Tuesday, June 30, 2009

Home Prices

Home prices fell less than forecasted in April. The 10 City and 20 City indices fell 18% and 18.1% (year over year) respectively. This data is a bit dated, mortgage rates bottomed in April. It will be interesting to see how the market responds to higher mortgage rates going forward.

Average Freddie Mac 30 Year Fixed rate (survey rate)

March: 5.00%

April: 4.81%

May: 4.86%

June: 5.42%

U.K. Slowed More Than Expected

The GDP of the United Kingdom dropped 2.4% in the first quarter of this year. Please check the link below for all of the gory details.

The graph above is courtesy of the Office for National Statistics and tracks the growth in real GDP: quarterly change and annual change. Unlike the U.S. report, the headline number IS NOT ANNUALIZED. This number is the quarter to quarter change. To make it apples and apples:

U.S. first quarter: -5.5% annualized growth rate of real GDP

U.K. first quarter: - 9.3% annualized growth rate of real GDP

Not even industrialized nations report data in the same fashion, so please, read carefully when analyzing overseas data.


Monday, June 29, 2009

China: Cautionary Tale


China's banks are an accident waiting to happen to every one of us

It's not just quantity of loans that is important, it's quality too (as we have just learned). Chinese equity markets have rebounded smartly from their recent lows, due in large part to easy money. It may be best to take a breather. Pundits first claimed that the economic crisis would be contained in the U.S., not spreading to the faster growing emerging markets. This was a faulty premise, these emerging markets depend on the U.S. for exports. It seems highly unlikely to me that these same economies can recover without a significant recovery in the U.S.

Sunday, June 28, 2009

New Math, Obama Style


Is stimulus creating jobs? Yes but.....

The above article concerns the number of jobs created by the stimulus package. Aside from actual hiring by the government, I'm not sure how one quantifies the number of jobs saved. Anyway, the White House has a formula that equates each $92,000 of stimulus funds to a job saved/created. OK then, here is my math:

6,000,000 jobs lost during this rec(depr)ession

$92,000 of stimulus needed per job

$552 billion of stimulus to get back to even on the jobs front

If the entire balance of the Recovery Act ($787 billion) was perfectly accessed to create jobs, the total would be 8.5 million.

When was the last time the federal government performed with perfect execution? Also, consider the fact that $650 million was spent on the analog to digital tv converter box program (spent on additional coupons and such). I doubt those funds saved over 7,000 jobs.

Major Economic Releases on the Horizon

Release Period Prior Median
Indicator Date Value Forecast
Case Shiller Monthly YO 6/30 April -18.7% -18.8%
Case Shiller Monthly In 6/30 April 140.0 n/a
Consumer Conf Index 6/30 June 54.9 55.2
ADP Payroll ,000’s 7/1 June -532 -390
Construct Spending MOM% 7/1 May 0.8% -0.6%
ISM Manu Index 7/1 June 42.8 44.5
ISM Prices Index 7/1 June 43.5 47.0
Pending Homes MOM% 7/1 May 6.7% 0.5%
Nonfarm Payrolls ,000’s 7/2 June -345 -350
Unemploy Rate % 7/2 June 9.4% 9.6%
Manu Payrolls ,000’s 7/2 June -156 -150
Hourly Earnings MOM% 7/2 June 0.1% 0.1%
Hourly Earnings YOY% 7/2 June 3.1% 2.9%
Avg Weekly Hours 7/2 June 33.1 33.1
Initial Claims ,000’s 7/2 27-Jun 627 615
Cont. Claims ,000’s 7/2 20-Jun 6738 6740
Factory Orders MOM% 7/2 May 0.7% 0.8%

Saturday, June 27, 2009

Failures Galore

Five more bank failures yesterday, 2009 total now equals 45. All five banks were quite small, I'm not sure if the FDIC is making the best use of their time. There are some good sized banks that are in significant trouble. The longer they linger, the more they will impact the taxpayer.

3/31/09: FDIC Deposit Insurance Fund (DIF) has a balance of $13 billion

5/22/09: FDIC announces special assessment to raise roughly $5.7 billion

Cost of 2nd quarter failures: $9 billion

That would leave the DIF with $9.7 billion. I'm sure the DIF has earned interest on their investments and collected additional premiums, so let's say the DIF has about $10.5 billion on hand.

My guess is that the imminent failure (my opinion) of Corus Bank will cost about $2.97 billion, dropping the DIF well below $10 billion.

The other good sized banks that are in danger of failing (my opinion again) are:

Frontier Bank
Ocean Bank
Westernbank Puerto Rico
AmTrust Bank
R-G Premier Bank of Puerto Rico

Loss estimates: $1.5 billion, $1.6 billion, $2.3 billion, $2.4 billion and $729 million respectively.

The total would be $8.6 billion, collapsing the fund into negative territory. That credit line will undoubtedly be tapped and we will be insuring our own deposits sooner than the markets think.

Friday, June 26, 2009

Personal Income & Spending: What Really Happened in May?

The above graphs track the same information over different time frames. The one on the right focuses on the last few years, highlighting the fact that income growth has stagnated.

Today's report announced that personal income increased $167.1 billion from the previous month. Consumption and savings increased as well: savings expanding at a much faster rate than spending. Please review the graph below.

However, the announcement that private wage & salary disbursements, goods producing industries' payrolls, and manufacturing payrolls decreased at a faster rate than the previous month caught me by surprise. In addition, service producing industries' payrolls and government wage & salary disbursements increased at a slower rate than the previous month. How can income expand without wages expanding?

Great question. The answer is........ "Personal Current Transfer Receipts." This figure increased by $162.6 billion in May, representing almost the entire gain in personal income. BEA's definition below:

Personal current transfer receipts

This component of personal income is payments to persons for which no current services are performed. It consists of payments to individuals and to nonprofit institutions by Federal, state, and local governments and by businesses.

Government payments to individuals includes retirement and disability insurance benefits, medical payments (mainly Medicare and Medicaid), income maintenance benefits, unemployment insurance benefits, veterans benefits, and Federal grants and loans to students. Government payments to nonprofit institutions excludes payments by the Federal Government for work under research and development contracts. Business payments to persons consists primarily of liability payments for personal injury and of corporate gifts to nonprofit institutions.

Please allow me to emphasize: "This component of personal income is payments to persons for which no current services are performed."


Thursday, June 25, 2009

Catching Up With Japan

No doubt can possibly remain, Japan is in the midst of deflation. The graph on the left tracks the year over year change in Japanese CPI. The price index is at the same level it was in August of 1993.

The graph on the right tracks Japan's current account position. As an exporting nation, Japan typically holds a current account surplus. This supply of foreign currency (i.e. US dollars) provides the fodder for the purchase of foreign assets. This is a volatile series, but the trend is clear: slowing global economies are decreasing their purchases of Japanese products. Perhaps this is why prices are falling in Japan.

Where is the Housing Market Bottom?

Back on May 26th, I suggested that the housing market would bottom when the lines on the above graph met again. My basic premise was (is) that housing prices should not significantly outperform inflation over long periods of time. A home is a depreciating asset: there are constantly new homes being built and upkeep of a home tracks inflation.

Feel free to debate my choices of housing price index and inflation measure, but I don't think the conclusions would be materially different.

The model incorporates the growth rate of the indices since the housing market top in the middle of 2006. Holding the growth rates constant, home prices and inflation would meet in August of 2010. At that point, prices would be another 19.2% lower than the last reading (March, 2009). An instantaneous drop of 26.2% would do the same job. It is easy to see that dragging this out will have no benefit. The foreclosure moratoriums and shadow inventory are only delaying the inevitable.

At this point, it appears that we have seen the bottom in mortgage lending rates (see previous posts on mortgage payment levels & affordability). The graphs below track rates and spreads, measuring the absolute level of borrowing and the incremental return required for mortgage lending. Help on this front should not be expected.

Jobless Claims

Another disappointment for the green shooters: 627,000 initial claims & 6,738,000 continuing claims in this week's report. In addition, the previous report's numbers were revised higher: more initial claims and more continuing claims than previously estimated. However, the revision to the continuing claims number was not enough to continue the record streak.

The IUR is still 5.0%, suggesting that corporations feel little need to add workers. Initial claims have now exceeded 600,000 for 21 straight weeks. With the revisions to the previous week's data, my first guess at the June payroll losses is 450,000.

Equity futures are trading around the overnight lows.

Wednesday, June 24, 2009

More on Housing

New home sales were reported today, falling short of forecasts: 342,000 (annualized rate). This means one thing to me: home prices are still too high.

The above graph tracks new home inventory. The number is arrived at by dividing the number of homes available by the most recent monthly sales rate. Although off the highs, this figure is considerably higher than the 20 year average of 5.8 months.

Based on the rebound in mortgage lending rates, it seems that any adjustment to affordability must come through home price. The graph below tracks affordability in terms of monthly mortgage payments.

Durable Goods and Today's Action

New orders for durable goods exceeding economists' estimates, climbing to $163.9 billion for the month of May (March & April numbers were revised a bit lower). Once again, could this signal a bottom? Sure, why not? However, this number is still running 25% lower than it was during 2008. This is certainly a casualty of the housing collapse. Not only are the builders and construction workers directly effected, but appliance factory workers, shippers, etc. are impacted as well.

Yesterday's data included existing home sales. The number came in a bit lower than the consensus estimate. Inventory moved a bit lower, but prices are still well below the trend line. Until housing stabilizes, neither the manufacturing or financial sector will recover.

On a related note, S&P downgraded several securities backed by jumbo prime mortgages. The surprising part of it: paper issued as early as 1998 was impacted. Since mortgages written that far back are not generally characterised by terrible underwriting standards (like 2005 - 2007, especially 2007), one could imply that job losses to stable bill payers are taking their toll on the housing market.

Equity futures are moving higher, Treasuries are moving lower and the dollar can't find a buyer. I can't imagine that much will happen before the Fed announcement this afternoon.

Sunday, June 21, 2009

Inflation Links


Don't believe the hyperinflation hype - dare to make cuts


Why Inflation Isn't The Danger

Some Levity: We All Need a Laugh

US To Trade Gold Reserves For Cash Through Cash4Gold.com

Upcoming Economic Data

Release Period Prior Median
Indicator Date Value Forecast
Exist Homes Mlns 6/23 May 4.68 4.82
Exist Homes MOM% 6/23 May 2.9% 3.0%
Durables Orders MOM% 6/24 May 1.7% -0.8%
Durables Ex-Trans MOM% 6/24 May 0.4% -0.4%
New Home Sales ,000’s 6/24 May 352 360
New Home Sales MOM% 6/24 May 0.3% 2.3%
GDP Annual QOQ% 6/25 1Q F -5.7% -5.7%
Personal Consump. QOQ% 6/25 1Q F 1.5% 1.5%
GDP Prices QOQ% 6/25 1Q F 2.8% 2.8%
Core PCE Prices QOQ% 6/25 1Q F 1.5% 1.5%
Initial Claims ,000’s 6/25 13-Jun 608 600
Cont. Claims ,000’s 6/25 6-Jun 6687 6707
Pers Inc MOM% 6/26 May 0.5% 0.3%
Pers Spend MOM% 6/26 May -0.1% 0.3%
PCE Deflator YOY% 6/26 May 0.4% 0.1%
Core PCE Prices MOM% 6/26 May 0.3% 0.1%
Core PCE Prices YOY% 6/26 May 1.9% 1.8%
U of Mich Conf. Index 6/26 June F 69.0 69.0

Saturday, June 20, 2009

Failure Friday Returns

40 banks have closed so far this year, three of which were closed yesterday. All three banks were on the bad banks list.

I am puzzled by the seemingly haphazard process that the FDIC is following when deciding to shutter a bank. Size is obviously a concern (the larger the bank, the longer it tends to linger), but beyond that, there seems to be no discernible pattern.

This Corus Bank saga is crazy. The bank is beyond repair and management has been selling shares by the millions in the last few weeks. The longer this bank is allowed to exist, the greater the risk to the FDIC. Since the FDIC is running out of money, that means more risk for you & me.

Thursday, June 18, 2009

Ratings Actions


Moody's downgraded a large Credit Suisse structure. Some securities went all the way from Aaa to below investment grade. Ouch.

Last week, Fitch hammered several tranches in a similar fashion: AAA to below investment grade.


Tread lightly if you want to buy financial stocks.

Weekly Jobless Claims

Reported initial jobless claims were in in line with estimates: 608,000 (increase of 3,000). The previous week's number was revised upward (slightly) to 605,000. Continuing jobless claims fell for the first time since January.

Please note:

- Continuing claims were thought to have fallen 2 weeks ago, but the number was revised higher

- Even if the number is not revised higher, we don't know why the number dropped. Was it because people are finding jobs or is it because their benefits expired? A few weeks ago, I made mention of this. The longer the slide in jobs continues, the tougher it becomes to interpret the data.

Wednesday, June 17, 2009

China Taking Up The Slack for the U.S. Consumer?

China's GDP: 54% of U.S. GDP

China's per capita GDP: 12.8% of U.S. per capita GDP

China's largest export destination: U.S. (19.1% of exports)

"Buy China" policy set to raise tensions


I think the rookies will stumble.

Inflation Like Zimbabwe?

I think Marc Faber is great, but come on now.

CPI Drops, Does it Understate Deflation?

CPI increased by 0.1% month over month: consensus estimate was an increase of 0.3%. The year over year drop came in at 1.0%, the largest annual decrease in quite some time. Please note: both figures are seasonally adjusted. The media is reporting a 1.3% year over year drop, this is not seasonally adjusted.

Fingers are pointing to the drop in energy prices as the main cause for the falling CPI. This is indeed a major cause. Energy costs impact consumer prices directly (home heating/cooling, gasoline) and indirectly (food prices, apparel, etc.). However, the largest component of the CPI is an item called Owner's equivalent rent of primary residence (OER). OER's weight is 24.4% of the index. From the BLS:

Rental equivalence.
This approach measures the change in the price of the shelter services provided by owner-occupied housing. Rental equivalence measures the change in the implicit rent, which is the amount a homeowner would pay to rent, or would earn from renting, his or her home in a competitive market. Clearly, the rental value of owned homes is not an easily determined dollar amount, and Housing survey analysts must spend considerable time and effort in estimating this value.

When initially introduced, the rental equivalence index’s monthly movement was calculated by reweighting the rent sample to represent owner-occupied units. Starting with the CPI for January 1987, the rental equivalence index movement was based on changes in the implicit rents of a sample of owner-occupied units. As part of the 1987 revision, BLS drew a new housing sample to replace the old rent sample. The new sample had both owner- and renter-occupied housing units.

As the above graph illustrates, this component has been moving higher as home prices have been tumbling. My question is, why hasn't this component been falling over the same time frame?

Perhaps there are different dynamics in the rental market. Well, the below graph indicates otherwise. The Market Tightness index is a diffusion index. Readings above 50 indicate the market is getting tighter, readings below 50 indicate that the market is easing and 50 indicates that the market is unchanged.

So, home prices have dropped, rental markets are experiencing slack, housing affordability has improved (http://www.realtor.org/research/research/housinginx), yet OER is higher? Any thoughts on this one?

Thank you.

Tuesday, June 16, 2009

Dow Jones Industrial Average 2009

...where it stops, nobody knows.

Based upon revised earnings estimates, I think fair value for the DJIA is 6,882 (drop of 19.1% from today's close). I backed into this number by taking my estimate for the S&P 500 and multiplying that by the the 200 day moving average of their ratio: 723.63 * 9.51

At this point, neither equity index is screaming over bought nor over sold. This will be a tricky couple of trading sessions until the FOMC meeting on the 24th (2 day meeting).

"I.P. Never Lies"

When I was back there in seminary school, an old time trader said to me "I.P. never lies."

Whenever I listened to him, I made money. Every time I forget what he told me.......

Anyway, there is tremendous slack in our economy. Slack = Deflation

Inflation: PPI

The first of the 2 monthly inflation reports was released today: PPI 0.2% month over month increase (lower than forecast).

On a year over year basis, producer prices have fallen 4.7%. This is rarefied territory for our country. This is not hyper-inflationary by the way.

In fact, it is continued deflation. Don't take your eye of the ball my friends. How many hyper-inflationary periods have started with 40% declines in home prices? How many times have gold buyers tried to push the price over (convincingly) $1,000? How many jobs have been lost the the last 18 months? How much have PRIVATE & CORPORATE borrowing decreased?

There is a big jump from where we are now to hyper-inflation.

Oh, and for all of those who have been saying "the market is bidding up oil and commodities and who knows better than the market. It is self fulfilling."

Just like when oil was $140.00 bbl..................

Housing Starts

Housing starts were reported today and the headline print exceeded expectations. Please note that these are rebounds from all time lows.

The above graph does not contain the headline numbers. It tracks the actual monthly activity: not seasonally adjusted, not annualized.

It is easy to pick out the seasonal patterns: May is the average peak, December is the average trough. If the trend continues, today's number would represent the peak activity. Ouch.

What are your thoughts about this number? There is obviously a tremendous supply of housing already, so a low level of starts would aid in the market rebound. However, an increase in starts keeps people working and could be indicative of a market bottom.

Monday, June 15, 2009

Alphabet Soup: ABS CDS

Quick review:

Credit default swaps (CDS) function as insurance policies for certain securities. If a bond defaults, a buyer's loss can be mitigated from the profit generated by the CDS.

CMBX: protection on commercial mortgage backed securities

ABX: protection on residential mortgage baked securities

At this point in the cycle, it is safe to say that the lower rated trances, (single A, triple BBB, triple B-) won't recover. Therefore, the prices will stay pinned at their current levels. The killer here is the higher rated tranches. To attain these higher ratings, these securities have the most stable cash flows in the deal structure. The lower rated tranches get stuck with the initial losses, an attempt to shield the higher rated tranches from diminished cashflow.

It is not working. Whether it's Fitch, S&P or Moody's issuing downgrade notices and warnings or you just take a look at the above graphs, more losses are on the way.

Bankruptcy Update

Please click on table to expand.

Two additions in the last week, including the owner of the Great Adventure theme park.

Wall Street Revenue: Update

The above graphs contain activity through April. It certainly appears that investment bankers will be busier this year than last. However, it is a pale shadow of years past.

Please note the asset backed and non-agency mbs portion of debt underwriting. These figures are virtually non-existent. I believe it is impossible to have the vaunted V shaped rebound consumer spending without these debt markets. This also implies continued weakness in student loan origination.

These borrowers depended on the easy credit afforded to them by the securitization markets. Unless the federal government plans to start lending directly to the people, we will not see this activity again.

Sunday, June 14, 2009

Upcoming Data

Release Period Prior Median
Indicator Date Value Forecast
Empire Manu. Index 6/15 June -4.6 -4.6
NAHB Housing Index 6/15 June 16 17
PPI MOM% 6/16 May 0.3% 0.6%
Core PPI MOM% 6/16 May 0.1% 0.1%
PPI YOY% 6/16 May -3.7% -4.4%
Core PPI YOY% 6/16 May 3.4% 3.2%
Housing Starts ,000’s 6/16 May 458 485
Building Permits ,000’s 6/16 May 498 509
Ind. Prod. MOM% 6/16 May -0.5% -1.0%
Cap. Util. % 6/16 May 69.1% 68.4%
CPI MOM% 6/17 May 0.0% 0.3%
Core CPI MOM% 6/17 May 0.3% 0.1%
CPI YOY% 6/17 May -0.7% -0.9%
Core CPI YOY% 6/17 May 1.9% 1.8%
Core CPI SA Index 6/17 May 218.594 219.031
CPI NSA Index 6/17 May 213.240 214.589
Current Account $ Blns 6/17 1Q -132.8 -84.8
Initial Claims ,000’s 6/18 13-Jun 601 605
Cont. Claims ,000’s 6/18 6-Jun 6816 6839
LEI MOM% 6/18 May 1.0% 1.0%
Philly Fed Index 6/18 June -22.6 -17.4

Friday, June 12, 2009

U.K. Banks React to Rising Rates


Wow, story about U.K. lenders increasing loan to value ratio to keep the business going.

Thursday, June 11, 2009

Impact of Higher Mortgage Rates Revisited

The Freddie Mac Survey Rate (30 year, fixed rate) for this week was just posted: 5.59%

That brings the June average to 5.44%:

revised price for equal monthly payment: $195,300.00

Homeowner's Equity

PLEASE click the above table to expand.

The housing market is in big trouble. Very few homeowners have the economic incentive to stay in their homes. The more protracted this correction becomes, the lower prices will have to go (my opinion).

Option ARM Accounting

Option ARM:

There are 2 key features to this loan, those being the rate component and the option component. ARM refers to the loan being an adjustable rate mortgage. The interest that the borrower pays fluctuates over time (it is usually fixed for an initial period of time) and is linked to a benchmark rate. For example, a loan may be indexed to the 1 year Treasury Bill rate. Each year, the mortgage payment is recalculated using the new rate observation.

This feature has been more common in Europe, but volume picked up in the USA when the overall interest rate level was quite low. In theory, there is nothing wrong or sneaky about these loans. They offer a degree of stability to banks because they can avoid the danger of a flattening yield curve. For the consumer, rising rates usually (I repeat, usually) coincide with higher home values. So their payments may be higher, but their homes are worth more.

The danger, as with most things, is in the disclosure. A consumer must have knowledge of the reset schedule, benchmark rate, initial fixed rate period, teaser features and future personal earnings expectations when making a decision.

The option component refers to the flexibility the homeowner has in making a mortgage payment. Typically, the mortgagee can make a fully amortizing payment (standard principal & interest payment), an interest only payment (only the standard interest due for that month) and a specified minimum payment (less than the interest only payment).

If a borrower does not make the full payment, the residual is tacked on to the balance of the loan. This is referred to as negative amortization. The principal balance actually increases over time.

Rising home prices mitigate the issue of negative amortization because it keeps the loan to value ratio in check. However, when prices fall, the ratio moves markedly higher. In addition, the choice of payments masks the intention of the borrower. A homeowner with every intention of defaulting can stay in the home longer by making very small payments.

A few years ago, I dove into a Washington Mutual annual report. What I found was absolutely horrific. On page 57 of the 2007 annual report is a table that spells out earnings from option ARMS.

December 31,




(dollars in millions)

Loan balance
$ 58,870
$ 63,557
$ 71,201
Capitalized interest recognized in earnings that resulted from negative amortization



Total amount by which the unpaid principal balance exceeded the original principal amount



Balance of loans that experienced a net increase in negative amortization during the year



Percentage of borrowers whose final loan payment of the year resulted in negative amortization:

By number of loans

50 %
51 %
42 %

By value of loans





Of course, the natural question is: How can the bank be sure that they will ever receive that money?

What happens when a loan of that type defaults? Do they restate the previous period's earnings lower?

This product is the single worst idea in financial history and ranks on the top 14 of all time worst human brain droppings.

JP Morgan is now the proud owner of these WaMu loans. Wells Fargo via Wachovia via Golden West also holds a large chunk of this stuff. Several estimates place the amount of these loans originated at $750 billion over the last few years. Not surprisingly, the bulk were backed by California real estate.

One more thing: these loans are subject to recast. Recasting occurs when the principal balance of the loan hits a specified level over a given time horizon. At that point, the mortgage payments are recalculated based on the new unpaid balance. As this occurs, foreclosure will skyrocket.

Weekly Jobless Claims

Initial claims retreated to 601,000: the lowest weekly figure since 1/24/09. This marked the 19th consecutive week of at least 600,000 initial claims.

Continuing claims rose to 6,816,000. The previous week's number were revised higher, so the record streak was not actually broken.

Retail Sales

Retail sales rebounded a bit in May: $340 billion ($338 billion in April).

Here is the bad part: retail sales are 9.18% below last year's pace. These numbers are now back to 2005 levels.

Mover in this months report were building material and garden equipment dealers (+1.3%) and gas stations (+3.6%).

Home Foreclosures

RealtyTrac's number: 321,480 foreclosure filings in May.

The number dropped from the previous month's 342,038, but marked the 3rd straight month over 300,000 (and the 5th out of the last 10). Ten states accounted for 77% of the filings, no real surprise as California, Florida and Nevada still feel the weight of real estate speculation gone wrong.

Wednesday, June 10, 2009

Back to China


China’s Exports Fall by Record After Global Demand Dries Up

...and they are buying iron ore like it's going out of style.

Impact of Higher Mortgage Rates

The above graph tracks the monthly mortgage payment assuming the median new home price and the Freddie 30 year mortgage rate.

March, 2009: home price $209,700; rate 4.81%; payment $1,101.49

April, 2009: rate 4.86%; to keep the same payment, price needed to drop to $208,500 (data released shortly)

May, 2009: rate 5.29%: to keep the same payment, price needed to drop to $198,600

That would be a 4.75% price drop in 1 month. Still shootin' greens partner?

Prospects for Commercial Mortgages


Commercial Mortgage Woes

Tuesday, June 9, 2009

Falling Prices In China


China’s Consumer Prices Decline 1.4%, Aiding Recovery

That is some interpretation by Bloomberg. Anyway, as I said earlier today: China is playing a dangerous game. Falling prices mean that there are too many goods.

Deflation & Debt: Japan

Japanese producer prices dropped by 5.4% (year over year) as announced by the Bank of Japan today.

There are several structural differences between our economy and the Japanese economy. However, their sovereign debt to GDP ratio is approximately 1.4:1 (they have 1.4 yen worth of debt for each yen of GDP) and they are experiencing deflation. Please keep this in mind if you are considering the reflation trade.

More On China



In conversations over the last few days, I have discussed the risks that China is taking with regards to their stimulus package. It was a significant amount of money and it is being deployed in the real economy: manufacturing & production.

It seemed to me that stockpiling was not the way to deal with a global slowdown. Does China know when this will end? It may seem like a good idea to buy industrial commodities when prices drop significantly, but I think it is a rookie mistake. How far will prices drop if the global economy does not rebound when China thinks it will?

Monday, June 8, 2009

Vulnerable Banks

Please click on the above table to expand.

Commercial loan concentration = (commercial & land development loans + commercial real estate loans + commercial & industrial loans) / earning assets

junior lien concentration = (junior lien loans + home equity loans) / earning assets

goodwill ratio = goodwill / equity capital

The list is comprised of banks with at least $20 billion in earning assets and a commercial loan concentration of at least 20%.

China: Land of the (un)Free


China Requires Censoring Software

I get the whole China argument, I do. However, if this is indicative of the state of the State......

Chinese democracy (aside from an album over 10 years in he making) doesn't exist. A republic doesn't exist.

The truly frightening thing is that our country may not be far off from this behavior:


S&P 500 Earnings Review

With 492 of the S&P 500 members reporting, it looks like 1st quarter earnings will total $7.59 (as reported, no operating earnings nonsense). The trailing 12 month tally will be $6.93, a far cry from the high set in June of 2007: $84.92 (yep!).

Valuation is, quite frankly, on another planet. It is possible that the recession is over and this is a bull market. However, there is little caution being exercised by market participants. Protective put buying is low and the market is overvalued by almost 27% in my opinion. To pay 27% more than historical valuations tells me that a bull market is a certainty. How can anyone be that sure of a profit picture that has dropped by almost 100% and a GDP that has dropped by more than 5% for 6 months?

S&P 500 should be at 689, maybe 705 tops.

Inside The Fed's Buying

The focus of this post will be mortgage backed security (MBS) purchases. On March 18 of this year, the Fed announced that it would purchase up to $1.25 trillion of Agency & GSE MBS this year. The purpose of this was to free up funds for mortgage issuance; the Fed was to provide mortgage market liquidity.

There is a major risk with his plan: Wall Street does not have the same motives as The Fed. Wall Street traders want to make money so they get bigger bonuses, The Fed think they can save the economy by pushing down mortgage rates. As a result, you have a market that is not acting rationally and will be prone to move in a volatile fashion (witness the last few weeks in the mortgage market, rate are up at least 0.30%).

Since MBS are subject to prepayments, their prices are sensitive to prevailing interest rates. If you own MBS, you want the market to be as docile as possible. Large upward moves in rates decrease the value of your cash flows and extend the effective life of the MBS, increasing risk. Also, large downward moves in rates encourage refinancing behavior, which shorten the effective life of MBS. This mitigates the benefit of the cashflow being worth more in a falling rate environment.

So we have a buyer (The FED) that does not have to act rationally because they can withstand losses that other market players would not tolerate.

In graph 1 tracks the coupon rate of the Fed MBS purchases. It is clear that the bulk of their buying has been 4.0% & 4.5% coupon MBS. Graph 2 tracks the relative rate environment since the program has begun. Notice that the Fed has not materially change the average coupon, even though the rate environment has move higher. Of course, The Fed is paying a lower price for those securities, but that is not the only concern. The Fed is sending conflicting signals to the market with regards to valuation.