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Wednesday, January 17, 2007


disquieting signs

with a housing bust underway and getting deeper all the time, questions regarding the remainder of the economy are burgeoning -- as are opinions regarding the answer. will the american economy engineer a soft landing? or will it succumb -- as is so much more common -- to a credit crunch, contraction and a period of recession?

one fearful sign regarding the more optimistic camp is the nature of its optimism. put most candidly, it amounts to this: the models say recession, but the mind says no.

According to [Dr. Leamer's] model, the probability of a recession in one year rose to 86 percent in January 2006 and to 100 percent in March 2006, and has been stuck at 100 percent through October 2006. According to this (imperfect) predictive probability, a recession is a virtual certainty and likely to commence in the first quarter of 2007.

My view, announced in December 2005, is that this time will be different. This time the problems in housing will stay in housing. So far, I am feeling very smug. But this keeps me up at night. In this column, first the models, and then the mind. The models say that a recession is coming soon. The mind says otherwise.

"this time will be different" -- words that have a tendency to end in all-too-familiar disaster.

it's difficult to contrive reasons why a major housing collapse should stay isolated -- it never has, and for good reason. real estate is a highly leveraged investment, and as such the banking system is intertwined with housing. indeed, as housing has gone south, reports are coming in of trouble in banking. subprime lenders -- that is, those who lent specifically to the more dangerous slices of the loan market at higher rates and often in recent years with too little diligence and too much greed, becoming a very large part of new loan generation by 2006 -- have already started to go bankrupt. and now credit quality is deteriorating in midmajor banks as foreclosures begin to spike -- including, notably, marshall and ilsley and us bancorp, midwestern banks far from either coast.

"It's finally happening," said David Hendler, an analyst at CreditSights Inc., an independent research firm, who has long warned of a weakening in credit quality.He said the pain is likely to be felt disproportionately by small- and mid-sized banks that are less diversified and over-reliant on construction and mortgage lending.

U.S. Bancorp, meanwhile, saw its net charge-offs jump about 25% to $169 million in the fourth quarter. While the levels were lower than a year ago, the company said the drop off was "principally due to" the bankruptcy law kicking in. Analysts said they were surprised by the magnitude of the increase in losses, although they pointed out that U.S. Bancorp's overall credit quality remains intact.

The Minneapolis-based bank, the sixth-largest in the U.S., is girding for more loans to sour. It predicted that charge-offs of retail loans "will continue to increase moderately during 2007" and that commercial loans losses will "continue to increase somewhat over the next several quarters."

The difficulties were especially pronounced at Marshall & Ilsley, a Milwaukee-based regional bank with a $12.5 billion market value. Net charge-offs jumped to $15 million in the fourth quarter, up 30% from the previous period. Its total nonperforming assets soared to $294 million from $234 million in the third quarter and about $150 million a year earlier. The higher losses stemmed from a variety of real-estate loans, particularly those to finance construction and land development. But a thicker slice of the company's commercial and residential mortgage loans also went bad during the quarter.

such deteriorations are often the canary in the coalmine of recession. economies in general -- and particularly managed-debt economies like ours -- rely on banks to lend in order to proffer money supply and provide the access to capital that the monads of any economy -- consumers and companies -- require to grow the whole. banks make money doing this by collecting fees and interest differentials, and so -- when times are good -- they lend as much as they can. the fee component has particularly become important since the development of the collateralized debt obligation, which allows banks to package and sell off their loans, freeing capital to make more loans. with a healthy aftermarket for higher-yielding cdo tranches in times of very low interest rates adn low volatility, banks have had no trouble making loans as fast as possible and passing on the loan (and its risks) to someone else without much care for the quality of the credit.

but now that aftermarket, growing wary of a possible housing shock, has become thinner -- and banks are being forced to retain some of their loans on their balance sheets, reducing the amount of new lending that they can do (and therefore profits) while increasing the risk to their capital (by retaining loans that may well go into default). this is what is being reported at us bancorp, m&i and wells fargo -- declining profits, increasing defaults. when banks become overextended in this fashion, they reflexively slow lending to protect capital -- and the economy contracts, forcing more foreclosures, beginning a vicious spiral of debt liquidation that we call recession.

with interest rates having been low for some time, many lenders have lent an unfathomably large amount to questionable credits -- as so often happens, out of short-run greed and a wishful belief that good times will last long enough to make a packet and get out. the sheer size of what is owed -- debt financing as a percentage of disposable income (the debt service ratio) is at record levels, as is the household debt-to-asset ratio -- is at least as important as interest rates, for even at low rates the cost of borrowing is huge for that reason. worse, faced with the prospect of declining asset prices and rising interest rates, these figures will probably get much worse before they get better. indeed, it is perfectly valid to wonder if -- with so much owed -- the united states is not on the cusp of a debt-deflation event that normalizes debt levels from extraordinarily high starting points.

in any case, even if a depression isn't lurking just offstage, it seems quite sensible to expect debt service ratios to grow, credits to deteriorate, lending and money supply to falter and recession to set in -- if and when interest rates rise. and that of course is the $64,000 question.

i recently read a very interesting paper that addressed the mechanics of low interest rates -- why they are low and have stayed low, why volatility is low -- in an effort to give insight on an eventual rise. it maintained convincingly that oil money -- cash paid by the west for oil -- has been returning to western economies directly (from the mideast and russia) and indirectly (from asian central banks) as asset purchasing power, particularly the purchasing of treasury debt and the aforementioned cdo's. as oil prices have risen -- tripling since 2003 -- the windfall has ever more aggressively been reinvested to keep rates down in spite of heated economic growth and the rising threat of inflation that has seen the federal reserve bank raise interest rates 13 consecutive times (inverting the yield curve). this amounts to literal billions flowing into western capital markets annually since 2003 -- enough to also reflate global capital markets post 2001-2, narrowing credit spreads and risk premia (i.e., boosting stock markets) because oil money tends to be riskier capital. the similarity is to the 1970s, except that whereas oil savings influx abetted wage inflation (the 'real' economy) then it abets asset inflation (the financial economy) now -- a product of our structural development from an industiral to a service economy.

on this view, the rise in global oil prices amounts to a massive wealth transfer from oil importers to oil exporters -- the asset value of oil in the ground has risen by a nominal $50bn. that wealth transfer requires a corresponding markdown on western balance sheets -- one that in the 1970s was facilitated by inflation destroying the value of western assets in real terms even as they held steady in nominal terms. in this incarnation, however, not only has the markdown not yet come -- it has been preceded by a period of interest rates suppressed by recycled petrodollar income which has encouraged a massive debt buildup that will because of the level of debt involved quite possibly require a severe debt-deflation depression to correct. even if it does not -- for, say, western monetary policy reasons -- the resultant avenue of correction will be runaway inflation. either way, a large expansion of risk premia is due -- either way, credit spreads and real interest rates will increase dramatically.

this correction is to be expected once the asset-burgeoning effects of oil revenue investment inflows recede. this can result from either a collapse in oil revenue reinvestments (oil price collapse, greater spending than saving in oil exporting economies) or in a forced delevering of petrodollars removing the amplification of purchasing power (as was engineered in 1981 by fed chairman paul volcker -- this latter may now require a broader view of inflation than the fed now takes, one which includes energy and asset prices). but the telltale indication is likely to arrive in expanding credit spreads, which have remained narrow in spite of yield curve inversion thanks to the abundant liquidity of petrodollar recycling.

as such, the collapse of oil prices (among other commodities) in recent days is quite possibly the beginning of the endgame for the 'petrodollar put'.

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Friday, January 12, 2007


the brink of insanity

in the aftermath of the president's speech outlining the plans for an escalation of the war in iraq, the commentariat has been abuzz. not a few have noted particularly the confluence of events about to be recorded here.

on this sunday past, the sunday times of london noted that, according to several israeli military sources, the israeli air force is training for a limited nuclear strike against iranian technical facilities that they believe make up the core of iran's nuclear enrichment program.

The attack would be the first with nuclear weapons since 1945, when the United States dropped atomic bombs on Hiroshima and Nagasaki. The Israeli weapons would each have a force equivalent to one-fifteenth of the Hiroshima bomb.

Under the plans, conventional laser-guided bombs would open “tunnels” into the targets. “Mini-nukes” would then immediately be fired into a plant at Natanz, exploding deep underground to reduce the risk of radioactive fallout.

“As soon as the green light is given, it will be one mission, one strike and the Iranian nuclear project will be demolished,” said one of the sources.

The plans, disclosed to The Sunday Times last week, have been prompted in part by the Israeli intelligence service Mossad’s assessment that Iran is on the verge of producing enough enriched uranium to make nuclear weapons within two years.

Israeli military commanders believe conventional strikes may no longer be enough to annihilate increasingly well-defended enrichment facilities. Several have been built beneath at least 70ft of concrete and rock. However, the nuclear-tipped bunker-busters would be used only if a conventional attack was ruled out and if the United States declined to intervene, senior sources said.

this is a continuation of the militaristic madness that has taken hold of the political far right in the west, previously expressed in vice-president cheney's own nuclear planning, since september 11. the terrible events of that day have since become license for the blackest impulses of fear-driven annihilationists -- that is, those who believe the annihilation of either "us" or "them" to be both imminent and unavoidable -- to be manifested as real policy behind western governments. "them", once being al-qaeda, then the taliban of afghanistan, then the iraq of saddam hussein, has now confusedly and irrationally metamorphosed into a bevy of possible spectres and phantoms -- the sunnis of iraq and syria and (more quietly) saudi arabia, as well as the persians of iran, as well as the resurgent taliban, as well as cold war favorites russia. the paranoia of the annihilationists has metastasized, and they seem to see nothing but possible enemies now.

other events appear to raise the conditional probability of such a disaster. the president's recent reordering of the top brass of the military seems potentially designed to remove anyone opposed to the regionalization of the war -- the yes men installed in 2003 to pave a dissent-free path into iraq have been replaced with new yes men for a new path.

bush further outlined in his address that he has sent a second carrier battle group into the persian gulf -- which has become crowded with american military hardware -- as well as patriot anti-missile systems. to this writer, it makes exceedingly little sense to deploy anti-missile systems into the current environment -- the only missile strikes in iraq today are being fired from american planes and ships. it does, however, begin to make sense if the american administration and military expect counterstrikes from an outside power, ostensibly in response to provocation.

UPDATE: steve clemons relays flynt leverett -- the groundwork is being laid for military operations in iran. indeed, the gossip in washington is that the orders have been sent.

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Thursday, January 04, 2007


why no good man will ever be president

one doesn't have to accept that ambitious and deeply amoral men like dick cheney must necessarily hold high american office. even as roman society (much like our own) degenerated from a highminded if naive imperialism toward outright despotism, it nonetheless found some good men to hold high office. criticisms of men like cicero and m. porcius cato are certainly available -- these are men who after all were creations of their degenerate times, and even to such a degree as they looked backward to a less divisive time for inspiration and (in cicero's case particularly) worked toward concordia ordinum they still sought paths to power in a way that mocked the myth of cincinnatus. indeed, at times their means were unfortunate, even contributory -- the staunch reactionary cato by his very rigidity in the face of the demands of newly-aware lower classes did as much to empower the triumvirs as anyone. but that they were ethical men who sought common peace over individual power is made clear especially in comparison to the ends sought and methodologies employed by men like crassus, pompey and caesar.

however, the demoralization of public leadership into a pandering power game at the hands of the demos is perhaps nowhere more evident than in such men because of the stark contrast their ostensibly higher aims offer. when cicero finally was made to knuckle under to the triumvirs, to defend vatinius and to sing the praises of pompey, the fate of rome was never more awfully apparent. there is no doubt that cicero found such men contemptibly dangerous. but his public cooption to their power -- the power of the demagogues -- marked the end of his political career just as surely as it assured the victory of those who would shatter the republic in the pursuit of unfettered imperial power.

john mccain is exposed in vanity fair as a man whose principles have, since 2004, been publicly compromised in exactly that way. locked out of the presidency by the bush political machine and the dominance of the more radical elements of the right which exercize great power in the primaries, mccain has sought to compromise with them -- cashiering his moral authority for a final run at the top.

moderation is the hallmark of moral leadership -- and mccain is no zealot. but compromising on issues like the military commissions act destroys the very heart of what might have made mccain a good man, and make him little more than another pursuer of power.

it is far from clear that mccain ever was a good man in the terms a common man would use. this is a member of the keating five, after all -- a fact unmentioned in the entire article -- and mccain is clearly as advocate of an american global imperium that puts it in a position where he feels some sort of action taken against iraq was not only valid but inevitable. by his own admission, paralyzed by fear, he cannot comprehend the failure that perhaps unbeknownst to him is already written in stone and has long been. that failure -- the ultimate failure to compromise, as it were, with difficult reality -- has led him to support escalation (or "surging" as it has been euphemized). he is deeply flawed.

so are we all. that he might have been a good man is more or less beyond question. but it is equally beyond question that the politics of empire have destroyed this man -- that his potential is not realized, that the damage is done by the very process of seeking leadership. i wonder if any good man could ever be the leader of this country as it now is.

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Great post gm,

This political system has destroyed lesser men than McCain. Why would he be any different. I don't think he is the same man today as he was before the Bush presidency.

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Wednesday, January 03, 2007


three graphs about housing

with housing now definitively contracting, some consideration may be given as to when price declines -- the new temporary paradigm of housing -- will abate. three graphs from calculated risk:

here we can see that new home sales bottomed sharply in 1981-82 and again in 1991, and that starts also did so in 1982 and 1991 (as well as 1975).

in looking at these graphs, we can see immediately that ofheo registered real price declines in 1979-1983 and 1989-1994 -- and that the final collapses in starts and sales occured not at the end of price declines but in the heart of the downtrends, which lasted some several quarters thereafter.

as one continues to monitor starts and sales -- both now falling sharply and probable to revisit and even break lowest lows before all is said and done as the greatest debt bubble in modern history disntegrates -- this will be something to bear in mind. yours truly managed to sell his 3-bedroom condo in summer 2006 (after nine months on the market) and has a rental contract out until november 2007. it seems highly improbable that prices will have found anything like a bottom in four quarters from today -- or even quite probably eight.

if one had to speculate as to where a reasonable endpoint for price declines would be, drawing a trendline on the ofheo real prices graph through previous troughs to today would indicate a current trough level of 126 or so -- meaning that, at 183, prices are in real terms some 45% overvalued from an area where housing might be considered at or near the bottom of its trend.


and how that is helping renters -- with the massive surge in unit construction, there's simply too much housing stock to fill. those holding two or more recently-purchased (since 2000) units with specialty mortgages are the ones who really stand to get crushed.

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