Wednesday, May 28, 2008

Week of May 19, 2008--What Does the Future Hold?

“I never think of the future, it comes soon enough,” said Albert Einstein. Even so, economists still love to forecast future business activity. And, there are some fairly reliable indexes that help to predict such activity. The best is perhaps The Conference Board’s Index of Leading Economic Indicators (LEI) that we have mentioned in past columns, which attempts to predict 6 months to 1 year ahead. The Conference Board also has a “Coincident” index with 4 indicators that mirror current economic conditions. Economists use the same 4 indicators to determine if we have entered a recession.

The Conference Board’s Coincident Index is currently split right down the middle. Two of its indicators—personal incomes and manufacturing and trade sales—increased in April, while industrial production and employment were shrinking. We cannot therefore say we have entered a recession.

The LEI that predicts future activity itself is made up of 10 indicators, and is slightly positive. The index rose 0.1 percent for the second straight month, after declining for 5 straight months. Six of its ten components were positive, beginning with higher stock prices. Its six-month average rose to a minus - 1.2 percent from a minus - 2.4 percent. It has therefore been predicting slightly negative overall growth this year.

The fact that the LEI (i.e., future growth) is still negative, while the Coincident Index is flat usually means we are still at the top of the last business cycle. So either slow growth continues, or a recession could still be in the works.

Another good indicator not part of the LEI is the National Association of Realtor’s pending existing-home sales index. It measures home sales under contract but not yet closed, so it is a predictor of future closed sales. March pending sales rose 12.5 percent in the Northeast, but continued to fall in other parts of the country. Overall, pending contract activity is down 20 percent in 12 months.

Of course, economic activity also depends on the inflation picture, which has been eating away at personal incomes and so consumer spending. The Consumer Price Index is still running at a 3.9 percent annual inflation rate, while the Producer Price Index for wholesale goods that go into consumer goods and services is up 6.5 percent.

And that has drained consumers’ pocketbooks. Outside of food and energy, for example, consumer spending was the weakest in 13 years last quarter, says Business Week. This is in fact helping to keep inflation from rising further. So-called ‘core inflation’ without food and energy prices, has risen just 1.2 percent in the past 3 months.

Higher inflation is perhaps the major reason that the Federal Reserve will not lower their short-term rates any further at present. When interest rates are below the inflation rate, monetary policy becomes very stimulative, which is inflationary, as we said in our last column.

Inflation is also fuelled by consumers’ expectations of future inflation. What in fact drives up prices is that consumers are willing to spend more, but only if they have the money to do so. So it really looks like those soaring food and energy prices have brought economic activity to a standstill. We will study its effect on home sales in our next column.

© Harlan Green 2008

Tuesday, May 27, 2008

Week of May 12, 2008--Interest vs Inflation?

This is really a Q&A item. Some of my readers have asked if interest rates are going lower? This is when we are in some kind of mini-recession, at least for homeowners and wage earners in many parts of the country. Doesn’t that mean less of a demand for loans as in 2001, which resulted in record low interest rates?

Well, yes. In fact, conventional, conforming interest rates packaged by Fannie Mae and Freddie Mac are near their record lows—only 0.5 to 0.75 percent above those lows—as we speak. But not jumbo rates, which is where almost all of the subprime grief is contained. That is because it is in those jumbo loan regions, such as California, where most of the defaults are occurring.

Mortgages are backed by bonds, hence the term ‘mortgage-backed’ securities. The bond market looks at several variables, including inflation, which has been rising of late along with gas and food prices. Another demand factor is that much of those low rates were due to foreigners’ excess supply of dollars being reinvested in the U.S. budget deficit.

But federal debt has ballooned—now $9 trillion, up from approx. $4 trillion in 2000. This means too many dollars are floating around the globe, which has caused the dollar’s value to decline by approximately one-third against other major currencies. So there has been a falloff in foreign demand for U.S. bonds and other securities, as foreigners seek investments in other currencies.

However I see a favorable outlook for even lower mortgage rates over time. Inflation should be moderating over the next 2 years, according to Federal Reserve Governor Janet Yellen. This is because wages are barely growing, and wages comprise two-thirds of a product’s cost. Also, the slower housing market will exert a “downward pressure” on economic activity and hence consumer demand through 2009, according to Yellen and other Fed Governors.

The stock market is another factor controlling interest rates, since bonds serve as a flight to quality when stock prices fall. For now, stocks are rallying in anticipation of a second-half-of-2008 recovery, thus keeping rates from dropping further. But a stock market recovery is questionable at best and will probably not boost rates this year. Hence stocks will probably not have much affect on interest rates.

Will the Fed continue to lower interest rates? Not when the Fed’s 2 percent funds’ rate is now zero when inflation is factored in. The core rate of retail (CPI) inflation is currently averaging 2.3 percent over the past year. Inflation would have to come down, in other words, for the Fed to lower rates any more.

The Fed and Alan Greenspan actually lowered the fed funds rate to 1 percent in 2003, which was below the inflation rate. This was the ‘real’ cause of the housing and credit bubbles, since money was in fact less than cheap then. It actually paid to borrow, since inflation shrank the ‘real’ loan amount faster than the interest rates of that time.

CONSUMER PRICE IDEX—The CPI for “All Urban Consumers” rose just 0.2 percent in April, and is up 3.9 percent in a year. The core rate is 2.3 percent in 12 months, so inflation seems to be moderating, mainly because energy prices didn’t rise at all in April. But food prices are still growing 5.1 percent in a year.

Why the 2009 date for a housing recovery? The jumbo loan market could take that long to work through its bad loan inventory. NAR chief economist Lawrence Yun pointed out that homeowners with subprime loans account for less than 10 percent of all homeowners. “Even so, subprime mortgages account for more than half of all foreclosures. Sharp price declines are principally in neighborhoods where subprime lending has been widely prevalent,” he said.

But the typical seller in the first quarter, who purchased their home six years ago, saw a sizable equity gain despite a price drop from a year ago. The median increase in value for sellers who purchased that home in the first quarter of 2002 is 23.8 percent, and the median home equity accumulation is $37,700, said Yun.

© Harlan Green 2008

WEEK OF MAY 5, 2008--Consumer Continue to Spend

American consumers are incredible. At a time when the value of a home is uncertain and job prospects shaky, consumers haven’t abandoned the Shopping Mall. Though banks have less money to lend, the Federal Reserve and now Congress are taking up the slack. The Fed has opened its credit lines to banks so that they can borrow against the mortgage-backed securities they cannot sell.

Congress is already sending out $140 billion in rebates and other relief for consumers. And it is debating giving the Federal Housing Administration another $300 billion to refinance overpriced mortgages, if lenders will take a 10 percent haircut on those mortgages. This should help to stabilize home prices, since something like one-third of all mortgages exceed their home’s value.

Are we really in a credit crunch? One sign that this may be a short-lived downturn is consumers continue to borrow, and retail sales are picking up. Everyone is lamenting the high energy and food prices that now take a 17 percent bite out of their pocketbooks. But the Federal Reserve just reported that consumer’s increased their debt load 7.2 percent in Q1 2008, the largest increase since last fall.

Credit card debt increased a whopping $6.3 billion, while non-revolving installment loans (such as auto) increased $9 billion. Consumers must be feeling more confident to be borrowing that kind of money. In fact, this was the largest quarterly increase in consumer debt since 2003!

What caused all that borrowing? Consumers are beginning to shop again. Among 33 retailers that have reported their April sales, more than two-thirds exceeded estimates, while one-third missed their numbers, according to Thomson Reuters. Discounters led with Wal-Mart and Costco sales up 3 percent.

Another boost to consumers is that the April unemployment rate fell back to 5 percent from 5.1 percent, mainly because 90,000 jobs were added to the service sector. The total number of employed increased by 362,000, while number of unemployed decreased by 189,000, according to the Household survey.

Another encouraging sign is that the Institute for Supply Managers’ March service-sector index rose to 52 percent from 49.8 percent in February. This may be why those 90,000 service-sector jobs were added; mainly in education, health care and professional services.

Yet 110,000 jobs were lost in construction and manufacturing, a sign that the real estate downturn isn’t the only problem. But the first quarter Gross Domestic Product “advance” growth estimate may be revised upward from 0.6 to a 1 percent growth rate, due to a slowing of imports in the latest balance of trade figures.

A bright sign of future growth was that first quarter labor productivity jumped to 2.2 percent, as workers produced more with less hours worked. It will take such higher productivity to keep essential goods affordable in the midst of soaring food and energy costs.

© Harlan Green 2008

Week of April 28, 2008--The Recession Question

No, we are not yet in a recession though consumers’ incomes and spending have not been able to keep up with inflation. The first quarter ‘advanced’ Gross Domestic Product estimate was the same as last quarter’s—0.6 percent growth. A recession means that economic growth has turned negative. So what is keeping growth in the black? Exports, which grew 5.5 percent and added 0.7 percent to GDP growth, negating slower consumer spending.

The Federal Reserve Open Market Committee also announced another one quarter percent rate drop, bringing the Prime Rate to 5 percent. Its press release said that “…economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. (But) The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time...”

This qualifier has convinced most economists that the Fed might now pause to see if the economy does improve. The April unemployment report was not as bad as predicted. The jobless rate actually dropped back to 5 percent from 5.1 percent and just 20,000 payroll jobs were lots, versus the expected 80,000.

And inflation is not exploding in spite of soaring gas and food prices, which now take up 17 percent of household incomes (versus 10 percent in past years). In fact, some inflation is good since rising prices are a sign of a rising demand for goods and services (and short supplies). The economy has grown a healthy 2.5 percent over the past 12 months, even after inflation is factored in.

One reason for the continued economic growth is that the Federal Reserve has been printing lots of money. The money supply has been increasing 12 percent over the past year, and a measure of the current money supply—MZM—increased a whopping 30 percent over the past 2 months thanks to the various stimulus packages from the Fed and federal government.

This doesn’t mean we are completely out of the woods, since real estate subtracted 1.2 percent from Q1 growth. March existing-home sales fell 2 percent with the national median price down 7.7 percent to $207,000 and for sale inventories at a 9.9-month supply.

Other economic indicators show flat growth as well, making this a very feeble recession at best.

LEADING INDICATORS—The Conference Board’s March Index of Leading Indicators (LEI) grew slightly, after 5 consecutive monthly declines. Five of its ten indicators showed growth, which means it is essentially flat growth.

MANUFACTURING—The Institute of Supply Managers’ March index was also unchanged at 48 percent, another flat indicator. But suppliers’ prices are soaring, which could crimp further growth in exports.

We will reach a bottom in home sales when prices no longer decline. In fact, a February price index by the government’s OFHEO of same home sales with conforming loan amounts actually rose 0.6 percent. But the Case-Shiller index for same-home sales in 20 cities that covers homes with jumbo loans as well fell another 3 percent in February and is down 12.7 percent in a year. This shows that the credit crunch is mostly affecting higher-end homes that require jumbo loan financing. Those home prices requiring conventional, conforming mortgage amounts to $417,000 for a single unit seem to be holding their own.

© Harlan Green 2008

Week of April 21, 2008--Some Real Estate is Holding

Home sales are stabilizing, even rising in some regions of the country. This is a sign that prices could soon be stabilizing as well. In fact, 73 of 150 metropolitan areas had an increased median price in the fourth quarter over Q4 in 2006, according to the National Association of Realtors.

And March national existing-home sales actually rose 2.2 percent in the Northeast and West, says the NAR. Its chief economist, Lawrence Yun, reports that sales have stabilized between 4.9 million and 5.1 million in the last 7 months since the credit crunch began.

Utah, Wyoming, North Dakota, and Montana all had price rises of 8-9 percent in Q4 2007, no surprise given their sparse population. And rising employment in Seattle and Portland boosted prices 1 percent in Q4.

Still, a 9.9-month inventory of existing-homes for sale will continue to depress prices in the coastal states that had the greatest price increases over the past year. In fact, economist Yun says that 18 percent of all Multiple Listing Service offerings had negative equity at the asking price, indicating either a short-sale or foreclosure. The overall median-home price is down 7.7 percent over last year to $207,000.

Lower prices are bringing buyers back into the market, however. The NAR’s February Housing Affordability Index is at 135 percent, up from 114 percent last February. It means that a family with a median annual income of $60,000 can now afford a house that is 135 percent of the median income, or $279,450. Affordability has improved because the median price has declined 9 percent in a year and fixed interest rates have fallen 0.5 percent.

EXISTING-HOME SALES—Overall sales fell 2 percent in March, and are down 19 percent in a year. Condo and coop sales actually rose 3.6 percent.

HOUSING PRICES—The Office of Housing Enterprise Oversight reported that same-home prices with conforming loan amounts rose 0.6 percent in February. Prices were down 9 percent in the Pacific Region in a year.

INFLATION—Both the wholesale (PPI) and retail (CPI) price indexes continued higher in March. The PPI soared 1.l percent, but its core rate without food and energy increased just 0.2 percent. The CPI rose just 0.3 percent. This shows that higher food and gas prices are depressing consumer spending. The reduced spending has taken more than 1 percent from economic growth.

Inflation is eating away at the U.S. consumer, in other words. The higher energy and food prices are the main obstacles to a recovery. Inflation normally subsides during a slowdown, but that hasn’t happened yet.

© Copyright 2008

Week of April 14, 2008--Non-traditional Mortgages


One reason for the huge, double-digit increase in home prices from 2003-05 was the growing popularity of so-called “non-traditional”, or adjustable rate mortgages. They were popular in part because interest rates were lower than the inflation rate of that time, which meant no effective interest rate was being charged. And since interest rates were at an all-time low, many borrowers didn’t realize that their ARM indexes could double, bringing up the underlying real interest rate to more than 8 percent in some cases.

Whether fully understood by borrowers or not, nontraditional mortgages are still popular. According to the trade journal Inside Mortgage Finance, nontraditional mortgages accounted for about one-third of all mortgage originations in 2006. A mortgage can be nontraditional because of these features or because of the way it is underwritten (for example, "low-doc [documentation]" and "no-doc" loans).

In a traditional mortgage, the first payment the borrower makes is the same amount as all subsequent payments. Whereas in nontraditional mortgages the study explains, "the borrower faces two payment regimes: an initial regime with low payments and a second regime where payments increase to fully amortize the loan and to compensate the lender for the cost of capital and riskiness of the loan."

But banks are cutting back on most non-traditional programs—at least those with no-doc and low-doc underwriting. So many borrowers of these mortgages can only hope their indexes continue to come down, which is possible if the Federal Reserve continues to drop their overnight and discount rates to member banks.

Economic activity pointed to some slight improvement in industrial production and the Conference Board’s Index of Leading Economic Indicators (LEI). Consumer incomes were still flat after accounting for inflation in March, though retail sales also picked up slightly.

LEI—The Conference Board’s March index of future business activity increased slightly for the first time in 5 months. Its coincident index that tracks the same 4 components used by the National Bureau of Economic Research to designate a recession was stronger. The components--industrial production, personal income, and manufacturing and trade sales increased in March, while payroll employment declined.

RETAIL SALES—Year-over-year sales rose 2 percent, mostly due to higher gasoline prices, but were flat after inflation. Internet and mail order sales were the biggest component, up 2.1 percent.

Inflation is eating away at the U.S. consumer. The higher energy and food prices are the main obstacles to a recovery. Inflation normally subsides during a slowdown, but that hasn’t happened yet. Crude prices have risen 70 percent in 1 year, according to Business Week, “robbing” 1.4 percentage points from U.S. gross domestic product growth. This is in fact what has brought the economy to a standstill.

It remains to be seen if all non-traditional mortgages will be banned. Wall Street is marking down the valuations of those banks still issuing them, including Washington Mutual, Countrywide Financial and Wachovia Bank. If so, it will cut off mortgage credit to a large segment of the self-employed, for which these programs were designed.

© Copyright 2008


The decline in March nonfarm payrolls by 80,000 and 232,000 over the past 3 months, has spurred Congress to come up with a mortgage recovery plan to help homeowners during the housing downturn. One effect of the downturn is that construction employment fell both in residential and non-residential building and contracting, and unemployment in the industry has jumped from 9 percent to 12 percent over the past year.

The latest report by Moody’s showed an increase in mortgages at least 30 days late to 4.46 percent in the first quarter 2008 and the foreclosure rate up to 1.39 percent of total outstanding mortgages. This is not much above long term historical rates of 4 percent for delinquencies and 1 percent for foreclosures, but still is affecting millions of homeowners.

And so the House and Senate are working on rescue packages that would provide $millions for counseling as well as expanding Federal Housing Administration (FHA) mortgage programs with another $300 billion to make it easier for homeowners to refinance into FHA loans, which allow up to 97 percent loan to value on both purchase and refinances.

One controversial provision would ban rebate pricing on mortgages. That would cost borrowers at least a 1 point (percent) origination fee that some borrowers may not be able to afford. The rebate is really financing the origination fee that all lenders charge and must be disclosed in the up front Good Faith estimate. Since fixed rates are priced like bonds (higher rate means lower points, and vice-versa), a so-called ‘zero point’ loan is one where the rates are raised slightly to pay for the origination fee.

The upper chamber granted approval to a package including $100 million in funds for housing counseling, $4 billion for local communities to buy and redevelop foreclosed homes, and a provision that allows losses incurred by businesses to be applied retroactively for four years. The Senate bill also contains a $7,000 tax credit for those who buy foreclosed homes.

Other regulations are being formulated by the Treasury and Federal Reserve to bring investment banks and hedge funds under their control that had been heretofore exempted, which allowed them to buy and sell the exotic mortgage packages with basically no capital requirement. In other words, the packaging was by borrowing with Other People’s Money.

Other news was mixed, with National Association of Realtor’s pending home sales index (PHSI)higher in the West and Northeast, but down in the Midwest and South. The PHSI in the Northeast rose 3.2 percent in February but remains 25.4 percent below a year ago. In the Midwest, the index declined 3.7 percent and is 17.4 percent lower than February 2007. The index in the South fell 5.5 percent in February and is 30.3 percent below a year ago. In the West, the index rose 2.1 percent but is 6.1 percent below February 2007.

The Federal Reserve Open Market Committee (FOMC) is expected to drop their overnight fed funds rate another one-half percent to 1.75 percent at its April 29-30 meeting, which is approaching its all time low set in 2003. This would bring the Prime Rate to 4.75 percent, and more relief to consumer loans and adjustable home equity lines tied to the Prime.

Consumer right now are treading water as spending rose just 2.5 percent in February, with most coming from a $4.7 billion boost in credit card debt. Consumers’ greatest concerns are soaring food and energy prices, and it is affecting consumer confidence. Hence consumers in the latest U. of Michigan sentiment survey raised their 1-year inflation expectation from 4.3 to 4.8 percent.

One of the first signs of a recovery in real estate and the general economy will be better inflation numbers. Right now it is keeping consumer spending at bay.

© Copyright 2008