by Calculated Risk on 5/12/2009 02:32:00 PM

GE Chief Executive Jeff Immelt is uncertain when growth will resume ...

From Reuters: GE CEO says economy stabilized, growth a question

Improved credit markets have brought stabilization to the economy but it is still not clear when growth will resume, General Electric Co Chief Executive Jeff Immelt said on Tuesday.

"The credit picture, we think, is improving and that's really one of the fundamentals to getting the broader economy doing better," Immelt said in an interview with Reuters. "Things certainly have stabilized and now the goal is to see where growth goes in the second half of the year."

And from PIMCO's El-Erian:

It was clear to us that, despite the very high hurdle that we always apply to such a statement, the world has changed in a manner that is unlikely to be reversed over the next few years. Put another way, markets are recovering from a shock that goes way, way beyond a cyclical flesh wound.
...
For the next 3–5 years, we expect a world of muted growth ...

And Bloomberg quotes Paul Krugman:

“It looks to me now as if the markets are now pricing in a rapid recovery, that they’re pricing in a V-shaped recession, which I consider extremely unlikely,” Krugman said at a forum in Shanghai today. “The market seems to be looking as if this is going to be an average recession, but it’s not.”

I thought a depression was unlikely, and I think an immaculate recovery is also unlikely. Something in the middle - that will feel like a recession to many - is more likely.

As I noted last week (see A Return to Trend Growth in 2010? and The Impact of Changes in the Saving Rate on PCE ), the usual engines of recovery - personal consumption expenditures (PCE) and residential investment (RI) - will both remain under pressure (even if they show some sluggish growth).

My forecast is for unemployment to stay elevated for some time, and the suggests minimal wage growth. And I also think household will increase their saving rate to repair their household balance sheet (and because of an aging population). This suggests PCE growth will probably be below trend.

And for RI, there is far too much inventory for any significant rebound in new home construction. So where will the growth come from?

by Calculated Risk on 5/12/2009 11:32:00 AM

The NAR reported today: Foreclosure and Short Sale Discounts Weigh Down Metro Area Median Prices

" ... first-time buyers account[ed] for half of all purchases during the first quarter ..."

“Close to 455,000 buyers purchased their first home during the first quarter, and those are likely just the first wave of new buyers coming into the market – they’re critical for a housing recovery,” [Lawrence Yun, NAR chief economist] said.

Most of the press release discusses the median price (something to ignore because of the change in mix), but there is a key point being missed - many of these sales are "one and done" with no move up buyer.

Click on graphis for larger image in new window.

Here is a graphic I created a couple years ago to show a normal market chain reaction.

At that time I wrote: "Not all chain reactions start with a first time buyer using a subprime loan, but the loss of a large number of subprime buyers will impact the entire chain."

Where are the move up buyers going to come from?

There is no "chain reaction" in the housing market - over half the sales are to first time buyers, and frequently the sellers are banks.

I hear this from real estate agents all the time: the agents (low end) are plenty busy with REOs and short sales, but the deals are mostly "one and done".

by Calculated Risk on 5/12/2009 09:25:00 AM

From Bloomberg: Advanta Shuts Down Credit-Card Lending Amid Surging Charge-Offs

Advanta Corp., the issuer of credit cards for small businesses, will halt new lending for its 1 million customers next month as the recession causes a surge in loan defaults. ... Advanta said ... charge-offs, or uncollectible debt, reached 20 percent on some cards as of March 31.
...
“We’ll be shutting down accounts for future transaction activities, but many of the customers will maintain balances and pay us off over time,” [Chief Financial Officer Philip Browne] said yesterday in a telephone interview.

Advanta was the 11th-biggest U.S. credit-card issuer at the end of 2008 with about $5 billion in outstanding balances, and the only major lender focused on small business borrowers ...

This is much higher loss rate than for consumer credit cards - the Fed's two year indicative loss rate was 18% to 20% for consumer credit cards - Advanta is seeing that in one year for some cards!

by Calculated Risk on 5/12/2009 08:31:00 AM

The Census Bureau reports:

The ... total March exports of $123.6 billion and imports of $151.2 billion resulted in a goods and services deficit of $27.6 billion, up from $26.1 billion in February, revised. March exports were $3.0 billion less than February exports of $126.6 billion. March imports were $1.6 billion less than February imports of $152.8 billion.

Click on graph for larger image.

The first graph shows the monthly U.S. exports and imports in dollars through March 2009.

Both imports and exports declined in March, although it appears the cliff diving in trade might be over.

On a year-over-year basis, exports are off 17.4% and imports are off 27%!

The second graph shows the U.S. trade deficit, with and without petroleum, through March.

The blue line is the total deficit, and the black line is the petroleum deficit, and the red line is the trade deficit ex-petroleum products.

Import oil prices increased slightly to $41.36 in March following eight consecutive monthly declines. Spot prices have increased since March, so it appears the decline in the trade deficit due to lower oil prices is over for now.

The trade deficit is mostly oil and China now, so any further significant decline in the deficit is unlikely in the short term. Although the NY Times reports: Chinese Exports Fall 22.6% in April

Exports from mainland China slumped 22.6 percent in April from a year earlier, official statistics showed — a fall that was not only larger than economists had expected but also bigger than that in March, when overseas shipments declined 17.1 percent.

by Calculated Risk on 5/11/2009 11:31:00 PM

From the NY Times: As Storefronts Become Vacant, Ads Arrive

Almost every category of advertising is declining precipitously in this economy, but there is one that is thriving. ...

Taking advantage of all the abandoned retail spaces in urban areas, marketers are leasing them at cut-rate prices and filling them with their ads.
...
“In the last year and a half, it’s been much easier to acquire locations,” said [Ray Lee, the managing director of ... a company that creates storefront advertisements].

Yeah ... "much easier to acquire locations". I bet!

by Calculated Risk on 5/11/2009 09:12:00 PM

From Crain's Chicago Business: Foreclosure wave slams suburbia (ht Atrios)

Home foreclosures are surging in Chicago's suburbs just as they level off or decline in many city neighborhoods already ravaged by mortgage defaults.

Foreclosure cases filed in the first quarter jumped between 25% and 70% from the fourth quarter in DuPage, Will, McHenry, Lake and Kane counties, according to new data provided to Crain's by the Woodstock Institute, a Chicago-based housing advocacy group. Meanwhile, foreclosures fell 8% in Chicago, the first quarterly decline in a year.
...
The shifting locus of new foreclosures shows how the recession and job losses are supplanting subprime lending as the main driver of mortgage defaults ... While the first wave of foreclosures hit hardest in poorer city neighborhoods ... the latest round is striking middle-class areas where most borrowers qualified for standard-rate mortgages.

The decline in foreclosures in Chicago might be because of the recent moratorium, but clearly foreclosures are moving into the middle-class areas.

We're all subprime now!

And that gives me an excuse to post this ...

Click on drawing for larger image in new window.

My friend and co-blogger Tanta originated the phrase "We're all subprime now!" One of her many talents was something she called "Excel Art". This drawing is from December 2007 and is titled "The Adventures of Mortgage Pig, Chapter 4: Hanging Over the Cubicles of the Mod Squad".

The drawing is from an excel file that Tanta used to explain how Option ARM loans recast - see Tanta's UberNerd post: On Option ARMs

by Calculated Risk on 5/11/2009 06:52:00 PM

UPDATE: Speech Text: The Supervisory Capital Assessment Program

My remarks this evening will focus on the Supervisory Capital Assessment Program, popularly known as the banking stress test. ...

It is important to note that this was not a solvency test. After including capital previously provided by the Treasury, all of these banking organizations currently have capital well in excess of the minimum stated capital requirements of the supervisors. Instead, the purpose of the exercise was to determine the size of the capital cushion that each organization would need to remain well capitalized and still be able to lend--even in an economic scenario more severe than expected.
...
Conclusion
In summary, the Supervisory Capital Assessment Program is an important element of broader and ongoing efforts by the Federal Reserve, other federal bank regulators, and the Treasury to ensure that our banking system has sufficient resources to navigate a challenging economic downturn. A collateral benefit is that many lessons of the exercise can be used to improve our supervisory processes. In particular, the supervisory capital assessment has demonstrated the benefits of using cross-firm, cross-portfolio information and the simultaneous review of a number of major firms to develop a more complete and fine-grained view of the health of the banking system.

Whether the objectives of the assessment program were achieved will only be known over time. We hope that in two or three years we will be able to reflect on the banking system's return to health with a sharply diminished reliance on government capital. More immediately, we hope and expect that the public and investors will take considerable comfort from the fact that our largest financial institutions have been evaluated in a comprehensive and rigorous fashion; and that they will, as a consequence, be required to have a capital buffer adequate to weather future losses and to supply needed credit to our economy--even if the economic downturn is more severe than is currently anticipated.

Fed Chairman Ben Bernanke will speak tonight at the Atlanta Fed's Financial Markets Conference in Jekyll Island, Georgia.

I believe Bernanke will be talking about the stress tests.

I'll post a link and excerpts from the prepared text when available ...

Here is the CNBC feed (maybe they will cover the speech).

by Calculated Risk on 5/11/2009 04:52:00 PM

Here is Meredith Whitney on banks and stress tests today ...

On the stress test leaks:

"I couldn't believe how poorly the impressions leaked, how effectively people say it was leaked, if it was any other company leaking that information there would be SEC investigations all over the place."

by Calculated Risk on 5/11/2009 04:19:00 PM

By popular demand, the 2nd graph is Doug's "Mega-Bear Quartet" that includes the Nikkei and NASDAQ bear markets.

Click on graph for larger image in new window.

The first graph is from Doug Short of dshort.com (financial planner): "Four Bad Bears".

This is the 2nd worst S&P 500 / DOW bear market in the U.S. in 100 years.

Note that the Great Depression crash is based on the DOW; the three others are for the S&P 500.

The second graph compares four significant bear markets: the Dow during the Great Depression, the NASDAQ, the Nikkei, and the current S&P 500.

See Doug's: "The Mega-Bear Quartet and L-Shaped Recoveries".

by Calculated Risk on 5/11/2009 03:09:00 PM

"We are, as far as growth is concerned, around the inflection point in the cycle"
European Central Bank President Jean-Claude Trichet, May 11, 2009

From The Times: Britain may be on road to recovery, says OECD

The worst of Britain's recession may now be over, according to the Organisation for Economic Co-operation and Development (OECD).

The OECD, the umbrella group for the top 30 developed nations, said its indicators, which are considered to be a bellwether for the global economic outlook, pointed to a strong slowdown in the OECD area, but said that Britain, France and Italy were showing “tentative signs” of a pause in the slowdown.

Canada, Japan, Germany and the US, are still in the midst of a "strong slowdown".
...
“However, with the exception of China, where signs of a pause have also emerged, major non-OECD economies still face deteriorating conditions,” the OECD said.
...
“We are, as far as growth is concerned, around the inflection point in the (economic) cycle,” said Jean-Claude Trichet, head of the European Central Bank, at a G10 meeting in Switzerland.

More from Bloomberg: Trichet Says Global Economy Is Near Turning Point

Once global growth starts to pick up, central banks will have to scale back their support for the economy, Trichet said.

“Insistence is put on the exit strategy, on the medium- term path that permits us to go back to a normal situation, a sound and sustainable situation,” he said. At the same time, central banks will “do what is necessary in terms of extraordinary measures, as long as necessary,” he added.

It took just a couple of months to go from Great Depression II to "green shoots". Now Trichet is talking about an "inflection point" and central bankers scaling back their support - this seems a little premature.

by Calculated Risk on 5/11/2009 01:44:00 PM

On Saturday I excerpted from a NY Times article Shift to Saving May Be Downturn’s Lasting Impact. I argued:

The saving rate will probably continue to rise (an aging population usually pushes the saving rate higher) and a rising saving rate will repair household balance sheets, but ... this will also keep pressure on personal consumption.

First, here is a graph of the annual saving rate back to 1929.

Click on graph for large image.

Notice that the saving rate went negative during the Depression as household used savings to supplement income. And the saving rate rose to over 25% during WWII.

There is a long period of a rising saving rate (from after WWII to 1974) and a long period of a declining saving rate (from 1975 to 2008).

Some of the change in saving rate was related to demographics. As the large baby boom cohort entered the work force in the mid '70s, the saving rate declined (younger families usually save less), however I expected the saving rate to start to rise as the boomers reached their mid-40s (in the late '90s). This didn't happen.

Perhaps the twin bubbles - stock market and housing - deluded the boomers into thinking they had saved more than they actually had. Perhaps the boomers were deluded by bad economic analysis (see David Malpass: Running on Empty?)

Whatever the reason, I expect the saving rate to continue to rise over the next year or two. And that raises a question: what will be the impact on PCE of a rising saving rate?

I created the following scatter graph for the period from 1955 through Q1 2009. This compares the annual change in PCE with the annual change in the saving rate.

Note that R-squared is only .125, so there are other factors impacting PCE (like changes in income!).

But a rising saving rate does seem to suppress PCE (as expected). If the saving rate rises to 8% by the end of 2010, this suggests that real PCE growth will be about 1% below trend per year.

So with wages barely rising, and a rising saving rate suppressing PCE, I'd expect PCE growth to be sluggish for some time. And since PCE is usually one of the engines of recovery (along with residential investment), I expect the recovery to be very sluggish too (no Immaculate recovery).

by Calculated Risk on 5/11/2009 10:51:00 AM

“Certainly the task that we have in front of us is large, but we know that we can get it done. Today it’s more probable that we would need to resort to a bankruptcy process. But there’s still a possibility and an opportunity for it to be done outside of a bankruptcy.”
GM Chief Executive Officer Fritz Henderson

The NY Times is live blogging the conference call, but there doesn't sound like much news.

GM received three bids for Hummer, and expects a sale by the end of May.

On the bonds:

Mr. Henderson said the Treasury told G.M. to offer its bondholders up to a 10 percent stake in the company in return for the $27 billion in debt that they hold but did not give a reason why. Bondholders have said the stake is too small compared to what others are receiving.

And that is why a BK is likely ...

by Calculated Risk on 5/11/2009 08:58:00 AM

A few quotes from Paul Krugman in China ...

From Reuters: Krugman fears lost decade for US due to half-steps

"We're doing half-measures that help the economy limp along without fully recovering, and we're having measures that help the banks survive without really thriving," Krugman said.

"We're doing what the Japanese did in the nineties," he told a small group of reporters during a visit to Beijing.
...
"I'm mostly worried that the U.S. and the euro zone will have Japanese-type lost decades," he said.
...
"It's clear the administration won't take radical action to strengthen the banks any time soon," he said.

by Calculated Risk on 5/10/2009 11:25:00 PM

Click on graph for larger image in new window.

The first graph is from Doug Short of dshort.com (financial planner): "Four Bad Bears".

The S&P 500 is up 37.4% from the bottom, but still off 40.6% from the peak.

Note that the Great Depression crash is based on the DOW; the three others are for the S&P 500.

The second graph is the Shanghai SSE composite index. I used to post this graph with the subtitle "Cliff Diving"!

The Shanghai composite is up again tonight, and this index is now up 54% from the bottom, but still off 55% from the peak.

Both these markets show how the denominator impacts percentages. Imagine a market that peaked at 100 and dropped to 30. Then rallied back to 50. The market would the be up 67% from the bottom: 50 minus 30 = 20, divided by 30, but still off 50% from the peak. That is why it helps to report both numbers!

The S&P 500 is up 37.4% from the bottom, but that just puts it near the level following the early October crash.

The U.S. futures are off tonight:

CBOT mini-sized Dow

Futures from barchart.com

CME Globex Flash Quotes

And the Asian markets. The Asian markets are mixed.

And a graph of the Asian markets.

Best to all.

by Calculated Risk on 5/10/2009 06:44:00 PM

From the NY Times: White House Forecasts No Job Growth Until 2010

Speaking on C-SPAN, Christina Romer, chairwoman of the White House Council of Economic Advisers, said that she expected the G.D.P. to begin growing in the fourth quarter of this year. ... Ms. Romer also said that she expected unemployment to rise even after the economy turns, saying that the G.D.P. has to grow at a rate of about 2.5 percent before unemployment will fall. Before that happens, she said, it is “unfortunately pretty realistic” that the unemployment rate could reach 9.5 percent. A reasonable estimate for the G.D.P.’s growth rate in 2010, she said, is three percent.

Three percent is pretty close to trend growth. Although three percent is possible, I think a more sluggish recovery is likely. Note: Romer isn't forecasting a "V-shaped" recovery with strong growth coming out of the recession.

The usual engines of recovery - personal consumption expenditures (PCE) and residential investment (RI) - will both be under pressure. With nearly stagnant wages and a rising saving rate (my forecast based on households repairing balance sheets and an aging population), PCE growth will probably be below trend. And for RI, there is far too much inventory for any significant rebound in new home construction. Where will growth come from? Not investment - there is too much capacity.

Meanwhile the banking system is still very fragile, with the Obama administration gambling that the banks will earn their way out of the mess.

I'm still amazed by the bipolar outlooks of forecasters: just a few months ago, many forecasters were openly talking about a 2nd Great Depression (while I was writing about seeing a bottom in a few key leading indicators), and now some forecasters are talking about an immaculate recovery. Amazing.

by Calculated Risk on 5/10/2009 03:19:00 PM

From the NY Times: Manhattan Calling

... Great Recession prices are drawing even the most loyal outer-borough dwellers back to Manhattan. ...

Among the lures: $1,600 one-bedrooms on the Lower East Side. Lenient landlords who no longer require security deposits. And an overriding sense that an obscenely overpriced borough is now, well, slightly more reasonably overpriced.

... "[T]his was a unique moment in real estate history where renters have the upper hand, which seemed unbelievable a couple of years ago." [said] Keith O’Brien, a 30-year-old in marketing and public relations ...

In the first three months of the year, one-bedroom rents in Manhattan fell 6.7 percent compared with the previous year, while Brooklyn one-bedrooms dropped just 3.2 percent, according to data from Citi Habitats and Ideal Properties Group ... Other reports show some Manhattan rents down by 10 percent from a year ago.

... prices at upscale rental buildings like 45 Wall Street have come down significantly, discounted by 15 to 20 percent in recent weeks.

This is mostly anecdotal data, but it does appear apartment rents are falling in much of the country.

by Calculated Risk on 5/10/2009 11:48:00 AM

From Saturday Night Live sorry about the ad.

(For serious posts on banking scroll down)

by Calculated Risk on 5/10/2009 10:50:00 AM

From the Financial Times: US banks claim line softened on $74bn (ht Bo)

US banks have been given government assurances they will be allowed to raise less than the $74.6bn in equity mandated by stress tests if earnings over the next six months outstrip regulators’ forecasts, bankers said.

The agreement, which was not mentioned when the government revealed the results on Thursday, means some banks may not have to raise as much equity through share issues and asset sales as the market is expecting. It could also increase the incentive for banks to book profits in the next two quarters.

The banks have 28 days to announce their capital-raising plans and until November 9 to implement them. Wells Fargo and other banks that will have to raise capital told the Financial Times that if operating profits were greater than the government’s stress-case forecast for the second and third quarter, they would receive credit for the difference. That, in turn, would reduce the need to raise fresh equity from other sources.

The banks have a real incentive to book profits during Q2 and Q3 - something to remember.

For more, see the comments of Nouriel Roubini and Jan Hatzius (Goldman's chief economist) that I posted yesterday: The Race: Future Earnings vs. Writedowns

by Calculated Risk on 5/09/2009 10:31:00 PM

Here is another video from Jillayne Schlicke at a foreclosure auction on April 24, 2009 in Bellevue, WA.

Did he say "Calculated Risk"? (1 min 14 sec)

by Calculated Risk on 5/09/2009 06:07:00 PM

The results of the stress test showed that the bulk of future bank losses will come from accrual loan portfolios, as opposed to exotic securities (most of the writedowns to date have come from these securities). Here is the quote from the stress test results:

"The bulk of the estimated losses – approximately $455 billion – come from losses on the BHCs’ accrual loan portfolios, particularly from residential mortgages and other consumer‐related loans. ... Estimated possible losses from trading‐related exposures and securities held in investment portfolios totaled $135 billion."
Federal Reserve, The Supervisory Capital Assessment Program: Overview of Results, May 7, 2009

Here is Professor Roubini's comment (from Ten Reasons Why the Stress Tests Are “Schmess” Tests and Why the Current Muddle-Through Approach to the Banking Crisis May Not Succeed):

Second, the capital/needs of these banks depend on a race between retained earnings before writedowns/provisioning that will be positive given a high net interest rate margin and the losses deriving from further writedowns. It appears that regulators have overestimated the amount of such retained earnings for 2009-2010. The IMF recently estimated that retained earnings (after taxes and dividends) for all US banks – not just these 19 ones – would be only $300 bn total over the 2009-2010 period. The stress tests – instead – assumed much higher retained earnings - $362 bn - for these 19 banks alone for the 2009-2010 period in the more adverse scenario. Since these 19 banks account for about half of US banks assets if one were to use the IMF estimate of net retained earnings for these 19 banks their net retained earnings for 2009-2010 would be $150 bn rather than the $362 bn assumed by the regulators. While the IMF may have been too conservative in its estimates of net retained earnings it appears that regulators may have been too generous to these 19 banks in forecasting their earnings in an adverse scenario. Thus, ex-post capital needs will be significantly higher if net retained earnings turn out to be lower than assumed in the stress tests.

And a more optimistic view from Jan Hatzius:

"The enormous volume of securities writedowns in 2008 basically overwhelmed the pre-provision earnings power of the banking industry. ... We think that most of the loss recognitions in securities has now occurred. U.S. banks will still need to recognize substantial losses, but this will be mainly the provisions for whole loans that are spread out over a somewhat longer period of time, and somewhat more predictable, and therefore won't be as violent as the securities write-downs, and as a result these remaining losses can be offset via pre-provision earnings to a much greater degree."
Jan Hatzius, Chief Economist, Goldman Sachs, Conference Call, May 8, 2009 (no link)

This brings up a key concept:

Imagine a bank holds a RMBS (Residential Mortgage Back Security). Forget about tranches - just imagine the security is based on 100 mortgage loans. All of the loans are current, but the security is actively traded, and the price falls to 50 cents on the dollar because investors believe that there are many default (and losses) coming. The bank has lost 50% immediately. The bank holds the security, not the loans - so it is the change in the value of the security that hits their income statement.

Perhaps the bank believes the most profitable thing to do is just keep the loans in its own portfolio (fair value accounting principle called "highest and best use"). Now the bank also has a portfolio of 100 loans with exactly the same characteristics as the RMBS. The Fair Value estimate for income producing loans for which there is no available market or counterparty will be based on the Income approach (discounted future cash flows). As before all of the loans are current, so the bank takes writedowns based on estimates of discounted future cash flows (they are being held to maturity). As the losses, both current and future, become estimable, the bank takes the writedown.

A large portion of Alt-A (like Option ARMs) is held on bank balance sheets. So the building Alt-A crisis will be written down as the losses are estimable. Tanta mentioned this last year in: Subprime and Alt-A: The End of One Crisis and the Beginning of Another

If the "subprime crisis" was about "exotic securities," the "Alt-A crisis" is going to be about bank balance sheets.

And this brings up a second key point:

The Fed estimated both future losses and future earnings. As Dr. Roubini noted, there will be a race between losses and earnings - and if the Fed overestimated earnings or underestimated losses, the banks will need additional capital. If Hatzius is correct, the banks will win (or draw) the race - if Roubini is correct, the banks will lose.

But whether the banks win or lose the race, the rapidly rising defaults for Alt-A (and HELOCs and Jumbo Prime) loans will impact house prices in neighborhoods where the loans are concentrated (mostly mid-to-high end areas).