Today's Opinion Picks July 6, 2009

Comment: I don't read the blog by Garth Turner, out of Canada, often, but I really like this piece below and he's an excellent writer. And, I recently responded to Garth in another blog's comment section, suggesting that the Fed and government can and will do anything in their power to fight deflation. So, it made me happy to see this well-written piece which may or may not have had anything to do with my comment to him.

Juxta

Historians may rue that, in the early 21st Century, as the planet reeled under three times its sustainable population, the climate tipped towards the irreversible, a fossil fuel-driven economy ran out of reserves and a billion faced hunger as foodstocks were diverted to run cars, young couples would sacrifice all for a mortgage. That is, I guess, if there’ll be historians. Anyway, here’s an interesting juxtaposition for you between the young who have wants, and no resources, and the mature who have funds, and smarts:

From this week’s Georgia Straight (which used to tell it straight):

For a week after they signed the papers on their Douglas Park townhome, John Morettie and Jessica Wilson felt nauseated with anxiety. Like about 40 percent of first-time home buyers, according to Statistics Canada, the couple waited until their 30s to dive in. On the one hand, they now have enough money flowing in to afford a Vancouver-sized mortgage. On the other, they need more space than a typical box-in-the-sky condo provides, due to a work-at-home situation and the imminent possibility of kids. So thanks to a once-in-a-lifetime low interest rate, they snagged a home.

The facts: John and Jessica lived in an apartment for which they paid $1,800 in rent. When mortgage rates temporarily dipped to 2.75%, they figured they could afford to ‘buy’ – which actually meant they could afford to rent a steaming pile debt.

“But we don’t have a lot of [wiggle] room,” he said. “We can go up to four percent, but then we’re done.” Oh crap.

Actually, it appears the two moist children borrowed $600,000, with monthly payments of $2,221. Plus property taxes, house insurance, mortgage insurance, amortized closing costs and maintenance, they will likely see a monthly carrying cost of at least $3,000, or 65% more than they paid to rent a home. The best part: they’d been offered $850,000 in financing. But not to wory. The executive director of the Mortgage Brokers Association of B.C. (Tamera Olsen) said, “I don’t think anyone wants to see what happened in 1981. The lenders are aware; they don’t want to see anyone lose their homes.…What I’m hearing is that any increase in rates will be gradual. Very gradual.” Maybe someone should tell Tamera that lenders do not set mortgage rates. But perhaps that’s a little technical for her. And where did she ‘hear’ what interest rates will do? Ben Bernanke on Twitter? Meanwhile John and Jessica might want to know payments on the $600,000 mega-loan, amortized over 35 years (meaning virtually no equity is being built up) can double to more than $4,200 if rates return to 8% – which is still a tad below the historic norm for the last two decades. It’s also twice the point at which they’d be financially screwed.

Now, this:

Mr. Turner: I have read your Real Estate book and followed your financial advice for several years. My question is simple… I am 45 years old with about one million dollars in cash. I have been waiting for the real estate market to collapse but each time it starts heading south the Government steps in to change the rules…whether it be extending the legal duration of a mortgage, or reducing the amount required for a downpayment, or most recently slashing interest rates and thereby making mortgages cheaper. So it would seem that now we have just about EVERYONE who has thought of getting into the market in…speculators, 1st time home buys…everyone. and many of these people are the greater fools because the prices have not retracted much compared with other countries around the world. My question is this…does our government make their policies to protect the dumbest Canadians out there? Is there a chance that real estate will ever be allowed to fall? Will the government resist raising interest rates to keep inflation in check now because it would cause havoc in the real estate market (prices dropping, foreclosures everywhere)? What would you suggest I do? I don’t want to rent for the rest of my life. — Dave

Well, Davey the millionaire, you did not get all that money by being naïve. So, you know the answers: Absolutely, the government will do everything in its power to distort the marketplace, tilt the playing field in favour of the John & Jessicas of this world, encourage a rapid plunge into debt and aggressively discourage people like you from saving money. Since our economy is essentially unsustainable, it can only maintain the semblance of status quo through growth. That growth gives ever-larger tax revenues, allowing the government to augment, and citizens and corporations to maintain debt payments with marginally increased incomes. When growth falls to zero or (as today) into slightly negative numbers, it is called a ‘recession.’ If it drops to 90% of former growth levels, it is called a ‘depression.’ Governments in Canada, the US, Europe and most of the rest of the world are currently doing everything they can to encourage borrowing and spending, in order to create demand and growth. The techniques include dropping interest rates to almost zero, deficit spending, printing new money, massive bailout loans to corporations, tax cuts to individuals, grants to new homebuyers and the propping up of unstable and failing companies and sectors in order to maintain jobs which will not last. But, Dave, you know this. You have no debts, and a million dollars. You are a deity. Wait.

Comment: A month ago I wrote an article on Seeking Alpha about negative interest rates. They make a lot of sense to me in a deflationary environment. I don't see why people get so bent out of shape when they are mentioned, because they are not unlike inflation in reverse, as nation's want that continued devaluation of the currency one way or another. The following is an excerpt from Edward Harrison, of Credit Writedowns which sums the Sweden move nicely:

Sweden: negative interest rates and quantitative easing
by Edward Harrison

So, here’s what the Swedes are saying:

1. Economic activity abroad is very weak and this hits Sweden hard. That means the Swedes can’t export their way to prosperity because no one is buying. Everyone is in a synchronized global downturn. One subtext I should mention is that Sweden is greatly affected by the collapse in the Baltics because there was a huge trade flow and banking relationship between Sweden and the Baltics. Therefore, the economic depression there is not good for the Swedes or their banking system.

2. A lower repo rate and repo rate path are needed to counteract the fall in production and employment and to attain the inflation target of 2 per cent. Output and employment in Sweden is so weak now that it is creating deflation. We have to lower interest rates in an effort to stimulate borrowing, which we hope increases credit and ultimately production and employment.

3. The Riksbank’s assessment is that after cutting the repo rate to 0.25 per cent it will have reached its lower limit in practice, and that the situation on the financial markets is still not completely normal. Look, we are cutting rates as low as they can go, effectively zero. And financial markets are still not normal. Banks just are not lending enough to create the credit in the system necessary to increase production and employment.

4. The Executive Board of the Riksbank has therefore decided to offer loans totalling SEK 100 billion to the banks at a fixed interest rate and with a maturity of 12 months. Because cutting rates, the policy tool we prefer, is not getting the job done, we are going to effectively print money out of thin air. We will start making loans to banks with fictitious money that we create solely to increase the amount of money in circulation in a desperate attempt to increase consumer and business credit, consumer price inflation, and output.

5. The deposit rate is at the same time cut to -0.25 per cent. And as an extra measure, we will start penalizing banks for not lending by charging them 0.25% for holding deposits at the Riksbank. Now, they will have every incentive to start lending…we hope.

Pretty aggressive plan, if you ask me. Will it work, though? Well, first of all, most every major central bank in the world, certainly the biggest: the Americans, the Eurozone, the British, the Swiss, and the Japanese, have rates near zero and are printing money. The world is awash in money and the incentive to borrow is huge. So, is the Swedish announcement qualitatively different? On some level, it is not. Nevertheless, it is the most aggressive policy and the fact that they are charging negative interest rates for deposits is unprecedented. This does make events in Sweden something to watch. Sweden Key Figures Moreover, the situation in Sweden is bleak. GDP is expected to contract 5.4% this year and inflation is expected to be negative. Clearly, the Swedes are in a deflationary spiral. It doesn’t help that its banks lent recklessly to the Baltics and that those countries are imploding.

Comment: I love concise, synopsis articles that are simple to understand, like the following. He never used the word deflation, but I think that's fairly obvious. I'm doubtful that things will turn around and be inflationary in 2-3 years. Bill Gross just said it will take at least "a generation" of a "new normal" in this month's newsletter.

No Signs of Economic Recovery in Sight
by Michael J. Golde

Here is just a sampling of signs that the economic recovery is nowhere is sight:

• California is issuing IOUs for billions of dollars of current obligations. State workers to be furloughed three days per month.
• Unemployment rate hits 9.5%, with 467,000 jobs shed. Job losses accelerating from previous month with estimates for unemployment to exceed 10% up to 11%.
• Automobile sales are still suffering despite massive incentives. Consequently, gross margins are being compressed. Sales without profits is not a recipe for long-term survival. Lear (LEA) and other suppliers to file for bankruptcy relief as sales slow and margins disappear.
• Once the current buyers of vehicles have bought at heavily discounted prices, sales will continue downward cycle as all who could afford and wanted to buy will have already done so.
• People who are unemployed or who fear job loss are not going to buy cars or fund an economic recovery. This is a nonsensical fallacy.
• The recent stock market rally is not based on improving fundamentals. It is based more on the herd mentality of Wall Street. The investment laggards must buy into the fool's rally to supposedly avoid falling further being competitors.
• Unfortunately for them, their clients are not going to participate in the recent rally; instead, they will suffer further losses as the market retreats.
• The FDIC has already shut down more banks this year than last year in its entirety by a factor of two.
• Home prices are still declining. The only increase in home sales relates to foreclosured properties or those in the midst of foreclosure.
• Consumer credit is constricting at a rapid pace and banks reduce credit risk and the cost of that reduced credit is ballooning. Hardly the condition for a return to prior consumer buying habits.
• The U.S. dollar is being continually devalued due to outrageous defecit spending. The value of the dollar versus other currencies will continue to decline if the profligate spending continues. It may already be too late to stave of a tidal wave of inflation once the world economic recovery returns in full force, two, three or more years from now. Don't expect an economic recovery until unemployment begins to decline for a substantial period of time and consumer credit eases.
• China has already indicated its intention to rely less on the dollar as the sole global reserve currency. As that movement expands, borrowing costs for the U.S. will continue to rise.
• The American taxpayers is being stressed to the max even before the cost of a new health care system and of environmental "cap" and "trade" are factored in.
• Similar to California, state governments throughout the country are on the brink of collapse due to the failure to align actual current revenues with prior outdated prognostications of revenue. State legislators lack the political backbone to curtail spending even in the face of economic catastrophe AND just as every individual household must do when sources of income decline.
• There are no "green shoots" of any lasting consequence. Whatever "green shoots" supposedly existed were manufactured by government manipulation of our capitalist system.
• When the government no longer respects contracts or the rule of law that has governed business relationship from time immemorial (with few exceptions) in favor of general notions of the public good or socialist tendencies, we are not fomenting the conditions for economic recovery but just the opposite as entrepreneurs and businesses can not rely on the sanctity of their negotiated arrangements.

New Evidence on the Foreclosure Crisis
by Stan Liebowitz

What is really behind the mushrooming rate of mortgage foreclosures since 2007? The evidence from a huge national database containing millions of individual loans strongly suggests that the single most important factor is whether the homeowner has negative equity in a house -- that is, the balance of the mortgage is greater than the value of the house. This means that most government policies being discussed to remedy woes in the housing market are misdirected. Many policy makers and ordinary people blame the rise of foreclosures squarely on subprime mortgage lenders who presumably misled borrowers into taking out complex loans at low initial interest rates. Those hapless individuals were then supposedly unable to make the higher monthly payments when their mortgage rates reset upwards.

But the focus on subprimes ignores the widely available industry facts (reported by the Mortgage Bankers Association) that 51% of all foreclosed homes had prime loans, not subprime, and that the foreclosure rate for prime loans grew by 488% compared to a growth rate of 200% for subprime foreclosures. (These percentages are based on the period since the steep ascent in foreclosures began -- the third quarter of 2006 -- during which more than 4.3 million homes went into foreclosure.) Sharing the blame in the popular imagination are other loans where lenders were largely at fault -- such as "liar loans," where lenders never attempted to validate a borrower's income or assets. This common narrative also appears to be wrong, a conclusion that is based on my analysis of loan-level data from McDash Analytics, a component of Lender Processing Services Inc. It is the largest loan-level data source available, covering more than 30 million mortgages.

......A simple statistic can help make the point: although only 12% of homes had negative equity, they comprised 47% of all foreclosures............ Many defaults could be mitigated if homeowners with financial resources know they can't just walk away. We are at a crossroads where we can undo the damage to the housing market by strengthening underwriting standards in a reasonable way. But to do so political leaders must face up to the actual causes of the mortgage crisis, not fictitious causes that fit political agendas and election strategies.

Public Pensions Cook the Books
By ANDREW G. BIGGS

Here's a dilemma: You manage a public employee pension plan and your actuary tells you it is significantly underfunded. You don't want to raise contributions. Cutting benefits is out of the question. To be honest, you'd really rather not even admit there's a problem, lest taxpayers get upset. What to do? For the administrators of two Montana pension plans, the answer is obvious: Get a new actuary. Or at least that's the essence of the managers' recent solicitations for actuarial services, which warn that actuaries who favor reporting the full market value of pension liabilities probably shouldn't bother applying. Public employee pension plans are plagued by overgenerous benefits, chronic underfunding, and now trillion dollar stock-market losses. Based on their preferred accounting methods -- which discount future liabilities based on high but uncertain returns projected for investments -- these plans are underfunded nationally by around $310 billion.

The numbers are worse using market valuation methods (the methods private-sector plans must use), which discount benefit liabilities at lower interest rates to reflect the chance that the expected returns won't be realized. Using that method, University of Chicago economists Robert Novy-Marx and Joshua Rauh calculate that, even prior to the market collapse, public pensions were actually short by nearly $2 trillion. That's nearly $87,000 per plan participant. With employee benefits guaranteed by law and sometimes even by state constitutions, it's likely these gargantuan shortfalls will have to be borne by unsuspecting taxpayers. Some public pension administrators have a strategy, though: Keep taxpayers unsuspecting. The Montana Public Employees' Retirement Board and the Montana Teachers' Retirement System declare in a recent solicitation for actuarial services that "If the Primary Actuary or the Actuarial Firm supports [market valuation] for public pension plans, their proposal may be disqualified from further consideration."

Scott Miller, legal counsel of the Montana Public Employees Board, was more straightforward: "The point is we aren't interested in bringing in an actuary to pressure the board to adopt market value of liabilities theory." While corporate pension funds are required by law to use low, risk-adjusted discount rates to calculate the market value of their liabilities, public employee pensions are not. However, financial economists are united in believing that market-based techniques for valuing private sector investments should also be applied to public pensions. Because the power of compound interest is so strong, discounting future benefit costs using a pension plan's high expected return rather than a low riskless return can significantly reduce the plan's measured funding shortfall. But it does so only by ignoring risk. The expected return implies only the "expectation" -- meaning, at least a 50% chance, not a guarantee -- that the plan's assets will be sufficient to meet its liabilities. But when future benefits are considered to be riskless by plan participants and have been ruled to be so by state courts, a 51% chance that the returns will actually be there when they are needed hardly constitutes full funding.

Public pension administrators argue that government plans fundamentally differ from private sector pensions, since the government cannot go out of business. Even so, the only true advantage public pensions have over private plans is the ability to raise taxes. But as the Congressional Budget Office has pointed out in 2004, "The government does not have a capacity to bear risk on its own" -- rather, government merely redistributes risk between taxpayers and beneficiaries, present and future. Market valuation makes the costs of these potential tax increases explicit, while the public pension administrators' approach, which obscures the possibility that the investment returns won't achieve their goals, leaves taxpayers in the dark. For these reasons, the Public Interest Committee of the American Academy of Actuaries recently stated, "it is in the public interest for retirement plans to disclose consistent measures of the economic value of plan assets and liabilities in order to provide the benefits promised by plan sponsors."................

California’s Nightmare Will Kill Obamanomics
by Kevin Hassett

......Obama has bet everything on passing health care this year. The publicity surrounding the California debt fiasco almost assures his resounding defeat. It takes years and years to make a mess as terrible as the California debacle, but the recipe is simple. All that you need is two political parties that are always willing to offer easy government solutions for every need of the voters, but never willing to make the tough decisions necessary to finance the government largess that results. Voters will occasionally change their allegiance from one party to the other, but the bacchanal will continue regardless of the names on the office doors. California has engaged in an orgy of spending, but, compared with our federal government, its legislators should feel chaste. The California deficit this year is now north of $26 billion. The U.S. federal deficit will be, according to the latest numbers, almost 70 times larger........