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

At the Columbia School of Journalism yesterday, a large part of our discussion was on how the media should report and interpret economic data. We used GDP and Inflation as the classic example.

By coincidence, the AP had this very astute article on Q2 GDP yesterday afternoon:

"It was a rare bit of stellar economic news. The Commerce Department revised Gross Domestic Product upward last month, saying the broad measure of the economy grew at an annual rate of 3.3 percent for the second quarter, up from an initial estimate of 1.9%.

One problem: A vocal group of analysts and economists isn’t buying it. "Quite frankly, we do not think the report passes the economic commonsense sniff test," wrote economists John Ryding and Conrad DeQuadros at RDQ Economics.

GDP measures the market value of everything produced by labor, plants and properties in the U.S. a total of $14.3 trillion for the second quarter. The government agency charged with calculating the first estimate of each quarter’s GDP has less time to do so than a ten-branch bank has to file an earnings report . . .

Criticisms of second-quarter GDP were more granular. Disbelievers say it was skewed by some of the conventions that make it consistent from one quarter to the next and strip out foreign inflation . . .

Then, there’s the inflation picture. To calculate growth, the government tries to strip out the illusion of growth that comes with higher prices. Nominal GDP, which includes inflation, can look great; but strip out that inflation and the picture can change markedly.

To strip inflation out of the data, the government devises a "deflator" that subtracts inflation from nominal GDP. In the second quarter, that deflator was 1.3, a figure that was half what it was in the first quarter and tied with a 10-year low. Starting with nominal GDP of 4.6 and subtracting that 1.3 deflator, we get real GDP of 3.3.

If the government had used the same deflator as it did for the first quarter, 2.6, GDP would have only been 2.0.

Consumer inflation for July was the fastest it had been in a generation, moving up at a rate of 5 percent for the previous 12 months. Had the deflator been that large, we would have seen negative growth for the second quarter."  (emphasis added)

Normally, we at TBP are months ahead of the MSM. If they are only a few weeks behind, that is a huge improvement.

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Previously:
Q2 GDP = 3.3% (kinda)   August 28, 2008
http://bigpicture.typepad.com/comments/2008/08/gdp-33.html

Is GDP (via BEA) Measuring Growth or Inflation?   August 28, 2008
http://bigpicture.typepad.com/comments/2008/08/are-you-measuri.html

Source:
Critics: GDP fails ‘commonsense sniff test’
AP, 3:45 p.m. ET, Tues., Sept. 9, 2008
http://www.msnbc.msn.com/id/26627761/

Real GDP? Maybe not, critics say
Associated Press, September 8, 2008

http://www.iht.com/articles/ap/2008/09/08/america/Uneasy-Economy-GDP-Challenged.php

An article in the weekend WSJ got me thinking about Real Estate related frauds of all kinds. Titled FBI Probes Unusual Incentives for Home Buyers, it looks at whether the homebuilder’s incentives, if not properly disclosed to a 3rd party mortgage underwriter, was a form of fraud:  

"When home sales began to slow at the start of the downturn, home builders offered buyers incentives — instead of reducing prices — to stimulate demand. The incentives included cars, tuition and credit-card payments, and even cash.

A sign is posted in front of a bank-owned home that is for sale in Richmond, Calif.
Now, federal investigators are questioning whether some of those incentives misled lenders and caused them to write mortgages that were artificially inflated, contributing to today’s home-price crash"

Anyone who follows the real estate market long enough will eventually become familiar with various forms of fraud that at times lurks in the industry. Any industry where large sums of money are involved invites unsavory characters.  With median home prices well over $200,000, housing was no different.

I do not believe Real Estate related fraud, under most circumstances,  is all that widespread or common. One of the many things that made the 2002-2006 housing boom so unusual, however, was that fraud had become pandemic.

What might start out as a minor conflicts of interest slips over time into something more nefarious. When False statements get made to counter- or third parties who in good faith rely on those statements to their detriment, you have the makings of fraud.  And what these types of undisclosed misleading statements become the norm, you have systemic fraud.

The most recent cycle saw many different types of fraud perpetrated by various industry players. All together, these various fraudulent actions contributed in a large way to the extent of the housing boom.

Here are what I see as the most common forms of fraud during the 2002 – 06 cycle:

1) Appraisal Fraud: Many appraisers found they could attract more referral business by inflating their appraisals to whatever the selling price was priced at. In a boom, it became easy to justify such fraud by using similarly priced homes in the neighborhood. Any basis of intrinsic value could be ignored, so long as “comparable” properties sold for similarly over-priced amounts.

The overuse of comparables helped justify prices that were increasingly unsupportable. As prices spiral upwards, the use of comparables becomes meaningless. High prices justify higher prices. It eventually reached the point where honest appraisers petitioned Washington D.C. to intervene in the widespread fraud. (The White House chose not to intervene).

2) Referral Fraud: Complicit in appraisal fraud were the real estate agencies that knowingly steered appraisal referrals to those agents they knew would give them the valuation they sought, rather than a true valuation. The agents and agencies were the enablers — they are the ones who incentivized the appraisers to commit the actual fraud. The agents were the unindicted co-conspirators to appraisal fraud, as they paid for, aided and abetted the actual fraud itself. 

Many buyers do not realize that real estate agents legally represent not them but the seller. They are motivated to close the transaction in order to get their commissions. This can lead to "questionable" referrals (including engineers as well).

3) Application Fraud: It was an open industry secret that mortgage applications were usually completed by mortgage brokers, rather than by the borrowers themselves. “Just leave those lines blank, we will take care of them” was a common refrain. Savvy brokers knew how to meet the requirements of each bank in order to get loans approved. Indeed, the “No credit check, no income verification” loans practically invited this kind of fraud.

That the banks knew what was going on and looked the other way, however, does not make this form of financial deception any less a felony.

4) Underwriting Fraud: Just how aware were the banks that these borrowers were unqualified?

An internal memo from JPM Chase reveals exactly how much the banks understood who they were lending to. It involves Zippy, Chase’s in-house automated loan underwriting system.  The memo’s title: "Zippy Cheats & Tricks." It explains to bank employees how to get an unqualified applicant approved for a mortgage. A Chase spokesperson denied that Zippy Cheats & Tricks was official policy; thus we are reassured that this was only "unofficial policy.”

5) Mortgage Fraud: Anyone who filled
out a mortgage app, and put false information on it committed fraud. I
do not believe, as some fraud apologists have claimed, that this rose
anywhere near the level of what has been so disingenuously termed “predatory borrowing.”

We know it happened on more than a few
occasions. Where the intent was to obtain financing that the borrower
would not have otherwise qualified for, it is fraudulent. That banks
should have been more proactive in protecting against this form of
deception is no excuse.

The bottom line remains that anyone who
overstated assets or income or understated debt or financial
obligations committed fraud.

6) Predatory Lending/False Statements: As of this writing, the FBI has arrested nearly 1,000 in connection to this form of fraud. A significant number of borrowers (I don’t have a definitive number) may have been subject to predatory lending.

There have been numerous examples of lenders deceptively convincing borrowers to agree to loan terms that are abusive. One of the most common versions in recent years was representing an adjustable rate loan as a 30 year fixed mortgage. Anecdotally, I have seen many examples of this.

Note: This list is really just on the home purchase side, and doesn’t even get to the doesn’t include the fraud by Moody’s and S&P in rating the various RMBS, CDO and CLS and other RE related structured products.
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QUESTION:  How many forms of fraud were associated with this last cycle in Real Estate, Mortgages, Securitization, Fund Management, Structured Products, etc. ? What other fraudulent activity took place?

What say ye?

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Previously:
How to Get an "Iffy" loan approved at JPM Chase (March 2008) 
http://bigpicture.typepad.com/comments/2008/03/zippy-cheats-tr.html

Source:
FBI Probes Unusual Incentives for Home Buyers
Investigators Ask Whether Payments Misled Lenders
NICK TIMIRAOS
WSJ, August 16, 2008; Page A2
http://online.wsj.com/article/SB121884641242946145.html

“He said we couldn’t afford to say no to anyone…”

-David A. Andrukonis, Freddie Mac’s former chief risk officer, about Freddie’s CEO, Richard F. Syron

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A quick excerpt from today’s must read article:

"The chief executive of the mortgage giant Freddie Mac rejected internal warnings that could have protected the company from some of the financial crises now engulfing it, according to more than two dozen current and former high-ranking executives and others.

That chief executive, Richard F. Syron, in 2004 received a memo from Freddie Mac’s chief risk officer warning him that the firm was financing questionable loans that threatened its financial health.

Today, Freddie Mac and the nation’s other major mortgage finance company, Fannie Mae, are in such perilous condition that the federal government has readied a taxpayer-financed bailout that could cost billions. Though the current housing crisis would have undoubtedly caused problems at both companies, Freddie Mac insiders say Mr. Syron heightened those perils by ignoring repeated recommendations.

In an interview, Freddie Mac’s former chief risk officer, David A. Andrukonis, recalled telling Mr. Syron in mid-2004 that the company was buying bad loans that “would likely pose an enormous financial and reputational risk to the company and the country.”

Mr. Syron received a memo stating that the firm’s underwriting
standards were becoming shoddier and that the company was becoming
exposed to losses, according to Mr. Andrukonis and two others familiar
with the document."

Astonishing . . . but here is  the money quote:

"Mr. Andrukonis was not the only cautionary voice at Freddie Mac at
the time. According to many executives, Mr. Syron was also warned that
the firm needed to expand its capital cushion, but instead that safety
net shrank. Mr. Syron was told to slow the firm’s mortgage purchases.
Instead, they accelerated.

Those and other choices initially paid off for Mr. Syron, who has collected more than $38 million in compensation since 2003. But when housing prices began declining in 2006, choices at Freddie
Mac and Fannie Mae proved disastrous. Stock prices at both companies
have fallen by more than 60 percent since February, destroying more
than $80 billion of shareholder value.

More than two dozen current and former high-ranking executives at
Freddie Mac, analysts, shareholders and regulators said in interviews
that Mr. Syron had ignored recommendations that could have helped avoid
the current crisis."

This was simply greed on the part of an executive, a transference of wealth from  Shareholders to himself . . .

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Related:
Ruminations on Moral Hazard   
naked capitalism, August 5, 2008
http://www.nakedcapitalism.com/2008/08/ruminations-on-moral-hazard.html

Previously:
Poole: Fannie, Freddie `Insolvent’ After Losses (July 2008)
http://bigpicture.typepad.com/comments/2008/07/poole-fannie-fr.html

FREDDIE MAC: Spending as if they had a good year (December 2007)
http://bigpicture.typepad.com/comments/2007/12/freddie-mac-spe.html

Fannie Mae Looks Like Hell (November 2007)
http://bigpicture.typepad.com/comments/2007/11/fannie-mae-look.html

Source:
At Freddie Mac, Chief Discarded Warning Signs
CHARLES DUHIGG
NYT,  August 5, 2008
http://www.nytimes.com/2008/08/05/business/05freddie.html

One of the fun things about publishing regularly is that on rare occasion, you get to coin a phrase. Publish enough and eventually one of your unique phrases will get some traction.

Folks who write regularly and have created a catch phrase include Doug Kass (Blah-flation), Jeff Saut (Ag-flation) and John Mauldin (the Muddle through Economy).

Inflation Ex Inflation is probably the best known prase I’ve coined, but there have been several others. The most recent was July 2007′s "Retail Slumming."Perhaps one day, the Pervasive Pollyannas of Prosperity will offset the Nattering Nabobs of Negativity.

One phrase I’ve mentioned a lot for several years now is the "Slow Motion Slow Down." The first time I used something close was in January 2006:

"In my mind, the significance of this is that the Real Estate may slow down in a slow motion fashion also."

And then more explicitly a few days later:

"Our expectation for the slow motion slow down rests on Real Estate cooling (which its been doing since August),
home construction and sales slipping, and prices slowly sliding. That
may stop the Fed from tightening appreciably further (2 and through?).
Mortgage rates staying below 6.5% allows Real Estate to maintain a
moderate level of activity — but one that is obviously way off its
prior white hot pace."

Which brings us to today. In a NYTime’s OpEd, Paul Krugman used the phrase "A Slow-Mo Meltdown." To be blunt, it doesn’t have  quite the alliterative pop of Slow Motion Slow Down; plus, a meltdown tends to occur rapidly, and the present meltdown has been going on for nearly a year. (Paul, feel free to borrow "Slow Motion Slow Down" — you’ll find its quite effective!)

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Question: What other interesting words or phrases have crept into the finacial vernacular over the past few years? Anything specific that you particularly like or dislike?

If you can include an author and/or URL, that would be great.   

What say ye?

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Previously:
Retail Follow Up (Friday, July 13, 2007)
http://bigpicture.typepad.com/comments/2007/07/retail-follow-u.html

Top Ticking Real Estate is Different Than Stocks (January 26, 2006)
http://bigpicture.typepad.com/comments/2006/01/top_ticking_rea.html

The Real Estate Soufflé (January 30, 2006)
http://bigpicture.typepad.com/comments/2006/01/clear_signs_tha.html

Source:
A Slow-Mo Meltdown
PAUL KRUGMAN
NYT, August 4, 2008
http://www.nytimes.com/2008/08/04/opinion/04krugman.html

Regarding the prior post (Barron’s: The Bear’s Back), Jason writes in to remind us that: "Barrons had a bull at the pool, on the Cover a few months ago and almost 2000 points ago too." Then the Bear this week…holy moly…who’s zooming who?"

We noted the article that Jason was referencing back in April: Professional Money Managers Are Bullish. The most interesting part of the survey was that 74% of find managers claimed
to be beating the S&P500. (Perhaps only the outperformers responded).

Regardless, here’s an excerpt:

"AND NOW, FOR SOME GOOD NEWS: THE OTHER SHOE isn’t going to drop. After a winter of discontent marked by massive write-offs on Wall Street and a wilting economy on Main, America’s portfolio managers have declared that the worst is over. More than half of the institutional investors participating in our latest Big Money poll say they’re bullish or very bullish about the prospects for stocks through the end of 2008. Their forecasts suggest they’re even more upbeat about the first half of 2009.

Graphic caption: More than 55% of pros think stocks are undervalued, and most plan to boost their holdings in coming months. Why financials could rally.

Much has changed since we took the pros’ pulse last October, little for the better. Oil is up, profits are down, credit’s constrained and a major brokerage is kaput. As for stocks, the Dow Jones Industrial Average peaked Oct. 9 at 14,164, only to plummet to 11,740 before regaining enough ground to land at 12,892.

As a result, our Big Money respondents say, bargains now abound. More than 55% of poll participants think the market is undervalued, while just 10% say it’s overvalued. Eighty-seven percent expect to be net buyers in the next three to six months; only 13% intend to sell more shares than they buy."

Buy Stocks! Buy Financials! turned out to be less than fabulous advice . . .

Whoops!  Same author, too. But to be fair, that column was a wrap up of what the professional investors who were surveyed in Barron’s Big Money Poll had to say.

At least this week’s cover piece is co-written by Randall Forsyth, who is no cheerleader and tends to be more skeptical than most.

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Previously:
Professional Money Managers Are Bullish (April 2008)
http://bigpicture.typepad.com/comments/2008/04/too-much-bearis.html

Source:
Back in the Pool
JACK WILLOUGHBY
BARRON’S COVER, MONDAY, APRIL 28, 2008

http://online.barrons.com/article/SB120916344041346031.html

The consensus in the media is that revisions higher in GDP to 0.9% means that the US has successfully avoided a recession.

I highly doubt that is the case.

The good news is that, and once again, I can comfortably slip into a (rather than mainstream) contrarian recession call. I was uncomfortable when the masses were ever so briefly agreeing with me anyway.

Why do I disagree? As the chart below shows, the revised GDP gains were 1) National Defense spending by Uncle Sam; 2) Inventory builds; and 3) net exports. That leaves the majority of the economy — call it "private domestic demand" — in contraction mode, with an annual rate of -0.4% (vs. -0.7% in advance GDP). Domestic Consumption,  Fixed Investment,  Exports, and State & Local governments all showed quarter over quarter losses. 

Its important to understand the significance of this factor. In the post WW2 era, this is a relatively rare occurrence. Merrill’s David Rosenberg points out that "Over the past five decades, such weakness in private domestic demand occurred barely more than 10% of the time." You can bet those times were not brisk expansions. 

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click for embarrassingly large charts

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charts by Jake

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Plenty of folks seem to think we have wished our way out of a
recession. They need to spend some more time with the actual data.