by Calculated Risk on 3/10/2006 09:18:00 PM

"Interestingly, the change in U.S. home mortgage debt over the past half-century correlates significantly with our current account deficit. To be sure, correlation is not causation, and there have been many influences on both mortgage debt and the current account."

Alan Greenspan, Current account, Feb 4, 2005

Click on graph for larger image.

With the release of the Fed's Flow of Funds report, we can look at the relationship between the annual increase in household mortgage debt and the trade deficit.

Note: I'm using the trade deficit instead of the current account deficit, since the current account for '05 has not been released yet.

I expect the annual increase in mortgage debt to decline in 2006. This is because I expect new and existing home purchases to decline, and homeowners to extract less equity from their homes in 2006.

The drop in mortgage activity is is one of the reasons I expect the trade deficit to stabilize in 2006. From my 2006 predictions:

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.

I should have been more clear. There is no way the trade deficit will decline on an annual basis in 2006, but I was expecting the deficit to stabilize or decline from the September to December level of $66 Billion per month.

The record January deficit of $68.5 Billion was a little disheartening, but mortgage extraction has just begun to slow. So far I've been wrong - but its early.

Drs. Brad Setser and Menzie Chinn are more pessimistic ...
Brad Setser: January trade data
Menzie Chinn: The downward march of the trade balance

by Calculated Risk on 3/09/2006 04:27:00 PM

New York Fed President Timothy Geithner spoke today on U.S. Monetary Policy in the Global Financial Environment

I will focus on two features of what is happening in the world economy and financial markets today ... These are, first, the behavior of forward interest rates in financial markets, and, second, the pattern of external imbalances.

These features are interesting, in part, because they seem somewhat anomalous, or inconsistent with what the past has led us to expect. They seem likely to be related to each other and both are a feature of the changes underway in global financial integration. Understanding the forces behind these phenomena or anomalies is important to thinking through what they mean for policy.

After discussing the possible causes for these two features, Giethner turns to the implications for policy:

What might this mean for the conduct of monetary policy? To the extent that these forces act to put downward pressure on interest rates and upward pressure on other asset prices, they would contribute to more expansionary financial conditions than would otherwise be the case. And, if all else were equal, which of course is unlikely ever to be the case, monetary policy in the affected countries would have to adjust in response; policy would have to act to offset these effects in order to achieve the same impact on the future path of demand and inflation. To do otherwise would run the risk that monetary policy would be too accommodative, pulling resources from the future in a way that would alter the trajectory for the growth of the capital stock, perhaps amplifying the imbalances, and compromising the price stability.
...
Let me conclude by observing that a constellation of factors has aligned to produce the current combination of low world interest rates, low risk premia and large global imbalances. Most of these factors are outside the control of U.S. monetary policy, and we do not fully understand their implications for our economy and for policy. The process of global economic integration makes it ever more important that we work to improve our understanding of how this complex of global monetary arrangements affects our objectives.

I suggest reading the entire speech.

by Calculated Risk on 3/09/2006 02:02:00 PM

The FED Flow of Funds report was released today. It shows that household mortgage debt increased at a record pace in 2005.

On a dollar basis, household mortgage debt increased by a near record $290.6 Billion in the 4th quarter. The last 8 quarters (billions increase in household mortgages, Includes loans made under home equity lines of credit):

q1 2004: $190.4
q2 2004: $211.1
q3 2004: $277.1
q4 2004: $232.9
q1 2005: $184.5
q2 2005: $277.9
q3 2005: $314.1
q4 2005: $290.6

From Rex Nutting of CBS MarketWatch: U.S. household debt up most in 20 years

U.S. households took on debt at the fastest pace in 20 years in 2005, fueled by a housing boom that boosted their net worth to a record $52.1 trillion, the Federal Reserve said Thursday.

The Fed's quarterly flow of funds report shows the explosion of debt in the U.S. economy continued in 2005, with net savings in the economy falling below 1% of gross domestic product for the first time on record.

Led by a surge in mortgage borrowing, U.S. households' debt increased 11.7% to record $11.5 trillion in 2005, the fastest growth since 1985, the Fed said.

And for the fourth quarter:

In the fourth quarter, total debt in the economy grew at an annual rate of 9.5%, down from 9.6% in the third quarter.

Household debt increased at an 11% pace, down from 12.4% in the third quarter. Mortgage debt increased 13.2%, down from 14.9% in the third quarter. Credit card debt fell 0.7% in the fourth quarter.

by Calculated Risk on 3/09/2006 12:01:00 AM

UPDATE: Brad Setser's comments are interesting: Mike Mandel, Ricardo Hausmann and Federico Sturzenegger better be right (January trade data)

The U.S. Census Bureau and the U.S. Bureau of Economic Analysis reports that the U.S. trade deficit for January was $68.5 Billion.


Click on graph for larger image.

The U.S. Census Bureau and the U.S. Bureau of Economic Analysis, through the Department of Commerce, announced today that total January exports of $114.4 billion and imports of $182.9 billion resulted in a goods and services deficit of $68.5 billion, $3.4 billion more than the $65.1 billion in December, revised.

January exports were $2.8 billion more than December exports of $111.6 billion. January imports were $6.2 billion more than December imports of $176.6 billion.

More to come.

by Calculated Risk on 3/08/2006 02:59:00 PM

From Reuters: Slowing housing won't sink spending: Poole

The U.S. housing sector may already be cooling but it should maintain its lofty level and not undermine the economic expansion, St. Louis Federal Reserve Bank President William Poole said on Wednesday.

"My hunch ... is that housing activity will stabilize and remain at a high level this year," Poole told the St. Louis Regional Chamber and Growth Association over breakfast.

Those are the big questions: Will housing activity "stabilize" or keep falling? And what will be the impact on jobs and the US economy?

Poole, who is not a voting member of the FOMC this year, said rising inventories of unsold U.S. houses signaled a slowdown may already be underway.

Some economists have forecast a downturn in the housing sector will sap consumer spending, which has been driving U.S. growth since a shallow recession in 2001.

They argue that homeowners have extracted equity from now more valuable homes to support spending despite, weak income growth in recent years. But Poole dismissed this concern.

"The marginal contribution to the pace of consumer spending stemming from the wealth effect -- that is, from households extracting a portion of their home equity to spend on goods and services -- is not likely to be a significant concern."

"The reason is that other economy-wide developments, especially income and employment growth, typically exert a much greater influence on the consumer's pocketbook and spending habits than does the state of the housing industry,' he said.

I disagree with Poole's comments. I think the substantial mortgage equity withdrawal (MEW) in recent years contributed significantly to GDP growth, and declining MEW will be a significant drag for the next few years.

by Calculated Risk on 3/08/2006 10:00:00 AM

The Mortgage Bankers Association (MBA) reports that mortgage application volume was steady for the week ending March 3rd.

Click on graph for larger image.

The Market Composite Index — a measure of mortgage loan application volume was 575.6 – an increase of 0.7 percent on a seasonally adjusted basis from 571.5 one week earlier. On an unadjusted basis, the Index increased 12.9 percent compared with the previous week, but was down 17.8 percent compared with the same week one year earlier.
The seasonally-adjusted Purchase Index decreased by 0.4 percent to 399.0 from 400.8 the previous week, whereas the Refinance Index increased by 2.6 percent to 1614.4 from 1573.5 one week earlier.

Mortgage rates increased:

The average contract interest rate for 30-year fixed-rate mortgages increased to 6.31 percent from 6.18 percent ...

The average contract interest rate for one-year ARMs increased to 5.69 percent from 5.64 percent ...

Change in mortgage applications from one year ago (from Dow Jones):

Total	-17.8%
Purchase	-11.8%
Refi	-25.8%
Fixed-Rate	-14.6%
ARM	-25.0%

Purchase activity is still fairly high though off from the peaks of 2005. Mortgage rates are increasing again, and will be increase again this week with the Ten Year note yield rising to 4.7%.

by Calculated Risk on 3/07/2006 09:33:00 PM

Dr. DeLong excerpts Krugman's Intro to Keynes's General Theory

"... Keynes was no socialist - he came to save capitalism, not to bury it. And there’s a sense in which The General Theory was... a conservative book.... Keynes wrote during a time of mass unemployment, of waste and suffering on an incredible scale. A reasonable man might well have concluded that capitalism had failed, and that only... the nationalization of the means of production - could restore economic sanity.... Keynes argued that these failures had surprisingly narrow, technical causes... because Keynes saw the causes of mass unemployment as narrow and technical, he argued that the problem’s solution could also be narrow and technical: the system needed a new alternator, but there was no need to replace the whole car. In particular, “no obvious case is made out for a system of State Socialism which would embrace most of the economic life of the community.”... Keynes argued that much less intrusive government policies could ensure adequate effective demand, allowing the market economy to go on as before.

Still, there is a sense in which free-market fundamentalists are right to hate Keynes. If your doctrine says that free markets, left to their own devices, produce the best of all possible worlds, and that government intervention in the economy always makes things worse, Keynes is your enemy. And he is an especially dangerous enemy because his ideas have been vindicated so thoroughly by experience.

Stripped down, the conclusions of The General Theory might be expressed as four bullet points:

1) Economies can and often do suffer from an overall lack of demand, which leads to involuntary unemployment

2) The economy’s automatic tendency to correct shortfalls in demand, if it exists at all, operates slowly and painfully

3) Government policies to increase demand, by contrast, can reduce unemployment quickly

4) Sometimes increasing the money supply won’t be enough to persuade the private sector to spend more, and government spending must step into the breach

To a modern practitioner of economic policy, none of this - except, possibly, the last point - sounds startling or even especially controversial. But these ideas weren’t just radical when Keynes proposed them; they were very nearly unthinkable. And the great achievement of The General Theory was precisely to make them thinkable....

There is much more at Dr. DeLong's blog.

I've read Keynes' General Theory of Employment, Interest and Money twice. It is a tough read, but well worth the effort.

by Calculated Risk on 3/06/2006 07:54:00 PM

The Financial Times is free this week.

From A chart for Japanese monetary policy By Takatoshi Ito

Toshihiko Fukui, governor of the Bank of Japan, has been sending a signal through speeches and testimony ... that the time is ripe for ending quantitative easing (QE).
...
The BoJ considers that the self-imposed conditions for an exit from QE – positive inflation, reflected in the consumer price index ... as an actual rate ... and as a forecast – have been satisfied.

It is widely expected that the BoJ will abolish QE in April, if not as early as this week. The drive for an early termination seems to have received strong encouragement after the government’s announcement on March 3 that the inflation rate for January 2006 (compared with January 2005) was 0.5 per cent.

Last autumn, when Mr Fukui and other BoJ policy board members hinted at the exit from QE, the government sent a strong signal not to do it hastily. But in the past few weeks, Heizo Takenaka, the interior minister, Hidenao Nakagawa, chairman of the LDP policy research council, and Junichiro Koizumi, the prime minister, have all changed their tone, suggesting they may not oppose the abolition of QE.

Although terminating QE in the near term seems to have become a foregone conclusion, it is not clear why the BoJ is in such a hurry, given that the level of inflation – 0.5 per cent – is still very low. The core inflation rate, excluding energy prices as well as food, is a still more modest 0.1 per cent.

Deflation risks remain, if energy prices stop rising or if the US economy slows down later this year. ... As the end of QE nears, a future path and guidelines for monetary policy are needed.
...
Inflation targeting is a popular framework for answering these questions. It is now practised by a majority of central banks among advanced countries.
...
Adopting inflation targeting will ensure independence, which will be essential when the BoJ contemplates raising the interest rate in cases where the government opposes the move. As the policy interest rate starts to become positive, medium-term and long-term interest rates will rise.
...
As Mr Fukui leads the termination of QE, he should set out the direction of future monetary policy definitively, with a numerical range. By defining the BoJ’s commitment and accountability, the path forward will be cleared.

by Calculated Risk on 3/05/2006 02:05:00 PM

The NY Times Magazine has an excellent article on economist Dr. Edward L. Glaeser: Home Economics. (hat tip to Dr. Thoma).

On the impact of the durability of housing:

... when cities grow, they expand significantly in population, but housing prices tend to rise slowly; even as Las Vegas grew by leaps and bounds in the 1990's, for instance, the average home there cost well under $200,000. When cities decline, however, the trends get flipped around. Population diminishes slowly, but housing prices tend to drop markedly.

Glaeser and Gyourko determined that the durable nature of housing itself explains this phenomenon. People can flee, but houses can take a century or more to finally fall to pieces. "These places still exist," Glaeser says of Detroit and St. Louis, "because the housing is permanent. And if you want to understand why they're poor, it's actually also in part because the housing is permanent." For Glaeser, this is the story not only of these two places but also of Buffalo, Baltimore, Cleveland, Philadelphia and Pittsburgh — the powerhouse cities of America in 1950 that consistently and inexorably lost population over the next 50 years. It is not just that there were poor people and the jobs left and the poor people were stuck there. "Thousands of poor come to Detroit each year and live in places that are cheaper than any other place to live in part because they've got durable housing still around," Glaeser says. The net population of Detroit usually decreases each year, in other words, but the city still attracts plenty of people drawn by its extreme affordability. As Gyourko points out, in the year 2000 the median house price in Philadelphia was $59,700; in Detroit, it was $63,600. Those prices are well below the actual construction costs of the homes. "To build them new, it would cost at least $80,000," Gyourko says, "so there's no builder who would build those today. And as long as those houses remain, the people remain."

Although Dr. Glaeser believes restrictive regulations have played an important role in surging house prices, he also thinks there has been a psychological component:

Glaeser ... says, "I'm comfortable with the notion that we're going to have a substantial correction over the next five years."

by Calculated Risk on 3/03/2006 02:26:00 PM

The yield on the Ten Year note has risen to 4.68%. This is about the same level as the second quarter of 2002.


Click on graph for larger image.

For the Ten Year, I plotted today's yield as Q2 2006. This shows yields on the Ten Year are close to Q2 2002 and probably means mortgage rates will rise next week close to Q2 2002 levels.

It will be interesting to see if the MBA purchase index shows another decline in activity.