Archive for August, 2007

Bernanke Sends the Perfect Message

Kurt Brouwer August 31st, 2007

Federal Reserve Chairman Ben Bernanke sent the perfect message to the financial markets in his talk today in Jackson Hole, WY. From the transcript of his speech, I excerpted three brief statements [emphasis added]:

‘…It is not the responsibility of the Federal Reserve-nor would it be appropriate-to protect lenders and investors from the consequences of their financial decisions...’

I believe he is absolutely correct on this point and I am thrilled that he made it so clearly and forcefully. This should take away some of the talk about bailing out Wall Street or even property speculators. He continued:

‘…But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy...’

‘…The Committee continues to monitor the situation and will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets…’

First, he made it clear the Fed is not going to drop interest rates precipitously in order to bail out Wall Street and its bonuses. Second, he told us that the Fed will take whatever steps necessary so that this problem does not spread throughout the economy.

That’s what we wanted to hear. And, the financial markets responded as well with a strong showing. Long may it last.

Hat tip: MarketBeat Blog

4% Economic Growth

Kurt Brouwer August 30th, 2007

Economic growth surged in the second quarter. Originally, GDP growth came in at 3.4% after inflation. Now, that number has been revised upward to an even 4% as this AP story illustrates [emphasis added]:

‘…The U.S. economy grew an annualized real 4.0 percent in the second quarter of 2007, up from an initially estimated 3.4 percent and hitting the highest growth since the first quarter of 2006, the Commerce Department said in a revised report Thursday.

The department traced the upward revision from the initial report last month to solid improvements in private investment in nonresidential items and exports.

The revised April-June growth in terms of inflation-adjusted gross domestic product matched a widely forecast expansion of around 4.0 percent and far eclipsed the first quarter’s torpid 0.6 percent growth…’

Okay, so the economy is surging. But wait, it’s really grinding to a halt. The AP goes on to lay out a litany of potential woes:

‘… However, the growth trend is not expected to last long. A credit squeeze stemming from increasing defaults on subprime mortgages has wreaked havoc in global financial markets, thus raising the specter of significantly slower growth in coming quarters…’

I would be dreaming if I did not think that economic growth has slumped due to the subprime lending mess, the resulting traffic jam in our credit markets as well as slumping residential construction. These problems are real. Yet, our economy has proven to be remarkably resilient in the face of soaring energy prices, slumping home prices, higher interest rates and many more negatives. No doubt the falling housing market will hurt. So will layoffs in construction, mortgage banking and home builders. But, despite all the problems, economic growth this year should still be solid.

Digging Into Home Mortgage Defaults

Kurt Brouwer August 30th, 2007

The default rate (being late 90 days or more on mortgage payments) on homes is going up. But are those home occupied by the owner or are they investment properties owned by investors or speculators?

This report posted on the WSJ’s Real Time Economics blog indicates that a significant chunk of defaulted mortgages are non-owner-occupied homes [emphasis added]:

‘…Mortgages on non-owner occupied properties in Nevada accounted for 32% of prime mortgage defaults as of June 30 as well as for 24% of subprime loan defaults, the MBA said. In the rest of the country, nonowner occupied homes accounted for 13% of prime defaults and 11% of subprime defaults.

“Defaults are on the rise in most parts of the country, but it should be recognized that it is not always the case of a homeowner losing his or her home,” said Doug Duncan, the MBA’s chief economist. Rather, it’s “often the case of an investor gambling on a continued increase in home values and losing that gamble,” Duncan said in a statement. Defaulted mortgages are those that are at least 90 days past due or in foreclosure.

In Florida, defaults for nonowner occupied property mortgages made up 25% of prime loans and 14% of subprime loans. In Arizona, defaults for nonowner occupied properties made up 26% of prime loans and 18% of subprime loans. And in California, nonowner occupied property defaults made up 21% of prime loans and 15% of subprime loans. California, Nevada, Arizona and Florida were among the states with the fastest home-price appreciation over the last five years, Duncan noted.

“This rapid price appreciation attracted both speculators and home builders, a volatile combination that lead to an oversupply of homes that was beyond the capacity of the local populations to support,” he said. “When this oversupply became apparent and prices began to fall, many of these investors simply walked away from their mortgages.”…’

So this poses an interesting issue. Many people, including Senator Charles Schumer (D-NY) and Bill Gross, have agitated for some form of Federal loan bailout program (see here). I’m sympathetic to the family that is struggling to keep their home, but I see no reason to have a bailout program that benefits thousands of over-leveraged real estate speculators.

Home Prices — Going Up 3.2% or Down 3.2%

Kurt Brouwer August 30th, 2007

Now this is confusing. A few days ago we posted on the Case - Shiller Index which showed housing prices falling by 3.2% (see here for the full post). Here was the main point [emphasis added]:

Kelly Evans of the Wall Street Journal reports [emphasis added]:

‘The decline in U.S. home prices accelerated in the second quarter as a glut of unsold homes and tighter lending standards continued to weigh on the market.

Home prices nationwide tumbled an average 3.2% from a year earlier, according to an index compiled by Standard & Poor’s Corp. The decline was sharper than the year-to-year decline in the first quarter, when the S&P/Case-Shiller national home-price index dropped 1.6%…’

Now, we have a report by Damian Paletta and Jeff Bater, also in the Wall Street Journal. Based on data from the Office of Federal Housing Enterprise Oversight (OFHEO). the piece reports that home prices going up-not down-by 3.2%, compared to prices from one year ago.

U.S. house prices appreciated 3.2% in the second quarter of 2007 from a year before, the Office of Federal Housing Enterprise Oversight reported Thursday…’

‘…Ofheo said prices rose only 0.1% in the second quarter from the first quarter, the lowest quarterly increase since 1994.

“House prices were basically flat in the second quarter despite tightening credit policies, rising foreclosure rates, and weakening buyer sentiment,” Ofheo director James Lockhart said. “Significant price declines appear localized in areas with weak economies or where price increases were particularly dramatic during the housing boom.”…’

The only thing I can figure is that the OFHEO statistics are lagging indicators or that they are looking at different types of properties. You can view the full report from OFHEO here.

Obviously, one of these dueling reports is going to be shown to be inaccurate. My sense is the Case-Schiller report reflects what I’m seeing better than the OFHEO report. The next quarterly releases on home prices will be very interesting.

Hat tip: MarketBeat Blog

Submerging No More — Emerging Markets Hold Their Own

Kurt Brouwer August 29th, 2007

Mutual funds that invest in so-called emerging markets have done pretty well this year. By way of background, the term emerging markets is a catch-all phrase that is now used as a substitute for the term Third World. It’s a catch-all phrase because it typically includes such disparate economies as Singapore, South Korea, China and India along with Turkey, Egypt, Vietnam, Cambodia and Sri Lanka.

Despite the limitations of the term, it is what we have. So emerging markets or emerging economies is what we will go with.

In the 1998 version of the hedge fund / credit crunch, emerging markets took a huge hit and, in many cases, became submerging markets. This year, things are different as this piece from David Gaffen at the WSJ MarketBeat Blog illustrates [emphasis added]:

‘…With all the volatility in the world markets, some are looking to a surprising place as the safe haven — emerging markets. In the past, emerging-market indexes were the first to be dumped, as they were often the most likely to suffer from global financial crises (or were the catalysts for it, as it was in 1998 when Russia defaulted on its debt)…’

‘…According to MSCI Barra, the world index of developed countries is down 5.94% over the last three months, including a 2.87% decline in August. For the year, the index has gained just 2.51%. The world emerging markets index, meanwhile, has gained 3.51% in the last three months despite a more volatile 5.6% decline in August. For the year, the index is up 15.09%…’

Despite the good gains this year, I think it is important to remember that emerging markets and the mutual funds that invest in them should still be more volatile than funds that invest in developed such as the U.S., Japan and Europe.

Global Growth and China Looming

The economic growth rate for emerging economies is often much higher than that of developed economies (see here for more). There are two big issues looming however. First of all, China. China’s economy is booming and its stock markets are red hot (pun intended). Their stocks will eventually come back to earth and that will hurt because China is a significant part of most emerging market portfolios.

The second issue is a more positive one. Growth rates around the globe are very good, in fact, better than they have ever been. MarketBeat Blog continues with a caveat for emerging market investors:

‘…The real problem, however, is growth — if the global economy were to go into a recession, or even just a sharp slowing, emerging markets would be at greater risk….’

The reason that emerging markets would be at greater risk in a recession is that many of these economies, particularly China and other Asian countries (Taiwan, South Korea, Thailand, Singapore), are highly-dependent on exports for the U.S. economy. If our economy catches cold by going into a mild recession, their economies may well catch pneumonia.

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