by Calculated Risk on 12/28/2005 07:10:00 PM

First, here are a few stories that I don't think will be big in 2006:

1) Energy Prices: I expect oil prices to stabilize or decline next year. WTI spot prices closed at $59.96 today. This prediction could be wildly wrong, especially if production falls at Ghawar or the US bombs Iran. This prediction is based on the increased level of investment, the current levels of crude oil stocks and a slowing World economy in 2006.

2) Bush Economic proposals: I think the Bush Administration will be shackled by scandals and Iraq, so I don't expect any major new proposals. I hope I'm wrong about Iraq.

3) Trade Deficit / Current Account Deficit: I could be wildly wrong here too, but I think the trade deficit will stabilize or even decline slightly next year. As the economy slows, I think imports will slow.

4) The Budget Deficit: Although I expect the General Fund deficit to grow to around $600 Billion in 2006, I don't think it will become a huge story until '07 or '08.

So, without trying to predict natural disasters, a pandemic or human stupidity (terrorism, bombing Iran, etc.), I think these are five possible candidates for the top economic stories of 2006:

5) The End of the Greenspan Era

OK. I'll start with a gimme. I think Dr. Bernanke will face a significant challenge in '06, perhaps by one the following top stories - perhaps by something completely unexpected. Stephen Roach recently wrote:

"Alan Greenspan faced a stock-market crash two months after he took over in August 1987. Paul Volcker had to cope with a rout in the bond market three months after he became chairman in August 1979. G. William Miller was challenged immediately by a dollar crisis in the spring of 1978. For Arthur Burns, it was the inflation bogie in the early 1970s."

When the challenge comes, expect investors to pine for their lost love: Alan Greenspan.

4) Housing Slowdown

In my opinion, the Housing Bubble was the top economic story of 2005, but I expect the slowdown to be a form of Chinese water torture. Sales for both existing and new homes will probably fall next year from the records set in 2005. And median prices will probably increase slightly, with declines in the more "heated markets".

3) Pension Blowup / Major Bankruptcy

Of course I am thinking GM, but maybe it will be another major corporation. Bankruptcy has become a tool to break labor agreements and terminate pension plans. This allows companies to "privatize profits and socialize risk" - and companies will increasingly use this tool.

Even "freezing" the pension plan has enormous consequences for many employees, since a large portion of the retirement benefit is accrued in the last few years before retirement. See the USAToday article: Pension problems loom for boomers.

2) Slowing Economy

If the US and the World economies slide into recession, this will be the top story next year. I still think it is too early to call, but I do think economic growth will slow substantially next year.

This slowdown will be partially housing related; as housing slows, real estate related employment will decline and jobs could become an issue in '06. Also, as mortgage equity withdrawal declines, consumer spending will slow.

And my prediction for the Top Story of '06:

1) Interest Rates

Like most investors, I expect the Fed to raise the Fed Funds rate 25 bps at each of the next two meetings to 4.75% in March. See Dr. Altig's graphs: An Inversion Arrives

And like many observers, I expect the Fed to start lowering rates later next year as the economy slows. But here is the surprise, I think long rates will start to rise when the Fed starts cutting the Fed Funds rate.

This will be Bernanke's "conundrum"! As the economy slows, this will reduce the trade deficit and also lower the amount of foreign dollars willing to invest in the US - the start of a possible vicious cycle.

I couldn't resist going out on a limb ... or a couple of limbs. Its fun making predictions - I'm looking forward to the comments.

Best to all. Happy New Year!

by Calculated Risk on 12/28/2005 10:49:00 AM

The Mortgage Bankers Association (MBA) reports: Mortgage Application Activity Slows Preceding Holiday Weekend

The Market Composite Index - a measure of mortgage loan application volume was 554.1 -- a decrease of 6.8 percent on a seasonally adjusted basis from 594.6 one week earlier. A holiday adjustment was included in the seasonally adjusted numbers to help account for the reduced application activity prior to the holiday weekend. On an unadjusted basis, the Index decreased 17.0 percent compared with the previous week and was up 3.1 percent compared with the same week one year earlier.

The seasonally-adjusted Purchase Index decreased by 4.5 percent to 432.9 from 453.1 the previous week whereas the Refinance Index decreased by 11.2 percent to 1259.1 from 1418.1 one week earlier.

Rates were steady:

The average contract interest rate for 30-year fixed-rate mortgages decreased to 6.21 percent from 6.22 percent on week earlier ...

The average contract interest rate for one-year ARMs decreased to 5.36 percent from 5.41 percent one week earlier...

Activity is falling, but still reasonably strong. These reports will be more informative after the holidays.

by Calculated Risk on 12/27/2005 01:09:00 AM

Looking back, I think these were the Top Five economic stories of 2005:

5) Social Security

Social Security is the story of what didn't happen.

Drs. Mark Thoma, Brad DeLong, Paul Krugman, Andrew Samwick and my friends at Angry Bear all contributed to my understanding of this issue.

4) Interest Rates

The Federal Reserve raised the Fed Funds Rate eight times in 2005; steadily increasing the rate at a measured pace (25 bps) after each Federal Reserve meeting. The Fed Funds rate started the year at 2.25% and finished at 4.25%.

The eight increases might be a big story in and of itself, except the even bigger story was Greenspan's "conundrum" with long rates. The Ten Year Treasury Note started the year yielding 4.22% and closed last week yielding 4.38%.

Amazing.

Looking ahead: It appears the yield curve will officially invert after the next Fed Meeting (Jan 31, 2006 - Greenspan's last meeting).

For more on the Fed, I suggest reading Dr. Tim Duy and Dr. William Polley.

3) Energy Prices

Another huge story was energy prices. Even though prices have dropped recently, oil and gasoline prices are substantially higher than last year. According to the DOE, at the end of 2004, the weighted average price was $32.07 per barrel (all grades) and $51.58 last week. That is a 61% increase in the price of crude oil.

For Energy issues, see Dr. James Hamilton.

2) Trade Deficit

The trade deficit continued to increase in 2005. For the Jan through Oct period, the US trade deficit was $598 Billion, up from $504 Billion for the comparable period in 2005. The US is heading for a $720+ Billion trade deficit for 2005, or close to 6% of GDP.

For more, see Dr. Brad Setser and Dr. Menzie Chinn.

And the biggest story of the year ...

1) The Housing Bubble

I've written extensively about housing on this blog and at Angry Bear. For daily updates, I've linked to several sites on the right under "Housing Sites".

I'll write a "looking forward" to 2006 post later this week. Note: Iraq and Katrina were also huge stories in 2005 from an economic perspective, as were hurricanes in general and global warming. Iraq is a huge story from many perspectives, but I am trying to stick to macroeconomics.

Best to all. Happy New Year!

by Calculated Risk on 12/23/2005 10:11:00 AM

According to the Census Bureau report, New Home Sales in November were at a seasonally adjusted annual rate of 1.245 million vs. market expectations of 1.30 million. October's record sales were revised down slightly to 1.404 million from 1.424 million.


Click on Graph for larger image.

NOTE: The graph starts at 700 thousand units per month to better show monthly variation.



The Not Seasonally Adjusted monthly rate was 85,000 New Homes sold, down from a revised 110,000 in October.

On a year over year basis, November 2005 sales were 1% higher than November 2004.



The median and average sales prices are trending down.

The median sales price of new houses sold in November 2005 was $225,200; the average sales price was $283,300.



The seasonally adjusted estimate of new houses for sale at the end of November was 503,000. This represents a supply of 4.9 months at the current sales rate.

The 503,000 units of inventory is the all time record for new houses for sale. On a months of supply basis, inventory is above the level of recent years.

This report is still reasonably strong.

by Calculated Risk on 12/22/2005 03:01:00 PM

The Ports of Long Beach and Los Angeles reported mixed import traffic for October.

Import traffic at the Port of Long Beach increased 2.0% compared to October. A total of 305 thousand loaded cargo containers came into the Port of Long Beach, compared to 299 thousand in October. The record is 313 thousand set in August 2005.

The Port of Los Angeles import traffic decreased 11% in November. Imports were 325.1 thousand containers, off from the record set in October for the Port of Los Angeles of 368.5 thousand containers.

For Long Beach, outbound traffic was up 3.6% to 107 thousand containers. At Los Angeles, outbound traffic was flat at 98 thousand containers.

The quantity of containers says nothing about the content value, but provides a rough guide on imports from China and the rest of Asia. Given these numbers, I expect imports from Asia to be about the same in November as in October.

by Calculated Risk on 12/21/2005 09:05:00 PM

From the Financial Times, Martin Wolf discusses the world economy:

Podcast: The surprises of the past year

Wolf's discussion starts a little slow, reciting a number of growth statistics, however the second half of the podcast regarding global imbalances is interesting.

by Calculated Risk on 12/21/2005 10:38:00 AM

The Mortgage Bankers Association (MBA) reports: Mortgage Application Volume Down In Latest Survey

The Market Composite Index — a measure of mortgage loan application volume was 594.6 -- a decrease of 4.0 percent on a seasonally adjusted basis from 619.3 one week earlier. On an unadjusted basis, the Index decreased 5.2 percent compared with the previous week and was down 15.2 percent compared with the same week one year earlier.

The seasonally-adjusted Purchase Index decreased by 5.2 percent to 453.1 from 477.9 the previous week, whereas the Refinance Index decreased by 1.6 percent to 1418.1 from 1441.8 one week earlier.

Click on graph for larger image.

The graph shows overall and purchase activity since June. Overall activity has fallen significantly due to the drop in refis.

Mortgage rates decreased slightly again last week:

The average contract interest rate for 30-year fixed-rate mortgages decreased to 6.22 percent from 6.28 percent on week earlier ...

The average contract interest rate for 15-year fixed-rate mortgages decreased to 5.76 percent from 5.83 percent ...

Overall this report shows purchase activity might be weakening, but it is still at a very high level.

by Calculated Risk on 12/20/2005 01:28:00 PM

From the FDIC: Federal Financial Regulatory Agencies Propose Guidance on Nontraditional Mortgage Products

UPDATE: I think this paragraph has the most teeth:

Collateral-Dependent Loans – Institutions should avoid the use of loan terms and underwriting practices that may result in the borrower having to rely on the sale or refinancing of the property once amortization begins. Loans to borrowers who do not demonstrate the capacity to repay, as structured, from sources other than the collateral pledged are generally considered unsafe and unsound. Institutions determined to be originating collateral-dependent mortgage loans, may be subject to criticism, corrective action, and higher capital requirements.

This is essentially a warning not to rely on the value of the property to bail out the home buyer. The teeth are "criticism, corrective action, and higher capital requirements.", with the higher capital requirements being the only significant penalty.

The Press Release:

The federal financial regulatory agencies today issued for comment proposed guidance on residential mortgage products that allow borrowers to defer repayment of principal and sometimes interest.

These nontraditional mortgage products include "interest-only" mortgage loans where a borrower pays no principal for the first few years of the loan and "payment option" adjustable-rate mortgages where a borrower has flexible payment options, including the potential for negative amortization. Institutions are also increasingly combining these mortgages with other practices, such as making simultaneous second-lien mortgages and allowing reduced documentation in evaluating the applicant’s creditworthiness.

While innovations in mortgage lending can benefit some consumers, the agencies are concerned that these practices can present unique risks that institutions must appropriately manage. They are also concerned that these products and practices are being offered to a wider spectrum of borrowers, including subprime borrowers and others who may not otherwise qualify for more traditional mortgage loans or who may not fully understand the associated risks of nontraditional mortgages.

The proposed guidance discusses the importance of carefully managing the potential heightened risk levels created by these loans. Toward that end, management should:

* Assess a borrower’s ability to repay the loan, including any balances added through negative amortization, at the fully indexed rate that would apply after the introductory period. The agencies recognize that this requirement differs from underwriting standards at some institutions and are specifically requesting comment on this aspect of the guidance.

* Recognize that certain nontraditional mortgage loans are untested in a stressed environment and warrant strong risk management standards as well as appropriate capital and loan loss reserves.

* Ensure that borrowers have sufficient information to clearly understand loan terms and associated risks prior to making a product or payment choice.

Comment is requested on all aspects of the guidance, particularly on the section regarding comprehensive debt service qualification standards. Comments are due sixty days after publication in the Federal Registrar. The guidance is attached.

Interagency Guidance on Nontraditional Mortgage Products

by Calculated Risk on 12/19/2005 08:52:00 PM

CNN Money asks: Is the party over?

The article includes "exclusive forecasts" for the 100 largest markets.

... the overall outlook seems reasonable: 7 percent appreciation for 2006 and flat for 2007. But markets that have seen the greatest appreciation over the past five years appear to be vulnerable.

Indeed, at some point in the next two years, according to the forecast, a third of the nation's 100 largest metro areas (accounting for 60 percent of the U.S. population) are expected to see modestly falling house prices.

Real estate bear markets often come in the form of steady declines over many years, rather than sudden sharp drops.

As inflation gradually gnaws away at the value of nominal home prices, regular folks might not take much notice. But in the long run the loss of wealth becomes all too real. From 1989 to 1997, for instance, Los Angeles residential real estate dropped more than 40 percent in inflation-adjusted terms.

The nation's most perilous regional market, according to the forecast data: Las Vegas, a speculator-infested hot spot. Prices there are projected to deflate by 7.9 percent next year, the year after by another 5 percent. For newcomers to the market and those with low-money-down deals who may have overleveraged themselves with adjustable-rate mortgages, even a modest downturn could mean financial jeopardy.

Check out the table at the bottom of the article. I think some of these projections are a little optimistic. Will San Antonio home prices increase 15% over the next two years? Will Boston stay flat, even with 8+ months supply (and growing)?

by Calculated Risk on 12/19/2005 03:13:00 PM

Please see Angry Bear for National Association of Home Builders HMI excerpts and links to historical tables.


Click on graph for larger image.

This graph shows New Home Sales vs. the NAHB traffic index from 1988 to 1991. Both series are seasonally adjusted and are normalized to 1988 = 100.

It appears that the NAHB index was generally a coincident indicator for New Home Sales in the previous housing slowdown.

With the fall in the NAHB HMI, I expect a similar fall in New Home Sales on Friday.