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Wednesday, March 30, 2005 10:48 PM

A Tsunami Wave of Foreclosures

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Mark Ijlal on his Profitable Investment In Bank Owned Foreclosures website writes:

"I remember 5 years ago when Darrick used to walk in, waving the foreclosure list in his hands and saying look we got a nice suburban house here for around $150,000, lets check it out. And now you can pretty much find couple of million dollar foreclosures every month, without looking."

"The thing that amazes me is how fast things have gone from 100 foreclosures per month per county to all of sudden couple of hundred foreclosures coming in month after month in almost every county."

That quote sums it all up nicely: foreclosures, even at the high end are soaring. Can everyone flip million dollar foreclosures for a profit? I guess so, but at this stage in the game, I think I'll take a pass. The real question is this: How come foreclosures are soaring if the economy is 3 years into a recovery and leading economic indicators are near all time highs? No doubt that is another economic conundrum puzzling Greenspan these days.

Well just how bad is it? That's a fair question and enquiring Mish Blog readers deserve answers. Let's take a look:

Houston foreclosures rise in record year
A record year for construction of new homes in Houston was offset by a negative side effect as the number of residential foreclosures increased sharply in 2004. A total of 19,866 homes were posted for foreclosure in Harris County, a significant jump from the 17,230 posted in 2003, according to the Foreclosure Listing Service.

Amanda LeCureux of the listing service says the number of postings in 2004 was the highest total the company had seen since mid-1989. While foreclosures were climbing, new single-family home starts reached 42,000, breaking the 40,000 barrier for the first time in city history.

Housing boom brings surge of foreclosures to Nashville area
The number of home foreclosures for Davidson and nine surrounding counties rose 52% to 3,004 last year, up from the 1,976 recorded in 2003. Credit counselors and others who work with people in financial distress said the surge in foreclosures adds a dark cloud to the otherwise sunny picture of a housing boom enjoyed locally and nationally since 2000. They say the numbers also point to the dangerous game many middle- and lower-income Americans are playing: living paycheck to paycheck while saddled with debt.

"A lot of Americans are living paycheck to paycheck," observed Howard Dvorkin, founder of the nonprofit Consolidated Credit Counseling Services Inc. in Fort Lauderdale, Fla. "We're spending every dollar we have. And then something happens in their life to cause them to fall off that tightrope."

Metro Denver area foreclosures up 34 in 2005%
Soaring foreclosure filings in Arapahoe County for the first three months of this year helped drive metro Denver's foreclosure rate 34 percent higher than the same period of last year and 30 percent higher than the fourth quarter of 2004.

The seven-county region's ballooning rates stem from bad borrowing and lending decisions, lagging income growth and flat home prices, experts say.

It's hard to continue blaming foreclosures only on the economy. Colorado added 27,900 jobs last year, and the state's unemployment rate dropped in January to 4.9 percent, the lowest level since September 2001.

Read that last sentence again. Then read it again.
How do massive increases in foreclosures jive with all this "ballyhooed job growth" and "things are getting better" BS coming from the FED and the Whitehouse? That my friends is the REAL conundrum that the FED should be worried about instead of pondering why long terms rates have not risen. Perhaps long term rates have not risen much is because there is far far more stress in the system than the FED is aware of!

What is anyone doing about it? Good question! Enquiring Mish readers might want to consider this:

Pa. Bank Chief Seeks to Stem Foreclosures

Pennsylvania's banking secretary said Tuesday he will press for new laws and regulations to stem a surge of home foreclosures that he said were due in part to unscrupulous lending practices.

Bill Schenck said the Banking Department believes it can reduce the state's mortgage foreclosure rate, one of the nation's worst, by focusing on sub-prime lending loans issued at higher rates and larger fees to customers with relatively poor credit. Pennsylvania is one of a number of states that have been hard-hit by foreclosures in recent years as home ownership opportunities have expanded, including for people with poor credit. Sub-prime loans are most prevalent in low-income and minority neighborhoods.

What is President Bush doing?
Zero-percent down home loans spark debate
"To boost homeownership among minorities and immigrants, the Bush administration has asked Congress to allow the FHA to insure mortgages with no down payment for first-time home buyers. Zero-down loans could carry a lot of risk. FHA Commissioner John Weicher told the House Financial Services Committee that, over the life of the loans, 17 percent of zero-down borrowers - about one in six - would be foreclosed on or be forced to sell their homes at a loss. In contrast, the estimated cumulative default rate for all FHA loans originated this fiscal year is 6.96 percent. "

Now that's interesting isn't it? The FHA commissioner estimates that 17% of zero down borrowers will fail. Who will pay the price? Taxpayers of course? Who else? Marginal people attempting to buy a home! Yes, that's correct: the very program designed to "help the poor" in this nonsensical "ownership society" is one of the factors that has driven housing to unaffordable levels. Of course the banks and FNM are all in favor of such programs. Who wouldn't be? After all, what lender would refuse to lend with the government backing the loan? Doesn't it seem that Pennsylvania's banking secretary and the FHA commissioner have radically different views than Bush as to what the real problem is?

Is there more?
That is of course another fair question and another question that enquiring Mish readers deserve an answer to. Yes indeed there is more.

Consider bankruptcy reform.
All of the lenders are in favor of it. Why not? It happens to be the most one sided bill in history. Short of reviving debtor prisons this bill is about as regressive as it gets. Lending institutions want protection against default, they want no restrictions on charging 30% interest rates, they want no restrictions on fees, penalties or anything else, and they want the proverbial "free lunch". The "free lunch" bill seems all greased up ad ready to go. It was the worst legislation that money could buy. In the meantime, the FHA and Pennsylvania's banking secretary warn about defaults and predatory lending. Go figure.

Unfortunately, the REAL Tsunami Wave of Foreclosures has not even started. Rising property values in California, Florida and other places have kept (for now) the consumer buoyant. Round after round of cash out refis has supported consumption. The REAL Tsunami starts when home equity in California and Florida goes negative. Let's consider a chart before wrapping things up:

Thanks to Contrary Investor

In spite of massively rising home prices, the percentage of home equity is at historic lows. Please bear in mind those are averages! There are many people with paid off houses. There are also tons of people leveraged in multiple houses at 100% financing and praying that home prices keep rising.

As discussed earlier there are already many areas of the country that are experiencing record forecloseures in spite of those rising home prices. What is happening is clear: The costs of home ownership (mortgage, property taxes, etc) as well as rising expenses such as food gasoline, and medical expenses are rising far faster than wages.

Over the long haul, real estate prices simply can not rise above local wages! I do not care about arguments such as: the scarcity of land, interest rates are low, boomers need a place to live, etc etc etc. over the long haul, simple logic dictates that prices simply can NOT stay above wages for a prolonged period of time. There will be hell to pay for this bubble when it pops. For now, in areas where home prices are still going up, equity extraction is still supporting consumption.

Given the 100%+ financing, speculators buying property sight unseen, multiple flips per day on a single house, and all of the other lunacies we have seen lately tells me to expect the "real upsurge" in foreclosures will start when the biggest of the big bubble areas (California & Florida) pop. That might be any time now, or it might be next year. It is very hard to tell with manias and we are clearly in one right now. Many people will be underwater when the tide turns.

In the meantime the FED seems bound and determined to "bring it on" with its new found inflation fighting warnings. Each hike (and once again I admit this has taken far more than I thought) brings us closer and closer to the edge of a massive "Tsunami Wave of Foreclosures". At this point there is nothing that anyone, including the FED, can do to prevent it.

Yes readers, it is 2000 all over again, this time in housing. Blame the FED when it happens, not for popping the bubble after the fact, but for blowing bubble after bubble after bubble in the first place.


Tuesday, March 29, 2005 8:10 PM

Tulip Mania and Social Security Reform

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What do Tulip Manias, Social Security, and the Stock Market all have in common? Enquiring minds just might wish to consider this fairy tale comparison.

When tulip prices started to rise in the 1630s, many Dutch burgomasters (the local mayors) started to invest in tulip bulbs. In the autumn of 1636, demand for tulips sagged as German princes ravaged by the Swedes in the Battle of Wittstock, began digging up their bulbs and selling them. The sudden glut caused prices to fall, and Dutch burgomasters began losing money. Rather than take their lumps, these politically connected investors tried to change the market rules on tulips. Ultimately, the burgomasters succeeded in ironing out a deal whereby the obligation to purchase bulbs at a fixed price would be suddenly converted into an opportunity to do so. In other words, they transformed tulip-bulb futures contracts into tulip-bulb options. The action was ratified by the Dutch legislature. On Feb. 24, 1637, the Dutch florists "announced that all futures contracts written since November 30, 1636 and up until the opening of the spring season, were to be interpreted as option contracts". In the worst-case scenario, investors would lose 3 percent of the price of the contract. In the best case, prices would rise above the strike price, and they could make an instant profit while assuming the minimal 3 percent risk. As a direct result of these sudden “rule changes”, people assumed there was little to no risk in buying tulip options, and the market exploded. By February 1637, the price of tulips had risen 20 times.

The demand for rare tulips increased so much that regular marts for their sale were established on the Stock Exchange of Amsterdam, in Rotterdam, Harlaem, Leyden, Alkmar, Hoorn, and other towns. Symptoms of gambling became obviously apparent. The stock-jobbers, ever on the alert for a new speculation, dealt largely in tulips, making use of all the means they so well knew how to employ to cause fluctuations in prices. At first, as in all these gambling mania, confidence was high and everybody gained. The tulip-jobbers speculated in the rise and fall of the tulip stocks, and made large profits by buying when prices fell, and selling out when they rose. Many individuals grew suddenly rich.

At last, however, the more prudent began to see that this folly could not last for ever. Rich people no longer bought the flowers to keep them in their gardens, but to sell them again at cent per cent profit. It was seen that somebody must lose fearfully in the end. As this conviction spread, prices fell, and never rose again. Confidence was destroyed, and a universal panic seized upon the dealers. Substantial merchants were reduced almost to beggary, and many a representative of a noble line saw the fortunes of his house ruined beyond redemption. After the crash was rolling, people demanded the government "do something." Initially, the government offered to buy the options at 10% of face value. But as prices plunged even lower, the government could not afford to follow through.

Fast forward to 2005.

The US government, weary of war with Iraq and facing increasing military expenditures as well as rising pension obligations and Social Security promises that can not be met, desperately needs a way to support a potentially sinking tulip bulb market (otherwise known as the US stock market). The head US burgomaster (otherwise known as President Bush) has his own "rule changes" in mind (otherwise known as Social Security reform). It seems all we have to do to bail out Social Security and other pension obligations is to pass a law requiring the common people to purchase tulip bulbs (stocks) with a portion of their income from each and every pay check. Even though many think the "tulip fund" will be solvent for another 14-40 years, the head burgomaster has decided that "rule changes" are his top priority.

Supposedly tulip bulbs purchased today will be harvested when individuals retire and those bulbs will provide a source of retirement income. It just so happens that a side benefit of this mandatory infusion of cash into the tulip markets is a means for the wealthy burgomasters in general (otherwise known as CEOs and stock option holders) to sell their bulbs before they rot. The proposed rule changes will also guarantee fees for the tulip bulb dealers (otherwise known as brokerage houses and insurance companies selling tulip annuities). These fees are an expression of gratitude for the massive contributions paid by the bulb dealers to the head burgomaster in his bid to get re-elected. Bulb dealers were ecstatic when their candidate won, and immediately the price of bulbs shot up nation wide. All that remains now is for the Dutch Legislature, excuse me I mean US Congress, (see how confusing this gets?) to ratify the proposed rule changes.

In 1982 the common people were told that social security taxes would be raised to guarantee solvency of the "tulip fund" (otherwise known as the "Social Security Trust Fund"). Now 20 years later, the common people are told there is no money left in the "tulip fund", that it was all spent, and that we need "rule changes" to guarantee the future solvency of the fund. These changes supposedly will revitalize our under-funded tulip fund.

Will these rule changes be any more successful than what ultimately transpired in 1637?

Enquiring minds want to know!
Unfortunately, our fairy tale must end here.
It will take many years before we know for sure but the up front cost to find out is a mere 1-2 Trillion US$ right now.

Credits and Thanks:
Portions of the above article are excerpts and/or paraphrased sections of Bulb Bubble Trouble, and Tulipomania Memoirs of Extraordinary Popular Delusions and the Madness of Crowds.

Thanks to my friend John Mozdzen for initially coming up with the idea for this article.


Saturday, March 26, 2005 1:41 PM

It's a Totally New Paradigm

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San Diego Home Prices (with thanks to piggington)

The "nothing can possibly go wrong" talk is rampant again. It's not stocks this time but Real Estate. Let's take a look at some quotes from the New York Times Article Trading Places: Real Estate Instead of Dot-Coms

Ron Shuffield, president of Esslinger-Wooten-Maxwell Realtors says that "South Florida is working off of a totally new economic model than any of us have ever experienced in the past." He predicts that a limited supply of land coupled with demand from baby boomers and foreigners will prolong the boom indefinitely.

"I just don't think we have what it takes to prick the bubble," said Diane C. Swonk, chief economist at Mesirow Financial in Chicago, who was an optimist during the 90's. "I don't think prices are going to fall, and I don't think they're even going to be flat."

"I look at this as a short-term investment," said Mr. Farquharson, 36, who works for a venture capital firm, "and plan to unload it as soon as things look dangerous."

Now there's a laugh. By the time it looks dangerous will there be anyone looking to buy? Doesn't it look and feel dangerous now? Is he blind or am I?

MoneyPenny on Silicon Investor writes: "I live in this fantasy land. SW Florida seems to believe that we are immune from any financial difficulty. I have a friend that is positive that real estate values will appreciate 20% a year for the next 10 years as Baby Boomers move to Florida. .... I stand in amazement but I am enjoying the amazing increase in my interior design business. I have never seen anything like it in my long career (37 years)."

Free money shills are everywhere: "Who Else Would Like to Learn How To Make Over $100,000, in 6 Months, With an Investment In Preconstruction Real Estate?"

Who needs models? "The demand for the product was so high that we could actually sell it without having a model to show them," said Glen Stegeman of Paseo Home Sales. "It is kind of crazy. It's a good crazy. Obviously the demand is there," said Stegeman.

The real estate bubble is not just limited to the US either. Brad Sester talks about the Trans-Pacific Real Estate Bubbles in China and how that is related to the housing bubble in the US.

Is this really a totally new economic model or is it just the same old story: Mammoth greed and speculation fueled by easy money and an intense belief that "nothing can possibly go wrong"? In the meantime I am getting "hate emails" from people bragging about flipping in Florida. I guess we should all retire and flip houses, sight unseen of course. Who needs to see a model? Heck, any plot of land with a 5 year plan to "build something really nice" on it is all it takes these days to get people interested. Then again, perhaps random taunts out of the blue from "true believers" are another sign of topping action.

Talk of "new paradigms" or "new economic models" has been associated with every major bubble in history, typically near the peak. Wasn't it just 5 short years ago that Greenspan proclaimed the "productivity miracle" and everyone was counting "clicks" on dot coms as the "new economic model"?

Just as soon as I finished writing this post, I found a new quotation to add.
It's perfect.

Gregory J. Heym, the chief economist at Brown Harris Stevens, is not sold on the inevitability of a downturn. He bases his confidence in the market on things like continuing low mortgage rates, high Wall Street bonuses and the tax benefits of home ownership.
"It is a new paradigm" he said.

Scroll back up and take a look at that first chart again. Current talk of "New Paradigms" and "New Economic Models" should tell you exactly where we are and where we are ultimately headed.


Wednesday, March 23, 2005 11:50 PM

Is the cyclical bull over?

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Let's take a look at several indices.

Here is the Nasdaq 100 Index - $NDX

There are clearly 5 waves up with powerful divergences at the top. Notice in particular the volume. There was very heavy selling for weeks at the top while the index went sideways. Sentiment was extremely strong although the index barely surpassed the high from a year earlier. If liquidity dries up this chart can get ugly in a hurry.

Here is the Internet Index - $DOT

This chart has not yet broken down. It led the Nasdaq advance from the lows and never looked back. Then again the index fell from 1250+ to 60+ so it was more than a bit oversold. Many companies in this index went under. Fundamentally you are looking at the survivors. That said, they are very richly priced after this advance and we have seen 5 clear waves up. Odds do not seem to favor being long here.

Here is the S&P 600 Small Cap Index - $SML

One can easily see 5 waves traced out. We are also flirting with the trendline.
Odds would seem to favor a significant correction here.
A bounce can be expected off the 200MA near 300. If that produces a H&S top rather than taking out the high, we could see a significant drop. After 5 clear waves up the odds for a breakdown vs a breakout seem high given the MACD and CCI divergences.

Here is the Semiconductor Index - $SOX

This is one ugly chart and one ugly index. Notice only 3 waves were traced out on this advance from the lows. A potential 4th wave was negated when the wave 1 up was crossed on what presumably was a wave 4 down. Oops Not Allowed. In Ewave terms this makes the entire move off the 2002 lows a corrective advance. This is the weakest of the charts we have looked at today.

Fundamentally there is support for this view based on declining DRAM prices, channel stuffing and lower prices on PCs, falling demand on cell phones, and new factories planned or coming online in China. Seldom do the leaders of the previous bubble lead the advance of the next one. The SOX has clearly lagged and should continue to lag.

There are many charts and many sectors that look similar to the preceeding charts.

On a fundamental basis we are in the worst possible environment for stocks:
1) Rising interest rates
2) A slowing economy
3) Difficult year over year earnings growth comparisons

Although housing is still robust, refis have dried up to a mere 20% of the peak levels just over a year ago. That is not supportive of increased consumer spending. All in all, fundamentally and technically the odds do not favor being long. Odds are this bull move is over. I look for a very significant correction in stocks this year.


Monday, March 21, 2005 11:46 PM

Bubble Talk at the FED

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Flashback December 21, 1999
Meeting of the Federal Open Market Committee (FOMC)

Following are some rather enlightening excerpts from that FOMC meeting.
Note: FED meeting minutes are sealed for 5 years. The December 1999 meeting minutes were only recently made publicly available.

Mr. Prell:
Once again in recent weeks, the market has defied our notions of valuation gravity by posting an appreciable further advance. Moreover, it has done so in a way that seems to highlight the risk that it will continue doing so. I refer to the incredible run-up in “tech” and e-commerce stocks, some of which have entered the big-cap realm without ever earning a buck. To illustrate the speculative character of the market, let me cite an excerpt from a recent IPO prospectus: “We incurred losses of $14.5 million in fiscal 1999 primarily due to expansion of our operations, and we had an accumulated deficit of $15.0 million as of July 31, 1999. We expect to continue to incur significant...expenses, particularly as a result of expanding our direct sales force…. We do not expect to generate sufficient revenues to achieve profitability and, therefore, we expect to continue to incur net losses for at least the foreseeable future. If we do achieve profitability, we may not be able to sustain it.” Based on these prospects, the VA Linux IPO recorded a first-day price gain of about 700 percent and has a market cap of roughly $9 billion. Not bad for a company that some analysts say has no hold on any significant technology. The warning language I’ve just read is at least an improvement in disclosure compared to the classic prospectus of the South Sea Bubble era, in which someone offered shares in “A company for carrying on an undertaking of great advantage, but nobody to know what it is.” But, I wonder whether the spirit of the times isn’t becoming similar to that of the earlier period.

Mr. Parry:
Analysis done by our staff suggests that successful IPOs have made a large number of employees wealthy, at least on paper. More than 150,000 persons are employed in the roughly 300 California- headquartered firms that have made IPOs in the last three years. About 125,000 of these employees probably have received stock or stock options as part of their compensation, giving them as a group about 15 percent ownership in their firms. Given the strong stock price performance this year, the aggregate market capitalization of these 300 firms recently jumped to about $450 billion dollars. As a result, about 125,000 Californians have seen the value of their stock or stock options jump to an average level of more than $300,000 per employee. Just as this newly created wealth is boosting demand, especially in California, it is clear that a collapse in market values would impose obvious downside risks.

Mr. Gramlich:
Herb Stein once said something that comes close to capturing the essence of economics: “Things that can’t go on, won’t.” As I think about my two years on this Committee, much of what has happened refutes Stein’s quote. Things that couldn’t go on, have gone right on! [Laughter] They may not do so forever, but they have continued much longer than anybody has forecast. The first example is labor markets. Since I’ve been here we have been talking about very tight labor markets as indicated by the unemployment rate, other measures of labor tightness, and Beigebook reports. We have all felt that at some point wages would start to accelerate but as yet they really haven’t--apart from some of the caveats that Mike Prell gave earlier. The second example is the stock market. Again, it has been seemingly overvalued since I’ve been here, but to this point stock prices have risen on balance. The third example is the dollar, which for a while now has seemingly been overvalued, if there is any limit at all on the accumulation by foreigners of dollar-denominated assets. But it is not yet falling. At the intellectual level we should, of course, keep studying these matters to see if we can improve our understanding of how the economy is operating. But studying and learning take time and in the meantime we have to know how to set monetary policy.

Mr. Ferguson: I think we are entering a period, as others have said, that is going to be somewhat challenging for us. In the short run, we clearly do not want to destabilize markets as we go into the Y2K period. One always hates to see a marathon runner trip up at the end, and we certainly don’t want to be the person from the stands who runs out and trips that runner up. In the longer run, obviously, as others have indicated, we don’t want to lose our ongoing battle with inflation expectations and inflation, or risk any damage to our own credibility.

Chairman Greenspan:
There are very evident imbalances in demand over supply, and indeed one can readily argue that virtually all of the problems stem from a wealth effect. Were it not for a significant rise in wealth-to-household income, we probably would find that the propensities to save would be relatively stable, that the unemployment rate would be very low but also stable, and that the current account deficit, while large, would not be increasing. …..
The bottom line is that the wealth effect--in line with Herb Stein’s remark--cannot continue and, therefore, will not continue.

The crucial issue for this meeting, as Don Kohn very clearly pointed out, is to recognize that we have a Y2K problem. It is a problem about which we do not want to become complacent and presume that it doesn’t matter. We want to communicate as effectively as we can that we have no intention of doing anything through the year-end and maybe for a short period thereafter. But we also don’t want to remove the general view in the market that we retain an upward bias and have not completed the tightening that we think needs to be done. We therefore face a tricky problem of trying to find a way to communicate all of that, taking into account what we think the market perceives about what we may or may not do, if our purpose is not to disturb the markets one way or the other.

Chairman Greenspan: That brings us to the end of our agenda, except for the pro forma announcement that our next meeting--as I’m sure you’re all acutely aware--is scheduled for February 1st and 2nd. Merry Christmas everybody and hopefully a Happy New Year!
It should be readily apparent to anyone reading those minutes that Greenspan has not exactly been honest when he said that "Bubbles can not be recognized in advance". It is rather obvious that a number of FED governors as well as Mr. Greenspan himself were well aware of the heated bubble in tech stocks in 1999.

Mr. Prell hit the nail on the head by comparing it to the South Sea Bubble. Mr. Parry talked of the wealth affect distortions and Mr. Gramlich mentioned they were discussing the bubble for two years! Both Mr. Ferguson and Chairman Greenspan were aware of the problem but their irrational fear of a Y2K disaster prevented them from doing anything about it.

Following is a rough historical timeline of the Greenspan FED.
1) 1996 Greenspan warns of irrational exuberance
2) 1998 Greenspan starts loosening money in an irrational Y2K scare.
3) 1999 Greenspan declares the "productivity miracle" and thinks the boom is sustainable
4) 2000 Greenspan is finally hiking rates right as the boom was turning to bust on its own accord
5) 2001 Jan 2001 Greenspan told Congress two things: a) we could have the Bush tax cuts and still have budget surpluses and b) the economy was not heading for recession. WRONG AND WRONG
6) 2001 Greenspan declares that bubbles can only be seen in hindsight and the best way to deal with them is after they blow up
7) 2002-2003 the FED panic cuts rates to 1% when housing was already strong enough and leading us out of the slump. This stimulus on top of tax cuts by Bush, tax credits by Bush, and FNM and FRE going completely berserk with easy lending standards such as 110% mortgages and round after round of cash out refis leads to house flipping in Southern California, Las Vegas, Florida, and Chicago among other places.
8) 2004 Greenspan declares there is no housing bubble
9) 2004 Greenspan declares that debt to asset ratios for consumers (based almost entirely on housing prices) is not a problem
10) 2004 Greenspan declares victory over deflation and openly brags about it.

The combination of #1 and #6 above together with the minutes of the Dec 21, 1999 FED meeting have presented me with my own conundrum: Is Greenspan's memory that poor or is he just a poor liar?

Here was a man that saw a bubble in 1996, declared there was no bubble in 1999 even though the FED was openly discussing it, and then in 2001 declared that bubbles can only be detected in hindsight. BTW, how can he possibly know whether or not there is a housing bubble if they can not bee seen in advance? I guess that is another conundrum for historians to ponder at a later date.

All of this makes me how Greenspan has any credibility left. Oh well, we only have to wait 5 more years to find out what they are really thinking.


Saturday, March 19, 2005 4:19 PM

Outsourcing the Soul of the US

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The outsourcing trend started with manufacturing. With the internet came "global wage arbitrage" and outsourcing progressed to call centers, XRAY analysis, and other medical diagnostics. After all, why should any company pay a US lab technician for analysis when they can just as easily take a test here then ship the results over the internet to a doctor in India who is willing to do the diagnosis for a fraction of the cost? Why stop there? Why not outsource R&D too?

For years we have heard pundits claim that "manufacturing does not matter", "those are only low paying jobs", and "the good jobs" (aka high paying design and innovation jobs etc) would stay in the US.

Why should those high paying jobs stay here? What could possibly make them stay here? Does the US have a lead in education or intelligence? Are US colleges turning out better engineers than do colleges in India? Are Chinese workers less intelligent or less hard word working than US workers? Isn’t it being more than a tad arrogant to assume so? Even IF the US had an insurmountable lead in talent, just what % of the total job force were those "good jobs" supposed to be anyway?

The point is now moot because the proof is in. We are now starting to see a big push towards outsourcing innovation and R&D, which up to this point have been the heart and soul of US technological advantage. Business Week discusses this very point in the March 21, 2005 Issue:

"Outsourcing Innovation"

When Western corporations began selling their factories and farming out manufacturing in the '80s and '90s to boost efficiency and focus their energies, most insisted all the important research and development would remain in-house.

But that pledge is now passé. Today, the likes of Dell, Motorola, and Philips are buying complete designs of some digital devices from Asian developers, tweaking them to their own specifications, and slapping on their own brand names. It's not just cell phones. Asian contract manufacturers and independent design houses have become forces in nearly every tech device, from laptops and high-definition TVs to MP3 music players and digital cameras. "Customers used to participate in design two or three years back," says Jack Hsieh, vice-president for finance at Taiwan's Premier Imaging Technology Corp., a major supplier of digital cameras to leading U.S. and Japanese brands. "But starting last year, many just take our product. Because of price competition, they have to."

On Feb. 8, Boeing Co. (BA ) said it is working with India's HCL Technologies to co-develop software for everything from the navigation systems and landing gear to the cockpit controls for its upcoming 7E7 Dreamliner jet. Pharmaceutical giants such as GlaxoSmithKline (GSK ) and Eli Lilly (LLY )are teaming up with Asian biotech research companies in a bid to cut the average $500 million cost of bringing a new drug to market. And Procter & Gamble Co. (PG ) says it wants half of its new product ideas to be generated from outside by 2010, compared with 20% now.

Some analysts even see a new global division of labor emerging: The rich West will focus on the highest levels of product creation, and all the jobs of turning concepts into actual products or services can be shipped out.

Consultant Daniel H. Pink, author of the new book A Whole New Mind, argues that the "left brain" intellectual tasks that "are routine, computer-like, and can be boiled down to a spec sheet are migrating to where it is cheaper, thanks to Asia's rising economies and the miracle of cyberspace." The U.S. will remain strong in "right brain" work that entails "artistry, creativity, and empathy with the customer that requires being physically close to the market."

Isn’t it interesting how the analysts keep paring down what processes will take place in the US while making silly excuses for what processes don't? Here is the progression so far: Manufacturing, Custom Manufacturing, Innovation & R&D, "Key Innovation" & R&D, Key Innovation, etc etc etc. That model finally blew up when there was nothing left and no one could figure out what "Key Innovation" really meant. Clearly that model had to be replaced so some analyst in complete fantasy land dreamt up the half-baked idea that the US will remain strong in "right brain" work. Are the "right brains" somehow deficient in citizens from China or India? Somehow, I think not.

Innovation may be vital, but there is no underlying reason it has to take place in the US. Indeed, with costs in the US of over 30 times the costs in India or China, there is every reason to believe this is just the start of the trend towards the outsourcing of our soul. If the trend continues long enough, the US will have nothing left but bunch of "over-hyped designer brand labels" offering little to no differentiation vs. "off-the shelf" products made by generic Asian manufacturers.

Will we keep our over-paid US marketing reps or will they go too? Why can’t the design of advertising campaigns be outsourced to India as well? Eventually everything that can be outsourced will be outsourced. The outsourcing progression in advertising will be the same as with technology: "Don’t worry, ‘cutting edge’ advertising campaign will always stay in the US"…… and on down the line. Eventually, no one will be able to define "cutting edge advertising" any more than they could define "cutting edge technology". Even if someone can define it, why would it stay in the US if there are far lower costs elsewhere? Right wrong or indifferent and without attempting to lay blame, it is vital to understand the processes that are in place:

The trend towards outsourcing is very strong and will remain strong because of "Global Wage Arbitrage". Wages in the US are 30 times wages in China. Quite literally any job that can happen cheaper somewhere else is at risk. "Global Wage Arbitrage" will continue to apply wage pressures on jobs in Western countries vs Asia and developing countries. That is the very nature of this trend and there is nothing likely to stop it until it completes.

The US wants it cake and to eat it too.
We want jobs but we also want to buy cheap goods at Wal-Mart. We blame China for "currency manipulation" but would scream bloody murder if the prices of TVs rose 300% to protect 2000 TV assembly jobs in Tennessee. At 30-1 wage differentials how can floating the RMB accomplish a thing unless the value of the US$ fell 80% Does the US really want to pay 80% more for oil and TVs and everything else?

OK. What if China paid their workers more? Wouldn't that raise the prices of all goods manufactured in China? (Answer: Yes it would). Would it bring back plants to the US? (Answer: No it would not. Some other country such as Brazil would step in and undercut us).

In the meantime outsourcing is profitable for CEOs and wall street fat cats. It has increased profits for many corporations but it comes with a price: class warfare.

The number of "haves" that can afford to pay extra for that designer label is rapidly shrinking vs. the ever growing number of "have nots" where price now means everything. Is a shirt with a small "Gucci" label worth 10 times more than something from Kohl’s or JC Penny’s? Well it is if you are a CEO with a $10 million salary on top of a huge bonus and stock options, not to mention an image to maintain, and nothing better to do with your money. After all, it’s damn hard to spend $10 million dollars. I wish someone would give me the chance.

Let’s look at outsourcing from a CEO’s point of view:
Outsource manufacturing, give yourself a raise.
Outsource innovation, give yourself a raise.
Outsource R&D, give yourself a raise.
Slash worker benefits, give yourself a raise.

Here are just two of the more preposterous bonuses granted to CEOs this year:
Ford CEO Receives $18 Mln in Compensation

Monday March 14, 2:14 pm ET
DETROIT Ford Motor Co. granted Chairman and Chief Executive Officer Bill Ford Jr. $18 million in restricted shares and stock options in compensation last week, the automaker said on Monday. For last year's performance, the automaker's board awarded Bill Ford with 600,720 restricted shares valued at $7.5 million in lieu of a cash salary and a BONUS of 240,288 restricted shares valued at $3 million.

This is a bonus for what? Ford is at a 52 week low and ultimately headed for bankruptcy. But let’s make sure the CEO can have one hell of a going away party. It’s the American way.

EMC CEO set for $13 mln in 2004 compensation

Joe Tucci, chief executive of corporate data storage leader EMC Corp., stands to pocket nearly $13 million for 2004 as the company held the line on salary and stock options but boosted restricted stock compensation, EMC said in a filing on Friday.

Tucci exercised 350,000 outstanding stock options with a value of $3.34 million during 2004. He holds 2.8 million additional exercisable options and 5.34 million shares that were not exercisable at the end of 2004, the proxy said. The total value of Tucci's in-the-money options is $26.5 million

This is a bonus for what? EMC stock has gone sideways for over a year. Is $26.5 million in stock options not enough? I guess not.

Real wages have decline for the average worker but the pay of CEOs is doubling or tripling from already outrageous levels. Here is what the New Your Times has to say about these new robber barons:

Captains of Piracy

Carly Fiorina was fired last month as chairman and chief executive of Hewlett-Packard. So why did the board reward her with a total of $8.15 million in her last full year before booting her out? Then there's Michael Eisner, who is finally being pushed out of the Walt Disney Company's chief executive post for running his company almost into the ground. Yet the Disney board recently gave him a $7.25 million cash bonus.

Bonuses for C.E.O.'s last year rose more than 46 percent, to a median of $1.14 million. Both the amount and the percentage increase were the highest since comparable studies began five years ago. Companies have shaved costs by laying off workers and reducing health care coverage - and then using those savings to slather more pay on top executives.

Since 1993, the average PAY for C.E.O.'s of the S.&P. 500 companies has tripled to $10 million at last count, while the number of Americans without health insurance has risen by six million. Public companies devoted about 10 percent of their profits to compensating their top five executives, up from 6 percent in the mid-1990's.

If there is anyone in need of outsourcing it is CEOs and boards of directors.
Why pay CEOs $10 million a year when we can easily replace them with a set of 5 rotating rubber stamps? Those stamps read as follows:

1) Outsource Innovation
2) Outsource R&D
3) Outsource Marketing
4) Reduce Employee Benefits
5) Feed Monkey More Peanuts

Number 5 is to pay the monkeys that replaced the CEOs.
When there are no more employees remaining in the US (except for retail clerks and a single low level manager per store) we will then be able to reward the monkeys with "a bonus banana". What the heck? I'm generous. Give them two.


Friday, March 18, 2005 12:06 AM

The Shrinking US Dollar

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By the time you see covers like that, trends are well estabablished.

Where was the warning about the US$ two years ago or even 1 year ago? Indeed, big money is not often made on front page news. Big money is made on page 16 news that is headed to page 1. The Euro was probably on page 16 in 2002. Now look at it. "The Shrinking Dollar" has been on page one of the Wall Street Journal for months and just made the big time with the cover of Newsweek. Is there anyone out there that is not aware of the plight of the US dollar?

Let's review the fundamentals,and then we can look at a few charts.

1) The Trade Deficit
In January the Trade Deficit hit an All-Time High of $665.9B. Foreigners finance our debt to the tune of two billion dollars a day. We are consuming close to 80% of the world's savings and we are not using that money for investments, we are using it for consumption. The US is on a binge of buying houses, SUVs, vacations and everything else. Fueled by rising asset home prices consumers are spending the equity in their houses and them some. The trend is unsustainable of course, but as long as it continues the problem will get worse and the US$ will likely continue sinking.

2) US Gov't Deficit Spending
Is there a fiscal conservative left? Who? Where? OK representative Ron Paul from Texas is one, but one vote is hardly enough to pass a good bill or defeat a poor one. President Bush seems hell bent on guns and butter spending while refusing to roll back massive tax breaks that even Greenspan now admits to being a mistake. Given that Congress just yesterday voted down "paygo" rules, we clearly have both a President and a Congress that have shown zero fiscal restraint. The sad thing about this fiscal irresponsibility is that it created no jobs in the US although it did create an enormous number of jobs in China and India. Private sector jobs in the US shrank during Bush's first term in office.

OK those are the fundamentals but what do the charts say? Let's take a look:

Euro Weekly

Australian Dollar Weekly

British Pound Weekly

Euro Monthly

Australian Dollar Monthly

As you can clearly see, Newsweek is rather late in the "Shrinking US$ Story".
The Euro has rallied from below 90 in April 2002 to over 130 right now for a gain of approximately 50% bottom to top.

Eliott Wavers need to bear in mind that although I traced out 5 wave patterns on these charts, there are other valid counts that suggest these trends can continue for quite some time. Indeed even the 5th wave up could keep subdividing higher for quite some time. The uptrend lines are still intact and shorting breakdowns in the Euro thinking the trend was over have been as ill advised as trying to pick a top on home builder stocks.

Fundamentally anyway, the US$ probably should keep falling. That said, a prudent person has to be aware of the duration of this move as well as the current excessive sentiment against the US$ and at least wonder if covers like Newsweek's "Incredible Shrinking Dollar" just might be mark a temporary peak.

Everyone now "knows" the US$ will keep falling. Will it? Still, the trend is the trend is the trend until it isn't.

What could cause the US$ to rally from a fundamental viewpoint?
1) Congress or the President could show some fiscal prudence
2) Social Security reform does not pass
3) Greenspan keeps hiking
4) Consumers finally throw in the towel on spending
5) Banks tighten lending standards
6) A blowup in the stock market and/or corporate bonds
7) A collapse in the US housing market
8) A collapse in home building even if home prices themselves stay lofty for a while longer
9) Rate cuts in Europe and/or trashing of the Stability Pact to allow larger deficits
10) Rate Cuts in the UK

Of those, I am only going to rule out #1. The rest certainly are possible and eventually most of them are likely. #8 could in fact trigger a cascade of 8-7-6-5-4-2 but would probably reverse or at least halt #3. The problem with playing for that cascade is that it could easily be precipitated by a panic collapse of the US$ rather than a collapse in housing or the stock markets.

My current inclanation, however, is that too many people are too focused on the "plight of the dollar" right now. A panic move is likely at some point but my "hunch" is that it will come later rather than sooner (after everyone gives up on it). In the meantime, watch those trendlines.


Wednesday, March 16, 2005 5:30 PM

Dark Clouds Over Detroit

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GM plunged today to a 10 year low when it finally confessed just how bad its operations really are. The world's largest automaker said it now expects a loss of about $1.50 per share in the first quarter, well below its prior target calling for breakeven results or better. For 2005 as a whole, GM scaled back expectations and now anticipates earnings of $1 to $2 per share, not the $4 to $5 in expected previously. This is a company headed for bankruptcy but the Wall Street pimps will not admit it until the bitter end. According to the S&P, GM and their finance arm General Motors Acceptance Corp. had about $300 billion in outstanding debt at the end of 2004. That will be one heck of a lot of write offs when they happen.

The S&P affirmed its long-term "BBB-" ratings and its short-term "A-3" ratings on GM and GMAC, but the outlook was changed to "negative" from "stable." The change reflects S&P's "heightened concerns regarding the profit potential of GM's core North American automotive business in the wake of the company's dramatically revised earnings and cash flow guidance," analyst Scott Sprinzen wrote in a research note. "Confidence that performance will be bolstered by the eventual introduction of new products is diminished because sales of major new products it has introduced recently have generally not met expectations," he said. Moody's said it may cut ratings on GM and GMAC. The ratings agency currently rates GM's long-term debt as "Baa2," two notches above junk.

The real story in today's fiasco is NOT the GM implosion but the fact that Fitch, Moody's and the S&P have not and will not cut GM's rating to junk. I am openly calling for the SEC to crack down on the relationship with rating companies and their clients. No one wants to be the first to upset a relationship or to spook the equity markets with a downgrade on a company as large as GM. At the current pace they will put this off for as long as they can, just as they did with Worldcom and Enron. Ratings companies are now totally useless. The problem here is clear, ratings companies should NOT be allowed to have relationships with the companies they rate.

How many times do Moody's, Fitch, and the S&P have to prove they can not police themselves. The only hope for accurate rating is if the companies are totally independent.

The New York Times commented on this in their February 2005 article
"Wanted: Credit Ratings. Objective Ones, Please"
"I think it's fair to say that the oversight of the industry is insufficient," said Annette L. Nazareth, director of market regulation at the Securities and Exchange Commission. "We want the firms to commit to meet certain standards with respect to policies and procedures on conflicts of interest and solicitation of ratings. Right now we don't have that at all."

In 1975, the S.E.C. ruled that the laws relating to debt carried by banks and financial institutions refer only to ratings provided by agencies that it recognizes. Right now, these are the big three and a much smaller fourth, Dominion Bond Rating Service of Canada. What you have, in other words, is an oligopoly.

Even more troubling, this oligopoly earns its keep from fees charged to the companies whose debt it rates. This conflicted business model means that the paying customers for these agencies are the corporations they analyze, not the investors who look to the ratings for help in assessing a company's creditworthiness.

This is not the first time that Standard & Poor's, MOODY's and Fitch have been in the hot seat. When Enron and WORLDCOM failed, investors were stunned by how long it had taken the agencies to recognize the companies' declining fortunes. For example, all three agencies had rated Enron an investment-grade company until four days before it filed for bankruptcy. They had rated WORLDCOM similarly until a few months before it collapsed.

I am encouraging everyone to Email the SEC at:
SEC Center for Complaints and Enforcement Tips and complain about the obvious conflict of interest between ratings companies and their clients..

US bankruptcies are expected ‘to surge’ amid JUNK bond deluge
Most Likely To Default
# Mitsubishi Motors Corp
# Holley Performance Products
# Motor Coach Industries
# Granite Broadcasting
# American Lawyer Media Holdings
# Interep National Radio Sales
# Sports Club Co
# Levi Strauss & Co
# Salton Inc

How long before GM and Ford are on that list?

The problem is that they should ALREADY be on that list. GM's credit spreads prove it! GM's debt trades at junk levels. Ok, So what's the big deal then? The big deal is that everyone pretends that GM is not junk and GM bonds go into portfolios that are not suited for junk. Many funds have a requirement to NOT have junk bonds in their portfolios. Conservative investors purchasing such funds have tons of this stuff forced on them by bond fund managers speculating in issues that are clearly junk but is not rated as such. Investors buying those funds are treated to the risk of GM whether they want it or not.

The ratings companies do not want to downgrade GM because it might cause them future business and because it will flood the junk bond market. Although the corporate bond market is huge, the junk bond market is only a tiny piece of it. GM has an enormous amount of debt so no one wants to do the right thing and call a spade a spade (or junk junk). If GM was downgraded it would likely cause repercussions in the stock market as well as the junk bond market. So what? Non-junk Corporate bond holders deserve to hold non-junk. Why can't we have some semblance of honesty? Well today any bond funds holding GM took a big hit. Let's take a look:

NYSE Price % Losers 2005-03-16

12 of the top 16 losers today were GM related.
11 of them were GM bonds.
Will there be a lawsuit coming up by bondholders against Moody's, Fitch, or the S&P?
Will there be a lawsuit coming up by bondholders against non-junk rated bond funds holding junk?

Somehow I do not think we have seen the end of this mess.
In the meantime this is what you need to do:
Email the SEC at:
SEC Center for Complaints and Enforcement Tips and complain about the obvious conflict of interest between ratings companies and their clients.


Tuesday, March 15, 2005 10:58 PM

The Echo Bubble in Home Builder Stocks

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Housing Stocks Echo Bubble

US Hombuilder Index - $HGX

Toll Brothers Chart

Homebuilder Insider selling in past 3 months =>

Ticker  # Insiders  Total Shares       Total
TOL 10 2,435,356 $152,195,965.25
NVR 6 219,642 $150,588,166.30
KBH 8 1,095,434 $112,854,481.35
NVR 4 4,073,302 $28,519,303.95
LEN 9 407,374 $22,550,826.99
HOV 5 325,500 $15,626,458.09
MDC 5 149,003 $11,509,084.69
RYL 7 140,343 $8,806,072.31
BZH 1 65,731 $8,084,463.34
PHM 3 60,533 $2,732,398.03
MTH 1 15,000 $1,433,594.97
PHM 2 21,000 $1,407,528.99
DHI 2 4,021 $158,219.97
MHO 1 1,000 $52,664.00
Insiders are bailing, interest rates are rising, speculation is rampant, home inventories are piling up and there are big divergences on the charts. Does it make any sense to be long this sector now?


Monday, March 14, 2005 10:08 PM

Housing Trends, Distortions, and Condo Mania

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Let's take a look at two of the hotter markets for 2004
San Diego County California and Las Vegas Nevada

San Diego Home Prices and Sales

San Diego Home Sale Trends

In San Diego County year over year sales are down 20.8% and average sale time (days on the market) has risen 50% from 40 days to 60 days. Somehow the median price has risen by 18%. Is the average buyer now being priced out of the market and some of the froth coming off? It sure seems like it.

Las Vegas Nevada

Las Vegas Home Sales

Las Vegas Home Sale Trends

In Las Vegas year over year sales are down 10.5% and average sale time (days on the market) has risen 45% from 33 days to 48 days. Again we see a divergence in median sales price. Those figures are as of December. Current figures are not yet available.

That is just a snapshot of two markets but it is indicative of nationwide trends: Sales times are ticking up along with inventories. At some point rising inventories will put price pressures on houses if in fact it has not started already. In a sense median prices can be misleading, especially in a declining sales environment as affordability rises above the qualifications of low end buyers. For example, two houses selling for $1 million each is quite a bit different than 8 sales, 6 at $250,000 and 2 at $1.2 million each. The signs are in place that the average buyer is no longer willing to chase prices. It is just a matter of time before gravity sets in.

Here is a trend well worth following.
Mortgage Debt and the Trade Deficit

Condo Mania in Florida
Condo boom worries Wall Street
"By way of anecdotal reports, we believe as much as 85 percent of all condominium sales in [the downtown Miami] market are accounted for by investors and speculators," Raymond James stated in a report issued by its equity analyst Rick T. Murray.

Downtown developers have brushed off worries about rampant speculation and rejected Thursday's reports. They note that buyers must place a 20 percent down payment on preconstruction condo units priced anywhere from $500,000 to more than $1 million.

"You don't put 20 percent down on a $500,000 condo when you are a speculator," said Martin, who has two other high-rise projects in downtown Miami along Biscayne Boulevard.

Yeah right! And someone putting 100% down on JDSU at $100 a share was not speculating either. It seems the excuses for this mania get sillier and sillier.

Finally, we need to be aware of possible upcoming distortions in the trend of home sales figures: Starting February 25, 2005, home sale figures will include condos and co-ops in addition to single-family homes.

It will be interesting to see how this affects the medium price, numbers of homes sold, and "affordability". Will these changes add to the confusion in the bond markets? Please be alert to that possibility.


Sunday, March 13, 2005 7:14 PM

The Housing Bubble is in its Final Blowoff Stage.

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The housing bubble is in its final blow off stage with the public "Flipping Houses" just as they flipped equities at the stock market peak in 2000. There are at least two recent books on flipping, and lots of real estate seminars telling people how to "cash in on the boom". Fraud and greed are rampant and when those are combined with enormous public participation, you know the end is at hand.

The inventory of houses for sale is rising along with interest rates and warning signals are flashing red in many major US real estate markets. Let's take a look at some of the signs of a blowoff top in the making.

Las Vegas
Inventory rises and Pulte slashes prices
Egged on by the stratospheric prices their neighbors were asking -- and getting -- homeowners in Las Vegas flooded the market with "for sale" signs. The number of existing houses posted for sale on the Multiple Listing Service ballooned from about 1,400 in February to more than 16,000 by October.

Among them were never-lived-in homes offered by investors who had bought them only months before from national homebuilders -- who were selling their own brand-new houses literally across the street.

In early fall one of those builders, Pulte Homes, took the extraordinary step of slashing prices by $25,000 to $180,000 on more than 20 of its Las Vegas-area developments. The move sent shock waves through the Las Vegas building industry.

Speculators abound in Florida condo market
Jack McCabe, head of McCabe Research and Consulting in Deerfield Beach, believes about 40 percent of the buyers in the condominium market to be investors, though he said that might be a conservative number.

McCabe's surveys show 25,000 condominium units either under construction or planned in Broward, Miami-Dade and Palm Beach counties within the next 18 months. Typically, people only buy about 4,000 or 4,500 condominiums a year in the region.

''Do the math,'' he said. ``I think we're looking at a 3- or 3 ½-year supply coming onto the market in 18 months.''

Cannon, the Integra analyst who is also a real estate columnist for The Herald, said the current buying and building boom could end as badly as one did in the 1980s. Back then, speculators -- including many from Latin America -- helped fuel high-rise construction along Miami's Brickell Avenue.

Chicago, Phoenix, Florida
Stock market woes induce many to try flipping real estate
Flipping is the practice of buying properties for resale, an investment strategy that has become wildly popular in Chicago and across the country. Disappointed with the stock market and dazzled by double-digit property-appreciation rates, amateur investors--apparently of every income stripe--are investing in real estate in droves.

They are snapping up everything from condo conversions in Chicago suburbs to new three-bedroom ranch homes in the Arizona desert. Ordinary people, armed with bargain mortgages, pooled family savings and cashed-out home equity, are buying for investment at levels that are starting to worry economic analysts.

In some subdivisions up to 60 percent of the owners were investors, which was leaving the regular homeowners in an uncomfortable situation. The market became flooded with rentals."

Washington, San Francisco, Florida
U.S. real estate: The next bursting bubble?
About 30 percent of condominium buyers in Washington and San Francisco and 40 percent in south Florida are obtaining mortgages for investment purposes, says Gregory Leisch, chief executive of Delta Associates, a real-estate research firm. In south Florida, median home prices are rising by as much as 29 percent annually; in southern California, 36 percent; and Las Vegas, 54 percent.

That's a sign the market may be overheating, says Stephen Roach, chief economist at Morgan Stanley in New York.

"The latest trends in house prices and savings are disturbing," Roach wrote in a Dec. 3 note to clients. "They underscore the distinct possibility that America's asset economy is in the midst of yet another bubble-induced blow-off."

Fraud Is Rampant
Mortgage Fraud Inflates Housing Bubbles
Mortgage fraud is rampant in the United States and not only are the illegal activities an immediate threat to home owners and local communities, the scourge could ultimately cause the kind of economic conditions associated with so-called "housing bubbles."

Mortgage fraud complaints more than doubled in 2004. The Federal Bureau of Investigations received 17,127 reports of mortgage fraud in the fiscal year that ended Sept. 30, 2004, compared to only 6,936 reports in the previous fiscal year.

Nationwide, mortgage fraud is estimated to have cost businesses nearly $48 billion and consumers about $5 billion in the past five years, according to a recent study by the Federal Trade Commission.

Track the latest Mortgage Fraud News Here:
Mortgage Fraud News

California Housing Affordability Drops 5 Points

California's Housing Affordability Index at 18 Percent in January
March 10, 2005--The percentage of households in California able to afford a median-priced home stood at 18 percent in January, a 5 percentage-point decrease compared with the same period a year ago when the Index was at 23 percent, according to a report released today by the California Association of REALTORS®.

C.A.R.'s monthly housing affordability index measures the percentage of households that can afford to purchase a median-priced home in California. C.A.R. also reports housing affordability indexes for regions and select counties within the state. The index is the most fundamental measure of housing well-being in the state.

When only 18% of the people in an entire state can afford to buy a house, you have a bubble. Some areas of the state are worse than others. Affordability in San Diego is down to 11% and Orange County is down to 12%. Over the long haul, housing prices can not rise faster than wages. We will either see housing prices fall or wages rise. The odds of wages rising with the FED attempting to cool the economy, mergers and consolidations causing numerous mass layoffs, andthe continued outsourcing of jobs to China and India are extremely small. All trends eventually revert to the mean and housing will not be different. People will be in for a shock when it happens.

Investors and second home buyers account for 36% of 2004 home sales
Investors buy more of housing market
Real estate speculators are buying at a pace that far exceeds previous estimates of their influence on the housing market, according to a first-of-its kind report the National Association of Realtors released this week. The report, based on two surveys, found that investors accounted for 23 percent of the nation's 2004 home sale transactions and second-home buyers made an additional 13 percent of all sales transactions. Previous estimates gleaned from other databases had suggested that 8.5 percent of all 2004 sales transactions were investments.

"I am astonished," said David Lereah, the association's chief economist. He said the data suggest a sea change in the role of real estate in the nation's economy.

"What we're seeing is that real estate is no longer just a place to live. It's a viable alternative to stocks and bonds," Lereah said. "Sept. 11 changed real estate forever, the way people look at it. They're nervous about stocks and bonds and they're placing money in real estate, which has proven to be a stable and wealth-building asset."

No! What we are seeing is the final blowoff top of a mammoth nationwide real estate bubble. "Flipping houses" is the latest "can't lose" phenomenon. When real estate is no longer just a place to live for the masses, warning signals should be flashing in everyone's head.

Here is an excellent article by the Wall Street Examiner on real estate values.
Don't "Ask," Just Sell
Most housing "experts," including (tongue in cheek) Mr. Greenspan, see no bubble, hear no bubble, speak no bubble. They are dreadfully wrong. This is a most bubblicious housing market, and not just on a regional or even national basis. It is global. When prices do start falling, they will fall far faster and in a much more widespread manner than anyone is predicting (with perhaps Robert Prechter and a few other notables being the rare exceptions). I won't try to tell you when this will happen, as any number of things could trigger it, but happen it will.

Today I see rising home inventories in most markets and lengthening "days to sell." I also see falling sales and increased building starts. Can things possibly get any "better?" Don't "ask," just sell.

Real estate may be a "local thing" but speculation is both massive enough and pervasive enough to proclaim a "national bubble". In fact, speculation is rampant in the US, the UK, Australia, China, and parts of Europe. It is a global phenomenon spurred on by mammoth liquidity injections by the FED in a foolish attempt to defeat the normal business cycle.

Unfortunately for the FED, housing is not in a "new paradigm" and "The Greater Fool Theory" in housing will suffer the same fate as we saw with stocks in the NazCrash of 2000. "It's not different this time"


Saturday, March 12, 2005 7:47 PM

Thoughts On The Trade Gap

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In January the U.S. trade gap widened to $58.3 billion. For all of 2004, the U.S. booked a record trade deficit of $617.1 billion, or 5.3 percent of gross domestic product. The trade gap with China widened by nearly $1 billion to $15.3 billion as exports plunged 20 percent. The trade gap with Canada widened to $6.2 billion, the most since June as imports grew by 4.3 percent.

Those that thought a falling dollar would cure this problem can look again. The US$ index is down about 40% since 2002 yet month after month the balance of trade just gets worse as evidenced by the following chart:

Following is a chart of the 3 month moving average of our trade deficit.
It is not a pretty picture.

The typical scapegoat for this sad state of affairs is China. That viewpoint is misguided and the following chart shows why. China accounted for only 15.2 Billion of that trade gap and given what is produced in China vs what is produced in the US there is no doubt in my mind that floating the RMB will not make one bit of difference. Is manufacturing going to return to the US with wages here 30 times what wages are in China? No chance!

At the Davos economic conference in January, the deputy governor of the People's Bank of China had this to say: "Outsiders don't know what exactly is happening in China. The idea that China has the key to the balance of the whole world's economy is totally wrong. The imbalances are attributable to many reasons, but not whether the yuan exchange rate is flexible or not flexible".

I would agree with that assessment. The problem is not China but the US. The US is in the midst of a "Crisis of Excess Liquidity". There is rampant housing speculation in housing and the stock market. People have treated their houses as ATMs and used cash out refis to leverage into more real estate and more consumption. This combined with lax credit standards and out and greed on behalf of sub-prime lenders together with cheap money from the FED is what is driving this frenzy.

I would have thought this situation to have been self correcting by now. I have been wrong. Manias last longer than even those that know the behavior of manias think. The problem is further compounced by Bush's proposed Social Security "reform". Smack in the face of horrid trade balances and US gov't budget deficits of approximately $400 billion, Bush wants to increase that deficit now to pay for a theoretical problem some 15-40 years down the road. The US treasury market is starting to revolt. If the Bush administration is not going to attempt even modest spending cuts, the bond market just might force the issue.

It will not be pretty and US consumers will bear the brunt of it. Historically, global imbalances such as the one we are in have only been corrected via recessions that wipe out previous mal-investments of capital. The upcoming recession will be a doozy as we have 20 years of reckless excesses to pay back.


Friday, March 11, 2005 6:59 PM

Should China Delay Floating the RMB?

Mish Moved to MishTalk.Com Click to Visit.

Everywhere, everyday someone is offering advice to China or Japan or Malaysia to sell their US$ reserves while they are “still worth something”.
Nouriel Roubini weighed in just today with his viewpoints on why China should stop building US$ reserves and remove the RMB peg.

Ten Reasons why China should move its peg and pull the plug on the US reckless policies

Nouriel has valid points, perhaps ten of them.
But is it as simple as that?
Certainly we have seen a lot of confused and conflicting statements from central bankers lately on what they might or might not do.
I addressed this yesterday in “Currency Madness”.

Here are 12 reasons why I think China should NOT float the RMB (for now), with a detailed explanation following.

Twelve Reasons Why China Should Delay Floating the RMB
1) The Chinese central bank does not want to trigger a currency crisis by floating the RMB too soon.
2) There is too much “hot money” flowing into China in hopes of making a quick killing on a currency repeg or float.
3) China thinks in terms of years or decades on policy changes. This is in contrast to US corporations that only care about “beating the street” by a penny for the upcoming quarter. There are far more risks associated in rushing things than in eventually getting them right.
4) Chinese banks might not be in a position to take the stress of floating the RMB at this time, even if other factors were conducive.
5) Just who is China and Japan or anyone else supposed to off load their reserves to in the face of ever growing US current account balances? Mars?
6) Fundamentals such as slowing worldwide growth do not favor floating the RMB at this time
7) There is no WTO requirement for China to float the RMB by 2007 as is commonly believed.
8) The Asian principle of “face saving” suggests that China can not be forced into premature action and that “Snowtalk” is counterproductive.
9) The peg has served China well. China did not blow up in the last Asian currency crisis because of that peg. The peg has provided stability and that stability is still useful.
10) The US has bigger problems that need addressing first.
11) Like it or not, a worldwide recession is in the cards. Throwing a float of the RMB on top of that problem might have severe unintended and undesirable consequences.
12) Paper losses on paper currencies look far bigger on paper than they actually are in the grand scheme of things that central bankers consider.

Let’s backtrack a moment to the World Economic Forum in Davos, Switzerland in January when Yu Yongding, an advisor to the monetary policy committee at the central bank of China told journalists attending forum that given the dollar's recent weakness, "now is the time to revalue ... We need more flexibility. That means revaluation."

Those statements were immediately retracted. An official in the People's Bank of China's information office said Friday that Yu was an academic adviser, not an official, and that his opinion did not reflect official policy. "(Yu Yongding's) remarks are only his personal view, and the opinions of an academic. It does not represent the central bank's policy"

This was not the first time Yu's remarks created friction with the central bank Yu previously came under pressure after he was quoted as telling an academic seminar that China was reducing its holdings of US treasuries because of the sagging US dollar. Those remarks triggered a steep sell-off of US treasuries. Yu later insisted he was misquoted and that he had actually said that China had reduced its treasury holdings as a proportion of its rapidly growing foreign reserves.

At any rate, there is far more to this story because things just are not as simple as they seem. Let’s take a look at why China will be slow to float and why China needs adequate foreign reserves.

The following articles help explain the situation.
They are not available in English, but those who speak Chinese can read the full reports here:

Those articles contain statements made by Zhou XiaoChuan, Governor of the People’s Bank of China. When dealing with China one must separate official policy and statements made by those who set policy from those who do not. Zhou XiaoChuan sets policy, other often quoted officials such as Yu Yongding do not.

Perhaps after a second incident, we just might be hearing a little less from Yu Yongding.
Most of us can not read Chinese (myself included), so bloggers everywhere can thank my friend Yiwu for the translated highlights below.

Yiwu's comments are italicized in brackets (The bolding is mine)……

Zhou said on Jan. 18th that "In 2004 China's foreign reserve increased a little fast, but the increase is not unreasonable. The year over year increase in China's foreign reserve grew at more than 50%, now standing at $609.9 billion.” [This is total reserves not just US$ reserves]. “We were keeping 3 months in reserve, but now the suggestion is to keep as much as 6 months of imports. So that means China needs to keep plenty of foreign reserves. Plus our imports have been increasing at an annual rate of 30%. Does that mean we should also increase our foreign reserves? This question is very complicated, and will influence our currency policy a lot.”

Zhou also said that “China should be prepared for the reversal of foreign investment.” Usually, foreign investors expect an annual return of 10%. [My own take, is if that expectation is not met that investment will leave. This might occur if the Chinese economy slows down or the US increases their interest rate].

Zhou said “Foreign investment would have to leave sooner or later. China has to make sure to be able to meet their demand when they want their money back.” [My own take, China is fully prepared for the exit of FDI in case China slows down]

Zhou said most of short-term foreign debt comes from the loan of foreign banks. And some of them are from foreign reserve of the enterprises. He thinks that this short-term foreign debt may very possibly have been changed into RMB now. So when conditions are right, “these short term debts might have to be exchanged back to foreign currency.” [My read, disappointed that China is not going to revalue or float the RMB].

"China has to prepare some foreign reserves to meet the possible reversal of foreign money, to prevent what had happened during Asian currency crisis from happening here in China". [Avoiding a currency crisis from happening in China is obviously a high priority.]

Considering all of the above, the current foreign reserve of China ($609.9 billion and counting) is not high after all”, Zhou said.
[The main points of Zhou’s speech are to prepare for the possible expatriation of foreign investment and the avoidance of a potential currency crisis.]

I would like to thank Yiwu for that translation as well as her comments, and I have a few comments of my own to add.

First let’s settle the question as to whether or not the RMB peg breaks WTO rules. I have seen many reports saying that China HAS to float by 2007. I believe those reports to be inaccurate.

China yuan peg doesn't break WTO rules
NEW YORK - US Trade Representative Robert Zoellick said on Wednesday that he did not think CHINA's exchange rate policy violated World Trade Organisation (WTO) rules. 'There's really no WTO obligation not to have a fixed exchange rate,' he said before speaking to the Asia Society. His remarks appeared to squash US manufacturers' hopes for the United States to challenge CHINA's exchange rate policy at the WTO.'You will recall the United States had a fixed exchange rate until 1971, when we were a member of the Gatt,' he said, referring to the predecessor organisation to the WTO

Next let’s consider just how vast China’s reserves are.
According to the US Treasury, China as of November 2004 held $191.1 billion in US debt.
To me, that is not an enormous sum of money, all things considered.

Three Reasons Why China Will Not Lift Its US$ Peg
One, China won't be pushed around. What Snow hasn't grasped is that a nascent superpower like China can't be seen as bowing to Washington. Among China's 1.3 billion people, many U.S. policies like the invasion of Iraq are highly unpopular. Every time Snow pushes China publicly to let the yuan rise, he merely delays such a step. This issue requires thoughtful, behind-the-scenes economic diplomacy, not podium thumping for the world's television cameras.

Two, China's financial system is still fragile, and debt has everything to do with it. Its 9 percent growth and seemingly bottomless appetite for commodities masks the fact China's banking system remains hobbled by bad loans. That China refuses to revalue the yuan even slightly suggests things may be more precarious than we know. China also faces a dual challenge unprecedented in modern economics. Not only must it slow growth to avoid an inflationary boom-and-bust cycle, but it also needs to create jobs for hundreds of millions of people displaced by the transition from socialism to capitalism. Since the currency peg is a key source of stability, it won't go away anytime soon, no matter what the U.S. says.

Three, the U.S. has its own public relations woes. When finance ministers from the Group of Seven industrial nations meet in London next month, the U.S. currency is likely to attract more criticism than China's. The dollar's weakness against the euro is irking Europeans, who fear slowing growth.

What Snow may not realize is that the more the dollar falls, the less likely a Chinese revaluation becomes. China grows more competitive along with the U.S. as the dollar drops. Also, the U.S. must consider how Japan will respond to all this. If Tokyo starts selling yen to boost the dollar, China, fearing a loss of competitiveness to Japan, will be slower to let the yuan rise.

Following is a not so polite way of telling Bush and Snow to take a hike.
China´s Ruogo asserts autonomy in yuan decisions
Li Ruogo, deputy governor of the Chinese central bank, told global economic pundits that the country was fully capable of handling the transition to a floating exchange rate by itself. Ruogo said China alone would decide when the time was right to dismantle the peg that keeps the yuan fixed to the US dollar, a move some economic commentators believe is necessary to correct growing imbalances in the global economy. "Leave this issue (of floating the yuan) to the Chinese people and the Chinese government. We will certainly figure out what is the most suitable approach for China's economic development," he said in a trenchant address to business leaders at the World Economic Forum here.

The deputy governor of the People's Bank of China said foreign monetary policy commentators were generally ignorant of economic conditions within the country. Their advice would therefore have little bearing on when the dollar peg would be removed. "Outsiders don't know what exactly is happening in China. We are happy to listen (to outside advice) but don't ask us to practice what you say," he said. "If we think it is correct (to float the currency) we'll go ahead, and if we think the time is not correct we will wait," regardless of "how heavy the outside pressure is." Ruogo rubbished arguments that allowing the yuan to rise in value against the US dollar would reduce the US' burgeoning trade deficit, regarded by many as the main threat to global economic stability

"The idea that China has the key to the balance of the whole world's economy is totally wrong. The imbalances are attributable to many reasons, but not whether the yuan exchange rate is flexible or not flexible," he said. The deputy governor reiterated Deputy Prime Minister Huang Ju's pledge to allow the yuan to float freely at some point, but not before structural improvements and banking reform were enacted.

My friend Yiwu offers this comment: [Li GuoGu (not Li Ruogo) is the right hand man of Zhou XiaoChuan. So what he said definitely reflects the official government position. The US should not expect to make China’s $1.4 trillion economy a scapegoat for the $20 trillion combined economy of the US and EU.]

The Northern Trust weighs in on the issue
Now there's renewed talk out of Washington suggesting that the yuan should be revalued at the earliest possible time, while some economists are digging out their overheating scenarios. All this is happening while Beijing digs in its heels and says everything's fine and the renminbi yuan rate is not going anywhere for the moment. Now that the discussion has started up again, which side has the stronger argument?

After weighing both sides, there is some validity in Beijing's claim that things are under control. First off, inflation has decreased markedly over the last half of the year, ending 2004 at a comfortable 2.4% on-the-year. This accomplishment alone implies some success in conquering the overheating issue, even though the CPI is a compiled statistic gathered from state and regional sources that may or may not be a reasonable representation of reality. However, the more convincing argument comes from figures out of the People's Bank of China (PBoC), namely money supply. This series shows a significant drop-off starting in Q2 2004, and only turning around as of last quarter. M2 data are also generally more accurate as they are maintained from the PBoC.

At the G-7 meeting during the first weekend in February, the topic of the yuan will be brought up along with the weakening dollar, and the Chinese renminbi will likely be part of the US response to criticisms about the faltering greenback. Understandably it would be dangerous for China to change its currency regime in the middle of a slowdown, assuming one is on the way, as a revaluation would exacerbate a slowing economy significantly. More importantly, there's no reason to believe Beijing will be persuaded by the industrialized nation's complaints and consider a near-term shift in the value of its currency. Strong words from the industrialized nations have rarely made much of an impact on China's internal decision making process, and right now Beijing's numbers are making the most convincing argument of all.

For all this talk of “not accumulating” reserves or selling reserves or whatever, no one has ever been able to tell me exactly what China or Japan or whoever is supposed to do with their current account surpluses. They can sell US$ but to who? Exactly who is the counter party that China and Japan and Malaysia are going to be selling their reserves to? It certainly will not be to the US. Can they offload their surpluses to France, Germany, or Mars? What will Mars do with them? How can everyone dump (or not add to reserves) as long as the US current account deficit keeps expanding?

This statement by Li GuoGu, deputy governor says it all: "The idea that China has the key to the balance of the whole world's economy is totally wrong. The imbalances are attributable to many reasons, but not whether the yuan exchange rate is flexible or not flexible." I believe Li GuoGu has this correct. The world’s imbalances are so severe that attempting to correct them solely via exchange rates can not possibly work. In fact it might precipitate another Asian currency crisis.

With the US government running massive budget deficits, $113.9 billion in February alone and with the balance of trade showing no signs of improvement in spite of a 40% drop in the US$ any notions of fixing the problem via exchange rates is pure fantasy.

The problem is that the US is still on a consumption binge at the consumer lever and federal level and until a legitimate effort is made to correct that situation, the problems are only going to get worse. Historically imbalances such as these have only been corrected by recessions and this time will be no different. China is likely to hold (and should hold in my opinion) substantial US$ reserves until some of the hot money is forced out and until the US makes some effort to correct its own problems first.

Finally, it is high time for currency traders and others to realize that paper profits or losses are not even close to the top of the list of problems for central bankers to worry about in this fiat world. I would place trade issues, exports, and financial stability ahead of concerns over paper losses in paper fiat currencies. Quite simply it is in everyone’s best interest right now to hope and pray that the US takes action on its own to correct those imbalances. Unfortunately those hopes are misguided.

The Bush administration is spending recklessly on military excursions and now appears to want to front load a social security problem 30 years from now into the current deficits. No effort has been made to rein in reckless spending on the part of US consumers. The problem is beyond repair except via destruction of debt and a massive US consumer led recession. When that happens it is entirely possible for the US$ to RISE opposite everyone’s expectations. If that forces hot money out of China, then China will be in a better position to consider major changes.

Let's recap the reasons:
Twelve Reasons Why China Should Delay Floating the RMB
1) The Chinese central bank does not want to trigger a currency crisis by floating the RMB too soon.
2) There is too much “hot money” flowing into China in hopes of making a quick killing on a currency repeg or float.
3) China thinks in terms of years or decades on policy changes. This is in contrast to US corporations that only care about “beating the street” by a penny for the upcoming quarter. There are far more risks associated in rushing things than in eventually getting them right.
4) Chinese banks might not be in a position to take the stress of floating the RMB at this time, even if other factors were conducive.
5) Just who is China and Japan or anyone else supposed to off load their reserves to in the face of ever growing US current account balances? Mars?
6) Fundamentals such as slowing worldwide growth do not favor floating the RMB at this time
7) There is no WTO requirement for China to float the RMB by 2007 as is commonly believed.
8) The Asian principle of “face saving” suggests that China can not be forced into premature action and that “Snowtalk” is counterproductive.
9) The peg has served China well. China did not blow up in the last Asian currency crisis because of that peg. The peg has provided stability and that stability is still useful.
10) The US has bigger problems that need addressing first.
11) Like it or not, a worldwide recession is in the cards. Throwing a float of the RMB on top of that problem might have severe unintended and undesirable consequences.
12) Paper losses on paper currencies look far bigger on paper than they actually are in the grand scheme of things that central bankers consider.

China will “eventually” float, but “eventually” might be a long time.


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