Monday, November 24, 2008


An astounding thing happened in October. Both retail and wholesale prices fell record amounts, after having risen record amounts in the preceding months. The why is both a testimony to the severity of this downturn and points the path to a recovery.

October’s retail Consumer Price Index fell 1 percent due an 8.6 percent plunge in energy prices, the steepest decline recorded by the Labor Dept. since records were kept in 1947, according to CBS Marketwatch. Wholesale Producer Prices plunged even further—2.8 percent—the most in 50 years.

All are signs of a deflation danger that happened to Japan in the 1990s. No one wants it. Deflation last happened during our Great Depression, which depressed wages as well as prices for several years. One month’s results do not necessarily mean it could happen in the U.S, of course. The main reason for the massive amounts of federal aid flooding the markets with money is to prevent it from happening here.

But the flood has not caused banks to begin to lend again—except for residential loans backed by Freddie Mac, Fannie Mae, FHA and VA, for all intents and purposes. There are still some super-jumbo programs available from the few savings and loan banks left with rates in the low 6 percent range (3 and 5-year fixed ARMs, that is), if they use the 1-yr MTA Treasury index.

And that is the problem. The 10-year benchmark Treasury Bond recently dove to 2.99 percent—something not seen since the 1950s. This is while the money supply has been growing in double digits—19 percent annualized just over the past 2 months. But the monies have been used to buy more Treasury bonds and bills in a flight to safety, which is like putting money under the mattress, rather than lent out to businesses and residences.

This is the big danger of deflation—money being hoarded rather than spent. In other words, the price drops were signs that consumers and manufacturers have cut back on their spending. Both retail sales and industrial production have declined 4.1 percent in a year, according to the Federal Reserve.

Nobel laureate Paul Krugman sounded the alarm once again in his New York Times column. We should not only worry about Japan’s 10-year malaise of deflation, but the similarities of the current malaise with our own Depression. It began during Herbert Hoover’s lame duck administration with the Roosevelt Administration not yet in power. We should not wait for a new administration to act when every day brings more bad news.

“The prospects for the economy look much grimmer now than they did as little as a week or two ago,” said Krugman. “Yet economic policy, rather than responding to the threat, seems to have gone on vacation…Japan’s ‘lost decade’ in the 1990s taught economists that it’s very hard to get the economy moving once expectations of inflation get too low.”

What should be done? Our government needs to get banks lending again, for starters, as Prime Minister Gordon Brown required of British banks who received government aid. Some of the $700 billion authorized by congress, for example, can subsidize lower mortgage interest rates. The historical, 30-year fixed rate should be at 4.5-5 percent when Treasury bond rates have fallen this low.

This translates to at least a 10 percent payment reduction, making mortgages much more affordable. It would get so many more home buyers into the market at a time of rising housing affordability and declining home prices.

© Harlan Green 2008

Saturday, November 22, 2008


The glimmer of light that we saw several columns ago amid the economic doom and gloom may be getting brighter. I don’t say this as a contrarian—those who sell when irrational exuberance reigns and buy when everyone is pessimistic—although contrarians can occasionally be right.

No, my pessimism is lifting because real estate in particular is beginning to recover. Not only because existing and new-home sales improved in September, but several states, including California, have recently seen a sharp drop in foreclosures, according to both RealtyTrac and the Mortgage Bankers Association (MBA)

MBA chief economist Jay Brinkman says that 8 states are now above the national delinquency rate of 6.41 percent. California and Florida continue to lead the way with 39 percent of all foreclosures started in the second quarter.
But RealtyTrac just reported a huge drop in new foreclosure filings in California for the second month, partly due to new legislation that requires a 30-day notice to the homeowner before a foreclosure auction can take place.

“We’ve seem sharp declines in new foreclosure filings after legislation mandating delays to the foreclosure process was signed into law in several states—most notably in California, where overall foreclosure activity was down by double-digit percentage points for the second straight month in October, and where default filings were 44 percent below October 2007 levels,” said RealtyTrac CEO James Saccacio.

California’s foreclosures decreased 18 percent in October, but even more remarkable was that the number of foreclosure filings are now down almost 50 percent from the peak reached just this August.

We should also see more improvements in financing when the new conforming loan limits take effect in January, as we said in last week’s column. It allows conforming loan amounts of $625,500 for a single unit up to $1,202,925 for 4 units (owner and non-owner, but with a maximum limit of 10 financed properties and 4 non-owner financed properties) in many California counties. You should call your favorite banker or broker for more details.

The National Association of Realtors’ affordability index has risen 7 percent since May, due to the lower housing prices and falling interest rates. And, last but not least, consumers may have begun spending again. This is after recent news that retail spending had actually decreased for two consecutive months.

September consumer credit increased 3.2 percent after decreasing 2.9 percent in August, with non-revolving loans (e.g., car loans) up 4.4 percent. This means fears that consumer spending had ground to a halt were unfounded. With gas prices below $3 per gallon, we might see a boost to consumer confidence and so a better Christmas than the doomsayers have predicted.

And lastly, the huge amount of fiscal stimulus by the federal government is beginning to take effect. Economist and now Nobel laureate Paul Krugman has stated that consumers need a $600 billion stimulus package to make up for the loss in economic growth to come out of this recession.

The House of Representatives is already considering an additional $300 billion on top of the $150 billion package of rebates given out earlier this year, while Treasury Secretary Paulson is diverting some $60 billion of his bailout plan to bolster consumer loans. That already adds up to $500 billion, which might do the trick.

© Harlan Green 2008


The effectiveness of any further stimulus package will depend on where the money is spent. With the unemployment rate rising to 6.5 percent and 240,000 payroll jobs lost in October, creating jobs will be the first priority, which is why President-elect Obama said more aid to Detroit automakers was a priority in his first press conference. Jobs were lost equally in the manufacturing and service-sectors. Health care was the only industry that added jobs.

Attention is also being focused on fixing the housing market, since most experts believe that housing has to show signs of a recovery to lead the economy out of this recession. As many as 20 percent of subprime and negatively amortized option ARMs are in default, so lenders are now working on several ways to stop the foreclosures.
Firstly, anyone behind in payments on their primary residence should contact the lender to work on lowering their interest rate and payment. And if eligible, they can petition FHA for a lower interest rate replacement loan if their current lender will accept a 10 percent reduction in principal.

We also discussed some proposals in last week’s column that called for the federal government stepping in to directly pay down either the loan amount if larger than the home’s value, or a direct subsidy to buy down current interest rates to more affordable levels.

The Federal Reserve has lowered its fed funds rate another one-half percent to 1 percent, the lowest rate since 2003. This brought more relief to short-term rates that determine adjustable mortgage rates including the Prime Rate, which is now 4 percent.

There was some good news. New and existing-home sales improved in September for the first time in a year, a sign that both prices and interest rates have fallen to more affordable levels. Conforming 30-year fixed rates are now in the 5 percent range, while the so-called jumbo-conforming 5 and 30-year fixed rates are hovering around 6 percent.

And new and improved conforming loan limits will take effect in January that will also boost housing sales and refinancing. It allows conforming loan amounts of $625,500 for a single unit up to $1,202,925 for 4 units. You should call your favorite banker or broker to get more details.

Housing affordability could continue to improve as housing prices continue to fall in many metropolitan areas, particularly in California and Florida. S&P’s Case-Shiller existing-home price index is down 20.3 percent from its June 2006 peak and homeowners have lost $4 trillion in equity. But values had risen more than 50 percent from 2003 to 2006, according to Case-Shiller, which means most homeowners still have substantial equity left.

The National Association of Realtors’ affordability index has risen significantly over the past 6 months. The index reached 135.2 September, which means a family with a median income of $60,350 can now afford a home 135 percent above the current median, existing single-family home price of $190,600. This is because the median price has fallen 13 percent from its high, while median income has risen a total of 9 percent over the past 3 years.

There is a growing consensus that the housing crisis is at least bottoming out, though no one knows when prices will begin to turn up. There is an incredible ‘overhang’ of 1 million excess housing units for sale that have to be absorbed before the supply of housing again equals demand. We will see that happening in two ways; sales will continue to pick up and the number of foreclosures and short-sales will shrink back to more normal levels.

© Harlan Green 2008


The U.S. Gross Domestic Product contracted at a 0.3% annualized rate in the third quarter, as consumer spending declined at the fastest rate in 28 years, the Commerce Department estimated Thursday. This is making an additional stimulus package even more urgent. The House of Representatives is now holding hearings on it, evaluating what economists and others are recommending.

Harvard economist Martin Feldstein wants government to stop the foreclosure hemorrhage by replacing 20 percent of mortgage debt with low interest government debt for the 12 million homeowners who have negative equity in their homes. The government’s debt would take precedence and so be paid off first in the event of any payoff.

“The president-elect should focus on developing a mechanism for identifying and funding spending initiatives that can occur quickly and that would otherwise not be done”, said Feldstein in a recent Washington Post editorial. “The increased government spending should include not only money for infrastructure such as bridges and roads but also for a wide range of equipment. Rebuilding some of the military capacity that has been depleted by the wars in Iraq and Afghanistan could be done relatively quickly and should be part of the overall package.”

An even more radical solution proposed at a recent 2-day Berkeley, California symposium on the mortgage meltdown by Glenn Hubbard and Christopher Mayer of the Columbia Business School is for the government to buy down interest rates. Under this plan, the government would take action to return mortgage rates to what they would otherwise be if the mortgage market were functioning normally (about 160 basis points above the 10-year Treasury rate). This means that 30-year fixed conforming rates should be around 5.5 percent, rather than the current 6.25 percent.

“The principal benefit of our plan is to reduce mortgage rates by nearly one percent, holding up house prices by 10 to 17 percent around the country relative to how much house prices would fall if the mortgage market remains dysfunctional,” says Hubbard and Mayer. “Lower mortgage rates would allow many homeowners to refinance their mortgages at more normal spreads and to improve affordability for potential new home buyers.”

The House stimulus package will probably include something for everyone. It is projected to cost about $300 billion, which corresponds to the drop in consumer spending over the past year. It is likely to include many of the same provisions that comprised a $61 billion stimulus measure that last month passed the House but died in the Senate, according to the Washington Post, including new money for roads and bridges, aid to cash-strapped state governments and extra funds for food stamps and unemployment insurance.

The decline in real (after inflation) gross domestic product was the largest since the end of the last recession in late 2001. The economy grew at a 2.8 percent pace in the second quarter. Final sales to domestic purchasers fell 1.8 percent, the largest decline in 17 years. Consumer spending dropped 3.1 percent, the first decline in 17 years and the biggest drop in 28 years, while business investment fell 1 percent. Investments in homes fell for the 11th straight quarter.

After getting a big boost from tax rebates in the second quarter, inflation-adjusted after-tax incomes fell 8.7 percent, the largest quarterly decline since U.S. record-keeping began in 1947. Though incomes fell much more in the Great Depression, when annual records were kept.

"The capitulation of the consumer is the primary catalyst behind what is clearly the first consumer-driven recession in three decades," wrote one economist about the GDP contraction. "Just about all sectors of the economy are in the process of a serious contraction." So it looks like anything that gives a boost to consumer spending could shorten this recession.

© Harlan Green 2008