Professor Mulligan: A Housing Recovery Is Inevitable

A steady stream of mostly positive data over the past 90 days is convincing more academics and analysts that the housing bust has reached its conclusion. Chicago economic professor Casey Mulligan writes in the New York Times that the current data suggests that a housing recovery is basically inevitable. Dan Rafter from Mortgage Roadmap has more.

A growing number of economists are joining the chorus: A housing recovery has begun.

To that, we can all add a hearty "Hallelujah!"

The latest economic type to opine that the housing recovery is now in progress is University of Chicago economics professor Casey Mulligan. In a column printed in the New York Times, Mulligan says that all the latest reports on housing starts, home sales and housing prices point to the beginning of a housing comeback.

Mulligan says that basic laws of supply and demand pretty much made a recovery an inevitability. For instance, the U.S. population has continued to grow. At the same time, homebuilders during the housing slump basically stopped building new homes. This leads to an increased demand. Sure enough, housing starts have finally begun to rise again.

As demand for housing increases, Mulligan says, we'll finally see housing prices stop their steep fall. This will lead to an eventual rise in national housing prices again. Mulligan does say, rightly so, that housing prices will not return to their 2005 levels. But that was the height of a very unsustainable period of housing-value appreciation.

Reading a column like this is a soothing way to start your morning. Much of my income is tied into the housing industry because I write for several publications that cover the mortgage and real estate businesses. I'm thrilled to see things finally start to improve.

Personally, I'll know that the housing slump is history once all those real estate trade magazines begin assigning me stories on a regular basis again.

This article has been republished from Mortgage Roadmap.

Unemployment Danger Still Hasn't Passed

Unemployment is still rearing its ugly head as the initial jobless claims increased slightly at the end of July, giving more credence to a jobless recovery. What does the uptick in unemployment mean for the prospects of economic recovery? James Picerno from The Capital Spectator has more on this.

Today's update on initial jobless claims reminds that the threat of economic contraction isn't vanquished. There's been progress, but the dark forces of decline are still lurking.

For the week ending July 25, the advance figure for seasonally adjusted initial claims was 584,000, an increase of 25,000 from the previous week's revised figure of 559,000. A rise in new fillings for unemployment benefits is unsettling at this precarious stage in the economic cycle. Still, there's nothing in today's numbers that convinces us to alter our view that the technical end of the recession is near. For the moment, last week's jump looks like statistical noise.

That's not to say that all danger has passed—it hasn't. But as our chart below reminds, the general trend in initial jobless claims remains one of decline. Then again, let's not forget that new filings have risen for two weeks running, albeit off of a relatively low base by the standards of this year. Another week or two of this behavior and it may be time to rethink our otherwise favorable outlook that the cycle's trough is unfolding right about now. We'd become more anxious if initial claims jumped above 600,000 in the coming weeks.



Meantime, weekly jobless claims are still signaling that the recession is about to end, if it hasn't already. Having peaked back in March at 674,000, the decline since then suggests that the worst of the economic contraction is behind us. Then again, history is only a guide, not a guarantee.

There's only one way to resolve the debate of whether we're past the worst of this recession: More data. Jobless claims have been suggesting for several months that there's light at the end of this tunnel. The only question is timing. The numbers of August, it seems, will be critical.

This post has been republished from James Picerno's blog, The Capital Spectator.

Top 5 Short-Term Real Estate Investments

Although real estate investment often requires a long-term view, the recent chaos in property markets throughout the world have produced some attractive opportunities for short-term return. Liam Bailey recently shared his top 5 short-term real estate investments at Overseas Property blog.

1. Repossessed Properties in Florida

Some people frown on what they see as profiteering from other people’s misery, but the way I see it is: these properties have already been repossessed and whether someone buys them or not the banks are not going to sympathetically give them back to their original owners. That aside we can look at the potential profit.

Florida has always been a massively popular place with overseas property buyers, but in recent years property had become so expensive that it was out of reach for most people. Florida in the present reality has been one of the worst affected regions by the housing crisis in the US and there are currently thousands of repossessed properties being sold at up to 50% less than their market value.

3, 4 and 5 bedroom (mansions) villas with private pools; the properties that you or I could only dream of are now within reach of the masses. Buying a property with 50% instant equity leaves buyers with only one question: will they ever regain their market value. In Florida’s case the answer is a resounding yes.

When we can talk about the international downturn and housing crises in past tense once and for all, Florida will regain its popularity with international buyers, and as things recover Florida residents will once again be buying houses in the normal way.

This isn’t going to happen overnight, the property is not going to regain its market value immediately after the recovery. But 2-3 years down the line you should be able to resell quite easily for a 20-30% profit, and possibly more and sooner on the particularly special properties in the most popular areas.

2. Repossessed Properties in Spain

These are pretty much the same as Florida; Spanish properties being sold at up to 50% less than their market value.

In Spain’s case though, the question of whether they will regain their true value needs to be looked at more closely. Spain was massively over-developed in the last few years; at the height of the boom more properties were built in Spain than in Italy, the UK and Germany put together. This has translated to massive over-supply problems that will plague the Spanish market for many years to come.

You simply need to consider who is going to buy the property from you when it is time to sell. If you are buying in one of the areas most popular with expats, and plan your exit strategy based on expatriate buyers, then you must avoid the most over-developed areas; sunbathing is not a spectator sport, and most people will want a half-decent view on at least one side of their holiday properties.

Negatives out of the way: Spain remains one of the most popular countries with overseas property buyers. Several major portals have put it in the top 5 most popular in the last few months, including Property Abroad.com (2nd, 1st in May), The Move Channel (2nd) and Prime location (2nd), and this is expected to start turning back into sales by the end of the year. So if you choose carefully, you should be able to resell a property you buy now for at least a 30% profit in 2-4 years.

3. Repossessed UK Property

You wouldn’t expect to find me recommending the UK for property investment, as I usually favor emerging markets. But over the long-term UK house prices are on an upward trend, and during the last boom prime properties, especially in London grew in value faster than emerging market property. The problem was it was out of reach of most people then.

Now that the downturn has caused thousands of UK properties to be repossessed, you can get some real bargains that are almost guaranteed to be worth their true market value within 5 years. That means a profit of 30% - 50% in five years depending how big a bargain you get.

Repossession became such a big problem in the UK that we attracted the major US repossessed auction house, the Real Estate Disposition Group, REDC, who have come to stack our properties high and sell em cheap. However I went to one of their auctions and wrote an article for First Time Buyer magazine comparing REDC to the other UK auction houses selling repossessed property, and found that the latter offered the biggest bargains.

4. Luxury Off Plan Property in Emerging Cities

Off plan property in emerging markets is usually sold at a discounted price, in lieu of the potential risk that exists when buying a property that only exists on paper. So, this always meant that potentially a profit could be made on the property immediately after its completion. This is why so many people got stung in Dubai; people were buying off plan property and then selling it weeks later for a profit, as prices grew exponentially the potential profit when the properties were completed was immense, until it emerged that some would never be completed and those left holding the hot-potato got their fingers burned.

The purchase of property off plan has been marred by the sudden onset of the international credit crunch, but if you do your own due-diligence and go to great lengths, it is still potentially one of the most profitable investments around.

Suggested steps to take include several trips to the country to make sure that the development is not funded by proceeds from off plan sales, research the developers’ track record and make sure that all the proper permissions are in place and that building is kept to what is permitted.

Buying an absolutely luxurious off plan property, i.e. a penthouse overlooking a waterway, in an emerging city like Kuala Lumpur, Rio de Janeiro or Panama City has the potential to grow in value immensely, both upon completion and as the city grows apace during the international recovery.

5. Off Plan Luxury Resort Property in Emerging Tourism Destinations
Some people will find it unbelievable that I have included this, because it is these that many of the people who lost out to the crunch had put money into. This is because on these investments you are putting all your eggs in one basket; you are reliant on foreign buyers when it comes time to sell.

For the people who tried to resell their properties off plan when the crunch set-in, it was worse; they were reliant not only on foreign buyers, but on foreign investors, which had all but disappeared.

Even at the worst point in the downturn, popular tourism markets like the Turks and Caicos were being kept afloat by foreign lifestyle buyers, who have remained active throughout. Lifestyle buyers are of course looking for completed property, not off plan.

That said, with high risk comes high reward: when you invest in a luxury resort property off plan in an emerging tourism market, you are buying a very special property at a knock down price. When it is completed it will be a high luxury property on a world class resort, which in a few years may well also be a world renowned resort. If you buy such a property now, you should be able to sell to a lifestyle buyer for at least twice what you paid when the resort is established 5 years down the line.

Article written by Liam Bailey of Property Abroad.com

This article has been republished from Overseas Property Blog, an international real estate investment blog.

The Flaw In The Government's Mortgage Modification Program

Although the government has attempted to help homeowners stay in their homes by modifying their mortgage, this has done little to slow the flood of foreclosures. Andrew from the blog Blown Mortgage explains a critical flaw in the government's loan modification program. Continue reading to learn more:

Despite the governments efforts to provide loan modifications for individuals and families in financial difficulties that are at risk of foreclosing on their loans the mortgage aid seems to be moving too slow for all the families to benefit from it.

This has made many experts to question why banks are moving so slowly to take advantage of a program that is designed to help both the borrower and the lender. The idea is that mortgage modifications benefit both borrowers and lenders as they allow banks to receive payments they would not get if the mortgage foreclosed in a buyers market where the security (normally the house itself) is in negative equity.

However recent research quoted in today´s Washington Post indicates that this only holds true with a certain kind of borrower, the type of borrower that truly can´t pay the monthly mortgage payments at the current level but would be able to pay them if the monthly payments were reduced. This is only one of three types of borrowers though. It seems that with the other two types of borrowers, loan modifications are just not cost effective.

These two types comprise:

1) Borrowers that are in such financial strife that no loan modification or mortgage refinance is going to help in the long run, ultimately they are going to have foreclose their loan.

2) Borrowers that can meet the payments even though this might mean serious financial difficulties, even losing their life savings.

Banks and lenders have little incentive to help either of these demographics of borrowers.

To illustrate imagine if you were a lender, a bank or even a private company that provided loans for a profit. Obviously you demand some sort of security to protect your investment in case the borrower cannot or will not pay, this could be jewelry, thee deeds of a property or a car. Then one day the borrower tells you he is going through financial hardship and needs a break in his payments, a reduction in his debt or his monthly payments. However you realize that this borrower is not going to be able to pay his loan whether you help him now or not. Negotiating with him now is just going to cost you money in time, work and whatever reduction or break you provide for his loan. On the other hand you could simply foreclose his loan and claim the security without losing nearly as much. What would you do?

Even the kindest philanthropic can see the negative incentive that such a lender would have to actually negotiate a solution with the borrower.

Could this explain why loan modifications are moving so slowly despite the huge incentive programs the government is providing to encourage loan modifications on mortgages that risk foreclosure.

It seems that Obama´s administration has also seen this flaw in their system and is currently negotiating with banks for further incentives for the provision of loan modifications to the most vulnerable borrowers.

This article has been republished from Blown Mortgage, a mortgage news and analysis site.

More Good Numbers From The Housing Market

Dan Rafter at Mortgage Roadmap describes recent numbers that suggests that housing is on the path to recovery. Although it is too soon to tell, June sales numbers in the US are encouraging. See the following post for the latest numbers.

You can practically hear the real estate agents screaming for joy. Yes, there is yet more evidence today that the housing market is in the midst of a recovery. Yes, it's early in the process. And, yes, again, it's still a fragile recovery. But it is a recovery, and that means that real estate agents may soon be seeing fatter paychecks.

Of course, consumers aren't too concerned about whether real estate agents make enough money to take that winter trip to Hawaii. They're more concerned about whether they can sell their homes and if they can sell them for a high enough figure. According to the Associated Press, housing prices are still suffering when compared to last year. But they are rising fairly steadily. Home sales, too, are increasing in most parts of the country.

Here's the good news in a nutshell: According to the Associated Press, home sales rose 3.6 percent to a seasonally adjusted annual rate of 4.89 million last month. That's up from a pace of 4.72 million recorded in May. And the sales increases were spread out; they were up in all four regions of the country.

If you're really looking for reason to cheer, June's home sales were as high as sales had been since way back in last October.

Housing prices are still a bit weak. The median sales price of an existing home stood at $181,800 in June. That's down 15 percent from a year ago. However, it is up a bit from the $174,700 median sales price that we saw in May.

Of course, it's not time to get too excited yet. We need to see several more months of this. We also need to see home values continue to increase. Talk to me next winter. Then we'll see just how strong this particular recovery is.

This post has been republished from Mortgage Roadmap.

Home Price Index Increases For The First Time In 3 Years

According to the S&P Case-Shiller Home Price Indices, US real estate prices increased for the first time since the housing decline started. Could this mark the turning point in the housing market? See the following article by Tim Iacono on the latest numbers on US real estate prices.

The May report(.pdf) for the S&P Case-Shiller Home Price Indexes showed the first monthly increase in three years, however, prospective home buyers and sellers should heed whatever few warnings they might hear today about reading too much into monthly data, especially around this time of the year.



"One month does not a trend change make" and this reality is quite easy to see in the chart above where there were many monthly price decreases prior to all 20 cities putting in their price peaks between 2005 and 2007.


For example, after a long string of monthly gains, Portland reported its first monthly price decrease in October of 2006 but didn't reach a peak until the following May - look for a similar occurrence as the beginning of a home price bottom starts to take shape.

From April to May, the 20-city index rose 0.5 percent while the 10-city index rose 0.4 percent, however, you can see in the chart below that there is a strong seasonal component to the data, monthly price changes improving around this time of the year regularly - look for more of the same in next month's report.



Conversely, price declines have their strongest seasonal influence during the winter, so, it will probably take another six or eight months to see another complete cycle for this pattern.

As shown below, both Los Angeles and San Diego have fallen out of the group of cities with annual price declines of 20 percent or more (indicated in blue) while Phoenix and Las Vegas improved only marginally, both maintaining 30+ percent declines as indicated in red.



David M. Blitzer, Chairman of the Index Committee at Standard & Poor's notes:

The pace of descent in home price values appears to be slowing. There is a clear inflection point in the year-over-year data, due to four consecutive months of improved rates of return, after the steep decline that began in the fall of 2005. In addition to the 10-City and 20-City Composites, 17 of the 20 metro areas also saw improvement in their annual returns compared to those of April. Looking at the monthly data, 13 of the 20 metro areas reported positive returns; and the 10-City and 20-City Composites reported positive returns for the first time since the summer of 2006.

To put it in perspective, these are the first time we have seen broad increases in home prices in 34 months. This could be an indication that home price declines are finally stabilizing. While many indicators are showing signs of life in the U.S. housing market, we should remember that on a year-over-year basis home prices are still down about 17% on average across all metro areas, so we likely do have a way to go before we see sustained home price appreciation.

The next few months of data should be pretty interesting, but, given the seasonal patterns in the second chart above, don't be surprised if home prices disappoint again later this year.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Why Bernanke Is Campaining

With many Americans critical over the Fed's aggressive monetary policy and a pending bill to audit the Federal Reserve, Bernanke has begun a public relations offensive to clear his name. James Picerno, author of The Capital Spectator, discusses why this is baffling behavior for a Fed chairman.

Your conventionally minded editor isn't used to seeing a Federal Reserve chairman take his monetary policy show on the road. Then again, we're from the old school, and we're not used to seeing pigs fly either. But we're obviously out of touch in the 21st century.

Ours is a world where formality gives way to "transparency," which comes in an ever-widening rainbow of colors. Fed chairman Ben Bernanke's "publicity tour" is certainly something new in the bag of central banking tricks. We thought that participating in so-called town hall forums and taking questions from the audience was an art reserved for politicians and talk-show hosts. We're wrong. It's also now just another tool in the otherwise dull business of managing money supply.

The old veneer of banking ceremony is fading, giving way to a penchant for empathy and personality tours. Imagine our surprise when we discovered that Mr. Bernanke was "disgusted" by some of the Fed's recent actions, as he explained to an inquiring member of the audience in yesterday's PBS television episode. Speaking of the various bailouts last fall, the Fed head confessed: “Nothing made me more angry than having to intervene, particularly in a few cases where companies took wild bets." Perhaps he might have simply said that the devil made him do it. Personally, we'd have like to see some tears to make the confession more convincing.

In any case, at least we know our Fed chairman is now sympathetic to the working man. Sure, the central bank has made some tough decisions, but it also has a heart. Expressing compassion of a sort for the little guy when setting interest rates and engaging in other activity looks to be the new new thing. Big, impersonal banking institutions are out; warm and fuzzy I-feel-your-pain monetary policy is in.

Is any of this surprising in the media-infested 21st century? Perhaps not. Indeed, Mr. Bernanke, whose term is up next year, is running for re-election to the Fed and of course he's intent on pulling every lever available on his behalf. Of course, before we can decide if his campaign is worthy of support we'll need to see his monetary policy platform. If it's superior to the plans of the rival candidates vying to run the Fed, well, perhaps Ben deserves another term.

To get the word out, Mr. Bernanke may want to consider running television ads in key districts. Sure, it'll be hard to capture viewers' attention by proclaiming to have a better monetary policy than the other guy. Television, it seems, just wasn't made for dispensing the finer points of quantitative easing and the value of watching M1 vs. M2. But, hey, that's a minor obstacle. Ben needs to speak to the man on the street, especially in those swing-voter districts that could tip the balance in what promises to be a tight race.

Actually, there's a bigger problem. Fed chairman aren't popularly elected, at least not yet. And last we checked, there are no obvious rival candidates openly campaigning for the Ben's position, at least not yet. Instead, the Fed chief is appointed by the President and confirmed by the Senate, or so we're told.

As a result, any resemblance between Mr. Bernanke's campaign for re-election—sorry, we meant reappointment—and a political campaign is merely coincidental.

This post has been republished from James Picerno's blog The Capital Spectator.

Photo from Wikipedia commons.

11 Percent Rise In New Home Sales Is Highest Jump In 8 Years

According to the Census Bureau, June was a strong month for new home builders. Tim Iacono from The Mess That Greenspan Made, takes a deeper look at the latest numbers from the new home market. Continue reading to learn more.

The Census Bureau reported(.pdf) an 11 percent increase in new home sales last month, the sharpest rise in eight years, as homebuilders attempt to mount a recovery from all-time record low sales levels earlier in the year.



Sales rose from an upwardly revised annual rate of 346,000 units in May to 384,000 units in June, the highest level since last November. Interestingly, sales in March and April were revised downward, not upward, as might be expected during a market bottom.

Inventory decreased as sales rose, the number of new homes on the market dropping to 281,000, the lowest level since 1998, and the months of supply metric fell from 10.2 months in May to 8.8 months in June.

Though sales prices for new homes are heavily influenced by incentives and are often quite misleading, builders appear to be slashing prices, the median price plunging 5.8 percent in June to $206,200, now down 12.0 percent from a year ago.

Once again, it's important to maintain a proper perspective on this news and the most important bit of data is that home prices continue to plunge - clearly not a sign that the housing market is springing back to life.

There is good news, however, for homebuilders in that sales may now have bottomed and the outlook for their industry may improve further after sales reached historic lows earlier in the year, lows that make all previous declines pale in comparison.

As noted here months ago when all-time record lows were first being made, in population-adjusted terms, the current housing downturn is without precedent. The pre-2009 all-time low of 338,000 in September of 1981 works out to a population-adjusted rate of about 460,000 today, meaning that, even after the recent "surge" in new home sales, another 20 percent increase is required just to get back to the previous record low!

While there has clearly been steady improvement in new home sales in recent months, recent increases are akin to your favorite 2000 technology stock rising 8 or 10 percent during a few months in 2001 after plunging 80 percent in 2000.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Should Obama Bring Bernanke Back?

There is widespread debate on whether Bernanke should be reappointed. While Bernanke receives his share of criticism, Economist Mark Thoma explains why it would be in the country's best interest for Obama to bring him back for a second term. See the following post from Economist's View to learn why.

Nouriel Roubini says:

Ben Bernanke ... deserves to be reappointed. Both the conventional and unconventional decisions made by this scholar of the Great Depression prevented the Great Recession of 2008-2009 from turning into the Great Depression 2.0.

Anna Schwartz has a different perspective:

As Federal Reserve chairman, Ben Bernanke has committed serious sins of commission and omission — and for those many sins, he does not deserve reappointment.

Here's how I see it. It's true that we failed to notice that the patient was getting sick. The signs of disease were there, but we either didn't see the signs or they were misdiagnosed. In fact, there's a case to be made that we saw some of the changes in the patient as signs of improving health. Had we made the correct diagnosis early enough, maybe we could have prevented the patient from getting sick (though it's not clear the patient would have taken our advice, so stronger measures than mere advice may have been required).

And once the patient showed up in the office and was clearly sick, we didn't get it right initially either. We thought the patient needed fluids - liquidity as they say - and the patient did need some of that, but we didn't immediately see that there were also some key nutrient deficiencies and chemical imbalances that were threatening to cause further problems.

Bu we kept at it with tests and other diagnostics, and eventually got a handle on the problem. Once we did, we began to administer the medicine the patient needed. The patient will get better, the deterioration was rapid and turning it around will be difficult - it won't happen fast enough to suit any of us - but what has been done prevented a complete collapse, and is helping to move the patient towards recovery.

So I'm with Nouriel, Bernanke should be reappointed. It's true that the progression of the underlying disease was largely missed, but that's pretty much true across the board, all the doctors missed it. It's also true that there was some dispute over how to interpret the initial symptoms and test results, and what to do to cure the patient. But again that was largely true across the board in the tumultuous period just after the patient began to exhibit clear and serious problems. It's not like everyone except the patient's doctors knew exactly what to do. The uncertainty in that initial period created fear, and the fear made the patient - who needed calm above all else - even worse off.

But as just noted, the doctors who were put in charge - Bernanke in particular - persevered and began to understand more precisely what was going wrong and what was needed, and that allowed them to save the patient from a much, much worse fate. They deserve credit for that. The patient will live, and that wasn't always so clear. In the initial confusion they did what you need to do - they administered wide spectrum drugs and other procedures that were known to abate the symptoms they were observing, and these did help, and that gave them time to find more targeted remedies. They used the time wisely to find and structure better remedies, and once those remedies were ready they used them to attack the various ways in which the disease was shutting down vital systems (not everything they tried worked, but the things that did work helped quite a bit).

There was one scary point, however, and that was when they thought the patient had become strong enough to go without the medicine, and they withdrew it too soon (the Lehman episode). The result was that they almost lost the patient completely, and only quick action saved the day. That's the one point where I think the doctors could have done better. I understand the concerns over the side effects of this medicine, but it was too soon and it created too much unnecessary uncertainty and fear.

But overall, they did the things that needed to be done to make sure the patient did not suffer an even worse, prolonged, debilitating collapse, and those efforts were successful. Failing to diagnose a disease is different from not knowing what to do once you figure it out. The disease was a difficult one to diagnose or it wouldn't have missed so widely, and it wasn't clear at first precisely what was wrong, but in every case, once they understood the problem, they took the proper course of action.

Here's the question I ask myself. If I were to suddenly come down with the same disease, would I want the current group with it's current leadership in charge of bringing me back to health, or would I want a different group led by someone new who thinks they know what to do, but has never actually been through it? I'd want this group, the one with experience. They're likely to have learned enough to spot the disease the next time and head it off all together, one hopes so. But if not and I get the disease, they are also likely to know just what to do - while avoiding the missteps they took the first time - to get me back on my feet as fast as possible (and please don't let politicians second guess them).

This post was originally published on Mark Thoma's blog, Economist's View.

Warren Buffet Wrong On Stock Market Prediction

The Oracle of Omaha may have made a rare incorrect prediction when he encouraged investors to buy stocks 9 months ago when the Dow was at 9,000. Today, the Dow is still at about 9,000 so Buffett went on record to reiterate his faith in US stocks. See the following post by Tim Iacono for more.

Don't get me wrong, Warren Buffet is admired around here quite a bit - more so than just about any other billionaire investor - but, going on CNBC this morning and being portrayed as a raging bull probably didn't do him any good in the eyes of those who are a bit more skeptical of the current market rally than is the CNBC staff.

His appearance today comes nine months after his memorable op-ed piece in the NY Times urging investors to buy shares. Coincidentally, the Dow was at about 9,000 back then too.



It's kind of hard to reconcile the "buy when there's blood in the streets" mantra that sounded so good last fall (even though the results weren't so hot) with a similar recommendation today, given the bubbly nature of stock markets around the world where, after the early-July bounce, investors appear to be loaded with optimism once again.

From CNBC this morning:

Warren Buffett tells CNBC that the economy still isn't showing any signs of life but that doesn't mean investors should stay away from stocks for the long-term.

In a live interview on Squawk Box this morning, Buffett says "business is still flat." But he stresses that doesn't mean he's negative on stocks, predicting the market will revive before the economy does.

"The market is very, very likely to turn up before business. But I don't try and time stocks. I try to price stocks."

He repeats his advice from his "Buy American" op-ed in The New York Times last fall: don't wait to buy stocks until the economy improves. By then, he says, you will have missed the biggest stock gains.

Even with the Dow hitting highs for the year around 9000, Buffett repeats his belief that stocks will outperform cash investments, such as Treasury notes, over the long-term. "I would much rather own equities at 9000 on the Dow than have a long investment in government bonds or a continuously rolling investment in short-term money."

From last year's editorial:

THE financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.

So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.

At least he's done a heck of a lot better with his Goldman Sachs shares than most retail investors have done with their mutual funds since last fall.

This post was republished from Tim Iacono's blog, The Mess That Greenspan Made.

What The Shape Of The Recovery Will Most Likely Look Like

What will the recovery look like? While there is still strong debate on the shape of the recovery, economist Mark Thoma explains how a structural change in the economy can change the trajectory of the recovery. From Mark Thoma's blog, Economist's View:

With unemployment rates still headed north, it is tough to see the Fed tightening within the next twelve months, if not longer. But will the job market surprise us? No clear indications can be gained from initial unemployment claims data which, although battered by unusual seasonal patterns, overall remains consistent with further drops in nonfarm payrolls. Indeed, this would be consistent with recent patterns of recession. David Altig declares:

...I'm quite sympathetic to DeLong's theme that the dynamics of U.S. labor markets coming out of recessions appear to have changed starting with the 1990–91 economic contraction. And it might be hard for many people to argue with DeLong's point that the U.S. economy is likely headed toward another so-called "jobless recovery." But until more facts are in and we're able to look back on what transpired, I think we still, at this point, must reasonably count the current run-up in the unemployment rate as a puzzle.

In the comments from my last piece, reader Spencer takes a different perspective, noting that forecasters have tended to underestimate the strength of recoveries, and further notes that recent moderate recoveries have followed atypical mild recessions. The current recession, however, is more typical of the pre-1990 variety, and, as such could be expected to yield a rapid recovery. A logical analysis from a long-time observer of business cycles; as always, one should have such an outcome on their continuum of possible events, but I tend not to be particularly sympathetic to the mild recession, mild recovery, big recession, big recovery analogy. It seems to be that a cursory look at the data suggests something very different is happening in the labor market and thus the strength of recoveries since the early 1980s. Look, for example at the pattern of durable goods manufacturing payrolls:



Previous to 1990, durable good jobs snapped back quickly, but that began changing after the 1980 recession, first with a muted rebound, than a slow return after the 1990 recession, and then with no return after the 2000 recession. That lack of rebound alone cost the recovery roughly 2 million jobs - and it seems that if the downturn was only mild, we should have expected these jobs to return. We will lose another 2 million at least by the time the current downturn is complete. Does anyone think these jobs are coming back? Anyone?

Likewise, nondurable goods manufacturing tells an even worse story:



In previous cycles, a rapid bounce, but simply an outright cliff dive since the mid 1990s. Again, do we think this trend will be reversed in the upcoming recovery? Another, albeit smaller sector:



To be sure, information services was coming off a bubble, but stability in the sector remained elusive even at the peak of the recent cycle.

These patterns suggest to me that the last fifteen years has seen intense structural change such that even mild recessions result in permanent dislocations. I have trouble that in the midst of such ongoing structural change a deeper recession will result in a less permanent dislocation. No, I suspect many of these jobs are gone for good, placing an additional weight on the job market during the recovery. Simply put, the danger is that in even a moderate recovery, the remaining expanding sectors will lack sufficient strength to compensate for these permanent losses.

Anticipating the comments, another way some might describe the patterns in the labor markets during recent recessions is that a variety of economic policy decisions by both Democratic and Republican administrations have had the impact of dismembering the industrial base of the US without encouraging the growth of sufficient replacement jobs, thereby throwing the American middle class under the train. That, however, is such a dark interpretation, as opposed to say, cheering the efforts of policymakers to lessen the burden of work on Americans by encouraging foreign nations to forsake their own consumption to provide goods for our citizens.

Bottom Line: I am not convinced that the equity run up confirms much more than the power of low expectations. Indeed, the bond market has yet to follow suit (when I would actually expect it to lead the way). I increasingly think that the debate between V and other shaped recoveries is really a debate over the degree of structural change occurring in the economy. If you believe this is a typical cycle, and that what was demanded and how it was produced is roughly the same after as before the recession, a V-shaped recovery is your likely candidate. If you believe that the current recession is simply intensifying a period of intense structural change, than you are looking for a U or L-shaped recovery. Notably Bernanke, by acknowledging that the US consumer is in no shape to continued its 25 year role as a shaper of global economic trends, seems to be siding with the structural change side of the coin.

This post has been republished from Mark Thoma's blog, Economist's View.

The Dark Side Of The Spike In Housing Starts

The unexpected spike in the annual pace of new home starts, boosted confidence in the housing market. But what if the housing market is not ready for more new homes? Constantine von Hoffman from Blown Mortgage discusses why developers should not be adding new inventory right now.

Last week the Commerce Department announced an unexpected 3.6% increase in housing starts in June. The 582,000 units started last month is a solid gain from May’s 562,000 and much more than the 532,000 analysts had been expecting.The increases were concentrated in single-family homes which were up 14% — the biggest rise since December 2004. Housing permits were also up; the 8.75% increase was the largest gain in a year.

This would seem to be good news. A sign that more people are buying or commissioning homes and that developers expect this trend to continue. However, developers have guessed very wrong in the very recent past. (See Florida, Phoenix, Las Vegas and the Case/Schiller index for examples.)

Many economic indicators suggest developers haven’t suddenly become a lot better in predicting the economy:

• The nation currently has more housing stock than it needs. That is why the price of existing houses is going down. More stock continues to be placed on the market at lower prices each month by investors desperate to get anything back on their investments.

• While the increase in the number of people claiming unemployment benefits nationally has slowed slightly (up only .1% in June) it is difficult to see that as a reason to build more homes.

• Mortgage delinquencies have continued to increase. The most recent FHA numbers showed approximately 71,700 more loans became 60 days or more delinquent in April. Loans 60-plus-days delinquent increased approximately 7% that month to 1.2 million.

• Commercial real estate prices dropped 7.6% in May. So it hardly seems that businesses are about to expand or staff back up.

• Companies that sell to the construction trade are not optimistic about the coming year. Caterpillar announced dealer inventories had been cut $1.5 billion in the first half of 2009 and the company expects that to continue. The reasons: “Factors depressing construction included high inventories of unsold homes, lower selling prices and continued stringent standards for mortgage qualification.”

So why the increase? As with so much economic activity these days the cause seems to be wishful thinking. Developers think first time home buyers are going to flood the market before the Dec. 1 end to a federal program offering first-timers an $8,000 tax credit.

While there are undoubtedly a number of wise families who have kept their financial powder dry and will be able to take advantage of the federal aid, why would they buy a house that has either just been completed or is about to be? They are understandably going to want to get the most for their money. Why would they choose brand new construction over very recently brand new – for less money?

Housing starts are frequently referred to as a leading economic indicator. Perhaps we should change that to a leading economic prayer.

This article was republished from Blown Mortgage, a mortgage news and analysis site.

Decoding The Erratic Jobless Claims Data

What should we make of the erratic swings in jobless claims which recently increased by 86,000 before dropping by 50,000. Examining historic trends can often spread light on what is going on. Tim Iacono from The Mess That Greenspan Made explains what factors could be influencing the job numbers.

The latest weekly jobless claims data will be released tomorrow morning and, after last week's strange report, it could offer even more interesting surprises.

Recall that, last week, seasonally adjusted jobless claims dropped almost 50,000 to 522,000, the lowest level since January, a development that was in stark contrast to changes in the raw data showing an increase of more than 86,000 from the week before, all of this prompting a good deal of head scratching for those who were interested in looking beyond the headline number.

To help understand just what happened, the jobless claims data going back some 20 years is shown below. Since this graphic contains so much data, there was no alternative than to create a much larger image - you'll have to click on it to make much sense of it.



Click to enlarge

The first thing you notice when comparing adjusted and unadjusted jobless claims data is that this data series really does need seasonal adjustment.

The most pronounced features are the January layoffs that come right after the holiday shopping season when, even in a booming economy, jobless claims double or triple at the start of every year.

The other big seasonal events are the summer layoff for autoworkers that normally occur during the first two weeks in July. These can also be seen clearly in the graphic above - jobless claims spike up early in July and then they go far below the seasonally adjusted data until they get ready to spike up again the next year.

The labor department tries to account for these patterns, applying seasonal adjustments to the incoming data, however, the system is not perfect, even less so during times of economic upheaval associated with recessions.

But, what's really intriguing about this data is the area to the right of the chart above, an enlarged version of which is reproduced here.

You can see the red and blue curves diverging dramatically over the last two weeks. The red curve, representing the seasonally adjusted claims fell from 617,000 to just 522,000 during this period while the unadjusted data rose from 559,857 to 667,534.

The fact that actual claims for unemployment insurance did not spike up much higher is the reason that most have cited for why the seasonally adjusted claims plunged - layoffs earlier in the year as GM and Chrysler entered and exited bankruptcy were said to have drawn from the pool of planned layoffs over the summer.

But, what's striking about this is that the downward move in seasonally adjusted claims (the plunging red curve) seems to be an extraordinary response to the rise of the unadjusted data (the blue curve).

Simply looking at the relationships between the January and July surges in unadjusted jobless claims over the last twenty years shows that the relative size of the two this year is not unusual in any way but, at no other time do the seasonally adjusted claims drop so sharply during the summer.

Around the year-end holidays much wilder moves are seen, even more so during recessions, but, in a data series that goes back to 1967, never has there been a bigger divergence between the adjusted and unadjusted data during any two week period of the summer and fewer auto related layoffs doesn't appear to explain this difference.

The Labor Department will likely be fielding more calls about this data tomorrow.

This article has been republished from Tim Iacono's blog, the Mess That Greenspan Made.

Anti-Federal Reserve Sentiment On The Rise

No one is immune from blame for the financial crisis, including the Federal Reserve, which is facing renewed anti-fed sentiment. This has reintroduced the debate on whether the role of the Federal Reserve should be part of the reform of the financial system. Mark Thoma from Economist's View discusses this issue in the following post.

Continuing the recent discussion here and elsewhere on Fed independence, this is not the first time audits and other threats to independence have been seriously considered:

On the mend, The Economist: It has been a long time since comments on the economy by an official of America’s Federal Reserve comments could be described as cheerful. Yet there was no denying the upbeat tone of Ben Bernanke’s testimony to Congress on Tuesday... His fingers may be crossed but it is clear that Mr. Bernanke thinks the recession, if not over now, soon will be.

That is a far cry, though, from seeing a threat from inflation and Mr. Bernanke made it clear that the federal funds target rate, now near zero, will remain there for a long time. On Wall Street, most reckon that means until well into 2010 at least.

Yet the Fed is already under pressure to explain how it intends to tighten monetary policy, even by congressmen who usually want nothing of the sort. ... Whether inflation [occurs] depends on if the Fed raises interest rates in time and thereby curbs the appetite for credit. Mr. Bernanke spent much of his testimony explaining how he can do just that. ...

Politics could ... interfere with the Fed’s willingness to tighten monetary policy in time. Congress’s nonpartisan investigative arm, the Government Accountability Office, can now audit the Fed with the exception of its monetary policy, lending programs or relations with foreign central banks. A bill in Congress would lift those prohibitions. Mr. Bernanke argued that the threat of such audits would lead investors to question the Fed’s willingness to do unpopular things, like tighten monetary policy, unsettling them and driving up long-term interest rates.

This is not idle speculation. Anti-Fed sentiment was also strong in the 1970s, when Congress first sought to have the GAO audit the central bank. Arthur Burns, chairman at the time, fought back, and a compromise was struck to allow audits, but with the current prohibitions. Mr. Burns later reflected that the effort of “warding off legislation that could destroy any hope of ending inflation” involved “political judgments” that may have weakened his anti-inflationary resolve.

For all the discussion, any tightening of policy is a long way off. ...

I think one of the problems that people are trying to get at when they want to take away the Fed's independence is the concentration of power within the Board of Governors (the view by some that the Board represents special rather than public interests, e.g. Wall street, also plays a role), and they see devices such as audits from the GAO as a check on that concentration of power. Here's an edited version of part of an old post:

While the Fed was initially structured to balance competing interests and to share power, the system has evolved into an institution with centralized rather than shared power. The intent to share power and balance competing interests is evident in the structure of the Federal Reserve system. For example, individual district banks are overseen by a board of nine part-time directors. These directors come in three types. Three of the nine are type A and are bankers, and three are type B and represent the business community. Legislation prohibits type B board members from being bankers. In a further attempt to make the process representative, type A and type B directors representing banking and business interests are elected by member banks within each of the twelve Federal Reserve districts. Type C directors are appointed by the Board of governors and are intended to represent the public interest within the district banks.

Thus, the districts themselves provide geographic representation that is population based, while control of the district banks balances public, banking, and business interests. Initially, the district banks functioned as twelve cooperating banks and each district had considerable control of monetary conditions within the district. It was very much a shared power arrangement. As one example of the power district banks had, each bank had full control of the discount rate for its district (the discount rate was the only tool available for controlling the money supply when the Fed was formed, open-market operations were not well understood until later and there was no provision for the Federal Reserve system to control reserve requirements, another way to affect the money supply).

The shared power arrangement within the Federal Reserve system changed after the Great Depression when monetary authorities failed to respond adequately to crisis condition. The problem, or so it seemed, was the shared power nature of the system. The deliberative, democratic nature of the institution prevented it from taking quick, decisive action when it was most needed. Furthermore, the Fed did not have the tools it needed to deal with system-wide disturbances, it was mostly equipped to deal with problems at individual banks (the discount window is well-suited to help individual banks, but not system wide disruptions; on the other hand, open-market operations can inject reserves system-wide and hence is a better tool for systemic problems).

The solution to this was to concentrate power into the hands of the central bank so that should a crisis occur, they can act quickly. There are risks, of course, to concentrating power so narrowly, but in the aftermath of the Depression we were quite willing to take that risk if it helped to avoid another catastrophic outcome (as it may well have done).

Thus, after the Great Depression power was concentrated. For example, banks no longer control the discount rate in their districts. They can propose a change in the discount rate at an FOMC meeting, but the Board of Governors must approve the rate and they will only approve one rate, the rate they decide. So while the rates are still formally set in the districts, they are essentially set by the Board of Governors. When all such changes in the concentration of power over time from the districts to the Central Bank in Washington D.C. are considered, it becomes very clear that the Fed has evolved from a very democratic, shared power arrangement at its inception to one where it functions, for all intents an purposes, as a single bank in Washington, D.C,. with twelve branches spread across the U.S.

*****

I am not at all in favor of lessening the degree of independence that the Fed currently has, but I do think we need to make changes in the way the President and Boards of the district banks are chosen. As it stands, the Board of Governors in Washington has considerable influence over who is appointed to key positions such as the President of the district banks, and those Presidents represent five of the twelve votes at the meetings where monetary policy is set. More independence of the district bank Presidents and other district bank personnel from the Board of Governors would be a healthy change (there is also a question of whether geographic representation through district banks is the best way to capture the public interest, but I'll leave that aside for now).

This article was republished from Mark Thoma's blog, Economist's View.

Infamous Watergate Hotel Is On The Market

The owners of the historic Watergate Hotel have defaulted on their loan and the building was put up for auction. In a sign of the times, the auction received zero bids. For more on this, see the following article from HousingWire.

The Watergate Hotel, a Washington, DC landmark brought to international prominence by the 1972 burglary of the Democratic National Committee headquarters — which ultimately led to the resignation of President Richard Nixon — is on the auction block.

Owner Monument Realty defaulted on its loan for the building, and a 30-day city notice of foreclosure that expired Thursday lists a $40m outstanding balance.

The Watergate Hotel has seen better days. It’s been closed since 2004, and while Monument fought with neighbors over its original plans to convert the building into luxury co-ops — a fight Monument ultimately lost, leaving the firm resigned to redevelop the site as a hotel —partner and equity investor Lehman Brothers went bankrupt, and the recession hit, putting the project in turmoil.

Now, auction firm Alex Cooper is accepting bids for the 12-story, 251-room building. The winning bidder will be required to make a $1m down payment.

The auction comes after failed negotiations between Monument and lender PB Capital.

The auction of such a high-profile piece of commercial property could be a defining moment in what some see as the next phase of the recession. Market observers have their sights set on the commercial real estate market over concerns that it could face similar difficulties as the housing market.

What does it say about the state of commercial real estate when the owner of the famed Watergate Hotel, whose name and infamy gave rise to major political scandals getting the “–gate” suffix applied to it — Bill Clinton’s Whitewatergate, George W. Bush’s Lawyergate, the 1970s Koreagate, just to name a few — can’t refinance its outstanding debt?

In his appearance before the House Financial Services Committee Tuesday, Fed Chair Ben Bernanke fielded questions on the state of the commercial real estate market, and unfortunately, the chair couldn’t provide many definitive answers.

Clearly, this issue will linger as the country navigates through economic recovery.

This article has been republished from HousingWire.

Ben Bernanke's Plan To Prevent Inflation

Ben Bernanke outlined his plan to prevent inflation in an article in the Wall Street Journal. While this plan sounds good on paper, economist Mark Thoma from Economist's View warns that the Fed can not raise interest rates too soon and risk sending the economy back into recession. See the following post on this topic.

Ben Bernanke says that when the economy starts to recover, the Fed will take the steps needed to prevent an outbreak of inflation (the substance of the arguments can be found in the full version):

The Fed’s Exit Strategy, by Ben Bernanke, Commentary, WSJ: The depth and breadth of the global recession has required a highly accommodative monetary policy. Since the onset of the financial crisis nearly two years ago, the Federal Reserve has reduced the ... federal-funds rate ... nearly to zero. We have also greatly expanded the size of the Fed’s balance sheet through purchases of longer-term securities and through targeted lending programs aimed at restarting the flow of credit.

These actions have softened the economic impact of the financial crisis. They have also improved the functioning of key credit markets...

My colleagues and I believe that accommodative policies will likely be warranted for an extended period. At some point, however, as economic recovery takes hold, we will need to tighten monetary policy to prevent the emergence of an inflation problem... We are confident we have the necessary tools to withdraw policy accommodation, when that becomes appropriate, in a smooth and timely manner.

The exit strategy is closely tied to the management of the Federal Reserve balance sheet. When the Fed makes loans or acquires securities, the funds ... ultimately appear in the reserve accounts held at the Fed by banks and other depository institutions. These reserve balances now total about $800 billion, much more than normal. ...

But as the economy recovers, banks should find more opportunities to lend out their reserves. That would produce faster growth in broad money (for example, M1 or M2) and easier credit conditions, which could ultimately result in inflationary pressures—unless we adopt countervailing policy measures. When the time comes to tighten monetary policy, we must either eliminate these large reserve balances or, if they remain, neutralize any potential undesired effects on the economy. ...

[W]e have two broad means of tightening monetary policy at the appropriate time: paying interest on reserve balances and taking various actions that reduce the stock of reserves. We could use either of these approaches alone; however, to ensure effectiveness, we likely would use both in combination. ... [T]hese policies would help to raise short-term interest rates and limit the growth of broad measures of money and credit, thereby tightening monetary policy.

Overall, the Federal Reserve has many effective tools to tighten monetary policy when the economic outlook requires us to do so. As my colleagues and I have stated, however, economic conditions are not likely to warrant tighter monetary policy for an extended period. We will calibrate the timing and pace of any future tightening, together with the mix of tools to best foster our dual objectives of maximum employment and price stability.

As I've said many times, I'm not particularly worried about inflation, reserves can be removed or neutralized as described. The worry is not so much that they will be too slow at removing reserves, it's that they will get trigger happy and start raising interest too soon potentially stalling the recovery or perhaps even sending the economy back downward. The Fed will need to be sure that things are getting better before beginning to raise interest rates, that's why it's good to hear them use the phrase "extended period" twice when describing how long interest rates will stay low. But there are long lags associated with monetary policy, and by the time the Fed knows for sure that economy is heading solidly in the right direction, it won't have much time left to reverse course and begin removing reserves. Even so, they need to be patient and avoid the more serious mistake of raising interest rates too soon.

This post has been republished from Mark Thoma's blog, Economist's View.

Inflation Down But Not Out

Although the risk of an imminent surge in inflation looks low and projected inflation still remains low, the threat of inflation in the future will not be going away. James Picerno discusses why we should not forget about this threat in the following post from The Capital Spectator.

The ascent in the yield on the 10-year Treasury Note during this past spring took a breather after rising to nearly 4.0% by mid-June. That prompted some to claim that the underlying source for the rise—worries about future inflation—were overbaked.

Perhaps, but we beg to differ, and have for some time. Even when the crisis of last fall was exploding with all its ignominious power, we were of a mind to expect a return of inflation at some point. The CPI report last week suggests that such expectations are still valid.

To be sure, the risk an imminent surge in inflation to lofty levels still looks low. Although deflationary forces are fading, the blowback from the financial crisis and the lingering effects of the current recession will reverberate for some time and so pricing pressures are still muted. Nonetheless, it's always been clear that the Federal Reserve's primary goal was to return the system to an inflationary bias. A mild one, if possible, but inflationary just the same. We never doubted the Fed's capacity for success on that front, and neither it seems does the bond market. The question is whether the central bank can let the genie out of the bottle just a little?

The genie already has his nose out. One example comes by way of the outlook for inflation based on the yield spread between the nominal and inflation-indexed varieties of the 10-year Treasury Notes. As our chart below shows, the market's 10-year inflation forecast is creeping up, again. Yes, it's still quite low—under 2.0%. But it's the directional momentum that's the issue. Having elevated the market's inflation expectations from zero to roughly 2% in the last six months, the Fed must soon begin to pull back on the liquidity injections, if only just slightly. Raising Fed funds to 0.5% would be reasonable at some point in the near future, up from the 0-0.25% range that currently prevails, if only to send a signal to the markets about intent.

One reason the message needs to be made is that traders don't think that's likely any time soon, based on Fed fund futures. The September 2009 contract, for instance, is trading at an implied 0.2% Fed funds rate.

A fair chunk of keeping inflationary pressures under wrap is a task of managing expectations, through time. There's currently no danger that expectations are set to run amuck, but neither can we afford to ignore the creeping rise in inflation expectations, even at low levels. Perhaps it's a false alarm, perhaps not. We just don't know. Waiting for definitive confirmation is too risky. Hedging the bet by slowly moving rates up over time--short of more compelling data to do something else--seems reasonable.

The future is undoubtedly full of surprises. But this much is clear: dismissing inflation as yesteryear's worry is asking for trouble.

This post was republished from The Capital Spectator.

JPMorgan Creates Illusion Of Profits

While reports of profits by JPMorgan Chase may have boosted the mood on Wall Street, the so called "profits" are merely an illusion created by an accounting loophole and does not mark the beginning of a banking recovery. To find out how the mega bank was able to conceal their massive losses with accounting slight of hand, see the following article from Money Morning.

It takes more than two to make a trend.

JPMorgan Chase & Co. (NYSE: JPM) yesterday (Thursday) became the second major U.S. investment bank – following Goldman Sachs Group Inc. (NYSE: GS) – to this week report windfall profits for the second-quarter. That’s helped fuel a four-day advance in U.S. stocks that’s seen the Dow Jones Industrial Average surge 7%.

Unfortunately, these two decidedly positive developments don’t necessarily indicate that better days have arrived for the U.S. banking sector.

To the contrary, many analysts – including Money Morning Investment Director Keith Fitz-Gerald – say these profits are merely a mirage created by an obscure accounting rule that allows banks to transform “toxic debt” on their balance sheets into income.

JPMorgan, the second-largest U.S. bank, said that that second-quarter profits were $2.7 billion, a jump of 36% from a year ago and 27% from the previous quarter.

A $1.1 billion, one-time reduction that resulted from the decision to repay $25 billion in Troubled Asset Relief Program (TARP) funds was offset by strong gains at the firm’s investment banking division.

Profit at JPMorgan’s investment banking division more than tripled as a result of record investment-banking fees and the strong performance in the fixed-income market. The investment-banking operations generated $1.47 billion of profit, almost quadruple the amount earned in last year’s second quarter.

Investment-banking fees – which zoomed 29% from a year ago and 62% from the first quarter – totaled $2.2 billion, and were a "record for any investment bank in any quarter," according to JPMorgan Chief Financial Officer Michael J. Cavanagh.

JPMorgan’s earnings in the first half of 2009 grew 11% to $4.86 billion, or 68 cents a share, from $4.38 billion, or $1.20 a share, in the first six months of 2008. Revenue jumped 43%, reaching $50.6 billion, from $35.3 billion last year.

JPMorgan’s announcement follows an equally impressive earnings report by rival Goldman Sachs, the largest investment bank in the country. Goldman said Tuesday that its revenue in the three months ended June 26 was $13.8 billion, compared with $9.43 billion in the first quarter and $9.42 billion in the second quarter a year earlier. Net income rose to $3.44 billion, or $4.93 a share.

Still, despite these banks’ stellar results, analysts are hesitant to say that the U.S. financial sector has bottomed, meaning that a rebound is under way.

Fitz-Gerald said last month that large investment banks like Goldman Sachs and JPMorgan would almost certainly generate record profits in the first half of the year as a result of less competition, favorable interest rates, and relaxed accounting standards.

Indeed, the Financial Accounting Standards Board has made it possible for the biggest U.S. banks to book profits on loans that have not been fully repaid.

“Called ‘accretable yield,’ these mega banks will book income on loans that have ‘reduced credit quality’ by recognizing the value of the bonds on their balance sheets and the cash flow those securities are expected to earn,” Fitz-Gerald said. “Please understand, we’re not talking about cash that’s already been earned, and not cash in the bank … we’re talking about cash flow those banks are expected to earn.”

In JPMorgan’s case, the firm took on $118.2 billion in toxic debt when it acquired Washington Mutual Inc. last year. As a receiver of that debt, JPMorgan was allowed to mark that debt down to “fair value,” or $88.65 billion. But now, the bank says that those same debts may appreciate by some $29.1 billion over the life of the loans. And as those loans are paid back, that money is booked as profit.

Of course, this distorts banks’ earnings and camouflages the deterioration in other banking segments.

For instance, consumer-loan losses continued to rise, as did losses on businesses loans. Retail banking earnings of $15 million were down sharply from earnings of $474 million in the first quarter, and $503 million in the second quarter of 2008. The consumer lending division reported a net loss of $955 million, compared with a net loss of $171 million in the prior year and $389 million in the prior quarter.

Home equity charge-offs jumped 4.61% to $1.3 billion. The bank warned that prime mortgage losses may be $600 million “over the next several quarters,” and that subprime losses may be $500 million.

Credit cards lost $672 million, compared to income of $250 million in the second-quarter last year. The bank warned that losses in its Chase credit-card portfolio may be 10% next quarter and will be “highly dependent” on unemployment after that. The unemployment rate rose to 9.5% in June, its highest level in two decades.

The managed charge-off rate, which generally tracks unemployment, climbed to 10.03% from 7.72% in the first quarter and 4.98% in the year-earlier period.

“For JPMorgan Chase, the challenge going forward is going to continue to be deterioration of credit,” Gerard Cassidy, a banking analyst at RBC Capital Markets, said in a Bloomberg Radio interview.

This article has been republished from Money Morning.

Could Regulation Have Prevented The Housing Bubble?

If the proposed financial regulation existed years ago, would it have been enough to prevent the financial crisis? Yale economist Robert Shiller explains why regulation like the Consumer Financial Protection Agency would not have averted the subprime mortgage bubble but could discourage innovation. Then economist Mark Thoma from Economist's View, provides his rebuttal.

Robert Shiller says that while a Consumer Financial Protection Agency is a good idea, it wouldn't have prevented the housing bubble:

Financial Invention vs. Consumer Protection, by Robert J. Shiller, Commentary, NY Times: James Watt, who invented the first practical steam engine in 1765, worried that high-pressure steam could lead to major explosions. So he avoided high pressure and ended up with an inefficient engine. It wasn’t until 1799 that Richard Trevithick ... created a high-pressure engine that opened a new age of steam-powered factories, railways and ships.

That is how innovation often proceeds — by learning from errors and hazards and gradually conquering problems through devices of increasing complexity...

Our financial system has essentially exploded... We need to invent our way out..., and, eventually, we will. That invention will proceed mostly in the private sector. Yet government must play a role, because civil society demands that people’s lives and welfare be ... protected from overzealous innovators who might disregard public safety and take improper advantage of nascent technology.

The Obama administration has proposed a ... Consumer Financial Protection Agency, which would be charged with safeguarding consumers against things like abusive mortgage, auto loan or credit card contracts. The new agency is to encourage “plain vanilla” products that are simpler and easier to understand. But representatives of the financial services industry have criticized the proposal as a threat to innovation...

If a consumer agency had been set up 20 years ago, would the subprime mortgage crisis have been prevented? We don’t know, but it seems improbable. Such an agency would most likely have slowed some abusive practices... That ... would have reduced the severity of the crisis, and that is no small thing.

On the other hand, unless these regulators were extremely vanilla in approach and just said no to any innovation, or unless they had an unusually deep understanding of speculative bubbles, I think they would have allowed most of those subprime mortgages. And they probably wouldn’t have had the detailed knowledge they would have needed to halt the decline of lending standards on prime mortgages in a timely way. In all likelihood, we would still be in this financial crisis.

In short, the new agency seems a good idea, and, if it is created, it should ... support innovation and ...be staffed by people who know finance..., including some who appreciate that human behavior must be understood and factored into financial design.

But that leaves us with the deeper quandary: Our society needs financial innovation, and still seems vulnerable to ... speculative bubbles that create truly big problems. Even if they can be mitigated, periodic crises may not be preventable, at least not by banning abusive credit cards or even by throwing the bad guys in jail. ...

The effectiveness of our free enterprise system depends on allowing business people to manage the myriad risks — including the risk of asset bubbles — that impinge on their operations in the long term. And this process needs constant change and improvement.

Complexity is not in itself a bad thing. ... A laptop computer is an immensely complex instrument... Yet it can be designed well so that it seems plain vanilla to the ultimate user.

And as for steam engines, the modern turbine high-pressure versions are not plain vanilla in any sense. They are sophisticated triumphs of engineering. They help generate most of our electric power with very few accidents.

I'm not sure his example works. If a modern turbine engine fails, it doesn't threaten the broader economy. If the engines were interconnected, so interconnected that the failure of one could bring them all down (beyond a single set at a given geographical location), then they might threaten the entire economy and be more like financial innovation.

The point is, because the costs of a steam or turbine engine blowing up are mostly localized, we can allow innovation to occur with very little regulation within the private sector without too much concern. Of course, we need to make sure that, say, a steam engine blowing up in a garage doesn't harm the neighbors, or harm any employees who might be there, and we also want to protect the inventors from themselves to some extent, but since the threat from an explosion is localized, we can allow innovation to proceed in the private sector under relatively light regulation without incurring great risks.

Suppose, however, that the turbine engines were interconnected and the failure of a single engine anywhere in the system could bring the whole system down, and not just for a day or two, but for months and months, and that the loss of so much power for so long would wreck the economy. In such a case, how much trust would you be willing to place in an unregulated private sector development of a new engine type for the grid? How much complexity would you be comfortable with? How much testing would you want the engines to undergo before being allowed in use? Would the fact that they have "very few accidents" as Shiller notes be of comfort?

When the dangers are great, we need to be careful. The financial grid is interconnected in just this way, and we need to do all that we can to ensure that new innovations do not become engines of destruction yet again.

This post was republished from Mark Thoma's blog, Economist's View.

Why The Government Must Keep Their Hands Off The Fed

Some people may place some of the blame of the financial collapse on the shoulders of the Fed but it would be a mistake for the government to take away the central bank's independence. See the following post from Economist Mark Thoma that explains why congress must keep their hands off the central bank.

Mark Gertler says the Fed's independence should not be compromised:

Congress must not touch the Federal Reserve, by Mark Gertler: The economy was experiencing the worst recession since the war. In Congress, members were beginning to wonder whether the Federal Reserve’s intervention strategy was extracting too great a toll on the economy. Some started to suggest publicly that it may be time to rein in the central bank’s independence.

Sound familiar? Though they bear a strong resemblance to ... today, the events I refer to in fact happened in the early 1980s, in the midst of what was then the most serious economic crisis since the Depression. The head of the institution under threat of losing its independence was none other than Paul Volcker.

Of course, Mr Volcker would go on to be recognised as one of the great central bankers of modern times. He would do so by standing firm against political pressures. By continuing on the course he set out, the economy recovered and a new era of price and output stability began. ... In the Volcker era, the political outcry occurred in the midst of the economic contraction that the Fed had engineered to tame inflation. The costs of the policy were plain to see, but the long-term benefits that would eventually emerge were difficult for many to imagine at the time.

The Fed’s role has been different this time round. Rather than trying to slow the economy, it has been acting to contain the damage brought on by the most complex financial crisis of modern history. By the accounts of many, the Fed has acted masterfully under difficult circumstances. ...

Given that hard times remain, nonetheless, it is natural that Congress is questioning the Fed, just as it did in the early 1980s. ... Unfortunately, the Fed cannot demonstrate what would have happened to the economy if it had not intervened in the way it did. Many observers agree that the situation would be far worse than it is today. Yet discussions of reining in central bank powers proceed as if the financial system would have stabilised itself without any Fed intervention.

The Fed well understands the lesson from the Volcker era that it can be effective only when it resists political attempts to influence its decisions. One can only hope that sober voices in Congress who appreciate the importance of central bank independence will help keep Capitol Hill from taking any measures that do permanent damage to the Fed.

A more constructive route for Congress would be to proceed with regulatory reform that would prevent a repeat of the current situation. At the core of the crisis is an antiquated regulatory system that permitted large financial institutions to take excessive risks. By giving the Fed the ability to monitor risk-taking by these institutions, Congress would diminish greatly the likelihood the central bank would again need to intervene directly in private credit markets.

The Fed may not have been perfect in its response to this or previous crises, but that doesn't mean that a less independent Fed would have done better. Taking away Fed independence - including subjecting the Fed to audits by the GAO - would be a mistake. In addition, if we are going to strengthen regulatory authority so that we can better monitor and reduce systemic risk that threatens the financial system - and we should - that authority needs to be in the hands of an independent entity, and the Fed is the natural place for this. Finally, its role in regulating system-wide risk is complementary to many of its other activities. For example, its role as a systemic risk regulator would involve monitoring risk within large institutions. Should a bank get into trouble, that would be helpful in assessing whether the bank should be granted access to the discount window in its capacity as lender of last resort.

We need to maintain an independent Fed, to give the Fed the powers it needs to monitor and regulate the level of overall risk, and to give the Fed the authority it now lacks to put banks through an orderly bankruptcy process so it can avoid bailing out financial institutions that are in trouble and a threat to overall the financial system.

Update: See Willem Buiter for a longer, more detailed version of many of the same points, e.g.:

Probably the single most damaging failure of the US Treasury, the US Congress and the US financial regulators was there inability/unwillingness to create a special resolution regime (SRR) with structured early intervention and prompt corrective action for all systemically important financial institutions (those too big, too complex, to interconnected, too international or too politically connected to fail in the ordinary Chapter 11 or Chapter 7 way). ...

But however weak its past performance and credentials, they are rock-solid compared to those of the other candidate institutions. ...

Only the Fed can fulfill the macro-prudential regulator-supervisor role. That is because it has the short-term deep pockets. It is the source of the ultimate, unquestioned liquidity in the economy, through its monopoly of the issuance of base money. Without the short-term deep pockets, a macro-prudential regulator/supervisor cannot act as lender of last resort, market maker of last resort or provider of enhanced credit support. It would be ... toothless...

He also makes this point:

The problem with this solution of the macro-prudential regulator/supervisor problem is that it is incompatible with central bank operational independence as interpreted since 1989 or thereabouts. ... When the central bank plays a quasi-fiscal role, as the Fed has been doing on an unprecedented scale in the current crisis, the fullest possible degree of accountability to the Congress, the tax payer and the citizens is essential. The Fed has no mandate to engage in quasi-fiscal operations, even when it is for a good cause. ...

If the same institution, the central bank, has to be in charge of both normal monetary policy and systemic risk regulation (albeit jointly with the Treasury for the systemic risk role), there is no elegant, first-best solution. Either monetary policy will be driven by politicians whose macroeconomics is limited to a partial understanding of the Keynesian cross and whose monetary policy views can be summarised by the proposition that the have never seen an official policy rate so low they would not want it even lower, or the central bank continues to act as an off-budget, off-balance sheet special purpose vehicle of the Treasury.

You pick.

Okay. As much as possible, monetary policy should be kept out of the hands of politicians.

This article has been republished from Mark Thoma's blog, Economist's View.