Entries for November 2007

Plenty of homeowners—especially those who saved up for big down payments so they could get a low-rate fixed mortgage—have little sympathy for their fellow Americans who gambled on subprime loans and the teaser rates that often came with them. And they might be rolling their eyes at news that Hank Paulson and his Treasury Department are nudging the mortgage industry—as Arnold Schwarzenegger has done in California—to voluntarily refrain from resetting some $400 billion worth of subprime adjustable-rate mortgages when the teaser rates expire next year.

But they should not be surprised. Consider this: Three of the four states with the highest number of foreclosures in October were potential 2008 swing states: Florida, Ohio, and Michigan. The political pressure to do something big and not wait for some reform of the Federal Housing Administration was becoming overwhelming. The Democratic-controlled U.S. House and Senate have certainly been working on a fix. For instance, presidential candidate and Senate Banking Chairman Chris Dodd has a bill to let judges restructure mortgages while in bankruptcy proceedings—a bill the industry vehemently opposes.

Yes, the economic growth numbers for the third quarter were revised sharply upward today, from 3.9 percent to 4.9 percent. And no, you shouldn't suddenly feel better about the economy—well, at least if you listen to the bears on Wall Street and their media megaphones. The pessimists say that the fourth quarter—the one we are now in—will see a sharp slowdown in growth as the housing downturn and credit crunch really take a bite out of the economy. And indeed, growth is probably in the midst of a downshift. Certainly, job growth isn't what it was a year ago.

But consider this: If you exclude housing, the economy grew at an astounding 6.1 percent rate, up from a 4.6 percent pace in the second quarter. My guys at Action Economics think gross domestic product growth will average 3.3 percent in the second half of 2007, versus a 2.2 percent average in the first half. That is more or less in keeping with what the White House is looking for. Team Bush today lowered its forecast for economic growth for next year to 2.7 percent from 3.1 percent previously. It also expects unemployment to rise to 4.9 percent.

But the 2008 election impact is this: The economy heading into Election Day will most likely be perceived by voters as worse than it is right now—and right now only a quarter of Americans, according to Gallup, rate the economy as "excellent" or "good."

Ed Yardeni of Oak Associates thinks he knows how to stop the credit crunch:

We have to consider the possibility that the Fed can't save the financial system all by itself with the blunt tools it has. So, I have another idea. Why not set up a government guaranteed Sub-prime Resolution Trust Corporation? It would buy all sub-prime mortgages (even those that are delinquent, but haven't defaulted) and related securities at 80 cents on the dollar and issue government-backed bonds. The government (we, the taxpayers) would provide the capital, i.e., take the hits if the mortgages are eventually resolved at less than 80 cents. Most estimates are that the problem will eventually cost $200 billion, roughly the size of the current annual federal deficit. I think it's a price worth paying to put this sorry mess behind us. In the early 1990s, we set up the RTC to clean up the S&L debacle, which cost about half as much to accomplish as the estimated $500 billion. By the way, the problem with freezing resets (the Arnold Schwarzenegger solution) is that so many ARMs have been securitized.

Fred Barnes of the Weekly Standard brings the hammer down on last night's YouTube debate among the Republican presidential candidates:

But it was chiefly the questions and who asked them that made the debate so appalling. By my recollection, there were no questions on health care, the economy, trade, the SCHIP children's health care issue, the "surge" in Iraq, the spending showdown between President Bush and Congress, terrorist surveillance, or the performance of the Democratic Congress.

Yes, yes, those consumer confidence numbers yesterday were lousy. But let's see, Wal-Mart says Black Friday sales exceeded their expectations by 40 to 60 percent. And my guys Brian Wesbury and Bob Stein over at First Trust Advisers tell me:

Early holiday shopping reports show little reason to fear the Grinch. One widely reported data set was very strong, while a poll of consumers was somewhat weak. We think there are solid reasons to put our chips on the report showing consumer strength. According to ShopperTrak RTC Corp., sales at 50,000+ shopping centers and malls across the country were up 8.3% on "Black Friday" (the day after Thanksgiving) versus the same day last year. Black Friday sales totaled $10.3 billion this year versus $9.5 billion last year. When Saturday is included, sales were up 7.2%. And according to ComScore Inc., a Reston, Virginia-based firm, Thanksgiving Day purchases via the internet were up 29% versus last year, while Black Friday Internet sales were up 22%.

To paraphrase JP Morgan, no one ever got rich betting against America.

Here's the conventional wisdom about the economy and its role in the 2008 presidential election: Simply put, if there's a recession, a Democrat wins and a Republican loses.

History says as much. In his book The 13 Keys to the Presidency, historian Allan Lichtman notes that all seven times since the Civil War when the economy was in recession in the fall of a presidential election year—1876, 1884, 1896, 1920, 1932, 1960, and 1980—the candidate from the opposition party was elected president.

Think we need billions of dollars of government spending on energy independence or climate change? First, think about stem cells. The apparent breakthrough in stem cell technology—it appears skin cells can be reprogrammed into stem cells—is not-so-good news for some half-dozen states that have invested in embryonic stem cell research, including California, which has committed to spending $3 billion over 10 years. Essentially, what those states decided to do was engage in a bit of industrial policy. They decided to let government rather than private enterprise and the market decide what the most promising stem cell technologies were. And now they appear to have bet on the wrong technological horse.

Indeed, the history of such efforts has been quite poor. Take Japan, a country many central-planning advocates used to point to as an example of how government can aid certain industries—at least they did before the country's two-decade economic funk. But as William Lewis of the McKinsey Global Institute notes in his marvelous book The Power of Productivity, the success of Japan and its Ministry of International Trade and Industry is mostly myth.

The whispers are getting louder: Ben Bernanke might be a one-term Fed chairman. (Alan Greenspan served, by the way, from 1987 to 2006.) This from economist David Hale in the Financial Times:

Ben Bernanke, the Fed chairman, does not want to preside over an election-year recession when the core inflation rate is barely 2 percent. That could jeopardise his chances of winning a second term in 2010.

Expect to hear more of that sort of talk.

Fred Thompson has come out with the most detailed tax reform package of any of the major Republican presidential candidates. In short, Thompson would extend the Bush tax cuts on income and investment set to expire at the end of 2010, cut the corporate tax rate to no more than 27 percent, eliminate the alternative minimum tax and the estate tax, and allow Americans to opt into a simpler, flat tax system. But it all sounds kind of pricey to the folks over at Bloomberg News: "Republican presidential candidate Fred Thompson proposed sweeping tax reductions, including extending President George W. Bush's cuts, that would cost $400 billion a year by 2012 and more than $3 trillion over 10 years."

My take: That sort of "static" analysis assumes taxes have no impact on economic growth. If the tax cut boosts growth, then the so-called lost revenue won't be anywhere near $400 billion a year. Plus, as the Thompson campaign notes, the candidate has also proposed a fix to Social Security, a far larger fiscal issue than the annual budget deficit.

Yet voters are in a foul mood and will most likely be skeptical of any and all talk of tax cuts from candidates who don't also seem as equally gung-ho to cut spending. Of course, talk of cutting programs can be used to bash a candidate, so it was pretty savvy of Mitt Romney to propose capping government, nondefense discretionary spending at the rate of inflation minus 1 percent and leaving the fine details to later. But if 2006 should have taught Republicans anything, it's that GOP voters, at least, are worried about spending just as much as they crave lower taxes.

You know there is something weird happening on Wall Street when you start receiving economic reports in your E-mail inbox titled "Angst isst seele auf (Fear eats the soul)," as I did recently from Bruce Kasman of JPMorgan Chase. If that's the attitude among the pros, no wonder the market has been selling off lately.

But it's Main Street, too, that has the willies. The great economic conundrum of the past few years has been the strange inability of so many Americans to notice and fully comprehend the indisputable fact that over the past five years, the economy has been expanding (up 15 percent), stock market rising (up 53 percent), real incomes rising (up 16 percent), and unemployment falling (to 4.7 percent from 5.7 percent, with 8 million new jobs). (Thanks to Ed Yardeni of Oak Associates for crunching the data.) As CNBC's Larry Kudlow loves to say, this economy is the "greatest story never told."

The Federal Reserve released its first quarterly economic forecast today, projecting economic growth, unemployment, and inflation for the next three years.

Here are the Fed's numbers—economic growth: 1.8 to 2.5 percent for 2008, 2.3 to 2.7 percent for 2009, and 2.5 to 2.6 percent for 2010; unemployment: 4.8 to 4.9 percent for 2008, 4.8 to 4.9 percent for 2009, and 4.7 to 4.9 percent for 2010; core inflation: 1.7 to 1.9 percent for 2008, 1.7 to 1.9 percent for 2009, and 1.6 to 1.9 percent for 2010.

My take: While that may be a great forecast for bond investors—unspectacular growth with low inflation—most Americans should be less than thrilled by it. Here is the key sentence from the report: "Economic activity was projected to expand at a pace broadly in line with participants' estimates of the rate of expansion of the economy's productive potential in 2009 and to continue at much the same pace in 2010."

In other words, growth at 3 percent or more is inflationary. Yuck. Compare those numbers with the 1983-1990 Reagan boom when annual growth in gross domestic product averaged 4.1 percent. The Clinton boom, too, was right around 4 percent. If Bernanke and company are right, that's all the more reason for America to adopt policies to make us more innovative and productive so the economy can grow faster than the low-ball Bernanke speed limit.

Another lousy day on Wall Street as I write this, but Mr. Market isn't making his recession call quite yet, according to Jason Trennert of Strategas Research:

We've constructed the Strategas Bellwether Index out of those stocks most highly correlated with GDP—the fit between the index and GDP growth is 74%. Worth noting, the index has shown a slowdown in growth, but still does not appear as weak as during the 2001 recession.

Economist James Glassman of JPMorgan notes that while the Federal Reserve will be unveiling its new quarterly economic forecasts tomorrow, the bond market is already doing some forecasting of its own—and the message is a total downer:

Market forecasts, those embedded in asset prices, however, have proven to earn their keep. Three numbers in particular are highly informative: 4.5% (the Fed's interest rate target); 3.31% (2-year Treasury note yield); 4.14% (10-year Treasury yield). Market prices imply that policy rates are still 100 basis points above equilibrium levels. The Federal Open Market Committee says the risks are balanced. Few outside the Beltway think so. ... The market view that the Fed will continue to cut rates, including a high probability that this will happen again on December 11, isn't about the upcoming data. It is about a realization that Federal Reserve policy needs to become accommodative, and soon, if there is any hope of cushioning the economy from the damage of drying credit pipelines. Forecasts are helpful, but forecasts can't incorporate what we can't see. And markets don't like what they see.

Kurt Brouwer over at the new-and-improved Fundmastery blog tells us why China won't dump the dollar:

We have known for a long time that those countries that export heavily to the U.S. do not want to see lots of appreciation in their own currencies because that would make their products less competitive here. Among these exporters, China is the largest. ... If China dumps dollars, then the dollar might fall and its own currency would probably appreciate versus the dollar, thus exacerbating a problem it already faces. In addition, China does not want to do anything that would help push the U.S. into a recession because when the U.S. economy slows, the rest of the world does too. In conclusion, it seems unlikely that China would dump dollars. In addition, China will probably have to keep increasing its dollar reserves for some time to come.

1) Kimberly Strassel of the Wall Street Journal deftly analyzes Rudy Giuliani's campaign strategy.

2) Tim Kane of the Heritage Foundation dismisses the link between the dollar and the trade deficit.

3) Russ Roberts of George Mason University tells "Why We Trade."

4) CNBC's Larry Kudlow is impressed by a peppier Fred Thompson.

4) Barry Ritholtz of the Big Picture sees inflation everywhere.

5) Donald Luskin of the Conspiracy to Keep You Poor and Stupid puts the beatdown on 2012/2016 presidential candidate Eliot Spitzer.