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

To elaborate further on my previous note on the Fed’s Flow of Funds statement and to illustrate the impact of debt on our economy, over the past 10 years total US debt (households, business, government at all levels and domestic financial institutions) has basically doubled from $24.6t at the end of 1999 to $50.9t as of Q2 2009. Nominal GDP has gone from $9.6t to $14.1t over the same time frame, a rise of 47%. Thus in the credit driven economy that we’ve seen over the past 10 years, it has taken more and more debt to generate $1 of GDP growth.

Rochdale Securities Dick Bove argues banks are more vulnerable to failure after Lehman’s collapse.

The Q2 US balance sheet is out via the Fed’s Flow of Funds statement and it reveals that household debt (home mortgages + consumer credit) as a % of disposable income fell to 118% from 120% in Q1 and 123% at the end of ’08 and vs the record high of 127% in ’06. It was last below 100% in 2001 and was at 89% 10 years ago so while we are headed in the right direction in terms of consumer financial health, the process could be a long one. According to the data, the value of household real estate ROSE by $323.4b which is strange considering home prices have continued to decline, albeit at a slower pace. This, in addition to a $1.6t rise in stock prices, led to an almost $2t rise in net worth. For the country as a whole, debt as a % of GDP was little changed at 360% due to an increase in government borrowing at all levels and this is up from 257% 10 years ago.

Helluva month, September ’08 was:

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Source:  CNBC.com

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James Bianco has run Bianco Research out of Chicago since November 1990. He has been producing fixed income commentaries with a circulation of hundreds of portfolio managers and traders. Jim’s commentaries have a special emphasis on: money flow characteristics of primary dealers, mutual funds, hedge funds, futures traders, banks, and institutional investors.

Prior to founding Bianco Research, Jim spent time in New York as Market Strategist for UBS Securities, and Equity Technical Analyst at First Boston and Shearson Lehman Brothers. He is a Chartered Market Technician (CMT) and a member of the Market Technicians Association (MTA).

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Watch Bond Fund Flows, Not Stock Fund Flows

• The New York Times – Cautiously, Small Investors Edge Back Into StocksParticipation in 401(k) plans held steady in 2008, even as the average account lost 28 percent of its value, according to Hewitt Associates, which tracks retirement plans. More people moved their money into cash or bonds for safety, but they did so at the margins. Over all, the contribution rate dropped less than half a percentage point. And in the first half of 2009, when stocks hit their worst levels and then pivoted higher, only 9 percent of investors made trades in their 401(k) accounts, according to Vanguard. At the same time, alternative investments like real estate have suffered mightily, while interest rates on certificates of deposit or even high-yield savings accounts have plunged, making them less attractive. “Inertia has really ruled,” said Pamela Hess, director of retirement research at Hewitt. “The vast majority of participants have changed nothing — not if they save, not how much they save. Nothing.” Now, some of the money that fled stocks for safe harbors like money-market funds and government bonds last year is beginning to return. Even with trillions still sheltered on the sidelines, some $56 billion has poured into equity funds since April, according to the Investment Company Institute. Of course, making money again can do a lot to bolster anybody’s confidence.

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Comment:

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Which bond funds? The chart below details bond fund buying.

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The real story is the public headlong rush into corporate bond via Corporate bond and strategic income funds (the first and last panels above). Interestingly, when spreads peaked in 2002, the public jumped headlong into high yield bond funds. This time they are avoiding these funds in favor of higher quality corporate bond and strategic income funds. So while they are taking more risk, their aggressiveness has not returned as quickly as 2002/2003.

What have corporate spreads done?

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Some interesting mixed data from the builders and permit seekers today.

The Good:

• Total housing starts rose 1.5% last month (seasonally adjusted) to 598,000 annual rate — the highest since November 2008;
• Starts are up 22.5% since January;
• Construction of housing two or more units jumped 25.3%; Construction of 5+ units were 35.3% higher on the month;
• NAHB housing market index rose 1 point to 19
• Building permits in August climbed 2.7% to a 579,000 annual rate

The Bad

• Single-family home starts declined 3.0%
• Overall Housing starts climbed less-than-expected 1.5% (seasonally adjusted 598,000)
• Housing completions dropped 5.5%
• Total starts were very close to the 600,000 annual rate, adding more houses to an already bloated supply of inventory;
• Monthly gain was due to multi-family construction

The Ugly

• Groundbreakings of homes five + units were down 48.2% on the year;
• Completions are off 25.3% in the past year;
• Year over year, housing starts were 29.6% lower than August 2008;
• The expiration of the government’s tax credit for first-time buyers is approaching.

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Sources:
Permits, Starts and Completions
Census Bureau, September 17, 2009

http://www.census.gov/const/newresconst.pdf

Housing starts and permits hit nine-month highs
Greg Robb
MarketWatch, Sept. 17, 2009, 10:46 a.m.

http://www.marketwatch.com/story/housing-starts-permits-at-nine-month-highs-2009-09-17

Housing Starts Post Moderate Rise
JEFF BATER and MAYA JACKSON RANDALL
WSJ, Sept. 17, 2009

http://online.wsj.com/article/SB125319026264319443.html

The Philly Fed survey was 14.1, 6 points more than expected and up from 4.2 in Aug. It’s at the highest level since June ’07 but the components were mixed as the headline figure is not a sum of its parts. New Orders fell to 3.3 from 4.2 and Employment fell by 1.4 points to -14.3. Backlogs did rise by 2 points but still remains negative. Shipments were up almost 8 points and at the highest since Dec ’07. Similar to the Empire survey, there is no sign that inventories are being refilled and in fact they still remain very lean as this category fell by 18 points to -18.1, the weakest since May. But, hopefully this is a backdrop to an eventual pickup. Prices Paid rose almost 5 points but Prices Received fell by 9. The 6 month outlook fell 9 points to the lowest since May. Net-net, manufacturing conditions are improving but hiring remains punk. “Firms expect conditions to improve over the next 6 months, and they expect modest growth in Q3 and Q4 of this year.”

“Extensive participation in the impersonal, transaction-oriented capital market does not seem to me an intrinsic part of commercial banking.”

-Paul Volcker

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In his bluntest speech yet on reforming Wall Street former Federal Chair Paul Volcker called on banks to operate with “far less risk.” Banks need to stick to their knitting, taking in deposits and lending money to people who can afford to service that debt. Further, as federally insured institutions, they should not be “making trading bets with their own capital.” Instead, they should be trading on behalf of their clients, not their own prop desks.

You know, more like, well, banks — and less like Hedge Funds.

This is a welcome change from the milquetoast reform proposals coming out of the Obama White House.

The irony of this is that Volcker is chairman of the White House’s Economic Recovery Advisory Board. One unfortunately gets the sense his advice has been mostly ignored by the White House. Hence, his support of much stricter regulation than the proposals we have so far seen from the banker’s friendly defenders of the status quo, Tim Geithner and Larry Summers.

Excerpt:

“The activities Mr. Volcker criticized have caused banks to incur major losses in recent years. Nonetheless, proprietary trading and related activities appear to be making a comeback as markets have thawed.Mr. Volcker said banks should be banned from “sponsoring and capitalizing” hedge funds and private-equity firms, which are largely unregulated. He also said “particularly strict supervision, with strong capital and collateral requirements, should be directed toward limiting proprietary securities and derivatives trading.”

The activities Mr. Volcker criticized have caused banks to incur major losses in recent years. Nonetheless, proprietary trading and related activities appear to be making a comeback as markets have thawed. He also said collateral and leverage restrictions against the largest nonbank financial institutions “may be needed.”

The comments reflect Mr. Volcker’s long-held view that banks should act more in line with their traditional role and not take extremely risky gambles, which could threaten the viability of commercial banks and expose the Federal Reserve and taxpayers to large risks. Asked after his speech if his comments represent a break with the White House’s proposal, he replied: “Nothing I said today should be a surprise” to the administration.”

Next week, Volcker will appear before Congress, where one hopes he will testify on their inexcusable acquiescence to bank lobbyists, and their inability to reform finance. “Grow a spine, you corrupt, chicken-shit cowards, before the country goes to Hell,” we wish he was overheard to remark.

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Source:
Volcker Calls for Restricting Banks’ Risk, Trading Activity
DAMIAN PALETTA and JOHN R. EMSHWILLER
WSJ, SEPTEMBER 17, 2009

http://online.wsj.com/article/SB125313031639216991.html

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from Yahoo Tech Ticker:

• Reinstate Glass-Steagall Separating banks from brokerage firms guarantees that “when Wall Street hits the wall… it doesn’t cause the banks to do the same,” says Ritholtz, who claims the Act was a major reason why the economy didn’t come crashing down along with stocks in October 1987.

• Repeal the Commodity Futures Modernization Act This rule “allowed derivatives to be exempt from all the rules that affect every other traded financial instrument,” and was a root cause of AIG’s problems, he says.

• Overturning the so-called Bear Stearns rule allowing leverage beyond 12 to 1 The SEC’s 2004 rule change, which eliminated some leverage restrictions on investment banks in favor of capital requirements by type of asset was a mistake, says Ritholtz. “Without overturning that, give us 5-10 years, we’ll be right back where we started.”

• Continuing to allow high-risk trades to be compensated regardless of profitability This issue is one already being addressed by the so-called Pay Czar Kenneth Feinberg.

• Regulating the non bank sub-prime lenders and mandating (and enforcing) lending standards This one is pretty self-explanatory and one few argue as a key reason for the subprime debacle.

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Source:
Forget Obama’s Speech, Here Are 6 Simple Ways to Reform Wall Street
Peter Gorenstein
Yahoo Tech Ticker, Sep 15, 2009

http://finance.yahoo.com/tech-ticker/article/330524/Forget-Obama’s-Speech-Here-Are-6-Simple-Ways-to-Reform-Wall-Street

August Housing Starts totaled 598k annualized, right in line with expectations while the prior month was revised up by 8k to 589k. The gain m/o/m was solely led by multi family construction as single family starts fell and the same can be said about Permits. Permits were 579k, 4k below the consensus but July was revised up by 4k. Both Starts and Permits are at the highest since Nov ’08. Single family starts rose in the Midwest but fell in the Northeast, South and West. With respect to housing construction, the tax credit’s both nationally and in CA, have distorted the housing market in terms of determining what would have happened without them and in the context of an industry that still has too much inventory and didn’t need more building. The fate of the tax incentives are still to be determined but the NAR estimates that about 350k people of the 1.8-2mm that have used the credits to buy their first home would not have bought one without it.