The Mortgage Corner

Ah, that is the $64,000 question we have been asking since 2008, when housing imploded. Where are conditions improving, if anywhere? The Fed announced it would continue to hold down interest rates, and loan modifications are helping to cut into the foreclosure inventory, which has declined slightly from its highs.

The S&PCase-Shiller same-home price index, the best measure of price changes, rose in 19 of its 20 metropolitan areas in May, with San Francisco,San Diego, Minneapolis, and Los Angeles most improved. Prices in its 10-city index rose 5.4 percent, and 4.6 percent in its 20-city index. But in spite of 3 consecutive monthly increases, S&P said prices were still moving sideways—which probably means they expect prices to decline in June and July after expiration of the tax credit deadline.

Prices have stabilized, in other words, but consumers are not yet convinced that the jobs picture will improve. So consumers continue to pay down mostly mortgage debt, says a New York Fed quarterly report on household debt and credit.

“Aggregate consumer debt continued to decline in the second quarter, continuing its trend of the previous six quarters,” said the report. “As of June 30, 2010, total consumer indebtedness was $11.7 trillion, a reduction of 6.7 percent from its peak level at the close of 2008Q3. Excluding mortgage and HELOC balances, consumer indebtedness fell 1.5 percent in the quarter and, after having fallen for six consecutive quarters, stands 8.4 percent below its 2008Q4 peak."

This has not helped new and existing-home sales, also recovering from expiration of the first-time homebuyer’s tax credit. Existing-home sales, which are completed transactions that include single-family, townhomes, condominiums and co-ops, dropped 27.2 percent to a seasonally adjusted annual rate of 3.83 million units in July from a downwardly revised 5.26 million in June, and are 25.5 percent below the 5.14 million-unit level in July 2009.

Sales are at the lowest level since the total existing-home sales series launched in 1999, and single family sales – accounting for the bulk of transactions – are at the lowest level since May of 1995, but actual totals are still lower than one year ago.

To put that number in perspective, according to the NAR, existing-home inventories increased to 3.98 million units in July from 3.89 million in June, piling up because of the lower sales rate. But the all time record high was 4.58 million homes for sale in July 2008, so inventories have actually declined 1.9 percent year-over-year. Inventory is therefore very much dependent on the sales’ rate.

So there are some signs of improvement. The latest Federal Reserve survey of Senior Loan Officers also indicated an easing of credit requirements for both residential and commercial loans over the past quarter, the first easing since 2008.

And delinquency rates are declining, according to the Q2 Mortgage Banker’s Association report. The seasonally adjusted delinquency rate stood at 5.98 percent for prime fixed loans (which make up some 60 plus of outstanding loans), 13.75 percent for prime ARM loans, 25.19 percent for subprime fixed loans, 29.50 percent for subprime ARM loans, 13.29 percent for FHA loans, and 7.79 percent for VA loans.

What is obvious is that the percentage of 90 day-late payments and foreclosures is increasing as a share of total delinquencies as lenders speed up the process of modifications and foreclosures to get delinquent loans off their books. The percentage of loans on which foreclosure actions were started during the second quarter was 1.11 percent, down 12 basis points (0.12 percent) from last quarter and down 25 basis points from one year ago.

The delinquency rate includes loans that are at least one payment past due but does not include loans in the process of foreclosure.  The percentage of loans in the foreclosure process at the end of the second quarter was 4.57 percent, a decrease of six basis points from the first quarter of 2010, but an increase of 27 basis points from one year ago.

“Consumers rationally jumped into the market before the deadline for the home buyer tax credit expired, said NAR economist Lawrence Yun. “Since May, after the deadline, contract signings have been notably lower and a pause period for home sales is likely to last through September,” he said. Even with sales pausing for a few months, annual sales are expected to reach 5 million in 2010 because of healthy activity in the first half of the year. To place in perspective, annual sales averaged 4.9 million in the past 20 years, and 4.4 million over the past 30 years,” Yun said.

Since sales’ statistics are notoriously imprecise (with ± 15 percent error), we can say that real estate sales have been treading water after an initial sales spurt in 2009, though existing-home prices actually increased 0.7 percent in July, indicating that expiration of the tax credits caused most of the sales’ decline in the lower-end of the market.

The bottom line is that banks seem to be finally committed to cleaning the bad loans off their books. This will probably keep prices from rising in the short term. But it will also enable them to reduce their loan loss reserves and so ease credit conditions for home buyers further, thus reducing inventories and boosting sales further.

Harlan Green © 2010

Popular Economics Weekly

Yes, Beware of Extraordinary Times is a much used saying these days.  It also applies to the extraordinary polarization of ideas in the economics profession at present. This is an election year, of course, which has distorted the debate on economic recovery.

We know that debt is bad, for instance, but borrowed debt is worse, says Alan Greenspan. So allowing some of the Bush-era tax cuts to expire may be a good thing, since those tax cuts reduced revenues while increasing the budget deficit. And the truism that one has to spend money to make money applies to government as well as the private sector. The just-ended Great Recession required government to borrow huge sums of money to make money—i.e., just to keep the U.S. economy afloat.

Government stepped in because the private sector downsized, shedding more than 8 million workers and shutting down whole sectors of the economy—both small businesses and large, from autos to airlines.

So it should be a no-brainer that government and the private sector need to find better ways to work together, rather than participating in the demonization that has caused such an extraordinary polarization of ideas—all government is inept, for instance, and all capitalists selfish and greedy. One area that both sectors should agree on is how to stimulate the demand that grows an economy. And right now there is little agreement on how to simulate economic growth.

Conservatives maintain we must pay down debt, and decrease government spending to stimulate economic growth—private business lives in eternal fear of debt and so won’t choose to expand when they worry about higher debts and future inflation, they say. While so-called liberals (who were at one time Eisenhower Republicans) believe that without government intervention during recessionary times, economies will stagnate and unemployment remain unacceptably high.

But in fact both government and the private sector are a part of what is called aggregate demand, the demand that stimulates economic growth. It is a relatively simple formula:

Where aggregate demand is AD,

• is Investment,
• is Government spending,
• is Net export,
  • is total exports, and
  • is total imports = a_m + b_m(Y − T).

Notice there is no mention of debt in the formula. Our Gross Domestic Product is its closest approximation, and the classical definition of a recession/depression is when GDP shrinks for at least 2 quarters. It shrank more than 4 quarters during this Great Recession, which is the main reason these are such extraordinary economic times.

The fact that we are fighting two wars with borrowed money, while recovering from a credit crisis and housing bubble that resulted from too much borrowed money, means that extraordinary measures are required. We must bury the hatchet between government and the private sector—doing nothing is not an option.

Historical hindsight tell us it was too little government regulation—both due to outmoded laws and lax oversight—and a private sector obsessed with profit over prudence that caused the Great Recession.

This has resulted in some $6 trillion in lost output of GDP, which could have been worse, if government had not come to the rescue.

Zero interest rates are scary during ordinary times, certainly. It is scary to savers and lenders, because it reduces their incomes. And it is scary to consumers because it signals falling prices, with lead to falling wages and fewer jobs.

But unless said aggregate demand begins to grow again, stagnation will continue. At present there is very uncertain growth, mainly because banks, investors and corporations are hoarding their assets. Corporations are hoarding their cash from a decade of record double-digit profits, investors from their stock and bond losses, banks because they are reluctant to lend until their capital base has been restored, while consumers continue to restore their wealth and wait for businesses to hire again.

It has been left to government to provide some stimulus during these times to satisfy the most basic human needs of shelter and food, by borrowing from the almost $1 trillion in excess bank reserves held by the Federal Reserve (that banks are not using) and $1.8 trillion in cash that corporations are hoarding.

In other words, when I + C + X-M falters, then the G of government has to provide the stimulus. That was the lesson of the Great Depression. It began in 1929 when the Hoover Administration’s tightened credit to combat inflation, and lasted until 1933 when Roosevelt instituted the modern government safety net—including social security, unemployment insurance, and the various government work projects that directly employed millions of the young and old.

The key is to find ways to unlock that demand. It makes sense that since consumers make up some 70 percent of economic activity at present, putting more money into consumers’ pockets is a must. But if in the form of tax breaks, it must flow to those in the lower income brackets, where it gets spent. Most of the tax benefits to date have gone to the upper 1 percent in the form of investor benefits—such as lower capital gains and dividends taxes—i.e., to the investor class who tend to save rather than spend most of their income.

Another remedy is bond trader Bill Gross’s suggestion of spending more on infrastructure. California is building its first high-speed rail service with federal stimulus money. This would employ more blue-collar construction workers who have been hardest-hit by this recession.

Also, homeownership is down from 70 percent to approximately 66 percent of households, with somewhere between 5 to 10 million of those households’ loans in danger of default, government can do more to support housing. Roosevelt during the 1930s actually took ownership of homes and rented them back to former homeowners, until they were able to buy them back. Today’s various loan modification programs are pale imitations of what was done then.

Yet government can only do so much to stimulate growth. The private sector must step up and find ways to stimulate greater demand for its products. Madison Avenue has always found ways to stimulate both wanted and unwanted consumer needs that result in an excess of choices. With corporations once again making record profits, there is no reason for them to resist hiring more workers. Labor productivity is at record highs because corporation continue to push their existing workforce to produce more.

That should also be the lesson of the Great Recession. Extraordinary times call for extraordinary measures.

Harlan Green © 2010

The Mortgage Corner

Bolstered by favorable interest rates and low house prices, housing affordability remained near its highest level nationwide for the sixth consecutive month since the series was first compiled nearly two decades ago, according to the National Association of Home Builders/Wells Fargo Housing Opportunity Index (HOI) released today. And both housing construction and new-home sales are beginning to rise again after a lull.

The HOI indicated that 72.3 percent of all new and existing homes sold in the second quarter of 2010 were affordable to families earning the national median income of $64,400. The index for the second quarter was slightly more affordable than the previous quarter and almost equaled the record-high 72.5 percent set during the first quarter of 2009. Until 2009, the HOI rarely topped 67 percent and never reached 70 percent.

“Homeownership is within reach of more households than it has been for almost a generation,” said NAHB Chairman Bob Jones. “Interest rates continue to hover at historic low levels, the economy is beginning to rebound and with house prices starting to stabilize, conditions are beginning to draw home buyers back into the market, which is a positive step on the path to recovery.”

Syracuse, N.Y., was the most affordable major housing market in the country, edging out Indianapolis-Carmel, Ind., which had held the top ranking for nearly five years. In Syracuse, 97.2 percent of all homes sold were affordable to households earning the area’s median family income of $64,300.

Housing starts also posted a modest comeback in July, rising 1.7 percent after an 8.7 percent decrease in June. The July annualized pace of 0.546 million units came in below the median forecast for 0.565 million units and is down 7.0 percent on a year-ago basis.

The July improvement was led by a 32.6 percent bounce back in multifamily starts, following a 33.3 percent drop in June, as more households become renters. The single-family component is still weighed down by inventories-declining 4.2 percent after dipping 1.7 percent in June.

By region, the gain in starts was led by a 3.9 percent rebound in the South. Other regions declined-the Northeast, down 25.9 percent; the West, down 4.9 percent; and the Midwest, down 1.1 percent.

New-home sales also recovered form recent lows. The June pace recovered to an annualized 330,000 from a revised 267,000 for May and revised 422,000 for April. While the comeback is welcome, the bad news is that May’s record drop was revised down notably from the initial estimate of a 33.0 percent decline. The latest figure is down 16.7 percent on a year-ago basis.

Monthly supply has seen sharp movement in recent months as that ratio is moved more by sales than by the number of homes on the market. Supply on the market eased somewhat to 7.6 months after surging to 9.6 in May. April had been pushed down to 6.1 months’ supply as sales bumped up to meet the signing deadline for tax credits. The median home price slipped 1.4 percent to $213,400. Year-on-year, the median price in June is down 0.6 percent. The bottom line is that the elevated inventory levels of new homes is helping keep prices low.

Another interesting statistic put out by Calculated Risk is the distribution of mortgage interest among homeowners.

A just released Census Bureau housing survey showed:

· 76.4 million owner occupied housing units in 2009.

· 24.2 million were owned free and clear (no mortgage). That is 31.7 percent.

· 26.8 million primary mortgages were originated in 2004 or earlier.

· 12.7 million primary mortgages were originated prior to 2000.

· 24.1 million primary mortgage had interest rates above 6 percent.

This is while the 30-year conforming fixed-rate mortgage averaged 4.42 percent for the week ending Aug. 19, a record low since Freddie started tracking the rate in 1971. And, there are at least 10.9 million homeowners with 2nd mortgages and another 800 thousand the 3 or more mortgages.

This all means that the new affordability is not available to everyone. Only 6.2 million of primary mortgages were under 5 percent (as of 2009). This will increase in 2010, but quite a few homeowners had primary mortgage interest rates above 6 percent. And the U.S Bureau of Economic Analysis recently reported that the effective rate on all mortgages was still above 6 percent in Q2.

Harlan Green © 2010

Financial FAQs

We are now hearing that pent up demand is growing as the economic recovery takes its time. What is it, and what would it mean for an earlier recovery? Fed Chairman Bernanke mentioned that ‘demand’ could grow in a recent speech to South Carolina’s legislators.

“While the support to economic activity from stimulative fiscal policies and firms’ restocking of their inventories will diminish over time, rising demand from households and businesses should help sustain growth…In particular, in the household sector, growth in real consumer spending seems likely to pick up in coming quarters from its recent modest pace, supported by gains in income and improving credit conditions. In the business sector, investment in equipment and software has been increasing rapidly, in part as a result of the deferral of capital outlays during the downturn and the need of many businesses to replace aging equipment.”

Demand usually refers to aggregate demand, a key concept of Keynesian economic theory. The theory being that if consumers, businesses and governments have growing incomes/revenues, then their ‘demand’ for more goods and services will increase. Pent-up demand is comprised of the elements that must grow to stimulate aggregate demand for more goods and services.  This might seem obvious to anyone who has taken Economics 101, but how to measure aggregate demand is not so obvious.

We know several factors that can stimulate demand. For instance, the 2010 Harvard Joint Housing Taskforce Study estimates that 15 million new households will be formed over the next decade, including immigrants. Yet new home growth has slowed drastically. And there are maybe 1 million surplus existing homes, due to the housing collapse. Yet even with the overhang, the demand for housing is bound to grow exponentially over the next decade.

New home sales in June actually rebounded 23.6 percent after plunging a revised 36.7 percent in May. The June pace recovered to an annualized 330,000 from a revised 267,000 for May and revised 422,000 for April. While the comeback is welcome, the bad news is that May’s record drop was revised down notably from the initial estimate of a 33.0 percent decline. The latest figure is down 16.7 percent on a year-ago basis.

Another factor that suppresses demand is surprise, deflation. We are now in a deflationary environment, and studies show that consumers hold back from purchases if they believe prices can fall further—which creates a self-fulfilling prophecy. So rising prices also will signal increasing demand.

For instance, the just released second quarter Gross Domestic Product report showed falling prices. Though economy-wide inflation accelerated in the second quarter as the GDP price index rose an annualized 1.8 percent, following a 1.0 percent in the first quarter.

The acceleration in prices was due to the impact from higher imports—which signals greater domestic demand. But the price index for gross domestic purchases, which measures prices paid by U.S. residents, increased a bare 0.1 percent annualized in the second quarter, following a 2.1 percent boost in the first quarter. The core rate excluding food and energy prices increased just 0.9 percent in the second quarter, compared with a rise of 1.6 percent in the previous quarter.

So despite all of the doomsayers, the recovery continued in the second quarter but at a moderate pace. Yes, growth is still below par but not into a double dip, thanks mainly to the TARP and ARRA programs’ stimulus spending. Second quarter GDP came in at an annualized 2.4 percent growth, following a revised first quarter gain of 3.7 percent.

The latest quarter was led by a rebound in residential investment, a jump in investment in equipment & software, and by inventories. Personal Consumption Expenditures also posted a moderate gain along with government purchases.

In fact, the best measure of pent-up demand, is what is called the “output gap”.  The San Francisco Federal Reserve puts out that calculation. It was minus 6.1 percent in Q1 2009, but would have been as high as 19 percent without the TARP and ARRA stimulus spending, says the Center for Budget and Policy Priorities (CBPP), a non-partisan think tank.

The output gap measures how far the economy is from its full employment or “potential” level that depends on supply-side factors of the economy: the supply of workers and their productivity. During a boom, economic activity may for a time rise above this potential level and the output gap is positive. During a recession, the economy drops below its potential level and the output gap is negative. In theory, the output gap can play a central role in monetary policy deliberations and strategy.

In fact, one of the goals of the Federal Reserve is to maintain full employment, which corresponds to an output gap of zero. And it is the employment rate that best determines output, so we know that the Fed isn’t going to begin to raise interest rates, until the unemployment rate declines substantially, which means that pent-up demand will begin to kick in.

Was Bernanke being too optimistic? We don’t think so, nor does the stock market, which continues to rally.

Harlan Green © 2010

The Mortgage Corner

The so-called ‘cash-in’ mortgage has become more popular of late for a number of reasons. It means paying down the mortgage, which is the opposite of cash-out refinancing where borrowers are taking cash out of the equity in their homes.

The main reasons homeowners are doing cash-in refinancing are first, bringing the loan amount more in line with lower home values. But also homeowners find that paying down, say, a 5 percent mortgage more quickly means they are saving 5 percent, vs. the very low interest rates from regular savings.

Amy Crews Cutts, deputy chief economist for Freddie Mac, says "The Fed doesn’t intend to start raising interest rates for a while…you’re not going to make money in CDs. (And) The stock market is giving people heart attacks on a daily basis with its ups and downs."

Consumers are paying down their overall debts with a vengeance in these uncertain times, as we have said in past columns—in part because mortgage rates are now at all-time lows, with conforming and so-called jumbo-conforming 30-year fixed rates below 4.5 percent. Even super-jumbo rates to $2 million are hovering around 5 percent these days.

And it looks like housing prices are finally on the mend with the latest (May) seasonally-adjusted Case-Shiller Home Price index up 1.3 percent. Economists caution that it is measuring prices during the height of the selling season, but 19 of the 20 cities in the index showed increases.

The Composite 10 is up 5.4 percent compared to May 2009. The Composite 20 is up 4.6 percent compared to May 2009. This is the fourth month with Year-over-Year price increases in a row.

Here are some reasons borrowers might consider a cash-in refinance, according to CBS Marketwatch:

· If it allows the borrower to stop paying private-mortgage insurance, required when the mortgage is more than 80 percent of the home’s value. Extra cash could allow a borrower to eliminate PMI, saving them monthly premium costs.

· Borrowers want to reduce their mortgage term, perhaps moving from a 30-year to a 15-year fixed-rate mortgage, Hsieh said. The extra cash can reduce the mortgage amount and make their monthly payments bearable.

· When the extra funds may get a borrower the lowest rates possible — those that require a loan-to-value ratio of less than 60 percent and a FICO score above 740, said Jack Pritchard, a mortgage consultant who co-founded Refinance.com, a site that helps borrowers evaluate mortgage and refinancing options.

· Extra cash can also sometimes bring a mortgage under the conforming loan limit so the borrower doesn’t have to pay higher jumbo rates. The conforming limit is $417,000 for single-family homes in many markets, and $729,750 in high-cost areas of the contiguous United States.

In what may be another sign of an improving housing market, the homeowner vacancy rate declined to 2.5 percent in Q2 2010. A normal rate for recent years appears to be about 1.7 percent, according to Calculated Risk. “This leaves the homeowner vacancy rate about 0.8 percent above normal. This data is not perfect, but based on the approximately 75 million homeowner occupied homes, we can estimate that there are close to 500 thousand excess vacant homes.”

Note that the vacancy rate rose sharply from 2006 to December 2007, the beginning of the Great Recession, a sign of massive overbuilding that caused the housing bubble. But it has now fallen, though not yet enough to erase the inventory overhang above historical vacancy levels.

But a recovery is in the offing as the combination of record low interest rates, a Fed still in the mood to be accommodative for an “extended period’, and housing prices back to early 2000 levels should entice more buyers into a buying frame of mind.

Harlan Green © 2010

Financial FQs

Most historians consider Harry Truman as one of our great Presidents, even though he didn’t consider himself as such. It wasn’t until later years showed the greatness of “give ‘em hell, Harry”, as he was called once at a whistle-stop during his 1948 presidential campaign that defeated the heavily favored New York Governor Thomas Dewey.

He faced tough economics times, as we do now, with an even larger debt load due to WWII, and 5 million servicemen/women returning home and out of work. He was also was faced with a Republican Congress in 1946, unhappy with the huge debt load. Sound familiar, as we said last week?

With so much uncertainty, he did what great Presidents do, he became a transformational leader, in the words of conservative columnist George Will. And he suffered the slings and arrows of disapproval for it. “The President is always abused. If he isn’t, he isn’t doing anything,” is one of his better-known ‘Trumanisms’.

What were the lessons learned? Daughter Margaret put together a book of his pithy sayings, in WHERE THE BUCK STOPS-The Personal and Private Writings of Harry S. Truman. Edited by Margaret Truman. 388 pp. New York: Warner Books, 1989.

Maybe his outstanding trait was that he was plain spoken—who grew up on a small farm in the heartland of Missouri. And he never left his roots, retiring back to his Independence in 1954. He never loved Washington, D.C., either. He once advised, "If you want a friend in Washington, get a dog."

””A good president just can’t pay any attention when the press tries to abuse him, Truman writes; ”the papers often abuse him when he’s right. It doesn’t bother any man in office who wants to do the right thing,” he adds. ”He goes ahead and does it no matter what the newspapers may say. I never cared anything about what they said about me as long as they didn’t jump on my family. If they did that, then they got into trouble.

”It doesn’t make any difference whether or not the thing he (the President) decides to do is unpopular, or whether his doing it makes him unpopular for a while. If he does the right thing the popularity will come. If he doesn’t, well, then, too bad.”

But that was just the surface. His economic philosophy mirrored Roosevelt’s New Deal, because he was always for the underdog. In fact, he won over Dewey because the pollsters who had predicted his defeat forgot to poll those lowest on the economic ladder who turned out in droves to vote for him.

And we have the same need now to boost the earning power of those wage and salary earners lowest on the economic ladder who comprise more than 50 percent of the workforce, yet whose incomes have stagnated after inflation since the 1970s.

Job formation has really been increasing since January, and real estate prices have inched up, but sales remain stagnant. This is while corporations have reported record profits over the last 2 quarters with the highest profit margins since WWII, yet they have not been investing in either new plants or employees.

And so government has had to step in to counteract the cash hoarding of some $1.8 trillion being held by the S&P 500 corporations alone. But why such a fear of debt, when the Great Depression has provided us with a lesson of what needs to be done to counteract such fears?

Economist Paul Krugman has pulled up some of the Great Depression’s history and surprise, the Hoover Administration’s emphasis on reducing deficit spending increased debt as a percentage of GDP, while shrinking actual GDP growth (and revenues). But increased government spending (and debt) during Roosevelt’s New Deal increased economic growth, so though debt loads were high, it brought the U.S. out of the 1929-1933 depression and produced 3 years of growth. The double-dip only returned in 1937, when Roosevelt listened to the bankers and tried to reduce the deficit prematurely.

“The experience of the 30s,” writes Krugman, “offers no support to those who worry about the debt consequences of deficit spending in a depressed economy — FDR didn’t do enough stimulus, but the spending he did do was not reflected in a spiraling, or even rising, debt burden. And the evidence is consistent with the view that austerity, Hoover-style, may well be self-defeating even in a narrow fiscal sense.”

Supporting the present picture is weak growth of the Conference Board’s Index of Leading Economic Indicators, a monthly snapshot of 12 important indicators that affect growth, such as interest rates, and hours worked.

"The LEI decreased in two of the last three months, but its level is still about 4.5 percent above its previous peak before the recession began," said Ataman Ozyildirim, economist at the Conference Board. "Moreover, the gains among the LEI components have been widespread, with the exception of housing permits and stock prices, pointing to an expanding economy, but at a slower pace in the second half of the year."

A major reason for continued sluggish growth is that real estate, the traditional first responder to better conditions has still to work off more than 1 million units in excess inventory built up over the bubble years. Total inventory peaked in 2006, but months of supply didn’t peak until 2008, as the sales’ rate declined drastically with bursting of the credit bubble.

This increase in inventory is especially bad news because the reported inventory is already historically very high, and the 8.9 months of supply in June is well above normal.

So there is good reason for the Fed to continue to hold interest rates at record lows, and Chairman Bernanke has promised to do so for “an extended period” in his latest congressional testimony. "We are ready and we will act if the economy does not continue to improve — if we don’t see the kind of improvements in the labor market that we are hoping for and expecting," he said.

Harlan Green © 2010

Popular Economics Weekly

Fed Chairman Ben Bernanke just gave his semi-annual report to Congress, and it looks like Bernanke and his Federal Reserve Governors continue to be cautious in advocating more stimulus. That is too bad, when a consensus is building that more monetary stimulus is needed to put monies into consumers’ pockets with jobs still hard to find.

Why have the Fed governors been so timid? It has more to do with ideology, than economic fundamentals. Since many of the Fed Governors are former bankers, they dislike debt, and the Fed has had to buy more than $2 trillion in mortgage-backed and Treasury securities to add liquidity to the system. This has kept interest rates at historic lows, but has only begun to bring real estate and job creation out of their doldrums.

Job formation has really been increasing since January, and real estate prices have inched up, but sales remain stagnant. This is while corporations have reported record profits over the last 2 quarters with the highest profit margins since WWII, yet have not been investing in either new plants or employees. Bernanke in his latest Humphrey-Hawkins congressional testimony said that it was because corporations had too much excess capacity, (which means they see insufficient demand for their products and services).

And so government has had to step in to counteract the cash hoarding of some $1.8 trillion being held by the S&P 500 corporations alone, to help stimulate that demand. But why such a fear of debt, when the Great Depression has provided us with a lesson of what needs to be done to counteract such fears?

Nobel economist Paul Krugman has pulled up some of the Great Depression’s history, which shows that the Hoover Administration’s emphasis on reducing deficit spending increased debt as a percentage of GDP, while shrinking actual GDP growth (and revenues). But increased government spending (and debt) during Roosevelt’s New Deal increased economic growth; so though debt loads were high, it brought the U.S. out of the 1929-1933 depression and produced 3 years of growth. The double-dip only returned in 1937, when Roosevelt listened to the bankers and tried to reduce the deficit prematurely.

“The experience of the 30s,” writes Krugman, “offers no support to those who worry about the debt consequences of deficit spending in a depressed economy — FDR didn’t do enough stimulus, but the spending he did do was not reflected in a spiraling, or even rising, debt burden. And the evidence is consistent with the view that austerity, Hoover-style, may well be self-defeating even in a narrow fiscal sense.”

Supporting the present picture is weak growth of the Conference Board’s Index of Leading Economic Indicators, a monthly snapshot of 12 important indicators that affect future growth, such as interest rates, and hours worked.

"The LEI decreased in two of the last three months, but its level is still about 4.5 percent above its previous peak before the recession began," said Ataman Ozyildirim, economist at the Conference Board. "Moreover, the gains among the LEI components have been widespread, with the exception of housing permits and stock prices, pointing to an expanding economy, but at a slower pace in the second half of the year."

A major reason for continued sluggish growth is that real estate has still to work off more than 1 million units in excess inventory built up over the bubble years. Total units of housing inventory peaked in 2006, but months of supply didn’t peak until 2008, as the sales’ rate declined drastically during the credit crisis and failure of lending institutions such as Lehman Brothers and Bear Stearns.

This increase in inventory is especially bad news because the reported 8.9 months of supply in June is well above normal.

So there is good reason for the Fed to continue to hold interest rates at record lows, and Chairman Bernanke has continued his promise to do so for “an extended period” in his testimony. "We are ready and we will act if the economy does not continue to improve — if we don’t see the kind of improvements in the labor market that we are hoping for and expecting," he said.

Harlan Green © 2010

The Mortgage Corner

The real estate market looks to be in limbo, but there is optimism that growing pent up demand will prevail as the jobs market improves. Although new-home construction has been stagnant, it hasn’t fallen substantially, while commercial property values are beginning to recover.

Single-family housing starts were virtually unchanged from the previous month at a seasonally adjusted annual rate of 454,000 units in June. Meanwhile, a 21.5 percent decline on the more volatile multifamily side weighed down the overall housing production number, which fell 5 percent to a 549,000-unit rate.

"As our most recent member surveys have indicated, builders remain very cautious in light of the sluggish pace of the economic recovery and the hesitancy they are seeing among potential home buyers," noted Bob Jones, chairman of the National Association of Home Builders (NAHB). "However, today’s report is actually somewhat encouraging, because it indicates that single-family production is stabilizing following an expected lull that occurred with the end of the home buyer tax credit program."

Commercial real estate is also showing improvement, according to Moody’s, reaching its low point in January 2010. The Moody’s commercial same-property index has mirrored the Case-Shiller Home price Index improvement, which began its rise in March ‘09, but began its price rise 9 months later, in other words.

U.S. commercial real estate prices increased 3.6 percent in May, the second consecutive monthly increase, as measured by Moody’s/REAL Commercial Property Price Indices CPPI. Commercial real estate prices in April rose 1.7 percent.

“We expect commercial real estate prices to remain choppy in the coming months,” said Moody’s Managing Director Nick Levidy in a release Monday. “The positive news of increasing prices over the past two months is tempered by low transaction volumes, forecasts for slowing macroeconomic growth and the rising risk of a double dip recession.”

Existing-home sales are also stagnant, and may have already experienced a minor double dip. Its future depends on the number of foreclosures still to happen, as a recent study said that in fact banks are selling more homes via REO sales than builders at the moment. Stats show that nationwide, in late 2006 new homes accounted for nearly 20 percent of all transactions, but in early 2009 the new home share was down to 14 percent, and starting in that month there were more REO sales in the preceding 12 month period than new homes sold. So for the last year and a half, banks have sold more houses than home builders, according to Calculated Risk.

Existing-home sales were at a seasonally adjusted annual rate of 5.66 million units in May, down 2.2 percent from an upwardly revised surge of 5.79 million units in April. May closings are 19.2 percent above the 4.75 million-unit level in May 2009, so sales are still positive year-over-year.

The Obama’s Administration’s Comprehensive Housing Initiative has been helping to keep homes out of foreclosure. Its July joint report by HUD and the U.S. Treasury said record low rates have helped more than 7.2 million homeowners to refinance since April of 2009, “resulting in more stable home prices and $12.9 billion in total borrower savings”.

And, HAMP (the Home Affordable Modification Program) has helped over twice as many homeowners compared to foreclosure completions: Nearly three million borrowers have received restructured mortgages since April 2009, outpacing the 1.24 million foreclosure completions for the same period. As more families are able to remain in their homes, household assets continue to rise with $1.1 trillion in home equity gained since April 2009, said the report. A continuation of commercial real estate improvement will be a signal that businesses are recovering, as will job creation, which then will give a boost to residential sales as well.

Harlan Green © 2010

Popular Economics Weekly

Newsweek’s chief foreign correspondent Fareed Zakaria wrote a very interesting column recently. He said, “The American economy is sputtering and we are running out of options…Can anything protect us from the dangers of stagnation or a double dip?”

Well yes. Bring back another “Give ‘em hell” Harry Truman, or have President Obama choose him as a model for how to weather the next year during an election season. President Truman was given that nickname for a reason. The post-WWII economy was going through the same malaise as today. Federal debt had ballooned to 120 percent of GDP to pay for war (vs. 80 percent today), unemployment was high, and Republicans crying deficit reduction had triumphed in the 1946 Congress.

Truman and the Democrats were alone in trying to keep the U.S. economy afloat, in other words. What was his response? Instead of compromising with deficit hawks by cutting spending, he blasted the “do nothing 80^th Congress of that time”, advocating Universal Health Care and extension of unemployment benefits. So when the deficit hawks in Congress voted down those benefits—both ‘blue dog’ Democrats and Republicans, we might add—he was able to blame them for the continuing malaise. Then he upset heavily favored New York Governor Thomas Dewey in 1948—it was one of the most famous comebacks in Presidential history.

Why is this malaise dragging on so long? With some $1.8 trillion in cash sitting on S&P 500 corporations’ balance sheets, and profit margins the highest since WWII, employers are refusing to hire more workers. Overall payroll jobs in June fell back 125,000 after spiking a revised 433,000 in May and after a 313,000 jump in April.  The net revision to combined April and May was up 25,000.

Zakaria maintains this is because of too much economic uncertainty. “"Almost every agency we deal with has announced some expansion of its authority, which naturally makes me concerned about what’s in store for us for the future," said one CEO he interviewed. “Another pointed out that between the health-care bill, financial reform and possibly cap-and-trade, his company had lawyers working day and night to figure out the implications of all these new regulations,” said Zakaria.

But that is not the real reason for the reluctance of businesses to hire. They are flush with cash, and demand is growing, after all. It’s because businesses have been living in a bubble they are reluctant to leave. It is called supply-side economics, because of a succession of business-friendly administrations that believed the bulk of government benefits should be directed to business, rather than consumers. This was mainly in the form of tax breaks, which are of little benefit to consumers—most of whom pay a payroll tax that has never been cut. Business tax breaks are an indirect form of government support, but nevertheless result in reduced revenues.

Yet consumers have been spending more as wages and salaries—80 percent of the workforce—are rising; have been rising in fact since July 2009, the nominal end of the Great Recession.

Even home prices are increasing. Seasonally adjusted, the Case-Shiller Home Price Index 10-city composite advanced 0.3 percent, as we said last week, after rising 0.1 percent in March. The year-on-year rate, a comparison less exposed to seasonal variation than the month-on-month comparison, is at plus 4.6 percent on the unadjusted side and at plus 4.7 percent when adjusted, up 1-1/2 percentage points from March on both scores. Yet with the tax credits expired, price gains are likely to soften in the near term or even turn a little negative.

So what is the lesson from “give ‘em hell, Harry”? Truman was not afraid to take on those who wanted to reduce government, when government was the only support for both businesses and consumers during tough times. Zakaria also admits as much: “The economic crisis forced the government to expand its authority in dozens of areas, from finance to automobiles,” he said.

Businesses and consumers are saying they have lost confidence—in both government and private business to lead us out of this recession. Businesses will begin to hire when such confidence is restored, which means financial regulations are in place they can count on. Real estate prices must continue to rise, as well, before homeowners regain their confidence. So the Obama administration must send out strong signals that such stimulus will continue, until business hiring kicks in.

Harlan Green © 2010

Popular Economics Weekly

As stock and bond investors cringe and run to their rabbit holes on news that European, or even Chinese economic growth may slow, the American consumer doesn’t seem as concerned. Domestic consumer incomes and spending look better in May.

The consumer sector got another boost with a jump in spending power. Personal income in May rose a solid 0.4 percent, following a 0.5 percent advance in April. Analysts had called for a 0.5 percent increase in personal income for the latest month. The key wages & salaries component gained 0.5 percent, matching April’s improvement.

Overall, personal consumption rose a modest 0.2 percent, following no change in April. A jump in auto sales helped offset softness in gasoline and other subcomponents in nondurables, as we said last week. By components, PCEs were led by a 0.8 percent boost in durables-reflecting motor vehicle sales. But services also were robust with a 0.5 percent jump.

Motor vehicles sales spiked to 14.1 million units annualized in August 2009 but plunged to 9.2 million units in September after special incentives ended.  But the good news was that sales returned to trend in just a few months with 11 million unit sales in May.  This was based on a stabilized consumer sector and credit that was not so difficult to get. Non-revolving credit, reflecting strong car sales, jumped $9.4 billion in April, according to the Federal Reserve.

Though consumer confidence is still shaky with conflicting U. of Michigan and Conference Board sentiment surveys, the Case-Shiller Home Price Index showed the first increase in home prices in 6 months. The unadjusted composite 10 index broke a long series of declines with a 0.7 percent surge, a surge that’s less dramatic when seasonally adjusted but still very good at plus 0.3 percent. The year-over-year rate, a comparison less exposed to seasonal variation than the month-to-month comparison, is at plus 4.6 percent on the unadjusted side and at plus 4.7 percent when adjusted, up 1-1/2 percentage points from March on both scores. Details show broad gains across nearly all cities.

The results are consistent with the existing home sales report that likewise showed large price gains in April followed by even larger gains in May, though sales are still flat.

Existing home sales fell 2.2 percent to an annual sales rate of 5.66 million from April’s 5.79 million.  The recent peak in existing home sales was 6.49 million units for November 2009 when the original tax incentives expired.  The more recent bump in sales from the second round topped at April’s 5.79 million units.  High supply will continue to pressure prices which did, however, firm 4.2 percent in May for both the median price ($179,600) and average price ($226,400).  The price gains likely were related to a shift in composition to more expensive homes.

What does this mean? That consumers continue to be cautious spenders, largely because of the current deflationary environment, which means they are counting on prices to fall further. This is a sign that is worrying Nobel economist Paul Krugman, for one. He has been lamenting the current G20 consensus that paying down debts is more important than further stimulus spending.

In other words, consumers pull back when prices are falling, which further damages economic growth. So there is no danger of inflation, which is the fear deficit hawks foster to justify the pain they want to inflict on the real estate market in particular.

Overall, the consumer sector is slowly gaining strength in terms of spending power. Purchases have been a little erratic due to off and on auto incentives and consumer caution in general. But the consumer sector took one step forward in May, helping the recovery continue.

Harlan Green © 2010