by Calculated Risk on 7/06/2006 10:55:00 AM

The Mortgage Bankers Association (MBA) reports: Application Volumes Increase

Click on graph for larger image.

The Market Composite Index, a measure of mortgage loan application volume, was 561.0, an increase of 5.9 percent on a seasonally adjusted basis from 529.6 one week earlier. On an unadjusted basis, the Index increased 5.9 percent compared with the previous week but was down 33.3 percent compared with the same week one year earlier.

The seasonally-adjusted Purchase Index increased by 6.5 percent to 414.2 from 389.0 the previous week and the Refinance Index increased by 5.0 percent to 1423.9 from 1356.0 one week earlier.

Mortgage rates were mixed:

The average contract interest rate for 30-year fixed-rate mortgages decreased to 6.80 percent from 6.86 percent ...

The average contract interest rate for one-year ARMs increased to 6.39 percent from 6.36 percent ...

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

Total	-33.3%
Purchase	-20.1%
Refi	-48.9%
Fixed-Rate	-32.1%
ARM	-35.8%

Purchase activity is off 20.1% compared to the same week last year. Despite the slight increase in activity this week, the MBA Purchase Index is indicating that the housing market is continuing to slow compared to 2005.

by Calculated Risk on 7/05/2006 02:44:00 PM

Kenneth Heebner, manager of the CGM Realty Fund was interviewed in the WSJ today. A few excerpts:

WSJ: How is the housing market?

Mr. Heebner: A significant decline in prices is coming. A huge buildup of inventories is taking place, and then we're going to see a major [retrenchment] in hot markets in California, Arizona, Florida and up the East Coast. These markets could fall 50% from their peaks.

WSJ: What has you so concerned?

Mr. Heebner: I'm worried that more people will default on their mortgages. Risky mortgages such as interest-only and pay-option adjustable-rate mortgages require no principal amortization and in some cases payment of only a fraction of the interest due, have been widely used in the last two years. Some people got 100% financing for their homes. It made the tech bubble look like a picnic. When housing is going up rapidly and you can buy far more than your income can support, some people are eager to make big profits by extending themselves financially.

As housing prices fall more people will be under water, and these people are just going to walk away from their homes. They are going to say, 'I'm outta here.' You're going to see increasing foreclosures over the next several years. As [home] prices come down, it will create a difficult environment for home builders.

WSJ: What data have you most worried?

Mr. Heebner: We're seeing a huge increase in inventories of unsold homes. The role of incentives in selling a home is increasing so the weakness doesn't show up immediately in list prices. Large price declines will follow in inflated markets.
...
WSJ: Given the big size of some of the markets that you see as inflated, won't the regional 'pops' reverberate throughout the economy?

Mr. Heebner: The pops will reduce the growth rate of the economy, but they won't precipitate a downturn. ...

WSJ: Do you agree with economists who have described the individual consumer as a linchpin of the economy during the past few years, using refinancings to fuel the expansion?

Mr. Heebner: Borrowing against home equity has been overrated as a source of economic stimulus. While it has been a factor in the economic expansion, I don't think it's been the most important factor.

Mr. Heebner has an excellent track record. Read the interview for more of his comments.

I think Mr. Heebner is underestimating the role that mortgage equity extraction has played in stimulating the economy over the last few years. I also think the "burst" will be more widespread than Mr. Heebner believes - because homeowners used nontraditional mortgages just about everywhere. Prices might not fall very much in the less frothy areas, but I believe housing activity will slow significantly in almost all areas.

by Calculated Risk on 7/05/2006 02:05:00 AM

The Census Bureau reported:

"that construction spending during May 2006 was estimated at a seasonally adjusted annual rate of $1,206.2 billion, 0.4 percent (±1.4%) below the revised April estimate of $1,210.5 billion. The May figure is 6.0 percent (±2.2%) above the May 2005 estimate of $1,137.5 billion."

The following graph shows private residential construction spending for New Single Family and Improvements, seasonally adjusted and annualized since 2000:


Click on graph for larger image.

It appears construction spending peaked in Q4 2005. I expect the drop in construction spending to start showing up in the BLS employment report soon. As I noted in May, construction employment has already started to decline in California.

From Federal Reserve economist Dr. Krainer's Economic Letter last week:

"For recession-related downturns, the real price of new houses declines about four quarters after the peak, on average. Real new house prices register no detectable declines surrounding the average non-recession-related downturn."

So far the behavior of this housing downturn is similar to recession related downturns. If the similarities continue, prices will start to fall about four quarters after the peak, or late this year.

Note: I'm not arguing for a recession; I'm just saying the market behavior is similar (with Krainer's caveats) to recession related housing slowdowns.

by Calculated Risk on 7/03/2006 01:46:00 PM

For the first nine months of the 2006 fiscal year (starts Oct 1st), the National Debt has increased $487.3 Billion. The record is $491.1 Billion for the first nine months of fiscal 2004.


Click on graph for larger image.

As a percent of GDP, the deficit has improved slightly over the last few years.

The annual increase in the debt is running around 4.5% to 5.0% of GDP. This is a classic "structural budget deficit" or "high employment deficit" - something most economists believe should be avoided.

If someone says the deficit is falling - laugh (or cry). Its not true. For an explanation, see my post on Angry Bear: Budget Metrics and the Cheating Clotheshorse

by Calculated Risk on 7/01/2006 12:54:00 AM

Fed Economist Dr. Krainer writes: Residential Investment over the Real Estate Cycle (thanks to Professor Thoma for the tip!)

Note: I'm going to jump ahead in the economic letter.

For recession-related downturns, the ratio (shown in Figure 3) starts to rise on average six quarters before the actual downturn, and continues to rise for six quarters into the downturn. For the average non-recession-related downturn, the inventory ratio turns up just one quarter before the downturn and then eases back down after two quarters (which is also the average duration of a non-recession-related downturn).

A key point in figure 4 is that the current behavior of inventory looks more like a recession related downturn than a non-recession related housing downturn.

This exercise indicates that prices seem to be considerably less useful predictors of downturns than quantity-type measures. This might seem surprising because, unlike sales volumes and inventories, prices have a forward-looking aspect and thus would seem to be good predictors of the future state of the housing market.

Figure 4 shows the average behavior of real new house prices leading up to and then following a peak in residential investment. The focus here is on new house prices because, presumably, they, rather than existing house prices, are most relevant for real estate developers' decisionmaking. Additionally, new house prices are likely to be more sensitive to market weakness than existing house prices. Developers are always "motivated sellers." If demand is soft, they generally do not have the option of withdrawing the house from the market and simply living in it. For recession-related downturns, the real price of new houses declines about four quarters after the peak, on average. Real new house prices register no detectable declines surrounding the average non-recession-related downturn. This basic stylized fact is even more apparent when using prices of existing homes. Only in the severest downturns do we witness real price declines, and never do these price declines come in advance of a downturn in investment.

One caveat to this analysis is that it is based on the comparison of the average behavior of a housing market series leading up to two different types of downturns in residential investment. Obviously, averaging in the figures masks a fair degree of variation across the different downturns. However, more formal statistical modeling supports the notion that variables such as sales volumes and inventory ratios yield earlier and more reliable signals when the downturn is recession-related. This is natural; recession-related downturns have tended to be more severe than the non-recession-related episodes.

It is also interesting to note that the recent behavior of the month's supply ratio bears more resemblance to the typical behavior before a recession-related downturn than to a non-recession-related downturn. Yet economists, such as those sampled in surveys of professional forecasters, are generally predicting only a moderation in overall economic growth in coming quarters. Given these conflicting observations, it is natural to wonder how much stand-alone information for predicting residential investment is contained in the housing market data. The answer, based on the last 30 years of data is mixed. If we estimate a model of the event that a residential downturn occurs using lagged values of the housing market variables mentioned above, we can generally improve the model prediction error by adding in forecasts of output growth. This suggests that it is best to consider economy-wide factors in addition to specific housing market variables when evaluating the real estate market.

Note: bold text is added emphasis

Where are we now with residential investment?


Click on graph for larger image.

This graph shows residential investment as a percent of GDP on a quarterly basis since 1980. It appears residential investment peaked in Q4 2005 and declined slightly (as a % of GDP) in Q1 2006.

Right now this housing slowdown looks more like a recession related slowdown.

On housing, also see Dr. Hamilton's All eyes on housing

"... it raises the possibility that, when the recognition does sink in, the current "gradual cooling" could quickly turn into something more impressive."

by Calculated Risk on 6/30/2006 09:14:00 PM

Last December I tried to predict the top economic stories of 2006. It's time for a short mid-year review.

I started with four stories that I thought wouldn't 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.

Oops. So far I've clearly been wrong on oil prices. WTI spot prices closed at $73.52 today, an increase of 22% over the last 6 months. That is a HUGE story.

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.

Correct so far.

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.

Correct so far, but for the wrong reason. I thought the trade deficit would stabilize at the Q4 levels because the US economy would be slowing down.

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.

Correct so far.

And now my top 5 predictions:

5) The End of the Greenspan Era I think Dr. Bernanke will face a significant challenge in '06, perhaps by one the following top stories - perhaps by something completely unexpected. ... When the challenge comes, expect investors to pine for their lost love: Alan Greenspan.

Bernanke hasn't faced a significant challenge yet, so it is too soon to tell.

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".

So far, so good.

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. ...

Nothing so far.

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.

Too early to say. Growth in the first quarter was definitely strong.

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 ... 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.

Too early to say - the FED hasn't even paused yet.

Summary: Mostly it's too soon to tell. I've clearly been wrong on oil prices and correct on the trade deficit, the budget deficit and the housing market - at least so far.

by Calculated Risk on 6/30/2006 09:57:00 AM

The BEA reports for May:

Personal income increased $38.3 billion, or 0.4 percent, and disposable personal income (DPI) increased $31.6 billion, or 0.3 percent, in May, according to the Bureau of Economic Analysis. Personal consumption expenditures (PCE) increased $40.3 billion, or 0.4 percent.

Core PCE increased 0.2 percent in May (2.6% annualized). Core PCE for May was below the April rate, but still above the high end of the FED's assumed target range (2%).


Click on graph for larger image.

The savings rate continued its downward trend. The savings rate, as a percent of DPI, was a negative 1.7%.

In the last post, the chart shows the quarterly savings rate. This post is the monthly savings rate. The Microsoft special dividend (Dec '04) and the impact of hurricane Katrina (Aug '05) are even more evident in the monthly chart.

by Calculated Risk on 6/29/2006 03:23:00 PM

Final Q1 GDP was released today and the headlines blared: First-quarter GDP growth strong

The U.S. economy grew at a revised 5.6 percent annual rate in the first quarter as the fastest pace of growth in 2-1/2 years ... The department pushed its estimate of first-quarter growth in gross domestic product up from 5.3 percent it reported a month ago.

But personal savings were revised down significantly. In the prelimary Q1 GDP report, personal savings were a negative $50.5 billion and the personal saving rate was reported as a negative 0.5 percent in Q1, 2006.

In the final Q1 GDP report, personal saving were a negative $128.1 Billion, and the savings rate was a negative -1.4%; almost as bad as the Q3 2005 savings rate that was partially attributed to hurricane Katrina's impact.


Click on graph for larger image.

Hurricane Katrina impacted personal savings in Q3 2005. In Q4 2004, the Microsoft special dividend distorted the personal savings numbers. In Q3 2001, personal savings spiked due to consumers behavior following 9/11.

Even though GDP was strong in Q1, the negative personal savings rate is a concern.

by Calculated Risk on 6/28/2006 09:31:00 AM

The Mortgage Bankers Association (MBA) reports: Mortgage Rates Increase, Application Volume Declines (link added)


Click on graph for larger image.

The Market Composite Index, a measure of mortgage loan application volume, was 529.6, a decrease of 6.7 percent on a seasonally adjusted basis from 567.6 one week earlier. On an unadjusted basis, the Index decreased 7.0 percent compared with the previous week but was down 31.0 percent compared with the same week one year earlier.

The seasonally-adjusted Purchase Index decreased by 6.2 percent to 389.0 from 414.8 the previous week and the Refinance Index decreased by 7.5 percent to 1356.0 from 1466.1 one week earlier.

Mortgage rates increased:

The average contract interest rate for 30-year fixed-rate mortgages increased to 6.86 percent from 6.73 percent ...

The average contract interest rate for one-year ARMs increased to 6.36 percent from 6.22 percent ...

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

Total	-31.0%
Purchase	-18.2%
Refi	-46.4%
Fixed-Rate	-30.1%
ARM	-32.9%

Both the Market Index and Purchase Index are at new lows for the last 3 years.


This graph shows the MBA Purchase Index percent change by month for 2006 from 2005.

Based on the MBA Purchase Index, the housing market is continuing to slow compared to 2005.

by Calculated Risk on 6/27/2006 06:09:00 PM

From Reuters: Chances rise for housing-driven recession

Merrill Lynch economists say there is now about a 40 percent chance of a recession in the first half of 2007 -- even without a widely anticipated 25 basis-point Federal Reserve rate hike this week.
...
Bernard Baumhol, executive director of The Economic Outlook Group in New York, said he believes chances of a recession in 2007 will increase to 35 percent if the federal funds rate -- at 5.0 percent going into this week's Fed policy meeting -- exceeds 5.5 percent.

"If the Fed gets to 6 percent, we're probably talking about a 50 percent probability of a recession in 2007," Baumhol said.

In the comments to an earlier post, bbb provided links to this recession calculator (based on a method outlined by Dr. Hamilton):

Reckoning the Odds of Recession

Visualizing the Probability of Recession

Using these tools, and values of 5.21% for the Ten Year, 5.05% for the 3 month, and 5.25% for the Fed Funds rate (expected), yields a probability of recession of 32%. That is the odds that America is in recession right now.

I am not ready to predict a recession, although an economic slowdown seems certain. On the other side, from the Reuters article:

'A housing-driven recession is "mathematically impossible," said Wachovia Bank senior economist Mark Vitner, because housing is derived from the rest of the economy and construction is actually a smaller portion of the U.S. economy than during the housing boom of the late 1970s. Even if home values soften in expensive markets, many homeowners are still sitting on substantial home equity cushions.'

Actually housing is a much larger percentage of the economy than in the late '70s. Using data from the BEA:


Click on graph for larger image. Note: 2006 is estimated from Q1 data for both graphs.

Residential investment is a larger part of the economy now than in the late '70s.


And from the Federal Reserve Flow of Funds report:

Mortgage debt as a percent of GDP is significantly higher now than in the late '70s.

And finally from the BLS, construction employment is higher now, as a percent of total employment, than in the late '70s. From '76 to '79, construction employment was 4.7% of total non-farm employment. Today, construction employment is 5.5% of total employment.

Although wrong on the facts, Mr. Vitner is correct that a housing slowdown alone has never taken the economy into recession. And that is one of the reasons I've been hesitant to forecast a recession.