Happy talk will not fix housing. Housing will lead to deflation.

No one wanted to listen when the housing crisis began. The Republicans were just as bad and clueless as the Democrats, probably worse.

It should have been obvious that falling prices, the evaporation of credit and rising unemployment would create the perfect housing storm. The situation is actually getting worse, not better.

Some of the happy talkers have seized on any morsel of positive news to declare things are improving. Surely, at some time markets will heal, but at a needless price and a mass destruction of equity and capital.

I am not even going to review the suggestions made on this blog and many others that would have helped. It was a waste of time then and remains so now. Doctrine overruled pragmatism. Take your medicine.

_____________


Prime Jumbo Trouble: The Foreclosures Keep Coming
By Nick Timiraos


WSJ
The volume of loans entering foreclosure and the rates of foreclosure starts showed no signs of slowing in July, even amid signs that early stage delinquencies may be slowing. Foreclosure starts increased by 7.1% in July, the second highest month on record, according to a monthly report by LPS Applied Analytics.

Among the report’s key conclusions: Foreclosure rates on prime jumbo loans, granted to borrowers with good credit and too large for backing from government agencies, surpassed the 2.98% average for all loan types in July, and continue to rise faster than any other loan type. Prime jumbo foreclosure rates are up a staggering 634% versus January 2008 levels, according to LPS Applied Analytics.

Meanwhile, a research report by FTN Financial notes that there are some signs that the rapid deterioration earlier this year of Alt-A loans, a level between prime and subprime that includes “liar’s loans” that didn’t require documentation of incomes, could stabilize in the coming months. But the same can’t be said about prime jumbo loans:

There is now very little financing available to support the high end of the housing market, and the performance trends in prime jumbo space are quite troubling. Therefore, we think the prime jumbo sector will surprise to the downside over the next 6-12 months, whereas the performance of the lower-loan balance Alt-A market will continue to flat-line for a few months before slowly improving starting in mid-2010.

A separate report by Hope Now, a mortgage industry coalition, found that foreclosure starts increased in July, to 284,000 from 251,000 in June, even as completed foreclosure sales decreased to 89,000, from 93,000.

The surplus economies of China, Japan, and Germany to be shattered?

Merkel's inflationary fretting may wake the bears from hibernation

Ambrose Evans-Pritchard, Telegraph

It is lonely in the diminishing camp of bears, says Ambrose Evans-Pritchard.


Published: 10:11PM BST 06 Jun 2009

Those of us who still question whether the world has purged its toxins are reduced to the same tiny band of moaning Druids from early 2007, when we shook our heads in disbelief as the carry trade swept Iceland to fresh madness and bankers laughed off sub-prime rot at Bear Stearns.

We learned then to thicken our skins with walnut juice, lie down in dark rooms, and dissent from Goldman Sachs. Such seclusion is called for once again as Goldman replays its BRIC anthem and raises its oil forecast to $85 a barrel this year, betting that the world will roar back on a tidal wave of liquidity.

It is perhaps unkind to mention that Goldman issued a $200 call at the top of the speculative frenzy last year, just before oil crashed, but they have broad shoulders.

Note that Total's Jean-Jacques Mosconi said markets are awash with so much crude that almost 100m barrels (a near record) are stored on tankers at sea. Note too that May electricity use fell 10pc in China's industrial hub of Guangdong from a year earlier. This is revealing, given that China's fiscal boost has reached peak and will fade later this year.

For guidance on where we are in this long-drawn saga, I look to Berkeley's Barry Eichengreen, author of the Great Depression classic Golden Fetters – which avoids the error of viewing the 1930s through a US prism.

He has crunched the latest data with Trinity College Dublin's Kevin O'Rourke for VoxEU, concluding that the global rupture over the last nine months has been more violent than in the early slump. This is logical. Global debt leverage is much greater this time.

The fall in industrial output has been roughly equal to the 1929-1930 stage for Germany and the Anglo-Saxons, but worse for Japan, France, Italy, and Eastern Europe. The collapse in world trade has been swifter: the global equity crash has been twice as bad. "It's a depression alright. The good news is that the policy response is very different. The question now is whether that response will work," they said.

The elastic was bound to snap back, just as it did in the bear rally of early 1931. Whether the underlying economy has begun to heal is another matter. World Bank chief economist Justin Yifu Lin said capacity utilization is running at an historic low of 50pc-60pc. Companies will have to fire a lot of workers. This is where the danger lies, and why he fears that deflation is creeping up on us.

Trade data from Asia are flashing warning signals again. Korea's exports were down 28.3pc in May, reversing the April rebound. Malaysia has slipped to -26pc, and India has touched a new low of -33pc.

US freight data is getting worse, not better. The Association of American Railroads said traffic was down 22pc in the third week of May from a year earlier. Canadian freight was down 34pc.

The American Trucking Association (ATA) said it saw fresh drops of 4.5pc in March and a further 2.2pc in April. Tonnage is down 13pc over 12 months. Bob Costello, the ATA's chief economist, said companies have not cut inventories fast enough to keep pace with declining sales. The contraction in truck volume has "accelerated".

Yes, the Baltic Dry Index for bulk shipping of resources has quadrupled since January, but this reflects China's bid to stockpile metals while prices are low.

Stephen Roach, Morgan Stanley's Far East chief, fears an "Asian Relapse", saying the region is prisoner to its fatal dependency on exports to the West. The export share of GDP has risen from 36pc to 47pc across developing Asia over the last decade.

"China's incipient rebound relies on a time-worn stimulus formula: upping the ante on infrastructure spending in anticipation of an eventual rebound of global demand," he said. The strategy cannot work this time because Americans have exhausted their credit, and their desire to borrow. Consumption will fall from its peak of 72pc of GDP to the "pre-bubble norm" of 67pc, if not more.

David Rosenberg from Gluskins Sheff expects Americans to retrench ferociously as 78m baby boomers face the looming threat of penury in old age. "The big story is that the personal savings rate hit a 15-year high of 5.7pc in April. I believe it could test the post-War peak of 15pc. Too many pundits are still living in the old paradigm of Americans shopping till they drop," he said.

If he is right, this will shatter the surplus economies of China, Japan, and Germany, unless they adjust fast to the new world order. Germany does not even seem to understand the problem it faces. Chancellor Angela Merkel lashed out last week at quantitative easing by the Fed, the Bank of England, and the European Central Bank, repeating the silly mantra that this will set off an inflationary storm.

How can it do so when the velocity of circulation has collapsed, and unemployment is rising everywhere? The Fed's "monetary multiplier" ended last week at 0.867, half its average of 1.7 over the last decade. The credit mechanism is still broken. This is what happened in Japan in its Lost Decade.

The ECB says the eurozone economy will contract until mid-2010, at best. Germany's trade association (Wirtschaftsverbände) warned Mrs Merkel last week that the credit drought threatens to become "life-threatening by the summer at the latest".

The list of countries in deflation is growing every month: Ireland (-3.5), Thailand (-3.3), China (-1.5), Switzerland (-1), Spain (-0.8), the US (-0.7), Singapore (-0.7), Taiwan (-0.5), Belgium (-0.4), Japan (-0.1), Sweden (-0.1), Germany (0).

Yet markets seem to think otherwise, and this has its own awful consequences. Inflation fears have driven 10-year US Treasury yields to 3.86pc, a full point above levels in March when the Fed intervened to force rates down. US mortgage rates have jumped to 5.29pc. Gilts have reached 3.92pc, and French 10-year bonds are at 4.05pc.

This bond revolt is enough to bring any global recovery to a shuddering halt. The irony is that those fretting loudest about inflation may themselves tip us into outright deflation, with all the perils of a debt compound trap. It is Angela Merkel who plays with fire.

A Modern Economy Can Be Destroyed By Sustained Deflation

How can this be a bad thing?

To most people the falling price of gasoline is a good thing. Less expensive flat screen televisions are very good and if you are looking to buy a house, a reduction in price may be the very thing to make it happen.

Falling prices seem very desirable on a personal or micro level, but to the world economy it can be a disaster. It is all dependent on the reason that prices are falling in the first place. If they fall because of increased productivity that is very beneficial. Consumer appliances and computers are two good examples.

Falling prices due to falling demand is not. The reason is basic, behind every price is an income. Falling incomes force further decreases in wages and the process continues. Think of a going out of business sale. Every item sold at or below cost only hastens then end of the enterprise and the jobs that go with it.

This article from the Telegraph discusses the current danger. It is significant.

______________________

Deflation virus is moving the policy test beyond the 1930s extremes
Debt deflation is tightening its grip over the entire global system. Interest rates are creeping towards zero in Japan, America, and now across most of Europe.

By Ambrose Evans-Pritchard, International Business Editor
Last Updated: 10:13PM GMT 06 Dec 2008
Telegraph

We are beyond the extremes of the 1930s. The frontiers of monetary policy are being pushed to limits that may now test viability of paper currencies and modern central banking.

You cannot drop below zero. So what next if the credit markets refuse to thaw? Yes, Japan visited and survived this policy Hell during its lost decade, but that was a local affair in an otherwise booming global economy. It tells us nothing.

This time we are all going down together. There is no deus ex machina to lift us out. Certainly not China, which is the most vulnerable of all.

As the risk grows, officials at the highest level of the British Government have begun to circulate a six-year-old speech by Ben Bernanke – at the time of its writing, a garrulous kid governor at the US Federal Reserve. Entitled Deflation: Making Sure It Doesn’t Happen Here, it is the manual of guerrilla tactics for defeating slumps by monetary means.

“The US government has a technology, called a printing press, that allows it to produce as many US dollars as it wishes at essentially no cost,” he said.
Critics had great fun with this when Bernanke later became Fed chief. But the speech is best seen as a thought experiment by a Princeton professor thinking aloud during the deflation mini-scare of 2002.

His point was that central banks never run out of ammunition. They have an inexhaustible arsenal. The world’s fate now hangs on whether he was right (which is probable), or wrong (which is possible).

As a scholar of the Great Depression, Bernanke does not think that sliding prices can safely be allowed to run their course. “Sustained deflation can be highly destructive to a modern economy,” he said.

Once the killer virus becomes lodged in the system, it leads to a self-reinforcing debt trap – the real burden of mortgages rises, year after year, house prices falling, year after year. The noose tightens until you choke. Subtly, it shifts wealth from workers to bondholders. It is reactionary poison. Ultimately, it leads to civic revolt. Democracies do not tolerate such social upheaval for long. They change the rules.

Bernanke’s central claim is that the big guns of monetary policy were never properly deployed during the Depression, or during the early years of Japan’s bust, so no wonder the slumps dragged on.

The Fed can create money out of thin air and mop up assets on the open market, like a sovereign sugar daddy. “Sufficient injections of money will ultimately always reverse a deflation.”

Bernanke said the Fed can “expand the menu of assets that it buys”. US Treasury bonds top the list, but it can equally purchase mortgage securities from US agencies such as Fannie, Freddie and Ginnie, or company bonds, or commercial paper. Any asset will do.
The Fed can acquire houses, stocks, or a herd of Texas Longhorn cattle if it wants. It can even scatter $100 bills from helicopters. (Actually, Japan is about to do this with shopping coupons).

All the Fed needs is emergency powers under Article 13 (3) of its code. This “unusual and exigent circumstances” clause was indeed invoked – very quietly – in March to save the US investment bank Bear Stearns.

There has been no looking back since. Last week the Fed began printing money to buy mortgage debt directly. The aim is to drive down the long-term interest rates used for most US home loans. The Bernanke speech is being put into practice, almost to the letter.

No doubt, such reflation a l’outrance can “work”, but what is the exit strategy? The policy leaves behind a liquidity lake. The risk is that this will flood the system once the credit pipes are unblocked. The economy could flip abruptly from deflation to hyper-inflation.

Nobel Laureate Robert Mundell warned last week that America faces disaster unless the Bernanke policy is reversed immediately. This is a minority view, but one held by a disturbingly large number of theorists. History will judge.

Most central bankers suffer from a déformation professionnelle. Those shaped by the 1970s are haunted by ghosts of libertine excess. Those like Bernanke who were shaped by the 1930s live with their Depression poltergeists.

His original claim to fame was work on the “credit channel” causes of slumps. Bank failures can snowball out of control as the “financial accelerator” kicks in. The cardinal error of the 1930s was to let lending contract.

This is why he went nuclear in January, ramming through the most dramatic rates cuts in Fed history. Events have borne him out.

A case can be made that Bernanke’s pre-emptive blitz has greatly reduced the likelihood of a catastrophe. It was no mean feat given that he had to face down a simmering revolt earlier this year from the Fed’s regional banks.

The sooner the Bank of England tears up its rule books and prepares to follow the script in Bernanke’s manual, the more chance we too have of avoiding a crash landing.
Monetary stimulus is a better option than fiscal sprees that leave us saddled with public debt – the path that nearly wrecked Japan.

Yes, I backed the Brown stimulus package – with a clothes-peg over my nose – but only as a one-off emergency. Public spending should be a last resort, as Keynes always argued.

Of course, Bernanke should not be let off the hook too lightly. Let us not forget that he was deeply complicit in creating the disaster we now face. He was cheerleader of Alan Greenspan’s easy-money stupidities from 2003-2006. He egged on debt debauchery.
It was he who provided the theoretical underpinnings of the Greenspan doctrine that one could safely ignore housing and stock bubbles because the Fed could simply “clean up afterwards”. Not so simply, it turns out.

As Bernanke said in his 2002 speech: “the best way to get out of trouble is not to get into it in the first place”. Too late now.

Why Deflation Must be Stopped

Deflation is sometimes likened to Dante's Inferno. "Abandon all hope" once you step into that Hellfire.


There is an underlying implication from many that the current financial crisis was caused by deadbeats and that they alone should suffer from their transgressions. That may be good politics or sound morality but it is bad and possibly fatal economics.

Intuitively, we all feel that falling prices are a good thing. That may be so for a short season but if it takes hold on a secular basis it can cause a pernicious and corrosive breakdown in unexpected parts of modern society.

Deflation is an avoidable consequence of bad policy, as an epidemic can be a result of bad hygiene. All will suffer needlessly. The Telegraph explains:

_____________________________

Abandon all hope once you enter deflation

The price of white truffles has fallen 84pc. Fines wines have dropped 65pc. Lobsters are off 52pc. Deflation has reached the City. It has engulfed housing and now threatens to spread through the broader economy, lodging like a virus in the British and global monetary systems.

By Ambrose Evans-Pritchard Telegraph
Last Updated: 7:27AM GMT 13 Nov 2008

We are not there yet but Mervyn King, the Governor of the Bank of England, says it is now "very likely" that the UK retail price index will turn negative next year. This is a drastic reversal of the oil and food spike that played such havoc with monetary policy over the summer. "The world changed in September," said the Governor.
The Bank's fan charts point to zero inflation at current interest rates of 3pc, but the startling new feature is that price falls could gather pace. This is a clear signal that the Monetary Policy Committee will cut rates again in December – perhaps by a full point to the historic low of 2pc, last seen in the Great Depression.
Mr King let slip yesterday that there is "obviously" a risk of deflation, although he remains sure it can be averted by a pre-emptive monetary blitz. Let us hope he is right.

The curse of deflation is that it increases the burden of debts. Incomes fall: debts stay the same. This way lies suffocation. It was bad enough in the early 1930s when US farmers faced a Sisyphean Task trying to meet mortgage payments on their land as crop prices kept sliding. They suffered mass foreclosure and fled West, as recounted in John Steinbeck's Grapes of Wrath.

We forget, however, that overall borrowing was modest in the 1930s. The great credit bubble of the last 20 years has pushed debt levels in Britain, the US and other Western societies to unprecedented highs. UK household debt reached a record 165pc of personal income last year. This is almost 50pc higher than the burden at the onset of the recession in the early 1990s. Our sensitivity to debt deflation is therefore greater.

"It is going to be absolute murder in Britain if inflation turns negative," said Professor Peter Spencer from York University. "The big difference with past episodes is that we are now much more heavily indebted. Few people owned their own houses in 1930s. Debts were miniscule."

Deflation has other insidious traits. It causes shoppers to hold back. They wait for lower prices. Once this psychology gains a grip, it can gradually set off a self-feeding spiral that is hard to stop.

It also redistributes wealth – the wrong way. Savings appreciate, which is nice for the "rentiers" with capital. The effect is a large transfer of income from working people with mortgages to bondholders. (These may be pension funds, of course).
The modern warning to us all is the "Lost Decade" in Japan, a loose term for the on-again, off-again slump that ultimately led to zero interest rates and – when that failed – to the printing of money. After 18 years, the Nikkei stock index is now trading at 8,700 – down from a peak of nearly 40,000. House prices have fallen by half. Yet after all the stimulus, the country is once again tipping back into deflation.
Governor King said Britain was likely to avoid this fate. "We've taken action much earlier than was the case in Japan," he said.

Not everybody agrees, even after the shock and awe cut of 1.5 percentage points by the MPC. Albert Edwards, global strategist at Société Générale, has long warned that central banks in the Anglo-Saxon countries have stored up trouble by stoking credit booms, and may find it harder than they think to engineer a soft-landing.

"This could easily go the way of Japan. It is true that Bank of England has moved faster, but Japan was a local bubble. This time it is the 'great unwind' on a global scale with leverage spaghetti everywhere," he said.

"The monetary authorities don't have foggiest idea themselves whether this is going to work. They're crossing their fingers and hoping," he said.

Nor is it clear whether rate cuts are gaining much traction. The average rate of tracker mortgages has risen 72 basis points since last month, and credit card rates have been rocketing. The Bank's transmission mechanism is not working properly. This a variant of the 1930s struggle when the central banks found themselves "pushing on a string", in the words of John Maynard Keynes. He called for public works to lift the economy out of its liquidity trap. This is more or less what the US, Japan, China, and parts of Europe are now doing – with more in store after the G20 this weekend. Britain has pitifully limited scope on this front. We had a budget deficit of 3pc of GDP at the top of the cycle – when we should have been in surplus – and we are heading for over 8pc. This is already nearing the danger level. If the Government now lets rip on fiscal policy, we could face a 'gilts strike' as foreign investors retreat from UK debt.
The Bank of England has not run out of ammo yet. It can cut rates to zero if necessary and then escalate to direct infusions of money by purchasing bonds – or indeed by buying a vast range of securities, assets and even houses if necessary. Ultimately it can print money to cover the budget deficit.

As the late Milton Friedman put it, governments can drop bundles of banknotes from helicopters. If they really want to defeat to deflation, they can. Mr Friedman may have overlooked the fact that gunmen can shoot down the helicopter – the Bank of France in October 1931, when it ditched the dollar; perhaps Asian bond investors today? – but that is to quibble.

Professor Spencer says the Bank of England has learned the hard lessons. Without the constraints of the ERM, Gold Standard, or any other fixed exchange system, it retains great freedom of action.

"They are very aware of the deflation risk. They are cutting rates very fast, and if necessary they too will turn to helicopters. But in the end they will keep the wolf from the door," he said.

Can Falling Property Values Be Stopped?

The US and the world got a surprise over the Iranian nuclear program. According to the POTUS, he just received the NIE report a week ago. As difficult at that is to believe, just suppose that it is true. (It can't be but let's pretend.) That would mean that the very person in charge of US security, with war making capability, was in the dark over a threat and non-threat, when underlings had superior knowledge of the real situation. Can that level of material ignorance exist in other areas of government?

For some human reason, due to breeding, or DNA, experience or history, we as a species, put trust in our leaders. Some cultures are more prone to do so than others. Americans seem to be split on the propensity to believe. Presently more people have confidence in the ability of the Federal Reserve to protect the economy and money system than do not. That is a very good thing, because if that gets shaken, we have a real problem.

It is also becoming very obvious to many and hopefully to the Fed that the world is not facing an inflation problem. The problem is deflation.

The ultimate store of human wealth is in the real property that they own and live in. When that value falls, the ability to maintain other values weakens. It can spread quickly and violently. The consequences to world stability and chaos are not calculable.

Let's hope that this is an isolated case. (It isn't):

Florida Fund's Debt Has `Indeterminate Value,' BlackRock Says

By Darrell Preston and David Evans

Dec. 5 (Bloomberg) -- Much of the debt held by a $14 billion Florida investment fund for schools and local governments is worth less than face value and the rest is so troubled that its value can't be determined, according to an official at the Wall Street firm hired to turn around the fund.

``I don't think there are very many securities in this market we can liquidate at par,'' or 100 cents on the dollar, Chris Stavrakos, co-managing head of cash management for New York-based BlackRock Inc., said in an interview yesterday.

The more than $2 billion of the worst securities that state officials agreed yesterday to spin off into a second investment pool have an ``indeterminate value,'' he said. Of that, about $867 million is in default, or 6 percent.

Coleman Stipanovich, the executive director of the agency that oversees the fund, resigned yesterday and BlackRock, which invests more than $1.3 trillion in fixed-income and other assets, was named interim manager.

Stipanovich's resignation came after more than $13 billion was pulled from the fund as the extent of the assets in trouble came to light. Investors have been cut off from their funds since Nov. 29, when the State Board of Administration froze withdrawals amid a run on the pool, which was the largest of its kind in the U.S. at $27 billion.

Local governments, school districts and other participants in the pool, a type of money-market fund, will have to wait to find out when and how much they will recover. The investors will temporarily lose access to 14 percent of their cash under BlackRock's plan.

Access to Money

The plan allows for local governments to take out the greater of 15 percent of their holdings or $2 million without penalty. BlackRock executives estimated the fund, called the Local Government Investment Pool, may reopen as soon as tomorrow.

``The plan BlackRock submitted is very responsible,'' Governor Charlie Crist, a Republican, said in an interview after a Cabinet meeting in Tallahassee. ``For those who need money, we can accommodate them.''

Crist, state Chief Financial Officer Alex Sink and Attorney General Bill McCollum are the state board's trustees. BlackRock, hired by the state Nov. 30 to review the fund, had at least six bankers going through its holdings last weekend to develop the plan presented yesterday, Stavrakos said.

The fund owns $175 million of debt issued by Axon Financial, a structured investment vehicle that has defaulted. It also holds $180 million of debt sold by Ottimo Funding, an SIV that had its credit rating slashed to D from C by Standard & Poor's on Nov. 9.

`Nobody Will Buy'

``Nobody will buy that paper,'' Stavrakos said. The fund owns $168 million of short-term debt issued by KKR Atlantic Funding Trust and $356 million from KKR Pacific Funding Trust, securities whose values aren't ``transparent,'' he said.

KKR Atlantic's ratings were cut to D from B by Fitch Ratings on Oct. 8, while KKR Pacific was lowered to D from B on Oct. 2. Fitch said the reduction to default on the debt reflected non-payment under the original terms. The debt was restructured to extend the maturities to February and March, and interest payments are continuing.

State officials have said that under existing law they are unable to guarantee repayment of the funds local governments and schools invested in the pool, according to Bill Montford, chief executive officer of the Florida Association of District School Superintendents. Crist and other state officials didn't discuss the issue yesterday even after investors asked for a guarantee in a document presented at the meeting.

``It isn't going to fly without a guarantee,'' said Wayne Blanton, executive director of the Florida School Boards Association.

To contact the reporters on this story: Darrell Preston in Tallahassee at dpreston@bloomberg.net ; David Evans in Los Angeles at davidevans@bloomberg.net .