Interest rates

In just the last couple of weeks interest rates on US Treasuries (I watch the 2 yr. treeas, but since the yield curve is almost flat this applies to all treasuries) have risen from about 4.6 to 4.95, and they do not appear to have peaked. I have a fair amount of CDs maturing in June. I decided to continue to wait for a peak before reinvesting in CDs or treasuries.

The sudden move appears to be related to the sale of bonds by one or more large hedge funds - just guessing.

Pressure building

The US economy is totally dependent on transportation. Americans need it, inter alia, to get to and from work, to go to malls, to bus or drive children to and from school, to bring food into the house, pleasure driving, boating. As the price of gasoline rises Americans will conserve their money by reducing or eliminating some gas consuming activities as well as some activities that are optional to their way of life. I have already observed some less traffic at local malls and restaurants.

But at $3.00/gal for gasoline the impact on economic activity still seems moderate although it is possible that the impact could worsen if the price remains high or increases substantially. The $.75 increase over the past few weeks was dramatic and is causing economic pain. Another $.75 increase during the course of the summer driving season could have a very serious negative impact on an American economy which is 70%-80% dependent on consumer spending.

This week Joe and I are preparing our boat for the sailing season. Soon I will have a chance observe if there is an imact on the marina and the local businesses that are dependent on water activities.

Bubble taxes

The following material corrects my impression that the cost of running the US government is presently attributable in large part to receipts from the sale of US treasuries. Although Treasuries obviously contribute somewhat to that burden, unexpectly I have discovered here that taxes attributable to the bubles take up most of the burden. So what happens in the soon to arrive recession? or depression? No wonder the government has been able to keep interest rates so low. Its because its demand/need for money from bond sales is relatively low. When this need increases its going to have to pay much more interest to attract money. Ka-Chung!!

http://wallstreetexaminer.com/blogs/winter/?p=724#more-724

"Let’s look at the mix, focusing on employment taxes withheld, taxes not withheld, and corporate taxes. I’m using the fiscal year to date (last Thursday in April) for all years to compare apples to apples.
2003: employment taxes: 815.9; not withheld: 169.4 (15.55% of total); corporations: 104.5 (9.6%)
2007: employment taxes: 1.017.4; not withheld: 283.6 (18.7%); corporation: 215.2 (14.2%)
As you can see overall tax reciepts have exploded 39.1% in just four years, but that corporate and not withheld today accounts for 32.9% of the mix, versus 25.5% in 2003. Let’s look at 2003 and 2006 to get the full effect in dollars for a whole fiscal year.
2003: employment taxes: 1.390.2 not withheld: 284.5 corporation: 187.7 = 1.862.42006: employment taxes: 1.617.5 not withheld: 417.6 corporation: 368.0 = 2.403.1
That’s a whopping $541 billion growth in tax receipts ($313 from not withheld and corporations) from these sources. That’s more than enough for the government to run a war machine, Katrina and ethanol scams, pad the pockets of corporate cronies, and run highly stimulative, irresponsible fiscal policies all nicely financed in large measure through price insensitive vendor lending from our “friends” in China. Little wonder that Hilary Clinton is setting this up as a central theme of her campaign. After all she may also inherit the Depression that results from this fiasco, and would be wise to set the stage".

Mauldin- recession now a 50% chance

http://www.2000wave.com/article.asp?id=mwo042707
"The homeowner vacancy rate rose to a new all-time high, even as rental vacancy rates fell slightly. Overall home ownership in the US is falling and is now at a three-year low. Including new homes under construction, there are a total of 2.5 million homes vacant, which is well over 3% of the total of the US housing stock (77.2 million non-rental homes). "
He notes that it will adversely impact spending by reducing on home improvements, furniture and appliances, and building materials: it will adversely impact housing-related employment which was up 50,000 jobs a month during the boom and is now an increasing drag on employment; there is a clear drag on household wealth, where there is an estimated 9 cents of consumer spending for each dollar in the increase in the value of a home; and, the boost from mortgage equity withdrawal (MEW) is reversing. The largest part of MEW came from the realization of capital gains as homes were sold. "The only source of MEW that remains strong is cash-out refinancing," Hoyt notes.
"It should be pointed out that spending from the wealth effect and MEW impact spending with a lag. The wealth effect is understood to play out over about two years. Spending from MEW occurs more quickly, but can still take up to three quarters."

The Sub prime mtg model for corp debt.

http://news.yahoo.com/s/ft/20070425/bs_ft/fto042520071733283602

The bank of England warns that "(risky) bank loans (including loans for the private equity industry) are repackaged and resold to new investors, such as pension and hedge funds." In other words, the banks are now using investors' money for new kinds of loans that are just as risky as sub-prime liar mortgages.

At the end of the day it looks like a lot of investrors who would never make these risky loans are going to end up owning them, and the banks that made them will have collected large fees and have no exposure.

The US government is apparently unconcerned since the FDIC insured money that the banks use is not being risked.

US Housing Slump hurts Latin Amer.- wsj

One could note that US employment numbers do not include illegals, but I believe that the more important point here is that the home building bust will be at least as big as the dot.com bust, and like the dot.com bust it will destroy or diminish the businesses, wage earners and economies that have any relationship to it. Here is the content of the article:

"The rapid slowdown of the U.S. housing sector could have dangerous implications for Latin America and the other emerging market countries that depend on remittances for their balance of payment needs.
Remittances became important a few years ago, when they began to eclipse other forms of capital flows, such as foreign direct investment, multilateral assistance and loans. In 2005, the World Bank estimated that the total level of money sent home by immigrants from emerging market countries was $223 billion. In 2006, Latin America received $62 billion in remittances, of which 75% was from the U.S. The multilaterals and Latin American governments were ecstatic about the increase in remitted funds. They attributed the inflows to changes in regulatory framework, the proliferation of financial transfer networks and a reduction in transfer costs. Some Central American governments issued long-term bonds, modeling their balance of payments on the steady increase in remitted funds. However, few people bothered to realize that much of the generated money was a result of the large increase in U.S. home construction and associated services. A jaunt around most U.S. construction sites revealed a cacophony of Spanish and Portuguese accents, along with a sea of Latino food vending cars. Latin American electricians, masons, painters, carpenters, plumbers and landscapers thrived as North American homeowners used second mortgages to modernize their dwellings. Unfortunately, everything that goes up must come down—and the decline in the U.S. housing market has dangerous implications for some emerging market countries.
A look at the remittance data and U.S. housing starts reveals a worrisome correlation. Regressing panel data provided by the IMF on annual remittances to Latin America against annual U.S. housing starts shows a high degree of correlation between 1997and 2005. The panel data consists of 15 countries, and the correlation was higher than 90% in 12 of the cases. The outlier was Paraguay, which had a negative correlation of .03%. This was not too surprising, given that most Paraguayan immigrants head off to Argentina. Unfortunately, Argentina suffered a severe crisis during the sample years, explaining the massive decline in Paraguayan remittances. Although the conclusions were fascinating, the sample sets had a small N (number of observations). Therefore, we decided to examine another sample set. Banco de Mexico has monthly remittance data through February 2007, and the fit was remarkable. Monthly remittances peaked in May 2006, at the same time that housing starts reached their zenith. However, the decline in remittances is occurring at a faster pace than the drop in housing starts, falling 26% from the peak. This is logical, given that Mexican immigrants will harbor their savings as they see job opportunities evaporate. The implication of these results is that some Latin American countries could see pressure on their current account balances, despite the increase in commodity prices. The contraction in remittances will dampen domestic consumption and hamper GDP growth rates. Countries which are extremely dependent on remittances, such as Mexico, Colombia and the Central American states, could see weaker exchange rates as transfers decline. The problems in the U.S. housing sector could have dire implications for home construction activity in Europe and the Middle East. This could affect emerging market countries in North Africa, as well as Pakistan and the Philippines, which also depend on remittances to cover their balance of payment requirements. "

Uh Oh!

http://www.safehaven.com/article-7399.htm
"In February net foreign buying of securities with maturities of more than a year plummeted to $43.2 billion from $83.7 billion in January, net buying of long term US securities would have totaled $58.1 billion in February, down from $98.8 billion in January. A subset of these numbers is the total collapse in net foreign purchases of debt issued by US government sponsored companies Fannie Mae and Freddie Mac which plummets to $2 billion in February down from $35.8 Billion in January."

It looks like the plan to bail out the US private mortgage industry via purchases by Fannie Mae and Freddie Mac of high risk mortgages, perhaps even mortgages in default, is running into difficulty.

Part II - Some Housing bubble detail

This link provides the kind of detail that the main stream press buries http://www.marketoracle.co.uk/Article795.html
Two excerpts are of outstanding importance:
1. "There are roughly 75 million housing units in the USA. About 25 million of those homes are owned free and clear. That leaves 50 million homeowners with sharing (roughly) $10 trillion in total mortgage debt. The risk of “resets” (that is, monthly payments that will go up after the introductory period of time) will affect 75% of all mortgages. (Some reports have already indicated that 80% of sub-prime mortgage holders have said that they will have difficulty paying the newly-adjusted payments)."
2."Of the 50 million or so active mortgages, it's estimated that only 12 million are “risk free,” that is, conventional loans with 20% down and a fixed rate."

The real estate crisis/opportunity - Part 1

I believe the housing bubble will take at least 2-5 years to unwind. We are now in the first phase. This spring many single familiy homes will go on the market as many people (many in financial difficulty) will try to sell their homes as last year's prices. I expect that their listings will be the cause of an increase in the existing glut of homes available which will only drive prices down.

Many will choose to not sell at a loss but they will be emotionally and financially burdened by the expenses of maintaining a vacant house. This will cause numerous owners to attempt to derive some income from their houses by offering them for rent in the vain hope that the housing market will recover quickly enough for their house to be sold at a profit at the expiration of the 1 year lease. But I predict that their unpleasant experiences as landlords will only further demoralize them. Not only will they be unable to obtain rents that are sufficient to cover their present mortgage payments, real estate taxes and necessary insurance, they will also incur additional expenses related to the repair of ordinary wear and tear, unpaid rent, tenant caused damages, and evictions.

In the meantime many adjustable rate mortgages will reset this year and next year at higher rates. This is the developing crisis.

Bernanke, 3/2/07 at Stanford

The truth about globalization is that it not only robbed the US economy of its manufacturing capability and its high paying manufacturing jobs, it is causing inflation in fuel and metals prices.

"On the other hand, not all aspects of globalization and trade reduce inflation. For example, globalization has been associated with strong growth in some large emerging-market economies, notably China and India, and this growth likely has contributed to recent increases in the prices of energy and other commodities. During 2003-05, for example, China alone accounted for nearly one-third of the growth in both global real gross domestic product (GDP) and oil consumption.
It is difficult to assess the exact extent to which increased demand by developing countries has contributed to the run-ups in commodity prices in recent years, as these prices are also affected by supply conditions and other factors. However, one study estimated that, if the share of world trade and world GDP enjoyed by non-industrial countries had remained at its 2000 levels, then by 2005 real oil prices would have been as much as 40 percent lower, and real metals prices 10 percent lower, than they actually were (Pain, Koske, and Sollie, 2006).
Accordingly, in the past several years, the effect of growth in developing economies on commodity prices has been a source of upward pressure on inflation in the United States and other industrial economies.
When the offsetting effects of globalization on the prices of manufactured imports and on energy and commodity prices are considered together, there seems to be little basis for concluding that globalization overall has significantly reduced inflation in the United States in recent years; indeed, the opposite may be true. Chairman Ben S. Bernanke, March 2, 2007

The PBS story

Nightly News on PBS has a story about condominium developers who have sued and obtained judgment from people who had contracted to buy 18 months ago. The price of the condos has fallen by 20% and the potential buyers simply wanted to walk away from their deals, losing only their deposits. The courts in Florida have sided with the developers and awarded judgments for the full original price.

I can not imagine why these people did not understand that they were always responsible for the full price.

Read John Mauldin's letter 3-23-07

Here is the linkhttp://www.2000wave.com/article.asp?id=mwo032307 , and this is portion that shocked me:

Now That's Cheap! I can hear you say, "It can't happen, John. Who would sell a home for less than 50% of what it cost?" So, let's go to the second story, courtesy of Dennis Gartman (see more on him below). Instead of my telling the story, since he's the far better storyteller, let's see what he has to say under a closing headline of "Now That's Cheap": "Knowing when something has gotten cheap is an art reserved to either the very wisest among us, or the very lucky, or at times the very stupid. It is not an art we are given to, although clearly we have some acquaintance with the latter. But sometimes even we can know when something has gotten cheap.... even very so, and it would appear that housing in Detroit, Michigan has gotten very, very cheap. Allow us to explain. "We were sent an article yesterday from Yahoo! News detailing the levels to which housing prices in Detroit have fallen, and they have fallen very far indeed. Apparently last week, a Texas auction firm was commissioned to sell off a number of homes there. The prices were unbelievably cheap, with 'house after house [selling] for less than the $29,000 that it costs to buy the average new car.' The auctioneer became so exercised that he enjoined the audience with the simple statement that 'Folks, the ground underneath the house goes with it. You do know that, right?' Several houses that went by the boards sold for less than $10,000... some even for less than $7,000. As one participant said, 'You cannot even buy a good used car for that!' "He's right. One gentleman, who a year ago thought he was buying a series of 'bargains' when he paid $70,000 for a number of houses, only to watch as houses of the same relative value in the same neighborhood sold over the weekend for half that. The gentleman in question apparently was not prepared to average down. "Sadly, these 'bargains' are not only in seedy, run-down depressed portion of the city. We read where a house in Bloomfield Hills, an area of the city we've been to several times in the past two years and is really very, very nice indeed, which had been listed for $525,000 sold for $130,000! Five years ago, at $525,000 the house was a bargain; at $130,000 it is even 'bargain-er.' However, when nice, tidy, small houses begin to sell for less than the price of a nice, tidy, used car, either cars are expensive or houses are inexpensive... or both. Now, how do we do the arb?"

Although this is only anecdotal it portends serious consequences. When I was a youngster in the 1930s depression I recall that my parents who lived in a high rise apartment house in the Bronx were afraid to spend $1500 for a foreclosed house that had been built in the 1920s at a cost of over $120,000. They were afraid not just of the comparitive cost of ownership vs cost of renting, they were afraid that the depression was a permanent condition and that the events in Europe were a precursor of war.

Hyperinflation in the US, Not now.

The way some people, even some very smart and sophisticated people, talk about the government printing money to support the economy, one should be afraid of imminent hyperinflation. I'm not because it isn't true. The US economy is presently supported by an overabundance of credit not actual money. As long as the abundant availability of credit continues the US government doesn't have to supply (print) an overabundance of money. It doesn't even have to collect sufficient taxes to support ever increasing and more expensive governmental functions because like the consumer the government is also supported by an overabundance of credit.

I would not be at all shocked if the US government does not back all this debt with its full faith and credit since it has not assumed a legal obigation for a lot of it, e.g., Fanny Mae and Freddie Mac debt, and no one can expect it to assume state and municipal governmental debt even though much of that debt is related to Federal governmental mandates or requirements.

Trading in a bear market

Trading in a bear market is difficult and hardly worthwhile. It is difficult because because accumulation zones are often not trustworthy, so that buying in an accumulation zone is more risky than it should be. For example, if one had bought AMD in the accumulation zone that occurred in the mid 20s, one would have a substantial loss. I did not.

It is hardly worthwhile to buy an equity in the accumulation zone, because the added risk requires that the amount of the "bet" be so small that if a loss occurs it will not hurt much. However, the gain that might be made is so small in relation to the total portfolio that is is not worth the risk. So, why bother to make such trades in a bear market.

Of course, there is always the double inverse ETFs. But there is a lot of risk here too. The first is that the wall streeters have access to so much credit that they probably could force the averages to new highs on a whim. The second is that the derivatives in the reverse ETFs have never been really tested for counterparty solvency if the indexes really do fall by say 25%.

Happy Fed Day 3-21-07

Look at that coordinated, fast, strong and simultaneous buying of the big banks on release of the Fed's meeting statement, e.g. LEH 71.94 at 2:14PM tp 75.15 at 3:01PM.

Inverse ETFs

I investigated the inverse ETFs because there is a very good chance that the US stock markets will drop dramatically in the near future. Wall street invites us to profit from the drop by investing in 200% inverse ETFs. But I have long ago learned that wall street is a master of deception. The QID which twice inversely tracks the Nasdaq QQQQs has the following statement in its description: "The Fund employs leveraged investment techniques to achieve its investment objective, which may expose the Fund to potentially dramatic changes (losses) in the value of its portfolio holdings ." This is a black box product using derivatives. The profile of the SDS which twice inversely tracks the S&P 500 states that it uses derivatives. Therefore, I have decided to not use these products. Who needs unanticipated dramatic losses.

I am content to make money the conservative way by waiting for good stocks to enter their accumulation zones, accumulating them there and selling when they are in their distibution zones.

It is common knowledge that the economy is floundering, that builders and their suppliers are struggling, that mortgage lenders are sinking, and that perhaps as many as 2,000,000 homes will be foreclosed. The most important question is what will the US government do. Will it try to pump up the economy with more debt? Will it save the mortgage bankers by using Fanny and Freddie to buy a $trillion of their defaulted mortgages? Or, will it preserve domestic tranquility by aborting the foreclosures?

I believe that the government cannot avert an economic slowdown. It cannot prevent a recession. And, it probably will cause a depression because our elected representatives will do what they always do, i.e., the bidding of the lobbyists.