optimism Index fell to 96.5 in December, putting the annual average at 98.9, the lowest since the 2001 average of 98.4 when the economy was in a recession.



The pessimistic outlook of small businesses is visible in their response to capital expenditure plans. The Capital Expenditure Index fell to 26.0 in December, the lowest since August 2005.



The index tracking employment plans of small businesses dropped to 10.0, the lowest since March 2005. The main implication from the survey is that small businesses do not expect robust economic conditions in the near term.

One of those surveys is monstrously wrong and here's my take: If small businesses are really expanding now just as the economy is slowing, they are likely to regret it quickly unless their business is bankruptcy or foreclosure related.

Rose Mortgage Corp

Yet another lender bit the dust today.
RMC - Rose Mortgage Corp
EFFECTIVE IMMEDIATELY ROSE MORTGAGE CORPORATION IS CLOSED.

The Housing Recovery Coffin

Three more nails were put into the "Housing is Recovering" coffin today, by WCI, DHI, and DuPont.

DuPont Sees '07 Buffeted By Housing, Auto Slowing

On Tuesday, the country's second-largest chemicals maker threw some cold water on growing optimism that the housing market has started to rebound.

Headwinds from U.S. housing and automotive markets "turned out to be stronger than expected" during the fourth quarter, as customers reduced their inventory levels to adjust to a decline in housing starts, Chief Financial Officer Jeffrey Keefer told investors in a separate call.

The company forecast drags from lower activity in U.S. housing and automotive production continuing this year, as new residential housing demand falls in the first half from the year-ago period and sluggish auto output cuts into first-quarter earnings.

In a stunning achievement WCI reported More Cancellations Than Orders for the entire 4th quarter. Nicely done WCI.

"Results for the fourth quarter will be below prior expectations due to a higher level of defaults than expected in both our Traditional Homebuilding and Tower Homebuilding operations, longer tower construction cycles, and the recording of significant impairments and write-offs," said Jerry Starkey, President and CEO of WCI Communities.

The company expected to close 621 traditional homes in the fourth quarter and actually closed 434 at an average price of approximately $760,000 while recording 187 defaults. Preliminary combined tower and traditional gross new orders totaled 261 for the fourth quarter but were offset by a combined total of 270 tower defaults and traditional home cancellations and defaults.

D.R. Horton Inc. (DHI) Chief Executive Don Tomnitz believes the housing industry is still in the "early stages" of its slowdown.

"Most downturns are longer and deeper (than people expect), and we are not seeing anything on the horizon to change that opinion," Tomnitz said during a conference call Tuesday to discuss the company's fiscal first-quarter earnings.

Tomnitz, who has weathered through three other housing downturns in the past 23 years prior to this one, said he expects the housing sector to remain "challenging" through at least fiscal 2007.

He said he expects it will take two to three quarters before the sector "bottoms out." After that, he said, he doesn't see a sharp rebound. "We're not expecting any rapid improvement" after that, he said. "It will be flat to slightly up in 2008."

The CEO's comments come as D.R. Horton reported a 65% earnings decline and took land-related writedowns of $77.7 million in the company's fiscal first quarter that ended Dec. 31.

A Surefire Investment

The St. Petersburg Times is reporting Loan deals on shaky ground.

Construction Compliance Inc. promised surefire investment homes with no money down. St. Petersburg's CCI would build houses on scattered lots from Hernando to Lee counties. Customers could resell them for a profit without spending a dime.

But the housing downturn has a way of spoiling best-laid plans. Not only has CCI ceased construction on scores of homes, but customers also have been left with half-built shells on which subcontractors are demanding payment.

The banking world is also feeling the shock. Bradenton's Coast Financial Holdings Inc., parent of Coast Bank, announced Friday that 482 mortgage loans made through a single builder were at risk. The bank didn't specify CCI in its filings; however, buyers and their attorneys have since confirmed its identity.

Within hours of the announcement, Coast's stock had plunged, closing down 28 percent Monday. If CCI collapses, individual borrowers have an obligation to meet their mortgage payments, though Coast suggested that some might default in light of the no-money-down deals they were promised.

Well toss another "surefire" investment scheme on the ash heap of history. This mess is really just beginning to unravel. More lenders are going to go bust and borrowers are going to be on the hook for unfinished condo towers and homes. A monument to the stupidity of it all is likely to be be half finished condo towers blighting Miami and other cities for years to come.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Gold, M3, and Willingness to Lend

Let's start with a quick look at the expansion of the monetary base in comparison to the expansion of broad money supply as measured by M3.

Monetary Base



M3



The above chart is from a discussion on Money Supply and Recessions. For this article, pay attention to the green line, ignoring the others. M3 started exploding in 1971 and it was not happenstance either. Here is a snip from The Last Great Bubble - Counterfeiting the Dollar.

1971 - Aug 15 - President Nixon closes the international gold window. U.S. Dollars are no longer redeemable in gold for international settlements. This marked the beginning of the current, anchorless floating currency regime, an not coincidentally, a decade of inflation.

The previous link is an interesting read from 2002 predicting the demise of the dollar even as it was still rising at the time. However, the article fails to point out that it was not just the US abandoning all ties to the gold standard, it was every country in the world.

This was the biggest experiment in fiscal madness the world has ever seen. Unleashed from the "burden" of gold redemptions, credit has soared far faster than base money supply. This in turn fueled asset bubble after asset bubble, but most notably in the global equity markets and housing.

Do those charts represent inflation? Absolutely, what else can they represent? Inflation is the expansion of money and credit and both money and credit went on a tear. But although the chart patterns are similar, the scale is enormously different. M3 dwarfs monetary base expansion.

There is without a doubt a bubble in credit. Money is being "swept" out of checking accounts and lent out. Bank reserves are non-existent. Fannie Mae and Freddie Mac have been creating debt out of thin air. That is what happens when money is no longer backed by anything. But the question is not "What happened?", as the charts clearly show that. The pertinent question is "What happens next?" As long as asset prices keep rising the bubble can keep expanding. Consumers can then keep borrowing against the rising value of their houses and stocks which in turn supports current consumption.

Is the ability to expand that credit bubble infinite?

I think not. Therein lies the problem. Every bubble sows the seeds of its own demise. Wages are not keeping up with ability to service debt. Global wage arbitrage and outsourcing ensures that trend will continue. Housing is not affordable and has risen several standard deviations beyond wage growth and rental costs. People purchased homes they could not afford just because someone was dumb enough to lend them money. The result is rising bankruptcies and foreclosures at a massive annual rate of growth.

Can the Fed keep expanding the bubble?
Once again the answer is no. Debt bubbles end when the central bank is no longer able or willing to extend credit and/or when consumers and businesses are no longer willing to borrow because further expansion and /or speculation no longer makes any economic sense.

Here is an alternative reason: Debt bubbles implode when the ability to service the debt can no longer be maintained. Bankruptcies and foreclosures are two ways to measure inability to service debt.

Foreclosures

Foreclosures are actually at a fairly low rate. It is the rate of change however that is alarming. Foreclosures increase 51 percent nationwide.

Foreclosures increased 94 percent last year to 157,417 homes in California, as homeowners struggle with fast-rising home payments and a slow-selling market, according to a Fair Oaks real estate investment advisory firm on Monday. California had the most foreclosures filed nationwide, while Nevada had the largest percentage increase at 175 percent last year compared to 2005, according to Foreclosures.com. Nationwide, almost 971,000 foreclosure filings were reported last year, 51 percent more than the 641,000 in 2005, according to the annual report.

Faith In The Fed

Right now there is enormous faith in the ability of the Fed to keep the bubble inflated. Inflationists fail to see that much of that credit borrowed into existence can never be paid back.

Yet somehow everyone thinks the Fed will expand money enough to matter if a credit bust happens. It has never worked that way in history. Take a good hard look at monetary base vs. M3. Interest rate policy at the Fed can not fuel that expansion forever.

The Treasury Department has massive ability to print money but it can not force banks to lend. It is important to understand the difference. Credit lending standards can only go far so far before bankruptcies and foreclosures force a change. That change is finally upon us and a huge secular reversal is now underway.

The Fed itself simply does not have the power to deposit money into consumer accounts so that bills can be paid. They probably would not do so even if they could because it would be to the detriment of banks and creditors. Will the Fed react to a debt implosion by cutting interest rates? Absolutely. The Fed is will likely attempt anything they can to help consumers service debt. History proves it and history proves gold will benefit as well. But the Fed can not create jobs or revive housing and neither can the Treasury.

Willingness To Lend

The Mortgage Lender Implode-O-Meter is reporting “Twelve lenders have now gone caput since December 2006”. This number has has been increasing at a rate of 1-2 a week since December. Two of those lenders were among the top twenty subprime lenders. One of them was Ownit Mortgage, the other was Mortgage Lender Network. Ownit Mortgage and MLN both went bankrupt.

Following is a partial list of lenders unable (via bankruptcy) or unwilling (because of huge losses) to make subprime loans.

2007-01-19: EquiBanc

Wachovia recently conducted an intensive strategic review of its mortgage business which has altered the company's approach to the origination of non-conforming loans. As a result, Wachovia has elected to close EquiBanc Mortgage - Wachovia's only business dedicated solely to non-conforming loans.

2007-01-19: FundingAmerica

Due to current market conditions in the mortgage industry, Funding America has decided to discontinue accepting any new business.

2007-01-08: Clear Choice Financial/Bay Capital

Clear Choice Financial, Inc. a Nevada corporation, announced that it is insolvent and in default on numerous obligations. Clear Choice has officially closed the mortgage lending offices of its wholly owned subsidiary, Bay Capital, located in Owings Mills, Maryland and Irvine, California.

2007-01-05: SecuredFunding

Based upon market conditions and limited product availability, we are ceasing wholesale operations. We have stopped accepting new applications, and will have until the 12th of January to fund out the pipeline. We appreciate your patience as we undergo this transition.

2006-12-29: MLN

Hundreds of workers in Rocky Hill left the office of a billion-dollar national company with boxes in hand and tears in their eyes. Mortgage Lender's Network, headquartered in Middletown, recently stopped funding new loans. "We're not going to get paid. We keep our benefits for two weeks, and we're not going to have a severance package." said MLN employee Melissa Goyette. The company is closing after losing a large financial backer and the failure of a last-minute bid to raise cash. The company was in the middle of building a new location in Wallingford that was to open later in the year.

2006-12-20: Harbourton Mortgage Investment Corporation

Harbourton Capital Group, Inc. announced that effective December 20, 2006, Harbourton Mortgage Investment Corporation (“HMIC”), its wholly owned mortgage-banking subsidiary, ceased funding new mortgage loans and initiated a process to wind down its operations. HMIC was forced to take these actions when it was unable to satisfactorily resolve mortgage repurchase claims asserted by selected investors that had purchased mortgage loans from HMIC. As a result of this action, HCG will likely write off its full investment in HMIC. HMIC’s recent ignificant losses and requirements for new capital negatively impacted HCG during 2006.

Eligible Buyer Pool

The pool of eligible buyers is now shrinking. Consider the article For credit risks, home loans harder to get. Here are some excerpts regarding changes in lending standards:

• Down Payments: New guidelines require 10 percent down according to Gary Akright, a mortgage broker at Dominion Mortgage Corp. The previous guidelines required 5 percent down.
• Credit scores: Previously, borrowers with a FICO credit score as low as 570 (out of 850) could qualify for a single loan financing 100 percent of their home purchase, Mr. Carmona of Homewood Mortgage in Carrollton said. "Now, across the board, it's jumped up to a 600 FICO score for an 80/20 loan".
• Subprime Rates: Rates on subprime mortgages have risen about a full percentage point since September, Mr. Carmona said, while regular mortgage rates have been relatively steady.
• Savings requirements: "They want to see borrowers have at least three months of reserves in their account in case of an emergency," Mr. Carmona said. "They want to see it in your bank account saved for at least 60 days. Usually, subprime lenders didn't ask for that."

Current Conditions vs. 70's and 80's

Conditions now are radically different than conditions in the 70's and 80's. A couple decades ago households went from one wage earner to two wage earners which increased purchasing power; wages and benefits were rising and not just for those at the top end; mortgage rates were set to decline nine full points; credit lending standards had plenty of room to drop; debt levels were low; the savings rate was high, and ability to take on debt was huge. Virtually none of those conditions exist today, not a single one. Yet many think that because commodity prices are rising that this is some sort of 70's and 80's replay. It simply can not be. The conditions are vastly different.

Willingness to Lend / Willingness to Borrow

• Credit standards are tightening
• The pool of willing lenders is clearly shrinking
• The pool of eligible home buyers is now shrinking with the tightening of credit standards
• The pool of willing buyers is shrinking along with a decrease in the willingness to speculate on housing

The psychology of both lenders and borrowers has now changed at the margin (subprime lending). This is how cascades start. When defaults continue it will progress further and further up the chains of credit worthiness. It is a mistake to think this will be confined to housing. It won't. If and when another huge hedge fund blowup, and/or there is a huge junk bond default, the leveraged buyout and merger mania markets will be hit hard. This is all poised to feed on itself once the ball gets rolling. A major credit bust is coming and it is only a matter of time.

There is massive belief in the Fed to be able to do something about that bust when it happens. That faith is totally unwarranted. Note again the huge difference between M3 and Base money. Also note that the Fed can not create jobs or put money directly into consumer accounts. Even if the Fed could deposit money into consumers pockets (the helicopter drop theory), to do so would be at the expense of banks and creditors. That makes the helicopter drop scenario implausible. However, the Fed will undoubtedly be willing to slash rates. But will banks be able and willing to lend? Will consumers be able and willing to borrow? A history of credit bubble collapses suggests otherwise as does the data presented above.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Cold Weather Forecast thru Mid-February

Following are some weather maps and weather related commentary courtesy of wxrisk.com. Someone sent these details to me and I thought I would pass them on. WxRisk seems to be a good site for weather related details.

Short Range January 22-23

It was a cold morning over the Plains.... with temps single digits and some below zero readings as well... and these below zero readings reached into all of CO and WY. The Midwest was not nearly as cold.

If you saw the BEARS vs. SAINTS playoff game late Sunday afternoon - early evening then you saw the heavy snow showers over Chicago. That was part of a new Arctic cold front that was sweeping through the Midwest and headed for the East coast. That front will arrive Tuesday and bring in a reinforcing shot of cold air -- Below Normal -- to the Northeast Quadrant -- the NE and ECB area combined -- for Tuesday and Wednesday. The heart of this cold air will NOT affect the Plains or Deep South. Those area will certainly NOT be mild but not nearly as cold as the Great Lakes and Northeast either.

On the West coast the strong Ridge in the Jet stream holds all this week so most of the West coast will stay mild / warm and dry even in the Pacific NW. By next Sunday the model show that ridge getting MUCH stronger which has major implications for the eastern half of the continental US in week 2.

Medium Range January 24 - 28

If you recall from late last week last SOME of the weather Models were showing a major Low developing on the East coast that could bring heavy snow and High winds to that area. As I stated last week the development of a POSSIBLE major Low for Jan 25 is going to be essential for keeping the trough over the eastern continental US in place. With No BIG Low off the East coast that moves into Eastern Canada the trough would slide East and the cold pattern over the Eastern US would weaken or break down.

Over the weekend all of the model data shows that Low will develop JAN 24-25 as a NEW arctic front drives into the Midwest and East coast. The Low that develops Jan 25 is going to be too far off the East coast to bring the big cities of the NE a snowstorm but it WILL form. The Low will undergo massive deepening as it moves in East Canada. The North winds created by this Low will be very strong...40 + MPH over the entire East coast.... on Friday ... so the wind chill be well shocking .

If there are energy traders in the Northeast continental US there that still doubt this new cold pattern will last... well this should make them think twice
By next Saturday and Sunday a NEW arctic HIGH will be driving S and E from south central Canada into the Plains and Midwest.

January 29 - February 3

The arctic HIGH that comes down JAN 27-28 drops into OK then slides east across the Deep South. This means the cold air mass over the Plains and Midwest will warm quickly and the Mild temps will move into the East coast for a day. BUT yet another Arctic HIGH will be dropping south from western and central Canada. The Next front sweeps East through the Plains and Midwest Jan 30 and reaches the East coast JAN 31

As long as that western North America Ridge stays strong and big over western Canada there will be NO shortage of cold fronts coming down. The cold pattern looks locked in into Mid FEB.

The reasoning can be seen below. The Map on the left side in the European Jet stream map for Day 8-9-10 and the map on the right hand side is the American weather model Jet stream map for Day 8-9-10.



Notice that BOTH maps show a HUGE ridge that extended way north past Alaska into the Arctic circle. Then note how those black lines PLUNGE from that ridge all the way into central and eastern continental US. That is a cold cold map folks.

The above commentary and chart are courtesy of wxrisk.com. A more detailed version of the above weather map can be found at http://www.wxrisk.com/MODELFOLDERS/today/test8.gif

If the above weather scenario plays out and energy can not rally now, the implications should be obvious.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

World Oil Demand

Findfacts is showing that Oil demand falls in Developed World for first time in 20 years.

Data issued by the Paris-based International Energy Agency (IEA), the energy watchdog of the industrialized countries including Ireland, show oil consumption in the 30 member countries of the Organization for Economic Cooperation and Development fell 0.6% in 2006. While the fall appears small, it marks the first annual drop in more than 20 years among the OECD countries, which use close to 60% of the 84.4 million barrels of oil used globally each day.

The fall in oil use by the industrialized world is a sign that the reactions to higher oil prices by businesses and consumers from the US to Germany to Japan may be adding up to a cycle-turning downdraft in demand. The resulting shift in global cash flows could mean a big boost for oil consumers' economies at the expense of producers and exporters. Other signals, both economic and psychological, have been popping up for some time: Demand for gas-guzzling sport-utility vehicles has been falling, while investment in and sales of alternative fuels such as ethanol are booming. Even the Bush administration is vowing to reduce America's dependence on crude.

Crude oil's fall to $50 a barrel may push US gasoline pump prices below $2 a gallon for the first time in more than two years, based on historical price moves. The last time the average price for regular gasoline was below $2 was in March 2005, according to the AAA, the largest U.S. motorist organization. Prices are already below $2 in some parts of the country, including Oklahoma City and Kansas City, Missouri.

Here are some charts to consider from the Energy Information Administration.

World Oil Demand


Oil Consumption



The above charts show that for now, total world oil demand simply is not expanding as fast as some lead us to believe. However, the rate of growth in China and Other Asia is substantial.

Long Term Trendline on Crude



Short term a bounce in crude off the 200MA is likely to happen. Seasonally a bounce might also be expected here, especially if the unusually warm weather turns harsh. Intermediate term we have a recession to deal with. Long term we also have to deal with peak oil. There are also tremendous geopolitical factors. Will Bush order an attack on Iran? Will Israel attack Iran? Will Iran be able to block the Strait of Hormuz effectively shutting down all Mideast oil? Just how stable is Saudi Arabia? The only one of those questions that can easily be answered is that Iran is unlikely to be able to block the Strait of Hormuz, but that does not imply that the world will be able to do without oil from Iran itself.

What we do know for sure is that oil demand fell for the first time in 20 years and that can not be signaling much of anything other than a global slowdown. Price is set at the margin and demand at the margin has declined. What we certainly do no know is most everything else including how much geopolitical tension is priced in or out.

Long term I believe in peak oil.
Long term I also believe the market (if left alone) will find a nice solution to peak oil.

One of the problems right now is the inability of those in power to let the market decide what to do. Instead we have seen absurd subsidies for ethanol, a stupid war in Iraq, a willingness to attack Iran, and a whole host of other nonsense outside the US including Chavez nationalizing oil in Venezuela. Furthermore we do not know the full extent of how much hedge funds have driven up the price of oil based on the above knowledge, nor can we really trust any source of information about oil from Saudi Arabia or the Mideast in general.

I was willing to take a stand on copper based on sinking housing demand, but this is way more difficult. I was quite bearish on crude above $75 but near $50 and bouncing off a 200MA the call is much more difficult.

For those that insist on a call, here it is. I expect a short term bounce off the 200MA then a fall to the $40-$50 range for a long basing action, followed by a blast higher. I reserve the right to immediately change my opinion without notice based on current events.

Note: This post is an opinion only and can not be construed as investment advice of any kind. Please consult your investment adviser before taking action on this or any other post you see here or elsewhere.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Credit Swaps And Bond Yields

Moody's is reporting Bonds Safest in at Least 4 Years, Credit Swaps Show.

By Shannon D. Harrington

The risk of owning corporate debt is the lowest in at least four years after housing data bolstered confidence that the worst of the residential real estate slump is over, according to traders who bet on corporate creditworthiness in the credit-default swap market.

"There's some optimism that credit quality will continue to remain strong and default rates will remain low," said Ira Jersey, a strategist at Credit Suisse in New York. "Homebuilders did pretty well because of housing starts and permit numbers. Certainly, with the jobless claims being low, people will have money to spend."

Credit-default swaps on homebuilders fell to the lowest in more than eight months as housing data lifted confidence that home sales are rebounding from last year's 18 percent drop, the worst plunge since 1990. A decline in the price of credit-default swap suggests improving perceptions of credit quality.

Contracts on $10 million in bonds of D.R. Horton Inc., the biggest U.S. homebuilder, fell to $65,100 from $73,000 Jan 12, CMA Datavision prices show. The price is the lowest since May.

"A lot of people are calling for the bottom of the market, and by mid-2007 we should see some sort of recovery," said CreditSights Inc. analyst Sarah Rowin in New York. "Although earnings are going to be down, the builders could come off relatively intact."

CDO Sales

The derivatives helped CDO sales surge last year to a record $497.1 billion, 81 percent more than in 2005, Morgan Stanley analysts said this month. The funds, which are sliced up according to risk and sold as bonds, appeal to investors because they can offer higher yields than the assets being pooled.

Credit-default swaps, which were conceived to protect bondholders against default and pay the buyer face value in exchange for the securities if a company does default, have become one of the best gauges of shifts in credit quality.

An estimated $26 trillion in the contracts are outstanding, the International Swaps and Derivatives Association said in September. Derivatives are financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in the weather or interest rates.

Let's see if we can take this apart piece by piece.

Shannon Harrington: "The risk of owning corporate debt is the lowest in at least four years."

Mish: No the "risk" is not the lowest. Yield spreads have compressed because the willingness to take on risk is at its highest point in at least four years. Spreads between junk and investment grade debt have collapsed. Do not confuse optimism with risk. An inverted yield curve suggests this optimism is not warranted, nor is the bounce in housing starts that significant. This all reminds me of the continued optimism in JDSU and CIEN in the Nazcrash of 2001 before they eventually lost over 90% of their value.

Ira Jersey: "There's some optimism that credit quality will continue to remain strong and default rates will remain low. Certainly, with the jobless claims being low, people will have money to spend."

Mish: Well you certainly have that optimism part right but you are confusing jobless claims with money to spend. A negative savings rate for 18 consecutive months suggests that consumers are spending money they do not have. Also note that we are continuing to lose high paying manufacturing jobs for low paying jobs at Walmart and Pizza hut. Also note that Mortgage Equity Withdrawal (MEW) is drying up as a source of funding. That is less money in pockets to spend. Finally, even IF consumers had more money to spend, at some point they will stop spending it. Debt burdens are at an all time high. That debt must be paid off. For spending to dramatically rise, both jobs and wages (not just for the fat cats) have to rise. That is not happening as global wage arbitrage and outsourcing continues unabated.

Shannon Harrington: "A decline in the price of credit-default swap suggests improving perceptions of credit quality."

Mish: Exactly. Please do not confuse perceptions with reality. Do not confuse perceptions with risk either.

Sarah Rowin: "A lot of people are calling for the bottom of the market, and by mid-2007 we should see some sort of recovery. Although earnings are going to be down, the builders could come off relatively intact."

Mish: Does bottom calling mean it will happen or does it represent unwarranted optimism? How many bottom calls were there when the Naz started plunging from the peak over 5000? Has anyone bothered to look at cash and inventory levels on homebuilders? Sarah, please take a look at homebuilder corporate statements. They are running out of both cash and profits, while inventories are soaring.

Morgan Stanley: CDO sales surged last year to a record $497.1 billion, 81 percent more than in 2005. The funds, which are sliced up according to risk and sold as bonds, appeal to investors because they can offer higher yields than the assets being pooled.

Mish: We will take a look at the "appeal" of higher yields in a chart below.

International Swaps: An estimated $26 trillion in the contracts are outstanding, the International Swaps and Derivatives Association said in September.

Mish: Wow. On the theory that "the bigger the bet the safer things must be" this must be a sure sign that "Corporate Bonds Are Safe".

Let's take a look at a chart of Moody's Baa Corporate Bonds to see what it might be saying.

Moody's Baa Bonds


Above chart by sharelynx.com.
Moody's Baa Bonds

Baa - Bonds and preferred stock which are rated Baa are considered as medium-grade obligations (i.e., they are neither highly protected nor poorly secured). Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well.

Baa bonds are just one step above junk. Yields are close to 6%.

Bank Deals - Best Rates shows that you can get up 6.19% for 6 months at some places. Hmmm. Lets see, do you want 6.19% on a 100% guaranteed bet or approximately the same thing on bonds rated one step above junk? Inquiring minds want to know what if anything is "appealing" about the risk/reward shown in that chart.

On that thought the Mish telepathic question lines are open. Hmmm. I am being flooded with calls. Fortunately the ideas expressed are all similar. They go something like this. "Mish, you are trashing corporate bonds at a mere 6% or so but if I recall correctly you like 10 year treasuries that yield even less. Please explain"

10 Year Treasuries



Above chart by sharelynx.com, modified by Mish.

Some newcomers might be confused about the seasons on the above chart. Those seasons correspond to something called the K-Cycle. K-Cycles are long. The last K-cycle Autumn peak was in 1929. That was followed by the great depression. With companies going bankrupt in the early 1930's the last place you wanted to be was in corporate bonds. Those in treasuries did great. Safety vs. "perceived safety" is the key. Although I am not calling for another depression, I am merely pointing out that the economic conditions are very similar. This case was presented in 1929 Revisited.

Interest Rate Interpretation of the K-Cycle



K-Cycle longer term view



If we are headed into "winter" the last place you want to be is in junk bonds. Even if we are not headed into "winter" where is the risk/reward for junk bonds when you can get nearly the same yields in CDs?

No matter how you slice it, credit swaps have pushed corporate yield spreads far into the blatantly complacent level where risk is enormous and rewards are slim. That is exactly the opposite of what Shannon Harrington is suggesting.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/