Stunning PMI Numbers

MicaNews is reporting PrivateMI Helps More Families Achieve Homeownership in January. What the headline should read is "The bottom falls out of PMI applications".

Mortgage Insurance Companies of America (MICA) reports that 90,330 borrowers used private mortgage insurance (PrivateMI) to buy or refinance a home in January. The number of borrowers using PrivateMI in January was 43.9% lower than the December total of 161,172.

The number of PrivateMI applications received in January by MICA members was 95,131 or 40.5% less than the 160,038 received in December. The dollar volume of primary insurance written on newly originated 1-to-4 family conventional mortgage loans totaled $13,633.4 million in January, a 48.8% decrease from the previous month’s $26,666.8 million. Traditional primary insurance totaled $10,038.3 million and bulk primary insurance totaled $3,595.1 million in January. In that same month, primary insurance in-force totaled $616,139.6 million. MICA members reported 37,270 cures and 49,311 defaults during January.

The statistics in this report include data from the following member companies: AIG United Guaranty, Genworth Mortgage Insurance Corporation, Mortgage Guaranty Insurance Corporation, PMI Mortgage Insurance Co., Republic Mortgage Insurance Company and Triad Guaranty Insurance Corporation.

MICA is the trade association representing the private mortgage insurance industry. Its members help loan originators and investors make funds available to home buyers for low down payment mortgages by protecting these institutions from a major portion of the financial risk of default.

PMI Activity



In spite of one of the warmest January on record
In spite of record housing starts

Housing starts jumped 14.5 percent to an annual rate of 2.28 million last month, the highest since March 1973, the Census Bureau reported. Economists surveyed by Briefing.com forecast that housing starts would come in at an annual rate of 2.02 million in the month.

The bottom is falling out of Private Mortgage Insurance.

What are these numbers telling us?

1. The January seasonal adjustments to housing starts are bogus?
2. Builders are scrambling to build everything they can before the bottom falls out?
3. The January PMI is an outlier?
4. People are putting more money down therefore need PMI?
5. Fewer people are buying houses?
   
6. Some combination of 1, 2, 5?

I vote for #6.
No doubt the bureaucrats overdid their January seasonal adjustments.
January is expected to be cold so they add starts to smooth seasonality.
Figure in a bunch of panicked builders on top of it, all scrambling to get rid of their land inventory while the getting is good, and voila you have the makings of a blow off top in housing starts. Obviously #4 is laughable and does not fly in the face of recent home buying trends.

PMI Defaults and Cures



Defaults picked up in October (the Katrina effect?) but have been steady since then. What is interesting is that cures went up as well. I do not think that flies in the face of the increasing numbers of bankruptcies we have seen, but it is what it is. Expect this conundrum to resolve itself via increasing numbers of defaults.

Both sets of numbers will be interesting to watch going forward.

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

Spotlight on Japan

Is Japan really a nation of savers?
I found some interesting graphs by Japan's Ministry of Finance describing the Current Japanese Fiscal Condition .

Japan's national debt as a % of GDP



Japan's net national debt



The above graphs were produced by Japan's Ministry of Finance.
The most current report I could find in English was from September 2005.
Japan's National Debt Hits New High

Japan's government debt ballooned to a record high of JPY 795.8 trillion (USD 7 trillion) at the end of June, according to a report released by the Japanese Finance Ministry. It was projected to be JPY 774 trillion for this fiscal year, so the national debt is growing faster than expected.

Japan has relied on government bond issues to make up for falling tax revenues. This has turned the nation into one of the world's most indebted countries. Japan 's public debt burden is now almost 160 per cent of its GDP, which makes it the highest in the industrialized world.

Even though Japan has a positive balance of trade with the US, Japan's government is squandering it. Basically, the private sector is saving and the government takes those savings and wastes them in imaginative ways.

On February 15th 2006 Japan's Fiscal Policy Minister said Japan May Have to Cut Spending by 20 Trillion Yen

The Japanese government may have to cut total spending by 20 trillion yen ($171 billion) by April 1, 2011, to meet its goal of balancing the budget if it does not raise taxes, Economic and Fiscal Policy Minister Kaoru Yosano said.

The projection was submitted at today's meeting of a government economic panel in Tokyo. Yosano made the comments following the panel's meeting.

Prime Minister Junichiro Koizumi has set a goal of balancing spending and revenue, without depending on new bond sales, by the early next decade. Japan can't stop the expansion of its public debt by spending cuts alone, Koizumi told parliament on Feb. 7, signaling Japan may have to raise taxes after he steps down in September.

Japan's public debt, combining that of both national and local governments, will reach 151 percent of gross domestic product by March 2007, the Ministry of Finance projected in December.

Given that it is already over 160% by earlier MOF projections I am not sure where the 151% comes from. Nonetheless, it should be quite clear by any means that the idea of Japan being a "nation of savers", as least as far as government deficit spending goes should be shattered.

What about that trade surplus?

On February 22nd Forbes reported Japan posts first trade deficit in 5 years, the largest since 1983.

Japan posted its first trade deficit in five years in January as surging crude oil prices bloated imports but economists believe that the trade gap was a one-off event.

The Ministry of Finance said the trade balance plunged into a deficit of 348.9 bln yen last month, against a surplus of 193.9 bln yen a year earlier, also due to a long New Year holiday at the start of the year.

'Due to a long New Year break, exports normally drop in January compared to other months, while surging crude oil prices and the cold weather helped imports stay at high levels, thereby resulting in the first trade deficit in five years,' an MoF official told a news briefing.

'Looking back at our records in the past 20 years, it was only in January that Japan has posted a trade deficit,' he added.

The last time Japan reported a trade deficit was in January 2001. The latest trade gap was the largest since January 1983 when the deficit reached 409.8 bln yen but nowhere near the deficit of 824.8 bln yen posted in January 1980.

Last month's figure was much wider than market expectations. Economists on average projected a deficit of 101.9 bln yen, according to a Nihon Keizai Shimbun poll of 23 research institutes. The forecasts ranged from a deficit of 378.6 bln yen to a surplus of 158.0 bln yen.

But the finance ministry said the trade deficit may be a blip and expects exports to remain brisk.

Let's explore the idea that "surging crude oil prices" are to blame.



Given that crude prices ran up from $25 to $70 without causing a deficit and stayed in a range near $62 (8 dollars off the high) for about 6 months, can oil really be the culprit?

Let's see if the YEN has any clues.



Hmmm. Does that help answer the question?

Of course, Japanese exports should have been helped by been helped by a falling YEN. Were they? I suspect that a slowing world economy may be hurting exports everywhere. What we do know for sure is that the falling YEN did not help Japan at all on its oil purchases.

Bloomberg is writing Japan's Boom May Explode Yen-Carry Trade.

Surprisingly strong growth in Japan is raising many eyebrows, not least those at the central bank anxious to scrap its zero-interest policy.

There can be little doubt 5.5 percent growth between October and December pushed the Bank of Japan further in that direction. Oddly, there are few if any signs global markets are bracing for higher debt yields in Japan.

Why? Japanese rates have been negligible for so long that investors take them for granted. This, after all, is the economy that's cried wolf too many times. The reason investors from New York to Singapore aren't ecstatic about Japan's recovery is the sense we've been here before -- many times.

Yet Japan's latest growth figures should make believers of some of the biggest skeptics. Not only did exports boost the economy in the fourth quarter, so did personal spending -- a sign optimism is spreading to households around the nation.

Rest assured the BOJ is noticing and will soon begin pulling liquidity out of Asia's biggest economy. Once that process begins, there's no telling how aggressive the BOJ will be and what effect it will have on bond yields.

Where Liquidity Begins

There are two reasons Japan's rate outlook is a huge story for global markets. One, yields in the biggest government debt market will head steadily higher for the first time in more than a decade. Two, it may mean the end of the so-called yen-carry trade.

"All liquidity starts in Japan, the world's largest creditor country," said Jesper Koll, chief economist for Japan at Merrill Lynch & Co. "When rates go up here, rates go up everywhere."

What makes the carry trade so worrisome is that nobody really knows how big it is. For example, the BOJ has no credible intelligence on how many hedge funds, investors and companies have borrowed cheaply in ultra-low-interest-rate yen and re-invested the funds in higher-yielding assets elsewhere.

A popular form of the strategy exploits the gap between U.S. and Japanese yields. Anyone borrowing for next to nothing in yen and parking the funds in U.S. Treasuries received a twofold payoff: the 3-plus percentage-point yield difference and the dollar's rise versus the yen. The latter dynamic boosts profits by the time they're converted back to yen.

Yet as the BOJ raises rates and more investors buy into Japan's revival, the yen is sure to rise, much to the chagrin of carry-trade aficionados. Realization the trade is moving against investors may send shockwaves through global markets.

It would start slowly with speculators suddenly closing positions that are becoming more expensive: dumping Treasuries, gold, Shanghai real estate, shares in Google Inc. or whatever else they used yen borrowings to bet on. The chain reaction would accelerate once the mainstream media jumped on the story.

If all this sounds far-fetched, think back to late 1998, which offers an example of the damage a panic among carry-traders can do.

Remember 1998

In October of that year, Russia's debt default and the implosion of Long-Term Capital Management LP shoulder-checked global markets. The disorienting period culminated in the yen, which had been weakening for years, surging 20 percent in less than two months.

Suddenly, just about anyone who'd borrowed cheaply in yen rushed for the exits. It prompted frantic conference calls among officials in Washington, Tokyo and Frankfurt. Just how big was the yen-carry trade? How much leverage was involved? What could policy makers do, if anything, to regain control?

Although the Japanese carry trade has a history of blowing up in spectacular fashion, it now seems that all eyes are on it. That makes the carry trade far less likely to be any sort of economic trigger. The last time the Yen carry trade did blow up, nobody talked about it beforehand. A watched pot never boils. In 2000 Greenspan was worried the economy was too strong (it imploded). In 2001 the FED and Bernanke were worried about deflation (the economy roared when interest rates were slashed to 1%), now the FED is worried about inflation again while Japan is still worried about deflation.

Japan is arguably in its own state of Economic Zugzwang and very reluctant to make a move. On one hand, Japan has a desire to get off its ZIRP policy (which would tend to strengthen the YEN if they do) on the other hand Japan still has an overwhelming desire to maintain exports in a world economy that is clearly slowing. Compounding the problem is rising oil prices as the YEN weakens vs. a declining value of its massive US Treasury portfolio if the YEN would strengthen. Eventually the market is going to force Japan to do something. In the meantime this article should be a reminder that every major fiat currency has huge structural flaws lurking somewhere. One can only choose be between relative degrees of fiscal insanity. That unfortunately is the current sad state of affairs.

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

The Red Queen Race

In Lewis Carroll's Through the Looking-Glass there is an incident involving the Red Queen, a representation of a Queen in chess, and Alice constantly running but remaining in the same spot. The scene is often referred to as The Red Queen's Race.

The Queen kept crying "Faster!" but Alice felt she could not go faster, though she had no breath to say so. The most curious part of the thing was, that the trees and the other things round them never changed their places at all: however fast they went, they never seemed to pass anything. "I wonder if all the things move along with us?" thought poor puzzled Alice. And the Queen seemed to guess her thoughts, for she cried, "Faster! Don't try to talk!"

Not that Alice had any idea of doing that. She felt as if she would never be able to talk again, she was getting so out of breath: and still the Queen cried, "Faster! Faster!" and dragged her along. "Are we nearly there?" Alice managed to pant out at last.

"Nearly there!" the Queen repeated. "Why, we passed it ten minutes ago! Faster!" And they ran on for a time in silence, with the wind whistling in Alice's ears, and almost blowing her hair off her head, she fancied.

"Now! Now!" cried the Queen. "Faster! Faster!" And they went so fast that at last they seemed to skim through the air, hardly touching the ground with their feet, till suddenly, just as Alice was getting quite exhausted, they stopped, and she found herself sitting on the ground, breathless and giddy. The Queen propped her against a tree, and said kindly, "You may rest a little now."

Alice looked round her in great surprise. "Why, I do believe we've been under this tree all the time! Everything's just as it was!"



"Of course it is," said the Queen: "what would you have it?"

"Well, in our country," said Alice, still panting a little, "you'd generally get to somewhere else -- if you ran very fast for a long time, as we've been doing."

"A slow sort of country!" said the Queen. "Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!"

The above image is thanks to the University of Virginia Library.

The Red Queen Race vs. the US Economy

Following is a chart of US GDP. It seems to have stalled.



Yet money and credit is still expanding.



Can consumers forever keep spending more than they make?



Government spending still climbs at a steady pace.



Spending is increasing far faster than revenues.
Is this sustainable?



Following is a chart of the CPI as published by the government.
Does anyone believe it?



Mish notes:
Yes, I realize that M3 is grossly distorted.
Unfortunately practically all government numbers are.
The CPI is certainly inaccurate and is probably understated.
It is impossible to say by how much as noted in Inflation: What the heck is it?
What we can say is that the CPI is subject to massive government manipulation.
We can also say that the GDP is distorted by hedonics and imputations.
Those not familiar with the concept of paying oneself rent and adjusting the GDP for "the value" of free checking accounts may wish to read Grossly Distorted Procedures.

Let's take a look at 4th quarter US GDP

The US economy hits the brakes in fourth quarter.

US gross domestic product, after expanding by an annualized 4.1 percent over July-September, dropped to its weakest pace in three years after 10 consecutive quarters of growth above 3.0 percent.

Economists said the surprising report foreshadowed a more moderate pace of expansion for the world's biggest economy in 2006.

But Treasury Secretary John Snow dismissed the GDP slowdown as "anomalous" and stressed the preliminary report was subject to revisions.

"Economic fundamentals point to continued strong economic performance in the United States in 2006. The US economy is performing well," he said.

"This report is the worst-case scenario for the Fed and Mr. Bernanke, and the new Fed chair will be tested right off the bat," commented Joel Naroff of Naroff Economic Advisors.

"The economy is slowing, though clearly not as rapidly as the headline number would have you think. At the same time, inflation is slowly accelerating," he said.

The GDP report showed that over 2005, the personal savings rate of Americans was negative for the first year since the depths of the Great Depression in 1933.

A spending binge by US consumers on the back of a red-hot property market has done much to elevate GDP growth in recent years. But housing has shown signs of slowing, triggering fears that consumers could rein in spending.

Other figures out Friday showed that sales of new US homes increased a surprising 2.9 percent in December. But the inventory of unsold homes increased 2.4 percent to a record 516,000.

The GDP report showed that consumer spending increased at an annual rate of 1.1 percent, down heavily from 4.1 percent in the third quarter. It was the slowest spending pace since the last US recession in mid-2001.

Notice how backwards the thinking is: "But housing has shown signs of slowing, triggering fears that consumers could rein in spending." Any rational person looking at the negative savings rate, the trade deficit, and rampant government spending should not be fearing a slowdown in consumer spending, the fear should be that consumer spending continues!

Posting on Kitco, Trotsky writes:
Since 2000, the US economy has officially grown by $1.4 trillion (inflation-adjusted GDP growth) . Over the same period, total credit market debt outstanding has grown by an astounding $9 trillion. Personal (household) debts alone have exploded by 60% over the past 5 years, from already elevated levels ($6.9 trillion to $11 trillion) . Nearly 90% of the reported GDP growth was in consumption and residential building.

The "recovery" continues to be the weakest post WW2 recovery on record, with capital spending stuck in limbo, real wages declining and job growth non-existent (private sector employment has risen only 1% since 2000 - compared to the 9% average of other post WW2 recoveries) .

Right now it takes a negative savings rate, expanding credit, and excessive government spending just to stand in one spot. The charts above prove it. Furthermore, if one subtracts imputations and hedonics, and adjusts the GDP by a CPI that better reflects reality, the logical conclusion is that the GDP was actually negative last quarter.

Let's consider one more passageway from Through the Looking-Glass:

I SHOULD see the garden far better," said Alice to herself, "if I could get to the top of that hill: and here's a path that leads straight to it -- at least, no, it doesn't do that -- -" (after going a few yards along the path, and turinng several sharp corners), "but I suppose it will at last. But how curiously it twists! It's more like a corkscrew than a path! Well, this turn goes to the hill, I suppose -- no, it doesn't! This goes straight back to the house! Well then, I'll try it the other way."

And so she did: wandering up and down, and "trying turn after turn, but always coming back to the house, do what she would. Indeed, once, when she turned a corner rather more quickly than usual, she ran against it before she could stop herself.

In "Wonderland" forward movements take one back to their starting point and rapid movements can cause very abrupt stops.

I picture Ben Bernanke as the new Red Queen.
He is now trapped in Zugzwang.

Definition: A German term for the obligation to move. All legal moves lead to a worsening of the position.

Click on the above link for multiple chess possibilities. Here is one example (taking poetic license) as the position shows a red king not a queen.



For non-chess fans who might not fully understand the above position: no matter which way Bernanke moves, white will next capture the red pawn, and march the remaining white pawn to victory. The red king can not capture the white pawn or move one square forward since either would put the king in "check" (subject to capture by the opposing king or pawn).

In economic terms, there is no magic mirror.
Bernanke is trapped in "Wonderland" but unlike Alice has no way out.
Bernanke gets to choose between hyperinflation and deflation.
The moment he can not run fast enough, the US economy will implode.
If he runs too fast, the value of the US dollar as well as the FED's power will both come to a very abrupt stop.
In effect Bernanke is in Zugzwang and he does not even know it.
Economic Checkmate.

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

A Toxic Mix in Ohio

The Akron Beacon Journal is reporting High-risk mortgages spread to Ohio's small towns.

COLUMBUS, Ohio - An increasing number of Ohioans who live in small towns and rural areas are losing their homes because of risky, high-interest mortgage loans, records show.

Sub-prime loans, which generally carry interest rates above 8 percent, are designed for people who can't qualify for traditional mortgages because of poor credit, low income or the lack of a down payment.

Mortgage brokers, who for years have marketed high-interest loans in poor city neighborhoods, have expanded their reach into the state's farmlands and Appalachian hills, The Columbus Dispatch reported for a story Sunday.

Ohioans signed 72,909 high-interest mortgages in 2004, about 16 percent of all mortgages signed that year.

That has contributed to Ohio's high foreclosure rate, the worst in the nation. About 10 percent of sub-prime borrowers were in foreclosure between July and September, triple the national figure, according to data from the Mortgage Bankers Association.

The state's biggest concentration of costly loans was in Hardin County in rural north-central Ohio. About 32 percent of mortgages there carried a high interest rate in 2004, a time when interest rates on a conventional loan averaged just 5 percent.

Sub-prime loans can provide a financial lifeline for people who otherwise couldn't buy or refinance a home, but they are also more expensive.

When Sammy and Tracy Bogue of Kenton, 56 miles northwest of Columbus, signed for a 7.5 percent adjustable rate loan, they understood that the rate could go up. In fact, the fine print shows that it will never go lower and could climb as high as 14.5 percent.

A foreclosure notice on their home was published this month in the local newspaper.

More than 59,000 foreclosure notices were filed in Ohio in 2004. In the first half of 2005, 3.3 percent of state home loans were in foreclosure, more than triple the national average, according to the Mortgage Bankers Association.

Hardin County registered the eighth-highest jump in foreclosures in Ohio from 1999 to 2004 - a spike of 181 percent. A similar acceleration occurred across much of rural and suburban Ohio, according to state Supreme Court statistics.

Ohio lawmakers are considering a predatory-lending bill called the Ohio Homebuyers' Protection Act.

The bill would remove a provision that exempts mortgage brokers and lenders from a state law prohibiting deceptive sales practices.

Doing so would open up brokers and lenders to lawsuits by the attorney general and individual borrowers who think they have been cheated or misled.

The bill also would make disciplinary action against brokers a matter of public record.

Three key sentences:

"Sub-prime loans can provide a financial lifeline for people who otherwise couldn't buy or refinance a home, but they are also more expensive."

"Ohio lawmakers are considering a predatory-lending bill called the Ohio Homebuyers' Protection Act. The bill would remove a provision that exempts mortgage brokers and lenders from a state law prohibiting deceptive sales practices."

"In the first half of 2005, 3.3 percent of state home loans were in foreclosure, more than triple the national average, according to the Mortgage Bankers Association."

Just Two Questions:

1. Are subprime loans more likely to be a lifeline or an anchor?
2. What kind of bill would have exempted mortgage brokers and lenders from deceptive sales practices in the first place?

The Toxic Mix:

• A rust-belt economy and outsourcing of jobs
• Predatory lending
• Incredibly weak laws that seem to encourage deceptive sales practices
• Juicy sub-prime fees
• Ease in passing the loan on to Fannie Mae or other mortgage backed securities buyers

As the economy weakens, expect the affects of this toxic mix to spread.
It's far too late to do much of anything about it.

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

Trade Wars Over Shoes

According to Bloomberg the EU will Impose 20% Duties on Shoes From China, Vietnam.

The European Union will impose import duties as high as 20 percent on some leather shoes from China and Vietnam starting in April, to prevent the footwear from being sold below cost on the bloc's markets.

The EU, which in the last year imported 120 million pairs of shoes from Vietnam and 95 million pairs from China worth 5 billion euros ($6 billion), said it will impose rising tariffs over six months, to a maximum of almost 20 percent of their value. China has threatened to retaliate if the European Trade Commissioner Peter Mandelson levies the additional duties.

"This is a very consumer-hostile measure and would be particularly burdensome to low-income families as well as traders, importers and retailers," said Ralph Kamphoener, senior trade adviser at EuroCommerce, which represents European companies that employ more than 22 million people in the EU.

The EU's proposal adds to a series of disputes with China over textile and apparel imports and piracy of copyrights, trademarks and patents. China's emergence as an industrial economy has also provoked tensions in the U.S., prompting calls from lawmakers and the administration of President George W. Bush for a revaluation of the yuan.

By phasing in the penalties from April 7, the European Commission, the bloc's executive agency, hopes to avoid the kind of distribution blockages that occurred when the EU limited imports of Chinese textiles last year. The categories under investigation range from tennis shoes to stiletto boots covering 8 percent of all shoes sold in Europe.

Commission spokesman Peter Power said there is "compelling evidence of serious state intervention in the leather footwear sector" in both China and Vietnam. That intervention takes the form of "cheap finance, non-market land rent, tax breaks and improper asset valuation leading to dumping," he told journalists in Brussels today, adding that "there's evidence of both dumping and injury."

Mandelson will propose the punitive duties to the EU's anti-dumping committee on March 9.

The duties would "have a serious impact on the export of Vietnamese shoes to the EU," said Do Thanh Hong, a vice chairman of the Vietnam Leather and Footwear Association. "Importers will buy shoes from countries that have lower prices, for example, Indonesia."

If ever there was a violation of free trade it would be the EU with its agricultural subsidies. That aside, the EU is now attempting to protect a bunch of inefficient Italian shoemakers at the expense of all of Europe's consumers.

This line says it all:
The duties would "have a serious impact on the export of Vietnamese shoes to the EU," said Do Thanh Hong, a vice chairman of the Vietnam Leather and Footwear Association. "Importers will buy shoes from countries that have lower prices, for example, Indonesia."

This measure simply will not stop importers from looking for the cheapest shoes they can get. In the meantime, consumers in all of Europe will be hurt in order to please a handful of Italian shoemakers. The plain truth of the matter is that importation and distribution of shoes from Asia is a far bigger business in Europe than Italian shoemaking. The tariffs will do immediate harm to business and consumers as well.

No one can win with the actions taken by the EU. Consumers will look elsewhere, Italian shoemakers will not recapture lost market share, and supply channels will be disrupted (at expense) to places like Indonesia. In short, it is a lose lose situation.

Expect to see more actions like this.
Trade wars and tariffs are one of the hallmarks of deflationary times.

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

Horton Slashes Prices in Sacramento

Is anyone shocked by some of the latest price reductions?
Check out these Sacramento price cuts :



The Chisholm
Was $434,136
Now $299,990
============
$134,146 or 30.9% reduction

The Tuolomne
Was $412,884
Now $319,990
============
$92,894 or 22.5% reduction

The Pacific Crest
Was $452,890
Now $324,990
============
$127,900 or 28.2% reduction

The Shasta
Was $480,828
Now $349,990
============
$130,838 or 27.2% reduction

If you paid full price for any of these, you might break even in 8-10 years.
Or you might not.
Imagine, putting 0% down and waking up $134,000 in the hole before commissions.

Hmmmm.
Here are two things that just do not seem to matter much anymore:

• "They are not making land anymore"
• "Everyone wants to live in California"

As shocked as anyone might be, this is just a down payment.
How long will it be before we hear "No one could possibly have seen this coming?"

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

Deceptive Pricing or Deep Discounts?

D.R. Horton is having a Spectacular President’s 3-day Sale at Savannah in Frederick.

METRO DENVER – “America’s Builder” is hosting a spectacular 3-Day President’s Weekend Sale on Saturday, February 18th through Monday, February 20 th at three master-planned communities in the metro Denver area. D. R. Horton – Melody Series and D. R. Horton’s Continental Series are offering incredible savings of up to $65,000 on select single-family homes at Savannah in the town of Frederick and Sapphire Pointe in Parker, respectively. Buyers in the market for a carefree condominium can visit D. R. Horton’s Trimark Series at Balterra in Aurora and enjoy a very generous savings worth up to $20,000.

A question came up on my blog as to whether or not the discounts offered by Centex, Meritage, KBHomes, and now Horton are real.

To kick this discussion off, let's refer to FTC Guides Against Deceptive Pricing .

§233.1 Former price comparisons.

(a) One of the most commonly used forms of bargain advertising is to offer a reduction from the advertiser's own former price for an article. If the former price is the actual, bona fide price at which the article was offered to the public on a regular basis for a reasonably substantial period of time, it provides a legitimate basis for the advertising of a price comparison. Where the former price is genuine, the bargain being advertised is a true one. If, on the other hand, the former price being advertised is not bona fide but fictitious -- for example, where an artificial, inflated price was established for the purpose of enabling the subsequent offer of a large reduction -- the ``bargain'' being advertised is a false one; the purchaser is not receiving the unusual value he expects. In such a case, the "reduced" price is, in reality, probably just the seller's regular price.

(b) A former price is not necessarily fictitious merely because no sales at the advertised price were made. The advertiser should be especially careful, however, in such a case, that the price is one at which the product was openly and actively offered for sale, for a reasonably substantial period of time, in the recent, regular course of his business, honestly and in good faith -- and, of course, not for the purpose of establishing a fictitious higher price on which a deceptive comparison might be based. And the advertiser should scrupulously avoid any implication that a former price is a selling, not an asking price (for example, by use of such language as, ``Formerly sold at $XXX''), unless substantial sales at that price were actually made.

(c) The following is an example of a price comparison based on a fictitious former price. John Doe is a retailer of Brand X fountain pens, which cost him $5 each. His usual markup is 50 percent over cost; that is, his regular retail price is $7.50. In order subsequently to offer an unusual ``bargain'', Doe begins offering Brand X at $10 per pen. He realizes that he will be able to sell no, or very few, pens at this inflated price. But he doesn't care, for he maintains that price for only a few days. Then he ``cuts'' the price to its usual level -- $7.50 -- and advertises: ``Terrific Bargain: X Pens, Were $10, Now Only $7.50!'' This is obviously a false claim. The advertised ``bargain'' is not genuine.

(d) Other illustrations of fictitious price comparisons could be given. An advertiser might use a price at which he never offered the article at all; he might feature a price which was not used in the regular course of business, or which was not used in the recent past but at some remote period in the past, without making disclosure of that fact; he might use a price that was not openly offered to the public, or that was not maintained for a reasonable length of time, but was immediately reduced.

(e) If the former price is set forth in the advertisement, whether accompanied or not by descriptive terminology such as ``Regularly,'' ``Usually,'' ``Formerly,'' etc., the advertiser should make certain that the former price is not a fictitious one. If the former price, or the amount or percentage of reduction, is not stated in the advertisement, as when the ad merely states, ``Sale,'' the advertiser must take care that the amount of reduction is not so insignificant as to be meaningless. It should be sufficiently large that the consumer, if he knew what it was, would believe that a genuine bargain or saving was being offered. An advertiser who claims that an item has been ``Reduced to $9.99,'' when the former price was $10, is misleading the consumer, who will understand the claim to mean that a much greater, and not merely nominal, reduction was being offered.

Now that does not mean that homebuilders are abiding by the law, but it does certainly mean they could be in serious trouble if they are not.

Here is a simple way of looking at it:

• Homebuilders raised prices because they could.
• There was a mad last dash to buy houses out of fear of missing ouit.
• Homebuilders raised prices into the consumer insanity.

I do not believe homebuilders raised prices just to offer discounts. The numbers of houses they sold at ever increasing prices proves it.

In situations like these, the obvious answer is not some sort of conspiracy just to be able to claim $150,000 off down the road. The obvious answer is builders have to take $150,000 off the prices in order to be able to sell them now.

To think otherwise is to believe yet another conspiracy theory as opposed to simply believing that buyers of homes were acting like "greater fools" outbidding each other for homes.

To someone that paid $150,000 or 15% higher or even $70,000 and 10% higher that is a very real discount and will keep that person underwater on their house for perhaps 10 years to come and perhaps even longer. The question is not whether repeated price hikes occurred (they did) the question was about whether prices were purposely raised just so later "discounts" could be advertised.

Nope. Sorry conspiracy theorists, prices of homes rose in response to blowoff demand, and prices are now declining as the bubble was pricked.
One can either believe that or one can believe in some sort of national price fixing and deceptive pricing scheme. Your choice.

That of course does not imply the value of "discounts" offered as upgrades, landscaping, etc are really at "fair price", but it does mean that someone likely overpaid by at least as much as the "discounts" say, and whoever did is now seriously now underwater.

I called a real estate broker in Florida to discuss this situation just today. He told me the discounts are real and substantial and things are even worse than I suspect. He cited two local homebuilders in Florida that just went bankrupt this past month on 60+ unit subdivisions that will never be built. Poof. Down payments vanished because subcontractors have first right to the money for work performed.

He also offered this explanation for the rising median prices we see: When a sale is booked, it is booked at full price even though substantial discounts are taken off. In other words we have dramatically inflated sales prices even though homes are really going for less money. Such distortions likely explain rising inventory and rising medium price in the face of declining sales and rising inventory. In other words, those rising medium prices (depending on area), could largely be total fiction.

The record home starts in January are only going to make matters worse. I had to laugh today when the president said the mortgage deduction would stay a part of tax law but added "If I were you I’d be worried about interest rates."

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

Limited Time Only

It started with Centex 12 hour sales for up to $150,000 off.
Meritage Fired Back with 48 hour sales.
Upping the ante time-wise is Ryan Homes offering $20,000 - $70,000 off
For "a limited time" only
On their Lovettsville, VA homesites.



$40,000 Off for a Limited Time Only!!!!

*Limited Time Only. Offer valid on select communities. May not be combined with any other offer. Listed prices do not reflect the additional discount. Must use NVR Mortgage. Prices and offers subject to change without notice.

Notice how the red star says $20,000 - $70,000 off but the text says $40,000.
I called Ryan at the number shown in the ad and the salesperson was not even aware of an online ad. I asked what units were $70,000 off and she did not know but thought it might be on the "executive series". I asked the price range for the "executive series" and the salesperson did not know that either.

After a brief interlude I was told that the "executive series" was priced $529,000 to $589,000.

So if one can get $70,000 off that line (I do not know because they do not know) that would be about 12-13% off depending on model.

Somehow I expect to see a lot more "limited time offers" from a lot more builders with even higher percentages off.

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

Peak Water?

Not only are risk preferences such that people are willing to speculate heavily on home price appreciation, they also seem willing to take a gamble on water supplies at the same time.

Please consider Vegas builder's Mohave County plan stirs worries:

If Arizona lawmakers want a reason to rethink the state's rural water laws, Earl Kemp figures he's stuck dead center in the middle of Exhibit A.

Kemp watches daily as earth-moving equipment rumbles past his home in rural Golden Valley, near Kingman, pushing aside dirt and desert scrub as a Las Vegas developer prepares to build the first of more than 130,000 homes. It's an eye-popping plan that, when the final shingle is nailed in 20 or 30 years, will leave behind a city the size of Mesa in a 40-mile radius.

The developer, Jim Rhodes, assembled ample land and promised to build roads, parks, schools and shopping centers. What he couldn't promise, not with certainty, was that he could provide enough water for all the people, a failing Kemp thought would doom the project.

"There's no water out here to begin with," said Kemp, who pays to have water hauled in because he can't hook up to one of the few small systems that serve Golden Valley. "We're depleting the aquifer day by day as it is. The native plants are dying. Everything's disappearing before our eyes because it's so dry."

But water worries haven't derailed the project. The Mohave County Board of Supervisors approved all but one of Rhodes' subdivisions in early December, and the fifth was hung up on land issues, not water. The Arizona Department of Water Resources has yet to finish its assessment of whether the area has adequate water to sustain nearly 400,000 people.

Even if the state finds the water supply inadequate - that's what appears likely unless the builder's engineers can shore up their studies - Rhodes can keep building. While developers must prove they have a 100-year assured water supply in Phoenix, Tucson and Prescott, they face no such regulation in rural Arizona and, under the law, can build even if the state rules their supply is inadequate.

Rep. Tom O'Halleran, R-Sedona, has filed bills in the Legislature that would force developers to disclose more information about water to buyers and grant cities and counties the authority to reject subdivisions that lack adequate water supplies.

But those bills don't have widespread support in rural Arizona, where elected officials resist state interference even as they complain about growing pains and dwindling water supplies. Many officials worry about losing revenue if growth slows.

Mohave County officials don't deny that they are missing some information about water supplies, but they insist they are only following the law. They angered opponents of the subdivisions when they said state law prevented them from rejecting proposals solely because the builders couldn't guarantee water supplies.

A Vegas suburb?

Bill Abbott hasn't conducted any engineering studies, but he can offer firsthand evidence that it isn't easy to maintain water in the arid valleys outside Kingman. He and his wife kept a few horses on their small spread and lived for years off two wells.

Then the wells started to slow and before long, they'd nearly gone dry. Abbott had to start hauling water and wound up selling his horses. He worries now about selling so many new homes without assurances that the water will hold out.

"When I see my wells going dry, when I see my horse trough going dry, I don't go out and buy more horses," he said.

It's a lovely situation isn't it?

• Wells going dry
• The Arizona Department of Water can not certify there is enough water
• Some people in the county already have to pay to have water hauled in
• 130,000 home are approved, water or not here they come
• All officials worry about is losing revenue if growth slows
• They are depleting the aquifer day by day and the native plants are dying
  

Peak Water?

I asked a friend of mine who is more knowledgeable about the SouthWest than I am.
Here are his comments:

Water is in very short supply in the South Western region of the United States. The most critical component of being able to build on a piece of land is being able to hook up to the municipal water supply, being given a water meter.

Many coastal cities north of Santa Barbara have a limited supply of water meters. They are auctioned at prices like $350k.

There is more water allocated to each user from the Colorado River than there is water to allocate. As long as some people are willing to sell their water this isn't an immediate problem.

Chevron's water rights for their Debeque CO shale oil project are leased, not sold, to the city of Las Vegas for drinking water. How will Las Vegas replace that in the future when Chevron won't extend the lease?

When buying property in this region, really examine where the water comes from and whether it is sufficient for long term supply. Many areas are using ground water that will be used up entirely in just a few decades.

Despite opposition from the Federal government, both New South Wales and Western Australia are building Reverse Osmosis desalination plants adjoining the ocean. Los Angeles County built a plant like this which is not currently in operation. I think this is the future, even though it costs fifteen times as much - at current energy prices.

Mohave County Arizona could be headed for a real problem. Right now, however, they are more worried about growth than water. I guess they assume that they haven't run out of water yet so they never will. I am looking ahead at the legal problems when someone drills a well, possibly causing another person's well to run dry. Heck what happens if they all run dry? Now perhaps this is not today's issue but is an issue 10 years down the road?

Right wrong or indifferent, developers do not seem to care. They were allotted 130,000+ houses and seem bound and determined to build them. The county is more worried about growth than water even though the Department of Water Resources has not yet finished its assessment of whether the area has adequate water to sustain the expected growth of nearly 400,000 people.

The Ogalla Aquifer

The Milwaukee Journal reports Water Resources going Down the Drain.

Mish note: That article is from 2003 but contains some nice graphics about the Ogalla Aquifer which helps supply the water needs for 8 states. Relentless pumping is causing problems in many locations. Other locations, often just miles away have not yet been affected. I encourage everyone to click on that link for a nice graphical presentation.

Is running out of water that far fetched?

If you think so, consider Scott City.

Farmers around Scott City pumped with abandon from the underground reservoir called the Ogallala Aquifer in the 1960s, '70s and '80s, raising record wheat, corn and alfalfa crops, and never once worrying that they might hit "E" on the tank fueling the economy.

But today, in a withering downtown that no longer has a place for residents to buy shoes or dress clothing, some have likened the situation to a car running out of gas.

Car dealer Spangler doesn't buy that analogy.
"It's a little more frightening than that," he says.
Just ask farmer Kelly Crist.

"If you run out of water for your crops, that's one thing," he says, recalling the day about a decade ago when his well went dry. "But when you go to your house and turn the shower on and there is no water, it's a serious situation."

Today, the 46-year-old farmer relies on an 800-foot-deep well that pokes into a deeper but smaller aquifer to fill his toilets, sinks and bathtub. In his farm fields outside Scott City, he depends solely on what falls from the sky to raise milo. He fears there isn't enough of a future to lure his children back to land their great-grandfather first tilled in 1890.

Water levels in the Ogallala, which stretches from Texas to South Dakota, vary in depth, and some communities have decades - or even more than a century - before the water runs out.

Scott City sits atop a shallow portion of the aquifer. Water experts say that makes it a window into the Plains' future.

"The area around Scott City is beginning to experience what the rest of the region is going to experience if we continue to pump the way we do," says Rex Buchanan of the Kansas Geological Survey. "If they keep going at the rate they are, it's not a sustainable lifestyle. Something has to give."

Scott City, which now has a population of about 4,000, won't become a ghost town. There won't be a violent economic crash, Buchanan says; it will be more like a bumpy landing. The irrigated corn will be swallowed up by dryland grain farms - a much less lucrative enterprise.

"We will do what we have to," says 49-year-old farmer Jay Wiechman, who still has some water left for irrigation on his farm just north of Scott City. Farmer Greg Graff already is. He has a foot in both worlds - half his operation still has adequate irrigation to grow corn, the other half has reverted to dryland farming. He says his pumps used to suck 1,500 gallons per minute out of the ground, but now that's dropped to between 200 and 300 gallons a minute. It is a pace that keeps the slow-recharging aquifer from depleting even further.

"For so many years, nobody thought about this," he says of the aquifer depletion. "Had we known then what we know now, we would have managed our aquifer differently."

Peak water?
For those living near the Great Lakes or where rivers run plentiful, the thought is far from everyone's mind. Unfortunately it seems far from everyone's mind, especially even in places where it should be a huge concern. Building in the desert is easy. Finding water when it runs out will be another story.

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

Margaritaville

I am pleased to bring you a singing Key West update with help from my friend Richard, a doctor who currently lives in Key West Florida. The song comes later. First let's tune into some commentary about Key West from Richard. Here goes:

My landlord died two weeks ago.
There are 4 apartments and 3 rooms renting in an old decrepit building he owned.

He had it on the market, For Sale By Owner, for $2.8 million.
Last Thursday, his son came down to take care of his estate.
The price dropped to $1,950,000.

I know the attorney who is working with the son.
The price will soon drop to $1,800,000.

Across the street, a former homeowner took a similar sized house to the one I am living in. He spent hundreds of thousands to subdivide it into 3 condos, the cheapest was $900,000, most expensive one was $1.3 million, the third unit went for $1.15 million.

Those three condos were on the market for over a year. Four months ago, some guy finally bought one of the two more expensive condos. I found out yesterday that this new owner had already folded his tent. He couldn't make the second or third payments on his new condo. He sold his condo for an immediate $400,000 thousand loss.

Now he doesn't have a place to live in Key West and he still owes some lender $400,000. Wow. Shades of buying on margin in year 2000 and having the brokerage wipe out your account and calling to say, "Hey, you owe us more!"

Next door, there are five condotels. They were formerly part of the great White Street Inn, which stayed fully occupied most of the year.

Well the White Street Inn owners wanted one grand big kill. So they closed down the nightly rentals, renovated the place into 5 condos and opted for the condotel designation which meant renters had to rent for a week. But the benefit is the new owner of the condotel had to pay no bed taxes to the city for infrastructure in return for not renting the place out nightly.

A funny thing is happening to all of these condotels: they are not occupied more than 25% of the time. Most of the time, they are dark and vacant.

Those units initially sold for $1.2 million.

Two of those units are on the market now, today, for $750k and $800k respectively. We can only speculate that the sap investors who were assured "Key West is HOT, HOT, HOT and you'll never have a problem keeping this place rented out," are now so deep underwater carrying mortgages that their sparse rentals can't possibly cover, they were forced to drop the prices on their places to meet new realities.

Anybody buying a house in this town at this time is trying to catch a falling guillotine.

Wait. There's one more statistic which news reports won't speak about especially if you are a realtor being quoted for the paper.

I think I told you about the young respected realtor in Key West who last year this time was quoted as saying, "You will never see another house in Key West sell for less than $600,000 again." His reasoning, like most of the Realtor herd: Key West is a very tiny island, land is at a premium, real estate prices are finally catching up to “Realtor Vision”: real estate will continue to double every few years."

Last week, the newspaper resurrected his quotes. There are houses not only under the $600,000 mark, but at this moment there are 11 houses in Key West under the $500,000 mark.

I looked at two of them yesterday. One was a "cottage, 284 sq. feet", the other was a "cute little condo bungalow" of 300 sq. ft. These two "investment properties" listed for $390,000 and $395,000 respectively. In former years, they were basically tool sheds. Those two tool sheds will be back to reality before this is all over.

The MLS listings down here do not include "For Sale By Owner" signs which have sprung up everywhere in Key West. All these homeowners upside down on fast depreciating homes are now trying to save the commissions the realtors would have gotten by doing it themselves.

If you averaged in the "For Sale By Home Owner" prices, the fastest falling on the island, prices have easily fallen over 25% in 6 months. But the MLS only averages the MLS listings. They don't want to mess up the cartel pricing with reality. That could cause a bigger rush to the exits than what is just beginning now.

Things are much worse in Key West real estate than the Real Estate cartel, i.e., realtors, appraisers, mortgage shop owners, builders, et al, are letting on.

If you want to buy a Key West home, here's what you do: keep working. Save your money. Come down here several years from now. Buy while there is blood in the streets.

This cartoon has just begun.

The above was from Richard. I will take the blame or credit (whichever you prefer) for putting the above post to music. It's now time for a song.

Sing with Mish - Margaritaville

Towin' my Chevy
From the back levee
My credit is now such a mess
But it was a fun time
With bottles of French wine
The Corvette is now repossessed

Wastin' away again in Margaritaville
Searching for my lost window pane
Some people claim that Katrina's to blame
But I know it's all Greenspan’s fault

I don't know the reason
That condos were screamin’
I’ve nothin' to show for 800K
The condo’s now empty
My loan's still a plenty
And how it got financed I haven't a clue

Wastin' away again in Margaritaville
Searching for my lost window pane
Some people claim that Katrina's to blame
But I know it could be my fault

I blew out my credit
But how did they let it
Get purchased without insurance
It seemed like a steal
They said it's a deal
It's now yours for a song and a dance

Wastin' away again in Margaritaville
Searching for my lost window pane
Some people claim that Katrina's to blame
But I know it's my own damn fault

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

KBH Insider Sales

Before we take a look at insider sales, let's take a look at KB Homes orders and cancellations.

Dow Jones is reporting KB Home Says Cancellations Up, Orders Down

KB Home (KBH) has noticed a surge in cancellations and a drop-off in orders in the first two months of fiscal 2006, and if this trend continues, the company said it likely will have to ratchet down its revenue guidance for the year, according to a 10K filing.

The comments appear to be a sign that the sharp drop-off in orders recently reported by luxury builder Toll Brothers Inc. (TOL) may not be limited to the luxury segment as many market experts presumed.
"There are signs that consumer demand in the United States for residential housing at current prices is softening," KB Home said in its 10K, which was filed with the Securities and Exchange Commission on Friday.
The Los Angeles builder noted that the U.S. Census Bureau reported that single-family housing starts in December fell 12% from November, and about 8% from December 2004. Also, the bureau reported that the median sales price for new homes declined approximately 3% in December from a year earlier.

"Our results to date in fiscal year 2006 reflect these broader market trends," the company said, whose fiscal year ends Nov. 30. "In the first two months of the (fiscal) year, we have experienced an increase in home order cancellations and a decline in net orders for new homes when compared to the same period last year."
If this trend continues, "we may be required to moderate our revenue guidance for fiscal year 2006," KB Home said.

However, the company said it doesn't expect to change its earnings-per-share guidance for fiscal 2006 as the company has accelerated its share buyback program. In December, KB Home's board authorized the repurchase of 10 million shares. Since then, the company has repurchased 2 million shares in addition to the 2 million shares it bought back during its fiscal fourth quarter under the previous authorization program.

Well fancy that.
Let's now take a look at KBH Insider sales:
(Click on chart for a better view)



Those transactions were as of February 14, 2006.
That is an incomplete list of the most recent transactions only.
Click here for a complete list of insider sales.

It's Mish telepathic question and answer time.
The thought lines are now open.
Hmmmm. It seems everyone has the same three questions:

1. How much of those share buybacks will insiders be selling into?
2. How much of those share buybacks are needed for insider options granted?
3. Is Albert Z. Praw (president) and Albert Praw (Private Shareholder) the same person?
   

It just so happens I spoke with KB Homes Investor Relations just today.

From KB Homes Investor Relations:
"KB issues between 500,000 and 750,000 options this past year".

"Albert Praw and Albert Z. Praw are the same person. Albert is a long-time employee of the company -- appears to be an option exercise."

I have no answer for the first question unfortunately.
Here is my own question:
Does anyone find it interesting that the president "planned" to dump 32,666 options the moment he could?

As interesting as that idea might be, please ponder following chart.
Congratulations appear to be in order for Chairman Bruce Karatz.



Cancellations up, orders down, massive bailout at the top.
How do they do they manage this every time?
Enquiring minds want to know.

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

End Game Analysis

Someone just alerted me to an interesting article by Steve Saville entitled The End Game. Following are some snips:

We occasionally read that deflation is inevitable because the total amount of debt in the system is so huge. The point will eventually be reached, according to those who are forecasting a deflationary outcome, when the amount of debt carried by the average person and the interest burden associated with the debt is so large relative to his/her income that he/she will be unwilling or unable to take-on additional debt; and at that time the total amount of money and credit in the system will begin to contract. That is, deflation* will occur.

No one can predict the future with certainty, but we would be extremely surprised if the uninterrupted inflation of the past 70 years were followed by a period of genuine deflation (a prolonged decline in the total supply of money and credit). One of the reasons this would surprise us is that there IS so much debt in the system. The high debt levels actually make deflation LESS likely, not more likely, because the current monetary system -- the world's greatest-ever Ponzi scheme -- could not survive a bout of genuine deflation. That is, deflation will never be a viable policy option regardless of how bad things get. Instead, the central banks of the world will likely risk destroying their currencies and obliterating the values of their bonds before they will permit deflation to occur.

For starters I have to give Steve Saville 100% credit for understanding what deflation is: "a prolonged decline in the total supply of money and credit". It is impossible to have any sort of reasonable debate unless one can agree on terms.

In Inflation: What the heck is it? I presented strong evidence that the proper definitions of inflation and deflation are as follows:

• Inflation is best described as a net expansion of money supply and credit.
• Deflation is logically the opposite, a net contraction of money supply and credit.

Thus it seems we have reasonable grounds for starting a discussion.

Steve Saville Continues:

The question then becomes: central banks may well WANT to avoid deflation at all cost, but will they be ABLE to avoid it? Will they be able to implement policies that cause the currency to lose its purchasing power in an environment where almost all potential borrowers are 'tapped out'?

We don't really understand why this is even a question because it's such a basic economic truth that someone with the ability to increase the supply of some 'thing' by an unlimited amount also has the ability to push the price of the thing down by as much as they desire. This is true regardless of whether the thing in question is a dollar or an apple or communications bandwidth. Central banks have the ability to create currency in unlimited amounts so they have the power to reduce the purchasing power of currency under any and all circumstances should they choose to do so.

But assuming the central banks don't just print currency and then drop it out of helicopters, how would new currency be brought into circulation at a time when most individuals and corporations were cutting back on their borrowing/spending?

One option would be for the government -- an entity that will always be able to borrow more currency into existence regardless of its current level of indebtedness -- to shoulder the entire burden of keeping the supply of money in an upward trend and the purchasing power of money in a downward trend. But even if the government decided not to go down this path the central bank would have other options. It could, for instance, start monetising the mortgage debt held by private banks.

There is a chance that monetising debt (buying debt with newly printed currency) would not be effective because it would simply shift debt from the balance sheets of commercial banks to the balance sheet of the central bank. The debt would continue to exist and the borrowers -- the people who mortgaged their houses -- would be in the same financial situation; it's just that they would owe money to the central bank instead of owing it to private banks.

There is, however, a surer way to get more money into circulation and reduce the purchasing power of the money. Taking the example of the US, instead of monetising debt the Fed could monetise assets. That is, rather than buying mortgages from commercial banks the Fed could buy houses. Furthermore, to achieve the desired purpose -- a reduction in the dollar's purchasing power -- the number of houses that would actually have to be bought might not be that great. The reason is that if the Fed came out and said something along the lines of "for the next 90 days we will use newly printed dollars to purchase anyone's house at a price equal to today's market value or the amount owing on the mortgage, whichever is the higher" there's a good chance that there would immediately be a substantial devaluation of the dollar relative to houses (and every other tangible asset).

The time when the Fed needs to resort to such drastic measures in order to keep the inflation going is probably many years away. The point is, the Fed does have the power to keep the inflation going and the fact that debt levels have become so high means it has no alternative other than to keep the inflation going. Our view, therefore, is that the inflation will continue until the dollar and all other fiat currencies become so devalued and discredited that they cease to function as mediums of exchange, or, at least, until inflation fears become great enough that the current monetary system is abandoned in favour of something else.

As we've said many times in the past, keeping the inflation going is not the real challenge for the Fed; rather, the real challenge for the Fed is to keep inflation EXPECTATIONS in check. In our opinion, the next time inflation expectations spiral out of control will be the last time because doing what Paul Volcker did at the end of the 1970s (pushing interest rates to astronomical heights) is no longer a viable policy option. This is why the Fed's biggest fear is an uncontrolled rise in inflation expectations.

Mish rebuttal.

Steve is correct about the "theoretical ability" of the FED to increase money supply at will. His statement" "Central banks have the ability to create currency in unlimited amounts so they have the power to reduce the purchasing power of currency under any and all circumstances should they choose to do so" is completely accurate. Has any deflationist ever disagreed?

Unfortunately there are huge practical reasons why they will not and why it would not work even if they tried. For starters, let's consider the statement "One option would be for the government -- an entity that will always be able to borrow more currency into existence regardless of its current level of indebtedness -- to shoulder the entire burden of keeping the supply of money in an upward trend and the purchasing power of money in a downward trend."

The FED can print but it can neither force people to borrow nor banks to lend. If banks do lend, there is no guarantee that the money does not pour into gold or silver. Just how effective would that be at solving anything?

Assume instead that the FED just gave money away. Well this would take an act of Congress for starters and even with that, inflationists ignore the Austrian construct of "Time Preference". Simply put, there is no guarantee the people would not take the money and just pay off debts. Given a negative savings rate, I think that would be likely. Does anyone think the government is going to give money away just so people could pay off debts? I don't. Regardless, how long could the government keep this up, even if it was tried, and what would interest rates soar to if they did? What would soaring interest rates do to housing? Booming Bankruptcies? You bet. Are bankruptcies deflationary? You bet.

Another argument that I have heard (but not proposed by Steve) was that the government could put a tax on savings accounts to force people to spend. Would that work? No, it would likely force more money into stocks or bonds, and/or it might cause people to just pay off more debts leaving banks with less money to lend. In short, it is likely that this idea too would be counter productive. In fact, the uproar at proposing it would be so strong, the idea would never fly in the first place.

Of more interest is the fact that Steve is worried about inflation expectations.
Speaking of which, exactly what would happen if the FED started monetizing houses as he proposed? To begin with, it is not in the FED's charter to buy houses, but assuming a Congressional bill allowed it, what would it accomplish?

If after a prolonged decline in housing prices (where people owe more money on them houses than they are worth) would not people (and lots of them) simply turn them over to the government? If so what would the government do with them? Whether they did so or not what would it do to inflation expectations?

Given that such a drastic measure has never been tried, what might the unforeseen consequences of monetizing houses be? Hmmm.... How about long term interest rates temporarily rocketing up to 10% causing even more people to be thrown out of work and even more people to walk away from their houses? The only valid conclusion is that monetizing houses is an interesting theory but it simply would not work even if Congress would approve it, which of course is doubtful in the first place.

At the crux of the matter are these simple facts:

• The FED can print money but it can not dictate where the money goes.
• The consequences of the FED attempting to control the long and the short end would likely be disastrous. It is actually impossible in practice.
  
• Deflationary forces such as global wage arbitrage and outsourcing can not be defeated by FED policy.
• Consumer debt in conjunction with a housing bust is simply the nut that inflationists can not crack. There just is no plausible scenario under which the government would bail out consumers at the expense of banks and creditors. The Bankruptcy Reform Act should be proof enough of that statement.

Five Constraints

In theory the inflationists are correct.
In practice the FED is constrained by five factors:

1. Ability of consumers/corporations to take on more debt
2. Willingness of consumers/corporations to take on more debt
3. Willingness of banks/credit companies to extend more credit
4. Ability of banks/credit companies to extend more credit
5. Unwillingness of the federal reserve to print themselves out of power

Let's dismiss corporate spending as to being any kind of savior for this economy right off the bat. We discarded that idea previously in Thoughts on the Handover Fallacy.

Given that consumer spending is 70% of the economy, consumers are the key to proper End Game Analysis. In a scenario where consumers are underwater on their house, out of work in a housing bust, and bankruptcies and late payments are soaring, would banks be willing to extend credit? At what interest rate? Might not consumer interest rates rise even in the face of lower fed funds rates? After all, the FED can not dictate consumer lending rates. The consequences if the FED attempted to do so would likely be severe as discussed earlier. What about the willingness of consumers to take on more debt even if the FED could force rates lower? Unfortunately for the FED, time preferences can change. A negative savings rate practically dictates that time preferences will change. Thus, the willingness of a baby boomer generation to take on more debt headed into retirement could very well be limited, even if further credit was extended.

Careful analysis shows that in practice, the FED can only control #4 above, if anything at all. Also note that hyperinflation ends the game. The FED will be very reluctant to print themselves out of power.

The case of inflationists is far greater in theory than it will prove to be in practice.

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

China vs. US risk comparison

Jim Jubak at TheStreet.Com is writing The New Risk From China: Deflation .

Could China, the driver of global inflation in commodities such as crude oil and iron ore, be looking at domestic deflation in 2006?

Deflation effectively took Japan out of the global economy for more than a decade, slowing global growth and increasing global economic volatility. Serious deflation in China has the potential to be a lot more dangerous. At its least damaging, it would flood the world's markets with even cheaper Chinese goods. At the worst it could stall the Chinese economy, a major driver of global growth, and even send the country into one of its periods of instability.

All that from a change in prices? You betcha.

A Chinese economic think tank at the country's top economic agency, the National Development and Reform Commission, raised the red flag on deflation on Jan. 12. Since then, Chinese officials have repeatedly gone out of their way to pooh-pooh the danger. So much effort spent on denial, of course, means that it's a problem that the communist regime takes seriously.

Deflation in the domestic Chinese economy would pressure companies to cut wages to keep up with falling prices. That, of course, would depress demand. Chinese consumers would have less money for purchases, which would depress prices further, which would lead to further wage cuts. Once a deflationary cycle like that gets started, it can be terribly hard to reverse. Just ask the Japanese, who are now emerging from years of deflation and no economic growth.

China wouldn't survive a bout of deflation anywhere nearly as well as Japan. Japan is an amazingly cohesive society; China, even in the midst of an economic boom, is deeply fissured. Deflation would strike hardest at precisely those in the countryside who have been left behind in the current boom. The richest 10% of Chinese control 45% of the country's wealth, according to Chinese government figures, and the poorest 10% hold about 1%.

About 250 million people in the country still earn less than $1 a day -- the official definition of poverty in China -- and 700 million live on less than $2 a day. Incomes among rural Chinese have actually declined in the last four years, the World Bank reports.

This rural 70% of China's population has an average income of just $318 a year. If benefits like superior schools and medical care are included in the calculation, the average urban income is a huge seven times greater than the average rural income, the Chinese Academy of Social Sciences has calculated.

Rising income inequality has led to a rising tide of protest. There were, officially, 87,000 public disturbances in 2005, up 6% from 74,000 disturbances in 2004, according to the Ministry of Public Security. (And you know that if that's the official number, the actual level of protest is much higher.)

All this, mind you, while the economy is booming and deflation is just a story told to scare naughty economists at bedtime. How did China get into this mess?

Start with an economy built around export growth and feed it with lots and lots of cheap money. And then ignore any signals that the rudimentary, somewhat free market might be sending you about overinvestment or overcapacity.

China's GDP grew 9.9% last year, according to Chinese government figures. That's after 10.1% growth in 2004 and 10% in 2003.

On the other hand, China has achieved this kind of growth only through massive overinvestment in the export sector. Even after a yearlong campaign to rein in investment in fixed assets -- you know, things like steel mills and aluminum foundries -- investments like these grew by 25.7% in 2005.

The result has been massive overcapacity in fixed assets. Look at coke producers -- capacity of 242 million tons exceeded demand in 2005 by 100 million tons. Or steelmakers -- capacity exceeded demand by 120 million tons. Production capacity in China's auto industry now exceeds annual sales in China by 2 million vehicles. The government has identified 10 sectors -- including aluminum, autos, cement, coke, steel and textiles -- with capacity problems.

Of course, this excess capacity hasn't ended plans to add even more capacity in these sectors. About 120 million tons of new coke capacity is under construction. New steel mills with capacity of 70 million tons are being built.

Companies can raise money to build clearly unnecessary and unprofitable factories, because all too many Chinese banks continue to make loans on the basis of political connections rather than market forecasts. Put a local entrepreneur and his local political patrons from the district government in the same room with a banker, and a loan pops out.

How do you make a profit if you're doing business in an industry with 100 million tons of spare capacity? Export, export, export -- to any international market that will buy your product. And cut your prices until the buyers can't resist. At home, cut prices and cut them again.

See how a system like this might produce both higher global prices for raw materials and lower prices for finished goods abroad and at home? You get global commodity inflation and domestic price deflation.

China hasn't seen domestic deflation yet. But the trends are enough to worry Beijing's economists. Consumer price inflation fell to 1.8% in 2005 from 3.9% in 2004. (Like all other Chinese statistics, regard this one with extreme skepticism.) Prices, according to the National Development and Reform Commission, could start to fall in the second half of 2006.

Watch instead the news on domestic protest. If the tide of protest keeps rising, if the repression gets more violent, you'll have a pretty good idea that the poorest of the Chinese are feeling the bite of deflation. The big danger is that the regime will feel so much pressure to restore order before the 2008 Beijing Olympics, meant as a national showcase, that it will resort to teaching the protesters some large-scale lesson like that imposed by the tanks of the Red Army in Tiananmen Square in 1989.

Actually makes you root for inflation, doesn't it?

Is China at risk of deflation?

Yes, for the very reasons Jim Jubak cites:

• Massive overcapacity in fixed assets
• Plans to add even more capacity in these sectors
• Too many Chinese banks continue to make loans on the basis of political connections

What Next?

In China: What Next? Andy Xie also mentions the overcapacity situation in China.

Overcapacity is causing investment slowdown: I estimate that fixed investment in industries that are experiencing overcapacity contributed 40-50% of GDP growth in 2005. Without other components of the GDP accelerating, China’s economy should slow in 2006.

Spending more on infrastructure won’t reverse the trend: The infrastructure areas that can justify more investment account for 4% of total investment, I believe. Spending more there won’t reverse the trend.

Stimulating property again could lead to another wave of bad debts: Giving property a second wind is a popular proposal for stimulating the economy. Cutting mortgage rates could boost sentiment. However, it would mostly encourage more speculation. The industry is already swollen and highly speculative.

Is Deflation Bad?

The idea that deflation is necessarily bad is where the rest of Jubak's analysis falls apart.

Jubak states "Deflation would strike hardest at precisely those in the countryside who have been left behind in the current boom. The richest 10% of Chinese control 45% of the country's wealth, according to Chinese government figures, and the poorest 10% hold about 1%."

For starters I fail to see how the percentage of wealth control is all that relevant in and of itself. I will get to the reason for that statement in just a bit, but first let's show without a doubt the inequality problem is actually worse in the US.

Wealth Inequality

According to Wealth inequality: data and models, published by Federal Reserve Bank of Chicago and University of Minnesota on August 17, 2005, US wealth is highly concentrated and very unequally distributed. The top 1% hold one third, and the richest 5% hold more than half of total wealth. At the other extreme, a significant fraction of the population holds little or no wealth at all. It seems the concentration of wealth is the United States is even greater than that in China.

Would deflation "strike hardest at precisely those in the countryside who have been left behind in the current boom"? To answer that question let's first address the question at the very heart of the matter. Who does deflation hurt the worst? The answer to the latter question is easy: those heavily in debt and those dependent on forever rising property values. Having answered the critical question, let's see how China fares in deflation vs. how the US would fare.

Risk of deflation - China

Is deflation going to hurt farmers left in the countryside in China? I think not. What debts do they have? Furthermore they would welcome lower prices on goods they buy now. Down the road they certainly would welcome lower property prices in the cities. I doubt demand or prices paid for their produce would drop much from here. People do have to eat. In practice most of China's private citizens would benefit, as their savings rate is enormous. Deflation would primarily hurt businesses sitting on malinvestments financed with debt. Deflation benefits savers. Let's also not forget China is a real growth story over the long haul. The problem for now is that China is too heavily dependent on overburdened and debt ridden US consumers. Lacking sufficient internal demand there is simply nowhere for excess Chinese capacity to go.

Risk of deflation - United States

Now let's turn to the US. Deflation in the US would help the cash rich at the expanse of those in debt or whose wealth is mostly or especially in assets like houses. Who would deflation hurt the most? Unfortunately the answer is the masses: those struggling from paycheck to paycheck and especially those who are upside down on a house mortgage and heavily in debt on their SUV or credit cards. Hopefully it is readily apparent that the US consumer, deep in debt with a negative savings rates is actually at far greater "lifestyle risk", relatively speaking, than someone from China. There is also no going back to the rural farm option. Thus it's not wealth distribution per se that determines who is most at risk, but rather the debt distribution and savings rates that will determine who fares worst. Looking further down the road, there is every liklihood of continued global wage arbitrage putting pressures on US wages, and with an economy pretty much tied to a property bubble with little pent up internal demand for anything, with baby boomers wanting to retire, and with rising medical and pension problems, the picture looks worse (relatively speaking) for the US. Indeed the standard of living in the US may be poised for its first decline since the great depression. It will be a rude awakening if and when it happens.

Free Market Comparison China vs. US

Jubak writes of a 'rudimentary free market' in China.
Heinz Blasnik, a friend of mine living in Austria had this response when I Emailed him the article:

I think there is FAR MORE economic liberty in China than in the West. This is confirmed by just about anyone who has ever been there. There is for instance simply NO welfare state at all. When you go into business, you can expect to be able to do as you please without state interference, aside from the occasional corrupt local bureaucrat on the take (and those live dangerously).

A good friend of mine is Chinese. He regularly travels between Austria and China and also confirms this view. His father was actually a big party apparatchik in Mao's time. While there's still a large and inefficient state sector (state owned companies living on subsidies), all the rest is a free-for-all in wheeling and dealing that we only know from the history books.

Misconceptions About China

• The idea that capitalism is stronger in the US than China is for the most part a myth or at least highly overrated.
• Wealth inequality is excessive in China. While that might be true, it is worse in the US.
• The idea that deflation would be 'bad' for China is misguided. There would be winners and losers in China but because of the high savings rate in China vs the negative savings rate in the US, because of serious overleverage to housing in the US, and because of enormous consumer debt levels in the US, a serious bout of deflation would be far worse for the US than China.

Conclusions

• Deflation whether here or elsewhere would be bad for some people (those heavily in debt and or those dependent on property and asset bubbles), but generally good for everyone else.
• Stoking the fires of inflation to keep global reflation alive would only put off the overcapacity problems while making matters worse down the road.
• Malinvestments in the housing, autos, and retail sectors seems most at risk in the US. In China, the property, aluminum, autos, cement, steel and textiles sectors appear to be most at risk.
• A global slowdown has begun and the popping of various property bubbles is at the heart of it.
  
• The downside risks are greatest in countries with the most consumer debt, the US and UK. Fighting the bust can only make matters worse.
• All in all, it's not a pretty picture especially with Bernanke at the helm.

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

Meritage Fires Back

Not to be oudone by wimpy 12 hours Centex sales
Meritage fires back with a 48 hours sale.



They need a pricing lesson from Centex however.
What's with this token $50,000 reduction anyway?



Question: Why is this woman unhappy?



Answer: She paid $150,000 too much for her Centex home just months ago.

She should have been raking leaves.

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

A Look at the Budget

Mish note:
This was one of the topics of discussion on my weekly podcast on HoweStreet. We also discussed gold, copper, and the monetary draining in China. Scroll down on the left and look for "The US Budget - Gold price pullback and Chinese manoeuvers - February 8". Click listen for an audio play.

Following is A Look at the Budget:

President Bush has proposed a $2.77 trillion dollar budget.

Bush defended his budget in New Hampshire and at White House.

Here is the official budget blueprint.

Following is An Agency by Agency Look at the Budget, complete with a Mish proposal as to how to balance it.

Agency: Department of Agriculture
Spending: $96.4 billion.
Percentage change from 2006: +0.2 percent
Mandatory Spending: $76.7 billion
Mish proposal: $6.4 billion (inspections only)
Mish savings: $90.0 billion

Agency: Department of Commerce
Spending: $6.3 billion
Percentage Change from 2006: -2.2 percent
Mandatory Spending: $167 million
Mish Proposal: $2.3 Billion
Mish Savings: $4.0 Billion

Agency: Department of Defense
Spending: $491.3 billion
Percentage Change from 2006: -8.7 percent
Mandatory Spending: $2 billion
Mish Proposal: $291.3 Billion
Mish Savings: $200 Billion

Agency: Department of Education
Spending: $63.4 billion
Percentage change from 2006: -28.5 percent
Mandatory spending: $9 billion
Mish Proposal: $33.4 Billion
Mish Savings: $30 Billion

Agency: Department of Energy
Spending: $20.7 billion
Percentage Change from 2006: -1.8 percent
Mish Proposal: $10.7 billion
Mish Savings: $10 billion

Agency: Environmental Protection Agency
Spending: $7.2 billion
Percentage change from 2005: -4.9 percent
Mish proposal: $12.2 billion
Mish savings: -$5.0 billion

Agency: Department of Health and Human Services
Spending: $697.7 billion
Percentage change from 2006: +3.1 percent
Mandatory spending: $627.8 billion
Mish Proposal: $597.7 billion
Mish Savings: $100 billion

Agency: Department of Homeland Security
Spending: $31 billion
Percentage Change from 2006: +9.8 percent
Mandatory Spending: $98 million
Mish Proposal: $8 Billion
Mish Savings: $23 Billion

Agency: Department of Housing and Urban Development
Spending: $33.5 billion
Percentage Change from 2006: -29.9 percent
Mish proposal: $1.5 billion
Mish savings: $32 Billion

Agency: Department of Interior
Spending: $9.1 billion
Percentage change from 2005: -2.4 percent
Mish proposal: $10.1 billion
Mish savings: -$1 billion

Agency: Department of Justice
Spending: $22.5 billion
Percentage change from 2006: -0.6 percent
Mandatory Spending: $3 billion
Mish proposal: $12.5 billion
Mish savings: $10 billion

Agency: Department of Labor
Spending: $54 billion
Percentage Change from 2006: +5.5 percent
Mandatory Spending: $43.2 billion
Mish proposal: $44 billion
Mish savings: $10 billion

Agency: National Aeronautics and Space Administration
Spending: $16.8 billion
Percentage Change from 2006: +1 percent
Mish proposal: $16.8 Billion
Mish savings: $0 billion

Agency: State Department
Spending: $33 billion
Percentage Change from 2006: +13.1 percent
Mish proposal: $23 billion
Mish savings: $10 billion

Agency: Department of Transportation
Spending: $67.7 billion
Percentage change from 2006: +4.9 percent
Mandatory outlays: $54.5 billion
Mish proposal: $67.7 billion
Mish savings: $0 billion

Agency: Treasury Department
Spending: $495.8 billion
Percentage Change from 2006: +9.2 percent
Mandatory Spending: $484.2 billion
Mish proposal: $495.8 Billion
Mish savings: $0 billion

Agency: Department of Veterans Affairs
Spending: $77.7 billion
Percentage Change from 2006: +10.4 percent
Mandatory Spending: $42 billion
Mish proposal: $70.7 billion
Mish savings: $7 billion
===============================================================
Mish savings: $526 billion
Mish additions: $6 billion
Mish savings: $500 billion

Comments:

I would essentially scrap the entire department of agriculture except for meat and crop inspections for health and safety reasons. If that requires more than $6.4 billion then adjust accordingly. There would be no more crop subsidies or farm subsidies.

We do not need troops in Europe, Japan, new ships, or more nuclear weapons of any kind. The US can not afford to be the world's policeman. I would reduce the number of ships, planes and bombs. The US spends as much as the entire rest of the world combined on military budget. If we cut it in half then we will spend half as much as the rest of the world combined. That should be enough to protect ourselves nicely. I allowed far more than that.

The EPA is underfunded. It is time to crack down on pollution and polluters. The additional cost here is a mere $5 billion. I would also increase the department of interior budget by about $1 billion to help preserve our national parks.

I do not know where, but out of an entitlement budget of close to $700 billion, we ought to be able to find $100 billion to cut somewhere. For starters we could roll back the last Medicare bill and probably save far more than that. Certainly down the road this should be reduced more.

I would practically eliminate the dept of labor, and along with it the Davis Bacon act and all sorts of other stupid legislation. I am not sure how this department can possibly spend $54 billion. I am making an assumption that $40 billion of it is a total waste.

Us intelligence is anything but. Slash the state department budget.

Interest on the debt must be paid. So there is little one can do with the treasury dept budget other than cut wasteful spending to ensure we do not pay more interest down the road.

The Dept of homeland security has proven to be useless. It's time to end all these wiretaps and every other silly thing they are doing. We got along nicely without this department before we do not need it now. The one thing I would do, however, is beef up security on the border with Mexico as well as send a lot of illegal aliens packing. That task however belongs under the military budget. Nonetheless I was generous. I allowed this department to waste $8 billion with the ultimate goal of merging the department back from wherever it came.

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