The Market Ticker

In light of China's view of the "safety" of their dollar-denominated investments, your several-times removed predecessor has some words of wisdom for you:

Treasury Secretary, Henry Morgenthau, angry at the Keynesian spenders, confided to his diary May 1939: "We have tried spending money. We are spending more than we have ever spent before and it does not work. And I have just one interest, and now if I am wrong somebody else can have my job. I want to see this country prosper. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises. I say after eight years of this administration, we have just as much unemployment as when we started.^[49] And enormous debt to boot."

Do we really need to repeat history in order to learn from it?

You have to love the National Association of Realtards:

Record low mortgage interest rates boosted pending home sales for the third consecutive month, with some benefit now from the first-time buyer tax credit, according to the National Association of Realtors^®.

Really?

Someone forgot to tell those people to lock the rates, right?  Oh, and that "its too late" now.

Here's the current chart of the TNX, which is the most-closely correlated index for mortgage rates on 30 year fixed money:

Now let's dissect their statement:

The Pending Home Sales Index in the Northeast shot up 32.6 percent to 78.9 in April and is 0.8 percent above a year ago. In the Midwest the index rose 9.8 percent to 90.4 and is 11.1 percent above April 2008. The index in the South slipped 0.2 percent to 93.0 in April but is 3.5 percent higher than a year ago. In the West the index rose 1.8 percent to 94.8 but is 2.9 percent below April 2008.

In APRIL.

This report is, again, from APRIL.

April was right after the "QE" announcement and rates went to historic lows almost immediately.  But they didn't stay there.

Now we have May, which you'll note hasn't been announced yet, and in addition these are pending (not closed) sales.

If the pending buyers did not lock rates, they are about to come to the closing table and find out that they cannot qualify any more with the more than one percent increase in rates (from ~4.75% to ~5.75%) over the last week.

New buyers of course (for June) must contend with this as well.

Oh, and the Realtors are still pumping overleveraged conditions and ignoring the principles of sound buying:

A median-income family, earning $60,900, could afford a home costing $296,800 in April

No.  A median-income family can afford a home costing $180,000; the 3:1 ratio is not off the financed amount, it is off the purchase price.

Their cited "25% principal and interest" ratio is unreasonably aggressive as well - the proper front-end ratio is 28% and covers all housing expenses, not just principal and interest.  They are (conveniently) leaving out property taxes, insurance and utility costs, none of which (of course) are able to be left out.

Yun cautions that the reporting sample for pending home sales is smaller than that of existing-home sales, so it is subject to greater variability. “In addition, the relationship between contracts on pending home sales and closings on existing-home sales is taking longer than in the past for several reasons,” he said. “Mortgage processing time has increased, it is taking many months to close on those homes requiring short sales with lender approval, and some sales are falling through at the last moment.”

No kidding.  A 60-day closing schedule makes it impossible in most cases to lock rates for the entire period at any sort of economic price, meaning that your deal is subject to blowing up when the expected financing cost suddenly jumps up.

How much difference does this make? 

That's easy to figure out.

At $4.75% a $100,000 financed amount for 30 years produces a P&I of $519.59.  That same payment at a rate of 5.75% produces a financed amount of $89,462.75, amounting to a devaluation of roughly 10.6% for every home in the nation.

So if you financed up to the maximum you could borrow and did not lock at 4.75%, you are now forced to demand either a 10% price concession from the seller (unlikely to be granted) or your deal blows up.

It's that simple.

It would be nice if we had "trade groups" that presented news in a balanced fashion.  That, however, would be unrealistic.

After all, they are salesmen.

Just like their former spokesman was a realistic and an excellent prognosticator of what real estate was going to do.  Remember these books and their veracity?

'Nuff said.

Funny how Bloomberg, who ran this originally, edited the headline and removed it.  Did someone in The Administration or Treasury call Bloomberg and complain?

Telegraph: In his first official visit to China since becoming Treasury Secretary, Mr Geithner told politicians and academics in Beijing that he still supports a strong US dollar, and insisted that the trillions of dollars of Chinese investments would not be unduly damaged by the economic crisis. Speaking at Peking University, Mr Geithner said: "Chinese assets are very safe." The comment provoked loud laughter from the audience of students.

This isn't worth a mention over here?

University students can see through our BS in seconds, but the sheeple here in America don't, and we continue to allow these clowns to have their hands on the levers of fiscal policy.

Simply amazing; the Chinese have clearly figured it out, and they're not beyond expressing it.

Of course our so-called "media", say much less our Washington Political Establishment, provide all the trappings of undeserved decorum to someone when college students in a foreign country can see right through it.

Turbo Timmy and our media continue to insist on the exquisite tailoring in Timmy's new suit, while the Chinese see his schlong and beer belly hanging out in the breeze.

The government's mantra since this crisis began was one of "stabilizing housing."

But "stabilizing housing" means low, stable mortgage rates.  This can only happen if government borrowing costs remain low and stable, since literally everything is referenced off Treasury rates in one form or another (and why wouldn't it be - if the government falls, no private debt is secure; ergo, that is the foundation of borrowing upon which all other interest rates are, and should be, based.)

Yet the government has sought to borrow literally two trillion dollars this year to spread around to various "favored sons", whether it be banks or automakers.

It is axiomatic that the higher your debt to income ratio the more risk lending your money has. 

It is also axiomatic that interest rates are calibrated by three factors:

• If the capital being borrowed is itself borrowed by the lender, the cost of the funds (that is, nobody will intentionally lend at a loss)
• The risk you will not pay back the loan
• The risk that inflation will make the money you pay with worth less

For sovereign borrowing the first factor doesn't exist as government borrowing is the base upon which all other lending occurs.  But the other two factors are most certainly active.

So if government wants to "support the housing market", meaning it wishes to have low and stable interest rates in the US Treasury complex, it would pursue a policy of fiscal austerity and a lack of "money printing" so that as tax receipts decline in a recession those who would lend to the government would see a fiscally-responsible borrower along with a low prospect of artificial inflationary pressure.  This would promote low and stable Treasury bond rates and thus low mortgage rates.

But our government has done exactly the opposite; it has borrowed and spent well north of a trillion dollars thus far, with commitments to borrow and spend another trillion.  It will in fact issue nearly $200 billion in new Treasury debt on a 4-week running basis through next week alone.

This originally resulted in lots of jawboning from China (in particular) and others, going back nearly a year, in the form of thinly-veiled threats to excise itself from the dollar and dollar instruments.  Some of those threats have materialized; it is clear, for example, that the Chinese and other foreign interests have been actively fleeing from mortgage-backed securities (and with good reason!) over the last year, and that they are rapidly eschewing longer-term Treasury debt, shifting transactions to the short end of the curve.

Did this result in a change in policy of our government?  No.

What it did result in is our supposedly-independent Federal Reserve choosing to monetize both MBS and Treasury debt.  A dispassionate view of that debt and the coupon that The Fed has purchased (Fan/Fred paper) suggests strongly that they could be underwater by as much as 10%.

It is for this reason of risk, by the way, that The Fed is barred by law from buying any instrument that is not backed by "full faith and credit" of The Federal Government.  We the people (and Congress), of course, are ignoring this law.

That shortfall makes for some very difficult problems for The Fed.  See, these are "mark-to-market" losses; in theory at least The Fed could choose to sit on that debt until it matures, and provided that Fannie and Freddie remain under government protection, the principal will be "safe".

However, doing so means that they must leave the dollars they printed in monetization of that debt in the economy!  That's a problem, in that this "excess liquidity" can (and is) contributing to speculative "froth".

Witness oil prices, up by a clean double from the low, along with other financially-traded commodities.

Last year oil hit a record of $150/bbl.  Why did it go to $150 into the maw of severe employment and output declines?

Simple: The Fed was lowering interest rates like a madman, cutting discount and other rates along with pumping liquidity into the economy.  All that "excess money" has to go somewhere, and absent overt manipulation it will attempt to find a place where it can feed speculative froth (and trading return) for those who have their maw on it.

Since we allow our banks to trade in the markets (ex Glass-Steagall) as a consequence of refusing to retain the lessons of The Depression this excess liquidity went directly into commodities.  The resulting rise in prices acted exactly like a multi-hundred-billion dollar tax increase on The American People, further adding to the economic decline.

When The Fed realized what was happening it then decided to intentionally drain liquidity from the system as a means of controlling what was shortly to become out-of-control long-term Treasury rates and commodity prices. 

The result of that action was the stock market crash - perhaps an "unintended" consequence, but not an accident; the acts taken by The Fed to drain liquidity were intentional.  As I noted on the 24th of September - three days before the market imploded - The Fed has been lying throughout this crisis as to both their acts and intentions.

Unfortunately whether The Fed recognizes the true issues at play - that we are in the middle of a credit bust caused by unreasonable credit extension, is unknown.  What is known is that Congress hasn't recognized it or been willing to deal with it, and that there is no Paul Volcker in The Fed who is willing to stand up and say "bite me!", withdrawing excess liquidity and forcing default of the bad debt in the system.

This cycle has not been broken.

We cannot "fix the economy" until we break this cycle and start telling the truth.  All we can manage to do is try to blow another bubble and create the faux appearance of prosperity, but not prosperity.

The bad news is that we're out of big enough bubbles for it to work.  Commodity markets are too small.  Housing has had its run, as did technology.  There is no market bigger than housing ($10+ trillion!) that can be exploited to blow the next bubble of sufficient size, and therefore, a multi-year faux recovery cannot take place.

The level of debt in the system and the costs of that debt service cannot be denied.  That interest coupon is a durable drain on GDP; money used to pay interest cannot be used to expand factories and fund new ideas.  This cannot be avoided and can only be reduced in impact through default of the debt; to reduce it through growth of GDP to the degree required would mandate a doubling of GDP without adding any more debt to the system - a feat that is in the realm of pure magical thinking.

We may well appear to "kick the can" for another six months or a year.  I doubt it will last much beyond the summer, but timing these things is difficult, and when it comes to timing that's the hardest part of being an economic prognosticator - the "what" is easy, the "when" isn't.

But until we see real economic clearing of the credit markets, which means the debt-to-GDP ratio gets down into the area of 100-150% of GDP (both public and private) there will be no durable recovery.  The lesson of Japan makes this clear - despite cranking up their debt levels in an attempt to monetize and force the markets to clear "their way", instead of removing the debt from their economy through default, they wound up with a stock, credit and real estate market that never recovered to its former levels, and is now in at least as much trouble as ours.

The Government will be forced by the bond market to either curtail spending or dramatically increase taxes.  The former is the right path, but there is no evidence that we will return government spending to a level consistent with reasonable economic growth (e.g. somewhere around the mid 1980s level!)  But raising taxes simply makes the covert tax increase from commodity speculation into an overt tax increase; the economic impact is the same.

What this means for you as an investor is that you can't be long-term focused with your investments.  This sort of environment forces you to be a trader, whether you want to be one or not, because the alternative is that you get caught in downdrafts like last fall.

Be aware of the risks here as an investor; we have rallied close to 40% off the low at 666, but the P/E of the S&P 500 is in the stratosphere.  Ignore the WSJ and Yahoo's so-called "P/E ratios" - they're not counting those companies that reported negative earnings, but in the real world negative numbers count!  Any durable recovery in the market requires that stock prices correlate to a meaningful degree with earnings on a forward basis - unless and until consumers have jobs and thus a durable source of funds to spend any so-called "recovery" as a consequence of liquidity pumping is in fact a false hope.