Wednesday, January 30, 2008

One Half Of One Percent


Today the Fed announced (
a one half of one percent reduction in the federal funds rate. The text of the Fed’s press release follows:

“The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 3 percent.

“Financial markets remain under considerable stress, and credit has tightened further for some businesses and households. Moreover, recent information indicates a deepening of the housing contraction as well as some softening in labor markets.

“The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.

“Today’s policy action, combined with those taken earlier, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks…...”

A comparison of this press release with earlier releases reveals a dramatic shift in the Fed’s priorities away from battling inflation toward forestalling recession.

Stay tuned.

© 2008 Michael B. Lehmann

Monday, January 28, 2008

Keep Hope Alive


The residential-real-estate industry has placed a lot of hope in the president’s proposal to reduce mortgage interest rates on jumbo loans by raising the dollar limits on the mortgages that Fannie Mae and Freddie Mac may acquire.

In its January 24 press release ( the National Association of Realtors (NAR) said:

“NAR projects the higher loan limit would increase annual home sales by nearly 350,000, reduce foreclosures by 140,000 to 210,000, and increase economic activity by $44 billion.”

NAR issued that press release to announce:

Existing-home sales – including single-family, townhomes, condominiums and co-ops – slipped 2.2 percent to a seasonally adjusted annual rate1 of 4.89 million units in December from a pace of 5.00 million in November, and are 22.0 percent below the 6.27 million-unit level in December 2006.”

Update the following chart with these numbers. Existing home sales have fallen by about two million, or around 30%. NAR’s estimated 350,000-sales improvement - that the rescue package could initiate - would help. But by how much and for how long would it halt the slide?

Existing-Home Sales

(Click on chart to enlarge)

Recessions shaded

Today the Census Bureau released ( ) its estimate for December 2007 new-home sales:

“Sales of new one-family houses in December 2007 were at a seasonally adjusted annual rate of 604,000, according to estimates released jointly today by the U.S. Census Bureau and the Department of Housing and Urban Development.”

Examine the chart below. If you update the data in your minds eye, you can see the scope of this unfolding debacle. The decline from 1.4 million at its peak to 604,000 today is almost a 60% drop – about twice as severe as the drop in existing-home sales. Should the decline continue it will be the worst since WWII.

New-Home Sales

(Click on chart to enlarge)

Recessions shaded

Finally, you can view the impact of all this on the residential-construction industry. As the Census Bureau said ( in its January 17 press release:

“Privately-owned housing starts in December were at a seasonally adjusted annual rate of 1,006,000. This is 14.2 percent (±8.3%) below the revised November estimate of 1,173,000 and is 38.2 percent (±4.9%) below the revised December 2006 rate of 1,629,000.”

Housing starts have also fallen by about 60%, about the same as the decline in new-home sales. The last chart makes clear that, should housing starts dip much below one million, this will be the industry’s worst post-WWII slump.

Housing Starts

(Click on chart to enlarge)

Recessions shaded

Keep hope alive………..

(The charts were taken from [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of Economic Indicators.)

© 2008 Michael B. Lehmann

Friday, January 25, 2008

We’ll See – Part Two


Yesterday’s blog discussed the tax-rebate portion of the economic stimulus package.

But there’s another part to the package – designed to boost the sinking residential-real-estate market. The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) make markets in mortgages. Once upon a time, banks made mortgage loans and held those mortgages in their portfolios. The federal government created Fannie and Freddie to allow mortgage originators to sell their mortgages and collect a fee for their services, thereby replenishing the originators capital and allowing the originator to write more mortgages. Fannie buys and holds mortgages, using funds generated by the sale of bonds (debentures) in the capital markets. Freddie buys mortgages and then bundles them into securities that it sells to investors. (You can recognize the forebears of the collateralized debt obligations that investment bankers created to finance their mortgage purchases.)

Problem is: Fannie and Freddie currently can’t make markets in jumbo loans above $417,000. Consequently interest rates are higher on jumbo loans, and these loans have recently become more difficult to obtain. The stimulus package would change that.

Here’s an excerpt from today’s San Francisco Chronicle ( that presents an excellent summary of the proposed changes together with a relevant example.

How stimulus package will work

“What: The tentative economic stimulus package would raise the limits on mortgage loans Fannie Mae and Freddie Mac can acquire. For one year, the limit would be 125 percent of an area's median cost, up to $729,750, a big jump from the current $417,000.* Likewise, the package would raise the limits for Federal Housing Administration loans up to $729,750 in high-cost areas, up from the current $362,000.

“Why it matters: Mortgages backed by Fannie and Freddie carry an interest rate a full percentage point or more lower than "jumbo" loans.

“Local impact: The Bay Area median home price stood at $620,000 in December. If the loan cap is raised, many more homeowners and home purchasers here would qualify for "conforming" loans at lower interest rates.

“Examples: For a 30-year fixed mortgage of $550,000, the monthly savings would be $353, Sen. Barbara Boxer's office said. For a 30-year fixed mortgage of $650,000, the savings would be $417 a month.

“What's next: The package has to pass the House, which seems likely, and then go to the Senate. Congress aims to get a bill to President Bush by mid-February. Experts said if the loan cap is raised, the new limit would be reflected in mortgage offerings almost immediately.

“More information:;;

“*The limit is now $625,500 in Hawaii, Alaska and Guam, which were once viewed as the nation's highest-cost areas.”

This plan would reduce the interest cost on jumbo loans and thereby improve the market for homes in areas were real-estate values are high. The big question, of course, is, “Will it work?”

It will be of some help, but can’t – by itself – correct the fundamental problem. We are in the midst of an asset deflation that some observers believe will become more severe as the year unfolds. As home prices fall, some owners will dump homes in the hope of getting a better price than they might receive a year from now. Potential buyers will hold back, waiting for prices the fall further. Supply is stimulated and demand restrained. Market forces behave perversely during the downdraft until a bottom is finally reached.

The proposed relief will help, but probably not reverse the fundamental – and destructive – forces at work.

© 2008 Michael B. Lehmann

Thursday, January 24, 2008

We’ll See


You’ve probably heard or seen an announcement that the House leadership reached a deal with the Bush administration for a $150 billion economic-stimulus package.

Here’s a description from the CNNMoney web site (

“Congressional leaders and Bush administration officials agreed Thursday on a $150 billion stimulus measure aimed at keeping the economy from falling into recession.

“Most single taxpayers would get $600 and most two-wage households would get at least $1,200. The deal includes an additional amount of $300 per child. A total of 116 million taxpayers will receive checks of some size.

“The main exception: higher-income taxpayers or individuals earning $75,000 or more or couples earning $150,000 or more. They would get reduced rebate checks, or none at all, depending on their income.”

Will it work? We’ll see.

It will boost consumption and will also boost liquidity, and both are necessary. The big question, of course, is, “Will the stimulus be sufficient to keep the economy out of the ditch to which it appears to be heading?”

No one knows, but there are reasons for doubt. Most observers credit the previous stimulus package with assisting the economy’s recovery from the 2001 recession. That shot-in-the-arm arrived at the end of the trough when the economy was poised for recovery. It was not intended to forestall recession.

Congress and the president hope today’s package will prevent recession. Preventing recession and aiding recovery are very different. The former is more difficult than the latter because the economy will eventually recover on its own, with or without stimulus.

And there is the analogous question of whether we are using one bucket of water on a three-bucket fire. The package may not be large enough to deal with the economy’s enormous problems: The mega housing slump, the credit market freeze-up and the high cost of energy. The Fed is helping with its bucket, too, but that may still leave us one bucket short.

© 2008 Michael B. Lehmann

Wednesday, January 23, 2008

Bear Trap?


Wall Street bounced back today. The S&P 500 rose almost 30 points and the Dow climbed by nearly 300. A good day, indeed, especially after so much doom and gloom.

Does this mean the worst is behind us? Probably not. Market volatility has been high over the past year, and sharp down days will follow today’s upside. If we are in a bear market, investors should avoid being trapped by temporary saw-tooth patterns that provide temporary respites. It’s the trend that counts.

An article in today’s Wall Street Journal (, ominously titled, “Stocks Show Classic Bear Signals….,” said in part:

“The current market looks a lot like the beginning of past bear markets, said Paul Desmond, president of market-research firm Lowry's Reports in North Palm Beach, Fla. First, the most troubled stocks decline -- home builders and financial stocks in the current case -- and then others gradually get hit, including small stocks, retailers and technology stocks. Finally even stocks of strong companies are affected.

“As a bear market develops, Mr. Desmond says, trading volume and price movement get heavier and heavier for stocks that are declining, and lighter and lighter on the buying side, as more investors look for a way out. When the selling reaches a climax, the bear market is nearing an end, but Mr. Desmond says he doesn't see any sign of a climax yet.

"We feel we have been in a bear market since July. Everything that we have seen since then has just been a progression, almost like a disease that you are monitoring and the disease is spreading," he says. "We are still a long way from a major bottom."

For an academic treatment of developments, you should look at the January 14, 2008 draft of Carmen M. Reinhart’s (University of Maryland) and Kenneth S. Rogoff’s (Harvard University) “Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An International Historical Comparison:”

The article begins by saying:

“The first major financial crisis of the 21st century involves esoteric instruments,
unaware regulators, and skittish investors. It also follows a well-trodden path laid down by centuries of financial folly. Is the “special” problem of sub-prime mortgages this time really different?

“Our examination of the longer historical record … finds stunning qualitative and quantitative parallels across a number of standard financial crisis indicators. To name a few, the run-up in U.S. equity and housing prices … large capital inflows closely tracks the average of the previous eighteen post World War II banking crises in industrial countries.”

The authors then assemble ample evidence that the U.S. recently trod a well-travelled path (the bubble) and can now expect to continue on the trail to financial crisis and severe recession.

Finally, CNNMoney’s web site ( reported today that Merrill Lynch forecast a 30% decline in home prices – extending through 2010 - before the worst is over. Here’s a quote from the article.

“The brokerage believes that home prices are still far above historical norms when compared to other measures such as rent or GDP. "By our calculations, it will take about a 20 to 30 percent decline in home prices to correct this imbalance," said the report.

“Merrill Lynch believes that housing starts will most likely slide another 30 percent by the end of 2008 - a historic low.

The report says that the inventory situation only continues to worsen, as homebuilders are now looking at more than a nine months' supply. "The current supply/demand environment does not favor a swift recovery in the housing market, in our view," according to the report.”

If Merrill’s prognosis is correct – and the article did point out that the National Association of Realtors believes Merrill is not correct – there’s calamity in store. Households face a wrenching loss of wealth, and that will have dire repercussions throughout the economy.

Some believe that the boom in China and India will remain on track and pull us along before we fall in the ditch. Maybe…….. But you should be aware that these economies are probably at the tail-end of their own bubbles. When they pop, we will suffer too. Remember that their strength depends on heavy investment in plant and equipment and their ability to continually raise exports to the US. If their stock markets pop, investment will shrink. If the U.S. economy weakens, their exports will suffer. Recession, as well as expansion, can reverberate among nations.

The bear could go global.

© 2008 Michael B. Lehmann

Tuesday, January 22, 2008

Panic City


Today the Fed reduced the federal funds rate by 3/4% ( and justified its actions with the following statement:

“The Federal Open Market Committee has decided to lower its target for the federal funds rate 75 basis points to 3-1/2 percent.

“The Committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth. While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets.

“The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.

“Appreciable downside risks to growth remain. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks......”

This was an unusually large cut enacted between regularly scheduled meetings. It also followed immediately on the heels of big losses in overseas stock markets.

There’s a sense of panic in the air. It’s instructive that Wall Street opened sharply lower despite the Fed’s move. It’s now about 1pm Eastern Time and U.S. stock markets still have three hours of trading before they close. The S&P 500 is down only ten points and could close higher for the day. Overall, however, the week has not started well.

© 2008 Michael B. Lehmann

Saturday, January 19, 2008

Who’s To Blame?


The Federal Reserve and the Bush administration are clear: They fear recession and have recommended the monetary (lower interest rate) and fiscal (tax rebate) policies designed to deal with that fear. But, no matter how swiftly they act, it’s doubtful that they can forestall recession. That cake is baked.

Why? Because the magnitude of the problem is far greater than the scope of the proposed remedies. In addition, acknowledging the extent of the problem exposes the Federal Reserve’s role in generating that problem.

To understand, recall the boom of the late 1990s. Capital expenditures soared. The chart below, which depicts business orders for new machinery, illustrates industry’s surge. Then the 2001 crash hit. Orders for new machinery plunged and the Federal Reserve came to the rescue by cutting interest rates. Business capital expenditures recovered sharply, but failed to grow beyond their 2000 peak. In earlier expansions business orders for new equipment doubled their value before the end of the business cycle.

Nondefense Capital Goods

(Click on chart to enlarge)

Recessions shaded

Low interest rates could not resurrect a hi-tech boom initiated by technological change and spurred onward by a stock-market bubble. The Fed’s remedy was not up to the task.

Instead the Fed’s medicine assisted a sector that was in no need of help. The chart below shows that real estate was already booming when it received the Fed’s easy-money blessing in 2001.

New-Home Sales

(Click on chart to enlarge)

Recessions shaded

For decades new-home sales had fluctuated in a range of 400,000 to 800,000 annually before reaching all-time highs in the late 90s. They barely suffered during the 2001 recession. Then, when the Fed depressed interest rates into the basement and held them there, real estate exploded. The new real-estate boom stood on the shoulders of the previous real-estate boom. It would eventually distort the economy.

You have to gaze at the chart above to appreciate the unprecedented nature and the enormity of what the Fed created. This was no ordinary cyclical upturn. This was the economic equivalent of a 100-year flood. To make matters worse, price-inflation did not surge to bring the boom to a timely halt. The Consumer Price Index (CPI) had climbed in the course of earlier building booms, and the Fed had boosted interest rates then to hasten those booms’ demise. The Fed let the latest real-estate boom run (just as it had let the boom run), despite this boom’s enormity, because price-inflation remained mild.

Unfortunately, stock-market and real-estate booms – known as asset inflations - don’t behave like ordinary price inflations. Buyers seek a capital gain and rush in to buy and re-sell. The faster prices rise, the greater the quantity demanded. As a result home prices – adjusted for inflation – recently rose at extraordinary rates to exceptional levels.

Eventually asset inflations collapse of their own accord because the asset’s price rises above any reasonable relationship to the asset’s ability to generate income. The bubble burst when stocks climbed beyond the underlying corporations’ ability to generate greater earnings. The recent real-estate boom began to collapse when home prices soared beyond any reasonable relationship to the rental income those homes could generate.

Now the chickens are coming home to roost. The powers-that-be hope that falling interest rates and tax rebates can encapsulate the outgoing tide. But the underlying distortions won’t just go away. The market is saddled with hundreds-of-thousands of homes that can’t be purchased at prevailing prices. A great asset deflation has begun. And just as asset inflations stimulate demand, asset deflations perversely discourage demand. Buyers will hang back, waiting for prices to fall further. There is a glut of homes and it will take time for the market to absorb that glut.

Unfortunately, many lives and livelihoods will face ruin on the way. Too bad, because Federal Reserve policy created this crisis. The skullduggery surrounding mortgage-lending practices was merely the superstructure of the problem. Skullduggery accompanies every great financial boom (think Enron). The Fed’s fundamental culpability is two-fold: (1) In response to a high-tech recession that falling interest rates could not alleviate, the Fed employed falling interest rates to stimulate a housing sector that was already enjoying boom conditions, and (2) The Fed’s protracted expansionary policy exacerbated an asset inflation whose demise will create a great deal of pain.

Yet this criticism is not directed at those responsible for the Fed’s actions. You can consult any economics text to see that the Fed’s policies were standard fare. It’s monetary policy itself that requires re-examination.

(The charts are taken from [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of Economic Indicators.)

© 2008 Michael B. Lehmann

Thursday, January 17, 2008

Fed Throws In The Towel


Today’s lead New York Times article ( carried the headline “Fed Chief Backs Quick Action to Aid Economy,” and the first sentence said , “Ben S. Bernanke, the Federal Reserve chairman, told Congress on Thursday that he favored quick passage of an economic stimulus package in combination with the Fed’s own measures to support economic growth.”

That’s a clear sign of where the Fed thinks the economy is heading: South. Concerns regarding inflation, while they may be present, no longer drive policy. The Fed wants a full-court press to deal with the recession that’s on our doorstep.

© 2008 Michael B. Lehmann

Wednesday, January 16, 2008

Another Nail


Eight times per year the Federal Reserve publishes an anecdotal summary of economic activity known as the Beige Book. Today’s report ( began as follows:

“Reports from the twelve Federal Reserve Districts suggest that economic activity increased modestly during the survey period of mid-November through December, but at a slower pace compared with the previous survey period. ….

“Most reports on retail activity indicated subdued holiday spending and further weakness in auto sales. However, most reports on tourism spending were positive. Residential real estate conditions continued to be quite weak in all Districts. Reports on commercial real estate activity varied, with some reports noting signs of softening demand. Manufacturing reports varied across industries, with pronounced weakness noted in housing-related industries as well as the automobile industry. Strong export orders and increased demand in industries whose products compete against imports was reported by some Districts. Demand for nonfinancial services remained generally positive, although some Districts commented on continuing weak demand for transportation services.”

Not so robust………..

And another Federal Reserve report released today indicates industrial activity has peaked, probably reached an inflection point and will begin heading south soon. Industrial production was flat in December and capacity utilization declined slightly (

Industrial production measures the output of the mining, manufacturing and public-utility sectors. Capacity utilization asks and answers the following question, “What is the current level of industrial production measured as a percentage of the maximum?” If the maximum output an industry can produce with its current plant and equipment is 100 tons of product a day, and it is currently producing 80 tons of product a day, then that industry is operating at 80% of capacity. Note that capacity utilization compares the level of productive capacity with the actual level of output. Both grow over time. If the percentage is rising, that means industrial production is gaining more rapidly than industry is adding new plant and equipment (productive capacity).

See the chart below for capacity utilization’s record.

Capacity Utilization

(Click on chart to enlarge)

Recessions shaded

The Fed’s latest report reveals that productive capacity (the amount of plant and equipment in place) rose by 1.8% in 2007 and industrial production grew by 1.5%. Both numbers are weak, but the fact that productive capacity increased more rapidly than production is of greater interest. As a result capacity utilization fell by 0,2% in 2007. That’s not much, but (as the chart above reveals) it’s the first time in the recent five-year expansion that capacity utilization has not risen year-over-year. That’s probably an inflection point and production will most likely begin to fall.

More import……… The fact that productive capacity rose while production stalled means that industry will now stop adding more capacity. Why add additional plant and equipment when the utilization rate for the existing stock is falling? Why add more factories and machinery when you’re using the present facilities at a slower pace? And that decision – to cut back on capital expenditures – can only make a bad situation worse. It means that the capital-goods industries will soon follow the construction-related industries south.

(The chart was taken from [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of Economic Indicators.)

© 2008 Michael B. Lehmann

Tuesday, January 15, 2008

Another Nail In The Coffin


This morning’s Bureaus of the Census news releases on retail sales ( made a bad situation look worse. Census reported that retail sales fell 0.4% in December. Many optimists had pointed to the consumer as the economy’s last show of strength. If consumption sinks, too, what’s left?

© 2008 Michael B. Lehmann

Monday, January 14, 2008

This Time It IS Different


The last two business cycles (the bubble and now the real-estate bubble) generated observations that “This time it’s different.” That is, there would be no recession despite the heady boom. In the late 1990s the New Economy advocates suggested that growing productivity guaranteed blue skies forever, and more recently some analysts have expressed faith in a soft landing because of consumer expenditures’ strength.

But the mood has turned gloomy very quickly. Yesterday’s New York Times ( ran a front-page news analysis headlined “No Quick Fix To Downturn,” and today’s Times carried a front-page ( story, “Americans Cut Back Sharply on Spending,” that explained why consumers may not rescue the economy.

Perceptions have changed because there are unique elements to the recent real-estate expansion and bust. Take a look at the following charts.

Existing-Home Sales

(Click on chart to enlarge)

Recessions shaded

New-Home Sales

(Click on chart to enlarge)

Recessions shaded

Residential real estate was not a growth industry until its 1995 – 2005 expansion, and now it will probably shrink back to its earlier size and drag the economy down with it. When this slump is over, and existing-home sales have fallen below 4 million and new-home sales are below 600 thousand, those charts will look like the python that swallowed the elephant. Wall Street mortgage securitization leveraged the Fed’s easy-money policy to enable those huge bulges in sales and building activity. This was like the 100-year flood: An event of epic propostions. Now that sales are plummeting and prices falling, it may be years before the glut of homes can be absorbed.

Historically inflation, and the Fed’s consequent tight-money (high interest rate) response to inflation, generated recession. Building activity resumed and recovery began as soon as inflation subsided and the Fed eased and interest rates fell. Residential building led the economy into and out of recession.

For example, compare inflation’s record in the chart below with the real-estate activity depicted in the charts above. Real-estate activity led the economic expansions of the 1970s, generating inflation and the Fed’s consequent high-interest-rate crackdown. As soon as recession hit and inflation slipped, the Fed eased and interest rates fell and residential building and sales bounced back.

New-Home Sales

(Click on chart to enlarge)

Recessions shaded

The Fed cracked down on inflation once-and-for-all under Paul Volcker in 1981. (The increased availability of imports and enhanced business productive capacity helped, too.) When the great residential-building boom of the 1990s began, chronic inflation was a memory. By the late 1990s existing-home and new-home sales were higher than they had ever been, yet inflation remained relatively mild.

When the bubble burst in 2001, the Fed relied on its traditional remedy to deal with recession: Lower interest rates. The bursting of the bubble had generated a slump in business investment that caused the recession. The Fed’s low interest-rate policy did little to alleviate the glut of hi-tech goods, but it did give home sales a major boost even though residential building was already strong. The Fed's easy-money policy distorted economic activity by helping where it could (i.e. residential real estate), not where it was needed (business capital expenditures). Moreover, as real-estate pushed to ever-greater records, there was no surge of inflation and consequent interest-rate run-up to choke off the boom. The Fed let the boom run, helping a strong sector get even stronger. When home sales, home building and home prices finally began to collapse in 2006, the circumstances were completely different from earlier downturns.

The 2001 – 2006 real-estate expansion was an asset bubble. Asset inflations, such as stock-market bubbles and unlike commodity-price inflations, feed on themselves because the purchaser can hold the asset for re-sale at a higher price. The asset’s use does not diminish its salability. In a speculative bubble such as 2001 – 2006, rising prices encourage – rather than discourage – demand. That led to residential real-estate’s over-building between 2001 and 2006.

In earlier booms inflation and rising interest rates quickly choked off demand, and home prices did not rise much faster than the rate of inflation. That didn’t happen this time, and the Fed refused to curtail the real-estate bubble. Now we are left with an over-priced housing stock that exceeds the nation’s ability to absorb that stock. It may take years of falling home prices and slack building activity to work off that excess capacity, and that may prolong recession more than in earlier downturns.

In the past home owners and home buyers reasonably expected home prices to quickly recover and renew their upward climb. Anyone with equity in a home expected to sell it at a gain. But today’s market is different because homeowners have little equity in their homes and they realize home prices will fall for a while. Why should someone with a $400,000 mortgage on a home whose value has fallen to $350,000 keep making payments when that person expects the home’s price to drop to $300,000? What’s the rational response? Walk away and let the bank foreclose. But that home will remain on the market (for sale or for rent) and further depress prices. In response to these conditions some homeowners may sell and some prospective buyers may postpone entering the market because they fear prices will fall even further. In other words, falling prices have may have begun to increase supply and depress demand.

This time it is different.

(The charts are taken from [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of Economic Indicators.)

© 2008 Michael B. Lehmann

Thursday, January 10, 2008

The Chairman Speaks


Today, in an address given in Washington, D.C., Ben Bernanke, the Federal Reserve’s Chairman, acknowledged that the economy has deteriorated even as credit-market conditions have – in his view - improved somewhat. You can peruse the full text at

Here are excerpts of Mr. Bernanke’s key remarks.

“Recently, however, incoming information has suggested that the baseline outlook for real activity in 2008 has worsened and the downside risks to growth have become more pronounced. …. On the whole, despite improvements in some areas, the financial situation remains fragile, and many funding markets remain impaired.

“A second consequential risk to the growth outlook concerns the performance of the labor market. ….

“Even as the outlook for real activity has weakened, there have been some important developments on the inflation front. Most notably, the same increase in oil prices that may be a negative influence on growth is also lifting overall consumer prices and probably putting some upward pressure on core inflation measures as well. …. Accordingly, in the months ahead we will be closely monitoring the inflation situation, particularly as regards inflation expectations.

“Monetary policy has responded proactively to evolving conditions. …. The Federal Reserve took these actions to help offset the restraint imposed by the tightening of credit conditions and the weakening of the housing market. However, in light of recent changes in the outlook for and the risks to growth, additional policy easing may well be necessary. … Based on that evaluation, and consistent with our dual mandate, we stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks.”

The Chairman remains concerned about inflation, but his focus has increasingly shifted toward the recession that some – perhaps including Mr. Bernanke - believe is now unfolding.

© 2008 Michael B. Lehmann

Wednesday, January 9, 2008

Even The Fed Is Not Unanimous


On January 8 the Fed released ( a summary of recent deliberations by the regional Federal Reserve Banks on whether or not they should lower the discount rate at which the Fed lends to banks. (Don’t confuse this rate with the Federal Funds rate, which is the rate at which banks lend to one another.)

Eight of the twelve regional Federal Reserve Banks concluded:

“Federal Reserve Bank directors in favor of reducing the primary credit
rate by 25 basis points generally agreed that the downside risks to economic growth had increased and that conditions in financial markets had recently deteriorated. Some directors thought that a reduction in the primary credit rate might improve liquidity in the interbank term funding market. In light of the financial market situation and other factors affecting economic prospects, these directors concluded that reducing the primary credit rate to 4-3/4 percent would be sufficient at this time. “

Two of the banks wished to cut even further:

“Federal Reserve Bank directors in favor of a 50-basis-point reduction expressed similar concerns. They believed, however, that financial market conditions and the economic outlook necessitated a larger reduction in order to provide some insurance against a more serious economic downturn. Accordingly, they supported a primary credit rate of 4-1/2 percent.”

And two banks believed no cut was necessary:

“Federal Reserve Bank directors who preferred to maintain the current primary
credit rate of 5 percent considered the incoming evidence of a slowdown in economic growth to be within their expectations and viewed the re-pricing of credit to be a necessary adjustment. In the absence of new material information, they considered concerns about a slowdown in economic activity to be offset by continued inflation pressures and judged that an unchanged primary credit rate was appropriate.”

You’re in good company if you’re undecided whether or not recession or inflation is the greater threat, although the large majority of the Federal Reserve banks voted to reduce the discount rate.

Meanwhile, on the same day the Fed also reported ( that consumer credit grew by $15.5 billion at a seasonally-adjusted annual rate. Multiplying by 12, that’s the annual equivalent of $186 billion. If you place that figure on the chart below, you can see no sign of weakness in the December data. Consumers borrowed heavily to support their purchases. Was that noise in the data? A fluke? Or is the economy really stronger than many observers realize?

Stay tuned.

Consumer Credit

(Click on chart to enlarge)

Recessions shaded

(The chart is taken from [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of Economic Indicators.)

© 2008 Michael B. Lehmann

Tuesday, January 8, 2008

How Bad A Recession?


More and more observers are turning gloomy regarding the economy’s outlook. If they are correct, and the economy faces recession, how bad will it be and how long will it last?

Yesterday’s blog drew your attention to the collapse of new-home sales by reporting November’s 647,000 sales rate. Update the chart below with that number and you’ll have an idea of the seriousness of the housing debacle.

New Home Sales

(Click on chart to enlarge)

Recessions shaded

Yesterday’s blog also commented on the disproportionate size of the 1995 – 2005 housing boom. The boom raises the question: “Were too many homes built, and how long before we can reasonably expect a construction revival?” It seems clear that low interest rates and risky financing encouraged speculation that put more homes on the market than the nation could afford. Now that the mania is over and the bubble is deflating, a related question is: “By how much must home prices fall to encourage renewed growth?”
Two recent articles in The New York Times and The Wall Street Journal indicate that the housing slump may be protracted and it will be a long time before we see a strong housing recovery. The New York Times article, by Peter Schiff on December 26, 2007, pulls no punches:

“We are suffering from a home value crisis, not simply a credit crisis….A recent study by the Federal Reserve Bank of Boston found that most foreclosures result from falling home prices, not from the resetting of mortgage rates…..

“Whether or not their payment levels are frozen, borrowers with loans that are greater than the values of their homes will have few incentives to keep paying their mortgages or to maintain their properties. Why spend more on a home in which they have no equity and which they may lose to foreclosure anyway?

“Everyone seems to agree that a return to traditional lending standards is a good idea, but no one seems willing to accept a return to rational prices as a consequence..…

“While the bubble was inflating, self-serving explanations were offered for why traditional formulas of home valuation no longer applied. As it turns out, the laws are still in effect. These traditional measures, like the relationship between home prices, rents and income, indicate that prices need to fall at least 30 percent more nationally. The sooner this balance is achieved, the sooner lenders will again commit capital. “

Why pay off a $400,000 mortgage on a home that is worth only $300,000? As long as people have an incentive to walk away from their homes, it is hard to see why prices should stop falling.

Moreover, as Greg Ip said in the January 3, 2008 Wall Street Journal, home prices must fall much further to reclaim their traditional relationship to rental payments:

“U.S. house prices "likely would have to fall considerably" to return to a normal relationship with rents, says a study by one former and two current Federal Reserve economists.

“…. the rent/price ratio is about a third below its long-term average. To return to normal would require some combination of falling prices and rising rents. The paper suggests house prices would need to fall about 3% a year, if rents grew in line with their 4% average annual growth this decade.

“Mr. Davis said the authors postulated a five-year horizon for the rent/price ratio to return to normal by looking at previous downturns. "When a downturn begins, it will last for a while."

Since it’s hard to imagine rents will rise rapidly if there is a glut of homes on the market, home prices must fall considerably. That price decline reduces the incentive to buy, and therefore build, residential real estate.

This observation bears repeating. It may be true that home prices must fall to attract renewed buyer interest, but it is also true that falling prices scare-away buyers. That’s the problem with asset inflations and deflations and why bubbles form and deflate. Rising prices attract speculators until the fundamentals become unbearable. Falling prices repel buyers until the fundamentals are undeniable. That’s why it takes a while for the bubble to inflate, and may take equally long to deflate.

That creates a grim prognosis for the residential construction industry and the entire economy. This may be no ordinary housing bust. Lending practices and speculation may have super-sized it.

(The chart is taken from [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of Economic Indicators.)

© 2008 Michael B. Lehmann

Monday, January 7, 2008



Friday’s employment report reinforced the perception that the economy is waning: Job growth slowed to 18,000 from 115,000 and the unemployment rate rose to 5.0% from 4.7%. Goods-producing sectors, such as manufacturing and construction, lost 75,000 jobs while service sectors, such as education and health, grew by 93,000.

This continues the struggle between the goods-producing and service sectors. The former have contracted while the latter have grown. Those who forecast recession believe the goods-producing losses will eventually overwhelm the service-sectors’ gains, and the overall economy will begin losing jobs. As you can see from the chart below, we’re almost there now.

Job Growth

(Click on chart to enlarge)

Recessions shaded

There is always noise in the data – random monthly swings from the trend line. But the trend is definitely downward. If it continues, we will be in negative territory soon.

The employment pessimism stems from the manufacturing and residential-construction malaise. The Institute for Supply Management reported that its manufacturing index fell to 47.7% in December: Examine the chart below to place that figure in perspective.

Purchasing Managers’ Index

(Click on chart to enlarge)

Recessions shaded

Once again, the trend is clear: The index is falling, and any figure below 50 is evidence of contraction.

The residential-construction slump is responsible for manufacturing’s drop. The building slowdown affects a host of manufacturing industries: Lumber and building materials; heating, cooling, kitchen and laundry equipment, and furniture and furnishings. The news here is grim, and keeps getting grimmer.

The Census Bureau recently announced 647,000 new homes sold in November: Compare that to the trend in the chart below.

New Home Sales

(Click on chart to enlarge)

Recessions shaded

There are two observations that leap out at the viewer. First, new-home sales have fallen by half and keep on shrinking. Manufacturing and overall employment will continue to deteriorate as long as new-home sales maintain their downward trend. Second, the enormity of the 1995-2005 boom is apparent: and raises this question: Are we over built? If we are, then the upcoming slump could last for some time. An excess inventory of new homes could depress building for a while, keeping manufacturing and employment in the doldrums.

(The charts were taken from [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of Economic Indicators.)

© 2008 Michael B. Lehmann