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Economy Freefall or Downhill Tumble?
May 2, 2009

Three battles are underway: Treasury borrowing versus interest rates, slower economic decline versus bottom, and banks versus everybody else.

Total Treasury new-cash borrowings this week and next: $171 billion, a tad high (the 2009 two-week average: $75 billion). The Fed on March 18 said it would buy $300 billion in Treasurys this year, many thought in an effort to control Treasury interest rates, specifically holding the 10-year under 3.00%. Not so: the 10-year is trading 3.16% today. One-quarter of the $300 billion has already been spent, the purpose to get cash in the economy around broken banks, not to rig Treasury rates.

The Treasury market is too big and too important to the world, and the Fed already has the other credit markets on life support. The longer you keep a patient on a ventilator, the harder to get him off, and we have a whole ward on vents.

The good news: mortgage rates have not risen in tandem, holding high fours. The Fed’s $1.25 trillion effort to push down mortgage rates is working because rollover refis don’t require new money, and even purchase loans are a wash versus payoff and foreclosure drains. Fannie, Freddie, and Ginnie already either own or guarantee half the outstanding $10 trillion -- and they are on the vent for good.

The April ISM survey does show a slower rate of decline: 40.1 versus 36.3 in March and cycle-bottom 32.9 in December. However, the ISM data show only changes in the rate of change. Any reading under 41.5 is deep recession, growth begins way up at 50, and a shift from free-fall to rolling downhill should not be confused with stability.

Another key indicator of cycle turn: new claims for unemployment insurance. Down a hair to 631,000 last week, they are holding below the early-April top at 668,000.

The precise location and timing of bottom does not matter. The important things: how solid the floor, and the shape of the recovery. The stock market yahoos all have out the “vee” charts, and we believe they are dead wrong on one cycle-marker: the lag between Fed-on-the-gas and economic acceleration. In cycles going back to WWII, the lag has been six to nine months, and theoretically the Fed put pedal to metal in September, eight months ago. However, this time the linkage is busted: no matter how hard the Fed hits the throttle, nothing is coming out of the fuel pump -- no credit.


Banks of all sizes have been on the run since fall: stripped of mortgage refis (banks just processing loans on the way to the Fed’s balance sheet), the Treasury says that October to February bank lending contracted almost 40%. Credit contraction entered a whole new stage about six weeks ago, pullback heaviest from 2nd mortgages (now 85% LTV max, at best), commercial real estate loans, and credit for consumers.

We had thought that the retreat by smaller banks was caused by make-my-day examiners, and one corrected us this week. “We’re not stupid; we know the economy needs credit -- these guys are shutting down on their own and blaming us.”

Mr. Obama’s sharp criticism of Chrysler’s senior secured lenders would be inappropriate in ordinary times. These are not ordinary. BofA’s stockholders at last removed Ken Lewis as chairman, but the board and new chairman are still cronies and hacks. The bank stress test is delayed again, the administration in obvious indecision about what to do with the results, the plans for toxic assets a faceplant. Meanwhile, bankers are elbowing women and children from the lifeboats. The administration seems to know it must insist on civic priorities for bankers, and doesn’t want to run the institutions, but it still hasn’t figured out how to get the bankers in the game.

Here’s the choice. You can let the bankers sail away, shrink credit, raise rates, and gradually accumulate adequate capital, and hope the Fed’s ventilator holds for another year or two or three. Or you can get over your fear of the reaction among the women and children and declare an emergency, which everyone already knows this is.
 

Another week of odd calm... at its heart a void of information from government. The economy is on life support, but the intentions of the physicians are unclear.

In the data details, nothing new: mortgage rates still rattle in a very narrow, high-four range, held so low only by the Fed’s massive buying. The stock market has shown some buoyancy, holding its ranges, Dow 8000 and S&P 850.

That optimistic trading is based on hopes that the economy will follow prior cycles: new weekly claims for unemployment insurance may have hit cycle-top at 665,000 in early April, and history says recessions end two months after that top. Historically, we’re overdue for an inventory pop -- new orders to replenish excessively depleted pipelines. Historically, we should soon begin to feel the stimulus spending.

Stocks reacted well to news of a slight decline in March sales of new and existing homes, and apparent drops in unsold inventories. However, there is still no increase in applications for purchase mortgages. Inventories are down because of foreclosure moratoria, and many millions of owners who think it unwise to try to sell -- best evidenced by a sharp drop in the number of Americans moving from one home to another, today about one-third below the numbers in the ‘80s and ‘90s.

The void... Secretary Geithner this week testified to Congress and delivered three speeches, all posted at www.ustreas.gov. He was commendably combative before Congress, but neither there nor in 25 pages of text did he describe the administration’s plans. He has always acknowledged urgency, the continuing dysfunction in credit markets, but dissembles about results, metrics to measure results, and intentions. The TALF program, central to renewing credit, fell dead flat at rollout; yet Geithner claimed its pathetic $1.4 billion opening was “relatively good for an early program.”

Mr. Obama last week at Georgetown offered a definitive economic speech in the style of an FDR fireside chat. His intentions are good, but as a policy document, or rhetoric to reassure the nation... an awful, ten-page fireside filibuster.

The peculiar calm in markets this week was in part due the usual late-month wait for fresh data early in the next. However, hanging over everything has been and will be: the results of the stress tests on banks. Apparently the bankers are being advised now, and leaks should appear shortly. Today’s release of the test parameters is black comedy, tell-‘em-nuthin’, a lousy harbinger of public results due on May 4th.

Everyone from parents to Presidents struggles with what to keep secret, how and when, and what to make public, how and when. Should I sit on this, for fear of alarming the audience? Or do I do more harm by trying to conceal things they already know and fear? Do I dare reveal my uncertainty about what to do in an emergency?

Normal people suddenly seated in government chairs become secrecy freaks. Classify everything “secret,” even the things the enemy already knows: no fate is worse than embarrassment. Secrecy is bureaucratic power: I know and you don’t.

The Fed’s special secret hell: if you knew what we’re doing, then you’d act based on us rather than on market and economic forces, which would distort markets and the economy, which we are trying to adjust, manipulate and manage. Have a nice day.

We are now two administrations and two years into tap-dancing around the insolvency of the banking system, and the devastating consequences of inadequate credit. The cautious IMF this week said US and European banks require $1.85 trillion to restore capital to the levels of 1995. The nation is scared, fully aware of deep trouble, and it is far past time for the authorities to speak plainly: what we’re trying, how and when we’ll know if it’s working, and our contingencies.

One public entity came clean, and we think tipped a card or two in the Fed’s hand. The Bank of Canada cut its overnight rate to match ours, .25%, and in unprecedented fashion said it would keep its rate there at least until June 2010. You don’t say that if you think you’re at economic bottom, nor without the company of the American Fed.
 

The Fed has succeeded in holding down Treasury and mortgage rates, but that is the only clear accomplishment by government so far this year.

A grand debate began last week between those who see Perfesser Bernanke’s “green shoots” and those who don’t. The Fed’s “beige book” summary described a “moderation in the pace of decline... some sectors stabilizing at a low level.” The Shooters pointed to better-than-expected bank earnings, slightly improved consumer confidence, a possible turn in unemployment claims, and flattening ISM surveys.

The no-bottom counter-data: the small-business NFIB survey hit second-worst in its 35-year history (not by coincidence, the 2Q’80 worst was the only credit crunch comparable to this in modern times). Industrial production fell 1.5% in March, and capacity in use dropped to 69.3%, the lowest measured in the 60-year series.

We think the Shooters are spinning. They have no case -- not yet.

The mechanics of bottom are slippery. A claimed “reduction in the rate of decline,” is often sophistry. Example: home sales have fallen from 7 million to 4.5 million. We will not fall another 2.5 million, hence a lesser rate of decline, but a silly observation in the face of foreclosures rising toward one million. Another: auto sales have fallen from 16 million to 9 million, and will not fall another 7 million, but soon ahead lies the bankruptcy of the majority of US-owned production and associated layoffs.

“Stabilizing at a low level” (we read the whole beige book, and the details do not support the summary) happens at some point in every recession. However, at this moment stability is illusion: more and more businesses are running at revenue below sustainability, unable to cover fixed costs, downsizing dominoes just beginning.


The key to all of this, of course, known to every Main Street businessperson and consumer, is CREDIT. Availability continues to contract sharply. The smaller the bank, the more demented threats by examiners against making loans; the larger the bank, the faster its CEO is running from government capital and pressure to make loans.

The entire commercial banking system is quickly curling into fetal position around remaining capital. If we make no loans, we won’t have new bad ones, and won’t need capital. We’ll raise our rates, sit with immense net-interest margins, and grow our own capital slowly -- anything but take government capital and surrender control.

Jamie Dimon, CEO of JPMorganChase, the most self-satisfied human in banking, without any embarrassment or awareness yesterday provided the low point in the crisis thus far. Dimon called his TARP capital “A scarlet letter, the TARP baby... We could pay it back tomorrow.” Would he participate in the Fed’s flagship PPIP effort to auction and clear bad assets? “No. We manage our own assets.”

In all public appearances, this Dimon creature has insisted that Chase is making lots of loans and satisfying the few qualified borrowers extant. Uh-huh. Sure. The Treasury reported that the 21 largest banks reduced lending across all categories by 2.2% in February; that reduction would have been far, far larger without the spike in mortgage refis, which are not bank loans, just “conduit” processing off into the Fed’s purchases.

Worse, everywhere: bankers un-making loans. A new FICO study found that 11% of Americans, good-credit performers on their loans, have had lines cut or closed. The NFIB says 28% of small firms have had lines cut, and 69% face worse terms. Ask your friends, and they’ll tell you the top closer of lines, arbitrary and blind... Chase.

There is a fight on for control of the banking system. We are losing. In a first-class national emergency, one without credit then without bottom, the first duty of banks is to provide adequate credit. That’s why we have guaranteed their liabilities since 1933.

We can theoretically limp along until banks restore capital internally, and then re-bloated crawl out to offer loans to whatever borrowers remain. However, we don’t know what’s worse: the risk of such a passive strategy, or the awful sense of moral soil at allowing the likes of Jamie Dimon to raise his finger to the nation.
 

10 tips for better gas mileage

Unless you drive a hybrid car or ride your bike to work, there's no way to escape the high gas prices. But there are ways you can get better gas mileage out of our vehicles - which will save you money in the long run, according to Edmunds.com, an online resource for automotive information.

Here are 10 to help you get better gas mileage:

1. Follow the Recommended Maintenance - A well-maintained vehicle will operate more efficiently. Fouled spark plugs, dirty air filters and clogged fuel filters will diminish fuel economy.

2. Keep Tires Properly Inflated - Under-inflated tires require more energy to roll; properly inflated tires can improve fuel economy by as much as 3 percent.

3. Take a Load Off - Heavier vehicles require more energy to move. Pack light and remove unnecessary items from the car.

4. Don't Drive Aggressively - Hitting the gas pedal hard after stopping, slamming on the brakes and speeding all decrease fuel efficiency.

5. Use the Highest Gear Possible - Lower gears use more power, so manual transmission drivers should switch to a higher gear when driving at a steady speed, and automatic transmission drivers should avoid using "sport" mode.

6. Use Cruise Control Selectively - Cruise control is a great asset on flat roads, but isn't the most efficient on hilly terrain.

7. Think Clean - Keeping your car washed and waxed improves its aerodynamics, thereby improving fuel efficiency. On a long trip, a quick run through a gas station car wash might more than pay for itself.

8. Avoid Excessive Idling - An idling car burns fuel. Whenever possible, turn your car off while waiting, and try to avoid drive-through windows and long toll booth lines.

9. Think Before You Ventilate - Air conditioning consumes more fuel, while rolled down windows decreases aerodynamics. Roll down windows when in slow-moving traffic; use the air conditioner when traveling at high speeds.

10. Combine Your Errands - Cold engines use more fuel than warm engines. Combining errands means the engine will be warmer for more of the trip.

Reality Trumps Wall Street
Posted April 10, 2009

This has been a strange week, marked by extreme divergence in evaluation of incoming economic data and disconnect between Main Street reality versus Washington proclamation. Mortgage and Treasury rates were stable; we no longer have markets, just the Fed -- damned glad to have ‘em, too.

The stock market began badly as solid, blue-collar bank analysts said the obvious: recession losses will soon overtake toxic dithering. Then wise assistance for life insurers gave support, and players turned on the stock-market horsefeathers machine.

A 20,000-person decline in unemployment claims was misread as a turning point, ignoring the other 654,000 claimants. Great news!: Only eight of the top ten retailers’ sales slid, instead of all ten. A gain in February exports was twisted into GDP floor: the $2 billion rise, 1.6%, is the kind of money Wall Street uses to light cigars; imports collapsed 23%, reflecting the actual drop in US demand. The NFIB small business study for March described conditions as bad as any in the 35-year history of the survey.

The Fed’s March meeting minutes again revised down the staff forecast, GDP decline “...expected to flatten out gradually over the second half of this year.”

Stocks rose happily throughout, and into glee at the sight of bankers in Easter Bunny suits. Wells Fargo announced positive earnings and a rosy forecast, which is certainly partly true, given its excellent mortgage franchise running hot. However, banks always make money if they limit write-offs of old loans gone bad.

The “stress test” of big banks was the object of spinners from all sides: the tests are a fraud designed to reassure the people... the tests will provide an excuse to nail a few bank CEOs... they are too tough... they are not tough enough. Bunny bankers say their banks are just fine. Give us cash and guarantees and leave us alone. Have an egg.

History books are filled with the cardinal symptom of empires in trouble: orders given in the capitol don’t make it to the countryside, and real information from the countryside fails to arrive in the capitol.

Bloomberg today reports that the Fed has instructed banks and examiners to keep secret the stress test results, for fear of revealing which banks are in trouble. Nothing is more important now than transparency, but as fine a job as the Fed has done it is still afraid of reality. Nobody trusts the banks’ balance sheets. Nobody. Big stock market rally, and 90-day T-bills still trade at Great Depression 0.17%.

Mr. Bernanke has his “green shoot” in resurrection of commercial paper, but only because the Fed still guarantees 20% of the market. Mr. Obama, today “Starting to see progress,” is either trying to boost morale or has been spun by an oddly optimistic Larry Summers and odd Sheila Bair. Mr. Obama’s new refi and loan-mod programs are off to an undetectable start, and won’t have a quarter the impact he’s been told.

Mr. Geithner’s babies, TALF and PPIP are DOA. The newest TALF round last month supported the sale of $1.4 billion in securitized loans (see “lighting cigars,” above). Banks don’t want to tender bad assets for auction, and private investors are not interested in buying, even with 94% Fed financing.

Meanwhile, no credit. Banks are busy canceling existing lines and refusing to roll over maturing ones. BofA is jacking rates on carried credit card balances from 7% to 13% -- which will be illegal next year, but it needs earnings now to save Ken Lewis.

Geithner’s effort to hold banks together as-is for future market recapitalization has its first serious challenge. The Congressional Oversight Panel was created to monitor TARP. Its Chairman, consumer rights lawyer/professor Elizabeth Warren, has jumped mission to full-scale second-guessing of Geithner’s plan. That kind of lawyer and jump usually drives us crazy, but Ms. Warren is dead-on (over-long, heavy with political code, but the April 7 report at http://cop.senate.gov is absolutely worth your time).

“The very notion that anyone would infuse money into a financially troubled entity without demanding changes in management is preposterous.” And more. Lots more.
 

Mortgage Interest Rates Are Down and Holding
Posted April 6, 2009

The Fed’s outright purchases of Agency MBS are having the desired effect: rates are down and staying down. Even the Fed’s immense power cannot force rates to 4.50% or lower (not quickly), but it has removed up-side volatility. Mortgage rates should have run back way above 5.00% in a week like this -- a big bear-market stock rally and immense refinance demand -- and instead held near 4.75%.

The chatter all week long, especially among the stock-happy adolescents at CNBC: bottoming is in process, and the worst is over. In the blogocracy, doom is predominant: the credit fixes and stimulus either won’t work in time or were the wrong things to try.

Reality is in the middle somewhere. The thing to hope for is decline in the rate of decline (yeah, we’re in that much trouble).

Housing first. Mortgage rates are down, which should stimulate consumer spending and aid a housing turn. Good try. In recent weeks, 80% of new mortgage applications have been for refinance, and purchase applications have not increased significantly since rates broke in December. Given suicidal credit and qualifying restrictions, still tightening, the only households that can refi are ones that least need to, and are most likely to save the monthly benefit and not spend.

Home sales appear to have slowed their numerical decline (pending sales rose 2.1% in February), but the overall numbers are very low, and the market distorted by a silent freeze on foreclosures. More are “continued,” instead of sold at auction; and servicers are required to use the new but non-operational refi and mod programs before foreclosing -- hence a lot of foreclosure water is building behind a weak dam.

The unemployment rate has slowed its rate of increase: to 8.5% in March, the .4% rise half the rate of February. However, payroll contraction is steady at minus 650,000 monthly, as are new claims for unemployment insurance at 660,000 weekly. That stable rate of loss is hardly reassuring.

Business and consumer conditions here and around the world are murky. In the US we junk thirteen million cars each year, but production and purchase have collapsed from sixteen million to nine; when might we see a bounce in demand for replacement, no matter how feeble? The global supply chain went to standstill in winter (Japan’s exports fell 49% in February); at some point some business will buy just to re-fill an empty pipeline, and that might produce a bottoming event. Many pointed hopefully at a 1.8% rise in February factory orders, but they barely offset a January negative revision.

The purchasing managers’ indices have flattened, manufacturing to 36.0 in March from February’s 35.8, but an end to economic contraction would require a reading clear up in the high 40s. Internal readings on inventories still show business’ determination to sell them off. Gasoline prices are little more than half a year ago, but driving miles are down, and refineries are operating at only 82% of capacity.


Some good news. Grim, but good. Mr. Obama’s tough-mindedness has begun to show. Last Thursday, the Automotive Working Group decided to fire Rick Wagoner as GM CEO (one group member: “It wasn’t the hardest decision we made”). Stephen Rattner, head of the group, asked Wagoner to fly back to DC on Friday, and fired him.

Fired him at roughly the same moment that the top 13 bank CEOs were meeting with the President. The announcement did not come until Sunday night. Wishful thinking on our part, but... do you suppose the small-caliber hole in the back of Wagoner’s head made an impression on the bankers? Might Obama have been silently measuring a few for shrouds and coffins, as object lessons to the others upon completion of bank stress tests later this month?

One person made this grisly observation: “China knows how to do some things right. After an execution, they send to the family of the departed a bill for the cost of the bullet.” To your heirs, Lewis, Dimon, others? Maybe, just maybe... act like public servants, restore some credit and leverage... or else.
 

There will be many turning points in this first global recession of the modern era, but this week marks one of the good ones. The players: the Fed, the Obama administration, and maybe, just maybe... the bankers.

The Fed is a central bank; all nations have one, each with one unique capability: the authority to print money. In normal times, central banks print money cautiously but routinely through the banking system, draining in good times, increasing in recessions.

In one corner of the Fed’s giant conference room hangs an imaginary but thick, red, silken rope. The kind of thing a Victorian might have used to call the butler. However, the imaginary one at the Fed has a huge, red, steel handle on the end. Since 1913, everyone visiting that room has known the rope and handle hang there, but no one ever talks about it, and all avoid even glancing at it.

Last Wednesday, Perfesser Bernanke pulled the handle. In extremis, in a flat-out national emergency threatening economic collapse, central banks must use the ultimate weapon: bypass broken banks and enter markets directly to buy financial assets with invented money in whatever amount necessary.

Neither media, people, nor markets have grasped the magnitude of the event or its power. In mortgages alone, the Fed expanded its purchase operation from $500 billion to $1.25 trillion. There is still a standoff between this irresistible force and the immovable object of refinance demand, but nobody in housing or waiting in line to refi should worry about a rise in rates. We will not decline quickly, and over time maybe not far, but we’re not going up -- normal up-side volatility is completely gone.

Same for Treasurys (the Fed is buying those, too). On the day the Perfesser pulled the handle, the 10-year T-note fell from 2.95% to 2.55%. This week the Treasury sold $100 billion in new paper, and the 10-year never rose beyond the 2.70s.

As much trouble as the world is in, do not underestimate the power of the Fed. The administration is flinching from declaring an emergency, but not the Fed.

Mr. Obama is still struggling for voice, sticking with his budget focus and inane assertion that this Walter Mondale dream of Christmas is essential for recovery.

However, Tim Geithner found his voice, and then some. In testimony with Perfesser Bernanke before Congress, the two men in fifteen minutes cut the knees from under all the populist AIG howlers in both parties, exposed their ignorance, and their grave, bi-partisan, and long-term failure to craft and support regulation of the financial system.

The new TALF and PPIP efforts, one to get lending going again and the other to deal with bank toxics, are underway, well-considered, and as good an initial effort as we can hope. It will be months before we feel their effect, or even know if they work (hence big red handle, above). Geithner and his boss could have done a lot better since inauguration to describe the agenda and its timing, but that miss is history.


Then, the banks. Mr. Obama met today with the dirty dozen top bank-CEOs, and afterwards none looked chastised. Too bad. We need their institutions to survive (to get our money back), and some of the CEOs should stay in their chairs. Most Americans wish that all of them would disappear into clouds of yellow, sulphurous smoke.

We have annoyed banking friends by repeatedly demanding that somebody in authority instruct these CEOs to behave (in particular, to make loans). Here’s the deal. Gradually since the 1960s bankers lost the discipline and control asserted in the Depression, after ’29 (even mighty Jack Morgan was called to account). These CEOs today -- still, despite the emergency -- have priorities ordered first to their personal ambitions, then to their stockholders, then to the nation.

Gentlemen, since 1933 the nation has guaranteed your deposits, and now all of your liabilities. We come first. Then your stockholders. Then you. Act like it. Now.

Obama & Co. must get that message across to the oligarchs, or an angry nation will.
 

Economy Deserves Full Attention of White House
Posted March 24, 2009

The Fed’s announcement of extraordinary intervention triggered ordinary responses in the markets: stocks had a nice moment; inflation mono-maniacs blew up gold and oil, and ran from the dollar; the 10-year T-note dropped from 2.95% to 2.52% in seconds; and briefly mortgages made it to 4.75% without fee.

All are reversing. The net mortgage gain: the plague of origination fees since December may give way, but rates are where they were, just under 5.00%, propped by unlimited demand. If the response has been tepid, did the Fed do the right thing? Absolutely. More, please (per Pimco’s Bill Gross, we need double or triple).

Here’s the problem: for more than a year, the markets have seen the Fed as the only branch of government responding to a first-class economic emergency. No matter what the Fed does, it cannot put out the fire by itself. It must have help from all engines of government, and from us. It still does not have that help.

Last year our government appeared disabled at the top, an exhausted and dysfunctional Presidency not in the game, creating policy vacuum and forcing the Fed Chairman and Treasury Secretary into public leadership roles beyond their means.

Incredibly, we still suffer from a void at the top -- very different in kind, but not result. From election day well past the inaugural, Mr. Obama appears to have given top priority to a new budget reordering social priorities. Without a sound economy, there is no money for healthcare or carbon or anything.

Without overriding priority, the clarity that only the President can bring, Congress is in normal fibrillation but with a virulent additive: the people are confused, frightened, angry, in pain, and want retribution but don’t know whom to strike. Democratic government is a mirror of the people, and in Congress we are getting who we are.

Specifics. To call this financial team a beached whale is an insult to whales and beaches. And it’s not their fault -- Geithner has been left out to dry on the sand just as badly as Hapless Hank Paulson. It is the President’s duty to display and to insist on a sense of urgency, and to explain to the people the predicament, and the plans of the administration -- if not formed, when they will be formed. We have none of that.

Showing up, glowing and funny on Jay Leno is appropriate for another time. Same for running Perfesser Bernanke out on 60 Minutes (... A new Depression? “I think we’ve averted that risk.” ...We’re out of the woods? “No.”). Larry Summers’ sudden leap into the public breach in the last week, with nothing to say... shades of Baghdad.

Substance. We still have no urgent effort to regulate credit default swaps, no comprehensive exchange for these super-toxic vectors. Fannie and Freddie are still paralyzed, their unspeakable Bush-crony regulator, James B. Lockhart III, still in place. Examiners have descended on regional and community banks: “Go ahead, make a loan. See what happens. Make my day.”

The people. The national rage at AIG bonuses reflects our dangerous mood, and also says we have no idea what is important. If Congress follows us to wild-swinging punishment, it will freeze efforts at repair. The bonuses are too small to matter, within the range of accounting error, and another 650,000 people lost their jobs last week.

The President should provide a proper target for national anger, and simultaneously identify the greatest failure in our system: boards of directors. These people, hauling down a quarter-million a year and options, had two duties: protect stockholders, and ride herd on CEOs. Mr. Obama, read into a camera the names of AIG’s directors. Denounce them and shun them, forbid them ever again to serve on the board of a public company. Then the names at Citi, Merrill, Bear, Lehman, WaMu, Countrywide....

One benefit beyond public venting: the names reveal the depth of our trouble. AIG’s directors included Martin Feldstein, brilliant economist; William Cohen, Senator (R., Maine) and Secretary of Defense; Richard Holbrooke, top foreign policy advisor in this and prior administrations.... Make boards accountable, or lose the game.
 

Administration’s Waiting Game Wears Thin
Posted March 13, 2009

The Treasury this week effortlessly raked in $64 billion by selling long-term debt, and mortgage markets stayed about the same, just under 5.00%.

The outside world may choke on our paper someday, but not when its economies are failing faster than ours. German orders for manufactured goods in January fell 38% from the prior year, its exports down 21%. China is trying domestic stimulus but lives on exports which are dropping at a 40% annual pace, its trade surplus down 87%.

Here we got a bounce in oversold stocks, and retail sales flattened, but last week another 650,000 people filed for unemployment benefits. In January, bellwether California’s unemployment reached 10.1%.

The absence of signs of bottom is not so troubling -- everyone knows that it will take a while -- it is the absence of evident bottoming mechanism that bugs people.

Under the government blanket a lot of wrestling is going on, but damned if we can tell who is on top, or even who is under there.

Mr. Obama appears completely pre-occupied by his out-year social agenda, sent forth by handlers or his own still-developing instinct to say peculiar things: yesterday persisting that we overreact to daily news: “A little bad, and ooohh we’re down on the dumps... Things are not as bad as we think.” Does he really believe that, or think he can make it so by saying so, or is he playing for time?

David Smick, the well-connected non-ideologue author of “The World Is Curved,” wrote in the Washington Post that Geithner has “a three-pronged approach, delay, delay, and delay in the hope that somebody comes up with a breakthrough.”

The NYTimes’ David Brooks and Tom Friedman, Rightie and Leftie respectively, both wrote this week to remark on the bi-partisan failure to notice an emergency.

Perfesser Bernanke this week spoke of the “worst financial crisis since the 1930s,” and for the third time in two weeks: “Until we stabilize the financial system, a sustainable economic recovery will remain out of reach.” To whom is he speaking? To us? To Congress? To the President? Got us, but evidently the system is not stable.

Larry Summers, the administration’s economic eminence grise, spoke today without any sense of urgency: “...Secretary Geithner will be detailing in the weeks ahead.” Weeks? How many, now? Then with his best, soft, I’m-smarter-than-all-of-you smile suggested this unpleasantness will pass with normal, cyclical return of demand. He expressed faith in assistance by the mortgage GSEs, apparently unaware of their stingy dysfunction. Bright as he is, it is odd not to perceive and touch the anxiety out here.

Some Democrats are already floating Stimulus II, prepared to test the outer limits of American credit. Our representatives this weekend will hector Europeans to borrow and spend along with us; Germany and France are not buying, steadfast that resolution to financial breakdown rests on government and citizens living within their means.

The Fed is active, very much so, and it may be that the Administration has all its chips on developments there. Two fronts: TALF, $1trillion or more as necessary to finance securitization of credit, jump-starting the “shadow banking system;” and PPIF, the Fed-financed public-private auction of toxic assets from banks. Patience is appropriate: it’s not easy to design a new financial system which must reward risk-taking, Congress always at the ready to punish any reward which it deems excessive. TALF has just been postponed again and will begin with undetectable volume; PPIF awaits bank stress-test results and Geithner details “in the weeks ahead.”

Meanwhile, one disgusting bank CEO after another announces that he doesn’t need Federal help and intends to return TARP money he never wanted, thereby to avoid Federal interference and to avoid making loans. BoA’s Lewis and Morgan-Chase’s Dimon could not have made more plain their self-importance over the needs of the society that insures their deposits. The values of the franchises must be preserved, but we still hope that one of Geithner’s details will involve settling the hash of the imperial banker.
 

New Denver Real Estate Website Helps Buyers Find the Perfect Home
Posted March 1, 2009

Searching for Real Estate or Homes in the Denver Colorado area?
I am pleased to announce the release of my new enhanced real estate listing website (compliments of Metro Brokers). It's the Most Advanced Real Estate Website in Colorado! Unlike most other real estate websites, mine does NOT require you to register FIRST in order to view property or listing information.

If you'd like to sign up to receive listing notices via e-mail, you can, but once again it is not a requirement. Search for homes throughout the entire Denver Metropolitan area or even throughout the state of Colorado from the comfort of your home. The website is so powerful that I hope it's not too overwhelming. Please visit the site and give me some feedback.

Using the new & improved Metro Brokers home search website, you can search tens of thousands of Colorado & Denver Metropolitan area MLS/IDX property listings in a list or map view to:

» see complete listing details for all types of properties available through the MLS/IDX
» view high resolution pictures
» view virtual tours & photo galleries
» contact me for more information or schedule a showing
» get directions & create your own personalized house tour
» explore different neighborhoods
» check out school districts, neighborhood schools & get C-SAP scores
» research recent sales & request a FREE market analysis
» locate amenities such as as shopping, dining, places of worship, hospitals & more!
» Contact Metro Brokers REALTOR Anthony Rael regarding any home or property you find online - regardless of which real estate agent or real estate brokerage firm the property is listed by.

Frequently Asked Questions - 2009 Homeowner Affordability & Stability Plan
Posted February 20, 2009
 

Big-Bank Worst-Case “Stress Test” is Underway
Posted February 20, 2009

Treasury Launches Bank Rescue – “Time is not on our side”
Updated February 17, 2009

Anthony Rael's Homebuyer & Homeowner Stimulus Package
Updated February 17, 2009
 

2009 Economic Stimulus Package
Updated February 17, 2009

Real Estate Market Update for January 2009
Updated February 12, 2009

Overall Denver metro area closed residential and condo transactions where down by 17% when comparing Jan '09 to Jan '08.  The average sold price dropped to $230,878 a 17.9% decrease over this time last year.  The good news is that inventory is remaining low compared to last year and number of new listings is down by 22%.  The average days on market was 99, a decrease of 12% and absorption rate in Denver real estate market showed a slight decrease to 7.7 months.
 

Aggregate Demand is not the Problem
Posted February 6, 2009

A big week ahead will bring the best chance to touch mortgage lows just under 5.00%, and also the best chance for chaos during the last 20-months’ falling-apart.

On Monday, Secretary Geithner will tell us what sort of financial system we may look forward to, if any. The details are secret; hence no idea how markets will react. On Tuesday, Perfesser Bernanke will begin two-day testimony to Congress (we don’t know who we would least like to be: the Perfesser, a Senator, or out here watching). On Thursday, the Treasury will complete the three-day sale of $67 billion in new bonds, and spasms like that are often followed by a modest rate decline.

To set the stage: today’s job data were awful, unemployment to 7.6%, but very uneven regionally, the worst in the Bubble Zones (California may have hit 10%). Press reports emphasize the number of jobs lost compared to the worst post-war recessions, but stick with percentages: there are one hundred million more Americans today than in ’74 and ’82, and we’re still a long way from those prior crests at 9.0% and 10.8%.

We’re also a long way from the top of this cycle. The 50% decline in Big-Three car sales guarantees assisted bankruptcies before summer.


Our government is not set up for crisis management -- in fact, it was designed to stop quick reaction to almost anything. Founders fearful of emotional lurching thought checks, balances, and deliberation were worthwhile sacrifices.

So, we have emotional lurching without action. First thing: forget about 4.00%. We’ll be happy to apologize if wrong. This factoid began as a push-rumor at the Realtors’ and builders’ associations (“Maybe if we get this whisper rolling, they’ll have to do it!”). This week, Mitch McConnell, Senate Republican leader, pushed 4.00% in a purely cynical effort to create the appearance that his party has ideas other than “No.”

The near-term impossibility of 4.00% is not a matter of choice or policy, just arithmetic. In the last month, markets confronted with $2-trillion-plus new Treasury borrowing this year have pushed the 10-year T-note yield up almost a percent (2.07% to 2.94%), and the 30-year T-bond to 3.65%.

Meanwhile, there are $10 trillion in US 1st mortgages outstanding. If the Treasury is struggling to sell IOUs, how can anyone honestly propose to refinance five times as much 30-year mortgage paper at about the same rate as 30-year Treasurys?

This collision between borrowing need and market capacity exposes more than just these deceitful four-flushers. The primary unanswerable challenge facing policy-makers on stage next week: having borrowed our way into trouble, how do we borrow our way out? The Keynesian rulebook, and principal could-a-been lesson from the Depression says we must borrow to spend whatever is necessary to support aggregate demand. Probably correct -- despite even Harry Reid (D, NV) stuffing in home-state goodies. Theory says it doesn’t matter how we spend, just spend, even if all we’re doing is throwing pillows into an elevator shaft. No jump-start, just cushion the landing.

We get all of that, but the itchy spot at the nape of my neck says that aggregate demand is not the problem. The problem is an unwind in asset values; overvalued and over-leveraged to be sure, to begin with, but credit withdrawn in such haste, asset-decline and lender-panic in self-reinforcing spiral for two years -- we don’t see aggregate stimulus stopping the spiral. This is not the 1930s; this is different. And, if massive borrowing pushes up interest rates, then the spiral will worsen, or force the Fed to buy the paper (might work, might not; brings its own hazards).

Narrow, pinched, and punishing Liquidationists, Libertarian types, and Mr.-Market fix-its insist that all weak banks be closed, that surviving ones should not be forced to make “bad loans,” and that there isn’t any loan demand from good borrowers, anyway.

They are mistaken. The only way to stop the asset spiral is irrational banking: take the risk of higher defaults by hosing credit into the worst of a recession. If not, the ultimate losses will be vastly larger, maybe unstoppable. Good luck, Mr. Geithner.
 

Long-term Treasury yields blew up this week, along with mortgage rates. In two weeks, the 10-year T-note has jumped from 2.25% to 2.85%, and mortgages from sub-5.00% to 5.50% (even that costs a 1% fee today), shutting down refinances altogether. Not even the all-time lows had created demand for purchase loans.

There are good odds that this move is temporary; even so, why did it happen?

The arithmetic alone is peculiar. The Fed began on January 5th to buy mortgages at a $100-billion-per-month rate. There is not half that much demand for new purchase loans, and refis are net-neutral in system supply and demand. So, somebody is selling existing loans in greater volume than Fed purchases. China and Japan, big holders of Ginnies, liquidating to raise cash for their own stimulus deals? Probably, but this week’s Treasury auctions found strong foreign demand.

The Grim Reaper theory: every nation on earth is trying to sell a mass of government debt to raise cash to save economies, but there isn’t enough money, rates will have to rise, and higher rates will intercept the stimulus intent. Could be, but we doubt it; there’s a lot of money in the world, and private loan demand has collapsed.

Then the inflationists insist it will be back any minute, and investors will only buy at higher rates. We know some of these people. They are impervious to evidence, utterly focused on the last war, certain they will find weapons of mass inflation.

Inflation is impossible without rising aggregate incomes and tight economic capacity, years away, and even then would require sustained Fed mismanagement. The California unemployment rate last month soared .9% to 9.3%. The 4th Quarter GDP decline at 3.8% understated by half the real damage, as inertia in the economy continued to “produce” inventories that piled up on shelves and docks. New orders for durable goods collapsed 2.6% in December alone. Deflation is the multi-year risk.

This Treasury/Market wreck, we think, is traceable to three altogether different perps.

First, the Fed. After its meeting this week it said for the third time in three months that it is considering buying long-term Treasurys to push their yields down. Get on with it, or shut up. While you’re at it, would one of your people please tell examiners of community banks to take off the brass knuckles?

Second, the new administration. We know... Obama has had ten days, Geithner three, but the vacuum in financial-system fix is awful to watch. The election was three months ago; this team obviously does not have internal agreement, nor with Congress. Detailed leaks in the press involve a compromise plan: a bad-bank, but numbers are too big to extract all assets; government will insure over the rest of the questionable assets, the sum growing hourly; keep banks in private hands and pray two-part TARP II makes banks look good enough to re-sell common stock and recapitalize.

We will instantly apologize if this approach works, but ol’ Bill Siedman had it right yesterday: this committee horse looks like a camel. Four or five humps. Bad hair.

Mr. Obama had it right, condemning Wall Street: “Shameful.. Show some restraint, discipline... responsibility.” However, he must make the leap that the senior officers in the financial system -- the individual human beings -- are for the most part beyond reform. They have thought their top priority was personal success, and still do.

BofA’s Lewis has destroyed 95% of stockholder value, and his crony board is still behind him. Treasurys and mortgages began to fall apart the day that Citi began to disassemble itself; BofA, Chase, and Wells are all still in pursuit of that failed model. Big bankers everywhere crouch in their bunkers, hoping each morning to find a newly deceased competitor, no strategy but defense. Buy mortgages? Don’t be silly.

The road to reformation of the system begins with one overriding principle: Mr. Banker, your top priority is the good of the society. If you’re not willing to take that oath in an emergency like this, we’ll find someone who will. Today. If that means temporary “nationalization,” get on with it.
 

Time to go Nuclear
Posted January 26, 2009

Long term rates rose this week, mortgages up to 5.25% even with a 1% origination fee. Refinance demand, fear of massive sales of Treasury bonds ahead, and a new banking freeze combined to do the damage.

Refinance demand is big, but not comparable to 2003. Yes, the industry is 75% smaller, but this time only the very best applicants have access to good rates. Treasury cash-raising may be a problem, but spreads to mortgages are still very wide, near the 2008 record 3.00%, and the Fed will begin to buy Treasurys shortly.

We think the central cause of the mortgage rate rise is the new deterioration among banks. Rates rose simultaneous with news late last week that Citi and BofA are toast. By late fall, banks looked as frozen as frozen can be, but never underestimate the ability of frightened bankers to find new ways not to lend money.

Sometime between now and Valentine’s Day, in a Treasury conference room Tim Geithner, Larry Summers, Sheila Bair (FDIC), Christina Romer (Council of Economic Advisors), Peter Orslag (OMB), Perfesser Bernanke, and Paul Volcker will decide how -- not if -- to “go nuclear.”

For the youth set, in the Cold War going nuclear was your last resort if you lost the conventional-weapon preliminaries. We had lost the conventional part of this financial combat even before Lehman’s collapse in September.

Tim Geithner to Congress this week: “In a crisis of this magnitude, the most prudent course is the most forceful course.” He made clear his frustration with the incremental and ad hoc measures taken last year. The need for magnitude is a given, but this group will be most uncomfortable with the choice of means.

Nothing like this crisis has happened before. Japan’s economy is otherworldly, and Scandinavian mini-economy banking rescues are doll-house models. The Great Depression was pre-electron. The go-nuclear choice of weapons will have only academic and theoretical basis. Nearly everyone in the group will have a different preference, yet all will have to agree, then take the deal to Mr. Obama who will probe and test the preparation, and then take the deal to a TARP-burned Congress.

No one will ever know if it was the best or even right choice -- nothing will matter except that it works.

The economy is in free-fall, headed for one-million-per-week layoffs. Bank stocks have lost half their remaining value since January 2. Real estate has entered a new level of weakness, commercial and residential: home construction is on the lowest track ever measured; two months of 5.00% mortgages failed to increase purchase demand; and even non-hysterical measures of home prices show steepening decline (OFHEO, down 1.8% in November).

Events have overtaken the time for extraction of bad assets. Old bad ones? The ones we just found? Assets okay now but certain to go bad by the 4th of July? Or by Christmas? We think we’re going to nationalize (might not use the word) some to several banks, and the test of nuclear success will be to get credit flowing immediately.


Several years ago, a lion of Virginia banking retired. At the convocation of bankers to honor him, pocket watch and all, he was asked what he thought was the greatest innovation in banking in his 50 years. Long pause. Furrowed brow. Then it came to him: he said, “Air conditioning.”

Here’s a better one. FHFA this week announced that by the end of this year, every home loan will be permanently tagged with the identity of the individual originating banker and employing company, and the name of the field and supervisory appraisers, together with the licensing status of all players. Individual histories will be tracked.

Fantastic! Borrowers and investors can look forward to vastly better performance. Nothing like sunshine to drive out the bad guys, and sharpen even the best.
 

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Mortgage rates popped up today, but not far. The rise came partly in normal protective selling in advance of a four-day weekend, including MLK and inauguration.

However, other upward pressures may be more durable. Refinance demand is overwhelming. Also, flight-to-quality buying of bonds abated when the stock market reinforced its November low, and upon signs of effective banking-system rescue by the Obamanauts. US rates are down here at two-and-a-quarter-century lows because we’re in trouble; when trouble recedes, rates will rise.


The handoff of executive authority from Bush to Obama began in disorderly fashion weeks ago, as the exhausted administration ceased to function. The dead end came last night, as the President expressed pride in “making the tough decisions.”

You can train a pigeon to make decisions. “Deciding” has no content; only quality counts. A few holdovers and unconfirmed appointees have begun the first competent action in a long time: the second round of TARP has been released at the urging and detailed assurances of Larry Summers, still on Harvard’s payroll.

Sheila Bair, who will continue at the FDIC, told CNBC this morning that work is underway to deal with troubled assets in the banking system. A questioner snapped, Don’t we already have that? “No.” She then described several crisis-containment measures that should have started 18 months ago. She did not state what will soon be clear: the $700 billion TARP is at least a trillion short. Maybe two.

Tim Geithner’s nomination to Treasury might have been torpedoed by two minor tax-filing errors. However, even Congress knows we’re in so much trouble that trivial entertainment no longer deserves a priority. We need this man.

Perfesser Bernanke on Tuesday laid out toxic-asset policy on the same line as Bair: good-bank bad-bank, asset guarantees, or other extraction. Most important: “In the future, financial firms of any type whose failure would pose a systemic risk must accept especially close regulatory scrutiny of their risk-taking.” Very, very well done. A global, electronic, 24/7, acutely inter-dependent financial system cannot rest on market-discipline dominoes. We are stuck with too-big-to-fail, and must adapt to that reality.

For all our faith in Obama’s pragmatic whizz-bangs, we have no idea how long it will take to reform the financial system. The depth of decadence revealed this week at Citi, Bank of America, and Merrill is beyond imagination.

Robert Rubin, previously second-only-to-Hamilton Treasury Secretary, slithered quietly away from the wreckage of Citi; his $17-million-per-year winnings intact, no accountability whatever for encouraging Citi to increase its risk-taking to ruin. After three rounds of bailout and guarantee, Citi is a $2.2 trillion basket case, a ward of the state, the great financial supermarket to be dismembered.

BofA’s CEO, Ken Lewis, has for years worked to turn it into a Citi, most recently via the dubious acquisition of disgraced Countrywide, and last in his scramble to buy long-coveted Merrill in September -- $44 billion for a firm minutes from following Lehman to the guillotine. Merrill’s John Thain, presumed straight arrow, has since expected his many-million bonus, in largest part for finding an idiot to buy the firm.

The world learned yesterday that Lewis had no idea that Merrill’s loss was too deep to absorb (despite two years of attempted acquisition), and that Thain either did not know or did not tell. Hence Paulson’s last act, gratia Dei: $110 billion to BofA to make sure that Merrill stays acquired and BofA survives. Now we own two supermarkets.

No matter how able the Obamanauts, we’re not going to get anywhere until these imperial CEOs, their co-conspirators, and especially their boards of directors face public disgrace. There will be no end to decadence until there is a personal price for undermining our society for the sake of ego, transcending mere greed. Remove these people, and forbid them ever again to lead or sit on the board of a public institution.
 

Can the New Obama Team Jump Start Lending?
January 12th, 2009

The Fed’s purchases of Agency MBS have succeeded in capping mortgage rates near 5.00% with the lowest fees. Those terms are limited to the best credits (80% or less, 740 FICO or better), which is why the Fed’s program is working. Of the nation’s $10 trillion in first mortgages, not more than one-third qualify, and more than half of those borrowers already have rates too close to 5.00% to consider refinancing. The remaining fraction “in the money” now, at least a trillion-worth, without the Fed’s intervention would have choked what’s left of the mortgage and credit markets, rates then rising to shut off demand.

The Fed may be able to buy rates down to the 4.50% promised land by spring or summer, but even at its $25-billion-per-week purchase rate the best short-term hope is for this lid to hold while we work off demand.

Not helping: obvious profiteering among the few remaining large mortgage wholesalers, expanding margins instead of reducing rates. With Fannie and Freddie out of the game, there is no cop to underbid the sharks.


Incoming economic data are lousy, which everyone knows. Instead of reciting the list, describe a pattern: the break in the global economy dates only to September, just four months ago. Yes, the official recession began a year ago, and the housing recession almost three years ago. However, this queasy off-the-table sensation, this shutdown in optional activity by consumers and businesses alike, and the credit-market snap from troubled to closed -- all just four months old.

The most pervasive sense throughout the economy, government, and academia: nobody has a good model for what happens next. The best-available outlook sits at www.federalreserve.gov, the minutes of the Fed’s mid-December meeting. It is an unhappy document, forecasting substantial GDP decline in the first half of 2009, very modest growth in the second half, net-negative for the year, risks to the downside.

So, what to watch for clues?

Mr. Obama has stuck to one-President-at-a-time in foreign policy, but this economic predicament and the Bush-Paulson vacuum forced him to an awkward policy speech yesterday. It should have been prime-time, with all the rhetorical thunder he can bring, to reassure the nation that for the first time in a dozen years the nation will be in capable and energetic hands. That’s still coming, and it will help us all.

We will begin to learn in two weeks what measures the Fed and Mr. Geithner wished to adopt but were roadblocked by Mr. Paulson and the White House. Geithner’s confirmation hearing will be painful theater, as yapping Congressional cretins blame him for things he tried to fix (Bear, Lehman) but was not allowed to, and blame him for things he did save (AIG). Geithner is disciplined and tough, will take the punishment, and will not lay blame where it belongs. However, we will learn quickly what might have been done as this new team swings into action.

The Fed has begun emergency action with MBS, and the next will be to buy Treasurys to keep their rates from rising on a flood of new borrowing.

Watch closely how the new team treats big-bank leadership. Since the first day of deposit insurance, commercial banks have been public utilities, like sewer plants. Time to assert control, for the benefit of the society. Look for an effort to identify and segregate toxic assets still in the banking system.

The most difficult and essential task: to intercept the credit-default spiral. For bankers, and mothballed Fannie and Freddie, it is perfectly rational to refuse to make loans until they have reliable models for collateral value and income to support debt service. However, if they refuse, they know their losses will be ever-worse. The unanimous industry answer to that conundrum has been to freeze.

Look for the Obamanauts to give permission, encouragement, and instruction to the credit world: err on the side of making loans. Now.
 

The Fed’s cut to “zero to 0.25%” cost of money and non-response in the mortgage markets combined to produce consternation among a refinance-hungry public.

Excepting a frantic hour at no-fee 4.75% on Wednesday morning, mortgage rates remain as they have been for ten days, roughly 5.00% with an inescapable origination fee. And that deal is available only for the best FICOs and loan-to-values.

These rates are not going lower any time soon, not on a sustained basis, not without extraordinary intervention by the Obamanauts. Miracles are rare.

The average client simply does not believe the paragraphs above. If we were not lifers in the mortgage trade, we wouldn’t believe them, either.

In the last month, irresponsible media reports, wishful expectation by housing industry survivors, and trial balloons by non-market theorists have made FOUR-AND-A-HALF a national imaginary fact.

Why are rates stuck? The main roadblock is the $10 trillion in outstanding first mortgages, rates scattered from mid-sixes to 5.25%. Toss out the ones that can’t refi (Jumbos, underwater vs. appraisal, clogged by piggy-back 2nd, stated-income or no-doc underwriting...), and the ARMs that no longer need to hurry -- $6 trillion, anyway. The first trillion, above 6.00%, everybody who bought from ’04 to ’08, is in the money right now, eligible to refi with quick recapture of costs. That volume is equivalent to the total production capacity of the mortgage industry in 2008, severely diminished since the September financial cardiac arrest.

But, refis are just rollovers, not new money...? The current owner of a 6.00% mortgage-backed security may have little interest in 5.00% or 4.50%. The last people who bought those, in ’03, lost money every day since. Worse, the financial system is still “deleveraging”, trying to sell IOUs, not buy.

But, if money doesn’t cost anything...? The Fed is acting in an emergency. It will not last forever. When it ends, rates will rise, explosively from time to time. The zero-cost money is overnight money, and it’s a bad idea to finance a 30-year loan with overnight money. Long-term Treasury rates are also approaching zero, the spread versus mortgages unbelievable. The Treasury market is the most liquid in the world; when the economy bottoms, today’s Treasury investors-for-safety will be able to dump at little loss. Even top-quality MBS are not very liquid... buyers at this level and below will get killed in the turn, and cannot hedge that risk in a Treasury market priced for GDII.

Why is “Four’ so hard? The one and only time that US mortgages reached 4.00%: at the GI-Bill rollout of VA loans on July 25, 1944. Went to 4.50% on May 5, 1953, and 4.75% on April 4, 1958, to 5.25% fifteen months later. That’s it, the cumulative history of four-something, all in a very different world. Also, those rates were set so low that the seller to a veteran had to pay two to four points for the veteran’s loan.

Why doesn’t the government buy, or just make 4% loans? See $10 trillion, above. The total US national debt traded on markets is only $6.5 trillion. One of the awful aspects of our predicament: having borrowed our way into trouble, there are limits to borrowing our way out.

But my brother-in-law said he got...!!!! Bernie Madoff’s clients got into trouble believing one-upmanship fables told by their neighbors. The fibs told in a locker room full of teenage boys about their sex escapades don’t hold a candle to your friends’ tales of their mortgage conquests.

Call me when we hit bottom, will you? Or at 4.00%, whichever. The law of refis: do any deal that works, recapturing costs in a year or so. Can’t know the future. Lock your rate, then don’t watch TV for three weeks. Or talk with your brother-in-law.

But you said rates could crawl lower... Yup. It took a year for rates to move from 6.25% to the 45-year low 5.25% in June 2003, working off masses of refis at each intermediate stage.

Lasted one month.
 

Visions of Sugar Plums…
December 14th, 2008

On Wednesday morning, mortgages rates collapsed close to 5.00% -- just under for fee-heavy deals, just above for fee-light, all a tad higher today.

Four notes on mortgage pricing. These super-low rates are limited to 740+ FICOs and 80% or less loan-to-value. Fannie and Freddie, despite 90 days in Federal hands, still maintain punitive FICO pricing. 695 FICOs have to pay a fee just to get 5.50%.

Second, the normal fee-versus-rate progression has been distorted for two weeks. Usually it’s a bad idea to pay fees to get a lower rate (payback out at six years); however, a confused and fearful investment world, far removed from retailers’ pricing interests and the “secondary market,” wants to buy loans only at a discount. The result from time to time favors paying a fee even to refi.

Third: prior large-scale rate drops have quickly reversed under pressure from waves of refi rate locks. This time that wave is a ripple. Demand is huge -- desperate -- but availability has been crushed by fallen values, the total absence of “stated” and “no-doc” underwriting, piggyback-2nd lenders who will not subordinate to 1st-mortgage refis, too-tough pricing for investors, no market for fixed Jumbos, and the FICO hits above.

Fourth: despite diminished volume, it is enough to prevent another rapid rate drop.

Global financial markets have paused today to attend a public policy ballet performed by The Sugar Plum Idiots.

Chrysler and GM have no plan for reinvention, and a bankruptcy-equivalent event is inevitable. The UAW’s three-decade hostage racket has concluded upon the demise of the hostages. The Democrats, desperate to save jobs that cannot be saved, want to punt themselves into their own Coffin Corner of procrastination and subsequent blame. Senate Republicans with filibuster power for another 40 days, 20 days longer than GM’s cash, have intercepted the Democrats’ punt. These Senators are certain that taking credit for cratering Detroit will be a great start on a reconstituted party, offering supply-side blindfolds and cigarettes to the nation.

Even better, while these Senators pose, they know the White House will not allow an uncontrolled bankruptcy in a free-fall economy. So, the same Dubya who would not allow TARP money to be used as a bridge for Detroit has now been forced to do so by his own party, rescuing Democrats.

Just when the descendants of Herbert Hoover could hope that his infamy would be replaced by the malpractice of another President... damn.

Briefly, a little TARP clarification, and a kind word for bankers. (Honest.)

Partly pandering, the rest in ignorance, half of that willful, Congress is angry about TARP. We were misled, we didn’t want to do it, we don’t know where the money went, it didn’t work, and we would rather have wasted the money ourselves.

This snit is remarkable deceit even for Congress. The Western banking system was broke, capital exhausted, eighteen months ago. By last July, markets closed to new capital-raising, toxic losses not recognized but in plain sight, the capital shortage was near $1trillion. After September’s seizure, Henry Paulson and Dubya, late, in free-market mental shackles, fumbling for a moment with toxic extraction, unaccountably came to the correct solution: provide capital! (As the Europeans already had.)

Of $350 billion TARP released so far, only $250 billion has been used as capital, and we know exactly where it is. The only error: it was only one-quarter the need last July. Tardiness and inadequacy have led to deep recession and more losses ahead -- cyclical, as opposed to prior “structural” toxics -- we’re going to need twice as much capital as we did in July. There are many ways to do the job, even without borrowing; Norway figured out how to recapitalize with non-tradable securities. Just paper the hole.

Banks cannot lend without capital. Today bankers are staring into a bottomless hole of future losses, most aware that their credit clamp will cause more losses. Perhaps the Norwegian ambassador is available. Beats watching the Sugar Plums.
 

In one of the few benefits of increasing age, the older you get, the more times you’ve blown off your eyebrows in the lab, and the less shocked you are when things that “can’t happen”... happen.

The markets today, a bunch of kids under 50, are jaw-dropped. So whacked up-side the head they can’t even find the big river in Egypt. They’ve spent their whole working lives back-testing risk models, back to the Civil War (between Athens and Sparta), absolutely certain of what can and cannot happen, leveraged to the eyeballs based on those boundaries. Addled, life-long conceptual frameworks shattered, these kids are frozen, and with them the supply of credit of all kinds. Right beside are commentators, academics, and policy makers clutching familiar pillows, eyes squeezed shut.

Harvard’s miracle investment returns on its endowment... they’ve lost 22% in 90 days, much of what’s left too illiquid to sell. Couldn’t happen -- not to smart guys. The rest of us... Lose 10% on a portfolio of AAA corporate bonds and munis? With no defaults, just market panic? Impossible. Roll over junk bond debt at 20%? Never happen. Fed goes to 1%, T-bills to 0.01%, and all other rates rise?. No way.

You want me to trade, buy, lever, borrow, lend... in THIS?

Please pause to take heart: there are many policy solutions available. It’s not clear which ones or combinations are best, but they will be found. We have only two temporary problems: the last 46 days of this inept administration; and without leadership, a fragmented and equally inept Congress. The economic news this week was so bad that we may get some action shortly on both fronts.

Herewith the list of things that will not work.

1. The 4.50% Mortgage Fairy. Hopeful clients understood quickly that they had been fooled, either by the housing industry trying pressure-by-leak, or by yet another Treasury pratfall. We may get to 4.50% sometime next year, but several trillion dollars worth of refinances lie between then and now. Progressive decline, as ’01-’03, is most probable, even with the Fed buying. Could the Treasury “buy down” rates for buyers? Sure: in today’s market, four points, $40 billion per $1 trillion in loans, but six years to get the full benefit of cash cost versus payment reduction. Silly -- and the reason most people don’t pay points to get a lower rate. Neither should the Treasury.

2. The Foreclosure Fairy. The blown housing bubble was central to economic decline last year and the first half of this. However, as home prices slip in non-bubble zones, and prime mortgages go into default, it is painfully clear that housing trouble is now effect, not cause. Every sensible foreclosure mitigation effort should be pursued, but will have little effect on an economy losing a half-million jobs in a month.

3. Unspeakable Boobs. The no-bailout crowd, joined by Eek!-Inflation! wrong-siders. Senator Richard Selby, (R.AL), puzzled but firm 1930’s re-enactor. CNBC’s Rick Santelli and Larry Kudlow, the last ride of the Mister-Marketeers. Then, Frankn’Doddstein.

4. Additional routine efforts by central banks, cutting rates and hosing cash. Global CB cuts are approaching zero percent, but are neither reducing the cost of credit nor increasing availability. This situation, full-on since September, is called a “liquidity trap,” in which cash floods into the banking system but nothing comes out.

5. “Stimulus” by Federal spending tends to be too late, and tends to fail for two other reasons. Until consumers gain some faith in the future, they will save the windfall, as they did rebate checks. Second, without credit to sustain commerce and jobs Federal stimulus is like transfusing a patient with an open artery.

6. The “quantitative easing” by the Fed that began last week -- outright purchase of debt securities with invented money -- will help to drive down rates, and fund the economy to some degree, but it is no substitute for a functioning banking system.

Therefore, (how hard is this?), get the infernal banking system going again. Every other nation on earth is doing so, and we’ll get to it... maybe inside 46 days.
 

Yesterday the Fed announced that it would begin to buy mortgage and other private debt securities -- easily the most dramatic and unprecedented action in the Fed’s 95-year history.

Mortgages immediately fell a half-percent to 5.50%. An immense volume of loan-rate locks has pushed rates back up a bit today, but the decline is highly likely to resume. For the first time in the last 18-months’ credit-market nightmare the authorities have moved in front of the crisis, jumping past broken banks to fund the nation.

The Fed buys and sells short-term T-bills every day, managing monetary policy and short-term rates. However, the only prior Fed direct purchase intervention to push down long-term rates was during and shortly after WWII, and that operation was limited strictly to Treasurys. This time the Fed will buy a wide spectrum of consumer credit, driving down rates, and will eventually re-open private markets in volume.

The Fed’s actual purchases will not begin until next week, but it said it would continue to buy “over several quarters.” The Fed did not indicate any target for how far it intends to push down mortgage rates.

Why now? Two things. Last week marked the ultimate fracture in the credit markets: Treasury yields to the floor, rates for all other IOUs to the sky. No credit, no bottom for the economy. Previous efforts to cut the cost of credit (loaning cash to banks, TARP injection of capital) had not yet worked, and could not be expected to work in time. Second: the next ten days will bring awful news of economic decline in November, and the first washout of Thanksgiving shopping in modern times.

Will it work? Oh, my, yes. In 1983, the Fed entered the market in a surprise purchase of T-bills. An itty-bitty thing. A roomful of calm-to-bored pros leaped in the air, screeching, “The Fed is IN!!!” And so that roar went up yesterday. All-powerful. The Fed hasn’t spent a dime, but is already swinging a psychological hammer. The markets had priced for Great Depression II. “If the Fed is in, then we aren’t going to have GDII... If the Fed is in, what am I doing out?”

When will it work on the economy? When it does. Recessions cannot bottom without plentiful and cheap credit. Credit-sensitive industries lead the way, houses and autos; both will take a while even with credit restored. Unemployment will not crest until the recession is over. Hence, the Fed will be in for “several quarters.”

Where will the Fed get the money? If you or we print money, we go to jail. When staring at a Depression, the Fed is supposed to print money. It has infinite capacity to do so, and in this case is buying very high quality IOUs that will rise in quality as the economy heals, can be sold then, or held to maturity. The main risk is off in the future: next time we’re in a little trouble, the troubled will ask the Fed to buy again. Answer: only once every 95 years.

At your dinner table tomorrow someone will say: Hang the Fed for this! Let the market work! Inflation is certain to follow! The dollar will crash! The Fed is a giant conspiracy! Gold gold gold! Hand this individual a turkey bone and hope he chokes. No Heimlich until he admits the Depression was not cool.

How to play refinancing? Any deal that recaptures closing costs in a year or so after tax effects, do it! As always... closing costs are not deductible, interest saved is; hence savings are overstated. Calculate interest savings, not changes in payment distorted by amortization. Avoid points and origination (deductible only over the whole life of the loan!). If you have an ARM... move now.

Whose idea was this? Many of us thought it was inevitable a year ago. The idea is in Perfesser Bernanke’s book. We’re a zero on a scale of conspiracy theorists, but we have to believe that when Obama’s new team reviewed options with the exhausted group still in charge, somebody said, “What in hell are you waiting for?” If it was Hapless Hank Paulson’s work by himself... or not... hand that man some pie. It is Thanksgiving.
 

One week ago today, Henry Pauslon announced that Federal efforts had “stabilized the banking system.” On Wednesday a new panic rolled through markets, running to Treasurys. T-bills 90 days and shorter fell to 0.01%, and the 10-year T-note from 3.61% to 3.01%. Few ran to mortgages: rates fell briefly below 6.00%, and are back there today. All ran from non-Federal credits, dumping munis and corporates.

In prior recessions, the fearful dumped stocks but bought IOUs of most kinds; the resulting cut in the cost of credit helped the economy to bottom. This Treasury separation from all other IOUs began in September, had not been seen since 1930, and marks terminal shortage of credit to the private sector.

The S&P500 closed yesterday at 748; on December 5, 1996, the day Alan Greenspan delivered his “irrational exuberance” speech, the close was 745. The old SOB knew what he was talking about after all. Too bad he forgot later on.

Why this new panic? Pending bankruptcies of GM and Chrysler. Understanding that Citibank will not survive as-is. The Fed forecast for GDP decline into mid-2009. New unemployment clams to 542,000 last week (the record was 700,000 at the tag end of the ‘79-’82 post-war worst, and we’ll beat that in some miserable week next year).

All bad, but no surprise. This new panic, putting us right back where we were in the September shutdown, was the direct result of the Paulson/Dubya decision last week to mothball Administration rescue efforts. The announcement refused a new battle with Congress for access to the second half of the $700 billion TARP funding, and all in the markets knew they were back on their own.

Our economy -- really the global economy, now -- has been “in the grip of an adverse feedback loop” (Janet Yellen, fine Prez of SF Fed). Credit defaults have cut credit availability, which has cut GDP, which has caused more credit defaults, which have cut credit, which will cut GDP.... The Treasury market separation described above is the signal that the spiral cannot stop by itself.

Only government can get in front of it and stop it. The application of infinite government resources must convince all economic players that their panic is self-defeating. Then it will stop, and risk-taking will resume. Just 30 days’ TARP effort had big effect, and then Paulson and Dubya shoved all downhill again.

The resources of government are still available. We promise that the Fed was not a party to the Paulson/Dubya decision, and will not take a day or an hour off between now and inauguration. There will be a big fight between the money hosers (aggregate stimulus, checks in the mail, infrastructure spending, foreclosures...), Democrats controllable only by a new President; and the capital-injectors, who know that the only spiral-stopper is adequate credit -- and who will prevail.


In soft times, both leadership and the led give priority to the trivial, ignore the substantial, and defer the critical. When times have been too easy for too long, a terrible word comes into play: decadence. When times turn tough, that internal rot for a time prevents self-salvation. Only for a time.

Then the spectacle of decadence and the anger it brings to us, and at our own participation -- that starts the turn. The three auto CEOs, private jets but no plans; Paulson and Bush; bankers taking public capital but making no loans and canceling old ones, credit cards, lines of credit, car loans, student loans... decadence personified.

Today on NPR Chris Dodd (D.,CT), Senate Banking Chair and in ordinary times ego-bloated and obnoxious, revealed good judgment, serious intent, and merciless fury. If we were a bank CEO or board member, we would today take off our toga, put down our grapes and goblet, and scramble on chubby legs to make loans.

As is said of another high authority, the wheels of Congress grind slow, but they grind exceeding fine.

The credit market thaw paused this week: Libor fell just a little, mortgages touched 6.00% and rebounded, short-term Treasury rates are still near zero, and corporate and consumer credit is as scarce and expensive as ever.

Massive, global intervention by central banks and national treasuries has been underway for only a month. Just seems longer when you’re having fun. Economic activity is slowing faster than businesses can make down-sizing decisions: only in the last week have unemployment claims risen above the 90-day average (by 25,000 to 516,000). October retail sales dropped 2.8%, the largest decline since the series began in 1992, and the NFIB said small-business sales conditions were the worst since 1980.

In 1933, just after his inauguration, Franklin Roosevelt delivered his first “fireside chat” on the radio. He began, “Tonight I would like to speak to you in simple terms about banking....” Afterwards, Will Rogers said that the terms were so simple that even bankers could understand.

Henry Paulson’s chats are televised. He looks like a man who has just stumbled in and out of a fireplace, puzzled but energetically slapping at embers, and in bold voice and many words trying to convince his audience that he is in charge and all is well.

He is doing a better job than it seems, and it is not his fault that this administration has no voice of leadership. His Wednesday speech abandoning TARP’s extraction of troubled assets shocked many people, but should not have: We are reassured by the WSJ report today that Paulson shifted to capital injection planning before final Congressional passage on October 3. The extraction idea might have worked 15 months ago, but is too late now. More good news: Treasury/Fed teams are working to reopen the non-bank “structured securities” market, essential to modern credit-creation. Yes, those markets ran wild and got us into this mess, but we cannot recover until they re-open.

The disturbing elements in the speech: asked when the Treasury would request from Congress the next $350 billion of TARP (all but $60 billion of the first half is now deployed), Mr. Paulson said, “We have no timeline on that.” Second, he flatly refused to instruct banks to make loans. Paulson did not address the bad news from Fannie and Freddie: in the two months since takeover, their borrowing costs have risen, and they have failed to increase mortgage purchases -- net, zero -- or to relax fees and terms.

We are caught in a transfer-of-power moment worthy of Tom Clancy, and uncertain policy and action are the result. In wartime Congress defers to the Executive Branch; but during a speed-of-light economic emergency, who is in charge? A request now for the rest of the TARP money would instantly ignite a frustrated and fantasizing Congress. The financial authorities are fighting a daily shape-shifting emergency requiring ad hoc responses. Congress naturally slows any policy or action, demands control, and fights internally for power. Only a strong President can bring order.

Congress and way too many other people think that housing markets are key to economic bottom and recovery. That was partly true until September, now completely backwards: the only way to stop prices from falling and to abate foreclosures is to get the economy going, and quickly. All current proposals to mitigate foreclosures will fail; and far worse, the time spent haggling over DOA proposals will starve effective economic action. Same goes, unfortunately, for the auto makers: bankruptcy and downsizing (not closure) are the inevitable result of 30 years’ mismanagement. After that, Federal assistance would be appropriate and useful.

There is only one way out of this or any other recession: restore CREDIT. All modern recessions resulted from the tight credit imposed by an inflation-fighting Fed, and recovery followed release of grip by the Fed. This time the financial system itself has failed, thus far defying the most dramatic monetary ease in the 95-year history of the Fed; we need the rest of the TARP money and a lot more from Congress. Now.

We don’t know how we’ll make it to Inauguration Day, and fear that we’ll have to.

The credit markets this week continued to thaw. All-important Libor fell another percent to 2.38% for 90-day money; and one-year is down to 2.84% -- ARMs resetting next month will settle just a hair above 5.00%. 30-year mortgage rates with no fees made it to 6.00%, but for the umpteenth time this year stopped at that barrier.

Central banks and treasuries around the world this week increased already-massive intervention: the Bank of England cut 1.5% in one whack yesterday, joined by the ECB’s .5% cut in the Eurozone. The Fed’s overnight rate is 1.00%, but actual domestic interbank trading has been 0.23%. They will succeed in stabilizing the patient.

The economic data are awful. You knew that -- no point in reciting. However, the pattern unfolding is important.

The last two recessions, ’01-’02 and ’91-’92, were miniature affairs discovered after conclusion, typical of all post-WWII recessions except the two big ones, ’73-‘74 and ’79-’82. Those were the first central bank fights against oil-spiked inflation; this fight began in 2006, and by summer caused a general economic slowdown. However, the breakdown in September was caused by a credit panic, not the Fed.

We have been here before. Not in 1930, and not in Japan, but in the spring of 1980. In October of 1979, inflation over 12%, Paul Volcker stood on the brakes and the economy quickly slowed. In late winter, benighted Jimmy Carter wanted to help with the inflation battle and decided that “credit controls” were just the thing: get Americans to stop borrowing, and inflation would die.

Even brutal Volcker took a dim view. The Fed had already jacked its rate to 17%, so it watered the controls to insignificance. However, following the President’s March 15 patriotic appeal to the nation to stop borrowing, that’s what we did. Credit panic.

The economy collapsed. GNP growth free-fell 9.9% (annualized) in the 2nd quarter of 1980, the deepest single-quarter decline in modern times. Then, chaos: the Fed had to ease in a still-inflationary economy, wasting the first year of the inflation fight, and then in September re-tightened, causing four more negative quarters scattered through ’81 and ’82, and unemployment crested at the very end, 10.8%.

Lessons. This is not a “still-inflationary” economy, and there will be no “re-tightening” -- not until the economy is in recovery. The credit panic underway will make this 4th quarter the worst negative since ’79-‘82, but concerted central-bank action is as likely to pull us out now as then. Slow in 2009, but not into the pit.

The central banks and treasuries are going to need some help. From the banks: loans! France this week threatened to fire senior managers unless they began to lend and at rates reflecting lower cost of money. The UK is hard at the same thing, banks to make loans an explicit quid pro quo of government capital injection. Bankers here better get with it, or Mr. Obama will turn loose Barney Frank. A fate worse than firing.

More help. Investors must resume risk-taking; and there’s nothing for that like the liquid courage of near-zero cost-of-cash.

And help from you. Do not accept passively the cancellation of a line of credit or a cap on a credit card. Inform someone senior in the miscreant bank that their contemptible and unpatriotic behavior will cost them reputation. Then march straight to a nearby small bank or credit union that will be delighted to hear from you.

Then educate yourself. Every financial crackpot in the nation is loose, scaring and confusing everybody from your neighbors to policy makers. Secrets of the Temple is a superb, readable history of the Volcker era, and of the Fed itself. The first half of imposing but enthralling Freedom From Fear is the best current account of the onset of the Depression, and the desperate and futile effort to find the fixes that are understood and available today. For the technically adept, nothing beats Bernanke’s own essays in The Great Depression. All in paperback -- and to see the breadth of opinion among escapees from the economic funny farm, scan the reviews of these books at Amazon.

Mortgage rates bottomed at 6.00% early in the week, down .75% in four days, and are back to 6.25% now (lowest fees). Five-something loans will have to wait for stabilization in global credit, or effective Federal intervention.

The depth of the recession ahead will depend on the job market, and the newest data shows surprising resilience: new claims for unemployment insurance are still inside the 60-day range, just under a half-million weekly. Since the onset of credit collapse on September 15, the real economy has resembled the adversary of the great swordsman, his blade so sharp that his opponent, neck cut through, did not realize the damage until he bent over. Comrades, until the authorities resolve this panic, stand straight.

There is a chance, and a good one despite layoffs and bankruptcies ahead, that the worst of the economic damage will be confined to our wealth, not the engines of production as in the ‘30s. Wealth we can rebuild; whole economies are harder. The “wealth effect” will run in reverse, diminishing consumption and investment in expansion. However, correctives abound: topping the list, it will be a pleasure to have so many Baby Boomers deferring retirement, working beside me into our 70s.

Another corrective: as asset prices fall, they find buyers. We’re amazed at the 5.5% increase in sales of existing homes in September. These were contracts written in August, and the market shocks since will hurt the months ahead, but the absorption of foreclosures is extraordinary. All markets describe multiple offers at entry-level prices.

If you’re caught in a once-in-a-century event..., might as well enjoy the details.

In the two weeks since the UK’s Gordon Brown led the way to bank recapitalization, the world-total has grown to about $2 trillion. $70byn UK, $55byn Norway, $700byn here, $70byn Switzerland... China, Russia, Malaysia, Singapore, Middle East.... More coming as necessary. We did some more of our own today to take heat off the FDIC fund, PNC acquiring the wreck of National City with $7byn in TARP money.

All-important inter-bank Libor has fallen from near 5% (versus Fed cost-of-money at 1.5%!) to 3.25%, but stopped there. The panicked run to short Treasurys abated, one-month yield rising from .05% last week to .37%, but today back to .22%; 30-year bonds today briefly fell below 4.00%, the lowest since first sold in 1977. One part of the Fed-Treasury effort to bust up panic: if the herd wants Treasurys, drown it in paper; by the end of next week the Treasury will have raised an incredible $600 billion in 20 days.

Speaking of cash... way back there in August, the world‘s great problem was inflation, which the Fed had been fighting with very tight monetary policy, money growth near zero since oil prices exploded in 2007. Since mid-September, the monetary base (St. Louis Fed) has increased by 50%, and the Fed will hose out as much money as long as necessary. If confronted by an “Ah-HAH! INFLATION!!!” fruitcake, and feel brave, say back: “We’re fighting deflation. You might pray that reflation works.” Those who ridiculed the deflation-antidote theories of “Helicopter Ben” Bernanke should take a moment to give thanks that he’s in the chair.

Financial markets are resisting treatment, even recapitalization, because the Great Run of ’08 has morphed into the Mother of All Margin Calls, and forced selling of everything. Oil diving from $150 to $80 was good consumer news, but $65 and falling is a catastrophe for producing economies and their leveraged investors. Lest you take pleasure in their pain, they used to have a lot of money to invest in American mortgages and stocks. The same applies to the euro, from $1.60 in freefall now passing $1.26, UK sterling from $2.00 going by $1.58, and commodities broadly down by half.

To visualize this margin-call cascade, think of a game of standing dominoes in a big room, exact borders vague. The dominoes are invisible, the length of lines and points of cross-connection unknown, dominoes coming into view only as they fall. The invisible game must play itself out. However, the authorities are already standing up the fallen and will inevitably win in the end -- as will we all, less wealthy but wide awake.

Four weeks ago yesterday marked the turning point in the Great Run of ’08: after the Lehman disaster the White House and Congress vowed to intervene as necessary.

Last Monday afternoon marked the fact of effective intervention, the authorities for the first time moving ahead of the crisis. The Treasury summoned the CEOs of the nine largest bank-survivors, and broke the capital-shortage by involuntary injection -- an event and scene without American precedent.

During these four wasted weeks, frozen credit markets did serious harm to an already recessionary economy. September industrial production collapsed by 2.8%, the largest decline since 1974, and retail sales slid 1.2%, double the forecast.

However, a weak labor market has resisted free-fall: last week 16,000 fewer people filed new claims for unemployment insurance. Foreign economies are sinking faster than ours, reinforcing global-price decline: September CPI was unchanged, and will soon go negative. The commodity collapse is already reversing pressure on consumers at the gas pump, will soon at the grocery, and by winter by prices for lots of things.


Many books will be written about the events leading to Monday’s meeting at Treasury. For the first time in a long time, at least back to the ‘70s, the Federal government asserted control over commercial banks. The Gucci cowboys of finance and their right-side buddies have since cried all sorts of foul out of arrogant habit, but from the day in 1933 that the first bank accepted an FDIC-eagle decal in its window, and deposit insurance, American banks were and are a form of public utility.

The Treasury did not tell the Nine why they were summoned, just “Be here at 3:00.” They were seated in alphabetical order, none more equal than the others. Across from them were Perfesser Bernanke, Secretary Pauslon, and FDIC’s Bair, who read the riot act to the Nine: the economy is failing, the credit markets flat-lined, and extraordinary action is necessary. The authorities slid across the table nine term sheets showing the amount of Federal capital each institution would intake, filled out in advance and without consultation, for signature. Now. Not for negotiation. For signature. Now.

Only one CEO argued (the WSJ and NYTimes accounts agree): Wells Fargo’s Kovacevich insisted that his bank didn’t need any capital, and was concerned for his $183-million retirement package. He will not enjoy the parts of future books about his conduct, and he signed with the rest, anyway.

That $125 billion in capital will likely come back to taxpayers in time, and another $125 billion will go to smaller banks (also to return) -- more beyond that as necessary. This capital injection should have been planned, politicked, and ready to go way back last spring, when the risks of arriving at this moment were so clear. If so, we would still be in recession, but not so hard to jump-start credit. All accounts of the wasted September concur: TARP, the Rube Goldberg extraction of bad assets, was Paulson’s work, at last giving way to the capital replenishment long-recommended by the Fed.

Many commentators have us sentenced to a long recession. We doubt it: our hope/hunch holds that the September stumble precipitated a sharper but shorter affair. The rescue came just in time, the risk of black hole intercepted. When Perfesser Bernanke says that he and his people “will not stand down” until we are on safe ground, believe him, and believe that he knows what to do. Progress will come in stages: first stabilization and pull-back from panic. Then the beginnings of adequate credit offered. Then the slow resumption of risk-taking by borrowers.

Opportunity for policy error will remain, but will move to the political sphere. Congress will demand a new, several-hundred-billion “stimulus” package. Tell them, “No!” They will also try to throw money at defaulting households -- no to that, too. The best way to help housing: an adequate supply of mortgage credit. The authorities will grope a while longer on that one, but the easy fix is in underwriting: last year credit swung from silly-easy to zilch, and re-centering would be a huge help.

Mortgage rates are stuck just above 6.00%, but at least not blowing up or shut down along with the rest of the credit world. We and our peers are operating normally.

Passage of the rescue bill has pushed up long-term Treasury rates, markets anticipating large sales of new Treasury bonds to raise bailout cash. The stock market has stopped nauseating freefalls twice this week at S&P 1100, rallying well now. These moves also reflect hopes for coordinated global central bank rate cuts over the weekend, and a Euro-zone version of our rescue package.

New economic data are awful, GDP obviously contracting in September. Auto sales fell below one million last month, 26% below last year. The always-reliable purchasing managers’ “ISM” manufacturing index plunged from an expected 50 reading to 43.5 (50 is a breakeven economy, 44 is recession). New claims for unemployment insurance are running a sustained half-million each week, double the rate in a healthy economy. Today’s crusher: payrolls fell 159,000 in September, half-again worse than forecast.

Before political and financial follies, the highest possible honor to Sheila Bair, FDIC head, for grace under pressure. She has gotten us out of WaMu and Wachovia with no hit to the insurance fund: no fuss, no mess, on time. Those of you worried about your bank accounts, stashing greenbacks -- cool it. We think our banks are fine, now.

This week we have been in the worst moments of the largest “run” in history, nothing remotely comparable, in part because of these damned electrons. Civilians and experts alike have been terribly confused, trying to understand what is happening.

Two things have complicated comprehension: until the last two-weeks’ disaster, this was the slowest-moving run in history, starting 14 months ago. A “walk” on banks, no matter how massive, does not focus the mind of Main Street voters. Second, this run has been at wholesale, bank-on-bank, money-market fund on commercial paper, funds on munis... but no lines of depositors, no deposits lost.

That missing panic on Main Street is the largest reason the House flinched on Monday, and “nay” voters still do not understand the fantastic and lasting harm they did. Rejection instantly caused the stock-market loss of $1.2 trillion, and spread the run all over the world. There is only one way to stop a run, and that’s with an unlimited mass of cash: drive up with a big truck-full, and start throwing bales of it at old ladies in the run. Flinch, and even this re-do loses force. The global element: the US is the only domestic-driven economy on the planet; the rest of the world earns its rice and strudel by selling stuff to us. If our Congress appears locked in cranio-sacral inversion, then the whole world is lost, and so it traded all week long.

More politics. The whole House faces re-election in 30 days, many new Democrats from conservative districts, many Republicans fighting a Democratic wave. The President is unable to fly top cover, to “go to the people” in a compelling speech. He is also the lamest duck of all time, and the House has no fear of him. One Congressman said of Lyndon Johnson, “If he wanted your vote, and you resisted, you had the strong impression that electricity to your district would be cut off and never turned on again.” In 30 days we will have a President-Elect deserving fearful respect, order restored.

The bill has passed, but execution of the absurdly complex plan will take a month or more. A lot of people are coalescing around a simple and fast “Reverse Sutton.” Willie Sutton focused his legendary work on removing cash from banks; instead of all this horsing around with re-underwriting toxic securities one at a time, buying at auction and re-selling, just give banks the capital they need. Do it in exchange for ownership, long-term workout, and by accounting fiction, not by selling new Treasurys.

Even then, we’ll have to jump-start the system, get bankers back to making loans. So, let’s invite the big dogs, BofA’s Lewis, Citi’s Pandit, Morgan-Chase’s Dimon down to Guantanamo for the weekend: “Gentlemen, meet the bucket and the board....”

Mortgage rates are unchanged, about 6.125%, just one aspect of completely frozen credit markets, hostage to a political moment without parallel.

The real economy is tipping over: New claims for unemployment insurance last week jumped to 493,000 from the 450,000 range. Orders for durable goods in August plunged 4.5%, double the forecast decline, and sales of New homes free-fell 11%.

When financial events move into politics, this column is relentlessly anti-partisan -- not “non-“, but anti. Nothing below is intended to favor either party or candidate.

Any large-scale Federal financial rescue was certain to face political chaos. However, within hours of rollout last Thursday this rescue collided with two linked and disastrous forces which may yet defeat immediate rescue.

When Secretary Paulson and Perfesser Bernanke went to the political authorities last week, the Perfesser’s Tales From The Crypt risks to the economy produced immediate bi-partisan support for a rescue. Then and since, as all Fed Chairpersons should, the Perfesser has left legislative details to the Treasury Secretary. In disaster number one, not clear until hearings on Tuesday, Paulson was not prepared.

Most grown-ups know that it’s a mistake to ask a group to vote on an important proposal without prior discussion. You wouldn’t spring something big on your PTA, your HOA, or your book club, and demand an immediate approval. You wouldn’t ask a Cub Scout troop to vote on a field trip without some testing of the water.

Hank Paulson would. Hank has had 13 months to prepare a contingency plan in case market solutions to this crisis failed, and quietly to explore alternatives with Congress. Instead, he dumped on Congress a three-page sketch of a highly technical and questionable proposal. Tuesday’s hearings in the first minutes revealed bi-partisan, confused, angry, and incredulous Senators, and a completely clueless Paulson.

This man, Paulson, this extraordinary fool, has not only failed to advise us in the Senate, to develop his plans with us, to find out what we can sell to a wounded nation, he is not prepared to defend his idea! We watched part of the testimony beside an experienced trial lawyer, who after fifteen minutes burst out laughing. We asked what was so funny; he said, “You can always tell when a witness has lost it -- they just babble.” Reports today are unanimous that one of last night’s negotiating sessions blew up when Paulson again bungled a description of his plan’s benefits and execution.

Over last weekend another force erupted all over the country: native, grass-roots rage at a bailout that would leave all the big institutions in place -- officers, directors, stockholders, all -- and offer to taxpayers the absurd promise of payback from hundreds of billions of trash that the institutions couldn’t unload on anyone else.

You tell us your precious markets will melt down without this? Why do we care? Your stock market can go to zero on Monday, and then you can come down here with us to find out how it feels not to be able pay the bills. More than half of Americans have no stake in these markets, no savings at all; and there is a political price to be paid for extreme inequality of income.

This bailout, incomprehensible to civilians and many experts and Senators, should have taken ownership in the institutions involved. Proper vetting to Congress months ago would have gotten that done. Instead, the same ancient American forces that ignited the Palin phenomenon, Jefferson-Jackson-Bryan-LaFollette Populism, have mobilized an anti-bank, anti-smarty-pants, street-level riot not seen in modern times.

Completing the scene: Mr. Bush’s nasty little speech on Wednesday, assigning blame and taking no responsibility; Mr. McCain’s grandstand play on economic issues he’s said for decades he’s not any good at; and Mr. Obama’s silent tip-toeing along.

Not pretty, but only-in-America: this flawed plan will probably pass by Sunday night, might work (50-50), might work in time (25-75), and we can always go to direct capital injection and ownership if Paulson’s Pratfall does just that.

We wrote last week that we heard “hoofbeats of cavalry on the way.” For a while this week it looked as though John Wayne had arrived to shoot the settlers and give firewater to the Apaches.

Mark this day: the worst of this crisis has passed. However, not yet the halfway point in time: we are thirteen months into this wreck, and you’ll sure as hell feel credit-market distress thirteen months from now. The greatest risk has passed.

Until yesterday the nation labored under the illusion that this crisis was a financial matter -- banks and markets thrashing around, remote from Main Street, something that would either solve itself or be calmed by usual means. In reality, of course, the financial matter was not remote and had been hopelessly lost by August, 2007.

Now this crisis is officially public property, in the political sphere, put there by final disaster on Wednesday, formally acknowledged today by the Fed, the Treasury, the President, both houses of Congress, both parties, and both Presidential candidates.

Before post-mortem, medals, and booby prizes, a brief timeout for the real world. The economy is sinking and will continue to do so, partly because it must to pass the inflation pig (no lipstick) still moving through the national python. New claims for unemployment insurance are continuously rising beyond forecast, 455,000 weekly now, and housing is not close to bottom, new-builds last month falling to a 17-year low.

Mortgage rates have risen to about 6.125%, a wrecked credit system unable create leverage to support higher prices for $5 trillion in mortgage-backed securities and lower rates. However, a somewhat less distracted Treasury Secretary will go to work on that problem shortly. So he said today (again). He and everybody else know that mortgage credit must be unlocked for housing to bottom.

The authorities, including White House and Congress, have obviously been working on today’s fix for months. Fed examiners have been inside securities firms since June for the first time ever, “lifting the kimono” to discover the Street’s secret losses. Thus we have an initial funding amount; not enough, but most to be recovered one day.

The authorities could not go public with planning until the market damage was so severe that a majority of both parties in Congress was willing to go along. The most difficult part of the journey ahead: helping the American people to understand, and to stay together despite contrary charlatans by the thousand.

Top honor: to Perfesser Bernanke. Quiet, no grandstand, the technician with the life-study knowledge of 1930 and the determination to prevent 1932.

An Honorable Discharge, no medal, to Hank Paulson. You hire an investment banker to look around corners for you. Relentlessly surprised, annoyed at the waste of his valuable time, Hank has only recently discovered that there are corners.

Medal of Honor: Tim Geithner, NY Fed Prez. If we are very, very lucky, this extraordinary man will stay in public service for a while longer.

The Boobs... oh, my. Start with the CEOs and boards of the failed firms. Name them, publicly humiliate them, and then shun them. Forbid them ever again to participate in a public company. That’s authentic “moral hazard.”

The Liquidationists. Find the hottest corner in Hades for those who thought (and still think) that mass bankruptcy and liquidation will bring proper punishment, future caution, and recovery. The Lehman butchery led directly to the AIG bloodbath and total system meltdown. Andrew Mellon, Herbert Hoover’s Treasury Secretary in 1931: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate... and recovery will follow in a few months.”

Another high honor goes to the irrepressible American spirit under pressure. On Tuesday, news crackled over Lehman’s in-house squawk box that Barclay’s Bank would buy half the wreckage, and perhaps 10,000 people, many of whom lost their life-savings, would still have jobs. Then the box played “God Save The Queen” to cheers.

Mortgage rates have not been able to hold the early-week low at 5.875%, but are no worse than 6.00% for the lowest-fee deals.

The Fannie-Freddie takeover instantly knocked retail mortgage rates down .375%, but that’s been it. The sky-high spread versus the 10-year T-note has compressed from 270bps to mere cloud-height, 235bps -- but that’s still 70bps too high. We have argued all year that the spread was not a credit matter, instead an artifact of an insolvent banking system unable to leverage positions. We win, and wish we hadn’t.

Economic data are sliding all over the world. US retail sales in August were the worst of the year, minus .7% ex-autos. Newly surveyed consumer confidence rose here, probably on cheaper gas, but anxiety and confusion among civilians runs deep.

To describe where we are today, begin with a review of the last year: in August 2007, the large end of the banking system suddenly froze. 60% of total US banking assets reside in the top 10 institutions, and the freeze came from sudden awareness that too many of those assets were bad, and the bad ones were spread across all large firms, banks and securities dealers alike.

From August to early spring, oil spiked from $90 to $145 while the housing bubble blew -- one inflationary, the other deflationary -- and the Fed fought both threats: one by letting the credit freeze slow the economy, the other by slashing its interest rate and making massive loans to the banking system. In that August-March interval, most people thought markets would heal with the Fed’s help. Bottom would be found. The halfway point would be reached. Surely we were in a late inning. Then Bear Stearns blew, and the Fed again rescued the system, extraordinary action in its finest hour.

The political world was not ready. Post-Bear, Congress flayed Bernanke & Co. The average citizen and pol were more angry at perpetrators than in pain: bailouts, big and inventive ones, never fly through Congress until pain exceeds anger. That moment came in August, the Fannie/Freddie takeover marking the moment: except for a pair of jackasses (Dodd, D.CT; Bunning, R.KY), Congressional reaction has been “well done.”

The hell of the politics of bailout: you can’t get permission until it’s really ugly, and then it might be too late.

In public and private messages, the authorities now know that the banking system is beyond self-healing, and is in a downward and self-reinforcing spiral, and traditional measures are exhausted. Ordinary rate cuts and discount-window lending will not fix the fundamental problem: “captial” in the banking system is net worth, equity, and the large end of the system is just as under water as too many homeowners. Truly extraordinary measures are required.

We think we hear the hoofbeats of cavalry. The Fannie/Freddie takeover was routine except for the astounding, plain-English word that the Treasury will begin to buy MBS to drive down spreads. Housing must bottom, and it will require cheap credit.

We now know that Mr. Bush with striking courage at the end of a tough run has backed Hank Paulson, will not kick the can to January, and will act as necessary in the middle of an election. Well done, indeed.

Lehman Brothers will not exist on Monday. It may be bought whole or in pieces, but it will not receive Bear-style Federal assistance and may be liquidated (that’s our guess). It has had a year to sell itself, but the massive arrogance of its CEO and fiduciary failure of its board have brought its end.

Then, right quick, showtime for the cavalry: WaMu, AIG, and several other banks and firms threaten a failure cascade. That spiral must be stopped right now. And it must be done with as little Federal cash as possible: T-bills yields are falling on credit fear, but bonds are losing value on fear of a bailout avalanche of Treasury sales. There is no way to know quite how (direct injection of capital, accounting fiction, glom wrecks into a giant workout zombie...), but the authorities have the will, the skill, and support.

A big run to Treasurys has pulled mortgage rates down to 6.25%, but the spread to the 3.58% 10-year T-note remains immense.

Three forces have knocked all Treasury yields down a quarter-percent in four days. First, money scrambling to get out of commodities and the euro has to buy dollar-something, and the first preference of the foreign investor is Treasurys. Second, the oil-commodity reversal and onset of global recession will obviously break inflation -- different places, different timing, but inflation as fear number one has been replaced by asset deflation. Which leads to force three: plain, panicked flight to quality.

The economic data were tertiary to the market moves themselves, above, and to a pair of speeches. Today’s double-the-forecast loss of 142,000 jobs in August (including revisions), yesterday’s news of weekly unemployment claims a sustained 445,000, sub-breakeven purchasing managers’ surveys, another 15.5% clunk in car sales... more confirmation than news.

If, two months ago, you asked any stock-market cheerleader what the Dow would do if oil suddenly dropped to $106, natural gas to $7, the euro to $1.42, sterling to $1.76... you’d have gotten, “To infinity, and beyond!” Instead, in the best marker of our deepening predicament, stocks are testing their lows of the year and this cycle. Break Dow 11,000/S&P 1,220 and the run to Treasurys will stampede -- maybe, just maybe enough to pull mortgages into the fives.

The speeches. On Wednesday, Eric Rosengren, president of the Boston Fed (copy and great charts at www.bos.frb.org), delivered a market-moving beauty.

In any difficult economic moment misunderstanding is easy, compounded by desires to settle old scores. In the last year, an especially unfortunate group of regional Fed presidents and their boards have chosen to ignore the credit crunch afflicting big banks but not their country colleagues, and to overweight the inflation fight, no matter what the consequences. The rogue’s gallery: Fisher at Dallas, Plosser at Philadelphia, Lacker at Richmond, Hoenig at Kansas City, Bullard at St. Louis, Lockhart at Atlanta. At the August 5 Fed meeting, three regionals demanded a hike in the discount rate, trying to force a Fed funds rise, or a commitment to do so soon.

Country bankers are funded by retail deposits, not Libor-based wholesale. Country banks have none of the explosive “structured-finance” devices that have ruined the big guys; sure, some dance with the development-loan devil, but most country bankers think an exciting loan is 50% LTV on a fully-leased medical building. All country bankers want to get even with the New York Gucci brigade.

Mr. Rosengren, supported by Ms. Yellen at San Francisco, blew to smithereens the fantasy of the country stiffs. Others have made the points, but not from a Fed podium: the crunch has cancelled the Fed’s rate cuts; the crunch did not take full form until this summer; and the crunch is deteriorating in reinforcing spiral. Most striking, the speech has a dead-end: not the slightest suggestion of what might be done, indicating to me that the Fed is out of options.

On Thursday, Bill Gross’s flowery version of the same song (www.pimco.com) contributed a couple of hundred points to the Dow dive. Gross added one stanza: get the Treasury involved, or else.

He is right, of course, but how should the Treasury deploy? And the Congress and taxpayer? Mr. Paulson and Mr. Bush are silent, but bailout proposals will shortly be a free-fire zone, election or no, the Duck to Crawford intercepted by events.

Lefties will want stimulus, job and infrastructure cash-hosing. Righties will want moral hazard, market solutions, and beneficial suffering. Wrong and wrong. The skilled and alert professional fire brigade (Feldstein, Summers... dozens) is confused and scattered, unsure how to deploy full force. The longer this goes, the less room for error. We cannot tolerate another clean miss like the housing bill.

Mortgage rates improved again this week, slightly, to 6.375%, the 10-year T-note trading often just under 3.80%, a resistance level since spring. The improvement anticipates a weakening economy, but a further decline in rates will depend on the fact of weakness. A test comes quickly, in the first August data due next week.

This week’s data had more headline than authentic strength, but there was some: in the 2nd quarter, export sales rocketed 13.9%, the long-delayed benefit of a weaker dollar. Exchange-rate cycles and their effects tend to be very long-wave, several-year affairs: even though the dollar has begun a turn to sensible levels, and foreign economies are entering slowdowns that will reduce their appetite for our exports, our export sales will help our economy for quite a while.

Overall GDP popped 3.3% in the 2nd quarter, but under-measured inflation made the GDP leap rather like the guy in the falling elevator who hoped to save himself by jumping just before hitting bottom. “Nominal” GDP rose 4.6%, adjusted to “real”, non-inflated dollars by subtracting the 1.3% inflation “deflator.” The deflator, usually an excellent measure, is way too low right now: actual overall inflation ran close to 5% in the 2nd quarter, and real GDP thus was negative, as it was in the 1st quarter also.

July data showed the rebate-check fade: personal income dropped .7%, and spending rose a slim .2%. Weekly unemployment filings slid from a new peak early in August, from 450,000 to 425,000, but the overall trend is not good.

July sales of new and existing homes appeared stable but were not. New home sales are measured by contracts written, and fallout is staggering, at least one-third. The leading cause: buyers can’t sell the homes they have. Resales are holding roughly 4.9 million annual, down from the 7 million peak. However, at the peak, “involuntary” sales were negligible; today they are almost one-third of the total, compressing “voluntaries”, down perhaps 60% from peak.

Case-Shiller continues its hysterical mis-measurement, insisting that home prices fell 15.9% in the last year. The excellent www.ofheo.gov data has national prices down 4.8%, nothing that bad since the 1930s. The foreclosure and walkaway damage is obvious; the silent corrosion is in the millions of households unable to sell, or to refi off bad-idea ARMs, and in diminished household faith in the future.

A way to pass time in the 13-month run of the Crunch has been, “Do they get it?” “They” being the authorities, “it” being the insolvency of the financial system.

They do. Worth your time: www.federalreserve.gov, the minutes of the August 5th meeting. Unusually short, clear, and grim, two things stand out: they get the risk of credit-default spiral (shrinking credit, more defaults, less credit...), and that risk is greater than inflation. The FDIC sure as hell gets it, staring at a bank/collateral spiral.

New game: What will they do about it? Treasury’s Henry Paulson was a daily fixture on the tube in July, appearing impatient with too much attention paid to spilled milk. All through August, Hank has been the soul of patience, and completely invisible.

Nobody knows what the White House gets, but Paulson’s inactivity looks like somebody has told him to cool it. Maybe through McCain’s nomination, maybe through the election, maybe all the way to the Escape to Crawford.

Neither candidate has a word to say, which is understandable, as many money pros still don’t get the nature and magnitude of the problem. At nomination, which candidate would like to explain to the people these choices ahead: If we guarantee Fannie and Freddie, what parts -- stock, bonds, preferred, subordinated? Then, which banks do we save, and their parts? If we save rich financial guys, what of Ford, Chrysler, and GM, and their retirees? What of the impulse to save homeowners, no matter how foolish, no matter how terribly unfair to the prudent but unlucky?

Not one of the four nominees has financial-market experience or evident knowledge. Better not to talk. However, election-cycle paralysis may be overtaken by events.

The Fannie/Freddie Deathwatch
August 22, 2008

Mortgage rates bottomed again at 6.50%, as they have since May, maintaining a consistently wide spread to the 10-year T-note, likewise bottomed at 3.80%. It will take a substantial negative economic event or news to break below these rates.

Economic data were thin. The July index of leading indicators fell hard, the outsize .7% drop entirely due to rising claims for unemployment benefits and a big slide in building permits. July housing starts dumped another 11%, surprising the remarkable number of people still with faith in a housing bottom nearby -- rather like finding pigeons who want to bet ten bucks on an instant replay.

The last weeks of summer are poorly attended in the markets, movements meaning little. The world’s central bankers are now convened in Jackson Hole, reports indicating a consensus forming around hope and the hazards of action. The shooting will start again immediately after Labor Day with fresh data from August, especially payrolls.

The big news right now is the Fannie/Freddie deathwatch. First thing: borrowers should relax; the consequences of demise for you will be either good news or no news.

The pending takeover is in many ways a non-story, just confirmation that Fannie and Freddie were, indeed, too big to fail. Hopes will be dashed at the Fed and Congress that takeover will benefit our decapitalized financial system and the economy. Maybe, just maybe, the authorities will absorb that lesson, and begin useful action.

Secretary Henry Paulson demanded total takeover power in July, telling Congress that if he had such power he would not have to use it. Wrong again, Hank. Holders of $5 trillion in F&F paper immediately wanted to be Treasury-guaranteed, and any possible sources of new capital instantly vanished. Invest, to be wiped out in takeover?

Paulson’s new problems: whom else to wipe out in an F&F takeover. Common stockholders are already gone. Holders of bonds have to be made good, as the $1.4 trillion-worth is a key asset in institutions all over the world. Preferred stock? Same deal. The cutoff decision will be precedent for the bank failures to come: who, exactly is TBTF, and when one tanks, who gets paid?

The very good news: current Fannie and Freddie management and regulators, captains of malfeasance, will be excused. Historical error aside, these people have been busy in the last six months undermining their sole purpose. Every loan now suffers a .50% fee surcharge. Since winter, every borrower with a credit score under 720 has suffered a surcharge; unless cancelled , that bar will rise to 740 on November 1st. The list of loans ineligible for F&F assistance is now longer than the one of still-doables.

The no-news is disappointing, but real: takeover will not improve mortgage rates. Maybe a little, if the surcharges are removed. In the market’s eye for credit, there is little difference between the presumption of too-big-to-fail and the fact.

But, won’t F&F be able to buy loans again, and push rates down? For housing to bottom, we must have lower rates and better availability, right?

Right on the second point, wrong on the first. There are $5 trillion in GSE mortgage-backed securities out there, and F&F own only $1.4 trillion. The principal owners of the other $3.6 trillion are giant institutions in desperate trouble. If anybody began to bid aggressively for MBS, trying to drive price up and yield down, those owners would dump their massive holdings in the same market mechanism holding rates up where they are. Any slide to 6.50%, and they elbow new borrowers out of the way. Neither F&F nor the US Treasury could possibly borrow enough money to buy them out.

Maybe, just maybe, the authorities will get the following equation. Normal MBS holdings are maintained with leverage of capital. Capital mostly gone, every big outfit is trying to reduce leverage. So, rates have to be high to attract un-leveraged buyers: mutual funds and such. The only way to restore leveraged buyers is to restore capital by Federal injection and/or accounting mirrors. Until the authorities make that leap, the real economy will deteriorate in gradual credit starvation.

Mortgage rates are falling, almost 6.50% with the lowest fees. All other interest rates are headed down as well, on glide path parallel to the global economy: the 10-year T-note to 3.83% (traded 4.10% only a week ago), and the 2-year down to 2.37% acknowledges zero probability of a Fed rate hike from its current 2% overnight rate.

Domestic data are sliding at shallow slope, but the stuff from overseas is dramatic.

Here, claims for unemployment insurance have sustained the jump to the 450,000 range, a decisive deterioration from the 375,000 in the first half of the year. Consumer confidence has been lousy for a while, but is now lousier: the lowest values have been for the future, current conditions better, but sinking now. July retail sales were flat, but adjusted for 5.6% year-over-year CPI a substantial real decline.

The negative news has been inevitable, and is perverse good news. There is no way to win an inflation fight without destroying demand, and the very good news is the Fed and other central banks are winning. At a price.

Japan’s 2nd Quarter GDP fell 2.4%, and the Eurozone minus .2%. Going lower. Asian results are not in, but the global-trade engine has entered a sharp reversal, everyone’s exports declining. The most immediate impact is a run to the dollar: the euro is $1.47 today (down $.03 in a week), oil is $112 (was $116), and gold $791 (was $858, the March top $1033). That’s a deflationary pattern. To buy the dollar you have to buy dollar-somethings, Treasurys the favorite, and maybe, just maybe, soon... mortgages.

Sidebar. The Russian adventure in Georgia is a help to the dollar, but is not a big deal. The Russians do not want NATO to proceed any further eastward (and it should not), and Georgia’s aggressive president crossed a bright tripwire that the US had warned him not to. Russia already controls Europe’s energy supply, and there is little additional advantage in whacking Georgia. The uniquely clumsy and brutal effort by the Russian kleptocracy hurts them far more than helps: the world is reminded that the US does dumb things with good intentions; the Russians poison your tea on purpose.

Fannie’s Mudd and Freddie’s Syron continue to whitewash their false fronts (Russians would appreciate their Potemkin villages), raising fees, tightening credit, freezing loan purchases, looking after their stockholders instead of the nation, unimpeded by their comic-book regulator, Lockhart, and utterly oblivious to pending nationalization. A rising unemployment rate will in some cases bring justice.

There is a place for government in the mortgage market: uniform underwriting standards are a Good Thing, leading to uniform and liquid mortgage-backed securities; and guarantee-for-fee is a good public/private business. Recreating a mortgage buyer-of-last-resort for emergencies like this one can wait.

The model for a proper mortgage agency already exists, but it’s not the Effing twins. Fannie owns $723 billion in loans and has corresponding borrowing (the problem!), and guarantees another $2.1 trillion; Freddie, respectively, $710 billion and $1.4 trillion. Fannie employs 6,400 people, Freddie “nearly 5,000” (FAQ on Freddie’s website: Is Freddie a risk to the taxpayer? “No.”).

Consider the Government National Mortgage Association, Ginnie Mae, born in 1968, carrying the full faith and credit of the US Treasury, guarantor of MBS holding FHA and VA loans. Outstanding Ginnie MBS are just short of a half-trillion dollars, growing $27 billion per month now, triple last year’s rate as the FHA is one of the last games in town. Ginnie owns no loans and does not borrow. It lost a little money in the ‘80s, the only time, the result of an FHA experiment with lunatic loan types (planned negative amortization above purchase price, the legendary 245 GPM, “Gyp ‘em!”) and some simultaneous regional housing meltdowns.

Ginnie employs 62 people. It has asked Congress for money to hire 14 more, but the ever-watchful, never-wasteful, green-eyeshade guardians of the budget have allowed seven. Parts of this credit crisis are tough to solve. This? Good grief.

Mortgage rates are a hair lower, under 6.75% now, but spreads to Treasurys have widened despite overt Treasury backing of Fannie and Freddie.

There is a three-track story unfolding today: the US economy, the ex-US global economy, and the Crunch. To maintain clarity, and composure, keep ‘em separate!

The domestic economy is weakening. New claims for unemployment insurance spiked last week to 448,000, and all hands expected some pullback; instead, 455,000 this week, the worst in six years. The collapse in auto sales to the 12-million-annual range (from 15.5 forecast) has been a recent, June-July event; however, modern “just-in-time” delivery of components means instantaneous negative feedback all the way back through the supply chain to labor and raw materials. Credit-default measures and bond prices indicate imminent bankruptcy by all of the used-to-be Big Three.

Housing shows no bottom, and without one soon, and tentative recovery, credit losses will be unbearable. The best marker of US condition: the Fed’s post-meeting statement abandoned its June observation that “downside risks have diminished;” and despite its new recitation of inflation risks made clear no intention to raise its rate.

The global scene is changing very rapidly, all for the good here and bad elsewhere.

In this past year, a tribe of economic astrologers have claimed that a weak dollar was the cause of high oil and all other US woes, and if only the Fed would tighten all would be well. This alternate universe collapsed in today’s trading.

The dollar was weak because our Fed properly eased into the Crunch (interest-rate differential is a prime driver, and ECB rates have been double our Fed’s), and because of our immense trade deficit. This week marks the beginning of dollar reversal, and reversal of a lot of other things.

The Euro-zone sag to recession means the ECB is done with rate hikes. It may take well into ’09 for 4.1% Euro inflation to break, and the ECB to ease, but that event is no longer a theory but visible on the horizon. German bond yields are in free-fall in anticipation. As the Euro-zone tanks along with us, so do markets for Asian exports, and weakness there is daily more plain, and will further undercut commodities.

The consequences of these shifts are profound in today’s markets. Oil has dropped to $116, natural gas to $8.39, and gold all the way to $858. The dollar is rising fast (certainly not because of some imaginary Fed defense): the euro barely holding $1.50, ditto sterling at $1.90 and yen at 110/$. Europe is inheriting our currency problem: the anti-inflationary benefit from lower energy prices will be delayed by falling euro value.


Then there’s the Crunch. Credit scarcity as measured by spreads to Treasurys now affects all borrowing. The notion that the Crunch is confined to mortgages and structured securities stands exposed as urban legend: top-quality municipal and corporate borrowers are suffering. Consumers show signs of last-ditch credit-card defense: consumer credit outstanding jumped $14 billion in June, borrowers unable to pay down month-end balances, nowhere else to turn for a loan.

The best model for the Crunch dates to January with Jan Hatzius (Goldman) and the Bank Credit Analyst with the same insight: capital shortage means insufficient credit by the following equation. System write-offs in the last year total about $500 billion, and only $350 billion in new capital has been raised. That $150-billion shortage, by the miracle of 12:1 bank leverage (and 25:1 broker-dealer and hedge-fund leverage) leads to a credit shortfall of at least $2 trillion. This shortage shows up as price-rationing: if you want to borrow, you have to pay a hefty spread over Treasurys or do without.

Losses yet unrecognized are at least double the ones taken, and market capital is almost unobtainable. Despite the excellent news on the dollar, energy, commodity, and inflation front, the Crunch is the dominant force, and worsening. That’s why the Dow is still lurching around in the 11,000s, instead of rocketing on that good news.

Mortgage rates are back down to 6.50% (low-fee), taken by sudden understanding that the economy probably passed its high point for the year in June.

A huge spike in unemployment claims (to 443,000 last week, 60,000 above recent range) may overstate weakness, and today’s announcement of 51,000 jobs lost in July may understate, but weakness is spreading beyond housing, construction, and manufacturing. The purchasing managers’ July survey came in dead flat, 50.0, but with the fewest new orders since October 2001, and tailing strength in exports.

2nd quarter GDP arrived plus 1.9%, propped by rebate checks and the best export sales ever (a weak dollar has its benefits). However, the Euro economy is now slowing faster than we are, and soon won’t be buying much (a strong euro has its penalties). The UK is in real trouble, retail sales to a 25-year low, mortgage approvals off 72%.

Western central banks fighting inflation (Asian ones are still flinching) have been helped by market-based credit tightening. However, beware of Frankenstein. Credit shortage is spreading to all sectors: corporate bond issuance, intact through spring, just had its worst month in five years, prime rates an immense 3% above Treasurys.

The new housing assistance bill, dismissed here briefly last week, deserves a more thorough hatchet-job.

Its centerpiece is a $300-billion FHA loan guarantee (not money) to refinance under-water home “owners.” Consider a Bubble-Zone victim who bought a $200,000 home five years ago, made a 5% down payment and got a 5-year interest-only ARM for $190,000. The home has fallen 25% in value to $150,000. She has made interest-only payments since, and her $190,000 loan is entering amortization reset.

Her rate is not bad, 5.50% even after adjustment. However, her payment will jump from $871 to a killing $1,167. To her rescue, the bill’s “Hope for Homeowners.” In the land of unfortunate acronyms, gotta call it HoHo.

HoHo provides for a write-down of the mortgage to 90% of current market value, to $135,000, plus a 3% refinance fee to the FHA, $139,000 total. HoHo further provides a 1.5% annual surcharge; added to 6.50% current market equals 8%, amortized for 30 years is $1,020 per month. Better by a little, possibly affordable, equity negligible, pride failing. Then there’s HoHo’s anti-equity kicker: when the place appreciates in value (how many years ahead?), and she either refinances off the 8% or sells, HoHo will take half of any appreciation. We bet HoHo won’t split costs.

While she considers HoHo humiliation, a new renter moves into the house next door, identical, rent $700. Millions of people just like her are now condemned as “Walkaways.” Professionals, fiddle with local examples; we think this one is mainstream.

A more pernicious provision in the bill is the First-Time Homebuyer Tax Credit, retroactive to April 9, 2008, $7,500 per household. This is a credit, not a deduction; if you owed $7,500 in ’08 taxes and had $7,500 withheld, you’ll get a refund of your whole withholding. The advice from this firm to all buyers except compulsive savers and the rich: don’t take the FHOBTAC credit.

There’s a fishhook in the FHOBTAC sirloin: you have to pay it back. $500 per year added to your taxes (good-bye, refund), and the whole remaining balance if you sell the palace. Own for three years, you’ll still owe $6,000. How many recipients of the credit will still have that cash when it’s time to pay at tax time? Scammers are already trying a payday-loan trap: assign your credit to us, and we’ll give you money for a down payment.

Meanwhile, mortgage credit starvation -- the real problem -- is doing its grim work. MGIC, the mortgage insurer, published its new regional risk guide: of 73 metro areas, two are strong, 31 soft or weak. Of the remaining 42 rated “stable,” 19 are weakening. It is one thing to allow Bubble Zones to correct, another to let a credit crunch do some inflation-fighting. But, allow the entire housing market to sink? Careful, fellas.

Proposed Fix Makes Trouble for Jumbo Loans
July 25, 2008

Mortgage rates are still stuck near 6.75%, the financial markets confused and locked-up until a blast of argument-resolving data arrives next Friday.

Oil down to $123 and natural gas to $9.25 helped stocks for a while, but they still fell apart on no-bottom housing news and a sinking job market. The economy is obviously weakening, but rates are held up by fear that inflation is the greater risk -- even the stock market’s Thursday elevator-shaft could not hold down long-term rates.

Let us take time for silly-season recognition of government worthies and their efforts to combat our problems. Stagflation? Credit-binge? Housing ex-bubble? Financial-system insolvency? Energy crisis?

We’re hard at work on it. Whatever.

Highest marks to the Fed. In retrospect, Perfesser Bernanke figured out the 1930 risks back in January. Rarely do courage, fast action, and effectiveness meet so well as in the Bear Stearns intervention.

Treasury Secretary Paulson has been late to the game. Distracted by his China-trade offensive, the record shows his great and misplaced faith that the financial system would recapitalize itself. However, he’s up to speed now: his ”Bazooka Backstop” of Fannie and Freddie was prepared before confidence broke in the GSEs. His progress to out-in-front shows elsewhere: Fed examination teams now operate inside the big securities dealers and the GSEs. We may be in trouble, but we’re not going to be surprised again by indolence among lesser regulators (SEC, OFHEO...).

Both the Fed and Treasury indicate knowledge that mortgage supply and system capital are inadequate, and are engaged in slightly panicky floating of new ideas (European-style mortgage “covered bonds,” legal maneuvers to source bank capital from private-equity firms...) which will not work well enough or soon enough. Short of something big, like a nouveau RTC, the authorities are running out of ideas, forced to band-aids, and playing for time and miracles. However, the absence of illusion is good.

In the background the Fed has been working on new regulations: the first issued are a new set of mortgage rules, and a good job. However, early drafts included a proposal to force mortgage brokers to disclose their compensation -- just brokers, not bankers (commercial bankers have long hoped to squash competition). All mortgage retailers are paid and incentivized the same way, of course, no matter where they work, but brokers were guilty of a much higher fraction of defaulted loans.

In an astounding development -- unprecedented, unbelievable -- the Fed hired a market research firm to test the new disclosures on consumers. Repeated re-drafting and re-testing revealed counterproductive confusion among the public, and the Fed dropped the idea. Gold star, guys. Might test a few thousand other “disclosures.”

Then there is this week’s housing bill. Barney Frank and Chris Dodd’s egomaniacal dream is going fall flatter than Phoenix vacant land, so flat that it may convince Congress to let the pros handle this trouble. Barney Mae calls for $300 billion in foreclosure-intercepting mortgage re-writes, under-water balances to be cut to the reduced market value of the home -- if the owners don’t mind a 1.5% annual fee and giving back 50% of any appreciation they might earn after years of defending a home that still has no equity. Send your keys straight to Barney.

Help for broken mortgage markets? Goodness, no: make it worse for jumbos, the most badly broken of all. Super-Fannies got squashed by $125,000 to $625,500, and the secondary cap reduced from 150% of local median home price to 115%. Boulder, with $650,000 median prices in a county with $350,000 median had briefly enjoyed $460,000 Super-Fannie money (the larger “MSA” controls, not the town) -- the only Front-Range county with any benefit at all. Forget that.

Thank you, Fed and Treasury. Congress, enjoy your August vacation. We’re safe while you’re there. Do enjoy what your constituents have to say.

A Fannie/Freddie Treasury guarantee on the way means mortgage rates have fallen, right? The huge spread between 10-year T-notes and mortgages has closed, for sure? All these mortgage-backed securities as good as Treasurys, they’re trading the same way? Fannie and Freddie can borrow cheaply, so mortgage rates will be cheap, too?

All wrong. This week’s mortgage trading removes any remaining dispute about the difficulty facing the financial system, the economy, and housing. Mortgage rates have soared to 6.75%, up .375% in a week, the spread over 4.07% 10-year notes wider.

All long-term rates had a rough week. The CPI jump got the initial blame (1.1% in June alone, 5.0% year-over-year), but everybody knew it was coming, guaranteed by $145 oil. However, offsetting CPI concern was Perfesser Bernanke’s grim testimony, pushing “below-trend growth” off into 2010; and a mere point-one percent gain in June retail sales -- that at the high point of rebate checks, done now.

The cause of the 10-year spike from 3.80% to 4.07% was this strange chain: early-week news of rapidly weakening Euro and Asian economies at last knocked oil into a three-day drop to $130. That news jangled the stock market -- the Irish Setter of finance -- into an ear- and tongue-flapping, eye-bulging race to buy. As soon as the fear of 1987 left stocks, so did the frightened bid for bonds, and up went T-rates.

Fair enough: falling oil trumps a sinking globe. For the moment.

The mortgage story is different and separate.

In normal times, from the mid-‘80s forward, retail low-fee Fannie mortgages were available at about 1.60% above the 10-year T-note, give or take 10bps. Mortgages today should be 5.75%, tops, at that level a help to ARM escapers, refiers of all kinds, and buyers of resale homes and foreclosures. Instead, since January the market has repeatedly traded 2.75% over the 10-year, a terrible burden on housing.

We have argued since last year that this spread had nothing to do with Fannie/Freddie credit fear, because the Ginnie spread was just as wide (Ginnies have been “full faith and credit” for 40 years). Instead, the spread is the best indication of the insolvency of the financial system.

If you’re MegaBanc, or WhiteShoe Securities, and you’ve lost your capital, and the market thinks it unwise to give you any more, the ONLY way to improve your capital ratio is to shrink your assets. Sell! You have to keep some cash, and cash-like Treasurys. Of course, you dare not try to sell the mountain of IOU-crap you created and hold, and are trying desperately to blame on subprime mortgages. That leaves high-quality MBS as the only assets you can sell without a loss.

Add to that: it’s not just MegaBanc and WhiteShoe... it is every single big institution trying to downsize simultaneously. Constant MBS selling has overwhelmed the modest buying by Fannie and Freddie, mutual funds and non-leveraged investors, and crowded out mortgage borrowers.

Meanwhile, the WSJ editorial crew, Kudlow’s Twits at CNBC, and dozens of serious blogs insist that the private sector is perfectly able to provide mortgages, and Fannie and Freddie should disband. Sophomoric, juvenile, irresponsible, puerile, ignorant.... The private sector at work? Ask somebody for a fixed-rate jumbo quote, and then ask how the top-end 20% of housing will survive with 8.25% money. If anybody qualifies.

After the FDIC seizure of IndyMac (which by itself may consume 15% of the FDIC’s cash), FDIC head Sheila Bair observed, “The housing crisis... is no longer confined to states that once had go-go markets,” asking for more “pro-active intervention.” Her thinking still runs to finding ways to keep financially failed households in their homes.

Won’t work. We must help buyers. She is correct about nationally deteriorating housing (Seattle the new poster child, good economy and all), guaranteed by mortgage starvation. The only way to housing recovery is to stop the financial-institution implosion, and that means Federal injection of capital and bad-asset extraction.

The Fannie-Freddie panic began on Wednesday -- that is, this Fannie-Freddie panic, as opposed to the prior ones. The firms had already lost 90% of their stock value, and can continue to lose half of their remaining value every day forever with no trouble. It’s losing the other half that’s a problem.

The immediate market response is perverse: mortgage rates have fallen a hair this week (near 6.375%), but Treasury bond yields have risen overnight (the 10-year from 3.81% to 3.92%), opposite the normal response to panic. The market logic: if Fannie and Freddie will be government-guaranteed, then all their mortgages and securities have suddenly improved in credit quality. Treasurys are hurt by the prospective cost of guarantee -- if it costs money, it means more borrowing and more Treasurys.

Meanwhile, lending operations are normal today, closings proceeding, although we are still desperately short of credit (Jumbos, ARMs, non-owner, flexible underwriting...).

The Fannie-Freddie story will be widely mis-reported, especially in those journals hostile to housing or to any intervention by government into markets.

The real story is a tale of public policy mangled by everybody connected to the two Agencies in the last 15 years -- both parties, two Administrations, eight Congresses, and real estate- and mortgage-industry lobbying.

Fannie and Freddie were created as last-resort buyers of mortgages in bad times, and in good times facilitators of mortgage securitization by guarantee. Guarantors face little risk, if underwriting is tough, and it is a good, self-sustaining fee business. Owning mortgages is high risk. Beginning in the early ‘90s, Fannie and Freddie jumped their charters, buying huge masses of loans in good times, roughly $3-trillion worth. This bloat on slim capital was a great benefit to their stockholders, whose interests were perfectly opposite the original charter: self-sacrifice in hard times, buying loans that nobody else wants in a moment of falling home prices. Right now!

The real story is very good news. Fannie and Freddie have high-quality portfolios, the only trash the “affordables” forced on them by Congress. A government takeover would wipe out stockholders, but might not cost a dime. Then the original charters will be restored: upon return of good times, both outfits will gradually sell their portfolios.

Here’s the bad news, and the reason for panic spreading to stocks and Treasurys. It is rather bad news.

Since the financial markets seized last August, the authorities have done well with emergency extensions of credit to the system, and especially the Fed’s finest hour in the liquidation of Bear Stearns. However, during that time, the Fed and Treasury have insisted that institutions -- many large banks and dealers -- can and should raise new capital in open markets.

The risk during this wait for market capital: credit starvation would kill the economy. Until institutions raise capital, their capacity to provide credit has been very limited, even running in reverse as the whole system has tried to shrink, selling existing loans, and choking on the unsalable trillions of bad loans and securities.

This Fannie-Freddie end-game has exposed that capital-raising plan as hopeless. If these guys with good assets cannot recapitalize, neither can the big banks and the Street. It was worth a try at market-sourcing, but we have believed since August that a nouveau Resolution Trust Corp would be required to extract the worst of the assets, take stock in the institutions, and work out the trash over a long time. That extraction will work (we’ve done it many times), but we’re a tad nervous that we waited too long, damage from credit starvation now may be hard to stop, especially in housing.

Some good news: the same Congresspersons who insisted all fall and winter, “No bailouts! Punish the lenders!”, by this weekend began a different chorus. “Necessary evil... Regrettable but unavoidable.” About time, guys; and we hope in time.

The immediate credit market response to a wave of new economic data is as-was, lowest fee mortgages 6.50%, 10-year T-note just under 4.00%.

However, last week marks very significant change: economic decline here and in Europe is now beyond argument, and the decline is fighting inflation for the Fed and ECB, neither of which needs to raise its rate further.

Evidence. The twin surveys by supply managers (“ISM”) in late June showed manufacturing at breakeven (50.2), and a surprising slide in the service sector (to 48.2 from 51.7). Friday’s much-anticipated payroll report had a loss of 59,000 jobs in June, and about that many lost in revisions of prior months. The ominous number, new claims for unemployment insurance, broke upward to 404,000 last week, the first time above 400K since the Katrina spike, and a recession level.

The stock market is obviously processing tough news, led by auto sales: sales collapsed 18.3% from June ’07 to June ’08. Chrysler off 35.9% and Ford minus 27.8% could be dismissed as punishment for bad management. Toyota off 21.4%? Toyota?

Ireland, Portugal, and Denmark have already posted negative GDP quarters this year. The June supply-manager survey in Spain cratered to 40.6, and the UK sank to 45.8 from 49.5; manufacturing is contracting now in France, Italy, and Austria. Germany’s export machine is the only forward motion in the Eurozone.

We will hear less from the crowd yapping for central-bank rate hikes, although they will seize on every temporary economic uptick, and on each inevitable but lagging rise in inflation. As their cry for policy error fades, politicians will fill the gap.

President Nicolas Sarkozy of France, an able and tough man, this week demanded that the ECB ease: “You can double, triple interest rates and that will not bring a decrease in the price of a barrel of Brent.”

Wrong! The world is in a commodity price shock because supply cannot expand as fast as demand in an overheated global economy. If the high prices of the commodities themselves fail to break demand, and to brake inflation, then it is the duty of the world’s central banks to break aggregate demand. Inducing recession is the only mechanism that will bring down the cost of a barrel of Brent. And it will.

Mr. Obama mentioned last week that economic stimulus may be needed, and “then the Fed could fight inflation.” This cognitive dissonance has ancient beginnings, recently deviling Ronald Reagan. The massive Reagan tax cuts in 1981 collided with Mr. Volcker’s recession, which made the inflation fight harder and longer than necessary. (The Supply Side fable lives on in some minds, but not in reality.)

The worst public-policy prescription: Congress and the Administration flooring the gas pedal at the same moment the Fed is on the brake. The result forces the Fed to put a second foot on. Aid the worst-hurt families (food-stamp equivalent for winter heating, extended unemployment benefits...), but allow the economy to slow. No more stimulus.


For Independence Day we have one hopeful estimate of future events unfolding in sequence. Ambrose Bierce warned against misuse of syllogism (“If one man can dig a post hole in 60 seconds, then surely 60 men can dig the hole in one second”), however, things are lining up nicely.

As Europe follows us into the tank, and then Asia, commodity prices will break, and credit losses will spread there, too. The great dollar outwash will reverse as foreign interest rates begin to fall, and cash will head here for safety. As commodities and the dollar reverse, so will inflation, first here, relaxing the grip on the American throat. Then the Fed will begin a gradual tightening process, new regulation on credit-creation in place, and we can get on with a lovely global recovery on sound footing.

Nothing troublesome ahead but another Asian overheating someday, and in the meantime figuring out what we’ll use for energy.

Mortgages are sticky near 6.50%, Treasury's getting most of the flight-to-quality benefit from the stock market dive.

Economic data last week were slim and predictable: consumer confidence fell again, and rebate checks plumped May spending and income, but gave no durable, corner-turning boost. The "personal consumption expenditure deflator" in the spending/income report confirmed the remarkable (and painful) "core" inflation performance, only a .1% gain: prices for everything except food and energy are on or over the edge of deflation.

This week was all Fed and markets. Analysts' responses to the Fed's meeting have described two different economies and mutually exclusive policy responses: one, the mainstream view that the economy is too weak for the Fed to raise its rate, the second that inflation-fighting and dollar defense are paramount.

The disagreement itself is traditional, but the extraordinary situation -- energy shock combined with 1930-style banking collapse and unprecedented emerging-market growth and trade and currency stress -- has added extraordinary heat and uncertainty.

There also appears to be an unusual political divide between the two views: the insurgents are right-side and stock-market champions in editorial dominance at CNBC, the WSJ, and Fox, joined by a few hard-headed and punishing characters in the Fed's own regional banks. The credit markets from late May until last week traded with the insurgents: the economy was not so bad, and the Fed should and would begin by August a sustained series of rate increases. Thus market rates rose in anticipation. The Fed's post-meeting statement made clear that near-term rate increases are unlikely, and the inflation/dollar defenders immediately accused the Fed of a lack of courage.

The object of the dispute is the Fed's set-point for the overnight cost of money, at 2% deemed too low by the insurgents. They claim that if the Fed began to raise it, the dollar would strengthen, dollar-denominated oil prices would fall, and so would inflation.

Possibly as late as the 1980s, this claim might have had merit; today's world is much more interdependent and resistant to unilateral action of this and other kinds. To fight inflation, so long as you're not printing money (we're not), you must slow your economy. We get from the policy insurgents either a belief in miracle cure without economic pain, or deception about just how slow they want the economy to get. In dollar defense, none of these people have a plan for the damage done by a $2 billion dollar per day excess of imports over exports -- Warren Buffett's well-made point.

The Fed funds rate is relative to many things: 2% today versus 5.25% last August, and the ECB's 4%, must be measured in relation to overall credit conditions, which are extremely -- possibly ruinously -- tight. A low funds rate is the only way the Fed can help the banking system to rebuild capital: earnings from wide short-long spreads.

Our only quarrel with the Fed's statement is its claim that "Downside risks to growth... have diminished somewhat." Mr. Buffet on Wednesday: "I watch kind of a lot of real-time data, and the economy is weakening -- if anything, weakness accelerating." Amex said that its June customer credit indicators had deteriorated "beyond our expectations." New purchase mortgage applications are two weeks into an 8%/week compound decline. OFHEO's balanced, broad, and non-hysterical measure of home prices finally began to decline in April.

Energy, commodity and food prices are out of control, but asset prices are deflating, houses and now stocks; the Dow is down 14% for '08, 19% since October. In evidence of terminal capital exhaustion, the DJ Wilshire Bank Index has lost half of its value in just 16 months. Chrysler denied plans to file for bankruptcy. Last week.

The Fed is playing this just right: fly the economy just above stall speed, because a stall might be catastrophic. Those who think a deep recession is a better idea should say so. The Fed needs help in the form of Asian/emerging slowdown; how, when, and with what political consequences there, we do not know, but it is coming.

Mortgage and Treasury Rates Remain Tight
May 26, 2008

Mortgage and Treasury rates have stayed within a tight range for six-straight weeks: 5.875% to 6.25% and 3.70% to 3.92% respectively.

Given the lurching in other markets, the credit market stability may seem other-worldly, but it is not -- recent bond trading accurately reflects the current economy. We are still stumbling forward, avoiding one open manhole after another. The cardinal indicator: the labor market is still intact, no waves of layoffs, new claims for unemployment insurance just as steady as interest rates. The Fed knocked 1% off its prior GDP forecast, down to a range of 0.3%-1.2% for the remainder of 2008.

The unprecedented mix of oil, inflation risk, housing recession, credit crunch, and explosive growth overseas has turned normal economic discussion -- the search for centerline probability -- into a freak show.

Back to the center, here, in three parts beginning with oil. Markets have had it right since oil first jumped the forty-buck fence in 2004: price increases will slow the US economy, and that slowing will cancel the inflation threat. In the ’73-’74 and ’78-’81 spikes the US immediately went to wage-price spiral, inflation each time to 11.8%; in ’90-’91 only to 5.5%. No spiral this time: foreign competition has capped wages, and as in ‘90-‘91 the Fed has kept clamps on money.
This oil spike is not as damaging as the ’73-’74 run from $3/bbl to $12/bbl, nor the ‘78-’81 trebling from $14 to $38. Oil has tripled this time, too, but new GDP today requires less than half the energy as then, and we are vastly wealthier -- that vast increase, of course, is the main reason that oil is up so far. We can afford to pay, as can overseas competitors that we have never had before.

To those who protest in pain: go find an old person and ask what it was like, twice in one ten-year span to wait in a mile-long line, pushing your car to be able to buy the 5-gallon limit. Have a look at the tattered, 35-year old solar panels on tract homes. Ask where those carpools went, and why HOV lanes require only two bodies.

Then inflation. Last week’s worst contribution came from Bill Gross, Poobah and Oracle of PIMCO. He announced (again) that US CPI numbers are fraudulent, and he is certain because inflation is high in other countries and so must be here. Beware of irresponsible twaddle from those who should be leading. His trump card: the 30% drop in the dollar must be the result of inflation. It is not, of course: it is the result of hosing $650 billion overseas in our annual excess of imports over exports.

The Fed is playing a very dangerous game exceptionally well. Inflation is under control here because the Fed is allowing the crunch, oil and housing effects to slow the economy, refusing to print money, and allowing us to suffer the consequences of unspeakably stupid public policies. If the economy slips into real recession, this Fed looks tough enough to let us find our own way out, and not try to print us out.

Housing. Center! Any home-price report containing the words “average,” “median,” “Case-Shiller,” or “Zillow” without qualification is an intentional effort to mislead. Hysteria sells. The national home market has shifted its mix of sales to lower-price ranges, and the portion of distressed sales has increased (1.45 million foreclosures will do that), thus each of the approaches above overstates the decline in prices.

However, the brand-new OFHEO data for Q1’08, appraisal-based and weighted-average, is disturbing. Its state-by-state listing (p 19-20, HPI) for the first time shows a nationwide stall. Only two states (Colorado and Indiana) enjoyed as much as 1% appreciation in the quarter. Only six states had price declines of 1% or more, but to have the whole USA go flat... that’s fragile.

Causes include slowdown and energy-crimped budgets, and certainly overshot prices in the Bubble Zones, but we think the unifying downward force is the inadequate and still shrinking supply of mortgage credit. There are non-inflationary fixes for that problem, all eluding policy makers for ten months. We are running out of time.

MMortgage and 10-year T-notes tried their tops all last week (6.25% and 3.92%, respectively), looking like they would break upward... and held. Rates improved Friday, but a run into the fives will require a weakening economy. Name your poison.

The stock market's persistent strength makes sense to all who believe that the economy bottomed in March, that we will not have a real recession, that the credit markets are healing quickly, that overseas strength will prop our economy and big-business profits, and that the tax rebate checks will ensure a good summer.

Piece of cake. Traders call it the Check Republic.

Some data support that argument. A little. The NFIB small-business index stabilized in April, but only a half-tick above March, the worst in 28 years. New claims for unemployment insurance are flat but high. The turndown in rates late Thursday followed reports contrary to worst-is-over: April industrial production tanked .8%, and capacity in use fell to 79.7%, the first time under 80% since 2005 recovery. Consumer confidence fell again, now to a June 1980 level (we remember, and would rather not).

The big unknown is overseas. Retail sales in China rose an annualized 22% last month, one-third of that gain was inflation at 8.5%, GDP 10.5% (after inflation). How long can that oil - and commodity - popping growth continue? Europe is in a worse collision between central banks, inflation, and growth than we are, the UK worst of all: inflation out of bounds above 3%, house prices and economy crumbling, the Bank of England unable to cut from its 5% benchmark, where our Fed was last August.

April CPI rose only .2% overall, the core rate .1%, as gasoline prices were "seasonally adjusted" to a .2% decline. That report triggered widespread rage among civilians, and contempt among bond traders (CNBC captured a crew wearing chef's hats to protest cooked numbers). These objections are foolish. The Fed understands distortions, studies dozens of inflation indicators, and has no interest in political cover from artificially low reports.

Given that argument, and the preserve-economy/fight-inflation conundrum facing the world's central banks, herewith a brief review of inflation principles.

Classically, inflation is "Too much money chasing too few goods and services." Note that both "toos" are relative, hence two different kinds of inflation: cost-pushed and demand-pulled. Note further two different sorts of demand-pulled: the money-printing kind (Weimar 1922-23), and the often-associated but different demand from an "overheated" economy. The deadly-dangerous inflation virus: when the two forms of demand-pulled combine into a "wage-price-spiral."

Inflation in the US today is cost-pushed. The Fed is not printing money in its efforts to resolve the crunch, nor does its 2% cost of money reflect easy credit. Credit today is much tighter than when the wheels came off last August. The exquisite discomfort here is caused by fixed incomes (wages capped by foreign competition) versus rising costs for energy, food, and health care. Other than pain, the effect is to force households to shrink spending on everything other than the three pushers. Deflationary!

On the Continent and in the UK inflation rates are similar to the US, but inflexible labor markets (unions and laws) prop up wages and threaten a wage-price spiral; that threat forces higher central bank rates there than here, ECB at 4% vs. our Fed's 2%.

Asia, India, Russia, the Middle East, and several emerging nations are in full-blown wage-price spiral and overheating beyond capacity, to a degree and kind making the 1970s US look disciplined. The authorities in none of these places appear to have the political clout to tap the brakes, let alone to stand on them.

Here, the Fed is trying exactly what it must: keep GDP growth close to zero -- not going negative if it can -- until cost pressure subsides. In the Eurozone, same deal but lagged six months to a year. Then (all on knees to pray) the slowdown will spread to Asia, breaking commodity and food prices, and perhaps mortgage rates as well.

Mortgage rates are sliding below 6% on a stock market fade, that in turn caused by Credit Crunch reality: fear of big-firm dominoes is past, but credit will be scarce and expensive for another year or more. No dominoes, but many, many shoes yet to drop.

$125 oil and resulting inflation has everybody rattled, blowing ultimate-top forecasts to $150-$200 (which means nobody knows). Central bankers worldwide are linked by euphemism: "We are prepared to deal with inflation as necessary." However, they can't deal with it by issuing rules, enforcing regulation, passing legislation, or spraying Raid! or Agent Orange.

Only two ways out. The first, underway: exert monetary restraint and hope to blazes that a gentle global slowdown leads to a collapse of overshot commodity prices. Despite rate cuts and lending-of-last-resort, even our Fed is on the tight side. If that doesn't work, turn to the Grim Reaper of economics: central banks must "destroy demand." Not since Paul Volcker stood on the brakes from '79-'82.

A third way: politicians can undercut the central bankers. A good start: suggest that gasoline prices are too high. Our leaders may not be willing to tell the people the truth, but markets will. American energy imports fell by about 2% last year, but consumption in the China/India/Russia/Middle East bloc (same-size market) rose by 4%. US coal was $45/ton last year and is now $99; natural gas is up 45%, and it's spring, not winter.

Congress, federal agencies including the Fed, and local governments are agreed on the need for a big, new effort to prevent foreclosures, White House opposition more on fine points of style than purpose. We fear that these measures -- any measures -- will fail and distract from effective means to soften the housing landing.

The elephant in the room, who cannot be mentioned in polite company: we gave mortgages to a few million households with deficient long-term financial behaviors, hopelessly incompatible with home ownership.

That's a hell of a thing to say about fellow citizens, but it is the case. "Subprime" by definition meant below the minimum standards of the FHA. Roughly $1.5 trillion will default: half of subprime and a like amount of the worst of Alt-A.

A year of all-out foreclosure prevention by traditional means has failed: recasting, forbearing, capitalizing interest, refinancing, canceling adjustment... all. The new measures include writing down loans to the level of fallen market value and refinancing the remainder. Fairness aside (deeply unfair to families who tough out this cycle), two realities will defy the new efforts. First, write-down/recast will leave these households still with no equity, no up-side to defend, and new monthly payments still higher than rent on equivalent housing. That ownership-rent gap has gaped throughout the cycle; the good news for a foreclosed family: replacement housing is cheap and plentiful.

Those in authority demanding foreclosure rescue, Barney Frank and most of Congress, joined by compassionate Americans, cannot conceive the financials of a 575 FICO subprime applicant. A dozen or more late payments, several defaulted loans, and a large mass of consumer debt outstanding; poor job stability (temporary, seasonal, intermittent, commissioned sales); also no money, no savings, retirement or otherwise, often tens of thousands in consumer debt, huge negative net worth... before purchase.

"But, you bailed out Wall Street -- why can't you do the same for these people facing foreclosure?"

Bear Stearns was not "bailed out." It was liquidated in an orderly manner.

Wise, tough-love policies would encourage rapid recycling of foreclosures, enabling quick acceptance of short-sale offers by servicers terrified of value second-guessing, and above all, making financing available for strong households to buy the foreclosures. The marketplace can absorb the volume, but it needs help. Orderly liquidation.

Long-term interest rates stayed about the same (mortgages 6.00%, 10-year Treasury 3.84%) as markets quarreled over the meaning of a new mountain of data.

The Labor Department said Friday that the unemployment rate in April declined to 5.0%, and payrolls lost only 20,000 jobs. For all the attention paid to this report each month, it often wildly mis-describes the economy; this one was so weird that not even economic optimists are crowing. In authentic news, claims for unemployment insurance jumped 35,000 to a cycle-high 380,000, total on benefits to a five-year, 3-million high.

The Fed’s post-meeting statement laid it out: “Economic activity remains weak.” Those who expected the Fed to identify a cycle-end, a rebound in sight, were mistaken. 1st quarter ’08 GDP arrived at a .6% gain, but adjusted for inventories contracted about 1%. The GDP measure of inflation was excellent, surprisingly stable.

Factory orders had a good month, plus 1.2%, driven by overseas demand. That foreign-market support for big business explains the sensation of two economies, big healthy, consumer not.

As the economy stumbles, the failure of political leadership has been matched by shortcomings in the professional financial class. Specifically, in the 45 days since the Bear Stearns liquidation the Fed has received extraordinarily unfair and unfounded criticism, the worst from people who should know better.

The Fed has been the only public agency to respond adequately to this crisis, yet talking-heads every hour rip it for its Bear action, its wider effort to provide liquidity and credit to the system, its inattention to inflation, and its rate cuts.

Above all other things the Fed today is raked for its failure to “defend the dollar.” It is true that in the near term international money runs uphill to high interest rates, especially if paid by low-inflation nations. The ECB has held the eurozone cost of money at 4.00% versus the Fed’s 2.00%, and a 10-year German Bund trades 4.12% versus our 3.85% -- no wonder the euro has become a collector’s item.

The Fed’s critics insist that its rate cuts are the cause of dollar decline. This argument is an ancient, gold-standard relic. If your nation ran a big trade deficit, and your currency weakened, and you began to hemorrhage gold, the only cure was to jack your rates to slow your economy so that your people could not afford to buy imports. In the modern, post-gold world (since 1972), trade deficits have tended to self-correct: the currency of the excessive importer lost purchasing power, and imports fell.

The rate-critics fail in endgame. Let’s suppose the Fed had raised its rate last week a percent or two. The dollar would have rocketed. Defended! For a while, until an already caving economy caved altogether, at which point the Fed would have to cut rates deeper than in the first place, triggering a dollar dive worse than the original.

When we hit economic bottom and begin recovery, the dollar will find better ground.

Trade flows are the real cause of structural dollar trouble, and our trade deficit in turn has two sources not imagined in classical economics: “managed trade” and oil.

The historical method to engineer a trade surplus (and allegedly to protect domestic industries) has been to tax imports by tariff. The Japanese invention after WWII was the “non-tariff” trade barrier: while pretending to embrace free trade, it was un-Japanese to buy foreign products. Likewise un-Malaysian, un-Korean, un-Taiwanese, un-Chinese -- all very much unlike the balanced trade conducted by Europe and Latin America. Our Pacific Tiger “partners” resist our exports by willful avoidance having nothing to do with currency or price advantage, running constant surpluses with us in the range of 7% of their GDPs. Oblivious, we pursue free trade, and are fleeced.

The second source of dollar trouble, oil... I do not know of a nation ever more dependent on importing a single commodity than we are (Rome and grain?). Do the math: 13.5 million barrels per day at $100/bbl = $492 billion this year.

And you jackasses want to blame the Fed for a weak dollar?

Long-term rates are about as-were last week, close to post-January highs: 30-year-fixed mortgages just above 6%, the 10-year T-note 3.82%).

However, the situation is changing and thick with propaganda. The keys: the difference between a retreat from panic and return to health, and rising global inflation.

New claims for unemployment insurance topped again at 375,000 last week and this week fell back again to 342,000 -- on edge, but on the right side of it. Stock market types were pleased at stability in March orders for durable goods, and downright thrilled that Ford made a profit last quarter (silly: made $100 million, lost $15.3 billion in ‘07).

The media are having a wonderful time mis-reporting housing conditions, ooing and ahhing every time Robert Shiller shouts “Fire!” in the theater. Last week he predicted (again) a “30% decline in housing prices.” All of them, Robert? Uniformly? Average? Do the math: if half the nation’s homes stay price-flat, the other half must fall 60%. Is that it? Or did you mean to say decline 30% in a few places? Some individual projects are off more than 60% right now (a FL condo or two... AZ and CA land), but the worst dozen mini-metro areas have yet to decline as much as 20%.

In authentic data, OFHEO found that home prices measured by appraisal and weighted by location (CA more than ND; NY more than AZ and NV combined...) rose .6% from January to February. Sales of existing homes are sliding gently, but still moving at a five million annual clip. Sales of new homes are off 37% in the last year, down to a half-million, but that is good news -- the less new inventory, the better.

Yelling “Fire!” is a bad idea, but so is telling the audience to stay seated when smoke is pouring from the ventilator. Headline stories all week long: the Crunch is over, credit markets are improving. Irresponsible nonsense.

Distress is measured by interest rate spreads between safe stuff and not, and availability of credit. We have seen nothing more than a pullback from panic: the 2-year T-note has run up from 1.70% to 2.36%, sensible as the Fed at 2.25% is about to pause its rate cuts (keep some dry powder, guys). The Treasury/junk spread has contracted from no-market 8.6% to merely disastrous 7%. Retail mortgages are still 2.50% above Treasurys, almost a point out of line, and no real market for Jumbos or any other securitized credit. Tax-exempt munis paid 1% over taxable Treasurys last month, and now pay the same -- improving from schizophrenia to clinical depression. The international bank-to-bank Libor spreads are still widening.

All now hangs on the real economy. The financial fire is contained, but the system is terribly vulnerable if a real recession develops, and it has not yet: GDP growth here is probably still above zero. The consumer is in real trouble (the Reuters/UofM confidence measure Friday fell to a 1982 low), but the Big end of business feels no pain, pulled along by trash-dollar exports and wildly overheated Asian and Emerging economies.

Lost in housing and “subprime” myopia, and domestic navel-gazing: the global rise of terrible inflation, nothing like it since the 1970s. $120 oil will have its consequences. Here, wages capped by foreign competition, food and energy inflation is slowing the economy; Asia/Emerging are in a runaway spiral. Recent annualized figures: China 9%, India 7% (doubled in six months), Philippines 6.9%, Vietnam 19.4%, Singapore 6.5%, Russia 12.7%, South Africa 9%, Saudi Arabia 8.7% (highest since the ’82 oil spike).
There are only three antidotes: the mad good fortune of a commodity collapse, or central-bank induced slowdown, or the ultimate violence of market-induced slowdown.

Global central bankers are cornered, best shown by the Bank of England’s meeting last week. UK GDP in the 1st quarter “grew” by 0.4%, mortgage approvals are down 50% in a year (reduced demand unmet by broken financial markets), but inflation is out of 3% bounds... what to do? The BOE voted 1-6-2 to cut its rate from 5.25% by .25%: one for deeper, six were in favor, and two opposed any cut.

The Fed this week may look a lot like that.

Psychology on the Street changed completely last week, to economic optimism and concern for inflation, and assumption that the Fed is done with rate cuts or will be shortly. Low-fee, fixed mortgages were 6.375%, jumping with all interest rates, long and short. The Fed-forecasting 2-year T-note soared from 1.70% to 2.24%.

Last week, “credit” appeared only in sentences including this clause: “The worst is over.” The worst probably is over for write-downs of the abysmal “structured securities” of the 2001-2007 era.

However, euphoria at that prospect masks these things: the financial system is still too busted to function properly, credit is extremely scarce and expensive, the system is terribly vulnerable to recession-cycle credit loss ahead, and inflation here, there, and everywhere is forcing global economic slowdown.

The loopy reply from the stock market: Business is great! Earnings are down but are headed up! Global trade will fix everything!

Let the data talk. The opening line in the Fed’s April beige book: “Reports from the twelve Federal Reserve Districts indicate that economic conditions have weakened....” In the Fed’s lexicon, a slow economy is “mixed,” one turning sour is “soft,” and one in trouble has weakened. The Fed does not use the term lightly.
Retail sales were .1% positive because of higher gasoline prices (ick); industrial production upticked a .3% hair, capacity in use hanging at 80% stall-speed.

New claims for unemployment insurance are also at an edge, about 375,000 weekly; extended claims rising near 3 million signal recession. CPI was okay: overall .3%, core .2%.

The Street’s party rests on good results at IBM, Google, and Caterpillar, and coulda-been-worse financials: Merrill wrote down only $6.6 billion, Citi only $16 billion. Only.
Give the financials this: despite the huge write-downs consuming most of the new capital raised by the two firms, their losses net of write-down were $1.96 billion and $5.11 billion, respectively, which means their current operations are making good money. In time they will re-capitalize themselves. In time for the economy?

The commentariat this week, even informed non-spinners, has announced “relaxing” of the Crunch, “normalization” beginning. They are partly correct, but not the part that matters to the economy. The Bear Stearns lesson is sinking in: no large institution will be allowed to fail, here or in Europe or anywhere.

Central banks will not allow it. So, big money fearful of that event has stopped its panicked buying of Treasurys (even gold), begun to unload, and up rates have gone.

Nevermind that they were worried about the wrong thing. The Crunch is still full-on: the spread between retail mortgages and the 10-year Treasury is still 2.50%, at least .80% out of line.

Fixed-rates in the mid-sixes intercept housing recovery, eliminate the benefit of payment-reducing refis to crimped household budgets, and makes ARM-escape impossible. The Jumbo market is still completely broken, and the new mini-Jumbos are a high-priced joke. Issuance of securitized credit of all kinds is at standstill.

In the broad credit markets, Libor is the global mark for all short-term borrowing. The WSJ last week discovered the Libor-setting British Bankers’ Association had for months conspired to understate the wildly high true cost: three-month dollar Libor is 2.91% on Friday (really) versus 90-day T-bills at 1.43%, five times a normal .3% spread.

The Treasury/Libor spread (called the “TED” spread for ancient reasons, Treasury/Eurodollar) has always been considered a default-risk measure: ultra-safe Treasurys versus unsecured bank-to-bank loans. We know now that no one need fear a major institutional failure, and so the heart of the Crunch is coming clear: Libor is high-cost because loans are scarce. Same for mortgages. Pure supply/demand.

How can loans be scarce with the Fed hosing loans into banks? Because system captial is impaired. There isn’t enough capital to support current loans outstanding, let alone new ones.

How the economy makes it through a slow, grinding recapitalization without adequate credit... that’s the question. That part of the worst is not over at all.

More news of a slowing economy Friday pushed money away from stocks and toward Treasury bonds, but in the routine since January, not to mortgages. The lowest-fee 30-year deals are still stuck just under 6.00%.

Friday's surprise, a big earnings miss and write-down at General Electric, is disturbing because it indicates the slowdown spreading beyond finance and housing (although GE is an immense financial enterprise). The same contagion showed in the newest small-business index (the National Federation of Independent Business), down in March to the lowest reading since the 2nd quarter 1980. In the 28-year interval, unlike measures of consumer confidence, the NFIB has never recorded a false negative: every index downturn has coincided with recession.

Yet, the crucial indicator for the economy -- jobs -- has yet to break hard. The spike in new claims for unemployment insurance two weeks ago completely reversed last week.

The race is still on: will we get an effective public-policy response to the Crunch before the economy fails, or after? Incredibly, now eight months into this, we are still very much alive. Rattled, angry with one another, but alive. There is still time.

However, public-policy formation this week moved in reverse.

Alan Greenspan, 82, Republican, was once regarded as the finest central banker of all time. Last year. Since his retirement he has frequently offered economic and market commentary, unlike any predecessor -- not particularly harmful, but not enlightening, either, and undercutting the authority of his successor. Since the onset of the Crunch, Mr. Greenspan has been consumed by an effort to defend his record, insisting that markets should be allowed to work unhindered, and regulators should not intercede in excess. Last week he said that he did "not regret a single decision" as Chairman.

Although most of the criticism hurled at Mr. Greenspan is either mistaken or debatable (especially that he kept the Fed's cost of money too low for too long, '02-'04), his term marked the most colossal regulatory failure in American history, the failure to intercept the credit bubble.

Paul Volcker, 80, Democrat, Fed Chairman '79-'87, six feet six inches tall, chewing a stogie always, brutal inflation-fighter, personal creator of the worst recession since the Depression (11% unemployment, 22% prime), no published memoir, no lucrative speaking tour, rose this week to criticize Perfesser Bernanke. He finds the Bear Stearns intervention a bad precedent, and same for emergency financing of Wall Street dealers. Once revered for his courage, he revealed his inner one-track: punishment is good.

Great work, guys.

Dubya returned from Europe to focus on Iraq.

Congress is hard at work to keep people in houses that they cannot afford.

Mr. Bernanke has dark circles under his eyes, and seems to have lost weight.

Treasury Secretary Paulson found the notes he misplaced last month. Too bad. "Those institutions that need capital should raise it." One did: WaMu found some old Texas S&L sharpies who dumped $7 billion into the wreck, structured a deal that pretended not to control the institution, doubled the shares of stock outstanding (stockholders who had already lost 75% of value were "diluted" into loss of half of the remainder), and shut down all of WaMu's mortgage offices and wholesale lending, firing 3,000 very able mortgage personnel in favor of yappers at a "call center."

WaMu is in mothballs, embalmed until the sharpies find the moment to sell the branches and their deposits. "Capital raising" in the marketplace has permanently extinguished yet another source of credit.

In this leadership vacuum, the American people are confused, worried, and pissed, which is the soul of good sense. Except in one respect: the economy is still alive! If we're a little lucky, the people will tire of blame and pretend solutions, and begin to send out the word: "Would you guys get together and fix this, please?"

A steady fade in the job market has renewed concern for recession -- as usual, perversely good news for mortgages, again crossing below 6%.

Payrolls in March contracted by 80,000 jobs, and prior-months' revisions clipped another 54,000. New claims for unemployment insurance spiked by 38,000 to 407,000, the worst week since Katrina. The purchasing managers' surveys showed general business activity neither shrinking nor growing in March, and on a par with February.

The economic decline is slow, but clear. The optimists (found now only on stock-touting CNBC and Fox) have switched from a "no problem" forecast to a short and shallow downturn, and worst-is-over in credit losses. Maybe so, but we continue to believe that a government effort to re-capitalize the financial system will be necessary.

The Crunch chokes on: Oppenheimer says that global debt underwriting has fallen 55% since July (a $2 trillion strangle). In the 1st quarter, global bond and stock underwriting combined fell 45%, issuance of mortgage-backed securities by 82%, and non-rated "junk" bonds by 88%. For those who still buy the Wall Street line that this is all about housing, note that new issuance of state and local student-loan securities, a $330 billion market, in the 1st quarter fell all the way. Zero.

For public-policy junkies, great theater last week. Genuine American heroes appeared before Congress to be flayed.

Since Crunch onset in August it has been hard to evaluate our economic leadership. Perfesser Bernanke has taken action from the beginning, but late, inadequate, and appeared to be detached. That judgment may have been fair through January, but has been mistaken since then. Our apologies: his speech last week (must read, short: www.federalreserve.gov), his opening of the Fed's floodgates in new and essentially infinite amount, his distance from Secretary Paulson in testimony, his refusal this time to guide Congress on fiscal giveaway ("That is your purview..."), his blunt warning of recession, and extraordinary leadership in snuffing the Bear Stearns panic -- together easily the most courageous performance by a Fed Chair since Volcker in '79. Given the lack of public support by the Administration, maybe best-ever.

Timothy Geithner, NY Fed Prez, same deal. Christopher Cox, Security and Exchange Commission Chair, took heat even from Fed colleagues, but he is trapped in an ineffective regulatory structure (one definition of Hell: great responsibility without authority) and showed another form of courage: no illusions, no excuses.

Senators Menendez (D, NJ), Bunning (R, KY), and others, joined by Rep. Ron Paul, the American Ahmadinejad of finance, variously raked, hectored, and needled the heroes for failure to protect the American taxpayer. Of course, they had done exactly that. The heroes' bitterness at the critique -- the lack of gratitude, the willful misunderstanding, the deceitful and cynical grandstanding -- was thinly disguised. A lesser man than Perfesser Bernanke might have left Congress thinking, "The next time I've got 24 hours to stop a meltdown, maybe I should just let it happen. When the markets shut down, visit Congress to ask what I am allowed to do."

The absence of Mr. Paulson (on "previously scheduled" junket to China) was disgraceful, and makes plain who is in pursuit of imaginary market solutions and who is aware of danger and prepared to act. Before his departure, he announced a new plan of market regulation which transparently fails the only test: sufficient power to prevent a replay of this credit disaster. The Street being the Street, a fox guarding the henhouse would be okay; Mr. Paulson is a hen guarding the henhouse.

In a time like this it is the duty of the Chief Executive to explain to the people, to relieve national economic confusion and fear, to mediate collective sacrifice among both parties, and to protect the likes of Bernanke and Geithner, securing adequate authority for them to do their jobs. The President's failure to fly top cover for these men, instead to give priority to another annoying descent upon European allies... unspeakable.

Mortgage rates rose slightly last week, the lowest-fee 30-year from just below 6.00% to a hair above. Spreads still gape versus Treasurys, at 2.50% above the 10-year defying all of the Fed’s latest efforts. 5-year ARMs, both conforming and Jumbo, are better in availability and rate, but both are scarcer and higher than in January.

The economy itself is in a curious place. Friday morning’s report of a half-percent gain in February personal income was head-scratching good news, not squaring with consumer confidence measures at 16-year lows, some components at 41-year all-time lows. Yet, the income gain is consistent with a labor market still intact, no wave of layoffs: this week’s claims for unemployment insurance fell a bit. More in that income report: core inflation is holding 2.0%, just barely.

The credit crunch has not released in the slightest, deepening again in bank-to-bank loan rates, municipal finance an expensive mess, and commercial paper shrinking again. The crunch is obviously spreading sideways among institutions and in Europe and Asia, but community and regional banks feel little pressure except from nervous examiners. The crunch is likely the cause of a rolling collapse of orders for durable goods, down 5.3% in January and another 1.7% in February.

As the crunch spirals downward, the media and politicians are spiraling upward in a self-reinforcing chorus of “No Taxpayer Bailout!”

The greatest hazard at hand is policy error, and today’s policy formation is proceeding exactly as did the 10-year S&L denial waltz.

Examples. Bear Stearns was “bailed out” or “rescued.” Like hell it was: it was liquidated. More than half of its 12,000 employees will lose their jobs, stockholders lost 94% of value, and senior officers and directors are gone. The Fed will babysit $29 billion in the worst toxic waste, and wreckage-acquiring Morgan-Chase will retain all other liabilities including litigation. The only people bailed out, rescued: taxpayers saved from the effects of a massive fire sale.

The Fed has arrogated no new powers in this and other measures since August, and done nothing inconsistent with its 1913 charter, yet media and polls sound like the Casablanca inspector: “Shocked! I am shocked!” Of course, the major problem in this ongoing crisis: the Fed has not been able to do new things (like inject capital, as Europeans are doing by the tens of billions right now).

The cautionary S&L tale began in 1978: the nation’s mortgages sat in 7,000 thrifts, funded by cost-controlled deposits. The Depression-era “Reg Q” lid had to come off (obsolete and destructive), but removal was followed by inflation-adjusted oil prices as high as today’s, inflation 2% in some single months, and deposit costs rose far above the mortgage portfolio return. The industry was toast by 1981 and everyone in it knew.

A taxpayer bailout then would have been cheap, maybe $75byn in ‘08 dollars. Oh, no! Can’t do that! Instead, merge busted outfits into strong ones. Two years later, the strong were broke. Still could have rigged a cheap bailout: there was nothing wrong except low market values for low-rate mortgages. Nope, uh-uh.

No, we’ll give the S&Ls new lending and investment powers, and they’ll “grow their way out of trouble.” They grew, all right. By 1987 they had created a $300byn loss on new loans. Policy makers, not quite done, that year made retroactive changes to the tax code that just about doubled that loss, not quite ten times the original exposure.

The “S&L Bailout”, as it is still recorded in national memory, arrived in 1989 with the sales of bonds to be repaid by fees on surviving banks and earnings in the FHLB system (still ongoing) -- not taxpayers. S&L stockholders, employees, officers, directors, and most borrowers were ruined. The only parties bailed out: the depositors. Taxpayers.

This time we don’t have 10 years in which to blunder. That time the economy was insulated from S&Ls -- they could stay liquid even while broke, and by ’83 Wall Street provided mortgage credit. This time... we won’t make it without credit.

Mortgage rates spiked to 6.75% last Wednesday, only Friday sliding back into 6.50% range (these rates with no loan fees). There is good reason to expect rates to fall back, and maybe a long way, but only in the context of effective intervention by Federal authorities.

There is no sign of such intervention at the moment. However, developments soon ahead will attract the attention of officials preoccupied with market solutions, ordinary monetary operations, opposition to any form of “bailout”, wishful thinking, denial, or the view from any of several ivory towers.

Last week marked the transition from a relatively orderly seven-month repricing of credit and reduction of leverage to fire sale. Just plain panicked dumping. The Fed’s Number One responsibility is orderly markets. Beyond inflation or economic growth or any other objective, orderly markets come first: prevent at any cost a disorderly liquidation that leads to chain-reaction systemic failure.

The Fed has failed. As have the Treasury, Congress, and the White House.

The spread between government guaranteed (or effectively so) mortgage-backed securities and 10-year Treasurys reached an all-time, utterly non-economic 3.00%.

The spread between AAA-rated municipal bonds and Treasurys is out of line by 2.00%. These and other credit markets last week for the most part ceased to function, the capital in the banking system effectively exhausted. Scott Simon of bond-giant Pimco, a calm sort whose remarks are usually limited to time and temperature, said, “Everything is telling you that the financial system is broken.”

The good news. We have believed since August that we would get to this place, and then obvious danger would overcome bailout resistance in both parties and the public. A financial accident would wake us up before grave damage would be done to the economy. We have all the tools crafted in the Depression, and in banking crises large and small since. These tools will work, and fast. A fire sale is a collapse of confidence, nothing-to-fear-but-fear-itself; confidence can be restored as fast as it left.

So what kind of accident will do the wake-up trick? The onset of credit-market fire sale is too technical for civilians, but they do get the stock market. The S&P 500 on Thursday broke crucial support at 1320, made a half-hearted rally Friday morning after job-market news that was awful but not disastrous, fell short, and has little “technical” support for about a thousand points. A meltdown like that will get the attention even of the stock market ya-yas so oblivious to this crisis since August.

The obvious onset of recession should have opened the door to Federal action by now, but dissemblers have muddied the moment. Nothing like an honest-to-goodness stock-market crash to clarify the mind. S&P 1283, Dow down 205. Even better: a morning when they ring the NYSE bell, but can’t open the market.

The top Pimco investment officer, Mohamed El-Erian, raided from Pimco by Harvard to run its gazillion-dollar endowment, then raided back by Pimco (the guy is hot) said: “A decision is going to have to be made to cross two lines in the sand: to use the government’s balance sheet, and to breach rights of property and contracts.” The only way to stop a credit fire-sale is by government guarantee and outright purchase of illiquid assets; the contracts are mortgages to be re-worked (We’re opposed to that foreclosure solution, but you can’t have everything).

More good news. Everybody needs something not to worry about: inflation is NOT a problem. Wage growth in the last year has been 3.7%, a half-point below inflation. Huge increases in energy and food costs are compressing spending on everything else, which is deflationary for everything else. Drop a brick with our name on it on the nearest stagflationist: you cannot have sustained inflation without a wage-price spiral.

And another thing: stop worrying about the dollar. Europe is following us into recession, and as global demand falls, we’ll see whose currency is safe.

Mortgage rates have begun a decline from the irrational levels of the last month, now approaching 6.00% and says here likely to cross back into the fives.

Part of the decline is due to deteriorating economic news. The toughest was a surge in new claims for unemployment insurance, up to 373,000, consistent with recession and suggesting that next week’s payroll report will show February contraction. Orders for durable goods tanked 5.3% in January, as have February measures of consumer confidence. Inflation is worrisome, but a soon-to-blow commodity bubble will fix that.

A two-part story today, housing as scapegoat for the failures of others. The real causes of this credit crunch -- still called “subprime” -- and the recession it has spawned are the grotesque failure of structured-finance products on the Street, and failure of oversight by their regulators.

The strange story of mortgage-rate spike and reversal began with the January fable that mortgage-backed securities (MBS) issued by Fannie, Freddie, and Ginnie (the “GSEs”) had become too toxic for investors to hold. That notion made no sense here: these GSE/MBS are as good as Treasurys, no matter what the ultimate default rate of mortgages within (Ginnies are guaranteed by the Treasury, F&F clearly “too big to fail”). The GSE/MBS market is $4.5 trillion, the deepest and most liquid market for anything on the planet except US Treasurys.

Yet, traders said throughout February: “Too many MBS sellers.” The excess on the market was certainly not new loan production. Now we know who those sellers were: big banks and Street dealers, capital impaired, dumping the only liquid assets they have to make room for trash flooding back onto their balance sheets. The back-wash: the remains of deals they sold but agreed to support if “something went wrong.”

The February went-wrong: almost $1 trillion in “auction-rate” securities -- actually good-quality muni-bonds, but held in short-term rollover structures (note: nothing whatever to do with housing or “subprime”). When rollover failed in renewed crunch, an avalanche of illiquid paper hit banks, triggering MBS sales and higher mortgage rates.

The financial press is having a wonderful time ginning-up a housing depression, this week shrieking about new home-price data: “Decline in Home Prices Accelerates” (WSJ), emphasizing the Case-Shiller index, down 8.9% in ’07.

Case-Shiller is designed to magnify home-price declines. Mr. Shiller correctly called the stock market bubble (his book “Irrational Exuberance” appeared on the day of ’00 collapse), and has spent the last several years mis-applying financial-market principles to real estate, gleefully predicting a 30-40% national crash in home prices.

The design flaw: it captures only sales of homes, obviously heavy with distressed transactions. For the authentic story and great methodology, visit www.OFHEO.gov and its All-Transactions House Price Index, which includes repeat appraisals in refinances, by definition free of distress. By that measure, national home prices in the 4th quarter rose by .8%. Prices fell in only 11 states, and in only five of those were declines in excess of one percent. See page 21 of the report for its critique of Case-Shiller.

At the micro level, some spots are in horrible trouble: of OFHEO’s 291 Metropolitan Statistical Areas, 15 had price declines last year in the 10%-19% range (all CA and FL). And the national market is decelerating: of 39 states with positive appreciation in the 4th quarter, 32 had gains of less than 1%.

The key to this unpleasant situation: housing is sinking because of credit starvation, not the other way around, housing wrecking credit markets. No matter what it takes, the supply of credit must be restored to housing and the rest of the economy.

The public policy response is still frozen, Democrats trying to help families who cannot afford their homes to stay in them, Mr. Paulson refusing assistance to the financial system: “I’m not interested in bailing out investors, lenders, and speculators.”

Long-term rates are beginning to trickle back down from the peculiar spike of the last two weeks. The lowest-fee mortgages from 6.375% to 6.25%, the 10-year T-note from 3.90% to 3.80%, the immense spread a measure of deepening crunch.

The data continued a pattern going back to last fall. The job market is holding surprisingly well: new claims for unemployment insurance have been steady for two months at an elevated but non-recession 350,000 weekly. Inflation is real, the core rate way out of bounds at 2.5% complicating the Fed’s life. The Philadelphia Fed’s newest survey continued to indicate recession, this time a longer-term slowdown.

The public policy response to the credit crunch here is paralyzed; not in Europe, where outright bailouts of banks by the dozen are underway from the UK to Germany. Secretary Paulson insists that this adventure is a normal, cyclical re-pricing of credit; he must know otherwise, but does not know what to do. Perfesser Bernanke might as well be on African safari with Dubya -- and would rather be there than face Congressional music Thursday and Friday in a required annual appearance.

Worse than paralysis: the soap-opera focus on preventing foreclosures. The press is packed with truly sad stories, scary forecasts, and grotesque misinformation about the actual situation, cause, and possible resolution.

Americans have deep residual memory of millions of families unfairly foreclosed during the Depression. Lost in today’s mass appeal to that memory: the great difference in circumstance. In 1930, American mortgages were short-term renewable affairs; borrowers had to re-qualify and survive re-appraisal as often as every five years. Even those who still had jobs -- in a time of 25% unemployment -- were often evicted. An Okie parents’ puzzled memory: “Nobody had any money... the banks were gone, and there just wasn’t any money....”

In that awful decade, most who lost their homes did so for no fault of their own, financially healthy households collapsed by external force. That is not today’s problem. To get at the heart of today we must put aside blame and cries of greed and predation among lenders, borrowers, Wall Streeters, investors, all. The sad reality: the vast majority to suffer foreclosure today were weak financial households to begin with.

Until roughly 2000, the dividing line between prudence and foolishness had for 76 years been the underwriting standards of the FHA -- the first long-term loan, invented in 1934 to stop the Depression foreclosures. The FHA allowed low-downpayment loans, only 3%, but you had to prove your income. If your job history looked weak (intermittent, or shaky by classification -- hourly construction, new commissioned sales,

seasonal), you would be declined in underwriting. You didn’t have to have money in savings, but if your new house payment would be higher than the rent you had paid, you either had to prove increased income, or demonstrate by savings that you had enough slack in your rental household budget to afford a higher payment.

FHA market share fell by more than half in the last decade, as did loans made with traditional mortgage insurance, because those lenders maintained income and “payment shock” standards, and lost out to the foolish ease of subprime and Alt-A.

The few households suffering temporary bad luck (job loss, health, divorce) deserve all the “workout” help the system can provide. The inherently weak households will defy every effort. Even extraordinary re-writes will beget re-default, the poorly maintained house creating deeper loss in the ultimate foreclosure, the troubled inventory overhanging the marketplace and preventing recovery.

Policy makers should look forward, not to the last, lost battle: the number-one-prime priority is restoration of an adequate supply of credit. Not just to re-work existing loans, but to enable quality borrowers to buy. If that means the Fed or Treasury entering the market to buy top-quality mortgage-backed securities to drive down this absurd spread to benchmark, then get on with it.

Mortgages struggled to stay as low as 5.75% (more below on the stubborn refusal of mortgages to follow the Fed down).

The biggest news of last week: the off-the-table January ISM survey (the ineptly re-named purchasing managers’ association), one of the very best real-time indicators, the 54-to-41 plunge the worst monthly result ever. A general intake of breath followed, not yet released. January retail sales were the worst in five years; credit cards declined in use and increased in distress; and Wal-Mart reported, sadly, that shoppers are using holiday gift cards to buy necessities -- diapers, pasta sauce, and detergent.

The only questions remaining: how deep and how long the recession?

This one is different in pattern from others (save perhaps ’91-’92 affair, a micro-mini crunch). By summer ’07 consumers were stressed by energy and housing, but the economy was still rolling along when the August Crunch began to tip it over. Standard recessions are consumer-first, then financial and credit trouble; this is vice-versa. Caught by atypical surprise, policy makers have floundered and flinched.

The problem: the August revelation of some $4 trillion in troubled assets. They had accumulated for years under the pretense of performance, but deteriorated steadily since ‘05. Each banker knew his own trouble, and in flash chain reaction each stopped dealing with his peers for fear that they were in as bad shape as he. Crunch.

That crunch was symptom, not cause. Since August we have been in an episode of “House”: while the Fed medicated the interbank symptom, the actual disease worsened, the crunch broadened, the economy deteriorated, and new symptoms forced the Fed into an undignified rate cut. Four times the Fed has cycled this way, patient sinking.

Enter Congress. Treasury Secretary Paulson set up Mr. Bernanke as messenger boy to plead for spending stimulus. New medication, wrong disease. There’s a lot we could do with $160 billion (one-fifth would have re-capitalized the bond and mortgage insurers, preventing perhaps hundreds of billions in write-downs ahead). This package will do nothing for the underlying problem, and was unnecessary: the Federal deficit has suddenly exploded from $150 billion to $400 billion, stimulus aplenty.

Bad ideas are pouring from pols and regulators, trying to get foreclosure toothpaste back into the tube instead of working on the real problem ($4 trillion...). There is no solution to foreclosures; most of these households were bad credits to begin with.

Brand new from energetic but dim Sheila Bair at FDIC: forgive loan balances (Whose? Ours? Please?). Increase the speed of workouts (From zero and pretending, to what?). Senator Dodd: intercept foreclosures by Treasury purchase of bad loans (Why just those?). Mrs. Clinton: freeze rates (ARMs began in 1980, rates fell for 25 years, and the first time rates go up, cancel the contracts?).

Freeze foreclosures for 90 days (What to do on day 91?). James Lockhart, regulator of Fannie and Freddie, working overtime to disrupt their mission (Mr. Power-Freak, we created them for this moment!).

Fellas... look: What are you going to do with the $4 trillion in bad paper? The “plan” seems to be to leave most of it in the banking system, financed by central bank credit. Hapless investors hold an unknown fraction, paralyzed as new buyers of securitized credit. The Fed-reduced cost of money will widen banks’ investment spreads, increase earnings and over time generate new capital. Over time. Meanwhile -- years -- the financial system cannot provide new credit because of the rotting mess in its belly.

Why are mortgage rates stuck up high, at just the moment that housing is desperate for cheap, well-underwritten credit? Banks cannot buy new Fannies, Freddies, and Ginnies because they are short of capital. Rather worse, they face new losses, balance sheets crowded with bad assets. So, they are sellers of the only good stuff they have. Sellers of our stuff. Sellers.

We would very much like to be proven wrong, but the word is “bailout”: extract the rot from the system and put it into a nouveau RTC. Then markets can function.

Contrary to the conviction of deeply confused civilians and reports by lazy news media, mortgage rates are unchanged, about 5.75% for the lowest-fee 30-year paper.

If you don’t believe us, visit www.freddiemac.com and its weekly survey. It is unbiased by sales jive, although it suffers from “survey lag” (early-week data released on Thursdays always misses real-time reality), and assumes a fractional origination fee. Last week’s “5.48%” captured the one-day hysterical bottom when the industry could not log onto rate-lock websites. Last Thursday’s “5.68% plus .4% origination” is still about right, and all but identical to the prior week’s “5.69% plus .5%.”

Yet, the media refer constantly to “dramatically lower mortgage rates.” They are better, but... drama? Freddie’s average for the whole of 2007 was 6.34%. A half-percent drop is nice for buyers, and a help to a few refinancers, but no fire sale.
“How can it be the same...!?!” says the client, after a cumulative 1.25% cut at the Fed in only eight days? Answers follow.

Brand new January economic data are not that bad. Says here not bad enough to justify the Fed’s panic, let alone to anticipate more cuts. Payroll growth slipped to flat in January (negative 17,000 is within the huge range of error and revision), unemployment down to 4.9% in a workforce statistical quirk -- soft, but hardly a recession. The purchasing managers reported their first gain in six months, likewise soft, but with persistent strength in foreign orders. 4th quarter GDP grew by a mere .6%;

however, aside from a temporary drawdown of business inventories grew at 2%.

The Fed’s form is disturbing to long-term investors. Central banking is not figure skating, but Mr. Bernanke has departed his predecessor’s 17 years of gradualism for lurching on the rink. A Fed that will lurch down will lurch up.

Investors bought long Treasurys and mortgages at these levels 2002-2004 because Mr. Greenspan said after every meeting into 2006: Excessive monetary stimulus most likely will be “removed at a measured pace.” Translation: you’re safe for now, and we’ll give you time to get out before we kill you.

In those late Greenspan years, deflation was the problem. Today, inflation is rising all over the world. Australia, 16-year-high 3.8% core; Europe 14-year-high 3.2%; UK 2.6% core; China 6%-plus, and an economy completely out of control beginning to export inflation to us. Each time the Fed has lurched to a catch-up ease, all the way back to August, it has rescued stocks, commodities, oil, gold, and tanked the dollar.

We have chewed on the Fed for its inaction and credit-wreck oblivion. However, this situation is NOT a monetary problem: it is a banking-system near-insolvency that may morph into a recession, each making the other worse. The crying need for six months has been transparency of credit loss and bad-asset firewall. Cuts in the overnight cost of money may intercept recession, but inflation means that these cuts cannot be maintained or removed at a measured pace.

A central bank chairman must be prepared for the ultimate sacrifice: no tough inflation problem was ever solved by slow growth. It takes a recession. It takes higher unemployment and crushing the commodity spiral. To get long-term rates down, Mr. Bernanke must get the good out of this slowdown: he must let it get ugly. Instead he has rescued inflation-pushing markets again and again.

Two non-Fed forces holding up mortgage rates: credit fear about Fannie and Freddie has the spread between mortgages and the all-defining 10-year Treasury (3.57% on the 1st) over two percent for the first time ever. Second, somebody by accident may arrive at an effective credit-wreck bailout: the giant bond insurers, Ambac and MBIA may be resolved in days. If no collapse, then credit fear will give way to inflation fear.

The Fed’s cuts have had a dramatic effect on ARM adjustments, and should revise estimates of housing doom to the better -- also reducing bond-market fear. This month, common one-year Libor-floating loans will adjust DOWN to 5.125%.

Wow. The basics: mortgages 5.75% the week of the 14th – the 18th, Monday the 21st a holiday, Tuesday markets stunned by the Fed’s .75% cut; mortgages early Wednesday morning to 5.375%(!), wholesale rate-locking websites crashed in an hour, mortgages back to 6.00%(!!) by Thursday noon. Citibank wholesale raised its rates nine separate times in 24 hours.

Summary: the economy -- including housing -- is probably better than feared, and we’ll all be okay. However, this was the worst week for economic public policy in our memory. We’ll survive it, too.

The details center on the Fed Chairman, and are not pretty.

First, a crucial concept: bond buyers love recessions and hate rescues. As the economy faints, bond players join a frightened scramble into bonds for safety, and make a great deal of money IF they can sell the bonds before the Fed rescue. If the Fed looks too easy too quickly, bonds reverse in self-protection.

A properly conducted Fed rescue must be delicate because rescue depends on lower long-term rates, not just the short-term ones that the Fed controls. Precedent is more important to the Fed than to the Supreme Court. If the Fed moves in stately, predictable, and dignified fashion, long-term rates will follow, even though reversal one day is inevitable. This economy needs lower long-term rates than any in modern times.

Last Thursday, Mr. Bernanke went to Congress to ask for a stimulus package “quickly.” A Chairman without confidence in his own resources immediately destabilized markets all over the world (Dow down 400 that day). The Fed Chairman never, ever goes to Congress to ask for stimulus: that’s the Administration’s job. The Chairman must stay in his tower, appearing confident, in charge, able to respond to any emergency, any and all doubts a state secret.

The destabilization worsened worldwide on our Monday holiday, futures indicating a down-500 Dow open on Tuesday. When the Fed cut .75 (to 3.50), the first assumption was that it knew of some new credit disaster. Like a man after a car accident patting himself, looking for injury or blood, markets took inventory. Nothing. The only reason for the timing of the ease was to support the stock market -- as Bernanke had done in August on purpose, and by accident in December. His extreme action, unprecedented in the entire history of the Fed, was notably not joined by any other central bank.

After that injury inventory, we thought maybe Bernanke had panicked -- soiled his skivvies as no Chairman before. Now... We think oblivious, or maybe a combination of the two. He has shown political ineptitude from the first months in office (blabbing intentions to a pretty reporter at a party), and does not appear to have learned a thing.

The consequence of random, academic-in-a-china-shop behavior: an already fragile and illiquid bond market raised rates and slowed trading.

The stimulus package has had similarly destabilizing results. At best it will be harmless. More likely, late, adding stimulus after the need has passed. The new mortgage limits, $625,000 for Fannie and $750,000 for FHA, will be intercepted by a 125%-of-median-prices lid in each Metropolitan Statistical Area. Out of 156 MSAs in NARs database, only 20 will benefit. In Boulder CO, the City has a home price median near $550,000, but the whole MSA is $367,000, hence a new Fannie/FHA limit (maybe -- not final) of $460,000, an undetectably minor help.

Good news: short term rates are so low that ARMs are adjusting down, into the 5s. Prime-based HELOCS are adjusting down from the mid-8s to low 6s. The whole of Wall Street thinks that home prices will fall to a clearing price, and they won’t -- foreclosures will rise for years, but Bubble Zone prices may well bottom this year.

Pending news: the Fed meets this week (Saints preserve us...), and mortgage-defining jobs data on Friday. Ultimately the economy drives rates, loopy Fed or no.

Long-term rates are unchanged this week, about the only things in finance that are. The 10-year T-note is still in the 3.80s, mortgages 6.00%, 5.875%, 6.00%....
Two big speeches (Treasury Secretary Paulson and Chairman Bernanke) and the demise of Countrywide overshadowed news of a steadily weakening economy and credit trouble spreading outward from mortgages.

The newest consumer data arrived in December retail results, uniformly lousy, and ATT described a pullback in consumer spending on the most basic services. American Express -- good, tough, old outfit -- is the newest to announce rising defaults.

Countrywide. Its borrowers in process, and sellers and Realtors nearby all should feel relieved. Fundings are now secure.
However, BofA’s acquisition has all the fingerprints of a liquidation, one in the interests of banking regulators to avoid the collateral scramble and firesale inevitable upon the instant of bankruptcy. The idiot stock market soared on the acquisition news on Thursday, and reality dawned today: BofA’s stock is down, its credit-risk premium up, Moody’s considering a downgrade.

So, what’s the benefit of this deal to BofA, good money after the bonehead $2byn infusion into Countrywide last September? First, good will and blessings from the whole regulatory apparatus. No other institution had the strength left to absorb the Countrywide wreck, and good deeds beget future favors. BofA’s September infusion may have bought it control, but system conditions have deteriorated so badly since that it need not have paid a dime -- regulators would have come to call, hats in hands.

Deconstruct the deal. The prize inside Countrywide is its loan servicing portfolio; right now a migraine, but $1.4 trillion in mortgage customers is a huge base of clients who instantly become BofA pigeons. Loan servicing has a common market value in excess of 1.5%; even if this pool is discounted for bulk and trouble to 1%, that’s $14 billion in value.

BofA is paying $4 billion for the overall wreck, meaning Countrywide minus its servicing portfolio has a negative value of at least minus $10 billion. Its dinky “bank” (really an S&L, easier regulation) is leveraged to the eyeballs and probably has a net-loss portfolio; and the insurance and securities and other tacked-on businesses only have value if originations run hot (not).

The massive origination arm has negative value also. Absent the fee-rich subprime and option ARM game, Countrywide is a low-margin, commodity Fannie-Freddie shop just like the rest of us. BofA needs another brand name like a moose needs a hat rack, and assumes future losses from litigation, portfolio, and downsizing. A lot of branch landlords are going to have some re-leasing to do.

Thus an industry re-sizes capacity from all-time-fantasy down to actual demand. Expect Washington Mutual to follow the merge-out parade.

The speeches. Mr. Paulson offered nothing, and the no-show hurt the markets. His gratuitous advice that firms re-capitalize ignored their grave difficulty in doing so.

Mr. Bernanke looked haggard. He has studied Class-A financial crises his whole life, but leading the Western banking system out of one is a different matter. The speech is an excellent read. He is under no illusions: “...The financial system remains fragile” [!!]. Long sentence, third para from end, after many promises to intervene to save the economy: [compressed] “However... unmoored inflation or eroded Fed credibility could reduce the Fed’s ability to counter shortfalls in economic growth.”

He is stuck: slash rates and take the inflation risk? Or fight inflation and let the economy fend for itself -- and become the most hated man in America?

If he cuts dramatically to save the economy, look for mortgage rates to rise. That’s the largest probability, now, political pressure on him too strong to withstand.

Long-term rates have fallen to the mid-December lows, and show almost every sign of going lower. The 10-year Treasury has reached 3.83%, and the lowest-fee mortgages are 5.875%.

The immediate drivers of decline: nosedives in brand-new data for December. $100 oil got the ink on Wednesday, January 2nd, but the bond-market mover was the purchasing managers’ manufacturing survey at 47.7 -- a five-year low, below the “50” breakeven level into contraction, still a hair above the 44 level marking recession. Today’s payroll data... maybe a hair above recession, maybe not: December unemployment jumped to 5.0%, the .3% leap the largest single-month in twelve years; and payrolls gained a meager 18,000 jobs, government-heavy, the private sector declining.

Not quite off the table-edge: hourly earnings actually increased at a 5% annual slope; and the service-sector purchasing managers’ survey is still positive at 53.9.
We don’t see any market mechanism that would intercept a significant slowdown, now. A recession might or might not ensue -- technically two consecutive quarters of negative GDP growth -- but the December pattern is not likely to reverse. The credit crunch is still in place, clenching gradually tighter and tighter, more than counteracting the Fed’s rate cuts thus far.

So, for mortgage rates, what’s with the “almost” in the lower forecast?
The one thing that could mess up a drop in mortgage rates to the low fives, maybe breaking the 5.25% ’02-’04 bottom: a rescue. There is only one that would work: the asset-firewalling bailout of the financial system recommended here for months, but the public is still far too angry at bad actors for that. Which leaves bad ideas for rescue.

Friday, Chairman Bernanke and Secretary Paulson met with Mr. Bush at the White House. Oh, to be a fly on the oval wall. Did the visitors tell Dad what happened to the family car, or will equivocation and procrastination prevail? This administration leans to market solutions or tax cuts. Fiscal stimulus might be in order, following Larry Summers “Three T’s” rule: timely, targeted, and temporary. Quickly cutting FICA taxes to zero below a certain income limit is a reasonable, never-tried idea, but Dubya and this Congress will never get a tax cut done in time, or properly.

The only other non-bailout rescue is monetary policy. Translation: BIG cuts in the 4.25% overnight cost of money, and going inter-meeting -- the January 30 and March 18 schedule is a long time to wait.

Here is the compound and circular problem with that rescue: the bond market won’t like the inflationary consequences. The economy and especially housing need lower long-term rates; if the Fed appears to abandon discipline, long rates will rise no matter how far the Fed cuts. As morning trading wears on, that very thing is happening: bonds are losing early gains.

We have struggled to understand the Fed’s silence since August, and its apparent failure to comprehend the magnitude and consequences of the credit crunch and to act accordingly. Re-reading the testimony, plowing through recent meeting minutes leads to an alternate theory, down William of Ockham’s road to simplicity of hypothesis (“Ockham’s Razor”). Mr. Bernanke is neither blind nor passive. When the Fed said in October that risks to growth and inflation were balanced, he meant exactly that. Both risks were awful, still are, but inflation is the more dangerous of the two.

The appropriate Fed policy cannot be discussed in public. No Chairman can tell the American people: “We will be slow to ease on purpose, following the economy downhill, making no effort to pre-empt recession until inflation is clearly under control.” A Chairman can embark on a public fight against inflation only when the public feels its pain; Bernanke must engage in brinkmanship to hold inflation below the 2% bound -- a priority on nobody’s screen except bond investors.

It’s the only way to get long-term rates down, and to achieve a durable rescue.

The monthly real estate market update provided above should be used for informational purposes only. The information is deemed reliable but not guaranteed and is based on Information from Metrolist, Inc. for the period reported through the report dates. Representation is based in whole or in part on data supplied by Metrolist, Inc. does not guarantee nor is in any way responsible for its accuracy. Data maintained by Metrolist, Inc. may not reflect all real estate activity in the market.