Central Perk: 21 oct. 2013

luni, 21 octombrie 2013

Mish's Global Economic Trend Analysis

Fed Wonders "Why Are Housing Inventories Low?"; More Than Meets the Fed's Eye
Dysfunctional Global Economy; Can Things Get Worse? Rediscovering the Price of Money
Growth in Social Security Benefits vs. Wage Growth

Fed Wonders "Why Are Housing Inventories Low?"; More Than Meets the Fed's Eye

Posted: 21 Oct 2013 06:20 PM PDT

Inquiring minds are reading the San Francisco Fed Economic Letter "Why Are Housing Inventories Low?"

Inventories of homes for sale have been slow to bounce back since the 2007–09 recession, despite steady house price appreciation since January 2012. One probable reason why many homeowners are not putting their homes on the market is that their properties may still be worth less than the value of their mortgages, which would leave them owing additional money after a sale. In other cases, homeowners may simply be hoping that house prices will continue to rise, allowing them to recover lost equity.

No matter what the condition of the economy might be, some base level of inventory for sale always exists in the housing market. Young homeowners may sell their homes in order to relocate for a job or because their family has gotten larger and they need more space. Older homeowners may sell because they no longer need so much space or they want to turn their housing investment into cash as they reach retirement. All these reasons for selling can be thought of as life-cycle motives not necessarily tied to the business cycle. Such noncyclical factors produce a general level of churning in the housing market. Nevertheless, inventories show a distinct cyclical pattern, rising in good times and falling in bad times. This could be due to the cyclical nature of credit conditions. The risk premiums charged by lenders and their willingness to accept loan applications tend to ease during good economic times, allowing more potential buyers to enter the market. At the same time though, the level of house prices is by far the most important cyclical variable that influences the inventory of homes for sale.

Two important points emerge from Figure 2. First, in the aggregate U.S. data, the for-rent inventory of homes as a share of total housing units has risen steadily during the recession and the recovery, while the for-sale inventory has steadily dropped and is now stabilizing.

The data do not extend far enough back to indicate whether this is typical over the economic cycle. But other sources, such as Census Bureau aggregate inventory data, suggest that the drop in owner-occupied units relative to renter-occupied units is unprecedented since the 1960s. This phenomenon is widespread. The surge in foreclosures during the housing bust cannot be the only cause of this shift.

In theory, falling house prices alone may keep some homeowners from selling. It may seem logical that decisions to sell should be based only on information about current and future market conditions. But David Genesove and Christopher Mayer (1997) show that homeowners take more time to sell their houses if prices have fallen since the original purchase. That is, two similar homeowners experiencing similar housing market conditions will behave differently if one of those homeowners has an unrealized loss on his or her house.

Another possible explanation for the breakdown in the normal relationship between prices and inventories of homes for sale is that homeowners may be taking a longer-term view of the housing market. It is well documented that house price changes are persistent, meaning that price rises are likely to be followed by more rises, and price drops by more drops. Homeowners with flexibility on the timing of their home sales can potentially take advantage of this persistence. If they observe prices going up, they may want to wait and gamble that the increases will continue, allowing them to sell later at a higher price.

The data are consistent with this explanation. Figure 4 confirms on a county level the negative relationship between prices and inventories shown at the aggregate level in Figure 1. On balance, counties that experienced relatively large increases in house prices over the past year also experienced relatively large declines in inventories available for sale.

Conclusion

History shows a long-run relationship between house prices and the number of houses available for sale. Thus, current inventories of homes for sale are low given more than a year of house price appreciation. County-level data suggest that many homeowners are waiting for prices to rise further in their markets. Markets that have seen the strongest house price appreciation and job growth are the ones where for-sale inventories have declined the most.

More Than Meets the Eye

I endorse the Fed's conclusion. However, the Fed's research analysis does not go far enough.

Inventories in some areas are low because "investors" are snapping houses up expecting further appreciation. Some of this is large scale investment like Blackrock, but Flippers are in the game too, especially at the high end.

Momentum trading is back in vogue as noted in "Bubblicious" High End Flipping Up 350%, Overall Flipping Down 13%.

Flipping is up at the high end but renting is up overall. As long as home prices keep rising the renters and the flippers and those buying on spec will do well. But ....

What About Demographics?

Who are the flippers and investors going to sell to? Aging boomers? Their kids fresh out of college with no job?

I suggest we are in the midst of an echo bubble that can only last as long as QE lasts, as long as Boomers keep on living, as long as cities don't collapse under pension obligations, and as long as taxes do not soar in an attempt to keep cities and pension plans alive.

How long is that? I really don't know. But it is far, far shorter than the life of the average mortgage. And even for all cash buyers, demographics suggest that rising rents are hardly a given.

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

Dysfunctional Global Economy; Can Things Get Worse? Rediscovering the Price of Money

Posted: 21 Oct 2013 11:46 AM PDT

Steen Jakobsen, chief economist of Saxo Bank in Denmark, says things are so bad they cannot get worse. Please consider Rediscovering the Price of Money.

I've been starting my speeches for some time now by saying: "I am the most optimistic I have been in almost thirty years in the market—if only because things can't get any worse."

Is that true, and more importantly, how do we get a fundamental change away from this extend-and-pretend which prevails not only in Europe but also the world?

History tells us that we only get real changes as a result of war, famine, social riots or collapsing stock markets. None of these is an issue for most of the world—at least not yet—but on the other hand we have never had less growth, worse demographics, or higher unemployment since WWII. This is a true paradox that somehow needs to be resolved, and quickly if we are to avoid wasting an entire generation of European youth.

Policymakers try to pretend we have achieved significant progress and stability as the result of their actions, but from a fundamental point of view that's a mere illusion. Italian banks today own more government debt than before the banking crisis, leaving them systematically more exposed to their own government, not less. The spread on government bonds between Germany and Club Med is down below historic averages, but the price has been a total suspension of the "price discovery" of money.

The price discovery of money is the cruel capitalistic part of any system. An economics textbook would call it the modus operandi by which capital is allocated where it can find the highest marginal utility. In practice, this should mean that the market dictates the price of money beyond one year—while at durations of less than one year, the central banks determine the price of money. The beauty of the system is that money is allocated in an auction where the highest bidder for "money" or "credit" gets filled on the price he or she deems to match his expected price of money.

Contrast the market-driven model with the present "success story" of relatively low sovereign spreads in Europe, which are driven by the European Central Bank president Mario Draghi's promise to do "whatever it takes" to keep the euro out of trouble. He has threatened to activate the European Financial Stability Facility and the European Stability Mechamism plus the full arsenal of policy tools to ensure stability.

By doing so, he has effectively suspended price discovery for sovereign debt and for money, as the ECB and local central banks will provide infinite liquidity to local banks and hence indirectly to their government in any market conditions. This one-sided offer from the ECB and the market means there is no power to discipline the government with higher rates or to allocate credit more generally. We have simply disconnected the market and the price of money.

This comes after Draghi's longer-term refinancing operation, a cheap funding for banks with little or no collateral, or the closest thing to quantitative easing you can have without calling it quantitative easing.

This is a problem because corporations that need to finance long-term projects, like building a power station over six to eight years, need a price for the credit they require throughout the building period. Right now they have an almost flat yield curve from zero to 30 years, which would be fine if it were realistic. But the problem is that one day in the "distant future" when the market normalises, interest rates should revert to their normal price, which is roughly inflation plus a risk premium.

In the case of an industrial company, an appropriate loan rate calculation could be something like: inflation plus Libor plus a risk spread, which might work out to about seven percent. Compare this with the rates available for highly creditworthy companies. Recently, Nestle was able to issue a four-year corporate bond at 0.75 percent—the lowest ever. Yes, it's nice for Nestle but remember the situation is created by the central banks presence in the market, not just due to the financial strength of Nestle.

A move from less than one percent to seven percent would administer an ugly shock to companies. We have created a negative vicious circle in which not only investors, but also companies are depending on low interest rates forever. They have priced their future earnings and costs on government support prices rather than on realistic market prices.

The worst thing about the situation, however, is that the reason a blue chip company like Nestle can borrow at less than one percent in the capital market is the lack of alternatives for banks and investors. Less creditworthy small and medium enterprises (SMEs) which make up as much as 80 percent of many countries' economies are not allowed to borrow. They are deemed too risky to lend to at the current "market rates" even though they hold the key to improving the employment and productivity picture.

They are willing to work cheaper, longer, harder and with higher risk tolerance in order to survive. So the remaining 20 percent of the economy occupied by large and publicly listed companies and banks gets 95 percent of all credit and 99 percent of all political capital. In other words, blue chips receive artificially low interest rates only because the SMEs don't get any credit. Herein lies my continued belief in the my traditional opening statement: things must get better soon because they can hardly get any worse.

We have never been in a more dysfunctional state at the corporate, political and individual level in history. It's time to realise that the reason capitalism won the war against communism in the 1980s was its strong market based economy—itself based on price discovery. Now the policymakers in their "wisdom" are copying everything a planned economy entails: central planning and control, no price discovery, one supplier of credit, money and the corollary effect of suppressing SMEs and even individuals.

Finally, history offers a compelling lesson: the last time the Federal Reserve engaged in a sizeable quantitative easing was in the 1940s. The low growth and falling inflation only reversed when the Federal Reserve stopped intervening due to a severe recession brought on by the policy mistakes of keeping QE in place too long.

In 2014, a bout of near or real recession in Germany and the US could kick start the price discovery mechanism again, which will help us to start healing the deep wounds left by years of policymakers compounding their errors with round after round of extend-and-pretend. Getting to the bottom is good in one sense: the only way is up.

By Steen Jakobsen

Can Things Get Worse?

I certainly agree with Steen on the dysfunctional state of the global economy, price discovery, and the implied bubble in corporate bonds. But are things so bad they cannot get worse?

In what sense? Any normalization of interest rates is going to crash the corporate bond market. When bonds crash, stocks will join the party. Is that better? Actually it is, but most won't view the accompanying recession as "getting better".

Illusion vs. Reality

The Fed offers an illusion that things are getting better now. The reality is the global economy has been getting more dysfunctional (and that dysfunction happened to lift financial assets).

Why Can't Things Get Worse?

Abenomics is guaranteed to heighten trade tensions and make things worse.
What about the surge of the Eurosceptics in parts of Europe?
What about the surge of Marine Le Pen' National Front party in France?

What's the Definition of "Better"?

What's "better" is in the eyes of the beholder. Some may construe anything that hastens the breakup of the eurozone is for the better.

Does the line stop at the National Front in France? With the neo-Nazi Golden Dawn party in Greece?

Breaking Point Optimism

Those who want to be optimistic on the basis "things cannot get more dysfunctional" have numerous things to be optimistic about

Global Equity Bubble
Corporate Bond Bubble
Sovereign Bond Bubble
Abenomics
Central Bank Intervention
China Property Bubble
China shadow Banking
Trade Protectionism
US Militarism
Social Security Promises
Pension Promises
European Bank Leverage
European Isolationism
Canadian Housing Prices
Australian Housing Prices

Recovery From the Ashes

Optimists who believe "things cannot get much worse" must expect the dam to break on most or all of those bubbles and distortions at once. Curiously if a dozen of the above dams/bubbles did break at once, it sure would not feel good when it happened, even to the optimists.

I suggest that if Steen's optimism is justified (and perhaps even if it's not) asset prices are highly likely to get clobbered, with equity prices dropping as much as 50%.

Yet, economically speaking, that would be a good thing, especially if a sound banking system (void of fractional reserve lending) arose from the economic ashes.

Unfortunately, a word of caution to the optimists is warranted. Central banks have a proven history of making matters worse over time and not learning anything along the way.

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

Growth in Social Security Benefits vs. Wage Growth

Posted: 21 Oct 2013 09:36 AM PDT

I have an update from reader Tim Wallace on Social Security.

Hello Mish

I made new Social Security charts that show:

Growth in percent from 1967 in average payout per month to those that receive social security

Amount of money paid out to those that recieve social security per worker in the USA

Average annual wages as presented in the Social Security systems "National Average Wage Index"

Senior citizens continue to receive all the benefits on the backs of the younger generations. By the way, I had to stop at 2011 as 2012 is not published yet.

Tim

Percentage Growth in Social Security Payments, Per Worker vs. Wage Growth

click on any chart for sharper image

Social Security Payments Per Worker

Demographics Says Path is Unsustainable

Clearly this payout trend is unsustainable, but what politician dare touch it?

Social Security is not that difficult a problem in theory (at least in comparison to Medicare), except for the politics of it all. Numerous things could be done to put the system in the green.

Possible Ways to Make Social Security Actuarially Sound

Raise retirement age
Raise or eliminate the cap on payroll taxes
Cut benefits
Collect Social Security on personal income
Implement a Tiered Cap structure
Means Testing

Democrats would oppose 1 and 3. Republicans might oppose all but 3. So, how does this mess end if politicians won't touch it?

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