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Thursday, November 30, 2006 12:17 AM

It's all an illusion

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MarketWatch is reporting Fed's big worry gets revised away.

A huge spike in wages and salaries in the second quarter proved to be an illusion, according to the latest data from the Bureau of Labor Statistics and the Bureau of Economic Affairs.
The revisions released Wednesday show that growth in unit labor costs (and therefore in inflationary pressures) has been much lower than assumed. That's good news on the inflation front.

But they also show that consumers don't have as much money as everyone thought they did ... $100 billion less on an annual basis.

The Fed had been expressing concern that wage pressures were building that would inevitably feed into higher prices. Compensation had surged 12.6% in the first quarter, but that was explained away at the time as a one-time payout of bonuses and stock options to a relatively small group of high-paid executives, many of them on Wall Street.

When the compensation surge repeated in the second quarter, policymakers began to worry that raises were showing up in weekly paychecks as well. That set off some alarm bells at the Fed. A recurring and widespread rise in wages is more inflationary than a one-time bonus given to a selected few.

Compensation up 1.4%, not 7.4%

But the new data show that, instead of growing at a 7.4% annual rate in the second quarter, employee compensation actually grew just 1.4%. The revisions were reported by the BEA on Wednesday as part of its revision to gross domestic product data, based on updated BLS figures from tax records. Third-quarter compensation was also revised slightly lower.

Unit labor costs should see a "very marked downward revision" next week, said Steven Wieting, an economist for Citigroup Global Markets.
Stephen Stanley, chief economist for RBS Greenwich Capital, figures that second-quarter unit labor costs will be revised from 5.4% annualized to negative 0.6%, and third-quarter unit labor cost growth could be cut from 3.8% to 3%. On a year-over-year basis, unit labor costs are probably growing at a 3.6% pace, rather than 5.4%.

"At a stroke, therefore, fears of surging unit labor costs boosting inflation, cited by Mr. Bernanke yesterday, should be greatly reduced," wrote Ian Shepherdson, chief U.S. economist for High Frequency Economics. "You'd have thunk someone at the BEA could have called him..."
This would be funny if it was not so pathetic. Month after month we listened to the Fed and bulls and treasury bears talk about how great things were and how fast wages were rising and the inflationary impact and yadda yadda yadda.

The Bond Market is wrong.
The Bond market is manipulated.
The Bond market is in a bubble.

All of the above are near universal opinions.
All are also wrong.
All this does heighten is the fact that the box Bernanke is keeps getting tighter and tighter and tighter.

The US dollar is collapsing once again.
Housing starts are still plunging.
Commercial real estate and jobs will both follow housing down.
But speculation in stocks is still running rampant with merger mania, leveraged buyouts, and debt induced stock buybacks.

What is one to do?

Lie is the answer and that is just what all these so called "inflation fighters" at the Fed have been doing. Where were they when the PPI and CPI and housing were soaring? Now all of a sudden they are worried about inflation when energy and home prices have both collapsed. The last lie was exposed today. Real wages are NEGATIVE and that includes the effect of huge bonuses for top end workers. The average Joe is getting crucified.

Wage Inflation?

Please try another lie. That one just got flushed today.
Mike Shedlock / Mish

Tuesday, November 28, 2006 9:51 PM

Catch 22

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Many of you have been asking for an update on the Florida housing scene from Mike Morgan at Morgan Florida. Although we chat several times a week, it has been hard to come up with a new angle given the steady deterioration in things. Hopefully the following post accomplishes the mission. It is an attempt to look at things from the perspective of the homebuilder rather than the home buyer, with a brief preliminary discussion on stock prices. Here goes... From Mike Morgan:

Chicken Little

I’ve been receiving quite a few calls regarding the surge in home builders’ stock prices. Well, first off, I am not a financial advisor. My research and consulting services are purely information for the end user to incorporate into their financial analysis.

I think that what’s going on nationwide in housing will effect the country to levels we have not seen since the Depression. Some of you may be equating me with Chicken Little. After all, Cramer is bullish on the home builders and so is Bill Gates. Well it’s not Bill Gates making the call. It’s his financial advisors that run the foundation that are making the call. Second, even if it were Bill Gates, he’s been wrong more than right for the last few years. Bill Gates is not Warren Buffet. As for Cramer, I have no comments except to say that his show speaks for itself. I think you can read between the lines. Finally, the market seems to have bought into the "Goldilocks" soft landing theory. Well housing has never seen a soft landing ever and I fail to see how this time can possibly be different given the affordability problems and the disparity between housing prices and rents, not just in Florida, but pretty much nationwide. With that comment, let's now turn our attention to the situation facing the homebuilders.

Catch 22

Following are the three business strategies builders are using to survive the downturn in home building.

1) Reduce Inventory

Housing inventory is at the highest level we have ever seen since the beginning of time, and growing daily. Back in early 2005 Centex was the first to realize the market was in trouble. They quietly contacted real estate agents and offered double commissions and huge discounts on inventory that would close prior to their fiscal year end of March 31, 2006. As this program grew, the other home builders initially ridiculed Centex, but in their own board rooms, they quickly started cooking up competitive discounts, incentives and commission bonuses. Now it’s a free for all to see who can leap frog the other on the way down, and who can get more creative with incentives. The Catch 22 here is simple. Margins after all of this nonsense are approaching zero for most builders, and the madness has not stopped. But if builders don’t dump standing inventory now, they will have heavier losses if they continue to carry these homes and watch prices further deteriorate as the competition drives prices down further. Catch 22

2) Monetize Land

As if standing inventory was not enough of a problem, builders have two additional problems. First they have land, some of which is entitled and improved. Second they have thousands of projects that are already started, with roads, sewers and utilities already in place and paid for with lots of debt. They might be able to walk from land options and land that is not entitled, but it is not very easy to walk away from land that is already in the development process with billions of dollars of debt tied up.

If the builders move forward with the developments, they are further increasing inventory. If they don't, they face problems with carrying costs of entitled land or shutting down a development that has already started. But carrying costs are not the only problems builders face. If they have already started the development, they most likely have a time frame with the local government to complete the build out. Some local governments require builders to post a bond insuring the completion of developments. And how many homes do you think a builder can sell in a ghost town of a few spec homes? People want to live in a community, not a construction site.

Thus we have the second Catch 22.

3) Scale Back

One would think this is the smartest option. When demand drops off, it is usually a good time to cut back on supply. But if the builders scale back, that means lower numbers for Wall Street. We’d see lower starts and lower sales and lower revenues and lower profit. Oh, almost forgot the "bonus factor". We’d also see lower bonuses to the top dogs who greedily reaped in tens of millions of dollars each during a market fueled by irrationally greedy speculators that essentially had nothing to do with their business acumen or experience.

One top builder has already announced they plan to continue building so they come out of this as a volume leader and capture branding. They’re losing money on each sale, but they’ll make it up in volume? That’s pretty expensive branding. Once again, we have a Catch 22. If the builders scale back, Wall Street will not see the numbers they want to see. If the builders don’t scale back, Wall Street will see some numbers, but the increase in inventory will complicate the problem with lower prices and bottom line losses will be the only numbers Wall Street will see.

Book Value

In addition to the three Catch 22 issues, Wall Street seems enamored with the low book values of the builders. I’ve got news for you. The book value numbers for this group are as misleading as a deaf and blind seeing eye dog. We’ve seen a few builders take write downs on some land, but if you crunch the numbers, it’s crystal clear that these write downs are not enough.


Look at D.R. Horton’s (DHI) recent write down in comparison to their land position. Look at Lennar (LEN) and the other builders referenced in the informative piece appearing in the October 2 issue of Barrons. Think about WCI Communities (WCI) and Brookfield Homes (BHS). Is their land old land with value, or is it relatively new land that they paid top dollar for. Finally, take a look at what happened to Kara Homes in New Jersey. A large regional builder that choked on their land and inventory. Choked right into bankruptcy.

This is where it gets tricky. It’s not easy finding out at what prices, where, and when the builders purchased land and/or options on land. For land purchased prior to 2000, the book value will most likely hold. For land purchased in 2005 or later, these guys are in trouble, and much of that land is probably worth 25-50% less than what they paid. For land purchased between 2000 and 2004, there is a grey area as to what the land is worth. The bottom line when it comes to land is that builders bought land just like the flippers bought their preconstruction homes. Price was a secondary issue. The primary concern was getting entitled land.

The crash of the housing industry is only now getting started, as it will spread virally to all of the boats it floated during the rising tide. Housing has touched every single segment of our economy, and it will darken all of those segments as the industry collapses to the worst levels we’ve seen since the Depression. The NAR and other groups producing numbers have been great cheerleaders, but when you’re pumping out misleading numbers, I don’t care how beautiful or loud the cheerleaders are, the situation is a no win catch 22 for the homebuilders no matter how one looks at it.
Thanks Mike.
I find it interesting to see yet another catch 22.
Please compare and contrast NAR Thinking Big for 07 with 2006 Subprime Loans Doing Badly.

"Thinking Big" outlines additional (and unwarranted) handouts the NAR wants from the Democrats including:
  • Subsidized flood and hurricane insurance
  • Eliminate of the FHA's 3 percent down payment requirement
  • Raising the cap on loan terms to 40 years
  • Getting the "FHA and Fannie Mae and Freddie Mac back on track and working in every state"
Following is an additional snip from the article.
Lereah called the big Democratic congressional win a "positive turn." "From a regulatory perspective, I think it's great," the economist said. "The Bush White House, a White House that has been pro-banking, not pro-real estate, has been declawed."

As he sees it, the GSEs have "had their hands tied behind their backs" while the administration and Congress battle over which agency will regulate the agencies and how to control the growth of their retained portfolios. But not for much longer.

"Now I see something different," Lereah said. "They will get a tough regulator, but they will be able to participate in a robust way once again. That's very good for all of us." The NAR senior vice president also called on the group to take a leadership roll with regard to housing policy. "We are the biggest association in America and I think the most powerful," he said. "We should develop our own housing agenda and lead rather than follow."
Lereah is a Loser

The policies Lereah espouses are the very same policies that made housing unaffordable in the first place: An ownership society promoting housing, subsidized insurance, decreased lending standards, and unmitigated growth in GSEs. I see four policies attempting to make "housing more affordable" all doing the exact opposite. Now Lereah's solution to the problem is the same solution that led to the bubble in the first place.

While pondering that idea, please consider 2006 Subprime Loans Doing Badly:
Subprime loans _ or loans made to borrowers with less than perfect credit _ from 2006 aren't just performing badly. The loans, in particular those used to back mortgage bonds, could prove to be one of the worst-performing groups yet, according to UBS.

In a conference call titled "How Bad is Subprime Collateral?" Tom Zimmerman, head of ABS research for UBS, and David Liu, head of mortgage credit, discussed how much higher loan delinquencies and foreclosures are for 2006 subprime loans compared with similar subprime loans from earlier years _ the result of deteriorating underwriting quality from lenders combined with a slower housing market.

Still, despite the adverse conditions, "I guess we are a bit surprised at how fast this has unraveled," said Zimmerman. While it's "not a secret that subprime collateral has performed pretty disastrously so far," he said, "I must say we were a bit surprised by the magnitude with which" the loans "deteriorated this year."

The rate of subprime loan delinquencies of 60 days or more _ meaning borrowers are that far behind in their payments _ has climbed to about 8 percent, up from about 4.5 percent a year ago.

These 60-day plus delinquencies jumped up fairly sharply in the past few months, to 3.63 percent for the 2006 loans in October, up from 2.95 percent in September and 1.62 percent in July, according to UBS research.
The Ultimate Catch 22

Learah is quite simply a huge part of the problem and zero part of the solution. Anyone that wants a house already has one or can not afford one. Looser lending standards will have a negative impact on both writeoffs and affordability.

Long term what is sorely needed is an enormous housing bust to deal with affordability issues as well as put a final end to the credit bubble we are in. But that will eliminate some of Lereah's perceived power and arguably all of his credibility so he can not go along with it. Instead he promotes the policies that got us into trouble in the first place.


The above post first appeared on Whiskey & Gunpowder.

Unrelated to this post (but not an ad for anything) I was on two podcasts today taking about liquidity issues, Monday's decline, Open Market Operations and other related topics. One was on a Christian radio station of all places (no link yet available) and the other was a roundtable discussion with Lee Adler, Steve Northwood, and Lee Wheeler on the Wall Street Examiner. Those interested may wish to tune in.

Mike Shedlock / Mish

4:19 PM

NRF Black Friday Distortions

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Over the weekend I received some taunts about how "great" Black Friday was.

Bloomberg reported U.S. Shoppers Spend 19% More on Thanksgiving Weekend.

Nov. 26 (Bloomberg) -- U.S. shoppers spent 18.9 percent more over the Thanksgiving weekend than last year, kicking off holiday gift buying with purchases of discounted wide-screen televisions and clothes, the National Retail Federation said.

Consumers spent an average $360.15 each over the weekend, up from $302.81 a year earlier, the NRF said today in a statement. Fewer people shopped, with about 140 million visiting stores during the four days including Thanksgiving, down from 145 million last year.
That did not jive with sales at Walmart as CNN Money reported Wal-Mart sees sluggish sales for November, including Black Friday results.
Wal-Mart Stores Inc. predicted surprisingly weak November sales on Saturday, but a survey of thousands of retail locations pointed to a relatively healthy start to the holiday shopping season.

Wal-Mart estimated that November sales fell 0.1 percent at its U.S. stores open at least a year - the forecast includes sales on Black Friday. At the same time, a survey by ShopperTrak estimated a 6 percent sales increase overall for the day, to $8.9 billion.

Wal-Mart's results would mark the company's first monthly same-store sales decline since April 1996. The retailer had expected same-store sales to be flat compared with the same period last year.
So who to believe, Wal-Mart or the National Retail Federation (NRF) ?
The Big Picture Blog puts this story to bed with More Bad Data from the NRF.
I’m kinda dumfounded to see this issue come up time and again, but -- there they go again: The National Retail Federation is once again putting out bad dope:

"Retailers kicked off the holiday selling season in style as shoppers across the country set their alarms for the wee hours of the morning to catch doorbuster specials. According to the National Retail Federation’s 2006 Black Friday Weekend Survey, conducted by BIGresearch, more than 140 million shoppers hit the stores on Black Friday weekend, spending an average of $360.15, up 18.9 percent from last year’s $302.81.*"

Or so said the NRF's press release. Note that little asterisk?* Follow it, and we see

"*Spending data includes Thursday, Friday, Saturday and projected spending for Sunday."

Even that disclaimer is inaccurate: First, this is not based upon actual sales data, but rather, is a survey of consumers. Not only that, but much of the survey results are self-reported projections of spending expectations -- not receipts.

Note that this has become an annual rite of error by NFR. In my opinion, based on my read of how they present this data, I suspect they are purposefully attempting to mislead the media. We saw the exact same issue last year in the way they report their survey: In 2005, the NATIONAL RETAIL FEDERATION said holiday Retail sales rose 22%; We later found the actual sales data was nowhere near that statement. Taking a survey forecast and reporting it as actual sales is not honest.

Given last year's debacle, as well as the more recent cheerleading back-to-school forecast, one would have hoped the NRF would make it clearer that this isn't actual sales data -- but rather, is a survey asking people how much they intend to spend, and on what items.
What I fail to understand is how Bloomberg and other places can fall for this nonsense time and time again. This is the direct equivalent of the Charley Brown / Lucy football scene being played every Thanksgiving in real life. Now let's wait for some real data.
Thanks Barry.

Mike Shedlock / Mish

Sunday, November 26, 2006 10:30 PM

A Mortgage Broker's Synopsis

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The following post is an email from Michael J. Dorff, a mortgage broker with Trans World Financial about the state of affairs in Orange County California. Monday evening I will have an update from Mike Morgan to share.


Here is a synopsis of the mortgage side of things here in Orange County and for that matter California in general.

What people don't see, the NAR in particular, is the upcoming train wreck. I am talking about all the sub prime loans for refinances as well as purchases that were taken out 2 to 3 yrs ago and are now all coming due to reset. My guess is that 99% of all sub prime loans are all done on a 2 or 3 yr fixed interest only type program. People thought that it made no sense to take a 30 year fixed loan those homes when the short term rates were a lot lower, but they were all wrong.

The time bomb is about ready to go off. All of the subprime loans taken out 2 to 3 years ago have margins of at least 5% or higher and usually based on the London LIBOR program. Those loans are starting to reset now at fully indexed rates somewhere in the high 9% to 10% range. When those loans were initiated 2 to 3 years ago, they all had start rates of high 5% to low 6%. As of now, the LIBOR alone stands at 5.388 for the 6 month and 5.336 for the 1 year. Take those LIBOR indexes and add the margins to see what is going to happen.

Here is a case in point. One of my clients who took out an interest only subprime loan from another lender just received her reset notice. Her current margin is 5.25% and her index for the 6 month LIBOR index is 5.388%. This means her new interest rate will shoot up to 10.638%. Her note states that her first adjustment cannot go higher than 9.2%. So she will be at 9.2% for the next 6 months. With an initial loan balance at $251,000 at 6.2% interest only, she had a monthly payment of $1,296.83. In December her new payment will be $1,924.33 for the following 6 months before it adjusts again. This is a $627.50 jump in monthly payment. She simply can not afford this payment.

Given her low credit score near 550, she is fortunate to still have equity that will allow her to refinance at all. Even still it is a tough task because not only does she have a bad score, she also a late pay on her record. The best option any sub prime lender would give her was 8.5% but she can not even afford that. The only option left is a Neg Am Option Arm Pick a Pay Loan where her payment is based on an payment rate of 2% but with a fully indexed adjustable rate of 7.4%. She will go negative if she cannot make the interest only portion of this loan. She also needs cash, $75, 000.00 of cash. Mish, that is your typical home ATM machine at work.

These Option Arm, Neg Am Pick a Pay Loan programs were one of the things keeping the home building bubble and mortgage lending bubbles going for the last 3 years. Without these products, the market (at least in California) would have collapsed 3 years ago. Instead the bubble just got bigger and bigger and we will see even a greater collapse when it comes. Ninety percent of those who take an interest only loan can only afford the interest only part and not only that, there entire lifestyles are planned around that payment.

Lenders don't really want people to pay the principle off anyway unless there is a prepayment penalty on it. Prepayment penalties are another scam in and of themselves. You can bet the lenders have made a killing on these 6 month interest prepay penalties. Bear in mind that once someone is subprime the odds of that ever being corrected are slim. Refinancing on better terms is usually not an option. Average credit scores for this group on the whole have not improved much if indeed at all over the last few years. I would guess that 80 to 90% of sub prime borrowers stay sub prime borrowers. Those borrowers are in a hole so deep they will never cleanup their credit to get A-paper rates. To top it off, many of them end up paying multiple prepayment penalty each time they need more money. They simply can't wait for their prepay period to expire. Ultimately it is a death spiral to bankruptcy.

Ask any Realtor out there if they know or really care about the types of loans there clients are getting. They may say yes but my assumption is they just want to make the sale. Ask any mortgage loan officer if he or she cares about what loan program they put their client in. Many will say yes but the reality is that they just want to close the loan and get their commission. First greed took over. Now it is a matter of survival.

Here is another reason why these loans are pushed: Lenders pay a lot of rebate on the back end on these loans which fuels the greed even more. Mortgage professionals can make up to 3.5% back end points on these loans while their client's minimum payment stays the same. When you are talking about the high loan amounts in California, the money to be made by pushing someone into one of these programs is huge. So are the temptations. Some lenders went so far as to put on their rate sheets that the maximum a broker or mortgage loan officer can make is $50, 000.00 on a given loan.

Initially investors and flippers loved these loans because their payment was so low that by the time they could flip a home there out of pocket expenses were nothing. It all works well when the market is going up. When it stops or even falls, say good bye!

Everyone is in same box. Realtors need sales, homebuilders need sales, and mortgage brokers need sales. Unfortunately those needs too often come before their clients needs. In the end, the bankruptcies and foreclosures that result from this mess will just keep adding to inventory, ultimately forcing home prices lower. We are only in the first year of decline. From where I sit things will get a lot worse before they can get better.

Michael J. Dorff
Trans World Financial
Huntington Beach, Ca. 92646
Thanks Michael.
Monday evening Mike Morgan puts himself in the shoes of a home builder and sees a giant catch 22. Stay tuned.

In the meantime I am doing one last plug for Kevin Kerr's Resource Trader Alert (RTA). Last week I posted a chart of Kevin Kerr's trades for 2006 and judging from the Email and blog postings there were many skeptics. For convenience I am repeating the chart of trades for 2006, followed by his track record for 2004 and 2005 that I did not post earlier.

Click on the chart for a better view.

In the above table there are 23 winners and 3 losers. One of the losses has a date of 2005 but it was an options spread and a portion of that spread was closed for a loss in 2006. Agora's legal department insisted the loss be included in trades for 2006.

Inquiring might be wondering about 2005 and 2004. RTA had 35 trades for 2005. The scorecard was 29 winners and 6 losers. For 2004 RTA had 10 trades, everyone was a winner.

2006 - 23 wins 3 losses
2005 - 29 wins 6 losses
2004 - 10 wins 0 losses

Note that RTA is strictly an option picking service as opposed to futures, so your full risk for each and every trade is known in advance.

Money Back Guarantee

Agora is currently offering a complete money back guarantee good for an entire year. Here is that guarantee:

As a special member and as part of this limited invitation, you'll have the right to cancel at any time during your membership. Yes, at any time. Even on the last day of your membership, for a refund of your full purchase price.


Many of you know that I have a relationship with Agora, so yes I stand to benefit if someone signs up. But if anyone is aware of a better track record on commodities than the one I posted above then please let me know.

Note to skeptics

I know that some of you are skeptics but the record is what it is. Some responses on my blog wondered about the meaning of "closed trade". Yes the record does include expired trades with options going to zero. That happened twice in 2005 but not at all in 2006 or 2004. Others wondered why that happened so infrequently and the answer is that Kevin likes to buy a lot of time so he only needs to be eventually correct as opposed to correct this month. His track record is such that he is usually eventually correct. Finally, remember there is a money back guarantee. You have the option of signing up and watching the trades without even taking them, just to monitor how things go for a while. At any point if you decide the service is not for you, you can close it out for 100% of your money back.

Past performance is of course no guarantee of future results, but for those interested in commodity trading with a limited predefined risk for each trade, with a right to a complete refund anytime for a full year, on a service with track record as good as Kerr's, please click here to signup now. Prices are set to rise Midnight November 27, 2006.

Mike Shedlock / Mish

Wednesday, November 22, 2006 3:10 AM

Open Market Operations, Interest Rates, and Gold

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I have been reading many claims in many places lately that "The Fed is pumping M3". Others claim that Fed Open Market Operations (repos and coupon passes) are purposely being used by the Fed to fuel the stock market. Others still point to manipulation in gold. This post attempts to look at those claims.

Let's start with An Examination of Interest Rate Targeting, a 108 page PDF study of Open Market Operations in Australia by Liam J. O’Hara. The study was specific to Australia but it applies equally to the FOMC. Don't worry, I condensed the highlights down to a single page with my thoughts following.

The section below from "Study Highlights" thru "End Study Highlights" are excerpts from that PDF. I did not indent as I usually do because many of the snips below also contained indentations that I wanted to preserve without making things too hard to read.

Study Highlights

OMO is designed to fully accommodate the demand for system-wide liquidity in order to maintain stability in short-term interest rates [not] as a tool to manipulate the money supply.

Mosler (2002) again finds similar evidence:

The target [of OMOs] is an interest rate, so the New York Trading desk need only respond to changes in that interest rate. If the federal funds rate trades above its target, for example, it is a simple matter to make funds available at the appropriate interest rate for member banks to borrow on an as-needed basis. There is no functional value to knowing how much the banks need in advance. The Fed can always readily supply, and indeed must supply, any quantity of $US reserves the banks demand at the going rate, or the federal funds rate will not be on target. There is no inherent constraint on the quantity [of money] as the target is the interest rate and the quantity necessarily floats to meet bank demands, so the Fed has no need to “be prepared” for any quantity demanded.
An historical examination of OMO over the past 10 years highlights the fact that the Reserve Bank has fully accommodated the demand for cash in order to maintain cash interest rates at their target levels, and the settlement system functional.

While central banks have explicitly expressed the view that they target short term interest rates, and the money supply is determined outside the system by the demand for credit, proponents of the old exogenous money approach still perpetuate false and misleading statements. Recently, Friedman (1994) stated:
It’s simple to state how the money supply is so centrally controlled. It’s hard to believe. I have observed that noneconomists find it almost impossible to believe that twelve people out of nineteen…sitting around a table in a magnificent Greek temple on Constitution Avenue in Washington have the awesome legal power to double or two halve the total quantity of money in the country. How they use that power depends on [a range] of complex pressures…But that does not alter the fact that they and they alone have the arbitrary power to determine the quantity of what economists call base or high-powered money…And the entire structure of liquid assets, including bank deposits, money-market funds, bonds, and so on, constitutes an inverted pyramid resting on the quantity of high-powered money at the apex and dependent on it.
The findings of this thesis have concluded an opposite view. In Australia, the Reserve Bank fully accommodates the demand for its own liabilities or order to target a cost of funds to the banking system and not a prescribed money base quantity.

End Study Highlights

Mish Comments

Not only does the article by O’Hara debunk myths about open market operations, it also perforce debunks myths about "The Fed pumping M3", a statement I have seen at least twice a week for months on end. The Fed is not really in control of credit at all, and that is an idea that too few seem willing to accept.

Readers may wish to read Possible targets of open market operations as well as Current goals and procedures of open market operations for confirmation of O’Hara's study.

The key point is that the Fed can only target one variable at a time. This Fed has chosen to target interest rates and thus money supply and the price of gold will do what they want to at that rate. If the Fed chose to target money supply instead, the market would then determine the interest rate. If the Fed chose to target the price of gold, the market would then set the other variables. Thus the Fed is not really "Pumping M3" it is merely supplying the demand for money at the artificial rate it is has targeted (with an emphasis on artificial). This indeed is part of the problem, but it is important to state the problem correctly.

Remember that the Fed can not force anyone to borrow who does not want to, nor can the Fed force banks to lend. Regardless of whether the Fed targets money supply or interest rates or the price of gold, the Fed is NOT in control of bankruptcies, foreclosures, job hiring, or the velocity of money. Those last two sentences are crucial to the deflationary argument. Bankruptcies and foreclosures are soaring, consumer spending is sinking, and jobs will follow housing with a lag.

Liquidity Traps & Helicopters

The current setup is essentially the liquidity trap that Japan fell into. Wikipedia has this (and much more) to say about Liquidity Traps.
Milton Friedman suggested that a monetary authority can escape a liquidity trap by bypassing financial intermediaries to give money directly to consumers or businesses. This is referred to as a money gift or as helicopter money (this latter phrase is meant to call forth the image of a central banker hovering in a helicopter, dropping suitcases full of money to individuals).
It has been suggested that the Japanese economy in the 1990's suffered from a "liquidity trap" scenario. This diagnosis prompted increased government spending and large budget deficits as a remedy. The failure of these measures to help the economy recover, combined with an explosion in the Japanese public debt suggest that fiscal policy may not have been adequate either. (Much of the government spending followed a stop/go pattern and involved spending on unneeded infrastructure.) American economist Paul Krugman suggests that, what was needed was a central bank commitment to steady positive monetary growth, which would encourage inflationary expectations and lower expected real interest rates, which would stimulate spending.
Milton Friedman is wrong and Japan proved it. Japan's national debt went from nowhere to 150% of GDP and they are still battling the aftermath of deflation for 18 years or more. For those wanting to see negative rants on Paul Krugman, try a Google search for Krugman + Mises. My simple statement about Krugman is that he puts the cart before the horse when it comes to economic growth. Artificially stimulating the economy eventually causes all sorts of problems.

Please note that the idea of a "liquidity trap" essentially flows from a Keynesian approach to economic/monetary policy in the belief that there is not enough money in the system and things would somehow be better if more money could be forced into the system. Unfortunately, the Fed simply does not know the correct amount of money or the correct interest rate on it either any more than it knows how to set the correct price of orange juice or TVs. We do not let the Fed set the price of TVs, so why should the Fed set the price of credit? The liquidity trap develops because there eventually comes a point where the central bank simply can not force additional credit down the throats of prospective borrowers. Practice has shown that although central banks will attempt to fight the resultant deflationary tide they won't resort to helicopter drop methods. In this regard, the Fed has far less power than anyone realizes in spite of possessing vast power in theory.

In the ideal Austrian approach, a self-regulating free market economy would continually set interest rates and money supply at the correct levels. Any belief that there was not enough money floating around would be construed as pure nonsense. No function money can fulfill would be disturbed by the stable money supply inherent in a free market. The more goods and quality improvements the economy would produce, the higher the money's purchasing power would become over time. This is of course the exact opposite of what happens in a debt based fiat system. In the final analysis, the important thing is not how much money there is, but what that money can buy.

Who is to blame?

It should be clear from the above that the Fed must take a big share of the blame for the mess we are in. The Fed has no real idea where interest rates should be and thus has no business setting them. This has even been admitted by the Fed itself as I pointed out in Confessions by the Fed.

If credit exploded out of control to the upside then it is simply because the Fed kept interest rates too low too long. The problem is what to do about it. Bernanke is absolutely scared to death of a credit contraction here (and he should be). But the Fed also has to be spooked by the leveraged buyouts, merge mania, stock buybacks, and derivative madness fueling the stock market. Consumer credit and housing will dictate what happens next.

Snake Eyes

The dice have been cast and the latest result was snake eyes.
First we saw Consumer Credit Plunge, with the other die showing a massive decline in housing permits and starts (see October Housing Starts, Permits, Foreclosures).

The box the Fed is in is of its own making, and that box keeps getting smaller and smaller. Eventually overall credit will start contracting regardless of what the Fed says or does, and the wizards behind the curtain will be exposed for the frauds that they are. This means that the Fed is going to be as out of control of the upcoming credit contraction as they were of the preceding credit expansion. It is the end of the line for the Fed and contrary to popular belief, open market operations are not going to hold things together.

RTA track record for 2006:

Mish Note:
What follows is a promotion for Resource Trader Alert (a commodity options trading service by Kevin Kerr at Agora Financial). Several people have sent me private emails complaining about the hype in Agora's ads (and I agree - in public - that some are way over-hyped) so I asked Agora for a simple spreadsheet of all of Kevin Kerr's trades for 2006.

The record speaks for itself.

Click on the chart for a better view.

In the above table there are 23 winners and 3 losers. One of the losses has a date of 2005 but it was an options spread and a portion of that spread was closed for a loss in 2006. Agora's legal department insisted the loss be included in trades for 2006.

Note that RTA is strictly an option picking service as opposed to futures, so your full risk for each and every trade is known in advance. All but 4 of the closed trades above had a maximum amount of $900 at risk.

Money Back Guarantee

Agora is currently offering a complete money back guarantee good for an entire year. Here is that guarantee:

As a special member and as part of this limited invitation, you'll have the right to cancel at any time during your membership. Yes, at any time. Even on the last day of your membership, for a refund of your full purchase price.

Many of you know that I have a relationship with Agora, so yes I stand to benefit if someone signs up. But if anyone is aware of a better track record on commodities than the one I posted above then please let me know.

Past performance is of course no guarantee of future results, but for those interested in commodity trading with a limited predefined risk for each trade, with a right to a complete refund anytime for a full year, on a service with track record as good as Kerr's, please click here to signup now. (Scroll to the bottom to ignore the hype on the signup page).

Prices are set to rise Midnight November 27, 2006.

Happy Thanksgiving Everyone!

Mike Shedlock / Mish

Tuesday, November 21, 2006 10:04 AM

Leading Economic Noise

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The Conference Board released the Leading Economic Indicators for October 2006 on November 20th.

Here are the highlights:

  • The U.S. leading index increased 0.2 percent
  • The coincident index increased 0.1 percent
  • The lagging index increased 0.2 percent
Here is a breakdown of weightings that make up the composite score:

Click on chart for a better view.

The two single biggest predictors of a recession are an inverted yield curve and declining housing permits but the table above shows that those two combined account for a mere 12.85% of the composite score while Money Supply (M2) single handedly accounts for a whopping 35.35% of the composite index.

Inquiring minds might be asking what effect M2 had on the composite index increasing by .2%.
But why stop there?
Following is the complete breakdown:

Click on chart for a much better view.

Consumer Expectations

Let's start off by dismissing complete silliness.
Consumer expectations are given more weight than housing permits.

Does anyone think consumers do what they say? I have been watching consumer sentiment for 5 years now and all I see is random noise. The most recent noise had consumer sentiment rising with the fall in gasoline prices. Consumer expectations added .30 to the index last month and .19 to the index this month. Everyone expected consumer sales to dramatically increase with the rise in consumer sentiment and the drop in gasoline prices.

What actually happened was that consumer credit plunged and consumer spending was anemic. Yet for some reason consumer expectations have a weighting of 2.91% vs. a weighting of 2.66% for housing permits and 1.86% for manufacturer's new orders. Does this make sense to anyone?

M2 as a Leading Indicator

I am most intrigued by the weighting of 35.35% given to M2. M2 added .43% to the composite total of .2%. Following is a chart of M2 Money Stock (left axis) and M2 Annualized Period Gains (right axis) since 1959, with recession periods in pink.

Click on chart for a much better view.

I am trying to figure out what if anything the above chart is saying.
The chart shows M2 spikes coming out of recessions three times, spikes in recessions twice, and nothing extraordinary once. We can also see the 1994 "soft landing" spike low.

The chart also shows enormous whipsaws in both directions outside the normal ranges in 2000, 2001, and 2003 (and also 1966-1967, 1986-1987, 2005-2006). In other years the overall series seems to jerk around with relatively high volatility between a smaller band of +2.5% to +10.0% and a larger band of +0.0% to +15.0%. with spikes on each side but way higher on the upside than the downside. On the left axis one can take a look an pretty much see that M2 goes up every year unabated.

For some reason the M2 series is given the highest weighting in leading indicators.

Housing Starts

Compare the above chart with the following chart of housing starts (once again with recessions in pink).

Yes I realize permits are the leading indicator and I used housing starts, but I used the charting service I had that could easily show recession periods. Anyway, which chart looks like it deserves more weighting? Notice that we are not even in recession yet, so who knows how low starts will go.

Yield Curve

Although the U.S. is not in recession (officially anyway) the massively inverted yield curve and housing starts are most assuredly predicting it.

Crisis of Excess Liquidity

The third biggest positive contributor to the index of leading indicators is the stock market. But I look at mergers, leveraged buyouts, volatility, and debt offerings at amazingly low spreads vs. treasuries (just to buy back stock) not as a leading indicator but rather as proof that we are in a "Crisis of Excess Liquidity". Does anyone seriously think recent stock market action is in any way shape or form, normal?

Merger Mania

Fil Zucchi on Minyanville offered these comments on the recent feeding frenzy in an article titled "If You Want It This Bad You Can Have It".
And so the frenzy continues. Freeport McMoran (FCX) swallows Phelps Dodge (PD) for a cool $27 billion. This makes FCX a copper company rather than a gold company with copper interests. The potential buy-out of PD had been kicked around for a number of months and even the premium is in the speculated range. Time will tell if this one works out, suffice to say this is a large bet that copper has not yet seen peak prices, or else FCX will find itself in a world of pain.

Let’s move on to Blackstone for Equity Office Property (EOP) (assuming that the WSJ speculation is correct) because when thrown in with CB Richard Ellis (CBG) buying Trammell Crow (TCC), and the Reckson Assoc. (RA) / SL Green Realty (SLG) merger, it is bringing the action in commercial real estate to a fever pitch.

What cannot be embellished is the fact that one of the shrewdest commercial players ever, EOP’s founder Sam Zell is bailing out; and perhaps the quintessential blue blood, old fashioned real estate outfit - Trammell - has unloaded itself to the CBG’s "cowboys." If this is not the second coming of Julian Robertson folding Tiger Management right at the 2000 market peak, then this time it must be different.
A bell seldom rings at the top or the bottom but that bell is ringing loud and clear now. Commercial real estate has peaked (give or take a few months). To be fair, I have been bearish on commercial real estate for a long time. But I have never once shorted that sector. Instead I have simply stood back in awe watching commercial REITs rise and rise and rise.

This latest feeding frenzy smacks of the same mania that had AOL taking under Time Warner (yes taking under is the correct word) and JDS merging with Uniphase in 1999 forming JDSU.
JDS Uniphase stock was a high-flyer tech stock investor favorite. Its stock price doubled three times and three stock splits of 2:1 occurred roughly every 90 days during the last half of 1999 through early 2000, making millionaires of many employees who were stock option holders, and further enabling JDS Uniphase to go on an acquisition and merger binge. After the telecom downturn, JDS Uniphase announced in late July 2001 the largest (up to then) write-down of goodwill and business losses in business history: $45 billion. Employment soon dropped as part of the Global Realignment Program from nearly 29,000 to approximately 5,300, many of its factories and facilities were closed around the world, and the stock price dropped from $153 per share to less than $2 per share.
No, I do not expect any declines that dramatic this go around, but the warning signs are flashing red for sure. On a fundamental basis it makes sense for commercial real estate to peak six months to a year after residential real estate peaks and Zell has to know it. New housing subdivisions go up creating urban sprawl and all sorts of strip malls and commercial real estate follow with a lag. With consumers throwing in the towel and a recession predicted by the two best indicators around, Zell is smelling a top or close to it.

One thing these mergers, leveraged buyouts, and stock buybacks financed by debt do is pump up broad money supply. One can either believe that activity or one can believe housing permits and the inverted yield curve. Bear in mind we saw the same type of merger mania action in 2000 right before the Nazcrash. Is history about to repeat?

Note: Leading Economic Noise will be one of the subjects of my next podcast on HoweStreet. If you have not yet seen the HoweStreet video interview with Marc Faber on November 14th you might want to check that out too.

Mike Shedlock / Mish

1:18 AM

Is California Going Bankrupt?

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History is about to repeat in California as the State's cash flood may be receding.

It's familiar: A handful of Californians make a killing on investments, and their tax payments send state revenues soaring. Lawmakers go on a spending spree, without a plan for paying the bills when fortunes turn.

That was the late 1990s, when the dot-com boom made the state flush but the gains proved fleeting, and California came perilously close to running out of cash.

Now, as Gov. Arnold Schwarzenegger prepares a landmark program to expand healthcare coverage to millions of uninsured residents, economists say the state may not have the funds to pay for it. Although tax receipts rose this year, they say, California is once again on budget quicksand.

"I'm at a loss to see how they are going to balance this budget," said Stephen Levy, director of the Center for the Continuing Study of the California Economy in Palo Alto.

"The state got bailed out last time around by a surprise revenue surge. That is unlikely to happen again."

The expanded programs in Schwarzenegger's election-year budget were funded largely by Silicon Valley millionaires — capital gains taxes on people who cashed in Google stock, for example, accounted for nearly $500 million in revenue, several experts said — and by the bubble in the housing market that began to deflate after tax receipts that fueled this year's spending were tallied.

"These surges don't last forever," said Ted Gibson, a former state economist. "At some point … that revenue stream will either diminish or completely dry up."

The governor Tuesday brushed aside warnings that state coffers could soon start to shrink. Referring to the $37-billion public-works borrowing package voters approved last week, Schwarzenegger said: "There will be so much construction activities going on that where the private sector will fall off, the public sector will pick up."

"With our infrastructure bonds, we will again stimulate the economy," he said.

"We're going to have a big revenue problem," said Christopher Thornberg, a partner at Beacon Economics in Los Angeles. "It is going to be a mess and Schwarzenegger in a year is going to wonder why he wanted to be reelected…. Sacramento is not going to have the cash to pay for things it wants."

In 1965, personal income taxes — one of the most volatile sources of cash for the state — accounted for less than a fifth of the state's revenues. Now they make up nearly half.

After voters rejected his "Live Within Our Means Act" in last year's special election, the governor changed course, supporting big spending increases for government programs. Democrats, too, dropped their call for changes in the tax code as state coffers swelled and more money was on the table — at least temporarily — to fund their policy priorities.

Now, analysts say, the inaction may come back to haunt the state. The influx of cash "we've seen in the last couple of years could go in the other direction," said Brad Williams, an economist in Hill's office. "It is just a question of when."
I am stunned. I should not be but I am. How can anyone possibly think .... "With our infrastructure bonds, we will again stimulate the economy"? The Arnold sounds like he is bragging that California's infrastructure is in bad shape. "There will be so much construction activities going on that where the private sector will fall off, the public sector will pick up."

Perhaps other states should wreck their roads and demolish their hospitals just so they too can be lucky enough to get voters to pass bond issues to stimulate the economy. Dear Arnold write this down on the blackboard are read it until you understand it: Unfunded public sector spending is exactly why this country is in the mess it is in. We have wasted well over half a trillion dollars in Iraq and exactly what did that stimulus buy us?

If floating bonds will stimulate the economy enough to pay for themselves why not float a trillion dollars worth of them? If printing presses were the key to prosperity, Zimbabwe could easily be the richest nation in the world.


The National Center for Policy Analysis (NCPA) is writing about CALIFORNIA'S MEGA-BONDS.
Tired of exasperating traffic jams, aging schools and inadequate affordable housing, Californians have launched a new era of public works construction. California voters agreed Tuesday to finance the program by issuing $37.3 billion in bonds -- an amount greater than the annual spending of any other state.

As a growing federal budget deficit has eroded financial aid for highways and other projects, debates have simmered in recent years in state capitals about how to pay for them.

Critics say California voters made a mistake:
  • The borrowing will top $73 billion once the bonds are paid off with interest in 30 years, thrusting the state deeper into debt just as it is rebounding from the dot-com bust.
  • That could lead to cuts in funding for social services and other programs, they warn.
Supporters -- most prominently Gov. Arnold Schwarzenegger -- argue:
  • The benefits of highway and public transit improvements, better-equipped schools and reduced threats of flooding will be worth the cost.
  • That is especially true, they say, in a state predicted to swell by the population of Ohio over the next 10 years.
The four propositions will spend $19.9 billion on roads and public transit, $10.4 billion on school construction, $4.1 billion on levees and other flood-control projects and $2.9 billion on affordable housing.
The California Model

The Boston Herald dove off the deep end by proposing California’s $37.3 billion public works rebuilding program could be model for other states.
California voters agreed Tuesday to finance the program by issuing $37.3 billion in bonds - an amount greater than the annual spending of any other state.

“Voters said they are willing to bear the costs and are unwilling to wait for the feds to get their act together,” said Everett Ehrlich of the Center for Strategic and International Studies, a Washington think tank. “That California would see it in its best interest to go it alone and make such a sizable new investment in its future is in many ways new and different.”

Allan Zaremberg, president of the California Chamber of Commerce, said passage of the mega bonds will become a catalyst for discussions nationwide about funding infrastructure. “This is a real victory for people who have the economy in mind,” Zaremberg said. “Gridlock costs money. It’s really important to maintain our infrastructure.”
For starters voters most assuredly are NOT willing to bear the costs. Did California vote to live within their means? No, California rejected Proposition 76: The California Live Within Our Means Act. Did California vote for any tax hikes? Once again the answer is no. So where is the money going to come from? Future generations? Spending that pays for itself? A hope and a wing and a prayer? As for this being a "real victory for people" I would say that Zaremberg's ideas are downright dangerous.

California may have a model alright but that model is the road to ruin and bankruptcy.


The Desert Sun is writing Housing market drag on state until 2008.
The downturn in the housing industry will continue to depress the state's economy for most of next year before stabilizing in 2008, the Legislature's top budget analyst predicted Wednesday. Legislative Budget Analyst Elizabeth Hill forecast that residential construction will fall by 4.4 percent in 2006 and by an additional 13 percent in 2007. Then the analyst said it should stabilize with about 175,000 permits issued annually through 2012.

''I think the real story in terms of California's economy as well as the nation is what is happening in the real estate industry,'' Hill said. She noted that the real estate industry, which includes developers, contractors, real estate brokers, title companies and financial institutions, make up 15 percent to 20 percent of the state's private sector economy.

The slowdown in this industry was the largest single factor in a sharp decline in personal income growth, resulting in a drop in withholding tax payments from over ten percent in the first half of 2006 to less than five percent in the third quarter, Hill reported.

''California has been hard hit by what has happened in the overall real estate sector,'' she said. ''That is the main reason we see the softness in California's economy through 2007 and the rebound in 2008.''

Overall, Hill projected the state budget would end with a $3 billion reserve, but then run short by about $5 billion in each of the following two years and by $1.2 billion annually through 2012 without cuts, tax or fee increases or borrowing.

The current real estate slowdown also could affect state and local governments through what Hill called a ''more subdued'' growth in property tax revenues. The recent real estate boom led to a 35 percent increase in property tax revenue between and after adjusting for inflation.

Hill is forecasting that the annual growth in property taxes will drop from 12 percent in to below 6 percent in, and then rebound modestly.
The Landing

Once again we have a prediction that seems to amount to a soft landing. The landing will be anything but soft. In fact once the downdraft in California gets going people may be wondering if there will be a landing at all.

During the boom times no one pays down debt or saves for the future. That is because booms by nature are artificial. We had a boom based on easy money and shrinking credit standards. There is no way to pay down debt because the boom itself was based on an expansion of debt not genuine growth and savings. What extra tax revenue that did come in was wasted. Now here we are less than one year from the biggest housing boom in history and California somehow needed to float another $43 billion in bonds.

We produced an enormous housing bubble of unprecedented magnitude. What do we have to show for it? A GDP of 1.6% and sinking fast is what we have to show for it. It is taking more and more and more credit just to stand still.

Rest assured California is going to need even more bonds in the years to come (if they expect to keep spending money they do not have). The housing bubble has now popped but the consequences have only begun. The bottom is going to fall out of income and property tax collection. Unemployment is going to soar along with bankruptcies. In a state where one out of 50 working age adults is a real estate agent there is bound to be severe problems in a property bust.

Back in December of 2005 Tom McClintock writing for ChronWatch wrote about Arnold and the California Bond Bombshell.
Bonds are seductive. They promise immediate gratification but they conceal a heavy price. They are certainly the most expensive way to finance projects, costing two dollars to retire every dollar of debt. Moreover, the state’s borrowing capacity is finite, requiring careful attention to priorities, since debt once issued cannot be rescinded – only repaid. And every dollar borrowed by this generation reduces the ability of the next generation to meet its own needs.

Gov. Schwarzenegger is now dealing with the result. He must restore the public works built by a generation of giants while discharging a mountain of pointless debt racked up by a generation of spendthrifts. Only by rigorously applying these principles can he hope to do so.
Arnold has made a stand. He and the voters of California have agreed to float $43 billion in bonds on top of $30 billion or so in existing bonds. In effect the voters of California seem to think they got something for nothing. But life doesn't work that way. Given there is no realistic way to pay this debt back, California is headed for bankruptcy. No, don't expect an announcement tomorrow, or even next year, but the die has been cast.

Mike Shedlock / Mish

Monday, November 20, 2006 11:40 AM

Housing Industry Employment

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I came across an interesting graph of Housing Industry Employment in a Center for Economic and Policy Research (CEPR) PDF entitled Is the Housing Bubble Collapsing? 10 Economic Indicators to Watch.

The article was written in June of 2006 so most of the data it was watching (home sales, home prices, etc) is now far out of date. Last on the list of indicators to watch was employment. There it seem the party has just begun.

Industry Employment

Data produced by the Bureau of Labor Statistics

The jump in employment in the housing-related series over the last 13 years is a good measure of the impact of the housing bubble. While overall employment increased by less than 22 percent from the 1993 to 2006, employment in the construction of residential buildings increased by almost 70 percent. Employment in real estate agencies increased by almost 30 percent over this period. Employment in residential specialty trade contractors increased by almost 28 percent in just the years from 2001 to 2006.

When the bubble deflates, employment levels in these sectors will fall back in line with their historic patterns, as construction and sales levels move to more normal levels.

If employment in housing-related sectors were to fall back to levels consistent with their share of their labor force in the mid-1990s, it would lead a loss of close to 1 million jobs. If the construction sector temporarily falls below its normal level of activity as inventories of unsold homes adjust to normal levels, the job loss would be even greater.
In October Housing Starts, Permits, Foreclosures there was a discussion on housing employment, repeated below for convenience.

Housing Starts vs. Employment
The following chart is courtesy of CalculatedRisk.
It shows residential construction employment vs. housing starts offset by six months.

Click on the chart for an easier to read view.

The chart above shows that although starts have plunged, completions remain high. This has ominous implications for construction jobs looking ahead. Given that employment will follow housing starts with a lag as existing construction completes, it appears that a minimum of 600,000 construction jobs will be lost over the next six months or so.

The ripple effect of the loss of those jobs, especially on consumer spending will be very noticeable. If anything, this may be a best case scenario on the unlikely assumption that starts and permits do not decline further. Note too that with the expected decline in consumer spending as a result of housing sector weakness, layoffs will likely cascade to a wide variety of other jobs especially restaurants and retail sales jobs.
Perhaps the above 600,000 jobs loss estimate was a bit on the optimistic side. Then again, perhaps those losses will take a lot longer to play out than the six month period as stated above. The bad news, however, is that the CEPR estimate of a potential 1,000,000 job loss assumes there will be no overshoot to the downside.

The CEPR estimate also does not address the ripple effect. On the way up, expansion in housing supported all sorts of retail activity like restaurants, nail salons, WalMarts, and Home Depots being built everywhere. The ripple effect ensures that job losses in those sectors will be magnified on the downside as well.

Mike Shedlock / Mish

Sunday, November 19, 2006 3:34 AM

October Housing Starts, Permits, Foreclosures

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Was it just last month that Greenspan and David Lereah at the National Association of Realtors were declaring a bottom in housing?

That myth was shattered on November 17th when the Census Bureau released the Residential Construction Report for October 2006.

Building Permits

  • Building permits fell 6.3 percent to a seasonally adjusted annual rate of 1,535,000.
  • Building permits fell 28.0 percent from the October 2005 rate of 2,131,000.
  • Single-family authorizations in October were at a rate of 1,173,000. This is 3.8 percent below the September figure of 1,219,000.
Housing Starts
  • Housing starts fell 14.6 percent to a seasonally adjusted annual rate of 1,486,000.
  • Housing starts fell 27.4 percent from the October 2005 rate of 2,046,000.
  • Single family housing starts in October were at a rate of 1,177,000. This is 15.9 percent below the September figure of 1,400,000.
This was a record 9th consecutive decline in housing permits as well as the lowest permit total since December 1997. Housing permits are a leading indicator so a further deterioration of future economic activity is to be expected.

New Home Sales

Lereah was crowing about new home sales back on October 26 when Commerce Department reports showed “New-home sales in the U.S. unexpectedly rose for a second month in September as selling prices declined by the most since 1970. Purchases increased 5.3 percent to an annual pace of 1.075 million during the month from a 1.021 million rate in August. The median price of a new home dropped 9.7 percent from a year earlier, partly a result of more sales of homes priced less than $200,000 and fewer purchases of more expensive houses. “

New home sales may have risen in theory but in actual practice it is likely that sales declined considerably. The reason is that cancellations are not reflected in new home sales stats and cancellations have been soaring.

  • D.R. Horton (DHI) reported a cancellation rate of 40%, compared with 29% a year ago.
  • Meritage Homes (MTH) reported a 37% cancellation rate, compared with 21% a year ago.
  • Standard Pacific (SPF) reported a 50% cancellation rate compared with 18% a year ago.
  • The overall average cancellation rate for big builders was at 40%, about twice as high as last year's levels, according to the WSJ.
Bottom Calling

Lereah was not the only bottom caller in housing. When the the National Association of Home Builders/Wells Fargo Housing Market Index (HMI) "exploded" by three points from 30 to 33 in the last two months, NAHB spokesmen offered these comments just one day prior to the release of the disastrous October housing starts data.
“More and more builders are seeing light at the end of the tunnel,” said NAHB President David Pressly, a home builder from Statesville, N.C. “Our members are telling us that the market is steadying after a significant downward correction. On the demand side, we look for sales to stabilize and gradually move up in the coming months.”

“With home prices leveling off, mortgage interest rates remaining near historic lows, energy prices declining and the economy continuing to generate solid growth in employment and household income, affordability is now on the mend and many consumers recognize that home buying conditions have improved,” said NAHB Chief Economist David Seiders. “Builders are picking up on this change in market momentum.”
HMI Charts

What the NAHB did not say was that the HMI is a diffusion index and that readings under 50 show contraction. Is a move from 30 to 33 statistically relevant?

Kevin Depew on Minyanville answered that question way back on October 18th when at that time the HMI index exploded up by one full point. Please consider the following charts.

Thanks Kevin & Minyanville!


RealtyTrac is reporting Foreclosures surpass 1 million mark in October.
“So far this year more than 1 million properties have entered some stage of foreclosure nationwide, up 27 percent from the same time last year,” said James J. Saccacio, chief executive officer of RealtyTrac.

“Monthly foreclosure filings were just below their high for the year, mirroring the trend from last year, when the most foreclosures of the year were also reported in October. Our data from the last three months shows that foreclosures are definitely trending upward, putting more pressure on an already strained housing market, and placing buyers and investors in the driver’s seat when it comes to negotiating home purchases.”
Foreclosures are actually close to historic lows, but the rate of change is ominous. Some of the bubble states like California are just now seeing an uptick because year over year home price appreciation was such that anyone having trouble making payments could escape simply by selling their home for a profit. With home prices no declining, mortgage rates resetting, and more home owners underwater that trend is about to change big time.

Housing Starts vs. Employment

The overall housing picture looks grim but is even worse than it looks, especially from an employment point of view. The following chart is courtesy of CalculatedRisk. It shows residential construction employment vs. housing starts offset by six months.

Click on the chart for an easier to read view.
Thanks CalculatedRisk!

The chart above shows that although starts have plunged, completions remain high. This has ominous implications for construction jobs looking ahead. Given that employment will follow housing starts with a lag as existing construction completes, it appears that a minimum of 600,000 construction jobs will be lost over the next six months or so.

The ripple effect of the loss of those jobs, especially on consumer spending will be very noticeable. If anything, this may be a best case scenario on the unlikely assumption that starts and permits do not decline further. Note too that with the expected decline in consumer spending as a result of housing sector weakness, layoffs will likely cascade to a wide variety of other jobs especially restaurants and retail sales jobs.

It remains to be seen if consumer spending ticks back up this Christmas season (I doubt it) but if it happens it will be the consumer’s last hurrah. A recession in 2007 is now all but guaranteed.

Mike Shedlock / Mish

Friday, November 17, 2006 12:58 PM

Red Tag Madness

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Reuters is reporting California auto sales seen slowing through 2007.

Auto sales in California, the largest U.S. market for cars and trucks, will slow for the rest of this year and next, a forecast released on Thursday by the state's auto dealers association said. The report commissioned by the California Motor Car Dealers association forecast a 2.5 percent decline in 2007 sales.

"The reasons for the sliding market are plentiful, including slower economic growth, rising interest rates, elevated consumer debt levels and the slowdown in the housing market," the report prepared by consultancy Auto Outlook said. The California market is seen as a bellwether for national auto sales, which were down about 3 percent over the first 10 months of this year from the same period a year earlier.

In one standout trend, the California data showed the shift away from Detroit-based automakers and toward Toyota Motor Corp. has been more pronounced in the state than in the national market this year. Toyota's U.S. sales are up 12 percent so far this year, taking the Japanese automaker's share of the overall light vehicle market to 15.2 percent from 12.2 percent a year ago.

But in California, the most populous and wealthiest U.S. state, Toyota gained 3.7 percentage points of market share through the first three quarters, the study said.
By contrast, the traditional Big Three lost 4.7 market share points in California, the study said. On a combined basis, the Detroit automakers represented just 41.2 percent of auto sales in California through the first nine months, well below their 54.1 percent share nationally.
In PPI, Gold, and Dr. Copper I noted the following auto sector highlights.
Prices for light motor trucks fell 9.7 percent following a 3.5-percent gain in September. For 12 months ending October 2006 the index for light motor trucks fell 12.4%

Passenger car prices fell 2.3 percent in October compared with a 2.8-percent advance in September. For 12 months ending October 2006, the index for passenger cars decreased 3.2 percent.
Red Tag Event

GM has been trying to shy away from incentives, but it appears that rising inventories have forced GM's hand. The Detroit Free Press is reporting GM to launch clearance incentives.
General Motors Corp. will begin an incentive program this weekend to help clear inventories of 2006 models, three dealers told Bloomberg News.

The “Red Tag” event might cut prices on many ’06 GM vehicles and runs Nov. 18-Jan. 2, Manpreet Wadan sales manager of Bill Pierre Chevrolet in Seattle, told Bloomberg. GM will also allow dealers to discount many 2007 vehicles by $500 or more, he said.

Wadan said the Corvette, Pontiac Solstice, GMC Sierra pickup, Saturn Sky and all Hummer, Cadillac and Saab models.

Phil Vilar, a sales manager for San Diego-based Seaside Buick Pontiac GMC, told Bloomberg some of the details haven’t been decided, such as the full range of models and the distribution of discounts.

John McDonald, a GM spokesman, declined to comment on the incentives.
Dealer Comments

GM might not be commenting but a GM dealer on the Motley FOOL who posts under the name JediKnight is. This is what Jedi has to say:
In case any board members or lurkers are going to buy a GM car between now and Jan 2...

As part of the "Red Tag" sale, GM has given each dealer an allotment of "coupons", size of allotment is based on the size of dealer's inventory. The dealer has the option of using anywhere from $250, up to $2,000 per unit and it's NOT a rebate, it's dealer-cash meaning he doesn't have to tell you about it.

Yes, coupons are limited so if a dealer tells you that your particular unit of choice "doesn't" qualify for the money, he may be telling the truth. By tonight, all dealers must PRE-DETERMINE which specific units to use how much money on.

It's ridiculous. So if I 'roll the dice' and put $2000 on say, a 2007 white Denali and quote you a price, but now you want the black one ... I gotta raise my price to you. Isn't that pleasant for both sides?

I'm passing this along so that IF you go to your local dealer, you know about it.

Sure you'll know dealer cost, etc via your research, but ask the dealer to "show you which units he put the red-tag cash on ... he has a list WITH VIN numbers".

Mostly dealers will use them towards remaining 06's but you never know.

Asking this question could save you anywhere from $250 to $2000.
Thanks Jedi!

Once again GM is turning to the only method it knows to reduce inventories and move cars, and that of course is incentives.

The economy is clearly slowing and if there was any doubts then the October housing start numbers should put an end to that doubt. Look for incentives of all kinds to dramatically increase from both GM and Ford in 2007 as the consumer led recession of 2007 kicks in full force.

Mike Shedlock / Mish

Wednesday, November 15, 2006 10:16 AM

Lies, Deceit, Greed

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I have been listening to the spin by NAR spokesman David Lereah. The contradictions are nothing sort of amazing.

In Looking for a Bottom on November 11th the Chicago Tribune quoted Lereah as saying:

1) "We need a price decline, we were overbloated"
2) "In 2007, it will be a flat year, maybe 1 percent [sales] drop, and that's it," "After 2007, we'll be back to expansion again."

Which is it, #1 or # 2? Or are we supposed to believe a 1% drop cures overbloatedness? Even if anyone was stupid enough to believe that a 1% drop cured overbloatedness exactly why wouldn't the promised expansion put us right back into overbloated territory again?

On November 13th in Realtors lament prices Lereah moans that home prices are too high.

1) "It's affordability – it's not just mortgage rates that make homes affordable, it's prices. I hope that as affordability starts to improve we see more first-time buyers again," Mr. Lereah said

Back on September 25th in U.S. Existing Home Sales Fall 0.5% in August Lereah said.

2) "We've been anticipating a price correction and now it's here. The price drop has stopped the bleeding for housing sales. We think the housing market has now hit bottom."

Once again is it #1 or is it #2?
If houses are not affordable then how have they hit bottom?
If housing has hit bottom then why do we need a decline to cure overbloating?

Inquiring minds may be wondering exactly what is in the punch that would cause 30,000 people to show up for a NAR annual meeting and listen to such nonsense. When did he call for that price correction anyway, and what evidence is there that the bleeding has stopped?

$40 Million Ad Blitz

Even though housing has bottomed a NAR ad blitz touts the housing market.

The National Association of Realtors is spending $40 million on full-page ads in the nation's biggest newspapers, including the Los Angeles Times, to convince people the market is A-OK.

"Don't delay," the ad says, urging readers to call Realtors, which represents 1.3 million brokers and agents.
If that ad proved anything it is the NAR is in a panic state and that housing has NOT bottomed. It was clearly a waste of $40 million dollars.

The theme of the ad campaign is
1) It's a great time to buy a home
2) It's a great time to sell a home

For the third time today I am asking is it #1 or is it #2?

Carrol Loyd in Don't Delay! Buy Or Sell Now! Right? writes:
This ad campaign seemed to come straight from the Mad Hatter's tea party.
How can it be a good time both to buy and to sell? Isn't that like saying it's a good time both to buy Microsoft and to sell Microsoft?
To answer Carol's questions: It' can't be good time to both buy and sell. As for the second question, given that one has to put up considerable margin to buy stocks but one can buy a home with 0% down it's hard to say exactly what it's like. For members of the NAR however, "It's [always] a great time to generate a commission."

NAHB Infomercials

Not to be outdone by the NAR, the National Association of Home Builders is making a package of "It's a Great Time to Buy" ready-to-use ads available to its members for free. Resources in the buy-now package include:
  • Talking points, Q&As and a sample press release
  • Sample op-eds, letter to the editor and newspaper columns
  • An economic backgrounder
  • Print and radio advertisements
  • Public relations advice on getting the message out through the media, events and Web sites
  • A home builders association guide on how to make the most of the package
  • Sample member communications, including a newsletter article and tips for engaging members in the campaign
A bunch of phony letter to the editor columns and "press releases" is just what we don't need. Those sample letters might be interesting but unfortunately they are available only to NAHB members. General consumer based propaganda from the NAHB can be found here.


The GlobeAndMail is reporting KB Homes CEO quits in stock option scandal.
Bruce Karatz, chairman and CEO of KB Homes, agreed to retire Sunday and repay the Los Angeles-based company $13-million (U.S.) after an internal report concluded the home construction company incorrectly reported stock option grants.

The company also announced the firing of Gary A. Ray, head of human resources, and the resignation of Richard B. Hirst, executive vice president and chief legal officer.

The KB review found the company used incorrect measurement dates for financial reporting purposes for yearly stock option grants from 1998 to 2005, the company said in a statement. As a result of the errors, KB expects a non-cash compensation expense of no more than $50-million. It said the errors may also require an increased tax provision.

Mr. Karatz was one of the highest-paid executives in 2005, making $155.9-million, mostly from exercising options, according to the Wall Street Journal. He had served as KB's CEO since 1986.

"I am extremely proud of everything that the entire KB team and I have accomplished over the past 20-plus years," Mr. Karatz said in a statement.
Wasn't $100-125 million enough for you Mr. Karatz?
PrudentBear had this comment:
"Since 1992, he has reaped nearly $180 million from exercising options. Last year, he made more than $150 million from salary, bonus, restricted stock grants and options exercises. The options exercises accounted for the bulk of his pay. The backdating appears to have begun in 1998, when Mr. Karatz received more than 450,000 options. That year also apparently marked a shift to much larger options awards — in each of several previous years, Mr. Karatz had received 100,000 options or fewer. His grants between 1998 and 2001 appeared particularly well-timed. In that period, he recorded one grant dated the day the stock touched its lowest closing price of the year, another at a quarterly low, and two more at monthly lows. One grant of 450,000 shares carried the date of Oct. 25, 1999, and an exercise price of $17.75, the year's lowest close."
Now, that's a track record to be proud of for sure.

Notes and Addendum.
The above originally appeared in Whiskey&Gunpowder on November 14.

Perhaps straight from the "Sample op-eds, letter to the editor and newspaper columns" from the NAHB "buy-now package" we see the following advertisement from a homebuilder presented as an opinion in the Asbury Park Press on November 15th:

Home buying a good investment in "down" cycle.
The homebuilders of New Jersey are still building and selling homes. The housing industry always has and continues to drive the local and state economy. Despite alarming reports of a "doom and gloom" market, real estate remains a solid, historically proven investment.

Contrary to what you have read, buying a new home is not a risky business. Since the national Savings and Loan crisis in the late 1980s, when banks failed as a result of overextended construction lending, a number of safeguards between builders and lending institutions have been established. These stringent regulations require banks to have sufficient net assets to protect themselves in the event of losses. Moreover, banks are exercising more fiscal caution and have established tighter credit guidelines.

In the 1980s, financial institutions were much more lenient in providing funding for "spec" houses under construction, but not yet sold. Today, residential builders may get financing only for the homes that are already under a sales contract and, thus, do not put themselves in a position of overextending financially with unsold inventory.
Not only can homebuyers remain confident about purchasing a newly constructed home, it's a buyer's market. There is no better time to buy a home than today. Prices are lower, interest rates are favorable and holding, and builders are more competitive.
Marc J. Siegel is president of the Shore Builders Association of Central New Jersey, Lakewood.
Much of what Siegel presents in regards to lending practices, credit guidelines, and spec building is easily refuted. Of course cancellation rates were not mentioned at all. Such writings do not belong on the opinion page but under the classified ad section.

Mike Shedlock / Mish

Tuesday, November 14, 2006 4:38 PM

The PPI, Gold, and Dr. Copper

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On November 14 the BLS released the Producer Price Indexes for October 2006.

Weak September data was followed up by even weaker October data.

PPI Highlights

  • Prices for light motor trucks fell 9.7 percent following a 3.5-percent gain in September. For 12 months ending October 2006 the index for light motor trucks fell 12.4%
  • Passenger car prices fell 2.3 percent in October compared with a 2.8-percent advance in September. For 12 months ending October 2006, the index for passenger cars decreased 3.2 percent.
  • The index for finished energy goods declined 5.0 percent in October following an 8.4-percent drop in September.
  • Residential natural gas declined 9.3 percent following a 1.8-percent advance in September.
  • Gasoline prices decreased 7.9 percent after dropping 22.2 percent a month earlier.
  • Food prices fell 0.8%. This was the largest drop since May.
  • Computer prices dropped 3.1%.
I have been watching the intermediate vs. final PPI for quite some time.
Following is Chart A from the BLS report to consider:

In May, July, and August price pressures in intermediate and crude goods were not being passed on to finished goods. One possible interpretation was lack of pricing power (i.e. inability to pass on cost increases). The more common interpretation was that the PPI on finished goods was poised to explode up. There is no longer any doubt which interpretation was correct.

Marketwatch is reporting First back-to-back PPI decline since July 2004.
  • The producer price index fell a sharp 1.6%, which matches a record low set in October 2001, the Labor Department reported Tuesday.
  • The decline in the PPI pushed the year-over-year rate on finished-goods prices to negative 1.6%, the first time it has been below zero since September 2002.
  • The core PPI, which excludes food and energy costs, fell 0.9%, the biggest drop since August 1993.

Bloomberg is reporting Gold Prices Decline in New York on Easing Inflation Concerns.
Gold in New York fell for the third straight session after prices paid to U.S. producers matched the biggest monthly slide ever in October, reducing the precious metal's appeal as a hedge against inflation.

The 1.6 percent drop in prices paid to factories, farmers and other producers followed a 1.3 percent decline in September. Analysts expect the U.S. to report lower consumer prices on Nov. 16. Gold dropped 1.2 percent in the previous two sessions.

"There's no inflation.," said Marty McNeill, a trader at R.F. Lafferty Inc. in New York. "If the PPI is down, gold usually would go lower."
These writers need to brush up on history. Gold tends to do very poorly in disinflation but very well thank you in deflation. Gold shocked everyone when it rose along with the U.S. dollar in 2005. It will shock everyone again by rising along with treasuries when deflation sets in.

Dr. Copper

The bullish symmetrical triangle that had been forming on the weekly chart has now broken decisively to the south.

$CRB 200 EMA Bounce

The $CRB has put in a weak bounce off the 200 EMA.
Whether or not that bounce holds is likely to depend entirely on energy prices so let's take a look at a weekly chart of crude.

OPEC has dropped production and is considering further cuts in an attempt to defend oil prices. In the wake of a dramatically slowing worldwide economy, a successful move by OPEC to hold oil prices high would only increase recessionary pressures. Historically such actions have failed.

Along with a Plunging PPI, plunging copper, plunging home prices, plunging housing starts, a plunging GDP, and plunging consumer credit there should be no doubt which way the economy is headed. The only unanswered question is: When does the stock market get the message?

Mike Shedlock / Mish

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