The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Ron Griess of The Chart Store takes a close look at SPX profitability and comes away unimpressed:

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Astonishing . . .

The higher than expected build in gasoline prices in today’s weekly DOE data is sending front month gasoline futures down 2.5%. This may result, in the next few days, in the very first decline in retail gasoline prices at the pump since April 28th, as measured by the daily AAA national unleaded gasoline price survey. During this period, the average retail price has risen from $2.05 per gallon to $2.68 as of yesterday. Prices bottomed at $1.62 on Dec 30th. This $1.06 rise in gasoline prices since Dec results in an extra $146b annualized that consumers need to cough up.

I discuss Bailout Nation with Aaron Task and Henry Blodget at Yahoo Tech Ticker:

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Source:
Mirror Image: Star Trek and Lessons of the Detroit Bailouts
Aaron Task, Henry Blodget
Yahoo Tech Ticker, Jun 16, 2009 04:41pm EDT

http://finance.yahoo.com/tech-ticker/article/265036/Mirror-Image-Star-Trek-and-Lessons-of-the-Detroit-Bailouts;_ylt=Aj9OQTs7qqqpW6vVUFHV9Jlk7ot4?

The May CPI rose .1% headline, .2% less than expected but the core gain of .1% was right in line with forecasts. Headline CPI y/o/y fell 1.3%, the most since April 1950 and was .4% greater than expected. The core rate rose 1.8% y/o/y. In the CPI, food prices make up a larger portion than energy and thus the .2% gain in energy prices was more than offset by a .2% drop in food prices. Owners Equivalent Rent, 24% of the overall CPI, rose .1% and this component has been a source of debate on where the CPI goes from here as some believe the decline in home purchases and drop in the home ownership rate will boost rents while on the flip side some think many homes for sale will in turn be rented and thus will keep a lid on rents. Apartment rents rose .1%. Net-net, with the continued uptick in energy prices, particularly gasoline and move higher in food prices, the headline CPI declines will start to recede and the core rate remains stubbornly positive.

On Nov 25th ’08, the Fed introduced their plan to buy MBS in order to lower mortgage rates to help jump start the housing market. Over the next 4 months, the average 30 yr mortgage rate fell around 140 bps to a low of 4.61% according to the MBA. However, the main beneficiary of the drop in rates in that time period ended up being refi’s, not purchases. While lowering one’s monthly payment is great, the plan’s focus was on the demand side of housing and the cumulative dollar amount of savings with refi’s is not large enough to move the needle in a $13.5T economy. With the 30 yr rate now back to 5.5%, the MBA today said the level of refi’s have now round tripped back to the Nov 21st level. Purchases fell 3.5%. ABC confidence fell 2 pts to -49 led by the Personal Finance component which fell to the lowest level since early Feb.

This is not nearly as wonky as it sounds — see if you can follow the thought process to the end.

I continue to be surprised at the general criticism and misunderstanding of the securitization process. Some have blamed the repackaging of these debt instruments as an underlying cause of the housing boom and collapse. By extension, goes the thinking, we therefore should blame Fannie Mae (and Freddie Mac) for the collapse.

There are several problems with this explanation:

1) Fannie Mae has been securitizing mortgages for nearly three quarters of a century; If after 70 years of well functioning securitizations, how did this process suddenly cause a collapse? The short answer is it didn’t, something else was the cause;

2) Many parts of the globe where there is no Fannie Mae — from the UK to Spain to South Korea to Australia — had their own boom and bust. Where there is little or no  securitization, but the same boom/bust cycle took place, there must obviously be another explanation for the root cause; As I made clear in Bailout Nation, it was ultra-low rates and an abdication of lending standards that were the causes — not securitization;

3) Securitization has, like all systems, a GIGO problem — garbage in, garbage out.

There have been several attempts to address this last issue. One of the fixes proposed is to require originators who sell mortgages to Wall Street securitizers to retain a portion of the mortgages:

“Lenders would be required to retain at least 5 percent of the risk of losses on each package of loan pieces, known as an asset-backed security. The employees and contractors who originate loans would be paid gradually, and they could get less if borrowers started to default.”

I don’t have a problem with that approach, but I would point out an even more egregious GIGO flaw in the securitization process: The absurd default warranties that the mortgages underwriters used. when selling these debt instruments to WallStreet.  This is one of the ways we concentrated, rather than disbursed lending risks.

Let’s go to a book excerpt comparing the old securitization model with the 2002-07 version:

“This was very different from the way traditional banks operated. To your local banker, a mortgage is a reliable and secured for m of lending. With few notable exceptions, lending standards by banks had always been rigorous. When a traditional depository bank originated a mortgage, it assumed it would hold on to the loan for the full 15- or 30-year term; depository banks felt no compulsion to resell them. Guarding against default over the life of that loan was the key to not only being profitable, but staying in business.

That wasn’t how the newfangled lend-to-securitize originators worked. In one of many examples of misplaced compensation schemes we have seen, they were paid on the volume, not the quality, of their loans. Besides, they didn’t need to find a buyer who was a good risk for 30 years—they needed only to find someone who wouldn’t default before the securitization process was complete. Thus, they had very different standards from the traditional lenders. The sellers of these mortgages made warranties to the Wall Street buyers of this paper that the borrowers would not default for 90 days—enough time for the loans to be sold off and repackaged as residential mortgage-backed securities (RMBSs).

This was a radical change in lending standards.”

- Bailout Nation, The Machinery of Subprime,

Sure, we can make the originators retain 5% of what they have underwritten, but I have a simpler idea is to simply require a warranty that is mor ein line with the term of the loan.

A default warranty of 3 or 6 months on 30 year mortgages is utterly absurd; Instead, we should mandate a 5 year warranty on 15 year mortgages, and a 7-10 year warranty on 30 years. This way, we align the interest of the underwriter with the securitizer and the ultimate buyer of that structured product.

Garbage in, garbage out problem fixed!

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Previously:
Paul Krugman is Wrong About Securitization (March 28th, 2009)

http://www.ritholtz.com/blog/2009/03/krugman-is-wrong-about-securitization/

Can There Be Market Solutions With No Real Markets? (March 30th, 2009)

http://www.ritholtz.com/blog/2009/03/can-there-be-market-solutions-with-no-real-markets/

Sources:
Regulatory Revamp Targets Securities at Heart of Crisis
Sellers of Mortgage Loans to Share In Losses Under White House Plan
Binyamin Appelbaum
Washington Post  June 16, 2009

http://www.washingtonpost.com/wp-dyn/content/article/2009/06/15/AR2009061502523.html

Understanding the Securitization of Subprime Mortgage Credit
Adam B. Ashcraft, Til Schuermann, Staff Report no. 318
Federal Reserve Bank of New York, March 2008

http://www.newyorkfed.org/research/staff_reports/sr318.pdf

Securitisation and financial stability
Hyun Song Shin
18 March 2009

http://www.voxeu.org/index.php?q=node/3287

Our quote of the day:

“The panic’s hasty retreat should not be confused with robust recovery. The rather indiscriminate bounce off the bottom — across virtually all assets and geographies — may be more indicative of a one-time reset, which may or may not be complete.”

-Federal Reserve Governor Kevin Warsh, remarks to the Institute of International Bankers annual meeting in New York.

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Sources:
Defining Deviancy
Governor Kevin Warsh
Institute of International Bankers Annual Meeting, New York, June 16, 2009

http://federalreserve.gov/newsevents/speech/warsh20090616a.htm

Fed’s Warsh warns of false optimism on U.S. economy
Ros Krasny
Reuters Jun 16, 2009 5:41pm EDT

http://www.reuters.com/article/smallBusinessNews/idUSTRE55F5FR20090616

Defining Deviancy
Governor Kevin Warsh
At the Institute of International Bankers Annual Meeting, New York, New York
June 16, 2009

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In a seminal essay delivered about 16 years ago, Senator Daniel Patrick Moynihan offered a striking view of the degradation of standards in society.¹ He observed that deviancy–measured as increases in crime, broken homes, and mental illness–reached levels unimagined by earlier generations. As a means of coping with the onslaught, society often sought to define the problem away. The definition of customary behavior was expanded. Actions once considered deviant from acceptable standards became, almost immaculately, within bounds.²

Society moves on, as it were. Well-meaning efforts are periodically made to treat its failings. But if these efforts prove less than successful, citizens and policymakers alike tend to grow increasingly accustomed to the unfortunate statistics. Every bit the reformer throughout his decades of public service, Moynihan seemed reluctantly resigned to society’s construct: “In this sense, the agencies of control often seem to define their job as that of keeping deviance within bounds rather than that of obliterating it altogether.”³

Given the financial crisis, deep contraction in the real economy, and extraordinary fiscal and monetary responses, I cannot help but wonder what constitutes deviance in economic terms in 2009 and beyond. What level of real economic output and unemployment is expected and, more important, accepted? And what level of volatility constitutes the “new normal”?⁴ As I will discuss, we must be wary of macroeconomic policies that–in the name of stability– may have the effect of lowering trend growth and employment rates.

In Moynihan’s framework, will we in the official sector be accepting of periods of significant financial and economic distress, however infrequent? That is, will deviancy be defined down with the understanding that a rare crisis is the price for dynamic, robust economic growth? Or will the official sector say, “Never again–not on our watch,” and become less tolerant of deviations in economic and financial conditions? Under the mantle of reforming capitalism, will policymakers instead define deviancy up, and seek to guarantee stability in our economic affairs?

I suspect that, for a time, policymakers will be more attracted to this latter path. Stability is a fine goal, but it is not a final one. Long after panic conditions have ended, stability threatens to displace economic growth as the primary macroeconomic policy objective. But we must recognize that the singular pursuit of stability, however well intentioned, may end up making our economy less productive, less adaptive, and less self-correcting–and in so doing, less able to deliver on its alluring promise. This fate, however, does not have to be ours. The U.S. economy is capable, in my judgment, of delivering more.

The Growth Experiment⁵
This most recent boom and bust is not, as they say, our country’s first rodeo, but it may turn out to be the most consequential since World War II. And, here, I am not just talking about the near-term peak-to-trough changes in growth and employment levels, which are likely to prove significant.

Policymakers are revealing new policy preferences and prescriptions–fiscal policy, trade policy, regulatory policy, and monetary policy, chiefly among them. Long after the official recession ends, the choices being made may significantly alter the contour of the U.S. economy. The harder question that remains is whether these changes will prove beneficial.

From the mid-1980s through 2007, U.S. real gross domestic product (GDP) growth averaged more than 3 percent per year, and was less volatile than in previous decades. The average unemployment rate was less than 5-3/4 percent, a full percentage point less than in the previous 15 years. Most notable was the realized acceleration in labor productivity in the mid-1990s.

The bipartisan, pro-growth policies that predominated during this period contributed meaningfully to these gains. Tax and spending decisions generally sought to expand the economic pie. Trade policies were aimed at opening new markets to U.S. products and services, and removing barriers domestically. Regulatory policies permitted failure, and relied in equal parts on capital requirements, regulatory standards, and, no less important, market discipline. As a result, businesses were well positioned to adopt new efficiency-enhancing technologies and processes to excel in the pro-growth environment. These policies helped drive significant productivity gains, and remarkable U.S. and global prosperity.⁶

Read the rest of this entry »

“The end to House price depreciation in the vast majority of areas in this country has at last arrived.” -James Cramer

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Do we even need to mention the absurdity of this?

James Cramer, who has called an inordinate number of Housing Bottoms since the market topped in 2005, now declares that “Housing Has Officially Bottomed.”

What does a bottom look like to Cramer? “Ramping sales, and sales in certain areas are up ten times those of last year, and an end to falling prices. That’s exactly what we’ve seen for the past three months.”

We have seen the housing collapse decelerate, but not stop falling. Price reductions have not ended.

No, we have not seen an explosion in new Housing Starts — rather, this is a noisy volatile series that frequently shows a monthly gain, but continue to show annual falls.

Oh, and that big jump in May housing starts? It is due to a 62% surge in multi-family homes — apartments, high rises, etc. — and not houses. If you want to read anything into it, the Home Builders are showing LESS CONFIDENCE in the Housing market, not more, as Jim asserts in the video.  Rather than building to sell, they are building to rent. Hardly a broad endorsement.

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And relying on a single month pop in this series is sheer foolishness: Each circled monthly number below shows a gain over the prior month — none of which resulted in a housing bottom:>

Chart via Barron’s Econoday

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Previously:
Worst Predictions for 2008 (December 31st, 2008)

http://www.ritholtz.com/blog/2008/12/worst-predictions-for-2008/

Yet Another Greenspan Housing Bottom Call (May 13th, 2009)

http://www.ritholtz.com/blog/2009/05/yet-another-greenspan-housing-bottom-call/

Sources:
Cramer: Housing Has Officially Bottomed
Tom Brennan
CNBC, June 16, 2009

http://www.cnbc.com/id/31388528

Video

http://www.cnbc.com/id/15840232?play=1&video=1155057267

I discuss the Economy and the Market with Aaron Task and Henry Blodget at Yahoo Tech Ticker:

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Source:

Second-Half Recovery Is “Nonsensical”: Economy Still Descending, Ritholtz Says
Aaron Task, Henry Blodget
Yahoo Tech Ticker, Jun 16, 2009 01:34pm

http://finance.yahoo.com/tech-ticker/article/264809/Second-Half-Recovery-Is-%22Nonsensical%22-Economy-Still-Descending-Ritholtz-Says;_ylt=AuAyuITbZBVxUbpbHVEHBddk7ot4?

Immelt was surprisingly compelling at the conference:

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