A temporary tariff on Chinese tires still pales in comparison to the estimated 40 percent advantage Chinese exports have as a result of currency manipulation.

read more

Most political experts believe that a strong economy favors incumbents, but the Post told readers the opposite in a front page piece that urged Democrats to embrace deficit reduction. The piece noted comments from several Democratic senatorial candidates urging budget cuts, then told readers:

"The new push for austerity could prove too little, too late for Democrats, who fear losing their majorities in both chambers of Congress. In dozens of House and Senate races, incumbent Democrats are struggling in polls, leading political analysts to raise the serious prospect of Republican takeovers in the House and even the Senate."

Of course the deficits that the country is now running are sustaining the economy. If the deficits were lower then output would be lower and unemployment would be higher. The Congressional Budget Office (CBO) recently estimated that the stimulus has reduced the unemployment rate by between 0.7 and 1.8 percentage points.

The CBO estimates imply that if the Democrats had been earlier in their push for fiscal austerity and not pushed through the stimulus, then the current unemployment rate would be between 10.3 percent and 11.4 percent. This Post piece asserts that this situation would have improved their electoral prospects in November, although it cites no one who backs up this position.

The editorial, which is not labeled as such, includes several other unsupported assertions. At one point it told readers that government spending is out of control, commenting that "Democrats vow to bring spending under control," which of course is only possible if spending is already out of control.

It also implies that the Democrats have spent recklessly commenting about their "conversion to fiscal restraint" and the difficulty of convincing voters that they are serious. Of course the only budget surpluses in the last 40 years were run with Democrats in the White House, and the largest structural deficits were run under Republican administrations, so it is a bit bizarre that the article would imply that Democrats need to convert to "fiscal restraint."

The article also told readers the country's fiscal health is in danger and that the changes need to restore it are unpopular:

"Some fiscal hawks are skeptical that either party is willing to make the unpopular decisions necessary to restore the country to fiscal health."

The financial markets do not believe that the country's fiscal health is in danger, otherwise they would not make long term loans to the government at interest rates below 3.0 percent. It is also not clear that the steps needed to ensure that long-term budget deficits do not become a problem are unpopular.

While source cited in the story (Robert Bixby, the director of the Concord Coalition) wants to cut Social Security, Medicare and Medicaid, it is only necessary to fix the U.S. health care system to ensure stable budgets into the indefinite future. If the United States paid the same per person health care costs as people in any other wealthy country we would face huge long-term budget surpluses rather than deficits.

The piece should have also pointed out Colorado Senator Michael Bennet's error when he asserted that we are borrowing from China because of our budget deficit. The United States is borrowing from China because of its trade deficit, which is in turn the result of an over-valued dollar. This is an embarassing gaffe from a senator.

It is also worth noting that this editorial did not once mention the unemployment rate. This is remarkable for a piece discussing the Democrats' election prospects.

 

 

I probably should have posted this discussion of naked CDS from Yeon-Koo Che and Rajiv Sethi, but for some reason I felt like something different from the usual fare:

Stephen Hawking's big bang gaps, by Paul Davies, CIF: Cosmologists are agreed that the universe began with a big bang 13.7 billion years ago. People naturally want to know what caused it. A simple answer is nothing: not because there was a mysterious state of nothing before the big bang, but because time itself began then – that is, there was no time "before" the big bang. The idea is by no means new. In the fifth century, St Augustine of Hippo wrote that "the universe was created with time and not in time". Religious people often feel tricked by this logic. They envisage a miracle-working God dwelling within the stream of time for all eternity and then, for some inscrutable reason, making a universe (perhaps in a spectacular explosion) at a specific moment in history. That was not Augustine's God, who transcended both space and time. Nor is it the God favored by many contemporary theologians. In fact, they long ago coined a term for it – "god-of-the-gaps" – to deride the idea that when science leaves something out of account, then God should be invoked to plug the gap. The origin of life and the origin of consciousness are favorite loci for a god-of-the-gaps, but the origin of the universe is the perennial big gap. In his new book, Stephen Hawking reiterates that there is no big gap in the scientific account of the big bang. The laws of physics can explain, he says, how a universe of space, time and matter could emerge spontaneously, without the need for God. And most cosmologists agree: we don't need a god-of-the-gaps to make the big bang go bang. It can happen as part of a natural process. A much tougher problem now looms, however. What is the source of those ingenious laws that enable a universe to pop into being from nothing? Traditionally, scientists have supposed that the laws of physics were simply imprinted on the universe at its birth, like a maker's mark. As to their origin, well, that was left unexplained. In recent years, cosmologists have shifted position somewhat. If the origin of the universe was a law rather than a supernatural event, then the same laws could presumably operate to bring other universes into being. The favored view now, and the one that Hawking shares, is that there were in fact many bangs, scattered through space and time, and many universes emerging therefrom, all perfectly naturally. The entire assemblage goes by the name of the multiverse. Our universe is just one infinitesimal component amid this vast – probably infinite – multiverse, that itself had no origin in time. So according to this new cosmological theory, there was something before the big bang after all – a region of the multiverse pregnant with universe-sprouting potential. A refinement of the multiverse scenario is that each new universe comes complete with its very own laws – or bylaws, to use the apt description of the cosmologist Martin Rees. Go to another universe, and you would find different bylaws applying. An appealing feature of variegated bylaws is that they explain why our particular universe is uncannily bio-friendly; change our bylaws just a little bit and life would probably be impossible. The fact that we observe a universe "fine-tuned" for life is then no surprise: the more numerous bio-hostile universes are sterile and so go unseen. So is that the end of the story? Can the multiverse provide a complete and closed account of all physical existence? Not quite. The multiverse comes with a lot of baggage, such as an overarching space and time to host all those bangs, a universe-generating mechanism to trigger them, physical fields to populate the universes with material stuff, and a selection of forces to make things happen. Cosmologists embrace these features by envisaging sweeping "meta-laws" that pervade the multiverse and spawn specific bylaws on a universe-by-universe basis. The meta-laws themselves remain unexplained – eternal, immutable transcendent entities that just happen to exist and must simply be accepted as given. In that respect the meta-laws have a similar status to an unexplained transcendent god. According to folklore the French physicist Pierre Laplace, when asked by Napoleon where God fitted into his mathematical account of the universe, replied: "I had no need of that hypothesis." Although cosmology has advanced enormously since the time of Laplace, the situation remains the same: there is no compelling need for a supernatural being or prime mover to start the universe off. But when it comes to the laws that explain the big bang, we are in murkier waters.

I’ve got my hands full aping Mum: Orangutan cradles lion cubs in unlikely babysitter role Daily Mail (hat tip reader dearieme)

Strong earthquake rocks New Zealand’s South Island BBC

Viking Experiment May Have Found Life’s Building Blocks on Mars After All Universe Today

Ancient Brew Masters Tapped Antibiotic Secret Science Daily (hat tip reader John M)

Sweat and breath damaging Sistine Chapel’s frescoes Telegraph

BACTERIA MAKE GOLD NUGGETS Discovery (hat tip reader John M)

Horns, claws and the bottom line Economist

Wild chimps outwit human hunters BBC (hat tip reader John D)

Author Simon Singh Puts Up a Fight in the War on Science Wired (hat tip reader John M)

Psychics and Fortune Tellers Being Regulated to Reduce Fraud Time. Lambert Strether asks why aren’t financial fortune tellers regulated too?

Collapse of Kabul Bank Points to Fatal Corruption of Karzai Government Juan Cole (hat tip reader Warren C)

The Purge at Cato David Frum (hat tip reader Sundog)

Megabanks Will Shrink, Bernanke Tells Financial Crisis Commission, Yet Doubts Over Too Big To Fail Remain Shahien Nasiripour, Huffington Post. Yes, Citi is skinnying down, and some others might too but if you believe enough banks will shrink enough (or equally important, that we’ll see less concentration among the top dealer firms), I have a bridge I’d like to sell you.

Pending Home Sales Reconfirm the Market is Crashing Michael White, Implode-o-Meter

Is the Economy as Broke as Lehman Was? Michael Hudson

Antidote du jour:

This post first appeared on March 11, 2008

Oooh, the week has barely started and we’ve already had an overdose of adrenaline-generating news. Thornburg Mortgage and Carlyle Capital, both twisting in the wind, battered by margin calls, look unlikely to escape bankruptcy (Thornburg has already defaulted on financing agreements; Carlyle is seeking a standstill). Freddie and Fannie took a further beating thanks to a Barron’s article that took a harsh look at Fannie’s finances. Bear Stearns and Lehman were the focus of worries about solvency. WaMu is reported to be seeking cash from private equity investors and sovereign wealth funds.

Now at first this looks like a financial market meltdown, but there is some interdependence in these developments. On the one hand, the latest market downturn has been triggered by the increase of the conforming loan limits for Fannie and Freddie, which has led to a rise in their credit spreads since late January. Since then, there has been more discussion in DC about various ways to ameliorate the ever-worsening housing mess, and too many solutions involve Freddie and Fannie sopping up dubious debt for anyone’s taste, particularly in the absence of an explicit Federal guarantee of their obligations. The sudden rise in spreads is effectively a protest against this line of action.

On the other hand, we’ve been in a credit contraction since last June. Any doubts as to its seriousness should have been put to rest in August. And anyone who had access to a chart showing subprime ARM resets over time (they peak in August 2008, continue at a high level through year end 2008, and the option ARM resets kick in in 2009-2011, admittedly at a lower level) should have concluded the crisis was not going to resolve itself quickly.

With this in mind, why were Bear and Lehman so highly geared? Lehman is levered 40 to 1, Bear is geared 34:1 (by contrast, Carlyie is levered 32:1). Trading firms should know better.

In deteriorating debt markets, the last thing you want to be carrying is a big balance sheet. Perhaps the banks in question assumed that the Fed’s interest rate cuts would produce enough gains in value (due to lower prevailing rates) to make deleveraging less urgent.

But now Bear and Lehman (and no doubt their peers as well) are delevearging out of necessity, as mark-to-market losses force them to write down assets, leading to hits to equity, and then putting them at gearing levels that are untenable. So shrink they must.

But witness a Bloomberg story Monday, the big prime brokers (Morgan Stanley, Goldman, Deutsche, and Bear control over 80% of the market) have increased their margin requirements.. This is going to push firms that might have OK under the old standards into margin call territory. That will lead to forced sales. That in turn will lead to lower asset prices.

There are reasonable odds that these forces sales will in some (perhaps many) cases lead to the recognition of lower market values which will force the investment banks to write down their own inventory (leading to further damage to their capital bases) and writedowns of collateral posted by other hedge funds, potentially leading to more position liquidations.

In 1998, when LTCM was on the ropes, the investment banks injected more capital and orchestrated an orderly liquidation. But here, there are too many players exposed, not enough managerial bandwidth to determine who might be worth exempting from the new margin terms (recall too that LTCM was in such bad shape that it opened its books; hedge funds are notoriously secretive, so any investment bank is operating with only a partial view of where its exposures lie).

We have other sightings of banks shooting themselves in the foot in misguided attempts to save their hides. Yesterday, we noted that credit card issuers were getting tougher with customers who came to them to restructure their debts via credit counselors. The idea of trying to extract more blood from turnips will backfire. First, if banks get too stringent, customers will quit trying to get themselves out of their debt mess; they’ll just default (and if you have a thick enough skin, you might simply outlast your bank, since they are unlikely to go to the expenses of forcing borrowers into bankruptcy. The statute of limitations on bad debts is as little as six years in some states). Second, to the extent customers who don’t have enough money to go around will simply rob Peter (their car or house payments) to pay Paul. To the extent that these measures lead to more housing defaults, it’s a worse outcome systemically. Third is that these measures are an invitation for Congress to gut the 2005 bankruptcy bill that the industry so eagerly sought.

But don’t expect matters to improve any time soon. We’ve entered the “every man for himself” phase, and we will no doubt see unintended consequences.

By Yeon-Koo Che, Professor of Economic Theory at Columbia University, and Rajiv Sethi, Professor of Economics, Barnard College, Columbia University, cross posted from VoxEU

The role of naked credit default swaps in the global crisis is an ongoing source of controversy. This column seeks to add some formal analysis to the debate. Its model finds that speculative side bets can have significant effects on economic fundamentals, including the terms of financing, the likelihood of default, and the scale and composition of investment expenditures.

There is arguably no class of financial transactions that has attracted more impassioned commentary over the past couple of years than naked credit default swaps. Robert Waldmann has equated such contracts with financial arson, Wolfgang Münchau with bank robberies, and Yves Smith with casino gambling. George Soros argues that they facilitate bear raids, as does Richard Portes (2010) who wants them banned altogether, and Willem Buiter considers them to be a prime example of harmful finance. In sharp contrast, John Carney believes that any attempt to prohibit such contracts would crush credit markets, Felix Salmon thinks that they benefit distressed debtors, and Sam Jones argues that they smooth out the cost of borrowing over time, thus reducing interest rate volatility.

One reason for the continuing controversy is that arguments for and against such contracts have been expressed informally, without the benefit of a common analytical framework within which the economic consequences of their use can be carefully examined. Since naked credit default swaps necessarily have a long and a short side and the aggregate payoff nets to zero, it is not immediately apparent why their existence should have any effect at all on the availability and terms of financing or the likelihood of default. And even if such effects do exist, it is not clear what form and direction they take, or the implications they have for the allocation of a society’s productive resources.

In a recent paper (Che and Sethi 2010), we have attempted to develop a framework within which such questions can be addressed and to provide some preliminary answers. We argue that the existence of naked credit default swaps has significant effects on the terms of financing, the likelihood of default, and the size and composition of investment expenditures. And we identify three mechanisms through which these broader consequences of speculative side bets arise: collateral effects, rollover risk, and project choice.

Heterogeneous beliefs and side bets

A fundamental (and somewhat unorthodox) assumption underlying our analysis is that the heterogeneity of investor beliefs about the future revenues of a borrower is due not simply to differences in information, but also to differences in the interpretation of information. Individuals receiving the same information can come to different judgments about the meaning of the data. They can therefore agree to disagree about the likelihood of default, interpreting such disagreement as arising from different models rather than different information. As in prior work by John Geanakoplos (2010) on the leverage cycle, this allows us to speak of a range of optimism among investors, where the most optimistic do not interpret the pessimism of others as being particularly informative. We believe that this kind of disagreement is a fundamental driver of speculation in the real world.

When credit default swaps are unavailable, the investors with the most optimistic beliefs about the future revenues of a borrower are natural lenders: they are the ones who will part with their funds on terms most favourable to the borrower. The interest rate then depends on the beliefs of the threshold investor, who in turn is determined by the size of the borrowing requirement. The larger the borrowing requirement, the more pessimistic this threshold investor will be (since the size of the group of lenders has to be larger in order for the borrowing requirement to be met). Those more optimistic than this investor will lend, while the rest find other uses for their cash.

Now consider the effects of allowing for naked credit default swaps. Those who are most pessimistic about the future prospects of the borrower will be inclined to buy naked protection, while those most optimistic will be willing to sell it. However, pessimists also need to worry about counterparty risk – if the optimists write too many contracts, they may be unable to meet their obligations in the event that a default does occur, an event that the pessimists consider to be likely. Hence the optimists have to support their positions with collateral, which they do by diverting funds that would have gone to borrowers in the absence of derivatives. The borrowing requirement must then be met by appealing to a different class of investors, who are neither so optimistic that they wish to sell protection, nor so pessimistic that they wish to buy it. The threshold investor is now clearly more pessimistic than in the absence of derivatives, and the terms of financing are accordingly shifted against the borrower. As a result, for any given borrowing requirement, the bond issue is larger and the price of bonds accordingly lower when investors are permitted to purchase naked credit default swaps.

This effect does not arise if credit default swaps can only be purchased by holders of the underlying security. In fact, it can be shown that allowing for only “covered” credit default swaps has much the same consequences as allowing optimists to buy debt on margin: it leads to higher bond prices, a smaller issue size for any given borrowing requirement, and a lower likelihood of eventual default. While optimists take a long position in the debt by selling such contracts, they facilitate the purchase of bonds by more pessimistic investors by absorbing much of the credit risk. In contrast with the case of naked credit default swaps, therefore, the terms of lending are shifted in favour of the borrower. The difference arises because pessimists can enter directional positions on default in one case but not the other.

Naked credit default swaps and self-fulfilling pessimism

While this simple model sheds some light on the manner in which the terms of financing can be affected by the availability of credit derivatives, it does not deal with one of the major objections to such contracts: the possibility of self-fulfilling bear raids. To address this issue it is necessary to allow for a mismatch between the maturity of debt and the life of the borrower. This raises the possibility that a borrower who is unable to meet contractual obligations because of a revenue shortfall can roll over the residual debt, thereby deferring payment into the future.

As many economists have previously observed, multiple self-fulfilling paths arise naturally in this setting (see, for instance, Calvo 1988, Cole and Kehoe 2000, and Cohen and Portes 2006). If investors are confident that debt can be rolled over in the future, they will accept lower rates of interest on current lending, which in turn implies reduced future obligations and allows the debt to be rolled over with greater ease. But if investors suspect that refinancing may not be available in certain states, they demand greater interest rates on current debt, resulting in larger future obligations and an inability to refinance if the revenue shortfall is large.

A key question then is the following: how does the availability of naked credit default swaps affect the range of borrowing requirements for which pessimistic paths (with significant rollover risk) exist? And, conditional on the selection of such a path, how are the terms of borrowing affected by the presence of these credit derivatives?

For reasons that are already clear from the baseline model, we find that pessimistic paths involve more punitive terms for the borrower when naked credit default swaps are present than when they are not. Moreover, we find that there is a range of borrowing requirements for which a pessimistic path exists if and only if such contracts are allowed. That is, there exist conditions under which fears about the ability of the borrower to repay debt can be self-fulfilling only in the presence of credit derivatives. It is in this precise sense that the possibility of self-fulfilling bear raids can be said to arise when the use of such derivatives is unrestricted.

The finding that borrowers can more easily raise funds and obtain better terms when the use of credit derivatives is restricted does not necessarily imply that such restrictions are desirable from a policy perspective. A shift in terms against borrowers will generally reduce the number of projects that are funded, but some of these ought not to have been funded in the first place. Hence the efficiency effects of a ban are ambiguous. However, such a shift in terms against borrowers can also have a more subtle effect with respect to project choice: it can tilt managerial incentives towards the selection of riskier projects with lower expected returns. This happens because a larger debt obligation makes projects with greater upside potential more attractive to the firm, as more of the downside risk is absorbed by creditors.

The impact of speculative side bets

The central message of our work is that the existence of zero-sum side bets on default has major economic repercussions. These contracts induce investors who are optimistic about the future revenues of borrowers, and would therefore be natural purchasers of debt, to sell credit protection instead. This diverts their capital away from potential borrowers and channels it into collateral to support speculative positions. As a consequence, the marginal bond buyer is less optimistic about the borrower’s prospects, and demands a higher interest rate in order to lend. This can result in an increased likelihood of default, and the emergence of self-fulfilling paths in which firms are unable to rollover their debt, even when such trajectories would not arise in the absence of credit derivatives. And it can influence the project choices of firms, leading not only to lower levels of investment overall but also in some cases to the selection of riskier ventures with lower expected returns.

James Tobin (1984) once observed that the advantages of greater “liquidity and negotiability of financial instruments” come at the cost of facilitating speculation, and that greater market completeness under such conditions could reduce the functional efficiency of the financial system, namely its ability to facilitate “the mobilisation of saving for investments in physical and human capital… and the allocation of saving to their more socially productive uses.” Based on our analysis, one could make the case that naked credit default swaps are a case in point.

This conclusion, however, is subject to the caveat that there exist conditions under which the presence of such contracts can prevent the funding of inefficient projects. Furthermore, an outright ban may be infeasible in practice due to the emergence of close substitutes through financial engineering. Even so, it is important to recognise that the proliferation of speculative side bets can have significant effects on economic fundamentals such as the terms of financing, the patterns of project selection, and the incidence of corporate and sovereign default.

• Economic consequences of speculative side bets: naked CDS - voxeu
• “Low for long”: A risky but necessary interest rate policy - voxeu
• How illegal immigrants are helping Social Security - Edward Schumacher-Matos
• Payroll Tax Holiday with a Twist - David Beckworth
• The Real Lesson of Labor Day - Robert Reich
• Re-learning the New Keynesian IS curve - Nick Rowe
• The U.S. auto industry is smaller but healthi - Daniel Gross
• On Health Care, the Devil's in the Details - Uwe E. Reinhardt
• The Skills Deficit - Daniel Gros
• The Great Jobs Depression Worsens... - Robert Reich
• The public sphere - Daniel Little
• Market Talk - links
• New Deal 2.0 - links
• Free Exchange - links
• Marginal Revolution - links
• Economix - links
• Abnormal Returns - links
• Brad DeLong - links

• The Employment Report: “We’ve Gone Essentially Nowhere in a Year” - CBS MoneyWatch.com
• Books: Alan Furst: Dark Star: Archive Entry From Brad DeLong's Webjournal DeLong: Books: Alan Furst: Dark Star: http://tinyurl.com/467ar #worthreading
• Payroll Tax Holiday a Poor Stimulus Idea — Center on Budget and Policy Priorities Chye-Ching Huang: Payroll Tax Holiday a Poor Stimulus Idea: http://tinyurl.com/2969gln #worthreading
• Attractions of Payroll Tax Holiday Diminish Upon Closer Examination, 12/3/01 Greenstein and Orszag: Attractions of Payroll Tax Holiday Diminish Upon Closer Examination: http://tinyurl.com/2abwyl9 #worthreading
• Want to know why people aren’t happy? | The Incidental Economist Aaron Carrol: Want to know why people aren’t happy with the health care system?: http://tinyurl.com/2czx589 #worthreading
• Worthwhile Canadian Initiative: Re-learning the New Keynesian IS curve
• New York Times Company : Investors : Press Release Finally! somebody else worth reading on the NYT oped page: Peter Orszag: http://tinyurl.com/33893q2 #worthreading
• Pipes: Free Exchange: RA + GI Only Free Exchange: RA + GI Only: http://tinyurl.com/246tzo3 #worthreading
• Aucassin and Nicolette

I just wanted to follow up on the rare earths piece which I recently published (click here at http://www.madhedgefundtrader.com/august-13-2010.html ). Despite lackluster market conditions at best, Molycorp (MCP) managed to raise $394 million through its July IPO at $14/share. The company will use the funds to reopen a rare earths mine at Mountain Pass, California, making it the largest such producer in the world outside of China. The company will start production by the end of the year, and go full scale by 2012.
This is important because China, supplier of 97% of the world’s supply of rare earths, has cut back export quotas by 40% this year. These incredibly expensive metals are crucial for the manufacture of a variety of alternative energy hardware, as well as a number of military applications. Since the launch, the stock has risen 11%, making it one of the best performing stocks in the market this summer.

So far, the Australian miner Lynas Corp (LYSCF) has been the big beneficiary of the stampede into rare earths shares, doubling since I first recommended it in May (click here for the call at http://www.madhedgefundtrader.com/may-3-2010.html ). Lynas offers established production and experienced management, higher grade ore with a 9.7% yield, higher levels of the more valuable rare earths, realizations per ton that are 57% higher, and a book value of 1.87.

MCP is expected to have a 8.24% yield, is easier to trade with a US listing, has better liquidity, and prospects of greater profitability down the road through vertical integration and economies of scale, at the price of a 2.61 book value. MCP may also receive a political boost in the fall if a group of 20 senators and congressmen are successful in getting the Department of Energy to provide $280 million in loan guarantees. Look at these companies as an alternative energy, national defense, commodity, inflation play, a win-win-win-win.

To see the data, charts, and graphs that support this research piece, as well as more iconoclastic and out-of-consensus analysis, please visit me at www.madhedgefundtrader.com . There, you will find the conventional wisdom mercilessly flailed and tortured daily, and my last two years of research reports available for free. You can also listen to me on Hedge Fund Radio by clicking on “This Week on Hedge Fund Radio” in the upper right corner of my home page.

Via Pension Pulse.

John Weisenthal of Clusterstock discussed his thoughts on Friday's job figures and put up an image of the scariest jobs chart ever (HT: Réal):

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The key thing to realize about today's good jobs report is that it was only good relative to expectations. Private sector job creation of 67,000 is not that impressive in any real sense.

 

And indeed, the latest update of the scariest jobs chart ever from Calculated Risk -- which shows how deep these jobs losses are compared to past recessions -- shows this comeback still isn't anything like past comebacks, and it will be ages before we get back to even.

Private sector job creation is the key to any sustainable recovery, but as the chart above shows, you need to create a lot of jobs to repair the devastation since 2007. In that sense, today's figures are not that impressive, but one can only hope they're indicating better days ahead.

Phil Izzo of the WSJ provided reaction to today's figures from a number of economists:

—It is a sigh of relief. The labor market in August was lethargic, but better than feared reducing the fears of a double-dip recession. Private payrolls went up 67,000 even though the overall nonfarm payroll fell 54,000 due to the census layoff. –Sung Won Sohn, Smith School of Business and Economics

 

–The August employment report confirms the “Big Stall” rather than outright contraction in the economy… Saying the economy isn’t about to contract is not, unfortunately, the same thing as saying that growth momentum has returned. If anything, a read into the details of the report indicates the extent of the economy’s stall. The growth in private payrolls was confined to Healthcare & Social Assistance (which seems to go up every month regardless), temp workers plus construction — of which 10,000 of the 19,000 were returning strikers. Everything else summed to zero and all of these sectors reported numbers that were marginally on one side or the other of zero. –Steven Blitz, Majestic Research

 

–The soft patch for jobs may have been extended for a fourth month today, but momentum in the economy is building and we can rule out a double-dip. –Christopher Rupkey, Bank of Tokyo-Mitsubishi

 

–Government employment losses in August more than offset the gains in private-sector employment. Most of the drop in public-sector payrolls is explained by the departure of 114,000 temporary Census workers. However, state and local government payrolls also continued to shrink in August. Since the start of this year state and local public-sector payrolls have fallen 135,000, or almost 17,000 per month. These job losses are almost certainly linked to the expected end of federal fiscal relief under the Administration’s stimulus program. –Gary Burtless, Brookings Institution

 

–Nonfarm [private] payrolls expanded by 67,000 in August… 67,000 jobs is just not enough and it cannot be spun otherwise. At the same time, the economy does continue to add a modest amount of jobs — since December 2009, private employment has increased by 763,000 jobs. This is not enough, especially so given the 8+ million jobs shed during the recession, but it is something. Given the increase in corporate profits among U.S. corporations, ongoing gains in payrolls should not be surprising. –Dan Greenhaus, Miller Tabak

 

–In August, job creation occurred across a number of sectors, including health care, construction, mining, and temporary help services for professional and business services. Despite the decline in total jobs, this report was mildly positive, as private sector jobs helped alleviate some of the Census losses. A recovery is clearly underway, although it will be a slow one for the job market. –Jason Schenker, Prestige Economics

 

–Construction employment registered an uptick for the first time since April. The nonres category accounted for all of the gain. This may be related to a ramping up of infrastructure projects. Manufacturing employment fell for the first time since December but this reflected a seasonal unwind of the rise in auto industry jobs that was evident in July. Moreover, the average workweek in the manufacturing sector ticked up 0.1 hours, so we see a manufacturing activity excluding motor vehicles up a sharp 0.8% in August –David Greenlaw, Morgan Stanley

 

–Private payrolls increased by 67,000 last month, down from 107,000 in July. However, that apparent slowdown may just be an illusion. Employment at vehicle manufacturing plants jumped by 22,000 in July and then fell back by exactly the same amount in August. We suspect this is a distortion caused by the unusually small number of plant shutdowns this summer. Strip that out and private employment growth actually pick up a little bit last month. –Paul Ashworth, Capital Economics

 

–It looks like the momentum in employment has been roughly steady in recent months at a modest pace that will not be enough to hold the unemployment rate steady. At current rates of labor force participation, the economy needs to generate 100,000 jobs to hold the unemployment rate steady. –Julia Coronado, BNP Paribas

 

–Viewed in isolation, a 67,000 private payroll increase this far into the recovery is very poor. But viewed against low expectations and against fears that the economy may be tumbling into a double-dip recession, today’s report is good news. It suggests that the recovery may be wobbly but that it is still staggering forward. –Nigel Gault, IHS Global Insight

 

– The fact that the labor market did not stall in August as many had feared suggests the recovery is sustained, if not robust. The increase in temp hiring suggests that employers, while suspicious about the strength of demand, see orders strong enough to justify taking on more help. The most recent Challenger report also suggests that companies have cut payrolls so deeply that any increase in demand will require more hiring. Businesses have squeezed as much as they can from their current workforces; once the economy gains some momentum, more permanent hiring is sure to follow. –Sophia Koropeckyj, Moody’s Economy.com

 

–Not a double dip, but still pretty anemic. So, stronger-than-expected, yes. Strong, no. –Stephen Stanley, Pierpoint Securities

 

–The small amount of job gains during the past few months not only reflects the response to slow output growth, but also a lack of confidence going forward. While this expansion might seem similar to recent post-recession periods, it is in fact much different. The economy as a whole has been weakened by a dismal housing market and slow consumption, which especially hamper small and medium- sized enterprises. Modest gains in private sector jobs, coupled with the large decline in government employment, are consistent with our forecast for continued sluggish growth. –Bart van Ark, The Conference Board

 

–The labor market has entered a holding pattern. After relatively mild improvements earlier this year, the key indicators of the strength of the labor market have shown virtually no improvement in recent months. The private sector has added an average of 78,000 jobs each month for the past three months, not nearly enough to begin to reduce unemployment. –Heather Boushey, Center for American Progress

 

–Hourly earnings post their biggest rise since January of this year at 0.3% month-over-month, this translates into a 1.7% month-over-month in wages. Hours worked which are still low remained at 34.2; we would look for this to improve further before we started to see any real aggressive in additions to payrolls. Temporary help also resumes additions, we like this as a leading indicator as temporary workers are far more flexible and firms are more willing to take them on in the early stages of a recovery. In a labour force of 154 million, these increases are not going to set the world alight (or more importantly drive strong consumer spending), but people will take encouragement where their can find it especially heading into a holiday weekend. –David Semmens, Standard Chartered Bank

 

–The largest increases in unemployment were among African Americans who saw their overall rate rise 0.8 percentage points to 16.3 percent, near the recession peak. The unemployment rate for black teens jumped 4.8 percentage points to 45.4%. Unemployment for Hispanics edged down to 12.0 percent, a full percentage point below its year-ago level. –Dean Baker, Center for Economic and Policy Research

Dean Baker is also predicting a 10% decline in house prices for the year and recently wrote this comment in counterpunch, Burning Down the House:

The howls of surprised economists were everywhere last week as the government reported on Tuesday that July had the sharpest single-month plunge in existing home sales on record. The next day the Commerce Department reported that new home sales hit a post-war low in July.

 

All the economists who had told us that the housing market had stabilized and that prices would soon rebound looked really foolish yet again. To understand how lost these professional error-makers really are it is only necessary to know that the Mortgage Bankers Association (MBA) puts out data on mortgage applications every week. The MBA index plummeted beginning in May, immediately after the last day (April 30) for signing a house sale contract that qualified for the homebuyers tax credit.

 

It typically takes 6-8 weeks between when a contract is signed and a house sale closes. The plunge in applications in May meant that homebuyers were not signing contracts to buy homes. This meant that sales would plummet in July. Economists with a clue were not surprised by the July plunge in home sales.

 

What should be clear is that the tax credits helped to pull housing demand forward. People who might have bought in the second half of 2010 or even 2011 instead bought their home before the tax credit expired. Now that the credit has expired, there is less demand than ever, leaving the market open for another plunge in prices. The support the tax credit gave to the housing market was only temporary.

 

It is worth asking what was accomplished by spending tens of billions of dollars to prop up the market for a bit over a year with these tax credits. First, this allowed millions of people to sell their home over this period at a higher price than would have otherwise been the case. The flip side is that more than five million people bought homes at prices that were still inflated by the bubble. Many of these buyers will see substantial loses when they resell their house.

 

The banks also had a stake in this. The homebuyers tax credit prevented prices from declining as rapidly as would have been the case otherwise. This allowed millions of homeowners to be able to sell their home at a price where they could pay off their mortgage. This made banks who could have been holding underwater mortgages very happy.

 

Of course someone had to issue the mortgage to all those people who bought homes at prices that are still inflated by the bubble. The overwhelming majority of the mortgages issued in the last year and a half are insured by the government, either through Fannie Mae and Freddie Mac, or through HUD. So, taxpayers are carrying the risk that further price declines will push these mortgages underwater, not banks or private investors.

 

The further plunge in house prices will have serious implications for the course of the recovery. By my calculations, the decline in house prices through the first half of 2009 eliminated $5-6 trillion of the $8 trillion of housing equity created by the bubble. Look to the further declines in the rest of this year to eliminate most or all of the remaining bubble equity.

 

The loss of this wealth will further dampen growth. This should drive home the fact that house prices, like the NASDAQ following the tech crash, are not coming back. Homeowners will have to come to grips with this massive loss of wealth. While many commentators (no doubt the surprised ones) complain that consumption is low, the reality is that consumption is still at an unusually high level relative to disposable income.

 

Furthermore, with a huge cohort of baby boomers approaching retirement with almost no wealth, there will be more need to save than ever. This need to save is accentuated by the plans of those in the Obama Administration and the congressional leadership to cut Social Security.

 

This means that we should expect consumption spending to weaken sharply in the second half of 2010 and into 2011 as the savings rate rises into the 8-10 percent range, further slowing economic growth. This comes against a backdrop where final demand had only been growing at a 1.2 percent average rate over the last four quarters.

 

Final demand is GDP, excluding inventories. Growth was boosted over the last year by the restocking of inventories. This process is largely completed, which means that we should expect GDP growth to be pretty much equal to final demand growth going forward.

 

Starting with a 1.2 percent growth rate, then throwing in weaker consumption due to further house price declines, state and local government cutbacks, and the winding down of stimulus, it is questionable whether growth will even remain positive over the next four quarters. Given all these negative factors, it is very hard to construct a story showing the economy on a healthy growth path, even though many economists still seem to think it is. Of course these economists were probably surprised by last month’s home sales data.

These are sobering thoughts from an economist who was among the first to predict the US housing crisis. Even if job creation picks up, it will do little to dent the fall in house prices. So while today's figures were better than expected, much more is needed to get the US economy back on solid footing. Below, I leave you with an overview of Friday's jobs report.

FDR to Congress:

Message of President Roosevelt to the Congress, September 3, 1940: I transmit herewith for the information of the Congress notes exchanged between the British Ambassador at Washington and the Secretary of State on September 2, 1940, under which this Government has acquired the right to lease naval and air bases in Newfoundland, and in the islands of Bermuda, the Bahamas, Jamaica, St. Lucia, Trinidad, and Antigua, and in British Guiana; also a copy of an opinion of the Attorney General dated August 27, 1940, regarding my authority to consummate this arrangement.

The right to bases in Newfoundland and Bermuda are gifts--generously given and gladly received. The other bases mentioned have been acquired in exchange for fifty of our over-age destroyers.

This is not inconsistent in any sense with our status of peace. Still less is it a threat against any nation. It is an epochal and far?reaching act of preparation for continental defense in the face of grave danger.

Preparation for defense is an inalienable prerogative of a sovereign state. Under present circumstances this exercise of sovereign right is essential to the maintenance of our peace and safety. This is the most important action in the reinforcement of our national defense that has been taken since the Louisiana Purchase. Then as now, considerations of safety from overseas attack were fundamental.

The value to the Western Hemisphere of these outposts of security is beyond calculation. Their need has long been recognized by our country, and especially by those primarily charged with the duty of charting and organizing our own naval and military defense. They are essential to the protection of the Panama Canal, Central America, the Northern portion of South America, The Antilles, Canada, Mexico, and our own Eastern and Gulf Seaboards. Their consequent importance in hemispheric defense is obvious. For these reasons I have taken advantage of the present opportunity to acquire them.

FRANKLIN D. ROOSEVELT

[Enclosures]

BRITISH EMBASSY, Washington, D. C., September 2, 1940

SIR:

I have the honour under instructions from His Majesty's Principal Secretary of State for Foreign Affairs to inform you that in view of the friendly and sympathetic interest of His Majesty's Government in the United Kingdom in the national security of the United States and their desire to strengthen the ability of the United States to cooperate effectively with the other nations of the Americas in the defence of the Western Hemisphere, His Majesty's Government will secure the grant to the Government of the United States, freely and without consideration, of the lease for immediate establishment and use of naval and air bases and facilities for entrance thereto and the operation and protection thereof, on the Avalon Peninsula and on the southern coast of Newfoundland, and on the east coast and on the Great Bay of Bermuda.

Furthermore, in view of the above and in view of the desire of the United States to acquire additional air and naval bases in the Caribbean and in British Guiana, and without endeavouring to place a monetary or commercial value upon the many tangible and intangible rights and properties involved, His Majesty's Government will make available to the United States for immediate establishment and use naval and air bases and facilities for entrance thereto and the operation and protection thereof, on the eastern side of the Bahamas, the southern coast of Jamaica, the western coast of St. Lucia, the west coast of Trinidad in the Gulf of Paria, in the island of Antigua and in British Guiana within fifty miles of Georgetown, in exchange for naval and military equipment and material which the United States Government will transfer to His Majesty's Government.

All the bases and facilities referred to in the preceding paragraphs will be leased to the United States for a period of ninety-nine years, free from all rent and charges other than such compensation to be mutually agreed on to be paid by the United States in order to compensate the owners of private property for loss by expropriation or damage arising out of the establishment of the bases and facilities in question.

His Majesty's Government, in the leases to be agreed upon, will grant to the United States for the period of the leases all the rights, power, and authority within the bases leased, and within the limits of the territorial waters and air spaces adjacent to or in the vicinity of such bases, necessary to provide access to and defence of such bases, and appropriate provisions for their control.

Without prejudice to the above?mentioned rights of the United States authorities and their jurisdiction within the leased areas, the adjustment and reconciliation between the jurisdiction of the authorities of the United States within these areas and the jurisdiction of the authorities of the territories in which these areas are situated, shall be determined by common agreement.

The exact location and bounds of the aforesaid bases, the necessary seaward, coast and anti-aircraft defences, the location of sufficient military garrisons, stores and other necessary auxiliary facilities shall be determined by common agreement.

His Majesty's Government are prepared to designate immediately experts to meet with experts of the United States for these purposes. Should these experts be unable to agree in any particular situation, except in the case of Newfoundland and Bermuda, the matter shall be settled by the Secretary of State of the United States and His Majesty's Secretary of State for Foreign Affairs.

I have [etc.]

LOTHIAN

The Honourable CORDELL HULL, Secretary of State of the United States, Washington, D.C.

DEPARTMENT OF STATE,

Washington, September 2, 1940.

EXCELLENCY:

I have received your note of September 2, 1940.... I am directed by the President to reply to your note as follows:

The Government of the United States appreciates the declarations and the generous action of His Majesty's Government as contained in your communication which are destined to enhance the national security of the United States and greatly to strengthen its ability to cooperate effectively with the other nations of the Americas in the defense of the Western Hemisphere. It therefore gladly accepts the proposals.

The Government of the United States will immediately designate experts to meet with experts designated by His Majesty's Government to determine upon the exact location of the naval and air bases mentioned in your communication under acknowledgment.

In consideration of the declarations above quoted, the Government of the United States will, immediately transfer to His Majesty's Government fifty United States Navy destroyers generally referred to as the twelve hundred-ton type.

Accept [etc.]

CORDELL HULL

His Excellency, The Right Honorable, THE MARQUESS of LOTHIAN, C. H., British Ambassador.

Source: U.S., Department of State, Publication 1983, Peace and War: United States Foreign Policy, 1931-1941 (Washington, D.C.: U.S., Government Printing Office, 1943), pp. 564-67

Note: this is an unofficial list of Problem Banks compiled only from public sources.

Here is the unofficial problem bank list for September 3, 2010.

Changes and comments from surferdude808: It was a comparatively quiet week for the Unofficial Problem Bank List as there were only four additions and no removals with the FDIC taking the long holiday weekend off from closures.

The additions include First National Bank of Chester County, Chester, PA ($1.2 billion Ticker: FCEC); Lafayette Savings Bank, FSB, Lafayette, IN ($379 million Ticker: LSBI); Oregon Community Bank & Trust, Oregon, WI ($195 million); and Hull Federal Savings Bank, Baltimore, MD ($27 million). Other changes include Prompt Corrective Action Orders issued by the Federal Reserve against First Community Bank ($2.6 billion Ticker: FSNM) and Sunrise Bank ($134 million) and OTS against AnchorBank, fsb ($4.0 billion Ticker: ABCW).

The Unofficial Problem Bank List includes 844 institutions with aggregate assets of $412 billion. This week the FDIC released its official count of problem institutions at 829 with assets of $403 billion as of June 30th. Click on graph for larger image in new window.

This graph shows the number of banks on the unofficial list. The number of institutions has more than doubled since we started the list in early August 2009 - even with all the bank failures (failures are removed from the list). The number of assets is up 50 percent over the last year.

On August 7, 2009, we listed 389 institutions with $276 billion in assets, and now the list has 844 institutions and $412 billion in assets.

The red dots are the number of banks on the official problem bank list as announced in the FDIC quarterly banking profile for Q2 2009 through Q2 2010. The dots are lagged one month because of the delay in announcing formal actions.

The unofficial count is close to the official count (the difference is mostly timing issues), and the FDIC will probably have close to 1,000 banks on the list by the end of the year.

John Weisenthal of Clusterstock discussed his thoughts on Friday's job figures and put up an image of the scariest jobs chart ever (HT: Réal):

The key thing to realize about today's good jobs report is that it was only good relative to expectations. Private sector job creation of 67,000 is not that impressive in any real sense.

And indeed, the latest update of the scariest jobs chart ever from Calculated Risk -- which shows how deep these jobs losses are compared to past recessions -- shows this comeback still isn't anything like past comebacks, and it will be ages before we get back to even.

Private sector job creation is the key to any sustainable recovery, but as the chart above shows, you need to create a lot of jobs to repair the devastation since 2007. In that sense, today's figures are not that impressive, but one can only hope they're indicating better days ahead.

Phil Izzo of the WSJ provided reaction to today's figures from a number of economists:

—It is a sigh of relief. The labor market in August was lethargic, but better than feared reducing the fears of a double-dip recession. Private payrolls went up 67,000 even though the overall nonfarm payroll fell 54,000 due to the census layoff. –Sung Won Sohn, Smith School of Business and Economics

–The August employment report confirms the “Big Stall” rather than outright contraction in the economy… Saying the economy isn’t about to contract is not, unfortunately, the same thing as saying that growth momentum has returned. If anything, a read into the details of the report indicates the extent of the economy’s stall. The growth in private payrolls was confined to Healthcare & Social Assistance (which seems to go up every month regardless), temp workers plus construction — of which 10,000 of the 19,000 were returning strikers. Everything else summed to zero and all of these sectors reported numbers that were marginally on one side or the other of zero. –Steven Blitz, Majestic Research

–The soft patch for jobs may have been extended for a fourth month today, but momentum in the economy is building and we can rule out a double-dip. –Christopher Rupkey, Bank of Tokyo-Mitsubishi

–Government employment losses in August more than offset the gains in private-sector employment. Most of the drop in public-sector payrolls is explained by the departure of 114,000 temporary Census workers. However, state and local government payrolls also continued to shrink in August. Since the start of this year state and local public-sector payrolls have fallen 135,000, or almost 17,000 per month. These job losses are almost certainly linked to the expected end of federal fiscal relief under the Administration’s stimulus program. –Gary Burtless, Brookings Institution

–Nonfarm [private] payrolls expanded by 67,000 in August… 67,000 jobs is just not enough and it cannot be spun otherwise. At the same time, the economy does continue to add a modest amount of jobs — since December 2009, private employment has increased by 763,000 jobs. This is not enough, especially so given the 8+ million jobs shed during the recession, but it is something. Given the increase in corporate profits among U.S. corporations, ongoing gains in payrolls should not be surprising. –Dan Greenhaus, Miller Tabak

–In August, job creation occurred across a number of sectors, including health care, construction, mining, and temporary help services for professional and business services. Despite the decline in total jobs, this report was mildly positive, as private sector jobs helped alleviate some of the Census losses. A recovery is clearly underway, although it will be a slow one for the job market. –Jason Schenker, Prestige Economics

–Construction employment registered an uptick for the first time since April. The nonres category accounted for all of the gain. This may be related to a ramping up of infrastructure projects. Manufacturing employment fell for the first time since December but this reflected a seasonal unwind of the rise in auto industry jobs that was evident in July. Moreover, the average workweek in the manufacturing sector ticked up 0.1 hours, so we see a manufacturing activity excluding motor vehicles up a sharp 0.8% in August –David Greenlaw, Morgan Stanley

–Private payrolls increased by 67,000 last month, down from 107,000 in July. However, that apparent slowdown may just be an illusion. Employment at vehicle manufacturing plants jumped by 22,000 in July and then fell back by exactly the same amount in August. We suspect this is a distortion caused by the unusually small number of plant shutdowns this summer. Strip that out and private employment growth actually pick up a little bit last month. –Paul Ashworth, Capital Economics

–It looks like the momentum in employment has been roughly steady in recent months at a modest pace that will not be enough to hold the unemployment rate steady. At current rates of labor force participation, the economy needs to generate 100,000 jobs to hold the unemployment rate steady. –Julia Coronado, BNP Paribas

–Viewed in isolation, a 67,000 private payroll increase this far into the recovery is very poor. But viewed against low expectations and against fears that the economy may be tumbling into a double-dip recession, today’s report is good news. It suggests that the recovery may be wobbly but that it is still staggering forward. –Nigel Gault, IHS Global Insight

– The fact that the labor market did not stall in August as many had feared suggests the recovery is sustained, if not robust. The increase in temp hiring suggests that employers, while suspicious about the strength of demand, see orders strong enough to justify taking on more help. The most recent Challenger report also suggests that companies have cut payrolls so deeply that any increase in demand will require more hiring. Businesses have squeezed as much as they can from their current workforces; once the economy gains some momentum, more permanent hiring is sure to follow. –Sophia Koropeckyj, Moody’s Economy.com

–Not a double dip, but still pretty anemic. So, stronger-than-expected, yes. Strong, no. –Stephen Stanley, Pierpoint Securities

–The small amount of job gains during the past few months not only reflects the response to slow output growth, but also a lack of confidence going forward. While this expansion might seem similar to recent post-recession periods, it is in fact much different. The economy as a whole has been weakened by a dismal housing market and slow consumption, which especially hamper small and medium- sized enterprises. Modest gains in private sector jobs, coupled with the large decline in government employment, are consistent with our forecast for continued sluggish growth. –Bart van Ark, The Conference Board

–The labor market has entered a holding pattern. After relatively mild improvements earlier this year, the key indicators of the strength of the labor market have shown virtually no improvement in recent months. The private sector has added an average of 78,000 jobs each month for the past three months, not nearly enough to begin to reduce unemployment. –Heather Boushey, Center for American Progress

–Hourly earnings post their biggest rise since January of this year at 0.3% month-over-month, this translates into a 1.7% month-over-month in wages. Hours worked which are still low remained at 34.2; we would look for this to improve further before we started to see any real aggressive in additions to payrolls. Temporary help also resumes additions, we like this as a leading indicator as temporary workers are far more flexible and firms are more willing to take them on in the early stages of a recovery. In a labour force of 154 million, these increases are not going to set the world alight (or more importantly drive strong consumer spending), but people will take encouragement where their can find it especially heading into a holiday weekend. –David Semmens, Standard Chartered Bank

–The largest increases in unemployment were among African Americans who saw their overall rate rise 0.8 percentage points to 16.3 percent, near the recession peak. The unemployment rate for black teens jumped 4.8 percentage points to 45.4%. Unemployment for Hispanics edged down to 12.0 percent, a full percentage point below its year-ago level. –Dean Baker, Center for Economic and Policy Research

Dean Baker is also predicting a 10% decline in house prices for the year and recently wrote this comment in counterpunch, Burning Down the House:

The howls of surprised economists were everywhere last week as the government reported on Tuesday that July had the sharpest single-month plunge in existing home sales on record. The next day the Commerce Department reported that new home sales hit a post-war low in July.

All the economists who had told us that the housing market had stabilized and that prices would soon rebound looked really foolish yet again. To understand how lost these professional error-makers really are it is only necessary to know that the Mortgage Bankers Association (MBA) puts out data on mortgage applications every week. The MBA index plummeted beginning in May, immediately after the last day (April 30) for signing a house sale contract that qualified for the homebuyers tax credit.

It typically takes 6-8 weeks between when a contract is signed and a house sale closes. The plunge in applications in May meant that homebuyers were not signing contracts to buy homes. This meant that sales would plummet in July. Economists with a clue were not surprised by the July plunge in home sales.

What should be clear is that the tax credits helped to pull housing demand forward. People who might have bought in the second half of 2010 or even 2011 instead bought their home before the tax credit expired. Now that the credit has expired, there is less demand than ever, leaving the market open for another plunge in prices. The support the tax credit gave to the housing market was only temporary.

It is worth asking what was accomplished by spending tens of billions of dollars to prop up the market for a bit over a year with these tax credits. First, this allowed millions of people to sell their home over this period at a higher price than would have otherwise been the case. The flip side is that more than five million people bought homes at prices that were still inflated by the bubble. Many of these buyers will see substantial loses when they resell their house.

The banks also had a stake in this. The homebuyers tax credit prevented prices from declining as rapidly as would have been the case otherwise. This allowed millions of homeowners to be able to sell their home at a price where they could pay off their mortgage. This made banks who could have been holding underwater mortgages very happy.

Of course someone had to issue the mortgage to all those people who bought homes at prices that are still inflated by the bubble. The overwhelming majority of the mortgages issued in the last year and a half are insured by the government, either through Fannie Mae and Freddie Mac, or through HUD. So, taxpayers are carrying the risk that further price declines will push these mortgages underwater, not banks or private investors.

The further plunge in house prices will have serious implications for the course of the recovery. By my calculations, the decline in house prices through the first half of 2009 eliminated $5-6 trillion of the $8 trillion of housing equity created by the bubble. Look to the further declines in the rest of this year to eliminate most or all of the remaining bubble equity.

The loss of this wealth will further dampen growth. This should drive home the fact that house prices, like the NASDAQ following the tech crash, are not coming back. Homeowners will have to come to grips with this massive loss of wealth. While many commentators (no doubt the surprised ones) complain that consumption is low, the reality is that consumption is still at an unusually high level relative to disposable income.

Furthermore, with a huge cohort of baby boomers approaching retirement with almost no wealth, there will be more need to save than ever. This need to save is accentuated by the plans of those in the Obama Administration and the congressional leadership to cut Social Security.

This means that we should expect consumption spending to weaken sharply in the second half of 2010 and into 2011 as the savings rate rises into the 8-10 percent range, further slowing economic growth. This comes against a backdrop where final demand had only been growing at a 1.2 percent average rate over the last four quarters.

Final demand is GDP, excluding inventories. Growth was boosted over the last year by the restocking of inventories. This process is largely completed, which means that we should expect GDP growth to be pretty much equal to final demand growth going forward.

Starting with a 1.2 percent growth rate, then throwing in weaker consumption due to further house price declines, state and local government cutbacks, and the winding down of stimulus, it is questionable whether growth will even remain positive over the next four quarters. Given all these negative factors, it is very hard to construct a story showing the economy on a healthy growth path, even though many economists still seem to think it is. Of course these economists were probably surprised by last month’s home sales data.

These are sobering thoughts from an economist who was among the first to predict the US housing crisis. Even if job creation picks up, it will do little to dent the fall in house prices. So while today's figures were better than expected, much more is needed to get the US economy back on solid footing. Below, I leave you with an overview of Friday's jobs report.

Research Support from the Institute for International Studies:

2010-2011 IIS Undergraduate Merit Scholarships

Description: The Institute of International Studies (IIS) at UC Berkeley is seeking to award a series of merit scholarships of up to $2000 each to support undergraduate research in any area on international studies. Research may be conducted while in EAP, or independently. The scholarship recipients will be called IIS Junior Scholars. All IIS Junior Scholars will present their findings in the form of a research paper at a conference held at IIS at the end of their scholarship year. The three strongest research papers, as determined by an IIS faculty panel, will each receive an additional $1000 prize.

Eligibility: Any UC Berkeley junior or senior with a minimum 3.5 GPA who has completed at least one semester of study in residence at Berkeley. All majors are eligible and encouraged to apply. (Note: concurrent enrollment students are not eligible to apply.)

Application Requirements: Applicants must submit a one-page research proposal that addresses:

• The research question
• Why it is important to the field of study
• A preliminary research plan

Proposals should briefly identify how the student is qualified to conduct the research (past or planned coursework, languages, etc). Proposals should also indicate the format for research (during EAP, as an independent study, etc). Applications must include unofficial transcripts and one letter of recommendation, which can come from a GSI or faculty member.

Submission: E-mail all required application components (as detailed above) as one .pdf document to iis.grants@gmail.com

Due Date: October 15, 2010

Contact: Please direct inquiries to iis.grants@gmail.com

Submitted by Bo Peng

Moderate inflation is good. This has been held as self-evident truth in modern monetary policy. But this will quickly become antisocial as the entire west goes through a structural change in demographics caused by babyboomer retirement. BoJ seems to have realized this early and well; they have managed their social transition with remarkably success, despite much sneering from western economists (I argued here  that the Japanese lost decades is in fact a great achievement that US will only wish to match in 10 years). ECB seems to have realized this judging from their proclaimed resolve for austerity as opposed to unlimited simulus. The big question is: when will Fed and US government realize this?

The reason for this fundamental shift is simple: soon-to-be retirees need to save but inflationary policy sacrifices savers for the sake of stimulating economic growth.

In normal demographics, this works because most people get to participate in the growing economy by staying employed or employing; even though everybody's savings get eroded by moderate inflation, there's a good chance that most will be more than compensated by increasing earnings. Retirees are net payers for inflation because they can't replenish with inceasing earnings, as is always the case. But if they're a small group, the society pretends they don't exist and moves merrily on.

Starting from right now, however, as babyboomers go into retirement or start deligently (perhaps belatedly) saving for retirement, inflationary policy will cause much more pain than ever seen before. Even under "moderate inflation" scenario, it's still a significant erosion of buying pwoer and living standard over 10, 20, 30 years. The effect will be quite painfully clear, and soon, for those living on fixed income.

As I said in the earlier article, we will some day, one way or another, realize that Japanese style stagnation is the best possible outcome during this transition. We are becoming a savers society whether you like it or not. Do we cope with it or fight a losing battle in which everyone loses?

Dave:

Twitter / daveweigel: Will Wilkinson/Brink Linds ...: Will Wilkinson/Brink Lindsey purge party undergoes surprise merger with bachelorette party

I have cleared the waitlist--if, that is, people would go ahead and choose sections with open seats:

ECON 1 001 SEPTEMBER 3, 2010: ENROLLED: 627. WAITLIST: 26. CAPACITY: 660

I confess I did not expect this to happen, certainly not this early in the term...

Before we get into the core visualizations, here are this week's key observations:

• Wheat net spec positions on the CBOT dropped substantially, from a record 36.7k to 25.9k W/W, even as they hit a fresh record on the KCBOT, at 71.6k from 67.6 W/W.
• After some fireworks earlier in the year, Cocoa net spec positions have plunged to the lowest in the year, and the first negative print in 2010, at -1.6K, compared to 8.1K the week prior.
• Silver COMEX net specs surged to the highest in 2010, hitting a 2010 record of 44.8K, compared to 34.8K the week prior.
• Gold Comex net specs came at the second highest print of 2010 at 238K, an increase from 221K the week prior, lower only to the 244K recorded on June 22.
• Currencies:
  • CHF - jumped to the highest in a month, at 14.3k, from 13.9k W/W
  • GBP - jumped to the lowest in over a month, at -15.3k, from -4.4k W/W
  • JPY - remained flat at 49.9K, compared to 51.0k W/W
  • EUR - short bets continue to increase in straight line, after hitting a 2010 high of -3.7K on August 10, the are now down to -25.6K, compared to -21.6K the week prior.

• The most interesting observation is the net spec breakdown in 2 Year, 5 Year and 10 Year Treasury: as can be seen on the chart below, 10 Year positions surged Week over Week, jumping by a stunning 80k contracts, to 62.9K from -19.9K the week prior. This was only the first time this series has gone positive for the entire year. This is a major bullish inversion point at a time when the 10 Year is finally starting to decline. Someone may get burned...

And here are select visualized COT's, courtesy of Libanman Futures

Consolidated commodities (non financials) COT report:

 

Financial COT report:

 

Submitted by RCS Investments

Bullish

+ Jobs report comes in much better than expected with the private sector generating 65,000 jobs, while prior months were revised higher.  This is the nail in the “we are about to enter a double-dip” coffin.  We are only experiencing a soft patch.  The economy will pick up steam in the 2H of 2010 and 2011.

+ Chicago PMI showed continued expansion and came in higher than expected.  New orders came in expansion territory and doesn’t point to contraction in this region in the months ahead, while jobs continue to be created.  This result led to a strong Manufacturing ISM reading which surprised everyone.  Finally, the American Association of Railroad’s weekly report shows the highest carload reading of the year.  These indicators show that the prospect of soft landing and steady growth are not only possible, but likely.  Double dip fears are way overblown.  These factors will buoy consumer confidence and loosen wallets in the months ahead.

+ China PMI comes in better than expected and points to a soft landing in China, followed by steady growth.  Meanwhile, Eurozone GDP rises the most in a year.  The global economic recovery has legs, it’s just taking a breather.  This can be seen from shipping indexes, which have been rising at a healthy clip.  (Link Courtesy of Calafia Beach Pundit)

+ Sentiment continues to side more with the Bulls as analysts are growing exceedingly pessimistic.  Many are expecting a double dip, therefore there’s a growing chance that things aren’t as bad as most believe.  (Link Courtesy of The Big Picture)

+  PCE metric shows that consumption increased more than expected, while August chain store sales rise more than analysts expected.  Why?  The job market is indeed recovering as per the Gallup Job Creation Poll.  It has been steadily increasing over the past three months.  Need more proof?  The ISM Manufacturing employment sub-index hit its highest level since 1983, while jobless claims have been steadily coming back down.

+ Housing prices as per the Case-Schiller index rose more than expected (third positive reading in a row) and points to continued stabilization in housing prices.  This will help consumer confidence and help bank balance sheets.  Meanwhile, pending home sales for July rose 5.2% and shows that the fall in demand from the tax credit has stabilized.

Bearish

- ECRI Leading Indicator Growth Rate shows continued weakness and is once again below the historically important -10% level, which if broken, has always presaged a recession in subsequent months.  Contrary to bullish news regarding the jobs report, this indicator is leading, not coincident. (Link Courtesy of Zero Hedge)

- The manufacturing sector, which has been responsible for most of the recovery in the economy, is about to falter.  Factory orders rose less than expected coming in at +0.1% for July, while inventories are rising at an accelerating clip, a sign that demand is not as strong as supply, factories will eventually need to reduce production.  Meanwhile, ISM Service Index came in below expectations with most sub-indicies showing weakness.  Employment for this sector, which comprises the bulk of the US economy, showed contraction for the first time since January.  New Orders also showed its weakest reading this year.

- Unit Labor costs were revised up much higher, while productivity has been coming back down.  Most of the rise in earnings has been due to extensive cost cutting (look at the unemployment rate!) — ie margin expansion.  With margins near all time highs, productivity declining and Labor Costs rising, end demand will have to carry earnings growth from here. Survey on end-demand says….

-  …PCE metric shows that income growth continues to struggle.  Slow income growth will anchor consumption growth as there is debt to be repaid and savings to accumulate.  Worse, what’s the unemployment rate at?  High supply of workers vs. low demand for labor points to wage growth crawling or worst case scenario,   contracting.  This could be seen in the Conference Board index of Consumer Confidence as less people expect a wage increase than people who expect a wage cut.  (See link in Bearish point below)

- Consumer spending is slowly decreasing as the Gallup Poll points to a very tepid August (smack in the middle of back-to-school).  The 4 week average for August is down 5%+ from the prior month, which was also down 3%.  Why is this occuring? Look at the Gallup, ABC, and Conference Board (average recession reading = 72 for some perspective) polls.  They show confidence is still in the dumps. There is clearly a trend of reduced/cautious spending.  This is further evidenced in the Goldman and Redbook metrics, which have shown a falling YoY growth rate over the past month as well.

- More signs of a consumer slowdown as the growth rate in auto sales in the US has all but vanished.  New sales rates are lower now than they were in 1990/1991.  If there is no significant growth in end demand soon, the flashy manufacturing numbers are not sustainable, plain and simple. (Link Courtesy of CalculatedRisk Blog)

Observations/Thoughts

  Here’s a great example of everyone trying to export their way out of their respective economic difficulties.  Unfortunately, this means that everyone is attempting to weaken their currencies (beggar thy neighbor policies).  That’s why you’ve seen Gold outperforming all asset classes this year.  How far down does the rabbit hole go?  Rumors are now surfacing towards the Fed initiating QE2 but instead of buying mortgage or treasury bonds, it would begin buying stocks, real estate, etc in an attempt to cut out the middle men that are the banks.  I’m not buying this for a couple of very important reasons.  The Fed would effectively and blatantly be screwing all savers, the prudent, and the retirees seeking income by plowing their wealth into bond funds for the better part of a year now (note, this cohort is the strongest political bloc in the country).  Second, pursing this policy would also signal to the rest of the world that full blown monetization is ongoing and the dollar would take a drastic turn lower.  Inflation would surely become more potent in commodities, while companies, having no pricing power would have their margins squeezed even more.  A dangerous stagflationary situation would develop, however, given that we may indeed be in a modern day depression I’ve come up with a new name.  We would be inviting a “Hyper-depression” if such policy were pursued.

Are problems in China worse than assumed?  Inflation troubles continue to surface, despite the government’s statistical office announcing rather muted CPI readings. One thing is certain, high growth rates in wages are certainly not helping matters for them.  Additionally, we can begin speculating that officials may be a little more forceful in deflating a stubborn real estate market.  However, they need to be careful in their policies as this is delicate process.

More articles are popping up regarding the Fed’s impotence in battling the recession.  This is something that I was thinking about at the beginning of the year.  While the Fed had helped the banks out with a large interest rate spread, demand for loans has been negligible.  Lack of credit creation and expansion is severely disrupting investment and recovery.  There’s really little the Fed can do in a balance sheet recession.  In general, the consumer is paying back all the debt he/she amassed over the past 2 decades.  Unfortunately, there’s not a quick fix to this problem in my view.  Lowering taxes will certainly help in the healing process, but current consumption would probably increase only marginally as consumers would sock away the extra cash for their retirement as their most important asset, their home, is not what it used to be, especially if the tax cuts were only for a year.  Maybe a massive jobs program similar to the New Deal that put people back to work to rebuild our infrastructure (the Recovery Act didn’t really help).  The problem is that if there is deadlock, can we really count on our politicians to agree and spend on another BIG stimulus package?

The Democrats are starting to lose control of the election and possibly their majority in congress.  Filibusters will become commonplace and important legislation may not get to a contracting economy on time.

Barton Biggs is at it again.  “This is not a time where you want to be underinvested.  The odds of a significant slowdown are one in five, pretty remote”.  This guys been flip flopping more than a pancake, and short-term, he’s been wrong at every turn last time I checked. Meanwhile, the most pessimistic on the street right now as far as GDP growth is concerned is Goldman Sachs with a forecast of +1.5% for the rest of the year and a 66% of sustainability in this recovery.  Clearly there hasn’t been capitulation, so we continue on our “slope of hope” IMHO.

David Rosenberg pointed out this article on the Economist regarding the current US job market’s woes.  After reading it, I decided to check out the jobs section in my Q1 outlook and found that my thoughts were quite similar.  I also wrote this in late 2009, where I mention technological innovation as a cause for recent jobless recoveries.  It appears that I am on the right track.

What letter does this look like to you?

From NFIB: Small Businesses Still Not Hiring William C. Dunkelberg, chief economist for the National Federation of Independent Business [said] “In August, most firms did not change employment, but for those that did, 11 percent (up one point from July) increased average employment by 2.3 employees, but 13 percent (down two points) reduced their workforces by an average of 3.5 workers. Job creation still has not crossed the 0 line in the small business sector.
...
“Over the next three months, 13 percent plan to reduce employment (up three points), and 8 percent plan to create new jobs (down one point), yielding a seasonally adjusted net 1 percent of owners planning to create new jobs, a point worse than July, but at least it’s positive.

“Overall, the job creation picture is still bleak. Weak sales and uncertainty about the future continue to hold back any commitments to growth, hiring or capital spending."Note: A large percentage of small businesses are in real estate related fields and that will keep hiring down for some time. The August survey will be released on Sept 14th, but once again the key problem is "weak sales".

Earlier employment posts today (with many graphs):

August Employment Report: 60K Jobs ex-Census, 9.6% Unemployment Rate

Employment-Population Ratio, Part Time Workers, Unemployed over 26 Weeks

Employment Diffusion Indices