One weekend can make you a millionaire!

I have proof too. Here it is.



Who in their right mind could possibly resist hearing this speaker?



I do not know about you, but I have already picked out my favorite classes (and no, I am not making these titles up).

1. Secrets of Super Flipping
2. Automatic Prosperity
3. Free Money From the Government
4. Earn $5,000 to $10,000 a Month
5. Flipping Luxury Homes

If "The Donald " was not enough pure excitement in and of himself, how can anyone possibly resist the lure of "Automatic Prosperity", perhaps via "Free Money From the Government"?

Whether you're an entrepreneur looking to invest in positive cash flow Real Estate or a first time homebuyer looking for a fantastic deal, you can't miss the Learning Annex Real Estate Wealth Expo. Not only will you learn how to build your wealth quickly, but you'll have the opportunity to make deals on the spot!!

Wow! Deals on the spot! If you were not sold already, that should be the icing on the cake. Anyone with several million wishing to turn it into one million should grab tickets now before they think better of it. I can not think of a better way to become a millionaire quickly than to go to a seminar like this with several million and make some "deals on the spot".

Promotions like this are just one more confirmation the top is already in. There is no such thing as "Automatic Prosperity" nor is there such a thing as a "Free Lunch".

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

Euro Bashing

TCS Daily is writing about Europe's Economic Fantasy.

One of the more enduring myths in Europe is the idea of a common currency area that would extend from the Atlantic to close to the Ural-mountains and that would make Europe by far the most important economic bloc on the planet. Not content with the idea of having the current 12 member countries participate in the euro, European leaders keep alive the pipedream of having another 15 countries, mainly from the former Soviet bloc, join the hitherto exclusive club. Yet pursuit of this dream runs the very real risk of accelerating the unraveling of the present currency union, which is already straining under the weight of its internal contradictions.

The daunting challenges to the euro experiment are perhaps best exemplified by the response I got from a former Salomon Brothers' emerging-market trader when I asked him where the next emerging market debt crisis would occur. Without missing a beat, he replied that it would take place in Greece, Italy or Portugal.

The present travails of Italy, the euro area's third largest economy, should provide a sobering lesson as to why the euro area is unlikely to survive in its present form. They should also underline why from a strictly economic viewpoint it is not a good idea to extend the present union to a group of 15 countries whose economic structure is so markedly different from those already in the union. For despite having joined the euro as early as 1999, Italy has not made the structural changes to its economy so sorely needed to meet the optimum currency requirements of a rigid currency union.

Italy's incapacity to reform, especially in its labor market, has already resulted in it having lost around 15 percentage points in international competitiveness to Germany and France over the past five years. This loss of competitiveness is in turn being mirrored in Italy losing export market share to these countries and it is sapping vitality from the Italian economy. As a result, over the past three years, Italy's economy has significantly underperformed that of the rest of Europe, while since the summer of 2005 its economy has been mired in virtual recession.

By having abandoned the lira in favor of the euro in 1999, Italy gave up all macro-economic policy flexibility to stabilize its economy. No longer having its own currency, Italy cannot engage in periodic exchange rate devaluations, as it did in the past, to rectify losses in international competitiveness. And no longer having its own monetary policy, Italy has to accept the interest rates set by the European Central Bank even though these rates might not necessarily conform to Italy's particular circumstances.

As if no longer having an independent monetary and exchange rate policy were not bad enough, under Europe's fiscal Stability Pact, Italy is committed to strengthening its public finances at a time of cyclical weakness. Italy's public finances are in a real mess. With a public debt to GDP ratio in excess of 105 percent, Italy is the most indebted of the major European countries. And with a government budget deficit of around 4 percent of GDP, Italy is in clear violation of Europe's Maastricht criteria despite the relatively low interest rates at which that deficit is still financed.

The only real way out for Italy is for it to restore competitiveness through far-reaching structural reforms, especially in the labor market. However, if the present Italian election campaign is any indicator, such painful reforms are not likely.
A similar story could be told of the poor prospects of deficit-ridden Greece, Portugal and Spain's ability to conform to the exacting requirements of euro-membership. This begs the question as to how much sense it makes to extend the euro to the former transition countries, when the existing members are having so much trouble getting the euro to work. Would not the inclusion of the transition countries merely add to the euro's present strains and accelerate its eventual demise by radically increasing the diversity of its membership? How much more likely is it that a Poland, a Hungary, or a Czech Republic will conform the rigorous requirements of the currency union than will the euro's struggling Mediterranean member countries?

If ever there was an article that correctly identified a problem yet pointed at a scapegoat, that article was it.

Here is the problem:

Italy's incapacity to reform, especially in its labor market, has already resulted in it having lost around 15 percentage points in international competitiveness to Germany and France over the past five years. This loss of competitiveness is in turn being mirrored in Italy losing export market share to these countries and it is sapping vitality from the Italian economy.

The inability to reform its markets is the problem. That would be the case whether Italy was on the Euro or the Lira, and it should be easy enough for anyone to see that. But no, the author blames the Euro rather than the lack of reform for Italy's problems.

By having abandoned the lira in favor of the euro in 1999, Italy gave up all macro-economic policy flexibility to stabilize its economy. No longer having its own currency, Italy cannot engage in periodic exchange rate devaluations, as it did in the past, to rectify losses in international competitiveness. And no longer having its own monetary policy, Italy has to accept the interest rates set by the European Central Bank even though these rates might not necessarily conform to Italy's particular circumstances.

Excuse me but since when are "periodic devaluations" ever a viable economic policy?
Italy should thank its lucky stars it is anchored to the Euro. Its currency would otherwise be worthless after repetitive devaluations and it still would not be able to compete with China or Japan on manufactured goods.

The problem with Italy is not the Euro. The problem is simply Italy's incapacity to reform. Blaming the Euro is a scapegoat. Yes the Euro has some problems but so does the US dollar and for that matter so does Michigan vs. Arizona, or Detroit vs. Chicago.

Long term the viability of the Euro is questionable but then again so is the long term viability of the US dollar. The fact of the matter is that all fiat currencies have problems and they all go to zero given enough time. Whether the US$ gets to zero before the Euro is of course debatable, but the Lira would be headed to zero faster than either on its own accord.

Desmond Lachman is engaging in unfounded Euro bashing, no more no less. Anyone that proposes "periodic exchange rate devaluations" as a solution to problems caused by incapacity to reform is simply barking up the wrong tree in more ways than one.

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

Hello Ben Bernanke!

Here are some pictures of what Greenspan left you to deal with.

A Flat Yield Curve



The above chart thanks to Bloomberg.

A recovery very long in the tooth



Skyrocketing Housing Inventory
















Plummeting New Home Sales















Flippers Out Of Luck



The above bench was photographed on Sunday, March 26, 2006. It is now a receptacle for flippers' key lockboxes. These flippers / investors are trying to sell their respective units in the building. Each lockbox represents a condo unit that is for sale or for rent. The condo project is called Halstead at Dunn Loring. It is located in Northern Virginia (Washington, DC suburbs). The iron bench is located on the west side of the condo building. There are about 220 units in this condo building. Across the street, Merrilee Dr, there is the second phase of this condo complex being built. The building is located at 2655 Prosperity Avenue, Fairfax, VA.

The above chart is courtesy of BubbleMeter

Gold Is Soaring



That concludes the graphical portion of this presentation. It is now time for the video portion of our program. A bowl of popcorn at this juncture might be appropriate. Thanks to Kevin Depew on Minyanville for finding the following link.

Video on Consumer Mentality

Don't Buy Stuff You Cannot Afford

The above video is hilarious (and short) so please play it.
Unfortunately the mentality displayed in that video is exactly the current mentality of the average US consumer.

Ben Bernanke, if you want to know who is largely responsible for this mess, I suggest that you (along with Greenspan) should look in a mirror.

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

GM market cap vs. credit swaps

GM Market Cap - $12.8 billion
GM Defaults Swaps - $1 trillion

Does anyone see a hint of a problem there?
If not, how about the fact that one player has 1/3 of that exposure?

Reuters writes Credit investors ponder GM-sized hole in universe.

GM, or its financing arm GMAC, is present in around 65 percent of synthetic collateralised debt obligations (CDOs), according to Standard & Poor's, and underlies an estimated $1 trillion of default swaps.

The company's impact is evidenced by the CDX credit default swap indices. The U.S.-based CDX4 equity tranche, containing GM, trades at 36 points up front; the same tranche in series 5, without GM, costs 27.5 points. One firm out of 125 accounts for almost a third of the premium.

Still, investors struggle to judge whether the automaker, which sells 21 percent of cars in the United States, will ultimately perish.

"A bankruptcy filing is unlikely this year," said Christophe Boulanger, auto analyst at Dresdner Kleinwort Wasserstein. "Unless Delphi goes on strike -- in which case they would stop production and it would all be over."

Parts supplier Delphi, which filed the biggest bankruptcy in U.S. automotive history in October, is negotiating with the United Auto Workers union and GM over wage and benefit issues, with a strike threatened if there is no settlement.

GMAC PIVOTAL

Should a strike be called, GM could be bankrupt by June, Boulanger said. After that any scenario might play out, but the status of GMAC will be crucial.

GMAC has traded at a premium to its parent in the credit markets on hopes a controlling stake will be sold, ring-fencing the company and possibly returning it to investment grade. Yet, despite GM's best efforts, no buyer has emerged.

Further complicating the outlook, if GMAC is not sold, and GM does go bankrupt, it is uncertain GMAC would be consolidated in the filing.

For bond investors, a GM bankruptcy would be hard, but a GMAC bankruptcy would be disastrous. GMAC is home to three quarters of the group's bonds, and is found in a large proportion of outstanding synthetic CDOs.

"The high degree of portfolio overlap between synthetic CDO transactions sets this asset class apart," said Standard & Poor's analyst Andrew South. "A rating action on GM could have a widespread effect on many CDOs."

The complex market in CDO squared, or CDOs of CDOs, also faces significant risk following a GM downgrade, one London-based hedge fund manager said.

"To be blunt -- it would be carnage," he said.

Ultimately it is probably investors who are best placed to judge GM's prognosis, and the cost of one-year default protection on GM is currently higher than five-year protection.

Of course, the best possible outcome may also be the most likely. That is, GM will survive.

Having spent around $15 billion renewing its product offering, it is certain the company will do everything in its power to avoid bankruptcy, Boulanger said.

In other words, if the elephant is still in the room in 18 months, you can probably ignore it.

There are so many ticking time bombs that it is simply impossible to predict which one blows up first. I suspect it will be something that no one is watching at the moment. That means the trigger is unlikely to be GM, bird flue, the YEN, Fannie Mae, or US treasuries but rather something that will become critical that the market has not focused on yet. Once the trigger is pulled, however, a cascade could pull in many of the bombs mentioned above.

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

Outrageous Bluffs

The guardian is reporting US-China trade war looms.

American senators could vote this week to slap tariffs of 27.5 per cent on all Chinese goods, amid a rising clamour of protectionist anger on Capitol Hill.

The sponsors of the so-called Schumer-Graham Bill were in Beijing last week - Chuck Schumer's first official trip overseas in 25 years - to press home the message that China's cheap currency gives it an unfair advantage over the Americans. Schumer, a Democrat who represents New York, and his Republican co-sponsor, Lindsey Graham of South Carolina, have been promised a vote on the measure by the end of March.

The US ran a trade deficit of more than $200bn with China last year, as shoppers sucked in low-cost consumer goods from the fast-growing economy. Like Japan in the Eighties, China is the target of protectionist rhetoric.

Schumer and Graham will hold talks with colleagues in Congress to decide whether to press their bill to a vote. 'The jury's out,' Schumer said. 'We're going to make a decision next week. We're not saying yes, we're not saying no.'

You are not saying yes and you are not saying no?
So what exactly are you saying? That this may or may not be a bluff?

Let's backtrack a bit and look at statements made by China on March 13.

China Daily is reporting Renminbi reform on sound track.

China will reform its foreign exchange system in an orderly way and will not bend to pressure from the US to float the yuan, said Zhou Xiaochuan, governor of the People's Bank of China.

China has its "own principles" to carry out its exchange rate reform and the current rate is appropriate, Zhou told reporters at the sideline of the annual session of National People's Congress (NPC) on Saturday.

US Treasury Secretary John Snow again urged China to float its exchange rate on Friday. There are reports that he is under mounting pressure from the US lawmakers to label China a currency manipulator in a report due in April. US President George W. Bush also said that he would adopt further movement to press China to appreciate its currency soon.

Premier Wen Jiabao said in this year's government report that China will improve the system of managed floating foreign currency exchange rates and keep the Renminbi exchange rate basically stable at an appropriate and balanced level.

No Currency Changes

A tougher stance yet was announced by the Chinese premier in China: No More Plans for Currency Changes.

Premier Says China Has No Plans for More Administrative Changes to Currency's Value

Premier Wen Jiabao said Tuesday that China sees no need for further one-time administrative changes in the exchange rate of its currency following a decision last July to drop its direct link to the dollar.

"There will be no more surprises," Wen said at a news conference.

"It is no longer necessary for us to take a one-off administrative means to affect the movement of the renminbi either upward or downward," he said.

I suppose those statements should be clear enough but that did not stop two US senators from parading to China on a fool's mission to attempt to persuade China to float the RMB or repeg it substantially higher. The threat is a 27.5% tariff on goods coming from China.

Supposedly this will bring jobs back to the US.
At 20-1 or 15-1 wage differentials it will not do anything of the kind but it will plunge the US headlong into a recession. A recession is headed our way anyway but such nonsense would of course make it worse.

Smoot-Hawley & Xenophobia

Phillip Swagel of the American Enterprise Institute said that unless Schumer drew back from the brink this week, he could become known as the Smoot of the 21st century: 'He would go down in history as the man who crashed the US economy.' He said the anti-China senators were likely to 'declare victory', having delivered their message to the Chinese in person.

Wikipedia discusses Smoot-Hawley and its effect on the Great Depression.

"I think we're riding a wave of xenophobia," says William Reinsch, president of the National Foreign Trade Council, a pro-trade group.

One thing I would like to emphasize is that trade wars, protectionism, and repudiation of credit excesses are all hallmarks of deflationary, not inflationary times as the following chart shows.

The Kondratieff Cycle



Global Tripwires

In Tripwires Stephen Roach of Morgan Stanley had this to say:

Investors are nearly unanimous these days in dismissing the mounting economic and political tensions of an unbalanced world -- arguing that it is in everyone’s best interest to keep the game going. The retort of increasingly smug US fund managers is typically something along the lines of, “What else are the Chinese going to buy -- euros?”

At the same time, I worry about an even more treacherous aspect of the endgame. An earlier era of globalization was brought to a tragic end by two world wars in the first half of the 20th century. While history rarely repeats itself, the rhymes never cease to amaze me.

Nation-specific rivalries have given way to threats coming from the amorphous terrorist ranks. Add in the current tensions associated with widening income disparities, real wage stagnation in developed countries, and the growing outbreak of trade frictions and protectionism, and today’s world looks far from secure. The tripwires of globalization are now being set.

In From Beijing to Dubai Roach writes.

My travel schedule is planned months in advance. It was only by happenstance that I found myself in both Beijing and Dubai this past week -- two of the more recent flashpoints in a US-led pushback against globalization. What I found in both cities unsettled me -- disappointment and frustration over America’s attitude toward two of its major providers of foreign capital. The feedback from Beijing and Dubai is that this image is going rapidly from bad to worse -- something a saving-short US economy can ill afford.

China is deeply troubled over the outright hostility from an increasingly xenophobic US Congress. The Chinese don’t believe that US politicians appreciate the potential risks that still lurk in this transitional economy. Instead, they are pressuring China as if it were operating from a position of much greater strength. China remains very much a tale of two economies -- a booming coastal region and a lagging interior. Most in Washington view China from the lenses of Beijing and Shanghai, and conclude that these two thriving metropolises personify the emergence of a powerful and mighty nation. What they don’t realize is that only 100 km away from either city lurks a China that has changed very little in the past thousand years. Yes, 560 million Chinese now live in urban centers around the country, although probably less than half these city dwellers have seen meaningful improvement in their standard of living over the past 30 years. Meanwhile, the rural population of some 745 million Chinese still tries to get by on $1-2 per day.

When I pointed this out to Senators Graham, Coburn, and Schumer in Beijing, Senator Schumer said, “I understand the structural point, but China still has to give.”

The editorialist in me says, if Washington -- or for that matter, beleaguered US manufacturers -- really wants China to give, then it needs to make that argument from a position of a macro strength and boost America’s national saving rate. Until, or unless, that happens, US-led China bashing is nothing short of political hypocrisy.

In Dubai, I was met by a similar sense of consternation. Fresh from the wounds of the rejected Dubai Ports World transaction, several major private equity investors in the UAE were blunt in expressing their sudden loss of appetite for US assets.

In the broad scheme of things, Dubai is a small player in the world of international finance. But to the extent that the Dubai backlash is emblematic of similar distaste from other Middle East investors -- hardly idle conjecture, in my view -- the repercussion cannot be minimized. Net foreign direct investment into the United States hit $128 billion in 2005 -- an increase of $22 billion from the inflows of 2004. If that trend now starts to reverse course, America’s already daunting current-account financing problem will only get worse.

From Beijing to Dubai, there is a growing undercurrent of economic anti-Americanism. The irony of it all is truly extraordinary: The US has the greatest external deficit in the history of the world, and is now sending increasingly negative signals to two of its most generous providers of foreign capital -- China and the Middle East. The United States has been extraordinarily lucky to finance its massive current account deficit on extremely attractive terms. If its lenders now start to push back, those terms could change quickly -- with adverse consequences for the dollar, real long-term US interest rates, and overly indebted American consumers. The slope is getting slipperier, and Washington could care less.

The Bluff Is Admitted

When I am researching a piece like this, I often gather material over the course of several weeks or even longer. I had been working on this "bluff theme" since the mid-March so I was especially pleased to find Inside the China Debate by Stephen Roach.

For me, the highlight of the annual China Development Forum always comes at the end of the gathering -- the traditional meeting with the Premier. Sometimes this exchange is tightly scripted, but at other times, it offers considerable food for thought. This was one of the latter examples. In a free-wheeling response to intense questioning from the assembled group of outside experts, Premier Wen Jiabao left little doubt of the strong resolve of the Chinese leadership in facing a series of daunting challenges in the years ahead.

[In response to the last question of the meeting by Steve Roach about "Globalization and Mistrust: The US-China Relationship at Risk"] The Premier was especially animated and intense in framing his response. “China views this relationship as very important,” he said, “and takes these risks very seriously.” He was emphatic in re-emphasizing the limited role that foreign exchange policy could play in tempering the US saving shortfall and related trade imbalance -- in effect, implying no major change in the RMB exchange rate. At the end of his discourse, he leaned forward, looked me straight in the eye, and stated with great emphasis, “You can take this message back to the American people: It is unfair to make China a scapegoat for structural problems facing the US economy.”

Three Senators in Beijing

The next morning, as luck would have it, I had the opportunity over breakfast to run Premier Wen’s comment by three US politicians who just happened to be in town -- Senators Schumer, Graham, and Coburn. Schumer and Graham, of course, are co-sponsors of a bill (S. 295) that would impose 27.5% tariffs on all Chinese imports into the US unless there was an RMB currency revaluation of a like amount. They were steeped with confidence that this bill had overwhelming support in the Senate and most likely comparable support in the House. And since it played to the angst of middle-class US wage earners, they did not expect the first veto of a politically-weakened President Bush to be exercised on this issue.

Chuck Schumer is a very smart and savvy man. He is using the bully pulpit of a prominent politician to put so much pressure on China that it will have no choice other than to give. Nor does he have much doubt that this approach will work. “This is exactly what I did in Japan in 1986,” he said -- apparently the last time he was in Asia. “It worked in Japan and it will work in China.”

In the end, Schumer doesn’t want tariffs -- he wants to go down in history as the man who made China blink. But he is perfectly prepared to play high-stakes political poker in order to achieve this objective. So is the rest of the US Congress. The big risk is that China calls Washington’s bluff and the two parties start to stumble down the very slippery slope of trade frictions and protectionism.

“I care deeply about the loss of US manufacturing jobs to China. [Said Schumer] If I am successful in cutting our trade deficit with the Chinese, not only will those jobs come back home but I will have succeeded in boosting US saving and cutting excess consumption. My bill can do all that and more.”

I am rarely speechless, but at that point, I started to choke on a huge bite of watermelon. “Let me get this straight,” I gasped, “tariffs will boost saving?” Too late -- he was already off to face the ever-present battery of cameras and microphones.

Going "All In"

That article had me laughing out loud. Not only do we see that the actions of Schumer are a bluff, but he openly admitted in public that he was indeed bluffing. Somehow he expects it to work. Why? What kind of arrogance is that?

This is tantamount to flipping over your hole cards in a game of Texas Hold’Em and disclosing to the table that you hold the two of clubs and the seven of diamonds. (To non-poker players, an unmatched 2-7 is the worst start one could have. If you had such a poor hand you would not show your cards then brag that you were going to win the pot).

China, not the US is holding the cards here. The US has 2-7 and China has paired aces. Is China supposed to fold? The problem goes beyond bluffing however, it shows arrogance and unwillingness to admit what the real problem is. The real problem that no one wants to hear about is rampant spending by US Congress and an administration that sees nothing wrong with blowing 500 billion dollars in Iraq attempting to be the world's policeman. The irony, as Roach points out is that China and others are lending us money at very favorable terms but we are complaining that the terms are "too favorable".

The danger of course is that Congress goes go "All In" and passes such a bill. Would President Bush sign it? WouldCongress be dumb enough to override that veto?

Another Bluff?

We have talked about this before but there is one more bluff that is worth another look at this time. In Deflation: Making Sure "It" Doesn't Happen Here Ben Bernanke states:

The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.

In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman's famous "helicopter drop" of money.

I think Bernanke is going to regret that speech for the rest of his life.
That said, the important questions are:

1. Was that an ill advised bluff of some kind or was Bernanke really serious?
2. If he was serious, would the rest of the FED go along with it?

The Greenspan Put

On March 16 2006 Federal Reserve board governor Donald Kohn said Fed won't act to preserve high home prices

'Greenspan put' theory doesn't stand scrutiny

The Federal Reserve has no intention of preserving all of the recent gains in home price values, said Federal Reserve board governor Donald Kohn on Thursday.
"If real estate prices begin to erode, homeowners should not expect to see all the gains of recent years preserved by monetary policy actions,' Kohn said in a speech prepared for delivery to a European Central Bank forum in Frankfurt, Germany.

In his remarks, Kohn attacked the popular 'Greenspan put' theory that Fed policy would always protect investors from sharp asset market drops while doing nothing to restrain these markets when prices rise.

"This argument strikes me as a misreading of history," Kohn said.
"Conventional policy as practiced by the Federal Reserve has not insulated investors from downside risk," he said.

It seems to me that Kohn has a poor memory. The Greenspan Fed has injected money into every scare (real or imagined) during his entire tenure: The Long Term Capital Management crisis, a nonexistent Y2K scare, and the bursting of the Nasdaq bubble in which interest rates were slashed to 1% to "Make Sure 'It' Doesn't Happen Here" are just three examples.

The most important question now is this: Is Kohn bluffing (hoping to smoothly talk down housing prices without crashing them), or is Bernanke bluffing, or are they both somehow bluffing? Interestingly enough, Bernanke might go so far out of his way to prove that he is an "inflation fighter" that he exacerbates the deflationary debt trap he is clearly in. Regardless of who is bluffing whom, the pot size is now enormous and the entire US economy is at stake. Does anyone have any chips left or are they all in the pot? Perhaps there is room left for one more raise. We will find out soon enough, but if protectionism kicks in there simply will not be any winners in this game.

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

Ignoring the Obvious

In Reflections on the Yield Curve and Monetary Policy, a speech before the Economic Club of New York on March 20, 2006 Bernanke listed four reasons "why the net demand for long-term issues may have increased, lowering the term premium". Let's take a look:

• First, longer-maturity obligations may be more attractive because of more stable inflation, better-anchored inflation expectations, and a reduction in economic volatility more generally. With the benefit of hindsight, we now recognize that an important change occurred in the U.S. economy (and, indeed, in other major industrial economies as well) sometime in the mid-1980s. Since that time, the volatilities of both real GDP growth and inflation have declined significantly, a phenomenon that economists have dubbed the "Great Moderation." I have argued elsewhere that improved monetary policies, which stabilized inflation and better anchored inflation expectations, are an important reason for this positive development; no doubt, structural changes in the economy such as deregulation, improved inventory control methods, and better risk-sharing in financial markets also contributed.
• A second possible explanation of the evident decline in the term premium is linked to the increased intervention in currency markets by a number of governments, particularly in Asia. According to this explanation, foreign official institutions, primarily central banks, have invested the bulk of their greatly expanded dollar holdings in U.S. Treasuries and closely substitutable securities, and these demands by the official sector have put downward pressure on yields. This interpretation has some support, including research that I did with two coauthors that found that longer-term yields came under significant downward pressure during episodes of heavy official purchases of dollars in 2004. However, these observations speak more to the existence of a short-term impact of large purchases and sales--the result of limits to liquidity in the very short run--than to the perhaps more important question of whether those transactions have a lasting effect on yields. On this latter issue, clear evidence is harder to come by. Several pieces of indirect evidence suggest that the long-term effect of foreign purchases on yields may be moderate. Notably, the global market for dollar-denominated bonds is enormous--perhaps around $25 trillion, including dollar-denominated debt issued by other countries as well as debt issued abroad by U.S. residents. In the long run, therefore, the market should be able to absorb purchases and sales of large absolute magnitude with relatively modest changes in yields. Indeed, long-term yields continued to fall over recent quarters even as foreign official holdings of Treasury securities increased at a slower pace than previously.
• Changes in the management of and accounting for pension funds are a third possible source of a declining term premium. Reforms proposed in the United States, Europe, and elsewhere are widely expected to encourage pension funds to be more fully funded and to take steps to better match the duration of their assets and liabilities. Together with the increased need of aging populations in the industrial countries to prepare for retirement, these changes may have increased the demand for longer-maturity securities. We have seen little direct evidence to date of sizable pension-fund portfolio shifts toward long-duration bonds, at least in the United States. But judging from anecdotal reports, bond investors might be attaching significant odds to scenarios in which pension funds tilt the composition of their portfolios toward such assets substantially over time.
• Fourth and finally, as investors' demands for long-duration securities may have increased over the past few years, the supply of such securities seems not to have kept pace. The average maturity of outstanding Treasury debt, for example, has dropped by 1‑1/2 years since its peak in 2001, a trend just now beginning to turn with the Treasury's reissuance of the thirty-year bond. Corporations and households, however, have taken advantage of low long-term rates to lengthen the duration of their debt in recent years, which has compensated to some extent for the reduced duration of available Treasury debt.

The Natural Interest Rate

Although it is possible that some of the above played small roles in what has transpired, Bernanke failed to list the most likely explanation for declining long term yields in the face of 15 consecutive hikes: This economy is ready to roll over and all it will take for that to happen is a prolonged housing slump. In all liklihood, the long bond sees that coming in a humongous credit repudiation ceremony and is simply reacting in advance.

Bernanke even went out of his way to dismiss both the inverted yield curve and the long bond yield in a silly discussion about the "natural interest rate":

Although macroeconomic forecasting is fraught with hazards, I would not interpret the currently very flat yield curve as indicating a significant economic slowdown to come, for several reasons.

First, in previous episodes when an inverted yield curve was followed by recession, the level of interest rates was quite high, consistent with considerable financial restraint. This time, both short- and long-term interest rates--in nominal and real terms--are relatively low by historical standards.

Second, as I have already discussed, to the extent that the flattening or inversion of the yield curve is the result of a smaller term premium, the implications for future economic activity are positive rather than negative.

Finally, the yield curve is only one of the financial indicators that researchers have found useful in predicting swings in economic activity. Other indicators that have had empirical success in the past, including corporate risk spreads, would seem to be consistent with continuing solid economic growth. In that regard, the fact that actual and implied volatilities of most financial prices remain subdued suggests that market participants do not harbor significant reservations about the economic outlook.

An alternative perspective holds that the recent behavior of interest rates does not presage an economic slowdown but suggests instead that the level of real interest rates consistent with full employment in the long run--the natural interest rate, if you will--has declined.

Paraphrasing Bernanke in 8 points:

1. The slowdown in housing, even though it contributed 50% of the jobs during this recovery is irrelevant.
2. There will be no lagging effect due to 15 consecutive rates hikes (counting March).
3. Unlike Spring of 2000, complacency, merger mania, and stock buybacks no longer matter. Instead they are a sign of strength.
   
4. Rising foreclosures and bankruptcies are not really a sign of stress.
5. The trade deficit is really a sign of a global savings glut. Everyone, everywhere should spend more than they make. We can, so can everyone else. It's the proverbial "free lunch".
   
6. Because of the brilliancy of the Fed, the natural interest rate has declined.
7. The Fed is omnipotent against any and all financial obstacles. There is no problem the Fed can not print its way out of.
8. The yield curve and the action of the long bond are simply wrong.
   

Paraphrasing Bernanke in a single sentence:

It's different this time!

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

The Apologists Club

I am pleased to announce the start of a new club. It is called the Real Estate Apologists Club (REAC). There are no dues or fees or membership drives. One can not ask or apply for membership although one can indeed be granted a membership without asking! Furthermore, one can not opt out either. If the club chooses you, you are in, whether you like it or not.

Those worthy of membership are simply granted active membership. Those unworthy are banned as outcasts. That is all there is to it. I will give some specific examples later in this blog to help clarify the membership rules and hierarchy, but first it is time to show some nice charts created by my friend Calculated Risk. The annotations and trendlines were added by me.

Click on any chart for an enhanced view of that chart.

Current Housing Inventory

Notice how home inventories kept bumping up against the upper trendline for months. In Autumn of 2005, there was a trendline breakout followed by an inventory explosion in January and February of 2006.

Bear in mind that home builders are still building like mad.

Some even went on land buying sprees as late as last Autumn. Over the next few months that new inventory will be added to the existing supply. Note too that while sales have declined, they are still at very high levels. Should sales decline further the months inventory numbers could skyrocket.

New Home Sales

This is yet another chart that only a true real estate believer could make excuses about.

Sales have been trending down ever since July.
There are no more stories about people camping out in Florida to get on a condo waiting list at absurd prices.

Florida, California, and other bubble areas have popped. Has that fazed any true blue believer in real estate one bit? Of course not and such people are likely card carrying REAC members.

REAC Admission Policy

OK Mish, who is in the club and who is out based on today's reporting?
Good question. Let's take a look:

The Financial Times is reporting Signs of slowdown in US housing.

Sales of new US homes plunged 10.5 per cent last month, prices fell and the stock of unsold homes hit its highest level in 10 years, providing the clearest indications yet that the red-hot housing market may be cooling.

New home sales slid to 1.08m, the fourth consecutive decline, and the price of new homes fell 3 per cent from a year ago. With a flood of new properties coming on to the market, at the present pace of sales, it will take 6.3 months to clear the backlog.

Ian Morris, economist at HSBC, said: “Over the next 12 months we suspect a hard landing is more likely.”

Whoa. Stop right there. Any economist even admitting the possibility of a hard landing, let alone thinking one is "more likely", is not what we are looking for as a certified REAC member. Ian Morris, this is your one and only warning. Any further talk like that and a black mark will be placed on your soul barring you from ever being considered for admission to the REAC. Clearly we are looking for much sterner stuff that that, so we simply move on.

The Herald Tribune is reporting Existing home sales drop, along with some prices

The Florida real estate market is definitely showing signs of doing what many economists have long predicted: slacking off the feverish tempo of 2004 and '05 and getting back to normal.

One area where that is becoming more evident is pricing, which has so far been almost unshakable bedrock in Southwest Florida's real estate market.

Though February's year-over-year median sales prices in the Sarasota and Charlotte County-North Port markets remained in the double digits -- 24 percent and 20 percent, respectively -- a report from the Florida Association of Realtors showed clear pricing pressures.

Bravo Realty's Thomas Heimann stands by his earlier bearish prediction of a 20 percent "price correction" this year.

Any predictions of 20% price corrections are pure blasphemy. There can be no warnings given for such outrageous talk. Thomas Heimann, a black mark has been placed on your soul and you must now pray to the REAC Pope for special dispensation.

The Palm Beach Post is reporting Home sales slow, prices dip.

The typical price of a house in Palm Beach County dipped for the third month in a row as the housing market continued its return to reality.

The median price for an existing single-family home sold in February was $391,000, the Florida Association of Realtors said Thursday. That's down slightly from January and well below November's peak of $421,500.

"We're not in a bust; we're in the middle of a correction," said Douglas Rill, a longtime broker and owner of the 140-agent Century 21 America's Choice in West Palm Beach. "That frenzied 2005 market is over."

The shift is a healthy one, said Kiku Martinson, director of real estate at Campbell & Rosemurgy, a 120-agent brokerage with offices in Boca Raton and Deerfield Beach.

"This is a better market for everyone," Martinson said. "We don't have the craziness that we had, where buyers had to make an offer right away. It's a little bit more relaxed, and buyers can study their options."

Still, many Realtors insist the slowdown is nothing more than a myth created by the media. Christian Angle, an agent at Earl A. Hollis Inc. in Palm Beach, said homes that are "priced right" are still selling.

"The market is very strong," Angle said. "My phone is ringing off the hook."

Ding Ding Ding, we have two "winners".
I am sorry Mr. Rill, you are not one of them. Your no-bust position is admirable of course, "We're not in a bust; we're in the middle of a correction" but talk of "corrections" are just too wishy washy right now. If you do not have a single sale for 6 months and then repeat your statement, we will place you back into consideration. For now, the REAC is looking for much sterner stuff.

This is more like it: The shift is a healthy one, said Kiku Martinson, director of real estate at Campbell & Rosemurgy, a 120-agent brokerage with offices in Boca Raton and Deerfield Beach. "This is a better market for everyone".

Wow! That is the kind of stern stuff we are looking for. Welcome to the club, Kiku.
We are also ringing the club inclusion bell for Christian Angle. "The market is very strong," Angle said. "My phone is ringing off the hook."

The Palm Beach Post is also reporting Potential foreclosures climb as housing market cools.

There's trouble in the bubble.

After three years of rapidly inflating real estate, loose credit and dicey financing, the number of court filings notifying Palm Beach County property owners they are facing foreclosure is rising.

Martin County's pre-foreclosure filings are at their highest level since February 2005, and in St. Lucie County 113 pre-foreclosure notices were filed between Jan. 1 and March 23.

The Palm Beach County numbers are not huge. February's 159 pre-foreclosure filings fall well below February 2005's 192.

But they represent a 34 percent hike from October, when the increase began.

"That is a trend, not a blip," said Jack McCabe, chief executive of McCabe Research and Consulting in Deerfield Beach, adding that too many good people took out too many bad loans.

I have been following this McCabe character for quite some time. He has a double black mark on his soul. That makes him ineligible for a plenary indulgence at any time in the future. He is forever banned from the REAC just as Pete Rose is from Baseball's Hall of Fame.

Triple black mark outcasts at this time include the evil Rich Toscano aka Professor Piggington, Patrick Killelea at Patrick.Net, Ben Jones at TheHousingBubbleBlog.Com and Robert Campbell at RealEstateTiming. Additional names will be added as appropriate.

The California Association of Realtors is reporting
California Sales ‘Plunge’, Inventory At Multi-Year High California Sales ‘Plunge’, Inventory At Multi-Year High

“Existing-home sales dropped significantly in California in February, falling 15.5 percent from the same period a year ago, as inventory levels climbed and median prices continued to escalate, an industry trade group reported today. Meanwhile, the February 2006 median price of an existing home in the state decreased 2.9 percent compared with January’s $551,300 median price.”

The state’s builders think the solution is more construction. “‘We may be producing some of America’s best college graduates, but we’re exporting them to states where owning a home is more than just a fantasy,’ said Alan Nevin, chief economist at the California Building Industry Association. The state’s 57 percent homeownership rate, the second lowest behind New York, lags far behind the national average of nearly 70 percent.”

Ding Ding Ding. We have another winner.
Alan Nevin, welcome to REAC. Anyone that thinks the solution to high inventory is more building and more condos is clearly a candidate for the REAC upper hierarchy. Perhaps Mr. Nevin would make a good Bishop.

I have two questions for Mr. Nevin:

1) If extra supply lowers prices as the CBIA suggests, how do prices not drop?
2) True believers think that housing prices will never drop, so why did median price drop 2.9% now year over year and how do you explain #1?

If those questions can be properly explained or avoided by Mr. Nevin, then he is eligible for promotion to Cardinal. A Papal candidate, however, would never put himself into such a tough predicament. We must look further to find the Pope of the REAC.

The Baltimore Sun is reporting New home sales drop by 10.5%.

"The new home market looks like it is starting to stagger," said Joel Naroff, chief economist at Naroff Economic Advisers, a Pennsylvania forecasting firm. "Bubbles do burst, they really do."

David Seiders, chief economist for the National Association of Home Builders, said he still believes that sales of new homes will post a moderate decline of around 8 percent this year, with home price gains slowing from double-digit increases of around 12 percent to about half that level.

Ding Ding Ding. Welcome to the club David Seinders, and a pox on your soul Mr. Naroff.

In a quote that I can not now find via Google search, but nonetheless I am positive I recorded accurately earlier today, I must ring the bell for Ian Shepherdson chief US economist at High Frequency Economics who described the figures as "awful" but said they did not yet provide convincing evidence of a collapse. "One bad month is not a trend, and sales may have been hit mid-month by the record snowstorm on the Atlantic seaboard." he said.

We had the third best Winter weather in recorded history and he is blaming a "mid-month snowstorm"? That is just what is needed for the REAC hierarchy: creative attacking thinking no matter how wrong that thinking is. Unfortunately he used the word "awful". That I am afraid is a no-no.

We are still ringing the bell, however, for his creative thought processes, yet we must caution Mr. Shepherdson for the obvious flaws in his thinking.

Highest praise and certain cardinalship would have been awarded for a statement like this: "Sales are extremely good given the mid-month record snowstorm on the Atlantic seaboard. One bad month is not a trend. Naysayers will be proven wrong just as they have for the last 32 years. A rebound can be expected anytime soon and smart buyers will be snapping up these bargains now ahead of the crowd. This is a good market for everyone. There has never been a better time to buy than now. They do not make land anymore and they never will again."

Repeated statements like the above, with no intermittent slips or mistakes, would make one eligible for Popedom, and then REAC sainthood. As for now, the search continues.

OK enough silliness.
Calculated Risk put out one more chart today and gave me permission to share it.

New Home Sales vs. Recessions



Anyone that fails to understand the significance of the above charts is likely to become a card carrying member of REAC. A real estate bust and recession are both coming our way.

Mish note: No offense is meant nor should any be taken by anyone of any religious faith. I used Catholic hierarchy analogies for this post only because I am familiar with them by upbringing. This was an attempt to poke fun at "The Apologists Club", no more no less, using ideas that I could easily relate to from personal experience.

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

Imaginary Numbers

Today's post is on Imaginary Numbers.
Some people are not aware of it but, there are actually two kinds of imaginary numbers.

For a mathematical answer to the question "What is an imaginary number?" all one has to do is Ask Dr. Math .

The other kind of imaginary number comes from CEOs, the US government, and places like the National Association of Realtors (NAR). Today's lesson is about the NAR.

The National Assn. of Realtors reported Thursday that sales of existing single-family homes rose 5.2% last month to a seasonally adjusted annual rate of 6.91 million units. The biggest increase in two years took economists by surprise. They had expected a drop of about 1% after five months of declines.

Here are a couple of charts:





Notice the steady rise in inventory.
Notice also that although sales were "reportedly" up vs. last month, they were still down as compared to the same month last year.

The telepathic question lines are now open.
I am flooded with two questions.
1) OK Mish so what?
2) Why do you call those numbers imaginary?

Those are both good questions.
Here is one explanation as to why they are imaginary: The NAR existing home sales numbers are "survey numbers". The NAR should easily be able to provide exact numbers by adding up the numbers from all the local real estate boards. Can this be difficult with today's computers? Instead they do a quick survey of questionable accuracy.

Let's take our own sample.

California

Sales fell for 5th consecutive month and were 1.7% below February 2005. Inventory is up from a year ago by 40.5%. Nominal year over year prices fell for 2nd month in a row.

The Orange County Register says: Selling a home? You're not alone.

Let's face it. There's only reason to look at the Realtors' monthly existing-home-sale report: the dirt on inventories. So here's February's "Unsold Inventory Index" for single-family detached homes being sold by owners:

* The O.C.: 10.4 months worth of homes to sell vs. 5.7 months for the same period a year ago.
* California: 6.7 months vs. 3.2 months a year ago.
* U.S.: 5.3 months vs. 4 months a year ago.

Inman News is reporting California home sales plunge 15.5%

Unsold inventory levels climb to highest in several years, trade group says.

Existing-home sales dropped significantly in California in February, falling 15.5 percent from the same period a year ago, as inventory levels climbed and median prices continued to escalate, an industry trade group reported today.

Closed escrow sales of existing, single-family detached homes in California totaled 513,745 in February at a seasonally adjusted annualized rate, down from 608,160 a year ago, according to the California Association of Realtors. Median prices increased 13.7 percent to $535,470 from $470,920 a year ago.

Meanwhile, the February 2006 median price of an existing home in the state decreased 2.9 percent compared with January's $551,300 median price.

Florida

The Florida Association of Realtors is reporting a 20% decrease in sales.

ORLANDO, Fla., March 23, 2006 Statewide, sales of single-family existing homes totaled 13,539 in February compared to 16,916 homes a year ago, for a 20 percent decrease, according to the Florida Association of Realtors® (FAR).

Virginia

Seven out of eight 7 out of 8 areas comprising the Northern Virginia Association of Realtors had fewer sales. All eight reported higher inventory levels.

Another telepathic question just came in:
Mish, do you have any evidence at the national level?
Yes, actually I do. Here goes:

MBA Applications

The Mortgage Bankers Association (MBA) reports Mortgage Application Volume Down Slightly In Latest Survey.

WASHINGTON, D.C. (March 22, 2006) — The Mortgage Bankers Association (MBA) today released its Weekly Mortgage Applications Survey for the week ending March 17. The Market Composite Index — a measure of mortgage loan application volume was 565.0 – a decrease of 1.6 percent on a seasonally adjusted basis from 574.4 one week earlier. On an unadjusted basis, the Index decreased 1.6 percent compared with the previous week but was down 13.8 percent compared with the same week one year earlier.

The seasonally-adjusted Purchase Index decreased by 2.3 percent to 393.6 from 403.0 the previous week whereas the Refinance Index decreased by 0.6 percent to 1574.5 from 1583.6 one week earlier. Other seasonally adjusted index activity includes the Conventional Index, which decreased 1.4 percent to 833.4 from 845.2 the previous week, and the Government Index, which decreased 4.4 percent to 117.4 from 122.8 the previous week.

The four week moving average for the seasonally-adjusted Market Index is down 0.2 percent to 574.0 from 575.3. The four week moving average is down 0.4 percent to 401.5 from 401.9 for the Purchase Index while this average is down 0.2 percent to 1588.8 from 1593.4 for the Refinance Index.

The refinance share of mortgage activity increased to 38.1 percent of total applications from 37.7 percent the previous week. The adjustable-rate mortgage (ARM) share of activity decreased to 28.3 percent of total applications from 28.8 percent the previous week.

Hmmm. Lets see... The Purchase Index four week moving average is down to 401.5. It was 470 in October, 448 in December, and 447 in January. Does that sound like nationally increasing sales? Whatever is going on with the February numbers, be it real or imaginary, the overall trend should be clear to all but the most obstinate of real estate bulls: Sales Lower, Inventories Higher.

Missouri

Let's look at one more item hot off the press today:

The Kansas City Star is reporting First default, then despair.

Rising interest rates and a cooling real estate market conspire to undermine the financial well-being of homeowners and feed an increase in foreclosures.

More first-time and lower-income homebuyers are losing the American dream to foreclosures on the courthouse steps.

Real estate experts in Kansas City and nationwide say they are seeing a trend in which homeowners — often using adjustable-rate mortgages — have been unable to keep up with fast-rising interest rates, forcing them to balance higher monthly payments against already soaring energy costs and living expenses.

Making matters worse, experts say a cooling real estate market makes it less likely that financially strapped consumers can count on rising home values and equity to bail them out.

“Many people are living on the razor’s edge,” said Kansas City mortgage attorney Berry S. Laws III. “When their interest rates go up, they automatically have to pay more for the mortgage. People are betting their homes will appreciate, but if the value of their homes flattens out, they face a deficit.”

The warning signs are everywhere:

• The Mortgage Bankers Association reports that the number of home-loan delinquencies nationwide in the last quarter of 2005 grew to a 2½-year high.
• The association also noted a growing inventory of foreclosed homes, suggesting that banks are getting stuck with repossessed homes they can’t resell.
• Foreclosure.com recently reported that the total number of foreclosures listed for sale in December rose 12.7 percent, reversing a recent trend of declining foreclosures. The online foreclosure-tracking firm estimated that about 92,000 foreclosed homes were on the U.S. market.

Last year, foreclosures rose 25 percent, according to RealtyTrac of California.

Nationally, bank regulators worry that mortgage delinquencies and resulting foreclosures will continue to increase this year.

“Rising mortgage delinquencies in 2005 apparently mark the end of a period of generally improving mortgage loan performance between 2002 and 2005,” said Richard A. Brown, chief economist for the Federal Deposit Insurance Corp., which insures banks.

According to FDIC statistics, the average 30-day past-due rate for subprime mortgages — those made to borrowers with limited or less than perfect credit — rose from 5.4 percent at the beginning of 2005 to 7.1 percent at year’s end, reversing an eight-year decline.

Missouri and Kansas borrowers may be faring worse.

Missouri’s average 30-day past-due rate rose last year from 7 percent to 9.2 percent, the FDIC said. Kansas’ rose from 5.7 percent to 7.6 percent.

Myra Batchelder, who heads the economic opportunity program at Demos, a New York think-tank on consumer issues, sees an ominous future for many Americans.

“The recent jump in foreclosures is a sign of a much larger problem: The American household economy is at a breaking point,” Batchelder said.

Bankruptcy obstacles

Some experts are predicting that the bankruptcy reform law that was adopted last year threatens to fuel an additional round of foreclosures.

The idea behind the law was to make it harder for consumers to shed debts. One big change requires credit counseling 180 days before filing for bankruptcy.

In the past, consumers who couldn’t pay their debts could go to a bankruptcy lawyer and immediately stop a foreclosure and at least keep a portion of their home’s value.

Not anymore, said Laws, the Kansas City mortgage attorney.

If homeowners can’t make house payments during the 180-day period before being approved to file for bankruptcy, Laws predicted, “they won’t be able to save their house. It’s a mess.”

Real Numbers

• Mortgage indebtedness grew by $2 trillion in 2004 and 2005 alone.
• Subprime lending grew 25 percent annually from 1994 to 2003, accounting for one of 10 home loans.
• Qualifying debt-to-income ratios for subprime loans have risen from 28 percent to more than 55 percent.
• U.S. average 30-day past due rates for subprime loans rose from 5.4 percent to 7.1 percent in 2005.
• Average 30-day past due rates for subprime loans in Missouri rose from 7 percent to 9.2 percent in 2005.
• Average 30-day past due rates for subprime loans in Kansas rose from 5.7 percent to 7.6 percent in 2005.

The Sad Truth

“The recent jump in foreclosures is a sign of a much larger problem: The American household economy is at a breaking point.”

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

Take the Package and Run

CNN Money is reporting GM offers workers up to $140K to leave.

General Motors is offering hourly workers as much as $140,000 each to leave the troubled automaker as it extends its push to cut labor costs and put an end to billions of dollars in losses.

GM announced the agreement with the United Auto Workers union Wednesday, though it did not give the details of the offer extended to all of its 113,000 U.S. hourly employees.

But a person familiar with terms of the offer said that UAW members with at least 10 years of service at the world's largest automaker will get $140,000 if they give up the retiree health care coverage that has become a crippling burden for GM. Those workers will keep their accrued pension benefits.

Those with less than 10 years service will get $70,000 if they leave without the health care coverage.

Industry experts said that relatively few GM employees were likely to take the buyouts, though, since most of them are eligible for an alternative early retirement package announced Wednesday that would allow them to keep their health care coverage.

Some workers could receive more than $100,000 under the early retirement plan, and that could limit the cost-savings to GM, analysts said.

"It's a major step forward but it's certainly no where near all what they have to accomplish to turn North America around," said David Healy at Burnham Securities, who does not have a formal rating on the stock.

The company announced the early retirement package as part of long-awaited contract agreement with bankrupt auto parts maker Delphi and the UAW -- a deal seen as key to avoiding a crippling strike at the parts supplier.

Some analysts said GM's moves were not enough to change their view of the stock, and the stock barely edged higher in afternoon trading on the New York Stock Exchange.

Efraim Levy, an auto analyst at Standard & Poor's, reiterated his "sell" recommendation on GM stock after the announcement. "I don't look at it as a particular positive by itself," he said.

Levy said most workers know the value of the retiree health care plan at GM and will not forfeit that benefit. "I'm sure there are people who could use an immediate cash infusion, but I don't think it'll be a big percentage," Levy said. "I don't think I would take that deal."

He said most who do take it will have another source for health coverage, such as a spouses' health plan, or will be those who doubt GM's retiree health care plan will survive in the long run.

He also said the agreement with Delphi, while an important step to avoiding a strike there, also is not a final solution to the negotiations between the bankrupt auto parts maker and the union.

UAW President Ron Gettelfinger said that while the union leaders support the buyout and early retirement offers, they still have serious disagreements with Delphi.

The top pay for a GM hourly employee is $27 an hour, but with benefits and future health care costs GM estimates that hour of work costs the company $73.73. The flat wage works out to about $56,000 a year before overtime, so those taking a $140,000 buyout would get about 2-1/2 years of pay in the lump sum.

GM has an incentive to offer buyouts and early retirement because of job guarantees for UAW members that run through September 2007. It announced plans in November to close a dozen plants and slash 30,000 jobs in North America, but without employees taking early retirement or the buyouts, GM will have to keep paying them almost their full salary.

GM also has contract obligations to the union members at Delphi, which it spun off in 1999. It said those costs could have gone as high as $12 billion, though last week it said the cost would likely be closer to the $5.5 billion pretax charge it took in the fourth quarter.

GM announced Wednesday it will take additional charges this year as part of the new offer.

Delphi executives, who are seeking steep concessions and set a March 30 deadline for a deal, have threatened to go to the bankruptcy court to have its labor deals thrown out without an agreement. The union has threatened a strike if Delphi takes that step.

Delphi said it will keep talking to try to reach a pact with the UAW and other unions at Delphi. But the three-way agreement announced Wednesday could clear the way for those pacts.

S&P's Levy is among those who do not think there will be a strike at Delphi. "There's too much at risk not to reach an agreement," he said.

Under the early retirement offer, GM's eligible workers are being offered $35,000 to retire now. GM also will offer 13,000 Delphi employees with 30 years of service the same $35,000 to retire. And GM is also offering jobs at GM to 5,000 Delphi employees to help its former parts unit cut costs.

GM has 36,000 U.S. hourly employees with at least 30 years of service who are eligible for retirement. Another 27,000 are within three years of that threshold, according to GM.

The latter group will also get an early retirement offer of $30,000 to $36,000 a year as they accrue service. The GM and Delphi employees who take those retirement incentives will retain their health care coverage.

The company says the average GM hourly employee is 50.4 years old and has 24 years of service, so a majority of the U.S. hourly work force is within a couple of years of retirement and will probably not even have to weigh giving up their retiree health care coverage.

I am struggling to reconcile two paragraphs from the article:

1) UAW members with at least 10 years of service at the world's largest automaker will get $140,000 if they give up the retiree health care coverage that has become a crippling burden for GM. Those workers will keep their accrued pension benefits.

2) Under the early retirement offer, GM's eligible workers are being offered $35,000 to retire now. GM also will offer 13,000 Delphi employees with 30 years of service the same $35,000 to retire. And GM is also offering jobs at GM to 5,000 Delphi employees to help its former parts unit cut costs.

It seems the difference between $35,000 and $140,000 is in giving up retiree health coverage. At $140,000 per employee, does anyone think these terms will ever get better?

Given that GM has an incentive to offer buyouts and early retirement because of job guarantees for UAW members that run through September 2007, it would seem likely that any such offers would be likely to decrease over time. Offers would end abruptly if GM decided to heck with it all and just filed for bankruptcy.

GM has 36,000 U.S. hourly employees with at least 30 years of service who are eligible for retirement. Another 27,000 are within three years of that threshold.

If everyone with 27 years of service takes the offer and drops the medical coverage, that would be 63,000 workers at $140,000 each or $8,820,000,000. That is quite a bit of cash given that Those workers will keep their accrued pension benefits.

Does GM even want to get rid of 63,000 workers? The announced cutback was 30,000 workers. Assume they are willing to get rid of another 15,000 workers. 45,000 workers at $140,000 each would set GM back $6,300,000,000.

But how does that even let GM off the hook? It would chew up considerable cash and GM would still have pension obligations.

It seems to me that this is a more than fair offer and the employees should take it.
Wouldn't $140,000 buy a lot of medical coverage if one wanted it?
Those over 65 would be eligible for Medicare would they not, so why not take the money and run?

I just do not comprehend this position by the S&P: Levy said most workers know the value of the retiree health care plan at GM and will not forfeit that benefit. "I'm sure there are people who could use an immediate cash infusion, but I don't think it'll be a big percentage," Levy said. "I don't think I would take that deal."

In light of the fact that the S&P has the odds of a GM bankruptcy at 30% and Levy himself "reiterated his "sell" recommendation on GM stock after the announcement. "I don't look at it as a particular positive by itself" he said, one can only wonder "What the heck is he thinking?" One can get 2 1/2 years pay and still not lose pension benefits or stay and worry about bankruptcy and the terms thereof for the rest of his life!

As I see it, there should be 63,000 workers scrambling for a mere 30,000 to 45,000 potential offers.

I did a quick post on this earlier today on the Motley FOOL without crunching through the numbers and this is what Kestral had to say:

Having seen people around me who have been offered packages, the right choice so far has always seemed to be to TAKE THE PACKAGE.

A typical example: a friend of mine worked for a school board for 20 years as a teacher assistant and the board needed to cut budget, so they offered her and some of her colleagues a package. She took the package which was a lump sum of money.

The board started doing things to those that stayed to "motivate" them to leave (e.g. assigning the TAs to two schools, one in the morning in the east side of town, then one in the afternoon on the west side). Those people got no package.

In other cases, packages were offered again but a lower amount.

So from what I've seen, when the offer a package: Do not pass GO, bypass Boardwalk, take a ride on the Reading Railroad and go directly to PACKAGE. TAKE IT.

On the assumption that $140,000 is indeed a valid offer I have to agree with Kestral "Do not pass GO, bypass Boardwalk, take a ride on the Reading Railroad and go directly to PACKAGE. TAKE IT."

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

In Praise of Saville

Steve Saville wrote a very nice piece on inflation entitled The Non-Stop Inflation. Although we disagree on the "end game" it sure is nice to see someone properly explain what inflation is, what it is not, and why measuring the CPI is fraught with so many problems as to make it useless. Steve wrote:

The definition

The correct definition of inflation is an increase in the supply of money that CAUSES a decrease in the purchasing power of money, but we usually define it as simply an increase in the supply of money. This is done, in part, for the practical reason that it's impossible to measure changes in the purchasing power of money on an economy-wide basis.

It is not possible to measure changes in the overall purchasing power of money because it is not possible to come up with a meaningful number that represents the average price level within an economy. There are, of course, price indices such as the CPI that purportedly represent the average price level, but these indices are generally worse than useless because they are calculated in such a way that they are guaranteed to paint a misleading picture. And in any case, even an honest attempt to determine the average price level would fail. The reason is that even if it were somehow possible to determine a meaningful number that represented the average of things as different as eggs and new cars, a calculation that was valid today would, in a dynamic economy, be obsolete tomorrow.

To illustrate just one of the insurmountable challenges of coming up with a price index that accurately represents the EFFECTS of inflation let's consider the hypothetical example of the $2 widget made in the US. In our example we'll assume that monetary inflation within the US over many years pushes up manufacturing costs such that these widgets can no longer be made in the US and sold at a profit for anything less than $3; in other words, if nothing else changes then the inflation will cause the dollar's purchasing power to fall from 0.5 widgets (2 dollars = 1 widget) to 0.33 widgets (3 dollars = 1 widget). But something else does change. Instead of raising the selling price of the widget from $2 to $3 in response to the increase in costs, what actually happens is that our hypothetical widget manufacturer keeps the selling price the same and opens a factory in a part of the world where manufacturing costs are much lower. Therefore, in our example inflation causes the dollar's purchasing power to fall and this, in turn, leads to the closure of a factory in the US and an increase in the quantity of imported goods. Inflation has obviously had an important effect, but it's unlikely that any price index will capture this effect.

There can be no real meaningful discussion of inflation or deflation unless one agrees on a definition. I am pleased to see that in spite of one of us being an inflationist and the other a deflationist, we have independently surmised what the real problem is: expansion of money supply and credit.

In Inflation: What the heck is it? and Inflation Monster Captured, I wrote many reasons why attempting to measure inflation by looking at the CPI was a fool's game. It is good to see someone who has a radically different view of the end game than I do at least agree as to what the problem is.

Given that the problem is a rampant expansion of money and credit, the solution can not possibly be a "price stability" policy that attempts to measure consumer prices. With all the hedonic adjustments (many justified but probably all overstated), with all the nonsense about core inflation vs. non-core inflation, with all the imputed economics, with all the understating of medical costs, and with enormous discrepancies between rental costs vs. housing ownership costs, there is not a person on this earth that could possibly know 2% price increases if it hit them smack in the face.

Right now I am in a huge debate with someone on Silicon Investor. It seems that even otherwise reasonable people (which I think both of us are), simply can not come to agreement about whether or not quality improvements should be factored into the CPI.

My position is that quality improvements should be factored in otherwise one is not comparing apples to apples. Take autos for example: antilock brakes, seat belts, air bags, improved gas mileage, air conditioning, CD players, electronic ignition, fold down seats, windows that safely shatter, better gas mileage, intermittent wipers, reduced emissions, etc, are all quality improvements that have appeared in cars over time.

As compared to 1924 even the amount of raw materials going into cars has gone up dramatically (copper, electronics, rubber, aluminum, steel, glass, etc). On a component basis alone (forgetting about quality improvements like intermittent wipers and safer glass) I just do not see how one can reasonably claim that the difference in price of a car today vs. 1924 can all be chalked up to "price inflation". Yet somehow there is a disagreement as to whether or not either component changes or quality improvements should be factored in. No wonder people have wildly differing views of price increases. In practice, it seems that people see the every price increase as "inflation" but fail to see or account for obvious improvements in quality. Getting agreement as to how to measure quality improvements is of course impossible if one can not even get agreement that it should be done at all.

To be sure, the government overstates those quality improvements and does so on purpose so as to lower the CPI. This makes Social Security and other cost of living adjustments (COLAs) as small as possible. Such manipulation is of course is another reason why CPI price targeting is wrong.

While I agree with Saville about the necessity of tracking money M3 is probably not the best way to do it. Shostak has pointed out problems with the "M-series" of money supply measures in Making Sense of Money Supply Data as well as other articles that he has written.

The distinction between money and credit it is an important one, and each needs to be tracked separately given the extent of our fractional reserve lending. In Japan, the government continually injected money for 18 years in an attempt to fight deflation but credit contracted at a greater rate nearly the entire time. I believe the same will happen here.

For those that want to compare my end game scenario with Steve's here they are.

Saville:
The End Game

Mish:
End Game Analysis
The Red Queen Race

For now, I want to thank Steve Saville for continuing to spread the word as to what inflation is and what it is not. Time will tell which (if either) of us has the "end game" pegged.

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

No Payments until January 2007

I called Ryland today about their "Choose-It" promotion. It was quite hard getting any information out of them.

Here is what I can gather:
This seems to be some kind of "fluff offer" that perhaps they are praying will work. It does not appear to me to be any substantial offering of any kind nor any real panic by Ryland.

I tried like mad to get the salesperson to tell me how much they would take off of homes (price reductions), but the best I could get was $30,000 - $60,000 in "select" Phoenix locations. He asked me where I wanted to live (and this is where it got harder as I do not know a thing about Phoenix). He gave me a friendly lecture about picking a section of the city first and starting there.

All I wanted to know was how big are the discounts and on what price homes. He was trying hard to NOT tell me that on a model by model or price range basis. It was my first unsuccessful attempt to get info. With Centex and others I was able to go model by model and have someone tell me what the reductions were. Not so with Ryland.

In Bubble Busting Phoenix I reported there were 14,601 Vacant Homes in greater Phoenix area. At the moment that does not seem to be of much concern to Ryland. I could only find a dozen or so homes on the Ryland site that were "available soon" and only one of them was "immediate".

Although the message boards I frequent were talking about this campaign, it does not seem to be panic but rather much ado amount nothing. Still Ryland will quickly be adding to the already mammoth supply of Phoenix inventory.

Here is an anecdote from StB on the Motley FOOL just today about Phoenix:

Well, we have had our house on the market for five months, nearly to the day. The first three months were capped by the holidays, non-aggressive pricing on our part, and non-aggressive marketing. In the subsequent two months, we got very aggressive on our price and marketing, but it took us cutting our list price $5k under where we thought it would move to get significant traffic through the doors.

We are now under contract for $12k under our list price...again, more than we thought. Over the timeframe, our list price dropped by $30k, and our final sell price is also $30k less than we originally thought it would sell for. During the time our house was on the market, we saw identical floor plans in this community sell for continually decreasing price: September (before ours went on the market) the price has steadily declined by about $10k every six weeks. Folks, if you needed any further confirmation that the PHOENIX market is declining, here is your anecdotal evidence.

I am making a note to check back into Ryland Phoenix in a few months when more houses will be available. It will be interesting to see who wants to buy a home and for what price in the dead heat of summer. I am also wondering how long it will be before we see "No payments until January 2009".

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

The Current Account and Credibility Gaps

The U.S. current account deficit widened by 21.3% to a record $224.9 billion for the fourth quarter of 2005 the Commerce Department reported Tuesday March 14th. The deficit was 7.0% of the nation's gross domestic product, also a record.



For all of 2005, the current account balance grew to a record deficit of $804.9 billion, totaling a record 6.4% of GDP.

The current account balance is a broad measure of the nation's economic balance sheet with the rest of the world. It encompasses both trade and capital flows. It essentially measures the nation's debt with the rest of the world, which must be financed by loans from abroad or asset sales to foreigners. It was the ninth annual record in the past ten years. The deficit in the third quarter was revised to a record $185.4 billion, compared with the original estimate of $195.8 billion.



Alice in Wonderland

In our current Alice in Wonderland scenario, the US (one of the richest per capita income countries in the world) is borrowing heavily from China (one of the poorest).

In Save More! Save Less! Stephen Roach had this to say Mar 09, 2006:

The two major players in the global economy, the US and China, are operating at opposite ends of the saving spectrum. Thrifty Chinese have taken saving to excess, while profligate Americans have spent their way into debt.

Last year China saved about half of its gross domestic product, or some $1.1 trillion. At the same time, the US saved only 13% of its national income, or $1.6 trillion. That's right, the US, whose economy is six times the size of China's, can't manage to save twice as much money.

And that's just looking at national averages that include saving by consumers, businesses, and governments. The contrast is even starker at the household level — a personal saving rate in China of about 30% of household income, compared with a US rate that dipped into negative territory last year (-0.4% of after-tax household income).

These are extreme readings by any standard. The US hasn't pushed its personal saving rate this far into negative territory since 1933, in the depths of the Depression. And the Chinese rate is higher than it has been at any point in the past 28 years, since its modern reforms began. Similar extremes show up in the consumption shares of the two economies — the mirror image of trends in personal saving rates. US consumption has held at a record 71% of GDP since early 2002, while Chinese consumption appears to have slipped to a record low of about 50% of GDP in 2005.

America's lack of saving has also put unprecedented demands on the rest of the world, since the US must import surplus saving from abroad in order to grow. America's current account deficit hit a record of nearly 6.5% of GDP in 2005 and could well be headed north of 7% this year. That translates into a lifeline of foreign capital totaling about $3 billion per business day.

There is a more insidious connection between the saving postures of China and the US: Chinese savers are, in effect, subsidizing the spending binge of American consumers.

In Tripwires on Mar 13, 2006 Stephen Roach went on to say:

The Dubai port incident, unfortunately, is only the tip of a much bigger iceberg. There was also last year’s high-profile rejection of a bid to buy Unocal by a Chinese oil company. Moreover, in recent weeks, Washington’s increasingly xenophobic politicians have gone even further. A leading US senator floated the possibility of legislation preventing cross-border acquisitions of US companies by foreign state-owned entities. And during last week’s negotiations over the debt ceiling bill -- with a lifting of the government’s debt limit required only because a saving-short US has decided to up the ante on deficit spending -- there was actually an attempt made to restrict foreign ownership of US Treasuries. The good news, if you want to call it that, is that this latter attempt has since been watered down “only” to require a detailed accounting of the overseas holding of US government debt. But the irony of these politically motivated efforts to throw “sand in the gears” of America’s external funding mechanism is especially striking: At precisely the moment when the US has pushed its external funding requirements into unprecedented territory, it is becoming more and more aggressive in dictating the terms of the requisite inflows.

To me, all this speaks of an increasingly treacherous endgame for the current state of tranquility in world financial markets -- especially the all-important expectational underpinnings of the dollar and longer-term US real interest rates. Investors are nearly unanimous these days in dismissing the mounting economic and political tensions of an unbalanced world -- arguing that it is in everyone’s best interest to keep the game going. The retort of increasingly smug US fund managers is typically something along the lines of, “What else are the Chinese going to buy -- euros?”

Add in the current tensions associated with widening income disparities, real wage stagnation in developed countries, and the growing outbreak of trade frictions and protectionism, and today’s world looks far from secure. The tripwires of globalization are now being set.

Bernanke Washes His Hands

On March 14th Ben Bernanke attempted to wash the US Government's hands as well as the FED's own hands by claiming Imbalances are driven by markets not policy.

Global trade imbalances are a market-driven phenomenon that government policies can do little to address, U.S. Federal Reserve Chairman Ben Bernanke said in a letter released on Tuesday.

"In the absence of a shift in market perceptions of the relative attractiveness of U.S. and foreign assets, government policies would likely have only limited effects on the trade balance," Bernanke said in the March 9 letter to New Jersey Democratic Sen. Robert Menendez.

The letter was in response to a question the senator submitted in connection with a February 16 Senate Banking Committee hearing on the Fed's semiannual report on monetary policy. "This excess saving has been attracted to the United States by our favorable investment climate, strong productivity growth, and deep financial markets," he said.

Quite frankly this is preposterous. The FED slashed interest rates to 1%, which spawned off a global property bubble, reignited the stock market bubble, and embarked on the greatest liquidity experiment the world has ever seen. Meanwhile the Bush administration slashed taxes, increased spending and Ben Bernanke wants us to believe that somehow this is China's fault and not US government and FED policies largely responsible for this situation?!

To top it off, not only do we run enormous imbalances with the rest of the world we want to tell them what they can or can not buy with THEIR dollars. At precisely the moment when the US has pushed its external funding requirements into unprecedented territory, [the US] is becoming more and more aggressive in dictating the terms of the requisite inflows.

Last year we refused to let China buy controlling interest in Unocal , and recently refused to let the United Arab Emirates take over operations of our ports. For the record, oil is fungible and it would not have mattered one bit whether we sold Unocal to China vs. anyone else. Just Last week Congress actually had the audacity to propose restricting foreign ownership of US Treasuries (quite frankly that is laughable or scary depending on how you look at it). We also restrict "sensitive" software, military hardware, and anything else they really want.

Ben Bernanke, care for a little debate on this idea of yours that "Market Forces" and not the government that is the culprit here?

Protectionism

Does anyone believe US threats of "protectionist barriers" unless China takes action on currency reform?

Speaking on Tuesday, US Commerce Secretary Carlos Gutierrez said that if China did not take action on currency reform it would encourage those in the US seeking to put up "protectionist barriers".

Support for legislation which would slap tariffs of more than 25% on certain Chinese goods if Beijing does not further revalue the yuan is thought to be gaining support among sections of Congress. Pressure is growing for China to act ahead of a visit by Chinese president Hu Jintao to the US next month.

"If our economic relationship is to stay afloat, China needs to lighten the load by carrying out reforms and delivering results," Mr. Gutierrez said.

I am wondering if that is a credible threat. Are we really hell bent on raising prices of Chinese goods 25% to save 300 underwear manufacturing jobs in the US? Then again it could be a serious mistake to underestimate blatant stupidity on behalf of Congress in general and this Congress in particular. It will be shades of Smoot-Hawley if we pass such legislation.

Quite frankly, and unfortunately there are credibility gaps of this nature everywhere you look: on the budget, on social security, on WOMDs, on Iraq, on housing, on wiretapping, on Medicaid, on homeland security, on jobs and on the war on terror. Furthermore there is a blatant bombardment of BS from both the public an private sectors.

Housing Credibility Gaps

David Lereah, the National Association of Realtors chief economist, said the latest housing reading shows a flattening that is in line with "the soft landing we've been expecting." for the housing market. "We are at a much more sustainable level of home sales now - a welcome cooling from the super-heated conditions that were driving exceptional price gains."

How can he possibly know we are experiencing a soft landing when we have not landed yet? Furthermore does anyone find his statement credible that Realtors "welcome" this cooling?

What is that saying about swampland in Florida? I think it goes something like this: "If you believe 'that' then I've got some swampland in Florida to sell you." Is that what is happening here? St. Joe Company Introduces "FloridaWild" Land Parcels of 40 Acres and More, Ideal for Outdoor Enthusiasts and Conservationists.

Ideal? Ideal for what? Wading in muck and getting attacked by swarms of mosquitoes?
I think there is a serious credibility issue here.

Snow is Confident

Back on March 3rd treasury Secretary Snow said the Failure to save shows confidence in future paychecks.

In a telephone interview with The Chronicle, Snow said that he thinks wages now are at a "tipping point" where they will start rising. Snow also put a positive spin on Americans' negative savings rate. Recent studies have shown that in 2005 average spending outpaced earnings for the first time since 1933 as people financed consumption by dipping into savings or taking on debt.

"One way to look at it is that people tend to consume out of their expected long-term income," he said. "The strong consumption could be interpreted, probably should be interpreted, as a vote of confidence in the direction of the economy and the fact that people feel good about their prospective earnings, the sustainability of their jobs and the strength of the job markets."

Does anyone really find that credible? If so, I've got some swampland in Florida to sell you.

Bernanke Praises Derivatives

On March 15 Ben Bernanke was quoted as saying Derivatives make economy resilient

"Although no single factor accounts for this favorable performance, derivative instruments undoubtedly have contributed to this resilience because they offer firms means for managing their risks," Bernanke said.
His comment was in response to a question submitted in writing from Republican Sen. Mike Crapo of Idaho in connection with a February 16 Senate Banking Committee hearing on the Fed's semiannual report on monetary policy.
Bernanke said derivatives, whose value is based on that of some underlying factor, "have contributed to our understanding of the measurement and management of risk" and thus helped make the financial system as a whole more resistant to shocks.
"Certainly, derivatives instruments pose challenges to risk managers and to supervisors, but these risks are manageable and thus far have been managed quite well," Bernanke said.
"Market discipline has provided strong incentives for effective risk management, the key to ensuring that the benefits of derivatives continue to be realized," he added.

On March 15 Bloomberg reported Credit Derivatives Market Expands to $17.3 Trillion.

The global market for credit derivatives increased by 39 percent to $17.3 trillion in the second half of 2005 on demand for contracts to bet on corporate credit quality or insure against defaults, the International Swaps and Derivatives Association said.

Credit-default swaps, which pay compensation in the event of borrowers defaulting on their debt, expanded 105 percent in the full year, leading an increase in the $236-trillion market for derivatives, or contracts based on underlying assets. The market's growth was slower than 123 percent increase in 2004, ISDA said in a report today at its annual meeting in Singapore.

Regulators are worried that credit derivatives are increasing too quickly for banks to control. The Federal Reserve Bank of New York has demanded action to tackle a backlog of contracts left unsigned for weeks or months, and for banks to address a shortage of bonds to settle contracts.

Contracts to swap between fixed and floating interest payments, the biggest derivatives market, increased 6 percent to $213.2 trillion, ISDA said. The growth rate was slower than the 10 percent expansion in the first half, said New York-based ISDA, a trade group representing more than 700 banks, securities firms and institutional investors.

The other side of the Derivative Debate

Back on March 7th, Howard Simmons (one of my favorite contributors to RealMoney.com) wrote an interesting piece entitled Dana Bonds Show Ugly Credit Incentive . Following are a few snips:

One of the sadder and more predictable outgrowths of the expansion of the Federal Savings and Loan Insurance Corp. (FSLIC) insurance in 1980 to $100,000 per account was the emergence of the "Texas Run" toward troubled S&Ls. That's right, toward. As word spread that an S&L was in trouble, it was forced to pay a higher rate on its certificates of deposit. CD brokers, not to be confused with homonymous seedy brokers, bundled all sorts of small deposits into $100,000 packages and sent them to the troubled S&L. Who cared if the S&L then failed? The CDs were insured.
Credit Default Insurance

The topic of credit default swaps (CDS) and how they are used was outlined here last April and then again in May. These instruments act as put options; they allow the bondholder to deliver the bonds at par, the bond's face value, to the CDS writer in the event of a credit event. As the risk of bankruptcy or another credit event rises, the price of a CDS expressed in basis points rises as well. CDS writers, like those who write put options, are on the hook to buy the bonds at par to deliver to the CDS buyers.

Just as the open interest of a futures or options contract can swell to a quantity greater than what is available for delivery, the volume of CDS contracts created in this over-the-counter market can swell way beyond the physical quantity of the actual corporate bonds being covered. And I do mean way beyond; while actual data are hard to come by, some estimate that the volume of outstanding CDS contracts on bonds for now-bankrupt auto parts manufacturer Delphi was 140 to 175 times the actual quantity of bonds available.

The world of distressed-security hedge funds and the emergence of credit traders have created a situation wherein the bondholder gets rewarded when the company gets in trouble. Every corporate bond with an excess of CDS written on it now embeds a call option on the firm's bankruptcy. Once a firm gets into trouble and blood is in the water, the bondholders may have a positive incentive to see the firm fail.

Yes, insurance changes behavior. Free stock options created problems in the 1990s boom. Will these "free" call options on bankruptcy create incentives among the bondholders, especially those who hold CDS protection, to see the firm fail? Absolutely, and the sooner we address this issue, the fewer next-generation Enrons and WorldComs we will see.

So we have a world where 14,000% to 17,500% of the total bonds of a corporation are in play via credit derivatives and this according to Bernanke "makes the economy resilient"? Is infinite leverage is a good thing? It must be according to Bernanke.

Ben Bernanke ($Ben) has long ago blown his credibility. Every time he opens his mouth the credibility gap seems to widen. I apologize for not posting a chart of the combined total credibility gap. It simply went off the scale.

Notes:
There is an audio covering this blog and much more on Howe Street.
Please look in the left hand column for "Startling stats and a Credibility Gap" by Mike 'Mish' Shedlock. In the past, some people have reported problems playing those podcasts. I think most of the problems have been solved, even for Apple users. Please play that podcast and let me know of any problems you are experiencing, and I will pass them on to HoweStreet.

I am also pleased to announce that I am starting a newsletter called the "Survival Report" with a good friend, Brian McAuley, a superb chart technician. For more details please subscribe to Whiskey & Gunpowder, a free publication. The current edition is available for free at The Survival Report. Brian and I welcome your feedback and your suggestions.

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