Wednesday, May 27, 2009

May 26, 2009
Peru, ME

Friday, May 22, 2009

Going Parabolic

This is not your usual garden-variety recession. Because total debt in the U.S., public and private, exploded to four times GDP (a once-in-a-lifetime ratio) over the past twenty years, the unwind now underway will be protracted and brutal. As of the end of March, almost 8% of all single-family mortgages were classified as delinquent, up from 3.7% the year before and 1.6 % in March 2006. (Click on the graph above.) The problem? Too many houses--and not enough homeowner equity to justify all that construction.

We began 2009 with 19 million empty homes in the U.S., the most EVER. The vacancy rate stood at 2.9%, the highest since record-keeping began in 1956. Housing starts in April fell to a seasonally adjusted annual rate of 458,000, the lowest since record-keeping began in 1959. Applications for building permits, an indicator of future construction activity, fell to a seasonally adjusted annual rate of 494,000, the lowest since record-keeping began in 1960. In other words, we are seeing numbers NEVER seen before. The overhang is so huge that if all housing starts halted today, it would still take more than two years to work through the inventory at the current pace of sales.

Nationwide, 649,917 homes received at least one foreclosure-related filing in the first three months of this year--more than double the number in the year-earlier period--despite a government-whistled timeout on foreclosure activity at the nation's biggest banks. Now the grace period is up, and banks are racing to liquidate repossessed property before they go belly-up. Largely because of home-mortgage defaults, 33 banks were seized by the FDIC between New Year's Day and yesterday, resulting in a cumulative drawdown of $5.4 billion in the agency's Deposit Insurance Fund (money used to indemnify trapped depositors). Today the 34th failure was announced: BankUnited FSB, with a price tag of $4.9 billion all by itself. That leaves $8.6 billion in the DIF before the hat goes out (again) to the taxpayer.

Can the banks earn their way out of this mess? Not if the economy continues to tank, a likely outcome in light of rising interest rates. The 10-year U.S. Treasury note is fast approaching 3 1/2% (see graph below):

As one would expect in an environment of rising interest rates, applications for home loans have started to decline. According to an index compiled by the Mortgage Bankers Association (MBA), applications this week are down 14% from the week before--and 43% from the April peak. The "green shoots" represented by the refinancing spurts last winter and earlier this spring (graph below) are getting weed-whipped:

[below: updated for week ending June 26, 2009]

Getting back to parabolae, check out the spike (below) in the price-to-earnings ratio of the S&P 500 companies. A reversion to the mean would require either a dramatic increase in earnings or a dramatic decrease in stock prices. Which is more likely? Choose between these two answers: (A) the latter, or (B) definitely the latter.

[update, 05-28-09:]
More data were released today by the MBA in its quarterly National Delinquency Survey, which found that 9.12% of all residential mortgages in the first quarter were delinquent (at least one payment past due), the highest level since the data series began in 1979. Add to that another 3.85% that were somewhere in the foreclosure process, and you've got 1 in 8 loans in trouble. Homes entering the foreclosure process rose from Q4's 1.08% to a record 1.37%.

Thursday, May 14, 2009


(click for larger image)

Economic recovery will be delayed and difficult, and here are two reasons why. First (chart above), the personal savings rate among Americans has turned abruptly upward. That means that purchases of discretionary consumer items will likely remain depressed for some time. Second (chart below), interest rates are headed up despite the recession because the U.S. Treasury is flooding the market with long bonds--too much supply, too little demand. And higher rates are a drag on economic growth. The Federal Reserve hopes to counteract that drag by buying up U.S. bonds. Unintended consequence? Inflation.

Tuesday, May 12, 2009

Shooting Against the Messenger

In the Emperor-has-no-clothes Department (and you thought E.D. stood for erectile dysfunction), financial analyst Meredith Whitney has been opening eyes ever since credit markets went limp in August 2007. Until then, big investment banks ruled. They were posting huge profits by peddling risky derivatives to greedy investors, as well as to unsuspecting state treasurers (that means you, Dave Lemoine) reaching for a few extra basis points of yield on cash reserves. But then skeptics like Madame Whitney began looking closely at (and behind) the banks' balance sheets and said "Hey, guess what, you guys are technically insolvent!" The CEOs at Citigroup and Merrill Lynch soon lost their jobs.

So began a cascade of defaults and bank runs that resulted in the disappearance of some of the biggest names on Wall Street--Bear Stearns, Lehman Brothers, even Mother Merrill. Executives in Brooks Brothers suits began jumping out of windows. Some had parachutes; some hit the pavement. It got so bad that bank operators masquerading as government officials (stand up, Henry Paulson) devised all sorts of taxpayer-funded programs to bail out their brethren. Rarely have acronyms sparked such acrimony: TARP, TALF, and TICKED OFF, to name a few. Congress went along, as it is paid to do.

Is the worst now behind us? Whitney thinks not, despite the fact that bank stocks have pulled out of their nosedive to zero. She believes the recent rally has been cleverly orchestrated by Oligarchy Inc. to provide a brief window of opportunity for teetering banks to issue new stock to smitten investors. Financial statements for the first quarter were massaged, nipped, and tucked to look almost good, earning most banks passing marks in the so-called "stress" tests just concluded by the Treasury Department. Those getting "Incompletes" were given time to raise additional capital. Capital requirements were calculated by extrapolating those puffed-up Q1 earnings.

Whitney insists that those "earnings" are not replicable. She points out that banks are sucking liquidity out of consumers' wallets, cutting credit lines to cardholders by $1 to $2 trillion. And as consumers retrench, sales-tax collections by state governments shrink (never mind the meltdown in income-tax payments caused by nearly 6 million layoffs in the past sixteen months). State and municipal spending accounts for 12% of GDP, so the wind-down becomes self-reinforcing. A V-shaped recovery, in Whitney's view, is highly unlikely. So, for that matter, is an L-shaped recovery.

She is thinking of a shape that is more, um, flaccid. Her pessimism, it must be acknowledged, has begun to grate on some industry cheerleaders. Despite her prescience thus far, she is bound to get it wrong at some future point. It happens to the best of them. But if you're thinking about betting against Whitney and buying into the financial-sector euphoria, you have to ask yourself, "Do I feel lucky today?"

[update, 05-27-09:]
The Federal Deposit Insurance Corporation just released its Quarterly Banking Profile, which shows that the number of "problem banks" in the U.S. increased in the January-March period from 252 to 305, with combined assets at risk approaching a quarter of a trillion dollars. Another 21 banks failed during the same period, the largest number since Q4 1992, shrinking the Deposit Insurance Fund from $17.3 to $13 billion. One bank in five lost money during the quarter. "Noninterest revenue is up at larger banks," pointed out FDIC Chair Sheila Bair, "particularly trading revenues"--meaning that profits were made not by floating a sinking ship, but by rearranging the deck chairs. Even after first-quarter charge-offs of $37.8 billion in bad loans, non-current loans and leases rose by $59.2 billion, or 26%. Of all loans and leases, 3.76% were non-current, the highest level since Q2 1991.

Saturday, May 2, 2009

Biennial Budget 2.0: Pathetic

You would think that an elected official, his last campaign behind him, would exhibit some independence and leadership. You would expect a willingness to confront tough issues head-on and to develop long-term solutions. No posturing, no sugar-coating. A termed-out executive has a rare opportunity to concentrate on the job at hand without the distraction of the next election--to do what is right, not just what is politically expedient.

If you think Maine's governor is rising to such an occasion, think again. John Baldacci seems content to go out not with a bang, but with a whimper, the lamest of ducks. Yesterday Baldacci released a do-over of his proposed 2010-11 budget after reviewing new projections that state revenues will likely come up a half-billion dollars short during the biennium. "This budget makes serious and difficult reductions," he insisted, yet in the same press release he observed that "there are no additional layoffs in this proposal." Say what?

Republicans were perplexed. "I was surprised not to see more significant structural changes going forward," said Senate minority leader Kevin Raye. Current economic and demographic trends suggest that we will not soon be able to afford the level of government spending to which we became accustomed during the past decade. If revenues in Fiscal Year 2010 are going to decline by $200 million, then spending needs to be reduced by the same amount. Yet Baldacci's proposed cuts address only 15% of the shortfall. Where will the rest come from?

$68 M of federal stimulus money (originally targeted for new jobs)
$24 M from the "Rainy Day" fund (none left for Baldacci's successor)
$35 M from income- and property-taxpayers
$16 M from more aggressive collection of tax receivables
$9 M from reduced payments to healthcare providers
$7.5 M from phantom savings yet to be identified
$6 M in "shared" revenues from cities and towns

If that looks like smaller government to you, I have a great deal on a bridge that I would like to sell you.

The latest revenue projections, attenuated though they may be, still look unrealistically high. FY2010 is going to be a real house of horrors, as credit-card defaults, commercial real-estate foreclosures (did you see the winning bid on Boston's John Hancock Tower?), and bank failures will wreak considerable havoc in the national economy. All those "green shoots" that the Fed chairman has been talking about are about to get napalmed. There is no way that Maine's general-fund revenues in FY2010 and FY2011 will remain nearly flat with FY2009, as the Governor currently expects.

But that's O.K., a politician's best friend--a New Commission (fanfare, please)--will do the heavy lifting, tasked with "streamlining" state government. Baldacci, a politician to the end, will do the spotting.