THE BE YOUR OWN ECONOMIST ® BLOG
Today the Fed announced (http://www.federalreserve.gov/newsevents/press/monetary/20080130a.htm)
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
Wednesday, January 30, 2008
Monday, January 28, 2008
Keep Hope Alive
THE BE YOUR OWN ECONOMIST ® BLOG
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 (http://www.realtor.org/press_room/news_releases/2008/ehs_jan08_existing_home_sales_down.html) 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 (http://www.census.gov/const/newressales.pdf ) 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 (http://www.census.gov/const/newresconst.pdf) 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 http://www.beyourowneconomist.com. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of Economic Indicators.)
© 2008 Michael B. Lehmann
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 (http://www.realtor.org/press_room/news_releases/2008/ehs_jan08_existing_home_sales_down.html) 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 (http://www.census.gov/const/newressales.pdf ) 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 (http://www.census.gov/const/newresconst.pdf) 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 http://www.beyourowneconomist.com. [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
THE BE YOUR OWN ECONOMIST ® BLOG
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 (http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/01/25/MNS7UL6SQ.DTL) 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: www.fanniemae.com; www.freddiemac.com; www.fha.gov.
“*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
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 (http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/01/25/MNS7UL6SQ.DTL) 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: www.fanniemae.com; www.freddiemac.com; www.fha.gov.
“*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
THE BE YOUR OWN ECONOMIST ® BLOG
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 (http://money.cnn.com/2008/01/24/news/economy/stimulus_package/index.htm?postversion=2008012417:
“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
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 (http://money.cnn.com/2008/01/24/news/economy/stimulus_package/index.htm?postversion=2008012417:
“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?
THE BE YOUR OWN ECONOMIST ® BLOG
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 (http://online.wsj.com/article/SB120104941530008299.html?mod=todays_us_page_one), 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:” http://www.economics.harvard.edu/faculty/rogoff/files/Is_The_US_Subprime_Crisis_So_Different.pdf.
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 (http://money.cnn.com/2008/01/23/real_estate/merrill_forecast/index.htm?postversion=2008012317) 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
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 (http://online.wsj.com/article/SB120104941530008299.html?mod=todays_us_page_one), 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:” http://www.economics.harvard.edu/faculty/rogoff/files/Is_The_US_Subprime_Crisis_So_Different.pdf.
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 (http://money.cnn.com/2008/01/23/real_estate/merrill_forecast/index.htm?postversion=2008012317) 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
THE BE YOUR OWN ECONOMIST ® BLOG
Today the Fed reduced the federal funds rate by 3/4% (http://www.federalreserve.gov/newsevents/press/monetary/20080122b.htm) 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
Today the Fed reduced the federal funds rate by 3/4% (http://www.federalreserve.gov/newsevents/press/monetary/20080122b.htm) 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 BE YOUR OWN ECONOMIST ® BLOG
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 dot.com 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 dot.com 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 dot.com 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 http://www.beyourowneconomist.com/. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of Economic Indicators.)
© 2008 Michael B. Lehmann
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 dot.com 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 dot.com 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 dot.com 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 http://www.beyourowneconomist.com/. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of Economic Indicators.)
© 2008 Michael B. Lehmann
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