Volume Volume Volume

How do you lose $1,227 per vehicle? Volume Volume Volume.
Reuters is reporting G.M. Sold Lots of Cars and Lost $1,227 Each

• General Motors lost an average of $1,227 for each vehicle in the first half of the year in North America, while its crosstown rival, the Ford Motor Company, lost $139, according to new research from Harbour Consulting.
• "G.M. has two to three people sitting at home for every single person working today, and that has a huge legacy-cost impact on them," Laurie A. Felax, vice president of Harbour Consulting, told an automotive conference on Monday. "It wipes away any profit that they have."
• By contrast, the three largest Japanese-owned automakers - Toyota, Honda and Nissan - all made well over $1,000 a vehicle in North America. Nissan's profit averaged $1,826 a vehicle; Toyota $1,488; and Honda $1,203 in the first half of their 2005 fiscal year, Ms. Felax said.
• Japanese automakers, which continue to gain United States market share, have high profit per vehicle because they have more efficient manufacturing operations and lower benefit costs for retired workers, Ms. Felax said.
• The relatively new plants of the Japanese automakers in North America also have younger workers and a mostly nonunion work force.
  

General Motors is clearly not long term viable as we noted in GM Expectations just a few days ago. What's holding up the stock then? Perhaps it's people thinking the government will not let GM go under, perhaps it's sheer silliness, perhaps in this yield starved world people playing for dividends think they can all get out in time before some sort of "event" happens.

Some people think that Kerkorian may be a white knight for GM.

His plan to inject $870 million into the automaker, increasing his stake to just under 9 percent, provided a vote of confidence in GM. "Kerkorian has a reputation for turning his investments into gold".

Short term, Kerkorian did force up share prices by offering to buy GM shares well above market cost. With GM losing market share in North America and struggling as well to rein in crippling health care and pension costs, in the face of a very nasty consumer led recession coming up, I see it all as misguided hope.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Concern Over Oil

I have received many questions about oil recently.
Indeed, given its importance to the world's economy Mish pleads "guilty as charged" for failing to comment on this vital economic component. I hope to correct that oversight with this post.

Here are four typical questions from my blog and/or from the message boards I post on.

1) Mish, I've been wondering about oil prices and a common explanation we always hear as to why they are so high. I don't think I've ever seen this covered before so I was wondering if you'd take a shot.

2) Mish, I would also like to know what you think about the high oil prices. Andy Xie from Morgan Stanely believes oil prices are high due to speculation and are due to fall sharply in the medium term. See Asia/Pacific: Scary Oil

3) Mish, why are oil prices going up with oil reserves at 5 year highs and crude in contango?

4) Mish, Please respond to Noland's Thesis in a thoughtful, analytical and classy manner.

First off let me state that I am a firm believer in the concept of "Peak Oil". No meaningful discussion about oil can commence unless and until one has at least some knowledge about that concept.

Peak oil is the point in time when extraction of oil from the earth reaches its highest point and then begins to decline. We won't be able to say with certainty when we have reached peak oil until after the fact. Many experts say we have already reached the peak. Others say not yet, but within the next few years.

I am pretty sure most Mish readers are familiar with the idea, but if not here are three good sources:

• PeakOil.Org
• Twilight in the Desert: The Coming Saudi Oil Shock
• Matthew Simmons

Addressing question #1: Why are oil prices so high?
Mish responds with a question: Are oil prices high?
At $60 a barrel, oil is priced at 18 cents a pint!
Yes that is correct: 18 cents a pint. You can not buy water for 18 cents a pint.
In fact can you get anything but oil for 18 cents a pint?
If so what, and does anyone want it?
Given peak oil and geopolitical concerns on top of it, one can make an easy subjective case that oil is bargain basement priced at $60 barrel.
My friend CalculatedRisk offers this perspective about oil prices on an inflation adjusted basis.

Let's now tackle Andy Xie's claim that speculators are pushing up the price of oil.
His claim is easily refuted by looking at actual stats.

Here are the current stats from the commitment of traders report (COTs) as of this writing on August 14 2005. Notes on the following chart for those not familiar with it.

• COT reports come out every week on Friday for every commodity and for currencies and major indices as well.
• By the time you click on the above link a new report might be out so don't expect to match the table below after 2005-08-18
• Although the report comes out on Friday it is based on data from the preceding Tuesday, in this case 2005-08-09
  
• Non-Reportable positions are the small specs (you and I)
• Non-Commercial positions are major players (hedge funds)
• Commercial positions are the producers (forward selling of oil delivery) and hedgers (e.g. airlines having a vested interest in hedging oil costs)
• The producers will always be net short
• Shorts and longs always balance out to zero
  

CRUDE OIL, LIGHT SWEET - NEW YORK MERCANTILE EXCHANGE

OPTION AND FUTURES COMBINED POSITIONS AS OF 08/09/05          |
--------------------------------------------------------------| NONREPORTABLE
NON-COMMERCIAL      |   COMMERCIAL    |      TOTAL      |   POSITIONS
--------------------------|-----------------|-----------------|-----------------
Long  | Short  |Spreads |  Long  | Short  |  Long  | Short  |  Long  | Short
--------------------------------------------------------------------------------
(CONTRACTS OF 1,000 BARRELS)                         OPEN INTEREST:    1,452,515
COMMITMENTS
154,921   87,259  415,351  796,636  853,820  1366908  1356430   85,607   96,085

CHANGES FROM 08/02/05 (CHANGE IN OPEN INTEREST:     75,127)
18,337    9,999   20,930   28,155   35,582   67,421   66,510    7,706    8,617

Looking quickly, one can see that small specs are net short. This is not surprising given that small traders are most often wrong. Big specs are indeed net long but the amount is not that huge. I have been following these reports for quite some time and the amount of spec long positions overall is not significant. It is well within normal patterns. Thus point blank, Andy Xie is wrong to be blaming speculators for huges rises in oil prices.

On a fundamental basis, given a "Peak Oil" background of diminishing capacity, diminishing reserves, and a world population that is rising, with China and India coming of age causing increased demand at the margin (and in commodity pricing it is the nth margin that matters), it really should not be of shock to anyone that oil prices are rising. Thus Andy Xie has been wrong fundamentally as well. He has been bearish on both China and oil for as long as I can remember.

Andy Xie may eventually be right, but it will not be because of speculators throwing in the towel. This is what it comes down to: IF a slowing world economy decreases the demand for oil more than the "peak oil" pressures of diminishing supply over time are causing prices to rise, then and only then will prices drop.

Personally I think that will happen at some point but there is a huge wildcard. What happens if Islamic fundamentalists overthrow the Saudi government? What happens if terrorists in Saudi Arabia blow up refineries? What happens if Iran shuts off oil supplies? Quite frankly oil will skyrocket on any of those. Regardless of my fundamental beliefs that the world economy is about to go to hell in a hand basket, oil is a very tough short (and oil bears have indeed been carted out in wheel barrows). Should a huge unsustainable spike come on horrific geopolitical news, I might be inclined to short that spike via puts with a known risk. We will see when the time comes. A second caveat is that should a worldwide recession reduce oil demand enough to cause prices to drop, it will be a temporary drop only. Coming out of the recession, demand will pick back up and we will be further along the peak oil supply curve as well.

Let’s turn our attention to question #3:
Why are oil prices going up with oil reserves at 5 year highs and crude in contango?
That is a good question.
First off let’s define "contango".
In futures or options trading, a market in which longer-term contracts carry a higher price than near-term contracts. The premium accorded to longer maturities is a normal condition of the market and reflects the cost of carrying the commodity for future delivery.

Hmmm. Given that contango describes a state in which prices are cheaper now than expected prices in the future, it sure seems logical for one to be filling reserves now doesn't it?

Thus we have rising reserves.
Or do we?
Enquiring Mish readers want proof.
The August 11th edition of Futures and Commodity Market News reported the following:

"Gasoline stock falls are providing some support to prices, but overall the rises in crude and distillates are bearish for prices which the bulls are ignoring," IFR senior analyst Tim Evans said.

Further, US crude stockpiles are now 8.4 pct above their five year average. "This is not just a token surplus but a genuine glut."

"The gamesmanship continues as traders try to push the price to even more high's, ignoring the fundamentals, which suggest there is no imminent shortage," he said.

Wow that sure looks like hugely rising reserves does it not?
Enquiring Mish readers do not give up so easily and fire further questions.
This one just came in telepathically just now.
Is there a genuine glut or is there more to this story?

I have not heard of Tim Evans before but we have already discredited the nonsense about "gamesmanship" pushing prices higher. Perhaps Andy Xie reads Tim Evans. Who knows? We have also already proven (hopefully anyway) that 18 cents a pint is a reasonably cheap price, so now let's turn our focus on the "genuine glut" theory.

If crude stocks are 8.4% above the 5 year average does that mean there is a glut?
What if demand is 10% higher than 5 years ago? How about 20% higher? 40% anyone? The point I am trying to make is that anyone that thinks they can define a "glut" on the sole basis of a 5 year average of inventory without looking at a 5 year average in increasing demand is foolish.

Mish is there any evidence of increasing demand?
First off let me say that increasing demand should be obvious to anyone given all the sales of gas guzzling Hummers and SUVs in addition to the obvious rise in demand from China. That said, enquiring Mish readers deserve better answers than that, so let's consider the concept of "days of forward cover" .

OPEC research shows that days of forward cover is a far better indicator of oil prices than current inventory levels. Enquiring minds might wish to check out the graphs on page 3. While inventory levels may be at 5 year highs, the days of forward cover at current demand levels relatively low.

In short there is no current glut in oil inventory levels, although there might be later if demand falls off the cliff in a worldwide recession.

NEXT!
We have one last question to tackle.
I saved it for last because it is the most subjective.
I was asked to "Please respond to Noland's Thesis in a thoughtful, analytical and classy manner."
For starters let me point out that the article behind the credit bulletin link given above is subject to change. If you click on the above link, it it might be for a different date on a different topic. What the reader (from Silicon Investor) is asking about is Noland's Global Inflationary Boom Thesis. Following is the pertinent section:

"There is no better evidence to support the Global Inflationary Boom Thesis than $67 crude. And there was today news from China that July retail sales were up 12.7% from a year earlier (4-month high) and that China’s M2 money supply expanded last month at the fastest pace in a year (16.3%). Also today, India reported a stronger-than-expected 11.7% rise in industrial production. The Wall of Global Liquidity – much emanating from U.S. mortgage borrowings and speculative leveraging - continues to fuel the Chinese boom, as it does to only somewhat lesser degrees throughout Asia, India and elsewhere."

Let me say a couple of things. I like Noland. He generally does a credible job in pointing out the imbalances in the global economy. He is well aware of the "credit bubble" that is driving this train wreck to be. He is 100% correct about the existance of a mammoth "Credit Bubble". However, I think he is just plain wrong with his statement "There is no better evidence to support the Global Inflationary Boom Thesis than $67 crude". I will give him a chance to take it back. I propose there is no better evidence of a Global Inflationary Boom than housing bubbles on multiple continents.

That said, the global housing bubble is starting to collapse. A housing collapse is well under way in Australia, housing is starting to collapsing in the UK, and housing seems to be on the brink of a collapse in the US. One can make a case that something stronger than "Baby Steps" was needed to halt the credit bubble, but that case was stronger before these cracks in housing started to appear. Also, please bear in mind that the real problem was slashing interest rates to 1% in the first place, not the "Baby Steps" unwinding of it all. Those 1% rates fueled housing bubbles everywhere at a time when our economy already had an election stimulus, huge tax incentives for businesses, a firm housing market to begin with, and a huge war stimulus with money pouring into companies servicing the war effort.

Noland also proclaims "These days, analysts mistake the effects of massive global manufacturing investment (a Credit Inflation Manifestation!) for a continuation of the nineties 'disinflationary' environment. This is a major analytical error."

I completely agree with Noland that there is a "Credit Inflation Manifestation". I also agree that there is a major analytical error but that error is on behalf of Noland. From my perspective Noland fails to correctly analyze the aftermath of what will happen to those malinvestments and overcapacity once the global housing bubble collapses. K-Cycle theory (as well as actual historical outcomes) says that the end of a credit expansion cycle is a K-Winter deflationary credit collapse, not an inflationary inferno. I have not yet seen a valid set of reasons as to why this time will be different.

In the meantime, attempting to target inflation by focusing on the price of oil when

1. Demand for oil is hugely inelastic
2. Supply of oil is subject to peak oil concerns
3. Supply of oil is subject to geopolitical factors
4. Oil has naturally rising demand simply because the world's population is growing

is just plain wrong.

Specifically, interest rates hikes are a rather broad brush method at controlling demand. Given the relative inelasticity of oil demand, attempting to control oil prices with such measures would likely not work until major economic activity dramatically slowed across the board. It would even be conceivable that we would be headed for economic depression before such a mechanism "worked". In short, it would be very poor economic policy to even think about attempting to control demand for "peak anything" via broad brushed interest rate policy decisions.

What nearly everyone fails to understand is that this is not 1970. Oil price increases are not in general being passed along with the exception of prices the gasoline pump. Gasoline prices will at some point have the affect of dampening consumer spending, at least at the margin. It is probably already starting. At any rate, rising oil prices are not exerting the same inflationary pressures that we saw the last go around. To paraphrase Dorothy, “Toto I don’t think this is 1970 anymore”.

Right now, rising oil prices are more of an economic drag on the economy as opposed to a massive inflationary force to be reckoned with. Unless and until wages rise to compensate for increased gasoline prices, it will likely stay that way. Given there is little evidence of either wage growth or job growth and given a collapse in demand when the housing bubble collapses, inflationary pressures of rising oil prices will likely be minimal for the foreseeable future.

Some people are focused on the CRB commodities index as opposed to just oil prices. That too, is just another red herring. The CRB is extremely skewed by energy prices. Consumer spending, a zero% savings rate, the housing bubble, and reckless extension of credit are what economists should be focusing on. When the housing bubble pops, its all over, regardless of what oil prices do. It does remain to be seen how many more "Baby Steps" are necessary to crash housing, but I think not many given the cracks that seem to be appearing all over the place.

If one accepts the notion that peak oil can not effectively be reined in by broad brushed interest rate policy, then how should one attempt to control it? I think peak oil is better addressed by specifically targeting oil demand as opposed to reducing the demand for everything. In that regard, taxes on oil, credits for low mileage cars, taxes on "gas guzzlers", mandates for higher gas mileage cars and trucks, taxes on oil company profits, and just plain "market forces" would all be better than firing a missile at demand in general on account of rising oil prices. Please not that I am not saying that a missile should not have been fired, I am saying that firing a missile because of rising oil prices is bad policy. There is a difference.

Thus I contend that Noland missed the boat twice: once by focusing on oil, second by accusing others of making a "major analytical error" when it seems that he is the one failing to see the deflationary aftermath of a housing bubble collapse. Even in such an aftermath, it is entirely possible that oil prices will still be "high" because of peak oil issues.

Regardless of what oil prices do, this house of cards is so shaky that it will eventually collapse on its own accord. All credit bubbles eventually collapse. This one will not be different. The moral implications of letting this bubble get so far out of hand lie with Greenspan and the FED. Greenspan’s idea that bubbles are best addressed after the fact is the very reason why each bubble he blows is bigger than the last. In excessively fighting every economic slowdown with ever increasing liquidity, he has repeatedly bailed out his banking buddies at the expense of someone else. That someone else is typically the average taxpayer who was sucked into one of his bubbles or was punished by it for long periods of time by staying out while everyone else played the greater fool theory. Greenspan will easily go down in history as the worst FED chairman ever on both a moral and results oriented basis. If I have ever said anything that Puplava and Noland both agree with, that is probably it.

Mish notes: This article first appeared in Whiskey and Gunpowder.
In that version I listed oil at 24 cents a pint. I had it correct in the temporary holding version in my blog. It seems I failed to get that correction to W&G. This was my error. I received the following email early this evening.

"In the latest Whiskey and Gunpowder you say:
At $60 a barrel, oil is priced at 24 cents a pint!
Yes that is correct: 24 cents a pint. You cannot buy water for 24 cents a pint. In fact, can you get anything but oil for 24 cents a pint?
By my math 60 divided by 42 is 1.42857, and that divided by 8 is about 18 cents a pint. It seems you used 31 gals. per barrel -- which is right for a fermented beverage but not for oil".

The responder provided a link to the correct defination of barrel. Thanks for that correction Bill. I need people to keep me on my toes. So for those of you that think oil is high priced at 24 cents a pint it is actually only 18 cents a pint at $60. Is that cheap enough?

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

GM Expectations

Reuters is reporting that GM seeks to lower expectations.

Let's take a look:

General Motors Corp is seeking to lower expectations ahead of a meeting this week when it will update Wall Street analysts on its financial and business outlook.

The meeting is set for Tuesday at GM's headquarters in Detroit where a morning session will focus on product development and the company's redesigned cars, trucks and sport utility vehicles. That will be followed by an afternoon briefing on financial issues at GM, which lost $2.5 billion in its North American auto business in the first half of the year.

Tom Kowaleski, chief spokesman for the world's largest automaker, said analysts should not expect any earnings forecasts from GM, which were suspended after it posted a stunning $1.1 billion loss in the first quarter.

Is anyone shocked by GM seeking to lower expectations? I am not. The only way GM could lower my expectations would be if GM declared bankruptcy tomorrow. That in fact would be stunning. In the meantime there is still oodles of money for wall street to make by selling GM bonds to an unsuspecting public. Ford is in a similar situation. Obviously GM expectations are still way too high if they need to be “engineered down” once again and so soon.

It’s time to face the facts. The only way GM and Ford can possibly survive is if they can do both of the following:

1. Dump their long term pension benefits on to the Pension Benefit Guarantee Corp before they go under. Note: The PBGC is a federal agency supported 100% by the US taxpayer.
2. Start producing better cars

Personally I doubt that both are likely. Heck, even one of them alone might be next to impossible. Thus, I fully expect both GM and Ford to go bankrupt in due time. This does not mean they go out of business since the airlines are going bankrupt one right after another and they are still operating as well. Likewise I expect similar taxpayer bailouts of GM highly likely.

I do not know about you but my expectations for GM were not lowered one bit by reading that article. However, my timeframe for bankruptcy has indeed moved once notch closer to sooner rather than later.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Three more rate hikes this year?

Fed Watch: Forecast Calls For More Rate Hikes

The call for more rate hikes seems to be rapidly forming a consensus. Is that contrarian? I guess we will see. Nonetheless, Tim Duy makes a pretty compelling case, not for what should be done, but for what is likely. I agree with his analysis: as long as housing stays reasonably strong, the FED will keep hiking.

Here is Mr. Duy's bottom line conclusion:
In short, regardless of the possibility of a recession in 2006, I still see the Fed as laying the groundwork for continued monetary tightening, even as they see the possibility that financial markets are not entirely prepared for that outcome.

I agree with Duy that the markets just are not prepared for such continued tightening. Here are the implications, if he is correct:

• I think it will invert the yield curve
• I think it will lead to a recession sooner rather than later
• It will be bad news for equity markets.
• It will be bad news for housing
• It will be bad news for commodities in general
• It should be bad news for gold and silver
• It should be good for longer dated treasuries
• It should be good for bets on continued tightening of the yield curve
• It should be good for the US$

I guess we will soon get to see soon enough just how far Greenspan is willing to go to salvage his miserable legacy of blowing bubble after bubble. Popping this bubble is long overdue, but the real problem was letting things get completely out of hand in the first place as the Greenspan FED did. This next recession is going to be a killer for anyone over-leveraged in debt. Long term, I think history will see Greenspan for the charlatan that he is. That will of course be Greenspan's ultimate and final legacy.

I have a few final comments.

• The markets have likely not yet felt the full ramifications of the 10 hikes to date.
• IF the FED gets in three more hikes they will be well above "neutral" IMO.
• The FED has a history of over shooting both ways and is overshooting right now.
• Once the FED pauses, housing will likely be complete toast.
• The FED will believe that that can revive housing but they will be wrong.
• When the FED pauses, buy gold and hang on for dear life.
• The FED is going to eventually take back nearly every one of these hikes to fight the upcoming housing and debt deflation. It will not help.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Reflections on Central Banking

Following are some comments made by Greenspan at a symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming August 26, 2005. The subject matter of Greenspan's speech was "Reflections on Central Banking". Here are some of the highlights:

"History has not dealt kindly with the aftermath of protracted periods of low risk premiums"

"Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher prices"

"Given our inevitably incomplete knowledge about key structural aspects of an ever-changing economy and the sometimes asymmetric costs or benefits of particular outcomes, the paradigm on which we have settled has come to involve, at its core, crucial elements of risk management. In this approach, a central bank needs to consider not only the most likely future path for the economy but also the distribution of possible outcomes about that path. The decision makers then need to reach a judgment about the probabilities, costs, and benefits of various possible outcomes under alternative choices for policy."

"The structure of our economy will doubtless change in the years ahead. In particular, our analysis of economic developments almost surely will need to deal in greater detail with balance sheet considerations than was the case in the earlier decades of the postwar period."

Mish has some questions for Mr. Greenspan and the FED.

1. The FED was created in 1913 supposedly to steer the economy in the right direction. It did not do a very good job in the late 20's and early 30's did it?
2. Given your admission that the "economy will doubtless change" in the years ahead, why do you foolishly think you can guide the economy down the correct path, when you have blown the two largest bubbles in history?
3. Given your admission of "inevitably incomplete knowledge about key structural aspects of an ever-changing economy" just why the hell do you think the FED can steer the economy better than the market can?
4. Given your obviously bad track record, why shouldn't you abolish yourselves?
   

By the way, here is the complete text of Greenspan's speech. Given that the complete text is lengthy and generally boring save a few key quotes for everyone to ponder, I am pleased to offer this fine translation by Ramsey Su on Silicon Investor.

For 18 years, the Feds led be me, the supreme highness of the universe, did not have a clue what we were doing. So we think the economy is zigging so we zigged faster. As it turned out, the economy is really zagging so we zagged. In the end, we just decided to roll up all those zig-zag reports and had one hell of a smoke. Now that the party is over, it is time for me to get the hell out of here and let someone else clean up my mess.

There you have it. That is what Greenspan really meant to say.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Prolonging the Agony

CNN Money is reporting that
Card purchases jump to 70% of gasoline sales at convenience stores. This is up from 54% last year.

Convenience stores, which sell about three-quarters of all gasoline sold in the nation, have seen the use of credit cards for motor fuel purchases rise to 70 percent of all gasoline purchases from about 54 percent last year, according to the industry group.

Drivers are seen reaching into their pockets for plastic more often as they try to stretch their budgets.

"Consumers are trying to displace the pain for a few weeks," said Jeff Lenard, a spokesman for the group, which includes stores owned by oil companies.

Not only are consumers paying high gas prices, they now are willing to pay insane interest rate charges by prolonging the payment agony. Is willing the right word? Perhaps forced is a better word if they are struggling to pay bills and have no cash because prices are rising faster than wages. Of course this begs the question "What happens when housing prices decline and cash out refis can no longer be used to pay the gas bill?"

I believe it's time for some more Mish awards.
In the "So stupid we just have to try it again" category, Mish nominates the state of Hawaii PUC. Let's take a look.

The Public Utilities Commission likely will set the wholesale price cap for unleaded regular gasoline on O'ahu at $2.74 today, and it could lead to higher prices at the pump starting Sept. 1.

Hawaii will have the nation's only government-imposed restrictions on gasoline prices beginning next month, and today is when the PUC is scheduled to list the price limits on its Web site. The price caps will be adjusted weekly — on Wednesdays — and take effect the following week.

Based on The Advertiser's calculations, the wholesale cap will be $2.74 including 58 cents in taxes. That is almost equal to the average retail price of nearly $2.75 a gallon for regular gasoline in Honolulu yesterday. Assuming retailers add a markup, the price consumers pay at the pump will be higher under the gas cap.

No one knows what will happen to pump prices when the caps take effect because it only caps wholesale prices. However, if wholesalers charge the highest prices allowed under the law and retailers maintain an estimated 12 cents a gallon markup, the price cap could lead to a jump at the pump to $2.86 a gallon.

Mish has a few thoughts and questions:

• Does anyone think this will accomplish anything other than creating longer gasoline lines or perhaps even causing higher prices at the pump by companies gouging to the highest rate allowed?
• If they are going to raise the cap weekly, is there a point in having one?
• Did anyone in Hawaii study the effectiveness of wage/price controls the last time someone was stupid enough to try it?
• Perhaps the idea was just so stupid that someone felt obligated to try it again to see if it will work better the second time. I have a hint for whoever that genius was: It won't work any better this time around than it did the last time someone was stupid enough to try this.
  

The "stupidest oil taunt in history" award obviously goes to Pat Robertson. Speaking about Hugo Chavez, the democratically elected president of Venezuela, Pat Robertson, a former US presidential candidate had this to say: "If he thinks we're trying to assassinate him, I think that we really ought to go ahead and do it. It's a whole lot cheaper than starting a war. And I don't think any oil shipments will stop."

Look. Everyone knows that Chavez is a left wing nut job with ties to Castro. Just to make it even more clear, I am not any kind of fan of Chavez, in any way. However, the plain fact of the matter is he was democratically elected and the people in Venezuela support him. I apologize for injecting politics into the Mish blog, but facts are facts. It is simply not our place to decide what is best for Venezuela or anyone else for that matter.

One of the reasons gas prices are high is because Iraq is pumping less oil now than before we stupidly invaded that country. Now US religious leaders go around casually advocating assassination attempts on freely elected leaders of other countries. Robertson attempted to deny that he said "assassination" but when it was apparent just how bad a lie that was, he then attempted a half baked non-apology. I am sorry but Robertson never really did apologize.

"Mr. Robertson has been one of the president's staunchest allies," said Bernardo Álvarez, the Venezuelan ambassador to the United States. "His statement demands the strongest condemnation by the White House." I happen to agree. The entire affair was totally disgusting. All we saw was a bunch of duck and hide, wishy-washy statements from the administration, none from Bush himself, with everyone attempting to distance themselves from Robertson rather than do what was right. What would have been right was an immediate renouncement of Robertson's comments by President Bush himself.

This administration and their supporters are one of the largest sets of hypocrites in history. The USA Today nails it with this editorial comment: "If a major religious figure in any other nation were even to hint at the assassination of the president of these sovereign United States, he, and perhaps his country as well, would be excoriated for dangerous extremism and branded a terrorist — or worse."

Mish's "Gutless Award" of the year is a three way tie: The Traditional Values Coalition, the Family Research Council and the Christian Coalition. All of them said through spokesmen that they were "too busy to comment". Yeah right. Wait a second, better make that a 4 way tie since President Bush gutlessly hides from damn near everything.

Venezuela just so happens to be the fifth-largest oil exporter and a major supplier of oil to the United States. We should be thankful to have nearby oil. It is just not smart policy to go about antagonizing leaders of other countries, especially democratically elected ones. It just makes us look like the hypocrites that we are, and it certainly does not help the situation in the Mid-east either.

You want to blame someone for rising oil prices?
Blame Bush. OK blame Greenspan too. If you want to call it a tie, I can easily accept that.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Are you missing the real estate boom? (part 2)

On August 11 2005 Reuters reported that
Moody's affirms Fannie Mae 'AAA' senior debt rating.

Moody's Investors Service on Thursday affirmed the 'AAA' senior debt ratings of Fannie Mae (FNM.N: Quote, Profile, Research) , the largest U.S. home finance provider but said its preferred stock and subordinated debt remain on review for possible downgrade.

I do not know about you, butI do not find it likely that that Moody's can possibly know precisely what Fannie Mae's debt rating should be. I offer the following as proof:

Matthew Goldstein on the street.com reports Fannie Restatement Nowhere Near Done.

The government-sponsored mortgage finance firm says it might not complete the restatement before the second half of 2006. The lengthy delay is just one more indication of the size of the accounting irregularities at the nation's biggest buyer of mortgages.

"As our normal business operations continue, we also are committing every available resource to the restatement,'' said Fannie President and CEO Daniel Mudd. "This year we expect that over 30% of our employees will spend over half their time on it, and many more are involved."

In fact, the restatement is such a big task, Fannie expects to hire some 1,500 consultants by year's end.

Let's see if I have my facts straight.

1. Fannie Mae's books are so screwed up and they are so late in reporting that there are threats of FNM being delisted.
2. It will take 1,500 consultants to straighten out their derivatives mess.
3. Moody's is willing to affirm their AAA debt rating anyway.
   

Mish can Fannie Mae be delisted?
Yes, not only can it, but perhaps it should have already been done.
Let's take a look.

Fannie said the NYSE may start a delisting proceeding when a company fails to file its annual report in a timely manner. Current exchange standards allow the NYSE to continue a listing for nine months from the due date of the financial filing, and for Fannie, that extension ends Dec. 16, the company said.

The exchange may opt to extend the listing for another three months, according to Fannie.

Still, Fannie Mae said it was unlikely to report any results before the second half of 2006.

Please bear in mind that even though Fannie May can and possibly should be delisted, I seriously doubt that it will be. A lot of mutual funds would have had to dump amazingly large holdings of Fannie Mae if it was delisted. They would not be happy about it either. Is it possible this at all influenced Moody's decision?

With that thought in mind, please remember the "Big Three" failed to see LTCM coming, failed to see Enron coming, failed to see Tyco coming, failed to see Worldcom coming, etc. Clearly something is wrong somewhere. What is it? Is it because of relationships that the big three maintains with the customers they rate, or is it just plain bad luck, or is it something else?

At any rate, how can anyone possibly know what is in those books if it takes 1,500 consultants working for a year to straighten them out? I contend that no one can possibly know what the bottom line result of that audit will be. If one does not know what is in the books, the next logical question is: How can it be possible to affirm a top rating on that company's debt? Hmmm the questions keep coming. Going one step further, Does anyone even care what is in the books? The final question along these line is: Even if someone does care, are they just hoping that nothing bad comes up knowing they have a fallback excuse "We did not know what was in the books".

Clearly we need to remove all such doubts if credibility on debt ratings is to be truly restored. That means that all rating companies need to be completely independent of outside relationships with companies that they rate. It also means that companies should be competing for business solely on the accuracy of their ratings, not on anything else. I have a strong suspicion that we would have seen Worldcom, Enron, and Tyco all downgraded far earlier if accuracy was what mattered most.

Part of the problem lies in the fact that billions of dollars change hands when there are even small changes in debt ratings. A downgrade to junk (as with GM recently) can have a severe impact. It almost seems as if everyone has to firmly expect it before it happens. Nudge nudge wink wink. On unexpected unfavorable ratings business relationships will be stressed. The solution is not more "oversight" committees or more accusations and subsequent denials from the Big Three that they are not at fault. We need to remove suspicion of fault and the only way to do that is for outside relationships need to be made illegal.

Back in February, the New York Times said Wanted: Credit Ratings. Objective Ones, Please.

"I think it's fair to say that the oversight of the industry is insufficient," said Annette L. Nazareth, director of market regulation at the Securities and Exchange Commission. "We want the firms to commit to meet certain standards with respect to policies and procedures on conflicts of interest and solicitation of ratings. Right now we don't have that at all."

Obviously no progress has been made since then. Perhaps the ratings agencies will not care unless and until they are slapped with a thousand lawsuits. Forget the lawsuits, change the law so that confidence in the system is restored and rating agencies have a NEGATIVE incentive to play games. Do that an the credibility problem goes away instantly. Given how totally messed up legislation is these days, I fully expect to see dozens of "oversight committees" rather than correcting the basic problem of ensuring that there are no relationships between rating companies and the companies they rate.

For arguments sake, however, let's give Moody's the benefit of the doubt and assume that everything is fine for now and there are no new surprises forthcoming in Fannie Mae's books if and when they are every completed. Are we off the hook?

I think not. Regardless of whether or not something is wrong with Fannie's books, given all of the appraisal fraud, no doc loans, 0% down loans, piggyback loans, and negative amortization loans, people better be well prepared for a huge credit implosion when this mess blows up. In the meantime, party on dudes as banks and other mortgage originators attempt to keep the good loans on their books but pass the trash on to Fannie Mae or someone else. That garbage is ending up in state pension plans, other retirement plans, and in the hands of hedge funds and others that probably have no idea just how toxic it is. In the meantime the sheep are grazing and perhaps a blatant attempt is being purposely made to spread the Fannie Mae risk around enough so that no single entity gets wiped out by it all.

Let's take a look at one more thing.
Please listen to at least the last 15 minutes of the Saxon Capital, Inc. Earnings Conference Call (Q2 2005).

Given that some of you are too simply time pressed to do that, following is a brief transcription of the highlights. Starting about 43:10 minutes in Saxon states.....

• Too much risk taking will lead to a "credit event"
• Much of the volume of competitors is refinancing customers from one product to another to another to another.
• If you are going to be competitive in the business, you HAVE to have a product basket that the customer is demanding and the market is willing to provide
• Offering these products will allow us back into these markets
• 45:25
• "At the point in time WHEN the credit event comes, AND IT WILL we will be very well placed to take advantage of what happens next"
• "I am concerned about the level of capital" of our competitors "to service the bonds as those portfolios age"
• "Should real estate on the west coast flatten out I would be worried about a credit event"
• There are people that will buy a 100% Loan to Value (LTV). We do not have that product we do not believe in it. We want the stated income borrower to actually have some skin in the game"
• We can now offer those products but "We have no intentions of putting those loans in our portfolio... We are going to pass them thru to other investors"
• Question: and you think that is a good strategy thinking this is The Perfect Storm you are describing?
• Answer: "As long as the market is willing to provide that credit... they attempt to deliver the customer as much cash as possible with the least amount of investigation or effort...That's what drives our customer... In order to get the customers we want we need to be able to offer those products"
• Question: "Since I have known you, you have been bearish on the industry ... now you are saying I want to be more like people offering products that are unsustainable. I am struggling with that"
• Answer: "The only difference is that I do not intend to put those in my portfolio... and the day that I can't sell these (to someone else) is the day that I stop offering them".

If lender conference calls are routinely discussing "Credit Events" and "Perfect Storms" and companies such as Saxon are only willing to take on loans as long as they can pass the trash to Fannie Mae or someone else, exactly what confidence should there be in

• Fannie Mae
• The System in general
• Financial institutions specifically
• The Big Three credit rating companies
  
• What the pundits are saying out housing
• What the administration is saying about the recovery

Right now the questions Mish is asking are as follows:

1. How long will it be before we see genuine reform of the credit rating companies?
2. How long will mortgage originators willfully and knowingly take total garbage just because they can pass the trash on to others?
   
3. With horror stories like I presented above, is there any boom left in real estate other than a loud popping of the bubble?
4. How many lawsuits will eventually be filed by people losing their homes?
5. What will the ultimate cost to taxpayers be for the upcoming credit implosion and subsequent bailout of the credit industry?
   

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Want a job? Join the crowd.

11,000 apply for 400 openings at Wal-Mart's new Oakland store

Stephen Levy, an economist for the Center for Continuing Study of the California Economy, said the pent-up demand for work reflects the Bay Area's slow recovery from the dot-com crash.

"There's still a lot of people who were put out of work in the last four years who still don't have a job," Levy said.

Some people actually believe that unionizing Wal-Mart has a chance with people this badly in need of a job. Here's a hint: Unions have no chance of penetrating Wal-Mart.

This is the bottom line:

"It's not about Wal-Mart -- it's about the rest of the labor market," Levy said. "If the rest of the labor market was strong, you wouldn't have 11,000 people applying for 400 JOBS."

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

A Sign of the Times

The Sacramento Bee reports 'For Sale' signs mushroom, stay up longer.

• Jim Eggleston, owner of Sacramento's biggest residential "For Sale" sign installer, predicts this will be his busiest week in 21 years in business. He's had to hire an extra worker and buy a new delivery truck since his crew planted a one-day record of 225 signs on Monday.
• "There are whole lot of houses going up for sale," says Eggleston, who promises next-day installation when a real estate broker orders a new sign. "The number of 'For Sale' signs we're removing keeps going down relative to the number we're putting up."
• "The inventory is ramping up and we're now seeing a changing market - the bell has tolled," said Michael Lyon, head of TrendGraphix and Lyon Real Estate.
• Reductions in asking prices are now rampant: In May there were 2,318 price reductions in the four-county region; in July there were 4,100 and this month is on pace to see about 4,500, TrendGraphix reports.
• The local Building Industry Association reports that in July the number of people shopping in new home subdivisions in the capital region fell to 32,679 - down 25 percent from a year ago and the lowest for July since 1999. Some in the industry have argued that shoppers of both new and resale homes were scarce last month because of the extreme heat.
• "We're starting to get a slew of invitations from builders ... where they're holding their models open to brokers before they're open to the public," said agent Britt Wiseman of Coldwell Banker's Sierra Oaks office. "That's a dramatic change."
• "You look at home prices, at the kind of mortgage payments they require and at income levels that haven't risen all that dramatically and something is a little out of whack," says Brad Williams, chief economist for the state Legislative Analyst's Office, which prepares economic forecasts for the Legislature. "It wouldn't surprise me if you hit a sort of price ceiling and see a downward adjustment in prices."

According to the Bee, Brad Williams chief economist for the state Legislative Analyst's Office "doesn't foresee a housing collapse" even though he admits "something is a little out of wack".

A little out of whack asks Mish? That's kind of like saying the ocean was a little out of whack in that devastating tsunami that wrecked Southeast Asia last December. By the way, no one saw that tsunami coming either even though geographic reports picked up the earthquake that triggered it long before the waves crashed to shore. In this case, the signs should be readily apparent to everyone. Unfortunately, no one wants to believe them.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Are You Missing the Real Estate Boom? (Part 1)

Realtors say home prices are 'close to a peak,' with condos to fall

"The housing market is probably close to a peak right now in terms of sales activity, but there is tremendous momentum," said David Lereah, chief economist for the association, in a statement. "Sales are expected to coast at historically high levels into next year, but they will trend slightly downward."

Lereah's statement Tuesday comes six months after the release of his book, Are You Missing the Real Estate Boom? Why Home Values and Other Real Estate Investments Will Climb Through the End of the Decade and How to Profit From Them.

Can't afford to buy?
No problem.
The Orange County Register reports Buyers Doubling Down

More buyers are piggybacking, using tow loans to buy an O.C. home.

Buyers are commonly using yet another new loan trick. They take out two mortgages at the time of purchase in so-called "piggyback" transactions, according to DataQuick.

Piggybacks are frequently used by cash- strapped buyers who can't meet a key financial hurdle.

Lenders prefer a down payment so large that a key mortgage ratio – the loan's size vs. the value of the home – is 80 percent or less. That's an industry quality standard to get the best mortgage deals.

But as purchase prices soar, lenders now allow buyers to essentially borrow the down payment shortfall: a first mortgage at the desired 80 percent loan-to-value ratio plus a second mortgage to make up the difference.

Such double dippers averaged 38 percent of all local buyers in the 12 months ended in June – basically double the rate in 2002, DataQuick says. A decade ago, just 2 percent of O.C. home purchases went piggyback.

With every boom comes two things:
1) Panic fear of "missing out"
2) Rampant fraud

Let's take a look at #2 since #1 should be blatantly obvious by now.

The Detroit News reports
Refinancers must beware foreclosure 'rescuers'

Fast-talking predators can quickly get your home for a fraction of what it is really worth.

You may think kindly toward companies that would offer a hand to debt-ridden homeowners on the brink of foreclosure. Don't. The majority of these so-called foreclosure "rescuers" are actually predators who offer sinking homeowners what Harvard Law School professor and bankruptcy expert Elizabeth Warren calls "the cement life jacket."

Before you're even aware of it these scam artists will have acquired your home for a fraction of what it would have brought at sale. Or, in an even worse scenario, they will have transferred your title into a trust that then enables them to rent or "resell" your property to equally hoodwinked buyers while, to your surprise, you remain legally obligated to make the mortgage payments.

Foreclosure "rescue" scams fall into three main categories:

• Phantom help: The "rescuer" charges outrageous fees for light-duty phone calls or paperwork that the homeowner could easily do, none of which results in saving the home. This predatory scam gives homeowners a false sense of hope and prevents them from seeking qualified help.

• The bailout: In this scam the homeowner is deceived into signing over title with the belief that they will be able to remain in the house as a renter and eventually buy it back over time. The terms of these scams are so onerous that the buy-back becomes impossible, the homeowner loses possession and the "rescuer" walks off with most or all of the equity.

• The bait-and-switch: In this scam, the homeowners think they are signing documents to bring the mortgage current, but instead actually surrender their ownership. They usually don't even know they've been scammed until they're evicted.

Following is an Email about fraud from a broker friend of mine. In this case it is about appraisal fraud. Dave Donhoff of No Bull Mortgage writes:

A friend of mine is a retired mortgage banker with over 40 years in the industry... one of the pioneers of the original equity stand-alone 2nd, and over 25 years in management at Beneficial Finance. He not only KNOWS all the myriad regulatory issues (Reg Z (TILA,) Reg X (RESPA,) FACTA, Sarbanes-Oxley, and many others,) he's been involved in crafting them at various stages in his career.

He & I watch & chat about the "fraud blogs" (by industry attorneys) daily, and marvel at the blatant, unrepentant fraud that goes unconstrained at several of the mortgage industry professional's discussion boards.

So... My pal calls up the FBI (and goes through a massive runaround of hand-offs & brush-offs to get to someone who theoretically is in the authorized position,) explains who he is & what his background is (to establish he's not just another crackpot old fogie complaining about noisy-neighbor communist insurgents,) and seeks to find who he can channel airtight fraud leads to for prosecution. FINALLY he's handed off tom someone who appears to understand the issues, and has an interest in proceeding. This agent sets an appointment to personally visit my pal on-site at my buddy's home.

The day comes (last week,) and the agent doesn't show. Instead two junior agents come out in his place, have absolutely no clue about anything about the finance business, let alone the pertinent laws and regulations, and merely do a "fill in the forms" data collection interview with my pal, as though it were a police report for a stolen car. The attitude was very clearly "let's get this over with... don't call us, we'll call you."

Mind you... we see brazen and pure banking fraud being committed, out in the open, by not only loan originators, but by wholesale lenders' agents, and underwriters (not to mention "make it work, whatever it takes" real estate agents,) CONSTANTLY! It's being done, unencrypted, on industry message boards nationally... it's BEGGING to be "trimmed" (if not whacked at the knees unmercifully!)

The FBI delivered a very clear & obvious message;
"This isn't news, this isn't terrorism... this is only going to be little fish commercial issues, so we frankly don't give a damn... but thank you, and have a nice day ;~)"

So... I have no idea what the solution is, short of the disease going full course. Our regulatory enforcement is less than sufficient, it's leaving the warehouse backdoor open, going to the roughneck bar, and bragging about it.

Cheers,
Dave Donhoff
National Mortgage Broker/Banker

Check out this snip of a horror story posted by MEW on the Motley FOOL.
Mew writes:

A few years ago I refinanced my house and got a lower mortgage, took a little money out for some landscaping and bills. Loan was $187K, house was appraised at $225K.

This Spring, I went to refinance again, unfortunately because times have been hard, employment has been on and off and we were hoping to sell the house in a few years so I refinanced to an interest only loan, took some money to pay more bills, and kept a pretty low rate, 5.25 fixed I think. At this time, just a few short months ago, the appraisal of my house was $260K, my new loan amount 204K.

I was only willing to refinance and take out money because my home was now valued at 260K. .... 260K seemed high to me, I've also seen non-remodeled homes on my street selling for under 200K, but I thought I could probably sell for 240K.

I live in an area that realtors say is "hot". It's a neighborhood that used to be undesirable because it was near the airport, but now the airport has moved far away and the old airport is a very hip and trendy new home community. New shopping areas are springing up around this area, recently they built a brand new arts magnet school one block away. ....

So, we decided we would try to sell the house this month. I called a realtor ....They did a very thorough comp evaluation and came back to me saying I would be lucky to get 200K for the house.

In my mind, I thought I would like to list it for 250K and accept 240K. I was floored. I explained the 260K appraisal and the response "oh yeah. appraisers do that for mortgage brokers to get the loans/refinances" - IS THIS LEGAL? ETHICAL?

Let's address Mew's Question: "Is this Legal? Is this ethical?"

• No it is not legal, but proving appraisal fraud is going to be very tough to do.
• Is it unethical? Of course, but no one cares.
• Credit card companies like it because they get paid and consumers just go right out and run up their credit card debts again.
• Originators like it because they get paid to originate the loan no matter how bad it is.
• Originators in turn take all of the poor loans and sell them to Fannie Mae or to other "investors" stupidly striving for yields just slightly better than Treasuries with nearly infinite more risk on a percentage wise basis.

As long as originators can count on selling mortgages to Fannie Mae (no matter how bad they are) or securitize them in packages of loans sold to "investors", blatant fraud is likely to continue. Such practices will continue until credit lending eventually blows up. At that time there will be 24 congressional hearings trying to figure out "how it happened".

I am quite confident that in the upcoming "biggest hand washing affair in history", the loudest proclamation will be "No one could possibly have seen this coming".

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

A discussion with Androcles

Androcles (Andy) is a poster on one of the stock message boards that I run. He is in fact a frequent thorn in my side. Unlike others who think hyperinflation is coming in conjunction with a housing crash (something I think has been successfully rebutted more times than I want to discuss), Androcles argues that the economy is stronger than anyone thinks on account of the underground economy, and that there will be no housing bust because of that. Let's tune in to what Androcles is saying:

In America right now there are millions of workers doing more than one job (receiving some form of compensation); examples, firemen, special-duty cops, lifeguards moonlighting as bartenders, computer techs repairing PCs in their spare time. Heck, Mish does several himself; full-time consultant, photographer who sells his work to magazines, and blogger who gets paid sales commissions. Does this mean that Mish is one worker or three? I'd say one. Some would say two...or even three.

Millions of undocumented aliens are driving taxis, selling newspapers, pumping gas, digging ditches, picking grapes, driving trucks, writing code for software start-ups, etc. Do you count these workers as members of the labor force? Not if they work off the books as most do to avoid being deported.

In other words, there is no way you can accurately count either the employed or unemployed in America. All I can say is..."look around you." Haven't you noticed the large numbers of Asians, Latinos, and Eastern Europeans doing the work Americans won't do? Our country is overrun with immigrants from all corners of the planet. They all have a job. Why? Because they'd starve if they didn't. I don't see any starving people walking the streets of Boston.

I still maintain that the labor force numbers in America are understated due to the millions who work off the books or in activities that are never reported to the government. The underground economy in this country is bigger than ever. Accordingly, the unemployment rate is overstated because the government is using the wrong denominator in its calculations.

Andy

Following is my reply to Androcles (Andy).
Andy, that was an excellent thought provoking post and well deserving of recs.
You are of course correct about lots of things but I disagree about your bottom line conclusion.

Yes, there are tens of thousands of undocumented workers, many of them illegal aliens, more or less adding to the economy in varying ways (or taking jobs from US workers if looked at in another way). But some stats do not lie either, such as the number of weeks people average on unemployment. Nor do unemployment stats count the "underemployed" such as those with a degree in engineering working at Walmart.

Eventually people have to take something. Eventually in this case is when benefits run out. In the meantime debt keeps piling up, and up, and up. In a normal recovery, debt is paid off. In this recovery, savings has fallen to zero, private sector employment is negative (actually I think it finally went positive a month or two ago) and even if you think it is understated, the fact remains it is pathetic.

The key statistics are
1) how much deeper in debt everyone is
2) how little of the excesses were wiped out by the last recession
3) how we keep losing manufacturing jobs but gaining jobs at retail places such as Walmart

By now it should be obvious to everyone that this economy is in "recovery" and will only stay in "recovery" as long as housing is strong. Close to 40% of the job creation in this recovery is directly related to housing. Yet, in spite of mammoth increases in the numbers of houses and associated construction jobs, job creation has paled. Now, I realize you dispute that. But unemployment numbers have only dropped because the participation rate has dropped. That is yet another problem with this recovery. A falling participation rate in a recovery is nonsense.

Then again, it seems you might be suggesting that the falling participation rate is wrong. Let’s assume for a minute that you are correct. The question is where to from here? Does this recovery continue until everyone owns 3 houses? Does it even make sense to include illegal aliens in the participation rate in the first place? What happens when everyone owns three houses? Is it meaningless to you that only 12-14% of the people can afford a house in California? Perhaps you think the answer is 0% down and that makes things affordable. If so you sound like all the rest of the cheerleaders. But please let’s look ahead. What is the next step when we have declining real wages and affordability based on zero% down? Is the next step in affordability -25% down? In other words, unless wages pick up and pick up substantially, there are no new marginal buyers except by dropping lending standards. Do you not think lending standards are dropping like a rock? Foreclosures in many areas are skyrocketing.

Let's return to debt levels. People are getting by in spite of falling wages, in spite of decreasing benefits, in spite of rising gasoline prices, in spite of higher heating and cooling bills, and in spite of higher property taxes for one reason only. That reason should be obvious. In case it is not, here is the reason: people are figuratively eating their houses. There has been round after round after round of cash out refis supporting consumption. The savings rate has fallen to zero and debt is rocketing.

This entire house of cards rests on two things:
1) rising property values
2) very high real estate sales

If either of those falls it is all over. In fact, this mess is the world’s biggest Ponzi scheme to date. Actually I can shorten the above two points to one if you like: As soon as the credit bubble stops expanding, kiss this economy goodbye.

The FED has unleashed a monster. That monster is a housing/credit bubble far bigger than any in history. People are buying second and even third homes. Greenspan is even worrying about "froth". As you know, I have no respect for Greenspan but one can usually tell what is on his mind. In this case it is what to do about the housing bubble. In two to three years (or a lot less perhaps) I believe the FED will be praying to start another property bubble.

For the life of me I can not see how you think this is all sustainable.

• Housing prices enormously above rental values
• Zero% savings
• Falling real wages
• Speculation in Florida, California, Las Vegas, Chicago, Boston and numerous other places.
• Condos being bought sight unseen.
• Outsourcing and layoffs continue.

Bear in mind that I do think the US will survive all of this. Long term I think we pass the economic torch over to China but I doubt that happens in our life time. The UK did not vanish when it passed the torch to the US and as best as I can tell Spain is still on the map in spite of the sinking of the Spanish Armada. So, as bearish as I sound sometimes, I am not calling for the end of the world or the end of the US.

What I am calling for is a great deal of pain and soul searching and correction of obvious malinvestments when anyone that can breathe qualifies for a 0% down no-doc loan on properties that have risen 100% in three years while real wages have shrunk.

By the way, I am not sure if I have one job or three jobs or even five jobs and those curious about my photography might wish to take a peek at Mish's Photography. Now, photography might be one off my businesses but "blog advertising" surely is not. Since my blog’s inception back in February I have raked in a grand total of $66 (in credits) from site advertising. I have not even received a check yet. Thus I would be hard pressed to call blogging a job.

On the other hand, I have a strong feeling there are relatively large numbers of people attempting to sell stuff on EBAY that are struggling to make ends meet, yet for the point of the household survey consider themselves employed. Thus while I am inclined to agree with you that all is not what it seems with the participation rate, I also propose that perhaps all is not what it seems with the participation rate! Think about that for a second. How many are attempting to sell stuff on EBAY, attempting to make a living at multi-level marketing, starting businesses that are doomed to fail (etc etc etc) and call themselves "employed". Take me for example. You want to count me once. How many time have I been counted? I don't know, do you?

No doubt many people are working a second or a third job. You want to count them once. How many times were they counted? For someone working two jobs I have a hard time thinking they were not counted at least once. On the other hand, how many people are counted as having a job when all they have is $66 income coming in from blog advertising? Who knows?

Thus your theory on the participation rate works both ways. Regardless of what it is, however, the very second housing breaks down there is going to be a massive revelation on what is sustainable going forward.

For now, I am willing to accept much of what you have said simply because the "underground economy" in conjunction with loose credit standards and the ability to treat one’s house as an ATM is the only plausible explanation for the resilience of this economy. The key question is what happens going forward. I think we are about to find out and I think the results will not be pretty.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Gold's Honest Discipline

I just finished reading a copy of a book entitled
"The Monetary Elite vs. Gold's Honest Discipline"
by Vincent R. LoCascio.

LoCascio makes a compelling case that although it's possible to maintain the integrity of money in a fiat system, historically only the discipline of a gold standard has succeeded in preventing massive abuses by the monetary elite.

Of course the above should be painfully obvious to everyone by now, but unfortunately it is not.
I offer as proof Ron Paul's final debate with Greenspan before the House Financial Affairs Committee, July 20, 2005.

Ron Paul:
To me, this system that we have today is a convenient way to default on our debt – to liquidate our debt after the inflationary scheme.

Even you, in the 1960s, described the paper system as a scheme for the confiscation of wealth.

And, in many ways, I think this is exactly what has happened. We have learned to adapt to deficit financing. But in many ways, the total debt is not that bad because it goes down in real terms.

As bad as it is, in real terms, it’s not nearly as high.

But, since we went on a total paper standard in 1971, we have increased our money supply essentially 12-fold. Debt in this country, federal debt, has gone up 19-fold – but that is in nominal dollars, not in real dollars.

So my question is this: Is it not true that the paper system that we work with today is actually a scheme to default on our debt? And is it not true that, for this reason, that’s a good argument for people not – eventually, at some day – wanting to buy Treasury bills because they will be paid back with cheaper dollars?

And, indeed, in our lifetime, we certainly experienced this in the late 1970s – that interest rates had to go up pretty high and that this paper system serves the interests of big government and deficit financing because it’s a sneaky way of paying for it.

At the same time, it hurts the people who are retired and put their money in savings.

And aligned with this question, I would like to ask something to dealing exactly with gold, is that: If paper money – today it seems to be working rather well – but if the paper system doesn’t work, when will the time come? What will the signs be that we should reconsider gold?

Even in 1981, when you came before the Gold Commission, people were frightened about what was happening – and that’s not too many years ago. And you testified that it might not be a bad idea to back our government bonds with gold in order to bring down interest rates.

So what are the conditions that might exist for the central bankers of the world to reconsider gold?

We do know that they haven’t given up on gold. They haven’t gotten rid of their gold. They’re holding it there for some reason.

So what’s the purpose of the gold if it isn’t with the idea that some day they might need it? They don’t hold lead or pork bellies. They hold gold.

So what are the conditions that you might anticipate when the world may reconsider gold?

Greenspan:
Would there be any advantage, at this particular stage, in going back to the gold standard?

And the answer is: I don’t think so, because we’re acting as though we were there.

So I think central banking, I believe, has learned the dangers of fiat money, and I think, as a consequence of that, we’ve behaved as though there are, indeed, real reserves underneath the system.

As for me I can not believe Ron Paul let him Greenspan get away with that response so easily. Perhaps his time was up or perhaps he was too staggered by the silliness of Greenspan's reply to fire off another round of questions.

No matter how one slices it, money supply going up 12 fold and debt 19 fold since Nixon defaulted on the gold standard is hardly acting as if we were still on the gold standard. Indeed, what little discipline we once had was thrown out the window long ago and has not been seen since.

LoCascio writes:
Today each country's central bank, in conjunction with commercial banks, can create and distribute money without limit. This process does violence to what should be the most sacrosanct characteristic of sound money: its scarcity integrity. Fractional reserve banking, by its very nature, compromises the monetary unit's scarcity integrity.

With debt up 19 fold in conjunction with Greenspan's latest and all time biggest bubble otherwise known as housing, exactly where do we go from here? Given the illiquidity of housing, I am inclined to believe housing is the "bubble of last resort". With global wage arbitrage, outsourcing, and rampant speculation in housing and the credit markets, this is the end of the line. There are no bigger bubbles to be blown.

The picture in my mind at this point is that of Greenspan playing The Sorcerer's Apprentice. (If you have not yet seen Fantasia, I highly recommend doing so).

At any rate, if you can relate to the scene in Fantasia where buckets of water were splashing around everywhere as the apprentice unleashed a "nightmare of liquidity", then you have the right image in your head.

OK Mish, where to from here?
Good question. Let's consider the Wisdom of Ludwig Von Mises:

"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."

"The boom squanders through malinvestment scarce factors of production and reduces the stock available through overconsumption; its alleged blessings are paid for by impoverishment."

"The individual does not blame the authorities for having fostered the boom. He reviles them for the inevitable collapse. In the opinion of the public, more inflation and more credit expansion are the only remedy against the evils which inflation and credit expansion have brought about."

"Credit expansion is the governments' foremost tool in their struggle against the market economy. In their hands it is the magic wand designed to conjure away the scarcity of capital goods, to lower the rate of interest or to abolish it altogether, to finance lavish government spending, to expropriate the capitalists, to contrive everlasting booms, and to make everybody prosperous."

I had to laugh when I saw that Von Mises quote referring to "the magic wand". Indeed, history will not be so kind to Greenspan. He will be not be remembered as "The Maestro" but as "The Sorcerer's Apprentice" looking for the easy way out of every problem to the point of his own undoing.

If the theory that housing is the "bubble of last resort" holds true, we will not have long to find out whether or not this grossly absurd credit expansion is over.

Back to the book....
LoCascio explains "If meaningful reform is not forthcoming, a financial crisis dwarfing all previous crises is probably in the cards. One can not know when the crisis will occur but one will know why: the lack of scarcity and distributional integrity in the monetary unit".

Obviously LoCascio is an optimist. I think it is far too late to prevent a calamity that wipes out the malinvestments and excesses of a twenty year boom that were built upon bubble after bubble of reckless credit expansion.

Nonetheless, LoCascio attempts to address the challenge of creating a "Moral Monetary System". He argues that the root of the current problem is that inflation is perverse because increases in the money supply are distributed unevenly an unfairly. Any solution must remove the ability of the FED to create and distribute money. He also mentions two related problems that must be rectified: First our monetary unit must be defined. Second, money needs to be distinguished from credit.

I will save a discussion of money supply for a later date, but LoCascio as others before him, have pointed out numerous flaws with current measures such as M1, M2, M3, MZM etc. The preceding measures blur credit with money in varying degrees and have other flaws as well that will be a subject for further discussion at a later date. For now, let's just say that credit is so often blurred with money in our current system that it is hard not to be confused.

The heart of his proposal is to use money that has 100% backing with no more fractional reserves on demand deposits (checking accounts). Thus money can not be at one's disposal in a checking account while simultaneously being lent to someone else. "Money is only money if it is available to the owner on demand at face value". Finally, money would be once again be backed by gold.

To date no one has put together a way to get from here to there.
LoCascio attempts to do just that with an eight step program in which
1) Credit is distinguished from money
2) A preliminary money supply figure is determined and published based on step 1
3) A day of reckoning (DOR) announced on which money supply would be "corrected"
4) Fractional reserve banks will cease to exist
5) Time deposits will be kept distinct from demand deposits
6) Leading up to the DOR money totals and credit totals will be fine tuned
7) On the DOR existing federal reserve notes (dollars) will be replaced with Treasury Certificates (TC) that are payable on demand in gold
8) Taking the number of ounces of gold held by the treasury and dividing that by the TCs, one gets a price value for gold and notes are redeemable at that price. A dollar once again has a value associated with it.

Note: The above is a very short summary of what was proposed and LoCascio admits more work is needed to get everything correct. Obviously, there would be a huge windfall to anyone owning gold (unless gold profits were once again confiscated) and there would be other consequences as well. In a brief phone conversation as well as in his book, LoCascio emphasized the odds of his plan happening are very remote and that this was primarily a theoretical exercise.

One such difficulty that LoCascio did not deeply delve into is the global problem required in getting all the Central Bankers to agree to carry out such a plan simultaneously. Also, given our current trade imbalances, there would be huge pains for the US to go back to an honest system right now.

While I think LoCascio underestimates the theoretical difficulties of such an endeavor, it is very clear that the current system is broken beyond repair. In that regard, I am more of an optimist than LoCascio. Something will have to replace Bretton Woods II given that the current system is clearly not sustainable. Why not use the ideas outlined in his book as a starting point?

Like it or not, the US will have to start thinking about long term consequences or the markets will eventually force the issue. My guess by now should be obvious. Time will be ripe for a "fresh honest start" after the repudiation of Greenspan's wizardry comes via an enormous deflationary collapse. Unfortunately, that final collapse may be years away if we follow the Japanese Model.

Regardless of whether or not one thinks it is either desirable or even possible to return to a gold standard as described, the book is a very good read on the problems of the current fiat system in which money, backed by nothing, can be created at will by the elite for the sole benefit of the elite.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Bank Lending Practices

Following are some highlights from the
US gov't Senior Loan Officer Opinion Survey on Bank Lending Practices.

Domestic commercial banks reported a further easing of lending standards and terms for commercial and industrial (C&I) loans and commercial real estate loans over the past three months. At U.S. branches and agencies of foreign banks, in contrast, lending standards and terms for these types of loans were little changed over the same period. On net, domestic banks experienced stronger demand for C&I loans over the past three months, while foreign institutions indicated that demand for business loans was about unchanged. Both domestic and foreign institutions reported stronger demand for commercial real estate loans, on balance. A notable net fraction of domestic respondents reported stronger demand for loans to purchase homes over the past three months, while a small net percentage of banks also experienced a strengthening in demand for consumer loans. On net, credit standards for residential mortgages and consumer loans were about unchanged in the July survey, but a significant proportion of respondents indicated increased willingness to make consumer installment loans.

About one-fifth of domestic institutions reported in the July survey that they had become more willing to make consumer installment loans over the previous three months, a somewhat larger share than in April. However, standards and terms on credit card and non-credit-card consumer loans were reportedly little changed, on net, over the same period. A modest net fraction of banks reported stronger demand for consumer loans in the July survey.

A large majority of respondents reported that their bank had securitized less than one quarter of nontraditional mortgages originated over the past year. These institutions accounted for about one-half of the residential mortgages on the respondents' books. In contrast, three large banks—which accounted for almost 40 percent of the respondents' residential mortgages outstanding—indicated that the share of nontraditional mortgage originations that had been securitized exceeded 75 percent. On balance, a majority of the banks indicated that they were less likely to securitize nontraditional mortgage products than traditional mortgages.

What I find most interesting is that large banks are passing 75% of the trash as soon as they can, perhaps only keeping the very best of it from their most credit worthy customers, but the small institutions were doing the opposite, passing only 25% of the trash on to Fannie Mae and other investors. This should tell you something about the risk being assumed by some of the smaller players. It should also tell you that a minimum of 25% of these loans would not have been written at all had the originators not been able to pass the trash to someone else (Fannie Mae or some other "investor") willing to accept damn near anything in the belief that there is no associated risks with these loose lending standards. I will have some more to say about this in an upcoming article.

Mike Shedlock /Mish
http://globaleconomicanalysis.blogspot.com/

The Goldilocks Economy

Flashback Wednesday August 3 I proposed .....
Those with idle time on their hands might wish to turn on CNBC and count how many times they say "Goldilocks Economy".

It seems the good folks at the BCA decided to do take that idea one step further. Not that the following should surprise any Mish readers but it seems that Goldilocks Is Overbought.

The "goldilocks" scenario that has been supporting global financial markets is fully discounted.

Click on the above link for a nice graph of how many times "Goldilocks Economy" was mentioned in a major newspaper or magazine article recently.

By the way, Goldilocks is a fairy tale, just like our economy.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Treasury Auction Disappointing?

Marketwatch reports Treasury's 5-year auction disappoints bond market

The Treasury Department's $13 billion auction of 5-year notes met with mixed demand, analysts said. The yield was 4.223%, above the 4.214% anticipated, based on trading in the "when-issued" market. The low 21.8% participation by indirect bidders, including central banks, was deemed disappointing. It's the second lowest on record. Overall demand was better. The bid-to-cover ratio showed that $2.92 in bids were received for every $1 sold, up from $2.37 in July and the best since $3.06 in August 2000. The broader Treasury market traded lower after the auction, erasing early gains seen in relief over the Federal Reserve's inflation assessment.

What I want to know is:

• Exactly who was disappointed?
• What was there to be disappointed about?
  

Here's what I see:

• Indirect bidders took a mere 21%
• The 5-yr yield barely budged (in fact yields barely budged across the spectrum).
• This was hardly the Armageddon that bond bears were predicting.
• Maybe that's who was disappointed.
  

I have long maintained that US demand will pick up where foreign demand leaves off.
4% rates will look rather good compared to a crashing housing and stock market.
If this is the start of a trend, then perhaps we are about to find out.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Unlock Shock and Libor Creep

I received the following question from a poster on the Motley Fool.
Mish, why do you think a few more hikes will "break" housing? I mean, I think housing will break for a plethora of reasons, but so far these hikes have only affected the ARM rate trend and have had little or no effect on 30 year fixed mortgage rates. What seems to be the result of the divergent trends of the 30 year rates and the ARM rates is that houses are sitting longer on the market, but not selling significantly lower. If 10 rate hikes have had so little effect on the 30 year rates, why should a few more matter?
Smufty

Smufty, housing will break regardless of what the FED does at this point. The global economy is slowing and housing is in decline big time in places like Australia and the UK. It would eventually die of exhaustion here as well, regardless of what rates were set at.

As for why a "few more matters" is because there are a lot of people out there that got a 1 or 2 yr adjustable rate ARMs and those are about to reset big time. Adjustable rate mortgages have been averaging well over 30% and in some places like California “creative alternatives” have averaged over 50% of the loan totals. Some of the people that got in near the absolute lows in interest rates might go from 3% to 5% overnight. I think the range might be something like a 33-65% overnight increase in interest payments. That will be one hell of an "Unlock Shock".

Others on interest only libor based loans are slowly getting whacked to death. For 350K borrowed on an interest only libor product, I estimate payments to have gone up from about 1000 a month to 1600 a month and two more hikes are likely coming. Someone who stretched on one of those loans to make the monthly payment "affordable" is now finding it increasingly "not affordable". Let's call this affect "Libor Creep".

Every passing month there are more and more people whose initial lock period is about to come into "Unlock Shock" and there are more and more people slowly getting whacked by "Libor Creep". When Greenspan raises the FED Fund rate tomorrow, the latter group will immediately see another 25 bps hike.

What I do not know is how many people had 1-yr ARMs vs 2-yr ARMs vs 3-Yr ARMS etc and what the initial rates were. What we do know for sure is that anyone who got loans near the bottom in rates or got a "teaser rate" good for one or two years might be in for a rude awakening on that first adjustment. Those that were not 100% prepared for hikes are going to come under huge pressures. Heaven help those that have to sell but can't because home prices have dropped in the meantime.

Here is a final thought. Even for those that were prepared for it, that jump in interest payments is going to take away from discretionary spending or savings. "Unlock Shock" and "Libor Creep" are increasingly likely to have a noticeable affect on the economy but I do not know how to measure it.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Interest rates have peaked this cycle

With the exception of the US and possibly Japan, interest rates have peaked this cycle. The worldwide economy is clearly slowing and the fat lady is singing in many countries.

Europe didn't even have a tightening cycle and the odds are huge that the UK is through. Housing is weakening in some New Zealand areas and Bloomberg is reporting Australia's Central Bank Signals Rates Are on Hold.

Of course that leaves the US alone in central bank tightening. They have perhaps another two hikes at a "measured pace" until housing breaks but good. Once that happens the easy prediction is the FED will start cutting rates at a pace that is decidedly "not measured".

Japan is on a different cycle actually and is just now coming out of deflation. Japan may start hiking just as everyone else is finished, but it is also possible that the slowing worldwide economy tosses Japan right back into a recession.

At any rate, according to the above article Australia's central bank said inflation pressures have eased and economic growth is slowing, signaling it is unlikely to increase interest rates again this year. The Australian dollar fell.

Risks of a jump in inflation are "not as strong as they had been earlier in the year," the Reserve Bank of Australia said today in its quarterly statement on monetary policy released in Sydney. The bank dropped comments from previous quarterly statements in which it said higher rates may be needed.

The bank's comments and a report showing job advertisements fell to a two-year low in July reinforced expectations Governor Ian Macfarlane will keep borrowing costs unchanged until at least March 2006.

The A$800 billion ($612 billion) economy, in its 14th straight year of expansion, grew 1.9 percent in the first quarter from a year earlier as home building and business investment declined. That's less than half the 4.1 percent pace in the year-earlier quarter and compares with 3.6 percent growth in the U.S. economy in the same period.

"Domestic demand has slowed from its previous rapid pace and is now on a more sustainable trend," the bank said. Consumers are "borrowing less and increasing their spending less quickly than they were a year or two ago."

An index measuring retail sales fell 0.3 percent in July, the fourth consecutive drop, Cashcard Australia Ltd. said today. The index is based on electronic card transactions in the month.

As for "Domestic demand has slowed from its previous rapid pace and is now on a more sustainable trend": I think "sustainable downtrend" is a better description. What is happening should be obvious. A housing bust has sapped consumer spending. It is happening right now in the UK as well, and it lasted for 18 years in Japan. The US is next up in the queue.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

GM offers "heaps of gold" to entice car buyers

That news appeared in an article by Andy Mukherjee at Bloomberg in which he was wondering ....
When Will India Kick Its $200 Bln Gold Habit?

Let's take a look:

If John Maynard Keynes were alive today, he would be horrified to see gold rallying again, and for a reason very familiar to the British economist: India's 'ruinous' love of the 'barbaric relic.'

Almost 100 years after Keynes used those words to chide India for its extravagance, the billion-people nation shows no signs of losing its fondness for the metal. India accounts for 18 percent of world demand, more than any other country.

Gold traders aren't the only ones betting on Indian wedding demand. General Motors Corp.'s Indian unit is trying to whip up demand by throwing in a free gift of 30,000 rupees ($690) worth of gold jewelry for every purchase of its Chevrolet Optra sedan.

"Plush leather seats, jewel-effect headlamps and heaps of gold for your wife," says the GM ad line.

With increasing modernization and urbanization in the nation, the proportion of gold in the bridal trousseau should also have been on the wane. However, India's gold consumption rose 57 percent from a year earlier in the 12 months ended March 31, on top of a 63 percent jump in the previous year.

"Gold holdings among Indian households at current market value are about 2.5 times the current equity holding of $80 billion," said Chetan Ahya, a Morgan Stanley economist. In other words, some $200 billion, or the equivalent of 29 percent of India's gross domestic product, is locked up in jewelry.

Economists continue to debate whether Indian demand is excessive; social activists ask what it'll take to end the continual harassment of brides for dowry more than four decades after the practice was outlawed in 1961.

The question for gold traders is whether Indian demand will stay strong enough to push prices even higher. Investors such as Marc Faber in Hong Kong have predicted $5,000 an ounce. Much before prices scale those scary heights, the metal's appeal to Indians may start to diminish.

According to India's latest census, more than 47 million girls in the age group of 15 to 29 have yet to marry. Assuming 80 percent of them do so in the next five years, that's 38 million weddings. At a very modest 10 grams per wedding, or slightly less than one-third of an ounce, that would translate into 76 metric tons of demand a year, enough to buy a fifth of all gold mined in South Africa last year.

"It's a good thing Keynes isn't around to see that" says Mr. Mukherjee.

Will this help GM? Somehow I rather doubt it. Will GM boost gold sales? I rather doubt that as well (at least to any significant degree). On the other hand, 38 million weddings at the projected rate seems like a fair amount of gold. Perhaps gold bugs need to monitor the number of Indian weddings.

Unfortunately, Mr. Mukherjee who seems to agree with Keynes, completely misses the boat on two key points.
1) Gold is going to be around a lot longer than the Rupee, or for that matter, the US$.
2)In a world awash in overcapacity, investing in gold seems far smarter than investing in more widget makers.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/